Edgar Filing: Territorial Bancorp Inc.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the Quarterly Period ended September 30, 2012

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

For transition period from to

Commission File Number 1-34403

TERRITORIAL BANCORP INC.

(Exact Name of Registrant as Specified in Charter)

Maryland

26-4674701

(State or Other Jurisdiction

of Incorporation)

(I.R.S. Employer

Identification No.)


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

(808) 946-1400

Registrant’s telephone number, including area code

Not Applicable

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

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

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

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

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

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

10,901,705 shares of Common Stock, par value $0.01 per share, were issued and outstanding as of October 31, 2012.

TERRITORIAL BANCORP INC.

Form 10-Q Quarterly Report

Table of Contents


PART I

ITEM 1.	FINANCIAL STATEMENTS	1
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	28
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	42
ITEM 4.	CONTROLS AND PROCEDURES	43

PART II

ITEM 1.	LEGAL PROCEEDINGS	45
ITEM 1A.	RISK FACTORS	45
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	45
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	45
ITEM 4.	MINE SAFETY DISCLOSURES	45
ITEM 5.	OTHER INFORMATION	45
ITEM 6.	EXHIBITS	45

SIGNATURES		46

PART I

ITEM 1.

FINANCIAL STATEMENTS

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Balance Sheets (Unaudited)

(Dollars in thousands, except share data)


	September 30,			December 31,
	2012			2011

ASSETS
Cash and cash equivalents	$	155,265		$	131,937
Investment securities held to maturity, at amortized cost (fair value of $633,513 and $687,319 at September 30, 2012 and December 31, 2011, respectively)		595,607			653,871
Federal Home Loan Bank stock, at cost		12,238			12,348
Loans held for sale		4,032			3,231
Loans receivable, net		746,874			688,095
Accrued interest receivable		4,676			4,780
Premises and equipment, net		5,082			5,450
Real estate owned		176			408
Bank-owned life insurance		30,940			30,234
Deferred income taxes receivable		3,035			2,648
Prepaid expenses and other assets		4,755			4,569


Total assets	$	1,562,680		$	1,537,571


LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits	$	1,226,527		$	1,166,116
Advances from the Federal Home Loan Bank		20,000			20,000
Securities sold under agreements to repurchase		70,000			108,300
Investment purchases pending settlement		1,136			0
Accounts payable and accrued expenses		23,158			22,816
Current income taxes payable		147			3,114
Advance payments by borrowers for taxes and insurance		2,295			3,264


Total liabilities		1,343,263			1,323,610


Stockholders’ Equity:
Preferred stock, $.01 par value; authorized 50,000,000 shares, no shares issued or outstanding		0			0
Common stock, $.01 par value; authorized 100,000,000 shares; issued and outstanding 10,901,705 and 11,022,309 shares at September 30, 2012 and December 31, 2011, respectively		109			110
Additional paid-in capital		94,920			97,640
Unearned ESOP shares		(7,952	)		(8,319	)
Retained earnings		135,915			128,300
Accumulated other comprehensive loss		(3,575	)		(3,770	)


Total stockholders’ equity		219,417			213,961


Total liabilities and stockholders’ equity	$	1,562,680		$	1,537,571

See accompanying notes to consolidated financial statements.

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

(Dollars in thousands, except per share data)


	Three Months Ended September 30,					Nine Months Ended September 30,
	2012		2011			2012		2011
Interest and dividend income:
Investment securities	$	5,551	$	6,907		$	18,360	$	20,167
Loans		9,187		8,798			27,326		26,444
Other investments		88		85			259		258

Total interest and dividend income		14,826		15,790			45,945		46,869


Interest expense:
Deposits		1,492		1,700			4,644		5,109
Advances from the Federal Home Loan Bank		105		105			313		295
Securities sold under agreements to repurchase		629		1,067			2,364		3,153

Total interest expense		2,226		2,872			7,321		8,557


Net interest income		12,600		12,918			38,624		38,312
Provision (reversal of allowance) for loan losses		167		(39	)		172		83


Net interest income after provision for loan losses		12,433		12,957			38,452		38,229


Noninterest income:
Service fees on loan and deposit accounts		444		534			1,474		1,690
Income on bank-owned life insurance		239		245			706		725
Gain on sale of investment securities		429		74			729		140
Gain on sale of loans		669		138			1,516		374
Other		141		177			346		588

Total noninterest income		1,922		1,168			4,771		3,517


Noninterest expense:
Salaries and employee benefits		5,202		6,017			15,416		16,630
Occupancy		1,316		1,267			3,930		3,714
Equipment		800		792			2,423		2,366
Federal deposit insurance premiums		192		191			574		678
Loss on extinguishment of debt		123		0			321		0
Other general and administrative expenses		964		954			3,069		2,887

Total noninterest expense		8,597		9,221			25,733		26,275


Income before income taxes		5,758		4,904			17,490		15,471
Income taxes		2,111		1,918			6,457		6,100

Net income	$	3,647	$	2,986		$	11,033	$	9,371


Basic earnings per share	$	0.36	$	0.28		$	1.09	$	0.85
Diluted earnings per share	$	0.36	$	0.28		$	1.08	$	0.84
Cash dividends declared per common share	$	0.11	$	0.09		$	0.32	$	0.25
Basic weighted-average shares outstanding		10,052,630		10,659,532			10,126,371		10,969,320
Diluted weighted-average shares outstanding		10,199,400		10,835,649			10,205,408		11,117,444

See accompanying notes to consolidated financial statements.

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)

(Dollars in thousands)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011

Net income	$	3,647	$	2,986	$	11,033	$	9,371

Change in unrealized loss on securities		8		2		18		189
Reduction of noncredit related losses on securities not expected to be sold		177		0		177		0

Other comprehensive income		185		2		195		189

Comprehensive income	$	3,832	$	2,988	$	11,228	$	9,560

See accompanying notes to consolidated financial statements.

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

and Comprehensive Income (Unaudited)

(Dollars in thousands)


	Common Stock			Additional Paid-in Capital			Unearned ESOP Shares			Retained Earnings			Accumulated Other Comprehensive (Loss)/Income			Total Stockholders’ Equity

Balances at December 31, 2010	$	122		$	119,153		$	(8,808	)	$	119,397		$	(2,505	)	$	227,359

Net income		0			0			0			9,371			0			9,371
Other comprehensive income		0			0			0			0			189			189
Cash dividends declared		0			0			0			(2,746	)		0			(2,746	)
Share-based compensation		1			2,790			0			0			0			2,791
Allocation of 36,699 ESOP shares		0			362			367			0			0			729
Repurchase of 1,202,471 shares of company common stock		(12	)		(23,463	)		0			0			0			(23,475	)


Balances at September 30, 2011	$	111		$	98,842		$	(8,441	)	$	126,022		$	(2,316	)	$	214,218


Balances at December 31, 2011	$	110		$	97,640		$	(8,319	)	$	128,300		$	(3,770	)	$	213,961

Net income		0			0			0			11,033			0			11,033
Other comprehensive income		0			0			0			0			195			195
Cash dividends declared		0			0			0			(3,418	)		0			(3,418	)
Share-based compensation		1			2,016			0			0			0			2,017
Allocation of 36,699 ESOP shares		0			438			367			0			0			805
Repurchase of 275,186 shares of company common stock		(2	)		(5,890	)		0			0			0			(5,892	)
Exercise of 41,275 options on common stock		0			716			0			0			0			716


Balances at September 30, 2012	$	109		$	94,920		$	(7,952	)	$	135,915		$	(3,575	)	$	219,417

See accompanying notes to consolidated financial statements.

