BOH

Bank of Hawaii Corporation: Q2 2007 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended June 30, 2007. Bank of Hawaii Corporation is a bank holding company headquartered in Honolulu, Hawaii, providing financial products and services in Hawaii and the Pacific Islands (Guam, American Samoa). The company operates through four segments: Retail Banking, Commercial Banking, Investment Services, and Treasury. As of July 20, 2007, there were 49,353,090 shares of common stock outstanding.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability: Net income increased by 15.2% to $95.1 million for the six months ended June 30, 2007, compared to $82.5 million in the same period in 2006. Diluted EPS rose from $1.59 to $1.89.
• Revenue Mix: Noninterest income grew 12.5% to $119.0 million, driven by increases in trust fees, service charges, and insurance income. This growth offset a 2.5% decline in Net Interest Income (NII) to $197.0 million.
• Interest Rate Environment: Net Interest Margin compressed by 24 basis points to 4.09% due to an inverted or flat yield curve and increased funding costs on deposits and repurchase agreements.
• Balance Sheet: Total assets increased 3.8% year-over-year. Loans and leases decreased slightly ($57 million) from year-end 2006 but increased 2% compared to June 2006. Deposits grew 7% year-over-year.
• Accounting Adjustments: The adoption of new accounting standards (SFAS 156, FSP 13-2, FIN 48) on January 1, 2007, resulted in a cumulative reduction to retained earnings of approximately $29.2 million, primarily related to leveraged lease transactions and tax uncertainties.

Outlook, Risks, and Management Commentary

• 2007+ Plan: Management is executing a strategic plan emphasizing revenue growth, service integration, and risk discipline. The plan targets a return on assets above 1.7% and return on equity above 25%.
• Tax Matters: The company reached a settlement with the IRS regarding a Lease In-Lease Out (LILO) transaction in June 2007, resulting in a $1.5 million credit to net income. However, the IRS is still reviewing five Sale In-Lease Out (SILO) transactions, creating uncertainty regarding future tax liabilities.
• Credit Quality: Asset quality remains strong. Non-performing assets (NPAs) were $6.3 million (0.10% of total loans). The allowance for loan and lease losses was 1.39% of outstanding loans.
• Market Risk: The company is exposed to interest rate risk. Simulations indicate the balance sheet is approximately neutral to parallel rate changes but sensitive to yield curve inversions. Mortgage servicing rights are hedged using a trading portfolio of mortgage-backed securities.
• Capital Management: The company remains "well capitalized." It repurchased 0.7 million shares in the first half of 2007 and declared a quarterly dividend of $0.41 per share.

Investor Verification Checklist

• SILO Tax Exposure: Verify the status of the IRS review of the five SILO transactions and the adequacy of the $130.6 million unrecognized tax benefit liability.
• Net Interest Margin Trend: Monitor the impact of the inverted yield curve on future NII and funding costs, particularly regarding time deposits and repurchase agreements.
• Accounting Adjustments: Review the specific impacts of SFAS 156 (Mortgage Servicing Rights) and FSP 13-2 (Leveraged Leases) on future earnings volatility.
• Loan Portfolio Concentration: Assess the risk profile of the airline industry exposure ($98.1 million total exposure) and the concentration of commercial real estate in Hawaii.
• Share Repurchase Program: Track the remaining $47.3 million authorization under the share repurchase program and its impact on earnings per share.