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Section 1: 10-K/A (10-K/A)

Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K/A
(Amendment No. 1)
 
(Mark One)
 
ý      Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the Fiscal year ended December 31, 2017
 
or
 
o         Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
Commission file number: 001-31567
 
Central Pacific Financial Corp.
(Exact name of registrant as specified in its charter)
 
Hawaii
 
99-0212597
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
220 South King Street, Honolulu, Hawaii
 
96813
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code:
(808) 544-0500
 
Securities registered pursuant to Section 12(b) of the Act: 
Title of each class
 
Name of each exchange on which registered
Common Stock, No Par Value

 
New York Stock Exchange

 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer x
 
Accelerated Filer o
Non-Accelerated Filer o (Do not check if a smaller reporting company)
Smaller Reporting Company o
 
Emerging Growth Company o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act . o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes o No ý
 
As of June 30, 2017, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $926,672,000. As of February 13, 2018, the number of shares of common stock of the registrant outstanding was 29,872,222 shares.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s proxy statement for the 2018 annual meeting of shareholders are incorporated by reference into Part III of this annual report on Form 10-K to the extent stated herein. The proxy statement will be filed within 120 days after the end of the fiscal year covered by this annual report on Form 10-K.
 





EXPLANATORY NOTE

This Amendment No. 1 on Form 10-K/A (“Amendment No. 1”) amends the Annual Report of Central Pacific Financial Corp. (the “Company”) on Form 10-K for the fiscal year ended December 31, 2017, as filed with the Securities and Exchange Commission on February 28, 2018 (the “Original Filing”).

This Amendment No. 1 is being filed solely to revise the Report of Independent Registered Public Accounting Firm related to KPMG LLP's opinion on our consolidated financial statements contained in Part II, Item 8 of the Original Filing. During the processing of the Original Filing, the following statement in KPMG LLP's opinion was inadvertently omitted, "we or our predecessor firms have served as the Company's auditor since 1975".

Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), currently-dated certifications from the Company’s Chief Executive Officer and Chief Financial Officer are filed as Exhibits to Amendment No. 1, as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. Except as described above, this Amendment No. 1 does not amend, update, or change any other information contained in the Original Filing.


2



PART II
 
ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors

Central Pacific Financial Corp.:

Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Central Pacific Financial Corp. and subsidiaries (the Company) as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for each of the years in the three‑year period ended December 31, 2017, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three‑year period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 28, 2018 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ KPMG LLP
 
 
 
We or our predecessor firms have served as the Company’s auditor since 1975.
 
 
Honolulu, Hawaii
 
February 28, 2018
 


3



Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors
Central Pacific Financial Corp.:

Opinion on Internal Control Over Financial Reporting
We have audited Central Pacific Financial Corp. and subsidiaries (the Company) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes (collectively, the consolidated financial statements), and our report dated February 28, 2018 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ KPMG LLP
 
Honolulu, Hawaii
 
February 28, 2018
 

4



CENTRAL PACIFIC FINANCIAL CORP. & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
December 31,
 
2017
 
2016
 
(Dollars in thousands)
Assets
 

 
 

Cash and due from financial institutions
$
75,318

 
$
75,272

Interest-bearing deposits in other financial institutions
6,975

 
9,069

Investment securities:
 
 
 
Available-for-sale, at fair value
1,304,891

 
1,243,847

Held to maturity, fair value of: $189,201 at December 31, 2017 and $214,366 at December 31, 2016
191,753

 
217,668

Total investment securities
1,496,644

 
1,461,515

 
 
 
 
Loans held for sale
16,336

 
31,881

Loans and leases
3,770,615

 
3,524,890

Allowance for loan and lease losses
(50,001
)
 
(56,631
)
Loans and leases, net of allowance for loan and lease losses
3,720,614

 
3,468,259

 
 
 
 
Premises and equipment, net
48,348

 
48,258

Accrued interest receivable
16,581

 
15,675

Investment in unconsolidated subsidiaries
7,088

 
6,889

Other real estate owned
851

 
791

Mortgage servicing rights
15,843

 
15,779

Core deposit premium
2,006

 
4,680

Bank-owned life insurance
156,293

 
155,593

Federal Home Loan Bank stock
7,761

 
11,572

Other assets
53,050

 
79,003

Total assets
$
5,623,708

 
$
5,384,236

 
 
 
 
Liabilities and Equity
 

 
 

Deposits:
 

 
 

Noninterest-bearing demand
$
1,395,556

 
$
1,265,246

Interest-bearing demand
933,054

 
862,991

Savings and money market
1,481,876

 
1,390,600

Time
1,145,868

 
1,089,364

Total deposits
4,956,354

 
4,608,201

 
 
 
 
Federal Home Loan Bank advances and other short-term borrowings
32,000

 
135,000

Long-term debt
92,785

 
92,785

Other liabilities
42,534

 
43,575

Total liabilities
5,123,673

 
4,879,561

 
 
 
 
Equity:
 

 
 

Preferred stock, no par value, authorized 1,000,000 shares; issued and outstanding none at: December 31, 2017, and December 31, 2016

 

Common stock, no par value, authorized 185,000,000 shares; issued and outstanding: 30,024,222 at December 31, 2017 and 30,796,243 at December 31, 2016
503,988

 
530,932

Surplus
86,098

 
84,180

Accumulated deficit
(89,036
)
 
(108,941
)
Accumulated other comprehensive income (loss)
(1,039
)
 
(1,521
)
Total shareholders' equity
500,011

 
504,650

Non-controlling interest
24

 
25

Total equity
500,035

 
504,675

Total liabilities and equity
$
5,623,708

 
$
5,384,236


See accompanying notes to consolidated financial statements.

5



CENTRAL PACIFIC FINANCIAL CORP. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
(Dollars in thousands, except per share data)
Interest income:
 

 
 

 
 

Interest and fees on loans and leases
$
144,224

 
$
132,028

 
$
118,887

Interest and dividends on investment securities:
 
 
 
 
 
Taxable investment securities
33,933

 
30,848

 
32,969

Tax-exempt investment securities
3,874

 
3,975

 
4,022

Dividend income on investment securities
49

 
42

 
36

Interest on deposits in other financial institutions
356

 
67

 
35

Dividend income on Federal Home Loan Bank stock
126

 
179

 
86

Total interest income
182,562

 
167,139

 
156,035

Interest expense:
 

 
 

 
 

Interest on deposits:
 

 
 

 
 

Demand
641

 
489

 
399

Savings and money market
1,099

 
1,043

 
916

Time
9,457

 
4,074

 
2,312

Interest on short-term borrowings
183

 
578

 
254

Interest on long-term debt
3,479

 
3,005

 
2,626

Total interest expense
14,859

 
9,189

 
6,507

Net interest income
167,703

 
157,950

 
149,528

Provision (credit) for loan and lease losses
(2,674
)
 
(5,517
)
 
(15,671
)
Net interest income after provision for loan and lease losses
170,377

 
163,467

 
165,199

Other operating income:
 

 
 

 
 

Mortgage banking income
6,962

 
8,069

 
7,254

Service charges on deposit accounts
8,468

 
7,891

 
7,829

Other service charges and fees
11,518

 
11,449

 
11,461

Income from fiduciary activities
3,674

 
3,435

 
3,343

Income from bank-owned life insurance
3,388

 
2,685

 
2,034

Net gain on sales of foreclosed assets
205

 
607

 
568

Gain on sale of premises and equipment

 
3,537

 

