Fair value measurements - HECO

9 Months Ended

Sep. 30, 2013

Fair value measurements

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 is 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 (to be announced) 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 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 and from discounting the future cash flows using the current rates offered for debt of the same or similar remaining maturities.

Derivative financial instruments.  See “Fair value measurements on a recurring basis” below.

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:

	Carrying or notional		Estimated fair value
(in thousands)	amount		Level 1		Level 2		Level 3		Total
September 30, 2013
Financial assets
Money market funds	$	10	$	—	$	10	$	—	$	10
Available-for-sale investment and mortgage-related securities	535,264		—		535,264		—		535,264
Investment in stock of Federal Home Loan Bank of Seattle	93,413		—		93,413		—		93,413
Loans receivable, net	4,010,961		—		—		4,149,137		4,149,137
Derivative assets	24,196		—		558		—		558
Financial liabilities									0
Deposit liabilities	4,310,842		—		4,313,560		—		4,313,560
Short-term borrowings—other than bank	131,341		—		131,341		—		131,341
Other bank borrowings	239,612		—		252,230		—		252,230
Long-term debt, net—other than bank	1,422,880		—		1,431,434		—		1,431,434
Derivative liabilities	22,185		202		73		—		275
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									0
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

As of September 30, 2013 and December 31, 2012, loan commitments and unused lines and letters of credit issued by ASB had notional amounts of $1.6 billion and $1.5 billion, respectively, and their estimated fair value on such dates were $0.6 million and $1.2 million, respectively. As of September 30, 2013 and December 31, 2012, loans serviced by ASB for others had notional amounts of $1.4 billion and $1.3 billion, respectively, and the estimated fair value of the servicing rights for such loans was $16.6 million and $11.9 million, respectively.

Fair value measurements on a recurring basis.

Securities.  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.

Derivative financial instruments.  ASB enters into interest rate lock commitments (IRLC) for residential mortgage loans, which commit ASB to lend funds to a potential borrower at a specific interest rate and within a specified period of time. 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.

ASB utilizes forward commitments as economic hedges against potential changes in the values of the IRLCs and loans held for sale. To reduce the impact of price fluctuations of IRLC and mortgage loans held for sale, ASB will purchase to be announced (TBA) mortgage-backed securities forward commitments, mandatory and best effort commitments. These commitments help protect our loan sale profit margin from fluctuations in interest rates.  The changes in the fair value of these commitments are recognized as part of mortgage banking income on the consolidated statements of income. TBA 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 similarly to the IRLCs using quoted prices in the market place that are observable and are classified as Level 2 measurements.

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

	Fair value measurements using
	Quoted prices in active markets for identical assets		Significant otherobservable  inputs		Significant unobservable inputs
(in thousands)	(Level 1)		(Level 2)		(Level 3)
September 30, 2013
Money market funds (“other” segment)	$	—	$	10	$	—
Available-for-sale securities (bank segment)
Mortgage-related securities-FNMA, FHLMC and GNMA	$	—	$	357,977	$	—
Federal agency obligations	—		98,265		—
Municipal bonds	—		79,022		—
	$	—	$	535,264	$	—
Derivative assets (1)
Interest rate lock commitments	$	—	$	556	$	—
Forward commitments	—		2		—
	$	—	$	558	$	—
Derivative liabilities (1) - Forward commitments	$	202	$	73	$	—
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	$	—

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(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.

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. During the first nine months of 2013, it was not required that a measurement of the fair value of goodwill be calculated and goodwill was not measured at fair value.

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

			Fair value measurements
(in millions)	Balance		Level 1		Level 2		Level 3
Loans
September 30, 2013	$	5	$	—	$	—	$	5
December 31, 2012	21		—		—		21
Real estate acquired in settlement of loans
September 30, 2013	$	—	—		—		$	—
December 31, 2012	3		—		—		3

At September 30,2013 and 2012, 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 the value placed on the assets of the business, 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 September 30, 2013, the significant unobservable inputs used in the fair value measurement were as follows:

	Fair value at				Significant unobservable  input value (1)
($ in thousands)	September 30, 2013		Valuation technique	Significant unobservable input	Range	Weighted Average
Residential loans	$	4,028	Fair value of property or collateral	Appraised value less 7% selling cost	44-96%	81%
Home equity lines of credit	172		Fair value of property or collateral	Appraised value less 7% selling cost	46-50%	50%
Commercial loans	759		Fair value of property or collateral	Fair value of business assets	31-91%	60%
Total loans	4,959
Real estate acquired in settlement of loans	192		Fair value of property or collateral	Appraised value less 7% selling cost	81-95%	90%

 (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 measurement.

Hawaiian Electric Company, Inc. and Subsidiaries

Fair value measurements

Fair value measurements

See Note 9 “Fair value measurements,” of HEI’s “Notes to Consolidated Financial Statements” for discussions of fair value estimates, grouping of financial instruments and methods and assumptions used to estimate the fair value of short-term borrowings and long-term debt.

The estimated fair values of certain of the electric utilities’ financial instruments were as follows:

	September 30, 2013				December 31, 2012
(in thousands)	Carrying amount		Estimated fair value (Level 2)		Carrying amount		Estimated fair value (Level 2)
Financial liabilities
Short-term borrowings - non-affiliates	$	73,246	$	73,246	$	—	$	—
Long-term debt, net, including amounts due within one year	1,147,880		1,149,213		1,147,872		1,181,631

Fair value measurements on a nonrecurring basis.  From time to time, the Utilities may be required to measure certain liabilities at fair value on a nonrecurring basis in accordance with GAAP. The fair value of the Utilities ARO (Level 3) was determined by discounting the expected future cash flows using market-observable risk-free rates as adjusted by Hawaiian Electric’s credit spread. Also, see “Asset retirement obligations” in Note 5.