UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
   
FORM 10-Q
   

(Mark One)
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31,September 30, 2018
 
or

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from               to              
 
Commission file number 001-31567
 
 g119311bai001a12.jpg

CENTRAL PACIFIC FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
 
Hawaii 99-0212597
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
 
220 South King Street, Honolulu, Hawaii 96813
(Address of principal executive offices) (Zip Code)
 
(808) 544-0500
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer", "accelerated filer", "smaller reporting company", and "emerging growth company" in Rule 12b-2 of the Exchange Act.:
 
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
Emerging growth company o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act . o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý
 
The number of shares outstanding of registrant's common stock, no par value, on April 25,October 26, 2018 was 29,600,23729,172,431 shares.
 


 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
Form 10-Q
 
Table of Contents
 Page
   
Item 1.Financial Statements (Unaudited) 
   
 
   
 
   
 
   
 
   
 
   
 
   
   
   
   
   
   
   
   
 

 

PART I.   FINANCIAL INFORMATION
 
Forward-Looking Statements
 
This document may contain forward-looking statements concerning: projections of revenues, income/loss, earnings/loss per share, capital expenditures, dividends, capital structure, net interest margin or other financial items, plans and objectives of management for future operations, future economic performance, or any of the assumptions underlying or relating to any of the foregoing. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts, and may include the words "believes," "plans," "intends," "expects," "anticipates," "forecasts," "hopes," "should," "estimates" or words of similar meaning. While we believe that our forward-looking statements and the assumptions underlying them are reasonably based, such statements and assumptions are by their nature subject to risks and uncertainties, and thus could later prove to be inaccurate or incorrect. Accordingly, actual results could materially differ from projections for a variety of reasons, to include, but not be limited to: adverse changes in the financial performance and/or condition of our borrowers and, as a result, increased loan delinquency rates, deterioration in asset quality, and losses in our loan portfolio; the impact of local, national, and international economies and events (including natural disasters such as volcanoes, wildfires, tsunamis, storms and earthquakes) on the Company's business and operations and on tourism, the military, and other major industries operating within the Hawaii market and any other markets in which the Company does business; deterioration or malaise in domestic economic conditions, including any destabilization in the financial industry and deterioration of the real estate market, as well as the impact of declining levels of consumer and business confidence in the state of the economy in general and in financial institutions in particular; changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act, changes in capital standards, other regulatory reform, including but not limited to regulations promulgated by the Consumer Financial Protection Bureau, government-sponsored enterprise reform, and any related rules and regulations on our business operations and competitiveness; the costs and effects of legal and regulatory developments, including the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews and the effect of, and our ability to comply with, any regulatory orders or actions we are or may become subject to; ability to successfully implement our initiatives to lower our efficiency ratio; the ability to address any material weakness in our internal controls over financial reporting or disclosure controls and procedures; the effects of and changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, securities market and monetary fluctuations; negative trends in our market capitalization and adverse changes in the price of the Company's common stock; political instability; acts of war or terrorism; changes in consumer spending, borrowings and savings habits; failure to maintain effective internal control over financial reporting or disclosure controls and procedures; technological changes; changes in the competitive environment among financial holding companies and other financial service providers; the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; our ability to attract and retain key personnel; changes in our organization, compensation and benefit plans; and our success at managing the risks involved in the foregoing items. For further information on factors that could cause actual results to materially differ from projections, please see the Company's publicly available Securities and Exchange Commission filings, including the Company's Form 10-K for the last fiscal year and, in particular, the discussion of "Risk Factors" set forth therein. The Company does not update any of its forward-looking statements except as required by law.

 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
(dollars in thousands)March 31,
2018
 December 31,
2017
September 30,
2018
 December 31,
2017
Assets 
  
 
  
Cash and due from banks$59,905
 $75,318
$82,668
 $75,318
Interest-bearing deposits in other banks5,875
 6,975
7,051
 6,975
Investment securities:      
Available-for-sale debt securities, at fair value1,326,092
 1,304,066
1,233,002
 1,304,066
Held-to-maturity debt securities, at amortized cost; fair value of: $171,399 at March 31, 2018 and $189,201 at December 31, 2017177,078
 191,753
Held-to-maturity debt securities, at amortized cost; fair value of: $146,466 at September 30, 2018 and $189,201 at December 31, 2017152,852
 191,753
Equity securities, at fair value753
 825
885
 825
Total investment securities1,503,923
 1,496,644
1,386,739
 1,496,644
      
Loans held for sale7,492
 16,336
4,460
 16,336
      
Loans and leases3,816,146
 3,770,615
3,978,027
 3,770,615
Allowance for loan and lease losses(49,217) (50,001)(46,826) (50,001)
Net loans and leases3,766,929
 3,720,614
3,931,201
 3,720,614
      
Premises and equipment, net47,436
 48,348
46,184
 48,348
Accrued interest receivable16,070
 16,581
16,755
 16,581
Investment in unconsolidated subsidiaries6,478
 7,088
15,283
 7,088
Other real estate owned595
 851
414
 851
Mortgage servicing rights15,821
 15,843
15,634
 15,843
Core deposit premium1,337
 2,006

 2,006
Bank-owned life insurance156,611
 156,293
157,085
 156,293
Federal Home Loan Bank stock9,007
 7,761
10,965
 7,761
Other assets53,808
 53,050
54,201
 53,050
Total assets$5,651,287
 $5,623,708
$5,728,640
 $5,623,708
      
Liabilities 
  
 
  
Deposits: 
  
 
  
Noninterest-bearing demand$1,349,029
 $1,395,556
$1,403,534
 $1,395,556
Interest-bearing demand946,464
 933,054
935,130
 933,054
Savings and money market1,533,483
 1,481,876
1,503,465
 1,481,876
Time1,151,455
 1,145,868
1,161,551
 1,145,868
Total deposits4,980,431
 4,956,354
5,003,680
 4,956,354
      
Short-term borrowings56,000
 32,000
105,000
 32,000
Long-term debt92,785
 92,785
92,785
 92,785
Other liabilities37,963
 42,534
49,024
 42,534
Total liabilities5,167,179
 5,123,673
5,250,489
 5,123,673
      
Equity 
  
 
  
Preferred stock, no par value, authorized 1,000,000 shares; issued and outstanding: none at March 31, 2018 and December 31, 2017
 
Common stock, no par value, authorized 185,000,000 shares; issued and outstanding: 29,707,122 at March 31, 2018 and 30,024,222 at December 31, 2017493,794
 503,988
Surplus86,497
 86,098
Preferred stock, no par value, authorized 1,000,000 shares; issued and outstanding: none at September 30, 2018 and December 31, 2017
 
Common stock, no par value, authorized 185,000,000 shares; issued and outstanding: 29,270,398 at September 30, 2018 and 30,024,222 at December 31, 2017478,721
 503,988
Additional paid-in capital87,939
 86,098
Accumulated deficit(78,454) (89,036)(61,406) (89,036)
Accumulated other comprehensive income (loss)(17,729) (1,039)(27,103) (1,039)
Total shareholders' equity484,108
 500,011
478,151
 500,011
Non-controlling interest
 24

 24
Total equity484,108
 500,035
478,151
 500,035
Total liabilities and equity$5,651,287
 $5,623,708
$5,728,640
 $5,623,708
See accompanying notes to consolidated financial statements.
 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited) 
Three Months Ended
March 31,
Three Months Ended
September 30,
 Nine Months Ended
September 30,
(dollars in thousands, except per share data)2018 20172018 2017 2018 2017
Interest income: 
  
 
  
  
  
Interest and fees on loans and leases$37,390
 $34,957
$40,531
 $36,289
 $116,620
 $106,777
Interest and dividends on investment securities:          
Taxable interest8,843
 8,135
8,490
 8,540
 26,050
 25,156
Tax-exempt interest933
 979
920
 966
 2,786
 2,919
Dividends15
 12
26
 12
 44
 36
Interest on deposits in other banks84
 74
109
 163
 310
 298
Dividends on Federal Home Loan Bank stock45
 56
60
 23
 145
 100
Total interest income47,310
 44,213
50,136
 45,993
 145,955
 135,286
Interest expense: 
  
 
  
  
  
Interest on deposits: 
  
 
  
  
  
Demand180
 140
181
 177
 554
 471
Savings and money market369
 257
593
 281
 1,421
 797
Time3,425
 1,717
4,744
 2,637
 12,203
 6,490
Interest on short-term borrowings43
 31
146
 9
 237
 86
Interest on long-term debt971
 813
1,147
 894
 3,221
 2,563
Total interest expense4,988
 2,958
6,811
 3,998
 17,636
 10,407
Net interest income42,322
 41,255
43,325
 41,995
 128,319
 124,879
Provision (credit) for loan and lease losses(211) (80)(59) (126) 262
 (2,488)
Net interest income after credit for loan and lease losses42,533
 41,335
Net interest income after provision (credit) for loan and lease losses43,384
 42,121
 128,057
 127,367
Other operating income: 
  
 
  
  
  
Mortgage banking income1,847
 1,943
1,923
 1,531
 5,545
 5,431
Service charges on deposit accounts2,003
 2,036
2,189
 2,182
 6,169
 6,338
Other service charges and fees3,034
 2,748
3,286
 3,185
 9,697
 8,986
Income from fiduciary activities956
 864
1,159
 911
 3,132
 2,739
Equity in earnings of unconsolidated subsidiaries43
 61
71
 176
 151
 388
Fees on foreign exchange211
 163
220
 101
 708
 394
Investment securities gains (losses)
 
 
 (1,640)
Income from bank-owned life insurance318
 1,117
1,055
 1,074
 1,874
 2,774
Loan placement fees197
 134
115
 86
 532
 366
Net gain on sales of foreclosed assets
 102

 19
 
 205
Other345
 846
802
 304
 1,596
 1,472
Total other operating income8,954
 10,014
10,820
 9,569
 29,404
 27,453
Other operating expense: 
  
 
  
  
  
Salaries and employee benefits18,505
 17,387
19,011
 18,157
 56,299
 53,527
Net occupancy3,266
 3,414
3,488
 3,404
 10,114
 10,153
Equipment1,068
 842
1,048
 969
 3,160
 2,778
Amortization of core deposit premium669
 668
669
 669
 2,006
 2,006
Communication expense898
 900
903
 944
 2,547
 2,735
Legal and professional services1,821
 1,792
1,528
 1,854
 5,118
 5,633
Computer software expense2,267
 2,252
2,672
 2,346
 7,244
 6,788
Advertising expense612
 392
612
 626
 1,841
 1,408
Foreclosed asset expense294
 36
212
 24
 537
 123
Other4,118
 3,777
3,996
 4,518
 12,515
 12,155
Total other operating expense33,518
 31,460
34,139
 33,511
 101,381
 97,306
Income before income taxes17,969
 19,889
20,065
 18,179
 56,080
 57,514
Income tax expense3,692
 6,810
4,872
 6,367
 12,386
 20,598
Net income$14,277
 $13,079
$15,193
 $11,812
 $43,694
 $36,916
Per common share data: 
  
 
  
  
  
Basic earnings per common share$0.48
 $0.43
$0.52
 $0.39
 $1.48
 $1.21
Diluted earnings per common share$0.48
 $0.42
$0.52
 $0.39
 $1.47
 $1.20
Cash dividends declared$0.19
 $0.16
$0.21
 $0.18
 $0.61
 $0.52
Shares used in computation:   
Weighted average common shares outstanding used in computation:       
Basic shares29,807,572
 30,714,895
29,297,465
 30,300,195
 29,536,536
 30,526,260
Diluted shares30,041,351
 31,001,238
29,479,812
 30,514,459
 29,743,238
 30,758,989
 See accompanying notes to consolidated financial statements.
 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 
 Three Months Ended
March 31,
 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(dollars in thousands) 2018 2017 2018 2017 2018 2017
Net income $14,277
 $13,079
 $15,193
 $11,812
 $43,694
 $36,916
Other comprehensive income (loss), net of tax:            
Net change in unrealized gain (loss) on investment securities (14,971) 2,124
 (6,072) (293) (24,712) 4,626
Minimum pension liability adjustment 256
 (364)
Defined benefit plans 217
 285
 623
 111
Total other comprehensive income (loss), net of tax (14,715) 1,760
 (5,855) (8) (24,089) 4,737
Comprehensive income (loss) $(438) $14,839
Comprehensive income $9,338
 $11,804
 $19,605
 $41,653
 
See accompanying notes to consolidated financial statements.
 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (Unaudited)
 
  Common
Shares
Outstanding
 Preferred
Stock
 Common
Stock
 Surplus Accumulated
Deficit
 Accumulated
Other
Comprehensive
Income (Loss)
 Non-
Controlling
Interest
 Total
  (dollars in thousands, except per share data)
 Balance at December 31, 201730,024,222
 $
 $503,988
 $86,098
 $(89,036) $(1,039) $24
 $500,035
 Impact of the adoption of new accounting standards (1)
 
 
 
 1,975
 (1,975) 
 
 Net income
 
 
 
 14,277
 
 
 14,277
 Other comprehensive loss
 
 
 
 
 (14,715) 
 (14,715)
 Cash dividends ($0.19 per share)
 
 
 
 (5,670) 
 
 (5,670)
 2,850 net shares of common stock purchased by directors' deferred compensation plan
 
 (83) 
 
 
 
 (83)
 344,362 shares of common stock repurchased and other related costs(344,362) 
 (10,111) 

 
 
 
 (10,111)
 Share-based compensation27,262
 
 
 399
 
 
 
 399
 Non-controlling interest
 
 
 
 
 
 (24) (24)
 Balance at March 31, 201829,707,122
 $
 $493,794
 $86,497
 $(78,454) $(17,729) $
 $484,108
                 
 Balance at December 31, 201630,796,243
 $
 $530,932
 $84,180
 $(108,941) $(1,521) $25
 $504,675
 Net income
 
 
 
 13,079
 
 
 13,079
 Other comprehensive income
 
 
 
 
 1,760
 
 1,760
 Cash dividends ($0.16 per share)
 
 
 
 (4,922) 
 
 (4,922)
 113,750 shares of common stock repurchased and other related costs(113,750) 
 (3,529) 
 
 
 
 (3,529)
 Share-based compensation18,726
 
 
 498
 
 
 
 498
 Non-controlling interest
 
 
 
 
 
 
 
 Balance at March 31, 201730,701,219
 $
 $527,403
 $84,678
 $(100,784) $239
 $25
 $511,561
                 
 (1) Represents the impact of the adoption of Accounting Standards Update ("ASU") 2018-02 and ASU 2016-01. See Note 2 - Recent Accounting Pronouncements to the consolidated financial statements for additional information.
 
 Common
Shares
Outstanding
 Preferred
Stock
 Common
Stock
 Additional Paid-In Capital Accumulated
Deficit
 Accumulated
Other
Comprehensive
Income (Loss)
 Non-
Controlling
Interest
 Total
 (dollars in thousands, except per share data)
Balance at December 31, 201730,024,222
 $
 $503,988
 $86,098
 $(89,036) $(1,039) $24
 $500,035
Impact of the adoption of new accounting standards (1)
 
 
 
 139
 (139) 
 
Adjusted balance at January 1, 201830,024,222
 
 503,988
 86,098
 (88,897) (1,178) 24
 500,035
Impact of the adoption of new accounting standards (2)
 
 
 
 1,836
 (1,836) 
 
Net income
 
 
 
 43,694
 
 
 43,694
Other comprehensive loss
 
 
 
 
 (24,089) 
 (24,089)
Cash dividends ($0.61 per share)
 
 
 
 (18,039) 
 
 (18,039)
16,950 net shares of common stock purchased by directors' deferred compensation plan
 
 (504) 
 
 
 
 (504)
849,290 shares of common stock repurchased and retired and other related costs(849,290) 
 (24,763) 

 
 
 
 (24,763)
Share-based compensation95,466
 
 
 1,841
 
 
 
 1,841
Distribution from variable interest entity
 
 
 
 
 
 (24) (24)
Balance at September 30, 201829,270,398
 $
 $478,721
 $87,939
 $(61,406) $(27,103) $
 $478,151
                
Balance at December 31, 201630,796,243
 $
 $530,932
 $84,180
 $(108,941) $(1,521) $25
 $504,675
Net income
 
 
 
 36,916
 
 
 36,916
Other comprehensive income
 
 
 
 
 4,737
 
 4,737
Cash dividends ($0.52 per share)
 
 
 
 (15,888) 
 
 (15,888)
12,020 net shares of common stock purchased by directors' deferred compensation plan
 
 (385) 
 
 
 
 (385)
697,483 shares of common stock repurchased and retired and other related costs(697,483) 
 (21,304) 
 
 
 
 (21,304)
Share-based compensation89,988
 
 
 1,120
 
 
 
 1,120
Net loss from variable interest entity
 
 
 
 
 
 (1) (1)
Balance at September 30, 201730,188,748
 $
 $509,243
 $85,300
 $(87,913) $3,216
 $24
 $509,870
                
(1) Represents the impact of the adoption of Accounting Standards Update ("ASU") ASU 2016-01. See Notes 1 and 2 to the consolidated financial statements for additional information.
(2) Represents the impact of the adoption of ASU 2018-02. See Note 2 to the consolidated financial statements for additional information.
                
 
See accompanying notes to consolidated financial statements.
 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three Months Ended
March 31,
Nine Months Ended
September 30,
(dollars in thousands)2018 20172018 2017
Cash flows from operating activities: 
  
 
  
Net income$14,277
 $13,079
$43,694
 $36,916
Adjustments to reconcile net income to net cash provided by operating activities:   
   
Provision (credit) for loan and lease losses(211) (80)262
 (2,488)
Depreciation and amortization1,599
 1,537
Write down of other real estate, net of gain on sale256
 (162)
Depreciation and amortization of premises and equipment4,700
 4,768
Gain or loss on sale of other real estate, net of write-downs431
 (192)
Amortization of core deposit premium and mortgage servicing rights1,126
 1,188
3,419
 3,549
Net amortization and accretion of premium/discounts on investment securities2,922
 2,966
8,465
 8,960
Share-based compensation399
 498
Share-based compensation expense1,841
 1,120
Net loss on sales of investment securities
 1,640
Net gain on sales of residential mortgage loans(972) (1,312)(3,013) (3,101)
Proceeds from sales of loans held for sale64,106
 86,663
183,967
 249,866
Originations of loans held for sale(54,290) (63,375)(169,078) (225,712)
Equity in earnings of unconsolidated subsidiaries(43) (61)(151) (388)
Net increase in cash surrender value of bank-owned life insurance(318) (208)(792) (3,256)
Deferred income taxes3,620
 6,685
12,201
 19,984
Net tax benefits from share-based compensation72
 125
185
 614
Net change in other assets and liabilities(3,198) (2,373)(7,925) (15,701)
Net cash provided by operating activities29,345
 45,170
78,206
 76,579
Cash flows from investing activities: 
  
 
  
Proceeds from maturities of and calls on investment securities available-for-sale40,039
 49,204
114,508
 128,588
Proceeds from sales of investment securities available-for-sale
 96,019
Purchases of investment securities available-for-sale(85,240) (107,512)(85,334) (333,242)
Proceeds from maturities of and calls on investment securities held-to-maturity14,545
 6,069
38,491
 19,455
Net loan proceeds (originations)(46,144) 2,111
(190,022) (63,835)
Purchases of loan portfolios
 (24,121)(20,867) (50,725)
Proceeds from sale of foreclosed loans/other real estate owned40
 102
46
 286
Proceeds from bank-owned life insurance
 782

 2,921
Purchases of premises and equipment(687) (1,582)
Net purchases of premises and equipment(2,536) (4,849)
Net return of capital from unconsolidated subsidiaries539
 438
614
 549
Contributions to unconsolidated subsidiaries
 (4)
Net (purchases of) proceeds from redemption of FHLB stock(1,246) 4,239
(3,204) 5,088
Net cash used in investing activities(78,154) (70,270)(148,304) (199,749)
Cash flows from financing activities: 
  
 
  
Net increase in deposits24,077
 169,243
47,326
 319,296
Net (decrease) increase in short-term borrowings24,000
 (114,000)
Net increase (decrease) in short-term borrowings73,000
 (135,000)
Cash dividends paid on common stock(5,670) (4,922)(18,039) (15,888)
Repurchases of common stock and other related costs(10,111) (3,529)(24,763) (21,304)
Net cash provided by financing activities32,296
 46,792
77,524
 147,104
Net increase (decrease) in cash and cash equivalents(16,513) 21,692
7,426
 23,934
Cash and cash equivalents at beginning of period82,293
 84,341
82,293
 84,341
Cash and cash equivalents at end of period$65,780
 $106,033
$89,719
 $108,275
      
Supplemental disclosure of cash flow information: 
  
 
  
Cash paid during the period for: 
  
 
  
Interest$4,877
 $2,396
$15,969
 $9,097
Income taxes22
 
23
 7,900
Supplemental disclosure of non-cash investing and financing activities:      
Net change in common stock held by directors’ deferred compensation plan504
 385
Net reclassification of loans to foreclosed loans/other real estate owned40
 
40
 154
 See accompanying notes to consolidated financial statements.
 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES
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, as amended by our Form 10-K/A for the fiscal year ended December 31, 2017. 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 December 2015, we acquired a 50% ownership interest in a mortgage loan origination and brokerage company, One Hawaii HomeLoans, LLC. The bank concluded that the investment meets the consolidation requirements under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 810, "Consolidation." The bank concluded that the entity meets the definition of a variable interest entity and that we are the primary beneficiary of the variable interest entity. Accordingly, the investment was consolidated into our financial statements. One Hawaii HomeLoans, LLC was terminated in 2017, and final payment of taxes and distributions to members werewas made in March 2018.

We have 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 subsidiaries: Gentry HomeLoans, LLC, Haseko HomeLoans, LLC and Island Pacific HomeLoans, LLC. We also had 50% ownership interest in one additional mortgage loan origination and brokerage company, Pacific Access Mortgage, LLC, which was also accounted for using the equity method and was included in investment in unconsolidated subsidiaries. Pacific Access Mortgage, LLC was terminated in 2017, and final payment of taxes and distributions to members werewas made in March 2018.

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

Our investments in unconsolidated subsidiaries accounted for under the equity and cost methods were $0.1$0.2 million and $6.3$15.1 million, respectively, at March 31,September 30, 2018 and $0.6 million and $6.5 million, respectively, at December 31, 2017. Our policy for determining impairment of these investments includes an evaluation of whether a loss in value of an investment is other than temporary. Evidence of a loss in value includes absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. We perform impairment tests whenever indicators of impairment are present. If the value of an investment declines and it is considered other than temporary, the investment is written down to its respective fair value in the period in which this determination is made.

The Company sponsors the Central Pacific Bank Foundation, which is not consolidated in the Company's financial statements.

Reclassifications

The Company's equity investment securities in the prior year have been reclassified from available-for-sale debt securities to conform to the current year's presentation.presentation in accordance with Accounting Standards Update ("ASU") 2016-01, "Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Liabilities." The reclassification had no impact on the Company's reported net income or shareholders' equity.

 


2.   RECENT ACCOUNTING PRONOUNCEMENTS
 
Accounting Standards Adopted in 2018

In May 2014, the FASB issued Accounting Standards Update ("ASU")ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)." ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This ASU replaces most existing revenue recognition guidance in GAAP. ASU 2014-09 was initially effective for the Company's reporting period beginning on January 1, 2017. However, in August 2015, the FASB issued ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date" which deferred the effective date by one year. For financial reporting purposes, the standard allows for either a full retrospective or modified retrospective adoption. The FASB has also issued additional updates to provide further clarification to specific implementation issues associated with ASU 2014-09. These updates include ASU 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations," ASU 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing," ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients," and ASU 2016-20 "Technical Corrections and Improvements to Topic 606." Our revenue is comprised of net interest income on financial assets and financial liabilities, which is our main source of income, and other operating income. The scope of ASU 2014-09 explicitly excludes net interest income, as well as other revenues associated with financial assets and liabilities, including loans, leases, securities and derivatives. With respect to other operating income, the Company conducted a comprehensive scoping exercise to determine the revenue streams that are in scope of the guidance. This included reviewing the contracts potentially impacted by the standard in revenue streams such as deposit-related fees, merchant fees, bank card fees, interchange fees, commissions income, trust and asset management fees, foreign exchange fees, and loan placement fees. We adopted ASU 2014-09 and all subsequent amendments to the standard beginning January 1, 2018 under the modified retrospective approach. Based on our analysis, the standard required us to change how we recognize certain recurring revenue streams on a gross versus net basis. This resulted in an increase in other service charges and fees totaling $0.1$0.2 million and $0.5 million during the first quarter ofthree and nine months ended September 30, 2018, respectively, and the resultant increase in other operating expense-other for the same amount. These changes did not have an impact to our net income; as such a cumulative effect adjustment to opening accumulated deficit was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606 while prior period amounts continue to be recorded in accordance with legacy GAAP. Refer to Note 1211 - Revenue from Contracts with Customers for further discussion on the Company's accounting policies for revenue sources within the scope of Accounting Standards Codification ("ASC") 606.

In January 2016, the FASB issued ASU 2016-01, "Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Liabilities." The amendments in ASU 2016-01 made targeted improvements to GAAP as follows: 1) required equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, 2) simplified the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, 3) eliminated the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities, 4) eliminated the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, 5) required public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, 6) required an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, 7) required separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements, and 8) clarified that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The Company adopted ASU 2016-01 beginning January 1, 2018, which resulted in a reclassification of the Company's equity investment securities portfolio of $0.8$0.9 million and $0.8 million as of March 31,September 30, 2018 and December 31, 2017, respectively, from available-for-sale debt securities to equity securities on the Company's consolidated balance sheets. Changes in fair value are recognized in net income. In addition, during the first quarter of 2018, the Company recorded a cumulative effect adjustment which increased opening retained earnings (or reduced opening accumulated deficit) and decreased accumulated other comprehensive income (loss) ("AOCI") by $0.1 million related to the unrealized gains on the equity investment securities portfolio and changes in the fair value of the equity investment securities portfolio were recognized in net income. The Company also engaged a third-party consultant, who used a refined calculation to determine the fair value of our loans held for investment portfolio using the exit price notion, which is included in our fair value disclosures in Note 1817 - Fair Value of Financial Assets and Liabilities. The refined calculation did not have a material impact on our fair value disclosures.

 


In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments." ASU 2016-15 provided guidance on eight statement of cash flow classification issues and was intended to reduce the current and future diversity in practice described in the amendments. Current GAAP is either unclear or does not include specific guidance on the eight statement of cash flow classification issues included in ASU 2016-15. The Company adopted ASU 2016-15 effective January 1, 2018. The amendments in ASU 2016-15 did not impact the Company's financial statements as our current practice was consistent with the update.

