Bank of Hawaii Corp (BOH) 2003 Q3 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Bank of Hawaii Corporation third quarter 2003 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 will open the conference up for questions and answers following the presentation.

I will now turn the call over to Cindy Wyrick, Senior Vice President of Investor Relations. Please go ahead, ma'am.

Hi, everyone thank you for joining us today as we review Bank of Hawaii's financial results for the third quarter of 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, and Dave Thomas, Vice Chairman and head of our Retail Banking Group.

Comments today will refer to the financial information included in 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 that the assumptions we have made are reasonable, there are a variety of reasons that the actual results may differ materially from those projected.

And now, I'd like to turn the call over to Mike O'Neill.

Hello everyone.

Third quarter 2003 was a very good quarter for the Bank of Hawaii. We saw positive progress in all fronts. Our credit quality measures were improved, our margin expanded, total revenue increased, and our expenses went down.

Our systems conversion to the Metavante platform was completed in July and we've been successfully operating on Metavante since the conversion. In addition to the strong progress reflected in our financial results, our business environment is improving as the Hawaii economy strengthens. Most importantly, all of our businesses are growing.

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

Thanks, Mike. And thank you all for joining us.

In the third quarter Bank of Hawaii Corporation's net income was $36.7 million and 61 cents per share. These earnings increased significantly from second quarter 2003 net income of $30 million and 48 cents per share. Third quarter earnings included a higher level of net interest and non-interest income, lower expenses, and lower systems replacement cost compared to the second quarter.

Our return on assets for the third quarter 2003 was 1.53%, compared to 1.27% in the second quarter. Our return on equity for the quarter was 16.69%, up from 12.93% last quarter. On a per-share basis, our net income of 61 cents was up from 43 cents in last year's third quarter.

Our net income was up significantly from the $30.2 million earned in the third quarter of 2002. Net interest income was $91.1 million in the third quarter, up $620,000 or about half a percent from the second quarter. Our net interest margin for the third quarter was 4.15%, up three basis points from last quarter. Compared to last year's third quarter our net interest margin was up 12 basis points. We've included an analysis of the changes from last quarter in net interest income in Table 6 that accompanies our earnings release. The increase in net interest income from the second quarter is primarily due to the change in asset mix and the volume of assets funded by lower-cost liabilities which increased the interest rate spread.

Again, in the third quarter of 2003, we recorded no provision for loan losses. Net charge-offs were $5.3 million for the quarter compared to $2.1 million in the second quarter. Net charge-offs in the third quarter of 2002 were $4.5 million. The increase in losses compared to the second quarter was primarily due to charging off $3.6 million in consumer loans that remained after we closed four Pacific Island branches in late 2002. Our credit quality and loan losses continue to benefit from our stable Hawaii economy.

Non-interest income for the third quarter was $53.8 million, an increase of $3.1 million from last quarter, and $6.8 million from the third quarter of last year. These increases were primarily due to a higher level of loan prepayment fees, and compared to last year, increases in mortgage banking and insurance income. Trust and asset management income was about even with last quarter, and our asset management performance has continued to improve.

Non-interest expenses totaled $88.9 million in the third quarter, down by $6.5 million from last quarter. The decrease was due to lower salaries, equipment, and systems replacement costs. In the third quarter of 2003, systems replacement costs were $5.8 million lower than in the second quarter.

As we previously reported, we've completed our systems conversion at the expected cost of $35.5 million. Our systems are functioning very well and customer service and satisfaction have improved. Importantly, we're on track to save over $17 million per year in costs. Excluding the systems replacement costs in 2003, non-interest income -- non-interest expenses, excuse me, decreased $761,000 from the second quarter.

Included in our third quarter expenses is a $1.5 million contribution to our charitable foundation. We evaluate the need to fund our foundation each quarter and decided to make this discretionary contribution given the strong results this quarter. Our income tax rate was 34.5%, about the rate we expect for the full year 2003.

Tables 11 and 11a, provide a summary of business segment results which is how the management team evaluates business performance. 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 income between assets and liabilities and then attribute these revenues to the business units. We separately assign direct costs and allocate the costs of support units to the business units. The result of this process is net income after capital charge or NIAC. We also calculate the percentage return on allocated capital which we refer to as risk-adjusted return on capital or RAROC.

