10-K 1 bkgmf-10k_20181231.htm 10-K bkgmf-10k_20181231.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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

For the fiscal year ended December 31, 2018

OR

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

For the transition period from                      to                      .

Commission file number: 000-54483

 

BankGuam Holding Company

(Exact name of registrant as specified in its charter)

 

 

Guam

 

66-0770448

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

111 W Chalan Santo Papa

Hagåtña, Guam 96910

(671) 472-5300

(Address, including Zip Code, and telephone number, including area code, of the registrant’s principal executive offices)

 

Securities registered pursuant to Section 12(g) of the Act:

 

Title of Each Class

 

Name of Each Exchange on which Registered

Common Stock, $0.2083 par value

 

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes      No      

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes      No      

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 every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registration was required to submit such files).    Yes      No      

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K.  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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

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 Act).    Yes      No  

The aggregate market value of the voting stock held by non-affiliates of the Registrant was $54,604,681 based on the number of shares held by non-affiliates of the registrant as of June 30, 2018, and based on the closing sale price of common stock on June 29, 2018, which is the last business day of the registrant’s most recently completed second fiscal quarter. This calculation does not reflect a determination that persons are affiliates for any other purposes.

Number of shares of common stock outstanding as of March 15, 2019: 9,647,819.

 

 

 

 

 

 

 


 

BANKGUAM HOLDING COMPANY

FORM 10-K

TABLE OF CONTENTS

 

 

 

 

 

 

 

Page

 

 

 

 

 

PART I.

 

 

 

6

 

 

 

 

 

 

 

Item 1.

 

Business

 

 

 

6

 

 

 

 

 

 

 

Item 1A.

 

Risk Factors

 

 

 

14

 

 

 

 

 

 

 

Item 1B.

 

Unresolved Staff Comments

 

 

 

24

 

 

 

 

 

 

 

Item 2.

 

Properties

 

 

 

24

 

 

 

 

 

 

 

Item 3.

 

Legal Proceedings

 

 

 

24

 

 

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

 

 

24

 

 

 

 

 

PART II.

 

 

 

25

 

 

 

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

 

 

25

 

 

 

 

 

 

 

Item 6.

 

Selected Financial Data

 

 

 

27

 

 

 

 

 

 

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

28

 

 

 

 

 

 

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

50

 

 

 

 

 

 

 

Item 8.

 

Financial Statements and Supplementary Data

 

 

 

50

 

 

 

 

 

 

 

Item 9.

 

Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

 

 

 

51

 

 

 

 

 

 

 

Item 9A.

 

Controls and Procedures

 

 

 

51

 

 

 

 

 

 

 

Item 9B.

 

Other Information

 

 

 

52

 

 

 

 

 

PART III.

 

 

 

53

 

 

 

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

 

 

53

 

 

 

 

 

 

 

Item 11.

 

Executive Compensation

 

 

 

53

 

 

 

 

 

 

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

 

 

53

 

 

 

 

 

 

 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

 

 

53

 

 

 

 

 

 

 

Item 14.

 

Principal Accountant Fees and Services

 

 

 

53

 

 

 

 

 

PART IV.

 

 

 

54

 

 

 

 

 

 

 

Item 15.

 

Exhibits and Financial Statement Schedules

 

 

 

54

 

 

 

 

 

 

 

2


 

 

 

 

 

Incorporated by Reference

Exhibit No.

Exhibit Description

 

Form

Exhibit

Filing Date

Filed Herewith

 

 

 

 

 

 

 

2.01

Agreement and Plan of Reorganization and Merger dated October 29, 2010 between BankGuam Holding Company and Bank of Guam

 

8-K (File No. 000-54483)

2.01

August 16, 2011

 

3.01

Second Amended and Restated Articles of Incorporation of BankGuam Holding Company (including Certificate of Designation of 5.50% Fixed Rate/Floating Rate Noncumulative Preferred Stock, Series A, of BankGuam Holding Company)

 

8-K (File No. 000-54483)

3.1

August 26, 2016

 

3.02

First Amended By-Laws of BankGuam Holding Company

 

10-Q (File No. 000-54483)

3.03

November 13, 2012

 

9.01

Voting Trust Agreement dated November 29, 2013 between certain shareholders of BankGuam Holding Company and Lourdes A. Leon Guerrero, as Trustee

 

10-K (File No. 000-54483)

9.02

March 17, 2014

 

10.01

Stock Purchase Agreement dated May 27, 2016 between David J. John and BankGuam Holding Company

 

8-K (File No. 000-54483)

10.01

January 17, 2017

 

10.02*

Employment Agreement dated January 11, 2017 between Bank of Guam and Francisco M. Atalig

 

8-K (File No. 000-54483)

10.07

January 17, 2017

 

10.03*

Exhibits A and B to the Employment Agreement dated January 11, 2017 between Bank of Guam and Francisco M. Atalig

 

8-K/A (File No. 000-54483)

10.07

January 20, 2017

 

10.04*

Employment Agreement dated May 1, 2013 between Bank of Guam and Lourdes A. Leon Guerrero

 

10-K (File No. 000-54483)

10.01

March 17, 2014

 

10.05*

Agreement to Extend Employment Agreement dated December 29, 2017 between Lourdes A. Leon Guerrero and Bank of Guam

 

8-K (File No. 000-54483)

10.1

January 4, 2018

 

10.06*

Second Agreement to Extend Employment Agreement dated March 26, 2018 between Lourdes A. Leon Guerrero and Bank of Guam

 

10-K (File No. 000-54483)

10.06

June 29, 2018

 

10.07*

Employment Agreement dated June 27, 2013 between Bank of Guam and William D. Leon Guerrero

 

10-K (File No. 000-54483)

10.02

March 17, 2014

 

10.08*

Agreement to Extend Employment Agreement dated May 29, 2018 between William D. Leon Guerrero and Bank of Guam

 

10-K (File No. 000-54483)

10.08

June 29, 2018

 

10.09*

BankGuam Holding Company 2011 Amended and Restated Employee Stock Purchase Plan

 

S-8 (File No. 333-182615)

99.1

July 11, 2012

 

10.10*

BankGuam Holding Company Stock Service Award Plan

 

S-8 (File No. 333-196854)

99.1

June 18, 2014

 

10.11

Form of Private Placement Subscription Agreement

 

8-K (File No. 000-54483)

10.1

September 21, 2016

 

3


 

21.01

List of Significant Subsidiaries of the Company

 

S-1 (File No. 333-220357)

21.01

September 6, 2017

 

23.01

Consent of Independent Registered Public Accounting Firm

 

 

 

 

X

31.01

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act – Joaquin P.L.G. Cook

 

 

 

 

 

X

31.02

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act – Francisco M. Atalig

 

 

 

 

 

X

32.01

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act

 

 

 

 

X

 

 

 

 

 

 

 

101

Interactive Data Files Pursuant to Rule 405 of Regulation S-T: (i) Consolidated Statements of Financial Condition as of December 31, 2018 and 2017, (ii) Consolidated Statements of Income for the years ended December 31, 2018, 2017 and 2016, (iii) Consolidated Statements of Comprehensive Income for the years ended  December 31, 2018, 2017 and 2016; (iv) Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2018, 2017 and 2016; (v) Consolidated Statements of Cash Flows for the years ended  December 31, 2018, 2017 and 2016 ; and (vi) Notes to Consolidated Financial Statements

 

 

 

 

X

 

 

 

 

 

 

 

* Management contract or compensatory plan or arrangement.

 

 

Signatures

 

 

 

55

 

 

4


 

Cautionary Note Regarding Forward-Looking Statements

For purposes of this Annual Report, the terms the “Company,” “we,” “us” and “our” refer to BankGuam Holding Company and its subsidiaries. This Annual Report on Form 10-K contains statements that are not historical in nature, are predictive in nature, or that depend upon or refer to future events or conditions or contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. These include, among other things, statements regarding:

 

Competition for loans and deposits and failure to attract or retain deposits and loans;

 

Local, regional, national and global economic conditions and events, and the impact they may have on us and our customers, and our assessment of that impact on our estimates, including the allowance for loan losses and fair value measurements;

 

Risks associated with concentrations in real estate related loans;

 

Changes in the level of nonperforming assets and charge-offs and other credit quality measures, and their impact on the adequacy of our allowance for loan losses and our provision for loan losses;

 

The effects of and changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Federal Open Market Committee of the Federal Reserve Board;

 

Stability of funding sources and continued availability of borrowings;

 

The effect of changes in laws and regulations with which the Company and Bank of Guam must comply, including any change in Federal Deposit Insurance Corporation insurance premiums;

 

Our ability to raise capital or incur debt on reasonable terms;

 

Regulatory limits on Bank of Guam’s ability to pay dividends to the Company;

 

The impact of the Dodd Frank Wall Street Reform and Consumer Protection Act and the implementation of its associated rules and regulations;

 

The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;

 

Changes in the deferred tax asset valuation allowance in future quarters;

 

The costs and effects of legal and regulatory developments, including resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations or reviews;

 

The ability to increase market share and control expenses; and,

 

Our success in managing the risks involved in the foregoing items,

as well as other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements may be preceded by, followed by or include the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “will,” “is designed to” and similar expressions. We claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for all forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are subject to risks, uncertainties and assumptions about our business that could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in the forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in “Risk Factors” included elsewhere in this Annual Report and as may be updated in filings we make from time to time with the U.S. Securities and Exchange Commission (“SEC”), including our Quarterly Reports on Form 10-Q to be filed by us in our fiscal year ending December 31, 2019. We have no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or risks, except to the extent required by applicable securities laws. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements. New information, future events or risks could cause the forward-looking events we discuss in this Annual Report not to occur. You should not place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this Annual Report.

 

 

 

5


 

PART I

ITEM 1.

Business

General

BankGuam Holding Company (the “Company”), a Guam corporation organized in 2011, is a bank holding company registered under the Bank Holding Company Act of 1956, as amended. The Company provides a wide range of banking services through Bank of Guam, our wholly-owned subsidiary and principal asset (the “Bank”). Unless the context indicates otherwise, references to the “Company” include the Company’s subsidiaries, including the Bank. The Company, the Bank and their subsidiaries are sometimes referred to hereinafter as “we,” “our” or “us”.

The Bank is a regional community bank that was organized in Guam, a United States flag territory, in 1972. The Bank provides a variety of financial services to individuals, businesses and government entities through its branch network. The Bank’s primary deposit products are demand deposits, savings and time certificates of deposit, and its primary lending products are consumer, commercial and real estate loans. We attract deposits throughout our market area with a customer-oriented product mix, competitive pricing and convenient locations. We lend in all markets where we have a physical presence through our branch network. The Bank also provides many other financial services to its customers, including trade financing and trust services.

In addition to the traditional financial services offered, the Bank offers credit life, health, auto and homeowners insurance through its subsidiary, BG Insurance, as agents for various insurance companies, and also offered retail wealth management services in collaboration with its former affiliate, Money Concepts, through the end of May 2016. In August 2015, the Company chartered a second subsidiary, BankGuam Investment Services (“BGIS”) (formerly BankGuam Investment and Insurance Services), in an effort to enhance the options and opportunities of our customers to build future income and wealth. BGIS was capitalized in the amount of $300 thousand during the first quarter of 2016, and was in full operation by the end of May 2016.

In May 2016, the Company entered into a Stock Purchase Agreement to acquire 25% of ASC Trust Corporation, a Guam trust company. In July 2016, subsequent to the approval of the Federal Reserve Bank of San Francisco in June 2016, the purchase was executed. The Company borrowed $3.5 million in the form of subordinated debt in connection with the purchase to finance the transaction. The Agreement provides for the acquisition of an additional 20% of the stock of ASC Trust Corporation in April 2019, which has been revised to July 2019, and another 25% in April 2021, with both future purchases subject to regulatory approval. The Stock Purchase Agreement contains customary warranties, representations and indemnification provisions.

Other than holding the shares of the Bank, BGIS and ASC Trust Corporation, the Company conducts no significant activities, although it is authorized, with the prior approval of its principal regulator, the Board of Governors of the Federal Reserve System, to engage in a variety of activities related to the business of banking. Currently, substantially all of the Company’s operations are conducted and substantially all of its assets are owned by the Bank, which accounts for substantially all of its consolidated revenues, expenses and operating income. BGIS is a registered investment company, primarily involved in providing investment advisory services and trading securities for its customers. ASC Trust Corporation is primarily involved in administering 401(k) retirement plans and other employee benefit programs for its customers.

Bank of Guam

The Bank is a Guam-chartered bank headquartered at 111 West Chalan Santo Papa in Hagåtña, Guam 96910. It was incorporated in March 1972 and opened for business in December of that year. We operate through 22 full service branch offices, including 11 in Guam; two in Saipan and one each in Tinian and Rota, all in the Commonwealth of the Northern Mariana Islands; one in the Republic of Palau; one each in the states of Yap, Chuuk, Pohnpei and Kosrae in the Federated States of Micronesia; one in the Republic of the Marshall Islands; and one in San Francisco, California.

The Bank’s business strategy has been to emphasize and support economic growth and development in and among the U.S.-affiliated islands in the western Pacific Ocean. To accomplish this goal, the Bank offers competitively-priced deposit and loan products and other financial services that are primarily tailored to the needs of consumers, small businesses and government entities. Although the needs of our customers in a small, remote island environment can be particularly challenging for a community bank, we have succeeded in providing a broad range of services, such as trade financing and corporate trust services, that are typically provided only by much larger, money center institutions.

Our lending products include commercial, real estate, construction, consumer and Small Business Administration-guaranteed loans. We also provide home mortgage and home equity loans. Commercial loans and industrial loans comprise the largest portion of the Bank’s loan portfolio. Residential mortgage loans comprise the second largest portion of the Bank’s loan portfolio.

6


 

We offer a wide range of deposit products for retail and business banking markets including checking accounts, interest-bearing transaction accounts, savings accounts, time deposits and retirement accounts. Our branch network enables us to attract deposits from throughout our market area with a customer-oriented product mix, competitive pricing and convenient locations.

