CPF · Read the filing

ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

We are a bank holding company that, through our banking subsidiary, Central Pacific Bank, offers full service commercial banking in the state of Hawaii.

We strive to provide exceptional customer service and products that meet our customers' needs. Our products and services consist primarily of the following:

•Loans: Our loans consist of commercial, financial and agricultural, commercial mortgage, and construction loans to small and medium-sized companies, business professionals, and real estate investors and developers, as well as residential mortgage, home equity and consumer loans to local homeowners and individuals. Our lending activities contribute to a key component of our revenues reported in interest income.

•Deposits: We offer a full range of deposit products and services including checking, savings and time deposits, cash management, and electronic banking services. We also maintain a broad branch and ATM network in the state of Hawaii. The interest paid on such deposits has a significant impact on our interest expense, an important factor in determining our earnings. In addition, fees and service charges on deposit accounts contribute to our revenues.

Additionally, we offer wealth management products and services, such as non-deposit investment products, annuities, insurance, investment management, asset custody and general consultation and planning services.

Executive Overview

In 2020, we believe we delivered strong financial performance for the Company despite the pandemic environment.

•We recorded net income of $37.3 million, or $1.32 per diluted common share in 2020, compared to $58.3 million, or $2.03 per diluted common share in 2019.

•We recorded pre-tax pre-provision income of $88.2 million in 2020, compared to $84.2 million in 2019.

•We recorded return on average assets ("ROA") and return on average shareholders' equity ("ROE") ratios of 0.58% and 6.85%, respectively, in 2020, compared to ROA and ROE ratios of 0.99% and 11.36%, respectively, in 2019.

•Asset quality remains strong as our nonperforming assets totaled $6.2 million, or 0.09% of total assets at December 31, 2020, compared to $1.7 million, or 0.03% of total assets at December 31, 2019.

•We realized strong loan growth of $514.6 million, or 11.6% (or growth of $98.2 million or 2.2% excluding Small Business Administration ("SBA") Paycheck Protection Program ("PPP") loans), as well as strong core deposit growth of $786.9 million, or 18.5% in 2020.

•We completed a $55 million private placement of ten-year fixed-to-floating rate subordinated notes which strengthened our capital position.

•Our capital position and consistent profitability allowed us to increase our regular cash dividends paid from $0.90 per share in 2019 to $0.92 per share in 2020.

RISE2020

Commencing in the second quarter of 2019, the Company launched RISE2020, a multifaceted initiative intended to enhance customer experience, drive stronger long-term growth and profitability, improve shareholder returns and lower our efficiency ratio. RISE2020 includes initiatives in the following key areas of opportunity: Digital Banking, Revenue Enhancements, Branch Transformation and Operational Excellence. RISE2020 is intended to provide Central Pacific Bank with premier products and services in several strategic areas. During 2019, the outsourcing of the Company's residential mortgage loan servicing, the launch of its new website under the cpb.bank domain name and the implementation of its end-to-end commercial loan origination system was completed. During the first quarter of 2020, the Company opened its concept branch, providing its customers a glimpse into the future of Central Pacific Bank. After significant development, the Company's new online and

mobile banking platforms for its retail customers launched in August 2020. The rollout of newly upgrade ATMs was completed in the fourth quarter of 2020. Despite several challenges resulting from the impact of the COVID-19 pandemic, the Company completed its RISE2020 initiative culminating with the grand opening of the fully renovated Central Pacific Plaza headquarters building and flagship main branch, and the launch of a new brand design in early January 2021.

Basis of Presentation

Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements under "Part II, Item 8. Financial Statements and Supplementary Data."

COVID-19 Pandemic

The ongoing novel coronavirus disease ("COVID-19") pandemic has caused significant disruption in the local, national and global economies and financial markets. The pandemic has resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities. Continuation and further spread of COVID-19 could cause additional quarantines, shutdowns, reductions in business activity and financial transactions, labor shortages, supply chain interruptions and overall economic and financial market instability.

In response to the anticipated economic effects of COVID-19, the Board of Governors of the Federal Reserve System (the "FRB") has taken a number of actions that have significantly affected the financial markets in the United States, including actions intended to result in substantial decreases in market interest rates. On March 3, 2020, the 10-year Treasury yield fell below 1.00% for the first time, and the FRB reduced the target federal funds range by 50 basis points to 1.00% to 1.25%. On March 15, 2020, the FRB further reduced the target federal funds range by 100 basis points to 0% to 0.25% and announced a $700 billion quantitative easing program in response to the expected economic downturn caused by COVID-19. On March 22, 2020, the FRB announced that it would continue its quantitative easing program in amounts necessary to support the smooth functioning of markets for Treasury securities and agency MBS. We expect that these reductions in interest rates, among other actions of the FRB and the Federal government generally, especially if prolonged, could adversely affect our net interest income, margins and profitability. In the December 2020 meeting, the FRB elected to hold the target federal funds rate at 0% to 0.25% and officials expects rates to remain near zero through 2023.

In late March 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law as an over $2 trillion economic stimulus package. The CARES Act is intended to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors.

In December 2020, Congress passed another $900 billion aid package, or the Consolidated Appropriations Act, 2021, which extends certain relief provisions under the CARES Act.

Hawaii's economy continues to be significantly impacted by COVID-19. On March 4, 2020, Hawaii Governor David Ige issued a Proclamation declaring a state of emergency to support ongoing State and county responses to COVID-19. Since then, Governor Ige issued seventeen supplemental emergency proclamations which includes travel restrictions and other measures.

As a result of these restrictions, the spread of COVID-19 has been relatively contained. The infection rate in the State of Hawaii is one of the lowest per capita in the country at 1,816 cases per 100,000 population. As of February 8, 2021 the Centers for Disease Control and Prevention reported there were 26,500 cases (7-day moving average of 75.9 new infections) and 418 COVID-19-related deaths in Hawaii.

During the first quarter of 2020, in response to Governor Ige's statewide restrictions on the movements of Hawaii residents and visitors to combat the potential spread of COVID-19 in Hawaii, the Company announced it would temporarily close certain branch locations. The decision to temporarily close the branches was made to protect the health and well-being of the Company's employees and customers. Some branches, such as the in-store branches with limited floor space, made it challenging to operate with social distancing in mind. The staff from the temporarily closed branches were redeployed to work at the remaining branches or assist other areas of the bank. The Company quickly responded to the changing environment by executing its business continuity plan and the majority of our support staff, even at the executive level, were working remotely on a full-time or rotating basis. The Company continues to prudently manage through the pandemic and has put in place preventative measures including face masks, plexiglass shields, social distancing and enhanced cleaning. The Company is implementing a gradual, phased-in return-to-office plan that includes a portion of the workforce continuing with flexible, remote work schedules. The Company believes the actions it has taken to-date, allows it to meet the needs of its customers and community while ensuring the safety of all employees and customers.

During the remainder of 2020, the Company re-opened several of its branches that were temporarily closed. In July 2020, the Board of Directors of the Company approved a plan to consolidate four branches on the island of Oahu in 2020. Three of the branches are in-store branches on Oahu, which were temporarily closed since March 2020 due to the COVID-19 pandemic, and were permanently closed during the third quarter of 2020. These in-store branches had a small square footage which did not allow for adequate social distancing. The fourth branch was a full-service branch on Oahu that was closed during the fourth quarter of 2020. Our digital rollout is well-aligned with our branch consolidation initiative, and we expect that much of the transactional activity that was processed by these branches can be migrated to our digital channels. We also have other neighboring branches in close proximity that are available for customer full-service needs. The Company incurred $0.3 million in pre-tax expenses related to the consolidation of the three in-store branches during the third quarter of 2020 and an additional $1.3 million in pre-tax expenses related to the consolidation of the fourth branch during the fourth quarter of 2020. The Company anticipates annual expense savings of approximately $1.8 million related to the consolidation of the four branches.

COVID-19 may also materially disrupt banking and other financial activity generally and in Hawaii where the bank operates. This may result in a decline in customer demand for our products and services, including loans and deposits which could negatively impact our liquidity position and our growth strategy. Any one or more of these developments could have a material adverse effect on our business, operations, consolidated financial condition, and consolidated results of operations.

Financial position and results of operations

The disruptions in the economy have impaired and will continue to impair the ability of some of our borrowers to make their monthly loan payments, which could result in significant increases in delinquencies, defaults, foreclosures and declining collateral values. As a result, the COVID-19 pandemic could result in the recognition of credit losses in our loan portfolios and increase our allowance for credit losses, particularly as businesses remain closed and as more customers are expected to draw on their lines of credit or seek additional loans to help finance their businesses. Similarly, because of changing economic and market conditions affecting issuers, we may be required to recognize an allowance for credit losses in future periods on the securities we hold as well as reductions in other comprehensive income.

Through guidance from regulatory agencies, the Company is prudently working with its borrowers impacted by COVID-19 to defer payments, interest, and fees. Loans on active payment forbearance or deferrals granted to borrowers impacted by the COVID-19 pandemic declined significantly from $567.9 million or, 11.3% of the total loan portfolio (or 12.7% excluding PPP loans) as of June 30, 2020, to $120.2 million, or 2.4% of the total loan portfolio (or 2.6% excluding PPP loans), as of December 31, 2020 as many borrowers resumed payments.

The following table sets forth all loans to borrowers impacted by COVID-19 on active payment forbearance or deferral and the percentage of loans on active payment forbearance or deferral to total loans and total loans, excluding PPP loans, as of December 31, 2020:

Real estate:

The Company’s interest income could also be reduced due to COVID-19. Interest and fees still accrue on amounts that are deemed collectible during the deferral period, however, should the Company later determine that collection of payments is not expected and eventual credit losses on these deferred payments emerge, accrued and unpaid interest income and fees will need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. During the third quarter of 2020, the Company recorded a reserve on the accrued interest receivable for loans on active forbearance or deferral totaling $0.2 million. This reserve balance remained unchanged during the fourth quarter of 2020. The Company may need to increase this reserve or reverse accrued interest receivable which may negatively impact interest income in future periods if it is determined that the accrued interest receivable is uncollectible.

The Company’s aggregate fee income could be reduced due to COVID-19. The Company has experienced a decline in transactional activity due to COVID-19. In addition, to support our customers during this difficult time, the Company temporarily waived non-CPB ATM fees and early withdrawal fees on our time deposits and granted temporary increases on debit card and mobile deposit transaction limits throughout the second quarter of 2020. Beginning July 1, 2020, we reinstated these fees that were waived throughout the previous quarter, but the temporary increases on debit card and mobile deposit transaction limits remain in place.

Liquidity and capital

Through our past experience during the Great Recession in the late 2000s, we believe we have developed robust liquidity and capital stress tests and comprehensive liquidity and capital contingency plans. We further believe our liquidity and capital positions are strong. The Company currently estimates that it has sufficient liquidity and capital to withstand an economic recession brought about by COVID-19. However the Company's regulatory capital ratios could be adversely impacted by significant credit losses and lower interest income and fees or by a longer and deeper recession than we currently anticipate. To protect against this possibility, the Company issued $55.0 million in subordinated debt in October 2020 which is classified as tier 2 capital for regulatory purposes, and downstreamed $46.8 million to the bank.

The Company relies on cash on hand as well as dividends from its subsidiary bank to service its debt. If the Company’s capital deteriorates such that its subsidiary bank is unable to pay dividends to it for an extended period of time, the Company may not be able to service its debt or pay dividends to its shareholders.

The Company’s liquidity is impacted by loan principal and interest payment deferrals that are being granted for certain customers due to COVID-19. Cash flow from loan payments was reduced due to the deferrals which were granted for three to nine months. Requests for loan payment deferrals continued to significantly decline in the fourth quarter of 2020 as economic recovery in Hawaii started to begin. While a significant number of loan payment deferrals ended in the fourth quarter of 2020, we assisted some borrowers with additional deferrals as needed. Additionally, liquidity could be adversely impacted if customers withdraw significant deposit balances due to COVID-19 concerns.

In the case of loans serviced by the Company for certain third parties, including those under the Federal National Mortgage Association ("FNMA") and Federal Home Loan Mortgage Corp. ("FHLMC") programs, the Company is required to advance to the owners the payment of principal and interest on a scheduled basis for four months even when such payment was not collected from the borrower due to payment forbearance granted or payment delinquency. Such amounts advanced are recorded as a receivable by the Company and are expected to be collected from the borrower and/or government agencies (FNMA or FHLMC).

The Company maintains access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile. The collateral that is pledged for wholesale funding lines, could lose value and may result in less funding availability. The Company has access to thePaycheck Protection Program Liquidity Facility (“PPPLF”), which is an extension of credit to eligible financial institutions that originate PPP loans that takes the PPP loans as collateral at face value. If funding costs are elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin. If an extended recession caused large numbers of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.

In March 2020, we decided to suspend our share repurchase program until we know more about the extent the pandemic will have on the economy and our business. In January 2021, our Board of Directors approved a new authorization to repurchase up to $25 million in common stock. We can provide no assurance when or if we will resume our share repurchases.

Asset valuation

The Company currently does not expect COVID-19 to affect its ability to account timely for the assets on its balance sheet; however, this could change in future periods. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances such as widening credit spreads, the Company does not anticipate significant changes in the methodology used to determine the fair value of assets measured in accordance with GAAP.

The Company has a significant real estate loan portfolio. Due to COVID-19, the real estate loan collateral used to secure such loans could experience a reduction in value. Further, the ability for the Company to obtain appraisals of property value could be difficult during COVID-19. This may lead to credit impairments and asset write-downs. Thus far, Hawaii real estate collateral values have held up, but we cannot be assured this will continue.

Processes, controls and business continuity plan

The Company's Business Continuity Plan includes a Pandemic Preparedness Plan which it successfully activated in early March 2020. The Company’s remote workforce plan has been rolled out with an overall smooth transition. The Company already had Virtual Private Network ("VPN") technology capability, and during the first quarter of 2020, expanded VPN access to over 70% of its employees. In addition to VPN, the Company believes it is well-setup with the latest technologies that enable our operations to continue efficiently. The Company is using collaboration tools and several other cloud-based software programs. For its customers, during the third quarter of 2020 the Company launched its premier digital banking platform which is one of the key initiatives and milestones in its RISE2020 initiative.

