9. Fair Value Measurement

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

Valuation techniques including the market approach, the income approach and/or the cost approach are utilized to determine fair value. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Valuation policies and procedures are determined by our investment department and reported to our Asset/Liability Committee (“ALCO”) for review. An entity must consider all aspects of nonperforming risk, including the entity’s own credit standing when measuring fair value of a liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. A fair value hierarchy for valuation inputs gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 Inputs - Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

Level 3 Inputs - Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity's own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Securities Available for Sale – U.S. Treasury securities are reported at fair value utilizing Level 1 inputs. Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, we obtain fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Securities Carried at Fair Value through Income – U.S. Treasury securities are reported at fair value utilizing Level 1 inputs. Other securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, we obtain fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

We review the prices quarterly supplied by the independent pricing service for reasonableness and to ensure such prices are aligned with traditional pricing matrices. In addition, we obtain an understanding of their underlying pricing methodologies and their Statement on Standards for Attestation Engagements-Reporting on Controls of a Service Organization (“SSAE 16”). We validate prices supplied by the independent pricing service by comparison to prices obtained from, in most cases, three additional third party sources. For securities where prices are outside a reasonable range, we further review those securities to determine what a reasonable price estimate is for that security, given available data.

Certain financial assets are measured at fair value in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of fair value accounting or write-downs of individual assets. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with our monthly and/or quarterly valuation process. There were no transfers between Level 1 and Level 2 during the nine months ended September 30, 2012.

Loans Held for Sale - These loans are reported at the lower of cost or fair value. Fair value is determined based on expected proceeds, which are based on sales contracts and commitments and are considered Level 2 inputs. At September 30, 2012 and December 31, 2011, based on our estimates of fair value, no valuation allowance was recognized.

Foreclosed Assets – Foreclosed assets are initially carried at fair value less costs to sell. The fair value measurements of foreclosed assets can include Level 2 measurement inputs such as real estate appraisals and comparable real estate sales information, in conjunction with Level 3 measurement inputs such as cash flow projections, qualitative adjustments, sales cost estimates, etc. As a result, the categorization of foreclosed assets is Level 3 of the fair value hierarchy. In connection with the measurement and initial recognition of certain foreclosed assets, we may recognize charge-offs through the allowance for loan losses.

Impaired Loans – Certain impaired loans may be reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 3 inputs based on customized discounting criteria or appraisals. At September 30, 2012 and December 31, 2011, the impact of loans with specific reserves based on the fair value of the collateral was reflected in our allowance for loan losses.

Certain nonfinancial assets and nonfinancial liabilities measured at fair value on a recurring basis include reporting units measured at fair value in the first step of a goodwill impairment test. Certain nonfinancial assets measured at fair value on a nonrecurring basis include nonfinancial assets and nonfinancial liabilities measured at fair value in the second step of a goodwill impairment test, as well as intangible assets and other nonfinancial long-lived assets (such as real estate owned) that are measured at fair value in the event of an impairment.

The following tables summarize assets measured at fair value on a recurring and nonrecurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):



	At or For the Nine Months Ended September 30, 2012
			Fair Value Measurements at the End of the Reporting Period Using
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Gains (Losses)
Recurring fair value measurements
Investment Securities:
State and Political Subdivisions	$	555,014	$	—	$	555,014	$	—	$	—
Other Stocks and Bonds	3,620		—		2,917		703		(181		)
Mortgage-backed Securities:
U.S. Government Agencies	102,922		—		102,922		—		—
Government-Sponsored Enterprise	763,030		—		763,030		—		—
Total recurring fair value measurements	$	1,424,586	$	—	$	1,423,883	$	703	$	(181	)

Nonrecurring fair value measurements
Foreclosed assets (1)	$	1,030	$	—	$	—	$	1,030	$	(441	)
Impaired loans (2)	11,477		—		—		11,477		(91		)
Total nonrecurring fair value measurements	$	12,507	$	—	$	—	$	12,507	$	(532	)



	At or For the Year Ended December 31, 2011
			Fair Value Measurements at the End of the Reporting Period Using
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Recurring fair value measurements
Securities Available for Sale
Investment Securities:
State and Political Subdivisions	$	282,457	$	—	$	282,457	$	—
Other Stocks and Bonds	499		—		—		499
Mortgage-backed Securities:
U.S. Government Agencies	107,052		—		107,052		—
Government-Sponsored Enterprise	609,074		—		609,074		—
Total available for sale securities	$	999,082	$	—	$	998,583	$	499
Securities carried at fair value through income
Mortgage-backed Securities:
U.S. Government Agencies	$	30,413	$	—	$	30,413	$	—
Government-Sponsored Enterprise	617,346		—		617,346		—
Total securities carried at fair value through income	$	647,759	$	—	$	647,759	$	—
Total recurring fair value measurements	$	1,646,841	$	—	$	1,646,342	$	499

Nonrecurring fair value measurements
Foreclosed assets (1)	$	775	$	—	$	—	$	775
Impaired loans (2)	9,731		—		—		9,731
Total nonrecurring fair value measurements	$	10,506	$	—	$	—	$	10,506


(1)	Losses represent related losses on foreclosed properties that were written down subsequent to their initial classification as foreclosed properties.


