NOTE 12. FAIR VALUE MEASUREMENTS

ASC Topic 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:


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

•

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 municipal securities, agency residential and commercial MBS, collateralized loan obligations, agency and registered publicly rated private label CMOs, corporate debt securities, SBA securities, and asset-backed securitizations.

•

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 observable inputs from a pricing service not corroborated by observable market data, and includes our non-rated private label CMOs, non-rated private label asset-backed securities, and equity warrants.

We use fair value to measure certain assets and liabilities on a recurring basis, primarily securities available‑for‑sale and derivatives. 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, CDI, and other long‑lived assets.

The following tables present information on the assets measured and recorded at fair value on a recurring basis as of the dates indicated:



	Fair Value Measurements as of
	December 31, 2017
Measured on a Recurring Basis	Total		Level 1		Level 2		Level 3
	(In thousands)
Securities available‑for‑sale:
Residential MBS and CMOs:
Agency MBS	$	246,274	$	—	$	246,274	$	—
Agency CMOs	275,709		—		275,709		—
Private label CMOs	125,987		—		103,113		22,874
Municipal securities	1,680,068		—		1,680,068		—
Agency commercial MBS	1,163,969		—		1,163,969		—
Corporate debt securities	19,295		—		19,295		—
Collateralized loan obligations	7,015		—		7,015		—
SBA securities	160,334		—		160,334		—
Asset-backed and other securities	95,780		5,922		47,749		42,109
Total securities available-for-sale	3,774,431		5,922		3,703,526		64,983
Equity warrants	5,161		—		—		5,161
Other derivative assets	1,873		—		1,873		—
Total recurring assets	$	3,779,592	$	5,922	$	3,703,526	$	70,144
Derivative liabilities	$	1,379	$	—	$	1,379	$	—



	Fair Value Measurements as of
	December 31, 2016
Measured on a Recurring Basis	Total		Level 1		Level 2		Level 3
	(In thousands)
Securities available‑for‑sale:
Residential MBS and CMOs:
Agency MBS	$	502,443	$	—	$	502,443	$	—
Agency CMOs	146,289		—		146,289		—
Private label CMOs	125,469		—		68,567		56,902
Municipal securities	1,456,459		—		1,456,459		—
Agency commercial MBS	547,692		—		547,692		—
Corporate debt securities	47,509		—		47,509		—
Collateralized loan obligations	156,887		—		156,887		—
SBA securities	178,845		—		178,845		—
Asset-backed and other securities	62,237		2,080		51,784		8,373
Total securities available-for-sale	3,223,830		2,080		3,156,475		65,275
Equity warrants	5,497		—		—		5,497
Other derivative assets	694		—		694		—
Total recurring assets	$	3,230,021	$	2,080	$	3,157,169	$	70,772
Derivative liabilities	$	3,285	$	—	$	3,285	$	—

During the year ended December 31, 2017, there was a $0.6 million transfer of private label CMOs from Level 2 to Level 3, a $21.2 million transfer of private label CMOs from Level 3 to Level 2, and a $1.2 million transfer from Level 3 equity warrants to Level 1 securities available-for-sale for assets measured on a recurring basis. During the year ended December 31, 2016, there were no transfers of assets either between Level 1 and Level 2, and there was a $0.8 million transfer from Level 3 equity warrants to Level 1 securities available-for-sale for assets measured on a recurring basis.

The following table presents information about the quantitative inputs and assumptions used to determine the fair values provided by our third party pricing service for our Level 3 private label CMOs and asset-backed securities available-for-sale measured at fair value on a recurring basis as of the date indicated:



	December 31, 2017
	Private Label CMOs		Asset-Backed Securities
		Weighted		Weighted
	Range of	Average	Range of	Average
Unobservable Inputs	Inputs	Input	Inputs	Input
Voluntary annual prepayment speeds	3.6% - 43.6%	8.6%	5% - 15%	13.8%
Annual default rates	0.1% - 15.3%	2.5%	1% - 2%	1.9%
Loss severity rates	4.0% - 102%	55.8%	10% - 60%	53.9%
Discount rates	1.8% - 10.3%	5.3%	3.2% - 4.3%	3.6%

