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Fair Value Measurements

6 Months Ended

Jun. 30, 2020

(In Thousands)

Fair Value Measurements and the Fair Level Hierarchy

ASC 820, “Fair Value Measurements and Disclosures,” provides guidance for using fair value to measure assets and liabilities and also establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to a valuation based on quoted prices in active markets for

identical assets and liabilities (Level 1), moderate priority to a valuation based on quoted prices in active markets for similar assets and liabilities and/or based on assumptions that are observable in the market (Level 2), and the lowest priority to a valuation based on assumptions that are not observable in the market (Level 3).

Recurring Fair Value Measurements

The Company carries certain assets and liabilities at fair value on a recurring basis in accordance with applicable standards. The Company’s recurring fair value measurements are based on the requirement to carry such assets and liabilities at fair value or the Company’s election to carry certain eligible assets and liabilities at fair value. Assets and liabilities that are required to be carried at fair value on a recurring basis include securities available for sale and derivative instruments. The Company has elected to carry mortgage loans held for sale at fair value on a recurring basis as permitted under the guidance in ASC 825, “Financial Instruments” (“ASC 825”).

The following methods and assumptions are used by the Company to estimate the fair values of the Company’s financial assets and liabilities that are measured on a recurring basis:

Securities available for sale: Securities available for sale consist primarily of debt securities, such as obligations of U.S. Government agencies and corporations, obligations of states and political subdivisions, mortgage-backed securities and trust preferred securities. Where quoted market prices in active markets are available, securities are classified within Level 1 of the fair value hierarchy. If quoted prices from active markets are not available, fair values are based on quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active, or model-based valuation techniques where all significant assumptions are observable in the market. Such instruments are classified within Level 2 of the fair value hierarchy. When assumptions used in model-based valuation techniques are not observable in the market, the assumptions used by management reflect estimates of assumptions used by other market participants in determining fair value. When there is limited transparency around the inputs to the valuation, the instruments are classified within Level 3 of the fair value hierarchy.

Derivative instruments: The Company uses derivatives to manage various financial risks. Most of the Company’s derivative contracts are extensively traded in over-the-counter markets and are valued using discounted cash flow models which incorporate observable market based inputs including current market interest rates, credit spreads, and other factors. Such instruments are categorized within Level 2 of the fair value hierarchy and include interest rate swaps and other interest rate contracts such as interest rate caps and/or floors. The Company’s interest rate lock commitments are valued using current market prices for mortgage-backed securities with similar characteristics, adjusted for certain factors including servicing and risk. The value of the Company’s forward commitments is based on current prices for securities backed by similar types of loans. Because these assumptions are observable in active markets, the Company’s interest rate lock commitments and forward commitments are categorized within Level 2 of the fair value hierarchy.

Mortgage loans held for sale in loans held for sale: Mortgage loans held for sale are primarily agency loans which trade in active secondary markets. The fair value of these instruments is derived from current market pricing for similar loans, adjusted for differences in loan characteristics, including servicing and risk. Because the valuation is based on external pricing of similar instruments, mortgage loans held for sale are classified within Level 2 of the fair value hierarchy.

The following table presents assets and liabilities that are measured at fair value on a recurring basis as of the dates presented:


	Level 1		Level 2		Level 3		Totals
June 30, 2020
Financial assets:
Trust preferred securities	$	—	$	—	$	7,679	$	7,679
Other available for sale securities	—		1,295,815		—		1,295,815
Total securities available for sale	—		1,295,815		7,679		1,303,494
Derivative instruments	—		40,982		—		40,982
Mortgage loans held for sale in loans held for sale	—		339,747		—		339,747
Total financial assets	$	—	$	1,676,544	$	7,679	$	1,684,223
Financial liabilities:
Derivative instruments:	$	—	$	26,934	$	—	$	26,934


	Level 1		Level 2		Level 3		Totals
December 31, 2019
Financial assets:
Trust preferred securities	$	—	$	—	$	9,986	$	9,986
Other available for sale securities	—		1,280,627		—		1,280,627
Total securities available for sale	—		1,280,627		9,986		1,290,613
Derivative instruments	—		8,498		—		8,498
Mortgage loans held for sale in loans held for sale	—		318,272		—		318,272
Total financial assets	$	—	$	1,607,397	$	9,986	$	1,617,383
Financial liabilities:
Derivative instruments	$	—	$	10,000	$	—	$	10,000

The Company reviews fair value hierarchy classifications on a quarterly basis. Changes in the Company’s ability to observe inputs to the valuation may cause reclassification of certain assets or liabilities within the fair value hierarchy. Transfers between levels of the hierarchy are deemed to have occurred at the end of period. There were no such transfers between levels of the fair value hierarchy during the six months ended June 30, 2020.

