Fair Value Measurements

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined using quoted market prices. However, in many instances, quoted market prices are not available. In such instances, fair values are determined using various valuation techniques. Various assumptions and observable inputs must be relied upon in applying these techniques. Accordingly, the fair value estimates may not be realized in an immediate transfer of the respective asset or liability.

Fair Value Hierarchy

The three levels within the fair value hierarchy are as follows:


•	Level 1: Valuation is based upon unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

•

Level 2: Fair value is calculated using inputs other than quoted market prices that are directly or indirectly observable for the asset or liability. The valuation may rely on quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit ratings, etc.) or inputs that are derived principally or corroborated by market data by correlation or other means.


•	Level 3: Inputs for determining the fair value of the respective assets or liabilities are not observable. Level 3 valuations are reliant upon pricing models and techniques that require significant management judgment or estimation.

Categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Securities

When quoted prices are available in an active market, the Company classifies securities within Level 1 of the valuation hierarchy. Level 1 securities include equity securities in financial institutions and U.S. Treasury bills.

If quoted market prices are not available, the Company employs an independent pricing service that utilizes matrix pricing to calculate fair value. Such fair value measurements consider observable data such as dealer quotes, market spreads, cash flows, yield curves, live trading levels, trade execution data, market consensus prepayments speeds, credit information, and respective terms and conditions for debt instruments. The Company employs procedures to monitor pricing services’ assumptions and establishes processes to challenge pricing services’ valuations that appear unusual or unexpected. Level 2 securities include agency CMOs-GSE, corporate debt, single-issuer trust preferred securities, mortgage-backed securities-GSE, CMBS securities and auction rate preferred securities.

When a market is illiquid or there is a lack of transparency around the inputs to valuation, the respective securities are classified as Level 3 and reliance is placed upon internally developed models, and management judgment and evaluation for valuation. Pooled trust preferred securities are currently classified as Level 3.

Due to the continued inactive market and illiquid nature of pooled trust preferred securities in the entire capital structure, an internal cash flow model is used to value these securities on a quarterly basis. The Company employs an internal CDO model for projection of future cash flows and discounting those cash flows to a net present value. Each underlying issuer in the pool is rated internally using the latest financial data on each institution, and future deferrals, defaults and losses are then estimated on the basis of continued stress in the financial markets. Further, all current and projected deferrals are not assumed to cure, and all current and projected defaults are assumed to have no recovery value. The resulting net cash flows are then discounted at current market levels for similar types of products that are actively trading. To determine potential OTTI due to credit losses, management compares the amortized cost to the present value of expected cash flows adjusted for deferrals and defaults using the discount margin at the time of purchase. Other factors considered include an analysis of excess subordination and temporary interest shortfall coverage. Additional interest deferrals, defaults, or ratings changes could result in future OTTI charges.

Investments in Private Equity Funds

The Company generally accounts for its percentage ownership of investments in private equity funds at cost, subject to impairment testing, while certain of the funds are included at fair value based upon the net asset value of the respective fund. At September 30, 2012, investments in private equity funds consisted of $1.6 million recorded at fair value and $10.3 million recorded at cost. These are private investments that cannot be redeemed since the Company’s investment is distributed as the underlying investments are liquidated, which generally takes 10 years. There are currently no plans to sell any of these investments prior to their liquidation. The investments in private equity funds included at fair value are classified within Level 3 of the fair value hierarchy. The investments in private equity funds that are carried at cost are considered to be measured at fair value on a non-recurring basis when there is impairment. The Company has $1.9 million in unfunded commitments remaining for its investments in private equity funds at September 30, 2012.

Investments Held in Rabbi Trust

The investments held in a Rabbi Trust primarily include mutual funds that invest in equity and fixed income securities. Shares of mutual funds are valued based on net asset value, which represents quoted market prices for the underlying shares held in the mutual fund. Therefore, investments held in the Rabbi Trust are classified within Level 1 of the fair value hierarchy. The Company has elected to measure the investments in the Rabbi Trust at fair value. The Company consolidates the invested assets of the trust along with the total deferred compensation obligations and includes them in other assets and other liabilities, respectively, including them in the Condensed Consolidated Balance Sheets. Earnings in the Rabbi Trust, including appreciation or depreciation, are reflected as other non-interest income and changes in the corresponding liability are reflected as compensation and benefits in the Condensed Consolidated Statements of Operations. The cost basis of the investments held in the Rabbi Trust is $5.5 million at September 30, 2012.

