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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period ended June 30, 2011

or

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For transition period from             to            

Commission File Number 1-34403

 

 

TERRITORIAL BANCORP INC.

(Exact Name of Registrant as Specified in Charter)

 

 

 

Maryland		26-4674701
(State or Other Jurisdiction of Incorporation)		(I.R.S. Employer Identification No.)

 

1132 Bishop Street, Suite 2200, Honolulu, Hawaii		96813
(Address of Principal Executive Offices)		(Zip Code)

(808) 946-1400

Registrant’s telephone number, including area code

Not Applicable

(Former name or former address, if changed since last report)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  x    No  ¨.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  x     No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨		Smaller reporting company		¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  x.

Indicate the number of shares outstanding of each of the Issuer’s classes of common stock as of the latest practicable date.

11,579,493 shares of Common Stock, par value $0.01 per share, were issued and outstanding as of July 31, 2011.

 

 

 

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TERRITORIAL BANCORP INC.

Form 10-Q Quarterly Report

Table of Contents

 

PART I
ITEM 1.		FINANCIAL STATEMENTS			1
ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			23
ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			37
ITEM 4.		CONTROLS AND PROCEDURES			39
PART II
ITEM 1.		LEGAL PROCEEDINGS			40
ITEM 1A.		RISK FACTORS			40
ITEM 2.		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			40
ITEM 3.		DEFAULTS UPON SENIOR SECURITIES			40
ITEM 4.		[RESERVED]			40
ITEM 5.		OTHER INFORMATION			40
ITEM 6.		EXHIBITS			40
SIGNATURES					41

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PART I

 

ITEM 1.

FINANCIAL STATEMENTS

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Balance Sheets (Unaudited)

(Dollars in thousands, except share data)

 

		June 30, 2011				December 31, 2010
ASSETS
Cash and cash equivalents		$	124,250			$	194,435
Investment securities available for sale			0				15,010
Investment securities held to maturity, at amortized cost (fair value of $662,186 and $546,844 at June 30, 2011 and December 31, 2010, respectively)			642,112				530,555
Federal Home Loan Bank stock, at cost			12,348				12,348
Loans held for sale			1,764				3,234
Loans receivable, net			661,408				641,790
Accrued interest receivable			4,942				4,536
Premises and equipment, net			5,497				5,426
Real estate owned			162				0
Bank-owned life insurance			29,747				29,266
Deferred income taxes receivable			1,090				22
Prepaid expenses and other assets			4,889				6,790
Total assets		$	1,488,209			$	1,443,412
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits		$	1,107,021			$	1,076,470
Advances from the Federal Home Loan Bank			20,000				10,000
Securities sold under agreements to repurchase			115,200				105,200
Accounts payable and accrued expenses			19,005				20,430
Current income taxes payable			1,416				577
Advance payments by borrowers for taxes and insurance			3,043				3,376
Total liabilities			1,265,685				1,216,053
Commitments and contingencies
Stockholders’ Equity
Preferred stock, $.01 par value; authorized 50,000,000 shares, no shares issued or outstanding			0				0
Common stock, $.01 par value; authorized 100,000,000 shares; issued and outstanding 11,592,590 and 12,177,418 shares at June 30, 2011 and December 31, 2010, respectively			116				122
Additional paid-in capital			109,294				119,153
Unearned ESOP shares			(8,563	)			(8,808	)
Retained earnings			123,995				119,397
Accumulated other comprehensive loss			(2,318	)			(2,505	)
Total stockholders’ equity			222,524				227,359
Total liabilities and stockholders’ equity		$	1,488,209			$	1,443,412

See accompanying notes to consolidated financial statements.

 

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

(Dollars in thousands, except per share data)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Interest and dividend income:
Investment securities		$	6,889			$	6,641			$	13,260			$	13,448
Loans			8,763				8,582				17,646				17,111
Other investments			81				99				173				175
Total interest and dividend income			15,733				15,322				31,079				30,734
Interest expense:
Deposits			1,701				2,970				3,409				5,929
Advances from the Federal Home Loan Bank			104				45				190				45
Securities sold under agreements to repurchase			1,052				1,057				2,086				2,141
Total interest expense			2,857				4,072				5,685				8,115
Net interest income			12,876				11,250				25,394				22,619
Provision for loan losses			14				158				122				158
Net interest income after provision for loan losses			12,862				11,092				25,272				22,461
Non-interest income:
Total other-than-temporary impairment losses			0				0				0				(3,510	)
Portion of loss recognized in other comprehensive income (before taxes)			0				0				0				1,106
Net other-than-temporary impairment losses			0				0				0				(2,404	)
Service fees on loan and deposit accounts			598				665				1,156				1,288
Income on bank-owned life insurance			241				254				480				509
Gain on sale of investment securities			0				282				66				350
Gain on sale of loans			92				175				236				255
Other			292				102				411				148
Total non-interest income			1,223				1,478				2,349				146
Non-interest expense:
Salaries and employee benefits			5,487				4,347				10,613				9,007
Occupancy			1,226				1,143				2,447				2,282
Equipment			808				734				1,574				1,450
Federal deposit insurance premiums			191				298				487				590
Other general and administrative expenses			933				909				1,933				1,891
Total non-interest expense			8,645				7,431				17,054				15,220
Income before income taxes			5,440				5,139				10,567				7,387
Income taxes			2,055				1,904				4,182				2,691
Net income		$	3,385			$	3,235			$	6,385			$	4,696
Basic earnings per share		$	0.31			$	0.29			$	0.57			$	0.41
Diluted earnings per share		$	0.30			$	0.29			$	0.57			$	0.41
Cash dividends declared per common share		$	0.09			$	0.05			$	0.16			$	0.10
Basic weighted average shares outstanding			10,992,653				11,321,814				11,126,781				11,315,738
Diluted weighted average shares outstanding			11,120,248				11,321,814				11,239,913				11,315,738

See accompanying notes to consolidated financial statements.

 

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

and Comprehensive Income (Unaudited)

(Dollars in thousands)

 

		Common Stock				Additional Paid-in Capital				Unearned ESOP Shares				Retained Earnings				Accumulated Other Comprehensive (Loss)/Income				Total Stockholders’ Equity
Balances at December 31, 2009		$	122				118,823				(9,297	)			111,082				(1,059	)			219,671
Comprehensive income:
Net income			0				0				0				4,696				0				4,696
Other comprehensive loss, net of tax:
Investment securities:
Noncredit related losses on securities not expected to be sold, net of taxes of $427			0				0				0				0				(679	)			(679	)
Total comprehensive income			0				0				0				0				0				4,017
Cash dividends declared			0				0				0				(1,131	)			0				(1,131	)
Allocation of 24,466 ESOP shares			0				225				244				0				0				469
Balances at June 30, 2010		$	122				119,048				(9,053	)			114,647				(1,738	)			223,026
Balances at December 31, 2010		$	122				119,153				(8,808	)			119,397				(2,505	)			227,359
Comprehensive income:
Net income			0				0				0				6,385				0				6,385
Other comprehensive loss, net of tax:
Investment securities:
Unrealized gain on securities, net of taxes of $118			0				0				0				0				187				187
Total comprehensive income																							6,572
Cash dividends declared			0				0				0				(1,787	)			0				(1,787	)
Stock compensation expense			0				1,389				0				0				0				1,389
Allocation of 24,466 ESOP shares			0				239				245				0				0				484
Repurchase of 584,828 shares of company stock			(6	)			(11,487	)			0				0				0				(11,493	)
Balances at June 30, 2011		$	116			$	109,294				(8,563	)			123,995				(2,318	)			222,524

See accompanying notes to consolidated financial statements.

 

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)

 

		Six Months Ended June 30,
		2011				2010
Cash flows from operating activities:
Net income		$	6,385			$	4,696
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			122				158
Depreciation and amortization			557				444
Deferred income tax benefit			(1,186	)			(1,119	)
Amortization of fees, discounts, and premiums			(22	)			90
Origination of loans held for sale			(27,541	)			(18,872	)
Proceeds from sales of loans held for sale			26,013				18,689
Gain on sale of loans, net			(236	)			(255	)
Net gain on sale of real estate owned			0				(1	)
Other-than-temporary impairment loss on investment			0				2,404
Purchases of investment securities held for trading			(19,800	)			(18,143	)
Proceeds from sale of investment securities held for trading			19,866				18,244
Gain on sale of investment securities held for trading			(66	)			(101	)
Gain on sale of investment securities available for sale			0				(249	)
Net gain on sale of premises and equipment			(5	)			0
ESOP expense			484				469
Share-based compensation expense			1,389				0
(Increase) decrease in accrued interest receivable			(406	)			47
Net increase in bank-owned life insurance			(481	)			(509	)
Net decrease in prepaid expenses and other assets			1,901				325
Net increase (decrease) in accounts payable and accrued expenses			(1,425	)			432
Net increase in income taxes payable			839				705
Net cash provided by operating activities			6,388				7,454
Cash flows from investing activities:
Purchases of investment securities held to maturity			(165,833	)			(30,505	)
Purchases of investment securities available for sale			0				(49,206	)
Principal repayments on investment securities held to maturity			68,558				63,957
Principal repayments on investment securities available for sale			525				90
Proceeds from sale of investment securities available for sale			0				49,365
Loan originations, net of principal repayments on loans receivable			(16,138	)			(27,964	)
Proceeds from sale of real estate owned			0				160
Proceeds from disposals of premises and equipment			5				0
Purchases of premises and equipment			(628	)			(742	)
Net cash provided by (used in) investing activities			(113,511	)			5,155

 

(Continued)

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)

 

		Six Months Ended June 30,
		2011				2010
Cash flows from financing activities:
Net increase in deposits		$	30,551			$	69,231
Proceeds from advances from the Federal Home Loan Bank			10,000				10,000
Proceeds from securities sold under agreements to repurchase			42,000				1,136
Repayments of securities sold under agreements to repurchase			(32,000	)			(26,136	)
Purchases of Fed Funds			10				10
Sales of Fed Funds			(10	)			(10	)
Net increase (decrease) in advance payments by borrowers for taxes and insurance			(333	)			20
Repurchases of company stock			(11,493	)			0
Cash dividends paid			(1,787	)			(1,131	)
Net cash provided by financing activities			36,938				53,120
Net increase (decrease) in cash and cash equivalents			(70,185	)			65,729
Cash and cash equivalents at beginning of the period			194,435				135,953
Cash and cash equivalents at end of the period		$	124,250			$	201,682
Supplemental disclosure of cash flow information:
Cash paid for:
Interest on deposits and borrowings		$	5,684			$	8,249
Income taxes			4,529				3,105
Supplemental disclosure of noncash investing activities:
Loans transferred to real estate owned		$	162			$	0

See accompanying notes to consolidated financial statements.

