Bank of Hawaii Corp (BOH) 2002 Q4 法說會逐字稿

Good afternoon and welcome, ladies and gentlemen, to the Bank of Hawaii fourth quarter earnings conference call. At this time, I would like to inform you that this conference is being recorded, and that all participants are in a listen-only mode.

At the request of the company, we will open up the conference for questions and answers following the presentation. Should you have a question, please press star one on your telephone. If you wish to withdraw your question, please press star two.

It is now my pleasure to turn the floor over to your host, Ms. Cindy Wyrick, Senior VP of Investor Relations. The floor is yours, ma'am.

Thank you, Jennifer (ph). Hello, everyone, and thank you everyone for joining us today as we review Bank of Hawaii's financial results for the fourth quarter of 2002. With me today is our Chairman and CEO, Mike O'Neill; our Chief Financial Officer, Al Landon; Vice Chairman and Chief Risk Officer Bill Nelson; and Dave Thomas, Vice Chairman and Head of our Retail Banking Group.

Comments today will refer to the financial information included with our earnings announcement, released earlier this morning. As we mentioned in previous conference calls, non-core items and the effect of business divestitures during 2001 continue to have a significant impact on comparability with prior-year results. Therefore we're going to focus more on the linked quarter comparisons.

Before we get started, let me remind that you today's conference call will contain some forward-looking statements. While we believe the assumptions we've made are reasonable, there are a variety of reasons that actual results may differ materially from those projected.

With that, I would like to turn the call over to Mike O'Neill.

Hello. 2002 was a successful one for Bank of Hawaii, and very much in line with the strategic plan we presented in April 2001. Our credit quality improved, our margins strengthened, our share repurchase program returned nearly $530 million to our shareholders, and our technology conversion program is both on schedule and on budget.

Most importantly, our people are far more focused on our key markets in Hawaii, Guam, and American Samoa, and as a result, our customer and employee satisfaction measures have strengthened materially. Our businesses are poised for growth in 2003, and we remain optimistic that we'll be able to continue to improve our efficiency and hope to benefit from an improved economy this year.

We're updating our guidance for 2003 to $131 million in net income. As we've said for some time, our reported return on equity and earnings per share will continue to be heavily influenced by the timing and cost of share repurchases.

Now Al Landon will provide a more detailed review of Bank of Hawaii Corporation's financial performance in the fourth quarter of 2002.

Thanks, Mike. Good afternoon and morning, everyone. I want to start with some comments about our income statements.

For the year 2002, our earnings were $121.2 million or $1.70 per share, compared to 117.8 million or $1.46 per share in 2001. The improvement is in line with our plans and reflects our focus on reducing risk, improving efficiency, and returning capital to shareholders.

Our fourth quarter earnings were $28.9 million and 44 cents per share. These results compare to net income for the fourth quarter of last year of 26.3 million or 34 cents per share. The increase in fourth quarter earnings was primarily due to the strong mortgage origination and sales. Our return on assets for the year was 1.22 percent, and for the fourth quarter 2002 was 1.20 percent. Although our equity levels are decreasing, they remain quite high and our return on equity for the year 2002 was 10.24 percent and for the quarter was 10.72 percent.

Excluding systems replacements costs, fourth quarter net income was $33.8 million or 51 cents per share, as shown in Table 11. This pro forma income does not include a provision for net loan losses, since no provision was necessary to maintain an adequate allowance per loan losses.

Our net interest margin was up two basis points from last quarter to 4.05 percent. Compared to last year's fourth quarter, our net interest margin was up 12 basis points. For the year, our net interest margin was up eight basis points to 3.99 percent. As we've said before 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 were satisfied with the net interest margin, although the decrease in rates in the fourth quarter slowed the expected growth in our margin.

As I mentioned, we recorded no provision for loan losses in the fourth quarter. Net charge-offs were 11.6 million for the quarter. The increase in loan losses from $4.5 million last -- in the third quarter was due to the write-off of an $8.8 million investment in an leveraged aircraft lease. Otherwise, our credit quality and loan losses continued to benefit from the stable Hawaii economy, as well as our improved credit management processes and collection procedures.

