Territorial Bancorp Inc. - FORM 10-Q

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EX-32 - EX-32 - Territorial Bancorp Inc.	tbnk-20170331xex32.htm
EX-31.2 - EX-31.2 - Territorial Bancorp Inc.	tbnk-20170331ex312ef4a4d.htm
EX-31.1 - EX-31.1 - Territorial Bancorp Inc.	tbnk-20170331ex311cf45c1.htm

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the Quarterly Period ended March 31, 2017

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For transition period from to

Commission File Number 1-34403

TERRITORIAL BANCORP INC.

(Exact Name of Registrant as Specified in Charter)

Maryland		26-4674701
(State or Other Jurisdiction of Incorporation)		(I.R.S. Employer Identification No.)

1132 Bishop Street, Suite 2200, Honolulu, Hawaii		96813
(Address of Principal Executive Offices)		(Zip Code)

(808) 946-1400

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and formal fiscal year, if changed since last report)

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 ☒ No ☐.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐		Accelerated filer ☒
Non-accelerated filer ☐		(Do not check if a smaller reporting company)
Smaller reporting company ☐		Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: 9,830,438 shares of Common Stock, par value $0.01 per share, were issued and outstanding as of April 30, 2017.

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TERRITORIAL BANCORP INC.

Form 10-Q Quarterly Report

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PART I

ITEM 1.	FINANCIAL STATEMENTS	1
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	26
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	34
ITEM 4.	CONTROLS AND PROCEDURES	36

PART II

ITEM 1.	LEGAL PROCEEDINGS	37
ITEM 1A.	RISK FACTORS	37
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	37
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	37
ITEM 4.	MINE SAFETY DISCLOSURES	37
ITEM 5.	OTHER INFORMATION	37
ITEM 6.	EXHIBITS	37

SIGNATURES		38

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PART I

ITEM 1. FINANCIAL STATEMENTS

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Balance Sheets (Unaudited)

(Dollars in thousands, except share data)


	March 31,		December 31,
	2017		2016
ASSETS
Cash and cash equivalents	$	103,123	$	61,273
Investment securities held to maturity, at amortized cost (fair value of $392,384 and $407,922 at March 31, 2017 and December 31, 2016, respectively)		391,988		407,656
Loans held for sale		1,752		1,601
Loans receivable, net		1,367,217		1,335,987
Federal Home Loan Bank stock, at cost		5,013		4,945
Federal Reserve Bank stock, at cost		3,103		3,095
Accrued interest receivable		4,766		4,732
Premises and equipment, net		4,843		4,327
Bank-owned life insurance		43,520		43,294
Income taxes receivable		—		122
Deferred income tax assets, net		7,537		7,905
Prepaid expenses and other assets		2,929		2,625
Total assets	$	1,935,791	$	1,877,562

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits	$	1,548,906	$	1,493,200
Advances from the Federal Home Loan Bank		69,000		69,000
Securities sold under agreements to repurchase		55,000		55,000
Accounts payable and accrued expenses		23,419		23,258
Income taxes payable		3,328		1,616
Advance payments by borrowers for taxes and insurance		3,514		5,702
Total liabilities		1,703,167		1,647,776

Stockholders’ Equity:
Preferred stock, $.01 par value; authorized 50,000,000 shares, no shares issued or outstanding		—		—
Common stock, $.01 par value; authorized 100,000,000 shares; issued and outstanding 9,805,248 and 9,778,974 shares at March 31, 2017 and December 31, 2016, respectively		98		98
Additional paid-in capital		72,149		71,914
Unearned ESOP shares		(5,750)		(5,872)
Retained earnings		171,441		168,962
Accumulated other comprehensive loss		(5,314)		(5,316)
Total stockholders’ equity		232,624		229,786
Total liabilities and stockholders’ equity	$	1,935,791	$	1,877,562

See accompanying notes to consolidated financial statements.

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

(Dollars in thousands, except per share data)


	Three Months Ended
	March 31,
	2017		2016
Interest income:
Loans	$	13,513	$	12,361
Investment securities		3,081		3,875
Other investments		187		144
Total interest income		16,781		16,380

Interest expense:
Deposits		1,651		1,408
Advances from the Federal Home Loan Bank		254		257
Securities sold under agreements to repurchase		216		218
Total interest expense		2,121		1,883

Net interest income		14,660		14,497
Provision for loan losses		71		28

Net interest income after provision for loan losses		14,589		14,469

Noninterest income:
Service fees on loan and deposit accounts		556		456
Income on bank-owned life insurance		226		247
Gain on sale of investment securities		95		—
Gain on sale of loans		63		61
Other		82		122
Total noninterest income		1,022		886

Noninterest expense:
Salaries and employee benefits		5,118		5,426
Occupancy		1,449		1,420
Equipment		866		906
Federal deposit insurance premiums		148		225
Other general and administrative expenses		1,126		1,082
Total noninterest expense		8,707		9,059

Income before income taxes		6,904		6,296
Income taxes		2,583		2,512
Net income	$	4,321	$	3,784

Basic earnings per share	$	0.47	$	0.42
Diluted earnings per share	$	0.46	$	0.41
Cash dividends paid per common share	$	0.20	$	0.18
Basic weighted-average shares outstanding		9,215,142		9,034,919
Diluted weighted-average shares outstanding		9,445,989		9,305,615

See accompanying notes to consolidated financial statements.

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

(Dollars in thousands)


	Three Months Ended
	March 31,
	2017		2016
Net income	$	4,321	$	3,784

Change in unfunded pension liability		—		(21)
Change in unrealized loss on securities		2		2
Change in noncredit related loss on trust preferred securities		—		2
Other comprehensive income (loss), net of tax		2		(17)
Comprehensive income	$	4,323	$	3,767

See accompanying notes to consolidated financial statements.

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity (Unaudited)

(Dollars in thousands, except per share data)


									Accumulated
			Additional		Unearned				Other		Total
	Common		Paid-in		ESOP		Retained		Comprehensive		Stockholders’
	Stock		Capital		Shares		Earnings		Income (Loss)		Equity
Balances at December 31, 2015	$	96	$	70,118	$	(6,361)	$	161,024	$	(5,236)	$	219,641

Net income		—		—		—		3,784		—		3,784
Other comprehensive loss		—		—		—		—		(17)		(17)
Cash dividends paid ($0.18 per share)		—		—		—		(1,645)		—		(1,645)
Share-based compensation		—		661		—		—		—		661
Allocation of 12,233 ESOP shares		—		198		122		—		—		320
Exercise of 16,270 options for common stock		1		282		—		—		—		283

Balances at March 31, 2016	$	97	$	71,259	$	(6,239)	$	163,163	$	(5,253)	$	223,027

Balances at December 31, 2016	$	98	$	71,914	$	(5,872)	$	168,962	$	(5,316)	$	229,786

Net income		—		—		—		4,321		—		4,321
Other comprehensive income		—		—		—		—		2		2
Cash dividends paid ($0.20 per share)		—		—		—		(1,842)		—		(1,842)
Share-based compensation		—		(38)		—		—		—		(38)
Allocation of 12,233 ESOP shares		—		273		122		—		—		395
Repurchase of 28,702 shares of company common stock		(1)		(954)		—		—		—		(955)
Exercise of 54,976 options for common stock		1		954		—		—		—		955

Balances at March 31, 2017	$	98	$	72,149	$	(5,750)	$	171,441	$	(5,314)	$	232,624

See accompanying notes to consolidated financial statements.

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)


	Three Months Ended
	March 31,
	2017		2016
Cash flows from operating activities:
Net income	$	4,321	$	3,784
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		71		28
Depreciation and amortization		243		302
Deferred income tax expense		367		596
Amortization of fees, discounts, and premiums		(129)		(160)
Origination of loans held for sale		(8,098)		(10,242)
Proceeds from sales of loans held for sale		8,011		10,952
Gain on sale of loans, net		(63)		(61)
Gain on sale of investment securities held to maturity		(95)		—
ESOP expense		395		320
Share-based compensation expense		(38)		661
Increase in accrued interest receivable		(34)		(119)
Net increase in bank-owned life insurance		(226)		(247)
Net increase in prepaid expenses and other assets		(304)		(82)
Net increase (decrease) in accounts payable and accrued expenses		161		(1,902)
Net decrease in advance payments by borrowers for taxes and insurance		(2,188)		(2,103)
Net (increase) decrease in income taxes receivable		122		(1,311)
Net increase (decrease) in income taxes payable		1,712		(290)

Net cash from operating activities		4,228		126

Cash flows from investing activities:
Purchases of investment securities held to maturity		—		(1,323)
Principal repayments on investment securities held to maturity		14,162		14,107
Proceeds from sale of investment securities held to maturity		1,589		—
Loan originations, net of principal repayments on loans receivable		(31,158)		(25,108)
Purchases of Federal Home Loan Bank stock		(68)		(155)
Purchases of Federal Reserve Bank stock		(8)		(20)
Purchases of premises and equipment		(759)		(18)

Net cash from investing activities		(16,242)		(12,517)

(Continued)

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)


	Three Months Ended
	March 31,
	2017		2016
Cash flows from financing activities:
Net increase in deposits	$	55,706	$	29,822
Proceeds from exercise of stock options		—		283
Cash dividends paid		(1,842)		(1,645)

Net cash from financing activities		53,864		28,460

Net increase in cash and cash equivalents		41,850		16,069

Cash and cash equivalents at beginning of the period		61,273		65,919

Cash and cash equivalents at end of the period	$	103,123	$	81,988

Supplemental disclosure of cash flow information:
Cash paid for:
Interest on deposits and borrowings	$	2,003	$	1,871
Income taxes		429		3,517

Supplemental disclosure of noncash investing and financing activities:
Company stock acquired through net settlement transactions	$	955	$	—

See accompanying notes to consolidated financial statements.

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

(1) Basis of Presentation

The accompanying unaudited consolidated financial statements of Territorial Bancorp Inc. (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, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These interim condensed consolidated financial statements and notes should be read in conjunction with the Company’s consolidated financial statements and notes thereto filed as part of the Annual Report on Form 10-K for the year ended December 31, 2016. In the opinion of management, all adjustments necessary for a fair presentation have been made and consist only of normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year.

(2) Organization

On July 10, 2009, Territorial Savings Bank completed a conversion from a mutual holding company to a stock holding company. As part of the conversion, Territorial Mutual Holding Company and Territorial Savings Group, Inc., the former holding companies for Territorial Savings Bank, ceased to exist as separate legal entities, and Territorial Bancorp Inc. became the holding company for Territorial Savings Bank. Upon completion of the conversion and reorganization, a special “liquidation account” was established in an amount equal to the total equity of Territorial Mutual Holding Company as of December 31, 2008. The liquidation account is to provide eligible account holders and supplemental eligible account holders who maintain their deposit accounts with Territorial Savings Bank after the conversion with a liquidation interest in the unlikely event of the complete liquidation of Territorial Savings Bank after the conversion. The balance of the liquidation account at December 31, 2016 was $12.2 million.

