Central Pacific Financial Corp: Form 10-Q for the period ended Sep 30, 2023

Forward-Looking Statements and Factors that Could Affect Future Results

Certain statements contained in this quarterly report on Form 10-Q that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act"), notwithstanding that such statements are not specifically identified. In addition, certain statements may be contained in our future filings with the U.S. Securities and Exchange Commission ("SEC"), in press releases and in oral and written statements made by us or with our approval that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, capital expenditures, the payment or nonpayment of dividends, capital position, credit losses, and net interest margin or other financial items; (ii) statements of plans, objectives and expectations of Central Pacific Financial Corp. (the "Company") or its management or Board of Directors, including those relating to business plans, use of capital resources, products or services and regulatory developments and regulatory actions; (iii) statements of future economic performance including anticipated performance results from our Banking-as-a-Service ("BaaS") initiative; and (iv) any statements of the assumptions underlying or relating to any of the foregoing. Words such as "believe," "plan," "anticipate," "expect," "intend," "forecast," "hope," "target," "continue," "remain," "estimate," "will," "should," "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

While we believe that our forward-looking statements and the assumptions underlying them are reasonably based, such statements and assumptions are by their nature subject to risks and uncertainties, and thus could later prove to be inaccurate or incorrect. Accordingly, actual results could differ materially from those statements or projections for a variety of reasons. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

• the effects of inflation and rising interest rates;
• the adverse effects of recent bank failures and the potential impact of such developments on customer confidence, deposit behavior, liquidity and regulatory responses thereto;
• the adverse effects of the COVID-19 pandemic virus (and ongoing pandemic variants) on local, national and international economies, including, but not limited to, the adverse impact on tourism and construction in the State of Hawaii, our borrowers, customers, third-party contractors, vendors and employees;
• supply chain disruptions;
• the increase in inventory or adverse conditions in the real estate market and deterioration in the construction industry;
• adverse changes in the financial performance and/or condition of our borrowers and, as a result, increased loan delinquency rates, deterioration in asset quality, and losses in our loan portfolio;
• our ability to successfully implement and achieve the objectives of our BaaS initiatives, including adoption of the initiatives by customers and risks faced by any of our bank collaborations including reputational and regulatory risk;
• the impact of local, national, and international economies and events (including natural disasters such as wildfires, volcanic eruptions, hurricanes, tsunamis, storms, earthquakes and pandemic viruses and diseases) on the Company's business and operations and on tourism, the military, and other major industries operating within the Hawaii market and any other markets in which the Company does business;
• deterioration or malaise in domestic economic conditions, including any destabilization in the financial industry and deterioration of the real estate market, as well as the impact of declining levels of consumer and business confidence in the state of the economy in general and in financial institutions in particular;
• changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements;
• the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), changes in capital standards, other regulatory reform and federal and state legislation, including but not limited to regulations promulgated by the Consumer Financial Protection Bureau (the "CFPB"), government-sponsored enterprise reform, and any related rules and regulations which affect our business operations and competitiveness;
• the costs and effects of legal and regulatory developments, including legal proceedings and lawsuits we are or may become subject to, or regulatory or other governmental inquiries and proceedings and the resolution thereof, the results of regulatory examinations or reviews and the effect of, and our ability to comply with, any regulations or regulatory orders or actions we are or may become subject to;
• ability to successfully implement our initiatives to lower our efficiency ratio;
• the effects of and changes in trade, monetary and fiscal policies and laws, including the interest rate policies of the Board of Governors of the Federal Reserve System (the "FRB" or the "Federal Reserve");
• securities market and monetary fluctuations, including the replacement of the London Interbank Offered Rate ("LIBOR") Index and the impact on our loans and debt which are tied to that index and uncertainties regarding potential alternative reference rates, including the Secured Overnight Financing Rate ("SOFR");
• negative trends in our market capitalization and adverse changes in the price of the Company's common stock;
• political instability;
• acts of war or terrorism;
• changes in consumer spending, borrowings and savings habits;
• cybersecurity and data privacy breaches and the consequence therefrom;
• failure to maintain effective internal control over financial reporting or disclosure controls and procedures;
• the ability to address deficiencies in our internal controls over financial reporting or disclosure controls and procedures;
• technological changes and developments;
• changes in the competitive environment among financial holding companies and other financial service providers;
• the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board ("PCAOB"), the Financial Accounting Standards Board ("FASB") and other accounting standard setters and the cost and resources required to implement such changes;
• our ability to attract and retain key personnel;
• changes in our personnel, organization, compensation and benefit plans;
• and our success at managing the risks involved in the foregoing items.

For further information with respect to factors that could cause actual results to materially differ from the expectations or projections stated in the forward-looking statements, please see the Company's publicly available Securities and Exchange Commission filings, including the Company's Form 10-K for the last fiscal year and in particular, the discussion of "Risk Factors" set forth therein and herein. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this document. Forward-looking statements speak only as of the date on which such statements are made. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events except as required by law.

Overview

Central Pacific Financial Corp. ("CPF") is a Hawaii corporation and a bank holding company. Our principal business is to serve as a holding company for our bank subsidiary, Central Pacific Bank. We refer to Central Pacific Bank herein as "our Bank" or "the Bank," and when we say "the Company," "we," "us" or "our," we mean the holding company on a consolidated basis with the Bank and our other consolidated subsidiaries.

Central Pacific Bank is a full-service community bank with 27 branches and 58 ATMs located throughout the State of Hawaii as of September 30, 2023.

The Bank offers traditional deposit and lending products and services to consumer and business customers such as accepting demand, money market, savings and time deposits, originating loans, including commercial loans, construction loans, commercial real estate loans, residential mortgage loans, and consumer loans and fiduciary and investment management services.

Basis of Presentation

Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements under "Part I, Item 1. Financial Statements (Unaudited)." The following discussion should also be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2022 filed with the U.S. Securities and Exchange Commission (the "SEC") on February 24, 2023, including the “Risk Factors” set forth therein.

Critical Accounting Policies and Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") requires that management make certain judgments and use certain estimates and assumptions that affect amounts reported and disclosures made. Actual results may differ from those estimates and such differences could be material to the financial statements.