 

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TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

 

(1)	Basis of Presentation

The accompanying unaudited consolidated financial statements of Territorial Bancorp Inc. have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These interim condensed consolidated financial statements and notes should be read in conjunction with Territorial Bancorp Inc.’s consolidated financial statements and notes thereto filed as part of the Annual Report on Form 10-K for the year ended December 31, 2010. In the opinion of management, all adjustments necessary for a fair presentation have been made and include all normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year.

 

(2)	Organization

On November 4, 2008, the Board of Directors of Territorial Mutual Holding Company approved a plan of conversion and reorganization under which Territorial Mutual Holding Company would convert from a mutual holding company to a stock holding company. The conversion to a stock holding company was approved by the depositors and borrowers of Territorial Savings Bank and the Office of Thrift Supervision (OTS) and included the filing of a registration statement with the U.S. Securities and Exchange Commission. Upon the completion of the conversion and reorganization on July 10, 2009, Territorial Mutual Holding Company and Territorial Savings Group, Inc. ceased to exist as separate legal entities and Territorial Bancorp Inc. became the holding company for Territorial Savings Bank. A total of 12,233,125 shares were issued in the conversion at $10 per share, raising $122.3 million of gross proceeds. Approximately $3.7 million of conversion expenses have been offset against the gross proceeds. Territorial Bancorp Inc.’s common stock began trading on the NASDAQ Global Select Market under the symbol “TBNK” on July 13, 2009.

Upon completion of the conversion and reorganization, a special “liquidation account” was established in an amount equal to the total equity of Territorial Mutual Holding Company as of December 31, 2008. The liquidation account is to provide eligible account holders and supplemental eligible account holders who maintain their deposit accounts with Territorial Savings Bank after the conversion with a liquidation interest in the unlikely event of the complete liquidation of Territorial Savings Bank after the conversion. The liquidation account will be reduced annually to the extent that eligible account holders and supplemental eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder’s or supplemental eligible account holder’s interest in the liquidation account. In the event of a complete liquidation of Territorial Savings Bank, and only in such event, each account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the adjusted qualifying account balances then held.

 

(3)	Recently Adopted Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) amended the Fair Value Measurements and Disclosures topic of the FASB Accounting Standards Codification (“ASC”). The amendment requires disclosures about the significant transfers in and out of Level 1 and Level 2 fair value measurements and the reasons for the transfers, and requires the reconciliation of activity in Level 3 fair value measurements be made on a gross basis. The amendment also clarifies the level of

 

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disaggregation required in disclosures and the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements for Level 2 or Level 3 items. The part of the amendment related to the reconciliation of Level 3 activity is effective for interim and annual periods beginning after December 15, 2010, and was adopted by the Company on January 1, 2011. The remaining parts of the amendment were effective for interim and annual periods beginning after December 15, 2009, and were adopted by the Company on January 1, 2010. The Fair Value of Financial Instruments footnote has been updated to include the revised disclosures.

In April 2011, the FASB amended the Receivables topic of the FASB ASC. The amendment helps creditors determine whether a troubled debt restructuring has occurred by clarifying whether a restructuring constitutes a concession and whether the debtor is experiencing financial difficulties. The amendment also requires disclosures related to troubled debt restructurings that were initially effective for periods ending after December 15, 2010, but deferred to make the effective date concurrent with this amendment. The amendment is effective for the first interim or annual period beginning on or after June 15, 2011. The Company does not expect the adoption of this amendment to have a material effect on its consolidated financial statements.

In April 2011, the FASB amended the Transfers and Servicing topic of the FASB ASC. The amendment modifies the criteria used to determine whether a repurchase agreement is accounted for as a sale or as a secured borrowing. The amendment is effective for interim or annual periods beginning on or after December 15, 2011. Early adoption is not permitted. The Company does not expect the adoption of this amendment to have any effect on its consolidated financial statements.

In May 2011, the FASB amended the Fair Value Measurement topic of the FASB ASC. The amendment results in common fair value measurement and disclosure requirements in U.S. generally accepted accounting principles and International Financial Reporting Standards. The amendment both clarifies the intent about existing fair value measurements as well as changes the principle or requirement for measuring fair value or disclosing fair value information. The amendment is effective for interim or annual periods beginning after December 15, 2011. Early application is not permitted. The Company does not expect the adoption of this amendment to have a material effect on its consolidated financial statements.

In June 2011, the FASB amended the Comprehensive Income topic of the FASB ASC. The amendment eliminates the option of presenting components of other comprehensive income as part of the statement of changes in stockholder’s equity. Nonowner changes in stockholder’s equity must be presented either in a continuous statement of comprehensive income or in two separate but consecutive statements. The amendment is effective for interim or annual periods beginning after December 15, 2011, with early adoption permitted. The adoption of this amendment will affect the location of disclosures related to other comprehensive income, but the Company does not expect any other material effect on its consolidated financial statements.

 

(4)	Cash and Cash Equivalents

The table below presents the balances of cash and cash equivalents:

 

(Dollars in thousands)		June 30, 2011				December 31, 2010
Cash and due from banks		$	8,392			$	8,827
Interest-earning deposits in other banks			115,858				185,608
Cash and cash equivalents		$	124,250			$	194,435

 

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(5)	Investment Securities

The amortized cost and fair values of investment securities are as follows:

 

		Amortized cost				Gross unrealized								Estimated fair value
(Dollars in thousands)						Gains				Losses
June 30, 2011:
Held to maturity:
U.S. government-sponsored mortgage-backed securities		$	642,080				21,584				(1,664	)		$	662,000
Trust preferred securities			32				154				0				186
Total		$	642,112				21,738				(1,664	)		$	662,186
December 31, 2010:
Held to maturity:
U.S. government-sponsored mortgage-backed securities		$	530,523				18,191				(1,998	)		$	546,716
Trust preferred securities			32				96				0				128
Total		$	530,555				18,287				(1,998	)		$	546,844
Available for sale:
U.S. government-sponsored mortgage-backed securities		$	15,540				0				(530	)		$	15,010
Total		$	15,540				0				(530	)		$	15,010

$15.0 million of U.S. government-sponsored mortgage-backed securities were reclassified from available for sale to held to maturity during the three months ended June 30, 2011. Management considers the held to maturity classification of these securities to be appropriate as the Company has the positive intent and ability to hold these securities to maturity.

The amortized cost and estimated fair value of investment securities at June 30, 2011 are shown below. Incorporated in the maturity schedule are mortgage-backed and trust preferred securities, which are allocated using the contractual maturity as a basis. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(Dollars in thousands)		Amortized Cost				Estimated fair value
Held to maturity:
Due after 5 years through 10 years		$	9,881			$	10,200
Due after 10 years			632,231				651,986
Total		$	642,112			$	662,186

 

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Realized gains and losses and the proceeds from sales of securities available for sale and trading are shown in the table below. All sales of securities were U.S. government-sponsored mortgage-backed securities.

 

		Three months ended June 30,								Six months ended June 30,
(Dollars in thousands)		2011				2010				2011				2010
Proceeds from sales		$	0			$	44,408			$	19,866			$	67,609
Gross gains			0				282				66				350
Gross losses			0				0				0				0

Investment securities with carrying values of $310.4 million at June 30, 2011 were pledged to secure public deposits, securities sold under agreements to repurchase and transaction clearing accounts.

Provided below is a summary of investment securities which were in an unrealized loss position at June 30, 2011 and December 31, 2010. The Company has the ability to hold these securities until such time as the value recovers or the securities mature.

 

		Less than 12 months								12 months or longer								Total
Description of securities		Fair value				Unrealized losses				Fair value				Unrealized Losses				Number of Securities				Fair value				Unrealized losses
(Dollars in thousands)
June 30, 2011:
Mortgage-backed securities		$	99,124				1,631				1,454				33				21				100,578				1,664
Total		$	99,124				1,631				1,454				33				21				100,578				1,664
December 31, 2010:
Mortgage-backed securities		$	98,524				2,480				2,962				48				17				101,486				2,528
Total		$	98,524				2,480				2,962				48				17				101,486				2,528

Trust Preferred Securities. At June 30, 2011, the Company owns two trust preferred securities, PreTSL XXIII and XXIV, with a carrying value of $32,000. The difference between the carrying value of $32,000 and the remaining amortized cost basis of $1.1 million is included as a component of accumulated other comprehensive loss, net of taxes, and is related to non-credit factors such as the trust preferred securities market being inactive. The trust preferred securities represent investments in a pool of debt obligations issued primarily by holding companies for Federal Deposit Insurance Corporation-insured financial institutions. All of these securities are classified in the Bank’s held-to-maturity investment portfolio.

The trust preferred securities market is considered to be inactive as there were only five transactions in the last 18 months in similar tranches to the securities owned by the Company. The Company used a discounted cash flow model to determine whether these securities are other-than-temporarily impaired. The assumptions used in preparing the discounted cash flow model include the following: estimated discount rates, estimated deferral and default rates on collateral, and estimated cash flows.

 

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Based on the Company’s review, the Company’s investment in trust preferred securities did not incur additional impairment during the quarter ending June 30, 2011 as the present value of cash flows exceed the amortized cost basis of $1.1 million.

At June 30, 2011, PreTSL XXIII and XXIV are rated C by Fitch.

It is reasonably possible that the fair values of the trust preferred securities could decline in the near term if the overall economy and the financial condition of some of the issuers continue to deteriorate and the liquidity of these securities remains low. As a result, there is a risk that the Company’s amortized cost basis of $1.1 million on its trust preferred securities could be other-than-temporarily impaired in the near term. The impairment could be material to the Company’s consolidated statements of income.