Equity in earnings of unconsolidated subsidiaries
602

 
723

 
578

Fees on foreign exchange
529

 
519

 
450

Loan placement fees
536

 
494

 
720

Net losses on sales of investment securities
(1,410
)
 

 
(1,866
)
Other
2,024

 
2,907

 
2,428

Total other operating income
36,496

 
42,316

 
34,799

Other operating expense:
 

 
 

 
 

Salaries and employee benefits
72,286

 
73,500

 
66,429

Net occupancy
13,571

 
14,065

 
14,432

Legal and professional services
7,724

 
6,856

 
7,340

Computer software expense
9,192

 
9,475

 
8,831

Amortization of core deposit premium
2,674

 
2,675

 
2,674

Communication expense
3,659

 
3,694

 
3,483

Equipment
3,785

 
3,399

 
3,475

Advertising expense
2,408

 
2,401

 
2,550

Foreclosed asset expense
151

 
152

 
486

Other
16,367

 
17,346

 
17,342

Total other operating expense
131,817

 
133,563

 
127,042

Income before income taxes
75,056

 
72,220

 
72,956

Income tax expense
33,852

 
25,228

 
27,088

Net income
$
41,204

 
$
46,992

 
$
45,868

 
 
 
 
 
 
Per common share data:
 

 
 

 
 

Basic earnings per share
$
1.36

 
$
1.52

 
$
1.42

Diluted earnings per share
1.34

 
1.50

 
1.40

Cash dividends declared
0.70

 
0.60

 
0.82

See accompanying notes to consolidated financial statements.

6



CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
(Dollars in thousands)
Net income
$
41,204

 
$
46,992

 
$
45,868

Other comprehensive income (loss), net of tax:
 
 
 

 
 

Net change in unrealized gain (loss) on investment securities
344

 
(4,452
)
 
(4,405
)
Minimum pension liability adjustment
138

 
2,728

 
1,449

Total other comprehensive income (loss), net of tax
482

 
(1,724
)
 
(2,956
)
Comprehensive income
$
41,686

 
$
45,268

 
$
42,912

 
See accompanying notes to consolidated financial statements.


7



CENTRAL PACIFIC FINANCIAL CORP. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
 
 
Common
Shares
Outstanding
 
Preferred
Stock
 
Common
Stock
 
Surplus
 
Accumulated
Deficit
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Non
Controlling
Interests
 
Total
 
(Dollars in thousands, except per share data)
Balance at December 31, 2014
35,233,674

 
$

 
$
642,205

 
$
79,716

 
$
(157,039
)
 
$
3,159

 
$

 
$
568,041

Net income

 

 

 

 
45,868

 
$

 

 
45,868

Other comprehensive loss

 

 

 

 

 
(2,956
)
 

 
(2,956
)
Cash dividends declared ($0.82 per share)

 

 

 

 
(26,143
)
 

 

 
(26,143
)
8,159 net shares of common stock sold by directors' deferred compensation plan

 

 
(154
)
 

 

 

 

 
(154
)
4,122,881 shares of common stock repurchased and other related costs
(4,122,881
)
 

 
(93,533
)
 

 

 

 

 
(93,533
)
Share-based compensation expense
250,659

 

 
360

 
3,131

 

 

 

 
3,491

Non-controlling interest expense

 

 

 

 

 

 
25

 
25

Balance at December 31, 2015
31,361,452

 
$

 
$
548,878

 
$
82,847

 
$
(137,314
)
 
$
203

 
$
25

 
$
494,639

Net income

 

 

 

 
46,992

 

 

 
46,992

Other comprehensive loss

 

 

 

 

 
(1,724
)
 

 
(1,724
)
Cash dividends declared ($0.60 per share)

 

 

 

 
(18,619
)
 

 

 
(18,619
)
22,800 net shares of common stock sold by directors' deferred compensation plan

 

 
(681
)
 

 

 

 

 
(681
)
796,822 shares of common stock repurchased and other related costs
(796,822
)
 

 
(18,206
)
 

 

 

 

 
(18,206
)
Share-based compensation expense
231,613

 

 
941

 
1,333

 

 

 

 
2,274

Balance at December 31, 2016
30,796,243

 
$

 
$
530,932

 
$
84,180

 
$
(108,941
)
 
$
(1,521
)
 
$
25

 
$
504,675

Net income

 

 

 

 
41,204

 

 

 
41,204

Other comprehensive income

 

 

 

 

 
482

 

 
482

Cash dividends declared ($0.70 per share)

 

 

 

 
(21,299
)
 

 

 
(21,299
)
12,020 net shares of common stock sold by directors' deferred compensation plan

 

 
(385
)
 

 

 

 

 
(385
)
864,483 shares of common stock repurchased and other related costs
(864,483
)
 

 
(26,559
)
 

 

 

 

 
(26,559
)
Share-based compensation expense
92,462

 

 

 
1,918

 

 

 

 
1,918

Non-controlling interest expense

 

 

 

 

 

 
(1
)
 
(1
)
Balance at December 31, 2017
30,024,222

 
$

 
$
503,988

 
$
86,098

 
$
(89,036
)
 
$
(1,039
)
 
$
24

 
$
500,035

 
See accompanying notes to consolidated financial statements.


8



CENTRAL PACIFIC FINANCIAL CORP. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Year Ended December 31,
 
2017
 
2016
 
2015
 
(Dollars in thousands)
Cash flows from operating activities:
 
 
 

 
 

Net income
$
41,204

 
$
46,992

 
$
45,868

Adjustments to reconcile net income to net cash provided by operating activities:


 


 


Provision (credit) for loan and lease losses
(2,674
)
 
(5,517
)
 
(15,671
)
Depreciation and amortization of premises and equipment
6,441

 
6,049

 
5,870

Gain on sale of premises and equipment

 
(3,537
)
 

Amortization of mortgage servicing rights and core deposit premium
4,962

 
7,741

 
6,859

Write down of other real estate, net of gain on sale
(192
)
 
(251
)
 
198

Net amortization of investment securities
11,674

 
12,945

 
10,246

Share-based compensation expense
1,918

 
1,333

 
3,131

Net losses on sales of investment securities
1,410

 

 
1,866

Net gain on sale of residential mortgage loans
(4,069
)
 
(7,631
)
 
(6,107
)
Proceeds from sales of loans held for sale
319,556

 
432,331

 
379,318

Origination of loans held for sale
(299,942
)
 
(442,472
)
 
(377,638
)
Equity in earnings of unconsolidated subsidiaries
(602
)
 
(723
)
 
(578
)
Increase in cash surrender value of bank-owned life insurance
(3,940
)
 
(3,132
)
 
(2,407
)
Deferred income taxes
32,206

 
24,427

 
26,079

Net tax benefits from share-based compensation
544

 

 

Net change in other assets and liabilities
(11,712
)
 
7,930

 
(2,529
)
Net cash provided by operating activities
96,784

 
76,485

 
74,505

 
 
 
 
 
 
Cash flows from investing activities:
 

 
 

 
 

Proceeds from maturities of and calls on available-for-sale investment securities
169,472

 
204,426

 
165,492

Proceeds from sales of available-for-sale investment securities
114,536

 

 
117,496

Purchases of available-for-sale investment securities
(356,887
)
 
(195,456
)
 
