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FAIR VALUE OF FINANCIAL INSTRUMENTS

9 Months Ended

Sep. 30, 2023

The following table presents estimated fair values of the Company’s financial instruments as of September 30, 2023 and December 31, 2022, whether or not recognized or recorded in the Consolidated Statements of Financial Condition (dollars in thousands):


		September 30, 2023				December 31, 2022
	Level	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Assets:
Cash and cash equivalents	1	$	251,706	$	251,706	$	243,062	$	243,062
Securities—trading	3	25,268		25,268		28,694		28,694
Securities—available-for-sale	2	2,287,993		2,287,993		2,789,031		2,789,031
Securities—held-to-maturity	2	1,074,574		846,061		1,109,319		933,513
Securities—held-to-maturity	3	7,582		7,592		8,648		8,667
Securities purchased under agreements to resell	2	—		—		300,000		300,000
Loans held for sale	2	54,158		54,213		56,857		56,948
Loans receivable, net	3	10,464,457		9,914,151		10,005,259		9,810,965
Equity securities	1	552		552		553		553
FHLB stock	3	15,600		15,600		12,000		12,000
Bank-owned life insurance	1	303,347		303,347		297,565		297,565
Mortgage servicing rights	3	14,151		36,469		15,331		35,148
SBA servicing rights	3	717		717		835		835
Investments in limited partnerships	3	12,841		12,841		12,427		12,427
Derivatives:
Interest rate swaps	2	23,809		23,809		19,339		19,339
Interest rate lock and forward sales commitments	2,3	338		338		142		142
Liabilities:
Demand, interest checking and money market accounts	2	8,964,786		8,964,786		10,186,439		10,186,439
Regular savings	2	2,751,453		2,751,453		2,710,090		2,710,090
Certificates of deposit	2	1,458,313		1,440,378		723,530		702,581
FHLB advances	2	140,000		140,000		50,000		50,000
Other borrowings	2	188,440		188,440		232,799		232,799
Subordinated notes, net	2	92,748		90,322		98,947		96,718
Junior subordinated debentures	3	66,284		66,284		74,857		74,857
Derivatives:
Interest rate swaps	2	45,938		45,938		37,150		37,150

Interest rate lock and forward sales commitments	2,3	25		25		118		118
Risk participation agreement	2	19		19		67		67

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). When measuring fair value, management will maximize the use of observable inputs and minimize the use of unobservable inputs whenever possible. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s estimates for market assumptions.

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.

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 September 30, 2023 and December 31, 2022 (in thousands):


	September 30, 2023
	Level 1		Level 2		Level 3		Total
Assets:
Securities—trading


Corporate bonds (Trust Preferred Securities)	$	—	$	—	$	25,268	$	25,268



Securities—available-for-sale
U.S. Government and agency obligations	—		34,327		—		34,327
Municipal bonds	—		123,598		—		123,598
Corporate bonds	—		91,018		—		91,018
Mortgage-backed or related securities	—		1,819,452		—		1,819,452
Asset-backed securities	—		219,598		—		219,598
	—		2,287,993		—		2,287,993

Loans held for sale(1)	—		11,634		—		11,634
Equity securities	552		—		—		552
SBA servicing rights	—		—		717		717
Investment in limited partnerships	—		—		12,841		12,841

Derivatives
Interest rate swaps	—		23,809		—		23,809
Interest rate lock and forward sales commitments	—		236		102		338
	$	552	$	2,323,672	$	38,928	$	2,363,152

Liabilities:

Junior subordinated debentures	$	—	$	—	$	66,284	$	66,284
Derivatives
Interest rate swaps	—		45,938		—		45,938

Interest rate lock and forward sales commitments	—		—		25		25
Risk participation agreement	—		19		—		19
	$	—	$	45,957	$	66,309	$	112,266


	December 31, 2022
	Level 1		Level 2		Level 3		Total
Assets:
Securities—trading


Corporate bonds (Trust Preferred Securities)	$	—	$	—	$	28,694	$	28,694




Securities—available-for-sale
U.S. Government and agency obligations	—		55,108		—		55,108
Municipal bonds	—		261,209		—		261,209
Corporate bonds	—		121,853		—		121,853
Mortgage-backed or related securities	—		2,139,336		—		2,139,336
Asset-backed securities	—		211,525		—		211,525

