Atlantic Union Bankshares Corporation Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

FAIR VALUE MEASUREMENTS

FAIR VALUE MEASUREMENTS

9 Months Ended

Sep. 30, 2018

The Company follows ASC 820, Fair Value Measurements and Disclosures, to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. ASC 820 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants.

ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:



Level 1		Valuation is based on quoted prices in active markets for identical assets and liabilities.

Level 2		Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the markets.

Level 3		Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market. These unobservable inputs reflect the Company’s assumptions about what market participants would use and information that is reasonably available under the circumstances without undue cost and effort.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements.

Derivative instruments

As discussed in Note 8 “Derivatives”, the Company records derivative instruments at fair value on a recurring basis. The Company utilizes derivative instruments as part of the management of interest rate risk to modify the re-pricing characteristics of certain portions of the Company’s interest-bearing assets and liabilities. The Company has contracted with a third party vendor to provide valuations for derivatives using standard valuation techniques and therefore classifies such valuations as Level 2. Third party valuations are validated by the Company using Bloomberg Valuation Service’s derivative pricing functions. No material differences were identified during the validation as of September 30, 2018 and December 31, 2017. The Company has considered counterparty credit risk in the valuation of its derivative assets and has considered its own credit risk in the valuation of its derivative liabilities.

In the second quarter of 2018, the Bank announced that it had entered into an agreement with a third party mortgage company to allow TFSB to offer residential mortgages from certain Bank locations on the terms and conditions set forth in the agreement. Concurrently with this arrangement, the Bank began the process of winding down the operations of UMG, the Company's reportable mortgage segment. Prior to this announcement, during the normal course of business, the Company entered into interest rate lock commitments related to the origination of mortgage loans held for sale, as well as best effort forward delivery commitments to mitigate interest rate risk; these instruments were recorded at estimated fair value based on the value of the underlying loan, which in turn was based on quoted prices for similar loans in the secondary market. This value, however, was adjusted by a pull-through rate, which considered the likelihood that the loan in a lock position would ultimately close. The pull-through rate was derived from the Company’s internal data and was adjusted using significant management judgment. The pull-through rate was largely dependent on the loan processing stage that a loan was currently in and the change in prevailing interest rates from the time of the rate lock. As such, interest rate lock commitments are classified as Level 3. An increase in the pull-through rate utilized in the fair value measurement of the interest rate lock commitment derivative resulted in positive fair value adjustments, while a decrease in the pull-through rate resulted in a negative fair value adjustment. As a result of the UMG wind down, at September 30, 2018, the Company had no interest rate locks with a weighted average pull-through rate, and a weighted average pull-through rate of approximately 80% as of December 31, 2017. The interest rate lock commitments are recorded as a component of “Other Assets” on the Company’s Consolidated Balance Sheet.

AFS Securities

AFS securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data (Level 2). If the inputs used to provide the evaluation for certain securities are unobservable and/or there is little, if any, market activity, then the security would fall to the lowest level of the hierarchy (Level 3).

The Company’s investment portfolio is primarily valued using fair value measurements that are considered to be Level 2. The Company has contracted with a third party portfolio accounting service vendor for valuation of its securities portfolio. The vendor’s primary source for security valuation is IDC, which evaluates securities based on market data. IDC utilizes evaluated pricing models that vary by asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.

The vendor utilizes proprietary valuation matrices for valuing all municipals securities. The initial curves for determining the price, movement, and yield relationships within the municipal matrices are derived from industry benchmark curves or sourced from a municipal trading desk. The securities are further broken down according to issuer, credit support, state of issuance, and rating to incorporate additional spreads to the industry benchmark curves.

The Company primarily uses Bloomberg Valuation Service, an independent information source that draws on quantitative models and market data contributed from over 4,000 market participants, to validate third party valuations. Any material differences between valuation sources are researched by further analyzing the various inputs that are utilized by each pricing source. No material differences were identified during the validation as of September 30, 2018 and December 31, 2017.

The carrying value of restricted Federal Reserve Bank and FHLB stock approximates fair value based on the redemption provisions of each entity and is therefore excluded from the following table.

Marketable Equity Securities

Marketable securities are carried at fair value. Fair value is based on the reported market price of the publicly traded stock (Level 1).

