x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period
ended September 30, 2018
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
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 16, 2018, there were 41,752,644 shares of common stock outstanding.
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, 2017.
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 $15.4 million and $17.5 million as of September 30, 2018 and December 31, 2017, respectively. These unfunded commitments are unconditional and legally binding and are recorded in other liabilities in the consolidated statements of condition. See Note 6 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 $81.2 million and $87.6 million as of September 30, 2018 and December 31, 2017, respectively, and is included in other assets in the consolidated statements of condition.
Tax Cuts and Jobs Act
Public law No. 115-97, known as the Tax Cuts and Jobs Act (the "Tax Act"), which was enacted on December 22, 2017, reduced the U.S. federal corporate tax rate from 35% to 21% effective January 1, 2018. Also on December 22, 2017, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for tax effects of the Tax Act. SAB 118 provides a measurement period of up to one year from the enactment date to complete the accounting. Any adjustments during this measurement period will be included in net earnings from continuing operations as an adjustment to income tax expense in the reporting period when such adjustments are determined. Based on the information available and current interpretation of the rules, the Company estimated the impact of the reduction in the corporate tax rate and remeasurement of certain deferred tax assets and liabilities. The provisional amount recorded in the fourth quarter of 2017 related to the remeasurement of the Company's deferred tax balance resulted in additional income tax expense of $3.6 million. An additional $0.1 million was expensed in the first quarter of 2018 due to the remeasurement of the Company’s deferred tax balance. In addition, during the first quarter of 2018, the Company recorded a $2.0 million basis adjustment on its low income housing partnership investments, which consequently reduced income tax expense by the same amount. The remeasurement of the Company’s deferred tax balance in the third quarter of 2018 resulted in an income tax expense reduction of $0.3 million. The Company finalized the impact of the Tax Act in the third quarter of 2018.
Accounting Standards Adopted in 2018
In May 2014, the Financial Accounting Standards Board (“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 prior 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. Subsequent to the issuance of ASU 2014-09, the FASB issued targeted updates to clarify specific implementation issues including 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.” 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. Since the standard does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, the new standard did not have a material impact on revenue most closely associated with financial instruments, including interest income and expense. The Company completed its overall assessment of revenue streams and review of related contracts potentially affected by the ASUs, including trust and asset management fees, deposit related fees, interchange fees, merchant income, and annuity and insurance commissions.
Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams. The Company also completed 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). Based on its evaluation, the Company determined that the classification of certain debit and credit card related costs should change (i.e., costs previously recorded as expense is now recorded as contra-revenue, and vice versa). These classification changes resulted in immaterial changes to both revenue and expense. The Company also determined that certain costs related to ATMs should be recorded as an expense rather than a reduction of revenue. This change did not have a material effect to noninterest income or expense. The Company adopted ASU 2014-09 and its related amendments on its required effective date of January 1, 2018 utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Consistent with the modified retrospective approach, the Company did not adjust prior period amounts for the debit and credit card costs and the ATM costs reclassifications noted above. See Note 15 Revenue Recognition for more information.
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 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. The Company adopted ASU No. 2016-01 on January 1, 2018 did not have a material impact on the Company’s Consolidated Financial Statements. In accordance with (5) above, the Company measured the fair value of its loan portfolio as of September 30, 2018 using an exit price notion (see Note 14 Fair Value of Assets and Liabilities).
In August 2016, the FASB issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments.” At the time, GAAP was unclear or did 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 was effective for interim and annual reporting periods beginning after December 15, 2017. Entities were 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. The Company adopted ASU No. 2016-15 on January 1, 2018. ASU No. 2016-15 did not 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 are required to 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 of net periodic benefit cost separately (e.g., Other Noninterest Expense) from the line item that includes the service cost. ASU No. 2017-07 became effective for interim and annual reporting periods beginning after December 15, 2017. 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 adopted ASU No. 2017-07 on January 1, 2018 and utilized 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 did not have a material impact on the Company’s Consolidated Financial Statements.