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

The Company identified a significant accounting policy, which involves a higher degree of judgment and complexity in making certain estimates and assumptions that affect amounts reported in our consolidated financial statements. At September 30, 2023 and December 31, 2022, the significant accounting policy that we believed to be the most critical in preparing our consolidated financial statements is the determination of the allowance for credit losses ("ACL") on loans. This is further described in Note 1 - Summary of Significant Accounting Policies included in the accompanying notes to the consolidated financial statements for the quarterly period ended September 30, 2023, Note 1 - Summary of Significant Accounting Policies included in the accompanying notes to the consolidated financial statements for the year ended December 31, 2022, and the section titled "Critical Accounting Policies and Use of Estimates" in Management's Discussion and Analysis of Financial Condition and Operating Results included in the Company's 2022 Annual Report on Form 10-K.

Financial Summary

Net income for the three months ended September 30, 2023 was $13.1 million, or $0.49 per diluted share, compared to net income of $16.7 million, or $0.61 per diluted share for the three months ended September 30, 2022. Net income for the nine months ended September 30, 2023 was $43.8 million, or $1.62 per diluted share, compared to net income of $53.7 million, or $1.94 per diluted share for the nine months ended September 30, 2022. Net income for the nine months ended September 30, 2022 included an $8.5 million non-recurring gain on sale of Class B common stock of Visa, Inc., partially offset by a $4.9 million non-recurring, non-cash settlement charge related to the termination and settlement of our defined benefit pension plan.

During the three months ended September 30, 2023, the Company recorded a debit to the provision for credit losses of $4.9 million, compared to a debit to the provision of $0.4 million during the three months ended September 30, 2022. During the nine months ended September 30, 2023, the Company recorded a debit to the provision for credit losses of $11.0 million, compared to a credit to the provision of $1.8 million during the nine months ended September 30, 2022. The increase in the provision for credit losses during the three and nine months ended September 30, 2023, compared to the same year-ago periods, is primarily due to higher charge-offs of our U.S. Mainland unsecured consumer loan portfolio, and the outlook for continued pressure on the national consumer segment.

Excluding the provision for credit losses and income tax expense, the Company's pre-provision net revenue ("PPNR") for the three months ended September 30, 2023 was $22.4 million, compared to $23.0 million for the three months ended September 30, 2022. PPNR for the nine months ended September 30, 2023 was $68.7 million, compared to PPNR of $70.0 million for the nine months ended September 30, 2022.

The following table presents annualized returns on average assets ("ROA") and average shareholders' equity ("ROE"), and basic and diluted earnings per share ("EPS") for the periods presented. ROA and ROE are annualized based on a 30/360 day convention.

50

Non-GAAP Financial Measures

The Company uses certain non-GAAP financial measures in addition to our GAAP results to provide useful information for evaluating our cash operating performance, ability to service debt, compliance with debt covenants and measurement against competitors. This information should be considered as supplemental in nature and should not be considered in isolation or as a substitute for the related financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be comparable to similarly entitled measures reported by other companies.

Pre-Provision Net Revenue

The Company believes that PPNR, a non-GAAP financial measure, is useful as a tool to help evaluate the ability to provide for credit costs through operations. The following table presents a reconciliation of the Company's PPNR for the periods presented:

(dollars in thousands)

Efficiency Ratio

The Company believes that the efficiency ratio, a non-GAAP financial measure, provides useful supplemental information that is important to a proper understanding of the Company's business results and operating efficiency, which is calculated by dividing total other operating expense by total revenue (net interest income and total other operating income).

The following table presents a calculation of our efficiency ratio for the periods presented:

(dollars in thousands)

Our efficiency ratio improved slightly to 63.91% in the third quarter of 2023, compared to 64.62% in the year-ago quarter. For the nine months ended September 30, 2023, our efficiency ratio improved slightly to 63.89%, compared to 64.19% in the year-ago period.

The lower efficiency ratio in the third quarter of 2023 was primarily due to higher other operating income, combined with lower other operating expense, partially offset by lower net interest income compared to the year-ago period.

Recent Industry Developments

Beginning in March 2023, the banking industry experienced significant volatility due to recent high-profile regional bank failures, which resulted in industry-wide concerns related to liquidity, deposit outflows, unrealized or unrecognized losses on investment securities and impacting consumer confidence in the banking industry. As a result, the Company took a number of preemptive actions during the first half of 2023, which included pro-active outreach to clients and other liquidity contingency planning actions, such as maximizing funding sources and increasing liquidity monitoring in response to these recent developments.

Despite industry and market volatility, we believe the Company’s balance sheet, asset quality and liquidity position remained solid. The Company's total deposits of $6.87 billion increased by $69.0 million during the three months ended September 30, 2023 and increased by $138.5 million during the nine months ended September 30, 2023. The Company's deposit portfolio is diversified and long-tenured and 65% of total deposits were FDIC-insured or collateralized as of September 30, 2023. The Company had $438.7 million in cash on its balance sheet and approximately $2.47 billion in total other liquidity sources, including available borrowing capacity and unpledged investment securities as of September 30, 2023. Total available sources of liquidity as a percentage of uninsured and uncollateralized deposits was 122%.

Finally, the Company’s capital remained strong with the leverage, tier 1 risk-based capital, total risk-based capital, and common equity tier 1 capital ratios of 8.7%, 11.9%, 14.1%, and 11.0%, respectively, as of September 30, 2023, all exceeding "well capitalized" regulatory standards.

Material Trends

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

On August 8, 2023, a series of wildfires broke out on the Island of Maui, in Kula, Upcountry Maui, Kihei, and most devastatingly in the town of Lahaina. The wildfires took the lives of at least 98 people and destroyed over 2,200 structures, of which approximately 86% were residential homes. The disaster area had more than 800 business establishments with about 7,000 employees. Initial unemployment claims jumped from an average of 130 cases per week before the wildfire to 865 cases in the first week after the fire, to 4,449 in the second week, and to 2,705 cases in the third week. A total of 88 transpacific flights to Maui were cancelled in August, representing 23,083 air seats. Visitors to Maui decreased by approximately 58% in August 2023 compared to August 2022. West Maui officially reopened to visitors in early October 2023 and government officials are encouraging travelers to return to Maui, while avoiding the affected area, to support its economic recovery.

