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TBNK > SEC Filings for TBNK > Form 10-K on 23-Apr-2014All Recent SEC Filings

Show all filings for TERRITORIAL BANCORP INC.

Form 10-K for TERRITORIAL BANCORP INC.


23-Apr-2014

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 this 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.


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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 assets totaled $6.0 million or 0.37% of total assets at December 31, 2013, compared to $4.4 million, or 0.28% of total assets at December 31, 2012, and $3.3 million, or 0.22% of total assets at December 31, 2011. As of December 31, 2013, nonperforming assets consisted of 19 mortgage loans for $6.0 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 $39,000, $415,000 and $418,000 for the years ended December 31, 2013, 2012 and 2011, 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 2013, we sold $82.2 million of fixed-rate mortgage loans, obtained $30.0 million of long-term, fixed-rate borrowings and purchased $5.1 million of shorter-duration mortgage-backed securities. In 2012, we sold $107.9 million of fixed-rate mortgage loans and purchased $8.2 million of shorter-duration mortgage-backed securities. In 2011, we sold $61.2 million of fixed-rate mortgage loans and obtained $57.0 million of long-term, fixed-rate borrowings. See "-Management of Market Risk" for a discussion of the actions we took in 2011, 2012 and 2013 in managing interest rate risk.

Territorial Savings Bank's investments in 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, 2013, our borrowing capacity at the Federal Home Loan Bank of Seattle was $375.3 million compared to $370.6 million at December 31, 2012.

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 materially 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.

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 $537,000 at December 31, 2013. The difference between the book value of $537,000 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.

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

We evaluated our $11.7 million investment in FHLB stock for other-than-temporary impairment as of December 31, 2013. 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, 2013, 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 2013, 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


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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 16 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, 2013, we used weighted-average discount rates of 4.20% 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. At December 31, 2012, we used a weighted-average discount rate 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. 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 decrease in the discount rate or an increase in the asset return rate would reduce pension expense in 2013, while an increase in the discount rate or a decrease in the asset return rate would have the opposite effect. A 25 basis point decrease in the discount rate assumptions would decrease 2013 pension expense by $2,000 and increase year-end 2013 pension liability by $498,000, while a 25 basis point decrease in the asset return rate would increase 2013 pension expense by $28,000.

Balance Sheet Analysis

Assets. At December 31, 2013, our assets were $1.617 billion, an increase of $42.3 million, or 2.7%, from $1.575 billion at December 31, 2012. The increase was caused by an $81.7 million increase in loans receivable due to an increase in loan production, a $58.8 million increase in investment securities, which occurred as purchases exceeded repayments and sales and a $9.1 million increase in bank owned life insurance. This was partially offset by a $107.5 million decrease in cash and cash equivalents.

Cash and Cash Equivalents. At December 31, 2013, we had $75.4 million of cash and cash equivalents compared to $182.8 million at December 31, 2012. During 2013, cash and cash equivalents decreased by $107.5 million due to an $81.7 million increase in loans receivable, a $58.8 million increase in investment securities, the repurchase of $19.6 million of common stock and the payment of $6.2 million of common stock dividends. This was partially offset by a $50.9 million increase in deposits and net income of $14.6 million.


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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,
                                2013                  2012                  2011                  2010                  2009
                          Amount     Percent    Amount     Percent    Amount     Percent    Amount     Percent    Amount     Percent
                                                                   (Dollars in thousands)
Real estate loans:
First mortgage:
One- to four-family
residential              $ 823,273     95.41 % $ 741,334     94.84 % $ 654,412     94.13 % $ 604,456     93.16 % $ 555,473     91.87 %
Multi-family
residential                  4,877      0.57       6,888      0.88       6,956      1.00       5,408      0.83       3,807      0.63
Construction,
commercial and other        13,554      1.57      13,819      1.77      11,140      1.60      13,300      2.05      16,672      2.76
Home equity loans and
lines of credit             16,524      1.91      15,202      1.94      17,253      2.48      20,064      3.09      21,789      3.60
Other loans                  4,649      0.54       4,481      0.57       5,488      0.79       5,635      0.87       6,895      1.14

Total loans                862,877    100.00 %   781,724    100.00 %   695,249    100.00 %   648,863    100.00 %   604,636    100.00 %

Other items:
Unearned fees and
discounts, net              (4,849 )              (5,176 )              (5,613 )              (5,585 )              (5,255 )
Allowance for loan
losses                      (1,486 )              (1,672 )              (1,541 )              (1,488 )              (1,681 )

Loans receivable, net    $ 856,542             $ 774,876             $ 688,095             $ 641,790             $ 597,700

Loan Portfolio Maturities and Yields. The following table summarizes the scheduled maturities of our loan portfolio at December 31, 2013. 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
Due During the Years                               Average                      Average                        Average                       Average                Average                Average
Ending December 31,                  Amount          Rate       Amount           Rate           Amount           Rate         Amount          Rate        Amount      Rate      Amount       Rate
                                                                                                       (Dollars in thousands)
2014                             $            1        7.38 % $       432             7.00 % $        875            5.00 % $         -              - % $    707       6.95 % $   2,015       6.11 %
2015 to 2018                              2,279        4.99             -                -          1,005            6.63         1,488           5.30      1,154       5.51       5,926       5.45
2019 and beyond                         820,993        4.29         4,445             5.52         11,674            5.12        15,036           4.88      2,788       5.59     854,936       4.32

Total                            $      823,273        4.29 % $     4,877             5.65 % $     13,554            5.22 % $    16,524           4.91 % $  4,649       5.78 % $ 862,877       4.33 %


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The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at December 31, 2013 that are contractually due after December 31, 2014.

