Fair value measurements

3 Months Ended

Mar. 31, 2020

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 bonds 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 credit 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. 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. MSRs 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 its 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. The fair value of fixed-maturity certificates of deposit was estimated by discounting the future cash flows using the rates currently offered for FHLB advances of similar remaining maturities. Deposit liabilities are classified in Level 2 of the valuation hierarchy.

Other borrowings. For 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 fixed-rate long-term debt—other than bank 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. The carrying amount of floating rate long-term debt—other than bank approximated fair value because of the short-term interest reset periods. Long-term debt—other than bank is classified in Level 2 of the valuation hierarchy.

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 mandatory delivery loan sale commitments are determined using quoted prices in the market place that are observable and 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.


			Estimated fair value
(in thousands)	Carrying or notional amount		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)		Total
March 31, 2020
Financial assets
HEI consolidated

Available-for-sale investment securities	$	1,340,241	$	—	$	1,311,515	$	28,726	$	1,340,241
Held-to-maturity investment securities	134,656		—		142,570		—		142,570
Stock in Federal Home Loan Bank	9,760		—		9,760		—		9,760
Loans, net	5,122,003		—		18,155		5,287,943		5,306,098
Mortgage servicing rights	9,120		—		—		10,350		10,350

Derivative assets	63,662		—		1,852		—		1,852


Financial liabilities
HEI consolidated
Deposit liabilities	791,665		—		797,075		—		797,075
Short-term borrowings—other than bank	99,956		—		99,956		—		99,956
Other bank borrowings	157,605		—		157,606		—		157,606
Long-term debt, net—other than bank	2,068,092		—		2,226,265		—		2,226,265
Derivative liabilities	74,800		585		4,575		—		5,160
Hawaiian Electric consolidated
Short-term borrowings	99,956		—		99,956		—		99,956
Long-term debt, net	1,510,635		—		1,655,449		—		1,655,449


December 31, 2019
Financial assets
HEI consolidated

Available-for-sale investment securities	$	1,232,826	$	—	$	1,204,229	$	28,597	$	1,232,826
Held-to-maturity investment securities	139,451		—		143,467		—		143,467
Stock in Federal Home Loan Bank	8,434		—		8,434		—		8,434
Loans, net	5,080,107		—		12,295		5,145,242		5,157,537
Mortgage servicing rights	9,101		—		—		12,379		12,379

Derivative assets	25,179		—		300		—		300


Financial liabilities
HEI consolidated
Deposit liabilities	769,825		—		765,976		—		765,976
Short-term borrowings—other than bank	185,710		—		185,710		—		185,710
Other bank borrowings	115,110		—		115,107		—		115,107
Long-term debt, net—other than bank	1,964,365		—		2,156,927		—		2,156,927
Derivative liabilities	51,375		33		2,185		—		2,218
Hawaiian Electric consolidated
Short-term borrowings	88,987		—		88,987		—		88,987
Long-term debt, net	1,497,667		—		1,670,189		—		1,670,189

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


	March 31, 2020										December 31, 2019
	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-backed securities — issued or guaranteed by U.S. Government agencies or sponsored agencies	$	—	$	1,141,452	$	—	$	—	$	1,026,385	$	—
U.S. Treasury and federal agency obligations	—		110,293		—		—		117,787		—
Corporate bonds	—		59,770		—		—		60,057		—
Mortgage revenue bonds	—		—		28,726		—		—		28,597
	$	—	$	1,311,515	$	28,726	$	—	$	1,204,229	$	28,597
Derivative assets
Interest rate lock commitments (bank segment)¹	$	—	$	1,852	$	—	$	—	$	297	$	—
Forward commitments (bank segment)¹	—		—		—		—		3		—

	$	—	$	1,852	$	—	$	—	$	300	$	—
Derivative liabilities

Forward commitments (bank segment)¹	$	585	$	—	$	—	$	33	$	12	$	—

Interest rate swap (Other segment)²	—		4,575		—		—		2,173		—
	$	585	$	4,575	$	—	$	33	$	2,185	$	—

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

² Derivatives are included in other liabilities in the balance sheets.

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


	Three months ended March 31
Mortgage revenue bonds	2020		2019
(in thousands)
Beginning balance	$	28,597	$	23,636
Principal payments received	—		—
Purchases	129		4,334
Unrealized gain (loss) included in other comprehensive income	—		—
Ending balance	$	28,726	$	27,970

ASB holds two mortgage revenue bonds 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 March 31, 2020, the weighted average discount rate was 2.99%, 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 using
(in thousands)	Balance		Level 1		Level 2		Level 3
March 31, 2020

Loans	$	—	$	—	$	—	$	—

December 31, 2019
Loans	25		—		—		25

For the three months ended March 31, 2020 and 2019, 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

December 31, 2019

Residential land

Fair value of property or collateral

Appraised value less 7% selling cost

N/A (2)

Total loans

(1) Represents percent of outstanding principal balance.

(2) N/A - Not applicable. There is one asset in each fair value measurement type.

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

- 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.

+ References + Details