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Fair Value Measurements

9 Months Ended

Sep. 30, 2019

Fair value represents the estimated price at which an orderly transaction to sell an asset or to transfer a liability would take place between market participants at the measurement date under current market conditions (i.e., an exit price concept).

Following is a description of the valuation methodologies used for the Corporation’s more significant instruments measured on a recurring basis at fair value, including the general classification of such instruments pursuant to the valuation hierarchy.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Investment Securities Available for Sale: Where quoted prices are available in an active market, investment securities are classified in Level 1 of the fair value hierarchy. If quoted market prices are not available for the specific security, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows, with consideration given to the nature of the quote and the relationship of recently evidenced market activity to the fair value estimate, and are classified in Level 2 of the fair value hierarchy. Lastly, in certain cases where there is limited activity or less transparency around inputs to the estimated fair value, securities are classified within Level 3 of the fair value hierarchy. To validate the fair value estimates, assumptions, and controls, the Corporation looks to transactions for similar instruments and utilizes independent pricing provided by third party vendors or brokers and relevant market indices. While none of these sources are solely indicative of fair value, they serve as directional indicators for the appropriateness of the Corporation’s fair value estimates. The Corporation has determined that the fair value measures of its investment securities are classified predominantly within Level 2 of the fair value hierarchy. See Note 6 for additional disclosure regarding the Corporation’s investment securities.

Equity Securities with Readily Determinable Fair Values: The Corporation's portfolio of equity securities with readily determinable fair values is primarily comprised of CRA Qualified Investment mutual funds. Since quoted prices for the Corporation's equity securities are readily available in an active market, they are classified within Level 1 of the fair value hierarchy. See Note 6 for additional disclosure regarding the Corporation’s equity securities.

Residential Loans Held for Sale: Residential loans held for sale, which consist generally of current production of certain fixed-rate, first-lien residential mortgage loans, are carried at estimated fair value. Management has elected the fair value option to account for all newly originated mortgage loans held for sale, which results in the financial impact of changing market conditions being reflected currently in earnings as opposed to being dependent upon the timing of sales. Therefore, the continually adjusted values better reflect the price the Corporation expects to receive from the sale of such loans. The estimated

fair value is based on what secondary markets are currently offering for portfolios with similar characteristics, which the Corporation classifies as a Level 2 fair value measurement.

Derivative Financial Instruments (Interest Rate-Related Instruments): The Corporation utilizes interest rate swaps to hedge exposure to interest rate risk and variability of fair value related to changes in the underlying interest rate of the hedged item. These hedged interest rate swaps are classified as fair value hedges. See Note 10 for additional disclosure regarding the Corporation’s fair value hedges.

In addition, the Corporation offers interest rate-related instruments (swaps and caps) to service its customers’ needs, for which the Corporation simultaneously enters into offsetting derivative financial instruments (i.e., mirror interest rate-related instruments) with third parties to manage its interest rate risk associated with these financial instruments. The valuation of the Corporation’s derivative financial instruments is determined using discounted cash flow analysis on the expected cash flows of each derivative and also includes a nonperformance / credit risk component (credit valuation adjustment). See Note 10 for additional disclosure regarding the Corporation’s interest rate-related instruments.

The discounted cash flow analysis component in the fair value measurement reflects the contractual terms of the derivative financial instruments, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. More specifically, the fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) with the variable cash payments (or receipts) based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. Likewise, the fair values of interest rate options (i.e., interest rate caps) are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates fall below (or rise above) the strike rate of the floors (or caps), with the variable interest rates used in the calculation of projected receipts on the floor (or cap) based on an expectation of future interest rates derived from observable market interest rate curves and volatilities.

The Corporation also incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative financial instruments for the effect of nonperformance risk, the Corporation has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

While the Corporation has determined that the majority of the inputs used to value its interest rate-related derivative financial instruments fall within Level 2 of the fair value hierarchy, the credit valuation adjustments utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. The Corporation has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions as of September 30, 2019 and December 31, 2018, and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivative financial instruments. Therefore, the Corporation has determined that the fair value measures of its derivative financial instruments in their entirety are classified within Level 2 of the fair value hierarchy.

