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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 September 30, 2015
 
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: 1-6887
 
BANK OF HAWAII CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
 
99-0148992
(State of incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
130 Merchant Street, Honolulu, Hawaii
 
96813
(Address of principal executive offices)
 
(Zip Code)
 1-888-643-3888
(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 (Section 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, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o  No ý
 
As of October 20, 2015, there were 43,291,544 shares of common stock outstanding.



Bank of Hawaii Corporation
Form 10-Q
Index
 
 
 
Page
 
 
 
Part I - Financial Information
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

1


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Income (Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(dollars in thousands, except per share amounts)
2015

 
2014

 
2015

 
2014

Interest Income
 

 
 

 
 

 
 

Interest and Fees on Loans and Leases
$
75,874

 
$
68,089

 
$
220,400

 
$
197,433

Income on Investment Securities
 
 
 
 
 
 
 
Available-for-Sale
10,192

 
10,286

 
30,663

 
31,743

Held-to-Maturity
20,689

 
26,067

 
67,928

 
80,894

Deposits
2

 
3

 
7

 
7

Funds Sold
291

 
176

 
818

 
481

Other
312

 
302

 
924

 
906

Total Interest Income
107,360

 
104,923

 
320,740

 
311,464

Interest Expense
 

 
 

 
 

 
 

Deposits
2,410

 
2,391

 
7,183

 
7,142

Securities Sold Under Agreements to Repurchase
6,307

 
6,523

 
19,118

 
19,385

Funds Purchased
3

 
3

 
9

 
10

Other Debt
749

 
627

 
1,987

 
1,903

Total Interest Expense
9,469

 
9,544

 
28,297

 
28,440

Net Interest Income
97,891

 
95,379

 
292,443

 
283,024

Provision for Credit Losses

 
(2,665
)
 

 
(4,864
)
Net Interest Income After Provision for Credit Losses
97,891

 
98,044

 
292,443

 
287,888

Noninterest Income
 

 
 

 
 

 
 

Trust and Asset Management
11,907

 
11,716

 
36,442

 
35,573

Mortgage Banking
3,291

 
1,646

 
8,453

 
5,455

Service Charges on Deposit Accounts
8,669

 
9,095

 
25,409

 
26,611

Fees, Exchange, and Other Service Charges
13,340

 
13,390

 
39,589

 
39,699

Investment Securities Gains, Net
24

 
1,858

 
10,341

 
6,097

Annuity and Insurance
1,721

 
2,348

 
5,650

 
6,401

Bank-Owned Life Insurance
1,609

 
1,644

 
5,431

 
4,765

Other
2,660

 
3,253

 
10,138

 
9,598

Total Noninterest Income
43,221

 
44,950

 
141,453

 
134,199

Noninterest Expense
 

 
 

 
 

 
 

Salaries and Benefits
46,576

 
45,530

 
143,966

 
137,508

Net Occupancy
7,403

 
9,334

 
25,341

 
28,005

Net Equipment
4,804

 
4,473

 
14,918

 
13,745

Data Processing
3,920

 
3,665

 
11,366

 
11,156

Professional Fees
2,258

 
1,835

 
6,857

 
6,708

FDIC Insurance
2,139

 
1,750

 
6,347

 
5,881

Other
24,788

 
14,443

 
53,582

 
42,656

Total Noninterest Expense
91,888

 
81,030

 
262,377

 
245,659

Income Before Provision for Income Taxes
49,224

 
61,964

 
171,519

 
176,428

Provision for Income Taxes
14,948

 
20,195

 
53,647

 
54,577

Net Income
$
34,276

 
$
41,769

 
$
117,872

 
$
121,851

Basic Earnings Per Share
$
0.79

 
$
0.95

 
$
2.72

 
$
2.77

Diluted Earnings Per Share
$
0.79

 
$
0.95

 
$
2.71

 
$
2.75

Dividends Declared Per Share
$
0.45

 
$
0.45

 
$
1.35

 
$
1.35

Basic Weighted Average Shares
43,181,233

 
43,859,396

 
43,290,137

 
44,034,047

Diluted Weighted Average Shares
43,427,730

 
44,088,553

 
43,514,898

 
44,250,033

 
The accompanying notes are an integral part of the Consolidated Financial Statements (Unaudited).

2


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income (Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(dollars in thousands)
 
2015

 
2014

 
2015

 
2014

Net Income
 
$
34,276

 
$
41,769

 
$
117,872

 
$
121,851

Other Comprehensive Income, Net of Tax:
 
 

 
 

 
 

 
 

Net Unrealized Gains on Investment Securities
 
7,051

 
403

 
4,735

 
15,291

Defined Benefit Plans
 
219

 
157

 
659

 
469

Total Other Comprehensive Income
 
7,270

 
560

 
5,394

 
15,760

Comprehensive Income
 
$
41,546

 
$
42,329

 
$
123,266

 
$
137,611

 
The accompanying notes are an integral part of the Consolidated Financial Statements (Unaudited).

3


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Condition (Unaudited)
(dollars in thousands)
September 30,
2015

 
December 31,
2014

Assets
 

 
 

Interest-Bearing Deposits in Other Banks
$
3,609

 
$
2,873

Funds Sold
274,873

 
360,577

Investment Securities
 

 
 

Available-for-Sale
2,279,722

 
2,289,190

Held-to-Maturity (Fair Value of $4,181,613 and $4,504,495)
4,121,768

 
4,466,679

Loans Held for Sale
3,222

 
5,136

Loans and Leases
7,689,772

 
6,897,589

Allowance for Loan and Lease Losses
(104,038
)
 
(108,688
)
Net Loans and Leases
7,585,734

 
6,788,901

Total Earning Assets
14,268,928

 
13,913,356

Cash and Due From Banks
208,601

 
172,126

Premises and Equipment, Net
108,987

 
109,854

Accrued Interest Receivable
47,512

 
44,654

Foreclosed Real Estate
1,392

 
2,311

Mortgage Servicing Rights
23,301

 
24,695

Goodwill
31,517

 
31,517

Bank-Owned Life Insurance
266,568

 
262,807

Other Assets
207,317

 
225,888

Total Assets
$
15,164,123

 
$
14,787,208

 
 
 
 
Liabilities
 

 
 

Deposits
 

 
 

Noninterest-Bearing Demand
$
4,102,713

 
$
3,832,943

Interest-Bearing Demand
2,631,542

 
2,559,570

Savings
5,016,462

 
4,806,575

Time
1,186,245

 
1,434,001

Total Deposits
12,936,962

 
12,633,089

Funds Purchased
8,459

 
8,459

Securities Sold Under Agreements to Repurchase
632,138

 
688,601

Other Debt
270,801

 
173,912

Retirement Benefits Payable
54,978

 
55,477

Accrued Interest Payable
5,869

 
5,148

Taxes Payable and Deferred Taxes
25,294

 
27,777

Other Liabilities
131,268

 
139,659

Total Liabilities
14,065,769

 
13,732,122

Shareholders’ Equity
 

 
 

Common Stock ($.01 par value; authorized 500,000,000 shares;
issued / outstanding: September 30, 2015 - 57,749,071 / 43,342,940
and December 31, 2014 - 57,634,755 / 43,724,208)
575

 
574

Capital Surplus
539,112

 
531,932

Accumulated Other Comprehensive Loss
(21,292
)
 
(26,686
)
Retained Earnings
1,293,416

 
1,234,801

Treasury Stock, at Cost (Shares: September 30, 2015 - 14,406,131
and December 31, 2014 - 13,910,547)
(713,457
)
 
(685,535
)
Total Shareholders’ Equity
1,098,354

 
1,055,086

Total Liabilities and Shareholders’ Equity
$
15,164,123

 
$
14,787,208

 The accompanying notes are an integral part of the Consolidated Financial Statements (Unaudited).

4


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Shareholders’ Equity (Unaudited)
(dollars in thousands)
Common
Shares Outstanding

 
Common Stock

 
Capital
Surplus

 
Accum.
Other
Compre-
hensive
Income
(Loss)

 
Retained Earnings

 
Treasury Stock

 
Total

Balance as of December 31, 2014
43,724,208

 
$
574

 
$
531,932

 
$
(26,686
)
 
$
1,234,801

 
$
(685,535
)
 
$
1,055,086

Net Income

 

 

 

 
117,872

 

 
117,872

Other Comprehensive Income

 

 

 
5,394

 

 

 
5,394

Share-Based Compensation

 

 
5,698

 

 

 

 
5,698

Common Stock Issued under Purchase and Equity
Compensation Plans and Related Tax Benefits
246,851

 
1

 
1,482

 

 
(376
)
 
11,011

 
12,118

Common Stock Repurchased
(628,119
)
 

 

 

 

 
(38,933
)
 
(38,933
)
Cash Dividends Declared ($1.35 per share)

 

 

 

 
(58,881
)
 

 
(58,881
)
Balance as of September 30, 2015
43,342,940

 
$
575

 
$
539,112

 
$
(21,292
)
 
$
1,293,416

 
$
(713,457
)
 
$
1,098,354

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of December 31, 2013
44,490,385

 
$
572

 
$
522,505

 
$
(31,823
)
 
$
1,151,754

 
$
(631,032
)
 
$
1,011,976

Net Income

 

 

 

 
121,851

 

 
121,851

Other Comprehensive Income

 

 

 
15,760

 

 

 
15,760

Share-Based Compensation

 

 
5,831

 

 

 

 
5,831

Common Stock Issued under Purchase and Equity
Compensation Plans and Related Tax Benefits
314,579

 
1

 
1,194

 

 
(318
)
 
7,976

 
8,853

Common Stock Repurchased
(811,235
)
 

 

 

 

 
(46,910
)
 
(46,910
)
Cash Dividends Declared ($1.35 per share)

 

 

 

 
(59,948
)
 

 
(59,948
)
Balance as of September 30, 2014
43,993,729

 
$
573

 
$
529,530

 
$
(16,063
)
 
$
1,213,339

 
$
(669,966
)
 
$
1,057,413

The accompanying notes are an integral part of the Consolidated Financial Statements (Unaudited).

5


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
 
Nine Months Ended
 
September 30,
(dollars in thousands)
2015

 
2014

Operating Activities
 

 
 

Net Income
$
117,872

 
$
121,851

Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
 

 
 

Provision for Credit Losses

 
(4,864
)
Impairment on Equipment Held for Sale
9,453

 

Depreciation and Amortization
9,541

 
9,280

Amortization of Deferred Loan and Lease Fees
(1,282
)
 
(1,341
)
Amortization and Accretion of Premiums/Discounts on Investment Securities, Net
38,753

 
37,592

Share-Based Compensation
5,698

 
5,831

Benefit Plan Contributions
(1,413
)
 
(1,229
)
Deferred Income Taxes
(10,618
)
 
(8,522
)
Net Gains on Sales of Loans and Leases
(2,510
)
 
(2,285
)
Net Gains on Sales of Investment Securities
(10,341
)
 
(6,097
)
Proceeds from Sales of Loans Held for Sale
142,391

 
64,545

Originations of Loans Held for Sale
(137,293
)
 
(58,448
)
Tax Benefits from Share-Based Compensation
(403
)
 
(435
)
Net Change in Other Assets and Other Liabilities
9,719

 
(22,210
)
Net Cash Provided by Operating Activities
169,567

 
133,668

 
 
 
 
Investing Activities
 

 
 

Investment Securities Available-for-Sale:
 

 
 

Proceeds from Prepayments and Maturities
256,581

 
251,633

Proceeds from Sales
68,166

 
14,609

Purchases
(317,458
)
 
(230,007
)
Investment Securities Held-to-Maturity:
 

 
 

Proceeds from Prepayments and Maturities
715,776

 
586,037

Purchases
(389,213
)
 
(418,825
)
Net Change in Loans and Leases
(800,482
)
 
(516,395
)
Premises and Equipment, Net
(8,673
)
 
(8,204
)
Net Cash Used in Investing Activities
(475,303
)
 
(321,152
)
 
 
 
 
Financing Activities
 

 
 

Net Change in Deposits
303,873

 
446,785

Net Change in Short-Term Borrowings
(56,463
)
 
(71,369
)
Proceeds from Long-Term Debt
100,000

 

Tax Benefits from Share-Based Compensation
403

 
435

Proceeds from Issuance of Common Stock
7,244

 
8,317

Repurchase of Common Stock
(38,933
)
 
(46,910
)
Cash Dividends Paid
(58,881
)
 
(59,948
)
Net Cash Provided by Financing Activities
257,243

 
277,310

 
 
 
 
Net Change in Cash and Cash Equivalents
(48,493
)
 
89,826

Cash and Cash Equivalents at Beginning of Period
535,576

 
463,746

Cash and Cash Equivalents at End of Period
$
487,083

 
$
553,572

Supplemental Information
 

 
 

Cash Paid for Interest
$
27,168

 
$
26,726

Cash Paid for Income Taxes
52,808

 
46,369

Non-Cash Investing Activities:
 

 
 

Transfer from Loans to Foreclosed Real Estate
787

 
3,377

Transfers from Loans to Loans Held for Sale
93,539

 

 
The accompanying notes are an integral part of the Consolidated Financial Statements (Unaudited).

6


Bank of Hawaii Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

Note 1.  Summary of Significant Accounting Policies

Basis of Presentation

Bank of Hawaii Corporation (the “Parent”) is a Delaware corporation and a bank holding company headquartered in Honolulu, Hawaii.  Bank of Hawaii Corporation and its subsidiaries (collectively, the “Company”) provide a broad range of financial products and services to customers in Hawaii, Guam, and other Pacific Islands.  The Parent’s principal operating subsidiary is Bank of Hawaii (the “Bank”).  All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements of the Company 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, they do not include all of the information and accompanying notes required by GAAP for complete financial statements.  In the opinion of management, the consolidated financial statements reflect normal recurring adjustments necessary for a fair presentation of the results for the interim periods.

Certain prior period information has been reclassified to conform to the current period presentation.

These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.  Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes.  Actual results may differ from those estimates and such differences could be material to the financial statements.

Accounting Standards Adopted in 2015

In January 2014, the FASB issued ASU No. 2014-01, "Accounting for Investments in Qualified Affordable Housing Projects." ASU No. 2014-01 permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense. This new guidance also requires new disclosures for all investors in these projects (see Note 5 to the Consolidated Financial Statements). The Company adopted ASU No. 2014-01 effective January 1, 2015. Upon adoption, the guidance must be applied retrospectively to all periods presented. However, entities that used the effective yield method to account for investments in these projects before adoption may continue to do so for these pre-existing investments. Prior to adoption of ASU No. 2014-01, the Company accounted for such investments using the effective yield method and continued to do so for these pre-existing investments after adopting ASU No. 2014-01. The Company expects future investments to meet the criteria required for the proportional amortization method and plans to make such an accounting policy election. There were no new investments being amortized since the adoption of ASU No. 2014-01 on January 1, 2015, and therefore, the adoption of ASU No. 2014-01 has not had a material impact on the Company's Consolidated Financial Statements.

In January 2014, the FASB issued ASU No. 2014-04, "Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure." The objective of this guidance is to clarify when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU No. 2014-04 states that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure; or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, ASU No. 2014-04 requires interim and annual disclosure of both: (1) the amount of foreclosed residential real estate property held by the creditor; and (2) the recorded

7


investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The Company adopted ASU No. 2014-04 effective January 1, 2015. The adoption of ASU No. 2014-04 did not have a material impact on the Company's Consolidated Financial Statements.

In June 2014, the FASB issued ASU No. 2014-11, "Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures." The new guidance aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as repurchase financings with the accounting for other typical repurchase agreements. Going forward, these transactions would all be accounted for as secured borrowings. The guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement, which has resulted in outcomes referred to as off-balance-sheet accounting. The amendments in the ASU require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. The amendments in the ASU also require expanded disclosures, effective June 30, 2015, about the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings (see Note 6 to the Consolidated Financial Statements). The Company adopted the amendments in this ASU effective January 1, 2015. As of September 30, 2015, all of the Company's repurchase agreements were typical in nature (i.e., not repurchase-to-maturity transactions or repurchase agreements executed as a repurchase financing) and are accounted for as secured borrowings. As such, the adoption of ASU No. 2014-11 did not have a material impact on the Company's Consolidated Financial Statements.

In June 2014, the FASB issued ASU No. 2014-12, "Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period." The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Topic 718, Compensation - Stock Compensation, as it relates to awards with performance conditions that affect vesting to account for such awards. The performance target should not be reflected in estimating the grant-date fair value of the award. However, compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. Entities may apply the amendments in this ASU either: (1) prospectively to all awards granted or modified after the effective date; or (2) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. The Company adopted ASU No. 2014-12 effective January 1, 2015. As of September 30, 2015, the Company did not have any share-based payment awards that included performance targets that could be achieved after the requisite service period. As such, the adoption of ASU No. 2014-12 did not have a material impact on the Company's Consolidated Financial Statements.

In August 2014, the FASB issued ASU No. 2014-14, “Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure.” The objective of this guidance is to reduce diversity in practice related to how creditors classify government-guaranteed mortgage loans, including FHA and VA guaranteed loans, upon foreclosure. Some creditors reclassify those loans to real estate consistent with other foreclosed loans that do not have guarantees; others reclassify the loans to other receivables. The amendments in this guidance require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The Company adopted ASU No. 2014-14 effective January 1, 2015. The adoption of ASU No. 2014-14 did not have a material impact on the Company's Consolidated Financial Statements.

Accounting Standards Pending Adoption

In May 2014, the FASB and the International Accounting Standards Board (the "IASB") jointly issued a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP and International Financial Reporting Standards ("IFRS"). Previous revenue recognition guidance in GAAP comprised broad revenue recognition concepts together with numerous revenue requirements for particular industries or transactions, which

8


sometimes resulted in different accounting for economically similar transactions. In contrast, IFRS provided limited revenue recognition guidance and, consequently, could be difficult to apply to complex transactions. Accordingly, the FASB and the IASB initiated a joint project to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS that would: (1) remove inconsistencies and weaknesses in revenue requirements; (2) provide a more robust framework for addressing revenue issues; (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provide more useful information to users of financial statements through improved disclosure requirements; and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. To meet those objectives, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers." The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies generally will be required to use more judgment and make more estimates than under current guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The standard was initially effective for public entities for interim and annual reporting periods beginning after December 15, 2016; early adoption is not permitted. However, in August 2015, the FASB issued ASU No. 2015-14, "Revenue from Contracts with Customers - Deferral of the Effective Date" which defers the effective date by one year (i.e., interim and annual reporting periods beginning after December 15, 2017). Early adoption is permitted, but not before the original effective date (i.e., interim and annual reporting periods beginning after December 15, 2016). For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. The Company is currently evaluating the provisions of ASU No. 2014-09 and will be closely monitoring developments and additional guidance to determine the potential impact the new standard will have on the Company's Consolidated Financial Statements.

In February 2015, the FASB issued ASU No. 2015-02, “Amendments to the Consolidation Analysis.” This ASU affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. Specifically, the amendments: (1) modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities; (2) eliminate the presumption that a general partner should consolidate a limited partnership; (3) affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; and (4) provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. ASU No. 2015-02 is effective for interim and annual reporting periods beginning after December 15, 2015. The adoption of ASU No. 2015-02 is not expected to have a material impact on the Company's Consolidated Financial Statements.

In April 2015, the FASB issued ASU No. 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” This ASU provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The new guidance does not change the accounting for a customer’s accounting for service contracts. ASU No. 2015-05 is effective for interim and annual reporting periods beginning after December 15, 2015. The Company’s current method of accounting for fees paid in a cloud computing arrangement is consistent with the accounting guidance provided by ASU No. 2015-05. Therefore, the adoption of ASU No. 2015-05 is not expected to have a material impact on the Company's Consolidated Financial Statements.


9


Note 2.  Investment Securities

The amortized cost, gross unrealized gains and losses, and fair value of the Company’s investment securities as of September 30, 2015 and December 31, 2014 were as follows:

(dollars in thousands)
Amortized Cost

 
Gross
Unrealized Gains

 
Gross
Unrealized Losses

 
Fair Value

September 30, 2015
 

 
 

 
 

 
 

Available-for-Sale:
 

 
 

 
 

 
 

Debt Securities Issued by the U.S. Treasury and Government Agencies
$
363,780

 
$
5,042

 
$
(165
)
 
$
368,657

Debt Securities Issued by States and Political Subdivisions
715,515

 
22,107

 
(412
)
 
737,210

Debt Securities Issued by Corporations
313,166

 
390

 
(2,995
)
 
310,561

Mortgage-Backed Securities:
 

 
 

 
 

 
 

    Residential - Government Agencies
341,457

 
8,244

 
(1,232
)
 
348,469

    Residential - U.S. Government-Sponsored Enterprises
407,568

 
4,693

 

 
412,261

    Commercial - Government Agencies
105,735

 

 
(3,171
)
 
102,564

Total Mortgage-Backed Securities
854,760

 
12,937

 
(4,403
)
 
863,294

Total
$
2,247,221

 
$
40,476

 
$
(7,975
)
 
$
2,279,722

Held-to-Maturity:
 

 
 

 
 

 
 

Debt Securities Issued by the U.S. Treasury and Government Agencies
$
499,731

 
$
4,613

 
$

 
$
504,344

Debt Securities Issued by States and Political Subdivisions
246,884

 
15,917

 

 
262,801

Debt Securities Issued by Corporations
155,175

 
1,691

 
(823
)
 
156,043

Mortgage-Backed Securities:
 
 
 
 
 
 
 

    Residential - Government Agencies
2,335,710

 
39,593

 
(11,588
)
 
2,363,715

    Residential - U.S. Government-Sponsored Enterprises
619,545

 
6,864

 
(4
)
 
626,405

    Commercial - Government Agencies
264,723

 
4,321

 
(739
)
 
268,305

Total Mortgage-Backed Securities
3,219,978

 
50,778


(12,331
)

3,258,425

Total
$
4,121,768

 
$
72,999

 
$
(13,154
)
 
$
4,181,613

 
 
 
 
 
 
 
 
December 31, 2014
 

 
 

 
 

 
 

Available-for-Sale:
 

 
 

 
 

 
 

Debt Securities Issued by the U.S. Treasury and Government Agencies
$
325,365

 
$
5,933

 
$
(40
)
 
$
331,258

Debt Securities Issued by States and Political Subdivisions
723,474

 
21,941

 
(1,445
)
 
743,970

Debt Securities Issued by Corporations
298,272

 
546

 
(3,985
)
 
294,833

Mortgage-Backed Securities:
 
 
 
 
 
 
 

    Residential - Government Agencies
452,493

 
10,986

 
(1,043
)
 
462,436

    Residential - U.S. Government-Sponsored Enterprises
276,390

 
2,262

 
(191
)
 
278,461

    Commercial - Government Agencies
186,813

 

 
(8,581
)
 
178,232

Total Mortgage-Backed Securities
915,696

 
13,248

 
(9,815
)
 
919,129

Total
$
2,262,807

 
$
41,668

 
$
(15,285
)
 
$
2,289,190

Held-to-Maturity:
 

 
 

 
 

 
 

Debt Securities Issued by the U.S. Treasury and Government Agencies
$
498,767

 
$
2,008

 
$
(1,159
)
 
$
499,616

Debt Securities Issued by States and Political Subdivisions
249,559

 
15,459

 

 
265,018

Debt Securities Issued by Corporations
166,686

 
109

 
(3,442
)
 
163,353

Mortgage-Backed Securities:
 
 
 
 
 
 
 

    Residential - Government Agencies
2,862,369

 
45,407

 
(20,636
)
 
2,887,140

    Residential - U.S. Government-Sponsored Enterprises
379,365

 
3,635

 
(15
)
 
382,985

    Commercial - Government Agencies
309,933

 
241

 
(3,791
)
 
306,383

Total Mortgage-Backed Securities
3,551,667

 
49,283

 
(24,442
)
 
3,576,508

Total
$
4,466,679

 
$
66,859

 
$
(29,043
)
 
$
4,504,495


10



The table below presents an analysis of the contractual maturities of the Company’s investment securities as of September 30, 2015.  Debt securities issued by government agencies (Small Business Administration securities) and mortgage-backed securities are disclosed separately in the table below as these investment securities may prepay prior to their scheduled contractual maturity dates.
(dollars in thousands)
Amortized Cost

 
Fair Value

Available-for-Sale:
 

 
 

Due in One Year or Less
$
128,506

 
$
129,124

Due After One Year Through Five Years
450,881

 
454,110

Due After Five Years Through Ten Years
436,542

 
447,542

Due After Ten Years
73,243

 
77,701

 
1,089,172

 
1,108,477

 
 
 
 
Debt Securities Issued by Government Agencies
303,289

 
307,951

Mortgage-Backed Securities:
 

 
 

    Residential - Government Agencies
341,457

 
348,469

    Residential - U.S. Government-Sponsored Enterprises
407,568

 
412,261

    Commercial - Government Agencies
105,735

 
102,564

Total Mortgage-Backed Securities
854,760

 
863,294

Total
$
2,247,221

 
$
2,279,722

 
 
 
 
Held-to-Maturity:
 

 
 

Due in One Year or Less
$
9,994

 
$
10,008

Due After One Year Through Five Years
500,499

 
505,481

Due After Five Years Through Ten Years
286,833

 
295,665

Due After Ten Years
104,464

 
112,034

 
901,790

 
923,188

Mortgage-Backed Securities:
 

 
 

    Residential - Government Agencies
2,335,710

 
2,363,715

    Residential - U.S. Government-Sponsored Enterprises
619,545

 
626,405

    Commercial - Government Agencies
264,723

 
268,305

Total Mortgage-Backed Securities
3,219,978

 
3,258,425

Total
$
4,121,768

 
$
4,181,613


Investment securities with carrying values of $2.5 billion and $2.8 billion as of September 30, 2015 and December 31, 2014, respectively, were pledged to secure deposits of governmental entities and securities sold under agreements to repurchase.

The table below presents the gains and losses from the sales of investment securities for the three and nine months ended September 30, 2015 and 2014.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands)
2015

 
2014

 
2015

 
2014
Gross Gains on Sales of Investment Securities
$
1,504

 
$
1,858

 
$
11,821

 
$
6,097

Gross Losses on Sales of Investment Securities
(1,480
)
 

 
(1,480
)
 

Net Gains on Sales of Investment Securities
$
24

 
$
1,858

 
$
10,341

 
$
6,097




11


The Company’s investment securities in an unrealized loss position, segregated by continuous length of impairment, were as follows:
 
Less Than 12 Months
 
12 Months or Longer
 
Total
(dollars in thousands)
Fair Value

 
Gross Unrealized Losses

 
Fair Value

 
Gross Unrealized Losses

 
Fair Value

 
Gross Unrealized Losses

September 30, 2015
 

 
 

 
 

 
 

 
 

 
 

Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
Debt Securities Issued by the U.S. Treasury
   and Government Agencies
$
33,551

 
$
(156
)
 
$
5,072

 
$
(9
)
 
$
38,623

 
$
(165
)
Debt Securities Issued by States
   and Political Subdivisions
55,896

 
(412
)
 

 

 
55,896

 
(412
)
Debt Securities Issued by Corporations
101,626

 
(1,392
)
 
143,489

 
(1,603
)
 
245,115

 
(2,995
)
Mortgage-Backed Securities:
 
 
 
 
 
 
 
 


 


    Residential - Government Agencies
34,152

 
(115
)
 
9,832

 
(1,117
)
 
43,984

 
(1,232
)
    Commercial - Government Agencies

 

 
102,564

 
(3,171
)
 
102,564

 
(3,171
)
Total Mortgage-Backed Securities
34,152

 
(115
)
 
112,396

 
(4,288
)
 
146,548

 
(4,403
)
Total
$
225,225

 
$
(2,075
)
 
$
260,957

 
$
(5,900
)
 
$
486,182

 
$
(7,975
)
Held-to-Maturity:
 
 
 
 
 
 
 
 
 
 
 
Debt Securities Issued by Corporations
$

 
$

 
$
74,246

 
$
(823
)
 
$
74,246

 
$
(823
)
Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
 
    Residential - Government Agencies
380,442

 
(2,777
)
 
440,675

 
(8,811
)
 
821,117

 
(11,588
)
    Residential - U.S. Government-Sponsored Enterprises
14,425

 
(4
)
 

 

 
14,425

 
(4
)
    Commercial - Government Agencies
27,251

 
(359
)
 
55,578

 
(380
)
 
82,829

 
(739
)
Total Mortgage-Backed Securities
422,118

 
(3,140
)
 
496,253

 
(9,191
)
 
918,371

 
(12,331
)
Total
$
422,118

 
$
(3,140
)
 
$
570,499

 
$
(10,014
)
 
$
992,617

 
$
(13,154
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 

 
 

 
 

 
 

 
 

 
 

Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
Debt Securities Issued by the U.S. Treasury
     and Government Agencies
$
1,729

 
$
(2
)
 
$
5,546

 
$
(38
)
 
$
7,275

 
$
(40
)
Debt Securities Issued by States
     and Political Subdivisions
78,068

 
(305
)
 
94,543

 
(1,140
)
 
172,611

 
(1,445
)
Debt Securities Issued by Corporations
73,829

 
(1,171
)
 
180,335

 
(2,814
)
 
254,164

 
(3,985
)
Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
 
     Residential - Government Agencies
3,025

 
(8
)
 
12,215

 
(1,035
)
 
15,240

 
(1,043
)
     Residential - U.S. Government-Sponsored Enterprises
103,824

 
(191
)
 

 

 
103,824

 
(191
)
     Commercial - Government Agencies

 

 
178,232

 
(8,581
)
 
178,232

 
(8,581
)
Total Mortgage-Backed Securities
106,849

 
(199
)
 
190,447

 
(9,616
)
 
297,296

 
(9,815
)
Total
$
260,475

 
$
(1,677
)
 
$
470,871

 
$
(13,608
)
 
$
731,346

 
$
(15,285
)
Held-to-Maturity:
 
 
 
 
 
 
 
 
 
 
 
Debt Securities Issued by the U.S. Treasury
and Government Agencies
$
70,016

 
$
(134
)
 
$
144,222

 
$
(1,025
)
 
$
214,238

 
$
(1,159
)
Debt Securities Issued by Corporations
46,196

 
(349
)
 
82,109

 
(3,093
)
 
128,305

 
(3,442
)
Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
 
     Residential - Government Agencies
280,967

 
(1,207
)
 
845,911

 
(19,429
)
 
1,126,878

 
(20,636
)
     Residential - U.S. Government-Sponsored Enterprises
45,754

 
(15
)
 

 

 
45,754

 
(15
)
     Commercial - Government Agencies
124,594

 
(179
)
 
171,091

 
(3,612
)
 
295,685

 
(3,791
)
Total Mortgage-Backed Securities
451,315

 
(1,401
)
 
1,017,002

 
(23,041
)
 
1,468,317

 
(24,442
)
Total
$
567,527

 
$
(1,884
)
 
$
1,243,333

 
$
(27,159
)
 
$
1,810,860

 
$
(29,043
)


12


The Company does not believe that the investment securities that were in an unrealized loss position as of September 30, 2015, which were comprised of 125 securities, represent an other-than-temporary impairment.  Total gross unrealized losses were primarily attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities.  As of September 30, 2015 and December 31, 2014, the gross unrealized losses reported for mortgage-backed securities were primarily related to investment securities issued by the Government National Mortgage Association. The Company does not intend to sell the investment securities that were in an unrealized loss position and it is not more likely than not that the Company will be required to sell the investment securities before recovery of their amortized cost basis, which may be at maturity.