On June 25, 2014, Territorial Savings Bank converted from a federal savings bank to a Hawaii state-chartered savings bank. On July 10, 2014, Territorial Savings Bank became a member of the Federal Reserve System.

(3) Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) amended the Revenue Recognition topic of the FASB Accounting Standards Codification (ASC). The amendment seeks to clarify the principles for recognizing revenue as well as to develop common revenue standards for U.S. generally accepted accounting principles and International Financial Reporting Standards. The amendment is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. In August 2015, the FASB deferred the effective date of the amendment by one year. However, entities may still choose to adopt the amendment as of the original effective date. The Company plans to adopt this amendment effective January 1, 2018. The Company does not expect the adoption of this amendment to have an effect on most items of income, including interest income and most categories of noninterest income. The Company is still studying the effects that this amendment will have on certain items of noninterest income, such as commissions earned from insurance and investment sales. However, the Company does not expect that there will be a material effect on its consolidated financial statements.

In January 2016, the FASB amended the Financial Instruments – Overall topic of the FASB ASC. The amendment addresses several aspects of recognition, measurement, presentation and disclosure of financial instruments. Included are: (a) a requirement to measure equity investments at fair value, with changes in fair value recognized in net income, (b) a simplification of the impairment assessment of equity investments without readily determinable fair values, (c) the elimination of the requirement to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet, and (d) a requirement to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. The amendment is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The

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Company has performed a preliminary evaluation and does not expect the adoption of this amendment to have a material effect on its consolidated financial statements.

In February 2016, the FASB amended the Leases topic of the FASB ASC. The primary effects of the amendment will be to recognize lease assets and lease liabilities on the balance sheet and to disclose certain information about leasing arrangements. The amendment is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company has several lease agreements for branch locations and equipment that will require recognition on the consolidated balance sheets upon adoption of the amendment. The Company will continue to evaluate the effects that the adoption of this amendment will have on its consolidated financial statements.

In March 2016, the FASB amended the Compensation – Stock Compensation topic of the FASB ASC. The amendment includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. Some of the key provisions of the amendment require companies to record all excess tax benefits and tax deficiencies as income tax benefit or expense in the income statement rather than as an adjustment to additional paid-in capital. In addition, the amendments requires that excess tax benefits should be reported as an operating activity on the statement of cash flows and increases the amount an employer can withhold for taxes for share-based compensation awards. The amendment is effective for annual periods beginning after December 15, 2016. The Company adopted this amendment effective January 1, 2017. The adoption of this amendment has resulted in increased volatility to income tax expense related to excess tax benefits and tax deficiencies for share-based compensation. The amount of tax benefits or deficiencies recognized in income tax expense depends on the number of options exercised and the difference in the stock prices at the exercise and grant dates. In the three months ended March 31, 2017, the Company recognized $208,000 of tax benefits related to the exercise of stock options.

In June 2016, the FASB amended various sections of the FASB ASC related to the accounting for credit losses on financial instruments. The amendment changes the threshold for recognizing losses from a “probable” to an “expected” model. The new model is referred to as the current expected credit loss model and applies to loans, leases, held-to-maturity investments, loan commitments and financial guarantees. The amendment requires the measurement of all expected credit losses for financial assets as of the reporting date (including historical experience, current conditions and reasonable and supportable forecasts) and enhanced disclosures that will help financial statement users understand the estimates and judgments used in estimating credit losses and evaluating the credit quality of an organization’s portfolio. The amendment is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company will apply the amendment’s provisions as a cumulative-effect adjustment to retained earnings at the beginning of the first period the amendment is effective. The Company is currently evaluating the effects that the adoption of this amendment will have on its consolidated financial statements by gathering the information that is necessary to make the calculations required by the amendment. This may result in increased credit losses on financial instruments recorded in the consolidated financial statements.

In March 2017, the FASB amended the Compensation – Retirement Benefits topic of the FASB ASC. The amendment requires the service cost component of net benefit cost to be reported in the same line item as other compensation costs arising from employee services. It also requires the other components of net benefit cost to be reported in the income statement separately from the service cost component. The amendment is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The Company has performed a preliminary evaluation and does not expect the adoption of this amendment to have a material effect on its consolidated financial statements.

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(4) Cash and Cash Equivalents

The table below presents the balances of cash and cash equivalents:


	March 31,		December 31,
(Dollars in thousands)	2017		2016
Cash and due from banks	$	9,319	$	9,043
Interest-earning deposits in other banks		93,804		52,230
Cash and cash equivalents	$	103,123	$	61,273

Interest-earning deposits in other banks consist primarily of deposits at the Federal Reserve Bank.

(5) Investment Securities

The amortized cost and fair values of investment securities are as follows:


	Amortized		Gross Unrealized				Estimated
(Dollars in thousands)	Cost		Gains		Losses		Fair Value
March 31, 2017:
Held-to-maturity:
U.S. government-sponsored mortgage-backed securities	$	390,945	$	6,891	$	(6,574)	$	391,262
Trust preferred securities		1,043		79		—		1,122
Total	$	391,988	$	6,970	$	(6,574)	$	392,384

December 31, 2016:
Held-to-maturity:
U.S. government-sponsored mortgage-backed securities	$	406,498	$	7,285	$	(7,024)	$	406,759
Trust preferred securities		1,158		5		—		1,163
Total	$	407,656	$	7,290	$	(7,024)	$	407,922

The amortized cost and estimated fair value of investment securities at March 31, 2017 are shown below. Incorporated in the maturity schedule are mortgage-backed and trust preferred securities, which are allocated using the contractual maturity as a basis. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.


	Amortized		Estimated
(Dollars in thousands)	Cost		Fair Value
Held-to-maturity:
Due within 5 years	$	18	$	18
Due after 5 years through 10 years		49		49
Due after 10 years		391,921		392,317
Total	$	391,988	$	392,384

Realized gains and losses and the proceeds from sales of securities held to maturity and trading are shown in the table below. All sales of securities were U.S. government-sponsored mortgage-backed securities.


	Three Months Ended
	March 31,
(Dollars in thousands)	2017		2016
Proceeds from sales	$	1,589	$	—
Gross gains		95		—
Gross losses		—		—

During the three months ended March 31, 2017, the Company received proceeds of $1.6 million from the sale of $1.5 million of held-to-maturity mortgage-backed securities, resulting in gross realized gains of $95,000. The Company

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did not sell any held-to-maturity mortgage-backed securities during the three months ended March 31, 2016. The sale of these mortgage-backed securities, for which the Company had already collected a substantial portion of the outstanding purchased principal (at least 85%), is in accordance with the Investments – Debt and Equity Securities topic of the FASB ASC and does not taint management’s assertion of intent to hold remaining securities in the held-to-maturity portfolio to maturity.

Investment securities with amortized costs of $273.3 million and $239.9 million at March 31, 2017 and December 31, 2016, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase and transaction clearing accounts.

Provided below is a summary of investment securities which were in an unrealized loss position at March 31, 2017 and December 31, 2016. The Company does not intend to sell these securities until such time as the value recovers or the securities mature and it is not more likely than not that the Company will be required to sell the securities prior to recovery of value or the securities mature.


	Less Than 12 Months				12 Months or Longer				Total
			Unrealized				Unrealized		Number of			Unrealized
Description of securities	Fair Value		Losses		Fair Value		Losses		Securities	Fair Value		Losses
(Dollars in thousands)
March 31, 2017
Mortgage-backed securities	$	171,571	$	5,239	$	22,651	$	1,335	48	$	194,222	$	6,574
December 31, 2016
Mortgage-backed securities	$	179,741	$	5,599	$	23,402	$	1,425	50	$	203,143	$	7,024

Mortgage-Backed Securities. The unrealized losses on the Company’s investment in mortgage-backed securities were caused by increases in market interest rates subsequent to purchase. All of the mortgage-backed securities are guaranteed by Freddie Mac or Fannie Mae, which are U.S. government-sponsored enterprises, or Ginnie Mae, which is a U.S. government agency. Since the decline in market value is attributable to changes in interest rates and not credit quality, and the Company does not intend to sell these investments until maturity and it is not more likely than not that the Company will be required to sell such investments prior to recovery of its cost basis, the Company does not consider these investments to be other-than-temporarily impaired as of March 31, 2017 and December 31, 2016.

Trust Preferred Securities. At March 31, 2017, the Company owned one trust preferred security, PreTSL XXIII. The trust preferred security represents an investment in a pool of debt obligations issued primarily by holding companies for Federal Deposit Insurance Corporation-insured financial institutions. This security is classified in the Company’s held-to-maturity investment portfolio.

The trust preferred securities market is considered to be inactive as only six transactions have occurred over the past 63 months in the same tranche of securities that we own and no new issues of pooled trust preferred securities have occurred since 2007. We used a discounted cash flow model to determine whether this security is other-than-temporarily impaired. The assumptions used in preparing the discounted cash flow model include the following: estimated discount rates, estimated deferral and default rates on collateral, and estimated cash flows.

Based on the Company’s review, the Company’s investment in PreTSL XXIII did not incur additional impairment during the three months ended March 31, 2017.

PreTSL XXIII has an amortized cost and a remaining cost basis of $1.0 million at March 31, 2017 and there is no accumulated other comprehensive loss related to noncredit factors.

It is reasonably possible that the fair value of the trust preferred security could decline in the near term if the overall economy and the financial condition of some of the issuers deteriorate further and the liquidity of this security remains low. As a result, there is a risk that the Company’s remaining cost basis of $1.0 million on the trust preferred security could be credit-related other-than-temporarily impaired in the near term. The impairment, if any, could be material to the Company’s consolidated statements of income.

