FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents estimated fair values of the Company’s financial instruments as of March 31, 2017 and December 31, 2016, whether or not measured at fair value in the Consolidated Statements of Financial Condition (in thousands):



		March 31, 2017				December 31, 2016
	Level	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Assets:
Cash and cash equivalents	1	$	300,708	$	300,708	$	247,719	$	247,719
Securities—trading	2,3	24,753		24,753		24,568		24,568
Securities—available-for-sale	2	1,223,764		1,223,764		800,917		800,917
Securities—held-to-maturity	2,3	266,391		269,402		267,873		270,528
Loans held for sale	2	86,707		87,937		246,353		246,815
Loans receivable	3	7,421,255		7,303,871		7,451,148		7,337,608
FHLB stock	3	10,334		10,334		12,506		12,506
Bank-owned life insurance	1	159,948		159,948		158,936		158,936
Mortgage servicing rights	3	15,272		18,846		15,249		16,740
Derivatives:
Interest rate swaps	2	7,268		7,268		8,330		8,330
Interest rate lock and forward sales commitments	2	628		628		482		482
Liabilities:
Demand, interest checking and money market accounts	2	5,685,219		5,685,219		5,552,690		5,552,690
Regular savings	2	1,592,023		1,592,023		1,523,391		1,523,391
Certificates of deposit	2	1,144,718		1,127,412		1,045,333		1,028,866
FHLB advances	2	213		213		54,216		54,216
Other borrowings	2	120,245		120,245		105,685		105,685
Junior subordinated debentures	3	96,040		96,040		95,200		95,200
Derivatives:
Interest rate swaps	2	7,268		7,268		8,330		8,330
Interest rate lock and forward sales commitments	2	337		337		289		289

The Company measures and discloses 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). GAAP establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements. Among other things, the accounting standard requires the reporting entity 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 at a future date. 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 certain financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. Transfers between levels of the fair value hierarchy are deemed to occur at the end of the reporting period.

Items Measured at Fair Value on a Recurring Basis:

The following tables present financial assets and liabilities measured at fair value on a recurring basis and the level within the fair value hierarchy of the fair value measurements for those assets and liabilities as of March 31, 2017 and December 31, 2016 (in thousands):



	March 31, 2017
	Level 1		Level 2		Level 3		Total
Assets:
Securities—trading
U.S. Government and agency obligations	$	—	$	1,322	$	—	$	1,322
Municipal bonds	—		334		—		334
Corporate Bonds (Trust Preferred Securities)	—		—		21,361		21,361
Mortgage-backed or related securities	—		1,617		—		1,617
Equity securities	—		119		—		119
	—		3,392		21,361		24,753
Securities—available-for-sale
U.S. Government and agency obligations	—		90,672		—		90,672
Municipal bonds	—		110,545		—		110,545
Corporate bonds	—		10,558		—		10,558
Mortgage-backed or related securities	—		983,198		—		983,198
Asset-backed securities	—		28,693		—		28,693
Equity securities	—		98		—		98
	—		1,223,764		—		1,223,764

Loans held for sale	—		7,282		—		7,282

Derivatives
Interest rate swaps	—		7,268		—		7,268
Interest rate lock and forward sales commitments	—		628		—		628
	$	—	$	1,242,334	$	21,361	$	1,263,695

Liabilities:
Advances from FHLB	$	—	$	213	$	—	$	213
Junior subordinated debentures, net of unamortized deferred issuance costs	—		—		96,040		96,040
Derivatives
Interest rate swaps	—		7,268		—		7,268
Interest rate lock and forward sales commitments	—		337		—		337
	$	—	$	7,818	$	96,040	$	103,858



	December 31, 2016
	Level 1		Level 2		Level 3		Total
Assets:
Securities—trading
U.S. Government and agency obligations	$	—	$	1,326	$	—	$	1,326
Municipal bonds	—		335		—		335
Corporate Bonds (Trust Preferred Securities)	—		—		21,143		21,143
Mortgage-backed securities	—		1,641		—		1,641
Equity securities	—		123		—		123
	—		3,425		21,143		24,568
Securities—available-for-sale
U.S. Government and agency obligations	—		56,978		—		56,978
Municipal bonds	—		109,853		—		109,853
Corporate bonds	—		10,283		—		10,283
Mortgage-backed securities	—		594,712		—		594,712
Asset-backed securities	—		28,993		—		28,993
Equity securities	—		98		—		98
	—		800,917		—		800,917

