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 June 30, 2014 and December 31, 2013, securities available for sale, residential real estate mortgage loans held for sale and derivatives were 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.

Fair Value Option Election

GAAP 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. The Corporation elected the fair value option for its portfolio of residential real estate mortgage loans held for sale to reduce certain timing differences and better match changes in fair value of the loans with changes in the fair value of the derivative loan sale contracts use to economically hedge them.

The aggregate principal amount of the residential real estate mortgage loans held for sale was $21.8 million and $11.5 million, respectively, at June 30, 2014 and December 31, 2013. The aggregate fair value of these loans as of the same dates was $22.4 million and $11.6 million, respectively. As of June 30, 2014 and December 31, 2013, the aggregate fair value of residential real estate mortgage loans held for sale exceeded the aggregate principal amount by $644 thousand and $181 thousand, respectively.

There were no residential real estate mortgage loans held for sale 90 days or more past due at June 30, 2014 and December 31, 2013.

The following table presents the changes in fair value related to mortgage loans held for sale, interest rate lock commitments and commitments to sell 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)
	Three Months						Six months
Periods ended June 30,	2014			2013			2014			2013
Mortgage loans held for sale		$387			($898	)		$463			($1,959	)
Interest rate lock commitments	326			(855		)	603			(1,773		)
Commitments to sell	(753		)	1,753			(1,066		)	3,724
Total changes in fair value		($40	)		$—			$—			($8	)

Items Measured at Fair Value on a Recurring Basis

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. There were no Level 1 securities held at June 30, 2014 and December 31, 2013.

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, obligations of state and political subdivisions, trust preferred debt securities and corporate bonds.

Securities not actively traded whose fair value is determined through the use of cash flows utilizing inputs that are unobservable are classified as Level 3. There were no such securities held at June 30, 2014 and December 31, 2013.

Mortgage Loans Held for Sale

The fair values of mortgage loans held for sale are generally estimated based on secondary market rates offered for loans with similar characteristics. When secondary market information exists, these loans are classified as Level 2. 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 changes 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. There were no level 3 mortgage loans held for sale held at June 30, 2014 and December 31, 2013.

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 residential real estate 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. There were no level 3 forward loan commitments held at June 30, 2014 and December 31, 2013.

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. Such collateral primarily consists of real estate and, to a lesser extent, other business assets. For collateral dependent loans for which repayment is dependent on the sale of the collateral, management adjusts the fair value for estimated costs to sell. For collateral dependent loans for which repayment is dependent on the operation of the collateral, such as accruing troubled debt restructured loans, estimated costs to sell are not incorporated into the measurement. Management may also 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 in the Consolidated Balance Sheets is adjusted to fair value less costs to sell upon transfer out of loans through a charge to the 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 may adjust 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
June 30, 2014	Level 1		Level 2		Level 3
Assets:
Securities available for sale:
Obligations of U.S. government-sponsored enterprises		$—		$10,012		$—		$10,012
Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises	—		228,285		—		228,285
Obligations of states and political subdivisions	—		56,391		—		56,391
Individual name issuer trust preferred debt securities	—		26,635		—		26,635
Corporate bonds	—		6,255		—		6,255
Mortgage loans held for sale	—		22,407		—		22,407
Derivative assets (1):
Interest rate swap contracts with customers	—		3,159		—		3,159
Forward loan commitments	—		1,014		—		1,014
Total assets at fair value on a recurring basis		$—		$354,158		$—		$354,158
Liabilities:
Derivative liabilities (1):
Mirror swap contracts with counterparties		$—		$3,226		$—		$3,226
Interest rate risk management swap contracts	—		773		—		773
Forward loan commitments	—		1,658		—		1,658
Total liabilities at fair value on a recurring basis		$—		$5,657		$—		$5,657


(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, 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
Obligations of states and political subdivisions	—		62,859		—		62,859
Individual name issuer trust preferred debt securities	—		24,684		—		24,684
Pooled trust preferred debt securities	—		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 counterparties		$—		$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.