In March 2017, the FASB issued ASU 2017-07, "Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost." ASU 2017-07 requires an entity to present the service cost component of the net periodic benefit cost in the same line item or items in the statement of income as other employee compensation costs arising from services rendered by the pertinent employees during the period. In addition, only the service cost component is eligible for capitalization. The other components of net benefit costs should be presented in the statement of income separately from the service cost component and outside a subtotal of income from operations, if one is presented. If a separate line item is used to present the other components, that line item shall be described appropriately. The line items used in the income statement to present the components other than the service cost component shall be disclosed if a Company elects to not present them in a separate line item. The Company adopted ASU 2017-07 effective January 1, 2018. The amendments in ASU 2017-07 did not impact the Company's financial statements.

In March 2017, the FASB issued ASU 2017-08, "Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities." ASU 2017-08 shortens the amortization period for certain callable debt securities held at a premium to the earliest call date. ASU 2017-08 does not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. TheAlthough ASU 2017-08 is effective for the Company's reporting period beginning on January 1, 2019, the Company adopted ASU 2017-08elected to early adopt the standard effective January 1, 2018. The amendments in ASU 2017-08 did not have a material impact to the Company's financial statements.

In May 2017, the FASB issued ASU 2017-09, "Compensation-Stock Compensation (Topic 718): Scope of Modification." ASU 2017-09 was issued to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation - Stock Compensation, to a change to the terms or conditions of a share-based payment award. Diversity in practice has arisen in part because some entities apply modification accounting under Topic 718 for modifications to terms and conditions that they consider substantive, but do not when they conclude that particular modifications are not substantive. Others apply modification accounting for any change to an award, except for changes that they consider purely administrative in nature. Still others apply modification accounting when a change to an award changes the fair value, the vesting, or the classification of the award. In practice, it appears that the evaluation of a change in fair value, vesting, or classification may be used to evaluate whether a change is substantive. ASU 2017-09 includes guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718. The Company adopted ASU 2017-09 effective January 1, 2018. The amendments in ASU 2017-09 did not impact the Company's financial statements as the Company has not historically had any scope modifications and has no plans to do so in the near future.

In February 2018, the FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." ASU 2018-02 was issued to address certain stranded tax effects in AOCI as a result of H.R.1., commonly referred to as the Tax Cuts and Jobs Act ("Tax Reform"). ASU 2018-02 provides companies the option to reclassify stranded tax effects within AOCI to retained earnings (or accumulated deficit) in each period in which the effect of the change from the newly enacted corporate tax rate is recorded. The amount of the reclassification is calculated on the basis of the difference between the historical and newly enacted tax rates for deferred tax assets and liabilities related to items within AOCI. ASU 2018-02 requires companies to disclose its accounting policy related to releasing income tax effects from accumulated other comprehensive income, whether it has elected to reclassify the stranded tax effects, and information about the other income tax effects that are reclassified. Although ASU 2018-02 wasis effective for the Company's reporting period beginning on January 1, 2019, the Company elected to early adopt the standard effective January 1, 2018. As a result, the Company recorded cumulative effect adjustments which increased opening retained earnings (or reduced opening accumulated deficit) and decreased AOCI for the stranded tax effects related to the Company's defined benefit pension and supplemental retirement plan obligations and the unrealized gainloss on the Company's investment securities portfolio by $1.4 million and $0.5 million, respectively.

Impact of Other Recently Issued Accounting Pronouncements on Future Filings

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." ASU 2016-02 increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key
 

information about leasing arrangements. The ASU establishes a right-of-use ("ROU") model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term of longer than 12 months. The FASB has also made available several practical expedients to assist entities with the adoption of ASU 2016-02. Among other things, these practical expedients require no reassessment of whether existing contracts are or contain leases as well as no reassessment of lease classification for current leases. In July 2018, the FASB released ASU 2018-11, "Leases (Topic 842 Targeted Improvements)," which adds an additional practical expedient that allows entities to elect not to recast comparative periods presented when transitioning to Topic 842. During the quarter ended September 30, 2018, the Company has engaged a software vendor to assist in the implementation of ASU 2016-02 and has completed testing of completeness and accuracy of the lease population. The ASU is effective for the Company's reporting period beginning January 1, 2019 and must be applied using the modified retrospective approach. Based on preliminary evaluation, the ASU will not have a material impact on our consolidated financial statements as the projected minimum lease payments under existing leases subject to the ASU are less than one percent of our total assets as of September 30, 2018.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments," which significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren’t measured at fair value through net income. In issuing the standard, the FASB is responding to criticism that today’s “incurred loss” guidance delays the recognition of credit losses on loans, leases, held-to-maturity debt securities, loan commitments, and financial guarantees, and instead provides for a current expected credit loss (“CECL”) approach to determine the allowance for credit losses. CECL requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. In addition, this guidance modifies the accounting treatment for other-than-temporary impairment for available-for-sale debt securities. Organizations will continue to use judgment to determine which loss estimation methods are appropriate for their circumstances. This guidance requires entities to record a cumulative effect adjustment to the consolidated balance sheet as of the beginning of the first reporting period in which the guidance is effective. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with earlier adoption permitted. As such, the Company will implement CECL for the reporting period beginning January 1, 2020. The new guidance will require significant operational changes, particularly in data collection and analysis.

The Company has formed a steering committee that is responsible for oversight of the Company’s implementation strategy for compliance with provisions of the new standard. The Company has also established a project management governance process to manage the implementation across affected disciplines. An external provider specializing in community bank loss driver and CECL reserving model design as well as other related consulting services has been retained, and we have begun to evaluate potential CECL modeling alternatives. As part of this process, the Company has determined potential loan pool segmentation and sub-segmentation under CECL, as well as evaluated the key economic loss drivers for each segment. Further, the Company has engaged a third party economic forecasting service to utilize in developing the Company's reasonable and supportable forecasts under CECL. The Company presently plans to generate and evaluate model scenarios under CECL in tandem with its current reserving processes for interim and annual reporting periods in 2019. While the Company is currently unable to reasonably estimate the impact of adopting this new guidance, management expects the impact of adoption will be significantly influenced by the composition and quality of the Company’s loans and investment securities as well as the economic conditions as of the date of adoption. The Company also anticipates significant changes to the processes and procedures for calculating the reserve for credit losses and continues to evaluate the potential impact on our consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." ASU 2017-12 was issued to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The FASB believes that such amendments will: 1) improve the transparency of information about an entity’s risk management activities and 2) simplify the application of hedge accounting. The ASU allows an entity that qualifies for the last-of-layer method to reclassify securities from the held-to-maturity category to the available-for-sale category. The ASU is effective for the the Company's reporting period beginning on January 1, 2019. Early adoption is permitted. We are currently in the process of evaluating the potential impact the amendments will have on our consolidated financial statements, but we do not expect the adoption of the ASU to have a material impact on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement." The ASU is part of the FASB's disclosure framework project to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of the information required by generally accepted accounting principles. The ASU modifies disclosure requirements on fair value

measurements in Topic 820 and is effective for the Company's reporting period beginning January 1, 2020. Early adoption is permitted. Based on preliminary evaluation, the ASU will not have a material impact on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-14, "Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans." Like ASU 2018-13, this ASU is part of the FASB's disclosure framework project. This ASU modifies disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The ASU is effective for the Company's reporting period beginning January 1, 2021. Early adoption is permitted. Based on preliminary evaluation, the ASU will not have a material impact on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-15, "Intangibles—Goodwill and Other— Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract," which requires an entity in a cloud computing arrangement (i.e., hosting arrangement) that is a service contract to follow the internal-use software guidance in ASC 350-40 to determine which implementation costs to capitalize as assets or expense as incurred. Capitalized implementation costs should be presented in the same line item on the balance sheet as amounts prepaid for the hosted service, if any (generally as an “other asset”). The capitalized costs will be amortized over the term of the hosting arrangement, with the amortization expense being presented in the same income statement line item as the fees paid for the hosted service. ASU 2018-15 is effective for the Company's reporting period beginning January 1, 2020 and early adoption is permitted. We are currently in the process of evaluating the potential impact the amendments will have on our consolidated financial statements, but we do not expect the adoption of the ASU to have a material impact on our consolidated financial statements.

3. INVESTMENT SECURITIES
 
A summary of our investment portfolio is as follows:
 
(dollars in thousands)Amortized
Cost
 Gross
Unrealized
Gains
 Gross
Unrealized
Losses
 Fair
Value
Amortized
Cost
 Gross
Unrealized
Gains
 Gross
Unrealized
Losses
 Fair
Value
March 31, 2018 
  
  
  
September 30, 2018 
  
  
  
Held-to-maturity: 
  
  
  
 
  
  
  
Mortgage-backed securities: 
  
  
  
 
  
  
  
Residential - U.S. Government-sponsored entities$96,619
 $29
 $(3,510) $93,138
$87,356
 $
 $(4,339) $83,017
Commercial - U.S. Government-sponsored entities80,459
 
 (2,198) 78,261
65,496
 
 (2,047) 63,449
Total$177,078
 $29
 $(5,708) $171,399
Total held-to-maturity securities$152,852
 $
 $(6,386) $146,466
              
Available-for-sale: 
  
  
  
 
  
  
  
Debt securities: 
  
  
  
 
  
  
  
States and political subdivisions$177,766
 $1,385
 $(1,930) $177,221
$175,495
 $788
 $(2,731) $173,552
Corporate securities68,433
 51
 (426) 68,058
65,587
 23
 (477) 65,133
U.S. Treasury obligations and direct obligations of U.S Government agencies37,148
 84
 (79) 37,153
34,566
 
 (647) 33,919
Mortgage-backed securities: 
  
  
  
 
  
  
  
Residential - U.S. Government-sponsored entities831,728
 493
 (20,899) 811,322
763,635
 297
 (29,575) 734,357
Commercial - U.S. Government agencies and sponsored entities54,628
 
 (1,171) 53,457
53,618
 
 (2,413) 51,205
Residential - Non-government agencies44,667
 396
 (623) 44,440
42,069
 132
 (831) 41,370
Commercial - Non-government agencies135,010
 998
 (1,567) 134,441
134,914
 321
 (1,769) 133,466
Total$1,349,380
 $3,407
 $(26,695) $1,326,092
Total available-for-sale securities$1,269,884
 $1,561
 $(38,443) $1,233,002
              
Equity securities$619
 $134
 $
 $753
$712
 $173
 $
 $885

 

(dollars in thousands)Amortized
Cost
 Gross
Unrealized
Gains
 Gross
Unrealized
Losses
 Fair
Value
Amortized
Cost
 Gross
Unrealized
Gains
 Gross
Unrealized
Losses
 Fair
Value
December 31, 2017 
  
  
  
 
  
  
  
Held-to-maturity: 
  
  
  
 
  
  
  
Mortgage-backed securities: 
  
  
  
 
  
  
  
Residential - U.S. Government-sponsored entities$100,279
 $106
 $(2,222) $98,163
$100,279
 $106
 $(2,222) $98,163
Commercial - U.S. Government-sponsored entities91,474
 
 (436) 91,038
91,474
 
 (436) 91,038
Total$191,753
 $106
 $(2,658) $189,201
Total held-to-maturity securities$191,753
 $106
 $(2,658) $189,201
              
Available-for-sale: 
  
  
  
 
  
  
  
Debt securities: 
  
  
  
 
  
  
  
States and political subdivisions$178,459
 $2,041
 $(719) $179,781
$178,459
 $2,041
 $(719) $179,781
Corporate securities73,772
 582
 (76) 74,278
73,772
 582
 (76) 74,278
U.S. Treasury obligations and direct obligations of U.S Government agencies25,519
 60
 (69) 25,510
25,519
 60
 (69) 25,510
Mortgage-backed securities:       
       
Residential - U.S. Government-sponsored entities808,242
 2,230
 (9,789) 800,683
808,242
 2,230
 (9,789) 800,683
Commercial - U.S. Government agencies and sponsored entities40,012
 
 (287) 39,725
40,012
 
 (287) 39,725
Residential - Non-government agencies45,679
 1,084
 
 46,763
45,679
 1,084
 
 46,763
Commercial - Non-government agencies135,058
 2,461
 (193) 137,326
135,058
 2,461
 (193) 137,326
Total$1,306,741
 $8,458
 $(11,133) $1,304,066
Total available-for-sale securities$1,306,741
 $8,458
 $(11,133) $1,304,066
              
Equity securities$686
 $139
 $
 $825
$686
 $139
 $
 $825

 

The amortized cost and estimated fair value of investment securities at March 31,September 30, 2018 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
March 31, 2018September 30, 2018
(dollars in thousands)Amortized Cost Fair ValueAmortized Cost Fair Value
Held-to-maturity: 
  
 
  
Mortgage-backed securities: 
  
 
  
Residential - U.S. Government-sponsored entities$96,619
 $93,138
$87,356
 $83,017
Commercial - U.S. Government-sponsored entities80,459
 78,261
65,496
 63,449
Total$177,078
 $171,399
Total held-to-maturity securities$152,852
 $146,466
      
Available-for-sale: 
  
 
  
Due in one year or less$13,691
 $13,702
$63,878
 $63,916
Due after one year through five years156,766
 156,598
103,852
 103,115
Due after five years through ten years49,619
 49,279
50,639
 49,629
Due after ten years63,271
 62,853
57,279
 55,944
      
Mortgage-backed securities:      
Residential - U.S. Government-sponsored entities831,728
 811,322
763,635
 734,357
Commercial - U.S. Government agencies and sponsored entities54,628
 53,457
53,618
 51,205
Residential - Non-government agencies44,667
 44,440
42,069
 41,370
Commercial - Non-government agencies135,010
 134,441
134,914
 133,466
Total$1,349,380
 $1,326,092
Total available-for-sale securities$1,269,884
 $1,233,002
      
Equity securities$619
 $753
$712
 $885
 
We did not sell any available-for-sale securities during the three and nine months ended September 30, 2018.

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

We did not sell any available-for-sale securities during the three months ended March 31, 20182017 and September 30, 2017.

Investment securities of $1.04$1.00 billion and $1.08 billion at March 31,September 30, 2018 and December 31, 2017, respectively, were pledged to secure public funds on deposit and other long-term debt and short-term borrowings.


Provided below is a summary of the 335379 and 223 investment securities which were in an unrealized or unrecognized loss position at March 31,September 30, 2018 and December 31, 2017, respectively, aggregated by major security type and length of time in a continuous unrealized or unrecognized loss position.
 
 Less Than 12 Months 12 Months or Longer Total
(dollars in thousands)Fair
Value
 Unrealized
Losses
 Fair
Value
 Unrealized
Losses
 Fair
Value
 Unrealized
Losses
March 31, 2018 
  
  
  
  
  
Debt securities: 
  
  
  
  
  
States and political subdivisions$81,236
 $(1,043) $14,893
 $(887) $96,129
 $(1,930)
Corporate securities44,658
 (245) 5,177
 (181) 49,835
 (426)
U.S. Treasury obligations and direct obligations of U.S Government agencies10,852
 (79) 
 
 10,852
 (79)
Mortgage-backed securities: 
  
  
  
  
  
Residential - U.S. Government-sponsored entities550,723
 (10,744) 321,774
 (13,665) 872,497
 (24,409)
Residential - Non-government agencies26,466
 (623) 
 
 26,466
 (623)
Commercial - U.S. Government agencies and sponsored entities131,718
 (3,369) 
 
 131,718
 (3,369)
Commercial - Non-government agencies83,975
 (1,567) 
 
 83,975
 (1,567)
Total temporarily impaired securities$929,628
 $(17,670) $341,844
 $(14,733) $1,271,472
 $(32,403)

 Less Than 12 Months 12 Months or Longer Total
(dollars in thousands)Fair
Value
 Unrealized
Losses
 Fair
Value
 Unrealized
Losses
 Fair
Value
 Unrealized
Losses
September 30, 2018 
  
  
  
  
  
Debt securities: 
  
  
  
  
  
States and political subdivisions$87,069
 $(1,225) $26,654
 $(1,506) $113,723
 $(2,731)
Corporate securities54,275
 (301) 5,130
 (176) 59,405
 (477)
U.S. Treasury obligations and direct obligations of U.S Government agencies31,220
 (602) 2,699
 (45) 33,919
 (647)
Mortgage-backed securities: 
  
  
  
  
  
Residential - U.S. Government-sponsored entities285,808
 (7,950) 513,681
 (25,964) 799,489
 (33,914)
Residential - Non-government agencies24,690
 (831) 
 
 24,690
 (831)
Commercial - U.S. Government agencies and sponsored entities57,509
 (1,873) 57,145
 (2,587) 114,654
 (4,460)
Commercial - Non-government agencies93,778
 (1,769) 
 
 93,778
 (1,769)
Total temporarily impaired securities$634,349
 $(14,551) $605,309
 $(30,278) $1,239,658
 $(44,829)

 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, 2017 
  
  
  
  
  
Debt securities: 
  
  
  
  
  
States and political subdivisions$53,811
 $(305) $15,403
 $(414) $69,214
 $(719)
Corporate securities
 
 5,307
 (76) 5,307
 (76)
U.S. Treasury obligations and direct obligations of U.S Government agencies10,740
 (69) 
 
 10,740
 (69)
Mortgage-backed securities: 
  
  
  
  
  
Residential - U.S. Government-sponsored entities335,883
 (3,372) 340,219
 (8,639) 676,102
 (12,011)
Residential - Non-government agencies
 
 
 
 
 
Commercial - U.S. Government-sponsored entities130,763
 (723) 
 
 130,763
 (723)
Commercial - Non-government agencies28,490
 (193) 
 
 28,490
 (193)
Total temporarily impaired securities$559,687
 $(4,662) $360,929
 $(9,129) $920,616
 $(13,791)

Other-Than-Temporary Impairment ("OTTI")
 
Unrealized losses for allManagement evaluates investment securities are reviewed to determine whether the losses are deemed "other-than-temporary." Investment securities are evaluated for OTTI on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation, to determine whether athe unrealized losses on investment securities, or the decline in their value below amortized cost is other-than-temporary."other-than-temporary." The term "other-than-temporary" is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. In conducting this assessment, for securities in an unrealized loss position we evaluate a number of factors including, but not limited to:
 
The length of time and the extent to which fair value has been less than the amortized cost basis;
Adverse conditions specifically related to the security, an industry, or a geographic area;
The historical and implied volatility of the fair value of the security;
The payment structure of the debt security and the likelihood of the issuer being able to make payments;
Failure of the issuer to make scheduled interest or principal payments;
Any rating changes by a rating agency; and

Recoveries or additional declines in fair value subsequent to the balance sheet date.
 
The term "other-than-temporary"Management also assesses whether it intends to sell, or it is more likely than not intendedthat it will be required to indicate that the decline is permanent, but indicates that the prospects forsell, a near-termsecurity in an unrealized loss position before recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying valueits amortized cost basis. If either of the investment. Once acriteria regarding intent or requirement to sell is met, the decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding impairment charge to earnings is recognized for anticipated credit losses.
 
For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

In order to determine OTTI for purchased beneficial interests that, on the purchase date, were not highly rated, the Company compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.

The declines in market value were primarily attributable to changes in interest rates and volatility in the credit and financial markets. Because we have no intent to sell securities in an unrealized loss position and it is not more likely than not that we will be required to sell such securities before recovery of its amortized cost basis, we do not consider our investments to be other-than-temporarily impaired.

Visa and MasterCard Class B Common Stock

As of September 30, 2018, the Company owns 34,631 shares and 11,170 shares of Class B common stock of Visa, Inc. ("Visa") and MasterCard, Inc. ("MasterCard"), respectively. Due to transfer restrictions and the lack of readily determinable fair values of Class B common stock of Visa and MasterCard, the Company chooses to carry the shares on the Company's consolidated balance sheets at zero cost basis.

4. LOANS AND LEASES
 
Loans and leases, excluding loans held for sale, consisted of the following:
 
(dollars in thousands)March 31, 2018 December 31, 2017September 30, 2018 December 31, 2017
Commercial, financial and agricultural$516,160
 $503,738
$564,900
 $503,738
Real estate:

 



 

Construction62,046
 64,525
69,065
 64,525
Residential mortgage1,347,555
 1,337,193
1,388,925
 1,337,193
Home equity425,510
 412,230
455,599
 412,230
Commercial mortgage1,007,296
 979,239
1,034,951
 979,239
Consumer454,967
 470,819
462,198
 470,819
Leases285
 362
170
 362
Gross loans and leases3,813,819
 3,768,106
3,975,808
 3,768,106
Net deferred costs2,327
 2,509
2,219
 2,509
Total loans and leases, net of deferred costs$3,816,146
 $3,770,615
$3,978,027
 $3,770,615
      
 
During the threenine months ended March 31,September 30, 2018, we foreclosed on one loan totaling $40 thousand, which was sold at a small premium to book value.

During the threenine months ended March 31,September 30, 2017, we did not forecloseforeclosed on any loans. one loan totaling $0.1 million.

During the threenine months ended March 31,September 30, 2018 and 2017, we did not transfer any loans to the held-for-sale category.


We did not sell any portfolio loans during the threenine months ended March 31,September 30, 2018 and 2017.

DuringIn May 2018, we purchased an auto loan portfolio totaling $20.6 million which included a $0.1 million premium over the three$20.5 million outstanding balance. At the time of purchase, the auto loans had a weighted average remaining term of 63 months ended March 31, 2018,and a weighted average yield, net of the premium paid and servicing costs, of 3.89%.

In November 2017, we did notpurchased an auto loan portfolio totaling $33.1 million which included a $1.1 million premium over the $31.9 million outstanding balance. At the time of purchase, anythe auto loans had a weighted average remaining term of 76 months and a weighted average yield, net of the premium paid and servicing costs, of 3.04%.

In May 2017, we purchased an auto loan portfolios.portfolio totaling $26.6 million which included a $0.9 million premium over the $25.7 million outstanding balance. At the time of purchase, the auto loans had a weighted average remaining term of 77 months and a weighted average yield, net of the premium paid and servicing costs, of 2.67%.

In March 2017, we purchased a directan auto loan portfolio totaling $24.1 million which included a $0.4 million premium over the $23.8 million outstanding balance. At the time of purchase, the auto loans had a weighted average remaining term of 55 months and a weighted average yield, net of the premium paid and servicing costs, of 2.60%.

Impaired Loans
 
The following tables present by class, the balance in the allowance for loan and lease losses (the "Allowance") and the recorded investment in loans and leases based on the Company's impairment measurement method as of March 31,September 30, 2018 and December 31, 2017:
 
   Real Estate      
(dollars in thousands)Comml, Fin & Ag Constr Resi Mortgage Home Equity Comml Mortgage Consumer Leases Total
March 31, 2018 
  
  
    
    
  
Allowance: 
  
  
    
    
  
Individually evaluated for impairment$
 $
 $
 $
 $
 $
 $
 $
Collectively evaluated for impairment7,476
 1,714
 14,207
 3,328
 16,186
 6,306
 
 49,217
Total ending balance$7,476
 $1,714
 $14,207
 $3,328
 $16,186
 $6,306
 $
 $49,217
                
Loans and leases: 
  
  
    
    
  
Individually evaluated for impairment$457
 $2,517
 $13,626
 $659
 $3,704
 $
 $
 $20,963
Collectively evaluated for impairment515,703
 59,529
 1,333,929
 424,851
 1,003,592
 454,967
 285
 3,792,856
Subtotal516,160
 62,046
 1,347,555
 425,510
 1,007,296
 454,967
 285
 3,813,819
Net deferred costs (income)320
 (393) 3,933
 (1) (1,468) (64) 
 2,327
Total loans and leases, net of deferred costs (income)$516,480
 $61,653
 $1,351,488
 $425,509
 $1,005,828
 $454,903
 $285
 $3,816,146

   Real Estate      
(dollars in thousands)Comml, Fin & Ag Constr Resi Mortgage Home Equity Comml Mortgage Consumer Leases Total
September 30, 2018 
  
  
    
    
  
Allowance: 
  
  
    
    
  
Individually evaluated for impairment$
 $
 $87
 $
 $
 $
 $
 $87
Collectively evaluated for impairment7,867
 1,291
 14,048
 3,718
 13,470
 6,345
 
 46,739
Total ending balance$7,867
 $1,291
 $14,135
 $3,718
 $13,470
 $6,345
 $
 $46,826
                
Loans and leases: 
  
  
    
    
  
Individually evaluated for impairment$388
 $2,355
 $12,660
 $415
 $3,439
 $
 $
 $19,257
Collectively evaluated for impairment564,512
 66,710
 1,376,265
 455,184
 1,031,512
 462,198
 170
 3,956,551
Subtotal564,900
 69,065
 1,388,925
 455,599
 1,034,951
 462,198
 170
 3,975,808
Net deferred costs (income)464
 (424) 3,744
 
 (1,501) (64) 
 2,219
Total loans and leases, net of deferred costs (income)$565,364
 $68,641
 $1,392,669
 $455,599
 $1,033,450
 $462,134
 $170
 $3,978,027

   Real Estate      
(dollars in thousands)Comml, Fin & Ag Constr Resi Mortgage Home Equity Comml Mortgage Consumer Leases Total
December 31, 2017 
  
  
    
    
  
Allowance: 
  
  
    
    
  
Individually evaluated for impairment$
 $
 $
 $
 $
 $
 $
 $
Collectively evaluated for impairment7,594
 1,835
 14,328
 3,317
 16,801
 6,126
 
 50,001
Total ending balance$7,594
 $1,835
 $14,328
 $3,317
 $16,801
 6,126
 $
 $50,001
                
Loans and leases: 
  
  
    
    
  
Individually evaluated for impairment$491
 $2,597
 $13,862
 $416
 $3,914
 $
 $
 $21,280
Collectively evaluated for impairment503,247
 61,928
 1,323,331
 411,814
 975,325
 470,819
 362
 3,746,826
Subtotal503,738
 64,525
 1,337,193
 412,230
 979,239
 470,819
 362
 3,768,106
Net deferred costs (income)281
 (285) 4,028
 
 (1,442) (73) 
 2,509
Total loans and leases, net of deferred costs (income)$504,019
 $64,240
 $1,341,221
 $412,230
 $977,797
 $470,746
 $362
 $3,770,615


There was one impaired loan with an allowance of $0.1 million recorded as of September 30, 2018. There were no impaired loans with an allowance recorded as of March 31, 2018 and December 31, 2017. The following table presents by class, information related to impaired loans as of March 31,September 30, 2018 and December 31, 2017:
 
March 31, 2018 December 31, 2017September 30, 2018 December 31, 2017
Unpaid
Principal
Balance
 Recorded
Investment
 Allowance
Allocated
 Unpaid
Principal
Balance
 Recorded
Investment
 Allowance
Allocated
Unpaid
Principal
Balance
 Recorded
Investment
 Allowance
Allocated
 Unpaid
Principal
Balance
 Recorded
Investment
 Allowance
Allocated
(dollars in thousands)(dollars in thousands)
Impaired loans with no related Allowance recorded: 
  
  
  
  
  
Commercial, financial & agricultural$568
 $457
 $
 $602
 $491
 $
Impaired loans: 
  
  
  
  
  
Commercial, financial and agricultural$498
 $388
 $
 $602
 $491
 $
Real estate:                      
Construction7,867
 2,517
 
 7,947
 2,597
 
7,705
 2,355
 
 7,947
 2,597
 
Residential mortgage14,685
 13,626
 
 14,920
 13,862
 
13,689
 12,660
 87
 14,920
 13,862
 
Home equity659
 659
 
 416
 416
 
415
 415
 
 416
 416
 
Commercial mortgage3,704
 3,704
 
 3,914
 3,914
 
3,439
 3,439
 
 3,914
 3,914
 
Total impaired loans$27,483
 $20,963
 $
 $27,799
 $21,280
 $
$25,746
 $19,257
 $87
 $27,799
 $21,280
 $

The following table presents by class, the average recorded investment and interest income recognized on impaired loans for the three and nine months ended March 31,September 30, 2018 and 2017:
 
Three Months EndedThree Months Ended Nine Months Ended
March 31, 2018 March 31, 2017September 30, 2018 September 30, 2017 September 30, 2018 September 30, 2017
(dollars in thousands)Average
Recorded
Investment
 Interest
Income
Recognized
 Average
Recorded
Investment
 Interest
Income
Recognized
Average
Recorded
Investment
 Interest
Income
Recognized
 Average
Recorded
Investment
 Interest
Income
Recognized
 Average
Recorded
Investment
 Interest
Income
Recognized
 Average
Recorded
Investment
 Interest
Income
Recognized
Commercial, financial & agricultural$483
 $2
 $1,873
 $
Commercial, financial and agricultural$399
 $12
 $1,212
 $3
 $498
 $17
 $1,500
 $7
Real estate:     
  
     
  
      
  
Construction2,557
 26
 2,885
 24
2,382
 30
 2,704
 26
 2,476
 84
 2,800
 74
Residential mortgage13,744
 137
 19,302
 97
12,857
 123
 16,444
 189
 13,208
 419
 17,951
 1,356
Home equity567
 
 1,181
 
447
 

 1,418
 
 516
 

 1,343
 1
Commercial mortgage3,809
 38
 5,519
 47
3,483
 36
 4,440
 179
 3,653
 110
 5,143
 272
Total$21,160
 $203
 $30,760
 $168
$19,568
 $201
 $26,218
 $397
 $20,351
 $630
 $28,737
 $1,710
 
Foreclosure Proceedings

The Company did not have anyhad $0.1 million of residential mortgage loans collateralized by residential real estate property that were in the process of foreclosure at March 31,September 30, 2018. The Company had $40 thousand of residential mortgage loans collateralized by residential real estate property that were in the process of foreclosure at December 31, 2017.