The following table presents information about the quantitative inputs and assumptions used in the modified Black-Scholes option pricing model to determine the fair value for our Level 3 equity warrants measured at fair value on a recurring basis as of the date indicated:



	December 31, 2017
	Equity Warrants
	Weighted
	Average
Unobservable Inputs	Input
Volatility	16.7%
Risk-free interest rate	2.1%
Remaining life assumption (in years)	3.7

The following table summarizes activity for our Level 3 private label CMOs measured at fair value on a recurring basis for the years indicated:



	Year Ended December 31,
Level 3 Private Label CMOs	2017			2016			2015
	(In thousands)
Balance, beginning of year	$	56,902		$	81,241		$	33,947
Total included in earnings	2,256			1,636			1,104
Total unrealized loss in comprehensive income	(742		)	(1,648		)	(1,388		)
Sales	(4,732		)	—			—
Transfer from Level 2	574			—			—
Transfers to Level 2	(21,165		)	—			—
Net settlements	(10,219		)	(24,327		)	(3,881		)
Addition from the Square 1 acquisition	—			—			51,459
Balance, end of year	$	22,874		$	56,902		$	81,241

The following table summarizes activity for our Level 3 asset-backed securities measured at fair value on a recurring basis for the years indicated:



	Year Ended December 31,
Level 3 Asset-Backed Securities	2017			2016			2015
	(In thousands)
Balance, beginning of year	$	8,373		$	18,200		$	—
Total included in earnings	367			96			—
Total unrealized (loss) gain in comprehensive income	(937		)	94			—
Purchases	42,910			—			—
Net settlements	(8,604		)	(10,017		)	—
Addition from the Square 1 acquisition	—			—			18,200
Balance, end of year	$	42,109		$	8,373		$	18,200

The following table summarizes activity for our Level 3 equity warrants measured at fair value on a recurring basis for the year ended December 31, 2017 and 2016 and the period from the October 6, 2015 Square 1 acquisition date to December 31, 2015:



	Year Ended December 31,						Period Ended
Level 3 Equity Warrants	2017			2016			December 31, 2015
	(In thousands)
Balance, beginning of year or acquisition date	$	5,497		$	4,914		$	5,552
Total included in earnings	2,532			1,402			530
Sales	(3,093		)	(1,894		)	(1,529		)
Issuances	1,407			1,911			363
Transfers to Level 1 (securities available-for-sale)	(1,182		)	(836		)	(2		)
Balance, end of year	$	5,161		$	5,497		$	4,914

The following tables present assets measured at fair value on a non‑recurring basis as of the dates indicated:



	Fair Value Measurement as of
	December 31, 2017
Measured on a Non‑Recurring Basis	Total		Level 1		Level 2		Level 3
	(In thousands)
Impaired Non‑PCI loans	$	61,095	$	—	$	5,143	$	55,952
Loans held for sale	483,563		—		483,563		—
Total non-recurring	$	544,658	$	—	$	488,706	$	55,952



	Fair Value Measurement as of
	December 31, 2016
Measured on a Non‑Recurring Basis	Total		Level 1		Level 2		Level 3
	(In thousands)
Impaired Non‑PCI loans	$	149,749	$	—	$	1,661	$	148,088
OREO	11,224		—		11,224		—
Investments carried at cost	242		—		—		242
Total non-recurring	$	161,215	$	—	$	12,885	$	148,330

The following table presents losses recognized on assets measured on a nonrecurring basis for the years indicated:



	Year Ended December 31,
Loss on Assets Measured on a Non‑Recurring Basis	2017		2016		2015
	(In thousands)
Impaired Non‑PCI loans	$	20,422	$	43,240	$	16,097
Loans held for sale	957		—		—
OREO	14		2,576		4,726
Investments carried at cost	—		10		17
Total net loss	$	21,393	$	45,826	$	20,840

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



	December 31, 2017
			Valuation	Unobservable		Weighted
Asset	Fair Value		Technique	Inputs	Range	Average
	(In thousands)
Impaired Non-PCI loans	$	41,984	Discounted cash flows	Discount rates	2.00% - 10.20%	7.43%
	13,968		Third party appraisals	No discounts
Total non-recurring Level 3	$	55,952

