Bank of Hawaii Corp (BOH) 2002 Q3 法說會逐字稿

Good morning and good afternoon, ladies and gentlemen and welcome to the Bank of Hawaii Corporation third quarter earnings release conference call. At this time, I'd like to inform you that this conference is being recorded and that all participants are in a listen-only mode. We will open up the conference for questions and answers after the presentation. I will now turn the conference over to Cindy Wyrick, Senior Vice President of Investor Relations. Please go ahead, ma'am.

Hello, everyone and thanks for joining Bank of Hawaii for our third quarter 2002 Earnings Conference Call. With me today is our Chairman and CEO, Mike O'Neill. Our Chief Financial Officer, Al Landon. Vice Chair of Corporate Risk, Bill Nelson and our Chief Economist, Paul Brubaker. Before we get started, today's conference call will contain forward-looking statements. While we believe the assumptions we've made are reasonable, there are a variety of reasons that the actual results may differ materially from those projected as outlined in today's news release. Now I'd like to turn the call over to Mike O'Neill.

Good morning and good afternoon. The third quarter of 2002 was a good one for Bank of Hawaii, characterized by stable revenues, a widening net interest margin, controlled expenses and further improvement in credit quality. During the quarter, our systems conversion project gained momentum. Expenses related to the important project negatively impacted our reported results. Al will provide more information on the contract in his comments. We made good progress with our share repurchase program. We bought 4 million shares during the quarter and have purchased an additional 1.3 million shares thus far in October. Program to date, nearly $470 million has been returned to our shareholders. We are reafirming 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 and costs of share repurchases. Now, Al will provide a more detailed review of Bank of Hawaii Corporation's performance for the third quarter of 2002. Al?

Thanks, Mike, hello, everyone. My comments today refer to the financial information included in our earnings announcement released earlier this morning.

We followed our usual format, but added two new tables, table 7, the summarized certain credit exposures and table 10, showing the cost of our systems replacement project. As we have indicated in prior quarters, because of the complexity on a associated with the activities last year, comparisons with 2001 are difficult and perhaps less meaningful. Internally, we focused more on length quarter comparisons. Table 11 includes pro forma information that shows our performance for the last seven quarters without the effects of our current systems replacement project, divested businesses and restructuring transactions. It also excludes goodwill amortization from last year's results. Because of the many items involved with the divest yours and restructurings, the preparation of this information required estimates in some cases. Our third quarter earnings were $30.2 million or 43 cents per share. These results compared to net income for the third quarter of last year of $31.1 million or 37 cents per share. The slight decrease from prior year's earnings due to the $6.6 million of cost of systems replacement projects in 2002. Our return on assets for the third quarter of 2002 was 1.22%. We continue to hold very high levels of capital as Mike indicated, which held our return on equity to 10.4%, but that was up from 9.94% last quarter. Excluding the systems replacement cost from this year, third quarter net income was $34.4 million as shown on table 11. This equates to 49 cents per share. Further adjusting pro forma income for the absence of a provision by deducting net loan losses of $4.5 million would produce net income of $31.5 million or 45 cents per diluted share. Our net interest margin was up six basis points from last quarter to 4.03. Compared to last year's third quarter, our net interest margin was up 14 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're pleased with the net interest margin.

In the third quarter, we recorded no provision for loan losses. Net charge-offs were $4.5 million for the quarter. Our credit quality and loan losses continued to benefit from the improved Hawaii economy as well as our improved credit management processes and collection procedures. Our net charge-offs represented 33 basis points of average loans outstanding, up slightly from $3.3 million or 24 basis points last quarter. Charge-offs were about the same as last quarter at just over $7 million, but recoveries decreased. Non-interest income was $48.2 million, down slightly from $48.9 million last quarter. Mortgage banking revenues increased nearly $1 million from last quarter, due to the increased loan origination and sales. Trust in asset management revenues decreased slightly due to largely decreased values of securities managed. Other income decreased primarily due to a change in classification between quarters. Non-interest expense was generally in line with our expectations and except for the systems replacement cost is flat or showed a slight reduction from the second quarter. In the third quarter, we recognized systems replacement costs of $6.6 million. These costs were less than the $7.8 million we expected due to the timing of professional services involved in the conversion. The run rate for our non-interest expenses was slightly less than our expected run rate for the fourth quarter. However, that rate could vary a couple million dollars either way. We're continuing to invest in delivery channels and processes to improve our customer service. We've summarized some of those investments on page 5 of our earnings release.

