Territorial Bancorp Inc. - FORM 10-Q

Attached files

file	filename
EX-32 - EX-32 - Territorial Bancorp Inc.	tbnk-20170930xex32.htm
EX-31.2 - EX-31.2 - Territorial Bancorp Inc.	tbnk-20170930ex312a5dfa6.htm
EX-31.1 - EX-31.1 - Territorial Bancorp Inc.	tbnk-20170930ex311eeb8c3.htm

Table of Contents

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 September 30, 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: 9,880,501 shares of Common Stock, par value $0.01 per share, were issued and outstanding as of October 31, 2017.

Table of Contents

TERRITORIAL BANCORP INC.

Form 10-Q Quarterly Report

Table of Contents

PART I

ITEM 1.	FINANCIAL STATEMENTS	1
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	30
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	44
ITEM 4.	CONTROLS AND PROCEDURES	45

PART II

ITEM 1.	LEGAL PROCEEDINGS	46
ITEM 1A.	RISK FACTORS	46
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	46
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	46
ITEM 4.	MINE SAFETY DISCLOSURES	46
ITEM 5.	OTHER INFORMATION	46
ITEM 6.	EXHIBITS	46

SIGNATURES		48

Table of Contents

PART I

ITEM 1. FINANCIAL STATEMENTS

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Balance Sheets (Unaudited)

(Dollars in thousands, except share data)


	September 30,		December 31,
	2017		2016
ASSETS
Cash and cash equivalents	$	38,385	$	61,273
Investment securities available for sale		2,910		—
Investment securities held to maturity, at amortized cost (fair value of $415,112 and $407,922 at September 30, 2017 and December 31, 2016, respectively)		411,657		407,656
Loans held for sale		495		1,601
Loans receivable, net		1,434,753		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		4,985		4,732
Premises and equipment, net		5,658		4,327
Bank-owned life insurance		43,976		43,294
Deferred income tax assets, net		7,172		7,905
Prepaid expenses and other assets		4,350		2,747
Total assets	$	1,962,457	$	1,877,562

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits	$	1,571,367	$	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		24,341		23,258
Income taxes payable		1,693		1,616
Advance payments by borrowers for taxes and insurance		3,764		5,702
Total liabilities		1,725,165		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 9,855,555 and 9,778,974 shares at September 30, 2017 and December 31, 2016, respectively		99		98
Additional paid-in capital		72,729		71,914
Unearned ESOP shares		(5,505)		(5,872)
Retained earnings		175,286		168,962
Accumulated other comprehensive loss		(5,317)		(5,316)
Total stockholders’ equity		237,292		229,786
Total liabilities and stockholders’ equity	$	1,962,457	$	1,877,562

See accompanying notes to consolidated financial statements.

Table of Contents

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

(Dollars in thousands, except per share data)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2017		2016		2017		2016
Interest income:
Loans	$	13,837	$	13,052	$	40,877	$	38,060
Investment securities		3,169		3,496		9,328		11,121
Other investments		171		121		530		411
Total interest income		17,177		16,669		50,735		49,592

Interest expense:
Deposits		2,033		1,485		5,459		4,363
Advances from the Federal Home Loan Bank		264		259		779		772
Securities sold under agreements to repurchase		221		220		654		656
Total interest expense		2,518		1,964		6,892		5,791

Net interest income		14,659		14,705		43,843		43,801
Provision for loan losses		54		107		2		219

Net interest income after provision for loan losses		14,605		14,598		43,841		43,582

Noninterest income:
Service fees on loan and deposit accounts		427		493		1,490		1,422
Income on bank-owned life insurance		228		240		681		727
Gain on sale of investment securities		150		60		431		250
Gain on sale of loans		28		114		154		304
Other		76		96		234		320
Total noninterest income		909		1,003		2,990		3,023

Noninterest expense:
Salaries and employee benefits		5,201		5,265		15,254		15,947
Occupancy		1,529		1,432		4,439		4,285
Equipment		882		865		2,630		2,683
Federal deposit insurance premiums		152		144		448		596
Other general and administrative expenses		997		939		3,451		3,181
Total noninterest expense		8,761		8,645		26,222		26,692

Income before income taxes		6,753		6,956		20,609		19,913
Income taxes		2,580		2,792		7,814		7,928
Net income	$	4,173	$	4,164	$	12,795	$	11,985

Basic earnings per share	$	0.45	$	0.45	$	1.38	$	1.31
Diluted earnings per share	$	0.44	$	0.44	$	1.34	$	1.28
Cash dividends paid per common share	$	0.30	$	0.18	$	0.70	$	0.54
Basic weighted-average shares outstanding		9,280,018		9,102,837		9,250,537		9,065,892
Diluted weighted-average shares outstanding		9,521,201		9,325,506		9,535,875		9,280,260

See accompanying notes to consolidated financial statements.

Table of Contents

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

(Dollars in thousands)


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2017		2016		2017		2016
Net income	$	4,173	$	4,164	$	12,795	$	11,985

Change in unfunded pension liability		—		—		—		(21)
Change in unrealized loss on securities		12		4		(1)		10
Change in noncredit related loss on trust preferred securities		—		45		—		91
Other comprehensive income (loss), net of tax		12		49		(1)		80
Comprehensive income	$	4,185	$	4,213	$	12,794	$	12,065

See accompanying notes to consolidated financial statements.

Table of Contents

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		—		—		—		11,985		—		11,985
Other comprehensive income		—		—		—		—		80		80
Cash dividends paid ($0.54 per share)		—		—		—		(4,938)		—		(4,938)
Share-based compensation		1		1,778		—		—		—		1,779
Allocation of 36,699 ESOP shares		—		612		367		—		—		979
Repurchase of 100,758 shares of company common stock		(1)		(2,724)		—		—		—		(2,725)
Exercise of 93,100 options for common stock		1		1,616		—		—		—		1,617

Balances at September 30, 2016	$	97	$	71,400	$	(5,994)	$	168,071	$	(5,156)	$	228,418

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

Net income		—		—		—		12,795		—		12,795
Other comprehensive loss		—		—		—		—		(1)		(1)
Cash dividends paid ($0.70 per share)		—		—		—		(6,471)		—		(6,471)
Share-based compensation		—		48		—		—		—		48
Allocation of 36,699 ESOP shares		—		777		367		—		—		1,144
Repurchase of 91,456 shares of company common stock		(1)		(2,905)		—		—		—		(2,906)
Exercise of 166,837 options for common stock		2		2,895		—		—		—		2,897

Balances at September 30, 2017	$	99	$	72,729	$	(5,505)	$	175,286	$	(5,317)	$	237,292

See accompanying notes to consolidated financial statements.

