Bank of Hawaii Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; balance-sheet comparisons are to December 31, 2011 unless noted. Unaudited consolidated results. The company provides banking and related financial services in Hawaii, Guam, and other Pacific Islands.
Financial results and key metrics
| Metric | Q1 2012 | Comparable / prior date |
|---|---|---|
| Net interest income | $97.9 million | $99.7 million, Q1 2011 |
| Provision for credit losses | $0.4 million | $4.7 million, Q1 2011 |
| Noninterest income | $48.1 million | $53.9 million, Q1 2011 |
| Noninterest expense | $85.2 million | $86.1 million, Q1 2011 |
| Net income | $43.8 million | $42.4 million, Q1 2011 |
| Diluted EPS | $0.95 | $0.88, Q1 2011 |
| Net interest margin | 3.06% | 3.24%, Q1 2011 |
| Efficiency ratio | 58.35% | 56.04%, Q1 2011 |
| Return on average assets / equity | 1.29% / 17.26% | 1.32% / 16.86%, Q1 2011 |
| Operating cash flow | $49.7 million | $66.4 million, Q1 2011 |
Net income rose 3% and diluted EPS rose 8% year over year, while net interest income and total noninterest income declined. The lower credit-loss provision and improved mortgage banking income supported earnings; lower debit-card income and securities gains partly offset those benefits.
Financial position, credit, and capital
- Assets and lending: Total assets were $13.76 billion, down from $13.85 billion at year-end. Loans and leases increased 1% from year-end to $5.60 billion, with residential mortgage balances the main source of growth.
- Funding and liquidity: Deposits were $10.62 billion, broadly stable from year-end. Cash and cash equivalents were $370.9 million; available-for-sale securities were $3.47 billion. Repurchase-agreement liabilities were $1.83 billion, and long-term debt was $30.7 million. Investing cash flow was negative $231.1 million, reflecting securities activity and loan growth; financing cash flow was negative $117.6 million.
- Credit quality: The allowance for loan and lease losses was $135.6 million, or 2.42% of loans, versus $138.6 million, or 2.50%, at year-end. Net charge-offs were $3.4 million (0.24% annualized of average loans), down 29% from Q1 2011. Nonperforming assets were $41.4 million, up from $40.8 million at year-end; nonaccrual loans were 0.68% of loans. Total TDR balances were $36.1 million.
- Capital: Shareholders’ equity was $995.9 million. The company reported a 16.50% Tier 1 capital ratio, 17.76% total capital ratio, and 6.57% Tier 1 leverage ratio; management stated the company and Bank were well capitalized. The board declared a $0.45 per-share quarterly dividend. The company repurchased 638,844 shares under its program for $30.0 million during the quarter.
- Cash and shareholder returns: Ending cash and cash equivalents were $370.9 million versus $647.8 million at March 31, 2011. Dividends paid were $20.7 million.
Material changes and unusual items
- Net interest margin fell 18 basis points year over year as lower asset yields, especially on loans and securities, outweighed lower deposit funding costs. Average earning assets increased 6% year over year, partly from securities and loan growth.
- Noninterest income fell 11% year over year. Debit-card income declined $3.0 million, primarily reflecting Durbin Amendment pricing restrictions; net securities results shifted from a $6.1 million gain in Q1 2011 to a nominal loss in Q1 2012.
- Mortgage banking income increased 62% to $5.1 million, primarily on higher originations and favorable movements in mortgage-related derivatives. Mortgage originations were $293.8 million; loan sales were $98.7 million as the company retained more conforming loans.
- Other noninterest income included a $3.5 million pretax gain from a lessee’s early buyout of two cargo-ship leveraged leases, partly offset by a $1.0 million pretax loss related to an aircraft lease sale and termination. The transaction also generated a $2.7 million tax benefit, contributing to a lower effective tax rate of 27.55% versus 32.60%.
- Comprehensive income was $37.5 million, including $6.3 million of other comprehensive loss, mainly from unrealized investment-securities losses.
Outlook, risks, and contingencies
Management gave no specific earnings or financial guidance. It anticipated possible continued economic recovery and improved loan-growth prospects, but remained cautious about economic conditions, loan demand, interest rates, regulation, and fee pressure. Management said continued credit improvement and economic stability could support lower allowance levels in future periods. It expected the full-year 2012 impact of Durbin-related compliance to significantly reduce debit-card income and emphasized expense control and maintaining liquidity, reserves, and capital.
- Key credit exposures identified include residential homebuilding and land loans, home equity lending, air-transportation leases, and lending on neighbor islands. Management cited Hawaii tourism, employment, energy costs, and domestic and global economic volatility as relevant risks.
- Interest-rate risk remains material: management’s 12-month simulation estimated net interest income would decline 6.6% under an immediate 100-basis-point rate decrease and rise 2.2% under an immediate 200-basis-point increase. A flattening or inverted yield curve could also reduce income.
- Unfunded commitments to extend credit were $1.95 billion; standby and commercial letters of credit totaled about $79.1 million. These contractual amounts do not necessarily represent future cash needs.
- Repurchase-agreement liabilities carry refinancing and liquidity considerations; most were fixed-rate, with varying maturities and termination rights. Derivative counterparties could require collateral or settlement if specified credit-rating or capitalization triggers were breached; management said current ratings and capital exceeded those thresholds.
- Mortgage representation-and-warranty exposure: $3.0 billion of residential mortgages had been sold, generally on a non-recourse basis. One $0.3 million loan was repurchased in Q1 without loss; there were no pending repurchase requests at March 31. Management had not established a liability, while noting future requests could increase.
- The $9.0 million overdraft-fee class-action settlement received final court approval in February 2012; the settlement had been paid in 2011 and refunds were reported paid by April 20, 2012. Other ordinary-course legal matters remained, with outcomes potentially material in a particular period if unexpected developments arise.
- Management identified Basel III, Dodd-Frank implementation, regulatory compliance costs, operational and cybersecurity risks, litigation, natural disasters, and possible disruption to Hawaii tourism among broader risks. No material changes to the 2011 Form 10-K risk factors were reported.
Investor verification priorities
- Assess whether the sharp year-over-year reduction in the credit-loss provision is sustainable against nonperforming assets, delinquencies, charge-offs, and the allowance coverage ratio.
- Verify the durability of earnings excluding the cargo-lease buyout gain and tax benefit, and monitor continuing Durbin-related debit-card revenue pressure.
- Track net interest margin and sensitivity to lower rates, yield-curve changes, mortgage prepayments, and securities portfolio duration.
- Review growth and credit performance in residential mortgages and the higher-risk homebuilding, land, home-equity, neighbor-island, and air-transportation exposures.
- Monitor liquidity and funding concentration, including repurchase agreements, public deposits, collateral needs, and the $2.03 billion total of credit commitments.
- Confirm capital levels, planned buybacks and dividends, and the potential effects of evolving regulatory capital, liquidity, and stress-testing requirements.