The Company did not sustain any damages to its facilities or ATMs on Maui. As of September 30, 2023, the Company had approximately $107 million in loans to borrowers in Maui, of which the Company has estimated $78 million were not impacted by the Maui wildfires. This estimate is based on the information available to the Company at the time of this filing. Additional information, as it becomes available, could change this estimate.

In response to the Maui wildfires, the Company provided three to six months interest and/or principal loan payment deferrals to customers who were directly impacted by the wildfires on a case-by-case basis. The Company granted 142 loan payment deferrals on loan balances totaling $32.7 million as of September 30, 2023.

While the Maui wildfires will likely lead to sharp and persistent economic losses on the island of Maui, there may be limited adverse effects on the broader Hawaii economy. Although Maui represents a significant share of Hawaii's tourism, and total visitors to Hawaii have fallen, many believe some would-be visitors to Maui will instead travel to the other Hawaiian Islands, such as Oahu, Kauai or Hawaii Island.

Prior to the Maui wildfires, Hawaii’s economy continued its recovery from the COVID-19 pandemic. According to the latest available statistics from the Hawaii Tourism Authority ("HTA"), a total of 6.7 million visitors arrived to the Hawaiian Islands year-to-date through August 31, 2023, mainly from the U.S. Mainland. This was an 8.0% increase from the 6.2 million visitors during the same period last year, and represents a recovery of approximately 94% from the 7.1 million visitors during the same period in the pre-pandemic and record year in 2019. Japanese visitor arrivals continue to increase modestly, however, year-to-date through August 31, 2023, are only at around 32% of pre-pandemic levels. According to more recent available data from the Department of Business, Economic Development and Tourism, Japanese visitor arrivals are now at approximately 48% of pre-pandemic levels based on the 7-day moving average as of October 15, 2023 compared to the same 7 days in 2019.

Total spending for visitors arriving in the eight months ended August 31, 2023 was $14.41 billion, up 10.1% from $13.10 billion in the same period last year, and up by 19.6% from $12.06 billion in the eight months ended August 31, 2019.

According to a September 2023 report by the University of Hawaii Economic Research Organization ("UHERO"), total visitor arrivals by air are expected to be approximately 9.4 million in 2023, which is lower than previously projected due to the Maui wildfires, but an increase of approximately 1.9% from 9.2 million last year. Visitor spending is expected to increase approximately 1.7% to $19.57 billion in 2023 which would exceed last year's record year for visitor spending of $19.25 billion.

The Department of Labor and Industrial Relations reported that Hawaii's seasonally adjusted annual unemployment rate improved to 2.8% in the month of September 2023, compared to 3.7% in the month of September 2022 and the national seasonally adjusted unemployment rate of 3.8% in the month of September 2023. UHERO projects Hawaii's seasonally adjusted annual unemployment rate to be approximately 3.7% in 2023.

Real estate is lending one of the primary focuses for the Company, including residential mortgage and commercial mortgage loans. As a result, the Company is dependent on the strength of Hawaii's real estate market. While the Hawaii housing market continues to experience some moderation in sales activity and prices, there continues to be strong demand and low inventory. According to the Honolulu Board of Realtors, sales of Oahu single-family homes and condominiums in the nine months ended September 30, 2023 were down 30.5% and 31.2%, respectively, from the same prior year period. The Oahu single-family home median price in the nine months ended September 30, 2023 fell 5.4% to $1.05 million from $1.11 million in the same prior year period. The Oahu condominium median price in the nine months ended September 30, 2023 fell 1.0% to $505,000 from $510,000 in the same prior year period.

Hawaii's economy is measured by the growth of real personal income and real gross state product. UHERO projects real personal income to grow by 2.9% and real gross state product to grow by 3.4% for 2023.

Banking-as-a-Service Initiative

In January 2022, the Company announced the launch of a new Banking-as-a-Service ("BaaS") initiative with the goal of expanding the Company both in and beyond Hawaii by investing in or collaborating with fintech companies. In the first quarter of 2022, the Company made a $2.0 million minority equity investment in Swell Financial, Inc. ("Swell"), a new fintech company. During the fourth quarter of 2022, Swell launched a consumer banking application that combined checking, credit and more into one integrated account, and Central Pacific Bank serving as the bank sponsor. As a result of a variety of adverse factors affecting Swell’s business and its strategy, the portfolio of Swell Cash and Credit accounts, which were immaterial, were closed in June 2023 and the Bank is no longer serving as the bank sponsor of Swell. As discussed in Note 5 - Investments in Unconsolidated Entities in the accompanying notes to the consolidated financial statements in this report, the Company entered into a transaction with Swell in the third quarter of 2023 whereby Swell repurchased the Company’s entire preferred and common stock equity investment in exchange for $0.5 million in cash, certain intellectual property rights and a platform usage fee agreement related to products that may be launched by Swell or its affiliates in the future (not to exceed $1.5 million in value). The Company cannot provide any assurance that the platform usage fees will be collected.

Due to the current operating environment, the BaaS initiative is not expected to have a material impact on the Company's financial statements in 2023. The Company continues to evaluate potential future BaaS opportunities.

Results of Operations

Net Interest Income

Net interest income, when annualized and expressed as a percentage of average interest earning assets, is referred to as "net interest margin." Interest income, which includes loan fees and resultant yield information, is expressed on a taxable-equivalent basis using a federal statutory tax rate of 21% for the three and nine months ended September 30, 2023 and 2022. A comparison of net interest income on a taxable-equivalent basis for the three and nine months ended September 30, 2023 and 2022 is presented below.

(dollars in thousands)

Net interest income (expressed on a taxable-equivalent basis) was $52.1 million for the third quarter of 2023, representing a decrease of $3.5 million, or 6.2% from $55.6 million in the year-ago quarter. The decrease from the year-ago quarter was primarily due to an increase in interest expense of $16.2 million, which was attributable to increases in average balances and average rates paid on interest-bearing deposits and long-term debt. The increases in average balances and average rates paid on interest-bearing deposits reflects the continued shift in the deposit portfolio composition from demand to higher cost savings and money market and time deposits. These increases outpaced the increases in average balances and average yields earned on loans.