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 carrying amounts and estimated fair values of certain financial instruments as of the dates indicated:



	December 31, 2017
	Carrying		Estimated Fair Value
	Amount		Total		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and due from banks	$	233,215	$	233,215	$	233,215	$	—	$	—
Interest‑earning deposits in financial institutions	165,222		165,222		165,222		—		—
Securities available‑for‑sale	3,774,431		3,774,431		5,922		3,703,526		64,983
Investment in FHLB stock	20,790		20,790		—		20,790		—
Investments carried at cost	977		9,573		—		—		9,573
Loans held for sale	481,100		483,563		—		483,563		—
Loans and leases held for investment, net	16,833,287		17,023,098		—		5,143		17,017,955
Equity warrants	5,161		5,161		—		—		5,161
Other derivative assets	1,873		1,873		—		1,873		—

Financial Liabilities:
Core deposits	15,937,012		15,937,012		—		15,937,012		—
Non-core non-maturity deposits	863,202		863,202		—		863,202		—
Time deposits	2,065,322		2,055,104		—		2,055,104		—
Borrowings	467,342		467,343		467,000		343		—
Subordinated debentures	462,437		444,383		—		444,383		—
Derivative liabilities	1,379		1,379		—		1,379		—



	December 31, 2016
	Carrying		Estimated Fair Value
	Amount		Total		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and due from banks	$	337,965	$	337,965	$	337,965	$	—	$	—
Interest‑earning deposits in financial institutions	81,705		81,705		81,705		—		—
Securities available‑for‑sale	3,223,830		3,223,830		2,080		3,156,475		65,275
Investment in FHLB stock	21,870		21,870		—		21,870		—
Investments carried at cost	1,416		3,843		—		—		3,843
Loans and leases held for investment, net	15,298,716		15,494,808		—		1,661		15,493,147
Equity warrants	5,497		5,497		—		—		5,497
Other derivative assets	694		694		—		694		—

Financial Liabilities:
Core deposits	12,523,834		12,523,834		—		12,523,834		—
Non-core non-maturity deposits	1,174,487		1,174,487		—		1,174,487		—
Time deposits	2,172,290		2,166,187		—		2,166,187		—
Borrowings	905,812		905,838		591,000		314,838		—
Subordinated debentures	440,744		424,507		—		424,507		—
Derivative liabilities	3,285		3,285		—		3,285		—

The following is a description of the valuation methodologies used to measure our assets recorded at fair value (under ASC Topic 820, “Fair Value Measurement”) 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 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 publicly traded 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 non-rated private label CMOs, non-rated private label asset-backed securities, and equity warrants (collectively, “the Level 3 Securities”) were categorized as Level 3 due in part to the inactive market for such securities. There is a wide range of prices quoted for our Level 3 Securities 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 relating to our Level 3 Securities to be a significant unobservable input. Our fair value estimate was based on either 1) 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, or 2) pricing estimates we obtained from brokers. We determined the reasonableness of the fair values by reviewing assumptions at the individual security level about prepayment, default expectations, estimated loss severity factors, and discount rates, all of which are not directly observable in the market. Significant changes in default expectations, loss severity 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.

Non-PCI loans and leases. As Non-PCI loans and leases are not measured at fair value, the following discussion relates to estimating the fair value disclosures under ASC Topic 825. Fair values are estimated for portfolios of loans and leases with similar financial characteristics. Loans are segregated by type and further segmented into fixed and adjustable rate interest terms by credit risk categories. The fair value estimates do not take into consideration the value of the loan portfolio in the event the loans are sold outside the parameters of normal operating activities. The fair value of performing fixed rate loans is estimating by discounting scheduled cash flows through the estimated maturity using estimated market prepayment speeds. The fair value of equipment leases is estimated by discounting scheduled lease and expected lease residual cash flows over their remaining term. The estimated market discount rates used for performing fixed rate loans and equipment leases are current market rates for instruments with similar risk and similar terms. The fair value of performing adjustable-rate loans is estimated by discounting scheduled cash flows through the next repricing date. As these loans reprice frequently at market rates and the credit risk is not considered to be greater than normal, the market value is typically close to the carrying amount of these loans. These methods and assumptions are not based on the exit price concept of fair value.

