25. FAIR VALUE OF FINANCIAL ASSETS AND FINANCIAL 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 financial institutions, interest-bearing deposits in other financial institutions, accrued interest receivable, the majority of Federal Home Loan Bank advances and other 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. In accordance with ASU 2016-01, the fair value of loans as of December 31, 2018 are based on the notion of exit price. The fair value of loans as of December 31, 2017 was measured based on the notion of entry 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, if any, net of applicable selling costs on our consolidated balance sheets.

Federal Home Loan Bank Stock

It is not practical to determine the fair value of FHLB stock due to the restrictions placed on its transferability.

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.

Derivatives

The fair values of derivative financial instruments 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.

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.

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 core deposit premium.



					Fair Value Measurement Using
	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)
	(Dollars in thousands)
December 31, 2018
Financial assets:
Cash and due from financial institutions	$	80,569	$	80,569	$	80,569	$	—	$	—
Interest-bearing deposits in other financial institutions	21,617		21,617		21,617		—		—
Investment securities	1,354,812		1,350,576		826		1,338,581		11,169
Loans held for sale	6,647		6,647		—		6,647		—
Loans and leases, net of allowance for loan and lease losses	4,030,450		3,938,380		—		—		3,938,380
Federal Home Loan Bank stock	16,645		N/A		N/A		N/A		N/A
Accrued interest receivable	17,000		17,000		17,000		—		—

Financial liabilities:
Deposits:
Noninterest-bearing deposits	1,436,967		1,436,967		1,436,967		—		—
Interest-bearing demand and savings deposits	2,402,268		2,402,268		2,402,268		—		—
Time deposits	1,107,255		1,099,560		—		—		1,099,560
Federal Home Loan Bank advances and other short-term borrowings	197,000		197,000		—		197,000		—
Long-term debt	122,166		118,057		—		118,057		—
Accrued interest payable (included in other liabilities)	5,051		5,051		5,051		—		—



						Fair Value Measurement Using
	Notional Amount	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)
		(Dollars in thousands)
December 31, 2018
Off-balance sheet financial instruments:
Commitments to extend credit	1,030,322	1,205		1,205		—	1,205		—
Standby letters of credit and financial guarantees written	13,377	201		201		—	201		—

Derivatives:
Interest rate lock commitments	2,158	11		11		—	11		—
Forward sale commitments	8,530	(95	)	(95	)	—	(95	)	—



					Fair Value Measurement Using
	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)
	(Dollars in thousands)
December 31, 2017
Financial assets:
Cash and due from financial institutions	$	75,318	$	75,318	$	75,318	$	—	$	—
Interest-bearing deposits in other financial institutions	6,975		6,975		6,975		—		—
Investment securities	1,496,644		1,494,092		825		1,481,473		11,794
Loans held for sale	16,336		16,336		—		16,336		—
Loans and leases, net of allowance for loan and lease losses	3,720,614		3,684,834		—		21,280		3,663,554
Federal Home Loan Bank stock	7,761		N/A		N/A		N/A		N/A
Accrued interest receivable	16,581		16,581		16,581		—		—

Financial liabilities:
Deposits:
Noninterest-bearing deposits	1,395,556		1,395,556		1,395,556		—		—
Interest-bearing demand and savings deposits	2,414,930		2,414,930		2,414,930		—		—
Time deposits	1,145,868		1,140,064		—		—		1,140,064
Federal Home Loan Bank advances and other short-term borrowings	32,000		32,000		—		32,000		—
Long-term debt	92,785		70,139		—		70,139		—
Accrued interest payable (included in other liabilities)	3,698		3,698		3,698		—		—



									Fair Value Measurement Using
	Notional Amount		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)
			(Dollars in thousands)
December 31, 2017
Off-balance sheet financial instruments:
Commitments to extend credit	$	917,405	$	1,140		$	1,140		$	—	$	1,140		$	—
Standby letters of credit and financial guarantees written	13,551		203			203			—		203			—

Derivatives:
Interest rate lock commitments	2,494		12			12			—		12			—
Forward sale commitments	18,748		(26		)	(26		)	—		(26		)	—

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 year ended December 31, 2018.

The following table below presents the the fair value of assets and liabilities measured on a recurring basis:



				Fair Value at Reporting Date Using
	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
December 31, 2018
Available for sale securities:
Debt securities:
States and political subdivisions	$	173,674		$	—	$	162,505		$	11,169
Corporate securities	54,849			—		54,849			—
U.S. Treasury obligations and direct obligations of U.S Government agencies	32,574			—		32,574			—
Mortgage-backed securities:
Residential - U.S. Government-sponsored entities ("GSEs")	717,052			—		717,052			—
Residential - Non-government sponsored entities ("Non-GSEs")	41,118			—		41,118			—
Commercial - U.S. GSEs and agencies	51,483			—		51,483			—
Commercial - Non-GSEs	134,728			—		134,728			—
Equity securities	826			826		—			—
Derivatives: Interest rate lock and forward sale commitments	(84		)	—		(84		)	—
Total	$	1,206,220		$	826	$	1,194,225		$	11,169



				Fair Value at Reporting Date Using
	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
	(Dollars in thousands)
December 31, 2017
Available for sale securities:
Debt securities:
States and political subdivisions	$	179,781		$	—	$	167,987		$	11,794
Corporate securities	74,278			—		74,278			—
U.S. Treasury obligations and direct obligations of U.S Government agencies	25,510			—		25,510			—
Mortgage-backed securities:
Residential - U.S. Government-sponsored entities ("GSEs")	800,683			—		800,683			—
Residential - Non-government sponsored entities ("Non-GSEs")	46,763			—		46,763			—
Commercial - U.S. GSEs and agencies	39,725			—		39,725			—
Commercial - Non-GSEs	137,326			—		137,326			—
Equity securities	825			825		—			—
Derivatives: Interest rate lock and forward sale commitments	(14		)	—		(14		)	—
Total	$	1,304,877		$	825	$	1,292,258		$	11,794

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:



	Available for Sale Debt Securities - States and Political Subdivisions
	(Dollars in thousands)
Balance as of December 31, 2016	$	12,196
Principal payments received	(358		)
Purchases	—
Unrealized net loss included in other comprehensive loss	(44		)
Balance as of December 31, 2017	$	11,794
Principal payments received	(373		)
Purchases	—
Unrealized net loss included in other comprehensive loss	(252		)
Balance as of December 31, 2018	$	11,169

Within the state and political subdivisions debt securities category, the Company holds four mortgage revenue bonds issued by the City and County of Honolulu with an aggregate fair value of $11.2 million and $11.8 million at December 31, 2018 and 2017, 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 December 31, 2018, the weighted average discount rate utilized was 5.06%, 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.

The following table presents the fair value of assets measured on a nonrecurring basis and the level of valuation assumptions used to determine the respective fair values:



			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Losses
	(Dollars in thousands)
December 31, 2018
Other real estate (1)	$	414	$	—	$	414	$	—	$	—
Total									$	—

December 31, 2017
Impaired loans	$	21,280	$	—	$	21,280	$	—	$	—
Other real estate (1)	851		—		851		—		—
Total									$	—


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