ITEM 1. BUSINESS

General

        Central Pacific Financial Corp. is a Hawaii corporation and a bank holding company registered under the Bank Holding Company Act of 1956, as amended. Our principal business is to serve as a holding company for our bank subsidiary, Central Pacific Bank. Pursuant to a Plan of Reorganization and Agreement of Merger, our company was organized on February 1, 1982 to serve as a holding company for our subsidiary, Central Pacific Bank. Central Pacific Bank was incorporated in its present form in the State of Hawaii on March 16, 1982 in connection with the holding company reorganization, and its predecessor entity was incorporated in the State of Hawaii on January 15, 1954. On September 15, 2004, we completed a merger with CB Bancshares, Inc. CB Bancshares' subsidiaries, which became our wholly-owned subsidiaries, included City Bank, CB Bancshares' banking subsidiary, among others. In February 2005, Central Pacific Bank merged with City Bank, with Central Pacific Bank as the surviving entity. We refer to Central Pacific Bank herein as our bank or the bank and when we say "we," "our or the "Company, we mean the holding company on a consolidated basis with the bank and our other consolidated subsidiaries. When we refer to "Central Pacific Financial Corp." or to the holding company, we are referring to the parent company on a standalone basis.

        Through our bank, we offer full-service commercial banking, with thirty-seven bank branches and 95 ATMs located throughout the State of Hawaii. Our administrative and main offices are located in Honolulu, and we have thirty other branches on the island of Oahu. In addition, we operate three branches on the island of Maui, one branch on the island of Kauai and two branches on the island of Hawaii. We also have five loan production offices serving customers in California and Washington. Our bank's deposits are insured by the Federal Deposit Insurance Corporation, or the FDIC, up to applicable limits. The bank is not a member of the Federal Reserve System.

        Our bank is a full-service community bank offering a broad range of banking products and services including accepting time and demand deposits and originating loans, including commercial loans, real estate and construction loans, consumer loans and mortgage loans. We derive our income primarily from interest on commercial real estate loans, commercial loans, residential mortgage loans and construction loans and, to a lesser extent, on interest on investment securities and fees received in

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connection with deposit services as well as other services offered. Our major operating expenses are the interest paid by our bank on deposits and borrowings, salaries and employee benefits and general operating expenses. Our bank relies on a foundation of locally generated deposits. Our operations, like those of other financial institutions that operate in our market, are significantly influenced by economic conditions in Hawaii, including the strength of the real estate market, and the fiscal and regulatory policies of the federal and state government and the regulatory authorities that govern financial institutions. For more information about the regulation of our holding company and bank, see "—Supervision and Regulation."

        We are committed to maintaining a premier, relationship-based community bank in Hawaii that serves the needs of small to medium-sized businesses and the owners and employees of those businesses. In addition, we are expanding our loan growth opportunities and providing geographic diversification of our credit risk through our loan production offices in California and Washington. The strategy for serving our target markets is the delivery of a finely-focused set of value-added products and services that satisfy the primary needs of our customers, emphasizing superior service and relationships as opposed to transaction volume.

The Merger

        On September 15, 2004, we completed our merger with CB Bancshares, Inc., the former holding company for City Bank. As a result, City Bank became our wholly owned subsidiary. We merged our two banking subsidiaries, Central Pacific Bank and City Bank, on February 22, 2005. Central Pacific Bank is the surviving entity, as well as our brand name going forward. Concurrently, we integrated the information technology platforms used by Central Pacific Bank and City Bank.

        In connection with the merger of Central Pacific Bank and City Bank, we consolidated 9 branches on February 22, 2005. Taking into account the Wailuku, Maui branch we opened in February, our total branch count has been reduced from 45 at December 31, 2004 to 37. In addition, our headquarters have been consolidated into Central Pacific Financial Corp.'s existing headquarters.

        Following the completion of the merger, we implemented a Voluntary Separation Program, or VSP, which was offered to certain employees of both merging organizations. The VSP consisted of a monetary compensation package for those employees that decided to voluntarily terminate their relationship with us. As of December 31, 2004, 102 employees had decided to participate in the VSP. We expect the VSP to be fully implemented in the second quarter of 2005.

        In connection with the merger, we issued 11.9 million shares of our common stock and paid $88.9 million in cash for total merger consideration of $423.1 million, based on our stock price as of September 15, 2004. Our merger with CB Bancshares was accounted for under the purchase method of accounting, and CB Bancshares' results are included in our consolidated financial statements from September 15, 2004.

