Note 6. 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 March 31, 2012 and December 31, 2011. The assets presented under "nonrecurring fair value measurements" in the table 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).

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.


			Fair Value Measurements at Reporting Date Using:
	March 31, 2012		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	$	49,039	$	49,039	$	—	$	—
U.S. government agency securities		107,846		—		107,846		—
Obligations of states and political subdivisions		19,685		—		19,685		—
Residential mortgage-backed securities		482,929		—		436,711		46,218
Trust preferred securities		65,416		10,060		16,854		38,502
Corporate and other debt securities		57,948		28,422		29,526		—
Equity securities		48,111		26,898		21,213		—

Total available for sale		830,974		114,419		631,835		84,720
Trading securities		22,190		—		22,190		—
Loans held for sale ⁽¹⁾		15,892		—		15,892		—
Other assets ⁽²⁾		6,481		—		6,481		—

Total assets	$	875,537	$	114,419	$	676,398	$	84,720

Liabilities
Junior subordinated debentures issued to
VNB Capital Trust I ⁽³⁾		151,409		151,409		—		—
Other liabilities ⁽²⁾		20,580		—		20,580		—

Total liabilities	$	171,989	$	151,409	$	20,580	$	—

Non-recurring fair value measurements:
Collateral dependent impaired loans ⁽⁴⁾	$	62,273	$	—	$	—	$	62,273
Loan servicing rights		9,913		—		—		9,913
Foreclosed assets		8,430		—		—		8,430

Total	$	80,616	$	—	$	—	$	80,616


			Fair Value Measurements at Reporting Date Using:
	December 31, 2011		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. government agency securities	$	90,748	$	—	$	90,748	$	—
Obligations of states and political subdivisions		20,214		—		20,214		—
Residential mortgage-backed securities		310,137		—		259,977		50,160
Trust preferred securities		63,858		19,576		17,131		27,151
Corporate and other debt securities		39,610		30,603		9,007		—
Equity securities		41,953		23,506		18,447		—

Total available for sale		566,520		73,685		415,524		77,311
Trading securities		21,938		—		21,938		—
Loans held for sale ⁽¹⁾		25,169		—		25,169		—
Other assets ⁽²⁾		5,211		—		5,211		—

Total assets	$	618,838	$	73,685	$	467,842	$	77,311

Liabilities
Junior subordinated debentures issued to
VNB Capital Trust I ⁽³⁾	$	160,478	$	160,478	$	—	$	—
Other liabilities ⁽²⁾		21,854		—		21,854		—

Total liabilities	$	182,332	$	160,478	$	21,854	$	—

Non-recurring fair value measurements:
Collateral dependent impaired loans ⁽⁴⁾	$	66,854	$	—	$	—	$	66,854
Loan servicing rights		9,078		—		—		9,078
Foreclosed assets		15,874		—		—		15,874

Total	$	91,806	$	—	$	—	$	91,806

(1)	Loans held for sale (which consist of residential mortgages) are carried at fair value and had contractual unpaid principal balances totaling approximately $15.4 million and $24.3 million at March 31, 2012 and December 31, 2011, respectively.

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

(3)	The junior subordinated debentures had contractual unpaid principal obligations totaling $146.7 million and $157.0 million at March 31, 2012 and December 31, 2011, respectively.

(4)	Excludes covered loans acquired in the FDIC-assisted transactions and other purchased credit-impaired loans acquired in the first quarter of 2012.

The changes in Level 3 assets measured at fair value on a recurring basis for the three months ended March 31, 2012 and 2011 are summarized below:


		Three Months Ended March 31, 2012					Three Months Ended March 31, 2011
	Trading Securities		Available For Sale Securities			Trading Securities			Available For Sale Securities
	(in thousands)
Balance, beginning of the period	$	—	$	77,311		$	21,903		$	138,655
Transfers out of Level 3:
Residential mortgage-backed securities		—		—			—			(44,771	)
Trust preferred securities		—		—			(21,903	)		(17,397	)
Corporate and other debt securities		—		—			—			(12,914	)
Equity securities		—		—			—			(9,353	)
Total net losses for the period included in:
Net income		—		—			—			(825	)
Other comprehensive income		—		11,107			—			1,361
Settlements		—		(3,698	)		—			(2,383	)

Balance, end of the period	$	—	$	84,720		$	—		$	52,373

Change in unrealized losses for the period included in earnings for assets held at the end of the reporting period ⁽¹⁾	$	—	$	—		$	—		$	(825	)⁽²⁾

(1)	Represents net losses that are due to changes in economic conditions and management's estimates of fair value.

(2)	Represents the net impairment losses on securities recognized in earnings for the period.

During the quarters ended March 31, 2012 and 2011, there were no transfers of assets between Level 1 and Level 2.

