NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements of Central Pacific Financial Corp. and Subsidiaries (herein referred to as the "Company," "we," "us," or "our") have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.
These interim condensed consolidated financial statements and notes should be read in conjunction with the Company's consolidated financial statements and notes thereto filed on Form 10-K for the fiscal year ended December 31, 2022. In the opinion of management, all adjustments necessary for a fair presentation have been made and include all normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year.
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, we acquired a 50% ownership interest in a mortgage loan origination and brokerage company, Oahu HomeLoans, LLC. The bank concluded that the entity met the definition of a variable interest entity ("VIE") and that the Bank was the primary beneficiary of the VIE. As a result, the investment met the consolidation requirements under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 810, "Consolidation." Accordingly, the investment has been consolidated into our financial statements. In March 2022, Oahu HomeLoans, LLC was terminated.
The Company 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: Gentry HomeLoans, LLC, Haseko HomeLoans, LLC and Island Pacific HomeLoans, LLC.
The Company 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.
During the first quarter of 2022, the Company invested $2.0 million in Swell Financial, Inc. ("Swell"), a new fintech company, 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 of its waitlist were invited to sign up for Swell Cash and Credit. In addition, the Company is also collaborating with Swell and Elevate Credit, Inc. (NYSE: ELVT), a provider of digital solutions. In the first quarter of 2023, Elevate was 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 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 that the cost method for the investment was appropriate. The investment is included in investment in unconsolidated entities. The Company had $1.1 million and $1.3 million in unfunded commitments related to the investment as of March 31, 2023 and December 31, 2022, respectively.
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.
Investments in unconsolidated entities accounted for under the equity, proportional amortization and cost methods were $0.1 million, $40.2 million and $5.6 million, respectively, at March 31, 2023 and $0.1 million, $40.9 million and $5.6 million, respectively, at December 31, 2022. The Company's 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.
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 AOC and 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, which 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 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 (with no minimum credit rating), non-agency residential MBS (with a minimum credit rating of AAA) and non-agency commercial MBS (with a minimum credit rating of BBB and meets the 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 (with a minimum credit rating of BBB), and corporate bonds (with a minimum credit rating of BBB-).
Interest income on investment securities includes amortization of premiums and accretion of discounts. We amortize premiums and accrete discounts 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 March 31, 2023 and the Company did not reverse any accrued interest against interest income during the three months ended March 31, 2023.
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 if 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 impairment that has not been recorded through an ACL is recognized in AOCI.
Changes in the ACL are recorded as a provision for (or reversal of) 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 March 31, 2023, the decline in market values of our AFS debt securities was primarily attributable to changes in interest rates and volatility in the financial markets. We have no intent to sell securities in an unrealized loss position and it is unlikely we will be required to sell such securities before recovery of its amortized cost basis. Therefore, we did not record any ACL as a result of credit loss.
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 on AFS debt securities together with accrued interest receivable on HTM securities and loans in the consolidated balance sheets. Accrued interest receivable on AFS debt securities totaled $2.9 million and $3.1 million as of March 31, 2023 and December 31, 2022, 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 and $1.3 million as of March 31, 2023 and December 31, 2022, respectively.
Federal Home Loan Bank Stock
As 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 FHLB capital stock equal to the sum of a membership investment requirement and an activity-based investment requirement. The securities are reported at cost and are presented separately in the consolidated balance sheets.
Loans
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 the yield and typically 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 $16.3 million and $16.0 million at March 31, 2023 and December 31, 2022, respectively, and is reported together with accrued interest on HTM and AFS debt securities on the consolidated balance sheets. Upon adoption of 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”) Prior to the Adoption of ASU 2022-02
The Company adopted ASU No. 2022-02, "Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures", using the prospective transition method. Thus, the Company will continue to account for existing TDRs under the TDR accounting guidance and all new loan modifications will be accounted for under the new loan modification accounting model as described in Note 2 - Recent Accounting Pronouncements.
Prior to the adoption of ASU 2022-02, on January 1, 2023, the Company accounted for and reported a loan as a TDR when two conditions were met: 1) the borrower was experiencing financial difficulty and 2) the Company granted 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 resulted in only an insignificant delay in payment was not considered a concession. A delay may have been considered insignificant if 1) the payments subject to the delay were insignificant relative to the unpaid principal or collateral value and the contractual amount due or 2) the delay in timing of the restructured payment period was insignificant relative to the frequency of payments, the debt’s original contractual maturity or original expected duration.
TDRs that were performing and on accrual status as of the date of the modification remained on accrual status. TDRs that were nonperforming as of the date of modification generally remained as nonaccrual until the prospect of future payments in accordance with the modified loan agreement was reasonably assured and generally demonstrated when the borrower maintained compliance with the restructured terms for a predetermined period of at least six months. TDRs with temporary below-market concessions remained designated as a TDR regardless of the accrual or performance status until the loan was paid off.
Expected credit losses are estimated on a collective (pool) basis when they share similar risk characteristics. A TDR financial asset was evaluated with other financial assets on a collective basis if it shared similar characteristics with other financial assets and individually evaluated if it did not share similar risk characteristics with other financial assets. The Company’s ACL reflects all effects of a TDR when an individual asset is specifically identified as a reasonably expected TDR. The Company determined a TDR was reasonably expected no later than the point at which the lender concluded that a modification was the best course of action and it was at least reasonably possible for the troubled borrower to accept some form of concession from the lender to avoid a default. Reasonably expected TDRs and executed TDRs were evaluated to determine the required ACL using the same method as all other loans held for investment, except when the value of a concession could not be measured using a method other than the discounted cash flow method. When the value of a concession was measured using the discounted cash flow method, the ACL was 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 during 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 will be incurred and the Company can make a reasonable estimate of the loss. In these instances, the likelihood and/or time frame of recovery for 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 adjustments 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, or other internal and external factors.
The Company uses the Moody’s Analytics Baseline forecast service for its economic forecast assumption. 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 as it is reasonable and supportable. It is updated at least monthly with 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 accounts for 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 the most appropriate risk ratings or bands of payment delinquency (including TDR or non-accrual status) 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 that 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.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| 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 | | |
| | | | | | | | |
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
Commercial, financial and agricultural loans 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. Although our underwriting policy and practice generally requires secondary sources of support or collateral to mitigate risk, the borrower’s business is typically regarded as the principal source of repayment.
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 secured by single family owner-occupied primary residences in Hawaii. Economic conditions such as unemployment levels, future changes in interest rates, Hawaii home prices 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 primarily 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 (term) loans, including auto 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/Loss Given Default ("PD/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, loans modified for borrowers experiencing financial difficulty, TDRs prior to the adoption of ASU 2022-02 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, loans modified for borrowers experiencing financial difficulty, TDRs prior to the adoption of ASU 2022-02 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 of the loan. The methodology considers historical loss experience and 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 the discounted cash flow (“DCF”) method. Individually evaluated loans are not included in the collective evaluation.
Determining the Term
Expected credit losses are estimated over the contractual term of the loans and are adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: 1) management has a reasonable expectation at the reporting date that a modification will be executed with an individual borrower or 2) 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 on the Company’s consolidated balance sheets. The Company estimates the amount of expected losses (excluding commitments identified as unconditionally cancellable) 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 reserve for off-balance sheet credit exposures 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. Changes in the reserve for off-balance sheet credit exposures is recorded as a provision for credit losses on off-balance sheet credit exposures, which is included in the provision for credit losses on the Company's statement of income.
2. RECENT ACCOUNTING PRONOUNCEMENTS
Accounting Standards Adopted in 2023
In March 2022, the FASB issued ASU No. 2022-01, "Derivatives and Hedging (Topic 815): Fair Value Hedging—Portfolio Layer Method", which clarifies the guidance on fair value hedge accounting of interest rate risk portfolios of financial assets. ASU 2022-01 updates guidance in Topic 815, to expand the scope of the current last-of-layer method to 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. Additionally, ASU 2022-01 clarifies that basis adjustments related to existing portfolio layer hedge relationships should not be considered when measuring credit losses on the financial assets included in the closed portfolio. Further, ASU 2022-01 clarifies that any reversal of fair value hedge basis adjustments associated with an actual breach should be recognized in interest income immediately. ASU 2022-01 was effective for fiscal years beginning after December 15, 2022, with early adoption permitted. The Company adopted ASU 2022-01 effective January 1, 2023 and it did not have an impact on our consolidated financial statements as 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 TDR accounting guidance 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. Instead of applying the recognition and measurement guidance for TDRs, an entity would apply the loan refinancing and restructuring guidance to determine whether a modification or other form of restructuring results in a new loan or a continuation of an existing loan. Additionally, the amendments in ASU 2022-02 require that an entity disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases in the existing vintage disclosures within the scope of Subtopic 326-20, Financial Instruments—Credit Losses—Measured at Amortized Cost. ASU 2022-02 was effective for fiscal years beginning after December 15, 2022, with early adoption permitted. ASU 2022-02 requires prospective transition for disclosures related to loan restructurings for borrowers experiencing financial difficulty and the presentation of current-period gross write-offs by year of origination while removing the presentation of current-period recoveries and net write-off from the vintage disclosure for charge-offs. The guidance related to the recognition and measurement of existing TDRs and new loan modifications or restructurings may be adopted on a prospective or modified retrospective transition method. The Company adopted ASU 2022-02 effective January 1, 2023 using the prospective transition method.
As of our adoption date, loan modifications or restructurings for borrowers experiencing financial difficulty are evaluated to determine whether they result in a new loan or a continuation of an existing loan. Loan restructurings for borrowers experiencing financial difficulty are generally accounted for as a continuation of the existing loan as the terms of the restructured loans are typically not at market rates. At adoption of this guidance on January 1, 2023, there was no material impact on our financial statements.
When a loan is restructured under ASU 2022-02, we continue to measure impairment on the loan using the discounted cash flow method that utilizes a prepayment-adjusted discount rate based on the loan’s restructured terms. Under the TDR accounting model, we used the discount rate that was in effect prior to the restructuring to measure impairment. Using the interest rate that was in effect prior to the restructuring resulted in the recognition, in the allowance for credit losses, of the economic concession that we granted to borrowers as part of the loan restructuring. Using a post-restructuring interest rate does not result in the recognition of an economic concession in the allowance for credit losses.
