12. Fair value measurements

GAAP permits an entity to choose to measure eligible financial instruments and other items at fair value. The Company has not made any fair value elections at September 30, 2015.

Pursuant to GAAP, fair value is defined as the 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. A three-level hierarchy exists in GAAP for fair value measurements based upon the inputs to the valuation of an asset or liability.

•

Level 1 — Valuation is based on quoted prices in active markets for identical assets and liabilities.

•

Level 2 — Valuation is determined from quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar instruments in markets that are not active or by model-based techniques in which all significant inputs are observable in the market.

•

Level 3 — Valuation is derived from model-based and other techniques in which at least one significant input is unobservable and which may be based on the Company’s own estimates about the assumptions that market participants would use to value the asset or liability.

When available, the Company attempts to use quoted market prices in active markets to determine fair value and classifies such items as Level 1 or Level 2. If quoted market prices in active markets are not available, fair value is often determined using model-based techniques incorporating various assumptions including interest rates, prepayment speeds and credit losses. Assets and liabilities valued using model-based techniques are classified as either Level 2 or Level 3, depending on the lowest level classification of an input that is considered significant to the overall valuation. The following is a description of the valuation methodologies used for the Company’s assets and liabilities that are measured on a recurring basis at estimated fair value.

Trading account assets and liabilities

Trading account assets and liabilities consist primarily of interest rate swap agreements and foreign exchange contracts with customers who require such services with offsetting positions with third parties to minimize the Company’s risk with respect to such transactions. The Company generally determines the fair value of its derivative trading account assets and liabilities using externally developed pricing models based on market observable inputs and, therefore, classifies such valuations as Level 2. Mutual funds held in connection with deferred compensation arrangements have been classified as Level 1 valuations. Valuations of investments in municipal and other bonds can generally be obtained through reference to quoted prices in less active markets for the same or similar securities or through model-based techniques in which all significant inputs are observable and, therefore, such valuations have been classified as Level 2.

Investment securities available for sale

The majority of the Company’s available-for-sale investment securities have been valued by reference to prices for similar securities or through model-based techniques in which all significant inputs are observable and, therefore, such valuations have been classified as Level 2. Certain investments in mutual funds and equity securities are actively traded and, therefore, have been classified as Level 1 valuations.

Included in collateralized debt obligations are securities backed by trust preferred securities issued by financial institutions and other entities. The Company could not obtain pricing indications for many of these securities from its two primary independent pricing sources. The Company, therefore, performed internal modeling to estimate the cash flows and fair value of its portfolio of securities backed by trust preferred securities at September 30, 2015 and December 31, 2014. The modeling techniques included estimating cash flows using bond-specific assumptions about future collateral defaults and related loss severities. The resulting cash flows were then discounted by reference to market yields observed in the single-name trust preferred securities market. In determining a market yield applicable to the estimated cash flows, a margin over LIBOR ranging from 4% to 10%, with a weighted-average of 8%, was used. Significant unobservable inputs used in the determination of estimated fair value of collateralized debt obligations are included in the accompanying table of significant unobservable inputs to Level 3 measurements. At September 30, 2015, the total amortized cost and fair value of securities backed by trust preferred securities issued by financial institutions and other entities were $28 million and $50 million, respectively, and at December 31, 2014 were $30 million and $50 million, respectively. Securities backed by trust preferred securities issued by financial institutions and other entities constituted all of the available-for-sale investment securities classified as Level 3 valuations.

The Company ensures an appropriate control framework is in place over the valuation processes and techniques used for significant Level 3 fair value measurements. Internal pricing models used for significant valuation measurements have generally been subjected to validation procedures including testing of mathematical constructs, review of valuation methodology and significant assumptions used.

Real estate loans held for sale

The Company utilizes commitments to sell real estate loans to hedge the exposure to changes in fair value of real estate loans held for sale. The carrying value of hedged real estate loans held for sale includes changes in estimated fair value during the hedge period. Typically, the Company attempts to hedge real estate loans originated for sale from the date of close through the sale date. The fair value of hedged real estate loans held for sale is generally calculated by reference to quoted prices in secondary markets for commitments to sell real estate loans with similar characteristics and, accordingly, such loans have been classified as a Level 2 valuation.

