Overview

Central Pacific Financial Corp. ("CPF") is a Hawaii corporation and a bank holding company. Our principal business is to serve as a holding company for our bank subsidiary, Central Pacific Bank. We refer to Central Pacific Bank herein as "our bank" or "the bank," and when we say "the Company," "we," "us" or "our," we mean the holding company on a consolidated basis with the Bank and our other consolidated subsidiaries.

Central Pacific Bank is a full-service community bank with 37 branches and more than 100 ATMs located throughout the State of Hawaii. The Bank offers a broad range of products and services including accepting time and demand deposits and originating loans, including commercial loans, construction loans, commercial and residential mortgage loans, and consumer loans. The Bank also has offices in California serving customers there.

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, including the real estate market generally and the residential construction market. 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.

Our process for determining the reserve for unfunded commitments is consistent with our process for determining the Allowance and is adjusted for estimated loan funding probabilities. Reserves for unfunded commitments are recorded separately through a valuation allowance included in other liabilities. Credit losses for off-balance sheet credit exposures are deducted from the allowance for credit losses on off-balance sheet credit exposures in the period in which the liability is settled. The allowance for credit losses on off-balance sheet credit losses is established by a charge to other operating expense.

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.

During the second and third quarters of 2009, we experienced significant increases in our Allowance as the general economic conditions and real estate markets in which we operate continued to deteriorate. General predictions of the economic conditions of the markets we serve are not encouraging and we are unable to accurately predict future changes in the real estate market. Accordingly, we are not able to assess the significance of potential increases in our Allowance that we may need to incur if real estate values do not improve and continue to decline in the markets that we serve. However, we anticipate that our credit costs will remain at elevated levels over the coming quarters due to the uncertain economic environment in which we currently operate.

Loans Held for Sale

Loans held for sale consists of Hawaii residential mortgage loans, as well as mainland residential and commercial construction loans. Hawaii residential mortgage loans classified as held for sale are carried at the lower of cost or fair value on an aggregate basis while mainland residential and commercial construction loans are recorded at the lower of cost or fair value on an individual basis.

In subsequent periods, if the fair value of a loan classified as held for sale is less than its cost basis, a valuation adjustment is recognized in our consolidated statement of operations in other operating expense and the carrying value of the loan is adjusted accordingly. The valuation adjustment may be recovered in the event that the fair value increases, which is also recognized in our consolidated statement of operations in other operating expense.

The fair value of loans classified as held for sale are generally based upon quoted prices for similar assets in active markets, acceptance of firm offer letters with agreed upon purchase prices, discounted cash flow models that take into account market observable assumptions, or independent appraisals of the underlying collateral securing the loans.

Goodwill and Other Intangible Assets

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 negative industry or economic trends, disruptions to our business, unexpected significant changes or planned changes in use of the assets, divestitures and market capitalization declines may result in impairments to goodwill. Absent any impairment indicators, we perform our goodwill impairment test annually.

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. We reconcile the estimated fair values of our reporting units to our total market capitalization plus a control premium. Estimating future cash flows and determining fair values of the reporting units is judgmental and often involves the use of significant estimates and 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.

In the third quarter of 2009, we experienced a significant decline in our market capitalization which we determined was an indicator that an impairment test was required. As a result of our impairment test at September 30, 2009, we determined that goodwill associated with our Hawaii Market reporting unit was impaired and we recorded a non-cash impairment charge of $50.0 million. All remaining goodwill at September 30, 2009 is attributable to our Hawaii Market reporting unit. Subsequent to September 30, 2009, we experienced further significant declines in our market capitalization. Further declines in our market capitalization and other factors such as the significant deterioration of the Hawaii Market reporting unit's operations may result in further impairment of our goodwill.

Deferred Tax Assets and Tax Contingencies

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.