Derivative Financial Instruments (Foreign Currency Exchange Forwards): The Corporation provides foreign currency exchange services to customers. In addition, the Corporation may enter into a foreign currency exchange forward to mitigate the exchange rate risk attached to the cash flows of a loan or as an offsetting contract to a forward entered into as a service to its customer. The valuation of the Corporation’s foreign currency exchange forwards is determined using quoted prices of foreign currency exchange forwards with similar characteristics, with consideration given to the nature of the quote and the relationship of recently evidenced market activity to the fair value estimate, and is classified within Level 2 of the fair value hierarchy. See Note 10 for additional disclosures regarding the Corporation’s foreign currency exchange forwards.

Derivative Financial Instruments (Commodity Contracts): The Corporation enters into commodity contracts to manage commercial customers' exposure to fluctuating commodity prices, for which the Corporation simultaneously enters into offsetting derivative financial instruments (i.e., mirror commodity contracts) with third parties to manage its risk associated with these financial instruments. The valuation of the Corporation’s commodity contracts is determined using quoted prices of the underlying instruments, and also includes a nonperformance / credit risk component (credit valuation adjustment). See Note 10 for additional disclosures regarding the Corporation’s commodity contracts.

While the Corporation has determined that the majority of the inputs used to value its commodity derivative financial instruments fall within Level 2 of the fair value hierarchy, the credit valuation adjustments utilize Level 3 inputs, such as probability of default and loss given default of the underlying loans to evaluate the likelihood of default by itself and its

counterparties. The Corporation has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions as of September 30, 2019 and December 31, 2018, and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivative financial instruments. Therefore, the Corporation has determined that the fair value measures of its derivative financial instruments in their entirety are classified within Level 2 of the fair value hierarchy.

The table below presents the Corporation’s financial instruments measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018, aggregated by the level in the fair value hierarchy within which those measurements fall:



($ in Thousands)	Fair Value Hierarchy	September 30, 2019		December 31, 2018
Assets
Investment securities available for sale
U.S. Treasury securities	Level 1	$	—	$	999
Obligations of state and political subdivisions (municipal securities)	Level 2	553,418		—
Residential mortgage-related securities
FNMA / FHLMC	Level 2	143,009		295,252
GNMA	Level 2	1,080,584		2,128,531
Private-label	Level 2	758		1,003
Commercial mortgage-related securities
FNMA / FHLMC	Level 2	21,791		—
GNMA	Level 2	1,363,948		1,220,797
FFELP asset backed securities	Level 2	269,789		297,360
Other debt securities	Level 2	2,993		3,000
Total investment securities available for sale	Level 1	$	—	$	999
Total investment securities available for sale	Level 2	$	3,436,289	$	3,945,943
Equity securities with readily determinable fair values	Level 1	1,652		1,568
Residential loans held for sale	Level 2	137,655		64,321
Interest rate-related instruments^(a)	Level 2	100,376		52,796
Foreign currency exchange forwards^(a)	Level 2	3,153		721
Commodity contracts^(a)	Level 2	25,388		35,426
Purchased options (time deposit)	Level 2	13		109
Interest rate products (designated as hedging instruments)	Level 2	114		—
Interest rate lock commitments to originate residential mortgage loans held for sale	Level 3	2,017		2,208
Liabilities
Interest rate-related instruments^(a)	Level 2	$	17,586	$	52,653
Foreign currency exchange forwards^(a)	Level 2	2,823		675
Commodity contracts^(a)	Level 2	24,758		34,340
Written options (time deposit)	Level 2	13		109
Interest rate products (designated as hedging instruments)	Level 2	—		40
Forward commitments to sell residential mortgage loans	Level 3	590		2,072

(a) Figures are presented gross before netting. See Note 10 Derivative and Hedging Activities and Note 11 Balance Sheet Offsetting for information relating to the impact of offsetting derivative assets and liabilities and cash collateral with the same counterparty where there is a legally enforceable master netting agreement in place.

