Fair Value Measurements

The Corporation uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. As of December 31, 2011, securities available for sale, mortgage loans held for sale and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as collateral dependent impaired loans, property acquired through foreclosure or repossession and mortgage servicing rights. These nonrecurring fair value adjustments typically involve the application of lower-of-cost-or-market accounting or write-downs of individual assets.

ASC 825 allows for the irrevocable option to elect fair value accounting for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis that may otherwise not be required to be measured at fair value under other accounting standards. Washington Trust elected the fair value option for its portfolio of mortgage loans held for sale pursuant to forward sale commitments originated after July 1, 2011 in order to reduce certain timing differences and better match changes in fair values of the loans with changes in the fair value of the derivative forward loan sale contracts used to economically hedge them. The election under ASC 825 related to mortgage loans held for sale does not result in a transition adjustment to retained earnings and instead, changes in fair value have an impact on earnings.

The following tables summarize information related to mortgage loans held for sale, commitments to originate fixed-rate mortgage loans to be sold and commitments to sell fixed-rate mortgage loans.



(Dollars in thousands)	December 31, 2011					December 31, 2010
	Notional or Principal Amount		Fair Value			Notional or Principal Amount		Fair Value
Mortgage loans held for sale (1)		$19,624		$20,340			$13,894	N/A
Commitments to originate	56,950		1,864			10,893		(104	)
Commitments to sell	76,574		(2,580		)	24,901		539



(Dollars in thousands)
Years ended December 31,	2011			2010		2009
Mortgage loans held for sale		$716			$—		$—
Commitments to originate	1,968			54		(325		)
Commitments to sell	(3,119		)	228		503
Total changes in fair value (2)		($435	)		$282		$178


(1)	At December 31, 2011, the difference between the aggregate fair value and the aggregate principal amount of mortgage loans held for sale amounted to $716 thousand. There were no mortgage loans held for sale 90 days or more past due as of December 31, 2011.


(2)	Changes in fair values are reported as a component of net gains on loan sales and commissions on loan originated for others in the Consolidated Statements of Income.

Fair value is a market-based measurement, not an entity-specific measurement. Fair value measurements are determined based on the assumptions the market participants would use in pricing the asset or liability. In addition, GAAP specifies a hierarchy of valuation techniques based on whether the types of valuation information (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Corporation’s market assumptions. These two types of inputs have created the following fair value hierarchy:


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


•	Level 2 – Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.


•	Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable in the markets and which reflect the Corporation’s market assumptions.

Determination of Fair Value

Fair values are based on 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. When available, the Corporation uses quoted market prices to determine fair value. If quoted prices are not available, fair value is based upon valuation techniques such as matrix pricing or other models that use, where possible, current market-based or independently sourced market parameters, such as interest rates. If observable market-based inputs are not available, the Corporation uses unobservable inputs to determine appropriate valuation adjustments using methodologies applied consistently over time.

The following is a description of valuation methodologies for assets and liabilities recorded at fair value, including the general classification of such assets and liabilities pursuant to the valuation hierarchy.

Items Measured at Fair Value on a Recurring Basis

Securities

Securities available for sale are recorded at fair value on a recurring basis. When available, the Corporation uses quoted market prices to determine the fair value of securities; such items are classified as Level 1. This category includes exchange-traded equity securities.

Level 2 securities include debt securities with quoted prices, which are traded less frequently than exchange-traded instruments, whose value is determined using matrix pricing with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes obligations of U.S. government-sponsored enterprises, mortgage-backed securities issued by U.S. government agencies and U.S government-sponsored enterprises, municipal bonds, trust preferred securities, corporate bonds and certain preferred equity securities.

In certain cases where there is limited activity or less transparency around inputs to the valuation, securities may be classified as Level 3. As of December 31, 2011 and 2010, level 3 securities were comprised of two pooled trust preferred debt securities, in the form of collateralized debt obligations, which were not actively traded. As of December 31, 2011 and 2010, the Corporation concluded that the low level of activity for its Level 3 pooled trust preferred debt securities continued to indicate that quoted market prices are not indicative of fair value. The Corporation obtained valuations including broker quotes and cash flow scenario analyses prepared by a third party valuation consultant. The fair values were assigned a weighting that was dependent upon the methods used to calculate the prices. The cash flow scenarios (Level 3) were given substantially more weight than the broker quotes (Level 2) as management believed that the broker quotes reflected highly limited sales evidenced by an inactive market. The cash flow scenarios were prepared using discounted cash flow methodologies based on detailed cash flow and credit analysis of the pooled securities. The weighting was then used to determine an overall fair value of the securities. Management believes that this approach is most representative of fair value for these particular securities in current market conditions.

