Bank of Hawaii Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; unaudited. Bank of Hawaii provides banking and financial services primarily in Hawaii, Guam, and other Pacific Islands.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $122.9 million | $116.3 million | $362.4 million | $338.5 million |
| Net interest margin | 3.07% | 2.92% | 3.04% | 2.91% |
| Provision for credit losses | $3.8 million | $4.0 million | $11.4 million | $12.7 million |
| Noninterest income | $41.5 million | $42.4 million | $126.8 million | $143.6 million |
| Noninterest expense | $90.5 million | $88.6 million | $275.7 million | $265.4 million |
| Income before income taxes | $70.1 million | $66.1 million | $202.1 million | $204.0 million |
| Net income | $56.9 million | $45.9 million | $165.7 million | $141.7 million |
| Diluted EPS | $1.36 | $1.08 | $3.93 | $3.32 |
Q3 net income rose 24% year over year; nine-month net income rose 17%. The nine-month increase occurred despite slightly lower pretax income, as the effective tax rate fell to 18.00% from 30.54%, mainly reflecting the federal corporate tax rate reduction under the Tax Act and other tax benefits. Q3 effective tax rate was 18.75%, versus 30.62%.
Balance sheet, liquidity, capital, and credit
- At September 30, total assets were $17.0 billion, loans and leases $10.2 billion, deposits $14.8 billion, and shareholders’ equity $1.25 billion. Loans grew $434 million (4%) from year-end 2017; deposits declined $41 million (less than 1%).
- Cash and cash equivalents were $335.0 million, down from $447.9 million at year-end. Nine-month cash flows were $209.4 million provided by operations, $72.9 million used in investing, and $249.4 million used in financing.
- Other debt was $185.7 million, including $175 million in FHLB advances and $10.7 million in capital lease obligations. FHLB advances declined $75 million after maturities. Repurchase-agreement funding was $504.3 million. Additional borrowing capacity was $2.2 billion from the FHLB and $558.9 million from the Federal Reserve, based on pledged collateral.
- Regulatory capital ratios remained well-capitalized: CET1 13.19%, Tier 1 13.19%, total capital 14.38%, and Tier 1 leverage 7.55%.
- Allowance for loan and lease losses was $108.7 million, or 1.06% of loans, compared with $107.3 million and 1.10% at year-end. Nonperforming assets fell to $13.8 million from $16.1 million; NPA ratio was 0.13%. Nine-month net charge-offs were $10.1 million, or 0.14% annualized.
Material changes and management commentary
- Management attributed stronger net interest income and margin to loan growth and a shift in earning assets from securities toward higher-yielding loans. Higher deposit costs partly offset asset-yield gains.
- Nine-month noninterest income decreased $16.7 million, primarily because 2017 included a $12.5 million gain from selling Visa Class B shares; 2018 included $3.1 million of net securities losses, including Visa-related fees and a $1.0 million charge following a conversion-ratio reduction. Mortgage banking income fell 39% year to date, primarily on lower conforming loan sales.
- Noninterest expense increased 4% year to date, including higher salaries, occupancy, equipment, and data-processing costs. A $2.0 million legal reserve was recorded in Q1 2018.
- Management described Hawaii’s economy as positive, citing tourism, construction, low unemployment, and a strong real-estate market. It characterized credit quality, reserves, liquidity, and capital as sound. The filing provides no quantified earnings or margin guidance.
- Management’s interest-rate simulation estimated that a gradual +200-basis-point move would raise next-12-month net interest income 2.0%, while a gradual -100-basis-point move would reduce it 1.2%; a flattening or inverted yield curve could reduce income. These are model estimates, not guidance.
Risks, contingencies, and notable items
- Loan exposure is concentrated in Hawaii and the Pacific Islands, including real estate lending; results are sensitive to local economic conditions and tourism. Hawaii municipal securities were $463.3 million, 57% of municipal holdings.
- Unrealized losses on investment securities increased with interest rates: gross losses were $159.8 million at September 30 versus $73.9 million at year-end. Management attributed losses primarily to rates, did not consider the securities other-than-temporarily impaired, and stated it did not intend or expect to be required to sell them before recovery.
- Commitments to extend credit totaled $2.91 billion; standby and commercial letters of credit brought total credit commitments to $2.99 billion. These amounts are not necessarily expected cash outflows.
- Mortgage representation-and-warranty exposure included $2.7 billion of sold residential loans outstanding. Six loans totaling $1.6 million were repurchased during the first nine months, with no material losses; there were no pending repurchase requests at quarter-end. Management had not recorded a repurchase-loss liability.
- Legal proceedings are in the ordinary course; management did not expect outcomes materially beyond recorded reserves, but noted unexpected developments could result in losses exceeding reserves. The filing reports no material change in previously disclosed risk factors.
- CECL adoption is expected to affect the reserve for credit losses; the amount of the impact was still under evaluation. New lease accounting was expected to increase reported assets and liabilities and affect regulatory capital ratios, but not materially affect income.
Most important facts for investors to verify
- Whether loan growth and improved net interest margin persist as deposit funding costs rise.
- Credit performance and reserve adequacy as the portfolio expands, particularly Hawaii real-estate and consumer exposures, and the eventual CECL impact.
- Whether securities valuation losses remain interest-rate-driven and whether liquidity or capital could be affected by any need to sell securities.
- How much earnings growth depends on the lower tax rate and other tax benefits versus underlying pretax operating performance.
- Future mortgage banking trends, Visa-related liabilities, legal matters, and the timing and scale of share repurchases and dividends.