The methodologies Trustmark uses in determining the fair values are based primarily on the use of independent, market-based data to reflect a value that would be reasonably expected upon exchange of the position in an orderly transaction between market participants at the measurement date. The predominant portion of assets that are stated at fair value are of a nature that can be valued using prices or inputs that are readily observable through a variety of independent data providers. The providers selected by Trustmark for fair valuation data are widely recognized and accepted vendors whose evaluations support the pricing functions of financial institutions, investment and mutual funds, and portfolio managers. Trustmark has documented and evaluated the pricing methodologies used by the vendors and maintains internal processes that regularly test valuations for anomalies.

Trustmark utilizes an independent pricing service to advise it on the carrying value of the securities available for sale portfolio. As part of Trustmark’s procedures, the price provided from the service is evaluated for reasonableness given market changes. When a questionable price exists, Trustmark investigates further to determine if the price is valid. If needed, other market participants may be utilized to determine the correct fair value. Trustmark has also reviewed and confirmed its determinations in thorough discussions with the pricing source regarding their methods of price discovery.

Mortgage loan commitments are valued based on the securities prices of similar collateral, term, rate and delivery for which the loan is eligible to deliver in place of the particular security. Trustmark acquires a broad array of mortgage security prices that are supplied by a market data vendor, which in turn accumulates prices from a broad list of securities dealers. Prices are processed through a mortgage pipeline management system that accumulates and segregates all loan commitment and forward-sale transactions according to the similarity of various characteristics (maturity, term, rate, and collateral). Prices are matched to those positions that are deemed to be an eligible substitute or offset (i.e., “deliverable”) for a corresponding security observed in the marketplace.

Trustmark estimates fair value of the MSR through the use of prevailing market participant assumptions and market participant valuation processes. This valuation is periodically tested and validated against other third-party firm valuations.

Trustmark obtains the fair value of interest rate swaps from a third-party pricing service that uses an industry standard discounted cash flow methodology. In addition, credit valuation adjustments are incorporated in the fair values to account for potential nonperformance risk. In adjusting the fair value of its interest rate swap contracts for the effect of nonperformance risk, Trustmark has considered any applicable credit enhancements such as collateral postings, thresholds, mutual puts, and guarantees. In conjunction with the FASB’s fair value measurement guidance, Trustmark made an accounting policy election to measure the credit risk of these derivative financial instruments, which are subject to master netting agreements, on a net basis by counterparty portfolio.

Trustmark has determined that the majority of the inputs used to value its interest rate swaps offered to qualified commercial borrowers fall within Level 2 of the fair value hierarchy, while the credit valuation adjustments associated with these derivatives utilize Level 3 inputs, such as estimates of current credit spreads. Trustmark has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its interest rate swaps and has determined that the credit valuation adjustment is not significant to the overall valuation of these derivatives. As a result, Trustmark classifies its interest rate swap valuations in Level 2 of the fair value hierarchy.

Trustmark also utilizes exchange-traded derivative instruments such as Treasury note futures contracts and option contracts to achieve a fair value return that offsets the changes in fair value of the MSR attributable to interest rates. Fair values of these derivative instruments are determined from quoted prices in active markets for identical assets therefore allowing them to be classified within Level 1 of the fair value hierarchy. In addition, Trustmark utilizes derivative instruments such as interest rate lock commitments in its mortgage banking area which lack observable inputs for valuation purposes resulting in their inclusion in Level 3 of the fair value hierarchy.

At this time, Trustmark presents no fair values that are derived through internal modeling. Should positions requiring fair valuation arise that are not relevant to existing methodologies, Trustmark will make every reasonable effort to obtain market participant assumptions, or independent evaluation.

The following tables summarize financial assets and financial liabilities measured at fair value on a recurring basis at September 30, 2022 and December 31, 2021, segregated by the level of valuation inputs within the fair value hierarchy utilized to measure fair value ($ in thousands). There were no transfers between fair value levels for the nine months ended September 30, 2022 and the year ended December 31, 2021.


	September 30, 2022
	Total		Level 1		Level 2		Level 3
U.S. Treasury securities	$	416,278	$	416,278	$	—	$	—
U.S. Government agency obligations		9,116		—		9,116		—
Obligations of states and political subdivisions		4,763		—		4,763		—
Mortgage-backed securities		2,014,329		—		2,014,329		—
Securities available for sale		2,444,486		416,278		2,028,208		—
LHFS		165,213		—		165,213		—
MSR		132,615		—		—		132,615
Other assets - derivatives		9,027		16		9,879		(868	)
Other liabilities - derivatives		52,652		7,999		44,653		—


	December 31, 2021
	Total		Level 1		Level 2		Level 3
U.S. Treasury securities	$	344,640	$	344,640	$	—	$	—
U.S. Government agency obligations		13,727		—		13,727		—
Obligations of states and political subdivisions		5,714		—		5,714		—
Mortgage-backed securities		2,874,796		—		2,874,796		—
Securities available for sale		3,238,877		344,640		2,894,237		—
LHFS		275,706		—		275,706		—
MSR		87,687		—		—		87,687
Other assets - derivatives		24,809		2,794		20,156		1,859
Other liabilities - derivatives		4,677		414		4,263		—

The changes in Level 3 assets measured at fair value on a recurring basis for the nine months ended September 30, 2022 and 2021 are summarized as follows ($ in thousands):


	MSR			Other Assets - Derivatives
Balance, January 1, 2022	$	87,687		$	1,859
Total net (loss) gain included in Mortgage banking, net (1)		30,476			(401	)
Additions		14,452			—
Sales		—			(2,326	)
Balance, September 30, 2022	$	132,615		$	(868	)

The amount of total gains (losses) for the period included in earnings that are attributable to the change in unrealized gains or losses still held at September 30, 2022	$	41,530		$	(1,181	)

Balance, January 1, 2021	$	66,464		$	9,560
Total net (loss) gain included in Mortgage banking, net (1)		(4,378	)		7,664
Additions		22,015			—
Sales		—			(14,715	)
Balance, September 30, 2021	$	84,101		$	2,509

The amount of total gains (losses) for the period included in earnings that are attributable to the change in unrealized gains or losses still held at September 30, 2021	$	11,037		$	2,722

(1)

Total net (loss) gain included in Mortgage banking, net relating to the MSR includes changes in fair value due to market changes and due to run-off.

