As filed with the Securities and Exchange Commission on March 30, 1998 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Mark One [x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1997 or [ ] 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 CPB INC. (Exact name of registrant as specified in its charter) <TABLE> <S> <C> 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) </TABLE> Registrant's telephone number, including area code: (808) 544-0500
Securities registered pursuant to Section 12(b) of the Act: <TABLE> <S> <C> Title of each class Name of each exchange on which registered NONE NONE </TABLE> Securities registered pursuant to Section 12(g) of the Act: Common Stock, No Par Value (Title of class) 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 or Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [X] As of February 27, 1998, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $156,168,000. Number of shares of common stock of the registrant outstanding as of February 27, 1998: 10,585,184 shares The following documents are incorporated by reference herein: <TABLE> <CAPTION> Part of Form 10-K Into Which Document Incorporated Incorporated - ------------------------------------- --------------- <S> <C> 1997 Annual Report to Shareholders Parts II and IV Definitive Proxy Statement for the Annual Meeting of Shareholders which will be filed within 120 days of the fiscal year ended December 31, 1997 Part III </TABLE>
PART I. ITEM 1. BUSINESS Organization CPB Inc. (the "Company") is a Hawaii corporation organized on February 1, 1982 pursuant to a Plan of Reorganization and Agreement of Merger as a bank holding company and is subject to the Bank Holding Company Act of 1956, as amended. The Company's principal business is to serve as a holding company for its subsidiary, Central Pacific Bank (the "Bank"). The Bank was incorporated in its present form in the State of Hawaii on March 16, 1982 in connection with the holding company reorganization, and its predecessor entity was incorporated in the State of Hawaii on January 15, 1954. The Bank's deposits are insured by the Federal Deposit Insurance Corporation ("FDIC") up to applicable limits. The Bank is not a member of the Federal Reserve System. Based on total consolidated assets at December 31, 1997, the Company was the third largest bank holding company in Hawaii. The Bank owns 100% of the outstanding stock of CPB Properties, Inc. ("CPB Properties"), a company which is the managing partner and 50% owner of CKSS Associates ("CKSS"), a Hawaii limited partnership. CKSS owns Central Pacific Plaza, in which the Company's and Bank's headquarters and main office are located. CKSS also developed the Kaimuki Plaza, in which one of the Bank's branch offices is located. In addition, CPB Properties owns the property on which the Bank's Moiliili branch office is located, as well as the property underlying the Kaimuki Plaza. See "ITEM 2. PROPERTIES." In 1998, the Bank established CPB Real Estate, Inc. as a Real Estate Investment Trust ("REIT") to acquire and hold stable, long-term real estate related assets including participation interests in residential mortgage loans and commercial real estate loans and mortgage-backed securities. An application and notice to form the REIT as an operating subsidiary of the Bank was filed with the Hawaii Commissioner of Financial Institutions (the "Hawaii Commissioner") on January 8, 1998, and a similar notice was filed with the Regional Director of the Federal Deposit Insurance Corporation ("FDIC") on that same date. Approval from the Hawaii Commissioner of Financial Institutions was issued on February 20, 1998, and a "no-objection" letter was issued by the FDIC on February 17, 1998. On February 25, 1998, the Executive Committee of the Bank approved, confirmed, and ratified the establishment and formation of the REIT. On March 2, 1998, the Bank transferred its interest in $518.9 million of real estate loans and mortgage-backed securities to the REIT in exchange for 100% of the issued and outstanding common stock of the REIT. The Company also owns 49% of Trans-Pacific Mortgage Group LLC. Trans-Pacific Mortgage Group LLC was formed to enhance the Company's market penetration in the residential mortgage business. The principal office of the Company is located at 220 South King Street, Honolulu, Hawaii 96813, and its telephone number is (808) 544-0500. Banking Services The Bank is a full-service commercial bank which currently has 26 banking offices located throughout the State of Hawaii. Its administrative and main office is located in Honolulu, and there are 19 other branches on the island of Oahu. In addition, the Bank maintains one branch on the island of Maui, two branches on the island of Kauai and three branches on the island of Hawaii. Through its network of banking offices, the Bank emphasizes personalized services and offers a full range of banking services to small- and medium-sized businesses, professionals and individuals in Hawaii. 3
The Bank offers a variety of deposit instruments. These include personal and business checking and savings accounts, including interest-bearing negotiable order of withdrawal ("NOW") accounts, money market accounts and time certificates of deposit. Lending activities include granting of commercial, consumer and real estate loans. The Bank offers inventory and accounts receivable financing, furniture, fixture and equipment financing, short-term operating loans, and commercial real estate and construction loans. Consumer loans include home equity lines of credit, loans for automobiles, home improvement and debt consolidation, personal and professional lines of credit and other installment and term loans for other personal needs. The Bank offers VISA and MasterCard credit card services and CHECK CARD, a debit card service, to its customers. The Bank is also a member of the Plus ATM Network and offers an Infoline service, providing telephonic account information, bill payment and funds transfer services. Specialized services designed to attract and service the needs of commercial customers and account holders include cash management and lockbox services, merchant windows, travelers' checks, safe deposit boxes, international banking services, night depository facilities and wire transfer services. The Bank's Trust Division offers asset management and custody services for a variety of accounts including revocable and irrevocable trusts, agency accounts, guardianships of property, charitable remainder trusts and probates. Market Area and Competition The Bank competes in the financial services industry mainly targeting retail and small to midsized businesses. The market is highly competitive with 4
6 commercial banks, 4 savings and loans as well as numerous credit unions and finance companies operating in the State of Hawaii. The two largest banks in the state are pursuing aggressive strategies to increase market share and to deliver new services. Pacific Century Financial Corporation had $15.0 billion in total assets at year end 1997. Bank of Hawaii, one of its subsidiary banks, maintains approximately 58% of the assets held by banks in the State of Hawaii. First Hawaiian, Inc. is the second largest bank holding company with $8.1 billion in assets at year end 1997. First Hawaiian Bank, the subsidiary bank, has approximately a 30% share of the commercial banking market in Hawaii. American Savings Bank, a subsidiary of Hawaiian Electric Industries, Inc., held $5.4 billion in assets at year end 1997, following the acquisition during 1997 of most of the assets of Bank of America-Hawaii, which had purchased Honolulu Federal Savings and Loan in 1992 and Liberty Bank in 1994. Central Pacific Bank is the third largest commercial bank maintaining market share of close to 7%. At $1.5 billion in assets, The Bank is building its position in the marketplace as a local community bank which is large enough to provide a wide range of banking services and yet, small enough to deliver personalized service. Bank of Hawaii and First Hawaiian Bank tend to lead the market with respect to new products and pricing. Central Pacific Bank offers a full range of banking services to small- and medium-sized businesses, professionals and individuals. Banking services include a variety of deposit, loans, personal trust and other proven products and services. The Bank also remains competitive with pricing and superior service levels. The Bank has a distribution network of 26 branches and a strong capital base to provide for expansion opportunities in our quest to better serve our community. With recent consolidation in the financial services industry, competition has intensified. The larger institutions are very focused in the business banking and personal banking areas, while leveraging their large branch and electronic banking networks to attract retail customers. The Bank faces substantial competition for deposits and loans throughout its market areas. Competition for deposits comes primarily from other commercial banks, savings institutions, credit unions, money market funds and other investment alternatives. The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations and office hours. Competition for loans comes primarily from other commercial banks, savings institutions, mortgage banking firms, credit unions and other financial intermediaries. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized services. The Bank faces competition for deposits and loans throughout its market areas not only from local institutions but also from out-of-state financial intermediaries which have opened loan production offices or which solicit deposits in its market areas. Many of the financial intermediaries operating in the Bank's market areas offer certain services, such as investment and international banking services, 5
