NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2022, 2021, and 2020
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 27 branches and 64 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, full-service ATMs, 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. and 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.
Operating Segments
Operations, resource allocation and financial performance are managed by the Company's Executive Committee, or its chief operating decision maker ("CODM"), on a Company-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable segment.
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 January 2020, the bank acquired a 50% ownership interest in a mortgage loan origination and brokerage company, Oahu HomeLoans, LLC. The bank concluded that the investment meets the consolidation requirements under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 810, "Consolidation." The bank also concluded that the entity meets the definition of a variable interest entity and that we are the primary beneficiary of the variable interest entity. Accordingly, the investment has been consolidated into the Company's financial statements. In March 2022, Oahu HomeLoans, LLC was terminated.
The bank has 50% ownership interests in three other mortgage loan origination and brokerage companies which are accounted for using the equity method and are included in investment in unconsolidated entities in the Company's consolidated balance sheets: Gentry HomeLoans, LLC, Haseko HomeLoans, LLC and Island Pacific HomeLoans, LLC.
The bank has low income housing tax credit partnership investments that are accounted for under the proportional amortization method and are included in investment in unconsolidated entities in the Company's consolidated balance sheets.
During the first quarter of 2022, the Company invested $2.0 million in Swell Financial, Inc. ("Swell"), which included $1.5 million in other intangible assets and services provided in exchange for Swell non-voting common stock and $0.5 million in cash in exchange for Swell preferred stock. During the fourth quarter of 2022, Swell launched a consumer banking application that combines checking, credit and more into one integrated account, with Central Pacific Bank serving as the bank sponsor. Swell began with an alpha pilot, where members off its waitlist were invited to sign up for Swell Cash and Credit. During the fourth quarter of 2022, Elevate announced that it had entered into a definitive agreement to be acquired by Park Cities Asset Management, LLC, who is also the largest investor in Swell. The Company does not have the ability to exercise
significant influence over Swell and the investment does not have a readily determinable fair value. As a result, the Company determined that the cost method of accounting for the investment was appropriate. The investment is included in investments in unconsolidated entities in the Company's consolidated balance sheets.
In 2021, the Company committed $2.0 million to the JAM FINTOP Banktech Fund, L.P., an investment fund designed to help develop and accelerate technology adoption at community banks across the United States. The Company does not have the ability to exercise significant influence over the JAM FINTOP Banktech Fund, L.P. and the investment does not have a readily determinable fair value. As a result, the Company determined that the cost method of accounting for the investment was appropriate. The investment is included in investment in unconsolidated entities in the Company's consolidated balance sheets.
The Company also has other non-controlling equity investments in affiliates that are accounted for under the cost method and are included in investment in unconsolidated entities in the Company's consolidated balance sheets.
Investments in unconsolidated entities accounted for under the equity, proportional amortization and cost methods were $0.1 million, $40.9 million and $5.6 million, respectively, at December 31, 2022 and $0.2 million, $25.9 million and $3.6 million, respectively, at December 31, 2021. 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 the inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. Impairment tests are performed 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 credit losses, reserve for credit losses on off-balance sheet credit exposures, deferred income tax assets and income tax expense, valuation of investment securities, mortgage servicing rights and the related amortization thereon, the liability related to the Supplemental Executive Retirement Plans, and the fair value of certain financial instruments.
Cash and Cash Equivalents
Cash and cash equivalents include cash and due from financial institutions, interest-bearing deposits in other financial institutions, federal funds sold and all highly liquid investments with maturities of three months or less at the time of purchase. Net cash flows are reported for customer loan and deposit transactions, interest-bearing deposits in other financial institutions, and federal funds purchased and repurchase agreements.
Investment Securities
Investments in debt securities are designated as trading, available-for-sale ("AFS"), or held-to-maturity ("HTM"). Investments in debt securities are designated as HTM only if we have the positive intent and ability to hold these securities to maturity. HTM securities are reported at amortized cost in the consolidated balance sheets. Trading securities are reported at fair value, with changes in fair value included in net income. Debt securities not classified as HTM or trading are classified as AFS and are reported at fair value, with net unrealized gains and losses, net of applicable taxes, excluded from net income and included in accumulated other comprehensive income (loss) ("AOCI").
Transfers of investment securities from AFS to HTM are accounted for at fair value as of the date of the transfer. The difference between the fair value and the par value at the date of transfer is considered a premium or discount and is accounted for accordingly. Any unrealized gain or loss at the date of the transfer is reported in AOCI, and is amortized over the remaining life of the security as an adjustment of yield in a manner consistent with the amortization of any premium or discount, and will offset or mitigate the effect on interest income of the amortization of the premium or discount for that HTM security.
Equity securities with readily determinable fair values are carried at fair value, with changes in fair value included in net income. Equity securities without readily determinable fair values are carried at cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment.
The Company classifies its investment securities portfolio into the following major security types: mortgage-backed securities ("MBS"), other debt securities and equity securities. The Company’s MBS portfolio is comprised primarily of residential MBS issued by United States of America ("U.S.") government entities and agencies. These securities are either explicitly or implicitly guaranteed by an agency of the U.S. government, are highly rated by major rating agencies and have a long history of no credit losses. The remainder of the MBS portfolio are commercial MBS issued by U.S government entities and agencies (for which there is no minimum credit rating), non-agency residential MBS (which shall meet a minimum credit rating of AAA) and non-agency commercial MBS (which shall meet a minimum credit rating of BBB and meet minimum internal credit guidelines).
The Company’s other debt securities portfolio is comprised of obligations issued by U.S. government entities and agencies, obligations issued by states and political subdivisions (which shall meet a minimum credit rating of BBB), and corporate bonds (which shall meet a minimum credit rating of BBB-).
Interest income on investment securities includes amortization of premiums and accretion of discounts. We amortize premiums to the earliest call date. We accrete discounts associated with investment securities using the effective interest method over the life of the respective security instrument. Gains and losses on the sale of investment securities are recorded on the trade date and determined using the specific identification method.
A debt security is placed on nonaccrual status at the time any principal or interest payments become 90 days delinquent. Interest accrued but not received for a security placed on non-accrual status is reversed against current period interest income. There were no investment securities on nonaccrual status as of December 31, 2022 and the Company did not reverse any accrued interest against interest income during the year ended December 31, 2022.
Allowance for Credit Losses (“ACL”) for AFS Debt Securities
AFS debt securities in an unrealized loss position are evaluated for impairment at least quarterly. For AFS debt securities in an unrealized loss position, the Company first assesses whether or not it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the investment security’s amortized cost basis is written down to fair value through net income.
For AFS debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In conducting this assessment for debt securities in an unrealized loss position, management evaluates the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the investment security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any unrealized loss that has not been recorded through an ACL is recognized in AOCI.
Changes in the ACL are recorded as a provision (credit) for credit losses. Losses are charged against the ACL when management believes the uncollectibility of an AFS debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met.
As of December 31, 2022, the declines in market values of our AFS debt securities were primarily attributable to changes in interest rates and volatility in the 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 believe a credit loss exists and an ACL was not recorded.
The Company has made a policy election to exclude accrued interest receivable from the amortized cost basis of debt securities and report accrued interest receivable together with accrued interest on loans in the consolidated balance sheets. Accrued interest receivable on AFS debt securities totaled $3.1 million and $4.6 million as of December 31, 2022 and 2021, respectively. Accrued interest receivable on AFS debt securities is excluded from the estimate of credit losses.
ACL for HTM Debt Securities
Management measures expected credit losses on HTM debt securities on a collective basis by major security type. For pools of such securities with common risk characteristics, the historical lifetime probability of default and severity of loss in the event of default is derived or obtained from external sources. Expected credit losses for these securities are estimated using a loss rate methodology which considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts.
Expected credit loss on each security in the HTM portfolio that do not share common risk characteristics with any of the pools of debt securities is individually measured based on net realizable value, or the difference between the discounted value of the expected future cash flows, based on the original effective interest rate, and the recorded amortized cost basis of the security.
Securities in the HTM portfolio are issued by or contain collateral issued by U.S. government sponsored enterprises ("GSEs") and carry implicit guarantees from the U.S. government. Due to the implicit guarantee and the long history of no credit losses, no allowance for credit losses was recorded for these securities.
Accrued interest on HTM debt securities is reported in accrued interest receivable on the consolidated balance sheets and is excluded from the estimate of credit losses.
Accrued interest receivable on HTM debt securities totaled $1.3 million as of December 31, 2022. The Company did not have any HTM debt securities or accrued interest receivable on HTM debt securities as of December 31, 2021.
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.
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 credit 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 estimated credit losses resulting from repurchased loans.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost, net of the ACL. Amortized cost is the unpaid principal amount outstanding, net of unamortized purchase premiums and discounts, unamortized deferred loan origination fees and costs and cumulative principal charge-offs. Purchase premiums and discounts are generally amortized into interest income over the contractual terms of the underlying loans using the effective interest method. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income over the life of the related loan as an adjustment to yield and are amortized using the interest method over the contractual term of the loan, adjusted for actual prepayments. Deferred loan fees and costs on loans paid in full are recognized as a component of interest income on loans.
Interest income on loans is accrued at the contractual rate of interest on the unpaid principal balance. Accrued interest receivable on loans totaled $16.0 million and $12.1 million at December 31, 2022 and 2021, respectively, and is reported together with accrued interest on AFS debt securities on the consolidated balance sheets. Upon adoption of Accounting Standards Update ("ASU") 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” the Company made the accounting policy election to not measure an estimate of credit losses on accrued interest receivable as the Company writes off any uncollectible accrued interest receivable in a timely manner.
Nonaccrual Loans
The Company determines delinquency status by considering the number of days full payments required by the contractual terms of the loan are past due. Commercial, scored small business, automobile and other consumer loans are generally placed on nonaccrual status when principal and/or 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. Residential mortgage and home equity loans, are generally placed on nonaccrual status when principal and/or interest payments are 120 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 collectability 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 and the loan is restored to accrual status. A nonaccrual loan may be restored to an accrual basis when principal and interest payments are current for a predetermined period, normally at least six months, and full payment of principal and interest is reasonably assured.
Troubled Debt Restructuring (“TDR”)
A loan is accounted for and reported as a TDR when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) the Company grants a concession to the borrower experiencing financial difficulty that it would not otherwise consider for a borrower or transaction with similar credit risk characteristics. A restructuring that results in only an insignificant delay in payment is not considered a concession. A delay may be considered insignificant if the payments subject to the delay are insignificant relative to the unpaid principal or collateral value and the contractual amount due, or the delay in timing of the restructured payment period is insignificant relative to the frequency of payments, the debt’s original contractual maturity or original expected duration.
TDRs that are performing and on accrual status as of the date of the modification remain on accrual status. TDRs that are nonperforming as of the date of modification generally remain as nonaccrual until the prospect of future payments in accordance with the modified loan agreement is reasonably assured, generally demonstrated when the borrower maintains compliance with the restructured terms for a predetermined period, normally at least six months. TDRs with temporary below-market concessions remain designated as a TDR regardless of the accrual or performance status until the loan is paid off.
Expected credit losses are estimated on a collective (pool) basis when they share similar risk characteristics. If a TDR financial asset shares similar risk characteristics with other financial assets, it is evaluated with those other financial assets on a collective basis. If it does not share similar risk characteristics with other financial assets, it is evaluated individually. The Company’s ACL reflects all effects of a TDR when an individual asset is specifically identified as a reasonably expected TDR. The Company has determined that a TDR is reasonably expected no later than the point when the lender concludes that modification is the best course of action and it is at least reasonably possible that the troubled borrower will accept some form of concession from the lender to avoid a default. Reasonably expected TDRs and executed TDRs are evaluated to determine the required ACL using the same method as all other loans held for investment, except when the value of a concession cannot be measured using a method other than the discounted cash flow method. When the value of a concession is measured using the discounted cash flow method, the ACL is determined by discounting the expected future cash flows at the original interest rate of the loan.
Based on the underlying risk characteristics, TDRs performing in accordance with their modified contractual terms may be collectively evaluated.
ACL for Loans
Under the current expected credit loss methodology, the ACL for loans is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Our policy is to charge off a loan 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 ACL for loans as recoveries, and finally to unaccrued interest.
The ACL for loans represents management's estimate of all expected credit losses over the expected life of our existing loan portfolio. Management estimates the ACL balance using relevant available information about the collectability of cash flows, from internal and external sources, including historical information relating to past events, current conditions, and reasonable and supportable forecasts of future economic conditions. When the Company is unable to forecast future economic events, management may revert to historical information.
The Company's methodologies incorporate a reasonable and supportable forecast period of one year and revert to historical loss information on a straight-line basis over one year when its forecast is no longer deemed reasonable and supportable.
The Company maintains an ACL at an appropriate level as of a given balance sheet date to absorb management’s best estimate of expected life of loan credit losses.
Historical credit loss experience provides the basis for the Company’s expected credit loss estimate. Adjustments to historical loss information may be made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, or when historical asset terms do not reflect the contractual terms of the financial assets being evaluated.
The ACL methodology may also consider other adjustments to address changes in conditions, trends, and circumstances such as local 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. These factors include: lending policies, imprecision in forecasting future economic conditions, loan profile, lending staff, problem loan trends, loan review, collateral, credit concentration and other internal and external factors.
The Company uses the Moody’s Analytics Baseline forecast for its economic forecast consideration. The Moody’s Analytics Baseline forecast includes both National and Hawaii specific economic indicators. The Moody’s Analytics forecast service is widely used in the industry and is reasonable and supportable. It is updated at least monthly and includes a variety of upside and downside economic scenarios from the Baseline. Generally the Company will use the most recent Baseline forecast from Moody’s as of the balance sheet date. During times of economic and market volatility or instability, the Company may include a qualitative factor for forecast imprecision that factors in other potential economic scenarios available by Moody’s Analytics or may apply overrides to its statistical models to enhance the reasonableness of its loss estimates.
The ACL is measured on a collective or pool basis when similar risk characteristics exist. The Company segments its portfolio generally by Federal Financial Institutions Examination Council ("FFIEC") Call Report codes. Loan pools are further segmented by risk utilizing risk ratings or bands of payment delinquency (including TDR or non-accrual status), depending on what is most appropriate for each segment. Additional sub-segmentation may be utilized to identify groups of loans with unique risk characteristics relative to the rest of the portfolio.
The Company relies on a third-party platform which offers multiple methodologies to measure historical life-of-loan losses. The Company has also developed statistical models internally to incorporate future economic conditions and forecast expected credit losses based on various macro-economic indicators such as unemployment and income levels.
The Company has identified the following portfolio segments to measure the allowance for credit losses. For all segments the economic forecast length is one year and reversion method is one year.
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Loan Segment | | Historical Lifetime Loss Method | | Historical Lookback Period | | Economic Forecast Length | | Reversion Method |
Construction | | Probability of Default/Loss Given Default ("PD/LGD") | | 2008-Present | | One Year | | One Year (straight-line basis) |
Commercial real estate | | PD/LGD | | 2008-Present | | |
Multi-family mortgage | | PD/LGD | | 2008-Present | | |
Commercial, financial and agricultural | | PD/LGD | | 2008-Present | | |
Home equity lines of credit | | Loss-Rate Migration | | 2008-Present | | |
Residential mortgage | | Loss-Rate Migration | | 2008-Present | | |
Consumer - other revolving | | Loss-Rate Migration | | 2008-Present | | |
Consumer - non-revolving | | Loss-Rate Migration | | 2008-Present | | |
Purchased Mainland portfolios (Dealer, Other consumer) | | Weighted-Average Remaining Maturity ("WARM") | | 2008-Present | | |
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Below is a description and the risk characteristics of each segment:
Construction loans
Construction loans include both residential and commercial development projects. Each construction project is evaluated for economic viability and construction loans pose higher credit risks than typical secured loans. Financial strength of the borrower, completion risk (the risk that the project will not be completed on time and within budget) and geographic location are the predominant risk characteristics of this segment.
Commercial real estate loans
Commercial real estate loans are secured by commercial properties. The predominant risk characteristic of this segment is operating risk, which is the risk that the borrower will be unable to generate sufficient cash flows from the operation of the property. Interest rate conditions and the commercial real estate market through economic cycles also impact risk levels.
Multi-family mortgage loans
Multi-family mortgage loans can comprise multi-building properties with extensive amenities to a single building with no amenities. The primary risk characteristic of this segment is operating risk or the ability to generate sufficient rental cash flows from the operation of the property.
Commercial, financial and agricultural loans
Loans in this category consist primarily of term loans and lines of credit to small and middle-market businesses and professionals. The predominant risk characteristics of this segment are the cash flows of the business we lend to, global cash flows including guarantor liquidity, as well as economic and market conditions. The borrower’s business is typically regarded as the principal source of repayment, though our underwriting policy and practice generally requires secondary sources of support or collateral to mitigate risk.
Paycheck Protection Program ("PPP") loans are also in this category and are considered lower risk as they are guaranteed by the Small Business Administration ("SBA") and may be forgivable in whole or in part in accordance with the requirements of the PPP.
Residential mortgage loans
Residential mortgage loans include fixed-rate and adjustable-rate loans primarily secured by single-family owner-occupied primary residences in Hawaii. Economic conditions such as unemployment levels, future changes in interest rates and other market factors impact the level of credit risk inherent in the portfolio.
Home equity lines of credit
Home equity lines of credit include fixed or floating interest rate loans and are secured by single-family owner-occupied primary residences in Hawaii. They are underwritten based on a minimum FICO score, maximum debt-to-income ratio, and maximum combined loan-to-value ratio. Home equity lines of credit are monitored based on credit score, delinquency, end of draw period and maturity.
Consumer loans - other revolving
This segment consists of consumer unsecured lines of credit. Its predominant risk characteristics relate to current and projected economic conditions as well as employment and income levels attributed to the borrower.
Consumer loans - non-revolving
This segment consists of consumer non-revolving loans, including dealer loans. Its predominant risk characteristics relate to current and projected economic conditions as well as employment and income levels attributed to the borrower.
Purchased consumer portfolios
Credit risk for purchased consumer loans is managed on a pooled basis. The predominant risk characteristics of purchased consumer loans include current and projected economic conditions, employment and income levels, and the quality of purchased consumer loans.
Below is a description of the methodologies mentioned above:
Probability of Default ("PD")/Loss Given Default ("LGD")
The PD/LGD calculation is based on a cohort methodology whereby loans in the same cohort are tracked over time to identify defaults and corresponding losses. PD/LGD analysis requires a portfolio segmented into pools, and we elected to then further sub-segment by risk characteristics such as Risk Rating, TDR status and nonaccrual status to measure losses accurately. PD measures the count or dollar amount of loans that defaulted in a given cohort. LGD measures the losses related to the loans that defaulted. Total loss rate is calculated using the formula, "PD times LGD".
Loss-Rate Migration
Loss-rate migration analysis is a cohort-based approach that measures cumulative net charge-offs over a defined time-horizon to calculate a loss rate that will be applied to the loan pool. Loss-rate migration analysis requires the portfolio to be segmented into pools then further sub-segmented by risk characteristics such as days past due, delinquency counters, TDR status and nonaccrual status to measure loss rates accurately. The key inputs to run a loss-rate migration analysis are the length and frequency 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".
Weighted-Average Remaining Maturity ("WARM")
Under the WARM methodology, lifetime losses are calculated by determining the remaining life of the loan pool and then applying a loss rate which includes a forecast component over this remaining life. The methodology considers historical loss experience as well as a loss forecast expectation to estimate credit losses for the remaining balance of the loan pool. The calculated loss rate is applied to the contractual term (adjusted for prepayments) to determine the loan pool’s current expected credit losses.
Other
If a loan ceases to share similar risk characteristics with other loans in its segment, it will be moved to a different pool sharing similar risk characteristics. Loans that do not share risk characteristics are evaluated on an individual basis based on the fair value of the collateral or other approaches such as discounted cash flow (“DCF”) techniques. Loans evaluated individually are not included in the collective evaluation.
Determining the Term
Expected credit losses represent life-of-loan loss estimates and are calculated based on the estimated remaining life of the loans which considers the contractual term of the loans, prepayments and other assumptions. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company. If such renewal options or extensions are present, these options are evaluated in determining the contractual term.