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The table below provides a cumulative roll forward of credit losses recognized in earnings for debt securities held and not intended to be sold:


	Three Months Ended March 31,
(Dollars in thousands)	2017		2016
Balance at the beginning of the period	$	2,403	$	2,403
Credit losses on debt securities for which other-than-temporary impairment was not previously recognized		—		—
Credit losses on debt securities which were sold		—		—
Balance at the end of the period	$	2,403	$	2,403

The table below shows the components of accumulated other comprehensive loss, net of taxes, resulting from other-than-temporarily impaired securities:


	March 31,
(Dollars in thousands)	2017		2016
Noncredit losses on other-than-temporarily impaired securities, net of taxes	$	—	$	145

(6) Loans Receivable and Allowance for Loan Losses

The components of loans receivable are as follows:


	March 31,		December 31,
(Dollars in thousands)	2017		2016
Real estate loans:
First mortgages:
One- to four-family residential	$	1,319,590	$	1,289,364
Multi-family residential		9,471		9,551
Construction, commercial and other		23,915		23,346
Home equity loans and lines of credit		14,668		14,805
Total real estate loans		1,367,644		1,337,066
Other loans:
Loans on deposit accounts		246		204
Consumer and other loans		5,004		4,360
Total other loans		5,250		4,564
Less:
Net unearned fees and discounts		(3,137)		(3,191)
Allowance for loan losses		(2,540)		(2,452)
Total unearned fees, discounts and allowance for loan losses		(5,677)		(5,643)
Loans receivable, net	$	1,367,217	$	1,335,987

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The table below presents the activity in the allowance for loan losses by portfolio segment:


			Construction,		Home
			Commercial		Equity
			and Other		Loans and
	Residential		Mortgage		Lines of		Consumer
(Dollars in thousands)	Mortgage		Loans		Credit		and Other		Unallocated		Totals
Three months ended March 31, 2017:
Balance, beginning of period	$	1,594	$	519	$	2	$	115	$	222	$	2,452
Provision (reversal of allowance) for loan losses		(11)		45		(1)		23		15		71
		1,583		564		1		138		237		2,523
Charge-offs		(11)		—		—		(5)		—		(16)
Recoveries		31		—		—		2		—		33
Net recoveries (charge-offs)		20		—		—		(3)		—		17
Balance, end of period	$	1,603	$	564	$	1	$	135	$	237	$	2,540


			Construction,		Home
			Commercial		Equity
			and Other		Loans and
	Residential		Mortgage		Lines of		Consumer
(Dollars in thousands)	Mortgage		Loans		Credit		and Other		Unallocated		Totals
Three months ended March 31, 2016:
Balance, beginning of period	$	1,380	$	517	$	3	$	72	$	194	$	2,166
Provision (reversal of allowance) for loan losses		18		(8)		—		14		4		28
		1,398		509		3		86		198		2,194
Charge-offs		—		—		—		(14)		—		(14)
Recoveries		—		—		—		3		—		3
Net charge-offs		—		—		—		(11)		—		(11)
Balance, end of period	$	1,398	$	509	$	3	$	75	$	198	$	2,183

In 2016, the Company changed the look-back period that is used to calculate the historical loss rates from five to seven years. The look-back period was extended to seven years because the longer look-back period is considered to be more representative of an entire economic cycle. The seven year look-back period includes loan charge-offs and recoveries from the recession and the subsequent economic recovery. The change in the look-back period did not have a material effect on the allowance for loan losses.

Management considers the allowance for loan losses at March 31, 2017 to be at an appropriate level to provide for probable losses that can be reasonably estimated based on general and specific conditions at that date. While the Company uses the best information it has available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. To the extent actual outcomes differ from the estimates, additional provisions for credit losses may be required that would reduce future earnings. In addition, as an integral part of their examination process, the Federal Reserve Board will periodically review the allowance for loan losses and may require the Company to increase the allowance based on their analysis of information available at the time of their examination.

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The table below presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method:


			Construction,		Home
			Commercial		Equity
			and Other		Loans and
	Residential		Mortgage		Lines of		Consumer
(Dollars in thousands)	Mortgage		Loans		Credit		and Other		Unallocated		Totals
March 31, 2017:
Allowance for loan losses:
Ending allowance balance:
Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	—
Collectively evaluated for impairment		1,603		564		1		135		237		2,540
Total ending allowance balance	$	1,603	$	564	$	1	$	135	$	237	$	2,540

Loans:
Ending loan balance:
Individually evaluated for impairment	$	4,491	$	—	$	181	$	—	$	—	$	4,672
Collectively evaluated for impairment		1,321,510		23,821		14,493		5,261		—		1,365,085
Total ending loan balance	$	1,326,001	$	23,821	$	14,674	$	5,261	$	—	$	1,369,757

December 31, 2016:
Allowance for loan losses:
Ending allowance balance:
Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	—
Collectively evaluated for impairment		1,594		519		2		115		222		2,452
Total ending allowance balance	$	1,594	$	519	$	2	$	115	$	222	$	2,452

Loans:
Ending loan balance:
Individually evaluated for impairment	$	5,587	$	—	$	156	$	1	$	—	$	5,744
Collectively evaluated for impairment		1,290,209		23,256		14,656		4,574		—		1,332,695
Total ending loan balance	$	1,295,796	$	23,256	$	14,812	$	4,575	$	—	$	1,338,439

The table below presents the balance of impaired loans individually evaluated for impairment by class of loans:


			Unpaid
	Recorded		Principal
(Dollars in thousands)	Investment		Balance
March 31, 2017:
With no related allowance recorded:
One- to four-family residential mortgages	$	4,491	$	5,323
Home equity loans and lines of credit		181		232
Total	$	4,672	$	5,555

December 31, 2016:
With no related allowance recorded:
One- to four-family residential mortgages	$	5,587	$	6,469
Home equity loans and lines of credit		156		204
Consumer and other		1		1
Total	$	5,744	$	6,674

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The table below presents the average recorded investment and interest income recognized on impaired loans by class of loans:


	For the Three Months Ended
	March 31,
	Average		Interest
	Recorded		Income
(Dollars in thousands)	Investment		Recognized
2017:
With no related allowance recorded:
One- to four-family residential mortgages	$	4,525	$	17
Home equity loans and lines of credit		183		—
Total	$	4,708	$	17

2016:
With no related allowance recorded:
One- to four-family residential mortgages	$	6,265	$	20
Home equity loans and lines of credit		125		—
Total	$	6,390	$	20

There were no loans individually evaluated for impairment with a related allowance for loan loss as of March 31, 2017 or December 31, 2016. Loans individually evaluated for impairment do not have an allocated allowance for loan loss because they were written down to fair value at the time of impairment.

The table below presents the aging of loans and accrual status by class of loans:


															Loans
															More Than
															90 Days
	30 - 59		60 - 89		90 Days or										Past Due
	Days Past		Days Past		Greater		Total Past		Loans Not		Total		Nonaccrual		and Still
(Dollars in thousands)	Due		Due		Past Due		Due		Past Due		Loans		Loans		Accruing
March 31, 2017:
One- to four-family residential mortgages	$	314	$	—	$	845	$	1,159	$	1,315,391	$	1,316,550	$	3,311	$	—
Multi-family residential mortgages		—		—		—		—		9,451		9,451		—		—
Construction, commercial and other mortgages		—		—		—		—		23,821		23,821		—		—
Home equity loans and lines of credit		38		—		77		115		14,559		14,674		181		—
Loans on deposit accounts		—		—		—		—		246		246		—		—
Consumer and other		4		—		—		4		5,011		5,015		—		—

Total	$	356	$	—	$	922	$	1,278	$	1,368,479	$	1,369,757	$	3,492	$	—

December 31, 2016:
One- to four-family residential mortgages	$	185	$	133	$	1,358	$	1,676	$	1,284,590	$	1,286,266	$	4,402	$	—
Multi-family residential mortgages		—		—		—		—		9,530		9,530		—		—
Construction, commercial and other mortgages		—		—		—		—		23,256		23,256		—		—
Home equity loans and lines of credit		16		35		49		100		14,712		14,812		156		—
Loans on deposit accounts		—		—		—		—		204		204		—		—
Consumer and other		3		—		1		4		4,367		4,371		1		—

Total	$	204	$	168	$	1,408	$	1,780	$	1,336,659	$	1,338,439	$	4,559	$	—

The Company primarily uses the aging of loans and accrual status to monitor the credit quality of its loan portfolio. When a mortgage loan becomes seriously delinquent (90 days or more contractually past due), it displays weaknesses that may result in a loss. As a loan becomes more delinquent, the likelihood of the borrower repaying the loan decreases and the loan becomes more collateral-dependent. A mortgage loan becomes collateral-dependent when the proceeds for repayment can be expected to come only from the sale or operation of the collateral and not from borrower repayments. Generally, appraisals are obtained after a loan becomes collateral-dependent or is four months

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delinquent. The carrying value of collateral-dependent loans is adjusted to the fair value of the collateral less selling costs. Any commercial real estate, commercial, construction or equity loan that has a loan balance in excess of a specified amount is also periodically reviewed to determine whether the loan exhibits any weaknesses and is performing in accordance with its contractual terms.

The Company had 16 nonaccrual loans with a book value of $3.5 million at March 31, 2017 and 19 nonaccrual loans with a book value of $4.6 million as of December 31, 2016. The Company collected interest on nonaccrual loans of $38,000 and $57,000 during the three months ended December 31, 2017 and 2016, respectively, but due to regulatory requirements, the Company recorded the interest as a reduction of principal. The Company would have recognized additional interest income of $59,000 and $69,000 during the three months ended March 31, 2017 and 2016, had the loans been accruing interest. The Company did not have any loans more than 90 days past due and still accruing interest as of March 31, 2017 and December 31, 2016.

There were no loans modified in a troubled debt restructuring during the three months ended March 31, 2017 or 2016. There were no new troubled debt restructurings within the past 12 months that subsequently defaulted.

The Company had 11 troubled debt restructurings totaling $2.4 million as of March 31, 2017 that were considered to be impaired. This total included 10 one- to four-family residential mortgage loans totaling $2.3 million and one home equity loan for $104,000. Five of the loans, totaling $1.2 million, are performing in accordance with their restructured terms and accruing interest at March 31, 2017. Five of the loans, totaling $1.1 million, are performing in accordance with their restructured terms but not accruing interest at March 31, 2017. One of the loans, for $149,000, was more than 149 days delinquent and not accruing interest as of March 31, 2017 The Company had 13 troubled debt restructurings totaling $2.9 million as of December 31, 2016 that were considered to be impaired. This total included 12 one- to four-family residential mortgage loans totaling $2.8 million and one home equity loan for $107,000. Five of the loans, totaling $1.2 million, were performing in accordance with their restructured terms and accruing interest at December 31, 2016. Seven of the loans, totaling $1.6 million, were performing in accordance with their restructured terms but not accruing interest at December 31, 2016. One of the loans, for $149,000, was more than 149 days delinquent and not accruing interest as of December 31, 2016. Restructurings include deferrals of interest and/or principal payments and temporary or permanent reductions in interest rates due to the financial difficulties of the borrowers. At March 31, 2017, we had no commitments to lend any additional funds to these borrowers.

The Company had no real estate owned as of March 31, 2017 or December 31, 2016. There were four one- to four-family residential mortgage loans totaling $702,000 in the process of foreclosure as of March 31, 2017 and December 31, 2016.

