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Fair Value Measurement

9 Months Ended

Sep. 30, 2019

Note 10 – Fair Value Measurement

The following table presents estimated fair values of the Company's financial instruments as of September 30, 2019 and December 31, 2018, whether or not recognized or recorded at fair value in the Condensed Consolidated Balance Sheets:


(in thousands)		September 30, 2019						December 31, 2018
	Level	Carrying Value		Fair Value		Carrying Value		Fair Value
FINANCIAL ASSETS:
Cash and cash equivalents	1	$	1,191,444	$	1,191,444	$	622,637	$	622,637
Equity and other investment securities	1,2	64,764		64,764		61,841		61,841
Investment securities available for sale	2	2,842,076		2,842,076		2,977,108		2,977,108
Investment securities held to maturity	3	3,320		4,338		3,606		4,644
Loans held for sale, at fair value	2	355,022		355,022		166,461		166,461
Loans and leases, net	3	21,364,506		21,566,083		20,277,795		20,117,939
Restricted equity securities	1	54,463		54,463		40,268		40,268
Residential mortgage servicing rights	2,3	151,383		151,383		169,025		169,025
Bank owned life insurance	1	318,533		318,533		313,626		313,626
Derivatives	2,3	200,412		200,412		49,484		49,484
Visa Inc. Class B common stock⁽¹⁾	3	—		—		—		99,353
FINANCIAL LIABILITIES:
Deposits	1,2	$	22,434,734	$	22,457,847	$	21,137,486	$	21,116,852
Securities sold under agreements to repurchase	2	296,717		296,717		297,151		297,151
Borrowings	2	1,106,674		1,105,167		751,788		738,107
Junior subordinated debentures, at fair value	3	267,798		267,798		300,870		300,870
Junior subordinated debentures, at amortized cost	3	88,553		69,511		88,724		76,569
Derivatives	2	6,285		6,285		15,982		15,982

⁽¹⁾ In June 2019, the Company sold all 486,346 shares of the Visa Inc. Class B common stock held, an equity security that did not have a readily determinable fair value, resulting in a one-time realized gain of $81.9 million. Accordingly, the book value and fair value are zero at September 30, 2019, as the Company no longer holds this security.

Fair Value of Assets and Liabilities Measured on a Recurring Basis

The following tables present information about the Company's assets and liabilities measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018:


(in thousands)	September 30, 2019
Description	Total		Level 1		Level 2		Level 3
FINANCIAL ASSETS:
Equity and other investment securities

Investments in mutual funds and other securities	$	52,218	$	52,218	$	—	$	—
Equity securities held in rabbi trusts	12,102		12,102		—		—
Other investments securities ⁽¹⁾	444		—		444		—
Investment securities available for sale
U.S. Treasury and agencies	587,200		—		587,200		—
Obligations of states and political subdivisions	269,030		—		269,030		—
Residential mortgage-backed securities and collateralized mortgage obligations	1,985,846		—		1,985,846		—

Loans held for sale, at fair value	355,022		—		355,022		—
Residential mortgage servicing rights, at fair value ⁽²⁾	151,383		—		36,191		115,192
Derivatives
Interest rate lock commitments	9,070		—		—		9,070
Interest rate forward sales commitments	801		—		801		—
Interest rate swaps	189,366		—		189,366		—
Foreign currency derivative	1,175		—		1,175		—
Total assets measured at fair value	$	3,613,657	$	64,320	$	3,425,075	$	124,262
FINANCIAL LIABILITIES:
Junior subordinated debentures, at fair value	$	267,798	$	—	$	—	$	267,798
Derivatives
Interest rate forward sales commitments	1,260		—		1,260		—
Interest rate swaps	4,010		—		4,010		—
Foreign currency derivative	1,015		—		1,015		—
Total liabilities measured at fair value	$	274,083	$	—	$	6,285	$	267,798

⁽¹⁾ Other investment securities includes securities held by Umpqua Investments as trading debt securities.

