BOH

Business Context and Reporting Period

Company: Bank of Hawaii Corporation (formerly Pacific Century Financial Corporation)

Reporting Period: Fiscal year ended December 31, 2002

Overview: The Company is a Delaware bank holding company with its primary subsidiary, Bank of Hawaii, headquartered in Honolulu. Operations focus on Hawaii and the Pacific Islands (Guam, American Samoa). In 2002, the Company completed the merger of its savings and loan subsidiary, First Savings, into the Bank. The year was characterized by the continued execution of a strategic plan to reduce credit risk, streamline operations, and divest non-core businesses (completed in 2001), while initiating a major Information Technology Systems Replacement Project (ITSRP).

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability: Net income increased 2.9% to $121.2 million, driven by a significant reduction in the Provision for Loan and Lease Losses ($11.6 million in 2002 vs. $74.3 million in 2001) and lower non-interest expenses. Diluted EPS rose 16.4%.
• Revenue: Net interest income declined 19.5% due to the 2001 divestitures and a managed reduction of the loan portfolio to improve asset quality. Non-interest income dropped 55.5%, primarily because 2001 included $173.4 million in gains from the sale of banking operations.
• Asset Quality: Significant improvement observed. Non-performing assets (NPAs) decreased 31.7% to $54.4 million (1.01% of total loans). Net charge-offs fell to $27.7 million (0.51% of average loans) from $121.4 million in 2001.
• Balance Sheet: Total assets decreased 10.5% to $9.52 billion as the Company reduced loan balances and loans held for sale. Long-term debt decreased 34% as the Company used proceeds from prior divestitures to pay down borrowings.
• Capital Management: The Company repurchased 11.8 million shares of common stock for $332.2 million in 2002. Shareholders' equity declined 18.5% due to these repurchases and dividends, offset partially by earnings.

Guidance, Outlook, and Risks

• 2003 Outlook: Management expects full-year 2003 net income of approximately $131 million. Earnings are projected to increase in the second half of 2003 following the completion of the IT systems conversion. No provision for loan losses is expected for 2003, though this remains subject to credit risk assessments.
• IT Systems Replacement Project (ITSRP): The Company entered a seven-year outsourcing agreement with Metavante Corporation. Costs incurred in 2002 were $13.6 million, with an additional $21.9 million expected in 2003. The project aims to reduce annual operating costs by approximately $17.0 million and reduce staffing by 250 employees.
• Key Risks:
  • Credit Risk: While overall asset quality improved, the airline industry remains a concern due to bankruptcies and rising fuel costs. The Company charged off $8.8 million related to a U.S. air carrier in Q4 2002.
  • Guam Exposure: Economic stress and damage from Super Typhoon Pongsona in December 2002 impacted the Guam portfolio ($431.5 million exposure). Management determined no additional provisioning was required at year-end.
  • Market Risk: Interest rate risk is managed via a Monte Carlo simulation model. A 200 basis point increase in rates is estimated to increase Net Interest Income by 7.66%.

Investor Verification Checklist

• Asset Quality Trends: Verify the stability of the low provision for loan losses ($11.6M) and the trend in non-performing assets, specifically monitoring the Guam portfolio and airline exposure.
• ITSRP Execution: Monitor the timeline and cost overruns of the IT outsourcing project, as delays could impact the projected $17 million in annual savings.
• Dividend Sustainability: Confirm the Bank's ability to pay dividends to the parent company, noting that special dividends in 2002 required regulatory approval and future dividends are tied to earnings.
• Continuing Business Performance: Review "Continuing Business" metrics (Net Income of $131.5M) to isolate core operational performance from one-time divestiture gains or restructuring costs.
• Capital Ratios: Verify that Tier 1 and Total Capital ratios remain well above regulatory minimums despite the reduction in equity from share repurchases.