Our Services

        We offer a full range of banking services and products to small and medium-sized businesses, professionals and individuals. We provide our customers with an array of commercial and consumer loan products, including commercial real estate and construction loans, residential mortgage loans, commercial loans and lines of credit, and consumer loans and lines of credit.

        Through our bank, we concentrate our lending activities in three principal areas:

(1)

Commercial Real Estate and Construction Lending. Loans in this category consist primarily of loans secured by commercial real estate, including, but not limited to, structures and facilities to support

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activities designated as industrial, warehouse, general office, retail, health care, religious and multi-family dwellings. Also included in this category are loans to finance the construction of the aforementioned types of commercial real estate. Our underwriting policy generally requires net cash flow from the property to cover the debt service while maintaining an appropriate amount of reserve. Additionally, liquidation of the collateral is available as a secondary source of repayment.

In addition to our branches throughout Hawaii, we operate five loan production offices in California and Washington that are staffed by experienced relationship officers formerly from in-state banks. The loans originated in these loan production offices are commercial real estate and construction loans.

(2)

Residential Mortgage Lending. Residential mortgage loans include both fixed- and adjustable-rate loans primarily secured by single-family owner-occupied residences. We typically require maximum loan-to-value ratios of 80%, although higher levels are permitted with accompanying mortgage insurance. We emphasize residential mortgage loans for owner-occupied primary residences and do not actively seek loans on high-end residences, vacation homes and investment properties. First mortgage loans secured by residential properties generally carry a moderate level of credit risk. With an average loan size of approximately $200,000, readily marketable collateral and a strong residential real estate market, credit losses on residential mortgages have been minimal during the past two years. However, future changes in interest rates and other market factors can impact the marketability of collateral and thus the level of credit risk inherent in the portfolio. As with all loans, managing credit risk in the residential mortgage market requires strong underwriting standards and diligent monitoring and handling of problems that may arise.

(3)

Commercial Lending and Leasing. Loans in this category consist primarily of term loans, lines of credit and equipment leases to small and middle-market businesses and professionals located in the State of Hawaii. The borrower's business is typically regarded as the principal source of repayment, although our underwriting policy and practice generally require additional sources of collateral, including real estate and other business assets, as well as personal guarantees where possible to mitigate risk. Risks of credit losses are greater in this loan category relative to secured loans, such as commercial and residential mortgages where a greater percentage of the loan amount is usually covered by collateral. Nonetheless, any collateral or personal guarantees obtained on commercial loans can mitigate the increased risk and help to reduce credit losses.

        In addition, we offer deposit products and services including checking, savings and time deposits, cash management and internet banking services.

Our Market Area and Competition

        Based on deposit market share among FDIC-insured financial institutions in Hawaii, we were the fourth-largest depository institution in the State of Hawaii at December 31, 2004, with more than $3.3 billion in deposits, representing a 14% market share.

        First Hawaiian Bank, the Hawaii-based subsidiary bank of Bancwest Corporation, had $7.1 billion in domestic deposits at year-end 2004, or approximately 30% deposit market share in the State of Hawaii. Bank of Hawaii, the largest subsidiary of Bank of Hawaii Corporation, had $6.9 billion in domestic deposits at year-end 2004, representing approximately 29% of the deposits in the State of Hawaii. American Savings Bank, a subsidiary of Hawaiian Electric Industries, Inc., held $4.3 billion in deposits at year-end 2004, or approximately 19% of the deposits in the State of Hawaii.

        The banking and financial services industry in the State of Hawaii generally, and in our target market areas, is highly competitive. The increasingly competitive environment is a result primarily of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of

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consolidation among financial services providers. We compete for loans, deposits, and customers with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers. Many of these competitors are much larger in total assets and capitalization and have greater access to capital markets.

        In order to compete with the other financial services providers in the State of Hawaii, we principally rely upon local promotional activities, personal relationships between customers and our officers, directors and employees, and specialized services tailored to meet the needs of our customers and the communities we serve. We remain competitive by offering flexibility and superior service levels, coupled with competitive interest rates and pricing.