⁽²⁾ For more discussion of the portion of MSR at fair value transferred to level 2, refer to Note 12, Subsequent Event.


(in thousands)	December 31, 2018
Description	Total		Level 1		Level 2		Level 3
FINANCIAL ASSETS:
Equity and other investment securities

Investments in mutual funds and other securities	$	50,475	$	50,475	$	—	$	—
Equity securities held in rabbi trusts	10,918		10,918		—		—
Other investments securities ⁽¹⁾	448		—		448		—
Investment securities available for sale
U.S. Treasury and agencies	39,656		—		39,656		—
Obligations of states and political subdivisions	309,171		—		309,171		—
Residential mortgage-backed securities and collateralized mortgage obligations	2,628,281		—		2,628,281		—

Loans held for sale, at fair value	166,461		—		166,461		—
Residential mortgage servicing rights, at fair value	169,025		—		—		169,025
Derivatives
Interest rate lock commitments	6,757		—		—		6,757
Interest rate forward sales commitments	1		—		1		—
Interest rate swaps	42,276		—		42,276		—
Foreign currency derivative	450		—		450		—
Total assets measured at fair value	$	3,423,919	$	61,393	$	3,186,744	$	175,782
FINANCIAL LIABILITIES:
Junior subordinated debentures, at fair value	$	300,870	$	—	$	—	$	300,870
Derivatives
Interest rate forward sales commitments	2,963		—		2,963		—
Interest rate swaps	12,746		—		12,746		—
Foreign currency derivative	273		—		273		—
Total liabilities measured at fair value	$	316,852	$	—	$	15,982	$	300,870

⁽¹⁾ Other investment securities includes securities held by Umpqua Investments as trading debt securities.

The following methods were used to estimate the fair value of each class of financial instrument that is carried at fair value in the tables above:

Securities— Fair values for investment securities are based on quoted market prices when available or through the use of alternative approaches, such as matrix or model pricing, or broker indicative bids, when market quotes are not readily accessible or available. Management periodically reviews the pricing information received from the third-party pricing service and compares it to a secondary pricing service, evaluating significant price variances between services to determine an appropriate estimate of fair value to report.

Loans Held for Sale— Fair value for residential mortgage loans originated as held for sale is determined based on quoted secondary market prices for similar loans, including the implicit fair value of embedded servicing rights.

Residential Mortgage Servicing Rights— The fair value of the MSR is estimated using a discounted cash flow model. Assumptions used include market discount rates, anticipated prepayment speeds, delinquency and foreclosure rates, and ancillary fee income net of servicing costs. This model is periodically validated by an independent model validation group. The model assumptions and the MSR fair value estimates are also compared to observable trades of similar portfolios as well as to MSR broker valuations and industry surveys, as available. Management believes the significant inputs utilized are indicative of those that would be used by market participants. Approximately $36.2 million of MSR was held for sale as of September 30, 2019, so the fair value of this portion was based upon the sales price as the transaction was completed shortly after quarter end. Accordingly, the portion of the MSR asset sold in the fourth quarter were transferred to level 2 in the fair value hierarchy.

Junior Subordinated Debentures— The fair value of junior subordinated debentures is estimated using an income approach valuation technique. The significant inputs utilized in the estimation of fair value of these instruments are the credit risk adjusted spread and three-month LIBOR. The credit risk adjusted spread represents the nonperformance risk of the liability, contemplating the inherent risk of the obligation. The Company periodically utilizes a valuation firm to determine or validate the reasonableness of inputs and factors that are used to determine the fair value. The ending carrying (fair) value of the junior subordinated debentures measured at fair value represents the estimated amount that would be paid to transfer these liabilities in an orderly transaction amongst market participants. Due to credit concerns in the capital markets and inactivity in the trust preferred markets that have limited the observability of market spreads, we have classified this as a Level 3 fair value measure.

