BANK OF HAWAII CORP quarterly report, Q2 FY2019

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Bank of Hawaii Corporation — Q2 2019 Form 10-Q

Business context and reporting period

Unaudited results for the quarter and six months ended June 30, 2019. Bank of Hawaii provides financial services in Hawaii, Guam, and other Pacific Islands. Management described Hawaii’s economy as positive, with low unemployment and a generally strong real estate market, while visitor spending declined year over year.

Financial performance and condition

  • Q2 earnings: Net income was $56.9 million, up 4% from $54.7 million; diluted EPS was $1.40 versus $1.30. Revenue, measured as net interest income plus noninterest income, was $169.5 million, up about 5%.
  • First-half earnings: Net income was $115.7 million, up 6%; diluted EPS was $2.82 versus $2.57. Revenue was $338.1 million, up about 4%.
  • Interest income and margins: Q2 net interest income rose 3% to $124.1 million, while net interest margin was unchanged at 3.04%. First-half net interest income rose 4% to $248.9 million; margin increased six basis points to 3.08%. Higher asset yields and loan growth were partly offset by higher deposit costs.
  • Fees and expenses: Q2 noninterest income increased 10% to $45.5 million, including higher mortgage banking and customer swap fees. Noninterest expense rose 2% to $92.7 million. First-half expense was nearly flat at $185.8 million.
  • Credit costs and asset quality: Q2 provision for credit losses was $4.0 million, compared with $3.5 million; first-half provision was $7.0 million versus $7.6 million. Allowance for loan and lease losses was $107.7 million, or 1.00% of loans. Nonperforming assets increased to $21.8 million from $12.9 million at year-end, primarily reflecting higher commercial mortgage nonaccruals.
  • Balance sheet and funding: Total assets were $17.7 billion; loans and leases were $10.8 billion, up 3% from year-end; deposits were $15.5 billion, also up 3%. Cash and cash equivalents were $490.4 million. Other debt was $110.6 million, including $100 million of FHLB advances; repurchase agreements were $504.3 million.
  • Cash flow and capital: First-half operating cash flow was $100.0 million, investing cash outflow was $445.7 million, and financing cash inflow was $310.2 million; cash declined $35.6 million. The company reported a 12.46% CET1 ratio and 13.57% total capital ratio and remained “well capitalized.” Shareholders’ equity was $1.29 billion.

Material changes and unusual items

  • On June 10, the company transferred $1.0 billion of prepayable securities from held-to-maturity to available-for-sale under newly adopted accounting guidance. It also repositioned the securities portfolio; first-half net securities losses were $1.6 million.
  • Unrealized investment-security losses fell substantially from year-end, mainly as interest rates declined. First-half other comprehensive income was $23.6 million.
  • Effective tax rates increased to 21.84% for Q2 and 20.35% for the first half, partly because the securities repositioning reduced municipal-bond tax benefits. First-half annuity and insurance income included a one-time commission.
  • The company adopted lease accounting in 2019, recording $103.3 million of operating lease right-of-use assets and $110.5 million of related liabilities; management said the adoption did not materially affect income or cash flows.

Outlook, commentary, risks, and contingencies

  • No specific earnings or financial guidance was provided. Management said loan growth and a healthy Hawaii economy supported performance, but noted that lower visitor spending and changes in economic conditions could affect results.
  • Interest-rate simulations estimated that a gradual 100-basis-point increase would raise annual net interest income by 1.6%, while a 100-basis-point decline would reduce it by 1.7%; immediate shocks produced larger modeled effects. A flatter or inverted yield curve could reduce net interest income.
  • Management expected the CECL standard, planned for adoption in Q1 2020, to affect the reserve for credit losses; the magnitude remained under evaluation and would depend partly on portfolio composition and economic conditions.
  • Risks include LIBOR transition exposure, interest-rate and liquidity risk, credit deterioration, competition, operational and cybersecurity events, litigation, and possible impacts to Hawaii tourism. A consumer overdraft class action remained unresolved; another overdraft-fee case had settled for an amount described as immaterial.
  • Credit commitments totaled $2.78 billion. Management reported no material mortgage repurchase exposure or pending repurchase requests, but noted contractual representation-and-warranty and servicing obligations.

Key facts investors should verify

  • Whether commercial mortgage nonaccruals and total nonperforming assets continue to rise, and how that compares with charge-offs and allowance coverage.
  • Whether loan growth and net interest margin can offset higher deposit funding costs and any changes in interest rates.
  • The earnings quality and recurrence of portfolio repositioning effects, customer swap fees, and the one-time insurance commission.
  • The eventual CECL reserve impact and progress toward implementation in 2020.
  • Capital and liquidity trends after dividends and repurchases; first-half buybacks and cash dividends were $78.2 million and $52.2 million, respectively.