In addition, correspondent bank deposit accounts are maintained to enable the Bank to transact types of activity that it would otherwise be unable to perform or would not be cost effective due to the size of the Bank or the volume of activity. The Bank has utilized several correspondent banks to process a variety of transactions. The Bank also provides a multitude of other products and services to complement our lending and depository services. These include wire and Automated Clearing House transfers, cashier’s checks, traveler’s checks, corporate and consumer credit cards, bank-by-mail, ATMs, night depositories, safe deposit boxes, direct deposit, electronic funds transfers, online banking and bill payments, merchant services, check imaging, and other customary banking services. We currently operate ATMs in eighty-five locations.

The Bank has a trust department, primarily engaged in corporate trust services under indenture.

Competition

Banking and the financial services industry in Guam are highly competitive. The market is dominated by the Bank, two of Hawaii’s largest banks and two locally-organized federal credit unions. Also, as a result of the U.S. military presence as a longtime employer, military credit unions have physical branches at the island’s main military facilities and in the civilian community. The Bank’s presence in the remaining areas of the western Pacific is less competitive, and in many cases the Bank remains the dominant financial services organization in the islands. In the San Francisco Bay area, where the Bank has had a branch office since 1983, the Bank’s California division primarily focuses its lending efforts on owner-occupied commercial real estate and commercial investor properties. The division provides financing to hotels, gasoline service stations, apartments, office and retail space, and residential care homes for the elderly and disabled, and also works closely with selected banks in loan participations. Framing this environment is the increasingly competitive setting as a result of regulatory, technological and product delivery systems changes.

Larger banks have a competitive advantage because of global marketing campaigns and U.S. name recognition. They also offer extensive international trade finance and discount brokerage services that the Bank is not currently prepared to provide. To compensate for this, the Bank has arrangements with correspondent banks and other financial institutions to deliver such services to its customers.

To compete with other financial institutions in its service area, the Bank relies principally on local media as well as personal contact by directors, officers and employees with existing and potential customers. The Bank emphasizes to customers the advantages of dealing with a locally-owned and managed community-oriented institution. Because decisions are made locally by people who are intimately familiar with the economy, the legal structure and the developmental needs of the islands, the Bank is able to respond quickly and effectively to its customers’ needs. The Bank also provides local service and timely decision-making for small businesses and local governments.

The financial services industry continues to undergo rapid technological changes involving the frequent introductions of new technology-driven products and services that have further increased competition. The Bank often adopts these new technologies and products ahead of its competitors, but there is no assurance that these technological improvements, if made, will increase the Company’s operational efficiency, or that the Company will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.

Employees

At December 31, 2018, the Bank had 623.5 full-time equivalent employees (FTEs), an increase from 617.5 FTEs a year earlier. The Bank’s employees are not represented by any union or collective bargaining agreement, and the Bank believes its employee relations are good.

Supervision and Regulation

Recent Developments

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) of 2010 significantly changed the U.S. bank regulatory structure and affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act required various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies were given significant discretion in drafting the implementing rules and regulations. Although many of the final rules and regulations called for by the Dodd-Frank Act have been adopted, the implementation of some of those rules and regulations is in its early stages, and rulemaking has not yet become

7


 

final for certain Dodd-Frank Act provisions. On May 24, 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “EGRRCPA”) amended provisions in the Dodd-Frank Act as well as certain other statutes administered by the federal bank agencies. We continue to monitor and implement rules and regulations of the Dodd-Frank Act and the EGRRCPA as they are adopted and modified, and to evaluate their application to our business.

Among other things, the Dodd-Frank Act requires the federal banking agencies to establish minimum leverage and risk-based capital requirements for insured banks and their holding companies. The federal banking agencies issued a joint final rule, or the ‘‘Final Capital Rule,’’ that implements the Basel III capital standards and establishes the minimum capital levels required under the Dodd-Frank Act. We commenced compliance with the Final Capital Rule on January 1, 2015, we have been in compliance with that Rule throughout 2018, and we expect to continue to be in full compliance with the increasingly stringent capital requirements that it will phase in through 2019. The Final Capital Rule establishes a minimum common equity Tier 1 capital ratio of 6.5% of risk-weighted assets for a ‘‘well-capitalized’’ institution and increases the minimum Tier 1 risk-based capital ratio for a ‘‘well-capitalized’’ institution from 6.0% to 8.0%. Additionally, the Final Capital Rule requires an institution to maintain a 2.5% common equity Tier 1 capital conservation buffer over the 6.5% minimum risk-based capital requirement to avoid restrictions on the ability to pay dividends, discretionary bonuses, and engage in share repurchases. The Final Capital Rule also increases the required capital for certain categories of assets, including high-volatility construction real estate loans, but retains the current capital treatment of residential mortgages. Under the Final Capital Rule, we made the election to exclude unrealized gains and losses from the calculation of our regulatory capital. Implementation of these standards, or any other new regulations, may adversely affect our ability to pay dividends, or require us to reduce business levels or raise capital, including in ways that may adversely affect our results of operations or financial condition.

In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as “Basel IV”). Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including by recalibrating risk weights and introducing new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provide a new standardized approach for operational risk capital. Under the proposed framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing-in through January 1, 2027. Under the current capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Company. The impact of Basel IV on the Company and the Bank will depend on the manner in which it is implemented by the federal bank regulatory agencies.

On August 28, 2018, the Federal Reserve Board issued an interim final rule required by the EGRRCPA that expands the applicability of the Federal Reserve Board’s small bank holding company policy statement (the “SBHC Policy Statement”) to bank holding companies with total consolidated assets of less than $3 billion (up from the prior $1 billion threshold). Under the SBHC Policy Statement, qualifying bank holding companies have additional flexibility in the amount of debt they can issue and are also exempt from the Basel III capital standards (subsidiary depository institutions of qualifying bank holding companies are still subject to capital requirements). The Company currently has less than $3 billion in total consolidated assets and would likely qualify under the revised SBHC Policy Statement. However, the Company does not currently intend to issue a material amount of debt or take any other action that would cause its capital ratios to fall below the minimum ratios required by the Basel III capital standards.

On November 21, 2018, the federal banking agencies jointly issued a proposed rule required by the EGRRCPA that would permit qualifying banks and bank holding companies that have less than $10 billion in consolidated assets to elect to be subject to a 9% leverage ratio that would be applied using less complex leverage calculations (commonly referred to as the community bank leverage ratio or “CBLR”). Under the proposed rule, banks and bank holding companies that opt into the CBLR framework and maintain a CBLR of greater than 9% would not be subject to other risk-based and leverage capital requirements under the Basel III Capital Rules and would be deemed to have met the well capitalized ratio requirements under the “prompt corrective action” framework. The rule is in proposed form so the content and scope of the final rule, and its impact on the Company and the Bank (if any), cannot be determined. Consequently, the Company and the Bank cannot yet determine whether they intend to opt into the CBLR framework.

It is difficult to predict at this time what other specific impacts the Dodd-Frank Act and the remaining, yet-to-be-written implementing rules and regulations will have on community banks. However, compliance with the EGRRCPA, the Dodd-Frank Act and its implementing rules and regulations has resulted in, and is expected to continue to result in, increased operating and compliance costs.

Introduction

Banking is a complex, highly regulated industry. The primary goals of the regulatory scheme are to maintain a safe and sound banking system, protect depositors and the FDIC insurance fund, and facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress and the states have created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the financial services industry in general. Consequently, the growth and earnings performance of the Bank can be affected not only by management decisions and general economic conditions, but also by the requirements of applicable state and federal statues, regulations and the policies of various governmental regulatory authorities, including the Federal Reserve Board, the FDIC, and the banking authorities of each of the jurisdictions in which the Bank operates.

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The Bank’s business is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve Board and the FDIC. The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating unemployment) through its open-market operations in U.S. Government securities, by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target Federal Funds and discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits, and also affect interest earned on interest-earning assets and paid on interest-bearing liabilities. The nature and impact of any future changes in monetary and fiscal policies on the Bank are difficult to predict.

The system of supervision and regulation applicable to financial services businesses governs most aspects of the business of the Bank, including: (i) the scope of permissible business; (ii) investments; (iii) reserves that must be maintained against deposits; (iv) capital levels that must be maintained; (v) the nature and amount of collateral that may be taken to secure loans; (vi) the establishment of new branches; (vii) mergers and consolidations with other financial institutions; and (viii) the payment of dividends.

From time to time, federal and local legislation is enacted which may have the effect of materially increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers. In addition, the various bank regulatory agencies often adopt new rules, regulations and policies to implement and enforce existing legislation. It cannot be predicted whether, or in what form, any such legislation or regulations or changes in policy may be enacted, or the extent to which the business of the Bank or the Company would be affected thereby. The Bank cannot predict whether or when potential legislation will be enacted and, if enacted, the effect that it, or any implemented regulations and supervisory policies, would have on our financial condition or results of operations. In addition, the outcome of examinations, any litigation or any investigations initiated by federal or local authorities may result in necessary changes in our operations that may increase our costs.

Set forth below is a description of the significant elements of the laws and regulations applicable to the Company and the Bank. The description is qualified in its entirety by reference to the full text of the statutes, regulations and policies that are described. Also, such statutes, regulations and policies are continually under review by the U.S. Congress and local legislatures and federal and local regulatory agencies, and, where applicable, their foreign counterparts. A change in statutes, regulations or regulatory policies applicable to the Company or the Bank could have a material effect on our business.

Regulation of BankGuam Holding Company

As a bank holding company, the Company is registered under the Bank Holding Company Act of 1956, as amended (“BHCA”), and is subject to regulation and periodic examination by the Federal Reserve Board. The Company is also required to file periodic reports of its operations and any additional information regarding its activities and those of its subsidiaries, as may be required by the Federal Reserve Board.

Federal Reserve Board regulations require bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. Under these regulations, the holding company is expected to commit resources to support its bank subsidiary, including at times when the holding company may not be in a financial position to provide such support. Bank holding companies must also maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting their subsidiary bank. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary bank will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice, a violation of the Federal Reserve Board’s regulations, or both.

Under the BHCA, a bank holding company must obtain the Federal Reserve Board’s approval before: (i) directly or indirectly acquiring more than 5% ownership or control of any voting shares of another bank or bank holding company; (ii) acquiring all or substantially all of the assets of another bank; or (iii) merging or consolidating with another bank holding company.

The business activities of the Company, as a bank holding company, are restricted by the BHCA. Under the BHCA and the Federal Reserve’s bank holding company regulations, the Company may only engage in, acquire or control voting securities or assets of a company engaged in: (i) banking, or managing or controlling banks and other subsidiaries authorized under the BHCA; and, (ii) any non-banking activity the Federal Reserve has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. These include any incidental activities necessary to carry on those activities as well as a variety of activities that the Federal Reserve has determined to be so closely related to the business of banking as to be a proper incident thereto.

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There are various restrictions on the ability of the holding company to borrow from, and engage in certain other transactions with, its bank subsidiary. In general, these restrictions require that any extensions of credit by the Bank to any single affiliate of the Bank must be secured by designated amounts of specified collateral and are limited to 10% of the Bank’s capital stock and surplus, and, as to the Company and all other affiliates of the Bank collectively, to 20% of the Bank’s capital stock and surplus. Federal law also provides that extensions of credit and other transactions between the Bank and the Company must be on terms and conditions, including credit standards, that are substantially the same or at least as favorable to the Bank as those prevailing at the time for comparable transactions involving non-affiliated companies or, in the absence of comparable transactions, on terms and conditions, including credit standards, that in good faith would be offered to or would apply to non-affiliated companies.

Federal law prohibits a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, for example, the Bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer must obtain or provide some additional credit, property or services from or to the Bank other than a loan, discount, deposit or trust services; (ii) the customer must obtain or provide some additional credit, property or service from or to the Company or the Bank; or, (iii) the customer must not obtain some other credit, property or services from competitors, except reasonable requirements to ensure soundness of the credit extended.

The principal source of the Company’s cash revenues are dividends from its subsidiary, the Bank. The Company’s earnings and activities are affected by legislation, by regulations and by local legislative and administrative bodies and decisions of courts in the jurisdictions in which we conduct business. For example, these include limitations on the ability of the Bank to pay dividends to the Company and our ability to pay dividends to our stockholders. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiary.

Regulation of the Bank

General. As a Guam-chartered bank, the Bank is subject to supervision, periodic examination and regulation by the Guam Banking Commission. As a member of the Federal Deposit Insurance Corporation, the Bank is also subject to supervision, periodic examination and regulation by the FDIC as the Bank’s primary federal regulator. If, as a result of an examination, the Guam Banking Commission or the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory, or that the Bank or its management is violating or has violated any law or regulation, the Guam Banking Commission and the FDIC have residual authority to: (i) require affirmative action to correct any conditions resulting from any violation or practice; (ii) direct an increase in capital; (iii) restrict the Bank’s growth geographically, by products and services, or by mergers and acquisitions; (iv) enter into informal nonpublic or formal public memoranda of understanding or written agreements; (v) enjoin unsafe and unsound practices and issue cease and desist orders to take corrective action; (vi) remove officers and directors and assess civil monetary penalties; and, (vii) take possession of, close and liquidate the Bank.

Guam law permits locally-chartered commercial banks to engage in any activity permissible for national banks. Therefore, the Bank may form subsidiaries to engage in the many so-called “closely related to banking” or “nonbanking” activities commonly conducted by national banks in operating subsidiaries, and further, pursuant to the Gramm-Leach-Bliley Act, the Bank may conduct certain “financial” activities in a subsidiary to the same extent as may a national bank, provided the Bank is and remains “well-capitalized,” “well-managed” and in satisfactory compliance with the Community Reinvestment Act (discussed below).

The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Des Moines. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region and makes available loans or advances to its members. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. As an FHLB member, the Bank is required to own a certain amount of capital stock in the FHLB. At December 31, 2018, the Bank was in compliance with the FHLB’s stock ownership requirement.

