Bank of Hawaii Corporation — Q2 2012 Form 10-Q
Reporting period: Unaudited quarter and six months ended June 30, 2012; comparisons are with the corresponding 2011 periods unless noted. The company is a bank holding company serving Hawaii, Guam, and other Pacific Islands.
Financial performance and condition
- Q2 earnings: Net income was $40.7 million, up 16%; diluted EPS was $0.90, up from $0.74. For the first six months, net income was $84.6 million, up 9%, and diluted EPS was $1.85 versus $1.62.
- Revenue and expenses: Q2 net interest income was $95.4 million, down 2%, and noninterest income was $46.8 million, down 5%. Noninterest expense fell 14% to $80.7 million. Six-month net interest income was $193.3 million, noninterest income $94.9 million, and noninterest expense $166.0 million.
- Margins and returns: Net interest margin was 2.98% in Q2 and 3.02% for the first half, each down 18 basis points year over year. Q2 return on average assets was 1.19%, return on average equity 16.19%, and efficiency ratio 56.77%.
- Credit costs: Q2 provision for credit losses was $0.6 million versus $3.6 million; first-half provision was $1.0 million versus $8.3 million. First-half net charge-offs were $7.1 million, down from $10.7 million.
- Cash flow: First-half operating cash flow was $95.6 million, investing cash outflow $145.0 million, and financing cash inflow $13.7 million. Cash and cash equivalents ended the period at $634.2 million, down $35.7 million from year-end.
- Balance sheet and liquidity: Total assets were $13.92 billion, up modestly from $13.85 billion at December 31, 2011. Deposits rose 9% to $11.55 billion; loans and leases rose 2% to $5.67 billion. Cash and cash equivalents were $634.2 million and available-for-sale securities were $3.34 billion.
- Debt and capital: Repurchase-agreement funding fell 45% to $1.07 billion, mainly as public entities shifted balances into time deposits. Long-term debt was $28.1 million. Shareholders’ equity was $1.00 billion. The company reported a 16.41% Tier 1 capital ratio, 17.67% total capital ratio, and 6.57% Tier 1 leverage ratio; the company and bank were described as well capitalized.
- Credit quality: Allowance for loan and lease losses was $132.4 million, or 2.34% of loans, versus $138.6 million and 2.50% at year-end. Nonperforming assets were $41.5 million versus $40.8 million; nonaccrual loans were 0.69% of loans. Total troubled-debt restructurings were approximately $40.0 million.
Material changes versus prior periods
- Earnings improved despite lower net interest income and noninterest income, supported by lower credit provisions and operating expenses. The expense comparison benefited from a $9.0 million overdraft-litigation settlement accrual in Q2 2011.
- Mortgage banking income increased to $7.6 million in Q2, primarily reflecting higher refinancing originations and favorable movements in mortgage-related derivative fair values. First-half originations increased 44% to $585.7 million.
- Debit card income declined materially following Durbin Amendment interchange pricing limits: down 49% in Q2 and 48% for the first half.
- Lower asset yields reduced net interest margin, partly offset by lower deposit funding costs. Residential mortgage balances grew, while commercial loans and leases declined.
- The deposit increase was largely matched by lower repurchase-agreement balances as local government entities shifted funding to time deposits.
Outlook, commentary, and risks
- Management described Hawaii’s economy as stable and generally improving, citing stronger tourism, but remained cautious about the recovery, interest rates, and loan demand. Loan growth may improve in some portfolios if conditions remain stable.
- For the remainder of 2012, management emphasized expense control and maintaining adequate liquidity, credit reserves, and capital. It warned that Durbin-related effects were expected to significantly reduce 2012 debit card income. Management said the allowance could decline in future periods if credit quality and economic conditions remain stable.
- Key risks include interest-rate and margin pressure, Hawaii tourism and local economic conditions, credit deterioration in residential home building, land, home equity, air transportation leases and neighbor-island exposures, regulatory and compliance costs, operational and cybersecurity disruptions, and litigation. The filing identifies no material change to the prior annual report’s risk factors.
- Interest-rate simulations indicated that a gradual 100-basis-point decline could reduce annual net interest income by 2.4%; an immediate 100-basis-point decline could reduce it by 7.1%. Rising rates were modeled to increase income, while a flattening or inverted yield curve could be adverse.
- Mortgage-loan representation-and-warranty exposure included two repurchases in the first half with $0.7 million unpaid principal and no losses; there were no pending repurchase requests at June 30. Other legal proceedings remain subject to ordinary-course contingency assessment.
- Unusual items included a $3.5 million first-quarter pretax gain from early buyouts of two cargo-ship leveraged leases and a $1.0 million pretax loss on an aircraft-lease sale and termination. The prior-year overdraft settlement was finally approved in February 2012 and refunds were paid by April.
- No numerical full-year earnings guidance was provided. The filing notes that interim results are not necessarily indicative of full-year results. The board approved an additional $75 million of share-repurchase authority in July; a $0.45 quarterly dividend was also declared.
Important facts for investors to verify
- Whether declining net interest margin and Durbin-related fee pressure are offset by deposit pricing, loan growth, or expense actions.
- Trends in nonperforming assets, charge-offs, troubled restructurings, higher-risk loan exposures, and the adequacy of the allowance.
- The composition and stability of deposit growth, including public time deposits, and the funding and maturity profile of repurchase agreements.
- Mortgage-banking earnings’ dependence on refinancing volumes, derivative fair values, and servicing-right assumptions.
- Capital and liquidity capacity under evolving Basel III and stress-testing requirements, alongside planned dividends and share repurchases.
- Potential exposure from mortgage-loan representations and warranties, servicing obligations, and other legal contingencies.