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. Multiple quotes or prices may be obtained in this process and the Company determines which fair value is most appropriate based on market information and analysis. Quotes obtained through this process are generally non-binding. The Company follows established procedures to ensure that assets and liabilities are properly classified in the fair value hierarchy. Level 2 securities include SBA loan pool securities, U.S. government agency and U.S. government sponsored enterprise 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 December 31, 2018 and 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 Ginnie Mae loan pools that become severely delinquent which are valued based on an internal model. 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 December 31, 2018, there were no loans delinquent more than 90 days and eligible to be repurchased out of GNMA loan pools. GNMA loans delinquent more than 90 days were subject to a repurchase option that was eliminated as a result of the sale of the related MSRs to third parties during 2018. 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:

Interest Rate Swaps and Caps. 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 December 31, 2018 and 2017, MSRs valued based on a third party provider's valuation were $1.7 million and $2.1 million, respectively. At December 31, 2018 and 2017, MSRs held-for-sale of $66 thousand and $29.8 million, respectively, were valued based on a market bid adjusted for 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 December 31, 2018:



			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)
December 31, 2018
Assets
Securities available-for-sale:
SBA loan pools securities	$	910	$	—	$	910	$	—
U.S. government agency and U.S. government sponsored enterprise residential mortgage-backed securities	437,442		—		437,442		—
Non-agency residential mortgage-backed securities	427		—		427		—
Non-agency commercial mortgage-backed securities	132,199		—		132,199		—
Collateralized loan obligations	1,421,522		—		1,421,522		—
Loans held-for-sale, carried at fair value ⁽¹⁾	27,180		—		2,140		25,040
Mortgage servicing rights ⁽²⁾	1,770		—		—		1,770
Derivative assets:
Interest rate swaps and caps ⁽³⁾	1,534		—		1,534		—
Liabilities
Derivative liabilities:
Interest rate swaps and caps ⁽⁴⁾	1,600		—		1,600		—


(1)	Includes loans held-for-sale carried at fair value of $19.5 million ($2.1 million at Level 2 and $17.4 million at Level 3) of discontinued operations, which are included in Assets of Discontinued Operations on the Consolidated Statements of Financial Condition


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


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


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

The following table presents the Company’s financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2017:



			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)
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 ⁽¹⁾	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 $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 on 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.

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:



	Year Ended December 31,
($ in thousands)	2018			2017			2016
Mortgage servicing rights
Balance at beginning of period ⁽¹⁾	$	31,852		$	76,121		$	49,939
Total gains or losses (realized/unrealized):
Included in earnings—fair value adjustment ⁽⁴⁾	(1,155		)	(10,240		)	(5,709		)
Additions	—			12,127			49,293
Sales, paydowns, and other ⁽²⁾	(28,927		)	(46,156		)	(17,402		)
Balance at end of period	$	1,770		$	31,852		$	76,121
Loans repurchased or eligible to be repurchased from Ginnie Mae Loan Pools ⁽³⁾
Balance at beginning of period	$	98,940		$	58,260		$	18,291
Total gains or losses (realized/unrealized):
Included in earnings—fair value adjustment ⁽⁵⁾	(1,378		)	(781		)	216
Additions	23,678			117,215			51,123
Sales, settlements, and other ⁽⁶⁾	(96,200		)	(75,754		)	(11,370		)
Balance at end of period	$	25,040		$	98,940		$	58,260


(1)	Includes MSRs of discontinued operations, which is included in Assets of Discontinued Operations on the Consolidated Statements of Financial Condition, of $0, $37.7 million, and $22.9 million, respectively, for the years ended December 31, 2018, 2017 and 2016 in balance at beginning of period.


(2)	Includes $37.8 million of MSRs sold as a part of discontinued operations for the year ended December 31, 2017.

(3)

Includes loans repurchased from Ginnie Mae loan pools of discontinued operations, which is included in Assets of Discontinued Operations on the Consolidated Statements of Financial Condition, of $32.3 million, $58.3 million and $18.3 million, respectively, in balance at beginning of period, and $17.3 million, $32.3 million and $58.3 million, respectively, in balance at end of period for the years ended December 31, 2018, 2017 and 2016.


(4)	Included in Loan Servicing Income in the Consolidated Statements of Operations.


(5)	Included in Net Gain on Sale of Loans in the Consolidated Statements of Operations.


(6)	Included in sales, settlements and other are $66.0 million of GNMA loans subject to repurchase option that were derecognized when the associated mortgage servicing rights were sold during the year ended December 31, 2018.

Loans repurchased or eligible to be repurchased from Ginnie Mae loan pools had aggregate unpaid principal balances of $25.5 million and $99.7 million at December 31, 2018 and 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 Ginnie Mae 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 December 31, 2018 and 2017:



($ in thousands)	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted-Average)
December 31, 2018
Mortgage servicing rights ⁽¹⁾	$	3,362	Discounted cash flow	Discount rate	9.50% to 13.00% (11.27%)
				Prepayment rate	8.00% to 66.34% (12.67%)
December 31, 2017
Mortgage servicing rights ⁽¹⁾	$	3,915	Discounted cash flow	Discount rate	8.50% to 13.00% (10.87%)
				Prepayment rate	8.00% to 49.97% (12.49%)


(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 December 31, 2018 and 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 Ginnie Mae pools at December 31, 2018 and 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.