 

Aging Analysis of Accruing and Non-Accruing Loans and Leases
 
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 and leases as of March 31,September 30, 2018 and December 31, 2017:
 
(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 and
Leases
Not
Past Due
 TotalAccruing
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 and
Leases
Not
Past Due
 Total
March 31, 2018 
  
  
  
  
  
  
Commercial, financial & agricultural$1,076
 $428
 $
 $
 $1,504
 $514,976
 $516,480
September 30, 2018 
  
  
  
  
  
  
Commercial, financial and agricultural$1,821
 $326
 $
 $
 $2,147
 $563,217
 $565,364
Real estate:         
    
         
    
Construction
 
 
 
 
 61,653
 61,653

 
 
 
 
 68,641
 68,641
Residential mortgage4,129
 381
 
 2,184
 6,694
 1,344,794
 1,351,488
98
 708
 
 2,197
 3,003
 1,389,666
 1,392,669
Home equity49
 175
 
 659
 883
 424,626
 425,509
1,582
 
 
 415
 1,997
 453,602
 455,599
Commercial mortgage
 
 
 
 
 1,005,828
 1,005,828
12
 
 
 
 12
 1,033,438
 1,033,450
Consumer2,149
 839
 417
 
 3,405
 451,498
 454,903
1,849
 604
 333
 
 2,786
 459,348
 462,134
Leases
 
 
 
 
 285
 285

 
 
 
 
 170
 170
Total$7,403
 $1,823
 $417
 $2,843
 $12,486
 $3,803,660
 $3,816,146
$5,362
 $1,638
 $333
 $2,612
 $9,945
 $3,968,082
 $3,978,027

(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 and
Leases
Not
Past Due
 TotalAccruing
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 and
Leases
Not
Past Due
 Total
December 31, 2017 
  
  
  
  
  
  
 
  
  
  
  
  
  
Commercial, financial & agricultural$410
 $355
 $
 $
 $765
 $503,254
 $504,019
Commercial, financial and agricultural$410
 $355
 $
 $
 $765
 $503,254
 $504,019
Real estate:         
    
         
    
Construction
 
 
 
 
 64,240
 64,240

 
 
 
 
 64,240
 64,240
Residential mortgage4,037
 2,127
 49
 2,280
 8,493
 1,332,728
 1,341,221
4,037
 2,127
 49
 2,280
 8,493
 1,332,728
 1,341,221
Home equity105
 264
 
 416
 785
 411,445
 412,230
105
 264
 
 416
 785
 411,445
 412,230
Commercial mortgage
 
 
 79
 79
 977,718
 977,797

 
 
 79
 79
 977,718
 977,797
Consumer2,126
 1,056
 515
 
 3,697
 467,049
 470,746
2,126
 1,056
 515
 
 3,697
 467,049
 470,746
Leases
 
 
 
 
 362
 362

 
 
 
 
 362
 362
Total$6,678
 $3,802
 $564
 $2,775
 $13,819
 $3,756,796
 $3,770,615
$6,678
 $3,802
 $564
 $2,775
 $13,819
 $3,756,796
 $3,770,615
 
Modifications

Troubled debt restructurings ("TDRs") included in nonperforming assets at March 31,September 30, 2018 consisted of sixthree Hawaii residential mortgage loans with a combined principal balance of $0.6$0.4 million.

Concessions made to the original contractual terms of these loans consisted primarily of the deferral of interest and/or principal payments due to deterioration in the borrowers' financial condition. The principal balances on these TDRs had matured and/or were in default at the time of restructure, and we have no commitments to lend additional funds to any of these borrowers. There were $12.4$11.3 million of TDRs still accruing interest at March 31,September 30, 2018, none of which were more than 90 days delinquent. At December 31, 2017, there were $12.6 million of TDRs still accruing interest, none of which were more than 90 days delinquent.
 
Some loans modified in a TDR may already be on nonaccrual status and partial charge-offs may have already been taken against the outstanding loan balance. Thus, these loans have already been identified as impaired and have already been evaluated under the Company's allowance for loan and lease losses (the "Allowance") methodology. Loans that were not on nonaccrual status when modified in a TDR may have the financial effect of increasing the specific allowance associated with the loan. The loans modified in a TDR did not have a material effect on our provision for loan and lease losses (the "Provision") and the Allowance during the three and nine months ended March 31,September 30, 2018.

 

The following table presents by class, information related to loans modified in a TDR during the period presented. There were no loans modified in a TDR during the three months ended March 31, 2018.

(dollars in thousands)Number of
Contracts
 Recorded
Investment
(as of Period End)
 Increase in the
Allowance
Number of
Contracts
 Recorded
Investment
(as of Period End)
 Increase in the
Allowance
Three Months Ended March 31, 2017 
  
  
Commercial, financial & agricultural1
 $659
 $
Three Months Ended September 30, 2018 
  
  
Real estate: Residential mortgage3
 $575
 $
Total1
 $659
 $
3
 $575
 $
     
Nine Months Ended September 30, 2018 
  
  
Real estate: Residential mortgage3
 $575
 $
Total3
 $575
 $
     
Three Months Ended September 30, 2017 
  
  
Real estate: Residential mortgage1
 70
 
Total1
 $70
 $
     
Nine Months Ended September 30, 2017 
  
  
Commercial, financial and agricultural1
 $632
 $
Real estate: Residential mortgage1
 70
 
Total2
 $702
 $

No loans were modified as a TDR within the previous twelve months that subsequently defaulted during the three and nine months ended March 31,September 30, 2018 and 2017.
 
Credit Quality Indicators
 
The Company categorizes loans and leases 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 and leases individually by classifying the loans and leases by credit risk. This analysis includes non-homogeneous loans and leases, such as commercial and commercial real estate loans. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:
 
Special Mention. Loans and leases 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 and leases classified as substandard are inadequately protected by the borrower's current financial condition and payment capability or of the collateral pledged, if any. Loans and leases so classified have a well-defined weakness or weaknesses that jeopardize the orderly repayment of debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.
 
Doubtful. Loans and leases classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or orderly repayment in full, on the basis of current existing facts, conditions and values, highly questionable and improbable. Possibility of loss is extremely high, but because of certain important and reasonably specific factors that may work to the advantage and strengthening of the exposure, its classification as an estimated loss is deferred until its more exact status may be determined.
 
Loss. Loans and leases classified as loss are considered to be non-collectible and of such little value that their continuance as bankable assets is not warranted. This does not mean the loan has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future. Losses are taken in the period in which they surface as uncollectible.

 


Loans and leases not meeting the criteria above are considered to be pass-rated. The following table presents by class and credit indicator, the recorded investment in the Company's loans and leases as of March 31,September 30, 2018 and December 31, 2017:
 
(dollars in thousands)Pass Special
Mention
 Substandard Loss Subtotal Net 
Deferred
Costs
(Income)
 TotalPass Special
Mention
 Substandard Loss Subtotal Net 
Deferred
Costs
(Income)
 Total
March 31, 2018 
  
  
    
  
  
Commercial, financial & agricultural$488,490
 $9,044
 $18,626
 $
 $516,160
 $320
 $516,480
September 30, 2018 
  
  
    
  
  
Commercial, financial and agricultural$535,574
 $11,496
 $17,830
 $
 $564,900
 $464
 $565,364
Real estate:         
    
         
    
Construction53,167
 8,879
 
 
 62,046
 (393) 61,653
69,065
 
 
 
 69,065
 (424) 68,641
Residential mortgage1,345,269
 
 2,286
 
 1,347,555
 3,933
 1,351,488
1,386,630
 
 2,295
 
 1,388,925
 3,744
 1,392,669
Home equity424,851
 
 659
 
 425,510
 (1) 425,509
455,184
 
 415
 
 455,599
 
 455,599
Commercial mortgage988,309
 8,597
 10,390
 
 1,007,296
 (1,468) 1,005,828
1,022,854
 10,982
 1,115
 
 1,034,951
 (1,501) 1,033,450
Consumer454,549
 
 191
 227
 454,967
 (64) 454,903
461,865
 
 135
 198
 462,198
 (64) 462,134
Leases285
 
 
 
 285
 
 285
170
 
 
 
 170
 
 170
Total$3,754,920
 $26,520
 $32,152
 $227
 $3,813,819
 $2,327
 $3,816,146
$3,931,342
 $22,478
 $21,790
 $198
 $3,975,808
 $2,219
 $3,978,027

(dollars in thousands)Pass Special
Mention
 Substandard Loss Subtotal Net 
Deferred
Costs
(Income)
 TotalPass Special
Mention
 Substandard Loss Subtotal Net 
Deferred
Costs
(Income)
 Total
December 31, 2017 
  
  
    
  
  
 
  
  
    
  
  
Commercial, financial & agricultural$474,995
 $7,543
 $21,200
 $
 $503,738
 $281
 $504,019
Commercial, financial and agricultural$474,995
 $7,543
 $21,200
 $
 $503,738
 $281
 $504,019
Real estate:         
    
         
    
Construction55,646
 8,879
 
 
 64,525
 (285) 64,240
55,646
 8,879
 
 
 64,525
 (285) 64,240
Residential mortgage1,334,760
 
 2,433
 
 1,337,193
 4,028
 1,341,221
1,334,760
 
 2,433
 
 1,337,193
 4,028
 1,341,221
Home equity411,814
 
 416
 
 412,230
 
 412,230
411,814
 
 416
 
 412,230
 
 412,230
Commercial mortgage955,865
 12,735
 10,639
 
 979,239
 (1,442) 977,797
955,865
 12,735
 10,639
 
 979,239
 (1,442) 977,797
Consumer470,243
 
 305
 271
 470,819
 (73) 470,746
470,243
 
 305
 271
 470,819
 (73) 470,746
Leases362
 
 
 
 362
 
 362
362
 
 
 
 362
��
 362
Total$3,703,685
 $29,157
 $34,993
 $271
 $3,768,106
 $2,509
 $3,770,615
$3,703,685
 $29,157
 $34,993
 $271
 $3,768,106
 $2,509
 $3,770,615
 
In accordance with applicable Interagency Guidance issued by our primary bank regulators, we define subprime borrowers as typically having weakened credit histories that include payment delinquencies and possibly more severe problems such as charge-offs, judgments, and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, debt-to-income ratios, or other criteria that may encompass borrowers with incomplete credit histories. Subprime loans are loans to borrowers displaying one or more of these characteristics at the time of origination or purchase. Such loans have a higher risk of default than loans to prime borrowers. At March 31, 2018 and December 31, 2017, we did not have any loans that we considered to be subprime.

 

5. ALLOWANCE FOR LOAN AND LEASE LOSSES
 
The following table presents by class, the activity in the Allowance for the periods indicated:
 
   Real Estate      
 Commercial,
Financial &
Agricultural
 Construction Residential Mortgage Home Equity Commercial Mortgage Consumer Leases Total
 (dollars in thousands)
Three Months Ended September 30, 2018
Beginning balance$7,525
 $1,811
 $14,252
 $3,168
 $15,094
 $6,331
 $
 $48,181
Provision (credit) for loan and lease losses495
 (526) (168) 544
 (1,632) 1,228
 
 (59)
 8,020
 1,285
 14,084
 3,712
 13,462
 7,559
 
 48,122
Charge-offs731
 
 
 
 
 1,762
 
 2,493
Recoveries578
 6
 51
 6
 8
 548
 
 1,197
Net charge-offs (recoveries)153
 (6) (51) (6) (8) 1,214
 
 1,296
Ending balance$7,867
 $1,291
 $14,135
 $3,718
 $13,470
 $6,345
 $
 $46,826
                
Three Months Ended September 30, 2017
Beginning balance$8,598
 $3,212
 $14,034
 $3,370
 $18,184
 $5,430
 $
 $52,828
Provision (credit) for loan and lease losses(690) (207) (526) (134) (541) 1,972
 
 (126)
 7,908
 3,005
 13,508
 3,236
 17,643
 7,402
 
 52,702
Charge-offs429
 
 
 
 
 1,709
 
 2,138
Recoveries165
 40
 124
 6
 7
 311
 
 653
Net charge-offs (recoveries)264
 (40) (124) (6) (7) 1,398
 
 1,485
Ending balance$7,644
 $3,045
 $13,632
 $3,242
 $17,650
 $6,004
 $
 $51,217
                
  Real Estate        Real Estate      
Commercial,
Financial &
Agricultural
 Construction Residential Mortgage Home Equity Commercial Mortgage Consumer Leases TotalCommercial,
Financial &
Agricultural
 Construction Residential Mortgage Home Equity Commercial Mortgage Consumer Leases Total
(dollars in thousands)(dollars in thousands)
Three Months Ended March 31, 2018
Nine Months Ended September 30, 2018Nine Months Ended September 30, 2018
Beginning balance$7,594
 $1,835
 $14,328
 $3,317
 $16,801
 $6,126
 $
 $50,001
$7,594
 $1,835
 $14,328
 $3,317
 $16,801
 $6,126
 $
 $50,001
Provision (credit) for loan and lease losses236
 (1,314) (147) 8
 (630) 1,636
 
 (211)1,227
 (1,749) (291) 383
 (3,383) 4,075
 
 262
7,830
 521
 14,181
 3,325
 16,171
 7,762
 
 49,790
8,821
 86
 14,037
 3,700
 13,418
 10,201
 
 50,263
Charge-offs498
 
 
 
 
 1,933
 
 2,431
1,971
 
 
 
 
 5,424
 
 7,395
Recoveries144
 1,193
 26
 3
 15
 477
 
 1,858
1,017
 1,205
 98
 18
 52
 1,568
 
 3,958
Net charge-offs (recoveries)354
 (1,193) (26) (3) (15) 1,456
 
 573
954
 (1,205) (98) (18) (52) 3,856
 
 3,437
Ending balance$7,476
 $1,714
 $14,207
 $3,328
 $16,186
 $6,306
 $
 $49,217
$7,867
 $1,291
 $14,135
 $3,718
 $13,470
 $6,345
 $
 $46,826
                              
Three Months Ended March 31, 2017
Nine Months Ended September 30, 2017Nine Months Ended September 30, 2017
Beginning balance$8,637
 $4,224
 $15,055
 $3,502
 $19,104
 $6,109
 $
 $56,631
$8,637
 $4,224
 $15,055
 $3,502
 $19,104
 $6,109
 $
 $56,631
Provision (credit) for loan and lease losses(66) (527) (259) (79) 72
 779
 
 (80)(403) (1,296) (2,280) (295) (1,600) 3,386
 
 (2,488)
8,571
 3,697
 14,796
 3,423
 19,176
 6,888
 
 56,551
8,234
 2,928
 12,775
 3,207
 17,504
 9,495
 
 54,143
Charge-offs500
 
 
 
 
 1,497
 
 1,997
1,266
 
 
 
 
 4,676
 
 5,942
Recoveries275
 21
 96
 2
 11
 410
 
 815
676
 117
 857
 35
 146
 1,185
 
 3,016
Net charge-offs (recoveries)225
 (21) (96) (2) (11) 1,087
 
 1,182
590
 (117) (857) (35) (146) 3,491
 
 2,926
Ending balance$8,346
 $3,718
 $14,892
 $3,425
 $19,187
 $5,801
 $
 $55,369
$7,644
 $3,045
 $13,632
 $3,242
 $17,650
 $6,004
 $
 $51,217
                              

Loans held for sale and other real estate assets are not included in our assessment of the Allowance.
 
Our Provision was a credit of $0.2$0.1 million and a debit of $0.3 million in the three and nine months ended March 31,September 30, 2018, respectively, compared to a credit of $0.1 million and a credit of $2.5 million in the three and nine months ended March 31, 2017.September 30, 2017, respectively.
 
6. SECURITIZATIONS
 
In prior years, we securitized certain residential mortgage loans with a U.S. Government sponsored entity and continue to service the residential mortgage loans. The servicing assets were recorded at their respective fair values at the time of securitization.
All unsold mortgage-backed securities from prior securitizations were categorized as available for sale securities and were therefore recorded at their fair values of $1.3 million and $1.5 million at March 31, 2018 and December 31, 2017, respectively. The fair values of these mortgage-backed securities were based on quoted prices of similar instruments in active markets. Unrealized gains of $0.1 million and $0.1 million on unsold mortgage-backed securities were recorded in AOCI at March 31, 2018 and December 31, 2017, respectively.

7.6. INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
 
The components of the Company's investments in unconsolidated subsidiaries were as follows:
 
(dollars in thousands)March 31, 2018 December 31, 2017September 30, 2018 December 31, 2017
Investments in low income housing tax credit partnerships$3,494
 $3,608
$12,267
 $3,608
Trust preferred investments2,792
 2,792
2,792
 2,792
Investments in affiliates138
 634
170
 634
Other54
 54
54
 54
Total$6,478
 $7,088
$15,283
 $7,088
 

The Company had $2.6$9.5 million in unfunded low income housing commitments as of March 31,September 30, 2018 compared to $2.6 million at December 31, 2017. The Company expects to fund $1.9 million in 2018, and $0.7$4.0 million in 2019.2019, and $3.6 million in 2020.

Investments in low income housing tax credit ("LIHTC") partnerships are accounted for using the cost method. The following table presents amortization and tax credits recognized associated with our investments in LIHTC partnerships for the three and nine months ended March 31,September 30, 2018 and March 31,September 30, 2017:

(dollars in thousands)Three Months Ended
March 31, 2018
 Three Months Ended
March 31, 2017
Three Months Ended
September 30, 2018
 Three Months Ended
September 30, 2017
 Nine Months Ended
September 30, 2018
 Nine Months Ended
September 30, 2017
Cost method:          
Amortization expense recognized in other operating expense$114
 $233
$114
 $174
 $341
 $630
Tax credits recognized in income tax expense152
 266
152
 218
 457
 744

8.7. CORE DEPOSIT PREMIUM AND MORTGAGE SERVICING RIGHTS
 
The following table presents changes in core deposit premium and mortgage servicing rights for the three months ended March 31, 2018:periods presented:
 
(dollars in thousands)Core
Deposit
Premium
 Mortgage
Servicing
Rights
 TotalCore
Deposit
Premium
 Mortgage
Servicing
Rights
 Total
Balance, beginning of period$2,006
 $15,843
 $17,849
Balance, January 1, 2017$4,680
 $15,779
 $20,459
Additions
 435
 435

 1,857
 1,857
Amortization(669) (457) (1,126)(2,006) (1,543) (3,549)
Balance, end of period$1,337
 $15,821
 $17,158
Balance, September 30, 2017$2,674
 $16,093
 $18,767
     
Balance, January 1, 2018$2,006
 $15,843
 $17,849
Additions
 1,204
 1,204
Amortization(2,006) (1,413) (3,419)
Balance, September 30, 2018$
 $15,634
 $15,634
 
Income generated as the result of new mortgage servicing rights is reported as gains on sales of loans and totaled $0.4 million and $1.2 million for the three and nine months ended March 31,September 30, 2018, respectively, compared to $0.6 million and $1.9 million for the three and nine months ended March 31, 2017.September 30, 2017, respectively.

Amortization of mortgage servicing rights was $0.5 million and $1.4 million, respectively, for the three and nine months ended March 31,September 30, 2018, compared to $0.5 million and $1.5 million for the three and nine months ended March 31, 2017.September 30, 2017, respectively.


The following table presents the fair market value and key assumptions used in determining the fair market value of our mortgage servicing rights:
 
Nine Months Ended Nine Months Ended
(dollars in thousands)March 31, 2018 March 31, 2017September 30, 2018 September 30, 2017
Fair market value, beginning of period$17,161
 $18,087
$17,161
 $18,087
Fair market value, end of period18,463
 17,627
18,315
 16,777
Weighted average discount rate9.5% 9.5%9.5% 9.5%
Forecasted constant prepayment rate assumption14.2
 15.0
14.0
 16.5
 
The gross carrying value and accumulated amortization related to our core deposit premium and mortgage servicing rights are presented below:
 
March 31, 2018 December 31, 2017September 30, 2018 December 31, 2017
(dollars in thousands)Gross
Carrying
Value
 Accumulated
Amortization
 Net
Carrying
Value
 Gross
Carrying
Value
 Accumulated
Amortization
 Net
Carrying
Value
Gross
Carrying
Value
 Accumulated
Amortization
 Net
Carrying
Value
 Gross
Carrying
Value
 Accumulated
Amortization
 Net
Carrying
Value
Core deposit premium$44,642
 $(43,305) $1,337
 $44,642
 $(42,636) $2,006
$44,642
 $(44,642) $
 $44,642
 $(42,636) $2,006
Mortgage servicing rights64,836
 (49,015) 15,821
 64,401
 (48,558) 15,843
65,605
 (49,971) 15,634
 64,401
 (48,558) 15,843
Total$109,478
 $(92,320) $17,158
 $109,043
 $(91,194) $17,849
$110,247
 $(94,613) $15,634
 $109,043
 $(91,194) $17,849
 

Based on the core deposit premium and mortgage servicing rights held as of March 31,September 30, 2018, estimated amortization expense for the remainder of fiscal year 2018, the next five succeeding fiscal years and all years thereafter are as follows:
 
Estimated Amortization Expense
(dollars in thousands)Core
Deposit
Premium
 Mortgage
Servicing
Rights
 Total 
2018 (remainder)$1,337
 $1,076
 $2,413
$450
2019
 1,211
 1,211
1,566
2020
 1,017
 1,017
1,292
2021
 867
 867
1,087
2022
 733
 733
919
2023
 663
 663
789
Thereafter
 10,254
 10,254
9,531
$1,337
 $15,821
 $17,158
$15,634
 
We perform an impairment assessment of our core deposit premium and mortgage servicing rights whenever events or changes in circumstance indicate that the carrying value of those assetsthe asset may not be recoverable.

9.8. DERIVATIVES
 
We utilize various designated and undesignated derivative financial instruments to reduce our exposure to movements in interest rates including interest rate swaps, interest rate lock commitments and forward sale commitments. 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. At MarchSeptember 30, 2018 and December 31, 2018,2017, we were not party to any derivatives designated as part of a fair value or cash flow hedge.
 

Interest Rate Lock and Forward Sale Commitments
 
We 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 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 or other liabilities, with changes in fair value recorded in current period earnings. These instruments serve to reduce our exposure to movements in interest rates. At March 31,September 30, 2018, we were a party to interest rate lock and forward sale commitments on $3.1$15.5 million and $9.2$19.9 million of mortgage loans, respectively.
 
The following table presents the location of all assets and liabilities associated with our derivative instruments within the consolidated balance sheets:
 
Derivatives Financial Instruments Not Designated as Hedging InstrumentsDerivatives Financial Instruments Not Designated as Hedging Instruments Asset Derivatives Liability DerivativesDerivatives Financial Instruments Not Designated as Hedging Instruments Asset Derivatives Liability Derivatives
Fair Value at Fair Value at Fair Value at Fair Value at
(dollars in thousands) Balance Sheet Location March 31,
2018
 December 31,
2017
 March 31,
2018
 December 31,
2017
 Balance Sheet Location September 30,
2018
 December 31,
2017
 September 30,
2018
 December 31,
2017
Interest rate lock and forward sale commitments Other assets / other liabilities $28
 $35
 $21
 $49
 Other assets / other liabilities $92
 $35
 $29
 $49
 

The following table presents the impact of derivative instruments and their location within the consolidated statements of income:
 
Derivatives 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
 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, 2018    
Three Months Ended September 30, 2018    
Interest rate lock and forward sale commitments Mortgage banking income $21
 Mortgage banking income $91
Loans held for sale Other income (7) Other income (6)
        
Three Months Ended March 31, 2017    
Three Months Ended September 30, 2017    
Interest rate lock and forward sale commitments Mortgage banking income (207) Mortgage banking income (21)
Loans held for sale Other income (3)
    
Nine Months Ended September 30, 2018    
Interest rate lock and forward sale commitments Mortgage banking income 76
Loans held for sale Other income (6)
    
Nine Months Ended September 30, 2017    
Interest rate lock and forward sale commitments Mortgage banking income (148)
Loans held for sale Other income 

10.9. 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 $1.59$1.67 billion line of credit as of March 31,September 30, 2018, compared to $1.50 billion at December 31, 2017. At March 31,September 30, 2018, $1.53$1.56 billion was undrawn under this arrangement, compared to $1.47 billion at December 31, 2017. Short-term borrowings under this arrangement totaled $56.0$105.0 million at March 31,September 30, 2018, compared to $32.0 million at December 31, 2017.  There were no long-term borrowings under this arrangement at March 31,September 30, 2018 and December 31, 2017. FHLB advances available at March 31,September 30, 2018 were secured by certain real estate loans with a carrying value of $2.14$2.26 billion in accordance with the collateral provisions of the Advances, Security and Deposit Agreement with the FHLB.
 

