NOTE 20. FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale and derivatives are recorded at fair value on a recurring basis. From time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans and OREO. Additionally, the Company is required to disclose, but not record, the fair value of other financial instruments.

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

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

Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments and other accounts recorded or disclosed based on their fair value:

Cash, Due From Banks, Interest-Bearing Deposits in Banks and Federal Funds Sold: The carrying amount of cash, due from banks , interest-bearing deposits in banks and federal funds sold approximates fair value.

Securities Available For Sale: The fair value of securities available for sale is determined by various valuation methodologies. Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Level 2 securities include certain U.S. agency bonds, collateralized mortgage and debt obligations and certain municipal securities. The level 2 fair value pricing is provided by an independent third party and is based upon similar securities in an active market. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain residual municipal securities and other less liquid securities.

Other Investments: FHLB stock is included in other investment securities at its original cost basis, as cost approximates fair value and there is no ready market for such investments.

Mortgage Loans Held-for-Sale: The fair value of mortgage loans held for sale is determined on outstanding commitments from third party investors in the secondary markets and are classified within Level 2 of the valuation hierarchy.

Loans: The carrying amount of variable-rate loans that reprice frequently and have no significant change in credit risk approximates fair value. The fair value of fixed-rate loans is estimated based on discounted contractual cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The fair value of impaired loans is estimated based on discounted contractual cash flows or underlying collateral values, where applicable. A loan is determined to be impaired if the Company believes it is probable that all principal and interest amounts due according to the terms of the note will not be collected as scheduled. The fair value of impaired loans is determined in accordance with ASC 310-10, Accounting by Creditors for Impairment of a Loan, and generally results in a specific reserve established through a charge to the provision for loan losses. Losses on impaired loans are charged to the allowance when management believes the uncollectability of a loan is confirmed. Management has determined that the majority of impaired loans are Level 3 assets due to the extensive use of market appraisals. To the extent that market appraisals or other methods do not produce reliable determinations of fair value, these assets are deemed to be Level 3.

Other Real Estate Owned: The fair value of OREO is determined using certified appraisals that value the property at its highest and best uses by applying traditional valuation methods common to the industry. The Company does not hold any OREO for profit purposes and all other real estate is actively marketed for sale. In most cases, management has determined that additional write-downs are required beyond what is calculable from the appraisal to carry the property at levels that would attract buyers. Because this additional write-down is not based on observable inputs, management has determined that other real estate owned should be classified as Level 3.

Covered Assets: Covered assets include loans and other real estate owned on which the majority of losses would be covered by loss-sharing agreements with the FDIC. Management initially valued these assets at fair value using mostly unobservable inputs and, as such, has classified these assets as Level 3.

Intangible Assets and Goodwill: Intangible assets consist of core deposit premiums acquired in connection with business combinations and are based on the established value of acquired customer deposits. The core deposit premium is initially recognized based on a valuation performed as of the consummation date and is amortized over an estimated useful life of three to ten years. Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination. Goodwill and other intangible assets deemed to have an indefinite useful life are not amortized but instead are subject to an annual review for impairment.

FDIC Loss-Share Receivable: Because the FDIC will reimburse the Company for certain acquired loans should the Company experience a loss, an indemnification asset is recorded at fair value at the acquisition date. The indemnification asset is recognized at the same time as the indemnified loans, and measured on the same basis, subject to collectability or contractual limitations. The shared loss agreements on the acquisition date reflect the reimbursements expected to be received from the FDIC, using an appropriate discount rate, which reflects counterparty credit risk and other uncertainties. The shared loss agreements continue to be measured on the same basis as the related indemnified loans, and the loss share receivable is impacted by changes in estimated cash flows associated with these loans.

Cash Value of Bank Owned Life Insurance: The carrying value of cash value of bank owned life insurance approximates fair value.

Deposits: The carrying amount of demand deposits, savings deposits and variable-rate certificates of deposits approximates fair value. The fair value of fixed-rate certificates of deposits is estimated based on discounted contractual cash flows using interest rates currently being offered for certificates of similar maturities.