Reserve for Off-Balance Sheet Credit Exposures
The Company maintains a separate and distinct reserve for off-balance-sheet credit exposures which is included in other liabilities in the Company’s consolidated balance sheets. The Company estimates the amount of expected losses by calculating a commitment usage factor for letters of credit, non-revolving lines of credit, and revolving lines of credit over the remaining life during which the Company is exposed to credit risk via a contractual obligation to extend credit.
Letters of credit are generally unlikely to advance since they are typically in place only to ensure various forms of performance of the borrowers. Many of the letters of credit are cash secured. Non-revolving lines of credit are determined to be likely to advance as these are typically construction lines. Meanwhile, the likelihood of revolving lines of credit advancing varies with each individual borrower. Therefore, the future usage of each line was estimated based on the average line utilization of the revolving line of credit portfolio as a whole.
The estimate also applies the loss factors for each loan type used in the ACL for loans methodology, which is based on historical losses, economic conditions and reasonable and supportable forecasts. The reserve for off-balance sheet credit exposures is adjusted as a provision for off-balance sheet credit exposures. In 2021, the provision for off-balance sheet credit exposures was reclassified from other operating expense and is now included in the provision for credit losses in the consolidated statements of income. The consolidated statements of income in prior periods have been adjusted retrospectively to reflect this change.
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.
Other Real Estate
Other real estate is composed of properties acquired through deed-in-lieu or 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 ACL. 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.
Mortgage Servicing Rights
Mortgage servicing rights are recorded when loans are sold to third-parties with servicing of those loans retained and we classify and pool our mortgage servicing rights into buckets of homogeneous characteristics. 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 and is a component of mortgage banking income in the other operating income section of our consolidated statements of income. Amortization of the servicing rights is also reported as a component of mortgage banking 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, and servicing income and costs. 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 government FHA 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 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 are subject to judgments and often involve 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 the 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.
Federal Home Loan Bank Stock
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.
Non-Controlling Interest
Non-controlling interest is comprised of capital and undistributed profits of the member of Oahu HomeLoans, LLC, other than the bank. Non-controlling interest on our consolidated balance sheet totaled $48 thousand at December 31, 2021. In March 2022, Oahu HomeLoans, LLC was terminated. As a result, the Company did not hold any non-controlling interest on its consolidated balance sheet at December 31, 2022.
Share-Based Compensation
Share-based compensation cost is measured at the grant date, based on the estimated fair value of the award. We use the Black-Scholes option-pricing model to determine the fair-value of stock options, and the market price of the Company's common stock at the grant date for restricted stock awards. Share-based compensation is recognized as expense over the employee's requisite service period, generally defined as the vesting period. For awards with graded vesting, we recognize compensation expense on a straight-line basis over their respective vesting period. The Company's accounting policy is to recognize forfeitures as they occur. See Note 15 - 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. Net deferred tax assets (liabilities) are included in other assets (liabilities) in the Company's consolidated balance sheets. 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. As of December 31, 2022, the Company no longer has any 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 needs 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.
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 2022
In May 2021, the FASB issued ASU No. 2021-04, "Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40) Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options". ASU 2021-04 addresses issuer’s accounting for certain modifications or exchanges of freestanding equity-classified written call options. ASU 2021-04 is effective for fiscal years beginning after December 15, 2021 and interim periods within those fiscal years, with early adoption permitted. The Company adopted ASU 2021-04 effective January 1, 2022 and it did not have an impact on our consolidated financial statements as the Company does not have any freestanding equity-classified written call options.
In July 2021, the FASB issued ASU No. 2021-05, "Leases (Topic 842), Lessors—Certain Leases with Variable Lease Payments". ASU 2021-05 updates guidance in Topic 842 to restore long-standing accounting practice for certain sales-type leases with variable payments. ASU 2021-05 is effective for fiscal years beginning after December 15, 2021, with early adoption permitted. The Company adopted ASU 2021-05 effective January 1, 2022 and it did not have an impact on our consolidated financial statements as the Company does not have sale-type leases with variable payments.
Impact of Other Recently Issued Accounting Pronouncements on Future Filings
In March 2020, the FASB issued ASU 2020-04, "Reference Rate Reform (Topic 848)". This ASU provides optional expedients and exceptions for contracts, hedging relationships, and other transactions that reference LIBOR or other reference rates expected to be discontinued because of reference rate reform. Entities can (1) elect not to apply certain modification accounting requirements to contracts affected by reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Entities can also
(2) elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met. Finally, entities can (3) make a one-time election to sell and/or reclassify held-to-maturity (“HTM”) debt securities that reference an interest rate affected by reference rate reform. In January 2021, the FASB issued ASU 2021-01, "Reference Rate Reform (Topic 848)", which clarifies that all derivative instruments affected by the changes to interest rates used for discounting, margining or contract price alignment, regardless of whether they reference LIBOR or another rate expected to be discontinued as a result of reference rate reform, an entity may apply certain practical expedients in Topic 848. ASU 2020-04 and 2021-01 are elective and can be adopted between March 12, 2020 and December 31, 2022. In December 2022, the FASB issued ASU 2022-06, "Deferral of the Sunset Date of Topic 848", which extends the temporary relief provision period and allows companies to defer the adoption to December 31, 2024. The Company will elect optional expedients above for applicable contract modifications and hedge accounting for hedging relationships that meet the stated criteria. The Company does not expect the adoption of this pronouncement to have a material impact on the consolidated financial statements.
In March 2022, the FASB issued ASU No. 2022-01, "Derivatives and Hedging (Topic 815): Fair Value Hedging—Portfolio Layer Method". ASU 2022-01 updates guidance in Topic 815, to expand the current last-of-layer method, which will allow multiple hedged layers to be designated for a single closed portfolio of financial assets or one or more beneficial interests secured by a portfolio of financial instruments on a prospective basis. ASU 2022-01 is effective for fiscal years beginning after December 15, 2022, with early adoption permitted. The Company is in the process of evaluating the provisions of this ASU and its effects on our consolidated financial statements. However, we currently do not use the last-of-layer hedge accounting method.
In March 2022, the FASB issued ASU No. 2022-02, "Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures". ASU 2022-02 updates guidance in Topic 326, to eliminate the accounting guidance for TDRs by creditors in Subtopic 310-40, "Receivables—Troubled Debt Restructurings by Creditors", while enhancing disclosure requirements for certain loan refinancing and restructurings by creditors when a borrower is experiencing financial difficulty and to require entities to disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, Financial Instruments—Credit Losses—Measured at Amortized Cost. ASU 2022-02 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. The Company is in the process of evaluating the provisions of this ASU and its effects on our consolidated financial statements and plans on making the adoption for the upcoming effective interim period.
In June 2022, the FASB issued ASU 2022-03, "Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions". ASU 2022-03, (1) clarifies the guidance in Topic 820 when measuring the fair value of an equity security subject to contractual restrictions that prohibit the sale of an equity security, (2) amends a related illustrative example, and (3) introduces new disclosure requirements for equity securities subject to contractual sale restrictions that are measured at fair value in accordance with Topic 820. ASU 2022-03 is effective for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years, with early adoption permitted. The Company is in the process of evaluating the impact of this pronouncement on the consolidated financial statements.
2. INVESTMENT SECURITIES
The amortized cost, gross unrealized gains and losses, fair value and related allowance for credit losses on held-to-maturity ("HTM") and available-for-sale ("AFS") investment securities as of December 31, 2022 and 2021 are as follows:
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(Dollars in thousands) | Amortized Cost | | Gross Unrecognized Gains | | Gross Unrecognized Losses | | Fair Value | | ACL |
December 31, 2022 | | | | | | | | | |
Held-to-Maturity: | | | | | | | | | |
Debt securities: | | | | | | | | | |
States and political subdivisions | $ | 41,840 | | | $ | — | | | $ | (4,727) | | | $ | 37,113 | | | $ | — | |
Mortgage-backed securities: | | | | | | | | | |
Residential - U.S. Government-sponsored entities ("GSEs") | 623,043 | | | — | | | (63,376) | | | 559,667 | | | — | |
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Total held-to-maturity investment securities | $ | 664,883 | | | $ | — | | | $ | (68,103) | | | $ | 596,780 | | | $ | — | |
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(Dollars in thousands) | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value | | ACL |
Available-for-Sale: | | | | | | | | | |
Debt securities: | | | | | | | | | |
States and political subdivisions | $ | 172,427 | | | $ | 6 | | | $ | (36,681) | | | $ | 135,752 | | | $ | — | |
Corporate securities | 36,206 | | | — | | | (5,995) | | | 30,211 | | | — | |
U.S. Treasury obligations and direct obligations of U.S Government agencies | 28,032 | | | — | | | (2,317) | | | 25,715 | | | — | |
Mortgage-backed securities: | | | | | | | | | |
Residential - U.S. Government-sponsored entities ("GSEs") | 498,989 | | | — | | | (75,186) | | | 423,803 | | | — | |
Residential - Non-government sponsored entities ("Non-GSEs") | 9,829 | | | — | | | (1,167) | | | 8,662 | | | — | |
Commercial - U.S. GSEs and agencies | 54,346 | | | — | | | (8,202) | | | 46,144 | | | — | |
Commercial - Non-GSEs | 1,541 | | | — | | | (34) | | | 1,507 | | | — | |
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Total available-for-sale investment securities | $ | 801,370 | | | $ | 6 | | | $ | (129,582) | | | $ | 671,794 | | | $ | — | |
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(Dollars in thousands) | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value | | ACL |
Available-for-Sale: | | | | | | | | | |
Debt securities: | | | | | | | | | |
States and political subdivisions | $ | 235,521 | | | $ | 3,156 | | | $ | (1,849) | | | $ | 236,828 | | | $ | — | |
Corporate securities | 41,687 | | | 24 | | | (1,065) | | | 40,646 | | | — | |
U.S. Treasury obligations and direct obligations of U.S Government agencies | 35,833 | | | 69 | | | (568) | | | 35,334 | | | — | |
Mortgage-backed securities: | | | | | | | | | |
Residential - U.S. GSEs | 1,213,910 | | | 4,899 | | | (19,993) | | | 1,198,816 | | | — | |
Residential - Non-GSEs | 11,942 | | | 335 | | | (64) | | | 12,213 | | | — | |
Commercial - U.S. GSEs and agencies | 66,287 | | | 756 | | | (1,194) | | | 65,849 | | | — | |
Commercial - Non-GSEs | 41,328 | | | 685 | | | — | | | 42,013 | | | — | |
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Total available-for-sale investment securities | $ | 1,646,508 | | | $ | 9,924 | | | $ | (24,733) | | | $ | 1,631,699 | | | $ | — | |
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In March 2022, the Company transferred 41 investment securities that were classified as AFS to HTM. The investment securities had an amortized cost basis of $361.8 million and a fair market value of $329.5 million. On the date of transfer, these securities had a total net unrealized loss of $32.3 million. There was no impact to net income as a result of the reclassification.
In May 2022, the Company transferred 40 investment securities that were classified as AFS to HTM. The investment securities had an amortized cost basis of $400.9 million and a fair market value of $343.7 million. On the date of transfer, these securities had a total net unrealized loss of $57.2 million. There was no impact to net income as a result of the reclassification.
These transfers were executed to mitigate the potential future impact to capital through accumulated other comprehensive loss in consideration of a rising interest rate environment and the impact of rising rates on the market value of the investment securities. The Company believes that it maintains sufficient liquidity for future business needs and it has the positive intent and ability to hold these securities to maturity.
The amortized cost and estimated fair value of our investment securities at December 31, 2022 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.
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| December 31, 2022 |
(Dollars in thousands) | Amortized Cost | | Fair Value | | Weighted Average Yield (1) |
Held-to-Maturity: | | | | | |
Due in one year or less | $ | — | | | $ | — | | | — | % |
Due after one year through five years | — | | | — | | | — | |
Due after five years through ten years | — | | | — | | | — | |
Due after ten years | 41,840 | | | 37,113 | | | 2.26 | |
Mortgage-backed securities: | | | | | |
Residential - U.S. Government-sponsored entities ("GSEs") | 623,043 | | | 559,667 | | | 1.93 | |
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Total held-to-maturity investment securities | $ | 664,883 | | | $ | 596,780 | | | 1.95 | % |
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Available-for-Sale: | | | | | |
Due in one year or less | $ | 5,774 | | | $ | 5,751 | | | 2.91 | % |
Due after one year through five years | 15,816 | | | 15,458 | | | 3.75 | |
Due after five years through ten years | 79,803 | | | 70,558 | | | 2.60 | |
Due after ten years | 135,272 | | | 99,911 | | | 2.43 | |
Mortgage-backed securities | | | | | |
Residential - U.S. GSEs | 498,989 | | | 423,803 | | | 2.03 | |
Residential - Non-GSEs | 9,829 | | | 8,662 | | | 3.33 | |
Commercial - U.S. GSEs and agencies | 54,346 | | | 46,144 | | | 2.35 | |
Commercial - Non-GSEs | 1,541 | | | 1,507 | | | 4.10 | |
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Total available-for-sale investment securities | $ | 801,370 | | | $ | 671,794 | | | 2.24 | % |
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Total investment securities | $ | 1,466,253 | | | $ | 1,268,574 | | | 2.10 | % |
(1)Weighted-average yields are computed on an annual basis, and yields on tax-exempt obligations are computed on a taxable-equivalent basis using a federal statutory tax rate of 21%.
In 2022, the Company did not sell any investment securities except for its Class B common stock of Visa which is discussed later in this footnote.
In 2021, proceeds from the sale of available-for-sale investment securities were $279.5 million and resulted in a net realized gain of $0.2 million. Gross realized gains and losses on the sale of available-for-sale investment securities totaled $3.4 million and $3.2 million, respectively. In 2021, proceeds from the sale of equity investment securities were $1.7 million.
In 2020, proceeds from the sale of available-for-sale investment securities were $180.1 million and resulted in a net realized loss of $0.2 million. Gross realized losses and gains on the sale of available-for-sale investment securities totaled $0.9 million and $0.7 million, respectively.
Investment securities of $607.7 million and $455.8 million at December 31, 2022 and 2021, respectively, were pledged to secure public funds on deposit and other long-term and short-term borrowings.
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 as of December 31, 2022 and 2021.
There were a total of 83 HTM securities in an unrecognized loss position at December 31, 2022. There were no HTM securities in an unrecognized loss position at December 31, 2021. There were a total of 243 and 153 AFS securities in an unrealized loss position at December 31, 2022 and 2021, respectively.
The following table summarizes HTM and AFS securities which were in an unrealized or unrecognized loss position at December 31, 2022 and 2021, aggregated by major security type and length of time in a continuous unrealized or unrecognized loss position:
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| Less Than 12 Months | | 12 Months or Longer | | Total |
Description of Securities | Fair Value | | Unrecognized Losses | | Fair Value | | Unrecognized Losses | | Fair Value | | Unrecognized Losses |
| (Dollars in thousands) |
December 31, 2022 | | | | | | | | | | | |
Held-to-Maturity: | | | | | | | | | | | |
Debt securities: | | | | | | | | | | | |
States and political subdivisions | $ | 37,113 | | | $ | (4,727) | | | $ | — | | | $ | — | | | $ | 37,113 | | | $ | (4,727) | |
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Mortgage-backed securities: | | | | | | | | | | | |
Residential - U.S. Government-sponsored entities ("GSEs") | 559,667 | | | (63,376) | | | — | | | — | | | 559,667 | | | (63,376) | |
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Total temporarily impaired HTM investment securities | $ | 596,780 | | | $ | (68,103) | | | $ | — | | | $ | — | | | $ | 596,780 | | | $ | (68,103) | |
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| 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, 2022 | | | | | | | | | | | |
Available-for-Sale: | | | | | | | | | | | |
Debt securities: | | | | | | | | | | | |
States and political subdivisions | $ | 52,244 | | | $ | (4,807) | | | $ | 78,389 | | | $ | (31,874) | | | $ | 130,633 | | | $ | (36,681) | |
Corporate securities | — | | | — | | | 30,211 | | | (5,995) | | | 30,211 | | | (5,995) | |
U.S. Treasury obligations and direct obligations of U.S Government agencies | 9,651 | | | (245) | | | 15,541 | | | (2,072) | | | 25,192 | | | (2,317) | |
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Mortgage-backed securities: | | | | | | | | | | | |
Residential - U.S. GSEs | 149,624 | | | (13,990) | | | 274,179 | | | (61,196) | | | 423,803 | | | (75,186) | |
Residential - Non-GSEs | 2,890 | | | (334) | | | 5,772 | | | (833) | | | 8,662 | | | (1,167) | |
Commercial - U.S. GSEs and agencies | 25,034 | | | (1,724) | | | 21,110 | | | (6,478) | | | 46,144 | | | (8,202) | |
Commercial - Non-GSEs | 1,506 | | | (34) | | | — | | | — | | | 1,506 | | | (34) | |
Total temporarily impaired AFS investment securities | $ | 240,949 | | | $ | (21,134) | | | $ | 425,202 | | | $ | (108,448) | | | $ | 666,151 | | | $ | (129,582) | |
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| 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, 2021 | | | | | | | | | | | |
Available-for-Sale: | | | | | | | | | | | |
Debt securities: | | | | | | | | | | | |
States and political subdivisions | $ | 79,360 | | | $ | (1,252) | | | $ | 10,864 | | | $ | (597) | | | $ | 90,224 | | | $ | (1,849) | |
Corporate securities | 8,633 | | | (235) | | | 21,960 | | | (830) | | | 30,593 | | | (1,065) | |
U.S. Treasury obligations and direct obligations of U.S Government agencies | 16,103 | | | (415) | | | 10,891 | | | (153) | | | 26,994 | | | (568) | |
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Mortgage-backed securities: | | | | | | | | | | | |
Residential - U.S. GSEs | 926,570 | | | (15,883) | | | 114,747 | | | (4,110) | | | 1,041,317 | | | (19,993) | |
Residential - Non-GSEs | — | | | — | | | 938 | | | (64) | | | 938 | | | (64) | |
Commercial - U.S. GSEs and agencies | 6,313 | | | (205) | | | 16,281 | | | (989) | | | 22,594 | | | (1,194) | |
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Total temporarily impaired AFS investment securities | $ | 1,036,979 | | | $ | (17,990) | | | $ | 175,681 | | | $ | (6,743) | | | $ | 1,212,660 | | | $ | (24,733) | |
Investment securities in an unrealized loss position are evaluated on at least 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. 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 are also evaluated.
The Company has evaluated its AFS investment securities that are in an unrealized loss position and has determined that the unrealized losses on the Company's investment securities are unrelated to credit quality and are primarily attributable to changes in interest rates and volatility in the financial markets since purchase. All of the investment securities in an unrealized loss position continue to be rated investment grade by one or more major rating agencies. 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, the Company has not recorded an ACL and does not consider these securities to be other-than-temporarily impaired as of December 31, 2022, which would result in unrealized losses on these securities being recognized into income.
Visa and MasterCard Class B Common Stock
In 2022, the Company sold its 34,631 shares of Class B common stock of Visa, Inc. ("Visa") and received net proceeds of $8.5 million. As of December 31, 2022, the Company no longer holds any shares of Class B common stock of Visa.
The Company received these shares in 2008 as part of Visa's initial public offering ("IPO"). These shares were transferable only under limited circumstances until they can be converted into shares of the publicly traded Class A common stock. This conversion will not occur until the resolution of certain litigation, which is indemnified by Visa members. Since its IPO, Visa has funded a litigation reserve to settle these litigation claims. At its discretion, Visa may continue to increase the litigation reserve based upon a change in the conversion ratio of each member bank’s restricted Class B common stock to unrestricted Class A common stock.
Due to the existing transfer restriction and the uncertainty of the outcome of the Visa litigation, the Company determined that the Visa Class B common stock did not have a readily determinable fair value and chose to carry the shares on the Company's consolidated balance sheets at zero cost basis. As a result, the entire net proceeds of $8.5 million were recognized as a pre-tax gain and included in net gain on sales of investment securities in the Company's consolidated statements of income.