The following tables provide a reconciliation for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs, or Level 3 inputs, as of the dates presented:


	2020		2019
Three Months Ended June 30, 2020	Trust preferred securities		Trust preferred securities
Three Months Ended June 30,
Balance at beginning of period	$	8,604	$	10,246
Accretion included in net income	9		9
Unrealized losses included in other comprehensive income	(903)		154




Settlements	(31)		(23)


Balance at end of period	$	7,679	$	10,386

Six Months Ended June 30,
Balance at beginning of period	$	9,986	$	10,633
Accretion included in net income	18		18
Unrealized losses included in other comprehensive income	(2,222)		(133)




Settlements	(103)		(132)


Balance at end of period	$	7,679	$	10,386

For each of the three and six months ended June 30, 2020 and 2019, respectively, there were no gains or losses included in earnings that were attributable to the change in unrealized gains or losses related to assets or liabilities held at the end of each respective period that were measured on a recurring basis using significant unobservable inputs.

The following table presents information as of June 30, 2020 about significant unobservable inputs (Level 3) used in the valuation of assets measured at fair value on a recurring basis:

Financial instrument

Fair
Value

Valuation Technique

Significant
Unobservable Inputs

Range of Inputs

Trust preferred securities

7,679

Discounted cash flows

Default rate

0-100%

Nonrecurring Fair Value Measurements

Certain assets and liabilities may be recorded at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically are a result of the application of the lower of cost or market accounting or a write-down occurring during the period.

The following table provides the fair value measurement for assets measured at fair value on a nonrecurring basis that were still held on the Consolidated Balance Sheets as of the dates presented and the level within the fair value hierarchy each is classified:


June 30, 2020	Level 1		Level 2		Level 3		Totals
Impaired loans	$	—	$	—	$	7,479	$	7,479
OREO	—		—		1,550		1,550
Mortgage servicing rights	—		—		51,474		51,474
Total	$	—	$	—	$	60,503	$	60,503


December 31, 2019	Level 1		Level 2		Level 3		Totals
Impaired loans	$	—	$	—	$	27,348	$	27,348
OREO	—		—		2,820		2,820
Mortgage servicing rights	—		—		53,208		53,208
Total	$	—	$	—	$	83,376	$	83,376

The following methods and assumptions are used by the Company to estimate the fair values of the Company’s financial assets measured on a nonrecurring basis:

Impaired loans: Loans considered impaired are reserved for at the time the loan is identified as impaired taking into account the fair value of the collateral less estimated selling costs. Collateral may be real estate and/or business assets including but not limited to equipment, inventory and accounts receivable. The fair value of real estate is determined based on appraisals by qualified licensed appraisers. The fair value of the business assets is generally based on amounts reported on the business’s financial statements. Appraised and reported values may be adjusted based on changes in market conditions from the time of valuation and management’s knowledge of the client and the client’s business. Since not all valuation inputs are observable, these nonrecurring fair value determinations are classified as Level 3. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors previously identified. Impaired loans that were measured or re-measured at fair value had a carrying value of $9,563 and $29,606 at June 30, 2020 and December 31, 2019, respectively, and a specific reserve for these loans of $2,084 and $2,258 was included in the allowance for credit losses as of such dates.

Other real estate owned: OREO is comprised of commercial and residential real estate obtained in partial or total satisfaction of loan obligations. OREO acquired in settlement of indebtedness is recorded at the fair value of the real estate less estimated costs to sell. Subsequently, it may be necessary to record nonrecurring fair value adjustments for declines in fair value. Fair value, when recorded, is determined based on appraisals by qualified licensed appraisers and adjusted for management’s estimates of costs to sell. Accordingly, values for OREO are classified as Level 3.

The following table presents OREO measured at fair value on a nonrecurring basis that was still held on the Consolidated Balance Sheets as of the dates presented:


	June 30, 2020		December 31, 2019







Carrying amount prior to remeasurement	$	2,154	$	3,726
Impairment recognized in results of operations	(604)		(906)
Fair value	$	1,550	$	2,820

Mortgage servicing rights: The Company retains the right to service certain mortgage loans that it sells to secondary market investors. Mortgage servicing rights are carried at the lower of amortized cost or fair value. Fair value is determined using an income approach with various assumptions including expected cash flows, market discount rates, prepayment speeds, servicing costs, and other factors. Because these factors are not all observable and include management’s assumptions, mortgage servicing rights are classified within Level 3 of the fair value hierarchy. Mortgage servicing rights were carried at amortized cost at June 30, 2020 and December 31, 2019. There were $14,522 of valuation adjustments on MSRs during the six months ended June 30, 2020 and $1,836 of valuation adjustments recognized during the twelve months ended December 31, 2019.

