FIRST HAWAIIAN, INC. (FHB) FY 2021 MD&A

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

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Cautionary Note Regarding Forward-Looking Statements

This Annual Report on Form 10-K, including the documents incorporated by reference herein, contains, and from time to time our management may make, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “might,” “should,” “could,” “predict,” “potential,” “believe,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would,” “annualized” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management's beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions, estimates and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.

A number of important factors could cause our actual results to differ materially from those indicated in these forward-looking statements, including the following: the impact of the ongoing COVID-19 pandemic and any other pandemic, epidemic or health-related crisis; the geographic concentration of our business; current and future economic and market conditions in the United States generally or in Hawaii, Guam and Saipan in particular; our dependence on the real estate markets in which we operate; concentrated exposures to certain asset classes and individual obligors; the effect of the current low interest rate environment or changes in interest rates on our business including our net interest income, net interest margin, the fair value of our investment securities, and our mortgage loan originations, mortgage servicing rights and mortgage loans held for sale; changes in the method pursuant to which LIBOR and other benchmark rates are determined or the discontinuance of LIBOR; the possibility of a deterioration in credit quality in our portfolio; the possibility we might underestimate the credit losses inherent in our loan and lease portfolio; our ability to maintain our Bank's reputation; the future value of the investment securities that we own; our ability to attract and retain customer deposits; our inability to receive dividends from our bank, pay dividends to our common stockholders and satisfy obligations as they become due; the effects of severe weather, geopolitical instability, including war, terrorist attacks, pandemics or other severe health emergencies and man-made and natural disasters; our ability to maintain consistent growth, earnings and profitability; our ability to attract and retain skilled employees or changes in our management personnel; our ability to effectively compete with other financial services companies and the effects of competition in the financial services industry on our business; the effectiveness of our risk management and internal disclosure controls and procedures; our ability to keep pace with technological changes; any failure or interruption of our information and communications systems; our ability to identify and address cybersecurity risks; the occurrence of fraudulent activity or effect of a material breach of, or disruption to, the security of any of our or our vendors’ systems; the failure to properly use and protect our customer and employee information and data; the possibility of employee misconduct or mistakes; our ability to successfully develop and commercialize new or enhanced products and services; changes in the demand for our products and services; the effects of problems encountered by other financial institutions; our access to sources of liquidity and capital to address our liquidity needs; our use of the secondary mortgage market as a source of liquidity; risks associated with the sale of loans and with our use of appraisals in valuing and monitoring loans; the possibility that actual results may differ from estimates and forecasts; fluctuations in the fair value of our assets and liabilities and off-balance sheet exposures; the effects of the failure of any component of our business infrastructure provided by a third party; the potential for environmental liability; the risk of being subject to litigation and the outcome thereof; the impact of, and changes in, applicable laws, regulations and accounting standards and policies; possible changes in trade, monetary and fiscal policies of, and other activities undertaken by, governments, agencies, central banks and similar organizations; our likelihood of success in, and the impact of, litigation or regulatory actions; our ability to continue to pay dividends on our common stock; contingent liabilities and unexpected tax liabilities that may be applicable to us as a result of the Reorganization Transactions; and damage to our reputation from any of the factors described above.

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Further, statements about the potential effects of the ongoing COVID-19 pandemic on our business, financial

condition, liquidity and results of operations may constitute forward-looking statements and are subject to the risk that the actual effects may differ, possibly materially, from what is reflected in those forward-looking statements due to factors and future developments that are uncertain, unpredictable and in many cases beyond our control, including the scope and duration of the pandemic, actions taken by governmental authorities in response to the pandemic, and the direct and indirect impact of the pandemic on our customers, clients, third parties and us.

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The foregoing factors should not be considered an exhaustive list and should be read together with the other cautionary statements set forth under “Item 1A. Risk Factors” in this Annual Report on Form 10-K. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to update or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by applicable law.

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Company Overview

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FHI, a bank holding company, owns 100% of the outstanding common stock of FHB. FHB was founded in 1858 under the name Bishop & Company and was the first successful banking partnership in the Kingdom of Hawaii and the second oldest bank formed west of the Mississippi River.

As of December 31, 2021, we were the largest full-service bank headquartered in Hawaii as measured by assets, loans and leases, deposits and net income. As of December 31, 2021, we had $25.0 billion of assets, $13.0 billion of gross loans and leases and $21.8 billion of deposits. We also generated $265.7 million of net income or diluted earnings per share of $2.05 per share for the year ended December 31, 2021. We operate our business through three operating segments: Retail Banking, Commercial Banking and Treasury and Other. See “Note 22. Reportable Operating Segments” in the notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data for more information.

Recent Developments regarding COVID-19 and the Hawaii and Global Economy

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Overview

The COVID-19 pandemic has brought unprecedented challenges to businesses and economies around the world, particularly those in the United States. Our business has been, and continues to be, impacted by the recent and ongoing outbreak of COVID-19. Restrictive measures to address the pandemic eased throughout 2021, resulting in the improvement of the U.S. economy, relatively to the corresponding period in 2020. The increased availability of COVID-19 vaccinations began to mitigate the public health effects of the pandemic. However, there was a rise in cases during the last three months of 2021 due to the Delta and Omicron variants of COVID-19 and slower progress on vaccination rates. Recovery from the related economic crisis continues to disproportionately affect certain industries, geographies, and demographics more than others.

We recognize that our customers continue to experience varying degrees of financial distress. There remains a high degree of uncertainty relating to the ongoing spread and severity of the virus and other potential new variants. To the extent that the economy continues to be negatively impacted by the pandemic, our results will be affected. In light of the uncertainties and continuing developments discussed herein, the ultimate adverse impact of COVID-19 cannot be reliably estimated at this time, but it has been and is expected to continue to be material.

Hawaii Economy

Hawaii’s economy continues to be significantly impacted by COVID-19 and the responses to it. Because the Hawaii economy is heavily dependent on tourism, the combination of various response measures to the COVID-19 pandemic resulted in significant fluxes in Hawaii unemployment. The statewide seasonally adjusted unemployment rate was 5.7% in December 2021 compared to 9.3% in December 2020, according to the State of Hawaii Department of Labor and Industrial Relations, while the national seasonally adjusted unemployment rate was 3.9% in December 2021 compared to 6.7% in December 2020. Despite decreasing unemployment rates, Hawaii’s demand for workers continues to strengthen but is constrained by a labor shortage that, in many cases, is impeding business activity throughout the State.

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Visitor arrivals for the year ended December 31, 2021 increased by 150.3% compared to the same period in 2020, according to the Hawaii Tourism Authority. However, the timing and extent of the recovery of the Hawaii tourism industry remains highly uncertain and beyond our control.

The volume of home sales on Oahu has increased relative to the corresponding period of 2020, which was significantly impacted by the COVID-19 pandemic. For the year ended December 31, 2021, the volume of single-family home sales increased by 17.9%, while condominium sales increased by 53.1% compared to the same period in 2020, according to the Honolulu Board of Realtors. The median price of single-family home sales and condominium sales on Oahu was $990,000 and $475,000, respectively, or an increase of 19.3% and 9.2%, respectively, for the year ended December 31, 2021 as compared to the same period in 2020. As of December 31, 2021, months of inventory of single-family homes and condominiums on Oahu remained low at approximately 0.8 and 1.6 months, respectively. Lastly, state general excise and use tax revenues increased by 18.6% for year ended December 31, 2021 as compared to the same period in 2020, according to the Hawaii Department of Business, Economic Development & Tourism.

Legislative and Regulatory Developments

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Actions taken by the federal government and the Federal Reserve and other bank regulatory agencies to partially mitigate the economic effects of COVID-19 and related containment measures have had, and will continue to have, an impact on our financial position and results of operations. These actions are further discussed below.

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The Federal Reserve has instituted a number of other measures to mitigate the lasting impact from the COVID-19 pandemic and to support the flow of credit to households and businesses, offset forced liquidations and restore liquidity in the financial markets. For example, among other things, the Federal Reserve lowered the rate charged on its discount window while extending the length of the loans offered and introduced a number of additional facilities designed to enhance support for small and mid-sized businesses.

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The U.S. government has also enacted certain fiscal stimulus measures in several phases to counteract the economic disruption caused by COVID-19, such as:

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We are continuing to monitor the potential development of additional legislation and further actions taken by the U.S. government.

