BOH

Business Context and Reporting Period

Company: Pacific Century Financial Corporation (Parent of Bank of Hawaii Corp)

Filing Type: Form 10-Q (Unaudited)

Reporting Period: Quarter and six months ended June 30, 1998

Overview: Pacific Century is a financial holding company with operations primarily in Hawaii, the Pacific, Asia, and the U.S. Mainland. The period was marked by a significant restructuring plan, increased loan loss provisions due to the Asian financial crisis, and the acquisition of Banque Paribas interests in New Caledonia and French Polynesia.

Key Financial Metrics

Performance Ratios (6 Months 1998):

• Return on Average Assets (ROAA): 0.50%
• Return on Average Equity (ROAE): 6.53%
• Net Interest Margin: 4.25%
• Efficiency Ratio: 70.7% (Excluding restructuring charge: 65.7%)

Material Changes vs. Prior Period

• Earnings Decline: Net income for the six months ended June 30, 1998, dropped 47.8% compared to the prior year. This was driven by a $19.4 million pre-tax restructuring charge and a $47.9 million increase in the provision for loan losses.
• Loan Loss Provisions: The provision for loan losses surged to $60.3 million for the first half of 1998 (vs. $12.4 million in 1997). Gross charge-offs totaled $50.1 million, with $26.2 million attributed to foreign loans, largely due to the Asian economic crisis (Thailand and Indonesia).
• Restructuring Charge: A one-time charge of $19.4 million was recognized in Q2 1998 related to the merger of First Federal Savings and Loan Association of America with Bank of Hawaii, the consolidation of U.S. Mainland banks, and branch closures.
• Acquisitions: In May 1998, the company acquired Group Paribas' interest in Banque Paribas Pacifique and Banque Paribas Polynesie, adding approximately $304 million in assets.
• Non-Performing Assets (NPAs): NPAs rose to $139.3 million (1.47% of total loans) from $97.1 million (1.02%) at year-end 1997, driven by increases in foreign and commercial loan categories.

Guidance, Outlook, and Risks

Management Commentary: Management attributes the earnings decline to the restructuring initiative and the Asian financial crisis. The restructuring plan aims to achieve annualized pre-tax expense reductions of approximately $22 million over two years. The company remains focused on the Asia-Pacific region but is closely monitoring credit exposure in countries affected by the crisis.

Risks and Contingencies:

• Asian Economic Crisis: Continued volatility in Thailand, Indonesia, and South Korea poses credit risk. The company has increased loan loss reserves in response.
• Hawaii Economy: Weak economic growth in Hawaii, exacerbated by reduced Asian tourism spending, impacts local lending performance.
• Year 2000 (Y2K) Compliance: The company estimates incremental costs of approximately $30 million to address Y2K issues. Cumulative costs through June 30, 1998, were $8.9 million. Management aims to have critical systems compliant by December 31, 1998.
• Market Risk: The company is exposed to interest rate and foreign currency risks. A 200 basis point rise in interest rates would decrease net interest income by 1.8%.

Investor Verification Checklist

• Restructuring Progress: Verify the timeline and cost realization of the announced branch closures and bank mergers.
• Asian Credit Exposure: Monitor the specific status of non-performing loans in Thailand and Indonesia and the adequacy of the loan loss reserve.
• Y2K Costs: Track actual spending against the $30 million estimate and the status of vendor compliance.
• Deposit Stability: Assess the trend in domestic deposits, which declined slightly year-over-year, amidst competitive pressures.
• Capital Ratios: Confirm that regulatory capital ratios (Total Capital 11.66%, Tier 1 9.56%) remain well above the "well-capitalized" thresholds despite the earnings hit.