Note 10. Fair Value Measurements

GAAP sets forth a definition of fair value, establishes a consistent framework for measuring fair value, and requires disclosure for each major asset and liability category measured at fair value on either a recurring or non-recurring basis. GAAP also clarifies 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, GAAP establishes 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 March 31, 2018 and December 31, 2017, and that were included in the Company’s Consolidated Statements of Condition at those dates:


	Fair Value Measurements at March 31, 2018
(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	$	—	$	1,971,177	$	—	$	—	$	1,971,177
GSE CMOs		—		541,587		—		—		541,587

Total mortgage-related securities	$	—	$	2,512,764	$	—	$	—	$	2,512,764

Other Securities Available for Sale:
U. S. Treasury Obligations	$	199,430	$	—	$	—	$	—	$	199,430
GSE debentures		—		473,069		—		—		473,069
Corporate bonds		—		89,718		—		—		89,718
Municipal bonds		—		68,607		—		—		68,607
Capital trust notes		—		48,364		—		—		48,364

Total other securities	$	199,430	$	679,758	$	—	$	—	$	879,188

Total securities available for sale	$	199,430	$	3,192,522	$	—	$	—	$	3,391,952

Equity securities:
Preferred stock	$	15,243	$	—	$	—	$	—	$	15,243
Mutual funds and common stock		—		16,826		—		—		16,826

Total equity securities	$	15,243	$	16,826	$	—	$	—	$	32,069

Total securities	$	214,673	$	3,209,348	$	—	$	—	$	3,424,021

Other Assets:
Loans held for sale	$	—	$	31,402	$	—	$	—	$	31,402
Mortgage servicing rights		—		—		2,575		—		2,575


	Fair Value Measurements at December 31, 2017
(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	$	—	$	2,068,842	$	—	$	—	$	2,068,842
GSE CMOs				549,904						549,904

Total mortgage-related securities	$	—	$	2,618,746	$	—	$	—	$	2,618,746

Other Securities Available for Sale:
U. S. Treasury Obligations	$	199,898	$	—	$	—	$	—	$	199,898
GSE debentures		—		473,258		—		—		473,258
Corporate bonds		—		90,775		—		—		90,775
Municipal bonds		—		70,120		—		—		70,120
Capital trust notes		—		46,096		—		—		46,096
Preferred stock		15,434		—		—		—		15,434
Mutual funds and common stock		—		17,100		—		—		17,100

Total other securities	$	215,332	$	697,349	$	—	$	—	$	912,681

Total securities available for sale	$	215,332	$	3,316,095	$	—	$	—	$	3,531,427

Other Assets:
Loans held for sale	$	—	$	35,258	$	—	$	—	$	35,258
Mortgage servicing rights		—		—		2,729		—		2,729

(1)	Includes cash collateral received from, and paid to, counterparties.

(2)	Includes $1.9 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 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 and exchange-traded securities.

If quoted market prices are not available for a 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.

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 service valuations that appear to be unusual or unexpected.

The Company carries loans held for sale at fair value. The fair value of loans held for sale is based on an exit price, representing the amount that would be received when selling an asset in an orderly transaction between market participants. 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 a third-party valuation specialist. The specialist 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 periodically adjusts the underlying inputs and assumptions 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.

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 a reporting date.

Fair Value Option

Loans Held for Sale

The Company has elected the fair value option for its loans held for sale. These loans held for sale consist of one-to-four family and a $9.5 million CRE mortgage loan, which was 90 days or more past due at March 31, 2018.

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:


	March 31, 2018							December 31, 2017
(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	$	31,402	$	36,498	$	(5,096	)	$	35,258	$	34,563	$	695

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. The following table presents the changes in fair value related to initial measurement, and the subsequent changes in fair value included in earnings, for MSRs for the periods indicated:


	(Loss) Gain Included in Income from Changes in Fair Value⁽¹⁾
	For the Three Months Ended March 31,
(in thousands)	2018			2017
Mortgage servicing rights	$	(154	)	$	(2,789	)

(1)	Included in “Non-interest income.”

Changes in Level 3 Fair Value Measurements

The following tables present, for the three months ended March 31, 2018 and March 31, 2017, a roll-forward of the balance sheet amounts (including changes in fair value) for financial instruments classified in Level 3 of the valuation hierarchy:


(in thousands)	Fair Value January 1, 2018		Total Realized/Unrealized Gains/(Losses) Recorded in					Issuances		Settlements			Transfers to/(from) Level 3		Fair Value at Mar. 31, 2018		Change in Unrealized Gains/(Losses) Related to Instruments Held at March 31, 2018
(in thousands)	Fair Value January 1, 2018		Income/ (Loss)			Comprehensive (Loss) Income		Issuances		Settlements			Transfers to/(from) Level 3		Fair Value at Mar. 31, 2018
Mortgage servicing rights	$	2,729	$	(154	)	$	—	$	—	$	—		$	—	$	2,575	$	(154	)

(in thousands)	Fair Value January 1, 2017		Total Realized/Unrealized Gains/(Losses) Recorded in					Issuances		Settlements			Transfers to/(from) Level 3		Fair Value at Mar. 31, 2017		Change in Unrealized Gains/ (Losses) Related to Instruments Held at March 31, 2017
(in thousands)	Fair Value January 1, 2017		Income/ (Loss)			Comprehensive (Loss) Income		Issuances		Settlements			Transfers to/(from) Level 3		Fair Value at Mar. 31, 2017
Mortgage servicing rights	$	228,099	$	(2,726	)	$	—	$	7,574	$	(4,147	)	$	—	$	228,800	$	(2,726	)
Interest rate lock commitments		982		1,467			—		—		—			—		2,449		2,430

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. There were no transfers in or out of Levels 1, 2, or 3 during the three months ended March 31, 2018 or 2017.

