9. FAIR VALUE

Fair value represents the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Bank used the following methods and significant assumptions to estimate fair value:

Available-for-sale debt securities: Except for the Bank’s private label mortgage backed security and its TRUP investment, the fair value of available-for-sale debt securities is typically determined by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

The Bank’s private label mortgage backed security remains illiquid, and as such, the Bank classifies this security as a Level 3 security in accordance with ASC Topic 820, Fair Value Measurement. Based on this determination, the Bank utilized an income valuation model (present value model) approach in determining the fair value of this security.

See in this section of the filing under Footnote 2 “Investment Securities” for additional discussion regarding the Bank’s private label mortgage backed security.

The Company acquired its TRUP investment in 2015 and considered the most recent bid price for the same instrument to approximate market value at March 31, 2018. The Company’s TRUP investment is considered highly illiquid and also valued using Level 3 inputs, as the most recent bid price for this instrument is not always considered generally observable.

Equity securities with readily determinable fair value: Quoted market prices in an active market are available for the Bank’s Community Reinvestment Act (“CRA”) mutual fund investment and fall within Level 1 of the fair value hierarchy.

The fair value of the Company’s Freddie Mac preferred stock is determined by matrix pricing, as described above (Level 2 inputs).

Mortgage loans held for sale, at fair value: The fair value of mortgage loans held for sale is determined using quoted secondary market prices. Mortgage loans held for sale are classified as Level 2 in the fair value hierarchy.

Consumer loans held for sale, at fair value: The Company has elected to carry certain installment loans, which are originated through its RCS segment and generally sold within 21 days of origination, at fair value. The fair value for these loans is based on contractual terms, Level 3 inputs.

Mortgage Banking derivatives: Mortgage Banking derivatives used in the ordinary course of business primarily consist of mandatory forward sales contracts (“forward contracts”) and interest rate lock loan commitments. The fair value of the Bank’s derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants. The pricing is derived from market observable inputs that can generally be verified and do not typically involve significant judgment by the Bank. Forward contracts and rate-lock loan commitments are classified as Level 2 in the fair value hierarchy.

Interest rate swap agreements: Interest rate swaps are recorded at fair value on a recurring basis. The Company values its interest rate swaps using a third-party valuation service and classifies such valuations as Level 2. Valuations of these interest rate swaps are also received from the relevant counterparty and validated against the Company’s calculations. The Company has considered counterparty credit risk in the valuation of its interest rate swap assets and has considered its own credit risk in the valuation of its interest rate swap liabilities.

Impaired loans: Collateral-dependent impaired loans generally reflect partial charge-downs to their respective fair value, which is commonly based on recent real estate appraisals or broker price opinions (“BPOs”). These appraisals or BPOs may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the process by the independent experts to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements or aging reports, adjusted or 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, resulting in a Level 3 fair value classification. Collateral-dependent loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Premises carried at fair value: Premises and equipment are accounted for at the lower of cost less accumulated depreciation or fair value less estimated costs to sell. The fair value of Bank premises are commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches, including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other real estate owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals or BPOs. These appraisals or BPOs may utilize a single approach or a combination of approaches, including comparable sales and the income approach. Adjustments are routinely made in the process by the independent experts to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for collateral-dependent impaired loans, impaired premises and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Bank. Once the appraisal is received, a member of the Bank’s Credit Administration Department reviews the assumptions and approaches utilized in the appraisal, as well as the overall resulting fair value in comparison with independent data sources, such as recent market data or industry-wide statistics. On at least an annual basis, the Bank performs a back test of collateral appraisals by comparing actual selling prices on recent collateral sales to the most recent appraisal of such collateral. Back tests are performed for each collateral class, e.g., residential real estate or commercial real estate, and may lead to additional adjustments to the value of unliquidated collateral of similar class.

Mortgage servicing rights: On at least a quarterly basis, MSRs are evaluated for impairment based upon the fair value of the MSRs as compared to carrying amount. If the carrying amount of an individual tranche exceeds fair value, impairment is recorded and the respective individual tranche is carried at fair value. If the carrying amount of an individual tranche does not exceed fair value, impairment is reversed if previously recognized and the carrying value of the individual tranche is based on the amortization method. The valuation model utilizes assumptions that market participants would use in estimating future net servicing income and can generally be validated against available market data (Level 2). There were no MSR tranches carried at fair value at March 31, 2018 and December 31, 2017.

