XML 17 R17.htm IDEA: XBRL DOCUMENT

Fair Value Accounting and Measurement

3 Months Ended

Sep. 30, 2011

Fair Value Accounting and Measurement

Note 11: FAIR VALUE ACCOUNTING AND MEASUREMENT

We have elected to record certain assets and liabilities at fair value. Fair value is defined 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 (that is, not a forced liquidation or distressed sale). The GAAP standard (ASC 820, Fair Value Measurements) establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements. Among other things, the standard requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s estimates for market assumptions. These two types of inputs create the following fair value hierarchy:

Level 1 – Quoted prices in active markets for identical instruments. An active market is a market in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. 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 – Observable inputs other than Level 1 including quoted prices in active markets for similar instruments, quoted prices in less active markets for identical or similar instruments, or other observable inputs that can be corroborated by observable market data.

Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs from non-binding single dealer quotes not corroborated by observable market data.

The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.

Items Measured at Fair Value on a Recurring Basis:

Banner records trading account securities, securities available-for-sale, FHLB debt and junior subordinated debentures at fair value on a recurring basis.

The securities assets primarily consist of U.S. Government and agency obligations, municipal bonds, corporate bonds, single issue trust preferred securities (TPS), pooled trust preferred collateralized debit obligation securities (TRUP CDO), mortgage-backed securities, equity securities and certain other financial instruments. The Level 1 measurements are based upon quoted prices in active markets. The Level 2 measurements are generally based upon a matrix pricing model from an investment reporting and valuation service. Matrix pricing is a mathematical technique used principally to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. The Level 3 measurements are based primarily on unobservable inputs. In developing Level 3 measurements, management incorporates whatever market data might be available and uses discounted cash flow models where appropriate. These calculations include projections of future cash flows, including appropriate default and loss assumptions, and market based discount rates.

From mid-2008 through the current quarter, the lack of active markets and market participants for certain securities resulted in an increase in Level 3 measurements. This has been particularly true for Banner’s TPS and TRUP CDO securities. As of September 30, 2011, Banner owned $32 million in current par value of these securities, exclusive of those securities Banner elected to write-off completely. The market for TRUP CDO securities is inactive, which was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which TRUP CDOs trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive as almost no new TRUP CDOs have been issued since 2007. There are still very few market participants who are willing and/or able to transact for these securities. Thus, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issuer or of the fair value of the security.

Given these conditions in the debt markets and the absence of observable transactions in the secondary and new issue markets, management determined that for the TRUP CDOs at September 30, 2011 and December 31, 2010:

o	The few observable transactions and market quotations that were available were not reliable for purposes of determining fair value,

An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs was equally or more representative of fair value than the market approach valuation technique used at measurement dates prior to 2008, and

o	The Company’s TRUP CDOs should be classified exclusively within Level 3 of the fair value hierarchy because of the significant assumptions required to determine fair value at the measurement date.

The TRUP CDO valuations were prepared by independent third parties who used proprietary cash flow models for analyzing collateralized debt obligations. Their approaches to determining fair value involve considering the credit quality of the collateral, assuming a level of defaults based on the probability of default of each underlying trust preferred security, creating expected cash flows for each TRUP CDO security and discounting that cash flow at an appropriate risk-adjusted rate plus a liquidity premium.

Management reviewed the valuation methodology and assumptions used by the independent third party providers, determined that with respect to performing securities the fair value estimates were reasonable and utilized those estimates in the Company’s reported financial statements. However, beginning with the quarter ended June 30, 2009 and continuing through the current quarter, for two securities for which Banner currently is not receiving any cash payments, management elected to override the third party fair value estimates and to reflect the fair value of these securities at zero, resulting in an OTTI charge recognized in previous periods.

