Note 13 — Fair Value

FASB ASC Topic 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States, and enhances disclosures about fair value measurements. FASB ASC Topic 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available for sale securities, derivative contracts, and mortgage servicing rights (“MSRs”) are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, OREO, and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

FASB ASC Topic 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

Level 1	Observable inputs such as quoted prices in active markets;
Level 2	Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
Level 3	Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

The following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities

Securities available for sale are valued on a recurring basis at quoted market prices where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange and The NASDAQ Stock Market, or U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities and debentures issued by government sponsored entities, municipal bonds and corporate debt securities. Securities held to maturity are valued at quoted market prices or dealer quotes similar to securities available for sale. The carrying value of FHLB stock approximates fair value based on the redemption provisions.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at fair value. The fair values of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics. As such, the fair value adjustments for mortgage loans held for sale are recurring Level 2.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan may be considered impaired and an ALLL may be established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using estimated fair value methodologies. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2018, substantially all of the impaired loans were evaluated based on the fair value of the collateral because such loans were considered collateral dependent. Impaired loans, where an allowance is established based on the fair value of collateral; require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company considers the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company considers the impaired loan as nonrecurring Level 3.

Other Real Estate Owned

Typically OREO, consisting of properties obtained through foreclosure or in satisfaction of loans, is reported at fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs (Level 2). However, OREO is considered Level 3 in the fair value hierarchy because management has qualitatively applied a discount due to the size, supply of inventory, and the incremental discounts applied to the appraisals. Management also considers other factors, including changes in absorption rates, length of time the property has been on the market and anticipated sales values, which have resulted in adjustments to the collateral value estimates indicated in certain appraisals. At the time of foreclosure, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the ALLL. Gains or losses on sale and generally any subsequent adjustments to the value are recorded as a component of OREO expense.

Derivative Financial Instruments

Fair value is estimated using pricing models of derivatives with similar characteristics; accordingly, the derivatives are classified within Level 2 of the fair value hierarchy (see Note 15—Derivative Financial Instruments for additional information).

Mortgage servicing rights

The estimated fair value of MSRs is obtained through an independent derivatives dealer analysis of future cash flows. The evaluation utilizes assumptions market participants would use in determining fair value including market discount rates, prepayment speeds, servicing income, servicing costs, default rates and other market driven data, as well as the market’s perception of future interest rate movements. MSRs are classified as Level 3.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis.


			Quoted Prices
			In Active		Significant
			Markets		Other		Significant
			for Identical		Observable		Unobservable
			Assets		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
June 30, 2018:
Assets
Derivative financial instruments	$	8,848	$	—	$	8,848	$	—
Loans held for sale		36,968		—		36,968		—
Securities available for sale:
Government-sponsored entities debt		47,613		—		47,613		—
State and municipal obligations		223,816		—		223,816		—
Mortgage-backed securities		1,306,570		—		1,306,570		—
Corporate securities		—		—		—		—
Total securities available for sale		1,577,999		—		1,577,999		—
Mortgage servicing rights		35,107		—		—		35,107
	$	1,658,922	$	—	$	1,623,815	$	35,107
Liabilities
Derivative financial instruments	$	8,097	$	—	$	8,097	$	—

December 31, 2017:
Assets
Derivative financial instruments	$	3,306	$	—	$	3,306	$	—
Loans held for sale		70,890		—		70,890		—
Securities available for sale:
Government-sponsored entities debt		85,509		—		85,509		—
State and municipal obligations		220,437		—		220,437		—
Mortgage-backed securities		1,340,687		—		1,340,687		—
Corporate securities		1,560		—		1,560		—
Total securities available for sale		1,648,193		—		1,648,193		—
Mortgage servicing rights		31,119		—		—		31,119
	$	1,753,508	$	—	$	1,722,389	$	31,119
Liabilities
Derivative financial instruments	$	3,248	$	—	$	3,248	$	—

June 30, 2017:
Assets
Derivative financial instruments	$	1,956	$	—	$	1,956	$	—
Loans held for sale		65,995		—		65,995		—
Securities available for sale:
Government-sponsored entities debt		75,952		—		75,952		—
State and municipal obligations		193,294		—		193,294		—
Mortgage-backed securities		1,068,597		—		1,068,597		—
Corporate securities		2,584		2,584		—		—
Total securities available for sale		1,340,427		2,584		1,337,843		—
Mortgage servicing rights		29,930		—		—		29,930
	$	1,438,308	$	2,584	$	1,405,794	$	29,930
Liabilities
Derivative financial instruments	$	592	$	—	$	592	$	—

Changes in Level 1, 2 and 3 Fair Value Measurements

When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the significance of the unobservable factors to the overall fair value measurement. However, since Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated to external sources), the gains and losses below include changes in fair value due in part to observable factors that are part of the valuation methodology.

