Fair value of financial instruments:

FASB ASC 820-10 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820-10 also establishes a framework for measuring the fair value of assets and liabilities according to a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The hierarchy maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that are derived from assumptions based on management’s estimate of assumptions that market participants would use in pricing the asset or liability based on the best information available under the circumstances.

The hierarchy is broken down into the following three levels, based on the reliability of inputs:

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs for assets or liabilities that are derived from assumptions based on management’s estimate of assumptions that market participants would use in pricing the assets or liabilities.

The Company records the fair values of financial assets and liabilities on a recurring and non-recurring basis using the following methods and assumptions:

Investment securities-Investment securities are recorded at fair value on a recurring basis. Fair values for securities are based on quoted market prices, where available. If quoted prices are not available, fair values are based on quoted market prices of similar instruments or are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the pricing relationship or correlation among other benchmark quoted securities. Investment securities valued using quoted market prices of similar instruments or that are valued using matrix pricing are classified as Level 2. When significant inputs to the valuation are unobservable, the available-for-sale securities are classified within Level 3 of the fair value hierarchy.

Where no active market exists for a security or other benchmark securities, fair value is estimated by the Company with reference to discount margins for other high-risk securities.

Loans held for sale-Loans held for sale are carried at fair value. Fair value is determined using current secondary market prices for loans with similar characteristics, that is, using Level 2 inputs.

Derivatives-The fair value of the interest rate swaps are based upon fair values provided from entities that engage in interest rate swap activity and is based upon projected future cash flows and interest rates. Fair value of commitments is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments, the difference between current levels of interest rates and the committed rates is also considered. These financial instruments are classified as Level 2.

Other real estate owned (“OREO”) - OREO is comprised of commercial and residential real estate obtained in partial or total satisfaction of loan obligations and excess land and facilities held for sale. OREO acquired in settlement of indebtedness is recorded at the lower of the carrying amount of the loan or the fair value of the real estate less costs to sell. Fair value is determined on a nonrecurring basis based on appraisals by qualified licensed appraisers and is adjusted for management’s estimates of costs to sell and holding period discounts. The valuations are classified as Level 3.

Mortgage servicing rights ("MSRs") - MSRs are carried at fair value. Fair value is determined using an income approach with various assumptions including expected cash flows, market discount rates, prepayment speeds, servicing costs, and other factors. As such, mortgage servicing rights are considered Level 3.

Collateral dependent loans (Impaired loans prior to the adoption of ASC 326) - loans for which, based on current information and events, the Company has determined foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the loan to be provided substantially through the operation or sale of the collateral and it is probable that the creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collateral dependent loans are classified as Level 3.

The following table contains the estimated fair values and the related carrying values of the Company's financial instruments. Items which are not financial instruments are not included.



	Fair Value
March 31, 2020	Carrying amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and cash equivalents	$	425,094	$	425,094	$	—	$	—	$	425,094
Investment securities	767,575		—		767,575		—		767,575
Loans, net	4,478,897		—		—		4,480,393		4,480,393
Loans held for sale	325,304		—		325,304		—		325,304
Interest receivable	19,644		—		3,625		16,019		19,644
Mortgage servicing rights	62,581		—		—		62,581		62,581
Derivatives	66,281		—		66,281		—		66,281
Financial liabilities:
Deposits:
Without stated maturities	$	4,142,635	$	4,142,635	$	—	$	—	$	4,142,635
With stated maturities	1,234,297		—		1,243,610		—		1,243,610
Securities sold under agreement to repurchase and federal funds sold	31,892		31,892		—		—		31,892
Federal Home Loan Bank advances	250,000		—		259,037		—		259,037
Subordinated debt	30,930		—		28,921		—		28,921
Other borrowings	15,000		—		15,000		—		15,000
Interest payable	8,893		427		8,466		—		8,893
Derivatives	66,696		—		66,696		—		66,696



