4. Fair Value

The Financial Accounting Standards Board (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 established 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 and Liabilities Measured on a Recurring Basis

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


	September 30, 2014
	Level 1		Level 2		Total
Assets
Available for sale debt securities:
U.S. Treasury and government agency securities	$	300,702	$	—	$	300,702
Municipal obligations		—		18,767		18,767
Corporate debt securities		3,500		—		3,500
Mortgage-backed securities		—		1,241,223		1,241,223
Collateralized mortgage obligations		—		88,558		88,558
Equity securities		9,660		—		9,660

Total available for sale securities		313,862		1,348,548		1,662,410

Derivative assets (1)		—		16,012		16,012

Total recurring fair value measurements - assets	$	313,862	$	1,364,560	$	1,678,422

Liabilities
Derivative liabilities (1)	$	—	$	16,440	$	16,440

Total recurring fair value measurements - liabilities	$	—	$	16,440	$	16,440

(1)	For further disaggregation of derivative assets and liabilities, see Note 5 - Derivatives.


	December 31, 2013
	Level 1		Level 2		Total
Assets
Available for sale debt securities:
U.S. Treasury and government agency securities	$	505	$	—	$	505
Municipal obligations		—		35,961		35,961
Corporate debt securities		3,500		—		3,500
Mortgage-backed securities		—		1,276,958		1,276,958
Collateralized mortgage obligations		—		94,125		94,125
Equity securities		10,723		—		10,723

Total available for sale securities		14,728		1,407,044		1,421,772

Derivative assets (1)		—		15,579		15,579

Total recurring fair value measurements - assets	$	14,728	$	1,422,623	$	1,437,351

Liabilities
Derivative liabilities (1)	$	—	$	15,006	$	15,006

Total recurring fair value measurements - liabilities	$	—	$	15,006	$	15,006

(1)	For further disaggregation of derivative assets and liabilities, see Note 5 - Derivatives.

Securities classified as level 1 within the valuation hierarchy include U.S. Treasury securities, obligations of U.S. Government-sponsored agencies, and certain other debt and equity securities. Level 2 classified securities include residential mortgage-backed securities and collateralized mortgage obligations that are issued or guaranteed by U.S. government agencies, and state and municipal bonds. The level 2 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 high quality securities of investment grade quality with a targeted duration, for the overall portfolio, generally between two and five. Company policies limit investments to securities having a rating of not less than “Baa” or its equivalent by a nationally recognized statistical rating agency. There were no transfers between valuation hierarchy levels during the periods shown.

The fair value of derivative financial instruments, which are predominantly customer interest rate swaps, is obtained from a third-party pricing service that uses an industry-standard discounted cash flow model that relies on inputs, LIBOR swap curves and 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 the 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 in their entirety in level 2 of the fair value hierarchy. The Company’s policy is to measure counterparty credit risk quarterly for all derivative instruments, including those 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.

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 tables present the Company’s financial assets that are measured at fair value (in thousands) on a nonrecurring basis for each of the fair value hierarchy levels.


	September 30, 2014
	Level 1		Level 2		Level 3		Total
Collateral-dependent impaired loans	$	—	$	34,482	$	—	$	34,482
Other real estate owned		—		—		20,742		20,742

Total nonrecurring fair value measurements	$	—	$	34,482	$	20,742	$	55,224


	December 31, 2013
	Level 1		Level 2		Level 3		Total
Collateral-dependent impaired loans	$	—	$	24,392	$	—	$	24,392
Other real estate owned		—		—		25,525		25,525

Total nonrecurring fair value measurements	$	—	$	24,392	$	25,525	$	49,917

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 these 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 of similar credit quality.

Loans Held for Sale – Residential mortgage loans originated for sale are classified as loans held for sale and carried at the lower of cost or market. These loans are generally sold within 90 days. For these short-term instruments, the carrying amounts are a reasonable estimate of fair values.

Accrued Interest Receivable and Accrued Interest Payable – For these short-term instruments, the carrying amounts are a reasonable estimate of fair values.

Deposits - The accounting guidance requires that the fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, 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 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 measurement for derivative financial instruments was 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 September 30, 2014 and December 31, 2013 (in thousands):


	September 30, 2014
	September 30, 2014						Total		Carrying
	Level 1		Level 2		Level 3		Fair Value		Amount
Financial assets:
Cash, interest-bearing bank deposits, and federal funds sold	$	803,917	$	—	$	—	$	803,917	$	803,917
Available for sale securities		313,862		1,348,548		—		1,662,410		1,662,410
Held to maturity securities		—		2,253,219		—		2,253,219		2,250,960
Loans, net		—		34,482		13,081,700		13,116,182		13,223,002
Loans held for sale		—		15,098		—		15,098		15,098
Accrued interest receivable		44,164		—		—		44,164		44,164
Derivative financial instruments		—		16,012		—		16,012		16,012
Financial liabilities:
Deposits	$	—	$	—	$	15,434,876	$	15,434,876	$	15,736,694
Federal funds purchased		7,625		—		—		7,625		7,625
Securities sold under agreements to repurchase		599,184		—		—		599,184		599,184
FHLB borrowings		565,000		—		—		565,000		565,000
Long-term debt		—		344,636		—		344,636		376,452
Accrued interest payable		5,663		—		—		5,663		5,663
Derivative financial instruments		—		16,440		—		16,440		16,440


	December 31, 2013
	December 31, 2013						Total		Carrying
	Level 1		Level 2		Level 3		Fair Value		Amount
Financial assets:
Cash, interest-bearing bank deposits, and federal funds sold	$	617,280	$	—	$	—	$	617,280	$	617,280
Available for sale securities		14,728		1,407,044		—		1,421,772		1,421,772
Held to maturity securities		100,316		2,476,268		—		2,576,584		2,611,352
Loans, net		—		24,392		12,023,330		12,047,722		12,191,191
Loans held for sale		—		24,515		—		24,515		24,515
Accrued interest receivable		42,977		—		—		42,977		42,977
Derivative financial instruments		—		15,579		—		15,579		15,579
Financial liabilities:
Deposits	$	—	$	—	$	15,352,024	$	15,352,024	$	15,360,516
Federal funds purchased		7,725		—		—		7,725		7,725
Securities sold under agreements to repurchase		650,235		—		—		650,235		650,235
Long-term debt		—		385,557		—		385,557		385,826
Accrued interest payable		4,353		—		—		4,353		4,353
Derivative financial instruments		—		15,006		—		15,006		15,006