Fair value measurements

Fair value measurement and disclosure valuation methodology. The following are descriptions of the valuation methodologies used for assets and liabilities recorded at fair value and for estimating fair value for financial instruments not carried at fair value:

Short-term borrowings—other than bank. The carrying amount of short-term borrowings approximated fair value because of the short maturity of these instruments.

Investment securities. The fair value of ASB’s investment securities is determined quarterly through pricing obtained from independent third-party pricing services or from brokers not affiliated with the trade. Non-binding broker quotes are infrequent and generally occur for new securities that are settled close to the month-end pricing date. The third-party pricing vendors ASB uses for pricing its securities are reputable firms that provide pricing services on a global basis and have processes in place to ensure quality and control. The third-party pricing services use a variety of methods to determine the fair value of securities that fall under Level 2 of ASB’s fair value measurement hierarchy. Among the considerations are quoted prices for similar securities in an active market, yield spreads for similar trades, adjustments for liquidity, size, collateral characteristics, historic and generic prepayment speeds, and other observable market factors.

To enhance the robustness of the pricing process, ASB will on a quarterly basis compare its standard third-party vendor’s price with that of another third-party vendor. If the prices are within an acceptable tolerance range, the price of the standard vendor will be accepted. If the variance is beyond the tolerance range, an evaluation will be conducted by ASB and a challenge to the price may be made. Fair value in such cases will be based on the value that best reflects the data and observable characteristics of the security. In all cases, the fair value used will have been independently determined by a third-party pricing vendor or non-affiliated broker.

The fair value of the mortgage revenue bond is estimated using a discounted cash flow model to calculate the present value of future principal and interest payments and, therefore is classified within Level 3 of the valuation hierarchy.

Loans held for sale. Residential and commercial loans are carried at the lower of cost or market and are valued using market observable pricing inputs, which are derived from third party loan sales and, therefore, are classified within Level 2 of the valuation hierarchy.

Loans held for investment. Fair value of loans held for investment is derived using a discounted cash flow approach which includes an evaluation of the underlying loan characteristics. The valuation model uses loan characteristics which includes product type, maturity dates and the underlying interest rate of the portfolio. This information is input into the valuation models along with various forecast valuation assumptions including prepayment forecasts, to determine the discount rate. These assumptions are derived from internal and third party sources. Since the valuation is derived from model-based techniques, ASB includes loans held for investment within Level 3 of the valuation hierarchy.

Impaired loans. At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Fair value is determined primarily by using an income, cost or market approach and is normally provided through appraisals. Impaired loans carried at fair value generally receive specific allocations within the allowance for loan losses. For collateral-dependent loans, fair value is commonly 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 independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Generally, impaired loans are evaluated quarterly for additional impairment and adjusted accordingly.

Real estate acquired in settlement of loans. Foreclosed assets are carried at fair value (less estimated costs to sell) and are generally based upon appraisals or independent market prices that are periodically updated subsequent to classification as real estate owned. Such adjustments typically result in a Level 3 classification of the inputs for determining fair value. ASB estimates the fair value of collateral-dependent loans and real estate owned using the sales comparison approach.

Mortgage servicing rights. Mortgage servicing rights (MSRs) are capitalized at fair value based on market data at the time of sale and accounted for in subsequent periods at the lower of amortized cost or fair value. Mortgage servicing rights are evaluated for impairment at each reporting date. ASB's MSRs are stratified based on predominant risk characteristics of the underlying loans including loan type and note rate. For each stratum, fair value is calculated by discounting expected net income streams using discount rates that reflect industry pricing for similar assets. Expected net income streams are estimated based on industry assumptions regarding prepayment expectations and income and expenses associated with servicing residential mortgage loans for others. Impairment is recognized through a valuation allowance for each stratum when the carrying amount exceeds fair value, with any associated provision recorded as a component of loan servicing fees included in "Revenues - bank" in the consolidated statements of income. A direct write-down is recorded when the recoverability of the valuation allowance is deemed to be unrecoverable. ASB compares the fair value of MSRs to an estimated value calculated by an independent third-party. The third-party relies on both published and unpublished sources of market related assumptions and their own experience and expertise to arrive at a value. ASB uses the third-party value only to assess the reasonableness of its own estimate.