Table of Contents

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)


	Nine Months Ended
	September 30,
	2017		2016
Cash flows from operating activities:
Net income	$	12,795	$	11,985
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		2		219
Depreciation and amortization		816		886
Deferred income tax expense		733		1,041
Amortization of fees, discounts, and premiums		(339)		(604)
Origination of loans held for sale		(19,023)		(39,336)
Proceeds from sales of loans held for sale		20,284		38,844
Gain on sale of loans, net		(154)		(304)
Gain on sale of investment securities held to maturity		(431)		(250)
Net loss on disposal of premises and equipment		25		—
ESOP expense		1,144		979
Share-based compensation expense		48		1,779
Increase in accrued interest receivable		(253)		(66)
Net increase in bank-owned life insurance		(682)		(727)
Net increase in prepaid expenses and other assets		(1,722)		(316)
Net increase in accounts payable and accrued expenses		1,083		1,558
Net decrease in advance payments by borrowers for taxes and insurance		(1,938)		(1,828)
Net (increase) decrease in income taxes receivable		119		(737)
Net increase (decrease) in income taxes payable		77		(444)

Net cash from operating activities		12,584		12,679

Cash flows from investing activities:
Purchases of investment securities held to maturity		(51,894)		(2,523)
Purchases of investment securities available for sale		(2,970)		—
Principal repayments on investment securities held to maturity		40,925		60,077
Principal repayments on investment securities available for sale		50		—
Proceeds from sale of investment securities held to maturity		7,446		3,923
Loan originations, net of principal repayments on loans receivable		(98,468)		(112,498)
Purchases of Federal Home Loan Bank stock		(1,609)		(275)
Proceeds from redemption of Federal Home Loan Bank stock		1,541		120
Purchases of Federal Reserve Bank stock		(8)		(59)
Purchases of premises and equipment		(2,172)		(190)

Net cash from investing activities		(107,159)		(51,425)

(Continued)

Table of Contents

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)


	Nine Months Ended
	September 30,
	2017		2016
Cash flows from financing activities:
Net increase in deposits	$	78,167	$	19,376
Proceeds from advances from the Federal Home Loan Bank		38,525		3,000
Repayments of advances from the Federal Home Loan Bank		(38,525)		(3,000)
Purchases of Fed Funds		10		10
Sales of Fed Funds		(10)		(10)
Proceeds from exercise of stock options		—		566
Repurchases of common stock		(9)		(1,674)
Cash dividends paid		(6,471)		(4,938)

Net cash from financing activities		71,687		13,330

Net decrease in cash and cash equivalents		(22,888)		(25,416)

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

Cash and cash equivalents at end of the period	$	38,385	$	40,503

Supplemental disclosure of cash flow information:
Cash paid for:
Interest on deposits and borrowings	$	6,698	$	5,770
Income taxes		6,956		8,068

Supplemental disclosure of noncash investing and financing activities:
Company stock acquired through stock swap and net settlement transactions	$	2,897	$	1,051

See accompanying notes to consolidated financial statements.

Table of Contents

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 Company has reviewed all revenue sources to determine if the sources are in scope for this guidance. Net interest income from financial assets and liabilities are explicitly excluded from the scope of the amendment. The Company’s overall assessment of key in-scope revenue sources include service charges on deposit accounts, rental income from safe deposit boxes and commissions on insurance and annuity sales. The guidance is not expected to have a significant impact on the Company’s revenue recognition for these key in-scope revenue sources. The Company plans to adopt this amendment effective January 1, 2018, under the modified retrospective approach with a cumulative effect adjustment to opening retained earnings, if such adjustment is considered to be significant.

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. Since the Company does not own any equity securities subject to the amendment in its investment portfolio, the amendment will not have a significant impact on its consolidated financial statements. The Company will continue to evaluate the effects that the

Table of Contents

use of exit prices will have on its fair value disclosures. The amendment is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.

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 amendment 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. For the three and nine months ended September 30, 2017, the Company recognized $150,000 and $541,000, respectively, 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.

Table of Contents

(4) Cash and Cash Equivalents

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


	September 30,		December 31,
(Dollars in thousands)	2017		2016
Cash and due from banks	$	10,118	$	9,043
Interest-earning deposits in other banks		28,267		52,230
Cash and cash equivalents	$	38,385	$	61,273

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

(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
September 30, 2017:
Available-for-sale:
U.S. government-sponsored mortgage-backed securities	$	2,920	$	—	$	(10)	$	2,910
Total	$	2,920	$	—	$	(10)	$	2,910

Held-to-maturity:
U.S. government-sponsored mortgage-backed securities	$	411,065	$	7,374	$	(4,252)	$	414,187
Trust preferred securities		592		333		—		925
Total	$	411,657	$	7,707	$	(4,252)	$	415,112

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 by maturity date at September 30, 2017 are shown below. Incorporated in the maturity schedule are mortgage-backed and trust preferred securities, which are

Table of Contents

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
Available-for-sale:
Due within 5 years	$	—	$	—
Due after 5 years through 10 years		—		—
Due after 10 years		2,920		2,910
Total	$	2,920	$	2,910

Held-to-maturity:
Due within 5 years	$	12	$	13
Due after 5 years through 10 years		50		50
Due after 10 years		411,595		415,049
Total	$	411,657	$	415,112

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


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(Dollars in thousands)	2017		2016		2017		2016
Proceeds from sales	$	2,393	$	801	$	7,446	$	3,923
Gross gains		150		60		431		250
Gross losses		—		—		—		—

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 $275.6 million and $239.9 million at September 30, 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 September 30, 2017 and December 31, 2016. The Company does not intend to sell held-to-maturity and available-for-sale securities

Table of Contents

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)
September 30, 2017:
Available-for-sale:
U.S. government-sponsored mortgage-backed securities	$	2,910	$	10	$	—	$	—	1	$	2,910	$	10

Held-to-maturity:
U.S. government-sponsored mortgage-backed securities	$	117,700	$	1,875	$	67,276	$	2,377	47	$	184,976	$	4,252

December 31, 2016:
Held-to-maturity:
U.S. government-sponsored 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 September 30, 2017 and December 31, 2016.

Trust Preferred Securities. At September 30, 2017, the Company owned one trust preferred security, PreTSL XXIII. PreTSL XXIII has an amortized cost and a remaining cost basis of $592,000 at September 30, 2017. 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 69 months in the same tranche of securities that we own and no new issuances 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 nine months ended September 30, 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 $592,000 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.

Table of Contents

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


	Nine Months Ended September 30,
(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:


	September 30,
(Dollars in thousands)	2017		2016
Noncredit losses on other-than-temporarily impaired securities, net of taxes	$	—	$	56

(6) Loans Receivable and Allowance for Loan Losses

The components of loans receivable are as follows:


	September 30,		December 31,
(Dollars in thousands)	2017		2016
Real estate loans:
First mortgages:
One- to four-family residential	$	1,390,037	$	1,289,364
Multi-family residential		9,334		9,551
Construction, commercial and other		22,490		23,346
Home equity loans and lines of credit		13,474		14,805
Total real estate loans		1,435,335		1,337,066
Other loans:
Loans on deposit accounts		285		204
Consumer and other loans		4,798		4,360
Total other loans		5,083		4,564
Less:
Net unearned fees and discounts		(3,166)		(3,191)
Allowance for loan losses		(2,499)		(2,452)
Total unearned fees, discounts and allowance for loan losses		(5,665)		(5,643)
Loans receivable, net	$	1,434,753	$	1,335,987

Table of Contents

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 September 30, 2017:
Balance, beginning of period	$	1,602	$	556	$	1	$	53	$	245	$	2,457
Provision (reversal of provision) for loan losses		30		16		—		18		(10)		54
		1,632		572		1		71		235		2,511
Charge-offs		—		—		—		(12)		—		(12)
Recoveries		—		—		—		—		—		—
Net charge-offs		—		—		—		(12)		—		(12)
Balance, end of period	$	1,632	$	572	$	1	$	59	$	235	$	2,499

Nine months ended September 30, 2017:
Balance, beginning of period	$	1,594	$	519	$	2	$	115	$	222	$	2,452
Provision (reversal of provision) for loan losses		(26)		53		(1)		(37)		13		2
		1,568		572		1		78		235		2,454
Charge-offs		(11)		—		—		(24)		—		(35)
Recoveries		75		—		—		5		—		80
Net recoveries (charge-offs)		64		—		—		(19)		—		45
Balance, end of period	$	1,632	$	572	$	1	$	59	$	235	$	2,499


			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 September 30, 2016:
Balance, beginning of period	$	1,444	$	567	$	3	$	56	$	206	$	2,276
Provision (reversal of provision) for loan losses		133		(87)		(1)		54		8		107
		1,577		480		2		110		214		2,383
Charge-offs		(33)		—		—		(5)		—		(38)
Recoveries		15		—		—		2		—		17
Net charge-offs		(18)		—		—		(3)		—		(21)
Balance, end of period	$	1,559	$	480	$	2	$	107	$	214	$	2,362

Nine months ended September 30, 2016:
Balance, beginning of period	$	1,380	$	517	$	3	$	72	$	194	$	2,166
Provision (reversal of provision) for loan losses		190		(37)		(1)		47		20		219
		1,570		480		2		119		214		2,385
Charge-offs		(33)		—		—		(23)		—		(56)
Recoveries		22		—		—		11		—		33
Net charge-offs		(11)		—		—		(12)		—		(23)
Balance, end of period	$	1,559	$	480	$	2	$	107	$	214	$	2,362

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 related to 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.