Nearly all of our real estate loans are collateralized by real estate located in the State of Hawaii. Loan-to-value ratios on these real estate loans generally do not exceed 80% at the time of origination.

During the three months ended March 31, 2017 and 2016, the Company sold $8.0 million and $10.9 million, respectively, of mortgage loans held for sale and recognized gains of $63,000 and $61,000, respectively. The Company had three loans held for sale totaling $1.8 million at March 31, 2017 and five loans held for sale totaling $1.6 million at December 31, 2016.

The Company serviced loans for others of $39.6 million at March 31, 2017 and $41.5 million at December 31, 2016. Of these amounts, $2.0 million and $2.2 million relate to securitizations for which the Company continues to hold the related mortgage-backed securities at March 31, 2017 and December 31, 2016, respectively. The amount of contractually specified servicing fees earned for the three-month periods ended March 31, 2017 and 2016 was $28,000 and $34,000, respectively. The fees are reported in service fees on loan and deposit accounts in the consolidated statements of income.

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(7) Securities Sold Under Agreements to Repurchase

Securities sold under agreements to repurchase are treated as financings and the obligations to repurchase the identical securities sold are reflected as a liability with the securities collateralizing the agreements classified as an asset. Securities sold under agreements to repurchase are summarized as follows:


	March 31, 2017				December 31, 2016
			Weighted				Weighted
	Repurchase		Average		Repurchase		Average
(Dollars in thousands)	Liability		Rate		Liability		Rate
Maturing:
1 year or less	$	25,000	1.46	%	$	25,000	1.46	%
Over 1 year to 2 years		20,000	1.66			—	—
Over 2 years to 3 years		10,000	1.65			25,000	1.66
Over 3 years to 4 years		—	—			5,000	1.65
Total	$	55,000	1.57	%	$	55,000	1.57	%

Below is a summary comparing the carrying value and fair value of securities pledged to secure repurchase agreements, the repurchase liability, and the amount at risk at March 31, 2017. The amount at risk is the greater of the carrying value or fair value over the repurchase liability and refers to the potential loss to the Company if the secured lender fails to return the security at the maturity date of the agreement. All the agreements to repurchase are with JP Morgan Securities and the securities pledged are mortgage-backed securities issued and guaranteed by U.S. government-sponsored enterprises. The repurchase liability cannot exceed 90% of the fair value of securities pledged. In the event of a decline in the fair value of securities pledged to less than the required amount due to market conditions or principal repayments, the Company is obligated to pledge additional securities or other suitable collateral to cure the deficiency.

Weighted

Carrying

Fair

Average

Value of

Repurchase

Amount

Months to

(Dollars in thousands)

Securities

Liability

at Risk

Maturity

Maturing:

Over 90 days

60,546

60,283

55,000

5,546

(8) Offsetting of Financial Liabilities

Securities sold under agreements to repurchase are subject to a right of offset in the event of default. See note 7, Securities Sold Under Agreements to Repurchase, for additional information.


					Net Amount of		Gross Amount Not Offset in the
	Gross Amount		Gross Amount		Liabilities		Balance Sheet
	of Recognized		Offset in the		Presented in the		Financial		Cash Collateral
(Dollars in thousands)	Liabilities		Balance Sheet		Balance Sheet		Instruments		Pledged		Net Amount
March 31, 2017:
Securities sold under agreements to repurchase	$	55,000	$	—	$	55,000	$	55,000	$	—	$	—

December 31, 2016:
Securities sold under agreements to repurchase	$	55,000	$	—	$	55,000	$	55,000	$	—	$	—

(9) Employee Benefit Plans

The Company has a noncontributory defined benefit pension plan (Pension Plan) that covers most employees with at least one year of service. Effective December 31, 2008, under approved changes to the Pension Plan, there were no further accruals of benefits for any participants and benefits will not increase with any additional years of service. Net periodic benefit cost, subsequent to December 31, 2008, has not been significant and is not disclosed in the table below.

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The Company also sponsors a Supplemental Employee Retirement Plan (SERP), a noncontributory supplemental retirement benefit plan, which covers certain current and former employees of the Company for amounts in addition to those provided under the Pension Plan.

The components of net periodic benefit cost were as follows:


	SERP
	Three Months Ended
	March 31,
(Dollars in thousands)	2017		2016
Net periodic benefit cost for the period:
Service cost	$	10	$	14
Interest cost		35		33
Expected return on plan assets		—		—
Amortization of prior service cost		—		—
Recognized actuarial loss		—		—
Recognized curtailment loss		—		—
Net periodic benefit cost	$	45	$	47

(10) Employee Stock Ownership Plan

Effective January 1, 2009, Territorial Savings Bank adopted an Employee Stock Ownership Plan (ESOP) for eligible employees. The ESOP borrowed $9.8 million from the Company and used those funds to acquire 978,650 shares, or 8%, of the total number of shares issued by the Company in its initial public offering. The shares were acquired at a price of $10.00 per share.

The loan is secured by the shares purchased with the loan proceeds and will be repaid by the ESOP over the 20-year term of the loan with funds from Territorial Savings Bank’s contributions to the ESOP and dividends payable on the shares. The interest rate on the ESOP loan is an adjustable rate equal to the prime rate, as published in The Wall Street Journal. The interest rate adjusts annually and will be the prime rate on the first business day of the calendar year.

Shares purchased by the ESOP are held by a trustee in an unallocated suspense account, and shares are released annually from the suspense account on a pro-rata basis as principal and interest payments are made by the ESOP to the Company. The trustee allocates the shares released among participants on the basis of each participant’s proportional share of compensation relative to all participants. As shares are committed to be released from the suspense account, Territorial Savings Bank reports compensation expense based on the average fair value of shares released with a corresponding credit to stockholders’ equity. The shares committed to be released are considered outstanding for earnings per share computations. Compensation expense recognized for the three months ended March 31, 2017 and 2016 amounted to $321,000 and $261,000, respectively.

Shares held by the ESOP trust were as follows:


	March 31,		December 31,
	2017		2016
Allocated shares		385,230		372,997
Unearned shares		574,960		587,193
Total ESOP shares		960,190		960,190
Fair value of unearned shares, in thousands	$	17,922	$	19,283

The ESOP restoration plan is a nonqualified plan that provides supplemental benefits to certain executives who are prevented from receiving the full benefits contemplated by the ESOP’s benefit formula. The supplemental cash payments consist of payments representing shares that cannot be allocated to the participants under the ESOP due to IRS limitations imposed on tax-qualified plans. We accrue for these benefits over the period during which employees

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provide services to earn these benefits. For the three months ended March 31, 2017 and 2016 we accrued $117,000 and $77,000, respectively, for the ESOP restoration plan.

(11) Share-Based Compensation

On August 19, 2010, Territorial Bancorp Inc. adopted the 2010 Equity Incentive Plan, which provides for awards of stock options and restricted stock to key officers and outside directors. In accordance with the Compensation – Stock Compensation topic of the FASB ASC, the cost of the 2010 Equity Incentive Plan is based on the fair value of the awards on the grant date. The fair value of restricted stock is based on the closing price of the Company’s stock on the grant date. The fair value of stock options is estimated using a Black-Scholes option pricing model using assumptions for dividend yield, stock price volatility, risk-free interest rate and option term. These assumptions are based on our judgments regarding future events, are subjective in nature, and cannot be determined with precision. The cost of the awards will be recognized on a straight-line basis over the three, five- or six-year vesting period during which participants are required to provide services in exchange for the awards.

The Company recognized compensation expense, measured as the fair value of the share-based award on the date of grant, on a straight-line basis over the vesting period. Share-based compensation is recorded in the statement of income as a component of salaries and employee benefits with a corresponding increase in shareholders’ equity. The table below presents information on compensation expense and the related tax benefit for all share-based awards:


	For the Three Months Ended
	March 31,
(In thousands)	2017		2016
Compensation expense	$	9	$	661
Income tax benefit		4		266

Shares of our common stock issued under the 2010 Equity Incentive Plan shall be authorized but unissued shares. The maximum number of shares that will be awarded under the plan will be 1,862,637 shares.

Stock Options

The table below presents the stock option activity for the three months ended March 31, 2017 and 2016:


		Weighted			Aggregate
		Average		Remaining	Intrinsic
		Exercise		Contractual	Value
	Options	Price		Life (years)	(in thousands)
Options outstanding at December 31, 2016	706,430	$	17.43	3.70	$	10,884
Granted	—		—	—		—
Exercised	54,976		17.36	—		874
Forfeited	—		—	—		—
Expired	—		—	—		—
Options outstanding at March 31, 2017	651,454	$	17.44	3.46	$	8,945

Options outstanding at December 31, 2015	832,300	$	17.42	4.70	$	8,588
Granted	—		—	—		—
Exercised	16,270		17.36	—		140
Forfeited	—		—	—		—
Expired	—		—	—		—
Options outstanding at March 31, 2016	816,030	$	17.42	4.45	$	7,048

Options vested and exercisable at March 31, 2017	649,054	$	17.41	3.44	$	8,933

There were no options that vested in the three months ended March 31, 2017 or 2016.

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The following summarizes certain stock option activity of the Company:


	For the Three Months Ended
	March 31,
(In thousands)	2017		2016
Intrinsic value of stock options exercised	$	874	$	140
Proceeds received from stock options exercised		955		283
Tax benefits realized from stock options exercised		307		38
Total fair value of stock options that vested		—		—

During the three months ended March 31, 2017, we issued 26,274 shares of common stock, net, in exchange for 54,976 stock options and 28,702 shares of common stock. Pursuant to the provisions of our equity incentive plan, optionees are permitted to use the value of our common stock they own in a stock swap transaction or net settlement to pay the exercise price of stock options.

As of March 31, 2017, the Company had $7,000 of unrecognized compensation costs related to the stock option plan that will be amortized over a three-year vesting period.

Restricted Stock Awards

Restricted stock awards are accounted for as fixed grants using the fair value of the Company’s stock at the time of grant. Unvested restricted stock awards may not be disposed of or transferred during the vesting period. Restricted stock awards carry with them the right to receive dividends.

The table below presents the restricted stock award activity:


		Weighted
		Average Grant
	Restricted	Date Fair
	Stock Awards	Value
Nonvested at December 31, 2016	2,400	$	26.23
Granted	—		—
Vested	—		—
Forfeited	—		—
Nonvested at March 31, 2017	2,400	$	26.23

Nonvested at December 31, 2015	114,542	$	17.67
Granted	—		—
Vested	—		—
Forfeited	—		—
Nonvested at March 31, 2016	114,542	$	17.67

As of March 31, 2017, the Company had $44,000 of unrecognized compensation costs related to restricted stock awards that will be amortized over the three-year vesting period.