        Our mainland loan production offices in California and Washington likewise face formidable competition in the commercial real estate lending sector. Competitors range from large national banks, including Wells Fargo Bank, Bank of America, Washington Mutual, and US Bancorp, to regional and community banks. Nonbanks, including brokerage firms, conduits and insurance companies, also compete for commercial real estate lending business. This competition has resulted in aggressive pricing and the easing of underwriting standards in these markets. To mitigate these competitive pressures and credit risks, we rely upon our teams of experienced commercial real estate lenders and a lending approach which targets clients with solid track records, substantial net worth and adequate liquidity.

Business Concentrations

        No individual or single group of related accounts is considered material in relation to the assets or deposits of our bank, or in relation to the overall business of the Company. However, approximately 75% of our loan portfolio held for investment at December 31, 2004 consisted of real estate-related loans, including construction loans, commercial real estate mortgage loans and residential mortgage loans. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Loan Portfolio." Moreover, our business activities are currently focused primarily in Hawaii, California and Washington, with the majority of our business concentrated in Hawaii. Consequently, our results of operations and financial condition are affected by the general trends in the Hawaii, California and Washington economies and, in particular, the commercial and residential real estate markets.

Our Subsidiaries

        On September 15, 2004, we completed our merger with CB Bancshares, Inc. CB Bancshares' subsidiaries, which became our wholly-owned subsidiaries, included City Bank, Datatronix Financial Services, Inc. and O.R.E., Inc. (dissolved effective December 31, 2004). In February 2005, Central Pacific Bank merged with City Bank, with Central Pacific Bank as the surviving entity. Datatronix offers item processing services to banks, thrifts, credit unions and other financial institutions in Hawaii and California.

        Other wholly-owned subsidiaries include CPB Capital Trust I, CPB Capital Trust II, CPB Statutory Trust III, CPB Capital Trust IV, CPB Statutory Trust V, CB Technology, Inc., ISL Capital Corporation, CPB Real Estate, Inc. ("CPBREI") and Citibank Properties, Inc. ("CPI").

        Our bank also owns 50% of Pacific Access Mortgage, LLC, a Hawaii limited liability corporation.

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Supervision and Regulation

General

        Bank holding companies and banks are extensively regulated under both federal and state law. This regulation is intended primarily for the protection of depositors and the Bank Insurance Fund and not for the benefit of our shareholders. Set forth below is a summary description of the material laws and regulations that relate to our operations. The description is qualified in its entirety by reference to the applicable laws and regulations.

Central Pacific Financial Corp.

        We are a registered bank holding company subject to regulation under the Bank Holding Company Act. We file with the Federal Reserve Board periodic reports and such additional information as the Federal Reserve Board may require. The Federal Reserve Board conducts examinations of us.

        Under Federal Reserve Board regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. We are also required by the Federal Reserve Board to maintain certain levels of capital. It is the Federal Reserve Board's policy that a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board's regulations or both.

        The Federal Reserve Board may require us to terminate an activity or terminate control of or liquidate or divest certain subsidiaries, affiliates or investments when the Federal Reserve Board believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of our banking subsidiary. Under certain circumstances, we must file written notice and obtain approval from the Federal Reserve Board prior to purchasing or redeeming our equity securities.

        We are required to obtain the prior approval of the Federal Reserve Board for the acquisition of more than 5% of the outstanding shares of any class of voting securities or substantially all of the assets of any bank or bank holding company. Prior approval of the Federal Reserve Board is also required for a merger or consolidation with another bank holding company.

        We are prohibited by the Bank Holding Company Act, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or furnishing services to our subsidiaries. However, subject to the prior notice or approval of the Federal Reserve Board, we may engage in any, or acquire shares of companies engaged in, activities that are deemed by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

        We are also a "financial institution holding company" as contemplated by Hawaii law. As such, we are subject to examination by, and may be required to file reports with, the Hawaii Commissioner of Financial Institutions.

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Central Pacific Bank

        Central Pacific Bank, as a Hawaii-chartered bank, is subject to primary supervision, periodic examination, and regulation by the Hawaii Commissioner of Financial Institutions and the FDIC. The bank is also subject to certain regulations promulgated by the Federal Reserve Board. If, as a result of an examination of the bank, the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of its operations are unsatisfactory or that it or its management is violating or has violated any law or regulation, various remedies are available to the FDIC. Such remedies include the power to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict its growth, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate its deposit insurance, which for a Hawaii-chartered bank would result in a revocation of its charter. The Hawaii Commissioner of Financial Institutions separately enjoys many of the same remedial powers.

