10-Q 1 boh_20170930x10q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-Q
 
(Mark One)
 
x          Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period
    ended September 30, 2017
or
o                 Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition
period from              to            
 
Commission File Number: 1-6887
 
BANK OF HAWAII CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
99-0148992
(State of incorporation)
 
(I.R.S. Employer Identification No.)
 
 
 
130 Merchant Street, Honolulu, Hawaii
 
96813
(Address of principal executive offices)
 
(Zip Code)
 1-888-643-3888
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See 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 x
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o  No x
 
As of October 17, 2017, there were 42,478,643 shares of common stock outstanding.



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

1


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Income (Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(dollars in thousands, except per share amounts)
2017

 
2016

 
2017

 
2016

Interest Income
 

 
 

 
 

 
 

Interest and Fees on Loans and Leases
$
94,621

 
$
83,489

 
$
273,467

 
$
246,707

Income on Investment Securities
 
 
 
 
 
 
 
Available-for-Sale
11,987

 
10,313

 
34,906

 
31,648

Held-to-Maturity
20,334

 
19,315

 
59,958

 
59,874

Deposits
5

 
1

 
12

 
7

Funds Sold
1,579

 
695

 
3,165

 
2,066

Other
235

 
166

 
673

 
531

Total Interest Income
128,761

 
113,979

 
372,181

 
340,833

Interest Expense
 

 
 

 
 

 
 

Deposits
6,663

 
3,232

 
15,352

 
9,199

Securities Sold Under Agreements to Repurchase
4,664

 
5,713

 
14,928

 
18,000

Funds Purchased

 
3

 
42

 
9

Short-Term Borrowings

 

 
64

 

Other Debt
1,117

 
1,119

 
3,327

 
3,139

Total Interest Expense
12,444

 
10,067

 
33,713

 
30,347

Net Interest Income
116,317

 
103,912

 
338,468

 
310,486

Provision for Credit Losses
4,000

 
2,500

 
12,650

 
1,500

Net Interest Income After Provision for Credit Losses
112,317

 
101,412

 
325,818

 
308,986

Noninterest Income
 

 
 

 
 

 
 

Trust and Asset Management
11,050

 
11,008

 
34,325

 
34,971

Mortgage Banking
3,237

 
6,362

 
10,356

 
13,639

Service Charges on Deposit Accounts
8,188

 
8,524

 
24,522

 
25,117

Fees, Exchange, and Other Service Charges
13,764

 
14,023

 
41,061

 
41,445

Investment Securities Gains (Losses), Net
(566
)
 
(328
)
 
11,047

 
10,540

Annuity and Insurance
1,429

 
1,653

 
5,585

 
5,560

Bank-Owned Life Insurance
1,861

 
1,911

 
4,908

 
5,010

Other
3,447

 
4,961

 
11,758

 
14,558

Total Noninterest Income
42,410

 
48,114

 
143,562

 
150,840

Noninterest Expense
 

 
 

 
 

 
 

Salaries and Benefits
51,626

 
49,725

 
153,341

 
150,528

Net Occupancy
7,727

 
8,510

 
24,026

 
22,671

Net Equipment
5,417

 
4,913

 
16,624

 
15,387

Data Processing
3,882

 
3,620

 
11,173

 
11,543

Professional Fees
3,044

 
2,396

 
8,415

 
7,082

FDIC Insurance
2,107

 
2,104

 
6,413

 
6,600

Other
14,795

 
16,264

 
45,363

 
47,178

Total Noninterest Expense
88,598

 
87,532

 
265,355

 
260,989

Income Before Provision for Income Taxes
66,129

 
61,994

 
204,025

 
198,837

Provision for Income Taxes
20,248

 
18,501

 
62,306

 
60,889

Net Income
$
45,881

 
$
43,493

 
$
141,719

 
$
137,948

Basic Earnings Per Share
$
1.09

 
$
1.02

 
$
3.35

 
$
3.23

Diluted Earnings Per Share
$
1.08

 
$
1.02

 
$
3.32

 
$
3.21

Dividends Declared Per Share
$
0.52

 
$
0.48

 
$
1.52

 
$
1.41

Basic Weighted Average Shares
42,251,541

 
42,543,122

 
42,336,441

 
42,730,571

Diluted Weighted Average Shares
42,565,364

 
42,778,346

 
42,662,163

 
42,947,059

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

2


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income (Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(dollars in thousands)
 
2017

 
2016

 
2017

 
2016

Net Income
 
$
45,881

 
$
43,493

 
$
141,719

 
$
137,948

Other Comprehensive Income (Loss), Net of Tax:
 
 

 
 

 
 

 
 

Net Unrealized Gains (Losses) on Investment Securities
 
444

 
(5,528
)
 
8,444

 
8,323

Defined Benefit Plans
 
146

 
140

 
439

 
422

Total Other Comprehensive Income (Loss)
 
590

 
(5,388
)
 
8,883

 
8,745

Comprehensive Income
 
$
46,471

 
$
38,105

 
$
150,602

 
$
146,693

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

3


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Condition (Unaudited)
(dollars in thousands)
September 30,
2017

 
December 31,
2016

Assets
 

 
 

Interest-Bearing Deposits in Other Banks
$
3,161

 
$
3,187

Funds Sold
512,868

 
707,343

Investment Securities
 

 
 

Available-for-Sale
2,322,668

 
2,186,041

Held-to-Maturity (Fair Value of $3,960,956 and $3,827,527)
3,960,598

 
3,832,997

Loans Held for Sale
9,752

 
62,499

Loans and Leases
9,573,956

 
8,949,785

Allowance for Loan and Lease Losses
(106,881
)
 
(104,273
)
Net Loans and Leases
9,467,075

 
8,845,512

Total Earning Assets
16,276,122

 
15,637,579

Cash and Due From Banks
245,487

 
169,077

Premises and Equipment, Net
125,162

 
113,505

Accrued Interest Receivable
51,526

 
46,444

Foreclosed Real Estate
1,393

 
1,686

Mortgage Servicing Rights
24,436

 
23,663

Goodwill
31,517

 
31,517

Bank-Owned Life Insurance
278,425

 
274,188

Other Assets
234,234

 
194,708

Total Assets
$
17,268,302

 
$
16,492,367

 
 