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)


	Nine Months Ended
	September 30,
	2012			2011

Cash flows from operating activities:
Net income	$	11,033		$	9,371
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		172			83
Depreciation and amortization		852			835
Deferred income tax benefit		(516	)		(1,126	)
Amortization of fees, discounts, and premiums		53			(44	)
Origination of loans held for sale		(75,184	)		(34,600	)
Proceeds from sales of loans held for sale		75,899			35,221
Gain on sale of loans, net		(1,516	)		(374	)
Net gain on sale of real estate owned		(43	)		0
Purchases of investment securities held for trading		0			(36,171	)
Proceeds from sale of investment securities held for trading		0			36,311
Gain on sale of investment securities held for trading		0			(140	)
Gain on sale of investment securities held to maturity		(729	)		0
Net gain on sale of premises and equipment		0			(5	)
ESOP expense		805			729
Share-based compensation expense		2,016			2,791
Excess tax benefits from share-based compensation		(54	)		0
(Increase) decrease in accrued interest receivable		104			(346	)
Net increase in bank-owned life insurance		(706	)		(725	)
Net (increase) decrease in prepaid expenses and other assets		(186	)		1,543
Net increase (decrease) in accounts payable and accrued expenses		342			(703	)
Net decrease in income taxes payable		(2,967	)		(161	)

Net cash provided by operating activities		9,375			12,489


Cash flows from investing activities:
Purchases of investment securities held to maturity		(111,467	)		(211,257	)
Principal repayments on investment securities held to maturity		160,668			97,289
Principal repayments on investment securities available for sale		0			525
Proceeds from sale of investment securities held to maturity		9,983			0
Loan originations, net of principal repayments on loans receivable		(57,911	)		(20,403	)
Proceeds from redemption of Federal Home Loan Bank stock		110			0
Proceeds from sale of real estate owned		451			0
Proceeds from disposals of premises and equipment		0			5
Purchases of premises and equipment		(484	)		(973	)

Net cash (used in) provided by investing activities		1,350			(134,814	)

(Continued)

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

(Dollars in thousands)


	Nine Months Ended
	September 30,
	2012			2011

Cash flows from financing activities:
Net increase in deposits	$	60,411		$	62,847
Proceeds from advances from the Federal Home Loan Bank		100			10,000
Repayments of advances from the Federal Home Loan Bank		(100	)		0
Proceeds from securities sold under agreements to repurchase		0			47,000
Repayments of securities sold under agreements to repurchase		(38,300	)		(32,000	)
Purchases of Fed Funds		10			10
Sales of Fed Funds		(10	)		(10	)
Net decrease in advance payments by borrowers for taxes and insurance		(969	)		(1,288	)
Excess tax benefits from share-based compensation		54			0
Proceeds from issuance of common stock		717			0
Repurchases of company stock		(5,892	)		(23,475	)
Cash dividends paid		(3,418	)		(2,746	)

Net cash provided by financing activities		12,603			60,338


Net increase (decrease) in cash and cash equivalents		23,328			(61,987	)

Cash and cash equivalents at beginning of the period		131,937			194,435


Cash and cash equivalents at end of the period	$	155,265		$	132,448


Supplemental disclosure of cash flow information:
Cash paid for:
Interest on deposits and borrowings	$	7,478		$	8,531
Income taxes		9,940			7,388

Supplemental disclosure of noncash investing activities:
Loans transferred to real estate owned	$	176		$	162
Investments purchased, not settled		1,136			0

See accompanying notes to consolidated financial statements.

TERRITORIAL BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

(1)

Basis of Presentation

The accompanying unaudited consolidated financial statements of Territorial Bancorp Inc. have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. These interim condensed consolidated financial statements and notes should be read in conjunction with Territorial Bancorp Inc.’s consolidated financial statements and notes thereto filed as part of the Annual Report on Form 10-K for the year ended December 31, 2011. In the opinion of management, all adjustments necessary for a fair presentation have been made and include all normal recurring adjustments. Interim results of operations are not necessarily indicative of results to be expected for the year.

(2)

Organization

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

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

(3)

Recently Adopted Accounting Pronouncements

In April 2011, the Financial Accounting Standards Board (FASB) amended the Transfers and Servicing topic of the FASB Accounting Standards Codification (ASC). The amendment modified the criteria used to determine whether a repurchase agreement is accounted for as a sale or as a secured borrowing. The amendment was effective for interim or annual periods beginning on or after December 15, 2011. Early adoption was not permitted. The Company adopted this amendment on January 1, 2012, and the adoption did not have any effect on its consolidated financial statements.

In May 2011, the FASB amended the Fair Value Measurement topic of the FASB ASC. The amendment results in common fair value measurement and disclosure requirements in U.S. generally accepted accounting principles and International Financial Reporting Standards. The amendment both clarifies the intent about existing fair value measurements as well as changed the principle or requirement for measuring fair value or disclosing fair value information. The amendment was effective for interim or annual periods beginning after December 15, 2011. Early application was not permitted. The Company adopted this amendment on January 1, 2012, and the adoption did not have a material effect on its consolidated financial statements.

In June 2011, the FASB amended the Comprehensive Income topic of the FASB ASC. The amendment eliminated the option of presenting components of other comprehensive income as part of the statement of changes in stockholders’ equity. Nonowner changes in stockholders’ equity must be presented either in a continuous statement of comprehensive income or in two separate but consecutive statements. The amendment was effective for interim or annual periods beginning after December 15, 2011, with early adoption permitted. In December 2011, the FASB deferred the effective date of the part of this amendment requiring reclassifications out of accumulated other comprehensive income to be shown on the face of the financial statements. Pending a final decision on this issue by the FASB, previous disclosure requirements will remain in effect. The Company adopted this amendment on January 1, 2012, and other than the location of disclosures related to other comprehensive income, the adoption did not have a material effect on its consolidated financial statements.

In December 2011, the FASB amended the Balance Sheet topic of the FASB ASC. The amendment requires disclosures about the gross and net information related to instruments and transactions eligible for offset in the statement of financial position. The disclosures are meant to assist users of financial statements to more easily compare information that is presented based on the differing offsetting requirements of U.S. generally accepted accounting principles and International Financial Reporting Standards. The amendment is effective for interim and annual periods beginning on or after January 1, 2013. The Company does not expect the adoption of this amendment to have a material effect on its consolidated financial statements.

(4)

Cash and Cash Equivalents

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


	September 30,		December 31,
(Dollars in thousands)	2012		2011

Cash and due from banks	$	12,634	$	8,692
Interest-earning deposits in other banks		142,631		123,245

Cash and cash equivalents	$	155,265	$	131,937

(5)

Investment Securities

The carrying and fair values of investment securities are as follows:


	Carrying		Gross unrealized					Estimated
(Dollars in thousands)	value		Gains		Losses			fair value

September 30, 2012:
Held to maturity:
U.S. government-sponsored mortgage-backed securities	$	595,281	$	38,189	$	(283	)	$	633,187
Trust preferred securities		326		0		0			326

Total	$	595,607	$	38,189	$	(283	)	$	633,513


December 31, 2011:
Held to maturity:
U.S. government-sponsored mortgage-backed securities	$	653,839	$	33,490	$	(269	)	$	687,060
Trust preferred securities		32		227		0			259

Total	$	653,871	$	33,717	$	(269	)	$	687,319

The carrying value and estimated fair value of investment securities at September 30, 2012 are shown below. Incorporated in the maturity schedule are mortgage-backed and trust preferred securities, which are allocated using the contractual maturity as a basis. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.