(344,766
)
Proceeds from maturities of and calls on held-to-maturity investment securities
25,237

 
30,989

 
26,524

Purchases of held-to-maturity investment securities

 
(1,644
)
 
(37,043
)
Loan (originations) and payments, net
(166,051
)
 
(239,006
)
 
(218,195
)
Purchases of loan portfolios
(83,784
)
 
(76,946
)
 
(68,754
)
Proceeds from sales of loans originated for investment

 

 
6,658

Proceeds from sales of other real estate
286

 
2,850

 
6,691

Proceeds from bank-owned life insurance
3,240

 
1,506

 
723

Proceeds from sale of premises and equipment

 
4,287

 

Purchases of premises and equipment
(6,531
)
 
(5,896
)
 
(5,817
)
Distributions from unconsolidated subsidiaries
658

 
645

 
524

Contributions to unconsolidated subsidiaries
(114
)
 
(5
)
 

Proceeds from redemption (purchases) of FHLB stock
3,811

 
(2,966
)
 
35,326

Net cash used in investing activities
(296,127
)
 
(277,216
)
 
(315,141
)
 
 
 
 
 
 
Cash flows from financing activities:
 

 
 

 
 

Net increase in deposits
348,153

 
174,762

 
323,139

Net (decrease) increase in FHLB advances and other short-term borrowings
(103,000
)
 
66,000

 
31,000

Cash dividends paid on common stock
(21,299
)
 
(18,619
)
 
(26,143
)
Repurchases of common stock
(26,559
)
 
(18,206
)
 
(93,533
)
Net proceeds from issuance of common stock and stock option exercises

 
941

 
360

Net cash provided by financing activities
197,295

 
204,878

 
234,823

 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
(2,048
)
 
4,147

 
(5,813
)
 
 
 
 
 
 
Cash and cash equivalents at beginning of year
84,341

 
80,194

 
86,007

Cash and cash equivalents at end of year
$
82,293

 
$
84,341

 
$
80,194

 
 
 
 
 
 
Supplemental cash flow information:
 

 
 

 
 

Cash paid during the year for:
 

 
 

 
 

Interest
$
12,717

 
$
8,705

 
$
6,453

Income taxes
8,401

 

 
1,642

Cash received during the year for:
 
 
 
 
 

Income taxes

 
1,605

 

Supplemental non-cash disclosures:
 
 
 
 
 

Net change in common stock held by directors' deferred compensation plan
$
385

 
$
681

 
$
154

Net reclassification of loans to other real estate
154

 
1,428

 
5,903

Net transfer of portfolio loans to loans held for sale

 

 
6,658

 
See accompanying notes to consolidated financial statements.


9



CENTRAL PACIFIC FINANCIAL CORP. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2017, 2016, and 2015
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Description of Business
 
Central Pacific Financial Corp. is a bank holding company. Our principal operating subsidiary, Central Pacific Bank, is a full-service commercial bank with 35 branches and 79 ATMs located throughout the state of Hawaii. The bank engages in a broad range of lending activities including originating commercial loans, commercial and residential mortgage loans, home equity loans and consumer loans. The bank also offers a variety of deposit products and services. These include personal and business checking and savings accounts, money market accounts and time certificates of deposit. Other products and services include debit cards, internet banking, mobile banking, cash management services, traveler's checks, safe deposit boxes, international banking services, night depository facilities, foreign exchange and wire transfers. Wealth management products and services include non-deposit investment products, annuities, insurance, investment management, asset custody and general consultation and planning services.
 
When we refer to "the Company," "we," "us" or "our," we mean Central Pacific Financial Corp. & Subsidiaries (consolidated). When we refer to "Central Pacific Financial Corp." or to the holding company, we are referring to the parent company on a standalone basis. When we refer to "our bank" or "the bank," we mean "Central Pacific Bank."
 
The banking business depends on rate differentials, the difference between the interest rates paid on deposits and other borrowings and the interest rates received on loans extended to customers and investment securities held in our portfolio. These rates are highly sensitive to many factors that are beyond our control. Accordingly, the earnings and growth of the Company are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment.
 
We have the following three reportable segments: (1) Banking Operations, (2) Treasury and (3) All Others. The Banking Operations segment includes construction and commercial real estate lending, commercial lending, residential mortgage lending, consumer lending, trust services, retail brokerage services, and our retail branch offices, which provide a full range of deposit and loan products, as well as various other banking services. The Treasury segment is responsible for managing the Company's investment securities portfolio and wholesale funding activities. The All Others segment consists of all activities not captured by the Banking Operations and Treasury segments described above and includes activities such as electronic banking, data processing and management of bank owned properties. For further information, see Note 26 - Segment Information.
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
 
In December 2015, we acquired a 50% ownership interest in a mortgage loan origination and brokerage company, One Hawaii HomeLoans, LLC. The bank concluded that the investment met the consolidation requirements under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 810, "Consolidation". The bank also concluded that the entity met the definition of a variable interest entity and that we were the primary beneficiary of the variable interest entity. Accordingly, the investment has been consolidated into our financial statements as of December 31, 2017 and 2016. One Hawaii HomeLoans, LLC was terminated in 2017 with final payment of taxes and distributions to members pending.

We have 50% ownership interests in four other mortgage loan origination and brokerage companies which are accounted for using the equity method and are included in investment in unconsolidated subsidiaries: Pacific Access Mortgage, LLC, Gentry HomeLoans, LLC, Haseko HomeLoans, LLC and Island Pacific HomeLoans, LLC. Pacific Access Mortgage, LLC was terminated in 2017 with final payment of taxes and distributions to members pending.

We also have equity investments in affiliates that are accounted for under the cost method and are included in investment in unconsolidated subsidiaries.

Our investments in unconsolidated subsidiaries accounted for under the equity and cost methods were $0.6 million and $6.5 million, respectively, at December 31, 2017 and $0.7 million and $6.2 million, respectively, at December 31, 2016. Our policy for determining impairment of these investments includes an evaluation of whether a loss in value of an investment is other than temporary. Evidence of a loss in value includes absence of an ability to recover the carrying amount of the investment or

10



the inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. We perform impairment tests whenever indicators of impairment are present. If the value of an investment declines and it is considered other than temporary, the investment is written down to its respective fair value in the period in which this determination is made.
 
The Company sponsors the Central Pacific Bank Foundation, which is not consolidated in the Company's financial statements.
 
Use of Estimates
 
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States ("GAAP") requires management to make estimates and assumptions that reflect the reported amounts of assets and liabilities and disclosures of contingent assets and contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance and provision for loan and lease losses, reserves for unfunded loan commitments, deferred income tax assets and income tax expense, valuation of investment securities, mortgage servicing rights and the related amortization thereon, pension liability and the fair value of certain financial instruments.
 
Cash and Cash Equivalents
 
For purposes of the consolidated statements of cash flows, we consider cash and cash equivalents to include cash and due from banks, interest-bearing deposits in other banks, federal funds sold and all highly liquid investments with maturities of three months or less at the time of purchase.
 
Investment Securities
 
Investments in debt securities and marketable equity securities are designated as trading, available-for-sale, or held-to-maturity. Securities are designated as held-to-maturity only if we have the positive intent and ability to hold these securities to maturity. Held-to-maturity debt securities are reported at amortized cost. Trading securities are reported at fair value, with changes in fair value included in earnings. Available-for-sale securities are reported at fair value, with net unrealized gains and losses, net of taxes, included in accumulated other comprehensive income (loss) ("AOCI").
 
