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TBNK > SEC Filings for TBNK > Form 10-K on 15-Mar-2013All Recent SEC Filings

Show all filings for TERRITORIAL BANCORP INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for TERRITORIAL BANCORP INC.


15-Mar-2013

Annual Report


ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The objective of this section is to help readers understand our views on our results of operations and financial condition. You should read this discussion in conjunction with the consolidated financial statements and notes to the consolidated financial statements that appear elsewhere in the annual report.

Overview

We have historically operated as a traditional thrift institution. The significant majority of our assets consist of long-term, fixed-rate residential mortgage loans and mortgage-backed securities, which we have funded primarily with deposit accounts, securities sold under agreements to repurchase and Federal Home Loan Bank advances. This has resulted in our being particularly vulnerable to increases in interest rates, as our interest-bearing liabilities mature or reprice more quickly than our interest-earning assets.

We have continued our focus on originating one- to four-family residential real estate loans. Our emphasis on conservative loan underwriting has resulted in low levels of nonperforming assets at a time when many financial institutions are experiencing significant asset quality issues. Our nonperforming


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assets totaled $4.4 million or 0.28% of total assets at December 31, 2012, compared to $3.3 million, or 0.22% of total assets at December 31, 2011, and $808,000, or 0.06% of total assets at December 31, 2010. As of December 31, 2012, nonperforming assets included 19 mortgage loans for $4.4 million. Our nonperforming loans and loss experience has enabled us to maintain a relatively low allowance for loan losses in relation to other peer institutions and correspondingly resulted in low levels of provisions for loan losses. Our provisions for loan losses were $415,000, $418,000 and $345,000 for the years ended December 31, 2012, 2011 and 2010, respectively.

Other than our loans for the construction of one- to four-family residential homes, we do not offer "interest only" mortgage loans on one- to four-family residential properties (where the borrower pays interest for an initial period, after which the loan converts to a fully amortizing loan). We also do not offer loans that provide for negative amortization of principal, such as "Option ARM" loans, where the borrower can pay less than the interest owed on their loan, resulting in an increased principal balance during the life of the loan. We do not offer "subprime loans" (loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios) or Alt-A loans (traditionally defined as nonconforming loans having less than full documentation). We also do not own any private label mortgage-backed securities that are collateralized by Alt-A, low or no documentation or subprime mortgage loans.

Our operations in recent years have been affected by our efforts to manage our interest rate risk position. In 2010, we obtained $10.2 million of shorter-duration mortgage-backed securities, sold $45.1 million of fixed-rate mortgage loan production and obtained $10.0 million of long-term, fixed-rate borrowings. In 2011, we sold $61.2 million of fixed-rate mortgage loan production and obtained $57.0 million of long-term, fixed-rate borrowings. In 2012, we sold $107.9 million of fixed-rate mortgage loans and purchased $8.2 million of shorter-duration mortgage-backed securities. See "-Management of Market Risk" for a discussion of all of the actions we took in 2010, 2011 and 2012 in managing interest rate risk.

All of the Bank's mortgage-backed securities and collateralized mortgage obligations have been issued by Freddie Mac, Fannie Mae or Ginnie Mae, U.S. government-sponsored enterprises. These agencies guarantee the payment of principal and interest on the Bank's mortgage-backed securities. We do not own any preferred stock issued by Fannie Mae or Freddie Mac. As of December 31, 2012, our borrowing capacity at the Federal Home Loan Bank of Seattle was $370.6 million compared to $361.0 million at December 31, 2011.

Critical Accounting Policies

We consider accounting policies that require management to exercise significant judgment or discretion or make significant assumptions that have, or could have, a material impact on the carrying value of certain assets or on income, to be critical accounting policies. We consider the following to be our critical accounting policies:

Allowance for Loan Losses. We maintain an allowance for loan losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. To estimate credit losses on impaired loans (in accordance with the Receivables topic of the FASB ASC), we evaluate numerous factors, as described below in "-Allowance for Loan Losses." Based on our estimate of the level of allowance for loan losses required, we record a provision for loan losses to maintain the allowance for loan losses at an amount that provides for all losses that are both probable and reasonable to estimate.


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

Deterioration in the Hawaii real estate market could result in an increase in loan delinquencies, additional increases in our allowance for loan losses and provision for loan losses, as well as an increase in loan charge-offs.