Interest Income

Taxable-equivalent interest income was $72.6 million for the third quarter of 2023, representing an increase of $12.7 million, or 21.2%, from $59.9 million in the year-ago quarter. The increase during the third quarter of 2023, compared to the year-ago quarter was primarily attributable to an increase in average yield earned on loans of 65 basis points ("bps"), resulting in an increase in interest income of approximately $9.0 million, combined with an increase in average loan balances of $152.2 million, resulting in an increase in interest income of approximately $1.5 million. In addition, increases in the average balances and average yield earned on interest-bearing deposits in other financial institutions resulted in an increase in interest income of approximately $2.3 million.

Interest Expense

Interest expense was $20.5 million for the third quarter of 2023, representing an increase of $16.2 million, or 375.9%, from $4.3 million in the year-ago quarter. Due to the rising interest rate environment, average rates paid on interest-bearing deposits of 1.49% increased by 127 bps from the year-ago quarter, resulting in an increase in interest expense of approximately $14.8 million, and average interest-bearing deposit balances increased by $513.5 million from the year-ago quarter, resulting in an increase in interest expense of approximately $1.0 million. Average balances and average rates paid on long-term debt increased by $50.2 million and 103 bps, respectively, resulting in an increase in interest expense of approximately $1.0 million from the year-ago quarter.

Net Interest Margin

Our net interest margin of 2.88% for the third quarter of 2023 decreased by 29 bps from 3.17% in the year-ago quarter. The decrease in net interest margin for the third quarter of 2023 was primarily attributable to increases in average rates paid on interest-bearing deposits and long-term debt, which outpaced the increases in average yields earned on loans, interest-bearing deposits in other financial institutions and investment securities.

In an effort to rein in inflation, the FRB aggressively increased interest rates since the first quarter of 2022 when the Federal Funds Rate target was 0.00%-0.25%. Over the last 16 months, the FRB has raised the Federal Funds Rate by more than five percentage points, to the current 5.25-5.50%, a 22-year high.

Federal Reserve officials indicated that they anticipate one more hike before the end of the year and interest rates staying higher for longer with two cuts, or two fewer cuts than previously indicated, next year. The Company anticipates its average loan yield will continue to increase in the rising interest rate environment. Deposit and borrowing costs will also increase. The extent will depend on the competitive market environment and the Company's ability to retain and grow lower cost deposits. Such factors will influence the future direction of the net interest margin. In addition to the impacts from changes in monetary policy, other economic conditions may impact financial results in future periods. Inflationary concerns, labor shortages, changes to the political and regulatory environment, including geopolitical conflicts, supply chain disruptions and the possibility of future bank failures, could adversely impact the economy, which could negatively impact our financial results as well as our customers’ creditworthiness. In light of these potential issues, we continue to monitor our liquidity and capital positions.

(dollars in thousands)

Net interest income (expressed on a taxable-equivalent basis) was $159.5 million for the nine months ended September 30, 2023, representing a decrease of 0.3% from $159.9 million in the nine months ended September 30, 2022. The decrease from the year-ago period was primarily due to higher average balances and average rates paid on interest-bearing deposits and long-term debt, combined with a decrease in average investment securities balances. These negative variances were partially offset by increases in average loan balances, combined with increases in average yields earned on loans, interest-bearing deposits in other financial institutions and investment securities.

Interest Income

Taxable-equivalent interest income was $209.1 million for the nine months ended September 30, 2023, representing an increase of $40.9 million, or 24.3%, from $168.3 million in the year-ago period. The increase was primarily attributable to increases in average yields earned on loans of 70 bps and average loan balances of $294.4 million, resulting in increases in interest income of approximately $29.1 million and $8.1 million, respectively. In addition, the average yields earned on interest-bearing deposits in other financial institutions and investment securities increased by 470 bps and 16 bps, respectively, resulting in an increase in interest income of approximately $3.2 million and $1.8 million, respectively. These increases were partially offset by a decrease in average investment securities balances of $106.2 million during the nine months ended September 30, 2023, compared to the year-ago period, resulting in a decrease in interest income of approximately $1.5 million.

Interest Expense

Interest expense was $49.7 million for the nine months ended September 30, 2023, which increased by $41.3 million, or 495.7%, from $8.3 million in the year-ago period. Due to the rising interest rate environment, average rates paid on interest-bearing deposits of 1.19% increased by 106 bps and average interest-bearing deposit balances increased by $402.5 million from the year-ago period, resulting in increases in interest expense of approximately $36.6 million and $1.4 million, respectively. Increases in average balances and average rates paid on long-term debt of $40.8 million and 141 bps, respectively, resulted in an increase in interest expense of approximately $2.9 million from the year-ago period.

Net Interest Margin

Our net interest margin of 2.98% for the nine months ended September 30, 2023 decreased by 8 bps from 3.06% in the year-ago period. As previously discussed, the decrease in net interest margin for the nine months ended September 30, 2023 compared to the year-ago period was primarily attributable to the aforementioned increases in average rates paid on interest-bearing deposits and long-term debt, which outpaced the increases in average yields earned on loans, interest-bearing deposits in other financial institutions and investment securities.

Rate-Volume Analysis

For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (i) changes in average balances (volume) and (ii) changes in weighted average interest rates (rate). The change in volume is calculated as change in average balance, multiplied by prior period average yield/rate. The change in rate is calculated as change in average yield/rate, multiplied by current period volume. The change in interest income not solely due to change in volume or change in rate has been allocated proportionately to change in volume and change in average yield/rate.

(dollars in thousands)

Provision for Credit Losses

During the third quarter of 2023, we recorded a provision for credit losses of $4.9 million, which consisted of a provision for credit losses on loans of $4.5 million and a provision for credit losses on off-balance sheet credit exposures of $0.4 million.

During the nine months ended September 30, 2023, we recorded a provision for credit losses of $11.0 million, which consisted of a provision for credit losses on loans of $10.3 million and a provision for credit losses on off-balance sheet credit exposures of $0.7 million.

During the third quarter of 2022, we recorded a provision for credit losses of $0.4 million, which consisted of a debit to the provision for credit losses on loans of $0.7 million, offset by a credit to the provision for credit losses on off-balance sheet credit exposures of $0.3 million.

During the nine months ended September 30, 2022, we recorded a credit to the provision for credit losses of $1.8 million, which consisted of a credit to the provision for credit losses on loans of $0.7 million and a credit to the provision for credit losses on off-balance sheet credit exposures of $1.1 million.