Our income tax rate for the quarter was 36.4%, a slight and temporary increase from last quarter. During the quarter, our non-performing assets decreased to $63.3 million from $78.8 million at the end of June. Contributing to the decrease was the payoff and return to accrual of two local borrowers. There was also a lower inflow of non-performing loans. $7 million compared to $20.5 million in the second quarter of 2002. The new non-performing loans were smaller exposures, the largest being $1.8 million, which came from the west Pacific where borrowers continued to be effected by the recession in the Guam economy. Our current levels of non-performing assets are summarized on table 8. The current levels of non-performing assets are significantly reduced from year-ago levels. We're making good progress on ORE sales, but continue to have exposures to the air transportation as summarized in table 7. Our air transportation leases are current as of September 30, however, one of these air carriers has indicated publicly that bankruptcy is a possibility. Our exposure to that air carrier is $7.8 million in the form of an equity interest in the leverage lease. We have reserves available for the possible exposure. Table 7 also summarizes our credit exposure to the lodging and telecommunications industries and our exposure in syndicated loans. We took the opportunity this quarter to further reduce our syndicated loan exposure, which is down to $312 million of outstandings. Our largest syndicated loan outstanding is $27.1 million to a local shopping center operation. The 10 largest syndicated loans outstanding total $174 million. They're centered in real estate, hospitality and gaming.

Additionally, we have undrawn commitments of $764 million but less than 2% of the outstandings or commitments are classified. Additionally, our telecommunications industry exposure is now very small and is performing. Through June 30, we maintained our allowance for loan and lease losses at $159 million, which represented nearly 3% of loans. Given the strength of our allowance, continued reductions in internal classifications and delinquencies and improvements in the Hawaii economy, we concluded that the allowance could be reduced. Accordingly, we did not take a provision for loan losses and reduced the allowance to $154.5 million at September 30. I want to point out that our allowance at September 30 represents 2.94% of loans. In the future, we will continue to evaluate the level of risk in our portfolio and the economic environment each quarter and take a provision only to the extent no maintain the allowance at appropriate levels.

It might be helpful now to discuss some of the factors affecting our balance sheet. During the summer, we increased our investment securities as a result of extending the maturity on about $800 million of highly liquid assets. These assets were a consequence of our 2001 divestitures and had been invested initially overnight funds in anticipation of an increase in the short-term interest rates, which did not occur. The extension of maturities helped improve our net interest margin. However, accelerating prepayments of our investment portfolio in the third quarter generating increased liquidity and has partially offset the reinvestment. Accordingly, our liquidity remains very strong. Our maturity lengthening helped to mitigate some of our interest sensitivity, which had increased due to the recent volatility in interest rates. Based on our September 30 position, a 200 basis point parallel increase in rates would increase our net interest income about $7 million per quarter but would not change the value of our portfolio equity. During the quarter, our loan portfolio decreased slightly. Consumer loans decreased due to the acceleration of mortgage prepayments and our decision to sell a higher percentage of our loan origination. Other consumer loans continued to grow.

