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 June 30, 2007

 

 

 

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 0-10777

CENTRAL PACIFIC FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

Hawaii

 

99-0212597

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

220 South King Street, Honolulu, Hawaii 96813

(Address of principal executive offices) (Zip Code)

(808)544-0500

(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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer 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

The number of shares outstanding of registrant’s common stock, par value $.01 per share, on July 26, 2007 was 30,442,402 shares.

 




CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

Table of Contents

Part I.

 

Financial Information

 

 

 

 

 

Item I.

 

Financial Statements (Unaudited)

 

 

 

 

 

 

 

Consolidated Balance Sheets

June 30, 2007 and December 31, 2006

 

 

 

 

 

 

 

Consolidated Statements of Income

Three and six months ended June 30, 2007 and 2006

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows

Six months ended June 30, 2007 and 2006

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements

 

 

 

 

 

Item 2.

 

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

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

 

 

 

 

Part II.

 

Other Information

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

 

 

 

 

Item 1A.

 

Risk Factors

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity and Use of Proceeds

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

 

 

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

 

 

 

 

Item 5.

 

Other Information

 

 

 

 

 

Item 6.

 

Exhibits

 

 

 

Signatures

 

 

Exhibit Index

 

 

2




PART I.   FINANCIAL INFORMATION

Forward-Looking Statements

This document may contain forward-looking statements concerning projections of revenues, income, earnings per share, capital expenditures, dividends, capital structure, or other financial items, concerning plans and objectives of management for future operations, concerning future economic performance, or concerning any of the assumptions underlying or relating to any of the foregoing. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts, and may include the words “believes”, “plans”, “intends”, “expects”, “anticipates”, “forecasts” or words of similar meaning. While we believe that our forward-looking statements and the assumptions underlying them are reasonably based, such statements and assumptions are by their nature subject to risks and uncertainties, and thus could later prove to be inaccurate or incorrect. Accordingly, actual results could materially differ from projections for a variety of reasons, to include, but not limited to: the impact of local, national, and international economies and events (including natural disasters) on the Company’s business and operations and on tourism, the military, and other major industries operating within the Hawaii market and any other markets in which the Company does business; the impact of legislation affecting the banking industry; the impact of competitive products, services, pricing, and other competitive forces; movements in interest rates; loan delinquency rates and changes in asset quality; and adverse conditions in the public debt market, the stock market or other capital markets, including any adverse changes in the price of the Company’s stock. For further information on factors that could cause actual results to materially differ from projections, please see the Company’s publicly available Securities and Exchange Commission filings, including the Company’s Form 10-K for the last fiscal year. The Company does not update any of its forward-looking statements.

3




Item 1. Financial Statements

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands)

 

June 30,
2007

 

December 31,
2006

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Cash and due from banks

 

$

116,216

 

$

129,715

 

Interest-bearing deposits in other banks

 

5,153

 

5,933

 

Federal funds sold

 

14,900

 

 

Investment securities:

 

 

 

 

 

Held to maturity, at amortized cost (fair value of $48,619 at June 30, 2007 and $64,249 at December 31, 2006)

 

49,495

 

65,204

 

Available for sale, at fair value

 

811,085

 

833,154

 

Total investment securities

 

860,580

 

898,358

 

 

 

 

 

 

 

Loans held for sale

 

45,539

 

26,669

 

Loans and leases

 

3,937,023

 

3,846,004

 

Less allowance for loan and lease losses

 

51,409

 

52,280

 

Net loans and leases

 

3,885,614

 

3,793,724

 

 

 

 

 

 

 

Premises and equipment

 

78,122

 

77,341

 

Accrued interest receivable

 

25,337

 

26,269

 

Investment in unconsolidated subsidiaries

 

14,134

 

12,957

 

Goodwill

 

291,985

 

297,883

 

Core deposit premium

 

30,529

 

31,898

 

Mortgage servicing rights

 

11,253

 

11,640

 

Bank-owned life insurance

 

104,597

 

102,394

 

Federal Home Loan Bank stock

 

48,797

 

48,797

 

Other assets

 

30,842

 

23,614

 

Total assets

 

$

5,563,598

 

$

5,487,192

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing demand

 

$

623,778

 

$

661,027

 

Interest-bearing demand

 

444,875

 

438,943

 

Savings and money market

 

1,223,943

 

1,205,271

 

Time

 

1,622,261

 

1,539,242

 

Total deposits

 

3,914,857

 

3,844,483

 

 

 

 

 

 

 

Short-term borrowings

 

1,903

 

79,308

 

Long-term debt

 

817,067

 

740,189

 

Minority interest

 

13,117

 

13,130

 

Other liabilities

 

63,111

 

71,943

 

Total liabilities

 

4,810,055

 

4,749,053

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, no par value, authorized 1,000,000 shares, none issued

 

 

 

Common stock, no par value, authorized 100,000,000 shares, issued and outstanding 30,446,160 shares at June 30, 2007 and 30,709,389 shares at December 31, 2006

 

427,153

 

430,904

 

Surplus

 

53,932

 

51,756

 

Retained earnings

 

290,353

 

270,624

 

Accumulated other comprehensive loss

 

(17,895

)

(15,145

)

Total shareholders’ equity

 

753,543

 

738,139

 

Total liabilities and shareholders’ equity

 

$

5,563,598

 

$

5,487,192

 

 

See accompanying notes to consolidated financial statements.

