Fair Value Measurement of Assets and Liabilities

ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:



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



	Level 2	Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly (i.e., quoted prices on similar assets), for substantially the full term of the asset or liability.



	Level 3	Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

Assets and Liabilities Measured at Fair Value on a Recurring and Non-Recurring Basis

The following tables present the assets and liabilities that are measured at fair value on a recurring and nonrecurring basis by level within the fair value hierarchy as reported on the consolidated statements of financial condition at June 30, 2018 and December 31, 2017. The assets presented under “nonrecurring fair value measurements” in the tables below are not measured at fair value on an ongoing basis but are subject to fair value adjustments under certain circumstances (e.g., when an impairment loss is recognized).



	June 30, 2018		Fair Value Measurements at Reporting Date Using:
	June 30, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Recurring fair value measurements:
Assets
Investment securities:
Available for sale:
U.S. Treasury securities	$	48,667	$	48,667	$	—	$	—
U.S. government agency securities	38,006		—		38,006		—
Obligations of states and political subdivisions	211,529		—		211,529		—
Residential mortgage-backed securities	1,477,846		—		1,471,403		6,443
Trust preferred securities	2,279		—		2,279		—
Corporate and other debt securities	55,140		7,629		47,511		—
Total available for sale	1,833,467		56,296		1,770,728		6,443
Loans held for sale ⁽¹⁾	32,670		—		32,670		—
Other assets ⁽²⁾	30,132		—		30,132		—
Total assets	$	1,896,269	$	56,296	$	1,833,530	$	6,443
Liabilities
Other liabilities ⁽²⁾	$	37,902	$	—	$	37,902	$	—
Total liabilities	$	37,902	$	—	$	37,902	$	—
Non-recurring fair value measurements:
Collateral dependent impaired loans ⁽³⁾	$	36,957	$	—	$	—	$	36,957
Loan servicing rights	2,212		—		—		2,212
Foreclosed assets	1,239		—		—		1,239
Total	$	40,408	$	—	$	—	$	40,408



			Fair Value Measurements at Reporting Date Using:
	December 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Recurring fair value measurements:
Assets
Investment securities:
Available for sale:
U.S. Treasury securities	$	49,642	$	49,642	$	—	$	—
U.S. government agency securities	42,505		—		42,505		—
Obligations of states and political subdivisions	112,884		—		112,884		—
Residential mortgage-backed securities	1,223,295		—		1,215,935		7,360
Trust preferred securities	3,214		—		3,214		—
Corporate and other debt securities	51,164		7,783		43,381		—
Equity securities	11,201		1,382		9,819		—
Total available for sale	1,493,905		58,807		1,427,738		7,360
Loans held for sale ⁽¹⁾	15,119		—		15,119		—
Other assets ⁽²⁾	26,417		—		26,417		—
Total assets	$	1,535,441	$	58,807	$	1,469,274	$	7,360
Liabilities
Other liabilities ⁽²⁾	$	24,330	$	—	$	24,330	$	—
Total liabilities	$	24,330	$	—	$	24,330	$	—
Non-recurring fair value measurements:
Collateral dependent impaired loans ⁽³⁾	$	48,373	$	—	$	—	$	48,373
Loan servicing rights	5,350		—		—		5,350
Foreclosed assets	3,472		—		—		3,472
Total	$	57,195	$	—	$	—	$	57,195


(1)	Represents residential mortgage loans originated for sale that are carried at fair value and had contractual unpaid principal balances totaling approximately $32.1 million and $14.8 million at June 30, 2018 and December 31, 2017, respectively.


(2)	Derivative financial instruments are included in this category.


(3)	Excludes PCI loans.

The changes in Level 3 assets measured at fair value on a recurring basis for the three and six months ended June 30, 2018 and 2017 are summarized below:



	Available for Sale Securities
	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
	(in thousands)
Balance, beginning of the period	$	6,498		$	11,367		$	7,360		$	11,888
Total net gains (losses) included in other comprehensive income	313			(31		)	(85		)	13
Settlements, net	(368		)	(606		)	(832		)	(1,171		)
Balance, end of the period	$	6,443		$	10,730		$	6,443		$	10,730

No changes in unrealized gains or losses on Level 3 securities were included in earnings during the three and six months ended June 30, 2018 and 2017. There were no transfers of assets into or out of Level 3, or between Level 1 and Level 2, during the three and six months ended June 30, 2018 and 2017.

There have been no material changes in the valuation methodologies used at June 30, 2018 from December 31, 2017.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following valuation techniques were used for financial instruments measured at fair value on a recurring basis. All the valuation techniques described below apply to the unpaid principal balance, excluding any accrued interest or dividends at the measurement date. Interest income and expense are recorded within the consolidated statements of income depending on the nature of the instrument using the effective interest method based on acquired discount or premium.

Available for sale securities.

