| Fair Value Measurements | Fair Value Measurements The Company records 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. Fair value measurements are also utilized to determine the initial value of certain assets and liabilities, to perform impairment assessments, and for disclosure purposes. The Company uses quoted market prices and observable inputs to the maximum extent possible when measuring fair value. In the absence of quoted market prices, various valuation techniques are utilized to measure fair value. When possible, observable market data for identical or similar financial instruments is used in the valuation. When market data is not available, fair value is determined using valuation models that incorporate management’s estimates of the assumptions a market participant would use in pricing the asset or liability. Fair value measurements are classified within one of three levels based on the observability of the inputs used to determine fair value, as follows: • Level 1 — The valuation is based on quoted prices in active markets for identical instruments. • Level 2 — The valuation is based on observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. • Level 3 — The valuation is based on unobservable inputs that are supported by minimal or no market activity and that are significant to the fair value of the instrument. Level 3 valuations are typically performed using pricing models, discounted cash flow methodologies, or similar techniques that incorporate management’s own estimates of assumptions that market participants would use in pricing the instrument, or valuations that require significant management judgment or estimation. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company elected fair value accounting for mortgages held for sale and for its best-efforts forward sales commitments. The Company economically hedges its mortgages held for sale by either selling corresponding forward contracts on agency securities (free-standing derivatives) or obtaining best-efforts forward sales commitments with an investor to sell the loans at an agreed-upon price at the time the interest rate locks are issued to customers. The Company believes the election for mortgages held for sale will reduce certain timing differences and better match changes in the value of these assets with changes in the value of derivatives or best-best efforts forward sales commitments. At June 30, 2020 and December 31, 2019, all mortgages held for sale were carried at fair value. The following table shows the differences between the fair value carrying amount of mortgages held for sale measured at fair value and the aggregate unpaid principal amount the Company is contractually entitled to receive at maturity. (Dollars in thousands) Fair value carrying Aggregate Excess of fair value carrying amount over (under) unpaid principal June 30, 2020 Mortgages held for sale reported at fair value $ 36,508 $ 34,478 $ 2,030 (1) December 31, 2019 Mortgages held for sale reported at fair value $ 20,277 $ 19,890 $ 387 (1) (1) The excess of fair value carrying amount over (under) unpaid principal is included in mortgage banking income and includes changes in fair value at and subsequent to funding and gains and losses on the related loan commitment prior to funding. Financial Instruments on Recurring Basis: The following is a description of the valuation methodologies used for financial instruments measured at fair value on a recurring basis: Investment securities available-for-sale are valued primarily by a third party pricing agent. Prices supplied by the independent pricing agent, as well as their pricing methodologies and assumptions, are reviewed by the Company for reasonableness and to ensure such prices are aligned with market levels. In general, the Company’s investment securities do not possess a complex structure that could introduce greater valuation risk. The portfolio mainly consists of traditional investments including U.S. Treasury and Federal agencies securities, Federal agency mortgage pass-through securities, and general obligation and revenue municipal bonds. Pricing for such instruments is fairly generic and is easily obtained. On a quarterly basis, prices supplied by the pricing agent are validated by comparison to prices obtained from other third party sources for a material portion of the portfolio. The valuation policy and procedures for Level 3 fair value measurements of available-for-sale debt securities are decided through collaboration between management of the Corporate Accounting and Funds Management departments. The changes in fair value measurement for Level 3 securities are analyzed on a periodic basis under a collaborative framework with the aforementioned departments. The methodology and variables used for input are derived from the combination of observable and unobservable inputs. The unobservable inputs are determined through internal assumptions that may vary from period to period due to external factors, such as market movement and credit rating adjustments. Both the market and