NOTE 11—FAIR VALUE MEASUREMENTS

ASC 820, "Fair Value Measurement," defines fair value, establishes a framework for measuring fair value including a three-level valuation hierarchy, and expands disclosures about fair value measurements. Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date reflecting assumptions that a market participant would use when pricing an asset or liability. The hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:

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Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets.

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Level 2: Observable inputs other than Level 1, including quoted prices for similar assets and liabilities in active markets, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data, either directly or indirectly, for substantially the full term of the financial instrument. This category generally includes government agency and government-sponsored enterprise securities.

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Level 3: Inputs to a valuation methodology that are unobservable, supported by little or no market activity, and significant to the fair value measurement. These valuation methodologies generally include pricing models, discounted cash flow models, or a determination of fair value that requires significant management judgment or estimation. This category also includes unobservable inputs from a pricing service not corroborated by observable market data, and includes our covered private label CMOs.

We use fair value to measure certain assets on a recurring basis, primarily securities available-for-sale; we have no liabilities being measured at fair value. For assets measured at the lower of cost or fair value, the fair value measurement criteria may or may not be met during a reporting period and such measurements are therefore considered "nonrecurring" for purposes of disclosing our fair value measurements. Fair value is used on a nonrecurring basis to adjust carrying values for impaired loans and other real estate owned and also to record impairment on certain assets, such as goodwill, core deposit intangibles, and other long-lived assets.

The following table presents information on the assets measured and recorded at fair value on a recurring basis as of the date indicated:

	Fair Value Measurement as of September 30, 2013

	Total		Level 1		Level 2		Level 3
	(In thousands)
Measured on a Recurring Basis:
Securities available-for-sale:
Government agency and government-sponsored enterprise residential mortgage-backed securities	$	913,322	$	—	$	913,322	$	—
Covered private label CMOs		39,378		—		—		39,378
Municipal securities		439,635		—		439,635		—
Corporate securities		82,106		—		82,106		—
Other securities		37,706		514		37,192		—

	$	1,512,147	$	514	$	1,472,255	$	39,378

There were no transfers of assets either between Level 1 and Level 2 nor in or out of Level 3 of the fair value hierarchy for assets measured on a recurring basis during the three months ended September 30, 2013.

The following table presents information about quantitative inputs and assumptions used to evaluate the fair values provided by our third party pricing service for our Level 3 covered private label CMOs measured at fair value on a recurring basis as of September 30, 2013:

Unobservable Inputs	Range of Inputs

Voluntary annual prepayment speeds	0% - 32.6%	8.1	%
Annual default rates	0% - 46.2%	3.2	%
Loss severity rates	0% - 64.9%	35.3	%
Discount rates	0% - 13.5%	5.8	%

The following table summarizes activity for assets measured at fair value on a recurring basis that are categorized as Level 3 for the period indicated:

	Covered Private Label CMOs (Level 3)

	(In thousands)
Balance, December 31, 2012	$	44,684
Total realized in earnings		1,587
Decrease in unrealized gain in comprehensive income		(731	)
Net settlements		(6,162	)

Balance, September 30, 2013	$	39,378

The following tables present assets measured at fair value on a non-recurring basis as of the date indicated and the gains and (losses) recognized on such assets for the period indicated:

	Fair Value Measurement as of September 30, 2013

	Total		Level 1		Level 2		Level 3
	(In thousands)
Measured on a Non-Recurring Basis:
Non-PCI impaired loans	$	75,435	$	—	$	1,160	$	74,275
Non-covered other real estate owned		7,084		—		7,084		—
Covered other real estate owned		141		—		26		115
SBA loan servicing asset		853		—		—		853

	$	83,513	$	—	$	8,270	$	75,243

	Three Months Ended September 30, 2013			Nine Months Ended September 30, 2013

	(In thousands)
Gain (Loss) on Assets Measured on a Non-Recurring Basis:
Non-PCI impaired loans	$	(545	)	$	(2,422	)
Non-covered other real estate owned		(643	)		(643	)
Covered other real estate owned		(65	)		(69	)
SBA loan servicing asset		—			12

Total net loss	$	(1,253	)	$	(3,122	)

The following table presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a nonrecurring basis as of September 30, 2013:

Asset	Fair Value (in 000's)		Valuation Methodology	Unobservable Inputs	Range

Impaired loans⁽¹⁾	$	72,528	Discounted cash flow	Discount rates	4.06% - 8.81%	6.57	%
	$	490	Appraisals	No discounts
OREO⁽²⁾	$	115	Appraisals	Discount, including 8% for selling costs	30%	30	%
SBA loan servicing asset	$	853	Discounted cash flow	Prepayment speeds	3.40% - 16.34%		⁽³⁾
				Discount rates	9.63% - 13.26%		⁽³⁾

(1): Excludes $1.3 million of impaired loans with balances of $250,000 or less.
(2): As of September 30, 2013, there was one OREO measured at Level 3.
(3): Not readily available.