which the Bank does not offer directly. Additionally, banks with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the needs of larger customers. See "ITEM 1. BUSINESS - Economic Conditions, Government Policies, Legislation and Regulation." ECONOMIC CONDITIONS, GOVERNMENT POLICIES, LEGISLATION, AND REGULATION The Company's profitability, like most financial institutions, is primarily dependent on interest rate differentials. In general, the difference between the interest rates paid by the Bank on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by the Bank on its interest-earning assets, such as loans extended to its clients and securities held in its investment portfolio, comprise the major portion of the Company's earnings. These rates are highly sensitive to many factors that are beyond the control of the Company and the Bank, such as inflation, recession and unemployment, and the impact which future changes in domestic and foreign economic conditions might have on the Company and the Bank cannot be predicted. The business of the Company is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). The Federal Reserve Board implements national monetary policies (with objectives such as curbing inflation and combating recession) through its open-market operations in U.S. Government securities by adjusting the required level of reserves for depository institutions subject to its reserve requirements and by varying the target federal funds and discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits and also affect interest rates earned on interest-earning assets and paid on interest-bearing liabilities. The nature and impact on the Company and the Bank of any future changes in monetary and fiscal policies cannot be predicted. From time to time, legislative acts, as well as regulations, are enacted which have the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial institutions are frequently made in the U.S. Congress, in the state legislatures and before various bank regulatory agencies. See "Item 1. Business - Supervision and Regulation." 6
SUPERVISION AND REGULATION GENERAL Bank holding companies and banks are extensively regulated under both federal and state law. This regulation is intended primarily for the protection of depositors and the deposit insurance fund and not for the benefit of stockholders of the Company. Set forth below is a summary description of certain laws and regulations which relate to the operations of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. In recent years, significant legislative proposals and reforms affecting the financial services industry have been discussed and evaluated by Congress. Such proposals include legislation to revise the Glass-Steagall Act and the Bank Holding Company Act of 1956, as amended (the "BHCA"), and to expand permissible activities for banks, principally to facilitate the convergence of commercial and investment banking. Certain proposals also sought to expand insurance activities of banks. It is unclear whether any of these proposals, or any form of them, will be introduced in the current Congress and become law. Consequently, it is not possible to determine what effect, if any, they may have on the Company and the Bank. THE COMPANY The Company, as a registered bank holding company, is subject to regulation under the BHCA. The Company is required to file with the Federal Reserve Board quarterly, semi-annual and annual reports and such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may conduct examinations of the Company and its subsidiaries. The Federal Reserve Board may require that the Company terminate an activity or terminate control of or liquidate or divest certain subsidiaries or affiliates when the Federal Reserve Board believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The Federal Reserve Board also has the authority to regulate provisions of certain bank holding company debt, including authority to impose interest ceilings and reserve requirements on such debt. Under certain circumstances, the Company must file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming its equity securities. Under the BHCA and regulations adopted by the Federal Reserve Board, a bank holding company and its nonbanking subsidiaries are prohibited from requiring certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Further, the Company is required by the Federal Reserve Board to maintain certain levels of capital. See "--Capital Standards." 7
The Company is required to obtain the prior approval of the Federal Reserve Board for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior approval of the Federal Reserve Board is also required for the merger or consolidation of the Company and another bank holding company. The Company is prohibited by the BHCA, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiaries. However, the Company, subject to the prior approval of the Federal Reserve Board, may engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Board's policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both. The Company's securities are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). As such, the Company is subject to the information, proxy solicitation, insider trading, and other requirements and restrictions of the Exchange Act. THE BANK The Bank, as a Hawaii state-chartered bank, is subject to primary supervision, periodic examination, and regulation by the Hawaii Commissioner and the Federal Deposit Insurance Corporation ("FDIC"). If, as a result of an examination of the Bank, the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank's operations are unsatisfactory or that the bank or its management is violating or has violated any law or regulation, various remedies are available to the FDIC. Such remedies include the power to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove 8
officers and directors and ultimately to terminate the Bank's deposit insurance, which for a Hawaii state-chartered bank would result in a revocation of the Bank's charter. The Hawaii Commissioner has many of the same remedial powers. The Bank has never been subject to any such actions by the FDIC or the Hawaii Commissioner. Various requirements and restrictions under the laws of the State of Hawaii and the United States affect the operations of the Bank. State and federal statutes and regulations relate to many aspects of the Bank's operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, and capital requirements. Further, the Bank is required to maintain certain levels of capital. See "--Capital Standards." DIVIDENDS AND OTHER TRANSFERS OF FUNDS The Company is a legal entity separate and distinct from the Bank and its subsidiary. The Bank is subject to various statutory and regulatory restrictions on its ability to pay dividends to the Company. Hawaii law provides that a state-chartered bank may not declare or pay any dividend in an amount greater than its undivided profits then on hand, deducting therefrom all losses; all debts, unless the same are well secured, in which interest for a period of one year is unpaid and debts upon which final judgment has been recovered but has been for more than one year unsatisfied and on which interest for a period of one year is unpaid, unless the same are well secured; all assets which a banking examiner may have required to be charged off; and all expenses, interest, taxes, and depreciation. Under such restrictions, the amount available for payment of dividends to the Company by the Bank totaled $101.3 million at December 31, 1997. The FDIC also has authority to prohibit the Bank from engaging in activities that, in the FDIC's opinion, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the FDIC could assert that the payment of dividends or other payments might, under some circumstances, be such an unsafe or unsound practice. Further, the FDIC and the Federal Reserve Board have established guidelines with respect to the maintenance of appropriate levels of capital by banks or bank holding companies under their jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may be imposed under the prompt corrective action provisions of federal law could limit the amount of dividends which the Bank or the Company may pay. An insured depository institution is prohibited from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. See "--Prompt Corrective Regulatory Action and Other Enforcement Mechanisms" and "--Capital Standards" for a discussion of these additional restrictions on capital distributions. The Bank is subject to certain restrictions imposed by state and federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, the Company or other affiliates, the purchase of, or investments in, stock or other securities of its affiliates, the taking of 9