At September 30, 2011, Banner also directly owned approximately $18 million in current book value of TPS securities issued by three individual financial institutions for which no market data or independent valuation source is available. Similar to the TRUP CDOs above, there were too few, if any, issuances of new TPS securities or sales of existing TPS securities to provide Level 1 or even Level 2 fair value measurements for these securities. Management, therefore, utilized a discounted cash-flow model to calculate the present value of each security’s expected future cash flows to determine their respective fair values. Management took into consideration what little market data was available regarding discount rates, but concluded that most of the available information represented dated transactions and/or was not representative of active market transactions. Since these three TPS securities are also concentrated in the financial institutions sector, which continues to be under significant pricing pressure at September 30, 2011, management applied credit factors to differentiate these issues based upon its judgment of the risk profile of the various issuers. These credit factors were then incorporated into the model at September 30, 2011, and discount rates equal to three-month LIBOR plus 600 to 900 basis points were used to calculate the respective fair values of these securities. At September 30, 2011, Banner also has one TPS security for a large national bank with a par value of $5 million that is not actively traded, but for which more market data is available, permitting a Level 2 fair value measurement. All levels are reviewed annually for appropriateness.

Fair valuations for FHLB advances are estimated using fair market values provided by the lender, the FHLB of Seattle. The FHLB of Seattle prices advances by discounting the future contractual cash flows for individual advances using its current cost of funds curve to provide the discount rate. Management considers this to be a Level 2 input method.

The fair valuations of junior subordinated debentures (TPS debt that the Company has issued) were valued using discounted cash flows to maturity or to the next available call date, if based upon the current interest rate and credit market environment it was considered likely that the Company would elect early redemption. The majority, $98 million, of these debentures carry interest rates that reset quarterly, using the three-month LIBOR index plus spreads ranging from 1.38% to 3.35%. The remaining $26 million issue has a current interest rate of 6.56%, which is fixed until December 15, 2011 and then resets quarterly to equal three-month LIBOR plus a spread of 1.62%. In valuing the debentures at September 30, 2011, management evaluated discounted cash flows to maturity and for the discount rate used the September 30, 2011 three-month LIBOR plus 800 basis points, which resulted in a $785,000 increase in fair value during the third quarter of 2011. While the quarterly reset of the index on this debt would seemingly keep it close to market values, the disparity in the fixed spreads above the index and the inability to determine realistic current market spreads, due to lack of new issuances and trades, resulted in having to rely more heavily on assumptions about what spread would be appropriate if market transactions were to take place. Due to this reliance on assumptions and not on directly observable transactions, management considers this to be a Level 3 input method.

The following tables present financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010 (in thousands):

	September 30, 2011
	Level 1		Level 2		Level 3		Total
Assets:
Securities—available-for-sale
U.S. Government and agency	$	--	$	288,379	$	--	$	288,379
Municipal bonds		--		23,627		--		23,627
Corporate bonds		--		15,730		--		15,730
Mortgage-backed securities		--		55,934		--		55,934
		--		383,670		--		383,670
Securities—trading
U.S. Government and agency		--		3,633		--		3,633
Municipal bonds		--		5,986		--		5,986
TPS and TRUP CDOs		--		4,637		30,620		35,257
Mortgage-backed securities		--		39,998		--		39,998
Equity securities and other		--		545		--		545
		--		54,799		30,620		85,419
	$	--	$	438,469	$	30,620	$	469,089

Liabilities
Advances from FHLB at fair value	$	--	$	10,572	$	--	$	10,572
Junior subordinated debentures net of unamortized deferred issuance costs at fair value		--	-	--		48,770		48,770
	$	--	$	10,572	$	48,770	$	59,342

	December 31, 2010
	Level 1		Level 2		Level 3		Total
Assets:
Securities—available-for-sale
U.S. Government and agency	$	--	$	135,428	$	--	$	135,428
Municipal bonds		--		5,396				5,396
Corporate bonds		--		22,522		--		22,522
Mortgage-backed securities		--		36,881		--		36,881
		--		200,227		--		200,227
Securities—trading
U.S. Government and agency		--		4,379		--		4,379
Municipal bonds		--		6,398		--		6,398
TPS and TRUP CDOs		--		5,063		29,661		34,724
Mortgage-backed securities		--		49,688		--		49,688
Equity securities and other		--		190		--		190
		--		65,718		29,661		95,379
	$	--	$	265,945	$	29,661	$	295,606