For the year, net charge-offs were $27.7 million or a loss rate of 51 basis points compared to $121.4 million for 2001. Noninterest income for the year 2002 totaled 199.9 million. This total is not comparable with 2001 results, which included well over 200 million of asset sales gains and income from divested operations.

For the fourth quarter, noninterest income was $51.1 million, up from $47.4 million in the third quarter. Nearly all categories were up from or even with the third quarter, led by mortgage banking revenues which increased over $1 million due to increased loan origination and sales. However, trust and asset management revenues decreased about $500,000 due largely to decreased values of securities managed. We're now separately presenting insurance income, which had been included in other income. Absent insurance income, other income increased primarily due to a gain on a venture capital investment and from some bank-owned life insurance benefits.

For the full year 2002, noninterest expense was in line with our expectations. The increase in the fourth quarter was due to several specific factors. Compared to the third quarter of 2002, salary expense increased due to about $900,000 of additional commissions on increased mortgage originations and $750,000 of severance cost. Occupancy expense due to -- increase due to insurance costs and costs associated with a branch relocation.

Equipment costs were up due to annual software license fees and maintenance charges that typically increase in the fourth quarter. Other expenses increased from the third quarter due to $1.3 million in losses due to the Guam super typhoon and $1.7 million in professional fees. The professional fees included compensation plan (ph) consultants, seasonal audit costs, and some system improvement fees.

We also recognized a net restructuring cost of $385,000 due to closing four Pacific island branches. These costs were reduced by reversals of prior-year accruals for divestiture contingencies that were favorably resolved in the fourth quarter.

In the fourth quarter, we also recognized systems replacement costs of a little over $7 million, up from 6.6 million in the third quarter. In total, these costs were less than the $16.2 million we expected in the third and fourth quarters due to timing of expense recognition.

The run rate for noninterest expenses was slightly higher than we planned due to typhoon-related costs, increased commissions, and severance expense. However, we previously indicated that that rate could vary a couple million dollars. Our income tax rate was 34.1 percent, a slight and temporary decrease from prior quarters.

Now I would like to comment on credit quality. During the quarter, our non-performing assets decreased to $54.4 million from $63.3 million at the end of September and from $79.7 million at the end of the 2001. Contributing to the quarterly decrease was the sale of the majority of our largest parcel of foreclosed real estate.

There was an increase in the inflow of nonperforming loans, $12 million, compared to $7 million in the third quarter of 2002. The new nonperforming loans included a $3.7 million syndicated loan to a construction company and a $4.3 million loan impacted by the recession and typhoons that Guam has suffered. The elements (ph) of our nonperforming assets are summarized in Table 7.

We continue to have exposures to air transportation, as summarized in Table 6. The table reflects the charge-off of an $8.8 million investment in a leveraged aircraft lease due to a bankruptcy. Table 6 include some additional information about our aircraft and air carrier exposure, which is diversified by carrier and aircraft. Our air transportation leases are current as of December 31st. And based upon current conditions, we believe our aircraft exposures are adequately reserved.

The other area of potentially weaker credit quality is our Guam portfolio, where many of our borrowers have been adversely affected by the December super typhoon. We have outstanding loan balances of $429 million to Guam borrowers, of which $257 million are consumer and $172 million are commercial loans. We remain adequately reserved there as well.

Table 6 also summarizes our credit exposure to the lodging and telecommunication industries and syndicated loans. Our telecommunication industry outstandings are under $1 million. Our syndicated loan outstandings decreased slightly to $309 million. Our largest outstanding syndicated loan $28.4 million to a Hawaii-based hotel operator, and our second-largest is $26.9 million to a Hawaii shopping center operation.

The 10 largest syndicated loan outstandings total $181.2 million. These syndicated loans are centered in real estate, hospitality, and gaming.