such securities as collateral for loans, and the purchase of assets of the Company or other affiliates. Such restrictions prevent the Company and such other affiliates from borrowing from the Bank unless the loans are secured by collateral having a market value equal to the amount required by law. Further, the appropriate amount of covered transactions of the Bank with any affiliate is limited, individually, to 10.0% of the Bank's capital and surplus (as defined by federal regulations), and such secured loans and investments are limited, in the aggregate, as to all affiliates, to 20.0% of the Bank's capital and surplus (as defined by federal regulations). Additional restrictions on transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law. See "Item 1. Business - Supervision and Regulation - Prompt Corrective Action and Other Enforcement Mechanisms." CAPITAL STANDARDS The Federal Reserve Board and the FDIC have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as commercial loans. The federal banking agencies require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risked-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to total assets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categories used by regulators to rate banking organizations, the minimum leverage ratio of Tier 1 capital to total assets must be 3%. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. The following table presents the amounts of regulatory capital and the capital ratios for the Bank, compared to its minimum regulatory capital requirements as of December 31, 1997. <TABLE> <CAPTION> As of December 31, 1997 ---------------------------------------------------------------------------------- Actual Required Excess ---------------------- ------------------- ---------------------- Amount Ratio Amount Ratio Amount Ratio -------- ------ ------- ----- ------ ------ (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Leverage ratio . . . . . . $141,405 9.72% $58,187 4.0% $83,218 5.72% Tier 1 risk-based ratio . . 141,405 11.63 48,634 4.0 92,771 7.63 Total risk-based ratio . . 156,652 12.88 97,268 8.0 59,384 4.88 </TABLE> 10
The following table presents the amounts of regulatory capital and the capital ratios for the Company, compared to its minimum regulatory capital requirements as of December 31, 1997. <TABLE> <CAPTION> As of December 31, 1997 ----------------------------------------------------------------------------------- Actual Required Excess ---------------------- -------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio -------- ------ ------- ------ -------- ------ (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Leverage ratio . . . . . . $151,575 10.41% $58,252 4.0% $ 93,323 6.41% Tier 1 risk-based ratio . . 151,575 12.45 48,682 4.0 102,893 8.45 Total risk-based ratio . . 166,837 13.71 97,365 8.0 69,472 5.71 </TABLE> PROMPT CORRECTIVE ACTION AND OTHER ENFORCEMENT MECHANISMS Federal banking agencies possess broad powers to take corrective and other supervisory action to resolve the problems of insured depository institutions, including but not limited to those institutions that fall below one or more prescribed minimum capital ratios. Each federal banking agency has promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on its capital ratios: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At December 31, 1997, the Bank and the Company exceeded the required ratios for classification as "well capitalized." An institution that, based upon its capital levels, is classified as well capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. The federal banking agencies, however, may not treat a significantly undercapitalized institution as critically undercapitalized unless its capital ratio actually warrants such treatment. A bank may fall into the critically undercapitalized category if its "tangible equity" does not exceed two-percent of the bank's total assets. Federal guidelines generally define "tangible equity" as a bank's tangible assets less liabilities. Federal regulators may, among other alternatives, require the appointment of a conservator or a receiver for a critically undercapitalized bank. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation, or any condition imposed in writing by the agency or any written agreement with the agency. 11
SAFETY AND SOUNDNESS STANDARDS The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) asset growth, (v) earnings, and (vi) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these standards, an insured depository institution should: (i) conduct periodic asset quality reviews to identify problem assets, (ii) estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses, (iii) compare problem asset totals to capital, (iv) take appropriate corrective action to resolve problem assets, (v) consider the size and potential risks of material asset concentrations, and (vi) provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk. These new guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves. PREMIUMS FOR DEPOSIT INSURANCE The Bank's deposit accounts are insured by the Bank Insurance Fund ("BIF"), as administered by the FDIC, up to the maximum permitted by law. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC or the institution's primary regulator. The FDIC charges an annual assessment for the insurance of deposits, which as of December 31, 1997, ranged from 0 to 27 basis points per $100 of insured deposits, based on the risk a particular institution poses to its deposit insurance fund. The risk classification is based on an institution's capital group and supervisory subgroup assignment. Pursuant to the Economic Growth and Paperwork Reduction Act of 1996 (the "Act"), at January 1, 1997, the Bank began paying, in addition to its normal deposit insurance premium as a member of the BIF, an amount equal to approximately 1.3 basis points per $100 of insured deposits toward the retirement of the Financing Corporation bonds ("Fico Bonds") issued in the 1980s to assist in the recovery of the savings and loan industry. Members of the Savings Association Insurance Fund ("SAIF"), by contrast, pay, in addition to their normal deposit insurance premium, approximately 6.4 basis points. Under the Act, the FDIC is not permitted to establish SAIF assessment rates that are lower than comparable BIF assessment rates. Beginning no later than January 1, 2000, the rate paid to retire the Fico Bonds will be equal for members of the BIF and the SAIF. The Act also provides for the merging of the BIF and the SAIF by January 1, 1999 provided there are no financial institutions still chartered as savings associations at that time. Should the insurance funds be merged before January 1, 2000, the rate paid by all members of this new fund to retire the Fico Bonds would be equal. 12