Deposit liabilities. Includes only fixed-maturity certificates of deposit beginning in 2018. The fair value of fixed-maturity certificates of deposit was estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

Other borrowings. For fixed-rate advances and repurchase agreements, fair value is estimated using quantitative discounted cash flow models that require the use of interest rate inputs that are currently offered for advances and repurchase agreements of similar remaining maturities. The majority of market inputs are actively quoted and can be validated through external sources, including broker market transactions and third party pricing services.

Long-term debt—other than bank. Fair value of long-term debt of HEI and the Utilities was obtained from third-party financial services providers based on the current rates offered for debt of the same or similar remaining maturities and from discounting the future cash flows using the current rates offered for debt of the same or similar risks, terms, and remaining maturities.

Interest rate lock commitments (IRLCs). The estimated fair value of commitments to originate residential mortgage loans for sale is based on quoted prices for similar loans in active markets. IRLCs are classified as Level 2 measurements.

Forward sales commitments. To be announced (TBA) mortgage-backed securities forward commitments are classified as Level 1, and consist of publicly-traded debt securities for which identical fair values can be obtained through quoted market prices in active exchange markets. The fair values of ASB’s best efforts and mandatory delivery loan sale commitments are determined using quoted prices in the market place that are observable and are classified as Level 2 measurements.

Window forward contracts. The estimated fair value of the Utilities’ window forward contracts was obtained from a third-party financial services provider based on the effective exchange rate offered for the foreign currency denominated transaction. Window forward contracts are classified as Level 2 measurements.

The following table presents the carrying or notional amount, fair value and placement in the fair value hierarchy of the Company’s financial instruments. For stock in Federal Home Loan Bank, the carrying amount is a reasonable estimate of fair value because it can only be redeemed at par. For financial liabilities such as noninterest-bearing demand, interest-bearing demand, and savings and money market deposits, the carrying amount is a reasonable estimate of fair value as these liabilities have no stated maturity.



			Estimated fair value
	Carrying or notional amount		Quoted prices in active markets for identical assets		Significant other observable inputs		Significant unobservable inputs
(in thousands)			(Level 1)		(Level 2)		(Level 3)		Total
June 30, 2018
Financial assets
HEI consolidated
Available-for-sale investment securities	$	1,409,528	$	—	$	1,394,101	$	15,427	$	1,409,528
Held-to-maturity investment securities	62,630		—		61,444		—		61,444
Stock in Federal Home Loan Bank	10,158		—		10,158		—		10,158
Loans, net	4,727,189		—		5,250		4,774,079		4,779,329
Mortgage servicing rights	8,509		—		—		13,423		13,423
Derivative assets	24,537		—		250		—		250
Financial liabilities
HEI consolidated
Deposit liabilities¹	757,265		—		745,295		—		745,295
Short-term borrowings—other than bank	202,857		—		202,857		—		202,857
Other bank borrowings	126,930		—		126,904		—		126,904
Long-term debt, net—other than bank	1,783,009		—		1,816,310		—		1,816,310
Derivative liabilities	25,445		56		114		—		170
Hawaiian Electric consolidated
Short-term borrowings	91,880		—		91,880		—		91,880
Long-term debt, net	1,468,457		—		1,511,103		—		1,511,103
Derivative liabilities-window forward contracts	3,117		—		106		—		106
December 31, 2017
Financial assets
HEI consolidated
Available-for-sale investment securities	1,401,198		—		1,385,771		15,427		1,401,198
Held-to-maturity investment securities	44,515		—		44,412		—		44,412
Stock in Federal Home Loan Bank	9,706		—		9,706		—		9,706
Loans, net	4,628,381		—		11,254		4,770,497		4,781,751
Mortgage servicing rights	8,639		—		—		12,052		12,052
Derivative assets	17,812		—		393		—		393
Hawaiian Electric consolidated
Derivative assets-window forward contracts	3,240		—		256		—		256
Financial liabilities
HEI consolidated
Deposit liabilities¹	5,890,597		—		5,884,071		—		5,884,071
Short-term borrowings—other than bank	117,945		—		117,945		—		117,945
Other bank borrowings	190,859		—		190,829		—		190,829
Long-term debt, net—other than bank	1,683,797		—		1,813,295		—		1,813,295
Derivative liabilities	13,562		20		10		—		30
Hawaiian Electric consolidated
Short-term borrowings	4,999		—		4,999		—		4,999
Long-term debt, net	1,368,479		—		1,497,079		—		1,497,079

¹ Deposit liabilities as of December 31, 2017 include noninterest-bearing demand, interest-bearing demand, and savings and money market deposits, for which the carrying amount represents a reasonable estimate of fair value, as such liabilities have no stated maturity. The fair value of such financial liabilities are not included as of June 30, 2018 as a result of the Company’s adoption of ASU No. 2016-01.