At March 31,September 30, 2018 and December 31, 2017, our bank had additional unused borrowings available at the Federal Reserve discount window of $72.3$76.5 million and $73.0 million, respectively. As of March 31,September 30, 2018 and December 31, 2017, certain commercial and commercial real estate loans with a carrying value totaling $127.1$124.6 million and $129.2 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 October 2003, we created two wholly-owned statutory trusts, CPB Capital Trust II ("Trust II") and CPB Statutory Trust III ("Trust III"). Trust II issued $20.0 million in trust preferred securities bearing an interest rate of three-month LIBOR plus 2.85% and maturing on October 7, 2033. The principal assets of Trust II are $20.6 million of the Company's subordinated debentures with an identical interest rate and maturity as the Trust II trust preferred securities. Trust II issued $0.6 million of common securities to the Company.
Trust III issued $20.0 million in trust preferred securities bearing an interest rate of three-month LIBOR plus 2.85% and maturing on December 17, 2033. The principal assets of Trust III are $20.6 million of the Company's subordinated debentures with an identical interest rate and maturity as the Trust III trust preferred securities. Trust III issued $0.6 million of common securities to the Company.
In September 2004, we created a wholly-owned statutory trust, CPB Capital Trust IV ("Trust IV"). Trust IV issued $30.0 million in 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 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 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 subordinated debentures with an identical interest rate and maturity as the Trust V trust preferred securities. Trust V issued $0.6 million of common securities to the Company.
The trust preferred securities, the subordinated debentures that are the assets of Trusts II, III, IV and V and the common securities issued by Trusts II, III, IV and V are redeemable in whole or in part on any interest payment date on or after October 7, 2008 for Trusts II and III, and 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.

11.10. EQUITY
 
As a Hawaii state-chartered bank, Central Pacific Bank may only pay dividends to the extent it has retained earnings as defined under Hawaii banking law ("Statutory Retained Earnings"), which differs from GAAP retained earnings. As of March 31,September 30, 2018, the bank had Statutory Retained Earnings of $86.9$87.5 million.
 
Dividends are payable at the discretion of the Board of Directors and there can be no assurance that the Board of Directors will continue to pay dividends at the same rate, or at all, in the future. Our ability to pay cash dividends to our shareholders is subject to restrictions under federal and Hawaii law, including restrictions imposed by the FRB and covenants set forth in various agreements we are a party to, including covenants set forth in our subordinated debentures.

In January 2016, the Board of Directors authorized the repurchase of up to $30.0 million of the Company's common stock from time to time in the open market or in privately negotiated transactions, pursuant to a newly authorized share repurchase program (the "2016 Repurchase Plan"), which superseded in its entirety the repurchase plan that was previously approved by the Board of Directors.

In January 2017, the Board of Directors authorized the repurchase of up to $30.0 million of the Company's common stock from time to time in the open market or in privately negotiated transactions, pursuant to a newly authorized share repurchase program (the "2017 Repurchase Plan"). The 2017 Repurchase Plan replaced and superseded in its entirety the 2016 Repurchase Plan. In January 2017, prior to the 2017 Repurchase Plan being approved, 1,750 shares of common stock, at a cost of $0.1 million, were repurchased under the 2016 Repurchase Plan.


In November 2017, the Board of Directors authorized an increase in the share repurchase program authority by an additional $50.0 million (known henceforth as the "Repurchase Plan"). This amount is in addition to the $30.0 million in planned repurchases authorized in January 2017. There is no expiration date on the Repurchase Plan.

In the year ended December 31, 2017, 864,483 shares of common stock, at a cost of $26.6 million, excluding fees and expenses, were repurchased under the 2016 Repurchase Plan and the Repurchase Plan combined.


In the threenine months ended March 31,September 30, 2018, a total of 344,362849,290 shares of common stock, at a cost of $10.1$24.8 million, were repurchased under the Repurchase Plan. A total of $43.4$28.7 million remained available for repurchase under the Repurchase Plan as of March 31,September 30, 2018.

12.11. 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.

We also generate 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 our consolidated statements of income as components of other operating income are as follows:

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 cards and payments income, safe deposit rental income and other service charges, commissions and fees.

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, letters of credit, and travelers’ checks. 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.

Fees on Foreign Exchange

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.

Loan Placement Fees

Loan placement fees 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.

Gain on Sales of Foreclosed Assets

The Company records a gain or loss on the sale of a foreclosed property when control of the property transfers to the Company, which typically occurs at the time the deed is executed. The Company does not finance the sale of the foreclosed property.

The following presents the Company's other operating income, segregated by revenue streams that are in-scope and out-of-scope of ASC 606 for the threenine months ended March 31,September 30, 2018 and 2017.

Three Months Ended
March 31,
Three Months Ended
September 30,
 Nine Months Ended
September 30,
(dollars in thousands)2018 20172018 2017 2018 2017
Other operating income:          
In-scope of ASC 606          
Service charges on deposit accounts$2,003
 $2,036
$2,189
 $2,182
 $6,169
 $6,338
Other service charges on deposit accounts2,556
 2,211
Other service charges and fees2,778
 2,766
 8,169
 7,490
Income on fiduciary activities956
 864
1,159
 911
 3,132
 2,739
Fees on foreign exchange32
 39
26
 29
 86
 112
Loan placement fees197
 134
115
 86
 532
 366
Net gain on sales of foreclosed assets
 102

 19
 
 205
In-scope other operating income5,744
 5,284
6,267
 5,993
 18,088
 17,250
Out-of-scope other operating income3,210
 4,730
4,553
 3,576
 11,316
 10,203
Total other operating income$8,954
 $10,014
$10,820
 $9,569
 $29,404
 $27,453


13.12. MORTGAGE BANKING INCOME

Noninterest income from the Company's mortgage banking activities include the following components for the periods indicated:

 Three Months Ended
March 31,
(dollars in thousands)2018 2017
Mortgage banking income:   
Loan servicing fees$1,311
 $1,358
Amortization of mortgage servicing rights(457) (520)
Gain on sale of residential mortgage loans972
 1,312
Unrealized gain (loss) on interest rate locks21
 (207)
Total mortgage banking income$1,847
 $1,943

 Three Months Ended
September 30,
 Nine Months Ended
September 30,
(dollars in thousands)2018 2017 2018 2017
Mortgage banking income:       
Loan servicing fees$1,269
 $1,323
 $3,869
 $4,021
Amortization of mortgage servicing rights(519) (476) (1,413) (1,543)
Gain on sale of residential mortgage loans1,082
 705
 3,013
 3,101
Unrealized gain (loss) on interest rate locks91
 (21) 76
 (148)
Total mortgage banking income$1,923
 $1,531
 $5,545
 $5,431

14.
13. SHARE-BASED COMPENSATION
 
Restricted Stock Awards and Units
 
The table below presents the activity of restricted stock awards and units for the threenine months ended March 31,September 30, 2018:
 
Shares Weighted Average Grant Date Fair ValueShares Weighted Average Grant Date Fair Value
Non-vested restricted stock awards and units, beginning of period397,551
 $25.49
397,551
 $25.49
Changes during the period: 
  
 
  
Granted41,716
 29.46
116,152
 29.51
Vested(42,225) 24.14
(123,629) 24.40
Forfeited(2,957) 24.95
(20,294) 27.47
Non-vested restricted stock awards and units, end of period394,085
 26.06
369,780
 27.01

15.14. PENSION AND SUPPLEMENTAL EXECUTIVE RETIREMENT PLANS
 
Central Pacific Bank has a defined benefit retirement plan (the "Pension Plan") which covers certain eligible employees. The plan was curtailed effective December 31, 2002, and accordingly, plan benefits were fixed as of that date. The following table sets forth the components of net periodic benefit cost for the Pension Plan for the periods indicated:
 
Three Months Ended
March 31,
Three Months Ended
September 30,
 Nine Months Ended
September 30,
(dollars in thousands)2018 20172018 2017 2018 2017
Interest cost$231
 $229
$199
 $232
 $597
 $694
Expected return on plan assets(259) (264)(302) (264) (906) (792)
Amortization of net actuarial loss298
 296
245
 298
 735
 894
Net periodic cost$270
 $261
$142
 $266
 $426
 $796
 

Our bank also established Supplemental Executive Retirement Plans ("SERPs"), which provide certain (current and former) officers of our bank with supplemental retirement benefits. We have not entered into a SERP since December 31, 2008.

In the second quarter of 2017, the Company settled a portion of the SERP obligation of a former executive. As a result of the settlement, the Company remeasured the related SERP obligation and net periodic benefit cost and recognized a pro-rata net actuarial loss of $0.1 million in SERP expense and other comprehensive income.

The following table sets forth the components of net periodic benefit cost for the SERPs for the periods indicated:
 
Three Months Ended
March 31,
Three Months Ended
September 30,
 Nine Months Ended
September 30,
(dollars in thousands)2018 20172018 2017 2018 2017
Interest cost$97
 $115
$97
 $107
 $292
 $322
Amortization of net actuarial loss43
 26
44
 26
 130
 77
Amortization of net transition obligation5
 4
5
 4
 14
 13
Amortization of prior service cost5
 4
4
 5
 13
 13
Settlement
 
 
 138
Net periodic cost$150
 $149
$150
 $142
 $449
 $563

All components of net periodic benefit cost are included in salaries and employee benefits in the Company's consolidated statements of income.
 

16.15. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
 
The following tables present the components of other comprehensive income for the three and nine months ended March 31,September 30, 2018 and 2017, by component:
 
(dollars in thousands)Before Tax Tax Effect Net of TaxBefore Tax Tax Effect Net of Tax
Three Months Ended March 31, 2018 
  
  
Three Months Ended September 30, 2018 
  
  
Net unrealized losses on investment securities: 
  
  
 
  
  
Net unrealized losses arising during the period$(20,455) $(5,484) $(14,971)$(8,297) $(2,225) $(6,072)
Less: Reclassification adjustments from AOCI realized in net income
 
 

 
 
Net unrealized losses on investment securities(20,455) (5,484) (14,971)(8,297) (2,225) (6,072)
          
Defined benefit plans: 
  
  
 
  
  
Amortization of net actuarial loss341
 93
 248
289
 78
 211
Amortization of net transition obligation5
 1
 4
5
 2
 3
Amortization of prior service cost5
 1
 4
4
 1
 3
Settlement
 
 
Defined benefit plans, net351
 95
 256
298
 81
 217
          
Other comprehensive loss$(20,104) $(5,389) $(14,715)$(7,999) $(2,144) $(5,855)


(dollars in thousands)Before Tax Tax Effect Net of TaxBefore Tax Tax Effect Net of Tax
Three Months Ended March 31, 2017 
  
  
Net unrealized gains on investment securities: 
  
  
Net unrealized gains arising during the period$3,527
 $1,403
 $2,124
Three Months Ended September 30, 2017 
  
  
Net unrealized losses on investment securities: 
  
  
Net unrealized losses arising during the period$(487) $(194) $(293)
Less: Reclassification adjustments from AOCI realized in net income
 
 

 
 
Net unrealized gains on investment securities3,527
 1,403
 2,124
Net unrealized losses on investment securities(487) (194) (293)
          
Defined benefit plans: 
  
  
 
  
  
Net actuarial losses arising during the period(1,042) (415) (627)
Amortization of net actuarial loss421
 164
 257
324
 44
 280
Amortization of net transition obligation4
 1
 3
4
 2
 2
Amortization of prior service cost4
 1
 3
5
 2
 3
Settlement
 
 
Defined benefit plans, net(613) (249) (364)333
 48
 285
          
Other comprehensive income$2,914
 $1,154
 $1,760
Other comprehensive loss$(154) $(146) $(8)

(dollars in thousands)Before Tax Tax Effect Net of Tax
Nine Months Ended September 30, 2018 
  
  
Net unrealized losses on investment securities: 
  
  
Net unrealized losses arising during the period$(33,809) $(9,097) $(24,712)
Less: Reclassification adjustments from AOCI realized in net income
 
 
Net unrealized losses on investment securities
(33,809) (9,097) (24,712)

     
Defined benefit plans:   
  
Amortization of net actuarial loss865
 262
 603
Amortization of net transition obligation14
 4
 10
Amortization of prior service cost13
 3
 10
Defined benefit plans, net892
 269
 623

     
Other comprehensive loss$(32,917) $(8,828) $(24,089)
      

(dollars in thousands)Before Tax Tax Effect Net of Tax
Nine Months Ended September 30, 2017 
  
  
Net unrealized gains on investment securities: 
  
  
Net unrealized gains arising during the period$6,042
 $2,403
 $3,639
Less: Reclassification adjustments from AOCI realized in net income1,640
 653
 987
Net unrealized gains on investment securities7,682
 3,056
 4,626
      
Defined benefit plans: 
  
  
Net actuarial losses arising during the period(1,042) (415) (627)
Amortization of net actuarial loss971
 331
 640
Amortization of net transition obligation13
 5
 8
Amortization of prior service cost13
 5
 8
Settlement138
 56
 82
Defined benefit plans, net93
 (18) 111
      
Other comprehensive income$7,775
 $3,038
 $4,737
      
 


The following tables present the changes in each component of AOCI, net of tax, for the three and nine months ended March 31,September 30, 2018 and 2017:
 
(dollars in thousands)Investment
Securities
 Defined
Benefit
Plans
 AOCIInvestment
Securities
 Defined
Benefit
Plans
 AOCI
Three Months Ended March 31, 2018 
  
  
Three Months Ended September 30, 2018 
  
  
Balance at beginning of period$5,073
 $(6,112) $(1,039)$(14,161) $(7,087) $(21,248)
          
Impact of the adoption of new accounting standards(594) (1,381) (1,975)
     
Other comprehensive loss before reclassifications(14,971) 
 (14,971)
Other comprehensive income (loss) before reclassifications(6,072) 
 (6,072)
Reclassification adjustments from AOCI
 256
 256

 217
 217
Total other comprehensive income (loss)(14,971) 256
 (14,715)(6,072) 217
 (5,855)
          
Balance at end of period$(10,492) $(7,237) $(17,729)$(20,233) $(6,870) $(27,103)

(dollars in thousands)Investment
Securities
 Defined
Benefit
Plans
 AOCIInvestment
Securities
 Defined
Benefit
Plans
 AOCI
Three Months Ended March 31, 2017 
  
  
Three Months Ended September 30, 2017 
  
  
Balance at beginning of period$4,729
 $(6,250) $(1,521)$9,648
 $(6,424) $3,224
          
Other comprehensive income (loss)before reclassifications2,124
 (627) 1,497
Other comprehensive income before reclassifications(293) 
 (293)
Reclassification adjustments from AOCI
 263
 263

 285
 285
Total other comprehensive income (loss)2,124
 (364) 1,760
(293) 285
 (8)
          
Balance at end of period$6,853
 $(6,614) $239
$9,355
 $(6,139) $3,216

(dollars in thousands)Investment
Securities
 Defined
Benefit
Plans
 AOCI
Nine Months Ended September 30, 2018 
  
  
Balance at beginning of period$5,073
 $(6,112) $(1,039)
Impact of the adoption of new accounting standards(139) 
 (139)
Adjusted balance at beginning of period4,934
 (6,112) (1,178)
      
Impact of the adoption of new accounting standards(455) (1,381) (1,836)
      
Other comprehensive income (loss) before reclassifications(24,712) 
 (24,712)
Reclassification adjustments from AOCI
 623
 623
Total other comprehensive income (loss)(24,712) 623
 (24,089)
      
Balance at end of period$(20,233) $(6,870) $(27,103)
      

 

(dollars in thousands)Investment
Securities
 Defined
Benefit
Plans
 AOCI
Nine Months Ended September 30, 2017 
  
  
Balance at beginning of period$4,729
 $(6,250) $(1,521)
      
Other comprehensive income (loss) before reclassifications3,639
 (627) 3,012
Reclassification adjustments from AOCI987
 738
 1,725
Total other comprehensive income (loss)4,626
 111
 4,737
      
Balance at end of period$9,355
 $(6,139) $3,216
      

The following table presents the amounts reclassified out of each component of AOCI for the three and nine months ended March 31,September 30, 2018 and 2017:
 
Amount Reclassified from AOCI Affected Line Item in the Statement Where Net Income is PresentedAmount Reclassified from AOCI Affected Line Item in the Statement Where Net Income is Presented
Details about AOCI ComponentsThree months ended March 31, Three months ended September 30, 
(dollars in thousands)2018 2017 2018 2017 
Sale of investment securities available-for-sale$
 $
 Investment securities gains (losses)$
 $
 Investment securities gains (losses)

 
 Income tax benefit (expense)
 
 Income tax benefit (expense)
$
 $
 Net of tax$
 $
 Net of tax
        
Amortization of defined benefit retirement and supplemental executive retirement plan items 
  
   
  
  
Net actuarial loss$(341) $(421) (1)$(289) $(324) (1)
Net transition obligation(5) (4) (1)(5) (4) (1)
Prior service cost(5) (4) (1)(4) (5) (1)
Settlement
 
 (1)
 
 (1)
(351) (429) Total before tax(298) (333) Total before tax
95
 166
 Income tax benefit (expense)81
 48
 Income tax benefit (expense)
$(256) $(263) Net of tax$(217) $(285) Net of tax
        
Total reclassification adjustments from AOCI for the period$(256) $(263) Net of tax$(217) $(285) Net of tax


 Amount Reclassified from AOCI Affected Line Item in the Statement Where Net Income is Presented
Details about AOCI ComponentsNine months ended September 30, 
(dollars in thousands)2018 2017 
Sale of investment securities available-for-sale$
 $(1,640) Investment securities gains (losses)
 
 653
 Income tax benefit (expense)
 $
 $(987) Net of tax
      
Amortization of defined benefit retirement and supplemental executive retirement plan items 
  
  
Net actuarial loss$(865) $(971) (1)
Net transition obligation(14) (13) (1)
Prior service cost(13) (13) (1)
Settlement
 (138) (1)
 (892) (1,135) Total before tax
 269
 397
 Income tax benefit (expense)
 $(623) $(738) Net of tax
      
Total reclassification adjustments from AOCI for the period$(623) $(1,725) Net of tax
      
 
(1)These AOCI components are included in the computation of net periodic pension cost (see Note 1514 - Pension and Supplemental Executive Retirement Plans for additional details).

17.16. 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,
Three Months Ended
September 30,
 Nine Months Ended
September 30,
(dollars in thousands, except per share data)2018 20172018 2017 2018 2017
Net income$14,277
 $13,079
$15,193
 $11,812
 $43,694
 $36,916
          
Weighted average shares outstanding - basic29,807,572
 30,714,895
Weighted average common shares outstanding - basic29,297,465
 30,300,195
 29,536,536
 30,526,260
Dilutive effect of employee stock options and awards233,779
 286,343
182,347
 214,264
 206,702
 232,729
Weighted average shares outstanding - diluted30,041,351
 31,001,238
Weighted average common shares outstanding - diluted29,479,812
 30,514,459
 29,743,238
 30,758,989
          
Basic earnings per common share$0.48
 $0.43
$0.52
 $0.39
 $1.48
 $1.21
Diluted earnings per common share$0.48
 $0.42
$0.52
 $0.39
 $1.47
 $1.20
          
Anti-dilutive employee stock options and awards outstanding
 539

 80
 
 8

 

18.17. FAIR VALUE OF FINANCIAL ASSETS AND LIABILITIES
 
Disclosures about Fair Value of Financial Instruments
 
Fair value estimates, methods and assumptions are set forth below for our financial instruments.
 
Short-Term Financial Instruments
 
The carrying values of short-term financial instruments are deemed to approximate fair values. Such instruments are considered readily convertible to cash and include cash and due from banks,financial institutions, interest-bearing deposits in other banks,financial institutions, accrued interest receivable, the majority of Federal Home Loan Bank advances and other short-term borrowings, and accrued interest payable.

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

Loans
 
Fair values of loans are estimated based on discounted cash flows of portfolios of loans with similar financial characteristics including the type of loan, interest terms and repayment history. Fair values are calculated by discounting scheduled cash flows through estimated maturities using estimated market discount rates. Estimated market discount rates are reflective of credit and interest rate risks inherent in the Company's various loan types and are derived from available market information, as well as specific borrower information. In accordance with ASU 2016-01, the fair value of loans as of March 31,September 30, 2018 are based on the notion of exit price. The fair value of loans as of December 31, 2017 was measured using anbased on the notion of entry price notion.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.
 
Mortgage Servicing Rights

The initial fair value of themortgage servicing rightrights is calculated by a discounted cash flow model prepared by a third-party service provider based on market value assumptions at the time of origination. We assess the servicing right for impairment using current market value assumptions at each reporting period. Critical assumptions used in the discounted cash flow model include mortgage prepayment speeds, discount rates, costs to service, and ancillary income. Variations in our assumptions could materially affect the estimated fair values. Changes to our assumptions are made when current trends and market data indicate that new trends have developed. Current market value assumptions based on loan product types (fixed rate, adjustable rate and balloon loans) include average discount rates and prepayment speeds. Many of these assumptions are subjective and require a high level of management judgment. Our mortgage servicing rights portfolio and valuation assumptions are periodically reviewed by management.

Federal Home Loan Bank Stock
 
The equity investment in commonIt is not practical to determine the fair value of FHLB stock ofdue to the FHLB, which is redeemable for cash at par value, is reported atrestrictions placed on its par value.transferability.
 
Deposit Liabilities
 
The fair values of deposits with no stated maturity, such as noninterest-bearing demand deposits and interest-bearing demand and savings accounts, are equal to the amount payable on demand. The fair value of time deposits is estimated using discounted cash flow analyses. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
 
 

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

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

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

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

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

    Fair Value Measurement Using    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)
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, 2018 
  
  
  
  
September 30, 2018 
  
  
  
  
Financial assets 
  
  
  
  
 
  
  
  
  
Cash and due from banks$59,905
 $59,905
 $59,905
 $
 $
$82,668
 $82,668
 $82,668
 $
 $
Interest-bearing deposits in other banks5,875
 5,875
 5,875
 
 
7,051
 7,051
 7,051
 
 
Investment securities1,503,923
 1,498,244
 753
 1,485,953
 11,538
1,386,739
 1,380,353
 885
 1,368,324
 11,144
Loans held for sale7,492
 7,492
 
 7,492
 
4,460
 4,460
 
 4,460
 
Net loans and leases3,766,929
 3,706,552
 
 20,963
 3,685,589
3,931,201
 3,804,844
 
 19,170
 3,785,674
Mortgage servicing rights15,821
 18,463
 
 
 18,463
15,634
 18,315
 
 
 18,315
Federal Home Loan Bank stock9,007
 9,007
 9,007
 
 
10,965
 N/A
 N/A
 N/A
 N/A
Accrued interest receivable16,070
 16,070
 16,070
 
 
                  
Financial liabilities 
  
  
  
  
 
  
  
  
  
Deposits: 
  
  
  
  
 
  
  
  
  
Noninterest-bearing demand1,349,029
 1,349,029
 1,349,029
 
 
1,403,534
 1,403,534
 1,403,534
 
 
Interest-bearing demand and savings and money market2,479,947
 2,479,947
 2,479,947
 
 
2,438,595
 2,438,595
 2,438,595
 
 
Time1,151,455
 1,144,494
 
 
 1,144,494
1,161,551
 1,152,739
 

 
 1,152,739
Short-term borrowings56,000
 56,000
 
 56,000
 
105,000
 105,000
 
 105,000
 
Long-term debt92,785
 87,923
 
 87,923
 
92,785
 88,344
 
 88,344
 
Accrued interest payable (included in other liabilities)3,809
 3,809
 3,809
 
 
         
Off-balance sheet financial instruments 
  
  
  
  
Commitments to extend credit961,167
 1,183
 
 1,183
 
Standby letters of credit and financial guarantees written12,108
 182
 
 182
 
Derivatives:         
Interest rate lock commitments3,126
 13
 
 13
 
Forward sale commitments9,172
 (6) 
 (6) 

 

     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, 2017 
  
  
  
  
Financial assets 
  
  
  
  
Cash and due from banks$75,318
 $75,318
 $75,318
 $
 $
Interest-bearing deposits in other banks6,975
 6,975
 6,975
 
 
Investment securities1,496,644
 1,494,092
 825
 1,481,473
 11,794
Loans held for sale16,336
 16,336
 
 16,336
 
Net loans and leases3,720,614
 3,684,834
 
 21,280
 3,663,554
Mortgage servicing rights15,843
 17,161
 
 
 17,161
Federal Home Loan Bank stock7,761
 7,761
 7,761
 
 
Accrued interest receivable16,581
 16,581
 16,581
 
 
          
Financial liabilities 
  
  
  
  
Deposits: 
  
  
  
  
Noninterest-bearing demand1,395,556
 1,395,556
 1,395,556
 
 
Interest-bearing demand and savings and money market2,414,930
 2,414,930
 2,414,930
 
 
Time1,145,868
 1,140,064
 
 
 1,140,064
Short-term borrowings32,000
 32,000
 
 32,000
 
Long-term debt92,785
 70,139
 
 70,139
 
Accrued interest payable (included in other liabilities)3,698
 3,698
 3,698
 
 
          
Off-balance sheet financial instruments 
  
  
  
  
Commitments to extend credit917,405
 1,140
 
 1,140
 
Standby letters of credit and financial guarantees written13,551
 203
 
 203
 
Derivatives:         
Interest rate lock commitments2,494
 12
 
 12
 
Forward sale commitments18,748
 (26) 
 (26) 
       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)
September 30, 2018   
  
  
  
  
Derivatives           
Interest rate lock commitments$15,463
 $(4) $(4) $
 $(4) $
Forward sale commitments19,861
 67
 67
 
 67
 
            
Off-balance sheet financial instruments     
      
Commitments to extend credit1,066,761
 
 1,272
 
 1,272
 
Standby letters of credit and financial guarantees written13,465
 
 202
 
 202
 

     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, 2017 
  
  
  
  
Financial assets 
  
  
  
  
Cash and due from banks$75,318
 $75,318
 $75,318
 $
 $
Interest-bearing deposits in other banks6,975
 6,975
 6,975
 
 
Investment securities1,496,644
 1,494,092
 825
 1,481,473
 11,794
Loans held for sale16,336
 16,336
 
 16,336
 
Net loans and leases3,720,614
 3,684,834
 
 21,280
 3,663,554
Mortgage servicing rights15,843
 17,161
 
 
 17,161
Federal Home Loan Bank stock7,761
 N/A
 N/A
 N/A
 N/A
          
Financial liabilities 
  
  
  
  
Deposits: 
  
  
  
  
Noninterest-bearing demand1,395,556
 1,395,556
 1,395,556
 
 
Interest-bearing demand and savings and money market2,414,930
 2,414,930
 2,414,930
 
 
Time1,145,868
 1,140,064
 
 
 1,140,064
Short-term borrowings32,000
 32,000
 
 32,000
 
Long-term debt92,785
 70,139
 
 70,139
 

       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, 2017           
Derivatives           
Interest rate lock commitments$2,494
 $12
 $12
 $
 $12
 $
Forward sale commitments18,748
 (26) (26) 
 (26) 
            
Off-balance sheet financial instruments 
  
  
  
  
  
Commitments to extend credit917,405
 
 1,140
 
 1,140
 
Standby letters of credit and financial guarantees written13,551
 
 203
 
 203
 


Fair Value Measurements
 
We group our financial assets and liabilities at fair value into three levels based on the markets in which the financial assets and liabilities are traded and the reliability of the assumptions used to determine fair value as follows:
 
Level 1 — Valuation is based upon quoted prices (unadjusted) for identical assets or liabilities traded in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of discounted cash flow models and similar techniques that requires the use of significant judgment or estimation.
 
