Note 18. Fair Value of Financial Instruments

The Financial Accounting Standards Board (FASB) defines fair value as the exchange price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The FASB’s guidance also established a fair value hierarchy that prioritizes the inputs to these valuation techniques used to measure fair value, giving preference to quoted prices in active markets for identical assets or liabilities (level 1) and the lowest priority to unobservable inputs such as a reporting entity’s own data (level 3). Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical assets or liabilities in markets that are not active, observable inputs other than quoted prices, such as interest rates and yield curves, and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Fair Value of Assets Measured on a Recurring Basis

The following table presents for each of the fair-value hierarchy levels the Company’s financial assets and liabilities that are measured at fair value (in thousands) on a recurring basis in the consolidated balance sheets.


	December 31, 2015
(in thousands)	Level 1		Level 2		Total
Assets
Available for sale debt securities:
U.S. Treasury and government agency securities	$	—	$	134	$	134
Municipal obligations		—		39,607		39,607
Corporate debt securities		—		3,500		3,500
Mortgage-backed securities		—		1,758,373		1,758,373
Collateralized mortgage obligations		—		289,033		289,033
Equity securities		2,757		—		2,757

Total available for sale securities		2,757		2,090,647		2,093,404

Derivative assets (1)		—		23,251		23,251

Total recurring fair value measurements – assets	$	2,757	$	2,113,898	$	2,116,655

Liabilities
Derivative liabilities (1)	$	—	$	23,968	$	23,968

Total recurring fair value measurements – liabilities	$	—	$	23,968	$	23,968

(1)

For further disaggregation of derivative assets and liabilities, see Note 9 – Derivatives


	December 31, 2014
(in thousands)	Level 1		Level 2		Total

Assets
Available for sale debt securities:
U.S. Treasury and government agency securities	$	—	$	300,508	$	300,508
Municipal obligations		—		14,176		14,176
Corporate debt securities		—		3,500		3,500
Mortgage-backed securities		—		1,245,564		1,245,564
Collateralized mortgage obligations		—		86,864		86,864
Equity securities		9,553		—		9,553

Total available for sale securities		9,553		1,650,612		1,660,165

Derivative assets (1)		—		19,432		19,432

Total recurring fair value measurements – assets	$	9,553	$	1,670,044	$	1,679,597

Liabilities
Derivative liabilities (1)	$	—	$	20,860	$	20,860

Total recurring fair value measurements – liabilities	$	—	$	20,860	$	20,860

(1)

For further disaggregation of derivative assets and liabilities, see Note 9 – Derivatives

Securities classified as level 1 within the valuation hierarchy include U.S. Treasury securities and certain other debt and equity securities. Level 2 classified securities include obligations of U.S. Government agencies and U.S. Government-sponsored agencies, residential mortgage-backed securities, collateralized mortgage obligations that are issued or guaranteed by U.S. government agencies, and state and municipal bonds. The level 2 fair value measurements for investment securities are obtained quarterly from a third-party pricing service that uses industry-standard pricing models. Substantially all of the model inputs were observable in the marketplace or can be supported by observable data.

The Company invests only in high quality securities of investment grade quality with a targeted duration, for the overall portfolio, generally between two to five. Company policies generally limit investments to agency securities and municipal securities determined to be investment grade according to an internally generated score which generally includes a rating of not less than “Baa” or its equivalent by a nationally recognized statistical rating agency. There were no transfers between valuation hierarchy levels during the periods shown.

The fair value of derivative financial instruments, which are predominantly interest rate swaps, is obtained from a third-party pricing service that uses an industry-standard discounted cash flow model that relies on inputs, LIBOR swap curves, Overnight Index swap rate curves, and Eurodollar futures contracts. To comply with the accounting guidance, credit valuation adjustments are incorporated in the fair values to appropriately reflect nonperformance risk for both the Company and the counterparties. Although the Company has determined that the majority of the inputs used to value the derivative instruments fall within level 2 of the fair value hierarchy, the credit value adjustments utilize level 3 inputs, such as estimates of current credit spreads. The Company has determined that the impact of the credit valuation adjustments is not significant to the overall valuation of these derivatives. As a result, the Company has classified its derivative valuations in their entirety in level 2 of the fair value hierarchy. The Company’s policy is to measure counterparty credit risk quarterly for all derivative instruments subject to master netting arrangements consistent with how market participants would price the net risk exposure at the measurement date.

The Company also has certain derivative instruments associated with the Bank’s mortgage-banking activities. These derivative instruments include interest rate lock commitments on prospective residential mortgage loans and forward commitments to sell these loans to investors on a best efforts delivery basis. The fair value of these derivative instruments is measured using observable market prices for similar instruments and is classified as a level 2 measurement.

Fair Value of Assets Measured on a Nonrecurring Basis

Certain assets and liabilities are measured at fair value on a nonrecurring basis. Collateral-dependent impaired loans are level 2 assets measured at the fair value of the underlying collateral based on third-party appraisals that take into consideration market-based information such as recent sales activity for similar assets in the property’s market.