The undrawn commitments also decreased to 693 million. Less than 2 percent of the outstandings or commitments are classified. Through June 30th, we maintained our allowance for loan and lease losses at $159 million, which represented nearly 3 percent of loans. Given the strength of our allowance, continued reductions in internal classifications and delinquencies, and improvements in the Hawaii economy, we reduced the allowance.

We have not taken a provision for loan losses in the last two quarters of 2002. The allowance was $142.9 million at December 31st and represents 2.67 percent of loans. In the future, we will continue to evaluate the economic environment and the level of risk in our portfolio and recognize a provision for loan losses only to the extent necessary to maintain the allowance at appropriate levels.

As to our balance sheet, we took additional steps to lengthen maturity of some short-term assets. Near the end of the fourth quarter, we purchased approximately $180 million of second mortgage loans and $40 million of bank owned life insurance. We have also adjusted our deposit strategies and pricing. These actions helped to mitigate some of our asset sensitivity which had increased earlier in the quarter due to a decline in short-term interest rates.

Based on our December 31st position, a 200 basis points parallel increase in rates would increase our net income nearly $700 million per quarter and would not change the value of our portfolio or equity. Our liquidity position remains quite strong.

Our loan portfolio increased $100 million during the fourth quarter. The increase was centered in consumer loans where we added through organic growth as well as the purchase of second mortgages. This offset the decrease in residential mortgages that resulted from mortgage refinancing. Our commercial loan balances decreased slightly as we saw a small decrease in commercial mortgage and construction loans, but there was a small increase in commercial and industrial loans as shown in table 6.

We did not incur an impairment charge related to our mortgage servicing rights in the fourth quarter, although loan payments reduced the carrying value of our mortgage servicing rights by about $1.1 million to $28.8 million. These rights continue to be record on a conservative basis and were carried at about 81 basis points in aggregate.

Additionally the prepayment rate of Hawaii mortgages continues to be slower than the national experience. On the funding side of the balance sheet our deposits continued to increase and the shift away from time deposits continued. We've summarized the deposit balance levels in table 9. You'll note we also decreased short-term borrowings.

Our major operational initiative to outsource our mainframe base technology and related services to is proceeding in accordance with our plan. We plan to spend the next two quarters preparing for the conversion which will occur in the third quarter of 2003. Table 10 summarizes the incurred and expected costs of the system conversion which remained at the $35 million level. These costs are recognized over the conversion period that extends through the third quarter of 2003. We continue to estimate the savings from the systems conversion will be over $17 million per year for the seven-year term of the contract.

Earlier, I referred to an efficiency improvement we completed in the fourth quarter when we closed four small branches in the West Pacific that were not generating returns above the cost of capital. Additionally, we merged savings bank in Guam, which had about $160 million of assets into Bank of Hawaii. These were important moves in strengthening our brand in the West Pacific and will reduce our operating expense next year.

As to our economy in Hawaii, we continue to see stability. Visitor arrivals have remand at normal levels. Other economic activity in Hawaii remains relatively strong including employment and construction. The dock workers actions on the West Coast did not have a significant impact on the Hawaii economy.

Our strategic plan for 2001 through 2003 set a target for 2003 net income of $131 million. We believe that earnings of $131 million remain realistic for 2003 although the components of income have changed from our earlier plan. We expect that net income for the first two quarters of 2003 will be about the same level of earnings as the fourth quarter of 2002 primarily due to increases in systems replacements costs.

We expect our net interest income and margin will improve in the first quarter to about 95 million dollars and 4.25 percent. Noninterest income may decrease in the first two quarters as we plan to retain a greater portion of our mortgage production. Excluding direct costs of systems replacement, expenses may approach $90 million for the first two quarters, although we will try to reduce that spending level. We do expect our expenses to include more severance costs as we reduce the size of our management team. Our goal is to improve our efficiency ratio to 58 percent at the end of 2003.

Our earnings estimates are necessarily based on several assumption. We assume interest rates will increase beginning later in 2003 and by year end our forecast is that short-term rates will be 150 basis points higher. We expect economic condition will improve slightly in our markets and that loan losses will be below $5 million per quarter allowing for continued reserve reductions. We expect our systems conversions to be successful and reduce our costs. There are many other assumptions that affect our estimates including the absence of major geo political events.