In February 2018, the FASB issued ASU No. 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” This ASU allows a reclassification from accumulated other comprehensive income (“AOCI”) to retained earnings for certain income tax effects stranded in AOCI as a result of the Tax Act. Consequently, the reclassification eliminates the stranded tax effects resulting from the Tax Act and is intended to improve the usefulness of information reported to financial statement users. However, because the ASU only relates to the reclassification of the income tax effects of the Tax Act, the underlying guidance that requires the effect of a change in tax laws or rates to be included in income from continuing operations is not affected. ASU No. 2018-02 is effective for the Company's reporting period beginning on January 1, 2019; early adoption is permitted. The Company elected to adopt ASU No. 2018-02 during the first quarter of 2018, and elected to reclassify the income tax effects of the Tax Act from AOCI to retained earnings. The reclassification decreased AOCI and increased retained earnings by $7.5 million, with zero net effect on total shareholders’ equity. The Company utilizes the individual securities approach when releasing income tax effects from AOCI for its investment securities.
In September 2018, the FASB issued ASU No. 2018-15, “Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” This ASU requires an entity in a cloud computing arrangement (i.e., hosting arrangement) that is a service contract to follow the internal-use software guidance in ASC 350-40 to determine which implementation costs to capitalize as assets or expense as incurred. Capitalized implementation costs should be presented in the same line item on the balance sheet as amounts prepaid for the hosted service, if any (generally as an “other asset”). The capitalized costs will be amortized over the term of the hosting arrangement, with the amortization expense being presented in the same income statement line item as the fees paid for the hosted service. ASU 2018-15 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted. The Company elected to adopt ASU 2018-15 during the quarter ended September 30, 2018 on a prospective basis. ASU 2018-15 did not have a material impact on the Company’s Consolidated Financial Statements.
Accounting Standards Pending Adoption
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. 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. As the Company expects to elect the transition option provided in ASU No. 2018-11 (see below), the modified retrospective approach will be applied on January 1, 2019 (as opposed to January 1, 2017). The Company also expects to elect certain relief options offered in ASU 2016-02 including the package of practical expedients, the option not to separate lease and non-lease components and instead to account for them as a single lease component, and the option not to recognize right-of-use assets and lease liabilities that arise from short-term leases (i.e., leases with terms of twelve months or less). The Company will likely not elect the hindsight practical expedient, which allows entities to use hindsight when determining lease term and impairment of right-of-use assets. 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 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 the Company’s regulatory capital ratios. However, the Company does not expect the new guidance to have a material impact on the Company’s consolidated statements of income. The Company is nearing completion of its effort to compile a complete inventory of arrangements containing a lease and accumulating the lease data necessary to apply the amended guidance. In addition, the Company is implementing new software to aid in the transition, and the majority of the Company’s leases have been entered into this new leasing software program.
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 are not 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 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 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. The team has been working with an advisory consultant and is in the process of finalizing the methodologies that will be utilized. 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. The Company is continuing to evaluate the extent of the potential impact.
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.
In July 2018, the FASB issued ASU No. 2018-11, “Leases - Targeted Improvements” to provide entities with relief from the costs of implementing certain aspects of the new leasing standard, ASU No. 2016-02. Specifically, under the amendments in ASU 2018-11: (1) entities may elect not to recast the comparative periods presented when transitioning to the new leasing standard, and (2) lessors may elect not to separate lease and non-lease components when certain conditions are met. The amendments have the same effective date as ASU 2016-02 (January 1, 2019 for the Company). The Company expects to elect both transition options. ASU 2018-11 is not expected to have a material impact on the Company’s Consolidated Financial Statements.
In August 2018, the FASB issued ASU No. 2018-13, “Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU No. 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted. Entities are also allowed to elect early adoption the eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date. As ASU No. 2018-13 only revises disclosure requirements, it will not have a material impact on the Company’s Consolidated Financial Statements.
In August 2018, the FASB issued ASU No. 2018-14, “Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans.” This ASU makes minor changes to the disclosure requirements for employers that sponsor defined benefit pension and/or other postretirement benefit plans. ASU 2018-14 is effective for fiscal years ending after December 15, 2020; early adoption is permitted. As ASU 2018-14 only revises disclosure requirements, it will not have a material impact on the Company’s Consolidated Financial Statements.