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The State of Hawaii received at least $1.25 billion in federal aid from the CARES Act, with a majority of this federal aid used to help fund state and county government response efforts to COVID-19. Additional federal funding is expected to provide unemployment assistance, direct cash payments to Hawaii residents and funding to support local schools and colleges. The CAA provided an additional $1.7 billion in new federal funding, while extending the ability of the State of Hawaii and its local governments to use its previously received federal aid until December 31, 2021. The State of Hawaii has fully allocated the $1.6 billion of federal funding received from the American Rescue Plan.

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Impact to our Operations

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We saw a significant decrease in customer traffic in our branches in recent periods. As a result, in 2020, we strategically closed 26 of our branch locations on a temporary basis. As of January 2022, we reopened 19 of the temporarily closed branch locations in connection with the reopening of local businesses and permanently closed 7 branches. The temporary (or in certain cases, permanent) closures of bank branches and the safety precautions implemented at reopened branches could result in consumers becoming more comfortable with technology and seeing less need for face-to-face interaction. Our business is relationship driven and such changes could necessitate changes to our business practices to accommodate changing consumer behaviors. The Bank continues to adapt to these changing behaviors and launched its newly enhanced mobile banking application in April 2021, allowing customers to perform certain transactions virtually as well as integrate their financial information in one place. We continue to provide service to customers and operate our businesses on all islands of Hawaii, Guam and Saipan. Many of our employees continue to work remotely. We continue to emphasize the importance of practicing social distancing and good hygiene practices in the workplace, especially as more employees have returned to working in our physical offices and spaces.

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Impact on our Financial Position and Results of Operations

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We expect that COVID-19 will continue to impact commercial activity throughout the State of Hawaii and nationally, and thus continue to affect the way our customers (businesses and individuals), vendors and counterparties meet existing payment, or other, obligations to us. As Hawaii’s economy remains open, we expect that local consumption of goods and services will continue to improve. Although Hawaii’s economy had favorable results with the recent  holiday season, the timing and extent of the recovery of the Hawaii tourism industry continues to remain uncertain and is dependent upon, among other things, the number of cases declining around the globe, in the United States and, in particular, in Hawaii, public health impacts of the new COVID-19 variants, the continued administration of the vaccine to unvaccinated populations, and the effectivity and the duration of immunity granted by current vaccines.

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During this time of uncertainty, we remain committed to servicing our customers. The economic pressures and uncertainties arising from the COVID-19 pandemic has resulted in and may continue to result in specific changes in consumer and business spending and borrowing and saving habits, affecting the demand for loans and other products and services we offer. For example, certain industries may take longer to recover (particularly those that rely on visitors or in-person foot traffic) as certain consumers may still be hesitant to travel or return to full social interaction. We lend to customers operating in such industries including tourism, hotels/lodging, restaurants, entertainment and commercial real estate, among others. We will continue to closely monitor the impact that COVID-19 has on our customers and will adjust the means by which we assist our customers during this period of financial hardship.

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The uncertainty of the economy as it recovers from the pandemic may continue to have a negative impact on our financial position and results of operations. The national public health crisis arising from the COVID-19 pandemic, combined with other factors, including, but not limited to, inflation, labor shortages and supply chain disruption, could, despite improvements in 2021, again destabilize the financial markets and geographies in which we operate. The resulting economic pressure on consumers and uncertainty regarding the sustainability of any economic improvements could further impact the creditworthiness of potential and current borrowers. Borrower loan defaults that adversely affect our earnings correlate with deteriorating economic conditions, which, in turn, are likely to impact our borrowers’ creditworthiness and our ability to make loans.

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In light of volatility in the capital markets and economic disruptions, we continue to carefully monitor our capital and liquidity positions. As of December 31, 2021, the Company was “well-capitalized” and met all applicable regulatory capital requirements, including a Common Equity Tier 1 capital ratio of 12.24%, compared to the minimum requirement of 4.50%. We continue to anticipate that we will have sufficient capital levels to meet all of these requirements. Additionally, we continue to access our routine short-term funding sources, such as borrowings and repurchase agreements, and to assess longer-term funding sources. For additional discussions regarding our capital and liquidity positions and related risks, refer to the sections titled “Liquidity and Capital Resources” and “Capital” in this MD&A.

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These and other key factors could impact our profitability in future reporting periods. See Item 1A. Risk Factors, beginning in the section captioned “Summary of Risk Factors.”

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Selected Financial Data:

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Our financial highlights for the years indicated are presented in Table 1:

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The following table provides a reconciliation of net interest income, noninterest income, noninterest expense and net income to their “core” non-GAAP financial measures:

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The following table provides a reconciliation of these non-GAAP financial measures with their most closely related GAAP measures for the years indicated:

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Financial Highlights

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Net income was $265.7 million for the year ended December 31, 2021, an increase of $80.0 million or 43% as compared to 2020. Basic earnings per share was $2.06 per share for the year ended December 31, 2021, an increase of $0.63 per share or 44% as compared to 2020. Diluted earnings per share was $2.05 for the year ended December 31, 2021, an increase of $0.62 or 43% as compared to 2020. The increase was primarily due to a benefit to provision for credit losses (the "Provision") of $39.0 million for the year ended December 31, 2021, compared to a Provision of $121.7 million for the year ended December 31, 2020. This increase was partially offset by a $37.8 million increase in noninterest expense, a $25.3 million increase in the provision for income taxes, a $12.5 million decrease in noninterest income and a $5.2 million decrease in net interest income.

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Net income for the year ended December 31, 2021 was negatively impacted by $9.0 million in fees related to the prepayment of the $200.0 million FHLB advances, a $6.0 million charge on the funding swap for the Visa Class B restricted shares sold in 2016, a $2.1 million loss on litigation, and a $1.2 million severance cost expense. Core net income was $279.2 million for the year ended December 31, 2021, an increase of $89.9 million or 47% as compared to 2020. Core basic earnings per share was $2.17 for the year ended December 31, 2021, an increase of $0.71 or 49% as compared to 2020. Core diluted earnings per share was $2.16 for the year ended December 31, 2021, an increase of $0.71 or 49% as compared to 2020. Core net income and core basic and diluted earnings per share are non-GAAP financial measures. For a reconciliation to the most directly comparable GAAP financial measures for core net income and core basic and diluted earnings per share, see Table 2, GAAP to Non-GAAP Reconciliation.

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Net income was $185.8 million for the year ended December 31, 2020, a decrease of $98.6 million or 35% as compared to 2019. Basic earnings per share was $1.43 for the year ended December 31, 2020, a decrease of $0.71 or 33% as compared to 2019. Diluted earnings per share was $1.43 for the year ended December 31, 2020, a decrease of $0.70 or 33% as compared to 2019. The decrease was primarily due to a $107.9 million increase in the Provision and a $37.7 million decrease in net interest income, partially offset by a $39.3 million decrease in the provision for income taxes, a $4.8 million increase in noninterest income and a $2.8 million decrease in noninterest expense.

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Net income for the year ended December 31, 2020 was negatively impacted by a $4.8 million charge on the funding swap for the Visa Class B restricted shares sold in 2016. Core net income was $189.4 million for the year ended December 31, 2020, a decrease of $102.4 million or 35% as compared to 2019. Core basic earnings per share was $1.46 for the year ended December 31, 2020, a decrease of $0.73 or 33% as compared to 2019. Core diluted earnings per share was $1.45 for the year ended December 31, 2020, a decrease of $0.74 or 34% as compared to 2019. Core net income and core basic and diluted earnings per share are non-GAAP financial measures. For a reconciliation to the most directly comparable GAAP financial measures for core net income and core basic and diluted earnings per share, see Table 2, GAAP to Non-GAAP Reconciliation.

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Our return on average total assets was 1.09% for the year ended December 31, 2021, an increase of 24 basis points as compared to 2020, and our return on average total stockholders’ equity was 9.81% for the year ended December 31, 2021, an increase of 293 basis points as compared to 2020. Our return on average tangible assets was 1.13% for the year ended December 31, 2021, an increase of 24 basis points as compared to 2020, and our return on average tangible stockholders’ equity was 15.51% for the year ended December 31, 2021, an increase of 460 basis points as compared to 2020. Our efficiency ratio was 56.45% for the year ended December 31, 2021 as compared to 50.10% in 2020. Return on average tangible assets and return on average tangible stockholders’ equity are non-GAAP financial measures. For a reconciliation to the most directly comparable GAAP financial measures for return on average tangible assets and return on average tangible stockholders’ equity, see Table 3, GAAP to Non-GAAP Reconciliation.