Capital Standards

        The federal banking agencies have adopted risk-based minimum capital guidelines intended to provide a measure of capital that reflects the degree of risk associated with a banking organization's operations for both transactions reported on the balance sheet as assets and transactions which are recorded as off-balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off-balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk (such as cash), to 100% or more for assets with relatively high credit risk.

        The guidelines require a minimum ratio of qualifying total capital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital to risk-adjusted assets of 4%. In addition to the risk-based guidelines, federal banking regulators require banking organizations to maintain a minimum amount of Tier 1 capital to average assets, referred to as the leverage ratio. For a banking organization to qualify as "well-capitalized," the leverage ratio must generally be 5% at a minimum. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios. The Federal Reserve Board guidelines apply to us while the FDIC guidelines apply to Central Pacific Bank.

        As of December 31, 2004, our capital ratios and the capital ratios of Central Pacific Bank exceeded the minimum thresholds for a "well-capitalized" institution. City Bank, which was merged into Central Pacific Bank on February 22, 2005, maintained Tier 1 and leverage capital ratios that exceeded the thresholds for a "well-capitalized" institution and its total risk based capital ratio

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exceeded the threshold for an "adequately-capitalized" institution. The following table sets forth actual and required capital ratios as of December 31, 2004:

        The failure of our bank or us to maintain adequate capital could result in mandatory restrictions or prohibitions on our activities, including the ability to pay dividends.

USA PATRIOT Act of 2001

        We and our bank are subject to the USA PATRIOT Act of 2001, or the USA Patriot Act. Title III of the USA Patriot Act substantially broadens the scope of U.S. anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, defining new crimes and related penalties, and expanding the extra-territorial jurisdiction of the United States. The U.S. Treasury Department, or the Treasury, has issued a number of implementation regulations, which apply various requirements of the USA Patriot Act to financial institutions, and with which our bank must comply. These regulations also impose new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.

        Failure of a financial institution to comply with the USA Patriot Act's requirements could have serious legal and reputational consequences for the institution. We have adopted appropriate policies, procedures and controls to address compliance with the requirements of the USA Patriot Act under the

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existing regulations and will continue to revise and update its policies, procedures and controls to reflect changes required by the USA Patriot Act and the Treasury's regulations.

Employees

        At February 28, 2005, we employed 923 persons, 858 on a full-time basis and 65 on a part-time basis. We are not a party to any collective bargaining agreement.

Factors That May Affect Our Business

         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 of these risks occurs, our business, financial condition or results of operations could be materially and adversely affected.

         The costs of integrating our operations with CB Bancshares may be greater than we have anticipated, which could adversely affect our business and results of operations.

        We completed our merger with CB Bancshares on September 15, 2004. The aggregate costs of our merger with CB Bancshares may be greater than we have anticipated. We incurred charges to operations in the third and fourth fiscal quarters of 2004 to reflect costs associated with integrating our business and our operations with those of CB Bancshares. In addition, we will incur additional material charges in subsequent quarters to reflect additional costs associated with the merger. If these aggregate costs are greater than anticipated, they could adversely affect our business, results of operations and financial condition.

         Future results of the combined company may materially differ from the pro forma financial information previously disclosed.

        Future results of the combined company may be materially different from our expectations and the pro forma financial information statements previously disclosed, which only show a combination of our historical results with those of CB Bancshares. Merger-related charges may be higher or lower than we have estimated, depending upon how costly or difficult it is to integrate our two companies. Furthermore, these charges may decrease capital of the combined company that could be used for profitable, income-earning investments in the future.

         We may not realize the cost savings we have projected within the time periods we have projected, or to the full extent of our projections.

        We projected cost savings from the merger of $13 million in 2005, with $19 million fully phased in by 2006. Some assumptions on which we based our projections are no longer consistent with our business plan. For example, when we projected cost savings we expected to realize from the merger, we assumed that we would close CB Bancshares' loan production offices in California. However, we have subsequently decided to retain and expand such loan production offices. In addition, other assumptions on which we based our projections have become inapplicable. Accordingly, we may not achieve the cost savings we have projected or achieve them in a timely fashion.

         Integration of City Bank and Central Pacific Bank may prove more difficult or less advantageous than we anticipate.

