Note 16—Fair Value Measurement

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In addition, the Company has the ability to obtain fair values for markets that are not accessible.

These types of inputs create the following fair value hierarchy:

Level 1—Quoted prices in active markets for identical assets or liabilities.

Level 2—Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available. The Company’s own data used to develop unobservable inputs may be adjusted for market considerations when reasonably available.

The categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to assets and liabilities.

The Company used the following methods and significant assumptions to estimate fair value for certain assets measured and carried at fair value on a recurring basis:

Securities available-for-sale—The Company obtains fair value measurements from an independent pricing service. Management reviews the procedures used by the third party, including significant inputs used in the fair value calculations. 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. When market quotes are not readily accessible or available, alternative approaches are utilized, such as matrix or model pricing.

The Company’s methodology for pricing non-rated bonds focuses on three distinct inputs: equivalent rating, yield and other pricing terms. To determine the rating for a given non-rated municipal bond, the Company references a publicly issued bond by the same issuer if available as well as other additional key metrics to support the credit worthiness. Typically, pricing for these types of bonds would require a higher yield than a similar rated bond from the same issuer. A reduction in price is applied to the rating obtained from the comparable bond, as the Company believes if liquidated, a non-rated bond would be valued less than a similar bond with a verifiable rating. The reduction applied by the Company is one notch lower (i.e. a “AA” rating for a comparable bond would be reduced to “AA-” for the Company’s valuation). In 2018 and 2017, all of the ratings derived by the Company were “BBB” or better with and without comparable bond proxies. The fair value measurement of municipal bonds is sensitive to the rating input, as a higher rating typically results in an increased valuation. The remaining pricing inputs used in the bond valuation are observable. Based on the rating determined, the Company obtains a corresponding current market yield curve available to market participants. Other terms including coupon, maturity date, redemption price, number of coupon payments per year, and accrual method are obtained from the individual bond term sheets.

Servicing assets—Fair value is based on a loan-by-loan basis taking into consideration the original term to maturity, the current age of the loan and the remaining term to maturity. The valuation methodology utilized for the servicing assets begins with generating future cash flows for each servicing asset, based on their unique characteristics and market-based assumptions for prepayment speeds. The present value of the future cash flows are then calculated utilizing market-based discount rate assumptions.

Derivative instruments—Interest rate swaps are valued by a third party, using models that primarily use market observable inputs, such as yield curves, and are validated by comparison with valuations provided by the respective counterparties. Derivative financial instruments are included in other assets and other liabilities in the Consolidated Statements of Financial Condition.

The following tables summarize the Company’s financial assets and liabilities that were measured at fair value on a recurring basis at September 30, 2018 and December 31, 2017:

			Fair Value Measurements Using
September 30, 2018	Fair Value		Level 1		Level 2		Level 3
Financial assets
Securities available-for-sale
U.S. Treasury Notes	$	55,333	$	55,333	$	—	$	—
U.S. Government agencies		146,620		—		146,620		—
Obligations of states, municipalities, and political subdivisions		61,227		—		60,538		689
Residential mortgage-backed securities
Agency		285,448		—		285,448		—
Non-agency		73,563		—		73,563		—
Commercial mortgage-backed securities
Agency		71,987		—		71,987		—
Non-agency		30,046		—		30,046		—
Small Business Administration mortgage-backed securities		26,724		—		26,724		—
Corporate securities		37,413		—		37,413		—
Other securities		7,047		2,819		3,536		692
Servicing assets		20,674		—		—		20,674
Derivative assets		13,620		—		13,620		—
Financial liabilities
Derivative liabilities		2,769		—		2,769		—

			Fair Value Measurements Using
December 31, 2017	Fair Value		Level 1		Level 2		Level 3
Financial assets
Securities available-for-sale
U.S. Treasury Notes	$	14,863	$	14,863	$	—	$	—
U.S. Government agencies		52,958		—		52,958		—
Obligations of states, municipalities, and political subdivisions		33,170		—		32,795		375
Residential mortgage-backed securities
Agency		307,457		—		307,457		—
Non-agency		39,514		—		39,514		—
Commercial mortgage-backed securities
Agency		69,043		—		69,043		—
Non-agency		30,971		—		30,971		—
Corporate securities		29,976		—		29,976		—
Other securities		5,284		1,921		2,686		677
Servicing assets		21,400		—		—		21,400
Derivative assets		5,981		—		5,981		—
Financial liabilities
Derivative liabilities		994		—		994		—