Derivative Instruments— The fair value of the interest rate lock commitments and forward sales commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-through rate assumptions based on historical information, where appropriate. The pull-through rate assumptions are considered Level 3 valuation inputs and are significant to the interest rate lock commitment valuation; as such, the interest rate lock commitment derivatives are classified as Level 3. The fair value of the interest rate swaps is determined using a discounted cash flow technique incorporating credit valuation adjustments to reflect nonperformance risk in the measurement of fair value. Although the Bank has determined that the majority of the inputs used to value its interest rate swap derivatives fall within Level 2 of the fair value hierarchy, the CVA associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2019, the Bank has assessed the significance of the impact of the CVA on the overall valuation of its interest rate swap positions and has determined that the CVA are not significant to the overall valuation of its interest rate swap derivatives. As a result, the Bank has classified its interest rate swap derivative valuations in Level 2 of the fair value hierarchy.

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3)

The following table provides a description of the valuation technique, significant unobservable inputs, and qualitative information about the unobservable inputs for the Company's assets and liabilities classified as Level 3 and measured at fair value on a recurring basis at September 30, 2019:


Financial Instrument	Valuation Technique	Unobservable Input	Weighted Average
Residential mortgage servicing rights	Discounted cash flow
		Constant prepayment rate	13.35%
		Discount rate	9.75%
Interest rate lock commitments	Internal pricing model
		Pull-through rate	87.56%
Junior subordinated debentures	Discounted cash flow
		Credit spread	5.27%

Generally, any significant increases in the constant prepayment rate and discount rate utilized in the fair value measurement of the residential mortgage servicing rights will result in negative fair value adjustments (and a decrease in the fair value measurement). Conversely, a decrease in the constant prepayment rate and discount rate will result in a positive fair value adjustment (and increase in the fair value measurement).

An increase in the pull-through rate utilized in the fair value measurement of the interest rate lock commitment derivative will result in positive fair value adjustments (and an increase in the fair value measurement). Conversely, a decrease in the pull-through rate will result in a negative fair value adjustment (and a decrease in the fair value measurement).

Management believes that the credit risk adjusted spread utilized in the fair value measurement of the junior subordinated debentures carried at fair value is indicative of the nonperformance risk premium a willing market participant would require under current market conditions, that is, the inactive market. Management attributes the change in fair value of the junior subordinated debentures during the period to market changes in the nonperformance expectations and pricing of this type of debt. The widening of the credit risk adjusted spread above the Company's contractual spreads has primarily contributed to the positive fair value adjustments. Future contractions in the instrument-specific credit risk adjusted spread relative to the spread currently utilized to measure the Company's junior subordinated debentures at fair value as of September 30, 2019, or the passage of time, will result in negative fair value adjustments. Generally, an increase in the credit risk adjusted spread and/or the forward swap interest rate curve will result in positive fair value adjustments (and decrease the fair value measurement). Conversely, a decrease in the credit risk adjusted spread and/or the forward swap interest rate curve will result in negative fair value adjustments (and increase the fair value measurement).

The following tables provide a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three and nine months ended September 30, 2019 and 2018:


(in thousands)	Three Months Ended										Three Months Ended
	September 30, 2019										September 30, 2018
	Residential mortgage servicing rights		Interest rate lock commitments, net		Junior subordinated debentures, at fair value		Residential mortgage servicing rights		Interest rate lock commitments, net		Junior subordinated debentures, at fair value
Beginning Balance	$	139,780	$	8,149	$	277,028	$	166,217	$	6,782	$	280,669
Transfer out of Level 3	(36,191)		—		—		—		—		—
Change included in earnings	4,210		1,456		4,495		199		(284)		4,486
Change in fair values included in comprehensive income/loss	—		—		(8,450)		—		—		2,409
Purchases and issuances	7,393		9,027		—		8,622		4,679		—
Sales and settlements	—		(9,562)		(5,275)		—		(6,018)		(4,718)
Ending Balance	$	115,192	$	9,070	$	267,798	$	175,038	$	5,159	$	282,846
Net change in unrealized gains or (losses) relating to items held at end of period	$	11,045	$	9,070	$	(3,955)	$	6,206	$	5,159	$	6,895