INTERSTATE BANKING AND BRANCHING The BHCA currently permits bank holding companies from any state to acquire banks and bank holding companies located in any other state, subject to certain conditions, including certain nationwide- and state-imposed concentration limits. The Bank has the ability, subject to certain restrictions, to acquire by acquisition or merger branches outside its home state. The establishment of new interstate branches is also possible in those states with laws that expressly permit it. Interstate branches are subject to certain laws of the states in which they are located. Competition may increase further as banks branch across state lines and enter new markets. In April 1995, the Hawaii legislature enacted legislation to make necessary changes to Hawaii law to harmonize it with the interstate banking legislation passed by Congress. Currently, Hawaii's Interstate Banking Law provides that out-of-state banks may establish branches in Hawaii by merger, subject to certain limitations. However, an out-of-state bank that does not operate a branch in Hawaii may not acquire a branch or establish one de novo. In addition, foreign banks may establish "wholesale" branches and agencies in Hawaii; provided, however, that such banks may not accept retail deposits of less than $100,000 from individuals who are U.S. citizens or residents. These changes are likely to increase competition in the Company's market areas, especially from larger financial institutions and their holding companies. It is difficult to assess the impact such likely increased competition will have on the Company's operations. COMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act ("CRA") activities. The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low- and moderate-income neighborhoods. A bank may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws. The federal banking agencies may take compliance with such laws and CRA obligations into account when regulating and supervising other activities. A bank's compliance with its CRA obligations is based on a performance-based evaluation system which bases CRA ratings on an institution's lending service and investment performance. When a bank holding company applies for approval to acquire a bank or other bank holding company, the Federal Reserve Board will review the assessment of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application. Based on an examination conducted August 25, 1997, the Bank was rated outstanding in complying with its CRA obligations. 13
YEAR 2000 COMPLIANCE In May 1997, the Federal Financial Institutions Examination Council issued an interagency statement to the chief executive officers of all federally supervised financial institutions regarding Year 2000 project management awareness. It is expected that unless financial institutions address the technology issues relating to the coming of the Year 2000, there will be major disruptions in the operations of financial institutions. The statement provides guidance to financial institutions, providers of data services, and all examining personnel of the federal banking agencies regarding the Year 2000 problem. The federal banking agencies intend to conduct Year 2000 compliance examinations, and the failure to implement a Year 2000 program may be seen by the federal banking agencies as an unsafe and unsound banking practice. In addition, federal banking agencies will be taking into account Year 2000 compliance programs when analyzing applications and may deny an application based on Year 2000 related issues. The Company has evaluated its computer systems to assess the nature and extent of Year 2000 problems. The Company is currently converting its major banking hardware and software systems to a new integrated banking system which is scheduled for installation in mid-1998. The conversion is expected to solve a substantial part of the Bank's Year 2000 problem. This system and all other computer-based systems are scheduled to be fully tested and certified for Year 2000 compliance by the end of 1998. Additionally, the Company is communicating with external entities, including vendors and customers, to ensure that they are Year 2000 compliant. Expentitures related to the new integrated banking system are expected to be capitalized and amortized over their respective useful lives. Expenditures related to the Company's technical staff, which are being expensed during the period incurred, and other expenditures of addressing the Year 2000 issue are not expected to be material. 14
ACCOUNTING CHANGES In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement provides standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. A transfer of financial assets in which the transferor surrenders control over those assets is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in the exchange. This statement requires that liabilities and derivative securities incurred or obtained by transferors as part of a transfer of financial assets be initially valued at fair value, if practicable. It also requires that servicing rights and other retained interests in the transferred assets be measured by allocating the previous carrying amount between the assets sold, if any, and retained interests, if any, based on their relative fair values at the date of transfer. Furthermore, SFAS No. 125 requires that debtors reclassify financial assets pledged as collateral, and that secured parties recognize those assets and their obligation to return them in certain circumstances in which the secured party has taken control of those assets. Finally, SFAS No. 125 requires that a liability be eliminated if either: (a) the debtor pays the creditor and is relieved of its obligation for the liability, or (b) the debtor is legally released from being the primary obligor under the liability, either 15
judicially or by the creditor. Accordingly, a liability is not considered extinguished by an in-substance defeasance. SFAS No. 125 supersedes SFAS No. 122, "Accounting for Mortgage Servicing Rights," which was adopted by the Company effective January 1, 1996 and which management of the Company determined had no material impact on the Company's results of operations or financial position. In December 1996, the FASB issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125." SFAS No. 127 defers for one year the effective date of SFAS No. 125 as it relates to transactions involving secured borrowings and collateral and transfers and servicing of financial assets. This Statement also provides additional guidance on these types of transactions. The Company adopted those provisions of SFAS No. 125 which were not subject to deferral by SFAS No. 127 on January 1, 1997. Servicing assets were deemed immaterial and, accordingly, no disclosures were required, as permitted by SFAS No. 125. Further, the Company does not expect that the future application of SFAS No. 125 to the transactions covered under SFAS No. 127 will have a material impact on the Company's consolidated financial statements. In August 1997, the FASB issued SFAS No. 128, "Earnings Per Share." This statement replaces the presentation of primary earnings per share with a presentation of basic earnings per share. The statement also requires dual presentation of basic and diluted earnings per share by entities with complex capital structures and requires a reconciliation of the numerators and denominators between the two calculations. SFAS No. 128 is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. Adoption of the statement in December 1997 did not have a material impact on the Company's results of operations or financial position. In August 1997, FASB issued SFAS No. 129, "Disclosure of Information about Capital Structure." This statement establishes standards for disclosing information about capital structure, including pertinent rights and privileges of various securities outstanding. SFAS No. 129 is effective for financial statements for periods ending after December 15, 1997. Adoption of the the statement in December 1997 did not have a material impact on the Company's results of operations or financial position. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. This statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. The application of SFAS No. 130, effective January 1, 1998 is not expected to have a material impact on the Company's consolidated financial statements. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for the way that public business 16
enterprises report information about operating segments in both annual financial statements and interim financial reports issued to shareholders. The statement also establishes standards for related disclosures about products and services, geographic areas, and major customers. This Statement supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise," but retains the requirement to report information about major customers. It amends SFAS No. 94, "Consolidation of All Majority-Owned Subsidiaries," to remove the special disclosure requirements for previously unconsolidated subsidiaries. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. The application of SFAS No. 131, effective January 1, 1998, is not expected to have a material impact on the Company's consolidated financial statements. In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," an amendment of FASB Statements No. 87, "Employers' Accounting for Pensions," No. 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans," and No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." SFAS No. 132, effective for fiscal years beginning after December 15, 1997, standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis and eliminates certain disclosures that are no longer as useful as they were when SFAS Nos. 87, 88 and 106 were issued. The application of SFAS No. 132, effective from January 1, 1998, is not expected to have a material impact on the consolidated financial statements. Certain amounts in the consolidated financial statements and notes thereto for the previous two years have been reclassified to conform with the current year's presentation. Such reclassifications had no effect on the Company's results of operations. 17
