Fair Value of Financial Instruments

Valuation Methodologies and Fair Value Hierarchy

The primary financial instruments that the Company carries at fair value include investment securities available-for-sale, derivative instruments including Interest Rate Lock Commitments (“IRLCs”), and residential mortgage loans held-for-sale.

Debt securities issued by U.S. Government corporations and agencies, debt securities issued by U.S. states and political subdivisions, and agency residential and commercial mortgage-backed securities classified as available-for-sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent third party pricing service. We have processes in place to evaluate such third party pricing services to ensure information obtained and valuation techniques are appropriate. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. The investments in the Company’s portfolio are generally not quoted on an exchange but are actively traded in the secondary institutional markets.

The fair value of mortgage loans held-for-sale is based on what secondary markets are currently offering for portfolios with similar characteristics. The fair value measurements consider observable data that may include market trade pricing from brokers and the mortgage-backed security markets. As such, the Company classifies these loans as Level 2.

The Company classifies IRLCs on residential mortgage loans held-for-sale, which are derivatives under ASC 815-10-15, on a gross basis within other assets or other liabilities. The fair value of these commitments, while based on interest rates observable in the market, is highly dependent on the ultimate closing of the loans. These “pull-through” rates are based on both the Company’s historical data and the current interest rate environment and reflect the Company’s best estimate of the likelihood that a commitment will ultimately result in a closed loan. The loan servicing value is also included in the fair value of IRLCs. Because these inputs are not transparent in market trades, IRLCs are considered to be Level 3 assets.

Derivative instruments are primarily transacted in the secondary mortgage and institutional dealer markets and priced with observable market assumptions at a mid-market valuation point, with appropriate valuation adjustments for liquidity and credit risk. For purposes of valuation adjustments to its derivative positions, the Company has evaluated liquidity premiums that may be demanded by market participants, as well as the credit risk of its counterparties and its own credit if applicable. To date, no material losses due to a counterparty’s inability to pay any net uncollateralized position have occurred. Derivatives instruments are considered to be Level 3.

The credit risk associated with the underlying cash flows of an instrument carried at fair value was a consideration in estimating the fair value of certain financial instruments. Credit risk was considered in the valuation through a variety of inputs, as applicable, including, the actual default and loss severity of the collateral, and level of subordination. The assumption used to estimate credit risk applied relevant information that a market participant would likely use in valuing an instrument. Because mortgage loans held-for-sale are generally sold within a few weeks of origination, they are unlikely to demonstrate any of the credit weaknesses discussed above and as a result, the amount of any credit related adjustments to fair value during the years ended December 31, 2017 and 2016 was insignificant.

Recurring Fair Value Measurements

The following tables present certain information regarding financial assets measured at fair value on a recurring basis at December 31, 2017 and 2016. There were no transfers between Level 1, 2, and 3 during the year ended December 31, 2017:



				Fair Value Measurements at December 31, 2017
(in thousands)	Total			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Investment securities available-for-sale	$	120,121		$	—	$	120,121	$	—
Mortgage loans held-for-sale	269,140			—		269,140		—
Other assets⁽¹⁾	4,168			—		—		4,168
Other liabilities⁽¹⁾	(691		)	—		—		(691		)



				Fair Value Measurements at December 31, 2016
(in thousands)	Total			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Investment securities available-for-sale	$	144,310		$	—	$	144,310	$	—
Mortgage loans held-for-sale	252,712			—		252,712		—
Other assets⁽¹⁾	7,111			—		—		7,111
Other liabilities⁽¹⁾	(1,065		)	—		—		(1,065		)


(1)	Includes mortgage-related IRLCs and derivative financial instruments to hedge interest rate risk. IRLCs recorded on a gross basis.

The following table presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the years ended December 31, 2017 and 2016. The changes in the fair value of economic hedges are recorded in noninterest income from mortgage banking activities in the Consolidated Statements of Comprehensive Income and are designed to partially offset the change in fair value of the financial instruments referenced in the following table:



	As of or for the Year Ended December 31,
	2017						2016
(in thousands)	Other assets⁽¹⁾			Other liabilities⁽¹⁾			Other assets⁽¹⁾			Other liabilities⁽¹⁾
Beginning balance	$	7,111		$	(1,065	)	$	4,022		$	(651	)
Total gains (losses) included in earnings:
Issuances	24,763			(3,924		)	31,188			(10,698		)
Settlements and closed loans	(28,018		)	4,298			(25,963		)	10,284
Expirations	312			—			(2,136		)	—
Ending balance	$	4,168		$	(691	)	$	7,111		$	(1,065	)


(1)	Includes mortgage-related IRLCs and derivative financial instruments executed to hedge interest rate risk.