4




 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

(Amounts in thousands, except per share data)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Interest income:

 

 

 

 

 

 

 

 

 

Interest and fees on loans and leases

 

$

77,070

 

$

67,606

 

153,236

 

132,159

 

Interest and dividends on investment securities:

 

 

 

 

 

 

 

 

 

Taxable interest

 

8,866

 

8,947

 

17,578

 

17,510

 

Tax-exempt interest

 

1,365

 

1,277

 

2,728

 

2,595

 

Dividends

 

60

 

8

 

93

 

111

 

Interest on deposits in other banks

 

39

 

54

 

74

 

227

 

Interest on Federal funds sold and securities purchased under agreements to resell

 

109

 

2

 

119

 

54

 

Dividends on Federal Home Loan Bank stock

 

24

 

 

122

 

 

Total interest income

 

87,533

 

77,894

 

173,950

 

152,656

 

 

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

 

 

Interest on deposits:

 

 

 

 

 

 

 

 

 

Demand

 

141

 

143

 

279

 

292

 

Savings and money market

 

6,166

 

4,018

 

12,452

 

6,698

 

Time

 

17,424

 

12,303

 

33,257

 

23,279

 

Interest on short-term borrowings

 

303

 

583

 

808

 

814

 

Interest on long-term debt

 

10,616

 

8,680

 

20,584

 

17,214

 

Total interest expense

 

34,650

 

25,727

 

67,380

 

48,297

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

52,883

 

52,167

 

106,570

 

104,359

 

Provision for loan and lease losses

 

1,000

 

525

 

3,600

 

1,050

 

Net interest income after provision for loan and lease losses

 

51,883

 

51,642

 

102,970

 

103,309

 

 

 

 

 

 

 

 

 

 

 

Other operating income:

 

 

 

 

 

 

 

 

 

Service charges on deposit accounts

 

3,463

 

3,457

 

6,907

 

6,993

 

Other service charges and fees

 

3,414

 

2,995

 

6,771

 

5,999

 

Income from fiduciary activities

 

854

 

740

 

1,615

 

1,417

 

Equity in earnings of unconsolidated subsidiaries

 

167

 

147

 

424

 

331

 

Fees on foreign exchange

 

171

 

212

 

392

 

394

 

Loan placement fees

 

283

 

494

 

542

 

792

 

Gains on sales of loans

 

1,403

 

1,115

 

2,770

 

3,453

 

Income from bank-owned life insurance

 

1,183

 

785

 

2,214

 

1,709

 

Other

 

600

 

1,015

 

1,055

 

2,036

 

Total other operating income

 

11,538

 

10,960

 

22,690

 

23,124

 

 

 

 

 

 

 

 

 

 

 

Other operating expense:

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

16,888

 

17,615

 

33,294

 

36,677

 

Net occupancy

 

2,593

 

2,301

 

5,097

 

4,575

 

Equipment

 

1,325

 

1,280

 

2,555

 

2,453

 

Amortization of core deposit premium

 

685

 

974

 

1,370

 

1,948

 

Amortization of mortgage servicing rights

 

500

 

505

 

1,010

 

1,150

 

Communication expense

 

938

 

1,208

 

2,086

 

2,376

 

Legal and professional services

 

2,110

 

2,323

 

4,437

 

4,189

 

Computer software expense

 

893

 

647

 

1,692

 

1,240

 

Advertising expense

 

635

 

528

 

1,258

 

1,274

 

Other

 

4,764

 

4,077

 

9,008

 

9,355

 

Total other operating expense

 

31,331

 

31,458

 

61,807

 

65,237

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

32,090

 

31,144

 

63,853

 

61,196

 

Income taxes

 

11,074

 

10,706

 

22,702

 

21,419

 

Net income

 

$

21,016

 

$

20,438

 

$

41,151

 

$

39,777

 

 

 

 

 

 

 

 

 

 

 

Per share data:

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.69

 

$

0.67

 

1.34

 

$

1.31

 

Diluted earnings per share

 

0.68

 

0.66

 

1.33

 

1.29

 

Cash dividends declared

 

0.24

 

0.21

 

0.48

 

0.42

 

 

 

 

 

 

 

 

 

 

 

Shares used in computation:

 

 

 

 

 

 

 

 

 

Basic shares

 

30,555

 

30,466

 

30,627

 

30,453

 

Diluted shares

 

30,798

 

30,783

 

30,894

 

30,768

 

 

See accompanying notes to consolidated financial statements.

5




 

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

Six Months Ended
June 30,

 

(Dollars in thousands)

 

2007

 

2006

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

41,151

 

$

39,777

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Provision for loan and lease losses

 

3,600

 

1,050

 

Depreciation and amortization

 

3,515

 

3,410

 

Amortization of intangible assets

 

2,380

 

3,098

 

Net amortization of investment securities

 

859

 

1,461

 

Net loss on investment securities

 

 

19

 

Share-based compensation

 

2,176

 

1,702

 

Deferred income tax expense

 

4,363

 

39

 

Net gain on sale of loans

 

(2,770

)

(4,040

)

Proceeds from sales of loans held for sale

 

421,200

 

308,339

 

Originations of loans held for sale

 

(437,300

)

(268,524

)

Tax benefits from share-based compensation

 

 

(664

)

Equity in earnings of unconsolidated subsidiaries

 

(424

)

(334

)

Net change in other assets and liabilities

 

(13,049

)

(46,846

)

Net cash provided by operating activities

 

25,701

 

38,487

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Proceeds from maturities of and calls on investment securities held to maturity

 

15,644

 

3,045

 

Proceeds from maturities of and calls on investment securities available for sale

 

394,853

 

221,169

 

Proceeds from sales of investment securities available for sale

 

 

57

 

Purchases of investment securities available for sale

 

(378,709

)

(208,234

)

Net loan originations

 

(95,126

)

(136,846

)

Purchases of premises and equipment

 

(4,296

)

(7,211

)

Distributions from unconsolidated subsidiaries

 

577

 

767

 

Contributions to unconsolidated subsidiaries

 

(2,668

)

 

Net cash used in investing activities

 

(69,725

)

(127,253

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net increase in deposits

 

70,374

 

21,916

 

Proceeds from long-term debt

 

150,000

 

50,000

 

Repayments of long-term debt

 

(72,693

)

(55,653

)

Net increase (decrease) in short-term borrowings

 

(77,405

)

22,163

 

Cash dividends paid

 

(14,714

)

(12,796

)

Tax benefits from share-based compensation

 

 

664

 

Repurchases of common stock

 

(12,184

)

 

Proceeds from stock option exercises

 

1,267

 

478

 

Net cash provided by financing activities

 

44,645

 

26,772

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

621

 

(61,994

)

Cash and cash equivalents at beginning of period

 

135,648

 

164,740

 

Cash and cash equivalents at end of period

 

$

136,269

 

$

102,746

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

64,940

 

$

45,420

 

Income taxes

 

15,811

 

23,900

 

Cash received during the period for:

 

 

 

 

 

Income taxes

 

 

3,255

 

 

 

 

 

 

 

Supplemental disclosure of noncash investing and financing activities:

 

 

 

 

 

Net change in common stock held by directors’ deferred compensation plan

 

$

22

 

$

20

 

 

See accompanying notes to consolidated financial statements.