income valuation approaches are implemented using the following types of inputs: • U.S. treasuries are priced using the market approach and utilizing live data feeds from active market exchanges for identical securities. • Government-sponsored agency debt securities and corporate bonds are primarily priced using available market information through processes such as benchmark curves, market valuations of like securities, sector groupings and matrix pricing. • Other government-sponsored agency securities, mortgage-backed securities and some of the actively traded REMICs and CMOs, are primarily priced using available market information including benchmark yields, prepayment speeds, spreads and volatility of similar securities. • State and political subdivisions are largely grouped by characteristics, i.e., geographical data and source of revenue in trade dissemination systems. Since some securities are not traded daily and due to other grouping limitations, active market quotes are often obtained using benchmarking for like securities. Local direct placement municipal securities, with very little market activity, are priced using an appropriate market yield curve, which includes a credit spread assumption. Mortgages held for sale and the related loan commitments and forward contracts (hedges) are valued using a market value approach and utilizing an appropriate current market yield and a loan commitment closing rate based on historical analysis. Interest rate swap positions, both assets and liabilities, are valued by a third-party pricing agent using an income approach and utilizing models that use as their basis readily observable market parameters. This valuation process considers various factors including interest rate yield curves, time value and volatility factors. Validation of third party agent valuations is accomplished by comparing those values to the Company’s swap counterparty valuations. Management believes an adjustment is required to “mid-market” valuations for derivatives tied to its performing loan portfolio to recognize the imprecision and related exposure inherent in the process of estimating expected credit losses as well as velocity of deterioration evident with systemic risks embedded in these portfolios. Any change in the mid-market derivative valuation adjustment will be recognized immediately through the Consolidated Statements of Income. The following table shows the balance of assets and liabilities measured at fair value on a recurring basis. (Dollars in thousands) Level 1 Level 2 Level 3 Total June 30, 2020 Assets: Investment securities available-for-sale: U.S. Treasury and Federal agencies securities $ 82,605 $ 463,014 $ — $ 545,619 U.S. States and political subdivisions securities — 70,933 3,179 74,112 Mortgage-backed securities — Federal agencies — 391,278 — 391,278 Corporate debt securities — 44,088 — 44,088 Foreign government and other securities — 700 — 700 Total debt securities available-for-sale 82,605 970,013 3,179 1,055,797 Mortgages held for sale — 36,508 — 36,508 Accrued income and other assets (interest rate swap agreements) — 55,782 — 55,782 Total $ 82,605 $ 1,062,303 $ 3,179 $ 1,148,087 Liabilities: Accrued expenses and other liabilities (interest rate swap agreements) $ — $ 56,793 $ — $ 56,793 Total $ — $ 56,793 $ — $ 56,793 December 31, 2019 Assets: Investment securities available-for-sale: U.S. Treasury and Federal agencies securities $ 80,393 $ 446,571 $ — $ 526,964 U.S. States and political subdivisions securities — 82,213 2,292 84,505 Mortgage-backed securities — Federal agencies — 375,389 — 375,389 Corporate debt securities — 53,025 — 53,025 Foreign government and other securities — 700 — 700 Total debt securities available-for-sale 80,393 957,898 2,292 1,040,583 Mortgages held for sale — 20,277 — 20,277 Accrued income and other assets (interest rate swap agreements) — 21,975 — 21,975 Total $ 80,393 $ 1,000,150 $ 2,292 $ 1,082,835 Liabilities: Accrued expenses and other liabilities (interest rate swap agreements) $ — $ 22,352 $ — $ 22,352 Total $ — $ 22,352 $ — $ 22,352 The following table shows changes in Level 3 assets measured at fair value on a recurring basis for the quarter ended June 30, 2020 and 2019. (Dollars in thousands) U.S. States and Beginning balance April 1, 2020 $ 5,295 Total gains or losses (realized/unrealized): Included in earnings — Included in other comprehensive income (97) Purchases — Issuances — Sales — Settlements — Maturities (2,019) Transfers into Level 3 — Transfers out of Level 3 — Ending balance June 30, 2020 $ 3,179 Beginning balance April 1, 2019 $ 5,064 Total gains or losses (realized/unrealized): Included in earnings — Included in other comprehensive income 16 Purchases — Issuances — Sales — Settlements — Maturities (19) Transfers into Level 3 — Transfers out of Level 3 — Ending balance June 30, 2019 $ 5,061 There were no gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at June 30, 2020 or 2019. The following table shows the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a recurring basis. (Dollars in