Bank of Hawaii Corporation — Q1 2014 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2014; balance-sheet comparisons are to December 31, 2013. Bank of Hawaii provides financial services in Hawaii, Guam and other Pacific Islands. Management described Hawaii’s economy as positive, supported by tourism, construction, low unemployment and rising real estate prices, while visitor arrivals and spending were below the prior-year period.
Financial performance and condition
- Earnings: Net income was $38.6 million, up 7% year over year; diluted EPS was $0.87, also up 7%. Return on average assets was 1.12%, return on average equity 15.15%, and the efficiency ratio 60.54%.
- Revenue and margins: Net interest income was $93.2 million, up 5%; net interest margin was 2.87%, versus 2.82%. Noninterest income declined 6% to $44.8 million, while noninterest expense declined 1% to $83.5 million. No provision for credit losses was recorded.
- Cash flow: Operating activities provided $49.2 million; investing activities used $95.1 million; financing activities provided $127.5 million. Cash and cash equivalents increased $81.6 million to $545.3 million.
- Loans and credit: Loans and leases were $6.21 billion, up 2% from year-end. The allowance was $114.1 million, or 1.84% of loans, versus 1.89% at year-end. Net charge-offs were $1.3 million, or 0.09% of average loans on an annualized basis. Nonperforming assets fell to $37.0 million from $39.7 million; the NPA ratio was 0.60%.
- Liquidity, funding and debt: Deposits increased 1% to $12.04 billion. Repurchase-agreement borrowings were $797.2 million; long-term debt was $174.7 million. The company reported $1.1 billion of additional FHLB borrowing capacity and $693.4 million of additional FRB borrowing capacity, subject to available collateral.
- Capital: Shareholders’ equity was $1.03 billion. The Tier 1 capital ratio was 15.47%, total capital ratio 16.73%, and Tier 1 leverage ratio 7.06%; the company and Bank were classified as well capitalized.
Material changes versus comparable periods
- Higher net interest income reflected loan growth, lower investment-securities premium amortization and lower funding costs. Average loans and leases rose to $6.10 billion from $5.80 billion.
- Mortgage banking income fell $4.4 million, primarily from lower refinancing-related production and the decision to retain more conforming saleable loans.
- Investment-securities gains included a $2.16 million net gain, mainly from selling Visa Class B shares. In Q1 2013, mortgage banking income was higher and there were no investment-securities gains.
- Lower salaries and benefits helped reduce expenses; fewer full-time employees and lower separation expense were cited. The effective tax rate declined to 29.13% from 30.74%, including a $1.2 million benefit from release of reserves following settlement of prior-year Hawaii tax issues.
- Loans modified in troubled-debt restructurings declined to $55.4 million from $63.7 million at year-end. Total shareholders’ equity rose 2%; the company repurchased $14.3 million of stock and paid $20.1 million in dividends during the quarter.
Outlook, commentary, risks and unusual items
- No specific earnings or revenue guidance was provided. Management said higher interest rates could support margin improvement over time, but any benefit would take time to realize. Its simulation showed a 3.6% increase in future annual net interest income under an immediate 200-basis-point increase, versus a 4.3% decrease under an immediate 100-basis-point decline; results depend on model assumptions. A flatter or inverted yield curve could reduce income.
- Key credit exposures identified by management include residential land loans, home equity loans, air-transportation leases and lending on neighbor islands. Hawaii’s tourism sector is an important economic sensitivity. Management cited stable credit trends and considered the allowance adequate.
- Visa Class B shares are subject to transfer restrictions and litigation-related conversion uncertainty. The company sold 22,000 shares and agreed to compensate the buyer if Visa further reduces the conversion ratio; remaining shares are carried at zero cost basis. It also donated 5,500 shares to its foundation.
- There were three pending mortgage representation-and-warranty repurchase requests totaling $0.9 million; no repurchases occurred in the quarter. Management had not recorded a related loss liability, citing historical request and loss trends. It cautioned that requests could increase. No servicing-related repurchase requests were pending.
- Credit commitments totaled $2.44 billion, primarily unfunded commitments to extend credit; amounts may expire undrawn and are not necessarily future cash requirements. Management said pending legal matters were not expected to be materially in excess of accrued amounts, but unexpected developments could affect a particular period.
- Other risks include interest-rate and securities-market changes, regulation and capital/liquidity requirements, competition, operational and cyber incidents, third-party service-provider disruption, litigation, and natural disasters. Basel III capital requirements were scheduled to begin phasing in for the company in 2015; management expected well-capitalized status to continue.
- The Board declared a $0.45-per-share quarterly dividend in April, payable June 13, 2014. Future repurchases depend on market conditions, regulatory requirements and other factors. 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 improved net interest margin persist, particularly if rates or the yield curve move differently from management’s assumptions.
- Credit performance in residential mortgages, land and home-equity lending, neighbor-island exposures and aircraft leases; monitor delinquencies, nonperforming assets, charge-offs and allowance coverage.
- Whether lower mortgage production and mortgage banking income continue, and how retaining more loans affects balance-sheet growth and liquidity.
- Potential exposure from Visa conversion-ratio changes, mortgage repurchase requests and other legal or contingent matters.
- Liquidity and funding implications of deposit changes, repurchase agreements, unfunded commitments and evolving regulatory requirements.
- Capital deployment, including the announced dividend and future share repurchases; actual repurchases are not assured.