The table below provides a cumulative roll forward of credit losses recognized in earnings for debt securities held and not intended to be sold:

 

(Dollars in thousands)		2011				2010
Balance at January 1		$	5,885			$	3,481
Credit losses on debt securities for which other-than-temporary impairment was not previously recognized			0				2,404
Balance at June 30		$	5,885			$	5,885

The table below shows the components of comprehensive loss, net of taxes, resulting from other-than-temporarily impaired securities:

 

		June 30,
(Dollars in thousands)		2011				2010
Non-credit losses on other-than-temporarily impaired securities		$	679			$	679

 

(6)	Loans Receivable

The components of loans receivable are as follows:

 

(Dollars in thousands)		June 30, 2011				December 31, 2010
Real estate loans:
First mortgages:
One- to four-family residential		$	624,052			$	604,456
Multi-family residential			6,089				5,408
Construction, commercial, and other			16,344				14,412
Home equity loans and lines of credit			18,419				20,064
Total real estate loans			664,904				644,340
Other loans:
Loans on deposit accounts			734				895
Consumer and other loans			4,479				4,740
Total other loans			5,213				5,635
Less:
Net unearned fees and discounts			(5,779	)			(5,585	)
Undisbursed loan funds			(1,338	)			(1,112	)
Allowance for loan losses			(1,592	)			(1,488	)
			(8,709	)			(8,185	)
Loans receivable, net		$	661,408			$	641,790

 

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The activity in the allowance for loan losses on loans receivable is as follows:

 

		Three Months Ended June 30,								Six Months Ended June 30,
(Dollars in thousands)		2011				2010				2011				2010
Balance, beginning of period		$	1,566			$	1,658			$	1,488			$	1,681
Provision for loan losses			14				158				122				158
			1,580				1,816				1,610				1,839
Charge-offs			(15	)			(95	)			(55	)			(123	)
Recoveries			27				16				37				21
Net charge-offs			12				(79	)			(18	)			(102	)
Balance, end of period		$	1,592			$	1,737			$	1,592			$	1,737

The table below presents the activity in the allowance for loan losses by portfolio segment:

 

(Dollars in thousands)		Residential Mortgage				Construction Commercial and Other Mortgage Loans				Home Equity and Lines of Credit				Consumer and Other				Unallocated				Totals
Three months ended June 30, 2011:
Balance, beginning of period		$	592			$	370			$	276			$	240			$	88			$	1,566
Provision (reversal of allowance) for loan losses			6				20				1				(42	)			29				14
			598				390				277				198				117				1,580
Charge-offs			(3	)			0				0				(12	)			0				(15	)
Recoveries			20				0				0				7				0				27
Net charge-offs			17				0				0				(5	)			0				12
Balance, end of period		$	615			$	390			$	277			$	193			$	117			$	1,592
Six months ended June 30, 2011:
Balance, beginning of period		$	583			$	277			$	305			$	208			$	115			$	1,488
Provision (reversal of allowance) for loan losses			36				113				(28	)			(1	)			2				122
			619				390				277				207				117				1,610
Charge-offs			(27	)			0				0				(28	)			0				(55	)
Recoveries			23				0				0				14				0				37
Net charge-offs			(4	)			0				0				(14	)			0				(18	)
Balance, end of period		$	615			$	390			$	277			$	193			$	117			$	1,592

 

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The table below presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method:

 

(Dollars in thousands)		Residential Mortgage				Construction Commercial and Other Mortgage Loans				Home Equity and Lines of Credit				Consumer and Other				Unallocated				Totals
June 30, 2011:
Allowance for loan losses:
Ending allowance balance:
Individually evaluated for impairment		$	0			$	0			$	0			$	0			$	0			$	0
Collectively evaluated for impairment			615				390				277				193				117				1,592
Total ending allowance balance		$	615			$	390			$	277			$	193			$	117			$	1,592
Loans:
Ending loan balance:
Individually evaluated for impairment		$	3,605			$	0			$	0			$	4			$	0			$	3,609
Collectively evaluated for impairment			620,877				14,872				18,434				5,208				0				659,391
Total ending loan balance		$	624,482			$	14,872			$	18,434			$	5,212			$	0			$	663,000
December 31, 2010:
Allowance for loan losses:
Ending allowance balance:
Individually evaluated for impairment		$	0			$	0			$	0			$	0			$	0			$	0
Collectively evaluated for impairment			583				277				305				208				115				1,488
Total ending allowance balance		$	583			$	277			$	305			$	208			$	115			$	1,488
Loans:
Ending loan balance:
Individually evaluated for impairment		$	3,401			$	2			$	0			$	5			$	0			$	3,408
Collectively evaluated for impairment			600,981				13,185				20,079				5,625				0				639,870
Total ending loan balance		$	604,382			$	13,187			$	20,079			$	5,630			$	0			$	643,278

The table below presents the balance of impaired loans and the related amount of allocated loan loss allowances:

 

(Dollars in thousands)		June 30, 2011				December 31, 2010
Loans with no allocated allowance for loan losses		$	3,609			$	3,408
Loans with allocated allowance for loan losses			0				0
Total impaired loans		$	3,609			$	3,408
Amount of allocated loan loss allowance		$	0			$	0

 

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The table below presents the balance of impaired loans individually evaluated for impairment by class of loans:

 

(Dollars in thousands)		Recorded Investment				Unpaid Principal Balance				Related Allowance
June 30, 2011:
With no related allowance recorded:
One- to four-family residential mortgages		$	3,605			$	3,731			$	0
Consumer and other			4				4				0
Total		$	3,609			$	3,735			$	0
December 31, 2010:
With no related allowance recorded:
One- to four-family residential mortgages		$	3,401			$	3,413			$	0
Construction, commercial and other mortgages			2				2				0
Consumer and other			5				5				0
Total		$	3,408			$	3,420			$	0

The table below presents the average recorded investment and interest income recognized on impaired loans by class of loans:

 

		For the three months  ended June 30								For the six months ended June 30
(Dollars in thousands)		Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
2011:
With no related allowance recorded:
One- to four-family residential mortgages		$	3,606			$	35			$	3,606			$	68
Consumer and other			5				0				5				0
Total		$	3,611			$	35			$	3,611			$	68
2010:
With no related allowance recorded:
One- to four-family residential mortgages		$	3,349			$	33			$	3,649			$	77
Construction, commercial and other mortgages			0				0				0				0
Consumer and other			203				0				228				0
Total		$	3,552			$	33			$	3,877			$	77

There were no loans individually evaluated for impairment with a related allowance for loan loss as of June 30, 2011 or December 31, 2010.

Impaired loans at June 30, 2011 and December 31, 2010 amounted to $3.6 million and $3.4 million, respectively, and included all nonaccrual and restructured loans. During the six months ended June 30, 2011, the average recorded investment in impaired loans was $3.6 million and interest income recognized on impaired loans was $68,000. During the six months ended June 30, 2010, the average recorded investment in impaired loans was $3.9 million and interest income recognized on impaired loans was $77,000.

 

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The table below presents the aging of loans and accrual status by class of loans as of June 30, 2011 and December 31, 2010:

 

(Dollars in thousands)		30 – 59 Days Past Due				60 – 89 Days Past Due				90 Days or Greater Past Due				Total Past Due				Loans Not Past Due				Total Loans				Nonaccrual Loans				Loans More Than 90 Days Past Due and Still Accruing
June 30, 2011:
One- to four-family residential mortgages		$	572			$	799			$	1,008			$	2,379			$	616,053			$	618,432			$	1,008			$	0
Multi-family residential mortgages			0				0				0				0				6,050				6,050				0				0
Construction, commercial and other mortgages			272				0				0				272				14,600				14,872				0				0
Home equity and lines of credit			58				0				0				58				18,376				18,434				0				0
Loans on deposit accounts			0				0				0				0				734				734				0				0
Consumer and other			11				3				4				18				4,460				4,478				4				0
Total		$	913			$	802			$	1,012			$	2,727			$	660,273			$	663,000			$	1,012			$	0
December 31, 2010:
One- to four-family residential mortgages		$	1,476			$	0			$	801			$	2,277			$	596,732			$	599,009			$	801			$	0
Multi-family residential mortgages			0				0				0				0				5,373				5,373				0				0
Construction, commercial and other mortgages			0				0				2				2				13,185				13,187				2				0
Home equity and lines of credit			58				0				0				58				20,021				20,079				0				0
Loans on deposit accounts			0				0				0				0				895				895				0				0
Consumer and other			10				8				5				23				4,712				4,735				5				0
Total		$	1,544			$	8			$	808			$	2,360			$	640,918			$	643,278			$	808			$	0

The Company primarily uses the aging of loans and accrual status to monitor the credit quality of its loan portfolio. When a mortgage loan becomes seriously delinquent (90 days or more contractually past due), it displays weaknesses which may result in a loss. As a loan becomes more delinquent, the likelihood of the borrower repaying the loan decreases and the loan becomes more collateral dependent. A mortgage loan becomes collateral dependent when the proceeds for repayment can be expected to come only from the sale or operation of the collateral and not from borrower repayments. Generally, new appraisals are obtained after a loan becomes collateral dependent or is five months delinquent. The carrying value of collateral dependent loans is adjusted to the fair market value of the collateral less selling costs. Any commercial real estate, commercial, or construction loan that has a loan balance in excess of a specified amount is also periodically reviewed to determine whether the loan exhibits any weaknesses and is performing in accordance with its contractual terms.

The Company had five nonaccrual loans with a book value of $1.0 million at June 30, 2011 and seven nonaccrual loans with a book value of $808,000 as of December 31, 2010. The Company collected or recognized interest income on nonaccrual loans of $2,000 and $4,000 during the six months ended June 30, 2011 and 2010, respectively. The Company would have recognized additional interest income of $45,000 and $16,000 during the six months ended June 30, 2011 and 2010, respectively, had the loans been accruing interest. The Company did not have any loans 90 or more days past due and still accruing interest as of June 30, 2011 and December 31, 2010.

The Company had nine troubled debt restructurings totaling $2.6 million as of June 30, 2011, all of which were one- to four-family residential mortgage loans and considered to be impaired. All of the loans are performing in accordance with their restructured terms and accruing interest at June 30, 2011.

 

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There were nine restructured one- to four-family residential mortgage loans totaling $2.6 million as of December 31, 2010 that were considered to be impaired. All of the loans were performing in accordance with their restructured terms and accruing interest as of December 31, 2010. Restructurings include deferrals of interest and/or principal payments and temporary or permanent reductions in interest rates due to the financial difficulties of the borrowers. We have no commitments to lend any additional funds to these borrowers.

Nearly all of our real estate loans are collateralized by real estate located in the State of Hawaii. Loan-to-value ratios on these real estate loans generally do not exceed 80% at the time of origination.

During the six months ended June 30, 2011 and 2010, the Company sold $26.1 million and $18.7 million, respectively, of residential mortgage loans held for sale and recognized gains of $236,000 and $255,000, respectively. During the three months ended June 30, 2011 and 2010, the Company sold $6.9 million and $11.5 million, respectively, of mortgage loans held for sale and recognized gains of $92,000 and $175,000, respectively. The Company had five residential mortgage loans held for sale totaling $1.8 million at June 30, 2011 and 13 residential mortgage loans held for sale totaling $3.2 million at December 31, 2010. We have not had to repurchase any loans from Freddie Mac for the six months ended June 30, 2011 and 2010.

The Company serviced loans for others of $123.7 million at June 30, 2011 and $131.6 million at December 31, 2010. Of these amounts, $7.2 million and $8.1 million relate to securitizations for which the Company continues to hold the related mortgage-backed securities at June 30, 2011 and December 31, 2010, respectively. The amount of contractually specified servicing fees earned for the six-month periods ended June 30, 2011 and 2010 was $179,000 and $202,000, respectively. The amount of contractually specified servicing fees earned for the three-month periods ended June 30, 2011 and June 30, 2010 was $88,000 and $103,000, respectively. The fees are reported in service fees on loan and deposit accounts in the consolidated statements of income.