I should add that our 2003 plan does not reflect a charge for stock options. It's not clear to us that a standard practice has developed or that better financial information or decisions will result from changing our current practices.

As Mike mentioned earlier, our share repurchase program was successful in the fourth quarter. We repurchased 3.25 million shares and so far in January we've repurchased nearly 1.4 million shares. In December, our board of directors added another $230 million to our repurchase authorizations. This brings the total completed and authorized return of capital to $800 million. We plan to continue to make the repurchases in a disciplined manner. As we've previously indicated the volume and timing of share repurchases depends on market conditions that are difficult to predict. Since the share repurchase activity has a big impact on earnings per share we remain unable to provide earnings guidance per share.

We have declared our first quarter 2002 dividend at 19 cents per share. In summary, this was another quarter of progress on several fronts. The systems replacement project and other initiatives should lower our future operating costs and we remain optimistic that our economy and our investments in Hawaii and Pacific Island markets are setting the stage for future business generation. Mike, that concludes my comments.

Al. Thanks. We would now be happy to take any questions you may have.

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 you dial any numbers. If you have a question, please press star one on your telephone. If you wish to withdraw your question, please press star two. Your question will be taken in the order it is received. Please stand by for your first question. Please hold while we poll for questions. Our first question comes from Jim Bradshaw of D.A. Davidson & Co. Please pose your question.

Good morning. A couple of questions, first related to the IT project. The costs this quarter were about a million dollars less than you thought they might have been for the quarter. Just wondering if I should read anything into that or are you finding maybe the costs won't be as much or if they're going to be spread out a little bit differently than you previously anticipated? And then lastly the head count's down to about 2900, I believe at the end of the year on FTE basis and I think the initiatives the branch sales and the IT project might reduce things a little bit more, but wondered if you could give me a guess on what head count reductions we might see in the first quarter. Thanks.

Sure, Jim. Let me have Al Landon field those two questions.

Jim, as to the first on our systems replacement costs, I only wish that being a little bit lighter in the fourth quarter signaled that we were going to turn out that way. But our experience is that's not the nature of this beast. Rather, I think we should attribute it as you suggested we might to timing. A piece of this has do with consulting efforts and travel expenses and just the way the time, the way the costs fell in the fourth quarter, we ended up with fewer dollars to expense then. But what we believe right now is that that will increase our costs little bit in the first and second quarter as we go forward.

And Al, the timing doesn't suggest that there's any slippage on the conversion either, then, I assume, right?

No, it really doesn't. In fact, we're in quite good shape with where we're headed on that.

Okay.

And I should stress $35 million is still the number in aggregate that we expect. It's a timing issue.

Okay. Perfect. Thank you.

And as to the FTEs, I dent have a precise study of it, Jim. We're, as you can imagine or suggested with the branch closures that reduced the head count a little bit out in the Pacific Islands division and we are running just a little bit ahead in attrition in a couple of the areas that will be affected by the systems replacement costs. But we should expect further reductions before the end of the year 2003 and the timing and extend of that I can't be any more specific on right now.

One follow up, I guess, on a related matter. The loans, the second mortgage loans that you purchased this quarter or fourth quarter, were those out of market or in market loans?

Those were out of market mainland loans. Picked up a little bit of credit diversification there.

Thank you.

Our next question comes from Joseph Morford of RBC. Please pose your question.

Good morning, everyone. Al, I guess, had a question on the margin. You had mentioned in last quarter's call that it might be up ten basis or more due to maturity extensions and favorable deposit repricing. From your comments today, the sense is that the November rate cut is the primary difference there. Was there something else going on? And along those lines, how did the margin come out for the month of December and what's the biggest driver to taking it up to 425 in the first quarter? Thanks.