	—		2,789,031		—		2,789,031

Loans held for sale(1)	—		2,305		—		2,305
Equity securities	553		—		—		553
SBA servicing rights	—		—		835		835
Investment in limited partnerships	—		—		12,427		12,427

Derivatives
Interest rate swaps	—		19,339		—		19,339
Interest rate lock and forward sales commitments	—		61		81		142
	$	553	$	2,810,736	$	42,037	$	2,853,326

Liabilities:

Junior subordinated debentures	$	—	$	—	$	74,857	$	74,857
Derivatives
Interest rate swaps	—		37,150		—		37,150

Interest rate lock and forward sales commitments	—		76		42		118
Risk participation agreement	—		67		—		67
	$	—	$	37,293	$	74,899	$	112,192

(1) The unpaid principal balance of residential mortgage loans held for sale carried at fair value on a recurring basis was $11.5 million and $2.2 million at September 30, 2023 and December 31, 2022, respectively.

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

Securities: The estimated fair values of investment securities and mortgage-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), 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.

Equity Securities: Equity securities are invested in a publicly traded stock. The fair value of these securities is based on daily quoted market prices.

SBA Servicing Rights: Fair values are estimated based on an independent dealer analysis by discounting estimated net future cash flows from servicing. 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 SBA 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 SOFR (Secured Overnight Financing Rate). 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 measurement.

Derivatives: Derivatives include interest rate swap agreements, interest rate lock commitments to originate loans held for sale, forward sales contracts to sell loans and securities related to mortgage banking activities and risk participation agreements. 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. As the interest rate lock commitments use a pull-through rate that is considered an unobservable input, these derivatives are classified as a level 3 fair value measurement.

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 September 30, 2023 and December 31, 2022. 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, and 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 non-recurring basis at September 30, 2023 and December 31, 2022:


			Weighted Average Rate
Financial Instruments	Valuation Technique	Unobservable Inputs	September 30, 2023		December 31, 2022
Corporate bonds (TPS)	Discounted cash flows	Discount rate	10.91	%	8.27	%

Junior subordinated debentures	Discounted cash flows	Discount rate	10.91	%	8.27	%

Loans individually evaluated	Collateral valuations	Discount to appraised value	n/a		n/a
REO	Appraisals	Discount to appraised value	58.18	%	68.35	%

Interest rate lock commitments	Pricing model	Pull-through rate	92.79	%	78.65	%

SBA servicing rights	Discounted cash flows	Constant prepayment rate	15.91	%	14.10	%

Trust preferred securities: Management believes that the credit risk-adjusted spread used to develop the discount rate utilized in the fair value measurement of TPS 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 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 September 30, 2023, or the passage of time, will result in negative fair value adjustments. At September 30, 2023, the discount rate utilized was based on a credit spread of 551 basis points and three-month SOFR of 540 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.

SBA servicing asset: The constant prepayment rate (CPR) is set based on industry data. An increase in the CPR would result in a negative fair value adjustment, where a decrease in CPR would result in a positive fair value adjustment.

The following tables provide 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, 2023 and 2022 (in thousands):


	Three Months Ended
	September 30, 2023
	Level 3 Fair Value Inputs
	TPS		Borrowings—Junior Subordinated Debentures		Interest Rate Lock and Forward Sales Commitments		Investments in Limited Partnerships		SBA Servicing Asset
Beginning balance	$	25,659	$	67,237	$	268	$	12,776	$	845
Net change recognized in earnings	(391)		—		(191)		(268)		(128)
Net change recognized in accumulated other comprehensive income (AOCI)	—		(953)		—		—		—
Purchases, issuances and settlements	—		—		—		333		—


Ending balance at September 30, 2023	$	25,268	$	66,284	$	77	$	12,841	$	717

	Nine Months Ended
	September 30, 2023
	Level 3 Fair Value Inputs
	TPS Securities		Borrowings—Junior Subordinated Debentures		Interest Rate Lock and Forward Sales Commitments		Investments in Limited Partnerships		SBA Servicing Asset
Beginning balance	$	28,694	$	74,857	$	39	$	12,427	$	835
Net change recognized in earnings	(3,426)		—		38		(930)		(118)
Net change recognized in AOCI	—		(8,573)		—		—		—
Purchases, issuances and settlements	—		—		—		1,344		—



