10. FAIR VALUE DISCLOSURES OF FINANCIAL ASSETS AND LIABILITIES

FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES

ASC 820-10 defines fair value as 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. ASC 820-10 establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:


•	Level 1: Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

•

Level 2: Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that are derived principally from or can be corroborated by observable market data by correlation or other means.


•	Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using discounted cash flow methodologies, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The following tables present financial instruments carried at fair value as of September 30, 2018 and December 31, 2017 by level in the valuation hierarchy (as described above):



	September 30, 2018
(Dollars in thousands)	Quoted Prices in Active Markets for Identical Asset (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Fair Value
Assets measured at fair value on a recurring basis:
Available-for-sale securities:
CMO	$	—	$	300,030	$	—	$	300,030
FNMA MBS	—		548,738		—		548,738
FHLMC MBS	—		112,422		—		112,422
GNMA MBS	—		35,941		—		35,941
Other assets	—		977		—		977
Total assets measured at fair value on a recurring basis	$	—	$	998,108	$	—	$	998,108

Liabilities measured at fair value on a recurring basis:
Other liabilities	$	—	$	4,781	$	—	$	4,781

Assets measured at fair value on a nonrecurring basis:
Other investments⁽¹⁾	$	—	$	—	$	35,083	$	35,083
Other real estate owned	—		—		2,004		2,004
Loans held for sale	—		35,855		—		35,855
Impaired loans, net	—		—		50,545		50,545
Total assets measured at fair value on a nonrecurring basis	$	—	$	35,855	$	87,632	$	123,487

⁽¹⁾ See Note 1 for additional disclosures resulting from the Company's adoption of ASU 2016-01.



	December 31, 2017
(Dollars in thousands)	Quoted Prices in Active Markets for Identical Asset (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Fair Value
Assets measured at fair value on a recurring basis:
Available-for-sale securities:
CMO	$	—	$	246,539	$	—	$	246,539
FNMA MBS	—		473,987		—		473,987
FHLMC MBS	—		87,875		—		87,875
GNMA MBS	—		29,098		—		29,098
Other investments	623		—		—		623
Other assets	—		747		—		747
Total assets measured at fair value on a recurring basis	$	623	$	838,246	$	—	$	838,869

Liabilities measured at fair value on a recurring basis:
Other liabilities	$	—	$	3,225	$	—	$	3,225

Assets measured at fair value on a nonrecurring basis
Other real estate owned	—		—		2,503		2,503
Loans held for sale	—		31,055		—		31,055
Impaired loans, net	—		—		57,089		57,089
Total assets measured at fair value on a nonrecurring basis	$	—	$	31,055	$	59,592	$	90,647

There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the nine months ended September 30, 2018.

Fair value is based on quoted market prices, where available. If such quoted market prices are not available, fair value is based on internally developed models or obtained from third parties that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include unobservable parameters. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While we believe our valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Available-for-sale securities

As of September 30, 2018, securities classified as available-for-sale are reported at fair value using Level 2 inputs. Included in the Level 2 total are $997.1 million in Federal Agency MBS. We believe that this Level 2 designation is appropriate for these securities under ASC 820-10 as, with almost all fixed income securities, none are exchange traded, and all are priced by correlation to observed market data. For these securities we obtain fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, U.S. government and agency yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the security’s terms and conditions, among other factors.

Other investments

Other investments includes our investments in equity securities with and without readily determinable fair values. Equity investments with readily determinable fair values are categorized as Level 1. Equity investments without readily determinable fair values, which includes our Visa Class B shares, are categorized as Level 3. Our Visa Class B ownership includes shares acquired at no cost from our prior participation in Visa’s network while Visa operated as a cooperative as well as shares subsequently acquired through private transactions and auctions.

Our equity investments without readily determinable fair values are held at cost, and are adjusted for any observable transactions during the reporting period. As a result of our adoption of ASU 2016-01 and observable market transactions, we recorded an unrealized gain on our Visa Class B shares of $18.6 million during the nine months ended September 30, 2018. See Note 1 for further information.

Other real estate owned

Other real estate owned consists of loan collateral which has been repossessed through foreclosure or other measures. Initially, foreclosed assets are recorded at the fair value of the collateral less estimated selling costs. Subsequent to foreclosure, valuations are updated periodically and the assets may be marked down further, reflecting a new cost basis. The fair value of our real estate owned was estimated using Level 3 inputs based on appraisals obtained from third parties.

Loans held for sale

The fair value of our loans held for sale is based on estimates using Level 2 inputs. These inputs are based on pricing information obtained from wholesale mortgage banks and brokers and applied to loans with similar interest rates and maturities.

Impaired loans

We evaluate and value impaired loans at the time the loan is identified as impaired, and the fair values of such loans are estimated using Level 3 inputs in the fair value hierarchy. Each loan’s collateral has a unique appraisal and management’s discount of the value is based on the factors unique to each impaired loan. The significant unobservable input in determining the fair value is management’s subjective discount on appraisals of the collateral securing the loan, which typically ranges from 10% - 20%. Collateral may consist of real estate and/or business assets including equipment, inventory and/or accounts receivable and the value of these assets is determined based on the appraisals by qualified licensed appraisers hired by us. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, estimated costs to sell, and/or management’s expertise and knowledge of the client and the client’s business.