Nonrecurring Fair Value Measurements

Certain financial assets held by the Company are not included in the tables above, but are measured at fair value on a nonrecurring basis. The following tables present the assets that had changes in their recorded fair value and still held at the end of the reporting period by level within the fair value hierarchy based on the inputs used to estimate the fair value at the measurement date.



			Fair Value Measurements at December 31, 2017
(in thousands)	Total Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	23,257	$	—	$	—	$	23,257
ORE, net	4,993		—		—		4,993
Residential mortgage servicing rights	57,895		—		—		57,895
SBA servicing rights	1,027		—		—		1,027



			Fair Value Measurements at December 31, 2016
(in thousands)	Total Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	15,550	$	—	$	—	$	15,550
ORE, net	3,223		—		—		3,223
Residential mortgage servicing rights	44,600		—		—		44,600

Quantitative Information about Level 3 Fair Value Measurements

The following table shows the valuation technique and range, including weighted average, of the significant unobservable inputs and assumptions used in the fair value measurement of the Company’s Level 3 assets and liabilities:



($ in thousands)	Fair Value at December 31,				Valuation Technique	Unobservable Inputs	Range/Weighted Average at December 31, 2017	Range/Weighted Average at December 31, 2016
($ in thousands)	2017		2016		Valuation Technique	Unobservable Inputs	Range/Weighted Average at December 31, 2017	Range/Weighted Average at December 31, 2016
Nonrecurring:
Impaired loans	$	23,257	$	15,550	Appraised value less estimated selling costs	Estimated selling costs	0.00% - 10.00% 10.00%	0.00% - 10.00% 9.69%
Other real estate	4,993		3,223		Discounted appraisals less estimated selling costs	Estimated selling costs	0.00% - 10.00% 9.61%	0.00% - 10.00% 9.13%
Residential mortgage servicing rights	57,895		44,600		Discounted cash flows	Discount rate	9.64% - 11.13% 9.95%	9.64% - 11.13% 9.91%
						Modeled prepayment speeds	7.60% - 15.75% 8.19%	7.47% - 18.03% 7.98%
SBA servicing rights	1,027		—		Discounted cash flows	Discount rate	13.12%	N/A
						Modeled prepayment speeds	11.33%	N/A
Recurring:
IRLCs	$	3,439	$	3,231	Pricing model	Modeled pull-through ratio	83.14%	82.50%
Forward commitments	38		2,815		Investor pricing	Pricing spreads	90.00% - 104.94% 102.64%	90.00% - 106.14% 101.94%

The tables above exclude the initial measurement of assets and liabilities that were acquired as part of acquisitions accounted for as business combinations. These assets and liabilities were recorded at their fair value upon acquisition and were not remeasured during the periods presented unless specifically required by GAAP. Acquisition date fair values represent either Level 2 fair value measurements (investment securities, ORE, property, equipment, and borrowings) or Level 3 fair value measurements (loans, deposits, and core deposit intangible asset).

Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value less estimated closing costs. A loan is considered impaired if it is probable that the Company will be unable to collect all amounts contractually due according to the terms of the loan agreement. Measuring the impairment of loans using the present value of expected future cash flows, discounted at the loan’s effective interest rate, is not considered a fair value measurement. For collateral-dependent loans, fair value is measured based on the value of the collateral securing these loans and is classified as Level 3 in the fair value hierarchy. Collateral may include real estate or business assets, including equipment, inventory and accounts receivable. The value of real estate collateral is determined based on appraisals prepared by qualified licensed appraisers ordered by the Company’s internal appraisal department, which is independent of the Company’s lending function. If significant, the value of business equipment is based on an appraisal by qualified licensed appraisers ordered by the Company; otherwise, the equipment’s net book value on the business’ financial statements is the basis for the value of business equipment. Inventory and accounts receivable collateral are valued based on independent field examiner review or aging reports. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business. Impaired loans are evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.

