Fair Value Accounting

6 Months Ended

Jun. 30, 2017

Fair Value Disclosures [Abstract]

Fair Value Accounting

13. FAIR VALUE ACCOUNTING

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach, and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC 825 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 825 are described in "Note 1. Summary of Significant Accounting Policies" of these Notes to Unaudited Consolidated Financial Statements.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value is set forth below. Transfers between levels in the fair value hierarchy are recognized as of the end of the month following the event or change in circumstances that caused the transfer.

Under ASC 825, the Company elected the FVO treatment for junior subordinated debt held by WAL. This election is irrevocable and results in the recognition of unrealized gains and losses on these items at each reporting date. Due to the Company's election to early adopt an element of ASU 2016-01, effective January 1, 2015, these unrealized gains and losses are recognized as part of other comprehensive income rather than earnings. The Company did not elect FVO treatment for the junior subordinated debt assumed in the Bridge Capital Holdings acquisition in 2015.

All securities for which the fair value measurement option had been elected are included in a separate line item in the Consolidated Balance Sheets as securities measured at fair value. During the three months ended June 30, 2017, the Company sold all of its investment securities measured at fair value. No significant gain or loss was recognized upon sale of these securities.

For the three and six months ended June 30, 2017 and 2016, gains and losses from fair value changes on securities and junior subordinated debt were as follows:

	Changes in Fair Values for Items Measured at Fair Value Pursuant to Election of the Fair Value Option
	Unrealized Gain/(Loss) on Assets and Liabilities Measured at Fair Value, Net			Interest Income on Securities		Interest Expense on Junior Subordinated Debt			Total Changes Included in Current-Period Earnings			Total Changes Included in OCI
	(in thousands)
Three Months Ended June 30, 2017
Securities measured at fair value	$	—		$	2	$	—		$	2		$	—
Junior subordinated debt	(3,376		)	—		(791		)	(791		)	(2,089		)
Total	$	(3,376	)	$	2	$	(791	)	$	(789	)	$	(2,089	)
Six Months Ended June 30, 2017
Securities measured at fair value	$	—		$	9	$	—		$	9		$	—
Junior subordinated debt	(5,362		)	—		(1,540		)	(1,540		)	(3,318		)
Total	$	(5,362	)	$	9	$	(1,540	)	$	(1,531	)	$	(3,318	)
Three Months Ended June 30, 2016
Securities measured at fair value	$	(1	)	$	11	$	—		$	10		$	—
Junior subordinated debt	1,006			—		693			693			575
Total	$	1,005		$	11	$	693		$	703		$	575
Six Months Ended June 30, 2016
Securities measured at fair value	$	(6	)	$	22	$	—		$	16		$	—
Junior subordinated debt	2,218			—		1,373			1,373			1,334
Total	$	2,212		$	22	$	1,373		$	1,389		$	1,334

Interest income on securities measured at fair value is accounted for similarly to those classified as AFS. Any premiums or discounts are recognized in interest income over the term of the securities. Interest expense on junior subordinated debt is also determined under a constant yield calculation.

Fair value on a recurring basis

Financial assets and financial liabilities measured at fair value on a recurring basis include the following:

Securities measured at fair value: All of the Company’s securities measured at fair value, which consist of MBS, are reported at fair value utilizing Level 2 inputs in the same manner as described below for AFS securities.

AFS securities: Preferred stock, CRA investments, and certain corporate debt securities are reported at fair value utilizing Level 1 inputs. Other securities classified as AFS are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bond’s terms and conditions, among other things.

Historically, the Company has estimated the fair value of its CDO securities utilizing Level 3 inputs, which include pricing indications from comparable securities. During the year ended December 31, 2016, these securities were transferred from Level 3 to Level 2 as a result of an increase in the availability and reliability of the observable inputs utilized in the securities' fair value measurement.

Independent pricing service: The Company's independent pricing service provides pricing information on the majority of the Company's Level 1 and 2 securities. Management independently evaluates the fair value measurements received from the Company's third party pricing service through multiple review steps. First, management reviews what has transpired in the marketplace with respect to interest rates, credit spreads, volatility, and mortgage rates, among other things, and develops an expectation of changes to the securities' valuations from the previous quarter. Then, management obtains market values from additional sources. The pricing service provides management with observable market data including interest rate curves and mortgage prepayment speed grids, as well as dealer quote sheets, new bond offering sheets, and historical trade documentation. Management reviews the assumptions and decides whether they are reasonable. Management may compare interest rates, credit spreads, and prepayments speeds used as part of the assumptions to those that management believes are reasonable. Management may price securities using the provided assumptions to determine whether they can develop similar prices on like securities. Any discrepancies between management’s review and the prices provided by the vendor are discussed with the vendor and the Company’s other valuation advisors. Lastly, management selects a sample of investment securities and compares the values provided by its primary third party pricing service to the market values obtained from secondary sources and evaluates those with notable variances.