Assets and liabilities measured at fair value on a recurring basis, including financial assets and liabilities for which the Bank has elected the fair value option, are summarized below:


	Fair Value Measurements at
	March 31, 2018 Using:
	Quoted Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable		Total
	Assets		Inputs		Inputs		Fair
(in thousands)	(Level 1)		(Level 2)		(Level 3)		Value
Financial assets:
Available-for-sale debt securities:
U.S. Treasury securities and U.S. Government agencies	$	—	$	217,001	$	—	$	217,001
Private label mortgage backed security		—		—		4,120		4,120
Mortgage backed securities - residential		—		100,238		—		100,238
Collateralized mortgage obligations		—		82,745		—		82,745
Corporate bonds		—		9,979		—		9,979
Trust preferred security		—		—		3,900		3,900
Total available-for-sale debt securities	$	—	$	409,963	$	8,020	$	417,983

Equity securities with readily determinable fair value:
Freddie Mac preferred stock	$	—	$	328	$	—	$	328
Community Reinvestment Act mutual fund		2,418		—		—		2,418
Total equity securities with readily determinable fair value	$	2,418	$	328	$	—	$	2,746

Mortgage loans held for sale	$	—	$	4,496	$	—	$	4,496
Consumer loans held for sale		—		—		2,419		2,419
Rate lock loan commitments		—		443		—		443
Mandatory forward contracts		—		47		—		47
Interest rate swap agreements		—		1,494		—		1,494

Financial liabilities:
Interest rate swap agreements	$	—	$	1,360	$	—	$	1,360


	Fair Value Measurements at
	December 31, 2017 Using:
	Quoted Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable		Total
	Assets		Inputs		Inputs		Fair
(in thousands)	(Level 1)		(Level 2)		(Level 3)		Value
Financial assets:
Available-for-sale debt securities:
U.S. Treasury securities and U.S. Government agencies	$	—	$	307,592	$	—	$	307,592
Private label mortgage backed security		—		—		4,449		4,449
Mortgage backed securities - residential		—		106,374		—		106,374
Collateralized mortgage obligations		—		87,163		—		87,163
Corporate bonds		—		15,125		—		15,125
Trust preferred security		—		—		3,600		3,600
Total available-for-sale debt securities	$	—	$	516,254	$	8,049	$	524,303

Equity securities with readily determinable fair value:
Freddie Mac preferred stock	$	—	$	473	$	—	$	473
Community Reinvestment Act mutual fund		2,455		—		—		2,455
Total equity securities with readily determinable fair value	$	2,455	$	473	$	—	$	2,928

Mortgage loans held for sale	$	—	$	5,761	$	—	$	5,761
Consumer loans held for sale		—		—		2,677		2,677
Rate lock loan commitments		—		310		—		310
Interest rate swap agreements		—		312		—		312

Financial liabilities:
Mandatory forward contracts	$	—	$	9	$	—	$	9
Interest rate swap agreements		—		403		—		403

All transfers between levels are generally recognized at the end of each quarter. There were no transfers into or out of Level 1, 2 or 3 assets during the three months ended March 31, 2018 and 2017.

Private Label Mortgage Backed Security

The following table presents a reconciliation of the Bank’s private label mortgage backed security measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended March 31, 2018 and 2017:


	Three Months Ended
	March 31,
(in thousands)	2018		2017

Balance, beginning of period	$	4,449	$	4,777
Total gains or losses included in earnings:
Net change in unrealized gain		(2)		53
Recovery of actual losses previously recorded		38		—
Principal paydowns		(365)		(148)
Balance, end of period	$	4,120	$	4,682

The fair value of the Bank’s single private label mortgage backed security is supported by analysis prepared by an independent third party. The third party’s approach to determining fair value involved several steps: 1) detailed collateral analysis of the underlying mortgages, including consideration of geographic location, original loan-to-value and the weighted average FICO score of the borrowers; 2) collateral performance projections for each pool of mortgages underlying the security (probability of default, severity of default, and prepayment probabilities) and 3) discounted cash flow modeling.

The significant unobservable inputs in the fair value measurement of the Bank’s single private label mortgage backed security are prepayment rates, probability of default and loss severity in the event of default. Significant fluctuations in any of those inputs in isolation would result in a significantly different fair value measurement.