All U.S. Treasury securities, certain corporate and other debt securities, and certain preferred equity securities are reported at fair value utilizing Level 1 inputs. The majority of other investment securities are reported at fair value utilizing Level 2 inputs. The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom Valley has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricing. 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. Management reviews the data and assumptions used in pricing the securities by its third party provider to ensure the highest level of significant inputs are derived from market observable data. For certain securities, the inputs used by either dealer market participants or an independent pricing service may be derived from unobservable market information (Level 3 inputs). In these instances, Valley evaluates the appropriateness and quality of the assumption and the resulting price. In addition, Valley reviews the volume and level of activity for all available for sale and trading securities and attempts to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value and this results in fair values based on Level 3 inputs. In determining fair value, Valley utilizes unobservable inputs which reflect Valley’s own assumptions about the inputs that market participants would use in pricing each security. In developing its assertion of market participant assumptions, Valley utilizes the best information that is both reasonable and available without undue cost and effort.

In calculating the fair value for the available for sale securities under Level 3, Valley prepared present value cash flow models for four private label mortgage-backed securities. The cash flows for the Level 3 securities incorporated the expected cash flow of each security adjusted for default rates, loss severities and prepayments of the individual loans collateralizing the security.

The following table presents quantitative information about Level 3 inputs used to measure the fair value of these securities at June 30, 2018:



Security Type	Valuation Technique	Unobservable Input	Range	Weighted Average

Private label mortgage-backed securities	Discounted cash flow	Prepayment rate	1.8 - 28.8%	13.0	%
		Default rate	3.1 - 47.4	8.9
		Loss severity	45.4 - 62.0	57.1

Significant increases or decreases in any of the unobservable inputs in the table above in isolation would result in a significantly lower or higher fair value measurement of the securities. Generally, a change in the assumption used for the default rate is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

The cash flow assumptions for the Level 3 securities incorporated independent third party market participant data based on vintage year for each security. The discount rate utilized in determining the present value of cash flows for the mortgage-backed securities was arrived at by combining the yield on orderly transactions for similar maturity government sponsored mortgage-backed securities with (i) the historical average risk premium of similar structured private label securities, (ii) a risk premium reflecting current market conditions, including liquidity risk, and (iii) if applicable, a forecasted loss premium derived from the expected cash flows of each security. The estimated cash flows for each private label mortgage-backed security were then discounted at the aforementioned effective rate to determine the fair value. The quoted prices received from either market participants or independent pricing services are weighted with the internal price estimate to determine the fair value of each instrument.

Loans held for sale. The conforming residential mortgage loans originated for sale are reported at fair value using Level 2 inputs. The fair values were calculated utilizing quoted prices for similar assets in active markets. To determine these fair values, the mortgages held for sale are put into multiple tranches, or pools, based on the coupon rate and maturity of each mortgage. The market prices for each tranche are obtained from both Fannie Mae and Freddie Mac. The market prices represent a delivery price, which reflects the underlying price each institution would pay Valley for an immediate sale of an aggregate pool of mortgages. The market prices received from Fannie Mae and Freddie Mac are then averaged and interpolated or extrapolated, where required, to calculate the fair value of each tranche. Depending upon the time elapsed since the origination of each loan held for sale, non-performance risk and changes therein were addressed in the estimate of fair value based upon the delinquency data provided to both Fannie Mae and Freddie Mac for market pricing and changes in market credit spreads. Non-performance risk did not materially impact the fair value of mortgage loans held for sale at June 30, 2018 and December 31, 2017 based on the short duration these assets were held, and the high credit quality of these loans.

Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs. The fair value of Valley’s derivatives are determined using third party prices that are based on discounted cash flow analysis using observed market inputs, such as the LIBOR and Overnight Index Swap rate curves. The fair value of mortgage banking derivatives, consisting of interest rate lock commitments to fund residential mortgage loans and forward commitments for the future delivery of such loans (including certain loans held for sale at June 30, 2018 and December 31, 2017), is determined based on the current market prices for similar instruments provided by Fannie Mae and Freddie Mac. The fair values of most of the derivatives incorporate credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, to account for potential nonperformance risk of Valley and its counterparties. The credit valuation adjustments were not significant to the overall valuation of Valley’s derivatives at June 30, 2018 and December 31, 2017.

Assets and Liabilities Measured at Fair Value on a Non-recurring Basis

The following valuation techniques were used for certain non-financial assets measured at fair value on a nonrecurring basis, including impaired loans reported at the fair value of the underlying collateral, loan servicing rights and foreclosed assets, which are reported at fair value upon initial recognition or subsequent impairment as described below.

Impaired loans. Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral and are commonly referred to as “collateral dependent impaired loans.” Collateral values are estimated using Level 3 inputs, consisting of individual appraisals that may be adjusted based on certain discounting criteria. At June 30, 2018, certain appraisals were discounted based on specific market data by location and property type. During the quarter ended June 30, 2018, collateral dependent impaired loans were individually re-measured and reported at fair value through direct loan charge-offs to the allowance for loan losses and/or a specific valuation allowance allocation based on the fair value of the underlying collateral. The collateral dependent loan charge-offs to the allowance for loan losses were immaterial for the three and six months ended June 30, 2018 as compared to $1.9 million and $2.1 million for the three and six months ended June 30, 2017, respectively. At June 30, 2018, collateral dependent impaired loans with a total recorded investment of $60.3 million were reduced by specific valuation allowance allocations totaling $23.3 million to a reported total net carrying amount of $37.0 million.