We base our fair values on the price that we would expect to receive if an asset were sold or pay to transfer a liability in an orderly transaction between market participants at the measurement date. We also maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements.
 
We use fair value measurements to record adjustments to certain financial assets and liabilities and to determine fair value disclosures. Available for saleAvailable-for-sale and equity securities and derivatives are recorded at fair value on a recurring basis. From time to time, we

may be required to record other financial assets at fair value on a nonrecurring basis such as loans held for sale, impaired loans, 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.
 
The Company's policy is to recognize transfers into or out of a level as of the end of the reporting period. There were no transfers of financial assets and liabilities between Level 1 and Level 2 of the fair value hierarchy during the three and nine months ended March 31,September 30, 2018. Also, there were no transfers of financial assets and liabilities into or out of Level 3 of the fair value hierarchy during the three and nine months ended March 31,September 30, 2018.


The following tables present the fair value of assets and liabilities measured on a recurring basis as of March 31,September 30, 2018 and December 31, 2017:
 
  Fair Value at Reporting Date Using  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)
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, 2018 
  
  
  
Available-for-sale securities: 
  
  
  
September 30, 2018 
  
  
  
Available-for-sale securities 
  
  
  
Debt securities: 
  
  
  
 
  
  
  
States and political subdivisions$177,221
 $
 $165,683
 $11,538
$173,552
 $
 $162,408
 $11,144
Corporate securities68,058
 
 68,058
 
65,133
 
 65,133
 
U.S. Treasury obligations and direct obligations of U.S Government agencies37,153
 
 37,153
 
33,919
 
 33,919
 
Mortgage-backed securities: 
  
  
  
 
  
  
  
Residential - U.S. Government sponsored entities811,322
 
 811,322
 
734,357
 
 734,357
 
Commercial - U.S. Government agencies and sponsored entities53,457
 
 53,457
 
51,205
 
 51,205
 
Residential - Non-government agencies44,440
 
 44,440
 
41,370
 
 41,370
 
Commercial - Non-government agencies134,441
 
 134,441
 
133,466
 
 133,466
 
Total available-for-sale securities1,326,092
 
 1,314,554
 11,538
1,233,002
 
 1,221,858
 11,144
       
Equity securities753
 753
 
 
885
 885
 
 
Derivatives: Interest rate lock and forward sale commitments7
 
 7
 
       
Derivatives - Interest rate lock and forward sale commitments63
 
 63
 
Total$1,326,852
 $753
 $1,314,561
 $11,538
$1,233,950
 $885
 $1,221,921
 $11,144

   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, 2017 
  
  
  
Available-for-sale securities 
  
  
  
Debt securities: 
  
  
  
States and political subdivisions$179,781
 $
 $167,987
 $11,794
Corporate securities74,278
 
 74,278
 
U.S. Treasury obligations and direct obligations of U.S Government agencies25,510
 
 25,510
 
Mortgage-backed securities: 
  
  
  
Residential - U.S. Government sponsored entities800,683
 
 800,683
 
Commercial - U.S. Government agencies and sponsored entities39,725
 
 39,725
 
Residential - Non-government agencies46,763
 
 46,763
 
Commercial - Non-government agencies137,326
 
 137,326
 
Total available-for-sale securities1,304,066
 
 1,292,272
 11,794
        
Equity securities825
 825
 
 
        
Derivatives - Interest rate lock and forward sale commitments(14) 
 (14) 
Total$1,304,877
 $825
 $1,292,258
 $11,794
 

   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, 2017 
  
  
  
Available-for-sale securities: 
  
  
  
Debt securities: 
  
  
  
States and political subdivisions$179,781
 $
 $167,987
 $11,794
Corporate securities74,278
 
 74,278
 
U.S. Treasury obligations and direct obligations of U.S Government agencies25,510
 
 25,510
 
Mortgage-backed securities: 
  
  
  
Residential - U.S. Government sponsored entities800,683
 
 800,683
 
Commercial - U.S. Government agencies and sponsored entities39,725
 
 39,725
 
Residential - Non-government agencies46,763
 
 46,763
 
Commercial - Non-government agencies137,326
 
 137,326
 
Total available-for-sale securities1,304,066
 
 1,292,272
 11,794
Equity securities825
 825
 
 
Derivatives: Interest rate lock and forward sale commitments(14) 
 (14) 
Total$1,304,877
 $825
 $1,292,258
 $11,794

For the threenine months ended March 31,September 30, 2018 and 2017, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:
 
(dollars in thousands)Available for Sale
Debt Securities:
States and
Political
Subdivisions
Available for Sale
Debt Securities:
States and
Political
Subdivisions
Balance at December 31, 2017$11,794
$11,794
Principal payments received(91)(280)
Unrealized net gain (loss) included in other comprehensive income(165)(370)
Balance at March 31, 2018$11,538
Balance at September 30, 2018$11,144
 
 
Balance at December 31, 2016$12,196
$12,196
Principal payments received(89)(268)
Unrealized net gain (loss) included in other comprehensive income34
170
Balance at March 31, 2017$12,141
Balance at September 30, 2017$12,098
 
Within the states and political subdivisions available-for-sale debt securities category, the Company holds four mortgage revenue bonds issued by the City & County of Honolulu with an aggregate fair value of $11.5$11.1 million and $12.1 million at March 31,September 30, 2018 and March 31,September 30, 2017, respectively. The Company estimates the fair value of its mortgage revenue bonds by using a discounted cash flow model to calculate the present value of estimated future principal and interest payments.
 
The significant unobservable input used in the fair value measurement of the Company's mortgage revenue bonds is the weighted average discount rate. As of March 31,September 30, 2018, the weighted average discount rate utilized was 5.02%,5.28% compared to 4.73%4.50% at March 31,September 30, 2017 and 4.81% at December 31, 2017, which was derived by incorporating a credit spread over the FHLB Fixed-Rate Advance curve. Significant increases (decreases) in the weighted average discount rate could result in a significantly lower (higher) fair value measurement.


The following table presents the fair value of assets measured on a nonrecurring basis and the level of valuation assumptions used to determine the respective fair values as of March 31,September 30, 2018 and December 31, 2017:
 
  Fair Value Measurements Using  Fair Value Measurements Using
(dollars in thousands)Fair Value Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 Significant
Other
Observable
Inputs
(Level 2)
 Significant
Unobservable
Inputs
(Level 3)
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, 2018 
  
  
  
September 30, 2018 
  
  
  
Impaired loans (1)
$20,963
 $
 $20,963
 $
$19,170
 $
 $19,170
 $
Mortgage servicing rights18,463
 
 
 18,463
18,315
 
 
 18,315
Other real estate (2)
595
 
 595
 
414
 
 414
 
              
December 31, 2017 
  
  
  
 
  
  
  
Impaired loans (1)
$21,280
 $
 $21,280
 $
$21,280
 $
 $21,280
 $
Mortgage servicing rights17,161
 
 
 17,161
17,161
 
 
 17,161
Other real estate (2)
851
 
 851
 
851
 
 851
 

(1) 
Represents carrying value and related write-downs of loans for which adjustments are based on agreed upon purchase prices for the loans or the appraised value of the collateral.
 
(2) 
Represents other real estate that is carried at the lower of carrying value or fair value less costs to sell. Fair value is generally based upon independent market prices or appraised values of the collateral.


The significant unobservable inputs used in the fair value measurement of the Company's mortgage servicing rights are the weighted average discount rate and the forecasted constant prepayment rate. As of March 31,September 30, 2018, the weighted average discount rate and the forecasted constant prepayment rate utilized were 9.5% and 14.2%14.0%, respectively, compared to 9.5% and 15.0%16.5%, respectively, as of March 31,September 30, 2017 and 9.5% and 15.96%16.0%, respectively, as of December 31, 2017. Significant increases (decreases) in the weighted average discount rate and/or the forecasted constant prepayment rate could result in a significantly lower (higher) fair value measurement.

19.18. SEGMENT INFORMATION
 
We have the following three reportable segments: Banking Operations, Treasury and All Others. These segments are consistent with our internal functional reporting lines and are managed separately because each unit has different target markets, technological requirements, and specialized skills.
 
The Banking Operations segment includes construction and real estate development lending, commercial lending, residential mortgage lending, indirect auto lending, trust services, retail brokerage services and our retail branch offices, which provide a full range of deposit and loan products, as well as various other banking services. The Treasury segment is responsible for managing the Company's investment securities portfolio and wholesale funding activities. The All Others segment consists of all activities not captured by the Banking Operations or Treasury segments described above and includes activities such as electronic banking, data processing and management of bank owned properties.
 
The accounting policies of the segments are consistent with the Company's accounting policies that are described in Note 1 - Summary of Significant Accounting Policies to the consolidated financial statements in the Annual Report on Form 10-K, as amended by our Form 10-K/A for the year ended December 31, 2017 filed with the SEC. The majority of the Company's net income is derived from net interest income. Accordingly, management focuses primarily on net interest income, rather than gross interest income and expense amounts, in evaluating segment profitability.
 
Intersegment net interest income (expense) was allocated to each segment based upon a funds transfer pricing process that assigns costs of funds to assets and earnings credits to liabilities based on market interest rates that reflect interest rate sensitivity and maturity characteristics. All administrative and overhead expenses are allocated to the segments at cost. Cash, investment securities, loans and leases and their related balances are allocated to the segment responsible for acquisition and maintenance of those assets. Segment assets also include all premises and equipment used directly in segment operations.


Segment profits and assets are provided in the following table for the periods indicated.
(dollars in thousands)Banking
Operations
 Treasury All Others Total
Three Months Ended March 31, 2018 
  
  
  
Net interest income$36,142
 $6,180
 $
 $42,322
Inter-segment net interest income (expense)6,921
 (5,449) (1,472) 
Credit for loan and lease losses211
 
 
 211
Other operating income:       
Mortgage banking income993
 
 854
 1,847
Service charges on deposit accounts2,003
 
 
 2,003
Other service charges and fees1,143
 6
 1,885
 3,034
Income from fiduciary activities956
 
 
 956
Equity in earnings of unconsolidated subsidiaries43
 
 
 43
Fees on foreign exchange24
 187
 
 211
Income from bank-owned life insurance
 318
 
 318
Loan placement fees197
 
 
 197
Other155
 
 190
 345
Other operating income5,514
 511
 2,929
 8,954
Other operating expense(15,925) (385) (17,208) (33,518)
Administrative and overhead expense allocation(14,946) (223) 15,169
 
Income before taxes17,917
 634
 (582) 17,969
Income tax (expense) benefit(3,681) (130) 119
 (3,692)
Net income (loss)$14,236
 $504
 $(463) $14,277

(dollars in thousands)Banking
Operations
 Treasury All Others Total
Three Months Ended March 31, 2017 
  
  
  
Net interest income$34,090
 $7,165
 $
 $41,255
Inter-segment net interest income (expense)7,927
 (6,190) (1,737) 
Credit for loan and lease losses80
 
 
 80
Other operating income:       
Mortgage banking income1,120
 
 823
 1,943
Service charges on deposit accounts2,035
 1
 
 2,036
Other service charges and fees838
 
 1,910
 2,748
Income from fiduciary activities864
 
 
 864
Equity in earnings of unconsolidated subsidiaries61
 
 
 61
Fees on foreign exchange18
 129
 16
 163
Income from bank-owned life insurance
 1,117
 
 1,117
Loan placement fees134
 
 
 134
Net gain (loss) sale of foreclosed assets
 
 102
 102
Other654
 14
 178
 846
Other operating income5,724
 1,261
 3,029
 10,014
Other operating expense(15,018) (388) (16,054) (31,460)
Administrative and overhead expense allocation(13,704) (202) 13,906
 
Income before taxes19,099
 1,646
 (856) 19,889
Income tax (expense) benefit(6,540) (564) 294
 (6,810)
Net income (loss)$12,559
 $1,082
 $(562) $13,079

(dollars in thousands)Banking
Operations
 Treasury All Others Total
Three Months Ended September 30, 2018 
  
  
  
Net interest income$38,872
 $4,453
 $
 $43,325
Inter-segment net interest income (expense)7,524
 (4,327) (3,197) 
Credit (provision) for loan and lease losses59
 
 
 59
Other operating income:       
Mortgage banking income1,173
 
 750
 1,923
Service charges on deposit accounts2,189
 
 
 2,189
Other service charges and fees1,318
 8
 1,960
 3,286
Income from fiduciary activities1,159
 
 
 1,159
Equity in earnings of unconsolidated subsidiaries71
 
 
 71
Fees on foreign exchange22
 198
 
 220
Income from bank-owned life insurance
 1,055
 
 1,055
Loan placement fees115
 
 
 115
Other448
 58
 296
 802
Other operating income6,495
 1,319
 3,006
 10,820
Other operating expense(16,265) (335) (17,539) (34,139)
Administrative and overhead expense allocation(15,481) (206) 15,687
 
Income before taxes21,204
 904
 (2,043) 20,065
Income tax (expense) benefit(5,128) (215) 471
 (4,872)
Net income (loss)$16,076
 $689
 $(1,572) $15,193

(dollars in thousands)Banking
Operations
 Treasury All Others Total
Three Months Ended September 30, 2017 
  
  
  
Net interest income$35,191
 $6,804
 $
 $41,995
Inter-segment net interest income (expense)8,530
 (6,299) (2,231) 
Credit (provision) for loan and lease losses126
 
 
 126
Other operating income:       
Mortgage banking income684
 
 847
 1,531
Service charges on deposit accounts2,182
 
 
 2,182
Other service charges and fees1,303
 
 1,882
 3,185
Income from fiduciary activities911
 
 
 911
Equity in earnings of unconsolidated subsidiaries176
 
 
 176
Fees on foreign exchange23
 78
 

 101
Income from bank-owned life insurance
 1,074
 
 1,074
Loan placement fees86
 
 
 86
Net gain (loss) sale of foreclosed assets
 
 19
 19
Other140
 7
 157
 304
Other operating income5,505
 1,159
 2,905
 9,569
Other operating expense(15,242) (338) (17,931) (33,511)
Administrative and overhead expense allocation(15,635) (311) 15,946
 
Income before taxes18,475
 1,015
 (1,311) 18,179
Income tax (expense) benefit(6,470) (360) 463
 (6,367)
Net income (loss)$12,005
 $655
 $(848) $11,812

 

(dollars in thousands)Banking
Operations
 Treasury All Others Total
Nine Months Ended September 30, 2018 
  
  
  
Net interest income$112,295
 $16,024
 $
 $128,319
Inter-segment net interest income (expense)21,360
 (14,717) (6,643) 
Credit (provision) for loan and lease losses(262) 
 
 (262)
Other operating income:       
Mortgage banking income3,089
 
 2,456
 5,545
Service charges on deposit accounts6,169
 
 
 6,169
Other service charges and fees3,748
 22
 5,927
 9,697
Income from fiduciary activities3,132
 
 
 3,132
Equity in earnings of unconsolidated subsidiaries151
 
 
 151
Fees on foreign exchange75
 633
 
 708
Income from bank-owned life insurance
 1,874
 
 1,874
Loan placement fees532
 
 
 532
Other803
 60
 733
 1,596
Other operating income17,699
 2,589
 9,116
 29,404
Other operating expense(47,967) (1,078) (52,336) (101,381)
Administrative and overhead expense allocation(45,594) (652) 46,246
 
Income before taxes57,531
 2,166
 (3,617) 56,080
Income tax (expense) benefit(12,707) (478) 799
 (12,386)
Net income (loss)$44,824
 $1,688
 $(2,818) $43,694
        

(dollars in thousands)Banking
Operations
 Treasury All Others Total
March 31, 2018       
Investment securities$
 $1,503,923
 $
 $1,503,923
Loans and leases (including loans held for sale)3,823,638
 
 
 3,823,638
Other41,427
 210,042
 72,257
 323,726
Total assets$3,865,065
 $1,713,965
 $72,257
 $5,651,287
(dollars in thousands)Banking
Operations
 Treasury All Others Total
Nine Months Ended September 30, 2017 
  
  
  
Net interest income$103,839
 $21,040
 $
 $124,879
Inter-segment net interest income (expense)24,618
 (18,828) (5,790) 
Credit (provision) for loan and lease losses2,488
 
 
 2,488
Other operating income:       
Mortgage banking income2,953
 
 2,478
 5,431
Service charges on deposit accounts6,338
 
 
 6,338
Other service charges and fees3,288
 
 5,698
 8,986
Income from fiduciary activities2,739
 
 
 2,739
Equity in earnings of unconsolidated subsidiaries388
 
 
 388
Fees on foreign exchange65
 329
 
 394
Investments securities gains (losses)
 (1,640) 
 (1,640)
Income from bank-owned life insurance
 2,774
 
 2,774
Loan placement fees366
 
 
 366
Net gain (loss) sale of foreclosed assets
 
 205
 205
Other936
 24
 512
 1,472
Other operating income17,073
 1,487
 8,893
 27,453
Other operating expense(45,095) (1,048) (51,163) (97,306)
Administrative and overhead expense allocation(44,360) (741) 45,101
 
Income before taxes58,563
 1,910
 (2,959) 57,514
Income tax (expense) benefit(20,974) (684) 1,060
 (20,598)
Net income$37,589
 $1,226
 $(1,899) $36,916
        


(dollars in thousands)Banking
Operations
 Treasury All Others Total
September 30, 2018       
Investment securities$
 $1,386,739
 $
 $1,386,739
Loans and leases (including loans held for sale)3,982,487
 
 
 3,982,487
Other40,814
 237,043
 81,557
 359,414
Total assets$4,023,301
 $1,623,782
 $81,557
 $5,728,640

(dollars in thousands)Banking
Operations
 Treasury All Others Total
December 31, 2017       
Investment securities$
 $1,496,644
 $
 $1,496,644
Loans and leases (including loans held for sale)3,786,951
 
 
 3,786,951
Other42,243
 228,608
 69,262
 340,113
Total assets$3,829,194
 $1,725,252
 $69,262
 $5,623,708

20.19. LEGAL PROCEEDINGS
 
We are involved in legal actions arising in the ordinary course of business. Management, after consultation with our legal counsel, believes the ultimate disposition of those matters will not have a material adverse effect on our consolidated financial statements.

20. SUBSEQUENT EVENTS

On October 24, 2018, the Company submitted a redemption notice to the trustee and security holder to redeem, in whole, $20 million of floating rate trust preferred securities issued by Trust III. The trust preferred securities are being redeemed, along with $0.6 million in common securities issued by Trust III and held by the Company, as a result of the concurrent redemption of 100% of the Company's outstanding floating rate junior subordinated debentures due in December 2033 and held by Trust III, which underlie the trust preferred securities. The redemption is pursuant to the optional prepayment provisions of the indenture and is scheduled to occur on December 17, 2018.

The redemption price for the floating rate junior subordinated debentures will be equal to 100% of the principal amount plus accrued interest, if any, up to, but not including, the redemption date. The proceeds from the redemption of the floating rate junior subordinated debentures will be simultaneously applied to redeem all of the outstanding floating rate trust preferred securities at a price of 100% of the aggregate liquidation amount of the securities plus accumulated but unpaid distributions up to but not including the redemption date.

The Company has received all necessary regulatory approvals for the redemption. The redemption will be funded with excess cash currently available to the Company.

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Overview
 
Central Pacific Financial Corp. ("CPF") is a Hawaii corporation and a bank holding company. Our principal business is to serve as a holding company for our bank subsidiary, Central Pacific Bank. We refer to Central Pacific Bank herein as "our bank" or "the bank," and when we say "the Company," "we," "us" or "our," we mean the holding company on a consolidated basis with the bank and our other consolidated subsidiaries.
 
Central Pacific Bank is a full-service community bank with 35 branches and 8078 ATMs located throughout the state of Hawaii. The bank offers a broad range of products and services including accepting time, savings, money market, and demand deposits and originating loans, including commercial loans, construction loans, commercial and residential mortgage loans, and consumer loans.

Basis of Presentation
 
Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements under "Part I, Item 1. Financial Statements (Unaudited)." The following discussion should also be read in conjunction with the Company's Annual Report on Form 10-K, as amended by our Form 10-K/A for the year ended December 31, 2017 filed with the U.S. Securities and Exchange Commission (the "SEC") on February 28, 2018 and March 5, 2018, respectively.
 
Critical Accounting Policies and Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") requires that management make certain judgments and use certain estimates and assumptions that affect amounts reported and disclosures made. Accounting estimates are deemed critical when a different estimate could have reasonably been used or where changes in the estimate are reasonably likely to occur from period to period and would materially impact our consolidated financial statements as of or for the periods presented. Management has discussed the development and selection of the critical accounting estimates noted below with the Audit Committee of the Board of Directors, and the Audit Committee has reviewed the accompanying disclosures.

Investment Securities

Investments in debt securities are designated as trading, available-for-sale, or held-to-maturity. Securities are designated as held-to-maturity only if we have the positive intent and ability to hold these securities to maturity. Held-to-maturity debt securities are reported at amortized cost. Trading securities are reported at fair value, with changes in fair value included in earnings during the periods in which they arise. Available-for-sale securities are reported at fair value, with net unrealized gains and losses, net of taxes, included in accumulated other comprehensive income (loss) ("AOCI"). Marketable equity securities are reported at fair value, with net unrealized gains and losses, net of taxes, included in net income.

We use current quotations, where available, to estimate the fair value of investment securities. Where current quotations are not available, we estimate fair value based on the present value of expected future cash flows. We consider the facts of each security including the nature of the security, the amount and duration of the loss, credit quality of the issuer, the expectations for that security's performance and our intent and ability to hold the security until recovery. Declines in the value of debt securities and marketable equity securities that are considered other than temporary are recorded in other operating income.

Allowance for Loan and Lease Losses
 
The allowance for loan and lease losses (the "Allowance") is management's estimate of incurred credit losses inherent in our loan and lease portfolio at the balance sheet date. In determining the amount of our Allowance, we rely on an analysis of our loan portfolio, our experience and our evaluation of general economic conditions, as well as regulatory requirements. We maintain our Allowance at an amount we expect to be sufficient to absorb probable losses incurred in our loan and lease portfolio. At March 31,September 30, 2018, we had an Allowance of $49.2$46.8 million, compared to $50.0 million at December 31, 2017.

The Company's approach to developing the Allowance has three basic elements. These elements include specific reserves for individually impaired loans, a general allowance for loans other than those analyzed as individually impaired, and qualitative adjustments based on environmental and other factors which may be internal or external to the Company.
 

Specific Reserve
 
Individually impaired loans in all loan categories are evaluated using one of three valuation methods as prescribed under Accounting Standards Codification ("ASC") 310-10, "Fair Value of Collateral, Observable Market Price, or Cash Flow". A loan is generally evaluated for impairment on an individual basis if it meets one or more of the following characteristics: risk-rated as substandard, doubtful or loss, loans on nonaccrual status, troubled debt restructures, or any loan deemed prudent by management to so analyze. If the valuation of the impaired loan is less than the recorded investment in the loan, the deficiency will be charged off against the Allowance or, alternatively, a specific reserve will be established and included in the overall Allowance balance. The Company recorded a specific reserve of $0.1 million as of September 30, 2018 and did not record a specific reserve as of March 31, 2018 and December 31, 2017.

General Allowance

In determining the general allowance component of the Allowance, the Company utilizes a comprehensive approach to segment the loan portfolio into homogeneous groups. The Company's methodology segments the portfolio generally by FDIC Call

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

Qualitative Adjustments

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

In recognizing that current and relevant environmental (economic, market or other) conditions that can affect repayment may not yet be fully reflected in historical loss experience, qualitative adjustments are applied to factor in current loan portfolio and market intelligence. These adjustments, which are added to the historical loss rate, consider the nature of the Company's primary markets and are reasonable, consistently determined and appropriately documented. Management reviews the results of the qualitative adjustment quarterly to ensure it is consistent with the trends in the overall economy, and from time to time may make adjustments, if necessary, to ensure directional consistency.

Mortgage Servicing Rights

Mortgage servicing rights are recorded when loans are sold to third-parties with servicing of those loans retained and we classify our entire mortgage servicing rights into one pool. We utilize the amortization method to measure our mortgage servicing rights. Under the amortization method, we amortize our mortgage servicing rights in proportion to and over the period of net servicing income. Income generated as the result of new mortgage servicing rights is reported as gains on sales of loans and is a component of mortgage banking income in the other operating income section of our consolidated statements of income. Amortization of the servicing rights is also reported as a component of mortgage banking income. Ancillary income is recorded in other income.

Initial fair value of the servicing right is calculated by a discounted cash flow model prepared by a third-party service provider based on market value assumptions at the time of origination. We assess the servicing right for impairment using current market value assumptions at each reporting period. Critical assumptions used in the discounted cash flow model include mortgage prepayment speeds, discount rates, costs to service, and ancillary income. Variations in our assumptions could materially affect the estimated fair values. Changes to our assumptions are made when current trends and market data indicate that new trends have developed. Current market value assumptions based on loan product types (fixed-rate, adjustable-rate and balloon loans) include average discount rates and national prepayment speeds. Many of these assumptions are subjective and require a high

level of management judgment. Our mortgage servicing rights portfolio and valuation assumptions are periodically reviewed by management.

Prepayment speeds may be affected by economic factors such as changes in home prices, market interest rates, the availability of other credit products to our borrowers and customer payment patterns. Prepayment speeds include the impact of all borrower prepayments, including full payoffs, additional principal payments and the impact of loans paid off due to foreclosure liquidations. As market interest rates decline, prepayment speeds will generally increase as customers refinance existing mortgages under more favorable interest rate terms. As prepayment speeds increase, anticipated cash flows will generally decline resulting in a potential reduction, or impairment, to the fair value of the capitalized mortgage servicing rights. Alternatively, an increase in market interest rates may cause a decrease in prepayment speeds and therefore an increase in fair value of mortgage servicing rights.
We perform an impairment assessment of our mortgage servicing rights quarterly or whenever events or changes in circumstance indicate that the carrying value of those assets may not be recoverable. Our impairment assessments involve, among other valuation methods, the estimation of future cash flows and other methods of determining fair value. Estimating future cash flows and determining fair values is subject to judgments and often involves the use of significant estimates and assumptions. The variability of the factors we use to perform our impairment tests depend on a number of conditions, including the uncertainty about future events and cash flows. All such factors are interdependent and, therefore, do not change in isolation. Accordingly, our accounting estimates may materially change from period to period due to changing market factors.
Deferred Tax Assets and Tax Contingencies
Deferred tax assets and liabilities are recognized for the estimated future tax effects attributable to temporary differences and carryforwards. A valuation allowance may be required if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets, net of deferred tax liabilities ("DTA") will not be realized. In determining whether a valuation allowance is necessary, we consider the level of taxable income in prior years, to the extent that carrybacks are permitted under current tax laws, as well as estimates of future taxable income and tax planning strategies that could be implemented to accelerate taxable income, if necessary. If our estimates of future taxable income were materially overstated or if our assumptions regarding the tax consequences of tax planning strategies were inaccurate, some or all of our DTA may not be realized, which would result in a charge to earnings.