Commitments to originate real estate loans for sale and commitments to sell real estate loans

The Company enters into various commitments to originate real estate loans for sale and commitments to sell real estate loans. Such commitments are considered to be derivative financial instruments and, therefore, are carried at estimated fair value on the consolidated balance sheet. The estimated fair values of such commitments were generally calculated by reference to quoted prices in secondary markets for commitments to sell real estate loans to certain government-sponsored entities and other parties. The fair valuations of commitments to sell real estate loans generally result in a Level 2 classification. The estimated fair value of commitments to originate real estate loans for sale are adjusted to reflect the Company’s anticipated commitment expirations. The estimated commitment expirations are considered significant unobservable inputs contributing to the Level 3 classification of commitments to originate real estate loans for sale. Significant unobservable inputs used in the determination of estimated fair value of commitments to originate real estate loans for sale are included in the accompanying table of significant unobservable inputs to Level 3 measurements.

Interest rate swap agreements used for interest rate risk management

The Company utilizes interest rate swap agreements as part of the management of interest rate risk to modify the repricing characteristics of certain portions of its portfolios of earning assets and interest-bearing liabilities. The Company generally determines the fair value of its interest rate swap agreements using externally developed pricing models based on market observable inputs and, therefore, classifies such valuations as Level 2. The Company has considered counterparty credit risk in the valuation of its interest rate swap agreement assets and has considered its own credit risk in the valuation of its interest rate swap agreement liabilities.

The following tables present assets and liabilities at September 30, 2015 and December 31, 2014 measured at estimated fair value on a recurring basis:


	Fair value measurements at September 30, 2015		Level 1 (a)		Level 2 (a)		Level 3
	(in thousands)
Trading account assets	$	340,710		48,006		292,704		—
Investment securities available for sale:
U.S. Treasury and federal agencies		199,394		—		199,394		—
Obligations of states and political subdivisions		6,296		—		6,296		—
Mortgage-backed securities:
Government issued or guaranteed		10,714,048		—		10,714,048		—
Privately issued		82		—		—		82
Collateralized debt obligations		49,876		—		—		49,876
Other debt securities		120,468		—		120,468		—
Equity securities		69,345		40,370		28,975		—

		11,159,509		40,370		11,069,181		49,958

Real estate loans held for sale		493,453		—		493,453		—
Other assets (b)		79,539		—		61,707		17,832

Total assets	$	12,073,211		88,376		11,917,045		67,790

Trading account liabilities	$	233,006		—		233,006		—
Other liabilities (b)		9,489		—		9,304		185

Total liabilities	$	242,495		—		242,310		185


	Fair value measurements at December 31, 2014		Level 1 (a)		Level 2 (a)		Level 3
	(in thousands)
Trading account assets	$	308,175		51,416		256,759		—
Investment securities available for sale:
U.S. Treasury and federal agencies		161,947		—		161,947		—
Obligations of states and political subdivisions		8,198		—		8,198		—
Mortgage-backed securities:
Government issued or guaranteed		8,731,123		—		8,731,123		—
Privately issued		103		—		—		103
Collateralized debt obligations		50,316		—		—		50,316
Other debt securities		121,488		—		121,488		—
Equity securities		83,757		64,841		18,916		—

		9,156,932		64,841		9,041,672		50,419

Real estate loans held for sale		742,249		—		742,249		—
Other assets (b)		92,129		—		74,733		17,396

Total assets	$	10,299,485		116,257		10,115,413		67,815

Trading account liabilities	$	203,464		—		203,464		—
Other liabilities (b)		8,596		—		8,547		49

Total liabilities	$	212,060		—		212,011		49

(a)

There were no significant transfers between Level 1 and Level 2 of the fair value hierarchy during the nine months ended September 30, 2015 and the year ended December 31, 2014.

(b)

Comprised predominantly of interest rate swap agreements used for interest rate risk management (Level 2), commitments to sell real estate loans (Level 2) and commitments to originate real estate loans to be held for sale (Level 3).