Regulatory Capital Guidelines. The federal banking agencies have established minimum capital standards known as risk-based capital guidelines. These guidelines are intended to provide measures of capitalization that reflect the degree of risk associated with a bank’s operations. The risk-based capital guidelines include both a definition of capital and a framework for calculating the amount of capital that must be maintained against a bank’s assets and off-balance sheet items. The amount of capital required to be maintained is based upon the credit risks associated with the various types and quality of a bank’s assets and off-balance sheet items. A bank’s assets and off-balance sheet items are classified under several risk categories, with each category assigned a particular risk weighting from 0% to 150%. The Bank’s Tier 1 capital consists of its capital stock, capital surplus, treasury stock, undivided earnings and the cumulative effect of the FDIC’s adjustment of our intangible assets. Our Tier 2 capital adds to Tier 1 the allowed portion of our reserves for possible loan losses. The inclusion of Tier 2 capital as qualifying capital for regulatory purposes is subject to certain other requirements and limitations of the federal banking agencies. The federal regulators require a minimum ratio of total qualifying capital

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to risk-adjusted assets of 9.875%, a minimum ratio of Tier 1 capital to risk-adjusted assets of 7.875%, a minimum amount of Tier 1 capital to total assets (referred to as the “leverage ratio”) of 4% and a minimum ratio of Common Equity Tier 1 Capital to risk-adjusted assets of 6.375%. As of December 31, 2018, the Company’s capital levels met all minimum regulatory requirements and the Bank was considered “well capitalized” under the regulatory framework for prompt corrective action described below. There is no condition or event since December 31, 2018, that management believes has changed the Company’s or the Bank’s capitalization category.

As described above, on November 21, 2018, the federal banking agencies jointly issued a proposed rule required by the EGRRCPA that would permit qualifying banks and bank holding companies that have less than $10 billion in consolidated assets to elect to opt into the CBLR framework. Banks opting into the CBLR framework and maintaining a CBLR of greater than 9% would be deemed to have met the well capitalized ratio requirements under the "prompt corrective action" framework. The rule is in proposed form so the content and scope of the final rule, and its impact on the Company and the Bank (if any), cannot be determined. Consequently, the Company and the Bank cannot yet determine whether they intend to opt into the CBLR framework.

Prompt Corrective Action. The federal banking agencies possess broad powers to take prompt corrective action to resolve the problems of regulated banks. Each federal banking agency has issued regulations defining five capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Under the regulations, a bank shall be deemed to be:

 

“well capitalized” if it has a total risk-based capital ratio of 10.0% or more, has a Tier 1 risk-based capital ratio of 8.0% or more, has a leverage capital ratio of 5.0% or more, and a Common Equity Tier 1 risk-based capital ratio of 6.5% or more, and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure;

 

“adequately capitalized” if it has a total risk-based capital ratio of 9.875% or more, a Tier 1 risk-based capital ratio of 7.875% or more, a leverage capital ratio of 4.0% or more, and a Common Equity Tier 1 risk-based capital ratio of 6.375% or more, each excepting the leverage ratio including the 1.875% capital buffer required during 2018, and does not meet the definition of “well capitalized”;

 

“undercapitalized” if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 6.0%, a leverage capital ratio that is less than 4.0% (3.0% under certain circumstances), or a Common Equity Tier 1 risk-based capital ratio that is less than 4.5%;

 

“significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 4.0%, a leverage capital ratio that is less than 3.0%, or a Common Equity Tier 1 risk-based capital ratio that is less than 3.0%; and

 

“critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%.

Banks are prohibited from paying dividends or management fees to controlling persons or entities if, after making the payment, the bank would be “undercapitalized,” that is, the bank fails to meet the required minimum level for any relevant capital measure. Asset growth and branching restrictions apply to “undercapitalized” banks. Banks classified as “undercapitalized” are required to submit acceptable capital plans guaranteed by their holding company, if any. Broad regulatory authority was granted with respect to “significantly undercapitalized” banks, including forced mergers, growth restrictions, ordering new elections for directors, forcing divestiture by their holding company, if any, requiring management changes, and prohibiting the payment of bonuses to senior management. Even more severe restrictions are applicable to “critically undercapitalized” banks, those with capital at or less than 2%. Restrictions for these banks include the appointment of a receiver or conservator. All of the federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action.

A bank, based upon its capital levels, that is classified as “well capitalized,” “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for a hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment. At each successive lower capital category, an insured bank is subject to more restrictions. The federal banking agencies, however, may not treat an institution as “critically undercapitalized” unless its capital ratios actually warrant such treatment.

In addition to measures taken under the prompt corrective action provisions, insured banks may be subject to potential enforcement actions by federal banking agencies, or the banking regulators in any of the jurisdictions in which the Bank operates, for unsafe or unsound practices in conducting their businesses, or for violations of any law, rule, regulation or any condition imposed in writing by the agency, or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, and the issuance of removal and prohibition orders against “institution-affiliated” parties. The enforcement of such actions through injunctions or restraining orders may be based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.

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Neither the Company nor the Bank is currently operating under any corrective actions by their respective regulatory authorities.

Safety and Soundness Standards. The federal banking agencies have also adopted guidelines establishing safety and soundness standards for all insured depository institutions, as have the other regulatory authorities in jurisdictions in which the Bank operates. Those guidelines relate to internal controls, information systems, internal audit systems, loan underwriting and documentation, compensation and interest rate exposure. In general, the standards are designed to assist the various banking authorities in identifying and addressing problems at depository institutions before capital becomes impaired. If an institution fails to meet these standards, the appropriate banking authority may require the institution to submit a compliance plan and may institute enforcement proceedings if an acceptable compliance plan is not submitted.

FDIC Insurance and Insurance Assessments. The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of federally insured banks and savings institutions, and safeguards the safety and soundness of the banking and savings industries. The FDIC insures the Bank’s customer deposits through the Deposit Insurance Fund (“DIF”). The maximum deposit insurance amount is $250,000.

The amount of FDIC assessments paid by each DIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other supervisory factors. Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the FDIC is required to set the reserve ratio for the DIF annually at no less than 1.35% of estimated insured deposits. The FDIC may increase or decrease the assessment rate schedule on a semi-annual basis.

On February 7, 2011, as required by the Dodd-Frank Act, the FDIC adopted final rules to revise the assessment base to consist of average consolidated total assets during the assessment period minus the average tangible equity during the assessment period. In addition, the revisions eliminate the adjustment for secured borrowings and make certain other changes to the impact of unsecured borrowings and brokered deposits on an institution’s deposit insurance assessment. The rule also revises the assessment rate schedule to provide assessments ranging from 5 to 45 basis points, which took effect on April 1, 2011.

The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a risk to the DIF or that may prejudice the interest of depositors.

Depositor Preference. In the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.

Community Reinvestment Act (“CRA”). The CRA is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal bank regulatory agencies, in examining insured depository institutions, to assess their record of helping to meet the credit needs of their entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices. The CRA further requires the agencies to take a financial institution’s record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions, or holding company formations.

The federal banking agencies have adopted regulations which measure a bank’s compliance with its CRA obligations on a performance-based evaluation system. This system bases CRA ratings on an institution’s actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. The ratings range from “outstanding” to a low of “substantial noncompliance.” The Bank had a CRA rating of “satisfactory” as of its most recent regulatory examination. A copy of the rating report is publicly available for review in the Bank’s branches.

Other Consumer Protection Laws and Regulations. The bank regulatory agencies are increasingly focusing attention on compliance with consumer protection laws and regulations, and banks have been advised to carefully monitor their compliance with these laws and regulations. The federal Interagency Task Force on Fair Lending issued a policy statement on discrimination in home mortgage lending describing three methods that federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment, and evidence of disparate impact. In addition to CRA and fair lending requirements, the Bank is subject to numerous other federal consumer protection statutes and regulations. Due to heightened regulatory concern related to compliance with consumer protection laws and expanded regulations generally, the Bank may incur additional compliance costs or be required to expend additional funds for investments in the local communities it serves.

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Privacy. The Federal Reserve Board and other bank regulatory agencies have adopted guidelines for safeguarding confidential, personal customer information. These guidelines require financial institutions to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of such information, and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. The Bank has adopted a customer information security program to comply with these requirements.

Financial institutions are also required to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, financial institutions must provide explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, prohibits disclosing such information except as provided in the Bank’s policies and procedures. The Bank has implemented privacy policies addressing these restrictions, and these policies are distributed regularly to all existing and new customers of the Bank.

USA Patriot Act of 2001. Under the USA Patriot Act of 2001 (the “Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act,” or the “Patriot Act”), financial institutions are subject to prohibitions regarding specified financial transactions and account relationships, as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. Among other things, the Patriot Act requires: (i) enhanced due diligence policies, procedures, and controls on banks opening or holding accounts for foreign banks or wealthy foreign individuals; and, (ii) requires all financial institutions to establish anti-money laundering programs. The Bank has adopted and implemented policies and procedures to comply with the requirements of the Patriot Act.

Office of Foreign Assets Control Regulation. The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the “OFAC” rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and, (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences, including civil money penalties and potential criminal prosecution. The Bank has established policies and implemented procedures to detect and prohibit transactions that would violate the OFAC rules.

Other Aspects of Banking Law. The Bank is also subject to federal statutory and regulatory provisions covering, among other things, security procedures, insider and affiliated party transactions, management interlocks, electronic funds transfers, funds availability, and truth-in-savings.

Other Pending and Proposed Legislation

Other legislative and regulatory initiatives which could affect the Bank, the Company and the banking industry in general may be proposed or introduced before the United States Congress, the Guam legislature and other governmental bodies in the future. Such proposals, if enacted, may further alter the structure, regulation and competitive relationship among financial institutions, and may subject the Bank or the Company to increased regulation, disclosure and reporting requirements. In addition, the various banking regulatory agencies often adopt new rules and regulations to implement and enforce existing legislation. It cannot be predicted whether, or in what form, any such legislation or regulations may be enacted or the extent to which the business of the Bank or the Company would be affected thereby.

Available Information

The Company makes available free of charge through the Bank’s website (www.bankofguam.com) the Company’s Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports. The Company makes these reports available on the Bank’s website as soon as reasonably practicable after we electronically file such material with, or otherwise furnish it to, the SEC. The information posted on our website is not incorporated by reference into this Annual Report. The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

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ITEM 1A.

Risk Factors

Our business, financial condition and results of operations are subject to various risks, including those discussed below. The risks discussed are those that we believe are the most significant risks, although additional risks not presently known to us or that we currently deem less significant may also adversely affect our business, financial condition and results of operations, perhaps materially.

Risks Relating to Recent Economic Conditions and Governmental Response Efforts

Our business may be adversely affected by conditions in the financial markets and economic conditions generally.

The United States economy continues to recover from a downturn that started in 2007, but business activity and growth across industries and regions have not yet been fully restored. There are indications that the recovery is accelerating, and the decisions of the Federal Open Market Committee, which guides current monetary policy actions on behalf of the Federal Reserve System in carrying out its broader monetary policies, to raise its target interest rate on March 21, June 13, September 26 and December 19, 2018, expressed its confidence in the sustainability of recent economic growth in the United States. Consumer spending, liquidity and availability of credit are all improving, and the unemployment rate, which has fallen by more than half since October 2009, reached what many consider to be a full-employment level nationally. The unemployment rate in our California region is low, but has been persistently high in the island markets we serve.

The financial services industry was materially and adversely affected by the weakened economy and by the monetary policy responses intended to correct that weakness. The negative effect of historically low market interest rates reduced our interest rate margin despite us having established minimum rate levels on our variable rate loans. In order to retain core deposits and as a reputational matter, our consumer savings account rates have been higher than our competitors’ offerings for the past nine years. The recovery of the economy and gradual reduction of unemployment impacted our operating results negatively; however, the Bank has not experienced any adverse liquidity issues in recent years. Additionally, the remaining adverse conditions in the island economies may continue to have a negative effect on the ability of our borrowers to make timely repayments of their loans. These factors could expose us to an increased risk of loan defaults and losses, and have an adverse impact on our earnings.

Recent legislative and required regulatory initiatives will impose restrictions and requirements on financial institutions that could have an adverse effect on our business.

Current and future legal and regulatory requirements, restrictions, and regulations, including those imposed under the 2010 Dodd-Frank Act, which was enacted in response to the 2008 financial crisis and subsequent economic weakness, may adversely impact our profitability, financial condition and operations; may require us to invest significant management attention and resources to evaluate and make any changes required by the legislation and related regulations; and may make it more difficult for us to attract and retain qualified executive officers and employees. Few provisions of the Dodd-Frank Act were effective immediately, with various provisions becoming effective in stages. Many of the provisions required governmental agencies to implement rules that have increased regulation of the banking industry. As examples, these rules impact the ability of banks to charge certain fees and impose new restrictions on lending practices. The Dodd-Frank Act created a new financial consumer protection agency, known as the Consumer Financial Protection Bureau (the “Bureau”), that is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer compliance, which may increase our regulatory compliance burden and costs, and may restrict the financial products and services we offer to our customers.

The Dodd-Frank Act prohibits new trust preferred issuances from counting as Tier 1 capital. These restrictions limit our future capital strategies. Although neither the Bank nor the Company use derivative transactions, the Dodd-Frank Act also increases regulation of derivatives and hedging transactions, which could limit our ability in the future to enter into, or increase the costs associated with, interest rate and other hedging transactions. Although certain provisions of the Dodd-Frank Act, such as direct supervision by the Bureau, will not apply to banking organizations with less than $10 billion of assets, such as the Company, the changes resulting from the legislation will impact our business nonetheless. These and future changes may have a material, adverse effect on our business, our financial condition and the results of our operations. As discussed above, the EGRRCPA adopted in 2018 amended certain provisions of the Dodd-Frank Act as well as certain other statutes administered by the federal bank regulatory agencies. No other significant banking or bank holding company regulations were implemented during 2018.

On December 22, 2017, the Tax Cuts and Jobs Act (“the Act”) was signed into law. Most of the changes made to the Internal Revenue Code by the Act became effective January 1, 2018, and therefore had no effect on the profitability, financial condition or operations of the Company or the Bank during the year ended December 31, 2017. However, the lowering of the maximum corporate income tax rate from 35% to 21% required a revaluation of the Company’s deferred tax asset during the 2017 tax year, which resulted in a one-time negative effect on our profitability and our financial condition. During the year ended December 31, 2018, the Act had a substantial effect on the Company’s and the Bank’s net income after income taxes, primarily due to the reduction in the effective corporate income tax rate.

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Implementation of the new Basel III capital rules adopted by the federal bank regulatory agencies will require increased capital levels that could impede our growth and profitability.