6




CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.     BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements of Central Pacific Financial Corp. (the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These interim condensed consolidated financial statements and notes should be read in conjunction with the Company’s consolidated financial statements and notes thereto filed on Form 10-K for the fiscal year ended December 31, 2006. In the opinion of management, all adjustments necessary for a fair presentation have been made and include all normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year.

Certain prior period amounts in the condensed consolidated financial statements and notes thereto have been reclassified to conform to the current period presentation. Such reclassifications had no impact on net income or shareholders’ equity for any periods presented.

2.     RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140” (“SFAS 155”). SFAS 155 amends the guidance in SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” SFAS 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and amends SFAS 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. The Company adopted the provisions of SFAS 155 beginning January 1, 2007 and such adoption did not have a material impact on its consolidated financial statements.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140” (“SFAS 156”). SFAS 156 requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value and permits an entity to choose to either amortize servicing assets or servicing liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and assess servicing assets or servicing liabilities for impairment or increased obligation based on fair value at each reporting date, or measure servicing assets or servicing liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur. SFAS 156 also permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, provided that the available-for-sale securities are identified as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value, requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value and specifies additional disclosures for all separately recognized servicing assets and servicing

7




liabilities. The Company adopted the provisions of SFAS 156 beginning January 1, 2007 and such adoption did not have a material impact on its consolidated financial statements.

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) on January 1, 2007. As a result of the adoption, the Company recognized a net decrease of $5.3 million in the liability for uncertain tax positions, of which, $0.5 million was accounted for as an increase to beginning retained earnings, $5.3 million was accounted for as a decrease to goodwill and $0.5 million was recorded as a decrease in other liabilities. Including the cumulative effect of the decrease in the liability for uncertain tax positions, the Company’s unrecognized tax benefits totaled $6.9 million at January 1, 2007, of which $1.8 million represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods.

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state jurisdictions. The Company has substantially concluded all U.S. federal income tax matters for years through 1997. Federal income tax returns for 1998, 2000 through 2002, and 2004 are currently under examination. The Company’s continuing practice is to recognize interest and penalties related to income tax matters in interest expense and other expense, respectively. At the date of adoption, the Company had $2.1 million accrued for interest relating to income tax matters and at June 30, 2007, accrued interest amounted to $2.5 million. There were no penalties relating to income tax matters accrued at the date of adoption, as well as at June 30, 2007.

In September 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF No. 06-5, “Accounting for Purchases of Life Insurance - Determining the Amount that Could Be Realized in Accordance with FASB Tech Bulletin 85-4” (“EITF 06-5”). The EITF concluded that a policyholder should consider any additional amounts included in the contractual terms of the life insurance policy in determining the “amount that could be realized under the insurance contract” on a policy by policy basis. EITF 06-5 is effective for fiscal years beginning after December 15, 2006 and it requires that recognition of the effects of adoption should be either by (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. The Company adopted the provisions of EITF 06-5 beginning January 1, 2007 and such adoption did not have a material impact on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). The standard defines fair value, establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America and expands disclosure about fair value measurements. The pronouncement applies under other accounting standards that require or permit fair value measurements. Accordingly, the statement does not require any new fair value measurement. SFAS 157 is effective for fiscal years beginning after November 15, 2007 and the Company plans to adopt SFAS 157 on January 1, 2008. The Company is evaluating the requirements of SFAS 157 and is currently assessing the impact of this statement on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of this statement on its consolidated financial statements.

In March 2007, the FASB ratified EITF No. 06-10 “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements”

8




(“EITF 06-10”). EITF 06-10 requires that an employer recognize a liability for the postretirement benefit obligation related to a collateral assignment arrangement in accordance with SFAS No. 106 “Employers’ Accounting for Postretirement Benefits Other Than Pensions” (if deemed part of a postretirement plan) or Accounting Principles Board Opinion 12 “Omnibus Opinion-1967” (if not part of a plan). The consensus is applicable if, based on the substantive agreement with the employee, the employer has agreed to (a) maintain a life insurance policy during the postretirement period or (b) provide a death benefit. The EITF also reached a consensus that an employer should recognize and measure the associated asset on the basis of the terms of the collateral assignment arrangement. The Company is required to adopt EITF 06-10 effective January 1, 2008 and is currently assessing the impact of this EITF issue on its consolidated financial statements.

3.     LOANS AND LEASES

Loans, excluding loans held for sale, consisted of the following at the dates indicated:

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

Commercial, Financial and Agricultural

 

$

389,538

 

$

405,046

 

Real Estate:

 

 

 

 

 

Construction

 

1,098,710

 

1,144,680

 

Mortgage-Residential

 

953,098

 

898,932

 

Mortgage-Commercial

 

1,261,692

 

1,165,267

 

Consumer

 

193,912

 

195,436

 

Leases

 

53,041

 

50,741

 

 

 

3,949,991

 

3,860,102

 

Unearned income

 

(12,968

)

(14,098

)

Total loans and leases

 

$

3,937,023

 

$

3,846,004

 

 

4.     ALLOWANCE FOR LOAN AND LEASE LOSSES

The following table presents the changes in the allowance for loan and lease losses for the periods indicated:

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(Dollars in thousands)

 

Balance, beginning of period

 

$

50,614

 

$

53,057

 

$

52,280

 

$

52,936

 

 

 

 

 

 

 

 

 

 

 

Provision for loan and lease losses

 

1,000

 

525

 

3,600

 

1,050

 

 

 

 

 

 

 

 

 

 

 

Charge-offs

 

(843

)

(1,249

)

(5,678

)

(2,333

)

Recoveries

 

638

 

581

 

1,207

 

1,261

 

Net charge-offs

 

(205

)

(668

)

(4,471

)

(1,072

)

Balance, end of period

 

$

51,409

 

$

52,914

 

$

51,409

 

$

52,914

 

 

9




5.     GOODWILL AND OTHER INTANGIBLE ASSETS

The following table presents the changes in goodwill allocated to each of our reportable segments during the six months ended June 30, 2007:

 

 

 

Commercial

 

 

 

 

 

Hawaii

 

Real

 

 

 

 

 

Market

 

Estate

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

152,812

 

$

145,071

 

$

297,883

 

Reductions

 

(2,983

)

(2,915

)

(5,898

)

Balance, end of period

 

$

149,829

 

$

142,156

 

$

291,985

 

 

At June 30, 2007, goodwill recorded in conjunction with the acquisitions of CB Bancshares, Inc. (“CBBI”) and Hawaii HomeLoans, Inc. totaled $292.0 million. Goodwill at June 30, 2007 reflected a decrease of $5.9 million from the amount reported as of December 31, 2006 due to adjustments recorded on CBBI tax contingencies upon the adoption of FIN 48 of $5.3 million, as well as the reversal of previously accrued acquisition costs of $0.6 million.

