Bank of Hawaii Corp (BOH) 2005 Q1 法說會逐字稿

Welcome to the Bank of Hawaii Corporation's earnings call for the first-quarter 2005. My name is Sean and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session following today's presentation. (OPERATOR INSTRUCTIONS) At this time I'd like to turn the presentation over to Ms. Cindy Wyrick, Senior Vice President of Investor Relations. Please go ahead.

Hello, everyone, and thank you for joining us as we review Bank of Hawaii Corporation's financial results for the first quarter of 2005. Joining me today is our Chairman and CEO Al Landon; our vice chairman and CFO Rick Keene; the Vice Chairman and head of our Retail Banking group Dave Thomas; and our Vice Chairman of Corporate Risk Bill Nelson. Today's comments will refer to the financial information that was included with out earnings release that went out this morning.

Before we get started let me remind you that today's conference call will contain some forward-looking statements. While we believe the assumptions we have made are reasonable, there are always 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 Al Landon.

Hello, everyone. Bank of Hawaii traditionally has a good first quarter, and this one was no exception. We completed the quarter with solid financial performance. Our margin increased, revenue was up in nearly every category, and our expenses were down. This resulted in operating leverage of 9% compared to the fourth quarter of last year. We also continued to see growth in both loans and deposits.

Our return on equity exceeded 23%; our efficiency ratio dropped below 53% this quarter, and our portfolio continues to experience solid credit quality. Now I would like to ask Rick to provide you with some additional information about our first-quarter financial results. Rick?

Thanks, Al. Hello, everyone. As Al said, Bank of Hawaii Corporation had a good first quarter. Our net income was $45.5 million, 14% higher than last year's first quarter. This quarter's net income was $700,000 less than in the fourth quarter, but last quarter included a $6.5 million reversal of the allowance for loan losses.

The first-quarter diluted earnings per share was $0.83. Return on equity was 23.7%, and return on assets was 1.88%. Net interest income was $100.7 million in the first quarter, $700,000 higher than last quarter, and 4.6 million higher than the first quarter of 2004.

The increase in net interest income over the fourth quarter was primarily due to an increase in average loans outstanding and also to an improvement in lower yields. The positive impact of these two factors was partially offset by an 11 basis point increase in average interest rates paid on deposit. Although our deposit rates increased slightly this quarter, the general environment for deposits rates in Hawaii has remained stable.

Net (ph) margin for the fourth quarter was 4.3%, up 3 basis points from last quarter and up 13 basis points over the first quarter of last year. We have included an analysis of net interest income in table 6 to our earnings release.

In the first quarter of 2005 we did not record a provision for loan losses, compared to, as I mentioned earlier, the $6.5 million reversal of the allowance that was recorded last quarter. Non-interest income for the first quarter was $52.3 million, a $4 million increase from last quarter. The increase was due to higher mortgage banking income, due to a higher level of originations; higher Trust and Asset Management income, primarily from tax preparation fees and other annual fees that typically increase in the first quarter; and higher insurance income, in part due to increased sales volume of annuity and life insurance products. Another reason for the increase was that in the fourth quarter a $750,000 loss was incurred on the sale of securities.

Non-interest expenses in the first quarter were $80.9 million, $1.2 million lower than last quarter. Almost all categories of expenses were down from last quarter, which is reflective of ongoing expense control. Salaries and benefits were down due to a lower number of employees and a decline in stock-based compensation, partially offset by higher payroll tax expense in the first quarter.

There were two noncore expense items this quarter. The first was a $1.1 million gain on the sale of foreclosed property. The property had a zero carrying value due to previous sales of other parcels of the same property. This gain was recorded as a credit to expense. We also recognize a $1.3 million expense related to goodwill impairment. This goodwill was recorded in 2001 when a local insurance agency was acquired and merged into our existing retail insurance agency. We recently had some downsizing within that business unit which was a triggering event for the impairment charge. The amount written off was the total amount of goodwill that related to this insurance business unit.

While we are on the topic of expenses I wanted to mention the SEC's recent deferral of the effective date of FASB Statement 123R. This is the accounting standard that requires expensing of stock options. We now plan to implement this standard in January 2006. In last quarter's earnings release and in our Form 10-K, we indicated that we had planned to adopt this standard in July 2005, which would have resulted in a pretax charge to earnings of $1.5 million in the second half of this year.

For the first quarter the efficiency ratio was 52.9%, an improvement from 55.4% last quarter and 57.3% in the first quarter of last year. Operating income for the first quarter was more than 16% higher than the first quarter of 2004. Our effective tax equity first-quarter was 36.9%, higher than normal due to the goodwill environment, which was not tax deductible.

