FAIR VALUES OF FINANCIAL INSTRUMENTS

Fair Value Hierarchy

ASC 820-10 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The topic describes three levels of inputs that may be used to measure fair value:


•	Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.


•	Level 2: Significant observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.


•	Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Assets and Liabilities Measured on a Recurring Basis

Securities Available-for-Sale: The fair values of securities available-for-sale are generally determined by quoted market prices in active markets, if available (Level 1). If quoted market prices are not available, the Company primarily employs independent pricing services that utilize pricing models to calculate fair value. Such fair value measurements consider observable data such as dealer quotes, market spreads, cash flows, yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and respective terms and conditions for debt instruments. The Company employs procedures to monitor the pricing service's assumptions and establishes processes to challenge the pricing service's valuations that appear unusual or unexpected. Level 2 securities include U.S. Small Business Administration (SBA) loan pool securities, U.S. government agency and U.S. government sponsored enterprise (GSE) residential mortgage-backed securities, non-agency residential mortgage-backed securities, non-agency commercial mortgage-backed securities, collateralized loan obligations, and corporate debt securities. When a market is illiquid or there is a lack of transparency around the inputs to valuation, including at least one unobservable input, the securities are classified as Level 3 and reliance is placed upon internally developed models, and management judgment and evaluation for valuation. The Company had no securities available-for-sale classified as Level 3 at September 30, 2018 or December 31, 2017.

Loans Held-for-Sale, Carried at Fair Value: The fair value of loans held-for-sale is based on commitments outstanding from investors as well as what secondary market investors are currently offering for portfolios with similar characteristics, except for loans that are repurchased out of GNMA loan pools that become severely delinquent which are valued based on an internal model that estimates the expected loss the Company will incur on these loans. Loans previously sold to GNMA that are delinquent more than 90 days are subject to a repurchase option when that condition exists. These loans were re-recognized at fair value and offset by a secured borrowing, as the loans were still legally owned by GNMA but failed sale accounting treatment under GAAP due to the repurchase option. Loans held-for-sale subject to recurring fair value adjustments are classified as Level 2 or, in the case of loans repurchased, Level 3. The fair value includes the servicing value of the loans as well as any accrued interest. As of September 30, 2018, there were no loans that were delinquent more than 90 days and eligible to be repurchased out of GNMA loan pools. As of December 31, 2017, loans eligible to be repurchased out of GNMA loan pools of $66.0 million were classified as Level 3.

Derivative Assets and Liabilities: The Company offers interest rate swaps and caps products to certain loan customers to allow them to hedge the risk of rising interest rates on their variable rate loans. The Company originates a variable rate loan and enters into a variable-to-fixed interest rate swap with the customer. The Company also enters into an offsetting swap with a correspondent bank. These back-to-back agreements are intended to offset each other and allow the Company to originate a variable rate loan, while providing a contract for fixed interest payments for the customer. The net cash flow for the Company is equal to the interest income received from a variable rate loan originated with the customer. The fair value of these derivatives is based on a discounted cash flow approach. Due to the observable nature of the inputs used in deriving the fair value of these derivative contracts, the valuation of interest rate swaps is classified as Level 2.

Mortgage Servicing Rights: The Company retains servicing on some of its mortgage loans sold and elected the fair value option for these MSRs. Generally, the value is estimated based on a valuation from a third party provider that calculates the present value of the expected net servicing income from the portfolio based on key factors that include interest rates, prepayment assumptions, discount rate and estimated cash flows. Because of the significance of unobservable inputs, these servicing rights are classified as Level 3. At September 30, 2018 and December 31, 2017, MSRs valued based on a third party provider's valuation were $2.0 million and $2.1 million, respectively. At September 30, 2018 and December 31, 2017, MSRs held-for-sale of $66 thousand and $29.8 million, respectively, were valued based on a market bid adjusted for value associated with early payoffs and paydowns and included as Level 3.

The following table presents the Company’s financial assets and liabilities measured at fair value on a recurring basis as of the dates indicated:



			Fair Value Measurement Level
($ in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2018
Assets
Securities available-for-sale:
SBA loan pools securities	$	888	$	—	$	888	$	—
U.S. government agency and U.S. government sponsored enterprise residential mortgage-backed securities	439,468		—		439,468		—
Non-agency residential mortgage-backed securities	451		—		451		—
Non-agency commercial mortgage-backed securities	132,704		—		132,704		—
Collateralized loan obligations	1,486,321		—		1,486,321		—
Loans held-for-sale, carried at fair value ⁽¹⁾	28,314		—		2,558		25,756
Mortgage servicing rights ⁽²⁾	2,029		—		—		2,029
Derivative assets:
Interest rate swaps and caps ⁽³⁾	2,099		—		2,099		—
Liabilities
Derivative liabilities:
Interest rate swaps and caps ⁽⁴⁾	2,064		—		2,064		—
December 31, 2017
Assets
Securities available-for-sale:
SBA loan pools securities	$	1,058	$	—	$	1,058	$	—
U.S. government agency and U.S. government sponsored enterprise residential mortgage-backed securities	476,929		—		476,929		—
Non-agency residential mortgage-backed securities	756		—		756		—
Non-agency commercial mortgage-backed securities	310,511		—		310,511		—
Collateralized loan obligations	1,702,318		—		1,702,318		—
Corporate debt securities	83,897		—		83,897		—
Loans held-for-sale, carried at fair value ⁽⁵⁾	105,299		—		6,359		98,940
Mortgage servicing rights ⁽²⁾	31,852		—		—		31,852
Derivative assets:
Interest rate swaps and caps ⁽³⁾	1,005		—		1,005		—
Liabilities
Derivative liabilities:
Interest rate swaps and caps ⁽⁴⁾	1,033		—		1,033		—


(1)	Includes loans held-for-sale carried at fair value of $20.3 million ($2.6 million at Level 2 and $17.7 million at Level 3) of discontinued operations, which are included in Assets of Discontinued Operations in the Consolidated Statements of Financial Condition.


(2)	Included in Servicing Rights, Net in the Consolidated Statements of Financial Condition.


(3)	Included in Other Assets in the Consolidated Statements of Financial Condition.


(4)	Included in Accrued Expenses and Other Liabilities in the Consolidated Statements of Financial Condition.


(5)	Includes loans held-for-sale carried at fair value of $38.7 million ($6.4 million at Level 2 and $32.3 million at Level 3) of discontinued operations, which are included in Assets of Discontinued Operations in the Consolidated Statements of Financial Condition.

The following table presents a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), on a consolidated operations basis, for the periods indicated:



	Three Months Ended September 30,						Nine Months Ended September 30,
($ in thousands)	2018			2017			2018			2017
Mortgage servicing rights
Balance at beginning of period ⁽¹⁾	$	2,062		$	42,109		$	31,852		$	76,121
Total gains or losses (realized/unrealized):
Included in earnings—fair value adjustment	33			(1,905		)	(1,057		)	(4,984		)
Additions	—			574			—			12,126
Sales, paydowns, and other ⁽²⁾	(66		)	(2,063		)	(28,766		)	(44,548		)
Balance at end of period	$	2,029		$	38,715		$	2,029		$	38,715
Loans repurchased or subject to repurchase option from GNMA Loan Pools ⁽³⁾
Balance at beginning of period	$	33,234		$	73,545		$	98,940		$	58,260
Total gains or losses (realized/unrealized):
Included in earnings—fair value adjustment	(22		)	(809		)	(276		)	(794		)
Additions	711			24,537			28,096			59,768
Sales, settlements, and other	(8,167		)	(12,909		)	(101,004		)	(32,870		)
Balance at end of period	$	25,756		$	84,364		$	25,756		$	84,364


(1)	Includes MSRs of discontinued operations, which is included in Assets of Discontinued Operations in the Consolidated Statements of Financial Condition, of $37.7 million for the nine months ended September 30, 2017 in balance at beginning of period.


(2)	Includes $37.8 million of MSRs sold as a part of discontinued operations for the nine months ended September 30, 2017.

(3)

Includes loans repurchased from GNMA Loan Pools of discontinued operations, which is included in Assets of Discontinued Operations in the Consolidated Statements of Financial Condition, of $20.9 million and $52.1 million, respectively, for the three months ended September 30, 2018 and 2017 and $32.3 million and $58.3 million, respectively, for the nine months ended September 30, 2018 and 2017 in balance at beginning of period, and $17.7 million and $41.2 million, respectively, for the three and nine months ended September 30, 2018 and 2017 in balance at end of period.

Loans repurchased from GNMA loan pools and loans previously sold to GNMA that are delinquent more than 90 days and subject to a repurchase option held by the Company had aggregate unpaid principal balances of $26.2 million and $99.7 million at September 30, 2018 and December 31, 2017, respectively.

The following table presents, as of the dates indicated, quantitative information about Level 3 fair value measurements on a recurring basis, other than loans that become severely delinquent and are repurchased out of GNMA loan pools that were valued based on an estimate of the expected loss the Company will incur on these loans, which was included as Level 3 at September 30, 2018 and December 31, 2017:



($ in thousands)	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
September 30, 2018
Mortgage servicing rights ⁽¹⁾	$	1,963	Discounted cash flow	Discount rate	13.00% to 13.00% (13.00%)
				Prepayment rate	12.35% to 66.34% (16.25%)
December 31, 2017
Mortgage servicing rights ⁽¹⁾	$	2,059	Discounted cash flow	Discount rate	13.00% to 13.00% (13.00%)
				Prepayment rate	10.04% to 49.97% (16.54%)


(1)	Excludes MSRs held-for-sale of $66 thousand and $29.8 million, respectively, which were valued based on a market bid adjusted for expected obligations arising from standard representations and warranties at September 30, 2018 and December 31, 2017.

