Fair Value Measurement

As defined in ASC 820, Fair Value Measurements and Disclosures, fair value is defined as the price to sell an asset or transfer a liability in an orderly transaction between market participants in the principal market or most advantageous market for the asset or liability. Fair value is based on quoted market prices, when available, for identical or similar assets or liabilities. In the absence of quoted market prices, Management determines the fair value of the Corporation’s assets and liabilities using valuation models or third-party pricing services. Both of these approaches rely on market-based parameters when available, such as interest rate yield curves, option volatilities and credit spreads, or unobservable inputs. Unobservable inputs may be based on Management’s judgment, assumptions and estimates related to credit quality, liquidity, interest rates and other relevant inputs.

U.S. GAAP establishes a three-level valuation hierarchy for determining fair value that is based on the transparency of the inputs used in the valuation process. The inputs used in determining fair value in each of the three levels of the hierarchy, highest ranking to lowest, are as follow:


•	Level 1 — Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.


•	Level 2 — Significant other observable inputs other than Level 1 prices such 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 that reflect a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The level in the fair value hierarchy ascribed to a fair value measurement in its entirety is based on the lowest level input that is significant to the overall fair value measurement.

Valuation adjustments, such as those pertaining to counterparty and the Corporation's own credit quality and liquidity, may be necessary to ensure that assets and liabilities are recorded at fair value. Credit valuation adjustments are made when market pricing does not accurately reflect the counterparty's credit quality. As determined by Management, liquidity valuation adjustments may be made to the fair value of certain assets to reflect the uncertainty in the pricing and trading of the instruments when Management is unable to observe recent market transactions for identical or similar instruments. Liquidity valuation adjustments are based on the following factors:


•	the amount of time since the last relevant valuation;


•	whether there is an actual trade or relevant external quote available at the measurement date; and


•	volatility associated with the primary pricing components.

Management ensures that fair value measurements are accurate and appropriate by relying upon various controls, including:


•	an independent review and approval of valuation models;


•	recurring detailed reviews of profit and loss; and


•	a validation of valuation model components against benchmark data and similar products, where possible.

Management reviews any changes to its valuation methodologies to ensure they are appropriate and justified, and refines valuation methodologies as more market-based data becomes available. Transfers between levels of the fair value hierarchy are recognized at the end of the reporting period.

Additional information regarding the Corporation's accounting policies for determining fair value is provided in Note 1 (Summary of Significant Accounting Policies) under the heading “Fair Value Measurements.”

Financial Instruments Measured at Fair Value

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis at December 31, 2011 and 2010:



December 31, 2011
	Level 1		Level 2		Level 3		Total
Available-for-sale securities	$	3,299	$	3,262,715	$	87,539	$	3,353,553
Residential loans held for sale	—		30,077		—		30,077
Derivative assets	—		62,056		—		62,056
Total assets at fair value on a recurring basis	$	3,299	$	3,354,848	$	87,539	$	3,445,686
Derivative liabilities	$	—	$	86,106	$	—	$	86,106
True up liability	—		—		11,551		11,551
Total liabilities at fair value on a recurring basis	$	—	$	86,106	$	11,551	$	97,657

Note: There were no significant transfers between Levels 1 and 2 of the hierarchy during the year ended December 31, 2011.



December 31, 2010
	Level 1		Level 2		Level 3		Total
Available-for-sale securities	$	3,922	$	2,922,774	$	60,344	$	2,987,040
Residential loans held for sale	—		41,340		—		41,340
Derivative assets	—		47,764		—		47,764
Total assets at fair value on a recurring basis	$	3,922	$	3,011,878	$	60,344	$	3,076,144
Derivative liabilities	$	—	$	72,824	$	—	$	72,824
True up liability	—		—		12,061		12,061
Total liabilities at fair value on a recurring basis	$	—	$	72,824	$	12,061	$	84,885

Note: There were no significant transfers between Levels 1 and 2 of the hierarchy during the year ended December 31, 2010.

Available-for-sale securities. When quoted prices are available in an active market, securities are valued using the quoted price and are classified as Level 1. The quoted prices are not adjusted. Level 1 instruments include money market mutual funds.

Securities are classified as Level 2 if quoted prices for identical securities are not available, and fair value is determined using pricing models by a third-party pricing service. For the majority of available-for sale securities, the Corporation obtains fair value measurements from an independent third party pricing service. These instruments include municipal bonds; bonds backed by the U.S. government; corporate bonds; mortgage-backed securities; securities issued by the U.S. Treasury; and certain agency and corporate collateralized mortgage obligations. The independent pricing service uses industry-standard models to price U.S. Government agencies and MBSs that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating. For collateralized mortgage securities, depending on the characteristics of a given tranche, a volatility driven multidimensional static model or Option-Adjusted Spread model is generally used. Substantially all assumptions used by the independent pricing service for securities classified as Level 2 are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace.