	Carrying		Estimated
(Dollars in thousands)	value		fair value

Held to maturity:
Due after 5 years through 10 years	$	4,193	$	4,279
Due after 10 years		591,414		629,234

Total	$	595,607	$	633,513

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


	Three months ended September 30,				Nine months ended September 30,
(Dollars in thousands)	2012		2011		2012		2011

Proceeds from sales	$	5,424	$	16,445	$	9,983	$	36,311
Gross gains		429		74		729		140
Gross losses		0		0		0		0

During the three months ended September 30, 2012, all sales were related to $5.0 million of held-to-maturity debt securities. During the nine months ended September 30, 2012, all sales were related to $9.3 million of held-to-maturity debt securities. The sale of these securities, for which the Company had already collected a substantial portion of the outstanding principal (at least 85%), is in accordance with the Investment topic of the FASB ASC and will not affect the historical cost basis used to account for the remaining securities in the held-to-maturity portfolio. There were no sales of held-to-maturity securities during the three months or nine months ended September 30, 2011.

Investment securities with carrying values of $238.0 million and $281.0 million at September 30, 2012 and December 31, 2011, respectively, were pledged to secure public deposits, securities sold under agreements to repurchase and transaction clearing accounts.

Provided below is a summary of investment securities which were in an unrealized loss position at September 30, 2012 and December 31, 2011. The Company does not intend to sell these securities until such time as the value recovers or the securities mature and it is not more likely than not that the Company will be required to sell the securities prior to recovery of value or the securities mature.


	Less than 12 months				12 months or longer				Total
			Unrealized				Unrealized		Number of				Unrealized
Description of securities	Fair value		losses		Fair value		losses		securities		Fair value		losses
(Dollars in thousands)

September 30, 2012:
Mortgage-backed securities	$	10,793	$	282	$	60	$	1		13	$	10,853	$	283


December 31, 2011:
Mortgage-backed securities	$	17,697	$	268	$	122	$	1		7	$	17,819	$	269

Trust Preferred Securities. At September 30, 2012, the Company owns two trust preferred securities, PreTSL XXIII and XXIV. PreTSL XXIV has a carrying value and amortized cost basis of $0. PreTSL XXIII has a carrying value of $326,000 and an amortized cost basis of $1.1 million. For PreTSL XXIII, the difference between the carrying value of $326,000 and the remaining amortized cost basis of $1.1 million is included as a component of accumulated other comprehensive loss, net of taxes, and is related to noncredit factors such as the trust preferred securities market being inactive. The trust preferred securities represent investments in a pool of debt obligations issued primarily by holding companies for Federal Deposit Insurance Corporation-insured financial institutions. These securities are classified in the Bank’s held-to-maturity investment portfolio.

The trust preferred securities market is considered to be inactive as there were only six transactions in the last 21 months in similar tranches to the securities owned by the Company. The Company used a discounted cash flow model to determine whether these securities are other-than-temporarily impaired. The assumptions used in preparing the discounted cash flow model include the following: estimated discount rates, estimated deferral and default rates on collateral, and estimated cash flows.

Based on the Company’s review, the Company’s investment in trust preferred securities did not incur additional impairment during the quarter ending September 30, 2012 as the present value of cash flows exceeded the amortized cost basis of $1.1 million.

At September 30, 2012, PreTSL XXIII and XXIV are rated C by Fitch.

and the liquidity of these securities remains low. As a result, there is a risk that the Company’s amortized cost basis of $1.1 million on its trust preferred securities could be other-than-temporarily impaired in the near term. The impairment could be material to the Company’s consolidated statements of income.

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


(Dollars in thousands)	2012		2011

Balance at January 1	$	5,885	$	5,885
Credit losses on debt securities for which other-than-temporary impairment was not previously recognized		0		0


Balance at September 30	$	5,885	$	5,885

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


	September 30,
(Dollars in thousands)	2012		2011

Noncredit losses on other-than-temporarily impaired securities	$	502	$	679

(6)

Loans Receivable and Allowance for Loan Losses

The components of loans receivable are as follows:


	September 30,			December 31,
(Dollars in thousands)	2012			2011

Real estate loans:
First mortgages:
One- to four-family residential	$	715,026		$	654,412
Multi-family residential		6,800			6,956
Construction, commercial, and other		11,882			11,140
Home equity loans and lines of credit		15,120			17,253

Total real estate loans		748,828			689,761


Other loans:
Loans on deposit accounts		482			756
Consumer and other loans		4,288			4,732


Total other loans		4,770			5,488


Less:
Net unearned fees and discounts		(5,229	)		(5,613	)
Allowance for loan losses		(1,495	)		(1,541	)


		(6,724	)		(7,154	)


Loans receivable, net	$	746,874		$	688,095

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


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(Dollars in thousands)	2012			2011			2012			2011

Balance, beginning of period	$	1,457		$	1,592		$	1,541		$	1,488
Provision (reversal of allowance) for loan losses		167			(39	)		172			83


		1,624			1,553			1,713			1,571


Charge-offs		(137	)		(7	)		(273	)		(62	)
Recoveries		8			6			55			43


Net charge-offs		(129	)		(1	)		(218	)		(19	)


Balance, end of period	$	1,495		$	1,552		$	1,495		$	1,552

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


(Dollars in thousands)	Residential Mortgage			Construction, Commercial and Other Mortgage Loans			Home Equity Loans and Lines of Credit			Consumer and Other			Unallocated		Totals
Three months ended September 30, 2012:
Balance, beginning of period	$	552		$	641		$	35		$	107		$	122	$	1,457
Provision for loan losses		157			0			2			8			0		167

		709			641			37			115			122		1,624

Charge-offs		(125	)		0			(2	)		(10	)		0		(137	)
Recoveries		6			0			0			2			0		8

Net charge-offs		(119	)		0			(2	)		(8	)		0		(129	)

Balance, end of period	$	590		$	641		$	35		$	107		$	122	$	1,495


Nine months ended September 30, 2012:
Balance, beginning of period	$	631		$	285		$	258		$	291		$	76	$	1,541
Provision (reversal of allowance) for loan losses		151			364			(222	)		(167	)		46		172

		782			649			36			124			122		1,713

Charge-offs		(233	)		(8	)		(3	)		(29	)		0		(273	)
Recoveries		41			0			2			12			0		55

Net charge-offs		(192	)		(8	)		(1	)		(17	)		0		(218	)


Balance, end of period	$	590		$	641		$	35		$	107		$	122	$	1,495

Beginning with the quarter ended March 31, 2012, the Company enhanced its methodology for reviewing its loan portfolio when calculating the general portion of the allowance for loan losses. The modification consisted of additional segmentation of the residential mortgage loan portfolio by items such as year of origination, loan-to-value ratios, owner or nonowner occupancy status and the purpose of

the loan (purchase, cash-out refinance, no cash-out refinance or construction). As under our prior methodology, the allowance for loan loss for each segment of the loan portfolio is determined by calculating the historical loss of each segment for a two- to three-year look-back period and adding a qualitative adjustment for the following factors:

•

Changes in lending policies and procedures;

•

Changes in economic trends;

•

Changes in types of loans in the loan portfolio;

•

Changes in experience and ability of personnel in the loan origination and loan servicing departments;

•

Changes in the number and amount of delinquent loans and classified assets;

•

Changes in our internal loan review system;

•

Changes in the value of underlying collateral for collateral dependent loans;

•

Changes in any concentrations of credit; and

•

External factors such as competition, legal and regulatory requirements on the level of estimated credit losses in the existing loan portfolio.