Interest rate swaps: Interest rate swaps are reported at fair value utilizing Level 2 inputs. The Company obtains dealer quotations to value its interest rate swaps.

Junior subordinated debt: The Company estimates the fair value of its junior subordinated debt using a discounted cash flow model which incorporates the effect of the Company’s own credit risk in the fair value of the liabilities (Level 3). The Company’s cash flow assumptions are based on contractual cash flows as the Company anticipates that it will pay the debt according to its contractual terms.

As of June 30, 2017, the Company estimates the discount rate at 5.21%, which represents an implied credit spread of 3.91% plus three-month LIBOR (1.30%). As of December 31, 2016, the Company estimated the discount rate at 5.66%, which was a 4.66% credit spread plus three-month LIBOR (1.00%).

The fair value of assets and liabilities measured at fair value on a recurring basis was determined using the following inputs as of the periods presented: 

	Fair Value Measurements at the End of the Reporting Period Using:
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fair Value
	(in thousands)
June 30, 2017
Assets:
Available-for-sale
CDO	$	—	$	15,553	$	—	$	15,553
Commercial MBS issued by GSEs	—		115,327		—		115,327
Corporate debt securities	—		63,922		—		63,922
CRA investments	49,482		—		—		49,482
Preferred stock	97,506		—		—		97,506
Private label residential MBS	—		680,248		—		680,248
Residential MBS issued by GSEs	—		1,555,137		—		1,555,137
Tax-exempt	—		404,189		—		404,189
Trust preferred securities	—		29,405		—		29,405
U.S. government sponsored agency securities	—		71,391		—		71,391
U.S. treasury securities	—		2,498		—		2,498
Total AFS securities	$	146,988	$	2,937,670	$	—	$	3,084,658
Loans - HFS	$	—	$	16,736	$	—	$	16,736
Derivative assets (1)	—		3,793		—		3,793
Liabilities:
Junior subordinated debt (2)	$	—	$	—	$	55,772	$	55,772
Derivative liabilities (1)	—		64,153		—		64,153

(1) Derivative assets and liabilities relate to interest rate swaps, see "Note 9. Derivatives and Hedging Activities." In addition, the carrying value of loans is increased by $49,057 and the net carrying value of subordinated debt is decreased by $10,540 as of June 30, 2017, which relates to the effective portion of the hedges put in place to mitigate against fluctuations in interest rates.

(2) Includes only the portion of junior subordinated debt that is recorded at fair value at each reporting period pursuant to the election of FVO treatment.

	Fair Value Measurements at the End of the Reporting Period Using:
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Fair Value
	(in thousands)
December 31, 2016
Assets:
Measured at fair value
Residential MBS issued by GSEs	$	—	$	1,053	$	—	$	1,053
Available-for-sale
CDO	—		13,490		—		13,490
Commercial MBS issued by GSEs	—		117,792		—		117,792
Corporate debt securities	20,000		44,144		—		64,144
CRA investments	37,113		—		—		37,113
Preferred stock	94,662		—		—		94,662
Private label residential MBS	—		433,685		—		433,685
Residential MBS issued by GSEs	—		1,355,205		—		1,355,205
Tax-exempt	—		408,233		—		408,233
Trust preferred securities	—		26,532		—		26,532
U.S. government sponsored agency securities	—		56,022		—		56,022
U.S. treasury securities	—		2,502		—		2,502
Total AFS securities	$	151,775	$	2,457,605	$	—	$	2,609,380
Loans - HFS	$	—	$	18,909	$	—	$	18,909
Derivative assets (1)	—		4,220		—		4,220
Liabilities:
Junior subordinated debt	$	—	$	—	$	50,410	$	50,410
Derivative liabilities (1)	—		65,749		—		65,749

(1) Derivative assets and liabilities relate to interest rate swaps, see "Note 9. Derivatives and Hedging Activities." In addition, the carrying value of loans is increased by $$48,161 and the net carrying value of subordinated debt is decreased by$12,325as of December 31, 2016, which relates to the effective portion of the hedges put in place to mitigate against fluctuations in interest rates.