 
 
Liabilities
 

 
 

Deposits
 

 
 

Noninterest-Bearing Demand
$
4,825,643

 
$
4,772,727

Interest-Bearing Demand
2,896,559

 
2,934,107

Savings
5,363,866

 
5,395,699

Time
1,962,092

 
1,217,707

Total Deposits
15,048,160

 
14,320,240

Funds Purchased

 
9,616

Securities Sold Under Agreements to Repurchase
505,293

 
523,378

Other Debt
267,887

 
267,938

Retirement Benefits Payable
38,308

 
48,451

Accrued Interest Payable
6,717

 
5,334

Taxes Payable and Deferred Taxes
31,360

 
21,674

Other Liabilities
142,684

 
134,199

Total Liabilities
16,040,409

 
15,330,830

Shareholders’ Equity
 

 
 

Common Stock ($.01 par value; authorized 500,000,000 shares;
issued / outstanding: September 30, 2017 - 57,958,200 / 42,513,348
and December 31, 2016 - 57,856,672 / 42,635,978)
576

 
576

Capital Surplus
558,530

 
551,628

Accumulated Other Comprehensive Loss
(25,023
)
 
(33,906
)
Retained Earnings
1,491,830

 
1,415,440

Treasury Stock, at Cost (Shares: September 30, 2017 - 15,444,852
and December 31, 2016 - 15,220,694)
(798,020
)
 
(772,201
)
Total Shareholders’ Equity
1,227,893

 
1,161,537

Total Liabilities and Shareholders’ Equity
$
17,268,302

 
$
16,492,367

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

4


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

 
Common Stock

 
Capital
Surplus

 
Accum.
Other
Compre-
hensive
Income
(Loss)

 
Retained Earnings

 
Treasury Stock

 
Total

Balance as of December 31, 2016
42,635,978

 
$
576

 
$
551,628

 
$
(33,906
)
 
$
1,415,440

 
$
(772,201
)
 
$
1,161,537

Net Income

 

 

 

 
141,719

 

 
141,719

Other Comprehensive Income

 

 

 
8,883

 

 

 
8,883

Share-Based Compensation

 

 
5,332

 

 

 

 
5,332

Common Stock Issued under Purchase and Equity
Compensation Plans and Related Tax Benefits
319,377

 

 
1,570

 

 
(383
)
 
10,552

 
11,739

Common Stock Repurchased
(442,007
)
 

 

 

 

 
(36,371
)
 
(36,371
)
Cash Dividends Declared ($1.52 per share)

 

 

 

 
(64,946
)
 

 
(64,946
)
Balance as of September 30, 2017
42,513,348

 
$
576

 
$
558,530

 
$
(25,023
)
 
$
1,491,830

 
$
(798,020
)
 
$
1,227,893

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of December 31, 2015
43,282,153

 
$
575

 
$
542,041

 
$
(23,557
)
 
$
1,316,260

 
$
(719,059
)
 
$
1,116,260

Net Income

 

 

 

 
137,948

 

 
137,948

Other Comprehensive Income

 

 

 
8,745

 

 

 
8,745

Share-Based Compensation

 

 
5,020

 

 

 

 
5,020

Common Stock Issued under Purchase and Equity
Compensation Plans and Related Tax Benefits
224,018

 
1

 
2,003

 

 
(314
)
 
6,224

 
7,914

Common Stock Repurchased
(772,658
)
 

 

 

 

 
(51,365
)
 
(51,365
)
Cash Dividends Declared ($1.41 per share)

 

 

 

 
(60,663
)
 

 
(60,663
)
Balance as of September 30, 2016
42,733,513

 
$
576

 
$
549,064

 
$
(14,812
)
 
$
1,393,231

 
$
(764,200
)
 
$
1,163,859

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

5


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
 
Nine Months Ended
 
September 30,
(dollars in thousands)
2017

 
2016

Operating Activities
 

 
 

Net Income
$
141,719

 
$
137,948

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

 
 

Provision for Credit Losses
12,650

 
1,500

Depreciation and Amortization
9,832

 
9,734

Amortization of Deferred Loan and Lease Fees
(744
)
 
(1,089
)
Amortization and Accretion of Premiums/Discounts on Investment Securities, Net
29,685

 
33,234

Share-Based Compensation
5,332

 
5,020

Benefit Plan Contributions
(11,098
)
 
(929
)
Deferred Income Taxes
3,871

 
6,465

Net Gains on Sales of Loans and Leases
(5,615
)
 
(8,061
)
Net Gains on Sales of Investment Securities
(11,047
)
 
(10,540
)
Proceeds from Sales of Loans Held for Sale
238,137

 
152,185

Originations of Loans Held for Sale
(231,464
)
 
(187,117
)
Net Tax Benefits from Share-Based Compensation
2,515

 

Excess Tax Benefits from Share-Based Compensation

 
(916
)
Net Change in Other Assets and Other Liabilities
(37,405
)
 
(14,297
)
Net Cash Provided by Operating Activities
146,368

 
123,137

 
 
 
 
Investing Activities
 

 
 

Investment Securities Available-for-Sale:
 

 
 

Proceeds from Prepayments and Maturities
278,719

 
288,928

Proceeds from Sales
11,052

 
10,766

Purchases
(417,899
)
 
(248,839
)
Investment Securities Held-to-Maturity:
 

 
 

Proceeds from Prepayments and Maturities
654,484

 
545,133

Purchases
(795,272
)
 
(394,547
)
Net Change in Loans and Leases
(722,352
)
 
(954,616
)
Proceeds from Sales of Loans
137,717

 
118,089

Premises and Equipment, Net
(21,489
)
 
(8,823
)
Net Cash Used in Investing Activities
(875,040
)
 
(643,909
)
 
 
 
 
Financing Activities
 

 
 

Net Change in Deposits
727,920

 
557,262

Net Change in Short-Term Borrowings
(27,701
)
 
(74,891
)
Proceeds from Long-Term Debt

 
75,000

Repayments of Long-Term Debt

 
(50,000
)
Excess Tax Benefits from Share-Based Compensation

 
916

Proceeds from Issuance of Common Stock
11,679

 
6,903

Repurchase of Common Stock
(36,371
)
 
(51,365
)
Cash Dividends Paid
(64,946
)
 