As of March 31, 2018, we have a valuation allowance on our net DTA of $3.3 million, which relates to our California state income taxes as we do not expect to generate sufficient income in California to utilize the DTA. Given our seven consecutive years of profitability and the expectation of continued profitability, strong asset quality, and well-capitalized position, we continue to believe that it is more likely than not that our remaining net DTA totaling $26.5 million at March 31, 2018 will be realized.
We may establish income tax contingency reserves for potential tax liabilities related to uncertain tax positions. Tax benefits are recognized when we determine that it is more likely than not that such benefits will be realized. Where uncertainty exists due to the complexity of income tax statutes and where the potential tax amounts are significant, we generally seek independent tax opinions to support our positions. If our evaluation of the likelihood of the realization of benefits is inaccurate, we could incur additional income tax and interest expense that would adversely impact earnings, or we could receive tax benefits greater than anticipated which would positively impact earnings. The Company did not have any uncertain tax positions as of March 31, 2018 and December 31, 2017.

Impact of Other Recently Issued Accounting Pronouncements on Future Filings

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)." ASU 2016-02 increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU establishes a right-of-use ("ROU") model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term of longer than 12 months. The ASU is effective for the Company's reporting period beginning January 1, 2019 and must be applied using the modified retrospective approach. Based on preliminary evaluation, the ASU will not have a material impact on our consolidated financial statements as the projected minimum lease payments under existing leases subject to the ASU are less than one percent of our total assets as of March 31, 2018.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial

institutions and other organizations will use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation methods are appropriate for their circumstances. Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The ASU will be effective for the Company's reporting period beginning January 1, 2020. The Company has formed a steering committee whose primary purpose is to (i) provide oversight, (ii) facilitate collaboration among the department stakeholders, and (iii) be responsible for the Company’s implementation strategy for compliance with the ASU. The Company continues to evaluate the potential impact of the ASU. The Company anticipates significant changes to the processes and procedures for calculating the allowance for loan and lease losses and continues to evaluate the potential impact the ASU will have on our consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities." ASU 2017-12 was issued to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The FASB believes that such amendments will (1) improve the transparency of information about an entity’s risk management activities and (2) simplify the application of hedge accounting. The ASU is effective for the the Company's reporting period beginning on January 1, 2019. Early adoption is permitted. We are currently in the process of evaluating the potential impact the amendments will have on our consolidated financial statements, but we do not expect the adoption of the ASU to have a material impact on our consolidated financial statements.

Financial Summary
 
Net income for the three months ended March 31,September 30, 2018 was $14.3$15.2 million, or $0.48$0.52 per diluted share, compared to $13.1$11.8 million, or $0.42$0.39 per diluted share for the three months ended March 31,September 30, 2017. Net income for the nine months ended September 30, 2018 was $43.7 million, or $1.47 per diluted share, compared to $36.9 million, or $1.20 per diluted share for the nine months ended September 30, 2017.
 
The following table presents annualized returns on average assets and average shareholders' equity, and basic and diluted earnings per share for the periods indicated. Returns on average assets and average shareholders' equity are annualized based on a 30/360 day convention.

Three Months Ended
March 31,
Three Months Ended
September 30,
 Nine Months Ended
September 30,
2018 20172018 2017 2018 2017
Return on average assets1.01% 0.96%1.06% 0.85% 1.03% 0.90%
Return on average shareholders’ equity11.60
 10.24
12.54
 9.16
 11.99
 9.57
Basic earnings per common share$0.48
 $0.43
$0.52
 $0.39
 $1.48
 $1.21
Diluted earnings per common share0.48
 0.42
0.52
 0.39
 1.47
 1.20
 
Material Trends
 
The majority of our operations are concentrated in the state of Hawaii. As a result, our performance is significantly influenced by the real estate markets, and economic environment and environmental conditions in Hawaii. Macroeconomic conditions also influence our performance. A favorable business environment is generally characterized by expanding gross state product, low unemployment and rising personal income; while an unfavorable business environment is characterized by the reverse.

The economic outlook for Hawaii continues to be positive for 2018, followingFollowing the solid performances of our leading economic indicators in 2017, that continued inthe economic outlook for Hawaii continues to be positive for the remainder of 2018. Tourism continues to be Hawaii's center of strength and its most significant economic driver. For the sixth straight year in 2017, Hawaii's strong visitor industry broke records in five keys categories, including visitor arrivals and visitor spending. The visitor industry recorded a strong first quarter ofnine months ended September 30, 2018. According

to the Hawaii Tourism Authority ("HTA"), 2.57.5 million visitors visited the state in the threenine months ended March 31,September 30, 2018. This was an increase of 9.4%6.5% from the number of visitor arrivals in the threenine months ended March 31,September 30, 2017. The HTA also reported total spending by visitors increased to $4.8$13.6 billion in the threenine months ended March 31,September 30, 2018, or an increase of $442.5 million,$1.2 billion, or 10.1%9.8%, from the threenine months ended March 31,September 30, 2017. According to the Hawaii Department of Business, Economic Development and Tourism ("DBEDT"), total visitor arrivals and visitor spending are expected to increase 2.7%6.1% and 4.5%9.2% in 2018, respectively, and 1.6% and 3.7%3.2% in 2019, respectively.

After two years of consecutive growth above 2%, DBEDT reported Hawaii's economy, as measured by the growth of real personal income and real gross state product, continued positive growth in 2017, but at a slower pace. In its firstthird quarter of

2018 report, DBEDT projects real personal income and real gross state product to grow at a rate of 1.5%1.8% and 1.7%1.5%, respectively, for 2018 and 1.5%1.8% and 1.6%, respectively, for 2019.
 
Hawaii's labor market continuedcontinues to improvebe the tightest labor market in 2017.the nation. The Department of Labor and Industrial Relations reported that Hawaii's seasonally adjusted annual unemployment rate improved to 2.1%remained unchanged at 2.2% in MarchSeptember 2018, compared to 2.6%2.2% in MarchSeptember 2017. In addition, Hawaii's unemployment rate is among the lowest in the nation, and remained below the national seasonally adjusted unemployment rate of 4.1%3.7%. DBEDT projects Hawaii's seasonally adjusted annual unemployment rate to be at 2.6%2.2% in 2018 and 3.0%2.5% in 2019.

Real estate lending is a primary focus for us, including residential mortgage and commercial mortgage loans. As a result, we are dependent on the strength of Hawaii's real estate market. Home sales in Hawaii were strong and the housing market set several new records in 2017. These trends continued through the three months ended March 31, 2018. According to the Honolulu Board of Realtors, after a slow start to 2018, they continue to see a steady upward trend and anticipate peak sales in the late summer months. Oahu unit sales volume remained relatively unchangeddipped slightly by 3.7% for single-family homes while Oahu unit sales volume increased 0.7%and 0.1% for condominiums for the threenine months ended March 31,September 30, 2018, compared to the same time period last year. The median price for a single-family home on Oahu reached an all-time high of $812,500 in the month of September 2018, passing the record set in August 2018 of $810,000. For the threenine months ended March 31,September 30, 2018, the median sales price for single-family homes on Oahu was $765,000,$789,000, representing an increase of 2.0%4.2% from $750,000$757,000 in the same prior year period. The median sales price for condominiums on Oahu for the threenine months ended March 31,September 30, 2018 was $425,000,$429,500, representing an increase of 9.0%5.5% from $390,000$407,000 in the same prior year period. We believe the Hawaii real estate market will continue to remain strong infor the remainder of 2018, however, there can be no assurance that this will occur.

We are closely monitoring the Mount Kilauea lava eruptions in the Puna District on the Big Island of Hawaii. During the third quarter of 2018, we were paid off on six loans, with a total outstanding balance of $1.6 million in which the collateral properties were located in the Puna District. As of September 30, 2018, in the Puna District we have a total of 29 residential mortgage loans and home equity lines of credit remaining in our portfolio, with a total outstanding balance of $2.6 million. Within that portfolio, we are aware that one residential mortgage property with an aggregate outstanding balance of $0.1 million was destroyed by lava and the insurance claim for the remaining mortgage was denied. As such, management established a specific reserve in the same amount as of September 30, 2018 to cover the potential impairment of this loan.

During the third quarter of 2018, we also recorded an increase to the reserve for residential mortgage repurchase losses of $0.3 million, primarily due to potential losses on repurchases of loans impacted by the Mount Kilauea lava eruptions. We will continue to monitor and evaluate the impact of the Mount Kilauea lava eruptions on our business and financial condition.
 
As we have seen in the past, our operating results are significantly impacted by the economy in Hawaii and the composition of our loan portfolio. Loan demand, deposit growth, Provision, asset quality, noninterest income and noninterest expense are all affected by changes in economic conditions. If the residential and commercial real estate markets we have exposure to deteriorate, our results of operations would be negatively impacted.

In late 2008, the Federal Reserve lowered the target Federal Funds range to 0%-0.25%. In an attempt to help the overall economy, the Federal Reserve has kept interest rates low through its targeted Federal Funds rate.rate until the recession was safely over. In recent years, the Federal Reserve has begun raising the target Federal Funds range. During 2017, the Federal Reserve increased the Federal Funds rate three times, each time by 25 basis points. The

In September 2018. the Federal Reserve increasedraised the target Federal Funds range by another 25 bp duringfor the first quarter ofthird time in 2018, to 1.50%-1.75%, and has indicated that further increases are likely during the remainder of 2018,2.00%-2.25%. The Federal Reserve also kept its forecast for a fourth hike later this year, subject to economic conditions.

As the Federal Reserve increases the Federal Funds rate, overall interest rates will likely rise, which may negatively impact the U.S. economic recovery. Further, changes in monetary policy, including changes in interest rates, could influence, among other things, (i) the amount of interest we receive on loans and securities, (ii) the amount of interest we pay on deposits and borrowings, (iii) our ability to originate loans and obtain deposits and (iv) the fair value of our assets and liabilities.
 

Results of Operations
 
Net Interest Income
 
Net interest income, when annualized and expressed as a percentage of average interest earning assets, is referred to as "net interest margin." Interest income, which includes loan fees and resultant yield information, is expressed on a taxable equivalent basis using a federal statutory tax rate of 21% for the three and nine months ended March 31,September 30, 2018 and 35% for the three and nine months ended March 31,September 30, 2017. A comparison of net interest income on a taxable equivalenttaxable-equivalent basis ("net interest income") for the three and nine months ended March 31,September 30, 2018 and 2017 is set forth below.
 
(dollars in thousands)Three Months Ended March 31,Three Months Ended September 30,
2018 2017 Variance2018 2017 Variance
Average
Balance
 Average
Yield/
Rate
 Interest
Income/
Expense
 Average
Balance
 Average
Yield/
Rate
 Interest
Income/
Expense
 Average
Balance
 Average
Yield/
Rate
 Interest
Income/
Expense
Average
Balance
 Average
Yield/
Rate
 Interest
Income/
Expense
 Average
Balance
 Average
Yield/
Rate
 Interest
Income/
Expense
 Average
Balance
 Average
Yield/
Rate
 Interest
Income/
Expense
Assets   
      
  
    
  
   
      
  
    
  
Interest earning assets:   
                 
              
Interest-bearing deposits in other banks$22,790
 1.50% 84
 $39,910
 0.75% 74
 $(17,120) 0.75 % 10
$22,057
 1.97% 109
 $51,392
 1.26% 163
 $(29,335) 0.71 % (54)
Investment securities, excluding valuation allowance:                                  
Taxable (1)1,350,135
 2.62
 8,858
 1,329,915
 2.45
 8,147
 20,220
 0.17
 711
1,284,411
 2.65
 8,516
 1,363,289
 2.51
 8,552
 (78,878) 0.14
 (36)
Tax-exempt (1)165,176
 2.86
 1,181
 171,139
 3.52
 1,506
 (5,963) (0.66) (325)163,172
 2.86
 1,165
 169,347
 3.51
 1,486
 (6,175) (0.65) (321)
Total investment securities1,515,311
 2.65
 10,039
 1,501,054
 2.57
 9,653
 14,257
 0.08
 386
1,447,583
 2.67
 9,681
 1,532,636
 2.62
 10,038
 (85,053) 0.05
 (357)
Loans and leases, including loans held for sale (2)3,789,338
 3.98
 37,390
 3,547,718
 3.98
 34,957
 241,620
 
 2,433
3,941,511
 4.09
 40,531
 3,625,455
 3.98
 36,289
 316,056
 0.11
 4,242
Federal Home Loan Bank stock6,837
 2.61
 45
 6,773
 3.31
 56
 64
 (0.70) (11)7,773
 3.11
 60
 6,606
 1.38
 23
 1,167
 1.73
 37
Total interest earning assets5,334,276
 3.59
 47,558
 5,095,455
 3.54
 44,740
 238,821
 0.05
 2,818
5,418,924
 3.70
 50,381
 5,216,089
 3.55
 46,513
 202,835
 0.15
 3,868
Noninterest-earning assets303,929
  
  
 327,074
  
  
 (23,145)  
  290,901
  
  
 329,820
  
  
 (38,919)  
  
Total assets$5,638,205
  
  
 $5,422,529
  
  
 $215,676
  
  $5,709,825
  
  
 $5,545,909
  
  
 $163,916
  
  
                                  
Liabilities and Equity                                  
Interest-bearing liabilities: 
  
  
  
  
  
  
  
  
 
  
  
  
  
  
  
  
  
Interest-bearing demand deposits$935,483
 0.08% 180
 $879,428
 0.06% 140
 $56,055
 0.02 % 40
$933,405
 0.08% 181
 $916,885
 0.08% 177
 $16,520
  % 4
Savings and money market deposits1,499,419
 0.10
 369
 1,419,420
 0.07
 257
 79,999
 0.03
 112
1,524,121
 0.15
 593
 1,458,393
 0.08
 281
 65,728
 0.07
 312
Time deposits under $100,000179,547
 0.44
 195
 193,638
 0.38
 180
 (14,091) 0.06
 15
177,108
 0.53
 236
 187,231
 0.41
 192
 (10,123) 0.12
 44
Time deposits $100,000 and over1,029,972
 1.27
 3,230
 1,026,181
 0.61
 1,537
 3,791
 0.66
 1,693
1,049,446
 1.70
 4,508
 955,644
 1.02
 2,445
 93,802
 0.68
 2,063
Total interest-bearing deposits3,644,421
 0.44
 3,974
 3,518,667
 0.24
 2,114
 125,754
 0.20
 1,860
3,684,080
 0.59
 5,518
 3,518,153
 0.35
 3,095
 165,927
 0.24
 2,423
Short-term borrowings8,806
 1.97
 43
 14,777
 0.84
 31
 (5,971) 1.13
 12
25,163
 2.30
 146
 2,934
 1.27
 9
 22,229
 1.03
 137
Long-term debt92,785
 4.25
 971
 92,785
 3.55
 813
 
 0.70
 158
92,785
 4.90
 1,147
 92,785
 3.82
 894
 
 1.08
 253
Total interest-bearing liabilities3,746,012
 0.54
 4,988
 3,626,229
 0.33
 2,958
 119,783
 0.21
 2,030
3,802,028
 0.71
 6,811
 3,613,872
 0.44
 3,998
 188,156
 0.27
 2,813
Noninterest-bearing deposits1,355,687
    
 1,244,207
    
 111,480
    1,378,981
    
 1,375,625
    
 3,356
    
Other liabilities44,306
  
  
 41,264
  
  
 3,042
  
  44,079
  
  
 40,808
  
  
 3,271
  
  
Total liabilities5,146,005
  
  
 4,911,700
  
  
 234,305
  
  5,225,088
  
  
 5,030,305
  
  
 194,783
  
  
Shareholders’ equity492,184
  
  
 510,804
  
  
 (18,620)  
  484,737
  
  
 515,580
  
  
 (30,843)  
  
Non-controlling interest16
  
  
 25
  
  
 (9)  
  
  
  
 24
  
  
 (24)  
  
Total equity492,200
  
  
 510,829
  
  
 (18,629)  
  484,737
  
  
 515,604
  
  
 (30,867)  
  
Total liabilities and equity$5,638,205
  
  
 $5,422,529
  
  
 $215,676
  
  $5,709,825
  
  
 $5,545,909
  
  
 $163,916
  
  
                                  
Net interest income 
  
 $42,570
  
  
 $41,782
  
  
 $788
 
  
 $43,570
  
  
 $42,515
  
  
 $1,055
                                  
Interest rate spread  3.05%     3.21%     (0.16)%    2.99%     3.11%     (0.12)%  
                                  
Net interest margin 
 3.21%  
  
 3.30%  
  
 (0.09)%  
 
 3.20%  
  
 3.25%  
  
 (0.05)%  
       ��                          
(1) At amortized cost.                                  
(2) Includes nonaccrual loans.                                  
 



 Nine Months Ended September 30,
2018 2017 Variance
Average
Balance
 Average
Yield/
Rate
 Interest
Income/
Expense
 Average
Balance
 Average
Yield/
Rate
 Interest
Income/
Expense
 Average
Balance
 Average
Yield/
Rate
 Interest
Income/
Expense
Assets   
      
  
    
  
Interest earning assets:   
      
  
      
Interest-bearing deposits in other banks$23,713
 1.75% 310
 $38,089
 1.05% 298
 $(14,376) 0.70 % 12
Investment securities, excluding valuation allowance:                 
Taxable investment securities (1)1,325,180
 2.63
 26,094
 1,346,013
 2.50
 25,192
 (20,833) 0.13
 902
Tax-exempt investment securities (1)164,174
 2.86
 3,527
 170,211
 3.52
 4,491
 (6,037) (0.66) (964)
Total investment securities1,489,354
 2.65
 29,621
 1,516,224
 2.61
 29,683
 (26,870) 0.04
 (62)
Loans and leases, including loans held for sale (2)3,856,420
 4.04
 116,620
 3,589,124
 3.97
 106,777
 267,296
 0.07
 9,843
Federal Home Loan Bank stock7,261
 2.67
 145
 6,865
 1.94
 100
 396
 0.73
 45
Total interest earning assets5,376,748
 3.64
 146,696
 5,150,302
 3.55
 136,858
 226,446
 0.09
 9,838
Noninterest-earning assets294,090
  
  
 328,783
  
  
 (34,693)  
  
Total assets$5,670,838
  
  
 $5,479,085
  
  
 $191,753
  
  
                  
Liabilities and Equity 
  
  
  
  
  
      
Interest-bearing liabilities: 
  
  
  
  
  
  
  
  
Interest-bearing demand deposits$940,154
 0.08% 554
 $895,850
 0.07% 471
 $44,304
 0.01 % 83
Savings and money market deposits1,506,565
 0.13
 1,421
 1,434,778
 0.07
 797
 71,787
 0.06
 624
Time deposits under $100,000178,363
 0.48
 645
 190,877
 0.39
 560
 (12,514) 0.09
 85
Time deposits $100,000 and over1,042,353
 1.48
 11,558
 987,408
 0.80
 5,930
 54,945
 0.68
 5,628
Total interest-bearing deposits3,667,435
 0.52
 14,178
 3,508,913
 0.30
 7,758
 158,522
 0.22
 6,420
Short-term borrowings14,683
 2.16
 237
 11,877
 0.97
 86
 2,806
 1.19
 151
Long-term debt92,785
 4.64
 3,221
 92,785
 3.69
 2,563
 
 0.95
 658
Total interest-bearing liabilities3,774,903
 0.62
 17,636
 3,613,575
 0.39
 10,407
 161,328
 0.23
 7,229
Noninterest-bearing deposits1,367,574
    
 1,310,722
  
  
 56,852
    
Other liabilities42,414
  
  
 40,626
  
  
 1,788
  
  
Total liabilities5,184,891
  
  
 4,964,923
  
  
 219,968
  
  
Shareholders’ equity485,942
  
  
 514,137
  
  
 (28,195)  
  
Non-controlling interest5
  
  
 25
  
  
 (20)  
  
Total equity485,947
  
  
 514,162
  
  
 (28,215)  
  
Total liabilities and equity$5,670,838
  
  
 $5,479,085
  
  
 $191,753
  
  
                  
Net interest income 
  
 $129,060
  
  
 $126,451
  
  
 $2,609
                  
Interest rate spread  3.02%     3.16%     (0.14)%  
                  
Net interest margin 
 3.20%  
  
 3.28%  
  
 (0.08)%  
                  
(1)  At amortized cost.                 
(2)  Includes nonaccrual loans.                 
                  

Net interest income (expressed on a taxable-equivalent basis) was $42.6$43.6 million for the firstthird quarter of 2018, representing an increase of 1.9%2.5% from $41.8$42.5 million in the firstthird quarter of 2017. Net interest income (expressed on a taxable-equivalent basis) was $129.1 million for the nine months ended September 30, 2018, representing an increase of 2.1% from $126.5 million in the nine months ended September 30, 2017. The increase in the three and nine months ended September 30, 2018 was primarily attributable to a significant increase in average loans and leases and investment securities balances funded by growth in lower cost deposits. Offsettingdeposits, combined

with higher yields earned on the loans and leases and investment securities portfolios. Partially offsetting this increase was an increase in average time deposits $100,000 and over, combined with a 66 basis point ("bp")significant increase in rates paid on time deposits $100,000 and over. Time deposits $100,000 and over combinedprimarily consists of public funds which may be opportunistic sources of funding, but fluctuate more directly with changes in Federal Funds rates. The increase was also partially offset by a lower taxable-equivalent adjustment on the tax-exempt investment securities portfolio due to Tax Reform.
Average yields earned on our interest-earning assets during the first quarter of 2018 increased by 5 bp from the first quarter of 2017. Average rates paid on our interest-bearing liabilities increased by 21 bp in the first quarter of 2018 compared to the first quarter of 2017.

In the second quarter of 2017, we completed an investment portfolio repositioning strategy designed to enhance potential prospective earnings and improve net interest margin. In connection with the repositioning, we sold $97.7 million in lower-yielding available-for-sale investment securities, and purchased $97.4 million in higher yielding, longer duration investment securities. The securities sold had a duration of 3.3 years and an average yield of 1.91%. Gross proceeds from the sale were immediately reinvested back into securities with a duration of 4.6 and an average yield of 2.57%. The new securities were classified in the available-for-sale portfolio. Gross realized losses on the sale of the securities were $1.6 million, recorded in other operating income.

Interest Income
 
Taxable-equivalent interest income was $47.6$50.4 million for the firstthird quarter of 2018, representing an increase of 6.3%8.3% from $44.7$46.5 million in the firstthird quarter of 2017. The increase was primarily attributable to a $241.6$316.1 million increase in average loans and leases and a $14.3 million increase in average investment securities compared to the firstthird quarter of 2017, accounting for approximately $2.4 million and $0.1$3.2 million of the increase in interest income during the firstthird quarter of 2018, respectively.2018. In addition, the average yieldyields earned on the loans and leases and taxable investment securities portfolioportfolios during the firstthird quarter of 2018 increased by 1711 bp and 14 bp, respectively, compared to the firstthird quarter of 2017, accounting for approximately $0.7$1.1 million and $0.4 million of the increase in interest income.income, respectively. These increases were partially offset by a 65 bp decline in the average taxable-equivalent yield earned on the tax-exempt investment securities portfolio, primarily due to Tax Reform, which decreased interest income by $0.3 million.

Taxable-equivalent interest income was $146.7 million for the nine months ended September 30, 2018, representing an increase of 7.2% from $136.9 million in the nine months ended September 30, 2017. The increase was primarily attributable to a $267.3 million increase in average loans and leases compared to the nine months ended September 30, 2017, accounting for approximately $7.8 million of the increase in interest income during the nine months ended September 30, 2018. In addition, the average yields earned on the loans and leases and taxable investment securities portfolios during the nine months ended September 30, 2018 increased by 7 bp and 13bp, respectively, compared to the nine months ended September 30, 2017, accounting for approximately $2.0 million and $1.3 million of the increase in interest income, respectively. These increases were partially offset by a 66 bp decline in the average taxable-equivalent yield earned on the tax-exempt investment securities portfolio, primarily due to Tax Reform, which decreased interest income by $0.3$0.8 million.

Interest Expense
 
Interest expense for the firstthird quarter of 2018 was $5.0$6.8 million, representing an increase of 68.6%70.4% from the firstthird quarter of 2017. The increase was primarily attributable to a 6668 bp increase in average rates paid on time deposits $100,000 and over, which increased interest expense by $1.7$1.8 million.

Interest expense for the nine months ended September 30, 2018 was $17.6 million, representing an increase of 69.5% from the nine months ended September 30, 2017. The increase was primarily attributable to a 68 bp increase in average rates paid on time deposits $100,000 and over, which increased interest expense by $5.3 million. The increase in average rates paid on time deposits $100,000 and over during the three and nine months ended September 30, 2018 was primarily due to an increase in average rates paid on public deposits.

Net Interest Margin
 
Our net interest margin of 3.21%3.20% for the firstthird quarter of 2018 declined by 95 bp from the firstthird quarter of 2017 as deposit costs continue to increase faster than our loan yields. Our net interest margin of 3.20% for the nine months ended September 30, 2018 declined by 8 bp from the nine months ended September 30, 2017.

The average rates paid on our interest-bearing liabilities, which increased by 27 bp and 23 bp in the three and nine months ended September 30, 2018, respectively, compared to the same prior year periods, outpaced the increase in average yields earned on our interest-earning assets, which increased by 15 bp and 9 bp in the three and nine months ended September 30, 2018, respectively, compared to the same prior year periods.


The aforementioned increases in average rates paid on our time deposits $100,000 and over of 66 bpduring the three and nine months ended September 30, 2018 was partially offset by the increaseaforementioned increases in average yield earned on our loans and leases and taxable investment securities portfolio of 17 bp.portfolios. Due to Tax Reform and the resultant reduction in the federal statutory tax rate to 21% beginning January 1, 2018, compared to 35% starting in the first quarter of 2017,2018, the taxable-equivalent adjustment on interest income earned on the average tax-exempt investment securities portfolio decreased. This resulted in an approximately 2 bp reduction in the net interest margin in the first quarter ofthree and nine months ended September 30, 2018.