	Fair Value
December 31, 2019	Carrying amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and cash equivalents	$	232,681	$	232,681	$	—	$	—	$	232,681
Investment securities	691,676		—		691,676		—		691,676
Loans, net	4,378,503		—		—		4,363,903		4,363,903
Loans held for sale	262,518		—		262,518		—		262,518
Interest receivable	17,083		—		3,282		13,801		17,083
Mortgage servicing rights	75,521		—		—		75,521		75,521
Derivatives	21,981		—		21,981		—		21,981
Financial liabilities:
Deposits:
Without stated maturities	$	3,743,085	$	3,743,085	$	—	$	—	$	3,743,085
With stated maturities	1,191,853		—		1,200,145		—		1,200,145
Securities sold under agreement to repurchase and federal funds sold	23,745		23,745		—		—		23,745
Federal Home Loan Bank advances	250,000		—		250,213		—		250,213
Subordinated debt	30,930		—		29,706		—		29,706
Interest payable	6,465		376		6,089		—		6,465
Derivatives	17,933		—		17,933		—		17,933

The balances and levels of the assets measured at fair value on a recurring basis at March 31, 2020 are presented in the following table:



March 31, 2020	Quoted prices in active markets for identical assets (liabilities) (level 1)		Significant other observable inputs (level 2)		Significant unobservable inputs (level 3)		Total
Recurring valuations:
Financial assets:
Available-for-sale securities:
U.S. government agency securities	$	—	$	3,037	$	—	$	3,037
Mortgage-backed securities	—		499,658		—		499,658
Municipals, tax-exempt	—		235,677		—		235,677
Treasury securities	—		24,860		—		24,860
Corporate securities	—		985		—		985
Equity securities	—		3,358		—		3,358
Total	$	—	$	767,575	$	—	$	767,575
Loans held for sale	$	—	$	325,304	$	—	$	325,304
Mortgage servicing rights	—		—		62,581		62,581
Derivatives	—		66,281		—		66,281
Financial Liabilities:
Derivatives	—		66,696		—		66,696

The balances and levels of the assets measured at fair value on a non-recurring basis at March 31, 2020 are presented in the following table:



At March 31, 2020	Quoted prices in active markets for identical assets (liabilities) (level 1)		Significant other observable inputs (level 2)		Significant unobservable inputs (level 3)		Total
Non-recurring valuations:
Financial assets:
Other real estate owned	$	—	$	—	$	1,058	$	1,058
Collateral dependent loans:
Commercial and industrial	$	—	$	—	$	1,566	$	1,566
Residential real estate:
1-4 family mortgage	—		—		—		—
Residential line of credit	—		—		—		311
Commercial real estate:
Owner occupied	—		—		—		—
Non-owner occupied	—		—		5,704		5,704
Consumer and other	—		—		—		—
Total collateral dependent loans	$	—	$	—	$	7,270	$	7,270

The balances and levels of the assets measured at fair value on a recurring basis at December 31, 2019 are presented in the following table:



At December 31, 2019	Quoted prices in active markets for identical assets (liabilities) (level 1)		Significant other observable inputs (level 2)		Significant unobservable inputs (level 3)		Total
Recurring valuations:
Financial assets:
Available-for-sale securities:
Mortgage-backed securities	$	—	$	490,676	$	—	$	490,676
Municipals, tax-exempt	—		189,235		—		189,235
Treasury securities	—		7,448		—		7,448
Corporate securities	—		1,022		—		1,022
Equity securities	—		3,295		—		3,295
Total	$	—	$	691,676	$	—	$	691,676
Loans held for sale	$	—	$	262,518	$	—	$	262,518
Mortgage servicing rights	—		—		75,521		75,521
Derivatives	—		21,981		—		21,981
Financial Liabilities:
Derivatives	—		17,933		—		17,933

The balances and levels of the assets measured at fair value on a non-recurring basis at December 31, 2019 are presented in the following table:



At December 31, 2019	Quoted prices in active markets for identical assets (liabilities) (level 1)		Significant other observable inputs (level 2)		Significant unobservable inputs (level 3)		Total
Non-recurring valuations:
Financial assets:
Other real estate owned	$	—	$	—	$	9,774	$	9,774
Impaired Loans⁽¹⁾:
Commercial and industrial	$	—	$	—	$	6,481	$	6,481
Residential real estate:
1-4 family mortgage	—		—		378		378
Residential line of credit	—		—		321		321
Commercial real estate:
Owner occupied	—		—		951		951
Non-owner occupied	—		—		2,560		2,560
Total	$	—	$	—	$	10,691	$	10,691

(1) Includes both impaired non-purchased loans and collateral-dependent PCI loans.