(60,663
)
Net Cash Provided by Financing Activities
610,581

 
403,162

 
 
 
 
Net Change in Cash and Cash Equivalents
(118,091
)
 
(117,610
)
Cash and Cash Equivalents at Beginning of Period
879,607

 
755,721

Cash and Cash Equivalents at End of Period
$
761,516

 
$
638,111

Supplemental Information
 

 
 

Cash Paid for Interest
$
32,331

 
$
28,952

Cash Paid for Income Taxes
49,957

 
51,257

Non-Cash Investing Activities:
 

 
 

Transfer from Loans to Foreclosed Real Estate
2,559

 
1,058

Transfers from Loans to Loans Held for Sale
86,625

 
140,439

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

6


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

Note 1.  Summary of Significant Accounting Policies

Basis of Presentation

Bank of Hawaii Corporation (the “Parent”) is a Delaware corporation and a bank holding company headquartered in Honolulu, Hawaii.  Bank of Hawaii Corporation and its subsidiaries (collectively, the “Company”) provide a broad range of financial products and services to customers in Hawaii, Guam, and other Pacific Islands.  The accompanying consolidated financial statements include the accounts of the Parent and its subsidiaries. The Parent’s principal operating subsidiary is Bank of Hawaii (the “Bank”). 

The consolidated financial statements in this report have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the results for the interim periods. All such adjustments are of a normal recurring nature. Intercompany accounts and transactions have been eliminated in consolidation. Certain prior period information has been reclassified to conform to the current period presentation. Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for the full fiscal year or for any future period.

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and accompanying notes required by GAAP for complete financial statements and should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016

Use of Estimates in the Preparation of Financial Statements

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

Variable Interest Entities

Variable interests are defined as contractual ownership or other interests in an entity that change with fluctuations in an entity’s net asset value. The primary beneficiary consolidates the variable interest entity (“VIE”). The primary beneficiary is defined as the enterprise that has both the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and the obligation to absorb losses or the right to receive benefits that could be significant to the VIE.

The Company has limited partnership interests in several low-income housing partnerships. These partnerships provide funds for the construction and operation of apartment complexes that provide affordable housing to lower-income households. If these developments successfully attract a specified percentage of residents falling in that lower-income range, state and/or federal income tax credits are made available to the partners. The tax credits are generally recognized over 10 years. In order to continue receiving the tax credits each year over the life of the partnership, the low-income residency targets must be maintained.

Prior to January 1, 2015, the Company utilized the effective yield method whereby the Company recognized tax credits generally over 10 years and amortized the initial cost of the investment to provide a constant effective yield over the period that tax credits are allocated to the Company. On January 1, 2015, the Company adopted ASU No. 2014-01, “Accounting for Investments in Qualified Affordable Housing Projects” prospectively for new investments. ASU No. 2014-01 permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. As permitted by ASU No. 2014-01, the Company elected to continue to utilize the effective yield method for investments made prior to January 1, 2015.

Unfunded commitments to fund these low-income housing partnerships were $26.5 million and $16.2 million as of September 30, 2017 and December 31, 2016, respectively. These unfunded commitments are unconditional and legally binding

7


and are recorded in other liabilities in the consolidated statements of condition. See Note 5 Affordable Housing Projects Tax Credit Partnerships for more information.

The Company also has limited partnership interests in solar energy tax credit partnership investments. These partnerships develop, build, own and operate solar renewable energy projects. Over the course of these investments, the Company expects to receive federal and state tax credits, tax-related benefits, and excess cash available for distribution, if any. The Company may be called to sell its interest in the limited partnerships through a call option once all investment tax credits have been recognized. Tax benefits associated with these investments are generally recognized over six years.
These entities meet the definition of a VIE; however, the Company is not the primary beneficiary of the entities as the general partner has both the power to direct the activities that most significantly impact the economic performance of the entities and the obligation to absorb losses or the right to receive benefits that could be significant to the entities. While the partnership agreements allow the limited partners, through a majority vote, to remove the general partner, this right is not deemed to be substantive as the general partner can only be removed for cause.

The investments in these entities are initially recorded at cost, which approximates the maximum exposure to loss as a result of the Company’s involvement with these unconsolidated entities. The balance of the Company’s investments in these entities was $83.3 million and $78.9 million as of September 30, 2017 and December 31, 2016, respectively, and is included in other assets in the consolidated statements of condition.

Correction of an Immaterial Error to the Financial Statements

The Company determined during the fourth quarter of 2016 the proceeds from the sale of residential mortgage loans transferred from portfolio to held for sale were incorrectly reported on the consolidated statements of cash flows. The consolidated statement of cash flows for the nine months ended September 30, 2016 was adjusted to decrease the originations of loans held for sale by $136.7 million, decrease the proceeds from sales of loans held for sale by $116.6 million, and decrease the net change in other assets and other liabilities by $0.1 million. The net result was a $20.1 million increase to the net cash provided by operating activities. In addition, the net change in loans and leases was increased by $138.2 million, and a new line item, proceeds from sales of loans, was inserted for $118.1 million, resulting in a $20.1 million increase to net cash used in investing activities. Lastly, listed in the Supplemental Information section as a non-cash investing activity, transfers from loans to loans held for sale was decreased by $3.5 million. These corrections did not impact the consolidated statements of income or the consolidated statements of condition. The Company evaluated the effect of the incorrect presentation of the consolidated statements of cash flows, both qualitatively and quantitatively, and concluded it did not materially misstate the Company’s previously issued financial statements.

