Fair Value of Financial Instruments

6 Months Ended

Jun. 30, 2023

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. For mortgage loans HFS, fair value is determined using current secondary market prices for loans with similar characteristics, that is, using Level 2 inputs. Rebooked guaranteed GNMA optional repurchase loans included in loans held for sale do not meet the requirements under FASB ASC Topic 825 to be accounted for under the fair value option and are carried at their principal balance. For commercial loans held for sale, fair value is determined using an income approach with various assumptions including expected cash flows, market discount rates, credit metrics and collateral value when appropriate. As such, these are considered Level 3.

Derivatives						The fair value of the Company's interest rate swap agreements to facilitate customer transactions 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. The fair value of interest rate lock commitments associated with the mortgage pipeline 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. The fair values of the Company's designated cash flow and fair value hedges are determined by calculating the difference between the discounted fixed rate cash flows and the discounted variable rate cash flows. The fair values of both the Company's hedges, including designated cash flow hedges and designated fair value hedges are based on pricing models that utilize observable market inputs. These financial instruments are classified as Level 2.

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 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, MSRs are considered Level 3.

Collateral dependent loans						Collateral dependent loans are 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
June 30, 2023	Carrying amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and cash equivalents	$	1,160,354	$	1,160,354	$	—	$	—	$	1,160,354
Investment securities	1,422,391		—		1,422,391		—		1,422,391
Net loans held for investment	9,185,360		—		—		8,894,367		8,894,367
Loans held for sale, at fair value	78,906		—		69,639		9,267		78,906
Interest receivable	44,973		234		6,682		38,057		44,973
Mortgage servicing rights	166,433		—		—		166,433		166,433
Derivatives	47,132		—		47,132		—		47,132
Financial liabilities:
Deposits:
Without stated maturities	$	9,251,599	$	9,251,599	$	—	$	—	$	9,251,599
With stated maturities	1,620,656		—		1,611,764		—		1,611,764
Securities sold under agreements to repurchase and federal funds purchased	116,220		116,220		—		—		116,220
Federal Home Loan Bank advances	125,000		—		125,000		—		125,000
Subordinated debt, net	127,535		—		—		117,939		117,939

Interest payable	16,897		3,503		11,894		1,500		16,897
Derivatives	54,544		—		54,544		—		54,544


	Fair Value
December 31, 2022	Carrying amount		Level 1		Level 2		Level 3		Total
Financial assets:
Cash and cash equivalents	$	1,027,052	$	1,027,052	$	—	$	—	$	1,027,052
Investment securities	1,474,176		—		1,474,176		—		1,474,176
Net loans held for investment	9,164,020		—		—		9,048,943		9,048,943
Loans held for sale, at fair value	113,240		—		82,750		30,490		113,240
Interest receivable	45,684		126		6,961		38,597		45,684
Mortgage servicing rights	168,365		—		—		168,365		168,365
Derivatives	48,769		—		48,769		—		48,769
Financial liabilities:
Deposits:
Without stated maturities	$	9,433,860	$	9,433,860	$	—	$	—	$	9,433,860
With stated maturities	1,421,974		—		1,422,544		—		1,422,544
Securities sold under agreements to repurchase and federal funds purchased	86,945		86,945		—		—		86,945
Federal Home Loan Bank advances	175,000		—		175,000		—		175,000
Subordinated debt, net	126,101		—		—		118,817		118,817

Interest payable	8,648		2,571		4,559		1,518		8,648
Derivatives	63,229		—		63,229		—		63,229

The balances and levels of the assets measured at fair value on a recurring basis as of June 30, 2023 are presented in the following table:


At June 30, 2023	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	$	—	$	40,529	$	—	$	40,529
Mortgage-backed securities - residential	—		979,400		—		979,400
Mortgage-backed securities - commercial	—		17,254		—		17,254
Municipal securities	—		267,097		—		267,097
U.S. Treasury securities	—		108,221		—		108,221
Corporate securities	—		6,859		—		6,859
Equity securities, at fair value	—		3,031		—		3,031
Total securities	$	—	$	1,422,391	$	—	$	1,422,391
Loans held for sale, at fair value	$	—	$	69,639	$	9,267	$	78,906
Mortgage servicing rights	—		—		166,433		166,433
Derivatives	—		47,132		—		47,132
Financial Liabilities:
Derivatives	—		54,544		—		54,544

The balances and levels of the assets measured at fair value on a non-recurring basis as of June 30, 2023 are presented in the following table:


At June 30, 2023	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	$	—	$	—	$	582	$	582
Collateral dependent net loans held for investment:

Construction	—		—		540		540
Residential real estate:
1-4 family mortgage	$	—	$	—	$	389	$	389






Total collateral dependent loans	$	—	$	—	$	929	$	929

The balances and levels of the assets measured at fair value on a recurring basis as of December 31, 2022 are presented in the following table:


At December 31, 2022	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	$	—	$	40,062	$	—	$	40,062
Mortgage-backed securities - residential	—		1,034,193		—		1,034,193
Mortgage-backed securities - commercial	—		17,644		—		17,644
Municipal securities	—		264,420		—		264,420
U.S. Treasury securities	—		107,680		—		107,680
Corporate securities	—		7,187		—		7,187
Equity securities, at fair value	—		2,990		—		2,990
Total securities	$	—	$	1,474,176	$	—	$	1,474,176
Loans held for sale, at fair value	$	—	$	82,750	$	30,490	$	113,240
Mortgage servicing rights	—		—		168,365		168,365
Derivatives	—		48,769		—		48,769
Financial Liabilities:
Derivatives	—		63,229		—		63,229

The balances and levels of the assets measured at fair value on a non-recurring basis as of December 31, 2022 are presented in the following table:


At December 31, 2022	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	$	—	$	—	$	2,497	$	2,497
Collateral dependent net loans held for investment:


Residential real estate:
1-4 family mortgage	$	—	$	—	$	366	$	366

Commercial real estate:

Non-owner occupied	—		—		2,494		2,494

Total collateral dependent loans	$	—	$	—	$	2,860	$	2,860

The following tables present information as of June 30, 2023 and December 31, 2022 about significant unobservable inputs (Level 3) used in the valuation of assets measured at fair value on a nonrecurring basis:

June 30, 2023

Financial instrument

Fair Value

Valuation technique

Significant
unobservable inputs

Range of
inputs

Collateral dependent net loans
held for investment

929

Valuation of collateral

Discount for comparable sales

10%-35%

Other real estate owned

582

Appraised value of property less costs to sell

Discount for costs to sell

0%-15%

December 31, 2022

Financial instrument

Fair Value

Valuation technique

Significant
unobservable inputs

Range of
inputs

Collateral dependent loans
held for investment

2,860

Valuation of collateral

Discount for comparable sales

10%-35%

Other real estate owned

2,497

Appraised value of property less costs to sell

Discount for costs to sell

0%-15%

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 estimated selling and closing costs related to liquidation 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 borrower and borrower's business. As of June 30, 2023 and December 31, 2022, total amortized cost of collateral dependent loans measured on a non-recurring basis amounted to $1,158 and $3,054, respectively.

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 appraisers 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. Collateral dependent loans that are dependent on recovery through sale of equipment, such as farm equipment, automobiles and aircrafts are generally valued based on public source pricing or subscription services while more complex assets are valued through leveraging brokers who have expertise in the collateral involved.

