NOTE 13: FAIR VALUE MEASUREMENTS

The FASB issued guidance that, among other things, defined fair value, established a consistent framework for measuring fair value, and expanded disclosure for each major asset and liability category measured at fair value on either a recurring or non-recurring basis. The guidance clarified that fair value is an “exit” price, representing the amount that would be received when selling an asset, or paid when transferring a liability, in an orderly transaction between market participants. Fair value is thus a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the FASB established a three-tier fair value hierarchy that prioritizes the inputs used in measuring fair value as follows:

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Level 1 – Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

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Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

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Level 3 – Inputs to the valuation methodology are significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants use in pricing an asset or liability.

A financial instrument’s categorization within this valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The following tables present assets and liabilities that were measured at fair value on a recurring basis as of December 31, 2011 and 2010, and that were included in the Company’s Consolidated Statement of Condition at those dates:


	Fair Value Measurements at December 31, 2011 Using
(in thousands)	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Netting Adjustments		Total Fair Value
Mortgage-Related Securities Available for Sale:
GSE certificates	$	—		$	102,645		$	—	$	—	$	102,645
GSE CMOs		—			65,276			—		—		65,276
Private label CMOs		—			24,041			—		—		24,041

Total mortgage-related securities	$	—		$	191,962		$	—	$	—	$	191,962

Other Securities Available for Sale:
GSE debentures	$	—		$	458,766		$	—	$	—	$	458,766
Corporate bonds		—			—			—		—		—
U. S. Treasury obligations		—			—			—		—		—
State, county, and municipal		—			1,285			—		—		1,285
Capital trust notes		—			14,125			18,078		—		32,203
Preferred stock		—			195			—		—		195
Common stock		37,026			3,225			—		—		40,251

Total other securities	$	37,026		$	477,596		$	18,078	$	—	$	532,700

Total securities available for sale	$	37,026		$	669,558		$	18,078	$	—	$	724,662

Other Assets:
Loans held for sale	$	—		$	1,036,918		$	—	$	—	$	1,036,918
Mortgage servicing rights		—			—			116,416		—		116,416
Derivative assets		9,004			762			15,633		—		25,399
Liabilities:
Derivative liabilities	$	(20	)	$	(11,742	)	$	—	$	—	$	(11,762	)


	Fair Value Measurements at December 31, 2010 Using
(in thousands)	Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Netting Adjustments		Total Fair Value
Mortgage-Related Securities Available for Sale:
GSE certificates	$	—		$	211,515		$	—	$	—	$	211,515
GSE CMOs		—			222,303			—		—		222,303
Private label CMOs		—			51,362			—		—		51,362

Total mortgage-related securities	$	—		$	485,180		$	—	$	—	$	485,180

Other Securities Available for Sale:
GSE debentures	$	—		$	620		$	—	$	—	$	620
Corporate bonds		—			4,250			—		—		4,250
U. S. Treasury obligations		58,553			—			—		—		58,553
State, county, and municipal		—			1,334			—		—		1,334
Capital trust notes		—			13,467			28,537		—		42,004
Preferred stock		—			14,468			6,271		—		20,739
Common stock		34,387			5,889			—		—		40,276

Total other securities	$	92,940		$	40,028		$	34,808	$	—	$	167,776

Total securities available for sale	$	92,940		$	525,208		$	34,808	$	—	$	652,956

Other Assets:
Loans held for sale	$	—		$	1,203,844		$	—	$	—	$	1,203,844
Mortgage servicing rights		—			—			106,186		—		106,186
Derivative assets		152			14,067			53		—		14,272
Liabilities:
Derivative liabilities	$	(210	)	$	(3,908	)	$	—	$	—	$	(4,118	)

The Company reviews and updates the fair value hierarchy classifications for its assets on a quarterly basis. Changes from one quarter to the next that are related to the observability of inputs to a fair value measurement may result in a reclassification from one hierarchy level to another.

A description of the methods and significant assumptions utilized in estimating the fair value of available-for-sale securities follows:

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid government securities, exchange-traded securities, and derivatives.

