Bank of Hawaii Corporation — Q2 2018 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2018. The company provides banking and financial services primarily in Hawaii, Guam, and other Pacific Islands. Its loan portfolio and economic exposure are concentrated in Hawaii.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $120.5M | $112.3M | $239.5M | $222.2M |
| Net interest margin | 3.04% | 2.92% | 3.02% | 2.90% |
| Noninterest income | $41.3M | $45.2M | $85.3M | $101.2M |
| Noninterest expense | $90.8M | $88.2M | $185.2M | $176.8M |
| Net income | $54.7M | $44.7M | $108.8M | $95.8M |
| Diluted EPS | $1.30 | $1.05 | $2.57 | $2.24 |
- Q2 net income increased 23%; six-month net income increased 13%. Q2 diluted EPS rose 24%; six-month diluted EPS rose 15%.
- Q2 return on average assets was 1.30%, return on average equity 17.68%, and efficiency ratio 56.12%. For the six months, these were 1.29%, 17.71%, and 57.01%, respectively.
- Credit-loss provision was $3.5M in Q2 versus $4.3M a year earlier, and $7.6M for six months versus $8.7M. Net charge-offs were $3.3M in Q2 and $6.8M for six months.
Financial position, cash flow, and capital
- At June 30, total assets were $17.12B, loans and leases $10.05B, deposits $14.94B, and shareholders’ equity $1.25B. Since year-end 2017, loans grew 3%, deposits were up less than 1%, and equity rose 1%.
- Cash and cash equivalents were $677.8M, compared with $447.9M at year-end. Six-month operating cash flow was $128.5M; investing activities provided $153.0M and financing activities used $51.6M.
- Debt and funding included $504.2M of repurchase agreements, $235.7M of other debt (including $225.0M of FHLB advances), and $0.3M of short-term borrowings. The company reported $2.1B of additional FHLB borrowing capacity and $545.7M from the Federal Reserve based on pledged collateral.
- Regulatory capital ratios were 13.27% common equity Tier 1, 13.27% Tier 1, 14.47% total capital, and 7.53% Tier 1 leverage. The company and Bank were classified as well-capitalized.
- Dividends declared were $0.60 per share in Q2; six-month dividends were $1.12 per share. The company repurchased 497,021 shares for $42.2M in the first half.
Material changes and management commentary
- Higher net interest income reflected loan growth and improved margin as loans made up a greater share of earning assets. Higher loan and securities yields were partly offset by rising deposit costs; interest expense on deposits roughly doubled year over year for the first half.
- Noninterest income fell 9% in Q2 and 16% for the first half. Mortgage banking income declined 43% and 39%, respectively, primarily from reduced conforming loan sales. First-half securities results swung from an $11.6M gain in 2017 to a $2.4M loss in 2018, partly reflecting Visa-related costs and liability.
- Lower federal corporate tax rates under the Tax Cuts and Jobs Act were a major earnings benefit: the effective tax rate was 18.94% in Q2 and 17.60% for six months, versus 31.37% and 30.50%. First-half taxes also benefited from a $2.0M affordable-housing investment basis adjustment.
- Management described Hawaii’s economy as positive, citing strong tourism, construction, low unemployment, and real estate conditions. It reported no specific earnings or financial guidance.
Risks, contingencies, and unusual items
- Credit quality indicators were mixed: nonperforming assets declined to $15.2M from $16.1M at year-end, but accruing loans at least 90 days past due increased to $13.3M from $7.1M, primarily due to one commercial mortgage loan. The allowance was $108.2M, or 1.08% of loans, versus 1.10% at year-end.
- The $5.7B investment securities portfolio declined 8% from year-end. Gross unrealized losses rose to $138.8M from $73.9M, primarily attributed to higher interest rates; management said it did not intend, and was not more likely than not required, to sell loss-position securities before recovery.
- Interest-rate simulations estimate that a gradual 200-basis-point rate increase would raise future annual net interest income by 2.6%; a 100-basis-point decrease would reduce it by 1.4%. A flatter or inverted yield curve could reduce net interest income.
- A Visa Class B conversion-ratio reduction led to a $1.0M liability and contributed to Q2 securities-related losses; payment to prior share buyers was due in July. The company also reported a $2.0M legal reserve recorded in Q1. Management said pending legal matters were not expected to materially exceed reserves, while noting unexpected developments could result in greater losses.
- Mortgage representation-and-warranty exposure included $2.7B of sold loans; five loans totaling $1.2M were repurchased in the first half with no material losses, and no requests were pending at quarter-end. Management had not recorded a repurchase-loss liability.
- Management expects the forthcoming lease-accounting standard to affect the balance sheet and regulatory capital ratios, and the CECL credit-loss standard to affect the financial statements, particularly reserves; the extent of either impact remained under evaluation.
- Forward-looking risks include Hawaii tourism or economic weakness, interest-rate and market changes, competition, regulatory and tax developments, credit deterioration, litigation, operational or cybersecurity failures, and natural disasters. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether loan growth and higher asset yields continue to outpace deposit-cost increases, sustaining net interest margin.
- Whether the rise in 90-day-past-due accruing loans remains concentrated in the identified commercial mortgage exposure, and how charge-offs and reserves develop.
- How rising rates affect the large securities portfolio, unrealized losses, liquidity, and the modeled net-interest-income sensitivity.
- Whether lower mortgage sales and weaker fee categories persist, and how recurring earnings compare with Tax Act-related and other unusual benefits or costs.
- The eventual balance-sheet, reserve, and capital impacts of lease accounting and CECL, as well as any changes in legal or mortgage repurchase exposures.