During the third quarter of 2009, we established a valuation allowance against our net deferred tax assets ("DTAs") totaling $64.4 million. The establishment of the valuation allowance against our DTAs was primarily based upon our recent net operating losses. Of the total valuation allowance, $61.4 million was recognized as a non-cash charge to income tax expense, while the remaining $3.0 million was charged against AOCI.

We have established income tax contingency 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.

Defined benefit plan obligations and related assets of our defined benefit retirement plan are presented in Note 12 to the Consolidated Financial Statements. In 2002, the defined benefit retirement plan was curtailed and all plan benefits were fixed as of that date. 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, 2008, we used a weighted-average discount rate of 6.6% 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 2008 and the amount of pension expense to be recorded in 2009. 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 2009 pension expense by $0.1 million and year-end 2008 pension liability by $0.7 million, while a 0.25% change in the asset return rate would impact 2009 pension expense by less than $0.1 million.

Financial Summary

Further deterioration of the Hawaii and California commercial real estate markets and related declines in property values in those markets had a negative impact on our operating results during the third quarter of 2009, resulting in a net loss of $183.1 million during the period. Our results for the third quarter of 2009 included increased credit costs totaling $145.1 million, and non-cash charges of $50.0 million associated with the impairment of goodwill assigned to our Hawaii Market reporting unit and $61.4 million related to the establishment of a valuation allowance against our deferred tax assets. Net loss for the first nine months of 2009 was $215.0 million, compared to a net loss of $141.6 million for the comparable prior year period. The net loss recognized for the nine months ended September 30, 2009 included the aforementioned non-cash goodwill impairment charge of $50.0 million, compared to a non-cash goodwill impairment charge of $94.3 million in the comparable prior year period.

In January 2009, we issued $135.0 million in senior preferred stock in connection with our participation in the Capital Purchase Program ("CPP") of the U.S. Treasury's Troubled Asset Relief Program ("TARP"). The preferred stock carries an annual dividend of 5.0% during the first five years, increasing to 9.0% thereafter. We also issued warrants to purchase approximately 1.6 million shares of our common stock at an exercise price of $12.77 per share in connection with our participation in the CPP. The loss per common share for the current quarter and first nine months of 2009 of $6.38 and $7.67, respectively, were reflective of $2.0 million and $5.9 million of dividends declared or accrued on and accretion of the preferred stock for the related periods.

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. Average tangible equity is calculated as average shareholders' equity less average intangible assets, which includes goodwill, core deposit premium, customer relationships and non-compete agreements. Average intangible assets were $178.1 million and $179.2 million for the three and nine months ended September 30, 2009, respectively, and $178.8 million and $240.9 million for the comparable prior year periods.

                                        Three Months Ended            Nine Months Ended
                                           September 30,                September 30,
                                        2009            2008         2009           2008

Return (loss) on average assets          (13.59 ) %       0.22 %      (5.26 ) %      (3.30 ) %
Return (loss) on average
shareholders' equity                    (121.43 ) %       2.36 %     (45.71 ) %     (30.07 ) %
Return (loss) on average tangible
equity                                  (172.29 ) %       3.61 %     (63.99 ) %     (48.81 ) %
Basic and diluted earnings (loss)
per common share                     $    (6.38 )     $   0.11     $  (7.67 )     $  (4.94 )

Material Trends

The global and U.S. economies continue to experience a protracted slowdown in business activity as a result of disruptions in the financial system, including a lack of confidence in the worldwide credit markets. Currently, the U.S. economy remains in the midst of one of the weakest macroeconomic periods experienced since the Great Depression of the 1930s.

It is not clear at this time what impact U.S. Government programs such as the TARP CPP, the Term Asset-Backed Securities Loan Facility and Public-Private Investment Program, as well as other liquidity and funding initiatives of the Federal Reserve System, will have on the financial markets, the U.S. banking and financial industries, the broader U.S. and global economies, and more importantly, the local economies in the markets that we serve.

