Bank of Hawaii Corp (BOH) 2003 Q1 法說會逐字稿

Good morning and welcome, ladies and gentlemen to the Bank of Hawaii Corporation first quarter 2003 earnings conference call. At this time, I would like to inform you that this conference is being recorded. And all participants are in a listen-only mode. At the request of the company we'll open the conference up for questions and answers after the presentation. I'll turn the conference over to Cindy Wyrick, Investor Relations.

Hello, everyone and thank you for joining us today as we review Bank of Hawaii Corporation's financial results for the first quarter for 2003. With me today is our Chairman and CEO, Mike O'Neill; Financial Officer, Al Landon; Vice Chairman and Chief Risk Officer, Bill Nelson and Dave Thomas, the Vice Chairman and head of our Retail Banking group.

Comments today will refer to the financial information included to our earnings announcement released earlier this morning. Before we get started, let me remind you that today’s conference call will contain some forward-looking statements. While we believe the assumptions we have made are reasonable, there are a variety of reasons that actual results may differ materially from those projected, and now I'd like to turn the call over to Mike O'Neill.

Good morning or afternoon, everyone. The first quarter of 2003 was definitely a good one for Bank of Hawaii, despite weak market conditions and geopolitical instability. During the quarter, our credit quality indicators continue to improve, our margin strengthened. We saw growth in both loans and deposits. Our expenses are coming down, and our system conversion remains on budget and on schedule. The first quarter results in the ongoing resilience of the Hawaii economy have been very encouraging and we remain optimistic that we will continue to grow our businesses and improve our operating efficiencies during 2003. We are reaffirming our earnings guidance of [$131 million] in net income for the full year of 2003.

Now I'd like to ask Al Landon to provide you with a more detailed review of Bank of Hawaii Corporation's financial performance in the first quarter of 2003.

Thanks, Mike. Good afternoon, and morning, and thank you for joining us today. As Mike said, Bank of Hawaii Corporation had a good first quarter. Our net income was $29.8 million and 47 cents per share. These earnings are an increase from fourth quarter income of $28.9 million and [44] cents per share. The increase from fourth quarter earnings was primarily due to increased net interest income and expense reductions. Our return on assets for the first quarter of 2003 was 1.31%, up from 1.2%. Our return on equity for the quarter was 12.42%, up from 10.72% in the fourth quarter. On a per share basis, our net income of 47 cents was up from 41 cents in last year's first quarter. Compared to that first quarter of 2002, our reported net income was down slightly from 31.1 million. However, the first quarter of 2002 had no systems replacement cost, which totaled 7.4 million in the first quarter of 2003. Adjusting for that difference, we had a $3.5 million increase in net income compared to last year.

Our net interest margin for the first quarter was 4.29%, up 24 basis points from last quarter. Compared to last year's first quarter, our net interest margin was up 37 basis points. We've included an analysis of the net interest income changes from last year as table six, accompanying our earnings release. The increase in net interest income and margin from the fourth quarter is due primarily to an increase in higher yielding loans, as well as a reduction in lower [yielding] short term investments and borrowings. While we still have ample liquidity, we have deployed our assets more effectively and restructured and reduced our overall credit and market risk. Again, in the first quarter of 2003, we recorded no provision for loan losses.

Net charge-offs were down to $2.8 million for the quarter, compared to $11.6 million in the fourth quarter, and $8.3 million in the first quarter of 2002. Our credit quality and loan losses continue to benefit from improved risk management and the more stable Hawaii economy. Non-interest income for the first quarter totaled $44.8 million. This total was down from fourth and first quarters of 2002, primarily because of our decision to sell less of our mortgage loan production in the first quarter.

Other income also decreased, particularly from the fourth quarter, which had included a gain on a venture capital investment and bank owned life insurance benefits. Trust and asset management income decreased from the first quarter of last year due to market value declines but increased slightly from the fourth quarter. We were encouraged to see that most of the remaining categories were non-interest income were up compared to either quarter of last year.

Non-interest expense was down substantially from the fourth quarter. Excluding the system replacement cost in 2003 and restructuring cost in 2002, non-interest income also decreased significantly from the first quarter of last year. Salary expense was down due to fewer people and to a lesser extent the deferral of mortgage origination results that result from holding rather than selling mortgage production. Benefits expense increased consistent with our seasonal pattern.