Accounting Standards Adopted in 2017

In March 2016, the FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting.” This ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. Some of the key provisions of this new ASU include: (1) companies will no longer record excess tax benefits and certain tax deficiencies in additional paid-in capital (“APIC”). Instead, they will record all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement, and APIC pools will be eliminated. The guidance also eliminates the requirement that excess tax benefits be realized before companies can recognize them. In addition, the guidance requires companies to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity; (2) increase the amount an employer can withhold to cover income taxes on awards and still qualify for the exception to liability classification for shares used to satisfy the employer’s statutory income tax withholding obligation. The new guidance will also require an employer to classify the cash paid to a tax authority when shares are withheld to satisfy its statutory income tax withholding obligation as a financing activity on its statement of cash flows (current guidance did not specify how these cash flows should be classified); and (3) permit companies to make an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures can be estimated, as required today, or recognized when they occur. ASU No. 2016-09 is effective for interim and annual reporting periods beginning after December 15, 2016. The Company adopted ASU No. 2016-09 on January 1, 2017 and elected to recognize forfeitures as they occur. As allowed by the ASU, the Company’s adoption was prospective; therefore, prior periods have not been adjusted. The adoption of ASU No. 2016-09 could result in increased volatility to reported income tax expense related to excess tax benefits and tax deficiencies for employee share-based transactions. However, the actual amounts recognized in income tax expense will be dependent on the amount of employee share-based transactions and the stock price at the time of vesting or exercise. For the first nine months of 2017, the adoption of ASU No. 2016-09 resulted in a decrease to the provision for income taxes primarily due to the tax benefit from the exercise of stock options and the vesting of restricted stock.

8



In May 2017, the FASB issued ASU No. 2017-09, “Stock Compensation, Scope of Modification Accounting.” This ASU clarifies when changes to the terms of conditions of a share-based payment award must be accounted for as modifications. Companies will apply the modification accounting guidance if the value, vesting conditions or classification of the award changes. The new guidance should reduce diversity in practice and result in fewer changes to the terms of an award being accounted for as modifications, as the guidance will allow companies to make certain non-substantive changes to awards without accounting for them as modifications. It does not change the accounting for modifications. ASU No. 2017-09 is effective for interim and annual reporting periods beginning after December 15, 2017; early adoption is permitted. The Company elected to early adopt ASU No. 2017-09 in 2017. ASU No. 2017-09 did not have a material impact on the Company’s Consolidated Financial Statements.

Accounting Standards Pending Adoption

In May 2014, the FASB and the International Accounting Standards Board (the “IASB”) jointly issued a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP and International Financial Reporting Standards (“IFRS”). Previous revenue recognition guidance in GAAP consisted of broad revenue recognition concepts together with numerous revenue requirements for particular industries or transactions, which sometimes resulted in different accounting for economically similar transactions. In contrast, IFRS provided limited revenue recognition guidance and, consequently, could be difficult to apply to complex transactions. Accordingly, the FASB and the IASB initiated a joint project to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and IFRS that would: (1) remove inconsistencies and weaknesses in revenue requirements; (2) provide a more robust framework for addressing revenue issues; (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provide more useful information to users of financial statements through improved disclosure requirements; and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. To meet those objectives, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies generally will be required to use more judgment and make more estimates than under current guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The standard was initially effective for public entities for interim and annual reporting periods beginning after December 15, 2016; early adoption was not permitted. However, in August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers - Deferral of the Effective Date” which deferred the effective date by one year (i.e., to interim and annual reporting periods beginning after December 15, 2017). For financial reporting purposes, the standard allows for either full retrospective adoption, meaning the standard is applied to all of the periods presented, or modified retrospective adoption, meaning the standard is applied only to the most current period presented in the financial statements with the cumulative effect of initially applying the standard recognized at the date of initial application. In addition, the FASB has begun to issue targeted updates to clarify specific implementation issues of ASU 2014-09. These updates include ASU No. 2016-08, “Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” ASU No. 2016-10, “Identifying Performance Obligations and Licensing,” ASU No. 2016-12, “Narrow-Scope Improvements and Practical Expedients,” and ASU No. 2016-20 “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.” Since the guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, the Company does not expect the new guidance to have a material impact on revenue most closely associated with financial instruments, including interest income and expense. The Company is substantially complete with its overall assessment of revenue streams and reviewing of related contracts potentially affected by the ASU, including trust and asset management fees, deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. The Company’s assessment suggests that adoption of this ASU should not materially change the method in which we currently recognize revenue for these revenue streams. The Company is also substantially complete with its evaluation of certain costs related to these revenue streams to determine whether such costs should be presented as expenses or contra-revenue (i.e., gross vs. net). In addition, the Company is evaluating the ASU’s expanded disclosure requirements. The Company plans to adopt ASU No. 2014-09 on January 1, 2018 utilizing the modified retrospective approach with a cumulative effect adjustment to opening retained earnings, if such adjustment is deemed to be material.

In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by making targeted improvements to GAAP as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price

9


changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (4) eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (5) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (6) require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (7) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (8) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU No. 2016-01 is effective for interim and annual reporting periods beginning after December 15, 2017. Although the Company has not finalized its evaluation of the impact of adopting ASU No. 2016-01, adoption is not expected to have a material impact on the Company’s Consolidated Financial Statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases.” Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases): 1) a lease liability, which is the present value of a lessee’s obligation to make lease payments, and 2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Lessor accounting under the new guidance remains largely unchanged as it is substantially equivalent to existing guidance for sales-type leases, direct financing leases, and operating leases. Leveraged leases have been eliminated, although lessors can continue to account for existing leveraged leases using the current accounting guidance. Other limited changes were made to align lessor accounting with the lessee accounting model and the new revenue recognition standard. All entities will classify leases to determine how to recognize lease-related revenue and expense. Quantitative and qualitative disclosures will be required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The intention is to require enough information to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an entity’s leasing activities. ASU No. 2016-02 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. All entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. They have the option to use certain relief; full retrospective application is prohibited. The Company has several lease agreements, such as branch locations, which are currently considered operating leases, and therefore, not recognized on the Company’s consolidated statements of condition. The Company expects the new guidance will require these lease agreements to now be recognized on the consolidated statements of condition as a right-of-use asset and a corresponding lease liability. Therefore, the Company’s preliminary evaluation indicates the provisions of ASU No. 2016-02 are expected to impact the Company’s consolidated statements of condition, along with our regulatory capital ratios. However, the Company continues to evaluate the extent of potential impact the new guidance will have on the Company’s Consolidated Financial Statements. In addition, the Company is considering obtaining new software to aid in the transition to the new leasing guidance.

