11. Fair Value Disclosures

FASB ASC topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an 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. FASB ASC topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 instruments include securities traded on active exchange markets, such as the New York Stock Exchange, as well as U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets.

Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 instruments include securities traded in less active dealer or broker markets.

Level 3: Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

We used the following methods and significant assumptions to estimate fair value:

Securities: Where quoted market prices are available in an active market, securities (equity securities at fair value, trading or available for sale) are classified as Level 1 of the valuation hierarchy. Level 1 securities include certain preferred stocks included in our equity securities at fair value (trading securities as of December 31, 2017) for which there are quoted prices in active markets and US Treasuries (at December 31, 2017) in our securities available for sale portfolio. If quoted market prices are not available for the specific security, then fair values are estimated by (1) using quoted market prices of securities with similar characteristics, (2) matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices, or (3) a discounted cash flow analysis whose significant fair value inputs can generally be verified and do not typically involve judgment by management. These securities are classified as Level 2 of the valuation hierarchy and primarily include agency securities, private label mortgage-backed securities, other asset backed securities, obligations of states and political subdivisions, trust preferred securities, corporate securities and foreign government securities.

Loans held for sale: The fair value of mortgage loans held for sale is based on agency cash window loan pricing for comparable assets (recurring Level 2).

Impaired loans with specific loss allocations based on collateral value: From time to time, certain loans are considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. We measure our investment in an impaired loan based on one of three methods: the loan’s observable market price, the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. Those impaired loans not requiring an allowance for loan losses represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2018 and December 31, 2017, all of our impaired loans were evaluated based on either the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. When the fair value of the collateral is based on an appraised value or when an appraised value is not available we record the impaired loan as nonrecurring Level 3. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and thus will typically result in a Level 3 classification of the inputs for determining fair value.

Other real estate: At the time of acquisition, other real estate is recorded at fair value, less estimated costs to sell, which becomes the property’s new basis. Subsequent write-downs to reflect declines in value since the time of acquisition may occur from time to time and are recorded in net (gains) losses on other real estate and repossessed assets, which is part of non-interest expense - other in the Condensed Consolidated Statements of Operations. The fair value of the property used at and subsequent to the time of acquisition is typically determined by a third party appraisal of the property. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate 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 us. Once received, an independent third party, or a member of our Collateral Evaluation Department (for commercial properties), or a member of our Special Assets/ORE Group (for residential properties) 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. We compare the actual selling price of collateral that has been sold to the most recent appraised value of our properties to determine what additional adjustment, if any, should be made to the appraisal value to arrive at fair value. For commercial and residential properties we typically discount an appraisal to account for various factors that the appraisal excludes in its assumptions. These additional discounts generally do not result in material adjustments to the appraised value.

Capitalized mortgage loan servicing rights: The fair value of capitalized mortgage loan servicing rights is based on a valuation model used by an independent third party that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. Certain model assumptions are generally unobservable and are based upon the best information available including data relating to our own servicing portfolio, reviews of mortgage servicing assumption and valuation surveys and input from various mortgage servicers and, therefore, are recorded as Level 3. Management evaluates the third party valuation for reasonableness each quarter as part of our financial reporting control processes.

Derivatives: The fair value of rate-lock mortgage loan commitments is based on agency cash window loan pricing for comparable assets and the fair value of mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets (recurring Level 2). The fair value of interest rate swap and interest rate cap agreements are derived from proprietary models which utilize current market data. The significant fair value inputs can generally be observed in the market place and do not typically involve judgment by management (recurring Level 2). The fair value of purchased and written options is based on prices of financial instruments with similar characteristics and do not typically involve judgment by management (recurring Level 2).

Assets and liabilities measured at fair value, including financial assets for which we have elected the fair value option, were as follows:

	Fair Value Measure- ments		Fair Value Measurements Using
	Fair Value Measure- ments		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Un- observable Inputs (Level 3)
	(In thousands)
September 30, 2018:
Measured at Fair Value on a Recurring Basis
Assets
Equity securities at fair value	$	285	$	285	$	-	$	-
Securities available for sale
U.S. agency		20,423		-		20,423		-
U.S. agency residential mortgage-backed		125,061		-		125,061		-
U.S. agency commercial mortgage-backed		5,815		-		5,815		-
Private label mortgage-backed		28,973		-		28,973		-
Other asset backed		78,526		-		78,526		-
Obligations of states and political subdivisions		139,654		-		139,654		-
Corporate		34,570		-		34,570		-
Trust preferred		1,925		-		1,925		-
Foreign government		2,010		-		2,010		-
Loans held for sale		41,325		-		41,325		-
Capitalized mortgage loan servicing rights		23,151		-		-		23,151
Derivatives (1)		7,734		-		7,734		-
Liabilities
Derivatives (2)		2,696		-		2,696		-

