Bank of Hawaii Corp (BOH) 2003 Q2 法說會逐字稿

Good afternoon. Welcome, ladies and gentlemen, to the Bank of Hawaii's second quarter earnings conference call. At this time I would like to inform you that this conference is being recorded. All participants are in a listen-only mode. At the request of the company we will open the conference up for questions and answers following 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. Thanks for joining us today to review Bank of Hawaii's financial results for the second quarter 2003. 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, Dave Thomas, Vice Chairman and head of Retail Banking, and Gretchen Mohen, head of Technology and Operations, also Vice Chairman. Our comments today will refer to the financial information released this morning in our earnings announcement.

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

Now I'd like to turn the call over to Mike O'Neill.

Hello, everyone.

Second quarter 2003 was a really busy one for us. We completed our systems conversion on July 7th, and I'm happy to say that it was accomplished as scheduled and within budget. The scope and magnitude of this project were considerable, and I am pleased it was accomplished without major disruption to customer service. I'm very proud of our employees who worked extremely hard to achieve this goal.

In addition to this conversion, our credit quality indicators continued to improve during the quarter. Our deposits continued to grow and our expenses are coming down. Our loan pipeline has been growing, as well.

Second quarter financial results and on-going resilience of the Hawaii economy are encouraging, and we are optimistic that we will continue to grow our businesses and improve operating efficiency during 2003. As Al will talk about in more detail, we are reaffirming our previous earnings guidance for the year as a whole.

And now I'd like to ask Al to provide you with a more detailed review of Bank of Hawaii Corporation's financial performance in the second quarter, 2003.

Thanks, Mike and thank you all for joining us.

In the second quarter, Bank of Hawaii Corporation's net income was $30 million and 48 cents per share. These earnings increased slightly from first quarter 2003 net income of $29.8 million and 47 cents per share. Compared to the first quarter, the second quarter earnings included a higher level of mortgage banking income, offset by higher systems replacement costs. During the first quarter we retained most of the mortgage loan production in the portfolio. But in the second quarter we resumed to selling the loans into the secondary market.

Our return on assets for the second quarter 2003 was 1.27% compared to 1.21% in the first quarter. Our return on equity for the quarter was 12.93%, up from 12.42% last quarter. On a per-share basis, our net income of 48 cents was up from 42 cents in last year's second quarter.

Our net income was down slightly from the $31 million earned in the second quarter of 2002, however, there were a couple of notable differences. Second quarter 2003 results included $10.1 million of systems replacement costs and no provision for loan losses. The second quarter of 2002 had no expenses related to our systems replacement project, but had a provision for loan losses of $3.3 million. Taking these differences into account we had a nice increase in second quarter net income compared to last year.

Net interest income was $90.5 million in the second quarter, down $500,000, or 1/2 a percent from the first quarter. Our net interest margin for the second quarter was 4.12%, down 17 basis points from last quarter. Compared to last year's second quarter our net interest margin was up 15 basis points.

We've included an analysis of the changes from last quarter in net interest income in Table 6 accompanying our earnings release. The decrease in net interest income from the first quarter is primarily due to reductions in interest rates on earning assets, partially offset by increases in average loans and investment securities.

Again in the second quarter 2003 we recorded no provision for loan losses. Net charge-offs were $2.1 million for the quarter, compared to $2.8 million in the first quarter. Net charge-offs in the second quarter of 2002 were $3.3 million and a provision for loan losses was recorded for this amount. We have not recorded a provision for loan losses since the second quarter of 2002. Our credit quality and loan losses continue to benefit from our risk management processes and a stable Hawaii economy.

Non-interest income for the second quarter totalled $50.7 million, an increase of $6 million from last quarter and $2.8 million from the second quarter of last year. These increases were primarily due to increases in mortgage banking income, driven by gains on the sale of mortgage loans. As I mentioned before, in the first quarter of 2003, most of the loan production was retained in the portfolio, but loan sales were resumed in the second quarter.

