Bank of Hawaii Corp (BOH) 2004 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to your quarter three 2004 Bank of Hawaii Corporation earnings conference call. My name is Jeanne. I will be your coordinator. (OPERATOR INSTRUCTIONS.) At this time, I will turn the call over to your host Cindy Wyrick, Head of Investor Relations. Ma'am, over to you.

Hello, everyone, and thank you for joining us today as we review Bank of Hawaii's financial results for the third quarter of 2004. Joining me today is our Chairman and CEO, Al Landon; Vice Chairman and CFO, Rick Keene; Vice Chairman and Head of our Retail Banking Group, Dave Thomas, and our Vice Chairman of Corporate Risk, Bill Nelson.

The comments that we make today will refer to the financial information that is included in our earnings announcement released earlier this morning. Before we get started, let me remind you that today's 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 would like to turn the call over to Al Landon.

The third quarter of 2004 was another good quarter for Bank of Hawaii. We continued to perform well as indicated by our financial measures. Our margin expanded, total revenue increased, our expenses remained controlled, and operating leverage was positive. I am especially pleased with our return on equity, which exceeds 23 percent, and the continuing improvement in our efficiency ratio, as well as our excellent credit quality.

Our businesses are solidly on track to achieving the goals we set forth in our 2004 through 2006 plan. The Hawaii economy continues to expand. Consistent with our performance, our board has increased our quarterly dividend to 33 cents per share, up 10 percent from the previous dividend of 30 cents per share. And we plan to continue to repurchase our shares in a disciplined manner.

Now I would like to ask Rick to provide you with a more detailed review of our third-quarter financial results. We will then be happy to take your questions. Rick?

Thanks, Al. Hello, everyone. Bank of Hawaii Corporation had a good third quarter. Our net income was $43.1 million, 17 percent higher than last year's third-quarter earnings of $36.7 million. Third-quarter earnings per share of 78 cents was up 27.9 percent from 61 cents per share a year ago.

Third-quarter earnings were 2.6 percent lower than second-quarter earnings of $44.2 million or 79 cents per share. Our return on equity for the quarter was 23.42 percent, up from 16.69 percent in the same quarter last year, and our return on assets was 1.77 percent, up from 1.53 percent last year. Compared to the previous quarter, these financial measures had declined slightly. However, you may remember that we recorded a negative provision for loan losses of $3.5 million in the second quarter that impacts that comparison.

Net interest income was $98.8 million in the third quarter, $2.9 million higher than last quarter and $7.7 million higher than the third quarter of 2003. The increase in net interest income over the second quarter was primarily due to an increase in both the average balances and the yields earned on the loan portfolio and the investment portfolio. The increase over the third quarter of 2003 was due to higher average balances of investment securities, home equity loans and installment loans and a decrease in interest expense on deposits. Partially offsetting these positive factors was a decline in interest income on the mortgage portfolio. We have included an analysis of net interest income as Table 6 to our earnings release.

The net interest margin for the third quarter was 4.39 percent, up 22 basis points from last quarter's margin of 4.17 percent and up 24 basis points over last year's third quarter. The increase over last quarter is primarily due to three factors. First, the average balances of our short-term investments, specifically interest-bearing deposits and Fed funds sold, were down significantly from last quarter. You may recall that we had a sharp increase in short-term funding and liquidity at the beginning of the second quarter as we accommodated needs of our public sector clients. These funds were placed in short-term investments that will return to more normal levels during the second quarter, but nevertheless cause the second-quarter average balances of short-term funds to be high. The lower average balances in the third quarter contributed to the improvement in the margin.

Another factor was that the yields on earning assets improved from last quarter, especially for the investment portfolio where we had reinvested prepayments at the beginning of the third quarter when rates were higher.

And the third factor was we were able to maintain stable deposit rates when compared to last quarter.

In the third quarter of 2004, we did not record a provision for loan losses, and this is compared to the previously mentioned negative provision for loan losses of $3.5 million recorded last quarter. Noninterest income for the third quarter totaled $53.1 million, a $1.8 million decrease from the second quarter of 2004. The primary reason for the decline was a reduction of $1.1 million in mortgage banking income. Gains realized from the sales to mortgage loans were lower than last quarter due to a decrease in the volume of loans sold.