The following table presents information as of June 30, 2020 about significant unobservable inputs (Level 3) used in the valuation of assets measured at fair value on a nonrecurring basis:

Financial instrument

Fair
Value

Valuation Technique

Significant
Unobservable Inputs

Range of Inputs

Impaired loans

7,479

Appraised value of collateral less estimated costs to sell

Estimated costs to sell

4-10%

OREO

1,550

Appraised value of property less estimated costs to sell

Estimated costs to sell

4-10%

Fair Value Option

The Company elected to measure all mortgage loans originated for sale on or after July 1, 2012 at fair value under the fair value option as permitted under ASC 825. Electing to measure these assets at fair value reduces certain timing differences and better matches the changes in fair value of the loans with changes in the fair value of derivative instruments used to economically hedge them.

Net gains of $9,617 and $3,543 resulting from fair value changes of these mortgage loans were recorded in income during the six months ended June 30, 2020 and 2019, respectively. The amount does not reflect changes in fair values of related derivative instruments used to hedge exposure to market-related risks associated with these mortgage loans. The change in fair value of both mortgage loans held for sale and the related derivative instruments are recorded in “Mortgage banking income” in the Consolidated Statements of Income.

The Company’s valuation of mortgage loans held for sale incorporates an assumption for credit risk; however, given the short-term period that the Company holds these loans, valuation adjustments attributable to instrument-specific credit risk is nominal. Interest income on mortgage loans held for sale measured at fair value is accrued as it is earned based on contractual rates and is reflected in loan interest income on the Consolidated Statements of Income.

The following table summarizes the differences between the fair value and the principal balance for mortgage loans held for sale measured at fair value as of June 30, 2020 and December 31, 2019:


	Aggregate Fair Value		Aggregate Unpaid Principal Balance		Difference
June 30, 2020
Mortgage loans held for sale measured at fair value	$	339,747	$	320,018	$	19,729



December 31, 2019
Mortgage loans held for sale measured at fair value	$	318,272	$	308,160	$	10,112

Fair Value of Financial Instruments

The carrying amounts and estimated fair values of the Company’s financial instruments, including those assets and liabilities that are not measured and reported at fair value on a recurring basis or nonrecurring basis, were as follows as of the dates presented:


			Fair Value
As of June 30, 2020	Carrying Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	616,903	$	616,903	$	—	$	—	$	616,903

Securities available for sale	1,303,494		—		1,295,815		7,679		1,303,494
Loans held for sale	339,747		—		339,747		—		339,747
Loans, net	10,851,917		—		—		10,646,335		10,646,335
Mortgage servicing rights	51,474		—		—		51,474		51,474
Derivative instruments	40,982		—		40,982		—		40,982
Financial liabilities
Deposits	$	11,846,358	$	9,860,461	$	2,008,383	$	—	$	11,868,844
Short-term borrowings	341,810		341,810		—		—		341,810

Federal Home Loan Bank advances	152,250		—		158,173		—		158,173
Junior subordinated debentures	110,505		—		89,591		—		89,591
Subordinated notes	113,925		—		111,550		—		111,550
Derivative instruments	26,934		—		26,934		—		26,934


			Fair Value
As of December 31, 2019	Carrying Value		Level 1		Level 2		Level 3		Total
Financial assets
Cash and cash equivalents	$	414,930	$	414,930	$	—	$	—	$	414,930

Securities available for sale	1,290,613		—		1,280,627		9,986		1,290,613
Loans held for sale	318,272		—		318,272		—		318,272
Loans, net	9,637,476		—		—		9,321,039		9,321,039
Mortgage servicing rights	53,208		—		—		53,208		53,208
Derivative instruments	8,498		—		8,498		—		8,498
Financial liabilities
Deposits	$	10,213,168	$	8,052,536	$	2,158,431	$	—	$	10,210,967
Short-term borrowings	489,091		489,091		—		—		489,091

Federal Home Loan Bank advances	152,337		—		152,321		—		152,321
Junior subordinated debentures	110,215		—		104,480		—		104,480
Subordinated notes	113,955		—		117,963		—		117,963
Derivative instruments	10,000		—		10,000		—		10,000

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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