Interest income from taxable and non-taxable investment securities for the three and nine months ended September 30, 2015 and 2014 were as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands)
2015

 
2014

 
2015

 
2014

Taxable
$
25,569

 
$
31,053

 
$
82,638

 
$
96,796

Non-Taxable
5,312

 
5,300

 
15,953

 
15,841

Total Interest Income from Investment Securities
$
30,881

 
$
36,353

 
$
98,591

 
$
112,637


As of September 30, 2015, included in the Company's investment securities portfolio were debt securities issued by political subdivisions within the State of Hawaii of $579.0 million, representing 58% of the total fair value of the Company's municipal debt securities. Of the entire Hawaii municipal bond portfolio, 91% were credit-rated Aa2 or better by Moody's while most of the remaining Hawaii municipal bonds were credit-rated A2 or better by at least one nationally recognized statistical rating organization. Of the Company's total Hawaii municipal bond holdings, 77% were general obligation issuances. As of September 30, 2015, there were no other holdings of municipal debt securities that were issued by a single state or political subdivision which comprised more than 10% of the total fair value of the Company's municipal debt securities.

As of September 30, 2015 and December 31, 2014, the carrying value of the Company’s Federal Home Loan Bank of Des Moines (“FHLB Des Moines”) stock and Federal Reserve Bank stock was as follows:
(dollars in thousands)
September 30,
2015

 
December 31,
2014

Federal Home Loan Bank Stock
$
20,000

 
$
47,075

Federal Reserve Bank Stock
19,836

 
19,299

Total
$
39,836

 
$
66,374


These securities can only be redeemed or sold at their par value and only to the respective issuing government-supported institution or to another member institution.  The Company records these non-marketable equity securities as a component of other assets and periodically evaluates these securities for impairment.  Management considers these non-marketable equity securities to be long-term investments.  Accordingly, when evaluating these securities for impairment, management considers the ultimate recoverability of the par value rather than recognizing temporary declines in value.

Effective May 31, 2015, FHLB Des Moines completed its previously announced merger with the Federal Home Loan Bank of Seattle (“FHLB Seattle”). The continuing bank, FHLB Des Moines, remains headquartered in Des Moines with a western regional office in Seattle. Prior to the merger, the Company held stock in FHLB Seattle. Pursuant to the terms of the Merger Agreement, each share of FHLB Seattle stock was converted into one share of FHLB Des Moines stock. In addition, upon the merger, the Company's excess FHLB stock was redeemed and the Company’s membership effectively transferred to FHLB Des Moines.  The merger did not have a material impact on the Company's Consolidated Financial Statements or the Company's dealings with the continuing bank.

Visa Class B Restricted Shares

In 2008, the Company received Visa Class B restricted shares as part of Visa’s initial public offering. These shares are transferable only under limited circumstances until they can be converted into the publicly traded Class A common shares. This conversion will not occur until the settlement of certain litigation which is indemnified by Visa members, including the Company. Visa funded an escrow account from its initial public offering to settle these litigation claims. Should this escrow account not be sufficient to cover these litigation claims, Visa is entitled to fund additional amounts to the escrow account by reducing each member bank's Class B conversion ratio to unrestricted Class A shares. As of September 30, 2015, the conversion ratio was 1.6483.

13



During the first nine months of 2015, the Company recorded a $10.1 million net gain on the sale of 95,000 Visa Class B shares. Concurrent with these sales, the Company entered into an agreement with the buyer that requires payment to the buyer in the event Visa further reduces the conversion ratio. Based on the existing transfer restriction and the uncertainty of the outcome of the Visa litigation mentioned above, the remaining 288,714 Class B shares (475,887 Class A equivalents) that the Company owns are carried at a zero cost basis. The Company also contributed 13,800 Visa Class B restricted shares to the Bank of Hawaii Foundation during the first nine months of 2015. The contribution had no impact on noninterest expense; however, the contribution favorably impacted our effective tax rate in 2015.

Note 3.    Loans and Leases and the Allowance for Loan and Lease Losses

Loans and Leases

The Company’s loan and lease portfolio was comprised of the following as of September 30, 2015 and December 31, 2014:

(dollars in thousands)
September 30,
2015

 
December 31,
2014

Commercial
 

 
 

Commercial and Industrial
$
1,169,817

 
$
1,055,243

Commercial Mortgage
1,622,119

 
1,437,513

Construction
129,254

 
109,183

Lease Financing
202,055

 
226,189

Total Commercial
3,123,245

 
2,828,128

Consumer
 

 
 

Residential Mortgage
2,875,605

 
2,571,090

Home Equity
993,817

 
866,688

Automobile
367,640

 
323,848

Other 1
329,465

 
307,835

Total Consumer
4,566,527

 
4,069,461

Total Loans and Leases
$
7,689,772

 
$
6,897,589

1 
Comprised of other revolving credit, installment, and lease financing.
The majority of the Company's lending activity is with customers located in the State of Hawaii. A substantial portion of the Company's real estate loans are secured by real estate in Hawaii.

Net gains related to sales of residential mortgage loans, recorded as a component of mortgage banking income were $1.8 million and $0.3 million for the three months ended September 30, 2015 and 2014, respectively, and $4.1 million and $1.6 million for the nine months ended September 30, 2015 and 2014, respectively.

14


Allowance for Loan and Lease Losses (the “Allowance”)

The following presents by portfolio segment, the activity in the Allowance for the three and nine months ended September 30, 2015 and 2014.  The following also presents by portfolio segment, the balance in the Allowance disaggregated on the basis of the Company’s impairment measurement method and the related recorded investment in loans and leases as of September 30, 2015 and 2014.

(dollars in thousands)
Commercial

 
Consumer

 
Total

Three Months Ended September 30, 2015
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Balance at Beginning of Period
$
67,005

 
$
39,001

 
$
106,006

Loans and Leases Charged-Off
(160
)
 
(4,233
)
 
(4,393
)
Recoveries on Loans and Leases Previously Charged-Off
504

 
1,921

 
2,425

Net Loans and Leases Recovered (Charged-Off)
344

 
(2,312
)
 
(1,968
)
Provision for Credit Losses
(2,708
)
 
2,708

 

Balance at End of Period
$
64,641

 
$
39,397

 
$
104,038

Nine Months Ended September 30, 2015
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Balance at Beginning of Period
$
64,551

 
$
44,137

 
$
108,688

Loans and Leases Charged-Off
(650
)
 
(11,327
)
 
(11,977
)
Recoveries on Loans and Leases Previously Charged-Off
1,726

 
5,601

 
7,327

Net Loans and Leases Recovered (Charged-Off)
1,076

 
(5,726
)
 
(4,650
)
Provision for Credit Losses
(986
)
 
986

 

Balance at End of Period
$
64,641

 
$
39,397

 
$
104,038

As of September 30, 2015
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Individually Evaluated for Impairment
$
1,977

 
$
3,336

 
$
5,313

Collectively Evaluated for Impairment
62,664

 
36,061

 
98,725

Total
$
64,641

 
$
39,397

 
$
104,038

Recorded Investment in Loans and Leases:
 

 
 

 
 

Individually Evaluated for Impairment
$
29,016

 
$
39,013

 
$
68,029

Collectively Evaluated for Impairment
3,094,229

 
4,527,514

 
7,621,743

Total
$
3,123,245

 
$
4,566,527

 
$
7,689,772

 
 
 
 
 
 
Three Months Ended September 30, 2014
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Balance at Beginning of Period
$
71,886

 
$
41,952

 
$
113,838

Loans and Leases Charged-Off
(229
)
 
(3,432
)
 
(3,661
)
Recoveries on Loans and Leases Previously Charged-Off
1,202

 
1,648

 
2,850

Net Loans and Leases Recovered (Charged-Off)
973

 
(1,784
)
 
(811
)
Provision for Credit Losses
(6,619
)
 
3,954

 
(2,665
)
Balance at End of Period
$
66,240

 
$
44,122

 
$
110,362

Nine Months Ended September 30, 2014
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Balance at Beginning of Period
$
71,446

 
$
44,008

 
$
115,454

Loans and Leases Charged-Off
(1,863
)
 
(9,833
)
 
(11,696
)
Recoveries on Loans and Leases Previously Charged-Off
4,299

 
7,169

 
11,468

Net Loans and Leases Recovered (Charged-Off)
2,436

 
(2,664
)
 
(228
)
Provision for Credit Losses
(7,642
)
 
2,778

 
(4,864
)
Balance at End of Period
$
66,240

 
$
44,122

 
$
110,362

As of September 30, 2014
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Individually Evaluated for Impairment
$
2,449

 
$
3,653

 
$
6,102

Collectively Evaluated for Impairment
63,791

 
40,469

 
104,260

Total
$
66,240

 
$
44,122

 
$
110,362

Recorded Investment in Loans and Leases:
 

 
 

 
 

Individually Evaluated for Impairment
$
26,061

 
$
39,886

 
$
65,947

Collectively Evaluated for Impairment
2,702,863

 
3,837,540

 
6,540,403

Total
$
2,728,924

 
$
3,877,426

 
$
6,606,350


15


Credit Quality Indicators

The Company uses several credit quality indicators to manage credit risk in an ongoing manner.  The Company uses an internal credit risk rating system that categorizes loans and leases into pass, special mention, or classified categories.  Credit risk ratings are applied individually to those classes of loans and leases that have significant or unique credit characteristics that benefit from a case-by-case evaluation.  These are typically loans and leases to businesses or individuals in the classes which comprise the commercial portfolio segment.  Groups of loans and leases that are underwritten and structured using standardized criteria and characteristics, such as statistical models (e.g., credit scoring or payment performance), are typically risk-rated and monitored collectively.  These are typically loans and leases to individuals in the classes which comprise the consumer portfolio segment.

The following are the definitions of the Company’s credit quality indicators:

Pass:
Loans and leases in all classes within the commercial and consumer portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan or lease agreement. Management believes that there is a low likelihood of loss related to those loans and leases that are considered pass.

Special Mention:
Loans and leases in the classes within the commercial portfolio segment that have potential weaknesses that deserve management’s close attention. If not addressed, these potential weaknesses may result in deterioration of the repayment prospects for the loan or lease. The special mention credit quality indicator is not used for classes of loans and leases that are included in the consumer portfolio segment. Management believes that there is a moderate likelihood of some loss related to those loans and leases that are considered special mention.

Classified:
Loans and leases in the classes within the commercial portfolio segment that are inadequately protected by the sound worth and paying capacity of the borrower or of the collateral pledged, if any. Classified loans and leases are also those in the classes within the consumer portfolio segment that are past due 90 days or more as to principal or interest. Residential mortgage loans that are past due 90 days or more as to principal or interest may be considered pass if the Company is in the process of collection and the current loan-to-value ratio is 60% or less. Home equity loans that are past due 90 days or more as to principal or interest may be considered pass if the Company is in the process of collection, the first mortgage is with the Company, and the current combined loan-to-value ratio is 60% or less. Residential mortgage and home equity loans may be current as to principal and interest, but may be considered classified for a period of generally up to six months following a loan modification. Following a period of demonstrated performance in accordance with the modified contractual terms, the loan may be removed from classified status. Management believes that there is a distinct possibility that the Company will sustain some loss if the deficiencies related to classified loans and leases are not corrected in a timely manner.


16


The Company’s credit quality indicators are periodically updated on a case-by-case basis.  The following presents by class and by credit quality indicator, the recorded investment in the Company’s loans and leases as of September 30, 2015 and December 31, 2014.
 
September 30, 2015
(dollars in thousands)
Commercial
and Industrial

 
Commercial
Mortgage

 
Construction

 
Lease
Financing

 
Total
Commercial

Pass
$
1,122,454

 
$
1,551,159

 
$
127,541

 
$
201,473

 
$
3,002,627

Special Mention
20,726

 
31,145

 
88

 
85

 
52,044

Classified
26,637

 
39,815

 
1,625

 
497

 
68,574

Total
$
1,169,817

 
$
1,622,119

 
$
129,254

 
$
202,055

 
$
3,123,245

 
 
 
 
 
 
 
 
 
 
(dollars in thousands)
Residential
Mortgage

 
Home
Equity

 
Automobile

 
Other 1

 
Total
Consumer

Pass
$
2,859,438

 
$
989,433

 
$
367,009

 
$
328,873

 
$
4,544,753

Classified
16,167

 
4,384

 
631

 
592

 
21,774

Total
$
2,875,605

 
$
993,817

 
$
367,640

 
$
329,465

 
$
4,566,527

Total Recorded Investment in Loans and Leases
 
 

 
 

 
 

 
$
7,689,772

 
December 31, 2014
(dollars in thousands)
Commercial
and Industrial

 
Commercial
Mortgage

 
Construction

 
Lease
Financing

 
Total
Commercial

Pass
$
1,001,474

 
$
1,358,812

 
$
107,381

 
$
225,783

 
$
2,693,450

Special Mention
17,364

 
45,082

 

 
17

 
62,463

Classified
36,405

 
33,619

 
1,802

 
389

 
72,215

Total
$
1,055,243

 
$
1,437,513

 
$
109,183

 
$
226,189

 
$
2,828,128

 
 
 
 
 
 
 
 
 
 
(dollars in thousands)
Residential
Mortgage

 
Home
Equity

 
Automobile

 
Other 1

 
Total
Consumer

Pass
$
2,556,140

 
$
862,258

 
$
323,232

 
$
307,123

 
$
4,048,753

Classified
14,950

 
4,430

 
616

 
712

 
20,708

Total
$
2,571,090

 
$
866,688

 
$
323,848

 
$
307,835

 
$
4,069,461

Total Recorded Investment in Loans and Leases
 
 

 
 

 
 

 
$
6,897,589

1 
Comprised of other revolving credit, installment, and lease financing.

17


Aging Analysis

The following presents by class, an aging analysis of the Company’s loan and lease portfolio as of September 30, 2015 and December 31, 2014.
(dollars in thousands)
30 - 59
Days
Past Due

 
60 - 89
Days
Past Due

 
Past Due
90 Days
or More

 
Non-Accrual

 
Total
Past Due and
Non-Accrual

 
Current

 
Total
Loans and
Leases

 
Non-Accrual
Loans and
Leases that
are Current 2

As of September 30, 2015
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial and Industrial
$
4,830

 
$
1,361

 
$

 
$
8,532

 
$
14,723

 
$
1,155,094

 
$
1,169,817

 
$
571

Commercial Mortgage

 
29

 

 
1,058

 
1,087

 
1,621,032

 
1,622,119

 
833

Construction

 

 

 

 

 
129,254

 
129,254

 

Lease Financing

 

 

 

 

 
202,055

 
202,055

 

Total Commercial
4,830

 
1,390

 

 
9,590

 
15,810

 
3,107,435

 
3,123,245

 
1,404

Consumer
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Residential Mortgage
6,023

 
1,526

 
5,060

 
14,749

 
27,358

 
2,848,247

 
2,875,605

 
2,419

Home Equity
2,331

 
2,345

 
1,396

 
3,814

 
9,886

 
983,931

 
993,817

 
1,683

Automobile
7,827

 
1,612

 
631

 

 
10,070

 
357,570

 
367,640

 

Other 1
2,273

 
1,454

 
1,058

 

 
4,785

 
324,680

 
329,465

 

Total Consumer
18,454

 
6,937

 
8,145

 
18,563

 
52,099

 
4,514,428

 
4,566,527

 
4,102

Total
$
23,284

 
$
8,327

 
$
8,145

 
$
28,153

 
$
67,909

 
$
7,621,863

 
$
7,689,772

 
$
5,506

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2014
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Commercial and Industrial
$
992

 
$
356

 
$
2

 
$
9,088

 
$
10,438

 
$
1,044,805

 
$
1,055,243

 
$
7,819

Commercial Mortgage
458

 

 

 
745

 
1,203

 
1,436,310

 
1,437,513

 

Construction

 

 

 

 

 
109,183

 
109,183

 

Lease Financing

 

 

 

 

 
226,189

 
226,189

 

Total Commercial
1,450


356


2

 
9,833

 
11,641

 
2,816,487

 
2,828,128

 
7,819

Consumer
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Residential Mortgage
4,907

 
2,107

 
4,506

 
14,841

 
26,361

 
2,544,729

 
2,571,090

 
632

Home Equity
3,461

 
2,661

 
2,596

 
3,097

 
11,815

 
854,873

 
866,688

 
375

Automobile
7,862

 
1,483

 
616

 

 
9,961

 
313,887

 
323,848

 

Other 1
2,416

 
1,049

 
941

 

 
4,406

 
303,429

 
307,835

 

Total Consumer
18,646

 
7,300

 
8,659

 
17,938

 
52,543

 
4,016,918

 
4,069,461

 
1,007

Total
$
20,096

 
$
7,656

 
$
8,661

 
$
27,771

 
$
64,184

 
$
6,833,405

 
$
6,897,589

 
$
8,826

1 
Comprised of other revolving credit, installment, and lease financing.
2 
Represents non-accrual loans that are not past due 30 days or more; however, full payment of principal and interest is still not expected.

18


Impaired Loans

The following presents by class, information related to impaired loans as of September 30, 2015 and December 31, 2014.

(dollars in thousands)
Recorded
 Investment

 
Unpaid
 Principal
 Balance

 
Related 
Allowance for 
Loan Losses

September 30, 2015
 

 
 

 
 

Impaired Loans with No Related Allowance Recorded:
 

 
 

 
 

Commercial
 

 
 

 
 

Commercial and Industrial
$
14,131

 
$
24,605

 
$

Commercial Mortgage
7,337

 
7,337

 

Construction
1,626

 
1,626

 

Total Commercial
23,094

 
33,568

 

Total Impaired Loans with No Related Allowance Recorded
$
23,094

 
$
33,568

 
$

 
 
 
 
 
 
Impaired Loans with an Allowance Recorded:
 

 
 

 
 

Commercial
 

 
 

 
 

Commercial and Industrial
$
5,922

 
$
12,523

 
$
1,977

Total Commercial
5,922

 
12,523

 
1,977

Consumer
 

 
 

 
 

Residential Mortgage
30,253

 
36,046

 
3,169

Home Equity
1,191

 
1,191

 
13

Automobile
6,238

 
6,238

 
117

Other 1
1,331

 
1,331

 
37

Total Consumer
39,013

 
44,806

 
3,336

Total Impaired Loans with an Allowance Recorded
$
44,935

 
$
57,329

 
$
5,313

 
 
 
 
 
 
Impaired Loans:
 
 
 
 
 
Commercial
$
29,016

 
$
46,091

 
$
1,977

Consumer
39,013

 
44,806

 
3,336

Total Impaired Loans
$
68,029

 
$
90,897

 
$
5,313

 
 
 
 
 
 
December 31, 2014
 

 
 

 
 

Impaired Loans with No Related Allowance Recorded:
 

 
 

 
 

Commercial
 

 
 

 
 

Commercial and Industrial
$
9,763

 
$
15,013

 
$

Commercial Mortgage
6,480

 
6,480

 

Construction
1,689

 
1,689

 

Total Commercial
17,932

 
23,182

 

Total Impaired Loans with No Related Allowance Recorded
$
17,932

 
$
23,182

 
$

 
 
 
 
 
 
Impaired Loans with an Allowance Recorded:
 

 
 

 
 

Commercial
 

 
 

 
 

Commercial and Industrial
$
7,184

 
$
13,784

 
$
2,387

Total Commercial
7,184

 
13,784

 
2,387

Consumer
 

 
 

 
 

Residential Mortgage
32,331

 
37,989

 
3,445

Home Equity
1,012

 
1,012

 
16

Automobile
5,375

 
5,375

 
66

Other 1
913

 
913

 
34

Total Consumer
39,631

 
45,289

 
3,561

Total Impaired Loans with an Allowance Recorded
$
46,815

 
$
59,073

 
$
5,948

 
 
 
 
 
 
Impaired Loans:
 

 
 

 
 

Commercial
$
25,116

 
$
36,966

 
$
2,387

Consumer
39,631

 
45,289

 
3,561

Total Impaired Loans
$
64,747

 
$
82,255

 
$
5,948

1 Comprised of other revolving credit and installment financing.

19


The following presents by class, information related to the average recorded investment and interest income recognized on impaired loans for the three and nine months ended September 30, 2015 and 2014.

 
Three Months Ended
September 30, 2015
 
Three Months Ended
September 30, 2014
(dollars in thousands)
Average Recorded
Investment

 
Interest Income
Recognized

 
Average Recorded
Investment

 
Interest Income
Recognized

Impaired Loans with No Related Allowance Recorded:
 
 

 
 

 
 

Commercial
 

 
 

 
 

 
 

Commercial and Industrial
$
13,368

 
$
96

 
$
10,161

 
$
96

Commercial Mortgage
7,155

 
67

 
7,046

 
56

Construction
1,637

 
26

 
2,024

 
28

Total Commercial
22,160

 
189

 
19,231

 
180

Consumer
 
 
 
 
 
 
 
Other 1

 

 
9

 

Total Consumer

 

 
9

 

Total Impaired Loans with No Related Allowance Recorded
$
22,160

 
$
189

 
$
19,240

 
$
180

 
 
 
 
 
 
 
 
Impaired Loans with an Allowance Recorded:
 

 
 

 
 

 
 

Commercial
 

 
 

 
 

 
 

Commercial and Industrial
$
6,105

 
$
24

 
$
7,345

 
$
25

Total Commercial
6,105

 
24

 
7,345

 
25

Consumer
 

 
 

 
 

 
 

Residential Mortgage
30,719

 
265

 
31,989

 
269

Home Equity
1,191

 
9

 
1,029

 
13

Automobile
6,013

 
104

 
5,345

 
114

Other 1
1,218

 
28

 
576

 
12

Total Consumer
39,141

 
406

 
38,939

 
408

Total Impaired Loans with an Allowance Recorded
$
45,246

 
$
430

 
$
46,284

 
$
433

 
 
 
 
 
 
 
 
Impaired Loans:
 

 
 

 
 

 
 

Commercial
$
28,265

 
$
213

 
$
26,576

 
$
205

Consumer
39,141

 
406

 
38,948

 
408

Total Impaired Loans
$
67,406

 
$
619

 
$
65,524

 
$
613

 
 
 
 
 
 
 
 
 
Nine Months Ended
September 30, 2015
 
Nine Months Ended
September 30, 2014
(dollars in thousands)
Average Recorded
Investment

 
Interest Income
Recognized

 
Average Recorded
Investment

 
Interest Income
Recognized

Impaired Loans with No Related Allowance Recorded:
 
 

 
 

 
 

Commercial
 

 
 

 
 

 
 

Commercial and Industrial
$
12,074

 
$
304

 
$
11,518

 
$
254

Commercial Mortgage
6,799

 
198

 
9,041

 
167

Construction
1,658

 
80

 
1,540

 
66

Total Commercial
20,531

 
582

 
22,099

 
487

Consumer
 
 
 
 
 
 
 
Other 1

 

 
7

 

Total Consumer

 

 
7

 

Total Impaired Loans with No Related Allowance Recorded
$
20,531

 
$
582

 
$
22,106

 
$
487

 
 
 
 
 
 
 
 
Impaired Loans with an Allowance Recorded:
 

 
 

 
 

 
 

Commercial
 

 
 

 
 

 
 

Commercial and Industrial
$
6,401

 
$
78

 
$
8,260

 
$
80

Total Commercial
6,401

 
78

 
8,260

 
80

Consumer
 

 
 

 
 

 
 

Residential Mortgage
31,374

 
796

 
31,915

 
749

Home Equity
1,149

 
28

 
952

 
27

Automobile
5,737

 
319

 
5,235

 
327

Other 1
1,082

 
77

 
471

 
30

Total Consumer
39,342

 
1,220

 
38,573

 
1,133

Total Impaired Loans with an Allowance Recorded
$
45,743

 
$
1,298

 
$
46,833

 
$
1,213

 
 
 
 
 
 
 
 
Impaired Loans:
 

 
 

 
 

 
 

Commercial
$
26,932

 
$
660

 
$
30,359

 
$
567

Consumer
39,342

 
1,220

 
38,580

 
1,133

Total Impaired Loans
$
66,274

 
$
1,880

 
$
68,939

 
$
1,700

1 
Comprised of other revolving credit and installment financing.


20



For the three and nine months ended September 30, 2015 and 2014, the amounts of interest income recognized by the Company within the periods that the loans were impaired were primarily related to loans modified in a troubled debt restructuring that remained on accrual status.  For the three and nine months ended September 30, 2015 and 2014, the amount of interest income recognized using a cash-basis method of accounting during the periods that the loans were impaired was not material.

Modifications

A modification of a loan constitutes a troubled debt restructuring (“TDR”) when the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider.  Loans modified in a TDR were $66.3 million and $60.2 million as of September 30, 2015 and December 31, 2014, respectively.  There were no commitments to lend additional funds on loans modified in a TDR as of September 30, 2015 and December 31, 2014.

The Company offers various types of concessions when modifying a loan or lease. Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor is often requested. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a co-borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment period. Residential mortgage loans modified in a TDR generally include a lower interest rate and the loan being fully amortized for up to 40 years from the modification effective date. In some cases, the Company may forbear a portion of the unpaid principal balance with a balloon payment due upon maturity or pay-off of the loan. Land loans are also included in the class of residential mortgage loans. Land loans are typically structured as interest-only monthly payments with a balloon payment due at maturity. Land loan modifications usually involve extending the interest-only monthly payments up to an additional five years with a balloon payment due at maturity, or re-amortizing the remaining balance over a period up to 360 months. Interest rates are not changed for land loan modifications. Home equity modifications are made infrequently and uniquely designed to meet the specific needs of each borrower. Automobile loans modified in a TDR are primarily comprised of loans where the Company has lowered monthly payments by extending the term.

Loans modified in a TDR are typically already on non-accrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance.  As a result, loans modified in a TDR may have the financial effect of increasing the specific Allowance associated with the loan.  An Allowance for impaired consumer and commercial loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent.  Management exercises significant judgment in developing these estimates.


21


The following presents by class, information related to loans modified in a TDR during the three and nine months ended September 30, 2015 and 2014.
 
Loans Modified as a TDR for the
Three Months Ended September 30, 2015
 
Loans Modified as a TDR for the
Three Months Ended September 30, 2014
 
 

 
Recorded

 
Increase in

 
 

 
Recorded

 
Increase in

Troubled Debt Restructurings
Number of

 
Investment

 
Allowance

 
Number of

 
Investment

 
Allowance

(dollars in thousands)
Contracts

(as of period end)1
 
(as of period end)
 
 
Contracts

(as of period end)1
 
(as of period end)
 
Commercial
 

 
 

 
 

 
 

 
 

 
 

Commercial and Industrial
13

 
$
6,551

 
$

 
4

 
$
1,203

 
$
155

Total Commercial
13

 
6,551

 

 
4

 
1,203

 
155

Consumer
 

 
 

 
 

 
 

 
 

 
 

Residential Mortgage
2

 
749

 

 
6

 
1,581

 
56

Home Equity
1

 
168

 
2

 

 

 

Automobile
47

 
1,172

 
22

 
35

 
774

 
10

Other 2
50

 
344

 
9

 
35

 
255

 
8

Total Consumer
100

 
2,433

 
33

 
76

 
2,610

 
74

Total
113

 
$
8,984

 
$
33

 
80

 
$
3,813

 
$
229

 
 
 
 
 
 
 
 
 
 
 
 
 
Loans Modified as a TDR for the
Nine Months Ended September 30, 2015
 
Loans Modified as a TDR for the
Nine Months Ended September 30, 2014
 
 

 
Recorded

 
Increase in

 
 

 
Recorded

 
Increase in

Troubled Debt Restructurings
Number of

 
Investment

 
Allowance

 
Number of

 
Investment

 
Allowance

(dollars in thousands)
Contracts

(as of period end)1
 
(as of period end)
 
 
Contracts

(as of period end)1
 
(as of period end)
 
Commercial
 

 
 

 
 

 
 

 
 

 
 

Commercial and Industrial
27

 
$
8,438

 
$
4

 
16

 
$
5,416

 
$
156

Commercial Mortgage
2

 
1,179

 

 
1

 
332

 

Total Commercial
29

 
9,617

 
4

 
17

 
5,748

 
156

Consumer
 

 
 

 
 

 
 

 
 

 
 

Residential Mortgage
12

 
4,211

 
84

 
15

 
4,886

 
183

Home Equity
3

 
370

 
4

 
2

 
158

 
3

Automobile
119

 
2,723

 
51

 
112

 
2,213

 
29

Other 2
102

 
702

 
20

 
53

 
414

 
13

Total Consumer
236

 
8,006

 
159

 
182

 
7,671

 
228

Total
265

 
$
17,623

 
$
163

 
199

 
$
13,419

 
$
384

1 
The period end balances reflect all paydowns and charge-offs since the modification date.  TDRs fully paid-off, charged-off, or foreclosed upon by period end are not included.
2 
Comprised of other revolving credit and installment financing.

