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Fair Value Measurements
9 Months Ended
Sep. 30, 2016
Fair Value Disclosures [Abstract]  
Fair Value Measurements
Fair Value Measurements
The Corporation uses fair value measurements to record fair value adjustments on certain assets and liabilities and to determine fair value disclosures.  As of September 30, 2016 and December 31, 2015, securities available for sale, certain residential real estate mortgage loans held for sale, derivatives and the contingent consideration liability 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, certain residential real estate mortgage loans held for sale 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 has elected the fair value option for certain residential real estate mortgage loans held for sale to better match changes in fair value of the loans with changes in the fair value of the derivative loan sale contracts used to economically hedge them.

The aggregate principal amount of the residential real estate mortgage loans held for sale that were recorded at fair value was $43.8 million and $33.2 million, respectively, at September 30, 2016 and December 31, 2015. The aggregate fair value of these loans as of the same dates was $45.2 million and $34.0 million, respectively. As of September 30, 2016 and December 31, 2015, the aggregate fair value of residential real estate mortgage loans held for sale exceeded the aggregate principal amount by $1.3 million and $731 thousand, respectively.

There were no residential real estate mortgage loans held for sale 90 days or more past due as of September 30, 2016 and December 31, 2015.

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 which the fair value option was elected. Changes in fair values are reported as a component of mortgage banking revenues in the Consolidated Statements of Income.
(Dollars in thousands)
 
 
 
 
Three months
 
Nine months
Periods ended September 30,
2016
 
2015
 
2016

 
2015

Mortgage loans held for sale

$117

 

$490

 

$612

 

($79
)
Interest rate lock commitments
641

 
864

 
2,387

 
1,002

Commitments to sell mortgage loans
(665
)
 
(1,470
)
 
(2,845
)
 
(999
)
Total changes in fair value

$93

 

($116
)
 

$154

 

($76
)

Valuation Techniques
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. There were no Level 1 securities held at September 30, 2016 and December 31, 2015.

Level 2 securities include debt securities with quoted prices, which are traded less frequently than exchange-traded instruments. The fair value of these securities 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 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 states and political subdivisions, individual name issuer 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 Level 3 securities held at September 30, 2016 and December 31, 2015.

Mortgage Loans Held for Sale
The fair value of mortgage loans held for sale is estimated based on current market prices for similar loans in the secondary market and therefore are classified as Level 2 assets.

Collateral Dependent Impaired Loans
The fair value of collateral dependent loans that are deemed to be impaired is determined 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.

Loan Servicing Rights
Loans sold with the retention of servicing result in the recognition of loan servicing rights. Loan servicing rights are included in other assets in the Consolidated Balance Sheets and are amortized as an offset to mortgage banking revenues over the estimated period of servicing. Loan servicing rights are evaluated quarterly for impairment based on their fair value. Impairment exists if the carrying value exceeds the estimated fair value. Impairment is measured on an aggregated basis by stratifying the loan servicing rights based on homogeneous characteristics such as note rate and loan type. The fair value is estimated using an independent valuation model that estimates the present value of expected cash flows, incorporating assumptions for discount rates and prepayment rates. Any impairment is recognized through a valuation allowance and as a reduction to mortgage banking revenues. Loan servicing rights 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 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.

Derivatives
Interest rate swap and cap 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. The Corporation also 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. Although the Corporation has determined that the majority of the inputs used to value its interest rate swap and cap contracts fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with interest rate contracts and risk participation agreements utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Corporation and its counterparties. However, as of September 30, 2016 and December 31, 2015, the Corporation has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Corporation has classified its derivative valuations in their entirety as Level 2.

Fair value measurements of forward loan commitments (interest rate lock commitments and commitments to sell residential real estate mortgages) are estimated based on current market prices for similar assets in the secondary market and therefore are classified as Level 2 assets.

Contingent Consideration Liability
A contingent consideration liability was recognized upon the completion of the Halsey Associates, Inc. (“Halsey”) acquisition on August 1, 2015 and represents the estimated present value of future earn-outs to be paid based on the future revenue growth of the acquired business during the 5-year period following the acquisition.