Included in other noninterest income in the third quarter was a gain of $5.2 million on the sale of assets at the end of a leveraged lease. If you recall, there were two similar items in the second quarter, including a $3.2 million distribution from a partnership investment and a $2.5 million gain on the sale of a parcel of land which together totaled $5.7 million. We do not expect to recognize income from sources such as this in the fourth quarter.

Compared to the third quarter of 2003, noninterest income was relatively unchanged. As I mentioned, there was a $5.2 million gain in 2004 on an asset sale, and in last year's third quarter, we recognized a $3.1 million prepayment fee on a commercial loan. Excluding these two items, noninterest income was $2.9 million lower in the third quarter of 2004 than in 2003. The primary reason was the $4.2 million reduction in mortgage banking income from the record levels of 2003.

Offsetting the decline in mortgage banking income were increases in trust and asset management income, deposit service charges, merchant fees and ATM fees. Noninterest expenses in the third quarter were $900,000 lower than in the second quarter. And after considering the systems replacement costs that were incurred in 2003, noninterest expenses were also relatively flat compared to the third quarter of last year. Salaries and benefits were up 1.8 percent over last year. Base salaries and commissions were lower than in the third quarter of last year, but were offset by costs associated with stock compensation and separation expense. Equipment expense declined by $1.5 million or 20 percent as a result of the systems replacement project.

As we've discussed in previous quarters, one of our key internal measures is operating leverage. Our three-year plan illustrated that a combination of modest revenue growth and flat expenses would result in a 10 percent compound annual growth rate in operating income which we defined as pretax pre-provision income. We continue to be pleased with the increase in operating income compared to last year. The year-to-date operating income for the first nine months of the year is 32 percent higher than in 2003. Excluding the expenses related to the systems replacement project, our operating income is up a respectable 15 percent.

The efficiency ratio was 55.5 percent for the third quarter, down from 56.5 percent last quarter and 61.3 percent in the third quarter of last year. Excluding system replacement costs, the efficiency ratio was 58.3 percent in last year's third quarter. Our income tax rate for the third quarter was 36.3 percent, a slight increase from last quarter.

Table 11 in our press release provides a summary of business segment performance. The retail segment had a strong return of 33 percent on its allocated equity, down slightly from last year due to a lower earnings credit on deposit balances and to lower mortgage banking income when compared to the third quarter of 2003. The commercial segment also had a return of capital of 33 percent for the quarter, an improvement over last year mainly due to an increase in noninterest income from the sale of the leveraged lease assets that I discussed earlier.

The Investment Services segment had a return on its capital of 10 percent, down from last year due to a higher level of expenses associated with internal process review and improvement, the addition of some senior level investment professionals and product refinement. All of which are expected to better position our business.

Net interest income for the treasury segment was positively impacted by a reduction in the earnings credit for deposit and higher average balances in the investment portfolio. Note that the results of the treasury segment include the impact of changes in market interest rates on the Company's interest rate sensitivity, as well as expenses that are not allocated to the other business segment and the cost of capital that exceeds the capital needed by the other business segments.

The year-to-date 2004 NYAC measure for the total company was $50.7 million compared to $8.7 million for the same period last year.

Now some comments on credit quality. During the quarter, our nonperforming assets decreased to $16 million, down from $21.2 million at the end of June and $40.1 million at the end of September 2003. The third-quarter decrease was primarily due to the transfer of a foreclosed commercial property from other real estate owned into fixed assets. We have a branch in the building, and we recently increased the building's occupancy.

Nonperforming assets represent 0.27 percent of total loans and are at their lowest level in many years. Gross charge-offs in the third quarter were $5 million, and recoveries were $4.7 million, resulting in net charge-offs of $300,000. This compares to a net recovery last quarter of $1.2 million and net charge-offs in the third quarter of 2003 of $5.3 million. Year-to-date net charge-offs represented an annualized loss rate of 2 basis points.

The allowance for loan losses was $124.7 million at September 30, 2004, down $300,000 from June 30 and down $8 million from September 30 of last year. The allowance represented 2.14 percent of loans at September 30, 2004. We will continue to evaluate the economic environment and the level of risk in our portfolio each quarter and recognize the provision for loan losses only to the extent necessary to maintain the allowance at an appropriate level. Our intent has been to maintain the directional consistency between credit risk and the amount of the allowance.

