Bank of Hawaii Corporation — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010. Unaudited consolidated results. The company provides banking and financial services in Hawaii, Guam, and other Pacific Islands.
Financial performance and condition
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net interest income | $103.9m | $102.9m | $211.6m | $199.9m |
| Provision for credit losses | $15.9m | $28.7m | $36.7m | $53.6m |
| Noninterest income | $68.9m | $59.8m | $140.7m | $130.2m |
| Noninterest expense | $85.9m | $89.6m | $167.6m | $177.5m |
| Net income | $46.6m | $31.0m | $99.3m | $67.0m |
| Diluted EPS | $0.96 | $0.65 | $2.05 | $1.40 |
- Q2 net interest margin was 3.51%, down from 3.73%; the six-month margin was 3.61%, down from 3.75%. The efficiency ratio improved to 49.72% in Q2 from 55.07% and to 47.59% for the first half from 53.78%.
- At June 30, total assets were $12.86bn, loans and leases $5.44bn, deposits $9.32bn, and shareholders’ equity $1.01bn. Loans declined 6% from year-end and 12% year over year; deposits were down 1% from year-end but up 3% year over year.
- Cash and cash equivalents were $703.5m at June 30. For the first half, operating cash flow was $96.3m, investing cash flow was negative $238.8m, and financing cash flow was positive $290.9m.
- Long-term debt was $40.3m, down $50.0m from year-end after repayment of an FHLB advance. Repurchase-agreement funding was $2.08bn, up $462.7m from year-end, primarily reflecting placements for local government entities.
- The allowance for loan and lease losses was $147.4m, or 2.71% of loans, versus 2.49% at year-end. Nonperforming assets were $43.2m, down $5.1m from year-end. Net charge-offs were $14.9m in Q2 and $33.0m for the first half.
- Capital strengthened: Tier 1 capital ratio was 16.92%, total capital ratio 18.19%, and leverage ratio 7.09%. The company and Bank were classified as well capitalized.
Changes versus prior periods
- Net income rose 50% in Q2 and 48% in the first half. Management attributed improvement to lower funding costs, reduced credit-loss provision, and larger gains on investment-security sales.
- Investment-security gains were $15.0m in Q2 and $35.0m for the first half, compared with less than $0.1m in each corresponding 2009 period. These gains materially contributed to reported noninterest income and earnings.
- Loan balances and average loan balances contracted amid paydowns and weak demand. Average loans fell 12% year over year in both Q2 and the first half. Lower funding costs were partly offset by lower asset yields, contributing to margin compression.
- Mortgage banking income declined 31% in Q2 and 49% in the first half, reflecting lower origination and refinancing activity. Q2 residential mortgage originations fell 53% year over year.
- Credit provisions fell year over year, reflecting lower net charge-offs and somewhat improving conditions. However, residential mortgage nonaccruals increased from year-end, and management expected NPAs could rise near term as real-estate loan resolutions take time.
Outlook, commentary, risks, and unusual items
- Management gave no quantified earnings or revenue guidance. For the remainder of 2010, it said it would focus on asset quality, reserves, capital, liquidity, and customer opportunities. It considered further allowance increases potentially unnecessary based on current projections, but cautioned that future events could require additional reserves.
- Management described Hawaii’s economy as slightly improved in Q2: visitor arrivals improved and spending appeared stable, while job growth remained weak and construction activity low. It cited continued uncertainty and market volatility.
- Credit risks included residential homebuilding and land, home equity, and air-transportation leases. Management noted that air carriers faced pressure from fuel costs, pension obligations, weak demand, and limited pricing power. Real-estate resolution delays were also a concern.
- Interest-rate sensitivity had shifted to asset-sensitive. Management’s simulation estimated quarterly net interest income changes of +0.9% for a 200-basis-point rate increase and -1.5% for a 100-basis-point decrease. It identified falling rates as its greatest exposure; the filing cautions that these model estimates depend on assumptions.
- The company planned to resume share repurchases in Q3 2010, subject to market conditions and other factors; timing and amount were not assured. The Q2 dividend remained $0.45 per share, and the board declared another $0.45 quarterly dividend in July.
- The Dodd-Frank Act was signed into law on July 21, 2010. Management said the effect of the resulting rules was difficult to predict and could raise compliance costs. New overdraft opt-in rules and potential debit-card interchange regulation could also affect fee income.
- Unusual or nonrecurring influences included a $3.3m Q2 accrual for cash grants to purchase company stock; lower FDIC expense versus 2009, which included a $5.7m industry assessment; and prior-year gains from leveraged-lease and insurance-business transactions. A $1.2m gain from a railcar lease interest sale partially offset Q2 other-income declines.
- Credit commitments totaled $2.08bn, including $1.96bn of unfunded lending commitments; these amounts are not necessarily future cash requirements because commitments may expire undrawn. The filing reported no material change in contractual obligations from the 2009 annual report.
Most important facts for investors to verify
- How much earnings growth persists after excluding the $35.0m first-half investment-security gains and other unusual items.
- Whether loan quality and charge-offs continue to improve, particularly in residential mortgages, home equity, real estate development, and air-transportation exposures.
- Whether the 2.71% allowance remains adequate as NPAs and local economic conditions evolve.
- Funding and liquidity implications of increased repurchase-agreement balances, including their maturities, collateral, and rate sensitivity.
- The realized effect of lower loan demand, margin compression, and new consumer-finance and interchange rules on future revenue and earnings.
- Whether the planned Q3 share repurchases proceed and how they affect capital, alongside the declared dividend.