17. FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES

Disclosures about Fair Value of Financial Instruments

Fair value estimates, methods and assumptions are set forth below for our financial instruments.

Short-Term Financial Instruments

The carrying values of short-term financial instruments are deemed to approximate fair values. Such instruments are considered readily convertible to cash and include cash and due from banks, interest-bearing deposits in other banks, accrued interest receivable, short-term borrowings, and accrued interest payable.

Investment Securities

The fair value of investment securities is based on market price quotations received from third-party pricing services. The third-party pricing services utilize pricing models supported with timely market data information. Where quoted market prices are not available, fair values are based on quoted market prices of comparable securities.

Loans

Fair values of loans are estimated based on discounted cash flows of portfolios of loans with similar financial characteristics including the type of loan, interest terms and repayment history. Fair values are calculated by discounting scheduled cash flows through estimated maturities using estimated market discount rates. Estimated market discount rates are reflective of credit and interest rate risks inherent in the Company's various loan types and are derived from available market information, as well as specific borrower information. The fair value of loans are not based on the notion of exit price.

Loans Held for Sale

The fair value of loans classified as held for sale are generally based upon quoted prices for similar assets in active markets, acceptance of firm offer letters with agreed upon purchase prices, discounted cash flow models that take into account market observable assumptions, or independent appraisals of the underlying collateral securing the loans. We report the fair values of Hawaii and U.S. Mainland construction and commercial real estate loans net of applicable selling costs on our consolidated balance sheets.

Other Interest Earning Assets

The equity investment in common stock of the FHLB, which is redeemable for cash at par value, is reported at its par value.

Deposit Liabilities

The fair values of deposits with no stated maturity, such as noninterest-bearing demand deposits and interest-bearing demand and savings accounts, are equal to the amount payable on demand. The fair value of time deposits is estimated using discounted cash flow analyses. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

Long-Term Debt

The fair value of our long-term debt is estimated by discounting scheduled cash flows over the contractual borrowing period at the estimated market rate for similar borrowing arrangements.

Off-Balance Sheet Financial Instruments

The fair values of off-balance sheet financial instruments are estimated based on the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties, current settlement values or quoted market prices of comparable instruments.

For derivative financial instruments, the fair values are based upon current market values, if available. If there are no relevant comparables, fair values are based on pricing models using current assumptions for interest rate swaps and options.

Limitations

Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument. Because no market exists for a significant portion of our financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of future business and the value of assets and liabilities that are not considered financial instruments. For example, significant assets and liabilities that are not considered financial assets or liabilities include deferred tax assets, premises and equipment and intangible assets.



						Fair Value Measurement Using
(dollars in thousands)	Carrying Amount		Estimated Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
March 31, 2017
Financial assets
Cash and due from banks	$	83,670	$	83,670		$	83,670	$	—		$	—
Interest-bearing deposits in other banks	22,363		22,363			22,363		—			—
Investment securities	1,514,315		1,511,070			682		1,498,247			12,141
Loans held for sale	9,905		9,905			—		9,905			—
Net loans and leases	3,490,349		3,442,734			—		29,322			3,413,412
Federal Home Loan Bank stock	7,333		7,333			7,333		—			—
Accrued interest receivable	14,819		14,819			14,819		—			—

Financial liabilities
Deposits:
Noninterest-bearing demand	1,290,632		1,290,632			1,290,632		—			—
Interest-bearing demand and savings and money market	2,328,705		2,328,705			2,328,705		—			—
Time	1,158,107		1,154,056			—		—			1,154,056
Short-term borrowings	21,000		21,000			—		21,000			—
Long-term debt	92,785		69,234			—		69,234			—
Accrued interest payable (included in other liabilities)	2,118		2,118			2,118		—			—

Off-balance sheet financial instruments
Commitments to extend credit	841,752		1,066			—		1,066			—
Standby letters of credit and financial guarantees written	16,371		246			—		246			—
Derivatives:
Interest rate lock commitments	7,799		19			—		19			—
Forward sale commitments	17,630		(84		)	—		(84		)	—



					Fair Value Measurement Using
(dollars in thousands)	Carrying Amount		Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2016
Financial assets
Cash and due from banks	$	75,272	$	75,272	$	75,272	$	—	$	—
Interest-bearing deposits in other banks	9,069		9,069		9,069		—		—
Investment securities	1,461,515		1,458,213		660		1,445,357		12,196
Loans held for sale	31,881		31,881		—		31,881		—
Net loans and leases	3,468,259		3,426,976		—		30,723		3,396,253
Federal Home Loan Bank stock	11,572		11,572		11,572		—		—
Accrued interest receivable	15,675		15,675		15,675		—		—

Financial liabilities
Deposits:
Noninterest-bearing demand	1,265,246		1,265,246		1,265,246		—		—
Interest-bearing demand and savings and money market	2,253,591		2,253,591		2,253,591		—		—
Time	1,089,364		1,088,436		—		—		1,088,436
Short-term borrowings	135,000		135,000		—		135,000		—
Long-term debt	92,785		68,186		—		68,186		—
Accrued interest payable (included in other liabilities)	1,556		1,556		1,556		—		—

Off-balance sheet financial instruments
Commitments to extend credit	825,304		1,046		—		1,046		—
Standby letters of credit and financial guarantees written	16,043		241		—		241		—
Derivatives:
Interest rate lock commitments	879		6		—		6		—
Forward sale commitments	32,497		136		—		136		—

Fair Value Measurements

We group our financial assets and liabilities at fair value into three levels based on the markets in which the financial assets and liabilities are traded and the reliability of the assumptions used to determine fair value as follows:


•	Level 1 — Valuation is based upon quoted prices (unadjusted) for identical assets or liabilities traded 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 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

•

Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of discounted cash flow models and similar techniques that requires the use of significant judgment or estimation.