Measured at Fair Value on a Non-recurring basis:
Assets
Impaired loans (3)
Commercial
Income producing - real estate		225		-		-		225
Commercial and industrial		944		-		-		944
Mortgage
1-4 family		334		-		-		334
Resort lending		264		-		-		264
Other real estate (4)
Mortgage
1-4 family		94		-		-		94
Resort lending		1		-		-		1

(1)	Included in accrued income and other assets

(2)	Included in accrued expenses and other liabilities

(3)	Only includes impaired loans with specific loss allocations based on collateral value.

(4)	Only includes other real estate with subsequent write downs to fair value.

	Fair Value Measure- ments		Fair Value Measurements Using
	Fair Value Measure- ments		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Un- observable Inputs (Level 3)
	(In thousands)
December 31, 2017:
Measured at Fair Value on a Recurring Basis:
Assets
Trading securities	$	455	$	455	$	-	$	-
Securities available for sale
U.S. Treasury		898		898		-		-
U.S. agency		25,682		-		25,682		-
U.S. agency residential mortgage-backed		137,918		-		137,918		-
U.S. agency commercial mortgage-backed		9,760		-		9,760		-
Private label mortgage-backed		29,109		-		29,109		-
Other asset backed		93,898		-		93,898		-
Obligations of states and political subdivisions		172,945		-		172,945		-
Corporate		47,853		-		47,853		-
Trust preferred		2,802		-		2,802		-
Foreign government		2,060		-		2,060		-
Loans held for sale		39,436		-		39,436		-
Capitalized mortgage loan servicing rights		15,699		-		-		15,699
Derivatives (1)		3,080		-		3,080		-
Liabilities
Derivatives (2)		1,292		-		1,292		-

Measured at Fair Value on a Non-recurring basis:
Assets
Impaired loans (3)
Commercial
Income producing - real estate		274		-		-		274
Land, land development & construction-real estate		9		-		-		9
Commercial and industrial		1,051		-		-		1,051
Mortgage
1-4 family		339		-		-		339
Resort lending		207		-		-		207
Other real estate (4)
Mortgage
1-4 family		186		-		-		186
Resort lending		65		-		-		65

(1) Included in accrued income and other assets

(2) Included in accrued expenses and other liabilities

(3) Only includes impaired loans with specific loss allocations based on collateral value.

(4) Only includes other real estate with subsequent write downs to fair value.

There were no transfers between Level 1 and Level 2 during the nine months ended September 30, 2018 and 2017.

Changes in fair values for financial assets which we have elected the fair value option for the periods presented were as follows:

	Changes in Fair Values for the nine-Month Periods Ended September 30 for Items Measured at Fair Value Pursuant to Election of the Fair Value Option
	Net Gains (Losses) on Assets						Mortgage Loan Servicing, net			Total Change in Fair Values Included in Current Period Earnings
	Securities			Mortgage Loans			Mortgage Loan Servicing, net
	(In thousands)
2018
Equity securities at fair value	$	(170	)	$	-		$	-		$	(170	)
Loans held for sale		-			(120	)		-			(120	)
Capitalized mortgage loan servicing rights		-			-			694			694

2017
Trading securities	$	(63	)	$	-		$	-		$	(63	)
Loans held for sale		-			713			-			713
Capitalized mortgage loan servicing rights		-			-			(2,585	)		(2,585	)

For those items measured at fair value pursuant to our election of the fair value option, interest income is recorded within the Condensed Consolidated Statements of Operations based on the contractual amount of interest income earned on these financial assets and dividend income is recorded based on cash dividends received.

The following represent impairment charges recognized during the three and nine month periods ended September 30, 2018 and 2017 relating to assets measured at fair value on a non-recurring basis:

Loans which are measured for impairment using the fair value of collateral for collateral dependent loans had a carrying amount of $1.8 million, which is net of a valuation allowance of $0.8 million at September 30, 2018, and had a carrying amount of $1.9 million, which is net of a valuation allowance of $0.7 million at December 31, 2017. The provision for loan losses included in our results of operations relating to impaired loans was a net expense of $0.1 million and $0.3 million for the three month periods ending September 30, 2018 and 2017, respectively, and a net expense of $0.5 million for both nine month periods ending September 30, 2018 and 2017, respectively.