General economic conditions in Hawaii often lag the economic conditions experienced by the mainland U.S. and are expected to contract for the remainder of 2009 and into 2010. While the rest of the nation may see signs of stability or even recovery, Hawaii continues to experience a contraction of business, driven by decreased visitor spending, reduced construction and development activity, and consumer concerns over employment stability. Real personal incomes, as well as total payroll jobs are forecasted to decrease 1.1% and 3.0% in 2009, respectively. According to the Hawaii Department of Business Economic Development & Tourism ("DBEDT"), real gross state product is expected to contract by 1.1% in 2009. DBEDT also projects that 6.4 million visitors will visit the state, a 5.9% decrease from the number of visitors in 2008, with visitor days and expenditures projected to decrease 5.8% and 11.5% in 2009, respectively. The state's unemployment rate increased to 7.2% in September 2009 compared to 5.5% at December 31, 2008, however, it remained below the September 2009 national unemployment rate of 9.8%. In September 2009, the year-to-date number of single-family home resales on Oahu decreased by 16.2% while the median sales price decreased by 8.0% from a year ago. Despite the anticipated slowdown in home resales, the Hawaii housing market is expected to experience lower levels of price declines compared to the national housing market. Expectations from local economists and industry experts are for the Hawaii real estate market to continue its contraction in 2009 with declines in both unit sales volume and median prices.

California's economy is also expected to contract as the effects of falling home prices, limited credit availability, shrinking equity values and growing unemployment continue to linger. The outlook for the California economy calls for negative growth for the remainder of 2009, followed by weak growth in 2010 and improving slightly in 2011. According to the State of California Employment Development Department ("EDD"), nonfarm jobs in September 2009 stood at 14,200,400 jobs, a decrease of 732,700 jobs (4.9%) from September 2008. Construction employment posted the largest decline, down 144,000 jobs (19.0%) from the prior year. The California Association of Realtors ("CAR") reported that September 2009 unit home sales increased by 2.1%, while the median price decreased by 7.3% from year ago levels primarily driven by a significant rise in distressed sales, including foreclosures. CAR forecasts that the California median sales price will decline 21.8% to $271,000 in 2009, while the number of sales is projected to increase by 22.8% during the same period as distressed sales will continue to impact the market. According to the California Department of Finance ("CDOF"), average personal income is projected to decrease 1.0% in 2009 from the prior year and California's unemployment rate increased to 12.2% in September 2009 from 9.3% in December 2008. The unemployment rate in California continues to be well above the national unemployment rate.

Our results of operations in future periods will be significantly impacted by the economies in Hawaii, California and other markets we serve. Loan demand, deposit growth, provision for loan and lease losses, asset quality, noninterest income and noninterest expense may be affected by changes in economic conditions. If the California and Hawaii real estate markets do not improve or continue to deteriorate, or the economic environments in Hawaii, California and other markets we serve continue to deteriorate or suffer a material external shock, our results of operations may be negatively impacted. As we have seen during the third quarter and first nine months of 2009, the worsening economic conditions in the markets we serve have resulted in escalating credit costs and further deterioration in the asset quality of our loan portfolio.

Substantial amounts of our loan portfolio consist of loans collateralized by real property or are to persons in the real estate or related businesses. Accordingly, decreases in values of real property in the markets that we serve adversely impact not only the value of the collateral that we hold but also can impact the financial condition of our borrowers who we also rely upon for loan repayment. Many of our borrowers in the real estate or related businesses are suffering stress as a result of the downturn in real estate values. This year we have observed downward movement in real estate values in our markets, particularly in Hawaii, which was much more accelerated than we had anticipated. Our allowance for loan and lease costs and loan charge offs this year have been significantly affected by the impact of this upon the value of our collateral and the creditworthiness of our borrowers. As discussed above, general predictions by others of economic conditions in our markets are not encouraging and it is possible that the adverse economic environment could continue through 2010 or even beyond. Because we can not accurately predict future changes in the real estate markets, the amount of credit costs that we may need to incur is also uncertain. However, if real estate values do not improve and continue to decline in markets that we serve, we expect to continue to incur substantial credit costs while the impact of that is absorbed by our loan portfolio and our borrowers.

