
	Fair Value of Derivative and Other Financial Instruments

Energy Related Derivative Contracts

Overview

The primary objective for the use of derivative instruments, including energy contracts, options, and futures, is to manage price risk associated with forecasted purchases of energy and fuel used to generate electricity, as well as managing anticipated generation capacity in excess of forecasted demand from existing customers. The Company’s energy related derivative contracts manage commodity risk. PNM is required to meet the demand and energy needs of its retail and firm-requirements wholesale customers. PNM is exposed to market risk for its share of PVNGS Unit 3 and the needs of its firm-requirements wholesale customers not covered under a FPPAC. PNM’s operations are managed primarily through a net asset-backed strategy, whereby PNM’s aggregate net open forward contract position is covered by its forecasted excess generation capabilities or market purchases. PNM could be exposed to market risk if its generation capabilities were to be disrupted or if its load requirements were to be greater than anticipated. If all or a portion of load requirements were required to be covered as a result of such unexpected situations, commitments would have to be met through market purchases.

On November 1, 2011, PNMR completed the sale of First Choice. See Note 3. Accordingly, PNMR information reflects activity for First Choice through October 31, 2011. The difference between the PNMR and PNM amounts represents First Choice.

Commodity Risk

Marketing and procurement of energy often involve market risks associated with managing energy commodities and establishing open positions in the energy markets, primarily on a short-term basis. PNM routinely enters into various derivative instruments such as forward contracts, option agreements, and price basis swap agreements to economically hedge price and volume risk on power commitments and fuel requirements and to minimize the effect of market fluctuations in wholesale portfolios. PNM monitors the market risk of its commodity contracts using VaR calculations to maintain total exposure within management-prescribed limits in accordance with approved risk and credit policies.

First Choice was responsible for energy supply related to the sale of electricity to retail customers in Texas. TECA contains no provisions for the specific recovery of fuel and purchased power costs. The rates charged to First Choice customers were negotiated with each customer. First Choice purchased power at wholesale and sold power at retail to customers in the competitive ERCOT retail markets. First Choice’s strategy was to minimize its exposure to fluctuations in market energy prices by matching sales contracts with supply instruments designed to preserve targeted margins. However, First Choice had a residual exposure to wholesale power price risk for the mismatch between the forecast and actual load.

Accounting for Derivatives

Under derivative accounting and related rules for energy contracts, the Company accounts for its various derivative instruments for the purchase and sale of energy based on the Company’s intent. Energy contracts that meet the definition of a derivative under GAAP and do not qualify, or are not designated, for the normal sales and purchases exception are recorded on the balance sheet at fair value at each period end. The changes in fair value are recognized in earnings unless specific hedge accounting criteria are met and elected. Normal sales and purchases are not marked to market and are reflected in results of operations when the underlying transactions settle.

For derivative transactions meeting the definition of a cash flow hedge, the Company documents the relationships between the hedging instruments and the items being hedged. This documentation includes the strategy that supports executing the specific transaction and the methods utilized to assess the effectiveness of the hedges. Changes in the fair value of contracts qualifying for cash flow hedge accounting are included in AOCI to the extent effective. The Company assesses the effectiveness of hedge relationships at least quarterly using statistical data. Ineffectiveness gains and losses were immaterial for all periods presented. Gains or losses related to cash flow hedge instruments, including those de-designated, are reclassified from AOCI when the hedged transaction settles and impacts earnings. As of December 31, 2012 and 2011, the Company was not hedging its exposure to the variability in future cash flows from commodity derivatives through designated cash flows hedges.

The contracts recorded at fair value that do not qualify or are not designated for cash flow hedge accounting are classified as economic hedges. Economic hedges are defined as derivative instruments, including long-term power agreements, used to economically hedge generation assets, purchased power and fuel costs, and customer load requirements. Changes in the fair value of economic hedges are reflected in results of operations and are classified between operating revenues and cost of energy according to the intent of the hedge. The Company has no trading transactions.