	Nine Months Ended										Nine Months Ended
	September 30, 2019										September 30, 2018
	Residential mortgage servicing rights		Interest rate lock commitments, net		Junior subordinated debentures, at fair value		Residential mortgage servicing rights		Interest rate lock commitments, net		Junior subordinated debentures, at fair value
Beginning Balance	$	169,025	$	6,757	$	300,870	$	153,151	$	4,752	$	277,155
Transfer out of Level 3	(36,191)		—		—		—		—		—
Change included in earnings	(34,414)		4,455		13,952		(125)		(1,288)		12,544
Change in fair values included in comprehensive income/loss	—		—		(32,254)		—		—		5,605
Purchases and issuances	16,772		21,318		—		22,012		19,211		—
Sales and settlements	—		(23,460)		(14,770)		—		(17,516)		(12,458)
Ending Balance	$	115,192	$	9,070	$	267,798	$	175,038	$	5,159	$	282,846
Net change in unrealized gains or (losses) relating to items held at end of period	$	(14,243)	$	9,070	$	(18,302)	$	17,983	$	5,159	$	18,149

Changes in residential mortgage servicing rights carried at fair value are recorded in residential mortgage banking revenue within non-interest income. Gains (losses) on interest rate lock commitments carried at fair value are recorded in residential mortgage banking revenue within non-interest income. The contractual interest expense on the junior subordinated debentures is recorded on an accrual basis as interest on junior subordinated debentures within interest expense. Settlements related to the junior subordinated debentures represent the payment of accrued interest that is embedded in the fair value of these liabilities.

The change in fair value of junior subordinated debentures is attributable to the change in the instrument specific credit risk, accordingly, the unrealized gains on fair value of junior subordinated debentures for the three and nine months ended September 30, 2019 of $8.5 million and $32.3 million, respectively, are recorded net of tax as an other comprehensive gain of $6.3 million and $24.0 million, respectively. Comparatively, losses of $2.4 million and $5.6 million, respectively, were recorded net of tax as an other comprehensive loss of $1.8 million and $4.2 million, respectively, for the three and nine months ended September 30, 2018. The gain recorded for the three and nine months ended September 30, 2019 was due primarily to a decline in the discount rates, partially offset by an increase in the credit spread as compared to prior periods.

From time to time, certain assets are measured at fair value on a nonrecurring basis. These adjustments to fair value generally result from the application of lower-of-cost-or-market accounting or write-downs of individual assets due to impairment, typically on collateral dependent loans.

Fair Value of Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The following tables present information about the Company's assets and liabilities measured at fair value on a nonrecurring basis for which a nonrecurring change in fair value has been recorded during the reporting period. The amounts disclosed below represent the fair values at the time the nonrecurring fair value measurements were made, and not necessarily the fair value as of the dates reported upon.


(in thousands)	September 30, 2019
	Total		Level 1		Level 2		Level 3
Loans and leases	$	25,000	$	—	$	—	$	25,000
Other real estate owned	2,390		—		—		2,390
	$	27,390	$	—	$	—	$	27,390


(in thousands)	December 31, 2018
	Total		Level 1		Level 2		Level 3



Loans and leases	$	98,696	$	—	$	—	$	98,696
Other real estate owned	7,532		—		—		7,532
	$	106,228	$	—	$	—	$	106,228

The following table presents the losses resulting from nonrecurring fair value adjustments for the three and nine months ended September 30, 2019 and 2018:


(in thousands)	Three Months Ended						Nine Months Ended
	September 30, 2019		September 30, 2018		September 30, 2019		September 30, 2018



Loans and leases	$	20,435	$	14,436	$	51,212	$	42,158
Other real estate owned	279		—		3,013		66
Total loss from nonrecurring measurements	$	20,714	$	14,436	$	54,225	$	42,224

