Bank of Hawaii Corp (BOH) 2002 Q2 法說會逐字稿

Good afternoon and welcome, ladies and gentlemen, to the Bank of Hawaii Corporation second quarter conference call. At this time I would like to inform you that this conference is being recorded for rebroadcast and that all participants are in a listen-only mode. At the request of the company we will open the conference up for question and answers after the presentation. I will now turn the conference over to your host Cindy Wyrick. Ma'am, you may begin.

Hello, everyone, and thank you for joining us today for Bank of Hawaii's second quarter conference call. With me today is our chairman and CEO, Mike O'Neill; our chief financial officer, Al Landon; our vice chairman of corporate risk, Bill Nelson, and our chief economist, Paul Brubaker (ph). Before we get started I'll remind you today's conference call will contain some forward-looking statements and while we believe the assumption $we've made are reasonable there are a variety of reasons that the actual results may differ. And now I'd like to turn the call over to Mike O'Neill.

Good morning. The second quarter was a good one for us. Broadly in line with our expectations. Let me remind you again that comparing this year's financial results to those of prior periods remains complicated by last year's restructuring activity. Before providing you with some color on the quarter, I think it's note worthy that Hawaii's economy appears to be making steady progress towards recovery. Our unemployment rate at 4.2 percent is running well below the Mainland average. Now a few facts and observations on the quarter. Our net interest margin improved and we saw continued broad improvement in our asset quality. We believe that our loan totals that have been steadily managed down to reduce outside concentrations have reached an appropriate level. And we expect to see net growth by the end of the third quarter. Despite the challenging market conditions, our trust and asset management revenues were relatively stable. However, in light of the further sharp decline in the equity market since quarter end, maintaining the first half year's level of revenues in these businesses is unlikely. We're beginning to see the benefits from the hard work of our retail group. Since December total balances in our consumer checking accounts have grown at an annualized rate of 12.4 percent on a 5.4 percent growth in accounts. The introduction of new savings products has resulted in an annualized growth rate of 38.8 percent, and balances and consumer savings accounts with the growth in savings accounts running at five percent annualized. We're also pleased with the progress of our share repurchase program. During the second quarter we bought 3.9 million shares and have purchased an additional one million shares thus far in July. We have continued to remain disciplined in our approach to implementing the buy back program. I'm pleased with the results of our second quarter customer and employee satisfaction surveys. Overall customer satisfaction with the Bank of Hawaii increased significantly. And many employee satisfaction measures are at historical highs. While we made progress managing down our expense base, it's not where we would like it to be. As you've read in our release, in an effort to meaningfully reduce our operating costs and improve the functionality of our systems, we have signed an agreement with Metamonte (ph) Corporation to serve as our primary technology systems provider. Al Landon will talk more about the accounting ramifications of the Metamonte (ph) contract in his presentation. We're reaffirming our guidance for 2002 as it relates to net income. As we said for some time, our reported return on equity and earnings per share will continue to be heavily influenced by the timing it cost of share repurchases. Now Al will provide a more detailed review of Bank of Hawaii's performance for the second quarter of 2002.