The significant unobservable inputs used in the fair value measurement of the Company’s servicing rights include the discount rate and prepayment rate. The significant unobservable inputs used in the fair value measurement of the Company's loans repurchased from GNMA loan pools at September 30, 2018 and December 31, 2017 included an expected loss rate of 1.55 percent for insured loans and 20.00 percent for uninsured loans. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results.

Fair Value Option

Loans Held-for-Sale, Carried at Fair Value: The Company elected the fair value option for certain SFR mortgage loans held-for-sale. Electing to measure SFR mortgage loans held-for-sale at fair value reduces certain timing differences and better matches changes in the value of these assets with changes in the value of derivatives used as economic hedges for these assets. The Company also elected to record loans repurchased from GNMA at fair value, as the Company intends to sell them after curing any defects and, accordingly, they are classified as held-for-sale. Loans previously sold to GNMA that are delinquent more than 90 days are subject to a repurchase option when that condition exists. These loans were re-recognized at fair value and offset by a secured borrowing, as the loans were still legally owned by GNMA but failed sale accounting treatment under GAAP due to the repurchase option.

The following table presents the fair value and aggregate principal balance of certain assets, on a consolidated operations basis, under the fair value option:



	September 30, 2018							December 31, 2017
($ in thousands)	Fair Value		Unpaid Principal Balance		Difference			Fair Value		Unpaid Principal Balance		Difference
Loans held-for-sale, carried at fair value in continuing operations:
Total loans	$	8,024	$	8,239	$	(215	)	$	66,603	$	67,415	$	(812	)
Non-accrual loans ⁽¹⁾	1,852		1,958		(106		)	60,999		61,900		(901		)
Loans held-for-sale, carried at fair value in discontinued operations:
Total loans	$	20,290	$	20,842	$	(552	)	$	38,696	$	39,541	$	(845	)
Non-accrual loans ⁽²⁾	9,254		9,312		(58		)	24,073		24,297		(224		)


(1)	Includes loans guaranteed by the U.S. government of $1.5 million and $54.2 million, respectively, at September 30, 2018 and December 31, 2017.


(2)	Includes loans guaranteed by the U.S. government of $8.0 million and $20.7 million, respectively, at September 30, 2018 and December 31, 2017.

There were no loans held-for-sale that were 90 days or more past due and still accruing as of September 30, 2018 and December 31, 2017.

The assets and liabilities accounted for under the fair value option are initially measured at fair value. Gains and losses from subsequent changes in fair value are recognized in earnings. The following table presents changes in fair value related to subsequent changes in fair value included in earnings for these assets and liabilities measured at fair value for the periods indicated:



	Three Months Ended September 30,					Nine Months Ended September 30,
($ in thousands)	2018		2017			2018		2017
Net gains (losses) from fair value changes
Other income (continuing operations)	$	11	$	(70	)	$	198	$	(62	)
Net loss from mortgage banking activities (discontinued operations)	30		(996		)	127		(1,551		)

Changes in fair value due to instrument-specific credit risk were insignificant for the three and nine months ended September 30, 2018 and 2017. Interest income on loans held-for-sale under the fair value option is measured based on the contractual interest rate and reported in Loans and Leases, including Fees under Interest and Dividend Income and Income from Discontinued Operations in the Consolidated Statements of Operations.

Assets and Liabilities Measured on a Non-Recurring Basis

Impaired Loans and Leases: Impairment of collateral dependent loans and leases with specific allocations of the ALLL are generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically deemed significant unobservable inputs used for determining fair value and result in a Level 3 classification.

Loans Held-for-Sale, Carried at Lower of Cost or Fair Value: The Company records non-conforming jumbo mortgage loans held-for-sale and certain non-residential mortgage loans held-for-sale at the lower of cost or fair value, on an aggregate basis. The Company obtains fair values from a third party independent valuation service provider or uses quoted prices from similar assets, adjusted for specific attributes of that loan or similar market data, such as outstanding commitment from third party investors. Loans held-for-sale accounted for at the lower of cost or fair value are considered to be recognized at fair value when they are recorded at below cost, on an aggregate basis, and are classified as Level 2.

SBA Servicing Assets: SBA servicing assets represent the value associated with servicing SBA loans that have been sold. SBA servicing assets are accounted for at the lower of cost or market value and considered to be recognized at fair value when they are recorded at below cost and are classified as Level 3. The fair value for SBA servicing assets is determined through a discounted cash flow analysis that utilizes estimated market yield and projected prepayment speeds as inputs. All of these assumptions require a significant degree of management estimation and judgment. The fair market valuation is performed on a quarterly basis for SBA servicing assets.