Quantitative information about recurring Level 3 fair value measurement inputs for the Bank’s single private label mortgage backed security follows:


	Fair		Valuation
March 31, 2018 (dollars in thousands)	Value		Technique	Unobservable Inputs	Range

Private label mortgage backed security	$	4,120	Discounted cash flow	(1) Constant prepayment rate	5.0% - 6.5%

				(2) Probability of default	1.8% - 8.0%

				(3) Loss severity	50% - 85%


	Fair		Valuation
December 31, 2017 (dollars in thousands)	Value		Technique	Unobservable Inputs	Range

Private label mortgage backed security	$	4,449	Discounted cash flow	(1) Constant prepayment rate	3.5% - 6.5%

				(2) Probability of default	1.8% - 8.0%

				(3) Loss severity	60% - 85%

Trust Preferred Security

The following table presents a reconciliation of the Company’s TRUP measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2018 and 2017:


	Three Months Ended
	March 31,
(in thousands)	2018		2017

Balance, beginning of period	$	3,600	$	3,200
Total gains or losses included in earnings:
Discount accretion		10		11
Net change in unrealized gain		290		(11)
Balance, end of period	$	3,900	$	3,200

The fair value of the Company’s TRUP investment is based on the most recent bid price for this instrument, as provided by a third-party broker.

Mortgage Loans Held for Sale

The Bank has elected the fair value option for mortgage loans held for sale. These loans are intended for sale and the Bank believes that the fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loans and in accordance with Bank policy for such instruments. None of these loans were past due 90-days-or-more or on nonaccrual as of March 31, 2018 and December 31, 2017.

As of March 31, 2018 and December 31, 2017, the aggregate fair value, contractual balance, and unrealized gain was as follows:


(in thousands)	March 31, 2018		December 31, 2017

Aggregate fair value	$	4,496	$	5,761
Contractual balance		4,412		5,668
Unrealized gain		84		93

The total amount of gains and losses from changes in fair value included in earnings for the three months ended March 31, 2018 and 2017 for mortgage loans held for sale are presented in the following table:


	Three Months Ended
	March 31,
(in thousands)	2018		2017

Interest income	$	72	$	67
Change in fair value		(9)		(7)
Total included in earnings	$	63	$	60

Consumer Loans Held for Sale

RCS carries loans originated for sale through its installment loan program at fair value. Such loans are generally sold within 21 days of origination, with their fair value based on contractual terms. Interest income is recorded based on the contractual terms of the loan and in accordance with Bank policy for such instruments. None of these loans were past due 90-days-or-more or on nonaccrual as of March 31, 2018 and December 31, 2017.

A reconciliation of the Company’s consumer loans held for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2018 and 2017 is included in Footnote 3 of this section of the filing.

The significant unobservable inputs in the fair value measurement of the Bank’s installment loans are the net contractual premiums and level of loans sold at a discount price. Significant fluctuations in any of those inputs in isolation would result in a significantly lower/higher fair value measurement.

The following table presents quantitative information about recurring Level 3 fair value measurement inputs for installment loans as of March 31, 2018 and December 31, 2017:


	Fair		Valuation
March 31, 2018 (dollars in thousands)	Value		Technique	Unobservable Inputs	Rate

Consumer loans held for sale	$	2,419	Contractual Terms	(1) Net Premium	0.9%

				(2) Discounted Sales	5.0%


	Fair		Valuation
December 31, 2017 (dollars in thousands)	Value		Technique	Unobservable Inputs	Rate

Consumer loans held for sale	$	2,677	Contractual Terms	(1) Net Premium	0.9%

				(2) Discounted Sales	5.0%

As of March 31, 2018 and December 31, 2017 the aggregate fair value, contractual balance, and unrealized gain on consumer loans held for sale, at fair value, was as follows:


(in thousands)	March 31, 2018		December 31, 2017

Aggregate fair value	$	2,419	$	2,677
Contractual balance		2,291		2,535
Unrealized gain		128		142

The total amount of net gains from changes in fair value included in earnings for the three months ended March 31, 2018 and 2017 for consumer loans held for sale, at fair value, are presented in the following table:


	Three Months Ended
	March 31,
(in thousands)	2018		2017

Interest income	$	176	$	186
Change in fair value		(14)		82
Total included in earnings	$	162	$	268

Assets measured at fair value on a non-recurring basis are summarized below:


	Fair Value Measurements at
	March 31, 2018 Using:
	Quoted Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable		Total
	Assets		Inputs		Inputs		Fair
(in thousands)	(Level 1)		(Level 2)		(Level 3)		Value