Loans held for sale	—		9,600		—		9,600

Derivatives
Interest rate swaps	—		8,330		—		8,330
Interest rate lock and forward sales commitments	—		482		—		482
	$	—	$	822,754	$	21,143	$	843,897

Liabilities:
Advances from FHLB	$	—	$	54,216	$	—	$	54,216
Junior subordinated debentures, net of unamortized deferred issuance costs	—		—		95,200		95,200
Derivatives
Interest rate swaps	—		8,330		—		8,330
Interest rate lock and forward sales commitments	—		289		—		289
	$	—	$	62,835	$	95,200	$	158,035

The following methods were used to estimate the fair value of each class of financial instruments above:

Cash and Cash Equivalents: 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 continued limited activity in the trust preferred markets that have limited the observability of market spreads for some of the Company’s Trust Preferred Securities (TPS) securities, management has classified these securities as a Level 3 fair value measure. Management periodically reviews the pricing information received from third-party pricing services and tests those prices against other sources to validate the reported fair values.

Loans Held for Sale: Fair values for residential mortgage loans held for sale are determined by comparing actual loan rates to current secondary market prices for similar loans. Fair values for multifamily loans held for sale are calculated based on discounted cash flows using as a discount rate a combination of market spreads for similar loan types added to selected index rates.

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. 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. Fair value for impaired loans is also 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.

Bank-Owned Life Insurance: The fair value of BOLI policies owned is based on the various insurance contracts' cash surrender value.

Mortgage Servicing Rights: Fair values are estimated based on an independent dealer analysis of discounted cash flows. The evaluation utilizes assumptions market participants would use in determining fair value including prepayment speeds, delinquency and foreclosure rates, the discount rate, servicing costs, and the timing of cash flows. The mortgage servicing portfolio is stratified by loan type and fair value estimates are adjusted up or down based on the serviced loan interest rates versus current rates on new loan originations since the most recent independent analysis.

Deposits: The carrying amount of deposits with no stated maturity, such as savings and checking accounts, is a reasonable estimate of their fair value. The market value of certificates of deposit is based upon the discounted value of contractual cash flows. The discount rate is determined using current market rates on comparable instruments.

FHLB Advances: Fair valuations for Banner’s FHLB advances are estimated using fair market values provided by the lender, the FHLB of Des Moines. The FHLB of Des Moines prices advances by discounting the future contractual cash flows for individual advances, using its current cost of funds curve to provide the discount rate.

Junior Subordinated Debentures: The fair value of junior subordinated debentures is estimated using a discounted cash flow approach. The significant inputs included in the estimation of fair value are the credit risk adjusted spread and three month LIBOR. The credit risk adjusted spread represents the nonperformance risk of the liability. The Company utilizes an external valuation firm to validate the reasonableness of the credit risk adjusted spread used to determine the fair value. The junior subordinated debentures are carried at fair value which represents the estimated amount that would be paid to transfer these liabilities in an orderly transaction amongst market participants. Due to credit concerns in the capital markets and inactivity in the trust preferred markets that have limited the observability of market spreads, management has classified this as a Level 3 fair value measure.

Other Borrowings: Other borrowings include securities sold under agreements to repurchase and occasionally federal funds purchased and their carrying amount is considered a reasonable approximation of their fair value.

Derivatives: Derivatives include interest rate swap agreements, interest rate lock commitments to originate loans held for sale and forward sales contracts to sell loans and securities related to mortgage banking activities. Fair values for these instruments, which generally change as a result of changes in the level of market interest rates, are estimated based on dealer quotes and secondary market sources.

Off-Balance-Sheet Items: Off-balance-sheet financial instruments include unfunded commitments to extend credit, including standby letters of credit, and commitments to purchase investment securities. The fair value of these instruments is not considered to be material.