The table below presents a rollforward of the consolidated balance sheets amounts for the nine months ended September 30, 2019 and the year ended December 31, 2018, for financial instruments measured on a recurring basis and classified within Level 3 of the fair value hierarchy:



($ in Thousands)	Derivative Financial Instruments
Balance December 31, 2017	$	1,225
Total net gains (losses) included in income
Mortgage derivative gain (loss)	(1,085		)
Balance December 31, 2018	$	140
Total net gains (losses) included in income
Mortgage derivative gain (loss)	1,292
Balance September 30, 2019	$	1,428

For Level 3 assets and liabilities measured at fair value on a recurring basis as of September 30, 2019, the Corporation utilized the following valuation techniques and significant unobservable inputs:

Derivative Financial Instruments (Mortgage Derivative — Interest Rate Lock Commitments to Originate Residential Mortgage Loans Held for Sale): The fair value is determined by the change in value from each loan’s rate lock date to the expected rate lock expiration date based on the underlying loan attributes, estimated closing ratios, and investor price matrix determined to be reasonably applicable to each loan commitment. The closing ratio calculation takes into consideration historical experience and loan-level attributes, particularly the change in the current interest rates from the time of initial rate lock. The closing ratio is periodically reviewed for reasonableness and reported to the Associated Mortgage Risk Management Committee. At September 30, 2019, the closing ratio was 85%.

Derivative Financial Instruments (Mortgage Derivative — Forward Commitments to Sell Mortgage Loans): Mortgage derivatives include forward commitments to deliver closed-end residential mortgage loans into conforming Agency MBS or conforming Cash Forward sales. The fair value of such instruments is determined by the difference of current market prices for such traded instruments or available from forward cash delivery commitments and the original traded price for such commitments.

The Corporation also relies on an internal valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Corporation would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available. While there are Level 2 and 3 inputs used in the valuation models, the Corporation has determined that the majority of the inputs significant in the valuation of both of the mortgage derivatives fall within Level 3 of the fair value hierarchy. See Note 10 for additional disclosure regarding the Corporation’s mortgage derivatives.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Following is a description of the valuation methodologies used for the Corporation’s more significant instruments measured on a nonrecurring basis at the lower of amortized cost or estimated fair value, including the general classification of such instruments pursuant to the valuation hierarchy.

Commercial Loans Held for Sale: Commercial loans held for sale are carried at the lower of cost or estimated fair value. The estimated fair value is based on a discounted cash flow analysis, which the Corporation classifies as a Level 2 nonrecurring fair value measurement.

OREO: Certain OREO, upon initial recognition, was re-measured and reported at fair value through a charge off to the allowance for loan losses based upon the estimated fair value of the OREO, less estimated selling costs. The fair value of OREO, upon initial recognition or subsequent impairment, was estimated using appraised values, which the Corporation classifies as a Level 2 nonrecurring fair value measurement.

For Level 3 assets and liabilities measured at fair value on a nonrecurring basis as of September 30, 2019, the Corporation utilized the following valuation techniques and significant unobservable inputs:

Impaired Loans: The Corporation considers a loan impaired when it is probable that the Corporation will be unable to collect all amounts due according to the original contractual terms of the note agreement, including both principal and interest. Management has determined that commercial and consumer loan relationships that have nonaccrual status or have had their terms restructured in a troubled debt restructuring meet this impaired loan definition. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate, the estimated fair value of the underlying collateral for collateral-dependent loans, or the estimated liquidity of the note. See Note 7 for additional information regarding the Corporation’s impaired loans.

Mortgage Servicing Rights: MSR do not trade in an active, open market with readily observable prices. While sales of MSR do occur, the precise terms and conditions typically are not readily available to allow for a “quoted price for similar assets” comparison. Accordingly, the Corporation utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of its MSR. The valuation model incorporates prepayment assumptions to project MSR cash flows based on the current interest rate scenario, which is then discounted to estimate an expected fair value of the MSR. The valuation model considers portfolio characteristics of the underlying mortgages, contractually specified servicing fees, prepayment assumptions, discount rate assumptions, delinquency rates, late charges, other ancillary revenue, costs to service, and other economic factors. The Corporation periodically reviews and assesses the underlying inputs and assumptions used in the model. In addition, the Corporation compares its fair value estimates and assumptions to observable market data for MSR, where available, and to recent market activity and actual portfolio experience. Due to the nature of the valuation inputs, MSR are classified within Level 3 of the fair value hierarchy. The Corporation uses the amortization method (i.e., lower of amortized cost or estimated fair value measured on a nonrecurring basis), not fair value measurement accounting, for its MSR assets.

