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Disclosures About Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2020

Disclosures About Fair Value of Financial Instruments

DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

Customers uses fair value measurements to record fair value adjustments to certain assets and liabilities and to disclose the fair value of its financial instruments. ASC Topic 825, Financial Instruments, requires disclosure of the estimated fair value of an entity’s assets and liabilities considered to be financial instruments. For Customers, as for most financial institutions, the majority of its assets and liabilities are considered to be financial instruments. Many of these instruments lack an available trading market as characterized by a willing buyer and a willing seller engaging in an exchange transaction. For fair value disclosure purposes, Customers utilized certain fair value measurement criteria under ASC 820, Fair Value Measurements and Disclosures, as explained below.

In accordance with ASC 820, the fair value of a financial instrument is 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 is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for Customers' various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, focusing on an exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

The fair value guidance also establishes a fair value hierarchy and describes the following three levels used to classify fair value measurements.

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Prices or valuation techniques that require adjustments to inputs that are both significant to the fair value measurement and unobservable (i.e., supported with little or no market activity).

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 following methods and assumptions were used to estimate the fair values of Customers' financial instruments as of March 31, 2020 and December 31, 2019:

Financial Instruments Recorded at Fair Value on a Recurring Basis

Investment securities:

The fair values of equity securities, available for sale debt securities and debt securities reported at fair value based on a fair value option election are determined by obtaining quoted market prices on nationally recognized and foreign securities exchanges (Level 1), quoted prices in markets that are not active (Level 2), matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices, or internally and externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3). These assets are classified as Level 1, 2 or 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Loans held for sale - Residential mortgage loans (fair value option):

Customers generally estimates the fair values of residential mortgage loans held for sale based on commitments on hand from investors within the secondary market for loans with similar characteristics. These assets are classified as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Loans receivable - Commercial mortgage warehouse loans (fair value option):

The fair value of commercial mortgage warehouse loans is the amount of cash initially advanced to fund the mortgage, plus accrued interest and fees, as specified in the respective agreements. The loan is used by mortgage companies as short-term bridge financing between the funding of the mortgage loans and the finalization of the sale of the loans to an investor. Changes in fair value are not generally expected to be recognized because at inception of the transaction the underlying mortgage loans have already been sold to an approved investor. Additionally, the interest rate is variable, and the transaction is short-term, with an average life of under 30 days from purchase to sale. These assets are classified as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Derivatives (assets and liabilities):

The fair values of interest rate swaps, interest rate caps and credit derivatives are determined using models that incorporate readily observable market data into a market standard methodology. This methodology nets the discounted future cash receipts and the discounted expected cash payments. The discounted variable cash receipts and payments are based on expectations of future interest rates derived from observable market interest rate curves. In addition, fair value is adjusted for the effect of nonperformance risk by incorporating credit valuation adjustments for Customers and its counterparties. These assets and liabilities are classified as Level 2 fair values, based upon the lowest level of input that is significant to the fair value measurements.

The fair values of the residential mortgage loan commitments are derived from the estimated fair values that can be generated when the underlying mortgage loan is sold in the secondary market. Customers generally uses commitments on hand from third party investors to estimate an exit price and adjusts for the probability of the commitment being exercised based on Customers' internal experience (i.e., pull-through rate). These assets and liabilities are classified as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Derivative assets and liabilities are presented in "Other assets" and "Accrued interest payable and other liabilities" on the consolidated balance sheet.

The following information should not be interpreted as an estimate of Customers' fair value in its entirety because fair value calculations are only provided for a limited portion of Customers' assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making these estimates, comparisons between Customers' disclosures and those of other companies may not be meaningful.

Financial Instruments Recorded at Fair Value on a Nonrecurring Basis

Collateral-dependent loans:

Collateral-dependent loans are those loans that are accounted for under ASC 326, Financial Instruments - Credit Losses, in which the Bank has measured impairment generally based on the fair value of the loan’s collateral or discounted cash flow analysis. Fair value is generally determined based upon independent third-party appraisals of the properties that collateralize the loans, discounted cash flows based upon the expected proceeds, sales agreements or letters of intent with third parties. These assets are generally classified as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

Other real estate owned:

The fair value of OREO is determined by using appraisals, which may be discounted based on management’s review and changes in market conditions or sales agreements with third parties. All appraisals must be performed in accordance with the Uniform Standards of Professional Appraisal Practice. Appraisals are certified to the Bank and performed by appraisers on the Bank’s approved list of appraisers. Evaluations are completed by a person independent of management. The content of the appraisal depends on the complexity of the property. Appraisals are completed on a “retail value” and an “as is value”. These assets are classified as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.

The estimated fair values of Customers' financial instruments at March 31, 2020 and December 31, 2019 were as follows.