3. LOANS
Loans, excluding loans held for sale, net of ACL as of December 31, 2022 and 2021 consisted of the following:
| | | | | | | | | | | |
| December 31, |
(Dollars in thousands) | 2022 | | 2021 |
Commercial, financial and agricultural: | | | |
Small Business Administration Paycheck Protection Program ("SBA PPP") | $ | 2,654 | | | $ | 94,850 | |
Other | 544,495 | | | 530,383 | |
Real estate: | | | |
Construction | 167,366 | | | 123,351 | |
Residential mortgage | 1,940,456 | | | 1,875,200 | |
Home equity | 737,386 | | | 635,721 | |
Commercial mortgage | 1,364,998 | | | 1,222,138 | |
Consumer | 798,957 | | | 624,115 | |
| | | |
Gross loans | 5,556,312 | | | 5,105,758 | |
Net deferred fees | (846) | | | (4,109) | |
Total loans, net of deferred fees and costs | $ | 5,555,466 | | | $ | 5,101,649 | |
Allowance for credit losses | (63,738) | | | (68,097) | |
Total loans, net of allowance for credit losses | $ | 5,491,728 | | | $ | 5,033,552 | |
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, financial and agricultural 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.
The bank is a Small Business Administration ("SBA") approved lender and actively participated in assisting customers with loan applications for the SBA’s Paycheck Protection Program, or PPP, which was part of the CARES Act. PPP loans have a two or five-year term and earn interest at 1%. The SBA paid the originating bank a processing fee ranging from 1% to 5%, based on the size of the loan, which the Company is recognizing over the life of the loan as an adjustment of yield.
The SBA began accepting submissions for the initial round of PPP loans on April 3, 2020. In April 2020, the Paycheck Protection Program and Health Care Enhancement Act added an additional round of funding for the PPP. In June 2020, the Paycheck Protection Program Flexibility Act of 2020 was enacted, which among other things, gave borrowers additional time and flexibility to use PPP loan proceeds. Through the end of the second round in August 2020, the Company funded over 7,200 PPP loans totaling $558.9 million and received gross processing fees of $21.2 million. In December 2020, the Consolidated Appropriations Act, 2021 was passed which among other things, included a third round of funding and a new simplified forgiveness procedure for PPP loans of $150,000 or less. During 2021, the Company funded over 4,600 loans totaling $320.9 million in the third round, which ended on May 31, 2021, and received additional gross processing fees of $18.4 million.
The Company received forgiveness payments from the SBA and repayments from borrowers totaling $877.1 million as of December 31, 2022. A total outstanding balance of $2.7 million and net deferred fees of $0.1 million remains as of December 31, 2022.
The Company did not transfer any loans to the held-for-sale category during the years ended December 31, 2022 and 2021.
The Company has purchased loan portfolios, none of which were credit deteriorated at the time of purchase.
The following table presents loan purchases by class for the periods presented:
| | | | | | | | | | | | | | | | | |
(Dollars in thousands) | Consumer - Unsecured | | Consumer - Automobile | | Total |
Year Ended December 31, 2022 | | | | | |
Purchases: | | | | | |
Outstanding balance | $ | 229,283 | | | $ | 101,500 | | | $ | 330,783 | |
Purchase (discount) premium | (12,119) | | | 4,738 | | | (7,381) | |
Purchase price | $ | 217,164 | | | $ | 106,238 | | | $ | 323,402 | |
| | | | | |
Year Ended December 31, 2021 | | | | | |
Purchases: | | | | | |
Outstanding balance | $ | 199,813 | | | $ | 71,432 | | | $ | 271,245 | |
Purchase (discount) premium | (9,613) | | | 5,080 | | | (4,533) | |
Purchase price | $ | 190,200 | | | $ | 76,512 | | | $ | 266,712 | |
In the normal course of business, the 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. Related party loan balances were $37.4 million and $36.4 million as of December 31, 2022 and 2021, respectively.
Collateral-Dependent Loans
In accordance with ASC 326, a loan is considered collateral-dependent when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. The following table presents the amortized cost basis of collateral-dependent loans by class, which are individually evaluated to determine expected credit losses, and the related ACL allocated to these loans as of December 31, 2022 and 2021:
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| December 31, 2022 |
(Dollars in thousands) | Secured by 1-4 Family Residential Properties | | Secured by Nonfarm Nonresidential Properties | | Secured by Real Estate and Business Assets | | | | Total | | Allocated ACL |
| | | | | | | | | | | |
Real estate: | | | | | | | | | | | |
| | | | | | | | | | | |
Residential mortgage | $ | 5,653 | | | $ | — | | | $ | — | | | | | $ | 5,653 | | | $ | — | |
Home equity | 570 | | | — | | | — | | | | | 570 | | | — | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Total | $ | 6,223 | | | $ | — | | | $ | — | | | | | $ | 6,223 | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
(Dollars in thousands) | Secured by 1-4 Family Residential Properties | | Secured by Nonfarm Nonresidential Properties | | Secured by Real Estate and Business Assets | | | | Total | | Allocated ACL |
| | | | | | | | | | | |
Real estate: | | | | | | | | | | | |
| | | | | | | | | | | |
Residential mortgage | $ | 8,391 | | | $ | — | | | $ | — | | | | | $ | 8,391 | | | $ | — | |
Home equity | 786 | | | — | | | — | | | | | 786 | | | — | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Total | $ | 9,177 | | | $ | — | | | $ | — | | | | | $ | 9,177 | | | $ | — | |
Foreclosure Proceedings
Residential mortgage loans collateralized by residential real estate property that were in the process of foreclosure totaled $0.1 million and $0.7 million as of December 31, 2022 and 2021, respectively.
We did not foreclose on any loans during the years ended December 31, 2022 and 2021. We did not sell any foreclosed properties during the years ended December 31, 2022 and 2021.
Nonaccrual and Past Due Loans
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. The following tables present by class, the aging of the recorded investment in past due loans as of December 31, 2022 and 2021:
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| December 31, 2022 |
(Dollars in thousands) | Accruing Loans 30 - 59 Days Past Due | | Accruing Loans 60 - 89 Days Past Due | | Accruing Loans 90+ Days Past Due | | Nonaccrual Loans | | Total Past Due and Nonaccrual | | Loans and Leases Not Past Due | | Total | | Nonaccrual Loans with No ACL |
Commercial, financial and agricultural: | | | | | | | | | | | | | | | |
SBA PPP | $ | 471 | | | $ | 37 | | | $ | 13 | | | $ | — | | | $ | 521 | | | $ | 2,034 | | | $ | 2,555 | | | $ | — | |
Other | 546 | | | 131 | | | 26 | | | 297 | | | 1,000 | | | 542,947 | | | 543,947 | | | — | |
Real estate: | | | | | | | | | | | | | | | |
Construction | — | | | — | | | — | | | — | | | — | | | 166,723 | | | 166,723 | | | — | |
Residential mortgage | 303 | | | — | | | 559 | | | 3,808 | | | 4,670 | | | 1,936,329 | | | 1,940,999 | | | 3,808 | |
Home equity | 1,540 | | | — | | | — | | | 570 | | | 2,110 | | | 737,270 | | | 739,380 | | | 570 | |
Commercial mortgage | 160 | | | — | | | — | | | — | | | 160 | | | 1,362,915 | | | 1,363,075 | | | — | |
Consumer | 5,173 | | | 1,921 | | | 1,240 | | | 576 | | | 8,910 | | | 789,877 | | | 798,787 | | | — | |
| | | | | | | | | | | | | | | |
Total | $ | 8,193 | | | $ | 2,089 | | | $ | 1,838 | | | $ | 5,251 | | | $ | 17,371 | | | $ | 5,538,095 | | | $ | 5,555,466 | | | $ | 4,378 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 |
(Dollars in thousands) | Accruing Loans 30 - 59 Days Past Due | | Accruing Loans 60 - 89 Days Past Due | | Accruing Loans 90+ Days Past Due | | Nonaccrual Loans | | Total Past Due and Nonaccrual | | Loans and Leases Not Past Due | | Total | | Nonaccrual Loans with No ACL |
Commercial, financial and agricultural: | | | | | | | | | | | | | | | |
SBA PPP | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 91,327 | | | $ | 91,327 | | | $ | — | |
Other | 970 | | | 604 | | | 945 | | | 183 | | | 2,702 | | | 527,419 | | | 530,121 | | | — | |
Real estate: | | | | | | | | | | | | | | | |
Construction | 638 | | | — | | | — | | | — | | | 638 | | | 122,229 | | | 122,867 | | | — | |
Residential mortgage | 5,315 | | | — | | | — | | | 4,623 | | | 9,938 | | | 1,866,042 | | | 1,875,980 | | | 4,623 | |
Home equity | 234 | | | — | | | 44 | | | 786 | | | 1,064 | | | 636,185 | | | 637,249 | | | 786 | |
Commercial mortgage | — | | | — | | | — | | | — | | | — | | | 1,220,204 | | | 1,220,204 | | | — | |
Consumer | 2,444 | | | 712 | | | 374 | | | 289 | | | 3,819 | | | 620,082 | | | 623,901 | | | — | |
| | | | | | | | | | | | | | | |
Total | $ | 9,601 | | | $ | 1,316 | | | $ | 1,363 | | | $ | 5,881 | | | $ | 18,161 | | | $ | 5,083,488 | | | $ | 5,101,649 | | | $ | 5,409 | |
Interest income totaling $1.6 million, $0.8 million, and $0.4 million was recognized on nonaccrual loans, including loans held for sale, in 2022, 2021 and 2020, respectively. Additional interest income of $0.2 million, $0.3 million, and $0.2 million would have been recognized in 2022, 2021 and 2020, respectively, had these loans been accruing interest throughout those periods. Additionally, interest income of $0.3 million, $0.3 million, and $0.2 million was collected and recognized on charged-off loans in 2022, 2021 and 2020, respectively.
Troubled Debt Restructurings
Troubled debt restructurings ("TDRs") included in nonperforming assets at December 31, 2022 consisted of five Hawaii residential mortgage loans with a combined principal balance of $1.1 million. At December 31, 2021, TDRs included in nonperforming assets consisted of four loans with a principal balance of $0.4 million. There were $2.8 million of TDRs still accruing interest at December 31, 2022, none of which were more than 90 days delinquent. At December 31, 2021, there were $4.9 million of TDRs still accruing interest, none of which were more than 90 days delinquent.
The Company offers various types of concessions when modifying a loan. Concessions made to the original contractual terms of the loan typically consist of the deferral of interest and/or principal payments due to deterioration in the borrowers' financial
condition. In these cases, the principal balance on the TDR had matured and/or was in default at the time of restructure, and there were no commitments to lend additional funds to the borrower during the year ended December 31, 2022 and 2021. The loans modified in a TDR did not have a material effect on the Company's Provision and ACL during the years ended December 31, 2022 and 2021.
No loans were modified in a TDR during the year ended December 31, 2022. The following table presents by class, information related to loans modified in a TDR during the years ended December 31, 2021 and 2020:
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| Year Ended December 31, 2021 |
(Dollars in thousands) | Number of Loans | | Recorded Investment (as of period end) | | Increase in the ACL |
| | | | | |
Real estate: Residential mortgage | 1 | | | $ | 48 | | | $ | — | |
| | | | | |
| | | | | |
Total | 1 | | | $ | 48 | | | $ | — | |
| | | | | |
| Year Ended December 31, 2020 |
(Dollars in thousands) | Number of Loans | | Recorded Investment (as of period end) | | Increase in the ACL |
| | | | | |
Real estate: Residential mortgage | 1 | | | $ | 677 | | | $ | — | |
Real estate: Commercial mortgage | 1 | | | $ | 276 | | | $ | — | |
Consumer | 11 | | | $ | 207 | | | $ | — | |
Total | 13 | | | $ | 1,160 | | | $ | — | |
| | | | | |
No loans were modified as a TDR within the previous twelve months that subsequently defaulted during the years ended December 31, 2022, 2021 and 2020.
Credit Quality Indicators
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans by credit risk. This analysis includes non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk rating of loans:
Special Mention. Loans classified as special mention, while still adequately protected by the borrower's capital adequacy and payment capability, exhibit distinct weakening trends and/or elevated levels of exposure to external conditions. If left unchecked or uncorrected, these potential weaknesses may result in deteriorated prospects of repayment. These exposures require management's close attention so as to avoid becoming undue or unwarranted credit exposures.
Substandard. Loans classified as substandard are inadequately protected by the borrower's current financial condition and payment capability or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the orderly repayment of debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or orderly repayment in full, on the basis of current existing facts, conditions and values, highly questionable and improbable. Possibility of loss is extremely high, but because of certain important and reasonably specific factors that may work to the advantage and strengthening of the exposure, its classification as an estimate loss is deferred until its more exact status may be determined.
Loss. Loans classified as loss are considered to be non-collectible and of such little value that their continuance as bankable assets is not warranted. This does not mean the loan has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future. Losses are taken in the period in which they surface as uncollectible.
Loans not meeting the criteria above are considered to be pass-rated loans.
The following table presents the amortized cost basis, net of deferred (fees) costs of the Company's loans by class, credit quality indicator and origination year as of December 31, 2022. Revolving loans converted to term as of and during the year ended December 31, 2022 were not material to the total loan portfolio.
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| Amortized Cost of Term Loans by Origination Year | | | | |
(Dollars in thousands) | 2022 | | 2021 | | 2020 | | 2019 | | 2018 | | Prior | | Amortized Cost of Revolving Loans | | Total |
December 31, 2022 | | | | | | | | | | | | | | | |
Commercial, financial and agricultural - SBA PPP: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | $ | — | | | $ | 2,546 | | | $ | 9 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 2,555 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Subtotal | — | | | 2,546 | | | 9 | | | — | | | — | | | — | | | — | | | 2,555 | |
Commercial, financial and agricultural - Other: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 77,550 | | | 101,595 | | | 41,358 | | | 53,241 | | | 39,106 | | | 141,950 | | | 76,466 | | | 531,266 | |
Special Mention | 2,206 | | | 350 | | | 172 | | | 1,011 | | | 29 | | | — | | | 99 | | | 3,867 | |
Substandard | 188 | | | 176 | | | 833 | | | 256 | | | 116 | | | 7,215 | | | 30 | | | 8,814 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Subtotal | 79,944 | | | 102,121 | | | 42,363 | | | 54,508 | | | 39,251 | | | 149,165 | | | 76,595 | | | 543,947 | |
Construction: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 25,663 | | | 61,027 | | | 23,384 | | | 2,387 | | | 14,309 | | | 18,048 | | | 15,044 | | | 159,862 | |
Special Mention | — | | | 417 | | | — | | | — | | | 898 | | | — | | | — | | | 1,315 | |
Substandard | — | | | 4,850 | | | — | | | 696 | | | — | | | — | | | — | | | 5,546 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Subtotal | 25,663 | | | 66,294 | | | 23,384 | | | 3,083 | | | 15,207 | | | 18,048 | | | 15,044 | | | 166,723 | |
Residential mortgage: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 279,146 | | | 636,756 | | | 434,928 | | | 154,906 | | | 58,431 | | | 371,517 | | | — | | | 1,935,684 | |
| | | | | | | | | | | | | | | |
Substandard | — | | | — | | | 948 | | | — | | | 503 | | | 3,864 | | | — | | | 5,315 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Subtotal | 279,146 | | | 636,756 | | | 435,876 | | | 154,906 | | | 58,934 | | | 375,381 | | | — | | | 1,940,999 | |
Home equity: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 34,973 | | | 23,772 | | | 10,520 | | | 7,463 | | | 6,880 | | | 11,727 | | | 643,277 | | | 738,612 | |
Special Mention | — | | | — | | | — | | | — | | | — | | | — | | | 198 | | | 198 | |
Substandard | — | | | — | | | — | | | — | | | 78 | | | 453 | | | 39 | | | 570 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Subtotal | 34,973 | | | 23,772 | | | 10,520 | | | 7,463 | | | 6,958 | | | 12,180 | | | 643,514 | | | 739,380 | |
Commercial mortgage: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 226,137 | | | 208,230 | | | 119,531 | | | 129,950 | | | 145,932 | | | 472,267 | | | 11,473 | | | 1,313,520 | |
Special Mention | — | | | — | | | — | | | 11,388 | | | — | | | 16,082 | | | — | | | 27,470 | |
Substandard | — | | | 10,149 | | | — | | | 1,700 | | | 2,133 | | | 8,103 | | | — | | | 22,085 | |
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Subtotal | 226,137 | | | 218,379 | | | 119,531 | | | 143,038 | | | 148,065 | | | 496,452 | | | 11,473 | | | 1,363,075 | |
Consumer: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 358,609 | | | 242,942 | | | 59,352 | | | 50,899 | | | 20,065 | | | 10,958 | | | 54,038 | | | 796,863 | |
Special Mention | — | | | — | | | — | | | 113 | | | — | | | — | | | — | | | 113 | |
Substandard | 1 | | | 261 | | | 91 | | | 126 | | | 42 | | | 790 | | | — | | | 1,311 | |
| | | | | | | | | | | | | | | |
Loss | — | | | — | | | — | | | — | | | — | | | 500 | | | — | | | 500 | |
Subtotal | 358,610 | | | 243,203 | | | 59,443 | | | 51,138 | | | 20,107 | | | 12,248 | | | 54,038 | | | 798,787 | |
Total loans, net of deferred fees and costs | $ | 1,004,473 | | | $ | 1,293,071 | | | $ | 691,126 | | | $ | 414,136 | | | $ | 288,522 | | | $ | 1,063,474 | | | $ | 800,664 | | | $ | 5,555,466 | |
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| Amortized Cost of Term Loans by Origination Year | | | | |
(Dollars in thousands) | 2021 | | 2020 | | 2019 | | 2018 | | 2017 | | Prior | | Amortized Cost of Revolving Loans | | Total |
December 31, 2021 | | | | | | | | | | | | | | | |
Commercial, financial and agricultural - SBA PPP: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | $ | 84,254 | | | $ | 7,073 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 91,327 | |
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| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | |
Subtotal | 84,254 | | | 7,073 | | | — | | | — | | | — | | | — | | | — | | | 91,327 | |
Commercial, financial and agricultural - Other: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 122,729 | | | 68,021 | | | 56,531 | | | 52,375 | | | 31,817 | | | 93,957 | | | 79,131 | | | 504,561 | |
Special Mention | 1,441 | | | 1,278 | | | 2,443 | | | 96 | | | 8,671 | | | 354 | | | — | | | 14,283 | |
Substandard | — | | | 982 | | | 393 | | | 682 | | | 6,623 | | | 1,847 | | | 750 | | | 11,277 | |
| | | | | | | | | | | | | | | |
Subtotal | 124,170 | | | 70,281 | | | 59,367 | | | 53,153 | | | 47,111 | | | 96,158 | | | 79,881 | | | 530,121 | |
Construction: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 35,236 | | | 25,430 | | | 3,196 | | | 28,333 | | | 288 | | | 20,090 | | | 9,376 | | | 121,949 | |
| | | | | | | | | | | | | | | |
Substandard | — | | | — | | | — | | | 918 | | | — | | | — | | | — | | | 918 | |
| | | | | | | | | | | | | | | |
Subtotal | 35,236 | | | 25,430 | | | 3,196 | | | 29,251 | | | 288 | | | 20,090 | | | 9,376 | | | 122,867 | |
Residential mortgage: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 670,011 | | | 478,891 | | | 180,687 | | | 75,820 | | | 92,394 | | | 372,539 | | | 42 | | | 1,870,384 | |
Special Mention | — | | | 973 | | | — | | | — | | | — | | | — | | | — | | | 973 | |
Substandard | — | | | — | | | — | | | 577 | | | 881 | | | 3,165 | | | — | | | 4,623 | |
| | | | | | | | | | | | | | | |
Subtotal | 670,011 | | | 479,864 | | | 180,687 | | | 76,397 | | | 93,275 | | | 375,704 | | | 42 | | | 1,875,980 | |
Home equity: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 26,479 | | | 13,008 | | | 10,329 | | | 10,593 | | | 480 | | | 7,743 | | | 567,600 | | | 636,232 | |