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Our return on average total assets was 0.85% for the year ended December 31, 2020, a decrease of 55 basis points as compared to 2019, and our return on average total stockholders’ equity was 6.88% for the year ended December 31, 2020, a decrease of 402 basis points as compared to 2019. Our return on average tangible assets was 0.89% for the year ended December 31, 2020, a decrease of 58 basis points as compared to 2019, and our return on average tangible stockholders’ equity was 10.91% for the year ended December 31, 2020, a decrease of 671 basis points as compared to 2019. Our efficiency ratio was 50.10% for the year ended December 31, 2020 as compared to 48.36% in 2019. Return on average tangible assets and return on average tangible stockholders’ equity are non-GAAP financial measures. For a reconciliation to the most directly comparable GAAP financial measures for return on average tangible assets and return on average tangible stockholders’ equity, see Table 3, GAAP to Non-GAAP Reconciliation.

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Our results for the year ended December 31, 2021 were highlighted by the following:

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Our results for the year ended December 31, 2020 were highlighted by the following:

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Balance sheet highlights consisted of the following:

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Analysis of Results of Operations

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Net Interest Income

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For the years ended December 31, 2021, 2020, and 2019, average balances, related income and expenses, on a fully taxable-equivalent basis, and resulting yields and rates are presented in Table 4. An analysis of the change in net interest income, on a fully taxable-equivalent basis, is presented in Table 5.

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Net interest income, on a fully taxable-equivalent basis, was $533.3 million for the year ended December 31, 2021, a decrease of $3.1 million or 1% as compared to 2020. Our net interest margin was 2.43% for the year ended December 31, 2021, a decrease of 34 basis points as compared to 2020. The decrease in net interest income, on a fully taxable-equivalent basis, was primarily due to lower yields in most loan categories, a decrease in average loan balances in a few loan categories and lower yields in our investment securities portfolio. This was partially offset by higher average balances in our investment securities portfolio and lower deposit funding costs. Yields on our loans and leases were 3.42% for the year ended December 31, 2021, a decrease of 25 basis points as compared to 2020. We experienced a decrease in our yield from total loans primarily due to decreases in our commercial and industrial (excluding PPP loans), commercial real estate and residential mortgage loans. The decrease in our adjustable rate commercial and industrial and commercial real estate loans are typically based on LIBOR. Fees are accelerated into net interest income upon the forgiveness of PPP loans. Net interest income for the years ended December 31, 2021 and 2020, included $31.6 million and $16.7 million, respectively, of fees from PPP loans. As of December 31, 2021, there were approximately $5.4 million of additional fees remaining on our PPP loans that had not yet been recognized into income. For the year ended December 31, 2021, the average balance of our investment securities portfolio increased $2.2 billion or 45% to $7.1 billion. Yields on our investment securities portfolio were 1.46% for the year ended December 31, 2021, a decrease of 21 basis points compared to 2020. Deposit funding costs were $13.9 million for the year ended December 31, 2021, a decrease of $21.6 million or 61% compared to 2020. Rates paid on our interest-bearing deposits were 11 basis points for the year ended December 31, 2021, a decrease of 19 basis points compared to 2020.

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The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is affected by changes in the prime interest rate. The prime rate began in 2019 at 5.50% and decreased 50 basis points during the third quarter of 2019 (25 basis points in each of August and September) and 25 basis points in October 2019 to end the year at 4.75%. During 2020, the prime rate decreased 150 basis points in March to end the first quarter at 3.25%, where it remained as at the end of 2021. As noted above, our loan portfolio is also impacted by changes in the LIBOR. At December 31, 2021, the one-month and three-month U.S. dollar LIBOR interest rates were 0.10% and 0.21%, respectively. At December 31, 2020, the one-month and three-month U.S. dollar LIBOR interest rates were 0.14% and 0.24%, respectively, while at December 31, 2019, the one-month and three-month U.S. dollar LIBOR interest rates were 1.76% and 1.91%, respectively. The target range for the federal funds rate, which is the cost of immediately available overnight funds, began 2019 at 2.25% to 2.50% and decreased 50 basis points during the third quarter of 2019 (25 basis points in each of August and September) and 25 basis points in October 2019 to end the year at 1.50% to 1.75%. During 2020, the target range for the federal funds rate decreased 150 basis points in March to at 0.00% to 0.25%, where it remained as at the end of 2021. The decrease in the target range for the federal funds rate in 2020 was largely an emergency measure by the Federal Reserve aimed at mitigating the economic impact of COVID-19. In December 2021, the Federal Reserve released projections related to the target range for the federal funds rate that imply, while there can be no such assurance, increases in the federal funds rate will occur in 2022, followed by additional increases in 2023 and 2024.

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Net interest income, on a fully taxable-equivalent basis, was $536.4 million for the year ended December 31, 2020, a decrease of $37.0 million or 6% as compared to 2019. Our net interest margin was 2.77% for the year ended December 31, 2020, a decrease of 43 basis points as compared to 2019. The decrease in net interest income, on a fully taxable-equivalent basis, was primarily due to lower yields in all loan categories and lower yields in our investment securities portfolio and interest-bearing deposits in other banks. This was partially offset by lower deposit funding costs and higher average balances in our investment securities portfolio. Yields on our loans and leases were 3.67% for the year ended December 31, 2020, a decrease of 72 basis points as compared to 2019. We experienced a decrease in our yield from total loans primarily due to decreases in adjustable rate commercial and industrial and commercial real estate loans, which are typically based on LIBOR. Decreases in the yield on commercial and industrial loans also stemmed from our participation in the PPP, as these loans have a fixed interest rate of one percent per annum. For the year ended December 31, 2020, the average balance of our investment securities portfolio increased $596.3 million or 14% to $4.9 billion. Yields on our investment securities portfolio were 1.67% for the year ended December 31, 2020, a decrease of 48 basis points compared to 2019. Deposit funding costs were $35.5 million for the year ended December 31, 2020, a decrease of $52.4 million compared to 2019. Rates paid on our interest-bearing deposits were 30 basis points for the year ended December 31, 2020, a decrease of 51 basis points compared to 2019.

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Provision for Credit Losses

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The Provision was a benefit of $39.0 million for the year ended December 31, 2021, compared to a Provision of $121.7 million in 2020. For the year ended December 31, 2021, the Provision included a negative $38.7 million in provision for credit losses for loans and leases and a negative $0.3 million in provision for credit losses for the reserve for unfunded commitments. The benefit was largely due to improvements in the credit quality of our loan and lease portfolio and lower expected credit losses as a result of the economic recovery and easing of restrictions related to the COVID-19 pandemic. We recorded net charge-offs of $12.5 million and $30.9 million for the years ended December 31, 2021 and 2020, respectively. This represented net charge-offs of 0.10% and 0.23% of total average loans and leases for the years ended December 31, 2021 and 2020, respectively. The ACL was $157.3 million and $208.5 million as of December 31, 2021 and 2020, respectively, and represented 1.21% of total outstanding loans and leases as of December 31, 2021, compared to 1.57% of total outstanding loans and leases as of December 31, 2020. The reserve for unfunded commitments was $30.3 million as of December 31, 2021, compared to $30.6 million as of December 31, 2020. The Provision is recorded to maintain the ACL and the reserve for unfunded commitments at levels deemed adequate by management based on the factors noted in the “Risk Governance and Quantitative and Qualitative Disclosures About Market Risk — Credit Risk” section of this MD&A.

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Noninterest Income

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Table 6 presents the major components of noninterest income for the years ended December 31, 2021, 2020 and 2019:

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Total noninterest income was $184.9 million for the year ended December 31, 2021, a decrease of $12.5 million or 6% as compared to 2020. Total noninterest income was $197.4 million for the year ended December 31, 2020, an increase of $4.8 million or 3% as compared to 2019.

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Service charges on deposit accounts were $27.5 million for the year ended December 31, 2021, a decrease of $0.7 million or 2% as compared to 2020. This decrease was primarily due to a $0.7 million decrease in checking account service fees and a $0.2 million decrease in overdraft and checking account fees, partially offset by a $0.4 million increase in ATM interchange fees from customers. Service charges on deposit accounts were $28.2 million for the year ended December 31, 2020, a decrease of $5.6 million or 17% as compared to 2019. This decrease was primarily due to a $5.3 million decrease in overdraft and checking account fees, resulting from decreased transactions and spending due to the impact of the COVID-19 pandemic, and a $0.8 million decrease in ATM interchange fees from customers, partially offset by a $0.7 million increase in account analysis service charges.