Our higher risk exposures, including air transportation, are summarized in Table 8. These exposures remain relatively consistent with the amounts at the end of last quarter. In the evaluation of the allowance for loan losses, we have considered the current financial strain on airlines, which tends to offset improvement in the rest of our portfolio.

With respect to the balance sheet, assets totaled $9.6 billion at the end of September, relatively unchanged from last quarter. Total loans outstanding were up slightly over the second quarter, largely due to growth in the consumer lending portfolio. Loan originations in the commercial portfolio have been quite good, but again this quarter commercial loan balances were impacted by payoff activity, especially from our larger corporate clients.

Deposits declined by less than 1 percent from last quarter. Increases in savings and interest-bearing demand accounts were offset by declines in time deposits and non-interest-bearing demand deposits. The decrease in non-interest-bearing demand deposits compared with previous quarters was largely due to a reduction in custodial deposits related to mortgage servicing, not due to a decline in customer accounts. Our balance sheet remains positioned to benefit from interest rate increases, and our capital position continues to be strong.

The Hawaii economy also remains strong. Tourism, construction and real estate are positive factors, and unemployment fell to about 3 percent -- the lowest in the country. In spite of some recent inflationary pressures and barring a major event, we continue to expect that the remainder of 2004 and 2005 will be good for the economy in Hawaii.

Last quarter we indicated the Bank of Hawaii expected to earn net income in the range of $163 million to $167 million in 2004. We can now revise that range to $166 million and $168 million.

We continued our share repurchase program by purchasing 700,000 shares during the third quarter. Through October's 22, the Company has repurchased a total of 34 million shares and has returned over $1 billion to our shareholders since the program began in July 2001. As of this morning, we have remaining authorization of almost $109 million, and we plan to continue to make repurchases in a disciplined manner.

And as Al mentioned, our Board declared a dividend of 33 cents per share for the fourth quarter, which is a 10 percent increase over the previous dividend of 30 cents per share. In summary, this was another good quarter for the Company, and that concludes my comments, Al.

Thank you, Rick. Now we would be happy to take your questions.

(OPERATOR INSTRUCTIONS). Brett Rabatin. FTN Midwest Research.

Good morning or good afternoon rather.

That's right. We get both, don't worry?

A couple of questions. First off on the expense growth from a linked quarter perspective, if you back out the non-recurring items during the prior quarter, the other line item is up about 2 million linked quarter. Can you discuss or give any commentary first on that increase?

Well, if you back out the items that we disclosed last quarter, we talked about some legal fees and also a contribution to the foundation. We did not mention it, but we also had another $1 million contribution to the foundation in the third quarter.

Other than that, there really was not anything big. There were a lot of small timing differences, some maintenance loss on the buildings, timing and property taxes. Just some minor things. There was nothing else big.

Okay. And then I was curious, you mentioned in the press release you were talking about prepayments again in the commercial portfolio. I was curious if those were planned or if that was the result of refinancings or if you could give any additional color on that as well?

Bill, do you want to --?

Yes. This is Bill Nelson. To some extent, those were planned. We had two large corporate borrowers that have significant presence in Hawaii. One that had a huge asset sale of some of their businesses and properties and cancelled their credit facility which was outstanding, and another one simply refinanced it through other Capital Markets sources. We would expect both of those borrowers to come back to us in the next three or four months and do some resumption of the bank borrowings or credit commitments in perhaps a lesser amount. Those were the two big drivers in the third quarter in the commercial book.

The pipeline remains solid, as I think Rick mentioned. So we are adding assets to the book, but on a net basis it looks like we are not adding at a very rapid clip because of some of those prepayments of large corporate commitments.

Okay and then just one last question and I will turn it over to someone else. I was curious a number bankers are presently telling us that credit quality is the best they have seen in their career, and you guys again had some recoveries that resulted in pretty negligible charge-offs for the quarter. Can you discuss any visibility if you have some more pieces that you might be able to recover in additional quarters or any commentary on credit cost going forward?

That is very hard to predict. That is the recoveries, particularly on the commercial side. I think we have a little bit better sense on the consumer side in our different consumer retail businesses what sort of recovery ratios we might achieve over time, but on commercial it is pretty tough to predict. We have had some pretty good success here in the second quarter with a large foreign recovery, and then this quarter with a few more granular recoveries in the commercial area.