					Fair Value Measurements at March 31, 2020
(amounts in thousands)	Carrying Amount		Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Cash and cash equivalents	$	256,232	$	256,232	$	256,232	$	—	$	—
Debt securities, available for sale	696,353		696,353		—		696,353		—
Interest-only GNMA securities	15,276		15,276		—		—		15,276
Equity securities	1,028		1,028		1,028		—		—
Loans held for sale	450,157		450,157		—		1,388		448,769

Total loans and leases receivable, net of allowance for credit losses on loans and leases	9,721,991		10,198,615		—		2,518,012		7,680,603
FHLB, Federal Reserve Bank and other restricted stock	87,140		87,140		—		87,140		—
Derivatives	66,449		66,449		—		66,234		215

Liabilities:
Deposits	$	8,413,643	$	8,425,067	$	7,014,296	$	1,410,771	$	—

FRB advances	175,000		175,000		175,000		—		—
Federal funds purchased	705,000		705,000		705,000		—		—
FHLB advances	1,260,000		1,266,251		410,000		856,251		—
Other borrowings	123,732		97,517		—		97,517		—
Subordinated debt	181,185		154,304		—		154,304		—
Derivatives	118,189		118,189		—		118,189		—


					Fair Value Measurements at December 31, 2019
(amounts in thousands)	Carrying Amount		Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Cash and cash equivalents	$	212,505	$	212,505	$	212,505	$	—	$	—
Debt securities, available for sale	577,198		577,198		—		577,198		—
Interest-only GNMA securities	16,272		16,272		—		—		16,272
Equity securities	2,406		2,406		2,406		—		—
Loans held for sale	486,328		486,328		—		2,130		484,198

Total loans and leases receivable, net of allowance for credit losses on loans and leases	9,508,367		9,853,037		—		2,245,758		7,607,279
FHLB, Federal Reserve Bank and other restricted stock	84,214		84,214		—		84,214		—
Derivatives	23,608		23,608		—		23,529		79

Liabilities:
Deposits	$	8,648,936	$	8,652,340	$	6,980,402	$	1,671,938	$	—

Federal funds purchased	538,000		538,000		538,000		—		—
FHLB advances	850,000		852,162		—		852,162		—
Other borrowings	123,630		127,603		—		127,603		—
Subordinated debt	181,115		192,217		—		192,217		—
Derivatives	45,939		45,939		—		45,939		—

For financial assets and liabilities measured at fair value on a recurring and nonrecurring basis, the fair value measurements by level within the fair value hierarchy used at March 31, 2020 and December 31, 2019 were as follows:


	March 31, 2020
	Fair Value Measurements at the End of the Reporting Period Using
(amounts in thousands)	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Measured at Fair Value on a Recurring Basis:
Assets
Available for sale debt securities:
Agency-guaranteed residential mortgage-backed securities	$	—	$	172,814	$	—	$	172,814
Agency-guaranteed collateralized mortgage obligations	—		153,952		—		153,952

State and political subdivision debt securities	—		15,157		—		15,157
Collateralized mortgage obligations	—		5,566		—		5,566
Corporate notes	—		348,864		—		348,864
Interest-only GNMA securities	—		—		15,276		15,276
Equity securities	1,028		—		—		1,028
Derivatives	—		66,234		215		66,449
Loans held for sale – fair value option	—		1,388		—		1,388
Loans receivable, mortgage warehouse – fair value option	—		2,518,012		—		2,518,012
Total assets – recurring fair value measurements	$	1,028	$	3,281,987	$	15,491	$	3,298,506
Liabilities
Derivatives	$	—	$	118,189	$	—	$	118,189
Measured at Fair Value on a Nonrecurring Basis:
Assets

Collateral-dependent loans, net of specific reserves of $854	$	—	$	—	$	28,923	$	28,923


	December 31, 2019
	Fair Value Measurements at the End of the Reporting Period Using
(amounts in thousands)	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Measured at Fair Value on a Recurring Basis:
Assets
Available for sale debt securities:
Agency-guaranteed residential mortgage–backed securities	$	—	$	278,321	$	—	$	278,321

Corporate notes	—		298,877		—		298,877
Interest-only GNMA securities	—		—		16,272		16,272
Equity securities	2,406		—		—		2,406
Derivatives	—		23,529		79		23,608
Loans held for sale – fair value option	—		2,130		—		2,130
Loans receivable, mortgage warehouse – fair value option	—		2,245,758		—		2,245,758
Total assets – recurring fair value measurements	$	2,406	$	2,848,615	$	16,351	$	2,867,372
Liabilities
Derivatives	$	—	$	45,939	$	—	$	45,939
Measured at Fair Value on a Nonrecurring Basis:
Assets
Impaired loans, net of specific reserves of $852	$	—	$	—	$	14,272	$	14,272
Other real estate owned	—		—		78		78
Total assets – nonrecurring fair value measurements	$	—	$	—	$	14,350	$	14,350

The changes in residential mortgage loan commitments (Level 3 assets) measured at fair value on a recurring basis for the three months ended March 31, 2020 and 2019 are summarized in the tables below. Additional information about residential mortgage loan commitments can be found in NOTE 11 - DERIVATIVES INSTRUMENTS AND HEDGING ACTIVITIES.