The increase in the provision for credit losses on loans during the three and nine months ended September 30, 2023, compared to the same year-ago periods, is primarily due to higher charge-offs of our U.S. Mainland unsecured consumer loan portfolio, and the outlook for continued pressure on the national consumer segment.

We did not record a provision for credit losses on investment securities during the three and nine months ended September 30, 2023 and 2022.

We recorded net charge-offs of $3.9 million during the third quarter of 2023, compared to net charge-offs of $1.6 million in the year-ago quarter.

We recorded net charge-offs of $9.5 million during the nine months ended September 30, 2023, compared to net charge-offs of $3.0 million in the year-ago period.

Other Operating Income

The following tables present components of other operating income for the periods presented:

(dollars in thousands)

For the third quarter of 2023, total other operating income was $10.0 million, which increased by $0.4 million, or 4.3%, from $9.6 million in the year-ago quarter. The increase was primarily due to higher other service charges and fees of $0.2 million and higher income from bank-owned life insurance ("BOLI") of $0.2 million, compared to the year-ago quarter.

(dollars in thousands)

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For the nine months ended September 30, 2023, total other operating income was $31.5 million, which decreased by $4.8 million, or 13.3%, from $36.3 million in the year-ago period. The decrease from the year-ago period was primarily due to a non-recurring $8.6 million gain on sale of Class B common stock of Visa, Inc. ("Visa") recorded in the second quarter of 2022. Due to transfer restrictions on the Visa Class B common stock and the lack of a readily determinable fair value, the investment was carried at a zero cost basis, therefore the entire net proceeds from the sale of $8.5 million were recorded as a gain on sale of investment securities. In addition, the Company recorded lower mortgage banking income of $1.2 million during the nine months ended September 30, 2023, compared to the same year-ago period. These decreases were partially offset by higher income from BOLI of $3.2 million during the nine months ended September 30, 2023, compared to the same year-ago period.

The lower mortgage banking income during the three and nine months ended September 30, 2023 was primarily attributable to lower origination activity due to the rising interest rate environment. The higher income from BOLI during the three and nine months ended September 30, 2023 was primarily attributable to volatile equity market returns and their impact on corporate-owned life insurance policies used to hedge deferred compensation expense.

Other Operating Expense

The following tables present components of other operating expense for the periods presented:

(dollars in thousands)

For the third quarter of 2023, total other operating expense was $39.6 million, which decreased by $2.4 million, or 5.7%, from $42.0 million in the year-ago quarter. The decrease was primarily due to lower salaries and employee benefits of $3.8 million compared to the year-ago quarter, partially offset by higher FDIC insurance assessment of $0.5 million and computer software expense of $0.3 million. The decline in salaries and employee benefits is primarily due to lower incentive accruals and deferred compensation expense, as well as management of personnel count.

(dollars in thousands)

For the nine months ended September 30, 2023, total other operating expense was $121.6 million and decreased by $3.9 million, or 3.1%, from $125.6 million in the same year-ago period. The decrease was primarily due to a non-recurring non-cash charge of $4.9 million related to the termination and settlement of the Company's defined benefit retirement plan during the second quarter of 2022, combined with lower salaries and employee benefits of $4.2 million, compared to the same year-ago period. These decreases were partially offset by higher computer software expense of $2.9 million and higher FDIC insurance assessment of $1.4 million compared to the same year-ago period.

Income Taxes

The Company recorded income tax expense of $4.3 million for the third quarter of 2023, compared to $5.9 million in the same year-ago period. The effective tax rate for the third quarter of 2023 was 24.87%, compared to 26.15% in the same year-ago period.

The Company recorded income tax expense of $13.9 million for the nine months ended September 30, 2023, compared to $18.1 million in the same year-ago period. The effective tax rate for the nine months ended September 30, 2023 was 24.06%, compared to 25.24% in the same year-ago period. The decrease in the effective tax rate for the three and nine months ended September 30, 2023 was primarily attributable to higher tax-exempt BOLI income compared to the same year-ago periods, combined with lower pre-tax income compared to the same year-ago periods.

The valuation allowance on our net deferred tax assets ("DTA") at September 30, 2023 and December 31, 2022 totaled $3.4 million, which related entirely to our DTA from net apportioned net operating loss ("NOL") carryforwards for California state income tax purposes, as the Company does not expect to generate sufficient income in California to utilize the DTA.

Net of the valuation allowance, the Company's DTA totaled $39.6 million at September 30, 2023, compared to a DTA of $48.5 million as of December 31, 2022, and is included in other assets on our consolidated balance sheets. The decrease in DTA was primarily due to projected utilization of net operating loss carryforwards, which arose in 2022 due to unrealized losses on investment securities.

Financial Condition

Total assets were $7.64 billion at September 30, 2023 and increased by $205.2 million, or 2.8%, from $7.43 billion at December 31, 2022.

Investment Securities

Investment securities totaled $1.27 billion at September 30, 2023, which decreased by $71.4 million, or 5.3%, from $1.34 billion at December 31, 2022. The decrease in the investment securities portfolio reflects principal runoff of $77.0 million and a market valuation reduction on the AFS portfolio of $11.9 million, partially offset by purchases of investment securities of $19.1 million. The decline in the market valuation was primarily driven by the rising interest rate environment.

To mitigate the potential future impact to capital through AOCI due to the fluctuation in market valuation, during the first half of 2022, the Company transferred 81 investment securities that were classified as AFS to HTM. The investment securities had an amortized cost basis of $762.7 million and a fair market value of $673.2 million. On the date of transfers, these securities had a total net unrealized loss of $89.5 million. There was no impact to net income as a result of the reclassifications.

In addition, during the first quarter of 2022, the Company entered into a forward starting interest rate swap on certain municipal debt securities with a notional amount of $115.5 million. The Company will pay the counterparty a fixed rate of 2.095% and will receive a floating rate based on the Federal Funds effective rate. This transaction has an effective date of March 31, 2024 and a maturity date of March 31, 2029.

Loans

The following table presents outstanding loans by category and geographic location as of the dates presented:

(dollars in thousands)

Loans, net of deferred costs, totaled $5.51 billion at September 30, 2023, which decreased by $46.8 million, or 0.84%, from $5.56 billion at December 31, 2022. The decrease is primarily due to decreases in consumer of $115.5 million and residential mortgage loans of $10.3 million. These decreases were offset by increases in following loan portfolios: construction of $44.8 million, other commercial loans of $18.4 million and home equity of $14.6 million.