The changes in Level 3 assets and liabilities measured at estimated fair value on a recurring basis during the three months ended September 30, 2015 were as follows:


	Investment securities available for sale
	Privately issued mortgage-backed securities			Collateralized debt obligations			Other assets and other liabilities
	(in thousands)
Balance – June 30, 2015	$	88		$	50,483		$	11,206
Total gains (losses) realized/unrealized:
Included in earnings		—			—			21,709	(a)
Included in other comprehensive income		—			(472	)(d)		—
Settlements		(6	)		(135	)		—
Transfers in and/or out of Level 3 (b)		—			—			(15,268	)(c)

Balance – September 30, 2015	$	82		$	49,876		$	17,647

Changes in unrealized gains included in earnings related to assets still held at September 30, 2015	$	—		$	—		$	15,488	(a)

The changes in Level 3 assets and liabilities measured at estimated fair value on a recurring basis during the three months ended September 30, 2014 were as follows:


	Investment securities available for sale
	Privately issued mortgage-backed securities			Collateralized debt obligations			Other assets and other liabilities
	(in thousands)
Balance – June 30, 2014	$	119		$	56,200		$	22,023
Total gains (losses) realized/unrealized:
Included in earnings		—			—			9,657	(a)
Included in other comprehensive income		—			2,201	(d)		—
Settlements		(7	)		(3,593	)		—
Transfers in and/or out of Level 3 (b)		—			—			(15,188	)(c)

Balance – September 30, 2014	$	112		$	54,808		$	16,492

Changes in unrealized gains included in earnings related to assets still held at September 30, 2014	$	—		$	—		$	12,421	(a)

The changes in Level 3 assets and liabilities measured at estimated fair value on a recurring basis during the nine months ended September 30, 2015 were as follows:


	Investment securities available for sale
	Privately issued mortgage-backed securities			Collateralized debt obligations			Other assets and other liabilities
	(in thousands)
Balance – January 1, 2015	$	103		$	50,316		$	17,347
Total gains (losses) realized/unrealized:
Included in earnings		—			—			67,611	(a)
Included in other comprehensive income		—			5,153	(d)		—
Settlements		(21	)		(5,593	)		—
Transfers in and/or out of Level 3 (b)		—			—			(67,311	)(c)

Balance – September 30, 2015	$	82		$	49,876		$	17,647

Changes in unrealized gains included in earnings related to assets still held at September 30, 2015	$	—		$	—		$	15,965	(a)

The changes in Level 3 assets and liabilities measured at estimated fair value on a recurring basis during the nine months ended September 30, 2014 were as follows:


	Investment securities available for sale
	Privately issued mortgage-backed securities			Collateralized debt obligations			Other assets and other liabilities
	(in thousands)
Balance – January 1, 2014	$	1,850		$	63,083		$	3,941
Total gains (losses) realized/unrealized:
Included in earnings		—			—			63,557	(a)
Included in other comprehensive income		272	(d)		11,333	(d)		—
Settlements		(2,010	)		(19,608	)		—
Transfers in and/or out of Level 3 (b)		—			—			(51,006	)(c)

Balance – September 30, 2014	$	112		$	54,808		$	16,492

Changes in unrealized gains included in earnings related to assets still held at September 30, 2014	$	—		$	—		$	17,773	(a)

(a)

Reported as mortgage banking revenues in the consolidated statement of income and includes the fair value of commitment issuances and expirations.

(b)

The Company’s policy for transfers between fair value levels is to recognize the transfer as of the actual date of the event or change in circumstances that caused the transfer.

(c)

Transfers out of Level 3 consist of interest rate locks transferred to closed loans.

(d)

Reported as net unrealized gains (losses) on investment securities in the consolidated statement of comprehensive income.

The Company is required, on a nonrecurring basis, to adjust the carrying value of certain assets or provide valuation allowances related to certain assets using fair value measurements. The more significant of those assets follow.