Sure, Joe as to the margin for the fourth quarter, you were quite accurate in your observation that the 50 basis points drop in November was greater than we had anticipated and it affected us two ways. Certainly in the rate we were earning on our short-term assets but also it increased the repayment of some mortgage based assets which drove our asset volume down a little bit. So we attribute it to rate. Although it shows up just a little bit differently in our balance sheet.

Sure.

As to the uptick in the fourth quarter -- or in the first quarter, it was right at the end of the quarter that we purchased the second mortgage loans and our bank owned life insurance from the time of rate reduction we were lengthening some of our investment portfolio maturities. I think that its basically the combination of two things that will affect us in the first quarter. The purchase of assets right at the end of the quarter, which had very little impact in December. And then our decision that we've been implementing this month to hold more of our mortgage origination rather than sell it. And that will give us a nice lift in net interest income as well as margin as well as. We made our best forecast there with those number, the 95 and the 4.25. You know the vagaries of how that could affect us, but we're feeling that's a pretty good estimate right now.

Okay. Great. Just a follow-up on the organic consumer loan growth that you did see in the quarter. Any way to tell yet if that's largely being driven by cross sales to existing customers or is it more new business to the bank?

I'm going to ask Dave Thomas to field that, Joe.

Okay. Thanks.

The organic growth that we did see was very strong in the fourth quarter on an annualized basis approached 30 percent. And it really was principally driven by selling consumer credit to existing bank customers.

Okay. Appreciate it, Dave.

Our next question comes from Jackie Reeves of Putnam Lovell, please pose your question.

Thank you. A number of my questions have been answered. But on the tax rate, why was that temporarily declined into the fourth quarter?

Just a normal true up, Jackie for things that went on during the year and then we took a look at our effective rates related to leveraged leasing and timing there and that gave us a little bit of a benefit as well.

Okay.

But we were would expect it to return in the first quarter closer to traditional levels in that 35.5 percent range.

Great. I'm trying to get a little bit more comfortable with the zero provisioning and I know obviously you have very strong reserve coverage ratios. But taking a look at the nick (ph) portfolio, the air transportation, the exposure to real estate, hospital, so forth and so on, what, I guess, what would you have to see in those portfolios for you to start booking a provision again?

This is bill Nelson, Jackie. We do a every 90 days, we do a thorough review of the asset quality of the portfolio, both on the commercial and the consumer side. And we do a forward-looking statements of the assets, particularly those we have some concerns about and we run a number of different scenarios including some event type risks that could impact us as they have in the past out here in Hawaii. Based on that, we refresh our view every 90 days and I'm not seeing anything in the foreseeable future that would cause us to change the view that was communicated earlier this morning in terms of the provision for the year 2003. But it is something we review regularly and thoroughly and I'm quite comfortable with that, with the statements we've made at this point.

Jackie, this is Al. I think we would have to see a pretty significant reversal in the favorable trend of decreasing internal classifications and/or criticisms. Or we would have to see a significant dislocating event that would really weak an particular sector to which we had exposures.

Thank you very much.

Our next question comes from Campbell K. Chaney Sanders Morris Harris. Please pose your question.

Thank you. I had a question on the share count. I think a few quarters ago you gave us a rule of thumb that the difference between the diluted and the core or the base at the end of the quarter was about 2.1 million shares. Is that still a good number to use?

This is Cindy. Yes it is, Campbell. The quickest and easiest way to estimate it would be to take the difference between the average share count for the quarter and diluted share count and then use that as an adjustment against the end of quarter share count, just a real quick and easy approximation.

Right. Okay. That's all I had. Thank you.

Our next question comes from Adam Compton of KBW. Please pose your question.

Hi good morning. I noticed when you were talking about the net income guidance for this year, you mentioned that you have an expectation that rates are up by the end of the year. Can you give us any idea of the sensitivity of your expectations to that? For instance if rates stay about where they are, would that dramatically affect what you're looking for?