(2)	Loans represent collateral dependent impaired loans with a specific valuation allowance. Losses on these loans represent charge-offs which are netted against the allowance for loan losses.

The following tables present additional information about financial assets and liabilities measured at fair value on a recurring basis and for which we have utilized Level 3 inputs to determine fair value (in thousands):



	Nine Months Ended September 30,
	2012			2011
Other Stocks and Bonds
Balance at Beginning of Period	$	499		$	189

Total gains or losses (realized/unrealized):
Included in earnings	(181		)	—
Included in other comprehensive income (loss)	385			758
Purchases	—			—
Issuances	—			—
Settlements	—			—
Transfers in and/or out of Level 3	—			—
Balance at End of Period	$	703		$	947

The amount of total gains or losses for the periods included in earnings attributable to the change in unrealized gains or losses relating to assets still held at reporting date	$	(181	)	$	—



	Three Months Ended September 30,
	2012		2011
Other Stocks and Bonds
Balance at Beginning of Period	$	623	$	957

Total gains or losses (realized/unrealized):
Included in earnings	—		—
Included in other comprehensive income (loss)	80		(10		)
Purchases	—		—
Issuances	—		—
Settlements	—		—
Transfers in and/or out of Level 3	—		—
Balance at End of Period	$	703	$	947

The amount of total gains or losses for the periods included in earnings attributable to the change in unrealized gains or losses relating to assets still held at reporting date	$	—	$	—

The following tables present income statement classification of realized and unrealized gains and losses due to changes in fair value recorded in earnings for the periods presented for recurring Level 3 assets, as shown in the previous tables (in thousands):



	Nine Months Ended September 30, 2012
	Net Securities Gains (Losses)				Other Noninterest Income (Loss)					Total
Securities Available for Sale	Realized		Unrealized		Realized			Unrealized		Realized			Unrealized
Investment securities:
Other stocks and bonds	$	—	$	—	$	(181	)	$	—	$	(181	)	$	—

Three Months Ended September 30, 2012

Net Securities Gains

(Losses)

Other Noninterest Income

(Loss)

Total

Securities Available for Sale

Realized

Unrealized

Realized

Unrealized

Realized

Unrealized

Investment securities:

Other stocks and bonds

—

The following table presents quantitative information related to the significant unobservable inputs utilized in our Level 3 recurring fair value measurements as of September 30, 2012. No liabilities were recorded as Level 3 at September 30, 2012 (in thousands):



Securities Available for Sale Investment securities:	As of September 30, 2012
Securities Available for Sale Investment securities:	Fair Value		Valuation Techniques	Unobservable Input	Range of Inputs
Other stocks and bonds	$	703	Discounted Cash Flows	Constant prepayment rate	1% - 2

				Discount Rate	Libor + 14% - 15

				Loss Severity	25% - 100

The significant unobservable inputs used in the fair value measurement of our trust preferred securities (“TRUPS”) included the credit rating downgrades, the severity and duration of the mark-to-market loss, and the structural nuances of each TRUP. Our analysis of the underlying cash flows contemplated various default, deferral and recovery scenarios to arrive at our best estimate of cash flows. Significant increases (decreases) in any of those inputs would result in a significant lower (higher) fair value.

Level 3 assets recorded at fair value on a nonrecurring basis at September 30, 2012 included loans for which a specific allowance was established based on the fair value of collateral and other real estate for which fair value of the properties was less than the cost basis. For both asset classes, the unobservable inputs were the additional adjustments applied by management to the appraised values to reflect such factors as non-current appraisals and revisions to estimated time to sell. These adjustments are determined based on qualitative judgments made by management on a case-by-case basis and are not quantifiable inputs, although they are used in the determination of fair value.

We reported at fair value through income certain of our mortgage-backed securities with embedded derivatives and purchased at a significant premium, which we defined as greater than 111.111% as opposed to bifurcating the embedded derivative and valuing it on a stand-alone basis, as these embedded derivatives are not readily identifiable and measurable and as such cannot be bifurcated. At September 30, 2012, we had no securities carried at fair value through income. During the first quarter of 2012, we sold all of our securities carried at fair value through income. The sale of these securities resulted in a loss on sale of securities carried at fair value through income of $498,000. At December 31, 2011, we had $647.8 million classified as securities carried at fair value through income. The changes in fair value recorded in income was an increase of $3.3 million and $7.4 million for the three and nine months ended September 30, 2011, respectively.