Fair value is defined under GAAP as the 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. Fair value is based on current market quotes as available and is supplemented by modeling techniques and assumptions made by the Company to the extent quoted market prices or volatilities are not available. External pricing input availability varies based on commodity location, market liquidity, and term of the agreement. Valuations of derivative assets and liabilities take into account nonperformance risk including the effect of counterparties' and the Company’s credit risk. The Company regularly assesses the validity and availability of pricing data for its derivative transactions. Although the Company uses its best judgment in estimating the fair value of these instruments, there are inherent limitations in any estimation technique.

Commodity Derivatives

Commodity derivative instruments, recorded at fair value are summarized as follows:



	Economic Hedges
	December 31,
	2012			2011
	(In thousands)
PNM and PNMR
Current assets	$	3,785		$	3,713
Deferred charges	352			—
	4,137			3,713
Current liabilities	(1,000		)	(1,632		)
Long-term liabilities	(1,933		)	(2,437		)
	(2,933		)	(4,069		)
Net	$	1,204		$	(356	)

Certain of PNM's commodity derivative instruments in the above table are subject to master netting agreements whereby assets and liabilities could be offset in the settlement process. The Company does not offset fair value, cash collateral, and accrued payable or receivable amounts recognized for derivative instruments under master netting arrangements and the above table reflects the gross amounts of assets and liabilities. The amounts that could be offset under master netting agreements was immaterial at December 31, 2012 and 2011.

At December 31, 2012 and 2011, PNMR and PNM had no amounts recognized for the legal right to reclaim cash collateral. In addition, at December 31, 2012 and 2011, amounts posted as cash collateral under margin arrangements were $1.9 million and $1.8 million for both PNMR and PNM. PNMR and PNM had no obligations to return cash collateral at December 31, 2012 and 2011. Cash collateral amounts are included in other current assets on the Consolidated Balance Sheets.

PNM has a NMPRC approved hedging plan to manage fuel and purchased power costs related to customers covered by its FPPAC. The table above includes less than $0.1 million of current assets and current liabilities at December 31, 2012, and $0.5 million of current assets and current liabilities at December 31, 2011 related to this plan. The offsets to these amounts are recorded as regulatory assets and liabilities on the Consolidated Balance Sheets.

The following table presents the effect of mark-to-market commodity derivative instruments on earnings and OCI, excluding income tax effects. For cash flow hedges, including de-designated hedges, the earnings impact reflects the reclassification from AOCI when the hedged transactions settle.



	Economic Hedges						Qualified Cash Flow Hedges
	Year Ended December 31,						Year Ended December 31,
	2012			2011			2012		2011
	(In thousands)
PNMR
Electric operating revenues	$	6,168		$	5,682		$	—	$	—
Cost of energy	(460		)	(2,201		)	—		(422		)
Total gain (loss)	$	5,708		$	3,481		$	—	$	(422	)
Recognized in OCI							$	—	$	422
PNM
Electric operating revenues	$	6,168		$	5,682		$	—	$	—
Cost of energy	(460		)	(1,058		)	—		—
Total gain (loss)	$	5,708		$	4,624		$	—	$	—
Recognized in OCI							$	—	$	—

Commodity contract volume positions are presented in MMBTU for gas related contracts and in MWh for power related contracts. The table below presents PNMR’s and PNM’s net buy (sell) volume positions:



	Economic Hedges
	MMBTU	MWh
December 31, 2012
PNMR and PNM	1,127,500	(2,477,520	)
December 31, 2011
PNMR and PNM	1,499,000	(366,448	)

In connection with managing its commodity risks, the Company enters into master agreements with certain counterparties. If the Company is in a net liability position under an agreement, some agreements provide that the counterparties can request collateral from the Company if the Company’s credit rating is downgraded; other agreements provide that the counterparty may request collateral to provide it with “adequate assurance” that the Company will perform; and others have no provision for collateral.

