BANK OF HAWAII CORP annual report, FY2018

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Bank of Hawaii Corporation — 2018 Form 10-K

Reporting period: Fiscal year ended December 31, 2018; fourth-quarter results are also summarized. The company is a Hawaii-based bank holding company serving Hawaii, Guam, and other Pacific Islands through retail and commercial banking, investment services and private banking, and treasury activities.

Financial performance and condition

  • Full-year earnings: Net income was $219.6 million, up 19% from $184.7 million in 2017. Diluted EPS was $5.23, up 21% from $4.33. ROA was 1.29% and ROE was 17.63%, compared with 1.10% and 15.27%, respectively.
  • Revenue and margins: Net interest income was $486.4 million, up 6%; taxable-equivalent net interest margin increased 12 basis points to 3.05%. Total noninterest income fell 9% to $168.9 million, while noninterest expense rose 4% to $371.6 million. The efficiency ratio was 56.71%, versus 55.66%.
  • Taxes and credit costs: Income before taxes was $270.2 million, compared with $268.1 million. Tax expense fell 39% to $50.6 million, and the effective tax rate declined to 18.73% from 31.11%, principally reflecting the federal corporate tax rate reduction to 21%. Credit-loss provision was $13.4 million, down from $16.9 million.
  • Fourth quarter: Net income was $53.9 million and diluted EPS was $1.30, up 26% and 29%, respectively, from fourth-quarter 2017. Taxable-equivalent net interest margin was 3.10%, 12 basis points higher year over year.
  • Balance sheet: At year-end, assets were $17.14 billion, loans and leases $10.45 billion, deposits $15.03 billion, and shareholders’ equity $1.27 billion. Loans grew 7% and deposits 1% from 2017. Investment securities declined 11% to $5.50 billion as the company reduced holdings and redeployed proceeds toward loans.
  • Credit quality: Nonperforming assets declined 20% to $12.9 million; NPAs to loans and foreclosed real estate were 0.12%, versus 0.16%. The allowance for loan and lease losses was $106.7 million, or 1.02% of loans, compared with 1.10% a year earlier. Net charge-offs were $14.1 million, or 0.14% of average loans, versus $13.8 million, or 0.15%.
  • Cash flow and liquidity: Operating cash flow was $317.9 million, compared with $175.1 million in 2017; investing cash outflow was $74.7 million, versus $1.02 billion; financing cash outflow was $165.1 million, versus $415.0 million of inflow. Cash and cash equivalents ended at $526.0 million, up from $447.9 million. Management described liquidity as strong; available-for-sale securities were $2.0 billion, with additional borrowing capacity of $2.2 billion at the FHLB and $538.5 million at the Federal Reserve.
  • Debt and capital: Year-end repurchase agreements were $504.3 million and other debt was $135.6 million, primarily FHLB advances; short-term borrowings were immaterial. The Bank was well capitalized: CET1 ratio 12.46%, total capital ratio 13.61%, and leverage ratio 7.24%. The company’s corresponding ratios were 13.07%, 14.21%, and 7.60%.
  • Shareholder returns: Cash dividends paid were $98.5 million; share repurchases were $92.0 million. The annual dividend declared per share increased to $2.34 from $2.04. The stock closed at $67.32 at year-end, down from $85.70 at year-end 2017.

Material changes versus 2017

  • Earnings growth was driven primarily by lower tax expense and higher net interest income; pretax income increased only modestly.
  • Net interest income benefited from loan growth, a shift in earning-asset mix toward loans, and higher yields, partly offset by rising deposit costs.
  • Noninterest income weakened, including mortgage banking income down 35%, deposit service charges down 12%, and investment securities results shifting from a $10.4 million gain to a $3.9 million loss.
  • Consumer lending drove much of loan growth, notably automobile loans up 25%, alongside residential mortgage and home equity growth. Public and other deposits fell as the company reduced public time deposits.
  • Nonperforming assets improved, while the allowance-to-loans ratio declined as the loan portfolio expanded.

Outlook, commentary, risks, and unusual items

  • Outlook: The filing provides no formal earnings or revenue guidance. Management described Hawaii’s 2018 economy as healthy, supported by tourism, low unemployment, rising real estate prices, and active construction. Its stated strategy emphasizes customer service, growth balanced with risk management, and capital discipline.
  • Interest-rate exposure: Management’s year-end simulation estimated that a gradual 200-basis-point rise would increase next-12-month net interest income by 2.2%, while a gradual 100-basis-point decline would reduce it by 1.2%. An immediate 200-basis-point rise was estimated to increase it by 4.6%; an immediate 100-basis-point decline would reduce it by 3.5%. A flatter or inverted yield curve could reduce net interest income.
  • Notable items: The 2018 investment securities loss reflected fees related to prior Visa Class B share sales and a $1.0 million payment after Visa reduced its conversion ratio. Other income included a $2.8 million distribution from a low-income housing investment sale. The MyBankoh Rewards credit card portfolio was sold on November 1, 2018. The 2017 comparison included gains from Visa share sales.
  • Costs and legal matters: Salaries and benefits increased 5%; management cited merit and minimum-wage increases and higher self-insured medical costs. The company recorded $2.7 million in legal reserves during 2018 and disclosed two customer class-action lawsuits concerning overdraft practices; outcomes remain uncertain. Management said known matters were not expected to materially affect results beyond accrued amounts, but unexpected developments could be material.
  • Key risks: Results are concentrated in Hawaii and Pacific Island economies and sensitive to tourism, military spending, real estate and construction conditions, natural disasters, and weather. Other principal risks include interest rates and deposit competition, credit losses, regulation, cybersecurity and third-party system failures, litigation, and mortgage servicing or repurchase obligations.
  • Accounting changes: The company adopted revenue-recognition guidance in 2018 without material net-income impact. It adopted the lease standard on January 1, 2019, recording a $106.5 million operating-lease right-of-use asset and $113.4 million liability. Expected-credit-loss (CECL) guidance was planned for first-quarter 2020 adoption; management expected an effect on reserves but had not quantified it.
  • Audit and controls: Ernst & Young issued an unqualified opinion on the financial statements and internal control over financial reporting; management reported effective disclosure controls and internal controls.

Investor verification priorities

  • Assess whether net interest income and margin can withstand deposit-cost increases, weaker loan growth, or a flatter/inverted yield curve.
  • Review consumer credit performance, charge-offs, allowance coverage, and the effect of loan growth on reserve adequacy; evaluate the eventual CECL impact.
  • Separate recurring earnings from tax reform benefits, Visa-related losses, and the low-income housing distribution; monitor noninterest income and expense trends.
  • Examine securities unrealized losses and interest-rate sensitivity, particularly the mortgage-backed securities portfolio and its duration.
  • Track the overdraft litigation, mortgage repurchase and servicing exposure, and the sustainability of dividends and buybacks relative to capital and Bank dividend restrictions.