Table of Contents

Management considers the allowance for loan losses at September 30, 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 bank regulators 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.

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
September 30, 2017:
Allowance for loan losses:
Ending allowance balance:
Individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	—
Collectively evaluated for impairment		1,632		572		1		59		235		2,499
Total ending allowance balance	$	1,632	$	572	$	1	$	59	$	235	$	2,499

Loans:
Ending loan balance:
Individually evaluated for impairment	$	4,099	$	—	$	170	$	—	$	—	$	4,269
Collectively evaluated for impairment		1,392,170		22,405		13,310		5,098		—		1,432,983
Total ending loan balance	$	1,396,269	$	22,405	$	13,480	$	5,098	$	—	$	1,437,252

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

Table of Contents

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
September 30, 2017:
With no related allowance recorded:
One- to four-family residential mortgages	$	4,099	$	4,976
Home equity loans and lines of credit		170		229
Total	$	4,269	$	5,205

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

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


	For the Three Months Ended				For the Nine Months Ended
	September 30,				September 30,
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
(Dollars in thousands)	Investment		Recognized		Investment		Recognized
2017:
With no related allowance recorded:
One- to four-family residential mortgages	$	4,135	$	13	$	4,203	$	43
Home equity loans and lines of credit		172		—		177		—
Total	$	4,307	$	13	$	4,380	$	43

2016:
With no related allowance recorded:
One- to four-family residential mortgages	$	5,936	$	19	$	6,000	$	57
Home equity loans and lines of credit		162		—		163		—
Total	$	6,098	$	19	$	6,163	$	57

There were no loans individually evaluated for impairment with a related allowance for loan loss as of September 30, 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.

Table of Contents

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
September 30, 2017:
One- to four-family residential mortgages	$	438	$	—	$	652	$	1,090	$	1,385,864	$	1,386,954	$	3,179	$	—
Multi-family residential mortgages		—		—		—		—		9,315		9,315		—		—
Construction, commercial and other mortgages		—		—		—		—		22,405		22,405		—		—
Home equity loans and lines of credit		—		—		41		41		13,439		13,480		170		—
Loans on deposit accounts		—		—		—		—		285		285		—		—
Consumer and other		1		3		—		4		4,809		4,813		—		—

Total	$	439	$	3	$	693	$	1,135	$	1,436,117	$	1,437,252	$	3,349	$	—

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 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 $3.3 million at September 30, 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 $137,000 and $149,000 during the nine months ended September 30, 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 $169,000 and $211,000 during the nine months ended September 30, 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 September 30, 2017 and December 31, 2016.

There were no loans modified in a troubled debt restructuring during the nine months ended September 30, 2017 or 2016. There were no new troubled debt restructurings within the past 12 months that subsequently defaulted.

Table of Contents

The table below summarizes troubled debt restructurings by class of loans:


	Number of		Accrual		Number of		Nonaccrual
(Dollars in thousands)	Loans		Status		Loans		Status		Total
September 30, 2017:
One- to four-family residential mortgages		4	$	920		5	$	1,097	$	2,017
Home equity loans and lines of credit		—		—		1		96		96
Total		4	$	920		6	$	1,193	$	2,113

December 31, 2016:
One- to four-family residential mortgages		5	$	1,185		7	$	1,629	$	2,814
Home equity loans and lines of credit		—		—		1		107		107
Total		5	$	1,185		8	$	1,736	$	2,921

One of the restructured loans, for $149,000, was more than 149 days delinquent and not accruing interest as of September 30, 2017 and 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 September 30, 2017, we had no commitments to lend any additional funds to these borrowers.

The Company had no real estate owned as of September 30, 2017 or December 31, 2016. There were three one- to four-family residential mortgage loans totaling $652,000 and one home equity loan for $41,000 in the process of foreclosure as of September 30, 2017, and four one- to four-family residential mortgage loans totaling $702,000 in the process of foreclosure as of 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 nine months ended September 30, 2017 and 2016, the Company sold $20.3 million and $38.6 million, respectively, of mortgage loans held for sale and recognized gains of $154,000 and $304,000, respectively. The Company had one loan held for sale for $495,000 at September 30, 2017 and five loans held for sale totaling $1.6 million at December 31, 2016.

The Company serviced loans for others of $37.5 million at September 30, 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 September 30, 2017 and December 31, 2016, respectively. The amount of contractually specified servicing fees earned for the nine-month periods ended September 30, 2017 and 2016 was $80,000 and $99,000, respectively. The amount of contractually specified servicing fees earned for the three-month periods ended September 30, 2017 and 2016 was $26,000 and $31,000, respectively. The fees are reported in service fees on loan and deposit accounts in the consolidated statements of income.

Table of Contents

(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:


	September 30, 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 September 30, 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

61,372

61,614

55,000

6,614

(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
September 30, 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.

Table of Contents

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				SERP
	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(Dollars in thousands)	2017		2016		2017		2016
Net periodic benefit cost for the period:
Service cost	$	19	$	15	$	39	$	44
Interest cost		34		32		104		98
Expected return on plan assets		—		—		—		—
Amortization of prior service cost		—		—		—		—
Recognized actuarial loss		—		—		—		—
Recognized curtailment loss		—		—		—		—
Net periodic benefit cost	$	53	$	47	$	143	$	142

(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 September 30, 2017 and 2016 amounted to $298,000 and $283,000, respectively. Compensation expense recognized for the nine months ended September 30, 2017 and 2016 amounted to $923,000 and $804,000, respectively.

Shares held by the ESOP trust were as follows:


	September 30,		December 31,
	2017		2016
Allocated shares		392,351		372,997
Unearned shares		550,494		587,193
Total ESOP shares		942,845		960,190
Fair value of unearned shares, in thousands	$	17,379	$	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

Table of Contents

limitations imposed on tax-qualified plans. We accrue for these benefits over the period during which employees provide services to earn these benefits. For the three months ended September 30, 2017 and 2016, we accrued $97,000 and $122,000, respectively, for the ESOP restoration plan. For the nine months ended September 30, 2017 and 2016, we accrued $161,000 and $244,000, 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:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(In thousands)	2017		2016		2017		2016
Compensation expense	$	58	$	457	$	95	$	1,780
Income tax benefit		23		183		38		714

Shares of our common stock issued under the 2010 Equity Incentive Plan shall come from authorized 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 nine months ended September 30, 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	166,837		17.36	—		2,414
Forfeited	—		—	—		—
Expired	—		—	—		—
Options outstanding at September 30, 2017	539,593	$	17.45	2.96	$	7,616

Options outstanding at December 31, 2015	832,300	$	17.42	4.70	$	8,588
Granted	—		—	—		—
Exercised	93,100		17.36	—		908
Forfeited	—		—	—		—
Expired	—		—	—		—
Options outstanding at September 30, 2016	739,200	$	17.43	3.95	$	8,302

Options vested and exercisable at September 30, 2017	538,393	$	17.44	2.95	$	7,610

Table of Contents

The following summarizes certain stock option activity of the Company:


	For the Three Months Ended				For the Nine Months Ended
	September 30,				September 30,
(In thousands)	2017		2016		2017		2016
Intrinsic value of stock options exercised	$	744	$	368	$	2,414	$	908
Proceeds received from stock options exercised		971		551		2,897		1,616
Tax benefits realized from stock options exercised		245		121		838		216
Total fair value of stock options that vested		38		3,923		38		3,923

During the nine months ended September 30, 2017, we issued 75,707 shares of common stock, net, in exchange for 166,837 stock options and 91,130 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 September 30, 2017, the Company had $4,000 of unrecognized compensation costs related to the stock option plan that will be amortized over a three-year vesting period.

