ESTIMATED FAIR VALUES

Fair value represents the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. BancShares estimates fair value using discounted cash flows or other valuation techniques when there is no active market for a financial instrument. Inputs used in these valuation techniques are subjective in nature, involve uncertainties and require significant judgment. Therefore, the derived fair value estimates presented below are not necessarily indicative of the amounts BancShares would realize in a current market exchange.

Assets and liabilities are recorded at fair value according to a fair value hierarchy comprised of three levels. The levels are based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The level within the fair value hierarchy for an asset or liability is based on the lowest level of input that is significant to the fair value measurement (with Level 1 inputs considered highest and Level 3 inputs considered lowest). A brief description of each input level follows:


•	Level 1 inputs are quoted prices in active markets for identical assets and liabilities.


•	Level 2 inputs are quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the assets or liabilities and market corroborated inputs.


•	Level 3 inputs are unobservable inputs for the asset or liability. These unobservable inputs and assumptions reflect estimates that market participants would use in pricing the asset or liability.

BancShares' management reviews any changes to its valuation methodologies to ensure they are appropriate and supportable, and refines valuation methodologies as more market-based data becomes available. Transfers between levels of the fair value hierarchy are recognized at the end of the reporting period.

The methodologies used to estimate the fair value of financial assets and financial liabilities are discussed below.

Investment securities available for sale. Investment securities available for sale are carried at fair value. U.S. Treasury, government agency and mortgage-backed securities are generally measured at fair value using a third party pricing service. The third party provider evaluates securities based on comparable investments with trades and market data and utilizes pricing models that use a variety of inputs, such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids and offers, as needed. These securities are generally classified as Level 2. Corporate bonds and other, which consist of trust preferred securities, are generally measured at fair value based on indicative bids from broker-dealers that are not directly observable. These securities are considered Level 3.

Marketable equity securities. Equity securities are measured at fair value using observable closing prices. The valuation also considers the amount of market activity by examining the trade volume of each security. Equity securities are classified as Level 1 if they are traded in an active market and as Level 2 if the observable closing price is from a less than active market.

Loans held for sale. Certain residential real estate loans that are originated to be sold to investors are carried at fair value based on quoted market prices for similar types of loans. Accordingly, the inputs used to calculate fair value of originated residential real estate loans held for sale are considered Level 2 inputs. Portfolio loans that are subsequently transferred to held for sale to be sold in the secondary market are transferred at fair value. The fair value of the transferred portfolio loans is based on quoted prices that are considered Level 1 inputs.

Net loans and leases (Non-PCI and PCI). Fair value is estimated based on discounted future cash flows using the current interest rates at which loans with similar terms would be made to borrowers of similar credit quality. The inputs used in the fair value measurements for loans and leases are considered Level 3 inputs.

FHLB stock. The carrying amount of FHLB stock is a reasonable estimate of fair value, as these securities are not readily marketable and are evaluated for impairment based on the ultimate recoverability of the par value. BancShares considers positive and negative evidence, including the profitability and asset quality of the issuer, dividend payment history and recent redemption experience, when determining the ultimate recoverability of the par value. BancShares investment in FHLB stock is ultimately recoverable at par. The inputs used in the fair value measurement for the FHLB stock are considered Level 2 inputs.

Mortgage and other servicing rights. Mortgage and other servicing rights are carried at the lower of amortized cost or market and are, therefore, carried at fair value only when fair value is less than the amortized cost. The fair value of mortgage and other servicing rights is performed using a pooling methodology. Similar loans are pooled together and a model that relies on discount rates, estimates of prepayment rates and the weighted average cost to service the loans is used to determine the fair value. The inputs used in the fair value measurement for mortgage and other servicing rights are considered Level 3 inputs.

Deposits. For non-time deposits, carrying value is a reasonable estimate of fair value. The fair value of time deposits is estimated by discounting future cash flows using the interest rates currently offered for deposits of similar remaining maturities. The inputs used in the fair value measurement for deposits are considered Level 2 inputs.

Long-term obligations. For long-term obligations, the fair values are determined based on recent trades or sales of the actual security if available; otherwise, fair values are estimated by discounting future cash flows using current interest rates for similar financial instruments. The inputs used in the fair value measurement for long-term obligations are considered Level 2 inputs.