The following provides a description of the valuation technique and inputs for the Company's assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis. Unobservable inputs and qualitative information about the unobservable inputs are not presented as the fair value is determined by third-party information. The loans and leases amounts above represent impaired, collateral dependent loans and leases that have been adjusted to fair value. When we identify a collateral dependent loan or lease as impaired, we measure the impairment using the current fair value of the collateral, less selling costs. Depending on the characteristics of a loan or lease, the fair value of collateral is generally estimated by obtaining external appraisals, but in some cases, the value of the collateral may be estimated as having little to no value. If we determine that the value of the impaired loan or lease is less than its recorded investment, we recognize this impairment and adjust the carrying value of the loan or lease to fair value through the allowance for loan and lease losses. The loss represents charge-offs or impairments on collateral dependent loans and leases for fair value adjustments based on the fair value of collateral.

The other real estate owned amount above represents impaired real estate that has been adjusted to fair value. Other real estate owned represents real estate which the Bank has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned is recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property's new basis. Any write-downs based on the asset's fair value at the date of acquisition are charged to the allowance for loan and lease losses. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Fair value adjustments on other real estate owned are recognized within net loss on real estate owned. The loss represents impairments on other real estate owned for fair value adjustments based on the fair value of the real estate.

Fair Value Option

The following table presents the difference between the aggregate fair value and the aggregate unpaid principal balance of loans held for sale accounted for under the fair value option as of September 30, 2019 and December 31, 2018:


(in thousands)	September 30, 2019										December 31, 2018
	Fair Value		Aggregate Unpaid Principal Balance		Fair Value Less Aggregate Unpaid Principal Balance		Fair Value		Aggregate Unpaid Principal Balance		Fair Value Less Aggregate Unpaid Principal Balance
Loans held for sale	$	355,022	$	343,073	$	11,949	$	166,461	$	160,270	$	6,191

Residential mortgage loans held for sale accounted for under the fair value option are measured initially at fair value with subsequent changes in fair value recognized in earnings. Gains and losses from such changes in fair value are reported as a component of residential mortgage banking revenue. For the three and nine months ended September 30, 2019, the Company recorded a net decrease in fair value of $1.9 million and an increase of $5.8 million, respectively. For the three and nine months ended September 30, 2018, the Company recorded a net decrease in fair value of $6.5 million and $1.1 million, respectively.

The Company selected the fair value measurement option for existing junior subordinated debentures (the Umpqua Statutory Trusts) and for junior subordinated debentures acquired from Sterling. The remaining junior subordinated debentures were acquired through previous business combinations and were measured at fair value at the time of acquisition and subsequently measured at amortized cost.

Accounting for the selected junior subordinated debentures at fair value enables us to more closely align our financial performance with the economic value of those liabilities. Additionally, we believe it improves our ability to manage the market and interest rate risks associated with the junior subordinated debentures. The junior subordinated debentures measured at fair value and amortized cost are presented as separate line items on the balance sheet. The ending carrying (fair) value of the junior subordinated debentures measured at fair value represents the estimated amount that would be paid to transfer these liabilities in an orderly transaction amongst market participants under current market conditions as of the measurement date.

Due to inactivity in the junior subordinated debenture market and the lack of observable quotes of our, or similar, junior subordinated debenture liabilities or the related trust preferred securities when traded as assets, we utilize an income approach valuation technique to determine the fair value of these liabilities using our estimation of market discount rate assumptions. The Company monitors activity in the trust preferred and related markets, to the extent available, evaluates changes related to the current and anticipated future interest rate environment, and considers our entity-specific creditworthiness, to validate the reasonableness of the credit risk adjusted spread and effective yield utilized in our discounted cash flow model. We also consider changes in the interest rate environment in our valuation, specifically the absolute level and the shape of the slope of the forward swap curve.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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