Restricted Stock

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 may not be disposed of or transferred during the vesting period. Restricted stock carries the right to receive dividends, although dividends attributable to restricted stock are retained by the Company until the shares vest, at which time they are paid to the award recipient.

The table below presents the restricted stock activity:


		Weighted
		Average Grant
	Restricted	Date Fair
	Stock Awards	Value
Nonvested at December 31, 2016	2,400	$	26.23
Granted	9,604		29.53
Vested	1,200		26.23
Forfeited	—		—
Nonvested at September 30, 2017	10,804	$	29.16

Nonvested at December 31, 2015	114,542	$	17.67
Granted	—		—
Vested	112,142		17.49
Forfeited	—		—
Nonvested at September 30, 2016	2,400	$	26.23

During the nine months ended September 30, 2017, the Company issued 9,604 shares of restricted stock to certain members of executive management under the 2010 Equity Incentive Plan. The fair value of the restricted stock is based on the value of the Company’s stock on the date of grant. Restricted stock will vest over three years from the date of grant.

As of September 30, 2017, the Company had $278,000 of unrecognized compensation costs related to restricted stock.

During the nine months ended September 30, 2017, the Company issued 11,525 of performance-based restricted stock units (PRSUs) to certain members of executive management under the 2010 Equity Incentive Plan. These PRSUs will vest in the first quarter of 2020 after our Compensation Committee determines whether a performance condition that compares the Company’s return on average equity to the SNL Bank Index is achieved. Depending on the Company’s

Table of Contents

performance, the actual number of these PRSUs that are issued at the end of the vesting period can vary between 0% to 150% of the target award. For the PRSUs, an estimate is made of the number of shares expected to vest based on the probability that the performance criteria will be achieved to determine the amount of compensation expense to be recognized. This estimate is re-evaluated quarterly and total compensation expense is adjusted for any change in the current period.

The table below presents the PRSUs that will vest on a performance condition:


	Performance-
	Based Restricted
	Stock Units	Weighted
	Based on a	Average Grant
	Performance	Date Fair
	Condition	Value
Nonvested at December 31, 2016	—	$	—
Granted	11,525		29.53
Vested	—		—
Forfeited	—		—
Nonvested at September 30, 2017	11,525	$	29.53

The fair value of these PRSUs is based on the fair value of the Company’s stock on the date of grant. As of September 30, 2017, the Company had $215,000 of unrecognized compensation costs related to these PRSUs. Performance will be measured over a three-year performance period and will be cliff vested.

During the nine months ended September 30, 2017, the Company issued 2,881 of PRSUs to certain members of executive management under the 2010 Equity Incentive Plan. These PRSUs will vest in the first quarter of 2020 after our Compensation Committee determines whether a market condition that compares the Company’s total stock return to the SNL Bank Index is achieved. The number of shares that will be expensed will not be adjusted for performance. The fair value of these PRSUs is based on a Monte Carlo valuation of the Company’s stock on the date of grant. The assumptions which were used in the Monte Carlo valuation of the PRSUs are:

Grant date: May 25, 2017

Performance period: January 1, 2017 to December 31, 2019

2.60 year risk-free rate on grant date: 1.40%

December 31, 2016 closing price: $32.84

Closing stock price on the date of grant: $29.53

Annualized volatility (based on 2.60 year historical volatility as of the grant date): 15.7%

Annual dividend preceding the grant date: $0.80

The table below presents the PRSUs that will vest on a market condition:


	Performance-
	Based Restricted	Monte Carlo
	Stock Units	Valuation of
	Based on a	the Company's
	Market Condition	Stock
Nonvested at December 31, 2016	—	$	—
Granted	2,881		24.44
Vested	—		—
Forfeited	—		—
Nonvested at September 30, 2017	2,881	$	24.44

As of September 30, 2017, the Company had $41,000 of unrecognized compensation costs related to the PRSUs that are based on a market condition. Performance will be measured over a three-year performance period and will be cliff vested.

Table of Contents

(12) Earnings Per Share

Holders of unvested restricted stock receive nonforfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings. Unvested restricted stock awards that contain nonforfeitable rights to dividends or dividend equivalents are considered to be participating securities in the earnings per share computation using the two-class method. Under the two-class method, earnings are allocated to common shareholders and participating securities according to their respective rights to earnings.

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


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(Dollars in thousands, except per share data)	2017		2016		2017		2016
Net income	$	4,173	$	4,164	$	12,795	$	11,985
Income allocated to participating securities		(10)		(47)		(15)		(136)
Net income available to common shareholders	$	4,163	$	4,117	$	12,780	$	11,849

Weighted-average number of shares used in:
Basic earnings per share		9,280,018		9,102,837		9,250,537		9,065,892
Dilutive common stock equivalents:
Stock options and restricted stock units		241,183		222,669		285,338		214,368
Diluted earnings per share		9,521,201		9,325,506		9,535,875		9,280,260

Net income per common share, basic	$	0.45	$	0.45	$	1.38	$	1.31
Net income per common share, diluted	$	0.44	$	0.44	$	1.34	$	1.28

Table of Contents

(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 September 30, 2017
Balances at beginning of period	$	5,284	$	—	$	45	$	5,329
Other comprehensive income, net of taxes		—		—		(12)		(12)
Amounts reclassified from accumulated other comprehensive loss		—		—		—		—
Net current period other comprehensive income		—		—		(12)		(12)
Balances at end of period	$	5,284	$	—	$	33	$	5,317

Three months ended September 30, 2016
Balances at beginning of period	$	5,065	$	101	$	39	$	5,205
Other comprehensive income, net of taxes		—		(45)		(4)		(49)
Amounts reclassified from accumulated other comprehensive loss		—		—		—		—
Net current period other comprehensive income		—		(45)		(4)		(49)
Balances at end of period	$	5,065	$	56	$	35	$	5,156

Nine months ended September 30, 2017
Balances at beginning of period	$	5,284	$	—	$	32	$	5,316
Other comprehensive loss, net of taxes		—		—		1		1
Amounts reclassified from accumulated other comprehensive loss		—		—		—		—
Net current period other comprehensive loss		—		—		1		1
Balances at end of period	$	5,284	$	—	$	33	$	5,317

Nine months ended September 30, 2016
Balances at beginning of period	$	5,044	$	147	$	45	$	5,236
Other comprehensive loss (income), net of taxes		21		(91)		(10)		(80)
Amounts reclassified from accumulated other comprehensive loss		—		—		—		—
Net current period other comprehensive loss (income)		21		(91)		(10)		(80)
Balances at end of period	$	5,065	$	56	$	35	$	5,156

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


	Three Months Ended September 30,
	2017						2016
	Pretax				After Tax		Pretax				After Tax
(Dollars in thousands)	Amount		Tax		Amount		Amount		Tax		Amount
Unfunded pension liability	$	—	$	—	$	—	$	—	$	—	$	—
Noncredit related loss on trust preferred securities		—		—		—		(74)		29		(45)
Unrealized loss on securities		(21)		9		(12)		(7)		3		(4)
Total	$	(21)	$	9	$	(12)	$	(81)	$	32	$	(49)

Table of Contents


	Nine Months Ended September 30,
	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		—		—		—		(150)		59		(91)
Unrealized loss on securities		1		—		1		(17)		7		(10)
Total	$	1	$	—	$	1	$	(167)	$	87	$	(80)

(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 69 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%.