We use current quotations, where available, to estimate the fair value of investment securities. Where current quotations are not available, we estimate fair value based on the present value of expected future cash flows. We consider the facts of each security including the nature of the security, the amount and duration of the loss, credit quality of the issuer, the expectations for that security's performance and our intent and ability to hold the security until recovery. Declines in the value of debt securities and marketable equity securities that are considered other than temporary are recorded in other operating income. Realized gains and losses on the sale of investment securities are recorded in other operating income using the specific identification method.

Interest income on investment securities includes amortization of premiums and accretion of discounts. We amortize premiums and accrete discounts associated with investment securities using the interest method over the life of the respective security instrument.
 
We are a member of the Federal Home Loan Bank of Des Moines (the "FHLB"). The bank is required to obtain and hold a specific number of shares of capital stock of the FHLB equal to the sum of a membership investment requirement and an activity-based investment requirement. The securities are reported at cost and are presented separately in the consolidated balance sheets.
 
Loans Held for Sale
 
Loans held for sale consists of the following two types: (1) Hawaii residential mortgage loans that are originated with the intent to sell them in the secondary market and (2) non-residential mortgage loans in both Hawaii and the U.S. Mainland that were originated with the intent to be held in our portfolio but were subsequently transferred to the held for sale category. Hawaii residential mortgage loans classified as held for sale are carried at the lower of cost or fair value on an aggregate basis, while the non-residential Hawaii and U.S. Mainland loans are recorded at the lower of cost or fair value on an individual basis. Net fees and costs associated with originating and acquiring the Hawaii residential mortgage loans held for sale are deferred and included in the basis for determining the gain or loss on sales of loans held for sale. We report the fair values of the non-residential mortgage loans classified as held for sale net of applicable selling costs on our consolidated balance sheets.

11



 
Loans originated with the intent to be held in our portfolio are subsequently transferred to held for sale when our intent to hold for the foreseeable future has changed. At the time of a loan's transfer to the held for sale account, the loan is recorded at the lower of cost or fair value. Any reduction in the loan's value is reflected as a write-down of the recorded investment resulting in a new cost basis, with a corresponding reduction in the allowance for loan and lease losses.
 
In subsequent periods, if the fair value of a loan classified as held for sale is less than its cost basis, a valuation adjustment is recognized in our consolidated statement of income in other operating expense and the carrying value of the loan is adjusted accordingly. The valuation adjustment may be recovered in the event that the fair value increases, which is also recognized in our consolidated statement of income in other operating expense.
 
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. Collateral values are determined based on appraisals received from qualified valuation professionals and are obtained periodically or when indicators that property values may be impaired are present.
 
We sell residential mortgage loans under industry standard contractual provisions that include various representations and warranties, which typically cover ownership of the loan, compliance with loan criteria set forth in the applicable agreement, validity of the lien securing the loan, and other similar matters. We may be required to repurchase certain loans sold with identified defects, indemnify the investor, or reimburse the investor for any credit losses incurred. Our repurchase risk generally relates to early payment defaults and borrower fraud. We establish residential mortgage repurchase reserves to reflect this risk based on our estimate of losses after considering a combination of factors, including our estimate of future repurchase activity and our projection of incurred credit losses resulting from repurchased loans.

Loans
 
Loans are stated at the principal amount outstanding, net of unearned income. Unearned income represents net deferred loan fees (costs) that are recognized over the life of the related loan as an adjustment to yield. Net deferred loan fees (costs) are amortized using the interest method over the contractual term of the loan, adjusted for actual prepayments. Unamortized fees (costs) on loans paid in full are recognized as a component of interest income.
 
Interest income on loans is recognized on an accrual basis. For all loan types, the Company determines delinquency status by considering the number of days full payments required by the contractual terms of the loan are past due. Loans are placed on nonaccrual status when interest payments are 90 days past due, or earlier should management determine that the borrowers will be unable to meet contractual principal and/or interest obligations, unless the loans are well-secured and in the process of collection. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income should management determine that the collectibility of such accrued interest is doubtful. All subsequent receipts are applied to principal outstanding and no interest income is recognized unless the financial condition and payment record of the borrowers warrant such recognition. A nonaccrual loan may be restored to an accrual basis when principal and interest payments are current and full payment of principal and interest is expected.
 
Allowance for Loan and Lease Losses
 
The allowance for loan and lease losses (the "Allowance") is established through provisions for loan and lease losses (the "Provision") charged against income. Our policy is to charge a loan off in the period in which the loan is deemed to be uncollectible and all interest previously accrued but not collected is reversed against current period interest income. We consider a loan to be uncollectible when it is probable that a loss has been incurred and the Company can make a reasonable estimate of the loss. In these instances, the likelihood of and/or timeframe for recovery of the amount due is uncertain, weak, or protracted. Subsequent receipts, if any, are credited first to the remaining principal, then to the Allowance as recoveries, and finally to unaccrued interest.
 
The Allowance is management's estimate of credit losses inherent in our loan and lease portfolio at the balance sheet date. We maintain our Allowance at an amount we expect to be sufficient to absorb probable losses inherent in our loan and lease portfolio based on a projection of probable net loan charge-offs.

During the fourth quarter of 2016, the Company implemented an enhanced Allowance methodology due to the growth in the portfolio and improved credit quality. Management believes the enhanced methodology provides for greater precision in calculating the Allowance. The following summarizes the key enhancements made to the Allowance methodology:

12




Collapsed 128 segments into nine segments. The enhanced methodology uses FDIC Call Report codes to identify the nine segments.
Expanded the look-back period to 28 quarters to capture a longer economic cycle.
Utilized a migration analysis, versus average historical loss rate, to determine the historical loss rates for segments, with the exception of national syndicated loans due to limited loss history.
Applied a segment specific loss emergence period.
Determined qualitative reserves, calculated at the segment level, considering nine qualitative factors and based on a baseline risk weighting adjusted for current internal and external factors.
Eliminated the Moody's proxy rate that was applied under the previous methodology.
Eliminated the unallocated reserve.

These enhancements and continued improvement in portfolio credit quality resulted in a credit to the Provision of $2.6 million during the fourth quarter of 2016. In 2017 the Company continued to implement the enhanced Allowance methodology from the fourth quarter of 2016, which resulted in a credit to the Provision of $2.7 million in the year ended December 31, 2017.

The Company's approach to developing the Allowance has three basic elements. These elements include specific reserves for individually impaired loans, a general allowance for loans other than those analyzed as individually impaired, and qualitative adjustments based on environmental and other factors which may be internal or external to the Company. These three elements are explained below.
 
Specific Reserve
 
Individually impaired loans in all loan categories are evaluated using one of three valuation methods as prescribed under Accounting Standards Codification ("ASC") 310-10, Fair Value of Collateral, Observable Market Price, or Cash Flow. A loan is generally evaluated for impairment on an individual basis if it meets one or more of the following characteristics: risk-rated as substandard, doubtful or loss, loans on nonaccrual status, troubled debt restructures, or any loan deemed prudent by management to so analyze. If the valuation of the impaired loan is less than the recorded investment in the loan, the deficiency will be charged off against the Allowance or, alternatively, a specific reserve will be established and included in the overall Allowance balance.