Derivative Instruments

Derivative instruments are internally valued using observable inputs obtained from third parties. The resulting fair values are validated against valuations performed by independent third parties and are classified within Level 2 of the fair value hierarchy. Fed funds futures contracts are valued based on unadjusted quoted prices in active markets and are classified within Level 1 of the fair value hierarchy. In determining if any fair value adjustments related to credit risk are required, the Company evaluates the credit risk of its counterparties by considering factors such as the likelihood of default by the Company and its counterparties, its net exposures, the remaining contractual life, as well as the amount of collateral securing the position. The Company reviews its counterparty exposure on a regular basis, and, when necessary, appropriate business actions are taken to adjust the exposure. When determining fair value, the Company applies the portfolio exception with respect to measuring counterparty credit risk for all of its derivative transactions subject to a master netting arrangement. To date, the Company has not realized any losses due to a counterparty's inability to pay any net uncollateralized position. The change in value of derivative assets and liabilities attributable to credit risk was not significant during the reported periods.

A summary of fair values for assets and liabilities measured at fair value on a recurring basis is as follows:



	At September 30, 2012
(In thousands)	Carrying Balance		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets held at fair value:
Available for sale securities:
U.S. treasury bills	$	200	$	200	$	—	$	—
Agency CMOs - GSE	1,474,210		—		1,474,210		—
Corporate debt	118,138		—		118,138		—
Pooled trust preferred securities	28,253		—		—		28,253
Single issuer trust preferred securities	41,420		—		41,420		—
Equity securities	8,295		8,095		200		—
Mortgage-backed securities- GSE	1,069,217		—		1,069,217		—
CMBS	380,621		—		380,621		—
Total available for sale securities	3,120,354		8,295		3,083,806		28,253
Derivative instruments:
Interest rate swaps	56,485		—		56,485		—
Mortgage banking derivatives	1,323		—		1,323		—
Investments held in Rabbi Trust	5,706		5,706		—		—
Investments in private equity funds	1,615		—		—		1,615
Total financial assets held at fair value	$	3,185,483	$	14,001	$	3,141,614	$	29,868
Financial liabilities held at fair value:
Derivative instruments:
Interest rate swaps	$	63,646	$	—	$	63,646	$	—
Fed Fund futures contracts	447		447		—		—
Visa Swap	3		—		3		—
Total financial liabilities held at fair value	$	64,096	$	447	$	63,649	$	—



	At December 31, 2011
(In thousands)	Carrying Balance		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets held at fair value:
Available for sale securities:
U.S. treasury bills	$	200	$	200	$	—	$	—
Agency CMOs - GSE	1,940,242		—		1,940,242		—
Pooled trust preferred securities	28,998		—		—		28,998
Single issuer trust preferred securities	38,214		—		38,214		—
Equity securities	9,447		8,472		—		975
Mortgage-backed securities- GSE	527,310		—		527,310		—
CMBS	330,353		—		330,353		—
Total available for sale securities	2,874,764		8,672		2,836,119		29,973
Derivative instruments:
Interest rate swaps	47,134		—		47,134		—
Investments in private equity funds	2,841		—		—		2,841
Total financial assets held at fair value	$	2,924,739	$	8,672	$	2,883,253	$	32,814
Financial liabilities held at fair value:
Derivative instruments:
Interest rate swaps	$	58,424	$	—	$	58,424	$	—
Fed Fund futures contracts	1,365		—		1,365		—
Visa Swap	2		—		2		—
Total financial liabilities held at fair value	$	59,791	$	—	$	59,791	$	—

The following table presents the changes in Level 3 assets and liabilities that are measured at fair value on a recurring basis, for the three and nine months ended September 30, 2012 and 2011:



	Three months ended September 30,						Nine months ended September 30,
(In thousands)	2012			2011			2012			2011
Level 3, beginning of period (a)	$	30,976		$	50,628		$	32,814		$	61,098
Transfers out of Level 3 (b)	—			—			(975		)	—
Change in unrealized loss included in other comprehensive income	1,587			(13,569		)	2,279			(11,492		)
Unrealized gain (loss) included in net income	(539		)	(213		)	(1,161		)	(186		)
Realized loss on sale of available for sale securities	—			—			—			(3,343		)
Purchases/capital calls	—			179			126			411
Sales/proceeds	—			—			—			(5,487		)
Accretion/amortization	63			213			79			488
Calls/paydowns	(2,219		)	(2,746		)	(3,294		)	(6,759		)
Other	—			—			—			(238		)
Level 3, end of period	$	29,868		$	34,492		$	29,868		$	34,492

(a)

The Company's investments in private equity funds are included in Level 3 and has adjusted prior period balances to conform to the current period’s presentation. Management believes that these changes are immaterial to Webster’s financial statements and align reporting of such data more closely with reporting requirements resulting from the adoption of ASU 2011-4 Fair Value Measurement (Topic 820) “Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in US GAAP and IFRS”.