The Company also revised the qualitative factors which were used to determine the allowance for loan losses on construction, commercial and other mortgage loans, home equity loans and lines of credit and consumer and other loans. As a result of these modifications, the Company increased the portion of the allowance for loan losses attributable to construction, commercial and other mortgage loans and decreased the portion of the allowance for loan losses attributable to residential mortgage, home equity loans and lines of credit and consumer and other loans. The allocation of a portion of the allowance from one category of loans does not preclude its availability to absorb losses in other categories. The unallocated allowance is established for probable losses that have been incurred as of the reporting date but are not reflected in the allocated allowance.

Management considers the allowance for loan losses at September 30, 2012 to be at an appropriate level to provide for probable losses that can be estimated based on general and specific conditions. While the Company uses the best information it has available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. To the extent actual outcomes differ from the estimates, additional provisions for credit losses may be required that would reduce future earnings. In addition, as an integral part of their examination process, the Office of the Comptroller of the Currency will periodically review the allowance for loan losses. The Office of the Comptroller of the Currency may require the Company to increase the allowance based on their analysis of information available at the time of their examination.

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


(Dollars in thousands)	Residential Mortgage		Construction, Commercial and Other Mortgage Loans		Home Equity Loans and Lines of Credit		Consumer and Other		Unallocated		Totals
September 30, 2012:
Allowance for loan losses:
Ending allowance balance:
Individually evaluated for impairment	$	0	$	0	$	0	$	0	$	0	$	0
Collectively evaluated for impairment		590		641		35		107		122		1,495

Total ending allowance balance	$	590	$	641	$	35	$	107	$	122	$	1,495


Loans:
Ending loan balance:
Individually evaluated for impairment	$	7,018	$	0	$	158	$	0	$	0	$	7,176
Collectively evaluated for impairment		709,609		11,843		14,971		4,770		0		741,193

Total ending loan balance	$	716,627	$	11,843	$	15,129	$	4,770	$	0	$	748,369


December 31, 2011:
Allowance for loan losses:
Ending allowance balance:
Individually evaluated for impairment	$	0	$	0	$	0	$	0	$	0	$	0
Collectively evaluated for impairment		631		285		258		291		76		1,541

Total ending allowance balance	$	631	$	285	$	258	$	291	$	76	$	1,541


Loans:
Ending loan balance:
Individually evaluated for impairment	$	4,926	$	184	$	159	$	3	$	0	$	5,272
Collectively evaluated for impairment		650,901		10,872		17,105		5,486		0		684,364

Total ending loan balance	$	655,827	$	11,056	$	17,264	$	5,489	$	0	$	689,636

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


(Dollars in thousands)	September 30, 2012		December 31, 2011
Loans with no allocated allowance for loan losses	$	7,176	$	5,272
Loans with allocated allowance for loan losses		0		0

Total impaired loans	$	7,176	$	5,272


Amount of allocated loan loss allowance	$	0	$	0

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


(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance
September 30, 2012:
With no related allowance recorded:
One- to four-family residential mortgages	$	7,018	$	7,337
Home equity loans and lines of credit		158		165

Total	$	7,176	$	7,502


December 31, 2011:
With no related allowance recorded:
One- to four-family residential mortgages	$	4,926	$	5,206
Construction, commercial and other mortgages		184		241
Home equity loans and lines of credit		159		165
Consumer and other		3		3

Total	$	5,272	$	5,615

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


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
2012:
With no related allowance recorded:
One- to four-family residential mortgages	$	7,084	$	69	$	7,114	$	153
Home equity loans and lines of credit		159		2		158		5

Total	$	7,243	$	71	$	7,272	$	158


2011:
With no related allowance recorded:
One- to four-family residential mortgages	$	4,292	$	40	$	4,982	$	108
Consumer and other		29		0		54		0

Total	$	4,321	$	40	$	5,036	$	108

There were no loans individually evaluated for impairment with a related allowance for loan loss as of September 30, 2012 or December 31, 2011.

Impaired loans at September 30, 2012 and December 31, 2011 amounted to $7.2 million and $5.3 million, respectively, and included all nonaccrual and restructured loans. During the nine months ended September 30, 2012, the average recorded investment in impaired loans was $7.3 million and interest

income recognized on impaired loans was $158,000. During the nine months ended September 30, 2011, the average recorded investment in impaired loans was $5.0 million and interest income recognized on impaired loans was $108,000.

The table below presents the aging of loans and accrual status by class of loans:


(Dollars in thousands)	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or Greater Past Due		Total Past Due		Loans Not Past Due		Total Loans		Nonaccrual Loans		Loans More Than 90 Days Past Due and Still Accruing
September 30, 2012:
One- to four-family residential mortgages	$	1,401	$	0	$	1,855	$	3,256	$	706,611	$	709,867	$	4,483	$	0
Multi-family residential mortgages		0		0		0		0		6,760		6,760		0		0
Construction, commercial and other mortgages		0		0		0		0		11,843		11,843		0		0
Home equity loans and lines of credit		0		0		0		0		15,129		15,129		158		0
Loans on deposit accounts		0		0		0		0		482		482		0		0
Consumer and other		8		1		0		9		4,279		4,288		0		0

Total	$	1,409	$	1	$	1,855	$	3,265	$	745,104	$	748,369	$	4,641	$	0


December 31, 2011:
One- to four-family residential mortgages	$	499	$	0	$	2,148	$	2,647	$	646,268	$	648,915	$	2,582	$	0
Multi-family residential mortgages		0		0		0		0		6,912		6,912		0		0
Construction, commercial and other mortgages		0		0		184		184		10,872		11,056		184		0
Home equity loans and lines of credit		168		0		0		168		17,096		17,264		159		0
Loans on deposit accounts		0		0		0		0		756		756		0		0
Consumer and other		11		2		3		16		4,717		4,733		3		0

Total	$	678	$	2	$	2,335	$	3,015	$	686,621	$	689,636	$	2,928	$	0

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

The Company had 19 nonaccrual loans with a book value of $4.6 million at September 30, 2012 and 12 nonaccrual loans with a book value of $2.9 million as of December 31, 2011. The Company collected or recognized interest income on nonaccrual loans of $75,000 and $8,000 during the nine months ended September 30, 2012 and 2011, respectively. The Company would have recognized additional interest income of $119,000 and $84,000 during the nine months ended September 30, 2012 and 2011, respectively, had the loans been accruing interest. The Company did not have any loans more than 90 days past due and still accruing interest as of September 30, 2012 and December 31, 2011.