There were no changes in hierarchy classifications of Level 3 assets or liabilities for the six months ended June 30, 2018. A reconciliation of the beginning and ending balances of Level 3 assets and liabilities recorded at fair value on a recurring basis for the six months ended June 30, 2018 and 2017 is as follows:


(Dollars in thousands)	Assets		Liabilities
Fair value, January 1, 2018	$	31,119	$	—
Servicing assets that resulted from transfers of financial assets		3,112		—
Changes in fair value due to valuation inputs or assumptions		2,945		—
Changes in fair value due to decay		(2,069)		—
Fair value , June 30, 2018	$	35,107	$	—

Fair value, January 1, 2017	$	29,037	$	—
Servicing assets that resulted from transfers of financial assets		3,096		—
Changes in fair value due to valuation inputs or assumptions		(371)		—
Changes in fair value due to decay		(1,832)		—
Fair value, June 30, 2017	$	29,930	$	—

There were no unrealized losses included in accumulated other comprehensive income related to Level 3 financial assets and liabilities at June 30, 2018 or 2017.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The tables below present the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis:


			Quoted Prices
			In Active		Significant
			Markets		Other		Significant
			for Identical		Observable		Unobservable
			Assets		Inputs		Inputs
(Dollars in thousands)	Fair Value		(Level 1)		(Level 2)		(Level 3)
June 30, 2018:
OREO	$	17,222	$	—	$	—	$	17,222
Non-acquired impaired loans		5,909		—		—		5,909
December 31, 2017:
OREO	$	11,203	$	—	$	—	$	11,203
Non-acquired impaired loans		10,495		—		—		10,495
June 30, 2017:
OREO	$	14,430	$	—	$	—	$	14,430
Non-acquired impaired loans		3,754		—		—		3,754

Quantitative Information about Level 3 Fair Value Measurement


			Weighted Average
			June 30,		December 31,		June 30,
	Valuation Technique	Unobservable Input	2018		2017		2017
Nonrecurring measurements:
Non-acquired impaired loans	Discounted appraisals	Collateral discounts	3	%	3	%	5	%
OREO	Discounted appraisals	Collateral discounts and estimated costs to sell	17	%	21	%	25	%

Fair Value of Financial Instruments

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those models are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The use of different methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2018, December 31, 2017 and June 30, 2017. Such amounts have not been revalued for purposes of these consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents — The carrying amount is a reasonable estimate of fair value.

Investment Securities — Securities held to maturity are valued at quoted market prices or dealer quotes. The carrying value of FHLB stock approximates fair value based on the redemption provisions. The carrying value of the Company’s investment in unconsolidated subsidiaries approximates fair value. See Note 5—Investment Securities for additional information, as well as page 41 regarding fair value.

Loans held for sale — The fair values disclosed for loans held for sale are based on commitments from investors for loans with similar characteristics.

Loans — ASU 2016-01 - Financial Instruments – Overall – Recognition and Measurement of Financial Assets and Financial Liabilities became effective for the Company on January 1, 2018. This accounting standard requires the company to calculate the fair value of our loans for disclosure purposes based on an estimated exit price. In previous periods we have calculated fair value using only discounted cash flows on fixed rate loans. Therefore, the fair value for loans for June 30, 2018 will be calculated using a different method than that used at December 31, 2017 and June 30, 2017.

With ASU 2016-01, to estimate an exit price, all loans (fixed and variable) are being valued with a discounted cash flow analyses for loans that includes the Company’s estimate of future credit losses expected to be incurred over the life of the loans. Fair values for certain mortgage loans (e.g., one-to-four family residential) and other consumer loans are estimated using discounted cash flow analyses based on the Company’s current rates offered for new loans of the same type, structure and credit quality. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered by the Company for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using a discounted cash flow analyses.

For previous periods, variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Also, for all other loans where a discounted cash flow analyses was used, there was no estimate of future credit losses expected to be incurred over the life of the loans included in the valuation.

Deposit Liabilities — The fair values disclosed for demand deposits (e.g., interest and non-interest bearing checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts, and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Federal Funds Purchased and Securities Sold Under Agreements to Repurchase — The carrying amount of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values.

Other Borrowings — The fair value of other borrowings is estimated using discounted cash flow analysis on the Company’s current incremental borrowing rates for similar types of instruments.