Employees At February 27, 1998, the Company employed 610 persons, 597 on a full-time basis and 13 on a part-time basis. Management of the Company believes that it has favorable employee relations. The Company is not a party to any collective bargaining agreement. Selected Statistical Information The following tables and data set forth, for the respective periods shown, selected statistical information relating to the Company and the Bank. These tables should be read in conjunction with the information contained in "ITEM 6. SELECTED FINANCIAL DATA," "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," and "ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA." Loan Portfolio Total loans decreased to $1,041.0 million at December 31, 1997, compared with $1,042.0 million at the end of 1996, and $990.4 million at the end of 1995. Increases in loan volumes were recorded in the real estate - mortgage - commercial and commercial, financial and agricultural loan categories, which was offset by declines in real estate-mortgage residential and consumer loans. The Bank emphasizes residential and commercial mortgage loans, business loans to middle-market companies and professionals and consumer loans. Its marketing strategy for generating new loans includes a business calling program which requires officers at all levels to make client development visits to local businesses each month. In addition, the Bank uses television, radio, print and direct mail marketing. A significant portion of the Bank's loan portfolio is secured by real estate. Management believes that the Bank's underwriting guidelines, including collateral requirements, provide the Bank with protection against losses on delinquent loans. However, due to the slowdown in the Hawaiian economy, delinquencies and charge-offs during 1997 increased over the previous year. Continued recessionary conditions in Hawaii may further negatively impact the Bank's real estate collateral and adversely impact the level of nonperforming loans and provision for loan losses in the future. See "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Provision and Allowance for Loan Losses," "-- Nonperforming Assets" and "-- Financial Condition." At December 31, 1997, the Bank did not have any concentration of loans in any industry classified under the Standard Industrial Code which exceeded 10% of the Bank's total loans. 18
The following table sets forth information regarding outstanding loans by categories as of the dates indicated. Table I. Loans by Categories <TABLE> <CAPTION> December 31, --------------------------------------------------------- 1997 1996 1995 1994 1993 --------- ---------- ---------- --------- --------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Commercial, financial and agricultural $146,779 $141,735 $165,292 $211,257 $237,861 Real estate -- construction 45,082 43,520 47,853 52,811 41,572 Real estate -- mortgage -- residential 331,347 347,608 341,229 332,073 317,357 Real estate -- mortgage -- commercial 449,417 430,682 368,772 328,979 280,385 Consumer 68,398 78,431 67,210 66,848 68,593 ---------- ---------- -------- -------- -------- Total loans 1,041,023 1,041,976 990,356 991,968 945,768 Allowance for loan losses 19,164 19,436 20,156 18,296 17,131 ---------- ---------- -------- -------- -------- Net loans $1,021,859 $1,022,540 $970,200 $973,672 $928,637 ---------- ---------- -------- -------- -------- ---------- ---------- -------- -------- -------- </TABLE> 19
Commercial, Financial and Agricultural. Loans in this category consist primarily of small and middle-market businesses and professionals located in Hawaii. The Bank typically looks to the borrower's business as the principal source of repayment, although the Bank's underwriting policy generally requires additional sources of collateral, including real estate. Because the Bank has maintained its underwriting standards during the recent periods of recession and slow growth in the local economy, there are fewer lending opportunities which meet the Bank's underwriting criteria. Because of that and competition among financial institutions for loans, commercial loan volumes have declined during the past several years, from $237.9 million at December 31, 1993 to $146.8 million at December 31, 1997. Real Estate - Construction. Real estate - construction loans increased to $45.1 million at the end of 1997, from $43.5 million at the end of 1996 and $47.9 million at the end of 1995. The majority of the construction loans provided by the Bank in this category were used for residential development projects. Each construction project is evaluated for economic viability, and maximum loan-to-value ratios of 80% on commercial projects and 85% on residential projects are generally required. Real estate - mortgage - residential. Residential mortgage loans of $331.3 million are comprised primarily of adjustable rate one-to-four family first mortgages. In general, the Bank requires a maximum loan-to-value ratio of 80%, although higher levels are permitted with accompanying mortgage insurance. The Bank emphasizes making residential mortgage loans for owner- occupied primary residences and does not actively seek to make loans for vacation condominiums or homes. The Bank has also limited growth of mortgages for high-end residences because of higher volatility in their values. In order to limit such growth and provide for adequate collateral, the Bank requires lower than normal loan-to-value ratios for loans secured by such homes. Mortgage loans held for sale at December 31, 1997 totaled $8.7 million. Home equity lines of credit of $88.6 million, with maximum loan-to- value ratios of 75%, were also included in residential mortgage loans. Real Estate - Mortgage - Commercial. The major components of the Bank's portfolio of commercial, industrial and other mortgage loans at December 31, 1997 included $158.4 million for stores and offices, $49.8 million for warehouses and industrial buildings, and $34.3 million for apartment buildings with 5 or more units. 20
The following table sets forth certain information with respect to the composition of the Bank's Real Estate - Mortgage loan portfolio as of the dates indicated. Table II. Mortgage Loan Portfolio Composition <TABLE> <CAPTION> December 31, 1997 1996 1995 1994 1993 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- -------- ------- -------- ------- -------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Residential: 1-4 units $323,283 41.4% $341,890 43.9% $335,345 47.2% $328,282 49.7% $309,458 51.8% 5 or more units 8,064 1.0 5,718 0.7 5,884 0.8 3,791 0.6 7,899 1.3 Commercial, industrial and other 449,417 57.6 430,682 55.4 368,772 52.0 328,979 49.7 280,385 46.9 -------- ------ -------- ------ --------- ------ -------- ------ -------- ------ Total $780,764 100.0% $778,290 100.0% $710,001 100.0% $661,052 100.0% $597,742 100.0% -------- ------ -------- ------ --------- ------ -------- ------ -------- ------ -------- ------ -------- ------ --------- ------ -------- ------ -------- ------ </TABLE> 21
Consumer Loans. The following table sets forth the primary components of the Bank's Consumer loan portfolio as of the dates indicated. Table III. Consumer Loan Portfolio Composition <TABLE> <CAPTION> December 31, 1997 1996 1995 1994 1993 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- -------- ------- -------- ------- -------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Automobile $25,874 37.8% $35,424 45.2% $26,368 39.2% $27,786 41.6% $26,357 38.4% Credit cards and related plans 26,058 38.1 23,989 30.6 22,151 33.0 19,612 29.3 19,626 28.6 Other 16,466 24.1 19,018 24.2 18,691 27.8 19,450 29.1 22,610 33.0 -------- ------ -------- ----- -------- ------- -------- ------ -------- ------ Total $68,398 100.0% $78,431 100.0% $67,210 100.0% $66,848 100.0% $68,593 100.0% -------- ------ -------- ----- -------- ------- -------- ------ -------- ------ -------- ------ -------- ----- -------- ------- -------- ------ -------- ------ </TABLE> Automobile loans, comprised primarily of indirect dealer loans, were $25.9 million or 37.8% of the Consumer loan portfolio in 1997. This figure includes $25.0 million in indirect automobile loans. Credit cards and related plans have increased steadily over the past two years, following a national trend toward increased consumer debt. However, stagnation of the Hawaii economy has resulted in an increase in personal bankruptcies and consequently consumer loan losses. As detailed in Table VI, net charge-offs on consumer loans have increased by 45.9% over 1996 levels, which increased by 58.7% over 1995 net charge-offs. In response to rising delinquency and loss rates, the Bank has discontinued the practice of extending pre-approved credit on consumer loans and has provided additional resources to supplement collection efforts. 22