Impaired loans:
Residential real estate:
Owner occupied	$	—	$	—	$	3,269	$	3,269
Nonowner occupied		—		—		1,339		1,339
Commercial real estate		—		—		1,342		1,342
Commercial & industrial		—		—		744		744
Home equity		—		—		308		308
Total impaired loans*	$	—	$	—	$	7,002	$	7,002

Premises	$	—	$	—	$	2,896	$	2,896


	Fair Value Measurements at
	December 31, 2017 Using:
	Quoted Prices in		Significant
	Active Markets		Other		Significant
	for Identical		Observable		Unobservable		Total
	Assets		Inputs		Inputs		Fair
(in thousands)	(Level 1)		(Level 2)		(Level 3)		Value

Impaired loans:
Residential real estate:
Owner occupied	$	—	$	—	$	4,107	$	4,107
Nonowner occupied		—		—		237		237
Commercial real estate		—		—		1,366		1,366
Home equity		—		—		393		393
Total impaired loans*	$	—	$	—	$	6,103	$	6,103

Other real estate owned:
Residential real estate	$	—	$	—	$	83	$	83
Total other real estate owned	$	—	$	—	$	83	$	83

Premises	$	—	$	—	$	3,017	$	3,017

* The difference between the carrying value and the fair value of impaired loans measured at fair value is reconciled in a subsequent table of this Footnote.

The following tables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis:


					Range
	Fair		Valuation	Unobservable	(Weighted
March 31, 2018 (dollars in thousands)	Value		Technique	Inputs	Average)

Impaired loans - residential real estate owner occupied	$	3,269	Sales comparison approach	Adjustments determined for differences between comparable sales	0% - 54% (12%)

Impaired loans - residential real estate nonowner occupied	$	1,339	Sales comparison approach	Adjustments determined for differences between comparable sales	0% - 27% (13%)

Impaired loans - commercial real estate	$	79	Sales comparison approach	Adjustments determined for differences between comparable sales	21% (21%)

Impaired loans - commercial real estate	$	1,263	Income approach	Adjustments for differences between net operating income expectations	17% (17%)

Impaired loans - commercial & industrial	$	744	Sales comparison approach	Adjustments determined for differences between comparable sales	3% (3%)

Impaired loans - home equity	$	308	Sales comparison approach	Adjustments determined for differences between comparable sales	0% - 22% (14%)

Premises	$	2,896	Sales comparison approach	Adjustments determined for differences between comparable sales	8% - 68% (24%)


					Range
	Fair		Valuation	Unobservable	(Weighted
December 31, 2017 (dollars in thousands)	Value		Technique	Inputs	Average)

Impaired loans - residential real estate owner occupied	$	4,107	Sales comparison approach	Adjustments determined for differences between comparable sales	0% - 54% (10%)

Impaired loans - residential real estate nonowner occupied	$	237	Sales comparison approach	Adjustments determined for differences between comparable sales	0% - 8% (5%)

Impaired loans - commercial real estate	$	79	Sales comparison approach	Adjustments determined for differences between comparable sales	21% (21%)

Impaired loans - commercial real estate	$	1,287	Income approach	Adjustments for differences between net operating income expectations	17% (17%)

Impaired loans - home equity	$	393	Sales comparison approach	Adjustments determined for differences between comparable sales	0% - 23% (15%)

Other real estate owned - residential real estate	$	83	Sales comparison approach	Adjustments determined for differences between comparable sales	86% (86%)

Premises	$	3,017	Sales comparison approach	Adjustments determined for differences between comparable sales	4% - 67% (21%)

Impaired Loans

Collateral-dependent impaired loans are generally measured for impairment using the fair value for reasonable disposition of the underlying collateral. The Bank’s practice is to obtain new or updated appraisals or BPOs on the loans subject to the initial impairment review and then to evaluate the need for an update to this value on an as-necessary or possibly annual basis thereafter (depending on the market conditions impacting the value of the collateral). The Bank may discount the valuation amount as necessary for selling costs and past due real estate taxes. If a new or updated appraisal or BPO is not available at the time of a loan’s impairment review, the Bank may apply a discount to the existing value of an old valuation to reflect the property’s current estimated value if it is believed to have deteriorated in either: (i) the physical or economic aspects of the subject property or (ii) material changes in market conditions. The impairment review generally results in a partial charge-off of the loan if fair value less selling costs are below the loan’s carrying value. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

Impaired collateral-dependent loans are as follows:


(in thousands)	March 31, 2018		December 31, 2017

Carrying amount of loans measured at fair value	$	6,293	$	5,358
Estimated selling costs considered in carrying amount		725		752
Valuation allowance		(16)		(7)
Total fair value	$	7,002	$	6,103


	Three Months Ended
	March 31,
(in thousands)	2018		2017

Provisions on collateral-dependent, impaired loans	$	429	$	8

Other Real Estate Owned

Other real estate owned, which is carried at the lower of cost or fair value, is periodically assessed for impairment based on fair value at the reporting date. Fair value is determined from external appraisals or BPOs using judgments and estimates of external professionals. Many of these inputs are not observable and, accordingly, these measurements are classified as Level 3.