Trust and asset management income was down from last quarter due to the seasonal impact from tax services from the first quarter. Trust and asset management was also down from last year due to lower values of assets under management.

Non-interest expenses totalled $95.4 million in the second quarter, up by $5.2 million from the first quarter. The increase was due to increases in systems replacement costs and salaries. In the second quarter of 2003 systems replacement costs were $2.7 million higher than the first quarter. Salary expenses were up from the first quarter and from last year's second quarter due to the performance accelerated vesting of restricted shares that were granted to our managing team in 2000, annual salary increases that were effective early in the second quarter, and separation expenses included as we begin to reduce the size of our management team. Excluding the systems replacement costs in 2003, non-interest expenses decreased $4.1 million from the second quarter of 2002.

As Mike commented, the systems conversion was completed on time and is expected to be at budget when the final costs are recognized this quarter. We estimate that we will recognize additional costs of about $4.4 million in the third quarter of 2003, bringing us to the $35.5 million in total expected costs for the project.

I would add that since July 7 we've been operating on our new system. The operating performance was good at the start and has improved as our people have gained experience with the new system. I'll say more about this in a few minutes.

Our income tax rate was 34.5%, the rate we expect for the full year of 2003.

Table 11 provides a summary of business segment results, which is how the management team evaluates business performance. We first discussed this information with you last quarter.

For management analysis purposes 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 a fourth segment.

In measuring segment financial performance we allocate net interest income between assets and liabilities, and then attribute these revenues to the business units. We separately assign direct costs and allocate the cost of support units to the business unit. The result of this process is net income after capital charge or NIACC. We also calculate the percentage return on allocated capital, which we refer to as risk adjusted return on capital, or RAROC.

In the second quarter of 2003 the retail and commercial segments both had significant improvement in performance when compared with the second quarter of 2002. Similar to last quarter, deposit growth and expense reductions were significant factors affecting the performance of these segments. The retail segment also benefited from a higher average level of assets.

The results of the investment services segment also improved over the second quarter of last year, despite the uncertain market conditions that continued to impact the results of this segment.

The treasury segment reflects the impact of movements in market interest rates, given the company's interest rate sensitivity. The decline in interest rates reduced interest income in this segment during the second quarter of 2003. Additionally, most of the systems replacement costs, as well as the cost of excess capital, are allocated to the treasury segment.

Although the capital levels are being reduced, the amount of capital remains greater than is needed by the business segments, thus further reducing the NIACC of the treasury segment. I want to mention we're revising the formula we use to assign credit for the value of deposits to the segments and expect to make reclassifications in future reports.

We continue to see improvement in credit quality. During the second quarter our non-performing assets decreased to $42 million from $44.2 million at the end of March, and $78.8 million at June 30, 2002. Contributing to the quarterly decrease was the return to accrual or repayment of several smaller loans. The elements of our non-performing assets are summarized in Table 8 accompanying the earnings release.

The ratio of non-performing assets to loans and non-performing assets improved to 0.77of a percent at the end of the quarter, compared to 0.79 at the end of March and 1.45% in June, 2002.

Our more significant risk concentrations are summarized in Table 7. During the second quarter we saw some signs of improvement in each of our air transportation Guam and syndicated loan exposure. Our air transportation exposures remained at about the same level as last quarter, but the operating fundamentals of our leasees have improved. We also saw improvement in operations of some of our borrowers in Guam,although the economy there remains below par.

During the second quarter our syndicated loan outstandings decreased $41 million to $278 million. The undrawn commitments also decreased to $607 million, and as a result, we reduced our syndicated exposure by $67 million. The largest amounts of these syndicated loans are still in the real estate, hospitality, and gaming industries.

With the overall improvement in our credit quality we were able to continue the reduction of our allowance for loan losses. The allowance was $138 million at June 30, 2003, down $2.1 million from March 31, and down $4.9 million from year-end. Although we did not take a provision for loan losses in the last four quarters, the allowance still represents 2.52% of loans. We continue to evaluate the economic environment and the level of credit risk in our portfolio each quarter, and we will recognize a provision for loan losses to the extent necessary to maintain the allowance at an appropriate level.

