BANK OF HAWAII CORP quarterly report, Q3 FY2019

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Bank of Hawaii Corporation — Q3 2019 Form 10-Q

Business context and reporting period

Bank of Hawaii Corporation is a bank holding company headquartered in Honolulu, serving consumers, businesses, and governments in Hawaii, Guam, and other Pacific Islands. This unaudited filing covers the quarter and nine months ended September 30, 2019; balance-sheet comparisons are with December 31, 2018 unless noted.

Financial results and condition

  • Third-quarter earnings: Net income was $52.1 million, down 9% from $56.9 million; diluted EPS was $1.29 versus $1.36. Net interest income increased 2% to $124.9 million, while net interest margin declined to 3.01% from 3.07%. Noninterest income rose 12% to $46.5 million, but noninterest expense increased 11% to $100.3 million.
  • Nine-month earnings: Net income was $167.8 million, up 1%; diluted EPS rose 5% to $4.11. Net interest income increased 3% to $373.8 million and net interest margin was 3.05% versus 3.04%. Noninterest income rose 7% to $135.6 million and noninterest expense rose 4% to $286.1 million.
  • Revenue and costs: Mortgage banking income increased 148% in Q3 to $4.9 million and 67% for the nine months to $10.5 million, mainly from higher conforming loan sales. Deposit interest expense increased to $18.1 million in Q3 from $10.9 million, contributing to margin pressure. The Q3 effective tax rate was 22.08%, compared with 18.75%.
  • Balance sheet: Total assets were $17.7 billion; loans and leases were $10.9 billion, up 4%; deposits were $15.3 billion, up 2%. Shareholders’ equity was $1.29 billion. Cash and cash equivalents were $370.9 million, compared with $526.0 million at year-end.
  • Cash flow, nine months: Operating activities provided $152.7 million, investing activities used $515.8 million, and financing activities provided $207.9 million. Cash and cash equivalents declined by $155.1 million.
  • Debt and liquidity: Other debt was $110.6 million, including $100 million of FHLB advances. Repurchase-agreement borrowings were $604.3 million, up $100 million. The company reported unused borrowing capacity of $2.4 billion at the FHLB and $549.9 million at the Federal Reserve. Management described liquidity and capital as strong.
  • Capital and distributions: The company remained well-capitalized. Common Equity Tier 1 and total capital ratios were 12.33% and 13.44%, respectively; the Tier 1 leverage ratio was 7.32%. During the first nine months, it paid $78.5 million in dividends and repurchased $107.9 million of stock. The board declared a subsequent quarterly dividend of $0.67 per share, payable December 13, 2019.

Material changes versus comparable periods

  • Q3 net income declined primarily because of a $6.0 million increase in legal reserves for a tentative overdraft-practices class-action settlement, higher salaries and benefits, and higher income taxes. Higher mortgage banking and customer interest-rate-swap fee income and higher net interest income partly offset these costs.
  • Nine-month net income increased modestly as higher net interest income, mortgage banking income, and lower FDIC insurance expense were partly offset by higher compensation, the legal reserve, and higher taxes. A one-time insurance commission also supported noninterest income.
  • Nonperforming assets increased to $21.6 million from $12.9 million; nonaccrual loans rose to $18.7 million from $11.6 million. The increase was primarily in commercial mortgage nonaccrual loans. The allowance for loan and lease losses was $108.9 million, or 1.00% of loans, versus $106.7 million, or 1.02%, at year-end. Nine-month net charge-offs fell to $9.0 million from $10.1 million.
  • On June 10, the company reclassified $1.0 billion of prepayable debt securities from held-to-maturity to available-for-sale, with a $3.1 million net unrealized gain. It also repositioned the securities portfolio, including reducing municipal and certain mortgage-backed securities.

Outlook, risks, contingencies, and unusual items

  • Outlook: No quantified earnings or financial guidance is provided. Management described Hawaii’s economy as positive but expected a more modest growth rate. Unemployment in Hawaii was 2.7% in September; visitor arrivals increased while visitor spending declined in the reported periods.
  • Interest-rate sensitivity: The company’s simulation estimated that a gradual 100-basis-point rate increase would raise annual net interest income by 1.6%, while a 100-basis-point decrease would reduce it by 1.7%. An immediate 100-basis-point increase or decrease was estimated to change net interest income by +4.4% or -5.5%, respectively. A flatter or inverted yield curve could reduce net interest income.
  • Credit-loss accounting: The company planned to adopt CECL in Q1 2020 and expected it to affect the reserve for credit losses; the potential amount was still being evaluated. The filing identifies portfolio composition and economic conditions at adoption as relevant factors.
  • Legal contingency: A tentative settlement of the overdraft class action contemplated an $8.0 million payment, subject to documentation and court approval. The company increased its reserve to $8.0 million as of September 30. Other legal matters remain subject to uncertainty.
  • Other risks: The filing highlights Hawaii tourism and economic conditions, interest-rate and funding-cost changes, competition, operational and cybersecurity incidents, litigation, regulatory change, natural disasters, and the transition away from LIBOR. The company had LIBOR-linked loans and derivatives; LIBOR’s future availability was uncertain.
  • Unusual items: Q3 investment-security losses included fees related to prior Visa Class B share sales and a $0.5 million liability after Visa reduced its conversion ratio. A $0.2 million impairment charge was recorded on equipment held for sale. The company adopted lease accounting in 2019, recognizing operating lease right-of-use assets of $101.0 million and liabilities of $108.3 million; management said the adoption did not materially affect income or cash flows.

Important facts for investors to verify

  • Whether the overdraft class-action settlement received court approval and whether the $8.0 million reserve fully covers the settlement and related costs.
  • Trends in commercial mortgage nonaccruals and nonperforming assets, and the adequacy of credit reserves as CECL adoption approaches.
  • Whether deposit pricing and funding costs continue to pressure net interest margin, particularly if rates or the yield curve change.
  • The realized effects of the securities portfolio repositioning, including any further Visa-related conversion-ratio liabilities.
  • Future capital distributions, share repurchases, and capital ratios relative to asset growth and regulatory requirements.