22


The following presents by class, all loans modified in a TDR that defaulted during the three and nine months ended September 30, 2015 and 2014, and within twelve months of their modification date.  A TDR is considered to be in default once it becomes 60 days or more past due following a modification.
 
Three Months Ended
September 30, 2015
 
Three Months Ended
September 30, 2014
TDRs that Defaulted During the Period,
 

 
Recorded

 
Recorded
 
Within Twelve Months of their Modification Date
Number of

 
Investment

 
Number of

 
Investment

(dollars in thousands)
Contracts

 
(as of period end)1

 
Contracts

 
(as of period end)1

Commercial
 
 
 
 
 
 
 
Commercial and Industrial

 
$

 
1

 
$
22

Total Commercial

 

 
1

 
22

 
 
 
 
 
 
 
 
Consumer
 
 
 

 
 

 
 

Residential Mortgage
2

 
1,069

 

 

Automobile
3

 
52

 
5

 
64

Other 2
10

 
56

 
1

 
16

Total Consumer
15

 
1,177


6

 
80

Total
15

 
$
1,177

 
7

 
$
102

 
 
 
 
 
 
 
 
 
Nine Months Ended
September 30, 2015
 
Nine Months Ended
September 30, 2014
TDRs that Defaulted During the Period,
 

 
Recorded

 
Recorded
 
Within Twelve Months of their Modification Date
Number of

 
Investment

 
Number of

 
Investment

(dollars in thousands)
Contracts

 
(as of period end)1

 
Contracts

 
(as of period end)1

Commercial
 
 
 
 
 
 
 
Commercial and Industrial
1

 
$
4,341

 
3

 
$
723

Total Commercial
1

 
4,341

 
3

 
723

 
 
 
 
 
 
 
 
Consumer
 

 
 

 
 

 
 

Residential Mortgage
3

 
1,374

 
2

 
509

Automobile
6

 
108

 
7

 
110

Other 2
19

 
98

 
3

 
27

Total Consumer
28

 
1,580

 
12

 
646

Total
29

 
$
5,921

 
15

 
$
1,369

1 
The period end balances reflect all paydowns and charge-offs since the modification date.  TDRs fully paid-off, charged-off, or foreclosed upon by period end are not included.
2 
Comprised of other revolving credit and installment financing.
Commercial and consumer loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default.  If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment.  The specific Allowance associated with the loan may be increased, adjustments may be made in the allocation of the Allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan.

Foreclosure Proceedings

Consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure totaled $7.0 million as of September 30, 2015.

Note 4.  Mortgage Servicing Rights

The Company’s portfolio of residential mortgage loans serviced for third parties was $2.7 billion as of September 30, 2015 and $2.9 billion as of December 31, 2014.  Substantially all of these loans were originated by the Company and sold to third parties on a non-recourse basis with servicing rights retained.  These retained servicing rights are recorded as a servicing asset and are initially recorded at fair value (see Note 13 to the Consolidated Financial Statements for more information). Changes to the balance of mortgage servicing rights are recorded in mortgage banking income in the Company’s consolidated statements of income.

The Company’s mortgage servicing activities include collecting principal, interest, and escrow payments from borrowers; making tax and insurance payments on behalf of borrowers; monitoring delinquencies and executing foreclosure proceedings;

23


and accounting for and remitting principal and interest payments to investors.  Servicing income, including late and ancillary fees, was $1.8 million and $2.0 million for the three months ended September 30, 2015 and 2014, respectively, and $5.4 million and $6.0 million for the nine months ended September 30, 2015 and 2014, respectively.  Servicing income is recorded in mortgage banking income in the Company’s consolidated statements of income.  The Company’s residential mortgage investor loan servicing portfolio is primarily comprised of fixed rate loans concentrated in Hawaii.

For the three and nine months ended September 30, 2015 and 2014, the change in the carrying value of the Company’s mortgage servicing rights accounted for under the fair value measurement method was as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands)
2015

 
2014

 
2015

 
2014

Balance at Beginning of Period
$
2,188

 
$
2,960

 
$
2,604

 
$
3,826

Change in Fair Value:
 

 
 

 
 

 
 

Due to Change in Valuation Assumptions 1

 
(145
)
 
(251
)
 
(816
)
Due to Payoffs
(116
)
 
(72
)
 
(281
)
 
(267
)
Total Changes in Fair Value of Mortgage Servicing Rights
(116
)
 
(217
)
 
(532
)
 
(1,083
)
Balance at End of Period
$
2,072

 
$
2,743

 
$
2,072

 
$
2,743

1 
Primarily represents changes in discount rates and loan repayment rate assumptions, mostly due to changes in interest rates.

For the three and nine months ended September 30, 2015 and 2014, the change in the carrying value of the Company’s mortgage servicing rights accounted for under the amortization method, net of valuation allowance, was as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands)
2015

 
2014

 
2015

 
2014

Balance at Beginning of Period
$
21,238

 
$
23,437

 
$
22,091

 
$
24,297

Servicing Rights that Resulted From Asset Transfers
645

 
100

 
1,330

 
664

Amortization
(633
)
 
(742
)
 
(2,228
)
 
(2,094
)
Valuation Allowance Provision
(21
)
 
21

 
36

 
(51
)
Balance at End of Period
$
21,229

 
$
22,816


$
21,229


$
22,816

 
 
 
 
 
 
 
 
Valuation Allowance:
 
 
 
 
 
 
 
Balance at Beginning of Period
$

 
$
(72
)
 
$
(57
)
 
$

Valuation Allowance Provision
(21
)
 
21

 
36

 
(51
)
Balance at End of Period
$
(21
)
 
$
(51
)

$
(21
)

$
(51
)
 
 
 
 
 
 
 
 
Fair Value of Mortgage Servicing Rights Accounted for
 Under the Amortization Method
 

 
 

 
 

 
 

Beginning of Period
$
26,205

 
$
25,848

 
$
22,837

 
$
30,100

End of Period
$
24,419

 
$
24,336

 
$
24,419

 
$
24,336


The key data and assumptions used in estimating the fair value of the Company’s mortgage servicing rights as of September 30, 2015 and December 31, 2014 were as follows:
 
September 30,
2015

 
December 31, 2014

Weighted-Average Constant Prepayment Rate 1
10.01
%
 
11.62
%
Weighted-Average Life (in years)
6.98

 
6.28

Weighted-Average Note Rate
4.23
%
 
4.28
%
Weighted-Average Discount Rate 2
9.71
%
 
10.61
%
1 
Represents annualized loan repayment rate assumption.
2 
Derived from multiple interest rate scenarios that incorporate a spread to the London Interbank Offered Rate swap curve and market volatilities.

24


A sensitivity analysis of the Company’s fair value of mortgage servicing rights to changes in certain key assumptions as of September 30, 2015 and December 31, 2014 is presented in the following table.
(dollars in thousands)
September 30,
2015

 
December 31,
2014

Constant Prepayment Rate
 

 
 

Decrease in fair value from 25 basis points (“bps”) adverse change
$
(285
)
 
$
(265
)
Decrease in fair value from 50 bps adverse change
(565
)
 
(524
)
Discount Rate
 

 
 

Decrease in fair value from 25 bps adverse change
(284
)
 
(250
)
Decrease in fair value from 50 bps adverse change
(562
)
 
(495
)

This analysis generally cannot be extrapolated because the relationship of a change in one key assumption to the change in the fair value of the Company’s mortgage servicing rights usually is not linear.  Also, the effect of changing one key assumption without changing other assumptions is not realistic.

Note 5. Affordable Housing Projects Tax Credit Partnerships

The Company makes certain equity investments in various limited partnerships that sponsor affordable housing projects utilizing the Low Income Housing Tax Credit (LIHTC) pursuant to Section 42 of the Internal Revenue Code. The purpose of these investments is to achieve a satisfactory return on capital, to facilitate the sale of affordable housing product offerings, and to assist in achieving goals associated with the Community Reinvestment Act. The primary activities of the limited partnerships include the identification, development, and operation of multi-family housing that is leased to qualifying residential tenants. Generally, these types of investments are funded through a combination of debt and equity.

The Company is a limited partner in each LIHTC Partnership. Each limited partnership is managed by an unrelated third party general partner who exercises full control over the affairs of the limited partnership. The general partner has all the rights, powers and authority granted or permitted to be granted to a general partner of a limited partnership. Duties entrusted to the general partner of each limited partnership include, but are not limited to: investment in operating companies, company expenditures, investment of excess funds, borrowing funds, employment of agents, disposition of fund property, prepayment and refinancing of liabilities, votes and consents, contract authority, disbursement of funds, accounting methods, tax elections, bank accounts, insurance, litigation, cash reserve, and use of working capital reserve funds. Except for limited rights granted to consent to certain transactions, the limited partner(s) may not participate in the operation, management, or control of the limited partnership’s business, transact any business in the limited partnership’s name or have any power to sign documents for or otherwise bind the limited partnership. In addition, the general partner may only be removed by the limited partner(s) in the event the general partner fails to comply with the terms of the agreement or is negligent in performing its duties.

The general partner of each limited partnership has both the power to direct the activities which most significantly affect the performance of each partnership and the obligation to absorb losses or the right to receive benefits that could be significant to the entities. Therefore, the Company has determined that it is not the primary beneficiary of any LIHTC partnership. The Company uses the effective yield method to account for its pre-2015 investments in these entities. Beginning January 1, 2015, any new investments that meet the requirements of the proportional amortization method will be recognized using the proportional amortization method. As of September 30, 2015, there are no investments accounted for under the proportional amortization method. The Company's net affordable housing tax credit investments and related unfunded commitments were $70.7 million and $68.5 million as of September 30, 2015 and December 31, 2014, respectively, and are included in other assets in the consolidated statements of condition.


25


Unfunded Commitments

As of September 30, 2015, the expected payments for unfunded affordable housing commitments were as follows:
(dollars in thousands)
Amount

2015
$
6,954

2016
20,668

2017
1,148

2018
15

2019
75

Thereafter
67

Total Unfunded Commitments
$
28,927


The following table presents tax credits and other tax benefits recognized and amortization expense related to affordable housing for the three and nine months ended September 30, 2015 and 2014.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands)
2015

 
2014

 
2015

 
2014

Effective Yield Method
 
 
 
 
 
 
 
Tax credits and other tax benefits recognized
$
3,353

 
$
2,646

 
$
10,095

 
$
7,956

Amortization Expense in Provision for Income Taxes
1,922

 
1,402

 
5,813

 
4,162


There were no sales or impairment losses of LIHTC investments for the nine months ended September 30, 2015 and 2014.

Note 6. Balance Sheet Offsetting

Interest Rate Swap Agreements (“Swap Agreements”)
The Company enters into swap agreements to facilitate the risk management strategies of a small number of commercial banking customers. The Company mitigates the risk of entering into these agreements by entering into equal and offsetting swap agreements with highly-rated third party financial institutions. The swap agreements are free-standing derivatives and are recorded at fair value in the Company's consolidated statements of condition (asset positions are included in other assets and liability positions are included in other liabilities). The Company is party to master netting arrangements with its financial institution counterparties; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral, usually in the form of marketable securities, is posted by the counterparty with net liability positions in accordance with contract thresholds. The Company had net liability positions with its financial institution counterparties totaling $15.6 million and $16.2 million as of September 30, 2015 and December 31, 2014, respectively. See Note 11 to the Consolidated Financial Statements for more information.
Securities Sold Under Agreements to Repurchase (“Repurchase Agreements”)
The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities.  Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets.  As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as sales and subsequent repurchases of securities.  The obligation to repurchase the securities is reflected as a liability in the Company's consolidated statements of condition, while the securities underlying the repurchase agreements remain in the respective investment securities asset accounts. As a result, there is no offsetting or netting of the investment securities assets with the repurchase agreement liabilities. In addition, as the Company does not enter into reverse repurchase agreements, there is no such offsetting to be done with the repurchase agreements.

The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral pledged by the Company would be used to settle the fair value of the repurchase agreement should the Company be in default (e.g., fails to make an interest payment to the counterparty). For private institution repurchase agreements, if the private institution counterparty were to default (e.g., declare bankruptcy), the Company could cancel the repurchase agreement (i.e., cease payment of principal and interest), and attempt collection on the amount of collateral value in excess of the repurchase agreement fair value. The

26


collateral is held by a third party financial institution in the counterparty's custodial account. The counterparty has the right to sell or repledge the investment securities. For government entity repurchase agreements, the collateral is held by the Company in a segregated custodial account under a tri-party agreement. The Company is required by the counterparty to maintain adequate collateral levels. In the event the collateral fair value falls below stipulated levels, the Company will pledge additional securities. The Company closely monitors collateral levels to ensure adequate levels are maintained, while mitigating the potential risk of over-collateralization in the event of counterparty default.

The following table presents the remaining contractual maturities of the Company’s repurchase agreements as of September 30, 2015, disaggregated by the class of collateral pledged.
 
 
 Remaining Contractual Maturity of Repurchase Agreements
 (dollars in thousands)
 
 Up to
90 days

 
 91-365 days

 
 1-3 Years

 
 After
3 Years

 
 Total

September 30, 2015
 
 
 
 
 
 
 
 
 
 
 Class of Collateral Pledged:
 
 
 
 
 
 
 
 
 
 
 Debt Securities Issued by the U.S. Treasury and Government Agencies
 
$

 
$

 
$
195,799

 
$
110,446

 
$
306,245

 Debt Securities Issued by States and Political Subdivisions
 
2,147

 
52,001

 
100

 

 
54,248

 Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
     Residential - Government Agencies
 
2,828

 
43,089

 
18,379

 
108,038

 
172,334

     Residential - U.S. Government-Sponsored Enterprises
 

 
6,973

 
10,822

 
81,516

 
99,311

 Total
 
$
4,975

 
$
102,063

 
$
225,100

 
$
300,000

 
$
632,138



27


The following table presents the assets and liabilities subject to an enforceable master netting arrangement, or repurchase agreements, as of September 30, 2015 and December 31, 2014. The swap agreements we have with our commercial banking customers are not subject to an enforceable master netting arrangement, and therefore, are excluded from this table.
 
 
(i)
 
(ii)
 
(iii) = (i)-(ii)
 
(iv)
 
(v) = (iii)-(iv)
 
 
Gross Amounts
Recognized in the
Statements
 of Condition
 
 Gross Amounts
Offset in the
Statements
 of Condition
 
 Net Amounts
Presented in the
Statements
 of Condition
 
 Gross Amounts Not Offset in the Statements of Condition
 
 
(dollars in thousands)
 
 
 
 
Netting
Adjustments
per Master
Netting
Arrangements
 
Fair Value of Collateral
Pledged 1
 
 Net Amount
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate Swap Agreements:
 
 
 
 
 
 
 
 
 
 
 
 
    Institutional Counterparties
 
$
305

 
$

 
$
305

 
$
305

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate Swap Agreements:
 
 
 
 
 
 
 
 
 
 
 
 
    Institutional Counterparties
 
15,907

 

 
15,907

 
305

 

 
15,602

 
 
 
 
 
 
 
 
 
 
 
 
 
Repurchase Agreements:
 
 
 
 
 
 
 
 
 
 
 
 
    Private Institutions
 
575,000

 

 
575,000

 

 
575,000

 

    Government Entities
 
57,138

 

 
57,138

 

 
57,138

 

 
 
$
632,138

 
$

 
$
632,138

 
$

 
$
632,138

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate Swap Agreements:
 
 
 
 
 
 
 
 
 
 
 
 
    Institutional Counterparties
 
$
28

 
$

 
$
28

 
$
28

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate Swap Agreements:
 
 
 
 
 
 
 
 
 
 
 
 
    Institutional Counterparties
 
16,268

 

 
16,268

 
28

 

 
16,240

 
 
 
 
 
 

 
 
 
 
 

Repurchase Agreements:
 
 
 
 
 

 
 
 
 
 
 
    Private Institutions
 
600,000

 

 
600,000

 

 
600,000

 

    Government Entities
 
88,601

 

 
88,601

 

 
88,601

 

 
 
$
688,601

 
$

 
$
688,601

 
$

 
$
688,601

 
$

1 The application of collateral cannot reduce the net amount below zero. Therefore, excess collateral is not reflected in this table. For repurchase agreements with private institutions, the fair value of investment securities pledged was $0.7 billion as of September 30, 2015 and December 31, 2014. For repurchase agreements with government entities, the investment securities pledged to each government entity collectively secure both deposits as well as repurchase agreements. The Company had government entity deposits totaling $1.2 billion and $1.3 billion as of September 30, 2015 and December 31, 2014, respectively. The investment securities pledged as of September 30, 2015 and December 31, 2014 had a fair value of $1.9 billion and $2.1 billion, respectively.


28


Note 7.  Accumulated Other Comprehensive Income (Loss)

The following table presents the components of other comprehensive income (loss) for the three and nine months ended September 30, 2015 and 2014:
(dollars in thousands)
Before Tax

 
Tax Effect

 
Net of Tax

Three Months Ended September 30, 2015
 

 
 

 
 

Net Unrealized Gains (Losses) on Investment Securities:
 

 
 

 
 

Net Unrealized Gains (Losses) Arising During the Period
$
10,613

 
$
4,185

 
$
6,428

Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) that (Increase) Decrease Net Income:
 

 
 

 
 

  (Gain) Loss on Sale
(189
)
 
(74
)
 
$
(115
)
  Amortization of Unrealized Holding (Gains) Losses on Held-to-Maturity Securities 1
1,217

 
479

 
738

Net Unrealized Gains (Losses) on Investment Securities
11,641

 
4,590

 
7,051

Defined Benefit Plans:
 

 
 

 
 

Amortization of Net Actuarial Losses (Gains)
443

 
175

 
268

Amortization of Prior Service Credit
(81
)
 
(32
)
 
(49
)
Defined Benefit Plans, Net
362

 
143

 
219

Other Comprehensive Income (Loss)
$
12,003

 
$
4,733

 
$
7,270

 
 
 
 
 
 
Three Months Ended September 30, 2014
 

 
 

 
 

Net Unrealized Gains (Losses) on Investment Securities:
 

 
 

 
 

Net Unrealized Gains (Losses) Arising During the Period
$
825

 
$
325

 
$
500

Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) that (Increase) Decrease Net Income:
 
 
 
 
 
  Amortization of Unrealized Holding (Gains) Losses on Held-to-Maturity Securities 1
(160
)
 
(63
)
 
(97
)
Net Unrealized Gains (Losses) on Investment Securities
665

 
262

 
403

Defined Benefit Plans:
 

 
 

 
 

Amortization of Net Actuarial Losses (Gains)
339

 
133

 
206

Amortization of Prior Service Credit
(81
)
 
(32
)
 
(49
)
Defined Benefit Plans, Net
258

 
101

 
157

Other Comprehensive Income (Loss)
$
923

 
$
363

 
$
560

 
 
 
 
 
 
Nine Months Ended September 30, 2015
 

 
 

 
 

Net Unrealized Gains (Losses) on Investment Securities:
 

 
 

 
 

Net Unrealized Gains (Losses) Arising During the Period
$
6,307

 
$
2,489

 
$
3,818

Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) that (Increase) Decrease Net Income:
 
 
 
 
 
  (Gain) Loss on Sale
(189
)
 
(74
)
 
(115
)
  Amortization of Unrealized Holding (Gains) Losses on Held-to-Maturity Securities 1
1,702

 
670

 
1,032

Net Unrealized Gains (Losses) on Investment Securities
7,820

 
3,085

 
4,735

Defined Benefit Plans:
 

 
 

 
 

Amortization of Net Actuarial Losses (Gains)
1,330

 
524

 
806

Amortization of Prior Service Credit
(242
)
 
(95
)
 
(147
)
Defined Benefit Plans, Net
1,088

 
429

 
659

Other Comprehensive Income (Loss)
$
8,908

 
$
3,514

 
$
5,394

 
 
 
 
 
 
Nine Months Ended September 30, 2014
 

 
 

 
 

Net Unrealized Gains (Losses) on Investment Securities:
 

 
 

 
 

Net Unrealized Gains (Losses) Arising During the Period
$
26,143

 
$
10,313

 
$
15,830

Amounts Reclassified from Accumulated Other Comprehensive Income (Loss) that (Increase) Decrease Net Income:
 
 
 
 
 
  (Gain) Loss on Sale
(64
)
 
(25
)
 
$
(39
)
  Amortization of Unrealized Holding (Gains) Losses on Held-to-Maturity Securities 1
(825
)
 
(325
)
 
(500
)
Net Unrealized Gains (Losses) on Investment Securities
25,254

 
9,963

 
15,291

Defined Benefit Plans:
 

 
 

 
 

Amortization of Net Actuarial Losses (Gains)
1,016

 
400

 
616

Amortization of Prior Service Credit
(242
)
 
(95
)
 
(147
)
Defined Benefit Plans, Net
774

 
305

 
469

Other Comprehensive Income (Loss)
$
26,028

 
$
10,268

 
$
15,760

1 
The amount relates to the amortization/accretion of unrealized net gains and losses related to the Company's reclassification of available-for-sale investment securities to the held-to-maturity category. The unrealized net gains/losses will be amortized/accreted over the remaining life of the investment securities as an adjustment of yield.

29



The following table presents the changes in each component of accumulated other comprehensive income (loss), net of tax, for the three and nine months ended September 30, 2015 and 2014:
(dollars in thousands)
 
Investment Securities-Available-for-Sale

 
Investment Securities-Held-to-Maturity

 
Defined Benefit Plans

 
Accumulated Other Comprehensive Income (Loss)

Three Months Ended September 30, 2015
 
 
 
 
 
 
 
 
Balance at Beginning of Period
 
$
13,374

 
$
(8,261
)
 
$
(33,675
)
 
$
(28,562
)
Other Comprehensive Income (Loss) Before Reclassifications
 
6,428

 

 

 
6,428

Amounts Reclassified from Accumulated Other
        Comprehensive Income (Loss)
 
(115
)
 
738

 
219

 
842

Total Other Comprehensive Income (Loss)
 
6,313

 
738

 
219

 
7,270

Balance at End of Period
 
$
19,687

 
$
(7,523
)
 
$
(33,456
)
 
$
(21,292
)
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2014
 
 
 
 
 
 
 
 
Balance at Beginning of Period
 
$
13,991

 
$
(8,532
)
 
$
(22,082
)
 
$
(16,623
)
Other Comprehensive Income (Loss) Before Reclassifications
 
500

 

 

 
500

Amounts Reclassified from Accumulated Other
        Comprehensive Income (Loss)
 

 
(97
)
 
157

 
60

Total Other Comprehensive Income (Loss)
 
500

 
(97
)
 
157

 
560

Balance at End of Period
 
$
14,491

 
$
(8,629
)
 
$
(21,925
)
 
$
(16,063
)
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2015
 
 
 
 
 
 
 
 
Balance at Beginning of Period
 
$
15,984

 
$
(8,555
)
 
$
(34,115
)
 
$
(26,686
)
Other Comprehensive Income (Loss) Before Reclassifications
 
3,818

 

 

 
3,818

Amounts Reclassified from Accumulated Other
        Comprehensive Income (Loss)
 
(115
)
 
1,032

 
659

 
1,576

Total Other Comprehensive Income (Loss)
 
3,703

 
1,032

 
659

 
5,394

Balance at End of Period
 
$
19,687

 
$
(7,523
)
 
$
(33,456
)
 
$
(21,292
)
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2014
 
 
 
 
 
 
 
 
Balance at Beginning of Period
 
$
(1,300
)
 
$
(8,129
)
 
$
(22,394
)
 
$
(31,823
)
Other Comprehensive Income (Loss) Before Reclassifications
 
15,830

 

 

 
15,830

Amounts Reclassified from Accumulated Other
        Comprehensive Income (Loss)
 
(39
)
 
(500
)
 
469

 
(70
)
Total Other Comprehensive Income (Loss)
 
15,791

 
(500
)
 
469

 
15,760

Balance at End of Period
 
$
14,491

 
$
(8,629
)
 
$
(21,925
)
 
$
(16,063
)


30


The following table presents the amounts reclassified out of each component of accumulated other comprehensive income (loss) for the three and nine months ended September 30, 2015 and 2014:
Details about Accumulated Other
Comprehensive Income (Loss) Components
Amount Reclassified from Accumulated Other Comprehensive Income (Loss)1
 
Affected Line Item in the Statement Where Net Income Is Presented
 
Three Months Ended September 30,
 
(dollars in thousands)
2015

2014

 
Amortization of Unrealized Holding Gains (Losses) on
     Investment Securities Held-to-Maturity
$
(1,217
)
$
160

Interest Income
 
479

(63
)
Provision for Income Tax
 
(738
)
97

Net of Tax
Sale of Investment Securities Available-for-Sale
189


Investment Securities Gains, Net
 
(74
)

Provision for Income Tax
 
115


Net of tax
 
 
 
 
Amortization of Defined Benefit Plan Items
 
 
 
Prior Service Credit 2
81

81

 
Net Actuarial Losses 2
(443
)
(339
)
 
 
(362
)
(258
)
Total Before Tax
 
143

101

Provision for Income Tax
 
(219
)
(157
)
Net of Tax
 
 
 
 
Total Reclassifications for the Period
$
(842
)
$
(60
)
Net of Tax
 
 
 
 
Details about Accumulated Other
Comprehensive Income (Loss) Components
Amount Reclassified from Accumulated Other Comprehensive Income (Loss)1
 
Affected Line Item in the Statement Where Net Income Is Presented
 
Nine Months Ended September 30,
 
(dollars in thousands)
2015

2014

 
Amortization of Unrealized Holding Gains (Losses) on
     Investment Securities Held-to-Maturity
$
(1,702
)
$
825

Interest Income
 
670

(325
)
Provision for Income Tax
 
(1,032
)
500

Net of Tax
Sale of Investment Securities Available-for-Sale
189

64

Investment Securities Gains, Net
 
(74
)
(25
)
Provision for Income Tax
 
115

39

Net of tax
 
 
 
 
Amortization of Defined Benefit Plan Items
 
 
 
Prior Service Credit 2
242

242

 
Net Actuarial Losses 2
(1,330
)
(1,016
)
 
 
(1,088
)
(774
)
Total Before Tax
 
429

305

Provision for Income Tax
 
(659
)
(469
)
Net of Tax
 
 
 
 
Total Reclassifications for the Period
$
(1,576
)
$
70

Net of Tax
1 
Amounts in parentheses indicate reductions to net income.
2 
These accumulated other comprehensive income (loss) components are included in the computation of net periodic benefit cost and are included in Salaries and Benefits on the consolidated statements of income (see Note 10 for additional details).


31


Note 8.  Earnings Per Share

There were no adjustments to net income, the numerator, for purposes of computing earnings per share. The following is a reconciliation of the weighted average number of common shares outstanding for computing diluted earnings per share and antidilutive stock options and restricted stock outstanding for the three and nine months ended September 30, 2015 and 2014:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015

 
2014

 
2015

 
2014

Denominator for Basic Earnings Per Share
43,181,233

 
43,859,396

 
43,290,137

 
44,034,047

Dilutive Effect of Equity Based Awards
246,497

 
229,157

 
224,761

 
215,986

Denominator for Diluted Earnings Per Share
43,427,730

 
44,088,553

 
43,514,898

 
44,250,033

 
 
 
 
 
 
 
 
Antidilutive Stock Options and Restricted Stock Outstanding

 

 
4,546

 


Note 9.  Business Segments

The Company’s business segments are defined as Retail Banking, Commercial Banking, Investment Services, and Treasury and Other.  The Company’s internal management accounting process measures the performance of these business segments. This process, which is not necessarily comparable with similar information for any other financial institution, uses various techniques to assign balance sheet and income statement amounts to the business segments, including allocations of income, expense, the provision for credit losses, and capital.  This process is dynamic and requires certain allocations based on judgment and other subjective factors.  Unlike financial accounting, there is no comprehensive authoritative guidance for management accounting that is equivalent to GAAP.  Previously reported results have been reclassified to conform to the current reporting structure.

The net interest income of the business segments reflects the results of a funds transfer pricing process that matches assets and liabilities with similar interest rate sensitivity and maturity characteristics and reflects the allocation of net interest income related to the Company’s overall asset and liability management activities on a proportionate basis.  The basis for the allocation of net interest income is a function of the Company’s assumptions that are subject to change based on changes in current interest rates and market conditions.  Funds transfer pricing also serves to transfer interest rate risk to Treasury.  However, the other business segments have some latitude to retain certain interest rate exposures related to customer pricing decisions within guidelines.

The provision for credit losses reflects the actual net charge-offs of the business segments.  The amount of the consolidated provision for loan and lease losses is based on the methodology that we use to estimate our consolidated Allowance.  The residual provision for credit losses to arrive at the consolidated provision for credit losses is included in Treasury and Other.

Noninterest income and expense includes allocations from support units to business units.  These allocations are based on actual usage where practicably calculated or by management’s estimate of such usage.

