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, 2013 and 2012, securities available for sale, residential real estate 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.

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.

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 and corporate bonds.

Prior to December 31, 2013, Level 3 securities were comprised of pooled trust preferred debt securities, in the form of collateralized debt obligations, which were not actively traded. See Note 4 for additional disclosures regarding these pooled trust preferred debt securities. The Corporation had concluded that a low level of activity for its Level 3 pooled trust preferred debt securities indicated that quoted market prices were 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 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 securities. The weighting was then used to determine an overall fair value of the securities.

Mortgage Loans Held for Sale

Washington Trust has elected to carry newly originated closed residential real estate mortgage loans held for sale at fair value pursuant to ASC 825. Mortgage loans held for sale fair values are classified as Level 2 and are estimated based on secondary markets rates offered for loans with similar characteristics. In certain cases when quoted market prices are not available, fair value is determined by utilizing a discounted cash flow analysis and these assets are classified as Level 3. 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.

The aggregate principal amount of the residential real estate mortgage loans held for sale was $11.5 million and $48.4 million, respectively, at December 31, 2013 and 2012. The aggregate fair value of this portfolio was $11.6 million and $50.1 million, respectively, at December 31, 2013 and 2012. As of December 31, 2013 and 2012, the difference between the aggregate fair value and the aggregate principal amount of mortgage loans held for sale amounted to $181 thousand and $1.7 million, respectively. There were no mortgage loans held for sale 90 days or more past due as of December 31, 2013 and 2012.

The following table presents the changes in fair value related to mortgage loans held for sale, commitments to originate fixed-rate residential real estate mortgage loans to be sold and commitments to sell fixed-rate residential real estate mortgage loans for the periods indicated. Changes in fair values are reported as a component of net gains on loan sales and commissions on loans originated for others in the Consolidated Statements of Income.



(Dollars in thousands)
Years ended December 31,	2013			2012			2011
Mortgage loans held for sale		($1,505	)		$970			$716
Commitments to originate	(2,121		)	649			1,968
Commitments to sell	3,618			(1,611		)	(3,119		)
Total changes in fair value		($8	)		$8			($435	)

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. Additionally, in accordance with fair value measurement guidance in ASU 2011-04, Washington Trust has made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

Level 2 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. In certain cases when quoted market prices are not available, fair value is determined by utilizing a discounted cash flow analysis and these assets are classified as Level 3.

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 included in other assets on the Consolidated Balance Sheets is adjusted to fair value less costs to sell upon transfer out of loans through a charge to allowance for loan losses. Subsequently, it is carried at the lower of carrying value or fair value less costs to sell. Such subsequent valuation charges are charged through earnings. Fair value is generally based upon 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.

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, 2013	Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Obligations of U.S. government-sponsored enterprises		$—		$55,115		$—		$55,115
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	—		238,355		—		238,355
States and political subdivisions	—		62,859		—		62,859
Trust preferred securities:
Individual name issuers	—		24,684		—		24,684
Collateralized debt obligations	—		547		—		547
Corporate bonds	—		11,343		—		11,343
Mortgage loans held for sale	—		11,636		—		11,636
Derivative assets (1)
Interest rate swap contracts with customers	—		2,733		—		2,733
Forward loan commitments	—		402		—		402
Total assets at fair value on a recurring basis		$—		$407,674		$—		$407,674
Liabilities:
Derivative liabilities (1)
Mirror swap contracts with customers		$—		$2,703		$—		$2,703
Interest rate risk management swap contracts	—		1,012		—		1,012
Forward loan commitments	—		583		—		583
Total liabilities at fair value on a recurring basis		$—		$4,298		$—		$4,298


(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, 2012	Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Obligations of U.S. government-sponsored enterprises		$—		$31,670		$—		$31,670
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	—		231,233		—		231,233
States and political subdivisions	—		72,620		—		72,620
Trust preferred securities:
Individual name issuers	—		24,751		—		24,751
Collateralized debt obligations	—		—		843		843
Corporate bonds	—		14,381		—		14,381
Mortgage loans held for sale	—		40,243		9,813		50,056
Derivative assets (1)
Interest rate swap contracts with customers	—		3,851		—		3,851
Forward loan commitments	—		2,469		44		2,513
Total assets at fair value on a recurring basis		$—		$421,218		$10,700		$431,918
Liabilities:
Derivative liabilities (1)
Mirror swap contracts with customers		$—		$3,952		$—		$3,952
Interest rate risk management swap contracts	—		1,619		—		1,619
Forward loan commitments	—		4,005		186		4,191
Total liabilities at fair value on a recurring basis		$—		$9,576		$186		$9,762


(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, 2013 and 2012. The Corporation utilized a broker quote to value its pooled trust preferred security at December 31, 2013. As a result, this security was reclassified out of Level 3 and into Level 2. See Note 4 for additional disclosure regarding this pooled trust preferred security. There were no other transfers between Level 2 and Level 3 during the years ended during the years ended December 31, 2013 and 2012.