The Company is implementing a gradual, phased-in return-to-office plan that includes a portion of the workforce continuing with flexible, remote work schedules. Due to the recent rise in COVID-19 cases in Hawaii and nationwide, the return-to-office plan was delayed as a precautionary measure. The Company may incur additional cost related to its continued deployment of the remote workforce plan. A remote workforce plan potentially could introduce operational or internal control challenges and risks, including resource constraints. The Company is closely monitoring operations to mitigate those risks, and currently does not anticipate significant challenges to its ability to maintain its systems and internal controls in light of the measures the Company has taken to prevent the spread of COVID-19. However, should there be significant changes to government orders, the health and well-being of our workforce, or to our critical systems and vendors, there could be an adverse impact on our operations.

Lending operations and accommodations to borrowers

To support its customers during this difficult time, the Company has moved quickly to put in place a number of COVID-19 relief programs for its consumer and business customers affected by the pandemic. For its customers, the Company offered an employment disruption loan as well as consumer, commercial, commercial mortgage, and residential mortgage payment deferral programs. In addition, as previously mentioned, we waived non-CPB ATM fees and early withdrawal fees on our time deposits throughout the second quarter of 2020 and increased spending cap limits on debit cards and mobile deposit limits to $10,000 daily. Beginning July 1, 2020, the previously waived fees have been reinstated but the increased spending cap limits will remain in place temporarily.

The bank is a SBA approved lender and actively participated in assisting customers with loan applications for the SBA’s Paycheck Protection Program, or PPP, which was part of the CARES Act. PPP loans have a two or five-year term and earn interest at 1%. The SBA pays the originating bank a processing fee ranging from 1% to 5%, based on the size of the loan, which the Company is recognizing over the life of the loan. The Company saw tremendous interest in the PPP. With the significant increase in volume of PPP loan requests, the Company redeployed staff to handle and assist with loan processing. Additionally, the Company brought on some outside resources to assist with the PPP.

From April 3, 2020, the date the SBA began accepting submissions for the initial round of PPP loans through the end of the program in August 2020, the Company funded over 7,200 PPP loans totaling over $558 million and received gross processing fees of over $21 million. The Company has developed a PPP forgiveness portal and has begun the process of assisting our customers with applying for forgiveness from the SBA. Certain PPP loans have been paid-off and/or forgiven by the SBA resulting in a total outstanding balance of $426.0 million and net deferred fees of $9.6 million as of December 31, 2020. The Company has engaged a third party to assist with this process. Although the Company believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program, there could be risks and liabilities by the Company that cannot be determined at this time.

The Company became aware in September 2020 of a Federal criminal complaint related to PPP loan fraud on a $10.0 million PPP loan that the bank originated in April 2020. The CEO of the borrower was charged by the U.S. Department of Justice for submitting a fraudulent PPP loan application to the bank. The Federal investigation is ongoing and charges are currently pending. Neither the Company nor the bank is a party to the Federal complaint, and we have been cooperating with Federal authorities. We believe that we originated the subject PPP loan in accordance with all SBA PPP requirements. Accordingly, we currently expect that the SBA guarantee remains in effect. Based on current facts and circumstances, we expect to be fully repaid on the loan. Therefore we continue to hold the $10.0 million PPP loan on our balance sheet as a performing asset as of December 31, 2020.

The Company is staying in close contact with its customers and has increased its client outreach efforts. The Company’s commercial loan officers are frequently calling their key clients. The Company is monitoring its client’s financial health during this challenging time and is providing guidance to help them through the pandemic. Further, the Company believes it is prudently making loan modifications for certain borrowers to allow deferral of loan principal and/or interest for a short-term period.

The Company provided initial three-month principal and interest payment forbearance for our residential mortgage customers, and three-month principal and interest payment deferrals for our consumer customers. Both residential mortgage and consumer customers were granted extensions to their forbearance or deferral, if needed. The Company is deferring either the full loan payment or the principal component of the loan payment for typically three to six months for its commercial real estate and commercial and industrial loan customers on a case-by-case basis depending on need. As of December 31, 2020, the Company had loan payment forbearance or deferrals on outstanding balances of $120.2 million, or 2.4% of total loans (or 2.6% of total loans, excluding PPP loans). Of this amount, $28.1 million and $59.5 million were on second and third payment forbearance or deferrals, respectively, as of December 31, 2020.

In accordance with the revised interagency guidance issued in April 2020 and Section 4013 of the CARES Act, banks are provided an option to elect to not account for certain loan modifications related to COVID-19 as TDRs as long as the borrowers were not more than 30 days past due as of February 29, 2020 (time of modification program implementation) and December 31, 2019, respectively. The Company has identified eleven consumer loans totaling $0.2 million and one residential mortgage loan totaling $0.7 million during 2020, that were modified and did not meet the criteria under Section 4013 of CARES Act or the "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised)". As a result, these loans are included in the TDRs as of December 31, 2020. The Company had active loan deferrals with outstanding balances of approximately $119.3 million resulting from the COVID-19 pandemic that were not classified as a TDR at December 31, 2020 under Section 4013 of CARES Act or the "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised)".

Collectibility of the accrued interest on deferred loans is uncertain. During the third quarter of 2020, the Company recorded a reserve on the accrued interest receivable of loans on active forbearance or deferral totaling $0.2 million, with the offset recorded to provision for credit losses. This reserve remained unchanged as of December 31, 2020. The Company may need to increase this reserve or reverse accrued interest receivable which may negatively impact interest income in future periods if it is determined that the accrued interest receivable is uncollectible. Additional loan modifications to capitalize interest and/or extend loan terms may also be necessary. The Company anticipates requests for new or extended loan deferrals will continue at a slower pace through the first quarter of 2021.

Credit

Following the recovery from the Great Recession, the Company believes it has implemented a disciplined approach to credit that includes tighter underwriting standards with a focus on making quality loans and maintaining a diversified loan portfolio. The Company’s loan portfolio today is diversified by product and by industry.

In March 2020, the Company reviewed its entire commercial loan portfolio and actively reached out to its customers to determine the initial impact, if any, of COVID-19 on their businesses. The review continued throughout the remainder of 2020. The Company proactively worked with many of its customers in providing loan payment deferrals as well as assisted in the application and approval of PPP loans.

The volume of loan payment deferrals granted peaked in May at approximately $605 million in total loan balances, and has since declined to $120.2 million, or 2.4% of total loans (or 2.6% of total loans, excluding PPP loans), at December 31, 2020. The Company continues to support its consumer and residential customers with extensions to payment deferral or forbearance, as needed. The Company is also providing alternative payment plans on a limited basis following the end of the payment deferral period. Our consumer loan payment deferrals totaled $2.3 million at December 31, 2020, compared to $65.8 million at June 30, 2020.

Our residential mortgage loans on active payment forbearance totaled $70.4 million at December 31, 2020, compared to $176.6 million at June 30, 2020. The majority of the residential mortgage loans in forbearance were in their third 90-day forbearance period at December 31, 2020. Most borrowers are beginning to resume payments with the total count dropping from a peak of 467 at May 31, 2020 to 152 at December 31, 2020.

In our commercial, commercial real estate and construction loan portfolios, loans on active payment deferral totaled $47.5 million at December 31, 2020, compared to $325.4 million at June 30, 2020. The two highest exposures by industry are real estate and rental and leasing totaling approximately $33 million, or less than 1% of the total loan portfolio excluding PPP loans, and accommodation totaling approximately $8 million, or less than 1% of the total loan portfolio excluding PPP loans. The majority of the loans in the real estate category are supported by low loan-to-value ratios. The Company expects some of its borrowers will need a loan modification at the end of their second loan payment deferral, which will be handled on a case-by-case basis.

In the fourth quarter of 2020, we continued our stepped-up assessment and monitoring as well as our outreach to our customers. Criticized loans at December 31, 2020 increased by $111.9 million from the previous year to $192.3 million, or 4.2% of the total loan portfolio excluding PPP loans. Special mention loans increased by $103.5 million to $142.5 million, or 3.1% of the total loan portfolio excluding PPP loans. Classified loans increased by $8.3 million to $49.8 million, or 1.1% of the total loan portfolio excluding PPP loans. The loan downgrades were the result of our continued assessment of borrower risk based on the borrower’s near-term strategy and outlook, management strength and actions they’ve taken, overall financial condition, and external funding and deferral support. Approximately 12% of special mention balances and 5% of classified balances also received PPP loans.

The Company believes that the residential, home equity and commercial real estate and construction loan portfolios are lower risk. The weighted average loan-to-values at origination in these portfolios are 62%, 63%, and 61%, respectively, and we believe they will be less impacted by the pandemic. These loans comprise of $3.52 billion or 77.5% of our total loan portfolio, net of PPP loans. Overall, the Company's loan portfolio remains well diversified.

The disruptions in the economy resulting from the COVID-19 pandemic has impaired and will continue to impair the ability of some of our borrowers to make their monthly loan payments, which could result in significant increases in delinquencies, defaults, foreclosures and declining collateral values. As a result, the COVID-19 pandemic could result in the recognition of credit losses in our loan portfolios and increase our allowance for credit losses particularly as businesses remain closed and as more customers are expected to draw on their lines of credit or seek additional loans to help finance their businesses. Similarly, because of changing economic and market conditions affecting issuers, we may be required to recognize an allowance for credit losses in future periods on the securities we hold as well as reductions in other comprehensive income.

Business Environment

The majority of our operations are concentrated in the state of Hawaii. As a result, our performance is significantly influenced by strength of the real estate markets, the tourism industry and economic environment in Hawaii. Macroeconomic conditions also influence our performance. A favorable business environment is generally characterized by expanding gross state product, low unemployment and rising personal income; while an unfavorable business environment is characterized by the reverse.

Following the solid performances of our leading economic indicators in 2019, Hawaii's economy was greatly impacted by the COVID-19 pandemic in 2020.

Hawaii's visitor industry continues to be severely impacted by the COVID-19 pandemic as tourism was shut-down at the end of March 2020 in an attempt to isolate the State from travel-related transmission of COVID-19. Beginning October 15, 2020, passengers arriving from out-of-state and traveling inter-county could bypass the mandatory 14-day self-quarantine with a valid negative COVID-19 NAAT test result from a Trusted Testing and Travel Partner through the state’s Safe Travels program. Effective November 24, all trans-Pacific travelers participating in the pre-travel testing program were required to have a

negative test result before their departure to Hawai‘i, and test results would no longer be accepted once a traveler arrived in Hawai‘i. On December 2, Kaua‘i County temporarily suspended its participation in the state’s Safe Travels program, making it mandatory for all travelers to Kaua‘i to quarantine upon arrival. On December 10, the mandatory quarantine was reduced from 14 to 10 days in accordance with the U.S. Centers for Disease Control and Prevention’s ("CDC") guidelines.

According to preliminary year-end statistics from the Hawaii Tourism Authority ("HTA"), approximately 2.7 million total visitors arrived in the state in 2020. This was a decrease of 73.8% from the previous record high of 10.4 million visitor arrivals in 2019. The HTA also reported that total spending by visitors decreased to $5.11 billion in 2020, a decrease of 71.2%, from the previous record high of $17.72 billion in 2019. According to the Hawaii Department of Business Economic Development and Tourism ("DBEDT"), total visitor arrivals is expected to increase to approximately 6.2 million in 2021 and visitor spending is expected to increase to approximately $10.51 billion in 2021. We believe most of the tourism gains will be seen in the second half of 2021 after vaccines become widely available.

Hawaii's unemployment rate went from one of the lowest in the nation to one of the highest. The Department of Labor and Industrial Relations reported that Hawaii's seasonally adjusted annual unemployment rate increased from an average of 2.6% in the first quarter of 2020 to an average of 17.0% during April to September 2020. The unemployment rate has recently improved to 9.3% in December 2020, compared to 2.6% in December 2019 as travel restrictions have eased. Hawaii's unemployment rate in December 2020 of 9.3% ranked highest in the nation, above the national seasonally adjusted unemployment rate of 6.7%. DBEDT projects Hawaii's seasonally adjusted annual unemployment rate to be around 7.9% in 2021.

Hawaii's economy is measured by the growth of real personal income and real gross state product. DBEDT is expected to report real personal income grew by 5.6%, primarily due to federal assistance programs in 2020. Real gross state product is expected

to decline by approximately 11.2%, for 2020. DBEDT projects real personal income to decline by 8.9% and real gross state product for 2021 to increase by 2.1% for 2021.

Real estate lending is a primary focus for us, including residential mortgage and commercial mortgage loans. As a result, we are dependent on the strength of Hawaii's real estate market. The Oahu real estate market saw relatively stable activity in 2020 despite the challenging pandemic environment. According to the Honolulu Board of Realtors, the median price for a single-family home on Oahu for the year ended December 31, 2020 was $830,000, representing an increase of 5.2% from the median resale price of $789,000 for the year ended December 31, 2019. The median resale price for condominiums on Oahu was $435,000 for the year ended December 31, 2020, representing an increase of 2.4% from the median resale price of $425,000 for the year ended December 31, 2019. Oahu unit sales volume increased by 2.3% for single-family homes, but decreased by 13.0% for condominiums in 2020 from 2019.

As we have seen in the past, our operating results are significantly impacted by the economy in Hawaii and the composition of our loan portfolio. Loan demand, deposit growth, Provision, asset quality, noninterest income and noninterest expense are all affected by changes in economic conditions. If the residential and commercial real estate markets we have exposure to deteriorate our results of operations would be negatively impacted. See the "Overview of Results of Operations—Concentrations of Credit Risk" section for a further discussion on how a deteriorating real estate market, combined with the elevated concentration risk within our portfolio, could have a significant negative impact on our asset quality and credit losses.

In late 2008, the Federal Reserve lowered the target Federal Funds range to 0%-0.25%. In an attempt to help the overall economy, the FRB has kept interest rates low through its targeted Fed Funds rate until the recession was safely over. In recent years, the Federal Reserve has begun raising the target Federal Funds range. During 2018, the Federal Reserve increased the Federal Funds range four times, each by 25 basis points to 2.25%-2.50% as of December 31, 2018. The Federal Reserve left the Federal Funds range unchanged during the first half of 2019 but cut the Federal Funds range three times by 25 basis points during the second half of 2019 to 1.50%-1.75% as of December 31, 2019. On March 3, 2020, the Federal Reserve reduced the Federal Funds range by 50 basis points to 1.00% to 1.25%. On March 15, 2020, the Federal Reserve further reduced the Federal Funds range by 100 basis points to 0% to 0.25% and announced a $700 billion quantitative easing program in response to the expected economic downturn caused by COVID-19. In the September 2020 and December 2020 meetings, the Federal Reserve elected to hold the Federal Funds rate at 0% to 0.25% and officials expect rates to remain near zero through 2023.

