Fair Value Measurement of Assets and Liabilities

Accounting Standards Codification (ASC) Topic 820, “Fair Value Measurements and Disclosures,” 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 are described below:



	Level 1	Unadjusted exchange quoted prices in active markets for identical assets or liabilities, or identical liabilities traded as assets that the reporting entity has the ability to access at the measurement date.



	Level 2	Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly (i.e., quoted prices on similar assets), for substantially the full term of the asset or liability.



	Level 3	Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

Assets and Liabilities Measured at Fair Value on a Recurring and Non-Recurring Basis

The following tables present the assets and liabilities that are measured at fair value on a recurring and nonrecurring basis by level within the fair value hierarchy as reported on the consolidated statements of financial condition at September 30, 2017 and December 31, 2016. The assets presented under “nonrecurring fair value measurements” in the table below are not measured at fair value on an ongoing basis but are subject to fair value adjustments under certain circumstances (e.g., when an impairment loss is recognized).



	September 30, 2017		Fair Value Measurements at Reporting Date Using:
	September 30, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Recurring fair value measurements:
Assets
Investment securities:
Available for sale:
U.S. Treasury securities	$	50,148	$	50,148	$	—	$	—
U.S. government agency securities	44,230		—		44,230		—
Obligations of states and political subdivisions	118,402		—		118,402		—
Residential mortgage-backed securities	1,161,157		—		1,153,475		7,682
Trust preferred securities	5,393		—		3,278		2,115
Corporate and other debt securities	57,427		7,890		49,537		—
Equity securities	10,980		1,110		9,870		—
Total available for sale	1,447,737		59,148		1,378,792		9,797
Loans held for sale ⁽¹⁾	13,321		—		13,321		—
Other assets ⁽²⁾	26,696		—		26,696		—
Total assets	$	1,487,754	$	59,148	$	1,418,809	$	9,797
Liabilities
Other liabilities ⁽²⁾	$	23,868	$	—	$	23,868	$	—
Total liabilities	$	23,868	$	—	$	23,868	$	—
Non-recurring fair value measurements:
Collateral dependent impaired loans ⁽³⁾	$	33,260	$	—	$	—	$	33,260
Loan servicing rights	7,072		—		—		7,072
Foreclosed assets	1,762		—		—		1,762
Total	$	42,094	$	—	$	—	$	42,094



			Fair Value Measurements at Reporting Date Using:
	December 31, 2016		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Recurring fair value measurements:
Assets
Investment securities:
Available for sale:
U.S. Treasury securities	$	49,591	$	49,591	$	—	$	—
U.S. government agency securities	23,041		—		23,041		—
Obligations of states and political subdivisions	119,767		—		119,767		—
Residential mortgage-backed securities	1,015,542		—		1,005,589		9,953
Trust preferred securities	8,009		—		6,074		1,935
Corporate and other debt securities	60,565		8,064		52,501		—
Equity securities	20,858		1,306		19,552		—
Total available for sale	1,297,373		58,961		1,226,524		11,888
Loans held for sale ⁽¹⁾	57,708		—		57,708		—
Other assets ⁽²⁾	29,055		—		29,055		—
Total assets	$	1,384,136	$	58,961	$	1,313,287	$	11,888
Liabilities
Other liabilities ⁽²⁾	$	44,077	$	—	$	44,077	$	—
Total liabilities	$	44,077	$	—	$	44,077	$	—
Non-recurring fair value measurements:
Collateral dependent impaired loans ⁽³⁾	$	5,385	$	—	$	—	$	5,385
Loan servicing rights	6,489		—		—		6,489
Foreclosed assets	4,532		—		—		4,532
Total	$	16,406	$	—	$	—	$	16,406


(1)	Represents residential mortgage loans originated for sale that are carried at fair value and had contractual unpaid principal balances totaling approximately $13.1 million and $58.2 million at September 30, 2017 and December 31, 2016, respectively.


(2)	Derivative financial instruments are included in this category.


(3)	Excludes PCI loans.

The changes in Level 3 assets measured at fair value on a recurring basis for the three and nine months ended September 30, 2017 and 2016 are summarized below:



	Available for Sale Securities
	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
	(in thousands)
Balance, beginning of the period	$	10,730		$	13,101		$	11,888		$	13,793
Total net losses included in other comprehensive income	(448		)	(212		)	(435		)	(283		)
Settlements, net	(485		)	(492		)	(1,656		)	(1,113		)
Balance, end of the period	$	9,797		$	12,397		$	9,797		$	12,397

No changes in unrealized gains or losses on Level 3 securities were included in earnings during the three and nine months ended September 30, 2017 and 2016. There were no transfers of assets into or out of Level 3, or between Level 1 and Level 2, during the three and nine months ended September 30, 2017 and 2016.