Payable to the FDIC for shared-loss agreements. The fair value of the payable to the FDIC for shared-loss agreements is determined by the projected cash flows based on expected payments to the FDIC in accordance with the shared-loss agreements. Cash flows are discounted using current discount rates to reflect the timing of the estimated amounts due to the FDIC. The inputs used in the fair value measurement for the payable to the FDIC are considered Level 3 inputs.

Off-balance-sheet commitments and contingencies. Carrying amounts are reasonable estimates of the fair values for such financial instruments. Carrying amounts include unamortized fee income and, in some cases, reserves for any credit losses from those financial instruments. These amounts are not material to BancShares' financial position.

For all other financial assets and financial liabilities, the carrying value is a reasonable estimate of the fair value as of December 31, 2018 and 2017. The carrying value and fair value for these assets and liabilities are equivalent because they are relatively short term in nature and there is no interest rate or credit risk that would cause the fair value to differ from the carrying value. Cash and due from banks is classified on the fair value hierarchy as Level 1. Overnight investments, income earned not collected, short-term borrowings and accrued interest payable are considered Level 2.

The table presents the carrying values and estimated fair values for financial instruments as of December 31, 2018 and 2017.



	December 31, 2018				December 31, 2017
(Dollars in thousands)	Carrying value		Fair value		Carrying value		Fair value
Cash and due from banks	$	327,440	$	327,440	$	336,150	$	336,150
Overnight investments	797,406		797,406		1,387,927		1,387,927
Investment securities available for sale	4,557,110		4,557,110		7,180,180		7,180,180
Investment securities held to maturity	2,184,653		2,201,502		76		81
Marketable equity securities	92,599		92,599		—		—
Loans held for sale	45,505		45,505		51,179		51,179
Net loans and leases	25,299,564		24,845,060		23,374,932		22,257,803
Income earned not collected	109,903		109,903		95,249		95,249
Federal Home Loan Bank stock	25,304		25,304		52,685		52,685
Mortgage and other servicing rights	24,066		29,532		21,945		26,170
Deposits	30,672,460		30,623,214		29,266,275		29,230,768
Short-term borrowings	572,287		572,287		693,807		693,807
Long-term obligations	319,867		332,678		870,240		852,112
Payable to the FDIC for shared-loss agreements	105,618		105,846		101,342		102,684
Accrued interest payable	3,712		3,712		3,952		3,952

Among BancShares’ assets and liabilities, investment securities available for sale, marketable equity securities and loans held for sale are reported at their fair values on a recurring basis. For assets and liabilities carried at fair value on a recurring basis, the following table provides fair value information as of December 31, 2018 and December 31, 2017.



	December 31, 2018
			Fair value measurements using:
(Dollars in thousands)	Fair value		Level 1		Level 2		Level 3
Assets measured at fair value
Investment securities available for sale
U.S. Treasury	$	1,247,710	$	—	$	1,247,710	$	—
Government agency	256,835		—		256,835		—
Mortgage-backed securities	2,909,339		—		2,909,339		—
Corporate bonds	139,101		—		—		139,101
Other	4,125		—		—		4,125
Total investment securities available for sale	$	4,557,110	$	—	$	4,413,884	$	143,226
Marketable equity securities	$	92,599	$	17,887	$	74,712	—
Loans held for sale	$	45,505	$	—	$	45,505	$	—

	December 31, 2017
			Fair value measurements using:
	Fair value		Level 1		Level 2		Level 3
Assets measured at fair value
Investment securities available for sale
U.S. Treasury	$	1,657,864	$	—	$	1,657,864	$	—
Government agency	8,670		—		8,670		—
Mortgage-backed securities	5,340,756		—		5,340,756		—
Marketable equity securities	105,208		19,341		85,867		—
Corporate bonds	59,963		—		59,963		—
Other	7,719		—		7,719		—
Total investment securities available for sale	$	7,180,180	$	19,341	$	7,160,839	$	—
Loans held for sale	$	51,179	$	—	$	51,179	$	—

During the year ended December 31, 2018, $59.7 million of corporate bonds and $5.6 million of other investment securities available for sale were transferred from Level 2 to Level 3. The transfers were due to a lack of observable inputs and trade activity for those securities. There were no transfers between levels during the year ended December 31, 2017.