Table of Contents

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, including estimated prepayments, 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.

Table of Contents

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
September 30, 2017
Assets
Cash and cash equivalents	$	38,385	$	38,385	$	38,385	$	—	$	—
Investment securities available for sale		2,910		2,910		—		2,910		—
Investment securities held to maturity		411,657		415,112		—		414,187		925
Loans held for sale		495		499		—		499		—
Loans receivable, net		1,434,753		1,455,571		—		—		1,455,571
FHLB stock		5,013		5,013		—		5,013		—
FRB stock		3,103		3,103		—		3,103		—
Accrued interest receivable		4,985		4,985		2		1,111		3,872
Interest rate contracts		2		2		—		2		—

Liabilities
Deposits		1,571,367		1,570,959		—		1,272,086		298,873
Advances from the Federal Home Loan Bank		69,000		68,933		—		68,933		—
Securities sold under agreements to repurchase		55,000		54,986		—		54,986		—
Accrued interest payable		412		412		—		174		238
Interest rate contracts		2		2		—		2		—

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 September 30, 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.

Table of Contents

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

September 30, 2017
Interest rate contracts — assets	$	—	$	2	$	—	$	2
Interest rate contracts — liabilities		—		(2)		—		(2)
Available-for-sale investments		—		2,910		—		2,910

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 fair value of available-for-sale investments was determined using quoted market prices.

The table below presents the balance of assets measured at fair value on a nonrecurring basis as of September 30, 2017 and December 31, 2016 and the related gains and losses for the nine months ended September 30, 2017 and the year ended December 31, 2016:


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

September 30, 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.

Table of Contents

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 October 25, 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 November 22, 2017 to stockholders of record as of November 8, 2017.

Table of Contents

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,” “continue” 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. You should not place undue reliance on such statements. 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;

fluctuations in the demand for loans;

significant increases in loan losses;

Table of Contents

success in introducing new products and services;

failure or breaches of IT security systems;

ability to retain management team;

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.

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. As a result, we may be 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 $3.3 million, or 0.17% of total assets, at September 30, 2017, compared to $4.6 million, or 0.24% of total assets, at December 31, 2016. 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 $2,000 and $219,000 for the nine months ended September 30, 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 only 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.

We sold $20.3 million and $38.6 million of fixed-rate mortgage loans for the nine months ended September 30, 2017 and 2016, respectively. Long-term, fixed-rate borrowings remained constant at September 30, 2017 and 2016.

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 September 30, 2017 and December 31, 2016, we owned $414.0 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.

Table of Contents

Comparison of Financial Condition at September 30, 2017 and December 31, 2016

Assets. At September 30, 2017, our assets were $1.962 billion, an increase of $84.9 million, or 4.5%, from $1.878 billion at December 31, 2016. The increase in assets was primarily the result of a $97.7 million increase in total loans receivable and a $6.9 million increase in investment securities, which was partially offset by a $22.9 million decrease in cash and cash equivalents.

Cash and Cash Equivalents. Cash and cash equivalents were $38.4 million at September 30, 2017, a decrease of $22.9 million since December 31, 2016. The decrease in cash and cash equivalents was primarily caused by a $97.7 million increase in total loans, which was offset by a $78.2 million increase in deposits.

Loans. Total loans, including $495,000 of loans held for sale, were $1.435 billion at September 30, 2017, or 73.1% of total assets. During the nine months ended September 30, 2017, the loan portfolio, including loans held for sale, increased by $97.7 million, or 7.3%. 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 September 30, 2017, our securities portfolio totaled $414.6 million, or 21.1% of total assets. During the nine months ended September 30, 2017, the securities portfolio increased by $6.9 million, or 1.7%. The increase in the securities portfolio is due to purchases of new securities exceeding principal repayments and sales. During the nine months ended September 30, 2017, $52.0 million and $2.9 million of securities were purchased for the held-to-maturity and available-for-sale portfolios, respectively.

At September 30, 2017, none of the underlying collateral consisted of subprime or Alt-A (traditionally defined as nonconforming loans having less than full documentation) loans.

At September 30, 2017, we owned a trust preferred security with an amortized cost of $592,000. 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 69 months in the same tranche of securities we own and no new issuances 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 nine months ended September 30, 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 $592,000 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 $1.571 billion at September 30, 2017, an increase of $78.2 million, or 5.2%, since December 31, 2016. The growth in deposits was primarily due to an increase of $63.2 million in certificates of deposit and an increase of $13.2 million in savings accounts during the nine months ended September 30, 2017. The increase in certificates of deposit is primarily due to a $34.7 million increase in public deposits and $14.6 million in new accounts at our new Keeaumoku branch, which was opened in April 2017.

Borrowings. Our borrowings consist of advances from the Federal Home Loan Bank and funds borrowed under securities sold under agreements to repurchase. At September 30, 2017 and December 31, 2016, total borrowings remained constant at $124.0 million. We have not required any additional 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.

Table of Contents

Stockholders’ Equity. Total stockholders’ equity increased to $237.3 million at September 30, 2017 from $229.8 million at December 31, 2016. The increase in stockholders’ equity occurred as our net income for the year exceeded dividends paid to stockholders.

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 and are included with accrual loans in the tables. However, no interest income was attributed to nonaccrual loans. The yields set forth below include the effect of net deferred costs, discounts and premiums that are amortized or accreted to interest income.

Table of Contents


	For the Three Months Ended September 30,
	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)	$	1,371,678		$	13,248	3.86	%	$	1,226,054		$	12,433	4.06	%
Multi-family residential		9,363			111	4.74			9,656			114	4.72
Construction, commercial and other		22,046			250	4.54			25,189			278	4.41
Home equity loans and lines of credit		13,607			162	4.76			15,428			169	4.38
Other loans		4,984			66	5.30			4,297			58	5.40
Total loans		1,421,678			13,837	3.89			1,280,624			13,052	4.08
Investment securities:
U.S. government sponsored mortgage-backed securities (2)		407,547			3,169	3.11			444,514			3,496	3.15
Trust preferred securities		745			—	—			992			—	—
Total securities		408,292			3,169	3.10			445,506			3,496	3.14
Other		47,138			171	1.45			54,658			121	0.89
Total interest-earning assets		1,877,108			17,177	3.66			1,780,788			16,669	3.74
Non-interest-earning assets		70,268							68,176
Total assets	$	1,947,376						$	1,848,964

Interest-bearing liabilities:
Savings accounts	$	1,036,734			1,146	0.44	%	$	1,022,748			1,050	0.41	%
Certificates of deposit		278,375			871	1.25			213,409			423	0.79
Money market accounts		5,719			6	0.42			2,651			2	0.30
Checking and Super NOW accounts		179,670			10	0.02			171,624			10	0.02
Total interest-bearing deposits		1,500,498			2,033	0.54			1,410,432			1,485	0.42
Federal Home Loan Bank advances		70,262			264	1.50			69,033			259	1.50
Securities sold under agreements to repurchase		55,000			221	1.61			55,000			220	1.60
Total interest-bearing liabilities		1,625,760			2,518	0.62			1,534,465			1,964	0.51
Non-interest-bearing liabilities		84,177							85,962
Total liabilities		1,709,937							1,620,427
Stockholders’ equity		237,439							228,537
Total liabilities and stockholders’ equity	$	1,947,376						$	1,848,964

Net interest income				$	14,659						$	14,705
Net interest rate spread (3)						3.04	%						3.23	%
Net interest-earning assets (4)	$	251,347						$	246,323
Net interest margin (5)						3.12	%						3.30	%
Interest-earning assets to interest-bearing liabilities		115.46	%						116.05	%

(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.