The historically low interest rate environment that we continue to operate in is the result of the target Federal Funds range of 0%-0.25% initially set by the Federal Reserve in the fourth quarter of 2008 and other economic policies implemented by the FRB, which continued through the third quarter of 2015. In December 2015 and 2016, the Federal Reserve increased the target Federal Funds range to 0.25%-0.50%by 25 bp each year based on the improvement in labor market conditions and positive economic outlook. Citing improvement in labor market conditions, a move toward more stable prices, and a positive economic outlook, the Federal Reserve increased the target Federal Funds range three times in 2017, each by 25 bp. Furthermore, the Federal Reserve announced their intent to remove monetary policy accommodation through the gradual unwind of their balance sheet that grew following the recession through their quantitative easing programs.
TheIn September 2018, the Federal Reserve increasedraised the target Federal Funds range by another 25 bp duringfor the first quarter ofthird time in 2018, to 1.50%-1.75%2.00%-2.25%. We expect the targetThe Federal Funds rateReserve also kept its forecast for a fourth hike later this year, subject to gradually increase throughout 2018, as the labor market continues to strengthen and inflation expectations increase. Furthermore, fiscal policy actions have been interpreted as inflationary with the passage of the Tax Reform at the end of 2017.

economic conditions.

Provision for Loan and Lease Losses
 
Our Provision was a credit of $0.2$0.1 million during the firstthird quarter of 2018, compared to a credit of $0.1 million in the firstthird quarter of 2017. Our net charge-offs were $0.6$1.3 million during the firstthird quarter of 2018, compared to net charge-offs of $1.2$1.5 million in the firstthird quarter of 2017.

TheFor the nine months ended September 30, 2018, our Provision was a debit of $0.3 million, compared to a credit to the provision for loan and lease lossesof $2.5 million in the threenine months ended March 31, 2018 was primarily attributable to continued improvement in portfolio credit quality, combined with non-recurring recoveries of loans previously charged-off. Nonperforming assets ofSeptember 30, 2017. Our net charge-offs were $3.4 million asduring the nine months ended September 30, 2018, compared to net charge-offs of March 31, 2018 decreased by $0.2$2.9 million from December 31,in the nine months ended September 30, 2017.
 
Other Operating Income
 
The following tables set forth components of other operating income for the periods indicated:

Three Months EndedThree Months Ended
(dollars in thousands)March 31, 2018 March 31, 2017 $ Change % ChangeSeptember 30, 2018 September 30, 2017 $ Change % Change
Other operating income:              
Mortgage banking income$1,847
 $1,943
 $(96) -4.9 %$1,923
 $1,531
 $392
 25.6 %
Service charges on deposit accounts2,003
 2,036
 (33) -1.6 %2,189
 2,182
 7
 0.3 %
Other service charges and fees3,034
 2,748
 286
 10.4 %3,286
 3,185
 101
 3.2 %
Income from fiduciary activities956
 864
 92
 10.6 %1,159
 911
 248
 27.2 %
Equity in earnings of unconsolidated subsidiaries43
 61
 (18) -29.5 %71
 176
 (105) -59.7 %
Fees on foreign exchange211
 163
 48
 29.4 %220
 101
 119
 117.8 %
Investment securities gains (losses)
 
 
 N.M.
Income from bank-owned life insurance318
 1,117
 (799) -71.5 %1,055
 1,074
 (19) -1.8 %
Loan placement fees197
 134
 63
 47.0 %115
 86
 29
 33.7 %
Net gain on sales of foreclosed assets
 102
 (102) -100.0 %
 19
 (19) -100.0 %
Other: 
  
     
  
    
Income recovered on nonaccrual loans previously charged-off96
 561
 (465) -82.9 %395
 25
 370
 1,480.0 %
Other recoveries46
 37
 9
 24.3 %101
 32
 69
 215.6 %
Commissions on sale of checks86
 87
 (1) -1.1 %79
 86
 (7) -8.1 %
Other117
 161
 (44) -27.3 %227
 161
 66
 41.0 %
Total other operating income$8,954
 $10,014
 $(1,060) -10.6 %$10,820
 $9,569
 $1,251
 13.1 %
       


For the firstthird quarter of 2018, total other operating income of $9.0$10.8 million decreasedincreased by $1.1$1.3 million, or 10.6%13.1%, from $10.0$9.6 million in the year-ago quarter. The decreaseincrease from the year-ago quarter was primarily due to higher net gains on sales of residential mortgage loans of $0.4 million (included in mortgage banking income), higher income recovered on nonaccrual loans previously charged-off of $0.4 million, and higher income from fiduciary activities of $0.2 million.
 Nine Months Ended
(dollars in thousands)September 30, 2018 September 30, 2017 $ Change % Change
Other operating income:       
Mortgage banking income$5,545
 $5,431
 $114
 2.1 %
Service charges on deposit accounts6,169
 6,338
 (169) -2.7 %
Other service charges and fees9,697
 8,986
 711
 7.9 %
Income from fiduciary activities3,132
 2,739
 393
 14.3 %
Equity in earnings of unconsolidated subsidiaries151
 388
 (237) -61.1 %
Fees on foreign exchange708
 394
 314
 79.7 %
Investment securities gains (losses)
 (1,640) 1,640
 -100.0 %
Income from bank-owned life insurance1,874
 2,774
 (900) -32.4 %
Loan placement fees532
 366
 166
 45.4 %
Net gain on sales of foreclosed assets
 205
 (205) -100.0 %
Other: 
  
    
Income recovered on nonaccrual loans previously charged-off621
 611
 10
 1.6 %
Other recoveries196
 123
 73
 59.3 %
Commissions on sale of checks249
 258
 (9) -3.5 %
Other530
 480
 50
 10.4 %
Total other operating income$29,404
 $27,453
 $1,951
 7.1 %
        

For the nine months ended September 30, 2018, total other operating income of $29.4 million increased by $2.0 million, or 7.1%, from $27.5 million in the nine months ended September 30, 2017. The increase from the nine months ended September 30, 2017 was primarily due to investment securities losses of $1.6 million recorded in the year-ago period related to an investment portfolio repositioning, combined with higher commissions and fees on investment services of $0.6 million (included in other service charges and fees), higher income from fiduciary activities of $0.4 million, and higher fees on foreign exchange of $0.3 million. These increases were partially offset by lower income from bank-owned life insurance ("BOLI") of $0.8 million and lower income recovered on nonaccrual loans previously charged-off of $0.5 million, partially offset by higher commissions on investment services of $0.3 million (included in other service charges and fees).$0.9 million. The lower income from BOLI of $0.8 million was primarily attributable to $0.6$1.1 million in death benefit income recorded in the year-ago quarter.
period, compared to $0.4 million recorded in the current period.

 

Other Operating Expense
 
The following tables set forth components of other operating expense for the periods indicated:

Three Months EndedThree Months Ended
(dollars in thousands)March 31, 2018 March 31, 2017 $ Change % ChangeSeptember 30, 2018 September 30, 2017 $ Change % Change
Other operating expense:              
Salaries and employee benefits$18,505
 $17,387
 $1,118
 6.4 %$19,011
 $18,157
 $854
 4.7 %
Net occupancy3,266
 3,414
 (148) -4.3 %3,488
 3,404
 84
 2.5 %
Equipment1,068
 842
 226
 26.8 %1,048
 969
 79
 8.2 %
Amortization of core deposit premium669
 668
 1
 0.1 %669
 669
 
  %
Communication expense898
 900
 (2) -0.2 %903
 944
 (41) -4.3 %
Legal and professional services1,821
 1,792
 29
 1.6 %1,528
 1,854
 (326) -17.6 %
Computer software expense2,267
 2,252
 15
 0.7 %2,672
 2,346
 326
 13.9 %
Advertising expense612
 392
 220
 56.1 %612
 626
 (14) -2.2 %
Foreclosed asset expense294
 36
 258
 716.7 %212
 24
 188
 783.3 %
Other: 
  
     
  
    
Charitable contributions200
 151
 49
 32.5 %166
 141
 25
 17.7 %
FDIC insurance assessment434
 424
 10
 2.4 %437
 433
 4
 0.9 %
Miscellaneous loan expenses299
 261
 38
 14.6 %403
 302
 101
 33.4 %
ATM and debit card expenses648
 450
 198
 44.0 %686
 548
 138
 25.2 %
Amortization of investments in low-income housing tax credit partnerships114
 233
 (119) -51.1 %114
 174
 (60) -34.5 %
Armored car expenses166
 258
 (92) -35.7 %185
 176
 9
 5.1 %
Entertainment and promotions159
 158
 1
 0.6 %185
 818
 (633) -77.4 %
Stationery and supplies201
 178
 23
 12.9 %206
 204
 2
 1.0 %
Directors’ fees and expenses231
 207
 24
 11.6 %263
 208
 55
 26.4 %
Provision for residential mortgage loan repurchase losses331
 
 331
 N.M.
Increase (decrease) to the reserve for unfunded commitments41
 70
 (29) -41.4 %(71) 72
 (143) -198.6 %
Other1,625
 1,387
 238
 17.2 %1,091
 1,442
 (351) -24.3 %
Total other operating expense$33,518
 $31,460
 $2,058
 6.5 %$34,139
 $33,511
 $628
 1.9 %
       

For the firstthird quarter of 2018, total other operating expense was $33.5$34.1 million and increased by $2.1$0.6 million, or 6.5%1.9%, from $31.5$33.5 million in the year-ago quarter. The increase was primarily due to higher salaries and employee benefits of $1.1$0.9 million combined withand higher computer software expense of $0.3 million. The increase in salaries and employee benefits was primarily attributable to the write-downincrease in the Company's starting pay rate effective January 1, 2018 and merit salary increases effective in the second quarter of a foreclosed asset2018. These increases were partially offset by lower entertainment and promotions of $0.6 million and lower legal and professional services of $0.3 million (includedcompared to the year-ago period. The lower entertainment and promotions were primarily attributable to additional expenses incurred in the year-ago period related to a core deposit gathering campaign.

 Nine Months Ended
(dollars in thousands)September 30, 2018 September 30, 2017 $ Change % Change
Other operating expense:       
Salaries and employee benefits$56,299
 $53,527
 $2,772
 5.2 %
Net occupancy10,114
 10,153
 (39) -0.4 %
Equipment3,160
 2,778
 382
 13.8 %
Amortization of core deposit premium2,006
 2,006
 
  %
Communication expense2,547
 2,735
 (188) -6.9 %
Legal and professional services5,118
 5,633
 (515) -9.1 %
Computer software expense7,244
 6,788
 456
 6.7 %
Advertising expense1,841
 1,408
 433
 30.8 %
Foreclosed asset expense537
 123
 414
 336.6 %
Other: 
  
    
Charitable contributions497
 428
 69
 16.1 %
FDIC insurance assessment1,305
 1,286
 19
 1.5 %
Miscellaneous loan expenses1,026
 856
 170
 19.9 %
ATM and debit card expenses2,032
 1,466
 566
 38.6 %
Amortization of investments in low-income housing tax credit partnerships341
 630
 (289) -45.9 %
Armored car expenses584
 632
 (48) -7.6 %
Entertainment and promotions617
 1,222
 (605) -49.5 %
Stationery and supplies643
 612
 31
 5.1 %
Directors’ fees and expenses777
 665
 112
 16.8 %
Provision for residential mortgage loan repurchase losses331
 
 331
 N.M.
Increase (decrease) to the reserve for unfunded commitments36
 195
 (159) -81.5 %
Other4,326
 4,163
 163
 3.9 %
Total other operating expense$101,381
 $97,306
 $4,075
 4.2 %
        

For the nine months ended September 30, 2018, total other operating expense was $101.4 million and increased by $4.1 million, or 4.2%, from $97.3 million in the nine months ended September 30, 2017. The increase from the nine months ended September 30, 2017 was primarily due to higher salaries and employee benefits of $2.8 million, higher ATM and debit card expenses of $0.6 million, higher computer software expense of $0.5 million, and higher advertising, foreclosed asset expense).and equipment expenses of $0.4 million each. The increase in salaries and employee benefits was primarily attributable to the increase in the Company's starting pay rate and the pay scale for other wage progression positions effective January 1, 2018, combined with annual merit salary increases effective in the second quarter of 2017.2018. These increases were partially offset by lower entertainment and promotions of $0.6 million and lower legal and professional services of $0.5 million.

A key measure of operating efficiency tracked by management is the efficiency ratio, which is calculated by dividing total operating expenses by total revenue (net interest income and total other operating income). Management believes that the efficiency ratio provides useful supplemental information that is important to a proper understanding of the company's core business results by investors. Our efficiency ratio should not be viewed as a substitute for results determined in accordance with GAAP, nor is it necessarily comparable to the efficiency ratio presented by other companies.


The following table sets forth a reconciliation to our efficiency ratio for each of the periods indicated:


Three Months Ended
March 31,
Three Months Ended
September 30,
 Nine Months Ended
September 30,
(dollars in thousands)2018 20172018 2017 2018 2017
Total other operating expense$33,518
 $31,460
$34,139
 $33,511
 $101,381
 $97,306
          
Net interest income$42,322
 $41,255
$43,325
 $41,995
 $128,319
 $124,879
Total other operating income8,954
 10,014
10,820
 9,569
 29,404
 27,453
Total revenue$51,276
 $51,269
$54,145
 $51,564
 $157,723
 $152,332
          
Efficiency ratio65.37% 61.36%63.05% 64.99% 64.28% 63.88%

Our efficiency ratio increasedimproved to 65.37%63.05% in the firstthird quarter of 2018 compared to 61.36%64.99% in the year-ago quarter. The improvementimprovements in net interest income was offset by lowerand other operating income and, when combined withwere partially offset by higher other operating expenses as noted above, and resulted in the increaseimprovement in our efficiency ratio.

Our efficiency ratio increased from 63.88% in the nine months ended September 30, 2017 to 64.28% in the nine months ended September 30, 2018. The higher other operating expenses, partially offset by the improvements in net interest income and other operating income as noted above, resulted in a higher efficiency ratio.

Income Taxes
 
The Company recorded income tax expense of $3.7$4.9 million and $12.4 million for the three and nine months ended March 31,September 30, 2018, respectively, compared to $6.8$6.4 million and $20.6 million in the same prior year period.periods. The effective tax raterates for the three and nine months ended March 31,September 30, 2018 was 20.5%were 24.3% and 22.09%, respectively, compared to 34.2%35.0% and 35.81% in the same prior year period.periods, respectively. The decrease in income tax expense and the effective tax rate in the three and nine months ended March 31,September 30, 2018 was primarily due to lower pre-tax income, combined with the decline in the effectiveU.S. federal corporate tax rate attributable to Tax Reform,Reform. In addition, in the second quarter of 2017, the Company recorded additional income tax expense of $0.9 million related to a former executive's supplemental executive retirement plan ("SERP") benefit payout and adjustment to the DTA related to SERP. In the first quarter of 2018, the Company recorded an income tax benefit of $0.7 million related to a true-uprefinement of the revaluation of our deferredDTA. In the second quarter of 2018, the Company recorded an income tax assets.benefit of $0.6 million related to a tax accounting method change strategy that allows the deduction for certain expenses to be accelerated into the 2017 tax year under the higher corporate tax rate.

The remaining valuation allowance on our net DTA totaled $3.3 million at March 31,September 30, 2018 and $3.3 million at December 31, 2017, which related entirely to our DTA from net apportioned net operating loss ("NOL") carryforwards for California state income tax purposes as we do not expect to generate sufficient income in California to utilize the DTA. Net of this valuation allowance, the Company's net DTA totaled $26.5$24.5 million at March 31,September 30, 2018, compared to a net DTA of $26.5 million as of December 31, 2017, and is included in other assets on our consolidated balance sheets.
 
Financial Condition
 
Total assets at March 31,September 30, 2018 of $5.65$5.73 billion increased by $27.6$104.9 million from $5.62 billion at December 31, 2017. The increase in total assets was primarily due to our deposit growth and deployment of these proceeds into higher yielding assets.
 
Investment Securities
 
Investment securities of $1.50$1.39 billion at March 31,September 30, 2018 increaseddecreased by $7.3$109.9 million, or 0.5%7.3%, from December 31, 2017. The increasedecrease reflects investment securities purchases totaling $85.2$161.5 million partially offset byin principal runoff and a $20.6$34.2 million decrease in the market valuation on the available-for-sale portfolio, and $57.5 million in principal runoff.partially offset by investment securities purchases totaling $85.3 million.

 

Loans and Leases

The following table sets forth information regarding our outstanding loans and leases by category and geographic location as of the dates indicated.

(Dollars in thousands) March 31, 2018 December 31, 2017 $ Change % Change September 30, 2018 December 31, 2017 $ Change % Change
Hawaii:  
  
  
  
  
  
  
  
Commercial, financial and agricultural $413,181
 $400,529
 $12,652
 3.2 % $427,047
 $400,529
 $26,518
 6.6 %
Real estate:                
Construction 59,136
 61,643
 (2,507) (4.1) 66,286
 61,643
 4,643
 7.5
Residential mortgage 1,351,488
 1,341,221
 10,267
 0.8
 1,392,669
 1,341,221
 51,448
 3.8
Home equity 425,509
 412,230
 13,279
 3.2
 455,599
 412,230
 43,369
 10.5
Commercial mortgage 831,160
 807,009
 24,151
 3.0
 845,864
 807,009
 38,855
 4.8
Consumer 325,452
 322,713
 2,739
 0.8
 345,785
 322,713
 23,072
 7.1
Leases 285
 362
 (77) (21.3) 170
 362
 (192) (53.0)
Total loans and leases 3,406,211
 3,345,707
 60,504
 1.8
 3,533,420
 3,345,707
 187,713
 5.6
Allowance for loan and lease losses (43,939) (44,779) 840
 (1.9) (41,991) (44,779) 2,788
 (6.2)
Net loans and leases $3,362,272
 $3,300,928
 $61,344
 1.9
 $3,491,429
 $3,300,928
 $190,501
 5.8
                
U.S. Mainland:  
  
  
  
  
  
  
  
Commercial, financial and agricultural $103,299
 $103,490
 $(191) (0.2) $138,317
 $103,490
 $34,827
 33.7
Real estate:                
Construction 2,517
 2,597
 (80) (3.1) 2,355
 2,597
 (242) (9.3)
Residential mortgage 
 
 
 
 
 
 
 
Home equity 
 
 
 
 
 
 
 
Commercial mortgage 174,668
 170,788
 3,880
 2.3
 187,586
 170,788
 16,798
 9.8
Consumer 129,451
 148,033
 (18,582) (12.6) 116,349
 148,033
 (31,684) (21.4)
Leases 
 
 
 
 
 
 
 
Total loans and leases 409,935
 424,908
 (14,973) (3.5) 444,607
 424,908
 19,699
 4.6
Allowance for loan and lease losses (5,278) (5,222) (56) 1.1
 (4,835) (5,222) 387
 (7.4)
Net loans and leases $404,657
 $419,686
 $(15,029) (3.6) $439,772
 $419,686
 $20,086
 4.8
                
Total:  
  
  
  
  
  
  
  
Commercial, financial and agricultural $516,480
 $504,019
 $12,461
 2.5
 $565,364
 $504,019
 $61,345
 12.2
Real estate:                
Construction 61,653
 64,240
 (2,587) (4.0) 68,641
 64,240
 4,401
 6.9
Residential mortgage 1,351,488
 1,341,221
 10,267
 0.8
 1,392,669
 1,341,221
 51,448
 3.8
Home equity 425,509
 412,230
 13,279
 3.2
 455,599
 412,230
 43,369
 10.5
Commercial mortgage 1,005,828
 977,797
 28,031
 2.9
 1,033,450
 977,797
 55,653
 5.7
Consumer 454,903
 470,746
 (15,843) (3.4) 462,134
 470,746
 (8,612) (1.8)
Leases 285
 362
 (77) (21.3) 170
 362
 (192) (53.0)
Total loans and leases 3,816,146
 3,770,615
 45,531
 1.2
 3,978,027
 3,770,615
 207,412
 5.5
Allowance for loan and lease losses (49,217) (50,001) 784
 (1.6) (46,826) (50,001) 3,175
 (6.3)
Net loans and leases $3,766,929
 $3,720,614
 $46,315
 1.2
 $3,931,201
 $3,720,614
 $210,587
 5.7

Loans and leases, net of deferred costs, of $3.82$3.98 billion at March 31,September 30, 2018 increased by $45.5$207.4 million, or 1.2%5.5%, from December 31, 2017. The increase reflects net increases in the following loan portfolios: commercial, mortgage of $28.0 million, home equity of $13.3 million, commercial, financial and agricultural of $12.5$61.3 million, andcommercial mortgage of $55.7 million, residential mortgage of $10.3$51.4 million, and home equity of $43.4 million. These increases were partially offset by a net decreasesdecrease in the following loan portfolios: consumer of $15.8 million and construction of $2.6 million. The net increase in the loan portfolio also reflects loan charge-offs totaling $2.4 million during the three months ended March 31, 2018.of $8.6 million.

The Hawaii loan portfolio increased by $60.5$187.7 million, or 1.8%5.6%, from December 31, 2017. The increase reflects net increases in the following loan portfolios: commercialresidential mortgage of $24.2$51.4 million, home equity of $13.3$43.4 million, commercial mortgage of $38.9 million, commercial, financial and

agricultural of $12.7$26.5 million, and residential mortgageconsumer of $10.3$23.1 million. The increases in the real estate portfolios were primarily due to an increased demand from both new and existing customers.


The U.S. Mainland loan portfolio decreasedincreased by $15.0$19.7 million, or 3.5%4.6% from December 31, 2017. The net decreaseincrease was primarily attributable to net increases in the commercial, financial and agricultural loan portfolio of $34.8 million and commercial mortgage loan portfolio of $16.8 million, partially offset by a reduction in the consumer loan portfolio of $18.6 million, partially offset by$31.7 million.

In May 2018, we purchased a net increase in the commercial mortgageU.S. Mainland auto loan portfolio totaling $20.6 million which included a $0.1 million premium over the $20.5 million outstanding balance. At the time of $3.9 million.purchase, the auto loans had a weighted average remaining term of 63 months and a weighted average yield, net of the premium paid and servicing costs, of 3.89%.

Nonperforming Assets, Accruing Loans Delinquent for 90 Days or More, Restructured Loans Still Accruing Interest

The following table sets forth nonperforming assets, accruing loans delinquent for 90 days or more and restructured loans still accruing interest as of the dates indicated.

(dollars in thousands)March 31, 2018 December 31, 2017 $ Change % ChangeSeptember 30, 2018 December 31, 2017 $ Change % Change
Nonperforming Assets 
  
     
  
    
Nonaccrual loans (including loans held for sale): 
  
     
  
    
Real estate:              
Residential mortgage$2,184
 $2,280
 $(96) (4.2)$2,197
 $2,280
 $(83) (3.6)
Home equity659
 416
 243
 58.4
415
 416
 (1) (0.2)
Commercial mortgage
 79
 (79) (100.0)
 79
 (79) (100.0)
Total nonaccrual loans2,843
 2,775
 68
 2.5
2,612
 2,775
 (163) (5.9)
              
Other real estate owned ("OREO"):     
       
  
Real estate:              
Residential mortgage595
 851
 (256) (30.1)414
 851
 (437) (51.4)
Total OREO595
 851
 (256) (30.1)414
 851
 (437) (51.4)
Total nonperforming assets3,438
 3,626
 (188) (5.2)3,026
 3,626
 (600) (16.5)
              
Accruing Loans Delinquent for 90 Days or More              
Real estate:              
Residential mortgage
 49
 (49) (100.0)
 49
 (49) (100.0)
Consumer417
 515
 (98) (19.0)333
 515
 (182) (35.3)
Total accruing loans delinquent for 90 days or more417
 564
 (147) (26.1)333
 564
 (231) (41.0)
              
Restructured Loans Still Accruing Interest     
       
  
Commercial, financial and agricultural457
 491
 (34) (6.9)388
 491
 (103) (21.0)
Real estate:              
Residential mortgage10,555
 10,677
 (122) (1.1)9,747
 10,677
 (930) (8.7)
Commercial mortgage1,360
 1,466
 (106) (7.2)1,145
 1,466
 (321) (21.9)
Total restructured loans still accruing interest12,372
 12,634
 (262) (2.1)11,280
 12,634
 (1,354) (10.7)
              
Total nonperforming assets, accruing loans delinquent for 90 days or more and restructured loans still accruing interest$16,227
 $16,824
 $(597) (3.5)$14,639
 $16,824
 $(2,185) (13.0)
              
Ratio of nonaccrual loans to total loans and leases0.07% 0.07%    %0.07% 0.07%    %
Ratio of nonperforming assets to total loans and leases and OREO0.09% 0.10%   (0.01)%0.08% 0.10%   (0.02)%
Ratio of nonperforming assets and accruing loans delinquent for 90 days or more to total loans and leases and OREO0.10% 0.11%   (0.01)%0.08% 0.11%   (0.03)%
Ratio of nonperforming assets, accruing loans delinquent for 90 days or more, and restructured loans still accruing interest to total loans and leases and OREO0.43% 0.45%   (0.02)%0.37% 0.45%   (0.08)%
 


The following table sets forth activity in nonperforming assets as of the date indicated.

Year-to-Date Changes in Nonperforming Assets: 
 
(dollars in thousands)  
Balance at December 31, 2017$3,626
$3,626
Additions263
593
Reductions: 
 
Payments(155)(313)
Return to accrual status
(403)
Sales of nonperforming assets(40)(40)
Charge-offs and/or valuation adjustments(256)(437)
Total reductions(451)(1,193)
Net decrease(188)(600)
Balance at March 31, 2018$3,438
Balance at September 30, 2018$3,026

Nonperforming assets, which includes nonaccrual loans and leases and other real estate, totaled $3.4$3.0 million at March 31,September 30, 2018, compared to $3.6 million at December 31, 2017. There were no nonperforming loans classified as held for sale at March 31,September 30, 2018 and December 31, 2017. The decrease in nonperforming assets from December 31, 2017 was primarily attributable to a write-down$0.4 million in write-downs of a foreclosed asset, of$0.4 million in nonaccrual loans returned to accrual status, and $0.3 million and $0.2 million in repayments, offset by additions of $0.3$0.6 million in additions to nonaccrual loans.
 
Net changes to nonperforming assets by category included net decreases in Hawaii residential mortgage assets of $0.4$0.5 million and Hawaii commercial mortgage assets of $0.1 million, partially offset by a net increase in Hawaii home equity assets of $0.3 million.
 
Troubled debt restructurings ("TDRs") included in nonperforming assets at March 31,September 30, 2018 consisted of sixthree Hawaii residential mortgage loans with a combined principal balance of $0.6$0.4 million.

Concessions made to the original contractual terms of these loans consisted primarily of the deferral of interest and/or principal payments due to deterioration in the borrowers' financial condition. The principal balances on these TDRs had matured and/or were in default at the time of restructure and we have no commitments to lend additional funds to any of these borrowers. There were $12.4$11.3 million of TDRs still accruing interest at March 31,September 30, 2018, none of which were more than 90 days delinquent. At December 31, 2017, there were $12.6 million of TDRs still accruing interest, none of which were more than 90 days delinquent.