Our internal review procedures have confirmed that the fair values provided by the aforementioned third party valuation sources utilized by the Corporation are consistent with GAAP. Our fair values assumed liquidation in an orderly market and not under distressed circumstances. Due to the continued market illiquidity and credit risk for securities in the financial sector, the fair value of these securities is highly sensitive to assumption changes and market volatility.

Mortgage Loans Held for Sale

Effective July 1, 2011, Washington Trust elected to carry newly originated closed loans held for sale at fair value pursuant to ASC 825, “Financial Instruments”. Fair values are estimated based on what secondary markets are currently offering for loans with similar characteristics. Any change in the valuation of mortgage loans held for sale is based upon the change in market interest rates between closing the loan and the measurement date and an immaterial portion attributable to changes in instrument-specific credit risk. Mortgage loans held for sale are categorized as Level 2.

Derivatives

Interest rate swap contracts are traded in over-the-counter markets where quoted market prices are not readily available. Fair value measurements are determined using independent pricing models that utilize primarily market observable inputs, such as swap rates of different maturities and LIBOR rates and, accordingly, are classified as Level 2. Our internal review procedures have confirmed that the fair values determined with independent pricing models and utilized by the Corporation are consistent with GAAP. For purposes of potential valuation adjustments to its interest rate swap contracts, the Corporation evaluates the credit risk of its counterparties as well as that of the Corporation. Accordingly, Washington Trust considers factors such as the likelihood of default by the Corporation and its counterparties, its net exposures and remaining contractual life, among other factors, in determining if any fair value adjustments related to credit risk are required. Counterparty exposure is evaluated by netting positions that are subject to master netting agreements, as well as considering the amount of collateral securing the position.

Fair value measurements of forward loan commitments (interest rate lock commitments and commitments to sell fixed-rate residential mortgages) are estimated using the anticipated market price based on pricing indications provided from syndicate banks. These derivative financial instruments are categorized as Level 2.

Items Measured at Fair Value on a Nonrecurring Basis

Collateral Dependent Impaired Loans

Collateral dependent loans that are deemed to be impaired are valued based upon the fair value of the underlying collateral less costs to sell. Such collateral primarily consists of real estate and, to a lesser extent, other business assets. Management may adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values resulting from its knowledge of the property. Internal valuations are utilized to determine the fair value of other business assets. Collateral dependent impaired loans are categorized as Level 3.

Property acquired through foreclosure or repossession

Property acquired through foreclosure or repossession is adjusted to fair value less costs to sell upon transfer out of loans. Subsequently, it is carried at the lower of carrying value or fair value less costs to sell. Fair value is generally based upon independent market prices or appraised values of the collateral. Management adjusts appraised values to reflect estimated market value declines or apply other discounts to appraised values for unobservable factors resulting from its knowledge of the property, and such property is categorized as Level 3.

Loan Servicing Rights

Loan servicing rights do not trade in an active market with readily observable prices. Accordingly, we determine the fair value of loan servicing rights using a valuation model that calculates the present value of the estimated future net servicing income. The model incorporates assumptions used in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service and contractual servicing fee income. Loan servicing rights are subject to fair value measurements on a nonrecurring basis. Fair value measurements of our loan servicing rights use significant unobservable inputs and, accordingly, are classified as Level 3.

Items Recorded at Fair Value on a Recurring Basis

The tables below present the balances of assets and liabilities reported at fair value on a recurring basis.