For the three and six months ended June 30, 2017 and 2016, the change in Level 3 assets and liabilities measured at fair value on a recurring basis was as follows: 

	Junior Subordinated Debt
	Three Months Ended June 30,					Six Months Ended June 30,
	2017		2016			2017		2016
	(in thousands)
Beginning balance	$	52,396	$	45,716		$	50,410	$	46,928
Transfers into Level 3	—		—			—		—
Total gains (losses) for the period
Included in earnings	—		—			—		—
Included in other comprehensive income	3,376		(1,006		)	5,362		(2,218		)
Ending balance	$	55,772	$	44,710		$	55,772	$	44,710

	CDO Securities
	Three Months Ended June 30,				Six Months Ended June 30,
	2017		2016		2017		2016
	(in thousands)
Beginning balance	$	—	$	9,076	$	—	$	10,060
Transfers into Level 3	—		—		—		—
Total gains (losses) for the period
Included in other comprehensive income	—		1,107		—		123
Ending balance	$	—	$	10,183	$	—	$	10,183

The Company transferred all CDO securities from Level 3 to Level 2 during the year ended December 31, 2016 as a result of an increase in the availability and reliability of the observable inputs utilized in the securities' fair value measurement. The Company recognized this transfer between levels on October 31, 2016, in accordance with its policy to recognize transfers between levels in the fair value hierarchy as of the end of the month following the event or change in circumstance that caused the transfer.

For Level 3 assets and liabilities measured at fair value on a recurring basis as of June 30, 2017 and December 31, 2016, the significant unobservable inputs used in the fair value measurements were as follows: 

	June 30, 2017		Valuation Technique	Significant Unobservable Inputs	Input Value
	(in thousands)
Junior subordinated debt	$	55,772	Discounted cash flow	Implied credit rating of the Company	5.21	%

	December 31, 2016		Valuation Technique	Significant Unobservable Inputs	Input Value
	(in thousands)
Junior subordinated debt	$	50,410	Discounted cash flow	Implied credit rating of the Company	5.66	%

The significant unobservable inputs used in the fair value measurement of the Company’s junior subordinated debt as of June 30, 2017 and December 31, 2016 was the implied credit risk for the Company, calculated as the difference between the 20-year 'BB' rated financial index over the corresponding swap index.

Fair value on a nonrecurring basis

Certain assets are measured at fair value on a nonrecurring basis. That is, the assets are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents such assets carried on the balance sheet by caption and by level within the ASC 825 hierarchy:

	Fair Value Measurements at the End of the Reporting Period Using
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Active Markets for Similar Assets (Level 2)		Unobservable Inputs (Level 3)
	(in thousands)
As of June 30, 2017:
Impaired loans with specific valuation allowance	$	4,417	$	—	$	—	$	4,417
Impaired loans without specific valuation allowance (1)	76,575		—		—		76,575
Other assets acquired through foreclosure	30,988		—		—		30,988
As of December 31, 2016:
Impaired loans with specific valuation allowance	$	6,670	$	—	$	—	$	6,670
Impaired loans without specific valuation allowance (1)	60,738		—		—		60,738
Other assets acquired through foreclosure	47,815		—		—		47,815

(1) Net of loan balances with charge-offs of $20.8 million and $27.6 million as of June 30, 2017 and December 31, 2016, respectively.

For Level 3 assets measured at fair value on a nonrecurring basis as of June 30, 2017 and December 31, 2016, the significant unobservable inputs used in the fair value measurements were as follows:

	June 30, 2017		Valuation Technique(s)		Significant Unobservable Inputs	Range
	(in thousands)
Impaired loans	$	80,992	Collateral method	Third party appraisal or valuation	Costs to sell	4.0% to 10.0%
			Discounted cash flow method	Discount rate	Contractual loan rate	4.0% to 7.0%
				Scheduled cash collections	Probability of default	0% to 20.0%
				Proceeds from non-real estate collateral	Loss given default	0% to 70.0%
Other assets acquired through foreclosure	30,988		Collateral method	Third party appraisal	Costs to sell	4.0% to 10.0%

	December 31, 2016		Valuation Technique(s)		Significant Unobservable Inputs	Range
	(in thousands)
Impaired loans	$	67,408	Collateral method	Third party appraisal	Costs to sell	4.0% to 10.0%
			Discounted cash flow method	Discount rate	Contractual loan rate	4.0% to 7.0%
				Scheduled cash collections	Probability of default	0% to 20.0%
				Proceeds from non-real estate collateral	Loss given default	0% to 70.0%
Other assets acquired through foreclosure	47,815		Collateral method	Third party appraisal	Costs to sell	4.0% to 10.0%

Impaired loans: The specific reserves for collateral dependent impaired loans are based on collateral value, net of estimated disposition costs and other identified quantitative inputs. Collateral value is determined based on independent third-party appraisals or internally-developed discounted cash flow analyses. Appraisals may utilize a single valuation approach or a combination of approaches, including comparable sales and the income approach. Fair value is determined, where possible, using market prices derived from an appraisal or evaluation, which are considered to be Level 2. However, certain assumptions and unobservable inputs are often used by the appraiser, therefore qualifying the assets as Level 3 in the fair value hierarchy. In addition, 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. Internal discounted cash flow analyses are also utilized to estimate the fair value of impaired loans, which considers internally-developed, unobservable inputs such as discount rates, default rates, and loss severity.

