Bank of Hawaii Corporation — Q2 2013 Form 10-Q Summary
Business context and reporting period
Unaudited quarterly report for the three and six months ended June 30, 2013. Bank of Hawaii Corporation is a Honolulu-based bank holding company serving Hawaii, Guam, and other Pacific Islands. Comparisons below are with Q2 or the first six months of 2012, as applicable; balance-sheet comparisons are with December 31, 2012. Amounts are in U.S. dollars.
Financial performance and condition
- Q2 earnings: Net income was $37.8 million, down 7%; diluted EPS was $0.85, versus $0.90. For the first half, net income was $73.7 million, down 13%, and diluted EPS was $1.65, versus $1.85.
- Income and margins: Q2 net interest income was $87.3 million, down 8%, and net interest margin was 2.77%, down 21 basis points. First-half net interest income was $175.9 million, down 9%, with a 2.80% margin, down 22 basis points. Total noninterest income rose 3% to $48.0 million in Q2 and 1% to $95.8 million in the first half. Noninterest expense rose 1% to $81.2 million in Q2 and declined slightly to $165.6 million for the first half.
- Drivers: Lower loan and securities yields and reinvestment at lower rates weighed on net interest income. Q2 mortgage banking income fell 23% to $5.8 million, primarily due to higher rates reducing conforming loan production and margins. Trust and asset management income increased 8% to $12.1 million. Other Q2 income benefited from higher gains on leased asset sales.
- Credit: No provision for credit losses was recorded in the first half, compared with $1.0 million in the first half of 2012. The allowance was $124.6 million, or 2.13% of loans, versus $128.9 million, or 2.20%, at year-end. First-half net charge-offs were $4.3 million, down from $7.1 million. Nonperforming assets were $36.4 million, slightly below $37.1 million at year-end; nonaccrual loans were 0.57% of loans.
- Balance sheet and funding: Total assets were $13.73 billion, essentially unchanged from year-end. Loans and leases were $5.86 billion, also little changed; commercial lending growth was offset by lower consumer lending. Deposits were $11.45 billion, down $80.3 million. Repurchase-agreement funding increased $107.3 million to $866.2 million, and long-term debt rose $46.7 million to $174.7 million, mainly reflecting a $50 million FHLB advance at 0.60%, maturing in February 2016.
- Liquidity and capital: Cash and cash equivalents were $470.9 million at June 30. Management reported additional borrowing capacity of $1.0 billion from the FHLB and $679.3 million from the Federal Reserve, based on pledged collateral. The company was considered well capitalized; its Tier 1 capital ratio was 15.53%, total capital ratio 16.79%, and Tier 1 leverage ratio 6.95%. Shareholders’ equity was $986.4 million, down $35.3 million from year-end.
- Cash flow: First-half operating cash flow was $121.9 million, investing cash flow was negative $23.7 million, and financing cash flow was positive $19.9 million. Cash and cash equivalents increased $118.1 million from the start of the period to $470.9 million.
- Shareholder returns: The company declared $0.45 per share in dividends for each quarter; first-half dividends paid totaled $40.4 million. It repurchased $24.0 million of stock during the first half. The board declared another $0.45 quarterly dividend in July 2013.
Material changes and unusual items
- Rising market interest rates drove a substantial decline in investment-security fair values. First-half other comprehensive loss was $55.9 million after tax, primarily reflecting a $47.3 million after-tax decrease in available-for-sale securities. Gross unrealized losses on temporarily impaired securities rose to $83.7 million from $3.8 million at year-end. Management attributed losses primarily to interest-rate changes, not credit deterioration, and said it did not expect to sell the affected securities before recovery.
- During Q2, approximately $255 million of available-for-sale securities were transferred to held-to-maturity. Related after-tax unrealized losses of approximately $5.1 million remain in accumulated other comprehensive income and will be amortized over the securities’ estimated lives.
- The first-half 2012 comparison included a $3.5 million pretax gain from an early buyout of two cargo-ship leveraged leases and a related $2.7 million tax benefit. Q2 2013 income taxes included a $1.1 million benefit from releasing reserves after completion of a state tax audit.
- The company recorded a $0.5 million increase in its reserve for unfunded commitments. Total credit commitments were $2.33 billion, including $2.26 billion of unfunded commitments to extend credit; these amounts are not necessarily expected cash outflows.
Outlook, commentary, and risks
Management described Hawaii’s economy and credit trends as improving, citing tourism growth and lower credit losses. It said that, if the economy and credit quality remain stable or improve, the allowance could decline further. No specific full-year earnings or revenue guidance was provided.
Management remained cautious about interest rates, economic conditions, regulation, and net interest margin pressure. Continued rate increases could reduce mortgage applications and refinancing activity, lower mortgage banking income, and further reduce the fair value of available-for-sale securities and capital. The filing’s rate-sensitivity analysis estimated that a gradual +200-basis-point move would increase annual net interest income by 1.4%, while a gradual -100-basis-point move would reduce it by 1.5%; outcomes depend on model assumptions, and a flatter or inverted yield curve could reduce income.
Highlighted credit concerns include residential land loans, certain home-equity loans, air-transportation leases, and neighbor-island exposures. The company also cited regulatory and compliance costs, operational and cybersecurity risks, litigation, and possible mortgage-loan repurchase claims. Four residential mortgage loans totaling $1.5 million were repurchased in the first half without losses; one $0.5 million repurchase request was pending at June 30. Management reported no pending repurchase requests related to servicing activities and no direct exposure to European sovereign governments.
Important facts for investors to verify
- Whether net interest margin and asset yields stabilize, and how further rate changes affect securities values, capital, and mortgage banking.
- Whether credit quality continues to improve enough to support a lower allowance, especially given higher-risk loan categories, nonperforming assets, and rising TDR balances.
- The composition, repricing, maturity, and collateral requirements of repurchase-agreement funding and the new FHLB advance.
- Whether mortgage repurchase claims or servicing-related obligations increase beyond the limited amounts reported.
- The actual effects of Basel III capital rules and required stress testing; management said it was still evaluating the new capital rules.
- The sustainability of dividends and share repurchases relative to earnings, capital needs, and the effects of accumulated securities losses.