(Dollars in thousands)							Assets/Liabilities at Fair Value
	Fair Value Measurements Using
December 31, 2011	Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Obligations of U.S. government-sponsored enterprises		$—		$32,833		$—		$32,833
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	—		389,658		—		389,658
States and political subdivisions	—		79,493		—		79,493
Trust preferred securities:
Individual name issuers	—		22,396		—		22,396
Collateralized debt obligations	—		—		887		887
Corporate bonds	—		14,282		—		14,282
Common stocks	—		—		—		—
Perpetual preferred stocks	1,704		—		—		1,704
Mortgage loans held for sale	—		20,340		—		20,340
Derivative assets (1)
Interest rate swap contracts with customers	—		4,513		—		4,513
Forward loan commitments	—		1,864		—		1,864
Total assets at fair value on a recurring basis		$1,704		$565,379		$887		$567,970
Liabilities:
Derivative liabilities (1)
Mirror swap contracts with customers		$—		$4,669		$—		$4,669
Interest rate risk management swap contracts	—		1,802		—		1,802
Forward loan commitments	—		2,580		—		2,580
Total liabilities at fair value on a recurring basis		$—		$9,051		$—		$9,051


(1)	Derivative assets are included in other assets and derivative liabilities are reported in other liabilities in the Consolidated Balance Sheets.



(Dollars in thousands)							Assets/Liabilities at Fair Value
	Fair Value Measurements Using
December 31, 2010	Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Obligations of U.S. government-sponsored enterprises		$—		$40,994		$—		$40,994
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	—		429,771		—		429,771
States and political subdivisions	—		81,055		—		81,055
Trust preferred securities:
Individual name issuers	—		23,275		—		23,275
Collateralized debt obligations	—		—		806		806
Corporate bonds	—		15,212		—		15,212
Common stocks	809		—		—		809
Perpetual preferred stocks	2,178		—		—		2,178
Derivative assets (1)
Interest rate swap contracts with customers	—		3,690		—		3,690
Forward loan commitments	—		—		602		602
Total assets at fair value on a recurring basis		$2,987		$593,997		$1,408		$598,392
Liabilities:
Derivative liabilities (1)
Mirror swap contracts with customers		$—		$3,806		$—		$3,806
Interest rate risk management swap contracts	—		1,098		—		1,098
Forward loan commitments	—		—		167		167
Total liabilities at fair value on a recurring basis		$—		$4,904		$167		$5,071


(1)	Derivatives assets are included in other assets and derivative liabilities are reported in other liabilities in the Consolidated Balance Sheets.

It is the Corporation’s policy to review and reflect transfers between Levels as of the financial statement reporting date. There were no transfers in and/or out of Level 1 during the years ended December 31, 2011 and 2010. After evaluating forward loan commitments consisting of interest rate lock commitments and commitments to sell fixed-rate residential mortgages during the third quarter of 2011, it was determined that significant inputs and significant value drivers were observable in active markets, and the Corporation therefore reclassified these derivatives from out of Level 3 into Level 2. There were no other transfers between Level 2 and Level 3 during the years ended December 31, 2011 and 2010.

The following table presents the changes in Level 3 assets and liabilities measured at fair value on a recurring basis during the periods indicated.



Years ended December 31,	2011									2010
(Dollars in thousands)	Securities Available for Sale (1)			Derivative Assets / (Liabilities) (2)			Total			Securities Available for Sale (1)			Derivative Assets / (Liabilities) (2)		Total
Balance at beginning of period		$806			$435			$1,241			$1,065			$153		$1,218
Gains and losses (realized and unrealized):
Included in earnings (3)	(191		)	(1,263		)	(1,454		)	(417		)	282		(135		)
Included in other comprehensive income	272			—			272			158			—		158
Purchases	—			—			—			—			—		—
Issuances	—			—			—			—			—		—
Sales	—			—			—			—			—		—
Settlements	—			—			—			—			—		—
Transfers into Level 3	—			—			—			—			—		—
Transfers out of Level 3	—			828			828			—			—		—
Balance at end of period		$887			$—			$887			$806			$435		$1,241


(1)	During the periods indicated, Level 3 securities available for sale were comprised of two pooled trust preferred debt securities, in the form of collateralized debt obligations.

(2)

During the periods indicated, Level 3 derivative assets / liabilities consisted of forward loan commitments (interest rate lock commitments and commitments to sell fixed-rate residential mortgages). After evaluating forward loan commitments during the third quarter of 2011, it was determined that significant inputs and significant value drivers were observable in active markets, and the Corporation therefore reclassified these derivatives from out of Level 3 into Level 2.