If quoted market prices are not available for the specific security, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. These pricing models primarily use market-based or independently sourced market parameters as inputs, including, but not limited to, yield curves, interest rates, equity or debt prices, and credit spreads. In addition to observable market information, models incorporate transaction details such as maturity and cash flow assumptions. Securities valued in this manner would generally be classified within Level 2 of the valuation hierarchy and primarily include such instruments as mortgage-related and corporate debt securities.

The Company reviews quoted market prices supplied by independent pricing services, as well as their underlying pricing methodologies, for reasonableness. At various times, the Company will validate, on a sample basis, quoted market prices supplied by independent pricing services compared to market prices obtained from third-party sources or derived from internal models.

The Company carries loans held for sale originated by the Residential Mortgage Banking segment at fair value, in accordance with ASC Topic 825 “Financial Instruments.” The fair value of held-for-sale loans is primarily based on quoted market prices for securities backed by similar types of loans. The changes in fair value of these assets are largely driven by changes in interest rates subsequent to loan funding and changes in the fair value of servicing associated with the mortgage loans held for sale. Loans held for sale are classified within Level 2 of the valuation hierarchy.

In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. In valuing collateralized debt obligations (“CDOs”), which include pooled trust preferred securities and income notes, and certain single-issue capital trust notes, each of which are classified within Level 3, the determination of fair value may require benchmarking to similar instruments or analyzing default and recovery rates. Therefore, CDOs and certain single-issue capital trust notes are valued using a model based on the specific collateral composition and cash flow structure of the securities. Key inputs to the model consist of market spread data for each credit rating, collateral type, and other relevant contractual features. In instances where quoted price information is available, that price is considered when arriving at the security’s fair value. Where there is limited activity or less transparency around the inputs to the valuation of preferred stock, the valuation is based on a discounted cash flow model.

MSRs do not trade in an active open market with readily observable prices. The Company bases the fair value of its MSRs on the present value of estimated future net servicing income cash flows utilizing an internal valuation model. The Company estimates future net servicing income cash flows with assumptions that market participants would use to estimate fair value, including estimates of prepayment speeds, discount rates, default rates, refinance rates, servicing costs, escrow account earnings, contractual servicing fee income, and ancillary income. The Company reassesses and periodically adjusts the underlying inputs and assumptions in the model to reflect market conditions and assumptions that a market participant would consider in valuing the MSR asset. MSR fair value measurements use significant unobservable inputs and, accordingly, are classified within Level 3.

Exchange-traded derivatives that are valued using quoted prices are classified within Level 1 of the valuation hierarchy. The majority of the Company’s derivative positions are valued using internally developed models that use readily observable market parameters as their basis. These are parameters that are actively quoted and can be validated by external sources, including industry pricing services. Where the types of derivative products have been in existence for some time, the Company uses models that are widely accepted in the financial services industry. These models reflect the contractual terms of the derivatives, including the period to maturity, and market-based parameters such as interest rates, volatility, and the credit quality of the counterparty. Furthermore, many of these models do not contain a high level of subjectivity, as the methodologies used in the models do not require significant judgment, and inputs to the models are readily observable from actively quoted markets, as is the case for “plain vanilla” interest rate swaps and option contracts. Such instruments are generally classified within Level 2 of the valuation hierarchy. Derivatives that are valued based on models with significant unobservable market parameters, and that are normally traded less actively, have trade activity that is one-way, and/or are traded in less-developed markets, are classified within Level 3 of the valuation hierarchy.

The fair value of IRLCs for residential mortgage loans that the Company intends to sell is based on internally developed models. The key model inputs primarily include the sum of the value of the forward commitment based on the loans’ expected settlement dates and the projected values of the MSRs, loan level price adjustment factors, and historical IRLC fall-out factors. Such derivatives are classified as Level 3.

While the Company believes its valuation methods are appropriate and consistent with those of other market participants, the use of different methodologies or assumptions to determine the fair values of certain financial instruments could result in different estimates of fair values at the reporting date.

Changes in Level 3 Fair Value Measurements

The following tables present a roll-forward of the balance sheet amounts for the years ended December 31, 2011 and 2010 (including the change in fair value) for financial instruments classified in Level 3 of the valuation hierarchy.