As we have elected a prospective transition, the economic concession on a loan that was previously restructured and accounted for as a TDR will continue to be measured in our allowance for credit losses using the discount rate that was in effect prior to the restructuring and the economic concession may increase or decrease as we update our cash flow assumptions related to the expected life of the loan. Further, the component of the allowance for credit losses representing economic concessions will decrease as the borrower makes payments in accordance with the restructured terms of the mortgage loan and as the loan is sold, liquidated, or subsequently restructured.
We adopted the disclosure guidance related to the presentation of gross write-offs by year of origination in our vintage disclosures on January 1, 2023.
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 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.
3. INVESTMENT SECURITIES
The amortized cost, fair value and related ACL, and corresponding gross unrecognized or unrealized gains and losses on HTM and AFS debt securities at March 31, 2023 and December 31, 2022 are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value | | ACL |
| (dollars in thousands) | | | | | |
| March 31, 2023 | | | | | |
| Held-to-maturity: | | | | | | | | | | |
| Debt securities: | | | | | | | | | | |
| States and political subdivisions | | $ | 41,867 | | | $ | — | | | $ | (4,746) | | | $ | 37,121 | | | $ | — | |
| | | | | | | | | | |
| | | | | | | | | | |
| Mortgage-backed securities: | | | | | | | | | | |
| Residential - U.S. Government-sponsored entities | | 616,729 | | | 145 | | | (54,695) | | | 562,179 | | | — | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
| Total held-to-maturity securities | | $ | 658,596 | | | $ | 145 | | | $ | (59,441) | | | $ | 599,300 | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value | | ACL |
| (dollars in thousands) | | | | | |
| March 31, 2023 | | | | | |
| Available-for-sale: | | | | | | | | | | |
| Debt securities: | | | | | | | | | | |
| States and political subdivisions | | $ | 170,628 | | | $ | 26 | | | $ | (31,133) | | | $ | 139,521 | | | $ | — | |
| Corporate securities | | 36,087 | | | — | | | (4,990) | | | 31,097 | | | — | |
| U.S. Treasury obligations and direct obligations of U.S. Government agencies | | 26,533 | | | 5 | | | (2,195) | | | 24,343 | | | — | |
| Mortgage-backed securities: | | | | | | | | | | |
| Residential - U.S. Government-sponsored entities | | 488,550 | | | — | | | (67,066) | | | 421,484 | | | — | |
| Residential - Non-government agencies | | 9,614 | | | — | | | (977) | | | 8,637 | | | — | |
| Commercial - U.S. Government-sponsored entities | | 53,597 | | | — | | | (7,797) | | | 45,800 | | | — | |
| Commercial - Non-government agencies | | 16,497 | | | — | | | (191) | | | 16,306 | | | — | |
| Total available-for-sale securities | | $ | 801,506 | | | $ | 31 | | | $ | (114,349) | | | $ | 687,188 | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value | | ACL |
| (dollars in thousands) | | | | | |
| December 31, 2022 | | | | | |
| Held-to-maturity: | | | | | | | | | | |
| Debt securities: | | | | | | | | | | |
| States and political subdivisions | | $ | 41,840 | | | $ | — | | | $ | (4,727) | | | $ | 37,113 | | | $ | — | |
| Corporate securities | | — | | | — | | | — | | | — | | | — | |
| U.S. Treasury obligations and direct obligations of U.S. Government agencies | | — | | | — | | | — | | | — | | | — | |
| Mortgage-backed securities: | | | | | | | | | | |
| Residential - U.S. Government-sponsored entities | | 623,043 | | | — | | | (63,376) | | | 559,667 | | | — | |
| Residential - Non-government agencies | | — | | | — | | | — | | | — | | | — | |
| Commercial - U.S. Government-sponsored entities | | — | | | — | | | — | | | — | | | — | |
| Commercial - Non-government agencies | | — | | | — | | | — | | | — | | | — | |
| Total held-to-maturity securities | | $ | 664,883 | | | $ | — | | | $ | (68,103) | | | $ | 596,780 | | | $ | — | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value | | ACL |
| (dollars in thousands) | | | | | |
| December 31, 2022 | | | | | |
| 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 | | 498,989 | | | — | | | (75,186) | | | 423,803 | | | — | |
| Residential - Non-government agencies | | 9,829 | | | — | | | (1,167) | | | 8,662 | | | — | |
| Commercial - U.S. Government-sponsored entities | | 54,346 | | | — | | | (8,202) | | | 46,144 | | | — | |
| Commercial - Non-government agencies | | 1,541 | | | — | | | (34) | | | 1,507 | | | — | |
| Total available-for-sale securities | | $ | 801,370 | | | $ | 6 | | | $ | (129,582) | | | $ | 671,794 | | | $ | — | |
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.
During the three months ended March 31, 2023, the Company recorded a total of $1.7 million in amortization of unrecognized losses on the aforementioned investment securities transferred from AFS to HTM. As of March 31, 2023, the Company has recorded a total of $7.9 million in amortization of unrecognized losses on the aforementioned investment securities transferred from AFS to HTM.
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, estimated fair value and weighted average yield of our HTM and AFS debt securities at March 31, 2023, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may 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.
| | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Amortized Cost | | Fair Value | | Weighted Average Yield (1) |
| Held-to-maturity: | | | | | | |
| Debt securities: | | | | | | |
| Due in one year or less | | $ | — | | | $ | — | | | — | % |
| Due after one year through five years | | — | | | — | | | — | |
| Due after five years through ten years | | — | | | — | | | — | |
| Due after ten years | | 41,867 | | | 37,121 | | | 2.26 | |
| Mortgage-backed securities: | | | | | | |
| Residential - U.S. Government-sponsored entities | | 616,729 | | | 562,179 | | | 1.94 | |
| | | | | | |
| | | | | | |
| | | | | | |
| Total held-to-maturity securities | | $ | 658,596 | | | $ | 599,300 | | | 1.96 | % |
| | | | | | |
| Available-for-sale: | | | | | | |
| Debt securities: | | | | | | |
| Due in one year or less | | $ | 5,185 | | | $ | 5,171 | | | 3.01 | % |
| Due after one year through five years | | 16,601 | | | 16,323 | | | 3.90 | |
| Due after five years through ten years | | 76,927 | | | 69,210 | | | 2.68 | |
| Due after ten years | | 134,535 | | | 104,257 | | | 2.48 | |
| Mortgage-backed securities: | | | | | | |
| Residential - U.S. Government-sponsored entities | | 488,550 | | | 421,484 | | | 2.04 | |
| Residential - Non-government agencies | | 9,614 | | | 8,637 | | | 3.32 | |
| Commercial - U.S. Government-sponsored entities | | 53,597 | | | 45,800 | | | 2.35 | |
| Commercial - Non-government agencies | | 16,497 | | | 16,306 | | | 5.05 | |
| Total available-for-sale securities | | $ | 801,506 | | | $ | 687,188 | | | 2.33 | % |
| | | | | | |
(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%
During three months ended March 31, 2023, the Company did not sell any investment securities. In 2022, the Company completed one sale of investment securities for its Class B common stock of Visa during the second quarter and is discussed later in this footnote.
Investment securities with carrying values totaling $699.6 million and $607.7 million at March 31, 2023 and December 31, 2022, respectively, were pledged to secure public funds on deposit and other financial transactions.
At March 31, 2023 and December 31, 2022, there were no holdings of investment securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders' equity.
There were a total of 81 and 83 HTM investment securities which were in an unrecognized loss position, without an ACL, at March 31, 2023 and December 31, 2022, respectively. There were a total of 236 and 243 AFS investment securities which were in an unrealized loss position, without an ACL, at March 31, 2023 and December 31, 2022, respectively.