The following table provides a reconciliation of cash and cash equivalents reported within the consolidated statements of condition that sum to the total of the same such amounts shown in the consolidated statements of cash flows:
The amortized cost, gross unrealized gains and losses, and fair value of the Company’s investment securities as of September 30, 2018 and December 31, 2017 were as follows:
(dollars in thousands)
Amortized Cost
Gross Unrealized Gains
Gross Unrealized Losses
Fair Value
September 30, 2018
Available-for-Sale:
Debt Securities Issued by the U.S. Treasury and Government Agencies
$
420,400
$
474
$
(2,710
)
$
418,164
Debt Securities Issued by States and Political Subdivisions
574,755
4,275
(2,383
)
576,647
Debt Securities Issued by Government-Sponsored Enterprises
55
—
—
55
Debt Securities Issued by Corporations
224,997
65
(1,071
)
223,991
Mortgage-Backed Securities:
Residential - Government Agencies
198,364
1,807
(1,138
)
199,033
Residential - U.S. Government-Sponsored Enterprises
595,632
338
(23,778
)
572,192
Commercial - Government Agencies
64,414
—
(4,809
)
59,605
Total Mortgage-Backed Securities
858,410
2,145
(29,725
)
830,830
Total
$
2,078,617
$
6,959
$
(35,889
)
$
2,049,687
Held-to-Maturity:
Debt Securities Issued by the U.S. Treasury and Government Agencies
$
422,762
$
—
$
(2,185
)
$
420,577
Debt Securities Issued by States and Political Subdivisions
235,588
5,271
—
240,859
Debt Securities Issued by Corporations
101,120
—
(3,248
)
97,872
Mortgage-Backed Securities:
Residential - Government Agencies
1,956,198
3,140
(79,935
)
1,879,403
Residential - U.S. Government-Sponsored Enterprises
768,121
226
(31,029
)
737,318
Commercial - Government Agencies
180,698
—
(7,492
)
173,206
Total Mortgage-Backed Securities
2,905,017
3,366
(118,456
)
2,789,927
Total
$
3,664,487
$
8,637
$
(123,889
)
$
3,549,235
December 31, 2017
Available-for-Sale:
Debt Securities Issued by the U.S. Treasury and Government Agencies
$
424,912
$
2,053
$
(1,035
)
$
425,930
Debt Securities Issued by States and Political Subdivisions
618,167
9,894
(1,042
)
627,019
Debt Securities Issued by Corporations
268,003
199
(2,091
)
266,111
Mortgage-Backed Securities:
Residential - Government Agencies
233,268
3,129
(1,037
)
235,360
Residential - U.S. Government-Sponsored Enterprises
619,795
420
(10,403
)
609,812
Commercial - Government Agencies
71,999
—
(3,252
)
68,747
Total Mortgage-Backed Securities
925,062
3,549
(14,692
)
913,919
Total
$
2,236,144
$
15,695
$
(18,860
)
$
2,232,979
Held-to-Maturity:
Debt Securities Issued by the U.S. Treasury and Government Agencies
$
375,074
$
18
$
(1,451
)
$
373,641
Debt Securities Issued by States and Political Subdivisions
238,504
9,125
—
247,629
Debt Securities Issued by Corporations
119,635
123
(1,591
)
118,167
Mortgage-Backed Securities:
Residential - Government Agencies
2,229,985
9,975
(37,047
)
2,202,913
Residential - U.S. Government-Sponsored Enterprises
The table below presents an analysis of the contractual maturities of the Company’s investment securities as of September 30, 2018. 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
$
51,919
$
51,866
Due After One Year Through Five Years
631,703
630,347
Due After Five Years Through Ten Years
94,253
95,875
Due After Ten Years
22,912
23,568
800,787
801,656
Debt Securities Issued by Government Agencies
419,420
417,201
Mortgage-Backed Securities:
Residential - Government Agencies
198,364
199,033
Residential - U.S. Government-Sponsored Enterprises
595,632
572,192
Commercial - Government Agencies
64,414
59,605
Total Mortgage-Backed Securities
858,410
830,830
Total
$
2,078,617
$
2,049,687
Held-to-Maturity:
Due in One Year or Less
$
164,903
$
164,495
Due After One Year Through Five Years
347,271
346,571
Due After Five Years Through Ten Years
230,227
230,391
Due After Ten Years
17,069
17,851
759,470
759,308
Mortgage-Backed Securities:
Residential - Government Agencies
1,956,198
1,879,403
Residential - U.S. Government-Sponsored Enterprises
768,121
737,318
Commercial - Government Agencies
180,698
173,206
Total Mortgage-Backed Securities
2,905,017
2,789,927
Total
$
3,664,487
$
3,549,235
Investment securities with carrying values of $2.5 billion and $2.4 billion as of September 30, 2018 and December 31, 2017, 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, 2018 and 2017.
