Financial Instruments and Investments

The FASB guidance requires the Company to disclose estimated fair values for its financial instruments. The Company has determined that cash and temporary investments, investment in debt securities, accounts receivable, decommissioning trust funds, long-term debt, short-term borrowings under the RCF, accounts payable and customer deposits meet the definition of financial instruments. The carrying amounts of cash and temporary investments, accounts receivable, accounts payable and customer deposits approximate fair value because of the short maturity of these items. Investments in debt securities and decommissioning trust funds are carried at estimated fair value.

Long-Term Debt and Short-Term Borrowings Under the RCF. The fair values of the Company's long-term debt and short-term borrowings under the RCF are based on estimated market prices for similar issues and are presented below (in thousands):



	December 31,
	2018				2017
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Pollution Control Bonds	$	157,769	$	161,917	$	157,676	$	169,186
Senior Notes (1)	1,117,943		1,244,310		993,426		1,211,922
RGRT Senior Notes (1) (2)	109,507		111,440		44,886		47,070
RCF (2)	49,207		49,207		173,533		173,533
Total	$	1,434,426	$	1,566,874	$	1,369,521	$	1,601,711

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(1)	On June 28, 2018, the Company issued $125 million in aggregate principal amount of 4.22% Senior Notes due August 15, 2028 and guaranteed the issuance by the RGRT of $65 million in aggregate principal amount of 4.07% Senior Guaranteed Notes due August 15, 2025. See Part II, Item 8, Financial Statements and Supplementary Data, Note J of Notes to Financial Statements.

(2)

Nuclear fuel financing, as of December 31, 2018 and December 31, 2017, is funded through $110 million and $45 million RGRT Senior Notes and $26.2 million and $88.5 million, respectively under the RCF. As of December 31, 2018, $23 million was outstanding under the RCF for working capital or general corporate purposes. As of December 31, 2017, $85.0 million was outstanding under the RCF for working capital or general corporate purposes. The interest rate on the Company’s borrowings under the RCF is reset throughout the period reflecting current market rates. Consequently, the carrying value approximates fair value.

Treasury Rate Locks. The Company entered into treasury rate lock agreements in 2005 to hedge against potential movements in the treasury reference interest rate pending the issuance of the 6% Senior Notes. The treasury rate lock agreements met the criteria for hedge accounting and were designated as a cash flow hedge. In accordance with cash flow hedge accounting, the Company recorded the loss associated with the fair value of the cash flow hedge, net of tax, as a component of accumulated other comprehensive loss and amortizes the accumulated comprehensive loss to earnings as interest expense over the life of the 6% Senior Notes. In 2019, approximately $0.6 million of this accumulated other comprehensive loss item will be reclassified to interest expense.

Contracts and Derivative Accounting. The Company uses commodity contracts to manage its exposure to price and availability risks for fuel purchases and power sales and purchases and these contracts generally have the characteristics of derivatives. The Company does not trade or use these instruments with the objective of earning financial gains on the commodity price fluctuations. The Company has determined that all such contracts outstanding at December 31, 2018, except for certain natural gas commodity contracts with optionality features, that had the characteristics of derivatives met the "normal purchases and normal sales" exception provided in the FASB guidance for accounting for derivative instruments and hedging activities, and, as such, were not required to be accounted for as derivatives.

Marketable Securities. The Company’s marketable securities, included in the NDT in the balance sheets, are reported at fair value, which was $276.9 million and $286.9 million at December 31, 2018 and 2017, respectively. The investments in the NDT are classified as available for sale debt securities, equity securities and cash and cash equivalents. These investments are recorded at their estimated fair value in accordance with FASB guidance for certain investments in debt and equity securities. On January 1, 2018, the Company adopted ASU 2016-01, Financial Instruments-Overall, which eliminates the requirements to classify investments in equity securities with readily determinable fair values as trading or available for sale and requires entities to recognize changes in fair value for these securities in net income as reported in the Statements of Operations. ASU 2016-01 requires a modified-retrospective approach and therefore, comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.

The reported fair values include gross unrealized losses on securities classified as available for sale whose impairment the Company has deemed to be temporary. The tables below present the gross unrealized losses and the fair value of these securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):



	December 31, 2018
	Less than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Description of Securities (1):
Federal Agency Mortgage Backed Securities	$	6,187	$	(36	)	$	14,567	$	(510	)	$	20,754	$	(546	)
U.S. Government Bonds	4,005		(9		)	36,615		(1,663		)	40,620		(1,672		)
Municipal Debt Obligations	3,100		(74		)	9,037		(723		)	12,137		(797		)
Corporate Debt Obligations	22,259		(763		)	11,231		(731		)	33,490		(1,494		)
Total	$	35,551	$	(882	)	$	71,450	$	(3,627	)	$	107,001	$	(4,509	)

____________________


(1)	Includes approximately 156 securities.