Special Mention | — | | | — | | | — | | | — | | | — | | | — | | | 187 | | | 187 | |
Substandard | — | | | 176 | | | — | | | 79 | | | — | | | 575 | | | — | | | 830 | |
| | | | | | | | | | | | | | | |
Subtotal | 26,479 | | | 13,184 | | | 10,329 | | | 10,672 | | | 480 | | | 8,318 | | | 567,787 | | | 637,249 | |
Commercial mortgage: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 229,108 | | | 126,169 | | | 146,584 | | | 126,014 | | | 153,041 | | | 387,751 | | | 9,472 | | | 1,178,139 | |
Special Mention | — | | | — | | | 3,106 | | | 3,219 | | | 283 | | | 9,455 | | | — | | | 16,063 | |
Substandard | — | | | — | | | 1,760 | | | 8,050 | | | 1,784 | | | 14,408 | | | — | | | 26,002 | |
| | | | | | | | | | | | | | | |
Subtotal | 229,108 | | | 126,169 | | | 151,450 | | | 137,283 | | | 155,108 | | | 411,614 | | | 9,472 | | | 1,220,204 | |
Consumer: | | | | | | | | | | | | | | | |
Risk Rating | | | | | | | | | | | | | | | |
Pass | 308,326 | | | 96,066 | | | 91,194 | | | 41,995 | | | 20,719 | | | 9,446 | | | 55,311 | | | 623,057 | |
Special Mention | — | | | — | | | 181 | | | — | | | 10 | | | 7 | | | — | | | 198 | |
Substandard | 10 | | | 35 | | | 128 | | | 80 | | | 19 | | | 221 | | | — | | | 493 | |
Loss | — | | | — | | | — | | | — | | | — | | | 153 | | | — | | | 153 | |
Subtotal | 308,336 | | | 96,101 | | | 91,503 | | | 42,075 | | | 20,748 | | | 9,827 | | | 55,311 | | | 623,901 | |
Total loans, net of deferred fees and costs | $ | 1,477,594 | | | $ | 818,102 | | | $ | 496,532 | | | $ | 348,831 | | | $ | 317,010 | | | $ | 921,711 | | | $ | 721,869 | | | $ | 5,101,649 | |
The following tables present the recorded investment in the Company's loans by class and credit indicator as of December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | Pass | | Special Mention | | Substandard | | Loss | | Gross Loans | | Net Deferred (Fees) Costs | | Total Loans |
December 31, 2022 | | | | | | | | | | | | | |
Commercial, financial and agricultural: | | | | | | | | | | | | | |
SBA PPP | $ | 2,654 | | | $ | — | | | $ | — | | | $ | — | | | $ | 2,654 | | | $ | (99) | | | $ | 2,555 | |
Other | 531,814 | | | 3,867 | | | 8,814 | | | — | | | 544,495 | | | (548) | | | 543,947 | |
Real estate: | | | | | | | | | | | | | |
Construction | 160,505 | | | 1,315 | | | 5,546 | | | — | | | 167,366 | | | (643) | | | 166,723 | |
Residential mortgage | 1,935,141 | | | — | | | 5,315 | | | — | | | 1,940,456 | | | 543 | | | 1,940,999 | |
Home equity | 736,618 | | | 198 | | | 570 | | | — | | | 737,386 | | | 1,994 | | | 739,380 | |
Commercial mortgage | 1,315,443 | | | 27,470 | | | 22,085 | | | — | | | 1,364,998 | | | (1,923) | | | 1,363,075 | |
Consumer | 797,029 | | | 113 | | | 1,315 | | | 500 | | | 798,957 | | | (170) | | | 798,787 | |
| | | | | | | | | | | | | |
Total | $ | 5,479,204 | | | $ | 32,963 | | | $ | 43,645 | | | $ | 500 | | | $ | 5,556,312 | | | $ | (846) | | | $ | 5,555,466 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | Pass | | Special Mention | | Substandard | | Loss | | Gross Loans | | Net Deferred (Fees) Costs | | Total Loans |
December 31, 2021 | | | | | | | | | | | | | |
Commercial, financial and agricultural: | | | | | | | | | | | | | |
SBA PPP | $ | 94,850 | | | $ | — | | | $ | — | | | $ | — | | | $ | 94,850 | | | $ | (3,523) | | | $ | 91,327 | |
Other | 504,823 | | | 14,283 | | | 11,277 | | | — | | | 530,383 | | | (262) | | | 530,121 | |
Real estate: | | | | | | | | | | | | | |
Construction | 122,433 | | | — | | | 918 | | | — | | | 123,351 | | | (484) | | | 122,867 | |
Residential mortgage | 1,869,604 | | | 973 | | | 4,623 | | | — | | | 1,875,200 | | | 780 | | | 1,875,980 | |
Home equity | 634,704 | | | 187 | | | 830 | | | — | | | 635,721 | | | 1,528 | | | 637,249 | |
Commercial mortgage | 1,180,074 | | | 16,062 | | | 26,002 | | | — | | | 1,222,138 | | | (1,934) | | | 1,220,204 | |
Consumer | 623,271 | | | 181 | | | 510 | | | 153 | | | 624,115 | | | (214) | | | 623,901 | |
| | | | | | | | | | | | | |
Total | $ | 5,029,759 | | | $ | 31,686 | | | $ | 44,160 | | | $ | 153 | | | $ | 5,105,758 | | | $ | (4,109) | | | $ | 5,101,649 | |
4. ALLOWANCE FOR CREDIT LOSSES AND RESERVE FOR OFF-BALANCE SHEET CREDIT EXPOSURES
The following tables present the activity in the ACL for loans by class for the years ended December 31, 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial, Financial and Agricultural | | Real Estate | | | | | | | | |
(Dollars in thousands) | SBA PPP | | Other | | Construction | | Residential Mortgage | | Home Equity | | Commercial Mortgage | | Consumer | | | | | | Total |
Year ended December 31, 2022 |
Beginning balance | $ | 77 | | | $ | 10,314 | | | $ | 3,908 | | | $ | 12,463 | | | $ | 4,509 | | | $ | 18,411 | | | $ | 18,415 | | | | | | | $ | 68,097 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Provision (credit) for credit losses on loans | (75) | | | (2,518) | | | (1,117) | | | (954) | | | (431) | | | (509) | | | 5,892 | | | | | | | 288 | |
Subtotal | 2 | | | 7,796 | | | 2,791 | | | 11,509 | | | 4,078 | | | 17,902 | | | 24,307 | | | | | | | 68,385 | |
Charge-offs | — | | | 1,969 | | | — | | | — | | | — | | | — | | | 6,399 | | | | | | | 8,368 | |
Recoveries | — | | | 995 | | | 76 | | | 295 | | | 36 | | | — | | | 2,319 | | | | | | | 3,721 | |
Net charge-offs (recoveries) | — | | | 974 | | | (76) | | | (295) | | | (36) | | | — | | | 4,080 | | | | | | | 4,647 | |
Ending balance | $ | 2 | | | $ | 6,822 | | | $ | 2,867 | | | $ | 11,804 | | | $ | 4,114 | | | $ | 17,902 | | | $ | 20,227 | | | | | | | $ | 63,738 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial, Financial and Agricultural | | Real Estate | | | | | | | | |
(Dollars in thousands) | SBA PPP | | Other | | Construction | | Residential Mortgage | | Home Equity | | Commercial Mortgage | | Consumer | | | | | | Total |
Year ended December 31, 2021 |
Beginning balance | $ | 304 | | | $ | 18,717 | | | $ | 4,277 | | | $ | 16,484 | | | $ | 5,449 | | | $ | 22,163 | | | $ | 15,875 | | | | | | | $ | 83,269 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Provision (credit) for credit losses on loans [1] | (227) | | | (7,684) | | | (1,528) | | | (4,379) | | | (949) | | | (3,825) | | | 4,269 | | | | | | | (14,323) | |
Subtotal | 77 | | | 11,033 | | | 2,749 | | | 12,105 | | | 4,500 | | | 18,338 | | | 20,144 | | | | | | | 68,946 | |
Charge-offs | — | | | 1,723 | | | — | | | — | | | — | | | — | | | 4,402 | | | | | | | 6,125 | |
Recoveries | — | | | 1,004 | | | 1,159 | | | 358 | | | 9 | | | 73 | | | 2,673 | | | | | | | 5,276 | |
Net charge-offs (recoveries) | — | | | 719 | | | (1,159) | | | (358) | | | (9) | | | (73) | | | 1,729 | | | | | | | 849 | |
Ending balance | $ | 77 | | | $ | 10,314 | | | $ | 3,908 | | | $ | 12,463 | | | $ | 4,509 | | | $ | 18,411 | | | $ | 18,415 | | | | | | | $ | 68,097 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Commercial, Financial and Agricultural | | Real Estate | | | | | | | | |
(Dollars in thousands) | SBA PPP | | Other | | Construction | | Residential Mortgage | | Home Equity | | Commercial Mortgage | | Consumer | | | | | | Total |
Year ended December 31, 2020 |
Beginning balance | $ | — | | | $ | 8,136 | | | $ | 1,792 | | | $ | 13,327 | | | $ | 4,206 | | | $ | 11,113 | | | $ | 9,397 | | | | | | | $ | 47,971 | |
Impact of adoption of ASC 326 | — | | | (627) | | | 479 | | | 608 | | | (1,614) | | | 2,624 | | | 2,096 | | | | | | | 3,566 | |
Balance after adoption of ASC 326 | — | | | 7,509 | | | 2,271 | | | 13,935 | | | 2,592 | | | 13,737 | | | 11,493 | | | | | | | 51,537 | |
Provision for credit losses on loans [1] | 304 | | | 13,077 | | | 1,875 | | | 2,383 | | | 2,824 | | | 8,485 | | | 9,982 | | | | | | | 38,930 | |
Subtotal | 304 | | | 20,586 | | | 4,146 | | | 16,318 | | | 5,416 | | | 22,222 | | | 21,475 | | | | | | | 90,467 | |
Charge-offs | — | | | 3,026 | | | — | | | 63 | | | — | | | 75 | | | 8,191 | | | | | | | 11,355 | |
Recoveries | — | | | 1,157 | | | 131 | | | 229 | | | 33 | | | 16 | | | 2,591 | | | | | | | 4,157 | |
Net charge-offs | — | | | 1,869 | | | (131) | | | (166) | | | (33) | | | 59 | | | 5,600 | | | | | | | 7,198 | |
Ending balance | $ | 304 | | | $ | 18,717 | | | $ | 4,277 | | | $ | 16,484 | | | $ | 5,449 | | | $ | 22,163 | | | $ | 15,875 | | | | | | | $ | 83,269 | |
| | | | | | | | | | | | | | | | | | | |
[1] In 2020, the Company recorded a reserve on accrued interest receivable for loans on active payment forbearance or deferral, which were granted to borrowers impacted by the COVID-19 pandemic. This reserve was recorded as a contra-asset against accrued interest receivable with the offset to provision for credit losses. Due to the significant decline in loans on active forbearance or deferral, the Company reversed the $0.2 million reserve during the second quarter of 2021 and no longer has a reserve on accrued interest receivable as of December 31, 2022 and 2021. The provision for credit losses presented in this table excludes the provision (credit) for credit losses on accrued interest receivable of $0.2 million. |
The following table presents the activity in the reserve for off-balance sheet credit exposures, included in other liabilities, under ASC 326 during the years ended December 31, 2022, 2021 and 2020.
| | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, |
(Dollars in thousands) | | 2022 | | 2021 | | 2020 |
Balance, beginning of year | | $ | 4,804 | | | $ | 4,884 | | | $ | 1,272 | |
Impact of adoption of ASC 326 | | — | | | — | | | 740 | |
Balance after adoption of ASC 326 | | 4,804 | | | 4,884 | | | 2,012 | |
(Credit) provision for off-balance sheet credit exposures | | (1,561) | | | (80) | | | 2,872 | |
Balance, end of year | | $ | 3,243 | | | $ | 4,804 | | | $ | 4,884 | |
In accordance with GAAP, loans held for sale and other real estate assets are not included in our assessment of the ACL.
In determining the amount of our ACL, the Company relies on an analysis of its loan portfolio, experience and evaluation of general economic conditions, as well as regulatory requirements and input. If assumptions prove to be incorrect, the current ACL may not be sufficient to cover future credit losses and the Company may experience significant increases to the provision.
5. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following as of December 31, 2022 and 2021:
| | | | | | | | | | | |
| December 31, |
(Dollars in thousands) | 2022 | | 2021 |
Land | $ | 23,150 | | | $ | 14,184 | |
Office buildings and improvements | 145,793 | | | 141,628 | |
Furniture, fixtures and equipment | 37,194 | | | 35,515 | |
Gross premises and equipment | 206,137 | | | 191,327 | |
Accumulated depreciation and amortization | (114,503) | | | (110,973) | |
Net premises and equipment | $ | 91,634 | | | $ | 80,354 | |
Depreciation and amortization of premises and equipment were charged to the following operating expenses:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Net occupancy | $ | 4,720 | | | $ | 4,570 | | | $ | 3,616 | |
Equipment | 2,145 | | | 2,414 | | | 2,607 | |
Total | $ | 6,865 | | | $ | 6,984 | | | $ | 6,223 | |
6. INVESTMENTS IN UNCONSOLIDATED ENTITIES
Investments in unconsolidated entities as of December 31, 2022 and 2021 consisted of the following components:
| | | | | | | | | | | |
| December 31, |
(Dollars in thousands) | 2022 | | 2021 |
Investments in low income housing tax credit partnerships | $ | 40,939 | | | $ | 25,916 | |
Investments in common securities of statutory trusts | 1,547 | | | 1,547 | |
Investments in affiliates | 110 | | | 162 | |
Other | 4,045 | | | 2,054 | |
Total | $ | 46,641 | | | $ | 29,679 | |
During the first quarter of 2022, the Company invested $2.0 million in Swell Financial, Inc. ("Swell"), which included $1.5 million in other intangible assets and services provided in exchange for Swell non-voting common stock and $0.5 million in cash in exchange for Swell preferred stock. During the fourth quarter of 2022, Swell launched a consumer banking application that combines checking, credit and more into one integrated account, with Central Pacific Bank serving as the bank sponsor. The Company does not have the ability to exercise significant influence over Swell and the investment does not have a readily determinable fair value. As a result, the Company determined that the cost method of accounting for the investment was appropriate. The investment is included in investments in unconsolidated entities in the Company's consolidated balance sheets.
In 2021, the Company committed $2.0 million in the JAM FINTOP Banktech Fund, L.P., an investment fund designed to help develop and accelerate technology adoption at community banks across the United States. The Company does not have the ability to exercise significant influence over the JAM FINTOP Banktech Fund, L.P. and the investment does not have a readily determinable fair value. As a result, the Company determined that the cost method of accounting for the investment was appropriate. The investment is included in investment in unconsolidated entities in the Company's consolidated balance sheets. As of December 31, 2022, the Company had an unfunded commitment of $1.3 million related to the investment, which is expected to be paid in 2023. The unfunded commitment is included in other liabilities in the Company's consolidated balance sheets.
The Company invests in low income housing tax credit ("LIHTC") partnerships. As of December 31, 2022 and 2021, the Company had $23.6 million and $14.3 million, respectively, in unfunded commitments related to the LIHTC partnerships, which is included in other liabilities in the Company's consolidated balance sheets.
The expected payments for the unfunded commitments related to the Company's investments in unconsolidated entities as of December 31, 2022 are as follows:
| | | | | | | | | | | | | | | | | |
(Dollars in thousands) | LIHTC | | Other | | |
Year Ending December 31: | Partnerships | | Partnerships | | Total |
2023 | $ | 9,693 | | | $ | 1,303 | | | $ | 10,996 | |
2024 | 9,280 | | | — | | | 9,280 | |
2025 | 4,248 | | | — | | | 4,248 | |
2026 | 26 | | | — | | | 26 | |
2027 | 26 | | | — | | | 26 | |
Thereafter | 333 | | | — | | | 333 | |
Total commitments | $ | 23,606 | | | $ | 1,303 | | | $ | 24,909 | |
The following table presents amortization expense and tax credits recognized associated with our investments in LIHTC partnerships for the periods presented:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Proportional amortization method: | | | | | |
Amortization expense recognized in income tax expense | $ | 2,566 | | | $ | 2,174 | | | $ | 1,391 | |
Federal and state tax credits recognized in income tax expense | 2,938 | | | 2,373 | | | 1,599 | |
7. MORTGAGE SERVICING RIGHTS
The following table presents changes in our mortgage servicing rights for the periods presented:
| | | | | | | | | |
(Dollars in thousands) | | | Mortgage Servicing Rights | | |
| | | | | |
| | | | | |
| | | | | |
Balance as of December 31, 2020 | | | $ | 11,865 | | | |
Additions | | | 1,341 | | | |
Amortization | | | (3,468) | | | |
Balance as of December 31, 2021 | | | 9,738 | | | |
Additions | | | 631 | | | |
Amortization | | | (1,295) | | | |
Balance as of December 31, 2022 | | | $ | 9,074 | | | |
The gross carrying value, accumulated amortization, and net carrying value related to our mortgage servicing rights as of December 31, 2022 and 2021 are presented below:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 | | December 31, 2021 |
(Dollars in thousands) | Gross Carrying Value | | Accumulated Amortization | | Net Carrying Value | | Gross Carrying Value | | Accumulated Amortization | | Net Carrying Value |
| | | | | | | | | | | |
Mortgage servicing rights | $ | 69,413 | | | $ | (60,339) | | | $ | 9,074 | | | $ | 72,250 | | | $ | (62,512) | | | $ | 9,738 | |
Total | $ | 69,413 | | | $ | (60,339) | | | $ | 9,074 | | | $ | 72,250 | | | $ | (62,512) | | | $ | 9,738 | |
Based on our mortgage servicing rights held as of December 31, 2022, estimated amortization expense for the next five succeeding fiscal years and all years thereafter are as follows:
| | | | | |
(Dollars in thousands) | |
Year Ending December 31: | |
2023 | $ | 994 | |
2024 | 950 | |
2025 | 844 | |
2026 | 749 | |
2027 | 656 | |
Thereafter | 4,881 | |
Total | $ | 9,074 | |
The Company utilizes the amortization method to measure our mortgage servicing rights. Under the amortization method, mortgage servicing rights are amortized in proportion to and over the period of net servicing income. Income generated as the result of new mortgage servicing rights is reported as a component of mortgage banking income and totaled $0.6 million, $1.3 million, and $3.3 million in 2022, 2021 and 2020, respectively. Amortization of the servicing rights is reported as a component of mortgage banking income in the Company's consolidated statements of income. Ancillary income is recorded in other income. Mortgage servicing rights are recorded when loans are sold to third-parties with servicing of those loans retained, and are classified and pooled into buckets of homogeneous characteristics.
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. The servicing right is assessed 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, and servicing income and costs. 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 government FHA loans) include average discount rates, servicing costs and ancillary income. Many of these assumptions are subjective and require a high level of management judgment. The Company's 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, 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. As market interest rates decline, prepayment speeds will generally increase as customers refinance existing mortgages under more favorable interest rate terms. As prepayment speeds increase, anticipated cash flows will generally decline resulting in a potential reduction, or impairment, to the fair value of the capitalized mortgage servicing rights. Alternatively, an increase in market interest rates may cause a decrease in prepayment speeds and therefore an increase in fair value of mortgage servicing rights.
The following table presents the fair market value and key assumptions used in determining the fair market value of our mortgage servicing rights:
| | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 |
Fair market value, beginning of period | $ | 10,504 | | | $ | 12,003 | |
Fair market value, end of period | 12,061 | | | 10,504 | |
Weighted-average discount rate | 9.5 | % | | 9.5 | % |
Weighted-average prepayment speed assumption | 10.4 | % | | 19.0 | % |
Loans serviced for others as of December 31, 2022 and 2021 totaled $1.28 billion and $1.40 billion, respectively. Loans serviced for others are not reported as assets on the Company's consolidated balance sheets.
8. DERIVATIVES
The Company utilizes various designated and undesignated derivative financial instruments to reduce our exposure to movements in interest rates. All derivatives are measured at fair value on the Company's consolidated balance sheet. In each reporting period, we record the derivative instruments in other assets or other liabilities depending on whether the derivatives are in an asset or liability position. For derivative instruments that are designated as hedging instruments, the effective portion of the changes in the fair value of the derivative in AOCI, net of tax, is recorded until earnings are affected by the variability of cash flows of the hedged transaction. The portion of the gain or loss in the fair value of the derivative that represents hedge ineffectiveness is immediately recognized in current period earnings. For derivative instruments that are not designated as hedging instruments, changes in the fair value of the derivative are included in current period earnings. In 2022, the Company entered into a forward starting interest rate swap designated as a fair value hedge of certain municipal securities. The Company had no derivative instruments designated as hedging instruments as of December 31, 2021.