The provision for income taxes is allocated to business segments using a 37% effective tax rate. However, the provision for income taxes for our Leasing business unit (included in the Commercial Banking segment) and Auto Leasing portfolio and Pacific Century Life Insurance business unit (both included in the Retail Banking segment) are assigned their actual effective tax rates due to the unique relationship that income taxes have with their products. The residual income tax expense or benefit to arrive at the consolidated effective tax rate is included in Treasury and Other.

Retail Banking

Retail Banking offers a broad range of financial products and services to consumers and small businesses.  Loan and lease products include residential mortgage loans, home equity lines of credit, automobile loans and leases, personal lines of credit, installment loans, small business loans and leases, and credit cards.  Deposit products include checking, savings, and time deposit accounts.  Retail Banking also offers retail insurance products.  Products and services from Retail Banking are delivered to customers through 72 branch locations and 455 ATMs throughout Hawaii and the Pacific Islands, e-Bankoh (on-line banking service), a 24-hour customer service center, and a mobile banking service.


32


Commercial Banking

Commercial Banking offers products including corporate banking, commercial real estate loans, commercial lease financing, auto dealer financing, and deposit products.  Commercial lending and deposit products are offered to middle-market and large companies in Hawaii and the Pacific Islands.  Commercial real estate mortgages focus on customers that include investors, developers, and builders predominantly domiciled in Hawaii.  Commercial Banking also includes international banking and provides merchant services to its small business customers.

Investment Services

Investment Services includes private and international client banking, trust services, investment management, and institutional investment advisory services.  A significant portion of this segment’s income is derived from fees, which are generally based on the market values of assets under management.  The private banking and personal trust group assists individuals and families in building and preserving their wealth by providing investment, credit, and trust services to high-net-worth individuals.  The investment management group manages portfolios utilizing a variety of investment products. Institutional client services offer investment advice to corporations, government entities, and foundations.  This segment also provides a full service brokerage offering equities, mutual funds, life insurance, and annuity products.

Treasury and Other

Treasury consists of corporate asset and liability management activities, including interest rate risk management and a foreign currency exchange business.  This segment’s assets and liabilities (and related interest income and expense) consist of interest-bearing deposits, investment securities, federal funds sold and purchased, government deposits, and short and long-term borrowings.  The primary sources of noninterest income are from bank-owned life insurance, net gains from the sale of investment securities, and foreign exchange income related to customer-driven currency requests from merchants and island visitors.  The net residual effect of the transfer pricing of assets and liabilities is included in Treasury, along with the elimination of intercompany transactions.

Other organizational units (Technology, Operations, Marketing, Human Resources, Finance, Credit and Risk Management, and Corporate and Regulatory Administration) provide a wide-range of support to the Company’s other income earning segments.  Expenses incurred by these support units are charged to the business segments through an internal cost allocation process.


33


Selected business segment financial information as of and for the three and nine months ended September 30, 2015 and 2014 were as follows:
(dollars in thousands)
Retail Banking

 
Commercial Banking

 
Investment Services

 
Treasury
and Other

 
Consolidated Total

Three Months Ended September 30, 2015
 

 
 

 
 

 
 

 
 

Net Interest Income
$
51,732

 
$
37,133

 
$
4,517

 
$
4,509

 
$
97,891

Provision for Credit Losses
2,209

 
(226
)
 
(20
)
 
(1,963
)
 

Net Interest Income After Provision for Credit Losses
49,523

 
37,359

 
4,537

 
6,472

 
97,891

Noninterest Income
21,206

 
4,777

 
14,363

 
2,875

 
43,221

Noninterest Expense
(49,963
)
 
(25,482
)
 
(14,031
)
 
(2,412
)
 
(91,888
)
Income Before Provision for Income Taxes
20,766

 
16,654

 
4,869

 
6,935

 
49,224

Provision for Income Taxes
(7,352
)
 
(5,586
)
 
(1,802
)
 
(208
)
 
(14,948
)
Net Income
$
13,414

 
$
11,068

 
$
3,067

 
$
6,727

 
$
34,276

Total Assets as of September 30, 2015
$
4,578,333

 
$
3,102,549

 
$
232,641

 
$
7,250,600

 
$
15,164,123

 
 
 
 
 
 
 
 
 


Three Months Ended September 30, 2014
 

 
 

 
 

 
 

 


Net Interest Income
$
45,432

 
$
31,780

 
$
3,864

 
$
14,303

 
$
95,379

Provision for Credit Losses
1,853

 
(834
)
 
(9
)
 
(3,675
)
 
(2,665
)
Net Interest Income After Provision for Credit Losses
43,579

 
32,614

 
3,873

 
17,978

 
98,044

Noninterest Income
20,132

 
5,818

 
14,467

 
4,533

 
44,950

Noninterest Expense
(48,569
)
 
(16,410
)
 
(13,616
)
 
(2,435
)
 
(81,030
)
Income Before Provision for Income Taxes
15,142

 
22,022

 
4,724

 
20,076

 
61,964

Provision for Income Taxes
(5,498
)
 
(7,599
)
 
(1,751
)
 
(5,347
)
 
(20,195
)
Net Income
$
9,644

 
$
14,423

 
$
2,973

 
$
14,729

 
$
41,769

Total Assets as of September 30, 2014
$
3,896,841

 
$
2,680,761

 
$
192,739

 
$
7,739,825

 
$
14,510,166

 
 
 
 
 
 
 
 
 


Nine Months Ended September 30, 2015
 

 
 

 
 

 
 

 


Net Interest Income
$
150,631

 
$
107,292

 
$
13,153

 
$
21,367

 
$
292,443

Provision for Credit Losses
5,660

 
(956
)
 
(36
)
 
(4,668
)
 

Net Interest Income After Provision for Credit Losses
144,971

 
108,248

 
13,189

 
26,035

 
292,443

Noninterest Income
61,123

 
16,125

 
44,770

 
19,435

 
141,453

Noninterest Expense
(149,461
)
 
(59,786
)
 
(43,193
)
 
(9,937
)
 
(262,377
)
Income Before Provision for Income Taxes
56,633

 
64,587

 
14,766

 
35,533

 
171,519

Provision for Income Taxes
(20,097
)
 
(22,449
)
 
(5,463
)
 
(5,638
)
 
(53,647
)
Net Income
$
36,536

 
$
42,138

 
$
9,303

 
$
29,895

 
$
117,872

Total Assets as of September 30, 2015
$
4,578,333

 
$
3,102,549

 
$
232,641

 
$
7,250,600

 
$
15,164,123

 
 
 
 
 
 
 
 
 


Nine Months Ended September 30, 2014
 

 
 

 
 

 
 

 


Net Interest Income
$
130,971

 
$
86,934

 
$
11,098

 
$
54,021

 
$
283,024

Provision for Credit Losses
2,895

 
(2,164
)
 
(303
)
 
(5,292
)
 
(4,864
)
Net Interest Income After Provision for Credit Losses
128,076

 
89,098

 
11,401

 
59,313

 
287,888

Noninterest Income
59,473

 
17,617

 
43,228

 
13,881

 
134,199

Noninterest Expense
(146,581
)
 
(49,834
)
 
(41,379
)
 
(7,865
)
 
(245,659
)
Income Before Provision for Income Taxes
40,968

 
56,881

 
13,250

 
65,329

 
176,428

Provision for Income Taxes
(15,248
)
 
(19,343
)
 
(4,912
)
 
(15,074
)
 
(54,577
)
Net Income
$
25,720

 
$
37,538

 
$
8,338

 
$
50,255

 
$
121,851

Total Assets as of September 30, 2014
$
3,896,841

 
$
2,680,761

 
$
192,739

 
$
7,739,825

 
$
14,510,166



34


Note 10.  Pension Plans and Postretirement Benefit Plan
Components of net periodic benefit cost for the Company’s pension plans and the postretirement benefit plan are presented in the following table for the three and nine months ended September 30, 2015 and 2014.
 
Pension Benefits
 
Postretirement Benefits
(dollars in thousands)
2015

 
2014

 
2015

 
2014

Three Months Ended September 30,
 

 
 

 
 

 
 

Service Cost
$

 
$

 
$
182

 
$
157

Interest Cost
1,186

 
1,242

 
74

 
348

Expected Return on Plan Assets
(1,304
)
 
(1,275
)
 

 

Amortization of:
 

 
 

 
 

 
 

Prior Service Credit

 

 
(81
)
 
(81
)
Net Actuarial Losses (Gains)
443

 
352

 

 
(13
)
Net Periodic Benefit Cost
$
325

 
$
319

 
$
175

 
$
411

 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 

 
 

 
 

 
 

Service Cost
$

 
$

 
$
546

 
$
471

Interest Cost
3,559

 
3,727

 
722

 
1,043

Expected Return on Plan Assets
(3,913
)
 
(3,825
)
 

 

Amortization of:
 

 
 

 
 

 
 

Prior Service Credit

 

 
(242
)
 
(242
)
Net Actuarial Losses (Gains)
1,330

 
1,055

 

 
(39
)
Net Periodic Benefit Cost
$
976

 
$
957

 
$
1,026

 
$
1,233


The net periodic benefit cost for the Company’s pension plans and postretirement benefit plan are recorded as a component of salaries and benefits in the consolidated statements of income.  For the three and nine months ended September 30, 2015, the Company contributed $0.2 million and $0.4 million, respectively, to the pension plans and $0.3 million and $1.1 million, respectively, to the postretirement benefit plan.  The Company expects to contribute $0.5 million to the pension plans and $1.4 million to the postretirement benefit plan for the year ending December 31, 2015.

Note 11.  Derivative Financial Instruments

The notional amount and fair value of the Company's derivative financial instruments as of September 30, 2015 and December 31, 2014 were as follows:
 
 
September 30, 2015
 
 
December 31, 2014
(dollars in thousands)
Notional Amount
 
 
Fair Value

 
Notional Amount
 
 
Fair Value

Interest Rate Lock Commitments
 
$
7,920

 
$
437

 
 
$
2,354

 
$
152

Forward Commitments
 
6,806

 
(13
)
 
 
5,404

 
(13
)
Interest Rate Swap Agreements
 
 
 
 
 
 
 
 
 
Receive Fixed/Pay Variable Swaps
 
202,818

 
15,567

 
 
183,283

 
16,206

Pay Fixed/Receive Variable Swaps
 
202,818

 
(15,602
)
 
 
183,283

 
(16,240
)
Foreign Exchange Contracts
 
41,880

 
160

 
 
44,240

 
(345
)

The following table presents the Company’s derivative financial instruments, their fair values, and balance sheet location as of September 30, 2015 and December 31, 2014:
Derivative Financial Instruments
September 30, 2015
 
December 31, 2014
Not Designated as Hedging Instruments 1
Asset

 
Liability

 
Asset

 
Liability

(dollars in thousands)
Derivatives

 
Derivatives

 
Derivatives

 
Derivatives

Interest Rate Lock Commitments
$
437

 
$

 
$
152

 
$

Forward Commitments

 
13

 

 
13

Interest Rate Swap Agreements
16,177

 
16,212

 
16,262

 
16,296

Foreign Exchange Contracts
186

 
26

 
101

 
446

Total
$
16,800

 
$
16,251

 
$
16,515

 
$
16,755

1 
Asset derivatives are included in other assets and liability derivatives are included in other liabilities in the consolidated statements of condition.


35


The following table presents the Company’s derivative financial instruments and the amount and location of the net gains and losses recognized in the consolidated statements of income for the three and nine months ended September 30, 2015 and 2014:
 
Location of
 
 
 
 
 
 
 
 
Derivative Financial Instruments
Net Gains (Losses)
 
Three Months Ended
 
Nine Months Ended
Not Designated as Hedging Instruments
Recognized in the
 
September 30,
 
September 30,
(dollars in thousands)
Statements of Income
 
2015

 
2014

 
2015

 
2014

Interest Rate Lock Commitments
Mortgage Banking
 
$
755

 
$
363

 
$
2,165

 
$
2,244

Forward Commitments
Mortgage Banking
 
(210
)
 
3

 
(63
)
 
(483
)
Interest Rate Swap Agreements
Other Noninterest Income
 
429

 
12

 
836

 
126

Foreign Exchange Contracts
Other Noninterest Income
 
788

 
756

 
2,134

 
2,199

Conversion Rate Swap Agreement
Investment Securities Gains, Net
 

 
(123
)
 

 
(123
)
Total
 
 
$
1,762

 
$
1,011

 
$
5,072

 
$
3,963


Management has received authorization from the Bank’s Board of Directors to use derivative financial instruments as an end-user in connection with the Bank's risk management activities and to accommodate the needs of the Bank's customers.  As with any financial instrument, derivative financial instruments have inherent risks.  Market risk is defined as the risk of adverse financial impact due to fluctuations in interest rates, foreign exchange rates, and equity prices.  Market risks associated with derivative financial instruments are balanced with the expected returns to enhance earnings performance and shareholder value, while limiting the volatility of each.  The Company uses various processes to monitor its overall market risk exposure, including sensitivity analysis, value-at-risk calculations, and other methodologies.

Derivative financial instruments are also subject to credit and counterparty risk, which is defined as the risk of financial loss if a borrower or counterparty is either unable or unwilling to repay borrowings or settle transactions in accordance with the underlying contractual terms.  Credit and counterparty risks associated with derivative financial instruments are similar to those relating to traditional financial instruments.  The Company manages derivative credit and counterparty risk by evaluating the creditworthiness of each borrower or counterparty, adhering to the same credit approval process used for commercial lending activities.

As of September 30, 2015 and December 31, 2014, the Company did not designate any derivative financial instruments as formal hedging relationships.  The Company’s free-standing derivative financial instruments are required to be carried at their fair value on the Company’s consolidated statements of condition.  These financial instruments have been limited to interest rate lock commitments (“IRLCs”), forward commitments, interest rate swap agreements, foreign exchange contracts, and conversion rate swap agreements.

The Company enters into IRLCs for residential mortgage loans which commit us to lend funds to a potential borrower at a specific interest rate and within a specified period of time.  IRLCs that relate to the origination of mortgage loans that will be held for sale are considered derivative financial instruments under applicable accounting guidance.  Outstanding IRLCs expose the Company to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan.  To mitigate this risk, the Company utilizes forward commitments as economic hedges against the potential decreases in the values of the loans held for sale.  IRLCs and forward commitments are free-standing derivatives which are carried at fair value with changes recorded in the mortgage banking component of noninterest income in the Company’s consolidated statements of income.

The Company enters into interest rate swap agreements to facilitate the risk management strategies of a small number of commercial banking customers.  The Company mitigates the risk of entering into these agreements by entering into equal and offsetting interest rate swap agreements with highly rated third party financial institutions.  The interest rate swap agreements are free-standing derivatives and are recorded at fair value in the Company's consolidated statements of condition. Fair value changes are recorded in other noninterest income in the Company’s consolidated statements of income.  The Company is party to master netting arrangements with its financial institution counterparties; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes.  Collateral, usually in the form of marketable securities, is posted by the counterparty with net liability positions in accordance with contract thresholds.  See Note 6 to the Consolidated Financial Statements for more information.

The Company’s interest rate swap agreements with institutional counterparties contain credit-risk-related contingent features tied to the Company’s debt ratings or capitalization levels.  Under these provisions, if the Company’s debt rating falls below investment grade or if the Company’s capitalization levels fall below stipulated thresholds, certain counterparties may require immediate and ongoing collateralization on interest rate swaps in net liability positions, or may require immediate settlement of

36


the contracts.  As of September 30, 2015, the Company’s debt ratings and capital levels were in excess of these minimum requirements.

The Company utilizes foreign exchange contracts to offset risks related to transactions executed on behalf of customers.  The foreign exchange contracts are free-standing derivatives which are carried at fair value with changes included in other noninterest income in the Company’s consolidated statements of income.

As each sale of Visa Class B restricted shares was completed, the Company entered into a conversion rate swap agreement with the buyer that requires payment to the buyer in the event Visa further reduces the conversion ratio of Class B into Class A unrestricted common shares.  In the event of Visa increasing the conversion ratio, the buyer would be required to make payment to the Company.  This conversion rate swap agreement is usually valued at zero (i.e., no contingent liability recorded) as a drop in the conversion ratio is deemed by the Company to be neither probable nor reasonably estimable.  However, in September 2014, Visa announced a reduction of the conversion ratio. As a result, the Company recorded a $0.1 million liability in September 2014 which represented the amount paid to the buyer in October 2014.  As of September 30, 2015, the conversion rate swap agreement was valued at zero as further reductions to the conversion ratio were deemed neither probable nor reasonably estimable by management. See Note 2 to the Consolidated Financial Statements for more information.

Note 12.  Commitments, Contingencies, and Guarantees
The Company’s credit commitments as of September 30, 2015 and December 31, 2014 were as follows:
(dollars in thousands)
September 30,
2015

 
December 31,
2014

Unfunded Commitments to Extend Credit
$
2,477,839

 
$
2,388,432

Standby Letters of Credit
43,952

 
48,157

Commercial Letters of Credit
17,669

 
14,130

Total Credit Commitments
$
2,539,460

 
$
2,450,719


Unfunded Commitments to Extend Credit

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of the terms or conditions established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since commitments may expire without being drawn, the total commitment amount does not necessarily represent future cash requirements.

Standby and Commercial Letters of Credit

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  Standby letters of credit generally become payable upon the failure of the customer to perform according to the terms of the underlying contract with the third party, while commercial letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn on when the underlying transaction is consummated between the customer and a third party.  The contractual amount of these letters of credit represents the maximum potential future payments guaranteed by the Company.  The Company has recourse against the customer for any amount it is required to pay to a third party under a standby letter of credit, and generally holds cash or deposits as collateral on those standby letters of credit for which collateral is deemed necessary.

Contingencies

The Company is subject to various pending and threatened legal proceedings arising out of the normal course of business or operations. On at least a quarterly basis, the Company assesses its liabilities and contingencies in connection with outstanding legal proceedings utilizing the most recent information available. On a case-by-case basis, reserves are established for those legal claims for which it is probable that a loss will be incurred and the amount of such loss can be reasonably estimated. Based on information currently available, management believes that the eventual outcome of these other actions against the Company will not be materially in excess of such amounts reserved by the Company. However, in the event of unexpected future developments, it is possible that the ultimate resolution of those matters may result in a loss that materially exceeds the reserves established by the Company.

37



Risks Related to Representation and Warranty Provisions

The Company sells residential mortgage loans in the secondary market primarily to the Federal National Mortgage Association ("Fannie Mae"). The Company also pools Federal Housing Administration (“FHA”) insured and U.S. Department of Veterans Affairs (“VA”) guaranteed residential mortgage loans for sale to the Government National Mortgage Corporation ("Ginnie Mae"). These pools of FHA-insured and VA-guaranteed residential mortgage loans are securitized by Ginnie Mae. The agreements under which the Company sells residential mortgage loans to Fannie Mae or Ginnie Mae and the insurance or guaranty agreements with FHA and VA contain provisions that include various representations and warranties regarding the origination and characteristics of the residential mortgage loans. Although the specific representations and warranties vary among investors, insurance or guarantee agreements, they typically cover ownership of the loan, validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing the loan, compliance with loan criteria set forth in the applicable agreement, compliance with applicable federal, state, and local laws, and other matters. As of September 30, 2015, the unpaid principal balance of residential mortgage loans sold by the Company was $2.6 billion. The agreements under which the Company sells residential mortgage loans require delivery of various documents to the investor or its document custodian. Although these loans are primarily sold on a non-recourse basis, the Company may be obligated to repurchase residential mortgage loans or reimburse investors for losses incurred if a loan review reveals that underwriting and documentation standards were potentially not met. Some agreements may require the Company to repurchase delinquent loans. Upon receipt of a repurchase request, the Company works with investors or insurers to arrive at a mutually agreeable resolution. Repurchase demands are typically reviewed on an individual loan by loan basis to validate the claims made by the investor or insurer and to determine if a contractually required repurchase event has occurred. The Company manages the risk associated with potential repurchases or other forms of settlement through its underwriting and quality assurance practices and by servicing mortgage loans to meet investor and secondary market standards. During the nine months ended September 30, 2015, there were three residential mortgage loans repurchased with an aggregate unpaid principal balance of $0.9 million as a result of the representation and warranty provisions contained in these contracts. Two of these loans were delinquent as to principal and interest at the time of repurchase, however, no losses were incurred related to these repurchases. As of September 30, 2015, there were no pending repurchase requests related to representation and warranty provisions.

Risks Relating to Residential Mortgage Loan Servicing Activities

In addition to servicing loans in the Company's portfolio, substantially all of the loans the Company sells to investors are sold with servicing rights retained. The Company also services loans originated by other mortgage loan originators. As servicer, the Company's primary duties are to: (1) collect payments due from borrowers; (2) advance certain delinquent payments of principal and interest; (3) maintain and administer any hazard, title, or primary mortgage insurance policies relating to the mortgage loans; (4) maintain any required escrow accounts for payment of taxes and insurance and administer escrow payments; and (5) foreclose on defaulted mortgage loans or, to the extent consistent with the documents governing a securitization, consider alternatives to foreclosure, such as loan modifications or short sales. Each agreement under which the Company acts as servicer generally specifies a standard of responsibility for actions taken by the Company in such capacity and provides protection against expenses and liabilities incurred by the Company when acting in compliance with the respective servicing agreements. However, if the Company commits a material breach of obligations as servicer, the Company may be subject to termination if the breach is not cured within a specified period following notice. The standards governing servicing and the possible remedies for violations of such standards vary by investor. These standards and remedies are determined by servicing guides issued by the investors as well as the contract provisions established between the investors and the Company. Remedies could include repurchase of an affected loan. For the nine months ended September 30, 2015, there were no loans repurchased related to loan servicing activities. As of September 30, 2015, there were no pending repurchase requests related to loan servicing activities.

Although to date repurchase requests related to representation and warranty provisions and servicing activities have been limited, it is possible that requests to repurchase mortgage loans may increase in frequency as investors more aggressively pursue all means of recovering losses on their purchased loans. However, as of September 30, 2015, management believes that this exposure is not material due to the historical level of repurchase requests and loss trends and thus has not established a liability for losses related to mortgage loan repurchases. As of September 30, 2015, 99% of the Company's residential mortgage loans serviced for investors were current. The Company maintains ongoing communications with investors and continues to evaluate this exposure by monitoring the level and number of repurchase requests as well as the delinquency rates in the loans sold to investors.


38


Note 13.  Fair Value of Assets and Liabilities

Fair Value Hierarchy

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date.  GAAP established a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:
Level 1:
Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets.  A quoted price in an active market provides the most reliable evidence of fair value and is used to measure fair value whenever available.  A contractually binding sales price also provides reliable evidence of fair value.
 
 
Level 2:
Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that utilize model-based techniques for which all significant assumptions are observable in the market.
 
 
Level 3:
Inputs to the valuation methodology are unobservable and significant to the fair value measurement; inputs to the valuation methodology that utilize model-based techniques for which significant assumptions are not observable in the market; or inputs to the valuation methodology that require significant management judgment or estimation, some of which may be internally developed.
Management maximizes the use of observable inputs and minimizes the use of unobservable inputs when determining fair value measurements.  Management reviews and updates the fair value hierarchy classifications of the Company’s assets and liabilities on a quarterly basis.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Investment Securities Available-for-Sale

Fair values of investment securities available-for-sale were primarily measured using information from a third-party pricing service.  This service provides pricing information by utilizing evaluated pricing models supported with market data information.  Standard inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data from market research publications.  Level 1 investment securities are comprised of debt securities issued by the U.S. Treasury, as quoted prices were available, unadjusted, for identical securities in active markets.  Level 2 investment securities were primarily comprised of debt securities issued by the Small Business Administration, states and municipalities, corporations, as well as mortgage-backed securities issued by government agencies and government-sponsored enterprises.  Fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models.  In cases where there may be limited or less transparent information provided by the Company’s third-party pricing service, fair value may be estimated by the use of secondary pricing services or through the use of non-binding third-party broker quotes.

On a quarterly basis, management reviews the pricing information received from the Company’s third-party pricing service.  This review process includes a comparison to non-binding third-party broker quotes, as well as a review of market-related conditions impacting the information provided by the Company’s third-party pricing service.  Management primarily identifies investment securities which may have traded in illiquid or inactive markets by identifying instances of a significant decrease in the volume or frequency of trades relative to historical levels, as well as instances of a significant widening of the bid-ask spread in the brokered markets.  Investment securities that are deemed to have been trading in illiquid or inactive markets may require the use of significant unobservable inputs to determine fair value.  As of September 30, 2015 and December 31, 2014, management did not make adjustments to prices provided by the third-party pricing service as a result of illiquid or inactive markets.  On a quarterly basis, management also reviews a sample of securities priced by the Company’s third-party pricing service to review significant assumptions and valuation methodologies used.  Based on this review, management determines whether the current placement of the security in the fair value hierarchy is appropriate or whether transfers may be warranted.  The Company’s third-party pricing service has also established processes for us to submit inquiries regarding quoted prices.  Periodically, we will challenge the quoted prices provided by our third-party pricing service.  The Company’s third-party

39


pricing service will review the inputs to the evaluation in light of the new market data presented by us.  The Company’s third-party pricing service may then affirm the original quoted price or may update the evaluation on a going forward basis.

Loans Held for Sale

The fair value of the Company’s residential mortgage loans held for sale was determined based on quoted prices for similar loans in active markets, and therefore, is classified as a Level 2 measurement.

Mortgage Servicing Rights

Mortgage servicing rights do not trade in an active market with readily observable market data.  As a result, the Company estimates the fair value of mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income.  The Company stratifies its mortgage servicing portfolio on the basis of loan type.  The assumptions used in the discounted cash flow model are those that we believe market participants would use in estimating future net servicing income.  Significant assumptions in the valuation of mortgage servicing rights include estimated loan repayment rates, the discount rate, servicing costs, and the timing of cash flows, among other factors.  Mortgage servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation.

Other Assets

Other assets recorded at fair value on a recurring basis are primarily comprised of investments related to deferred compensation arrangements.  Quoted prices for these investments, primarily in mutual funds, are available in active markets.  Thus, the Company’s investments related to deferred compensation arrangements are classified as Level 1 measurements in the fair value hierarchy.

Derivative Financial Instruments

Derivative financial instruments recorded at fair value on a recurring basis are comprised of interest rate lock commitments (“IRLCs”), forward commitments, interest rate swap agreements, foreign exchange contracts, and Visa Class B to Class A shares conversion rate swap agreements.  The fair values of IRLCs are calculated based on the value of the underlying loan, which in turn is based on quoted prices for similar loans in the secondary market.  However, this value is adjusted by a factor which considers the likelihood that the loan in a locked position will ultimately close.  This factor, the closing ratio, is derived from the Bank’s internal data and is adjusted using significant management judgment.  As such, IRLCs are classified as Level 3 measurements.  Forward commitments are classified as Level 2 measurements as they are primarily based on quoted prices from the secondary market based on the settlement date of the contracts, interpolated or extrapolated, if necessary, to estimate a fair value as of the end of the reporting period.  The fair values of interest rate swap agreements are calculated using a discounted cash flow approach and utilize Level 2 observable inputs such as the LIBOR swap curve, effective date, maturity date, notional amount, and stated interest rate.  In addition, the Company includes in its fair value calculation a credit factor adjustment which is based primarily on management judgment.  Thus, interest rate swap agreements are classified as a Level 3 measurement.  The fair values of foreign exchange contracts are calculated using the Bank’s multi-currency accounting system which utilizes contract specific information such as currency, maturity date, contractual amount, and strike price, along with market data information such as the spot rates of specific currency and yield curves.  Foreign exchange contracts are classified as Level 2 measurements because while they are valued using the Bank’s multi-currency accounting system, significant management judgment or estimation is not required. The fair value of the Visa Class B restricted shares to Class A unrestricted common shares conversion rate swap agreement represents the amount owed by the Company to the buyer of the Visa Class B shares as a result of a reduction of the conversion ratio subsequent to the sales dates. As of September 30, 2015 and December 31, 2014, the conversion rate swap agreement was valued at zero as reductions to the conversion ratio were neither probable nor reasonably estimable by management. This conversion rate swap agreement is classified as a Level 2 measurement. See Note 11 to the Consolidated Financial Statements for more information.

The Company is exposed to credit risk if borrowers or counterparties fail to perform.  The Company seeks to minimize credit risk through credit approvals, limits, monitoring procedures, and collateral requirements.  The Company generally enters into transactions with borrowers and counterparties that carry high quality credit ratings.  Credit risk associated with borrowers or counterparties as well as the Company’s non-performance risk is factored into the determination of the fair value of derivative financial instruments.