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Credit and debit card fees were $63.6 million for the year ended December 31, 2021, an increase of $8.1 million or 15% as compared to 2020. This increase was primarily due to a $4.5 million increase in interchange settlement fees, a $3.7 million increase in merchant service revenues, a $1.2 million increase in ATM interchange and surcharge fees, and a $1.0 million increase in debit card interchange fees. This was partially offset by a $2.5 million increase in network association dues. Credit and debit card fees were $55.5 million for the year ended December 31, 2020, a decrease of $11.3 million or 17% as compared to 2019. This decrease was primarily due to an $8.3 million decrease in interchange settlement fees and a $7.1 million decrease in merchant service revenues, both resulting from decreased transactions and spending due to the impact of the COVID-19 pandemic. The decrease also related to a $2.3 million decrease in ATM interchange and surcharge fees, resulting from FHI waving ATM surcharge fees for a portion of the year ended December 31, 2020 as a response to the COVID-19 pandemic, and a $0.3 million decrease in credit card fees from cash advances. This was partially offset by a $7.1 million decrease in network association dues.

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Other service charges and fees were $38.6 million for the year ended December 31, 2021, an increase of $4.7 million or 14% as compared to 2020. This increase was primarily due to a $3.4 million increase in fees from annuities and securities, a $1.3 million increase in miscellaneous service fees, a $0.3 million increase in wire transfer fees, a $0.3 million increase in online banking fees, and a $0.3 million increase in fee income from our cash management services. This was partially offset by a $1.0 million decrease in service fees related to participation loans. Other service charges and fees were $33.9 million for the year ended December 31, 2020, a decrease of $2.4 million or 7% as compared to 2019. This decrease was primarily due to a $0.6 million decrease in insurance income, a $0.6 million decrease in service fees related to participation loans, a $0.6 million decrease in foreign exchange processing fees, a $0.5 million decrease in online banking fees, a $0.3 million decrease in fees from standby letters of credit arrangements and a $0.3 million decrease in fee income from our cash management services. This was partially offset by a $1.0 million increase in fees from annuities and securities.

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Trust and investment services income was $34.7 million for the year ended December 31, 2021, a decrease of $0.9 million or 3% as compared to 2020. This decrease was primarily due to a $1.9 million decrease in business cash management fees, a $0.4 million decrease in money market fund management fees, a $0.2 million decrease in personal property agency account fees, and a $0.2 million decrease in tax services. This was partially offset by a $1.2 million increase in investment management fees and a $0.9 million increase in irrevocable trust fees. Trust and investment services income was $35.7 million for the year ended December 31, 2020, an increase of $0.6 million or 2% as compared to 2019. This increase was primarily due to a $1.1 million increase in investment management fees, partially offset by a $0.4 million decrease in administrative fees for retirement accounts.

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BOLI income was $13.2 million for the year ended December 31, 2021, a decrease of $2.6 million or 16% as compared to 2020. This decrease was due to a $3.8 million decrease in BOLI earnings, partially offset by a $1.3 million increase in death benefit proceeds from life insurance policies. BOLI income was $15.8 million for the year ended December 31, 2020, an increase of $0.3 million or 2% as compared to 2019.

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Net gains on the sale of investment securities were $0.1 million for the year ended December 31, 2021, an increase in net gains of $0.2 million as compared to 2020. Net losses on the sale of investment securities were $0.1 million for the year ended December 31, 2020, a decrease in net losses of $2.6 million as compared to 2019.

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Other noninterest income was $7.2 million for the year ended December 31, 2021, a decrease of $21.4 million as compared to 2020. This decrease was primarily due to a $13.4 million decrease in gains on the sale of residential and commercial loans, a $5.8 million decrease in customer-related interest rate swap fees, a $1.3 million increase in net losses recognized in income related to derivative contracts, a $1.2 million decrease in income due to adjustments to certain liabilities assumed as a result of the Reorganization Transactions, a $0.7 million decrease in market adjustments on mutual funds purchased, a $0.6 million decrease in market adjustments for foreign exchange transactions, a $0.5 million decrease in volume-based incentives and a $0.5 million decrease in net mortgage servicing rights income. This was partially offset by a $2.1 million increase in gains on the sale of bank properties. Other noninterest income was $28.6 million for the year ended December 31, 2020, an increase of $20.7 million as compared to 2019. This increase was primarily due to a $15.8 million increase in gains on the sale of residential and commercial loans, a $3.9 million increase in customer-related interest rate swap fees, a $1.6 million increase in net mortgage servicing rights income and a $0.7 million decrease in net losses recognized in income related to derivative contracts. This was partially offset by a $1.1 million decrease in market adjustments for foreign exchange transactions.

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Noninterest Expense

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Table 7 presents the major components of noninterest expense for the years ended December 31, 2021, 2020 and 2019:

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Total noninterest expense was $405.5 million for the year ended December 31, 2021, an increase of $37.8 million or 10% as compared to 2020. Total noninterest expense was $367.7 million for the year ended December 31, 2020, a decrease of $2.8 million or 1% as compared to 2019.

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Salaries and employee benefits expense was $182.4 million for the year ended December 31, 2021, an increase of $8.2 million or 5% as compared to 2020. This increase was primarily due to a $3.4 million increase in temporary help expenses, a $3.4 million increase in incentive compensation, a $3.1 million increase in other compensation, including a nonrecurring severance cost of $1.2 million, a $2.1 million increase in base salaries and related payroll taxes, a $1.6 million increase in group health plan costs, a $0.7 million increase in retirement plan expenses, a $0.4 million increase in employee overtime pay expense and a $0.3 million increase in state unemployment tax expense. This was partially offset by a $7.0 million increase in deferred loan origination costs. Salaries and employee benefits expense was $174.2 million for the year ended December 31, 2020, an increase of $1.1 million or 1% as compared to 2019. This increase was primarily due to a $7.6 million increase in base salaries and related payroll taxes, a $1.5 million increase in incentive compensation and a $1.5 million increase in retirement plan expenses. This was partially offset by a $7.1 million increase in deferred loan origination costs, a $1.6 million decrease in group health plan costs and a $0.9 million decrease in other compensation, primarily related to bonuses resulting from the initial public offering and related stock-based compensation.

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Contracted services and professional fees were $63.3 million for the year ended December 31, 2021, an increase of $2.8 million or 5% as compared to 2020. This increase was primarily due to a $1.2 million increase in outside services, primarily attributable to marketing and new customer services, a $0.8 million increase in contracted data processing, primarily related to system upgrades and product enhancements, and a $0.7 million increase in audit, legal and consultant fees. Contracted services and professional fees were $60.5 million for the year ended December 31, 2020, an increase of $4.2 million or 8% as compared to 2019. This increase was primarily due to a $2.3 million increase in contracted data processing, primarily related to system upgrades and product enhancements, a $1.4 million increase in audit, legal and consultant fees, and a $0.8 million increase in outside services, primarily attributable to marketing and new customer services.

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Occupancy expense was $29.3 million for the year ended December 31, 2021, an increase of $0.5 million or 2% as compared to 2020. This increase was due to a $0.5 million increase in utilities expense. Occupancy expense was $28.8 million for the year ended December 31, 2020, an increase of $0.1 million or less than 1% as compared to 2019.

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Equipment expense was $24.7 million for the year ended December 31, 2021, an increase of $4.4 million or 22% as compared to 2020. This increase was primarily due to a $4.7 million increase in technology-related license and maintenance fees. Equipment expense was $20.3 million for the year ended December 31, 2020, an increase of $2.9 million or 17% as compared to 2019. This increase was primarily due to a $1.5 million increase in technology-related license and maintenance fees and a $1.2 million increase in furniture and equipment depreciation.

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Regulatory assessment and fees were $8.2 million for the year ended December 31, 2021, a decrease of $0.4 million or 5% as compared to 2020. Regulatory assessment and fees were $8.7 million for the year ended December 31, 2020, an increase of $1.3 million or 17% as compared to 2019. This increase was primarily due to a $1.3 million increase in the FDIC insurance assessment.