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



	December 31,
	2018							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	$	7,690	$	7,906	$	(216	)	$	66,603	$	67,415	$	(812	)
Non-accrual loans ⁽¹⁾	2,427		2,538		(111		)	60,999		61,900		(901		)
Loans past due 90 days or more and still accruing	—		—		—			—		—		—
Loans held-for-sale, carried at fair value in discontinued operations:
Total loans	$	19,490	$	20,027	$	(537	)	$	38,696	$	39,541	$	(845	)
Non-accrual loans ⁽²⁾	8,430		8,496		(66		)	24,073		24,297		(224		)
Loans past due 90 days or more and still accruing	—		—		—			—		—		—


(1)	Includes loans guaranteed by the U.S. government of $1.6 million and $54.2 million, respectively, at December 31, 2018 and 2017.


(2)	Includes loans guaranteed by the U.S. government of $7.6 million and $20.7 million, respectively, at December 31, 2018 and 2017.

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



	Year Ended December 31,
($ in thousands)	2018		2017			2016
Net gains (losses) from fair value changes
Net gain (loss) on sale of loans (continuing operations)	$	204	$	(170	)	$	29
Net revenue on mortgage banking activities (discontinued operations)	159		(288		)	7,365

Changes in fair value due to instrument-specific credit risk were insignificant for the years ended December 31, 2018, 2017 and 2016. 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 on the Consolidated Statements of Operations.

Assets and Liabilities Measured on a Non-Recurring Basis

Impaired Loans and Leases: The fair value of impaired loans and leases with specific allocations of the ALLL based on collateral values is generally based on recent real estate appraisals and AVMs. 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.

Other Real Estate Owned Assets: OREO assets initially are 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. The Company recorded valuation allowance expense for OREO assets of $53 thousand, $236 thousand and $31 thousand, respectively, for the years ended December 31, 2018, 2017 and 2016 in All Other Expense on 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)
December 31, 2018
Assets
Impaired loans:
SBA	$	226	—	—	$	226
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:



	Year Ended December 31,
($ in thousands)	2018			2017			2016
Impaired loans:
Single family residential mortgage	$	(115	)	$	(164	)	$	—
Commercial real estate	(1,752		)	—			—
SBA	(1,048		)	(200		)	—
Other consumer	(141		)	(29		)	—
Other real estate owned:
Single family residential	229			(284		)	(235		)

Estimated Fair Values of Financial Instruments

The following table presents the carrying amounts and estimated fair values of financial assets and liabilities as of the dates indicated:



	Carrying Amount		Fair Value Measurement Level
($ in thousands)	Carrying Amount		Level 1		Level 2		Level 3		Total
December 31, 2018
Financial assets
Cash and cash equivalents	$	391,592	$	391,592	$	—	$	—	$	391,592
Securities available-for-sale	1,992,500		—		1,992,500		—		1,992,500
Federal Home Loan Bank and other bank stock	68,094		—		68,094		—		68,094
Loans held-for-sale ⁽¹⁾	27,606		—		2,566		25,040		27,606
Loans and leases receivable, net of allowance	7,638,681		—		—		7,513,910		7,513,910
Accrued interest receivable	38,807		38,807		—		—		38,807
Derivative assets	1,534		—		1,534		—		1,534
Financial liabilities
Deposits	7,916,644		—		—		7,689,324		7,689,324
Advances from Federal Home Loan Bank	1,520,000		—		1,517,761		—		1,517,761
Long-term debt	173,174		—		174,059		—		174,059
Derivative liabilities	1,600		—		1,600		—		1,600
Accrued interest payable	13,253		13,253		—		—		13,253
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 allowance	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 $19.5 million ($2.1 million at Level 2 and $17.4 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.

On January 1, 2018, the Company adopted ASU 2016-01 and ASU 2018-03, which require the use of the exit price notion when measuring the fair values of financial instruments for disclosure purposes. Starting in the first quarter of 2018, the Company updated our methodology used to estimate fair values for our loan portfolio to conform to the new requirements. The methods and assumptions used to estimate fair value for the Company's financial instruments note recorded at fair value on a recurring or non-recurring basis are described as follows:

Cash and Cash Equivalents and Time Deposits in Financial Institutions: The carrying amounts of cash and cash equivalents and time deposits in financial institutions approximate fair value due to the short-term nature of these instruments (Level 1).

Federal Home Loan Bank and Other Bank Stock: Federal Home Loan Bank and other bank stock are recorded at cost, which approximates fair value. Ownership of FHLB stock is restricted to member banks, and purchases and sales of these securities are at par value with the issuer (Level 2).

Loans and Leases Receivable, Net of ALLL: For the year ended December 31, 2017, the fair value of loans and leases receivable is estimated based on the discounted cash flow approach. The discount rate was derived from the associated yield curve plus spreads and reflects the rates offered by the Bank for loans with similar financial characteristics. Yield curves are constructed by product and payment types. These rates could be different from what other financial institutions could offer for these loans. Additionally, the fair value of our loans may differ significantly from the values that would have been used had a ready market existed for such loans and may differ materially from the values that we may ultimately realize (Level 3). This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC Topic 820. For the year ended December 31, 2018, we utilized the exit price notion to determine the fair value of loans and leases receivable.

Accrued Interest Receivable: The carrying amount of accrued interest receivable approximates its fair value (Level 1).

Deposits: The fair value of deposits is estimated based on discounted cash flows. The cash flows for non-maturity deposits, including savings accounts and money market checking, are estimated based on their historical decaying experiences. The discount rate used for fair valuation is based on interest rates currently being offered by the Bank on comparable deposits as to amount and term (Level 3).

Advances from Federal Home Loan Bank and Other Borrowings: The fair values of advances from FHLB and other borrowings are estimated based on a discounted cash flow approach. The discount rate was derived from the current market rates for borrowings with similar remaining maturities (Level 2).

Long-Term Debt: Fair value of long-term debt is determined by observable data such as market spreads, cash flows, yield curves, credit information, and respective terms and conditions for debt instruments (Level 2).

Accrued Interest Payable: The carrying amount of accrued interest payable approximates its fair value (Level 1).