Loans

Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records nonrecurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Nonrecurring adjustments also include certain impairment amounts for collateral-dependent loans when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated valuation amount does not necessarily represent the fair value of the loan. Real estate collateral is typically valued using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace and the related nonrecurring fair value measurement adjustments have generally been classified as Level 2, unless significant adjustments have been made to the valuation that are not readily observable by market participants. Non-real estate collateral supporting commercial loans generally consists of business assets such as receivables, inventory and equipment. Fair value estimations are typically determined by discounting recorded values of those assets to reflect estimated net realizable value considering specific borrower facts and circumstances and the experience of credit personnel in their dealings with similar borrower collateral liquidations. Such discounts were generally in the range of 10% to 90% at September 30, 2015. As these discounts are not readily observable and are considered significant, the valuations have been classified as Level 3. Loans subject to nonrecurring fair value measurement were $177 million at September 30, 2015 ($106 million and $71 million of which were classified as Level 2 and Level 3, respectively), $173 million at December 31, 2014 ($94 million and $79 million of which were classified as Level 2 and Level 3, respectively) and $196 million at September 30, 2014 ($112 million and $84 million of which were classified as Level 2 and Level 3, respectively). Changes in fair value recognized for partial charge-offs of loans and loan impairment reserves on loans held by the Company on September 30, 2015 were decreases of $11 million and $53 million for the three- and nine-month periods ended September 30, 2015, respectively. Changes in fair value recognized for partial charge-offs of loans and loan impairment reserves on loans held by the Company on September 30, 2014 were decreases of $23 million and $46 million for the three- and nine-month periods ended September 30, 2014, respectively.

Assets taken in foreclosure of defaulted loans

Assets taken in foreclosure of defaulted loans are primarily comprised of commercial and residential real property and are generally measured at the lower of cost or fair value less costs to sell. The fair value of the real property is generally determined using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace, and the related nonrecurring fair value measurement adjustments have generally been classified as Level 2. Assets taken in foreclosure of defaulted loans subject to nonrecurring fair value measurement were $15 million and $21 million at September 30, 2015 and September 30, 2014, respectively. Changes in fair value recognized for those foreclosed assets held by the Company were not material during the three-month and nine-month periods ended September 30, 2015 and 2014.

Significant unobservable inputs to Level 3 measurements

The following tables present quantitative information about significant unobservable inputs used in the fair value measurements for Level 3 assets and liabilities at September 30, 2015 and December 31, 2014:

Fair value at
September 30,
2015

Valuation
technique

Unobservable
input/assumptions

Range
(weighted-
average)

(in thousands)

Recurring fair value measurements

Privately issued mortgage–backed securities

Two independent
pricing quotes

—

Collateralized debt obligations

49,876

Discounted cash flow

Probability of default

12%-57% (33%)

Loss severity

100%

Net other assets (liabilities)(a)

17,647

Discounted cash flow

Commitment
expirations

0%-66% (38%)

Fair value at
December 31,
2014

Valuation
technique

Unobservable
input/assumptions

Range
(weighted-
average)

(in thousands)

Recurring fair value measurements

Privately issued mortgage–backed securities

103

Two independent
pricing quotes

—

Collateralized debt obligations

50,316

Discounted cash flow

Probability of default

12%-57% (36%)

Loss severity

100%

Net other assets (liabilities)(a)

17,347

Discounted cash flow

Commitment
expirations

0%-96% (17%)

(a)

Other Level 3 assets (liabilities) consist of commitments to originate real estate loans.

Sensitivity of fair value measurements to changes in unobservable inputs

An increase (decrease) in the probability of default and loss severity for collateralized debt securities would generally result in a lower (higher) fair value measurement.

An increase (decrease) in the estimate of expirations for commitments to originate real-estate loans would generally result in a lower (higher) fair value measurement. Estimated commitment expirations are derived considering loan type, changes in interest rates and remaining length of time until closing.