The table below presents information about the Company’s new troubled debt restructurings by class of loans:


	2012						2011
(Dollars in thousands)	Number of Loans		Pre- Modification Recorded Investment		Post- Modification Recorded Investment		Number of Loans		Pre- Modification Recorded Investment		Post- Modification Recorded Investment
Three months ended September 30:
One- to four-family residential		12	$	3,694	$	3,694		0	$	0	$	0

Total		12	$	3,694	$	3,694		0	$	0	$	0


Nine months ended September 30:
One- to four-family residential		12	$	3,694	$	3,694		0	$	0	$	0

Total		12	$	3,694	$	3,694		0	$	0	$	0

There were no new troubled debt restructurings within the past 12 months that subsequently defaulted.

The Company had 22 troubled debt restructurings totaling $6.1 million as of September 30, 2012 that were considered to be impaired. This total included 21 one- to four-family residential mortgage loans totaling $6.0 million and one home equity loan for $158,000. Eight of the loans, totaling $2.5 million, are performing in accordance with their restructured terms and accruing interest at September 30, 2012. Twelve of the loans, totaling $2.8 million, are performing in accordance with their restructured terms but not accruing interest at September 30, 2012. Two of the loans, for $788,000, are 150 days or more delinquent and not accruing interest at September 30, 2012. There were 11 troubled debt restructurings totaling $2.9 million as of December 31, 2011 that were considered to be impaired. This total included ten one- to four-family residential mortgage loans totaling $2.8 million and one home equity loan for $159,000. Eight of the loans, totaling $2.3 million, are performing in accordance with their restructured terms and accruing interest at December 31, 2011. Two of the loans, totaling $344,000, are performing in accordance with their restructured terms but not accruing interest at December 31, 2011. One of the loans, for $248,000, is 59 days delinquent and not accruing interest at December 31, 2011. The increase in troubled debt restructurings primarily occurred when, in consultation with the Office of the Comptroller of the Currency, Territorial Savings Bank’s primary regulator, we classified 12 loans that had been modified to provide interest-only payments, totaling $3.7 million, as troubled debt restructurings. The increase in troubled debt restructuring has not had an effect on the adequacy of the Bank’s loan loss allowance. Management considers the allowance for loan losses at September 30, 2012 to be at an appropriate level to provide for probable losses that can be estimated. Restructurings include deferrals of interest and/or principal payments and temporary or permanent reductions in interest rates due to the financial difficulties of the borrowers. We have no commitments to lend any additional funds to these borrowers.

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

During the three months ended September 30, 2012 and 2011, the Company sold $28.9 million and $9.2 million, respectively, of mortgage loans held for sale and recognized gains of $669,000 and $138,000, respectively. During the nine months ended September 30, 2012 and 2011, the Company sold $75.1 million and $35.3 million, respectively, of mortgage loans held for sale and recognized gains of $1.5 million and $374,000, respectively. The Company had 14 loans held for sale totaling $4.0 million at September 30, 2012 and 12 loans held for sale totaling $3.2 million at December 31, 2011.

The Company serviced loans for others of $92.4 million at September 30, 2012 and $115.3 million at December 31, 2011. Of these amounts, $5.1 million and $6.2 million relate to securitizations for which the Company continues to hold the related mortgage-backed securities at September 30, 2012 and December 31, 2011, respectively. The amount of contractually specified servicing fees earned for the nine-month periods ended September 30, 2012 and 2011 was $212,000 and $266,000, respectively. The amount of contractually specified servicing fees earned for the three-month periods ended September 30, 2012 and 2011 was $68,000 and $87,000, respectively. The fees are reported in service fees on loan and deposit accounts in the consolidated statements of income.

(7)

Securities Sold Under Agreements to Repurchase

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


	September 30, 2012					December 31, 2011
			Weighted					Weighted
	Repurchase		average			Repurchase		average
(Dollars in thousands)	liability		rate			liability		rate

Maturing:
1 year or less	$	23,000		4.40	%	$	28,300		4.75	%
Over 1 year to 2 years		0		0.00			33,000		3.91
Over 2 years to 3 years		47,000		2.11			0		0.00
Over 3 years to 4 years		0		0.00			47,000		2.11


	$	70,000		2.86	%	$	108,300		3.35	%

During the three months ended September 30, 2012, the Company prepaid $10.0 million of securities sold under agreements to repurchase and incurred $123,000 of prepayment penalties. During the nine months ended September 30, 2012, the Company prepaid $25.0 million of securities sold under agreements to repurchase and incurred $321,000 of prepayment penalties.

Below is a summary comparing the carrying value and fair value of securities pledged to secure repurchase agreements, the repurchase liability, and the amount at risk at September 30, 2012. The amount at risk is the greater of the carrying value or fair value over the repurchase liability. All the agreements to repurchase are with JP Morgan Securities and the securities pledged are issued and guaranteed by U.S. government-sponsored enterprises.

Weighted

Carrying

Fair

average

value of

Repurchase

Amount

months to

(Dollars in thousands)

securities

liability

at risk

maturity

Maturing:

Over 90 days

80,059

85,924

70,000

15,924

(8)

Employee Benefit Plans

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

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

The components of net periodic benefit cost were as follows:


	SERP				SERP
	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(Dollars in thousands)	2012		2011		2012		2011
Net periodic benefit cost for the period
Service cost	$	49	$	111	$	147	$	332
Interest cost		25		53		74		161
Expected return on plan assets		0		0		0		0
Amortization of prior service cost		0		0		0		0
Recognized actuarial loss		0		0		0		0
Recognized curtailment loss		0		0		0		0


Net periodic benefit cost	$	74	$	164	$	221	$	493

(9)

Employee Stock Ownership Plan

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

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

Shares purchased by the ESOP are held by a trustee in an unallocated suspense account, and shares are released annually from the suspense account on a pro-rata basis as principal and interest payments are made by the ESOP to the Company. The trustee allocates the shares released among participants on the basis of each participant’s proportional share of compensation relative to all participants. As shares are committed to be released from the suspense account, Territorial Savings Bank reports compensation expense based on the average fair value of shares released with a corresponding credit to stockholders’ equity. The shares committed to be released are considered outstanding for earnings per share computations. Compensation expense recognized for the three months ended September 30, 2012 and 2011 amounted to $271,000 and $236,000, respectively. Compensation expense recognized for the nine months ended September 30, 2012 and 2011 amounted to $759,000 and $704,000, respectively.

Shares held by the ESOP trust were as follows:


	September 30,		December 31,
	2012		2011
Allocated shares		179,439		145,775
Unearned shares		795,154		831,853


Total ESOP shares		974,593		977,628


Fair value of unearned shares, in thousands	$	18,249	$	16,429

The ESOP restoration plan is a nonqualified plan that provides supplemental benefits to certain executives who are prevented from receiving the full benefits contemplated by the employee stock ownership plan’s benefit formula. The supplemental cash payments consist of payments representing shares that cannot be allocated to the participants under the ESOP due to IRS limitations imposed on tax-qualified plans. We accrue for these benefits over the period during which employees provide services to earn these benefits. For the three months ended September 30, 2012 and 2011, we accrued $80,000 and $1,000, respectively, for the ESOP restoration plan. For the nine months ended September 30, 2012 and 2011, we accrued $185,000 and $159,000, respectively, for the ESOP restoration plan.