Liabilities
Advances from FHLB at fair value	$	--	$	43,523	$	--	$	43,523
Junior subordinated debentures net of unamortized deferred issuance costs at fair value		--	-	--		48,425		48,425
	$	--	$	43,523	$	48,425	$	91,948

The following table provides a reconciliation of the assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three and nine months ended September 30, 2011 and 2010 (in thousands):

	Three Months Ended September 30, 2011 Level 3 Fair Value Inputs					Nine Months Ended September 30, 2011 Level 3 Fair Value Inputs
	TPS and TRUP CDOs			Borrowings— Junior Subordinated Debentures		TPS and TRUP CDOs			Borrowings— Junior Subordinated Debentures

Beginning balance	$	30,728		$	47,986	$	29,661		$	48,425

Total gains or losses recognized
Assets gains (losses), including OTTI		(91	)		--		1,018			--
Liabilities (gains) losses		--			784		--			345
Purchases, issuances and settlements		--			--		--			--
Paydowns and maturities		(17	)		--		(59	)		--
Transfers in and/or out of Level 3		--			--		--			--
Ending balance at September 30, 2011	$	30,620		$	48,770	$	30,620		$	48,770

	Three Months Ended September 30, 2010 Level 3 Fair Value Inputs						Nine Months Ended September 30, 2010 Level 3 Fair Value Inputs
	TPS and TRUP CDOs			Borrowings— Junior Subordinated Debentures			TPS and TRUP CDOs			Borrowings— Junior Subordinated Debentures

Beginning balance	$	30,590		$	49,808		$	30,192		$	47,694

Total gains or losses recognized
Assets gains (losses), including OTTI		(620	)		--			(222	)		--
Liabilities (gains) losses		--			(1,414	)		--			700
Purchases, issuances and settlements		--			--			--			--
Paydowns and maturities		--			--			--			--
Transfers in and/or out of Level 3		--			--			--			--
Ending balance at September 30, 2011	$	29,970		$	48,394		$	29,970		$	48,394

The Company has elected to continue to recognize the interest income and dividends from the securities reclassified to fair value as a component of interest income as was done in prior years when they were classified as available-for-sale. Interest expense related to the FHLB advances and junior subordinated debentures continues to be measured based on contractual interest rates and reported in interest expense. The change in fair market value of these financial instruments has been recorded as a component of other operating income.

Items Measured at Fair Value on a Non-recurring Basis:

Carrying values of certain impaired loans are periodically evaluated to determine if valuation adjustments, or partial write-downs, should be recorded. These non-recurring fair value adjustments are recorded when observable market prices or current appraised values of collateral indicate a shortfall in collateral value or discounted cash flows indicate a shortfall compared to current carrying values of the related loan. If the Company determines that the value of the impaired loan is less than the carrying value of the loan, the Company either establishes an impairment reserve as a specific component of the allowance for loan and lease losses (ALLL) or charges off the impaired amount. The remaining impaired loans are evaluated for reserve needs in homogenous pools within the Company’s ALLL methodology. As of September 30, 2011, the Company reviewed all of its classified loans totaling $237 million and identified $135 million which were considered impaired. Of those $135 million in impaired loans, $86 million were individually evaluated to determine if valuation adjustments, or partial write-downs, should be recorded, or if specific impairment reserves should be established. The $86 million had original carrying values of $112 million which have been reduced by partial write-downs totaling $26 million. In addition to these write-downs, in order to bring the impaired loan balances to fair value, Banner also established $9 million in specific reserves on these impaired loans. Impaired loans that were collectively evaluated for reserve purposes within homogenous pools totaled $49 million and were found to require allowances totaling $4 million. The $49 million evaluated for reserve purposes within homogeneous pools included $27 million of TDRs which are currently performing according to their restructured terms. The valuation inputs for impaired loans are considered to be Level 3 inputs.