Table 11 in the press release provides a summary of business segment performance. The retail segment had a strong return of 38% on its allocated equity, up from 29% last year due to higher consumer loan and deposit balances and higher mortgage banking income when compared to the first quarter of 2004. The commercial segment had a return on capital of 31% for the quarter, an improvement from 24% last year, mainly due to higher average loan balances and an increase in non-interest income.

The investment services segment had a solid return on its capital of 22%, which is comparable to last year. The rest of our operations are represented in the Treasury segment, which had a return of 20% in the first quarter. The first-quarter NIACC measure for the total Company was $20.2 million, compared to $13.8 million for the same period last year.

Now some comments on credit quality. Nonperforming assets were $13.4 million at the end of the quarter, down from 13.9 million at the end of 2004 and 27.9 million at the end of the first quarter of last year. Nonperforming assets represented 0.22% of total loans at the end of the first quarter.

Gross charge-offs in the first quarter were $5.8 million, and recoveries were 2.1 million, resulting in net charge-offs of 3.7 million. This compares to net charge-offs of 4.6 million last quarter. First-quarter 2005 net charge-offs represented an annualized loss rate of 25 basis points.

At the end of the first quarter the allowance for loan losses was $105 million and represented 1.75% of loans. We will continue to you evaluate the economic environment and the level of risk in our portfolio each quarter and recognize the provisions of loan losses as necessary to maintain the allowance at an appropriate level.

Our exposure to the air transportation industry is summarized in table 8. This exposure was down slightly from the amounts at the end of last quarter. In the evaluation of the allowance for loan losses we continue to consider the financial pressure being faced by some air carriers, which tends to offset the strength in the rest of our portfolio.

With respect to the balance sheet, assets totaled $9.9 billion at the end of March, $142 million higher than last quarter. Total loans outstanding were up slightly over the fourth quarter, largely due to growth in consumer loans. We continue to originate a steady volume of commercial loans, and our commercial pipeline continues to look good. But again this quarter the end-of-period commercial loan balances were impacted by payoff activity.

Deposits increased 2.5% over last quarter. The increase was primarily in interest-bearing demand and time deposits, partly offset by a decline in non-interest bearing deposits. As I mentioned earlier, interest rates on deposits have continued to be relatively stable in the Hawaii market. For example, our average rate on market accounts increased only 10 basis points during the first quarter. Our balance sheet remains positioned to benefit from interest rate increases, and our capital position continues to be strong.

We continued our share repurchase program by purchasing 2.4 million shares during the first quarter. Since quarter end we have repurchased just over 0.5 million additional shares. Through April 22, the Company has repurchased almost 38 million shares and has returned over $1.2 billion to our shareholders since the program began in 2001.

Last week our Board approved a $100 million increase for the repurchase program, which leaves an unused authorization of $127 million as of this morning. We plan to continue to make repurchases in a disciplined manner. Our Board also declared our second-quarter dividend of $0.33 per share. In summary this was another very solid quarter for the company. That concludes my comments, Al.

Thank you, Rick. We're pleased that Bank of Hawaii has continued the momentum we established last year. Now I'd like to comment a little about the remainder of 2005. The Hawaii economy remained strong during the first quarter. Hawaii experienced record numbers in tourism, home prices, and employment. Based on these conditions and the results of our first quarter, we now believe that our net income for 2005 will be in the range of approximately 176 to $179 million.

Our estimates are based on several assumptions. One particularly important element is the appropriate level of the allowance for loan and lease losses. At Rick reported, credit quality remains very strong. However, our net income estimate for 2005 currently includes a $10 million provision for loan and lease losses. It's important to remember that this provision estimate results in a $20 million change in pretax income from 2004, which included a $10 million return of income from the reserve. Of course, we re-evaluate the level of reserves needed on a quarterly basis and will adjust as necessary. Now would we be happy to take any questions you might have.

(OPERATOR INSTRUCTIONS) Campbell Chaney, Sanders Morris Harris.

Can you give me a little color on this nonperforming asset? Because the investment, I think, is $684,000.

Campbell, what? The nonperforming asset?

Yes, it's listed under investment of $684,000 that just showed up this quarter.

Think a second on what we've got there. Oh, I know what it is. Sure, I know what it is. We carried an investment; it is a loan we made to one of these microbusiness community development organizations here in Hawaii. Just some difficulties with their operation. So we moved that into nonperforming status. It is a little bit unusual, carrying it in investment, because I think from (technical difficulty) standpoint it is classified as an investment, community development investment.

Like an SBIC or something along those lines?