Our commercial loan balances decreased as we exited some syndicated loans and saw a slight decrease in commercial funding. I want to point out that the increase in commercial mortgages shown in table 6 is largely due to reclassifications which also caused a small increase in west Pacific hotel exposure. On the funding side of the balance sheet, our deposits continued to increase and the shift away from time deposits continued. We also decreased short-term borrowings and during the quarter, we repurchased more of our 8.25% trust preferred stock. We did not incur an impairment charge related to our mortgaing service charge in the third quarter. These rights, which have a carrying value of less than $30 million, have been recorded on a conservative basis and were carried at less than 80 basis points in aggregate. Additionally, the prepayment of Hawaii mortgages is slower than national experienced. Recently it's about 65% of national speeds. This adds further stability to the valuation of our mortgage servicing rights. As we indicated in July, we signed a contract with Metavanti Corporation to provide mainframe technology and related services in the future. The objective of our contract is to reduce our costs, simplify our operations and improve customer service. We're on schedule with our plan to spend the next three quarters preparing for the conversion, which will occur in the third quarter of 2003. As I mentioned, we have included table 10, which summarizes the incurred and expected costs of the systems convergence. We continue to monitor these estimates of expected converging costs which still total about $35 million. The costs will be recognized over the conversion period, which, as I said, will continue through the third quarter of 2003. We've shown these incremental conversion costs on a separate line in the expense category of our income statement. As we said last quarter, some of the timing is a little difficult to estimate. Because of the timing differences, we were able to recognize only $6.6 million in the third quarter of 2002, less than our original estimate of about $7.8 million. We think that $7.8 million is the best estimate to be incurred in the fourth quarter. The real positive of the system's conversion is in the benefits, which include significant cost reductions. We continue to estimate the savings from the conversion will be over $17 million per year for the seven-year term of the contract. These net savings were measured against current costs and do not include savings from future inflation. The reduction in costs will begin in the third quarter of 2003 and will be fully effective in the fourth quarter. In connection with the conversion, our business people are working on new systems and processes to improve customer service as well as reduce costs. We're also making improvements in some of our internal, non-technology operations that may further improve our efficiency.

Based on our current income and expense levels, the impact of the systems replacement cost could reduce our efficiency ratio to the upper 50s in 2003 and toward the mid-50s in 2004. Another efficiency improvement we are under taking is in the west Pacific. Later this quarter, we plan to close four small branches where we were not generating returns above the cost of capital. These closures may cost up to $1 million. Additionally, we plan to merge our small savings and loan in Guam with Bank of Hawaii. These are important moves in strengthening our brand in the west Pacific and should reduce our operating expenses next year. As to our economy in Hawaii, we continue to see stability. Visitor arrivals have continued to increase and in the aggregate, remain at normal levels. Other economic activity in Hawaii remains relatively strong, including the employment and construction. The dock workers' actions on the west coast do not appear to have had a noticeable impact on the Hawaii economy. We continue to believe that the annual estimate of $120 million in net income is realistic. We may be able to beat that by a bit.

We're forecasting that fourth quarter core net income may be down slightly from the third quarter. We expect that net interest income will increase slightly and non-interest income will remain about the same. Expenses, other than systems replacement costs, are expected to increase slightly as we make some year-end accruals and deal with some deferred maintenance in seasonal costs. We plan to reflect the costs of closing the four small west Pacific branches in the restructuring expense category of our income statement. It is too early for us to give further guidance on our earnings target for next year. You may recall that when we announced our strategic plan in April of 2001, we indicated we had set a net income target of $130 million for 2003. As Mike mentioned earlier, our share repurchase program was very successful in the third quarter. We repurchased just over 4 million shares. And so far in October, we've repurchased nearly 1.3 million shares. We continue our share repurchase authorizations and plan to make our repurchases in a disciplined manner. We have about 100 million of remaining repurchase authority and expect to extend our program. The volume of share repurchases has a big impact on earnings per share and accordingly, we remain unable to provide earnings per share guidance. I'd like to point out that we've increased our quarterly dividend from 18 cents to 19 cents per share effective this quarter.

In summary, this was another solid quarter with progress on several fronts. The systems replacement project gives us a significant opportunity to lower our costs and we're optimistic that our economy and our investments in our Hawaii and Pacific island markets are setting the stage for future business generation. Mike, that concludes my comments.

Thanks, Al. At this point, we'll be happy to take any questions.

