The federal regulatory authorities’ risk-based capital guidelines are based upon the 1988 capital accord of the Basel Committee on Banking Supervision, or the BIS. The BIS is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines for use by each country’s supervisors in determining the supervisory policies they apply. In 2004, the BIS published a new capital accord to replace its 1988 capital accord, with an update in November 2005 (“BIS II”). BIS II provides two approaches for setting capital standards for credit risk—an internal ratings-based approach tailored to individual institutions’ circumstances (which for many asset classes is itself broken into a “foundation” approach and an “advanced or A-IRB” approach, the availability of which is subject to additional restrictions) and a standardized approach that bases risk weightings on external credit assessments to a much greater extent than permitted in existing risk-based capital guidelines. BIS II also would set capital requirements for operational risk and refine the existing capital requirements for market risk exposures.

The U.S. banking and thrift agencies are developing proposed revisions to their existing capital adequacy regulations and standards based on BIS II. In September 2006, the agencies issued a notice of proposed rulemaking setting forth a definitive proposal for implementing BIS II in the United States that would apply only to internationally active banking organizations—defined as those with consolidated total assets of $250 billion or more or consolidated on-balance sheet foreign exposures of $10 billion or more—but that other U.S. banking organizations could elect but would not be required to apply. In December 2006, the agencies issued a notice of proposed rulemaking describing proposed amendments to their existing risk-based capital guidelines to make them more risk-sensitive, generally following aspects of the standardized approach of BIS II. These latter proposed amendments, often referred to as “BIS I-A,” would apply to banking organizations that are not internationally active banking organizations subject to the A-IRB approach for internationally active banking organizations and do not “opt in” to that approach.

The comment periods for both of the agencies’ notices of proposed rulemakings expired on March 26, 2007. The agencies have indicated their intent to have the new requirements first become effective in 2009 and that those provisions and the BIS I-A provisions for others will be implemented on similar timeframes.

The Company is not an internationally active banking organization and does not expect to opt-in to the A-IRB provisions once they become effective.

 

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Substantially all of the deposits of our bank subsidiary are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF. Our bank subsidiary paid no insurance assessments on these deposits during the most recent semi-annual period. However, in November 2006, the FDIC issued a final rule that became effective on January 1, 2007 that creates a new assessment system designed to more closely tie what banks pay for deposit insurance to the risks they pose and adopts a new base schedule of rates that the FDIC can adjust up or down, depending on the revenue needs of the insurance fund. This new assessment system is expected to result in increased annual assessments on deposits of our bank subsidiary of 5 to 7 cents for each $100 of domestically held deposits. An FDIC credit for prior contributions is expected to offset the assessment for 2007 and may offset a portion of the assessment for 2008. Significant increases in the insurance assessments our bank subsidiary pays will increase our costs once the credit is utilized or otherwise disposed of.

 

The FDIA provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.

The Community Reinvestment Act of 1977, or the CRA, requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and are assigned ratings. In order for a financial holding company to commence any new activity permitted by the BHC Act or to acquire any company engaged in any new activity permitted by the BHC Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA. Furthermore, banking regulators take into account CRA ratings when considering approval of a proposed transaction.

In accordance with the GLB Act, federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and in some circumstances allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. The privacy provisions of the GLB Act affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.

A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001, or the USA Patriot Act, substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The United States Treasury Department has issued a number of regulations that apply various requirements of the USA Patriot Act to financial institutions such as our bank and broker-dealer subsidiaries. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.

In November 2006, Central Pacific Bank agreed to a cease and desist order (the “Order”) with the FDIC and the DFI. The Order required the bank to take steps to improve its Bank Secrecy Act (“BSA”) program including detecting, monitoring and reporting large currency transactions and suspicious activity. Since receiving the order, the bank has implemented numerous improvements to address the requirements of the Order with regulatory guidance. The bank’s improvements to its BSA program included a new automated system designed to detect, monitor and report large currency transactions and suspicious activity. In November 2007, the bank was successful in having the Order terminated by the FDIC and DFI.

 

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The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the “OFAC” rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in or providing investment-related advice or assistance to a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.

From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and our operating environment in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. We cannot predict whether any such legislation will be enacted, and if enacted, the effect that it or any implementing regulations would have on our financial condition or results of operations. A change in statutes, regulations or regulatory policies applicable to us or any of our subsidiaries could have a material effect on our business.

At January 31, 2008, we employed 1,085 persons, 1,021 on a full-time basis and 64 on a part-time basis. We are not a party to any collective bargaining agreement.

Our internet website can be found at www.centralpacificbank.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports can be found on our internet website as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Copies of the Company’s filings with the SEC may also be obtained directly from the SEC’s website at www.sec.gov. These documents may also be obtained in print upon request by our shareholders to our Investor Relations Department.