The Company has originated, and acquired through a business combination, servicing assets classified as Level 3 of the fair value hierarchy. The Company acquired single-issuer trust preferred securities included in other securities categorized as Level 3 of the fair value hierarchy.

The Company has purchased, and acquired through a business combination, privately-issued municipal securities that are categorized as Level 3. These municipal securities are bonds issued for municipal government entities located in the Chicago metropolitan area and are privately placed, non-rated bonds without Committee on Uniform Security Identification Procedures numbers.

The Company did not have any transfers to or from Level 3 of the fair value hierarchy during the nine months ended September 30, 2018 or 2017.

The following table presents additional information about financial assets measured at fair value on recurring basis for which the Company used significant unobservable inputs (Level 3):

	Nine Months Ended September 30,
	2018		2017		2018			2017
	Investment Securities				Servicing Assets
Balance, beginning of period	$	1,052	$	1,080	$	21,400		$	21,091
Acquired assets at fair value		314		—		—			—
Additions, net		—		—		5,680			4,675
Amortization		4		3		—			—
Change in unrealized gain		11		6		—			—
Changes in fair value		—		—		(6,406	)		(4,097	)
Balance, end of period	$	1,381	$	1,089	$	20,674		$	21,669

The following table presents additional information about the unobservable inputs used in the fair value measurements on recurring basis that were categorized within Level 3 of the fair value hierarchy as of September 30, 2018:

Financial Instruments

Valuation Technique

Unobservable Inputs

Range of

Inputs

Weighted

Average

Range

Impact to

Valuation from an

Increased or

Higher Input Value

Obligations of states,

municipalities, and

political obligations

Discounted cash flow

Probability of default

1.3%—2.4%

1.8

Decrease

Single issuer trust preferred

Discounted cash flow

Probability of default

4.9%—7.0%

6.1

Decrease

Servicing assets

Discounted cash flow

Prepayment speeds

2.1%—25.9%

10.9

Decrease

Discount rate

7.7%—24.4%

14.9

Decrease

Expected weighted

average loan life

0.8—10.8 years

5.3 years

Increase

The Company used the following methods and significant assumptions to estimate fair value for certain assets measured and carried at fair value on a non-recurring basis:

Impaired loans (excluding acquired impaired loans)—Impaired loans, other than those existing on the date of a business acquisition, are primarily carried at the fair value of the underlying collateral, less estimated costs to sell, if the loan is collateral dependent. Valuations of impaired loans that are collateral dependent are supported by third party appraisals in accordance with the Bank’s credit policy. Impaired loans that are not collateral dependent are not material.

Assets held for sale—Assets held for sale consist of former branch locations and real estate previously purchased for expansion. Assets are considered held for sale when management has approved to sell the assets following a branch closure or other events. The properties are being actively marketed and transferred to assets held for sale based on the lower of carrying value or its fair value, less estimated costs to sell.

Other real estate owned—Certain assets held within other real estate owned represent real estate or other collateral that has been adjusted to its estimated fair value, less cost to sell, as a result of transferring from the loan portfolio at the time of foreclosure or repossession and based on management’s periodic impairment evaluation. From time to time, non-recurring fair value adjustments to other real estate owned are recorded to reflect partial write-downs based on an observable market price or current appraised value of property.