The discounted cash flow analyses that generate expected market prices utilize the observable characteristics of the MSR portfolio, as well as certain unobservable valuation parameters. The significant unobservable inputs used in the fair value measurement of the Corporation’s mortgage servicing rights are the weighted average constant prepayment rate and weighted average discount rate. Significant increases (decreases) in either of those inputs in isolation could result in a significantly lower (higher) fair value measurement.

These parameter assumptions fall within a range that the Corporation, in consultation with an independent third party, believes purchasers of servicing would apply to such portfolios sold into the current secondary servicing market. Discussions are held with members from Treasury and the Community, Consumer, and Business segment to reconcile the fair value estimates and the key assumptions used by the respective parties in arriving at those estimates. The Associated Mortgage Risk Management Committee is responsible for providing control over the valuation methodology and key assumptions. To assess the reasonableness of the fair value measurement, the Corporation also compares the fair value and constant prepayment rate to a value calculated by an independent third party on an annual basis. See Note 8 for additional disclosure regarding the Corporation’s MSR.

Equity Securities Without Readily Determinable Fair Values: The Corporation measures equity securities without readily determinable fair values at cost less impairment (if any), plus or minus observable price changes from an identical or similar investment of the same issuer, with such changes recognized in earnings. Included in equity securities without readily determinable fair values are 77,000 Visa Class B restricted shares carried at fair value. These shares are currently subject to certain transfer restrictions and will be convertible into Visa Class A shares upon final resolution of certain litigation matters involving Visa. Based on the current conversion factor, the Corporation expects 77,000 shares of Visa Class B to convert to 124,956 shares of Visa Class A upon the litigation resolution.

In its determination of the new carrying values upon observable price changes, the Corporation will adjust the prices if deemed necessary to arrive at the Corporation's estimated fair values. Such adjustments may include adjustments to reflect the different rights and obligations of similar securities and other adjustments. See Note 6 for additional disclosure regarding the Corporation’s equity securities without readily determinable fair values.

The following table presents the carrying value of equity securities without readily determinable fair values still held as of September 30, 2019 that are measured under the measurement alternative and the related adjustments recorded during the periods presented for those securities with observable price changes. These securities are included in the nonrecurring fair value tables when applicable price changes are observable. Also shown are the cumulative upward and downward adjustments for the Corporation's equity securities without readily determinable fair values as of September 30, 2019:



($ in Thousands)
Equity securities without readily determinable fair values
Carrying value as of December 31, 2018	$	—
Upward carrying value changes	13,444
Carrying value as of September 30, 2019	$	13,444

Cumulative upward carrying value changes between January 1, 2018 and September 30, 2019	$	13,444
Cumulative downward carrying value changes/impairment between January 1, 2018 and September 30, 2019	$	—

The table below presents the Corporation’s assets measured at fair value on a nonrecurring basis, aggregated by the level in the fair value hierarchy within which those measurements fall:



				Consolidated Statements of Income Category of Adjustment Recognized in Income	Adjustment Recognized in the Consolidated Statements of Income
($ in Thousands)	Fair Value Hierarchy	Fair Value
September 30, 2019
Assets
Impaired loans^(a)	Level 3	$	51,501	Provision for credit losses^(b)	$	(60,627	)
OREO^(c)	Level 2	2,413		Other noninterest expense	(1,453		)
Mortgage servicing rights	Level 3	70,241		Mortgage banking, net	(177		)
Equity securities	Level 3	13,444		Investment securities gains (losses), net	13,444

December 31, 2018
Assets
Impaired loans^(a)	Level 3	$	26,191	Provision for credit losses^(b)	$	(14,521	)
OREO^(c)	Level 2	2,200		Other noninterest expense	(1,545		)
Mortgage servicing rights	Level 3	81,012		Mortgage banking, net	545

(a) Represents individually evaluated impaired loans, net of the related allowance for loan losses.

(b) Represents provision for credit losses on individually evaluated impaired loans.

(c) If the fair value of the collateral exceeds the carrying amount of the asset, no charge off or adjustment is necessary, the asset is not considered to be carried at fair value, and is therefore not included in the table.