 

The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us. If any one or a combination of these risks occurs, our business, financial condition or results of operations could be materially and adversely affected.

 

Changes in economic conditions, in particular an economic slowdown in Hawaii or a continued slowdown in California, could materially hurt our business.

Our business is directly affected by factors such as economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government monetary and fiscal policies and inflation, all of which are beyond our control. The current deterioration in economic conditions in the United States generally, and any economic slowdown in Hawaii or a continued slowdown in California given the concentration of our loan portfolio in the region, could result in the following consequences, any of which could materially hurt our business:

·	Loan delinquencies may continue to increase;

·	Problem assets and foreclosures may continue to increase leading to more loan charge-offs;

·	Demand for our products and services may decline;

·	Low cost or non-interest bearing deposits may continue to decrease; and

·	Collateral for loans made by us, especially involving real estate, may continue to decline in value, in turn reducing customers’ borrowing power and reducing the value of assets and collateral associated with our existing loans.

 

A large percentage of our loans are collateralized by real estate and an adverse change in the real estate market may result in losses and adversely affect our profitability.

As we have seen in the last half of 2007 with the deteriorating market conditions of the California residential construction market, our results of operations in future periods may be significantly impacted by the economies in Hawaii, California and other markets we serve. Approximately 84% of our loan portfolio as of December 31, 2007 was comprised of loans primarily collateralized by real estate, 66% of these loans are concentrated in Hawaii, 30% in California and 4% in Washington. The continued deterioration of the California residential construction market, deterioration of the economic environment in Hawaii, California or other markets we serve, including a material decline in the real estate market, further declines in single-family home resales or a material external shock, may significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. In the event of a default with respect to any of these loans, amounts received upon sale of the collateral may be insufficient to recover outstanding principal and interest on the loan. As a result, we expect that our profitability would be negatively impacted by an adverse change in the real estate market.

A large percentage of our real estate loans are construction loans which involve the additional risk that a project may not be completed, increasing the risk of loss.

Approximately 35% of our real estate loan portfolio as of December 31, 2007 was comprised of construction loans. Fifty-one percent of these construction loans are in California, 42% are in Hawaii and the remaining 7% are in Washington. Repayment of construction loans is dependent upon the successful completion of the construction project, on time and within budget, and the successful sale of the completed project. If a borrower is unable to complete a construction project or if the marketability of the completed development is impaired, proceeds from the sale of the subject property may be insufficient to repay the loan. The continued decline in the California real estate market or a deterioration of the real estate market in any market we serve is likely to damage the marketability of these projects, as a result, we may incur loan losses which will adversely affect our profitability. We have had to increase our provision for loan and lease losses substantially over the latter part of 2007 and may have to do so again.

 

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Our business is subject to interest rate risk and fluctuations in interest rates may adversely affect our earnings.

The majority of our assets and liabilities are monetary in nature and subject to risk from changes in interest rates. Like most financial institutions, our earnings and profitability depend significantly on our net interest income, which is the difference between interest income on interest-earning assets such as loans and investment securities and interest expense on interest-bearing liabilities such as deposits and borrowings. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. If market interest rates should move contrary to our position, this “gap” will work against us and our earnings may be negatively affected. In light of our current volume and mix of interest-earning assets and interest-bearing liabilities, our interest rate spread could be expected to increase during periods of rising interest rates and, conversely, to decline during periods of falling interest rates. We are unable to predict or control fluctuations of market interest rates, which are affected by many factors including the following:

·	Inflation;

·	Recession;

·	Changes in unemployment;

·	The money supply; and

·	International disorder and instability in domestic and foreign financial markets.

Our asset/liability management strategy may not be able to control our risk from changes in market interest rates and it may not be able to prevent changes in interest rates from having a material adverse effect on our results of operations and financial condition. From time to time, we may reposition our investment portfolio, as we have done in 2007 and 2006, to reduce our net interest income volatility.

Our allowance for loan and lease losses may not be sufficient to cover actual loan losses, which could adversely affect our results of operations. Additional loan losses will likely occur in the future and may occur at a rate greater than we have experienced to date.

As a lender, we are exposed to the risk that our loan customers may not repay their loans according to their terms and that the collateral or guarantees securing these loans may be insufficient to assure repayment. We recently increased our loan loss provision and our current allowance may not be sufficient. We may experience significant loan losses that could have a material adverse effect on our operating results. Management makes various assumptions and judgments about the collectibility of our loan portfolio, which are regularly reevaluated and are based in part on:

 

·	Current economic conditions and their estimated effects on specific borrowers;

·	An evaluation of the existing relationships among loans, potential loan losses and the present level of the allowance for loan and lease losses;

·	Results of examinations of our loan portfolios by regulatory agencies; and

·	Management’s internal review of the loan portfolio.