I don't see a great repeat of that sort of thing. They will come in drips and drabs in the commercial side, and all of those that came this last quarter in commercial side were relatively small. $100,000; $200,000; $300,000 items and nothing that was of the size at all like we had in the second quarter. I don't see anything like what we had in the second quarter out there in the future at this point.

Great. Thanks, guys.

Jim Bradshaw. D.A. Davidson.

A couple of questions if I could. The severance or separation charges were a little higher than I was assuming this quarter. Anything unique and/or could you give me a forward guess at what the fourth quarter may look like?

Nothing particularly unique in that. There were none related to Mike's separation in that, and I think we had some agreements, some changes in sort of midlevel. Dave, anything?

Well, in our mortgage banking area because of the reduction in volume that we've seen this year, we have done some repositioning and restructuring there, and there were some separation expenses that we incurred as we repositioned our operations and underwriting groups with the mortgage area.

Good. Thank you. The second question relates to the line that you guys call home equity lending, not the purchase one but the other. Could you refresh my memory? Is that a Hawaii-based program, or are you nationally lending the net line item now, too?

The line item that we have there on the balance sheet for home equity is principally Hawaii. There are very small portion of loans in our Pacific Islands division, but it is virtually in (inaudible) in the state of Hawaii. We are doing no lending on the mainland in that particular line item.

And that number has been accelerating all the way through the year. It sounds like you are gaining some sales traction in that product particularly, too.

Yes, we've had some really really tremendous success with that product. Part of it is due to the strengthening real estate market. After years of little or negative equity in many homes in Hawaii, the past few years have freed up a lot of equity for our customers, and they are now taking advantage of that through the home equity loan product.

In addition to that, I think we had outstanding success, not only with our direct-mail programs that we have been doing recently, but with the increased focus through our branch network in terms of the sale of that product directly to consumers through the branch network. And that has been a real big plus in the increasing momentum that we have had in that product for the last two to three quarters.

Okay, good. And then my last question relates to the tax rate this quarter was a little higher than we assumed. I just wondered if that was a gross up from the tax return filing or anything else unusual in there?

No, it wasn't. It just -- it went up slightly. We expected to be around that range for the full year. We had our original forecast that we did, and as our income has gone up a little bit over our original forecast, our effective tax rate picked up a bit also. But nothing unusual there.

Joe Morford. RBC Capital Markets.

I had a couple of questions related to the margin. I guess first was were there any interest recoveries this quarter at all? Do you have plans to pay down any additional debt? And did the margin come out in the month of September relative to the average for the quarter?

We did not have any significant interest recoveries this quarter. The drivers behind it where as I mentioned in my comments. I don't have the specific margin for September in front of me, but it was pretty consistent in late second quarter as well as throughout the third quarter. We were down in the early part of the second quarter, but then it bounced back toward the end and it stayed relatively consistent.

Okay. Any plans to pay down additional debt at all?

As of right now, we don't have any plans to pay down any additional debt. We would like to, but we have done about as much as we can do there.

I guess related questions a little bit on the deposit side, how much escrow deposits -- mortgage escrow deposit -- did you lose in the quarter, and how much of that did you still have at the end of the third quarter? And then are you seeing any kind of or much pricing pressure on deposits at this point?

This is Dave Thomas. Let me talk about the pricing pressures on the retail deposits first, while Rick gathers the information on the escrow deposits. Clearly over the past few months as the Fed has consistently increased short-term interest rates, there is a growing expectation that our retail deposit rates will follow suit. To date surprisingly the market has not reacted with significant increase in consumer deposit rates.

We monitor our competitors closely to see any place where they might be changing rates. We have seen some increasing trend in time deposit rates, but the bulk of our deposits in money market and interest checking, in those areas the interest rates in the marketplace have remained I would say surprisingly stable. We would expect, as the Fed will continue to be increasing short-term rates, that there will be increasing pressure going forward, but we've certainly have not seen any to date, and we are prepared to continue to monitor the market and make sure that we have a competitively priced product out there as we look to the future. Rick?

Yes, as far as the custodial deposits, we lost about $20 million during the quarter in those deposits, but we have a remaining balance at the end of the quarter of around $50 million.