Other intangible assets include a core deposit premium and mortgage servicing rights. The following table presents changes in other intangible assets for the six months ended June 30, 2007:

 

Core

 

Mortgage

 

 

 

Deposit

 

Servicing

 

 

 

Premium

 

Rights

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

Balance, beginning of period

 

$

31,898

 

$

11,640

 

Additions

 

 

623

 

Amortization

 

(1,369

)

(1,010

)

Balance, end of period

 

$

30,529

 

$

11,253

 

 

The gross carrying value and accumulated amortization related to the core deposit premium and mortgage servicing rights are presented below:

 

June 30, 2007

 

December 31, 2006

 

 

 

Gross

 

 

 

 

 

Gross

 

 

 

 

 

 

 

Carrying

 

Accumulated

 

 

 

Carrying

 

Accumulated

 

 

 

 

 

Value

 

Amortization

 

Net

 

Value

 

Amortization

 

Net

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Core deposit premium

 

$

44,642

 

$

(14,113

)

$

30,529

 

$

44,642

 

$

(12,744

)

$

31,898

 

Mortgage servicing rights

 

19,717

 

(8,464

)

11,253

 

19,094

 

(7,454

)

11,640

 

 

10




Based on the core deposit premium and mortgage servicing rights held as of June 30, 2007, estimated amortization expense for the remainder of fiscal 2007, the next five succeeding fiscal years and all years thereafter are as follows:

 

Estimated Amortization Expense

 

 

 

 

 

Mortgage

 

 

 

Core Deposit

 

Servicing

 

 

 

Premium

 

Rights

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

2007 (remainder)

 

$

1,370

 

$

1,016

 

2008

 

2,491

 

1,617

 

2009

 

2,491

 

1,334

 

2010

 

2,491

 

1,159

 

2011

 

2,491

 

1,006

 

2012

 

2,491

 

876

 

Thereafter

 

16,704

 

4,245

 

 

 

$

30,529

 

$

11,253

 

 

The Company accounts for its mortgage servicing rights under the provisions of SFAS 156, which was adopted beginning January 1, 2007. Mortgage servicing rights are recorded when loans are sold to third-parties with servicing of those loans retained and the Company classifies its entire mortgage servicing rights into one class.

Initial fair value of the servicing right is calculated by a discounted cash flow model prepared by a third party service provider based on market value assumptions at the time of origination and the Company assesses the servicing right for impairment using current market value assumptions at each reporting period. Critical assumptions used in the discounted cash flow model include mortgage prepayment speeds, discount rates, costs to service and ancillary income. Variations in our assumptions could materially affect the estimated fair values. Changes to our assumptions are made when current trends and market data indicate that new trends have developed. Current market value assumptions based on loan product types (fixed rate, adjustable rate and balloon loans) include average discount rates and national prepayment speeds. Many of these assumptions are subjective and require a high level of management judgment. Our mortgage servicing rights portfolio and valuation assumptions are periodically reviewed by management.

Prepayment speeds may be affected by economic factors such as home price appreciation, market interest rates, the availability of other credit products to our borrowers and customer payment patterns. Prepayment speeds include the impact of all borrower prepayments, including full payoffs, additional principal payments and the impact of loans paid off due to foreclosure liquidations. As market interest rates decline, prepayment speeds will generally increase as customers refinance existing mortgages under more favorable interest rate terms. As prepayment speeds increase, anticipated cash flows will generally decline resulting in a potential reduction, or impairment, to the fair value of the capitalized mortgage servicing rights. Alternatively, an increase in market interest rates may cause a decrease in prepayment speeds and therefore and an increase in fair value of mortgage servicing rights.

The Company has elected to use the amortization method to measure its mortgage servicing rights. Under the amortization method, the Company amortizes its mortgage servicing rights in proportion to and over the period of net servicing income. Income generated as the result of new mortgage servicing rights is reported as gains on sales of loans and totaled $0.3 million and $0.6 million for the three and six months ended June 30, 2007, respectively, compared to $0.4 million and $1.2 million for the three and six months ended June 30, 2006, respectively. Amortization of the servicing rights is reported as amortization of mortgage servicing rights in the Company’s consolidated statements of income. Ancillary

11




income is recorded in other income.

The following table presents the fair market value and key assumptions used in determining the fair market value of the Company’s mortgage servicing rights as of June 30, 2007:

 

(Dollars in thousands)

 

Fair market value at January 1, 2007

 

$

12,086

 

Fair market value at June 30, 2007

 

$

13,057

 

Weighted average discount rate

 

8.6

%

Weighted average prepayment speed assumption

 

11.6

%

 

6.     MERGER WITH CB BANCSHARES, INC.

The Company completed its merger with CB Bancshares, Inc. (“CBBI”) on September 15, 2004 (the “Effective Date”). At the Effective Date, the Company recorded liabilities totaling $17.6 million for estimated costs to exit certain CBBI facilities and operations. These liabilities, net of tax, were included in the cost of the merger, resulting in an increase in goodwill. Certain adjustments to the estimates have been recorded as adjustments to the cost of the merger.