The table below presents information about the Company’s contingent requirements to provide collateral under commodity contracts having an objectively determinable collateral provision that are in net liability positions and are not fully collateralized with cash. Contractual liability represents commodity derivative contracts recorded at fair value on the balance sheet, determined on an individual contract basis without offsetting amounts for individual contracts that are in an asset position and could be offset under master netting agreements with the same counterparty. The table only reflects cash collateral that has been posted under the existing contracts and does not reflect letters of credit under the Company’s revolving credit facilities that have been issued as collateral. Net exposure is the net contractual liability for all contracts, including those designated as normal purchases and sales, offset by existing cash collateral and by any offsets available under master netting agreements, including both asset and liability positions.



Contingent Feature – Credit Rating Downgrade	Contractual Liability		Existing Cash Collateral		Net Exposure
	(In thousands)
December 31, 2012
PNMR and PNM	$	2,933	$	—	$	2,777
December 31, 2011
PNMR and PNM	$	4,036	$	—	$	4,036

Sale of Power from PVNGS Unit 3

In April 2008, PNM entered into three separate contracts for the sale of capacity and energy related to its entire interest in PVNGS Unit 3. Under two of the contracts, PNM sold 90 MW of firm capacity and energy. Under the third contract, PNM sold 45 MW of unit contingent capacity and energy. The term of the contracts was May 1, 2008 through December 31, 2010. Under the two firm contracts, the two buyers made prepayments of $40.6 million and $30.0 million. These amounts were recorded as deferred revenue and were amortized over the life of the contracts. The prepayments received under the firm contracts, as well as required subsequent monthly payments on them, are shown as a financing activity in the Consolidated Statement of Cash Flows as required by GAAP. The firm contracts were accounted for as cash flow hedges and changes in fair value were included in AOCI. The contingent contract was accounted for as a normal sale. Since January 1, 2011, PNM has been selling power from its interest in PVNGS Unit 3 daily at market prices. PNM has established fixed rates for all of these sales through the end of 2013 through hedging arrangements that are accounted for as economic hedges. PNM is also partially hedged for 2014.

Non-Derivative Financial Instruments

The carrying amounts reflected on the Consolidated Balance Sheets approximate fair value for cash, receivables, and payables due to the short period of maturity. Available-for-sale securities are carried at fair value. Available-for-sale securities for PNMR and PNM consist of PNM assets held in the NDT for its share of decommissioning costs of PVNGS and, beginning in August 2012, a trust for PNM's share of post-term reclamation costs related to the coal mines serving SJGS (Note 16), which investments are included in "other investments" on the Consolidated Balance Sheet. PNMR and PNM do not have any unrealized losses on available-for-sale securities. The fair value and gross unrealized gains of investments in available-for-sale securities are presented in the following table.



	December 31, 2012				December 31, 2011
	Unrealized Gains		Fair Value		Unrealized Gains		Fair Value
PNMR and PNM			(In thousands)
Equity securities:
Domestic value	$	5,223	$	30,044	$	3,549	$	25,143
Domestic growth	15,212		51,650		16,714		52,187
International and other	247		14,868		662		12,754
Fixed income securities:
Municipals	4,069		43,861		2,861		41,463
United States government	1,305		32,592		1,353		25,367
Corporate and other	1,100		14,868		742		9,171
Cash investments	—		4,628		—		2,766
	$	27,156	$	192,511	$	25,881	$	168,851

The proceeds and gross realized gains and losses on the disposition of available-for-sale securities for PNMR and PNM are shown in the following table. Realized gains and losses are determined by specific identification of costs of securities sold.



	Year Ended December 31,
	2012			2011			2010
	(In thousands)
Proceeds from sales	$	167,330		$	145,286		$	79,853
Gross realized gains	$	15,907		$	17,493		$	5,635
Gross realized (losses)	$	(8,170	)	$	(6,223	)	$	(3,704	)

Held-to-maturity securities are those investments in debt securities that the Company has the ability and intent to hold until maturity. Held-to-maturity securities consist of the investment in PVNGS lessor notes and certain items within other investments.

The Company has no available-for-sale or held-to-maturity securities for which carrying value exceeds fair value. There are no impairments considered to be “other than temporary” that are included in AOCI and not recognized in earnings.