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 and dividend income 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 and trading securities. All U.S. Treasury securities, certain corporate and other debt securities, and certain common and preferred equity securities (including certain trust preferred securities) are reported at fair values utilizing Level 1 inputs. The majority of the other accruing investment securities in which Valley has not previously recognized other-than-temporary impairment charges 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 certain private label mortgage-backed securities and trust preferred securities. The cash flows for the residential mortgage-backed 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 cash flows for trust preferred securities reflected the contractual cash flow, adjusted if necessary for potential changes in the amount or timing of cash flows due to the underlying credit worthiness of each issuer. The following table presents quantitative information about Level 3 inputs used to measure the fair value of these securities at March 31, 2012:


Security Type	Valuation Technique	Unobservable Input	Range			Weighted Average
Mortgage-backed securities	Discounted cash flow	Prepayment rate		1.6 -25.8	%		15.1	%
		Default rate		3.0-17.9			6.6
		Loss severity		39.2 -58.9			5.0
Trust preferred securities	Discounted cash flow	Default rate		0.0 -100.0	%		5.0	%
		Loss severity		0.0-100.0			27.0

Significant increases (decreases) in any of the unobservable inputs in the table above in isolation would result in a significantly lower (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.

For the Level 3 available for sale private label mortgage-backed securities, cash flow assumptions 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.

For the Level 3 available for sale trust preferred securities, consisting of two pooled securities, the resulting estimated future cash flows were discounted at a yield determined by reference to similarly structured securities for which observable orderly transactions occurred. The discount rate for each security was applied using a pricing matrix based on credit, security type and maturity characteristics to determine the fair value. The fair value calculations for both securities are received from an independent valuation advisor. In validating the fair value calculation from an independent valuation advisor, Valley reviews accuracy of the inputs and the appropriateness of the unobservable inputs utilized in the valuation to ensure the fair value calculation is reasonable from a market participant perspective.

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 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 March 31, 2012 and December 31, 2011 based on the short duration these assets were held, and the high credit quality of these loans.

Junior subordinated debentures issued to capital trusts. The junior subordinated debentures issued to VNB Capital Trust I are reported at fair value using Level 1 inputs. The fair value was estimated using quoted prices in active markets for similar assets, specifically the quoted price of the VNB Capital Trust I preferred stock traded under ticker symbol "VLYPRA" on the New York Stock Exchange. The preferred stock and Valley's junior subordinated debentures issued to the Trust have identical financial terms and therefore, the preferred stock's quoted price moves in a similar manner to the estimated fair value and current settlement price of the junior subordinated debentures. The preferred stock's quoted price includes market considerations for Valley's credit and non-performance risk and is deemed to represent the transfer price that would be used if the junior subordinated debenture were assumed by a third party. Valley's potential credit risk and changes in such risk did not materially impact the fair value measurement of the junior subordinated debentures at March 31, 2012 and December 31, 2011.

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 analyses using observed market interest rate curves and volatilities. The fair values 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. On January 1, 2012, Valley made an accounting policy election to use the exception within ASU No. 2011-04 regarding the measurement of the exposure to the counterparty credit risk (i.e., calculating credit valuation adjustments on a net basis by counterparty portfolio). The credit valuation adjustments were not significant to the overall valuation of Valley's derivatives at March 31, 2012 and December 31, 2011.

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 other real estate owned and other repossessed assets (upon initial recognition or subsequent impairment), goodwill measured at fair value in the second step of a goodwill impairment test, and loan servicing rights, core deposits, other intangible assets, and other long-lived assets measured at fair value for impairment assessment.

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 are significantly adjusted based on customized discounting criteria. At March 31, 2012, non-current appraisals were discounted up to 13.2 percent based on specific market data by location and property type. During the three months ended March 31, 2012, 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 direct collateral dependent loan charge-offs to the allowance for loan losses totaled $3.9 million for the three months ended March 31, 2012. At March 31, 2012, collateral dependent impaired loans with a recorded investment of $66.0 million were reduced by specific valuation allowance allocations totaling $3.7 million to a reported net carrying amount of $62.3 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 March 31, 2012, the fair value model used prepayment speeds (stated as constant prepayment rates) ranging from 9.8 percent to 25.9 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. During the first quarter of 2012, Valley recognized net recoveries of impairment charges on loan servicing rights totaling $420 thousand.

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 customized discounting criteria. The discounts on appraisals of foreclosed assets were immaterial at March 31, 2012. During the three months ended March 31, 2012, foreclosed assets measured at fair value upon initial recognition totaled $8.4 million.

