Note 11. 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, which prioritizes the inputs used in measuring fair value as follows:

—

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

—

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.

—

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 June 30, 2013 and December 31, 2012, and that were included in the Company’s Consolidated Statements of Condition at those dates:


	Fair Value Measurements at June 30, 2013 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⁽¹⁾		Total Fair Value
Assets:
Mortgage-Related Securities Available for Sale:
GSE certificates	$	--	$	29,389	$	--	$	--	$	29,389
GSE CMOs		--		63,130		--		--		63,130
Private label CMOs		--		13,370		--		--		13,370

Total mortgage-related securities	$	--	$	105,889	$	--	$	--	$	105,889

Other Securities Available for Sale:
GSE debentures	$	--	$	--	$	--	$	--	$
Municipal bonds		--		1,180		--		--		1,180
Capital trust notes		--		14,766		19,893		--		34,659
Preferred stock		94,133		27,580		--		--		121,713
Common stock		49,090		2,559		--		--		51,649

Total other securities	$	143,223	$	46,085	$	19,893	$	--	$	209,201

Total securities available for sale	$	143,223	$	151,974	$	19,893	$	--	$	315,090

Other Assets:
Loans held for sale	$	--	$	756,601	$	--	$	--	$	756,601
Mortgage servicing rights		--		--		214,959		--		214,959
Derivative assets-other⁽²⁾		1,475		50,581		--		(35,988)		16,068
Liabilities:
Interest rate lock commitments	$	--	$	--	$	(6,653)	$	--	$	(6,653)
Derivative liabilities		(767)		(25,324)		--		25,810		(281)

(1)	Includes cash collateral received and pledged.

(2)	Includes $1.3 million to purchase Treasury options.


	Fair Value Measurements at December 31, 2012 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
Assets:
Mortgage-Related Securities Available for Sale:
GSE certificates	$	--	$	92,679	$	--	$	--	$	92,679
GSE CMOs		--		67,160		--		--		67,160
Private label CMOs		--		17,416		--		--		17,416

Total mortgage-related securities	$	--	$	177,255	$	--	$	--	$	177,255

Other Securities Available for Sale:
GSE debentures	$	--	$	--	$	--	$	--	$	--
Municipal bonds		--		46,296		--		--		46,296
Capital trust notes		--		19,866		18,569				38,435
Preferred stock		124,734		284		--				125,018
Common stock		39,682		2,580		--		--		42,262

Total other securities	$	164,416	$	69,026	$	18,569	$	--	$	252,011

Total securities available for sale	$	164,416	$	246,281	$	18,569	$	--	$	429,266

Other Assets:
Loans held for sale	$	--	$	1,204,370	$	--	$	--	$	1,204,370
Mortgage servicing rights		--		--		144,520		--		144,520
Interest rate lock commitments		--		--		21,446		--		21,446
Derivative assets-other⁽¹⁾		5,939		2,910		--		(4,730)		4,119
Liabilities:
Derivative liabilities	$	(2,303)	$	(5,808)	$	--	$	4,730	$	(3,381)

(1)	Includes $5.3 million to purchase Treasury options.

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 for 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 values 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. 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.

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 capital trust notes, which may include pooled trust preferred securities, collateralized debt obligations (“CDOs”), and certain single-issue capital trust notes, the determination of fair value may require benchmarking to similar instruments or analyzing default and recovery rates. Therefore, 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, the price is considered when arriving at a 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.

Periodically, the Company uses fair values supplied by independent pricing services to corroborate the fair values derived from the pricing models. In addition, the Company reviews the fair values supplied by independent pricing services, as well as their underlying pricing methodologies, for reasonableness. The Company challenges pricing services’ valuations that appear to be unusual or unexpected.

The Company carries loans held for sale originated by the Residential Mortgage Banking segment at fair value, in accordance with ASC 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. Changes in the 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.

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 interest rate lock commitments (“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 closing ratios. The closing ratio is computed by the Company’s mortgage banking operation and is periodically reviewed by management for reasonableness. 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.

Fair Value Option

Loans Held for Sale

The Company has elected the fair value option for its loans held for sale. The Company’s loans held for sale consist of one-to-four family mortgage loans, none of which were more than 90 days past due at that date. Management believes the mortgage banking business operates on a short-term cycle. Therefore, in order to reflect the most relevant valuations for the key components of this business, and to reduce timing differences in amounts recognized in earnings, the Company has elected to record loans held for sale at fair value to match the recognition of IRLCs, MSRs, and derivatives, all of which are recorded at fair value in earnings. Fair value is based on independent quoted market prices of mortgage-backed securities comprised of loans with similar features to those of loans held for sale, where available, for mortgage-backed securities comprised of loans with similar features to those of loans held for sale, and adjusted as necessary for such items as servicing value, guaranty fee premiums, and credit spread adjustments.