The fair value measurement is based upon unobservable inputs, therefore, the contingent liability is classified within Level 3 of the fair value hierarchy. The unobservable inputs include probability estimates regarding the likelihood of achieving revenue growth targets and the discount rates utilized the discounted cash flow calculations applied to the estimates earn-outs to be paid. The discount rates used ranged from 3% to 4%. The contingent consideration liability is remeasured to fair value at each reporting period taking into consideration changes in those unobservable inputs. Changes in the fair value of the contingent consideration liability are included in noninterest expenses in the Consolidated Statements of Income.

The fair value of the contingency represents the estimated price to transfer the liability between market participants at the measurement date under current market conditions.

Items Recorded at Fair Value on a Recurring Basis
The following tables present the balances of assets and liabilities reported at fair value on a recurring basis:
(Dollars in thousands)
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
September 30, 2016
 
 
 
Assets:
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$75,484

 

$—

 

$75,484

 

$—

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
442,687

 

 
442,687

 

Obligations of states and political subdivisions
18,396

 

 
18,396

 

Individual name issuer trust preferred debt securities
25,684

 

 
25,684

 

Corporate bonds
2,005

 

 
2,005

 

Mortgage loans held for sale
45,162

 

 
45,162

 

Derivative assets (1)
24,847

 

 
24,847

 

Total assets at fair value on a recurring basis

$634,265

 

$—

 

$634,265

 

$—

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities (2)

$26,800

 

$—

 

$26,800

 

$—

Contingent consideration liability (3)
2,047

 

 

 
2,047

Total liabilities at fair value on a recurring basis

$28,847

 

$—

 

$26,800

 

$2,047


(1)
Derivative assets include interest rate risk management agreements, interest rate swap contracts with customers, risk participation-out agreements and forward loan commitments and are included in other assets in the Consolidated Balance Sheets.
(2)
Derivative liabilities include mirror swaps with counterparties, risk participation-in agreements and forward loan commitments and are included in other liabilities in the Consolidated Balance Sheets.
(3)
The contingent consideration liability is included in other liabilities in the Consolidated Balance Sheets.

(Dollars in thousands)
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
December 31, 2015
 
 
 
Assets:
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
Obligations of U.S. government-sponsored enterprises

$77,015

 

$—

 

$77,015

 

$—

Mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises
234,856

 

 
234,856

 

Obligations of states and political subdivisions
36,080

 

 
36,080

 

Individual name issuer trust preferred debt securities
25,138

 

 
25,138

 

Corporate bonds
1,955

 

 
1,955

 

Mortgage loans held for sale
33,969

 

 
33,969

 

Derivative assets (1)
9,490

 

 
9,490

 

Total assets at fair value on a recurring basis

$418,503

 

$—

 

$418,503

 

$—

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities (2)

$10,347

 

$—

 

$10,347

 

$—

Contingent Consideration Liability (3)
2,945

 

 

 
2,945

Total liabilities at fair value on a recurring basis

$13,292

 

$—

 

$10,347

 

$2,945


(1)
Derivative assets include interest rate risk management agreements, interest rate swap contracts with customers, risk participation-out agreements and forward loan commitments and are included in other assets in the Consolidated Balance Sheets.
(2)
Derivative liabilities include mirror swaps with counterparties, risk participation-in agreements and forward loan commitments and are included in other liabilities in the Consolidated Balance Sheets.
(3)
The contingent consideration liability is included 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 nine months ended September 30, 2016 and 2015, there were no transfers in and/or out of Level 1, 2 or 3.