The Company records REO at fair value on a non-recurring basis. REO properties are recorded at the lower of the Company’s investment or the fair market value of the property, less expected selling costs. REO properties are reviewed periodically to determine if valuation allowances are necessary. These valuation allowances are generally based on updated appraisals of the underlying properties. Further, management may direct a reduction of the selling price of a property which may result in an additional valuation allowance. Banner considers any valuation inputs related to REO to be Level 3 inputs. For the three months ended September 30, 2011, we recognized $4.6 million of additional impairment charges related to REO assets, compared to $8.6 million for the same quarter one year earlier. For the nine months ended September 30, 2011, these impairment charges totaled $12.4 million, compared to $9.9 million for the same period in 2010.

The Company records mortgage servicing rights at fair value on a non-recurring basis. The fair value of mortgage servicing rights is based on the objective characteristics of the servicing portfolio and is derived through a discounted cash flow analytical model of an independent external consultant. The analysis takes into consideration existing conditions in the secondary servicing markets (levels of supply and demand), as well as recently executed servicing transactions, if available. It also includes an analysis of rate trends, anticipated prepayment speeds, delinquencies, foreclosure rates and ancillary fee income. The valuation assumptions embedded within this analysis have been selected from a broad range of parameters and assumptions utilized by various buyers throughout the marketplace. Due to the lack of significant observable inputs utilized in the valuation model and how changes in these assumptions could potentially impact the ending valuation of this asset, as well as the lack of readily available quotes or observable trades of similar assets in the current period, we classify this as a Level 3 fair value measurement. Management believes the inputs utilized are indicative of those that would be used by market participants.

The following tables present the fair value measurement of assets and liabilities measured at fair value on a non-recurring basis and the level within the ASC 820 fair value hierarchy of the fair value measurements for those assets at September 30, 2011 and December 31, 2010 (in thousands):

	At or For the Nine Months Ended September 30, 2011
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Losses Recognized During the Period

Impaired loans	$	46,270	$	--	$	--	$	46,270	$	(14,784)
REO		66,459		--		--		66,459		(11,551)


	At or For the Year Ended December 31, 2010
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Losses Recognized During the Period

Impaired loans	$	75,827	$	--	$	--	$	75,827	$	(34,140)
REO		100,872		--		--		100,872		(18,029)

Fair Values of Financial Instruments:

The following table presents estimated fair values of the Company’s financial instruments as of September 30, 2011 and December 31, 2010, whether or not recognized or recorded in the consolidated balance sheets. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data in the development of the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The estimated fair value of financial instruments is as follows (in thousands):

	September 30, 2011						December 31, 2010
		Carrying Value			Estimated Fair Value			Carrying Value			Estimated Fair Value
Assets:
Cash and due from banks	$	288,327		$	288,327		$	361,652		$	361,652
Securities—trading		85,419			85,419			95,379			95,379
Securities—available-for-sale		383,670			383,670			200,227			200,227
Securities—held-to-maturity		79,289			83,372			72,087			73,916
Loans receivable held for sale		2,003			2,038			3,492			3,537
Loans receivable		3,137,115			3,158,093			3,302,224			3,227,429
FHLB stock		37,371			37,371			37,371			37,371
Bank-owned life insurance		58,058			58,058			56,653			56,653
Mortgage servicing rights		5,494			5,494			5,441			5,441

Liabilities:
Demand, NOW and money market accounts		1,554,181			1,474,036			1,417,193			1,317,022
Regular savings		670,210			626,165			616,512			572,356
Certificates of deposit		1,313,043			1,304,026			1,557,493			1,562,850
FHLB advances at fair value		10,572			10,572			43,523			43,523
Junior subordinated debentures at fair value		48,770			48,770			48,425			48,425
Other borrowings		139,704			139,704			175,813			175,813

Off-balance-sheet financial instruments:
Commitments to originate loans		617			617			310			310
Commitments to sell loans		(617	)		(617	)		(310	)		(310	)

Fair value estimates, methods and assumptions are set forth below for the Company’s financial and off-balance-sheet instruments:

Cash and Due from Banks: The carrying amount of these items is a reasonable estimate of their fair value.