Table of Contents


	For the Nine Months Ended September 30,
	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)	$	1,336,843		$	39,079	3.90	%	$	1,189,741		$	36,240	4.06	%
Multi-family residential		9,432			333	4.71			9,721			342	4.69
Construction, commercial and other		22,666			772	4.54			23,306			795	4.55
Home equity loans and lines of credit		14,219			499	4.68			15,580			504	4.31
Other loans		4,968			194	5.21			4,424			179	5.39
Total loans		1,388,128			40,877	3.93			1,242,772			38,060	4.08
Investment securities:
U.S. government sponsored mortgage-backed securities (2)		400,323			9,328	3.11			466,516			11,121	3.18
Trust preferred securities		967			—	—			943			—	—
Total securities		401,290			9,328	3.10			467,459			11,121	3.17
Other		58,094			530	1.22			67,627			411	0.81
Total interest-earning assets		1,847,512			50,735	3.66			1,777,858			49,592	3.72
Non-interest-earning assets		69,385							68,463
Total assets	$	1,916,897						$	1,846,321

Interest-bearing liabilities:
Savings accounts	$	1,031,650			3,261	0.42	%	$	1,015,992			3,107	0.41	%
Certificates of deposit		257,074			2,153	1.12			225,221			1,222	0.72
Money market accounts		4,936			16	0.43			2,204			6	0.36
Checking and Super NOW accounts		180,134			29	0.02			170,449			28	0.02
Total interest-bearing deposits		1,473,794			5,459	0.49			1,413,866			4,363	0.41
Federal Home Loan Bank advances		69,900			779	1.49			69,011			772	1.49
Securities sold under agreements to repurchase		55,000			654	1.59			55,000			656	1.59
Total interest-bearing liabilities		1,598,694			6,892	0.57			1,537,877			5,791	0.50
Non-interest-bearing liabilities		82,926							82,714
Total liabilities		1,681,620							1,620,591
Stockholders’ equity		235,277							225,730
Total liabilities and stockholders’ equity	$	1,916,897						$	1,846,321

Net interest income				$	43,843						$	43,801
Net interest rate spread (3)						3.09	%						3.22	%
Net interest-earning assets (4)	$	248,818						$	239,981
Net interest margin (5)						3.16	%						3.28	%
Interest-earning assets to interest-bearing liabilities		115.56	%						115.60	%

(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.

Table of Contents

Comparison of Operating Results for the Three Months Ended September 30, 2017 and 2016

General. Net income increased by $9,000, or 0.2%, to $4.2 million for the three months ended September 30, 2017. The increase in net income was due to a $212,000 decrease in income taxes and a $53,000 decrease in loan loss provisions. These were partially offset by a $116,000 increase in noninterest expense, a $94,000 decrease in noninterest income and a $46,000 decrease in net interest income.

Net Interest Income. Net interest income decreased by $46,000, or 0.3%, to $14.7 million for the three months ended September 30, 2017. Interest income increased by $508,000, or 3.0%, due to a $96.3 million increase in the average balance of interest-earning assets. This was offset by an eight basis point decrease in the yield of average interest-earning assets. Interest expense increased by $554,000, or 28.2%, due to a $91.3 million increase in the average balance of interest-bearing liabilities and an 11 basis point increase in the cost of average interest-bearing liabilities. The interest rate spread and net interest margin were 3.04% and 3.12%, respectively, for the three months ended September 30, 2017, compared to 3.23% and 3.30% respectively, for the three months ended September 30, 2016. The decreases in the interest rate spread and in the net interest margin are attributed to an eight basis point decrease in the yield of average interest-earning assets and an 11 basis point increase in the cost of average interest-bearing liabilities. The decrease in the yield on average interest-earning assets was primarily due to the principal repayments on higher-yielding mortgage loans and securities and the addition of new mortgage loans and securities with lower rates. The increase in the cost of average interest-bearing liabilities was primarily due to a 46 basis point increase in the cost of certificates of deposit, primarily public deposits, as new certificates of deposit with higher interest rates were opened.

Interest Income. Interest income increased by $508,000, or 3.0%, to $17.2 million for the three months ended September 30, 2017 from $16.7 million for the three months ended September 30, 2016. Interest income on loans increased by $785,000, or 6.0%, to $13.8 million for the three months ended September 30, 2017 from $13.1 million for the three months ended September 30, 2016. The increase in interest income on loans occurred primarily because the average balance of loans grew by $141.1 million, or 11.0%, 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 a 19 basis point decline in the average loan yield to 3.89% for the three months ended September 30, 2017 from 4.08% for the three months ended September 30, 2016. 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 $327,000, or 9.4%, to $3.2 million for the three months ended September 30, 2017 from $3.5 million for the three months ended September 30, 2016. The decrease in interest income on securities occurred because of a $37.2 million decrease in the average securities balance and a four basis point decrease in the average securities yield. The decline in the average balance and yield on securities occurred because repayments exceeded the amount of securities purchased and new securities added to the portfolio had lower yields.

Interest Expense. Interest expense increased by $554,000, or 28.2%, to $2.5 million for the three months ended September 30, 2017. Interest expense on deposits increased by $548,000, or 36.9%, from $1.5 million for the three months ended September 30, 2016 to $2.0 million for the three months ended September 30, 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 $90.1 million, or 6.4%, to $1.500 billion for the three months ended September 30, 2017 compared to $1.410 billion for the three months ended September 30, 2016. The growth in deposits is primarily due to a $65.0 million increase in the average balance of certificates of deposit and a $25.1 million increase in the average balance of savings, money market and checking accounts. The average rate paid on deposits increased by 12 basis points from 0.42% for the three months ended September 30, 2016 to 0.54% for the three months ended September 30, 2017, primarily due to a 46 basis point increase in certificate of deposit rates. The increase in the average rate paid on certificates of deposit is primarily due to higher interest rates paid on newly opened public deposits. Because our public deposits carry higher rates than retail deposits, any increase in current interest rates or in the balance of public deposits may continue to increase our interest expense.

Provision for Loan Losses. We recorded provisions for loan losses of $54,000 and $107,000 for the three months ended September 30, 2017 and September 30, 2016, respectively. The provisions for loan losses included net charge-offs of $12,000 and $21,000 for the three months ended September 30, 2017 and 2016, respectively. The decrease in loan loss provisions in the three months ended September 30, 2017 occurred as a result of improving credit quality of the

Table of Contents

loan portfolio and a reduction in loan losses. The provisions recorded resulted in ratios of the allowance for loan losses to total loans of 0.17% and 0.18% at September 30, 2017 and 2016, respectively. Nonaccrual loans totaled $3.3 million at September 30, 2017, or 0.23% of total loans at that date, compared to $4.8 million of nonaccrual loans at September 30, 2016, or 0.37% of total loans at that date. Nonaccrual loans as of September 30, 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 September 30, 2017 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 September 30, 2017 and 2016.