        We merged City Bank and Central Pacific Bank and their operating systems on February 22, 2005. We may encounter unforeseen difficulties in integrating the banks, which could make the integration more costly than expected and adversely affect our business and results of operations. In addition, the consolidation of branches accompanying the merger of the banks may result in the loss of significant

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customer deposits and revenues. If the loss of customer deposits and revenues from branch consolidations exceeds our expectations, our business and results of operations could be harmed.

         Operations in our mainland loan production offices have positively affected 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.

        Sustaining the expansion of loan production on the mainland depends on a number of factors, including the continued strength of the mainland real estate markets. The strength of these real estate markets could be negatively affected by anticipated increases in interest rates and any economic downturn, and our results of operation could be negatively impacted.

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

        CB Bancshares commenced operations in its California loan production offices in the first quarter of 2003, and we commenced operations in our Washington loan production office in the fourth quarter of 2004. 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 mainland loan production offices in California and Washington are generally unseasoned, and defaults on such loans would adversely affect our financial condition, results of operations and prospects.

        At December 31, 2004, loans originated in our California and Washington loan production offices amounted to approximately $415.8 million, or 13% of our total loan portfolio. In light of the limited operating history of our mainland loan production offices described in the previous risk factor, 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. If the market for commercial property experiences a decline in demand, commercial borrowers may suffer losses on their projects and be unable to repay their loans. Defaults on these loans would negatively affect our financial condition, results of operations and prospects.

         The loans made by our mainland loan production offices in California and Washington are concentrated among a limited number of customers in California and Washington, 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 mainland 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. In addition, disruption of a lending customer relationship could adversely affect our ability to introduce the customer to our deposit products. 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.

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         Loan growth from our mainland 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 mainland 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 for more than 10 years. If some or all of our mainland loan officers, or the members of our senior management staff who coordinate mainland operations, were to leave our company, it could adversely affect the expansion of our mainland operations and our ability to grow loans.

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

        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. Deterioration in economic conditions, in particular an economic slowdown in Hawaii, California or Washington, could result in the following consequences, any of which could hurt our business materially:

•

loan delinquencies may increase;



•

problem assets and foreclosures may increase;



•

demand for our products and services may decline;



•

low cost or non-interest bearing deposits may decrease; and



•

collateral for loans made by us, especially real estate, may 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.

        Approximately 75% of our loan portfolio as of December 31, 2004 was comprised of loans collateralized by real estate. An adverse change in the economy affecting real estate values generally or in our primary markets specifically could 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, our profitability could be negatively impacted by an adverse change in the real estate market.

         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

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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.

         Our allowance for loan and lease losses may not be sufficient to cover actual loan losses, which could adversely affect our results of operations.

        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 securing the payment of these loans may be insufficient to assure repayment. 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 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;



•

results of examinations of our loan portfolios by regulatory agencies; and



•

management's internal review of the loan portfolio.

        We maintain an allowance for loan and lease losses in an attempt to cover loan losses inherent in our loan portfolio. Additional loan losses will likely occur in the future and may occur at a rate greater than we have experienced to date. 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. While we are not currently aware of any fact or circumstance that would cause our allowance to be inadequate, if our assumptions prove to be incorrect, our current allowance may not be sufficient. In addition, adjustments may be necessary to allow for unexpected volatility or deterioration in the local or national economy. Material additions to the allowance would materially decrease our net income. In addition, federal regulators periodically review our allowance for loan and lease losses 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 increase in our allowance or loan charge-offs as required by these regulatory agencies could have a material adverse effect on our results of operations.

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         An interruption in or breach in security of our information systems may result in a loss of customer business.

        We rely heavily on communications and information systems to conduct our business. Any failure or interruptions or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposits, servicing or loan origination systems. The occurrence of any failures or interruptions could result in a loss of customer business and have a material adverse effect on our results of operations and financial condition.

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 in 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 Federal Reserve Board. If we fail to comply with federal and state bank regulations, the regulators may limit our activities or growth, fine 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 or are less regulated. Federal and state bank regulatory agencies regulate many aspects of our operations. These areas include:

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the capital we must maintain;



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the kinds of activities we can engage in;



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the kinds and amounts of investments we can make;



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the locations of offices;



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how much interest we can be pay on demand deposits;



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



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how much cash we must set aside as reserves for deposits.