Foreclosed assets are adjusted to fair value less estimated selling costs upon transfer of the loans to ORE, which becomes the new carrying value of the ORE. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value less estimated selling costs. Fair value is based on independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral using market data including recent sales activity for similar assets in the property’s market. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the property. Management continues to evaluate the appropriateness of appraised values on at least an annual basis.

Mortgage and SBA servicing rights are initially recorded at fair value when loans are sold with servicing retained. These assets are then amortized in proportion to and over the period of estimated net servicing income. On at least a quarterly basis, these servicing assets are assessed for impairment based on fair value. Management uses a model operated and maintained by an independent third party to assist in determining fair value which stratifies the servicing portfolio into homogeneous subsets with unique behavior characteristics. The model then converts those characteristics into income and expense streams, adjusts those streams for estimated prepayments, present values the adjusted streams, and combines the present values into a total. If the cost basis of any loan stratification tranche is higher than the present value of the tranche, an impairment is recorded. The Company periodically obtains an independent review of the valuation assumptions to validate the fair value estimate and the reasonableness of the assumptions used in measuring fair value. See Note 19 for additional disclosures related to assumptions used in the fair value calculation for mortgage and SBA servicing rights.

Management makes certain estimates and assumptions related to costs to service varying types of loans and pools of loans, prepayment speeds, the projected lives of loans and pools of loans sold servicing retained, and discount factors used in calculating the present values of servicing fees projected to be received. Management periodically obtains an independent review of the valuation assumptions to validate the fair value estimate and the reasonableness of the assumptions used in measuring fair value.

No less frequently than quarterly, management reviews the status of mortgage loans held-for-sale for which the fair value option has been elected and pools of servicing assets to determine if there is any impairment to those assets due to such factors as earlier than estimated repayments or significant prepayments. Any impairment identified in these assets results in reductions in their carrying values through a valuation allowance and a corresponding increase in operating expenses.

The significant unobservable input used in the fair value measurement of the Company’s IRLCs is the pull-through ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. Generally, the fair value of an IRLCs is positive (negative) if the prevailing interest rate is lower (higher) than the IRLCs rate. Therefore, an increase in the pull-through ratio (i.e., higher percentage of loans are estimated to close) will result in the fair value of the IRLCs increasing if in a gain position, or decreasing if in a loss position. The pull-through ratio is largely dependent on the processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. The pull-through ratio is estimated based on calculations provided by the secondary marketing department using historical data. The estimated pull-through ratio is periodically reviewed by the Company’s Secondary Marketing Department of the Mortgage Banking Division for reasonableness.

Forward commitments are instruments that are used to hedge the value of the IRLCs and mortgage loans held-for-sale. The Company takes investor commitments to sell a loan or pool of newly originated loans to an investor for an agreed upon price for delivery in the future. This type of forward commitment is also known as a mandatory commitment. Generally, the fair value of a forward commitment is negative (positive) if the prevailing interest rate is lower (higher) than the current commitment interest rate. The value of these commitments is ultimately determined by the investor that sold the commitment and represents a significant unobservable input used in the fair value measurement of the Company’s forward commitments.

Fair Value Option

The Company records mortgage loans held-for-sale at fair value. The Company chose to fair value these mortgage loans held-for-sale to better align results with the underlying economic changes in value of the loans and related hedge instruments. Interest income on residential mortgage loans held-for-sale is recorded on an accrual basis in the Consolidated Statements of Comprehensive Income under the heading “Interest income-loans, including fees.”

The servicing value is included in the fair value of the mortgage loans held-for-sale and initially recognized at the time the Company enters into IRLCs with borrowers. The mark-to-market adjustments related to mortgage loans held-for-sale and the associated economic hedges are reported in noninterest income from mortgage banking activities in the Consolidated Statements of Comprehensive Income.

The following table presents the difference between the aggregate fair value and the aggregate unpaid principal balance of loans held-for-sale for which the fair value option (“FVO”) has been elected as of December 31, 2017 and 2016. There were no loans held-for-sale measured under FVO that were 90 days or more past due or in nonaccrual status at December 31, 2017 or 2016.