Other Real Estate Owned Assets: Other Real Estate Owned (OREO) assets are initially recorded at fair value at the time of foreclosure. Thereafter, they are recorded at the lower of cost or fair value. The fair value of other real estate owned assets is generally based on recent real estate appraisals adjusted for estimated selling costs. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and result in a Level 3 classification due to the unobservable inputs used for determining fair value. Only OREO assets with a valuation allowance are considered to be carried at fair value. There was $0 and $134 thousand valuation allowance expense for OREO assets for the three months ended September 30, 2018 and 2017. The Company recorded valuation allowance expense for OREO assets of $53 thousand and $143 thousand for the nine months ended September 30, 2018 and 2017 in All Other Expense in the Consolidated Statements of Operations.

The following table presents the Company’s financial assets and liabilities measured at fair value on a non-recurring basis as of the dates indicated:



			Fair Value Measurement Level
($ in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2018
Assets
Loans held-for-sale:
Commercial and industrial	$	538	$	—	$	538	$	—
Impaired loans:
Commercial and industrial	502		—		—		502
Other consumer	3		—		—		3
SBA	76		—		—		76
December 31, 2017
Assets
Impaired loans:
SBA	$	174	—		—		$	174
Other real estate owned:
Single family residential	1,415		—		—		1,415

The following table presents the gains and (losses) recognized on assets measured at fair value on a non-recurring basis for the periods indicated:



	Three Months Ended September 30,						Nine Months Ended September 30,
($ in thousands)	2018			2017			2018			2017
Impaired loans:
Single family residential mortgage	$	—		$	(27	)	$	(115	)	$	(27	)
Commercial and industrial	(219		)	—			(511		)	—
SBA	1			(1		)	(379		)	(1		)
Other consumer	—			—			(141		)
Construction	—			—			—			(29		)
Other real estate owned:
Single family residential	35			(264		)	229			(236		)

Estimated Fair Values of Financial Instruments

The following table presents the carrying amounts and estimated fair values of financial assets and liabilities, on a consolidated operations basis, as of the dates indicated:



	Carrying Amount		Fair Value Measurement Level
($ in thousands)	Carrying Amount		Level 1		Level 2		Level 3		Total
September 30, 2018
Financial assets
Cash and cash equivalents	$	372,221	$	372,221	$	—	$	—	$	372,221
Securities available-for-sale	2,059,832		—		2,059,832		—		2,059,832
Federal Home Loan Bank and other bank stock	71,308		—		71,308		—		71,308
Loans held-for-sale ⁽¹⁾	29,672		—		3,916		25,756		29,672
Loans and leases receivable, net of ALLL⁽³⁾	7,195,511		—		—		7,082,175		7,082,175
Accrued interest receivable	38,951		38,951		—		—		38,951
Derivative assets	2,099		—		2,099		—		2,099
Financial liabilities
Deposits	7,401,742		—		—		7,200,816		7,200,816
Advances from Federal Home Loan Bank	1,640,000		—		1,636,772		—		1,636,772
Long term debt	173,096		—		177,048		—		177,048
Derivative liabilities	2,064		—		2,064		—		2,064
Accrued interest payable	13,226		13,226		—		—		13,226
December 31, 2017
Financial assets
Cash and cash equivalents	$	387,699	$	387,699	$	—	$	—	$	387,699
Securities available-for-sale	2,575,469		—		2,575,469		—		2,575,469
Federal Home Loan Bank and other bank stock	75,654		—		75,654		—		75,654
Loans held-for-sale⁽²⁾	105,765		—		6,866		98,940		105,806
Loans and leases receivable, net of ALLL⁽³⁾	6,610,074		—		—		6,601,767		6,601,767
Accrued interest receivable	35,355		35,355		—		—		35,355
Derivative assets	1,005		—		1,005		—		1,005
Financial liabilities
Deposits	7,292,903		—		—		7,063,613		7,063,613
Advances from Federal Home Loan Bank	1,695,000		—		1,695,039		—		1,695,039
Long term debt	172,941		—		180,560		—		180,560
Derivative liabilities	1,033		—		1,033		—		1,033
Accrued interest payable	7,321		7,321		—		—		7,321


(1)	Includes loans held-for-sale carried at fair value of $20.3 million ($2.6 million at Level 2 and $17.7 million at Level 3) of discontinued operations.


(2)	Includes loans held-for-sale carried at fair value of $38.7 million ($6.4 million at Level 2 and $32.3 million at Level 3) of discontinued operations.


(3)	In accordance with the Company's adoption of ASU No. 2016-01 during the first quarter of 2018, the fair value of loans as of September 30, 2018 was measured using an exit price notion. The fair value of loans as of December 31, 2017 was measured using an entry price notion.