Thanks, Mike and good morning and afternoon everyone. My comments will refer to the financial information included in our earnings announcement that was released earlier today. This quarter's financial information is clearer and easier to understand. However, because of the complexity associated with the divestiture and restructuring activities of last year, comparisons with 2001 information remain difficult. And perhaps less meaningful. Internally, we focused more on length quarter comparisons. But we've included in table 9 the quarterly summary that accompanies the earnings announcement, pro forma information that shows our performance for the last six quarters, without the effects of our divested businesses and restructuring transactions. It also excludes goodwill amortization. Because of the many elements involved with divestitures and restructurings, the preparation of this information required estimates in several cases. Our second quarter earnings were 31 million dollars, or 42 cents per share. These results compared to net income for the second quarter of last year of 26.7 million, or 32 cents per share. Improvement from prior year earnings is due to lower loan losses, improved efficiency, divestiture of nonstrategic operations and reduced shares outstanding. Our return on assets for the second quarter of 2002 improved to 1.23 percent. We continue to hold very high levels of capital, which held our return on equity to just under 10 percent. Our net interest margin was up four basis points from last quarter, to 3.97 percent. Compared to last year's second quarter, our net interest margin was up six basis points. Our asset mix, volume and funding have changed significantly from last year. Given the reduction in associated credit and funding risks, and the interest rate environment, we are pleased with the net interest margin. We remain slightly asset sensitive and should benefit with short-term interest rates begin to increase which we now expect will not occur until early next year. Our second quarter provision for loan losses was equal to net charge offs our credit quality and loan losses continue to benefit from the improvement in the Hawaii economy, as well as our improved collection procedures. We continue to reduce our credit exposure in the sinned indicated loan market. Our net charge offs decreased accordingly and were lower than our expectations. Noninterest income returned to more customary levels as mortgage banking revenues decreased 5.1 million from the unusually high first quarter level. Trust and asset management revenues decreased slightly due to decreased values of securities managed. Noninterest expense was generally in line with our expectations and shows a slight reduction in nearly all categories from the first quarter. As we indicated, we invested nearly $2 million in new sales and service processes during the quarter. The underlying run rate for noninterest expense is approaching what we think is a sustainable run rate for the rest of the year. However, that could vary by a couple percent either way. Our income tax was a normal level at - was at a normal level of 35.6 percent. During the quarter our nonperforming assets decreased to 78.8 million from 90.7 million dollars. The decrease was due to lower inflow of nonperforming loans totalling 20.5 million dollars compared to 36.4 million in the first quarter of 2002. The new non-performing loans primarily come from the West Pacific where borrowers have been affected by the continuing recession in the Guam economy. While the current levels of nonperforming assets remain high, they're significantly reduced from year ago levels. We remain optimistic that a significant reduction in the level of MPAs is achievable by the end of 2002. Progress is occurring on ORE sales. We continue to experience significant improvement in asset quality, measured by internal classification levels and delinquencies. Additionally, we continue to see the benefits of our improved loan administration and risk management processes. Through June 30th we've maintained our allowance for loan and lease losses at 159 million dollars, which now represents nearly three percent of loans. As we look forward, given the continued improvement in loan quality, we anticipate that the need for, and accordingly the level of the allowance, will be reduced. The timing and amount of that reduction will depend on the risk level in our loan portfolios which we evaluate late in each quarter. Given the level of our allowance, the improvement in overall credit quality, and the improvements in the Hawaii economy, we no longer plan to cover our net loan losses. As long as the overall lending environment remains stable or continues to improve. Rather, we will evaluate the level of risk in our portfolio and the economic environment each quarter and take a provision only to the extent necessary to maintain the allowance at the appropriate level. I do want to point out that last year, in the first quarter, we took a 52.5 million dollar provision to increase our allowance as we initiated a portfolio risk reduction strategy. We indicated at that time that we considered the provision to be necessary to fortify the allowance against worst case loan loss scenarios. Since that time our lending environment has become more stable and recently improved quite significantly. Accordingly, we do not believe that it's necessary to maintain the fortified level of the allowance. As to our economy in Hawaii, we continue to see improvement. Visitor arrivals have continued to increase and in the aggregate have returned to normal levels. Other economic activity in Hawaii remains relatively strong, including employment and construction. Return to normal levels of economic activity in Hawaii provide the further basis for our plans to reduce the level of the allowance for loan losses. As Mike commented we recently signed a contract with Metamonte (ph) Corporation to provide our mainframe technology and related services in the future. The objective of our contract with Metamonte (ph) is to reduce our costs, simplify our operations and improve customer service. Our plan is to spend the next year preparing for the conversion, which will occur in the third quarter of 2003. Our contract with Metamonte (ph) is for seven years. We expect that the incremental transition costs will total about 35 million dollars. That includes $12 million for direct conversion costs, of which about nine million will be paid to Metamonte (ph) for main frame related conversion services. And about three million will be paid to other providers for conversion of trust, mortgage and customer relationship management systems. Also included are 11 million dollars for write off of assets, mostly existing software and hardware. Six million dollars for outplacement and severance costs, and six million for other costs, including contract cancellation, professional fees, communication services, Hawaii excise tax, and, if necessary, staff augmentation. Generally these costs will be recognized over the conversion period. In earlier stages of our discussions with Metamonte (ph), we had explored a facilities management arrangement whereby we would sell our main frame and related software and transfer some of our technology people to Metamonte (ph). That would have created a loss on sale of our technology assets and created a liability for severance costs at contract signing. But we concluded there weren't sufficient benefits to justify the facilities management arrangement. With the change in the structure of our arrangement with met Monte, the accounting changes. We will now be effectively abandoning our hardware and software at the end of the year. The small amount of accounting guidance on this topic requires that we effectively accelerate the amortization over the short life of the assets until conversion. The severance and contract termination costs will be accounted for under a new accounting standard on disposal activities that calls for severance payments to be accounted for similar to retention payments. , when there's a work period between announcement and termination. And contract termination costs are recognized when the asset for services are no longer used. Other costs are recognized when incurred. The aggregate impact of all of that will be, rather than an up front large charge, the conversion costs will be recognized over the conversion period, which will last five quarters. We will show these incremental conversion related costs on a separate line in the expense category of our income statement. These amounts are estimates. And some of the timing was a little difficult to predict. We think the third quarter of 2002 will bear costs of about 7.8 million dollars. The conversion costs for the fourth quarter may be a bit higher. We currently estimate that the first three-quarters of next year will have costs of between five and a half and seven and a half million dollars each quarter. That's a lot of details on the costs of conversion. The real positive is in the benefits, including the cost reductions. We anticipate that the savings from the systems conversion will be over 17 million dollars per year, with a seven year term of the contract. These net savings are measured against current costs and do not include savings from inflation. If we consider the inflation inherent in future technology costs, the savings are even more significant. The cost benefits are largely from reduced payroll, software maintenance and depreciation costs. Net of the new processing charges. The reduction in costs will begin in the third quarter of 2003 and will be fully effective in the fourth quarter. And our business people are setting up new systems and processes to further improve customer service as well as reduce the costs. I also want to mention that we're considering improvements in some of our internal nontechnology operations that may further improve our efficiency. We plan to provide quarterly updates on the progress and costs of implementing our systems conversions. We continue to believe that our annual estimate of 120 million dollars in net income is realistic. We are forecasting that the third quarter core income may be down slightly from the second quarter. We expect that net interest income will increase slightly and noninterest income will decrease as trust and asset management income will be hard to sustain at the current levels given the negative trends in the equity market. Expenses, other than the systems replacement costs, should stay at about the same level as the second quarter. As Mike mentioned early our share repurchase program has been very successful in the second quarter. We repurchased 3.9 million shares. So far in July we've repurchased another million shares. We continue our share repurchase authorizations and plan to make such purchases in a disciplined manner. However, the volume of share repurchases will have a big impact on earnings per share and accordingly we remain unable to provide earnings per share guidance for forward quarters. In summary, this was a solid quarter with progress several fronts. The systems replacement project gives us significant opportunity to lower our costs and we're optimistic that our improved economy and internal emphasis on sales and service are setting the stage for future business generation. Mike, that concludes my comments.