Maturities and Sensitivities of Loans to Changes in Interest Rates The following table sets forth the maturity distribution of the Bank's loan portfolio at December 31, 1997. The table excludes real estate loans (other than construction loans) and consumer loans. Table IV. Maturity Distribution of Commercial and Construction Loans <TABLE> <CAPTION> Maturing ------------------------------------ Over one One year through Over or less five years five years Total -------- ---------- ---------- --------- (Dollars in thousands) <S> <C> <C> <C> <C> Commercial, financial and agricultural $75,553 $42,978 $28,248 $146,779 Real estate -- construction 30,207 11,164 3,711 45,082 ------- ------- ------- -------- Total $105,760 $54,142 $31,959 $191,861 ======= ======= ======= ======== </TABLE> 23
The following table sets forth the sensitivity of the amounts due after one year to changes in interest rates. Table V. Maturity Distribution of Fixed and Variable Rate Loans <TABLE> <CAPTION> Maturing ---------------------- Over one through Over five years five years Total ---------- ---------- ---------- (Dollars in thousands) <S> <C> <C> <C> With fixed interest rates $12,259 $12,447 $24,706 With variable interest rates 41,882 19,512 61,000 ------- ------- ------- Total $54,141 $31,959 $85,706 ======= ======= ======= </TABLE> Allowance for Loan Losses The allowance for loan losses is maintained at a level considered adequate to provide for potential losses on loans and other extensions of credit, including off-balance sheet credit exposures. The adequacy of the allowance for loan losses is based upon management's evaluation of the quality, character and inherent risks in the loan portfolio, current and projected economic conditions, and past loan loss experience. During 1997, $3.5 million was provided for loan losses compared to $2.5 million in 1996 and $3.3 million in 1995. In 1997, the Bank experienced net charge-offs of $3.8 million, compared with net charge-offs of $3.2 million in 1996 and $1.4 million in 1995. The allowance for loan losses at December 31, 1997 was $19.2 million, compared to $19.4 million at December 31, 1996 and $20.2 million at December 31, 1995. The ratio of allowance for loan losses to total loans was 1.84%, 1.87% and 2.04% at December 31, 1997, 1996 and 1995, respectively. Management believes that the allowance for loan losses at December 31, 1997 was adequate to absorb known and inherent risks in the portfolio. However, no assurance can be given that economic conditions which may adversely affect the Bank's service areas or other circumstances, such as material and sustained declines in real estate values, will not result in increased losses in the Bank's loan portfolio. See "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -- Provision and Allowance for Loan Losses" and "-- Nonperforming Assets." 24
The following table sets forth certain information with respect to the Bank's allowance for loan losses as of the dates or for the periods indicated. Table VI. Allowance for Loan Losses <TABLE> <CAPTION> Year ended December 31, 1997 1996 1995 1994 1993 ----------- ----------- ---------- -------- --------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Average amount of loans outstanding $1,044,538 $1,010,255 $1,004,094 $947,433 $911,611 Allowance for loan losses: Balance at beginning of year $ 19,436 $ 20,156 $ 18,296 $ 17,131 $ 15,378 ---------- ---------- ---------- -------- -------- Charge-offs: Commercial, financial and agricultural 1,139 662 146 129 225 Real estate -- construction -- -- -- -- -- Real estate -- mortgage -- residential 786 786 192 538 543 Real estate -- mortgage -- commercial 867 1,250 943 1,360 254 Consumer 1,250 857 540 492 620 ---------- ---------- ---------- -------- -------- TOTAL 4,042 3,555 1,821 2,519 1,642 ---------- ---------- ---------- -------- -------- Recoveries: Commercial, financial and agricultural 34 108 192 160 12 Real estate -- construction -- 19 -- -- -- Real estate -- mortgage -- residential 44 31 48 32 3 Real estate -- mortgage -- commercial -- -- -- -- -- Consumer 192 177 141 192 180 ---------- ---------- ---------- -------- -------- TOTAL 270 335 381 384 195 ---------- ---------- ---------- -------- -------- 25
Net loans charged off (recovered) 3,772 3,220 1,440 2,135 1,447 ---------- ---------- ---------- -------- -------- Provision charged to operations 3,500 2,500 3,300 3,300 3,200 ---------- ---------- ---------- -------- -------- Balance at end of year $19,164 $19,436 $20,156 $18,296 $17,131 ========== ========== ========== ======== ======== Ratios: Allowance for loan losses to loans outstand- ing at end of period 1.84% 1.87% 2.04% 1.84% 1.81% Net loans charged off (recovered) during period to average loans outstanding during period .36% .32% .14% .23% .16% </TABLE> Over the five-year period ended December 31, 1997, the allocation of the allowance for loan losses for the largest loan category, commercial real estate mortgage loans, increased steadily to correspond with increases in the total volume of loans and the level of loan losses in these categories. The Bank's practice is to make specific allocations to specific loans and unspecified allocations to each loan category based on Management's risk assessment. 26
The following table sets forth the allocation of the allowance for loan losses by loan category as of the dates indicated. Table VII. Allocation of Allowance for Loan Losses <TABLE> <CAPTION> 1997 1996 1995 1994 1993 --------------------- ------------------- ------------------ ------------------- -------------------- Percent Percent Percent Percent Percent of loans of loans of loans of loans of loans in each in each in each in each in cash Allowance category Allowance category Allowance category Allowance category Allowance category for loan to total for loan to total for loan to total for loan to total for loan to total losses loans losses loans losses loans losses loans losses loans ---------- --------- ---------- -------- --------- -------- --------- -------- --------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Commercial, financial and agricultural $ 2,700 14.1% $ 2,900 13.6% $ 4,100 16.7% $ 5,100 21.3% $ 6,100 25.2% Real estate -- construction 100 4.3 100 4.2 200 4.9 500 5.3 500 4.4 Real estate - mortgage -- residential 2,400 31.9 1,700 33.4 1,800 34.4 3,000 33.5 3,800 33.6 Real estate - mortgage -- commercial 6,700 43.1 9,300 41.3 7,800 37.2 5,500 33.2 5,300 29.5 Consumer 900 6.6 600 7.5 600 6.8 400 6.7 600 7.3 Unallocated 6,364 N/A 4,836 N/A 5,656 N/A 3,796 N/A 831 N/A ------- ------- ------- -------- ------- ------- ------- ------ ------- ------- TOTAL 19,164 100.0% $19,436 100.0% $20,156 100.0% $18,296 100.0% $17,131 100.0% ======= ======= ======= ======== ======= ======= ======= ====== ======= ======= </TABLE> 27
Investment Portfolio The following table sets forth the amounts and the distribution of investment securities held as of the dates indicated. Table VIII. Distribution of Investment Securities <TABLE> <CAPTION> December 31, -------------------------------------------------------------------------------------- 1997 1996 1995 ------------------------ ---------------------------- ----------------------------- Held to Available Held to Available Held to Available maturity for sale maturity for sale maturity for sale (at amor- (at estimated (at amor- (at estimated (at amor- (at estimated tized cost) fair value) tized cost) fair value) tized cost) fair value) ----------- ------------- ----------- -------------- ------------ ------------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> U.S. Treasury and other U.S. Government agencies $114,374 $148,434 $100,153 $113,339 $123,073 $129,699 States and political subdivisions 27,613 766 9,091 2,791 11,620 2,836 Other 10,701 18,823 -- 15,084 2,000 14,399 -------- -------- -------- -------- -------- -------- Total investment securities $152,688 $168,023 $109,244 $131,214 $136,693 $146,934 ======== ========= ======== ======== ======== ======== </TABLE> 28
The Bank did not hold investments of any nonfederal issuer in amounts exceeding 10% of stockholders' equity at December 31, 1997. Except for loans disclosed in "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Nonperforming Assets," the Bank did not have any other nonperforming or potentially problem interest-bearing assets at December 31, 1997. Maturity Distribution of Investment Portfolio The following table sets forth the maturity distribution of the investment portfolio at December 31, 1997. Table IX. Maturity Distribution of Investment Portfolio <TABLE> <CAPTION> Weighted Book average Portfolio Type and Maturity value yield<F1> Grouping -------- ------------ (Dollars in thousands) <S> <C> <C> Held-to-maturity portfolio: U.S. Treasury and other U.S. Government agencies: Within one year $ 27,937 5.855% After one but within five years 47,058 6.694 After five but within ten years 25,536 6.811 After ten years 13,843 6.733 -------- Total U.S. Treasury and other U.S. Government agencies 114,374 6.520 States and political subdivisions: Within one year -- -- After one but within five years 6,880 6.220 After five but within ten years 20,733 6.716 After ten years -- -- -------- Total states and political subdivisions 27,613 6.592 Other: Within one year -- -- After one but within five years 4,904 8.500 After five but within ten years -- -- After ten years 5,797 9.500 -------- Total other 10,701 9.042 Total held-to-maturity portfolio $152,688 6.710% ======== </TABLE> 29