The federal bank regulatory agencies adopted new capital requirements in mid-2013 that increased the minimum Tier 1 risk-based capital ratio, added a new minimum common equity Tier 1 capital ratio, established a new capital conservation buffer and changed the risk-weighting of certain assets. These requirements, initially implemented beginning in January 2015, are being phased in through 2019, providing banks with adequate time to adjust their balance sheets. Management has assessed the effects of the new rules on the Company and the Bank’s capital position. Although we currently exceed the new minimum requirements, they could have a material and adverse effect on our liquidity, capital resources, financial performance and financial condition in the future.

Any future FDIC insurance premium increases will adversely affect our earnings.

In April 2009, the FDIC revised its risk-based assessment system. The changes to the system involve adjustments to the risk-based calculation of an institution’s unsecured debt, secured liabilities and brokered deposits. Depending on any future losses that the FDIC Deposit Insurance Fund may suffer due to failed institutions, there can be no assurance that there will not be additional premium increases in order to replenish the Fund, but the rate of bank failures has diminished over the past four years, returning to historical norms. Our FDIC deposit insurance expense for the year ended December 31, 2018, was $1.3 million.

Risks Related to Our Markets and Business

Our profitability is dependent upon the economic conditions of the markets in which we operate.

We operate on ten relatively remote Pacific islands and in San Francisco, California, and, as a result, our financial condition and results of operations are affected by changes in the economic conditions in each of those areas. Our success depends upon the business activity, population, income levels, deposits and lending activity in these markets. Because some of our customers’ business and financial interests may extend well beyond these market areas, adverse economic conditions that affect those other market areas could reduce our growth rate, affect the ability of those customers to repay their loans, and generally affect our financial condition and results of operations. Other than in San Francisco, our lending operations are located in market areas dependent on tourism and fishing, along with a military presence and other federal government activities in Guam. The island economies have remained relatively stable, and the Commonwealth of the Northern Mariana Islands has resumed its economic growth after several years of challenges. However, because of the magnified influence of external events, these small island economies tend to be somewhat more volatile than larger economic systems. Thus, our borrowers could be adversely impacted by a downturn in these sectors of the economy that could reduce the demand for loans and adversely impact the borrowers’ ability to repay their loans, which would, in turn, increase our nonperforming assets. Because of our geographic concentration in several relatively small island economies, we are less able than many regional or national financial institutions to diversify our credit risks across multiple dissimilar markets. In recent years, we have taken the initiative to expand our operations in California in an effort to increase and help to stabilize our profitability.

Our loan portfolio has a large concentration of real estate loans in Guam and in San Francisco, which involves risks specific to real estate values.

A downturn in our real estate markets could adversely affect our business because many of our loans are secured by real estate. Real estate lending (including commercial and construction) is a large portion of our loan portfolio. At December 31, 2018, approximately $741.2 million, or 59.8% of our loan portfolio, was secured by various forms of real estate, including residential and commercial real estate. The real estate securing our loan portfolio is concentrated in Guam and San Francisco. From time to time, there have been adverse developments affecting real estate values in one or more of our markets, and the market value of real estate can fluctuate significantly in a short period of time as a result of changing market conditions. Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies, and acts of nature, such as earthquakes and typhoons. Additionally, commercial real estate lending typically involves larger loan principal amounts and the repayment of the loans generally is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. If real estate values decline, the value of the collateral securing some of our loans could be significantly reduced. Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished, and we would be more likely to suffer losses on defaulted loans.

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If we fail to maintain an effective system of internal controls and disclosure controls and procedures, we may not be able to accurately report our financial results or prevent fraud.

Effective internal control over financial reporting and disclosure controls and procedures are necessary for us to provide reliable financial reports, effectively prevent fraud and to operate successfully as a public company. If we cannot provide reliable financial reports or prevent fraud, our reputation and business would be harmed. In addition, failure in our internal control over financial reporting and disclosure controls and procedures could cause us to fail to meet the requirements of Rules 13a-15 and 15d-15 under the Exchange Act and, as a result, risk errors in our financial reporting to the Securities and Exchange Commission.

Each calendar quarter, management conducts an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. For additional information on the effectiveness of our internal controls over financial reporting, see Part II. Item 9A. “Controls and Procedures” in this Annual Report on Form 10-K.

Our performance depends on attracting and retaining key employees and skilled personnel to operate our business effectively, and the loss of one or more of those key personnel may materially and adversely affect our prospects.

Our success is dependent on our ability to recruit and retain qualified, skilled management, loan origination, finance, administrative, marketing and technical personnel to operate our business effectively. Competition for qualified employees and personnel in the banking industry is intense, and there is a limited number of persons with knowledge of, and experience in, the community banking industry in the markets we serve. In particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our Chief Executive Officer, our Chief Operating Officer, our Chief Financial Officer, and certain other key employees. Failure to maintain adequate staffing in key positions could adversely impact our operations and our ability to compete. We have implemented a succession plan to help mitigate this risk, including the appointment of two Executive Vice Presidents who will ultimately assume critical executive level positions.

As previously reported, our former Chief Executive Officer and President, Lourdes A. Leon Guerrero, resigned effective December 31, 2018, in advance of her inauguration as the Governor of Guam. Joaquin P.L.G. Cook, the Company’s and Bank’s Executive Vice President and Chief Sales & Service Officer, is serving as the Company’s and Bank’s Interim Chief Executive Officer and President until the Company identifies a successor for Ms. Leon Guerrero.

We are subject to credit risk.

There are inherent risks associated with our lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where we operate, as well as those within our region, across the United States and abroad. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing those loans. We are also subject to various laws and regulations that affect our lending activities. Failure to comply with applicable laws and regulations could subject us to regulatory enforcement action, which could result in the assessment of significant civil money penalties against us.

We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices. Although we believe that our underwriting criteria are appropriate for the various kinds of loans we make, we may incur losses on loans that meet our underwriting standards, and these losses may exceed the amounts set aside as reserves in our allowance for loan losses. Due to economic conditions in the recent past, many lending institutions, including the Bank, experienced declines in the performance of their loans, including consumer and commercial loans. The value of real estate collateral supporting some commercial loans declined and may decline again in the future. Developments in the financial industry and credit markets may adversely impact our financial condition and results of operations.

Our allowance for loan losses may not be adequate to cover actual loan losses, which could adversely affect our earnings.

We maintain an allowance for loan losses for possible defaults and other reductions in the principal value of the Bank’s loan portfolio. The allowance is established through a provision for loan losses based on management’s evaluation of the risks inherent in the loan portfolio and the general economy. The allowance is also appropriately increased for new loan growth. The allowance is based upon a number of factors, including the size of the loan portfolio, asset classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, management’s assessment of the credit risk inherent in the portfolio, historical loan loss experience and loan underwriting policies.

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We strive to carefully manage and monitor credit quality and to identify deteriorating loans, and adjust the allowance for loan losses accordingly. However, because future events are uncertain and because we may not successfully identify all deteriorating loans in a timely manner, there may be loans that deteriorate in an accelerated time frame. As a result, future additions to the allowance may be necessary. Further, because the loan portfolio contains some commercial real estate, construction, and land development loans with relatively large balances, deterioration in the credit quality of one or more of these loans may require a significant increase to the allowance for loan losses. Future additions to the allowance may also be required due to changes in the financial condition of borrowers, such as changes resulting from potentially worsening economic conditions, or as a result of incorrect assumptions by management in determining the allowance for loan losses. As discussed in Note 20 to our Consolidated Financial Statements included in this Annual Report on Form 10-K, at January 16, 2019, one large commercial loan customer with an outstanding relationship of $10.1 million in unsecured loans sought bankruptcy protection in order to reorganize under Chapter 11 of Title 11 of the United States Code.  The Bank retains the right of offset against a minimum of $4.7 million in the customer’s depository accounts, and has made a specific allowance for loan losses of $5.2 million at December 31, 2018.

Our regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by making additional provisions for loan losses, charged as an expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.

Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition.

At December 31, 2018, nonperforming loans were 0.57% of the total loan portfolio, and 0.37% of total assets, as compared to 0.66% and 0.41% at December 31, 2017, respectively, indicating a decreased level of risk. Nonperforming assets adversely affect our earnings in various ways. Depending upon economic and market conditions, we may incur losses relating to an increase in nonperforming assets. We do not record interest income on non-accrual loans or other real estate owned, thereby adversely affecting our income, and increasing our loan administration costs. Upon foreclosure or similar proceedings, we record the foreclosed asset at the fair value of the asset, reduced by estimated selling costs, which may result in a loss. An increase in the level of nonperforming assets increases our risk profile and may impact the capital levels our regulators believe are appropriate in light of the increased risk profile. While we reduce problem assets through collection efforts, asset sales, workouts, restructurings and otherwise, decreases in the value of the underlying collateral or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, our results of operations and our financial condition.

In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors, which can hinder the performance of their other responsibilities. If economic and market conditions worsen, it is possible that we will experience future increases in nonperforming assets, particularly if we are unsuccessful in our efforts to reduce our classified assets, which would have an adverse effect on our business.

We may be required to make additional provisions for loan losses and charge off additional loans in the future, which could adversely affect our results of operations.

For the year ended December 31, 2018, we recorded a $12.9 million provision for loan losses, charged off $8.2 million of loans, and recovered $1.8 million of loans previously charged off. At December 31, 2018, we had $741.2 million in commercial and residential real estate loans and construction loans, of which $11.8 million was on non-accrual. Commercial real estate loans comprise 17.1% of our nonperforming assets, while residential mortgage loans comprise 41.3%. Deterioration in the real estate market in Guam, San Francisco and/or the Commonwealth of the Northern Mariana Islands could affect the ability of our loan customers to service their debt, which could result in additional loan charge-offs and provisions for loan losses in the future, and could have a material adverse effect on our financial condition, results of operations and capital.

A large commercial loan borrower that filed for bankruptcy on January 16, 2019, was evaluated under ASC 450 – “Contingencies”. The Bank holds $4.7 million in deposits for which the Court has approved a right of offset against the borrower’s loans. The Bank also has assigned a specific allowance of $5.2 million to the outstanding debt. The outstanding loans under bankruptcy have been classified as substandard, but are still accruing interest and the scheduled payments on the loans remain current.

Our business is subject to interest rate risk, and variations in interest rates may negatively affect our financial performance.

Our earnings and cash flows are highly dependent upon net interest income. Net interest income is the difference between interest income earned on interest-bearing assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Our net interest income (including net interest spread and margin) and ultimately our earnings are impacted by changes in interest rates and monetary policy. Changes in interest rates and monetary policy can impact the demand for new loans, the

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credit profile of our borrowers, the yields earned on loans and securities, and the rates paid on deposits and borrowings. Given our current volume and mix of interest-bearing liabilities and interest-earning assets, we expect our interest rate spread (the difference in the rates paid on interest-bearing liabilities and the yields earned on interest-earning assets) as well as net interest income to increase as interest rates rise and, conversely, to decline if interest rates fall. Additionally, increasing levels of in-market and out-of-market competition in the banking and financial services business may decrease our net interest spread as well as net interest margin by forcing us to offer lower lending interest rates and pay higher deposit interest rates. Although we believe our current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates (such as a sudden and substantial increase in Prime and Fed Funds rates) as well as increasing competition may require us to increase rates on deposits at a faster pace than the yield we receive on interest-earning assets increases. The impact of any sudden and substantial move in interest rates and/or increased competition may have an adverse effect on our business, financial condition and results of operations, as our net interest income may be adversely affected.

Additionally, a sustained decrease in market interest rates could negatively affect our earnings. When interest rates decline, borrowers tend to refinance higher-rate, fixed-rate loans at lower rates, prepaying their existing loans. Under those circumstances, we would not be able to reinvest those prepayments in assets earning interest rates as high as the rates on the prepaid loans. In addition, our commercial loans, which carry variable interest rates that generally adjust in accordance with changes in the prime rate, will adjust to lower rates. Because of this, we have established minimum interest rates on those loans to mitigate our interest rate risk and potential reductions in income.

We are also significantly affected by the level of loan demand available in our markets. The inability to make sufficient loans directly affects the interest income we earn. Lower loan demand will generally result in lower interest income realized as we place funds in lower-yielding investments.

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn in markets in which our loans are concentrated, a change in our financial condition or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole.

If we lost a significant portion of our low-cost deposits, it would negatively impact our liquidity and profitability.

Our profitability depends in part on our success in attracting and retaining a stable base of low-cost deposits. At December 31, 2018, 31.1% of our deposit base was comprised of non-interest bearing deposits, and the average rate on our interest-bearing deposits during 2018 was 0.17%. While we generally do not believe these core deposits are very sensitive to interest rate fluctuations, the competition for these deposits in our markets is strong. If we were to lose a significant portion of our low-cost deposits, it could negatively impact our liquidity and profitability.

We may be the subject of litigation, which could result in legal liability and damage to our business and reputation.

From time to time, we may be subject to claims or legal action from customers, employees or others. Financial institutions like the Company and the Bank are facing a growing number of significant class actions, including those based on the manner of calculation of interest on loans and the assessment of overdraft fees. Future litigation could include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. We are also involved from time to time in other reviews, investigations and proceedings (both formal and informal) by governmental and other agencies regarding our business. These matters also could result in adverse judgments, settlements, fines, penalties, injunctions or other relief. Like other large financial institutions, we are also subject to risk from potential employee misconduct, including non-compliance with policies and improper use or disclosure of confidential information.

Our insurance may not cover all claims that may be asserted against us, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation. Should the ultimate judgments or settlements in any litigation exceed our insurance coverage, they could have a material adverse effect on our financial condition and results of operations. In addition, we may not be able to obtain appropriate types or levels of insurance in the future, nor may we be able to obtain adequate replacement policies with acceptable terms, if at all.

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If we are limited in our ability to originate loans secured by commercial real estate we may face greater risk in our loan portfolio.

Federal banking agencies have issued guidance regarding high concentrations of commercial real estate loans within bank loan portfolios. The guidance requires financial institutions that exceed certain levels of commercial real estate lending compared with their total capital to maintain heightened risk management practices that address the following key elements: board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. If there is any deterioration in our commercial real estate portfolio or if our regulators conclude that we have not implemented appropriate risk management practices, it could adversely affect our business, and could result in the requirement to maintain increased capital levels. Such capital may not be available at that time, and may result in our regulators requiring us to reduce our concentration in commercial real estate loans.