	December 31, 2017
	Less than 12 Months					12 Months or Longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Description of Securities (2):
Federal Agency Mortgage Backed Securities	$	4,700	$	(46	)	$	10,099	$	(165	)	$	14,799	$	(211	)
U.S. Government Bonds	28,866		(416		)	18,186		(969		)	47,052		(1,385		)
Municipal Debt Obligations	4,290		(73		)	9,736		(742		)	14,026		(815		)
Corporate Debt Obligations	10,685		(107		)	4,475		(331		)	15,160		(438		)
Total Debt Securities	48,541		(642		)	42,496		(2,207		)	91,037		(2,849		)
Domestic Equity Securities	962		(210		)	—		—			962		(210		)
Total	$	49,503	$	(852	)	$	42,496	$	(2,207	)	$	91,999	$	(3,059	)

______________________


(2)	Includes approximately 146 securities.

The Company monitors the length of time specific securities trade below their cost basis along with the amount and percentage of the unrealized loss in determining if a decline in fair value below recorded cost of debt securities classified as available for sale is considered to be other than temporary. The Company recognizes impairment losses on certain of its available for sale debt securities deemed to be other than temporary. In accordance with the FASB guidance, these impairment losses are recognized in net income, and a lower cost basis is established for these securities. In addition, the Company will research the future prospects of individual securities as necessary. The Company does not anticipate expending monies held in trust before 2044 or a later period when decommissioning of Palo Verde begins.

For the twelve months ended December 31, 2018, 2017 and 2016, the Company recognized other than temporary impairment losses on its available-for-sale securities as follows (in thousands):



	2018		2017		2016
Unrealized holding losses included in pre-tax income	$	—	$	—	$	(352	)

Investments categorized as available for sale securities also include gross unrealized gains which have not been recognized in the Company's net income. The table below presents the unrecognized gross unrealized gains and the fair value of these securities, aggregated by investment category (in thousands):



	December 31, 2018				December 31, 2017
	Fair Value		Unrealized Gains		Fair Value		Unrealized Gains
Description of Securities:
Federal Agency Mortgage Backed Securities	$	9,959	$	176	$	5,933	$	203
U.S. Government Bonds	6,987		149		11,129		256
Municipal Debt Obligations	1,952		120		2,558		109
Corporate Debt Obligations	8,283		222		19,514		1,067
Total Debt Securities	27,181		667		39,134		1,635
Domestic Equity Securities	—		—		120,065		45,587
International Equity Securities	—		—		28,804		5,908
Cash and Cash Equivalents	—		—		6,864		—
Total	$	27,181	$	667	$	194,867	$	53,130

The Company’s marketable securities include investments in mortgage backed securities, municipal, corporate and federal debt obligations. The contractual year for maturity for these available-for-sale securities as of December 31, 2018 is as follows (in thousands):



	Total		2019		2020 through 2023		2024 through 2028		2029 and Beyond
Federal Agency Mortgage Backed Securities	$	30,713	$	—	$	19	$	547	$	30,147
U.S. Government Bonds	47,607		8,302		20,377		15,008		3,920
Municipal Debt Obligations	14,089		657		5,916		5,245		2,271
Corporate Debt Obligations	41,773		3,101		20,032		6,618		12,022
Total Available for Sale Debt Securities	$	134,182	$	12,060	$	46,344	$	27,418	$	48,360

The Company's available for sale securities in the NDT are sold from time to time and the Company uses the specific identification basis to determine the amount to reclassify from AOCI into net income. The proceeds from the sale of these securities during the twelve months ended December 31, 2018, 2017, and 2016 and the related effects on pre-tax income are as follows (in thousands):



	2018			2017			2016
Proceeds from sales or maturities of available-for-sale securities	$	25,955		$	97,037		$	91,268
Gross realized gains included in pre-tax income	$	17		$	11,773		$	9,212
Gross realized losses included in pre-tax income	(1,462		)	(1,147		)	(1,220		)
Gross unrealized losses included in pre-tax income	—			—			(352		)
Net gains (losses) included in pre-tax income	$	(1,445	)	$	10,626		$	7,640

Upon the adoption of ASU 2016-01, Financial Instruments-Overall, on January 1, 2018, the Company records, on a modified-retrospective basis, changes in fair market value for equity securities held in the NDT in the Statements of Operations. The unrealized gains and losses recognized during the twelve months ended December 31, 2018 and related effects on pre-tax income are as follows (in thousands):



