Bank of Hawaii Corporation — Q3 2017 Form 10-Q
Business context and period. Unaudited results for the quarter and nine months ended September 30, 2017. The Honolulu-based bank provides financial services in Hawaii, Guam, and other Pacific Islands; lending is concentrated in Hawaii. Comparisons below are with Q3 or the first nine months of 2016, or with December 31, 2016 for balance-sheet figures. Dollar amounts are in millions unless noted.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $116.3 | $103.9 | $338.5 | $310.5 |
| Provision for credit losses | $4.0 | $2.5 | $12.7 | $1.5 |
| Noninterest income | $42.4 | $48.1 | $143.6 | $150.8 |
| Noninterest expense | $88.6 | $87.5 | $265.4 | $261.0 |
| Net income | $45.9 | $43.5 | $141.7 | $137.9 |
| Diluted EPS | $1.08 | $1.02 | $3.32 | $3.21 |
- Profitability: Q3 net interest margin was 2.92%, up 12 basis points year over year; nine-month margin was 2.91%, up 7 basis points. Q3 return on average assets was 1.07% and return on average equity 14.89%; nine-month figures were 1.14% and 15.77%. The efficiency ratio was 55.82% for Q3 and 55.05% year to date.
- Balance sheet at September 30: Total assets were $17.27 billion, loans and leases $9.57 billion, deposits $15.05 billion, shareholders’ equity $1.23 billion, and cash and cash equivalents $761.5 million. Loans grew 7% and deposits 5% from year-end 2016, with loan growth primarily in consumer lending.
- Credit quality: Allowance for loan and lease losses was $106.9 million, 1.12% of loans, versus $104.3 million and 1.17% at year-end. Nonperforming assets were $17.0 million, down from $19.8 million; nonaccrual loans were 0.16% of loans. Nine-month net charge-offs were $10.0 million, compared with $0.3 million in 2016, when a large commercial recovery benefited results.
- Debt and liquidity: Repurchase-agreement borrowings were $505.3 million and other debt $267.9 million. The company reported $2.0 billion of additional FHLB borrowing capacity and $676.5 million from the Federal Reserve based on pledged collateral. Available-for-sale securities had a carrying value of $2.3 billion.
- Capital and distributions: Regulatory capital ratios included a 13.27% Common Equity Tier 1 ratio, 14.51% total capital ratio, and 7.24% Tier 1 leverage ratio; the company said it was well-capitalized. Nine-month dividends paid were $64.9 million and stock repurchases cost $36.4 million. The board authorized an additional $100 million of repurchases on October 20, 2017.
- Cash flows, nine months: Operating activities provided $146.4 million; investing activities used $875.0 million; financing activities provided $610.6 million. Cash and cash equivalents declined $118.1 million to $761.5 million.
Material changes and management commentary
- Net income rose 5% in Q3 and 3% for the first nine months. Management attributed the increase chiefly to higher net interest income, reflecting loan growth, a larger share of higher-yielding loans in earning assets, and improved margin.
- Noninterest income fell 12% in Q3 and 5% year to date. Mortgage banking income declined 49% in Q3 and 24% year to date, primarily because of lower loan sales and margins. Other income also declined, including from lower customer swap fees and, year to date, lower gains on leased-asset sales.
- Year-to-date net securities gains included a $12.5 million gain on the sale of Visa Class B shares. Q3 salary and benefit expense included $2.1 million of separation expense; year-to-date salary and benefit expense also rose with merit increases.
- The reported increase in the year-to-date credit provision reflects the 2016 comparison, which included a substantial recovery of a previously charged-off commercial loan. Consumer net charge-offs, particularly in automobile and installment lending, were higher in 2017.
- Management described Hawaii’s economy as positive, citing strong tourism, construction, real estate, and low unemployment. Its interest-rate simulation estimated that a gradual 200-basis-point increase could raise annual net interest income by 3.2%, while a 100-basis-point decline could reduce it by 1.8%; modeled outcomes depend on assumptions and are not forecasts.
Outlook, risks, and unusual items
- The filing provides no specific earnings or revenue guidance. Management said interim results are not necessarily indicative of full-year or future results.
- Key stated risks include changes in Hawaii’s economy and tourism, interest rates and net interest margin, credit quality and reserves, competition, regulation and capital or liquidity requirements, litigation, cybersecurity and operational disruptions, and natural disasters or adverse weather.
- Credit commitments totaled $2.93 billion, including $2.79 billion of unfunded commitments to extend credit; these amounts are not necessarily future cash requirements because commitments may expire undrawn. The company also had $26.5 million in unfunded affordable-housing partnership commitments.
- Management reported pending and threatened legal proceedings in the ordinary course and said expected outcomes were not materially in excess of reserves, while noting unexpected developments could produce materially greater losses. Mortgage loan representation-and-warranty exposure included $2.7 billion of sold loans; there were no pending repurchase requests at quarter-end.
- Management concluded investment securities in unrealized loss positions were not other-than-temporarily impaired, attributing losses primarily to interest-rate changes rather than credit quality. The company reported an immaterial prior-period cash-flow presentation correction that did not affect income or balance-sheet statements.
- Accounting changes to monitor include CECL, which management expects to affect the financial statements, particularly credit-loss reserves, but whose impact remained under evaluation; and the lease standard, which management expects to increase recognized assets and liabilities and affect regulatory capital ratios. No material impact was expected from the pending revenue-recognition standard.
Important facts for investors to verify
- Whether loan growth, deposit pricing, and the shift toward higher-yielding loans can sustain net interest margin as funding costs change.
- Drivers of the higher provision and consumer charge-offs, and the adequacy of the allowance relative to portfolio growth and credit trends.
- Whether lower mortgage sales and margins persist, and how much reported earnings rely on episodic securities gains, including Visa share sales.
- Actual liquidity and capital effects of deposit mix changes, repurchase-agreement funding, and adoption of the lease and CECL standards.
- Developments in Hawaii’s tourism and property markets, mortgage servicing and repurchase exposures, legal contingencies, and the timing and scale of future repurchases.