The following table reflects the difference between the fair value carrying amount of loans held for sale for which the Company has elected the fair value option, and the unpaid principal balance.

June 30, 2013

December 31, 2012

(in thousands)

Fair Value
Carrying
Amount

Aggregate
Unpaid
Principal

Fair Value
Carrying Amount
Less Aggregate
Unpaid Principal

Fair Value
Carrying
Amount

Aggregate
Unpaid Principal

Fair Value
Carrying Amount
Less Aggregate
Unpaid Principal

Loans held for sale

$756,601

$767,766

$(11,165)

$1,204,370

$1,159,071

$45,299

Gains and Losses Included in Income for Assets Where the Fair Value Option Has Been Elected

The assets accounted for under the fair value option are initially measured at fair value. Gains and losses from the initial measurement and subsequent changes in fair value are recognized in earnings. For loans held for sale and mortgage servicing rights, the changes in fair value related to initial measurement and the subsequent changes in fair value included in earnings are shown for the periods indicated, below.


	Gain (Loss) Included in Mortgage Banking Income from Changes in Fair Value⁽¹⁾
	For the Three Months Ended June 30,								For the Six Months Ended June 30,
(in thousands)	2013				2012				2013				2012
Loans held for sale		$	(24,437	)		$	28,727			$	(14,765	)		$	33,674
Mortgage servicing rights			19,038				(26,562	)			15,766				(38,039	)

Total (loss) gain		$	(5,399	)		$	2,165			$	1,001			$	(4,365	)

(1)	Does not include the effect of hedging activities.

The Company has determined there is no instrument-specific credit risk related to its loans held for sale, due to the short duration of such assets.

Changes in Level 3 Fair Value Measurements

The following tables include a roll-forward of the balance sheet amounts for the six months ended June 30, 2013 and 2012 (including changes in fair value) for financial instruments classified in Level 3 of the valuation hierarchy:


(in thousands)	Fair Value			Total Realized/Unrealized Gains/(Losses) Recorded in							Issuances			Settlements			Transfers				Fair Value				Change in Unrealized Gains/ (Losses) Related to
(in thousands)	January 1, 2013			Income/ Loss				Comprehensive (Loss) Income			Issuances			Settlements			to/(from) Level 3				at June 30, 2013				Instruments Held at June 30, 2013
Available-for-sale capital securities		$	18,569		$	--			$	1,324		$	--		$	--		$	--			$	19,893			$	1,324
Mortgage servicing rights			144,520			15,766				--			54,673			--			--				214,959				47,848
Interest rate lock commitments			21,446			(28,099	)			--			--			--			--				(6,653	)			(6,541	)

(in thousands)	Fair Value			Total Realized/Unrealized Gains/(Losses) Recorded in							Issuances			Settlements			Transfers				Fair Value				Change in Unrealized Gains/ (Losses) Related to
(in thousands)	January 1, 2012			Income/ Loss				Comprehensive (Loss) Income			Issuances			Settlements			to/(from) Level 3				at June 30, 2012				Instruments Held at June 30, 2012
Available-for-sale capital securities and preferred stock		$	18,078		$	--			$	949		$	--		$	--		$	(3,054	)		$	15,973			$	820
Mortgage servicing rights			116,416			(38,039	)			--			57,799			--			--				136,176				(38,039	)
Interest rate lock commitments			15,633			13,964				--			--			--			--				29,597				13,964

The Company’s policy is to recognize transfers in and out of Levels 1, 2, and 3 at the end of the reporting period. There were no transfers in or out of Level 3 during the six months ended June 30, 2013. During the six months ended June 30, 2013, the Company transferred certain preferred stock to Level 2 from Level 1 as a result of decreased observable market activity for these securities. During the six months ended June 30, 2012, the Company transferred certain trust preferred securities from Level 3 to Level 2 as a result of increased observable market activity for these securities. There were no gains or losses recognized as a result of the transfer of securities during the six months ended June 30, 2013 or 2012. There were no transfers of securities between Levels 1 and 2 for the six months ended June 30, 2012.

For Level 3 assets and liabilities measured at fair value on a recurring basis as of June 30, 2013, the significant unobservable inputs used in the fair value measurements were as follows:

(dollars in thousands)

Fair Value at
June 30, 2013

Valuation Technique

Significant Unobservable Inputs

Significant
Unobservable
Input Value

Capital trust notes

19,893

Discounted Cash Flow

Weighted Average Discount Rate ⁽¹⁾

5.01%

Mortgage Servicing Rights

214,959

Discounted Cash Flow

Weighted Average Constant Prepayment Rate ⁽²⁾

9.60

Weighted Average Discount Rate

10.50

Interest Rate Lock Commitments

(6,653

)

Pricing Model

Weighted Average Closing Ratio

88.04

(1)	Derived from multiple interest rate scenarios that incorporate a spread to the London Interbank Offered Rate swap curve and market volatility.