In June 2016, the FASB issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments.” This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren’t measured at fair value through net income. In issuing the standard, the FASB is responding to criticism that today’s guidance delays recognition of credit losses. The standard will replace today’s “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. The CECL model does not apply to available-for-sale (“AFS”) debt securities. For AFS debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the credit losses will be recognized as allowances rather than reductions in the amortized cost of the securities. As a result, entities will recognize improvements to estimated credit losses immediately in earnings rather than as interest income over time, as they do today. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU 2016-13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU No. 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of

10


the first reporting period in which the guidance is effective (i.e., modified retrospective approach). The Company is continuing its implementation efforts through its Company-wide implementation team. This team has assigned roles and responsibilities, key tasks to complete, and a general timeline to be followed. The implementation team meets periodically to discuss the latest developments and ensure progress is being made. The team also keeps current on evolving interpretations and industry practices related to ASU 2016-13 via webcasts, publications, conferences, and peer bank meetings. Currently the team is in the process of gathering and reviewing historical data and evaluating different loss methodologies. The Company’s preliminary evaluation indicates the provisions of ASU No. 2016-13 are expected to impact the Company’s Consolidated Financial Statements, in particular the level of the reserve for credit losses. However, the Company continues to evaluate the extent of the potential impact.

In August 2016, the FASB issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments.” Current GAAP is unclear or does not include specific guidance on how to classify certain transactions in the statement of cash flows. This ASU is intended to reduce diversity in practice in how eight particular transactions are classified in the statement of cash flows. ASU No. 2016-15 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted, provided that all of the amendments are adopted in the same period. Entities will be required to apply the guidance retrospectively. If it is impracticable to apply the guidance retrospectively for an issue, the amendments related to that issue would be applied prospectively. As this guidance only affects the classification within the statement of cash flows, ASU No. 2016-15 is not expected to have a material impact on the Company’s Consolidated Financial Statements.

In January 2017, the FASB issued ASU No. 2017-04, “Simplifying the Test for Goodwill Impairment.” The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. ASU No. 2017-04 is effective for interim and annual reporting periods beginning after December 15, 2019, applied prospectively. Early adoption is permitted for any impairment tests performed after January 1, 2017. The Company expects to early adopt upon the next goodwill impairment test in 2017. ASU No. 2017-04 is not expected to have a material impact on the Company’s Consolidated Financial Statements.

In March 2017, the FASB issued ASU No. 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” Under the new guidance, employers will present the service cost component of the net periodic benefit cost in the same income statement line item (e.g., Salaries and Benefits) as other employee compensation costs arising from services rendered during the period. In addition, only the service cost component will be eligible for capitalization in assets. Employers will present the other components separately (e.g., Other Noninterest Expense) from the line item that includes the service cost. ASU No. 2017-07 is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted: however, the Company has decided not to early adopt. Employers will apply the guidance on the presentation of the components of net periodic benefit cost in the income statement retrospectively. The guidance limiting the capitalization of net periodic benefit cost in assets to the service cost component will be applied prospectively. The Company expects to utilize the ASU’s practical expedient allowing entities to estimate amounts for comparative periods using the information previously disclosed in their pension and other postretirement benefit plan footnote. ASU No. 2017-07 is not expected to have a material impact on the Company’s Consolidated Financial Statements.

In March 2017, the FASB issued ASU No. 2017-08, “Premium Amortization on Purchased Callable Debt Securities.” This ASU shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date. Today, entities generally amortize the premium over the contractual life of the security. The new guidance does not change the accounting for purchased callable debt securities held at a discount; the discount continues to be amortized to maturity. ASU No. 2017-08 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. The guidance calls for a modified retrospective transition approach under which a cumulative-effect adjustment will be made to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company is currently evaluating the provisions of ASU No. 2017-08 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements.

In August 2017, the FASB issued ASU No. 2017-12, “Targeted Improvements to Accounting for Hedging Activities.” This ASU’s objectives are to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities; and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. ASU No. 2017-12 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. The Company currently does not designate any derivative financial instruments as formal hedging relationships, and therefore, does not utilize hedge accounting. However, the Company is currently evaluating this ASU to determine whether its provisions will enhance the Company’s ability to employ risk management strategies, while improving the transparency and understanding of those strategies for financial statement users.

11


Note 2.  Investment Securities

The amortized cost, gross unrealized gains and losses, and fair value of the Company’s investment securities as of September 30, 2017 and December 31, 2016 were as follows:

(dollars in thousands)
Amortized Cost

 
Gross
Unrealized Gains

 
Gross
Unrealized Losses

 
Fair Value

September 30, 2017
 

 
 

 
 

 
 

Available-for-Sale:
 

 
 

 
 

 
 

Debt Securities Issued by the U.S. Treasury and Government Agencies
$
446,205

 
$
3,952

 
$
(953
)
 
$
449,204

Debt Securities Issued by States and Political Subdivisions
624,203

 
17,783

 
(23
)
 
641,963

Debt Securities Issued by Corporations
268,013

 
138

 
(2,305
)
 
265,846

Mortgage-Backed Securities:
 

 
 

 
 

 
 

    Residential - Government Agencies
247,418

 
3,605

 
(1,047
)
 
249,976

    Residential - U.S. Government-Sponsored Enterprises
646,013

 
1,056

 
(4,956
)
 
642,113

    Commercial - Government Agencies
76,260

 

 
(2,694
)
 
73,566

Total Mortgage-Backed Securities
969,691

 
4,661

 
(8,697
)
 
965,655

Total
$
2,308,112

 
$
26,534

 
$
(11,978
)
 
$
2,322,668

Held-to-Maturity:
 

 
 

 
 

 
 

Debt Securities Issued by the U.S. Treasury and Government Agencies
$
425,086

 
$
380

 
$
(735
)
 
$
424,731

Debt Securities Issued by States and Political Subdivisions
239,462

 
14,283

 

 
253,745

Debt Securities Issued by Corporations
123,660

 
478

 
(1,156
)
 
122,982

Mortgage-Backed Securities:
 
 
 
 
 
 
 

    Residential - Government Agencies
2,168,568

 
14,781

 
(21,313
)
 
2,162,036

    Residential - U.S. Government-Sponsored Enterprises
795,992

 
1,637

 
(6,918
)
 
790,711

    Commercial - Government Agencies
207,830

 
1,972

 
(3,051
)
 
206,751

Total Mortgage-Backed Securities
3,172,390

 
18,390


(31,282
)

3,159,498

Total
$
3,960,598

 
$
33,531

 
$
(33,173
)
 