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Advertising and marketing expense was $6.1 million for the year ended December 31, 2021, an increase of $0.4 million or 7% as compared to 2020. Advertising and marketing expense was $5.7 million for the year ended December 31, 2020, a decrease of $1.2 million or 18% as compared to 2019. This decrease was primarily due to a decrease in advertising costs related to direct mailing programs.

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Card rewards program expense was $25.2 million for the year ended December 31, 2021, an increase of $3.1 million or 14% as compared to 2020. This increase was primarily due to a $2.1 million increase in interchange fees paid to our credit card partners, a $0.6 million increase in priority rewards card redemptions and a $0.5 million increase in credit card cash reward redemptions. Card rewards program expense was $22.1 million for the year ended December 31, 2020, a decrease of $7.8 million or 26% as compared to 2019. This decrease was primarily due to a $3.8 million decrease in priority rewards card redemptions, a $2.8 million decrease in interchange fees paid to our credit card partners and a $1.2 million decrease in credit card cash reward redemptions. Decreased transactions and spending by our customers as a result of the COVID-19 pandemic led to decreased expenses for each of the aforementioned card reward programs.

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Other noninterest expense was $66.1 million for the year ended December 31, 2021, an increase of $18.7 million or 40% as compared to 2020. This increase was primarily due to $9.0 million in prepayment fees to terminate the Company’s FHLB fixed-rate advances, a $2.6 million increase in general and administrative expenses primarily around supplies, insurance, meals and entertainment and shipping and delivery, a $2.2 million increase in software amortization expense, a $2.1 million settlement payment in connection to a lawsuit against the Company, a $1.5 million increase in pension-related expenses, a $0.5 million increase in broker fees, and $0.5 million in estimated PPP loan losses. Other noninterest expense was $47.3 million for the year ended December 31, 2020, a decrease of $3.3 million or 7% as compared to 2019. This decrease was primarily due to a $2.8 million decrease in pension-related expenses, a $1.0 million decrease in charitable contributions, a $0.8 million decrease in travel expenses, and a $0.6 million decrease in collection fees on delinquent consumer loans. This was partially offset by a $2.1 million increase in software amortization expense.

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Provision for Income Taxes

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The provision for income taxes was $83.3 million (reflecting an effective tax rate of 23.86%) for the year ended December 31, 2021, compared with a provision for income taxes of $58.0 million (reflecting an effective tax rate of 23.79%) in 2020. Additional information about the provision for income taxes is presented in “Note 15. Income Taxes” in the notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data.

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Analysis of Business Segments

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Our business segments are Retail Banking, Commercial Banking, and Treasury and Other. Table 8 summarizes net income (loss) from our business segments for the years ended December 31, 2021, 2020 and 2019. Additional information about operating segment performance is presented in “Note 22. Reportable Operating Segments” in the notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data.

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The CARES Act, enacted on March 27, 2020, established, among other COVID-19 relief programs, a loan program (the “PPP”) for fully guaranteed loans (which may then be forgiven) to small businesses. In the second quarter of 2021, the Company made changes to the internal measurement of segment operating profits for the purpose of evaluating segment performance and resource allocation. The primary reason for the change was to align PPP loan balances within the business segment that directly manages them. Specifically, PPP loan balances previously included as part of the Retail Banking segment have been reclassified to the Commercial Banking segment. The reallocation of select PPP loan balances affected net interest income, net interest income after provision for credit losses, noninterest expense, provision for income taxes, net income and asset balances. The Company has reported its selected financial information using the new PPP loan balance alignments for year ended December 31, 2021. The Company has restated the selected financial information for the year ended December 31, 2020 in order to conform with the current presentation. As PPP loans were instituted in 2020, this reclassification had no impact to the year ended December 31, 2019.

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Retail Banking.  Our Retail Banking segment includes the financial products and services we provide to consumers, small businesses and certain commercial customers. Loan and lease products offered include residential and commercial mortgage loans, home equity lines of credit and loans, automobile loans and leases, secured and unsecured lines of credit, installment loans, and small business loans and leases. Deposit products offered include checking, savings and time deposit accounts. Our Retail Banking segment also includes our wealth management services. Products and services from Retail Banking are delivered to customers through 54 banking locations throughout the State of Hawaii, Guam and Saipan.

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Net income for the Retail Banking segment was $186.9 million for the year ended December 31, 2021, an increase of $43.3 million or 30% as compared to 2020. The increase in net income for the Retail Banking segment was primarily due to the Provision. The Provision was a benefit of $16.3 million for the year ended December 31, 2021, compared to a Provision of $52.7 million for the year ended December 31, 2020. The increase in net income for the Retail Banking segment also stemmed from a $10.5 million increase in net interest income, partially offset by a $15.0 million increase in noninterest expense, a $14.9 million increase in the provision for income taxes and a $6.4 million decrease in noninterest income. The decrease in the Provision was largely due to improvements in the credit quality of our loan and lease portfolio and lower expected credit losses as a result of the economic recovery and easing of restrictions related to the COVID-19 pandemic. The increase in net interest income was primarily due to higher spread on our residential real estate loans. The increase in noninterest expense was primarily due to higher overall expenses that were allocated to the Retail Banking segment, a settlement in connection with a lawsuit against the Company and an increase in equipment expense, partially offset by a decrease in salaries and employee benefits expense, occupancy expense and regulatory assessment and fees. The increase in the provision for income taxes was primarily due to the increase in pretax income. The decrease in noninterest income was primarily due to decreases in gains on the sale of residential loans, trust and investment services income, service charges on deposit accounts and market adjustments for foreign exchange transactions, partially offset by an increase in other service charges and fees. The increase in total assets for the Retail Banking segment was primarily due to an increase in residential real estate loans, partially offset by decreases in indirect automobile loans and other consumer loans.

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Net income for the Retail Banking segment was $143.7 million for the year ended December 31, 2020, a decrease of $60.9 million or 30% as compared to 2019. The decrease in net income for the Retail Banking segment was primarily due to a $46.5 million increase in the Provision, a $37.9 million decrease in net interest income and a $4.6 million increase in noninterest expense, partially offset by a $25.5 million decrease in the provision for income taxes and a $2.6 million increase in noninterest income. The increase in the Provision was primarily due to higher expected credit losses as a result of COVID-19 and its impact on our customers. The decrease in net interest income was primarily due to a decrease in transfer pricing credits on interest expenses from deposits as a result of lower yields on our deposit portfolio and lower spreads on our commercial and residential real estate portfolios. The increase in noninterest expense was primarily due to higher overall expenses that were allocated to the Retail Banking segment, partially offset by a decrease in salaries and employee benefits expense. The decrease in the provision for income taxes was primarily due to the decrease in pretax income. The increase in noninterest income was primarily due to increases in gains on the sale of residential loans and mortgage servicing rights, partially offset by a decrease in overdraft and checking account fees, an increase in amortization on mortgage servicing rights and a decrease in other service charges and fees. The decrease in total assets for the Retail Banking segment was primarily due to the sale of residential mortgages and decreases in consumer loans.

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Commercial Banking.  Our Commercial Banking segment includes our corporate banking related products, residential and commercial real estate loans, commercial lease financing, secured and unsecured lines of credit, automobile loans and auto dealer financing, business deposit products and credit cards. Commercial lending and deposit products are offered primarily to middle-market and large companies locally, nationally and internationally.

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Net income for the Commercial Banking segment was $119.8 million for the year ended December 31, 2021, an increase of $45.8 million or 62% as compared to 2020. The increase in net income for the Commercial Banking segment was primarily due to the Provision. The Provision was a benefit of $22.5 million for the year ended December 31, 2021, compared to a Provision of $53.9 million for the year ended December 31, 2020. The increase in net income for the Commercial Banking segment also stemmed from a $11.4 million increase in net interest income, partially offset by a $21.0 million increase in noninterest expense, a $15.6 million increase in the provision for income taxes and a $5.4 million decrease in noninterest income. The decrease in the Provision was largely due to improvements in the credit quality of our loan and lease portfolio and lower expected credit losses as a result of the economic recovery and easing of restrictions related to the COVID-19 pandemic. The increase in net interest income was primarily due to an increase in loan fees. The increase in noninterest expense was primarily due to higher overall expenses that were allocated to the Commercial Banking segment, and increases in salaries and benefits expense, card rewards program expense, supplies expense and estimated PPP loan losses. The increase in the provision for income taxes was primarily due to the increase in pretax income. The decrease in noninterest income was primarily due to decreases in gains on the sale of commercial loans, customer-related interest rate swap fees and volume-based incentives, partially offset by increases in credit and debit card fees and other service charges and fees. The decrease in total assets for the Commercial Banking segment was primarily due to decreases in PPP loans and our dealer flooring portfolio, partially offset by increases in our commercial real estate and our Shared National Credits portfolios.