The following tables summarize HTM and AFS investment securities, which were in an unrecognized or unrealized loss position at March 31, 2023 and December 31, 2022, aggregated by major security type and length of time in a continuous unrecognized or unrealized loss position.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than 12 Months | | 12 Months or Longer | | Total |
| (dollars in thousands) | | Fair Value | | Unrecognized Losses | | Fair Value | | Unrecognized Losses | | Fair Value | | Unrecognized Losses |
| March 31, 2023 | | | | | | |
| Held-to-maturity: | | | | | | | | | | | | |
| Debt securities: | | | | | | | | | | | | |
| States and political subdivisions | | $ | — | | | $ | — | | | $ | 37,121 | | | $ | (4,746) | | | $ | 37,121 | | | $ | (4,746) | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Mortgage-backed securities: | | | | | | | | | | | | |
| Residential - U.S. Government-sponsored entities | | 305,007 | | | (20,724) | | | 237,643 | | | (33,971) | | | 542,650 | | | (54,695) | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Total temporarily impaired securities | | $ | 305,007 | | | $ | (20,724) | | | $ | 274,764 | | | $ | (38,717) | | | $ | 579,771 | | | $ | (59,441) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than 12 Months | | 12 Months or Longer | | Total |
| (dollars in thousands) | | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses |
| March 31, 2023 | | | | | | |
| Available-for-sale: | | | | | | | | | | | | |
| Debt securities: | | | | | | | | | | | | |
| States and political subdivisions | | $ | 13,008 | | | $ | (307) | | | $ | 114,337 | | | $ | (30,826) | | | $ | 127,345 | | | $ | (31,133) | |
| Corporate securities | | — | | | — | | | 31,097 | | | (4,990) | | | 31,097 | | | (4,990) | |
| U.S. Treasury obligations and direct obligations of U.S Government agencies | | 5,749 | | | (140) | | | 17,011 | | | (2,055) | | | 22,760 | | | (2,195) | |
| Mortgage-backed securities: | | | | | | | | | | | | |
| Residential - U.S. Government-sponsored entities | | 9,673 | | | (240) | | | 411,811 | | | (66,826) | | | 421,484 | | | (67,066) | |
| Residential - Non-government agencies | | 2,843 | | | (274) | | | 5,795 | | | (703) | | | 8,638 | | | (977) | |
| Commercial - U.S. Government-sponsored entities | | — | | | — | | | 45,800 | | | (7,797) | | | 45,800 | | | (7,797) | |
| Commercial - Non-government agencies | | 16,306 | | | (191) | | | — | | | — | | | 16,306 | | | (191) | |
| Total temporarily impaired securities | | $ | 47,579 | | | $ | (1,152) | | | $ | 625,851 | | | $ | (113,197) | | | $ | 673,430 | | | $ | (114,349) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than 12 Months | | 12 Months or Longer | | Total |
| (dollars in thousands) | | Fair Value | | Unrecognized Losses | | Fair Value | | Unrecognized Losses | | Fair Value | | Unrecognized Losses |
| December 31, 2022 | | | | | | |
| Held-to-maturity: | | | | | | | | | | | | |
| Debt securities: | | | | | | | | | | | | |
| States and political subdivisions | | $ | 37,113 | | | $ | (4,727) | | | $ | — | | | $ | — | | | $ | 37,113 | | | $ | (4,727) | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Mortgage-backed securities: | | | | | | | | | | | | |
| Residential - U.S. Government-sponsored entities | | 559,667 | | | (63,376) | | | — | | | — | | | 559,667 | | | (63,376) | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Total temporarily impaired securities | | $ | 596,780 | | | $ | (68,103) | | | $ | — | | | $ | — | | | $ | 596,780 | | | $ | (68,103) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than 12 Months | | 12 Months or Longer | | Total |
| (dollars in thousands) | | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses |
| 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) | |
| Mortgage-backed securities: | | | | | | | | | | | | |
| Residential - U.S. Government-sponsored entities | | 149,624 | | | (13,990) | | | 274,179 | | | (61,196) | | | 423,803 | | | (75,186) | |
| Residential - Non-government agencies | | 2,890 | | | (334) | | | 5,772 | | | (833) | | | 8,662 | | | (1,167) | |
| Commercial - U.S. Government-sponsored entities | | 25,034 | | | (1,724) | | | 21,110 | | | (6,478) | | | 46,144 | | | (8,202) | |
| Commercial - Non-government agencies | | 1,506 | | | (34) | | | — | | | — | | | 1,506 | | | (34) | |
| Total temporarily impaired securities | | $ | 240,949 | | | $ | (21,134) | | | $ | 425,202 | | | $ | (108,448) | | | $ | 666,151 | | | $ | (129,582) | |
Investment securities in an unrecognized or 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 HTM and AFS investment securities that are in an unrecognized or unrealized loss position and has determined that the unrecognized or 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 unrecognized or unrealized loss position continue to be rated investment grade by one or more major rating agencies. As the Company does not intend to sell the HTM and AFS securities that are in an unrecognized or unrealized loss position and it is unlikely that we will be required to sell these securities before recovery of its amortized cost basis that may be at maturity, the Company has not recorded an ACL on these securities and the unrecognized or unrealized losses on these securities have not been recognized into income.
Visa Class B Common Stock
During the second quarter of 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 March 31, 2023, the Company no longer owns 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 could 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 in 2022.
4. LOANS AND CREDIT QUALITY
The following table presents loans by class, excluding loans held for sale, net of ACL as of March 31, 2023 and December 31, 2022:
| | | | | | | | | | | |
| (dollars in thousands) | March 31, 2023 | | December 31, 2022 |
| Commercial, financial and agricultural: | | | |
| Small Business Administration Paycheck Protection Program | $ | 1,883 | | | $ | 2,654 | |
| Other | 555,508 | | | 544,495 | |
| Real estate: | | | |
| Construction | 182,091 | | | 167,366 | |
| Residential mortgage | 1,940,639 | | | 1,940,456 | |
| Home equity | 741,894 | | | 737,386 | |
| Commercial mortgage | 1,363,507 | | | 1,364,998 | |
| Consumer | 772,424 | | | 798,957 | |
| | | |
| Gross loans | 5,557,946 | | | 5,556,312 | |
| Net deferred fees | (549) | | | (846) | |
| Total loans, net of deferred fees and costs | 5,557,397 | | | 5,555,466 | |
| Allowance for credit losses | (63,099) | | | (63,738) | |
| Total loans, net of allowance for credit losses | $ | 5,494,298 | | | $ | 5,491,728 | |
| | | |
The Company did not transfer any loans to the held-for-sale category during the three months ended March 31, 2023 and 2022.
The Company did not sell any loans originally held for investment during the three months ended March 31, 2023 and 2022.
As of March 31, 2023 and December 31, 2022, the Company did not have any loans categorized as purchased credit deteriorated, or "PCD".
The following table presents loans purchased by class during the periods presented:
| | | | | | | | | | | | | | | | | |
| (dollars in thousands) | U.S. Mainland Consumer - Unsecured | | U.S. Mainland Consumer - Automobile | | Total |
| Three Months Ended March 31, 2023 | | | | | |
| Purchases: | | | | | |
| Outstanding balance | $ | 3,780 | | | $ | 15,159 | | | $ | 18,939 | |
| (Discount) premium | — | | | 568 | | | 568 | |
| Purchase price | $ | 3,780 | | | $ | 15,727 | | | $ | 19,507 | |
| | | | | |
| Three Months Ended March 31, 2022 | | | | | |
| Purchases: | | | | | |
| Outstanding balance | $ | 48,142 | | | $ | 34,024 | | | $ | 82,166 | |
| (Discount) premium | (4,367) | | | 1,914 | | | (2,453) | |
| Purchase price | $ | 43,775 | | | $ | 35,938 | | | $ | 79,713 | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| Note: Purchases of unsecured consumer loans were made under forward flow purchase agreements. |
Foreclosure Proceedings
The Company had $1.4 million and $2.4 million of residential mortgage loans collateralized by residential real estate property that were in the process of foreclosure at March 31, 2023 and December 31, 2022, respectively.
The Company did not foreclose on any loans during the three months ended March 31, 2023 and 2022.
The Company did not sell any foreclosed properties during the three months ended March 31, 2023 and 2022.
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 March 31, 2023 and December 31, 2022. The following tables also present the amortized cost of loans on nonaccrual status for which there was no related ACL under ASC 326 as of March 31, 2023 and December 31, 2022.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | Accruing
Loans
30 - 59 Days
Past Due | | Accruing
Loans
60 - 89 Days
Past Due | | Accruing
Loans
Greater
Than
90 Days
Past Due | | Nonaccrual
Loans | | Total
Past Due
and
Nonaccrual | | Loans Not
Past Due | | Total Loans | | Nonaccrual
Loans
With
No ACL |
| March 31, 2023 | | | | | | | | | | | | | | | |
| Commercial, financial and agricultural: | | | | | | | | | | | | | | | |
| SBA PPP | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 1,821 | | | $ | 1,821 | | | $ | — | |
| Other | 1,114 | | | — | | | — | | | 264 | | | 1,378 | | | 553,686 | | | 555,064 | | | — | |
| Real estate: | | | | | | | | | | | | | | | |
| Construction | — | | | | | — | | | — | | | — | | | 181,474 | | | 181,474 | | | — | |
| Residential mortgage | 5,984 | | | 117 | | | — | | | 3,445 | | | 9,546 | | | 1,931,684 | | | 1,941,230 | | | 3,445 | |
| Home equity | 442 | | | — | | | — | | | 712 | | | 1,154 | | | 742,754 | | | 743,908 | | | 712 | |
| Commercial mortgage | — | | | — | | | — | | | 77 | | | 77 | | | 1,361,555 | | | 1,361,632 | | | 77 | |
| Consumer | 4,415 | | | 1,396 | | | 1,908 | | | 815 | | | 8,534 | | | 763,734 | | | 772,268 | | | — | |
| | | | | | | | | | | | | | | |
| Total | $ | 11,955 | | | $ | 1,513 | | | $ | 1,908 | | | $ | 5,313 | | | $ | 20,689 | | | $ | 5,536,708 | | | $ | 5,557,397 | | | $ | 4,234 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | Accruing
Loans
30 - 59 Days
Past Due | | Accruing
Loans
60 - 89 Days
Past Due | | Accruing
Loans
Greater
Than
90 Days
Past Due | | Nonaccrual
Loans | | Total
Past Due
and
Nonaccrual | | Loans Not
Past Due | | Total Loans | | Nonaccrual
Loans
With
No ACL |
| December 31, 2022 | | | | | | | | | | | | | | | |
| 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 | |
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 adoption of ASU 2022-02 under the prospective transition method eliminates the requirement to disclose collateral-dependent loans effective January 1, 2023. 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:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (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 |
| December 31, 2022 | | | | | | | | | | | |
| | | | | | | | | | | |
| Real estate: | | | | | | | | | | | |
| | | | | | | | | | | |
| Residential mortgage | $ | 5,653 | | | $ | — | | | $ | — | | | | | $ | 5,653 | | | $ | — | |
| Home equity | 570 | | | — | | | — | | | | | 570 | | | — | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Total | $ | 6,223 | | | $ | — | | | $ | — | | | | | $ | 6,223 | | | $ | — | |
| | | | | | | | | | | |
Loan Modifications for Borrowers Experiencing Financial Difficulty
Since the adoption of ASU 2022-02 on January 1, 2023 and during the three months ended March 31, 2023, the Company has not modified any material loans for borrowers experiencing financial difficulty.
Troubled Debt Restructurings Prior to the Adoption of ASU 2022-02
Prior to our adoption of ASU 2022-02, we accounted for a modification to the contractual terms of a loan that resulted in granting a concession to a borrower experiencing financial difficulties as a troubled debt restructuring ("TDR").
Loans identified as TDRs prior to our adoption of ASU 2022-02 included in nonperforming assets at March 31, 2023 consisted of five Hawaii loans with a principal balance of $1.1 million. There were $2.3 million of loans identified as TDRs prior to our adoption of ASU 2022-02 that were still accruing interest at March 31, 2023, none of which were more than 90 days delinquent. At December 31, 2022, there were $2.8 million of loans identified as TDRs prior to our adoption of ASU 2022-02 that were still accruing interest, none of which were more than 90 days delinquent.