Adjustments to fair value based on such non-recurring transactions generally result from the application of lower-of-cost-or-market accounting or write-downs of individual assets due to impairment. The following tables summarize the Company’s assets that were measured at fair value on a non-recurring basis, excluding acquired impaired loans, as of September 30, 2018 and December 31, 2017:

			Fair Value Measurements Using
September 30, 2018	Fair Value		Level 1		Level 2		Level 3
Non-recurring
Impaired loans
(excluding acquired impaired loans)
Commercial real estate	$	11,318	$	—	$	—	$	11,318
Residential real estate		1,871		—		—		1,871
Construction, land development, and other land		—		—		—		—
Commercial and industrial		15,918		—		—		15,918
Installment and other		—		—		—		—
Assets held for sale		8,343		—		—		8,343
Other real estate owned		4,891		—		—		4,891

			Fair Value Measurements Using
December 31, 2017	Fair Value		Level 1		Level 2		Level 3
Non-recurring
Impaired loans
(excluding acquired impaired loans)
Commercial real estate	$	12,783	$	—	$	—	$	12,783
Residential real estate		2,271		—		—		2,271
Construction, land development, and other land		—		—		—		—
Commercial and industrial		12,092		—		—		12,092
Installment and other		—		—		—		—
Assets held for sale		9,779		—		—		9,779
Other real estate owned		10,626		—		—		10,626

The following methods and assumptions were used by the Company in estimating fair values of other assets and liabilities for disclosure purposes:

Cash and cash equivalents—For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Securities held-to-maturity—The Company obtains fair value measurements from an independent pricing service. Management reviews the procedures used by the third party, including significant inputs used in the fair value calculations. 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. When market quotes are not readily accessible or available, alternative approaches are utilized, such as matrix or model pricing.

Restricted stock—The fair value has been determined to approximate cost.

Loans held for sale—The fair value of loans held for sale are based on quoted market prices, where available, and determined by discounted estimated cash flows using interest rates approximating the Company’s current origination rates for similar loans adjusted to reflect the inherent credit risk.

Loan and lease receivables, net—For certain variable rate loans that reprice frequently and with no significant changes in credit risk, fair value is estimated at carrying value. The fair value of other types of loans is estimated by discounting future cash flows, using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits—The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting future cash flows, using rates currently offered for deposits of similar remaining maturities.

Federal Home Loan Bank advances—The fair value of FHLB advances is estimated by discounting the agreements based on maturities using rates currently offered for FHLB advances of similar remaining maturities adjusted for prepayment penalties that would be incurred if the borrowings were paid off on the measurement date.

Securities sold under agreements to repurchase—The carrying amount approximates fair value due to maturities of less than ninety days.

Junior subordinated debentures—The fair value of junior subordinated debentures, in the form of trust preferred securities, is determined using rates currently available to the Company for debt with similar terms and remaining maturities.

Accrued interest receivable and payable—The carrying amount approximates fair value.

Commitments to extend credit and letters of credit—The fair values of these off-balance sheet commitments to extend credit and commercial and letters of credit are not considered practicable to estimate because of the lack of quoted market prices and the inability to estimate fair value without incurring excessive costs.

The estimated fair values of financial instruments and levels within the fair value hierarchy are as follows:

			September 30,				December 31,
	Fair Value		2018				2017
	Hierarchy Level		Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial assets
Cash and due from banks		1	$	25,162	$	25,162	$	19,404	$	19,404
Interest bearing deposits with other banks		2		119,594		119,594		38,945		38,945
Securities held-to-maturity		2		102,683		99,933		117,163		117,277
Other restricted stock		2		19,202		19,202		16,343		16,343
Loans held for sale		3		8,737		9,707		5,212		5,851
Loans and lease receivables, net		3		3,432,378		3,356,116		2,260,786		2,240,235
Accrued interest receivable		3		11,331		11,331		7,670		7,670
Financial liabilities
Non-interest bearing deposits		2		1,175,222		1,175,222		760,887		760,887
Interest bearing deposits		2		2,565,545		2,561,465		1,682,442		1,678,535
Accrued interest payable		2		2,971		2,971		1,306		1,306
Line of credit		2		—		—		—		—
Federal Home Loan Bank advances		2		425,000		425,000		361,506		361,500
Securities sold under repurchase agreement		2		24,446		24,446		31,187		31,187
Junior subordinated debentures		3		36,615		42,693		27,647		33,907