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Net income for the Commercial Banking segment was $74.0 million for the year ended December 31, 2020, a decrease of $18.6 million or 20% as compared to 2019. The decrease in net income for the Commercial Banking segment was primarily due to a $46.4 million increase in the Provision, partially offset by a $10.4 million increase in net interest income, a $10.3 million decrease in the provision for income taxes, a $4.6 million increase in noninterest income and a $2.4 million decrease in noninterest expense. The increase in the Provision was primarily due to higher expected credit losses as a result of COVID-19 and its impact on our customers. The increase in net interest income was primarily due to an increase in loan fees and higher spread on our commercial loans, partially offset by a decrease in transfer pricing credits on interest expenses from deposits as a result of lower yields on our deposit portfolio. The decrease in the provision for income taxes was primarily due to the decrease in pretax income. The increase in noninterest income was primarily due to gains on the sale of loans and increases in customer-related interest rate swap fees and volume-based incentives, partially offset by decreases in credit and debit card fees and other service charges and fees. The decrease in noninterest expense was primarily due to a decrease in card rewards program expense, partially offset by increases in contracted services expense and salaries and benefits expense, higher overall expenses that were allocated to the Commercial Banking segment, and an increase in other tax expense. The increase in total assets for the Commercial Banking segment was primarily due to PPP loans and an increase in construction loans, partially offset by decreases in our dealer flooring portfolios, Shared National Credits, indirect automobile loans and credit card balances.

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Treasury and Other.  Our Treasury and Other segment includes our treasury business, which consists of corporate asset and liability management activities, including interest rate risk management. The assets and liabilities (and related interest income and expense) of our treasury business consist of interest-bearing deposits, investment securities, federal funds sold and purchased, government deposits, short and long-term borrowings and bank-owned properties. Our primary sources of noninterest income are from BOLI, net gains from the sale of investment securities, foreign exchange income related to customer driven currency requests from merchants and island visitors and management of bank-owned properties in Hawaii and Guam. The net residual effect of the transfer pricing of assets and liabilities is included in Treasury and Other, along with the elimination of intercompany transactions.

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Other organizational units (Technology, Operations, Credit and Risk Management, Human Resources, Finance, Administration, Marketing, and Corporate and Regulatory Administration) provide a wide range of support to our other income earning segments. Expenses incurred by these support units are charged to the applicable business segments through an internal cost allocation process.

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Net loss for the Treasury and Other segment was $41.0 million for the year ended December 31, 2021, an increase in net loss of $9.1 million as compared to 2020. The increase in net loss was primarily due to a $27.1 million increase in net interest expense and a $1.9 million increase in noninterest expense, partially offset by a $15.4 million decrease in the Provision and a $5.2 million increase in the benefit for income taxes. The increase in net interest expense was primarily due to an increase in net transfer pricing charges that reside in the Treasury and Other segment, partially offset by an increase in our investment securities portfolio average balance and a decrease in our borrowings. The increase in noninterest expense was primarily due to prepayment fees to terminate the Company’s FHLB fixed-rate advances, and increases in salaries and employee benefits expense, contracted services and professional fees, equipment expense, software amortization expense, occupancy expense, pension-related expenses, regulatory assessment and fees, advertising and marketing expense, other insurance expense and supplies expense, partially offset by higher overall credits that were allocated to the Treasury and Other segment. The decrease in the Provision was largely due to improvements in the credit quality of our loan and lease portfolio and lower expected credit losses as a result of the economic recovery and easing of restrictions related to the COVID-19 pandemic. The increase in the benefit for income taxes was primarily due to the increase in pretax loss. The increase in total assets for the Treasury and Other segment was primarily due to increases in our investment securities portfolio and interest-bearing deposits in other banks.

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Net loss for the Treasury and Other segment was $31.9 million for the year ended December 31, 2020, an increase in net loss of $19.1 million as compared to 2019. The increase in net loss was primarily due to a $15.1 million increase in the Provision, a $10.2 million decrease in net interest income and a $2.3 million decrease in noninterest income, partially offset by a $4.9 million decrease in noninterest expense and a $3.5 million increase in the benefit for income taxes. The increase in the Provision was primarily due to higher expected credit losses as a result of COVID-19 and its impact on our customers. The decrease in net interest income was primarily due to lower earnings credits as a result of lower average yields in our loan portfolio and lower average yields in our investment securities portfolio and interest-bearing deposits in other banks, partially offset by a decrease in transfer pricing charges as a result of lower yields on our deposit portfolio. The decrease in noninterest income was primarily due to decreases in ATM surcharge fees, ATM interchange fees from customers and other service charges and fees, and insurance settlement income received in 2019, partially offset by a

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decrease in net losses on the sale of investment securities as a result of the investment portfolio restructuring and sale of 48 investment securities in January 2019. The decrease in noninterest expense was primarily due to lower overall expenses that were allocated to the Treasury and Other segment, and decreases in pension-related expenses, advertising and marketing expenses, charitable contributions and occupancy expense, partially offset by increases in equipment expense, salaries and employee benefits expense, software amortization expense and contracted services and professional fees. The increase in the benefit for income taxes was primarily due to the increase in pretax loss. The increase in total assets for the Treasury and Other segment was primarily due to increases in our investment securities portfolio and interest-bearing deposits in other banks.

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Analysis of Financial Condition

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Liquidity and Capital Resources

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Liquidity refers to our ability to maintain cash flow that is adequate to fund operations and meet present and future financial obligations through either the sale or maturity of existing assets or by obtaining additional funding through liability management. We consider the effective and prudent management of liquidity to be fundamental to our health and strength. Our objective is to manage our cash flow and liquidity reserves so that they are adequate to fund our obligations and other commitments on a timely basis and at a reasonable cost.

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Liquidity is managed to ensure stable, reliable and cost-effective sources of funds to satisfy demand for credit, deposit withdrawals and investment opportunities. Funding requirements are impacted by loan originations and refinancings, deposit balance changes, liability issuances and settlements and off-balance sheet funding commitments. We consider and comply with various regulatory and internal guidelines regarding required liquidity levels and periodically monitor our liquidity position in light of the changing economic environment and customer activity. Based on periodic liquidity assessments, we may alter our asset, liability and off-balance sheet positions. The Company’s Asset Liability Management Committee (“ALCO”) monitors sources and uses of funds and modifies asset and liability positions as liquidity requirements change. This process, combined with our ability to raise funds in money and capital markets and through private placements, provides flexibility in managing the exposure to liquidity risk.

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Immediate liquid resources are available in cash which is primarily on deposit with the Federal Reserve Bank of San Francisco (the “FRB”). As of December 31, 2021 and 2020, cash and cash equivalents were $1.3 billion and $1.0 billion, respectively. Potential sources of liquidity also include investment securities in our available-for-sale portfolio. The carrying value of our available-for-sale investment securities were $8.4 billion and $6.1 billion as of December 31, 2021 and 2020, respectively. As of December 31, 2021 and 2020, we maintained our excess liquidity primarily in collateralized mortgage obligations issued by Ginnie Mae, Fannie Mae and Freddie Mac and mortgage-backed securities issued by Ginnie Mae, Fannie Mae, Freddie Mac and Municipal Housing Authorities. As of December 31, 2021, our available-for-sale investment securities portfolio was comprised of securities with a weighted average life of approximately 5.8 years. These funds offer substantial resources to meet either new loan demand or to help offset reductions in our deposit funding base. Liquidity is further enhanced by our ability to pledge loans to access secured borrowings from the FHLB and the FRB. As of December 31, 2021, we have borrowing capacity of $1.8 billion from the FHLB and $1.1 billion from the FRB based on the amount of collateral pledged.

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Our core deposits have historically provided us with a long-term source of stable and relatively lower cost of funding. Our core deposits, defined as all deposits exclusive of time deposits exceeding $250,000, totaled $21.0 billion and $17.9 billion as of December 31, 2021 and 2020, which represented 96% and 93%, respectively, of our total deposits. These core deposits are normally less volatile, often with customer relationships tied to other products offered by the Company; however, deposit levels could decrease if interest rates increase significantly or if corporate customers increase investing activities and reduce deposit balances.