Accrued Interest — The carrying amounts of accrued interest approximate fair value.

Derivative Financial Instruments — The fair value of derivative financial instruments (including interest rate swaps) is estimated using pricing models of derivatives with similar characteristics.

Commitments to Extend Credit, Standby Letters of Credit and Financial Guarantees — The fair values of commitments to extend credit are estimated taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of guarantees and letters of credit are based on fees currently charged for similar agreements or on the estimated costs to terminate them or otherwise settle the obligations with the counterparties at the reporting date.

The estimated fair value, and related carrying amount, of the Company’s financial instruments are as follows:


	Carrying		Fair
(Dollars in thousands)	Amount		Value		Level 1		Level 2		Level 3
June 30, 2018
Financial assets:
Cash and cash equivalents	$	396,849	$	396,849	$	396,849	$	—	$	—
Investment securities		1,597,727		1,597,731		19,229		1,578,502		—
Loans held for sale		36,968		36,968		—		36,968		—
Loans, net of allowance for loan losses (1)		10,778,068		10,547,778		—		—		10,547,778
Accrued interest receivable		33,751		33,751		—		7,333		26,418
Mortgage servicing rights		35,107		35,107		—		—		35,107
Interest rate swap - non-designated hedge		7,750		7,750		—		7,750		—
Other derivative financial instruments (mortgage banking related)		1,098		1,098		—		1,098		—
Financial liabilities:
Deposits		11,638,289		10,675,705		—		10,675,705		—
Federal funds purchased and securities sold under agreements to repurchase		331,969		331,969		—		331,969		—
Other borrowings		115,754		119,221		—		119,221		—
Accrued interest payable		3,882		3,882		—		3,882		—
Interest rate swap - non-designated hedge		7,981		7,981		—		7,981		—
Interest rate swap - cash flow hedge		116		116		—		116		—
Off balance sheet financial instruments:
Commitments to extend credit		—		(62,060)		—		(62,060)		—
December 31, 2017
Financial assets:
Cash and cash equivalents	$	377,627	$	377,627	$	377,627	$	—	$	—
Investment securities		1,673,769		1,673,796		23,047		1,650,749		—
Loans held for sale		70,890		70,890		—		70,890		—
Loans, net of allowance for loan losses (1)		10,575,417		10,724,264		—		—		10,724,264
Accrued interest receivable		32,727		32,727		—		7,051		25,676
Mortgage servicing rights		31,119		31,119		—		—		31,119
Interest rate swap - non-designated hedge		2,367		2,367		—		2,367		—
Other derivative financial instruments (mortgage banking related)		939		939		—		939		—
Financial liabilities:
Deposits		11,532,766		10,796,380		—		10,796,380		—
Federal funds purchased and securities sold under agreements to repurchase		286,857		286,857		—		286,857		—
Other borrowings		216,385		219,421		—		219,421		—
Accrued interest payable		2,789		2,789		—		2,789		—
Interest rate swap - non-designated hedge		2,750		2,750		—		2,750		—
Interest rate swap - cash flow hedge		246		246		—		246		—
Other derivative financial instruments (mortgage banking related)		252		252		—		252		—
Off balance sheet financial instruments:
Commitments to extend credit		—		41,319		—		41,319		—
June 30, 2017
Financial assets:
Cash and cash equivalents	$	431,890	$	431,890	$	431,890	$	—	$	—
Investment securities		1,358,894		1,358,976		14,301		1,344,675		—
Loans held for sale		65,995		65,995		—		65,995		—
Loans, net of allowance for loan losses (1)		8,140,706		8,216,793		—		—		8,216,793
Accrued interest receivable		23,469		23,469		—		5,454		18,015
Mortgage servicing rights		29,930		29,930		—		—		29,930
Interest rate swap - non-designated hedge		208		208		—		208		—
Other derivative financial instruments (mortgage banking related)		1,748		1,748		—		1,748		—
Financial liabilities:
Deposits		9,031,654		8,481,700		—		8,481,700		—
Federal funds purchased and securities sold under agreements to repurchase		334,018		334,018		—		334,018		—
Other borrowings		98,147		100,723		—		100,723		—
Accrued interest payable		1,502		1,502		—		1,502		—
Interest rate swap - cash flow hedge		389		389		—		389		—
Interest rate swap - non-designated hedge		203		203		—		203		—
Off balance sheet financial instruments:
Commitments to extend credit		—		17,200		—		17,200		—
(1) - Loans, net of allowance for loan losses is being valued using a different method at June 30, 2018 from December 31, 2017 and June 30, 2017. See page 45 for explanation of change in method.