<TABLE> <S> <C> <C> Available-for-sale portfolio: U.S. Treasury and other U.S. Government agencies: Within one year $ 2,993 5.624% After one but within five years 51,391 5.820 After five but within ten years 36,813 5.944 After ten years 57,237 6.595 -------- Total U.S. Treasury and other U.S. Government agencies 148,434 6.146 States and political subdivisions: Within one year 766 6.357 After one but within five years -- -- After five but within ten years -- -- After ten years -- -- -------- Total states and political subdivisions 766 6.357 Other: Within one year -- -- After one but within five years -- -- After five but within ten years -- -- After ten years 18,823 7.416 -------- Total other 18,823 7.416 Total available-for-sale portfolio $168,023 6.289% ======== Total investment securities $320,711 6.489% ======== <F1> Weighted average yields are computed on an annual basis, and yields on tax-exempt obligations are computed on a taxable-equivalent basis using an assumed tax rate of 35%. </TABLE> 30
Deposits The Bank competes for deposits in Hawaii principally by providing quality customer service at its branch offices. The Bank, over the years, has developed a relatively large and stable base of core deposits which consists of noninterest-bearing demand, interest-bearing demand and savings deposits and time deposits under $100,000. Total deposits at December 31, 1997, 1996 and 1995 were $1,193.2 million, $1,123.6 million and $1,138.3 million, respectively. Deposits increased in 1997 by 6.2% compared with the 1.3% decrease recorded for 1996. Interest-bearing deposits, excluding time deposits of $100,000 and over, increased by 2.4% in 1997, compared with a decrease of 2.3% in 1996. Noninterest-bearing deposits increased by 0.2% in 1997 and decreased by 1.4% in 1996. The Bank's ratio of core deposits to total deposits was 73.4% at December 31, 1997, 76.5% at December 31, 1996 and 77.1% at December 31, 1995. Time deposits of $100,000 and over increased by 20.0% to $317.2 million in 1997 over the $264.3 million in 1996, which increased by 1.5% over the $260.3 million in 1995. See "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Financial Condition." 31
The following table sets forth information regarding the average deposits and the average rates paid for certain deposit categories for each of the periods indicated. Average balances are computed using daily average balances. Table X. Average Balances and Average Rates on Deposits <TABLE> <CAPTION> Year ended December 31, ------------------------------------------------------------ 1997 1996 1995 ------------------ ----------------- ------------------ Average Average Average Average rate Average rate Average rate balance paid balance paid balance paid ---------- ------- --------- ------- ---------- ------- <S> <C> <C> <C> <C> <C> <C> Noninterest-bearing demand deposits $ 155,232 --% $ 153,288 --% $ 152,002 --% Interest-bearing demand deposits 95,056 1.35 94,389 1.36 98,303 1.36 Savings and money market deposits 398,667 2.78 392,603 2.80 414,988 3.12 Time deposits 495,211 5.01 461,771 5.00 437,789 5.16 ---------- ---------- ---------- TOTAL $1,144,166 3.25% $1,102,051 3.21% $1,103,082 3.34% ========== ========== ========== </TABLE> 32
The remaining maturities of the certificates of deposit in denominations of $100,000 and over are set forth in the following table. XI. Remaining Maturities of Large Certificates of Deposit <TABLE> <CAPTION> December 31, 1997 (Dollars in thousands) ---------------------- <S> <C> Three months or less $151,342 Over three through six months 63,413 Over six through twelve months 86,522 Over twelve months 15,961 -------- Total $317,238 ======== </TABLE> ITEM 2. PROPERTIES The executive offices of the Company and the Bank are located at 220 South King Street, Honolulu, Hawaii 96813. All Bank properties, except for the properties in which the Hilo, Kailua-Kona and Moiliili branches and the operations center are situated, are occupied under leases which expire on various dates through 2019, and, in most instances, include options to renew. For the year ended December 31, 1997, net rent expense under these leases aggregated $4.4 million. For additional information relating to lease rental expense and commitments, see Note 16 to the Company's Consolidated Financial Statements in the 1997 Annual Report which is incorporated herein by reference. CPB Properties is a general partner and the managing partner with a 50% interest in CKSS. Other partners in CKSS are Kajima Development Corporation, a general partner, Sumitomo Corporation and Sumitomo Corporation of America, limited partners. CKSS was formed to develop, construct and lease a 22-story office building complex in the downtown financial district of Honolulu at the corner of King and Alakea Streets, which now serves as the Company's and the Bank's headquarters. The building contains 201,865 square feet of rentable space of which approximately 67,000 square feet are occupied by the Company. CKSS carried the building complex on its books at a net book value of $23.9 million as of December 31, 1997. To finance the building, CKSS entered into a loan agreement with The Sumitomo Bank, Limited ("Sumitomo") which is secured by a mortgage on Central Pacific Plaza. The loan agreement, as amended, allows CKSS to borrow up to $12.5 million at 0.75% above LIBOR. As of December 31, 1997, Sumitomo had advanced pursuant to its loan agreement the sum of $9.3 million, due on June 18, 2001. 33
The investment in CKSS is carried on the books of the Company under the equity method of accounting. See Notes 1 and 7 to the Company's Consolidated Financial Statements in the 1997 Annual Report which is incorporated herein by reference. In October 1992, CPB Properties, as lessor, entered into a lease agreement with CKSS for certain real property located in Kaimuki, Hawaii, effective from January 1, 1993 to December 31, 2047. Under the terms of the lease, CKSS would develop a 4-story office building (the "Kaimuki Plaza"). On April 30, 1993, CKSS and the Bank entered into a building loan agreement to borrow up to $12.2 million at .75% above LIBOR to finance the Kaimuki Plaza. At December 31, 1997, the Bank had advanced $10.7 million, due on August 10, 2001, pursuant to this loan agreement. At December 31, 1997, an additional $0.2 million was payable to the Bank, at 0.75% above LIBOR, pursuant to a loan agreement secured by second mortgages on the Central Pacific and Kaimuki Plazas, which matures on April 10, 2001. The weighted average interest rate on all loans related to the Company's headquarters and Kaimuki Plaza at December 31, 1997 was 6.947%. In November 1994, the Bank entered a 25-year lease agreement with CKSS to lease office space in the Kaimuki Plaza for its Kaimuki Branch. The lease is effective from November 1, 1994 through October 31, 2019. The Bank holds title to the land and building in which the Hilo branch office and operations center are situated. CPB Properties holds title to a portion of the land and the building in which the Moiliili branch office is situated. In August 1996, ownership of the operations center property was transferred from CPB Properties to the Bank at net book value in exchange for CPB Properties common stock, which was recorded as treasury stock. ITEM 3. LEGAL PROCEEDINGS The Company is a party to ordinary routine litigation incidental to its business, none of which is considered likely to have a materially adverse effect on the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to the Company's shareholders for a vote during the fourth quarter of 1997. ITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth, as of February 28, 1998, the executive officers of the Company, their positions, principal occupation during the past five years and ages. Each officer is appointed by the Board of Directors of the Company and serves at their pleasure. 34