Trustmark may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. Assets at September 30, 2022, which have been measured at fair value on a nonrecurring basis, include collateral-dependent LHFI. A loan is collateral dependent when the borrower is experiencing financial difficulty and repayment of the loan is expected to be provided substantially through the sale of the collateral. The expected credit loss for collateral-dependent loans is measured as the difference between the amortized cost basis of the loan and the fair value of the collateral, adjusted for the estimated cost to sell. Fair value estimates for collateral-dependent loans are derived from appraised values based on the current market value or as is value of the collateral, normally from recently received and reviewed appraisals. Current appraisals are ordered on an annual basis based on the inspection date or more often if market conditions necessitate. Appraisals are obtained from state-certified appraisers and are based on certain assumptions, which may include construction or development status and the highest and best use of the property. These appraisals are reviewed by Trustmark’s Appraisal Review Department to ensure they are acceptable, and values are adjusted down for costs associated with asset disposal. At September 30, 2022, Trustmark had outstanding balances of $47.4 million with a related ACL of $19.4 million in collateral-dependent LHFI, compared to outstanding balances of $44.4 million with a related ACL of $7.6 million in collateral-dependent LHFI at December 31, 2021. The collateral-dependent LHFI are classified as Level 3 in the fair value hierarchy.

Certain nonfinancial assets measured at fair value on a nonrecurring basis include foreclosed assets (upon initial recognition or subsequent impairment), nonfinancial assets and nonfinancial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets and other nonfinancial long-lived assets measured at fair value for impairment assessment.

Other real estate includes assets that have been acquired in satisfaction of debt through foreclosure and is recorded at the fair value less cost to sell (estimated fair value) at the time of foreclosure. Fair value is based on independent appraisals and other relevant factors. In the determination of fair value subsequent to foreclosure, Management also considers other factors or recent developments, such as changes in market conditions from the time of valuation and anticipated sales values considering plans for disposition, which could result in an adjustment to lower the collateral value estimates indicated in the appraisals. Periodic revaluations are classified as Level 3 in the fair value hierarchy since assumptions are used that may not be observable in the market.

Foreclosed assets of $3.0 million were remeasured during the first nine months of 2022, requiring write-downs of $1.0 million to reach their current fair values compared to $5.4 million of foreclosed assets that were remeasured during the first nine months of 2021, requiring write-downs of $328 thousand.

FASB ASC Topic 825, “Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.

The carrying amounts and estimated fair values of financial instruments at September 30, 2022 and December 31, 2021, are as follows ($ in thousands):


	September 30, 2022				December 31, 2021
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial Assets:
Level 2 Inputs:
Cash and short-term investments	$	489,735	$	489,735	$	2,266,829	$	2,266,829
Securities held to maturity		1,156,985		1,065,828		342,537		353,511
Level 3 Inputs:
Net LHFI and PPP loans		11,475,812		11,194,672		10,181,708		10,123,379

Financial Liabilities:
Level 2 Inputs:
Deposits		14,425,180		14,396,980		15,087,160		15,084,440
Federal funds purchased and securities sold under repurchase agreements		544,068		544,068		238,577		238,577
Other borrowings		223,172		223,165		91,025		91,022
Subordinated notes		123,207		113,750		123,042		128,438
Junior subordinated debt securities		61,856		47,629		61,856		49,485

Trustmark has elected to account for its mortgage LHFS under the fair value option, with interest income on these mortgage LHFS reported in interest and fees on LHFS and LHFI. The fair value of the mortgage LHFS is determined using quoted prices for a similar asset, adjusted for specific attributes of that loan. The mortgage LHFS are actively managed and monitored and certain market risks of the loans may be mitigated through the use of derivatives. These derivative instruments are carried at fair value with changes in fair value recorded as noninterest income in mortgage banking, net. The changes in the fair value of LHFS are largely offset by changes in the fair value of the derivative instruments. For the three and nine months ended September 30, 2022, net losses of $4.4 million and $6.7 million, respectively, were recorded as noninterest income in mortgage banking, net for changes in the fair value of LHFS accounted for under the fair value option, compared to a net losses of $593 thousand and $8.9 million for the three and nine months ended September 30, 2021, respectively. Interest and fees on LHFS and LHFI for the three and nine months ended September 30, 2022 included $2.0 million and $5.2 million, respectively, of interest earned on LHFS accounted for under the fair value option, compared to $1.7 million and $5.5 million for the three and nine months ended September 30, 2021, respectively. Election of the fair value option allows Trustmark 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 fair value option election does not apply to GNMA optional repurchase loans which do not meet the requirements under FASB ASC Topic 825 to be accounted for under the fair value option. GNMA optional repurchase loans totaled $67.7 million and $84.5 million at September 30, 2022 and December 31, 2021, respectively, and are included in LHFS on the accompanying consolidated balance sheets. For additional information regarding GNMA optional repurchase loans, please see the section captioned “Past Due LHFS” included in Note 3 – LHFI and Allowance for Credit Losses, LHFI.