Other expenses decreased from fourth and first quarters as we incurred less professional and other outside service costs. In the fourth quarter, we had recognized a $1.3 million loss due to the impact of a major typhoon on Guam.

Our people and the team from Metavante are doing a great job preparing for the upcoming conversion of our computer processing to Metavante. Additionally we have nearly completed the process of upgrading critical network components, including nearly all of our PCs and we've begun the important training phase for our customer service teams. We are pleased that the initial estimate of $17 million of annual cost savings looks very achievable. As I mentioned, we recognized systems replacement cost of $7.4 million in the first quarter of 2003, up from [$7.1] million in the fourth quarter. We expect to incur systems replacement costs of about $10 million in the second quarter of 2003. These costs are in line with our budget for systems replacement.

Our income tax rate for the first quarter was 34.6%, a slight increase from last quarter, at about the rate we expect for 2003. We've added some additional information to the earnings release this quarter. Table 11 includes a summary of business segment performance. Since this is the first time we've included segment information in our earnings release, I would like to provide some background on how the management team evaluates business performance. This management information is based upon and derived from the historical financial statements of Bank of Hawaii Corporation, but is probably not comparable with other companies. For management analysis, we divide the company into organizational units that comprise three major segments, retail, commercial and investment services. We separately measure treasury and certain other corporate activities. In measures segment financial performance we allocate net interest income between assets and liabilities, and then attribute it to the business units. We separately assign direct costs to the businesses. We also allocate the costs incurred by support units where it's practical to do so based on usage or other measures. We calculate the amount of capital necessary to compensate for risk inherent in each business unit.

We charge the businesses with that capital at a rate that we think represents the return expected by investors. We also make other adjustments to reflect the economic contribution of the business segments. The result of this process is net income after capital charge or NIAC, as we call it. By measuring the business performance after deducting the cost of capital, we can identify where value is being created. We also calculate the percentage return on allocated capital, which we refer to as risk adjusted return on capital or RAROC. Our governing objective is to maximize shareholder value over time. He believe growing NIAC is the best indicator of value building. In the first quarter of 2003, both the retail and commercial segments had a meaningful improvement in performance when compared with the first quarter of 2002. Solid deposit growth, low credit losses, and expense reductions were significant factors affecting the performance of both the retail and commercial segments. The retail segment also benefited from a higher level of assets. The non-interest income of the retail segment was affected by a decrease in mortgage banking income, as loans were retained in 2003. By contrast, 2002 included an unusually large gain in mortgage banking income, but resulted from a market recovery. Our investment services segment was affected by weak market conditions and had less opportunity to reduce expenses as important process improvements are currently under way. Despite these challenges, our investment services segment maintained a positive NIAC. The treasury segment reflects the impacts of movements in market interest rates on the company's interest rate sensitivity. The decline in interest rates reduced interest income in this segment during the first quarter of 2003. Additionally, most of the systems replacement costs are recognized in this segment as corporate costs. The cost of the amount of capital in excess of that needed by the other business segments also is allocated to the treasury.

Although our capital levels are being reduced, the total amount of the company's capital remains greater than that needed by the separate business segments. The cost of this extra capital is also reduced against the NIAC of the treasury segment. We plan to continue this business segment disclosure in future earnings releases to provide additional insight into our operations.

As Mike mentioned, we continue to see improvement in credit quality. During the quarter, our non-performing assets decreased to [$44.2] million, from $54.4 million at the end of December, and $90.7 million at March 31st, 2002. Contributing to the quarterly decrease was the reduction of three non-accruing loans totaling $7.8 million that were sold or returned to accrual status. We recognize the loss of $1.4 million on one of those loans. There was a decrease in the in-flow of nonperforming loans. $4.8 million compared to [$12 million] in the fourth quarter of 2002. The elements of our nonperforming assets are summarized in Table 8 accompanying our earnings release. The ratio of our non-performing assets to loans in non-performing assets improved to .79%.

We continue to have exposures to air transportation as summarized in Table 7. You may note there was a $1 million net increase in this exposure which represents a cash secured loan to a regional carrier. Our air transportation leases are current as of March 31st.

