NOTE 13. 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, 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, 2018
Measured on a Recurring Basis	Total		Level 1		Level 2		Level 3
	(In thousands)
Securities available‑for‑sale:
Residential MBS and CMOs:
Agency MBS	$	281,088	$	—	$	281,088	$	—
Agency CMOs	632,850		—		632,850		—
Private label CMOs	101,205		—		93,917		7,288
Municipal securities	1,312,194		—		1,312,194		—
Agency commercial MBS	1,112,704		—		1,112,704		—
U.S. Treasury securities	403,405		403,405		—		—
Asset-backed securities	81,385		—		41,440		39,945
SBA securities	67,047		—		67,047		—
Corporate debt securities	17,553		—		17,553		—
Total securities available-for-sale	4,009,431		403,405		3,558,793		47,233
Equity warrants	4,793		—		—		4,793
Other derivative assets	3,292		—		3,292		—
Equity investments with readily determinable fair values	4,891		4,891		—		—
Total recurring assets	$	4,022,407	$	408,296	$	3,562,085	$	52,026
Derivative liabilities	$	142	$	—	$	142	$	—



	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		—
SBA securities	160,334		—		160,334		—
Asset-backed securities	88,710		—		46,601		42,109
Corporate debt securities	19,295		—		19,295		—
Collateralized loan obligations	7,015		—		7,015		—
Equity investments ⁽¹⁾	7,070		5,922		1,148		—
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	$	3,781,465	$	5,922	$	3,705,399	$	70,144
Derivative liabilities	$	1,379	$	—	$	1,379	$	—

__________________________________________________________

(1) In connection with our adoption of ASU 2016-01 and ASU 2018-03 on January 1, 2018, we reclassified $7.1 million of equity investments from securities available-for-sale to other assets in the first quarter of 2018. The reclassification was applied prospectively without prior period amounts being restated.

During the year ended December 31, 2018, there was a $0.1 million transfer from Level 3 equity warrants to Level 1 equity investments with readily determinable fair values measured on a recurring basis. 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 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.

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, 2018
	Private Label CMOs		Asset-Backed Securities
		Weighted	Input or	Weighted
	Range of	Average	Range of	Average
Unobservable Inputs	Inputs	Input	Inputs	Input
Voluntary annual prepayment speeds	6.1% - 31.1%	10.2%	12% - 15%	6.9%
Annual default rates ⁽¹⁾	0.6% - 82.0%	1.9%	2%	2.0%
Loss severity rates ⁽¹⁾	5.3% - 135.2%	53.0%	60%	60.0%
Discount rates	2.4% - 9.7%	6.4%	3.2% - 5.2%	2.1%

____________________


(1)	The annual default rates and loss severity rates were the same for all of the asset-backed securities.

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, 2018
	Equity Warrants
	Weighted
	Average
Unobservable Inputs	Input
Volatility	16.6%
Risk-free interest rate	2.5%
Remaining life assumption (in years)	3.5

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	2018			2017			2016
	(In thousands)
Balance, beginning of year	$	22,874		$	56,902		$	81,241
Total included in earnings	1,737			2,256			1,636
Total unrealized loss in comprehensive income	(1,146		)	(742		)	(1,648		)
Sales	(4,880		)	(4,732		)	—
Transfer from Level 2	—			574			—
Transfers to Level 2	—			(21,165		)	—
Net settlements	(11,297		)	(10,219		)	(24,327		)
Balance, end of year	$	7,288		$	22,874		$	56,902

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	2018			2017			2016
	(In thousands)
Balance, beginning of year	$	42,109		$	8,373		$	18,200
Total included in earnings	(32		)	367			96
Total unrealized gain (loss) in comprehensive income	495			(937		)	94
Purchases	15,158			42,910			—
Net settlements	(17,785		)	(8,604		)	(10,017		)
Balance, end of year	$	39,945		$	42,109		$	8,373

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



	Year Ended December 31,
Level 3 Equity Warrants	2018			2017			2016
	(In thousands)
Balance, beginning of year	$	5,161		$	5,497		$	4,914
Total included in earnings	7,478			2,532			1,402
Exercises ⁽¹⁾	(8,589		)	(3,093		)	(1,894		)
Issuances	821			1,407			1,911
Transfers to Level 1 (equity investments with readily
determinable fair values)	(78		)	(1,182		)	(836		)
Balance, end of year	$	4,793		$	5,161		$	5,497

______________________


(1)	Upon exercise, warrants become equity securities in public companies. These are often subject to lock-up restrictions that must be met before the equity security can be sold, during which time they are reported as equity investments with readily determinable fair values.