$
3,960,956

 
 
 
 
 
 
 
 
December 31, 2016
 

 
 

 
 

 
 

Available-for-Sale:
 

 
 

 
 

 
 

Debt Securities Issued by the U.S. Treasury and Government Agencies
$
407,478

 
$
2,531

 
$
(1,294
)
 
$
408,715

Debt Securities Issued by States and Political Subdivisions
662,231

 
11,455

 
(1,887
)
 
671,799

Debt Securities Issued by Corporations
273,044

 
5

 
(3,870
)
 
269,179

Mortgage-Backed Securities:
 
 
 
 
 
 
 

    Residential - Government Agencies
240,412

 
4,577

 
(1,145
)
 
243,844

    Residential - U.S. Government-Sponsored Enterprises
511,234

 
971

 
(5,218
)
 
506,987

    Commercial - Government Agencies
89,544

 

 
(4,027
)
 
85,517

Total Mortgage-Backed Securities
841,190

 
5,548

 
(10,390
)
 
836,348

Total
$
2,183,943

 
$
19,539

 
$
(17,441
)
 
$
2,186,041

Held-to-Maturity:
 

 
 

 
 

 
 

Debt Securities Issued by the U.S. Treasury and Government Agencies
$
530,149

 
$
1,562

 
$
(771
)
 
$
530,940

Debt Securities Issued by States and Political Subdivisions
242,295

 
9,991

 

 
252,286

Debt Securities Issued by Corporations
135,620

 
416

 
(1,528
)
 
134,508

Mortgage-Backed Securities:
 
 
 
 
 
 
 

    Residential - Government Agencies
1,940,076

 
20,567

 
(23,861
)
 
1,936,782

    Residential - U.S. Government-Sponsored Enterprises
752,768

 
798

 
(10,919
)
 
742,647

    Commercial - Government Agencies
232,089

 
940

 
(2,665
)
 
230,364

Total Mortgage-Backed Securities
2,924,933

 
22,305

 
(37,445
)
 
2,909,793

Total
$
3,832,997

 
$
34,274

 
$
(39,744
)
 
$
3,827,527


12



The table below presents an analysis of the contractual maturities of the Company’s investment securities as of September 30, 2017.  Debt securities issued by government agencies (Small Business Administration securities) and mortgage-backed securities are disclosed separately in the table below as these investment securities may prepay prior to their scheduled contractual maturity dates.
(dollars in thousands)
Amortized Cost

 
Fair Value

Available-for-Sale:
 

 
 

Due in One Year or Less
$
79,756

 
$
80,005

Due After One Year Through Five Years
622,846

 
628,796

Due After Five Years Through Ten Years
164,664

 
172,362

Due After Ten Years
25,501

 
27,186

 
892,767

 
908,349

 
 
 
 
Debt Securities Issued by Government Agencies
445,654

 
448,664

Mortgage-Backed Securities:
 

 
 

    Residential - Government Agencies
247,418

 
249,976

    Residential - U.S. Government-Sponsored Enterprises
646,013

 
642,113

    Commercial - Government Agencies
76,260

 
73,566

Total Mortgage-Backed Securities
969,691

 
965,655

Total
$
2,308,112

 
$
2,322,668

 
 
 
 
Held-to-Maturity:
 

 
 

Due in One Year or Less
$
240,105

 
$
239,988

Due After One Year Through Five Years
255,274

 
257,753

Due After Five Years Through Ten Years
254,585

 
262,701

Due After Ten Years
38,244

 
41,016

 
788,208

 
801,458

Mortgage-Backed Securities:
 

 
 

    Residential - Government Agencies
2,168,568

 
2,162,036

    Residential - U.S. Government-Sponsored Enterprises
795,992

 
790,711

    Commercial - Government Agencies
207,830

 
206,751

Total Mortgage-Backed Securities
3,172,390

 
3,159,498

Total
$
3,960,598

 
$
3,960,956


Investment securities with carrying values of $2.7 billion and $2.4 billion as of September 30, 2017 and December 31, 2016, respectively, were pledged to secure deposits of governmental entities and securities sold under agreements to repurchase.

The table below presents the gains and losses from the sales of investment securities for the three and nine months ended September 30, 2017 and 2016.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands)
2017

 
2016

 
2017

 
2016

Gross Gains on Sales of Investment Securities
$

 
$

 
$
12,467

 
$
11,180

Gross Losses on Sales of Investment Securities
(566
)
 
(328
)
 
(1,420
)
 
(640
)
Net Gains (Losses) on Sales of Investment Securities
$
(566
)
 
$
(328
)
 
$
11,047

 
$
10,540


The losses during    the three and nine months ended September 30, 2017 and 2016 were due to fees paid to the counterparties of our prior Visa Class B share sale transactions.

13


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

 
Gross Unrealized Losses

 
Fair Value

 
Gross Unrealized Losses

 
Fair Value

 
Gross Unrealized Losses

September 30, 2017
 

 
 

 
 

 
 

 
 

 
 

Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
Debt Securities Issued by the U.S. Treasury
   and Government Agencies
$
77,995

 
$
(420
)
 
$
152,914

 
$
(533
)
 
$
230,909

 
$
(953
)
Debt Securities Issued by States
   and Political Subdivisions
11,064

 
(20
)
 
746

 
(3
)
 
11,810

 
(23
)
Debt Securities Issued by Corporations
22,995

 
(8
)
 
202,713

 
(2,297
)
 
225,708

 
(2,305
)
Mortgage-Backed Securities:
 
 
 
 
 
 
 
 


 


    Residential - Government Agencies
17,046

 
(4
)
 
12,048

 
(1,043
)
 
29,094

 
(1,047
)
    Residential - U.S. Government-Sponsored Enterprises
389,869

 
(3,512
)
 
55,238

 
(1,444
)
 
445,107

 
(4,956
)
    Commercial - Government Agencies

 

 
73,566

 
(2,694
)
 
73,566

 
(2,694
)
Total Mortgage-Backed Securities
406,915

 
(3,516
)
 
140,852

 
(5,181
)
 
547,767

 
(8,697
)
Total
$
518,969

 
$
(3,964
)
 
$
497,225

 
$
(8,014
)
 