ASC Topic 825, "Financial Instruments," requires disclosure of the estimated fair value of certain financial instruments and the methods and significant assumptions used to estimate such fair values. Additionally, certain financial instruments and all nonfinancial instruments are excluded from the applicable disclosure requirements.

The following tables present a summary of the carrying values and estimated fair values of certain financial instruments as of the dates indicated:

	September 30, 2013

			Estimated Fair Value
	Carrying or Contract Amount		Estimated Fair Value
	Carrying or Contract Amount		Total		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and due from banks	$	132,467	$	132,467	$	132,467	$	—	$	—
Interest-earning deposits in financial institutions		11,552		11,552		11,552		—		—
Securities available-for-sale		1,512,147		1,512,147		514		1,472,255		39,378
Investment in FHLB stock		34,095		34,095		—		34,095		—
Loans and leases, net		4,299,607		4,313,163		—		1,160		4,312,003
SBA loan servicing asset		853		853		—		—		853
Financial Liabilities:
Deposits:
Demand, money market, interest checking, and savings deposits		4,709,623		4,709,623		—		4,709,623		—
Time deposits		723,521		725,184		—		725,184		—
Borrowings		8,243		8,244		—		8,244		—
Subordinated debentures		132,500		132,365		—		132,365		—

	December 31, 2012

			Estimated Fair Value
	Carrying or Contract Amount		Estimated Fair Value
	Carrying or Contract Amount		Total		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and due from banks	$	89,011	$	89,011	$	89,011	$	—	$	—
Interest-earning deposits in financial institutions		75,393		75,393		75,393		—		—
Securities available-for-sale		1,355,385		1,355,385		8,985		1,301,716		44,684
Investment in FHLB stock		37,126		37,126		—		37,126		—
Loans and leases, net		3,498,329		3,551,674		—		4,975		3,546,699
SBA loan servicing asset		1,000		1,000		—		—		1,000
Financial Liabilities:
Deposits:
Demand, money market, interest checking, and savings deposits		3,888,794		3,888,794		—		3,888,794		—
Time deposits		820,327		823,912		—		823,912		—
Borrowings		12,591		12,611		—		12,611		—
Subordinated debentures		108,250		108,186		—		108,186		—

The following is a description of the valuation methodologies used to measure our assets recorded at fair value (under ASC Topic 820) and for estimating fair value for financial instruments not recorded at fair value (under ASC Topic 825).

Cash and due from banks. The carrying amount is assumed to be the fair value because of the liquidity of these instruments.

Interest-earning deposits in financial institutions. The carrying amount is assumed to be the fair value given the short-term nature of these deposits.

Securities available-for-sale. Securities available-for-sale are measured and carried at fair value on a recurring basis. Unrealized gains and losses on available-for-sale securities are reported as a component of accumulated other comprehensive income in the condensed consolidated balance sheets. See Note 5, Investment Securities, for further information on unrealized gains and losses on securities available-for-sale.

Fair value for securities categorized as Level 1, which are primarily equity securities, are based on readily available quoted prices. In determining the fair value of the securities categorized as Level 2, we obtain a report from a nationally recognized broker-dealer detailing the fair value of each investment security we hold as of each reporting date. The broker-dealer uses observable market information to value our securities, with the primary source being a nationally recognized pricing service. We review the market prices provided by the broker-dealer for our securities for reasonableness based on our understanding of the marketplace and we consider any credit issues related to the securities. As we have not made any adjustments to the market quotes provided to us and they are based on observable market data, they have been categorized as Level 2 within the fair value hierarchy.

Our covered private label CMOs are categorized as Level 3 due in part to the inactive market for such securities. There is a wide range of prices quoted for private label CMOs among independent third party pricing services and this range reflects the significant judgment being exercised over the assumptions and variables that determine the pricing of such securities. We consider this subjectivity to be a significant unobservable input and have concluded that the covered private label CMOs should be categorized as a Level 3 measured asset. Our fair value estimate was based on prices provided to us by a nationally recognized pricing service which we also use to determine the fair value of the majority of our securities portfolio. We determined the reasonableness of the fair values by reviewing assumptions at the individual security level about prepayment, default expectations, estimated severity loss factors, and discount rates, all of which are not directly observable in the market. Significant changes in default expectations, severity loss factors, or discount rates, which occur all together or in isolation, would result in different fair value measurements.

FHLB stock. Investments in FHLB stock are recorded at cost and measured for impairment quarterly. Ownership of FHLB stock is restricted to member banks and the securities do not have a readily determinable market value. Purchases and sales of these securities are at par value with the issuer. The fair value of investments in FHLB stock is equal to the carrying amount.