Changes in monetary policy, including changes in interest rates, could influence, among other things, (i) the amount of interest we receive on loans and securities, (ii) the amount of interest we pay on deposits and borrowings, (iii) our ability to originate loans and obtain deposits, and (iv) the fair value of our assets and liabilities.

Critical Accounting Policies and Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") requires that management make a number of judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expense in the financial statements and the related disclosures made. Various elements of our accounting policies, by their nature, involve the application of highly sensitive and judgmental estimates and assumptions. Some of these policies and estimates relate to matters that are highly complex and contain substantial inherent uncertainties. Actual amounts and values as of the balance sheet dates may be materially different than the amounts and values reported due to the inherent uncertainty in the estimation process. Also, future amounts and values could differ materially from those estimates due to changes in values and circumstances after the balance sheet date.

Accounting estimates are deemed critical when a different estimate could have reasonably been used or where changes in the estimate are reasonably likely to occur from period to period and would materially impact our consolidated financial statements as of or for the periods presented. Management has discussed the development and selection of the critical accounting policy and estimates noted below with the Audit Committee of the Board of Directors, and the Audit Committee has reviewed the accompanying disclosures.

The Company identified a significant accounting policy which involves a higher degree of judgment and complexity in making certain estimates and assumptions that affect amounts reported in our consolidated financial statements. At December 31, 2020, the significant accounting policy which we believed to be the most critical in preparing our consolidated financial statements is the determination of the allowance for credit losses. This is further described in Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements in this report.

On January 1, 2020, the Company adopted Accounting Standards Update ("ASU") 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which created material changes to the

Company’s existing critical accounting policy that existed at December 31, 2019. Effective January 1, 2020 through December 31, 2020, the significant accounting policy which we believe to be the most critical in preparing our consolidated financial statements is the determination of the allowance for credit losses on loans.

Allowance for Credit Losses on Loans

Management considers the policies related to the allowance for credit losses ("ACL") on loans as the most critical to the financial statement presentation. The total ACL on loans includes activity related to allowances calculated in accordance with Accounting Standards Codification (“ASC”) 326, "Financial Instruments – Credit Losses". The ACL is established through the provision for credit losses charged to current earnings. The amount maintained in the ACL reflects management’s continuing evaluation of the estimated credit losses expected to be recognized over the life of the loans in our loan portfolio at the balance sheet date. The ACL is comprised of specific reserves assigned to certain loans that don’t share general risk characteristics and general reserves on pools of loans that do share general risk characteristics. Factors contributing to the determination of specific reserves include the creditworthiness of the borrower, and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. For purposes of establishing the general reserve, we stratify the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and calculate the net amount expected to be collected over the life of the loans to estimate the expected credit losses in the loan portfolio. The Company’s methodologies for estimating the ACL consider available relevant information about the collectability of cash flows, including information about past events, current conditions, and reasonable and supportable forecasts. Refer to Note 1 - Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements in this report for further discussion of the risk factors considered by management in establishing the ACL.

Overview of Results of Operations

2020 vs. 2019 Comparison

In 2020, we recognized net income of $37.3 million, or fully diluted earnings per common share ("EPS") of $1.32, compared to net income of $58.3 million, or EPS of $2.03, in 2019. Our ROA and ROE for 2020 was 0.58% and 6.85%, respectively, compared to 0.99% and 11.36%, respectively, in 2019.

We recorded a provision for credit losses of $39.1 million in 2020, compared to $6.3 million in 2019. The higher provision for credit losses was driven by the economic forecast which captures the effect of the COVID-19 pandemic and led to the decline in net income, EPS, ROA and ROE in 2020 compared to 2019.

Net interest income increased by $13.6 million from 2019 to 2020, primarily driven by lower deposit and borrowing costs due to the historically low interest rate environment due to the pandemic environment, combined with net interest income and fees on PPP loans, partially offset by lower yields earned on the loans and investment securities portfolios.

Other operating income increased by $3.4 million from 2019 to 2020. The increase in other operating income was primarily due to higher mortgage banking income, partially offset by lower service charges on deposit accounts. In addition, the Company recorded a gain of $2.6 million during the first quarter of 2019 from the conversion of MasterCard Class B common stock received during their initial public offering to Class A common stock and immediate sale of the converted shares. See Table 3 - Components of Other Operating Income for more information.

Other operating expense increased by $13.1 million from 2019 to 2020. The increase was primarily due to higher salaries and employee benefits, higher provision for off-balance sheet credit exposures, higher computer software expenses, higher legal and professional expenses, branch consolidation costs, and higher advertising expense, partially offset by lower director deferred compensation plan expense and lower entertainment and promotions expense. See Table 4 - Components of Other Operating Expense for more information.

2019 vs. 2018 Comparison

In 2019, we recognized net income of $58.3 million, or EPS of $2.03, compared to net income of $59.5 million, or EPS of $2.01, in 2018. Our ROA and ROE for 2019 was 0.99% and 11.36%, respectively, compared to 1.05% and 12.22%, respectively, in 2018.

We recorded a credit to the provision for credit losses of $6.3 million in 2019, compared to a credit of $1.1 million in 2018.

Net interest income increased by $11.1 million from 2018 to 2019, primarily due to a significant increase in average loans, funded by runoff of the investment securities portfolio and a significant increase in core deposits, combined with an increase in average yields earned on loans and higher interest recoveries on nonaccrual loans. In addition, average government time deposits (included in time deposits of $100,000 and over) declined significantly. Partially offsetting these positive variances were increases in interest rates paid on interest-bearing deposits, primarily attributable to the four 25 basis point increases in the Federal Funds rate in 2018.

Other operating income increased by $3.0 million from 2018 to 2019. The increase in other operating income was primarily due to conversion of MasterCard Class B common stock received during their initial public offering to Class A common stock and immediate sale of the converted shares resulting in a gain of $2.6 million during the first quarter of 2019, combined with higher income from bank-owned life insurance, higher merchant and bank card fees and higher commissions and fees on investment services. These increases were partially offset by lower mortgage banking income and lower income recovered on nonaccrual loans previously charged-off. See Table 3 - Components of Other Operating Income for more information.

Other operating expense increased by $6.9 million from 2018 to 2019. The increase in other operating expense was primarily due to higher salaries and employee benefits, higher entertainment and promotions expense(included in other), higher computer software expense and higher net occupancy expense. These increases were partially offset by lower amortization of core deposit premium, lower FDIC insurance expense and a credit to the reserve for residential mortgage loan repurchase losses in 2019, compared to an increase to the reserve in 2018. See Table 4 - Components of Other Operating Expense for more information.

Net Interest Income

The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. Net interest income, when expressed as a percentage of average interest-earning assets, is referred to as "net interest margin." Interest income, which includes loan fees and resultant yield information, is expressed on a taxable-equivalent basis using a federal statutory tax rate of 21%. Table 2 presents an analysis of changes in components of net interest income between years. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (i) changes in volume and (ii) changes in rates. The change in volume is calculated as change in average balance, multiplied by prior period average yield/rate. The change in rate is calculated as change in average yield/rate, multiplied by current period volume. The change in interest income not solely due to change in volume or change in rate has been allocated proportionately to change in volume and change in average yield/rate.

Table 1. Average Balances, Interest Income and Expense, Yields, and Rates (Taxable-Equivalent)

Assets

Interest-earning assets:

Investment securities, excluding valuation allowance:

Liabilities and Equity

Interest-bearing liabilities:

Non-controlling interest 2 — 4

(1) At amortized cost.

(2) Includes nonaccrual loans.

Table 2. Analysis of Changes in Net Interest Income (Taxable-Equivalent)

Increase (Decrease)Due to Change In: Increase (Decrease)Due to Change In:

(Dollars in thousands) Volume Rate NetChange Volume Rate NetChange

Interest-earning assets

Investment securities, excluding valuation allowance:

Interest-bearing liabilities

Net interest income is our primary source of earnings and is derived primarily from the difference between the interest we earn on loans and investments versus the interest we pay on deposits and borrowings. Net interest income (expressed on a taxable-equivalent basis) totaled $198.3 million in 2020, which increased by $13.4 million, or 7.3%, from $184.9 million in 2019, which increased by $10.9 million, or 6.3%, from net interest income of $174.0 million recognized in 2018. The increase in net interest income for 2020 was primarily the result of lower deposit and borrowing costs due to the historically low interest rate environment during the pandemic environment, combined with net interest income and fees on PPP loans, partially offset by lower yields earned on the loans and investment securities portfolios.

Average yields earned on our interest-earning assets decreased by 40 bp in the year ended December 31, 2020, from the year ended December 31, 2019. The decrease in average yields earned on interest-earning assets in 2020 was primarily attributable to the 48 bp decrease in average yields earned on loans and the 34 bp decrease in average yields earned on investment securities.

Average rates paid on our interest-bearing liabilities in the year ended December 31, 2020 decreased by 47 bp from the year ended December 31, 2019. The decrease in average rates paid on our interest-bearing liabilities in 2020 was primarily attributable to the 106 bp decrease in average rates paid on our time deposits of $100,000 and over and the 20 bp decrease in average rates paid on our savings and money market deposits. Time deposits of $100,000 and over primarily consists of public funds which may be opportunistic sources of funding, but fluctuate more directly with changes in Federal Funds rates. In addition, average rates paid on FHLB advances and other short-term deposits and long-term debt decreased by 151 bp and 94 bp, respectively.

securities with an average yield of 1.27% and a weighted average life of 4.6 years. The investment securities sold had an average yield of 0.28% and a weighted average life of 1.2 years. Gross realized losses and gains on the sale of the investment securities were $0.3 million and $0.5 million, respectively. The specific identification method was used as the basis for determining the cost of all securities sold.

In the third quarter of 2020, $90.4 million in available-for-sale non-agency commercial mortgage-backed securities with retail mall exposure were sold to mitigate credit risk during the pandemic. The investment securities sold had an average yield of 3.44% and a weighted average life of 14.03 years. Gross realized gains and losses on the sale of the investment securities were $0.2 million and $0.6 million, respectively. The specific identification method was used as the basis for determining the cost of all securities sold.

In the third quarter of 2019, $53.9 million in lower-yielding available-for-sale securities were sold as part of an investment portfolio repositioning strategy designed to enhance potential prospective earnings and improve net interest margin. We received $53.9 million in gross proceeds and reinvested the proceeds in $52.5 million in higher-yielding, longer duration investment securities with an average yield of 2.54% and a weighted average life of 6.6 years. The investment securities sold had an average yield of 2.10% and a weighted average life of 3.2 years. Gross realized gains on the sale of the investment securities were $36 thousand. The specific identification method was used as the basis for determining the cost of all securities sold.

Interest Income

Our primary sources of interest income include interest on loans, which represented 87.4%, 84.1%, and 80.0% of taxable-equivalent interest income in 2020, 2019 and 2018, respectively, as well as interest earned on investment securities, which represented 12.4%, 15.4% and 19.7% of taxable-equivalent interest income, respectively. Interest income expressed on a taxable-equivalent basis of $213.1 million in 2020 decreased by $4.1 million, or 1.9%, from the $217.2 million earned in 2019, which increased by $17.9 million, or 9.0%, from the $199.3 million earned in 2018.

As depicted in Table 2, the decrease in interest income in 2020 from 2019 was primarily due to the decline in average yields earned on the loans and investment securities portfolios of 48 bp and 34 bp, respectively, which contributed to decreases in current year interest income of $23.2 million and $3.8 million, respectively. The $117.7 million decline in average investment securities also contributed to a decrease of $3.2 million in current year interest income. These decreases were partially offset by a $613.9 million increase in average loans, which contributed to an increase of $26.6 million in current year interest income. The increase in average loans was largely attributable to a $358.3 million average PPP loan portfolio, which contributed to an increase of $12.2 million in current year net interest income and an average yield of 3.41%.

The increase in interest income in 2019 from 2018 was primarily due to a significant increase in average loans, combined with higher yields earned on the loan portfolio, combined with higher nonrecurring interest. The $343.1 million increase in average loans contributed to an increase of $13.9 million in current year interest income. The 22 bp increase in average yields earned on loans, which was benefited by higher interest recoveries of $1.9 million, contributed to an increase of $9.3 million in current year interest income. These positive variances were partially offset by the $217.0 million decrease in average investment securities, which contributed to a decrease of $5.8 million in current year interest income.

Interest Expense

In 2020, interest expense was $14.7 million which represented a decrease of $17.6 million, or 54.4%, compared to interest expense of $32.3 million in 2019, which was an increase of $7.0 million, or 27.7%, compared to $25.3 million in 2018.

In 2020, the decreases in the average rates paid on savings and money market deposits of 20 bp, time deposits of $100,000 and over of 106 bp, FHLB advances and other short-term borrowings of 151 bp, and long-term debt of 94 bp, contributed to the decrease in interest expense in 2020 from 2019of $3.6 million, $8.4 million, $1.4 million, and $1.1 million, respectively. In addition, the decreases in average time deposits of $100,000 and over and FHLB advances and other short-term borrowings contributed to the decrease in current year interest expense of $1.9 million and $2.2 million, respectively.

In 2019, the increase in the average rates paid on savings and money market deposits of 20 bp and time deposits of $100,000 and over of 32 bp contributed to the increase in interest expense in 2019 from 2018of $3.0 million and $2.8 million, respectively. In addition, the increase in average FHLB advances and other short-term borrowings contributed to the increase in interest expense of $3.3 million. These increases were partially offset by the 64 bp decrease in rates paid on long-term debt resulting in a $0.7 million decline in interest expense. The decline in rates paid were primarily attributable to the pay off of

junior subordinated debentures of CPB Capital Trust II ("Trust II") and CPB Statutory Trust III ("Trust III"), both of which carried an interest rate of three-month LIBOR plus 2.85%.

Net Interest Margin

Our net interest margin was 3.30%, 3.35% and 3.22% in 2020, 2019 and 2018, respectively. The decrease in our net interest margin in 2020 from 2019 was primarily due to the historically low interest rate environment we are currently operating in due to the pandemic environment. Average yields earned on interest-earning assets declined by 40 bp, led by declines in average yields earned on loans and investment securities of 48 bp and 34 bp, respectively. These decreases were partially offset by a 47 bp decrease in average rates paid on interest-bearing liabilities.