Three Months Ended September 30,
Nine Months Ended September 30,
(dollars in thousands)
2018
2017
2018
2017
Gross Gains on Sales of Investment Securities
$
—
$
—
$
—
$
12,467
Gross Losses on Sales of Investment Securities
(729
)
(566
)
(3,097
)
(1,420
)
Net Gains (Losses) on Sales of Investment Securities
$
(729
)
$
(566
)
$
(3,097
)
$
11,047
The losses during the three months ended September 30, 2018 were due to fees paid to the counterparties of the Company’s prior Visa Class B share sale transactions. The losses during the nine months ended September 30, 2018 were due to fees paid to the counterparties of the Company’s prior Visa Class B share sale transactions combined with a $1.0 million liability recorded in second quarter 2018 related to a change in the Visa Class B conversion ratio.
The Company’s gross unrealized losses and the related fair value of investment securities, aggregated by investment category and length of time in a continuous unrealized loss position, 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, 2018
Available-for-Sale:
Debt Securities Issued by the U.S. Treasury
and Government Agencies
$
188,906
$
(1,089
)
$
168,680
$
(1,621
)
$
357,586
$
(2,710
)
Debt Securities Issued by States
and Political Subdivisions
256,816
(1,894
)
45,914
(489
)
302,730
(2,383
)
Debt Securities Issued by U.S.
Government-Sponsored Enterprises
50
—
—
—
50
—
Debt Securities Issued by Corporations
24,940
(60
)
163,986
(1,011
)
188,926
(1,071
)
Mortgage-Backed Securities:
Residential - Government Agencies
11,614
(128
)
16,470
(1,010
)
28,084
(1,138
)
Residential - U.S. Government-Sponsored Enterprises
133,539
(3,236
)
417,167
(20,542
)
550,706
(23,778
)
Commercial - Government Agencies
—
—
59,605
(4,809
)
59,605
(4,809
)
Total Mortgage-Backed Securities
145,153
(3,364
)
493,242
(26,361
)
638,395
(29,725
)
Total
$
615,865
$
(6,407
)
$
871,822
$
(29,482
)
$
1,487,687
$
(35,889
)
Held-to-Maturity:
Debt Securities Issued by the U.S. Treasury
and Government Agencies
$
296,511
$
(1,116
)
$
124,066
$
(1,069
)
$
420,577
$
(2,185
)
Debt Securities Issued by Corporations
38,493
(839
)
59,378
(2,409
)
97,871
(3,248
)
Mortgage-Backed Securities:
Residential - Government Agencies
444,465
(11,878
)
1,238,576
(68,057
)
1,683,041
(79,935
)
Residential - U.S. Government-Sponsored Enterprises
241,918
(5,869
)
489,643
(25,160
)
731,561
(31,029
)
Commercial - Government Agencies
98,194
(1,854
)
75,013
(5,638
)
173,207
(7,492
)
Total Mortgage-Backed Securities
784,577
(19,601
)
1,803,232
(98,855
)
2,587,809
(118,456
)
Total
$
1,119,581
$
(21,556
)
$
1,986,676
$
(102,333
)
$
3,106,257
$
(123,889
)
December 31, 2017
Available-for-Sale:
Debt Securities Issued by the U.S. Treasury
and Government Agencies
$
103,842
$
(599
)
$
132,071
$
(436
)
$
235,913
$
(1,035
)
Debt Securities Issued by States
and Political Subdivisions
172,343
(1,032
)
734
(10
)
173,077
(1,042
)
Debt Securities Issued by Corporations
12,985
(15
)
192,927
(2,076
)
205,912
(2,091
)
Mortgage-Backed Securities:
Residential - Government Agencies
11,035
(4
)
10,618
(1,033
)
21,653
(1,037
)
Residential - U.S. Government-Sponsored Enterprises
429,342
(5,720
)
150,887
(4,683
)
580,229
(10,403
)
Commercial - Government Agencies
—
—
68,747
(3,252
)
68,747
(3,252
)
Total Mortgage-Backed Securities
440,377
(5,724
)
230,252
(8,968
)
670,629
(14,692
)
Total
$
729,547
$
(7,370
)
$
555,984
$
(11,490
)
$
1,285,531
$
(18,860
)
Held-to-Maturity:
Debt Securities Issued by the U.S. Treasury and Government Agencies
$
254,283
$
(532
)
$
89,391
$
(919
)
$
343,674
$
(1,451
)
Debt Securities Issued by Corporations
25,490
(110
)
58,869
(1,481
)
84,359
(1,591
)
Mortgage-Backed Securities:
Residential - Government Agencies
1,030,472
(12,262
)
704,545
(24,785
)
1,735,017
(37,047
)
Residential - U.S. Government-Sponsored Enterprises
The Company does not believe that the investment securities that were in an unrealized loss position as of September 30, 2018, which were comprised of 520 individual 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, 2018 and December 31, 2017, 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, 2018 and 2017 were as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