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(12) Earnings Per Share

The table below presents the information used to compute basic and diluted earnings per share:


	Three Months Ended
	March 31,
(Dollars in thousands, except per share data)	2017		2016
Net income	$	4,321	$	3,784

Weighted-average number of shares used in:
Basic earnings per share		9,215,142		9,034,919
Dilutive common stock equivalents:
Stock options and restricted stock units		230,847		270,696
Diluted earnings per share		9,445,989		9,305,615

Net income per common share, basic	$	0.47	$	0.42
Net income per common share, diluted	$	0.46	$	0.41

We have two forms of our outstanding common stock: common stock and unvested restricted stock awards. Holders of unvested restricted stock awards receive nonforfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings. The computed basic and diluted earnings per share presented are substantially equivalent using both the two-class and the treasury stock methods of calculating earnings per share.

(13) Other Comprehensive Income and Loss

The table below presents the changes in the components of accumulated other comprehensive income and loss, net of taxes:


			Noncredit
			Related
			Loss on
	Unfunded		Trust		Unrealized
	Pension		Preferred		Loss on
(Dollars in thousands)	Liability		Securities		Securities		Total
Three months ended March 31, 2017
Balances at beginning of period	$	5,284	$	—	$	32	$	5,316
Other comprehensive income, net of taxes		—		—		(2)		(2)
Amounts reclassified from accumulated other comprehensive loss		—		—		—		—
Net current period other comprehensive income		—		—		(2)		(2)
Balances at end of period	$	5,284	$	—	$	30	$	5,314

Three months ended March 31, 2016
Balances at beginning of period	$	5,044	$	147	$	45	$	5,236
Other comprehensive loss (income), net of taxes		21		(2)		(2)		17
Amounts reclassified from accumulated other comprehensive loss		—		—		—		—
Net current period other comprehensive loss (income)		21		(2)		(2)		17
Balances at end of period	$	5,065	$	145	$	43	$	5,253

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The table below presents the tax effect on each component of accumulated other comprehensive loss:


	Three Months Ended March 31,
	2017						2016
	Pretax				After Tax		Pretax				After Tax
(Dollars in thousands)	Amount		Tax		Amount		Amount		Tax		Amount
Unfunded pension liability	$	—	$	—	$	—	$	—	$	21	$	21
Noncredit related loss on trust preferred securities		—		—		—		(3)		1		(2)
Unrealized loss on securities		(3)		1		(2)		(4)		2		(2)
Total	$	(3)	$	1	$	(2)	$	(7)	$	24	$	17

(14) Fair Value of Financial Instruments

In accordance with the Fair Value Measurements and Disclosures topic of the FASB ASC, the Company groups its financial assets and liabilities valued at fair value into three levels based on the markets in which the financial assets and liabilities are traded and the reliability of the assumptions used to determine fair value as follows:

· Level 1 — Valuation is based upon quoted prices (unadjusted) for identical assets or liabilities traded in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

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

· Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect management’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of discounted cash flow models and similar techniques that require the use of significant judgment or estimation.

In accordance with the Fair Value Measurements and Disclosures topic, the Company bases its fair values on the price that it would expect to receive if an asset were sold or the price that it would expect to pay to transfer a liability in an orderly transaction between market participants at the measurement date. Also as required, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when developing fair value measurements.

The Company uses fair value measurements to determine fair value disclosures. Investment securities held for sale and derivatives are recorded at fair value on a recurring basis. From time to time, the Company may be required to record other financial assets at fair value on a nonrecurring basis, such as loans held for sale, impaired loans and investments, and mortgage servicing assets. These nonrecurring fair value adjustments typically involve application of the lower of cost or fair value accounting or write-downs of individual assets.

Cash and Cash Equivalents, Accrued Interest Receivable and Accrued Interest Payable. The carrying amount approximates fair value because of the short maturity of these instruments.

Investment Securities. The estimated fair values of U.S. government-sponsored mortgage-backed securities are considered Level 2 inputs because the valuation for investment securities utilized pricing models that varied based on asset class and included trade, bid and other observable market information.

The trust preferred securities represent investments in a pool of debt obligations issued primarily by holding companies for Federal Deposit Insurance Corporation-insured financial institutions. The trust preferred securities market is considered to be inactive as only six transactions have occurred over the past 63 months in the same tranche of securities we own and no new issues of pooled trust preferred securities have occurred since 2007. The fair value of our trust preferred securities was determined using a discounted cash flow model. Our model used a discount rate equal to three-month LIBOR plus 20.00%.

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The discounted cash flow analysis includes a review of all issuers within the pool. The fair value of the trust preferred securities are classified as Level 3 inputs because they are based on discounted cash flow models.

FHLB Stock. FHLB stock, which is redeemable for cash at par value, is reported at its par value.

FRB Stock. FRB stock, which is redeemable for cash at par value, is reported at its par value.

Loans. The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of loans is not based on the concept of exit price.

Loans Held for Sale. The fair value of loans held for sale is determined based on the prices quoted in the secondary market for similar loans.

Deposits. The fair value of checking and Super NOW savings accounts, passbook accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting future cash flows using the rates currently offered for deposits with similar remaining maturities.

Advances From the FHLB and Securities Sold Under Agreements to Repurchase. Fair value is estimated by discounting future cash flows using the rates currently offered to the Company for debt with similar remaining maturities.

Interest Rate Contracts. The Company may enter into interest rate lock commitments with borrowers on loans intended to be sold. To manage interest rate risk on the lock commitments, the Company may also enter into forward loan sale commitments. The interest rate lock commitments and forward loan sale commitments are treated as derivatives and are recorded at their fair value determined by referring to prices quoted in the secondary market for similar contracts. Interest rate contracts that are classified as assets are included with prepaid expenses and other assets on the consolidated balance sheet while interest rate contracts that are classified as liabilities are included with accounts payable and accrued expenses.

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The estimated fair values of the Company’s financial instruments are as follows:


	Carrying				Fair Value Measurements Using
(Dollars in thousands)	Amount		Fair Value		Level 1		Level 2		Level 3
March 31, 2017
Assets
Cash and cash equivalents	$	103,123	$	103,123	$	103,123	$	—	$	—
Investment securities held to maturity		391,988		392,384		—		391,262		1,122
Loans held for sale		1,752		1,803		—		1,803		—
Loans receivable, net		1,367,217		1,379,331		—		—		1,379,331
FHLB stock		5,013		5,013		—		5,013		—
FRB stock		3,103		3,103		—		3,103		—
Accrued interest receivable		4,766		4,766		4		1,066		3,696
Interest rate contracts		69		69		—		69		—

Liabilities
Deposits		1,548,906		1,548,586		—		1,270,113		278,473
Advances from the Federal Home Loan Bank		69,000		68,946		—		68,946		—
Securities sold under agreements to repurchase		55,000		55,020		—		55,020		—
Accrued interest payable		335		335		—		172		163
Interest rate contracts		69		69		—		69		—

December 31, 2016
Assets
Cash and cash equivalents	$	61,273	$	61,273	$	61,273	$	—	$	—
Investment securities held to maturity		407,656		407,922		—		406,759		1,163
Loans held for sale		1,601		1,601		—		1,601		—
Loans receivable, net		1,335,987		1,352,137		—		—		1,352,137
FHLB stock		4,945		4,945		—		4,945		—
FRB stock		3,095		3,095		—		3,095		—
Accrued interest receivable		4,732		4,732		10		1,064		3,658
Interest rate contracts		104		104		—		104		—

Liabilities
Deposits		1,493,200		1,493,094		—		1,257,157		235,937
Advances from the Federal Home Loan Bank		69,000		69,068		—		69,068		—
Securities sold under agreements to repurchase		55,000		55,123		—		55,123		—
Accrued interest payable		218		218		—		172		46
Interest rate contracts		104		104		—		104		—

At March 31, 2017 and December 31, 2016, neither the commitment fees received on commitments to extend credit nor the fair value thereof was material to the consolidated financial statements of the Company.

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The table below presents the balance of assets and liabilities measured at fair value on a recurring basis:


(Dollars in thousands)	Level 1		Level 2		Level 3		Total

March 31, 2017
Interest rate contracts — assets	$	—	$	69	$	—	$	69
Interest rate contracts — liabilities		—		(69)		—		(69)

December 31, 2016
Interest rate contracts — assets	$	—	$	104	$	—	$	104
Interest rate contracts — liabilities		—		(104)		—		(104)

The fair value of interest rate contracts was determined by referring to prices quoted in the secondary market for similar contracts.

The table below presents the balance of assets measured at fair value on a nonrecurring basis as of March 31, 2017 and December 31, 2016 and the related gains and losses for the three months ended March 31, 2017 and the year ended December 31, 2016:


	Fair Value									Total Gains
(Dollars in thousands)	Adjustment Date	Level 1		Level 2		Level 3		Total		(Losses)

March 31, 2017
Impaired loans	3/31/2017	$	—	$	87	$	—	$	87	$	(11)

December 31, 2016
Trust preferred securities	9/30/2016	$	—	$	—	$	1,066	$	1,066	$	242
Mortgage servicing assets	6/30/2016		—		—		341		341		(49)
Impaired loans	8/31/2016		—		64		—		64		(33)
Loans held for sale	12/31/2016		—		1,601		—		1,601		(1)

The fair value of trust preferred securities is determined using a discounted cash flow model. The assumptions used in the discounted cash flow model are discussed above. Gains and losses on trust preferred securities that are credit related are included in net other-than-temporary impairment losses in the consolidated statements of income. Gains and losses on trust preferred securities that are not credit related are included in other comprehensive income in the consolidated statements of comprehensive income. Mortgage servicing assets are valued using a discounted cash flow model. Assumptions used in the model include mortgage prepayment speeds, discount rates and cost of servicing. Losses on mortgage servicing assets are included in service fees on loan and deposit accounts in the consolidated statements of income. The fair value of impaired loans is determined using the value of collateral less estimated selling costs. Gains and losses on impaired loans are included in the provision for loan losses in the consolidated statements of income. The fair value of loans held for sale is determined based on the prices quoted in the secondary market for similar loans. Losses on loans held for sale are included in gain on sale of loans in the consolidated statements of income.