The other area of potentially weaker credit quality is our Guam portfolio, where some of our borrowers have been adversely affected by the local economy and the typhoons that struck the island last year. We've also summarized our Guam credit exposure in Table 7.

Also presented in table 7 is our credit exposure to syndicate the loans. During the first quarter we reduced our total syndicated loan exposure by $50 million as a result of our ongoing efforts to reduce large non-relationship exposures. This reduction in total exposure is the net effect of a $60 million reduction in undrawn commitments and a $10 million increase in outstandings. The largest industry groups among the outstanding syndicated [inaudible] are real estate, hospitality and gaming.

With the overall improvement in our credit quality, we were able to continue the reduction of our allowance for loan losses. The allowance was $140 million at March 31st, 2003, down $2.8 million from year-end. Although we did not take a provision for loan losses in the last three quarters, the allowance still represents 2.52% of loans. We remain adequately reserved.

We continue to evaluate the economic environment and the level of risk in our portfolio each quarter, and recognize a provision for loan losses only to the extent necessary to maintain the allowance at the appropriate level. During the quarter, we took additional steps to lengthen the maturity of some short term assets. We held rather than sold a good portion of our mortgage origination and increased the average balance of residential mortgages by about $36 million. We are also adjusted our deposit strategies and pricing. These actions mitigate some of our asset sensitivity which had increased during the last two quarters due to a decline in short term interest rates. Although we have invested some of our excess liquidity, our liquidity position remains quite strong. In addition to the residential mortgages, our domestic, commercial and other loan portfolios increased, $40 million during the first quarter through organic growth. As a result of the low interest rates, our mortgage servicing prepayments increased, although we did not incur the impairment charge.

The loan prepayments reduced the carrying value of our mortgage servicing rights by about $3 million to $25.8 million. These rights continue to be recorded on a conservative basis and were carried at about 76 basis points in aggregate. Our funding trends continued during the first quarter as our demand in savings deposits continued to increase while time deposits and borrowings decreased.

The Hawaii economy remained relatively strong and stable, in spite of the war. Visitor arrivals have remained near normal levels, although we did receive fewer international passengers. Construction and real estate are very positive factors, and unemployment is now at 3%. Barring a major event, we expect that 2003 will be a solid year for the Hawaii economy.

Last quarter, we indicated that we expect Bank of Hawaii Corporation to earn $131 million of net income for 2003. Although the components of income have changed from our previous forecast, we continue to believe that the $131 million target is realistic.

Our second quarter net income should approximate first quarter earnings. We expect our net interest income will increase slightly in the second quarter, non-interest income should increase in the second quarter, as we plan to sell more of our mortgage production. Direct costs of systems replacement and other expenses will likely increase this quarter, and then start decreasing in the second half of 2003. Our goal remains to improve our efficiencies ratio to 58% by the end of this year.

Our earnings estimates are necessarily based on several assumptions. We continue to forecast that interest rates will increase in 2003. We expect economic conditions will remain solid in Hawaii, and improve in Guam, and that loan losses and credit quality will allow continued reserve reductions. There are many other assumptions that affect our estimates, including the absence of major geopolitical events.

Our share repurchase program performed well again in the first quarter, as we repurchased 2.86 million shares. But so far, in April, we have only been able to repurchase 140,000 shares as we were unable to maintain the repurchase volume during the last few weeks. We plan to continue to make repurchases in a disciplined manner, and as a result, our second quarter repurchases may be less than recent quarters. As we previously indicated, the volume and timing of share repurchases depends on market conditions that are difficult to predict. Accordingly, we remain unable to provide guidance on earnings per share.

We've declared our second quarter 2003 dividend of 19 cents per share.

In summary, this was a solid quarter. Our systems replacement project and other initiatives are on track to further improve customer service and reduce our future operating costs. And we remain optimistic that the Hawaii economy will help us achieve our 2003 earnings and performance targets. Mike, that concludes my comments.

Mike Thanks, Al. We'll take any questions that you may have at this point.

Thank you, sir. The question and answer session will begin at this time. If you're using a speakerphone, please pick up the handset before pressing any numbers. Should you have a question, please press star one on your push button 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.

Our first question comes from Joe Morford of RBC.

