15 ·Fair value measurements

Fair value estimates are based on the price that would be received to sell an asset, or paid upon the transfer of a liability, in an orderly transaction between market participants at the measurement date. The fair value estimates are generally determined based on assumptions that market participants would use in pricing the asset or liability and are based on market data obtained from independent sources. However, in certain cases, the Company uses its own assumptions about market participant assumptions based on the best information available in the circumstances. These valuations are estimates at a specific point in time, based on relevant market information, information about the financial instrument and judgments regarding future expected loss experience, economic conditions, risk characteristics of various financial instruments and other factors. These estimates do not reflect any premium or discount that could result if the Company were to sell its entire holdings of a particular financial instrument at one time. Because no active trading market exists for a portion of the Company’s financial instruments, fair value estimates cannot be determined with precision. Changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses could have a significant effect on fair value estimates, but have not been considered in making such estimates.

The Company groups its financial assets measured at fair value in three levels outlined as follows:

Level 1: Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

Level 2: Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that are derived principally from or can be corroborated by observable market data by correlation or other means.

Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using discounted cash flow methodologies, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The Company used the following methods and assumptions to estimate the fair value of each applicable class of financial instruments for which it is practicable to estimate that value:

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

Investment and mortgage-related securities. To determine the fair value of investment securities held in ASB’s available-for-sale portfolio, independent third-party vendor or broker pricing is used on an unadjusted basis. Prices for investments and mortgage-related securities are based on observable inputs, including historical trading levels or sector yields, using market-based valuation techniques. The third party pricing service uses applications, models and pricing matrices that correlate security prices to benchmark securities which are adjusted for various inputs. Inputs include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark security bids and offers, TBA prices, monthly payment information, and reference data including market research. The pricing service may prioritize inputs differently on any given day for any security, and not all inputs are available for use in the evaluation process on any given day or for each security. The pricing vendor corroborates its finding on an on-going basis by monitoring market activity and events.

Third party pricing services provide security prices in good faith using rigorous methodologies; however, they do not warrant or guarantee the adequacy or accuracy of their information. Therefore, ASB utilizes a separate third party pricing vendor to corroborate security pricing of the first pricing vendor. If the pricing differential between the two pricing sources exceeds an established threshold, a pricing inquiry will be sent to both vendors or to an independent broker to determine a price that can be supported based on observable inputs found in the market. Such challenges to pricing are required infrequently and are generally resolved using additional security-specific information that was not available to a specific vendor.

Loans receivable. The estimated fair value of loans receivable is determined based on characteristics such as loan category, repricing features and remaining maturity, and includes prepayment estimates.

For residential real estate loans, fair values were estimated by discounting estimated cash flows using discount rates based on current industry pricing for loans with similar contractual characteristics and remaining maturity.

For other types of loans, fair values were estimated by discounting contractual cash flows using discount rates that reflect current industry pricing for loans with similar characteristics and remaining maturity. Where industry pricing is not available, discount rates are based on ASB’s current pricing for loans with similar characteristics and remaining maturity.

The fair value of all loans was adjusted to reflect the Company’s current assessments of loan collectability. Also see “Fair value measurements on a nonrecurring basis” below.

Deposit liabilities. The fair value of savings, negotiable orders of withdrawal, demand and money market deposits was the amount payable on demand at the reporting date. 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 bank borrowings. Fair value was estimated by discounting the future cash flows using the current rates available for borrowings with similar credit terms and remaining maturities.

Long-term debt. Fair value was obtained from third-party financial services providers based on the current rates offered for debt of the same or similar remaining maturities.

Off-balance sheet financial instruments. The fair value of loans serviced for others was calculated by discounting expected net income streams using discount rates that reflect industry pricing for similar assets. Expected net income streams were estimated based on industry assumptions regarding prepayment speeds and income and expenses associated with servicing residential mortgage loans for others. The fair value of commitments to originate loans was estimated based on the change in current primary market prices of new commitments. Since lines of credit can expire without being drawn and customers are under no obligation to utilize the lines, no fair value was assigned to unused lines of credit. The fair value of letters of credit was estimated based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements.

The estimated fair values of certain of the Company’s financial instruments were as follows:

			Estimated fair value
(in thousands)	Carrying or notional amount		Level 1		Level 2		Level 3		Total

December 31, 2012
Financial assets
Money market funds	$	10	$	–	$	10	$	–	$	10
Available-for-sale investment and mortgage-related securities	671,358		–		671,358		–		671,358
Investment in stock of Federal Home Loan Bank of Seattle	96,022		–		96,022		–		96,022
Loans receivable, net	3,763,238		–		–		3,957,752		3,957,752
Financial liabilities
Deposit liabilities	4,229,916		–		4,235,527		–		4,235,527
Short-term borrowings—other than bank	83,693		–		83,693		–		83,693
Other bank borrowings	195,926		–		212,163		–		212,163
Long-term debt, net—other than bank	1,422,872		–		1,481,004		–		1,481,004