Great. Thanks, everyone.

Also going back to a previous question on the margin for September, the September margin was for 4.42 percent.

Mike McMahon. Sandler O'Neill.

Also good morning. I was wondering if I could get a little better sense of the volume of commercial originations in the quarter versus the payoffs? I know that the volume has been strong for the last couple of quarters, and I also know the payoffs have been strong, but I am trying to get a better sense for it.

This is Bill Nelson. I would say the commercial originations have been very good, really led by if we consider it part of commercial, that is commercial real estate. They have had some very strong originations this quarter, and their pipeline for the fourth quarter looking forward remains quite strong.

With respect to C&I, it has been reasonable but not nearly as strong as commercial real estate, and with C&I in general that has been offset by particularly the two large cancellations of credit commitments in the third quarter. But looking forward for C&I in the corporate bank, excluding the commercial real estate, they look like they have a solid pipeline looking forward for the fourth quarter in terms of what they expect to book during the fourth quarter.

So all in I think the forward look on real estate -- on C&I in general and particularly commercial real estate for new bookings looks good. It is hard to predict in terms of cancellations or refinancing by existing borrowers where we have outstandings, but we're not seeing anything material in the near future in terms of people refinancing away from us.

Rick, if there is a little bit of danger in being too numeric or precise in this, but I think you had done some calculation as to what our origination volume in the commercial area was for the quarter. Could you give us just kind of a general range of -- everybody forgive us. This is not a precise number, but something that we track a little bit here as our systems allow us.

Well, we think our net originations in terms of growth in outstandings were in the $80 plus million range for the quarter. And to put that in a little better perspective, and that's kind of a rough number, to get there pretty quickly, if you think about the top three clients, corporate clients that reduced their outstandings this quarter, and Bill talked about a couple of them while ago, all three of them were due to strategic business decisions that they made, not due to changes in banking relationships. But if you take the top three paydowns, the total is over $72 million this quarter.

That is very informative. I appreciate that.

Mike, there is a little risk about getting those kind of granular numbers on origination, because it is sort of difficult to track that precisely in our system. But I thought a little bit color on that might be helpful to you.

It is. I appreciate it very much. Thank you. Finally, can you remind us again what you are managing your leverage ratio down to as you methodically do your buybacks?

Yes, what we have been managing down to is about 7 percent.

And that seven percent, what leverage? Tier 1 leverage ratio?

Yet, Tier 1 leverage ratio. And we did actually see an increase in that. I think it was mentioned last quarter on the call that we were approaching the 7 percent and it actually went up this quarter due to -- actually our equity is higher than last quarter and our average balances are down slightly.

Kathy Steinbrecher. Piper Jaffray.

On your non-recurring items under other expenses, the 1 million (indiscernible), do you anticipate that you will have that in the fourth quarter as well?

Right now we don't have that in our forecast. That is a discretionary expense. We have a Bank of Hawaii foundation that's very active in the community, and whenever we can, we like to put some money into it. But right now we do not plan to do that in the fourth quarter, but depending on how the cash flow of the foundation looks in the fourth quarter that could change.

Also just a little bit additional color on the residential mortgage portfolio. Can you discuss originations during the quarter and prepayments?

The originations for the quarter continue to slow as we saw a reduction in refinancing activity. Even considering the continued volatility in the 10-year treasury, which is the primary pricing point for the portfolio, we have not seen a significant reemergence of a strong refinance market. Therefore, our prepayments have slowed along with that.

We do have a growing pipeline as we go into the fourth quarter, however, with a primary focus again on increasing our share of market in the standard purchase money business, and we would hope to see a little bit stronger originations in the fourth quarter, but that obviously is dependent upon the overall strength of the market in terms of purchase money transactions and then our ability to garner increasing share.

Okay. And can you also tell me the military expansion, how much that is contributing here in the last quarter to loan lending?

I will tackle that. I don't sense that there was a significant change in lending activity as it relates to the military. The buildup there is gradual. One of the things we talk about is the privatization of housing, and that really kicks in late this year and next year, and that will be more of a trickle down I think as contractors get receipts from the privatization from the construction phase of that. So nothing unusual in terms of military buildup affecting our loan volume at least that we were able to track.

Are you seeing different competition in any particular loan category?