The increase in our net interest margin in 2019 from 2018 was primarily due to a significant increase in loans, combined with the 25 bp increase in the average yield earned on total interest-earning assets, which outpaced the 16 bp increase in average rates paid on total interest-bearing liabilities. The average yield earned on loans increased by 22 bp, which was benefited by higher nonrecurring interest recoveries of $1.9 million.

During 2018, the Federal Reserve increased the Federal Funds range four times, each by 25 basis points to 2.25%-2.50% as of December 31, 2018. The Federal Reserve left the Federal Funds range unchanged during the first half of 2019 but cut the Federal Funds range three times by 25 basis points during the second half of 2019 to 1.50%-1.75% as of December 31, 2019. In response to the threat on the economy posed by the COVID-19 pandemic, in March 2020 the Federal Reserve made two emergency rate cuts totaling 150 basis points to the Federal Funds range down to 0-0.25%.

Other Operating Income

The following table sets forth components of other operating income and the total as a percentage of average assets for the periods indicated.

Table 3. Components of Other Operating Income

Dollar Change Percent Change

Mortgage banking income:

Net loss on sales of foreclosed assets (15) (145) — 130 (145) (89.7) N.M. *

Other:

* Not meaningful ("N.M.")

Total other operating income of $45.2 million in 2020 increased by $3.4 million, or 8.1%, from the $41.8 million earned in 2019, which increased by $3.0 million, or 7.7%, from the $38.8 million earned in 2018.

The increase in other operating income in 2020 from 2019 was primarily due to higher mortgage banking income of $7.0 million and higher bank-owned life insurance of $0.7 million. The higher mortgage banking income was attributable to a Company record $1.20 billion in loan originations by the Company's Home Loan division in 2020. The higher amortization of mortgage servicing rights (included in mortgage banking income) was primarily attributable to the decline in market interest rates. The higher income from bank-owned life insurance was primarily attributable to volatility in the equity markets. These increases were partially offset by lower service charges on deposit accounts of $2.2 million and a one-time gain of $2.6 million from the conversion of MasterCard Class B common stock received during their initial public offering to Class A common stock and immediate sale of the converted shares in the first quarter of 2019. During the second quarter of 2020, certain service charges were suspended to support our customers through the pandemic. In addition, there were less transactional activity due to the pandemic resulting in lower service charges on deposit accounts during 2020.

The increase in other operating income in 2019 from 2018 was primarily due to the aforementioned gain of $2.6 million on the conversion and subsequent sale of MasterCard stock in the first quarter of 2019, combined with higher income from bank-owned life insurance of $1.0 million, higher merchant and bank card fees of $0.7 million (included in other service charges and fees) and higher commissions and fees on investment services of $0.7 million (included in other service charges and fees). These increases were partially offset by lower mortgage banking income of $1.4 million and lower income recovered on

nonaccrual loans previously charged-off of $0.4 million. During the third quarter of 2019, the outsourcing of the Company's residential mortgage loans servicing was completed. Costs related to the outsourcing are included in net loan servicing fees as a component of mortgage banking income.

Other Operating Expense

The following table sets forth components of other operating expense and the total as a percentage of average assets for the periods indicated.

Table 4. Components of Other Operating Expense

Dollar Change Percent Change

Amortization of core deposit premium — — 2,006 — (2,006) N.M. (100.0)

Other:

Branch consolidation costs 1,631 — — 1,631 — N.M. N.M.

Litigation settlement 750 — — 750 — N.M. N.M.

FHLB advance prepayment fee 747 — — 747 — N.M. N.M.

* Not meaningful ("N.M.")

Total other operating expense of $154.7 million in 2020 increased by $13.1 million, or 9.2%, from total operating expense of $141.6 million in 2019, which increased by $6.9 million, or 5.2%, compared to 2018.

The increase in total other operating expense in 2020, compared to 2019, was primarily due to a higher provision for off-balance sheet credit exposures of $3.0 million, higher salaries and employee benefits of $2.8 million, higher computer software expense of $1.9 million, higher legal and professional services of $1.7 million, higher advertising expense of $1.1 million, and higher FDIC insurance assessment of $1.0 million. The increase in the provision for off-balance sheet credit exposures is

primarily due to the economic forecast used in the reserve estimate which captures the effect of the COVID-19 pandemic. The increase in the FDIC insurance assessment is primarily due to the increase in deposits, combined with the Small Bank Assessment Credits which were used up during the second quarter of 2020. In addition, the Company recognized several nonrecurring expenses in late 2020 totaling $5.9 million which included: $2.0 million in employee incentives and other benefits, $1.6 million in branch consolidation costs related to the closure of three in-store branches and one traditional branch in 2020, $0.8 million in settlements of legal proceedings, a $0.7 million FHLB advance prepayment fee, $0.6 million in losses on disposal of fixed assets and $0.5 million in other nonrecurring expenses (included in other). These increases were partially offset by lower directors' deferred compensation expense of $1.5 million and lower entertainment and promotions expense of $1.3 million. The variance in directors' deferred compensation plan expense is primarily due to volatility in the equity markets.

The increase in total other operating expense in 2019, compared to 2018, was primarily due to higher salaries and employee benefits of $6.9 million, higher entertainment and promotions expense of $1.0 million and higher computer software expense of $1.0 million. The increase in salaries and employee benefits was partially attributable to the addition of positions in strategic areas and higher commissions, combined with annual merit increases effective beginning the second quarter of 2019. These increases were partially offset by lower amortization of core deposit premium of $2.0 million, as the intangible asset was fully amortized as of September 30, 2018, and lower FDIC insurance expense of $0.9 million, primarily attributable to $0.9 million in Small Bank Assessment Credits received in the second half of 2019.

A key measure of operating efficiency tracked by management is the efficiency ratio, which is calculated by dividing total other operating expenses by total pre-provision revenue (net interest income plus other operating income). Management believes that the efficiency ratio provides useful supplemental information that is important to a proper understanding of the company's core business results by investors. Our efficiency ratio should not be viewed as a substitute for results determined in accordance with GAAP, nor is it necessarily comparable to the efficiency ratio presented by other companies. Our efficiency ratio increased to 63.71% in 2020, compared to 62.70% in 2019 and 63.59% in 2018. The increase in our efficiency ratio in 2020 was primarily driven by the aforementioned $5.9 million in nonrecurring increases in other operating expenses, partially offset by increases in net interest income and other operating income.

In 2018, the amortization of investments in low income housing tax credit ("LIHTC") partnerships was reclassified from other operating expense and is now included in income tax expense in the consolidated statements of income, which provides users a better understanding of the nature of the returns of such investments. The efficiency ratio in periods prior to the fourth quarter of 2018 have been adjusted retrospectively to reflect this change.

The following table sets forth a reconciliation to our efficiency ratio for each of the dates indicated and the impact of the reclassification of amortization of investments in LIHTC partnerships in the consolidated statements of income:

Table 5. Reconciliation of Efficiency Ratio

As Reclassified:

Unadjusted:

Impact of Change:

Total operating expenses $ — $ — $ (1,005) $ (744) $ (1,045)

Net interest income — — — $ — $ —

Total other operating income — — — — —

Total revenue $ — $ — $ — $ — $ —

Efficiency ratio — % — % (0.47) % (0.36) % (0.52) %

Income Taxes

In 2020, the Company recorded income tax expense of $11.8 million, compared to $19.6 million in 2019, and $18.8 million in 2018. Our effective tax rate was 24.0% in 2020 compared to 25.2% in 2019 and 24.0% in 2018.

The decrease in income tax expense and the effective tax rate in 2020 from 2019 was primarily attributable to lower pre-tax income, increasing the impact of net favorable permanent differences, primarily due to a higher provision for credit losses.

The increases in income tax expense and the effective tax rate in 2019 from 2018 were primarily due to an income tax benefit of $1.5 million related to the finalization of the impact of Tax Reform recorded in 2018, which also included the impact of a tax method change for software development and prepaid expenses that was filed in 2018.

As of December 31, 2020, the valuation allowance on our net deferred tax assets ("DTA") totaled $3.4 million, of which $3.2 million related to our DTA from net apportioned net operating loss ("NOL") carryforwards for California state income tax purposes as we do not expect to generate sufficient income in California to utilize the DTA. The remaining $0.2 million relates to a valuation allowance on the Hawaii capital loss carryforward balance that we do not expect to be able to utilize. Net of this valuation allowance, the Company's net DTA totaled $26.4 million as of December 31, 2020, compared to a net DTA of $16.5 million as of December 31, 2019, and is included in other assets on our consolidated balance sheets.

Financial Condition

Total assets of $6.59 billion at December 31, 2020 increased by $581.9 million, or 9.7%, from the $6.01 billion at December 31, 2019, and total liabilities of $6.05 billion at December 31, 2020 increased by $563.7 million, or 10.3%, from the $5.48 billion at December 31, 2019. The increase in total assets and total liabilities in 2020 was primarily due to our strong loan and deposit growth, led by our participation in loans originated under the SBA's PPP.

Loan Portfolio

Our lending activities are focused on commercial, financial and agricultural loans, commercial mortgages, and construction loans to small and medium-sized companies, business professionals, and real estate investors and developers, as well as residential mortgages, home equity and consumer loans to local home-buyers and individuals. Our strategy for generating commercial loans has traditionally relied upon teams of commercial real estate and commercial banking officers organized by geographical and industry lines who are responsible for client prospecting and business development.

To manage credit risk (i.e., the ability of borrowers to repay their loan obligations), management analyzes the borrower's financial condition, repayment source, collateral and other factors that could impact credit quality, such as national and local economic conditions and industry conditions related to respective borrowers. The general underwriting guidelines require analysis and documentation to include among other things, overall credit worthiness of borrower, guarantor support, use of funds, loan term, minimum equity, loan-to-value standards, repayment terms, sources of repayment, covenants, pricing, collateral, insurance, and documentation standards. All loan requests considered by us should be for a clearly defined legitimate purpose with a determinable primary source, as well as alternate sources of repayment. All loans should be supported by appropriate documentation including, current financial statements, credit reports, collateral information, asset verification, tax returns, title reports, and appraisals (where appropriate).

We score consumer and small business loans using underwriting matrices ("Scorecards") developed based on the results of an analysis from a reputable national credit scoring company commissioned by our bank. The Scorecards use the attributes that were determined to most highly correlate with probability of repayment. Those attributes include (i) credit score, (ii) credit limit amount, and (iii) debt-to-income ratio.

Loans totaled $4.96 billion at December 31, 2020, which increased by $514.6 million, or 11.6%, from the $4.45 billion at December 31, 2019, which increased by $371.2 million, or 9.1%, from the $4.08 billion held at December 31, 2018. The increase in our loan portfolio in 2020 was largely due to our participation in the SBA PPP and strong residential mortgage increased demand from new and existing customers. The increase in total loans included net increases in the following loan portfolios: PPP of $416.4 million, residential mortgage of $90.4 million, or 5.7%, home equity of $60.5 million, or 12.3%, commercial mortgage of $32.9 million, or 2.9%, and construction of $29.6 million, or 30.8%. These increases were partially offset by net decreases in the following loan portfolios: consumer of $90.0 million, or 15.8%, and other commercial, financial, and agricultural of $25.2 million, or 4.4%, In 2020, we did not foreclose on any loans. In addition, we recorded charge-offs of loans of $11.4 million.

The following table sets forth information regarding outstanding loans, net of deferred (fees) costs, by category as of the dates indicated.

Table 6. Loans by Categories

December 31,

Commercial, financial and agricultural:

SBA PPP $ 416,375 $ — $ — $ — $ —

Real estate:

The following table sets forth the geographic distribution of our loan portfolio, net of deferred (fees) costs, and related ACL as of the dates indicated.

Table 7. Geographic Distribution

(Dollars in thousands) Hawaii U.S. Mainland Total Hawaii U.S. Mainland Total

Commercial, financial and agricultural:

Real estate:

Commercial, Financial and Agricultural - Small Business Administration Payroll Protection Program

The bank is a SBA approved lender and actively participated in assisting customers with loan applications for the SBA’s Paycheck Protection Program, or PPP, which was part of the CARES Act. PPP loans have a two or five-year term and earn interest at 1%. The SBA pays the originating bank a processing fee ranging from 1% to 5%, based on the size of the loan, which the Company is recognizing over the life of the loan. The Company saw tremendous interest in the PPP. From April 3, 2020, the date the SBA began accepting submissions for the initial round of PPP loans through the end of the program in August 2020, the Company funded over 7,200 PPP loans totaling over $558 million and received gross processing fees of over $21 million. Certain PPP loans have been paid-off and/or forgiven by the SBA resulting in a total outstanding balance of $426.0 million and net deferred fees of $9.6 million as of December 31, 2020.

Commercial, Financial and Agricultural - Other

Loans in this category consist primarily of term loans and lines of credit to small and middle-market businesses and professionals. The borrower's business is typically regarded as the principal source of repayment, although our underwriting policy and practice generally requires additional sources of collateral, including real estate and other business assets, as well as personal guarantees where possible to mitigate risk. Risk of credit losses could be greater in this loan category relative to secured loans where a greater percentage of the loan amount is usually covered by collateral. Nonetheless, any collateral or personal guarantees obtained on commercial loans can mitigate the increased risk and help to reduce credit losses.

Our historical approach to commercial lending involves teams of lending and cash management personnel who focus on relationship development including loans, deposits and other bank services to new and existing commercial clients.

In 2020, our commercial, financial, and agricultural loan portfolio, excluding PPP loans, decreased by $25.2 million. Our commercial, financial, and agricultural loan portfolio decreased by $11.4 million in 2019, increased by $77.6 million in 2018 and decreased by $6.4 million in 2017. The decrease in 2020 was primarily attributable to runoff in the Hawaii portfolio of $27.9 million, partially offset by growth in the U.S. Mainland portfolio of $2.7 million.

Real Estate—Construction

Construction loans include both residential and commercial development projects. Each construction project is evaluated for economic viability. Construction loans pose higher credit risks than typical secured loans. In addition to the financial strength of the borrower, construction loans have the added element of completion risk, which is the risk that the project will not be completed on time and within budget, resulting in additional costs that could affect the economic viability of the project and market risk at the time construction is complete.

In 2020, our construction loan portfolio increased by $29.6 million. Our construction loan portfolio increased by $28.9 million in 2019, increased by $2.7 million in 2018, and decreased by $37.3 million in 2017. These fluctuations are driven by the start and completion of construction projects and are consistent with a normal construction cycle.