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

The treasury segment reflects the impact of movements in market interest rates given the interest rate sensitivity. With the increase in interest rates in the third quarter, we repositioned some of our portfolio and increased our securities holdings, there by increasing interest income in this segment. Additionally, most of the systems replacement costs, as well as the costs of excess capital, are allocated to the treasury segment. Although the capital levels continue to be reduced, the amount of capital remains greater than is needed by the business segments, thus further reducing the NIAC of the treasury segment.

I want to mention, that as we indicated last quarter, we have revised the formula we use to assign credit for the value of deposits to the segments and have reclassified those amounts in all periods presented. And with our improved performance and reduced capital levels we're now seeing positive NIAC for the company as a whole.

Our more significant risk concentrations are summarized in Table 7.

During the third quarter, we saw continued signs of improvement in each of our air transportation, Guam and syndicated loan exposure. While our air transportation exposures remained at about the same level as last quarter we saw a reduction in our exposure to borrowers in Guam. During the third quarter, our syndicated loans outstandings decreased $29 million to $249 million. The undrawn commitments increased slightly to $624 million, with a net reduction in syndicated exposure of $12 million. Since the beginning of 2001, we've reduced our syndicated and large borrow exposure by nearly $2 billion.

We continue to see improvement in credit quality. During the third quarter our nonperforming assets decreased to $40.1 million from $42 million at the end of June, and $63.3 million at September 30, 2002. The inflow of new nonperforming assets decreased significantly as summarized in Table 8 accompanying our earnings release. The ratio of nonperforming assets to loans and nonperforming assets improved to 72 basis points at the end of the quarter, compared to 77 basis points in June, and 120 basis points in September 2002.

With the overall improvement in credit quality, we were able to continue the reduction of our allowance for loan losses. The allowance was $132.7 million, at September 30, 2003, down $5.3 million from June 30th, and $10.2 million from year-end. Although we did not take a provision in the last five quarters, the allowance still represents 2.38% of loans. We will continue to evaluate the economic environment and the level of credit risk in our portfolio each quarter, and will recognize a provision for loan losses to the extent necessary to maintain the allowance at an appropriate level.

During the third quarter we saw growth in our loan and investment portfolios, funded by decrease in short-term assets. We managed to benefit from the volatility in interest rates, increasing our margin and realizing securities gains as we repositioned our investment portfolio.

Our asset levels were affected by significant amounts of prepayments during the third quarter. We plan to continue selling most of our mortgage production, but we reevaluate that decision regularly. We occasionally sell mortgage backed or 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 increase in interest rates, our mortgage servicing prepayments float, however, loan prepayments reduce the amount of the carrying value our mortgage servicing rights by about $1.6 million from the end of last quarter to $23.3 million. Our services rights are carried at 80 basis points in aggregate. We continued the trend of the last two years but reducing the level of higher cost, longer term funding, both in deposits and borrowings.

Our balance sheet at September 30th remained positioned to benefit from rate increases. Our liquidity position remains quite strong, which gives us flexibility to respond to changing market conditions.

The Hawaii economy remains stable, and shows increasing strength. Visitor arrivals were up during the third quarter and some sectors hit record highs. Domestic and international passenger volumes both increased, hotel occupancy was up as a result. Construction and real estate remain positive factors and unemployment is stable at around 4%. Personal income growth in Hawaii has been very solid. We continue to expect a solid performance for the Hawaii economy as we end 2003 and move into 2004.

As a result of the strong third quarter, we now expect that Bank of Hawaii Corporation will earn in excess of the $131 million of net income that we forecasted earlier for 2003. Some of that increase will come from realizing gains on the sale of lease residuals and ORE. We may also have some small increases in some expense categories as we increase advertising and maintenance of facilities.

We expect to keep our efficiency ratio near 58% through the end of 2003, and to further improve in future years years. We also expect that at year-end our run rates for return on assets should remain around 1.5%, and return on equity should get above 17%. Our earnings estimates are necessarily based on several assumptions including interest rates, sales transactions, economic conditions and loan quality. There are many other assumptions that affect our earnings estimates, including the absence of major geopolitical events.