General Allowance

In determining the general allowance component of the Allowance, the Company utilizes a comprehensive approach to segment the loan portfolio into homogeneous groups. The enhanced methodology segments the portfolio by FDIC Call Report codes. In the second quarter of 2017, an additional segment was added for auto dealer purchased loans. This results in ten segments, and is consistent with general industry practice. For the purpose of determining general allowance loss factors, loss experience is derived from a migration analysis, with the exception of national syndicated loans and auto dealer purchased loans where an average historical loss rate is applied due to limited historical loss experience. The key inputs to run a migration analysis are the length of the migration period, the dates for the migration periods to start and the number of migration periods used for the analysis. For each migration period, the analysis will determine the outstanding balance in each segment and/or sub-segment at the start of each period. These loans will then be followed for the length of the migration period to identify the amount of associated charge-offs and recoveries. A loss rate for each migration period is calculated using the formula ‘net charge-offs over the period divided by beginning loan balance'. The Allowance methodology applies a look back period to January 1, 2010. The Company extends its look back period with each additional quarter passing.

Qualitative Adjustments

Our Allowance methodology uses qualitative adjustments to address changes in conditions, trends, and circumstances such as economic conditions and industry changes that could have a significant impact on the risk profile of the loan portfolio, and provide for losses in the loan portfolio that may not be reflected and/or captured in the historical loss data. In order to ensure that the qualitative adjustments are in compliance with current regulatory standards and U.S. GAAP, the Company is primarily basing adjustments on the nine standard factors outlined in the 2006 Interagency Policy Statement on the Allowance for Loan and Lease Losses. These factors include: lending policies, economic conditions, loan profile, lending staff, problem loan trends, loan review, collateral, credit concentrations and other internal and external factors.

In recognizing that current and relevant environmental (economic, market or other) conditions that can affect repayment may not yet be fully reflected in historical loss experience, qualitative adjustments are applied to factor in current loan portfolio and market intelligence. These adjustments, which are added to the historical loss rate, consider the nature of the Company's

13



primary markets and are reasonable, consistently determined and appropriately documented. Management reviews the results of the qualitative adjustment quarterly to ensure it is consistent with the trends in the overall economy, and from time to time may make adjustments, if necessary, to ensure directional consistency.
 
Reserve for Unfunded Commitments
 
Our process for determining the reserve for unfunded loan commitments utilizes historical loss rates and is adjusted for estimated loan funding probabilities. The reserve for unfunded loan commitments is recorded separately through a valuation allowance included in other liabilities. Credit losses for off-balance sheet credit exposures are deducted from the allowance for credit losses on off-balance sheet credit exposures in the period in which the liability is settled. The allowance for credit losses on off-balance sheet credit losses is established by a charge to other operating expense.
 
Premises and Equipment
 
Premises and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are included in other operating expense and are computed using the straight-line method over the shorter of the estimated useful lives of the assets or the applicable leases. Useful lives generally range from five to thirty-nine years for premises and improvements, and one to seven years for equipment. Major improvements and betterments are capitalized, while recurring maintenance and repairs are charged to operating expense. Net gains or losses on dispositions of premises and equipment are included in other operating income and operating expense.

Core Deposit Premium and Mortgage Servicing Rights
 
Our core deposit premium is being amortized over 14 years which approximates the estimated life of the purchased deposits. The carrying value of our core deposit premium is periodically evaluated to estimate the remaining periods of benefit. If these periods of benefit are determined to be less than the remaining amortizable life, an adjustment to reflect such shorter life will be made.
 
Mortgage servicing rights are recorded when loans are sold to third-parties with servicing of those loans retained and we classify our entire mortgage servicing rights into one class. We utilize the amortization method to measure our mortgage servicing rights. Under the amortization method, we amortize our mortgage servicing rights in proportion to and over the period of net servicing income. Income generated as the result of new mortgage servicing rights is reported as gains on sales of loans. Amortization of the servicing rights is reported as a component of mortgage banking income in our consolidated statements of income. Ancillary income is recorded in other income.
 
Initial fair value of the servicing right is calculated by a discounted cash flow model prepared by a third-party service provider based on market value assumptions at the time of origination and we assess the servicing right for impairment using current market value assumptions at each reporting period. Critical assumptions used in the discounted cash flow model include mortgage prepayment speeds, discount rates, costs to service and ancillary income. Variations in our assumptions could materially affect the estimated fair values. Changes to our assumptions are made when current trends and market data indicate that new trends have developed. Current market value assumptions based on loan product types (fixed-rate, adjustable-rate and balloon loans) include average discount rates, servicing cost and ancillary income. Many of these assumptions are subjective and require a high level of management judgment. Our mortgage servicing rights portfolio and valuation assumptions are periodically reviewed by management.
 
Prepayment speeds may be affected by economic factors such as home price appreciation, market interest rates, the availability of other credit products to our borrowers and customer payment patterns. Prepayment speeds include the impact of all borrower prepayments, including full payoffs, additional principal payments and the impact of loans paid off due to foreclosure liquidations.
 
We perform an impairment assessment of our core deposit premium and mortgage servicing rights quarterly or whenever events or changes in circumstance indicate that the carrying value of those assets may not be recoverable. Our impairment assessments involve, among other valuation methods, the estimation of future cash flows and other methods of determining fair value. Estimating future cash flows and determining fair values is subject to judgments and often involves the use of significant estimates and assumptions. The variability of the factors we use to perform our impairment tests depend on a number of conditions, including uncertainty about future events and cash flows. All such factors are interdependent and, therefore, do not change in isolation. Accordingly, our accounting estimates may materially change from period to period due to changing market factors.

14




Other Real Estate

Other real estate is composed of properties acquired through foreclosure proceedings and is initially recorded at fair value less estimated costs to sell the property, thereby establishing the new cost basis of other real estate. Losses arising at the time of acquisition of such properties are charged against the Allowance. Subsequent to acquisition, such properties are carried at the lower of cost or fair value less estimated selling expenses, determined on an individual asset basis. Any deficiency resulting from the excess of cost over fair value less estimated selling expenses is recognized as a valuation allowance. Any subsequent increase in fair value up to its cost basis is recorded as a reduction of the valuation allowance. Increases or decreases in the valuation allowance are included in other operating expense. Net gains or losses recognized on the sale of these properties are included in other operating income.
 
Non-Controlling Interest
 
Non-controlling interest at December 31, 2017 was comprised of capital and undistributed profits of the member of One Hawaii HomeLoans, LLC, other than the bank. Non-controlling interest on our consolidated balance sheet at December 31, 2017 and December 31, 2016 totaled $24 thousand and $25 thousand, respectively. One Hawaii HomeLoans, LLC was terminated in 2017 with final payment of taxes and distributions to members pending.
 
Share Based Compensation
 
Share-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the employee's requisite service period. We use the Black-Scholes option-pricing model to determine the fair-value of stock options and we recognize compensation expense for all share-based payment awards on a straight-line basis over their respective vesting period. See Note 16 - Share-Based Compensation for further discussion of our stock-based compensation.
 
Income Taxes
 
Deferred tax assets and liabilities are recognized for the estimated future tax effects attributable to temporary differences and carryforwards. A valuation allowance may be required if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining whether a valuation allowance is necessary, we consider the level of taxable income in prior years, to the extent that carrybacks are permitted under current tax laws, as well as estimates of future taxable income and tax planning strategies that could be implemented to accelerate taxable income, if necessary. If our estimates of future taxable income were materially overstated or if our assumptions regarding the tax consequences of tax planning strategies were inaccurate, some or all of our deferred tax assets may not be realized, which would result in a charge to earnings. We recognize interest and penalties related to income tax matters in other expense.
 