Well, Adam, it would have some effect, that's for sure. I don't have a particular number in mind here that I could give you just because we will constantly monitor and adjust to that. We expect rates some time around mid-year to start up and then go up in a gradual fashion. If that weren't to happen, we would continue doing some maturity lengthening and might make other decisions around our mortgage portfolio depending on the repayment speed or refinancing speed that we could see going forward. That's probably as much as I think I can give you on that, Adam. But it certainly does have some sensitivity if rates hold flat, it will make it difficult to sustain that level of net interest income throughout the year.

Okay. Thank you.

The floor is still open for questions. Somehow have a question, please press star one on your push button telephone. If you wish to withdraw your question, please press star two. One moment, while we poll for questions. Our next question comes from Jim Bradshaw from D.A. Davidson & Co. Please pose your question.

Yes. Could you update us on Guam. I know right after the typhoon there was quite a bit of disruption in conditions. Can you give as you state of your operations there now?

Yeah. This is Al. I think actually, it's one of the bright spots for how our employees have performed. We've got all but two of our branches open permanently and we're taking a look at that. We're having temporary work conditions in a number of the branches and locations, but our people have just done a great job of both getting our merger completed at the end of the year and taking care of customers while there's a fair amount of recovery that our employees have to do. But we're in pretty good shape out there, given what's happened to us.

Yeah, I think in the short-term, Jim, there will be an impact on the economy which was not particularly strong even before the typhoon, but you'll see a decline in tourism offsetting that is the expectation that a significant amount of federal aid related to reconstruction will be coming through beginning shortly. So short-term difficulties, I think, but in the medium to long-term, we are hoping that things will get back to normal in no small part a result of the infusion of federal funds.

Thanks.

Also, I think the military is increasingly interested in Guam as a strategic location. We've seen a couple of nuclear submarines based there and I think there may well be more of that.

Our next question comes from Joseph Morford of RBC. Please pose your question.

Just a couple of follow-ups. Have there been any updated thoughts on what the ultimate target amount is for the capital base? I think in the past you said in the 600 to 700 million dollar range. Also, if you could elaborate on some of the improvement in the employee and customer satisfaction levels. Thanks.

Joe, this is Al. On the capital base, no further guidance on that from where we are right now. From what we've said in the past I mean. The 600 to 700 million level would seem about right.

Okay.

We would expect depending on market conditions to be at about an 8 percent ratio at the end of the year.

Okay.

Let me have Dave Thomas field the satisfaction question.

Joe, the improvement in satisfaction numbers both employee and customer is just a continuation of a trend that we've seen established now for several quarters. These are measures that we survey each quarter and this trend, as I said, has been improving pretty regularly. Over the past six month, it's really been accelerated I think by the implementation of our excellence in sales and service program which we launched in the middle of last year. A very focused program, bank wide for all of our employees to make sure they take the time to understand customer needs and provide solutions to those needs whether they be product sales or other customer based improvements. And that program has really taken hold deeply throughout the entire company and I think that's really helping us sustain the improvements that we've seen in both of these measures.

Okay. Thanks, Dave.

Our next question come Adam Compton of KBW. Please pose your question.

Hi, could you give us some idea of the credit characteristics on the purchased second mortgages as far as LTVs or FICA scores?

Yes, Adam. This is Dave Thomas. This is very high quality home equity portfolio. In terms of LTV, it's principally around a 90 percent LTV although there are some assets in the portfolio that go up to a maximum of 100, but nothing over 100. FICA scores are also very strong. I don't have with me the exact weighted average, but it is it compares very favorably to the existing portfolio we have in terms of our organic growth.

Okay. Thank you.

I think FICA scores average over 670. This portfolio is spread out over 12 states, probably 4900 or so loans so the average loan size is very modest and very granular.

Once again, the question and answer session has begun. If you have a question, please press star one on your push button telephone. If you wish to withdraw your question, please press star two. If there are no further questions, I would now like to turn the conference back to miss Cindy Wyrick.

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

Ladies and gentlemen, this concludes our conference for today. This call will be available for replay from January 27 to February 3 on 1-800-428-6051 and 973-317-5319 using pin number 273137. Thank you for participating and have a nice day. All parties may now disconnect.