$
1,016,194

 
$
(11,978
)
Held-to-Maturity:
 
 
 
 
 
 
 
 
 
 
 
Debt Securities Issued by the U.S. Treasury
   and Government Agencies
$
159,956

 
$
(238
)
 
$
49,804

 
$
(497
)
 
$
209,760

 
$
(735
)
Debt Securities Issued by Corporations
46,726

 
(716
)
 
14,589

 
(440
)
 
61,315

 
(1,156
)
Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
 
    Residential - Government Agencies
897,044

 
(6,532
)
 
516,479

 
(14,781
)
 
1,413,523

 
(21,313
)
    Residential - U.S. Government-Sponsored Enterprises
508,545

 
(4,881
)
 
59,202

 
(2,037
)
 
567,747

 
(6,918
)
    Commercial - Government Agencies
32,799

 
(573
)
 
55,820

 
(2,478
)
 
88,619

 
(3,051
)
Total Mortgage-Backed Securities
1,438,388

 
(11,986
)
 
631,501

 
(19,296
)
 
2,069,889

 
(31,282
)
Total
$
1,645,070

 
$
(12,940
)
 
$
695,894

 
$
(20,233
)
 
$
2,340,964

 
$
(33,173
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 

 
 

 
 

 
 

 
 

 
 

Available-for-Sale:
 
 
 
 
 
 
 
 
 
 
 
Debt Securities Issued by the U.S. Treasury
     and Government Agencies
$
143,715

 
$
(562
)
 
$
89,211

 
$
(732
)
 
$
232,926

 
$
(1,294
)
Debt Securities Issued by States
     and Political Subdivisions
211,188

 
(1,873
)
 
6,725

 
(14
)
 
217,913

 
(1,887
)
Debt Securities Issued by Corporations
67,332

 
(714
)
 
196,838

 
(3,156
)
 
264,170

 
(3,870
)
Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
 
     Residential - Government Agencies
38,355

 
(89
)
 
11,185

 
(1,056
)
 
49,540

 
(1,145
)
     Residential - U.S. Government-Sponsored Enterprises
397,385

 
(5,218
)
 

 

 
397,385

 
(5,218
)
     Commercial - Government Agencies
5,097

 
(164
)
 
80,420

 
(3,863
)
 
85,517

 
(4,027
)
Total Mortgage-Backed Securities
440,837

 
(5,471
)
 
91,605

 
(4,919
)
 
532,442

 
(10,390
)
Total
$
863,072

 
$
(8,620
)
 
$
384,379

 
$
(8,821
)
 
$
1,247,451

 
$
(17,441
)
Held-to-Maturity:
 
 
 
 
 
 
 
 
 
 
 
Debt Securities Issued by the U.S. Treasury
and Government Agencies
$
169,926

 
$
(771
)
 
$

 
$

 
$
169,926

 
$
(771
)
Debt Securities Issued by Corporations
69,601

 
(971
)
 
15,933

 
(557
)
 
85,534

 
(1,528
)
Mortgage-Backed Securities:
 
 
 
 
 
 
 
 
 
 
 
     Residential - Government Agencies
835,227

 
(15,313
)
 
231,377

 
(8,548
)
 
1,066,604

 
(23,861
)
     Residential - U.S. Government-Sponsored Enterprises
693,047

 
(10,919
)
 

 

 
693,047

 
(10,919
)
     Commercial - Government Agencies
87,586

 
(2,597
)
 
18,653

 
(68
)
 
106,239

 
(2,665
)
Total Mortgage-Backed Securities
1,615,860

 
(28,829
)
 
250,030

 
(8,616
)
 
1,865,890

 
(37,445
)
Total
$
1,855,387

 
$
(30,571
)
 
$
265,963

 
$
(9,173
)
 
$
2,121,350

 
$
(39,744
)


14


The Company does not believe that the investment securities that were in an unrealized loss position as of September 30, 2017, which were comprised of 306 securities, represent an other-than-temporary impairment.  Total gross unrealized losses were primarily attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities.  As of September 30, 2017 and December 31, 2016, the gross unrealized losses reported for mortgage-backed securities were mostly related to investment securities issued by the Government National Mortgage Association. The Company does not intend to sell the investment securities that were in an unrealized loss position and it is not more likely than not that the Company will be required to sell the investment securities before recovery of their amortized cost basis, which may be at maturity.

Interest income from taxable and non-taxable investment securities for the three and nine months ended September 30, 2017 and 2016 were as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(dollars in thousands)
2017

 
2016

 
2017

 
2016

Taxable
$
27,441

 
$
24,558

 
$
79,949

 
$
76,112

Non-Taxable
4,880

 
5,070

 
14,915

 
15,410

Total Interest Income from Investment Securities
$
32,321

 
$
29,628

 
$
94,864

 
$
91,522


As of September 30, 2017, included in the Company’s investment securities portfolio were debt securities issued by political subdivisions within the State of Hawaii of $510.3 million, representing 57% of the total fair value of the Company’s municipal debt securities. Of the entire Hawaii municipal bond portfolio, 95% were credit-rated Aa2 or better by Moody’s while the remaining Hawaii municipal bonds were credit-rated A2 or better by at least one nationally recognized statistical rating organization. Of the Company’s total Hawaii municipal bond holdings, 78% were general obligation issuances. As of September 30, 2017, there were no other holdings of municipal debt securities that were issued by a single state or political subdivision which comprised more than 10% of the total fair value of the Company’s municipal debt securities.

As of September 30, 2017 and December 31, 2016, the carrying value of the Company’s Federal Home Loan Bank of Des Moines stock and Federal Reserve Bank stock was as follows:
(dollars in thousands)
September 30,
2017

 
December 31,
2016

Federal Home Loan Bank Stock
$
20,000

 
$
20,000

Federal Reserve Bank Stock
20,645

 
20,063

Total
$
40,645

 
$
40,063


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

Visa Class B Restricted Shares

In 2008, the Company received Visa Class B restricted shares as part of Visa’s initial public offering. These shares are transferable only under limited circumstances until they can be converted into the publicly traded Class A common shares. This conversion will not occur until the settlement of certain litigation which is indemnified by Visa members, including the Company. Visa funded an escrow account from its initial public offering to settle these litigation claims. Should this escrow account be insufficient to cover these litigation claims, Visa is entitled to fund additional amounts to the escrow account by reducing each member bank’s Class B conversion ratio to unrestricted Class A shares. As of September 30, 2017, the conversion ratio was 1.6483.