 

Allowance for Loan and Lease Losses
 
The following table sets forth certain information with respect to the Allowance as of the dates and for the periods indicated:
 
Three Months Ended
March 31,
Three Months Ended
September 30,
 Nine Months Ended
September 30,
(dollars in thousands)2018 20172018 2017 2018 2017
Allowance for Loan and Lease Losses: 
  
 
  
  
  
Balance at beginning of period$50,001
 $56,631
$48,181
 $52,828
 $50,001
 $56,631
          
Provision (credit) for loan and lease losses(211) (80)(59) (126) 262
 (2,488)
          
Charge-offs:          
Commercial, financial and agricultural498
 500
731
 429
 1,971
 1,266
Consumer1,933
 1,497
1,762
 1,709
 5,424
 4,676
Total charge-offs2,431
 1,997
2,493
 2,138
 7,395
 5,942
          
Recoveries: 
  
 
  
  
  
Commercial, financial and agricultural144
 275
578
 165
 1,017
 676
Real estate:          
Construction1,193
 21
6
 40
 1,205
 117
Residential mortgage26
 96
51
 124
 98
 857
Home equity3
 2
6
 6
 18
 35
Commercial mortgage15
 11
8
 7
 52
 146
Consumer477
 410
548
 311
 1,568
 1,185
Total recoveries1,858
 815
1,197
 653
 3,958
 3,016
          
Net charge-offs573
 1,182
1,296
 1,485
 3,437
 2,926
          
Balance at end of period$49,217
 $55,369
$46,826
 $51,217
 $46,826
 $51,217
          
Allowance as a percentage of total loans and leases1.29% 1.56%1.18% 1.41% 1.18% 1.41%
          
Annualized ratio of net charge-offs to average loans and leases0.06% 0.13%0.13% 0.16% 0.12% 0.11%
 
Our Allowance at March 31,September 30, 2018 totaled $49.2$46.8 million compared to $50.0 million at December 31, 2017. The decrease in our Allowance during the threenine months ended March 31,September 30, 2018, was primarily attributable to continued improvement in the credit quality of the loan portfolio and is a direct result of $0.6$3.4 million in net charge-offs andoffset by a creditdebit to the Provision of $0.2$0.3 million.
 
Our Allowance as a percentage of total loans and leases decreased from 1.33% at December 31, 2017 to 1.29%1.18% at March 31,September 30, 2018. Our Allowance as a percentage of nonperforming assets increased from 1,378.96% at December 31, 2017 to 1,431.56%1,547.46% at March 31,September 30, 2018.
 
In accordance with GAAP, loans held for sale and other real estate assets are not included in our assessment of the Allowance.

Federal Home Loan Bank Stock
 
The bank is a member of the Federal Home Loan Bank of Des Moines (the "FHLB"). FHLB membership stock of $9.0$11.0 million at March 31,September 30, 2018 increased by $1.2$3.2 million, or 16.1%41.3%, from the FHLB membership stock balance at December 31, 2017.  FHLB membership stock has an activity-based stock requirement, thus as borrowings increase, so will the FHLB membership stock balance. There is a minimum requirement of $6.5 million in FHLB membership stock even if we have no borrowings outstanding.

 

Deposits
 
The following table sets forth the composition of our deposits by category for the periods indicated:

(dollars in thousands)March 31,
2018
 December 31,
2017
 $ Change % ChangeSeptember 30,
2018
 December 31,
2017
 $ Change % Change
Noninterest-bearing demand deposits$1,349,029
 $1,395,556
 $(46,527) (3.3)%$1,403,534
 $1,395,556
 $7,978
 0.6 %
Interest-bearing demand deposits946,464
 933,054
 13,410
 1.4
935,130
 933,054
 2,076
 0.2
Savings and money market deposits1,533,483
 1,481,876
 51,607
 3.5
1,503,465
 1,481,876
 21,589
 1.5
Time deposits less than $100,000177,999
 180,748
 (2,749) (1.5)174,920
 180,748
 (5,828) (3.2)
Core deposits4,006,975
 3,991,234
 15,741
 0.4
4,017,049
 3,991,234
 25,815
 0.6
              
Government time deposits703,467
 687,052
 16,415
 2.4
696,349
 687,052
 9,297
 1.4
Other time deposits $100,000 to $250,00097,800
 101,560
 (3,760) (3.7)104,339
 101,560
 2,779
 2.7
Other time deposits greater than $250,000172,189
 176,508
 (4,319) (2.4)185,943
 176,508
 9,435
 5.3
Total time deposits $100,000 and greater973,456
 965,120
 8,336
 0.9
986,631
 965,120
 21,511
 2.2
              
Total deposits$4,980,431
 $4,956,354
 $24,077
 0.5
$5,003,680
 $4,956,354
 $47,326
 1.0

Total deposits of $4.98$5.00 billion at March 31,September 30, 2018 reflected an increase of $24.1$47.3 million, or 0.5%1.0%, from total deposits of $4.96 billion at December 31, 2017. The increase was attributable to net increases in savings and money market deposits of $51.6 million, government time deposits of $16.4 million, and interest-bearing demand deposits of $13.4 million. These increases were offset by a net decrease in noninterest-bearing demand deposits of $46.5$21.6 million, other time deposits greater than $250,000 of $4.3$9.4 million, government time deposits of $9.3 million, noninterest-bearing demand deposits of $8.0 million, other time deposits $100,000 to $250,000 of $3.8$2.8 million, and interest-bearing demand deposits of $2.1 million. These increases were partially offset by a net decrease in time deposits less than $100,000 of $2.7$5.8 million.
 
Core deposits, which we define as demand deposits, savings and money market deposits, and time deposits less than $100,000, totaled $4.01$4.02 billion at March 31,September 30, 2018 and increased by $15.7$25.8 million, or 0.4%0.6%, from December 31, 2017.

Capital Resources
 
In order to ensure adequate levels of capital, we conduct an ongoing assessment of projected sources and uses of capital in conjunction with an analysis of the size and quality of our assets, the level of risk and regulatory capital requirements. As part of this ongoing assessment, the Board of Directors reviews our capital position on an ongoing basis to ensure it is adequate, including, but not limited to, need for raising additional capital or returning capital to our shareholders, including the ability to declare cash dividends or repurchase our securities.
 
Common and Preferred Equity
 
Shareholders' equity totaled $484.1$478.2 million at March 31,September 30, 2018, compared to $500.0 million at December 31, 2017. The decrease in total shareholders' equity was attributable to other comprehensive loss of $14.7$24.1 million, the repurchase of 344,362849,290 shares of common stock under our repurchase program, at a cost of $10.1$24.8 million, and cash dividends paid of $5.7$18.0 million, partially offset by net income of $14.3$43.7 million in the threenine months ended March 31,September 30, 2018. During the threenine months ended March 31,September 30, 2018, we repurchased approximately 1.1%2.8% of our common stock outstanding as of December 31, 2017.

The tangible common equity ratio is a non-GAAP financial measure which should be read and used in conjunction with the Company's GAAP financial information. Comparison of our tangible common equity ratio with those of other companies may not be possible because other companies may calculate the tangible common equity ratio differently. Our tangible common equity ratio is derived by dividing common shareholders' equity, less intangible assets (core deposit premium), by total assets, less intangible assets (core deposit premium).


The following table sets forth a reconciliation of our tangible common equity ratio for each of the periods indicated:


(dollars in thousands)March 31, 2018 December 31, 2017September 30, 2018 December 31, 2017
Total shareholders' equity$484,108
 $500,011
$478,151
 $500,011
Less: preferred stock
 
Total common equity484,108
 500,011
478,151
 500,011
Less: other intangible assets (core deposit premium)(1,337) (2,006)
 (2,006)
Tangible common equity$482,771
 $498,005
$478,151
 $498,005
      
Total assets$5,651,287
 $5,623,708
$5,728,640
 $5,623,708
Less: other intangible assets (core deposit premium)(1,337) (2,006)
 (2,006)
Tangible assets$5,649,950
 $5,621,702
$5,728,640
 $5,621,702
      
Tangible common equity ratio8.54% 8.86%8.35% 8.86%

Our tangible common equity ratio was 8.54%8.35% at March 31,September 30, 2018, compared to 8.86% at December 31, 2017. Our book value per share was $16.30$16.34 and $16.65 at March 31,September 30, 2018 and December 31, 2017, respectively. Our tangible book value per share was $16.25$16.34 and $16.59 at March 31,September 30, 2018 and December 31, 2017, respectively.
 
Holding Company Capital Resources
 
CPF is required to act as a source of strength to the bank under the Dodd-Frank Act. CPF is obligated to pay its expenses and payments on its junior subordinated debentures which fund payments on the outstanding trust preferred securities.
 
CPF relies on the bank to pay dividends to fund its obligations. As of March 31,September 30, 2018, on a stand-alone basis, CPF had an available cash balance of approximately $11.0$13.9 million in order to meet its ongoing obligations.

As a Hawaii state-chartered bank, the bank may only pay dividends to the extent it has retained earnings as defined under Hawaii banking law ("Statutory Retained Earnings"), which differs from GAAP retained earnings. As of March 31,September 30, 2018, the bank had Statutory Retained Earnings of $86.9$87.5 million. On April 24,October 23, 2018, the Company's Board of Directors declared a cash dividend of $0.21 per share on the Company's outstanding common stock, which was a 16.7% increase from the $0.18 per share a year-ago.
 
Dividends are payable at the discretion of the Board of Directors and there can be no assurance that the Board of Directors will continue to pay dividends at the same rate, or at all, in the future. Our ability to pay cash dividends to our shareholders is subject to restrictions under federal and Hawaii law, including restrictions imposed by the FRB and covenants set forth in various agreements we are a party to, including covenants set forth in our subordinated debentures.
 
In January 2016, the Board of Directors approved the authorization to repurchase up to $30.0 million of the Company's common stock (the "2016 Repurchase Plan"), which superseded in its entirety the repurchase plan that was previously approved by the Board of Directors.

In January 2017, the Board of Directors approved the authorization to repurchase up to $30.0 million of the Company's common stock (the "2017 Repurchase Plan"), which superseded in its entirety the 2016 Repurchase Plan. In January 2017, prior to the 2017 Repurchase Plan being approved, 1,750 shares of common stock, at a cost of $0.1 million, were repurchased under the 2016 Repurchase Plan.

In November 2017, the Board of Directors authorized an increase in the share repurchase program authority by an additional $50.0 million (known henceforth as the "Repurchase Plan"). This amount is in addition to the $30.0 million in planned repurchases authorized in January 2017. There is no expiration date on the Repurchase Plan.

In the year ended December 31, 2017, 864,483 shares of common stock, at a cost of $26.6 million, excluding fees and expenses, were repurchased under the 2016 Repurchase Plan and the Repurchase Plan combined.


In the threenine months ended March 31,September 30, 2018, a total of 344,362849,290 shares of common stock, at a cost of $10.1$24.8 million, were repurchased under the Repurchase Plan. As of March 31,September 30, 2018, $43.4$28.7 million remained under the Repurchase Plan. The plan has no set expiration or termination date.


Trust Preferred Securities

We have four statutory trusts, CPB Capital Trust II ("Trust II"), CPB Statutory Trust III ("Trust III"), CPB Capital Trust IV ("Trust IV") and CPB Statutory Trust V ("Trust V"), which issued a total of $90.0 million in floating rate trust preferred securities. The trust preferred securities, the underlying floating rate junior subordinated debentures that are the assets of Trusts II, III, IV and V, and the common securities issued by Trusts II, III, IV and V are redeemable in whole or in part on any interest payment date on or after October 7, 2008 for Trusts II and III, and 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 subordinated debenture interest payments, which would result in a deferral of dividend payments on the related trust preferred securities, for up to 20 consecutive quarterly periods without default or penalty.

In October 2018, the Company announced that it submitted a notice to redeem, in whole and at par, $20.0 million of floating rate trust preferred securities issued by Trust III and the underlying floating rate junior subordinated debentures, which are reported as long-term debt on the Company's balance sheet with an interest rate of 5.18% as of September 30, 2018. The redemption is pursuant to the optional prepayment provisions of the indenture and is scheduled to occur on December 17, 2018.

Regulatory Capital Ratios
 
General capital adequacy regulations adopted by the FRB and FDIC require an institution to maintain minimum leverage capital, Tier 1 risk-based capital, total risk-based capital, and common equity Tier 1 ("CET1") capital ratios. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. For a further discussion of the effect of forthcoming changes in required regulatory capital ratios, see the discussion in the "Business — Supervision and Regulation" sections of our 2017 Form 10-K, as amended by our Form 10-K/A.
 
The Company's and the bank's leverage capital, tier 1 risk-based capital, total risk-based capital, and CET1 risk-based capital ratios as of March 31,September 30, 2018 were above the levels required for a "well capitalized" regulatory designation.
 
 

The following table sets forth the Company's and the bank's capital ratios, as well as the minimum capital adequacy requirements applicable to all financial institutions as of the dates indicated.
 
 Actual Minimum Required
for Capital Adequacy
Purposes
 Minimum Required
to be
Well Capitalized
 Actual Minimum Required
for Capital Adequacy
Purposes
 Minimum Required
to be
Well Capitalized
(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Amount Ratio Amount Ratio Amount Ratio
Company  
  
  
  
  
  
  
  
  
  
  
  
At March 31, 2018:  
  
  
  
  
  
At September 30, 2018:  
  
  
  
  
  
Leverage capital $579,221
 10.3% $225,594
 4.0% $281,992
 5.0% $590,627
 10.3% $229,409
 4.0% $286,761
 5.0%
Tier 1 risk-based capital 579,221
 14.5
 239,451
 6.0
 319,268
 8.0
 590,627
 14.2
 249,494
 6.0
 332,659
 8.0
Total risk-based capital 629,179
 15.8
 319,268
 8.0
 399,085
 10.0
 639,157
 15.4
 332,659
 8.0
 415,824
 10.0
CET1 risk-based capital 489,221
 12.3
 179,588
 4.5
 259,405
 6.5
 500,627
 12.0
 187,121
 4.5
 270,285
 6.5
                        
At December 31, 2017:  
  
  
  
  
  
  
  
  
  
  
  
Leverage capital $578,607
 10.4% $223,646
 4.0% $279,557
 5.0% $578,607
 10.4% $223,646
 4.0% $279,557
 5.0%
Tier 1 risk-based capital 578,607
 14.7
 236,721
 6.0
 315,628
 8.0
 578,607
 14.7
 236,721
 6.0
 315,628
 8.0
Total risk-based capital 628,068
 15.9
 315,628
 8.0
 394,535
 10.0
 628,068
 15.9
 315,628
 8.0
 394,535
 10.0
CET1 risk-based capital 490,861
 12.4
 177,541
 4.5
 256,448
 6.5
 490,861
 12.4
 177,541
 4.5
 256,448
 6.5
                        
Central Pacific Bank  
  
  
  
  
  
  
  
  
  
  
  
At March 31, 2018:  
  
  
  
  
  
At September 30, 2018:  
  
  
  
  
  
Leverage capital $568,409
 10.1% $225,375
 4.0% $281,718
 5.0% $571,949
 10.0% $228,985
 4.0% $286,231
 5.0%
Tier 1 risk-based capital 568,409
 14.3
 239,125
 6.0
 318,834
 8.0
 571,949
 13.8
 248,867
 6.0
 331,822
 8.0
Total risk-based capital 618,240
 15.5
 318,834
 8.0
 398,542
 10.0
 620,479
 15.0
 331,822
 8.0
 414,778
 10.0
CET1 risk-based capital 568,409
 14.3
 179,344
 4.5
 259,052
 6.5
 571,949
 13.8
 186,650
 4.5
 269,605
 6.5
                        
At December 31, 2017:  
  
  
  
  
  
  
  
  
  
  
  
Leverage capital $565,412
 10.1% $223,431
 4.0% $279,289
 5.0% $565,412
 10.1% $223,431
 4.0% $279,289
 5.0%
Tier 1 risk-based capital 565,412
 14.4
 236,401
 6.0
 315,201
 8.0
 565,412
 14.4
 236,401
 6.0
 315,201
 8.0
Total risk-based capital 614,732
 15.6
 315,201
 8.0
 394,002
 10.0
 614,732
 15.6
 315,201
 8.0
 394,002
 10.0
CET1 risk-based capital 565,412
 14.4
 177,301
 4.5
 256,101
 6.5
 565,412
 14.4
 177,301
 4.5
 256,101
 6.5

Asset/Liability Management and Interest Rate Risk
Our earnings and capital are sensitive to risk of interest rate fluctuations. Interest rate risk arises when rate-sensitive assets and rate-sensitive liabilities mature or reprice during different periods or in differing amounts. In the normal course of business, we are subjected to interest rate risk through the activities of making loans and taking deposits, as well as from our investment securities portfolio and other interest-bearing funding sources. Asset/liability management attempts to coordinate our rate-sensitive assets and rate-sensitive liabilities to meet our financial objectives.

Our Asset/Liability Management Policy seeks to maximize the risk-adjusted return to shareholders while maintaining consistently acceptable levels of liquidity, interest rate risk and capitalization. Our Asset/Liability Management Committee, or ALCO, monitors interest rate risk through the use of interest rate sensitivity gap, net interest income and market value of portfolio equity simulation and rate shock analyses. This process is designed to measure the impact of future changes in interest rates on net interest income and market value of portfolio equity. Adverse interest rate risk exposures are managed through the shortening or lengthening of the duration of assets and liabilities.
ALCO utilizes a detailed and dynamic simulation model to measure and manage interest rate risk exposures. The monthly simulation process is designed to measure the impact of future changes in interest rates on net interest income and market value of portfolio equity and to allow ALCO to model alternative balance sheet strategies.


The following reflects our net interest income sensitivity analysis as of September 30, 2018, over a one-year horizon, assuming no balance sheet growth and given both a 100 bp upward and 100 bp downward parallel shift in interest rates.
Rate ChangeEstimated Net Interest Income Sensitivity
+100bp1.10 %
-100bp(2.65)%

Liquidity and Borrowing Arrangements
 
Our objective in managing liquidity is to maintain a balance between sources and uses of funds in order to economically meet the cash requirements of customers for loans and deposit withdrawals and participate in lending and investment opportunities as they arise. We monitor our liquidity position in relation to changes in loan and deposit balances on a daily basis to ensure maximum utilization, maintenance of an adequate level of readily marketable assets and access to short-term funding sources.
 
Core deposits have historically provided us with a sizable source of relatively stable and low cost funds, but are subject to competitive pressure in our market. In addition to core deposit funding, we also have access to a variety of other short-term and long-term funding sources, which include proceeds from maturities of our investment securities, as well as secondary funding sources such as the FHLB, secured repurchase agreements and the Federal Reserve discount window, available to meet our liquidity needs. While we historically have had access to these other funding sources, access to these sources may not be guaranteed and can be restricted in the future as a result of market conditions or the Company's and bank's financial position.
 
The bank is a member of and maintained a $1.59$1.67 billion line of credit with the FHLB as of March 31,September 30, 2018, compared to $1.50 billion at December 31, 2017. We had $56.0$105.0 million in short-term borrowings under this arrangement at March 31,September 30, 2018, compared to $32.0 million at December 31, 2017. There were no long-term borrowings under this arrangement at March 31,September 30, 2018 and December 31, 2017. FHLB advances available at March 31,September 30, 2018 were secured by certain real estate loans with a carrying value of $2.14$2.26 billion in accordance with the collateral provisions of the Advances, Security and Deposit Agreement with the FHLB. At March 31,September 30, 2018, $1.53$1.56 billion was undrawn under this arrangement, compared to $1.47 billion at December 31, 2017.

 
At March 31,September 30, 2018 and December 31, 2017, our bank had additional unused borrowings available at the Federal Reserve discount window of $72.3$76.5 million and $73.0 million, respectively. As of March 31,September 30, 2018 and December 31, 2017, certain commercial and commercial real estate loans with a carrying value totaling $127.1$124.6 million and $129.2 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.
 
Our ability to maintain adequate levels of liquidity is dependent on our ability to continue to maintain our strong risk profile and capital base. Our liquidity may also be negatively impacted by weakness in the financial markets and industry-wide reductions in liquidity.
 
Contractual Obligations
 
Information regarding our contractual obligations is provided in "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K, as amended by our Form 10-K/A for the year ended December 31, 2017. There have been no material changes in our contractual obligations since December 31, 2017.
 
Item 3. Quantitative and Qualitative Disclosures about Market Risk
 
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices such as interest rates, foreign currency rates, commodity prices and equity prices. Our primary market risk exposure is interest rate risk that occurs when rate-sensitive assets and rate-sensitive liabilities mature or reprice during different periods or in differing amounts. Asset/liability management attempts to coordinate our rate-sensitive assets and rate-sensitive liabilities to meet our financial objectives. The Asset/Liability Committee ("ALCO") monitors interest rate risk through the use of interest rate sensitivity gap, net interest income and market value of portfolio equity simulation, and rate shock analyses. Adverse interest rate risk exposures are managed through the shortening or lengthening of the duration of assets and liabilities.

The primary analytical tool we use to measure and manage our interest rate risk is a simulation model that projects changes in net interest income ("NII") as market interest rates change. Our ALCO policy requires that simulated changes in NII should be

within certain specified ranges, or steps must be taken to reduce interest rate risk. The results of the model indicate that the mix of rate-sensitive assets and liabilities at March 31,September 30, 2018 would not result in a fluctuation of NII that would exceed the established policy limits.

Item 4. Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
As of the end of the period covered by this report and pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended, (the "Exchange Act"), the Company's management, including the principal executive officer and principal financial officer, conducted an evaluation of the effectiveness and design of the Company's disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation, the Company's principal executive officer and principal financial officer concluded, as of the end of the period covered by this report, that the Company's disclosure controls and procedures were effective.
 
Changes in Internal Control Over Financial Reporting
 
As of the end of the period covered by this report, there have been no changes in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter to which this report relates that have materially affected or are reasonably likely to materially affect, our internal control over financial reporting.
 

PART II.   OTHER INFORMATION
 
Item 1A. Risk Factors
 
There have been no material changes from the Risk Factors as previously disclosed in our Annual Report on Form 10-K, as amended by our Form 10-K/A for the year ended December 31, 2017, as filed with the SEC on February 28, 2018 and March 5, 2018, respectively.respectively, except as described below.

Natural disasters and other external events could have a material adverse affect on our financial condition and results of operations.

Our branch offices as well as a substantial majority of our loan portfolio is in the State of Hawaii. As a result, natural disasters and other severe weather occurrences such as tsunamis, volcanic eruptions (such as the recent eruption of Mount Kilauea), hurricanes and earthquakes and other adverse external events, could have a significant effect on our ability to conduct our business and adversely affect the tourism and visitor industry in the State of Hawaii. Such events could affect the ability of our borrowers to repay their outstanding loans, impair the value of collateral securing our loans, cause significant property damage, result in loss of revenue, adversely impact our deposit base and/or cause us to incur additional expenses. Accordingly, the occurrence of any such natural disasters or severe weather events could have a material adverse effect on our business, which, in turn, could adversely affect our financial condition and results of operations.
 
Item 2.        Unregistered Sales of Equity Securities and Use of Proceeds.
 
Issuer Purchases of Equity Securities
 
In January 2017, our Board of Directors authorized the repurchase of up to $30.0 million of the Company's common stock from time to time on the open market or in privately negotiated transactions, pursuant to a newly authorized share repurchase program (the "2017 Repurchase Plan"). The 2017 Repurchase Plan replaced and superseded in its entirety the previous share repurchase program.

In November 2017, the Board of Directors authorized an increase in the 2017 Repurchase Plan authority by an additional $50.0 million (known henceforth as the "Repurchase Plan"). We cannot provide any assurance that we will be able to repurchase any shares of our common stock. In addition, our ability to repurchase common stock may be restricted by applicable federal or Hawaii law or by our regulators.

In the three months ended March 31,September 30, 2018, the Company repurchased 344,362235,043 shares of common stock, at an aggregate cost of $10.1$6.7 million, excluding fees and expenses, under the Repurchase Plan. As of March 31,September 30, 2018, a total of $43.4$28.7 million remained available for repurchase under the Repurchase Plan. There is no expiration date on the Repurchase Plan.
 
  Issuer Purchases of Equity Securities
Period Total
Number
of Shares
Purchased
 Average
Price Paid
per Share
 Total Shares
Purchased as
Part of Publicly
Announced
Programs
 Maximum Dollar
Value of
Shares That
May Yet Be
Purchased Under
the Program
January 1-31, 2018 98,000
 $30.35
 98,000
 $50,518,666
February 1-28, 2018 114,000
 29.08
 114,000
 47,204,015
March 1-31, 2018 132,362
 28.87
 132,362
 43,382,275
Total 344,362
 $29.36
 344,362
 $43,382,275
  Issuer Purchases of Equity Securities
Period Total
Number
of Shares
Purchased
 Average
Price Paid
per Share
 Total Shares
Purchased as
Part of Publicly
Announced
Programs
 Maximum Dollar
Value of
Shares That
May Yet Be
Purchased Under
the Program
July 1-31, 2018 73,500
 $29.15
 73,500
 $33,268,765
August 1-31, 2018 86,517
 28.32
 86,517
 30,818,711
September 1-30, 2018 75,026
 27.85
 75,026
 28,729,241
Total 235,043
 $28.43
 235,043
 28,729,241
  


 

Item 6. Exhibits
 
Exhibit No. Document
10.1
   
31.1 
   
31.2 
   
32.1 
   
32.2 
   
101.INS XBRL Instance Document*
   
101.SCH XBRL Taxonomy Extension Schema Document*
   
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document*
   
101.LAB XBRL Taxonomy Extension Label Linkbase Document*
   
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document*
   
101.DEF XBRL Taxonomy Extension Definition Linkbase Document*
   
   
   
* Filed herewith.
   
** Furnished herewith.
   


 

SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
  CENTRAL PACIFIC FINANCIAL CORP.
  (Registrant)
   
   
Date:May 9,November 6, 2018/s/ A. Catherine NgoPaul K. Yonamine
  A. Catherine NgoPaul K. Yonamine
  PresidentChairman and Chief Executive Officer
   
Date:May 9,November 6, 2018/s/ David S. Morimoto
  David S. Morimoto
  Executive Vice President and Chief Financial Officer


Central Pacific Bank Financial Corp.
Exhibit Index
Exhibit No.Document
10.1
31.1
31.2
32.1
32.2
101.INSXBRL Instance Document*
101.SCHXBRL Taxonomy Extension Schema Document*
101.CALXBRL Taxonomy Extension Calculation Linkbase Document*
101.LABXBRL Taxonomy Extension Label Linkbase Document*
101.PREXBRL Taxonomy Extension Presentation Linkbase Document*
101.DEFXBRL Taxonomy Extension Definition Linkbase Document*
*Filed herewith.
**Furnished herewith.



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