	December 31, 2018

Net gains and (losses) recognized on equity securities	$	(11,522	)
Less: Net gains and (losses) recognized on equity securities sold	7,079
Unrealized gains and (losses) recognized on equity securities still held at reporting date	$	(18,601	)

Fair Value Measurements. The FASB guidance requires the Company to provide expanded quantitative disclosures for financial assets and liabilities recorded on the balance sheet at fair value. Financial assets carried at fair value include the Company's decommissioning trust investments and investments in debt securities which are included in deferred charges and other assets on the Balance Sheets. The Company has no liabilities that are measured at fair value on a recurring basis. The FASB guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels as follows:

•

Level 1 – Observable inputs that reflect quoted market prices for identical assets and liabilities in active markets. Financial assets utilizing Level 1 inputs include the NDT investments in active exchange-traded equity securities, mutual funds and U.S. Treasury securities that are in a highly liquid and active market. The Institutional Funds are valued using the NAV provided by the administrator of the fund. The NAV price is quoted on a restrictive market although the underlying investments are traded on active markets. The NAV used for determining the fair value of the Institutional Funds-International Equity investments have readily determinable fair values. Accordingly, such fund values are categorized as Level 1.

•

Level 2 – Inputs other than quoted market prices included in Level 1 that are observable for the asset or liability either directly or indirectly. Financial assets utilizing Level 2 inputs include the NDT investments in fixed income securities. The fair value of these financial instruments is based on evaluated prices that reflect observable market information, such as actual trade information of similar securities, adjusted for observable differences.


•	Level 3 – Unobservable inputs using data that is not corroborated by market data and primarily based on internal Company analysis using models and various other analysis. Financial assets utilizing Level 3 inputs are the Company's investment in debt securities.

The securities in the NDT are valued using prices and other relevant information generated by market transactions involving identical or comparable securities. The FASB guidance identifies this valuation technique as the "market approach" with observable inputs. The Company analyzes available-for-sale securities to determine if losses are other than temporary.

The fair value of the NDT and investments in debt securities at December 31, 2018 and 2017, and the level within the three levels of the fair value hierarchy defined by the FASB guidance are presented in the table below (in thousands):



Description of Securities	Fair Value as of December 31, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Trading Securities:
Investments in Debt Securities	$	1,656	$	—	$	—	$	1,656
Equity Securities:
Domestic	$	111,325	$	111,325	$	—	$	—
International	24,540		24,540		—		—
Total Equity Securities	135,865		135,865		—		—
Available for Sale Debt Securities:
Federal Agency Mortgage Backed Securities	30,713		—		30,713		—
U.S. Government Bonds	47,607		47,607		—		—
Municipal Debt Obligations	14,089		—		14,089		—
Corporate Debt Obligations	41,773		—		41,773		—
Total Available for Sale Debt Securities	134,182		47,607		86,575		—
Cash and Cash Equivalents	6,858		6,858		—		—
Total	$	276,905	$	190,330	$	86,575	$	—



Description of Securities	Fair Value as of December 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Trading Securities:
Investments in Debt Securities	$	1,735	$	—	$	—	$	1,735
Available for sale:
Federal Agency Mortgage Backed Securities	$	20,732	$	—	$	20,732	$	—
U.S. Government Bonds	58,181		58,181		—		—
Municipal Debt Obligations	16,584		—		16,584		—
Corporate Debt Obligations	34,674		—		34,674		—
Subtotal, Debt Securities	130,171		58,181		71,990		—
Domestic	121,027		121,027		—		—
International	28,804		28,804		—		—
Subtotal, Equity Securities	149,831		149,831		—		—
Cash and Cash Equivalents	6,864		6,864		—		—
Total	$	286,866	$	214,876	$	71,990	$	—

Below is a reconciliation of the beginning and ending balance of the fair value of the investment in debt securities classified as trading securities (in thousands):



	2018			2017
Balance at January 1	$	1,735		$	1,421
Net unrealized gains (losses) in fair value recognized in income (a)	(79		)	314
Balance at December 31	$	1,656		$	1,735

_____________________

(a) These amounts are reflected in the Company's statements of operations as investment and interest income.

There were no transfers in or out of Level 1 and Level 2 fair value measurements categories due to changes in observable inputs during the twelve-month periods ending December 31, 2018 and 2017. There were no purchases, sales, issuances and settlements related to the assets in the Level 3 fair value measurement category during the twelve-month periods ending December 31, 2018 and 2017.