Thanks, Al.

Now we'd like to open for Q and A. The question and answer session will begin now. If you're using a speaker phone pick up the hand set before pressing any numbers if you have any questions press one four on your phone. If you want to withdraw your questions press one three. Your question will be taken in the order it was received. Please stand by for your first question. Thank you our first question comes from Joe Morford. Please state your question.

I understand you're down sizing certain portfolio's as well as the overall sin indicated exposure what's the growth portfolio in Hawaii, also what's your outlook for the next few quarters there will that be more commercial or consumer driven. I guess related to that if Paul can talk a little bit about the current outlook for the Hawaii economy.

This is Al. Several questions in that. I think in respect to loan growth going forward, the greatest opportunity for us is in the consumer area, where the retail team has just done a great job energizing what we would call retail consumer loans, (inaudible) and home equity loans would be the stand out. That's going to be balanced a little bit against the mortgage portfolio which for us is pretty good sized and is a little bit difficult to predict right now. But we think that's pretty well stabilized. The syndicated loan area is probably one that we are close to the bottom of. It could go down a little bit further. And we're optimistic with the pickup in the economy here that middle market and corporate loans will increase. Although that's going to be pretty small initially and dependent on how the economy continues to progress. This is another area where a lot of emphasis has been placed and we're getting good results. We see some up side there. That's kind of a broad view of loan expectations. Mike, anything you want to add to that?

Joe, to summarize Al's comments I think we've reached the bottom of where we want to be. I would hope you would see growth, the level of that growth is hard to determine. But it will be clearing itself here in the next few quarters.

Fair enough.

(ph) The best way to think about the economy is having returns to what was an underlying trajectory of two to three percent real personal income growth and one to two percent employment growth. If you start the calendar this July. And the reason I say that is the last three-quarters we've been working out of a 911 trough. I'm also smoothing through a fourth quarter 2002 period where the tourism numbers will look unusually strong. And of course that's just a bounce back from last year. Currently tourism is running about even. We've been getting about two and a half percent domestic visitor growth, in the two to three weeks in July and about minus 10 to minus 20 percent in the international side with a lot more variability there T. If you're minus 10, the numbers picking up. If you're minus 20 on the international side you drop to about a two percent decline overall. And so the remainder of the summer is going to be sort of key to fleshing out how much that balancing of domestic and international performance assistance itself through the important seasonal period. But generally getting back to the aggregate, the growth rate that I mentioned are pretty much consistent with the four and a half percent unemployment rate. We're likely to remain at. Which was the unemployment rate prior to September 11th. And so as I say, as of July, as of the third quarter of 2002, we're back on the track we were on prior to September 11th.

Thanks very much, Paul.

Our next question comes from Brian Harvey. Please state your question.

Thank you. Mike, I just had a question about the guidance for this year of 120 million dollars. It just seems a little bit low given the fact that you've done already 63 million in the first half of this year. And talking about the (inaudible) mentioned charge offs going forward. I'm trying to see where the fluctuation is versus what you've done already.