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, 2018
Measured on a Non‑Recurring Basis	Total		Level 1		Level 2		Level 3
	(In thousands)
Impaired loans	$	24,432	$	—	$	1,800	$	22,632
OREO	1,136		—		1,136		—
Total non-recurring	$	25,568	$	—	$	2,936	$	22,632



	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

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	2018		2017		2016
	(In thousands)
Impaired loans	$	9,198	$	20,422	$	43,240
Loans held for sale	—		957		—
OREO	74		14		2,576
Total net loss	$	9,272	$	21,393	$	45,816

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, 2018
			Valuation	Unobservable		Weighted
Asset	Fair Value		Technique	Inputs	Range	Average
	(In thousands)
Impaired loans	$	11,931	Discounted cash flows	Discount rates	3.75% - 8.00%	6.92%
Impaired loans	5,000		Negotiated discounted payoff from investors
Impaired loans	5,701		Third party appraisals	No discounts
Total non-recurring Level 3	$	22,632

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.

On January 1, 2018, we adopted ASU 2016-01 and ASU 2018-03 which requires the use of the exit price notion when measuring the fair values of financial instruments for disclosure purposes. Starting in the first quarter of 2018, we updated our methodology used to estimate the fair value for our loan portfolio to conform to the new requirements.

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



	December 31, 2018
	Carrying		Estimated Fair Value
	Amount		Total		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash and due from banks	$	175,830	$	175,830	$	175,830	$	—	$	—
Interest‑earning deposits in financial institutions	209,937		209,937		209,937		—		—
Securities available‑for‑sale	4,009,431		4,009,431		403,405		3,558,793		47,233
Investment in FHLB stock	32,103		32,103		—		32,103		—
Loans and leases held for investment, net	17,825,241		17,013,860		—		1,800		17,012,060
Equity warrants	4,793		4,793		—		—		4,793
Other derivative assets	3,292		3,292		—		3,292		—
Equity investments with readily determinable fair values	4,891		4,891		4,891		—		—

Financial Liabilities:
Core deposits	16,346,671		16,346,671		—		16,346,671		—
Non-core non-maturity deposits	518,192		518,192		—		518,192		—
Time deposits	2,005,638		2,017,137		—		2,017,137		—
Borrowings	1,371,114		1,371,114		1,371,000		114		—
Subordinated debentures	453,846		435,251		—		435,251		—
Derivative liabilities	142		142		—		142		—



	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		—
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		467,342		467,000		342		—
Subordinated debentures	462,437		444,383		—		444,383		—
Derivative liabilities	1,379		1,379		—		1,379		—

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 and non-rated private label asset-backed securities (collectively, “the Level 3 AFS 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 AFS 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 AFS 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.

Loans and leases. As 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 characteristics. Loans are segregated by type and further segmented into fixed and adjustable rate interest buckets by credit risk categories and by maturity dates. To determine the exit price of a loan or lease, the cash flows are estimated using a model which utilizes credit spreads and illiquidity premiums. The credit spread for a loan is determined by mapping loans' credit risk ratings to an equivalent corporate bond rating. Once the corporate bond rating is assigned, the credit spread is determined using corporate credit curves for corporate bonds that have a similar corporate bond rating and remaining term as the loan being valued. Illiquidity premiums are assigned to individual loans in a similar manner as an illiquidity premium amount is determined for each corporate bond rating. The credit spread above the appropriate rate curve and the illiquidity premium are considered to arrive at the discount rate curve applied to loan cash flows.

Impaired loans and leases. Nonaccrual loans and leases 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. Impaired loans and leases with outstanding balances over $250,000 are reviewed individually for the amount of impairment, if any. Impaired loans and leases with outstanding balances less than or equal to $250,000 may not be individually assessed for impairment but are assessed with reserves based on the average loss severity on historical impaired loans with similar risk characteristics.

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, 2018.

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 loan and lease 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, 2018. The amounts shown as net losses include the impairment recognized during the year ended December 31, 2018, for the loan and lease 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.

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, 2018.

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.

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.

Equity investments with readily determinable fair values. Our equity investments with readily determinable fair values include investments in public companies and publicly-traded mutual funds. Equity investments with readily determinable fair values are recorded at fair value with changes in fair value recorded in “Noninterest income - other.” During the first quarter of 2018, the Company reclassified $5.9 million of equity securities with readily determinable fair values previously included in securities available-for-sale to other assets on our consolidated balance sheet. The reclassification was applied prospectively without prior period amounts being restated. Fair value measurements related to these investments are typically classified within Level 1 of the fair value hierarchy.

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.

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, 2018, the amounts that will actually be realized or paid at settlement or maturity of the instruments could be significantly different.