Dave, anything you see in the retail side?

Not in terms of different competition. We continue to in our standard consumer lending activity face the same local competitors that we always have. In the mortgage banking business, in addition to those local competitors, we have several large national lenders that are here in the market, but there is nothing new or different in terms of that competitive environment.

I guess one of the national competitors sort of changed their strategy with Hawaii and pulled back some, and there is discussion that someone's going to take their place, but that is not a whole lot of traction with that yet. Is that right?

That is correct.

Bill, anything that you see in the commercial side?

Nothing that represents a major change in the sources of competition for commercial lending or real estate lending. Certainly there is lots of interest in the commercial real estate business here. There is new sources of equity that are coming into the market from time to time. But nothing really to report in terms of lots of different competition in lending.

Brian Harvey. Fox-Pitt Kelton.

Thank you. I just had a few questions here. Firstly on the guidance for this year, the new guidance of 166 to 168, if we sort of back out the first three quarters, I guess we are expecting somewhat of a decline in net income from the 43 this quarter to something like 39 to 41. So I guess my question is we are not expecting any sort of non-recurring gains in the quarter?

That is correct. The 5.2 million that we had this quarter is really sort of our quorum business. It is maybe a non-recurring or an frequent item, but we don't expect anything like that again in the fourth quarter. So you're right.

I just also want to talk about the level buyback activity. It seemed like you guys hit the breaks pretty hard this quarter, and with the amount of excess capital that you did finish the quarter out with, it is a little bit surprising. I just want to get your sense of maybe why the buyback slowed and maybe your thoughts about the fourth quarter?

Well, it did slow some, but really last quarter we actually did some large blocks. The last quarter was probably a bit higher than it normally would have been. So we did slow down some toward the early part of the quarter, and I think it was also mentioned during our call last time that we were approaching around the end of last quarter and the beginning of this quarter the 7 percent leverage. So we did back off a little bit, but we continue to move forward, continue to buyback programs in a disciplined manner the way we have been doing it in the past.

I think as we look forward, Rick, it is safe to say there where we are now is probably the floor for at least the next quarter, maybe two. That is somewhat influenced by the price and what goes on in the market. But it is reasonable to expect we could see a little bit of an uptick in the buyback here in the fourth quarter.

Okay. Just one other question just about Sarbanes-Oxley. We have heard a lot about the cost associated with that from a lot of other banks this past quarter. Can you maybe share with us what that cost was for you this quarter and what we might expect in the fourth quarter?

Well, it's free out here. Rick, maybe you want to comment on that?

I don't really have a number to give you. We don't really expect an increase in the fourth quarter related to that. A lot of the work we have done we have been doing internally. We've had a lot of internal resources focused on Sarbanes-Oxley just like everyone else in the country has. Internal audits have been very active on that, as well as the finance staff, credit review staff. We have been working very closely with external auditors, and the increase in audit fees that we have experienced this year is embedded in our number, and we have been accruing it all along the year.

I think we did see in this quarter I think our external audit fees did tick up a little bit, but nothing significant compared to prior quarters, and we don't really see a change related to that in the fourth quarter at all.

And just lastly, it is a small number here, but just on the 90 days past due it seemed like the residential mortgages had a bit of a tick up this quarter. Is there any color behind that?

No, there is not really. The quality of that portfolio is outstanding, and as the strength of the real estate market continues to unfold with growing equity in terms of individual consumers, what we find is where people do find themselves in financial difficulty, it is much easier for them to sell their homes and cash out of the place before we have to take significant collection activity. So that is nothing other than just normal activity there.

Brian, I think our numbers are low enough now that you get one or two good-sized mortgages, which occasionally we have, and somebody runs over the 90-day threshold, you can get a little bit of a decrease there. I think it is just normal ebb and flow.

Okay, just a couple of millionaires past due, huh?

They have credit problems, too, sometimes.

Campbell Chaney. Sanders Morris Harris.

In looking at your Investment Services group, did I hear Rick right in saying one of the reasons that RayRock (ph) was down for the quarter is you're investing in that business? I noticed the assets have been going up. If so, where are you investing and what kind of traction do you see gaining in the next 12 months let's say?

