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 appropriate 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

Available-for-Sale Investment 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, U.S. Treasury Bills, and interest rate futures contracts.

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. Management maintains procedures to monitor the pricing service's assumptions and establishes processes to challenge the pricing service's valuations that appear unusual or unexpected. Level 2 securities include agency CMO, agency MBS, agency CMBS, CLO, corporate debt, single-issuer trust preferred securities, and CMBS.

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

Derivative Instruments

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. The Company's other derivative instruments are valued using third-party valuation software, which considers the present value of cash flows discounted using observable forward rate assumptions. The resulting fair values are validated against valuations performed by independent third parties and are classified within Level 2 of the fair value hierarchy. In determining if any fair value adjustments related to credit risk are required, Webster evaluates the credit risk of its counterparties by considering factors such as the likelihood of default by the counterparties, its net exposures, the remaining contractual life, as well as the amount of collateral securing the position. Webster reviews its counterparty exposure on a regular basis, and, when necessary, appropriate business actions are taken to adjust the exposure. When determining fair value, Webster applies the portfolio exception with respect to measuring counterparty credit risk for all of its derivative transactions subject to a master netting arrangement. The change in value of derivative assets and liabilities attributable to credit risk was not significant during the reported periods.

Mortgage Banking Derivatives

Mortgage-backed securities are utilized by the Company in its efforts to manage risk of loss associated with its mortgage loan commitments and mortgage loans held for sale. Prior to closing and funding certain single-family residential mortgage loans, an interest rate lock commitment is generally extended to the borrower. During the period from commitment date to closing date, the Company is subject to the risk that market rates of interest may change. If market rates rise, investors generally will pay less to purchase such loans resulting in a reduction in the gain on sale of the loans or, possibly, a loss. In an effort to mitigate such risk, forward delivery sales commitments are established, under which the Company agrees to deliver whole mortgage loans to various investors or issue mortgage-backed securities. The fair value of mortgage banking derivatives is determined based on current market prices for similar assets in the secondary market and, therefore, classified within Level 2 of the fair value hierarchy.

Investments Held in Rabbi Trust

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 funds. Therefore, investments held in the Rabbi Trust are classified within Level 1 of the fair value hierarchy. Webster has elected to measure the investments held 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, in the accompanying 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 accompanying Condensed Consolidated Statements of Income. The cost basis of the investments held in the Rabbi Trust is $4.6 million as of September 30, 2014.

Alternative Investments

The Company generally records alternative investments at cost, subject to impairment testing. There are certain funds in which the ownership percentage is greater than 3% and are, therefore, recorded at fair value on a recurring basis based upon the net asset value of the respective fund. At September 30, 2014, alternative investments consisted of $0.5 million recorded at fair value and $16.2 million recorded at cost. These are non-public investments that cannot be redeemed since the Company’s investment is distributed as the underlying investments are liquidated. The alternative investments included at fair value are classified within Level 3 of the fair value hierarchy. The alternative investments 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 $6.9 million in unfunded commitments remaining for its alternative investments as of September 30, 2014. See Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Investment Securities Portfolio section for a further discussion on the Company's alternative investments.

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



	At September 30, 2014
(In thousands)	Total		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 investment securities:
U.S. Treasury Bills	$	525	$	525	$	—	$	—
Agency CMO	638,223		—		638,223		—
Agency MBS	1,090,820		—		1,090,820		—
Agency CMBS	80,383		—		80,383		—
CMBS	532,842		—		532,842		—
CLO	380,511		—		380,511		—
Pooled trust preferred securities	—		—		—		—
Single issuer trust preferred securities	39,382		—		39,382		—
Corporate debt	111,200		—		111,200		—
Equity securities	—		—		—		—
Total available-for-sale investment securities	2,873,886		525		2,873,361		—
Derivative instruments	43,039		8		43,031		—
Mortgage banking derivatives	387		—		387		—
Investments held in Rabbi Trust	5,841		5,841		—		—
Alternative investments	477		—		—		477
Total financial assets held at fair value	$	2,923,630	$	6,374	$	2,916,779	$	477
Financial liabilities held at fair value:
Derivative instruments	$	24,820	$	450	$	24,370	$	—
Total financial liabilities held at fair value	$	24,820	$	450	$	24,370	$	—



	At December 31, 2013
(In thousands)	Total		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 investment securities:
U.S. Treasury Bills	$	325	$	325	$	—	$	—
Agency CMO	806,912		—		806,912		—
Agency MBS	1,226,702		—		1,226,702		—
Agency CMBS	70,977		—		70,977		—
CMBS	464,274		—		464,274		—
CLO	357,641		—		357,641		—
Pooled trust preferred securities	28,490		—		—		28,490
Single issuer trust preferred securities	34,935		—		34,935		—
Corporate debt	113,091		—		113,091		—
Equity securities	3,584		3,309		275		—
Total available-for-sale investment securities	3,106,931		3,634		3,074,807		28,490
Derivative instruments	41,795		32		41,763		—
Mortgage banking derivatives	540		—		540		—
Investments held in Rabbi Trust	6,097		6,097		—		—
Alternative investments	565		—		—		565
Total financial assets held at fair value	$	3,155,928	$	9,763	$	3,117,110	$	29,055
Financial liabilities held at fair value:
Derivative instruments	$	24,038	$	259	$	23,779	$	—
Total financial liabilities held at fair value	$	24,038	$	259	$	23,779	$	—

The following table presents the changes in Level 3 assets and liabilities that are measured at fair value on a recurring basis:



	Three months ended September 30,						Nine months ended September 30,
(In thousands)	2014			2013			2014			2013
Level 3, beginning of period	$	11,668		$	31,572		$	29,055		$	116,280
Transfers out of Level 3 ⁽¹⁾	—			—			—			(248,844		)
Change in unrealized loss included in other comprehensive income	3,216			7,194			3,410			14,194
Unrealized loss included in net income	(29		)	(70		)	(261		)	(355		)
Realized gain on sale of available for sale securities	(1,680		)	269			2,656			269
Purchases/capital calls	173			—			173			159,412
Sales/proceeds	(12,881		)	(7,740		)	(34,576		)	(7,740		)
Accretion/amortization	10			26			62			214
Calls/paydowns	—			(483		)	(42		)	(2,662		)
Level 3, end of period	$	477		$	30,768		$	477		$	30,768

(1)

As of April 1, 2013, the CLO portfolio was transferred from Level 3 to Level 2 based on having more observable inputs in determining fair value. In prior quarters, the CLO portfolio was priced using average non-binding broker quotes. During the second quarter of 2013, the Company engaged a third-party pricing vendor to provide monthly fair value measurements. This methodology used is a combination of matrix pricing, observed market activity and metrics. Pricing inputs such as credit spreads are observable and market corroborated and, therefore, the CLO portfolio qualifies for Level 2 categorization. The market for CLO is an active market, and there is ample price transparency.

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.

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 residential mortgage loans held for sale is based on quoted market prices of similar loans sold in conjunction with securitization transactions. Accordingly, such loans are classified as Level 2 measurements. On occasion, the loans held for sale portfolio includes commercial loans in which adjustments are required for changes in loan characteristics. When observable data is unavailable, such loans are classified within Level 3. At December 31, 2013, the Company transferred loans held for sale from Level 3 to Level 2 as the secondary market for securities backed by similar loan types is actively traded, providing readily observable market pricing to be used as inputs for the estimated fair value of these loans.

Impaired Loans and Leases

Impaired loans and leases for which repayment 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.

Other Real Estate Owned (OREO) and Repossessed Assets

The total book value of OREO and repossessed assets was $5.2 million at September 30, 2014. 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 valuation may consider available pricing guides, auction results, and price opinions. Certain assets require assumptions about factors that are not observable in an active market in the determination of fair value and are classified as Level 3.

Mortgage Servicing Assets

Mortgage servicing assets are accounted for at cost, subject to impairment testing. When the carrying cost 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, 2014:



(Dollars in thousands)
Asset	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs
Impaired loans and leases	$	40,927	Real Estate Appraisals	Discount for appraisal type	2% - 15%
				Discount for costs to sell	0% - 8%
Other real estate owned	$	831	Real Estate Appraisals	Discount for appraisal type	0% - 25%
				Discount for costs to sell	8%
Mortgage servicing assets	$	29,213	Discounted cash flow	Constant prepayment rate	6.8% - 25.3%
				Discount rates	1.4% - 3.7%

Fair Value of Financial Instruments

The Company is required to disclose the estimated fair value of financial instruments, both assets and liabilities, for which it is practicable to estimate fair value. 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.

Held-to-Maturity Investment Securities

When quoted market prices are not available, the Company employs an independent pricing service 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. Webster has procedures to monitor the pricing service's assumptions and establishes processes to challenge the pricing service's valuations that appear unusual or unexpected. Held-to-Maturity investments which include agency CMO, agency MBS, agency CMBS, Municipal and Private Label MBS securities are classified within Level 2 of the fair value hierarchy.

Loans and Leases

The estimated fair value of loans and leases held for investment is calculated using a discounted cash flow method, using future prepayments and market interest rates inclusive of an illiquidity premium for comparable loans and leases. The associated cash flows are adjusted for credit and other potential losses. Fair value for impaired loans and leases is estimated using the net present value of the expected cash flows. Loans and leases 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 Borrowings

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

Federal Home Loan Bank Advances and Long-Term Debt

The fair value of Federal Home Loan Bank advances and 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 risk. Federal Home Loan Bank advances and long-term debt are classified within Level 2 of the fair value hierarchy.

The estimated fair values of selected financial instruments are as follows:



	At September 30, 2014				At December 31, 2013
(In thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial Assets
Level 2 inputs:
Held-to-maturity investment securities	$	3,641,979	$	3,699,825	$	3,358,721	$	3,370,912
Loans held for sale	26,083		26,453		20,802		20,903
Level 3 inputs:
Loans and leases	13,357,020		13,377,939		12,547,203		12,515,714
Mortgage servicing assets ⁽¹⁾	19,651		29,213		20,983		29,150
Alternative investments	16,188		19,208		16,582		17,047
Financial Liabilities
Level 2 inputs:
Deposit liabilities, other than time deposits	$	13,244,672	$	13,244,672	$	12,627,276	$	12,627,276
Time deposits	2,302,246		2,317,764		2,227,144		2,250,141
Securities sold under agreements to repurchase and other borrowings	1,236,975		1,257,595		1,331,662		1,365,427
Federal Home Loan Bank advances ⁽²⁾	2,290,204		2,301,591		2,052,421		2,063,312
Long-term debt ⁽³⁾	226,208		223,278		228,365		221,613


(1)	The carrying amount of mortgage servicing assets is net of $11 thousand and $0.2 million reserves at September 30, 2014 and December 31, 2013, respectively. The estimated fair value does not include such adjustments.


(2)	The carrying amount of FHLB advances is net of $43 thousand and $61 thousand in hedge accounting adjustments and discounts at September 30, 2014 and December 31, 2013, respectively. The estimated fair value does not include such adjustments.


(3)	The carrying amount of long-term debt is net of $1.1 million in discount at September 30, 2014 and $1.0 million in discount and hedge accounting adjustments, net at December 31, 2013. 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.