Securities Impairment. We periodically perform analyses to determine whether there has been an other-than-temporary decline in the value of our securities. Our held-to-maturity securities consist primarily of debt securities for which we have a positive intent and ability to hold to maturity, and are carried at amortized cost. Our available-for-sale securities are carried at fair value. We conduct a quarterly review and evaluation of the securities portfolio to determine if the value of any security has declined below its cost or amortized cost, and whether such decline is other-than-temporary. If such decline is deemed other-than-temporary, we would adjust the cost basis of the security by writing down the security for any credit losses through a charge on the income statement. The market values of our securities are affected by changes in interest rates as well as shifts in the market's perception of the issuers. The fair value of investment securities is usually based on quoted market prices or dealer quotes. However, if there are no observable market inputs (for securities such as trust preferred securities), we estimate the fair value using unobservable inputs. We discount projected cash flows using a risk-adjusted discount rate in accordance with the Fair Value Measurements and Disclosures topic of the FASB ASC.

On April 9, 2009, the Financial Accounting Standards Board revised the Investments-Debt and Equity Securities and the Fair Value Measurements topics of the FASB ASC. The revisions amend the other-than-temporary impairment guidance for U.S. GAAP for debt securities to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in a company's financial statements. Before these revisions, to conclude that an impairment was not other than temporary, an entity was required, among other considerations, to assert that it had the intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value in accordance with Securities and Exchange Commission Staff Accounting Bulletin Topic 5M, "Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities," and other authoritative literature. As a result of these revisions, an entity should assess whether the entity (a) has the intent to sell the debt security or (b) more likely than not will be required to sell the debt security before its anticipated recovery (for example, if its cash or working capital requirements or contractual or regulatory obligations indicate that the debt security will be required to be sold before the forecasted recovery occurs). The revisions also change the trigger used to assess the collectability of cash flows from "probable that the investor will be unable to collect all amounts due" to "the entity does not expect to recover the entire amortized cost basis of the security." If the present value of cash flows expected to be collected is less than the amortized cost basis of the security, an other-than-temporary impairment shall have occurred. We adopted the two revisions to the FASB ASC for the quarter ended March 31, 2009.

We had previously considered our investment in PreTSL XXIV to be other-than-temporarily impaired. PreTSL XXIV has a book value of $0. Our investment in PreTSL XXIII was determined to be other-than-temporarily impaired and we recorded an impairment charge of $2.4 million in the year ended December 31, 2010. PreTSL XXIII has a book value of $421,000. The difference between the book value of $421,000 and the remaining unamortized cost basis of $1.1 million is reported as other comprehensive loss and is related to noncredit factors such as an inactive trust preferred securities market.


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See also "Item 1A. Risk Factors" for a discussion on our investment in trust preferred securities.

We evaluated our $12.1 million investment in FHLB stock for other-than-temporary impairment as of December 31, 2012. Considering the long-term nature of this investment, the liquidity position of the FHLB of Seattle, the actions taken by the FHLB of Seattle to meet its regulatory capital requirement, and our intent not to sell this investment for a period of time sufficient to recover the par value, our FHLB stock was not considered other-than-temporarily impaired. As of December 31, 2012, the FHLB of Seattle has met all of its regulatory capital requirements. Moody's Investor Services and Standard and Poor's have given the FHLB of Seattle long-term credit ratings of Aaa and AA, respectively. Even though we did not recognize an other-than-temporary impairment loss on our investment in FHLB stock in 2012, continued deterioration in the FHLB of Seattle's financial position may result in future impairment losses.

Deferred Tax Assets. 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.

Defined Benefit Retirement Plan. Defined benefit plan obligations and related assets of our defined benefit retirement plan are presented in Note 15 to the Consolidated Financial Statements. Effective December 31, 2008, the defined benefit retirement plan was frozen 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. These bonds provide cash flows that match the timing of expected benefit payments. Asset returns are based upon the anticipated average rate of earnings expected on the invested funds of the plans.

At December 31, 2012, we used weighted-average discount rates of 4.90% and 4.20% for calculating annual pension expense and projected plan liabilities, respectively, and an expected long-term rate of return on plan assets of 7.75% for calculating annual pension expense. At December 31, 2011, we used a weighted-average discount rate of 5.80% and 4.90% for calculating annual pension expense and projected plan liabilities, respectively, and an expected long-term rate of return on plan assets of 7.75% for calculating annual pension expense. 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.