That would be pretty generous, but you've got the idea. It is part of that structure, Campbell.

I got you, okay. Then, hat's off to you all for your expenses and holding the line like you have. What kind of a run rate can we expect for your expenses going forward? Can you really juice that down a little bit more? Are we kind of at the bare bones run rate here, at about 80,000, or 80 million, 81 million.

I think we are in a pretty comfortable range right now. We have been targeting around 80, 81 million as a good run rate. However, it is going to bounce around a little bit. We have got some other expenses coming down the pike. For example, when we get into next year we have got these stock options and so forth. But I think this is a pretty decent run rate within a bound, within a range.

Okay. And the goodwill impairment is included in that? Just (multiple speakers) clarify that.

That is correct. But it is offset a little bit by the gain on sale of foreclosed property.

Okay, got you. Great quarter. Thanks a lot.

Jim Bradshaw, D.A. Davidson.

Al, a couple questions if I may. First off, regarding your -- in the consumer lending side, the residential real estate and home equity categories were both up nicely this quarter, especially home equity. Can you talk about sort of what -- is it all within Hawaii still? Or within footprint, I guess I should say. And/or are you doing any special marketing? Can you talk about your success there?

Dave, you on the phone?

Yes, I'm here.

Want to give Jim a little bit of information on that?

Yes, sure, Jim. In terms of the geographic focus of the growth, it's principally Hawaii. A little bit comes from our Pacific Islands division, but pretty much immaterial in terms of the total numbers. What we are continuing to see is the result of some, I think, favorable equity positions in the residential real estate market that allow people to take advantage of home equity loans; and some pretty consistent strong marketing campaigns.

As a matter-of-fact, not fully reflected in these numbers yet is the fact that we just concluded a very successful home equity marketing campaign at the end of the first quarter.

Okay, good. Then the last question I had revolved around your headcount. It's been fluctuating a little bit over the last few quarters. Can you give me an idea whether you were up or down in Q1; and anything else planned along headcount side for the second quarter?

If our recall correctly, Jim, we were down just a little bit in the first quarter versus the fourth quarter. We have been sort of consistently using our workforce more efficiently. That said, we don't have any program or activity in place to specifically reduce headcount in any of our business or support units. I would say that we are vigilant overall trying to make sure that we use our workforce as efficiently as we can.

We are pretty fortunate out here in Hawaii. We've got a pretty hard working group of people. The other thing that enters into this a little bit is the employment rates here in Hawaii right now. There are a lot of people looking for workers. Unemployment, if I remember, is 2.8% of something like that here in the last month. So part of this is purposeful focus on efficiency; and the other part is the challenge of finding employees in a robust market.

Sounds good. I appreciate it. The slight reduction in headcount, that included the downsizing from the insurance agency. That was in this quarter, is that correct?

Yes, it was.

Okay, great. Appreciate it. Thanks very much.

Andrea Jao, Lehman Brothers.

Just going to circle back on the margin. Just wanted to better understand the drivers of net interest margin expansion, because I think I am missing something. Your yield on earning assets showed an increase of 12 bps, while your cost on interest bearing liabilities showed an increase of 14 bps. So, what was offset?

Rick, you want to take that?

I think it was volume of loans. We had -- I haven't looked at this. We did have a mix in deposits; non-interest bearing demand changed some. We have increased some in loan volume as well, particularly in the commercial loans for this quarter over last quarter. I had not tried to do the analysis that you just did, Andrea; but I think the volume as well as some uptick in rates was the primary drivers there.

You might take a peek at the value that comes from non-interest-bearing demand. You can see that our spread narrowed just a touch, which is what you pointed out. But the contribution that comes from non-interest-bearing demand as rates go up is a little bit more significant, and that probably swings it the other way.

Great. Thank you.

Kathy Steinbrecher, Piper Jaffray.

Great quarter. Just a couple questions. The 1.9 million reduction in off-balance sheet reserves, was that a result of a charge-off or improving outlook?

This is Bill Nelson. That is a result of both we -- our charge-offs were 3.7 for the quarter net; and you combine that with a slightly improving outlook, which has been improving for quite some time now. And we saw our way clear to reduce the reserves by about that amount.

Bill, you were talking overall. I think Kathy was asking specifically about the off-balance sheet.

That is what we calculate every quarter. As of last quarter we realigned those into another liability from the basic reserve. That relates to just an improvement of quality as well as a reduction in the unused but legally binding commitments.

We had one piece of particularly good news right at the end of the quarter on an off-balance sheet commitment. That allowed us to make that reduction specifically.

The 1.9, so that was an improving outlook. Did that have any effect on the income statement?