Interest Reserves

Our policies require interest reserves for construction loans, including loans to build commercial buildings, residential developments (both large tract projects and individual houses), and multi-family projects.

The outstanding principal balance of loans with interest reserves was $59.0 million at December 31, 2020, compared to $37.1 million in the prior year, while remaining interest reserves was $5.3 million, or 8.9% of the outstanding principal balance of loans with interest reserves at December 31, 2020, compared to $4.0 million, or 10.9% of the outstanding principal balance of loans with interest reserves at December 31, 2019.

Interest reserves allow the Company to advance funds to borrowers to make scheduled payments during the construction period. These advances typically are capitalized and added to the borrower's outstanding loan balance, although we have the right to demand payment under certain circumstances. Our policy is to determine if interest reserve amounts are appropriately included in each project's construction budget and are adequate to cover the expected duration of the construction period.

The amount, terms, and conditions of the interest reserve are established when a loan is originated, although we generally have the option to demand payment if the credit profile of the borrower changes. We evaluate the viability and appropriateness of the construction project based on the project's complexity and feasibility, the timeline, as well as the creditworthiness of the borrowers, sponsors and/or guarantors, and the value of the collateral.

In the event that unfavorable circumstances alter the original project schedule (e.g., cost overruns, project delays, etc.), our policy is to evaluate whether or not it is appropriate to maintain interest capitalization or demand payment of interest in cash and we will work with the borrower to explore various restructuring options, which may include obtaining additional equity and/or requiring additional collateral. We may also require borrowers to directly pay scheduled interest payments.

Our process for determining that construction projects are moving as planned are detailed in our lending policies and guidelines. Prior to approving a loan, the Company and borrower generally agree on a construction budget, a proforma monthly disbursement schedule, and sales/leaseback assumptions. As each project progresses, the projections are measured against actual disbursements and sales/lease results to determine if the project is on schedule and performing as planned.

The specific monitoring requirements for each loan vary depending on the size and complexity of the project and the experience and financial strength of the borrower, sponsor and/or guarantor. At a minimum, to ensure that loan proceeds are properly disbursed and to assess whether it is appropriate to capitalize interest or demand cash payment of interest, our monitoring process generally includes:

•Physical inspection of the project to ensure work has progressed to the stage for which payment is being requested;

•Verification that the work completed is in conformance with plans and specifications and items for which disbursement is requested are within budget; and

•Determination that there continues to be satisfactory project progress.

In certain rare circumstances, we may decide to extend, renew, and/or restructure the terms of a construction loan. Reasons for the restructure can range from cost overruns to project delays and the restructuring can result in additional funds being advanced or an extension of the maturity date of the loan. Prior to the loan being restructured, our policy is to perform a detailed analysis to ensure that the economics of the project remain feasible and that the risks to the Company are within acceptable lending guidelines.

Real Estate—Mortgage

The following table sets forth information with respect to the composition of the Real Estate—Mortgage loan portfolio as of the dates indicated.

Table 8. Mortgage Loan Portfolio Composition

December 31,

Residential:

Residential

Residential mortgage loans include fixed-rate and adjustable-rate loans primarily secured by single-family owner-occupied primary residences in Hawaii. Maximum loan-to-value ratios of 80% are typically required for fixed-rate and adjustable-rate loans secured by single-family owner-occupied residences, although higher levels are permitted with accompanying mortgage insurance. First mortgage loans secured by residential properties generally carry a moderate level of credit risk. With an average loan size of approximately $0.5 million, marketable collateral and a stable Hawaii residential real estate market, credit losses on residential mortgage loans have been minimal during the past several years. However, economic conditions including unemployment levels, future changes in interest rates and other market factors can impact the marketability and value of collateral and thus the level of credit risk inherent in the portfolio.

Closed-end residential mortgage loan balances as of December 31, 2020 totaled $1.69 billion, increasing by $90.4 million, or 5.7%, from the $1.60 billion held at year-end 2019, which increased by $171.6 million, or 12.0%, from the $1.43 billion held at year-end 2018. The increase in closed-end residential mortgage loan balances in 2020 was primarily due to increased demand from both new and existing customers.

Residential mortgage loans held for sale at December 31, 2020 totaled $16.7 million, an increase of $7.6 million, or 83.7%, from the December 31, 2019 balance of $9.1 million, which increased by $2.4 million, or 36.6%, from the December 31, 2018 balance of $6.6 million. We did not securitize any residential mortgage loans in 2020, 2019 and 2018.

Home Equity

Home equity lines of credit ("HELOCs"), which typically carry floating interest rates, are underwritten according to policy and guidelines reviewed and approved by the Board of Directors. All HELOCs originated since early 2011 have a ten year draw period followed by a 20 year repayment period during which the principal balance will be fully amortized. HELOCs are underwritten using a qualifying payment which assumes the line is fully drawn and is amortizing as if it was in the repayment period. Underwriting criteria include a minimum FICO score, maximum debt-to-income ratio ("DTI"), and maximum combined loan-to-value ratio ("CLTV"). HELOCs are monitored based on default, delinquency, end of draw period, and maturity.

HELOC balances as of December 31, 2020 totaled $551.3 million, increasing by $60.5 million, or 12.3%, from the $490.7 million held at December 31, 2019, which increased by $21.8 million, or 4.6%, from the $469.0 million held at December 31, 2018.

Commercial

Real estate mortgage loans secured by commercial properties continue to represent a sizable portion of our loan portfolio. Our policy with respect to commercial mortgages is that loans be made for sound purposes, have a definite source and/or plan of repayment established at inception, and be backed up by reliable secondary sources of repayment and satisfactory collateral with good marketability. Loans secured by commercial property carry a greater risk than loans secured by residential property due to operating income risk. Operating income risk is the risk that the borrower will be unable to generate sufficient cash flow from the operation of the property. The commercial real estate market and interest rate conditions through economic cycles will impact risk levels.

Commercial mortgage balances as of December 31, 2020 totaled $1.16 billion, increasing by $32.9 million, or 2.9%, from the $1.12 billion held at December 31, 2019, which increased by $83.1 million, or 8.0%, from the $1.04 billion held at December 31, 2018. The increase in commercial mortgage balances in 2020 was primarily due to increased demand from both new and existing customers.

Consumer Loans

The following table sets forth the major components of our consumer loan portfolio as of the dates indicated.

Table 9. Consumer Loan Portfolio Composition

December 31,

For consumer loans, credit risk is managed on a pooled basis. Considerations include an evaluation of the quality, character and inherent risks in the loan portfolio, current and projected economic conditions and past loan loss experience. Consumer loans represent a moderate credit risk. Loans in this category are generally either unsecured or secured by personal assets such as

automobiles. The average loan size is generally small and risk is diversified among many borrowers. Our policy is to utilize credit-scoring systems for most of our consumer loans, which offer the ability to modify credit exposure based on our risk tolerance and loss experience. From time to time, we will tactically deploy funds, which are not utilized in our current short-term core lending markets, by purchasing certain consumer loan portfolios.

Consumer loans totaled $479.4 million at December 31, 2020, decreasing by $90.0 million, or 15.8%, from December 31, 2019 of $569.4 million, which increased by $77.2 million, or 15.7%, compared to the $492.2 million held at December 31, 2018.

At December 31, 2020, automobile loans, primarily indirect dealer loans, comprised 52.3% of consumer loans outstanding.

Total automobile loans of $250.7 million at December 31, 2020 decreased by $46.5 million, or 15.6%, from December 31, 2019 of $297.2 million, which increased by $13.0 million, or 4.6%, from $284.2 million at December 31, 2018.

In 2020, we did not purchase any U.S. Mainland automobile loan portfolios. In 2019, we purchased a U.S.Mainland automobile loan portfolio totaling $30.2 million, which included a $0.6 million premium over the $29.6 million outstanding balance. In 2018, we purchased a U.S.Mainland automobile loan portfolio totaling $20.6 million, which included a $0.1 million premium over the $20.5 million outstanding balance. In 2017, we purchased three U.S.Mainland automobile loan portfolios totaling $83.8 million, which included $2.3 million in premiums over the $81.4 million outstanding balance. In 2016, we purchased two U.S.Mainland automobile loan portfolios totaling $41.2 million, which included $0.9 million in premiums over the $40.3 million outstanding balance.

Purchased unsecured consumer loans of $97.2 million at December 31, 2020 decreased by $12.9 million, or 11.7%, from December 31, 2019 of $110.1 million, which increased by $72.4 million, or 192.4%, from $37.6 million at December 31, 2018.

In 2020, we purchased U.S. Mainland unsecured consumer loans under forward flow purchase agreements with outstanding balances totaling $54.8 million for $53.2 million, reflecting a net discount of $1.6 million. In 2019, we purchased U.S. Mainland unsecured consumer loan portfolios with outstanding balances totaling $112.2 million for $109.9 million, reflecting a net discount of $2.3 million. In 2018 and 2016, we also purchased U.S. Mainland unsecured consumer loan portfolios totaling $38.0 million and $35.7 million, respectively, which represented the outstanding balances at the time of purchase.

Other revolving credit plans loans include extensions of credit to individuals and totaled $75.0 million at December 31, 2020, which decreased by $7.1 million, or 8.6%, from December 31, 2019 of $82.1 million, which decreased by $1.1 million, or 1.3%, from $83.2 million at December 31, 2018.

Total student loans of $3.0 million at December 31, 2020 decreased by $2.2 million, or 41.6%, from December 31, 2019 of $5.2 million, which decreased by $3.5 million, or 40.0%, from $8.6 million at December 31, 2018, primarily due to run-off.

Other consumer loans of $53.5 million at December 31, 2020 decreased by $21.4 million, or 28.5%, from December 31, 2019 of $74.9 million, which decreased by $3.7 million, or 4.7%, from $78.6 million at December 31, 2018.

Concentrations of Credit Risk

As of December 31, 2020, approximately $3.52 billion, or 71.0% of loans outstanding were real estate-related, including construction loans, residential mortgage loans, home equity loans, and commercial mortgage loans.

The majority of our loans are made to companies and individuals with headquarters in, or residing in, the state of Hawaii. Consistent with our focus of being a Hawaii-based bank, 88.6% of our loan portfolio was concentrated in the Hawaii market while 11.4% was concentrated in the U.S. Mainland as of December 31, 2020.

Our foreign credit exposure as of December 31, 2020 was minimal and did not exceed 1% of total assets.

Maturities and Sensitivities of Loans to Changes in Interest Rates

At December 31, 2020, all PPP loans were fixed-rate. Commercial, financial and agricultural loans, excluding PPP loans, were 53.5% fixed-rate and 46.5% variable-rate. Real estate construction loans were 33.6% fixed-rate and 66.4% variable-rate. Residential mortgage loans were 42.8% fixed-rate and 57.2% variable-rate. Home equity lines and loans were 8.6% fixed-rate and 91.4% variable-rate. Commercial mortgage loans were 44.0% fixed-rate and 56.0% variable-rate. Consumer loans were 83.5% fixed-rate and 16.5% variable-rate.

Commercial loans and commercial mortgage loans with variable interest rates are underwritten at the current market rate of interest. For commercial loans and commercial real estate loans with a fixed-rate period that are not fully amortizing, the loans are underwritten at the current market rate of interest. At the expiration of the fixed-rate period and/or maturity, the projected loan balance at that time is underwritten at an interest rate based on the current interest rate plus two percent per annum (2%).

Qualifying payments for our variable-rate residential mortgage loans with initial fixed-rate periods of five years or less are calculated using the greater of the note rate plus 2% per annum or the fully indexed rate. Payments for our variable-rate loans with a fixed-rate period of greater than five years are calculated using the greater of the note rate or the fully indexed rate. The qualifying payment for our HELOCs is based on the fully indexed rate plus the required principal plus interest payment due during the repayment period assuming the line was fully drawn. Our consumer lines of credit use a qualifying payment based on a percentage of the credit limit that exceeds the actual required fully indexed interest rate payment calculation.

The following table sets forth the maturity distribution and sensitivities of the loan portfolio to changes in interest rates at December 31, 2020. Maturities are based on contractual maturity dates and do not factor in principal amortization. This differs from the assumptions used in Table 21 - Interest Rate Sensitivity.

Table 10. Maturity Distribution and Sensitivities of Loans to Changes in Interest Rates

Maturing

One Yearor Less Over OneThroughFive Years Over FiveYears Total

(Dollars in thousands)

Commercial, financial and agricultural - PPP

With variable interest rates — — — —

Total commercial, financial and agricultural — 425,993 — 425,993

Commercial, financial and agricultural - Other

Construction

Residential mortgage

Home equity

Commercial mortgage

Consumer

All loans

Provision and Allowance for Credit Losses

As described above under the "Critical Accounting Policies and Use of Estimates" section, the Provision is determined by management's ongoing evaluation of the loan portfolio and our assessment of the ability of the ACL to cover expected credit losses. Our methodology for determining the adequacy of the ACL and Provision takes into account many factors, including the level and trend of nonperforming and potential problem loans, net charge-off experience, current repayment by borrowers, fair value of collateral securing specific loans, changes in lending and underwriting standards and general economic factors, nationally and in the markets we serve.

The Company maintains its ACL at an appropriate level as of a given balance sheet date to absorb management's best estimate of expected credit losses in its loan portfolios that will likely be realized over the expected life of our loan portfolio. This is based upon management's comprehensive analysis of the risk profiles particular to the respective loan portfolios. Analysis of ACL appropriateness is performed quarterly to coincide with financial disclosure to the public and to the regulatory agencies and is governed by a Board-approved policy and methodology.

The following table sets forth certain information with respect to the ACL as of the dates or for the periods indicated.

Table 11. Allowance for Credit Losses

Year Ended December 31,

Allowance for Credit Losses ("ACL")

Charge-offs:

Real estate:

Construction — — — — —

Residential mortgage 63 — — 73 —

Home equity — 5 — — —

Commercial mortgage 75 — — — 209

Recoveries:

Real estate:

Ratios:

Our ACL at December 31, 2020 totaled $83.3 million, which increased by $35.3 million, or 73.6%, from December 31, 2019. When expressed as a percentage of total loans, our ACL increased to 1.68% at December 31, 2020, from 1.08% at December 31, 2019. Excluding the PPP loan portfolio, our ratio of ACL to total loans was 1.83% at December 31, 2020.