Repurchase Agreements and/or Other Borrowings: The carrying amount of variable rate borrowings and securities sold under repurchase agreements approximates fair value. The fair value of fixed rate other borrowings is estimated based on discounted contractual cash flows using the current incremental borrowing rates for similar type borrowing arrangements.

Subordinated Deferrable Interest Debentures: The carrying amount of the Company’s variable rate trust preferred securities approximates fair value.

Off-Balance-Sheet Instruments: Because commitments to extend credit and standby letters of credit are typically made using variable rates and have short maturities, the carrying value and fair value are immaterial for disclosure.

Derivatives: The Company has entered into derivative financial instruments to manage interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of the derivatives. This analysis reflects the contractual terms of the derivative, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair value of the derivatives are determined using the market standard methodology of netting the discounted future fixed cash receipts and the discounted expected variable cash payments. The variable cash payments are based on an expectation of future interest rates (forward curves derived from observable market interest rate curves).

The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting any applicable credit enhancements such as collateral postings, thresholds, mutual puts and guarantees.

Although the Company has determined that the majority of the inputs used to value its derivative fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself or the counterparty. However, as of December 31, 2013 and 2012, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustment is not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuation in its entirety is classified in Level 2 of the fair value hierarchy.

The following table presents the fair value measurements of assets and liabilities measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall as of December 31, 2013 and 2012:


	Fair Value Measurements on a Recurring Basis As of December 31, 2013
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
U.S. government sponsored agencies	$	13,926	$	-	$	13,926	$	-
State, county and municipal securities		112,754		-		112,754		-
Collateralized debt obligations		1,480		1,480		-		-
Corporate debt securities		10,325		-		8,325		2,000
Mortgage-backed securities		347,750		182,461		165,289		-
Mortgage loans held for sale		67,278		-		67,278		-

Total recurring assets at fair value	$	553,513	$	183,941	$	367,572	$	2,000


Derivative financial instruments	$	370	$	-	$	370	$	-

Total recurring liabilities at fair value	$	370	$	-	$	370	$	-


	Fair Value Measurements on a Recurring Basis As of December 31, 2012
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
U.S. government sponsored agencies	$	6,870	$	-	$	6,870	$	-
State, county and municipal securities		114,390		4,854		109,536		-
Corporate debt securities		10,328		-		8,328		2,000
Mortgage backed securities		215,321		23,893		191,428		-
Mortgage loans held for sale		48,786		-		48,786		-

Total recurring assets at fair value	$	395,695	$	28,747	$	364,948	$	2,000

Derivative financial instruments	$	2,978	$	-	$	2,978	$	-

Total recurring liabilities at fair value	$	2,978	$	-	$	2,978	$	-

The following table presents the fair value measurements of assets measured at fair value on a non-recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy as of December 31, 2013 and 2012:


	Fair Value Measurements on a Nonrecurring Basis As of December 31, 2013
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
Impaired loans carried at fair value	$	42,546	$	-	$	-	$	42,546
Other real estate owned		33,351		-		-		33,351
Purchased, non-covered loans		448,753		-		-		448,753
Purchased, non-covered other real estate owned		4,276		-		-		4,276
Covered loans		390,237		-		-		390,237
Covered other real estate owned		45,893		-		-		45,893

Total nonrecurring assets at fair value	$	965,056	$	-	$	-	$	965,056


	Fair Value Measurements on a Nonrecurring Basis As of December 31, 2012
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
Impaired loans carried at fair value	$	52,514	$	-	$	-	$	52,514
Other real estate owned		39,850		-		-		39,850
Covered loans		507,712		-		-		507,712
Covered other real estate owned		88,273		-		-		88,273

Total nonrecurring assets at fair value	$	688,349	$	-	$	-	$	688,349

The inputs used to determine estimated fair value of impaired loans and covered loans include market conditions, loan term, underlying collateral characteristics and discount rates. The inputs used to determine fair value of other real estate owned and covered other real estate owned include market conditions, estimated marketing period or holding period, underlying collateral characteristics and discount rates.