The following table summarizes activity for Level 3 assets:



	December 31, 2018
(Dollars in thousands)	Corporate bonds			Other
Balance at January 1, 2018	$	—		$	—
Transfers in	59,653			5,618
Amounts included in net income	169			22
Unrealized net (losses) gains included in other comprehensive income	(1,043		)	122
Acquisition	82,727			—
Sales / Calls	(2,405		)	(1,637		)
Balance at December 31, 2018	$	139,101		$	4,125

The following table presents quantitative information about Level 3 fair value measurements for fair value on a recurring basis at December 31, 2018.



(Dollars in thousands)			December 31, 2018
Level 3 assets	Valuation technique	Significant unobservable input	Fair Value
Corporate bonds	Indicative bid provided by broker	Multiple factors, including but not limited to, current operations, financial condition, cash flows, and recently executed financing transactions related to the company	$	139,101
Other	Indicative bid provided by broker	Multiple factors, including but not limited to, current operations, financial condition, cash flows, and recently executed financing transactions related to the company	4,125

Fair Value Option

BancShares has elected the fair value option for residential real estate loans originated to be sold. This election reduces certain timing differences in the Consolidated Statements of Income and better aligns with the management of the portfolio from a business perspective. The changes in fair value are recorded as a component of mortgage income in the Consolidated Statements of Income and were gains of $50 thousand and $2.9 million for the years ended December 31, 2018 and 2017, respectively, and a loss of $2.4 million for the year ended December 31, 2016.

The following table summarizes the difference between the aggregate fair value and the unpaid principal balance for residential real estate originated for sale measured at fair value as of December 31, 2018 and 2017.



	December 31, 2018
(Dollars in thousands)	Fair Value		Unpaid Principal Balance		Difference
Originated loans held for sale	$	45,505	$	44,073	$	1,432

	December 31, 2017
	Fair Value		Unpaid Principal Balance		Difference
Originated loans held for sale	$	51,179	$	49,796	$	1,383

No originated loans held for sale were 90 or more days past due or on nonaccrual status as of December 31, 2018 or December 31, 2017.

Certain other assets are adjusted to their fair value on a nonrecurring basis, including impaired loans, OREO and goodwill, which are periodically tested for impairment, and mortgage servicing rights, which are carried at the lower of amortized cost or market. Non-impaired loans held for investment, deposits, short-term borrowings and long-term obligations are not reported at fair value.

Impaired loans are considered to be at fair value if an associated allowance adjustment or current period charge-off has been recorded. The value of impaired loans is determined by either collateral valuations or discounted present value of the expected cash flow calculations. Collateral values are determined using appraisals or other third-party value estimates of the subject property with discounts generally between 6 and 11 percent applied for estimated selling costs and other external factors that may impact the marketability of the property. Expected cash flows are determined using expected payment information at the individual loan level, discounted using the effective interest rate. The effective interest rate generally ranges between 1 and 14 percent.

OREO that has been acquired or written down in the current year is considered to be at fair value, which uses asset valuations. Asset values are determined using appraisals or other third-party value estimates of the subject property with discounts generally between 6 and 11 percent applied for estimated selling costs and other external factors that may impact the marketability of the property. Changes to the value of the assets between scheduled valuation dates are monitored through continued communication with brokers and monthly reviews by the asset manager assigned to each asset. If there are any significant changes in the market or the subject property, valuations are adjusted or new appraisals ordered to ensure the reported values reflect the most current information.

For financial assets and liabilities carried at fair value on a nonrecurring basis, the following table provides fair value information as of December 31, 2018 and December 31, 2017.



	December 31, 2018
			Fair value measurements using:
(Dollars in thousands)	Fair value		Level 1		Level 2		Level 3
Impaired loans	$	105,994	$	—	$	—	$	105,994
Other real estate remeasured during current year	35,344		—		—		35,344

	December 31, 2017
			Fair value measurements using:
	Fair value		Level 1		Level 2		Level 3
Impaired loans	$	72,539	$	—	$	—	$	72,539
Other real estate remeasured during current year	40,167		—		—		40,167

No financial liabilities were carried at fair value on a nonrecurring basis as of December 31, 2018 and December 31, 2017.