The Company offered various types of concessions when modifying a loan. Concessions made to the original contractual terms of the loan typically consisted 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 three months ended March 31, 2023 and 2022. During the three months ended March 31, 2022, the Company did not modify any loans as a TDR prior to the adoption of ASU 2022-02.
No loans were modified as a TDR prior to the adoption of ASU 2022-02 within the previous twelve months that subsequently defaulted during the three months ended March 31, 2023 and 2022.
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. Loans that do not meet the following criteria that are analyzed individually as part of the described process are considered to be pass-rated 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. These loans 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, and in addition have weaknesses that make collection or orderly repayment in full on the basis of current existing facts, conditions and values, highly questionable and improbable. Although the possibility of loss is extremely high, its classification as an estimated loss is deferred until a more exact status may be determined due to certain important and reasonably specific factors that may work to the advantage and strengthening of the exposure.
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.
The following tables present the amortized cost basis of the Company's loans by class, credit quality indicator and origination year as of March 31, 2023 and December 31, 2022. Revolving loans converted to term as of and during the three months ended March 31, 2023 and 2022 were not material to the total loan portfolio. In addition, the following table includes gross charge-offs of loans by origination year in the three months ended March 31, 2023.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Amortized Cost of Term Loans by Year of Origination | | Amortized Cost of Revolving Loans | | |
| March 31, 2023 | | 2023 | | 2022 | | 2021 | | 2020 | | 2019 | | Prior | | | Total |
| Commercial, financial and agricultural - SBA PPP: | | | | | | | | | | | | | | | | |
| Risk Rating | | | | | | | | | | | | | | | | |
| Pass | | $ | — | | | $ | — | | | $ | — | | | $ | 1,813 | | | $ | 8 | | | $ | — | | | $ | — | | | $ | 1,821 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Subtotal | | — | | | — | | | — | | | 1,813 | | | 8 | | | — | | | — | | | 1,821 | |
| Commercial, financial and agricultural - Other: | | | | | | | | | | | | | | | | |
| Risk Rating | | | | | | | | | | | | | | | | |
| Pass | | 15,746 | | | 90,848 | | | 99,502 | | | 39,021 | | | 55,061 | | | 167,248 | | | 76,550 | | | 543,976 | |
| Special Mention | | — | | | 1,025 | | | 326 | | | 158 | | | 866 | | | 3 | | | — | | | 2,378 | |
| Substandard | | — | | | 198 | | | 191 | | | 786 | | | 223 | | | 7,213 | | | 99 | | | 8,710 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Subtotal | | 15,746 | | | 92,071 | | | 100,019 | | | 39,965 | | | 56,150 | | | 174,464 | | | 76,649 | | | 555,064 | |
| Construction: | | | | | | | | | | | | | | | | |
| Risk Rating | | | | | | | | | | | | | | | | |
| Pass | | — | | | 43,148 | | | 67,495 | | | 17,634 | | | 2,363 | | | 31,741 | | | 13,141 | | | 175,522 | |
| | | | | | | | | | | | | | | | |
| Substandard | | — | | | — | | | 5,264 | | | — | | | 688 | | | — | | | — | | | 5,952 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Subtotal | | — | | | 43,148 | | | 72,759 | | | 17,634 | | | 3,051 | | | 31,741 | | | 13,141 | | | 181,474 | |
| Residential mortgage: | | | | | | | | | | | | | | | | |
| Risk Rating | | | | | | | | | | | | | | | | |
| Pass | | 27,065 | | | 276,052 | | | 631,544 | | | 430,081 | | | 153,042 | | | 419,060 | | | — | | | 1,936,844 | |
| | | | | | | | | | | | | | | | |
| Substandard | | — | | | — | | | — | | | 941 | | | — | | | 3,445 | | | — | | | 4,386 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Subtotal | | 27,065 | | | 276,052 | | | 631,544 | | | 431,022 | | | 153,042 | | | 422,505 | | | — | | | 1,941,230 | |
| Home equity: | | | | | | | | | | | | | | | | |
| Risk Rating | | | | | | | | | | | | | | | | |
| Pass | | 2,621 | | | 34,091 | | | 22,823 | | | 10,251 | | | 7,066 | | | 19,154 | | | 647,191 | | | 743,197 | |
| | | | | | | | | | | | | | | | |
| Substandard | | — | | | — | | | — | | | — | | | 73 | | | 638 | | | — | | | 711 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Subtotal | | 2,621 | | | 34,091 | | | 22,823 | | | 10,251 | | | 7,139 | | | 19,792 | | | 647,191 | | | 743,908 | |
| Commercial mortgage: | | | | | | | | | | | | | | | | |
| Risk Rating | | | | | | | | | | | | | | | | |
| Pass | | 6,236 | | | 235,341 | | | 207,258 | | | 118,627 | | | 115,426 | | | 623,358 | | | 8,915 | | | 1,315,161 | |
| Special Mention | | — | | | — | | | — | | | — | | | 11,169 | | | 13,174 | | | — | | | 24,343 | |
| Substandard | | — | | | — | | | 10,140 | | | — | | | 1,691 | | | 10,297 | | | — | | | 22,128 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Subtotal | | 6,236 | | | 235,341 | | | 217,398 | | | 118,627 | | | 128,286 | | | 646,829 | | | 8,915 | | | 1,361,632 | |
| Consumer: | | | | | | | | | | | | | | | | |
| Risk Rating | | | | | | | | | | | | | | | | |
| Pass | | 22,455 | | | 347,894 | | | 226,217 | | | 52,531 | | | 44,247 | | | 24,122 | | | 52,079 | | | 769,545 | |
| | | | | | | | | | | | | | | | |
| Substandard | | — | | | 77 | | | 365 | | | 119 | | | 144 | | | 834 | | | 1 | | | 1,540 | |
| | | | | | | | | | | | | | | | |
| Loss | | — | | | — | | | — | | | — | | | — | | | 1,183 | | | — | | | 1,183 | |
| Subtotal | | 22,455 | | | 347,971 | | | 226,582 | | | 52,650 | | | 44,391 | | | 26,139 | | | 52,080 | | | 772,268 | |
| Total | | $ | 74,123 | | | $ | 1,028,674 | | | $ | 1,271,125 | | | $ | 671,962 | | | $ | 392,067 | | | $ | 1,321,470 | | | $ | 797,976 | | | $ | 5,557,397 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Gross Charge-Offs by Year of Origination | | Amortized Cost of Revolving Loans | | |
| Three Months Ended March 31, 2023 | | 2023 | | 2022 | | 2021 | | 2020 | | 2019 | | Prior | | | Total |
| Commercial, financial and agricultural: | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Other | | $ | — | | | $ | 144 | | | $ | 32 | | | $ | — | | | $ | 191 | | | $ | 412 | | | $ | — | | | $ | 779 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| Consumer | | — | | | 904 | | | 1,186 | | | 200 | | | 180 | | | 216 | | | — | | | 2,686 | |
| | | | | | | | | | | | | | | | |
| Year-to-date gross charge-offs | | $ | — | | | $ | 1,048 | | | $ | 1,218 | | | $ | 200 | | | $ | 371 | | | $ | 628 | | | $ | — | | | $ | 3,465 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Amortized Cost of Term Loans by Year of Origination | | Amortized Cost of Revolving Loans | | |
| December 31, 2022 | | 2022 | | 2021 | | 2020 | | 2019 | | 2018 | | Prior | | | Total |
| 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 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
| 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 | | $ | 1,004,473 | | | $ | 1,293,071 | | | $ | 691,126 | | | $ | 414,136 | | | $ | 288,522 | | | $ | 1,063,474 | | | $ | 800,664 | | | $ | 5,555,466 | |
| | | | | | | | | | | | | | | | |
5. ALLOWANCE FOR CREDIT LOSSES AND RESERVE FOR OFF-BALANCE SHEET CREDIT EXPOSURES
The following table presents by class, the activity in the ACL for loans under ASC 326 during the three months ended March 31, 2023 and March 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Commercial, Financial and Agricultural | | Real Estate | | | | | | | | | | |
| Three Months Ended March 31, 2023 | | SBA PPP | | Other | | Construction | | Residential Mortgage | | Home Equity | | Commercial Mortgage | | | | Consumer | | | | | | Total |
| Beginning balance | | $ | 2 | | | $ | 6,822 | | | $ | 2,867 | | | $ | 11,804 | | | $ | 4,114 | | | $ | 17,902 | | | | | $ | 20,227 | | | | | | | $ | 63,738 | |
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
| Provision (credit) for credit losses on loans | | (1) | | | 837 | | | 220 | | | (44) | | | (77) | | | (430) | | | | | 1,110 | | | | | | | 1,615 | |
| Subtotal | | 1 | | | 7,659 | | | 3,087 | | | 11,760 | | | 4,037 | | | 17,472 | | | | | 21,337 | | | | | | | 65,353 | |
| Charge-offs | | — | | | 779 | | | — | | | — | | | — | | | — | | | | | 2,686 | | | | | | | 3,465 | |
| Recoveries | | — | | | 250 | | | — | | | 53 | | | — | | | — | | | | | 908 | | | | | | | 1,211 | |
| Net charge-offs (recoveries) | | — | | | 529 | | | — | | | (53) | | | — | | | — | | | | | 1,778 | | | | | | | 2,254 | |
| Ending balance | | $ | 1 | | | $ | 7,130 | | | $ | 3,087 | | | $ | 11,813 | | | $ | 4,037 | | | $ | 17,472 | | | | | $ | 19,559 | | | | | | | $ | 63,099 | |
| | | | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Commercial, Financial and Agricultural | | Real Estate | | | | | | | | | | |
| Three Months Ended March 31, 2022 | | SBA PPP | | Other | | Construction | | Residential Mortgage | | Home Equity | | Commercial Mortgage | | | | Consumer | | | | | | Total |
| Beginning balance | | $ | 77 | | | $ | 10,314 | | | $ | 3,908 | | | $ | 12,463 | | | $ | 4,509 | | | $ | 18,411 | | | | | $ | 18,415 | | | | | | | $ | 68,097 | |
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
| Provision (credit) for credit losses on loans | | (41) | | | (848) | | | (72) | | | (1,532) | | | 132 | | | (2,356) | | | | | 1,786 | | | | | | | (2,931) | |
| Subtotal | | 36 | | | 9,466 | | | 3,836 | | | 10,931 | | | 4,641 | | | 16,055 | | | | | 20,201 | | | | | | | 65,166 | |
| Charge-offs | | — | | | 254 | | | — | | | — | | | — | | | — | | | | | 1,216 | | | | | | | 1,470 | |
| Recoveries | | — | | | 350 | | | — | | | 112 | | | — | | | — | | | | | 596 | | | | | | | 1,058 | |
| Net charge-offs (recoveries) | | — | | | (96) | | | — | | | (112) | | | — | | | — | | | | | 620 | | | | | | | 412 | |
| Ending balance | | $ | 36 | | | $ | 9,562 | | | $ | 3,836 | | | $ | 11,043 | | | $ | 4,641 | | | $ | 16,055 | | | | | $ | 19,581 | | | | | | | $ | 64,754 | |
| | | | | | | | | | | | | | | | | | | | | | |
In accordance with GAAP, other real estate assets are not included in our assessment of the ACL.