Securities are classified as Level 3 when there is limited activity in the market for a particular instrument and fair value is determined by obtaining broker quotes. Level 3 instruments include mortgage-backed securities issued and guaranteed by the National Credit Union Administration and single issuer trust preferred securities. These instruments are priced by the independent pricing service through a broker quote when sufficient information, such as cash flows or other security structure or market information, is not available to produce an evaluation. Broker-quoted securities are adjusted based solely on the receipt of updated quotes from market makers or broker-dealers recognized as market participants. A list of such issues is compiled by the independent pricing service daily. For broker-quoted issues, the independent pricing service applies a zero spread relationship to the bid-side valuation, resulting in the same values for the mean and ask.

The fair value detail by level in the fair value hierarchy as of December 31, 2011 is shown in the table below.



	Level 2			Level 3
	# Issues	Fair Value		# Issues	Fair Value
U.S.government agency debentures	7	$	123,069	—	$	—
U.S States and political subdivisions	523	357,731		—	—
Residential mortgage-backed securities:
U.S. government agencies	191	1,460,343		—	—
Residential collateralized mortgage-backed securities:
U.S. government agencies	105	1,137,834		1	—
Non-agency	1	2		4	43,305
Commercial collateralized mortgage obligations:
U.S. government agencies	12	129,127		—	—
Corporate debt securities	14	54,609		8	44,234
	853	$	3,262,715	13	$	87,539

On a monthly basis, Management validates the pricing methodologies utilized by our independent pricing service to ensure the fair value determination is consistent with the applicable accounting guidance and that the investments are properly classified in the fair value hierarchy. Management substantiates the fair values determined for a sample of securities held in portfolio by reviewing the key assumptions used by the independent pricing service to value the securities and comparing the fair values to prices from other independent sources for the same and similar securities. Management analyzes variances and conducts additional research with the independent pricing service, if necessary, and takes appropriate action based on its findings.

Loans held for sale. These loans are regularly traded in active markets through programs offered by the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal National Mortgage Association (“FNMA”), and observable pricing information is available from market participants. The prices are adjusted as necessary to include any embedded servicing value in the loans and to take into consideration the specific characteristics of certain loans. These adjustments represent unobservable inputs to the valuation but are not considered significant to the fair value of the loans. Accordingly, residential real estate loans held for sale are classified as Level 2.

Derivatives. The Corporation’s derivatives include interest rate swaps and written loan commitments and forward sales contracts related to residential mortgage loan origination activity. Valuations for interest rate swaps are derived from third party models whose significant inputs are readily observable market parameters, primarily yield curves, with appropriate adjustments for liquidity and credit risk. These fair value measurements are classified as Level 2. The fair values of written loan commitments and forward sales contracts on the associated loans are based on quoted prices for similar loans in the secondary market, consistent with the valuation of residential mortgage loans held for sale. Expected net future cash flows related to loan servicing activities are included in the fair value measurement of written loan commitments. A written loan commitment does not bind the potential borrower to entering into the loan, nor does it guarantee that the Corporation will approve the potential borrower for the loan. Therefore, when determining fair value, the Corporation makes estimates of expected “fallout” (interest rate locked pipeline loans not expected to close), using models, which consider cumulative historical fallout rates and other factors. Fallout can occur for a variety of reasons including falling rate environments when a borrower will abandon a fixed rate loan commitment at one lender and enter into a new lower fixed rate loan commitment at another, when a borrower is not approved as an acceptable credit by the lender, or for a variety of other non-economic reasons. Fallout is not a significant input to the fair value of the written loan commitments in their entirety. These measurements are classified as Level 2.

Derivative assets are typically secured through securities with financial counterparties or cross collateralization with a borrowing customer. Derivative liabilities are typically secured through the Corporation pledging securities to financial counterparties or, in the case of a borrowing customer, by the right of setoff. The Corporation considers factors such as the likelihood of default by itself and its counterparties, right of setoff, and remaining maturities in determining the appropriate fair value adjustments. All derivative counterparties approved by the Corporation’s Asset and Liability Committee are regularly reviewed, and appropriate business action is taken to adjust the exposure to certain counterparties, as necessary. Counterparty exposure is evaluated by netting positions that are subject to master netting agreements, as well as considering the amount of marketable collateral securing the position. This approach used to estimate impacted exposures to counterparties is also used by the Corporation to estimate its own credit risk on derivative liability positions. To date, no material losses have been incurred due to a counterparty’s inability to pay any uncollateralized position. There was no significant change in value of derivative assets and liabilities attributed to credit risk for the year ended December 31, 2011.