There have been no material changes in the valuation methodologies used at September 30, 2017 from December 31, 2016.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following valuation techniques were used for financial instruments measured at fair value on a recurring basis. All the valuation techniques described below apply to the unpaid principal balance, excluding any accrued interest or dividends at the measurement date. Interest income and expense are recorded within the consolidated statements of income depending on the nature of the instrument using the effective interest method based on acquired discount or premium.

Available for sale securities.

All U.S. Treasury securities, certain corporate and other debt securities, and certain preferred equity securities are reported at fair value utilizing Level 1 inputs. The majority of other investment securities are reported at fair value utilizing Level 2 inputs. The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom Valley has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricing. 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. Management reviews the data and assumptions used in pricing the securities by its third party provider to ensure the highest level of significant inputs are derived from market observable data. For certain securities, the inputs used by either dealer market participants or an independent pricing service may be derived from unobservable market information (Level 3 inputs). In these instances, Valley evaluates the appropriateness and quality of the assumption and the resulting price. In addition, Valley reviews the volume and level of activity for all available for sale and trading securities and attempts to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value and this results in fair values based on Level 3 inputs. In determining fair value, Valley utilizes unobservable inputs which reflect Valley’s own assumptions about the inputs that market participants would use in pricing each security. In developing its assertion of market participant assumptions, Valley utilizes the best information that is both reasonable and available without undue cost and effort.

In calculating the fair value for the available for sale securities under Level 3, Valley prepared present value cash flow models for certain private label mortgage-backed securities. The cash flows for the residential mortgage-backed securities incorporated the expected cash flow of each security adjusted for default rates, loss severities and prepayments of the individual loans collateralizing the security.

The following table presents quantitative information about Level 3 inputs used to measure the fair value of these securities at September 30, 2017:



Security Type	Valuation Technique	Unobservable Input	Range	Weighted Average

Private label mortgage-backed securities	Discounted cash flow	Prepayment rate	1.1 - 34.1%	18.0	%
		Default rate	1.4 - 30.9	6.7
		Loss severity	47.7 - 63.8	58.3

Significant increases or decreases in any of the unobservable inputs in the table above in isolation would result in a significantly lower or higher fair value measurement of the securities. Generally, a change in the assumption used for the default rate is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

For the Level 3 available for sale residential mortgage-backed securities (consisting of 4 private label securities), cash flow assumptions incorporated independent third party market participant data based on vintage year for each security. The discount rate utilized in determining the present value of cash flows for the mortgage-backed securities was arrived at by combining the yield on orderly transactions for similar maturity government sponsored mortgage-backed securities with (i) the historical average risk premium of similar structured private label securities, (ii) a risk premium reflecting current market conditions, including liquidity risk, and (iii) if applicable, a forecasted loss premium derived from the expected cash flows of each security. The estimated cash flows for each private label mortgage-backed security were then discounted at the aforementioned effective rate to determine the fair value. The quoted prices received from either market participants or independent pricing services are weighted with the internal price estimate to determine the fair value of each instrument.

For the Level 3 available for sale trust preferred securities (consisting of one pooled security), the resulting estimated future cash flow was discounted at a yield determined by reference to similarly structured securities for which observable orderly transactions occurred. The discount rate was applied using a pricing matrix based on credit, security type and maturity characteristics to determine the fair value. The fair value calculation is received from an independent valuation adviser. In validating the fair value calculation from an independent valuation adviser, Valley reviews the accuracy of the inputs and the appropriateness of the unobservable inputs utilized in the valuation to ensure the fair value calculation is reasonable from a market participant perspective.

Loans held for sale. The conforming residential mortgage loans originated for sale are reported at fair value using Level 2 inputs. The fair values were calculated utilizing quoted prices for similar assets in active markets. To determine these fair values, the mortgages held for sale are put into multiple tranches, or pools, based on the coupon rate and maturity of each mortgage. The market prices for each tranche are obtained from both Fannie Mae and Freddie Mac. The market prices represent a delivery price, which reflects the underlying price each institution would pay Valley for an immediate sale of an aggregate pool of mortgages. The market prices received from Fannie Mae and Freddie Mac are then averaged and interpolated or extrapolated, where required, to calculate the fair value of each tranche. Depending upon the time elapsed since the origination of each loan held for sale, non-performance risk and changes therein were addressed in the estimate of fair value based upon the delinquency data provided to both Fannie Mae and Freddie Mac for market pricing and changes in market credit spreads. Non-performance risk did not materially impact the fair value of mortgage loans held for sale at September 30, 2017 and December 31, 2016 based on the short duration these assets were held, and the high credit quality of these loans.

Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs. The fair value of Valley’s derivatives are determined using third party prices that are based on discounted cash flow analysis using observed market inputs, such as the LIBOR and Overnight Index Swap rate curves. The fair value of mortgage banking derivatives, consisting of interest rate lock commitments to fund residential mortgage loans and forward commitments for the future delivery of such loans (including certain loans held for sale at September 30, 2017 and December 31, 2016), is determined based on the current market prices for similar instruments provided by Fannie Mae and Freddie Mac. The fair values of most of the derivatives incorporate credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, to account for potential nonperformance risk of Valley and its counterparties. The credit valuation adjustments were not significant to the overall valuation of Valley’s derivatives at September 30, 2017 and December 31, 2016.

Assets and Liabilities Measured at Fair Value on a Non-recurring Basis

The following valuation techniques were used for certain non-financial assets measured at fair value on a nonrecurring basis, including impaired loans reported at the fair value of the underlying collateral, loan servicing rights and foreclosed assets, which are reported at fair value upon initial recognition or subsequent impairment as described below.

Impaired loans. Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral and are commonly referred to as “collateral dependent impaired loans.” Collateral values are estimated using Level 3 inputs, consisting of individual appraisals that may be adjusted based on certain discounting criteria. At September 30, 2017, certain appraisals were discounted based on specific market data by location and property type. During the quarter ended September 30, 2017, collateral dependent impaired loans were individually re-measured and reported at fair value through direct loan charge-offs to the allowance for loan losses and/or a specific valuation allowance allocation based on the fair value of the underlying collateral. There were no collateral dependent loan charge-offs to the allowance for loan losses for the three months ended September 30, 2017 as compared to $3.7 million for the three months ended September 30, 2016 and $2.1 million and $4.7 million for the nine months ended September 30, 2017 and 2016, respectively. At September 30, 2017, collateral dependent impaired loans with a total recorded investment of $38.3 million were reduced by specific valuation allowance allocations totaling $5.0 million to a reported total net carrying amount of $33.3 million.

Loan servicing rights. Fair values for each risk-stratified group of loan servicing rights are calculated using a fair value model from a third party vendor that requires inputs that are both significant to the fair value measurement and unobservable (Level 3). The fair value model is based on various assumptions, including but not limited to, prepayment speeds, internal rate of return (“discount rate”), servicing cost, ancillary income, float rate, tax rate, and inflation. The prepayment speed and the discount rate are considered two of the most significant inputs in the model. At September 30, 2017, the fair value model used prepayment speeds (stated as constant prepayment rates) from 0 percent up to 24 percent and a discount rate of 8 percent for the valuation of the loan servicing rights. A significant degree of judgment is involved in valuing the loan servicing rights using Level 3 inputs. The use of different assumptions could have a significant positive or negative effect on the fair value estimate. Impairment charges are recognized on loan servicing rights when the amortized cost of a risk-stratified group of loan servicing rights exceeds the estimated fair value. Valley recorded net recoveries of net impairment charges on its loan servicing rights totaling $134 thousand and $185 thousand for the three and nine months ended September 30, 2017, respectively. Valley recorded no net impairment charges on its loan servicing rights for the three months ended September 30, 2016 and net impairment charges totaling $457 thousand for the nine months ended September 30, 2016.

Foreclosed assets. Certain foreclosed assets (consisting of other real estate owned and other repossessed assets), upon initial recognition and transfer from loans, are re-measured and reported at fair value through a charge-off to the allowance for loan losses based upon the fair value of the foreclosed assets. The fair value of a foreclosed asset, upon initial recognition, is typically estimated using Level 3 inputs, consisting of an appraisal that is adjusted based on certain discounting criteria, similar to the criteria used for impaired loans described above. There were no discount adjustments of the appraisals of foreclosed assets at September 30, 2017. At September 30, 2017, foreclosed assets included $1.8 million of assets that were measured at fair value upon initial recognition or subsequently re-measured during the quarter ended September 30, 2017. The foreclosed assets charge-offs to the allowance for loan losses totaled $536 thousand and $245 thousand for the three months ended September 30, 2017 and 2016, respectively, and $1.5 million and $1.2 million for the nine months ended September 30, 2017 and 2016, respectively. The re-measurement of foreclosed assets at fair value subsequent to their initial recognition resulted in net losses within non-interest expense of $290 thousand for the nine months ended September 30, 2017, and $34 thousand and $946 thousand for three and nine months ended September 30, 2016, respectively. There were no losses on re-measurement during the three months ended September 30, 2017.

Other Fair Value Disclosures

ASC Topic 825, “Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.