(10)

Share-Based Compensation

On August 19, 2010, Territorial Bancorp Inc. adopted the 2010 Equity Incentive Plan, which provides for awards of stock options and restricted stock to key officers and outside directors. In accordance with the Compensation – Stock Compensation topic of the FASB ASC, the cost of the 2010 Equity Incentive Plan is based on the fair value of the awards on the grant date. The fair value of restricted stock is based on the closing price of the Company’s stock on the grant date. The fair value of stock options is estimated using a Black-Scholes option pricing model using assumptions for dividend yield, stock price volatility, risk-free interest rate and option term. These assumptions are based on our judgments regarding future events, are subjective in nature, and cannot be determined with precision. The cost of the awards will be recognized over a five to six-year vesting period.

Shares of our common stock issued under the Plan shall be authorized but unissued shares. The maximum number of shares that will be awarded under the plan will be 1,712,637 shares. Share-based compensation expense for the three months and nine months ended September 30, 2012 was $693,000 and $2.0 million, respectively.

Stock Options

The table below presents the stock option activity for the nine months ended September 30, 2012:


	Options		Weighted average exercise price		Remaining contractual life (years)		Aggregate intrinsic value (in thousands)
Options outstanding at December 31, 2011		871,144	$	17.36		8.67	$	2,082
Granted		3,085		23.62		8.00		0
Exercised		41,275		17.36		0.00		0
Forfeited		0		0.00		0.00		0
Expired		0		0.00		0.00		0

Options outstanding at September 30, 2012		832,954	$	17.38		7.92	$	4,640

As of September 30, 2012, the Company had $2.8 million of unrecognized compensation costs related to stock options. The cost of stock options will be amortized over a five to six-year vesting period. There were 138,929 options vested in the nine months ending September 30, 2012.

The fair value of the Company’s stock options was determined using the Black-Scholes option pricing formula. The following assumptions were used in the formula in 2010 and 2012:


	2010			2012

Expected volatility		31.98	%		36.83	%
Risk-free interest rate		2.58	%		0.81	%
Expected dividends		1.61	%		1.86	%
Expected life (in years)		6.75			5.50
Grant price for the stock options	$	17.36		$	23.62

There were no options granted in 2011. There were 3,085 options granted in the nine months ended September 30, 2012.

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

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

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

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

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

Restricted Stock Awards

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

The table below presents the restricted stock award activity for the nine months ended September 30, 2012:


	Restricted stock awards		Weighted average grant date fair value
Nonvested at December 31, 2011		563,994	$	17.36
Granted		2,735		23.62
Vested		113,332		17.39
Forfeited		0		0.00

Nonvested at September 30, 2012		453,397	$	17.39

There were 2,735 restricted stock awards granted in the nine months ended September 30, 2012 at a price of $23.62 per share.

As of September 30, 2012, the Company had $7.7 million of unrecognized compensation cost related to restricted stock awards. The cost of the restricted stock awards will be amortized over a five to six-year vesting period.

(11)

Earnings Per Share

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


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(Dollars in thousands, except share data)	2012		2011		2012		2011

Net income	$	3,647	$	2,986	$	11,033	$	9,371

Weighted-average number of shares used in:
Basic earnings per share		10,052,630		10,659,532		10,126,371		10,969,320
Dilutive common stock equivalents:
Stock options and restricted stock units		146,770		176,117		79,037		148,124

Diluted earnings per share		10,199,400		10,835,649		10,205,408		11,117,444

Net income per common share, basic	$	0.36	$	0.28	$	1.09	$	0.85

Net income per common share, diluted	$	0.36	$	0.28	$	1.08	$	0.84

(12)

Other Comprehensive Loss

The table below presents the changes in the components of other comprehensive loss:


	Three Months Ended September 30,
	2012							2011
(Dollars in thousands)	Beginning Balance		Comprehensive Income			Ending Balance		Beginning Balance		Comprehensive Income			Ending Balance

Unfunded pension liability	$	2,966	$	0		$	2,966	$	1,504	$	0		$	1,504
Noncredit related losses on securities not expected to be sold		679		(177	)		502		679		0			679
Unrealized loss on securities		115		(8	)		107		135		(2	)		133

	$	3,760	$	(185	)	$	3,575	$	2,318	$	(2	)	$	2,316


	Nine Months Ended September 30,
	2012							2011
(Dollars in thousands)	Beginning Balance		Comprehensive Income			Ending Balance		Beginning Balance		Comprehensive Income			Ending Balance

Unfunded pension liability	$	2,966	$	0		$	2,966	$	1,504	$	0		$	1,504
Noncredit related losses on securities not expected to be sold		679		(177	)		502		679		0			679
Unrealized loss on securities		125		(18	)		107		322		(189	)		133

	$	3,770	$	(195	)	$	3,575	$	2,505	$	(189	)	$	2,316

The table below presents the tax effect on each component of other comprehensive loss:


	Nine Months Ended September 30,
	2012							2011
(Dollars in thousands)	Pretax Amount		Tax			After Tax Amount		Pretax Amount		Tax			After Tax Amount

Unfunded pension liability	$	4,954	$	(1,988	)	$	2,966	$	2,488	$	(984	)	$	1,504
Noncredit related losses on securities not expected to be sold		812		(310	)		502		1,106		(427	)		679
Unrealized loss on securities		178		(71	)		107		222		(89	)		133

	$	5,944	$	(2,369	)	$	3,575	$	3,816	$	(1,500	)	$	2,316

(13)

Fair Value of Financial Instruments

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

•

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

•

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

•

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

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

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

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

Investment Securities. The estimated fair values of U.S. government-sponsored mortgage-backed securities are considered Level 2 inputs because the valuation for investment securities utilized pricing models that varied based on asset class and included trade, bid and other observable market information.

The trust preferred securities represent investments in a pool of debt obligations issued primarily by holding companies for Federal Deposit Insurance Corporation-insured financial institutions. The trust preferred securities market is considered to be inactive since there have been only six sales transactions of similar rated securities over the past 21 months and no new issues of pooled trust preferred securities have occurred since 2007. The fair value of our trust preferred securities was determined by an independent third-party pricing service that used a discounted cash flow model and included a review of all issuers within the pool. Our pricing service used a discount rate of three-month LIBOR plus 20.00% and provided a fair value estimate of $9.20 per $100 of par value for PreTSL XXIII. The fair value of the trust preferred securities are classified as Level 3 inputs because they are based on discounted cash flow models.

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

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

Loans Held for Sale. The fair value of loans held for sale is determined based on prices quoted in the secondary market for similar loans.

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

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

Interest Rate Contracts. The Company may enter into interest rate lock commitments with borrowers on loans intended to be sold. To manage interest rate risk on the lock commitments, the Company may also enter into forward loan sale commitments. The interest rate lock commitments and forward loan sale commitments are treated as derivatives and are recorded at their fair value determined by referring to prices quoted in the secondary market for similar contracts. Interest rate contracts that are classified as assets are included with prepaid expenses and other assets on the consolidated balance sheet while interest rate contracts that are classified as liabilities are included with accounts payable and accrued expenses.