Assets and liabilities accounted for under the fair value election are initially measured at fair value with subsequent changes in fair value recognized in earnings. Such changes in the fair value of assets for which we elected the fair value option are included in current period earnings with classification in the income statement line item reflected in the following tables (in thousands):



	Nine Months Ended September 30,
	2012		2011
Changes in fair value included in net income:
Mortgage-backed Securities:
U.S. Government Agencies	$	—	$	409
Government-Sponsored Enterprises	—		6,948
Total	$	—	$	7,357



	Three Months Ended September 30,
	2012		2011
Changes in fair value included in net income:
Mortgage-backed Securities:
U.S. Government Agencies	$	—	$	359
Government-Sponsored Enterprises	—		2,915
Total	$	—	$	3,274

Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet is required, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other estimation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Such techniques and assumptions, as they apply to individual categories of our financial instruments, are as follows:

Cash and cash equivalents - The carrying amounts for cash and cash equivalents is a reasonable estimate of those assets' fair value.

Investment and mortgage-backed and related securities - Fair values for these securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices for similar securities or estimates from independent pricing services.

FHLB stock and other investments - The carrying amount of FHLB stock is a reasonable estimate of those assets’ fair value.

Loans receivable - For adjustable rate loans that reprice frequently and with no significant change in credit risk, the carrying amounts are a reasonable estimate of those assets' fair value. The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Nonperforming loans are estimated using discounted cash flow analyses or the underlying value of the collateral where applicable.

Deposit liabilities - The fair value of demand deposits, savings accounts, and certain money market deposits is the amount on demand at the reporting date, that is, the carrying value. Fair values for fixed rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered for deposits of similar remaining maturities.

Federal funds purchased and repurchase agreements - Federal funds purchased and repurchase agreements generally have an original term to maturity of one day and thus are considered short-term borrowings. Consequently, their carrying value is a reasonable estimate of fair value.

FHLB advances - The fair value of these advances is estimated by discounting the future cash flows using rates at which advances would be made to borrowers with similar credit ratings and for the same remaining maturities.

Long-term debt - The carrying amount for the long-term debt is estimated by discounting future cash flows using estimated rates at which long-term debt would be made to borrowers with similar credit ratings and for the remaining maturities. This type of debt is issued much less frequently since the economic crisis beginning in 2007. Therefore, the discount rate is a best estimate.

The following tables present our financial assets, financial liabilities, and unrecognized financial instruments at both their respective carrying amounts and fair value (in thousands):



			Estimated Fair Value
September 30, 2012	Carrying Amount		Total		Level 1		Level 2		Level 3
Financial Assets
Cash and cash equivalents	$	131,972	$	131,972	$	131,972	$	—	$	—
Investment securities:
Held to maturity, at amortized cost	1,009		1,155		—		1,155		—
Mortgage-backed and related securities:
Held to maturity, at amortized cost	293,300		303,987		—		303,987		—
FHLB stock and other investments, at cost	36,003		36,003		—		36,003		—
Loans, net of allowance for loan losses	1,200,747		1,195,643		—		—		1,195,643
Loans held for sale	1,158		1,158		—		1,158		—
Financial liabilities:
Retail deposits	$	2,301,817	$	2,304,731	$	—	$	2,304,731	$	—
Federal funds purchased and repurchase agreements	1,468		1,468		—		1,468		—
FHLB advances	533,183		535,603		—		535,603		—
Long-term debt	60,311		42,861		—		42,861		—



			Estimated Fair Value
December 31, 2011	Carrying Amount		Total		Level 1		Level 2		Level 3
Financial Assets
Cash and cash equivalents	$	43,238	$	43,238	$	43,238	$	—	$	—
Investment securities:
Held to maturity, at amortized cost	1,496		1,707		—		1,707		—
Mortgage-backed and related securities:
Held to maturity, at amortized cost	365,631		381,584		—		381,584		—
FHLB stock and other investments, at cost	35,933		35,933		—		35,933		—
Loans, net of allowance for loan losses	1,068,690		1,073,298		—		—		1,073,298
Loans held for sale	3,552		3,552		—		3,552		—
Financial liabilities:
Retail deposits	$	2,321,671	$	2,329,243	$	—	$	2,329,243	$	—
Federal funds purchased and repurchase agreements	2,945		2,945		—		2,945		—
FHLB advances	622,535		636,129		—		636,129		—
Long-term debt	60,311		45,132		—		45,132		—

As discussed earlier, the fair value estimate of financial instruments for which quoted market prices are unavailable is dependent upon the assumptions used. Consequently, those estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Accordingly, the aggregate fair value amounts presented in the above fair value table do not necessarily represent their underlying value.

The estimated fair value of our commitments to extend credit, credit card arrangements and letters of credit, estimated using Level 3 inputs, was not material at September 30, 2012 or December 31, 2011.