The fair value estimates presented in the following table were based on pertinent market data and relevant information on the financial instruments available as of the valuation date. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire portfolio of financial instruments. Because no market exists for a portion of the financial instruments, fair value estimates may be based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For instance, Valley has certain fee-generating business lines (e.g., its mortgage servicing operation, trust and investment management departments) that were not considered in these estimates since these activities are not financial instruments. In addition, the tax implications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

The carrying amounts and estimated fair values of financial instruments not measured and not reported at fair value on the consolidated statements of financial condition at September 30, 2017 and December 31, 2016 were as follows:



	Fair Value Hierarchy	September 30, 2017				December 31, 2016
	Fair Value Hierarchy	Carrying Amount		Fair Value		Carrying Amount		Fair Value
		(in thousands)
Financial assets
Cash and due from banks	Level 1	$	215,600	$	215,600	$	220,791	$	220,791
Interest bearing deposits with banks	Level 1	128,226		128,226		171,710		171,710
Investment securities held to maturity:
U.S. Treasury securities	Level 1	138,714		147,126		138,830		147,495
U.S. government agency securities	Level 2	9,984		10,188		11,329		11,464
Obligations of states and political subdivisions	Level 2	495,157		511,159		566,590		577,826
Residential mortgage-backed securities	Level 2	1,088,389		1,081,703		1,112,460		1,102,802
Trust preferred securities	Level 2	49,819		38,998		59,804		47,290
Corporate and other debt securities	Level 2	41,559		41,971		36,559		37,720
Total investment securities held to maturity		1,823,622		1,831,145		1,925,572		1,924,597
Net loans	Level 3	18,082,496		17,741,813		17,121,684		16,756,655
Accrued interest receivable	Level 1	72,063		72,063		66,816		66,816
Federal Reserve Bank and Federal Home Loan Bank stock⁽¹⁾	Level 1	204,978		204,978		147,127		147,127
Financial liabilities
Deposits without stated maturities	Level 1	13,892,110		13,892,110		14,591,837		14,591,837
Deposits with stated maturities	Level 2	3,420,656		3,436,229		3,138,871		3,160,572
Short-term borrowings	Level 1	1,482,709		1,485,695		1,080,960		1,081,751
Long-term borrowings	Level 2	2,215,219		2,300,388		1,433,906		1,523,386
Junior subordinated debentures issued to capital trusts	Level 2	41,716		42,244		41,577		45,785
Accrued interest payable ⁽²⁾	Level 1	10,812		10,812		10,675		10,675


(1)	Included in other assets.


(2)	Included in accrued expenses and other liabilities.

The following methods and assumptions were used to estimate the fair value of other financial assets and financial liabilities in the table above:

Cash and due from banks and interest bearing deposits with banks. The carrying amount is considered to be a reasonable estimate of fair value because of the short maturity of these items.

Investment securities held to maturity. Fair values are based on prices obtained through an independent pricing service or dealer market participants with whom Valley has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricing. 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 (Level 2 inputs). Additionally, Valley reviews the volume and level of activity for all classes of held to maturity securities and attempts to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary. If applicable, the adjustment to fair value is derived based on present value cash flow model projections prepared by Valley utilizing assumptions similar to those incorporated by market participants.

Loans. Fair values of loans are estimated by discounting the projected future cash flows using market discount rates that reflect the credit and interest-rate risk inherent in the loan. The discount rate is a product of both the applicable index and credit spread, subject to the estimated current new loan interest rates. The credit spread component is static for all maturities and may not necessarily reflect the value of estimating all actual cash flows re-pricing. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.

Accrued interest receivable and payable. The carrying amounts of accrued interest approximate their fair value due to the short-term nature of these items.

Federal Reserve Bank and Federal Home Loan Bank stock. Federal Reserve Bank and FHLB stock are non-marketable equity securities and are reported at their redeemable carrying amounts, which approximate fair value.

Deposits. The carrying amounts of deposits without stated maturities (i.e., non-interest bearing, savings, NOW, and money market deposits) approximate their estimated fair value. The fair value of time deposits is based on the discounted value of contractual cash flows using estimated rates currently offered for alternative funding sources of similar remaining maturity.

Short-term and long-term borrowings. The carrying amounts of certain short-term borrowings, including securities sold under agreements to repurchase and FHLB borrowings (and from time to time, federal funds purchased) approximate their fair values because they frequently re-price to a market rate. The fair values of other short-term and long-term borrowings are estimated by obtaining quoted market prices of the identical or similar financial instruments when available. When quoted prices are unavailable, the fair values of the borrowings are estimated by discounting the estimated future cash flows using current market discount rates of financial instruments with similar characteristics, terms and remaining maturity.

Junior subordinated debentures issued to capital trusts. The fair value of debentures issued to capital trusts is estimated utilizing the income approach, whereby the expected cash flows, over the remaining estimated life of the security, are discounted using Valley’s credit spread over the current yield on a similar maturity of U.S. Treasury security or the three-month LIBOR for the variable rate indexed debentures (Level 2 inputs). The credit spread used to discount the expected cash flows was calculated based on the median current spreads for all fixed and variable publicly traded trust preferred securities issued by banks.