Hi, it's Joe Morford. Good morning, everybody. A couple of questions on the loan portfolio, specifically looking at the March end of period balances versus year-end. It looked like the commercial real estate was up maybe 100 million sequentially. I was wondering what was driving that, maybe some shift in construction credits to permit financing or anything else and separately on the mortgage side, residential mortgages, it sounds like you'll be returning to selling some of the production in the second quarter. Will you still be keeping some of that, and is there some sort of concentration level that you might be targeting, whether from loan mix or asset liability purposes or anything like that?

Joe, I'm going to ask Bill to deal about that first question on the increase in commercial real estate loans, and then Al will take on the second part.

Great, thanks.

Joe, this is Bill Nelson. We've had some increase in the commercial mortgage. As you know, from Table 7 in the earnings release, through the first quarter, and it's a variety of different commitments that we've made, and increase in outstandings. No particular one area. We had a variety of different commercial properties that represent that increase, no particular concentration in any one mortgage or anything like that. So it's just a variety. We've seen some strength in that area starting late last year, and that continues through the first quarter. We would expect some modest continuance of that moving forward.

Okay, thanks.

Joe, this is Al. With respect to our mortgage portfolio, you're right. We're going to pick up our sales activity, which is kind of our normal pattern there. We don't have any firm target, although I would say that somewhere around the level of holdings that we have now, it depends a lot on prepayments would be where we would end up for the year, or where we would try to stay. We will continue to look at what we originate and I would suspect for asset liability management purposes we'll keep some of those loans, particularly some of the variable rate loans.

Okay. Thanks, and maybe Mike, just one last follow-up question. In the last few weeks, there's been talk about the two smaller banks in town, CPB and CB Bank shares getting together. I was just wondering your reaction to that. Do you see any kind of longer term competitive threat at all?

Joe, I really don't have much of a reaction to, you know, the combination of those two banks. They're each about $2 billion banks so coming together they'll be $4 billion up against our, call it nine to ten. So you know, I guess there's some industrial logic to the combination. And I think I'll leave it at that.

Okay, that's fine. Thanks, Mike.

Our next question comes from Robert Lacoursiere of Lehman Brothers. Please pose your question.

Sorry, not to belabor the point on the mortgages, but just to see if I can understand a little bit better. How much of the drop on the sequential quarter basis in the mortgage banking line in fee income was the product of the loss or the less gain on the sales of these mortgages? And do we -- should we just expect it to snap back to a more normalized level next quarter as a result?

Robert, this is Al. I don't have exact figures on how much of the drop was due to the gain on sale, but I would say that most of it came from that. And so we would expect to see it come back to the range that it had been operating in before, but several factors affect that, as you can appreciate how much we sell, how much we originate and a little bit depends upon how prepayment speeds go as well. But I would say that you're reasonable in your figuring that most of that came from the absence of same sale gains.

All right, just still on the mortgage theme, one is you increased your amortization, there’s no impairment but you raised the amortization pace?

The prepayments speed up, and that basically causes those rights to go away. So while we didn't have any impairment of the value of our remaining rights, we have fewer mortgages serviced just as a result of the prepayments. Now, we captured a good bit of that business coming back in refinancing, and of course, got those loans, but since we didn't sell those into the marketplace, we didn't have that pick up as capitalized mortgage servicing rights.

All right, and if I could, on the other expense line, I don't know if I missed the explanation but can you give us a little bit of color, I assume the fourth quarter's numbers were replayed because of your year-end true-ups. Should we expect or can you give us a little color what else was behind the sequential quarter drop?

Well, there's a bunch of things. That's why we call that other. Professional services was the biggest piece, and then I mentioned also that we had an accrual for the typhoon out in Guam that hit on December, I think December 8th.

Um-hum.

The rest of it is basically normal kinds of things that happen around year-end, although I would say that -- I would tell you that we have been particularly diligent in trying to reign in our costs and expenditures. So you'll find things kind of in that discretionary or variable category, travel, education, our advertising folks were able to be effective with less media spend. So a variety of those sorts of savings individually small in amount, but they add up.

Thank you.

Our next question comes from Jim Bradshaw of D.A. Davidson.

