Note 19. Fair Value of Financial Instruments

The FASB defines fair value as the exchange price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The FASB’s guidance also establishes a fair value hierarchy that prioritizes the inputs to these valuation techniques used to measure fair value, giving preference to quoted prices in active markets for identical assets or liabilities (level 1) and the lowest priority to unobservable inputs such as a reporting entity’s own data (level 3). Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical assets or liabilities in markets that are not active, observable inputs other than quoted prices, such as interest rates and yield curves, and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Fair Value of Assets Measured on a Recurring Basis

The following tables present for each of the fair value hierarchy levels the Company’s financial assets and liabilities that are measured at fair value on a recurring basis in the consolidated balance sheets.



	December 31, 2018
(in thousands)	Level 1		Level 2		Level 3		Total
Assets
Available for sale debt securities:
U.S. Treasury and government agency securities	$	—	$	71,706	$	—	$	71,706
Municipal obligations		—		240,427		—		240,427
Corporate debt securities		—		3,500		—		3,500
Residential mortgage-backed securities		—		1,443,402		—		1,443,402
Commercial mortgage-backed securities		—		770,077		—		770,077
Collateralized mortgage obligations		—		161,925		—		161,925
Total available for sale securities		—		2,691,037		—		2,691,037
Derivative assets (1)		—		16,980		—		16,980
Total recurring fair value measurements - assets	$	—	$	2,708,017	$	—	$	2,708,017
Liabilities		—				—
Derivative liabilities (1)	$	—	$	14,923	$	7,304	$	22,227
Total recurring fair value measurements - liabilities	$	—	$	14,923	$	7,304	$	22,227

(1)

For further disaggregation of derivative assets and liabilities, see Note 10 – Derivatives.



	December 31, 2017
(in thousands)	Level 1		Level 2		Level 3		Total
Assets
Available for sale debt securities:
U.S. Treasury and government agency securities	$	—	$	97,272	$	—	$	97,272
Municipal obligations		—		243,786		—		243,786
Corporate debt securities		—		3,500		—		3,500
Residential mortgage-backed securities		—		1,715,213		—		1,715,213
Commercial mortgage-backed securities		—		687,135		—		687,135
Collateralized mortgage obligations		—		163,963		—		163,963
Total available for sale securities		—		2,910,869		—		2,910,869
Derivative assets (1)		—		14,157		—		14,157
Total recurring fair value measurements - assets	$	—		2,925,026	$	—		2,925,026
Liabilities						—
Derivative liabilities (1)	$	—	$	14,389	$	—	$	14,389
Total recurring fair value measurements - liabilities	$	—	$	14,389	$	—	$	14,389

(1)

For further disaggregation of derivative assets and liabilities, see Note 10 – Derivatives.

The fair value measurements for investment securities are obtained quarterly from a third-party pricing service that uses industry-standard pricing models. Substantially all of the model inputs are observable in the marketplace or can be supported by observable data. The Company invests only in securities of investment grade quality with a targeted duration, for the overall portfolio, generally between two and five years. Company policies generally limit investments to agency securities and municipal securities determined to be investment grade according to an internally generated score which generally includes a rating of not less than “Baa” or its equivalent by a nationally recognized statistical rating agency.

For the Company’s derivative financial instruments designated as hedges and those under the customer interest rate program, the fair value is obtained from a third-party pricing service that uses an industry-standard discounted cash flow model that relies on inputs, LIBOR swap curves, Overnight Index swap rate curves, observable in the marketplace. To comply with the accounting guidance, credit valuation adjustments are incorporated in the fair values to appropriately reflect nonperformance risk for both the Company and the counterparties. Although the Company has determined that the majority of the inputs used to value these derivative instruments fall within level 2 of the fair value hierarchy, the credit value adjustments utilize level 3 inputs, such as estimates of current credit spreads. The Company has determined that the impact of the credit valuation adjustments is not significant to the overall valuation of these derivatives. As a result, the Company has classified its derivative valuations for these instruments in level 2 of the fair value hierarchy. The Company’s policy is to measure counterparty credit risk quarterly for all derivative instruments subject to master netting arrangements consistent with how market participants would price the net risk exposure at the measurement date.