Our share repurchase program was very successful in the third quarter. We purchased 3.1 million shares which brings the year-to-date repurchase total to 8.1 million shares. We've now returned nearly $800 million of excess capital to our shareholders since July 2001.

Our Board recently approved repurchase of up to $200 million more of common stock. We expect to begin using that authority very soon, however, the pace of repurchase is likely to slow from last quarter. 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. Accordingly we remain unable to provide guidance on earnings per share.

Another significant development is the increase in our dividend. Our Board has declared our fourth quarter 2003 dividend of 30 cents per share up 58%, from the 19% dividend level of last quarter. 19-cent dividend level, thanks, Mike. The increase is intended to be responsive to tax changes as well as our improved earnings expectations. We plan to reevaluate our dividend levels annually.

For the rest of the year we'll be focussed on increasing sales, strengthening customer service and improving our efficiency. As we complete our next three-year plan, which we expect to announce in late January, we're optimistic about the prospects for Bank of Hawaii.

Mike, that concludes my comments.

Thanks, Al. We'll now take any questions you may have.

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 1 on your push button telephone. If you wish to withdraw your question, please press star 2. Your question will be taken in the order received. Please stand by for your first question.

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

Joseph Morford, III: Thanks. Good morning, everyone.

Just a couple of quick things on the income statement first. Al, I wondered if you could quantify the -- what's kind of an outsized amount in the prepayment penalties that came through in the third quarter?

And then on the expense run rate, you talked down $17 million from the second quarter of '02, backing out the charitable contribution, it looks like maybe you have another half a million or a million that may fall through off the current run rate. Is that right? And should we see that coming through all in the fourth quarter? Thanks.

Sure, Joe. Thank you.

The increase in the level of prepayment fees is somewhere in the two and a half million dollar range on a net basis. And if I understood right, you're looking at the spread between 2002 second quarter and now being a little bit greater than what would annualize to the 17 million?

Joseph Morford, III: Actually, maybe still a little less than -- it shows you still maybe have room to show another half a million or a million dollars a quarter.

I'm with you. And I would say that that's accurate.

Joseph Morford, III: And should we see that, then, in the fourth quarter? As it takes more time to --

Yeah, we'll see some indications of it in the fourth quarter. We would expect to see a little bit more of it in the first quarter as well. That's why I mentioned we may have a little bit of an increase because we're going to pick up our advertising and we've got some maintenance on facilities. So it won't all show up here in the fourth quarter.

Joseph Morford, III: Right. Okay.

Lastly, I just wondered if you could comment about what's driving the increase in the commercial/industrial portfolio? Is it just better line usage or, you know, market share? What would you attribute it to?

Joe, this is Bill Nelson.

I'd say that it's coming all across the board in Hawaii. I look at the pipeline regularly with our line of business heads, and as I evaluate the pipeline that's in the process of approval or having been approved and booked, it's looking pretty good. In middle market commercial banking, certainly commercial real estate, a bit in leasing, and those are the particular areas where I think it's doing well. We're finding some new business prospects as a good rate as well, in addition to growing our outstandings from our existing customers. So we're feeling good about the pipeline.

Joseph Morford, III: Okay. Thanks everyone.

Our next question comes from Brett Rabatin of FTN Midwest Research.

Hi guys, good morning. Couple questions for you.

First off, was curious on the insurance level for this quarter. Typically third quarter is your best of the year and I wanted to get? Thoughts on if 4Q would be a modest reduction in insurance revenues?

And then wanted to get your thoughts on the mortgage banking environment going forward, how you saw that progressing over the next quarter or two?

And then lastly, I did want to get a little more color on the loan growth at the end of the period versus average. Ending period was obviously pretty strong, was somewhat curious if there were some significant (INAUDIBLE) at the end of the quarter that would especially help average balances for 4Q?

Sure. This is Al. I'll address the insurance question first. Typically, the third quarter is the strongest quarter for us. And it comes from getting some volume rebate with some of our carriers. So I would think that we would see a little bit of falloff in the fourth quarter, that's a normal pattern. And consistent with what we would expect now. Could you give us --

Okay, I'm sorry, for the quick questions there, but the next piece was the mortgage banking?