At December 31, 2012, the available-for-sale and held-to-maturity debt securities had the following final maturities:



	Fair Value
	Available-for-Sale		Held-to-Maturity
	PNMR and PNM		PNMR		PNM
	(In thousands)
Within 1 year	$	2,374	$	3,695	$	—
After 1 year through 5 years	29,342		85,520		84,198
After 5 years through 10 years	15,943		—		—
After 10 years through 15 years	8,700		—		—
After 15 years through 20 years	11,217		—		—
After 20 years	23,745		—		—
	$	91,321	$	89,215	$	84,198

Fair Value Disclosures

The Company determines the fair values of its derivative and other financial instruments based on the hierarchy established in GAAP, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. GAAP describes three levels of inputs that may be used to measure fair value. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. Level 3 inputs used in determining fair values for the Company consist of internal valuation models.

For NDT investments, Level 2 fair values are provided by the trustee utilizing a pricing service. The pricing provider predominantly uses the market approach using bid side market value based upon a hierarchy of information for specific securities or securities with similar characteristics. For commodity derivatives, Level 2 fair values are determined based on market observable inputs, which are validated using multiple broker quotes, including forward price, volatility, and interest rate curves to establish expectations of future prices. Credit valuation adjustments are made for estimated credit losses based on the overall exposure to each counterparty. For long-term debt, Level 2 fair values are provided by an external pricing service. The pricing service primarily utilizes quoted prices for similar debt in active markets when determining fair value. For investments categorized as Level 3, primarily the PVNGS lessor notes and other investments, fair values were determined by discounted cash flow models that take into consideration discount rates that are observable for similar type assets and liabilities. Management of the Company independently verifies the information provided by pricing services.

The Company records any transfers between fair value hierarchy levels as of the end of each calendar quarter. There were no transfers between levels during the years ended December 31, 2012 and 2011.

Derivatives and Investments

Items recorded at fair value on the Consolidated Balance Sheets are presented below:



				GAAP Fair Value Hierarchy
	Total(1)			Quoted Prices in Active Market for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)
December 31, 2012				(In thousands)
PNMR and PNM
Decommissioning and reclamation investments
Cash and equivalents	$	4,628		$	4,628	$	—
Equity securities:
Domestic value	30,044			30,044		—
Domestic growth	51,650			51,650		—
International and other	14,868			14,868		—
Fixed income securities:
United States government	32,592			27,737		4,855
Municipals	43,861			—		43,861
Corporate and other	14,868			—		14,868
Total	$	192,511		$	128,927	$	63,584

Commodity derivative assets	$	4,137		$	—	$	4,137
Commodity derivative liabilities	(2,933		)	—		(2,933		)
Net	$	1,204		$	—	$	1,204



				GAAP Fair Value Hierarchy
	Total⁽¹⁾			Quoted Prices in Active Market for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)
December 31, 2011				(In thousands)
PNMR and PNM
NDT investments
Cash and equivalents	$	2,766		$	2,766	$	—
Equity securities:
Domestic value	25,143			25,143		—
Domestic growth	52,187			52,187		—
International and other	12,754			12,754		—
Fixed income securities:
United States government	25,367			21,409		3,958
Municipals	41,463			—		41,463
Corporate and other	9,171			—		9,171
Total	$	168,851		$	114,259	$	54,592

Commodity derivative assets	$	3,713		$	—	$	3,713
Commodity derivative liabilities	(4,069		)	—		(4,069		)
Net	$	(356	)	$	—	$	(356	)


⁽¹⁾	The Level 1 and 2 columns in the above table are presented based on the nature of each instrument. The total column is presented based on the balance sheet classification of the instruments. There were no account reclassifications between commodity derivative assets and commodity derivative liabilities and there were no Level 3 fair value measurements at December 31, 2012 and 2011.

A reconciliation of the changes in Level 3 fair value measurements is as follows:



	PNMR
	Year Ended December 31,
	2012		2011
	(In thousands)
Balance at beginning of period	$	—	$	(822	)
Total gains (losses) included in earnings	—		1,020
Purchases	—		3,163
Settlements	—		(1,578		)
Sale of First Choice	—		(1,783		)
Balance at end of period	$	—	$	—
Total gains (losses) included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the end of the period	$	—	$	—

The above gains and losses (realized and unrealized) for Level 3 fair value measurements included in earnings are reported in cost of energy.