 

(7)	Securities Sold Under Agreements to Repurchase

Securities sold under agreements to repurchase are treated as financings and the obligations to repurchase the identical securities sold are reflected as a liability with the dollar amount of securities underlying the agreements remaining in the asset accounts. Securities sold under agreements to repurchase are summarized as follows:

 

		June 30, 2011								December 31, 2010
(Dollars in thousands)		Repurchase liability				Weighted Average Rate				Repurchase liability				Weighted Average Rate
Maturing:
1 year or less		$	14,900				4.38	%		$	43,900				3.53	%
Over 1 year to 2 years			40,300				4.12				28,300				4.75
Over 2 years to 3 years			18,000				4.87				33,000				3.91
Over 3 years to 4 years			42,000				2.13				0				0
		$	115,200				3.55	%		$	105,200				3.98	%

 

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Below is a summary comparing the carrying value and fair value of securities pledged to secure repurchase agreements, the repurchase liability, and the amount at risk at June 30, 2011. The amount at risk is the greater of the carrying value or fair value over the repurchase liability. All the agreements to repurchase are with JP Morgan Chase Bank N.A. and JP Morgan Securities LLC. The securities pledged are issued and guaranteed by U.S. government-sponsored enterprises.

 

(Dollars in thousands)		Carrying value of securities				Fair Value of securities				Repurchase liability				Amount at risk				Weighted average months to maturity
Maturing:
Over 90 days		$	137,121			$	142,657			$	115,200			$	27,457				26
		$	137,121			$	142,657			$	115,200			$	27,457				26

 

(8)	Employee Benefit Plans

The Company has a noncontributory defined benefit pension plan (Pension Plan) that covers substantially all employees with at least one year of service. Effective December 31, 2008, under approved changes to the Pension Plan, there were no further accruals of benefits for any participants and benefits will not increase with any additional years of service. Net periodic benefit cost, subsequent to December 31, 2008, has not been significant and is not disclosed in the table below.

In addition, the Company sponsors a Supplemental Employee Retirement Plan (SERP), a noncontributory supplemental retirement benefit plan, which covers certain current and former employees of the Company for amounts in addition to those provided under the Pension Plan.

The components of net periodic benefit cost of SERP were as follows:

 

		Three Months Ended June 30,								Six Months Ended June 30,
(Dollars in thousands)		2011				2010				2011				2010
Net periodic benefit cost for the period
Service cost		$	111			$	155			$	221			$	310
Interest cost			54				89				108				177
Net periodic benefit cost		$	165			$	244			$	329			$	487

 

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(9)	Employee Stock Ownership Plan

Effective January 1, 2009, Territorial Savings Bank adopted an Employee Stock Ownership Plan (ESOP) for eligible employees. The ESOP borrowed $9.8 million from the Company and used those funds to acquire 978,650 shares or 8% of the total number of shares issued by the Company in its initial public offering. The shares were acquired at a price of $10.00 per share.

The loan is secured by the shares purchased with the loan proceeds and will be repaid by the ESOP over the 20-year term of the loan with funds from Territorial Savings Bank’s contributions to the ESOP and dividends payable on the shares. The interest rate on the ESOP loan is an adjustable rate equal to the prime rate, as published in The Wall Street Journal. The interest rate adjusts annually and will be the prime rate on the first business day of the calendar year.

Shares purchased by the ESOP are held by a trustee in an unallocated suspense account, and shares are released annually from the suspense account on a pro-rata basis as principal and interest payments are made by the ESOP to the Company. The trustee allocates the shares released among participants on the basis of each participant’s proportional share of compensation relative to all participants. As shares are committed to be released from the suspense account, Territorial Savings Bank reports compensation expense based on the average fair value of shares released with a corresponding credit to stockholders’ equity. The shares committed to be released are considered outstanding for earnings per share computations. Compensation expense recognized for the three months ended June 30, 2011 and 2010 amounted to $234,000 and $231,000, respectively. Compensation expense recognized for the six months ended June 30, 2011 and 2010 amounted to $468,000 and $465,000, respectively.

Shares held by the ESOP trust were as follows:

 

		June 30, 2011				December 31, 2010
Allocated shares			122,331				97,865
Unearned shares			856,319				880,785
Total ESOP shares			978,650				978,650
Fair value of unearned shares, in thousands		$	17,743			$	17,536

The ESOP restoration plan is a non-qualified plan that provides supplemental benefits to certain executives who are prevented from receiving the full benefits contemplated by the employee stock ownership plan’s benefit formula. The supplemental cash payments consist of payments representing shares that cannot be allocated to the participants under the ESOP due to IRS limitations imposed on tax-qualified plans. We accrue for these benefits over the period during which employees provide services to earn these benefits. For the three months ended June 30, 2011, we accrued $85,000 for the ESOP restoration plan. For the three months ended June 30, 2010, we reversed $25,000 of expenses for the ESOP restoration plan due to prior over-accruals. For the six months ended June 30, 2011 and 2010, we accrued $158,000 and $155,000, respectively, for the ESOP restoration plan.

 

(10)	Share-Based Compensation

On August 19, 2010, Territorial Bancorp Inc. adopted the 2010 Equity Incentive Plan, which provides for awards of stock options and restricted stock to key officers and outside directors. In accordance with the Compensation – Stock Compensation topic of the FASB ASC, the cost of the 2010 Equity Incentive Plan is based on the fair value of the awards on the grant date. The fair value of

 

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restricted stock is based on the closing price of the Company’s stock on the grant date. The fair value of stock options is estimated using a Black-Scholes option pricing model using assumptions for dividend yield, stock price volatility, risk-free interest rate and option term. These assumptions are based on our judgments regarding future events, are subjective in nature, and cannot be determined with precision. The cost of the awards will be recognized on a straight-line basis over the six-year vesting period during which participants are required to provide services in exchange for the awards.

Shares of our common stock issued under the Plan shall be authorized but unissued shares. The maximum number of shares that will be awarded under the plan will be 1,712,637 shares. Share-based compensation expense for the three months and six months ended June 30, 2011 was $698,000 and $1,389,000, respectively.

Stock Options

The table below presents the stock option activity for the six months ended June 30, 2011:

 

		Options				Weighted average exercise price				Remaining contractual life (years)				Aggregate intrinsic value (in  thousands)
Options outstanding at December 31, 2010			871,144			$	17.36				9.17			$	2,204
Granted			0				0				0				0
Exercised			0				0				0				0
Forfeited			0				0				0				0
Expired			0				0				0				0
Options outstanding at June 30, 2011			871,144			$	17.36				9.17			$	2,204

As of June 30, 2011, the Company had $3.8 million of unrecognized compensation costs related to stock options. The cost of stock options will be amortized in equal annual installments over the six-year vesting period. There were no options vested in the six months ended June 30, 2011.

The fair value of the Company’s stock options was determined using the Black-Scholes option pricing formula. The following assumptions were used in the formula:

 

Expected volatility			31.98	%
Risk-free interest rate			2.58	%
Expected dividends			1.61	%
Expected life (in years)			6.75
Grant price for the stock options		$	17.36

Expected volatility - Based on the historical volatility of the Company’s stock and a peer group of comparable thrifts.

Risk-free interest rate - Based on the U.S. Treasury yield curve and expected life of the options at the time of grant.

Expected dividends - Based on the quarterly dividend and the price of the Company’s stock at the time of grant.

 

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Expected life - Based on a weighted-average of the six-year vesting period and the 10-year contractual term of the stock option plan.

Grant price for the stock options - Based on the closing price of the Company’s stock on the date of grant.

Restricted Stock Awards

Restricted stock awards are accounted for as fixed grants using the fair value of the Company’s stock at the time of grant. Unvested restricted stock awards may not be disposed of or transferred during the vesting period. Restricted stock awards carry with them the right to receive dividends.

The table below presents the restricted stock award activity for the six months ended June 30, 2011:

 

		Restricted stock awards				Weighted average grant date fair value
Non-vested at December 31, 2010			713,600			$	17.36
Granted			0				0
Vested			0				0
Forfeited			0				0
Non-vested at June 30, 2011			713,600			$	17.36

There were no shares vested in the six months ended June 30, 2011.

As of June 30, 2011, the Company had $10.7 million of unrecognized compensation cost related to restricted stock awards. The cost of the restricted stock awards will be amortized in equal annual installments over the six-year vesting period.

 

(11)	Earnings Per Share

The table below presents the information used to compute basic and diluted earnings per share:

 

		Three Months Ended June 30,								Six Months Ended June 30,
(Dollars in thousands, except share data)		2011				2010				2011				2010
Net income		$	3,385			$	3,235			$	6,385			$	4,696
Weighted average number of shares used in:
Basic earnings per share			10,992,653				11,321,814				11,126,781				11,315,738
Dilutive common stock equivalents:
Stock options and restricted stock units			127,595				0				113,132				0
Diluted earnings per share			11,120,248				11,321,814				11,239,913				11,315,738
Net income per common share, basic		$	0.31			$	0.29			$	0.57			$	0.41
Net income per common share, diluted		$	0.30			$	0.29			$	0.57			$	0.41

 

 

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(12)	Fair Value of Financial Instruments

In accordance with the Fair Value Measurements and Disclosures topic of the FASB ASC, the Company groups its financial assets and liabilities at fair value into three levels based on the markets in which the financial assets and liabilities are traded and the reliability of the assumptions used to determine fair value as follows:

 

•

Level 1 – Valuation is based upon quoted prices (unadjusted) for identical assets or liabilities traded in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

 

•

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

•

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect management’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of discounted cash flow models and similar techniques that require the use of significant judgment or estimation.

In accordance with the Fair Value Measurements and Disclosures topic, the Company bases its fair values on the price that it would expect to receive if an asset were sold or pay to transfer a liability in an orderly transaction between market participants at the measurement date. Also as required, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when developing fair value measurements.

The Company uses fair value measurements to determine fair value disclosures. Investment securities held for sale and derivatives are recorded at fair value on a recurring basis. From time to time, the Company may be required to record other financial assets at fair value on a nonrecurring basis, such as loans held for sale, impaired loans and investments, and mortgage servicing assets. These nonrecurring fair value adjustments typically involve application of the lower of cost or fair value accounting or write-downs of individual assets.

Cash and Cash Equivalents, Accrued Interest Receivable, Accounts Payable and Accrued Expenses, Current Income Taxes Payable, and Advance Payments by Borrowers for Taxes and Insurance. The carrying amount approximates fair value because of the short maturity of these instruments.

Investment Securities. The fair values for investment securities were based on quoted market prices, if available, and were classified as Level 1. The estimated fair values of U.S. government-sponsored mortgage-backed securities are considered Level 1 inputs. If quoted market prices were not available, the valuation for investment securities utilized pricing models that varied based on asset class and included trade, bid and other observable market information. Securities priced using this information were classified as Level 2.