(b)	As of January 1, 2012, auction rate preferred securities were transferred from Level 3 to Level 2. These securities are considered to be Level 2 based upon observable market activity at full par value for recent transactions.

The following table presents information about quantitative inputs and assumptions for items categorized in Level 3 of the fair value hierarchy:



	At September 30, 2012
(In thousands)	Fair Value		Valuation Technique	Unobservable Input	Range (Weighted Average)
Pooled trust preferred securities	$	28,253	Discounted cash flow	Discount rate	6.55 - 10.86% (9.52%)
				Credit spread	394 - 825 bp (691 bp)

Discount rates are derived for each security depending on the original rating or a notched down rating based on management's judgment. The discount represents a market rate used to discount expected cash flows to determine the fair value of the security. Components of the calculated discount rate are published industry credit spreads and 30 year swap rate. When discount rates increase as a result of increase in rate or credit spread, there is a direct inverse correlation with fair value; as discount rates increase, fair value decreases. An increase in credit spreads correlates to an increase in discount rate and therefore a decrease in fair value.

Pooled trust preferred security issuer financials are reviewed on a quarterly basis and an internal credit rating (“shadow rating”) is updated for individual issuers in the model. The shadow rating is correlated to a Moody’s loss table to determine the loss impact on expected cash flows. There is a direct relationship between shadow rating and fair value; as shadow ratings decline the loss probability increases, expected cash flows decline and therefore fair value decreases. There may be instances when a one notch downgrade in credit ratings may not significantly impact the fair value of securities depending on the amount of collateral in the deal that is already rated “D” for which Webster Bank assumes 100% loss.

Assets Measured at Fair Value on a Non-Recurring Basis

Certain assets are measured at fair value on a non-recurring basis; that is, the assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following is a description of valuation methodologies used for assets measured on a non-recurring basis.

Impaired Loans

Impaired loans for which repayment of the loan is expected to be provided solely by the value of the underlying collateral are considered collateral dependent and are valued based on the estimated fair value of such collateral using Level 3 inputs based on customized discounting criteria.

Loans Held for Sale

Loans held for sale are accounted for at the lower of cost or market and are considered to be recognized at fair value when they are recorded at below cost. The fair value of loans held for sale is based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted as required for changes in loan characteristics and are classified within Level 3 of the fair value hierarchy.

Other Real Estate Owned (OREO) and Repossessed Assets

OREO and Repossessed Assets are accounted for at the lower of cost or market and are considered to be recognized at fair value when they are recorded at below cost. The fair value of OREO is based on independent appraisals or internal valuation methods, less estimated selling costs. The fair value of repossessed assets is based on available pricing guides, auction results and price opinions, less estimated selling costs. Certain assets require assumptions that are not observable in an active market in the determination of fair value and are classified as Level 3.

Mortgage Servicing Assets

The Company accounts for mortgage servicing assets at cost, subject to impairment testing. When the carrying value exceeds fair value, a valuation allowance is established to reduce the carrying cost to fair value. Fair value is calculated as the present value of estimated future net servicing income and relies on market based assumptions for loan prepayment speeds, servicing costs, discount rates, and other economic factors. As such, mortgage servicing assets are classified within Level 3 of the fair value hierarchy.

The table below presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at September 30, 2012:



(Dollars in thousands)
Asset	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs
Impaired Loans	$	34,618	Real Estate Appraisals	Discount for dated appraisal	0% - 15%
				Discount for costs to sell	3% - 8%
				Discount for payment status	25% - 33%
			Asset Appraisals	Discount to Inventory	21.4%
				Reduction for estimated accounts receivable recovery	98.8%
Other Real Estate	$	2,622	Appraisals	Discount for costs to sell	8%
				Discount for appraisal type	15% - 60%
Mortgage Servicing Rights	$	11,013	Discounted cash flow	Prepayment speeds	7.4% - 25%
				Discount Rates	2.6% - 4.4%

Assets and Liabilities Disclosed at Fair Value

The Company is required to disclose estimated fair value of financial instruments, both assets and liabilities, for which it is practicable to estimate fair value and the following is a description of valuation methodologies used for those assets and liabilities.