Other Fair Value Disclosures

The following table presents the amount of gains and losses from fair value changes included in income before income taxes for financial assets and liabilities carried at fair value for the three months ended March 31, 2012 and 2011:


		Gains (Losses) on Change in Fair Value
Reported in	Reported in	Three Months Ended
Consolidated Statements	Consolidated Statements	March 31,
of Financial Condition	of Income	2012			2011
		(in thousands)
Assets:
Available for sale securities	Net impairment losses on securities	$	—		$	(825	)
Trading securities	Trading (losses) gains, net		252			493
Loans held for sale	Gains on sales of loans, net		3,166			3,609
Liabilities:
Junior subordinated debentures issued to capital trusts	Trading (losses) gains, net		(1,240	)		2,889

		$	2,178		$	6,166

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 March 31, 2012 and December 31, 2011 were as follows


		March 31, 2012				December 31, 2011
	Fair Value Hierarchy	Carrying Amount		Fair Value		Carrying Amount		Fair Value
		(in thousands)
Financial assets
Cash and due from banks	Level 1	$	466,616	$	466,616	$	372,566	$	372,566
Interest bearing deposits with banks	Level 1		34,219		34,219		6,483		6,483
Investment securities held to maturity:
U.S. Treasury securities	Level 1		99,982		110,564		100,018		113,859
Obligations of states and political subdivisions	Level 2		442,551		460,131		433,284		453,201
Residential mortgage-backed securities	Level 2		1,090,434		1,133,217		1,180,104		1,230,993
Trust preferred securities	Level 2		193,298		180,521		193,312		174,753
Corporate and other debt securities	Level 2		52,197		56,011		52,198		54,391

Total investment securities held to maturity			1,878,462		1,940,444		1,958,916		2,027,197

Net loans	Level 3		11,016,652		10,974,970		9,665,839		9,645,517
Accrued interest receivable	Level 1		57,349		57,349		52,527		52,527
Federal Reserve Bank and Federal Home Loan Bank stock⁽¹⁾	Level 1		141,815		141,815		129,669		129,669
Financial liabilities
Deposits without stated maturities	Level 1		8,246,548		8,246,548		7,171,718		7,171,718
Deposits with stated maturities	Level 2		2,710,636		2,767,444		2,501,384		2,557,119
Short-term borrowings	Level 1		410,749		410,757		212,849		215,179
Long-term borrowings	Level 2		2,724,731		3,103,096		2,726,099		3,154,150
Junior subordinated debentures issued to capital trusts	Level 2		40,805		42,492		25,120		25,620
Accrued interest payable⁽²⁾	Level 1		4,026		4,026		3,798		3,798

(1)	Included in other assets.

(2)	Included in accrued expenses and other liabilities.

The following methods and assumptions that were used to estimate the fair value of other financial assets and financial liabilities in the table above:

Cash and due from banks and interest bearing deposits with banks. The carrying amount is considered to be a reasonable estimate of fair value because of the short maturity of these items.

Investment securities held to maturity. Fair values are based on prices 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 (Level 2 inputs). Additionally, Valley reviews the volume and level of activity for all classes of held to maturity 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. If applicable, the adjustment to fair value is derived based on present value cash flow model projections prepared by Valley utilizing assumptions similar to those incorporated by market participants.

Loans. Fair values of non-covered loans (i.e., loans which are not subject to loss-sharing agreements with the FDIC) and covered loans (i.e., loans subject to loss-sharing agreements with the FDIC) are estimated by discounting the projected future cash flows using market discount rates that reflect the credit and interest-rate risk inherent in the loan. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.

Accrued interest receivable and payable. The carrying amounts of accrued interest approximate their fair value due to the short-term nature of these items.

Federal Reserve Bank and Federal Home Loan Bank stock. The redeemable carrying amount of these securities with limited marketability approximates their fair value.

Deposits. Current carrying amounts approximate estimated fair value of demand deposits and savings accounts. The fair value of time deposits is based on the discounted value of contractual cash flows using estimated rates currently offered for alternative funding sources of similar remaining maturity.

Short-term and long-term borrowings. The carrying amounts of certain short-term borrowings, including securities sold under agreement to repurchase (and from time to time, federal funds purchased and overnight FHLB borrowings) approximate their fair values because they frequently re-price to a market rate. The fair values of other short-term and long-term borrowings are estimated by obtaining quoted market prices of the identical or similar financial instruments when available. When quoted prices are unavailable, the fair values of the borrowings are estimated by discounting the estimated future cash flows using current market discount rates of financial instruments with similar characteristics, terms and remaining maturity.

Junior subordinated debentures issued to capital trusts (excluding VNB Capital Trust I). There is no active market for the trust preferred securities issued by Valley capital trusts, except for the securities issued by VNB Capital Trust I whose related debentures are carried at fair value. Therefore, the fair value of debentures not carried at fair value is estimated utilizing the income approach, whereby the expected cash flows, over the remaining estimated life of the security, are discounted using Valley's credit spread over the current yield on a similar maturity of U.S. Treasury security or the three month-LIBOR for the variable rate indexed debentures (Level 2 inputs). Valley's credit spread was calculated based on the exchange quoted price for Valley's trust preferred securities issued by VNB Capital Trust I.