Loan servicing rights. Fair values for each risk-stratified group of loan servicing rights are calculated using a fair value model from a third party vendor that requires inputs that are both significant to the fair value measurement and unobservable (Level 3). The fair value model is based on various assumptions, including but not limited to, prepayment speeds, internal rate of return (“discount rate”), servicing cost, ancillary income, float rate, tax rate, and inflation. The prepayment speed and the discount rate are considered two of the most significant inputs in the model. At June 30, 2018, the fair value model used prepayment speeds (stated as constant prepayment rates) from 0 percent up to 24 percent and a discount rate of 8 percent for the valuation of the loan servicing rights. A significant degree of judgment is involved in valuing the loan servicing rights using Level 3 inputs. The use of different assumptions could have a significant positive or negative effect on the fair value estimate. Impairment charges are recognized on loan servicing rights when the amortized cost of a risk-stratified group of loan servicing rights exceeds the estimated fair value. Valley recorded net recoveries of net impairment charges on its loan servicing rights totaling $90 thousand and $317 thousand for the three and six months ended June 30, 2018, respectively, and $50 thousand and $51 thousand for the three and six months ended June 30, 2017, respectively.

Foreclosed assets. Certain foreclosed assets (consisting of other real estate owned and other repossessed assets), upon initial recognition and transfer from loans, are re-measured and reported at fair value through a charge-off to the allowance for loan losses based upon the fair value of the foreclosed assets. The fair value of a foreclosed asset, upon initial recognition, is typically estimated using Level 3 inputs, consisting of an appraisal that is adjusted based on certain discounting criteria, similar to the criteria used for impaired loans described above. There were no discount adjustments of the appraisals of foreclosed assets at June 30, 2018. At June 30, 2018, foreclosed assets included $1.2 million of assets that were measured at fair value upon initial recognition or subsequently re-measured during the quarter ended June 30, 2018. The foreclosed assets charge-offs to the allowance for the loan losses totaled $649 thousand and $282 thousand for the three months ended June 30, 2018 and 2017, respectively, and $1.2 million and $994 thousand for the six months ended June 30, 2018 and 2017, respectively. The re-measurement of foreclosed assets at fair value subsequent to their initial recognition resulted in net losses within non-interest expense of $145 thousand and $290 thousand for the six months ended June 30, 2018 and 2017, respectively.

Other Fair Value Disclosures

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 fair value estimates presented in the following table were based on pertinent market data and relevant information on the financial instruments available as of the valuation date. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire portfolio of financial instruments. Because no market exists for a portion of the financial instruments, fair value estimates may be based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For instance, Valley has certain fee-generating business lines (e.g., its mortgage servicing operation, trust and investment management departments) that were not considered in these estimates since these activities are not financial instruments. In addition, the tax implications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

The carrying amounts and estimated fair values of financial instruments not measured and not reported at fair value on the consolidated statements of financial condition at June 30, 2018 and December 31, 2017 were as follows:



	Fair Value Hierarchy	June 30, 2018				December 31, 2017
	Fair Value Hierarchy	Carrying Amount		Fair Value		Carrying Amount		Fair Value
		(in thousands)
Financial assets
Cash and due from banks	Level 1	$	307,428	$	307,428	$	243,310	$	243,310
Interest bearing deposits with banks	Level 1	164,838		164,838		172,800		172,800
Investment securities held to maturity:
U.S. Treasury securities	Level 1	138,598		141,605		138,676		145,257
U.S. government agency securities	Level 2	9,447		9,280		9,859		9,981
Obligations of states and political subdivisions	Level 2	615,651		616,786		465,878		477,479
Residential mortgage-backed securities	Level 2	1,185,165		1,146,450		1,131,945		1,118,044
Trust preferred securities	Level 2	49,833		43,334		49,824		40,088
Corporate and other debt securities	Level 2	31,500		31,327		46,509		46,771
Total investment securities held to maturity		2,030,194		1,988,782		1,842,691		1,837,620
Net loans	Level 3	23,095,954		22,752,737		18,210,724		17,562,153
Accrued interest receivable	Level 1	88,155		88,155		73,990		73,990
Federal Reserve Bank and Federal Home Loan Bank stock⁽¹⁾	Level 1	291,705		291,705		178,668		178,668
Financial liabilities
Deposits without stated maturities	Level 1	16,987,360		16,987,360		14,589,941		14,589,941
Deposits with stated maturities	Level 2	4,653,412		4,604,918		3,563,521		3,465,373
Short-term borrowings	Level 1	2,877,912		2,580,009		748,628		679,316
Long-term borrowings	Level 2	2,103,993		1,812,019		2,315,819		2,453,797
Junior subordinated debentures issued to capital trusts	Level 2	55,196		48,918		41,774		37,289
Accrued interest payable ⁽²⁾	Level 1	18,608		18,608		14,161		14,161


(1)	Included in other assets.


(2)	Included in accrued expenses and other liabilities.