No. It was simply an undrawn commitment that had some risk in it at the end of the year. It expired as we got to the end of the quarter, without being drawn. And the need for reserve on that went away.

Great. Thank you. Then your mortgage banking was up nicely. Was that from gain on sales loan or servicing?

It was primarily on the gain on sale of loans. We had a strong origination quarter. We still have a strong pipeline there. So that was primarily originations as bundled and you. originations which funneled into sales.

Dave, anything you want to add on mortgage banking there?

No, other than to emphasize what Rick just said. It was a very strong quarter for us. Despite interest rates bumping around quite a bit through the quarter, we continued to see good strength in both refinancing activity and new purchase money transactions.

Can you tell me what the margin was last quarter versus this quarter? The gain on sale margin?

I don't think that is information we have put out, and I don't think any of us have it here with us this morning.

How about the types of loan origination?

Dave, do you want to comment on that?

In terms of fixed versus variable, or refinance versus purchase?

Refinance versus purchase.

We were running about 50/50.

And fixed versus variable?

I'm sorry. I don't have my monthly mortgage report in front of me right now.

I think it is about 60% fixed and 40% floating.

If you looked at your overall portfolio , the loan growth expectation I think you had given was 4%. Was that a gross loan number, the 4% number that you had guided to in the fourth quarter?

Yes, it would be.

So are you still expecting 4% gross loan growth?

We don't see anything to change that right now. But that's a little tricky to get a good estimate on. Quarter to quarter, as we have said before, the liquidity and the economy out here makes that particularly difficult to predict. As we go into the second quarter we know we've got some good-sized outstanding where there is particularly liquidity in the borrower. So we may see even a quarter where it pulls back rather than expands. But that, while we like to see loan growth we like a strong economy even more, I guess.

Okay. Of your loans currently in the portfolio, do you disclose about what percentage is fixed right now versus adjustable?

It hasn't changed from the last time we talked.

Great. So salary expenses, do you expect that to -- that won't be as low as it was this quarter. You expect that to go up a little bit? Or the run rate would be about where it is?

I would expect in the second quarter it is probably going to up a little bit. We typically have across the board salary increases here for our staff take effect April 1. So we generally see a little blip up in the second quarter. But other than that probably pretty stable.

Let me see; the other question is the foreign loans. I didn't see that on your press release. Was there a change on how you allocate those loans?

No.

Okay. Great, thank you very much.

Brian Harvey with Fox-Pitt, Kelton.

Just had a few questions. I guess, Al, first on the guidance. It seems to be going up a couple of million dollars from the last quarter. Is that all just because of the fact that you are not going to be expensing stock options? Because it seems as though you had a relatively strong first quarter, and that sort of implies maybe a bit weaker performance in the back half of the year. Is there something we should be concerned about?

Brian, the expensing of stock options was a little bit less than half of the increase range. The first quarter was a nice strong one for us. There isn't anything that I know -- the way you phrase that question, is there anything you should be concerned about? There is nothing that I know to tell you that you should be concerned about.

I would remind you again about the provision. That we have in that range -- the 176 to 179 range -- the assumption that we will provision at approximately a $10 million level. You can see where our credit quality went this quarter. We take a look at it each quarter. But that would -- the circumstances would lead you to think that provisioning would be in the second half of the year.

We are going to have to see what circumstances look like as we get closer to that, and we will update you on any assumption changes relative to provisioning. But that provision change makes it a $20 million swing from last year, when we returned to income $10 million through the provision line.

Is that $10 million any change from the previous guidance, though?

No, it is the same.

Another question I just had is on the capital ratios. You had a very aggressive buyback program this quarter; and tangible capital slipped below 7%, which I thought in the past was sort of the targeted level for you guys. What are some of the thoughts in terms of capital ratios as you stand today? Any more comfort in driving those lower? Or any other thoughts you may have?

Our leverage ration is actually 7.4% at the end of the quarter.

Brian said tangible, so he is knocking (ph) goodwill.

Right, we're looking just at the leverage ratio, and that's the one we have been targeting. We've been targeting about 7% on that. It was 7.4 at the end of the period. Our target continues to be 7 on that, and we expect to be in the 7 range by the time we get to the end of the second quarter. So we have not keyed it off of the tangible ratio; we've keyed it off the leverage ratio.

Brian, more generally, no change in our capital plan or our capital expectation is what we're looking at. We had a big buyback quarter, as you saw. You may recall in the fourth quarter we actually had an increase in shares outstanding due to option exercises. And that factor plus market conditions suggested to us that it was appropriate to buy a little bit more in the first quarter.