Loans Held for Sale

Loans held for sale are carried at fair value. These loans currently consist of residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). At September 30, 2018, loans held for sale are included in "Assets of discontinued operations" on the Company's Consolidated Balance Sheets. Refer to Note 13 "Segment Reporting & Discontinued Operations" for further discussion regarding discontinued operations.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis at September 30, 2018 and December 31, 2017 (dollars in thousands):



	Fair Value Measurements at September 30, 2018 using
	Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Level 1		Level 2		Level 3		Balance
ASSETS
AFS securities:
Obligations of states and political subdivisions	$	—	$	563,473	$	—	$	563,473
Corporate and other bonds	—		161,492		—		161,492
Mortgage-backed securities	—		1,146,913		—		1,146,913
Other securities	—		11,263		—		11,263
Marketable equity securities	27,375		—		—		27,375
Loans held for sale	—		360		—		360
Derivatives:
Interest rate swap	—		23,943		—		23,943
Fair value hedges	—		3,468		—		3,468

LIABILITIES
Derivatives:
Interest rate swap	$	—	$	23,943	$	—	$	23,943
Cash flow hedges	—		2,526		—		2,526



	Fair Value Measurements at December 31, 2017 using
	Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Level 1		Level 2		Level 3		Balance
ASSETS
AFS securities:
Obligations of states and political subdivisions	$	—	$	301,824	$	—	$	301,824
Corporate and other bonds	—		113,880		—		113,880
Mortgage-backed securities	—		548,858		—		548,858
Other securities	—		9,660		—		9,660
Loans held for sale	—		40,662		—		40,662
Derivatives:
Interest rate swap	—		1,350		—		1,350
Cash flow hedges	—		49		—		49
Fair value hedges	—		1,598		—		1,598
Interest rate lock commitments	—		—		559		559
Best efforts forward delivery commitments	—		—		12		12

LIABILITIES
Derivatives:
Interest rate swap	$	—	$	1,350	$	—	$	1,350
Cash flow hedges	—		8,005		—		8,005
Fair value hedges	—		76		—		76

Certain assets are measured at fair value on a nonrecurring basis in accordance with U.S. GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements.

Impaired loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreements will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral dependent loans are reported at the fair value of the underlying collateral if repayment is solely from the underlying value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company’s collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data. When evaluating the fair value, management may discount the appraisal further if, based on their understanding of the market conditions, it is determined the collateral is further impaired below the appraised value (Level 3). At September 30, 2018 and December 31, 2017, the Level 3 weighted average adjustments related to impaired loans were 3.2% and 3.0%, respectively. The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Collateral dependent impaired loans allocated to the ALL are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Company’s Consolidated Statements of Income.

Foreclosed Properties & Former Bank Premises

Foreclosed properties and former bank premises are evaluated for impairment at least quarterly by the Bank’s Special Asset Loan Committee and any necessary write downs to fair values are recorded as impairment and included as a component of noninterest expense. Fair values of foreclosed properties and former bank premises are carried at fair value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as Level 3 valuation. At September 30, 2018 and December 31, 2017, the Level 3 weighted average adjustments related to foreclosed property were approximately 3.6% and 22.5%, respectively. At September 30, 2018 and December 31, 2017, there were no Level 3 weighted average adjustments related to bank premises.

Total valuation expenses related to foreclosed properties for the three months ended September 30, 2018 and 2017 totaled $42,000 and $249,000, respectively. Total valuation expenses related to foreclosed properties for the nine months ended September 30, 2018 and 2017 totaled $1.2 million and $506,000 respectively.

Total valuation expenses related to former bank premises for the three and nine months ended September 30, 2018 was $0 and for the three and nine months ended September 30, 2017 was $339,000.

The following tables summarize the Company’s financial assets that were measured at fair value on a nonrecurring basis at September 30, 2018 and December 31, 2017 (dollars in thousands):



	Fair Value Measurements at September 30, 2018 using
	Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Level 1		Level 2		Level 3		Balance
ASSETS
Impaired loans	$	—	$	—	$	2,614	$	2,614
Foreclosed properties	—		—		6,800		6,800
Former bank premises	—		—		4,615		4,615



	Fair Value Measurements at December 31, 2017 using
	Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Level 1		Level 2		Level 3		Balance
ASSETS
Impaired loans	$	—	$	—	$	3,229	$	3,229
Foreclosed properties	—		—		5,253		5,253
Former bank premises	—		—		1,383		1,383

ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments for interim periods and excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

Cash and Cash Equivalents

For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

HTM Securities

Loans

With the adoption of ASU No. 2016-01 during the first quarter of 2018, the fair value of loans at September 30, 2018 were estimated using an exit price, representing the amount that would be expected to be received if the Company sold the loans. At December 31, 2017, the fair value of performing loans were estimated by discounting expected future cash flows using a yield curve that is constructed by adding a loan spread to a market yield curve. Loan spreads are based on spreads currently observed in the market for loans of similar type and structure. Fair value for impaired loans and their respective level within the fair value hierarchy are described in the previous disclosure related to fair value measurements of assets that are measured on a nonrecurring basis.