Our asset levels were constrained by significant amounts of pre-payments during the second quarter. Although our level of mortgage assets decreased by the end of the quarter, our average holding of residential mortgages were up slightly from the amount we held in the first quarter. We plan to continue selling most of our mortgage production, but we re-evaluate that decision regularly.

We occasionally sell mortgage back to other investment securities in response to market conditions. Our goal is to optimize income without taking too much extension risk.

As a result of the low interest rates, our mortgage servicing pre-payments also increased, although we did not incur an impairment charge. The loan pre-payments reduced the carrying value of our mortgage servicing rights by about $1 million from the end of last quarter to $24.8 million. These servicing rights are carried at 78 basis points in aggregate. Aside from residential mortgages, our average commercial and other loan portfolios remained at about the same level as in the first quarter, in spite of the pre-payments.

For the last two years we've been reducing our level of higher cost longer-term funding. This funding trend continued during the quarter as our transaction deposits continued to increase while time deposits decreased. Additionally during the quarter, we benefited from the maturity of $100 million of our 6 7/8% subordinated debt. We replaced this with $50 million of 4% 7-year notes.

Our balance sheet at June 30 was positioned to benefit from rate increases. Our liquidity position remains quite strong, giving us flexibility to respond to changing market conditions.

Now I'd like to comment on some operational accomplishments that are not obvious in our financial results. In addition to converting our mainframe computer systems, we've replaced substantially all of our personal computers throughout the company this year. We have rebuilt our internal network with essentially all new servers and have updated our network connectivity between our operating locations. We've converted our item processing system to a modern platform.

Our trust business has upgraded its operating system, and our asset management business has a new organization structure and business motto. We've partnered with a very successful equity manager and also strengthened the research capabilities of our asset management business.

We've installed new origination and servicing technology in our mortgage business, which has the leading market share in Hawaii. Our other consumer lending and small business units have greatly improved their business models and customer service. Our insurance businesses are much improved and have new management structure.

Our people have accomplished a tremendous amount in the last 12 months. We expect it will take a few more months to get all of our systems operating at optimal level, but our employees' enthusiasm levels are high, and we expect our customers will continue to see improvement in the quality of our service and the value of doing business with Bank of Hawaii.

As we start the third quarter we're encouraged by the record levels of new business in the pipelines for our mortgage and commercial lending businesses. Later this quarter we'll begin to focus on our next 3-year plan, which we expect to announce in January.

The Hawaii economy remains stable and relatively strong. Visitor arrivals have remained near normal levels during the second quarter. Domestic passenger volume increased, but was offset by reductions in international passengers. However, in July, there's been an increase in international visitors.

Construction and real estate are very positive factors, and unemployment is now around 4%. Personal income growth in Hawaii has been very solid. Barring a major event, we continue to expect 2003 to be a solid year for the Hawaii economy.

In January, and again last April, we indicated that Bank of Hawaii Corporation expected to earn $131 million of net income for 2003. Although the components of income have changed from our previous forecast, we achieved our expected levels of earnings for the first two quarters of 2003. We continue to think that earning $131 million is realistic, thanks in part to the increase in interest rates in the last couple weeks.

We expect that net income will increase by a meaningful amount in both the third and fourth quarters. Our goal remains to improve our efficiency ratio to 58% by the end of 2003. Assuming we achieve that goal, at year-end, our run rates for return on assets should be over 1.5%, and return on equity should be over 17%.

Our earnings estimates are necessarily based on several assumptions, including interest rates, economic conditions, customer activity, loan losses, and credit quality. And there are many other assumptions that affect our estimates, including the absence of major geopolitical events.

Our share repurchase program continued to be successful in the second quarter. We repurchased 2.2 million shares, bringing the year-to-date repurchase total to 5.2 million shares. We plan to continue to make the repurchases in a disciplined manner.