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The table below presents the significant unobservable inputs for Level 3 nonrecurring fair value measurements:


				Unobservable
(Dollars in thousands)	Fair Value		Valuation Technique	Input	Value

December 31, 2016:
Trust preferred securities	$	1,066	Discounted cash flow	Discount rate		Three-month LIBOR plus 20.00%
Mortgage servicing assets		341	Discounted cash flow	Discount rate		10.50%
				Prepayment speed (PSA)		158.4 - 203.5
				Annual cost to service (per loan)	$	65

(15) Subsequent Events

On April 27, 2017, the Board of Directors of Territorial Bancorp Inc. declared a quarterly cash dividend of $0.20 per share of common stock. The dividend is expected to be paid on May 25, 2017 to stockholders of record as of May 11, 2017.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Statement Regarding Forward-Looking Information

This Quarterly Report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:

statements of our goals, intentions and expectations;

statements regarding our business plans, prospects, growth and operating strategies;

statements regarding the asset quality of our loan and investment portfolios; and

estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this Quarterly Report.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

general economic conditions, either internationally, nationally or in our market areas, that are worse than expected;

competition among depository and other financial institutions;

inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;

adverse changes in the securities markets;

changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;

our ability to enter new markets successfully and capitalize on growth opportunities;

our ability to successfully integrate acquired entities, if any;

changes in consumer spending, borrowing and savings habits;

changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission and the Public Company Accounting Oversight Board;

changes in our organization, compensation and benefit plans;

changes in our financial condition or results of operations that reduce capital available to pay dividends; and

changes in the financial condition or future prospects of issuers of securities that we own.

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Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

Overview

We have historically operated as a traditional thrift institution. The significant majority of our assets consist of long-term, fixed-rate residential mortgage loans and mortgage-backed securities, which we have funded primarily with deposit accounts, securities sold under agreements to repurchase and Federal Home Loan Bank advances. This has resulted in our being particularly vulnerable to increases in interest rates, as our interest-bearing liabilities mature or reprice more quickly than our interest-earning assets.

We have continued our focus on originating one- to four-family residential real estate loans. Our emphasis on conservative loan underwriting has resulted in continued low levels of nonperforming assets. Our nonperforming assets, which can include nonaccrual loans and real estate owned, totaled $3.5 million, or 0.18% of total assets at March 31, 2017, compared to $4.6 million, or 0.24% of total assets at December 31, 2016. As of March 31, 2017, nonperforming assets consisted of 16 mortgage loans totaling $3.5 million. Our nonperforming loans and loss experience has enabled us to maintain a relatively low allowance for loan losses in relation to other peer institutions and correspondingly resulted in low levels of provisions for loan losses. Our provisions for loan losses were $71,000 and $28,000 for the three months ended March 31, 2017 and 2016, respectively.

Other than our loans for the construction of one- to four-family residential homes, we do not offer “interest only” mortgage loans (where the borrower pays interest for an initial period, after which the loan converts to a fully amortizing loan) on one- to four-family residential properties. We also do not offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower can pay less than the interest owed on their loan, resulting in an increased principal balance during the life of the loan. We do not offer “subprime loans” (loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios) or Alt-A loans (traditionally defined as nonconforming loans having less than full documentation). We also do not own any private label mortgage-backed securities that are collateralized by Alt-A, low or no documentation or subprime mortgage loans.

Our operations in recent years have been affected by our efforts to manage our interest rate risk position. We sold $8.0 million and $10.9 million of fixed-rate mortgage loans for the three months ended March 31, 2017 and 2016, respectively. Long-term, fixed-rate borrowings remained constant for the three months ended March 31, 2017 and 2016, respectively.

Our investments in mortgage-backed securities have been issued by Freddie Mac or Fannie Mae, which are U.S. government-sponsored enterprises, or Ginnie Mae, which is a U.S. government agency. These agencies guarantee the payment of principal and interest on our mortgage-backed securities. We do not own any preferred stock issued by Fannie Mae or Freddie Mac. As of March 31, 2017 and December 31, 2016, we owned $390.9 million and $406.5 million, respectively, of mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae.

Critical Accounting Policies

There are no material changes to the critical accounting policies disclosed in Territorial Bancorp Inc.’s Annual Report on Form 10-K for the year ended December 31, 2016.

Comparison of Financial Condition at March 31, 2017 and December 31, 2016

Assets. At March 31, 2017, our assets were $1.936 billion, an increase of $58.2 million, or 3.1%, from $1.878 billion at December 31, 2016. The increase in assets was primarily the result of a $31.4 million increase in total loans receivable and a $41.9 million increase in cash and cash equivalents, which was partially offset by a $15.7 million decrease in investment securities.

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Cash and Cash Equivalents. Cash and cash equivalents were $103.1 million at March 31, 2017, an increase of $41.9 million since December 31, 2016. The increase in cash and cash equivalents was primarily caused by a $55.7 million increase in deposits and a $15.7 million decrease in investment securities. These increases were offset by funding a $31.4 million increase in total loans and the payment of $1.8 million of common stock dividends.

Loans. Total loans, including $1.8 million of loans held for sale, were $1.369 billion at March 31, 2017, or 70.7% of total assets. During the three months ended March 31, 2017, the loan portfolio, including loans held for sale, increased by $31.4 million, or 2.3%. The increase in the loan portfolio primarily occurred as the production of new one- to four-family residential loans exceeded principal repayments and loan sales.

Securities. At March 31, 2017, our securities portfolio totaled $392.0 million, or 20.2% of total assets. During the three months ended March 31, 2017, the securities portfolio decreased by $15.7 million, or 3.8%. The decrease in the securities portfolio is due to repayments and sales. There were no purchases of securities during the three months ended March 31, 2017.

At March 31, 2017, all of such securities were classified as held-to-maturity and none of the underlying collateral consisted of subprime or Alt-A (traditionally defined as nonconforming loans having less than full documentation) loans.

At March 31, 2017, we owned a trust preferred security with an amortized cost of $1.0 million. This security represents an investment in a pool of debt obligations primarily issued by holding companies of Federal Deposit Insurance Corporation-insured financial institutions.

The trust preferred securities market is considered to be inactive as only six transactions have occurred over the past 63 months in the same tranche of securities we own and no new issues of pooled trust preferred securities have occurred since 2007. We use a discounted cash flow model to determine whether this security is other-than-temporarily impaired. The assumptions used in preparing the discounted cash flow model include the following: estimated discount rates, estimated deferral and default rates on collateral, and estimated cash flows.

Based on our review, our investment in the trust preferred security did not incur additional impairment during the three months ended March 31, 2017.

It is reasonably possible that the fair value of the trust preferred security could decline in the near term if the overall economy and the financial condition of some of the issuers deteriorate further and the liquidity of this security remains low. As a result, there is a risk that our remaining cost basis of $1.0 million on the trust preferred security could be credit-related other-than-temporarily impaired in the near term. The impairment, if any, could be material to our consolidated statements of income.

Deposits. Deposits were $1.549 billion at March 31, 2017, an increase of $55.7 million, or 3.7%, since December 31, 2016. The growth in deposits was primarily due to an increase of $42.7 million in certificates of deposits and an increase of $10.9 million in savings and checking accounts during the three months ended March 31, 2017. The increase in certificates of deposit is primarily due to a $40.7 million increase in public deposits.

Borrowings. Our borrowings consist of advances from the Federal Home Loan Bank and funds borrowed under securities sold under agreements to repurchase. During the three months ended March 31, 2017, total borrowings remained constant at $124.0 million. We have not required any other borrowings to fund our operations. Instead, we have primarily funded our operations with additional deposits, proceeds from loan sales and principal repayments on loans and mortgage-backed securities.

Average Balances and Yields

The following tables set forth average balance sheets, average yields and rates, and certain other information at and for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Nonaccrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of net deferred costs, discounts and premiums that are amortized or accreted to interest income.

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	For the Three Months Ended March 31,
	2017							2016
	Average							Average
	Outstanding					Yield/Rate		Outstanding					Yield/Rate
	Balance			Interest		(1)		Balance			Interest		(1)
	(Dollars in thousands)
Interest-earning assets:
Loans:
Real estate loans:
First mortgage:
One- to four-family residential (2)	$	1,303,517		$	12,900	3.96	%	$	1,155,225		$	11,780	4.08	%
Multi-family residential		9,505			111	4.67			9,788			115	4.70
Construction, commercial and other		23,530			271	4.61			20,737			242	4.67
Home equity loans and lines of credit		14,901			169	4.54			15,516			164	4.23
Other loans		4,759			62	5.21			4,531			60	5.30
Total loans		1,356,212			13,513	3.99			1,205,797			12,361	4.10
Investment securities:
U.S. government sponsored mortgage-backed securities (2)		398,238			3,081	3.09			486,328			3,875	3.19
Trust preferred securities		1,145			—	—			916			—	—
Total securities		399,383			3,081	3.09			487,244			3,875	3.18
Other		73,657			187	1.02			73,212			144	0.79
Total interest-earning assets		1,829,252			16,781	3.67			1,766,253			16,380	3.71
Non-interest-earning assets		68,737							68,508
Total assets	$	1,897,989						$	1,834,761

Interest-bearing liabilities:
Savings accounts	$	1,027,879			1,038	0.40	%	$	1,009,039			1,024	0.41	%
Certificates of deposit		247,709			599	0.97			230,440			373	0.65
Money market accounts		4,032			5	0.50			1,748			2	0.46
Checking and Super NOW accounts		179,696			9	0.02			166,925			9	0.02
Total interest-bearing deposits		1,459,316			1,651	0.45			1,408,152			1,408	0.40
Federal Home Loan Bank advances		69,000			254	1.47			69,000			257	1.49
Securities sold under agreements to repurchase		55,000			216	1.57			55,000			218	1.59
Total interest-bearing liabilities		1,583,316			2,121	0.54			1,532,152			1,883	0.49
Non-interest-bearing liabilities		81,878							80,055
Total liabilities		1,665,194							1,612,207
Stockholders’ equity		232,795							222,554
Total liabilities and stockholders’ equity	$	1,897,989						$	1,834,761

Net interest income				$	14,660						$	14,497
Net interest rate spread (3)						3.13	%						3.22	%
Net interest-earning assets (4)	$	245,936						$	234,101
Net interest margin (5)						3.21	%						3.28	%
Interest-earning assets to interest-bearing liabilities		115.53	%						115.28	%

(1)

Annualized.

(2)

Average balance includes loans or investments available for sale, as applicable.

(3)

Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4)

Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(5)

Net interest margin represents net interest income divided by average total interest-earning assets.

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Comparison of Operating Results for the Three Months Ended March 31, 2017 and 2016

General. Net income increased by $537,000, or 14.2%, from $3.8 million for the three months ended March 31, 2016 to $4.3 million for the three months ended March 31, 2017. The increase in net income was due to a $401,000 increase in interest income, a $352,000 decrease in noninterest expense and a $136,000 increase in noninterest income. These were partially offset by a $238,000 increase in interest expense, a $71,000 increase in income taxes and a $43,000 increase in loan loss provisions.

