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FAIR VALUE OF FINANCIAL INSTRUMENTS

12 Months Ended

Dec. 31, 2019

FAIR VALUE

The following table presents estimated fair values of the Company’s financial instruments as of December 31, 2019 and 2018, whether or not recognized or recorded in the Consolidated Statements of Financial Condition (in thousands):



		December 31, 2019				December 31, 2018
	Level	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Assets:
Cash and cash equivalents	1	$	307,735	$	307,735	$	272,196	$	272,196
Securities—trading	2,3	25,636		25,636		25,896		25,896
Securities—available-for-sale	2	1,551,557		1,551,557		1,636,223		1,636,223
Securities—held-to-maturity	2	233,241		234,952		230,984		229,301
Securities—held-to-maturity	3	2,853		2,853		3,236		3,236
Loans receivable held for sale	2	210,447		210,670		171,031		171,157
Loans receivable	3	9,305,357		9,304,340		8,684,595		8,629,450
FHLB stock	3	28,342		28,342		31,955		31,955
Bank-owned life insurance	1	192,088		192,088		177,467		177,467
Mortgage servicing rights	3	14,148		22,611		14,638		25,813
Equity securities	1	—		—		352		352
Derivatives:
Interest rate swaps	2	15,202		15,202		3,138		3,138
Interest rate lock and forward sales commitments	2,3	1,108		1,108		471		471
Liabilities:
Demand, interest-bearing checking and money market	2	6,994,197		6,994,197		6,314,202		6,314,202
Regular savings	2	1,934,041		1,934,041		1,842,581		1,842,581
Certificates of deposit	2	1,120,403		1,117,921		1,320,265		1,298,238
Advances from FHLB	2	450,000		452,720		540,189		540,189
Junior subordinated debentures at fair value	3	119,304		119,304		114,091		114,091
Other borrowings	2	118,474		118,474		118,995		118,995
Derivatives:
Interest rate swaps	2	10,966		10,966		3,138		3,138
Interest rate lock and forward sales commitments	2	674		674		1,654		1,654

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 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. 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.

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 many of the 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 December 31, 2019 and 2018 (in thousands):



	December 31, 2019
	Level 1		Level 2		Level 3		Total
Assets:
Securities—trading
Corporate Bonds (TPS securities)	$	—	$	—	$	25,636	$	25,636

Securities—available-for-sale
U.S. Government and agency	—		89,598		—		89,598
Municipal bonds	—		107,157		—		107,157
Corporate bonds	—		4,365		—		4,365
Mortgage-backed securities	—		1,342,311		—		1,342,311
Asset-backed securities	—		8,126		—		8,126
	—		1,551,557		—		1,551,557

Loans held for sale	—		199,397		—		199,397

Derivatives
Interest rate swaps	—		15,202		—		15,202
Interest rate lock and forward sales commitments	—		317		791		1,108
	$	—	$	1,766,473	$	26,427	$	1,792,900
Liabilities
Junior subordinated debentures at fair value	$	—	$	—	$	119,304	$	119,304
Derivatives
Interest rate swaps	—		10,966		—		10,966
Interest rate lock and forward sales commitments	—		674		—		674
	$	—	$	11,640	$	119,304	$	130,944



	December 31, 2018
	Level 1		Level 2		Level 3		Total
Assets:
Securities—trading
Corporate Bonds (TPS securities)	$	—	$	—	$	25,896	$	25,896

Securities—available-for-sale
U.S. Government and agency	—		149,112		—		149,112
Municipal bonds	—		117,822		—		117,822
Corporate bonds	—		3,495		—		3,495
Mortgage-backed securities	—		1,343,861		—		1,343,861
Asset-backed securities	—		21,933		—		21,933
	—		1,636,223		—		1,636,223

Loans held for sale	—		164,767		—		164,767
Equity securities	—		352		—		352

Derivatives
Interest rate swaps	—		3,138		—		3,138
Interest rate lock and forward sales commitments	—		198		273		471
	$	—	$	1,804,678	$	26,169	$	1,830,847
Liabilities
Junior subordinated debentures at fair value	$	—	$	—	$	114,091	$	114,091
Derivatives
Interest rate swaps	—		3,138		—		3,138
Interest rate lock and forward sales commitments	—		1,654		—		1,654
	$	—	$	4,792	$	114,091	$	118,883

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

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 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.