The Company also has certain derivative instruments associated with the Bank’s mortgage-banking activities. These derivative instruments include interest rate lock commitments on prospective residential mortgage loans and forward commitments to sell these loans to investors on a best efforts delivery basis. The fair value of these derivative instruments is measured using observable market prices for similar instruments and is classified as a level 2 measurement.

The Company’s Level 3 liability consists of a derivative contract with the purchaser of 192,163 shares of Visa Class B common stock. Pursuant to the agreement, the Company retains the risks associated with the ultimate conversion of the Visa Class B common shares into shares of Visa Inc. Class A common stock, such that the counterparty will be compensated for any dilutive adjustments to the conversion ratio and the Company will be compensated for any anti-dilutive adjustments to the ratio. The agreement also requires periodic payments by the Company to the counterparty calculated by reference to the market price of Visa Class A common shares at the time of sale and a fixed rate of interest that steps up once after the eighth scheduled quarterly payment. The fair value of the liability is determined using a discounted cash flow methodology. The significant unobservable inputs used in the fair value measurement are the Company’s own assumptions about estimated changes in the conversion rate of the Visa Class B common shares into Visa Class A common shares, the date on which such conversion is expected to occur and the estimated growth rate of the Visa Class A common share price. Refer to Note 10 – Derivatives for information about the derivative contract with the counterparty.

The Company believes its valuation methods for its assets and liabilities carried at fair value are appropriate; however, the use of different methodologies or assumptions, particularly as applied to Level 3 assets and liabilities, could have a material effect on the computation of their estimated fair values.

Changes in Level 3 Fair Value Measurements and Quantitative Information about Level 3 Fair Value Measurements

The table below presents a rollforward of the amounts on the consolidated balance sheet for the year ended December 31, 2018 for financial instruments of a material nature that are classified within Level 3 of the fair value hierarchy and are measured at fair value on a recurring basis:

(in thousands)


Beginning balance	$	-
Entry into derivative contract		7,304
Ending balance	$	7,304

The table below provides an overview of the valuation techniques and significant unobservable inputs used in those techniques to measure the financial instrument measured on a recurring basis and classified within Level 3 of the valuation. The range of sensitivities that management utilized in its fair value calculations is deemed acceptable in the industry with respect to the identified financial instrument.

(in thousands)


Level 3 Class		Fair Value at December 31, 2018	Valuation Technique	Unobservable Input	Values Utilized
				VISA Class A Appreciation	6.0% - 18.0%
Other derivative liability	$	7,304	Discounted cash flow	Conversion rate	1.62x - 1.59x
				Time until resolution	24 - 48 months

The Company’s policy is to recognize transfers between valuation hierarchy levels as of the end of a reporting period. There were no transfers between levels during the periods presented.

Fair Value of Assets Measured on a Nonrecurring Basis

Certain assets and liabilities are measured at fair value on a nonrecurring basis. Collateral-dependent impaired loans are level 2 assets measured at the fair value of the underlying collateral based on independent third-party appraisals that take into consideration market-based information such as recent sales activity for similar assets in the property’s market.

Other real estate owned, including both foreclosed property and surplus banking property, are level 3 assets that are adjusted to fair value, less estimated selling costs, upon transfer to other real estate owned. Subsequently, other real estate owned is carried at the lower of carrying value or fair value less estimated selling costs. Fair values are determined by sales agreement or third-party appraisals as discounted for estimated selling costs, information from comparable sales, and marketability of the property.