Net Interest Income. Net interest income increased by $163,000, or 1.1%, to $14.7 million for the three months ended March 31, 2017 compared to $14.5 million for the three months ended March 31, 2016. Interest income increased by $401,000, or 2.4%, due to a $63.0 million increase in the average balance of interest-earning assets. This was offset by a four basis point decrease in the yield of average interest-earning assets. Interest expense increased by $238,000, or 12.6%, due to a $51.2 million increase in the average balance of interest-bearing liabilities and a five basis point increase in the cost of average interest-bearing liabilities. The interest rate spread and net interest margin were 3.13% and 3.21%, respectively, for the three months ended March 31, 2017, compared to 3.22% and 3.28%, respectively, for the three months ended March 31, 2016. The decreases in the interest rate spread and in the net interest margin can be attributed to a four basis point decrease in the yield of average interest-earning assets and a five basis point increase in the cost of average interest-bearing liabilities. The decrease in the yield of average interest-earning assets was primarily due to the payoff of higher-yielding mortgage loans and the addition of new loans with lower interest rates to the loan portfolio. The increase in the cost of average interest-bearing liabilities was primarily due to a 32 basis point increase in the cost of certificates of deposit as new deposits with higher interest rates were opened.

Interest Income. Interest income increased by $401,000, or 2.4%, to $16.8 million for the three months ended March 31, 2017 from $16.4 million for the three months ended March 31, 2016. Interest income on loans increased by $1.2 million, or 9.3%, to $13.5 million for the three months ended March 31, 2017 from $12.4 million for the three months ended March 31, 2016. The increase in interest income on loans occurred primarily because the average balance of loans grew by $150.4 million, or 12.5%, as new loan originations exceeded loan repayments and loan sales. The increase in interest income that occurred because of growth in the loan portfolio was partially offset by an 11 basis point decline in the average loan yield to 3.99% for the three months ended March 31, 2017. The decline in the average yield on loans occurred because of repayments on higher-yielding loans and additions of new loans with lower yields to the loan portfolio. Interest income on investment securities decreased by $794,000, or 20.5%, to $3.1 million for the three months ended March 31, 2017 from $3.9 million for the three months ended March 31, 2016. The decrease in interest income on securities occurred because of an $87.9 million decrease in the average securities balance and a nine basis point decrease in the average securities yield.

Interest Expense. Interest expense increased by $238,000, or 12.6%, to $2.1 million for the three months ended March 31, 2017. Interest expense on deposits increased by $243,000, or 17.3%, from $1.4 million for the three months ended March 31, 2016 to $1.7 million for the three months ended March 31, 2017. The increase in interest expense on deposits was due to an increase in the average outstanding balance and the average rate paid on deposits. The average outstanding balance of deposits increased by $51.2 million, or 3.6%, to $1.459 billion for the three months ended March 31, 2017 compared to $1.408 billion for the three months ended March 31, 2016. The growth in deposits is primarily due to a $40.7 million increase in public deposits held in certificates of deposit. The average rate paid on deposits increased by five basis points from 0.40% for the three months ended March 31, 2016 to 0.45% for the three months ended March 31, 2017, primarily due to a 32 basis point increase in certificate of deposit rates.

Provision for Loan Losses. We recorded provisions for loan losses of $71,000 and $28,000 for the three months ended March 31, 2017 and 2016, respectively. The provisions for loan losses included net recoveries of $17,000 for the three months ended March 31, 2017 and net charge-offs of $11,000 for the three months ended March 31, 2016. The provisions recorded resulted in ratios of the allowance for loan losses to total loans of 0.19% and 0.18% at March 31, 2017 and 2016, respectively. Nonaccrual loans totaled $3.5 million at March 31, 2017, or 0.25% of total loans at that date, compared to $5.2 million of nonaccrual loans at March 31, 2016, or 0.42% of total loans at that date. Nonaccrual loans as of March 31, 2017 and 2016 consisted primarily of one- to four-family residential real estate loans. To the best of our knowledge, we have provided for all losses that are both probable and reasonable to estimate at March 31, 2017

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and 2016. For additional information see note (6), “Loans Receivable and Allowance for Loan Losses” in our Notes to Consolidated Financial Statements.

Noninterest Income. The following table summarizes changes in noninterest income between the three months ended March 31, 2017 and 2016.


	Three Months Ended
	March 31,				Change
	2017		2016		$ Change		% Change
				(Dollars in thousands)
Service fees on loan and deposit accounts	$	556	$	456	$	100	21.9	%
Income on bank-owned life insurance		226		247		(21)	(8.5)	%
Gain on sale of investment securities		95		—		95	—	%
Gain on sale of loans		63		61		2	3.3	%
Other		82		122		(40)	(32.8)	%
Total	$	1,022	$	886	$	136	15.3	%

Noninterest income increased by $136,000 for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. During the three months ended March 31, 2017, service fees on loan and deposit accounts increased by $100,000, primarily due to incentives received on a new debit card agreement, an increase in appraisal fees and a decrease in the amortization of premiums on loans sold. During the three months ended March 31, 2017, we received proceeds of $1.6 million from the sale of $1.5 million of held-to-maturity mortgage-backed securities, resulting in gross realized gains of $95,000. We did not sell any held-to-maturity mortgage-backed securities during the three months ended March 31, 2016. The sale of these mortgage-backed securities, for which we had already collected a substantial portion of the original purchased principal (at least 85%), is in accordance with the Investments — Debt and Equity Securities topic of the FASB ASC and does not taint management’s assertion of intent to hold remaining securities in the held-to-maturity portfolio to maturity. Other income decreased by $40,000 primarily due to a decrease in commissions earned on annuity sales.

Noninterest Expense. The following table summarizes changes in noninterest expense between the three months ended March 31, 2017 and 2016.


	Three Months Ended
	March 31,					Change
	2017		2016		$ Change		% Change
				(Dollars in thousands)
Salaries and employee benefits	$	5,118	$	5,426	$	(308)	(5.7)	%
Occupancy		1,449		1,420		29	2.0	%
Equipment		866		906		(40)	(4.4)	%
Federal deposit insurance premiums		148		225		(77)	(34.2)	%
Other general and administrative expenses		1,126		1,082		44	4.1	%
Total	$	8,707	$	9,059	$	(352)	(3.9)	%

Noninterest expense decreased by $352,000 for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. Salaries and employee benefits expense decreased by $308,000 to $5.1 million for the three months ended March 31, 2017 from $5.4 million for the three months ended March 31, 2016 primarily due to a decrease in share-based compensation and an increase in the capitalized cost of new loan originations. The reduction in the cost of share-based compensation plans occurred as the majority of awards under our 2010 equity incentive plan became fully vested in 2016. In addition, an increase in the capitalized cost of new loan originations in 2017 reduced compensation expense. Federal deposit insurance premiums declined because of a decrease in the insurance assessment rate on deposits. The decrease in equipment expense was primarily due to a decrease in equipment depreciation expense and service bureau expense. The increase in other general and administrative expenses was mainly due to an increase in other professional fees, which was partially offset by a decrease in advertising expenses.

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Income Tax Expense. Income taxes were $2.6 million for the three months ended March 31, 2017, reflecting an effective tax rate of 37.4%, compared to $2.5 million for the three months ended March 31, 2016, reflecting an effective tax rate of 39.9%.

Income tax expense in the first quarter of 2017 included a $208,000 tax benefit related to the exercise of stock options. Starting in 2017 a new accounting standard requires that any excess tax benefits resulting from the exercise of stock options be recognized in income tax expense. Prior to the adoption of the new standard, the excess tax benefits were recorded as additional paid-in-capital. The amount of tax benefits or deficiencies recognized in income tax expense depends on the number of options exercised and the difference in the stock prices at the exercise and grant dates.

Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, cash balances at the Federal Reserve Bank, loan repayments, advances from the Federal Home Loan Bank, securities sold under agreements to repurchase, proceeds from loan sales and principal repayments on securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. We have established an Asset/Liability Management Committee, consisting of our President and Chief Executive Officer, our Vice Chairman and Co-Chief Operating Officer, our Senior Vice President and Chief Financial Officer and our Vice President and Controller, which is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of March 31, 2017.

We regularly monitor and adjust our investments in liquid assets based upon our assessment of:

(i)

expected loan demand;

(ii)

purchases and sales of investment securities;

(iii)

expected deposit flows and borrowing maturities;

(iv)

yields available on interest-earning deposits and securities; and

(v)

the objectives of our asset/liability management program.

Excess liquid assets are invested generally in interest-earning deposits or securities and may also be used to pay off short-term borrowings.

Our most liquid asset is cash. The amount of this asset is dependent on our operating, financing, lending and investing activities during any given period. At March 31, 2017, our cash and cash equivalents totaled $103.1 million. On that date, we had $55.0 million in securities sold under agreements to repurchase outstanding and $69.0 million of Federal Home Loan Bank advances outstanding, with the ability to borrow an additional $588.1 million under Federal Home Loan Bank advances.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements.

At March 31, 2017, we had $20.5 million in loan commitments outstanding, most of which were for fixed-rate loans, and had $28.3 million in unused lines of credit to borrowers. Certificates of deposit due within one year at March 31, 2017 totaled $158.3 million, or 10.2% of total deposits. If these deposits do not remain with us, we may be required

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to seek other sources of funds, including loan sales, brokered deposits, securities sold under agreements to repurchase and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before March 31, 2018. We believe, however, based on past experience, that a significant portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

Our primary investing activities are originating loans and purchasing mortgage-backed securities. During the three months ended March 31, 2017, we originated $87.4 million of loans. No securities were purchased in the three months ended March 31, 2017. During the three months ended March 31, 2016, we originated $66.0 million of loans and purchased $1.2 million of securities.

Financing activities consist primarily of activity in deposit accounts, Federal Home Loan Bank advances, securities sold under agreements to repurchase, stock repurchases and dividend payments. We experienced net increases in deposits of $55.7 million and $29.8 million for the three months ended March 31, 2017 and 2016, respectively. During the three months ended March 31, 2017, $40.7 million of the $55.7 million net increase in deposits is due to an increase in public deposits held in certificates of deposit. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors.

Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank, which provide an additional source of funds. Federal Home Loan Bank advances remained constant at $69.0 million during the three months ended March 31, 2017 and 2016. We had the ability to borrow up to an additional $588.1 million and $577.9 million from the Federal Home Loan Bank as of March 31, 2017 and December 31, 2016, respectively. We also utilize securities sold under agreements to repurchase as another borrowing source. Securities sold under agreements to repurchase remained constant at $55.0 million for the three months ended March 31, 2017 and 2016.