Other real estate, which is measured using the fair value of the property, had a carrying amount of $0.1 million which is net of a valuation allowance of $0.1 million at September 30, 2018, and a carrying amount of $0.3 million, which is net of a valuation allowance of $0.1 million, at December 31, 2017. Additional charges relating to other real estate measured at fair value of $0.04 million and $0.04 million were included in our results of operations during the three and nine month periods ended September 30, 2018, respectively and $0.03 million and $0.04 million during the same periods in 2017.

A reconciliation for all assets and (liabilities) measured at fair value on a recurring basis using significant unobservable inputs (Level 3) follows:

	Capitalized Mortgage Loan Servicing Rights
	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018		2017
	(In thousands)						(In thousands)
Beginning balance	$	21,848		$	14,515		$	15,699	$	-
Change in accounting		-			-			-		14,213
Beginning balance, as adjusted		21,848			14,515			15,699		14,213
Total gains (losses) realized and unrealized:
Included in results of operations		(198	)		(1,090	)		694		(2,585	)
Included in other comprehensive income (loss)		-			-			-		-
Purchases, issuances, settlements, maturities and calls		1,501			1,250			6,758		3,047
Transfers in and/or out of Level 3		-			-			-		-
Ending balance	$	23,151		$	14,675		$	23,151	$	14,675

Amount of total gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets and liabilities still held at September 30	$	(198	)	$	(1,090	)	$	694	$	(2,585	)

The fair value of our capitalized mortgage loan servicing rights has been determined based on a valuation model used by an independent third party as discussed above. The significant unobservable inputs used in the fair value measurement of the capitalized mortgage loan servicing rights are discount rate, cost to service, ancillary income and float rate. Significant changes in all four of these assumptions in isolation would result in significant changes to the value of our capitalized mortgage loan servicing rights. Quantitative information about our Level 3 fair value measurements measured on a recurring basis follows:

	Asset Fair Value		Valuation Technique	Unobservable Inputs	Range			Weighted Average
	(In thousands)
September 30, 2018
Capitalized mortgage loan servicing rights	$	23,151	Present value of net	Discount rate	10.00% to 13.00		%		10.15	%
			servicing revenue	Cost to service	$	68 to $317		$	81
				Ancillary income	20 to 36				22
				Float rate		3.07	%		3.07	%

December 31, 2017
Capitalized mortgage loan servicing rights	$	15,699	Present value of net	Discount rate	9.88% to 11.00		%		10.11	%
			servicing revenue	Cost to service	$	66 to $216		$	81
				Ancillary income	20 to 36				23
				Float rate		2.24	%		2.24	%

Quantitative information about Level 3 fair value measurements measured on a non-recurring basis follows:

Asset

Fair

Value

Valuation

Technique

Unobservable

Inputs

Range

Weighted

Average

(In thousands)

September 30, 2018

Impaired loans

Commercial

1,169

Sales comparison approach

Adjustment for differences between comparable sales

(32.5)% to 25.0%

(4.5

Mortgage

598

Sales comparison approach

Adjustment for differences between comparable sales

(40.1) to 30.4

(1.9

)

Other real estate

Mortgage

Sales comparison approach

Adjustment for differences between comparable sales

2.2 to 34.1

17.9

December 31, 2017

Impaired loans

Commercial

1,334

Sales comparison approach

Adjustment for differences between comparable sales

(32.5)% to 25.0%

(4.5

Mortgage

546

Sales comparison approach

Adjustment for differences between comparable sales

(21.1) to 34.1

(2.7

)

Other real estate

Mortgage

251

Sales comparison approach

Adjustment for differences between comparable sales

(33.0) to 44.5

(1.0

)

The following table reflects the difference between the aggregate fair value and the aggregate remaining contractual principal balance outstanding for loans held for sale for which the fair value option has been elected for the periods presented.

	Aggregate Fair Value		Difference		Contractual Principal
	(In thousands)
Loans held for sale
September 30, 2018	$	41,325	$	724	$	40,601
December 31, 2017		39,436		844		38,592