In determining the size of the allowance, we rely on an analysis of our loan portfolio, our experience and our evaluation of general economic conditions. If our assumptions prove to be incorrect, our current allowance may not be sufficient. We have recently made significant adjustments and additional adjustments may continue to be necessary if the local or national real estate markets continue their deterioration. Material additions to the allowance would materially decrease our net income. In addition, federal regulators periodically evaluate the adequacy of our allowance and may require us to increase our provision for loan and lease losses or recognize further loan charge-offs based on judgments different than those of our management. Any further increase in our allowance or loan charge-offs could have a material adverse effect on our results of operations.

 

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We operate in a highly competitive industry and market area.

We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional and community banks within the various markets we operate. Additionally, various out-of-state banks conduct significant business in the market areas in which we currently operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries.

 

The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.

Our ability to compete successfully depends on a number of factors, including, among other things:

·	The ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical standards and safe, sound assets;

·	The ability to expand our market position;

·	The scope, relevance and pricing of products and services offered to meet customer needs and demands;

·	The rate at which we introduce new products and services relative to its competitors;

·	Customer satisfaction with our level of service; and

·	Industry and general economic trends.

Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Our deposit customers may pursue alternatives to bank deposits or seek higher yielding deposits causing us to incur increased funding costs.

We are facing increasing deposit-pricing pressures. Checking and savings account balances and other forms of deposits can decrease when our deposit customers perceive alternative investments such as the stock market or other non-depository investments as providing superior expected returns. Furthermore, technology and other changes have made it more convenient for bank customers to transfer funds into alternative investments including products offered by other financial institutions or non-bank service providers. Additional increases in short-term interest rates could increase transfers of deposits to higher yielding deposits. Efforts and initiatives we undertake to retain and increase deposits, including deposit pricing, can increase our costs. When bank customers move money out of bank deposits in favor of alternative investments or into higher yielding deposits, we can lose a relatively inexpensive source of funds, thus increasing our funding costs.

Operations in our California loan production offices have a considerable affect on our results of operations, and sustaining these operations and growing loans may be more difficult than we expect, which could adversely affect our results of operations.

Expanding our loan production in California depends on a number of factors including improvement of the California real estate market. As we have seen in the California residential construction market during the second half of 2007, the strength of the real estate market and the results of our operations could continue to be negatively affected by an economic downturn and increases in market interest rates.

Because we have a limited operating history with respect to our California loan production offices, it is more difficult to predict our future prospects and financial performance, which may impair our ability to manage our business.

Our first California loan production office commenced operations in the first quarter of 2003. Consequently, our mainland offices have a limited history upon which we can rely in planning and making decisions that will affect our future operating results.

 

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Because we have a limited operating history with respect to our California loan production offices, it is more difficult to predict our future prospects and financial performance, which may impair our ability to manage our business.

Our first California loan production office commenced operations in the first quarter of 2003. Consequently, our mainland offices have a limited history upon which we can rely in planning and making decisions that will affect our future operating results.

 

The loans made by our California loan production offices are generally unseasoned and any defaults on such loans would adversely affect our financial condition, results of operations and prospects.

 

At December 31, 2007, loans originated in our California loan production offices totaled $1.1 billion, or 25% of our total loan portfolio. In light of the limited operating history of our mainland loan production offices described in the previous risk factor, we note that all of those loans were originated after January 1, 2003. The payment on such loans is typically dependent on the cash flows generated by the projects, which are affected by the supply and demand for commercial property within the relative market. Declines in the market for commercial property are causing commercial borrowers to suffer losses on their projects and they may be unable to repay their loans. Our reevaluation of these unseasoned loans that were originated in California has been a significant factor in the recent increase in our provision for loan and lease losses. Defaults of these loans or further deterioration in the credit worthiness of any of these borrowers would further negatively affect our financial condition, results of operations and prospects.

 

The loans made by our California loan production offices are concentrated among a limited number of customers and difficulty with a customer or loss of a customer could affect our results of operations and our ability to grow loans and deposits in the mainland.

Our California operations are dependent on a concentration of loans with a small number of key customers with whom individuals on our mainland loan staff have built strong relationships. Such a concentration of borrowers carries certain risks. Among other things, financial difficulty at one mortgaged real property could cause a borrower to defer maintenance at another mortgaged real property in order to satisfy current expenses with respect to the troubled mortgaged real property. A borrower could attempt to avert foreclosure on one mortgaged real property by filing a bankruptcy petition that might have the effect of interrupting monthly payments for an indefinite period on all of the related mortgage loans. Furthermore, the average size of loans in our mainland portfolio, especially those originated in Southern California, is larger than that of loans in our Hawaii portfolio, and such larger average loan size could make potential losses related to concentration risk more severe.