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.

Junior Subordinated Debentures: The fair value of junior subordinated debentures is estimated using an income approach technique. 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 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.

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 December 31, 2019 and 2018. The factors used in the fair value 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, quantitative and qualitative information about the unobservable inputs for the Company's assets and liabilities classified as Level 3 and measured at fair value on a recurring and nonrecurring basis at December 31, 2019 and 2018:



			December 31
			2019		2018
Financial Instruments	Valuation Technique	Unobservable Inputs	Weighted Average Rate		Weighted Average Rate
Corporate bonds (TPS securities)	Discounted cash flows	Discount rate	5.91	%	6.81	%
Junior subordinated debentures	Discounted cash flows	Discount rate	5.91	%	6.81	%
Impaired loans	Collateral valuations	Discount to appraised value	0.0% to 20.0%		0.0% to 8.5%
REO	Appraisals	Discount to appraised value	58.5	%	69.2	%
Interest rate lock commitments	Pricing model	Pull-through rate	89.61	%	88.96	%

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, 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 December 31, 2019, or the passage of time, will result in negative fair value adjustments. At December 31, 2019, the discount rate utilized was based on a credit spread of 400 basis points and three month LIBOR of 191 basis points.

Interest rate lock commitments: The fair value of the interest rate lock commitments is based on secondary market sources adjusted for an estimated pull-through rate. The pull-through rate is based on historical loan closing rates for similar interest rate lock commitments. An increase or decrease in the pull-through rate would have a corresponding, positive or negative fair value adjustment.

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 years ended December 31, 2019 and 2018 (in thousands):



	Level 3 Fair Value Inputs
	TPS Securities			Borrowings— Junior Subordinated Debentures
Balance at January 1, 2018	$	22,058		$	98,707
Total gains or losses recognized
Assets gains	3,838			—
Liabilities losses	—			15,384
Balance at December 31, 2018	25,896			114,091
Total gains or losses recognized
Assets gains	(260		)	—
Liabilities losses	—			(601		)
Purchases, issuances and settlements, including acquisitions	—			5,814
Balance at December 31, 2019	$	25,636		$	119,304

Interest income and dividends from the TPS securities are recoded as a component of interest income. Interest expense related to the junior subordinated debentures is measured based on contractual interest rates and reported in interest expense. The change in fair market value on TPS securities and on junior subordinated debentures prior to 2018 has been recorded as a component of non-interest income. Beginning in 2018, the change in fair value of the junior subordinated debentures, which represents changes in instrument specific credit risk, is recorded in other comprehensive income (loss).

Items Measured at Fair Value on a Non-recurring Basis

The following table presents financial assets and liabilities 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 at December 31, 2019 and 2018 (in thousands):



	December 31, 2019
	Level 1		Level 2		Level 3		Total
Impaired loans	$	—	$	—	$	14,853	$	14,853
REO	$	—	$	—	$	814	$	814

	December 31, 2018
	Level 1		Level 2		Level 3		Total
Impaired loans	$	—	$	—	$	2,915	$	2,915
REO	—		—		2,611		2,611

The following table presents the losses resulting from non-recurring fair value adjustments for the years ended December 31, 2019, 2018 and 2017 (in thousands):



	For the years ended December 31,
	2019			2018			2017
Impaired loans	$	(425	)	$	(910	)	$	(2,852	)
REO	—			(387		)	(256		)
Total loss from nonrecurring measurements	$	(425	)	$	(1,297	)	$	(3,108	)

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.

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 estimated fair value of the real estate, less expected selling costs. 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.

- 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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