Fair Value of Assets and Liabilities

9 Months Ended

Sep. 30, 2019

Fair Value Hierarchy

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. GAAP established a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:



Level 1:	Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available. A contractually binding sales price also provides reliable evidence of fair value.

Level 2:	Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that utilize model-based techniques for which all significant assumptions are observable in the market.

Level 3:	Inputs to the valuation methodology are unobservable and significant to the fair value measurement; inputs to the valuation methodology that utilize model-based techniques for which significant assumptions are not observable in the market; or inputs to the valuation methodology that require significant management judgment or estimation, some of which may be internally developed.

In some instances, an instrument may fall into multiple levels of the fair value hierarchy. In such instances, the instrument’s level within the fair value hierarchy is based on the lowest of the three levels (with Level 3 being the lowest) that is significant to the fair value measurement. Our assessment of the significance of an input requires judgment and considers factors specific to the instrument.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Investment Securities Available-for-Sale

Fair values of investment securities available-for-sale were primarily measured using information from a third-party pricing service. This service provides pricing information by utilizing evaluated pricing models supported with market data information. Standard inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data from market research publications. Level 1 investment securities are comprised of debt securities issued by the U.S. Treasury, as quoted prices were available, unadjusted, for identical securities in active markets. Level 2 investment securities were primarily comprised of debt securities issued by the Small Business Administration, states and municipalities, corporations, as well as mortgage-backed securities issued by government agencies and government-sponsored enterprises. Fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models. In cases where there may be limited or less transparent information provided by the Company’s third-party pricing service, fair value may be estimated by the use of secondary pricing services or through the use of non-binding third-party broker quotes.

On a quarterly basis, management reviews the pricing information received from the Company’s third-party pricing service. This review process includes a comparison to a second source. The Company’s third-party pricing service has also established processes for us to submit inquiries regarding quoted prices. Periodically, based on these reviews, the Company will challenge the quoted prices provided by the Company’s third-party pricing service. The Company’s third-party pricing service will review the inputs to the evaluation in light of the new market data presented by us. The Company’s third-party pricing service may then affirm the original quoted price or may update the evaluation on a going-forward basis. Generally, we do not adjust the price from the third-party service provider. On a quarterly basis, management also reviews a sample of securities priced by the Company’s third-party pricing service to review the significant assumptions and valuation methodologies used by the service. The information provided is comprised of market reference data, which may include reported trades; bids, offers, or broker-dealer dealer quotes; benchmark yields and spreads; as well as other reference data as appropriate. Based on this review, management determines whether the current placement of the security in the fair value hierarchy is appropriate or whether transfers may be warranted.

Loans Held for Sale

The fair value of the Company’s residential mortgage loans held for sale was determined based on quoted prices for similar loans in active markets, and therefore, is classified as a Level 2 measurement.

Mortgage Servicing Rights

Mortgage servicing rights do not trade in an active market with readily observable market data. As a result, the Company estimates the fair value of mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income. The Company stratifies its mortgage servicing portfolio on the basis of loan type. The assumptions used in the discounted cash flow model are those that the Company believes market participants would use in estimating future net servicing income. Significant assumptions in the valuation of mortgage servicing rights include estimated loan repayment rates, the discount rate, servicing costs, and the timing of cash flows, among other factors. Mortgage servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation.

Other Assets

Other assets recorded at fair value on a recurring basis are primarily comprised of investments related to deferred compensation arrangements. Quoted prices for these investments, primarily in mutual funds, are available in active markets. Thus, the Company’s investments related to deferred compensation arrangements are classified as Level 1 measurements in the fair value hierarchy.

Derivative Financial Instruments

Derivative financial instruments recorded at fair value on a recurring basis are comprised of IRLCs, forward commitments, interest rate swap agreements, foreign exchange contracts, and Visa Class B to Class A shares conversion rate swap agreements. The fair values of IRLCs are calculated based on the value of the underlying loan held for sale, which in turn is based on quoted prices for similar loans in the secondary market. However, this value is adjusted by a factor which considers the likelihood that the loan in a locked position will ultimately close. This factor, the closing ratio, is derived from the Bank’s internal data and is adjusted using significant management judgment. As such, IRLCs are classified as Level 3 measurements. Forward commitments are classified as Level 2 measurements as they are primarily based on quoted prices from the secondary market based on the settlement date of the contracts, interpolated or extrapolated, if necessary, to estimate a fair value as of the end of the reporting period. The fair values of interest rate swap agreements are calculated using a discounted cash flow approach and utilize Level 2 observable inputs such as a market yield curve, effective date, maturity date, notional amount, and stated interest rate. In addition, the Company includes in its fair value calculation a credit factor adjustment which is based primarily on management judgment. Thus, interest rate swap agreements are classified as a Level 3 measurement. The fair values of foreign exchange contracts are calculated using the Bank’s multi-currency accounting system which utilizes contract specific information such as currency, maturity date, contractual amount, and strike price, along with market data information such as the spot rates of specific currency and yield curves. Foreign exchange contracts are classified as Level 2 measurements because while they are valued using the Bank’s multi-currency accounting system, significant management judgment or estimation is not required. The fair value of the Visa Class B restricted shares to Class A unrestricted common shares conversion rate swap agreements represent the amount owed by the Company to the buyer of the Visa Class B shares as a result of a reduction of the conversion ratio subsequent to the sales date. As of September 30, 2019 and December 31, 2018, the conversion rate swap agreements were valued at $0.5 million and zero, respectively. This conversion rate swap agreement is classified as a Level 2 measurement. See Note 12 Derivative Financial Instruments for more information.