Good morning. A couple questions if I may. Excuse my voice. The purchased home equity loans, I calculate that they are runoff rate was something like 32, 33% so something about a three-year life. Is that a decent run rate and is there a reload function you might have on those?

Jim, this is Dave Thomas. In terms of the amortization in the first quarter, your rough calculations may be just a little bit ahead of the actual, but around the 30% range is where they were. They clearly were impacted by the level of interest rates, and I would say early in the quarter we saw amortization that was slightly ahead of our original model, but not dramatically so. As we got toward the end of the quarter, we saw the amortization or the prepayments on that portfolio get back in line with our original estimates. At this point in time, we don't have any plans right now to make any additional purchases. Our goal is to continue to focus our energies on organic growth in our home equity portfolio here in the Hawaiian market.

Jim, this is Al. I would just add to that our experience in the first quarter was roughly in line with what we thought when we purchased these loans. You may recall, we indicated that this was kind of to jumpstart our unit here in terms of covering our costs. So it's done that and our yield is just a little bit behind where we priced this thing when we bought them.

And then eventually you hoped to replace that runoff with home grown growth, I guess, too, huh?

Yes.

Absolutely. That's the plan.

And just one more. Could you give us some color on how the economy is shaping up in Guam now, after it's been a quarter or so since the typhoons hit?

Probably a little bit too early to tell at this point. As you would expect, it's naturally coming back. There's going to be a pickup in construction and infrastructure rebuilding, but I think maybe a little too early to give specific circumstances on how it's doing out there.

Thanks a lot. Those are helpful.

Okay, thanks, Jim.

Our next question comes from [Julianne Casarino] of Prospector Partners.

Could you walk me through kind of the logic behind why you stopped selling loans this quarter and started to portfolio them, and why continue to sell them next quarter? I'm just wondering for some background why that was.

This is Al, Julianne. Our thought on this, we study it every month in our asset liability management committee, and as we saw rates decreasing late fourth quarter and significantly into the first quarter, it gave us an opportunity from a funding standpoint, I think, to put these things into our -- put income into our net interest margin, and while we would do that opportunistically, we are at about the level of mortgages we think makes sense for us in the scenarios we see. So that's why we've returned to sales levels. Kind of an optimization model we try to run between net interest income and gain more sale from the mortgage servicing.

The loans that are in the portfolio right now, are those, can you give me about what percent are fixed rate and what percent are hybrids and what percent are fully adjustable?

I don't have that in the top of my memory. I think Dave's looking for a little bit of information. Do you have anything that gives it to you there, Dave?

Why don't we get back to you on that .

I've got it. Right now it terms of the total portfolio, it's about 60% fixed and about 40% adjustable.

And are the adjustables predominantly hybrids like fixed for a certain number of years?

Yes.

Okay, thank you.

Our next question comes from [Miles Wicson] of Rockefeller.

The pause in buyback activity, is that because the stock's at $33 or because there wasn't the liquidity there to buy it back?

Oh, it would be difficult to say, Miles. As you know, there's a period there where we don't have quite the same flexibility before our earnings release and that's probably about all I better say on that.

Are you as comfortable buying back your stock now at the absolute level it's at versus previous quarters?

Miles, we really tried not to you know, to make any comments about our strategy on these buybacks and I don't see any reason to change it.

All right, thanks.

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

Good morning. It looks like you've done some good works on the savings and deposit balances. They were up significantly in the quarter-to-quarter. Can you give us some color on what did you do to drive that number, and also on the fee income from deposit services was up as well. Can you give us some color on that number, what happened in the quarter to get the fees going? That's it. Thank you.

Yes, Campbell, this is Dave Thomas. In terms of the savings balances I think there really are two initiatives there that have positively impacted us. First is, in terms of our pricing strategy, we have continued to focus on having less concentration in time deposits, which have given our customers, I think, a pricing incentive to move into our nontime savings products, and then secondly, we feel we are beginning to see some very positive results from our focus in the sales management process, and garnering some more deposits from our existing customers, and bringing in new deposits. In terms of the fees related to the deposit accounts, it really is directly attributable, the fact that we had very good growth in checking accounts during the first quarter. We had a checking promotion that kicked off in January, which was very successful. We are continuing now for several months in a row to see net positive growth in our checking accounts, both interest bearing and non-interest bearing and of course, the number of accounts is what really drives those deposit fees. So I think that's the primary factor that's driven that in the first quarter.

