Bank of Hawaii Corporation — Q3 2014 Form 10-Q
Business context and reporting period. Unaudited results cover the quarter and nine months ended September 30, 2014; comparisons are with the same 2013 periods unless noted. The Honolulu-based bank holding company serves Hawaii, Guam, and other Pacific Islands. Management described Hawaii’s economy as positive, citing stable tourism, expanding construction, low unemployment, and a strong real estate market.
Financial performance and condition
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net interest income | $95.4m | $90.9m | $283.0m | $266.8m |
| Noninterest income | $45.0m | $45.1m | $134.2m | $140.9m |
| Noninterest expense | $81.0m | $83.0m | $245.7m | $248.5m |
| Net income | $41.8m | $37.7m | $121.9m | $111.4m |
| Diluted EPS | $0.95 | $0.85 | $2.75 | $2.50 |
| Net interest margin | 2.85% | 2.83% | 2.86% | 2.81% |
| Efficiency ratio | 57.74% | 61.01% | 58.88% | 60.96% |
Balance sheet at September 30, 2014: Total assets were $14.51bn; loans and leases, $6.61bn; deposits, $12.36bn; shareholders’ equity, $1.06bn; and long-term debt, $173.9m. Repurchase-agreement borrowings were $700.2m. Loans grew 8% and deposits grew 4% from December 31, 2013. Cash and cash equivalents were $553.6m. The company reported additional borrowing capacity of $1.3bn from the FHLB and $640.3m from the Federal Reserve, subject to pledged collateral.
Credit and capital: The allowance for loan and lease losses was $110.4m, or 1.67% of loans, versus $115.5m, or 1.89%, at year-end 2013. Nonperforming assets declined to $33.3m from $39.7m; the nonperforming-assets ratio fell to 0.50% from 0.65%. Net charge-offs were $0.2m for the first nine months, compared with $5.2m in 9M 2013. The company reported a 15.32% Tier 1 capital ratio, 16.57% total capital ratio, and 7.19% Tier 1 leverage ratio, and said the company and bank were well capitalized.
Cash flow, nine months: Operating activities provided $133.7m; investing activities used $321.2m; financing activities provided $277.3m. Cash and cash equivalents increased $89.8m to $553.6m. Financing included $446.8m of net deposit growth, $46.9m of share repurchases, and $59.9m of dividends paid.
Material changes and management commentary
- Q3 net income rose 11% and diluted EPS rose 12%; 9M net income rose 9%. Higher net interest income, lower expenses, and negative provisions for credit losses supported earnings.
- Management attributed stronger net interest income and margin mainly to loan growth, a larger share of loans in earning assets, lower securities premium amortization, and slightly lower deposit costs.
- The provision for credit losses was a benefit of $2.7m in Q3 and $4.9m for 9M, versus no provision in the 2013 comparison periods. Management cited a reduced specific reserve for one commercial client and, year to date, commercial loan recoveries and improved credit trends.
- Noninterest income was broadly flat in Q3 but fell 5% for 9M. Mortgage banking income declined 60% in Q3 and 67% for 9M, reflecting lower refinancing and production and the decision to retain more conforming loans. Securities gains were $1.9m in Q3 and $6.1m for 9M, primarily from Visa Class B share sales.
- Visa gains are an unusual earnings contributor: the shares carry transfer and litigation-related conversion risks. A conversion-ratio reduction led to a $0.1m liability payable to a buyer. The company also donated Visa shares to its foundation, which favorably affected the effective tax rate.
- The declared dividend remained $0.45 per share for Q3. The board declared another $0.45 quarterly dividend in October, payable December 12, 2014. The company repurchased 811,235 shares during 9M for $46.9m and had $89.2m of repurchase authority remaining at September 30.
Outlook, risks, and contingencies
- The filing provides no specific earnings or financial guidance. Management stated that interim results are not necessarily indicative of full-year results.
- Management expected net interest income to benefit if rates rise under its modeled parallel-rate scenarios, but noted that a flattening or inverted yield curve could reduce it. A gradual 100-basis-point rise was modeled to increase annual net interest income by 0.5%; a gradual 100-basis-point decline was modeled to reduce it by 1.2%.
- Key stated risks include Hawaii tourism or economic weakness, interest-rate and securities-market changes, credit deterioration, competition, regulatory and capital requirements, litigation, cybersecurity and operational disruptions, and natural disasters. Residential land, home equity, aircraft leases, and neighbor-island exposures were identified as relatively higher risk; management said higher-risk balances had declined 20% since year-end.
- Mortgage representation-and-warranty exposure included $2.8bn of residential loans sold. Seven loans totaling $2.0m were repurchased during 9M with no losses; there were no pending representation-and-warranty repurchase requests at September 30. One $0.3m servicing-related repurchase request was pending. Management had not established a mortgage repurchase loss liability, citing historical request and loss experience.
- The company disclosed ordinary-course legal proceedings and said management did not expect outcomes to be materially in excess of accrued amounts based on information then available, while noting unexpected developments could be material. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of earnings growth is sustainable without the negative credit-loss provision and Visa share-sale gains?
- Whether loan growth, deposit mix, funding costs, and securities premium amortization continue to support net interest margin.
- Credit quality and reserve adequacy as loans grow, particularly for Hawaii real estate, residential mortgages, and aircraft-related exposures.
- Interest-rate sensitivity assumptions and the valuation and prepayment assumptions underlying mortgage servicing rights and securities.
- Capital and liquidity headroom as regulatory requirements phase in, and the pace of dividends and share repurchases.
- Developments in mortgage servicing or repurchase claims, Visa litigation and conversion terms, and other legal or regulatory matters.