The Company is exposed to credit risk if borrowers or counterparties fail to perform. The Company seeks to minimize credit risk through credit approvals, limits, monitoring procedures, and collateral requirements. The Company generally enters into transactions with borrowers and counterparties that carry high quality credit ratings. Credit risk associated with borrowers or counterparties as well as the Company’s non-performance risk is factored into the determination of the fair value of derivative financial instruments.

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018:



	Quoted Prices in Active Markets for Identical Assets or Liabilities		Significant Other Observable Inputs		Significant Unobservable Inputs
(dollars in thousands)	(Level 1)		(Level 2)		(Level 3)		Total
September 30, 2019
Assets:
Investment Securities Available-for-Sale
Debt Securities Issued by the U.S. Treasury and Government Agencies	$	1,005	$	234,680	$	—	$	235,685
Debt Securities Issued by States and Political Subdivisions	—		53,982		—		53,982
Debt Securities Issued by U.S. Government-Sponsored Enterprises	—		21,895		—		21,895
Debt Securities Issued by Corporations	—		348,441		—		348,441
Mortgage-Backed Securities:
Residential - Government Agencies	—		1,228,637		—		1,228,637
Residential - U.S. Government-Sponsored Enterprises	—		537,336		—		537,336
Commercial - Government Agencies	—		168,418		—		168,418
Total Mortgage-Backed Securities	—		1,934,391		—		1,934,391
Total Investment Securities Available-for-Sale	1,005		2,593,389		—		2,594,394
Loans Held for Sale	—		36,720		—		36,720
Mortgage Servicing Rights	—		—		1,174		1,174
Other Assets	37,865		—		—		37,865
Derivatives ¹	—		432		40,260		40,692
Total Assets Measured at Fair Value on a Recurring Basis as of September 30, 2019	$	38,870	$	2,630,541	$	41,434	$	2,710,845

Liabilities:
Derivatives ¹	$	—	$	1,089	$	8,349	$	9,438
Total Liabilities Measured at Fair Value on a Recurring Basis as of September 30, 2019	$	—	$	1,089	$	8,349	$	9,438

December 31, 2018
Assets:
Investment Securities Available-for-Sale
Debt Securities Issued by the U.S. Treasury and Government Agencies	$	972	$	391,429	$	—	$	392,401
Debt Securities Issued by States and Political Subdivisions	—		563,996		—		563,996
Debt Securities Issued by U.S. Government-Sponsored Enterprises	—		56		—		56
Debt Securities Issued by Corporations	—		223,140		—		223,140
Mortgage-Backed Securities:
Residential - Government Agencies	—		190,442		—		190,442
Residential - U.S. Government-Sponsored Enterprises	—		578,527		—		578,527
Commercial - Government Agencies	—		59,380		—		59,380
Total Mortgage-Backed Securities	—		828,349		—		828,349
Total Investment Securities Available-for-Sale	972		2,006,970		—		2,007,942
Loans Held for Sale	—		10,987		—		10,987
Mortgage Servicing Rights	—		—		1,290		1,290
Other Assets	31,871		—		—		31,871
Derivatives ¹	—		812		13,792		14,604
Total Assets Measured at Fair Value on a Recurring Basis as of December 31, 2018	$	32,843	$	2,018,769	$	15,082	$	2,066,694

Liabilities:
Derivatives ¹	$	—	$	371	$	9,376	$	9,747
Total Liabilities Measured at Fair Value on a Recurring Basis as of December 31, 2018	$	—	$	371	$	9,376	$	9,747


¹	The fair value of each class of derivatives is shown in Note 12 Derivative Financial Instruments.