	Three Months Ended
	September 30,				Change
	2017		2016		$ Change		% Change
				(Dollars in thousands)
Service fees on loan and deposit accounts	$	427	$	493	$	(66)	(13.4)	%
Income on bank-owned life insurance		228		240		(12)	(5.0)	%
Gain on sale of investment securities		150		60		90	150.0	%
Gain on sale of loans		28		114		(86)	(75.4)	%
Other		76		96		(20)	(20.8)	%
Total	$	909	$	1,003	$	(94)	(9.4)	%

Noninterest income decreased by $94,000 for the three months ended September 30, 2017 compared to the three months ended September 30, 2016. During the three months ended September 30, 2017 and 2016, $3.7 million and $14.5 million, respectively, of mortgage loans held for sale were sold and gains of $28,000 and $114,000, respectively, were recognized. The decrease in service fees on loan and deposit accounts was primarily due to a decrease in fee income from brokering loans to other financial institutions. The decrease in other income was primarily due to a decrease in commissions earned on annuity and mutual fund sales. These decreases were partially offset by an increase in the gain on sale of investment securities. During the three months ended September 30, 2017 and 2016, we received proceeds of $2.4 million and $801,000, respectively, from the sale of $2.2 million and $741,000, respectively, of held-to maturity mortgage-backed securities, resulting in gross realized gains of $150,000 and $60,000, respectively. The sale of these mortgage-backed securities, for which we had already collected a substantial portion of the original purchased principal (at least 85%), was 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.

Noninterest Expense. The following table summarizes changes in noninterest expense between the three months ended September 30, 2017 and 2016.


	Three Months Ended
	September 30,					Change
	2017		2016		$ Change		% Change
				(Dollars in thousands)
Salaries and employee benefits	$	5,201	$	5,265	$	(64)	(1.2)	%
Occupancy		1,529		1,432		97	6.8	%
Equipment		882		865		17	2.0	%
Federal deposit insurance premiums		152		144		8	5.6	%
Other general and administrative expenses		997		939		58	6.2	%
Total	$	8,761	$	8,645	$	116	1.3	%

Noninterest expense increased by $116,000 for the three months ended September 30, 2017 compared to the three months ended September 30, 2016. Occupancy expense increased by $97,000 to $1.5 million for the three months ended September 20, 2017 from $1.4 million for the three months ended September 30, 2016 primarily due to an increase in repairs and maintenance and rent expense. The increase in other general and administrative expenses was mainly due to increases in marketing and other miscellaneous expenses. These increases were partially offset by a decrease in salaries

Table of Contents

and employee benefits expense. Salaries and employee benefits expense decreased primarily due to a decrease in share-based compensation. 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. The decrease in share-based compensation expense was partially offset by an annual salary increase and a decrease in the capitalized cost of new loan originations. The decrease in the capitalized cost of new loan originations in 2017 occurred as we closed fewer loans during the three months ended September 30, 2017 compared to the three months ended September 30, 2016.

Income Tax Expense. Income taxes were $2.6 million for the three months ended September 30, 2017, reflecting an effective tax rate of 38.2%, compared to $2.8 million for the three months ended September 30, 2016, reflecting an effective tax rate of 40.1%.

Income tax expense for the three months ending September 30, 2017 included a $150,000 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.

Comparison of Operating Results for the Nine Months Ended September 30, 2017 and 2016

General. Net income increased by $810,000, or 6.8%, from $12.0 million for the nine months ended September 30, 2016 to $12.8 million for the nine months ended September 30, 2017. The increase in net income was due to a $470,000 decrease in noninterest expense, a $217,000 decrease in loan loss provisions, a $114,000 decrease in income taxes and a $42,000 increase in net interest income. These were partially offset by a $33,000 decrease in noninterest income.

Net Interest Income. Net interest income increased by $42,000, or 0.1%, to $43.8 million for the nine months ended September 30, 2017. Interest income increased by $1.1 million, or 2.3%, due to a $69.7 million increase in the average balance of interest-earning assets. This was offset by a six basis point decrease in the yield of average interest-earning assets. Interest expense increased by $1.1 million, or 19.0%, due to a $60.8 million increase in the average balance of interest-bearing liabilities and a seven basis point increase in the cost of average interest-bearing liabilities. The interest rate spread and net interest margin were 3.09% and 3.16% respectively, for the nine months ended September 30, 2017, compared to 3.22% and 3.28% respectively, for the nine months ended September 30, 2016. The decreases in the interest rate spread and in the net interest margin are attributed to a six basis point decrease in the yield of average interest-earning assets and a seven 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 principal repayments on higher-yielding mortgage loans and securities and the addition of new mortgage loans and securities with lower rates. The increase in the cost of average interest-bearing liabilities was primarily due to a 40 basis point increase in the cost of certificates of deposit, primarily public deposits, as new certificates of deposit with higher interest rates were opened.

Interest Income. Interest income increased by $1.1 million, or 2.3%, to $50.7 million for the nine months ended September 30, 2017 from $49.6 million for the nine months ended September 30, 2016. Interest income on loans increased by $2.8 million, or 7.4%, to $40.9 million for the nine months ended September 30, 2017 from $38.1 million for the nine months ended September 30, 2016. The increase in interest income on loans occurred primarily because the average balance of loans grew by $145.4 million, or 11.7%, 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 a 15 basis point decline in the average loan yield to 3.93% for the nine months ended September 30, 2017 from 4.08% for the nine months ended September 30, 2016. 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 $1.8 million, or 16.1%, to $9.3 million for the nine months ended September 30, 2017 from $11.1 million for the nine months ended September 30, 2016. The decrease in interest income on securities occurred because of a $66.2 million decrease in the average securities balance and a seven basis point decrease in the average

Table of Contents

securities yield. The decline in the average balance and yield on securities occurred because repayments exceeded the amount of securities purchased and new securities added to the portfolio had lower yields.

Interest Expense. Interest expense increased by $1.1 million, or 19.0%, to $6.9 million for the nine months ended September 30, 2017. Interest expense on deposits increased by $1.1 million, or 25.1%, from $4.4 million for the nine months ended September 30, 2016 to $5.5 million for the nine months ended September 30, 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 $59.9 million, or 4.2%, to $1.474 billion for the nine months ended September 30, 2017 compared to $1.414 billion for the nine months ended September 30, 2016. The growth in deposits is primarily due to a $31.9 million increase in the average balance of certificates of deposit and a $28.1 million increase in the average balance of savings, money market and checking accounts. The average rate paid on deposits increased by eight basis points from 0.41% for the nine months ended September 30, 2016 to 0.49% for the nine months ended September 30, 2017, primarily due to a 40 basis point increase in certificate of deposit rates. The increase in the average rate paid on certificates of deposit is primarily due to higher interest rates paid on public deposits. Because our public deposits carry higher rates than retail deposits, any increase in current interest rates or in the balance of public deposits may continue to increase our interest expense.

Provision for Loan Losses. We recorded provisions for loan losses of $2,000 and $219,000 for the nine months ended September 30, 2017 and 2016, respectively. The provision for loan losses included net recoveries of $45,000 for the nine months ended September 30, 2017 and net charge-offs of $23,000 for the nine months ended September 30, 2016. The decrease in loan loss provisions in the nine months ended September 30, 2017 occurred as a result of improving credit quality of the loan portfolio and a reduction in loan losses. The provisions recorded resulted in ratios of the allowance for loan losses to total loans of 0.17% and 0.18% at September 30, 2017 and 2016, respectively. Nonaccrual loans totaled $3.3 million at September 30, 2017, or 0.23% of total loans at that date, compared to $4.8 million of nonaccrual loans at September 30, 2016, or 0.37% of total loans at that date. Nonaccrual loans as of September 30, 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 September 30, 2017 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 nine months ended September 30, 2017 and 2016.