thousands) Fair Value Valuation Methodology Unobservable Inputs Range of Inputs Weighted Average June 30, 2020 Debt securities available-for sale Direct placement municipal securities $ 3,179 Discounted cash flows Credit spread assumption 0.16% - 3.99% 3.10 % December 31, 2019 Debt securities available-for sale Direct placement municipal securities $ 2,292 Discounted cash flows Credit spread assumption 0.12% - 2.85% Financial Instruments on Non-recurring Basis: The Company may be required, from time to time, to measure certain other financial assets at fair value on a non-recurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower of cost or market accounting or impairment charges of individual assets. The Credit Policy Committee (CPC), a management committee, is responsible for overseeing the valuation processes and procedures for Level 3 measurements of impaired loans, other real estate and repossessions. The CPC reviews these assets on a quarterly basis to determine the accuracy of the observable inputs, generally third party appraisals, auction values, values derived from trade publications and data submitted by the borrower, and the appropriateness of the unobservable inputs, generally discounts due to current market conditions and collection issues. The CPC establishes discounts based on asset type and valuation source; deviations from the standard are documented. The discounts are reviewed periodically, annually at a minimum, to determine they remain appropriate. Consideration is given to current trends in market values for the asset categories and gains and losses on sales of similar assets. The Loan and Funds Management Committee of the Board of Directors is responsible for overseeing the CPC. Discounts vary depending on the nature of the assets and the source of value. Aircraft are generally valued using quarterly trade publications adjusted for engine time, condition, maintenance programs, discounted by 10%. Likewise, autos are valued using current auction values, discounted by 10%; medium and heavy duty trucks are valued using trade publications and auction values, discounted by 15%. Construction equipment is generally valued using trade publications and auction values, discounted by 20%. Real estate is valued based on appraisals or evaluations, discounted by 20% with higher discounts for property in poor condition or property with characteristics which may make it more difficult to market. Commercial loans subject to borrowing base certificates are generally discounted by 20% for receivables and 40% - 75% for inventory with higher discounts when monthly borrowing base certificates are not required or received. Impaired loans and related write-downs are based on the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are reviewed quarterly and estimated using customized discounting criteria, appraisals and dealer and trade magazine quotes which are used in a market valuation approach. In accordance with fair value measurements, only impaired loans for which a reserve for loan loss has been established based on the fair value of collateral require classification in the fair value hierarchy. As a result, only a portion of the Company’s impaired loans are classified in the fair value hierarchy. The Company has established MSRs valuation policies and procedures based on industry standards and to ensure valuation methodologies are consistent and verifiable. MSRs and related adjustments to fair value result from application of lower of cost or fair value accounting. For purposes of impairment, MSRs are stratified based on the predominant risk characteristics of the underlying servicing, principally by loan type. The fair value of each tranche of the servicing portfolio is estimated by calculating the present value of estimated future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other economic factors. Prepayment rates and discount rates are derived through a third party pricing agent. Changes in the most significant inputs, including prepayment rates and discount rates, are compared to the changes in the fair value measurements and appropriate resolution is made. A fair value analysis is also obtained from an independent third party agent and compared to the internal valuation for reasonableness. MSRs do not trade in an active, open market with readily observable prices and though sales of MSRs do occur, precise terms and conditions typically are not readily available and the characteristics of the Company’s servicing portfolio may differ from those of any servicing portfolios that do trade. Other real estate is based on the fair value of the underlying collateral less expected selling costs. Collateral values are estimated primarily using appraisals and reflect a market value approach. Fair values are reviewed quarterly, and new appraisals are obtained annually. Repossessions are similarly valued. For assets measured at fair value on a nonrecurring basis the following represents impairment charges (recoveries) recognized on these assets during the quarter ended June 30, 2020: impaired loans - $0.00 million; mortgage servicing rights - $0.55 million; repossessions - $0.00 million; and other real estate - $0.00 million. The following table shows the carrying value of assets measured at fair value on a non-recurring basis. (Dollars in thousands) Level 1 Level 2 Level 3 Total June 30, 2020 Impaired loans - collateral based $ — $ — $ 22,002 $ 22,002 Accrued income and other assets (mortgage servicing rights) — — 3,748 3,748 Accrued income and other assets (repossessions) — — 6,132 6,132 Accrued income and other assets (other real estate) — — 303 303 Total $ — $ — $ 32,185 $ 32,185 December 31, 2019 Impaired loans - collateral based $ — $ — $ 8,492 $ 8,492 Accrued income and other assets (mortgage servicing rights) — — 4,200 4,200 Accrued income and other assets (repossessions) — — 8,623 8,623 Accrued income and other assets (other real estate) — — 522 522 Total $ — $ — $ 21,837 $ 21,837 The following table below shows the valuation methodology and unobservable inputs for Level 3 assets and liabilities measured at fair value on a non-recurring basis. (Dollars in thousands) Carrying Value Fair Value Valuation Methodology Unobservable Inputs Range of Inputs Weighted Average June 30, 2020 Impaired loans $ 22,002 $ 22,002 Collateral based measurements including appraisals, trade publications, and auction values Discount for lack of marketability and current conditions 10% - 50% 18 % Mortgage servicing rights 3,748 4,023 Discounted cash flows Constant prepayment rate (CPR) 14.4% - 25.1% 19.9 % Discount rate 8.6% - 11.5% 8.9 % Repossessions 6,132 6,474 Appraisals, trade publications and auction values Discount for lack of marketability 3% - 19% 5 % Other real estate 303 324 Appraisals Discount for lack of marketability 0% - 6% 6 % December 31, 2019 Impaired loans $ 8,492 $ 8,492 Collateral based measurements including appraisals, trade publications, and auction values Discount for lack of marketability and current conditions 0% - 90% Mortgage servicing rights 4,200 5,986 Discounted cash flows Constant prepayment rate (CPR) 10.2% - 28.1% Discount rate 9.3% - 12.1% Repossessions 8,623 9,211 Appraisals, trade publications and auction values Discount for lack of marketability 3% - 25% Other real estate 522 564 Appraisals Discount for lack of marketability 0% - 11% GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring or non-recurring basis. The following table shows the fair values of the Company’s financial instruments. (Dollars in thousands) Carrying or Contract Value Fair Value Level 1 Level 2 Level 3 June 30, 2020 Assets: Cash and due from banks $ 67,591 $ 67,591 $ 67,591 $ — $ — Federal funds sold and interest bearing deposits with other banks 112,645 112,645 112,645 — — Investment securities, available-for-sale 1,055,797 1,055,797 82,605 970,013 3,179 Other investments 30,619 30,619 30,619 — — Mortgages held for sale 36,508 36,508 — 36,508 — Loans and leases, net of reserve for loan and lease losses 5,561,039 5,645,890 — — 5,645,890 Mortgage servicing rights 3,748 4,023 — — 4,023 Accrued interest receivable 20,976 20,976 — 20,976 — Interest rate swaps 55,782 55,782 — 55,782 — Liabilities: Deposits $ 5,993,456 $ 6,009,207 $ 4,493,408 $ 1,515,799 $ — Short-term borrowings 177,019 177,019 169,982 7,037 — Long-term debt and mandatorily redeemable securities 81,760 82,954 — 82,954 — Subordinated notes 58,764 51,391 — 51,391 — Accrued interest payable 9,427 9,427 — 9,427 — Interest rate swaps 56,793 56,793 — 56,793 — Off-balance-sheet instruments * — 288 — 288 — December 31, 2019 Assets: Cash and due from banks $ 67,215 $ 67,215 $ 67,215 $ — $ — Federal funds sold and interest bearing deposits with other banks 16,150 16,150 16,150 — — Investment securities, available-for-sale 1,040,583 1,040,583 80,393 957,898 2,292 Other investments 28,414 28,414 28,414 — — Mortgages held for sale 20,277 20,277 — 20,277 — Loans and leases, net of reserve for loan and lease losses 4,974,273 4,992,684 — — 4,992,684 Mortgage servicing rights 4,200 5,986 — — 5,986 Accrued interest receivable 19,125 19,125 — 19,125 — Interest rate swaps 21,975 21,975 — 21,975 — Liabilities: Deposits $ 5,357,326 $ 5,362,633 $ 3,708,828 $ 1,653,805 $ — Short-term borrowings 145,893 145,893 120,891 25,002 — Long-term debt and mandatorily redeemable securities 71,639 71,084 — 71,084 — Subordinated notes 58,764 61,469 — 61,469 — Accrued interest payable 13,918 13,918 — 13,918 — Interest rate swaps 22,352 22,352 — 22,352 — Off-balance-sheet instruments * — 281 — 281 — * Represents estimated cash outflows required to currently settle the obligations at current market rates. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. These estimates are subjective in nature and require considerable judgment to interpret market data. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange, nor are they intended to represent the fair value of the Company as a whole. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to management as of the respective balance sheet date. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein. |