Interest Rate Lock and Forward Sale Commitments
The Company enters into interest rate lock commitments on certain mortgage loans that are intended to be sold. To manage interest rate risk on interest rate lock commitments, the Company also enters into forward loan sale commitments. The interest rate lock and forward loan sale commitments are accounted for as undesignated derivatives and are recorded at their respective fair values in other assets or other liabilities, with changes in fair value recorded in current period earnings. These instruments serve to reduce our exposure to movements in interest rates. At December 31, 2022 and 2021, the Company was party to forward sale commitments on $1.1 million and $3.5 million of mortgage loans, respectively. As of December 31, 2022 and 2021, the Company did not have any outstanding interest rate lock commitments on mortgage loans.
Risk Participation Agreements
In the first and fourth quarters of 2020, the Company entered into credit risk participation agreements ("RPA") with financial institution counterparties for interest rate swaps related to loans in which the Company participates. The risk participation agreements entered into by us as a participant bank provide credit protection to the financial institution counterparties should the borrowers fail to perform on their interest rate derivative contracts with the financial institutions.
Back-to-Back Swap Agreements
The Company established a program whereby it originates a variable rate loan and enters into a variable-to-fixed interest rate swap with the customer. The Company also enters into an equal and offsetting swap with a highly rated third-party financial institution. These "back-to-back swap agreements" are intended to offset each other and allow the Company to originate a variable rate loan, while providing a contract for fixed interest payments for the customer. The net cash flow for the Company is equal to the interest income received from a variable rate loan originated with the customer. These back-to-back swap agreements are free-standing derivatives and are recorded at fair value in other assets or other liabilities on the Company's consolidated balance sheet, with changes recorded in current period earnings. The Company did not enter into any swap agreements with its borrowers and third party financial institutions during the year ended December 31, 2022. During the year ended December 31, 2021, the Company entered into swap agreements with its borrowers with a total notional amount of $33.1 million, offset by swap agreements with third party financial institutions with a total notional amount of $33.1 million. As of December 31, 2022, the Company pledged $10.0 million in cash as collateral for the back-to-back swap agreements.
Interest Rate Swaps
During the first quarter of 2022, we entered into a forward starting interest rate swap, with an effective date of March 31, 2024. This transaction had a notional amount totaling $115.5 million as of December 31, 2022, and was designated as a fair value hedge of certain municipal debt securities. The Company will pay the counterparty a fixed rate of 2.095% and will receive a floating rate based on the Federal Funds effective rate. The fair value hedge has a maturity date of March 31, 2029. The interest rate swap is carried on the Company’s consolidated balance sheet at its fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The changes in the fair value of the interest rate swap are recorded in interest income. The unrealized gains or losses due to changes in fair value of the hedged debt securities due to changes in benchmark interest rates are recorded as an adjustment to the hedged debt securities and offset in the same interest income line item.
The following table presents the location of all assets and liabilities associated with our derivative instruments within the Company's consolidated balance sheet:
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| | | | Asset Derivatives | | Liability Derivatives |
Derivatives Not Designated as | | Balance Sheet | | Fair Value at | | Fair Value at | | Fair Value at | | Fair Value at |
Hedging Instruments | | Location | | December 31, 2022 | | December 31, 2021 | | December 31, 2022 | | December 31, 2021 |
| | | | (Dollars in thousands) |
Interest rate lock and forward sale commitments | | Other assets / other liabilities | | $ | 10 | | | $ | 5 | | | $ | 2 | | | $ | 20 | |
Risk participation agreements | | Other assets / other liabilities | | — | | | — | | | — | | | 16 | |
Back-to-back swap agreements | | Other assets / other liabilities | | 4,611 | | | 435 | | | 4,611 | | | 435 | |
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| | | | Asset Derivatives | | Liability Derivatives |
Derivatives Designated as | | Balance Sheet | | Fair Value at | | Fair Value at | | Fair Value at | | Fair Value at |
Hedging Instruments | | Location | | December 31, 2022 | | December 31, 2021 | | December 31, 2022 | | December 31, 2021 |
| | | | (Dollars in thousands) |
Interest rate swap | | Other assets / other liabilities | | $ | 5,986 | | | $ | — | | | $ | — | | | $ | — | |
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The following table presents the impact of derivative instruments and their location within the Company's consolidated statements of income for the periods presented:
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Derivatives Not in Cash Flow Hedging Relationship | | Location of Gain (Loss) Recognized in Earnings on Derivatives | | Amount of Gain (Loss) Recognized in Earnings on Derivatives |
| | (Dollars in thousands) |
Year ended December 31, 2022 | | | | |
Interest rate lock and forward sale commitments | | Mortgage banking income | | $ | 8 | |
Loans held for sale | | Other income | | (3) | |
Risk participation agreements | | Other service charges and fees | | 16 | |
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Year ended December 31, 2021 | | | | |
Interest rate lock and forward sale commitments | | Mortgage banking income | | 98 | |
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Risk participation agreements | | Other service charges and fees | | 32 | |
Back-to-back swap agreements | | Other service charges and fees | | 600 | |
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Year ended December 31, 2020 | | | | |
Interest rate lock and forward sale commitments | | Mortgage banking income | | (76) | |
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Risk participation agreements | | Other service charges and fees | | 1,323 | |
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Derivatives in Cash Flow Hedging Relationship | | Location of Gain (Loss) Recognized in Earnings on Derivatives | | Amount of Gain (Loss) Recognized in Earnings on Derivatives |
| | (Dollars in thousands) |
Year ended December 31, 2022 | | | | |
Interest rate swap | | Interest income | | $ | (340) | |
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9. DEPOSITS
The Company had $991.2 million and $706.7 million of total time deposits as of December 31, 2022 and 2021, respectively. Contractual maturities of total time deposits as of December 31, 2022 were as follows:
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(Dollars in thousands) | |
Year Ending December 31: | |
2023 | $ | 912,198 | |
2024 | 52,870 | |
2025 | 12,048 | |
2026 | 6,527 | |
2027 | 7,186 | |
Thereafter | 376 | |
Total | $ | 991,205 | |
Time deposits that meet or exceed the FDIC insurance limit of $250,000 totaled $678.6 million and $488.8 million at December 31, 2022 and 2021, respectively. This includes $290.1 million and $215.0 million in government time deposits at December 31, 2022 and 2021, respectively, which are collateralized.
Contractual maturities of time deposits of $250,000 or more as of December 31, 2022 were as follows:
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(Dollars in thousands) | |
Three months or less | $ | 370,239 | |
Over three months through six months | 97,913 | |
Over six months through twelve months | 188,943 | |
2024 | 15,185 | |
2025 | 2,326 | |
2026 | 1,540 | |
2027 | 2,411 | |
Thereafter | — | |
Total | $ | 678,557 | |
Overdrawn deposit accounts totaling $0.7 million and $0.5 million have been reclassified as loans on the Company's consolidated balance sheets as of December 31, 2022 and 2021, respectively.
10. SHORT-TERM BORROWINGS
The bank is a member of the FHLB and maintained a $2.23 billion line of credit, of which $2.19 billion remained available as of December 31, 2022. At December 31, 2022, there were $5.0 million in short-term borrowings outstanding under this arrangement. At December 31, 2021, there were no short-term borrowings outstanding under this arrangement.
The FHLB provides standby letters of credit on behalf of the bank to secure certain public deposits. If the FHLB is required to make a payment on a standby letter of credit, the payment amount is converted to an advance at the FHLB. The standby letters of credit issued on our behalf by the FHLB totaled $36.0 million and $32.2 million as of December 31, 2022 and 2021, respectively.
The bank had additional unused borrowings available at the Federal Reserve discount window of $75.9 million and $55.4 million as of December 31, 2022 and 2021, respectively. Certain commercial real estate and commercial loans with carrying values totaling $125.0 million and $131.0 million were pledged as collateral on our line of credit with the Federal Reserve discount window as of December 31, 2022 and 2021, respectively. The Federal Reserve does not have the right to sell or repledge these loans.
Interest expense on short-term borrowings totaled $1.1 million, $2 thousand and $0.7 million in 2022, 2021 and 2020, respectively.
A summary of the bank's short-term borrowings as of December 31, 2022, 2021 and 2020 is as follows:
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| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Amount outstanding at December 31 | $ | 5,000 | | | $ | — | | | $ | 22,000 | |
Average amount outstanding during year | 37,210 | | | 607 | | | 89,904 | |
Highest month-end balance during year | 140,000 | | | 6,500 | | | 222,000 | |
Weighted-average interest rate on balances outstanding at December 31 | 4.60 | % | | — | % | | 0.29 | % |
Weighted-average interest rate during year | 2.84 | % | | 0.30 | % | | 0.80 | % |
11. LONG-TERM DEBT
Long-term debt, which is based on original maturity, consisted of subordinated notes and debentures totaling $105.9 million and $105.6 million at December 31, 2022 and 2021, respectively. There were no long-term FHLB advances outstanding at December 31, 2022 and 2021.
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| December 31, |
(Dollars in thousands) | 2022 | | 2021 |
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Subordinated debentures | $ | 51,547 | | | $ | 51,547 | |
Subordinated notes, net of issuance costs | 54,312 | | | 54,069 | |
Total | $ | 105,859 | | | $ | 105,616 | |
At December 31, 2022, future principal payments on long-term debt based on redemption date or final maturity are as follows (dollars in thousands):
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(Dollars in thousands) | |
Year Ending December 31: | |
2023 | $ | — | |
2024 | — | |
2025 | — | |
2026 | — | |
2027 | — | |
Thereafter | 106,547 | |
Total | $ | 106,547 | |
FHLB Advances
The bank had no FHLB long-term advances outstanding as of December 31, 2022 and 2021. At December 31, 2022, the bank had FHLB advances available of approximately $2.19 billion, which was secured by certain real estate loans with a carrying value of $3.28 billion in accordance with the collateral provisions of the Advances, Pledge and Security Agreement with the FHLB. The bank did not incur any interest expense on FHLB long-term advances in 2022 and 2021. Interest expense on FHLB long-term advances was $1.5 million in 2020.
Subordinated Debentures
As of December 31, 2022 and 2021, the Company had the following junior subordinated debentures outstanding:
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(Dollars in thousands) | December 31, 2022 and 2021 |
Name of Trust | Amount of Subordinated Debentures | | Interest Rate |
Trust IV | $ | 30,928 | | | Three month LIBOR + 2.45% |
Trust V | 20,619 | | | Three month LIBOR + 1.87% |
Total | $ | 51,547 | | | |
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In September 2004, the Company created a wholly-owned statutory trust, CPB Capital Trust IV ("Trust IV"). Trust IV issued $30.0 million in floating rate trust preferred securities bearing an interest rate of three-month LIBOR plus 2.45% and maturing on December 15, 2034. The principal assets of Trust IV are $30.9 million of the Company's junior subordinated debentures with an identical interest rate and maturity as the Trust IV trust preferred securities. Trust IV issued $0.9 million of common securities to the Company.
In December 2004, the Company created a wholly-owned statutory trust, CPB Statutory Trust V ("Trust V"). Trust V issued $20.0 million in floating rate trust preferred securities bearing an interest rate of three-month LIBOR plus 1.87% and maturing on December 15, 2034. The principal assets of Trust V are $20.6 million of the Company's junior subordinated debentures with an identical interest rate and maturity as the Trust V trust preferred securities. Trust V issued $0.6 million of common securities to the Company.
The Company is not considered the primary beneficiary of Trusts IV and V, therefore the trusts are not considered a variable interest entity and are not consolidated in the Company's financial statements. Rather the subordinated debentures are shown as a liability on the Company's consolidated balance sheets. The Company's investment in the common securities of the trusts are included in investment in unconsolidated entities in the Company's consolidated balance sheets.
The floating rate trust preferred securities, the junior subordinated debentures that are the assets of Trusts IV and V and the common securities issued by Trusts IV and V are redeemable in whole or in part on any interest payment date on or after December 15, 2009 for Trust IV and V, or at any time in whole but not in part within 90 days following the occurrence of certain events. Our obligations with respect to the issuance of the trust preferred securities constitute a full and unconditional guarantee by the Company of each trust's obligations with respect to its trust preferred securities. Subject to certain exceptions and limitations, we may elect from time to time to defer interest payments on the subordinated debentures, which would result in a deferral of distribution payments on the related trust preferred securities, for up to 20 consecutive quarterly periods without default or penalty.
The subordinated debentures may be included in Tier 1 capital, with certain limitations applicable, under current regulatory guidelines and interpretations.
Subordinated Notes
As of December 31, 2022 and 2021, the Company had the following subordinated notes outstanding:
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(Dollars in thousands) | December 31, 2022 and 2021 |
Name | Amount of Subordinated Notes | | Interest Rate |
October 2020 Private Placement | $ | 55,000 | | | 4.75% for the first five years. Resets quarterly thereafter to the then current three-month SOFR. |
Total | $ | 55,000 | | | |
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On October 20, 2020, the Company completed a $55.0 million private placement of ten-year fixed-to-floating rate subordinated notes, which will be used to support regulatory capital ratios and for general corporate purposes. The Company exchanged the privately placed notes for registered notes with the same terms and in the same aggregate principal amount at the end of the fourth quarter of 2020. The Notes bear a fixed interest rate of 4.75% for the first five years through November 1, 2025 and will reset quarterly thereafter for the remaining five years to the then current three-month Secured Overnight Financing Rate ("SOFR"), as published by the Federal Reserve Bank of New York, plus 456 basis points.
The subordinated notes may be included in Tier 2 capital, with certain limitations applicable, under current regulatory guidelines and interpretations. The subordinated notes had a carrying value of $54.3 million, net of unamortized debt issuance costs of $0.7 million, at December 31, 2022.
12. EQUITY
As a Hawaii state-chartered bank, Central Pacific Bank may only pay dividends to the extent it has retained earnings as defined under Hawaii banking law ("Statutory Retained Earnings"), which differs from GAAP retained earnings. As of December 31, 2022 and 2021, the bank had Statutory Retained Earnings of $145.7 million and $114.0 million, respectively.
Dividends are payable at the discretion of the Board of Directors and there can be no assurance that the Board of Directors will continue to pay dividends at the same rate, or at all, in the future. Our ability to pay cash dividends to our shareholders is subject to restrictions under federal and Hawaii law, including restrictions imposed by the FRB and covenants set forth in various agreements we are a party to, including covenants set forth in our subordinated debentures.
We repurchase shares of our common stock when we believe such repurchases are in the best interests of the Company.
In January 2021, the Company’s Board of Directors authorized the repurchase of up to $25.0 million of its common stock from time to time in the open market or in privately negotiated transactions, pursuant to a newly authorized share repurchase program (the "2021 Repurchase Plan"). The 2021 Repurchase Plan replaced and superseded in its entirety the share repurchase program previously approved by the Company's Board of Directors, which had $26.6 million in remaining repurchase authority due to the Company temporarily suspending the share repurchase program in March 2020 due to uncertainty in the wake of the COVID-19 pandemic.
In January 2022, the Company’s Board of Directors authorized the repurchase of up to $30.0 million of its common stock from time to time in the open market or in privately negotiated transactions, pursuant to a newly authorized share repurchase program (the "2022 Repurchase Plan"). The 2022 Repurchase Plan replaced and superseded in its entirety the 2021 Repurchase Plan, which had $5.3 million in remaining repurchase authority. The Company's 2022 Repurchase Plan is subject to a one year expiration.
In the year ended December 31, 2022, a total of 868,613 shares of common stock, at a cost of $20.7 million, were repurchased under the Company's share purchase programs. A total of $10.3 million remained available for repurchase under the Company's 2022 Repurchase Plan at December 31, 2022.
In the year ended December 31, 2021, 696,894 shares of common stock, at a cost of $18.7 million, were repurchased under the Company's share repurchase programs.
13. REVENUE FROM CONTRACTS WITH CUSTOMERS
Revenue Recognition
Accounting Standards Codification ("ASC") 606, "Revenue from Contracts with Customers", establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity's contracts to provide goods or services to its customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to receive in exchange for those goods or services. Revenue is recognized as performance obligations are satisfied.
The Company recognizes revenues as they are earned based on contractual terms, as transactions occur, or as services are provided and collectability is reasonably assured. Our principal source of revenue is derived from interest income on financial instruments, such as our loan and investment securities portfolios, as well as revenue related to our mortgage banking activities. These revenue-generating transactions are out of scope of ASC 606, but are subject to other GAAP and discussed elsewhere within our disclosures.
The Company also generates other revenue in connection with our broad range of banking products and financial services. Descriptions of our other revenue-generating activities that are within the scope of ASC 606, which are presented in the Company's consolidated statements of income as components of other operating income are as follows:
Mortgage banking income
Loan placement fees, included in mortgage banking income, primarily represent revenues earned by the Company for loan placement and underwriting. Revenues for these services are recorded at a point-in-time, upon completion of a contractually identified transaction, or when an advisory opinion is provided.
Service charges on deposit accounts
Revenue from service charges on deposit accounts includes general service fees for monthly account maintenance and activity- or transaction-based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when our performance obligation is completed, which is
generally monthly for account maintenance services or when a transaction has been completed (such as stop payment fees). Payment for such performance obligations are generally received at the time the performance obligations are satisfied.
Other Service Charges and Fees
Revenue from other service charges and fees includes fees on foreign exchange, cards and payments income, safe deposit rental income and other service charges, commissions and fees.
The Company provides foreign currency exchange services to customers, whereby cash can be converted to different foreign currencies, and vice versa. As a result of the services, a gain or loss is recognized on foreign currency transactions, as well as income related to commissions and fees earned on each transaction. Revenue from the commissions and fees earned on the transactions fall within the scope of ASC 606, and is recorded in a manner that reflects the timing of when transactions occur, and as services are provided. Realized and unrealized gains or losses related to foreign currency are out of scope of ASC 606.
Cards and payments income includes interchange fees from debit cards processed through card association networks, merchant services, and other card related services. Interchange rates are generally set by the credit card associations and based on purchase volumes and other factors. Interchange fees are recognized as transactions occur. Interchange expenses related to cards and payments income are presented gross in other operating expense. Merchant services income represents account management fees and transaction fees charged to merchants for the processing of card association network transactions. Merchant services revenue is recognized as transactions occur, or as services are performed.
Other service charges, commissions and fees include automated teller machines ("ATM") surcharge and interchange fees, bill payment fees, cashier’s check and money order fees, wire transfer fees, loan brokerage fees, and commissions on sales of insurance, broker-dealer products, and letters of credit. Revenue from these fees and commissions is recorded in a manner that reflects the timing of when transactions occur, and as services are provided.
Based on the nature of the commission agreement with the broker-dealer and each insurance provider, we may recognize revenue from broker-dealer and insurance commissions over time or at a point-in-time as our performance obligation is satisfied.
Income from Fiduciary Activities
Income from fiduciary activities includes fees from wealth management, trust, custodial and escrow services provided to individual and institutional customers. Revenue is generally recognized monthly based on a minimum annual fee and/or the market value of assets in custody. Additional fees are recognized for transactional activity.
Revenue from trade execution and brokerage services is earned through commissions from trade execution on behalf of clients. Revenue from these transactions is recognized at the trade date. Any ongoing service fees are recognized on a monthly basis as services are performed.
Net Gain (Loss) on Sales of Foreclosed Assets
The Company records a gain or loss on the sale of a foreclosed property when control of the property transfers to the Company, which typically occurs at the time the deed is executed. The Company does not finance the sale of the foreclosed property.