The Hawaii loan portfolio increased by $55.8 million, or 1.2%, from December 31, 2022. The increase reflects increases in the following loan portfolios: construction of $23.8 million, other commercial and industrial loans of $21.4 million, commercial mortgage of $15.9 million and home equity of $14.6 million. These increases were partially offset by decreases in residential mortgage of $10.3 million and consumer of $8.5 million.

The U.S. Mainland loan portfolio decreased by $102.5 million, or 10.7% from December 31, 2022. The decrease was primarily attributable to decreases in consumer loans of $107.0 million, commercial mortgage loans of $13.6 million and other commercial and industrial loans of $2.9 million, partially offset by a net increase in construction loans of $20.9 million. As a prudent measure, we continue to let the U.S. Mainland unsecured consumer loan portfolio run off. Refer to Note 3 - Loans and Credit Quality in the accompanying notes to the consolidated financial statements in this report for information on U.S. Mainland loan portfolio purchases.

Nonperforming Assets and Accruing Loans 90+ Days Past Due

The following table presents nonperforming assets and accruing loans 90+ days past due as of the dates presented:

(dollars in thousands)

64

The following table presents year-to-date activities in nonperforming assets for the period presented:

(dollars in thousands)

Nonperforming assets, which includes nonaccrual loans and other real estate owned, totaled $6.7 million at September 30, 2023, compared to $5.3 million at December 31, 2022. There were no nonperforming loans classified as held for sale at September 30, 2023 and December 31, 2022. The increase in nonperforming assets from December 31, 2022 was primarily attributable to additions to nonaccrual loans totaling $11.0 million, partially offset by $6.5 million in repayments of nonaccrual loans, $0.4 million in loans returned to accrual status and $2.7 million in net charge-offs, valuation and other adjustments.

Since the adoption of ASU 2022-02 on January 1, 2023 and during the three and nine months ended September 30, 2023, the Company has not modified any material loans for borrowers experiencing financial difficulty. In response to the Maui wildfires, the Company provided three to six months interest and/or principal loan payment deferrals to customers who were directly impacted by the wildfires on a case-by-case basis. The Company granted 142 loan payment deferrals on loan balances totaling $32.7 million as of September 30, 2023. The loan payment deferrals were not considered more than minor and thus are not reportable as loan modifications to borrowers facing financial difficulty.

Prior to our adoption of ASU 2022-02, we accounted for a modification to the contractual terms of a loan that resulted in granting a concession to a borrower experiencing financial difficulties as a troubled debt restructuring ("TDR").

Loans identified as TDRs prior to our adoption of ASU 2022-02 included in nonperforming assets at September 30, 2023 consisted of six Hawaii loans with a combined principal balance of $1.0 million. There were $2.1 million of loans identified as TDRs prior to our adoption of ASU 2022-02 still accruing interest at September 30, 2023, none of which were more than 90 days delinquent. At December 31, 2022, there were $2.8 million of loans identified as TDRs prior to our adoption of ASU 2022-02 still accruing interest, none of which were more than 90 days delinquent.

Criticized loans at September 30, 2023 declined by $16.9 million from December 31, 2022 to $60.2 million, or 1.1% of the total loan portfolio. Special mention loans declined by $8.6 million to $24.4 million, or 0.4% of the total loan portfolio. Classified loans declined by $8.4 million to $35.8 million, or 0.6% of the total loan portfolio.

The Company's ratio of classified assets and other real estate owned to tier 1 capital and the ACL was 4.89% at September 30, 2023, which decreased from 6.25% at December 31, 2022.

Allowance for Credit Losses

The following table presents certain information with respect to the ACL as of the dates and for the periods presented:

(dollars in thousands)

Our ACL totaled $64.5 million at September 30, 2023, compared to $63.7 million at December 31, 2022 and $64.4 million at September 30, 2022.

During the third quarter of 2023, we recorded a provision for credit losses on loans of $4.5 million and net charge-offs of $3.9 million. During the nine months ended September 30, 2023, we recorded a provision for credit losses on loans of $10.3 million and net charge-offs of $9.5 million.

The increase in the provision for credit losses on loans during the three and nine months ended September 30, 2023, compared to the same year-ago periods, is primarily due to higher charge-offs of our U.S. Mainland unsecured consumer loan portfolio, and the outlook for continued pressure on the national consumer segment.

Our ratio of ACL to total loans was 1.17% at September 30, 2023, compared to 1.15% at December 31, 2022 and 1.19% at September 30, 2022.

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

Deposits

The Company's deposit portfolio is diversified and long-tenured. The Company's business model is based on long-term customer relationships. Approximately 50% of the Company's customers have been banking with us for more than 10 years.

The following table presents the composition of our deposits by category as of the dates presented:

(dollars in thousands)

Our total deposits of $6.87 billion at September 30, 2023 increased by $138.5 million, or 2.1%, from total deposits of $6.74 billion at December 31, 2022. Net increases in time deposits up to $250,000 of $135.4 million, other time deposits greater than $250,000 of $113.2 million, government time deposits of $110.1 million, and savings and money market deposits of $10.5 million, were offset by net decreases in noninterest-bearing demand deposits of $123.3 million and interest-bearing demand deposits of $107.3 million. Due to the rising interest rate environment, we continued to see a shift in the composition of the deposit portfolio from demand deposits to savings and money market and time deposits.

Our core deposits, which we define as demand deposits, savings and money market deposits, and time deposits up to $250,000, totaled $5.99 billion at September 30, 2023 and decreased by $84.7 million, from $6.08 billion at December 31, 2022. Core deposits as a percentage of total deposits was 87.1% at September 30, 2023, compared to 90.2% at December 31, 2022. Our average cost of total deposits was 84 bps during the nine months ended September 30, 2023, compared to 9 bps during the year-ago period.

The Company had estimated uninsured deposits of $2.98 billion, or 43% of total deposits as of September 30, 2023, compared to an estimated $2.78 billion, or 41% of total deposits as of December 31, 2022. The Company had fully collateralized deposits of approximately $591.1 million and $438.4 million as of September 30, 2023 and December 31, 2022, respectively. The Company's estimated uninsured deposits, excluding fully collateralized deposits, totaled $2.38 billion, or 35% of total deposits as of September 30, 2023, compared to the estimated $2.34 billion, or 35% of total deposits as of December 31, 2022.