The gross amount of impaired loans, which are measured for impairment by either calculating the expected future cash flows discounted at the loan’s effective interest rate or determining the fair value of the collateral for collateral dependent loans was $55.9 million and $62.1 million at September 30, 2018 and December 31, 2017, respectively. The valuation allowance on impaired loans was $5.4 million as of September 30, 2018 and $5.0 million as of December 31, 2017.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The reported fair values of financial instruments are based on a variety of factors. In certain cases, fair values represent quoted market prices for identical or comparable instruments. In other cases, fair values have been estimated based on assumptions regarding the amount and timing of estimated future cash flows that are discounted to reflect current market rates and varying degrees of risk. Accordingly, the fair values may not represent actual values of the financial instruments that could have been realized as of period-end or that will be realized in the future.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and cash equivalents

For cash and short-term investment securities, including due from banks, federal funds sold or purchased under agreements to resell and interest-bearing deposits with other banks, the carrying amount is a reasonable estimate of fair value.

Investment securities

Fair value is estimated using quoted prices for similar securities, which we obtain from a third party vendor. We utilize one of the largest providers of securities pricing to the industry and management periodically assesses the inputs used by this vendor to price the various types of securities owned by us to validate the vendor’s methodology as described above in available-for-sale securities.

Other investments

Other investments includes our investments in equity securities with and without readily determinable fair values (see discussion in “Fair Value of Financial Assets and Liabilities” section above).

Loans held for sale

Loans held for sale are carried at their fair value (see discussion in “Fair Value of Financial Assets and Liabilities” section above).

Loans

Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type: commercial, commercial mortgages, owner-occupied commercial, construction, residential mortgages and consumer. For loans that reprice frequently, the book value approximates fair value. The fair values of other types of loans, with the exception of reverse mortgages, are estimated by discounting expected cash flows using the current rates at which similar loans would be made to borrowers with comparable credit ratings and for similar remaining maturities. The fair values of reverse mortgages are based on the net present value of the expected cash flows using a discount rate specific to the reverse mortgages portfolio. The fair value of nonperforming loans is based on recent external appraisals of the underlying collateral. Estimated cash flows, discounted using a rate commensurate with current rates and the risk associated with the estimated cash flows, are used if appraisals are not available. This technique does contemplate an exit price.

Stock in the Federal Home Loan Bank (FHLB) of Pittsburgh

The fair value of FHLB stock is assumed to be equal to its cost basis, since the stock is non-marketable but redeemable at its par value.

Other assets

Other assets includes, among other things, investments in subsidiaries, prepaid expenses, interest and fee income receivable, derivative financial instruments and deferred tax assets (see discussion in “Fair Value of Financial Assets and Liabilities” section above).

Deposits

The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, money market and interest-bearing demand deposits, is assumed to be equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using rates currently offered for deposits with comparable remaining maturities.

Borrowed funds

Rates currently available to us for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt.

Other Liabilities

Other liabilities includes, among others, cash flow derivatives and derivatives on the residential mortgage held for sale pipeline. Valuation of our cash flow derivatives is obtained from an independent pricing service and also from the derivative counterparty. Valuation of the derivative related to the residential mortgage held for sale pipeline is based on valuation of the loans held for sale portfolio as described above in Loans held for sale.

Off-balance sheet instruments

The fair value of off-balance sheet instruments, including commitments to extend credit and standby letters of credit, approximates the recorded net deferred fee amounts, which are not significant. Because commitments to extend credit and letters of credit are generally not assignable by either us or the borrower, they only have value to us and the borrower.

The book value and estimated fair value of our financial instruments are as follows:



		September 30, 2018				December 31, 2017
(Dollars in thousands)	Fair Value Measurement	Book Value		Fair Value		Book Value		Fair Value
Financial assets:
Cash and cash equivalents	Level 1	$	711,372	$	711,372	$	723,866	$	723,866
Investment securities available for sale	See previous table	997,131		997,131		837,499		837,499
Investment securities held to maturity	Level 2	152,577		150,583		161,186		162,853
Other investments	Level 1,3	35,083		35,083		14,671		45,326
Loans, held for sale	Level 2	35,855		35,855		31,055		31,055
Loans, net⁽¹⁾⁽²⁾	Level 2,3	4,835,591		4,802,841		4,719,229		4,699,458
Impaired loans, net	Level 3	50,545		50,545		57,089		57,089
Stock in FHLB of Pittsburgh	Level 2	16,540		16,540		31,284		31,284
Accrued interest receivable	Level 2	21,331		21,331		19,405		19,405
Other assets	Level 3	977		977		2,883		2,883
Financial liabilities:
Deposits	Level 2	5,723,916		5,685,435		5,247,604		4,848,588
Borrowed funds	Level 2	545,089		538,395		937,806		937,605
Standby letters of credit	Level 3	328		328		603		603
Accrued interest payable	Level 2	7,119		7,119		1,037		1,037
Other liabilities	Level 2	4,781		4,781		3,188		3,188

⁽¹⁾ Excludes impaired loans, net.

⁽²⁾ Includes reverse mortgage loans, which are categorized as Level 3.

At September 30, 2018 and December 31, 2017 we had no commitments to extend credit measured at fair value.