If because of our concentration of commercial real estate loans, or for any other reasons, we are limited in our ability to originate loans secured by commercial real estate, our results of operations may be negatively impacted and we may incur greater risk in our loan portfolio.

The laws and regulations, including the Dodd-Frank Act, applicable to the banking industry could change at any time, and these changes may adversely affect our business and profitability.

We are subject to extensive federal and state regulation. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably. The increased scope, complexity, and cost of corporate governance, reporting, and disclosure practices are proportionately higher for a company of our size and will affect our profitability more than that of some of our larger competitors. We expect to experience increasing compliance costs related to this supervision and regulation.

Also, the 2016 national election results and new administration have introduced additional uncertainty into future implementation and enforcement of the Dodd-Frank Act and other financial sector regulatory requirements. Such additional regulation and supervision may increase our costs and limit our ability to pursue business opportunities. The effects of any such recently enacted, or proposed, legislation and regulatory programs on us cannot reliably be determined at this time.

The Consumer Financial Protection Bureau (the “CFPB”) recently issued “ability-to-repay” and “qualified mortgage” rules that may have a negative impact on our loan origination process and foreclosure proceedings, which could adversely affect our business, operating results and financial condition.

On January 10, 2013, the CFPB issued a final rule to implement the “qualified mortgage” provisions of the Dodd-Frank Act requiring mortgage lenders to consider consumers’ ability to repay home loans before extending them credit. The CFPB’s “qualified mortgage” rule, which became effective on January 10, 2014, describes certain minimum requirements for lenders making ability-to-repay determinations, but does not dictate that they follow particular underwriting models. Lenders will be presumed to have complied with the ability-to-repay rule if they issue “qualified mortgages,” which are generally defined as mortgage loans prohibiting or limiting certain risky features. Loans that do not meet the ability-to-repay standard can be challenged in court by borrowers who default, and the absence of ability-to-repay status can be used against a lender in foreclosure proceedings. Any loans that we make outside of the “qualified mortgage” criteria could expose us to an increased risk of liability and reduce or delay our ability to foreclose upon the underlying property. Any decreases in loan origination volume or increases in compliance and foreclosure costs caused by the rule could negatively affect our business, operating results and financial condition. The CFPB also has adopted a number of additional requirements and issued additional guidance, including with respect to appraisals, escrow accounts and servicing, each of which entails increased compliance costs. In addition, the CFPB likely will continue to make rules relating to consumer protection, and it is difficult to predict which of our products and services will be subject to these rules or how these rules will be implemented.

Compliance with the Dodd-Frank Act has increased our regulatory compliance burdens, may increase our operating costs and may adversely impact our earnings or capital ratios, or both.

Signed into law on July 21, 2010, the Dodd-Frank Act has represented a significant overhaul of many aspects of the regulation of the financial services industry. Among other things, the Dodd-Frank Act created the CFPB, tightened capital standards, imposed clearing and margining requirements on many derivatives activities and generally increased oversight and regulation of financial institutions and financial activities.

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In addition to the self-implementing provisions of the statute, the Dodd-Frank Act calls for over 200 administrative rulemakings by numerous federal agencies to implement various parts of the legislation. While many rules have been finalized or issued in proposed form, additional rules have yet to be proposed. It is not possible at this time to predict when all such additional rules will be issued, their final form or requirements, their applicability to the Company or the Bank, or when they will be implemented.

The cost of complying with the new consumer protection regulations and policies could adversely affect our business.

The Dodd-Frank Act created the CFPB, a new regulatory entity with broad powers to supervise and enforce consumer protection laws. The CFPB has extensive rulemaking authority for a wide range of consumer protection laws that apply to banks and other types of lenders, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. It also has examination and enforcement authority over all banks with more than $10 billion in assets. Institutions with less than $10 billion in assets, like the Bank, are examined for compliance with consumer protection laws by their primary bank regulators, but these regulators defer to the CFPB’s rules and interpretations in evaluating a bank’s compliance with consumer protection laws. Therefore, although the CFPB does not directly supervise us, the actions of the CFPB significantly impact our operations.

The CFPB has set forth numerous rules and guidance documents since its inception concerning a wide range of consumer protection laws, many of which are directly applicable to our operations. For example, the CFPB recently imposed new requirements regarding the origination and servicing of residential mortgage loans, limitations on the manner in which loan originators may be compensated, mandatory disclosures on documentation given to borrowers, and an obligation on the part of lenders to verify a borrower’s “ability to repay” a residential mortgage loan before extending credit, among others. The CFPB likely will continue to make rules relating to consumer protection, and it is difficult to predict which of our products and services will be subject to these rules or how these rules will be implemented. However, compliance with CFPB regulations likely will result in additional operating and compliance costs that could have a material adverse effect on our business, consolidated financial condition, results of operations, or cash flows.

We have the ability to borrow from the Federal Home Loan Bank, and there can be no assurance their programs will continue in their current manner.

We have access to funding by the Federal Home Loan Bank of Des Moines for term advances; we also borrow from correspondent banks under our Fed Funds lines of credit from time to time, primarily to test the continuing availability of those lines. The amount loaned to us is generally dependent on the value of the collateral pledged. These lenders could reduce the percentages loaned against various collateral categories, could eliminate their acceptance of certain types of collateral, and could otherwise modify or even terminate their loan programs, particularly to the extent they are required to do so because of capital adequacy or other balance sheet concerns. Any change or termination of the programs under which we borrow from the Federal Home Loan Bank of Des Moines or correspondent banks could have an adverse effect on our liquidity and profitability.

Our results of operations may be adversely affected by other-than-temporary impairment charges relating to our securities portfolio.

We may be required to record future impairment charges on our securities, including our stock in the Federal Home Loan Bank of Des Moines, if they suffer declines in value that we consider other-than-temporary. Numerous factors, including the lack of liquidity for re-sale of certain securities, the absence of reliable pricing information for some securities, adverse changes in the business climate, adverse regulatory actions or unanticipated changes in the competitive environment, could have a negative effect on our securities portfolio in future periods. Significant impairment charges could also negatively impact our regulatory capital ratios and result in the Bank not being classified as “well-capitalized” for regulatory purposes.

We may need to raise additional capital in the future, and such capital may not be available when needed or at all.

We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet regulatory requirements, our commitments or our business needs. Our ability to raise additional capital, if needed, will depend, among other things, on conditions in the capital markets at that time, which are outside of our control, and our financial performance. The loss of confidence in financial institutions may increase our cost of funding and limit our access to some of our customary funding sources, including, but not limited to, inter-bank borrowings and borrowings from the discount window of the Federal Reserve.

We cannot provide assurances that such capital will be available to us on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, depositors of the Bank or counterparties participating in the capital markets, may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity.

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We must effectively manage our growth strategy.

As part of our general growth strategy, we may expand into additional communities or attempt to strengthen our position in our current markets by opening new offices. To the extent that we are able to open additional offices, we are likely to temporarily experience the effects of higher operating expenses relative to operating income from the new operations for a period of time, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets. Our current growth strategies involve internal growth from our current offices and the addition of new offices over time, so that the additional overhead expenses associated with recent openings are absorbed prior to opening other new offices.

We have a nominal amount of deferred tax asset and cannot assure that it will be fully realized.

Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between the carrying amounts and tax basis of assets and liabilities computed using enacted tax rates. If we determine that we will not achieve sufficient future taxable income to realize our net deferred tax asset, we are required under generally accepted accounting principles to establish a full or partial valuation allowance. If we determine that a valuation allowance is necessary, we are required to incur a charge to operations. We regularly assess available positive and negative evidence to determine whether it is more likely than not that our net deferred tax asset will be realized. Realization of a deferred tax asset requires us to apply significant judgment and is inherently speculative because it requires estimates that cannot be made with certainty. At December 31, 2018, we had a net deferred tax asset of $6.9 million. For the year ended December 31, 2018, we established a partial valuation allowance of $2.2 million to reduce the net deferred tax asset of $9.1 million because, in management’s opinion, it is more likely than not that only the remaining $6.9 million will be realized. If we were to determine at some point in the future that we will not achieve sufficient future taxable income to realize our net deferred tax asset, we would be required, under generally accepted accounting principles, to establish a full or increase any partial valuation allowance, which would require us to incur a charge to operations for the period in which the determination was made. Such an increase in the valuation allowance was made in the year ending December 31, 2017, due to the passage of the Tax Cuts and Jobs Act into law on December 22, 2017, which, among other things, reduced the maximum corporate income tax rate from 35% to 21%.  The deferred tax asset valuation allowance at December 31, 2018, was increased by $215 thousand, as compared to a decrease of $1.2 million at December 31, 2017.

We face strong competition from financial service companies and other companies that offer banking services.

We face substantial competition in all phases of our operations from a variety of different competitors. Our competitors, including larger commercial banks, community banks, savings and loan associations, credit unions, consumer finance companies, insurance companies, brokers, investment advisors and other financial institutions, compete with the lending and deposit-gathering services we offer. Increased competition in our markets may result in reduced loans and deposits.

Many of these competing institutions have much greater financial and marketing resources than we have. Due to their size, many competitors can achieve larger economies of scale in a broader range of products and services than we can. If we are unable to offer competitively priced products and services, our business may be negatively affected.

Some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies and federally insured financial institutions, and are not subject to increased supervisory oversight arising from regulatory examinations. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services. The banking business in our primary market areas is very competitive, and the level of competition facing us may increase further, which may limit our asset growth and financial results.

In the future, the Bank and/or the Company may become subject to supervisory actions and/or enhanced regulation that could have a material adverse effect on our business, operating flexibility, financial condition, the value of our common stock and our ability to pay dividends to our stockholders.

Under federal, state and local laws and regulations pertaining to the safety and soundness of insured depository institutions, various state or local regulators (for non-federally chartered banks), the Federal Reserve Board (for bank holding companies and member banks), the local financial industry regulators of the various jurisdictions in which the Bank operates and, separately, the FDIC as the insurer of bank deposits, each have the authority to compel or restrict certain activities on our part if they determine that we have insufficient capital or are otherwise operating in a manner that may be deemed to be inconsistent with safe and sound banking practices. Under their respective authority, our bank regulators can require us to enter into informal or formal enforcement orders, including board resolutions, memoranda of understanding, written agreements, and consent or cease and desist orders, pursuant to which we may be required to take identified corrective actions to address cited concerns or to refrain from taking certain actions. Neither the Bank nor the Company is currently operating under any regulatory enforcement orders.

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Technology is continually changing and we must effectively implement new technologies.

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables us to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy their demands for convenience, as well as to create additional efficiencies in our operations as we continue to grow and expand our geographic and product markets. In order to anticipate and develop new technology, we employ a qualified staff of internal information system specialists and consider this area a core part of our business. We do not develop our own software products, but have been able to respond to technological changes in a timely manner through association with leading technology vendors. We must continue to make substantial investments in technology, which may affect our results of operations. If we are unable to make such investments, or we are unable to respond to technological changes in a timely manner, our operating costs may increase, which could adversely affect our operating results.

System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other potential liabilities.

The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by malicious parties. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. Computer break-ins and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and may cause existing and potential customers to refrain from doing business with us. We employ external auditors to conduct auditing and testing for weaknesses in our systems, controls, firewalls and encryption to reduce the likelihood of any security failures or breaches, as well as both internal and external monitoring systems to detect and report any attempt to overcome our electronic defenses. Although we, with the help of third-party service providers and auditors, intend to continue to implement effective security technology and establish operational procedures to prevent such damage, there can be no assurance that these security measures will ultimately be successful. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer transaction data. A failure of such security measures would present a reputational risk, and could have a material adverse effect on our financial condition and results of operations.

Breaches of third parties’ network security could subject us to increased operating costs and other liabilities.

In recent years, there have been numerous highly publicized breaches of customer databases maintained by both public and private entities, often compromising personally identifiable information. These breaches increase the risk that compromised information may be used to fraudulently obtain financial services. The Bank has established systems to mitigate the possibility that some compromised information could be used fraudulently to open deposit and/or loan accounts.  Despite all reasonable efforts, though, we are unable to be absolutely certain that the risk of that form of fraud is entirely eliminated.

Further, some of these third party data breaches have compromised credit card information, creating an opportunity to defraud the Bank and its credit card customers by initiating fraudulent charges using the compromised card information. Under current law, the Bank retains potential liabilities associated with those fraudulent charges. Also, when it is known that a credit card has been compromised, the Bank incurs costs in replacing the card. As a result, a third-party network security breach could have a material adverse effect on our financial condition and the results of our operations.

Managing operational risk is important to attracting and maintaining customers, investors and employees.

Operational risk represents the risk of loss resulting from our operations, including but not limited to, the risk of fraud by employees or persons outside the Bank, the execution of unauthorized transactions by employees, transaction processing errors and breaches of the internal control system, and failure to effectively meet compliance requirements. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. Operational risk is inherent in all business activities, and the management of this risk is important to the achievement of our business objectives. In the event of a breakdown in our internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action and suffer damage to our reputation. We have a stringent code of ethics and attendant procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures might not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased regulatory oversight.

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Severe weather, natural disasters, acts of war or terrorism, and other external events could significantly impact our business.

Severe weather, natural disasters, acts of war or terrorism, and other adverse external events or conditions have the potential to significantly impact our ability to conduct business. Such events or conditions could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. For example, our primary market areas in Guam and the Commonwealth of the Northern Mariana Islands (the “CNMI”) are subject to typhoons, earthquakes and wildland fires, and our California region is subject to earthquakes and wildland fires. All of the islands in our market are at risk from more frequent and more intense storms, coastal flooding and coastal erosion related to climate change. Operations in our market could be disrupted by both the evacuation of large portions of the population as well as damage and/or lack of access to our banking and operational facilities. While we have experienced severe weather and strong earthquakes in the past and resumed our operations promptly, a recurrence of these, along with acts of war, terrorism or other adverse external events or conditions, may occur in the future. Although management has established a business continuity plan, disaster recovery policies and corresponding procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Uncertain geopolitical conditions could have a material adverse effect on our business and the markets that we serve, which could cause the market price of our common stock to decline.