The trust preferred securities represent investments in a pool of debt obligations issued primarily by holding companies for Federal Deposit Insurance Corporation-insured financial institutions. The trust preferred securities market is considered to be inactive since there have been only five sales transactions of similar rated securities over the past 18 months and no new issues of pooled trust preferred securities

 

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have occurred since 2007. The fair value of our trust preferred securities was determined by an independent third-party pricing service which used a discounted cash flow model. Our pricing service used a discount rate of 22.00% and provided a fair value estimate of $5.26 per $100 of par value for PreTSL XXIII.

The discounted cash flow analysis included a review of all issuers within each collateral pool and incorporated higher deferral and default rates in the cash flow projections over the next three years and a forecast of lower deferral and default rates in later years. The fair value of the trust preferred securities are classified as Level 3 inputs because they are based on discounted cash flow models.

FHLB Stock. FHLB stock, which is redeemable for cash at par value, is reported at its par value.

Loans. The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of loans is not based on the concept of exit price.

Deposits. The fair value of checking and Super NOW savings accounts, passbook accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated by discounting future cash flows using the rates currently offered for deposits with similar remaining maturities.

Advances from the FHLB and Securities Sold Under Agreements to Repurchase. Fair value is estimated by discounting future cash flows using the rates currently offered to the Company for debt with similar remaining maturities.

The estimated fair values of the Company’s financial instruments are as follows:

 

		June 30, 2011								December 31, 2010
(Dollars in thousands)		Carrying amount				Estimated fair value				Carrying Amount				Estimated fair value
Assets
Cash and cash equivalents		$	124,250				124,250				194,435				194,435
Investment securities available for sale			0				0				15,010				15,010
Investment securities held to maturity			642,112				662,186				530,555				546,844
FHLB stock			12,348				12,348				12,348				12,348
Loans held for sale			1,764				1,811				3,234				3,234
Loans receivable, net			661,408				693,480				641,790				666,339
Accrued interest receivable			4,942				4,942				4,536				4,536
Liabilities
Deposits		$	1,107,021				1,110,968				1,076,470				1,078,590
Advances from the Federal Home Loan Bank			20,000				20,455				10,000				10,274
Securities sold under agreement to repurchase			115,200				119,517				105,200				109,953
Accounts payable and accrued expenses			19,005				19,005				20,430				20,430
Current income taxes payable			1,416				1,416				577				577
Advance payments by borrowers for taxes and insurance			3,043				3,043				3,376				3,376

 

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At June 30, 2011 and December 31, 2010, neither the commitment fees received on commitments to extend credit nor the fair value thereof was material to the consolidated financial statements of the Company.

The table below presents the balance of assets and liabilities measured at fair value on a recurring basis:

 

(Dollars in thousands)		Level 1				Level 2				Level 3				Total
June 30, 2011
Interest rate contracts – assets		$	0				23				0				23
Interest rate contracts – liabilities			0				(23	)			0				(23	)
December 31, 2010
Interest rate contracts – assets		$	0				456				0				456
Interest rate contracts – liabilities			0				(314	)			0				(314	)
Available-for-sale investments			0				15,010				0				15,010

The fair value of interest rate contracts was determined by referring to prices quoted in the secondary market for similar contracts. Gains and losses are included in gain on sale of loans in the consolidated statements of income. The fair value of available-for-sale investments was determined using quoted market prices for similar investments. The losses, net of taxes, are included in accumulated other comprehensive loss in the consolidated balance sheets.

The table below presents the balance of assets measured at fair value on a nonrecurring basis and the related gains and losses for the six months ended June 30, 2011 and the year ended December 31, 2010:

 

(Dollars in thousands)		Level 1				Level 2				Level 3				Total				Total Losses
June 30, 2011
Impaired loans		$	0				0				2,427				2,427				1
December 31, 2010
Impaired loans		$	0				254				2,429				2,683				183
Trust preferred securities			0				0				128				128				2,404
Mortgage servicing assets			0				0				1,366				1,366				64

The fair value of impaired loans that are considered to be collateral-dependent is determined using the value of collateral less estimated selling costs. Gains and losses are included in the provision for loan losses in the consolidated statements of income. The fair value of trust preferred securities was determined by an independent third-party pricing service using a discounted cash flow model. The assumptions used in the discounted cash flow model are discussed above. Losses on trust preferred securities are included in net other-than-temporary impairment losses in the consolidated statements of income. Mortgage servicing assets are valued using a cash flow model prepared by an independent third-party appraiser. Assumptions used in the model include mortgage prepayment speeds, discount rates, cost of servicing and ancillary income. Losses on mortgage servicing assets are included in service fees on loan and deposit accounts in the consolidated statements of income.

 

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(13)	Subsequent Events

On August 4, 2011, the Board of Directors of Territorial Bancorp Inc. declared a quarterly cash dividend of $0.09 per share of common stock. The dividend is expected to be paid on September 1, 2011 to stockholders of record as of August 18, 2011.

On July 18, 2011, Harold Ohama, who served as a director of the Company and the Bank, passed away. Mr. Ohama had been a director for 15 years. During the third quarter of 2011, the Company will recognize approximately $732,000 of pre-tax expense ($439,000 after tax) which was previously being amortized through August 2016, in connection with the acceleration of Mr. Ohama’s stock options and restricted stock granted under the Company’s 2010 Equity Incentive Plan.

Effective July 21, 2011, the Bank’s primary federal regulator, the Office of Thrift Supervision, was merged into the Comptroller of the Currency (the primary federal regulator for national banks). In addition, Territorial Bancorp Inc. became subject to regulation by the Board of Governors of the Federal Reserve System, including holding company capital requirements, that Territorial Bancorp Inc. was not subject to as a savings and loan holding company. As previously disclosed, we expect that compliance with new regulations and being supervised by one or more new regulatory agencies could increase our expenses.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Statement Regarding Forward-Looking Information

This Quarterly Report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:

 

•

statements of our goals, intentions and expectations;

 

•

statements regarding our business plans, prospects, growth and operating strategies;

 

•

statements regarding the asset quality of our loan and investment portfolios; and

 

•

estimates of our risks and future costs and benefits.

These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this Quarterly Report.

 

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The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

 

•

general economic conditions, either nationally or in our market areas, that are worse than expected;

 

•

competition among depository and other financial institutions;

 

•

inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;

 

•

adverse changes in the securities markets;

 

•

changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;

 

•

our ability to enter new markets successfully and capitalize on growth opportunities;

 

•

our ability to successfully integrate acquired entities, if any;

 

•

changes in consumer spending, borrowing and savings habits;

 

•

changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission and the Public Company Accounting Oversight Board;

 

•

changes in our organization, compensation and benefit plans;

 

•

changes in our financial condition or results of operations that reduce capital available to pay dividends; and

 

•

changes in the financial condition or future prospects of issuers of securities that we own.

Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

Critical Accounting Policies

There are no material changes to the critical accounting policies disclosed in Territorial Bancorp Inc.’s Annual Report on Form 10-K for the year ended December 31, 2010.

Comparison of Financial Condition at June 30, 2011 and December 31, 2010

Assets. At June 30, 2011, our assets were $1.488 billion, an increase of $44.8 million, or 3.1%, from $1.443 billion at December 31, 2010. The growth in assets was primarily the result of increases in investment securities and loans receivable, which were partially offset by a decrease in cash and cash equivalents.

Cash and Cash Equivalents. Cash and cash equivalents were $124.3 million at June 30, 2011, a decrease of $70.2 million since December 31, 2010. Cash and cash equivalents, along with the proceeds from a $30.6 million increase in deposits and a $20.0 million increase in borrowings, were primarily used to fund an increase of $96.5 million in investment securities and $18.1 million in total loans.

 

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Loans. Total loans, including $1.8 million of loans held for sale, were $663.2 million at June 30, 2011, or 44.6% of total assets. During the six months ended June 30, 2011, the loan portfolio increased by $18.1 million, or 2.8%. The increase in the loan portfolio occurred as one- to four-family residential loan production exceeded principal repayments and loan sales.

Securities. At June 30, 2011, our securities portfolio totaled $642.1 million, or 43.1% of assets. At June 30, 2011, all of such securities were classified as held to maturity and none of the underlying collateral consisted of subprime or Alt-A (traditionally defined as non-conforming loans having less than full documentation) loans. During the six months ended June 30, 2011, our securities portfolio increased by $96.5 million, or 17.7%, primarily due to purchases exceeding repayments.

$15.0 million of U.S. government-sponsored mortgage-backed securities were reclassified from available for sale to held to maturity during the three months ended June 30, 2011. Management considers the held to maturity classification of these securities to be appropriate as the Company has the positive intent and ability to hold these securities to maturity.

At June 30, 2011, we owned trust preferred securities with a carrying value of $32,000. This portfolio consists of two securities (PreTSL XXIII and PreTSL XXIV), which represent investments in a pool of debt obligations issued primarily by holding companies for Federal Deposit Insurance Corporation-insured financial institutions.

The trust preferred securities market is considered inactive as only five sales transactions of similarly rated securities have occurred over the past 18 months. In addition, there have been no new issues of pooled trust preferred securities since 2007. Because the trust preferred securities market is inactive, we use a discounted cash flow model to determine whether they are other-than-temporarily impaired. The assumptions used in preparing the discounted cash flow model include the following: estimated discount rates (using yields of comparable traded instruments adjusted for illiquidity and other risk factors), estimated deferral and default rates on collateral, and estimated cash flows.

Based on the Company’s review, the Company’s investment in trust preferred securities did not incur additional impairment during the quarter ending June 30, 2011 as the present value of cash flows exceeded the amortized cost basis of $1.1 million.

At June 30, 2011, PreTSL XXIII and XXIV are rated C by Fitch.

It is reasonably possible that the fair values of the trust preferred securities could decline in the near term if the overall economy and the financial condition of some of the issuers continue to deteriorate and the liquidity of these securities remains low. As a result, there is a risk that the Company’s amortized cost basis of $1.1 million on its trust preferred securities could become other-than-temporarily impaired in the near term. The impairment could be material to the Company’s consolidated statements of income.

Deposits. Deposits were $1.107 billion at June 30, 2011, an increase of $30.6 million, or 2.8%, since December 31, 2010. The increase in deposits was caused by opening a new branch and our continuing to promote higher than market rates for savings accounts.

Borrowings. Historically, our borrowings consisted primarily of advances from the Federal Home Loan Bank of Seattle and funds borrowed under securities sold under agreements to repurchase. During the six months ended June 30, 2011, our borrowings increased by $20.0 million, or 17.4%, to $135.2 million, due to a $10.0 million net increase in securities sold under agreements to repurchase and a $10.0 million increase in Federal Home Loan Bank advances. The increase in long-term borrowings was part of the Bank’s strategy to control interest rate risk.