Results of Operations

Net Interest Income

Net interest income, when expressed as a percentage of average interest earning
assets, is referred to as "net interest margin." Interest income, which includes
loan fees and resultant yield information, is expressed on a taxable equivalent
basis using an assumed income tax rate of 35%. A comparison of net interest
income on a taxable equivalent basis ("net interest income") for the three and
nine months ended September 30, 2009 and 2008 is set forth below.

                                            Three Months Ended                                Three Months Ended
                                            September 30, 2009                                September 30, 2008
                                 Average         Average          Amount           Average         Average          Amount
(Dollars in thousands)           Balance       Yield/Rate       of Interest        Balance       Yield/Rate       of Interest

Assets
Interest earning assets:
 Interest-bearing deposits in
other banks                    $   166,365          0.25 %     $         106     $       946          1.59 %     $           4
 Federal funds sold &
securities purchased
  under agreements to resell        10,978          0.13                   3           6,799          1.94                  33
 Taxable investment securities
(1)                                924,659          4.23               9,770         690,643          5.04               8,703
 Tax-exempt investment
securities (1)                      93,661          6.15               1,441         143,943          5.77               2,078
 Loans and leases, net of
unearned income (2)              3,672,714          5.26              48,594       4,134,700          6.19              64,224
 Federal Home Loan Bank stock       48,797             -                   -          48,797          1.40                 171
  Total interest earning
assets                           4,917,174          4.85              59,914       5,025,828          5.96              75,213
Nonearning assets                  471,748                                           527,877
  Total assets                 $ 5,388,922                                       $ 5,553,705

Liabilities and Shareholders'
Equity
Interest-bearing liabilities:
 Interest-bearing demand
deposits                       $   553,218          0.26 %     $         364     $   469,966          0.21 %     $         251
 Savings and money market
deposits                         1,443,260          0.89               3,250       1,085,721          1.16               3,171
 Time deposits under $100,000      595,792          2.28               3,429         669,914          2.70               4,544
 Time deposits $100,000 and
over                               684,272          1.62               2,789         988,691          2.57               6,388
 Short-term borrowings             257,079          0.22                 144         262,865          2.39               1,583
 Long-term debt                    592,041          4.01               5,982         882,017          3.59               7,965
  Total interest-bearing
liabilities                      4,125,662          1.53              15,958       4,359,174          2.18              23,902
Noninterest-bearing deposits       587,002                                           592,505
Other liabilities                   62,955                                            76,236
Total equity & non-controlling
interest                           613,303                                           525,790
  Total liabilities and equity $ 5,388,922                                       $ 5,553,705

Net interest income                                            $      43,956                                     $      51,311

Net interest margin                                 3.56 %                                            4.07 %



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                                             Nine Months Ended                                 Nine Months Ended
                                            September 30, 2009                                September 30, 2008
                                 Average         Average          Amount           Average         Average          Amount
(Dollars in thousands)           Balance       Yield/Rate       of Interest        Balance       Yield/Rate       of Interest

Assets
Interest earning assets:
 Interest-bearing deposits in
other banks                    $    79,468          0.20 %     $         117     $       714          1.99 %     $          11
 Federal funds sold &
securities purchased
  under agreements to resell         9,552          0.13                   9           4,617          2.21                  76
 Taxable investment securities
(1)                                846,076          4.34              27,562         713,360          5.11              27,317
 Tax-exempt investment
securities (1)                     111,804          5.97               5,006         149,000          5.72               6,393
 Loans and leases, net of
unearned income (2)              3,848,970          5.53             159,317       4,242,621          6.30             200,195
 Federal Home Loan Bank stock       48,797             -                   -          48,797          1.27                 464
  Total interest earning
assets                           4,944,667          5.19             192,011       5,159,109          6.07             234,456
. . .