Fair value option

The following table summarizes the Company's loans held for sale as of the dates presented:


	June 30,		December 31,
	2023		2022
Loans held for sale under a fair value option:
Commercial loans held for sale	$	9,267	$	30,490

Mortgage loans held for sale	69,639		82,750
Total loans held for sale, at fair value	78,906		113,240
Loans held for sale not accounted for under a fair value option:
Mortgage loans held for sale - guaranteed GNMA repurchase option	20,225		26,211
Total loans held for sale	$	99,131	$	139,451

Mortgage loans held for sale

The Company measures mortgage loans originated for sale at fair value under the fair value option as permitted under ASC 825, "Financial Instruments" ("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 losses of $129 and $179 resulting from fair value changes of mortgage loans were recorded in income during the three and six months ended June 30, 2023, respectively, compared to net gains (losses) of $4,671 and $(12,203) during the three and six months ended June 30, 2022, 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 net change in fair value of these loans held for sale and derivatives resulted in net gains of $874 and $453 for the three and six months ended June 30, 2023, respectively, compared to net losses of $5,354 and $12,902 during the three and six months ended June 30, 2022, respectively. 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.

The Company’s valuation of mortgage loans held for sale incorporates an assumption for credit risk; however, given the short-term period that the Company holds these mortgage loans held for sale, valuation adjustments attributable to instrument-specific credit risk is nominal.

Rebooked GNMA optional repurchase loans do not meet the requirements under FASB ASC Topic 825 to be accounted for under the fair value option. As such, these loans are excluded from the below disclosures.

Commercial loans held for sale

The Company has a portfolio of shared institutional healthcare loans that were acquired during a 2020 business combination. These commercial loans are also being measured under the fair value option. As such, these loans are excluded from the allowance for credit losses. The following tables set forth the changes in fair value associated with this portfolio for the three and six months ended June 30, 2023 and 2022:


	Three Months Ended June 30, 2023
	Principal Balance		Fair Value Discount		Fair Value
Carrying value at beginning of period	$	12,467	$	(2,957)	$	9,510
Change in fair value:
Pay-downs and pay-offs	(235)		—		(235)

Changes in valuation included in other noninterest income	—		(8)		(8)
Carrying value at end of period	$	12,232	$	(2,965)	$	9,267

	Six Months Ended June 30, 2023
	Principal Balance		Fair Value Discount		Fair Value
Carrying value at beginning of period	$	34,357	$	(3,867)	$	30,490
Change in fair value:
Pay-downs and pay-offs	(22,125)		—		(22,125)

Changes in valuation included in other noninterest income	—		902		902
Carrying value at end of period	$	12,232	$	(2,965)	$	9,267


	Three Months Ended June 30, 2022
	Principal balance		Fair Value discount		Fair Value
Carrying value at beginning of period	$	85,816	$	(7,637)	$	78,179
Change in fair value:
Pay-downs and pay-offs	(38,354)		—		(38,354)

Changes in valuation included in other noninterest income	—		(2,010)		(2,010)
Carrying value at end of period	$	47,462	$	(9,647)	$	37,815

	Six Months Ended June 30, 2022
	Principal balance		Fair Value discount		Fair Value
Carrying value at beginning of period	$	86,762	$	(7,463)	$	79,299

Change in fair value:
Pay-downs and pay-offs	(39,300)		—		(39,300)

Changes in valuation included in other noninterest income	—		(2,184)		(2,184)
Carrying value at end of period	$	47,462	$	(9,647)	$	37,815

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 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 and nonaccrual loans measured at fair value as of June 30, 2023 and December 31, 2022:


June 30, 2023	Aggregate fair value		Aggregate Unpaid Principal Balance		Difference
Mortgage loans held for sale measured at fair value	$	69,639	$	68,589	$	1,050


Nonaccrual commercial loans held for sale	9,267		12,232		(2,965)

December 31, 2022	Aggregate fair value		Aggregate Unpaid Principal Balance		Difference
Mortgage loans held for sale measured at fair value	$	82,750	$	81,520	$	1,230
Commercial loans held for sale measured at fair value	21,201		22,126		(925)

Nonaccrual commercial loans held for sale	9,289		12,231		(2,942)

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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