How many accounts did you get in the first quarter, and can we expect the same kind of growth going out into the next few quarters?

I don't have the specific account numbers right here with me. And in terms of future growth, the growth rate that we see in new accounts obviously is closely tied to our promotional activity, and we had a very strong promotional activity during January and February. We don't have a checking account or a deposit focus promotional activity scheduled for the second quarter. So while we expect to see continued growth, it probably will not be at the same pace that we saw in the first quarter, just because of lightening up on the promotional activity.

Okay, great. Thank you.

Our next question comes from Brian Mic Harvey of Fox-Pitt, Kelton. Please pose your question.

Good morning. I just had a couple of questions. I want to get back on the mortgage numbers for a little bit here. Can you talk about what the average coupon was of the mortgages that you added this quarter, and were they fixed rate and what type of loan, third year or 15-year fixed rate loans?

Bryan, this is Al. Those are pretty specific questions, and I'm not sure that I've got anything with me that tells exactly what we had for -- what went into the portfolio. I would say generally that they're around the market yield. We didn't do anything special in terms of promotional activity rate-wise. We've continued to strengthen our mortgage business, as you know, over the last year, and have a good sales force and our servicing routines are processing routines on origination continue to work very well. We've also improved our technology out there. But in terms of details of incremental portfolio composition, I think we'll probably have to try and get back to you later today.

Okay. You indicated that you'd become less asset sensitive. Do you have any sort of numbers to put behind that in terms of, you know, rise or a decrease in interest rates and what impact that would have on the balance sheet?

We do monitor that on a regular basis, and if you'll bear with me, I have some sensitivity information. There's a danger in over-relying on that, I guess, just because our experience is, as you heard us talk about interest rates before, they never work out exactly the way you think they're going to. It looks to me like we've got about an $8 million upside on 100 basis point increase in rates, and that would be sort of an assumption of a parallel increase.

One just unrelated question about the cost savings. You said $17 million is still on target. Is that versus the $83 million of total expenses if you exclude the replacement costs this quarter? Is that kind of used --

I wish it were, Brian. We've been consistent with our 17 million, and that's based on the expense run rate for the second quarter of last year, when we announced that.

Okay.

And it's hard to really get at all of the details of what has been implemented already, but our technology and operation folks have been doing a super job in terms of taking down headcount through attrition here, as we've gone along, and as we've made individual areas, or as we've hit individual performance targets for our plan. So it's a little optimistic to think we'd be able to get it off of this quarter's run rate.

But you can't say how much of the 17 is included in this quarter's run rate?

I don't have the exact number there, and I'd be reluctant to speculate on that. I think the only target we've really identified is 17 off of the second quarter's run rate from last year.

Okay, thank you.

As a reminder, ladies and gentlemen, should have you a question, please press star one on your push button telephone. If you wish to withdraw your question, please press star two. Our next question comes from Joseph Morford of RBC. Please pose your question.

Thanks, just a follow-up. Right, where you're not commenting specifically on your buyback strategy, I wonder are you still targeting a 8% equity asset ratio by the end of this year and on a related or separate actually capital management question, your new table, Page 11, I just wondered the RAROC at the retail banking at 36% and 24% for commercial banking, what kind of targets do have you for those?

As to the capital at the end of the year, Joe, 8% would still seem to be a pretty reasonable floor for us. As you can appreciate that varies a little bit depending on the repurchase. Mike?

Yes, on the sec. question, Joe, clearly RAROC is not what we're driving for. Wher' driving for NIAC. Any opportunity that we would get in any retail or commercial is above our cost of capital, which we think today is about 12%, we would take advantage of. So a reduction in RAROC would not trouble me if were accompanied by a corresponding increase in NIAC.

That's what I thought. Thanks.

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 additional questions or you need clarification on any of the issues discussed here today, please feel free to contact me at 808-537-8430. Thanks everyone. Have a great day.

Ladies and gentlemen, this concludes our conference for today. Should you wish to access the replay of this call, you may do so by dialing 1-800-428-6051 or 973-709-2089 using access P.I.N. number of 273138. Thank you all for participating and have a nice day. All parties may now disconnect.