<TABLE> Principal Occupation Name and Position During Past Five Years Age <S> <C> <C> Joichi Saito Chairman of the Board and Chief 62 Chairman of the Executive Officer, Central Pacific Board and Chief Bank (1996-Present); President Executive Officer and Chief Operating Officer, Central Pacific Bank (1989-1995) Naoaki Shibuya President and Chief Operating 56 President Officer, Central Pacific Bank (1996-Present); Executive Vice President, Central Pacific Bank (1993-1995); Executive Vice President, The Sumitomo Bank of California (1989-1993) Austin Y. Imamura Executive Vice President 51 Vice President and and Secretary, Central Pacific Secretary Bank (1991-Present) Neal K. Kanda Executive Vice President, Central 49 Vice President and Pacific Bank (1996-Present); Treasurer Executive Vice President and Controller, Central Pacific Bank (1993-1996); Senior Vice President and Controller, Central Pacific Bank (1990-1993) </TABLE> PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS For information concerning the market for the Company's common stock and related shareholder matters, see "Common Stock Price Range and Dividends" contained in the 1997 Annual Report, which is incorporated herein by reference, and "ITEM 1. BUSINESS -- Supervision and Regulation -- Restrictions on Transfers of Funds to the Company by the Bank." 35
ITEM 6. SELECTED FINANCIAL DATA For selected financial data concerning the Company, see "Selected Consolidated Financial Data" contained in the 1997 Annual Report, which is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For Management's discussion and analysis of financial condition and results of operations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in the 1997 Annual Report, which is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES REGARDING MARKET RISK For quantitative and qualitative disclosures regarding market risk, see "Quantitative and Qualitative Disclosures About Market Risk" contained in the 1997 Annual Report, which is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA For financial statements of the Company, see "Supplementary Financial Information," and "Consolidated Financial Statements and Notes," including the "Independent Auditor's Report" thereon, in the 1997 Annual Report, which is incorporated herein by reference. See "ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K" below for financial statements filed as a part of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Except as hereinafter noted, the information concerning directors and executive officers of the Company is incorporated by reference from the section entitled "Election of Directors" of the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual Report on Form 10-K. For information concerning executive officers of the Company, see "ITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT." ITEM 11. EXECUTIVE COMPENSATION Information concerning executive compensation is incorporated by reference from the section entitled "Compensation of Directors and Executive Officers" of the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual Report on Form 10-K. 36
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information concerning security ownership of certain beneficial owners and management is incorporated by reference from the sections entitled "Principal Shareholders," and "Election of Directors" of the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual Report on Form 10-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information concerning certain relationships and related transactions is incorporated by reference from the section entitled "Certain Transactions" of the Company's Proxy Statement, which is filed as Exhibit No. 99 to this Annual Report on Form 10-K. PART IV. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Financial Statements and Schedules (1) The following financial statements included in the registrant's 1997 Annual Report are incorporated herein by reference. Page number references are to page numbers in the 1997 Annual Report. <TABLE> <CAPTION> Page <S> <C> CPB Inc. and Subsidiary: Independent Auditors' Report 40 Consolidated Balance Sheets at December 31, 1997 and 1996 18 Consolidated Statements of Income for the Years ended December 31, 1997, 1996 and 1995 19 Consolidated Statements of Changes in Stockholders' Equity for the Years ended December 31, 1997, 1996 and 1995 20 Consolidated Statements of Cash Flows for the Years ended December 31, 1997, 1996 and 1995 21 Notes to Consolidated Financial Statements 22 (2) All schedules are omitted because they are not applicable, not material or because the information is included in the consolidated financial statements or the notes thereto. </TABLE> 37
<TABLE> <S> <C> (b) Reports on Form 8-K The Company filed a report on Form 8-K on October 20, 1997 reporting under Item 5 - Other Business a 2-for-1 stock split effective November 14, 1997. (c) Exhibits Exhibit No. Document 3.1 Restated Articles of Incorporation of CPB Inc., as amended 3.2 Amended Bylaws of CPB Inc.(1) 10.1 Limited Partnership Agreement of CKSS Associates Limited Partnership dated July 10, 1981 and among CPB Properties, Inc., Kajima Hawaii Corporation, Sumitomo Corporation and Sumitomo Corporation of America(2) 10.2 CPB Inc. 1986 Stock Option Plan, as amended (3)(6) 10.3 Lease dated February 1, 1983 by and between CKSS Associates and Central Pacific Bank, as amended by First Amendment of Lease between CKSS Associates and Central Pacific Bank dated March 3, 1984, as amended by Second Amendment of Lease between CKSS Associates and Central Pacific Bank dated April 3, 1987, as amended by Third Amendment of Lease between CKSS Associates and Central Pacific Bank dated September 24, 1992.(1) 10.4 Share Purchase Agreement dated as of November 20, 1986 by and among The Sumitomo Bank, Limited and CPB Inc.(1) 10.5 Split Dollar Life Insurance Plan(4)(6) 10.6 Common Stock Purchase Warrant issued December 16, 1996 to The Sumitomo Bank, Limited(5) 10.7 Form of Common Stock Purchase Warrant issued July 30, 1997 to The Sumitomo Bank, Limited 10.8 Central Pacific Bank and Subsidiaries 1997 Annual Executive Incentive Plan(6) 10.9 Central Pacific Bank Supplemental Executive Retirement Plan(5) (6) 10.10 CPB Inc. 1997 Stock Option Plan(5)(6) 13 Annual Report to Shareholders for the year ended December 31, 1997 (parts not incorporated by reference are furnished for informational purposes and are not filed herewith) 38
21 Subsidiaries of CPB Inc. 23 Accountants' Consent 27.1 Financial Data Schedule (Fiscal year ended December 31, 1997) 27.2 Amended Financial Data Schedule (Fiscal years ending December 31, 1996 and 1995; quarters ending March 31, 1997, June 30, 1997 and September 30, 1997) 27.3 Amended Financial Data Schedule (Quarters ending March 31, 1996, June 30, 1996 and September 30, 1996) 99 Proxy Statement for Annual Meeting of Shareholders to be held on April 21, 1998 (7) - ---------------------- (1) Filed as Exhibits 3.2, 10.10, 10.16 and 10.18 to the registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, filed with the Securities and Exchange Commission on March 17, 1994. (2) Filed as Exhibit 10.7 to registrant's Registration Statement on Form S-14 (Registration No. 2-76608), filed with the Securities and Exchange Commission on March 23, 1982, which is incorporated herein by this reference. (3) Filed as Exhibit 28.1 to registrant's Registration Statement on Form S-8 (Registration No. 33-11462), filed with the Securities and Exchange Commission on January 22, 1987, which is incorporated herein by this reference. (4) Filed as Exhibit 10.16 to registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, filed with the Securities and Exchange Commission on March 27, 1992. (5) Filed as Exhibits 10.6, 10.8 and 10.9 to registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, filed with the Securities and Exchange Commission on March 28, 1997. (6) Denotes management contract or compensation plan or arrangement. (7) Filed with the Securities and Exchange Commission on March 25, 1998 and incorporated herein by this reference. </TABLE>
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: March 25, 1998. CPB INC. (Registrant) By /s/ Joichi Saito JOICHI SAITO Chairman of the Board and Chief Executive Officer 38
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. <TABLE> <CAPTION> Signature Title Date <S> <C> <C> /s/ Joichi Saito Chairman of the Board March 25, 1998 - --------------------- and Chief Executive Joichi Saito Officer (Principal Executive Officer), Director /s/ Neal K. Kanda Vice President, March 25, 1998 - --------------------- Treasurer Neal K. Kanda (Principal Financial Officer, Principal Accounting Officer) /s/ Paul Devens Director March 25, 1998 - --------------------- Paul Devens /s/ Alice F. Guild Director March 25, 1998 - --------------------- Alice F. Guild /s/ Dennis I. Hirota Director March 25, 1998 - --------------------- Dennis I. Hirota, Ph.D. /s/ Stanley W. Hong Director March 25, 1998 - --------------------- Stanley W. Hong Director March __, 1998 - --------------------- Daniel M. Nagamine - --------------------- Director March __, 1998 Shunichi Okuyama /s/ Yoshiharu Satoh Director March 25, 1998 - --------------------- Yoshiharu Satoh /s/ Naoaki Shibuya Director March 25, 1998 - --------------------- Naoaki Shibuya </TABLE> 39