We base our fair values on the price that we would expect to receive if an asset were sold or pay to transfer a liability in an orderly transaction between market participants at the measurement date. We also maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements.

We use fair value measurements to record adjustments to certain financial assets and liabilities and to determine fair value disclosures. Available for sale securities and derivatives are recorded at fair value on a recurring basis. From time to time, we may be required to record other financial assets at fair value on a nonrecurring basis such as loans held for sale, impaired loans and mortgage servicing rights. These nonrecurring fair value adjustments typically involve application of the lower of cost or fair value accounting or write-downs of individual assets.

There were no transfers of financial assets and liabilities between Level 1 and Level 2 of the fair value hierarchy during the three months ended March 31, 2017.

The following tables present the balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2017 and December 31, 2016:



				Fair Value at Reporting Date Using
(dollars in thousands)	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
March 31, 2017
Available for sale securities:
Debt securities:
States and political subdivisions	$	185,421		$	—	$	173,280		$	12,141
Corporate securities	94,335			—		94,335			—
Mortgage-backed securities:
Residential - U.S. Government sponsored entities	821,372			—		821,372			—
Commercial - U.S. Government agencies and sponsored entities	13,460			—		13,460			—
Residential - Non-government agencies	49,517			—		49,517			—
Commercial - Non-government agencies	138,102			—		138,102			—
Other	682			682		—			—
Total available for sale securities	1,302,889			682		1,290,066			12,141
Derivatives: Interest rate lock and forward sale commitments	(65		)	—		(65		)	—
Total	$	1,302,824		$	682	$	1,290,001		$	12,141



			Fair Value at Reporting Date Using
(dollars in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2016
Available for sale securities:
Debt securities:
States and political subdivisions	$	185,041	$	—	$	172,845	$	12,196
Corporate securities	99,389		—		99,389		—
Mortgage-backed securities:
Residential - U.S. Government sponsored entities	769,986		—		769,986		—
Residential - Non-government agencies	51,547		—		51,547		—
Commercial - Non-government agencies	137,224		—		137,224		—
Other	660		660		—		—
Total available for sale securities	1,243,847		660		1,230,991		12,196
Derivatives: Interest rate lock and forward sale commitments	142		—		142		—
Total	$	1,243,989	$	660	$	1,231,133	$	12,196

For the three months ended March 31, 2017 and 2016, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:



(dollars in thousands)	Available for Sale Debt Securities: States and Political Subdivisions
Balance at December 31, 2016	$	12,196
Principal payments received	(89		)
Unrealized net gain included in other comprehensive income	34
Balance at March 31, 2017	$	12,141

Balance at December 31, 2015	$	12,479
Principal payments received	(83		)
Unrealized net gain included in other comprehensive income	259
Balance at March 31, 2016	$	12,655

Within the state and political subdivisions debt securities category, the Company holds four mortgage revenue bonds issued by the City & County of Honolulu with an aggregate fair value of $12.1 million and $12.7 million at March 31, 2017 and March 31, 2016, respectively. The Company estimates the fair value of its mortgage revenue bonds by using a discounted cash flow model to calculate the present value of estimated future principal and interest payments.

The significant unobservable input used in the fair value measurement of the Company's mortgage revenue bonds is the weighted average discount rate. As of March 31, 2017, the weighted average discount rate utilized was 4.73%, compared to 3.00% at December 31, 2016, which was derived by incorporating a credit spread over the FHLB Fixed-Rate Advance curve. Significant increases (decreases) in the weighted average discount rate could result in a significantly lower (higher) fair value measurement.

For assets measured at fair value on a nonrecurring basis that were recorded at fair value on our balance sheet at March 31, 2017 and December 31, 2016, the following table provides the level of valuation assumptions used to determine the respective fair values:



			Fair Value Measurements Using
(dollars in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
March 31, 2017
Impaired loans (1)	$	29,322	$	—	$	29,322	$	—
Other real estate (2)	851		—		851		—

December 31, 2016
Impaired loans (1)	$	30,723	$	—	$	30,723	$	—
Other real estate (2)	791		—		791		—


(1)	Represents carrying value and related write-downs of loans for which adjustments are based on agreed upon purchase prices for the loans or the appraised value of the collateral.


(2)	Represents other real estate that is carried at the lower of carrying value or fair value less costs to sell. Fair value is generally based upon independent market prices or appraised values of the collateral.