We establish income tax contingency reserves for potential tax liabilities related to uncertain tax positions. Tax benefits are recognized when we determine that it is more likely than not that such benefits will be realized. Where uncertainty exists due to the complexity of income tax statutes, and where the potential tax amounts are significant, we generally seek independent tax opinions to support our positions. If our evaluation of the likelihood of the realization of benefits is inaccurate, we could incur additional income tax and interest expense that would adversely impact earnings, or we could receive tax benefits greater than anticipated which would positively impact earnings.

Earnings per Share
 
Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period, excluding unvested restricted stock awards. Diluted earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period, increased by the dilutive effect of stock options and stock awards, less shares held in a Rabbi trust pursuant to a deferred compensation plan for directors.
 
Forward Foreign Exchange Contracts
 
We are periodically a party to a limited amount of forward foreign exchange contracts to satisfy customer requirements for foreign currencies. These contracts are not utilized for trading purposes and are carried at market value, with realized gains and losses included in fees on foreign exchange.
 

15



Derivatives and Hedging Activities
 
We recognize all derivatives on the balance sheet at fair value. On the date that we enter into a derivative contract, we designate the derivative as (1) a hedge of the fair value of an identified asset or liability ("fair value hedge"), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to an identified asset or liability ("cash flow hedge") or (3) a transaction not qualifying for hedge accounting ("free standing derivative"). For a fair value hedge, changes in the fair value of the derivative and, to the extent that it is effective, changes in the fair value of the hedged asset or liability, attributable to the hedged risk, are recorded in current period net income in the same financial statement category as the hedged item. For a cash flow hedge, changes in the fair value of the derivative, to the extent that it is effective, is recorded in other comprehensive income (loss) ("OCI"). These changes in fair value are subsequently reclassified to net income in the same period(s) that the hedged transaction affects net income in the same financial statement category as the hedged item. For free standing derivatives, changes in fair values are reported in current period other operating income.
 
Accounting Standards Adopted in 2017

In March 2016, the FASB issued ASU 2016-09, "Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting." ASU 2016-09 simplifies the accounting for share-based payments. Specifically, the amendments: 1) require entities to record all excess tax benefits and tax deficiencies as an income tax benefit or expense in the income statement; 2) change the classification of excess tax benefits to an operating activity in the statement of cash flows; 3) allows entities to elect an accounting policy to either estimate the number of forfeitures or account for forfeitures when they occur; and 4) allows entities to withhold up to the maximum individual statutory tax rate without classifying the awards as a liability. We adopted ASU 2016-09 effective January 1, 2017 and elected to recognize forfeitures as they occur. The Company’s adoption was prospective, therefore, prior periods have not been adjusted. The adoption of ASU 2016-09 could result in greater volatility to reported income tax expense related to excess tax benefits and tax deficiencies for employee share-based payments. The volatility results from changes in the share price and timing of exercise of share options and vesting of share awards. For the year ended December 31, 2017, the adoption of ASU 2016-09 resulted in a decrease to the provision for income taxes due to the tax benefit from the vesting of restricted stock units.

Accounting Standards Pending Adoption

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)." ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. ASU 2014-09 was initially going to be effective for the Company's reporting period beginning on January 1, 2017. However, in August 2015, the FASB issued ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date" which defers the effective date by one year. For financial reporting purposes, the standard allows for either a full retrospective or modified retrospective adoption. The FASB has also issued additional updates to provide further clarification to specific implementation issues associated with ASU 2014-09. These updates include ASU 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations," ASU 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing," ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients," and ASU 2016-20 "Technical Corrections and Improvements to Topic 606." Our revenue is comprised of net interest income on financial assets and financial liabilities, which is our main source of income, and other operating income. The scope of ASU 2014-09 explicitly excludes net interest income, as well as other revenues associated with financial assets and liabilities, including loans, leases, securities and derivatives. With respect to other operating income, the Company has conducted a comprehensive scoping exercise to determine the revenue streams that are in scope of the guidance. This includes reviewing the contracts potentially impacted by the standard in revenue streams such as deposit related fees, merchant fees, bank card fees, interchange fees, commissions income, trust and asset management fees, foreign exchange fees, and loan placement fees. The Company is substantially complete with its evaluation of the effect that the adoption will have on its financial statements. Based on our analysis, we expect that the standard will require us to change how we recognize certain recurring revenue streams on a gross versus net basis; however, the standard will not have an impact to our net income or any material impact to our consolidated financial statements. We continue to follow implementation issues relevant to the banking industry, and consider the disclosure requirements upon implementation and adoption of the standard beginning January 1, 2018 under the modified retrospective approach; however, we do not expect a cumulative-effect adjustment to opening retained earnings (accumulated deficit) will be recorded.

2. RESERVE REQUIREMENTS
 
The bank is required by the Federal Reserve Bank of San Francisco to maintain reserves based on the amount of deposits held. The amount held as a reserve by our bank at December 31, 2017 and 2016 was $63.4 million and $63.1 million, respectively.

16




3. INVESTMENT SECURITIES
 
A summary of our investment securities portfolio as of December 31, 2017 and 2016 is as follows:
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(Dollars in thousands)
December 31, 2017
 
 
 
 
 
 
 
Held-to-Maturity:
 
 
 
 
 
 
 
Mortgage-backed securities:
 
 
 
 
 
 
 
Residential-U.S. Government sponsored entities
$
100,279

 
$
106

 
$
(2,222
)
 
$
98,163

Commercial-U.S. Government sponsored entities
91,474

 

 
(436
)
 
91,038

Total held-to-maturity investment securities
$
191,753

 
$
106

 
$
(2,658
)
 
$
189,201

 
 
 
 
 
 
 
 
Available-for-Sale:
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
States and political subdivisions
$
178,459

 
$
2,041

 
$
(719
)
 
$
179,781

Corporate securities
73,772

 
582

 
(76
)
 
74,278

U.S. Treasury obligations and direct obligations of U.S Government agencies
25,519

 
60

 
(69
)
 
25,510

Mortgage-backed securities:
 
 
 
 
 
 
 
Residential-U.S. Government sponsored entities
808,242

 
2,230

 
(9,789
)
 
800,683

Residential-Non-government sponsored entities
45,679

 
1,084

 

 
46,763

Commercial-U.S. Government agencies and sponsored entities
40,012

 

 
(287
)
 
39,725

Commercial-Non-government sponsored entities
135,058

 
2,461

 
(193
)
 
137,326

Other
686

 
139

 

 
825

Total available-for-sale investment securities
$
1,307,427

 
$
8,597

 
$
(11,133
)
 
$
1,304,891


 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(Dollars in thousands)
December 31, 2016
 
 
 
 
 
 
 
Held-to-Maturity:
 
 
 
 
 
 
 
Mortgage-backed securities:
 
 
 
 
 
 
 
Residential-U.S. Government sponsored entities
$
124,082

 
$
92

 
$
(2,474
)
 
$
121,700

Commercial-U.S. Government sponsored entities
93,586

 

 
(920
)
 
92,666

Total held-to-maturity investment securities
$
217,668

 
$
92

 
$
(3,394
)
 
$
214,366

 
 
 
 
 
 
 
 
Available-for-Sale:
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
States and political subdivisions
$
184,836

 
$
2,002

 
$
(1,797
)
 
$
185,041

Corporate securities
98,596

 
974

 
(181
)
 
99,389

Mortgage-backed securities:
 
 
 
 
 
 
 
Residential-U.S. Government sponsored entities
775,803

 
3,698

 
(9,515
)
 
769,986

Residential-Non-government sponsored entities
51,681

 
627

 
(761
)
 
51,547

Commercial-Non-government sponsored entities
135,248

 
2,387

 
(411
)
 
137,224

Other
564

 
96

 

 
660

Total available-for-sale investment securities
$
1,246,728

 
$
9,784

 
$
(12,665
)
 
$
1,243,847


17




The amortized cost and estimated fair value of our investment securities at December 31, 2017 by contractual maturity are shown below. Actual maturities may differ from contractual maturities as issuers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.
 