Loan growth from our California operations is dependent on relationships between certain key customers and our current mainland loan staff who in turn have forged relationships with certain key members of our management team, and the departure of these individuals could adversely affect our business.

 

Our California operations are dependent on the relationships with customers built by our experienced teams of lenders, many of whom have worked with each other and with key individuals on our senior management team. The February 2008 departure of a senior member of our management team in California could negatively impact the Company's relationship with certain customers and our ability to expand or maintain our California operations at current levels. If any additional California loan officers or the members of our senior management staff who coordinate California operations were to leave the Company, it could also adversely affect our mainland operations.

We are subject to environmental liability risk associated with lending activities.

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we require an environmental review before initiating any foreclosure action on real property, these other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.

 

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Governmental regulation may impair our operations or restrict our growth.

We are subject to significant governmental supervision and regulation. These regulations are intended primarily for the protection of depositors. Statutes and regulations affecting our business may be changed at any time and the interpretation of these statutes and regulations by examining authorities may also change. Within the last several years, Congress and the President have passed and enacted significant changes to these statutes and regulations. There can be no assurance that such changes to the statutes and regulations or to their interpretation will not adversely affect our business. In addition to governmental supervision and regulation, we are subject to changes in other federal and state laws, including changes in tax laws, which could materially affect the banking industry. We are subject to the rules and regulations of the FRB. If we fail to comply with federal and state bank regulations, the regulators may limit our activities or growth, fine us or ultimately put us out of business. Banking laws and regulations change from time to time. Bank regulations can hinder our ability to compete with financial services companies that are not regulated in the same manner or are less regulated. Federal and state bank regulatory agencies regulate many aspects of our operations. These areas include:

 

·	The capital that must be maintained;

·	The kinds of activities that can be engaged in;

·	The kinds and amounts of investments that can be made;

·	The locations of offices;

·	Insurance of deposits and the premiums that we must pay for this insurance; and

·	How much cash we must set aside as reserves for deposits.

We may be unsuccessful in our federal or Hawaii state tax appeals, or ongoing tax audits may result in additional tax liabilities.

We are currently appealing certain tax assessments by the Internal Revenue Service and the State of Hawaii Department of Taxation. While we believe that we have properly applied the relevant income tax statutes and have obtained supporting opinions from tax consultants, we may be unsuccessful in one or more of our appeals. While we have established contingency reserves as deemed appropriate, adverse decisions or settlements could result in income tax and related interest exposure in excess of amounts reserved.

Our controls and procedures may fail or be circumvented.

Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.

We face risks associated with future acquisitions.

Our ability to obtain regulatory approval of acquisitions is subject to constraints related to the BSA and the CRA, as described below in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Subject to our ability to successfully address these regulatory concerns, we may pursue future acquisition opportunities. Risks commonly encountered in existing and future acquisitions include, among other things:

·	The difficulty of integrating the operations and personnel of acquired companies and branches;

·	The potential disruption of our ongoing business;

·	The potential diversion of our management’s time and attention;

·	The inability of our management to maximize our financial and strategic position by the successful implementation of uniform product offerings and the incorporation of uniform technology into our product offerings and control systems;

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·	The inability of our management to comply with reporting requirements;

 

·	The inability to maintain uniform standards, controls, procedures and policies and the impairment of relationships with employees and customers as a result of changes in management;

·	The potential exposure to unknown or contingent liabilities of the acquired company;

·	Exposure to potential asset quality issues of the acquired company;

·	The possible loss of key employees and customers of the acquired company;

·	Difficulty in estimating the value of the acquired company;

 

·	Incurring expenses related to impairment of goodwill and amortization of intangible assets; and

·	Potential changes in banking or tax laws or regulations that may affect the acquired company.

 

We may not be successful in overcoming these risks or any other problems encountered in connection with acquisitions. Our integration of operations of banks or branches that we acquire may not be successfully accomplished and may take a significant amount of time. Our inability to improve the operating performance of banks and branches we have acquired or to successfully integrate their operations could have a material adverse effect on our business, financial condition, results of operations and cash flows. We expect to hire additional employees and retain consultants to assist with integrating our operations and we cannot assure you that those individuals or firms will perform as expected or be successful in addressing these issues.

Our growth and expansion may strain our ability to manage our operations and our financial resources.