 

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Average Balances and Yields

The following tables set forth average balance sheets, average yields and rates, and certain other information at and for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of net deferred costs, discounts and premiums that are amortized or accreted to interest income.

 

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		For the Three Months Ended June 30,
		2011												2010
		Average Outstanding Balance				Interest				Yield/ Rate (1)				Average Outstanding Balance				Interest				Yield/ Rate (1)
		(Dollars in thousands)
Interest-earning assets:
Loans:
Real estate loans:
First mortgage:
One- to four-family residential (5)		$	615,677			$	8,075				5.25	%		$	563,414			$	7,769				5.52	%
Multi-family residential			6,139				98				6.39				4,612				79				6.85
Construction, commercial and other			14,481				222				6.13				17,352				297				6.85
Home equity loans and lines of credit			18,608				283				6.08				21,248				334				6.29
Other loans			5,332				85				6.38				6,420				103				6.42
Total loans			660,237				8,763				5.31				613,046				8,582				5.60
Investment securities:
U.S. government sponsored mortgage-backed securities (5)			637,814				6,889				4.32				587,527				6,641				4.52
Trust preferred securities			32				—				—				32				—				—
Total securities			637,846				6,889				4.32				587,559				6,641				4.52
Other			147,756				81				0.22				178,936				99				0.22
Total interest-earning assets			1,445,839				15,733				4.35				1,379,541				15,322				4.44
Non-interest-earning assets			50,105												49,430
Total assets		$	1,495,944											$	1,428,971
Interest-bearing liabilities:
Savings accounts		$	761,757			$	1,177				0.62	%		$	707,067			$	2,289				1.29	%
Certificates of deposit			214,141				509				0.95				233,839				666				1.14
Money market accounts			607				1				0.66				533				1				0.75
Checking and Super NOW accounts			108,862				14				0.05				102,238				14				0.05
Total interest-bearing deposits			1,085,367				1,701				0.63				1,043,677				2,970				1.14
Federal Home Loan Bank advances			19,999				104				2.08				8,791				45				2.05
Other borrowings			117,354				1,052				3.59				105,213				1,057				4.02
Total interest-bearing liabilities			1,222,720				2,857				0.93				1,157,681				4,072				1.41
Non-interest-bearing liabilities			45,715												48,893
Total liabilities			1,268,435												1,206,574
Stockholders’ equity			227,509												222,397
Total liabilities and stockholders’ equity		$	1,495,944											$	1,428,971
Net interest income						$	12,876											$	11,250
Net interest rate spread (2)											3.42	%											3.03	%
Net interest-earning assets (3)		$	223,119											$	221,860
Net interest margin (4)											3.56	%											3.26	%
Interest-earning assets to interest-bearing liabilities			118.25	%											119.16	%

 

(1)	Annualized

(2)	Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(3)	Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(4)	Net interest margin represents net interest income divided by average total interest-earning assets.

(5)	Average balance includes loans or investments available for sale.

 

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		For the Six Months Ended June 30,
		2011												2010
		Average Outstanding Balance				Interest				Yield/ Rate (1)				Average Outstanding Balance				Interest				Yield/ Rate (1)
		(Dollars in thousands)
Interest-earning assets:
Loans:
Real estate loans:
First mortgage:
One- to four-family residential (5)		$	612,451			$	16,273				5.31	%		$	559,089			$	15,522				5.55	%
Multi-family residential			6,094				196				6.43				4,235				146				6.89
Construction, commercial and other			14,111				427				6.05				17,233				561				6.51
Home equity loans and lines of credit			18,933				578				6.11				21,352				674				6.31
Other loans			5,440				172				6.32				6,539				208				6.36
Total loans			657,029				17,646				5.37				608,448				17,111				5.62
Investment securities:
U.S. government sponsored mortgage-backed securities (5)			617,081				13,260				4.30				590,673				13,448				4.55
Trust preferred securities			32				—				—				1,758				—				—
Total securities			617,113				13,260				4.30				592,431				13,448				4.54
Other			158,370				173				0.22				161,286				175				0.22
Total interest-earning assets			1,432,512				31,079				4.34				1,362,165				30,734				4.51
Non-interest-earning assets			49,959												49,902
Total assets		$	1,482,471											$	1,412,067
Interest-bearing liabilities:
Savings accounts		$	757,517			$	2,362				0.62	%		$	687,203			$	4,510				1.31	%
Certificates of deposit			210,758				1,018				0.97				240,731				1,390				1.15
Money market accounts			626				1				0.32				37,846				12				0.06
Checking and Super NOW accounts			106,956				28				0.05				63,611				17				0.05
Total interest-bearing deposits			1,075,857				3,409				0.63				1,029,391				5,929				1.15
Federal Home Loan Bank advances			18,342				190				2.07				4,420				45				2.04
Other borrowings			112,609				2,086				3.70				107,665				2,141				3.98
Total interest-bearing liabilities			1,206,808				5,685				0.94				1,141,476				8,115				1.42
Non-interest-bearing liabilities			47,317												48,461
Total liabilities			1,254,125												1,189,937
Stockholders’ equity			228,346												222,130
Total liabilities and stockholders’ equity		$	1,482,471											$	1,412,067
Net interest income						$	25,394											$	22,619
Net interest rate spread (2)											3.40	%											3.09	%
Net interest-earning assets (3)		$	225,704											$	220,689
Net interest margin (4)											3.55	%											3.32	%
Interest-earning assets to interest-bearing liabilities			118.70	%											119.33	%

 

(1)	Annualized

(2)	Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(3)	Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(4)	Net interest margin represents net interest income divided by average total interest-earning assets.

(5)	Average balance includes loans or investments available for sale.

 

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Comparison of Operating Results for the Three Months Ended June 30, 2011 and 2010

General. Net income increased by $150,000, or 4.6%, to $3.4 million for the three months ended June 30, 2011 from $3.2 million for the three months ended June 30, 2010. The increase in net income was caused by a $1.2 million decrease in interest expense, a $411,000 increase in interest and dividend income and a $144,000 decrease in the provision for loan losses. This was partially offset by a $1.2 million increase in non-interest expense, a $255,000 decrease in non-interest income and a $151,000 increase in income taxes.

Net Interest Income. Net interest income increased by $1.6 million, or 14.5%, to $12.9 million for the three months ended June 30, 2011 compared to $11.3 million for the three months ended June 30, 2010. Interest expense decreased by $1.2 million, or 29.8%, due to a 48 basis point decrease in the average cost of interest-bearing liabilities, which was partially offset by a $65.0 million increase in the average balance of interest-bearing liabilities. Interest and dividend income increased by $411,000, or 2.7%, due primarily to a $66.3 million increase in the average balance of interest-earning assets, which was partially offset by a nine basis point decrease in the average yield on interest-earning assets. The interest rate spread and net interest margin were 3.42% and 3.56%, respectively, for the three months ended June 30, 2011, compared to 3.03% and 3.26%, respectively, for the three months ended June 30, 2010.

Interest and Dividend Income. Interest and dividend income increased by $411,000, or 2.7%, to $15.7 million for the three months ended June 30, 2011 from $15.3 million for the three months ended June 30, 2010. Interest income on investment securities increased by $248,000, or 3.7%, to $6.9 million for the three months ended June 30, 2011 from $6.6 million for the three months ended June 30, 2010. The increase in interest income on securities occurred primarily because of a $50.3 million increase in the average balance of investment securities, which was partially offset by a 20 basis point decrease in the average yield on securities. The decrease in yield occurred as higher-yielding mortgage-backed securities were repaid and the Company purchased new mortgage-backed securities that had lower yields. The decrease in yields on the mortgage-backed securities purchased occurred because of a drop in long-term mortgage rates. Interest income on loans increased by $181,000, or 2.1%, to $8.8 million for the three months ended June 30, 2011 from $8.6 million for the three months ended June 30, 2010. The increase in interest income on loans occurred because the average balance of loans grew by $47.2 million, or 7.7%, as new loan originations exceeded loan repayments and loan sales. The increase in interest income that occurred because of growth in the loan portfolio was partially offset by a 29 basis point decline in the average loan yield to 5.31% for the three months ended June 30, 2011. The decline in the average yield on loans occurred because of repayments on higher-yielding loans while new loans with lower yields were added to the loan portfolio.

Interest Expense. Interest expense decreased by $1.2 million, or 29.8%, to $2.9 million for the three months ended June 30, 2011 compared to $4.1 million for the three months ended June 30, 2010. Interest expense on deposits decreased $1.3 million, or 42.7%, to $1.7 million for the three months ended June 30, 2011 from $3.0 million for the three months ended June 30, 2010. During the three months ended June 30, 2011, interest expense on savings accounts and certificates of deposit declined by $1.1 million and $157,000, respectively. During the three months ended June 30, 2011, the average interest rate on savings accounts and certificates of deposit decreased by 67 and 19 basis points, respectively. We lowered the rates we pay on savings accounts and certificates of deposit due to declining market interest rates.

 

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Provision for Loan Losses. We recorded provisions for loan losses of $14,000 and $158,000 for the three months ended June 30, 2011 and 2010, respectively. The provisions made during the three months ended June 30, 2011 included $26,000 of general loan loss provisions due to the increase in non-performing loans. Non-performing loans totaled $1.0 million at June 30, 2011, or 0.15% of total loans at that date, compared to $692,000 of non-performing loans at June 30, 2010, or 0.11% of total loans at that date. Non-performing loans as of June 30, 2011 and 2010 consisted primarily of one- to four-family residential real estate loans. The provisions made during the three months ended June 30, 2010 included specific reserves of $142,000 related to $567,000 of loans consisting of two one- to four-family residential real estate loans and one commercial loan. In addition, $30,000 of general loan loss provisions was recorded in the three months ended June 30, 2010 in recognition of deteriorating environmental factors. We experienced charge offs of $15,000 and $95,000 and recoveries of $27,000 and $16,000 for the three months ended June 30, 2011 and 2010, respectively. The allowance for loan losses to total loans was 0.24% and 0.28% at June 30, 2011 and 2010, respectively. To the best of our knowledge, we have provided for all losses that are both probable and reasonable to estimate at June 30, 2011 and 2010.

Non-Interest Income. The following table summarizes changes in non-interest income between the three months ended June 30, 2011 and 2010.