For the three and nine months ended September 30, 2019 and 2018, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis were as follows:



(dollars in thousands)	Mortgage Servicing Rights ¹			Net Derivative Assets and Liabilities ²
Three Months Ended September 30, 2019
Balance as of July 1, 2019	$	1,212		$	19,956
Realized and Unrealized Net Gains (Losses):
Included in Net Income	(38		)	4,360
Transfers to Loans Held for Sale	—			(3,736		)
Variation Margin Payments	—			11,331
Balance as of September 30, 2019	$	1,174		$	31,911
Total Unrealized Net Gains (Losses) Included in Net Income Related to Assets Still Held as of September 30, 2019	$	—		$	31,911

Three Months Ended September 30, 2018
Balance as of July 1, 2018	$	1,366		$	391
Realized and Unrealized Net Gains (Losses):
Included in Net Income	(39		)	730
Transfers to Loans Held for Sale	—			(1,012		)
Variation Margin Payments	—			(293		)
Balance as of September 30, 2018	$	1,327		$	(184	)
Total Unrealized Net Gains (Losses) Included in Net Income Related to Assets Still Held as of September 30, 2018	$	—		$	(184	)

Nine Months Ended September 30, 2019
Balance as of January 1, 2019	$	1,290		$	4,416
Realized and Unrealized Net Gains (Losses):
Included in Net Income	(116		)	9,602
Transfers to Loans Held for Sale	—			(7,750		)
Variation Margin Payments	—			25,643
Balance as of September 30, 2019	$	1,174		$	31,911
Total Unrealized Net Gains (Losses) Included in Net Income Related to Assets Still Held as of September 30, 2019	$	—		$	31,911

Nine Months Ended September 30, 2018
Balance as of January 1, 2018	$	1,454		$	894
Realized and Unrealized Net Gains (Losses):
Included in Net Income	(127		)	2,234
Transfers to Loans Held for Sale	—			(2,591		)
Variation Margin Payments	—			(721		)
Balance as of September 30, 2018	$	1,327		$	(184	)
Total Unrealized Net Gains (Losses) Included in Net Income Related to Assets Still Held as of September 30, 2018	$	—		$	(184	)


¹	Realized and unrealized gains and losses related to mortgage servicing rights are reported as a component of mortgage banking income in the Company’s consolidated statements of income.


²	Realized and unrealized gains and losses related to interest rate lock commitments are reported as a component of mortgage banking income in the Company’s consolidated statements of income. Realized and unrealized gains and losses related to interest rate swap agreements are reported as a component of other noninterest income in the Company’s consolidated statements of income.

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of September 30, 2019 and December 31, 2018, the significant unobservable inputs used in the fair value measurements were as follows:



		Significant Unobservable Inputs (weighted-average)					Fair Value
(dollars in thousands)	Valuation Technique	Description	Sept. 30, 2019		Dec. 31, 2018		Sept. 30, 2019		Dec. 31, 2018
Mortgage Servicing Rights	Discounted Cash Flow	Constant Prepayment Rate ¹	11.81	%	7.01	%	$	24,848	$	30,508
		Discount Rate ²	6.96	%	9.59	%

Net Derivative Assets and Liabilities:
Interest Rate Lock Commitments	Pricing Model	Closing Ratio	91.87	%	89.00	%	$	2,788	$	871
Interest Rate Swap Agreements	Discounted Cash Flow	Credit Factor	0.20	%	0.06	%	$	29,123	$	3,545


¹	Represents annualized loan repayment rate assumption.


²	Derived from multiple interest rate scenarios that incorporate a spread to a market yield curve and market volatilities.

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage servicing rights are the weighted-average constant prepayment rate and weighted-average discount rate. Significant increases (decreases) in any of those inputs in isolation could result in a significantly lower (higher) fair value measurement. Although the constant prepayment rate and the discount rate are not directly interrelated, they generally move in opposite directions of each other.

The Company estimates the fair value of mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income. The Company’s Treasury Division enters observable and unobservable inputs into the model to arrive at an estimated fair value. To assess the reasonableness of the fair value measurement, the Treasury Division performs a back-test by comparing the model’s results to historical prepayment data. The Treasury Division also compares the fair value of the Company’s mortgage servicing rights to a value calculated by an independent third-party. Discussions are held with members from the Treasury, Mortgage Banking, and Controllers Divisions, along with the independent third-party to discuss and reconcile the fair value estimates and key assumptions used by the respective parties in arriving at those estimates. A subcommittee of the Company’s Asset/Liability Management Committee is responsible for providing oversight over the valuation methodology and key assumptions.

The significant unobservable input used in the fair value measurement of the Company’s IRLCs is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. Generally, the fair value of an IRLC is positive (negative) if the prevailing interest rate is lower (higher) than the IRLC rate. Therefore, an increase in the closing ratio (i.e., higher percentage of loans are estimated to close) will increase the gain or loss. The closing ratio is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. The closing ratio is computed by the Company’s secondary marketing system using historical data and the ratio is periodically reviewed by the Company for reasonableness.