For the years ended December 31, 2013 and 2012, there was not a change in the methods and significant assumptions used to estimate fair value.

The following table shows significant unobservable inputs used in the fair value measurement of Level 3 assets and liabilities.


Measurements	Fair Value at December 31, 2013		Valuation Technique	Unobservable Inputs	Range
(Dollars in Thousands)
Nonrecurring:
Impaired loans	$	42,546	Third party appraisals and discounted cash flows	Collateral discounts and discount rates	4.00% - 75.00%
Other real estate owned	$	33,351	Third party appraisals	Collateral discounts and estimated costs to sell	10.00% - 74.00%
Purchased, non-covered loans	$	448,753	Third party appraisals and discounted cash flows	Collateral discounts and discount rates	1.00% - 40.00%
Purchased non-covered other real estate owned	$	4,276	Third party appraisals	Collateral discounts and estimated costs to sell	15.00% - 63.00%
Covered loans	$	390,237	Third party appraisals and discounted cash flows	Collateral discounts Discount rate	1.75% - 75.00%
Covered real estate owned	$	45,893	Third party appraisals	Collateral discounts and estimated costs to sell	10.00% - 86.00%
Recurring:
Investment securities available for sale	$	2,000	Discounted par values	Credit quality of underlying issuer	0.00%

The transfers between the fair value hierarchy levels during the years ended December 31, 2013 and 2012 involved the transferring of loans to impaired loans, impaired loans to other real estate owned and covered loans to covered other real estate owned. These transfers are reflected in the Company’s reconciliation of Level 3 assets below.


	Investment securities available for sale		Impaired loans carried at fair value			Other real estate owned			Purchased, non- covered loans		Purchased, non- covered other real estate owned		Covered loans			Covered other real estate owned
									(Dollars in Thousands)
Beginning balance, January 1, 2012	$	2,000	$	70,296		$	50,301		$	-	$	-	$	571,489		$	78,617
Total gains (losses) included in net income		-		-			(11,843	)		-		-		-			2,892
Purchases, sales, issuances, and settlements, net		-		-			(20,428	)		-		-		(20,479	)		(36,534	)
Transfers in or out of Level 3		-		-			4,038			-		-		-			-
Asset reclassification, within Level 3		-		(17,782	)		17,782			-		-		(43,298	)		43,298

Ending balance, December 31, 2012		2,000		52,514			39,850			-		-		507,712			88,273
Total gains (losses) included in net income		-		-			(5,883	)		-		-		-			(3,280	)
Purchases, sales, issuances, and settlements, net		-		(831	)		(9,753	)		448,753		4,276		(85,642	)		(57,818	)
Transfers in or out of Level 3		-		-			-			-		-		-			(13,115	)
Asset reclassification, within Level 3		-		(9,137	)		9,137			-		-		(31,833	)		31,833

Ending balance, December 31, 2013	$	2,000	$	42,546		$	33,351		$	448,753	$	4,276	$	390,237		$	45,893

The carrying amount and estimated fair value of the Company’s financial instruments, not shown elsewhere in these financial statements, were as follows:


			Fair Value Measurements at December 31, 2013 Using:
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(Dollars in Thousands)
Financial assets:
Loans, net	$	2,435,067	$	-	$	1,565,919	$	881,536	$	2,447,455

Financial liabilities:
Deposits	$	2,999,231	$	-	$	3,000,061	$	-	$	3,000,061
Other borrowings	$	194,572	$	-	$	194,572	$	-	$	194,572

			Fair Value Measurements at December 31, 2012 Using:
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(Dollars in Thousands)
Financial assets:
Loans, net	$	1,934,754	$	-	$	1,406,366	$	560,226	$	1,966,592

Financial liabilities:
Deposits	$	2,624,663	$	-	$	2,624,883	$	-	$	2,624,883