As we have previously indicated, the volume and timing of share repurchases depends on market conditions that are difficult to predict. Accordingly, we remain unable to provide earnings per share guidance.

Our board has declared our third quarter dividend at 19 cents per share. And we're reviewing our dividend policy and expect to increase our dividends.

To summarize, this was a quarter of major accomplishments. Much of our systems replacement project is complete and related initiatives are on track to reduce our future operating costs. Our credit quality continues to improve and the Hawaii economy remains sufficiently strong to support the on-going development of our businesses.

Mike, that concludes my comments.

Thanks, Al. Now we'll be happy to take any questions you may have.

Thank you, sir. The question-and-answer session will begin at this time. If you are using a speaker phone, please pick up the hand set before pressing any numbers. Should you have a question, please press star 1 on your push-button telephone. If you wish to withdraw your question, please press star 2. Your questions will be taken in the order they are received. Please stand by for your first question.

Our first question comes from Brian Harvey of Fox-Pitt Kelton. Please state your question.

Thank you. Good morning. Can you give us an update of where you think you are in terms of the cost savings of the $17 million on a run rate at the end of the quarter? You talk about reducing expenses, $17 million versus the second quarter of '02. Just want to get a better sense of where you think you're at percentage-wise.

I'm going to ask Al Landon to field that.

Brian, we have come along right in line with what we expect, and are still nicely on target for the $17 million. The components of that are compensation. As we've gone through the project we've made selective changes in head count, reductions in head count, in several areas, and we probably have a couple more quarters for that to show up completely in its impact. We've also been reducing our equipment costs, and that's going to take probably through this quarter for it to get out of the system.

It's a little bit hard to distinguish it in our financial statements because we've been making other cost reductions going forward, as well. But we're very comfortable with the $17 million savings at this point.

Is that $17 million including any of the benefits from the management reductions you talked about this quarter?

No.

Can you quantify that impact?

We're still working our way through that. Mike, do you want to add anything there?

No, I think one of the things we're doing, Brian, is we're taking a look at the overall levels of management. Clearly, three years ago we had some significant problems to deal with. We brought in some people to deal with them that had lots of experience. The stabilization in our results has the effect of, you know, our not needing the same sort of swat team that we needed three years ago. So we're going through the process of reducing those levels.

That involved a couple of people this quarter, and I think over the course of the next, call it four to five quarters, you will see a steady reduction as we develop people that were here to take on, you know, new responsibilities. The effect of all that will be to save us significant money. Let's say over the course of the next five quarters, you know, as much as $3 million on a run rate basis.

Okay, great. Thank you.

Our next question comes from Joe Morford of RBC Capital Markets. Please pose your question.

Hi. It's actually Brian Conn. I have two quick questions. One was, according to some of your competitors , smaller competitors in your marketplace, they've seen pricing pressure increase both CNI loans, as well as commercial real estate loans. And they said some banks have been giving concessions on terms of rate, as well as underwriting criteria. To what extent are you saying this? I know you said that you're seeing the pipelines actually build.

And can you comment on that, as well as how big the increase might be in the pipelines from this quarter from last quarter?

The pipeline is growing. This is Bill Nelson speaking. And we're seeing it growing in the Hawaii commercial banking business, and commercial real estate, in particular. We have not seen any need to compromise on our underwriting standards from our past practices, and we're not seeing a great deal of evidence in the marketplace that would suggest that we have to, to keep the market share that we've got. So, the pipeline is looking good.

We have had runoff in the last two quarters, which reflect some of the reduction in commercial lending balances from large corporates that have taken the opportunity to re-finance, these are good quality names, due to the low interest rate environment and their opportunity to get longer-term fixed rate financing. We've seen that in the hotel sector a little bit, in the gaming sector a little bit, but we do have good underlying organic growth in the pipeline and loans that are being booked.

Are those pressures -- I would imagine -- should have lessened as the 10-year, sort of, has backed up in the last couple weeks? The repricing pressure on the gaming as well as the hotel?