The following table presents the change in the contingent consideration liability, a Level 3 liability measured at fair value on a recurring basis, during the periods indicated:
(Dollars in thousands)
 
 
 
 
 
 
 
 
Three months
 
Nine months
Periods ended September 30,
2016
 
2015
 
2016
 
2015
Balance at beginning of period

$2,986

 

$—

 

$2,945

 

$—

Initial recognition

 
2,904

 

 
2,904

Change in fair value
(939
)
 
16

 
(898
)
 
16

Payments

 

 

 

Balance at end of period

$2,047

 

$2,920

 

$2,047

 

$2,920






Items Recorded at Fair Value on a Nonrecurring Basis
The following table presents the carrying value of assets held at September 30, 2016, which were written down to fair value during the nine months ended September 30, 2016:
(Dollars in thousands)
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
 
 
Assets:
 
 
 
 
 
 
 
Collateral dependent impaired loans

$5,726

 

$—

 

$—

 

$5,726

Loan servicing rights
3,314

 

 

 
3,314

Property acquired through foreclosure or repossession
575

 

 

 
575

Total assets at fair value on a nonrecurring basis

$9,615

 

$—

 

$—

 

$9,615



The allowance for loan losses on collateral dependent impaired loans amounted to $1.0 million at September 30, 2016.

The following table presents the carrying value of assets held at December 31, 2015, which were written down to fair value during the year ended December 31, 2015:
(Dollars in thousands)
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
 
 
Assets:
 
 
 
 
 
 
 
Collateral dependent impaired loans

$10,545

 

$—

 

$—

 

$10,545

Property acquired through foreclosure or repossession
270

 

 

 
270

Total assets at fair value on a nonrecurring basis

$10,815

 

$—

 

$—

 

$10,815


The allowance for loan losses on collateral dependent impaired loans amounted to $2.4 million at December 31, 2015.

The following tables present valuation techniques and unobservable inputs for 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)
Fair Value
Valuation Technique
Unobservable Input
Range of Inputs Utilized
(Weighted Average)
September 30, 2016
Collateral dependent impaired loans

$5,726

Appraisals of collateral
Discount for costs to sell
0% - 20% (10%)
 
 
 
Appraisal adjustments (1)
0% - 15% (14%)
 
 
 
 
 
Loan servicing rights

$3,314

Discounted Cash Flow
Discount rates
10% - 14% (11%)
 
 
 
Prepayment rates
13% - 24% (16%)
 
 
 
 
 
Property acquired through foreclosure or repossession

$575

Appraisals of collateral
Discount for costs to sell
10%
 
 
 
Appraisal adjustments (1)
6% - 15% (13%)
(1)
Management may adjust appraisal values to reflect market value declines or other discounts resulting from its knowledge of the property.

(Dollars in thousands)
Fair Value
Valuation Technique
Unobservable Input
Range of Inputs Utilized
(Weighted Average)
December 31, 2015
Collateral dependent impaired loans

$10,545

Appraisals of collateral
Discount for costs to sell
0% - 20% (2%)
 
 
 
 
 
Property acquired through foreclosure or repossession

$270

Appraisals of collateral
Discount for costs to sell
12%
 
 
 
Appraisal adjustments (1)
32%
(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 the measurement date 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)
 
 
 
 
 
 
 
 
 
September 30, 2016
Carrying Amount
 
Total
Fair Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Financial Assets:
 
 
 
 
 
 
 
 
 
Securities held to maturity

$16,848

 

$17,492

 

$—

 

$17,492

 

$—

Loans, net of allowance for loan losses
3,155,706

 
3,190,240

 

 

 
3,190,240

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Time deposits

$913,649

 

$916,994

 

$—

 

$916,994

 

$—

FHLBB advances
671,615

 
685,238

 

 
685,238

 

Junior subordinated debentures
22,681

 
16,732

 

 
16,732

 



(Dollars in thousands)
 
 
 
 
 
 
 
 
 
December 31, 2015
Carrying Amount
 
Total
Fair Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Financial Assets:
 
 
 
 
 
 
 
 
 
Securities held to maturity

$20,023

 

$20,516

 

$—

 

$20,516

 

$—

Loans, net of allowance for loan losses
2,986,058

 
3,004,782

 

 

 
3,004,782

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Time deposits

$833,898

 

$834,574

 

$—

 

$834,574

 

$—

FHLBB advances
378,973

 
388,275

 

 
388,275

 

Junior subordinated debentures
22,681

 
16,468

 

 
16,468