Yeah, a little bit of what we would expect for mortgage banking as we go forward?

Correct.

Certainly with the change in interest rates, we would expect to see slow-down in refinance volume, which will certainly impact us like it does most of the other originators. That will also slow down the prepayments in our servicing portfolio, which should enrich a little bit the value of our servicing as well as the servicing net revenues.

So on balance, we would expect, logically, to see some slowdown in income, but we're still expecting the fourth quarter to be a pretty good quarter for us in mortgage banking. And then your third quarter -- third question was with respect to increase in loans at the end of the quarter. Is that right?

Correct, versus average balances for the quarter was significantly higher end of period versus average.

Bill, do you want to address that?

I would say that in the commercial portfolio I think the organic growth was fairly even across the period. We did have the reduction of a couple of large commercial mortgages during the period, one in July and one towards the end of the September, so that might have affected the averages somewhat. But that's the only thing I can think of at this point. I could look into it a little bit further if you need me to.

That's okay. And one last question. I know you guys are looking at things quarterly in terms of making a loan loss provision, but at this given time, do you think there will be any provisioning for '04?

We do look at it every quarter. We believe that the adequacy of the reserve is still quite good, and we just have to keep looking at it every quarter. But I think that as we look at the outlook, it will be dependent upon the continued strength of the portfolio, which we're very comfortable with right now, and the outlook which we're very comfortable right now. And so it certainly could point towards a continuation for some time of non-provisioning, but we revisit it every 90 days.

Okay. Thanks, guys.

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

Good morning. A couple of three quick ones if I could.

Al, when you talked about the margin impact from mortgage-backed securities prepayment activity, was that number you gave 2 1/2 million, did that include the impact from the purchased home equity portfolio as well as -- it looks like the yield on that was funny this quarter.

We got a fair amount of prepayment, which accelerated, as you can appreciate, the amortization of the premium on those. So that was what drove that to a lower level than what we've experienced in the previous quarters or what we would anticipate going forward.

So that was probably about a half million dollars of premium amortization in the quarter, so --

Jim, I -- you caught me without a number here.

Okay.

That would seem reasonable, although maybe just even a little bit low.

Okay.

Second question I have probably for Bill is in the CNI growth, would you characterize the growth there as new customers rather than draw-downs on existing lines?

Yeah. This is new money, Jim.

This is probably 20% here in the last two or three quarters of the new organic growth has been pure new customers. The remainder of that, I would say, is new money to existing customers, not draw-downs on existing unused credit facilities. Or renewals of existing facilities.

Utilization rates are still pretty low though on the CNI credits compared to, say, recent history or relative history?

I think the utilization rates are about where they were. Certainly on the corporate portfolio they're relatively low because we have a lot of commercial paper backup lines. But, I think yeah the answer to your question, other than the corporate bank, I'd say the utilization rates are about where they have been.

Okay.

Then just lastly, could you update us on what's -- what Guam looks like now? It looks like you've had some nice reductions there, in facilities, but could you talk about the economic impacts over there?

Well, I'd say Guam is -- Guam is still in a bit of a trough as they have been for some time. The impact of the typhoon last December has worked its way through the portfolio and where there have been problems of that resulted from that, we've seen those. But I suppose we've seen far fewer problems in the credit portfolio, be it consumer or commercial, than what we thought could have been the case from the severity of that typhoon. So the economic impacts on our customers, I think, have been felt as it relates to that by now. They continue to struggle with tourism down there, but it certainly has not gotten any worse, and they've continued to bounce along.

So I would say that the quality of the portfolio is as it has been. We've seen some improvement in some areas of the consumer portfolio, and we've been able to eliminate a sizable commercial real estate obligation down there during the quarter, which we're pleased to do.

Thanks a lot, appreciate it .

Are there any other questions?

Mike, this is Al, I've got one thing I'd like to add, if I might. Joe Morford if you're still on the phone, you asked a question about the decrease in expenses toward our $17 million savings, and I think you talked about a number in the half million dollars range. We could do even better than that as we go forward. Just taking a look at some of the components here and the changes that are driven off of our technology replacement. There's upside from that half million, even in the fourth quarter.