Other real estate owned, including both foreclosed property and surplus banking property, are level 3 assets that are adjusted to fair value, less estimated selling costs, upon transfer to other real estate owned. Subsequently, other real estate owned is carried at the lower of carrying value or fair value less estimated selling costs. Fair values are determined by sales agreement or third-party appraisals as discounted for estimated selling costs, information from comparable sales, and marketability of the property.

The following table presents for each of the fair value hierarchy levels the Company’s financial assets that are measured at fair value on a nonrecurring basis:


	December 31, 2015
(in thousands)	Level 1		Level 2		Level 3		Total
Collateral dependent impaired loans	$	—	$	93,602	$	—	$	93,602
Other real estate owned		—		—		17,206		17,206

Total nonrecurring fair value measurements	$	—	$	93,602	$	17,206	$	110,808


	December 31, 2014
(in thousands)	Level 1		Level 2		Level 3		Total
Collateral dependent impaired loans	$	—	$	30,204	$	—	$	30,204
Other real estate owned		—		—		29,715		29,715

Total nonrecurring fair value measurements	$	—	$	30,204	$	29,715	$	59,919

Accounting guidance from the FASB requires the disclosure of estimated fair value information about certain on- and off-balance sheet financial instruments, including those financial instruments that are not measured and reported at fair value on a recurring basis. The significant methods and assumptions used by the Company to estimate the fair value of financial instruments are discussed below.

Cash, Short-Term Investments and Federal Funds Sold – For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

Securities – The fair value measurement for securities available for sale was discussed earlier in the note. The same measurement techniques were applied to the valuation of securities held to maturity.

Loans, Net – The fair value measurement for certain impaired loans was discussed earlier in the note. For the remaining portfolio, fair values were generally determined by discounting scheduled cash flows using discount rates determined with reference to current market rates at which loans with similar terms would be made to borrowers with similar credit quality.

Loans Held For Sale – These loans are recorded at fair value and carried at the lower of cost or market. The carrying amount is considered a reasonable estimate of fair value.

Deposits – The accounting guidance requires that the fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits and interest-bearing checking and savings accounts, be assigned fair values equal to amounts payable upon demand (carrying amounts). The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Securities Sold under Agreements to Repurchase, Federal Funds Purchased, and FHLB Borrowings – For these short-term liabilities, the carrying amount is a reasonable estimate of fair value.

Long-Term Debt – The fair value is estimated by discounting the future contractual cash flows using current market rates at which debt with similar terms could be obtained.

Derivative Financial Instruments – The fair value measurement for derivative financial instruments was discussed earlier in the note.

The following tables present the estimated fair values of the Company’s financial instruments by fair value hierarchy levels and the corresponding carrying amount at December 31, 2015 and 2014.


	December 31, 2015						Total Fair Value		Carrying Amount
(in thousands)	Level 1		Level 2		Level 3		Total Fair Value		Carrying Amount
Financial assets:
Cash, interest-bearing bank deposits, and federal funds sold	$	869,429	$	—	$	—	$	869,429	$	869,429
Available for sale securities		2,757		2,090,647		—		2,093,404		2,093,404
Held to maturity securities		—		2,375,851		—		2,375,851		2,370,388
Loans, net		—		93,602		15,334,201		15,427,803		15,522,135
Loans held for sale		—		20,434		—		20,434		20,434
Derivative financial instruments		—		23,251		—		23,251		23,251

Financial liabilities:
Deposits	$	—	$	—	$	18,327,425	$	18,327,425	$	18,348,912
Federal funds purchased		10,100		—		—		10,100		10,100
Securities sold under agreements to repurchase		513,544		—		—		513,544		513,544
FHLB Borrowings		900,000		—		—		900,000		900,000
Long-term debt		—		494,565		—		494,565		495,999
Derivative financial instruments		—		23,968		—		23,968		23,968


	December 31, 2014						Total Fair Value		Carrying Amount
(in thousands)	Level 1		Level 2		Level 3		Total Fair Value		Carrying Amount
Financial assets:
Cash, interest-bearing bank deposits, and federal funds sold	$	1,159,403	$	—	$	—	$	1,159,403	$	1,159,403
Available for sale securities		9,553		1,650,612		—		1,660,165		1,660,165
Held to maturity securities		—		2,186,340		—		2,186,340		2,166,289
Loans, net		—		30,204		13,672,427		13,702,631		13,766,514
Loans held for sale		—		20,252		—		20,252		20,252
Derivative financial instruments		—		19,432		—		19,432		19,432

Financial liabilities:
Deposits	$	—	$	—	$	16,398,878	$	16,398,878	$	16,572,831
Federal funds purchased		12,000		—		—		12,000		12,000
Securities sold under agreements to repurchase		624,573		—		—		624,573		624,573
FHLB Borrowings		515,000		—		—		515,000		515,000
Long-term debt		—		346,379		—		346,379		374,371
Derivative financial instruments		—		20,860		—		20,860		20,860