Thank you. The question and answer session will begin at this time. If you are using a speaker phone, please pick up the handset before pressing any numbers. Should you have a question, please press 1-4 on your touch-tone phone. If you wish to withdrawal your question, please press 1-3. The question will be taken in the order it is received. Stand by for your first question. The first question comes from Brian Harvey, please state your affiliation and question.

Fox-Pitt Kelton. Good morning, everyone. Can you talk a little bit about the margin. We saw a little improvement here. How much more benefit can you get from lowering the funding cost through either lowering the borrowings or the growth in deposits? And I think you made a comment about expecting net interest income to be up in the quarter. I'm trying to see how that would work out relative to the margin and shrinkage of the balance sheet?

Brian, during the third quarter, we were making our maturity extensions so we only have part of the effect of those in the third quarter and as I mentioned, we continue to see positive deposit and other funding cost trends. We would expect that the margin would continue to improve during the fourth quarter. I would say that we could look for 10 basis points in increase, maybe just a touch better than that.

Would that more be coming on the cost side as opposed to the asset yields?

Oh! Um... I think it's about an even split.

Okay. My other question was related to the other expenses, they seem to be down pretty materially lien quarter, is there anything driving those numbers this quarter or last quarter to make those trends unusual?

I think I mentioned that our run rate in the third quarter was a little lower than we would expect for the fourth quarter. There is nothing material in there other than I would say that expense control is pretty high on the priority list around here, in terms of how we look at things. So, we've got a goal of continuously lowering those expenses. But there isn't any one thing that's a big driver until we get into the implementation of systems replacement next year.

So, there is no cost savings from the implementation at this point?

No, if there will, it will be very modest, just a little thing here or there.

Okay. Thank you.

The next question comes from Joseph Morford. State your affiliation and question.

RBC Capital Markets. I guess if you look at your table 6 on the loan portfolio balances, specifically the commercial industrial portfolio, if you adjust for the reclassification and then, you know, the $36 million drop in syndicated lending exposure, looks like CNI loans were still down, you know, $50 million or 5% sequentially. I wondered if you could talk a bit more about that and when we might expect to see a turn around or growth in that portfolio? And then a related issue, just how much more downsizing should we expect in the portfolio?

This is Bill Nelson and, yes, we continue to see a little bit of reduction in the syndicated portfolio and the CNI portfolio. The slope of reduction has gotten smaller and smaller over time. It's close to flattening out, but the demand for loans has been relatively low. Offsetting the CNI portfolio pattern has been some modest growth in consumer lending and small business banking. And we would expect to see a continuous of that and relatively flat pattern in the mortgage area.

Okay. Thanks very much.

Your next question comes from Jim Bradshaw. State your question and affiliation.

Good morning, D.A. Davidson. Mike, could you talk about the progress you're making in -- I guess for lack of a better term, the retail initiative, the class selling opportunities and things you've been working on in the Hawaii branch network? And then a couple of other unrelated questions, if I can throw them all out at once, approximately, what's the deposit balances of the four branches that you're going to close or consolidate this quarter? And then lastly, could you talk a little bit about the -- maybe for Paul Brubaker, the spending habits of the Japanese visitors, I haven't seen data for a while, but suspect with visitor counts being kind of muddy on that-side, whether the Japanese visitors are spending less as they come over and what impact it's having on your retail business outlook. Thanks.

Sure, Jim. Let me, we'll sort of split up the responding here, but let me start with the retail. We have essentially looked at that business across sort of four axis. The first being access, in other words, how convenient is our network. The second being price, are we pricing at a level that is appropriate to the value? The third, our service levels, you know, are service levels good enough, particularly in this market that is highly service-oriented. And we, I think, have made very, very real progress in terms of improving our value proposition. As time goes on, it is clear to us that service in this market is going to be the driver of performance. And so we are spending lots of time on a number of initiatives. The most important being excellence in sales and service. We put 1300 people through that program which is aimed at improving service and through service improvement in increasing sales. We are expecting to see some benefits of that next year. So, steady progress, quite visible progress in terms of cross sales and small business. We've gone from about 2.3 to about 2.5 during the period we started measuring it. Our cross sale ratio in consumer is still about 2.2, which clearly is not terrific. And so there's plenty of room to improve, particularly given the services that we've got. So, that's about all I want to say on that. Steady progress, but clearly a lot more potential, I guess is the way I would conclude. As it relates to the positive balances in those branches I want to say it is $12 million from memory. Does that sound right to you, Al?