The following table presents the estimated amount of time deposits in excess of the FDIC insurance limit of $250,000 by remaining maturity as of September 30, 2023:

(dollars in thousands)

Capital Resources

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

Common Equity

Our total shareholders' equity was $468.6 million at September 30, 2023, compared to $452.9 million at December 31, 2022. The change in total shareholders' equity was primarily attributable to net income of $43.8 million and other comprehensive loss of $5.6 million, partially offset by cash dividends declared of $21.1 million and the repurchase of $2.6 million in shares of our common stock under our stock repurchase programs in the nine months ended September 30, 2023.

Our total shareholders' equity to total assets ratio was 6.14% at September 30, 2023, compared to 6.09% at December 31, 2022. Our book value per share was $17.33 and $16.76 at September 30, 2023 and December 31, 2022, respectively.

Holding Company Capital Resources

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

CPF relies on the Bank to pay dividends to fund its obligations. On a stand-alone basis, CPF had an available cash balance of $21.4 million as of September 30, 2023 in order to meet its ongoing obligations.

As a Hawaii state-chartered bank, the Bank may only pay dividends to the extent it has retained earnings as defined under Hawaii banking law ("Statutory Retained Earnings"), which differs from GAAP retained earnings. The Bank had Statutory Retained Earnings of $161.5 million as of September 30, 2023. Provisions of federal law also impact the ability of the Bank to pay dividends to CPF and the ability of CPF to pay dividends to our shareholders and repurchase our common stock.

On October 24, 2023, the Company's Board of Directors declared a cash dividend of $0.26 per share on the Company's outstanding common stock, which remained unchanged from $0.26 per share a year-ago. Dividends are payable at the discretion of the Board of Directors and there can be no assurance that the Company will continue to pay dividends at the same rate, or at all, in the future. Our ability to pay cash dividends to our shareholders is subject to restrictions under federal and Hawaii law, including restrictions imposed by the FRB and covenants set forth in various agreements we are a party to, including covenants set forth in our subordinated debentures and subordinated notes.

On January 25, 2022, the Company's Board of Directors approved a new share repurchase authorization of up to $30 million of its common stock (the "2022 Repurchase Plan"), which replaced and superseded the previous share repurchase plan. During 2022, the Company repurchased 868,613 shares of common stock, at an aggregate cost of $20.7 million under the Company's share repurchase program.

On January 24, 2023, the Company's Board of Directors approved a new share repurchase authorization of up to $25 million of its common stock from time to time in the open market or in privately negotiated transactions, pursuant to a newly authorized share repurchase plan (the "2023 Repurchase Plan"). The 2023 Repurchase Plan replaces and supersedes in its entirety the 2022 Repurchase Plan, which had $10.3 million in remaining share repurchase authority as of December 31, 2022.

Following the regional bank failures occurring in March 2023, the Company has significantly reduced its volume of share repurchases to strengthen capital and liquidity considering the elevated market risks. The Company will continue to monitor the environment and assess risk and return as part of its ongoing capital management decisions on future share repurchases.

During the nine months ended September 30, 2023, the Company repurchased 130,010 shares of common stock, at an aggregate cost of $2.6 million under the Company's share repurchase program (48,760 shares at an aggregate cost of $1.0 million under the 2022 Repurchase Plan and 81,250 shares at an aggregate cost of $1.6 million under the 2023 Repurchase Plan). As of September 30, 2023, $23.4 million remained available for repurchase under the Company's 2023 Repurchase Plan.

Trust Preferred Securities

As of September 30, 2023, we have two remaining statutory trusts, CPB Capital Trust IV ("Trust IV") and CPB Statutory Trust V ("Trust V"), which issued a total of $50.0 million in floating rate trust preferred securities. The trust preferred securities, the underlying floating rate junior subordinated debentures that are the assets of Trusts IV and V, and the common securities issued by Trusts IV and V are redeemable in whole or in part on any interest payment date on or after December 15, 2009 for Trust IV and V, or at any time in whole but not in part within 90 days following the occurrence of certain events. Our obligations with respect to the issuance of the trust preferred securities constitute a full and unconditional guarantee by the Company of each trust's obligations with respect to its trust preferred securities. Subject to certain exceptions and limitations, we may elect from time to time to defer subordinated debenture interest payments, which would result in a deferral of dividend payments on the related trust preferred securities, for up to 20 consecutive quarterly periods without default or penalty.

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

Subordinated Notes

On October 20, 2020, the Company completed a $55 million private placement of ten-year fixed-to-floating rate subordinated notes, which will be used to support regulatory capital ratios and for general corporate purposes. The Company exchanged the privately placed notes for registered notes with the same terms and in the same aggregate principal amount at the end of the fourth quarter of 2020. The notes bear a fixed interest rate of 4.75% for the first five years and will reset quarterly thereafter for the remaining five years to the then current three-month Secured Overnight Financing Rate, as published by the Federal Reserve Bank of New York, plus 456 bps. The subordinated notes had a carrying value of $54.5 million, net of unamortized debt issuance costs of $0.5 million, at September 30, 2023.

The subordinated notes may be included in Tier 2 capital, with certain limitations applicable, under current regulatory guidelines and interpretations.

Regulatory Capital Ratios

The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

In March 2020, the FDIC, FRB and OCC, collectively, issued three interim final rules that impact the reporting of regulatory capital in the Call Report. The revisions include:

1. Revising the definition of eligible retained income in the capital rule;

2. Permitting banking organizations to neutralize the effects of purchasing assets through the Money Market Mutual Fund Liquidity Facility ("MMLF") on their risk-based and leverage capital ratios;

3. Providing banking organizations that implement the Accounting Standards Update No. 2016-13, "Financial Instruments – Credit Losses, Topic 326, Measurement of Credit Losses on Financial Instruments", before the end of 2020 the option to delay for two years an estimate of the CECL methodology’s effect on regulatory capital, relative to the incurred loss methodology’s effect on capital, followed by a three-year transition period;

4. Allowing banking organizations to implement the final rule titled Standardized Approach for Calculating the Exposure Amount of Derivative Contracts (the "SA-CCR rule") for the first quarter of 2020, on a best efforts basis.