                                             Due After December 31, 2014
                                           Fixed       Adjustable      Total
                                                    (In thousands)

Real estate loans:
First mortgage:
One- to four-family residential         $   818,150   $      5,122   $ 823,272
Multi-family residential                      3,948            497       4,445
Construction, commercial and other            8,996          3,683      12,679
Home equity loans and lines of credit         5,524         11,000      16,524
Other loans                                   3,348            594       3,942

Total loans                             $   839,966   $     20,896   $ 860,862

Securities. At December 31, 2013, our securities portfolio totaled $613.4 million, or 37.9% of assets. At that date, our securities held to maturity consisted of securities with the following amortized costs: $586.7 million of mortgage-backed securities, $26.2 million of collateralized mortgage obligations and $537,000 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, 2013, 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, 2013, we held no common or preferred stock of Fannie Mae or Freddie Mac.

During the year ended December 31, 2013, our securities portfolio increased by $58.8 million, or 10.6%, primarily due to purchases exceeding repayments and sales.

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,
                                    2013                        2012                        2011
                          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                $  200,058   $    191,717   $  124,106   $    127,929   $   69,254   $     73,043
Freddie Mac                  331,753        326,707      348,569        371,141      462,546        486,895
Collateralized mortgage
obligations (1)               26,238         25,853       44,302         44,698       74,548         76,408
Ginnie Mae                    54,850         53,193       37,275         39,936       47,491         50,714
Total U.S. government
sponsored
mortgage-backed
securities                   612,899        597,470      554,252        583,704      653,839        687,060

Trust preferred
securities                       537            537          421            421           32            259

Total                     $  613,436   $    598,007   $  554,673   $    584,125   $  653,871   $    687,319



(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, 2013, 2012 and 2011 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 has been attributable to changes in interest rates and not credit quality, and we have had, and continue to have, the


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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, 2013, 2012 or 2011.

At December 31, 2013, we owned trust preferred securities with a carrying value of $537,000. 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 24 months in the same tranche of securities that we own. We 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 $15.15 per $100 of par value for PreTSL XXIII.

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

At December 31, 2013, 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 stockholders' equity.


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Portfolio Maturities and Coupons. The composition and maturities of the investment securities portfolio at December 31, 2013 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. No tax-equivalent adjustments have been made, as we did not hold any tax-free investment securities at December 31, 2013.

                                                                     More than One Year            More than Five Years
                                        One Year or Less             through Five Years             through Ten Years          More than Ten Years               Total Securities
                                                    Weighted                      Weighted                      Weighted                    Weighted                               Weighted
                                   Amortized        Average       Amortized       Average       Amortized        Average       Amortized    Average    Amortized                   Average
                                      Cost           Coupon         Cost           Coupon         Cost           Coupon          Cost        Coupon       Cost       Fair Value     Coupon
                                                                                                   (Dollars in thousands)
Held to Maturity:
U.S. government sponsored
mortgage-backed securities:
Fannie Mae                        $          -               - % $         -               - % $        67             4.54 % $   199,991       3.18 % $  200,058   $    191,717       3.18 %
Freddie Mac                                  -               -             -               -           381             4.99       331,372       3.45      331,753        326,707       3.45
Collateralized mortgage
obligations (1)                              -               -           804            4.35             -                -        25,434       3.20       26,238         25,853       3.24
Ginnie Mae                                   -               -             -               -             -                -        54,850       3.29       54,850         53,193       3.29
Total U.S. government sponsored
mortgage-backed securities                   -               -           804            4.35           448             4.92       611,647       3.34      612,899        597,470       3.34
Trust preferred securities                   -               -             -               -             -                -           537       2.35          537            537       2.35

Total                             $          -               - % $       804            4.35 % $       448             4.92 % $   612,184       3.34 % $  613,436   $    598,007       3.34 %



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

Bank-Owned Life Insurance. We invest in bank-owned life insurance to provide us with a funding source for our benefit plan obligations. Bank-owned life insurance also generally provides us noninterest income that is nontaxable. Federal regulations generally limit our investment in bank-owned life insurance to 25% of our Tier 1 capital plus our allowance for loan losses. At December 31, 2013, this limit was $50.4 million, and we had invested $40.2 million in bank-owned life insurance at that date.


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Deposits. We accept deposits primarily from the areas in which our offices are located. We rely on our competitive pricing, convenient locations and customer service to attract and retain deposits. We offer a variety of deposit accounts . . .

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