Our business is subject to geopolitical conditions in the western Pacific, including concerns over North Korea’s nuclear weapons program and China’s expanded military operations in the South and East China Seas. From time to time, there have been heightened security concerns regarding North Korea’s nuclear weapons and long-range ballistic missile programs. This has resulted in increased uncertainty regarding both North Korea’s actions and those of the United States. If North Korea were to take an aggressive action, including acts of war, the markets we serve may be disrupted and our business operations could be affected as well. China’s assertion of sovereignty over several disputed islands and fortification of some of those islands conflicts with the interests of the United States involving safe passage and navigation in the same areas have increased the risks of confrontation in the region. Any of these events could result in a decline in the market price of shares of our common stock.

 

We have identified material weaknesses in our internal control over financial reporting which could, if not remediated, result in material misstatements in our financial statements.

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.

As further described in Part II. Item 9A. “Controls and Procedures” in this Annual Report on Form 10-K, during the first quarter of 2019, we concluded that a material weakness existed as of December 31, 2018. Specifically, management identified a control deficiency that constituted a material weakness in our internal control over financial reporting related to certain monitoring practices related to our core operating system.

As of the date of this filing, we have made substantial progress in remediating this material weakness. We are continuing to execute and monitor our remediation plan. If our remedial measures are insufficient, or if additional material weaknesses or significant deficiencies in our internal controls are detected, we could be required to restate our financial results, lose investor confidence or experience a decline in the price of our securities.

23


 

Risks Related to Our Securities

The price of our common stock may fluctuate significantly, and this may make it difficult for stockholders to resell shares of common stock at times or at prices they find attractive.

The Company common stock is traded in the Over-the-Counter market under the symbol “BKGMF.” The trading volume has historically been substantially less than that of larger financial services companies. This may make it difficult for stockholders to resell shares of common stock at times or at prices they find attractive. Stock price volatility may also make it more difficult to sell common stock quickly and at attractive prices.

During the fourth quarter of 2016, the Company issued $9.8 million of preferred stock in a private placement, structured to qualify as Tier 1 capital. There are restrictions on the ability of shareholders to sell these shares, and the Company is required to obtain prior regulatory approval before they can be redeemed or repurchased.

ITEM 1B.

Unresolved Staff Comments

None.

ITEM 2.

Properties

Our properties consist primarily of leased office facilities for our branch offices. Our headquarters facility, which we own, consists of 74,240 square feet in Hagåtña, Guam. We also own the buildings of our Santa Cruz branch in Guam, our Garapan branch in Saipan and the Rota branch in the CNMI, which comprise 47,292 square feet in total. These branch buildings are situated on leased land. We believe our facilities are in excellent condition and suitable for the conduct of our business. For purposes of operating efficiency, our Santa Cruz branch was consolidated into our Hagåtña branch in December 2017.

For additional information on operating leases and rent expense, see Note 16 to the Consolidated Financial Statements.

ITEM 3.

Legal Proceedings

Neither the Company nor the Bank is involved in any legal proceedings other than those occurring on a routine basis in the ordinary course of business. The majority of such proceedings have been initiated by the Bank in the process of collecting delinquent loans. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the financial condition, results of operations and cash flows of the Company as of December 31, 2018.

ITEM 4.

Mine Safety Disclosures

None.

 

 

24


 

PART II

ITEM 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market and Dividend Information

The Company’s common stock is quoted on the OTC Bulletin Board under the symbol “BKGMF.” Transactions of the Company’s common stock through private negotiated sales are also facilitated with the assistance of the Bank’s Trust Department. Management is not aware of any securities dealers which actively make a market in the Company’s common stock. No assurance can be given that an active trading market will be sustained for the common stock at any time in the future. The following table sets forth the high and low sale price for the common stock for the periods indicated, along with cash dividend payments for each of the quarters presented. The stock prices in the table are based upon information provided by the Bank’s Trust Department, and are derived from private sales executed through the Bank’s Trust Department and prices quoted through the OTC Bulletin Board.

 

 

 

Stock Price

 

 

 

 

 

 

 

High

 

 

Low

 

 

Dividend Per Share

 

Year ended December 31, 2018

 

 

 

 

 

 

 

 

 

 

 

 

Fourth Quarter

 

$

11.99

 

 

$

10.00

 

 

$

0.100

 

Third Quarter

 

$

12.00

 

 

$

10.00

 

 

$

0.100

 

Second Quarter

 

$

12.00

 

 

$

9.00

 

 

$

0.100

 

First Quarter

 

$

12.25

 

 

$

7.00

 

 

$

0.100

 

Year ended December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

Fourth Quarter

 

$

12.25

 

 

$

7.00

 

 

$

0.100

 

Third Quarter

 

$

12.00

 

 

$

9.50

 

 

$

0.100

 

Second Quarter

 

$

12.66

 

 

$

10.00

 

 

$

0.100

 

First Quarter

 

$

12.00

 

 

$

9.75

 

 

$

0.100

 

As of March 15, 2019, there were approximately 4,494 holders of record of common stock. There are no other classes of common equity.

Dividend Policy

At its discretion, the Board of Directors of the Company declares dividends to its stockholders on a quarterly basis. The Company declared and paid dividends of $0.10 per share to stockholders as of a declaration date for each share of common stock outstanding in each of the eight calendar quarters ended December 31, 2018.

The amount of future dividends will depend upon our earnings, financial condition, capital requirements and other factors, and will be determined by our Board of Directors on a quarterly basis. It is the policy of the Federal Reserve Board that bank holding companies generally pay dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. It is also the policy of the Federal Reserve Board that bank holding companies not maintain dividend levels that undermine the holding company’s ability to be a source of strength to its banking subsidiaries. Additionally, in consideration of the current financial and economic environment, the Federal Reserve Board has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong. Under the federal Prompt Corrective Action regulations, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company is undercapitalized, and the FDIC may prohibit a non-member bank from paying any dividends if the bank is undercapitalized.

As a holding company, our ability to pay cash dividends is affected by the ability of our bank subsidiary, the Bank, to pay cash dividends. The ability of the Bank (and our ability) to pay cash dividends in the future and the amount of any such cash dividends is and could in the future be further influenced by bank regulatory requirements and approvals and capital guidelines. Funds for payment of any cash dividends by the Company would be obtained from its investments as well as dividends from the Bank. The decision whether to pay dividends will be made by our Board of Directors in light of conditions then existing, including factors such as our results of operations, financial condition, business conditions, regulatory capital requirements and covenants under any applicable contractual arrangements, including agreements with regulatory authorities.

The Company also has $9.8 million in preferred stock outstanding for which it paid $546 thousand in dividends in 2018.

25


 

Securities Authorized for Issuance Under Equity Compensation Plans

Stock Purchase Plan

The Bank’s 2011 Employee Stock Purchase Plan (the “2011 Plan”) was adopted by the Bank’s Board of Directors and approved by the Bank’s Stockholders on May 2, 2011, to replace the Bank’s 2001 Non-Statutory Stock Option Plan. This plan was subsequently adopted by the Company. The 2011 Plan is open to all employees of the Company and the Bank who have met certain eligibility requirements.

Under the 2011 Plan, as amended and restated as of July 1, 2012, eligible employees can purchase, through payroll deductions, shares of common stock at a discount. The right to purchase stocks is granted to eligible employees during a quarterly offer period that is established from time to time by the Board of Directors of the Company. Eligible employees cannot accrue the right to purchase more than $25 thousand worth of stock at the fair market value at the beginning of each offer period. Eligible employees also may not purchase more than one thousand five hundred (1,500) shares of stock in any one offer period. The shares are purchased at 85% of the fair market price of the stock on the enrollment date.

 

 

 

At December 31, 2018

 

 

 

Number of securities to be issued upon exercise of outstanding options, warrants and rights

 

 

Weighted-average exercise price of outstanding options and rights

 

 

Number of securities remaining available for future issuance under equity compensation plans  (excluding securities reflected in column (a))

 

Plan category

 

(a)

 

 

(b)

 

 

(c)

 

Equity compensation plans

   approved by security holders

 

 

-

 

 

$

8.71

 

 

 

1,393,294

 

Equity compensation plans not

   approved by security holders

 

 

-

 

 

$

-

 

 

 

-

 

Total

 

 

-

 

 

$

8.71

 

 

 

1,393,294

 

 

26


 

ITEM 6.

Selected Financial Data

 

 

 

For the years ended December 31,

 

 

 

2018

 

 

2017

 

 

2016

 

 

2015

 

 

2014

 

 

 

(Dollar and Share Amounts in Thousands, Except Per Share Data)

 

INCOME STATEMENT DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

90,042

 

 

$

81,683

 

 

$

75,549

 

 

$

69,805

 

 

$

66,478

 

Interest expense

 

 

2,120

 

 

 

2,195

 

 

 

2,143

 

 

 

1,894

 

 

 

3,760

 

Net interest income before provision for loan losses

 

 

87,922

 

 

 

79,488

 

 

 

73,406

 

 

 

67,911

 

 

 

62,718

 

Provision for loan losses

 

 

12,862

 

 

 

7,519

 

 

 

3,900

 

 

 

4,500

 

 

 

4,540

 

Net interest income after provision for loan losses

 

 

75,060

 

 

 

71,969

 

 

 

69,506

 

 

 

63,411

 

 

 

58,178

 

Non-interest income

 

 

15,719

 

 

 

16,563

 

 

 

13,892

 

 

 

10,992

 

 

 

10,813

 

Non-interest expense

 

 

75,027

 

 

 

70,352

 

 

 

64,129

 

 

 

59,047

 

 

 

55,675

 

Income before income taxes

 

 

15,752

 

 

 

18,180

 

 

 

19,269

 

 

 

15,356

 

 

 

13,316

 

Income tax expense

 

 

2,913

 

 

 

9,636

 

 

 

5,716

 

 

 

4,066

 

 

 

3,756

 

Net income

 

 

12,839

 

 

 

8,544

 

 

 

13,553

 

 

 

11,290

 

 

 

9,560

 

Preferred stock dividends

 

 

(546

)

 

 

(552

)

 

 

(49

)

 

 

-

 

 

 

-

 

Net income attributable to common stockholders

 

$

12,293

 

 

$

7,992

 

 

$

13,504

 

 

$

11,290

 

 

$

9,560

 

PER COMMON SHARE DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic net income

 

$

1.28

 

 

$

0.86

 

 

$

1.46

 

 

$

1.25

 

 

$

1.08

 

Diluted net income

 

$

1.28

 

 

$

0.86

 

 

$

1.46

 

 

$

1.25

 

 

$

1.08

 

Book value per common share

 

$

14.36

 

 

$

13.64

 

 

$

13.21

 

 

$

12.14

 

 

$

11.44

 

Weighted average number of shares outstanding —

   basic

 

 

9,614

 

 

 

9,291

 

 

 

9,251

 

 

 

9,017

 

 

 

8,818

 

Weighted average number of shares outstanding —

   diluted

 

 

9,614

 

 

 

9,291

 

 

 

9,251

 

 

 

9,017

 

 

 

8,818

 

Shares outstanding at period end

 

 

9,646

 

 

 

9,414

 

 

 

9,268

 

 

 

9,241

 

 

 

8,929

 

BALANCE SHEET DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities

 

$

454,777

 

 

$

555,935

 

 

$

520,927

 

 

$

329,816

 

 

$

337,904

 

Net loans

 

$

1,212,141

 

 

$

1,209,824

 

 

$

1,158,045

 

 

$

1,054,250

 

 

$

967,399

 

Allowance for loan losses

 

$

23,774

 

 

$

17,279

 

 

$

15,435

 

 

$

14,159

 

 

$

12,526

 

Goodwill and other intangible assets

 

$

783

 

 

$

783

 

 

$

783

 

 

$

783

 

 

$

783

 

Total assets

 

$

1,891,702

 

 

$

1,965,946

 

 

$

1,921,552

 

 

$

1,544,284

 

 

$

1,465,739

 

Total deposits

 

$

1,728,823

 

 

$

1,816,132

 

 

$

1,778,670

 

 

$

1,422,671

 

 

$

1,355,514

 

Total stockholders’ equity

 

$

148,295

 

 

$

138,147

 

 

$

132,202

 

 

$

112,142

 

 

$

102,183

 

SELECTED PERFORMANCE RATIOS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

 

0.67

%

 

 

0.44

%

 

 

0.77

%

 

 

0.74

%

 

 

0.66

%

Return on average equity

 

 

8.86

%

 

 

6.24

%

 

 

11.22

%

 

 

10.50

%

 

 

9.78

%

Dividend payout

 

 

31.35

%

 

 

46.52

%

 

 

27.41

%

 

 

32.07

%

 

 

41.59

%

Equity to assets

 

 

7.84

%

 

 

7.03

%

 

 

6.88

%

 

 

7.26

%

 

 

6.97

%

Net interest margin

 

 

4.79

%

 

 

4.24

%

 

 

4.39

%

 

 

4.66

%

 

 

4.52

%

CAPITAL RATIOS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total risk-based

 

 

13.33

%

 

 

12.49

%

 

 

12.61

%

 

 

12.45

%

 

 

11.83

%

Tier 1 risk-based

 

 

12.07

%

 

 

11.24

%

 

 

11.36

%

 

 

11.20

%

 

 

10.58

%

Tier 1 leverage

 

 

7.77

%

 

 

6.97

%

 

 

7.06

%

 

 

7.40

%

 

 

7.01

%

Common Equity Tier 1 risk-based

 

 

11.66

%

 

 

10.83

%

 

 

10.93

%

 

 

11.20

%

 

 

N/A

 

 

 

27


 

ITEM 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of the Company and its wholly-owned subsidiary, the Bank. This information is intended to facilitate the understanding and assessment of significant changes and trends related to our financial condition and the results of operations. This discussion and analysis should be read in conjunction with our consolidated financial statements and the accompanying notes presented elsewhere in this Annual Report.

Executive Summary

This summary is intended to identify the most important matters on which management focuses when it evaluates the financial condition and performance of the Bank. When evaluating financial condition and performance, management looks at certain key metrics and measures. The Bank’s evaluation includes comparisons with peer group financial institutions and its own performance objectives established in internal planning processes.