The following presents the Company's other operating income, segregated by revenue streams that are in-scope and out-of-scope of ASC 606 for the periods presented:
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| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Other operating income: | | | | | |
In-scope of ASC 606 | | | | | |
Mortgage banking income | $ | 1,060 | | | $ | 1,993 | | | $ | 1,128 | |
Service charges on deposit accounts | 8,197 | | | 6,358 | | | $ | 6,234 | |
Other service charges and fees | 16,581 | | | 15,281 | | | 11,621 | |
Income on fiduciary activities | 4,565 | | | 5,075 | | | 4,829 | |
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In-scope other operating income | 30,403 | | | 28,707 | | | 23,812 | |
Out-of-scope other operating income | 17,516 | | | 14,353 | | | 21,386 | |
Total other operating income | $ | 47,919 | | | $ | 43,060 | | | $ | 45,198 | |
14. MORTGAGE BANKING INCOME
Noninterest income from the Company's mortgage banking activities includes the following components for the periods presented:
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| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Mortgage banking income: | | | | | |
Net loan servicing fees | $ | 2,259 | | | $ | 2,733 | | | $ | 2,754 | |
Amortization of mortgage servicing rights | (1,295) | | | (3,468) | | | (6,167) | |
Net gain on sale of residential mortgage loans | 1,778 | | | 6,376 | | | 16,043 | |
Unrealized gain (loss) on interest rate locks | 8 | | | 98 | | | (76) | |
Loan placement fees | 1,060 | | | 1,993 | | | 1,128 | |
Total mortgage banking income | $ | 3,810 | | | $ | 7,732 | | | $ | 13,682 | |
15. SHARE-BASED COMPENSATION
In accordance with ASC 718, compensation expense is recognized only for those shares expected to vest, based on the Company's historical experience and future expectations. The following table summarizes the effects of share-based compensation for options and awards granted under the Company's equity incentive plans for each of the periods presented:
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| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Salaries and employee benefits | $ | 4,567 | | | $ | 4,580 | | | $ | 3,822 | |
Directors stock awards | 350 | | | 91 | | | 165 | |
Income tax benefit | (1,461) | | | (1,449) | | | (809) | |
Net share-based compensation effect | $ | 3,456 | | | $ | 3,222 | | | $ | 3,178 | |
Upon exercise or vesting of a share-based award, if the tax deduction exceeds the compensation cost that was previously recorded for financial statement purposes, this will result in an excess tax benefit. Effective January 1, 2017, ASU 2016-09, "Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" requires the Company to recognize all excess tax benefits or tax deficiencies through the income statement as income tax expense/benefit. Under previous GAAP, any excess tax benefits were recognized in additional-paid-in-capital to offset current-period and subsequent-period tax deficiencies. The Company recorded income tax benefit of $0.1 million in 2022, income tax benefit of $0.2 million in 2021, and income tax expense of $0.3 million in 2020, as a result of restricted stock units vesting during the year.
The Company's share-based compensation arrangements are described below:
Equity Incentive Plans
The Company has adopted equity incentive plans for the purpose of granting options, restricted stock and other equity based awards for the Company's common stock to directors, officers and other key individuals. Option awards are generally granted with an exercise price equal to the market price of the Company's common stock at the date of grant; those option awards generally vest based on three or five years of continuous service and have 10-year contractual terms. Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the stock option plans below). The Company has historically issued new shares of common stock upon exercises of stock options and purchases of restricted awards.
In April 2013, the Company adopted and shareholders approved the 2013 Stock Compensation Plan ("2013 Plan") making available 2,200,000 shares for grants to employees and directors. Upon adoption of the 2013 Plan, all unissued shares from the previous plan were frozen and no new grants were granted under the previous plan. Shares may continue to be settled under the previous plan pursuant to previously outstanding awards. New shares are issued from the 2013 Plan.
A total of 747,332, 843,469 and 996,850 shares were available for future grants under our 2013 Plan as of December 31, 2022, 2021 and 2020, respectively.
Stock Options
The fair value of each option award is estimated on the date of grant based on the following:
Valuation and amortization method— The fair value of stock options granted is estimated using the Black-Scholes option pricing formula and a single option award approach. Historical data is used to estimate option exercise and employee termination activity within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.
Expected life —The expected life of options represents the period of time that options granted are expected to be outstanding.
Expected volatility —Expected volatility is based on the historical volatility of the Company's common stock.
Risk-free interest rate —The risk-free interest rate for periods within the contractual life of the option is based on the Treasury yield curve in effect at the time of grant.
Expected dividend —The expected dividend assumption is based on our current expectations about our anticipated dividend policy.
The following is a summary of option activity for our stock option plans for the year ended December 31, 2022:
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| Number of Units | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Term (in years) | | Aggregate Intrinsic Value (in thousands) |
Stock options outstanding as of January 1, 2022 | 47,440 | | | $ | 14.32 | | | | | |
Changes during the year: | | | | | | | |
Granted | — | | | — | | | | | |
Exercised | (47,440) | | | 14.32 | | | | | $ | 706 | |
Expired | — | | | — | | | | | |
Forfeited | — | | | — | | | | | |
Stock options outstanding as of December 31, 2022 | — | | | — | | | 0.0 | | — | |
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Vested and exercisable as of December 31, 2022 | — | | | | | 0.0 | | — | |
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The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying option awards and the quoted price of the Company's common stock for the options that were in-the-money as of December 31, 2022.
There were 47,440 and 86,373 options exercised during the years ended December 31, 2022 and 2021, respectively. The aggregate intrinsic value of options exercised in 2022 and 2021 under our stock option plan determined as of the date of exercise was $0.7 million and $0.9 million, respectively. There were no options exercised in 2020.
As of December 31, 2022, all compensation costs related to stock options granted to employees under our stock option plans have been recognized.
There were no shares that vested in 2022, 2021 and 2020. As of December 31, 2022, all shares have been vested and exercised.
No stock options were granted during the years ended December 31, 2022, 2021 and 2020.
Restricted Stock and and Performance Stock Units
Under the 2013 Plan, the Company awarded restricted stock units ("RSUs") and performance stock units ("PSUs") to non-officer directors and certain senior management personnel. The awards typically vest over a two, three or five year period from the date of grant and are subject to forfeiture until performance and employment targets are achieved. Compensation expense is measured as the market price of the stock awards on the grant date, and is recognized over the specified vesting periods.
As of December 31, 2022, there was $3.5 million of total unrecognized compensation cost related to RSUs and PSUs that is expected to be recognized over a weighted-average period of 1.7 years.
The table below presents the activity of RSUs and PSUs for each of the periods presented:
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| Number of Units | | Weighted Average Grant Date Fair Value | | Fair Value of RSUs and PSUs That Vested During The Year (in thousands) |
Unvested as of December 31, 2019 | 366,467 | | | $ | 28.89 | | | |
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Changes during the year: | | | | | |
Granted | 322,180 | | | 18.11 | | | |
Forfeited | (28,058) | | | 23.79 | | | |
Vested | (128,215) | | | 29.48 | | | $ | 3,780 | |
Unvested as of December 31, 2020 | 532,374 | | | 22.49 | | | |
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Changes during the year: | | | | | |
Granted | 221,774 | | | 21.93 | | | |
Forfeited | (75,850) | | | 21.95 | | | |
Vested | (192,959) | | | 23.42 | | | 5,077 | |
Unvested as of December 31, 2021 | 485,339 | | | 21.95 | | | |
| | | | | |
Changes during the year: | | | | | |
Granted | 99,887 | | | 28.99 | | | |
Forfeited | (53,980) | | | 25.66 | | | |
Vested | (178,781) | | | 21.91 | | | 4,787 | |
Unvested as of December 31, 2022 | 352,465 | | | 23.40 | | | |
| | | | | |
| | | | | |
16. PENSION PLANS
Defined Benefit Retirement Plan
The bank had a defined benefit retirement plan that covered substantially all of its employees who were employed during the period that the plan was in effect. The plan was initially curtailed in 1986, and accordingly, plan benefits were fixed as of that date. Effective January 1, 1991, the bank reactivated its defined benefit retirement plan. As a result of the reactivation, employees for whom benefits were fixed in 1986 began to accrue additional benefits under a new formula that became effective January 1, 1991. Employees who were not participants at curtailment, but were subsequently eligible to join, became participants effective January 1, 1991. Under the reactivated plan, benefits are based upon the employees' years of service and their highest average annual salaries in a 60-consecutive-month period of service, reduced by benefits provided from the bank's terminated money purchase pension plan. The reactivation of the defined benefit retirement plan resulted in an increase of $5.9 million in the unrecognized prior service cost, which was amortized over a period of 13 years. Effective December 31, 2002, the bank curtailed its defined benefit retirement plan, and accordingly, plan benefits were fixed as of that date.
In January 2021, the Board of Directors approved termination of, and authorized Company management to commence taking action to terminate, the defined benefit retirement plan. The Company received a favorable determination letter from the IRS and no objection from the Pension Benefit Guaranty Corporation on the Form 500 standard termination notice in January 2022. The Company completed the termination and settlement of the plan in the second quarter of 2022. Upon final plan termination and settlement, the Company recognized a one-time noncash settlement expense of $4.9 million, which was recorded in other operating expense. As of December 31, 2022, the Company has no further defined benefit retirement plan liability or ongoing pension expense recognition.
The following tables set forth information pertaining to the defined benefit retirement plan:
| | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 |
Change in benefit obligation: | | | |
Benefit obligation at beginning of year | $ | 20,420 | | | $ | 21,919 | |
Interest cost | 212 | | | 485 | |
Actuarial gains | (1,766) | | | (427) | |
Benefits paid | (5,398) | | | (1,557) | |
Annuity purchase | (13,468) | | | — | |
Benefit obligation at end of the year | — | | | 20,420 | |
| | | |
Change in plan assets, at fair value: | | | |
Fair value of plan assets at beginning of year | 20,785 | | | 21,153 | |
Actual return on plan assets | (1,969) | | | 1,189 | |
Employer contributions | 50 | | | — | |
Benefits paid | (5,398) | | | (1,557) | |
Annuity purchase | (13,468) | | | — | |
Fair value of plan assets at end of year | — | | | 20,785 | |
| | | |
Funded status at end of year | $ | — | | | $ | 365 | |
| | | |
Amounts recognized in AOCI: | | | |
Net actuarial losses | $ | — | | | $ | (4,699) | |
| | | |
Benefit obligation actuarial assumptions: | | | |
Weighted-average discount rate | N/A | | 2.4 | % |
| | | |
|
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Components of net periodic benefit cost: | | | | | |
Interest cost | $ | 212 | | | $ | 485 | | | $ | 641 | |
Expected return on plan assets | (207) | | | (549) | | | (920) | |
Amortization of net actuarial losses | 225 | | | 701 | | | 909 | |
Settlement | 4,884 | | | — | | | — | |
Net periodic benefit cost | $ | 5,114 | | | $ | 637 | | | $ | 630 | |
| | | | | |
Net periodic cost actuarial assumptions: | | | | | |
Weighted-average discount rate | 2.4 | % | | 2.3 | % | | 3.1 | % |
Expected long-term rate of return on plan assets | 2.3 | % | | 2.7 | % | | 4.5 | % |
The long-term rate of return on plan assets reflects the weighted-average long-term rates of return for the various categories of investments held in the plan. The expected long-term rate of return is adjusted when there are fundamental changes in expected returns on the plan investments.
There were no plan assets remaining as of December 31, 2022. The defined benefit retirement plan assets as of December 31, 2021 consisted of debt securities and money market funds. The asset allocations by asset category were as follows:
| | | | | | | | | |
| | | December 31, 2021 |
| | | |
Debt securities | | | 85.9 | % |
Money market funds | | | 14.1 | |
Total | | | 100.0 | % |
In preparation of the defined benefit retirement plan termination, the plan asset allocations were adjusted to minimize market risk, which included eliminating all equity securities and adjusting the portfolio duration in 2021. There were no equity securities and no shares of the Company's common stock included in plan assets as of December 31, 2022 and 2021.
The fair values of the defined benefit retirement plan as of December 31, 2021 by asset category were as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Total |
December 31, 2021 | | | | | | | |
Money market funds | $ | 2,938 | | | $ | — | | | $ | — | | | $ | 2,938 | |
Exchange traded funds | 10,712 | | | — | | | — | | | 10,712 | |
Government obligations | — | | | 1,899 | | | — | | | 1,899 | |
| | | | | | | |
| | | | | | | |
Corporate bonds and debentures | — | | | 5,236 | | | — | | | 5,236 | |
Total | $ | 13,650 | | | $ | 7,135 | | | $ | — | | | $ | 20,785 | |
With the termination of the defined benefit retirement plan in the second quarter of 2022, the Company no longer has any estimated future payments due and is no longer required by funding regulations or laws to make any contributions to our defined benefit retirement plan.
Supplemental Executive Retirement Plans
In 1995, 2001, 2004 and 2006, our bank established Supplemental Executive Retirement Plans ("SERP") that provide certain officers of the Company with supplemental retirement benefits. On December 31, 2002, the 1995 and 2001 SERP were curtailed. In conjunction with the merger with CB Bancshares, Inc. ("CBBI"), we assumed CBBI's SERP obligation.
The following tables set forth information pertaining to the SERP:
| | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 |
Change in benefit obligation | | | |
Benefit obligation at beginning of year | $ | 12,297 | | | $ | 12,740 | |
Interest cost | 301 | | | 264 | |
Actuarial gains | (2,960) | | | (398) | |
Benefits paid | (418) | | | (309) | |
Benefit obligation at end of year | 9,220 | | | 12,297 | |
| | | |
Change in plan assets | | | |
Fair value of plan assets at beginning of year | — | | | — | |
Employer contributions | 418 | | | 309 | |
Benefits paid | (418) | | | (309) | |
Fair value of plan assets at end of year | — | | | — | |
| | | |
Funded status at end of year | $ | (9,220) | | | $ | (12,297) | |
| | | |
Amounts recognized in AOCI | | | |
Net transition obligation | $ | (7) | | | $ | (26) | |
| | | |
Net actuarial losses | 701 | | | (2,337) | |
Total amounts recognized in AOCI | $ | 694 | | | $ | (2,363) | |
| | | |
Benefit obligation actuarial assumptions | | | |
Weighted-average discount rate | 5.0 | % | | 2.5 | % |
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Components of net periodic benefit cost | | | | | |
Interest cost | $ | 301 | | | $ | 264 | | | $ | 341 | |
Amortization of net actuarial (gains) losses | 79 | | | 335 | | | 251 | |
Amortization of net transition obligation | 18 | | | 18 | | | 18 | |
Amortization of prior service cost | — | | | — | | | 14 | |
| | | | | |
Net periodic benefit cost | $ | 398 | | | $ | 617 | | | $ | 624 | |
| | | | | |
Net periodic cost actuarial assumptions | | | | | |
Weighted-average discount rate | 2.7 | % | | 2.1 | % | | 3.1 | % |
The SERP holds no plan assets other than employer contributions that are paid as benefits during the year. The Company expects to contribute $0.6 million to the SERP in 2023.
Estimated future benefit payments reflecting expected future service for the SERP in each of the next five years, in the aggregate for the five years and thereafter are as follows:
| | | | | |
(Dollars in thousands) | |
Year Ending December 31: | |
2023 | $ | 573 | |
2024 | 570 | |
2025 | 566 | |
2026 | 561 | |
2027 | 556 | |
2028-2032 | 4,817 | |
Thereafter | 1,577 | |
Total | $ | 9,220 | |
17. 401(K) RETIREMENT SAVINGS PLAN
The Company maintains a 401(k) Retirement Savings Plan ("Retirement Savings Plan") that covers substantially all employees of the Company. The Retirement Savings Plan allows employees to direct their own investments among a selection of investment alternatives and is funded by employee elective deferrals, employer matching contributions and employer discretionary contributions.
The Company has the option of making regular matching contributions on employee's elective deferrals. The Company has sole discretion in determining the percentage to be matched, subject to limitations of the Internal Revenue Code. From January 1, 2020 to June 30, 2020, the Company matched 100% of an employee's elective deferrals, up to 4% of the employee's pay each pay period. Effective July 1, 2020, matching contributions were temporarily suspended due to economic uncertainty in the wake of the COVID-19 pandemic. In lieu of matching contributions, an equity grant of the Company's common stock was granted to all 401(k)-eligible employees as of June 30, 2020 that will vest ratably over three years. The equity grants were made outside of the Retirement Savings Plan.
From January 1, 2021 through June 30, 2021, matching contributions remained suspended. Effective July 1, 2021 through December 31, 2021, we matched 100% of an employees effective deferrals, up to 2% of the employee's pay each pay period. Effective January 1, 2022 through December 31, 2022, we matched 100% of an employees effective deferrals, up to 4% of the employee's pay each pay period.
The Company also has the option of making discretionary contributions into the Retirement Savings Plan and has sole discretion in determining the discretionary contribution, subject to limitations of the Internal Revenue Code. On December 31, 2020, the Company made a discretionary contribution to all 401(k)-eligible employees, excluding Executive Committee and Managing Committee members, of 2% of the employee's eligible compensation, up to $1,250 per employee. The Company did not make any discretionary contributions in 2022 and 2021.
Total contributions to the Retirement Savings Plan totaled $2.4 million, $0.5 million and $2.1 million in 2022, 2021 and 2020, respectively.
18. OPERATING LEASES
The Company leases certain property and equipment with lease terms expiring through 2045. In some instances, a lease may contain renewal options for periods ranging from five to 15 years. All renewal options are likely to be exercised and therefore have been recognized as part of our right-of-use assets and lease liabilities in accordance with ASC 842, "Leases". Certain leases also contain variable payments that are primarily determined based on common area maintenance costs and Hawaii state tax rates. All leases are operating leases and any short-term leases are not included in the calculation of the right-of-use assets and lease liabilities. The most significant assumption related to the Company’s application of ASC 842 was the discount rate assumption. As most of the Company’s lease agreements do not provide for an implicit interest rate, the Company uses the collateralized interest rate that the Company would have to pay to borrow over a similar term to estimate the Company’s lease liability.
Total lease cost, cash flow information, weighted-average remaining lease term and weighted-average discount rate is summarized below for the periods indicated:
| | | | | | | | | | | | | |
| Year Ended December 31, | | |
(Dollars in thousands) | 2022 | | 2021 | | |
Lease cost: | | | | | |
Operating lease cost | $ | 5,495 | | | $ | 6,397 | | | |
Variable lease cost | 3,278 | | | 2,476 | | | |
Less: sublease income | (48) | | | (78) | | | |
Total lease cost | $ | 8,725 | | | 8,795 | | | |
| | | | | |
Other information: | | | | | |
Operating cash flows from operating leases | $ | (5,896) | | | $ | (6,533) | | | |
Weighted-average remaining lease term - operating leases | 11.22 years | | 11.91 years | | |
Weighted-average discount rate - operating leases | 3.95 | % | | 3.93 | % | | |
The following is a schedule of annual undiscounted cash flows for our operating leases and a reconciliation of those cash flows to the operating lease liabilities for the next five succeeding fiscal years and all years thereafter:
| | | | | | | | | | | | | | | | | |
(Dollars in thousands) | | | | | |
Year Ending December 31, | Undiscounted Cash Flows | | Lease Liability Expense | | Lease Liability Reduction |
2023 | $ | 5,100 | | | $ | 1,328 | | | $ | 3,772 | |
2024 | 4,438 | | | 1,202 | | | 3,236 | |
2025 | 4,152 | | | 1,078 | | | 3,074 | |
2026 | 4,089 | | | 958 | | | 3,131 | |
2027 | 4,080 | | | 835 | | | 3,245 | |
Thereafter | 23,049 | | | 3,618 | | | 19,431 | |
Total | $ | 44,908 | | | $ | 9,019 | | | $ | 35,889 | |
In addition, the Company leases certain properties that it owns as lessor. All of these leases are operating leases. The following represents lease income related to these leases that was recognized for the periods indicated:
| | | | | | | | | | | | | |
| Year Ended December 31, | | |
(Dollars in thousands) | 2022 | | 2021 | | |
Total rental income recognized | $ | 2,228 | | | 2,094 | | | |
Based on the Company's leases as lessor as of December 31, 2022, estimated lease payments for the next five succeeding fiscal years and all years thereafter are as follows:
| | | | | |
(Dollars in thousands) | |
Year Ending December 31, | |
2023 | $ | 1,001 | |
2024 | 835 | |
2025 | 675 | |
2026 | 555 | |
2027 | 533 | |
Thereafter | 2,300 | |
Total | $ | 5,899 | |
19. INCOME TAXES
Components of income tax expense (benefit) for the years ended December 31, 2022, 2021 and 2020 were as follows:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Current expense: | | | | | |
Federal | $ | 996 | | | $ | 11,304 | | | $ | 22,014 | |
State | (1,965) | | | 3,626 | | | 2,833 | |
Total current | (969) | | | 14,930 | | | 24,847 | |
Deferred expense: | | | | | |
Federal | 18,854 | | | 8,654 | | | (12,952) | |
State | 6,956 | | | 2,174 | | | (135) | |
Total deferred | 25,810 | | | 10,828 | | | (13,087) | |
Provision for income taxes | $ | 24,841 | | | $ | 25,758 | | | $ | 11,760 | |
Income tax expense (benefit) for the periods presented differed from the "expected" tax expense (computed by applying the U.S. federal corporate tax rate of 21% for the years ended December 31, 2022, 2021 and 2020, to income (loss) before income taxes) for the following reasons:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Computed "expected" tax expense (benefit) | $ | 20,741 | | | $ | 22,187 | | | $ | 10,297 | |
Increase (decrease) in taxes resulting from: | | | | | |
Tax-exempt interest income | (692) | | | (526) | | | (528) | |
Other tax-exempt income | (392) | | | (734) | | | (799) | |
Low-income housing tax credits | (530) | | | (365) | | | (332) | |
State income taxes, net of Federal income tax effect, excluding impact of deferred tax valuation allowance | 4,982 | | | 5,377 | | | 2,590 | |
Change in the beginning-of-the-year balance of the valuation allowance for deferred tax assets allocated to income tax expense | 39 | | | (39) | | | (22) | |
| | | | | |
Other, net | 693 | | | (142) | | | 554 | |
Total | $ | 24,841 | | | $ | 25,758 | | | $ | 11,760 | |
The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows:
| | | | | | | | | | | |
| December 31, |
(Dollars in thousands) | 2022 | | 2021 |
Deferred tax assets | | | |
Lease liability | $ | 9,598 | | | $ | 10,891 | |
Allowance for credit losses | 13,534 | | | 14,382 | |
Accrued expenses | 3,737 | | | 3,616 | |
Employee retirement benefits | 1,941 | | | 2,547 | |
| | | |
| | | |
| | | |
Federal net operating loss carryforwards | 16,363 | | | — | |
State net operating loss carryforwards | 7,583 | | | 3,091 | |
Restricted stock and non-qualified stock options | 388 | | | 611 | |
Premises and equipment | 4,717 | | | 4,678 | |
Other | 9,504 | | | 6,333 | |
Total deferred tax assets | 67,365 | | | 46,149 | |
| | | |
Deferred tax liabilities | | | |
Right-of-use lease asset | 9,356 | | | 10,546 | |
Intangible assets | 2,427 | | | 2,604 | |
| | | |
| | | |
| | | |
| | | |
Other | 3,647 | | | 3,808 | |
Total deferred tax liabilities | 15,430 | | | 16,958 | |
| | | |
Less: Deferred tax valuation allowance | 3,398 | | | 3,359 | |
| | | |
Net deferred tax assets | $ | 48,537 | | | $ | 25,832 | |
In assessing the realizability of our net DTA, management considers whether it is more likely than not that some portion or all of the DTA will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income and tax-planning strategies in making this assessment.