True-up liability. In connection with the George Washington and Midwest acquisitions, the Bank has agreed to pay the FDIC should the estimated losses on the acquired loan portfolios as well as servicing fees earned on the acquired loan portfolios not meet the loss thresholds specified in the purchase agreements. The determination of the true-up liability is specified in the purchase agreements and is payable to the FDIC on April 14, 2020 for the George Washington acquisition and on July 15, 2020 for the Midwest acquisition. The value of the true-up liability is discounted to reflect the uncertainty in the timing and payment of the true-up liability by the Bank. As of December 31, 2011, the estimated fair value of the George Washington true-up liability was $4.3 million and the Midwest true-up liability was $7.2 million.

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the year ended December 31, 2011 are summarized as follows:



	Available-for-sale securities			True-up liability
Balance at December 31, 2009	$	42,447		$	—
Gains included in earnings	—			614
Unrealized gains (a)	17,897			—
Purchases	—			11,447
Sales	—			—
Settlements	—			—
Net transfers into (out of) Level 3	—			—
Balance at December 31, 2010	$	60,344		$	12,061
Losses included in earnings	—			(510		)
Unrealized losses (a)	(1,065		)	—
Purchases	83,876			—
Sales	(44,924		)	—
Settlements	(10,692		)	—
Net transfers into (out of) Level 3	—			—
Balance at December 31, 2011	$	87,539		$	11,551

(a) Reported in other comprehensive income (loss)

Certain financial assets and liabilities are measured at fair value on a nonrecurring basis. Generally, nonrecurring valuations are the result of applying accounting standards that require assets or liabilities to be assessed for impairment, or recorded at the lower-of-cost or fair value. The following table presents the balances of assets and liabilities measured at fair value on a nonrecurring basis at December 31, 2011:



	December 31, 2011								December 31, 2010
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Mortgage servicing rights	$	—	$	—	$	17,749	$	17,749	$	—	$	—	$	—	$	—
Impaired and nonaccrual loans	—		—		75,992		75,992		—		—		140,990		140,990
Other property (1)	—		—		18,933		18,933		—		—		22,974		22,974
Other real estate covered by loss share	—		—		62,737		62,737		—		—		59,132		59,132
Total assets at fair value on a nonrecurring basis	$	—	$	—	$	175,411	$	175,411	$	—	$	—	$	223,096	$	223,096

(1) Represents the fair value, and related change in the value, of foreclosed real estate and other collateral owned by the Corporation during the period

Mortgage Servicing Rights. The Corporation carries its mortgage servicing rights at lower of cost or fair value, and therefore, can be subject to fair value measurements on a nonrecurring basis. Since sales of mortgage servicing rights tend to occur in private transactions and the precise terms and conditions of the sales are typically not readily available, there is a limited market to refer to in determining the fair value of mortgage servicing rights. As such, like other participants in the mortgage banking business, the Corporation relies primarily on a discounted cash flow model, incorporating assumptions about loan prepayment rates, discount rates, servicing costs and other economic factors, to estimate the fair value of its mortgage servicing rights. Since the valuation model uses significant unobservable inputs, the Corporation classifies mortgage servicing rights as Level 3.

The Corporation utilizes a third party vendor to perform the modeling to estimate the fair value of its mortgage servicing rights. The Corporation reviews the estimated fair values and assumptions used by the third party in the model on a quarterly basis. The Corporation also compares the estimates of fair value and assumptions to recent market activity and against its own experience.

Impaired and nonaccrual loans. Fair value adjustments for these items typically occur when there is evidence of impairment. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. The Corporation measures fair value based on the value of the collateral securing the loans. Collateral may be in the form of real estate or personal property including equipment and inventory. The vast majority of the collateral is real estate. The value of the collateral is determined based on internal estimates as well as third party appraisals or price opinions. These measurements were classified as Level 3.

Other Property. Other property includes foreclosed assets and properties securing residential and commercial loans. Assets acquired through, or in lieu of, loan foreclosures are recorded initially at the lower of the loan balance or fair value, less estimated selling costs, upon the date of foreclosure. Fair value is based upon appraisals or third-party price opinions and, accordingly, considered a Level 3 classification. Subsequent to foreclosure, valuations are updated periodically, and the assets may be marked down further, reflecting a new carrying amount.