(dollars in thousands)
2018
2017
2018
2017
Taxable
$
28,855
$
27,441
$
85,931
$
79,949
Non-Taxable
4,554
4,880
14,006
14,915
Total Interest Income from Investment Securities
$
33,409
$
32,321
$
99,937
$
94,864
As of September 30, 2018, included in the Company’s investment securities portfolio were debt securities issued by political subdivisions within the State of Hawaii of $463.3 million, representing 57% of the total fair value of the Company’s municipal debt securities. Of the entire Hawaii municipal bond portfolio, 96% were credit-rated Aa2 or better by Moody’s while the remaining Hawaii municipal bonds were credit-rated A1 or better by at least one nationally recognized statistical rating organization. Of the Company’s total Hawaii municipal bond holdings, 80% were general obligation issuances. As of September 30, 2018, 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, 2018 and December 31, 2017, 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, 2018
December 31, 2017
Federal Home Loan Bank Stock
$
17,000
$
20,000
Federal Reserve Bank Stock
20,858
20,645
Total
$
37,858
$
40,645
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 will be 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, 2018, the conversion ratio was 1.6298. See Note 12 Derivative Financial Instruments for more information.
The Company occasionally sells these Visa Class B shares to other financial institutions. Concurrent with every sale the Company enters 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 83,014 Class B shares (135,296 Class A equivalents) that the Company owns as of September 30, 2018 are carried at a zero cost basis.
Note 4. 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, 2018 and December 31, 2017:
(dollars in thousands)
September 30, 2018
December 31, 2017
Commercial
Commercial and Industrial
$
1,314,609
$
1,279,347
Commercial Mortgage
2,237,020
2,103,967
Construction
176,447
202,253
Lease Financing
172,232
180,931
Total Commercial
3,900,308
3,766,498
Consumer
Residential Mortgage
3,596,627
3,466,773
Home Equity
1,625,208
1,585,455
Automobile
625,086
528,474
Other 1
483,833
449,747
Total Consumer
6,330,754
6,030,449
Total Loans and Leases
$
10,231,062
$
9,796,947
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 $0.4 million and $1.4 million for the three months ended September 30, 2018 and 2017, respectively, and $1.1 million and $4.6 million for the nine months ended September 30, 2018 and 2017, respectively.
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, 2018 and 2017. 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, 2018 and 2017.
(dollars in thousands)
Commercial
Consumer
Total
Three Months Ended September 30, 2018
Allowance for Loan and Lease Losses:
Balance at Beginning of Period
$
63,712
$
44,476
$
108,188
Loans and Leases Charged-Off
(449
)
(5,578
)
(6,027
)
Recoveries on Loans and Leases Previously Charged-Off
542
2,187
2,729
Net Loans and Leases Recovered (Charged-Off)
93
(3,391
)
(3,298
)
Provision for Credit Losses
1,274
2,526
3,800
Balance at End of Period
$
65,079
$
43,611
$
108,690
Nine Months Ended September 30, 2018
Allowance for Loan and Lease Losses:
Balance at Beginning of Period
$
65,822
$
41,524
$
107,346
Loans and Leases Charged-Off
(1,140
)
(16,536
)
(17,676
)
Recoveries on Loans and Leases Previously Charged-Off
1,236
6,359
7,595
Net Loans and Leases Recovered (Charged-Off)
96
(10,177
)
(10,081
)
Provision for Credit Losses
(839
)
12,264
11,425
Balance at End of Period
$
65,079
$
43,611
$
108,690
As of September 30, 2018
Allowance for Loan and Lease Losses:
Individually Evaluated for Impairment
$
135
$
3,810
$
3,945
Collectively Evaluated for Impairment
64,944
39,801
104,745
Total
65,079
43,611
108,690
Recorded Investment in Loans and Leases:
Individually Evaluated for Impairment
$
12,190
$
42,218
$
54,408
Collectively Evaluated for Impairment
3,888,118
6,288,536
10,176,654
Total
$
3,900,308
$
6,330,754
$
10,231,062
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