I just thought I'd better mention that to clarify so that you didn't have an expectation that we were limited to that half million.

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

Thank you. Good morning.

I just had a couple of questions on the margin and then just a strategic question.

First on the margin, could you just put a little more color around the outlook for the fourth quarter? We've seen some of the prepayments come through and some of that's going to dissipate in the fourth quarter, and you had some higher premium on the home equity portfolio as well. Can you just talk about some of the components as you see that progressing in the fourth quarter? And the second part of that is just in the growth and the investment securities we've seen over the last couple quarters, the health of maturity has been a building component, is that going to be a continuing trend in the future?

Brian, this is Al.

We would expect that based on what's happened so far, and I hazard to say, moderate stability or modest stability in the interest rate environment, that our margin could probably strengthen a little bit here into the fourth quarter. That's probably as specific as I should be right now. I hope that's responsive.

Okay.

And then the second part of your question was with respect to health maturity. Is that right?

That's correct.

I think we've got that positioned pretty well where we want it now so that I would anticipate future transactions at least in the near term would have an impact on the available for sale rather than the held to maturity part of the portfolio.

Okay.

My second question is just on the growth stage of the company. We've gone through the cleanup of the credit as well as the system replacement, and now, Mike, as you look forward in the next few years where does the growth come from and where does the next stage of this recovery of the company come from?

Brian, I think we're going to put away the power tools here and take out the scalpel and the chisel. We no longer have any big efforts to undertake and complete. What we are going to focus on now is really the customer.

I mean, I think we've done a very good job, despite all the distractions of the last three years of improving our market position both in the retail and the commercial side. But we now can really launch that at the exclusion of pretty much everything else. So I guess if I had to answer that question, it would be two things: It would be, one, better execution across from the client which I think is already visible but I think can be that much better, and then secondly, for lack of a better word, tinkering on efficiency. There's no longer one big project, there are probably 10 projects, but taken as a whole, I think can have a significant impact on our efficiency. That would be the two big efforts. I don't think we're anywhere near where we can be, assuming we keep chipping away as I just described.

Are there any new financial metrics you think we should be looking for from you guys?

No, I think the standard ones. We clearly run our company on the basis of NIAC and RAROC, that translates to return on equity. Clearly margin is an important factor and efficiency ratio. I think if you look at those, that's certainly the way we look at the company.

Okay. And are you guys now in a position to be an acquirer as opposed to your past where you've been more internally focussed?

Well, I suppose we are certainly in a position to do that. There's not a long list of successful acquisitions by Hawaii companies. And I guess never say never, but I'm pretty close to saying never. You know, we've got a lot of work to do in my judgment on continuing to improve our position here. And I think once we feel like we have optimized, which I think is quite a ways off, who knows, we may look at something but certainly nothing on the horizon.

Okay, thank you.

Our next question comes from Michael Shepps(phonetic) of Crest Investments. Please pose your question.

It's been answered, thank you.

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

Hi, good morning.

Given the strength in the yen versus the dollar over the last year or so, any indication of a higher propensity to spend buy Japanese tourists? I know they aren't as important as they were 10 years ago but certainly they're important in the overall scheme for Hawaii tourism.

You know, Adam, good question.

There's a great correlation between yen/dollar exchange rates and Japanese visitor arrivals. That currency is very strong right now and we are seeing a pickup. Clearly, not to the levels of 1997. I mean, we saw 2.3 million Japanese come in '97. I guess the forecast for this year in totality is about 1.5. The guess is that it will hover around that 1.5, 1.6, maybe getting up to 1.8 but that's kind of range we're talking about. It has driven in in no small part by the exchange rate.

Thank you.

Ladies and gentlemen, 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.

Once again, ladies and gentlemen, 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'd like to thank everyone for joining us today and if you should have additional questions or need further clarification on any of the issues we discussed here today, please feel free to call me at (808)537-8430. Thanks everyone, have a great day.

Ladies and gentlemen, this concludes the conference for today. Should you wish to access the replay for this call you may do so by dialing 1(800)428-6051 or 973-709-2089 using pin Number 273140. All parties may now disconnect. Thank you and have a great day.