The unobservable input used in the fair value measurement of the Company’s interest rate swap agreements is the credit factor. This factor represents the risk that a counterparty is either unable or unwilling to settle a transaction in accordance with the underlying contractual terms. A significant increase (decrease) in the credit factor could result in a significantly lower (higher) fair value measurement. The credit factor is determined by the Treasury Division based on the risk rating assigned to each counterparty in which the Company holds a net asset position. The Company’s Credit Policy Committee periodically reviews and approves the Expected Default Frequency of the Economic Capital Model for Credit Risk. The Expected Default Frequency is used as the credit factor for interest rate swap agreements.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company may be required periodically to measure certain assets and liabilities at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of lower-of-cost-or-fair value accounting or impairment write-downs of individual assets. The following table represents the assets measured at fair value on

a nonrecurring basis as of September 30, 2019. There were no assets measured at fair value on a nonrecurring basis as of

December 31, 2018.



(dollars in thousands)	Fair Value Hierarchy	Net Carrying Amount		Valuation Allowance
September 30, 2019
Mortgage Servicing Rights - amortization method	Level 3	$	23,674	$	(28	)
Other Assets- Equipment Held for Sale	Level 3	—		(217		)

The write-down of mortgage servicing rights accounted for under the amortization method was primarily due to changes in certain key assumptions used to estimate fair value. As previously mentioned, all of the Company's mortgage servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation. The Company's equipment held for sale at September 30, 2019 represented aircraft parts that were previously on lease agreements. An impairment charge of $0.2 million (included in other noninterest expense in the Company's consolidated statements of income) was recorded in the third quarter of 2019 to reduce the carrying value to estimated fair value less cost to sell based on recent appraisals, market conditions, and management judgment. Due to the use of significant unobservable inputs combined with significant management judgment regarding the fair value of the equipment held for sale, the carrying value was deemed a Level 3 measurement.

Fair Value Option

The Company elects the fair value option for all residential mortgage loans held for sale. This election allows for a more effective offset of the changes in fair values of the loans held for sale and the derivative financial instruments used to financially hedge them without having to apply complex hedge accounting requirements. As noted above, the fair value of the Company’s residential mortgage loans held for sale was determined based on quoted prices for similar loans in active markets.

The following table reflects the difference between the aggregate fair value and the aggregate unpaid principal balance of the Company’s residential mortgage loans held for sale as of September 30, 2019 and December 31, 2018.



(dollars in thousands)	Aggregate Fair Value		Aggregate Unpaid Principal			Aggregate Fair Value Less Aggregate Unpaid Principal
September 30, 2019
Loans Held for Sale	$	36,720		$	36,039		$	681

December 31, 2018
Loans Held for Sale	$	10,987		$	10,656		$	331

Changes in the estimated fair value of residential mortgage loans held for sale are reported as a component of mortgage banking income in the Company’s consolidated statements of income. For the three and nine months ended September 30, 2019 and 2018, the net gains or losses from the change in fair value of the Company’s residential mortgage loans held for sale were not material.

Financial Instruments Not Recorded at Fair Value on a Recurring Basis

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments not recorded at fair value on a recurring basis as of September 30, 2019 and December 31, 2018. This table excludes financial instruments for which the carrying amount approximates fair value. For short-term financial assets such as cash and cash equivalents, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For non-marketable equity securities such as Federal Home Loan Bank and Federal Reserve Bank stock, the carrying amount is a reasonable estimate of fair value as these securities can only be redeemed or sold at their par value and only to the respective issuing government supported institution or to another member institution. For financial liabilities such as noninterest-bearing demand, interest-bearing demand, and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.



					Fair Value Measurements
	Carrying				Quoted Prices in Active Markets for Identical Assets or Liabilities		Significant Other Observable Inputs		Significant Unobservable Inputs
(dollars in thousands)	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2019
Financial Instruments - Assets
Investment Securities Held-to-Maturity	$	2,946,910	$	2,972,273	$	355,442	$	2,616,831	$	—
Loans ¹	10,514,438		10,784,711		—		—		10,784,711

Financial Instruments - Liabilities
Time Deposits	1,806,083		1,805,230		—		1,805,230
Securities Sold Under Agreements to Repurchase	604,299		633,599		—		633,599
Other Debt ²	100,000		100,627		—		100,627

December 31, 2018
Financial Instruments - Assets
Investment Securities Held-to-Maturity	$	3,482,092	$	3,413,994	$	352,216	$	3,061,778	$	—
Loans ¹	10,084,527		10,008,417		—		—		10,008,417

Financial Instruments - Liabilities
Time Deposits	1,745,522		1,734,447		—		1,734,447		—
Securities Sold Under Agreements to Repurchase	504,296		504,288		—		504,288		—
Other Debt ²	125,000		124,559		—		124,559		—


¹	Carrying amount is net of unearned income and the Allowance.

Excludes capitalized lease obligations.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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