(2)	Represents annualized loan repayment rate assumptions.

The significant unobservable input used in the fair value measurement of the Company’s capital trust notes is the weighted average discount rate. The fair value of the capital trust notes will move in the opposite direction of the discount rate (i.e., if the discount rate decreases, the value of the capital trust notes will increase). The Company estimates the expected cash flows for such securities, and discounts them using the weighted average discount rates noted above, to arrive at the estimated fair value.

The significant unobservable inputs used in the fair value measurement of the Company’s MSRs are the weighted average constant prepayment rate and the weighted average discount rate. Significant increases (decreases) in any of those inputs in isolation could result in significantly lower or higher fair value measurements. Although the constant prepayment rate and the discount rate are not directly interrelated, they generally will move in opposite directions.

The significant unobservable input used in the fair value measurement of the Company’s IRLCs is the closing ratio, which represents the percentage of loans currently in a lock position that management estimates will ultimately close. Generally, the fair value of an IRLC is positive if the prevailing interest rate is lower than the IRLC rate, and the fair value of an IRLC is negative if the prevailing interest rate is higher than the IRLC rate. Therefore, an increase in the closing ratio (i.e., a higher percentage of loans estimated to close) will result in the fair value of the IRLC increasing if in a gain position, or decreasing if in a loss position. The closing ratio is largely dependent on the stage of processing that a loan is currently in, and the change in prevailing interest rates from the time of the rate lock.

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 June 30, 2013 and December 31, 2012, and that were included in the Company’s Consolidated Statements of Condition at those dates:


	Fair Value Measurements at June 30, 2013 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		$--		$ --		$14,887		$14,887
Other assets ⁽¹⁾		--		24,391		--		24,391

Total		$--		$24,391		$14,887		$39,278

(1)	Represents the fair value of OREO, based on the appraised value of the collateral subsequent to its initial classification as OREO.


	Fair Value Measurements at December 31, 2012 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		$--		$ --		$76,704		$76,704
Other assets ⁽¹⁾		--		22,664		--		22,664

Total		$--		$22,664		$76,704		$99,368

(1)	Represents the fair value of OREO, based on the appraised value of the collateral subsequent to its initial classification as OREO.

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. When available, quoted market prices 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 tables summarize the carrying values, estimated fair values, and the fair value measurement levels of financial instruments that were not carried at fair value on the Company’s Consolidated Statements of Condition at June 30, 2013 and December 31, 2012:


	June 30, 2013
							Fair Value Measurement Using
(in thousands)	Carrying Value			Estimated Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Financial Assets:
Cash and cash equivalents		$	1,319,710		$	1,319,710		$	1,319,710			$	--			$	--
Securities held to maturity			5,626,605			5,540,835			--				5,535,659				5,177
FHLB stock⁽¹⁾			482,173			482,173			--				482,173				--
Loans, net			31,638,995			31,653,074			--				--				31,653,074
Mortgage servicing rights			96			96			--				--				96
Financial Liabilities:
Deposits			25,287,862			25,337,711			17,381,704	⁽²⁾			7,956,007	⁽³⁾			--
Borrowed funds			12,992,017			14,151,085			--				14,151,085				--

(1)	Carrying value and estimated fair value are at cost.

(2)	Includes NOW and money market accounts, savings accounts, and non-interest-bearing accounts.

(3)	Certificates of deposit.


	December 31, 2012
							Fair Value Measurement Using
(in thousands)	Carrying Value			Estimated Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Financial Assets:
Cash and cash equivalents		$	2,427,258		$	2,427,258		$	2,427,258			$	--			$	--
Securities held to maturity			4,484,262			4,705,960			--				4,648,766				57,194
FHLB stock⁽¹⁾			469,145			469,145			--				469,145				--
Loans, net			31,580,636			31,977,472			--				--				31,977,472
Mortgage servicing rights			193			193			--				--				193
Financial Liabilities:
Deposits		$	24,877,521		$	24,909,496		$	15,756,607	⁽²⁾		$	9,152,889	⁽³⁾		$	--
Borrowed funds			13,430,191			14,935,580			--				14,935,580				--

(1)	Carrying value and estimated fair value are at cost.

(2)	Includes NOW and money market accounts, savings accounts, and non-interest-bearing accounts.

(3)	Certificates of deposit.

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

Cash and Cash Equivalents

Cash and cash equivalents include cash and due from banks and fed 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

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

Ownership in equity securities of the FHLB is restricted and there is no established market for their resale. The carrying amount approximates the fair value.

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 Sub-topic 820-10, “Fair Value Measurements.”

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 current 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 certificates of deposit (“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 June 30, 2013 and December 31, 2012.