As of December 31, 2022, the valuation allowance on our net DTA totaled $3.4 million, which related to our DTA from net apportioned net operating loss ("NOL") carryforwards for California state income tax purposes as the Company does not expect to generate sufficient income in California to utilize the DTA. The net change in the valuation allowance was an increase of $39 thousand in 2022, compared to a decrease of $39 thousand in 2021.
Net of this valuation allowance, the Company's net DTA totaled $48.5 million as of December 31, 2022, compared to a net DTA of $25.8 million as of December 31, 2021, and is included in other assets in the Company's consolidated balance sheets.
At December 31, 2022, the Company had NOL carryforwards for U.S. Federal income tax purposes of $77.9 million and state income tax purposes of $132.0 million, which are available to offset future taxable income. The U.S. Federal NOL carryforwards can be carried forward indefinitely to offset future federal taxable income. The Hawaii NOL carryforwards can also be carried forward indefinitely, while the other state NOL carryforwards will begin to expire if not utilized beginning in 2028.
Utilization of the NOL carryforwards and credits may be subject to annual limitations due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitations may result in the expiration of net operating losses and credits before they are able to be utilized. The Company does not expect any previous ownership changes, as defined under Sections 382 and 383 of the Internal Revenue Code, to result in an ultimate limitation that will materially reduce the total amount of net operating loss carryforwards that can be utilized.
At December 31, 2022, the Company did not have any material unrecognized tax benefits that, if recognized would favorably affect the effective income tax rate in future periods. The Company does not expect our unrecognized tax benefits to change significantly over the next 12 months.
The Company is subject to U.S. federal income tax as well as income tax of multiple state jurisdictions. As of December 31, 2022, the Company’s federal tax returns for 2016 and earlier, and the state tax returns for 2018 and earlier were no longer subject to examination by the taxing authorities. However, tax periods closed in a prior period may be subject to audit and re-examination by tax authorities for which tax carryforwards are utilized in subsequent years.
20. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table presents the components of other comprehensive income (loss) for the years ended December 31, 2022, 2021 and 2020, by component:
| | | | | | | | | | | | | | | | | |
(Dollars in thousands) | Before Tax | | Tax Effect | | Net of Tax |
Year ended December 31, 2022 | | | | | |
Net change in fair value of investment securities: | | | | | |
Net unrealized losses on investment securities arising during the period | $ | (204,250) | | | $ | (54,109) | | | $ | (150,141) | |
| | | | | |
Less: Amortization of unrealized losses on investment securities transferred to HTM | 6,218 | | | 1,520 | | | 4,698 | |
Net change in fair value of investment securities | (198,032) | | | (52,589) | | | (145,443) | |
| | | | | |
Net change in fair value of derivative: | | | | | |
Net unrealized gains arising during the period | 6,326 | | | 1,681 | | | 4,645 | |
Net change in fair value of derivative | 6,326 | | | 1,681 | | | 4,645 | |
| | | | | |
Defined benefit retirement plan and SERPs: | | | | | |
Net actuarial gains arising during the period | 2,007 | | | 537 | | | 1,470 | |
Amortization of net actuarial losses | 304 | | | 81 | | | 223 | |
Amortization of net transition obligation | 18 | | | 4 | | | 14 | |
| | | | | |
Settlement | 4,884 | | | 1,817 | | | 3,067 | |
Defined benefit retirement plan and SERPs | 7,213 | | | 2,439 | | | 4,774 | |
Other comprehensive loss | $ | (184,493) | | | $ | (48,469) | | | $ | (136,024) | |
| | | | | | | | | | | | | | | | | |
(Dollars in thousands) | Before Tax | | Tax Effect | | Net of Tax |
Year ended December 31, 2021 | | | | | |
Net change in fair value of investment securities: | | | | | |
Net unrealized losses on investment securities arising during the period | $ | (41,237) | | | $ | (11,030) | | | $ | (30,207) | |
Less: Reclassification adjustment for gains realized in net income | (150) | | | (40) | | | (110) | |
| | | | | |
Net change in fair value of investment securities | (41,387) | | | (11,070) | | | (30,317) | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
Defined benefit retirement plan and SERPs: | | | | | |
Net actuarial gains arising during the period | 2,014 | | | 544 | | | 1,470 | |
Amortization of net actuarial losses | 1,036 | | | 291 | | | 745 | |
Amortization of net transition obligation | 18 | | | 4 | | | 14 | |
| | | | | |
| | | | | |
Defined benefit retirement plan and SERPs | 3,068 | | | 839 | | | 2,229 | |
Other comprehensive loss | $ | (38,319) | | | $ | (10,231) | | | $ | (28,088) | |
| | | | | | | | | | | | | | | | | |
(Dollars in thousands) | Before Tax | | Tax Effect | | Net of Tax |
Year ended December 31, 2020 | | | | | |
Net change in fair value of investment securities: | | | | | |
Net unrealized gains on investment securities arising during the period | $ | 15,939 | | | $ | 4,260 | | | $ | 11,679 | |
Less: Reclassification adjustment for losses realized in net income | 201 | | | 54 | | | 147 | |
| | | | | |
Net change in fair value of investment securities | 16,140 | | | 4,314 | | | 11,826 | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
Defined benefit retirement plan and SERPs: | | | | | |
Net actuarial losses arising during the period | (1,488) | | | (508) | | | (980) | |
Amortization of net actuarial losses | 1,160 | | | 310 | | | 850 | |
Amortization of net transition obligation | 18 | | | 5 | | | 13 | |
Amortization of prior service cost | 14 | | | 4 | | | 10 | |
| | | | | |
Defined benefit retirement plan and SERPs | (296) | | | (189) | | | (107) | |
Other comprehensive income | $ | 15,844 | | | $ | 4,125 | | | $ | 11,719 | |
The following table presents the changes in each component of AOCI, net of tax, for the years ended December 31, 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | Investment Securities | | Derivatives | | Defined Benefit Plans | | AOCI |
Year ended December 31, 2022 | | | | | | | |
Balance at beginning of period | $ | (3,666) | | | $ | — | | | $ | (4,294) | | | $ | (7,960) | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Other comprehensive (loss) income before reclassifications | (150,141) | | | 4,645 | | | 1,470 | | | (144,026) | |
Amounts reclassified from AOCI | 4,698 | | | — | | | 3,304 | | | 8,002 | |
Net other comprehensive income (loss) | (145,443) | | | 4,645 | | | 4,774 | | | (136,024) | |
Balance at end of period | $ | (149,109) | | | $ | 4,645 | | | $ | 480 | | | $ | (143,984) | |
| | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | Investment Securities | | | | Defined Benefit Plans | | AOCI |
Year ended December 31, 2021 | | | | | | | |
Balance at beginning of period | $ | 26,651 | | | | | $ | (6,523) | | | $ | 20,128 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Other comprehensive (loss) income before reclassifications | (30,207) | | | | | 1,470 | | | (28,737) | |
Amounts reclassified from AOCI | (110) | | | | | 759 | | | 649 | |
Net other comprehensive income (loss) | (30,317) | | | | | 2,229 | | | (28,088) | |
Balance at end of period | $ | (3,666) | | | | | $ | (4,294) | | | $ | (7,960) | |
| | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | Investment Securities | | | | Defined Benefit Plans | | AOCI |
Year ended December 31, 2020 | | | | | | | |
Balance at beginning of period | $ | 14,825 | | | | | $ | (6,416) | | | $ | 8,409 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Other comprehensive income (loss) before reclassifications | 11,679 | | | | | (980) | | | 10,699 | |
Amounts reclassified from AOCI | 147 | | | | | 873 | | | 1,020 | |
Total other comprehensive income (loss) | 11,826 | | | | | (107) | | | 11,719 | |
Balance at end of period | $ | 26,651 | | | | | $ | (6,523) | | | $ | 20,128 | |
The following table presents the amounts reclassified out of each component of AOCI for the years ended December 31, 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | | | | | | | |
| Amount Reclassified from AOCI | | Affected Line Item in the |
| Year ended December 31, | | Statement Where Net |
Details about AOCI Components | 2022 | | 2021 | | 2020 | | Income is Presented |
| (Dollars in thousands) | | |
Sale of available-for-sale investment securities: | | | | | | | |
Realized gains (losses) on available-for-sale investment securities | $ | — | | | $ | 150 | | | $ | (201) | | | Net gains (losses) on sales of investment securities |
Tax effect | — | | | (40) | | | 54 | | | Income tax benefit (expense) |
Net of tax | $ | — | | | $ | 110 | | | $ | (147) | | | |
| | | | | | | |
Amortization of unrealized losses on investment securities transferred to HTM | $ | (6,218) | | | $ | — | | | $ | — | | | Interest and dividends on investment securities |
Tax effect | 1,520 | | | — | | | — | | | Income tax expense |
Net of tax | $ | (4,698) | | | $ | — | | | $ | — | | | |
| | | | | | | |
Defined benefit plan items: | | | | | | | |
Amortization of net actuarial losses | $ | (304) | | | $ | (1,036) | | | $ | (1,160) | | | Other operating expense - other (1) |
Amortization of net transition obligation | (18) | | | (18) | | | (18) | | | Other operating expense - other (1) |
Amortization of prior service cost | — | | | — | | | (14) | | | Other operating expense - other (1) |
Settlement | (4,884) | | | — | | | — | | | Other operating expense - other (1) |
Total before tax | (5,206) | | | (1,054) | | | (1,192) | | | |
Tax effect | 1,902 | | | 295 | | | 319 | | | Income tax expense |
Net of tax | $ | (3,304) | | | $ | (759) | | | $ | (873) | | | |
| | | | | | | |
Total reclassifications, net of tax | $ | (8,002) | | | $ | (649) | | | $ | (1,020) | | | |
(1)These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note 16 - Pension Plans for additional details).
21. EARNINGS PER SHARE
The table below presents the information used to compute basic and diluted earnings per share for the years ended December 31, 2022, 2021 and 2020:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
(In thousands, except per share data) | 2022 | | 2021 | | 2020 |
Net income | $ | 73,928 | | | $ | 79,894 | | | $ | 37,273 | |
| | | | | |
Weighted-average shares outstanding for basic earnings per share | 27,398,445 | | | 28,003,744 | | | 28,074,543 | |
Add: Dilutive effect of employee stock options and awards | 169,335 | | | 253,579 | | | 106,033 | |
| | | | | |
| | | | | |
Weighted-average shares outstanding for diluted earnings per share | 27,567,780 | | | 28,257,323 | | | 28,180,576 | |
| | | | | |
Basic earnings per share | $ | 2.70 | | | $ | 2.85 | | | $ | 1.33 | |
Diluted earnings per share | $ | 2.68 | | | $ | 2.83 | | | $ | 1.32 | |
There were no potentially anti-dilutive securities that have been excluded from the dilutive share calculation for the years ended December 31, 2022, 2021, and 2020.
22. CONTINGENT LIABILITIES AND OTHER COMMITMENTS
The Company and its subsidiaries are involved in legal actions arising in the ordinary course of business. Management, after consultation with legal counsel, believes the ultimate disposition of those matters will not have a material adverse effect on our consolidated financial statements.
In the normal course of business there are outstanding contingent liabilities and other commitments such as unused letters of credit and items held for collections, which are not reflected in the accompanying consolidated financial statements. Management does not anticipate any material losses as a result of these transactions.
23. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees written, forward foreign exchange contracts, interest rate contracts, risk participation agreements, and back-to-back swap agreements. Those instruments involve, to varying degrees, elements of credit, interest rate and foreign exchange risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments.
Exposure to credit loss in the event of nonperformance by the counter-party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. For forward foreign exchange contracts and interest rate contracts, the contract amounts do not represent exposure to credit loss. The Company controls the credit risk of these contracts through credit approvals, limits and monitoring procedures. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation of the counter-party. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby letters of credit and financial guarantees written are conditional commitments issued by us to guarantee the performance of a customer to a third-party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds collateral for those commitments in which collateral is deemed necessary.
Interest rate options issued on residential mortgage loans expose us to interest rate risk, which is economically hedged with forward interest rate contracts. These derivatives are carried at fair value with changes in fair value recorded as a component of mortgage banking income in other operating income in the consolidated statements of income. The amount of interest rate options fluctuates based on residential mortgage volume.
Forward interest rate contracts represent commitments to purchase or sell loans at a future date at a specified price. The Company enters into forward interest rate contracts on our residential mortgage held for sale loans. These derivatives are carried at fair value with changes in fair value recorded as a component of mortgage banking income in other operating income in the consolidated statements of income. Risks arise from the possible inability of counter-parties to meet the terms of their contracts and from movements in market rates. Management reviews and approves the creditworthiness of the counter-parties to its forward interest rate contracts.
Risk participation agreements represent agreements with a financial institution counterparty for interest rate swaps related to loans in which we participate. These derivatives are carried at fair value with changes in fair value recorded as a component of other service charges and fees. The risk participation agreements entered into by us as a participant bank provide credit protection to the financial institution counterparty should the borrowers fail to perform on their interest rate derivative contracts with that financial institution.
The Company established a program whereby it originates a variable rate loan and enters into a variable-to-fixed interest rate swap with the customer. The Company also enters into an equal and offsetting swap with a highly rated third-party financial
institution. These "back-to-back swap agreements" are intended to offset each other and allows the Company to originate a variable rate loan, while providing a contract for fixed interest payments for the customer. The net cash flow for the Company is equal to the interest income received from a variable rate loan originated with the customer. These back-to-back swap agreements are free-standing derivatives and are recorded at fair value on the Company's consolidated balance sheet in other assets or other liabilities, and changes to the fair value recorded in other service charges and fees on the consolidated statement of income.
Forward foreign exchange contracts represent commitments to purchase or sell foreign currencies at a future date at a specified price. These derivatives are carried at fair value with changes in fair value recorded as a component of other operating income in the consolidated statements of income. Risks arise from the possible inability of counter-parties to meet the terms of their contracts and from movements in foreign currency exchange rates. Management reviews and approves the creditworthiness of its forward foreign exchange counter-parties. At December 31, 2022 and 2021, the Company did not have any forward foreign exchange contracts.
During the first quarter of 2022, the Company entered into a forward starting interest rate swap, with an effective date of March 31, 2024. This transaction had a notional amount totaling $115.5 million as of December 31, 2022, and was designated as a fair value hedge of certain municipal debt securities. The Company will pay the counterparty a fixed rate of 2.095% and will receive a floating rate based on the Federal Funds effective rate. The fair value hedge has a maturity date of March 31, 2029. The interest rate swap is carried on the Company’s consolidated balance sheet at its fair value in other assets (when the fair value is positive) or in other liabilities (when the fair value is negative). The changes in the fair value of the interest rate swap are recorded in interest income. The unrealized gains or losses due to changes in fair value of the hedged debt securities due to changes in benchmark interest rates are recorded as an adjustment to the hedged debt securities and offset in the same interest income line item.
At December 31, 2022 and 2021, financial instruments with off-balance sheet risk were as follows:
| | | | | | | | | | | |
| December 31, |
(Dollars in thousands) | 2022 | | 2021 |
Notional amount of: | | | |
Financial instruments whose contract amounts represent credit risk: | | | |
Commitments to extend credit | $ | 1,328,791 | | | $ | 1,266,596 | |
Standby letters of credit and financial guarantees written | 5,367 | | | 6,634 | |
| | | |
Notional amount of: | | | |
Financial instruments whose contract amounts exceed the amount of credit risk: | | | |
Back-to-back swap agreements: | | | |
Assets | 32,335 | | | 33,112 | |
Liabilities | 32,335 | | | 33,112 | |
| | | |
Forward interest rate contracts | 1,110 | | | 3,525 | |
Risk participation agreements | 36,835 | | | 37,531 | |
Interest rate swap agreements | 115,545 | | | — | |
24. 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 FHLB 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. The weighted-average discount rate used in the valuation of loans was 7.44% as of December 31, 2022. In accordance with ASU 2016-01, the fair value of loans are based on the notion of exit price as of December 31, 2022 and 2021.
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. The fair values of Hawaii and U.S. Mainland construction and commercial real estate loans, if any, are reported net of applicable selling costs on the Company's consolidated balance sheets.
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 fair value of time deposits is estimated by discounting future cash flows using rates currently offered for FHLB advances of similar remaining maturities. The weighted-average discount rate used in the valuation of time deposits was 4.96% as of December 31, 2022.
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. The weighted-average discount rate used in the valuation of long-term debt was 7.28% as of December 31, 2022.