December 31, 2011
Financial assets
Money market funds	$	10	$	–	$	10	$	–	$	10
Available-for-sale investment and mortgage-related securities	624,331		–		624,331		–		624,331
Investment in stock of Federal Home Loan Bank of Seattle	97,764		–		97,764		–		97,764
Loans receivable, net	3,652,419		–		–		3,886,253		3,886,253
Financial liabilities
Deposit liabilities	4,070,032		–		4,075,6561		–		4,075,656		1
Short-term borrowings—other than bank	68,821		–		68,821		–		68,821
Other bank borrowings	233,229		–		250,486		–		250,486
Long-term debt, net—other than bank	1,340,070		–		1,400,241		–		1,400,241

1 Revised (increased by $83.9 million) to correct an error in the estimated fair value disclosure at December 31, 2011.

As of December 31, 2012 and 2011, loan commitments and unused lines and letters of credit issued by ASB had notional amounts of $1.5 billion and $1.3 billion, respectively, and their estimated fair value on such dates were $1.2 million and $0.3 million, respectively. As of December 31, 2012 and 2011, loans serviced by ASB for others had notional amounts of $1.3 billion and $993.3 million and the estimated fair value of the servicing rights for such loans was $11.9 million and $9.8 million, respectively.

Fair value measurements on a recurring basis. While securities held in ASB’s investment portfolio trade in active markets, they do not trade on listed exchanges nor do the specific holdings trade in quoted markets by dealers or brokers. All holdings are valued using market-based approaches that are based on exit prices that are taken from identical or similar market transactions, even in situations where trading volume may be low when compared with prior periods. Inputs to these valuation techniques reflect the assumptions that consider credit and nonperformance risk that market participants would use in pricing the asset based on market data obtained from independent sources. Available-for-sale securities were comprised of federal agency obligations and mortgage-backed securities and municipal bonds.

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

	Fair value measurements using
	Quoted prices in	Significant other	Significant
	active markets for identical	observable inputs	unobservable inputs
(in thousands)	assets (Level 1)	(Level 2)	(Level 3)

December 31, 2012
Money market funds (“other” segment)	$ –	$ 10	$ –
Available-for-sale securities (bank segment)
Mortgage-related securities-FNMA, FHLMC and GNMA	$ –	$417,383	$ –
Federal agency obligations	–	171,491	–
Municipal bonds	–	82,484	–
	$ –	$671,358	$ –
December 31, 2011
Money market funds (“other” segment)	$ –	$ 10	$ –
Available-for-sale securities (bank segment)
Mortgage-related securities-FNMA, FHLMC and GNMA	$ –	$344,865	$ –
Federal agency obligations	–	220,727	–
Municipal bonds	–	58,739	–
	$ –	$624,331	$ –

Fair value measurements on a nonrecurring basis. From time to time, the Company may be required to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from the writedowns of individual assets. ASB does not record loans at fair value on a recurring basis. However, from time to time, ASB records nonrecurring fair value adjustments based on the current appraised value of the collateral securing the loans or unobservable market assumptions. Unobservable assumptions reflect ASB’s own estimate of the fair value of collateral used in valuing the loan. ASB may also be required to measure goodwill at fair value on a nonrecurring basis. See “Goodwill and other intangibles” in Note 1 for ASB’s goodwill valuation methodology. During 2012 and 2011, goodwill was not measured at fair value.

From time to time, the Company may be required to measure certain liabilities at fair value on a nonrecurring basis in accordance with GAAP. The fair value of HECO’s ARO (Level 3) was determined by discounting the expected future cash flows using market-observable risk-free rates as adjusted by HECO’s credit spread (also see Note 3).

Assets measured at fair value on a nonrecurring basis were as follows:

		Fair value measurements using
		Quoted prices in active	Significant other	Significant
		markets for identical	Observable inputs	Unobservable inputs
(in millions)	Balance	assets (Level 1)	(Level 2)	(Level 3)

Loans
December 31, 2012	$ 21	$ –	$ –	$ 21
December 31, 2011	34	–	–	34

For 2012 and 2011, there were no adjustments to fair value for ASB’s loans held for sale.

Residential loans. The fair value of ASB’s residential loans that were written down due to impairment was determined based on third party appraisals, which include the appraisers’ assumptions and judgment, and therefore, is classified as a Level 3 measurement.

Home equity lines of credit. The fair value of ASB’s home equity lines of credit that were written down due to impairment was determined based on third party appraisals, which include the appraisers’ assumptions and judgment, and therefore, is classified as a Level 3 measurement.

Commercial loans. The fair value of ASB’s commercial loans that were written down due to impairment was determined based on third party appraisals, which include the appraisers’ assumptions and judgment, the value placed on the assets of the business and cash flows generated by the business entity, and therefore, is classified as a Level 3 measurement.