Impaired Non‑PCI loans. Nonaccrual loans and performing troubled debt restructured loans are considered impaired for reporting purposes and are measured and recorded at fair value on a non‑recurring basis. Nonaccrual Non‑PCI loans with an unpaid principal balance over $250,000 and all performing troubled debt restructured loans are reviewed individually for the amount of impairment, if any. Nonaccrual Non‑PCI loans with an unpaid principal balance less than $250,000 are not individually assessed for impairment but are instead reserved for under our general reserve component.

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 year ended December 31, 2017.

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 impaired Non‑PCI loan balances shown above as measured on a non-recurring basis represent those nonaccrual and restructured loans for which impairment was recognized during the year ended December 31, 2017. The amounts shown as net losses include the impairment recognized during the year ended December 31, 2017, for the loan balances shown.

Loans held for sale. Loans held for sale are carried at the lower of cost or fair value, with fair value adjustments recorded on a nonrecurring basis. The loans held for sale at December 31, 2017 consisted of cash flow loans, and the fair value of these loans was based on sale agreements which we entered into during the fourth quarter of 2017. Loans held for sale which are under contract for sale are considered Level 2 in the fair value hierarchy.

Investments that do not have readily determinable fair values. Other investments accounted for under the cost or equity methods of accounting are carried at fair value on a nonrecurring basis to the extent that they are determined to be other-than-temporarily impaired during the period. As there is rarely an observable price or market for such investments, we determine fair value using internally developed models. Our models utilize industry valuation benchmarks, such as multiples of net revenue or EBITDA, to determine a value for the underlying enterprise. We may also reduce the value determined by the model due to illiquidity or other investee-specific characteristics which may affect the fair value. Significant decreases to these valuation benchmarks would result in significant decreases in the estimated fair values. We reduce this value by the value of debt outstanding to arrive at an estimated equity value of the enterprise. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the pricing indicated by the external event is used to corroborate our internal valuation. Fair value measurements related to these investments are typically classified within Level 3 of the fair value hierarchy.

OREO. The fair value of OREO is generally based on the lower of 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 year ended December 31, 2017.

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.

Deposits. Deposits are carried at historical cost. The fair values of deposits with no stated maturity, such as core deposits (defined as noninterest‑bearing demand, interest checking, money market, and savings accounts) and non-core non-maturity deposits, are 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 include overnight FHLB advances and other fixed‑rate term borrowings. Borrowings are carried at amortized cost. The fair value of overnight FHLB advances is equal to the carrying value and considered Level 1. The fair value of fixed‑rate borrowings is calculated by discounting scheduled cash flows through the 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 and are considered Level 2.

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 and are considered Level 2.

Derivative assets and liabilities. Derivatives are carried at fair value on a recurring basis and primarily relate to forward exchange contracts which we enter into to manage foreign exchange risk. Our derivatives are principally traded in over-the-counter markets where quoted market prices are not readily available. Instead, the fair value of derivatives is estimated using market observable inputs such as foreign exchange forward rates, interest rate yield curves, volatilities and basis spreads. We also consider counter-party credit risk in valuing our derivatives. We typically classify our foreign exchange derivatives in Level 2 of the fair value hierarchy.

Equity Warrants. Equity warrants with net settlement terms are received in connection with extending loan commitments to certain of our customers. We estimate the fair value of equity warrants using a Black-Scholes option pricing model to approximate fair market value. For warrants of private companies, the model estimates market value for each warrant based on the most recent equity offering at the time of issuance, the warrant's exercise price, the warrant's expected life, a risk-free interest rate based on a duration-matched U.S. Treasury rate and volatility factors derived from the iShares Russell Microcap index (IWC). For warrants of publicly-traded companies, the model estimates market value for each warrant based on the underlying share price as of the evaluation date, the warrant's exercise price, the warrant's expected life, a risk-free interest rate based on a duration-matched U.S. Treasury rate and uses a company-specific volatility factor. We typically classify our equity warrant derivatives in Level 3 of the fair value hierarchy.

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 not assignable 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 December 31, 2017, the amounts that will actually be realized or paid at settlement or maturity of the instruments could be significantly different.