The carrying amounts and fair values of investments in PVNGS lessor notes, other investments, and long-term debt, which are not recorded at fair value on the Consolidated Balance Sheets are presented below:



					GAAP Fair Value Hierarchy ⁽¹⁾
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
December 31, 2012	(In thousands)
PNMR
Long-term debt	$	1,672,290	$	1,969,362	$	—	$	1,966,725	$	2,637
Investment in PVNGS lessor notes	$	77,682	$	84,198	$	—	$	—	$	84,198
Other investments	$	5,599	$	6,965	$	774	$	—	$	6,191
PNM
Long-term debt	$	1,215,579	$	1,385,433	$	—	$	1,385,433	$	—
Investment in PVNGS lessor notes	$	77,682	$	84,198	$	—	$	—	$	84,198
Other investments	$	494	$	494	$	494	$	—	$	—
TNMP
Long-term debt	$	311,589	$	418,166	$	—	$	418,166	$	—
Other investments	$	281	$	281	$	281	$	—	$	—

December 31, 2011
PNMR
Long-term debt	$	1,674,013	$	1,873,002
Investment in PVNGS lessor notes	$	107,094	$	108,742
Other investments	$	12,207	$	14,208
PNM
Long-term debt	$	1,215,540	$	1,294,846
Investment in PVNGS lessor notes	$	107,094	$	108,742
Other investments	$	2,900	$	3,052
TNMP
Long-term debt	$	310,963	$	413,966
Other investments	$	271	$	271


⁽¹⁾	GAAP does not require disclosure of the fair value hierarchy information prior to 2012

Investments Held by Employee Benefit Plans

As discussed in Note 12, PNM and TNMP have trusts that hold investment assets for their pension and other postretirement benefit plans. The fair value of the assets held by the trusts impacts the determination of the funded status of each plan, but the assets are not reflected on the Company's Consolidated Balance Sheets. Both the PNM Pension Plan and the TNMP Pension Plan hold units of participation in the PNM Resources, Inc. Master Trust (the “PNMR Master Trust”), which was established for the investment of assets of the pension plans. Fair value of alternative investments is determined based on net asset value as reported by fund managers.

The fair values of investments held by the employee benefit plans are as follows:



			GAAP Fair Value Hierarchy
	Total		Quoted Prices in Active Market for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2012			(In thousands)
PNM Pension Plan
Participation in PNMR Master Trust Total Plan Investments	$	517,238	$	205,491	$	232,730	$	79,017
TNMP Pension Plan
Participation in PNMR Master Trust Total Plan Investments	$	66,450	$	26,462	$	25,817	$	14,171
PNM OPEB Plan
Cash and equivalents	$	4,976	$	4,976	$	—	$	—
Equity securities:
International funds	2,651		—		2,651		—
Domestic growth	46,145		19,511		26,634		—
Other funds	7,588		—		7,588		—
Fixed income securities:
Mutual funds	4,176		4,176		—		—
Total Assets	$	65,536	$	28,663	$	36,873	$	—
TNMP OPEB Plan
Cash and equivalents	$	42	$	42	$	—	$	—
Equity securities:
International funds	1,444		—		1,444		—
Domestic growth	1,289		1,289		—		—
Other funds	3,660		—		3,660		—
Fixed income securities:
Mutual funds	2,325		2,325		—		—
Total Assets	$	8,760	$	3,656	$	5,104	$	—