BOLI

The carrying value of BOLI approximates fair value. The Company records these policies at their cash surrender value, which is estimated using information provided by insurance carriers.

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. With the adoption of ASU No. 2016-01 during the first quarter of 2018, the fair value of certificates of deposits at September 30, 2018 were valued using a discounted cash flow calculation that includes a market rate analysis of the current rates offered by market participants for certificates of deposits that mature in the same period. At December 31, 2017, the fair value of certificates of deposit was estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

Borrowings

The carrying value of the Company’s repurchase agreements is a reasonable estimate of fair value. With the adoption of ASU No. 2016-01 during the first quarter of 2018, subordinated debt and trust preferred cash flows at September 30, 2018 are forecasted at the stated coupon rate and discounted back to the measurement date using the prevailing market rate. The prevailing market rate is based on implied market yields for recently issued debt with similar durations by institutions of similar size. Other borrowings, including subordinated debt and trust preferred at December 31, 2017 are discounted using the current yield curve for the same type of borrowing. For borrowings with embedded optionality, a third party source is used to value the instrument.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

The carrying values and estimated fair values of the Company’s financial instruments at September 30, 2018 and December 31, 2017 are as follows (dollars in thousands):



			Fair Value Measurements at September 30, 2018 using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Total Fair Value
	Carrying Value		Level 1		Level 2		Level 3		Balance
ASSETS
Cash and cash equivalents	$	282,212	$	282,212	$	—	$	—	$	282,212
AFS securities	1,883,141		—		1,883,141		—		1,883,141
HTM securities	235,333		—		232,710		—		232,710
Marketable equity securities	27,375		27,375		—		—		27,375
Restricted stock	112,390		—		112,390		—		112,390
Loans held for sale	360		—		360		—		360
Net loans	9,370,304		—		—		9,258,960		9,258,960
Derivatives:
Interest rate swap	23,943		—		23,943		—		23,943
Fair value hedge	3,468		—		3,468		—		3,468
Interest rate lock commitments	—		—		—		—		—
Accrued interest receivable	41,691		—		41,691		—		41,691
BOLI	261,874		—		261,874		—		261,874

LIABILITIES
Deposits	$	9,834,695	$	—	$	9,851,948	$	—	$	9,851,948
Borrowings	1,554,642		—		1,542,161		—		1,542,161
Accrued interest payable	6,017		—		6,017		—		6,017
Derivatives:
Interest rate swap	23,943		—		23,943		—		23,943
Cash flow hedges	2,526		—		2,526		—		2,526



			Fair Value Measurements at December 31, 2017 using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs		Total Fair Value
	Carrying Value		Level 1		Level 2		Level 3		Balance
ASSETS
Cash and cash equivalents	$	199,373	$	199,373	$	—	$	—	$	199,373
AFS securities	974,222		—		974,222		—		974,222
HTM securities	199,639		—		203,483		—		203,483
Restricted stock	75,283		—		75,283		—		75,283
Loans held for sale	40,662		—		40,662		—		40,662
Net loans	7,103,344		—		—		7,117,593		7,117,593
Derivatives:
Interest rate swap	1,350		—		1,350		—		1,350
Cash flow hedges	49		—		49		—		49
Fair value hedges	1,598		—		1,598		—		1,598
Interest rate lock commitments	559		—		—		559		559
Best efforts forward delivery commitments	12		—		—		12		12
Accrued interest receivable	26,427		—		26,427		—		26,427
BOLI	182,854		—		182,854		—		182,854

LIABILITIES
Deposits	$	6,991,718	$	—	$	6,977,845	$	—	$	6,977,845
Borrowings	1,219,414		—		1,198,645		—		1,198,645
Accrued interest payable	2,538		—		2,538		—		2,538
Derivatives:
Interest rate swap	1,350		—		1,350		—		1,350
Cash flow hedges	8,005		—		8,005		—		8,005
Fair value hedges	76		—		76		—		76

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. Borrowers with fixed rate obligations, however, are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.