Total Level 3 impaired loans had an estimated fair value of $81.0 million and $67.4 million at June 30, 2017 and December 31, 2016, respectively. Impaired loans with a specific valuation allowance had a gross estimated fair value of $8.3 million and $10.9 million at June 30, 2017 and December 31, 2016, respectively, which was reduced by a specific valuation allowance of $3.9 million and $4.2 million, respectively.

Other assets acquired through foreclosure: Other assets acquired through foreclosure consist of properties acquired as a result of, or in-lieu-of, foreclosure. These assets are initially reported at the fair value determined by independent appraisals using appraised value less estimated cost to sell. Such properties are generally re-appraised every twelve months. There is risk for subsequent volatility. Costs relating to the development or improvement of the assets are capitalized and costs relating to holding the assets are charged to expense.

Fair value is determined, where possible, using market prices derived from an appraisal or evaluation, which are considered to be Level 2. However, certain assumptions and unobservable inputs are often used by the appraiser, therefore qualifying the assets as Level 3 in the fair value hierarchy. When significant adjustments are based on unobservable inputs, such as when a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the resulting fair value measurement has been categorized as a Level 3 measurement. The Company had $31.0 million and $47.8 million of such assets at June 30, 2017 and December 31, 2016, respectively.

Credit vs. non-credit losses

Under the provisions of ASC 320, Investments-Debt and Equity Securities, OTTI is separated into the amount of total impairment related to the credit loss and the amount of the total impairment related to all other factors. The amount of the total OTTI related to the credit loss is recognized in earnings. The amount of the total impairment related to all other factors is recognized in OCI.

For the three and six months ended June 30, 2017 and 2016, the Company determined that no securities experienced credit losses.

There is no OTTI balance recognized in comprehensive income as of June 30, 2017 and 2016.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair value of the Company’s financial instruments is as follows: 

	June 30, 2017
	Carrying Amount		Fair Value
			Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets:
Investment securities:
HTM	$	132,802	$	—	$	137,526	$	—	$	137,526
AFS	3,084,658		146,988		2,937,670		—		3,084,658
Derivative assets	3,793		—		3,793		—		3,793
Loans, net	13,858,184		—		13,546,599		80,992		13,627,591
Accrued interest receivable	75,994		—		75,994		—		75,994
Financial liabilities:
Deposits	$	16,031,113	$	—	$	16,037,566	$	—	$	16,037,566
Customer repurchase agreements	32,661		—		32,661		—		32,661
Qualifying debt	375,444		—		—		401,093		401,093
Derivative liabilities	64,153		—		64,153		—		64,153
Accrued interest payable	16,146		—		16,146		—		16,146

	December 31, 2016
	Carrying Amount		Fair Value
			Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets:
Investment securities:
HTM	$	92,079	$	—	$	91,966	$	—	$	91,966
AFS	2,609,380		151,775		2,457,605		—		2,609,380
Trading	1,053		—		1,053		—		1,053
Derivative assets	4,220		—		4,220		—		4,220
Loans, net	13,083,732		—		12,736,336		67,408		12,803,744
Accrued interest receivable	70,320		—		70,320		—		70,320
Financial liabilities:
Deposits	$	14,549,863	$	—	$	14,553,931	$	—	$	14,553,931
Customer repurchase agreements	41,728		—		41,728		—		41,728
FHLB advances	80,000		—		80,000		—		80,000
Qualifying debt	367,937		—		—		375,626		375,626
Derivative liabilities	65,749		—		65,749		—		65,749
Accrued interest payable	15,354		—		15,354		—		15,354

Interest rate risk

The Company assumes interest rate risk (the risk to the Company’s earnings and capital from changes in interest rate levels) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments, as well as its future net interest income will change when interest rate levels change and that change may be either favorable or unfavorable to the Company.

Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the Company's change in EVE and net interest income resulting from hypothetical changes in interest rates. If potential changes to EVE and net interest income resulting from hypothetical interest rate changes are not within the limits established by the BOD, the BOD may direct management to adjust the asset and liability mix to bring interest rate risk within BOD-approved limits. As of June 30, 2017, the Company’s interest rate risk profile was within BOD-approved limits.

WAB has an ALCO charged with managing interest rate risk within the BOD-approved limits. Limits are structured to prohibit an interest rate risk profile that does not conform to both management and BOD risk tolerances. There is also ALCO reporting at the Parent company level for reviewing interest rate risk for the Company, which gets reported to the BOD and its Finance and Investment Committee.

Fair value of commitments

The estimated fair value of standby letters of credit outstanding at June 30, 2017 and December 31, 2016 is insignificant. Loan commitments on which the committed interest rates are less than the current market rate are also insignificant at June 30, 2017 and December 31, 2016.