Impaired loans (excluding PCI loans). Nonaccrual loans and performing restructured loans are considered impaired for reporting purposes and are measured and recorded at fair value on a non-recurring basis. Non-PCI nonaccrual loans with an unpaid principal balance over $250,000 and all performing restructured loans are reviewed individually for the amount of impairment, if any. Non-PCI nonaccrual loans with an unpaid principal balance of $250,000 or less are evaluated for impairment collectively.

To the extent a loan is collateral dependent, we measure such impaired loan based on the estimated fair value of the underlying collateral. The fair value of each loan's collateral is generally based on estimated market prices from an independently prepared appraisal, which is then adjusted for the cost related to liquidating such collateral; such valuation inputs result in a nonrecurring fair value measurement that is categorized as a Level 2 measurement. The Level 2 measurement is based on appraisals obtained within the last 12 months and for which a charge-off was recognized or a change in the specific valuation allowance was made during the nine months ended September 30, 2013.

When adjustments are made to an appraised value to reflect various factors such as the age of the appraisal or known changes in the market or the collateral, such valuation inputs are considered unobservable and the fair value measurement is categorized as a Level 3 measurement. The impaired loans categorized as Level 3 also include unsecured loans and other secured loans whose fair values are based significantly on unobservable inputs such as the strength of a guarantor, including an SBA government guarantee, cash flows discounted at the effective loan rate, and management's judgment.

The Non-PCI impaired loan balances shown above represent those nonaccrual and restructured loans for which impairment was recognized during the nine months ended September 30, 2013. The amounts shown as net losses include the impairment recognized during the nine months ended September 30, 2013, for the loan balances shown. Of the $50.8 million of nonaccrual loans at September 30, 2013, $1.1 million were written down to their collateral fair values through charge-offs during the quarter.

Other real estate owned. The fair value of foreclosed real estate, both non-covered and covered, is generally based on estimated market prices from independently prepared current appraisals or negotiated sales prices with potential buyers, less estimated costs to sell; such valuation inputs result in a fair value measurement that is categorized as a Level 2 measurement on a nonrecurring basis. As a matter of policy, appraisals are required annually and may be updated more frequently as circumstances require in the opinion of management. The Level 2 measurement for OREO is based on appraisals obtained within the last 12 months and for which a write-down was recognized during the nine months ended September 30, 2013.

When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value as a result of known changes in the market or the collateral and there is no observable market price, such valuation inputs result in a fair value measurement that is categorized as a Level 3 measurement. To the extent a negotiated sales price or reduced listing price represents a significant discount to an observable market price, such valuation input would result in a fair value measurement that is also considered a Level 3 measurement. The OREO losses disclosed are write-downs based on either a recent appraisal obtained after foreclosure or an accepted purchase offer by an independent third party received after foreclosure.

SBA servicing asset. In accordance with ASC Topic 860, "Transfers and Servicing," the SBA servicing asset, included in other assets in the condensed consolidated balance sheets, is carried at its implied fair value. The fair value of the servicing asset is estimated by discounting future cash flows using market-based discount rates and prepayment speeds. The discount rate is based on the current U.S. Treasury yield curve, as published by the Department of the Treasury, plus a spread for the marketplace risk associated with these assets. We utilize estimated prepayment vectors using SBA prepayment information provided by Bloomberg for pools of similar assets to determine the timing of the cash flows. These nonrecurring valuation inputs are considered to be Level 3 inputs.

Deposits. Deposits are carried at historical cost. The fair value of deposits with no stated maturity, such as noninterest bearing demand deposits, interest checking, money market, and savings accounts, is equal to the amount payable on demand as of the balance sheet date and considered Level 2. The fair value of time deposits is based on the discounted value of contractual cash flows and considered Level 2. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. No value has been separately assigned to the Company's long-term relationships with its deposit customers, such as a core deposit intangible.

Borrowings. Borrowings are carried at amortized cost. The fair value of fixed-rate borrowings is calculated by discounting scheduled cash flows through the estimated maturity dates or call dates, if applicable, using estimated market discount rates that reflect current rates offered for borrowings with similar remaining maturities and characteristics.

Subordinated debentures. Subordinated debentures are carried at amortized cost. The fair value of subordinated debentures with variable rates is determined using a market discount rate on the expected cash flows.

Commitments to extend credit. The majority of our commitments to extend credit carry current market interest rates if converted to loans. Because these commitments are generally unassignable by either the borrower or us, they only have value to the borrower and us. The estimated fair value approximates the recorded deferred fee amounts and is excluded from the table above because it is not material.

Limitations

Fair value estimates are made at a specific point in time and are based on relevant market information and information about the financial instrument. These estimates do not reflect income taxes or any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a portion of the Company's financial instruments, fair value estimates are based on what management believes to be conservative judgments regarding expected future cash flows, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimated fair values are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Since the fair values have been estimated as of September 30, 2013, the amounts that will actually be realized or paid at settlement or maturity of the instruments could be significantly different.