As Al already talked we will have charges related to systems replacement project and the one thing that is pretty clear that you probably heard from other people in the same business, our trust and asset management business is unlikely to sustain the revenue levels that it had in the first half. So those are three variables that really come to mind. The provision, the cost of the systems replacement project and at this point the likely decline in fees from trust and asset management, it looks like net 90 interest income may well increase. But perhaps not at the same level. So as Al has suggested maybe slightly down from where we've been running, based on the snapshot today.

Okay. So you're including the systems charge in the 120 million dollar forecast?

Yes.

Thank you

Thank you, our next question comes from Jackie Reeves. Please state your question.

Thank you. Mine dovetails on those projections. I believe you stated an efficiency target of 62 percent for 2002. Is that still intact?

Jackie, I think we're going to be close to that. I don't want to get too microscopic about it.

Sure.

It bounces around a little bit. But that's certainly still our target.

And just to be sure, the statement before was that the top line on the (inaudible) loan quarter basis was expected to be down. Meaning net in interest income?

No, net interest income we would expect would strengthen a little bit in the quarter. Noninterest income we expect is going to soft ten a little bit.

On the credit quality front, you're quite passionate in your statements about the cleanup of the credit quality and expectations of that going forward. I'm curious how the decision came to match charge offs this quarter and is there a possibility of having a negative provision going forward?

The decision on matching charge offs is kind of a quarter by quarter decision. And we sort of committed at the beginning of the quarter that the more likely would stay that course. So that's what we did through the second quarter. That's sort of a judgment we have to make. As we look forward, I guess we'll consider a negative provision. If there's something that tells us that that action would be prudent. But for us, reevaluating kind of the credit risk in the portfolio at the end of each quarter and taking this in small increments, and given the unusual situation out there with the economy and world conditions seems like a prudent thing for us to do, Jackie.

We're not saying no, but as we have thought about this, the installment plan looks like it would be the more prudent approach.

Do you have the period end diluted share count?

I don't think I have a period end with me. We were - let's see we just - I shouldn't answer that question because I don't have the details, Jackie.

We'll give you a call back, though.

Thank you

Our next question comes from Jim Bradshaw. Please state your question.

Good morning. A couple of questions. First, Al, could you talk about what impact the buy back may have had on the margin for the quarter, and then secondly, Mike, you talked about the asset side, sort of being comfortable where it sits today. But what about the liability side? Are you comfortable with the mix of deposits and other borrowings or would you like to further tinker with that as we go forward?

Jim, the share repurchase program probably strengthened margin just a little bit and probably hurt net income. Rates continue to stay low. So we're using discretionary funds and I want to say we were getting about 17 on those rates or on those funds. We also, of course, sort of tie this up with our funding program and we've continued to decrease the emphasis on term and increased the emphasis on savings accounts. So I don't have a precise number for you that that affected us. We'd have to go through a calculation of it, I guess. As to the liability side, we're just going to continue where we are managing those opportunistically looking at ways to reduce our borrowing costs and then continue to shift into nonterm deposit structures.

Thank you

Thank you, our next question comes from Campbell Chaney. Please state your question.

Good morning, I actually have two questions. One is the diluted share count at period end, seeing if you can give me a call back on that as well. The second one is your mortgage servicing asset. Can you give us some color on any of the impairment charges in the quarter, what your CPR rates are, what your average coupon is.

As to the servicing, we've stayed pretty conservative. We're under one percent of servicing value to announce service. We did not have any impairment in the second quarter. Average coupon, Campbell, I don't have. We'll have to give you a call back on that.

That's fine. Then the CPR rate?

I don't have that either.

Can you give me a call back, that would be terrific.

We'll do.

Thank you

Thank you. Once again should you have a question please press the No. 14 on your push button phone at this time. If you would like to withdraw your question press 13. Our next question comes from Mark Lynch. Please state your question.

Hello, my question was as the economy nationally gets pushed up further I was wondering if you were getting comfortable with the idea of moving the liquidity of your balance sheet the billion three to interest-bearing deposits to longer maturity assets? Or whether you're still waiting for better opportunities there?

Mark, we think that reducing that liquidity a little bit would be helpful to us now. And we're a little more comfortable with that than where we would have been in the springtime.

Thank you

Thank you, there are no further questions. I will turn the conference back to Cindy Wyrick to conclude.

I'd like to thank you all for joining me today and joining our management team. If you do have additional questions or any further clarification on any of the issues we've discussed today, please feel free to call me at 808-537-8430 and I will get back to you on the questions we haven't been able to answer today. Thank you.

Ladies and gentlemen, that concludes our conference for today. If you would like to access the rebroadcast please dial 1-800-428-6051 for domestic callers with pass code 248890. Call (inaudible) for international callers with pass code 248890. Thank you for participating. All parties may now disconnect.