The following table presents for each of the fair value hierarchy levels the Company’s financial assets that are measured at fair value on a nonrecurring basis:



	December 31, 2018
(in thousands)		Level 1		Level 2		Level 3		Total
Collateral dependent impaired loans	$	—	$	170,918	$	—	$	170,918
Other real estate and foreclosed assets, net		—		—		14,594		14,594
Total nonrecurring fair value measurements	$	—	$	170,918	$	14,594	$	185,512



	December 31, 2017
(in thousands)		Level 1		Level 2		Level 3		Total
Collateral dependent impaired loans	$	—	$	184,205	$	—	$	184,205
Other real estate and foreclosed assets, net		—		—		19,608		19,608
Total nonrecurring fair value measurements	$	—	$	184,205	$	19,608	$	203,813

Accounting guidance from the FASB requires the disclosure of estimated fair value information about certain on- and off-balance sheet financial instruments, including those financial instruments that are not measured and reported at fair value on a recurring basis. The significant methods and assumptions used by the Company to estimate the fair value of financial instruments are discussed below.

Cash, Short-Term Investments and Federal Funds Sold – For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

Securities – The fair value measurement for securities available for sale was discussed earlier in the note. The same measurement techniques were applied to the valuation of securities held to maturity.

Loans, Net – The fair value measurement for certain impaired loans was discussed earlier in the note. For the remaining portfolio, fair values were generally determined by discounting scheduled cash flows using discount rates determined with reference to current market rates at which loans with similar terms would be made to borrowers with similar credit quality.

Loans Held For Sale – These loans are recorded at fair value and carried at the lower of cost or market. The carrying amount is considered a reasonable estimate of fair value.

Deposits – The accounting guidance requires that the fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits and interest-bearing checking and savings accounts, be assigned fair values equal to amounts payable upon demand (carrying amounts). The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Securities Sold under Agreements to Repurchase, Federal Funds Purchased and Short-Term FHLB Borrowings – For these short-term liabilities, the carrying amount is a reasonable estimate of fair value.

Long-Term Debt – The fair value is estimated by discounting the future contractual cash flows using current market rates at which debt with similar terms could be obtained.

Derivative Financial Instruments – The fair value measurements for derivative financial instruments were discussed earlier in the note.

The following tables present the estimated fair values of the Company’s financial instruments by fair value hierarchy levels and the corresponding carrying amount at December 31, 2018 and 2017.



	December 31, 2018
							Total		Carrying
(in thousands)	Level 1		Level 2		Level 3		Fair Value		Amount
Financial assets:
Cash, interest-bearing bank
deposits, and federal funds sold	$	494,466	$	—	$	—	$	494,466	$	494,466
Available for sale securities		—		2,691,037		—		2,691,037		2,691,037
Held to maturity securities		—		2,935,856		—		2,935,856		2,979,547
Loans, net		—		170,918		19,555,969		19,726,887		19,831,897
Loans held for sale		—		28,150		—		28,150		28,150
Derivative financial instruments		—		16,980		—		16,980		16,980
Financial liabilities:
Deposits	$	—	$	—	$	23,129,574	$	23,129,574	$	23,150,185
Federal funds purchased		425		—		—		425		425
Securities sold under agreements
to repurchase		428,599		—		—		428,599		428,599
Short-term FHLB Borrowings		1,160,104		—		—		1,160,104		1,160,104
Long-term debt		—		223,135		—		223,135		224,993
Derivative financial instruments		—		14,923		7,304		22,227		22,227



	December 31, 2017
							Total		Carrying
(in thousands)	Level 1		Level 2		Level 3		Fair Value		Amount
Financial assets:
Cash, interest-bearing bank
deposits, and federal funds sold	$	479,332	$	—	$	—	$	479,332	$	479,332
Available for sale securities		—		2,910,869		—		2,910,869		2,910,869
Held to maturity securities		—		2,962,010		—		2,962,010		2,977,511
Loans, net		—		184,205		18,403,303		18,587,508		18,786,855
Loans held for sale		—		39,865		—		39,865		39,865
Derivative financial instruments		—		14,157		—		14,157		14,157
Financial liabilities:
Deposits	$	—	$	—	$	22,238,847	$	22,238,847	$	22,253,202
Federal funds purchased		140,754		—		—		140,754		140,754
Securities sold under agreements
to repurchase		430,569		—		—		430,569		430,569
FHLB Borrowings		1,132,567		—		—		1,132,567		1,132,567
Long-term debt		—		303,631		—		303,631		305,513
Derivative financial instruments		—		14,389		—		14,389		14,389