(3)

Losses included in earnings for Level 3 securities available for sale consisted of credit-related impairment losses on the two Level 3 pooled trust preferred debt securities. Credit-related impairment losses of $191 thousand and $417 thousand were recognized in 2011 and 2010, respectively. The losses included in earnings for Level 3 derivative assets and liabilities, which were comprised of forward loan commitments (interest rate lock commitments and commitments to sell fixed-rate residential mortgages), were included in net gains on loan sales and commissions on loans originated for others in the Consolidated Statements of Income.

Items Recorded at Fair Value on a Nonrecurring Basis

Certain assets are measured 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 market accounting or write-downs of individual assets. The valuation methodologies used to measure these fair value adjustments are described above.

The following table presents the carrying value of certain assets measured at fair value on a nonrecurring basis during the year ended December 31, 2011.



(Dollars in thousands)	Carrying Value at December 31, 2011
	Level 1		Level 2		Level 3		Total
Assets:
Collateral dependent impaired loans		$—		$—		$10,391		$10,391
Loan servicing rights	—		—		765		765
Property acquired through foreclosure or repossession	—		—		1,758		1,758
Total assets at fair value on a nonrecurring basis		$—		$—		$12,914		$12,914

Collateral dependent impaired loans with a carrying value of $10.4 million at December 31, 2011 were subject to nonrecurring fair value measurement during the year ended December 31, 2011. As of December 31, 2011, the allowance for loan losses allocation on these loans amounted to $1.4 million.

During the year ended December 31, 2011, certain loan servicing rights were written down to their fair value resulting in an immaterial valuation allowance increase, which was recorded as a component of net gains on loan sales and commissions on loans originated for others in the Corporation’s Consolidated Statement of Income.

For the year ended December 31, 2011, property acquired through foreclosures or repossession with a fair value of $2.0 million was transferred from loans. Prior to the transfer, the assets whose fair value less costs to sell was less than the carrying value were written down to fair value through a charge to the allowance for loan losses. For the year ended December 31, 2011, valuation adjustments to reflect property acquired through foreclosure or repossession at fair value less cost to sell resulted in a charge to the allowance for loan losses of $328 thousand. Subsequent to foreclosures, valuations are updated periodically, and assets may be marked down further, reflecting a new cost basis. Subsequent valuation adjustments resulted in a charge to earnings of $642 thousand for the year ended December 31, 2011.

The following table presents the carrying value of certain assets measured at fair value on a nonrecurring basis during the year ended December 31, 2010.



(Dollars in thousands)	Carrying Value at December 31, 2010
	Level 1		Level 2		Level 3		Total
Assets:
Collateral dependent impaired loans		$—		$—		$4,242		$4,242
Mortgage loans held for sale	—		13,894		—		13,894
Property acquired through foreclosure or repossession	—		—		1,634		1,634
Total assets at fair value on a nonrecurring basis		$—		$13,894		$5,876		$19,770

Collateral dependent impaired loans with a carrying value of $4.2 million at December 31, 2010 were subject to nonrecurring fair value measurement during the year ended December 31, 2010. As of December 31, 2010, the allowance for loan losses allocation on these loans amounted to $1.2 million.

For the year ended December 31, 2010, the mortgage loans held for sale portfolio was written down to its fair value resulting in a valuation allowance increase of $123 thousand, which was recorded as a component of net gains on loan sales and commissions on loans originated for others in the Corporation’s Consolidated Statements of Income.

For the year ended December 31, 2010, property acquired through foreclosures or repossession with a fair value of $3.0 million was transferred from loans. Prior to the transfer, the assets whose fair value less costs to sell was less than the carrying value, were written down to fair value through a charge to the allowance for loan losses. For the year ended December 31, 2010, valuation adjustments to reflect property acquired through foreclosure or repossession at fair value less cost to sell resulted in a charge to the allowance for loan losses of $141 thousand. Subsequent to foreclosures, valuations are updated periodically, and assets may be marked down further, reflecting a new cost basis. Subsequent valuation adjustments resulted in a charge to earnings of $618 thousand for the year ended December 31, 2010.