 
December 31, 2017
 
Amortized Cost
 
Fair Value
 
(Dollars in thousands)
Held-to-Maturity:
 
 
 
Mortgage-backed securities:
 
 
 
Residential-U.S. Government-sponsored entities
$
100,279

 
$
98,163

Commercial-U.S. Government-sponsored entities
91,474

 
91,038

Total held-to-maturity investment securities
$
191,753

 
$
189,201

 
 
 
 
Available-for-Sale:

 

Due in one year or less
$
8,796

 
$
8,799

Due after one year through five years
165,356

 
166,447

Due after five years through ten years
40,762

 
41,166

Due after ten years
62,836

 
63,157

Mortgage-backed securities

 

Residential-U.S. Government-sponsored entities
808,242

 
800,683

Residential-Non-government agencies
45,679

 
46,763

Commercial-U.S. Government agencies and sponsored entities
40,012

 
39,725

Commercial-Non-government agencies
135,058

 
137,326

Other
686

 
825

Total available-for-sale investment securities
$
1,307,427

 
$
1,304,891


In the second quarter of 2017, we completed an investment portfolio repositioning strategy designed to enhance potential prospective earnings and improve net interest margin. In connection with the repositioning, we sold $97.7 million in lower-yielding available-for-sale securities, and purchased $97.4 million in higher-yielding, longer duration investment securities. The investment securities sold had a duration of 3.3 years and an average yield of 1.91%. Gross proceeds of the sale of $96.0 million were immediately reinvested back into investment securities with a duration of 4.6 years and an average yield of 2.57%. The new securities were classified in the available-for-sale portfolio. There were no gross realized gains on the sale of the investment securities. Gross realized losses on the sale of the investment securities were $1.6 million. The specific identification method was used as the basis for determining the cost of all securities sold.

There were no investment security sales in 2016.
 
In the second quarter of 2015, we completed an investment portfolio repositioning strategy designed to reduce net interest income volatility and enhance the potential prospective earnings and an improved net interest margin. In connection with the repositioning, we sold $119.4 million in lower-yielding available-for-sale non-agency collateralized mortgage obligation securities, and purchased $120.6 million in higher yielding, longer duration mortgage-backed securities. The securities sold had an average net yield of 1.35% and a weighted average life of 4.4 years. Gross proceeds of the sale of $117.5 million were reinvested into agency mortgage-backed securities with an average net yield of 2.71% and weighted average life of 7.6 years. The new securities were classified in the available-for-sale portfolio. There were no gross realized gains on the sale of the available-for-sale investment securities. Gross realized losses on the sale of the available-for-sale investment securities were $1.9 million. The specific identification method was used as the basis for determining the cost of all securities sold.

Investment securities of $1.08 billion and $1.05 billion at December 31, 2017 and 2016, respectively, were pledged to secure public funds on deposit and other long-term and short-term borrowings.

18




At December 31, 2017 and 2016, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders' equity.
 
There were a total of 223 and 242 securities in an unrealized or unrecognized loss position at December 31, 2017 and 2016, respectively. The following table summarizes securities which were in an unrealized or unrecognized loss position at December 31, 2017 and 2016, aggregated by major security type and length of time in a continuous unrealized or unrecognized loss position:
 
 
Less Than 12 Months
 
12 Months or Longer
 
Total
Description of Securities
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(Dollars in thousands)
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
States and political subdivisions
$
53,811

 
$
(305
)
 
$
15,403

 
$
(414
)
 
$
69,214

 
$
(719
)
Corporate securities

 

 
5,307

 
(76
)
 
5,307

 
(76
)
U.S. Treasury obligations and direct obligations of U.S Government agencies
10,740

 
(69
)
 

 

 
10,740

 
(69
)
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Residential-U.S. Government sponsored entities
335,883

 
(3,372
)
 
340,219

 
(8,639
)
 
676,102

 
(12,011
)
Commercial-U.S. Government sponsored entities
130,763

 
(723
)
 

 

 
130,763

 
(723
)
Commercial-Non-government sponsored entities
28,490

 
(193
)
 

 

 
28,490

 
(193
)
Total temporarily impaired securities
$
559,687

 
$
(4,662
)
 
$
360,929

 
$
(9,129
)
 
$
920,616

 
$
(13,791
)

 
Less Than 12 Months
 
12 Months or Longer
 
Total
Description of Securities
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(Dollars in thousands)
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
 
 
 
 
States and political subdivisions
$
85,288

 
$
(1,797
)
 
$

 
$

 
$
85,288

 
$
(1,797
)
Corporate securities
20,357

 
(181
)
 

 

 
20,357

 
(181
)
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Residential-U.S. Government sponsored entities
648,923

 
(11,766
)
 
3,978

 
(223
)
 
652,901

 
(11,989
)
Residential-Non-government sponsored entities
30,596

 
(761
)
 

 

 
30,596

 
(761
)
Commercial-U.S. Government sponsored entities
92,666

 
(920
)
 

 

 
92,666

 
(920
)
Commercial-Non-government sponsored entities
52,880

 
(411
)
 

 

 
52,880

 
(411
)
Total temporarily impaired securities
$
930,710

 
$
(15,836
)
 
$
3,978

 
$
(223
)
 
$
934,688

 
$
(16,059
)
 
The unrealized losses on the Company's investment securities were caused by market conditions. Investment securities are evaluated on a quarterly basis, and include evaluating the changes in the investment securities' ratings issued by rating agencies and changes in the financial condition of the issuer, and for mortgage related securities, delinquency and loss information with respect to the underlying collateral, changes in levels of subordination for the Company's particular position within the repayment structure, and remaining credit enhancement as compared to projected credit losses of the security. All of these investment securities continue to be investment grade rated by one or more major rating agencies.

Other-than-temporary impairment ("OTTI")
 
Unrealized losses for all investment securities are reviewed to determine whether the losses are "other-than-temporary." Investment securities are evaluated for OTTI on at least a quarterly basis and more frequently when economic or market

19



conditions warrant such an evaluation to determine whether a decline in their value below amortized cost is other-than-temporary. In conducting this assessment, we evaluate a number of factors including, but not limited to:
 
The length of time and the extent to which fair value has been less than the amortized cost basis;
Adverse conditions specifically related to the security, an industry, or a geographic area;
The historical and implied volatility of the fair value of the security;
The payment structure of the debt security and the likelihood of the issuer being able to make payments;
Failure of the issuer to make scheduled interest or principal payments;
Any rating changes by a rating agency; and
Recoveries or additional decline in fair value subsequent to the balance sheet date.
 