In the three months ended March 31, 2023, we recorded a provision for credit losses of $1.9 million, which consisted of a provision for credit losses on loans of $1.6 million and a provision for credit losses on off-balance sheet credit exposures of $0.3 million.
In the three months ended March 31, 2022, we recorded a credit to the provision for credit losses of $3.2 million, which consisted of a credit to the provision for credit losses on loans of $2.9 million and a credit to the provision for credit losses on off-balance sheet credit exposures of $0.3 million.
The following table presents the activity in the reserve for off-balance sheet credit exposures, included in other liabilities, during the three months ended March 31, 2023 and March 31, 2022.
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| (dollars in thousands) | 2023 | | 2022 | | | | |
| Beginning balance | $ | 3,243 | | | $ | 4,804 | | | | | |
| | | | | | | |
| | | | | | | |
| Provision (credit) for off-balance sheet credit exposures | 237 | | | (264) | | | | | |
| Ending balance | $ | 3,480 | | | $ | 4,540 | | | | | |
| | | | | | | |
6. INVESTMENTS IN UNCONSOLIDATED ENTITIES
The components of the Company's investments in unconsolidated entities were as follows:
| | | | | | | | | | | |
| (dollars in thousands) | March 31, 2023 | | December 31, 2022 |
| Investments in low income housing tax credit partnerships, net of amortization | $ | 40,225 | | | $ | 40,939 | |
| Investments in common securities of statutory trusts | 1,547 | | | 1,547 | |
| Investments in affiliates | 136 | | | 110 | |
| Other | 4,045 | | | 4,045 | |
| Total | $ | 45,953 | | | $ | 46,641 | |
The Company invests in low-income housing tax credit ("LIHTC") and other partnerships. The Company had commitments to fund LIHTC partnerships totaling $47.8 million and $47.8 million as of March 31, 2023 and December 31, 2022, respectively. Unfunded commitments related to LIHTC partnerships totaled $23.6 million at March 31, 2023 and December 31, 2022, and are included in other liabilities in the Company's consolidated balance sheets. The investments are accounted for under the proportional amortization method and are included in investments 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. Swell launched a consumer banking app that combines checking, credit and more into one integrated account, and Central Pacific Bank will serve 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.
During the second quarter of 2021, the Company committed $2.0 million to the JAM FINTOP Banktech Fund, L.P., a venture capital investment fund designed to help develop and accelerate technology adoption at community banks across the United States. The Company had $1.1 million and $1.3 million in unfunded commitments related to the investment as of March 31, 2023 and December 31, 2022, respectively, which is recorded in other liabilities. The investment is accounted for under the cost method and is included in investment in unconsolidated entities.
The expected payments for the unfunded commitments of LIHTC and other partnerships as of March 31, 2023 for the remainder of fiscal year 2023, the next five succeeding fiscal years, and all years thereafter are as follows:
| | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | | | | |
| Year Ending December 31, | LIHTC | | Other | | Total |
| 2023 (remainder) | $ | 9,693 | | | $ | 1,123 | | | $ | 10,816 | |
| 2024 | 9,280 | | | — | | | 9,280 | |
| 2025 | 4,248 | | | — | | | 4,248 | |
| 2026 | 26 | | | — | | | 26 | |
| 2027 | 26 | | | — | | | 26 | |
| 2028 | 20 | | | — | | | 20 | |
| Thereafter | 313 | | | — | | | 313 | |
| Total unfunded commitments | $ | 23,606 | | | $ | 1,123 | | | $ | 24,729 | |
The following table presents amortization and tax credits recognized associated with our investments in LIHTC partnerships for the three months ended March 31, 2023 and March 31, 2022:
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| (dollars in thousands) | 2023 | | 2022 | | | | |
| Proportional amortization method: | | | | | | | |
| Amortization expense recognized in income tax expense | $ | 714 | | | $ | 607 | | | | | |
| Tax credits recognized in income tax expense | 892 | | | 709 | | | | | |
7. MORTGAGE SERVICING RIGHTS
The following table presents changes in mortgage servicing rights for the periods presented:
| | | | | |
| (dollars in thousands) | |
| Balance at December 31, 2022 | $ | 9,074 | |
| Additions | 58 | |
| Amortization | (189) | |
| Balance at March 31, 2023 | $ | 8,943 | |
| |
| Balance at December 31, 2021 | $ | 9,738 | |
| Additions | 276 | |
| Amortization | (534) | |
| Balance at March 31, 2022 | $ | 9,480 | |
Income generated as the result of new mortgage servicing rights is reported as gains on sales of loans and totaled $0.1 million for the three months ended March 31, 2023, compared to $0.3 million for the three months ended March 31, 2022.
Amortization of mortgage servicing rights totaled $0.2 million for the three months ended March 31, 2023, compared to $0.5 million for the three months ended March 31, 2022.
The following tables present the fair market value and key assumptions used in determining the fair market value of our mortgage servicing rights:
| | | | | | | | | | | |
| Three Months Ended March 31, |
| (dollars in thousands) | 2023 | | 2022 |
| Fair market value, beginning of period | $ | 12,061 | | | $ | 10,504 | |
| Fair market value, end of period | 11,875 | | | 11,166 | |
| Weighted average discount rate | 9.5 | % | | 9.5 | % |
| Weighted average prepayment speed assumption | 10.3 | % | | 18.3 | % |
The carrying values and accumulated amortization related to our mortgage servicing rights are presented below:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | March 31, 2023 | | December 31, 2022 |
| (dollars in thousands) | Gross
Carrying
Value | | Accumulated
Amortization | | Net
Carrying
Value | | Gross
Carrying
Value | | Accumulated
Amortization | | Net
Carrying
Value |
| | | | | | | | | | | |
| Mortgage servicing rights | $ | 69,471 | | | $ | (60,528) | | | $ | 8,943 | | | $ | 69,413 | | | $ | (60,339) | | | $ | 9,074 | |
| | | | | | | | | | | |
Based on the mortgage servicing rights held as of March 31, 2023, estimated amortization expense for the remainder of fiscal year 2023, the next five succeeding fiscal years and all years thereafter are as follows:
| | | | | |
| (dollars in thousands) | |
| Year Ending December 31, | |
| 2023 (remainder) | $ | 668 | |
| 2024 | 833 | |
| 2025 | 756 | |
| 2026 | 684 | |
| 2027 | 610 | |
| 2028 | 548 | |
| Thereafter | 4,844 | |
| Total | $ | 8,943 | |
We perform an impairment assessment of our mortgage servicing rights whenever events or changes in circumstance indicate that the carrying value of the asset may not be recoverable.
8. DERIVATIVES
We utilize various designated and undesignated derivative financial instruments to reduce our exposure to movements in interest rates. We measure all derivatives at fair value on our 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 cash flow hedging instruments, we record the effective portion of the changes in the fair value of the derivative in AOCI, net of tax, until earnings are affected by the variability of cash flows of the hedged transaction. We immediately recognize the portion of the gain or loss in the fair value of the derivative that represents hedge ineffectiveness 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.
Interest Rate Lock and Forward Sale Commitments
We may enter 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, we may also enter into forward loan sale commitments. The interest rate locks and forward loan sale commitments are accounted for as undesignated derivatives and are recorded at their respective fair values in other assets and 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 March 31, 2023, we were not a party to any interest rate lock or forward sale commitments.
Risk Participation Agreements
In the first and fourth quarters of 2020, we entered into credit risk participation agreements ("RPA") with financial institution counterparties for interest rate swaps related to loans in which we participate. The risk participation agreements entered into by us and 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 on our consolidated balance sheet in other assets or other liabilities. As of March 31, 2023, the Company had swap agreements with its borrowers with a total notional amount of $32.1 million, offset by swap agreements with third party financial institutions with the same total notional amount of $32.1 million. As of March 31, 2023, the Company held $8.5 million in counter-party collateral related to the back-to-back swap agreements.