An increase in the discount rate or asset return rate would reduce pension expense in 2012, while a decrease in the discount rate or asset return rate would have the opposite effect. A 25 basis point decrease in the discount rate assumptions would increase 2012 pension expense by $515 and year-end 2012 pension liability by $491,000, while a 25 basis point decrease in the asset return rate would increase 2012 pension expense by $27,000.


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Balance Sheet Analysis

Assets. At December 31, 2012, our assets were $1.575 billion, an increase of $37.1 million, or 2.4%, from $1.538 billion at December 31, 2011. The increase was caused by an $86.8 million increase in loans receivable due to an increase in loan production, and a $50.9 million increase in cash and cash equivalents. This was partially offset by a $99.2 million decrease in investment securities, which occurred as repayments and sales of securities exceeded purchases.

Cash and Cash Equivalents. At December 31, 2012, we had $182.8 million of cash and cash equivalents compared to $131.9 million at December 31, 2011. During 2012, cash and cash equivalents increased by $50.9 million due to a $71.7 million increase in deposits, a $99.2 million decrease in investment securities and net income of $14.8 million. This was partially offset by an $86.8 million increase in loans receivable, the payoff of $38.3 million of securities sold under agreements to repurchase, the repurchase of $8.0 million of common stock and the payment of $5.7 million of common stock dividends.


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Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio at the dates indicated.

                                                                                                                   At December 31,
                                                              2012                         2011                         2010                         2009                         2008
                                                      Amount        Percent        Amount        Percent        Amount        Percent        Amount        Percent        Amount        Percent
                                                                                                               (Dollars in thousands)
Real estate loans:
First mortgage:
One- to four-family residential                      $ 741,334         94.84 %    $ 654,412         94.13 %    $ 604,456         93.16 %    $ 555,473         91.87 %    $ 581,251         90.94 %
Multi-family residential                                 6,888          0.88          6,956          1.00          5,408          0.83          3,807          0.63          3,756          0.59
Construction, commercial and other                      13,819          1.77         11,140          1.60         13,300          2.05         16,672          2.76         18,099          2.83
Home equity loans and lines of credit                   15,202          1.94         17,253          2.48         20,064          3.09         21,789          3.60         29,956          4.69
Other loans                                              4,481          0.57          5,488          0.79          5,635          0.87          6,895          1.14          6,097          0.95



Total loans                                            781,724        100.00 %      695,249        100.00 %      648,863        100.00 %      604,636        100.00 %      639,159        100.00 %


Other items:
Unearned fees and discounts, net                        (5,176 )                     (5,613 )                     (5,585 )                     (5,255 )                     (5,100 )
Allowance for loan losses                               (1,672 )                     (1,541 )                     (1,488 )                     (1,681 )                       (899 )


Loans receivable, net                                $ 774,876                    $ 688,095                    $ 641,790                    $ 597,700                    $ 633,160

Loan Portfolio Maturities and Yields. The following table summarizes the scheduled maturities of our loan portfolio at December 31, 2012. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.

                                                                         One- to four-family                Multi-family residential             Construction, commercial              Home equity loans and
                                                                       residential real estate                     real estate                     and other real estate                  lines of credit                  Other loans                     Total
                                                                                         Weighted                             Weighted                              Weighted                           Weighted                    Weighted                      Weighted
                                                                                          Average                              Average                              Average                            Average                     Average                       Average
                                                                       Amount              Rate             Amount              Rate              Amount              Rate            Amount             Rate         Amount         Rate          Amount          Rate
                                                                                                                                                           (Dollars in thousands)
Due During the Years Ending December 31,
2013                                                               $           18              6.02 %    $           0              0.00 %    $            0             0.00 %    $          2             8.88 %    $ 1,056           6.58 %    $   1,076           6.57 %
2014 to 2017                                                                  569              5.59                768              6.34               1,087             6.69               391             5.34          947           6.68          3,762           6.31
2018 and beyond                                                           740,747              4.49              6,120              5.91              12,732             5.21            14,809             5.63        2,478           5.73        776,886           4.54


Total                                                              $      741,334              4.49 %    $       6,888              5.96 %    $       13,819             5.33 %    $     15,202             5.62 %    $ 4,481           6.13 %    $ 781,724           4.55 %


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The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at December 31, 2012 that are contractually due after December 31, 2013.