The term "other-than-temporary" is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized for anticipated credit losses.
 
The declines in market value were primarily attributable to changes in interest rates and volatility in the credit and financial markets. Because we have no intent to sell securities in an unrealized loss position and it is not more likely than not that we will be required to sell such securities before recovery of its amortized cost basis, we do not consider our investments to be other-than-temporarily impaired.
 
4. LOANS AND LEASES
 
Loans and leases, excluding loans held for sale, consisted of the following as of December 31, 2017 and 2016:
 
 
December 31,
 
2017
 
2016
 
(Dollars in thousands)
Commercial, financial & agricultural
$
503,738

 
$
509,987

Real estate:
 
 
 
Construction
64,525

 
101,729

Residential mortgage
1,337,193

 
1,213,983

Home equity
412,230

 
361,210

Commercial mortgage
979,239

 
886,615

Consumer
470,819

 
448,610

Leases
362

 
677

Subtotal
3,768,106

 
3,522,811

Net deferred costs
2,509

 
2,079

Total loans and leases
$
3,770,615

 
$
3,524,890


There are different types of risk characteristics for the loans in each portfolio segment. The construction and real estate segment's predominant risk characteristics are the collateral and the geographic location of the property collateralizing the loan, as well as the operating cash flow for the commercial real estate properties. The commercial and industrial (including leases) segment's predominant risk characteristics are the cash flows of the business we lend to, the global cash flows and liquidity of the guarantors of such losses, as well as economic and market conditions. The consumer segment's predominant risk characteristics are employment and income levels as they relate to the consumer.
 
During the year ended December 31, 2017, we transferred the collateral in one portfolio loan with a carrying value of $0.1 million to other real estate. We did not transfer any loans to the held-for-sale category during the year ended December 31, 2017. In addition, we did not sell any portfolio loans during the year ended December 31, 2017.

In 2017, we purchased three auto loan portfolios totaling $83.8 million, which included a $2.3 million premium over the $81.4 million outstanding balance. At the time of purchase, the auto loan portfolios had a weighted average remaining term of 70 months.

20



 
During the year ended December 31, 2016, we transferred the collateral in two portfolio loans with a carrying value of $1.3 million to other real estate. We did not transfer any loans to the held-for-sale category during the year ended December 31, 2016. In addition, we did not sell any portfolio loans during the year ended December 31, 2016.

In 2016, we purchased two auto loan portfolios totaling $41.2 million, which included a $0.9 million premium over the $40.3 million outstanding balance. At the time of purchase, the auto loan portfolios had a weighted average remaining term of 64 months. In 2016, we also purchased two unsecured consumer loan portfolios totaling $35.7 million, which represented the outstanding balance at the time of purchases. At the time of purchases, the unsecured consumer loans had a weighted average remaining term of 38 months.
 
In the normal course of business, our bank makes loans to certain directors, executive officers and their affiliates. These loans are made in the ordinary course of business at normal credit terms. As of December 31, 2017 and December 31, 2016, related party loan balances were $32.2 million and $17.1 million, respectively.

Impaired Loans
 
The following tables present by class, the balance in the Allowance and the recorded investment in loans and leases based on the Company's impairment method as of December 31, 2017 and 2016:
 
 
 
 
Real Estate
 
 
 
 
 
 
 
Comml.,
Fin. &
Ag.
 
Constr.
 
Resi.
Mortgage
 
Home
Equity
 
Comml.
Mortgage
 
Consumer
 
Leases
 
Total
 
(Dollars in thousands)
December 31, 2017
 

 
 

 
 

 
 
 
 

 
 
 
 

 
 

Allowance:
 

 
 

 
 

 
 
 
 

 
 
 
 

 
 

Individually evaluated for impairment
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

Collectively evaluated for impairment
7,594

 
1,835

 
14,328

 
3,317

 
16,801

 
6,126

 

 
50,001

Total ending balance
$
7,594

 
$
1,835

 
$
14,328

 
$
3,317

 
$
16,801

 
$
6,126

 
$

 
$
50,001

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans and leases:
 

 
 

 
 

 
 

 
 

 
 
 
 

 
 

Individually evaluated for impairment
$
491

 
$
2,597

 
$
13,862

 
$
416

 
$
3,914

 
$

 
$

 
$
21,280

Collectively evaluated for impairment
503,247

 
61,928

 
1,323,331

 
411,814

 
975,325

 
470,819

 
362

 
3,746,826

Subtotal
503,738

 
64,525

 
1,337,193

 
412,230

 
979,239

 
470,819

 
362

 
3,768,106

Net deferred costs (income)
281

 
(285
)
 
4,028

 

 
(1,442
)
 
(73
)
 

 
2,509

Total ending balance
$
504,019

 
$
64,240

 
$
1,341,221

 
$
412,230

 
$
977,797

 
$
470,746

 
$
362

 
$
3,770,615


 
 
 
Real Estate
 
 
 
 
 
 
 
 
 
Comml.,
Fin. &
Ag.
 
Constr.
 
Resi.
Mortgage
 
Home
Equity
 
Comml.
Mortgage
 
Consumer
 
Leases
 
Unallocated
 
Total
 
(Dollars in thousands)
December 31, 2016
 

 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Allowance:
 

 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Individually evaluated for impairment
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

 
$

Collectively evaluated for impairment
8,637

 
4,224

 
15,055

 
3,502

 
19,104

 
6,109

 

 

 
56,631

Total ending balance
$
8,637

 
$
4,224

 
$
15,055

 
$
3,502

 
$
19,104

 
$
6,109

 
$

 
$

 
$
56,631

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans and leases:
 

 
 

 
 

 
 

 
 

 
 
 
 

 
 
 
 

Individually evaluated for impairment
$
1,877

 
$
2,936

 
$
19,940

 
$
333

 
$
5,637

 
$

 
$

 
$

 
$
30,723

Collectively evaluated for impairment
508,110

 
98,793

 
1,194,043

 
360,877

 
880,978

 
448,610

 
677

 

 
3,492,088

Subtotal
509,987

 
101,729

 
1,213,983

 
361,210

 
886,615

 
448,610

 
677

 

 
3,522,811

Net deferred costs (income)
453

 
(191
)
 
3,251

 
(1
)
 
(1,176
)
 
(257
)
 

 

 
2,079

Total ending balance
$
510,440

 
$
101,538

 
$
1,217,234

 
$
361,209

 
$
885,439

 
$
448,353

 
$
677

 
$

 
$
3,524,890



21



The following table presents by class, impaired loans as of December 31, 2017 and 2016:
 
 
December 31, 2017
 
December 31, 2016
 
Unpaid
Principal
Balance
 
Recorded
Investment
 
Allowance
Allocated
 
Unpaid
Principal
Balance
 
Recorded
Investment
 
Allowance
Allocated
 
(Dollars in thousands)
Impaired loans with no related Allowance recorded:
 

 
 

 
 

 
 

 
 

 
 

Commercial, financial & agricultural
$
602

 
$
491

 
$

 
$
1,988

 
$
1,877

 
$

Real estate:
 
 
 
 
 
 
 
 
 
 
 
Construction
7,947

 
2,597

 

 
9,056

 
2,936

 

Residential mortgage
14,920

 
13,862

 

 
21,568

 
19,940

 

Home equity
416