On January 1, 2020, the Company adopted ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” using the modified retrospective method for all financial assets measured at

amortized cost and off-balance sheet credit exposures. The Company recorded increases of $3.6 million to the ACL for loans and $0.7 million to the reserve for off-balance sheet credit exposures, included in other liabilities, offset by a net decrease to retained earnings (or a net increase to accumulated deficit) of $3.2 million and a $1.1 million increase to other assets for the related impact to net deferred tax assets as of January 1, 2020 for the cumulative effect of adopting ASU 2016-13.

The Provision of $39.1 million, or $38.9 million excluding the provision on accrued interest receivable, recognized during the year was offset by $7.2 million in net charge-offs during the year. The Provision reflects the incorporation of estimated life-of-loan losses under ASC 326 and the economic forecast under the current COVID-19 pandemic.

The increase in our ACL as a percentage of total loans from December 31, 2019 to December 31, 2020 reflects the adoption of ASU 2016-13 and the economic forecast under the current COVID-19 pandemic.

Our ACL as a percentage of our nonaccrual loans decreased from 3,084.95% at December 31, 2019 to 1,344.78% at December 31, 2020.

This trend was consistent with the Company's strong credit quality as represented by nonperforming assets of $6.2 million, $1.7 million, and $2.7 million at December 31, 2020, 2019 and 2018, respectively. Net charge-offs were $7.2 million, $6.3 million, and $1.0 million, respectively, for the years ended December 31, 2020, 2019 and 2018.

The following table sets forth the allocation of the ACL by loan category as of the dates indicated. Our practice is to make specific allocations on impaired loans and general allocations to each loan category based on management's risk assessment and estimated loss rate.

Table 12. Allocation of Allowance for Credit Losses

December 31,

Commercial, financial and agricultural:

PPP $ 304 8.4 % $ — — % $ — — % $ — — % $ — — %

Real estate:

The ACL allocated to PPP loans totaled $0.3 million, or 0.1%, of total PPP loans at December 31, 2020.

The ACL allocated to commercial, financial and agricultural loans totaled $18.7 million, or 3.4%, of total commercial, financial and agricultural loans at December 31, 2020, compared to $8.1 million, or 1.4%, of related loans at December 31, 2019.

The ACL allocated to construction loans totaled $4.3 million, or 3.4%, of total construction loans at December 31, 2020, compared to $1.8 million, or 1.9%, of construction loans outstanding at December 31, 2019.

The ACL allocated to our residential mortgage loans totaled $16.5 million, or 1.0%, of total residential mortgage loans at December 31, 2020, compared to $13.3 million, or 0.8%, of related loans at December 31, 2019.

The ACL allocated to our home equity loans totaled $5.4 million, or 1.0%, of total home equity loans at December 31, 2020, compared to $4.2 million, or 0.9%, of related loans at December 31, 2019.

The ACL allocated to commercial mortgage loans totaled $22.2 million, or 1.9%, of total commercial mortgage loans at December 31, 2020, compared to $11.1 million, or 1.0%, of related loans at December 31, 2019.

The ACL allocated to consumer loans totaled $15.9 million, or 3.3% of total consumer loans at December 31, 2020, compared to $9.4 million, or 1.7% of related loans at December 31, 2019.

The increases in the ending ACL amount and the ACL as a percentage loans across all loan categories is primarily due to the adoption of ASU 2016-13 and the economic forecast under the COVID-19 pandemic. In addition, the increases in the ACL amounts of the PPP, construction, residential mortgage, home equity, and commercial mortgage portfolios are consistent with the increases in the respective loan portfolios.

In accordance with GAAP, loans held for sale and other real estate assets are not included in our assessment of the ACL.

Nonperforming Assets, Accruing Loans Delinquent for 90 Days or More, Restructured Loans Still Accruing Interest

The following table sets forth nonperforming assets ("NPAs"), accruing loans delinquent for 90 days or more and restructured loans still accruing interest at the dates indicated.

Table 13. Nonperforming Assets, Past Due and Restructured Loans

December 31,

Nonaccrual loans [1]

Commercial, financial and agricultural - Other $ 1,461 $ 467 $ — $ — $ 1,877

Real estate:

Commercial mortgage — — — 79 864

Other real estate owned ("OREO")

Real estate:

Home equity — 164 — — —

Accruing loans delinquent for 90 days or more [1]

Real estate:

Restructured loans still accruing interest [1]

Commercial, financial and agricultural - Other 100 135 220 491 —

Real estate:

Construction — — — — 21

Consumer 207 — — — —

Ratios:

Nonaccrual loans as a percentage of loans 0.12 % 0.03 % 0.06 % 0.07 % 0.24 %

December 31,

Year-to-date changes in NPAs:

Reductions:

Charge-offs, valuation and other adjustments (660) (95) (437) 93 166

Nonperforming assets, which includes nonaccrual loans, nonperforming loans classified as held for sale, if any, deferrals, and other real estate, totaled $6.2 million, or 0.09% of total assets at December 31, 2020, compared to $1.7 million, or 0.03% of total assets at December 31, 2019. Nonperforming assets at December 31, 2020 were comprised entirely of nonaccrual loans totaling $6.2 million, none of which were loans classified as held for sale.

The increase in 2020 was attributable to $14.3 million in gross additions, offset by $4.0 million in repayments, the sale of $4.4 million of NPAs, $0.7 million in loans returned to accrual status and $0.7 million in charge-offs, valuation and other adjustments.

Net changes to nonperforming assets by category during 2020 included net increases in Hawaii residential mortgage assets totaling $3.1 million, Hawaii commercial, financial and agricultural assets of $1.0 million and Hawaii home equity assets of $0.3 million.

Loans delinquent for 90 days or more still accruing interest totaled $0.8 million at December 31, 2020, compared to $1.0 million at December 31, 2019.

Troubled debt restructurings ("TDRs") included in nonperforming assets at December 31, 2020 consisted of two Hawaii residential mortgage loans with a combined principal balance of $0.3 million. There were $7.8 million of TDRs still accruing interest at December 31, 2020, of which $0.7 million was more than 90 days delinquent. At December 31, 2019, there were $7.5 million of TDRs still accruing interest, none of which were more than 90 days delinquent.

Loan payment forbearance or deferrals were made for borrowers impacted by the COVID-19 pandemic with loan balances totaling 120.2 million, or 2.4% of total loans (or 2.6% of total loans, excluding PPP loans), as of December 31, 2020, compared to a peak of approximately $605 million in May 2020.

The Company's ratio of classified assets and other real estate owned to tier 1 capital and the ACL increased from 6.75% at December 31, 2019 to 7.49% at December 31, 2020.

Investment Portfolio

The following table sets forth the amounts and distribution of investment securities held as of the dates indicated.

Table 14. Distribution of Investment Securities

December 31,

Debt securities:

Mortgage-backed securities:

Investment securities totaled $1.18 billion at December 31, 2020, increasing by $55.9 million, or 5.0%, from the $1.13 billion held at December 31, 2019, which decreased by $226.7 million, or 16.7%, from the $1.35 billion at year-end 2018.

In the fourth quarter of 2020, $89.9 million in available-for-sale securities were sold as part of an investment portfolio rebalancing strategy due to the large downward shift in interest rates and the change in expected prepayments. We received $90.1 million in gross proceeds and reinvested the proceeds in $105.1 million in higher yield, longer duration investment securities with an average yield of 1.27% and a weighted average life of 4.6 years. The investment securities sold had an average yield of 0.28% and a weighted average life of 1.2 years. Gross realized gains and losses on the sale of the investment securities were $0.5 million and $0.3 million, respectively. The specific identification method was used as the basis for determining the cost of all securities sold.

In the third quarter of 2020, $90.4 million in available-for-sale non-agency commercial mortgage-backed securities with retail mall exposure were sold to mitigate credit risk during the pandemic. The investment securities sold had an average yield of 3.44% and a weighted average life of 14.03 years. Gross realized losses and gains on the sale of the investment securities were $0.6 million and $0.2 million, respectively. The specific identification method was used as the basis for determining the cost of all securities sold.

In the third quarter of 2019, $53.9 million in lower-yielding available-for-sale securities were sold as part of an investment portfolio repositioning strategy designed to enhance potential prospective earnings and improve net interest margin. We received $53.9 million in gross proceeds and reinvested the proceeds in $52.5 million in higher-yielding, longer duration investment securities with an average yield of 2.54% and a weighted average life of 6.6 years. The investment securities sold had an average yield of 2.10% and a weighted average life of 3.2 years. Gross realized gains and losses on the sale of the investment securities were $83 thousand and $47 thousand, respectively. The specific identification method was used as the basis for determining the cost of all securities sold.

Maturity Distribution of Investment Portfolio

The following table sets forth the maturity distribution of the investment portfolio and weighted average yields by investment type and maturity grouping at December 31, 2020.

Table 15. Maturity Distribution of Investment Portfolio

Portfolio Type and Maturity Grouping CarryingValue WeightedAverageYield (1)

(Dollars in thousands)

Available-for-sale portfolio:

Debt securities - States and political subdivisions:

After one but within five years 27,063 3.09

After five but within ten years 38,421 3.36

Total debt securities - States and political subdivisions 168,766 2.71

Debt securities - Corporate:

After one but within five years 5,285 3.15

After five but within ten years 37,597 1.64

After ten years — —

Total debt securities - Corporate 48,008 1.86

Within one year — —

After one but within five years 1,618 1.69

After five but within ten years 19,844 1.29

Residential mortgage-backed securities - U.S. GSEs:

After one but within five years — —

After five but within ten years 59,245 1.86

Total residential mortgage-backed securities - U.S. GSEs 778,826 1.91

Within one year — —

After one but within five years — —

After five but within ten years — —

Total residential mortgage-backed securities - Non-GSEs 23,423 3.81

Commercial mortgage-backed securities - U.S. GSEs and agencies:

Within one year — —

After one but within five years — —

After five but within ten years 39,921 2.88

Total commercial mortgage-backed securities - U.S. GSEs and agencies 87,469 1.91

Commercial mortgage-backed securities - Non-GSEs:

Within one year — —

After one but within five years — —

After five but within ten years 42,972 3.04

After ten years — —

Total commercial mortgage-backed securities - Non-GSEs 42,972 3.04

Portfolio Type and Maturity Grouping CarryingValue WeightedAverageYield (1)

(Dollars in thousands)

Total available-for-sale portfolio $ 1,182,609 2.09 %

Equity securities:

No stated maturity $ 1,351 — %

Total equity securities $ 1,351 — %

(1)Weighted average yields are computed on an annual basis, and yields on tax-exempt obligations are computed on a taxable-equivalent basis using a federal statutory tax rate of 21%.

As of December 31, 2020, the weighted average yield of the investment portfolio of 2.09% decreased by 62 bp from 2.71% in the prior year.

Deposits

The primary source of our funding comes from deposits in the state of Hawaii. In this competitive market, we strive to distinguish ourselves by providing exceptional customer service in our branch offices and through digital channels, and establishing long-term relationships with businesses and their principals. Our focus has been to develop a large, stable base of core deposits, which are comprised of non-interest bearing and interest-bearing demand deposits, savings and money market deposits, and time deposits less than $100,000. Time deposits in amounts of $100,000 and greater are generally considered to be more price-sensitive than relationship-based and are thus given less focus in our marketing and sales efforts.

The following table sets forth the composition of our deposits by category as of the dates indicated.

Table 16. Deposits by Categories

December 31,

Total deposits of $5.80 billion at December 31, 2020 increased by $676.1 million, or 13.2%, from total deposits of $5.12 billion at December 31, 2019. Total deposits at December 31, 2019 increased by $173.5 million, or 3.5%, over the year-end 2018 balance of $4.95 billion. The increase in deposits in 2020 reflects net increases in noninterest-bearing demand deposits of $339.7 million, savings and money market deposits of $332.0 million and interest-bearing demand deposits of $131.9 million. The net increases were partially offset by decreases in other time deposits greater than $100,000 (excluding government time deposits) totaling $78.1 million, government time deposits of $32.7 million and time deposits less than $100,000 of $16.7 million. The deposit of funds from PPP and other stimulus programs into new and existing deposit accounts, combined with an increase in rate of personal savings largely contributed to the increase in deposits in 2020. In addition, off-balance sheet investment funds from several large clients were brought back into deposit accounts. The addition of funds from PPP and other stimulus programs may be temporary as PPP funds are spent by the businesses in accordance with the program. Going forward, the Company is focused on expanding banking relationships with the new businesses we assisted with PPP.

Core deposits totaled $5.05 billion at December 31, 2020 and increased by $786.9 million, or 18.5%, from December 31, 2019, which increased by $243.4 million or 6.1% from December 31, 2018. Core deposits as a percentage of total deposits was 87.1% at December 31, 2020, compared to 83.2% at December 31, 2019 and 81.2% at December 31, 2018. For additional information regarding the contractual maturities of our time deposits, See Note 10 - Deposits to the Consolidated Financial Statements under "Part II, Item 8. Financial Statements and Supplementary Data."

The table below sets forth information regarding the average balances and average rates paid for certain deposit categories for each of the years indicated. Average balances are computed using daily average balances. The average rate on time deposits, which are most sensitive to changes in market rates, decreased by 91 bp in 2020, while savings and money market deposit rates decreased by 20 bp. The average rate paid on all deposits decreased 29 bp to 0.19% in 2020 from 0.48% in 2019, which increased from 0.39% in 2018.

Table 17. Average Balances and Average Rates on Deposits

Year Ended December 31,

We expect overall deposit rates to hold relatively steady in 2021 based on the Federal Open Market Committee's recent statements. In addition to the external interest rate environment, the overall direction and magnitude of rate movements in our deposit base will largely depend on the level of deposit growth we need to maintain adequate liquidity and competitive pricing considerations.

Contractual Obligations

The following table sets forth contractual obligations (excluding deposit liabilities) as of December 31, 2020.

Table 18. Contractual Obligations

Payments Due By Period

Short-term borrowings $ 22,000 $ — $ — $ — $ 22,000

Components of short-term borrowings and long-term debt are discussed in Note 11 - Short-Term Borrowings and Note 12 - Long-Term Debt, respectively, to the Consolidated Financial Statements under "Part II, Item 8. Financial Statements and Supplementary Data." Pension plan obligations include obligations under our defined benefit retirement plan and Supplemental Executive Retirement Plans, which are discussed in Note 17 - Pension Plans to the Consolidated Financial Statements under "Part II, Item 8. Financial Statements and Supplementary Data." Operating leases represent leases on bank premises as discussed in Note 19 - Operating Leases to the Consolidated Financial Statements under "Part II, Item 8. Financial Statements and Supplementary Data." Purchase obligations represent other contractual obligations to purchase goods or services at specified terms including, but not limited to, software licensing agreements, equipment maintenance contracts and professional service contracts. Other long-term liabilities represent expected payments for unfunded commitments related to our investments in LIHTC partnerships.