The Company elected to exercise the option to delay for two years the CECL methodology's effect on regulatory capital followed by a three-year transition period to phase out the aggregate amount of the capital benefit provided during the initial two-year delay.

General capital adequacy regulations adopted by the FRB and FDIC require an institution to maintain minimum leverage capital, tier 1 risk-based capital, total risk-based capital, and common equity tier 1 ("CET1") capital ratios. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. For a further discussion of the effect of forthcoming changes in required regulatory capital ratios, see the discussion in the "Business — Supervision and Regulation" sections of our 2022 Form 10-K.

The following table presents the Company's and the Bank's capital ratios, as well as the minimum capital adequacy requirements applicable to all financial institutions as of the dates presented. The Company's and the Bank's leverage capital, tier 1 risk-based capital, total risk-based capital, and CET1 risk-based capital ratios as of September 30, 2023 and December 31, 2022 were above the levels required for a "well capitalized" regulatory designation.

(dollars in thousands)

[1] Under the Basel III Capital Rules, the Company and the Bank must also maintain the required Capital Conservation Buffer ("CCB"), which is 2.5% above the minimum risk-based capital ratios, to avoid becoming subject to restrictions on capital distributions and certain discretionary bonus payments.

Asset/Liability Management and Interest Rate Risk

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

Our Asset/Liability Management Policy seeks to maximize the risk-adjusted return to shareholders while maintaining consistently acceptable levels of liquidity, interest rate risk and capitalization. Our Asset/Liability Management Committee, or ALCO, monitors interest rate risk through the use of net interest income ("NII") and economic value of equity ("EVE") simulation and various hypothetical interest rate scenarios that may include gradual, immediate or non-parallel rate changes. This process is designed to measure the impact of future changes in interest rates on NII and EVE. Potentially adverse interest rate risk exposures are managed through the shortening or lengthening of the duration of assets and liabilities.

ALCO utilizes a detailed and dynamic simulation model to measure and manage interest rate risk exposures. The simulation incorporates various assumptions which may impact results. Key modeling assumptions are made around the timing of interest rate changes, the prepayment of mortgage-related assets, pricing spreads of assets and liabilities and the timing and magnitude of deposit rate changes in relation to changes in the overall level of interest rates.

The following reflects our net interest income sensitivity analysis as of the dates presented. Net interest income is estimated assuming no balance sheet growth under a flat interest rate scenario. The net interest income sensitivity is measured as the change in net interest income in alternate interest rate scenarios as a percentage of the flat rate scenario. The alternate rate scenarios typically assume rates move up or down 100 bps or 200 bps in either a gradual or an instantaneous, parallel fashion.

Liquidity and Borrowing Arrangements

Our objective in managing liquidity is to maintain a balance between sources and uses of funds in order to economically meet the cash requirements of customers for loans and deposit withdrawals and participate in lending and investment opportunities as they arise. We monitor our liquidity position in relation to changes in loan and deposit balances on a daily basis to ensure maximum utilization, maintenance of an adequate level of readily marketable assets and access to short-term funding sources.

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

As of September 30, 2023, the Company had $438.7 million in cash on its balance sheet and approximately $2.47 billion in total other liquidity sources, including available borrowing capacity and unpledged investment securities. Total available sources of liquidity as a percentage of uninsured and uncollateralized deposits was 122%. Refer to Note 8 - Short-Term Borrowings and Long-Term Debt in the accompanying notes to the consolidated financial statements in this report for information on the Company's borrowing arrangements.

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

Information regarding our material contractual obligations is provided in "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the year ended December 31, 2022. There have been no material changes in our cash requirements from known contractual and other obligations since December 31, 2022. We believe we will be able to meet our contractual obligations as they come due through the maintenance of adequate liquidity levels. We expect to maintain adequate liquidity levels through profitability, loan payoffs, securities repayments and maturities and continued deposit gathering activities. We also have various borrowing mechanisms in place for both short-term and long-term liquidity needs.

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices such as interest rates, foreign currency rates, commodity prices and equity prices. Our primary market risk exposure is interest rate risk that occurs when rate-sensitive assets and rate-sensitive liabilities mature or reprice during different periods or in differing amounts. Asset/liability management attempts to coordinate our rate-sensitive assets and rate-sensitive liabilities to meet our financial objectives. The Asset/Liability Committee ("ALCO") monitors interest rate risk through the use of net interest income and economic value of equity simulation, and various interest rate scenarios. Potentially adverse interest rate risk exposures are managed through the shortening or lengthening of the duration of assets and liabilities.

The primary analytical tool we use to measure and manage our interest rate risk is a simulation model that projects changes in net interest income ("NII") as market interest rates change. Our ALCO policy requires that simulated changes in NII should be within certain specified ranges, or steps must be taken to reduce interest rate risk. The results of the model indicate that the mix of rate-sensitive assets and liabilities at September 30, 2023 would not result in a fluctuation of NII that would exceed the established policy limits.

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report and pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended, (the "Exchange Act"), the Company's management, including the principal executive officer and principal financial officer, conducted an evaluation of the effectiveness and design of the Company's disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation, the Company's principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control Over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the period covered by this report, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

There have been no material changes from the Risk Factors as previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC on February 24, 2023, except as described below:

Recent negative developments affecting the banking industry, such as bank failures or concerns involving liquidity, may have a material adverse effect on the Company’s operations.

Recent high-profile bank failures in the first half of 2023, and the resulting media coverage, has caused general uncertainty and concern regarding the liquidity adequacy of the banking industry and in particular, regional and community banks like the Company. Uncertainty and concern may be compounded by the reach and depth of media attention, including social media, and its ability to disseminate concerns or rumors about these kinds of events or other similar risks, and may have in the past and may in the future lead to market-wide liquidity problems and concerns from the Company's own customer base. These bank failures underscore the importance of maintaining diversified sources of funding as key measures to ensure the safety and soundness of a financial institution. As a result, market conditions and other external factors may impact the competitive landscape for deposits in the banking industry and could materially adversely impact the Company's liquidity and results of operations. While the Department of the Treasury, the Federal Reserve, and the FDIC have made statements ensuring that depositors of these recently failed banks would have access to their deposits, including uninsured deposit accounts, there is no guarantee that such actions will be successful in restoring customer confidence in the banking industry.