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 and liabilities and premises and equipment.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | Fair Value Measurement Using |
(Dollars in thousands) | Carrying Amount | | Estimated Fair Value | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) |
December 31, 2022 | | | | | | | | | |
Financial assets: | | | | | | | | | |
Cash and due from financial institutions | $ | 97,150 | | | $ | 97,150 | | | $ | 97,150 | | | $ | — | | | $ | — | |
Interest-bearing deposits in other financial institutions | 14,894 | | | 14,894 | | | 14,894 | | | — | | | — | |
Investment securities | 1,336,677 | | | 1,268,574 | | | — | | | 1,261,306 | | | 7,268 | |
Loans held for sale | 1,105 | | | 1,105 | | | — | | | 1,105 | | | — | |
Loans, net of ACL | 5,491,728 | | | 5,043,436 | | | — | | | — | | | 5,043,436 | |
| | | | | | | | | |
Accrued interest receivable | 20,345 | | | 20,345 | | | 20,345 | | | — | | | — | |
| | | | | | | | | |
Financial liabilities: | | | | | | | | | |
Deposits: | | | | | | | | | |
Noninterest-bearing deposits | 2,092,823 | | | 2,092,823 | | | 2,092,823 | | | — | | | — | |
Interest-bearing demand and savings deposits | 3,652,195 | | | 3,652,195 | | | 3,652,195 | | | — | | | — | |
Time deposits | 991,205 | | | 975,086 | | | — | | | — | | | 975,086 | |
FHLB advances and other short-term borrowings | 5,000 | | | 5,000 | | | — | | | 5,000 | | | — | |
Long-term debt | 105,859 | | | 93,729 | | | — | | | — | | | 93,729 | |
Accrued interest payable (included in other liabilities) | 4,739 | | | 4,739 | | | 4,739 | | | — | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Fair Value Measurement Using |
(Dollars in thousands) | 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) |
December 31, 2022 | | | | | | | | | | | |
Off-balance sheet financial instruments: | | | | | | | | | | | |
Commitments to extend credit | $ | 1,328,791 | | | $ | — | | | $ | 1,270 | | | $ | — | | | $ | 1,270 | | | $ | — | |
Standby letters of credit and financial guarantees written | 5,367 | | | — | | | 80 | | | — | | | 80 | | | — | |
| | | | | | | | | | | |
Derivatives: | | | | | | | | | | | |
Back-to-back swap agreements: | | | | | | | | | | | |
Assets | 32,335 | | | 4,611 | | | 4,611 | | | — | | | — | | | 4,611 | |
Liabilities | (32,335) | | | (4,611) | | | (4,611) | | | — | | | — | | | (4,611) | |
| | | | | | | | | | | |
Forward sale commitments | 1,110 | | | 8 | | | 8 | | | — | | | 8 | | | — | |
Risk participation agreements | 36,835 | | | — | | | — | | | — | | | — | | | — | |
Interest rate swap agreements | 115,545 | | | 5,986 | | | 5,986 | | | — | | | — | | | 5,986 | |
| | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | Fair Value Measurement Using |
(Dollars in thousands) | Carrying Amount | | Estimated Fair Value | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) |
December 31, 2021 | | | | | | | | | |
Financial assets: | | | | | | | | | |
Cash and due from financial institutions | $ | 81,506 | | | $ | 81,506 | | | $ | 81,506 | | | $ | — | | | $ | — | |
Interest-bearing deposits in other financial institutions | 247,401 | | | 247,401 | | | 247,401 | | | — | | | — | |
Investment securities | 1,631,699 | | | 1,631,699 | | | — | | | 1,623,080 | | | 8,619 | |
Loans held for sale | 3,531 | | | 3,531 | | | — | | | 3,531 | | | — | |
Loans, net of ACL | 5,033,552 | | | 4,741,379 | | | — | | | — | | | 4,741,379 | |
| | | | | | | | | |
Accrued interest receivable | 16,709 | | | 16,709 | | | 16,709 | | | — | | | — | |
| | | | | | | | | |
Financial liabilities: | | | | | | | | | |
Deposits: | | | | | | | | | |
Noninterest-bearing deposits | 2,291,246 | | | 2,291,246 | | | 2,291,246 | | | — | | | — | |
Interest-bearing demand and savings deposits | 3,641,180 | | | 3,641,180 | | | 3,641,180 | | | — | | | — | |
Time deposits | 706,732 | | | 704,645 | | | — | | | — | | | 704,645 | |
| | | | | | | | | |
Long-term debt | 105,616 | | | 94,558 | | | — | | | — | | | 94,558 | |
Accrued interest payable (included in other liabilities) | 1,122 | | | 1,122 | | | 1,122 | | | — | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Fair Value Measurement Using |
(Dollars in thousands) | 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) |
December 31, 2021 | | | | | | | | | | | |
Off-balance sheet financial instruments: | | | | | | | | | | | |
Commitments to extend credit | $ | 1,266,596 | | | $ | — | | | $ | 1,347 | | | $ | — | | | $ | 1,347 | | | $ | — | |
Standby letters of credit and financial guarantees written | 6,634 | | | — | | | 100 | | | — | | | 100 | | | — | |
| | | | | | | | | | | |
Derivatives: | | | | | | | | | | | |
Back-to-back swap agreements: | | | | | | | | | | | |
Assets | 33,112 | | | 435 | | | 435 | | | — | | | — | | | 435 | |
Liabilities | 33,112 | | | (435) | | | (435) | | | — | | | — | | | (435) | |
| | | | | | | | | | | |
Forward sale commitments | 3,525 | | | 1 | | | 1 | | | — | | | 1 | | | — | |
Risk participation agreements | 37,531 | | | (16) | | | (16) | | | — | | | — | | | (16) | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Fair Value Measurements
Financial assets and liabilities are grouped 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 require the use of significant judgment or estimation.
Fair values are based on the price that the Company 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. When developing fair value measurements, the use of observable inputs are maximized and the use of unobservable inputs are minimized.
Fair value measurements are used to record adjustments to certain financial assets and liabilities and to determine fair value disclosures. Available-for-sale investment securities and derivatives are recorded at fair value on a recurring basis. From time to time, the Company 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 financials assets and liabilities into and out of Level 3 of the fair value hierarchy during the year ended December 31, 2022.
The following table below presents the fair value of assets and liabilities measured on a recurring basis:
| | | | | | | | | | | | | | | | | | | | | | | |
| | | Fair Value at Reporting Date Using |
(Dollars in thousands) | Fair Value | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) |
December 31, 2022 | | | | | | | |
Available-for-sale investment securities: | | | | | | | |
Debt securities: | | | | | | | |
States and political subdivisions | $ | 135,752 | | | $ | — | | | $ | 129,168 | | | $ | 6,584 | |
Corporate securities | 30,211 | | | — | | | 30,211 | | | — | |
U.S. Treasury obligations and direct obligations of U.S Government agencies | 25,715 | | | — | | | 25,715 | | | — | |
Mortgage-backed securities: | | | | | | | |
Residential - U.S. Government-sponsored entities ("GSEs") | 423,803 | | | — | | | 423,803 | | | — | |
Residential - Non-government sponsored entities ("Non-GSEs") | 8,662 | | | — | | | 7,978 | | | 684 | |
Commercial - U.S. GSEs and agencies | 46,144 | | | — | | | 46,144 | | | — | |
Commercial - Non-GSEs | 1,507 | | | — | | | 1,507 | | | — | |
| | | | | | | |
Total investment securities | 671,794 | | | — | | | 664,526 | | | 7,268 | |
| | | | | | | |
Derivatives: | | | | | | | |
| | | | | | | |
Forward sale commitments | 8 | | | — | | | 8 | | | — | |
Interest rate swap agreements | 5,986 | | | — | | | — | | | 5,986 | |
| | | | | | | |
| | | | | | | |
Total derivatives | 5,994 | | | — | | | 8 | | | 5,986 | |
Total | $ | 677,788 | | | $ | — | | | $ | 664,534 | | | $ | 13,254 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | Fair Value at Reporting Date Using |
(Dollars in thousands) | Fair Value | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) |
December 31, 2021 | | | | | | | |
Available-for-sale investment securities: | | | | | | | |
Debt securities: | | | | | | | |
States and political subdivisions | $ | 236,828 | | | $ | — | | | $ | 229,147 | | | $ | 7,681 | |
Corporate securities | 40,646 | | | — | | | 40,646 | | | — | |
U.S. Treasury obligations and direct obligations of U.S Government agencies | 35,334 | | | — | | | 35,334 | | | — | |
Mortgage-backed securities: | | | | | | | |
Residential - U.S. Government-sponsored entities ("GSEs") | 1,198,816 | | | — | | | 1,198,816 | | | — | |
Residential - Non-government sponsored entities ("Non-GSEs") | 12,213 | | | — | | | 11,275 | | | 938 | |
Commercial - U.S. GSEs and agencies | 65,849 | | | — | | | 65,849 | | | — | |
Commercial - Non-GSEs | 42,013 | | | — | | | 42,013 | | | — | |
| | | | | | | |
Total investment securities | 1,631,699 | | | — | | | 1,623,080 | | | 8,619 | |
| | | | | | | |
Derivatives: | | | | | | | |
Interest rate lock commitments | 1 | | | — | | | 1 | | | — | |
Forward sale commitments | (16) | | | — | | | — | | | (16) | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Total derivatives | (15) | | | — | | | 1 | | | (16) | |
Total | $ | 1,631,684 | | | $ | — | | | $ | 1,623,081 | | | $ | 8,603 | |
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: | | |
(Dollars in thousands) | States and Political Subdivisions | | Residential - Non-Government Agencies | | Total |
Balance as of December 31, 2020 | $ | 11,337 | | | $ | 989 | | | $ | 12,326 | |
Principal payments received | (2,841) | | | (22) | | | (2,863) | |
| | | | | |
Unrealized net loss included in other comprehensive loss | (815) | | | (29) | | | (844) | |
Balance as of December 31, 2021 | 7,681 | | | 938 | | | 8,619 | |
Principal payments received | (212) | | | (23) | | | (235) | |
| | | | | |
Unrealized net loss included in other comprehensive loss | (885) | | | (231) | | | (1,116) | |
Balance as of December 31, 2022 | $ | 6,584 | | | $ | 684 | | | $ | 7,268 | |
Within the state and political subdivisions debt securities category, the Company holds two mortgage revenue bonds issued by the City and County of Honolulu with an aggregate fair value of $6.6 million and $7.7 million at December 31, 2022 and 2021, respectively. Within the residential non-government agency available-for-sale debt securities category, the Company holds two mortgage backed bonds issued by Habitat for Humanity with an aggregate fair value of $0.7 million and $0.9 million at December 31, 2022 and 2021, respectively. The Company estimates the aggregate fair value of $7.3 million 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 and Habitat for Humanity mortgage backed bonds is the weighted-average discount rate. As of December 31, 2022, the weighted-average discount rate utilized was 6.41%, 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.
25. PARENT COMPANY AND REGULATORY RESTRICTIONS
The retained earnings of the parent company, Central Pacific Financial Corp., included $339.4 million of equity in undistributed losses of Central Pacific Bank as of December 31, 2022.
Central Pacific Bank, as a Hawaii state-chartered bank, may only pay dividends to the extent it has retained earnings as defined under Hawaii banking law ("Statutory Retained Earnings"), which differs from GAAP retained earnings. The bank had Statutory Retained Earnings of $145.7 million and $114.0 million as of December 31, 2022 and 2021, respectively. For further information, see Note 12 - Equity.
The Company and the bank are subject to various regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.
The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. banks ("Basel III rules") became effective for the Company on January 1, 2015, and were fully phased in on January 1, 2019. Under the Basel III rules, the Company must hold a "capital conservation buffer" above the adequately capitalized risk-based capital ratios. The capital conservation buffer was phased in at the rate of 0.625% per year from 0.625% in 2016 to 2.50% on January 1, 2019. The capital conservation buffer for 2019, 2018 and 2017 was 2.50%, 1.875% and 1.25%, respectively. The net unrealized gain or loss on investment securities is not included in computing regulatory capital. Management believes the Company and bank met all capital adequacy requirements to which they are subject as of December 31, 2022.
Prompt corrective action regulations provide five classifications: well-capitalized, adequately capitalized, under-capitalized, significantly under-capitalized, and critically under-capitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If under-capitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. The bank was categorized as "well-capitalized" and maintained the required capital conservation buffer under the regulatory framework for prompt corrective action as of December 31, 2022 and 2021. There are no conditions or events since then that management believes have changed the institution’s category.
The following table sets forth actual and required capital and capital ratios for the Company and the bank, as well as the minimum capital adequacy requirements applicable generally to all financial institutions as of the dates indicated.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Actual | | Minimum required for capital adequacy purposes | | Minimum required to be well-capitalized |
(Dollars in thousands) | Amount | | Ratio | | Amount | | Ratio (1) | | Amount | | Ratio |
Company | | | | | | | | | | | |
As of December 31, 2022 | | | | | | | | | | | |
Tier 1 capital to avg. assets (leverage ratio) | $ | 642,302 | | | 8.5 | % | | $ | 301,053 | | | 4.0 | % | | | | N/A |
Tier 1 capital to risk-weighted assets | 642,302 | | | 11.3 | | | 340,151 | | | 6.0 | | | | | N/A |
Total capital to risk-weighted assets | 764,283 | | | 13.5 | | | 453,535 | | | 8.0 | | | | | N/A |
Common equity tier 1 ("CET1") capital to risk-weighted assets | 592,302 | | | 10.5 | | | 255,113 | | | 4.5 | | | | | N/A |
| | | | | | | | | | | |
As of December 31, 2021 | | | | | | | | | | | |
Tier 1 capital to avg. assets (leverage ratio) | 622,130 | | | 8.5 | | | 293,382 | | | 4.0 | | | | | N/A |
Tier 1 capital to risk-weighted assets | 622,130 | | | 12.2 | | | 307,215 | | | 6.0 | | | | | N/A |
Total capital to risk-weighted assets | 741,291 | | | 14.5 | | | 409,620 | | | 8.0 | | | | | N/A |
CET1 capital to risk-weighted assets | 572,130 | | | 11.2 | | | 230,411 | | | 4.5 | | | | | N/A |
| | | | | | | | | | | |
Central Pacific Bank | | | | | | | | | | | |
As of December 31, 2022 | | | | | | | | | | | |
Tier 1 capital to avg. assets (leverage ratio) | $ | 675,331 | | | 9.0 | % | | $ | 300,584 | | | 4.0 | % | | $ | 375,730 | | | 5.0 | % |
Tier 1 capital to risk-weighted assets | 675,331 | | | 11.9 | | | 339,422 | | | 6.0 | | | 452,563 | | | 8.0 | |
Total capital to risk-weighted assets | 742,312 | | | 13.1 | | | 452,563 | | | 8.0 | | | 565,704 | | | 10.0 | |
CET1 capital to risk-weighted assets | 675,331 | | | 11.9 | | | 254,567 | | | 4.5 | | | 367,708 | | | 6.5 | |
| | | | | | | | | | | |
As of December 31, 2021 | | | | | | | | | | | |
Tier 1 capital to avg. assets (leverage ratio) | 652,987 | | | 8.9 | | | 292,877 | | | 4.0 | | | 366,096 | | | 5.0 | |
Tier 1 capital to risk-weighted assets | 652,987 | | | 12.8 | | | 306,497 | | | 6.0 | | | 408,663 | | | 8.0 | |
Total capital to risk-weighted assets | 717,000 | | | 14.0 | | | 408,663 | | | 8.0 | | | 510,828 | | | 10.0 | |
CET1 capital to risk-weighted assets | 652,987 | | | 12.8 | | | 229,873 | | | 4.5 | | | 332,038 | | | 6.5 | |
| | | | | | | | | | | |
(1) Under the Basel III Capital Rules, the Company and the bank must also maintain the required Capital Conservation Buffer ("CCB") to avoid becoming subject to restrictions on capital distributions and certain discretionary bonus payments to management. The CCB is calculated as a ratio of CET1 capital to risk-weighted assets, and effectively increases the required minimum risk-based capital ratios. The CCB requirement was phased in over a three-year period that began on January 1, 2016. The phase-in period ended on January 1, 2019, and the CCB is now at its fully phased-in level of 2.5%. |
Condensed financial statements of the parent company are as follows:
CENTRAL PACIFIC FINANCIAL CORP.
CONDENSED BALANCE SHEETS
| | | | | | | | | | | |
| December 31, |
(Dollars in thousands) | 2022 | | 2021 |
Assets | | | |
Cash and cash equivalents | $ | 16,915 | | | $ | 20,090 | |
| | | |
Investment in subsidiary bank | 534,817 | | | 639,050 | |
| | | |
Other assets | 14,442 | | | 12,029 | |
Total assets | $ | 566,174 | | | $ | 671,169 | |
| | | |
Liabilities and Equity | | | |
Long-term debt | $ | 105,859 | | | $ | 105,616 | |
Other liabilities | 7,444 | | | 7,334 | |
Total liabilities | 113,303 | | | 112,950 | |
| | | |
Shareholders’ equity: | | | |
Preferred stock, no par value, authorized 1,000,000 shares; issued and outstanding none at December 31, 2022 and 2021 | — | | | — | |
Common stock, no par value, authorized 185,000,000 shares; issued and outstanding 27,025,070 and 27,714,071 shares at December 31, 2022 and 2021, respectively | 408,071 | | | 433,263 | |
Additional paid-in capital | 101,346 | | | 98,073 | |
Retained earnings | 87,438 | | | 34,843 | |
Accumulated other comprehensive loss | (143,984) | | | (7,960) | |
Total shareholders’ equity | 452,871 | | | 558,219 | |
| | | |
Total equity | 452,871 | | | 558,219 | |
| | | |
Total liabilities and equity | $ | 566,174 | | | $ | 671,169 | |
CENTRAL PACIFIC FINANCIAL CORP.
CONDENSED STATEMENTS OF INCOME
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Income: | | | | | |
Dividends from subsidiary bank | $ | 47,427 | | | $ | 54,016 | | | $ | 24,015 | |
Interest income: | | | | | |
Interest income from subsidiary bank | 3 | | | 3 | | | 4 | |
Other income | 64 | | | 43 | | | 52 | |
Total income | 47,494 | | | 54,062 | | | 24,071 | |
| | | | | |
Expense: | | | | | |
Interest expense on long-term debt | 4,930 | | | 4,097 | | | 2,095 | |
Other expenses | 2,317 | | | 3,504 | | | 1,293 | |
Total expenses | 7,247 | | | 7,601 | | | 3,388 | |
| | | | | |
Income before income taxes and equity in undistributed income of subsidiaries | 40,247 | | | 46,461 | | | 20,683 | |
Income tax expense (benefit) | (1,917) | | | (1,968) | | | (690) | |
Income before equity in undistributed income of subsidiaries | 42,164 | | | 48,429 | | | 21,373 | |
| | | | | |
Equity in undistributed income of subsidiary bank | 31,764 | | | 31,465 | | | 15,900 | |
| | | | | |
Net income | $ | 73,928 | | | $ | 79,894 | | | $ | 37,273 | |
CENTRAL PACIFIC FINANCIAL CORP.
CONDENSED STATEMENTS OF CASH FLOWS
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
(Dollars in thousands) | 2022 | | 2021 | | 2020 |
Cash flows from operating activities: | | | | | |
Net income | $ | 73,928 | | | $ | 79,894 | | | $ | 37,273 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Deferred income tax expense (benefit) | (26) | | | 70 | | | 2,552 | |
| | | | | |
Equity in undistributed income of subsidiary bank | (31,764) | | | (31,465) | | | (15,900) | |
| | | | | |
Share-based compensation expense | 3,273 | | | 3,231 | | | 3,231 | |
| | | | | |
Net change in other assets and liabilities | (20) | | | (85) | | | (3,010) | |
Net cash provided by operating activities | 45,391 | | | 51,645 | | | 24,146 | |
| | | | | |
Cash flows from investing activities: | | | | | |
Contributions to subsidiary bank | — | | | — | | | (46,750) | |
Proceeds from sale of investment securities | — | | | 1,653 | | | — | |
| | | | | |
| | | | | |
Net cash provided by (used in) investing activities | — | | | 1,653 | | | (46,750) | |
| | | | | |
Cash flows from financing activities: | | | | | |
Net proceeds from issuance of common stock and stock option exercises | 679 | | | 1,236 | | | — | |
Net proceeds from subordinated debt | — | | | — | | | 53,838 | |
| | | | | |
Repurchases of common stock | (20,740) | | | (18,669) | | | (4,749) | |
Cash dividends paid on common stock | (28,505) | | | (26,959) | | | (25,935) | |
Net cash (used in) provided by financing activities | (48,566) | | | (44,392) | | | 23,154 | |
| | | | | |
Net (decrease) increase in cash and cash equivalents | (3,175) | | | 8,906 | | | 550 | |
| | | | | |
Cash and cash equivalents at beginning of year | 20,090 | | | 11,184 | | | 10,634 | |
Cash and cash equivalents at end of year | $ | 16,915 | | | $ | 20,090 | | | $ | 11,184 | |
26. SUBSEQUENT EVENTS
In January 2023, the Board of Directors authorized the repurchase of up to $25.0 million of its common stock from time to time in the open market or in privately negotiated transactions, pursuant to a newly authorized share repurchase program. The share repurchase program replaced and superseded in its entirety the 2022 Repurchase Plan. The 2022 Repurchase Plan had $10.3 million in remaining repurchase authority as of December 31, 2022.
In accordance with the Inflation Reduction Act of 2022, beginning January 1, 2023, an excise tax of 1% on the aggregate fair value of stock repurchased less the fair value of stock issued will be imposed if repurchases of stock exceed $1 million over the course of the year.