(in thousands)	Aggregate Fair Value December 31, 2017		Aggregate Unpaid Principal Balance at December 31, 2017		Aggregate Fair Value Over Unpaid Principal
Residential mortgage loans held-for-sale	$	269,140	$	262,315	$	6,825

(in thousands)	Aggregate Fair Value December 31, 2016		Aggregate Unpaid Principal Balance at December 31, 2016		Aggregate Fair Value Over Unpaid Principal
Residential mortgage loans held-for-sale	$	252,712	$	250,095	$	2,616

The net fair value gain (loss) related to mortgage banking activities for items measured at fair value pursuant to election of FVO was $4.2 million, $(2.8) million, and $464,000 for the years ended December 31, 2017, 2016, and 2015, respectively.

Fair Value of Financial Instruments

The estimated fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. In cases where quoted market prices for the Company’s various financial instruments are not available, fair values are based on settlements using present value or other valuation techniques. Those techniques are significantly affected by the imprecision in estimating unobservable inputs and the assumptions used, including the discount rate and estimates of future cash flows. While the Company believes its valuation methods are appropriate, 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 instruments. In that regard, the aggregate fair value amounts presented in the tables below do not represent the underlying value of the Company.

The following tables include the carrying amount and estimated fair value, as well as the level within the fair value hierarchy, of the Company’s financial instruments. The fair value estimates presented are based upon relevant information available to management as of December 31, 2017 and 2016:



			Fair Value Measurements at December 31, 2017
(in thousands)	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Fair Value
Financial instruments (assets):
Cash and cash equivalents	$	186,302	$	186,302	$	—	$	—	$	186,302
Investment securities available-for-sale	120,121		—		120,121		—		120,121
Investment securities held-to-maturity	21,689		—		17,684		4,001		21,685
Total loans, net ⁽¹⁾	3,908,949		—		269,140		3,466,838		3,735,978
Financial instruments (liabilities):
Noninterest-bearing demand deposits	1,125,598		—		—		1,125,598		1,125,598
Interest-bearing deposits	2,741,602		—		—		2,739,204		2,739,204
Short-term borrowings	150,580		—		150,580		—		150,580
Subordinated debt	120,587		—		114,402		—		114,402



			Fair Value Measurements at December 31, 2016
(in thousands)	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Fair Value
Financial instruments (assets):
Cash and cash equivalents	$	149,711	$	149,711	$	—	$	—	$	149,711
Investment securities available-for-sale	144,310		—		144,310		—		144,310
Investment securities held-to-maturity	16,583		—		12,438		4,096		16,534
Total loans, net ⁽¹⁾	3,737,761		—		252,712		3,236,345		3,489,057
Financial instruments (liabilities):
Noninterest-bearing demand deposits	964,900		—		—		964,900		964,900
Interest-bearing deposits	2,665,694		—		—		2,664,872		2,664,872
Short-term borrowings	243,351		—		243,351		—		243,351
Subordinated debt	120,454		—		114,537		—		114,537


(1)	Includes $269,140 and $252,712 in residential mortgage loans held-for-sale at December 31, 2017, and 2016, respectively, for which the Company has elected FVO.

The carrying amounts reported in the Consolidated Balance Sheets for cash and cash equivalents reasonably approximates the fair values of those assets. For investment securities, fair value equals quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities or dealer quotes.

Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type. The fair value of performing loans is calculated by discounting scheduled cash flows through the remaining maturities using estimated market discount rates that reflect the credit and interest rate risk inherent in the loans along with a market risk premium and liquidity discount.

Fair value for significant nonperforming loans is estimated taking into consideration recent external appraisals of the underlying collateral for loans that are collateral dependent. If appraisals are not available or if the loan is not collateral dependent, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.

The fair value of deposits with no stated maturities, such as noninterest-bearing demand deposits, savings, interest-bearing demand, and money market accounts, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows based on the discount rates currently offered for deposits of similar remaining maturities.

The fair value of the Company’s borrowings is estimated based on the quoted market price for the same or similar issued or on the current rates offered for debt of the same remaining maturities.

For off-balance sheet instruments, fair values are based on rates currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing for loan commitments and letters of credit. Fees related to these instruments were immaterial at December 31, 2017 and 2016, and the carrying amounts represent a reasonable approximation of their fair values. Loan commitments, letters and lines of credit, and similar obligations typically have variable interest rates and clauses that deny funding if the customer’s credit quality deteriorates. Therefore, the fair values of these items are not significant and are not included in the foregoing schedule.