Securities: The estimated fair values of investment securities and mortgaged-backed securities are priced using current active market quotes, if available, which are considered Level 1 measurements. For most of the portfolio, matrix pricing based on the securities’ relationship to other benchmark quoted prices is used to establish the fair value. These measurements are considered Level 2. Due to the increasing credit concerns in the capital markets and inactivity in the trust preferred markets that have limited the observability of market spreads for some of the Company’s TRUP CDO securities (see earlier discussion above in determining the securities’ fair market value), management has classified these securities as a Level 3 fair value measure.

Loans Receivable: Fair values are estimated first by stratifying the portfolios of loans with similar financial characteristics. Loans are segregated by type such as multifamily real estate, residential mortgage, nonresidential mortgage, commercial/agricultural, consumer and other. Each loan category is further segmented into fixed- and adjustable-rate interest terms and by performing and non-performing categories. A preliminary estimate of fair value is then calculated based on discounted cash flows using as a discount rate the current rate offered on similar products, plus an adjustment for liquidity to reflect the non-homogeneous nature of the loans. The preliminary estimate is then further reduced by the amount of the allowance for loan losses to arrive at a final estimate of fair value.

The fair value of performing residential mortgages held for sale is estimated based upon secondary market sources by type of loan and terms such as fixed or variable interest rates. Fair value for significant non-performing loans is based on recent appraisals or estimated cash flows discounted using rates commensurate with risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information.

FHLB Stock: The fair value is based upon the redemption value of the stock which equates to its carrying value. Ownership of FHLB stock is restricted to the member institutions, and can only be purchased and redeemed at par.

Mortgage Servicing Rights: Fair values are estimated based on current pricing for sales of servicing for new loans adjusted up or down based on the serviced loan’s interest rate versus current market new loan rates.

Deposit Liabilities: The fair value of deposits with no stated maturity, such as savings, checking and NOW accounts, is estimated by applying decay rate assumptions to segregated portfolios of similar deposit types to generate cash flows which are then discounted using short-term market interest rates. The market value of certificates of deposit is based upon the discounted value of contractual cash flows. The discount rate is determined using the rates currently offered on the FHLB yield curve.

FHLB Advances and Other Borrowings: Fair valuations for Banner’s FHLB advances are estimated using fair market values provided by the lender, the FHLB of Seattle. The FHLB of Seattle prices advances by discounting the future contractual cash flows for individual advances using its current cost of funds curve to provide the discount rate. This is considered to be a Level 2 input method. Other borrowings are priced using discounted cash flows to the date of maturity based on using current rates at which such borrowings can currently be obtained.

Junior Subordinated Debentures: Due to the increasing credit concerns in the capital markets and inactivity in the trust preferred markets that have limited the observability of market spreads (see earlier discussion above in determining the junior subordinated debentures’ fair market value), junior subordinated debentures have been classified as a Level 3 fair value measure. Management believes that the credit risk adjusted spread and resulting discount rate utilized is indicative of those that would be used by market participants.

Commitments: Commitments to sell loans with notional balances of $67 million and $31 million at September 30, 2011 and December 31, 2010, respectively, have a carrying value of $617,000 and $310,000, representing the fair value of such commitments. Interest rate lock commitments to originate loans held for sale with notional balances of $67 million and $31 million at September 30, 2011 and December 31, 2010, respectively, have a carrying value of ($617,000) and ($310,000). The fair value of commitments to sell loans and of interest rate locks reflects changes in the level of market interest rates from the date of the commitment or rate lock to the date of the Company’s financial statements. Other commitments to fund loans totaled $862 million and $738 million at September 30, 2011 and December 31, 2010, respectively, and have no carrying value at both dates, representing the cost of such commitments. There were no commitments to purchase or sell securities at September 30, 2011 or December 31, 2010.

Limitations: The fair value estimates presented herein are based on pertinent information available to management as of September 30, 2011 and December 31, 2010. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

Fair value estimates are based on existing on- and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business. The fair value has not been estimated for assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not financial instruments include the deferred tax assets/liabilities; land, buildings and equipment; costs in excess of net assets acquired; and real estate held for sale.