The following table sets forth information related to the exit costs accrued, adjustments to estimates and payments made against accrued amounts:

 

Balance at

 

Adjustments to

 

 

 

Balance at

 

 

 

December 31, 2006

 

estimates

 

Payments

 

June 30, 2007

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Lease termination fees

 

$

5,012

 

$

251

 

$

(1,418

)

$

3,845

 

Asset write-offs

 

271

 

(271

)

 

 

Contract termination fees

 

319

 

(319

)

 

 

Total

 

$

5,602

 

$

(339

)

$

(1,418

)

$

3,845

 

 

7.     SHARE REPURCHASE

In April 2006, the Company’s board of directors authorized the repurchase and retirement of up to 600,000 shares of the Company’s common stock (the “2006 Repurchase Plan”). The 2006 Repurchase Plan remained in effect through April 26, 2007.

On April 26, 2007, the Company’s board of directors authorized the repurchase and retirement of up to 600,000 shares, of which 300,200 shares remain authorized for repurchase as of June 30, 2007, under a new repurchase plan that will remain in effect through April 30, 2008 (the “2007 Repurchase Plan”). On July 25, 2007, the Company’s board of directors authorized the repurchase of an additional 1,500,000 shares under the 2007 Repurchase Plan. Repurchases may be made from time to time on the open market or in privately negotiated transactions. The repurchase authorization under the 2007 Repurchase Plan rescinded the planned repurchase of any remaining shares under the Company’s 2006 Repurchase Plan.

During the six months ended June 30, 2007, the Company repurchased and retired a total of 355,800 shares of common stock for approximately $12.2 million.

12




8.     SHARE-BASED COMPENSATION

The following table reflects total share-based compensation recognized for the periods indicated:

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

$

914

 

830

 

2,176

 

$

1,702

 

Income tax benefit

 

(366

)

(333

)

(872

)

(682

)

Net share-based compensation effect

 

$

548

 

$

497

 

$

1,304

 

$

1,020

 

 

In accordance with SFAS 123R, the Company is required to base initial share-based compensation expense on the estimated number of awards for which the requisite service and performance is expected to be rendered.

Stock Option Plans

The Company has adopted stock option plans for the purpose of granting options to purchase the Company’s common stock to directors, officers and other key individuals. Option awards are generally granted with an exercise price equal to the market price of the Company’s common stock at the date of grant; those option awards generally vest based on three or five years of continuous service and have 10-year contractual terms. Certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the stock option plans below). The Company has historically issued new shares of common stock upon exercises of stock options and purchases of restricted awards.

In February 1997, the Company adopted the 1997 Stock Option Plan (“1997 Plan”) basically as a continuance of the 1986 Stock Option Plan. In April 1997, the Company’s shareholders approved the 1997 Plan, which provided 2,000,000 shares of the Company’s common stock for grants to employees as qualified incentive stock options and to directors as nonqualified stock options.

In September 2004, the Company adopted and the Company’s shareholders approved the 2004 Stock Compensation Plan (“2004 Plan”) making available 1,989,224 shares for grants to employees and directors. Upon adoption of the 2004 Plan, all unissued shares from the 1997 Plan were frozen and no new options will be granted under the 1997 Plan. Optionees may exercise outstanding options granted pursuant to the 1997 Plan until the expiration of the respective options in accordance with the original terms of the 1997 Plan. To satisfy share issuances pursuant to the share-based compensation programs, the Company issues new shares from the 2004 Plan.

13




The following is a summary of option activity for the Company’s stock option plans for the six months ended June 30, 2007:

 

 

 

Weighted Average

 

 

 

Shares

 

Exercise Price

 

Outstanding at January 1, 2007

 

990,324

 

$

25.55

 

Changes during the period:

 

 

 

 

 

Granted

 

71,000

 

35.90

 

Exercised

 

(56,294

)

18.06

 

Expired

 

 

 

Forfeited

 

(23,674

)

34.66

 

Outstanding at June 30, 2007

 

981,356

 

26.51

 

 

The Company estimates the fair value of stock options granted using the Black-Scholes option pricing formula and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. There were no stock options granted to employees during the three months ended June 30, 2007, as well as the three and six months ended June 30, 2006. The fair value of the Company’s stock options granted to employees for the six months ended June 30, 2007 was estimated using the following weighted-average assumptions:

Expected volatility

 

33.3

%

Risk free interest rate

 

4.5

%

Expected dividends

 

2.8

%

Expected life (in years)

 

7.5

 

Weighted average fair value

 

$

11.40

 

 

Restricted Stock Awards

Under the 1997 and 2004 Plans, the Company awarded restricted stock awards to its non-officer directors and certain senior management personnel. The awards typically vest over a three or five year period. Compensation expense is measured as the market price of the stock awards on the grant date, and is recognized over the specified vesting periods.

The table below presents the activity of restricted stock awards for the six months ended June 30, 2007:

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

 

 

Grant Date

 

 

 

Shares

 

Fair Value

 

Nonvested at January 1, 2007

 

22,520

 

$

34.35

 

Changes during the period:

 

 

 

 

 

Granted

 

22,000

 

35.81

 

Vested

 

(900

)

27.75

 

Forfeited

 

(1,500

)

35.90

 

Nonvested at June 30, 2007

 

42,120

 

35.20

 

 

Performance Shares and Stock Appreciation Rights

In 2005, the Company established a Long Term Incentive Plan (“LTIP”) that covers certain executive and senior management personnel. The LTIP is comprised of three components: performance shares, stock appreciation rights and cash awards.

14




Performance shares are granted under the 2004 Plan and vest based on achieving both performance and service conditions. Performance conditions require achievement of stated goals including earnings per share, credit quality and efficiency ratio targets. The service condition requires employees to be employed continuously with the Company through March 15, 2008.  The fair value of the grant to be recognized over this service period is determined based on the market value of the stock on the grant date, multiplied by the probability of the granted shares being earned. This requires the Company to assess the expectation over the performance period of the performance targets being achieved as well as to estimate expected pre-vested cancellations. To the extent that the actual achievement falls short of the originally determined expectation (probability), then there is no adjustment to reduce the remaining compensation cost to be recognized. If, on the other hand, the actual achievement exceeds the expected achievement, then compensation cost is adjusted for the reporting period and over the remaining service period to reflect the increased expected compensation cost.