Limitations: The fair value estimates presented herein are based on pertinent information available to management as of March 31, 2017 and December 31, 2016. The factors used in the fair values estimates are subject to change subsequent to the dates the fair value estimates are completed, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3):

The following table provides a description of the valuation technique, unobservable inputs, and qualitative information about the unobservable inputs for certain of the Company's assets and liabilities classified as Level 3 and measured at fair value on a recurring and non-recurring basis at March 31, 2017 and December 31, 2016:



			Weighted Average Rate
Financial Instruments	Valuation Techniques	Unobservable Inputs	March 31, 2017		December 31, 2016
Corporate Bonds (TPS securities)	Discounted cash flows	Discount rate	6.15	%	6.00	%
Junior subordinated debentures	Discounted cash flows	Discount rate	6.15		6.00
Impaired loans	Collateral Valuations	Discount to appraised value	25	%	n/a
REO	Appraisals	Discount to appraised value	0% to 45%		0% to 45%

TPS securities : Management believes that the credit risk-adjusted spread used to develop the discount rate utilized in the fair value measurement of TPS securities is indicative of the risk premium a willing market participant would require under current market conditions for instruments with similar contractual rates and terms and conditions and issuers with similar credit risk profiles and with similar expected probability of default. Management attributes the change in fair value of these instruments, compared to their par value, primarily to perceived general market adjustments to the risk premiums for these types of assets subsequent to their issuance.

Junior subordinated debentures: Similar to the TPS securities discussed above, management believes that the credit risk-adjusted spread utilized in the fair value measurement of the junior subordinated debentures is indicative of the risk premium a willing market participant would require under current market conditions for an issuer with Banner's credit risk profile. Management attributes the change in fair value of the junior subordinated debentures, compared to their par value, primarily to perceived general market adjustments to the risk premiums for these types of liabilities subsequent to their issuance. Future contractions in the risk adjusted spread relative to the spread currently utilized to measure the Company's junior subordinated debentures at fair value as of March 31, 2017, or the passage of time, will result in negative fair value adjustments. At March 31, 2017, the discount rate utilized was based on a credit spread of 500 basis points and three-month LIBOR of 115 basis points.

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 months ended March 31, 2017 and 2016 (in thousands):



	Three Months Ended
	March 31, 2017
	Level 3 Fair Value Inputs
	TPS Securities		Borrowings—Junior Subordinated Debentures
Beginning balance	$	21,143	$	95,200
Total gains or losses recognized
Assets gains	218		—
Liabilities losses	—		840
Ending balance at March 31, 2017	$	21,361	$	96,040

	Three Months Ended
	March 31, 2016
	Level 3 Fair Value Inputs
	TPS Securities		Borrowings—Junior Subordinated Debentures
Beginning balance	$	18,699	$	92,480
Total gains or losses recognized
Assets gains	119		—
Liabilities losses	—		399
Purchases, issuances and settlements, including acquisitions	1,725		—
Ending balance at March 31, 2016	$	20,543	$	92,879

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 non-interest income.

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

The following tables present financial assets measured at fair value on a non-recurring basis and the level within the fair value hierarchy of the fair value measurements for those assets as of March 31, 2017 and December 31, 2016 (in thousands):



	March 31, 2017
	Level 1		Level 2		Level 3		Total
Impaired loans	$	—	$	—	$	680	$	680
REO	—		—		3,040		3,040

	December 31, 2016
	Level 1		Level 2		Level 3		Total
REO	—		—		11,081		11,081

The following table presents the gains (losses) resulting from non-recurring fair value adjustments for the three months ended March 31, 2017 and 2016 (in thousands):



	Three months ended March 31,
	2017			2016
Impaired loans	$	—		$	(16	)
REO	(50		)	(205		)
Total gain (loss) from non-recurring measurements	$	(50	)	$	(221	)

Impaired loans: Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of collateral if the loan is collateral dependent. If this practical expedient is used, the impaired loans are considered to be held at fair value. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. Impaired loans are periodically evaluated to determine if valuation adjustments, or partial write-downs, should be recorded. The need for valuation adjustments arises when observable market prices or current appraised values of collateral indicate a shortfall in collateral value 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 losses or charges off the impaired amount. These valuation adjustments are considered non-recurring fair value adjustments. The remaining impaired loans are evaluated for reserve needs in homogenous pools within the Company’s methodology for assessing the adequacy of the allowance for loan losses.

REO: The Company records REO (acquired through a lending relationship) at fair value on a non-recurring basis. Fair value adjustments on REO are based on updated real estate appraisals which are based on current market conditions. All REO properties are recorded at the lower of the estimated fair value of the real estate, less expected selling costs, or the carrying amount of the defaulted loans. From time to time, non-recurring fair value adjustments to REO are recorded to reflect partial write-downs based on an observable market price or current appraised value of property. Banner considers any valuation inputs related to REO to be Level 3 inputs. The individual carrying values of these assets are reviewed for impairment at least annually and any additional impairment charges are expensed to operations.