Interest Rate Swaps
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 March 31, 2023, 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 tables present the location of all assets and liabilities associated with our derivative instruments within the consolidated balance sheets:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Derivative Financial Instruments Not Designated as Hedging Instruments | | Asset Derivatives | | Liability Derivatives |
| Fair Value at | | Fair Value at |
| (dollars in thousands) | | Balance Sheet Location | | March 31,
2023 | | December 31,
2022 | | March 31,
2023 | | December 31,
2022 |
| Interest rate lock and forward sale commitments | | Other assets / other liabilities | | $ | — | | | $ | 10 | | | $ | — | | | $ | 2 | |
| | | | | | | | | | |
| Back-to-back swap agreements | | Other assets / other liabilities | | 3,636 | | | 4,611 | | | 3,636 | | | 4,611 | |
| | | | | | | | | | |
| Derivative Financial Instruments Designated as Hedging Instruments | | Asset Derivatives | | Liability Derivatives |
| Fair Value at | | Fair Value at |
| (dollars in thousands) | | Balance Sheet Location | | March 31,
2023 | | December 31,
2022 | | March 31,
2023 | | December 31,
2022 |
| Interest rate swap | | Other assets / other liabilities | | $ | 4,444 | | | $ | 5,986 | | | $ | — | | | $ | — | |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
The following tables present the impact of derivative instruments and their location within the consolidated statements of income:
| | | | | | | | | | | | | | |
Derivative Financial Instruments
Not Designated as Hedging Instruments | | Location of Gain (Loss)
Recognized in
Earnings on Derivatives | | Amount of Gain (Loss)
Recognized in
Earnings on Derivatives |
| (dollars in thousands) | | |
| Three Months Ended March 31, 2023 | | | | |
| Interest rate lock and forward sale commitments | | Mortgage banking income | | $ | (8) | |
| | | | |
| | | | |
| | | | |
| | | | |
| Three Months Ended March 31, 2022 | | | | |
| Interest rate lock and forward sale commitments | | Mortgage banking income | | 143 | |
| | | | |
| Risk participation agreements | | Other service charges and fees | | 16 | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
Derivative Financial Instruments
Designated as Hedging Instruments | | Location of Loss
Recognized in
Earnings on Derivatives | | Amount of Loss
Recognized in
Earnings on Derivatives |
| (dollars in thousands) | | |
| Three Months Ended March 31, 2023 | | | | |
| Interest rate swap | | Interest income | | $ | 57 | |
| | | | |
| Three Months Ended March 31, 2022 | | | | |
| Interest rate swap | | Interest income | | — | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
| | | | |
9. SHORT-TERM BORROWINGS AND LONG-TERM DEBT
Federal Home Loan Bank Advances and Other Borrowings
The bank is a member of the Federal Home Loan Bank of Des Moines (the "FHLB") and maintained a $2.05 billion line of credit as of March 31, 2023, compared to $2.23 billion at December 31, 2022. At March 31, 2023, $1.94 billion was undrawn under this arrangement, compared to $2.19 billion at December 31, 2022. There were $25.0 million in short-term borrowings under this arrangement bearing an interest rate of 5.07% at March 31, 2023, compared to $5.0 million at December 31, 2022. Letters of credit under this arrangement that are used to collateralize certain government deposits totaled $36.0 million as of March 31, 2023, and remained unchanged from $36.0 million as of December 31, 2022. There were $50.0 million in long-term borrowings under this arrangement bearing interest rates between 4.02% and 4.62% at March 31, 2023, compared to no long-term borrowings at December 31, 2022. FHLB advances and standby letters of credit available at March 31, 2023 were secured by certain real estate loans with a carrying value of $3.19 billion in accordance with the collateral provisions of the Advances, Security and Deposit Agreement with the FHLB.
At March 31, 2023 and December 31, 2022, our bank had additional unused borrowings available at the Federal Reserve discount window of $76.6 million and $75.9 million, respectively. As of March 31, 2023 and December 31, 2022, certain commercial and commercial real estate loans with a carrying value totaling $123.2 million and $125.0 million, respectively, were pledged as collateral on our line of credit with the Federal Reserve discount window. The Federal Reserve does not have the right to sell or repledge these loans.
Subordinated Debentures
In September 2004, we 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, we 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.
At March 31, 2023 and December 31, 2022, the Company had the following junior subordinated debentures outstanding, which are recorded in long-term debt on the Company's consolidated balance sheets:
| | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | | | | | |
| Name of Trust | | March 31, 2023 | | December 31, 2022 | | Interest Rate |
| Trust IV | | $ | 30,928 | | | $ | 30,928 | | | Three month LIBOR + 2.45% |
| Trust V | | 20,619 | | | 20,619 | | | Three month LIBOR + 1.87% |
| Total | | $ | 51,547 | | | $ | 51,547 | | | |
| | | | | | |
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 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 March 31, 2023 and December 31, 2022, the Company had the following subordinated notes outstanding:
| | | | | | | | | | | | | | |
| (dollars in thousands) | | | | |
| Description | | March 31, 2023 | | 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 plus 456 basis points. |
| | | | |
| (dollars in thousands) | | | | |
| Description | | December 31, 2022 | | 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 plus 456 basis points. |
| | | | |
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 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 $54.4 million, net of unamortized debt issuance costs of $0.6 million, at March 31, 2023.
10. 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, "Revenue from Contracts with Customers" for the three months ended March 31, 2023 and 2022:
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| (dollars in thousands) | 2023 | | 2022 | | | | |
| Other operating income: | | | | | | | |
| In-scope of ASC 606 | | | | | | | |
| Mortgage banking income | $ | 151 | | | $ | 235 | | | | | |
| Service charges on deposit accounts | 305 | | | 1,861 | | | | | |
| Other service charges and fees | 4,379 | | | 3,863 | | | | | |
| Income on fiduciary activities | 1,321 | | | 1,154 | | | | | |
| | | | | | | |
| | | | | | | |
| In-scope other operating income | 6,156 | | | 7,113 | | | | | |
| Out-of-scope other operating income | 4,853 | | | 2,438 | | | | | |
| Total other operating income | $ | 11,009 | | | $ | 9,551 | | | | | |
11. SHARE-BASED COMPENSATION
Restricted and Performance Stock Units
Under the Company's 2013 Stock Compensation Plan, the Company awards restricted stock units ("RSUs") and performance stock units ("PSUs") to our 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 typically measured as the market price of the stock awards on the grant date, and is recognized over the specified vesting periods.
The table below presents the activity of RSUs and PSUs for the three months ended March 31, 2023:
| | | | | | | | | | | | | | | | | |
| (dollars in thousands, except per share data) | Shares | | Weighted Average Grant Date Fair Value | | Fair Value of RSUs and PSUs That Vested During the Period |
| Non-vested RSUs and PSUs, beginning of period | 352,465 | | | $ | 23.40 | | | |
| Changes during the period: | | | | | |
| Granted | 111,680 | | | 23.05 | | | |
| Forfeited | (46,801) | | | 25.17 | | | |
| Vested | (128,350) | | | 23.17 | | | $ | 3,017 | |
| Non-vested RSUs and PSUs, end of period | 288,994 | | | 23.08 | | | |
12. SUPPLEMENTAL EXECUTIVE RETIREMENT AND DEFINED BENEFIT RETIREMENT PLANS
Supplemental Executive Retirement Plans
In 1995, 2001, 2004 and 2006, our bank also established Supplemental Executive Retirement Plans ("SERPs"), which provide certain (current and former) 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 projected benefit obligation of the unfunded SERPs is recorded in other liabilities on the Company's consolidated balance sheets. The projected benefit obligation was $9.2 million at March 31, 2023, which remained relatively unchanged from $9.2 million at December 31, 2022.
The following table sets forth the components of net periodic benefit cost for the SERPs for the periods indicated:
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| (dollars in thousands) | 2023 | | 2022 | | | | |
| Interest cost | $ | 112 | | | $ | 75 | | | | | |
| Amortization of net actuarial (gain) loss | (19) | | | 21 | | | | | |
| Amortization of net transition obligation | 2 | | | 4 | | | | | |
| | | | | | | |
| | | | | | | |
| Net periodic benefit cost | $ | 95 | | | $ | 100 | | | | | |
All components of net periodic benefit cost are included in other operating expenses in the Company's consolidated statements of income.
Defined Benefit Retirement Plan
Central Pacific 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 who 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 defined benefit retirement plan in the second quarter of 2022. Upon final plan termination and settlement, the Company recognized a one-time noncash settlement charge of $4.9 million which was recorded in other operating expense. As of March 31, 2023, the Company has no further defined benefit retirement plan liability or ongoing pension expense recognition.