The table below presents activity of performance shares for the six months ended June 30, 2007:

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

 

 

Grant Date

 

 

 

Shares

 

Fair Value

 

Nonvested at January 1, 2007

 

82,438

 

$

34.67

 

Changes during the period:

 

 

 

 

 

Granted

 

 

 

Forfeited

 

(6,835

)

34.34

 

Nonvested at June 30, 2007

 

75,603

 

34.70

 

 

Stock appreciation rights (“SARs”) are granted under the 2004 Plan. These SARs require the employee to achieve the same performance conditions as the performance shares described above as well as to satisfy service conditions that approximate three years from the date of grant. Upon exercise of the SAR, for each SAR exercised, the grantee shall be entitled to receive value equal to the difference between the market value of a share on the date of exercise minus the market value of a share on the date of grant. The Company shall pay the value owing to the grantee upon exercise in whole shares. No cash will be awarded upon exercise, and no fractional shares will be issued or delivered.

As the SARs plan is a stock-settled SAR, this plan is an equity-classified award under SFAS 123R. As such, the financial and income tax accounting for this type of award is identical to that of a nonqualified stock option plan. Therefore, the grant date fair value is determined at the grant date using the same method as would be used for determining the fair value of a grant of a nonqualified stock option, which has historically been the Black-Scholes formula. Similar to the performance shares addressed above, the amount of compensation cost to be recognized is the fair value of the SAR grant adjusted based on expectations of achieving the performance requirements and also the expected pre-vested cancellations. Compensation costs arising from the SARs will be recognized ratably over the requisite service period.

There were no grants of SARs for the three months ended June 30, 2007.  The fair value of SARs granted to employees for the three months ended June 30, 2006 was estimated using the Black-Scholes option pricing formula with the following weighted-average assumptions: expected volatility of 34.3%, risk free interest rate of 5.1%, expected dividends of 2.3% and expected life of 6.5 years, resulting in a weighted average fair value of $12.40 per grant. The fair value of SARs granted to employees for the six months ended June 30, 2007 and 2006 was estimated using the Black-Scholes option pricing formula with the following weighted-average assumptions:

15




 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2007

 

2006

 

Expected volatility

 

31.7

%

34.4

%

Risk free interest rate

 

4.5

%

4.7

%

Expected dividends

 

2.8

%

2.4

%

Expected life (in years)

 

6.5

 

6.5

 

Weighted average fair value

 

$

10.49

 

$

10.78

 

 

The table below presents activity of SARs for the six months ended June 30, 2007:

 

 

 

Weighted Average

 

 

 

Shares

 

Exercise Price

 

Outstanding at January 1, 2007

 

56,161

 

$

34.95

 

Changes during the period:

 

 

 

 

 

Granted

 

33,883

 

35.90

 

Forfeited

 

(8,701

)

35.49

 

Outstanding at June 30, 2007

 

81,343

 

35.29

 

9.     ACCUMULATED OTHER COMPREHENSIVE LOSS

Components of accumulated other comprehensive loss, net of taxes, were as follows:

 

June 30,

 

December 31,

 

 

 

2007

 

2006

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

Unrealized holding losses on available-for-sale investment securities

 

$

(20,553

)

$

(15,422

)

Pension liability adjustments

 

(9,305

)

(9,853

)

Tax benefit

 

11,963

 

10,130

 

Accumulated other comprehensive loss, net of tax

 

(17,895

)

(15,145

)

 

Components of comprehensive income for the periods indicated were as follows:

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

21,016

 

$

20,438

 

$

41,151

 

$

39,777

 

Unrealized gain (loss) on investment securities, net of taxes

 

(4,883

)

(2,778

)

(3,078

)

(8,035

)

Pension adjustments, net of taxes

 

328

 

 

328

 

 

Comprehensive income

 

$

16,461

 

$

17,660

 

$

38,401

 

$

31,742

 

 

10. PENSION PLANS

Central Pacific Bank (“CPB”) has a defined benefit retirement plan (the “Pension Plan”) which covers certain eligible employees. The plan was curtailed effective December 31, 2002, and accordingly, plan benefits were fixed as of that date. The following table sets forth the components of net periodic benefit cost for the Pension Plan:

16




 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Interest cost

 

$

446

 

$

385

 

$

892

 

$

770

 

Expected return on assets

 

(560

)

(505

)

(1,120

)

(1,010

)

Amortization of unrecognized loss

 

264

 

226

 

528

 

452

 

Net periodic cost

 

$

150

 

$

106

 

$

300

 

$

212

 

CPB also established Supplemental Executive Retirement Plans (“SERPs”), which provide certain officers of CPB with supplemental retirement benefits. The following table sets forth the components of net periodic benefit cost for the SERPs:

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Service cost

 

$

140

 

$

182

 

$

280

 

$

364

 

Interest cost

 

136

 

135

 

272

 

270

 

Amortization of unrecognized transition obligation

 

5

 

49

 

10

 

98

 

Amortization of prior service cost

 

5

 

4

 

10

 

8

 

Amortization of unrecognized (gain) loss

 

1

 

(12

)

2

 

(24

)

Net periodic cost

 

$

287

 

$

358

 

$

574

 

$

716

 

 

11.  EARNINGS PER SHARE

The following table presents the information used to compute basic and diluted earnings per share for the periods indicated:

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(In thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

21,016

 

$

20,438

 

$

41,151

 

$

39,777

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding - basic

 

30,555

 

30,466

 

30,627

 

30,453

 

Dilutive effect of employee stock options and awards

 

243

 

317

 

267

 

315

 

Weighted average shares outstanding - diluted

 

30,798

 

30,783

 

30,894

 

30,768

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.69

 

$

0.67

 

$

1.34

 

$

1.31

 

Diluted earnings per share

 

$

0.68

 

$

0.66

 

$

1.33

 

$

1.29

 

 

17




12.  SEGMENT INFORMATION

The Company has three reportable segments: Commercial Real Estate, Hawaii Market, and Treasury. The segments reported are consistent with internal functional reporting lines. They are managed separately because each unit has different target markets, technological requirements, marketing strategies and specialized skills. The Commercial Real Estate segment includes construction and real estate development lending in Hawaii, California and Washington. The Hawaii Market segment includes retail branch offices, commercial lending, residential mortgage lending and servicing, indirect auto lending, trust services and retail brokerage services. A full range of deposit and loan products and various other banking services are offered. The Treasury segment is responsible for managing the Company’s investment securities portfolio and wholesale funding activities.