Cash, Due from Banks, and Interest-bearing Deposits

The carrying amount of cash, due from banks, and interest-bearing deposits is used to approximate fair value, given the short time frame to maturity and as such assets do not present unanticipated credit concerns. Cash, Due from Banks, and Interest-bearing deposits are classified within Level 1 of the fair value hierarchy.

Loans and Lease Receivables

The Company employs an independent third party to provide fair value estimates for loans and leases held for investment. Such estimates are calculated using discounted cash flow analysis, using market interest rates for comparable loans. The associated cash flows are adjusted for credit and other potential losses. Fair value for impaired loans is estimated using the net present value of the expected cash flows or the fair value of the underlying collateral if repayment is collateral dependent. Loans and lease receivables are classified within Level 3 of the fair value hierarchy.

Deposit Liabilities

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. Deposit liabilities are classified within Level 2 of the fair value hierarchy.

Securities Sold Under Agreements to Repurchase and Other Short Term Borrowings

Carrying value is an estimate of fair value for those securities sold under agreements to repurchase and other short term borrowings that mature within 90 days. The fair values of all other short term borrowings are estimated using discounted cash flow analyses based on current market rates adjusted, as appropriate, for associated credit and option risks. Securities sold under agreements to repurchase and other short term borrowings are classified within Level 2 of the fair value hierarchy.

Federal Home Loan Bank Advances and Other Long Term Debt

The fair value of long term debt is estimated using a discounted cash flow technique. Discount rates are matched with the time period of the expected cash flow and are adjusted, as appropriate, to reflect credit and option risk. Long term debt and Federal Home Loan Bank advances are classified within Level 2 of the fair value hierarchy.

A summary of estimated fair values of significant financial instruments consisted of the following:



	At September 30, 2012
(In thousands)	Carrying Balance		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Securities available for sale	$	3,120,354	$	8,295	$	3,083,806	$	28,253
Securities held-to-maturity	3,142,160		—		3,321,317		—
Loans held for sale	91,207		—		—		91,207
Loans, net	11,727,652		—		—		11,626,902
Mortgage servicing assets (a)	12,407		—		—		12,811
Investments in private equity funds	1,615		—		—		1,615
Derivative instruments	56,485		—		56,485		—
Investments held in Rabbi Trust	5,706		5,706		—		—
Liabilities
Deposits other than time deposits	$	11,786,738	$	—	$	11,786,738	$	—
Time deposits	2,626,699		—		2,670,366		—
Securities sold under agreements to repurchase and other short-term borrowings	1,310,015		—		1,373,475		—
Federal Home Loan Bank advances (b)	1,452,660		—		1,478,212		—
Long-term debt (c)	335,678		—		296,667		—
Derivative instruments	64,096		447		63,649		—



	At December 31, 2011
(In thousands)	Carrying Balance		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Securities available for sale	$	2,874,764	$	8,672	$	2,836,119	$	29,973
Securities held-to-maturity	2,973,727		—		3,130,546		—
Loans held for sale	57,391		—		—		57,391
Loans, net	10,991,917		—		—		11,097,390
Mortgage servicing assets (a)	7,831		—		—		9,968
Investments in private equity funds	12,343		—		—		12,343
Derivative instruments	47,134		—		47,134		—
Liabilities
Deposits other than time deposits	$	10,821,390	$	—	$	10,619,712	$	—
Time deposits	2,834,635		—		2,883,006		—
Securities sold under agreements to repurchase and other short-term borrowings	1,164,706		—		1,212,228		—
Federal Home Loan Bank advances (b)	1,252,609		—		1,283,871		—
Long-term debt (c)	552,589		—		505,635		—
Derivative instruments	59,791		—		59,791		—


(a)	The carrying amount of mortgage servicing assets is net of $1.6 million and $0.9 million reserves at September 30, 2012 and December 31, 2011, respectively. The estimated fair value does not include such adjustments.


(b)	The carrying amount of FHLB advances is net of $0.1 million and $0.8 million in hedge accounting adjustments and discounts at September 30, 2012 and December 31, 2011, respectively. The estimated fair value does not include such adjustments.


(c)	The carrying amount of Long-term debt is net of $5.8 million and $11.7 million in hedge accounting adjustments and discounts at September 30, 2012 and December 31, 2011, respectively. The estimated fair value does not include such adjustments.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings or any part of a particular financial instrument. Because no active market exists for a significant portion of Webster’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These factors 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.