The primary activity of the Bank is commercial banking, as it has been since the Bank opened in Guam in 1972. The Company’s operations are located entirely in the U.S. territories, the U.S.-affiliated nations of the western Pacific, and in the San Francisco Bay area of California. The largest community in the Bank’s western Pacific market is Guam, followed by the Commonwealth of the Northern Mariana Islands. The market includes a number of transportation-, travel- and tourism-related companies in the region, as well as substantial U.S. Department of Defense and other U.S. federal government activities in Guam. The Company’s customers are primarily transnational corporations, governments, closely-held businesses and individuals.

During 2018, there were five significant factors that impacted the Company’s financial condition and operations:

 

Over the course of the year, tourist arrivals continued to increase in Guam and other islands in the region, excepting the Republic of Palau. In Guam, the number of visitors reached its highest level in history, at 1.55 million. This was due, in part, to the fact that a 9.2% decrease in Japanese arrivals was more than offset by increasing arrivals from South Korea, with the latter increasing by 9.1%. The continuing growth in Guam’s tourism industry and increasing arrivals in the other islands led to modest improvements in payroll employment and other aspects of the regional economy, enhancing the Bank’s business.

 

The military buildup continues, and substantial funding is being provided for the relocation of U.S. Marines from Okinawa to Guam.  Several contracts, totaling hundreds of millions of dollars, were executed during 2017 and 2018, and additional years of construction and related activity are expected to bring increased investment and income to Guam. Once completed, the activities that these projects support will provide a sustained contribution to the economy.

 

Many of Guam’s resident construction workers have been absorbed by military construction projects, and the disinclination of the U.S. Department of Homeland Security to issue H-2B visas to temporary foreign construction workers has brought work on civilian projects nearly to a standstill. The resulting difficulty building new structures in the civilian community as existing structures age and are taken out of service has distorted Guam’s real estate market, causing developed land prices to rise while raw land prices decrease. In addition, many investment opportunities in the private sector that would have brought outside funds into the local economy have been lost, slowing the pace of Guam’s economic growth.

 

The Commonwealth of the Northern Mariana Islands experienced two typhoons during 2018, and sustained substantial damage to housing, commercial buildings and public facilities. Bank of Guam offered the temporary suspension of loan payments in order to help the CNMI recover. Repairs to reconstruction of the islands’ infrastructure and superstructure continue through the date of this filing.

 

The continuing strength of the economy in the San Francisco Bay area provided ample opportunities to expand the Bank’s business there, leading to an increase of 1.9% in the California region’s loan portfolio, supplementing 13.6% growth in loans in the Commonwealth of the Northern Mariana Islands and supporting overall growth of 0.7% in the total loan portfolio, as loans in Guam decreased by 1.0%. The 3.8% decrease in the Bank’s asset base reflected an 18.3% reduction of our investment portfolio, partially offset by an increase of 23.0% in our cash and cash equivalents. The 4.6% decrease in total liabilities during the year was partially offset by the 7.3% increase in our stockholders’ equity.

For the year ended December 31, 2018, net income attributable to common stockholders was $12.3 million, or $1.28 per diluted common share. For the year ended December 31, 2017, net income was $8.0 million, or $0.86 per diluted common share. For the year ended December 31, 2016, net income was $13.5 million, or $1.46 per diluted common share.

28


 

The returns on average assets and average equity for the year ended December 31, 2018, were 0.67% and 8.86%, respectively, compared to 0.44% and 6.24%, respectively, for 2017, and 0.77% and 11.22%, respectively, for 2016.

The following are major factors that impacted the Company’s results of operations:

 

Net interest income increased 10.6% to $87.9 million for the year ended December 31, 2018, from $79.5 million for the year ended December 31, 2017, due to an $8.4 million increase in interest income that was enhanced by a reduction of $75 thousand in interest expense. Net interest income increased by 8.3% to $79.5 million for the year ended December 31, 2017, from $73.4 million for the year ended December 31, 2016, due to a $6.1 million increase in interest income that was partially offset by an increase of $52 thousand in interest expense.

 

The net interest margin increased 54 basis points to 4.79% for the year ended December 31, 2018, compared with 4.24% for the year ended December 31, 2017. The increase in the net interest margin for 2018 compared to 2017 was primarily due to a 32 basis point increase in the average yields on loans, a 43 basis point increase in the average yield on our securities portfolio and a 49 basis point increase in the average yield on our deposits with other financial institutions; the average rates that we paid on deposits increased by 0.6 basis points. Despite the decrease in the overall average yield of 16 basis points on our total earning assets, higher loan and investment volumes generated higher interest income that more than offset the higher gross amount of interest paid on our customers’ deposits.

 

The provision for loan losses was $12.9 million for the year ended December 31, 2018, $5.3 million higher than the provision during 2017. The 2018 provision was increased to reflect the growth of $8.7million in our loan portfolio and as protection against possible losses in relation to a single large borrower that we expected to file and did file for Chapter 11 bankruptcy in January 2019.  The provision is deemed by management to provide a sufficient allowance for loan losses due to the higher risk to the overall loan portfolio and to net losses of $6.4 million during the year. The provision for loan losses was $7.5 million for the year ended December 31, 2017, which was $3.6 million higher than the provision during the previous year. The provision for loan losses was $3.9 million for the year ended December 31, 2016, including $12 thousand assigned to the reserve for off-balance sheet risk.

 

Non-interest income was $15.7 million for the year ended December 31, 2018, $844 thousand less than the $16.6 million for the year ended December 31, 2017. The decrease in non-interest income in 2018 compared to 2017 was primarily due to a reduction of $881 thousand in trustee fees and a reversal of $597 thousand in net investment securities gains, from a gain of $4 thousand in 2017 to a loss of $593 thousand in 2018, partially offset by a $448 thousand increase in other income and a $289 thousand increase in net cardholder income. The decrease in trustee fees represents a return to a more normal level after a large, one-time increase in 2017. The loss on the sale of investment securities occurred due to a need to replenish our liquidity after large withdrawals and funds transfers during the first half of 2018. Non-interest income was $16.6 million for the year ended December 31, 2017, $2.7 million more than the $13.9 million for the year ended December 31, 2016. The increase in non-interest income in 2017 compared to 2016 was primarily due to increases of $2.5 million in trustee fees, $792 thousand in service charges and fees, $314 thousand in net income from merchant services and a $257 thousand increase in other income, partially offset by an $813 thousand decrease in net cardholder income, and a reduction of $397 thousand in our realized gain on the sale of investment securities.

 

Non-interest expense was $75.0 million for the year ended December 31, 2018, compared to $70.4 million for the year ended December 31, 2017. The increase of 6.6%, primarily due to an increase of $2.5 million in salaries and employee benefits, an additional $1.0 million in equipment and depreciation expense, a rise of $810 thousand in professional services expense, a $610 thousand increase in occupancy expense and an increase of $517 thousand in expenses related to other real estate owned, partially offset by a $742 thousand decrease in general, administrative and other expenses. Non-interest expense was $70.4 million for the year ended December 31, 2017, compared to $64.1 million for the year ended December 31, 2016. The increase of 9.7%, primarily due to an increase of $2.6 million in salaries and employee benefits, an additional $1.7 million in equipment and depreciation expense, a rise of $1.0 million in general, administrative and other expenses, and a $400 thousand increase in occupancy expenses.

 

The 50.3% increase of net after tax income to $12.8 million in 2018 compared to $8.5 million 2017 was due to the $8.4 million increase in net interest income and the $6.7 million decrease in income tax expense, partially offset by the $5.3 million increase in our provision for loan losses, the $4.7 million increase in non-interest expense and the $844 thousand decrease in non-interest income. The 37.0% decrease of net after tax income to $8.5 million in 2017 compared to $13.6 million in 2016 was due to the $6.2 million increase in non-interest expense, the $3.9 million increase in income tax expense and the $3.6 million increase in our provision for loan losses, offset by the $6.1 million increase in total interest income.

29


 

The following are important factors in understanding our current financial condition and liquidity position:

 

Cash, interest-bearing deposits in other banks, and investment securities available-for-sale collectively decreased by $50.8 million (8.7%), to $536.1 million, at December 31, 2018, from $586.9 million at December 31, 2017. This decrease in liquid assets is due to a decrease of $79.7 million in securities available-for-sale, partially offset by a $24.7 million increase in interest bearing deposits in other banks and a $4.2 million increase in cash.

 

Total assets decreased by $74.2 million (3.8%), from $1.97 billion at December 31, 2017, to $1.89 billion at December 31, 2018. This decrease was composed of a $101.3 million or 18.3% decrease in investment securities, to $449.1 million at December 31, 2018, compared to $550.5 million at December 31, 2017, and a decrease of $5.5 million in other assets to $44.6 million, partially offset by an increase of $29.0 million in cash and cash equivalents, from $126.1 million at December 31, 2017, to $155.1 million at December 31, 2018, and an increase of $2.3 million in net loans (net of deferred fees and the allowance for loan losses) during the same period. The increase in loans was primarily attributable to an increase of $24.4 million in gross commercial loans, to $844.4 million at the end of 2018 compared to $820.0 million a year earlier, partially offset by a decrease of $15.7 million in gross consumer loans, to $394.2 million at December 31, 2018, from $409.9 million at December 31, 2017. As the contra to the decrease of total assets, total liabilities decreased by $84.4 million, to $1.74 billion at December 31, 2018, based upon a decrease of $87.3 million in total deposits from the previous year end, partially offset by an increase of $2.9 million in other liabilities. Reducing the effect of the decrease in total liabilities, total stockholders’ equity increased by $10.1 million, composed of the $8.4 million increase in retained earnings and $2.7 million in additional paid-in common stock, offset by an increase of $1.1 million in accumulated other comprehensive loss.

 

Classified assets increased to $74.5 million at December 31, 2018, compared to $32.2 million at December 31, 2017.

 

The allowance for loan losses at December 31, 2018, was $23.8 million, or 1.92% of total gross loans. The allowance for loan losses at December 31, 2017, was $17.3 million, or 1.40% of total gross loans.

 

Nonperforming loans decreased by $1.1 million to $7.1 million, or 0.57% of total gross loans, at December 31, 2018, from $8.1 million, or 0.66% of total gross loans, at December 31, 2017.

 

Net loan charge-offs were $6.4 million during the year ended December 31, 2018, as compared to the $5.7 million in net charge-offs for the year ended December 31, 2017.

 

The ratio of noncore funding of $14.2 million (which consists of $250,000 and over time deposits plus short-term borrowings) to total assets was 0.75% at December 31, 2018, compared to $16.5 million, or 0.84% of total assets, at December 31, 2017.

 

The loan-to-deposit ratio increased to 71.6% at December 31, 2018, as compared to 67.7% at December 31, 2017, due to total gross loan growth of $8.7 million and the $87.3 million decrease in deposits.

 

Capital ratios significantly exceed regulatory requirements for a well-capitalized financial institution, both at the Company level and in the Bank. The leverage ratio of the Company was 7.99%, with a Tier 1 risk-based capital ratio of 12.40%, a total risk-based capital ratio of 13.66%, and a common equity Tier 1 risk-based capital ratio of 11.61% at December 31, 2018. The leverage ratio at the Company was 7.19%, with a Tier 1 risk-based capital ratio of 11.58%, a total risk-based capital ratio of 12.83% and a common equity Tier 1 risk-based capital ratio of 10.78% at December 31, 2017. The leverage ratio at the Bank was 7.77%, with a Tier 1 risk-based capital ratio of 12.07%, a total risk-based capital ratio of 13.33%, and a common equity Tier 1 risk-based capital ratio of 11.66% at December 31, 2018. The leverage ratio at the Bank was 6.97%, with a Tier 1 risk-based capital ratio of 11.24%, a total risk-based capital ratio of 12.49% and a common equity Tier 1 risk-based capital ratio of 10.83% at December 31, 2017. The regulatory well-capitalized guidelines are a minimum of a 5% leverage ratio, an 8% Tier 1 risk-based capital ratio, a 10% total risk-based capital ratio, and a 6.5% common equity Tier 1 risk-based capital ratio. The changes in our capital ratios from December 31, 2017, to December 31, 2018, were due to the retention of $8.4 million in earnings during 2018.

Deposits

The composition and cost of the Bank’s deposit base are important in analyzing the Bank’s net interest margin and balance sheet liquidity characteristics. The Bank’s depositors are generally located in its primary market area. Depending on loan demand and other funding requirements, the Bank also attracts deposits through its interest rate pricing. The Bank monitors all deposits that may be sensitive to interest rate changes to help ensure that liquidity risk does not become excessive due to deposit migration. Deposits at December 31, 2018, were $1.73 billion, compared to $1.82 billion at December 31, 2017. The 4.8% decrease was primarily due to the reductions of $44.3 million (9.0%) in deposits in the Freely Associated States of Micronesia, primarily due to the disbursement of funds from one large commercial depositor, $36.0 million (3.8%) in deposits in Guam, in the ordinary course of business, and $8.2 million (2.4%) in the Commonwealth of the Northern Mariana Islands, partially offset by an increase of $1.1 million (2.4%) in the Bank’s deposits in the California region.

30


 

The Bank does not currently accept brokered deposits because it already maintains ample liquidity.

Liquidity

Our liquidity position refers to our ability to maintain cash flows sufficient to fund operations and to meet obligations and other commitments in a timely fashion. We believe that the Bank’s liquidity position is more than sufficient to meet our operating expenses, borrowing needs and other obligations for 2019, and management has tested and determined that, even under severely stressed scenarios, the Bank’s liquidity will be more than adequate to meet our requirements. Our liquidity decreased substantially during 2018. Once the increases in our loan portfolio and other assets were accommodated, the decrease in our liabilities and smaller increase in our equity were channeled into an increase in cash and cash equivalents, but together they did not fully offset the decrease in our available-for-sale investment securities. At December 31, 2018, we had $155.1 million in cash and cash equivalents and approximately $172.3 million in available borrowing capacity from various sources, including the Federal Home Loan Bank (“FHLB”), the Federal Reserve Bank of San Francisco (“FRB”), and Federal Funds facilities with several financial institutions. The Bank also had $168.9 million in unpledged securities available at December 31, 2018. Our loan-to-deposit ratio increased to 71.6% at December 31, 2018, compared to 67.7% at December 31, 2017, as our gross loans increased by 0.7% and our deposits decreased by 4.8%.