It may be just a touch higher than that, but it's a low number, Jim. And it's not anything that's going to affect our funding mix or create any difficulty there. It's well under 100. I just don't have any details with me. I will see if I can dig something up here while we're getting this.

We will try to get back to you before the end of the conference call.

Okay, thanks.

Okay. Al -- I mean, sorry, Paul, maybe could talk about the question on the economy.

Yes, just for reference purposes, those of you who are looking for the data, the state's department of business economic development has the most recent July visitor survey results on their website. So, you're welcome to check it out. I encourage you to check it out because there is a lot of antidotal suggestion that the spending patterns have changed a lot. But the data do not bear that out. The Japanese spending pattern settled to about $250 per person per day beginning about three years ago. And that has been fairly stable not with standing the changes in volume. We think maybe the spending patterns may have been enhanced a little bit the last six to nine months than it was one year earlier, but basically the spending patterns have not changed very much. So, it's really volume effects that are driving most of what people observe and if you look at the most recent daily data going back over two years to block out the 2001 post-911 interval, right now, net/net, taking into account the longer length of stay on the domestic visitors, the total for visitor days this month through the 21st at any rate; off about .4%. So, we're basically squared up in terms of a volume measure. When you imply the spending differential, with $250 per day for a Japanese visitor and $150 per day for a U.S. domestic visitor, the spending estimate for those same first three weeks of October would be down 1.8%. So, again, very small changes going back over a two-year interval to skip over the 2001 period and I think that's actually a fair characterization of tourism as a whole. About where it was prior to 9-11.

Thanks, that's very helpful.

Jim, this is Al, I just got some information on the deposit levels in the branches you asked about.

Great.

At September 30th, it is $37 million. And that's been coming down as we've made some announcements out there in the west Pacific already. So, it's somewhere in the $50 million range historically.

Perfect, thank you very much.

Sure.

The next question comes from Campbell Chaney. Please state your affiliation followed by your question.

Sanders Morris Harris. I'm going piggyback on Jim's questions about the retail bank. Can you give us an idea about net inflows or outflows for the quarter in various deposit segments like customers versus how many new checking accounts, how many new savings accounts, those type of products.

Yep. We can probably get that information for you, Campbell, but it's not handy. Why don't I have Cindy get back to you with that deposit information. On the lending side,consumer lending, as you know, we got that information broken out in table 6. But as it relates to deposits, it's not handy.

Yeah, if you can get back to me, that would be helpful.

We will.

I do have just a touch of the information, Campbell in broad categories. On demand deposits, we were up like 180 some million and savings was up like 106 and time was off in the 103ish range.

I saw the average deposit balances. Where has the strength been geographically, around the islands or the west Pacific? Probably not. But where you're seeing the traction on the ground.

I don't know if we have with us right now any of that kind of detail. We will just have to get that back to you when we -- Paul, it's certainly got macroeconomic trends.

To the extent that it is a reflection of what's going on in the underlying economy, it is pretty clear now that the about, death the -- both the shift in domestic travels, direct and to the islands, and the overwhelming growth in construction, particularly residential construction; also focused in the neighbor island market there. May be some of that reflected in the data, but I can't say that. I can only tell you that seems to be where the economy is really hidden right now.

Okay, great. Thank you.

As a reminder, if you have a question, please press 1-4 on your touch-tone phone. If there are no further questions, I will now turn the conference back to Cindy Wyrick.

I'd like to thank everyone for joining us today. If you have any questions or need further clarification on any of the issues we've discussed today, please feel free contact me at 808-537-8430. Thanks, everyone.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so at 1-800-428-6051 or 973-709-2089. With an I.D. number of 261724. This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.