Continued growth may present operating and other problems that could adversely affect our business, financial condition and results of operations. Our growth may place a strain on our administrative, operational, personnel and financial resources and increase demands on our systems and controls. We anticipate that our business growth may require continued enhancements to and expansion of our operating and financial systems and controls and may strain or significantly challenge them. Our inability to continue to upgrade or maintain effective operating and financial control systems and to recruit and hire necessary personnel or to successfully integrate new personnel into our operations could adversely impact our financial condition, results of operations and cash flows. In addition, we cannot assure you that our existing operating and financial control systems and infrastructure will be adequate to maintain and effectively monitor future growth.

New lines of business or new products and services may subject us to additional risks.

From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and our price and profitability targets may not prove feasible. External factors such as compliance with regulations, competitive alternatives and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, results of operations and financial condition.

We rely on dividends from our subsidiaries for most of our revenue.

Because we are a holding company with no significant assets other than our bank, we currently depend upon dividends from our bank for a substantial portion of our revenues. Our ability to pay dividends will therefore continue to depend in large part upon our receipt of dividends or other capital distributions from our bank. Our ability to pay dividends is subject to the restrictions of the Hawaii law.

 

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The ability of the bank to pay dividends or make other capital distributions to us is also subject to the regulatory authority of the FDIC and Hawaii law as further described in the Supervision and Regulation section of Item 1. Business. As of December 31, 2007, Central Pacific Bank could have paid, in the aggregate, approximately $204.3 million in dividends without the prior approval of the FDIC.

 

We may not be able to attract and retain skilled people.

 

Our success depends in large part on our ability to attract and retain key people and there are a limited number of qualified persons with knowledge of and experience in the banking industry in each of our markets. Furthermore, recent demand for skilled finance and accounting personnel among publicly traded companies has increased the importance of attracting and retaining these people. Competition for the best people can be intense given the tight labor market in Hawaii and we may not be able to hire people or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

 

Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

 

We continually encounter technological change.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

We are subject to claims and litigation pertaining to fiduciary responsibility.

From time to time, customers make claims and take legal action pertaining to our performance of our fiduciary responsibilities. Regardless of whether customer claims and legal action related to our performance of our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services, as well as impact customer demand for our products and services. Any financial liability or reputational damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Severe weather, natural disasters, acts of war or terrorism and other external events could significantly impact our business.

Severe weather, natural disasters, such as wildfires, tsunamis and earthquakes, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

 

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We hold title to the land and building in which our headquarters, Kaimuki branch office, Hilo branch office, Kailua-Kona branch office, Pearl City branch office and certain operations offices are located. We also hold title to the buildings in which our Moiliili, McCully, Kalihi and Beretania branch offices and operations center are located, a portion of the land underlying a commercial office building in which our residential mortgage lending subsidiary is housed, as well as a portion of land on which the Moiliili branch office and the data processing operations offices are located. The remaining lands on which the Moiliili branch and the data processing operations offices are located, as well as all of the land on which the McCully, Kalihi and Beretania branch offices are located, are leased. We also own four floors of a commercial office condominium in downtown Honolulu where certain administrative and support operations are located.

We occupy or hold leases for approximately 50 other properties including our remaining branch offices and four loan production offices in California. These leases expire on various dates through 2038 and generally contain renewal options for periods ranging from five to 15 years. For additional information relating to lease rental expense and commitments, see Note 16 to the Consolidated Financial Statements.

 

 