Details of other real estate owned carrying value and write downs follow:



(in thousands)	March 31, 2018		December 31, 2017

Other real estate owned carried at fair value	$	—	$	83
Other real estate owned carried at cost		160		32
Total carrying value of other real estate owned	$	160	$	115


	Three Months Ended
	March 31,
(in thousands)	2018		2017

Other real estate owned write-downs during the period	$	—	$	70

Premises

The Company’s Traditional Banking segment classified four of its former banking centers as held for sale as of March 31, 2018 and December 31, 2017. Impairment charges are recorded when the value of a piece of property is reappraised or reassessed below the property’s then-carrying value. Impairment charges related to these properties were as follows:


	Three Months Ended
	March 31,
(in thousands)	2018		2017

Impairment charges on premises	$	104	$	58

The carrying amounts and estimated fair values of all financial instruments at March 31, 2018 and December 31, 2017 follow:


			Fair Value Measurements at
			March 31, 2018:
									Total
	Carrying								Fair
(in thousands)	Value		Level 1		Level 2		Level 3		Value

Assets:
Cash and cash equivalents	$	362,122	$	362,122	$	—	$	—	$	362,122
Available-for-sale debt securities		417,983		—		409,963		8,020		417,983
Held-to-maturity debt securities		62,844		—		63,515		—		63,515
Equity securities with readily determinable fair values		2,746		2,418		328		—		2,746
Mortgage loans held for sale, at fair value		4,496		—		4,496		—		4,496
Consumer loans held for sale, at fair value		2,419		—		—		2,419		2,419
Consumer loans held for sale, at the lower of cost or fair value		7,380		—		7,380		—		7,380
Loans, net		4,000,159		—		—		3,978,974		3,978,974
Federal Home Loan Bank stock		32,067		—		—		—		NA
Accrued interest receivable		11,772		—		11,772		—		11,772

Liabilities:
Noninterest-bearing deposits	$	1,241,127		—	$	1,241,127		—	$	1,241,127
Transaction deposits		2,098,796		—		2,098,796		—		2,098,796
Time deposits		377,700		—		373,075		—		373,075
Securities sold under agreements to repurchase and other short-term borrowings		175,682		—		175,682		—		175,682
Federal Home Loan Bank advances		440,000		—		432,140		—		432,140
Subordinated note		41,240		—		32,352		—		32,352
Accrued interest payable		1,041		—		1,041		—		1,041

NA - Not applicable


			Fair Value Measurements at
			December 31, 2017:
									Total
	Carrying								Fair
(in thousands)	Value		Level 1		Level 2		Level 3		Value

Assets:
Cash and cash equivalents	$	299,351	$	299,351	$	—	$	—	$	299,351
Available-for-sale debt securities		524,303		—		516,727		8,049		524,303
Held-to-maturity debt securities		64,227		—		65,133		—		65,133
Equity securities with readily determinable fair values		2,928		2,455		473		—		2,928
Mortgage loans held for sale, at fair value		5,761		—		5,761		—		5,761
Consumer loans held for sale, at fair value		2,677		—		—		2,677		2,677
Consumer loans held for sale, at the lower of cost or fair value		8,551		—		8,551		—		8,551
Loans, net		3,971,265		—		—		3,938,998		3,938,998
Federal Home Loan Bank stock		32,067		—		—		—		NA
Accrued interest receivable		12,082		—		12,082		—		12,082

Liabilities:
Noninterest-bearing deposits	$	1,022,042		—	$	1,022,042		—	$	1,022,042
Transaction deposits		2,049,493		—		2,049,493		—		2,049,493
Time deposits		361,623		—		358,627		—		358,627
Securities sold under agreements to repurchase and other short-term borrowings		204,021		—		204,021		—		204,021
Federal Home Loan Bank advances		737,500		—		730,712		—		730,712
Subordinated note		41,240		—		31,763		—		31,763
Accrued interest payable		1,100		—		1,100		—		1,100

NA - Not applicable