Disclosures of fair value of financial instruments

The carrying amounts and estimated fair value for financial instrument assets (liabilities) are presented in the following table:


	September 30, 2015
	Carrying amount			Estimated fair value			Level 1		Level 2			Level 3
	(in thousands)
Financial assets:
Cash and cash equivalents	$	1,249,704		$	1,249,704		$	1,193,831	$	55,873		$	—
Interest-bearing deposits at banks		4,713,266			4,713,266			—		4,713,266			—
Trading account assets		340,710			340,710			48,006		292,704			—
Investment securities		14,494,539			14,521,740			40,370		14,283,075			198,295
Loans and leases:
Commercial loans and leases		20,233,177			19,920,031			—		—			19,920,031
Commercial real estate loans		28,720,537			28,633,973			—		71,357			28,562,616
Residential real estate loans		8,211,062			8,302,630			—		4,918,613			3,384,017
Consumer loans		11,375,472			11,280,973			—		—			11,280,973
Allowance for credit losses		(933,798	)		—			—		—			—

Loans and leases, net		67,606,450			68,137,607			—		4,989,970			63,147,637
Accrued interest receivable		242,935			242,935			—		242,935			—
Financial liabilities:
Noninterest-bearing deposits	$	(28,189,330	)	$	(28,189,330	)	$	—	$	(28,189,330	)	$	—
Savings deposits and NOW accounts		(41,757,661	)		(41,757,661	)		—		(41,757,661	)		—
Time deposits		(2,791,367	)		(2,810,224	)		—		(2,810,224	)		—
Deposits at Cayman Islands office		(206,185	)		(206,185	)		—		(206,185	)		—
Short-term borrowings		(173,783	)		(173,783	)		—		(173,783	)		—
Long-term borrowings		(10,174,289	)		(10,219,180	)		—		(10,219,180	)		—
Accrued interest payable		(73,475	)		(73,475	)		—		(73,475	)		—
Trading account liabilities		(233,006	)		(233,006	)		—		(233,006	)		—
Other financial instruments:
Commitments to originate real estate loans for sale	$	17,647		$	17,647		$	—	$	—		$	17,647
Commitments to sell real estate loans		(8,379	)		(8,379	)		—		(8,379	)		—
Other credit-related commitments		(118,656	)		(118,656	)		—		—			(118,656	)
Interest rate swap agreements used for interest rate risk management		60,782			60,782			—		60,782			—


	December 31, 2014
	Carrying amount			Estimated fair value			Level 1		Level 2			Level 3
	(in thousands)
Financial assets:
Cash and cash equivalents	$	1,373,357		$	1,373,357		$	1,296,923	$	76,434		$	—
Interest-bearing deposits at banks		6,470,867			6,470,867			—		6,470,867			—
Trading account assets		308,175			308,175			51,416		256,759			—
Investment securities		12,993,542			13,023,956			64,841		12,750,396			208,719
Loans and leases:
Commercial loans and leases		19,461,292			19,188,574			—		—			19,188,574
Commercial real estate loans		27,567,569			27,487,818			—		307,667			27,180,151
Residential real estate loans		8,657,301			8,729,056			—		5,189,086			3,539,970
Consumer loans		10,982,794			10,909,623			—		—			10,909,623
Allowance for credit losses		(919,562	)		—			—		—			—

Loans and leases, net		65,749,394			66,315,071			—		5,496,753			60,818,318
Accrued interest receivable		227,348			227,348			—		227,348			—
Financial liabilities:
Noninterest-bearing deposits	$	(26,947,880	)	$	(26,947,880	)	$	—	$	(26,947,880	)	$	—
Savings deposits and NOW accounts		(43,393,618	)		(43,393,618	)		—		(43,393,618	)		—
Time deposits		(3,063,973	)		(3,086,126	)		—		(3,086,126	)		—
Deposits at Cayman Islands office		(176,582	)		(176,582	)		—		(176,582	)		—
Short-term borrowings		(192,676	)		(192,676	)		—		(192,676	)		—
Long-term borrowings		(9,006,959	)		(9,139,789	)		—		(9,139,789	)		—
Accrued interest payable		(63,372	)		(63,372	)		—		(63,372	)		—
Trading account liabilities		(203,464	)		(203,464	)		—		(203,464	)		—
Other financial instruments:
Commitments to originate real estate loans for sale	$	17,347		$	17,347		$	—	$	—		$	17,347
Commitments to sell real estate loans		(7,065	)		(7,065	)		—		(7,065	)		—
Other credit-related commitments		(119,079	)		(119,079	)		—		—			(119,079	)
Interest rate swap agreements used for interest rate risk management		73,251			73,251			—		73,251			—