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	Year Ended December 31,
Selected Financial Data	2007				2006				2005				2004				2003
	(Dollars in thousands, except per share data)
Statement of Income Data:
Total interest income	$	349,877			$	320,381			$	263,250			$	150,389			$	110,231
Total interest expense		137,979				109,532				66,577				30,217				20,178
Net interest income		211,898				210,849				196,673				120,172				90,053
Provision for loan and lease losses		53,001				1,350				3,917				2,083				700
Net interest income after provision for loan and
lease losses		158,897				209,499				192,756				118,089				89,353
Other operating income		45,804				43,156				41,002				22,018				15,834
Goodwill impairment		48,000				-				-				-				-
Other operating expense (excluding goodwill
impairment)		128,556				132,163				124,772				86,131				55,578
Income before income taxes		28,145				120,492				108,986				53,976				49,609
Income taxes		22,339				41,312				36,527				16,582				15,669
Net income		5,806				79,180				72,459				37,394				33,940
Balance Sheet Data (Year-End):
Interest-bearing deposits in other banks	$	241			$	5,933			$	9,813			$	52,978			$	5,145
Investment securities (1)		881,254				898,358				925,285				850,821				540,785
Loans and leases		4,141,705				3,846,004				3,552,749				3,099,830				1,443,154
Allowance for loan and lease losses		92,049				52,280				52,936				50,703				24,774
Goodwill		244,702				298,996				303,358				284,712				-
Core deposit premium		28,750				31,898				35,795				49,188				-
Total assets		5,680,386				5,487,192				5,239,139				4,651,902				2,170,268
Core deposits (2)		2,833,317				2,860,926				2,814,435				2,716,973				1,419,100
Total deposits		4,002,719				3,844,483				3,642,244				3,327,026				1,753,284
Long-term debt		916,019				740,189				749,258				587,380				184,184
Total shareholders' equity		674,403				738,139				676,234				567,862				194,599
Per Share Data:
Basic earnings per share	$	0.19			$	2.60			$	2.42			$	1.90			$	2.12
Diluted earnings per share		0.19				2.57				2.38				1.87				2.07
Cash dividends declared		0.98				0.88				0.73				0.64				0.64
Book value		23.45				24.04				22.22				20.17				12.11
Diluted weighted average shares outstanding
(in thousands)		30,406				30,827				30,487				20,017				16,397
Financial Ratios:
Return on average assets		0.10	%			1.50	%			1.48	%			1.25	%			1.64	%
Return on average shareholders' equity		0.77				11.16				11.16				12.37				18.33
Net income to average tangible shareholders' equity		1.35				21.01				22.88				18.45				18.33
Average equity to average assets		13.58				13.45				13.29				10.08				8.95
Efficiency ratio (3)		47.80				49.67				49.59				57.77				51.94
Net interest margin (4)		4.33				4.55				4.63				4.51				4.79
Net charge-offs to average loans		0.33				0.05				0.05				0.06				0.01
Nonperforming assets to year-end loans & other
real estate (5)		1.48				0.23				0.35				0.35				0.25
Allowance for loan and lease losses to year-end loans		2.22				1.36				1.49				1.64				1.72
Allowance for loan and lease losses to
nonaccrual loans		149.57				583.61				421.77				492.79				688.74
Dividend payout ratio		515.79				33.85				30.17				33.68				30.19
(1) Held-to-maturity securities at amortized cost, available-for-sale securities at fair value.
(2) Noninterest-bearing demand, interest-bearing demand and savings deposits, and time deposits under $100,000.
(3) Efficiency ratio is derived by dividing other operating expense excluding amortization and impairment of intangible assets
and goodwill by net operating revenue (net interest income on a taxable equivalent basis plus other operating income
before securities transactions).
(4) Computed on a taxable equivalent basis using an assumed income tax rate of 35%.
(5) Nonperforming assets include nonaccrual loans, nonaccrual loans held for sale and other real estate.

 

 

We are a bank holding company that, through our banking subsidiary, Central Pacific Bank, offers full service commercial banking in the state of Hawaii. In addition, we have four loan production offices serving customers in California. In 2007, we decided to exit the market in the state of Washington in order to refocus our efforts in the Hawaii and California markets.

Our products and services focus on two areas:

·	Loans: We focus our lending activities on commercial, commercial mortgage and construction loans to small and medium-sized companies, business professionals and real estate developers. Our lending activities contribute to a key component of our revenues—interest income.

·

Deposits: We strive to provide exceptional customer service and products that meet our customers’ needs, like our Exceptional Account and Totally Free Checking and maintenance of a broad branch and ATM network in the state of Hawaii. Raising funds through our deposit accounts enables us to support our lending activities. The interest paid on such deposits has a significant impact on our interest expense, an important factor in determining our earnings. In addition, fees and service charges on deposit accounts contribute to our revenues.

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

In this discussion, we have included statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of The Private Securities Litigation Reform Act of 1995. These forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and beyond our control. These statements relate to our future plans and objectives, among other things. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results may differ, possibly materially, from the results indicated in the forward-looking statements. Important factors that could, among others, cause our results to differ, possibly materially, from those indicated in the forward-looking statements are discussed above under “Business-Factors that May Affect Our Business” in Part I, Item 1 of this Annual Report on Form 10-K.

Our operating results during the first half of 2007 were generally favorable due to a combination of factors including sequential loan and deposit growth, strong asset quality and our ability to control expenses. However, during the second half of 2007, our operating results were negatively impacted primarily by the rapid decline in the California residential construction market as the weakening of the U.S. housing sector became worse than most observers expected. Despite the deterioration of the California housing and construction markets during the second half of 2007, we were able to:

·	Increase total loans and leases (excluding loans held for sale) by 7.7% over the prior year;

·	Grow total assets by 3.5% over the prior year;

·	Increase total deposits by 4.1% over the prior year;

 

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·	Increase total interest income by 9.2% over the prior year; and

·	Enhance our risk monitoring systems and compliance processes to a sufficient level that enabled us to successfully lift the previously agreed upon Order in November 2007.