During the first quarter of 2017, the Company recorded a $12.5 million gain on the sale of 90,000 Visa Class B shares. Concurrent with every sale of Visa Class B shares, the Company has entered into an agreement with the buyer that requires payment to the buyer in the event Visa further reduces the conversion ratio. Based on the existing transfer restriction and the uncertainty of the outcome of the Visa litigation mentioned above, the remaining 90,914 Class B shares (149,854 Class A equivalents) that the Company owns as of September 30, 2017 are carried at a zero cost basis.


15


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

Loans and Leases

The Company’s loan and lease portfolio was comprised of the following as of September 30, 2017 and December 31, 2016:

(dollars in thousands)
September 30,
2017

 
December 31,
2016

Commercial
 

 
 

Commercial and Industrial
$
1,252,238

 
$
1,249,791

Commercial Mortgage
2,050,998

 
1,889,551

Construction
232,487

 
270,018

Lease Financing
204,240

 
208,332

Total Commercial
3,739,963

 
3,617,692

Consumer
 

 
 

Residential Mortgage
3,366,634

 
3,163,073

Home Equity
1,528,353

 
1,334,163

Automobile
506,102

 
454,333

Other 1
432,904

 
380,524

Total Consumer
5,833,993

 
5,332,093

Total Loans and Leases
$
9,573,956

 
$
8,949,785

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

Net gains related to sales of residential mortgage loans, recorded as a component of mortgage banking income were $1.4 million and $3.6 million for the three months ended September 30, 2017 and 2016, respectively, and $4.6 million and $9.8 million for the nine months ended September 30, 2017 and 2016, respectively.

16


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

The following presents by portfolio segment, the activity in the Allowance for the three and nine months ended September 30, 2017 and 2016.  The following also presents by portfolio segment, the balance in the Allowance disaggregated on the basis of the Company’s impairment measurement method and the related recorded investment in loans and leases as of September 30, 2017 and 2016.

(dollars in thousands)
Commercial

 
Consumer

 
Total

Three Months Ended September 30, 2017
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Balance at Beginning of Period
$
66,182

 
$
40,171

 
$
106,353

Loans and Leases Charged-Off
(611
)
 
(5,607
)
 
(6,218
)
Recoveries on Loans and Leases Previously Charged-Off
598

 
2,148

 
2,746

Net Loans and Leases Recovered (Charged-Off)
(13
)
 
(3,459
)
 
(3,472
)
Provision for Credit Losses
295

 
3,705

 
4,000

Balance at End of Period
$
66,464

 
$
40,417

 
$
106,881

Nine Months Ended September 30, 2017
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Balance at Beginning of Period
$
65,680

 
$
38,593

 
$
104,273

Loans and Leases Charged-Off
(909
)
 
(16,500
)
 
(17,409
)
Recoveries on Loans and Leases Previously Charged-Off
1,200

 
6,167

 
7,367

Net Loans and Leases Recovered (Charged-Off)
291

 
(10,333
)
 
(10,042
)
Provision for Credit Losses
493

 
12,157

 
12,650

Balance at End of Period
$
66,464

 
$
40,417

 
$
106,881

As of September 30, 2017
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Individually Evaluated for Impairment
$
136

 
$
3,762

 
$
3,898

Collectively Evaluated for Impairment
66,328

 
36,655

 
102,983

Total
$
66,464

 
$
40,417

 
$
106,881

Recorded Investment in Loans and Leases:
 

 
 

 
 

Individually Evaluated for Impairment
$
21,738

 
$
39,385

 
$
61,123

Collectively Evaluated for Impairment
3,718,225

 
5,794,608

 
9,512,833

Total
$
3,739,963

 
$
5,833,993

 
$
9,573,956

 
 
 
 
 
 
Three Months Ended September 30, 2016
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Balance at Beginning of Period
$
62,029

 
$
41,903

 
$
103,932

Loans and Leases Charged-Off
(209
)
 
(4,707
)
 
(4,916
)
Recoveries on Loans and Leases Previously Charged-Off
296

 
2,221

 
2,517

Net Loans and Leases Recovered (Charged-Off)
87

 
(2,486
)
 
(2,399
)
Provision for Credit Losses
442

 
2,058

 
2,500

Balance at End of Period
$
62,558

 
$
41,475

 
$
104,033

Nine Months Ended September 30, 2016
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Balance at Beginning of Period
$
60,714

 
$
42,166

 
$
102,880

Loans and Leases Charged-Off
(670
)
 
(12,888
)
 
(13,558
)
Recoveries on Loans and Leases Previously Charged-Off
7,619

 
5,592

 
13,211

Net Loans and Leases Recovered (Charged-Off)
6,949

 
(7,296
)
 
(347
)
Provision for Credit Losses
(5,105
)
 
6,605

 
1,500

Balance at End of Period
$
62,558

 
$
41,475

 
$
104,033

As of September 30, 2016
 

 
 

 
 

Allowance for Loan and Lease Losses:
 

 
 

 
 

Individually Evaluated for Impairment
$
11

 
$
3,436

 
$
3,447

Collectively Evaluated for Impairment
62,547

 
38,039

 
100,586

Total
$
62,558

 
$
41,475

 
$
104,033

Recorded Investment in Loans and Leases:
 

 
 

 
 

Individually Evaluated for Impairment
$
21,793

 
$
38,450

 
$
60,243

Collectively Evaluated for Impairment
3,467,761

 
5,166,093

 
8,633,854

Total
$
3,489,554

 
$
5,204,543

 
$
8,694,097


17


Credit Quality Indicators

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

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

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

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

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


18


The Company’s credit quality indicators are periodically updated on a case-by-case basis.  The following presents by class and by credit quality indicator, the recorded investment in the Company’s loans and leases as of September 30, 2017 and December 31, 2016.
 
September 30, 2017
(dollars in thousands)
Commercial
and Industrial

 
Commercial
Mortgage

 
Construction

 
Lease
Financing

 
Total
Commercial

Pass
$
1,206,294

 
$
1,997,523

 
$
231,033