Territorial Bancorp Inc. is a separate legal entity from Territorial Savings Bank and must provide for its own liquidity to pay dividends, repurchase shares of its common stock and for other corporate purposes. Territorial Bancorp Inc.’s primary source of liquidity is dividend payments from Territorial Savings Bank. The ability of Territorial Savings Bank to pay dividends to Territorial Bancorp Inc. is subject to regulatory requirements. At March 31, 2017, Territorial Bancorp Inc. (on an unconsolidated, stand-alone basis) had liquid assets of $21.4 million.

Territorial Savings Bank and the Company are subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. On July 10, 2014, Territorial Savings Bank became a member of the Federal Reserve System. The Federal Reserve requires that Territorial Savings Bank maintain a Tier 1 Leverage Capital ratio of 9.0% for three years as a condition of membership. Effective January 1, 2015, the well capitalized threshold for Tier 1 risk-based capital was increased from 6.0% to 8.0% and a new capital standard, common equity tier 1 risk-based capital, was implemented with a 6.5% ratio requirement for a financial institution to be considered well capitalized. Additionally, effective January 1, 2015, consolidated regulatory capital requirements identical to those applicable to the subsidiary depository institutions became applicable to savings and loan holding companies over $1.0 billion in assets, such as the Company. The capital requirements become fully-phased in on January 1, 2019. At March 31, 2017, Territorial Savings Bank and the Company exceeded all of the fully-phased in regulatory capital requirements and are considered to be “well capitalized” under regulatory guidelines. The tables below present the fully-phased in capital required to be considered “well-capitalized” as a percentage of total and risk-weighted assets and the percentage and the total amount of capital maintained for Territorial Savings Bank and the Company at March 31, 2017 and December 31, 2016:

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(Dollars in thousands)	Required Ratio			Actual Amount	Actual Ratio
March 31, 2017:
Tier 1 Leverage Capital
Territorial Savings Bank (1)	9.00	%	$	215,891	11.40	%
Territorial Bancorp Inc.	5.00	%	$	237,939	12.56	%
Common Equity Tier 1 Risk-Based Capital (2)
Territorial Savings Bank	9.00	%	$	215,891	24.68	%
Territorial Bancorp Inc.	9.00	%	$	237,939	27.19	%
Tier 1 Risk-Based Capital (2)
Territorial Savings Bank	10.50	%	$	215,891	24.68	%
Territorial Bancorp Inc.	10.50	%	$	237,939	27.19	%
Total Risk-Based Capital (2)
Territorial Savings Bank	12.50	%	$	218,525	24.98	%
Territorial Bancorp Inc.	12.50	%	$	240,573	27.50	%

December 31, 2016:
Tier 1 Leverage Capital
Territorial Savings Bank (1)	9.00	%	$	219,365	11.76	%
Territorial Bancorp Inc.	5.00	%	$	235,102	12.60	%
Common Equity Tier 1 Risk-Based Capital (2)
Territorial Savings Bank	9.00	%	$	219,365	25.30	%
Territorial Bancorp Inc.	9.00	%	$	235,102	27.11	%
Tier 1 Risk-Based Capital (2)
Territorial Savings Bank	10.50	%	$	219,365	25.30	%
Territorial Bancorp Inc.	10.50	%	$	235,102	27.11	%
Total Risk-Based Capital (2)
Territorial Savings Bank	12.50	%	$	221,912	25.59	%
Territorial Bancorp Inc.	12.50	%	$	237,649	27.41	%

(1)

As a condition of membership in the Federal Reserve System, Territorial Savings Bank is required to maintain a Tier 1 Leverage Capital ratio of 9.00% for three years beginning on July 10, 2014.

(2)

The required Common Equity Tier 1 Risk-Based Capital, Tier 1 Risk-Based Capital and Total Risk-Based Capital ratios are based on the fully-phased in capital ratios in the Basel III capital regulations plus the 2.50% capital conservation buffer that becomes effective on January 1, 2019.

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our potential future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. In addition, we enter into commitments to sell mortgage loans.

Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities and agreements with respect to investments. Except for an increase of $42.7 million in certificates of deposit and a decrease of $30.0 million in loan commitments between December 31, 2016 and March 31, 2017, there have not been any material changes in contractual obligations and funding needs since December 31, 2016.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest

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rates. Our Board of Directors has established an Asset/Liability Management Committee, which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors.

Because we have historically operated as a traditional thrift institution, the significant majority of our assets consist of long-term, fixed-rate residential mortgage loans and mortgage-backed securities, which we have funded primarily with deposit accounts, securities sold under agreements to repurchase and Federal Home Loan Bank advances. In addition, there is little demand for adjustable-rate mortgage loans in the Hawaii market area. This has resulted in our being particularly vulnerable to increases in interest rates, as our interest-bearing liabilities mature or reprice more quickly than our interest-earning assets.

Our policies do not permit hedging activities, such as engaging in futures, options or swap transactions, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage-backed securities.

Economic Value of Equity. We use an interest rate sensitivity analysis that computes changes in the economic value of equity (EVE) of our cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. EVE represents the market value of portfolio equity and is equal to the present value of assets minus the present value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market-risk-sensitive instruments in the event of an instantaneous and sustained 100 to 400 basis point increase or a 100 basis point decrease in market interest rates with no effect given to any steps that we might take to counter the effect of that interest rate movement. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. Given the current relatively low level of market interest rates, an EVE calculation for an interest rate decrease of greater than 100 basis points has not been prepared.

The following table presents our internal calculations of the estimated changes in our EVE as of December 31, 2016 (the latest date for which we have available information) that would result from the designated instantaneous changes in the interest rate yield curve.


									Increase
									(Decrease) in
			Estimated				EVE Ratio as a		EVE Ratio as a
Change in			Increase				Percent of		Percent of
Interest Rates	Estimated EVE		(Decrease) in		Percentage		Present Value		Present Value of
(bp) (1)	(2)		EVE		Change in EVE		of Assets (3)(4)		Assets (3)(4)
(Dollars in thousands)
+400	$	179,026	$	(65,939)	(26.92)	%	11.77	%	(1.37)	%
+300	$	202,014	$	(42,951)	(17.53)	%	12.59	%	(0.55)	%
+200	$	224,802	$	(20,163)	(8.23)	%	13.28	%	0.14	%
+100	$	242,648	$	(2,317)	(0.95)	%	13.61	%	0.47	%
0	$	244,965	$	—	—	%	13.14	%	—	%
-100	$	220,732	$	(24,233)	(9.89)	%	11.46	%	(1.68)	%

(1)

Assumes an instantaneous uniform change in interest rates at all maturities.

(2)

EVE is the difference between the present value of an institution’s assets and liabilities.

(3)

Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.

(4)

EVE Ratio represents EVE divided by the present value of assets.

Interest rates on Freddie Mac mortgage-backed securities on March 31, 2017 and December 31, 2016 have not changed. Since mortgage rates have not changed between quarters, there has likely been no significant change in the estimated EVE.

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Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in EVE. Modeling changes in EVE requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the EVE table presented assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the EVE table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our EVE and net interest income and will differ from actual results.

ITEM 4. CONTROLS AND PROCEDURES

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chairman of the Board, President and Chief Executive Officer and the Senior Vice President and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of March 31, 2017. Based on that evaluation, the Company’s management, including the Chairman of the Board, President and Chief Executive Officer and the Senior Vice President and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.

During the quarter ended March 31, 2017, there have been no changes in the Company’s internal control over financial reporting 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

ITEM 1. LEGAL PROCEEDINGS

The Company and its subsidiaries are subject to various legal actions that are considered ordinary, routine litigation incidental to the business of the Company, and no claim for money damages exceeds ten percent of the Company’s consolidated assets. In the opinion of management, based on currently available information, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s results of operations.

ITEM 1A. RISK FACTORS

There have been no material changes to the risk factors as disclosed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission for the period ended December 31, 2016.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) Not applicable.

(b) Not applicable.

(c) Stock Repurchases. The following table sets forth information in connection with repurchases of our shares of common stock during the three months ended March 31, 2017:


				Total Number of	Maximum Number of
				Shares Purchased as	Shares That May Yet
		Average Price		Part of Publicly	be Purchased Under
	Total Number of	Paid per		Announced Plans or	the Plans or
Period	Shares Purchased (1)	Share		Programs	Programs (2)
January 1, 2017 through January 31, 2017	20,030	$	33.16	—	217,300
February 1, 2017 through February 28, 2017	8,672		33.48	—	217,300
March 1, 2017 through March 31, 2017	—		—	—	217,300

Total	28,702	$	33.25	—	217,300

______________________________

(1)

Includes shares repurchased by the Company to pay the exercise price in connection with stock swap or net settlement transactions related to the exercise of stock options.

(2)

On or about March 7, 2016, our Board of Directors authorized the repurchase of up to 275,000 shares of our common stock. We have entered into a Rule 10b5-1 plan with respect to our stock repurchase plan. The repurchase plan has no expiration date.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

The exhibits required by Item 601 of Regulation S-K are included with this Form 10-Q and are listed on the “Index to Exhibits” immediately following the Signatures.

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SIGNATURES

Pursuant to the requirements 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.


	TERRITORIAL BANCORP INC.
	(Registrant)


Date: May 9, 2017	/s/ Allan S. Kitagawa
	Allan S. Kitagawa
	Chairman of the Board, President and
	Chief Executive Officer


Date: May 9, 2017	/s/ Melvin M. Miyamoto
	Melvin M. Miyamoto
	Senior Vice President and Chief Financial Officer

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INDEX TO EXHIBITS


Exhibit
Number		Description

31.1		Certification of Allan S. Kitagawa, Chairman of the Board, President and Chief Executive Officer, Pursuant to Rule 13a-14(a) and Rule 15d-14(a).

31.2		Certification of Melvin M. Miyamoto, Senior Vice President and Chief Financial Officer, Pursuant to Rule 13a-14(a) and Rule 15d-14(a).

32		Certification of Allan S. Kitagawa, Chairman of the Board, President and Chief Executive Officer, and Melvin M. Miyamoto, Senior Vice President 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		The following materials from Territorial Bancorp, Inc’s Form 10-Q report for the quarter ended March 31, 2017, formatted in XBRL pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income; (iii) Consolidated Statements of Comprehensive Income; (iv) Consolidated Statements of Stockholders’ Equity (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements.

101.INS		Interactive datafile XBRL Instance Document
101.SCH		Interactive datafile XBRL Taxonomy Extension Schema Document
101.CAL		Interactive datafile XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		Interactive datafile XBRL Taxonomy Extension Definition Linkbase Document
101.LAB		Interactive datafile XBRL Taxonomy Extension Label Linkbase
101.PRE		Interactive datafile XBRL Taxonomy Extension Presentation Linkbase Document

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