It is the Corporation’s policy to review and reflect transfers between Levels as of the financial statement reporting date. During the six months ended June 30, 2014 and 2013, there were no transfers in and/or out of Level 1, 2 or 3.

There were no Level 3 assets and liabilities measured at fair value on a recurring basis during the three and six months ended June 30, 2014.

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



Three months ended June 30,	2013
(Dollars in thousands)	Securities Available for Sale (1)			Mortgage Loans Held for Sale (2)			Derivative Assets / (Liabilities) (3)			Total
Balance at beginning of period		$404		7,955				$48			$8,407
Gains and losses (realized and unrealized):
Included in earnings (4)	—			48			(48		)	—
Included in other comprehensive income	(7		)	—			—			(7		)
Purchases	—			—			—			—
Issuances	—			(5,176		)	—			(5,176		)
Sales	—			(2,827		)	—			(2,827		)
Settlements	—			—			—			—
Transfers into Level 3	—			—			—			—
Transfers out of Level 3	—			—			—			—
Balance at end of period		$397			$—			$—			$397



Six months ended June 30,	2013
(Dollars in thousands)	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
Gains and losses (realized and unrealized):
Included in earnings (4)	(2,772		)	(150	)	142			(2,780		)
Included in other comprehensive income	2,459			—		—			2,459
Purchases	—			—		—			—
Issuances	—			12,692		—			12,692
Sales	—			(22,355	)	—			(22,355		)
Settlements	(133		)	—		—			(133		)
Transfers into Level 3	—			—		—			—
Transfers out of Level 3	—			—		—			—
Balance at end of period		$397		—			$—			$397


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


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


(3)	Level 3 derivative assets / liabilities consisted of forward loan commitments (interest rate lock commitments and commitments to sell residential real estate 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 Income Statement. 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.

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 summarizes such assets, which were written down to fair value during the six months ended June 30, 2014:



(Dollars in thousands)	June 30, 2014
	Level 1		Level 2		Level 3		Total
Collateral dependent impaired loans		$—		$—		$6,643		$6,643
Property acquired through foreclosure or repossession	—		—		492		492
Total assets at fair value on a nonrecurring basis		$—		$—		$7,135		$7,135

The allowance for loan losses on collateral dependent impaired loans amounted to $912 thousand at June 30, 2014.

The following table summarizes such assets, which were written down to fair value during the year ended December 31, 2013:



(Dollars in thousands)	December 31, 2013
	Level 1		Level 2		Level 3		Total
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 allocation on collateral dependent impaired loans amounted to $453 thousand at December 31, 2013.

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 for the dates indicated.



(Dollars in thousands)	June 30, 2014
	Fair Value		Valuation Technique	Unobservable Input	Range of Inputs Utilized (Weighted Average)
Collateral dependent impaired loans		$6,643	Appraisals of collateral	Discount for costs to sell	10% - 25% (11%)
				Appraisal adjustments (1)	0% - 40% (5%)
Property acquired through foreclosure or repossession		$492	Appraisals of collateral	Discount for costs to sell	0% - 10% (7%)
				Appraisal adjustments (1)	9% - 22% (15%)



(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%)


(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 June 30, 2014 and December 31, 2013 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 market prices for sales of similar loans on the secondary market. The fair value of floating rate commercial and consumer loans approximates carrying value. 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. 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. FHLBB 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. 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 and accrued interest payable.



(Dollars in thousands)					Fair Value Measurements
June 30, 2014	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
Financial Assets:
Securities held to maturity		$27,814		$28,618		$—		$28,618		$—
Loans, net of allowance for loan losses	2,553,855		2,604,038		—		—		2,604,038
Loan servicing rights	2,868		3,188		—		—		3,188

Financial Liabilities:
Time deposits		$796,255		$798,437		$—		$798,437		$—
FHLBB advances	322,056		337,519		—		337,519		—
Junior subordinated debentures	22,681		17,704		—		17,704		—



(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	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		—