In January 2021, the Board of Directors approved termination of, and authorized Company management to commence taking actions to terminate, the Company's defined benefit retirement plan. Final settlement is expected to occur in 2022.

Contractual obligations in Table 18 - Contractual Obligations do not include off-balance sheet arrangements. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees written, forward foreign exchange contracts, forward interest rate contracts and interest rate swaps and options. These instruments and the related off-balance sheet exposures are discussed in detail in Note 24 - Financial Instruments With Off-Balance Sheet Risk to the Consolidated Financial Statements under "Part II, Item 8. Financial Statements and Supplementary Data."

Capital Resources

In order to ensure adequate levels of capital, we conduct an ongoing assessment of projected sources and uses of capital in conjunction with an analysis of the size and quality of our assets, the anticipated performance of our business (including the effects of the COVID-19 pandemic), and the level of risk and regulatory capital requirements. As part of this ongoing assessment, the Board of Directors reviews our capital position on an ongoing basis to ensure it is adequate, including, but not limited to, the need for raising additional capital (whether debt and/or equity) or returning capital to our shareholders, including the ability to declare cash dividends or repurchase our securities.

Common and Preferred Equity

Shareholders' equity totaled $546.7 million at December 31, 2020, an increase of $18.2 million, or 3.4%, from the $528.5 million at December 31, 2019, which increased by $36.8 million, or 7.5%, from December 31, 2018. When expressed as a percentage of total assets, shareholders' equity was 8.3% at December 31, 2020, compared to 8.8% at December 31, 2019 and 8.5% at December 31, 2018.

The increase in shareholders' equity from December 31, 2019 to December 31, 2020 was primarily attributable to net income of $37.3 million and accumulated other comprehensive income of $11.7 million, partially offset by cash dividends paid of $25.9

million and the repurchase of 206,802 shares of our common stock for a total cost of $4.7 million, under our stock repurchase program. During 2020 we repurchased approximately 0.7% of our common stock outstanding at December 31, 2019.

The increase in shareholders' equity from December 31, 2018 to December 31, 2019 was primarily attributable to: net income of $58.3 million and accumulated other comprehensive income of $27.6 million, partially offset by the repurchase of 797,003 shares of our common stock for a total cost of $22.8 million, under our stock repurchase program and cash dividends paid of $25.7 million. During 2019 we repurchased approximately 2.8% of our common stock outstanding at December 31, 2018.

Our tangible common equity ratio was 8.29% at December 31, 2020, compared to 8.79% at December 31, 2019 and 8.47% at December 31, 2018. Our book value per share was $19.40, $18.68, and $16.97 at year-end 2020, 2019 and 2018, respectively. The decrease in our tangible common equity ratio in 2020 from 2019 was primarily attributable to the significant increase in total assets, primarily attributable to the loans originated under the PPP program. The increase in our book value per share from 2019 was primarily attributable to net income and other comprehensive income recorded in 2020 of $37.3 million and $11.7 million, respectively, combined with the suspension of the share repurchase program in 2020.

The tangible common equity ratio is a non-GAAP financial measure which should be read and used in conjunction with the Company's GAAP financial information. Comparison of our tangible common equity ratio with those of other companies may not be possible because other companies may calculate the tangible common equity ratio differently. Our tangible common equity ratio is derived by dividing common shareholders' equity, less intangible assets (excluding mortgage servicing rights), by total assets, less intangible assets (excluding mortgage servicing rights). As of December 31, 2020, 2019 and 2018, the Company did not own any intangible assets.

The following table sets forth a reconciliation of our tangible common equity ratio for each of the dates indicated:

Table 19. Reconciliation to Tangible Common Equity Ratio

December 31,

Less:

Preferred stock — — —

Other intangible assets (core deposit premium) — — —

Less: Other intangible assets (core deposit premium) — — —

Tangible common equity to tangible assets 8.29 % 8.79 % 8.47 %

Trust Preferred Securities

As of December 31, 2019, we have two remaining statutory trusts, CPB Capital Trust IV ("Trust IV") and CPB Statutory Trust V ("Trust V"), which issued a total of $50.0 million in floating rate trust preferred securities. Our obligations with respect to the issuance of the trust preferred securities constitute a full and unconditional guarantee by the Company of the trusts' obligations with respect to its trust preferred securities. Subject to certain exceptions and limitations, we may elect from time to time to defer subordinated debenture interest payments, which would result in a deferral of dividend payments on the related trust preferred securities, for up to 20 consecutive quarterly periods without default or penalty.

The Company determined that its investments in Trust IV and Trust V did not represent a variable interest and therefore the Company was not the primary beneficiary of each of the trusts. As a result, consolidation of the trusts by the Company were not required.

On December 17, 2018, the Company completed the redemption of $20.0 million in floating rate trust preferred securities of Trust III bearing an interest rate of three-month LIBOR plus 2.85% and maturing on December 17, 2033. The redemption price

was 100% of the aggregate liquidation amount of the securities plus accumulated but unpaid distributions up to but not including the redemption date. The Company also redeemed $0.6 million of common securities issued by Trust III and held by the Company, as a result of the concurrent redemption of 100% of the principal assets of Trust III, or $20.6 million of the Company's junior subordinated debentures with an identical interest rate and maturity as the Trust III trust preferred securities. The redemption was pursuant to the optional prepayment provisions of the indenture. On January 9, 2019, Trust III was canceled with the state of Connecticut.

On January 7, 2019, the Company completed the redemption of $20.0 million in floating rate trust preferred securities of Trust II bearing an interest rate of three-month LIBOR plus 2.85% and maturing on October 7, 2033. The redemption price was 100% of the aggregate liquidation amount of the securities plus accumulated but unpaid distributions up to but not including the redemption date. The Company also redeemed $0.6 million of common securities issued by Trust II and held by the Company, as a result of the concurrent redemption of 100% of the principal assets of Trust II, or $20.6 million of the Company's junior subordinated debentures with an identical interest rate and maturity as the Trust II trust preferred securities. The redemption was pursuant to the optional prepayment provisions of the indenture. On January 22, 2019, Trust II was canceled with the state of Delaware.

We also previously had CPB Capital Trust I ("Trust I"), which was canceled in August 2014.

Subordinated Notes

On October 20, 2020, the Company completed a $55 million private placement of ten-year fixed-to-floating rate subordinated notes, which will be used to support regulatory capital ratios and for general corporate purposes. The Company exchanged the privately placed notes for registered notes with the same terms and in the same aggregate principal amount at the end of the fourth quarter of 2020. The notes bear a fixed interest rate of 4.75% for the first five years and will reset quarterly thereafter for the remaining five years to the then current three-month Secured Overnight Financing Rate, as published by the Federal Reserve Bank of New York, plus 456 basis points. The subordinated notes totaled $53.8 million as of December 31, 2020, and includes $1.2 million in debt issuance costs, which are being amortized over the expected life.

Holding Company Capital Resources

CPF is required to act as a source of strength to the bank under the Dodd-Frank Act. CPF is obligated to pay its expenses and payments on its junior subordinated debentures which fund payments on the outstanding trust preferred securities and subordinated notes.

CPF relies on the bank to pay dividends to it to fund its obligations. As of December 31, 2020, on a stand-alone basis, CPF had an available cash balance of approximately $11.2 million in order to meet its ongoing obligations.

As a Hawaii state-chartered bank, the bank may only pay dividends to the extent it has retained earnings as defined under Hawaii banking law ("Statutory Retained Earnings"), which differs from GAAP retained earnings. As of December 31, 2020, the bank had Statutory Retained Earnings of $82.5 million.

Dividends are payable at the discretion of the Board of Directors and there can be no assurance that the Board of Directors will continue to pay dividends at the same rate, or at all, in the future. Our ability to pay cash dividends to our shareholders is subject to restrictions under federal and Hawaii law, including restrictions imposed by the FRB and covenants set forth in various agreements we are a party to, including covenants set forth in our subordinated debentures. For further information, see the "Dividends — Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities" section.

Share Repurchases

We repurchase shares of our common stock when we believe such repurchases are in the best interests of the Company and our shareholders.

In June 2019, the Company’s Board of Directors authorized the repurchase of up to $30 million of its common stock from time to time in the open market or in privately negotiated transactions, pursuant to a newly authorized share repurchase program (the "2019 Repurchase Plan"). The 2019 Repurchase Plan replaced and superseded in its entirety the share repurchase program previously approved by the Company's Board of Directors, which had $6.8 million in remaining repurchase authority.

In 2019, 797,003 shares of common stock, at a cost of $22.8 million, were repurchased under the previous share repurchase plan and the 2019 Repurchase Plan combined.

In January 2020, the Company’s Board of Directors authorized the repurchase of up to $30 million of its common stock from time to time in the open market or in privately negotiated transactions, pursuant to a newly authorized share repurchase program (the "2020 Repurchase Plan"). The 2020 Repurchase Plan replaced and superseded in its entirety the 2019 Repurchase Plan, which had $19.8 million in remaining repurchase authority.

In March 2020, the Company temporarily suspended the 2020 Repurchase Plan due to uncertainty during the current COVID-19 pandemic.

In 2020, 206,802 shares of common stock, at a cost of $4.7 million, were repurchased under the 2019 Repurchase Plan. A total of $26.6 million remained available for repurchase under the 2020 Repurchase Plan at December 31, 2020.

In January 2021, the Company’s Board of Directors approved a new authorization to resume repurchases of up to $25 million of its common stock from time to time in the open market or in privately negotiated transactions, pursuant to a newly authorized share repurchase program. The new repurchase plan replaces and supersedes in its entirety the 2020 Repurchase Plan. Our ability to repurchase shares is subject to the discretion of our Board of Directors and approval of our regulators, and there can be no assurance that the Board will repurchase shares of our common stock in the future.

Cybersecurity

In recent years, cybersecurity has gained prominence within the financial services industry due to increases in the quantity and sophistication of cyber-attacks, which include significant distributed denial-of-service and credential validation attacks, malicious code and viruses and attempts to breach the security of systems, which, in certain instances, have resulted in unauthorized access to customer account data.

The bank has a number of complex information systems used for a variety of functions by customers, employees and vendors. In addition, third parties with which the bank does business or that facilitate business activities (e.g., vendors, exchanges, clearing houses, central depositories and financial intermediaries) could also be sources of cybersecurity risk to the bank, including with respect to breakdowns or failures of their systems, misconduct by the employees of such parties, or cyber-attacks which could affect their ability to deliver a product or service to the bank.

As a regulated financial institution, we must adhere to the security requirements and expectations of the applicable regulatory agencies, which include requirements related to data privacy, systems availability and business continuity planning, among others. The regulatory agencies have established guidelines for the responsibilities of the Board of Directors and senior management, which include establishing policy, appointing and training personnel, implementing review and testing functions and ensuring an appropriate frequency of updates.

The Board of Directors overall, and its Board Compliance Committee more specifically, oversees cybersecurity risk. The Executive Committee overall, and our Chief Legal Officer, our Chief Technology Officer and our Chief Information Officer more specifically, manages the cybersecurity risk at the operational level. Various reports on cybersecurity are provided to our Executive Committee and a quarterly update is provided to the Board Compliance Committee and the Board of Directors.

As a complement to the overall cybersecurity infrastructure, the bank utilizes a number of internal training methods, both formally through mandatory courses and informally through written communications and other updates. Internal policies and procedures have been implemented to require the reporting of potential phishing attacks or other security risks. The bank also uses third party services as part of its cybersecurity framework, and any such third parties are required to comply with the bank’s policies regarding information security and confidentiality. In addition, the bank retains third party groups to assess and supplement the bank’s cybersecurity needs. These cyber-attacks have not, to date, resulted in any material disruption to the bank’s operations or harm to its customers and have not had a material adverse effect on the bank’s results of operations; however, there can be no assurance that a sophisticated cyber-attack can be detected or thwarted.

Transaction Risk

Transaction risk is the risk to earnings or capital arising from problems in service, activity or product delivery. This risk is significant within any bank and is interconnected with other risk categories in most activities throughout the Company. Transaction risk is a function of internal controls, information systems, associate integrity, and operating processes. It arises daily throughout the Company as transactions are processed. It pervades all divisions, departments and centers and is inherent

in all products and services we offer.

In general, transaction risk is defined as high, medium or low by the Company. The audit plan ensures that high risk areas are reviewed annually. We utilize internal auditors and independent audit firms to test key controls of operational processes and to audit information systems, compliance management programs, loan programs and trust services.

The key to managing transaction risk is in the design, documentation and implementation of well-defined procedures and controls. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, but not absolute, assurances of the effectiveness of these systems and controls, and that the objectives of these controls have been met.

Compliance Risk

Compliance risk is the risk to earnings or capital arising from violations of, or non-conformance with, laws, rules, regulations, prescribed practices, or ethical standards. Compliance risk also arises in situations where the laws or rules governing certain products or activities of the bank’s customers may be ambiguous or untested. Compliance risk exposes us to fines, civil money penalties, payment of damages, and the voiding of contracts. Compliance risk can also lead to a diminished reputation, reduced business value, limited business opportunities, lessened expansion potential, and lack of contract enforceability. The Company utilizes independent external firms to conduct compliance audits as a means of identifying weaknesses in the compliance program.

There is no single or primary source of compliance risk. It is inherent in every activity. Frequently, it blends into operational risk and transaction risk. A portion of this risk is sometimes referred to as legal risk. This is not limited solely to risk from failure to comply with consumer protection laws; it encompasses all laws, as well as prudent ethical standards and contractual obligations. It also includes the exposure to litigation from all aspects of banking, traditional and non-traditional.

Our risk management policies and codes of ethical conduct are cornerstones for controlling compliance risk. An integral part of controlling this risk is the proper training and development of employees. The Director of Compliance is responsible for developing and executing a comprehensive compliance training program. The Director of Compliance, in consultation with our internal and external legal counsel, seeks to provide our employees with adequate training commensurate to their job functions to ensure compliance with banking laws and regulations.

Our risk management policies and programs includes a risk-based audit program aimed at identifying internal control deficiencies and weaknesses. We have in-depth audits performed by an independent audit firm under the direction of the Director of Internal Audit and supplemented by independent external firms, and periodic monitoring performed by our risk management personnel. Annually, an Audit Plan for the Company is developed and presented for approval to the Audit Committee.