Ending balance at September 30, 2023	$	25,268	$	66,284	$	77	$	12,841	$	717

	Three Months Ended
	September 30, 2022
	Level 3 Fair Value Inputs
	TPS		Borrowings—Junior Subordinated Debentures		Interest Rate Lock and Forward Sales Commitments		Investments in Limited Partnerships		SBA Servicing Asset
Beginning balance	$	27,886	$	72,229	$	357	$	11,881	$	1,015
Net change recognized in earnings	497		—		(389)		(38)		(72)
Net change recognized in AOCI	—		1,612		—		—		—
Purchases, issuances and settlements	—		—		—		296		—



Ending balance at September 30, 2022	$	28,383	$	73,841	$	(32)	$	12,139	$	943

	Nine Months Ended
	September 30, 2022
	Level 3 Fair Value Inputs
	TPS Securities		Borrowings—Junior Subordinated Debentures		Interest Rate Lock and Forward Sales Commitments		Investments in Limited Partnerships		SBA Servicing Asset
Beginning balance	$	26,981	$	119,815	$	1,467	$	10,257	$	1,161
Net change recognized in earnings	1,402		765		(1,499)		(410)		(218)
Net change recognized in AOCI	—		3,779		—		—		—
Purchases, issuances and settlements	—		—		—		2,292		—
Redemptions	—		(50,518)		—		—		—


Ending balance at September 30, 2022	$	28,383	$	73,841	$	(32)	$	12,139	$	943

Interest income and dividends from TPS are recorded 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 value of the junior subordinated debentures, which represents changes in instrument specific credit risk, is recorded in other comprehensive income. The change in fair value of TPS securities, investments in limited partnerships and the SBA servicing asset are recorded as a component of non-interest income. The change in fair value of the interest rate lock and forward sales commitments are included in mortgage banking operations in non-interest income.

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

The following tables present 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 as of September 30, 2023 and December 31, 2022 (in thousands):


	September 30, 2023
	Level 1		Level 2		Level 3		Total

REO	$	—	$	—	$	546	$	546

Loans held for sale	—		40,063		—		40,063

	December 31, 2022
	Level 1		Level 2		Level 3		Total
Loans individually evaluated	$	—	$	—	$	1,883	$	1,883
REO	—		—		340		340
Loans held for sale	—		49,474		—		49,474

The following table presents the gains and losses resulting from non-recurring fair value adjustments for the three and nine months ended September 30, 2023 and September 30, 2022 (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2023		2022		2023		2022

REO	$	—	$	—	$	—	$	—
Loans held for sale	(456)		(2,200)		(919)		(3,261)
Total loss from non-recurring measurements	$	(456)	$	(2,200)	$	(919)	$	(3,261)

Loans individually evaluated: Expected credit losses for loans evaluated individually are measured based on the present value of expected future cash flows discounted at the loan’s original effective interest rate or when the Bank determines that foreclosure is probable, the expected credit loss is measured based on the fair value of the collateral as of the reporting date, less estimated selling costs, as applicable. As a practical expedient, the Bank measures the expected credit loss for a loan using the fair value of the collateral, if repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty based on the Bank’s assessment as of the reporting date. In both cases, if the fair value of the collateral is less than the amortized cost basis of the loan, the Bank will recognize an allowance as the difference between the fair value of the collateral, less costs to sell (if applicable) and the amortized cost basis of the loan. If the fair value of the collateral exceeds the amortized cost basis of the loan, any expected recovery added to the amortized cost basis will be limited to the amount previously charged-off. Subsequent changes in the expected credit losses for loans evaluated individually are included within the provision for credit losses in the same manner in which the expected credit loss initially was recognized or as a reduction in the provision that would otherwise be reported.

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.

Loans held for sale: The multifamily held for sale loans are carried at the lower of cost or market value. Lower of cost or market adjustments for multifamily loans held for sale are calculated based on discounted cash flows using a discount rate that is a combination of market spreads for similar loan types added to selected index rates. If the fair value of the multifamily held for sale loans is lower than the amortized cost basis of the loans, a net unrealized loss is recognized through the valuation allowance as a charge against income.

- 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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