40


The table below presents the balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014:
 
Quoted Prices
in Active
Markets for
Identical Assets
or Liabilities

 
Significant
Other
Observable
Inputs

 
Significant
Unobservable
Inputs

 
 

(dollars in thousands)
(Level 1)

 
(Level 2)

 
(Level 3)

 
Total

September 30, 2015
 

 
 

 
 

 
 

Assets:
 

 
 

 
 

 
 

Investment Securities Available-for-Sale
 

 
 

 
 

 
 

Debt Securities Issued by the U.S. Treasury
      and Government Agencies
$
60,706

 
$
307,951

 
$

 
$
368,657

Debt Securities Issued by States and Political Subdivisions

 
737,210

 

 
737,210

Debt Securities Issued by Corporations

 
310,561

 

 
310,561

Mortgage-Backed Securities:
 

 
 

 
 

 


  Residential - Government Agencies

 
348,469

 

 
348,469

  Residential - U.S. Government-Sponsored Enterprises

 
412,261

 

 
412,261

    Commercial - Government Agencies

 
102,564

 

 
102,564

Total Mortgage-Backed Securities

 
863,294

 

 
863,294

Total Investment Securities Available-for-Sale
60,706

 
2,219,016



 
2,279,722

Loans Held for Sale

 
3,222

 

 
3,222

Mortgage Servicing Rights

 

 
2,072

 
2,072

Other Assets
19,548

 

 

 
19,548

Derivatives 1

 
186

 
16,614

 
16,800

Total Assets Measured at Fair Value on a
Recurring Basis as of September 30, 2015
$
80,254

 
$
2,222,424

 
$
18,686

 
$
2,321,364

 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

Derivatives 1
$

 
$
39

 
$
16,212

 
$
16,251

Total Liabilities Measured at Fair Value on a
Recurring Basis as of September 30, 2015
$

 
$
39


$
16,212

 
$
16,251

 
 
 
 
 
 
 
 
December 31, 2014
 

 
 

 
 

 
 

Assets:
 

 
 

 
 

 
 

Investment Securities Available-for-Sale
 

 
 

 
 

 
 

Debt Securities Issued by the U.S. Treasury
      and Government Agencies
$
61,271

 
$
269,987

 
$

 
$
331,258

Debt Securities Issued by States and Political Subdivisions

 
743,970

 

 
743,970

Debt Securities Issued by Corporations

 
294,833

 

 
294,833

Mortgage-Backed Securities:
 

 
 

 
 

 


  Residential - Government Agencies

 
462,436

 

 
462,436

  Residential - U.S. Government-Sponsored Enterprises

 
278,461

 

 
278,461

    Commercial - Government Agencies

 
178,232

 

 
178,232

Total Mortgage-Backed Securities

 
919,129




919,129

Total Investment Securities Available-for-Sale
61,271

 
2,227,919



 
2,289,190

Loans Held for Sale

 
5,136

 

 
5,136

Mortgage Servicing Rights

 

 
2,604

 
2,604

Other Assets
18,794

 

 

 
18,794

Derivatives 1

 
101

 
16,414

 
16,515

Total Assets Measured at Fair Value on a
Recurring Basis as of December 31, 2014
$
80,065

 
$
2,233,156

 
$
19,018

 
$
2,332,239

 
 
 
 
 
 
 


Liabilities:
 

 
 

 
 

 


Derivatives 1
$

 
$
459

 
$
16,296

 
$
16,755

Total Liabilities Measured at Fair Value on a
Recurring Basis as of December 31, 2014
$

 
$
459


$
16,296

 
$
16,755

1 
The fair value of each class of derivatives is shown in Note 11 to the Consolidated Financial Statements.

41


For the three and nine months ended September 30, 2015 and 2014, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis were as follows:
(dollars in thousands)
Mortgage
Servicing Rights 1

 
Net Derivative
Assets and
Liabilities 2

Three Months Ended September 30, 2015
 

 
 

Balance as of July 1, 2015
$
2,188

 
$
370

Realized and Unrealized Net Gains (Losses):
 

 
 

Included in Net Income
(116
)
 
752

Transfers to Loans Held for Sale

 
(720
)
Balance as of September 30, 2015
$
2,072

 
$
402

Total Unrealized Net Gains (Losses) Included in Net Income
Related to Assets Still Held as of September 30, 2015
$

 
$
402

 
 
 
 
Three Months Ended September 30, 2014
 

 
 

Balance as of July 1, 2014
$
2,960

 
$
107

Realized and Unrealized Net Gains (Losses):
 

 
 

Included in Net Income
(217
)
 
369

Transfers to Loans Held for Sale

 
(408
)
Balance as of September 30, 2014
$
2,743

 
$
68

Total Unrealized Net Gains (Losses) Included in Net Income
Related to Assets Still Held as of September 30, 2014
$
(145
)
 
$
68

 
 
 
 
Nine Months Ended September 30, 2015
 

 
 

Balance as of January 1, 2015
$
2,604

 
$
118

Realized and Unrealized Net Gains (Losses):
 

 
 

Included in Net Income
(532
)
 
2,164

Transfers to Loans Held for Sale

 
(1,880
)
Balance as of September 30, 2015
$
2,072

 
$
402

Total Unrealized Net Gains (Losses) Included in Net Income
Related to Assets Still Held as of September 30, 2015
$
(251
)
 
$
402

 
 
 
 
Nine Months Ended September 30, 2014
 

 
 

Balance as of January 1, 2014
$
3,826

 
$
379

Realized and Unrealized Net Gains (Losses):
 

 
 

Included in Net Income
(1,083
)
 
2,363

Transfers to Loans Held for Sale

 
(2,674
)
Balance as of September 30, 2014
$
2,743

 
$
68

Total Unrealized Net Gains (Losses) Included in Net Income
Related to Assets Still Held as of September 30, 2014
$
(816
)
 
$
68

1 
Realized and unrealized gains and losses related to mortgage servicing rights are reported as a component of mortgage banking income in the Company’s consolidated statements of income.
2 
Realized and unrealized gains and losses related to interest rate lock commitments are reported as a component of mortgage banking income in the Company’s consolidated statements of income.  Realized and unrealized gains and losses related to interest rate swap agreements are reported as a component of other noninterest income in the Company’s consolidated statements of income.

42


For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of September 30, 2015 and December 31, 2014, the significant unobservable inputs used in the fair value measurements were as follows:
 
 
 
 
Significant Unobservable Inputs
(weighted-average)
 
Fair Value
(dollars in thousands)
 
Valuation
 Technique
 
Description
 
Sept. 30,
2015

 
Dec. 31,
2014

 
Sept. 30,
2015

 
Dec. 31,
2014

Mortgage Servicing Rights
 
Discounted Cash Flow
 
Constant Prepayment Rate 1
 
10.01
%
 
11.62
%
 
$
26,491

 
$
25,441

 
 
 
 
Discount Rate 2
 
9.71
%
 
10.61
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Derivative Assets and Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest Rate Lock Commitments
 
Pricing Model
 
Closing Ratio
 
92.32
%
 
93.85
%
 
$
437

 
$
152

Interest Rate Swap Agreements
 
Discounted Cash Flow
 
Credit Factor
 
0.21
%
 
0.21
%
 
$
(35
)
 
$
(34
)
1 
Represents annualized loan repayment rate assumption.
2 
Derived from multiple interest rate scenarios that incorporate a spread to the London Interbank Offered Rate swap curve and market volatilities.
The significant unobservable inputs used in the fair value measurement of the Company’s mortgage servicing rights are the weighted-average constant prepayment rate and weighted-average discount rate. Significant increases (decreases) in any of those inputs in isolation could result in a significantly lower (higher) fair value measurement.  Although the constant prepayment rate and the discount rate are not directly interrelated, they generally move in opposite directions of each other.

The Company estimates the fair value of mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income.  The Company’s Treasury Division enters observable and unobservable inputs into the model to arrive at an estimated fair value.  To assess the reasonableness of the fair value measurement, the Treasury Division performs a back-test by applying the model to historical prepayment data.  The fair value and constant prepayment rate are also compared to forward-looking estimates to assess reasonableness.  The Treasury Division also compares the fair value of the Company’s mortgage servicing rights to a value calculated by an independent third party.  Discussions are held with members from the Treasury, Mortgage Banking, and Controllers Divisions, along with the independent third party to discuss and reconcile the fair value estimates and key assumptions used by the respective parties in arriving at those estimates.  A subcommittee of the Company’s Asset/Liability Management Committee is responsible for providing oversight over the valuation methodology and key assumptions.

The significant unobservable input used in the fair value measurement of the Company’s IRLCs is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close.  Generally, the fair value of an IRLC is positive (negative) if the prevailing interest rate is lower (higher) than the IRLC rate.  Therefore, an increase in the closing ratio (i.e., higher percentage of loans are estimated to close) will increase the gain or loss.  The closing ratio is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock.  The closing ratio is computed by our secondary marketing system using historical data and the ratio is periodically reviewed by the Company’s Secondary Marketing Department of the Mortgage Banking Division for reasonableness.

The unobservable input used in the fair value measurement of the Company’s interest rate swap agreements is the credit factor.  This factor represents the risk that a counterparty is either unable or unwilling to settle a transaction in accordance with the underlying contractual terms.  A significant increase (decrease) in the credit factor could result in a significantly lower (higher) fair value measurement.  The credit factor is determined by the Treasury Division based on the risk rating assigned to each counterparty in which the Company holds a net asset position.  The Company’s Credit Policy Committee periodically reviews and approves the Expected Default Frequency of the Economic Capital Model for Credit Risk.  The Expected Default Frequency is used as the credit factor for interest rate swap agreements.


43


Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company may be required periodically to measure certain assets and liabilities at fair value on a nonrecurring basis in accordance with GAAP.  These adjustments to fair value usually result from the application of lower-of-cost-or-fair value accounting or impairment write-downs of individual assets.  The following table represents the assets measured at fair value on a nonrecurring basis as of September 30, 2015 and December 31, 2014.

(dollars in thousands)
Fair Value
Hierarchy
 
Net Carrying
Amount

 
Valuation
Allowance

September 30, 2015
 
 
 
 
 
Mortgage Servicing Rights - amortization method
Level 3
 
$
21,229

 
$
21

Foreclosed Real Estate
Level 3
 
1,392

 

Other Assets - Equipment Held for Sale
Level 3
 
4,657

 
9,453

 
 
 
 
 
 
December 31, 2014
 
 
 
 
 
Mortgage Servicing Rights - amortization method
Level 3
 
$
22,091

 
$
57

Foreclosed Real Estate
Level 3
 
2,311

 
89


The write-down of mortgage servicing rights accounted for under the amortization method was primarily due to changes in certain key assumptions used to estimate fair value. As previously mentioned, all of the Company's mortgage servicing rights are classified as Level 3 measurements due to the use of significant unobservable inputs, as well as significant management judgment and estimation. The December 31, 2014 valuation allowance for the Company's foreclosed real estate related to one commercial property. This property was sold in the third quarter of 2015. The Company's equipment held for sale represents six aircraft that were previously on lease agreements. An impairment charge of $9.5 million (included in other noninterest expense in the Company's consolidated statements of income) was recorded in the third quarter of 2015 to reduce the carrying value to estimated fair value less cost to sell based on recent appraisals, market conditions, and management judgment. Due to the use of significant unobservable inputs combined with significant management judgment regarding the fair value of the six aircraft, the carrying value is deemed a Level 3 measurement. For segment reporting (see Note 9 to the Consolidated Financial Statements), the carrying value is included in the Commercial Banking segment. As appraisals on foreclosed real estate and equipment held for sale are not necessarily completed on the period end dates presented in the table above, the fair value information presented may not reflect the actual fair value as of September 30, 2015 and December 31, 2014.

Fair Value Option

The Company elected the fair value option for all residential mortgage loans held for sale originated on or after October 1, 2011.  This election allows for a more effective offset of the changes in fair values of the loans held for sale and the derivative financial instruments used to financially hedge them without having to apply complex hedge accounting requirements.  As noted above, the fair value of the Company’s residential mortgage loans held for sale was determined based on quoted prices for similar loans in active markets.

The following table reflects the difference between the aggregate fair value and the aggregate unpaid principal balance of the Company’s residential mortgage loans held for sale as of September 30, 2015 and December 31, 2014.
(dollars in thousands)
Aggregate Fair Value

 
Aggregate Unpaid Principal
 
 
Aggregate Fair Value
Less Aggregate
 Unpaid Principal
 
September 30, 2015
 

 
 
 

 
 
 

Loans Held for Sale
$
3,222

 
 
$
3,009

 
 
$
213

 
 
 
 
 
 
 
 
December 31, 2014
 

 
 
 

 
 
 

Loans Held for Sale
$
5,136

 
 
$
4,740

 
 
$
396

Changes in the estimated fair value of residential mortgage loans held for sale are reported as a component of mortgage banking income in the Company’s consolidated statements of income.  For the three and nine months ended September 30, 2015 and 2014, the net gains or losses from the change in fair value of the Company’s residential mortgage loans held for sale were not material.


44


Financial Instruments Not Recorded at Fair Value on a Recurring Basis

The assumptions used below are expected to approximate those that market participants would use in valuing these financial instruments.

Investment Securities Held-to-Maturity

The fair value of the Company’s investment securities held-to-maturity was primarily measured using information from a third-party pricing service.  Level 1 investment securities are comprised of debt securities issued by the U.S. Treasury as quoted prices were available, unadjusted, for identical securities in active markets.  If quoted prices were not available, fair values were estimated primarily by obtaining quoted prices for similar assets in active markets or through the use of pricing models.  In cases where there may be limited or less transparent information provided by the Company’s third-party pricing service, fair value may be estimated by the use of secondary pricing services or through the use of non-binding third-party broker quotes.

Loans

The fair value of the Company’s loans was estimated by discounting the expected future cash flows using the current interest rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  Loans were first segregated by type such as commercial, real estate, and consumer, and were then further segmented into fixed and variable rate and loan quality categories.  Expected future cash flows were projected based on contractual cash flows, adjusted for estimated prepayments.

Time Deposits

The fair values of the Company’s time deposits were estimated using discounted cash flow analyses.  The discount rates used were based on rates currently offered for deposits with similar remaining maturities.  The fair values of the Company’s time deposit liabilities do not take into consideration the value of the Company’s long-term relationships with depositors, which may have significant value.

Securities Sold Under Agreements to Repurchase

The fair value of the Company’s securities sold under agreements to repurchase was calculated using discounted cash flow analyses, applying discount rates currently offered for new agreements with similar remaining maturities and considering the Company’s non-performance risk.

Other Debt

The fair value of the Company’s other debt was calculated using a discounted cash flow approach and applying discount rates currently offered for new notes with similar remaining maturities and considering the Company’s non-performance risk.


45


The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments not recorded at fair value on a recurring basis as of September 30, 2015 and December 31, 2014.  This table excludes financial instruments for which the carrying amount approximates fair value.  For short-term financial assets such as cash and cash equivalents, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization.  For non-marketable equity securities such as Federal Home Loan Bank and Federal Reserve Bank stock, the carrying amount is a reasonable estimate of fair value as these securities can only be redeemed or sold at their par value and only to the respective issuing government supported institution or to another member institution.  For financial liabilities such as noninterest-bearing demand, interest-bearing demand, and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.
 
 
 
 
 
Fair Value Measurements
 
Carrying

 
 
 
Quoted Prices
 in Active
 Markets for
Identical
 Assets or
Liabilities

 
Significant
Other
Observable
Inputs

 
Significant
Unobservable
Inputs

(dollars in thousands)
Amount

 
Fair Value

 
(Level 1)

 
(Level 2)

 
(Level 3)

September 30, 2015
 

 
 

 
 

 
 

 
 

Financial Instruments - Assets
 

 
 

 
 

 
 

 
 

Investment Securities Held-to-Maturity
$
4,121,768

 
$
4,181,613

 
$
504,344

 
$
3,677,269

 
$

Loans 1
7,354,296

 
7,837,382

 

 

 
7,837,382

 
 
 


 
 
 
 
 
 
Financial Instruments - Liabilities
 

 


 
 

 
 

 
 

Time Deposits
1,186,245

 
1,190,119

 

 
1,190,119

 

Securities Sold Under Agreements to Repurchase
632,138

 
700,916

 

 
700,916

 

Other Debt 2
259,938

 
262,061

 

 
262,061

 

 
 
 


 
 
 
 
 
 
December 31, 2014
 

 


 
 

 
 

 
 

Financial Instruments - Assets
 

 


 
 

 
 

 
 

Investment Securities Held-to-Maturity
$
4,466,679

 
$
4,504,495

 
$
499,616

 
$
4,004,879

 
$

Loans 1
6,542,719

 
7,048,757

 

 

 
7,048,757

 
 
 
 
 
 
 
 
 
 
Financial Instruments - Liabilities
 

 


 
 

 
 

 
 

Time Deposits
1,434,001

 
1,437,064

 

 
1,437,064

 

Securities Sold Under Agreements to Repurchase
688,601

 
758,781

 

 
758,781

 

Other Debt 2
163,005

 
163,911

 

 
163,911

 

1 
Net of unearned income and the Allowance.
2 
Excludes capitalized lease obligations.


46


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by the fact that they do not relate strictly to historical or current facts and may include statements concerning, among other things, the anticipated economic and business environment in our service area and elsewhere, credit quality and other financial and business matters in future periods, our future results of operations and financial position, our business strategy and plans and our objectives and future operations. We also may make forward-looking statements in our other documents filed or furnished with the Securities and Exchange Commission. In addition, our senior management may make forward-looking statements orally to analysts, investors, representatives of the media and others.
Our forward-looking statements are based on numerous assumptions, any of which could prove to be inaccurate and actual results may differ materially from those projected because of a variety of risks and uncertainties, including, but not limited to: 1) general economic conditions either nationally, internationally, or locally may be different than expected, and particularly, any event that negatively impacts the tourism industry in Hawaii; 2) unanticipated changes in the securities markets, public debt markets, and other capital markets in the U.S. and internationally; 3) competitive pressures in the markets for financial services and products; 4) the impact of legislative and regulatory initiatives, particularly the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"); 5) changes in fiscal and monetary policies of the markets in which we operate; 6) the increased cost of maintaining or the Company's ability to maintain adequate liquidity and capital, based on the requirements adopted by the Basel Committee on Banking Supervision and U.S. regulators; 7) actual or alleged conduct which could harm our reputation; 8) changes in accounting standards; 9) changes in tax laws or regulations or the interpretation of such laws and regulations; 10) changes in our credit quality or risk profile that may increase or decrease the required level of our reserve for credit losses; 11) changes in market interest rates that may affect credit markets and our ability to maintain our net interest margin; 12) the impact of litigation and regulatory investigations of the Company, including costs, expenses, settlements, and judgments; 13) any failure in or breach of our operational systems, information systems or infrastructure, or those of our merchants, third party vendors and other service providers; 14) any interruption or breach of security of our information systems resulting in failures or disruptions in customer account management, general ledger processing, and loan or deposit systems; 15) changes to the amount and timing of proposed common stock repurchases; and 16) natural disasters, public unrest or adverse weather, public health, and other conditions impacting us and our customers' operations. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included under the section entitled “Risk Factors” in Part II of this report and Part I of our Annual Report on Form 10-K for the year ended December 31, 2014, and subsequent periodic and current reports filed with the U.S. Securities and Exchange Commission (the “SEC”). Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” and similar expressions are intended to identify forward-looking statements but are not exclusive means of identifying such statements. We undertake no obligation to update forward-looking statements to reflect later events or circumstances.

Overview

Bank of Hawaii Corporation (the “Parent”) is a Delaware corporation and a bank holding company headquartered in Honolulu, Hawaii.  The Parent’s principal operating subsidiary is Bank of Hawaii (the “Bank”).

The Bank, directly and through its subsidiaries, provides a broad range of financial services and products to businesses, consumers, and governments in Hawaii, Guam, and other Pacific Islands.  References to “we,” “our,” “us,” or the “Company” refer to the Parent and its subsidiaries that are consolidated for financial reporting purposes.

Our business strategy is to use our unique market knowledge, prudent management discipline and brand strength to deliver exceptional value to our stakeholders.
Hawaii Economy

General economic conditions in Hawaii remained positive during the third quarter of 2015 led by an active construction industry, stable tourism, low unemployment, and a strong real estate market.  For the first eight months of 2015, total visitor arrivals increased 4.1% while total visitor spending increased 3.1% compared to the same period in 2014. The statewide seasonally-adjusted unemployment rate was at 3.4% in September 2015 compared to 5.1% nationally. For the first nine months of 2015, the volume of single-family home sales on Oahu increased 4.9%, while the volume of condominium sales on Oahu increased 5.1% compared with the same period in 2014.  The median price of single-family home sales and condominium sales on Oahu increased 4.0% and 1.4%, respectively, for the first nine months of 2015 compared to the same period in 2014. As of

47


September 30, 2015, months of inventory of single-family homes and condominiums on Oahu remained low at 3.2 months and 3.5 months, respectively.

Earnings Summary

Net income for the third quarter of 2015 was $34.3 million, a decrease of $7.5 million or 18% compared to the same period in 2014.  Diluted earnings per share was $0.79 for the third quarter of 2015, a decrease of $0.16 or 17% compared to the same period in 2014. The Company has made a strategic decision to dispose of all of its remaining aircraft leases, which we substantially entered into in the 1990s, and accordingly, has recorded a $6.5 million after tax ($10.5 million pre-tax) impairment charge in the third quarter of 2015.

Our lower earnings for the third quarter of 2015 were primarily due to the following:

Other noninterest expense for the third quarter of 2015 was $24.8 million, an increase of $10.3 million or 72% compared to the same period in 2014. This increase was primarily due to a $9.5 million impairment charge on six aircraft which were previously on lease agreements (an additional $1.0 million was due to the expected loss on the pending sale of an aircraft lease and recorded in other noninterest income, see below). As we intend to sell these aircraft, the impairment charge reduced the carrying value of these aircraft to estimated fair value less cost to sell.
We recorded no provision for credit losses in the third quarter of 2015 compared to a $2.7 million negative provision recorded in the same period in 2014. The negative provision was primarily due to the reduction in the specific reserve related to one commercial client.
Net gains on sales of investment securities totaled less than $0.1 million in the third quarter of 2015 compared to $1.9 million during the same period in 2014. The net gain in the third quarter of 2014 was due to a $1.9 million gain on the sale of 23,000 Visa Class B shares. In the first quarter of 2015, we recorded a $10.1 million gain on the sale of 95,000 Visa Class B shares. The sale of Visa Class B shares was larger in the first quarter of 2015 due to our new counterparty's minimum transaction requirement. Due to the large first quarter sale, we did not sell additional Visa Class B shares during the second and third quarters, nor do we anticipate further sales of Visa Class B shares for the remainder of 2015. The Company received these Class B shares in 2008 as part of Visa's initial public offering and they are transferable only under limited circumstances until they can be converted to the publicly traded Class A shares. We also contributed to the Bank of Hawaii Foundation 4,500 and 5,700 Visa Class B shares during the third quarters of 2015 and 2014, respectively. These contributions had no impact on noninterest expense; however, these contributions favorably impacted our effective tax rate.
Salaries and benefits expense for the third quarter of 2015 was $46.6 million, an increase of $1.0 million or 2% compared to the same period in 2014. Commission expense increased by $0.4 million primarily due to an increase in both loan origination and refinance activity. In addition, share-based compensation and medical expense increased by $0.4 million and $0.3 million, respectively.

Other noninterest income for the third quarter of 2015 was $2.7 million, a decrease of $0.6 million or 18% compared to the same period in 2014. This decrease was primarily due to a $1.0 million expected loss on the pending sale of an aircraft lease.

These items were partially offset by the following:

Provision for income taxes for the third quarter of 2015 was $14.9 million, a decrease of $5.2 million or 26% compared to the same period in 2014 primarily due to lower pretax income and a lower effective income tax rate primarily due to an increase in energy tax credit investments.

Net interest income for the third quarter of 2015 was $97.9 million, an increase of $2.5 million or 3% compared to the same period in 2014.  The increase was primarily due to higher loan volume. Our net interest margin was 2.77% in the third quarter of 2015, a decrease of 8 basis points compared to the same period in 2014. The decrease was primarily due to lower yields in our investment securities and loans, reflective of the current low interest rate environment.
Net occupancy expense for the third quarter of 2015 was $7.4 million, a decrease of $1.9 million or 21% compared to the same period in 2014 primarily due to a $1.7 million gain on the sale of two real estate properties in Guam.
Net income for the first nine months of 2015 was $117.9 million, a decrease of $4.0 million or 3% compared to the same period in 2014.  Diluted earnings per share was $2.71 for the first nine months of 2015, a decrease of $0.04 or 1% compared to the same period in 2014.

48


Our lower earnings for the first nine months of 2015 were primarily due to the following:

Other noninterest expense for the first nine months of 2015 was $53.6 million, an increase of $10.9 million or 26% compared to the same period in 2014. This increase was primarily due to the aforementioned $9.5 million impairment charge on six aircraft which were previously on lease agreements. In addition, amortization expense related to our solar energy partnership investments increased by $0.7 million and credit card expense increased by $0.6 million. These increases were partially offset by a $0.6 million decrease in our debit card mileage program travel expense.
Salaries and benefits expense for the first nine months of 2015 was $144.0 million, an increase of $6.5 million or 5% compared to the same period in 2014 due in part to a $2.2 million increase in separation expense. Commission expense increased by $1.7 million primarily due to an increase in both loan origination and refinance activity. In addition, share-based compensation and incentive compensation increased by $1.2 million and $0.9 million, respectively.
We recorded no provision for credit losses for the first nine months of 2015 compared to a $4.9 million negative provision recorded in the same period in 2014. The negative provision in 2014 was primarily due to several large commercial loan recoveries during the first nine months of 2014, combined with the aforementioned reduction in the specific reserve related to one commercial client during the third quarter of 2014.
These items were partially offset by the following:
Net interest income for the first nine months of 2015 was $292.4 million, an increase of $9.4 million or 3% compared to the same period in 2014.  The increase was primarily due to higher loan volume. Our net interest margin was 2.79% for the first nine months of 2015, a decrease of 7 basis points compared to the same period in 2014. The decrease was primarily due to lower yields in our investment securities and loans, reflective of the current low interest rate environment.
Net gains on sales of investment securities totaled $10.3 million for the first nine months of 2015 compared to $6.1 million during the same period in 2014. This increase was primarily due to the aforementioned $10.1 million gain on the sale of 95,000 Visa Class B shares during the first quarter of 2015. During the first nine months of 2014, we recorded a $5.8 million gain on the sale of 68,500 Visa Class B shares. We also contributed to the Bank of Hawaii Foundation 13,800 and 16,900 Visa Class B shares during the first nine months of 2015 and 2014, respectively. These contributions had no impact on noninterest expense; however, these contributions favorably impacted our effective tax rate.
Mortgage banking income for the first nine months of 2015 was $8.5 million, an increase of $3.0 million or 55% compared to the same period in 2014. This increase was primarily due to our decision to sell conforming saleable loans from our mortgage portfolio which generated gains on sales of residential mortgage loans.
Net occupancy expense for the first nine months of 2015 was $25.3 million, a decrease of $2.7 million or 10% compared to the same period in 2014 primarily due to the aforementioned $1.7 million gain on the sale of two real estate properties in Guam. In addition, electricity rates were down due in part to lower oil prices.
Other noninterest income for the first nine months of 2015 was $10.1 million, an increase of $0.5 million or 6% compared to the same period in 2014. This increase was primarily due to an additional $0.8 million in fees related to our customer interest rate swap derivative program and a $0.5 million referral fee received in the second quarter of 2015 related to the transition of various services provided to some institutional 401k plans. In addition, we recorded $0.5 million in fee revenue from our Managed Account Portfolio Solutions platform, our new investment advisory services product launched in September 2014. These increases were partially offset by the aforementioned $1.0 million expected loss on the pending sale of an aircraft lease.

We maintained a strong balance sheet during the third quarter of 2015, with adequate reserves for credit losses, and high levels of liquidity and capital.
Total loans and leases were $7.7 billion as of September 30, 2015, an increase of $792.2 million or 11% from December 31, 2014 primarily due to growth in both our commercial and consumer lending portfolios.
The allowance for loan and lease losses (the “Allowance”) was $104.0 million as of September 30, 2015, a decrease of $4.7 million or 4% from December 31, 2014.  The Allowance represents 1.35% of total loans and leases outstanding as of September 30, 2015 and 1.58% of total loans and leases outstanding as of December 31, 2014. The decrease was commensurate with the Company's credit risk profile, loan portfolio growth and composition, and a healthy Hawaii economy.
As of September 30, 2015, the total carrying value of our investment securities portfolio was $6.4 billion, a decrease of $354.4 million or 5% compared to December 31, 2014. During the first nine months of 2015, we continued to reduce our

49


positions in mortgage-backed securities issued by Ginnie Mae. We re-invested these proceeds primarily into higher yielding loan products. In addition, we increased our holdings in Fannie Mae and Freddie Mac mortgage-backed securities, and to a lesser extent Small Business Administration securities.
Total deposits were $12.9 billion as of September 30, 2015, an increase of $303.9 million or 2% from December 31, 2014 primarily due to higher commercial and consumer core deposits.
Total shareholders’ equity was $1.1 billion as of September 30, 2015, an increase of $43.3 million or 4% from December 31, 2014.  We continued to return capital to our shareholders in the form of share repurchases and dividends.  During the first nine months of 2015, we repurchased 628,119 shares of our common stock at a total cost of $38.9 million under our share repurchase program and from shares purchased from employees and/or directors in connection with stock swaps, income tax withholdings related to the vesting of restricted stock, and shares purchased for a deferred compensation plan. We also paid cash dividends of $58.9 million during the first nine months of 2015.