	Fair Value		Total Realized/Unrealized Gains/(Losses) Recorded in											Fair Value		Change in Unrealized Gains/ (Losses) Related to
(in thousands)	January 1, 2011		(Loss) Income			Comprehensive (Loss) Income			Issuances		Transfers out of Level 3			at Dec. 31, 2011		Instruments Held at December 31, 2011
Available-for-sale capital securities and preferred stock	$	34,808	$	(6,160	)	$	(8,479	)	$	—	$	(2,091	)	$	18,078	$	(14,639	)
Mortgage servicing rights		106,186		(71,830	)		—			82,060		—			116,416		(71,830	)
Derivatives, net		53		15,580			—			—		—			15,633		15,580


	Fair Value		Total Realized/Unrealized Gains/(Losses) Recorded in									Fair Value		Change in Unrealized Gains/ (Losses) Related to
(in thousands)	January 1, 2010		Income			Comprehensive (Loss) Income		Issuances		Transfers into Level 3		at Dec. 31, 2010		Instruments Held at December 31, 2010
Available-for-sale capital securities and preferred stock	$	33,783	$	(13,668	)	$	14,693	$	—	$	—	$	34,808	$	1,025
Mortgage servicing rights		8,617		(3,198	)		—		100,767		—		106,186		(3,198	)
Derivatives, net		32		21			—		—		—		53		21

The Company’s policy is to recognize transfers in and out of Levels 1, 2, and 3 as of the end of the reporting period. During the year ended December 31, 2011, the Company transferred certain trust preferred securities out of Level 3 as a result of increased observable market activity for these securities. In addition, $18.1 million of OTTI was recognized on certain preferred stock that had been classified as Level 3. There were no gains or losses recognized as a result of the transfer of securities during the year ended December 31, 2011. There were no transfers of securities between Levels 1 and 2 for the years ended December 31, 2011 or 2010.

Assets Measured at Fair Value on a Non-Recurring Basis

Certain assets are measured at fair value on a non-recurring basis. Such instruments are subject to fair value adjustments under certain circumstances (e.g., when there is evidence of impairment). The following tables present assets and liabilities that were measured at fair value on a non-recurring basis as of December 31, 2011 and 2010, and that were included in the Company’s Consolidated Statements of Condition at those dates:


	Fair Value Measurements at December 31, 2011 Using
(in thousands)	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Fair Value
Certain impaired loans	$	—	$	—	$	72,582	$	72,582
Other assets⁽¹⁾		—		26,810		—		26,810

	$	—	$	26,810	$	72,582	$	99,392

(1)

Represents the fair value of OREO that was measured at fair value subsequent to its initial classification as OREO.


	Fair Value Measurements at December 31, 2010 Using
(in thousands)	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Fair Value
Loans held for sale	$	—	$	3,233	$	—	$	3,233
Certain impaired loans		—		—		237,975		237,975

	$	—	$	3,233	$	237,975	$	241,208

The fair values of collateral-dependent impaired loans are determined using various valuation techniques, including consideration of appraised values and other pertinent real estate market data.

Other Fair Value Disclosures

Certain FASB guidance requires the disclosure of fair value information about the Company’s on- and off-balance-sheet financial instruments. Quoted market prices, when available, are used as the measure of fair value. In cases where quoted market prices are not available, fair values are based on present-value estimates or other valuation techniques. Such fair values are significantly affected by the assumptions used, the timing of future cash flows, and the discount rate.

Because assumptions are inherently subjective in nature, estimated fair values cannot be substantiated by comparison to independent market quotes. Furthermore, in many cases, the estimated fair values provided would not necessarily be realized in an immediate sale or settlement of such instruments.

The following table summarizes the carrying values and estimated fair values of the Company’s financial instruments at December 31, 2011 and 2010:


	December 31,
	2011				2010
(in thousands)	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial Assets:
Cash and cash equivalents	$	2,001,737	$	2,001,737	$	1,927,542	$	1,927,542
Securities held to maturity		3,815,854		3,966,185		4,135,935		4,157,322
Securities available for sale		724,662		724,662		652,956		652,956
FHLB stock		490,228		490,228		446,014		446,014
Loans, net		30,152,154		30,755,121		29,041,595		29,454,199
Mortgage servicing rights		117,012		117,012		107,378		107,378
Derivatives		25,399		25,399		14,272		14,272
Financial Liabilities:
Deposits	$	22,274,130	$	22,321,011	$	21,809,051	$	21,846,984
Borrowed funds		13,960,413		15,423,474		13,536,116		14,801,131
Derivatives		11,762		11,762		4,118		4,118

The methods and significant assumptions used to estimate fair values for the Company’s financial instruments are as follows:

Cash and Cash Equivalents

Cash and cash equivalents include cash and due from banks and federal funds sold. The estimated fair values of cash and cash equivalents are assumed to equal their carrying values, as these financial instruments are either due on demand or have short-term maturities.