                                                   Due After December 31, 2013
                                               Fixed        Adjustable        Total
                                                          (In thousands)

     Real estate loans:
     First mortgage:
     One- to four-family residential         $ 735,583     $      5,733     $ 741,316
     Multi-family residential                    5,640            1,248         6,888
     Construction, commercial and other         11,808            2,011        13,819
     Home equity loans and lines of credit       6,247            8,953        15,200
     Other loans                                 3,134              291         3,425


     Total loans                             $ 762,412     $     18,236     $ 780,648

Securities. At December 31, 2012, our securities portfolio totaled $554.7 million, or 35.2% of assets. At that date, our securities held to maturity consisted of securities with the following amortized costs: $510.0 million of mortgage-backed securities, $44.3 million of collateralized mortgage obligations and $421,000 of trust preferred securities. All of the mortgage-backed securities and collateralized mortgage obligations were issued by Fannie Mae, Freddie Mac or Ginnie Mae. At December 31, 2012, none of the underlying collateral consisted of subprime or Alt-A loans (traditionally defined as nonconforming loans having less than full documentation). At December 31, 2012, we held no common or preferred stock of Fannie Mae or Freddie Mac.

During the year ended December 31, 2012, our securities portfolio decreased by $99.2 million, or 15.2%, primarily due to repayments and sales exceeding purchases.


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The following table sets forth the amortized cost and estimated fair value of our securities portfolio (excluding Federal Home Loan Bank of Seattle common stock) at the dates indicated.

                                                                           At December 31,
                                                2012                            2011                            2010
                                     Amortized                       Amortized                       Amortized
                                        Cost         Fair Value         Cost         Fair Value         Cost         Fair Value
                                                                           (In thousands)
Held to Maturity:
U.S. government sponsored
mortgage-backed securities:
Fannie Mae                           $  124,106     $    127,929     $   69,254     $     73,043     $   62,174     $     65,576
Freddie Mac                             348,569          371,141        462,546          486,895        301,450          310,082
Collateralized mortgage
obligations (1)                          44,302           44,698         74,548           76,408        122,209          125,427
Ginnie Mae                               37,275           39,936         47,491           50,714         44,690           45,631

Total U.S. government sponsored
mortgage-backed securities              554,252          583,704        653,839          687,060        530,523          546,716

Trust preferred securities                  421              421             32              259             32              128


Total                                $  554,673     $    584,125     $  653,871     $    687,319     $  530,555     $    546,844


Available for Sale:
U.S. government sponsored
mortgage-backed securities:
Freddie Mac                          $        0     $          0     $        0     $          0     $    5,148     $      4,965
Ginnie Mae                                    0                0              0                0         10,392           10,045

Total U.S. government sponsored
mortgage-backed securities           $        0     $          0     $        0     $          0     $   15,540     $     15,010

(1) All of our collateralized mortgage obligations have been issued by Fannie Mae, Freddie Mac or Ginnie Mae.

Any unrealized loss on individual mortgage-backed securities as of December 31, 2012, 2011 and 2010 was caused by increases in current market interest rates. All of our mortgage-backed securities are guaranteed by U.S. government-sponsored enterprises. Since the decline in market value had been attributable to changes in interest rates and not credit quality, and we have had, and continue to have, the intent not to sell these investments, and it is not more likely than not that we will be required to sell such investments prior to the recovery of the amortized cost basis, we have not considered these investments to be other-than-temporarily impaired as of December 31, 2012, 2011 or 2010.

At December 31, 2012, we owned trust preferred securities with a carrying value of $421,000. This portfolio consists of two securities, which represent investments in a pool of debt obligations issued by Federal Deposit Insurance Corporation-insured financial institutions, insurance companies and real estate investment trusts.

The trust preferred securities market is considered to be inactive as only three transactions have occurred over the past 12 months in the same tranche of securities owned by the Company. The Company used a discounted cash flow model to determine whether these securities are other-than-temporarily impaired. The assumptions used in preparing the discounted cash flow model include the following: estimated discount rates, estimated deferral and default rates on collateral, and estimated cash flows. We used a discount rate equal to three-month LIBOR plus 20.00% and provided a fair value estimate of $11.90 per $100 of par value for PreTSL XXIII.

See also "Item 1A. Risk Factors" for a discussion on our investment in trust preferred securities.


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At December 31, 2012, we had no investments in a single company (other than U.S. government sponsored enterprises) or entity that had an aggregate book value in excess of 10% of our consolidated equity.


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Portfolio Maturities and Coupons. The composition and maturities of the investment securities portfolio at December 31, 2012 are summarized in the . . .

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