Certain nonfinancial assets and nonfinancial liabilities measured at fair value on a nonrecurring basis include the fair value analysis in the second step of a goodwill impairment test, and intangible assets and other nonfinancial long-lived assets measured at fair value for impairment assessment.

The Corporation's significant Level 3 measurements which employ unobservable inputs that are readily quantifiable pertain to MSR and impaired loans.

The table below presents information about these inputs and further discussion is found above:



	Valuation Technique	Significant Unobservable Input	Weighted Average Input Applied
September 30, 2019	Valuation Technique	Significant Unobservable Input	Weighted Average Input Applied
Mortgage servicing rights	Discounted cash flow	Discount rate	9%
Mortgage servicing rights	Discounted cash flow	Constant prepayment rate	13%
Impaired Loans	Appraisals / Discounted cash flow	Collateral / Discount factor	48%

Fair Value of Financial Instruments

The Corporation is required to disclose estimated fair values for its financial instruments.

Fair value estimates are set forth below for the Corporation’s financial instruments:



		September 30, 2019				December 31, 2018
	Fair Value Hierarchy Level	Carrying Amount		Fair Value		Carrying Amount		Fair Value
($ in Thousands)	Fair Value Hierarchy Level	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets
Cash and due from banks	Level 1	$	523,435	$	523,435	$	507,187	$	507,187
Interest-bearing deposits in other financial institutions	Level 1	236,010		236,010		221,226		221,226
Federal funds sold and securities purchased under agreements to resell	Level 1	100		100		148,285		148,285
Investment securities held to maturity	Level 1	999		1,019		—		—
Investment securities held to maturity	Level 2	2,199,420		2,280,265		2,740,511		2,710,271
Investment securities available for sale	Level 1	—		—		999		999
Investment securities available for sale	Level 2	3,436,289		3,436,289		3,945,943		3,945,943
Equity securities with readily determinable fair values	Level 1	1,652		1,652		1,568		1,568
Equity securities without readily determinable fair values	Level 3	13,444		13,444		—		—
FHLB and Federal Reserve Bank stocks	Level 2	207,443		207,443		250,534		250,534
Residential loans held for sale	Level 2	137,655		137,655		64,321		64,321
Commercial loans held for sale	Level 2	11,597		11,597		14,943		14,943
Loans, net	Level 3	22,540,285		22,422,568		22,702,406		22,317,395
Bank and corporate owned life insurance	Level 2	670,739		670,739		663,203		663,203
Derivatives (other assets)^(a)	Level 2	129,044		129,044		89,052		89,052
Interest rate lock commitments to originate residential mortgage loans held for sale (other assets)	Level 3	2,017		2,017		2,208		2,208
Financial liabilities
Noninterest-bearing demand, savings, interest-bearing demand, and money market accounts	Level 3	$	21,512,804	$	21,512,804	$	22,081,992	$	22,081,992
Brokered CDs and other time deposits^(b)	Level 2	2,909,759		2,910,112		2,815,401		2,815,401
Short-term funding^(c)	Level 2	108,444		108,444		157,074		157,074
Long-term funding	Level 2	796,799		842,196		795,611		826,612
FHLB advances	Level 2	2,877,727		2,938,923		3,574,371		3,565,572
Standby letters of credit^(d)	Level 2	2,715		2,715		2,482		2,482
Derivatives (accrued expenses and other liabilities)^(a)	Level 2	45,180		45,180		87,817		87,817
Forward commitments to sell residential mortgage loans (accrued expenses and other liabilities)	Level 3	590		590		2,072		2,072

(a) Figures are presented gross before netting. See Note 10 Derivative and Hedging Activities and Note 11 Balance Sheet Offsetting for information relating to the impact of netting derivative assets and derivative liabilities as well as the impact from offsetting cash collateral paid to the same derivative counterparty where there is a legally enforceable master netting agreement in place.

(b) When the estimated fair value is less than the carrying value, the carrying value is reported as the fair value.

(d) The commitment on standby letters of credit was $272 million at September 30, 2019 and $256 million at December 31, 2018. See Note 12 for additional information on the standby letters of credit and for information on the fair value of lending-related commitments.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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