Lending

Our loans originate almost entirely through the branch offices located in our primary market. As the Bank approached a saturation point in our island service area, we expanded our activities in California through our branch in San Francisco. The total loan portfolio remains well diversified with commercial and industrial loans accounting for 19.7% and commercial real estate loans accounting for 45.3% of the total loan portfolio at December 31, 2018. Construction loans rose from 0.8% of the portfolio at December 31, 2017, to 3.2% at December 31, 2018. Residential mortgages and other consumer-related loans accounted for the remaining 31.8% of total loans at December 31, 2018. The increase in gross loans during 2018 compared to 2017 was primarily due to an increase of $24.4 million, or 3.0%, in our commercial loan portfolio, partially offset by a $15.7 million, or 3.8%, decrease in consumer loans. The Bank also had a decrease of $15.9 million in loans sold to the Federal Home Loan Mortgage Corporation (“Freddie Mac”) from $205.5 million at December 31, 2017, to $189.6 million at December 31, 2018, but these loans are off-book, except for the value of the associated mortgage servicing rights. The Bank exercises careful selectivity with respect to the types of loans it chooses to originate.

Net Interest Income

The management of interest income and expense is fundamental to the performance of the Company and the Bank. Net interest income, the difference between interest income and interest expense, is the largest component of the Bank’s total revenue. Management closely monitors both total net interest income and the net interest margin (net interest income divided by average earning assets).

The Bank, through its asset and liability management policies and practices, as overseen by its Asset and Liability Committee, seeks to maximize net interest income without exposing itself to an excessive level of interest rate risk. Interest rate risk is managed by monitoring the pricing, maturity and repricing options of all classes of interest-bearing assets and liabilities. This is discussed in more detail under Liquidity and Asset/Liability Management. In addition, as the market allows, we take measures and initiatives to improve our net interest margin, including increasing loan rates, maintaining interest rate floors on floating rate loans, reducing nonperforming assets, managing deposit interest rates and reducing higher-cost deposits.

From January 22, 2008, through December 16, 2008, the Federal Reserve’s Open Market Committee reduced its target short-term interest rates by 325 basis points, to a range of 0.00% to 0.25%, in response to the credit crisis and economic downturn that resulted from the collapse in the U.S. housing market and the subsequent global recession. The target Federal Funds Rate was raised to a range of 0.25% to 0.50% on December 16, 2015, then again to a range of 0.50% to 0.75% on December 15, 2016. During 2017, the target Federal Funds Rate was increased by 25 basis points three times, on March 15, June 14 and December 13, and four more times during 2018, on March 21, June 13, September 26 and December 19, ending in a target range from 2.25% to 2.50%. The increase in short-term rates has gradually affected the rates applicable to the Bank’s floating rate loans. Despite the increase in short-term interest rates, the overall cost of interest-bearing deposits, which represent the Bank’s primary funding source, decreased by 3.9% by the end of 2018, as deposits tend to re-price more slowly than floating rate loans and the decrease in higher-yielding deposits, such as savings accounts and certificates of deposit, was more than proportional to the overall decrease in deposits. The increase in the level of short-term interest rates, including the prime rate, has helped the Bank to increase its net interest margin, from 4.24% in 2017 to 4.79% in 2018.

31


 

Management of Credit Risk

We continue to proactively identify, quantify and manage our problem loans. Early identification of problem loans and potential future losses helps enable us to resolve credit issues with potentially less risk and lower ultimate losses. We maintain an allowance for loan losses in an amount that we believe is adequate to absorb probable and projected incurred losses in the portfolio. While we strive to carefully monitor and manage credit quality and to identify loans that may be deteriorating, circumstances can change at any time that may result in future losses for loans included in the portfolio, that as of the date of the financial statements have not yet been identified as potential problem loans. Through established credit practices, we adjust the allowance for loan losses accordingly. However, because future events are uncertain, there may be loans that deteriorate, some of which could occur in an accelerated time frame. As a result, future additions to the allowance may be necessary. Because the loan portfolio contains a number of commercial loans, commercial real estate and construction loans with relatively large balances, deterioration in the credit quality of one or more of these loans may require a significant increase to the allowance for loan losses. Future additions to the allowance may also be required based on changes in the financial condition of borrowers, such as have resulted due to changing economic conditions. Additionally, federal and local banking regulators throughout our market area, as an integral part of their supervisory function, periodically review our allowance for loan losses. These regulatory agencies may require us to recognize further loan loss provisions or charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses may have a material adverse effect on our financial condition and results of operation.

We also maintain a reserve against potential credit risks associated with our unfunded off-balance sheet loan commitments.

Further discussion of the management of credit risk appears under “Provision for Loan Losses” and “Allowance for Loan Losses”.

Capital Management

As part of its asset and liability management process, the Company continually assesses its capital position to take into consideration growth, expected earnings, risk profile and potential corporate activities that it may choose to pursue.

During the past several years, the Bank’s principal source of increases in capital has been retained earnings, supplemented by stock purchases through our Employee Stock Purchase Plan. See Note 14 of Notes to Consolidated Financial Statements in Item 15 of this Annual Report for a description of the Employee Stock Purchase Plan. Since the formation of the Company in 2011, though, the Bank’s assets have grown by 71.4%, prompting the Bank to seek additional sources of capital. Those more traditional sources of additional capital are finally catching up, having increased by 67.1% during the same period. A portion of the increase in capital was derived from the sale of additional common and preferred stock.

Although the Bank remains “well capitalized” by all four regulatory measures of capital adequacy, the Bank’s Tier 1 ratio had been decreasing because of its rapid asset growth, primarily attributed to the substantial growth in customer deposits. Consequently, the Company placed an additional $2.8 million of its common stock during, 2015, placed $9.8 million in non-cumulative perpetual preferred stock during 2016 and placed an additional $4.2 million of common stock in a registered public offering between September 29, 2017 and March 31, 2018.

In the 2015 and 2016 offerings, the Company issued its stock to certain "accredited investors" within the meaning of Rule 501 of the Securities Act of 1933, as amended (the "Securities Act") in reliance on the exemption from registration afforded under Section 4(2) of the Securities Act and Rule 504 of Regulation D under the Securities Act, at a purchase price of $9.85 per common share in 2015 and a purchase price of $1,000.00 per preferred share in 2016 (the "Private Offerings"). These were restricted shares, which could not be resold for a period of two years. The terms of the offerings were set forth in their respective Stock Purchase Agreements, dated July 30, 2015, and September 28, 2016, entered into between the Company and each investor. The stock offered in the Private Offerings has not been registered under the Securities Act or state securities laws, and may not be offered or sold in the United States without being registered with the SEC or through an applicable exemption from SEC registration requirements.

During the fourth quarter of 2017 and the first quarter of 2018, the Company issued an additional $4.2 million in common stock in an SEC-registered public offering at a purchase price of $12.25 per common share.

A portion of the proceeds from these offerings was used to retire subordinated debt, while the remainder will allow the Company to support the continued organic growth of its banking subsidiary in its existing market areas and will enable us to further serve the needs of individuals and businesses in those markets.

32


 

Results of Operations

The Bank earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less a provision for loan losses and interest expense on interest-bearing liabilities. The second is non-interest income, which primarily consists of service charges and fees, income from merchants for processing credit and debit card transactions, non-interest income from holders of the Bank’s credit cards, trustee fees and net investment securities gains. The majority of the Company’s non-interest expenses are operating costs that relate to providing a full range of banking services to our customers.

Distribution, Rate and Yield

The following Distribution, Rate and Yield table presents the average amounts outstanding during 2018 and 2017 for the major categories of the Company’s balance sheet, the average interest rates earned or paid thereon, and the resulting net interest margin on average interest earning assets for the periods indicated. Average balances are based on monthly averages.

 

 

 

Years Ended December 31,

 

 

 

2018

 

 

2017

 

 

 

Average

Balance

 

 

Interest

Earned/Paid

 

 

Average

Yield/Rate

 

 

Average

Balance

 

 

Interest

Earned/Paid

 

 

Average

Yield/Rate

 

Interest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Short term investments1

 

$

94,878

 

 

$

1,202

 

 

 

1.27

%

 

$

129,699

 

 

$

1,009

 

 

 

0.78

%

Investment Securities²

 

 

503,180

 

 

 

9,682

 

 

 

1.92

%

 

 

549,508

 

 

 

8,217

 

 

 

1.50

%

Loans³

 

 

1,239,065

 

 

 

79,158

 

 

 

6.39

%

 

 

1,193,488

 

 

 

72,457

 

 

 

6.07

%

Total earning assets

 

 

1,837,123

 

 

 

90,042

 

 

 

4.90

%

 

 

1,872,695

 

 

 

81,683

 

 

 

4.36

%

Noninterest earning assets

 

 

86,959

 

 

 

 

 

 

 

 

 

 

 

84,985

 

 

 

 

 

 

 

 

 

Total Assets

 

$

1,924,082

 

 

 

 

 

 

 

 

 

 

$

1,957,680

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing checking accounts

 

$

266,061

 

 

$

318

 

 

 

0.12

%

 

$

274,615

 

 

$

326

 

 

 

0.12

%

Money market and savings accounts

 

 

921,281

 

 

 

1,676

 

 

 

0.18

%

 

 

987,470

 

 

 

1,726

 

 

 

0.17

%

Certificates of deposit

 

 

32,708

 

 

 

116

 

 

 

0.35

%

 

 

44,165

 

 

 

143

 

 

 

0.32

%

Other borrowings

 

 

-

 

 

 

10

 

 

 

0.00

%

 

 

-

 

 

 

-

 

 

 

0.00

%

Total interest-bearing liabilities

 

 

1,220,050

 

 

 

2,120

 

 

 

0.17

%

 

 

1,306,250

 

 

 

2,195

 

 

 

0.17

%

Non-interest bearing liabilities

 

 

559,102

 

 

 

 

 

 

 

 

 

 

 

514,615

 

 

 

 

 

 

 

 

 

Total Liabilities

 

 

1,779,152

 

 

 

 

 

 

 

 

 

 

 

1,820,865

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

144,930

 

 

 

 

 

 

 

 

 

 

 

136,815

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’

   equity

 

$

1,924,082

 

 

 

 

 

 

 

 

 

 

$

1,957,680

 

 

 

 

 

 

 

 

 

Net interest income

 

 

 

 

 

$

87,922

 

 

 

 

 

 

 

 

 

 

$

79,488

 

 

 

 

 

Interest rate spread

 

 

 

 

 

 

 

 

 

 

4.73

%

 

 

 

 

 

 

 

 

 

 

4.19

%

Net interest margin

 

 

 

 

 

 

 

 

 

 

4.79

%

 

 

 

 

 

 

 

 

 

 

4.24

%

 

1

Includes interest bearing deposit balances we maintain with other financial institutions and the Federal Reserve Bank of San Francisco.

2

Includes all investment securities in the Available-for-Sale and the Held-to-Maturity classifications.

3

Includes average balances of non-accrual loans.

The Distribution, Rate and Yield table above sets forth the dollar amounts in interest earned and paid for each major category of interest earning assets and interest-bearing liabilities for the noted periods, as well as their respective yields and costs, and the resulting interest rate spreads and net interest margins.

The Bank’s net interest margin, expressed as a percentage of average earning assets, was 4.79% for 2018, up 55 basis points from 4.24% for 2017, even as average earning assets decreased by 1.9% during the year, from $1.87 billion in 2017 to $1.84 billion in 2018. The reason for the increase in the net interest margin was that our funding cost decreased by 3.4%, from $2.2 million in 2017 to $2.1 million in 2018, while our average earning assets generated an increase of $8.4 million, from $81.7 million in 2017 to $90.0 million in 2018. Our average loan balances increased by $45.6 million, or 3.8%, and the average yield on the entire loan portfolio increased by 32 basis points so that interest earnings on loans increased by $6.7 million, or 10.2%. New loans made in a rising rate environment, as well as the repricing of outstanding variable rate loans, caused the increase in the average yield on the loan portfolio. Yields on our investment securities portfolio increased by 43 basis points and the yield on short term investments went up by 49 basis points. Average total interest-bearing liabilities decreased by 6.6% during 2018, to $1.22 billion from $1.31 billion the previous year.

33


 

Net interest income for the year ended December 31, 2018, increased by $8.4 million, to $87.9 million, compared to $79.5 million a year earlier, primarily due to an increase in interest income derived from the growth in our loan portfolio, supplemented by increases in earnings on average investment securities balances and our short term deposits in other banks, including the Federal Reserve Bank of San Francisco. Net interest income for 2017 increased by $5.9 million, to $79.5 million, compared to $73.4 million in 2016, primarily due to an increase in interest income derived from the growth in our investment securities portfolio, supplemented by increases in earnings on average loan balances and our short term deposits in other banks, including the Federal Reserve Bank of San Francisco. The Bank’s net interest margin was 4.24% for 2017, down 15 basis points from 4.39% for 2016, even though average earning assets increased by 12.0% during the year, from $1.67 billion in 2016 to $1.87 billion in 2017.

A substantial portion of the Bank’s earning assets are variable-rate loans that re-price when the Bank’s reference rate, which usually corresponds with the New York prime lending rate, is changed. This is in contrast to a large base of core deposits that are generally slower to re-price. This causes the Bank’s balance sheet to be asset-sensitive, which means that, all else being equal, net interest margin will be higher during periods when short-term interest rates are rising and lower when rates are falling. However, we will not necessarily have to raise rates on the personal savings portion of our core deposits as general market interest rates increase, increasing the sensitivity of our net interest margin to rising interest rates.

The following table provides information regarding the changes in interest income and interest expense, attributable to changes in rates and changes in volumes that contribute to the total change in net interest income for the years ending December 31, 2018 and 2017. Variances attributable to both rate and volume changes are equal to the change in rate times the change in average balance and are included below in the average volume column.

 

 

 

Years Ended December 31, 2018 and 2017

 

 

 

(In thousands)

 

 

 

 

 

 

 

Attributable to:

 

 

 

Net Change in

Interest