Well, where we have been investing is in personal, generally a little bit in systems and processed around that and primarily on the relationships side and in the asset management area. We have brought in an equity portfolio manager and a senior marketing specialist, both with local routes, both who have good following in our marketplace, and importantly our equity performance for the third quarter has been positive, exceeding the benchmark I think in all of our equity funds. (multiple speakers).

To predict that going forward is a very difficult thing for us to do. So what we are trying to do is work on our fundamental processes, make sure that they are solid and build on our existing relationships here in Hawaii. Predicting what that will get us is tempered quite a bit by market factors and by competition and probably pretty dangerous to say anything more.

Is it going to be more of the institutional push or retail for these relationship managers?

We are going to be broad-based in it, but institutional is clearly where we have the biggest immediate opportunity and I think where we had the biggest need. We had people working both sort of retail and institutional, and by adding some talent focusing on the institutional side, it will allow our other people to concentrate on retail.

Okay, great. And this institutional would be mostly Hawaiian-based I take it?

Yes.

Andrea Jao. Lehman Brothers.

I was hoping you could give a bit more color on the drivers for the strength in the CRE pipeline? Then I have a follow-up housekeeping type question?

I would say among the drivers -- this is Bill Nelson -- some increase in construction activity here. There is building of a high-rise site type residential properties, luxury condominiums and midrange condominiums. We are seeing a bit of that construction activity in the marketplace. There is some conversion of existing properties, resort type properties, that are attached to or related to resort properties. Conversion from hotel type space into condominium type space, and not very much in the area of industrial or commercial sector of commercial real estate, that is commercial buildings, but certainly in the refinancing of existing mortgages where their properties are built-up and occupied and that sort of thing, as well as some construction as I just mentioned are probably the key drivers.

Are these mostly in Oahu or in the other areas as well?

I would say mostly in Oahu, but some on the big island and certainly Maui weighs in quite well in terms of the balance between I would say probably 40 percent Oahu -- I don't want to be too specific, but probably more in Oahu but solid contribution from Maui and a little bit less from the big island.

Great. Follow-up question on the "for coast" (ph) real estate line. You mentioned earlier that the decrease was because you transferred that to fixed assets. But when I look at the premises and equipment line that is kind of stable from June 30 to September 30. Am I looking at the wrong line item?

No, probably not. We are only talking about a $4 million asset, so it would not have that much of an impact.

Okay, great. Thank you.

Fred Cannon. Keefe, Bruyette & Woods.

Just a quick question. Most of my questions have already been answered. Kind of a philosophical question. I noted that both your expense discipline and your capital management and your credit are excellent, but we have not seen much growth. I just note that I think loan deposits are up a little less than 5 percent year-over-year, and core P (ph) growth still does not appear to come through in the numbers. I was wondering given the strength of the Hawaiian economy, is there some point where we can expect to see a little more acceleration in growth, or should we expect as per your three-year plan that kind of 4 percent growth is kind of what we should expect at Bank of Hawaii?

Well, we don't see anything that should change us from where our plan was put together at the 4 percent level. Our aspiration certainly is to do more than that, and as the economy continues to be strong, what amount of that flows into the banking sector is sort of the mystery. We are doing everything we can to position ourselves well to participate in that. As you can see, it comes from a mixture of segments, and the real I guess tricky part is to determine what mortgage will do because that has sort worked from record highs as a function of interest rates. And the other parts of non-interest income are making continuous improvement in their process and we think will show growth over the future.

But nothing stands out to us that says it is going to be higher than that 4 percent now. Even that is a little difficult from quarter to quarter to get. As you know, it sort of varies around.

Sure, thanks.

(OPERATOR INSTRUCTIONS). Joe Morford. RBC Capital Markets.

Just a follow-up and really more of a follow-up to Fred's question. I guess if you could give us an update on how your progress has been in terms of improving the number of relationships you have per household given that it seemed like it's going to be hard to increase your household penetration given it was pretty significant already? But just doing more business with the customers you have, how does that whole initiative progress?

Dave, that is in the retail area. Do you want to comment?

I think it's an important initiative across the entire bank. I mean even in commercial banking, we look at the depth of relationships that we have. But we have talked about it quite a bit in terms of the consumer household.