Securities Held to Maturity and Available for Sale

If quoted market prices are not available for a specific security, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. These pricing models primarily use market-based or independently sourced market parameters as inputs, including, but not limited to, yield curves, interest rates, equity or debt prices, and credit spreads. In addition to observable market information, pricing models also incorporate transaction details such as maturity and cash flow assumptions.

Federal Home Loan Bank Stock

The fair value of FHLB stock approximates the carrying amount, which is at cost.

Loans

The loan portfolio is segregated into various components for valuation purposes in order to group loans based on their significant financial characteristics, such as loan type (mortgages or other) and payment status (performing or non-performing). The estimated fair values of mortgage and other loans are computed by discounting the anticipated cash flows from the respective portfolios. The discount rates reflect current market rates for loans with similar terms to borrowers of similar credit quality. The estimated fair values of non-performing mortgage and other loans are based on recent collateral appraisals.

The methods used to estimate the fair value of loans are extremely sensitive to the assumptions and estimates used. While management has attempted to use assumptions and estimates that best reflect the Company’s loan portfolio and current market conditions, a greater degree of subjectivity is inherent in these values than in those determined in active markets. Accordingly, readers are cautioned in using this information for purposes of evaluating the financial condition and/or value of the Company in and of itself or in comparison with any other company.

In addition, these methods of estimating fair value do not incorporate the exit-price concept of fair value described in ASC Topic 820-10, “Fair Value Measurements and Disclosures.”

Loans Held for Sale

Fair value is based on independent quoted market prices, where available, and adjusted as necessary for such items as servicing value, guaranty fee premiums, and credit spread adjustments.

Mortgage Servicing Rights

MSRs do not trade in an active market with readily observable prices. Accordingly, the Company utilizes a valuation model that calculates the present value of estimated future cash flows. The model incorporates various assumptions, including estimates of prepayment speeds, discount rates, refinance rates, servicing costs, and ancillary income. The Company reassesses and periodically adjusts the underlying inputs and assumptions in the model to reflect market conditions and assumptions that a market participant would consider in valuing the MSR asset.

Derivative Financial Instruments

For exchange-traded futures and exchange-traded options, the fair value is based on observable quoted market prices in an active market. For forward commitments to buy and sell loans and mortgage-backed securities, the fair value is based on observable market prices for similar securities in an active market. The fair value of IRLCs for one-to-four family mortgage loans that the Company intends to sell is based on internally developed models. The key model inputs primarily include the sum of the value of the forward commitment based on the loans’ expected settlement dates, the value of MSRs arrived at by an independent MSR broker, government agency price adjustment factors, and historical IRLC fall-out factors.

Deposits

The fair values of deposit liabilities with no stated maturity (i.e., NOW and money market accounts, savings accounts, and non-interest-bearing accounts) are equal to the carrying amounts payable on demand. The fair values of CDs represent contractual cash flows, discounted using interest rates currently offered on deposits with similar characteristics and remaining maturities. These estimated fair values do not include the intangible value of core deposit relationships, which comprise a significant portion of the Company’s deposit base.

Borrowed Funds

The estimated fair value of borrowed funds is based either on bid quotations received from securities dealers or the discounted value of contractual cash flows with interest rates currently in effect for borrowed funds with similar maturities and structures.

Off-Balance-Sheet Financial Instruments

The fair values of commitments to extend credit and unadvanced lines of credit are estimated based on an analysis of the interest rates and fees currently charged to enter into similar transactions, considering the remaining terms of the commitments and the creditworthiness of the potential borrowers. The estimated fair values of such off-balance-sheet financial instruments were insignificant at December 31, 2011 and 2010.