 

		Three Months Ended June  30,								Change
		2011				2010				$ Change				% Change
		(In thousands)
Other-than-temporary impairment loss on investments, net		$	—			$	—			$	—				—
Service fees on loan and deposit accounts			598				665				(67	)			(10.1	)%
Income on bank-owned life insurance			241				254				(13	)			(5.1	)%
Gain on sale of investment securities			—				282				(282	)			(100.0	)%
Gain on sale of loans			92				175				(83	)			(47.4	)%
Other			292				102				190				186.3	%
Total		$	1,223			$	1,478			$	(255	)			(17.3	)%

Non-interest income decreased by $255,000 for the three months ended June 30, 2011. During the three months ended June 30, 2010, the Company realized gains of $282,000 from sales of securities. During the three months ended June 30, 2011, we did not sell any investment securities. Other non-interest income was $292,000 for the quarter ended June 30, 2011 compared to $102,000 for the quarter ended June 30, 2010. The increase in other non-interest income is due to a legal settlement of an insurance claim in the amount of $194,000.

 

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Non-Interest Expense. The following table summarizes changes in non-interest expense between the three months ended June 30, 2011 and 2010.

 

		Three Months Ended June  30,								Change
		2011				2010				$ Change				% Change
		(In thousands)
Salaries and employee benefits		$	5,487			$	4,347			$	1,140				26.2	%
Occupancy			1,226				1,143				83				7.3	%
Equipment			808				734				74				10.1	%
Federal deposit insurance premiums			191				298				(107	)			(35.9	)%
Other general and administrative expenses			933				909				24				2.6	%
Total		$	8,645			$	7,431			$	1,214				16.3	%

Salaries and employee benefits increased for the quarter ending June 30, 2011 primarily because of $762,000 of expenses accrued for the equity incentive plan, which was not in existence during the quarter ended June 30, 2010. In addition, the Company incurred a bank-wide budgeted salary increase of approximately 2.0%, which was effective July 1, 2010, and higher cash bonus and ESOP accruals.

Income Tax Expense. Income taxes were $2.1 million for the three months ended June 30, 2011, reflecting an effective tax rate of 37.8% compared to $1.9 million for the three months ended June 30, 2010, reflecting an effective tax rate of 37.1%. The increase in the effective tax rate for the three months ended June 30, 2011 is primarily due to consistent amounts of non-taxable income received from bank-owned life insurance relative to an increase in pre-tax income.

Comparison of Operating Results for the Six Months Ended June 30, 2011 and 2010

General. Net income increased by $1.7 million, or 36.0%, to $6.4 million for the six months ended June 30, 2011 from $4.7 million for the six months ended June 30, 2010. The increase in net income was primarily caused by a $2.4 million decrease in interest expense, a $2.2 million increase in non-interest income and a $345,000 increase in interest and dividend income. This was partially offset by a $1.8 million increase in non-interest expense and a $1.5 million increase in income taxes.

Net Interest Income. Net interest income increased by $2.8 million, or 12.3%, to $25.4 million for the six months ended June 30, 2011 compared to $22.6 million for the six months ended June 30, 2010. Interest expense decreased by $2.4 million, or 29.9%, due to a 48 basis point decrease in the average cost of interest-bearing liabilities, which was partially offset by a $65.3 million increase in the average balance of interest-bearing liabilities. Interest and dividend income increased by $345,000, or 1.1%, due primarily to a $70.3 million increase in the average balance of interest-earning assets, which was offset by 17 basis point decrease in the average yield on interest-earning assets. The interest rate spread and net interest margin were 3.40% and 3.55%, respectively, for the six months ended June 30, 2011, compared to 3.09% and 3.32%, respectively, for the six months ended June 30, 2010.

Interest and Dividend Income. Interest and dividend income increased by $345,000, or 1.1%, to $31.1 million for the six months ended June 30, 2011 from $30.7 million for the six months ended June 30, 2010. Interest income on loans increased by $535,000, or 3.1%, to $17.6 million for the six months ended June 30, 2011 from $17.1 million for the six months ended June 30, 2010. The increase in interest income on loans occurred because the average balance of loans grew by $48.6 million, or 8.0%, as new loan originations exceeded loan repayments and loan sales. The increase in interest income which occurred because of growth in the loan portfolio was partially offset by a 25 basis point decline in the

 

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average loan yield to 5.37% for the six months ended June 30, 2011. The decline in the average yield on loans occurred because of repayments on higher-yielding loans while new loans with lower yields were added to the loan portfolio. The increase in interest income on loans was partially offset by a $188,000, or 1.4%, decrease in interest income on investment securities to $13.3 million for the six months ended June 30, 2011 from $13.4 million for the six months ended June 30, 2010. The decrease in interest income on securities occurred primarily because of a 24 basis point decrease in the average yield on securities, which was offset by a $24.7 million increase in the average securities balance. The decrease in yield occurred as higher-yielding mortgage-backed securities were repaid and the Company purchased new mortgage-backed securities that had lower yields. The decrease in yields on the mortgage-backed securities purchased occurred because of a drop in long-term mortgage rates.

Interest Expense. Interest expense decreased by $2.4 million, or 29.9%, to $5.7 million for the six months ended June 30, 2011 compared to $8.1 million for the six months ended June 30, 2010. Interest expense on deposits decreased $2.5 million, or 42.5%, to $3.4 million for the six months ended June 30, 2011 from $5.9 million for the six months ended June 30, 2010. During the six months ended June 30, 2011, interest expense on savings accounts and certificates of deposit declined by $2.1 million and $372,000, respectively. During the six months ended June 30, 2011, the average interest rate on savings accounts and certificates of deposit decreased by 69 and 18 basis points, respectively. We lowered the rates we pay on savings accounts and certificates of deposit due to declining market interest rates and increased liquidity from principal repayments on loans and mortgage-backed securities.

Provision for Loan Losses. We recorded provisions for loan losses of $122,000 and $158,000 for the six months ended June 30, 2011 and 2010, respectively. The provisions made during the six months ended June 30, 2011 included $104,000 of general loan loss provisions due to the increase in non-performing loans. Non-performing loans totaled $1.0 million at June 30, 2011, or 0.15% of total loans at that date, compared to $692,000 of non-performing loans at June 30, 2010, or 0.11% of total loans at that date. Non-performing loans as of June 30, 2011 and 2010 consisted primarily of one- to four-family residential real estate loans. The provisions made during the six months ended June 30, 2010 included specific reserves of $142,000 related to $567,000 of loans consisting of two one- to four-family residential real estate loans and one commercial loan. In addition, $30,000 of general loan loss provisions was recorded in the six months ended June 30, 2010 in recognition of deteriorating environmental factors. We experienced charge offs of $55,000 and $123,000 and recoveries of $37,000 and $21,000 for the six months ended June 30, 2011 and 2010, respectively. The allowance for loan losses to total loans was 0.24% and 0.28% at June 30, 2011 and 2010, respectively. To the best of our knowledge, we have provided for all losses that are both probable and reasonable to estimate at June 30, 2011 and 2010.

 

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Non-Interest Income. The following table summarizes changes in non-interest income between the six months ended June 30, 2011 and 2010.

 

		Six Months Ended June 30,								Change
		2011				2010				$ Change				% Change
		(In thousands)
Other-than-temporary impairment loss on investments, net		$	—			$	(2,404	)		$	2,404				100.0	%
Service fees on loan and deposit accounts			1,156				1,288				(132	)			(10.2	)%
Income on bank-owned life insurance			480				509				(29	)			(5.7	)%
Gain on sale of investment securities			66				350				(284	)			(81.1	)%
Gain on sale of loans			236				255				(19	)			(7.5	)%
Other			411				148				263				177.7	%
Total		$	2,349			$	146			$	2,203				1,508.9	%

Non-interest income rose by $2.2 million for the six months ended June 30, 2011. We recognized a $2.4 million loss for other-than-temporary impairment on our investments in trust preferred securities during the six months ended June 30, 2010. In the six months ended June 30, 2011, we did not incur any other-than-temporary impairment loss on our investments. See”—Comparison of Financial Condition at June 30, 2011 and December 31, 2010—Securities” for a discussion of these securities. For the six months ended June 30, 2011 and 2010, we recognized gains of $66,000 and $350,000, respectively, on the sale of investment securities. Other non-interest income was $411,000 for the six months ended June 30, 2011 compared to $148,000 for the six months ended June 30, 2010. The increase in other non-interest income is primarily due to a legal settlement of an insurance claim in the amount of $194,000.

Non-Interest Expense. The following table summarizes changes in non-interest expense between the six months ended June 30, 2011 and 2010.

 

		Six Months Ended June 30,								Change
		2011				2010				$ Change				% Change
		(In thousands)
Salaries and employee benefits		$	10,613			$	9,007			$	1,606				17.8	%
Occupancy			2,447				2,282				165				7.2	%
Equipment			1,574				1,450				124				8.6	%
Federal deposit insurance premiums			487				590				(103	)			(17.5	)%
Other general and administrative expenses			1,933				1,891				42				2.2	%
Total		$	17,054			$	15,220			$	1,834				12.0	%

Salaries and employee benefits increased for the six months ended June 30, 2011 primarily because of $1.5 million of expenses accrued for the equity incentive plan, which was not in existence during the quarter ended June 30, 2010. In addition, the Company incurred a bank-wide budgeted salary increase of approximately 2.0%, which was effective July 1, 2010, and higher cash bonus accruals.

Income Tax Expense. Income taxes were $4.2 million for the six months ended June 30, 2011, reflecting an effective tax rate of 39.6% compared to $2.7 million for the six months ended June 30, 2010, reflecting an effective tax rate of 36.4%. The increase in the effective tax rate for the six months ended June 30, 2011 is primarily due to consistent amounts of non-taxable income received from bank-owned life insurance relative to an increase in pre-tax income.

 

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Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, cash balances at the Federal Reserve Bank, loan repayments, advances from the Federal Home Loan Bank of Seattle, borrowings using securities sold under agreements to repurchase, maturities and principal repayments on held-to-maturity and available for sale securities and the sale of available-for-sale securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. We have established an Asset/Liability Management Committee, consisting of our Chairman of the Board, President and Chief Executive Officer, our Vice Chairman and Co-Chief Operating Officer, our Senior Vice President and Treasurer and our Vice President and Controller, which is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of June 30, 2011.

We regularly monitor and adjust our investments in liquid assets based upon our assessment of:

 

(i)

expected loan demand;

 

(ii)

expected deposit flows and borrowing maturities;

 

(iii)

yields available on interest-earning deposits and securities; and

 

(iv)

the objectives of our asset/liability management program.

Excess liquid assets are invested generally in interest-earning deposits and mortgage-backed securities. Excess liquid assets may also be used to pay off short-term borrowings.

Our most liquid asset is cash and cash equivalents. The amount of this asset is dependent on our operating, financing, lending and investing activities during any given period. At June 30, 2011, cash and cash equivalents totaled $124.3 million. On that date, we had $20.0 million of Federal Home Loan Bank advances outstanding and $115.2 million in securities sold under agreements to repurchase outstanding, with the ability to borrow an additional $352.6 million under Federal Home Loan Bank advances.

Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements.