With the exception of marketable securities, certain off-balance sheet financial instruments and one-to-four family residential mortgage loans originated for sale, the Company’s financial instruments are not readily marketable and market prices do not exist. The Company, in attempting to comply with the provisions of GAAP that require disclosures of fair value of financial instruments, has not attempted to market its financial instruments to potential buyers, if any exist. Since negotiated prices in illiquid markets depend greatly upon the then present motivations of the buyer and seller, it is reasonable to assume that actual sales prices could vary widely from any estimate of fair value made without the benefit of negotiations. Additionally, changes in market interest rates can dramatically impact the value of financial instruments in a short period of time. The following assumptions, methods and calculations were used in determining the estimated fair value of financial instruments not measured at fair value in the consolidated balance sheet.

Cash and cash equivalents, interest-bearing deposits at banks, deposits at Cayman Islands office, short-term borrowings, accrued interest receivable and accrued interest payable

Due to the nature of cash and cash equivalents and the near maturity of interest-bearing deposits at banks, deposits at Cayman Islands office, short-term borrowings, accrued interest receivable and accrued interest payable, the Company estimated that the carrying amount of such instruments approximated estimated fair value.

Investment securities

Estimated fair values of investments in readily marketable securities were generally based on quoted market prices. Investment securities that were not readily marketable were assigned amounts based on estimates provided by outside parties or modeling techniques that relied upon discounted calculations of projected cash flows or, in the case of other investment securities, which include capital stock of the Federal Reserve Bank of New York and the Federal Home Loan Bank of New York, at an amount equal to the carrying amount.

Loans and leases

In general, discount rates used to calculate values for loan products were based on the Company’s pricing at the respective period end. A higher discount rate was assumed with respect to estimated cash flows associated with nonaccrual loans. Projected loan cash flows were adjusted for estimated credit losses. However, such estimates made by the Company may not be indicative of assumptions and adjustments that a purchaser of the Company’s loans and leases would seek.

Deposits

Pursuant to GAAP, the estimated fair value ascribed to noninterest-bearing deposits, savings deposits and NOW accounts must be established at carrying value because of the customers’ ability to withdraw funds immediately. Time deposit accounts are required to be revalued based upon prevailing market interest rates for similar maturity instruments. As a result, amounts assigned to time deposits were based on discounted cash flow calculations using prevailing market interest rates based on the Company’s pricing at the respective date for deposits with comparable remaining terms to maturity.

The Company believes that deposit accounts have a value greater than that prescribed by GAAP. The Company feels, however, that the value associated with these deposits is greatly influenced by characteristics of the buyer, such as the ability to reduce the costs of servicing the deposits and deposit attrition which often occurs following an acquisition.

Long-term borrowings

The amounts assigned to long-term borrowings were based on quoted market prices, when available, or were based on discounted cash flow calculations using prevailing market interest rates for borrowings of similar terms and credit risk.

Other commitments and contingencies

As described in note 13, in the normal course of business, various commitments and contingent liabilities are outstanding, such as loan commitments, credit guarantees and letters of credit. The Company’s pricing of such financial instruments is based largely on credit quality and relationship, probability of funding and other requirements. Loan commitments often have fixed expiration dates and contain termination and other clauses which provide for relief from funding in the event of significant deterioration in the credit quality of the customer. The rates and terms of the Company’s loan commitments, credit guarantees and letters of credit are competitive with other financial institutions operating in markets served by the Company. The Company believes that the carrying amounts, which are included in other liabilities, are reasonable estimates of the fair value of these financial instruments.

The Company does not believe that the estimated information presented herein is representative of the earnings power or value of the Company. The preceding analysis, which is inherently limited in depicting fair value, also does not consider any value associated with existing customer relationships nor the ability of the Company to create value through loan origination, deposit gathering or fee generating activities.

Many of the estimates presented herein are based upon the use of highly subjective information and assumptions and, accordingly, the results may not be precise. Management believes that fair value estimates may not be comparable between financial institutions due to the wide range of permitted valuation techniques and numerous estimates which must be made. Furthermore, because the disclosed fair value amounts were estimated as of the balance sheet date, the amounts actually realized or paid upon maturity or settlement of the various financial instruments could be significantly different.