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,	2013												2012
(Dollars in thousands)	Securities Available for Sale (1)			Mortgage Loans Held for Sale (2)			Derivative Assets / (Liabilities) (3)			Total			Securities Available for Sale (1)			Mortgage Loans Held for Sale (2)		Derivative Assets / (Liabilities) (3)			Total
Balance at beginning of period		$843			$9,813			($142	)		$10,514			$887			$—		$—			$887
Gains and losses (realized and unrealized):
Included in earnings (4)	(3,489		)	(150		)	142			(3,497		)	(221		)	—		—			(221		)
Included in other comprehensive income	3,326			—			—			3,326			177			—		—			177
Purchases	—			—			—			—			—			—		—			—
Issuances	—			12,692			—			12,692			—			9,813		(142		)	9,671
Sales	—			(22,355		)	—			(22,355		)	—			—		—			—
Settlements	(133		)	—			—			(133		)	—			—		—			—
Transfers into Level 3	—			—			—			—			—			—		—			—
Transfers out of Level 3	(547		)	—			—			(547		)	—			—		—			—
Balance at end of period		$—			$—			$—			$—			$843			$9,813		($142	)		$10,514


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


(2)	During the periods indicated, Level 3 mortgage loans held for sale consisted of certain mortgage loans whose fair value was determined utilizing a discounted cash flow analysis.


(3)	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) whose fair value was determined utilizing a discounted cash flow analysis.

(4)

Losses included in earnings for Level 3 securities available for sale were included in net impairment losses recognized in earnings in the Consolidated Statements of Income. Losses included in earnings for Level 3 mortgage loans held for sale and derivative assets and liabilities were included in net gains on loan sales and commissions on loans originated for others in the Consolidated Statements of Income.

The Corporation had no Level 3 assets and liabilities measured at fair value on a recurring basis at December 31, 2013. The following table presents additional quantitative information about assets measured at fair value on a recurring basis for which the Corporation utilized Level 3 inputs to determine fair value at December 31, 2012.



(Dollars in thousands)
	Fair Value			Valuation Technique	Unobservable Input	Range of Inputs Utilized (Weighted Average)
Trust preferred securities:
Collateralized debt obligations		$843		Discounted Cash Flow	Discount Rate	16.75%
					Cumulative Default %	3.3% - 100% (25.7%)
					Loss Given Default %	85% - 100% (90.9%)

Mortgage loans held for sale		$9,813		Discounted Cash Flow	Interest Rate	2.875% - 4.95% (3.71%)
					Credit Risk Adjustment	0.25%

Forward loan commitments - assets		$44		Discounted Cash Flow	Interest Rate	3.25% - 3.875% (3.56%)
					Credit Risk Adjustment	0.25%

Forward loan commitments - liabilities		($186	)	Discounted Cash Flow	Interest Rate	3.25% - 3.875% (3.69%)
					Credit Risk Adjustment	0.25%

Trust Preferred Debt Securities in the Form of Collateralized Debt Obligations

Given the low level of market activity for trust preferred securities in the form of collateralized debt obligations, the discount rate utilized in the fair value measurement was derived by analyzing current market yields for trust preferred securities of individual name issuers in the financial services industry. Adjustments were then made for credit and structural differences between these types of securities. There is an inverse correlation between the discount rate and the fair value measurement. When the discount rate increases, the fair value decreases.

Other significant unobservable inputs to the fair value measurement of collateralized debt obligations included prospective defaults and recoveries. The cumulative default percentage represents the lifetime defaults assumed, excluding currently defaulted collateral and including all performing and currently deferring collateral. As a result, the cumulative default percentage also reflects assumptions of the possibility of currently deferring collateral curing and becoming current. The loss given default percentage represents the percentage of current and projected defaults assumed to be lost. There is an inverse correlation between the cumulative default and loss given default percentages and the fair value measurement. When the default percentages increase, the fair value decreases.

Mortgage Loans Held for Sale and Derivative Assets / Liabilities

Significant unobservable inputs to the fair market value measurement for certain mortgage loans held for sale and certain forward loan commitments include interest rate and credit risk. Interest rates approximate the Corporation’s current origination rates for similar loans. Credit risk approximates the Corporation’s current loss exposure factor for similar loans.

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, 2013.