Valuation of Other Financial Instruments

The methodologies for estimating the fair value of financial instruments that are measured at fair value on a recurring or nonrecurring basis are discussed above. The methodologies for other financial instruments are discussed below.

FHLBB Stock

No market exists for shares of the FHLBB. Subject to certain limitations, such stock may be redeemed at par upon termination of FHLBB membership and is, therefore, valued at par, which equals cost.

Loans

Fair values are estimated for categories of loans with similar financial characteristics. Loans are segregated by type and are then further segmented into fixed rate and adjustable rate interest terms to determine their fair value. The fair value of fixed rate commercial and consumer loans is calculated by discounting scheduled cash flows through the estimated maturity of the loan using interest rates offered at December 31, 2011 and 2010 that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Corporation's historical repayment experience. For residential mortgages, fair value is estimated by using quoted market prices for sales of similar loans on the secondary market, adjusted for servicing costs. The fair value of floating rate commercial and consumer loans approximates carrying value. The fair value of nonaccrual loans is calculated by discounting estimated cash flows, using a rate commensurate with the risk associated with the loan type or by other methods that give consideration to the value of the underlying collateral.

Deposit Liabilities

The fair value of demand deposits, NOW accounts, money market accounts and savings accounts is equal to the amount payable on demand as of December 31, 2011 and 2010. The discounted values of cash flows using the rates currently offered for deposits of similar remaining maturities were used to estimate the fair value of certificates of deposit.

Federal Home Loan Bank Advances

Rates currently available to the Corporation for advances with similar terms and remaining maturities are used to estimate fair value of existing advances.

Junior Subordinated Debentures

The fair value of the junior subordinated debentures is estimated using rates currently available to the Corporation for debentures with similar terms and maturities.

Securities Sold Under Agreements to Repurchase

The carrying amount of securities sold under repurchase agreements is estimated based on bid quotations received from brokers.

Standby Letters of Credit

The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties. Letters of credit contain provisions for fees, conditions and term periods that are consistent with customary market practices. Accordingly, the fair value amounts (considered to be the discounted present value of the remaining contractual fees over the unexpired commitment period) would not be material and therefore are not disclosed.

The following table presents the fair values of financial instruments:



(Dollars in thousands)	December 31, 2011				December 31, 2010
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial Assets:
Cash and cash equivalents		$87,020		$87,020		$92,736		$92,736
Mortgage loans held for sale	20,340		20,340		13,894		13,894
Securities available for sale	541,253		541,253		594,100		594,100
Securities held to maturity	52,139		52,499		—		—
FHLBB stock	42,008		42,008		42,008		42,008
Loans, net of allowance for loan losses	2,117,357		2,198,940		1,967,055		2,029,951
Accrued interest receivable	8,841		8,841		8,568		8,568
Bank-owned life insurance	53,783		53,783		51,844		51,844
Customer related interest rate swap contracts	4,513		4,513		3,690		3,690
Forward loan commitments (1)	1,864		1,864		602		602
Loan servicing rights (2)	765		937		757		913

Financial Liabilities:
Noninterest-bearing demand deposits		$339,809		$339,809		$228,437		$228,437
NOW accounts	257,031		257,031		241,974		241,974
Money market accounts	406,777		406,777		396,455		396,455
Savings accounts	243,904		243,904		220,888		220,888
Time deposits	878,794		891,378		948,576		962,608
FHLBB advances	540,450		577,315		498,722		533,802
Junior subordinated debentures	32,991		20,391		32,991		22,092
Securities sold under repurchase agreements	19,500		19,500		19,500		20,543
Other borrowings	258		258		3,859		3,859
Accrued interest payable	3,202		3,202		3,999		3,999
Customer related interest rate swap contracts	4,669		4,669		3,806		3,806
Interest rate risk management contract	1,802		1,802		1,098		1,098
Forward loan commitments (1)	2,580		2,580		167		167


(1)	Interest rate lock commitments written for our residential real estate mortgage loans that we intend to sell.


(2)	The carrying value of loan servicing rights is net of $172 thousand and $156 thousand reserves at December 31, 2011 and 2010, respectively. The estimated fair value does not include such adjustment.