Disclosures about Fair Value of Financial Instruments

The carrying amount and fair value of the Corporation’s financial instruments are as follows:



		At December 31,
		2011				2010
		Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
	Cash and due from banks	$	377,319	$	377,319	$	523,113	$	523,113
	Investment securities	3,494,389		3,579,390		3,154,333		3,207,754
	Loan held for sale	30,077		30,077		41,340		41,340
	Net noncovered loans	7,641,245		7,373,801		7,087,398		6,716,214
	Net covered loans and loss share receivable	1,460,723		1,460,723		1,963,021		1,963,021
	Accrued interest receivable	42,274		42,274		41,830		41,830
	Mortgage servicing rights	17,640		17,749		21,317		21,579
	Derivative assets	62,056		62,056		47,764		47,764

Financial liabilities:
	Deposits	11,431,609		11,445,777		11,268,006		11,275,440
	Federal funds purchased and securities sold under agreements to repurchase	866,265		866,265		777,585		782,668
	Wholesale borrowings	203,462		211,623		326,007		329,465
	Accrued interest payable	3,915		3,915		6,560		6,560
	Derivative liabilities	86,106		86,106		72,824		72,824
	True up liability	11,551		11,551		12,061		12,061

The following methods and assumptions were used to estimate the fair values of each class of financial instrument presented:

Cash and due from banks – For these short-term instruments, the carrying amount is considered a reasonable estimate of fair value.

Investment securities – See Financial Instruments Measured at Fair Value above.

Loans held for sale – The majority of loans held for sale are residential mortgage loans which are recorded at fair value. All other loans held for sale are recorded at the lower of cost or market, less costs to sell. See Financial Instruments Measured at Fair Value above.

Net noncovered loans – The loan portfolio was segmented based on loan type and repricing characteristics. Carrying values are used to estimate fair values of variable rate loans. A discounted cash flow method was used to estimate the fair value of fixed-rate loans. Discounting was based on the contractual cash flows, and discount rates are based on the year-end yield curve plus a spread that reflects current pricing on loans with similar characteristics. If applicable, prepayment assumptions are factored into the fair value determination based on historical experience and current economic conditions.

Net covered loans and loss share receivable – Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques. The discount rates used for loans are based on current market rates for new originations of comparable loans and include adjustments for liquidity concerns. The discount rate does not include a factor for credit losses as that has been included in the estimated cash flows.

Loss share receivable – This loss sharing asset is measured separately from the related covered assets as it is not contractually embedded in the covered assets and is not transferable with the covered assets should the Bank choose to dispose of them. Fair value was estimated using projected cash flows related to the Loss Share Agreements based on the expected reimbursements for losses and the applicable loss sharing percentages. These cash flows were discounted to reflect the uncertainty of the timing and receipt from the FDIC.

Accrued interest receivable – The carrying amount is considered a reasonable estimate of fair value.

Mortgage servicing rights – See Financial Instruments Measured at Fair Value above.

Deposits – The estimated fair value of deposits with no stated maturity, which includes demand deposits, money market accounts and other savings accounts, are established at carrying value because of the customers’ ability to withdraw funds immediately. A discounted cash flow method is used to estimate the fair value of fixed rate time deposits. Discounting was based on the contractual cash flows and the current rates at which similar deposits with similar remaining maturities would be issued.

Federal funds purchased and securities sold under agreements to repurchase and wholesale borrowings – The carrying amount of variable rate borrowings including federal funds purchased is considered to be their fair value. Quoted market prices or the discounted cash flow method was used to estimate the fair value of the Corporation’s long-term debt. Discounting was based on the contractual cash flows and the current rate at which debt with similar terms could be issued.

Accrued interest payable – The carrying amount is considered a reasonable estimate of fair value.

Derivative assets and liabilities – See Financial Instruments Measured at Fair Value above.

True-up liability – See Financial Instruments Measured at Fair Value above.

Financial Instruments Recorded at Fair Value

The Corporation may elect to report most financial instruments and certain other items at fair value on an instrument-by-instrument basis with changes in fair value reported in net income. This election can be made at the acquisition of an eligible financial asset, financial liability or firm commitment or when certain specified reconsideration events occur. The fair value election may not be revoked once an election is made.

The Corporation has elected to fair value newly originated conforming fixed rate and adjustable-rate first mortgage loans held for sale. The election of the fair value option aligns the accounting for these loans with the related hedges. It also eliminates the requirements of hedge accounting under U.S. GAAP.

Interest income on loans held for sale is accrued on the principal outstanding primarily using the “simple-interest” method. None of these loans were 90 days or more past due, nor were any on nonaccrual as of December 31, 2011 and 2010.

As of December 31, 2011 and 2010, the aggregate fair value, contractual balance and gain or loss on loans held for sale was as follows:



	December 31, 2011		December 31, 2010
Aggregate fair value	$	30,077	$	41,340
Contractual balance	28,948		41,024
Gain	1,129		316

Loans held for sale are measured at fair value with changes in fair value recognized in current earnings. The change in fair value of loans held for sale included in earnings for the years ended December 31, 2011 and 2010 was $0.8 million and $0.2 million, respectively.