50


Our financial highlights are presented in Table 1.
Financial Highlights
 
 
 
 
 
 
Table 1

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(dollars in thousands, except per share amounts)
2015

 
2014

 
2015

 
2014

For the Period:
 

 
 

 
 

 
 

Operating Results
 

 
 

 
 

 
 

Net Interest Income
$
97,891

 
$
95,379

 
$
292,443

 
$
283,024

Provision for Credit Losses

 
(2,665
)
 

 
(4,864
)
Total Noninterest Income
43,221

 
44,950

 
141,453

 
134,199

Total Noninterest Expense
91,888

 
81,030

 
262,377

 
245,659

Net Income
34,276

 
41,769

 
117,871

 
121,851

Basic Earnings Per Share
0.79

 
0.95

 
2.72

 
2.77

Diluted Earnings Per Share
0.79

 
0.95

 
2.71

 
2.75

Dividends Declared Per Share
0.45

 
0.45

 
1.35

 
1.35

 
 
 
 
 
 
 
 
Performance Ratios
 

 
 

 
 

 
 

Return on Average Assets
0.89
%
 
1.15
%
 
1.05
%
 
1.15
%
Return on Average Shareholders’ Equity
12.45

 
15.57

 
14.62

 
15.53

Efficiency Ratio 1
65.12

 
57.74

 
60.47

 
58.88

Net Interest Margin 2
2.77

 
2.85

 
2.79

 
2.86

Dividend Payout Ratio 3
56.96

 
47.37

 
49.63

 
48.74

Average Shareholders’ Equity to Average Assets
7.18

 
7.41

 
7.15

 
7.38

 
 
 
 
 
 
 
 
Average Balances
 

 
 

 
 

 
 

Average Loans and Leases
$
7,545,985

 
$
6,488,780

 
$
7,301,656

 
$
6,290,548

Average Assets
15,220,660

 
14,372,375

 
15,069,405

 
14,221,143

Average Deposits
13,008,890

 
12,200,654

 
12,887,019

 
12,016,485

Average Shareholders’ Equity
1,092,592

 
1,064,589

 
1,077,828

 
1,048,924

 
 
 
 
 
 
 
 
Market Price Per Share of Common Stock
 

 
 

 
 

 
 

Closing
$
63.49

 
$
56.81

 
$
63.49

 
$
56.81

High
69.00

 
60.75

 
69.00

 
61.73

Low
58.53

 
55.55

 
53.90

 
53.45

 
 
 
 
 
 
 
 
 
September 30,
2015

 
December 31,
2014

 
 
 
 
As of Period End:
 

 
 

 
 
 
 
Balance Sheet Totals
 

 
 

 
 
 
 
Loans and Leases
$
7,689,772

 
$
6,897,589

 
 
 
 
Total Assets
15,164,123

 
14,787,208

 
 
 
 
Total Deposits
12,936,962

 
12,633,089

 
 
 
 
Other Debt
270,801

 
173,912

 
 
 
 
Total Shareholders’ Equity
1,098,354

 
1,055,086

 
 
 
 
 
 
 
 
 
 
 
 
Asset Quality
 

 
 

 
 
 
 
Non-Performing Assets
29,545

 
30,082

 
 
 
 
Allowance for Loan and Lease Losses
$
104,038

 
$
108,688

 
 
 
 
Allowance to Loans and Leases Outstanding
1.35
%
 
1.58
%
 
 
 
 
 
 
 
 
 
 
 
 
Capital Ratios
 

 
 

 
 
 
 
Common Equity Tier 1 Capital Ratio 4
14.11
%
 
n/a
 
 
 
 
Tier 1 Capital Ratio 4
14.11

 
14.69
%
 
 
 
 
Total Capital Ratio 4
15.37

 
15.94

 
 
 
 
Tier 1 Leverage Ratio 4
7.18

 
7.13

 
 
 
 
Total Shareholders’ Equity to Total Assets
7.24

 
7.14

 
 
 
 
Tangible Common Equity to Tangible Assets 5
7.05

 
6.94

 
 
 
 
Tangible Common Equity to Risk-Weighted Assets 4, 5
13.78

 
14.46

 
 
 
 
 
 
 
 
 
 
 
 
Non-Financial Data
 

 
 

 
 
 
 
Full-Time Equivalent Employees
2,154

 
2,161

 
 
 
 
Branches
72

 
74

 
 
 
 
ATMs
455

 
459

 
 
 
 
1 
Efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and total noninterest income).
2 
Net interest margin is defined as net interest income, on a taxable-equivalent basis, as a percentage of average earning assets.
3 
Dividend payout ratio is defined as dividends declared per share divided by basic earnings per share.
4 
September 30, 2015 calculated under Basel III rules, which became effective January 1, 2015.
5 
Tangible common equity to tangible assets and tangible common equity to risk-weighted assets are Non-GAAP financial measures.  See the “Use of Non-GAAP Financial Measures” section below.

51


Use of Non-GAAP Financial Measures

The ratios “tangible common equity to tangible assets” and “tangible common equity to risk-weighted assets” are Non-GAAP financial measures.  The Company believes these measurements are useful for investors, regulators, management and others to evaluate capital adequacy relative to other financial institutions.  Although these Non-GAAP financial measures are frequently used by stakeholders in the evaluation of a financial institution, they have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.  Table 2 provides a reconciliation of these Non-GAAP financial measures with their most closely related GAAP measures.

GAAP to Non-GAAP Reconciliation
 

 
Table 2

(dollars in thousands)
September 30,
2015

 
December 31,
2014

Total Shareholders’ Equity
$
1,098,354

 
$
1,055,086

Less: Goodwill
31,517

 
31,517

Tangible Common Equity
$
1,066,837

 
$
1,023,569

 
 
 
 
Total Assets
$
15,164,123

 
$
14,787,208

Less: Goodwill
31,517

 
31,517

Tangible Assets
$
15,132,606

 
$
14,755,691

Risk-Weighted Assets, determined in accordance with prescribed regulatory requirements 1
$
7,740,028

 
$
7,077,035

 
 
 
 
Total Shareholders’ Equity to Total Assets
7.24
%
 
7.14
%
Tangible Common Equity to Tangible Assets (Non-GAAP)
7.05
%
 
6.94
%
 
 
 
 
Tier 1 Capital Ratio 1
14.11
%
 
14.69
%
Tangible Common Equity to Risk-Weighted Assets (Non-GAAP) 1
13.78
%
 
14.46
%
1 September 30, 2015 calculated under Basel III rules, which became effective January 1, 2015.

52


Analysis of Statements of Income

Average balances, related income and expenses, and resulting yields and rates are presented in Table 3.  An analysis of the change in net interest income, on a taxable-equivalent basis, is presented in Table 4. 
Average Balances and Interest Rates - Taxable-Equivalent Basis
 
 
 
 
 
Table 3
 
 
Three Months Ended
 
Three Months Ended
 
Nine Months Ended
 
Nine Months Ended
 
September 30, 2015
 
September 30, 2014
 
September 30, 2015
 
September 30, 2014
 
Average

 
Income/

 
Yield/

 
Average

 
Income/

 
Yield/

 
Average

 
Income/

 
Yield/

 
Average

 
Income/

 
Yield/

(dollars in millions)
Balance

 
Expense

 
Rate

 
Balance

 
Expense

 
Rate

 
Balance

 
Expense

 
Rate

 
Balance

 
Expense

 
Rate

Earning Assets
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 

Interest-Bearing Deposits in Other
   Banks
$
3.4

 
$

 
0.22
%
 
$
4.1

 
$

 
0.24
%
 
$
3.3

 
$

 
0.27
%
 
$
4.6

 
$

 
0.20
%
Funds Sold
508.2

 
0.3

 
0.22

 
326.2

 
0.2

 
0.21

 
488.8

 
0.8

 
0.22

 
301.9

 
0.5

 
0.21

Investment Securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Taxable
1,524.4

 
6.5

 
1.69

 
1,508.0

 
6.6

 
1.75

 
1,547.8

 
19.5

 
1.68

 
1,527.2

 
20.7

 
1.81

  Non-Taxable
719.4

 
5.8

 
3.19

 
704.0

 
5.7

 
3.22

 
722.8

 
17.2

 
3.18

 
694.4

 
16.9

 
3.24

Held-to-Maturity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
       Taxable
3,953.3

 
19.1

 
1.93

 
4,390.2

 
24.4

 
2.23

 
4,032.8

 
63.2

 
2.09

 
4,465.2

 
76.0

 
2.27

       Non-Taxable
247.3

 
2.4

 
3.93

 
250.9

 
2.5

 
3.95

 
248.2

 
7.3

 
3.93

 
251.7

 
7.5

 
3.96

Total Investment Securities
6,444.4

 
33.8

 
2.09

 
6,853.1

 
39.2

 
2.29

 
6,551.6

 
107.2

 
2.18

 
6,938.5

 
121.1

 
2.33

Loans Held for Sale
13.4

 
0.1

 
3.82

 
2.0

 

 
4.03

 
9.2

 
0.3

 
3.72

 
3.3

 
0.1

 
4.43

Loans and Leases 1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and Industrial
1,166.7

 
9.3

 
3.15

 
980.8

 
8.9

 
3.61

 
1,151.3

 
27.2

 
3.16

 
951.8

 
24.8

 
3.48

Commercial Mortgage
1,568.2

 
15.0

 
3.79

 
1,350.6

 
13.3

 
3.89

 
1,506.3

 
43.0

 
3.82

 
1,301.3

 
38.6

 
3.97

Construction
124.5

 
1.5

 
4.93

 
126.2

 
1.3

 
4.20

 
118.2

 
4.2

 
4.75

 
109.0

 
3.6

 
4.35

Commercial Lease Financing
216.2

 
1.9

 
3.50

 
235.1

 
2.0

 
3.33

 
222.4

 
5.8

 
3.46

 
240.6

 
5.1

 
2.81

Residential Mortgage
2,832.4

 
28.8

 
4.07

 
2,396.7

 
25.3

 
4.22

 
2,734.0

 
84.6

 
4.13

 
2,336.1

 
75.1

 
4.29

Home Equity
961.3

 
8.6

 
3.58

 
823.3

 
8.1

 
3.92

 
915.8

 
24.9

 
3.63

 
803.8

 
23.7

 
3.94

Automobile
359.2

 
4.7

 
5.18

 
296.6

 
4.0

 
5.29

 
345.1

 
13.5

 
5.21

 
280.3

 
11.2

 
5.33

Other 2
317.5

 
6.1

 
7.60

 
279.5

 
5.2

 
7.45

 
308.6

 
17.3

 
7.49

 
267.6

 
15.3

 
7.66

Total Loans and Leases
7,546.0

 
75.9

 
4.00

 
6,488.8

 
68.1

 
4.18

 
7,301.7

 
220.5

 
4.03

 
6,290.5

 
197.4

 
4.19

Other
37.5

 
0.3

 
3.33

 
71.4

 
0.3

 
1.69

 
51.6

 
0.9

 
2.39

 
74.1

 
0.9

 
1.63

Total Earning Assets 3
14,552.9

 
110.4

 
3.02

 
13,745.6

 
107.8

 
3.13

 
14,406.2

 
329.7

 
3.05

 
13,612.9

 
320.0

 
3.14

Cash and Due From Banks
131.6

 
 
 
 
 
152.4

 
 
 
 
 
131.3

 
 
 
 
 
144.5

 
 
 
 
Other Assets
536.2

 
 
 
 
 
474.4

 
 
 
 
 
531.9

 
 
 
 
 
463.7

 
 
 
 
Total Assets
$
15,220.7

 
 
 
 
 
$
14,372.4

 
 
 
 
 
$
15,069.4

 
 
 
 
 
$
14,221.1

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-Bearing Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 

 
 

 
 
 
 
 
 
Interest-Bearing Deposits
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand
$
2,622.4

 
$
0.2

 
0.03
%
 
$
2,417.4

 
$
0.2

 
0.03
%
 
$
2,604.0

 
$
0.6

 
0.03
%
 
$
2,367.8

 
$
0.5

 
0.03
%
Savings
5,067.8

 
1.1

 
0.09

 
4,591.4

 
1.0

 
0.09

 
5,011.2

 
3.3

 
0.09

 
4,549.4

 
2.9

 
0.09

Time
1,201.3

 
1.1

 
0.36

 
1,440.1

 
1.2

 
0.34

 
1,278.1

 
3.3

 
0.35

 
1,440.1

 
3.7

 
0.35

Total Interest-Bearing Deposits
8,891.5

 
2.4

 
0.11

 
8,448.9

 
2.4

 
0.11

 
8,893.3

 
7.2

 
0.11

 
8,357.3

 
7.1

 
0.11

Short-Term Borrowings
8.5

 

 
0.14

 
9.3

 

 
0.14

 
8.5

 

 
0.14

 
9.5

 

 
0.14

Securities Sold Under Agreements to Repurchase
643.3

 
6.3

 
3.84

 
715.6

 
6.5

 
3.57

 
664.4

 
19.1

 
3.79

 
766.4

 
19.4

 
3.34

Other Debt
223.2

 
0.8

 
1.34

 
173.8

 
0.6

 
1.44

 
190.5

 
2.0

 
1.39

 
174.6

 
1.9

 
1.45

Total Interest-Bearing Liabilities
9,766.5

 
9.5

 
0.38

 
9,347.6

 
9.5

 
0.40

 
9,756.7

 
28.3

 
0.38

 
9,307.8

 
28.4

 
0.40

Net Interest Income
 
 
$
100.9

 
 
 
 
 
$
98.3

 
 
 
 
 
$
301.4

 
 
 
 
 
$
291.6

 
 
Interest Rate Spread
 
 
 
 
2.64
%
 
 
 
 
 
2.73
%
 
 
 
 
 
2.67
%
 
 
 
 
 
2.74
%
Net Interest Margin
 
 
 
 
2.77
%
 
 
 
 
 
2.85
%
 
 
 
 
 
2.79
%
 
 
 
 
 
2.86
%
Noninterest-Bearing Demand Deposits
4,117.4

 
 
 
 
 
3,751.8

 
 
 
 
 
3,993.7

 
 
 
 
 
3,659.2

 
 
 
 
Other Liabilities
244.2

 
 
 
 
 
208.4

 
 
 
 
 
241.2

 
 
 
 
 
205.2

 
 
 
 
Shareholders’ Equity
1,092.6

 
 
 
 
 
1,064.6

 
 
 
 
 
1,077.8

 
 
 
 
 
1,048.9

 
 
 
 
Total Liabilities and Shareholders’ Equity
$
15,220.7

 
 
 
 
 
$
14,372.4

 
 
 
 
 
$
15,069.4

 
 
 
 
 
$
14,221.1

 
 
 
 
1 
Non-performing loans and leases are included in the respective average loan and lease balances.  Income, if any, on such loans and leases is recognized on a cash basis.
2 
Comprised of other consumer revolving credit, installment, and consumer lease financing.
3 
Interest income includes taxable-equivalent basis adjustments, based upon a federal statutory tax rate of 35%, of $3.0 million and $2.9 million for the three months ended September 30, 2015 and 2014, respectively, and $8.9 million and $8.6 million for the nine months ended September 30, 2015 and 2014, respectively.

53


Analysis of Change in Net Interest Income - Taxable-Equivalent Basis
 
Table 4

 
Nine Months Ended September 30, 2015
 
Compared to September 30, 2014
(dollars in millions)
Volume 1

 
Rate 1

 
Total

Change in Interest Income:
 

 
 

 
 

Funds Sold
$
0.3

 
$

 
$
0.3

Investment Securities
 
 
 
 
 

Available-for-Sale
 
 
 
 


  Taxable
0.3

 
(1.5
)
 
(1.2
)
  Non-Taxable
0.7

 
(0.4
)
 
0.3

Held-to-Maturity
 
 
 
 


       Taxable
(7.0
)
 
(5.8
)
 
(12.8
)
       Non-Taxable
(0.1
)
 
(0.1
)
 
(0.2
)
Total Investment Securities
(6.1
)
 
(7.8
)
 
(13.9
)
Loans Held for Sale
0.2

 

 
0.2

Loans and Leases
 
 
 
 


Commercial and Industrial
4.9

 
(2.5
)
 
2.4

Commercial Mortgage
5.9

 
(1.5
)
 
4.4

Construction
0.3

 
0.3

 
0.6

Commercial Lease Financing
(0.4
)
 
1.1

 
0.7

Residential Mortgage
12.4

 
(2.9
)
 
9.5

Home Equity
3.1

 
(1.9
)
 
1.2

Automobile
2.5

 
(0.2
)
 
2.3

Other 2
2.3

 
(0.3
)
 
2.0

Total Loans and Leases
31.0

 
(7.9
)
 
23.1

Other
(0.3
)
 
0.3

 

Total Change in Interest Income
25.1

 
(15.4
)
 
9.7

 
 
 
 
 
 
Change in Interest Expense:
 
 
 
 
 

Interest-Bearing Deposits
 
 
 
 
 

Demand
0.1

 

 
0.1

Savings
0.3

 
0.1

 
0.4

Time
(0.4
)
 

 
(0.4
)
Total Interest-Bearing Deposits

 
0.1

 
0.1

Securities Sold Under Agreements to Repurchase
(2.8
)
 
2.5

 
(0.3
)
Other Debt
0.2

 
(0.1
)
 
0.1

Total Change in Interest Expense
(2.6
)
 
2.5

 
(0.1
)
 
 
 
 
 


Change in Net Interest Income
$
27.7

 
$
(17.9
)
 
$
9.8

1 
The change in interest income and expense not solely due to changes in volume or rate has been allocated on a pro-rata basis to the volume and rate columns.
2 
Comprised of other consumer revolving credit, installment, and consumer lease financing.

Net Interest Income
Net interest income is affected by the size and mix of our balance sheet components as well as the spread between interest earned on assets and interest paid on liabilities.  Net interest margin is defined as net interest income, on a taxable-equivalent basis, as a percentage of average earning assets.
Net interest income was $97.9 million in the third quarter of 2015, an increase of $2.5 million or 3% compared to the same period in 2014. On a taxable-equivalent basis, net interest income was $100.9 million in the third quarter of 2015, an increase of $2.6 million or 3% compared to the same period in 2014. Net interest income was $292.4 million for the first nine months of 2015, an increase of $9.4 million or 3% compared to the same period in 2014. On a taxable-equivalent basis, net interest income was $301.4 million for the first nine months of 2015, an increase of $9.8 million or 3% compared to the same period in 2014. The net interest income increase was primarily due to growth in both our commercial and consumer lending portfolios. Net interest margin was 2.77% for the third quarter of 2015, a decrease of eight basis points compared to the same period in 2014. Net interest margin was 2.79% for the first nine months of 2015, a decrease of seven basis points compared to the same

54


period in 2014. The lower margins in 2015 were primarily due to lower yields in our investment securities and loans, reflective of the current low interest rate environment.
Yields on our earning assets decreased by 11 basis points in the third quarter of 2015 and by nine basis points in the first nine months of 2015 compared to the same periods in 2014 primarily due to lower yields in our investment securities and loan portfolio. Yields on our investment securities portfolio decreased by 20 basis points in the third quarter of 2015 and by 15 basis points in the first nine months of 2015 compared to the same periods in 2014 primarily due to higher premium amortization and reinvestment into lower yielding securities due to the current low interest rate environment. Yields on our loans and leases decreased by 18 basis points in the third quarter of 2015 and by 16 basis points in the first nine months of 2015, with lower yields in nearly every loan category, compared to the same periods in 2014 as a result of the current low interest rate environment. Yields on our commercial and industrial portfolio declined by 46 basis points in the third quarter of 2015 and by 32 basis points in the first nine months of 2015 compared to the same periods in 2014 primarily due in part to a large interest income recovery in the third quarter of 2014. Yields on our residential mortgage portfolio decreased by 15 basis points in the third quarter of 2015 and by 16 basis points in the first nine months of 2015 compared to the same periods in 2014 primarily due to continued payoff activity of higher-rate mortgage loans and the addition to our portfolio of lower-rate mortgage loans. Partially offsetting the lower yields on our earning assets in the third quarter and in the first nine months of 2015 compared to the same periods in 2014 were slightly lower funding cost. The lower funding costs in 2015 compared to 2014 were partially offset by the higher rates paid on our securities sold under agreements to repurchase. Rates paid on our securities sold under agreements to repurchase increased by 27 basis points in the third quarter of 2015 and by 45 basis points in the first nine months of 2015 compared to the same periods in 2014 primarily due to a decrease in repurchase agreements with local government entities which have relatively shorter terms at lower interest rates. The remaining balance in our repurchase agreements consists mainly of those with private entities which have relatively longer terms at higher interest rates.
Average balances of our earning assets increased by $807.3 million or 6% in the third quarter of 2015 and by $793.3 million or 6% in the first nine months of 2015 compared to the same periods in 2014 primarily due to an increase in the average balances of our loans and leases. Average balances of our loans and leases portfolio increased by $1.1 billion in the third quarter of 2015 and by $1.0 billion in the first nine months of 2015 compared to the same periods in 2014 primarily due to higher average balances in our commercial and industrial, commercial mortgage, and residential mortgage portfolios. The average balance of our commercial and industrial loan portfolio increased by $185.9 million in the third quarter of 2015 and by $199.5 million in the first nine months of 2015 compared to the same periods in 2014 due to an increase in corporate demand for funding. The average balance of our commercial mortgage portfolio increased by $217.6 million in the third quarter of 2015 and by $205.0 million in the first nine months of 2015 compared to the same periods in 2014 primarily due to increased demand from new and existing customers as the real estate market in Hawaii continued to improve. The average balance of our residential mortgage portfolio increased by $435.7 million in the third quarter of 2015 and by $397.9 million in the first nine months of 2015 compared to the same periods in 2014 primarily due to an increase in loan origination and refinance activity, coupled with our decision to add more conforming saleable loans to our portfolio. Partially offsetting the increase in the average balances of our loans and leases portfolio was a $408.7 million decrease in the average balance of our total investment securities portfolio in the third quarter of 2015 and a $386.9 million decrease in the first nine months of 2015 compared to the same periods in 2014 primarily due to the shift in the mix of our earning assets from investment securities to loans.
Average balances of our interest-bearing liabilities increased by $418.9 million or 4% in the third quarter of 2015 and by $448.9 million or 5% in the first nine months of 2015 compared to the same periods in 2014 primarily due to continued growth in our relationship checking and savings deposit products as well as growth in our business savings product, partially offset by decreases in our time deposits and repurchase agreements.
Provision for Credit Losses

The provision for credit losses (the "Provision") reflects our judgment of the expense or benefit necessary to achieve the appropriate amount of the Allowance.  We maintain the Allowance at levels adequate to cover our estimate of probable credit losses as of the end of the reporting period.  The Allowance is determined through detailed quarterly analyses of the loan and lease portfolio.  The Allowance is based on our loss experience and changes in the economic environment, as well as an ongoing assessment of credit quality.  Additional factors that are considered in determining the amount of the Allowance are the level of net charge-offs, non-performing assets, risk rating migration, as well as changes in our portfolio size and composition. We recorded no provision in the third quarter of 2015 compared to a negative provision of $2.7 million in the same period in 2014. The negative provision was primarily due to a reduction in a specific reserve related to one commercial client. We recorded no provision for the first nine months of 2015 compared to a $4.9 million negative provision recorded in the same period in 2014. The negative provision in 2014 was primarily due to several large commercial loan recoveries combined with the aforementioned reduction in the specific reserve related to one commercial client. Our decision to not record a Provision during the first nine months of 2015 was reflective of our evaluation as to the adequacy of the Allowance. For further

55


discussion on the Allowance, see the “Corporate Risk Profile - Reserve for Credit Losses” section in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A").

Noninterest Income

Noninterest income decreased by $1.7 million or 4% in the third quarter of 2015 and increased by $7.3 million or 5% for the first nine months of 2015 compared to the same periods in 2014.

Table 5 presents the components of noninterest income.
Noninterest Income
 
 
 
 
 
 
 
 
 
 
Table 5

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(dollars in thousands)
2015

 
2014

 
Change

 
2015

 
2014

 
Change

Trust and Asset Management
$
11,907

 
$
11,716

 
$
191

 
$
36,442

 
$
35,573

 
$
869

Mortgage Banking
3,291

 
1,646

 
1,645

 
8,453

 
5,455

 
2,998

Service Charges on Deposit Accounts
8,669

 
9,095

 
(426
)
 
25,409

 
26,611

 
(1,202
)
Fees, Exchange, and Other Service Charges
13,340

 
13,390

 
(50
)
 
39,589

 
39,699

 
(110
)
Investment Securities Gains, Net
24

 
1,858

 
(1,834
)
 
10,341

 
6,097

 
4,244

Annuity and Insurance
1,721

 
2,348

 
(627
)
 
5,650

 
6,401

 
(751
)
Bank-Owned Life Insurance
1,609

 
1,644

 
(35
)
 
5,431

 
4,765

 
666

Other Income
2,660

 
3,253

 
(593
)
 
10,138

 
9,598

 
540

Total Noninterest Income
$
43,221

 
$
44,950

 
$
(1,729
)
 
$
141,453

 
$
134,199

 
$
7,254


Trust and asset management income is comprised of fees earned from the management and administration of trusts and other customer assets.  These fees are largely based upon the market value of the assets we manage and the fee rate charged to customers.  Total trust assets under administration were $9.0 billion and $10.5 billion as of September 30, 2015 and 2014, respectively.  Trust and asset management income increased by $0.2 million or 2% in the third quarter of 2015 and by $0.9 million or 2% for the first nine months of 2015 compared to the same periods in 2014. The year-to-date increase was primarily due to a $1.0 million increase in special service fees, primarily termination fees. In addition, revocable and irrevocable trust fees increased by $0.7 million due to additional accounts and increased market values. These increases were partially offset by a $0.5 million decrease in employee benefit trust fees primarily due to a decline in number of accounts and market values. In addition, IRA fees decreased by $0.3 million.

Mortgage banking income is highly influenced by mortgage interest rates, the housing market, and the amount of saleable loans we sell from our portfolio.  Mortgage banking income increased by $1.6 million or 100% in the third quarter of 2015 and by $3.0 million or 55% for the first nine months of 2015 compared to the same periods in 2014. These increases were primarily due to our decision to sell conforming saleable loans from our mortgage portfolio which generated gains on sales of residential mortgage loans.

Service charges on deposit accounts decreased by $0.4 million or 5% during the third quarter of 2015 compared to the same period in 2014.  This decrease was primarily due to a $0.5 million decrease in overdraft fees. Service charges on deposit accounts decreased by $1.2 million or 5% for the first nine months of 2015 compared to the same period in 2014.  This decrease was primarily due to a $0.9 million decrease in overdraft fees and a $0.4 million decrease in account analysis fees.

Fees, exchange, and other service charges are primarily comprised of debit and credit card income, fees from ATMs, merchant service activity, and other loan fees and service charges.  Fees, exchange, and other service charges remained relatively unchanged in the third quarter of 2015 and for the first nine months of 2015 compared to the same periods in 2014. Year-to-date decreases in other loan fees ($0.7 million), merchant income ($0.4 million), and ATM fees ($0.4 million) were largely offset by a $1.4 million increase in commissions and fees related to our credit card business.

Net gains on sales of investment securities totaled less than $0.1 million in the third quarter of 2015 compared to $1.9 million during the same period in 2014. The net gain in the third quarter of 2014 was due to a $1.9 million gain on the sale of 23,000 Visa Class B shares. Net gains on sales of investment securities totaled $10.3 million for the first nine months of 2015 compared to $6.1 million during the same period in 2014. This increase was primarily due to a $10.1 million gain on the sale of 95,000 Visa Class B shares during the first quarter of 2015. During the first nine months of 2014, we recorded a $5.8 million gain on the sale of 68,500 Visa Class B shares. We received these Class B shares in 2008 as part of Visa's initial public offering. These shares are transferable only under limited circumstances until they can be converted into the publicly traded Class A shares. This conversion will not occur until the settlement of certain litigation which is indemnified by Visa members such as the Company. Visa funded an escrow account from its initial public offering to settle these litigation claims. Should

56


this escrow account not be sufficient to cover these litigation claims, Visa is entitled to fund additional amounts to the escrow account by reducing each member bank's Class B conversion ratio to unrestricted Class A shares. Concurrent with the sale of these Visa Class B shares, we entered into an agreement with the buyer that requires payment to the buyer in the event Visa further reduces the conversion ratio. Based on the existing transfer restriction and the uncertainty of the covered litigation, the remaining 288,714 Visa Class B shares (475,887 Class A equivalent shares) that we own are carried at a zero cost basis. We also contributed to the Bank of Hawaii Foundation 4,500 and 5,700 Visa Class B shares during the third quarters of 2015 and 2014, respectively. For the first nine months of 2015 and 2014, we contributed 13,800 and 16,900 Visa Class B shares, respectively, to the Bank of Hawaii Foundation.

Annuity and insurance decreased by $0.6 million or 27% in the third quarter of 2015 and by $0.8 million or 12% for the first nine months of 2015 compared to the same periods in 2014. These decreases were primarily due to lower sales of our annuity products.

Bank-owned life insurance remained relatively unchanged in the third quarter of 2015 and increased by $0.7 million or 14% for the first nine months of 2015 compared to the same periods in 2014.  The year-to-date increase was primarily due to a $0.6 million death benefit received in the second quarter of 2015.

Other noninterest income decreased by $0.6 million or 18% in the third quarter of 2015 compared to the same period in 2014. This decrease was primarily due to a $1.0 million expected loss on the pending sale of an aircraft lease. In 1998, the Company became the lessor of this aircraft, which is leased to a major global air carrier headquartered in the U.S., with a 2018 lease expiration date. This pending sale, which is expected to close in the fourth quarter of 2015, occurred as a result of the Company’s strategic decision to dispose of all of its remaining aircraft leases. This decrease was partially offset by an additional $0.4 million in fees related to our customer interest rate swap derivative program. Other noninterest income increased by $0.5 million or 6% for the first nine months of 2015 compared to the same period in 2014. This increase was primarily due to an additional $0.8 million in fees related to our customer interest rate swap derivative program and a $0.5 million referral fee received in the second quarter of 2015 related to the transition of various services provided to some institutional 401k plans. In addition, we recorded $0.5 million in fee revenue from our Managed Account Portfolio Solutions platform, our new investment advisory services product launched in September 2014. These increases were partially offset by the aforementioned $1.0 million expected loss on the pending sale of an aircraft lease.


57


Noninterest Expense

Noninterest expense increased by $10.9 million or 13% in the third quarter of 2015 and by $16.7 million or 7% for the first nine months of 2015 compared to the same periods in 2014.