	Nine Months Ended
	September 30,				Change
	2017		2016		$ Change		% Change
				(Dollars in thousands)
Service fees on loan and deposit accounts	$	1,490	$	1,422	$	68	4.8	%
Income on bank-owned life insurance		681		727		(46)	(6.3)	%
Gain on sale of investment securities		431		250		181	72.4	%
Gain on sale of loans		154		304		(150)	(49.3)	%
Other		234		320		(86)	(26.9)	%
Total	$	2,990	$	3,023	$	(33)	(1.1)	%

Noninterest income decreased by $33,000 for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016. During the nine months ended September 30, 2017 and 2016, the Company sold $20.3 million and $38.6 million, respectively, of mortgage loans held for sale and recognized gains of $154,000 and $304,000, respectively. Other income decreased by $86,000 primarily due to a decrease in commissions earned on annuity and mututal fund sales. These decreases were partially offset by increases in the gain on sale of investment securities and in service fees on loan and deposit accounts. During the nine months ended September 30, 2017 and 2016, we received proceeds of $7.4 million and $3.9 million, respectively, from the sale of $7.0 million and $3.7 million, respectively, of held-to-maturity mortgage-backed securities, resulting in gross realized gains of $431,000 and $250,000, respectively. The sale of these mortgage-backed securities, for which we had already collected a substantial portion of

Table of Contents

the original purchased principal (at least 85%), was 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. During the nine months ended September 30, 2017, service fees on loan and deposit accounts increased by $68,000, primarily due to incentives received on a new debit card agreement and a decrease in the amortization of premiums on loans sold. These were partially offset by decreases in return item fees and ATM fees.

Noninterest Expense. The following table summarizes changes in noninterest expense between the nine months ended September 30, 2017 and 2016.


	Nine Months Ended
	September 30,				Change
	2017		2016		$ Change		% Change
				(Dollars in thousands)
Salaries and employee benefits	$	15,254	$	15,947	$	(693)	(4.3)	%
Occupancy		4,439		4,285		154	3.6	%
Equipment		2,630		2,683		(53)	(2.0)	%
Federal deposit insurance premiums		448		596		(148)	(24.8)	%
Other general and administrative expenses		3,451		3,181		270	8.5	%
Total	$	26,222	$	26,692	$	(470)	(1.8)	%

Noninterest expense decreased by $470,000 for the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016. Salaries and employee benefits expense decreased by $693,000 primarily due to a decrease in share-based compensation. 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. The decrease in share-based compensation expense was partially offset by an annual salary increase, an increase in ESOP plan expenses that occurred because of the Company’s higher stock price and a decrease in the capitalized cost of new loan originations. The decrease in the capitalized cost of new loan originations in 2017 occurred as we closed fewer loans during the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016. Federal deposit insurance premiums declined because of a decrease in the insurance premium rate on deposits. These decreases were partially offset by increases in other general and administrative and occupancy expenses. The increase in other general and administrative expenses was mainly due to increases in marketing, audit, and other miscellaneous expenses. The increase in occupancy expense was due to an increase in rent expense and repairs and maintenance expenses.

Income Tax Expense. Income taxes were $7.8 million for the nine months ended September 30, 2017, reflecting an effective tax rate of 37.9%, compared to $7.9 million for the nine months ended September 30, 2016, reflecting an effective tax rate of 39.8%.

Income tax expense for the nine months ended September 30, 2017 included a $541,000 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

Table of Contents

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 September 30, 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 September 30, 2017, our cash and cash equivalents totaled $38.4 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 $604.3 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 September 30, 2017, we had $30.8 million in loan commitments outstanding, most of which were for fixed-rate loans, and had $26.6 million in unused lines of credit to borrowers. Certificates of deposit due within one year at September 30, 2017 totaled $149.8 million, or 9.5% of total deposits. If these deposits do not remain with us, we may be required 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 September 30, 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 nine months ended September 30, 2017 and 2016 we originated $242.7 million and $280.7 million of loans, respectively and purchased $54.9 million and $2.4 million of securities, respectively.

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 $78.2 million and $19.4 million for the nine months ended September 30, 2017 and 2016, respectively. 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 at September 30, 2017 and 2016. We had the ability to borrow up to an additional $604.3 million and $577.9 million from the Federal Home Loan Bank as of September 30, 2017 and December 31, 2016, respectively. We also utilize securities

Table of Contents

sold under agreements to repurchase as another borrowing source. Securities sold under agreements to repurchase remained constant at $55.0 million at the nine months ended September 30, 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 September 30, 2017, Territorial Bancorp Inc. (on an unconsolidated, stand-alone basis) had liquid assets of $24.4 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. 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 September 30, 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 September 30, 2017 and December 31, 2016:

Table of Contents


(Dollars in thousands)	Required Ratio			Actual Amount	Actual Ratio
September 30, 2017:
Tier 1 Leverage Capital
Territorial Savings Bank	5.00	%	$	216,506	11.14	%
Territorial Bancorp Inc.	5.00	%	$	242,609	12.48	%
Common Equity Tier 1 Risk-Based Capital (1)
Territorial Savings Bank	9.00	%	$	216,506	23.74	%
Territorial Bancorp Inc.	9.00	%	$	242,609	26.58	%
Tier 1 Risk-Based Capital (1)
Territorial Savings Bank	10.50	%	$	216,506	23.74	%
Territorial Bancorp Inc.	10.50	%	$	242,609	26.58	%
Total Risk-Based Capital (1)
Territorial Savings Bank	12.50	%	$	219,090	24.02	%
Territorial Bancorp Inc.	12.50	%	$	245,193	26.86	%

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

(1)

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.

(2)

On July 10, 2014, Territorial Savings Bank became a member of the Federal Reserve System. As a condition of membership, Territorial Savings Bank was required to maintain a Tier 1 Leverage Capital ratio of 9.00% for three years.

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 $63.0 million in certificates of deposit and a decrease of $19.7 million in loan commitments between December 31, 2016 and September 30, 2017, there have not been any material changes in contractual obligations and funding needs since December 31, 2016.

Table of Contents

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 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. We sold $20.3 million and $38.6 million of fixed-rate mortgage loans for the nine months ended September 30, 2017 and 2016, respectively, to reduce our interest rate risk.

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.

Table of Contents

The following table presents our internal calculations of the estimated changes in our EVE as of June 30, 2017 (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	$	178,580	$	(70,231)	(28.23)	%	11.47	%	(1.56)	%
+300	$	202,267	$	(46,544)	(18.71)	%	12.32	%	(0.71)	%
+200	$	226,226	$	(22,585)	(9.08)	%	13.05	%	0.02	%
+100	$	245,573	$	(3,238)	(1.30)	%	13.45	%	0.42	%
0	$	248,811	$	—	—	%	13.03	%	—	%
-100	$	219,529	$	(29,282)	(11.77)	%	11.16	%	(1.87)	%

(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 have declined by eight basis points between June 30, 2017 and September 30, 2017. The decrease in interest rates has not likely had a material effect on estimated EVE.

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 September 30, 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.

The Company has determined that the new amendment on revenue recognition will not have a significant impact on key in-scope revenue sources. The Company will be adopting new controls and procedures, which would identify any changes in volume or new sources of in-scope revenue.

Table of Contents

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 September 30, 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)
July 1, 2017 through July 31, 2017	—	$	—	—	217,300
August 1, 2017 through August 31, 2017	21,289		30.13	—	217,300
September 1, 2017 through September 30, 2017	10,737		31.57	—	217,300

Total	32,026	$	30.61	—	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.

Table of Contents

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 September 30, 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

Table of Contents

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: November 8, 2017	/s/ Allan S. Kitagawa
	Allan S. Kitagawa
	Chairman of the Board, President and
	Chief Executive Officer


Date: November 8, 2017	/s/ Melvin M. Miyamoto
	Melvin M. Miyamoto
	Senior Vice President and Chief Financial Officer

Attached files

Stock widget

Investing forum

Territorial Bancorp Inc. Reports