For Level 3 assets and liabilities measured at fair value on a recurring basis as of March 31, 2018, the significant unobservable inputs used in the fair value measurements were as follows:


(dollars in thousands)	Fair Value at Mar. 31, 2018	Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Value
Mortgage servicing rights	$2,575	Discounted Cash Flow	Weighted Average Constant Prepayment Rate ⁽¹⁾		10.66	%
			Weighted Average Discount Rate		12.00

(1)	Represents annualized loan repayment rate assumptions.

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 or decreases in either 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 move in opposite directions.

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 March 31, 2018 and December 31, 2017, and that were included in the Company’s Consolidated Statements of Condition at those dates:


	Fair Value Measurements at March 31, 2018 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 ⁽¹⁾	$	—	$	—	$	15,558	$	15,558
Other assets ⁽²⁾	$	—	$	—		3,121		3,121

Total	$	—	$	—	$	18,679	$	18,679

(1)	Represents the fair value of impaired loans, based on the value of the collateral.

(2)	Represents the fair value of repossessed assets, based on the appraised value of the collateral subsequent to its initial classification as repossessed assets.


	Fair Value Measurements at December 31, 2017 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 ⁽¹⁾	$	—	$	—	$	45,837	$	45,837
Other assets ⁽²⁾		—		—		4,357		4,357

Total	$	—	$	—	$	50,194	$	50,194

(1)	Represents the fair value of impaired loans, based on the value of the collateral.

(2)	Represents the fair value of repossessed assets, based on the appraised value of the collateral subsequent to its initial classification as repossessed assets.

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

Other Fair Value Disclosures

For 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 fair value measurement levels of financial instruments that were not carried at fair value on the Company’s Consolidated Statements of Condition at March 31, 2018 and December 31, 2017:


	March 31, 2018
					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	$	2,680,772	$	2,680,772	$	2,680,772		$	—		$	—
FHLB stock ⁽¹⁾		622,989		622,989		—			622,989			—
Loans, net		38,759,685		38,462,422		—			—			38,462,422
Financial Liabilities:
Deposits	$	29,235,434	$	29,178,221	$	20,172,114	⁽²⁾	$	9,006,107	⁽³⁾	$	—
Borrowed funds		13,343,759		13,176,141		—			13,176,141			—

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

(2)	Interest-bearing checking and money market accounts, savings accounts, and non-interest-bearing accounts.

(3)	Certificates of deposit.


	December 31, 2017
					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	$	2,528,169	$	2,528,169	$	2,528,169		$	—		$	—
FHLB stock ⁽¹⁾		603,819		603,819		—			603,819			—
Loans, net		38,265,183		38,254,538		—			—			38,254,538
Financial Liabilities:
Deposits	$	29,102,163	$	29,044,852	$	20,458,517	⁽²⁾	$	8,586,335	⁽³⁾	$	—
Borrowed funds		12,913,679		12,780,653		—			12,780,653			—

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

(2)	Interest-bearing checking 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 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

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 maturities and cash flow assumptions.

Federal Home Loan Bank Stock

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

Loans

The Company discloses the fair value of loans measured at amortized cost using an exit price notion. Prior to adopting ASU No. 2016-01, the Company measured the fair value of loans that are accounted for at amortized cost under an entry price notion. The entry price notion previously applied by the Company used a discounted cash flows technique to calculate the present value of expected future cash flows for a financial instrument. The exit price notion uses the same approach, but also incorporates other factors, such as enhanced credit risk, illiquidity risk, and market factors. The Company determined the fair value on substantially all of its loans for disclosure purposes, on an individual loan basis. The discount rates reflect current market rates for loans with similar terms to borrowers having similar credit quality on an exit price basis. The estimated fair values of non-performing mortgage and other loans are based on recent collateral appraisals. For those loans where a discounted cash flow technique was not considered reliable, the Company used a quoted market price for each individual loan.

Mortgage Servicing Rights

MSRs do not trade in an active market with readily observable prices. Accordingly, the Company bases the fair value of its MSRs on a valuation performed by a third-party valuation specialist. This specialist determines fair value based on the present value of estimated future net servicing income cash flows, and incorporates 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 specialist and the Company evaluate, and periodically adjust, as necessary, these underlying inputs and assumptions to reflect market conditions and changes in the assumptions that a market participant would consider in valuing MSRs.

Deposits

The fair values of deposit liabilities with no stated maturity (i.e., interest-bearing checking 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 March 31, 2018 and December 31, 2017.