Table 6 presents the components of noninterest expense.
Noninterest Expense
 
 
 
 
 
 
 
 
 
 
Table 6

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(dollars in thousands)
2015

 
2014

 
Change

 
2015

 
2014

 
Change

Salaries
$
28,905

 
$
28,990

 
$
(85
)
 
$
85,033

 
$
85,448

 
$
(415
)
Incentive Compensation
4,223

 
4,242

 
(19
)
 
13,696

 
12,832

 
864

Share-Based Compensation
2,616

 
2,226

 
390

 
7,712

 
6,466

 
1,246

Commission Expense
1,639

 
1,283

 
356

 
5,158

 
3,448

 
1,710

Retirement and Other Benefits
4,064

 
4,056

 
8

 
12,912

 
12,853

 
59

Payroll Taxes
2,200

 
2,162

 
38

 
8,063

 
7,909

 
154

Medical, Dental, and Life Insurance
2,870

 
2,557

 
313

 
8,503

 
7,902

 
601

Separation Expense
59

 
14

 
45

 
2,889

 
650

 
2,239

Total Salaries and Benefits
46,576

 
45,530


1,046


143,966


137,508


6,458

Net Occupancy
7,403

 
9,334

 
(1,931
)
 
25,341

 
28,005

 
(2,664
)
Net Equipment
4,804

 
4,473

 
331

 
14,918

 
13,745

 
1,173

Data Processing
3,920

 
3,665

 
255

 
11,366

 
11,156

 
210

Professional Fees
2,258

 
1,835

 
423

 
6,857

 
6,708

 
149

FDIC Insurance
2,139

 
1,750

 
389

 
6,347

 
5,881

 
466

Other Expense:
 
 
 
 

 
 
 
 
 

Delivery and Postage Services
2,248

 
2,063

 
185

 
6,792

 
6,678

 
114

Mileage Program Travel
1,116

 
1,407

 
(291
)
 
3,597

 
4,228

 
(631
)
Merchant Transaction and Card Processing Fees
1,125

 
1,033

 
92

 
3,495

 
3,277

 
218

Advertising
1,536

 
1,433

 
103

 
3,811

 
3,867

 
(56
)
Impairment on Equipment Held for Sale
9,453

 

 
9,453

 
9,453

 

 
9,453

Other
9,310

 
8,507

 
803

 
26,434

 
24,606

 
1,828

Total Other Expense
24,788

 
14,443

 
10,345

 
53,582

 
42,656

 
10,926

Total Noninterest Expense
$
91,888

 
$
81,030

 
$
10,858

 
$
262,377

 
$
245,659

 
$
16,718


Salaries and benefits expense increased by $1.0 million or 2% in the third quarter of 2015 compared to the same period in 2014. Commission expense increased by $0.4 million primarily due to an increase in both loan origination and refinance activity. Share-based compensation increased by $0.4 million due to additional restricted stock units being amortized and the value of restricted stock units increasing as a result of the Company's higher share price. Medical, dental, and life insurance expense increased by $0.3 million primarily due to a medical reserve adjustment recorded in the current quarter. Salaries and benefits expense increased by $6.5 million or 5% for the first nine months of 2015 compared to the same period in 2014 due in part to a $2.2 million increase in separation expense. Commission expense increased by $1.7 million primarily due to an increase in both loan origination and refinance activity. Share-based compensation increased by $1.2 million due to additional restricted stock units being amortized and the value of restricted stock units increasing as a result of the Company's higher share price. In addition, incentive compensation increased by $0.9 million.

Net occupancy expense decreased by $1.9 million or 21% in the third quarter of 2015 and by $2.7 million or 10% for the first nine months of 2015 compared to the same periods in 2014 primarily due to a $1.7 million gain on the sale of two real estate properties in Guam. In addition, electricity rates were down due in part to lower oil prices.

Net equipment expense increased by $0.3 million or 7% in the third quarter of 2015 and by $1.2 million or 9% for the first nine months of 2015 compared to the same periods in 2014. These increases were primarily due to an increase in software license fees and maintenance.

Professional fees increased by $0.4 million or 23% in the third quarter of 2015 compared to the same period in 2014 primarily due to an increase in services within our support units. Professional fees increased by $0.1 million or 2% for the first nine months of 2015 compared to the same period in 2014.


58


FDIC Insurance increased by $0.4 million or 22% in the third quarter of 2015 and by $0.5 million or 8% for the first nine months of 2015 compared to the same periods in 2014. These increases were primarily due to a $0.3 million credit adjustment received in the third quarter of 2014.

Other noninterest expense increased by $10.3 million or 72% in the third quarter of 2015 compared to the same period in 2014. This increase was primarily due to a $9.5 million impairment charge on six aircraft. In 1997 and 1999, the Company became the lessor of these aircraft, the leases of which have now expired. The Company is in the process of disposing of these aircraft. Based on recent appraisals, market conditions, and management judgment, we determined that the net realizable value of these aircraft has been impaired. As we intend to sell these aircraft, the impairment charge reduced the carrying value of these aircraft to estimated fair value less cost to sell. Other noninterest expense increased by $10.9 million or 26% for the first nine months of 2015 compared to the same period in 2014. This increase was primarily due to the aforementioned $9.5 million impairment charge on six aircraft which were previously on lease agreements. In addition, amortization expense related to our solar energy partnership investments increased by $0.7 million and credit card expense increased by $0.6 million. These increases were partially offset by a $0.6 million decrease in our debit card mileage program travel expense.

Provision for Income Taxes

Table 7 presents our provision for income taxes and effective tax rates.
Provision for Income Taxes and Effective Tax Rates
 
 
 
 
 
 
Table 7

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands)
2015

 
2014

 
2015

 
2014

Provision for Income Taxes
$
14,948

 
$
20,195

 
$
53,647

 
$
54,577

Effective Tax Rates
30.37
%
 
32.59
%
 
31.28
%
 
30.93
%

Our lower effective tax rate for the third quarter of 2015 compared to the same period in 2014 was primarily due to lower pretax income and an increase in energy tax credit investments.  Our higher effective tax rate for the first nine months of 2015 compared to the same period in 2014 was primarily due to a $1.2 million release of reserves in the first nine months of 2014 related to a settlement with the State of Hawaii related to prior year tax issues.

Analysis of Statements of Condition

Investment Securities

The carrying value of our investment securities portfolio was $6.4 billion as of September 30, 2015, a decrease of $354.4 million or 5% compared to December 31, 2014. As of September 30, 2015, our investment securities portfolio was comprised of securities with an average base duration of approximately 3.4 years.

We continually evaluate our investment securities portfolio in response to established asset/liability management objectives, changing market conditions that could affect profitability, and the level of interest rate risk to which we are exposed.  These evaluations may cause us to change the level of funds we deploy into investment securities, change the composition of our investment securities portfolio, and change the proportion of investments made into the available-for-sale and held-to-maturity investment categories.

During the first nine months of 2015, we continued to reduce our positions in mortgage-backed securities issued by Ginnie Mae. We re-invested these proceeds primarily into higher yielding loan products. In addition, we increased our holdings in Fannie Mae and Freddie Mac mortgage-backed securities, and to a lesser extent Small Business Administration securities. Ginnie Mae mortgage-backed securities continue to be our largest concentration in our portfolio. As of September 30, 2015, our portfolio of Ginnie Mae mortgage-backed securities was primarily comprised of securities issued in 2008 or later. As of September 30, 2015, the credit ratings of these mortgage-backed securities were all AAA-rated, with a low probability of a change in ratings in the near future. As of September 30, 2015, our available-for-sale investment securities portfolio was comprised of securities with an average base duration of approximately 2.6 years.

Gross unrealized gains in our investment securities portfolio were $113.5 million as of September 30, 2015 and $108.5 million as of December 31, 2014.  Gross unrealized losses on our temporarily impaired investment securities were $21.1 million as of September 30, 2015 and $44.3 million as of December 31, 2014.  The gross unrealized loss positions were primarily related to mortgage-backed securities issued by Ginnie Mae. See Note 2 to the Consolidated Financial Statements for more information.


59


As of September 30, 2015, included in our investment securities portfolio were debt securities issued by political subdivisions within the State of Hawaii of $579.0 million, representing 58% of the total fair value of the Company's municipal debt securities. Of the entire Hawaii municipal bond portfolio, 91% were credit-rated Aa2 or better by Moody's while most of the remaining Hawaii municipal bonds were credit-rated A2 or better by at least one nationally recognized statistical rating organization. Approximately 77% of our Hawaii municipal bond holdings were general obligation issuances. As of September 30, 2015, there were no other holdings of municipal debt securities that were issued by a single state or political subdivision which comprised more than 10% of the total fair value of our municipal debt securities.

Loans and Leases

Table 8 presents the composition of our loan and lease portfolio by major categories.

Loan and Lease Portfolio Balances
 
Table 8

(dollars in thousands)
September 30,
2015

 
December 31,
2014

Commercial
 

 
 

Commercial and Industrial
$
1,169,817

 
$
1,055,243

Commercial Mortgage
1,622,119

 
1,437,513

Construction
129,254

 
109,183

Lease Financing
202,055

 
226,189

Total Commercial
3,123,245

 
2,828,128

Consumer
 

 
 

Residential Mortgage
2,875,605

 
2,571,090

Home Equity
993,817

 
866,688

Automobile
367,640

 
323,848

Other 1
329,465

 
307,835

Total Consumer
4,566,527

 
4,069,461

Total Loans and Leases
$
7,689,772

 
$
6,897,589

1 
Comprised of other revolving credit, installment, and lease financing.

Total loans and leases as of September 30, 2015 increased by $792.2 million or 11% from December 31, 2014 due to growth in both our commercial and consumer lending portfolios.

Commercial loans and leases as of September 30, 2015 increased by $295.1 million or 10% from December 31, 2014.  Commercial and industrial loans increased by $114.6 million or 11% from December 31, 2014 due to an increase in corporate demand for funding. Commercial mortgage loans increased by $184.6 million or 13% from December 31, 2014 primarily due to increased demand from new and existing customers as the real estate economy in Hawaii continued to improve. Construction loans increased by $20.1 million or 18% from December 31, 2014 primarily due to increased activity in construction projects such as condominiums and low-income housing. Lease financing decreased by $24.1 million or 11% from December 31, 2014 primarily due to aircraft leveraged leases which matured in September 2015 and the pending sale of one aircraft lease.

Consumer loans and leases as of September 30, 2015 increased by $497.1 million or 12% from December 31, 2014.  Residential mortgage loans increased by $304.5 million or 12% from December 31, 2014 primarily due to an increase in loan origination and refinance activity, coupled with our decision to retain additional conforming saleable loans in our portfolio. Home equity loans increased by $127.1 million or 15% from December 31, 2014 as a result of successful campaigns to drive new production and upfront line draws. In addition, we experienced steady line utilization during the first nine months of 2015. Automobile loans increased by $43.8 million or 14% from December 31, 2014 due to market share gains resulting from enhanced loan pricing. Other consumer loans increased by $21.6 million or 7% from December 31, 2014 due to growth in our consumer credit card balances and installment loans.


60


Table 9 presents the composition of our loan and lease portfolio by geographic area and by major categories.
Geographic Distribution of Loan and Lease Portfolio
 
Table 9

(dollars in thousands)
Hawaii

 
U.S. Mainland 1

 
Guam

 
Other Pacific Islands

 
Foreign 2 

 
Total

September 30, 2015
 

 
 

 
 

 
 

 
 

 
 

Commercial
 

 
 

 
 

 
 

 
 

 
 

Commercial and Industrial
$
1,052,837

 
$
54,151

 
$
61,929

 
$
621

 
$
279

 
$
1,169,817

Commercial Mortgage
1,494,272

 
30,403

 
97,444

 

 

 
1,622,119

Construction
129,254

 

 

 

 

 
129,254

Lease Financing
41,303

 
154,319

 
1,969

 

 
4,464

 
202,055

Total Commercial
2,717,666

 
238,873

 
161,342

 
621

 
4,743

 
3,123,245

Consumer
 

 
 

 
 

 
 

 
 

 
 

Residential Mortgage
2,769,676

 

 
103,162

 
2,767

 

 
2,875,605

Home Equity
958,557

 
2,740

 
30,872

 
1,648

 

 
993,817

Automobile
288,389

 
80

 
74,094

 
5,077

 

 
367,640

Other 3
248,818

 

 
39,078

 
41,568

 
1

 
329,465

Total Consumer
4,265,440

 
2,820

 
247,206

 
51,060

 
1

 
4,566,527

Total Loans and Leases
$
6,983,106

 
$
241,693

 
$
408,548

 
$
51,681

 
$
4,744

 
$
7,689,772

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 

 
 

 
 

 
 

 
 

 
 

Commercial
 

 
 

 
 

 
 

 
 

 
 

Commercial and Industrial
$
935,258

 
$
67,367

 
$
50,699

 
$
897

 
$
1,022

 
$
1,055,243

Commercial Mortgage
1,318,413

 
27,060

 
92,040

 

 

 
1,437,513

Construction
109,183

 

 

 

 

 
109,183

Lease Financing
44,238

 
176,618

 
647

 

 
4,686

 
226,189

Total Commercial
2,407,092

 
271,045

 
143,386

 
897

 
5,708

 
2,828,128

Consumer
 

 
 

 
 

 
 

 
 

 
 

Residential Mortgage
2,460,353

 

 
107,714

 
3,023

 

 
2,571,090

Home Equity
831,722

 
3,909

 
29,377

 
1,680

 

 
866,688

Automobile
248,598

 
285

 
69,985

 
4,980

 

 
323,848

Other 3
233,396

 

 
34,885

 
39,547

 
7

 
307,835

Total Consumer
3,774,069

 
4,194

 
241,961

 
49,230

 
7

 
4,069,461

Total Loans and Leases
$
6,181,161

 
$
275,239

 
$
385,347

 
$
50,127

 
$
5,715

 
$
6,897,589

1 
For secured loans and leases, classification as U.S. Mainland is made based on where the collateral is located.  For unsecured loans and leases, classification as U.S. Mainland is made based on the location where the majority of the borrower’s business operations are conducted.
2 
Loans and leases classified as Foreign represent those which are recorded in the Company’s international business units.
3 
Comprised of other revolving credit, installment, and lease financing.

Our commercial and consumer lending activities are concentrated primarily in Hawaii and the Pacific Islands.  Our commercial loan and lease portfolio to borrowers based on the U.S. Mainland includes leveraged lease financing and participation in Shared National Credits.  Our consumer loan and lease portfolio includes limited lending activities on the U.S. Mainland.

Our Hawaii loan and lease portfolio increased by $801.9 million or 13% from December 31, 2014, reflective of a healthy Hawaii economy.


61


Other Assets

Table 10 presents the major components of other assets.
Other Assets
 

 
Table 10

(dollars in thousands)
September 30,
2015

 
December 31,
2014

Federal Home Loan Bank and Federal Reserve Bank Stock
$
39,836

 
$
66,374

Derivative Financial Instruments
16,800

 
16,515

Low-Income Housing and Other Equity Investments
78,725

 
77,495

Deferred Compensation Plan Assets
19,548

 
18,794

Prepaid Expenses
10,104

 
7,787

Accounts Receivable
18,080

 
13,405

Other
24,224

 
25,518

Total Other Assets
$
207,317

 
$
225,888


Other assets decreased by $18.6 million or 8% from December 31, 2014. This decrease was primarily due to the redemption of excess FHLB stock upon the merger of FHLB Des Moines and FHLB Seattle (see Note 2 to the Consolidated Financial Statements for more information), partially offset by a $4.0 million purchase of additional FHLB stock during the current quarter. This additional stock purchase was required in order to borrow an additional $100.0 million from the FHLB (see the "Other Debt" section in MD&A). The decrease in other assets was partially offset by a $4.7 million increase in accounts receivable primarily resulting from a pending sale of an aircraft lease.

Deposits

Table 11 presents the composition of our deposits by major customer categories.
Deposits
 

 
Table 11

(dollars in thousands)
September 30,
2015

 
December 31,
2014

Consumer
$
6,254,862

 
$
6,092,929

Commercial
5,397,857

 
5,163,352

Public and Other
1,284,243

 
1,376,808

Total Deposits
$
12,936,962

 
$
12,633,089


Total deposits were $12.9 billion as of September 30, 2015, an increase of $303.9 million or 2% from December 31, 2014. This increase was primarily due to a $234.5 million increase in commercial deposits, mainly reflecting core deposit growth. In addition, consumer deposits increased by $161.9 million primarily due to continued growth in our relationship checking and savings deposit products. Partially offsetting these increases was a $92.6 million decrease in public and other deposits primarily resulting from a decline in time deposits, partially offset by an increase in core deposits.

Table 12 presents the composition of our savings deposits.
Savings Deposits
 

 
Table 12

(dollars in thousands)
September 30,
2015

 
December 31,
2014

Money Market
$
1,809,344

 
$
1,766,173

Regular Savings
3,207,118

 
3,040,402

Total Savings Deposits
$
5,016,462

 
$
4,806,575



62


Securities Sold Under Agreements to Repurchase

Table 13 presents the composition of our securities sold under agreements to repurchase.
Securities Sold Under Agreements to Repurchase
 
Table 13

(dollars in thousands)
September 30,
2015

 
December 31,
2014

Private Institutions
$
575,000

 
$
600,000

Government Entities
57,138

 
88,601

Total Securities Sold Under Agreements to Repurchase
$
632,138

 
$
688,601


Securities sold under agreements to repurchase as of September 30, 2015 decreased by $56.5 million or 8% from December 31, 2014. This decrease was due to the maturity dates ending for one private institution repurchase agreement and one government entity repurchase agreement during the third quarter of 2015. As of September 30, 2015, the weighted-average maturity was 136 days for our repurchase agreements with government entities and 3.8 years for our repurchase agreements with private institutions. Some of our repurchase agreements with private institutions may be terminated at earlier specified dates by the private institution or in some cases by either the private institution or the Company. If all such agreements were to terminate at the earliest possible date, the weighted average maturity for our repurchase agreements with private institutions would decrease to 1.5 years.  As of September 30, 2015, the weighted-average interest rate for outstanding agreements with government entities and private institutions was 0.33% and 4.22%, respectively, with all rates being fixed. Each of our repurchase agreements is accounted for as a collateralized financing arrangement (i.e., a secured borrowing) and not as a sale and subsequent repurchase of securities. 

Other Debt

Table 14 presents the composition of our other debt.
Other Debt
 
 
Table 14

(dollars in thousands)
September 30,
2015

 
December 31,
2014

Federal Home Loan Bank Advances
$
250,000

 
$
150,000

Non-Recourse Debt
9,938

 
13,005

Capital Lease Obligations
10,863

 
10,907

Total
$
270,801

 
$
173,912


Other debt was $270.8 million as of September 30, 2015, an increase of $96.9 million or 56% from December 31, 2014. This increase was primarily due to four FHLB advances totaling $100.0 million borrowed in the third quarter of 2015. As of September 30, 2015, our six FHLB advances totaled $250.0 million with a weighted-average interest rate of 0.88% and maturity dates ranging from 2015 to 2018. These advances were primarily for asset/liability management purposes. As of September 30, 2015, our remaining unused line of credit with the FHLB was $1.1 billion.


63


Analysis of Business Segments

Our business segments are defined as Retail Banking, Commercial Banking, Investment Services, and Treasury and Other.

Table 15 summarizes net income from our business segments.  Additional information about segment performance is presented in Note 9 to the Consolidated Financial Statements.
Business Segment Net Income
 
 
 
 
 
 
Table 15

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands)
2015

 
2014

 
2015

 
2014

Retail Banking
$
13,414

 
$
9,644

 
$
36,536

 
$
25,720

Commercial Banking
11,068

 
14,423

 
42,138

 
37,538

Investment Services
3,067

 
2,973

 
9,303

 
8,338

Total
27,549

 
27,040


87,977


71,596

Treasury and Other
6,727

 
14,729

 
29,895

 
50,255

Consolidated Total
$
34,276

 
$
41,769


$
117,872


$
121,851


Retail Banking

Net income increased by $3.8 million or 39% in the third quarter of 2015 and by $10.8 million or 42% in the first nine months of 2015 compared to the same periods in 2014 primarily due to increases in net interest income and noninterest income, partially offset by increases in noninterest expense and the Provision. The increase in net interest income was primarily due to higher volume in both the lending and deposit portfolios and partially due to higher earnings credits on the segment’s deposit portfolio. The increase in noninterest income was primarily due to higher mortgage banking income as a result of our decision to sell conforming salable loans from our mortgage portfolio which generated gains on sales of residential mortgage loans. The year-to-date increase in noninterest income was also due to higher commissions and fees income related to our credit card business. The increase in noninterest expense in 2015 compared to 2014 was primarily due to higher allocated expenses. The year-to-date increase in noninterest expense was also due to higher credit card expense. The increase in the Provision in the third quarter of 2015 compared to the same period in 2014 was due to higher net charge-offs in the credit card and indirect auto portfolios. The year-to-date increase in the Provision was due to higher net recoveries in 2014 of loans and leases previously charged-off.

Commercial Banking

Net income decreased by $3.4 million or 23% in the third quarter of 2015 compared to the same period in 2014 primarily due to a decrease in noninterest income and due to increases in noninterest expense and the Provision. These were partially offset by an increase in net interest income. The decrease in noninterest income was primarily due to a $1.0 million expected loss on the pending sale of an aircraft lease. The increase in noninterest expense was primarily due to a $9.5 million impairment charge on six aircraft which were previously on lease agreements. The increase in the Provision was due to lower net recoveries of loans and leases in the current period. The increase in net interest income was primarily due to higher volume in both the lending and deposit portfolios and partially due to higher earnings credits on the segment’s deposit portfolio.

Net income increased by $4.6 million or 12% for the first nine months of 2015 compared to the same period in 2014 primarily due to an increase in net interest income, partially offset by increases in noninterest expense and the Provision. The increase in net interest income was primarily due to higher volume in both the lending and deposit portfolios and partially due to higher earnings credits on the segment’s deposit portfolio. The increase in noninterest expense was primarily due to the aforementioned $9.5 million impairment charge on six aircraft which were previously on lease agreements. The increase in the Provision was due to lower net recoveries of loans and leases in the current period.

Investment Services

Net income increased by $0.1 million or 3% in the third quarter of 2015 compared to the same period in 2014 primarily due to an increase in net interest income, partially offset by an increase in noninterest expense. The increase in net interest income was due to both higher volume and higher earnings credits on the segment’s deposit portfolio. The increase in noninterest expense was primarily due to higher allocated expenses.


64


Net income increased by $1.0 million or 12% for the first nine months of 2015 compared to the same period in 2014 primarily due to increases in net interest income and noninterest income, partially offset by an increase in noninterest expense. The increase in net interest income was due to both higher volume and higher earnings credits on the segment’s deposit portfolio. The increase in noninterest income was primarily due to a $0.5 million referral fee received in the second quarter of 2015 related to the transition of various services provided to some institutional 401k plans. In addition, noninterest income increased due to higher trust termination, servicing, irrevocable trust, and investment advisory fees. The increase in noninterest expense was primarily due to higher salaries and allocated expenses.

Treasury and Other

Net income decreased by $8.0 million or 54% in the third quarter of 2015 compared to the same period in 2014 primarily due to decreases in net interest income and noninterest income.  The decrease in net interest income was primarily due to higher deposit funding costs and lower interest income from the investment securities portfolio resulting from a reduction in volume and lower associated yields partially offset by an increase in funding income related to lending activities. The decrease in noninterest income was primarily due to a $1.9 million net gain on sale of 23,000 Visa Class B shares in 2014. The Provision in this business segment represents the residual provision for credit losses to arrive at the total Provision for the Company.

Net income decreased by $20.4 million or 41% for first nine months of 2015 compared to the same period in 2014 primarily due to a decrease in net interest income and an increase in noninterest expense, partially offset by an increase in noninterest income.  The decrease in net interest income was primarily due to higher deposit funding costs and lower interest income from the investment securities portfolio resulting from a reduction in volume and lower associated yields partially offset by an increase in funding income related to lending activities. The increase in noninterest expense was due to higher separation expense. The increase in noninterest income was primarily due to a $10.1 million gain on the sale of 95,000 Visa Class B shares during the first quarter of 2015. During the first nine months of 2014, we recorded a $5.8 million gain on the sale of 68,500 Visa Class B shares.

Other organizational units (Technology, Operations, Marketing, Human Resources, Finance, Credit and Risk Management, and Corporate and Regulatory Administration) included in Treasury and Other provide a wide-range of support to the Company's other income earning segments.  Expenses incurred by these support units are charged to the business segments through an internal cost allocation process.

Corporate Risk Profile

Credit Risk

As of September 30, 2015, our overall credit risk profile reflects a healthy Hawaii economy, as our levels of non-performing assets and credit losses remain well controlled. The underlying risk profile of our lending portfolio continued to remain strong during the first nine months of 2015.

We actively manage exposures with deteriorating asset quality to reduce levels of potential loss exposure and closely monitor our reserves and capital to address both anticipated and unforeseen issues.  Risk management activities include detailed analysis of portfolio segments and stress tests of certain segments to ensure that reserve and capital levels are appropriate.  We perform frequent loan and lease-level risk monitoring and risk rating reviews, which provide opportunities for early interventions to allow for credit exits or restructuring, loan and lease sales, and voluntary workouts and liquidations.


65


Non-Performing Assets and Accruing Loans and Leases Past Due 90 Days or More

Table 16 presents information on non-performing assets (“NPAs”) and accruing loans and leases past due 90 days or more.
Non-Performing Assets and Accruing Loans and Leases Past Due 90 Days or More
 
 
Table 16

(dollars in thousands)
September 30,
2015

 
December 31,
2014

Non-Performing Assets
 

 
 

Non-Accrual Loans and Leases
 

 
 

Commercial
 

 
 

Commercial and Industrial
$
8,532

 
$
9,088

Commercial Mortgage
1,058

 
745

Total Commercial
9,590

 
9,833

Consumer
 
 
 
Residential Mortgage
14,749

 
14,841

Home Equity
3,814

 
3,097

Total Consumer
18,563

 
17,938

Total Non-Accrual Loans and Leases
28,153

 
27,771

Foreclosed Real Estate
1,392

 
2,311

Total Non-Performing Assets
$
29,545

 
$
30,082

 
 
 
 
Accruing Loans and Leases Past Due 90 Days or More
 
 
 
Commercial
 
 
 
Commercial and Industrial
$

 
$
2

Total Commercial

 
2

Consumer
 
 
 
Residential Mortgage
5,060

 
4,506

Home Equity
1,396

 
2,596

Automobile
631

 
616

Other 1
1,058

 
941

Total Consumer
8,145

 
8,659

Total Accruing Loans and Leases Past Due 90 Days or More
$
8,145

 
$
8,661

Restructured Loans on Accrual Status and Not Past Due 90 Days or More
$
49,506

 
$
45,474

Total Loans and Leases
$
7,689,772

 
$
6,897,589

Ratio of Non-Accrual Loans and Leases to Total Loans and Leases
0.37
%
 
0.40
%
Ratio of Non-Performing Assets to Total Loans and Leases and Foreclosed Real Estate
0.38
%
 
0.44
%
Ratio of Commercial Non-Performing Assets to Total Commercial Loans and Leases
   and Commercial Foreclosed Real Estate
0.31
%
 
0.38
%
Ratio of Consumer Non-Performing Assets to Total Consumer Loans and Leases
   and Consumer Foreclosed Real Estate
0.44
%
 
0.47
%
Ratio of Non-Performing Assets and Accruing Loans and Leases Past Due 90 Days
   or More to Total Loans and Leases and Foreclosed Real Estate
0.49
%
 
0.56
%
Changes in Non-Performing Assets
 

 
 

Balance as of December 31, 2014
$
30,082

 
 

Additions
6,957

 
 

Reductions
 
 
 

Payments
(3,638
)
 
 

Return to Accrual Status
(1,935
)
 
 

Sales of Foreclosed Real Estate
(1,420
)
 
 

Charge-offs/Write-downs
(501
)
 
 

Total Reductions
(7,494
)
 
 

Balance as of September 30, 2015
$
29,545

 
 

1 
Comprised of other revolving credit, installment, and lease financing.

66


NPAs consist of non-accrual loans and leases, and foreclosed real estate.  Changes in the level of non-accrual loans and leases typically represent increases for loans and leases that reach a specified past due status, offset by reductions for loans and leases that are charged-off, paid down, sold, transferred to foreclosed real estate, or are no longer classified as non-accrual because they have returned to accrual status.

Total NPAs were $29.5 million as of September 30, 2015, a decrease of $0.5 million or 2% from December 31, 2014.  The decrease was primarily due to the sale of one commercial foreclosed real estate property. The ratio of our NPAs to total loans and leases and foreclosed real estate was 0.38% as of September 30, 2015 and 0.44% as of December 31, 2014.

Commercial and industrial non-accrual loans decreased by $0.6 million or 6% from December 31, 2014 due to paydowns. As of September 30, 2015, five commercial borrowers comprised 97% of the non-accrual balance in this category.  We have individually evaluated these five loans for impairment and have recorded partial charge-offs totaling $11.9 million on three of these loans.

Commercial mortgage non-accrual loans increased by $0.3 million or 42% from December 31, 2014. The increase was primarily due to the addition of one credit. We have individually evaluated the remaining commercial mortgage non-accrual loans for impairment and have recorded no charge-offs.

The largest component of our NPAs continues to be residential mortgage loans. Residential mortgage non-accrual loans decreased by $0.1 million or 1% from December 31, 2014.  Residential mortgage non-accrual loans remain at elevated levels due mainly to the lengthy judiciary foreclosure process as well as residential mortgage loan modifications the bank entered into to assist borrowers wishing to remain in their residences despite having financial challenges.  As of September 30, 2015, our residential mortgage non-accrual loans were comprised of 36 loans with a weighted average current LTV ratio of 63%.