Real estate acquired in settlement of loans. The fair value of ASB’s real estate acquired in settlement of loans that were written down due to impairment was determined based on third party appraisals, which include the appraisers’ assumptions and judgment, and therefore, is classified as a Level 3 measurement.

For loans and real estate acquired in settlement of loans classified as Level 3 as of December 31, 2012, the significant unobservable inputs used in the fair value measurement were as follows:

($ in thousands)	Fair value at December 31, 2012	Valuation technique	Significant unobservable input	Significant unobservable input value
Residential loans	$16,401	Fair value of property or collateral	Appraised value	13 - 96%
Home equity lines of credit	581	Fair value of property or collateral	Appraised value	22 - 80%

Commercial loan	14	Fair value of property or collateral	U.S. government agency guarantee	85%
Commercial loan	118	Fair value of property or collateral	Appraised value	73%
Commercial loan	225	Fair value of property or collateral	Insurance proceeds	60%
Commercial loans	1,203	Fair value of property or collateral	Fair value of business assets	9 - 94%
Commercial loan	1,961	Discounted cash flow	Present value of expected future cash flows based on anticipated debt restructuring	Paydown of loan – 61%
			Discount rate	4.5%
Total commercial loans	3,521
Real estate acquired in settlement of loans	2,529	Fair value of property or collateral	Appraised value	58 – 99%

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

Retirement benefit plans

Assets held in various trusts for the retirement benefit plans (Plans) are measured at fair value on a recurring basis and were as follows:

	Pension benefits				Other benefits
		Fair value measurements using				Fair value measurements using
		Quoted prices in active markets for identical assets	Significant other observable inputs	Significant unobserv- able inputs		Quoted prices in active markets for identical assets	Significant other observable inputs	Significant unobserv- able inputs
(in millions)	December 31	(Level 1)	(Level 2)	(Level 3)	December 31	(Level 1)	(Level 2)	(Level 3)
2012
Equity securities	$513	$513	$ –	$ –	$ 83	$ 83	$ –	$ –
Equity index funds	95	95	–	–	15	15	–	–
Fixed income securities	338	125	213	–	47	41	6	–
Pooled and mutual funds and other	78	1	76	1	13	–	13	–
Total	1,024	$734	$289	$ 1	158	$139	$19	$ –
Receivables and payables, net	(53)				(1)

Fair value of plan assets	$971				$157

2011
Equity securities	$425	$425	$ –	$ –	$ 73	$ 73	$ –	$ –
Equity index funds	82	82	–	–	15	15	–	–
Fixed income securities	283	98	185	–	43	37	6	–
Pooled and mutual funds and other	87	1	86	–	13	–	13	–
Total	877	$606	$271	$ –	144	$125	$19	$ –
Receivables and payables, net	(37)				(1)
Fair value of plan assets	$840				$143

The fair values of the financial instruments shown in the table above represent the Company’s best estimates of the amounts that would be received upon sale of those assets or that would be paid to transfer those liabilities in an orderly transaction between market participants at that date. Those fair value measurements maximize the use of observable inputs. However, in situations where there is little, if any, market activity for the asset or liability at the measurement date, the fair value measurement reflects the Company’s judgments about the assumptions that market participants would use in pricing the asset or liability. Those judgments are developed by the Company based on the best information available in the circumstances.

In connection with the adoption of the fair value measurement standards, the Company adopted the provisions of ASU No. 2009-12, “Investments in Certain Entities that Calculate Net Asset Value per Share (or Its Equivalent),” which allows for the estimation of the fair value of investments in investment companies for which the investment does not have a readily determinable fair value, using net asset value per share or its equivalent as a practical expedient.

The Company used the following valuation methodologies for assets measured at fair value. There have been no changes in the methodologies used at December 31, 2012 and 2011.

Equity securities, equity index funds, U.S. Treasury fixed income securities and public mutual funds (Level 1). Equity securities, equity index funds, U.S. Treasury fixed income securities and public mutual funds are valued at the closing price reported on the active market on which the individual securities or funds are traded.

Fixed income securities, equity securities, pooled securities and mutual funds (Level 2). Fixed income securities, other than those issued by the U.S. Treasury, are valued based on yields currently available on comparable securities of issuers with similar credit ratings. Equity securities and pooled and mutual funds include commingled equity funds and other closed funds, respectively, that are not open to public investment and are valued at the net asset value per share. Certain other investments are valued based on discounted cash flow analyses, using observable inputs.

Other (Level 3). Venture capital interest is valued at historical cost, modified by revaluation of financial assets and financial liabilities at fair value through profit or loss.

For 2012 and 2011, the changes in Level 3 assets were as follows:

	2012		2011
(in thousands)	Pension benefits	Other benefits	Pension benefits	Other benefits
Balance, January 1	$217	$ 7	$141	$ 5
Realized and unrealized gains (losses)	(24)	(1)	92	3
Purchases and settlements, net	388	12	(16)	(1)
Balance, December 31	$581	$18	$217	$ 7