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


					Fair Value Measurements Using
(Dollars in thousands)	Carrying amount		Fair value		Level 1		Level 2		Level 3
September 30, 2012
Assets
Cash and cash equivalents	$	155,265	$	155,265	$	155,265	$	0	$	0
Investment securities held to maturity		595,607		633,513		0		633,187		326
FHLB stock		12,238		12,238		12,238		0		0
Loans held for sale		4,032		4,282		0		4,282		0
Loans receivable, net		746,874		789,415		0		0		789,415
Accrued interest receivable		4,676		4,676		4,676		0		0
Interest rate contracts		662		662		0		662		0

Liabilities
Deposits		1,226,527		1,228,263		1,017,448		0		210,815
Advances from the Federal Home Loan Bank		20,000		20,483		0		0		20,483
Securities sold under agreements to repurchase		70,000		72,768		0		0		72,768
Accounts payable and accrued expenses		23,158		23,158		23,158		0		0
Interest rate contracts		597		597		0		597		0
Current income taxes payable		147		147		147		0		0
Advance payments by borrowers for taxes and insurance		2,295		2,295		2,295		0		0

December 31, 2011
Assets
Cash and cash equivalents	$	131,937	$	131,937	$	131,937	$	0	$	0
Investment securities held to maturity		653,871		687,319		0		687,060		259
FHLB stock		12,348		12,348		12,348		0		0
Loans held for sale		3,231		3,352		0		3,352		0
Loans receivable, net		688,095		790,220		0		0		790,220
Accrued interest receivable		4,780		4,780		4,780		0		0
Interest rate contracts		156		156		0		156		0

Liabilities
Deposits		1,166,116		1,167,855		942,365		0		225,490
Advances from the Federal Home Loan Bank		20,000		20,525		0		0		20,525
Securities sold under agreements to repurchase		108,300		112,306		0		0		112,306
Accounts payable and accrued expenses		22,816		22,816		22,816		0		0
Interest rate contracts		139		139		0		139		0
Current income taxes payable		3,114		3,114		3,114		0		0
Advance payments by borrowers for taxes and insurance		3,264		3,264		3,264		0		0

At September 30, 2012 and December 31, 2011, neither the commitment fees received on commitments to extend credit nor the fair value thereof was material to the consolidated financial statements of the Company.

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


(Dollars in thousands)	Level 1		Level 2			Level 3		Total

September 30, 2012
Interest rate contracts - assets	$	0	$	662		$	0	$	662
Interest rate contracts - liabilities		0		(597	)		0		(597	)

December 31, 2011
Interest rate contracts - assets	$	0	$	156		$	0	$	156
Interest rate contracts - liabilities		0		(139	)		0		(139	)

The fair value of interest rate contracts was determined by referring to prices quoted in the secondary market for similar contracts. Gains and losses are included in gain on sale of loans in the consolidated statements of income.

The table below presents the balance of assets measured at fair value on a nonrecurring basis as of September 30, 2012 and December 31, 2011 and the related losses for the nine months ended September 30, 2012 and the year ended December 31, 2011:


(Dollars in thousands)	Level 1		Level 2		Level 3		Total		Total Gains (Losses)

September 30, 2012
Impaired loans	$	0	$	211	$	5,335	$	5,546	$	(163	)
Mortgage servicing assets		0		0		679		679		(209	)
Trust preferred securities		0		0		326		326		294

December 31, 2011
Impaired loans	$	0	$	885	$	2,766	$	3,651	$	(219	)
Mortgage servicing assets		0		0		970		970		(34	)

The fair value of impaired loans that are considered to be collateral-dependent is determined using the value of collateral less estimated selling costs. The fair value of impaired loans that are not considered to be collateral-dependent is determined using a discounted cash flow analysis. Assumptions used in the analysis include the discount rate and projected cash flows. Gains and losses on impaired loans are included in the provision for loan losses in the consolidated statements of income. Mortgage servicing assets are valued using a cash flow model prepared by an independent third-party appraiser. Assumptions used in the model include mortgage prepayment speeds, discount rates, cost of servicing and ancillary income. Losses on mortgage servicing assets are included in service fees on loan and deposit accounts in the consolidated statements of income. The fair value of trust preferred securities was determined by an independent third-party pricing service using a discounted cash flow model. The assumptions used in the discounted cash flow model are discussed above. Gains and losses on trust preferred securities that are credit related are included in net other-than-temporary impairment losses in the consolidated statements of income. Gains and losses on trust preferred securities that are not credit related are included in other comprehensive income in the consolidated statements of comprehensive income.

The table below presents the significant unobservable inputs for Level 3 nonrecurring fair value measurements:


(Dollars in thousands)	Fair Value		Valuation Technique	Unobservable Input	Value

September 30, 2012:
Impaired loans - non-collateral dependent	$	5,335	Discounted cash flow	Discount rate (1)	3.73% - 6.94%

Mortgage servicing assets		679	Discounted cash flow	Discount rate	10.00%
				Prepayment speed (PSA)	191.5 - 332.1
				Cost to service (Basis points)	40

Trust preferred securities		326	Discounted cash flow	Discount rate	Three-month LIBOR plus 20%

December 31, 2011:
Impaired loans - non-collateral dependent	$	2,766	Discounted cash flow	Discount rate (1)	3.73% - 6.94%

Mortgage servicing assets		970	Discounted cash flow	Discount rate	10.00%
				Prepayment speed (PSA)	180.1 - 437.9
				Cost to service (Basis points)	40

(1)	Represents the yield on contractual cash flows prior to modification in troubled debt restructurings.

(14)

Subsequent Events

On November 1, 2012, the Board of Directors of Territorial Bancorp Inc. declared a quarterly cash dividend of $0.12 per share of common stock. The dividend is expected to be paid on November 29, 2012 to stockholders of record as of November 15, 2012.

ITEM 2.

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

Cautionary Statement Regarding Forward-Looking Information

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

•

statements of our goals, intentions and expectations;

•

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

•

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

•

estimates of our risks and future costs and benefits.

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

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

•

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

•

competition among depository and other financial institutions;

•

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

•

adverse changes in the securities markets;

•

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

•

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

•

our ability to successfully integrate acquired entities, if any;

•

changes in consumer spending, borrowing and savings habits;

•

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

•

changes in our organization, compensation and benefit plans;

•

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

•

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

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

Critical Accounting Policies

There are no material changes to the critical accounting policies disclosed in Territorial Bancorp Inc.’s Annual Report on Form 10-K for the year ended December 31, 2011.

Comparison of Financial Condition at September 30, 2012 and December 31, 2011

Assets. At September 30, 2012, our assets were $1.563 billion, an increase of $25.1 million, or 1.6%, from $1.538 billion at December 31, 2011. The growth in assets was primarily the result of an increase in loans receivable and cash and cash equivalents, which was partially offset by a decrease in investment securities.

Cash and Cash Equivalents. Cash and cash equivalents were $155.3 million at September 30, 2012, an increase of $23.3 million since December 31, 2011. The growth in cash and cash equivalents resulted primarily from a $60.4 million increase in deposits, which was partially offset by cash used to pay off $38.3 million of securities sold under agreements to repurchase.