Foreclosed real estate represents property acquired as the result of borrower defaults on loans.  Foreclosed real estate is recorded at fair value, less estimated selling costs, at the time of foreclosure.  On an ongoing basis, properties are appraised as required by market conditions and applicable regulations.  Foreclosed real estate decreased by $0.9 million or 40% from December 31, 2014 primarily due to the sale of one commercial property.

Loans and Leases Past Due 90 Days or More and Still Accruing Interest

Loans and leases in this category are 90 days or more past due, as to principal or interest, and are still accruing interest because they are well secured and in the process of collection.  Loans and leases past due 90 days or more and still accruing interest were $8.1 million as of September 30, 2015, a $0.5 million or 6% decrease from December 31, 2014.

Impaired Loans

Impaired loans are defined as loans for which we believe it is probable we will not collect all amounts due according to the contractual terms of the loan agreement.  Included in impaired loans are all classes of commercial non-accruing loans (except lease financing and small business loans), all loans modified in a TDR (including accruing TDRs), and other loans where we believe that we will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Impaired loans exclude lease financing and smaller balance homogeneous loans (consumer and small business non-accruing loans) that are collectively evaluated for impairment.  Impaired loans were $68.0 million as of September 30, 2015 and $64.7 million as of December 31, 2014, and had a related Allowance of $5.3 million as of September 30, 2015 and $5.9 million as of December 31, 2014.  As of September 30, 2015, we have recorded charge-offs of $22.9 million related to our total impaired loans.  Our impaired loans are considered in management's assessment of the overall adequacy of the Allowance.


67


Table 17 presents information on loans with terms that have been modified in a TDR.
Loans Modified in a Troubled Debt Restructuring
 
 
Table 17

(dollars in thousands)
September 30,
2015

 
December 31,
2014

Commercial
 
 
 
Commercial and Industrial
$
18,941

 
$
13,176

Commercial Mortgage
6,758

 
5,734

Construction
1,625

 
1,689

Total Commercial
27,324

 
20,599

Consumer
 
 
 
Residential Mortgage
30,253

 
32,331

Home Equity
1,191

 
1,012

Automobile
6,238

 
5,375

Other 1
1,331

 
913

Total Consumer
39,013

 
39,631

Total
$
66,337

 
$
60,230

 
1 
Comprised of other revolving credit, installment, and lease financing.

Loans modified in a TDR increased by $6.1 million or 10% from December 31, 2014. This increase was primarily reflected in the commercial and industrial portfolio. Residential mortgage loans remain our largest TDR loan class.


68



Reserve for Credit Losses

Table 18 presents the activity in our reserve for credit losses.
Reserve for Credit Losses
 
 
 
 
 
 
Table 18

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(dollars in thousands)
2015

 
2014

 
2015

 
2014

Balance at Beginning of Period
$
111,893

 
$
119,725

 
$
114,575

 
$
121,521

Loans and Leases Charged-Off
 
 
 
 
 
 
 
Commercial
 
 
 
 
 
 
 
Commercial and Industrial
(160
)
 
(229
)
 
(650
)
 
(1,797
)
Lease Financing

 

 

 
(66
)
Consumer
 
 
 
 
 
 
 
Residential Mortgage

 
(22
)
 
(613
)
 
(674
)
Home Equity
(634
)
 
(475
)
 
(1,061
)
 
(1,379
)
Automobile
(1,476
)
 
(957
)
 
(4,141
)
 
(2,585
)
Other 1
(2,123
)
 
(1,978
)
 
(5,512
)
 
(5,195
)
Total Loans and Leases Charged-Off
(4,393
)
 
(3,661
)
 
(11,977
)
 
(11,696
)
Recoveries on Loans and Leases Previously Charged-Off
 

 
 

 
 

 
 

Commercial
 

 
 

 
 

 
 

Commercial and Industrial
426

 
1,177

 
1,528

 
4,229

Commercial Mortgage
15

 
14

 
43

 
43

Construction
8

 
8

 
24

 
21

Lease Financing
55

 
3

 
131

 
6

Consumer
 
 
 
 
 
 
 
Residential Mortgage
282

 
299

 
720

 
2,906

Home Equity
693

 
531

 
2,140

 
1,433

Automobile
508

 
322

 
1,398

 
1,110

Other 1
438

 
496

 
1,343

 
1,720

Total Recoveries on Loans and Leases Previously Charged-Off
2,425

 
2,850

 
7,327

 
11,468

Net Loans and Leases Charged-Off
(1,968
)
 
(811
)
 
(4,650
)
 
(228
)
Provision for Credit Losses

 
(2,665
)
 

 
(4,864
)
Provision for Unfunded Commitments
185

 

 
185

 
(180
)
Balance at End of Period 2
$
110,110

 
$
116,249

 
$
110,110

 
$
116,249

 
 
 
 
 
 
 
 
Components
 

 
 

 
 

 
 

Allowance for Loan and Lease Losses
$
104,038

 
$
110,362

 
$
104,038

 
$
110,362

Reserve for Unfunded Commitments
6,072

 
5,887

 
6,072

 
5,887

Total Reserve for Credit Losses
$
110,110

 
$
116,249

 
$
110,110

 
$
116,249

 
 
 
 
 
 
 
 
Average Loans and Leases Outstanding
$
7,545,985

 
$
6,488,780

 
$
7,301,656

 
$
6,290,548

 
 
 
 
 
 
 
 
Ratio of Net Loans and Leases Charged-Off to
   Average Loans and Leases Outstanding (annualized)
0.10
%
 
0.05
%
 
0.09
%
 
0.00
%
Ratio of Allowance for Loan and Lease Losses to
   Loans and Leases Outstanding
1.35
%
 
1.67
%
 
1.35
%
 
1.67
%
1 
Comprised of other revolving credit, installment, and lease financing.
2 
Included in this analysis is activity related to the Company’s reserve for unfunded commitments, which is separately recorded in other liabilities in the consolidated statements of condition.

We maintain a reserve for credit losses that consists of two components, the Allowance and a reserve for unfunded commitments (the “Unfunded Reserve”).  The reserve for credit losses provides for the risk of credit losses inherent in the loan and lease portfolio and is based on loss estimates derived from a comprehensive quarterly evaluation.  The evaluation reflects analyses of individual borrowers and historical loss experience, supplemented as necessary by credit judgment that considers observable trends, conditions, and other relevant environmental and economic factors.  The level of the Allowance is adjusted by recording an expense or recovery through the Provision.  The level of the Unfunded Reserve is adjusted by recording an expense or recovery in other noninterest expense.


69


Allowance for Loan and Lease Losses

As of September 30, 2015, the Allowance was $104.0 million or 1.35% of total loans and leases outstanding, compared with an Allowance of $108.7 million or 1.58% of total loans and leases outstanding as of December 31, 2014.  The decrease in the Allowance was commensurate with the Company's strong credit risk profile and a healthy Hawaii economy.

Net charge-offs on loans and leases were $2.0 million or 0.10% of total average loans and leases, on an annualized basis, in the third quarter of 2015 compared to $0.8 million or 0.05% of total average loans and leases, on an annualized basis, in the third quarter of 2014. All of our commercial portfolios were in net recovery positions in the first nine months of 2015. Net recoveries in our commercial portfolios were $1.1 million for the first nine months of 2015 compared to $2.4 million for the same period in 2014. Net recoveries in the first nine months of 2014 were primarily due to recoveries related to two commercial and industrial loans. Net charge-offs in our consumer portfolios were $5.7 million for the first nine months of 2015 compared to $2.7 million for the same period in 2014. The lower net charge-offs in the first nine months of 2014 were primarily due to the recovery of three residential mortgage loans.

Although we determine the amount of each component of the Allowance separately, the Allowance as a whole was considered appropriate by management as of September 30, 2015, based on our ongoing analysis of estimated probable credit losses, credit risk profiles, economic conditions, coverage ratios, and other relevant factors.

The Reserve for Unfunded Commitments

The Unfunded Reserve was $6.1 million as of September 30, 2015, an increase of $0.2 million from December 31, 2014. The process used to determine the Unfunded Reserve is consistent with the process for determining the Allowance, as adjusted for estimated funding probabilities.


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Market Risk
 
Market risk is the potential of loss arising from adverse changes in interest rates and prices.  We are exposed to market risk as a consequence of the normal course of conducting our business activities.  Our market risk management process involves measuring, monitoring, controlling, and mitigating risks that can significantly impact our statements of income and condition.  In this management process, market risks are balanced with expected returns in an effort to enhance earnings performance, while limiting volatility.

Our primary market risk exposure is interest rate risk.

Interest Rate Risk

The objective of our interest rate risk management process is to maximize net interest income while operating within acceptable limits established for interest rate risk and maintaining adequate levels of funding and liquidity. The potential cash flows, sales, or replacement value of many of our assets and liabilities, especially those that earn or pay interest, are sensitive to changes in the general level of interest rates.  This interest rate risk arises primarily from our core business activities of extending loans and accepting deposits. Our investment securities portfolio is also subject to significant interest rate risk.  

Many factors affect our exposure to changes in interest rates such as general economic and financial conditions, customer preferences, historical pricing relationships, and repricing characteristics of financial instruments. Our earnings are affected not only by general economic conditions but also by the monetary and fiscal policies of the U.S. and its agencies, particularly the Federal Reserve Bank (the “FRB”).  The monetary policies of the FRB can influence the overall growth of loans, investment securities, and deposits and the level of interest rates earned on assets and paid for liabilities.

In managing interest rate risk, we, through the Asset/Liability Management Committee (“ALCO”), measure short and long-term sensitivities to changes in interest rates.  The ALCO, which is comprised of members of executive management, utilizes several techniques to manage interest rate risk, which include:

adjusting the balance sheet mix or altering the interest rate characteristics of assets and liabilities;
changing product pricing strategies;
modifying characteristics of the investment securities portfolio; and
using derivative financial instruments.

Our use of derivative financial instruments, as detailed in Note 11 to the Consolidated Financial Statements, has generally been limited.  This is due to natural on-balance sheet hedges arising out of offsetting interest rate exposures from loans and investment securities with deposits and other interest-bearing liabilities.  In particular, the investment securities portfolio is utilized to manage the interest rate exposure and sensitivity to within the guidelines and limits established by the ALCO.  We utilize natural and offsetting economic hedges in an effort to reduce the need to employ off-balance sheet derivative financial instruments to hedge interest rate risk exposures.  Expected movements in interest rates are also considered in managing interest rate risk.  Thus, as interest rates change, we may use different techniques to manage interest rate risk.

A key element in our ongoing process to measure and monitor interest rate risk is the utilization of an asset/liability simulation model that attempts to capture the dynamic nature of the balance sheet.  The model is used to estimate and measure the balance sheet sensitivity to changes in interest rates.  These estimates are based on assumptions about the behavior of loan and deposit pricing, repayment rates on mortgage-based assets, and principal amortization and maturities on other financial instruments.  The model’s analytics include the effects of standard prepayment options on mortgages and customer withdrawal options for deposits.  While such assumptions are inherently uncertain, we believe that our assumptions are reasonable. 


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We utilize net interest income simulations to analyze short-term income sensitivities to changes in interest rates.  Table 19
presents, for the twelve months subsequent to September 30, 2015 and December 31, 2014, an estimate of the change in net interest income that would result from a gradual and immediate change in interest rates, moving in a parallel fashion over the entire yield curve, relative to the measured base case scenario.  The base case scenario assumes the balance sheet and interest rates are generally unchanged.  Based on our net interest income simulation as of September 30, 2015, net interest income is expected to increase as interest rates rise. This is due in part to our strategy to maintain a relatively short investment portfolio duration. In addition, rising interest rates would drive higher rates on loans and investment securities, as well as induce a slower pace of premium amortization on certain securities within our investment portfolio. However, lower interest rates would likely cause a decline in net interest income as lower rates would lead to lower yields on loans and investment securities, as well as drive higher premium amortization on existing investment securities. Since deposit costs are already at low levels, lower interest rates are unlikely to significantly impact our funding costs. Based on our net interest income simulation as of September 30, 2015, net interest income sensitivity to changes in interest rates for the twelve months subsequent to September 30, 2015 was slightly less sensitive compared to the sensitivity profile for the twelve months subsequent to December 31, 2014.

Net Interest Income Sensitivity Profile
 
 
 
Table 19

 
Impact on Future Annual Net Interest Income
(dollars in thousands)
September 30, 2015
 
December 31, 2014
Gradual Change in Interest Rates (basis points)
 
 
 
 
 
 
 

+200
$
6,786

 
1.7
 %
 
$
7,934

 
2.0
 %
+100
3,062

 
0.8
 %
 
3,740

 
1.0
 %
-100
(5,865
)
 
-1.5
 %
 
(6,528
)
 
-1.7
 %
 
 
 
 
 
 
 
 
Immediate Change in Interest Rates (basis points)
 
 
 
 
 
 
 
+200
$
16,884

 
4.2
 %
 
$
18,962

 
4.8
 %
+100
7,957

 
2.0
 %
 
8,804

 
2.2
 %
-100
(19,869
)
 
-5.0
 %
 
(20,755
)
 
-5.3
 %

To analyze the impact of changes in interest rates in a more realistic manner, non-parallel interest rate scenarios are also simulated.  These non-parallel interest rate scenarios indicate that net interest income may decrease from the base case scenario should the yield curve flatten or become inverted for a period of time.  Conversely, if the yield curve should steepen, net interest income may increase.

Other Market Risks

In addition to interest rate risk, we are exposed to other forms of market risk in our normal business transactions.  Foreign currency and foreign exchange contracts expose us to a small degree of foreign currency risk.  These transactions are primarily executed on behalf of customers.  Our trust and asset management income are at risk to fluctuations in the market values of underlying assets, particularly debt and equity securities.  Also, our share-based compensation expense is dependent on the fair value of our stock options, restricted stock units, and restricted stock at the date of grant.  The fair value of stock options, restricted stock units, and restricted stock is impacted by the market price of the Parent’s common stock on the date of grant and is at risk to changes in equity markets, general economic conditions, and other factors.

Liquidity Risk Management

The objective of our liquidity risk management process is to manage cash flow and liquidity in an effort to provide continuous access to sufficient, reasonably priced funds.  Funding requirements are impacted by loan originations and refinancings, deposit balance changes, liability issuances and settlements, and off-balance sheet funding commitments.  We consider and comply with various regulatory guidelines regarding required liquidity levels and periodically monitor our liquidity position in light of the changing economic environment and customer activity.  Based on periodic liquidity assessments, we may alter our asset, liability, and off-balance sheet positions.  The ALCO monitors sources and uses of funds and modifies asset and liability positions as liquidity requirements change.  This process, combined with our ability to raise funds in money and capital markets and through private placements, provides flexibility in managing the exposure to liquidity risk.

In an effort to satisfy our liquidity needs, we actively manage our assets and liabilities.  We have immediate liquid resources in cash which is primarily on deposit with the FRB. Potential sources of liquidity also include investment securities in our available-for-sale securities portfolio, our ability to sell loans in the secondary market, and to secure borrowings from the FRB and FHLB.  Our held-to-maturity securities, while not intended for sale, may also be utilized in repurchase agreements to

72


obtain funding. Our core deposits have historically provided us with a long-term source of stable and relatively lower cost source of funding.  Additional funding is available through the issuance of long-term debt.

Maturities and payments on outstanding loans also provide a steady flow of funds. Additionally, as of September 30, 2015, investment securities with a carrying value of $139.5 million were due to contractually mature in one year or less. Liquidity is further enhanced by our ability to pledge loans to access secured borrowings from the FHLB and FRB. As of September 30, 2015, we could have borrowed an additional $1.1 billion from the FHLB and an additional $592.0 million from the FRB based on the amount of collateral pledged.

We continued our focus on maintaining a strong liquidity position throughout the first nine months of 2015.  As of September 30, 2015, cash and cash equivalents were $487.1 million, the carrying value of our available-for-sale investment securities was $2.3 billion, and total deposits were $12.9 billion.  As of September 30, 2015, our available-for-sale investment securities portfolio was comprised of securities with an average base duration of approximately 2.6 years.

Capital Management

We actively manage capital, commensurate with our risk profile, to enhance shareholder value. We also seek to maintain capital levels for the Company and the Bank at amounts in excess of the regulatory "well-capitalized" thresholds. Periodically, we may respond to market conditions by implementing changes to our overall balance sheet positioning to manage our capital position.

The Company and the Bank are each subject to regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements could cause certain mandatory and discretionary actions by regulators that, if undertaken, would likely have a material effect on our financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative and qualitative measures.  These measures were established by regulation intended to ensure capital adequacy.  As of September 30, 2015, the Company and the Bank were considered “well capitalized” under this regulatory framework.  The Company’s regulatory capital ratios are presented in Table 20 below.  There have been no conditions or events since September 30, 2015 that management believes have changed either the Company’s or the Bank’s capital classifications.

As of September 30, 2015, shareholders' equity was $1.1 billion, an increase of $43.3 million or 4% from December 31, 2014. For the first nine months of 2015, net income of $117.9 million, common stock issuances of $12.1 million, shared-based compensation of $5.7 million, and other comprehensive income of $5.4 million were partially offset by cash dividends paid of $58.9 million, and common stock repurchased of $38.9 million. In the first nine months of 2015, included in the amount of common stock repurchased were 588,255 shares repurchased under our share repurchase program. These shares were repurchased at an average cost per share of $61.70 and a total cost of $36.3 million. From the beginning of our share repurchase program in July 2001 through September 30, 2015, we repurchased a total of 52.6 million shares of common stock and returned a total of $1.96 billion to our shareholders at an average cost of $37.24 per share. As of September 30, 2015, remaining buyback authority under our share repurchase program was $36.9 million. From October 1, 2015 through October 20, 2015, the Parent repurchased an additional 53,000 shares of common stock at an average cost of $64.23 per share for a total of $3.4 million.  Remaining buyback authority under our share repurchase program was $33.5 million as of October 20, 2015.  The actual amount and timing of future share repurchases, if any, will depend on market and economic conditions, regulatory rules, applicable SEC rules, and various other factors.

In October 2015, the Parent’s Board of Directors declared a quarterly cash dividend of $0.45 per share on the Parent’s outstanding shares.  The dividend will be payable on December 14, 2015 to shareholders of record at the close of business on November 30, 2015.

The final rules implementing the Basel Committee on Banking Supervision's (“BCBS”) capital guidelines for U.S. banks became effective for the Company on January 1, 2015, with full compliance with all of the final rule's requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of September 30, 2015, the Company's capital levels remained characterized as "well-capitalized" under the new rules. See the “Regulatory Initiatives Affecting the Banking Industry" section below for further discussion on Basel III.

We continue to evaluate the potential impact that regulatory rules may have on our liquidity and capital management strategies, including Basel III and those required under the Dodd-Frank Act. See the “Regulatory Initiatives Affecting the Banking Industry" section below for further discussion on the potential impact that these regulatory rules may have on our liquidity and capital requirements.


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Table 20 presents our regulatory capital and ratios as of September 30, 2015 and December 31, 2014.
Regulatory Capital and Ratios
 
 
Table 20
(dollars in thousands)
September 30,
2015

 
December 31,
2014

 
Regulatory Capital
 
 
 
 
Shareholders’ Equity
$
1,098,354

 
$
1,055,086

 
Less:
Goodwill 2
27,422

 
31,517

 
 
Defined Benefit Plans Adjustment
(33,455
)
 
(34,115
)
 
 
Net Unrealized Gains (Losses) on Investment Securities 3
12,163

 
15,984

 
 
Other
(198
)
 
2,069

 
Common Equity Tier 1 Capital
1,092,422

 
n/a

 
 
 
 
 
 
Tier 1 Capital
1,092,422

 
1,039,631

 
Allowable Reserve for Credit Losses
96,915

 
88,785

 
Total Regulatory Capital 1
$
1,189,337

 
$
1,128,416

 
 
 
 
 
 
Risk-Weighted Assets 1
$
7,740,028

 
$
7,077,035

 
 
 
 
 
 
Key Regulatory Capital Ratios 1
 

 
 

 
Common Equity Tier 1 Capital Ratio
14.11

%
n/a

%
Tier 1 Capital Ratio
14.11

 
14.69

 
Total Capital Ratio
15.37

 
15.94

 
Tier 1 Leverage Ratio
7.18

 
7.13

 
1 September 30, 2015 calculated under Basel III rules, which became effective January 1, 2015.
2 September 30, 2015 calculated net of deferred tax liabilities.
3 September 30, 2015 includes unrealized gains and losses related to the Company's reclassification of available-for-sale investment securities to the held-to-maturity category.



74


Regulatory Initiatives Affecting the Banking Industry

Basel III

The FRB and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision's (“BCBS”) capital guidelines for U.S. banks. Under the final rules, minimum requirements increased for both the quantity and quality of capital held by the Company. The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer, comprised of common equity Tier 1 capital, was also established above the regulatory minimum capital requirements. This capital conservation buffer will be phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Strict eligibility criteria for regulatory capital instruments were also implemented under the final rules. The final rules also revised the definition and calculation of Tier 1 capital, Total Capital, and risk-weighted assets.

The phase-in period for the final rules became effective for the Company on January 1, 2015, with full compliance with all of the final rules’ requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of September 30, 2015, the Company's capital levels remained characterized as "well-capitalized" under the new rules.

On September 3, 2014, the FRB, the FDIC, and the Office of the Comptroller of the Currency finalized the Liquidity Coverage Ratio (“LCR”), which requires banks to hold highly liquid assets relative to cash outflows over a 30-day period during a stressed scenario. The LCR generally applies to banking organizations with over $50.0 billion in assets, and therefore, should not directly impact the Company.

Management continues to monitor regulatory developments and their potential impact to the Company's liquidity requirements.

Stress Testing

The Dodd-Frank Act requires federal banking agencies to issue regulations that require banks with total consolidated assets of more than $10.0 billion to conduct and publish company-run annual stress tests to assess the potential impact of different scenarios on the consolidated earnings and capital of each bank and certain related items over a nine-quarter forward-looking planning horizon, taking into account all relevant exposures and activities. On October 9, 2012, the FRB published final rules implementing the stress testing requirements for banks, such as the Company, with total consolidated assets of more than $10.0 billion but less than $50.0 billion.  These rules set forth the timing and type of stress test activities, as well as rules governing controls, oversight and disclosure.

In March 2014, the FRB, OCC, and FDIC issued final supervisory guidance for these stress tests. This joint final supervisory guidance discusses supervisory expectations for stress test practices, provides examples of practices that would be consistent with those expectations, and offers additional details about stress test methodologies. It also emphasizes the importance of stress testing as an ongoing risk management practice.

We submitted our latest stress testing results, utilizing data as of September 30, 2014, to the FRB on March 31, 2015.  On June 26, 2015, we made our first stress test-related public disclosure (posted on our website), utilizing data as of September 30, 2014.

Debit Card Interchange Fees

On July 31, 2013, a U.S. District Court judge declared invalid provisions of the rule issued by the FRB under the Durbin Amendment of the Dodd-Frank Act, regarding the amount of the debit card interchange fee cap and the network non-exclusivity provisions, which was effective October 1, 2011. The court ruled that the FRB, when determining the amount of the fee cap, erred in using criteria outside the scope Congress intended to determine the fee cap, thereby causing the fee cap to be set higher than warranted. The court also ruled that the Durbin Amendment required merchants to be given a choice between multiple unaffiliated networks (signature and PIN networks) for each debit card transaction, as opposed to the FRB’s rule allowing debit card networks and issuers to make only one network available for each type of debit transaction. In September 2013, the U.S. District Court judge agreed to the FRB’s request to leave the existing rules in place until an appeals court rules on the case.

On March 21, 2014, a panel of the U.S. Court of Appeals for the District of Columbia (the "Court") overturned the U.S. District Court’s opinion. The Court concluded that the FRB “reasonably interpreted the Durbin Amendment” to allow issuers to

75


recover certain costs that are incremental to the authorization, clearing, and settlement (“ACS”) costs. Finding that the FRB’s interpretation was reasonable, the Court then analyzed whether the FRB reasonably concluded that issuers could recover the four specific costs challenged by the merchants:  fixed ACS costs, network processing fees, fraud losses and transaction monitoring costs. The Court acknowledged that such a task was not “an exact science” and involved policy determinations in which the FRB had “expertise” and to which the FRB was entitled to “special deference.” The Court also rejected the merchants’ argument that the Durbin Amendment “unambiguously” required that there be multiple unaffiliated network routing options for each debit card transaction. The Court ruled that the FRB’s final rule does exactly what Congress contemplated, which is that under the rule, issuers and networks are prohibited from restricting the number of payment card networks on which an electronic debit transaction may be processed to only affiliated networks. The Court remanded one issue relating to recovery of transactions-monitoring costs back to the FRB, asking it to articulate a reasonable justification for determining that transactions-monitoring costs fell within the interchange fee standard rather than in the fraud-prevention adjustment. On August 18, 2014, some of the trade associations and retailers filed an appeal with the U.S. Supreme Court seeking review of the decision of the Court. On January 20, 2015, the U.S. Supreme Court announced it would not hear retailers’ challenge to the FRB's debit card interchange fee rules. The U.S. Supreme Court's decision not to hear the case keeps intact the March 21, 2014 ruling by the Court. On August 11, 2015, the FRB clarified the remanded issue regarding transactions-monitoring costs mentioned above. The clarification explains that the FRB included these costs in the base interchange fee rather than the fraud-prevention adjustment because “transactions-monitoring is integral to an issuer’s decision to authorize a specific transaction.” Management will continue to monitor the developments related to this matter and any potential impact on the Company's statements of income.

Operational Risk

Operational risk represents the risk of loss resulting from our operations, including, but not limited to, the risk of fraud by employees or persons outside the Company, errors relating to transaction processing and technology, failure to adhere to compliance requirements, and the risk of cyber security attacks.  We are also exposed to operational risk through our outsourcing arrangements, and the effect that changes in circumstances or capabilities of our outsourcing vendors can have on our ability to continue to perform operational functions necessary to our business.  The risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. Operational risk is inherent in all business activities, and management of this risk is important to the achievement of Company goals and objectives.

Our Operating Risk Committee (the “ORC”) provides oversight and assesses the most significant operational risks facing the Company.  We have developed a framework that provides for a centralized operating risk management function through the ORC, supplemented by business unit responsibility for managing operational risks specific to their business units. Our internal audit department also validates the system of internal controls through ongoing risk-based audit procedures and reports on the effectiveness of internal controls to executive management and the Audit and Risk Committee of the Board of Directors.

We continuously strive to strengthen our system of internal controls to improve the oversight of operational risk.  While our internal controls have been designed to minimize operational risks, there is no assurance that business disruption or operational losses will not occur.  On an ongoing basis, management reassesses operational risks, implements appropriate process changes, and invests in enhancements to our systems of internal controls. 

Off-Balance Sheet Arrangements, Credit Commitments, and Contractual Obligations

Off-Balance Sheet Arrangements

We hold interests in several unconsolidated variable interest entities (“VIEs”).  These unconsolidated VIEs are primarily low-income housing partnerships and solar energy partnerships.  Variable interests are defined as contractual ownership or other interests in an entity that change with fluctuations in an entity’s net asset value. The primary beneficiary consolidates the VIE.  We have determined that the Company is not the primary beneficiary of these entities.  As a result, we do not consolidate these VIEs.

Credit Commitments and Contractual Obligations

Our credit commitments and contractual obligations have not changed materially since previously reported in our Annual Report on Form 10-K for the year ended December 31, 2014.


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Item 3. Quantitative and Qualitative Disclosures About Market Risk

See the “Market Risk” section of MD&A.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of September 30, 2015.  The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.  Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2015.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended September 30, 2015 that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.


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Part II - Other Information

Item 1A. Risk Factors

There are no material changes from the risk factors set forth under Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

The Parent’s repurchases of its common stock during the third quarter of 2015 were as follows:
Issuer Purchases of Equity Securities
 
 
 
 

 
 
 

Period
Total Number of Shares Purchased 1

 
Average Price Paid Per Share

 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs

 
Approximate Dollar Value
 of Shares that May Yet Be
 Purchased Under the
 Plans or Programs 2
 
July 1 - 31, 2015
57,054

 
$
66.99

 
56,500

 
 
$
47,684,588

August 1 - 31, 2015
73,888

 
64.95

 
73,000

 
 
42,944,976

September 1 - 30, 2015
96,500

 
62.14

 
96,500

 
 
36,948,699

Total
227,442

 
$
64.27

 
226,000

 
 
 
1 
During the third quarter of 2015, 1,442 shares were purchased from employees and/or directors in connection with income tax withholdings related to the vesting of restricted stock and shares purchased for a deferred compensation plan.  These shares were not purchased as part of the publicly announced program.  The shares were purchased at the closing price of the Parent’s common stock on the dates of purchase.
2 
The share repurchase program was first announced in July 2001.  As of September 30, 2015, $36.9 million remained of the total $2.0 billion total repurchase amount authorized by the Parent’s Board of Directors under the share repurchase program. The program has no set expiration or termination date.

Item 6. Exhibits

A list of exhibits to this Form 10-Q is set forth on the Exhibit Index and is incorporated herein by reference.


78


Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date:
October 26, 2015
 
Bank of Hawaii Corporation
 
 
 
 
 
 
By:
/s/ Peter S. Ho
 
 
 
Peter S. Ho
 
 
 
Chairman of the Board,
 
 
 
Chief Executive Officer, and
 
 
 
President
 
 
 
 
 
 
By:
/s/ Kent T. Lucien
 
 
 
Kent T. Lucien
 
 
 
Chief Financial Officer


79


Exhibit Index
Exhibit Number
 
 
 
31.1
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as Amended, Adopted Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
 
 
31.2
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as Amended, Adopted Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
 
 
32
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
101
Interactive Data File


80