The following table sets forth the components of net periodic benefit cost for the defined benefit retirement plan for the periods indicated:
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| (dollars in thousands) | 2023 | | 2022 | | | | |
| Interest cost | $ | — | | | $ | — | | | | | |
| Expected return on plan assets | — | | | (12) | | | | | |
| Amortization of net actuarial loss | — | | | 112 | | | | | |
| Settlement | — | | | — | | | | | |
| Net periodic benefit cost | $ | — | | | $ | 100 | | | | | |
13. OPERATING LEASES
We lease certain land and buildings for our bank branches and ATMs. In some instances, a lease may contain renewal options to extend the term of the lease. Renewal options that are likely to be exercised 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 we do not include any short term leases 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 period indicated:
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| (dollars in thousands) | 2023 | | 2022 | | | | |
| Lease cost: | | | | | | | |
| Operating lease cost | $ | 1,325 | | | $ | 1,390 | | | | | |
| Variable lease cost | 888 | | | 830 | | | | | |
| Less: Sublease income | (17) | | | (12) | | | | | |
| Total lease cost | $ | 2,196 | | | $ | 2,208 | | | | | |
| | | | | | | |
| Other information: | | | | | | | |
| Operating cash flows from operating leases | $ | (1,390) | | | $ | (1,506) | | | | | |
| Weighted-average remaining lease term - operating leases | 11.22 years | | 11.49 years | | | | |
| Weighted-average discount rate - operating leases | 3.96 | % | | 3.92 | % | | | | |
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 remainder of fiscal year 2023, the next five succeeding fiscal years and all years thereafter:
| | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Undiscounted Cash Flows | | Lease Liability Discount on Cash Flows | | Lease Liability |
| Year Ending December 31, | | | |
| 2023 (remainder) | | $ | 3,736 | | | $ | 994 | | | $ | 2,742 | |
| 2024 | | 4,467 | | | 1,210 | | | 3,257 | |
| 2025 | | 4,181 | | | 1,085 | | | 3,096 | |
| 2026 | | 4,118 | | | 965 | | | 3,153 | |
| 2027 | | 4,108 | | | 840 | | | 3,268 | |
| 2028 | | 3,509 | | | 723 | | | 2,786 | |
| Thereafter | | 19,682 | | | 2,908 | | | 16,774 | |
| Total | | $ | 43,801 | | | $ | 8,725 | | | $ | 35,076 | |
| | | | | | |
| | | | | | |
In addition, the Company, as lessor, leases certain properties that it owns. All of these leases are operating leases. The following represents lease income related to these leases that was recognized for the period indicated:
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| (dollars in thousands) | 2023 | | 2022 | | | | |
| Total rental income recognized | $ | 562 | | | $ | 951 | | | | | |
Based on the Company's leases as lessor as of March 31, 2023, estimated lease payments for the remainder of fiscal year 2023, the next five succeeding fiscal years and all years thereafter are as follows:
| | | | | |
| (dollars in thousands) | |
| Year Ending December 31, | |
| 2023 (remainder) | $ | 1,008 | |
| 2024 | 1,189 | |
| 2025 | 1,074 | |
| 2026 | 939 | |
| 2027 | 882 | |
| 2028 | 532 | |
| Thereafter | 1,839 | |
| Total | $ | 7,463 | |
| |
| |
14. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following tables present the components of other comprehensive income (loss) ("AOCI") for the three months ended March 31, 2023 and 2022, by component:
| | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Before Tax | | Tax Effect | | Net of Tax |
| Three Months Ended March 31, 2023 | | | | | | |
| Net change in fair value of investment securities: | | | | | | |
| Net unrealized gains on AFS investment securities arising during the period | | $ | 15,258 | | | $ | 4,052 | | | $ | 11,206 | |
| | | | | | |
| Less: Amortization of unrealized losses on investment securities transferred to HTM | | 1,668 | | | 443 | | | 1,225 | |
| Net change in fair value of investment securities | | 16,926 | | | 4,495 | | | 12,431 | |
| | | | | | |
| Net change in fair value of derivatives: | | | | | | |
| Net unrealized losses arising during the period | | (1,599) | | | (436) | | | (1,163) | |
| | | | | | |
| Net change in fair value of derivatives | | (1,599) | | | (436) | | | (1,163) | |
| | | | | | |
| SERPs: | | | | | | |
| | | | | | |
| Amortization of net actuarial loss | | (19) | | | (5) | | | (14) | |
| Amortization of net transition obligation | | 2 | | | — | | | 2 | |
| | | | | | |
| | | | | | |
| SERPs | | (17) | | | (5) | | | (12) | |
| | | | | | |
| Other comprehensive income | | $ | 15,310 | | | $ | 4,054 | | | $ | 11,256 | |
| | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Before Tax | | Tax Effect | | Net of Tax |
| Three Months Ended March 31, 2022 | | | | | | |
| Net change in fair value of investment securities: | | | | | | |
| Net unrealized losses on AFS investment securities arising during the period | | $ | (108,448) | | | $ | (28,998) | | | $ | (79,450) | |
| | | | | | |
| | | | | | |
| Net change in fair value of investment securities | | (108,448) | | | (28,998) | | | (79,450) | |
| | | | | | |
| Net change in fair value of derivatives: | | | | | | |
| Net unrealized losses arising during the period | | $ | (50) | | | $ | (13) | | | $ | (37) | |
| | | | | | |
| Net change in fair value of derivatives | | (50) | | | (13) | | | (37) | |
| | | | | | |
| Defined benefit retirement plan and SERPs: | | | | | | |
| | | | | | |
| Amortization of net actuarial loss | | 133 | | | 36 | | | 97 | |
| Amortization of net transition obligation | | 4 | | | 1 | | | 3 | |
| | | | | | |
| | | | | | |
| Defined benefit retirement plan and SERPs | | 137 | | | 37 | | | 100 | |
| | | | | | |
| Other comprehensive loss | | $ | (108,361) | | | $ | (28,974) | | | $ | (79,387) | |
| | | | | | |
The following tables present the changes in each component of AOCI, net of tax, for the three months ended March 31, 2023 and 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Investment Securities | | Derivatives | | SERPs [1] | | AOCI |
| Three Months Ended March 31, 2023 | | | | | | | | |
| Balance at beginning of period | | $ | (149,109) | | | $ | 4,645 | | | $ | 480 | | | $ | (143,984) | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| Other comprehensive income (loss) before reclassifications | | 11,206 | | | (1,163) | | | — | | | 10,043 | |
| Reclassification adjustments from AOCI | | 1,225 | | | — | | | (12) | | | 1,213 | |
| Total other comprehensive income (loss) | | 12,431 | | | (1,163) | | | (12) | | | 11,256 | |
| | | | | | | | |
| Balance at end of period | | $ | (136,678) | | | $ | 3,482 | | | $ | 468 | | | $ | (132,728) | |
| | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| (dollars in thousands) | | Investment Securities | | Derivatives | | Defined Benefit Retirement Plan and SERPs [1] | | AOCI |
| Three Months Ended March 31, 2022 | | | | | | | | |
| Balance at beginning of period | | $ | (3,666) | | | $ | — | | | $ | (4,294) | | | $ | (7,960) | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| Other comprehensive loss before reclassifications | | (79,450) | | | (37) | | | — | | | (79,487) | |
| Reclassification adjustments from AOCI | | — | | | — | | | 100 | | | 100 | |
| Total other comprehensive (loss) income | | (79,450) | | | (37) | | | 100 | | | (79,387) | |
| | | | | | | | |
| Balance at end of period | | $ | (83,116) | | | $ | (37) | | | $ | (4,194) | | | $ | (87,347) | |
| | | | | | | | |
[1] During the second quarter of 2022, the Company settled all obligations related to its defined benefit retirement plan. As a result, all subsequent activity in the Company's AOCI balance related to the defined benefit retirement plan and SERPs relates entirely to SERPs.
The following table presents the amounts reclassified out of each component of AOCI for the three months ended March 31, 2023 and 2022:
| | | | | | | | | | | | | | | | | | | | |
| | Amount Reclassified from AOCI | | Affected Line Item in the Statement Where Net Income is Presented |
| (dollars in thousands) | | Three Months Ended March 31, | |
| Details about AOCI Components | | 2023 | | 2022 | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| Amortization of unrealized losses on investment securities transferred to held-to-maturity: | | | | | | |
| Amortization | | $ | (1,668) | | | $ | — | | | Interest and dividends on investment securities |
| Tax effect | | 443 | | | — | | | Income tax expense |
| Net of tax | | $ | (1,225) | | | $ | — | | | |
| | | | | | |
| Defined benefit retirement and supplemental executive retirement plan items: | | | | | | |
| Amortization of net actuarial gain (loss) | | $ | 19 | | | $ | (133) | | | Other operating expense - other |
| Amortization of net transition obligation | | (2) | | | (4) | | | Other operating expense - other |
| | | | | | |
| | | | | | |
| Total before tax | | 17 | | | (137) | | | |
| Tax effect | | (5) | | | 37 | | | Income tax benefit (expense) |
| Net of tax | | $ | 12 | | | $ | (100) | | | |
| | | | | | |
| Total reclassification adjustments from AOCI for the period, net of tax | | $ | (1,213) | | | $ | (100) | | | |
| | | | | | |
15. EARNINGS PER SHARE
The following table presents the information used to compute basic and diluted earnings per common share for the periods indicated:
| | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | |
| (dollars in thousands, except per share data) | 2023 | | 2022 | | | | |
| Net income | $ | 16,187 | | | $ | 19,438 | | | | | |
| | | | | | | |
| Weighted average common shares outstanding - basic | 26,999,138 | | | 27,591,390 | | | | | |
| Dilutive effect of employee stock options and awards | 122,874 | | | 283,534 | | | | | |
| Weighted average common shares outstanding - diluted | 27,122,012 | | | 27,874,924 | | | | | |
| | | | | | | |
| Basic earnings per common share | $ | 0.60 | | | $ | 0.70 | | | | | |
| Diluted earnings per common share | $ | 0.60 | | | $ | 0.70 | | | | | |
| | | | | | | |
| | | | | | | |
16. FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES
Disclosures about Fair Value of Financial Instruments
Fair value estimates, methods and assumptions are set forth below for our financial instruments.
Short-Term Financial Instruments
The carrying values of short-term financial instruments are deemed to approximate fair values. Such instruments are considered readily convertible to cash and include cash and due from financial institutions, interest-bearing deposits in other financial institutions, accrued interest receivable, the majority of Federal Home Loan Bank advances and other short-term borrowings, and accrued interest payable.
Investment Securities
The fair value of investment securities is based on market price quotations received from third-party pricing services. The third-party pricing services utilize pricing models supported with timely market data information. Where quoted market prices are not available, fair values are based on quoted market prices of comparable securities.
Loans
Fair values of loans are estimated based on discounted cash flows of portfolios of loans with similar financial characteristics including the type of loan, interest terms and repayment history. Fair values are calculated by discounting scheduled cash flows through estimated maturities using estimated market discount rates. Estimated market discount rates are reflective of credit and interest rate risks inherent in the Company's various loan types and are derived from available market information, as well as specific borrower information. As of March 31, 2023, the weighted average discount rate used in the valuation of loans was 7.33%. In accordance with ASU 2016-01, the fair value of loans are measured based on the notion of exit price.
Loans Held for Sale
The fair value of loans classified as held for sale are generally based upon quoted prices for similar assets in active markets, acceptance of firm offer letters with agreed upon purchase prices, discounted cash flow models that take into account market observable assumptions, or independent appraisals of the underlying collateral securing the loans. We report the fair values of Hawaii and U.S. Mainland construction and commercial real estate loans, if any, net of applicable selling costs on our 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, for the purposes of this disclosure, are shown to equal the carrying amount which is the amount payable on demand. The fair value of time deposits is estimated by discounting future cash flows using rates currently offered for FHLB advances of similar remaining maturities. As of March 31, 2023, the weighted average discount rate used in the valuation of time deposits was 5.14%. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
Long-Term Debt
The fair value of our long-term debt is estimated by discounting scheduled cash flows over the contractual borrowing period at the estimated market rate for similar borrowing arrangements. As of March 31, 2023, the weighted average discount rate used in the valuation of long-term debt was 6.81%.