I'm speaking for refinancing that was done over the last 90 days, and I think you're right, Brian, there's probably some easing of that sort of pressure, and perhaps we'll see through this quarter a lessening of refinancing activity. And as I said, we've seen it mostly in the larger corporate sector, less so in the local middle market or small business sector.

Thanks.

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

Good afternoon. A couple of quick questions, if I may. It looks like the runoff has been centered in the syndicated portfolio and the purchased home equity loans, principally, but -- I'm having, sort of, trouble triangulating your core growth in the portfolio without those, sort of, unique pieces of the portfolio. Q3 looks like it will have more payoff from the Guam Hotel that paid off recently here. Can you give me a better idea of what, sort of, you think the core growth rate in your non-specialized portfolios looks like?

I think the core growth rate -- I'll speak to the commercial sector first -- is across mostly the local Hawaii commercial market and the commercial real estate market, which for us, those assets are almost all in the state of Hawaii. The core growth rate's much less so in large corporate because of what I describe as some of the runoff of some of that portfolio. Core growth, a little bit less in the leasing sector, although there has been some growth in Guam, which you see in Table 7 towards the bottom. And that's some increase in some high-quality commercial credits that we've put on very selectively down there, and then some growth in one of our retail installment lending sectors.

So, I'd say the growth is -- the organic growth and pipeline -- is across those markets, and in the retail side we continue to see very steady quarter over quarter growth in small business lending and also in the home equity portfolio, which is not the purchase portfolio. And then also in installment lending -- automobiles and personal loans. So that's how I would characterize it.

Thanks. One more quick one, if I may. The planned dividend raise is, you think, going to replace a portion of the $105 million or so buy-back authority that you have outstanding, or are those mutually exclusive events?

Well, they're obviously related, Jim, but I would consider them, if not mutually exclusive, certainly separate at this point. We continue to review that, but at this point I think you can count on both.

Okay, thanks a lot. Appreciate it.

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

If you could give more color on the transformation of our securities portfolio. In the text of your release you talk about deleveraging. Can you add to this -- because I actually see the average balances going up quarter on quarter, but if you can give us anything in terms of composition, whether it's measured in the type of securities or whether it's in duration.

Robert, this is Al. We monitor that pretty closely in terms of market conditions at this point. We've got quite a decent amount of liquidity, and the amount of pre-payment coming in the second quarter really increased that. The deleveraging we talked about there is the decrease in long-term debt. Then it, kind of, refers back to last year when we bought back a lot of our Trust Preferred and took a lot of leverage off of our balance sheet following the dispositions.

At the end of the second quarter, we continued to accumulate cash and did into the third quarter. And then as rates have moved here in the last couple weeks we've lengthened some of those maturities. We haven't particularly changed the character of the securities that we're investing in. We have lengthened the duration of that a little bit from an amount that was probably too short of duration last year, just due to the uncertainty of rates to where we're, kind of, a normalized level right now.

Can you tell us approximately what that level of average duration is on your portfolio?

I don't have it with me and I don't think we've disclosed that anywhere.

If I could on a related follow-up -- can you tell us if there was any premium amortization that affected the margin compression quarter on quarter?

The answer is yes. But not a significant amount. I think like everybody, we've got some premium securities, and as you get those pre-payments accelerating, that hits you a little bit. I don't believe there's anything there that's significant, Robert, and we didn't have any class of securities where there was an outlying amount of premium or premium amortization.

All right, thank you.

Ladies and gentlemen, as I reminder, should you have a question, please press star 1 on your push-button telephone. If you wish to withdraw your question, please press star 2.

If there are no further questions, I will now turn the conference back to Cindy Wyrick.

I would like to thank everyone for joining us today. If you 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, have a nice day, everyone.

Ladies and gentlemen, this concludes our conference for today. If you wish to access the replay of this call, you may do so by dialing 1-800-428-6051 or 973-709-2089 with a pin number of 273139. Thanks for participating. Have a nice day.