(Dollars in thousands)	Carrying Value at December 31, 2013
	Level 1		Level 2		Level 3		Total
Assets:
Collateral dependent impaired loans		$—		$—		$11,177		$11,177
Property acquired through foreclosure or repossession	—		—		435		435
Total assets at fair value on a nonrecurring basis		$—		$—		$11,612		$11,612

The allowance for loan losses on the collateral dependent impaired loans included above amounted to $453 thousand at December 31, 2013.

The following table presents the carrying value of certain assets measured at fair value on a nonrecurring basis during the year ended December 31, 2012.



(Dollars in thousands)	Carrying Value at December 31, 2012
	Level 1		Level 2		Level 3		Total
Assets:
Collateral dependent impaired loans		$—		$—		$9,550		$9,550
Property acquired through foreclosure or repossession	—		—		1,073		1,073
Total assets at fair value on a nonrecurring basis		$—		$—		$10,623		$10,623

The allowance for loan losses on the collateral dependent impaired loans included above amounted to $2.0 million at December 31, 2012.

The following tables present additional quantitative information about assets measured at fair value on a nonrecurring basis for which the Corporation has utilized Level 3 inputs to determine fair value.



(Dollars in thousands)	December 31, 2013
	Fair Value		Valuation Technique	Unobservable Input	Range of Inputs Utilized (Weighted Average)
Collateral dependent impaired loans		$11,177	Appraisals of collateral	Discount for costs to sell	1% - 45% (11%)
				Appraisal adjustments (1)	0% - 50% (2%)
Property acquired through foreclosure or repossession		$435	Appraisals of collateral	Discount for costs to sell	2% - 10% (9%)
				Appraisal adjustments (1)	0% - 22% (13%)



(Dollars in thousands)	December 31, 2012
	Fair Value		Valuation Technique	Unobservable Input	Range of Inputs Utilized (Weighted Average)
Collateral dependent impaired loans		$9,550	Appraisals of collateral	Discount for costs to sell	0% - 50% (11%)
				Appraisal adjustments (1)	0% - 27% (18%)
Property acquired through foreclosure or repossession		$1,073	Appraisals of collateral	Discount for costs to sell	0% - 10% (5%)
				Appraisal adjustments (1)	15% - 34% (21%)


(1)	Management may adjust appraisal values to reflect market value declines or other discounts resulting from its knowledge of the property.

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.

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, 2013 and 2012 that reflect the credit and interest rate risk inherent in the loan. The fair value of floating rate commercial and consumer loans approximates carrying value. The estimate of maturity is based on the Corporation’s historical repayment experience. For residential mortgages, fair value is estimated by using market prices for sales of similar loans in the secondary market. Fair value for impaired loans is estimated using a discounted cash flow method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or if the loan is collateral dependent, at the fair value of the collateral less costs to sell. Loans are classified within Level 3 of the fair value hierarchy.

Time Deposits

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 time deposits. Time deposits are classified within Level 2 of the fair value hierarchy.

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. FHLB advances are categorized as Level 2.

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. Junior subordinated debentures are categorized as Level 2.

The following tables present the carrying amount, estimated fair value and placement in the fair value hierarchy of the Corporation’s financial instruments as of December 31, 2013 and 2012. The tables exclude financial instruments for which the carrying value approximates fair value. Financial assets for which the fair value approximates carrying value include cash and cash equivalents, FHLBB stock, accrued interest receivable and bank-owned life insurance. Financial liabilities for which the fair value approximates carrying value include non-maturity deposits, other borrowings and accrued interest payable.



(Dollars in thousands)					Fair Value Measurements
December 31, 2013	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Securities held to maturity		$29,905		$29,865		$—		$29,865		$—
Loans, net of allowance for loan losses	2,434,998		2,479,527		—		—		2,479,527
Loan servicing rights (1)	2,698		2,767		—		—		2,767

Financial Liabilities:
Time deposits		$790,762		$797,748		$—		$797,748		$—
FHLBB advances	288,082		308,317		—		308,317		—
Junior subordinated debentures	22,681		16,282		—		16,282		—


(1)	The carrying value of loan servicing rights is net of $69 thousand in reserves as of December 31, 2013. The estimated fair value does not include such adjustment.



(Dollars in thousands)					Fair Value Measurements
December 31, 2012	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Securities held to maturity		$40,381		$41,420		$—		$41,420		$—
Loans, net of allowance for loan losses	2,263,130		2,350,153		—		—		2,350,153
Loan servicing rights (1)	1,110		1,275		—		—		1,275

Financial Liabilities:
Time deposits		$870,232		$879,705		$—		$879,705		$—
FHLBB advances	361,172		392,805		—		392,805		—
Junior subordinated debentures	32,991		23,371		—		23,371		—


(1)	The carrying value of loan servicing rights is net of $165 thousand in reserves as of December 31, 2012. The estimated fair value does not include such adjustment.