We have made steady progress in the improvement of that number. It is a hard number to move given the large base that we have. But the progress has been steady. Frankly, we look at that number more as an outcome of our efforts as opposed to a specific goal or target. It is important for us to continue to maintain the discipline of our sales culture, which is focused on identifying customer needs and providing solutions to those needs. Making sure that we provide the right product to the right customers as opposed to just sell products indiscriminately in order to increase a target number or something like that.

So we are pleased with the progress that we made in the depth of penetration in our household. It has been steady progress, and we think that we have got good momentum as we look toward the future.

Can you quantify at all or update some of the numbers when you initially came out with your restructuring plan or whatever, kind of the numbers that you had and any specific progress that you have made there?

Well, as I recall when the original plan was established back in '01, our penetration was around 2.2 per consumer household. We now are running around 2.4. So that has been good steady progress. It is challenging, though, on a comparative basis because you also have to realize that in between those two times we went through the system conversion, and as we went through the system conversion, the translation was not one for one. Some of the accounts were consolidated, some households were viewed differently, and so that gave us a little bit of challenge in terms of maintaining a consistent look over a long period of time.

Okay. One other quick follow-up was on the direction for the classified asset trends, are they still declining, or have they pretty much stabilized now?

This is Bill Nelson. I would say they are pretty stabilized right now. They are -- we had some very modest improvement this last quarter. But I think we also have to recognize that we do have a large airline portfolio, and there has been an impact in terms of fuel cost that has hit that entire industry, and we have tried to acknowledge some of that in the way we internally grade credits. But I think that is still evolving as we get more results from that industry. So I would say, to answer your basic question, it seems relatively flat right now.

Jackie Reeves. Ryan Beck.

I apologize if you answered this one question, but on the service charges line, I have heard commentary from some other franchises that there is actually, behind some of the decline there in the fee revenue, some changes in the client behavior. Are you seeing that as well?

Dave, anything you see in the retail sector?

Not that we have observed. Jackie, can you be more specific in terms of what kind of behavior?

Specifically it had to do with various fees being levied on the clients, and they were just getting smarter or more in tune with what those fees were and in the future avoiding them.

I think the customers are always going to manage their financial affairs and try to minimize their fees as a general comment. But we have not increased any fees here in our market for several years, any material deposit fees. We have done some very modest changes in ancillary fees to the accounts, but not the core fees on the deposit accounts themselves, and so it has not been anything to really change our customers' behavior. So we have not observed anything.

We sure work with our customers to make sure they understand our products and our pricing, and what we want is for them to choose the product that works best for them economically. So part of our relationship management approach that Dave spoke about earlier is to make sure that we are clear on what our fee structure is and allow customers the right to adjust their product mix to best meet their needs. And that is throughout the thing. It has biggest impact in retail just because the law of large numbers of customers, but we are doing the same thing in our Investment Services and commercial groups as well.

Okay. Secondly on the economy, are you seeing any signs throughout your marketplace as I noticed the term maybe even reaching full employment of any pricing pressures in terms of having a difficult time finding employees? Is your salary based -- how are you looking at that, or is it being impacted at this point in time?

You are right. When you get down to a 3 percent or a couple of times even less unemployment rate at the margin, there are certainly jobs that are difficult to fill. We get anecdotal stories all the time about builders bringing in construction crews from the West Coast. First, it was Southern California, and if that got stronger there, then I hear stories about coming in from Central Washington. And as well in the service industries, there are challenges there from time to time. But I think that has just become kind of a pattern of what goes on here in Hawaii for the last year or year and half. Any other comments there?

Thank you.

Jim Bradshaw. D.A. Davidson.

Sorry. I had one follow-up I forgot earlier. Is the drop in mortgage banking related to accelerated amortization, or was there any impairment charge in the quarter?

No, there were no impairment charges, and actually amortization of our MSR has moderated somewhat as the refinance activity has slowed down. The change in the mortgage banking income is directly related to the volume of loans that we had for sale during the quarter and secondarily just some pricing pressures in terms of narrowing of margins on loans sold.

There are no questions at this time. I would like to turn the call back over to the presenters for their closing remarks.

I would like to thank everyone for joining us today. As always, if you have any additional questions or any further clarification on any of the issues discussed here today, please feel free to call me at 808-537-8430. Thanks, everyone, and have a great day.

Ladies and gentlemen, thank you for joining us on the call. You may now disconnect.