There were no transfers between Level 1, 2 or 3 during the periods presented.

The following table presents information as of March 31, 2020 about significant unobservable inputs (Level 3) used in the valuation of assets measured at fair value on a nonrecurring basis:



Financial instrument	Fair Value		Valuation technique	Significant Unobservable inputs	Range of inputs
Collateral dependent loans	$	7,270	Valuation of collateral	Discount for comparable sales	0%-30%
Other real estate owned	$	1,058	Appraised value of property less costs to sell	Discount for costs to sell	0%-15%

The following table presents information as of December 31, 2019 about significant unobservable inputs (Level 3) used in the valuation of assets measured at fair value on a nonrecurring basis:



Financial instrument	Fair Value		Valuation technique	Significant Unobservable inputs	Range of inputs
Impaired loans⁽¹⁾	$	10,691	Valuation of collateral	Discount for comparable sales	0%-30%
Other real estate owned	$	9,774	Appraised value of property less costs to sell	Discount for costs to sell	0%-15%

(1) Includes both impaired non-purchased loans and collateral-dependent PCI loans.

For collateral dependent loans, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the loan as of the measurement date. Fair value of the loan's collateral is determined by third-party appraisals, which are then adjusted for the estimated selling and closing costs related to liquidation of of the collateral. Collateral dependent loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on changes in market conditions from the time of valuation and management's knowledge of the client and client's business. Other real estate owned acquired in settlement of indebtedness is recorded at fair value of the real estate less estimated costs to sell. Subsequently, it may be necessary to record nonrecurring fair value adjustments for declines in fair value. Any write-downs based on the asset's fair value at the date of foreclosure are charged to the allowance for credit losses. Appraisals for both collateral dependent loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the lending administrative department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry wide statistics.

Fair value option

The Company measures all loans originated for sale at fair value under the fair value option as permitted under ASC 825. Electing to measure these assets at fair value reduces certain timing differences and more accurately matches the changes in fair value of the loans with changes in the fair value of derivative instruments used to economically hedge them.

Net gains of $5,818 and losses of $1,207 resulting from fair value changes of mortgage loans were recorded in income during the three months ended March 31, 2020 and 2019, respectively. The amount does not reflect changes in fair values of related derivative instruments used to hedge exposure to market-related risks associated with these mortgage loans. The change in fair value of both loans held for sale and the related derivative instruments are recorded in Mortgage Banking Income in the Consolidated Statements of Income. Election of the fair value option allows the Company to reduce the accounting volatility that would otherwise result from the asymmetry created by accounting for the financial instruments at the lower of cost or fair value and the derivatives at fair value.

As of March 31, 2020 and December 31, 2019, there was $54,569 and $51,705, respectively, of GNMA loans previously sold that the Company did not record on its Consolidated balance sheets as the Company determined there not to be a more-than-trivial benefit based on an analysis of interest rates and an assessment of potential reputational risk associated with these loans.

The Company’s valuation of loans held for sale incorporates an assumption for credit risk; however, given the short-term period that the Company holds these loans, valuation adjustments attributable to instrument-specific credit risk is nominal. Interest income on loans held for sale measured at fair value is accrued as it is earned based on contractual rates and is reflected in loan interest income in the Consolidated Statements of Income.

The following table summarizes the differences between the fair value and the principal balance for loans held for sale measured at fair value as of March 31, 2020 and December 31, 2019:



March 31, 2020	Aggregate fair value		Aggregate Unpaid Principal Balance		Difference
Mortgage loans held for sale measured at fair value	$	325,304	$	311,836	$	13,468
Past due loans of 90 days or more	—		—		—
Nonaccrual loans	—		—		—

December 31, 2019
Mortgage loans held for sale measured at fair value	$	262,518	$	254,868	$	7,650
Past due loans of 90 days or more	—		—		—
Nonaccrual loans	—		—		—