We began 2007 with the primary focus of expanding and solidifying deposit relationships in support of strong loan demand and mitigating the impact of competitive factors and interest rate driven shifts in deposit composition. Although asset quality also remained strong through the first half of 2007 with a net loan charge-off ratio of 0.23% and a nonperforming assets to loans ratio of 0.03%, during the second half of 2007 our focus quickly shifted to managing credit risk as we experienced a deterioration in our California residential construction loan portfolio. Home sales activity in California began to drop off dramatically starting in August 2007, largely due to the tightening of lending standards resulting from the nationwide increase in subprime mortgage defaults and foreclosures. This drop off, combined with overcapacity in the California real estate market, resulted in the suspension of many projects and made it increasingly difficult to move existing inventory. These factors in turn caused a noticeable slowing of absorption rates and certain of our borrowers in the California residential construction market found it increasingly difficult to repay amounts due on their outstanding balances. As a result, we experienced a significant increase in credit costs during the second half of 2007.

For further discussion of these trends and other factors affecting our business, see “Overview of Results of Operations.”

The majority of our operations are concentrated in the states of Hawaii and California. Accordingly, our business performance is directly affected by conditions in the banking industry, macro economic conditions and the real estate market in those states. A favorable business environment is generally characterized by expanding gross state product, low unemployment and rising personal income.

General economic conditions in Hawaii continued to moderate in 2007 after exceptional growth in 2004 and 2005 and moderate growth in 2006. Tourism remains Hawaii’s most significant economic driver, and according to the Hawaii Department of Business Economic Development & Tourism (“DBEDT”), 7.4 million visitors visited the state in 2007. This was a slight decrease of 1.2% from the number of visitor arrivals in 2006. However, increased daily visitor spending boosted total visitor spending to a record $12.2 billion, an increase of 0.9% over 2006. The Department of Labor and Industrial Relations reported that Hawaii’s seasonally adjusted unemployment rate was 3.2% in December 2007, compared to 2.0% in December 2006. Despite the increase, Hawaii’s unemployment rate remained well below the national seasonally adjusted unemployment rate of 5.0%. The DBEDT projects real personal income growth to approximate 1.8% in 2007, and remain relatively unchanged through 2008. The DBEDT also projects real gross state product growth of 2.8% in 2008. With real estate lending as a primary focus, including construction loans, residential mortgages and commercial mortgages, we are also dependent on the strength of the real estate market. Following several years of strong growth in 2004 and 2005, the Hawaii real estate market further cooled in 2007 as it did in 2006. According to the Honolulu Board of Realtors, for the full year 2007, Oahu unit sales volume dropped 10.2% for single-family homes and dropped 13.8% for condominiums. Despite the decrease in unit sales volumes, median sales prices in 2007 for single-family homes and condominiums on Oahu were $643,500 and $325,000, respectively, representing increases of 2.1% and 4.8%, respectively, over 2006 median prices. Expectations are for the Hawaii real estate market to continue to moderate with slight declines in unit sales volumes and sales prices likely in 2008.

 

The economy in California began to cool in the second half of 2007, primarily caused by the slowdown in the real estate market. The residential real estate market in California began to show clear signs of weakness and began rapidly deteriorating in August 2007. The Central Valley and Inland Empire areas of California have been particularly hard hit and foreclosure rates continue to rise in those areas. The decline of the real estate market generally has been significantly worsened by recent events in the sub-prime and non-prime loan markets. The California Association of Realtors (“CAR”) reported that December 2007 unit home sales declined 33.4%, while the median price fell 16.5% from year ago levels. CAR forecasts continued declines in home prices and unit sales in 2008 as decreased affordability and the impact of tighter credit underwriting standards amid rising default rates in sub-prime and non-prime mortgages are expected to continue to impact housing growth. According to the California Department of Finance (“CDOF”), average personal income increased by 5.6% in 2007 from one year ago and projections for 2008 call for an increase of 4.8% from 2007. The CDOF also reported that California civilian workforce grew by 2.3% to 18.4 million in December 2007 from 18.0 million a year ago, while California’s seasonally adjusted unemployment rate in December 2007 increased to 6.1% from 4.8% in the prior year.

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires that management make certain judgments and use certain estimates and assumptions that affect amounts reported and disclosures made. Accounting estimates are deemed critical when a different estimate could have reasonably been used or where changes in the estimate are reasonably likely to occur from period to period and would materially impact our consolidated financial statements as of or for the periods presented. Management has discussed the development and selection of the critical accounting estimates noted below with the Audit Committee of the Board of Directors, and the Audit Committee has reviewed the accompanying disclosures.