The All Others category includes activities such as electronic banking, data processing, and management of bank owned properties.

The accounting policies of the segments are consistent with the Company’s accounting policies that are described in Note 1 to the consolidated financial statements in the Annual Report on Form 10-K for the year ended December 31, 2006 filed with the Securities and Exchange Commission. The majority of the Company’s net income is derived from net interest income. Accordingly, management focuses primarily on net interest income, rather than gross interest income and expense amounts, in evaluating segment profitability.

Intersegment net interest income (expense) was allocated to each segment based upon a funds transfer pricing process that assigns costs of funds to assets and earnings credits to liabilities based on market interest rates that reflect interest rate sensitivity and maturity characteristics. All administrative and overhead expenses are allocated to the segments at cost. Cash, investment securities, loans and their related balances are allocated to the segment responsible for acquisition and maintenance of those assets. Segment assets also include all premises and equipment used directly in segment operations.

Segment profits and assets are provided in the following table for the periods indicated.

18




 

 

 

Commercial

 

Hawaii

 

 

 

 

 

 

 

 

 

Real Estate

 

Market

 

Treasury

 

All Others

 

Total

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 2007:

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

43,883

 

$

12,690

 

$

(3,690

)

$

 

$

52,883

 

Intersegment net interest income (expense)

 

(27,656

)

19,505

 

1,717

 

6,434

 

 

Provision for loan losses

 

(60

)

(940

)

 

 

(1,000

)

Other operating income

 

67

 

9,282

 

2,309

 

(120

)

11,538

 

Other operating expense

 

(1,729

)

(16,453

)

(565

)

(12,584

)

(31,331

)

Administrative and overhead expense allocation

 

(1,806

)

(9,252

)

(444

)

11,502

 

 

Income taxes

 

(4,918

)

(5,205

)

(962

)

11

 

(11,074

)

Net income (loss)

 

$

7,781

 

$

9,627

 

$

(1,635

)

$

5,243

 

$

21,016

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 2006:

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

37,148

 

$

15,975

 

$

(956

)

$

 

$

52,167

 

Intersegment net interest income (expense)

 

(22,302

)

17,673

 

(1,064

)

5,693

 

 

Provision for loan losses

 

2

 

(527

)

 

 

(525

)

Other operating income

 

147

 

8,808

 

1,396

 

609

 

10,960

 

Other operating expense

 

(2,171

)

(15,112

)

(571

)

(13,604

)

(31,458

)

Administrative and overhead expense allocation

 

(1,632

)

(9,533

)

(97

)

11,262

 

 

Income taxes

 

(4,145

)

(5,842

)

(825

)

106

 

(10,706

)

Net income (loss)

 

$

7,047

 

$

11,442

 

$

(2,117

)

$

4,066

 

$

20,438

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 2007:

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

88,066

 

$

24,927

 

$

(6,423

)

$

 

$

106,570

 

Intersegment net interest income (expense)

 

(54,370

)

39,043

 

2,133

 

13,194

 

 

Provision for loan losses

 

(60

)

(3,540

)

 

 

(3,600

)

Other operating income

 

81

 

18,365

 

4,205

 

39

 

22,690

 

Other operating expense

 

(3,591

)

(33,940

)

(1,214

)

(23,062

)

(61,807

)

Administrative and overhead expense allocation

 

(3,591

)

(16,312

)

(528

)

20,431

 

 

Income taxes

 

(10,219

)

(10,120

)

(1,732

)

(631

)

(22,702

)

Net income (loss)

 

$

16,316

 

$

18,423

 

$

(3,559

)

$

9,971

 

$

41,151

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 2006:

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

$

72,161

 

$

33,602

 

$

(1,404

)

$

 

$

104,359

 

Intersegment net interest income (expense)

 

(42,153

)

33,457

 

(2,552

)

11,248

 

 

Provision for loan losses

 

(87

)

(963

)

 

 

(1,050

)

Other operating income

 

196

 

18,689

 

2,922

 

1,317

 

23,124

 

Other operating expense

 

(4,319

)

(30,657

)

(1,080

)

(29,181

)

(65,237

)

Administrative and overhead expense allocation

 

(3,710

)

(20,991

)

(259

)

24,960

 

 

Income taxes

 

(9,185

)

(10,985

)

(1,553

)

304

 

(21,419

)

Net income (loss)

 

$

12,903

 

$

22,152

 

$

(3,926

)

$

8,648

 

$

39,777

 

 

 

 

 

 

 

 

 

 

 

 

 

 At June 30, 2007:

 

 

 

 

 

 

 

 

 

 

 

Investment securities

 

$

 

$

 

$

860,580

 

$

 

$

860,580

 

Loans and leases (including loans held for sale)

 

2,096,593

 

1,885,969

 

 

 

3,982,562

 

Other

 

151,821

 

256,045

 

275,218

 

37,372

 

720,456

 

Total assets

 

$

2,248,414

 

$

2,142,014

 

$

1,135,798

 

$

37,372

 

$

5,563,598

 

 

 

 

 

 

 

 

 

 

 

 

 

 At December 31, 2006:

 

 

 

 

 

 

 

 

 

 

 

Investment securities

 

$

 

$

 

$

898,358

 

$

 

$

898,358

 

Loans and leases (including loans held for sale)

 

2,058,257

 

1,814,416

 

 

 

3,872,673

 

Other

 

154,691

 

258,534

 

265,696

 

37,240

 

716,161

 

Total assets

 

$

2,212,948

 

$

2,072,950

 

$

1,164,054

 

$

37,240

 

$

5,487,192

 

 

19




Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Portions of the financial outlook for 2007 that follows is as previously communicated in our July 26, 2007, Current Report on Form 8-K release of second quarter 2007 results. Since that time, the financial markets have exhibited extraordinary volatility. In light of market conditions as of this filing and uncertainty about how long the markets will remain volatile, we are currently unable to estimate the impact of these market conditions on our operating results for the rest of the year.

