BANK OF HAWAII CORP quarterly report, Q3 FY2013

Bank of Hawaii Corporation — Q3 2013 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2013. Unaudited consolidated results. The company is a Honolulu-based bank holding company serving Hawaii, Guam, and other Pacific Islands.

Financial performance

Metric	Q3 2013	Q3 2012	Nine months 2013	Nine months 2012
Net interest income	$90.9 million	$93.6 million	$266.8 million	$287.0 million
Noninterest income	$45.1 million	$52.4 million	$140.9 million	$147.3 million
Net income	$37.7 million	$41.2 million	$111.4 million	$125.8 million
Diluted EPS	$0.85	$0.92	$2.50	$2.77
Net interest margin	2.83%	2.98%	2.81%	3.01%

Net interest income plus noninterest income, a simple measure of total revenue before provision and expenses, was $136.0 million in Q3, down about 7% year over year; nine-month revenue was $407.7 million, down about 6%.
Q3 pretax income was $53.0 million, versus $61.1 million; the effective tax rate declined to 28.91% from 32.55%, helped by a $2.0 million release of prior-year state-audit reserves. The nine-month tax rate was 29.99% versus 31.06%.
Noninterest expense fell 2% in Q3 and 1% year to date. The efficiency ratio worsened to 61.01% in Q3 from 58.13%, and to 60.96% year to date from 57.76%.
Cash dividends declared were $0.45 per share in Q3, unchanged year over year; $1.35 per share was declared for the first nine months.

Balance sheet, liquidity, and capital

At September 30, total assets were $13.85 billion, loans and leases $6.01 billion, deposits $11.61 billion, shareholders’ equity $992.7 million, and long-term debt $174.7 million. Loans grew 3% and deposits 1% from December 31, 2012.
Cash and cash equivalents were $389.2 million at period-end, compared with $409.9 million a year earlier. Nine-month operating cash flow was $169.1 million, investing cash flow was a use of $266.5 million, and financing cash flow provided $133.8 million.
Repurchase-agreement funding was $847.2 million, up 12% from year-end. The company reported additional borrowing capacity of $1.1 billion from the FHLB and $656 million from the Federal Reserve based on pledged collateral.
Regulatory capital ratios were 15.42% Tier 1, 16.68% total capital, and 6.95% Tier 1 leverage. Management stated that the company and bank were well-capitalized; it also believed the company would remain well-capitalized under the forthcoming Basel III rules.
Equity declined $29.0 million from year-end, largely reflecting securities-related other comprehensive loss, dividends, and repurchases, partly offset by earnings. Accumulated other comprehensive loss was $33.5 million, versus $29.2 million of accumulated other comprehensive income at year-end.
Cash dividends paid in the first nine months totaled $60.5 million. The company repurchased 660,539 shares for $33.2 million; $39.0 million of authorization remained at September 30. The board declared a $0.45 quarterly dividend on October 25, payable December 13, 2013.

Material changes versus comparable periods

Q3 net income fell 9% and nine-month net income fell 11% year over year. Lower net interest income and mortgage banking income were principal pressures.
Mortgage banking income declined 65% in Q3 to $4.1 million and 33% year to date to $16.4 million, as higher rates reduced conforming loan production and margins. Management warned that further rate increases could reduce applications and refinancing activity.
Lower yields on loans and securities reduced net interest margin. Management attributed the pressure to reinvestment of securities and new loan originations at lower yields; it said a steeper yield curve could eventually help margins, though any benefit would take time.
Commercial loans grew, led by commercial mortgages and commercial and industrial lending. Residential mortgage balances declined amid lower originations and continued paydowns. Total loans and leases rose $152.1 million from year-end.
The allowance for loan and lease losses fell to $123.7 million, or 2.06% of loans, from $128.9 million, or 2.20%, at year-end. No loan-loss provision was recorded in the first nine months of 2013; net charge-offs were $5.2 million, down from $8.6 million.
Nonperforming assets declined to $33.8 million from $37.1 million at year-end; the NPA ratio fell to 0.56% from 0.63%. Impaired loans nevertheless increased to $71.7 million from $50.6 million, including four commercial borrowers with $21.2 million in loans and a related allowance of $7.4 million.
Unrealized losses on investment securities increased as market rates rose. The company transferred $579.9 million of available-for-sale securities to held-to-maturity during the period, citing capital-management considerations and its intent and ability to hold them to maturity.

Outlook, risks, and contingencies

No specific earnings or revenue guidance was provided. Management described Hawaii’s economy as improving, citing tourism growth, low unemployment, and stronger home sales and prices. It planned to focus on expense control and maintaining liquidity, credit reserves, and capital.
Management said the allowance could decline further if the Hawaii economy and credit quality remain stable; deterioration could require a different reserve level. Key higher-risk exposures identified were residential land loans, home equity loans, air transportation leases, and some neighbor-island lending.
Interest-rate changes pose risks to net interest margin, mortgage production, and available-for-sale securities values and capital. Modeling estimated that an immediate +200 basis-point move would increase annual net interest income by 4.0%, while an immediate -100 basis-point move would reduce it by 5.1%; a flattening or inverted yield curve could also reduce income. These are model estimates, not forecasts.
Other disclosed risks include Hawaii tourism or economic weakness, competition, regulation (including Basel III and Dodd-Frank), litigation, credit quality, operational or cyber incidents, third-party service providers, and natural disasters. The company was preparing for required stress testing, with initial results due to the Federal Reserve by March 31, 2014.
Pending and threatened legal matters arose in the ordinary course; management did not expect outcomes materially beyond accrued amounts based on information available, but noted unexpected developments could materially affect a period.
Mortgage representation-and-warranty exposure included two pending repurchase requests totaling $0.6 million. Six loans with $2.3 million unpaid principal were repurchased during the first nine months without loss. Management had not established a repurchase-loss liability, judging exposure not material based on historical requests and losses.
The company’s Hawaii municipal bond holdings were concentrated: $567.5 million, or 67% of municipal debt fair value, was issued by Hawaii political subdivisions. Management reported strong ratings for those holdings and attributed most securities unrealized losses to interest-rate movements rather than credit deterioration.

Important facts for investors to verify

Whether net interest margin stabilizes or improves, and how future rates affect securities values, mortgage activity, and capital.
Whether loan growth continues and whether improving reported delinquencies and nonperforming assets are accompanied by stable credit performance, particularly in impaired commercial loans and identified higher-risk portfolios.
Whether the allowance remains adequate if economic or credit conditions change, given the zero provision recorded year to date and management’s stated possibility of further reserve reductions.
Trends in mortgage banking income, trust and asset-management fees, and expense control, including separation costs and the worsening efficiency ratio.
Capital and liquidity effects of securities valuation changes, repurchase funding, regulatory implementation, and continued dividends and buybacks.
Developments in mortgage repurchase claims, litigation, and regulatory matters; the filing states that the ultimate effect of certain contingencies is uncertain.