5. Financial Instruments and Fair Value Disclosures

Financial instruments that potentially subject us to significant concentrations of credit or market risk consist primarily of periodic temporary investments of excess cash, trade accounts receivable and investments in debt securities, including residential mortgage-backed securities. We generally place our excess cash investments in U.S. government-backed short-term money market instruments through several financial institutions. At times, such investments may be in excess of the insurable limit. We periodically evaluate the relative credit standing of these financial institutions as part of our investment strategy.

Concentrations of credit risk with respect to our trade accounts receivable are limited primarily due to the entities comprising our customer base. Since the market for our services is the offshore oil and gas industry, this customer base has consisted primarily of major and independent oil and gas companies and government-owned oil companies. Based on our current customer base and the geographic areas in which we operate, we do not believe that we have any significant concentrations of credit risk at September 30, 2017.

In general, before working for a customer with whom we have not had a prior business relationship and/or whose financial stability may be uncertain to us, we perform a credit review on that company. Based on that analysis, we may require that the customer present a letter of credit, prepay or provide other credit enhancements. We record a provision for bad debts on a case-by-case basis when facts and circumstances indicate that a customer receivable may not be collectible and, historically, losses on our trade receivables have been infrequent occurrences.

Fair Values

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy prescribed by GAAP requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:


Level 1		Quoted prices for identical instruments in active markets. Level 1 assets include short-term investments such as money market funds and U.S. Treasury bills and notes. Our Level 1 assets at September 30, 2017 consisted of cash held in money market funds of $242.2 million and time deposits of $20.6 million. Our Level 1 assets at December 31, 2016 consisted of cash held in money market funds of $125.7 million and time deposits of $20.6 million.

Level 2		Quoted market prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Level 2 assets and liabilities may include residential mortgage-backed securities, corporate bonds purchased in a private placement offering and over-the-counter foreign currency forward exchange contracts. Our Level 2 assets at September 30, 2017 and December 31, 2016 consisted solely of residential mortgage-backed securities, which were valued using a model-derived valuation technique based on the quoted closing market prices received from a financial institution. The inputs used in our valuation are obtained from a Bloomberg curve analysis which uses par coupon swap rates to calculate implied forward rates so that projected floating rate cash flows can be calculated. The valuation techniques underlying the models are widely accepted in the financial services industry and do not involve significant judgment.

Level 3		Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Level 3 assets and liabilities generally include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation or for which there is a lack of transparency as to the inputs used. Our Level 3 assets at September 30, 2017 and December 31, 2016 consisted of nonrecurring measurements of certain of our drilling rigs and associated spare parts and supplies for which we recorded impairment losses in the second quarter of 2017 and during 2016.

Market conditions could cause an instrument to be reclassified among Levels 1, 2 and 3. Our policy regarding fair value measurements of financial instruments transferred into and out of levels is to reflect the transfers as having occurred at the beginning of the reporting period. There were no transfers between fair value levels during the nine-month period ended September 30, 2017 or the year ended December 31, 2016.

Certain of our assets and liabilities are required to be measured at fair value on a recurring basis in accordance with GAAP. In addition, certain assets and liabilities may be recorded at fair value on a nonrecurring basis. Generally, we record assets at fair value on a nonrecurring basis as a result of impairment charges. We recorded impairment charges related to certain of our drilling rigs and related rig spare parts and supplies, which were measured at fair value on a nonrecurring basis, during each of the nine-month periods ended September 30, 2017 and 2016, of $71.3 million and $678.1 million, respectively.

Assets and liabilities measured at fair value are summarized below.


	September 30, 2017
	Fair Value Measurements Using
	Level 1		Level 2		Level 3		Assets at Fair Value		Total Losses for Nine Months Ended
	(In thousands)
Recurring fair value measurements:
Assets:
Short-term investments	$	262,887	$	—	$	—	$	262,887
Mortgage-backed securities		—		4		—		4

Total assets	$	262,887	$	4	$	—	$	262,891

Nonrecurring fair value measurements:
Assets:
Impaired assets ⁽¹⁾	$	—	$	—	$	2,000	$	2,000	$	71,268

(1)

Represents the total book value as of September 30, 2017 of one ultra-deepwater rig and one deepwater semisubmersible rig, which were written down to their estimated recoverable amounts during the second quarter of 2017 and were reported as “Drilling and other property and equipment, net of accumulated depreciation,” in our Condensed Consolidated Balance Sheets at September 30, 2017.


	December 31, 2016
	Fair Value Measurements Using
	Level 1		Level 2		Level 3		Assets at Fair Value		Total Losses for Year Ended ⁽¹⁾
	(In thousands)
Recurring fair value measurements:
Assets:
Short-term investments	$	146,360	$	—	$	—	$	146,360
Mortgage-backed securities		—		35		—		35

Total assets	$	146,360	$	35	$	—	$	146,395

Nonrecurring fair value measurements:
Assets:
Impaired assets ⁽²⁾	$	—	$	—	$	69,153	$	69,153	$	678,145

(1)	Represents impairment losses of $8.1 million and $670.0 million recognized during the year ended December 31, 2016 related to our rig spare parts and supplies and certain impaired rigs, respectively.

(2)

Represents the total book value as of December 31, 2016 for 11 drilling rigs ($45.5 million) and for rig spare parts and supplies ($23.6 million), which were previously written down to their estimated recoverable amounts. Of the total fair value, $23.6 million, $0.4 million and $45.1 million were reported as “Prepaid expenses and other current assets,” “Assets held for sale” and “Drilling and other property and equipment, net of accumulated depreciation,” respectively, in our Condensed Consolidated Balance Sheets at December 31, 2016.

We believe that the carrying amounts of our other financial assets and liabilities (excluding long-term debt), which are not measured at fair value in our Condensed Consolidated Balance Sheets, approximate fair value based on the following assumptions:

•

Cash and cash equivalents — The carrying amounts approximate fair value because of the short maturity of these instruments.

•

Accounts receivable and accounts payable — The carrying amounts approximate fair value based on the nature of the instruments.

•

Short-term borrowings — The carrying amounts approximate fair value because of the short term of these instruments.

We consider our senior notes to be Level 2 liabilities under the GAAP fair value hierarchy and, accordingly, the fair value of our senior notes was derived using a third-party pricing service at September 30, 2017 and December 31, 2016. We perform control procedures over information we obtain from pricing services and brokers to test whether prices received represent a reasonable estimate of fair value. These procedures include the review of pricing service or broker pricing methodologies and comparing fair value estimates to actual trade activity executed in the market for these instruments occurring generally within a 10-day period of the report date. Fair values and related carrying values of our senior notes are shown below.


	September 30, 2017				December 31, 2016
	Fair Value		Carrying Value		Fair Value		Carrying Value
	(In millions)
5.875% Senior Notes due 2019	$	—	$	—	$	518.6	$	499.8
3.45% Senior Notes due 2023		225.0		249.3		215.0		249.3
7.875% Senior Notes due 2025		528.8		496.4		—		—
5.70% Senior Notes due 2039		411.3		497.1		392.5		497.1
4.875% Senior Notes due 2043		562.5		748.9		532.7		748.9

We have estimated the fair value amounts by using appropriate valuation methodologies and information available to management. Considerable judgment is required in developing these estimates, and accordingly, no assurance can be given that the estimated values are indicative of the amounts that would be realized in a free market exchange.

See Note 7.