			GAAP Fair Value Hierarchy
	Total		Quoted Prices in Active Market for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2011	(In thousands)
PNM Pension Plan
Participation in PNMR Master Trust	$	444,466	$	176,279	$	184,054	$	84,133
TNMP Pension Plan
Participation in PNMR Master Trust	$	62,139	$	24,118	$	23,466	$	14,555
PNM OPEB Plan
Cash and equivalents	$	1,128	$	1,128	$	—	$	—
Equity securities:
International funds	2,740		—		2,740		—
Domestic value	1,289		1,289		—		—
Domestic growth	43,016		22,215		20,801		—
Other funds	7,678		—		7,678		—
Fixed income securities:
Mutual funds	4,006		4,006		—		—
Total Assets	$	59,857	$	28,638	$	31,219	$	—
TNMP OPEB Plan
Cash and equivalents	$	180	$	180	$	—	$	—
Equity securities:
International funds	1,248		—		1,248		—
Domestic value	551		551		—		—
Domestic growth	738		738		—		—
Other funds	3,048		—		3,048		—
Fixed income securities:
Mutual funds	2,694		2,694		—		—
Total Assets	$	8,459	$	4,163	$	4,296	$	—

The fair values of investments in the PNMR Master Trust are as follows:



			GAAP Fair Value Hierarchy
	Total		Quoted Prices in Active Market for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2012	(In thousands)
PNMR Master Trust
Cash and equivalents	$	10,404	$	10,404	$	—	$	—
Equity securities:
International	39,867		39,867		—		—
Domestic value	39,492		39,492		—		—
Domestic growth	63,888		63,888		—		—
Other funds	17,035		—		17,035		—
Fixed income securities:
Corporate	101,936		—		101,936		—
United States government	148,341		78,302		70,039		—
Municipals	3,639		—		3,639		—
Other funds	65,898		—		65,898		—
Alternative investments:
Private equity funds	38,212		—		—		38,212
Hedge funds	31,277		—		—		31,277
Real estate funds	23,699		—		—		23,699
Total Fair Value of Plan Investments	$	583,688	$	231,953	$	258,547	$	93,188
December 31, 2011
PNMR Master Trust
Cash and equivalents	$	6,753	$	6,753	$	—	$	—
Equity securities:
International	37,173		37,173		—		—
Domestic value	58,350		57,437		913		—
Domestic growth	65,004		65,004		—		—
Other funds	15,271		—		15,271		—
Fixed income securities:
Corporate	59,730		—		59,730		—
United States government	104,102		34,030		70,072		—
Municipals	3,478		—		3,478		—
Other funds	58,056		—		58,056		—
Alternative investments:
Private equity funds	37,100		—		—		37,100
Hedge funds	36,904		—		—		36,904
Real estate funds	24,684		—		—		24,684
Total Assets	$	506,605	$	200,397	$	207,520	$	98,688

A reconciliation of the changes in Level 3 fair value measurements is as follows:



	Year Ended December 31,
Level 3 Fair Value Assets and Liabilities	2012			2011
	(In thousands)
PNM Pension	Master Trust			Master Trust
Balance at beginning of period	$	84,133		$	78,940
Actual return on assets sold during the period	2,627			1,624
Actual return on assets still held at period end	2,386			1,404
Purchases	5,498			4,030
Sales	(15,627		)	(1,865		)
Balance at end of period	$	79,017		$	84,133
TNMP Pension
Balance at beginning of period	$	14,555		$	13,659
Actual return on assets sold during the period	197			280
Actual return on assets still held at period end	179			243
Purchases	413			695
Sales	(1,173		)	(322		)
Balance at end of period	$	14,171		$	14,555

Additional information concerning changes in Level 3 fair value measurements for the PNMR Master Trust is as follows:

Level 3 Fair Value Assets and Liabilities



PNMR Master Trust	Private equity funds			Hedge funds			Real estate funds			Total
				(In thousands)
Balance at December 31, 2010	$	32,935		$	37,622		$	22,042		$	92,599
Actual return on assets sold during the period	1,904			—			—			1,904
Actual return on assets still held at period end	2,372			(718		)	(7		)	1,647
Purchases	2,076			—			2,649			4,725
Sales	(2,187		)	—			—			(2,187		)
Balance at December 31, 2011	37,100			36,904			24,684			98,688
Actual return on assets sold during the period	2,966			(80		)	(62		)	2,824
Actual return on assets still held at period end	40			2,453			72			2,565
Purchases	3,906			—			2,005			5,911
Sales	(5,800		)	(8,000		)	(3,000		)	(16,800		)
Balance at December 31, 2012	$	38,212		$	31,277		$	23,699		$	93,188