	Residential Mortgage Loan Commitments
	Three Months Ended March 31,
(amounts in thousands)	2020		2019
Balance at December 31	$	79	$	69
Issuances	215		77
Settlements	(79)		(69)
Balance at March 31	$	215	$	77

There were no transfers between levels during the three months ended March 31, 2020 and 2019.

The following table summarizes financial assets and financial liabilities measured at fair value as of March 31, 2020 and December 31, 2019 on a recurring and nonrecurring basis for which Customers utilized Level 3 inputs to measure fair value. The unobservable Level 3 inputs noted below contain a level of uncertainty that may differ from what is realized in an immediate settlement of the assets. Therefore, Customers may realize a value higher or lower than the current estimated fair value of the assets. The interest-only GNMA securities are Level 3 assets measured at fair value on a recurring basis under a fair value option election. For the three months ended March 31, 2020, cash settlements of $1.0 million were applied to the carrying value of the interest-only GNMA securities, net of premium amortization expense. At March 31, 2020, Customers used an internally developed discounted cash flow model to value the interest-only GNMA securities. The significant unobservable input used in the discounted cash flow model included prepayment speed. Significant increases (decreases) in this input would result in a significantly lower (higher) fair value measurement.

Quantitative Information about Level 3 Fair Value Measurements

March 31, 2020

Fair Value
Estimate

Valuation Technique

Unobservable Input

Range

(Weighted Average) ⁽⁴⁾

(amounts in thousands)

Collateral-dependent – real estate

27,735

Collateral appraisal ⁽¹⁾

Business asset valuation⁽³⁾

Liquidation expenses ⁽²⁾

Business asset valuation⁽⁴⁾

8% - 10%

(8%)

11% - 45%

(20%)

Collateral-dependent loans – commercial & industrial

1,188

Collateral appraisal ⁽¹⁾

Business asset valuation ⁽³⁾

Liquidation expenses⁽²⁾

Business asset valuation adjustments ⁽⁴⁾

8% - 8%

(8%)

8% - 8%

(8%)

Interest-only GNMA securities

15,276

Discounted cash flow

Constant prepayment rate

5% - 13%

(12%)

Residential mortgage loan commitments

215

Adjusted market bid

Pull-through rate

80% - 80%

(80%)

(1)Obtained from approved independent appraisers. Appraisals are current and in compliance with credit policy. Customers does not generally discount appraisals.   Fair value is also estimated based on sale agreements or letters of intent with third parties.

(2)Appraisals are adjusted by management for liquidation expenses. The range and weighted average of liquidation expense adjustments are presented as a percentage of the appraisal.

(3)Business asset valuation obtained from independent party.

(4)Business asset valuations may be adjusted by management for qualitative factors including economic conditions and the condition of the business assets. The range and weighted average of the business asset adjustments are presented as a percent of the business asset valuation.

Quantitative Information about Level 3 Fair Value Measurements

December 31, 2019

Fair Value
Estimate

Valuation Technique

Unobservable Input

Range

(Weighted Average) ⁽⁴⁾

(amounts in thousands)

Impaired loans – real estate

12,767

Collateral appraisal ⁽¹⁾

Business asset valuation⁽³⁾

Liquidation expenses ⁽²⁾

Business asset valuation⁽⁴⁾

8% - 10%

(8%)

34% - 45%

(37%)

Impaired loans – commercial & industrial

1,505

Collateral appraisal ⁽¹⁾

Business asset valuation ⁽³⁾

Liquidation expenses ⁽²⁾

Business asset valuation adjustments ⁽⁴⁾

8% - 8%

(8%)

8% - 50%

(22%)

Interest-only GNMA securities

16,272

Discounted cash flow

Constant prepayment rate

9% - 14%

12%

Other real estate owned

Collateral appraisal ⁽¹⁾

Liquidation expenses ⁽²⁾

8% - 9%

(9%)

Residential mortgage loan commitments

Adjusted market bid

Pull-through rate

85% - 85%

(85%)

(1)Obtained from approved independent appraisers. Appraisals are current and in compliance with credit policy. Customers does not generally discount appraisals.

(2)Appraisals are adjusted by management for liquidation expenses. The range and weighted average of liquidation expense adjustments are presented as a percentage of the appraisal.

(3)Business asset valuation obtained from independent party.

- 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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