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Our material cash requirements from our current and long-term contractual obligations as of December 31, 2021 are summarized in the following table:

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Commitments to extend credit, standby letters of credit and commercial letters of credit do not necessarily represent future cash requirements in that these commitments often expire without being drawn upon; therefore, these items are not included in the table above. Purchase obligations arise from agreements to purchase goods or services that are enforceable and legally binding. Other contracts included in purchase obligations primarily consist of service agreements for various systems and applications supporting bank operations, including the systems and applications in the Bank’s new core system expected to be implemented in 2022. Postretirement benefit contributions represent the minimum expected contribution to the postretirement benefit plan. Actual contributions may differ from these estimates.

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Our liability for unrecognized tax benefits (“UTBs”) as of December 31, 2021 and 2020 were $204.1 million and $154.5 million, respectively. The increase in UTB was primarily due to additions related to state tax refund claims for periods during which the Company was the parent company for the state combined returns filed with BNPP and BOW. We are unable to reasonably estimate the period of cash settlement with the respective taxing authority. As a result, our liability for UTBs is not disclosed in the table above.

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See the discussion of credit, lease and other contractual commitments in “Note 4. Loans and Leases” and “Note 17. Commitments and Contingent Liabilities” in the notes to the consolidated financial statements included Item 8. Financial Statements and Supplementary Data.

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Other material cash requirements include general corporate operating activities, stock repurchases, and capital to be returned to our shareholders.

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We expect to meet these obligations from dividends paid by the Bank to the Parent. Additional sources of liquidity available to us include selling residential real estate loans in the secondary market, taking out short- and long-term borrowings and issuing long-term debt and equity securities. At the start of the pandemic, we increased our liquidity position through additional public time deposits in anticipation of a surge in funding needs due to our participation in the PPP and other additional liquidity needs. While our public time deposits have since decreased from the fourth quarter of 2020, we have continued to maintain high levels of liquidity as of December 31, 2021. We believe that our existing cash, cash equivalents, investments, and cash expected to be generated from operations, will be sufficient to meet our cash requirements within the next twelve months and beyond.

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Potential Demands on Liquidity from Off-Balance Sheet Arrangements

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We have off-balance sheet arrangements, such as variable interest entities, guarantees, and certain financial instruments with off-balance sheet risk, that may affect the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

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Variable Interest Entities

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We hold interests in several unconsolidated variable interest entities (“VIEs”). These unconsolidated VIEs are primarily low-income housing tax credit investments in partnerships and limited liability companies. Variable interests are defined as contractual ownership or other interests in an entity that change with fluctuations in an entity’s net asset value. The primary beneficiary consolidates the VIE. Based on our analysis, we have determined that the Company is not the primary beneficiary of these entities. As a result, we do not consolidate these VIEs. Unfunded commitments to fund these low-income housing tax credit investments were $62.6 million and $89.0 million as of December 31, 2021 and 2020, respectively.

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Guarantees

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We sell residential mortgage loans in the secondary market primarily to Fannie Mae or Freddie Mac. The agreements under which we sell residential mortgage loans to Fannie Mae or Freddie Mac contain provisions that include various representations and warranties regarding the origination and characteristics of the residential mortgage loans. Although the specific representations and warranties vary among investors, insurance or guarantee agreements, they typically cover: ownership of the loan; validity of the lien securing the loan; the absence of delinquent taxes or liens against the property securing the loan; compliance with loan criteria set forth in the applicable agreement; compliance with applicable federal, state, and local laws; and other matters. As of December 31, 2021 and 2020, the unpaid principal balance of our portfolio of residential mortgage loans sold was $1.7 billion and $2.2 billion, respectively. The agreements under which we sell residential mortgage loans require delivery of various documents to the investor or its document custodian. Although these loans are primarily sold on a non-recourse basis, we may be obligated to repurchase residential mortgage loans or reimburse investors for losses incurred if a loan review reveals that underwriting and documentation standards were potentially not met in the origination of those loans. Upon receipt of a repurchase request, we work with investors to arrive at a mutually agreeable resolution. Repurchase demands are typically reviewed on an individual loan by loan basis to validate the claims made by the investor to determine if a contractually required repurchase event has occurred. We manage the risk associated with potential repurchases or other forms of settlement through our underwriting and quality assurance practices and by servicing mortgage loans to meet investor and secondary market standards. For the year ended December 31, 2021, there were two residential mortgage loan repurchases totaling $0.6 million and there were no pending repurchase requests.

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In addition to servicing loans in our portfolio, substantially all of the loans we sell to investors are sold with servicing rights retained. We also service loans originated by other mortgage loan originators. As servicer, our primary duties are to: (1) collect payments due from borrowers; (2) advance certain delinquent payments of principal and interest; (3) maintain and administer any hazard, title, or primary mortgage insurance policies relating to the mortgage loans; (4) maintain any required escrow accounts for payment of taxes and insurance and administer escrow payments; and (5) foreclose on defaulted mortgage loans, or loan modifications or short sales. Each agreement under which we act as servicer generally specifies a standard of responsibility for actions taken by the Company in such capacity and provides protection against expenses and liabilities incurred by the Company when acting in compliance with the respective servicing agreements. However, if we commit a material breach of obligations as servicer, we may be subject to termination if the breach is not cured within a specified period following notice. The standards governing servicing and the possible remedies for violations of such standards vary by investor. These standards and remedies are determined by servicing guides issued by the investors as well as the contract provisions established between the investors and the Company. Remedies could include repurchase of an affected loan. For the year ended December 31, 2021, we had no repurchase requests related to loan servicing activities, nor were there any pending repurchase requests as of December 31, 2021.

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Although to date repurchase requests related to representation and warranty provisions and servicing activities have been limited, it is possible that requests to repurchase mortgage loans may increase in frequency as investors more aggressively pursue all means of recovering losses on their purchased loans. However, as of December 31, 2021, management believes that this exposure is not material due to the historical level of repurchase requests and loss trends and thus has not established a liability for losses related to mortgage loan repurchases. As of December 31, 2021, 99% of our residential mortgage loans serviced for investors were current. We maintain ongoing communications with investors and continue to evaluate this exposure by monitoring the level and number of repurchase requests as well as the delinquency rates in loans sold to investors.

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Financial Instruments with Off-Balance Sheet Risk

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The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby and commercial letters of credit which are not reflected in the consolidated financial statements.

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See “Note 17. Commitments and Contingent Liabilities” in the notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data for more information on our financial instruments with off-balance sheet risk.

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Investment Securities

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Table 10 presents the estimated fair value of our available-for-sale investment securities portfolio as of December 31, 2021 and 2020:

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Table 11 presents the maturity distribution at amortized cost and weighted-average yield to maturity of our available-for-sale investment securities portfolio as of December 31, 2021:

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The fair value of our available-for-sale investment securities portfolio was $8.4 billion as of December 31, 2021, an increase of $2.4 billion or 39% compared to December 31, 2020. The higher balances in investment securities were primarily due to deploying excess balance sheet liquidity. Our available-for-sale investment securities are carried at fair value with changes in fair value reflected in other comprehensive income (loss) or through the Provision.

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As of December 31, 2021, we maintained all of our investment securities in the available-for-sale category recorded at fair value in the consolidated balance sheets, with $4.7 billion invested in collateralized mortgage obligations issued by Ginnie Mae, Fannie Mae and Freddie Mac. Our available-for-sale portfolio also included $3.4 billion in mortgage-backed securities issued by Ginnie Mae, Fannie Mae, Freddie Mac and Municipal Housing Authorities, $192.6 million in debt securities issued by the U.S. Treasury and government agencies (U.S. International Development Finance Corporation bonds), $105.2 million in collateralized loan obligations and $44.2 million in debt securities issued by states and political subdivisions.

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We continually evaluate our investment securities portfolio in response to established asset/liability management objectives, changing market conditions that could affect profitability and the level of interest rate risk to which we are exposed. These evaluations may cause us to change the level of funds we deploy into investment securities and change the composition of our investment securities portfolio.

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Gross unrealized gains in our investment securities portfolio were $24.6 million and $97.1 million as of December 31, 2021 and 2020, respectively. Gross unrealized losses in our investment securities portfolio were $157.3 million and $10.7 million as of December 31, 2021 and 2020, respectively. The increase in unrealized loss and decrease in unrealized gains in our investment securities portfolio was primarily due to higher market interest rates as of December 31, 2021, relative to December 31, 2020, resulting in a lower valuation. Additionally, the increase in unrealized loss and decrease in unrealized gain positions were primarily related to our collateralized mortgage obligations, commercial mortgage-backed securities and residential mortgage-backed securities, the fair value of which is sensitive to changes in market interest rates.