Fair value measurements on a recurring basis. Assets and liabilities measured at fair value on a recurring basis were as follows:



	June 30, 2018						December 31, 2017
	Fair value measurements using						Fair value measurements using
(in thousands)	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Available-for-sale investment securities (bank segment)
Mortgage-related securities-FNMA, FHLMC and GNMA	$	—	$	1,177,832	$	—	$	—	$	1,201,473	$	—
U.S. Treasury and federal agency obligations	—		175,933		—		—		184,298		—
Corporate bonds	—		40,336		—		—		—		—
Mortgage revenue bond	—		—		15,427		—		—		15,427
	$	—	$	1,394,101	$	15,427	$	—	$	1,385,771	$	15,427
Derivative assets
Interest rate lock commitments (bank segment)¹	$	—	$	248	$	—	$	—	$	133	$	—
Forward commitments (bank segment)¹	—		2		—		—		4		—
Window forward contracts (electric utility segment)²	—		—		—		—		256		—
	$	—	$	250	$	—	$	—	$	393	$	—
Derivative liabilities
Interest rate lock commitments (bank segment) ¹	$	—	$	—	$	—	$	—	$	2	$	—
Forward commitments (bank segment) ¹	56		8		—		20		8		—
Window forward contracts (electric utility segment)²	—		106		—		—		—		—
	$	56	$	114	$	—	$	20	$	10	$	—

¹ Derivatives are carried at fair value with changes in value reflected in the balance sheet in other assets or other liabilities and included in mortgage banking income.

² Derivatives are included in regulatory assets and/or liabilities in the balance sheets.

There were no transfers of financial assets and liabilities between Level 1 and Level 2 of the fair value hierarchy during the six months ended June 30, 2018.

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis were as follows:



	Three months ended June 30				Six months ended June 30
Mortgage revenue bond	2018		2017		2018		2017
(in thousands)
Beginning balance	$	15,427	$	15,427	$	15,427	$	15,427
Principal payments received	—		—		—		—
Purchases	—		—		—		—
Unrealized gain (loss) included in other comprehensive income	—		—		—		—
Ending balance	$	15,427	$	15,427	$	15,427	$	15,427

ASB holds one mortgage revenue bond issued by the Department of Budget and Finance of the State of Hawaii. The Company estimates the fair value by using a discounted cash flow model to calculate the present value of estimated future principal and interest payments. The unobservable input used in the fair value measurement is the weighted average discount rate. As of June 30, 2018, the weighted average discount rate was 3.40% which was derived by incorporating a credit spread over the one month LIBOR rate. Significant increases (decreases) in the weighted average discount rate could result in a significantly lower (higher) fair value measurement.

Fair value measurements on a nonrecurring basis. Certain assets and liabilities are measured at fair value on a nonrecurring basis and therefore are not included in the tables above. These measurements primarily result from assets carried at the lower of cost or fair value or from impairment of individual assets. The carrying value of assets measured at fair value on a nonrecurring basis were as follows:



			Fair value measurements
(in thousands)	Balance		Level 1		Level 2		Level 3
June 30, 2018
Loans	$	232	$	—	$	—	$	232
December 31, 2017
Loans	2,621		—		—		2,621

For six months ended June 30, 2018 and 2017, there were no adjustments to fair value for ASB’s loans held for sale.

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis:



					Significant unobservable input value ⁽¹⁾
($ in thousands)	Fair value		Valuation technique	Significant unobservable input	Range	Weighted Average
June 30, 2018
Residential loans	$	232	Fair value of collateral	Appraised value less 7% selling cost	62-69%	68%
Total loans	$	232

December 31, 2017
Residential loans	$	613	Fair value of collateral	Appraised value less 7% selling cost	71-92%	84%
Commercial loans	2,008		Fair value of collateral	Appraised value	71-76%	75%
Total loans	$	2,621

(1) Represent percent of outstanding principal balance.

Significant increases (decreases) in any of those inputs in isolation would result in significantly higher (lower) fair value measurements.