Loans. Total loans, including $4.0 million of loans held for sale, were $750.9 million at September 30, 2012, or 48.1% of total assets. During the nine months ended September 30, 2012, the loan portfolio increased by $59.6 million, or 8.6%. The increase in the loan portfolio occurred as the production of new one- to four-family residential loans exceeded principal repayments and loan sales. The continued high level of loan originations is due primarily to the current interest rate environment.

Securities. At September 30, 2012, our securities portfolio totaled $595.6 million, or 38.1% of total assets. At September 30, 2012, all of such securities were classified as held-to-maturity and none of the underlying collateral consisted of subprime or Alt-A (traditionally defined as nonconforming loans having less than full documentation) loans. During the nine months ended September 30, 2012, our securities portfolio decreased by $58.3 million, or 8.9%, as repayments and sales exceeded purchases.

At September 30, 2012, we owned trust preferred securities with a carrying value of $326,000. This portfolio consists of two securities, which represent investments in a pool of debt obligations issued by Federal Deposit Insurance Corporation-insured financial institutions, insurance companies and real estate investment trusts.

The trust preferred securities market is considered to be inactive as only six transactions have occurred over the past 21 months in similar tranches to the securities owned by the Company. The Company used a discounted cash flow model to determine whether these securities are other-than-temporarily impaired. The assumptions used in preparing the discounted cash flow model include the following: estimated discount rates, estimated deferral and default rates on collateral, and estimated cash flows. The Company used a discount rate equal to three-month LIBOR plus 20.00% and determined fair value to be $9.20 per $100 of par value.

Based on the Company’s review, the Company’s investment in trust preferred securities did not incur additional impairment during the quarter ending September 30, 2012, as the present value of cash flows exceeded the amortized cost basis of $1.1 million.

At September 30, 2012, these trust preferred securities are rated C by Fitch.

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

Deposits. Deposits were $1.227 billion at September 30, 2012, an increase of $60.4 million, or 5.2%, since December 31, 2011. The increase in deposits was caused by our continuing to promote higher-than-market rates for our savings accounts.

Borrowings. Our borrowings consist primarily of advances from the Federal Home Loan Bank of Seattle and funds borrowed under securities sold under agreements to repurchase. During the nine months ended September 30, 2012, our borrowings decreased by $38.3 million, or 29.9%, to $90.0 million, due to the pay off of securities sold under agreements to repurchase. We have not required any other borrowings to fund our operations. Instead, we have primarily funded our operations with the net proceeds from our stock offering, additional deposits, proceeds from loan sales and principal repayments on loans and mortgage-backed securities.

Average Balances and Yields

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


	For the Three Months Ended September 30,
	2012								2011
	Average Outstanding Balance			Interest		Yield/ Rate (1)			Average Outstanding Balance			Interest		Yield/ Rate (1)
	(Dollars in thousands)

Interest-earning assets:
Loans:
Real estate loans:
First mortgage:
One- to four-family residential (2)	$	703,000		$	8,629		4.91	%	$	618,576		$	8,127		5.26	%
Multi-family residential		6,826			104		6.09			6,082			97		6.38
Construction, commercial and other		11,652			158		5.42			14,512			217		5.98
Home equity loans and lines of credit		15,207			222		5.84			18,052			272		6.03
Other loans		4,791			74		6.18			5,244			85		6.48

Total loans		741,476			9,187		4.96			662,466			8,798		5.31
Investment securities:
U.S. government sponsored mortgage-backed securities (2)		612,325			5,551		3.63			648,645			6,907		4.26
Trust preferred securities		35			0		0.00			32			0		0.00

Total securities		612,360			5,551		3.63			648,677			6,907		4.26
Other		160,494			88		0.22			154,679			85		0.22

Total interest-earning assets		1,514,330			14,826		3.92			1,465,822			15,790		4.31
Non-interest-earning assets		48,105								51,035

Total assets	$	1,562,435							$	1,516,857


Interest-bearing liabilities:
Savings accounts	$	861,845		$	1,108		0.51	%	$	776,218		$	1,178		0.61	%
Certificates of deposit		212,099			375		0.71			222,619			510		0.92
Money market accounts		532			0		0.00			510			1		0.78
Checking and Super NOW accounts		115,715			9		0.03			106,229			11		0.04

Total interest-bearing deposits		1,190,191			1,492		0.50			1,105,576			1,700		0.62
Federal Home Loan Bank advances		19,998			105		2.10			20,001			105		2.10
Securities sold under agreements to repurchase		82,099			629		3.06			119,927			1,067		3.56

Total interest-bearing liabilities		1,292,288			2,226		0.69			1,245,504			2,872		0.92
Non-interest-bearing liabilities		51,540								48,860

Total liabilities		1,343,828								1,294,364
Stockholders’ equity		218,607								222,494

Total liabilities and stockholders’ equity	$	1,562,435							$	1,516,858


Net interest income				$	12,600							$	12,918

Net interest rate spread (3)							3.23	%							3.39	%
Net interest-earning assets (4)	$	222,042							$	220,318

Net interest margin (5)							3.33	%							3.53	%
Interest-earning assets to interest-bearing liabilities		117.18	%							117.69	%

(1)	Annualized

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

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

(4)	Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

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


	For the Nine Months Ended September 30,
	2012							2011
	Average Outstanding Balance		Interest		Yield/ Rate (1)			Average Outstanding Balance		Interest		Yield/ Rate (1)
	(Dollars in thousands)

Interest-earning assets:
Loans:
Real estate loans:
First mortgage:
One- to four-family residential (2)	$	682,826	$	25,575		4.99	%	$	614,515	$	24,400		5.29	%
Multi-family residential		6,755		311		6.14			6,090		293		6.41
Construction, commercial and other		11,870		500		5.62			14,246		644		6.03
Home equity loans and lines of credit		16,062		707		5.87			18,636		850		6.08
Other loans		5,056		233		6.14			5,374		257		6.38

Total loans		722,569		27,326		5.04			658,861		26,444		5.35
Investment securities:
U.S. government sponsored mortgage-backed securities (2)		632,208		18,360		3.87			627,718		20,167		4.28
Trust preferred securities		33		0		0.00			32		0		0.00

Total securities		632,241		18,360		3.87			627,750		20,167		4.28
Other		158,197		259		0.22			157,126		258		0.22

Total interest-earning assets		1,513,007		45,945		4.05			1,443,737		46,869		4.33
Non-interest-earning assets		51,758							50,322

Total assets	$	1,564,765						$	1,494,059


Interest-bearing liabilities:
Savings accounts	$	842,717	$	3,354		0.53	%	$	763,819	$	3,540		0.62	%
Certificates of deposit		217,268		1,262		0.77			214,755		1,528		0.95
Money market accounts		520		1		0.26			587		2		0.45
Checking and Super NOW accounts		113,634		27		0.03			106,711		39		0.05

Total interest-bearing deposits		1,174,139		4,644		0.53			1,085,872		5,109		0.63
Federal Home Loan Bank advances		20,000		313		2.09			18,901		295		2.08
Securities sold under agreements to repurchase		96,550		2,364		3.26			115,075		3,153		3.65

Total interest-bearing liabilities		1,290,689		7,321		0.76			1,219,848		8,557		0.94
Non-interest-bearing liabilities		56,029							47,837

Total liabilities		1,346,718							1,267,685
Stockholders’ equity		218,047							226,374

Total liabilities and stockholders’ equity	$	1,564,765						$	1,494,059


Net interest income