Derivatives
The fair values of derivative financial instruments are based upon current market values, if available. If there are no relevant comparable values, 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 and financial instrument information. 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 cannot be determined with precision as they are subjective in nature and involve uncertainties and matters of significant judgment. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of future business and the value of assets and liabilities that are not considered financial instruments. For example, significant assets and liabilities that are not considered financial assets or liabilities include deferred tax assets, premises and equipment and intangible assets.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | Fair Value Measurement Using |
| (dollars in thousands) | Carrying
Amount | | Estimated
Fair Value | | Quoted Prices
in Active
Markets for
Identical Assets
(Level 1) | | Significant
Other
Observable
Inputs
(Level 2) | | Significant
Unobservable
Inputs
(Level 3) |
| March 31, 2023 | | | | | | | | | |
| Financial assets: | | | | | | | | | |
| Cash and due from banks | $ | 108,535 | | | $ | 108,535 | | | $ | 108,535 | | | $ | — | | | $ | — | |
| Interest-bearing deposits in other banks | 90,247 | | | 90,247 | | | 90,247 | | | — | | | — | |
| Investment securities | 1,345,784 | | | 1,286,488 | | | — | | | 1,279,183 | | | 7,305 | |
| | | | | | | | | |
| Loans, net of ACL | 5,494,298 | | | 5,075,864 | | | — | | | — | | | 5,075,864 | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| Accrued interest receivable | 20,473 | | | 20,473 | | | 20,473 | | | — | | | — | |
| | | | | | | | | |
| Financial liabilities: | | | | | | | | | |
| Deposits: | | | | | | | | | |
| Noninterest-bearing demand | 2,028,087 | | | 2,028,087 | | | 2,028,087 | | | — | | | — | |
| Interest-bearing demand and savings and money market | 3,571,588 | | | 3,571,588 | | | 3,571,588 | | | — | | | — | |
| Time | 1,147,293 | | | 1,132,282 | | | — | | | — | | | 1,132,282 | |
| FHLB advances and other short-term borrowings | 25,000 | | | 25,000 | | | — | | | 25,000 | | | — | |
| Long-term debt | 155,920 | | | 138,077 | | | — | | | — | | | 138,077 | |
| Accrued interest payable (included in other liabilities) | 7,688 | | | 7,688 | | | 7,688 | | | — | | | — | |
| | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | 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) |
| March 31, 2023 | | | | | | | | | | | |
| Off-balance sheet financial instruments: | | | | | | | | | | | |
| Commitments to extend credit | $ | 1,382,978 | | | $ | — | | | $ | 1,365 | | | $ | — | | | $ | 1,365 | | | $ | — | |
| Standby letters of credit and financial guarantees written | 5,194 | | | — | | | 78 | | | — | | | 78 | | | — | |
| | | | | | | | | | | |
| Derivatives: | | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| Risk participation agreements | 36,634 | | | — | | | — | | | — | | | — | | | — | |
| Back-to-back swap agreements: | | | | | | | | | | | |
| Assets | 32,136 | | | 3,636 | | | 3,636 | | | — | | | — | | | 3,636 | |
| Liabilities | (32,136) | | | (3,636) | | | (3,636) | | | — | | | — | | | (3,636) | |
| Interest rate swap agreements | 115,545 | | | 4,444 | | | 4,444 | | | — | | | — | | | 4,444 | |
| | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | 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 banks | $ | 97,150 | | | $ | 97,150 | | | $ | 97,150 | | | $ | — | | | $ | — | |
| Interest-bearing deposits in other banks | 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 demand | 2,092,823 | | | 2,092,823 | | | 2,092,823 | | | — | | | — | |
| Interest-bearing demand and savings and money market | 3,652,195 | | | 3,652,195 | | | 3,652,195 | | | — | | | — | |
| Time | 991,205 | | | 975,086 | | | — | | | — | | | 975,086 | |
| | | | | | | | | |
| 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: | | | | | | | | | | | |
| | | | | | | | | | | |
| Forward sale commitments | 1,110 | | | 8 | | | 8 | | | — | | | 8 | | | — | |
| Risk participation agreements | 36,835 | | | — | | | — | | | — | | | — | | | — | |
| Back-to-back swap agreements: | | | | | | | | | | | |
| Assets | 32,335 | | | 4,611 | | | 4,611 | | | — | | | — | | | 4,611 | |
| Liabilities | (32,335) | | | (4,611) | | | (4,611) | | | — | | | — | | | (4,611) | |
| Interest rate swap agreements | 115,545 | | | 5,986 | | | 5,986 | | | — | | | — | | | 5,986 | |
| | | | | | | | | | | |
Fair Value Measurements
We group our financial assets and liabilities at fair value into three levels based on the markets in which the financial assets and liabilities are traded and the reliability of the assumptions used to determine fair value as follows:
•Level 1 — Valuation is based upon quoted prices (unadjusted) for identical assets or liabilities traded in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.
•Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
•Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in
pricing the asset or liability. Valuation techniques include use of discounted cash flow models and similar techniques that requires the use of significant judgment or estimation.
We base our fair values on the price that we would expect to receive if an asset were sold, or the price that we would expect to pay to transfer a liability in an orderly transaction between market participants at the measurement date. We also maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements.
We use fair value measurements to record adjustments to certain financial assets and liabilities and to determine fair value disclosures. Available-for-sale securities and derivatives are recorded at fair value on a recurring basis. Periodically, we may be required to record other financial assets at fair value on a nonrecurring basis such as loans held for sale, impaired loans, mortgage servicing rights, and other real estate owned. These nonrecurring fair value adjustments typically involve application of the lower of cost or fair value accounting or write-downs of individual assets.
As discussed in Note 8 - Derivatives, during the first quarter of 2022, the Company entered into a forward starting interest rate swap, which was measured at fair value using Level 3 inputs. There were no other transfers of financial assets and liabilities into or out of Level 3 of the fair value hierarchy during the three months ended March 31, 2023.
The following tables present the fair value of assets and liabilities measured on a recurring basis as of March 31, 2023 and December 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | Fair Value at Reporting Date Using |
| (dollars in thousands) | Fair Value | | Quoted Prices
in Active
Markets for
Identical Assets
(Level 1) | | Significant
Other
Observable
Inputs
(Level 2) | | Significant
Unobservable
Inputs
(Level 3) |
| March 31, 2023 | | | | | | | |
| Available-for-sale securities: | | | | | | | |
| Debt securities: | | | | | | | |
| States and political subdivisions | $ | 139,521 | | | $ | — | | | $ | 132,927 | | | $ | 6,594 | |
| Corporate securities | 31,097 | | | — | | | 31,097 | | | — | |
| U.S. Treasury obligations and direct obligations of U.S. Government agencies | 24,343 | | | — | | | 24,343 | | | — | |
| Mortgage-backed securities: | | | | | | | |
| Residential - U.S. Government-sponsored entities | 421,484 | | | — | | | 421,484 | | | — | |
| Residential - Non-government agencies | 8,637 | | | — | | | 7,926 | | | 711 | |
| Commercial - U.S. Government-sponsored entities | 45,800 | | | — | | | 45,800 | | | — | |
| Commercial - Non-government agencies | 16,306 | | | — | | | 16,306 | | | — | |
| | | | | | | |
| Total available-for-sale investment securities | 687,188 | | | — | | | 679,883 | | | 7,305 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| Derivatives: | | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| Interest rate swap agreements | 4,444 | | | — | | | — | | | 4,444 | |
| Total derivatives | 4,444 | | | — | | | — | | | 4,444 | |
| Total | $ | 691,632 | | | $ | — | | | $ | 679,883 | | | $ | 11,749 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| | | | 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 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 | 423,803 | | | — | | | 423,803 | | | — | |
| Residential - Non-government agencies | 8,662 | | | — | | | 7,978 | | | 684 | |
| Commercial - U.S. Government-sponsored entities | 46,144 | | | — | | | 46,144 | | | — | |
| Commercial - Non-government agencies | 1,507 | | | — | | | 1,507 | | | — | |
| | | | | | | |
| Total available-for-sale investment securities | 671,794 | | | — | | | 664,526 | | | 7,268 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| Derivatives: | | | | | | | |
| Interest rate lock 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 | |
For the three months ended March 31, 2023 and 2022, 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 at December 31, 2022 | $ | 6,584 | | | $ | 684 | | | $ | 7,268 | |
| Principal payments received | (56) | | | (6) | | | (62) | |
| Unrealized net gain included in other comprehensive income | 66 | | | 33 | | | 99 | |
| | | | | |
| Balance at March 31, 2023 | $ | 6,594 | | | $ | 711 | | | $ | 7,305 | |
| | | | | | |
| Balance at December 31, 2021 | $ | 7,681 | | | $ | 938 | | | $ | 8,619 | |
| Principal payments received | (55) | | | (5) | | | (60) | |
| Unrealized net loss included in other comprehensive income | (397) | | | (81) | | | (478) | |
| | | | | |
| Balance at March 31, 2022 | $ | 7,229 | | | $ | 852 | | | $ | 8,081 | |
Within the states and political subdivisions available-for-sale debt securities category, the Company held two mortgage revenue bonds issued by the City & County of Honolulu had an aggregate fair value of $6.6 million at March 31, 2023 and remained relatively unchanged from $6.6 million at December 31, 2022.
Within the other MBS non-agency category, the Company held two mortgage backed bonds issued by Habitat for Humanity with an aggregate fair value of $0.7 million at March 31, 2023 and also remained relatively unchanged from $0.7 million at December 31, 2022.
The Company estimates the aggregate fair value of $7.3 million and $7.3 million as of March 31, 2023 and December 31, 2022, respectively, 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 City & County of Honolulu mortgage revenue bonds and Habitat for Humanity mortgage backed bonds is the weighted-average discount rate. As of March 31, 2023, the weighted average discount rate utilized was 6.15%, compared to 6.41% at December 31, 2022, 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.
There were no assets measured on a nonrecurring basis as of March 31, 2023 and December 31, 2022.