At June 30, 2011, we had $7.6 million in loan commitments outstanding, most of which were for fixed-rate loans. In addition to commitments to originate loans, we had $19.0 million in unused lines of credit to borrowers as of June 30, 2011. Certificates of deposit due within one year at June 30, 2011 totaled $164.8 million, or 14.9% of total deposits. If these deposits do not remain with us, we may be required to seek other sources of funds, including loan sales, brokered deposits, securities sold under agreements to repurchase and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before June 30, 2012. We believe, however, based on past experience that a portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

 

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Our primary investing activities are originating loans and purchasing mortgage-backed securities. During the three months ended June 30, 2011 and 2010, we originated $32.5 million and $46.0 million of loans, respectively, and purchased $49.9 million and $5.1 million of securities, respectively. During the six months ended June 30, 2011 and 2010, we originated $105.2 million and $78.3 million of loans, respectively, and purchased $165.8 million and $30.5 million of securities, respectively.

Financing activities consist primarily of activity in deposit accounts, Federal Home Loan Bank advances and securities sold under agreements to repurchase. We experienced net increases in deposits of $30.6 million and $69.2 million for the six months ended June 30, 2011 and 2010, respectively. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors.

Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank of Seattle, which provide an additional source of funds. We also utilize securities sold under agreements to repurchase as another borrowing source. Federal Home Loan Bank advances increased by $10.0 million for the six months ended June 30, 2011. We had the ability to borrow up to an additional $352.6 million and $342.3 million from the Federal Home Loan Bank of Seattle as of June 30, 2011 and 2010, respectively. Securities sold under agreements to repurchase increased by $10.0 million for the six months ended June 30, 2011, compared to a decrease of $25.0 million for the six months ended June 30, 2010.

Territorial Savings Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At June 30, 2011, Territorial Savings Bank exceeded all regulatory capital requirements. Territorial Savings Bank is considered “well capitalized” under regulatory guidelines. The tables below present the capital required as a percentage of total and risk-weighted assets and the percentage and the total amount of capital maintained at June 30, 2011 and December 31, 2010.

As of June 30, 2011

(dollars in thousands)

 

		Required				Territorial Savings Bank
Tier 1 Capital			4	%		$	206,545				13.83	%
Total Risk-Based Capital			8	%		$	208,136				40.90	%
Tier 1 Risk-Based Capital			4	%		$	206,545				40.59	%

As of December 31, 2010

(dollars in thousands)

 

		Required				Territorial Savings Bank
Tier 1 Capital			4	%		$	202,527				14.02	%
Total Risk-Based Capital			8	%		$	204,015				43.06	%
Tier 1 Risk-Based Capital			4	%		$	202,527				42.75	%

 

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Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our potential future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. In addition, we enter into commitments to sell mortgage loans.

Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities and agreements with respect to investments. Except for obtaining $10.0 million of Federal Home Loan Bank advances, $10.0 million of securities sold under agreements to repurchase and a decrease of $7.7 million in certificates of deposit between December 31, 2010 and June 30, 2011, there have not been any material changes in contractual obligations and funding needs since December 31, 2010.

 

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. Our Board of Directors has established an Asset/Liability Management Committee, which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors.

Because we have historically operated as a traditional thrift institution, the significant majority of our assets consist of long-term, fixed-rate residential mortgage loans and mortgage-backed securities, which we have funded primarily with checking and savings accounts and short-term borrowings. In addition, there is little demand for adjustable-rate mortgage loans in the Hawaii market area. This has resulted in our being particularly vulnerable to increases in interest rates, as our interest-bearing liabilities mature or reprice more quickly than our interest-earning assets.

Our policies do not permit hedging activities, such as engaging in futures, options or swap transactions, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage-backed securities.

Net Portfolio Value. The Office of Thrift Supervision requires the computation of amounts by which the difference between the present value of an institution’s assets and liabilities (the institution’s net portfolio value or “NPV”) would change in the event of a range of assumed changes in market interest rates. The Office of Thrift Supervision provides all institutions that file a Consolidated Maturity/Rate Schedule as a part of their quarterly Thrift Financial Report with a report that measures the sensitivity of net portfolio value. The Office of Thrift Supervision simulation model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of net portfolio value. Historically, the Office of Thrift Supervision model estimated the economic value of each type of asset, liability and off-balance sheet contract using the current interest rate yield curve with instantaneous increases or decreases of 100 to 300 basis points in 100 basis point increments. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. Given the current relatively low level of market interest rates, an NPV calculation for an interest rate decrease of greater than 100 basis points has not been prepared. The Office of Thrift Supervision provides us the results of the interest rate sensitivity model, which is based on information we provide to the Office of Thrift Supervision to estimate the sensitivity of our net portfolio value.

The table below presents, as of March 31, 2011, the Office of Thrift Supervision’s calculation of the estimated changes in our net portfolio value that would result from the designated instantaneous changes in the interest rate yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.

 

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Change in Interest Rates (bp) (1)		Estimated NPV (2)				Estimated Increase (Decrease) in NPV				Percentage Change in NPV				NPV Ratio as a Percent of Present Value of Assets (3)(4)				Increase (Decrease) in NPV Ratio as a Percent of Present Value of Assets (3)(4)
+300		$	155,150			$	(131,321	)			(45.84	)%			10.80	%			(7.33	)%
+200		$	201,935			$	(84,536	)			(29.51	)%			13.58	%			(4.55	)%
+100		$	247,870			$	(38,601	)			(13.47	)%			16.12	%			(2.01	)%
0		$	286,471				—				—				18.13	%			—
(100)		$	311,674			$	25,203				8.80	%			19.36	%			1.23	%

 

(1)	Assumes an instantaneous uniform change in interest rates for all maturities.

(2)	NPV is the difference between the present value of an institution’s assets and liabilities.

(3)	Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.

(4)	NPV Ratio represents NPV divided by the present value of assets.

The table above indicates that at March 31, 2011, in the event of a 200 basis point increase in interest rates, we would experience a 29.5% decrease in net portfolio value. In the event of a 100 basis point decrease in interest rates, we would experience an 8.8% increase in net portfolio value.

In addition to the Office of Thrift Supervision’s calculations with respect to the effects of changes in interest rates on net portfolio value, we prepare our own internal calculations, which utilize a single interest rate scenario and prepayment assumption in calculating the market value of fixed- and adjustable-rate loans (compared to the Office of Thrift Supervision model, which uses an option-based pricing methodology). Our model also calculates the average life and value for core deposit intangibles that is based on a core deposit study we completed in 2009, whereas the Office of Thrift Supervision model uses a nationwide study to estimate the average life and value for core deposit intangibles. The following table presents our internal calculations of the estimated changes in our net portfolio value as of March 31, 2011 that would result from the designated instantaneous changes in the interest rate yield curve:

 

Change in Interest Rates (bp) (1)		Estimated NPV (2)				Estimated Increase (Decrease) in NPV				Percentage Change in NPV				NPV Ratio as a Percent of Present Value of Assets (3)(4)				Increase (Decrease) in NPV Ratio as a Percent of Present Value of Assets (3)(4)
+300		$	237,010			$	(59,678	)			(20.11	)%			15.62	%			(3.06	)%
+200		$	261,966			$	(34,722	)			(11.70	)%			16.95	%			(1.73	)%
+100		$	285,238			$	(11,450	)			(3.86	)%			18.13	%			(0.55	)%
0		$	296,688				—				—				18.68	%			—
(100)		$	271,458			$	(25,230	)			(8.50	)%			17.32	%			(1.36	)%

 

(1)	Assumes an instantaneous uniform change in interest rates for all maturities.

(2)	NPV is the difference between the present value of an institution’s assets and liabilities.

(3)	Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.

(4)	NPV Ratio represents NPV divided by the present value of assets.

We believe that our interest rate risk position has not weakened between March 31, 2011 and June 30, 2011.

 

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Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in net portfolio value. Modeling changes in net portfolio value requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the net portfolio value tables presented assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the net portfolio value tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

 

ITEM 4.

CONTROLS AND PROCEDURES

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chairman of the Board, President and Chief Executive Officer and the Senior Vice President and Treasurer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of June 30, 2011. Based on that evaluation, the Company’s management, including the Chairman of the Board, President and Chief Executive Officer and the Senior Vice President and Treasurer, concluded that the Company’s disclosure controls and procedures were effective.

During the quarter ended June 30, 2011, there have been no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II

 

ITEM 1.

LEGAL PROCEEDINGS

The Company and its subsidiaries are subject to various legal actions that are considered ordinary, routine litigation incidental to the business of the Company, and no claim for money damages exceeds ten percent of the Company’s consolidated assets. In the opinion of management, based on currently available information, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s results of operations.

 

ITEM 1A.

RISK FACTORS

There have been no material changes from Risk Factors as previously disclosed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission for the period ended December 31, 2010.

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

(a)

Not applicable.

 

(b)

Not applicable.

 

(c)

Not applicable.

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4.

[RESERVED]

 

ITEM 5.

OTHER INFORMATION

None.

 

ITEM 6.

EXHIBITS

The exhibits required by Item 601 of Regulation S-K are included with this Form 10-Q and are listed on the “Index to Exhibits” immediately following the Signatures.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

						TERRITORIAL BANCORP INC.
						(Registrant)
		Date: August 8, 2011						/s/    ALLAN S. KITAGAWA
								Allan S. Kitagawa
								Chairman of the Board, President and Chief Executive Officer
		Date: August 8, 2011						/s/    MELVIN M. MIYAMOTO
								Melvin M. Miyamoto
								Senior Vice President and Treasurer

 

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INDEX TO EXHIBITS

 

Exhibit Number		Description
31.1		Certification of Allan S. Kitagawa, Chairman of the Board, President and Chief Executive Officer, Pursuant to Rule 13a-14(a) and Rule 15d-14(a).
31.2		Certification of Melvin M. Miyamoto, Senior Vice President and Treasurer, Pursuant to Rule 13a-14(a) and Rule 15d-14(a).
32		Certification of Allan S. Kitagawa, Chairman of the Board, President and Chief Executive Officer, and Melvin M. Miyamoto, Senior Vice President and Treasurer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101		The following financial statements from Territorial Bancorp Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, filed on August 8, 2011, formatted in XBRL: (i) Consolidated Statements of Income, (ii) Condensed Consolidated Balance Sheets, (iii) Condensed Consolidated Statements of Cash Flows, (iv) Consolidated Statements of Equity, (v) the Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.

 

101.INS		Interactive datafile		XBRL Instance Document
101.SCH		Interactive datafile		XBRL Taxonomy Extension Schema Document
101.CAL		Interactive datafile		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		Interactive datafile		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB		Interactive datafile		XBRL Taxonomy Extension Label Linkbase
101.PRE		Interactive datafile		XBRL Taxonomy Extension Presentation Linkbase Document

 

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