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We conduct a regular assessment of our investment securities portfolio to determine whether any securities are impaired. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and the ACL is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through the ACL is recognized in other comprehensive income. For the years ended December 31, 2021 and 2020, we did not record any credit losses related to our investment securities portfolio.

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We are required to hold non-marketable equity securities, comprised of FHLB stock, as a condition of our membership in the FHLB system. Our FHLB stock is accounted for at cost, which equals par or redemption value. As of December 31, 2021 and 2020, we held $10.1 million and $18.1 million in FHLB stock, respectively, which is recorded as a component of other assets in our consolidated balance sheets.

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See “Note 3. Investment Securities” in the notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data for more information on our investment securities portfolio.

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Loans and Leases

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Table 12 presents the composition of our loan and lease portfolio by major categories as of December 31, 2021 and 2020:

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Total loans and leases were $13.0 billion as of December 31, 2021, a decrease of $317.1 million or 2% from December 31, 2020, with decreases in commercial and industrial loans, consumer loans and lease financing, partially offset by increases in commercial real estate loans, construction loans and residential real estate loans. The decrease in total loans and leases was primarily due to our participation in the PPP which had a total amortized cost basis of $216.4 million as of December 31, 2021, a decrease of $584.8 million from December 31, 2020. It is possible that the continued effects of COVID-19 on the economy could result in less demand for our loan products.

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Commercial and industrial loans are made primarily to corporations, middle market and small businesses for the purpose of financing equipment acquisition, expansion, working capital and other general business purposes. We also offer a variety of automobile dealer flooring lines to our customers in Hawaii and California to assist with the financing of their inventory. Commercial and industrial loans were $2.1 billion as of December 31, 2021, a decrease of $932.4 million or 31% from December 31, 2020. This decrease was primarily due to a decrease in PPP loans, as well as a reduction in dealer flooring balances, partially offset by an increase in our Shared National Credits during the year. The decrease in dealer flooring balances was driven by the global chip shortage that has been adversely impacting the automobile industry.

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Commercial real estate loans are secured by first mortgages on commercial real estate at loan to value (“LTV”) ratios generally not exceeding 75% and a minimum debt service coverage ratio of 1.20 to 1. The commercial properties are predominantly apartments, neighborhood and grocery anchored retail, industrial, office, and to a lesser extent, specialized properties such as hotels. The primary source of repayment for investor property and owner occupied property is cash flow from the property and the operating cash flow from the business, respectively. Commercial real estate loans were $3.6 billion as of December 31, 2021, an increase of $246.9 million or 7% from December 31, 2020. This increase was primarily due to an increase in U.S. Mainland commercial real estate loans during the year.

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Construction loans are for the purchase or construction of a property for which repayment will be generated by the property. Loans in this portfolio are primarily for the purchase of land, as well as for the development of commercial properties, single family homes and condominiums. We classify loans as construction until the completion of the construction phase. Following construction, if a loan is retained by the Bank, the loan is reclassified to the commercial real estate or residential real estate classes of loans. Construction loans were $814.0 million as of December 31, 2021, an increase of $78.2 million or 11% from December 31, 2020. The increase was primarily due to an increase in U.S. Mainland and Hawaii construction loan draws during the year.

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Residential real estate loans are generally secured by 1-4 unit residential properties and are underwritten using traditional underwriting systems to assess the credit risks and financial capacity and repayment ability of the consumer. Decisions are primarily based on LTV ratios, debt-to-income (“DTI”) ratios, liquidity and credit scores. LTV ratios generally do not exceed 80%, although higher levels are permitted with mortgage insurance. We offer fixed rate mortgage products and variable rate mortgage products with interest rates that are subject to change every year after the first, third, fifth or tenth year, depending on the product and are based on LIBOR. Variable rate residential mortgage loans are underwritten at fully-indexed interest rates. We generally do not offer interest-only, payment-option facilities, Alt-A loans or any product with negative amortization. Residential real estate loans were $5.0 billion as of December 31, 2021, an increase of $428.1 million or 9% from December 31, 2020. This increase was primarily due to increases in residential mortgages of $393.1 million and home equity lines of $35.0 million during the year.

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Consumer loans consist primarily of open- and closed-end direct and indirect credit facilities for personal, automobile and household purchases as well as credit card loans. We seek to maintain reasonable levels of risk in consumer lending by following prudent underwriting guidelines, which include an evaluation of personal credit history, cash flow and collateral values based on existing market conditions. Consumer loans were $1.2 billion as of December 31, 2021, a decrease of $123.9 million or 9% from December 31, 2020. The decrease in consumer loans was primarily due to decreases in indirect automobile loans and other unsecured consumer loans.

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Lease financing consists of commercial single investor leases and leveraged leases. Underwriting of new lease transactions is based on our lending policy, including but not limited to an analysis of customer cash flows and secondary sources of repayment, including the value of leased equipment, the guarantors’ cash flows and/or other credit enhancements. No new leveraged leases are being added to the portfolio and all remaining leveraged leases are running off. Lease financing was $231.4 million as of December 31, 2021, a decrease of $14.0 million or 6% from December 31, 2020. The reduction was reflective of weak demand for new business equipment and vehicles in the Hawaii market coupled with supply chain disruption causing significant delays in deliveries of new orders.

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See “Note 4. Loans and Leases” in the notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data and the discussion in “Analysis of Financial Condition — Allowance for Credit Losses” of this MD&A for more information on our loan and lease portfolio.

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The Company’s loan and lease portfolio includes adjustable-rate loans, primarily tied to Prime and LIBOR, hybrid rate loans, for which the initial rate is fixed for a period from one year to as much as ten years, and fixed rate loans, for which the interest rate does not change through the life of the loan. Table 13 presents the recorded investment in our loan and lease portfolio as of December 31, 2021:

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Tables 14 and 15 present the geographic distribution of our loan and lease portfolio as of December 31, 2021 and 2020:

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Our lending activities are concentrated primarily in Hawaii. However, we also have lending activities on the U.S. mainland, Guam and Saipan. Our commercial lending activities on the U.S. mainland include automobile dealer flooring activities in California, participation in the Shared National Credits Program and selective commercial real estate projects based on existing customer relationships. Our lease financing portfolio includes commercial leveraged and single investor lease financing activities both in Hawaii and on the U.S. mainland.  However, no new leveraged leases are being added to the portfolio and all remaining leveraged leases are running off. Our consumer lending activities are concentrated primarily in Hawaii and to a smaller extent, Guam and Saipan.

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Table 16 presents certain contractual loan maturity categories and sensitivities of those loans to changes in interest rates as of December 31, 2021:

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Credit Quality

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We evaluate certain loans and leases, including commercial and industrial loans, commercial real estate loans and construction loans, individually for impairment and non-accrual status. A loan is considered to be impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan. We generally place a loan on non-accrual status when management believes that collection of principal or interest has become doubtful or when a loan or lease becomes 90 days past due as to principal or interest, unless it is well secured and in the process of collection. Loans on non-accrual status are generally classified as impaired, but not all impaired loans are necessarily placed on non-accrual status. See “Note 5. Allowance for Credit Losses” in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data for more information about our credit quality indicators.

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For purposes of managing credit risk and estimating the ACL, management has identified three categories of loans (commercial, residential real estate and consumer) that we use to develop our systematic methodology to determine the ACL. The categorization of loans for the evaluation of credit risk is specific to our credit risk evaluation process and these loan categories are not necessarily the same as the loan categories used for other evaluations of our loan portfolio. See “Note 5. Allowance for Credit Losses” in the notes to the consolidated financial statements included in Item 8. Financial Statements and Supplementary Data for more information about our approach to estimating the ACL.

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The following tables and discussion address non-performing assets, loans and leases that are 90 days past due but are still accruing interest, impaired loans and loans modified in a troubled debt restructuring.

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Non-Performing Assets and Loans and Leases Past Due 90 Days or More and Still Accruing Interest

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Table 17 presents information on our Non-Performing Assets (“NPAs”) and Accruing Loans and Leases Past Due 90 Days or More as of December 31, 2021 and 2020:

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Table 18 presents the activity in NPAs for the years ended December 31, 2021 and 2020:

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