Critical Accounting Policies

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires that management make certain judgments and use certain estimates and assumptions that affect amounts reported and disclosures made. Accounting estimates are deemed critical when a different estimate could have reasonably been used or where changes in the estimate are reasonably likely to occur from period to period and would materially impact our consolidated financial statements as of or for the periods presented.  Management has discussed the development and selection of the critical accounting estimates noted below with the Audit Committee of the Board of Directors, and the Audit Committee has reviewed the accompanying disclosures.

Allowance for Loan and Lease Losses

We maintain an allowance for loan and lease losses (the” Allowance”) at an amount we expect to be sufficient to absorb probable losses inherent in our loan and lease portfolio based on a projection of probable net loan charge-offs. For loans classified as impaired, an estimated impairment loss is calculated. To estimate loan charge-offs on other loans, we evaluate the level and trend of nonperforming and potential problem loans and historical loss experience. We also consider other relevant economic conditions and borrower-specific risk characteristics, including current repayment patterns of our borrowers, the fair value of collateral securing, specific loans, changes in our lending and underwriting standards and general economic factors, nationally and in the markets we serve. Estimated loss rates are determined by loan category and risk profile, and an overall required Allowance is calculated. Based on our estimate of the level of Allowance required, a provision for loan and lease losses (the “Provision”) is recorded to maintain the Allowance at an appropriate level.

Since we cannot predict with certainty the amount of loan and lease charge-offs that will be incurred, and because the eventual level of loan and lease charge-offs are impacted by numerous conditions beyond our control, a range of loss estimates could reasonably have been used to determine the Allowance and Provision. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review our Allowance. Such agencies may require that we recognize additions to the Allowance based on their judgments about information available to them at the time of their examination. Accordingly, actual results could differ from those estimates.

Goodwill and Other Intangible Assets

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), we review the carrying amount of goodwill for impairment on an annual basis. Additionally, we perform an impairment assessment of goodwill and other intangible assets whenever events or changes in circumstances indicate that the carrying value of goodwill and other intangible assets may not be recoverable. Significant changes in circumstances can be both internal to our strategic and financial direction, as well as changes to the competitive and economic landscape.

Our impairment assessment of goodwill and other intangible assets involves the estimation of future cash flows and the fair value of reporting units to which goodwill is allocated. Estimating future cash flows

20




and determining fair values of the reporting units is only an estimate and often involves the use of significant assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of the impairment charge.

Deferred Tax Assets and Tax Contingencies

We account for income taxes in accordance with SFAS 109, “Accounting for Income Taxes” and FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”).

Deferred tax assets and liabilities are recognized for the estimated future tax effects attributable to temporary differences and carryforwards. A valuation allowance may be required if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining whether a valuation allowance is necessary, we consider the level of taxable income in prior years, to the extent that carrybacks are permitted under current tax laws, as well as estimates of future taxable income and tax planning strategies that could be implemented to accelerate taxable income if necessary. If our estimates of future taxable income were materially overstated, or if our assumptions regarding the tax consequences of tax planning strategies were inaccurate, some or all of our deferred tax assets may not be realized, which would result in a charge to earnings.

We have established income tax contingencies reserves for potential tax liabilities related to uncertain tax positions. Tax benefits are recognized when we determine that it is more likely than not that such benefits will be realized. Where uncertainty exists due to the complexity of income tax statutes, and where the potential tax amounts are significant, we generally seek independent tax opinions to support our positions. If our evaluation of the likelihood of the realization of benefits is inaccurate, we could incur additional income tax and interest expense that would adversely impact earnings, or we could receive tax benefits greater than anticipated which would positively impact earnings.

Effective January 1, 2007, we adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS 109.

Defined Benefit Retirement Plan

Defined benefit plan obligations and related assets of our defined benefit retirement plan are presented in Note 14 to the Consolidated Financial Statements for the year ended December 31, 2006 included in the Company’s Annual Report on Form 10-K. Plan assets, which consist primarily of marketable equity and debt securities, are typically valued using market quotations. Plan obligations and the annual pension expense are determined by independent actuaries through the use of a number of assumptions. Key assumptions in measuring the plan obligations include the discount rate and the expected long-term rate of return on plan assets. In determining the discount rate, we utilize a yield that reflects the top 50% of the universe of bonds, ranked in the order of the highest yield. Asset returns are based upon the anticipated average rate of earnings expected on the invested funds of the plans. At December 31, 2006, we used a weighted-average discount rate of 5.9% and an expected long-term rate of return on plan assets of 8.0%, which affected the amount of pension liability recorded as of year-end 2006 and the amount of pension expense to be recorded in 2007. For both the discount rate and the asset return rate, a range of estimates could reasonably have been used which would affect the amount of pension expense and pension liability recorded. A 0.25% change in the discount rate assumption would impact 2007 pension expense by $0.1 million and year-end 2006 pension liability by $0.7 million, while a 0.25% change in the asset return rate would impact 2007 pension expense by $0.1 million.

21




Financial Summary

Net income for the second quarter of 2007 was $21.0 million, or $0.68 per diluted share, compared to $20.4 million, or $0.66 per diluted share, for the second quarter of 2006, an increase of 2.8%. The year-over-year increase in net income resulted from a $0.7 million increase in net interest income and a $0.6 million increase in other operating income, offset by an increase in our provision for loan and lease losses of $0.5 million.

Net income for the first six months of 2007 of $41.2 million represented an increase of $1.4 million, or 3.5%, over the comparable prior year period.  The increase in net income was primarily attributable to an increase in net interest income of $2.2 million and a decease in other operating expenses of $3.4 million, offset by an increase in our provision for loan and lease losses of $2.6 million and an increase in income taxes of $1.3 million. Results for the first six months of 2006 included an after-tax charge of $1.3 million, or $0.04 per diluted share, in retirement expenses for a former senior executive.

The following table presents annualized returns on average assets, average shareholders’ equity, average tangible equity and basic and diluted earnings per share for the periods indicated.

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Return on average assets

 

1.52

%

1.57

%

1.50

%

1.53

%

Return on average shareholders’ equity

 

10.99

%

11.71

%

10.87

%

11.49

%

Return on average tangible equity

 

19.03

%

22.17

%

19.04

%

22.19

%

Basic earnings per share

 

$

0.69

 

$

0.67

 

$