Our risk management team conducts periodic monitoring of our compliance efforts with a special focus on those areas that expose us to compliance risk. The purpose of the periodic monitoring is to verify whether our employees are adhering to established policies and procedures. Any material exceptions identified are brought forward to the appropriate department head, the Audit Committee and the Board Compliance Committee.

We recognize that customer complaints can often identify weaknesses in our compliance program which could expose us to risk. Therefore, we attempt to ensure that all complaints are given prompt attention. The Director of Compliance reviews formal complaints to determine if a significant compliance risk exists and communicates those findings to our Board Compliance Committee.

Strategic Risk

Strategic risk is the risk to earnings or capital arising from adverse decisions or improper implementation of strategic decisions. This risk is a function of the compatibility between an organization’s goals, the resources deployed against those goals and the quality of implementation.

Strategic risks are identified as part of the strategic planning process. Offsite strategic planning sessions, with members of the Board of Directors and Executive Committee, are held annually. The strategic review consists of an economic assessment, competitive analysis, industry outlook and legislative and regulatory review.

A primary measurement of strategic risk is peer group analysis. Key performance ratios are compared to peer groups consisting

of U.S. banks of comparable size and complexity and banks in the Hawaii market to identify any sign of weakness and potential opportunities.

Another measure is the comparison of the actual results of previous strategic initiatives against the expected results established prior to implementation of each strategy.

Asset/Liability Management and Interest Rate Risk

Our earnings and capital are sensitive to risk of interest rate fluctuations. Interest rate risk arises when rate-sensitive assets and rate-sensitive liabilities mature or reprice during different periods or in differing amounts. In the normal course of business, we are subjected to interest rate risk through the activities of making loans and taking deposits, as well as from our investment securities portfolio and other interest-bearing funding sources. Asset/liability management attempts to coordinate our rate-sensitive assets and rate-sensitive liabilities to meet our financial objectives.

Our Asset/Liability Management Policy seeks to maximize the risk-adjusted return to shareholders while maintaining consistently acceptable levels of liquidity, interest rate risk and capitalization. Our Asset/Liability Management Committee, or ALCO, monitors interest rate risk through the use of interest rate sensitivity gap, net interest income and market value of portfolio equity simulation and rate shock analyses. This process is designed to measure the impact of future changes in interest rates on net interest income and market value of portfolio equity. Adverse interest rate risk exposures are managed through the shortening or lengthening of the duration of assets and liabilities.

Interest rate risk can be analyzed by monitoring an institution's interest rate sensitivity gap and changes in the gap over time. An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets and the amount of interest-bearing liabilities maturing or repricing within a specified time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, the earnings of an institution with a positive gap theoretically may be positively affected due to its interest-earning assets repricing to a greater extent than its interest-bearing liabilities. An adverse impact would be expected for an institution with a negative gap.

The following table sets forth information regarding our interest rate sensitivity gap at December 31, 2020. The assumptions used in determining interest rate sensitivity of various asset and liability products had a significant impact on the resulting table. For purposes of this presentation, assets and liabilities are classified by the earliest repricing date or maturity. All interest-bearing demand and savings balances are included in the three-months-or-less category, even though repricing of these accounts is not contractually required and may not actually occur during that period. Since all interest rates and yields do not adjust at the same velocity or magnitude, and since volatility is subject to change, the interest rate sensitivity gap is only a general indicator of interest rate risk.

Table 20. Rate Sensitivity of Assets, Liabilities and Equity

Assets

Liabilities and Equity

Noninterest-bearing deposits $ 1,790,269 $ — $ — $ — $ — $ — $ 1,790,269

FHLB advances and other short-term borrowings 22,000 — — — — — 22,000

ALCO also utilizes a detailed and dynamic simulation model to measure and manage interest rate risk exposures. The monthly simulation process is designed to measure the impact of future changes in interest rates on net interest income and market value of portfolio equity and to allow ALCO to model alternative balance sheet strategies.

The following reflects our net interest income sensitivity analysis as of December 31, 2020, over a one-year horizon, assuming no balance sheet growth and given both a 100 bp upward and 100 bp downward parallel shift in interest rates.

Rate Change Estimated Net Interest Income Sensitivity

The table below presents information on financial instruments held that are sensitive to changes in interest rates. For purposes of this presentation, expected maturities of interest-sensitive assets and liabilities are contractual maturities. Interest-bearing demand and savings deposits, which have indeterminate maturities, are included in the earliest maturity category. The resulting table is based on numerous assumptions including prepayment rates on mortgage-related assets and forecasted market interest rates. This differs from the assumptions used in Table 10 - Maturity Distribution and Sensitivities of Loans to Changes in Interest Rates. See Note 25 - Fair Value of Financial Assets and Financial Liabilities to the Consolidated Financial Statements under "Part II, Item 8. Financial Statements and Supplementary Data" for a discussion of the calculation of fair values.

Maturities and fair values of interest-sensitive assets and liabilities may vary from expectation if actual experience differs from the assumptions used.

Table 21. Interest Rate Sensitivity

Expected Maturity Within

Interest-sensitive assets

Equity investment securities $ — $ — $ — $ — $ — $ 1,351 $ 1,351 $ 1,351

Interest-sensitive liabilities

The preceding sensitivity analysis does not represent our forecast and should not be relied upon as being indicative of expected operating results. These estimates are based upon numerous assumptions including: the magnitude and timing of interest rate

changes, prepayments on loans and investment securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment of asset and liability cash flows and others.

Liquidity

Our objective in managing liquidity is to maintain a balance between sources and uses of funds in order to economically meet the cash requirements of customers for loans and deposit withdrawals and participate in lending and investment opportunities as they arise. We monitor our liquidity position in relation to changes in loan and deposit balances on a daily basis to assure maximum utilization, maintenance of an adequate level of readily marketable assets and access to short-term funding sources. Our loan-to-deposit ratio at December 31, 2020 was 85.6% compared to 86.9% at December 31, 2019. Our liquidity may be negatively impacted by unforeseen demands on cash or if our deposit customers withdraw funds due to uncertainties surrounding our financial condition or prospects.

The consolidated statements of cash flows identify the three major categories of sources and uses of cash as operating, investing and financing activities. As presented in the consolidated statements of cash flows, cash provided by operating activities has provided a significant source of funds during the past three years. Cash provided by operating activities totaled $76.8 million in 2020, $72.2 million in 2019, and $103.5 million in 2018. The primary source of cash provided by operating activities continues to be our net operating income, exclusive of non-cash items such as the Provision and asset impairments.

Net cash used in investing activities amounted to $596.9 million, $129.0 million and $211.1 million in 2020, 2019 and 2018, respectively. Investment securities and lending activities generally comprise the largest components of investing activities, although the level of investment securities activities are impacted by the relationship of loan and deposit growth during the period. In 2020, 2019 and 2018, net loan originations accounted for $479.6 million, $237.5 million and $250.2 million, respectively, of cash used in investing activities. In addition, purchases of portfolio loans totaled $53.2 million, $140.1 million and $58.6 million in 2020, 2019 and 2018, respectively. Net purchases of investment securities totaled $49.7 million in 2020, compared to net proceeds received from sales and maturities of investment securities of $253.6 million and $111.2 million in 2019 and 2018, respectively. Net purchases of premises and equipment totaled $26.0 million, $7.2 million and $3.2 million in 2020, 2019 and 2018, respectively. Investing activities included proceeds from sales of loans originated for investment in 2020 totaled $10.7 million. We did not sell any loans originated for investment in 2019 and 2018. Proceeds from sales of foreclosed loans and other real estate of $0.2 million, $0.1 million, and $46 thousand in 2020, 2019 and 2018, respectively.

Cash provided by financing activities totaled $521.2 million, $57.6 million, and $127.6 million in 2020, 2019 and 2018, respectively. Deposit activities, borrowings and capital transactions represent the major components of financing activities. In 2020 and 2019, deposits increased by $676.1 million and $173.5 million, respectively, compared to a net decrease in deposits of $9.9 million in 2018. Net cash outflows of FHLB advances and short-term borrowings totaled $128.0 million in 2020 and $47.0 million in 2019, compared to net cash inflows from FHLB advances and short-term borrowings of $165.0 million in 2018. Repayments of long-term debt totaled $115.9 million, $20.6 million and $20.6 million in 2020, 2019 and 2018, respectively. Proceeds from long-term debt totaled $119.8 million and $50.0 million in 2020 and 2018, respectively. As with investment securities, the level of net borrowings is impacted by the levels of loan and deposit growth or contraction during the period. Capital transactions, primarily cash dividends and stock repurchases, totaled $30.7 million, $48.3 million and $57.0 million of cash used in 2020, 2019 and 2018, respectively.

Core deposits have historically provided us with a sizable source of relatively stable and low cost funds but are subject to competitive pressure in our market. In addition to core deposit funding, we also have access to a variety of other short-term and long-term funding sources, which include proceeds from maturities of our investment securities, as well as secondary funding sources such as the FHLB, secured repurchase agreements and the Federal Reserve discount window, available to meet our liquidity needs. While we historically have had access to these other funding sources, continued access to these sources may not be guaranteed and can be restricted in the future as a result of market conditions or the Company's and bank's financial position.

The bank is a member of and maintained a $1.81 billion line of credit with the FHLB as of December 31, 2020, of which $1.52 billion remained available as of December 31, 2020. Short-term advances under this arrangement totaled $22.0 million and $150.0 million at December 31, 2020 and 2019, respectively. There were no long-term advances with the FHLB outstanding at December 31, 2020 as $25 million in long-term advances matured and $25 million in long-term advances were prepaid during 2020. Long-term advances with the FHLB as of December 31, 2019 totaled $50.0 million. FHLB advances outstanding at December 31, 2019 were secured by certain real estate loans with a carrying value of $2.48 billion in accordance with the collateral provisions of the Advances Pledge and Security Agreement with the FHLB.

The FHLB provides standby letters of credit on behalf of the bank to secure certain public deposits. If the FHLB is required to make a payment on a standby letter of credit, the payment amount is converted to an advance at the FHLB. The standby letters

of credit issued on our behalf by the FHLB totaled $268.0 million and $78.9 million at December 31, 2020 and 2019, respectively.

The bank also maintained a line of credit with the Federal Reserve discount window of $64.5 million and $65.3 million as of December 31, 2020 and 2019, respectively. There were no advances outstanding under this arrangement at December 31, 2020 and 2019. Advances under this arrangement would have been secured by certain commercial and commercial real estate loans with a carrying value totaling $136.9 million. The Federal Reserve does not have the right to sell or repledge these loans. See Note 11 - Short-Term Borrowings and Note 12 - Long-Term Debt to the Consolidated Financial Statements under "Part II, Item 8. Financial Statements and Supplementary Data" for additional information regarding our borrowings.

Our ability to maintain adequate levels of liquidity is dependent on our ability to continue to maintain our strong risk profile and capital base. Our liquidity may also be negatively impacted by weakness in the financial markets and industry-wide reductions in liquidity.

Holding Company Liquidity

For the holding company on a stand-alone basis, in 2020, net cash provided by operating activities amounted to $24.1 million. The primary source of funds in operating activities included dividends received from the bank of $24.0 million. Net cash provided by financing activities amounted to $23.2 million. During the fourth quarter of 2020, the Company completed a $55 million private placement of ten-year fixed-to-floating rate subordinated notes, which was partially offset by $1.2 million in debt issuance costs, cash dividends of $25.9 million paid to our common shareholders and repurchases of common stock totaling $4.7 million. Cash used in investing activities included a $46.8 million contribution to the bank from the proceeds received from the private placement.

In 2019, net cash provided by operating activities amounted to $62.2 million. The primary source of funds in operating activities included dividends received from the bank of $63.0 million. Net cash used in financing activities amounted to $69.0 million. The primary use of funds in financing activities included the repurchases of common stock totaling $22.8 million and cash dividends of $25.7 million paid to our common shareholders. In addition, junior subordinated debentures issued by Trust II totaling $20.6 million were repaid in 2019.

In 2018, net cash provided by operating activities amounted to $79.8 million. The primary source of funds in operating activities included dividends received from the bank of $82.0 million. Net cash used in financing activities amounted to $77.6 million. The primary use of funds in financing activities included the repurchases of common stock totaling $32.8 million and cash dividends of $24.1 million paid to our common shareholders. In addition, junior subordinated debentures issued by Trust III totaling $20.6 million were repaid in 2018.

Off-Balance Sheet Arrangements

In the normal course of business, we enter into off-balance sheet arrangements to meet the financing needs of our banking customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees written, forward foreign exchange contracts, forward interest rate contracts, interest rate swaps and options, and risk participation agreements. These instruments and the related off-balance sheet exposures are discussed in detail in Note 24 - Financial Instruments With Off-Balance Sheet Risk to the Consolidated Financial Statements under "Part II, Item 8. Financial Statements and Supplementary Data." In the unlikely event that we must satisfy a significant amount of outstanding commitments to extend credit, liquidity will be adversely impacted, as will credit risk. The remaining components of off-balance sheet arrangements, primarily interest rate options and forward interest rate contracts related to our mortgage banking activities, are not expected to have a material impact on our consolidated financial position or results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Quantitative and qualitative disclosures about market risk is set forth under "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Asset/Liability Management and Interest Rate Risk" and in Note 25 - Fair Value of Financial Assets and Financial Liabilities to the Consolidated Financial Statements under "Part II, Item 8. Financial Statements and Supplementary Data."

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Shareholders and the Board of Directors of

Central Pacific Financial Corp.

Honolulu, Hawaii

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Central Pacific Financial Corp. and subsidiaries (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.

Change in Accounting Principle

As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for credit losses effective January 1, 2020 due to the adoption of Financial Accounting Standard Board (FASB) Accounting Standards Codification No. 326, Financial Instruments – Credit Losses (ASC 326). The Company adopted the new credit loss standard using the modified retrospective method provided in Accounting Standards Update No. 2016-13 such that prior period amounts are not adjusted and continue to be reported in accordance with previously applicable generally accepted accounting principles. The adoption of the new credit loss standard and its subsequent application is also communicated as a critical audit matter below.

Basis for Opinions

CPF US Equity

CPF · 10-K · period ended 2020-12-31

ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CPF US Equity☆

CPF · 10-K · period ended 2020-12-31

ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CPF US Equity