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, categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. As such, 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.

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 and U.S. Treasury Bills.

If quoted market prices are not available, the Company classifies securities within Level 2 of the valuation hierarchy, and 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, non-agency CMBS, CLO, single-issuer trust preferred securities, and corporate debt securities.

Derivative Instruments. Foreign exchange contracts are valued based on unadjusted quoted prices in active markets and classified within Level 1 of the fair value hierarchy. 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 adjustment related to credit risk is 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 the 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 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 Consolidated Statements of Income. The cost basis of the investments held in Rabbi Trust is $3.9 million as of December 31, 2015.

Alternative Investments. The Company generally records alternative investments at cost, subject to impairment testing. 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. 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. Alternative investments are non-public entities that cannot be redeemed since the Company’s investment is distributed as the underlying investments are liquidated. As such, these investments are classified within Level 3 of the fair value hierarchy. The Company has $6.8 million in unfunded commitments remaining for its alternative investments as of December 31, 2015. See the Investment Securities Portfolio section of Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations for additional discussion of the Company's alternative investments.

Contingent Consideration. The contingent consideration arrangement entitles the Company to receive a rebate of the purchase price relating to the premium paid for account attrition that occurs during the eighteen-month period beginning on the acquisition date. The valuation is reliant upon a pricing model and techniques that require significant management judgment or estimation. Therefore, the contingent consideration is classified within Level 3 of the fair value hierarchy. The key assumptions considered in the valuation model are a 2.5% annual growth rate in deposits, a 13.0% annual account attrition rate plus approximately 6.0% of shock attrition in 2015, a 16.5% discount rate, and a premium on deposits of 4.5%. Subsequent to acquisition closing, the fair value will adjusted for any changes primarily in attrition milestones.

Contingent Liability. The liability valuation is based upon unobservable inputs. Therefore, the contingent liability is classified within Level 3 of the fair value hierarchy. The fair value of the contingency represents the estimated price to transfer the liability between market participants at the measurement date under current market conditions.

Summaries of the fair values of assets and liabilities measured at fair value on a recurring basis are as follows:



	At December 31, 2015
(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	$	924	$	924	$	—	$	—
Agency CMO	548,754		—		548,754		—
Agency MBS	1,065,109		—		1,065,109		—
Agency CMBS	215,350		—		215,350		—
Non-agency CMBS	579,266		—		579,266		—
CLO	429,159		—		429,159		—
Single issuer trust preferred securities	37,170		—		37,170		—
Corporate debt	106,321		—		106,321		—
Equity securities	2,578		2,578		—		—
Total available-for-sale investment securities	2,984,631		3,502		2,981,129		—
Derivative instruments	61,147		183		60,964		—
Mortgage banking derivatives	819		—		819		—
Investments held in Rabbi Trust	5,372		5,372		—		—
Alternative investments	3,471		—		—		3,471
Contingent Consideration	5,331		—		—		5,331
Total financial assets held at fair value	$	3,060,771	$	9,057	$	3,042,912	$	8,802
Financial liabilities held at fair value:
Derivative instruments	$	40,298	$	66	$	40,232	$	—
Contingent Liability	6,000		—		—		6,000
Total financial liabilities held at fair value	$	46,298	$	66	$	40,232	$	6,000



	At December 31, 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	550,988		—		550,988		—
Agency MBS	1,028,518		—		1,028,518		—
Agency CMBS	80,266		—		80,266		—
Non-agency CMBS	553,393		—		553,393		—
CLO	425,734		—		425,734		—
Single issuer trust preferred securities	38,245		—		38,245		—
Corporate debt	110,301		—		110,301		—
Equity securities	5,903		5,903		—		—
Total available-for-sale investment securities	2,793,873		6,428		2,787,445		—
Derivative instruments	52,872		—		52,872		—
Mortgage banking derivatives	18		—		18		—
Investments held in Rabbi Trust	5,901		5,901		—		—
Alternative investments	475		—		—		475
Total financial assets held at fair value	$	2,853,139	$	12,329	$	2,840,335	$	475
Financial liabilities held at fair value:
Derivative instruments	$	36,777	$	293	$	36,484	$	—
Contingent Liability	—		—		—		—
Total financial liabilities held at fair value	$	36,777	$	293	$	36,484	$	—

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



	Financial Assets
(In thousands)	Alternative Investments			Contingent Consideration		Total			Contingent Liability
Balance at January 1, 2015	$	475		$	—	$	475		$	—
Acquisition	—			5,000		5,000			6,000
Unrealized (loss) gain included in net income	(170		)	331		161			—
Purchases/capital funding	3,219			—		3,219			—
Distributions	(53		)	—		(53		)	—
Balance at December 31, 2015	$	3,471		$	5,331	$	8,802		$	6,000

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 within Level 2 of the fair value hierarchy. On occasion, the loans held for sale portfolio includes commercial loans, which require adjustments for changes in loan characteristics. When observable data is unavailable, such loans are classified within Level 3.

Collateral Dependent 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 customized discounting criteria. As such, collateral dependent impaired loans and leases are classified as Level 3 of the fair value hierarchy.

Other Real Estate Owned (OREO) and Repossessed Assets. The total book value of OREO and repossessed assets was $5.0 million at December 31, 2015. 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, as such, OREO and repossessed assets are classified as Level 3 of the fair value hierarchy.

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, the primary risk inherent in valuing mortgage servicing assets is the impact of fluctuating interest rates on the servicing revenue stream. 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 December 31, 2015:



(Dollars in thousands)
Asset	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs
Impaired loans and leases	$	19,644	Real Estate Appraisals	Discount for appraisal type	4% - 15%
				Discount for costs to sell	0% - 8%
Other real estate owned	$	652	Real Estate Appraisals	Discount for appraisal type	0% - 20%
				Discount for costs to sell	8%
Mortgage servicing assets	$	33,568	Discounted cash flow	Constant prepayment rate	7.4% - 32.4%
				Discount rates	1.4% - 3.4%

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, these 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, net. 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. The 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 FHLB 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. FHLB 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 December 31,
	2015				2014
(In thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial Assets:
Level 2
Held-to-maturity investment securities	$	3,923,052	$	3,961,534	$	3,872,955	$	3,948,706
Loans held for sale	37,091		37,457		67,952		68,705
Level 3
Loans and leases, net	15,496,745		15,453,892		13,740,761		13,775,850
Mortgage servicing assets ⁽¹⁾	20,698		33,568		19,379		28,690
Alternative investments	12,900		14,294		16,524		18,046
Financial Liabilities:
Level 2
Deposit liabilities, other than time deposits	$	15,866,624	$	15,866,624	$	13,380,018	$	13,380,018
Time deposits	2,086,154		2,095,357		2,271,587		2,288,760
Securities sold under agreements to repurchase and other borrowings	1,151,400		1,163,974		1,250,756		1,271,596
Federal Home Loan Bank advances ⁽²⁾	2,664,139		2,647,872		2,859,431		2,872,515
Long-term debt ⁽³⁾	226,356		218,143		226,237		227,751

The following adjustments to the carrying amount are not included in the fair value:


(1)	Mortgage servicing assets is net of reserves of $32 thousand at December 31, 2015 and $23 thousand at December 31, 2014.


(2)	FHLB advances is net of unamortized premiums of $24 thousand at December 31, 2015 and $37 thousand at December 31, 2014.


(3)	Long-term debt is net of unamortized discounts of $1.0 million at December 31, 2015 and $1.1 million at December 31, 2014.

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. 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.