 

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Allowance for Loan and Lease Losses

We maintain an allowance for loan and lease losses (the “Allowance”) at an amount we expect to be sufficient to absorb probable losses inherent in our loan and lease portfolio based on a projection of probable net loan charge-offs. For loans classified as impaired, an estimated impairment loss is calculated. To estimate loan charge-offs on other loans, we evaluate the level and trend of nonperforming and potential problem loans and historical loss experience. We also consider other relevant economic conditions and borrower-specific risk characteristics, including current repayment patterns of our borrowers, the fair value of collateral securing specific loans, changes in our lending and underwriting standards and general economic factors, nationally and in the markets we serve, including the real estate market generally and the residential construction market. Estimated loss rates are determined by loan category and risk profile, and an overall required Allowance is calculated. Based on our estimate of the level of Allowance required, a provision for loan and lease losses (the “Provision”) is recorded to maintain the Allowance at an appropriate level. We adjusted our Provision in the third and fourth quarters of 2007 in accordance with our risk assessment policies to account for an increase in exposure which was primarily caused by changes in the California residential construction market.

 

Reserves for unfunded commitments are recorded separately through a valuation allowance included in other liabilities. Credit losses for off-balance sheet credit exposures are deducted from the allowance for credit losses on off-balance sheet credit exposures in the period in which the liability is settled. The allowance for credit losses on off-balance sheet credit losses is established by a charge to other operating expense.

Since we cannot predict with certainty the amount of loan and lease charge-offs that will be incurred and because the eventual level of loan and lease charge-offs are impacted by numerous conditions beyond our control, a range of loss estimates could reasonably have been used to determine the Allowance and Provision. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review our Allowance. Such agencies may require that we recognize additions to the Allowance based on their judgments about information available to them at the time of their examination. Accordingly, actual results could differ from those estimates.

 

Deterioration in the Hawaii real estate market or continued deterioration in the California real estate market could result in an increase in loan delinquencies, additional increases in our Allowance and Provision, as well as an increase in loan charge-offs.

Goodwill and Other Intangible Assets

2007 vs. 2006 Comparison

Our net income of $5.8 million in 2007 was a decrease of $73.4 million, or 92.7%, from the $79.2 million recognized in 2006. The decrease in our net income for 2007 was driven by $53.0 million in provision for loan and lease losses directly attributable to the significant and rapid deterioration in the California residential construction market which began to affect us in the second half of 2007, as well as a $48.0 million goodwill impairment charge associated with our Commercial Real Estate reporting segment, which includes the California residential construction loan portfolio. Partially offsetting the negative effects of the increase in the provision for loan and lease losses and the goodwill impairment charge was the decrease in income tax expense as there was a disproportionate recognition of our federal and state tax credits compared to our taxable income. Net income in 2007 was also impacted by $2.4 million of additional income tax expense resulting from the settlement of a tax contingency item, $2.0 million of income tax benefit related to certain income tax adjustments, a $1.1 million after tax reversal of prior year incentive compensation accruals and a $1.0 million after tax loss on an investment portfolio repositioning.

Diluted earnings per share of $0.19 for 2007 decreased by $2.38, or 92.6%, from 2006, while cash dividends declared of $0.98 per common share increased by $0.10, or 11.4%, over prior year amounts. Return on average assets of 0.10% in 2007 decreased from 1.50% in 2006 and return on average equity was 0.77% in 2007 compared to 11.16% in 2006. Our efficiency ratio, which measures operating expenses before the amortization and impairment of intangible assets and goodwill as a percentage of tax-equivalent total revenue, was 47.80% in 2007 compared to 49.67% in 2006.

 

2006 vs. 2005 Comparison

In 2006, our net income of $79.2 million increased by $6.7 million, or 9.3%, over the $72.5 million recognized in 2005. The increase in net income in 2006 reflected growth in net interest income and other operating income which more than offset increased operating expenses. Net income in 2006 included after-tax charges totaling $3.8 million relating to executive retirement expenses, income tax liability adjustments, an investment securities portfolio repositioning and an employee benefit-related liabilities adjustment.

Diluted earnings per share for 2006 of $2.57 increased by $0.19, or 8.0%, compared to the $2.38 earned in 2005, while cash dividends declared of $0.88 per common share increased by 20.5% over the dividends of $0.73 per share declared in 2005. Return on average assets of 1.50% in 2006 increased slightly over the 1.48% in 2005 and return on average equity remained unchanged at 11.16% in 2006. Our efficiency ratio increased slightly to 49.67% from 49.59% in 2005.

 

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Net Interest Income

Table 1 sets forth information concerning average interest earning assets and interest-bearing liabilities and the yields and rates thereon. Table 2 presents an analysis of changes in components of net interest income between years. Net interest income, when expressed as a percentage of average interest earning assets, is referred to as “net interest margin.” Interest income, which includes loan fees and resultant yield information, are expressed on a taxable equivalent basis using an assumed income tax rate of 35%.