Bank of Hawaii Corporation — Q1 2018 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2018, compared with Q1 2017; balance-sheet comparisons are with December 31, 2017. The Honolulu-based bank serves Hawaii, Guam, and other Pacific Islands. Management described Hawaii’s economy as positive, citing tourism, construction, low unemployment, and a strong real estate market.
Key financial results
| Metric | Q1 2018 | Q1 2017 / prior period |
|---|---|---|
| Net interest income | $119.0 million | $109.9 million; up 8% |
| Net interest margin | 3.00% | 2.89% |
| Noninterest income | $44.0 million | $55.9 million; down 21% |
| Noninterest expense | $94.4 million | $88.6 million; up 7% |
| Income before taxes | $64.5 million | $72.8 million |
| Net income | $54.0 million | $51.2 million; up 6% |
| Diluted EPS | $1.28 | $1.20 |
| Effective tax rate | 16.19% | 29.72% |
| Efficiency ratio | 57.91% | 53.42% |
Net income rose despite lower pretax income, principally because the federal corporate tax rate fell under the Tax Cuts and Jobs Act. Higher net interest income also helped; the lower noninterest income reflected the absence of the prior-year Visa share-sale gain.
Balance sheet, cash flow, credit, and capital
- Loans and leases: $9.92 billion at March 31, up $119.7 million (1%) from year-end, primarily from consumer growth. Deposits were $14.96 billion, up $73.2 million (less than 1%).
- Liquidity and cash flow: Cash and cash equivalents were $565.2 million, versus $447.9 million at year-end. Operating cash flow was $74.9 million, compared with $41.7 million in Q1 2017; investing activities provided $32.0 million versus using $284.5 million; financing activities provided $10.5 million versus $106.8 million. The Bank reported $2.1 billion of remaining FHLB borrowing capacity and $516.3 million of FRB capacity.
- Debt: Other debt totaled $235.7 million, including $225.0 million of FHLB advances, down $25.0 million from year-end after an advance matured. Repurchase-agreement funding was $505.3 million, unchanged.
- Credit quality: The allowance for loan and lease losses was $107.9 million, or 1.09% of loans, versus 1.10% at year-end. Q1 provision was $4.1 million; annualized net charge-offs were 0.15% of average loans. Nonperforming assets were $15.7 million, or 0.16% of loans and foreclosed real estate. Loans 90 days or more past due but still accruing were $8.2 million.
- Capital and shareholder returns: Shareholders’ equity was $1.24 billion. Regulatory ratios were 13.37% common equity Tier 1, 14.59% total capital, and 7.46% Tier 1 leverage; the Company said it remained “well capitalized.” It repurchased $17.5 million of shares and declared $0.52 per share in dividends during the quarter.
- Investment securities: The portfolio’s carrying value was approximately $6.0 billion, down $187.9 million from year-end. Gross unrealized losses were $120.3 million versus $73.9 million, which management attributed primarily to higher interest rates rather than credit deterioration. Management said it did not intend, and was not likely required, to sell securities in loss positions before recovery.
Material changes and unusual items
- Net interest income increased as average loans grew and the mix of earning assets shifted toward loans. Deposit costs also rose, particularly on time deposits.
- Noninterest income fell $11.9 million, chiefly because Q1 2017 included gains from selling Visa Class B shares; Q1 2018 instead recorded $0.7 million of Visa-related losses/fees. Q1 2018 other income included a $2.8 million distribution from a low-income-housing investment sale.
- Expenses increased $5.8 million. Salaries and benefits rose $3.3 million, including merit and minimum-wage increases and $1.0 million of separation expense; other expense included a $2.0 million increase in legal reserves.
- The Tax Act reduced the federal corporate tax rate to 21%. The quarter also included a $2.0 million low-income-housing investment basis adjustment that reduced income tax expense. The Company early-adopted guidance allowing a $7.5 million reclassification from accumulated other comprehensive loss to retained earnings, with no effect on total equity.
- Shareholders’ equity reflected an $8.9 million other comprehensive loss, including investment-security valuation effects. Management said the securities’ unrealized losses were primarily rate-related.
Outlook, risks, and contingencies
The filing provides no quantified earnings or revenue guidance. Management’s 12-month interest-rate simulation estimated that a gradual 200-basis-point increase could raise net interest income 2.5%, while a gradual 100-basis-point decrease could lower it 1.3%. An immediate 200-basis-point increase was estimated to raise it 5.8%; an immediate 100-basis-point decrease was estimated to lower it 4.1%. These are model estimates, not forecasts; management also noted that a flattening or inverted yield curve could reduce net interest income.
Key risks include local economic weakness, particularly an adverse effect on Hawaii tourism; interest-rate and securities-market changes; deposit-cost competition; credit quality and reserve estimates; operational, cyber, vendor, and regulatory risks; and legal proceedings. The portfolio is concentrated in Hawaii, including real estate lending. Credit commitments totaled $2.91 billion, including $2.83 billion of unfunded commitments to extend credit; these amounts do not necessarily represent future funding needs. The Company reported $2.6 billion of unpaid principal on residential mortgage loans sold, generally on a non-recourse basis but subject to representations, warranties, and certain servicing obligations. Management reported no pending repurchase requests at quarter-end and said legal outcomes were not expected to materially exceed recorded reserves, while noting unexpected developments could cause greater losses.
Management expects the forthcoming lease standard to affect reported assets and liabilities and potentially regulatory capital ratios. It also expects the new expected-credit-loss standard (CECL) to affect the financial statements, particularly the credit-loss reserve; the amount of either impact was not yet clear. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Assess whether loan growth and the shift from securities to loans can sustain net interest income as deposit costs rise.
- Separate recurring fee income and expenses from the Visa-related comparison, housing-investment distribution, tax-rate change, and legal-reserve increase.
- Monitor credit trends, including past-due accruing loans, residential mortgage nonaccruals, charge-offs, and reserve adequacy as CECL implementation proceeds.
- Review the rate sensitivity, duration, and unrealized-loss exposure of the securities portfolio, including the sizable mortgage-backed securities and Hawaii municipal holdings.
- Verify capital, liquidity, and shareholder-return capacity alongside planned repurchases, the declared $0.60-per-share dividend for June 2018, and potential regulatory/accounting changes.