Just lastly, on the mortgage banking, did you have any recapture of the MSR valuation reserve this quarter?

No. We haven't taken any impairment charge on the MSR. So the accounting rules won't let us have any recovery on that.

Okay. Thank you.

Unfortunately.

Fred Cannon with KBW.

Just a question. Your operating leverage was very positive, if I look at it year-over-year. I think your revenue was up 5.6% and your expenses were down 2.9%, which is allowing the efficiency ratio to continue to fall. I guess the question is, Al, is there a point at which you get to an efficiency level where you might start to begin to increase expenses more in line with the somewhat stronger growth that you seem to be getting than probably early expectations had?

From a theoretical standpoint that is clearly out there, Fred. We haven't spent any time calculating expense increases yet. I think it's a function of the productivity that comes with a good economy. As I mentioned earlier we've got a pretty hard-working team here who were really focused in the first quarter.

We are going to try to keep that momentum up, but quarter to quarter these ratios get to pretty fine. It's I think a little bit difficult to say quarter to quarter exactly what that's going to be.

But in line with Rick's comments, it is kind of flat expenses for a while?

I would think so. We're pleased with getting to this level. We will work hard to maintain our efficiency there.

Great. Great to see this quarter. Thanks.

Mark Kehoe, Merrill Lynch.

I was wondering whether you could talk about your trust fees, the driver there, whether it was season or (indiscernible) going on?

Some of it was seasonal. We have -- typically in the first quarter and a little bit bleed over into the second quarter -- you have tax preparation fees. So generally we see an uptick in the first quarter. We also have some accounts that are billed based on an annual cycle. So we have a little bit uptick there as well. So some of it is seasonal.

Mark, the other part of that is related to our Asset Management business. And there we've seen the performance of our funds pick up a little bit. And interest rates going up a little bit have helped us with our fee structure there.

My last question was in terms of the story about the ATM upgrades in Hawaii. Will that impact the Bank of Hawaii's cost base?

Nothing significant. We've got it factored into our forecast. While it is a significant undertaking for us to hit that many ATMs, there isn't anything that would change our cost structure there.

Clearly with us installing that many new ATMs, we will see an increase in our depreciation. But that is going to be significantly offset because of reduced maintenance expense.

Thank you.

There you have it, Mark. A little bit more information. Thanks Dave.

Brett Rabatin, FTN Midwest Research.

A couple questions. First I wanted to talk about service charges during the quarter. I know your markets are a little different than the average mainland market. But can you guys talk about the service charges which were flattish from a linked-quarter perspective. Many companies have been reporting slightly lower revenues on that line item this quarter.

Dave, that would be something you might want to help us with.

I can comment specifically to the consumer service charges. In terms of our monthly deposit service charges, quarter-over-quarter they were pretty much flat. There wasn't much of an increase. The biggest increase that we saw in terms of non-interest income and account-related fees is overdraft protection -- or I'm sorry, NSF fees. OD NSF fees.

We had mentioned I think a couple quarters ago that we had implemented several initiatives related to policies and processes which would lead to increased non-interest income. We are beginning to see the benefits of that now, over the past couple of quarters.

Can you talk about how much the commercial account analysis fees and that sort of thing is -- how big a piece of that is, in relation to the total deposit service charges at this point?

I'm focusing on the consumer fees. I can talk generally about the analysis fees. But I don't have the specific information on all the account analysis fees. I can say generally because of rising interest rates, therefore providing larger funds credit for our commercial customers, we've seen some slight decreases in our analysis fees. But I don't have all the specifics.

Well, it was good to see the fee income, that line item was flat, nonetheless. Can you also talk about hour-day (ph)? The last quarter we were talking about prepayments affecting the loan growth. Obviously it sounds like you're still a little cautious on that going forward. Is that a reflection of customers being more conservative? Or is that a function of fixed-rate financing from other available sources? Or where are you guys seeing that be the result of?

I will ask Bill to give you a little bit of color around that.

We've continued to see that now for a number of quarters, which is prepayments of commercial obligations. Some of that is a real function of the success and robustness of the economy here, and the ability of customers in general to generate a lot of excess cash flow on the commercial front.

We're also seeing some prepayments in the commercial real estate area as certain construction projects get built out and then financed permanently. I think we will continue to see that for the foreseeable future as well. But on the other hand we have offsetting that a stronger level of pipeline in terms of deals that are lined up in most of our commercial businesses than we've had in the past.

So the pipeline continues very strong, led by commercial real estate; and construction portfolio features prominently within commercial real estate. So we see a continuance of that going forward. So there is a balance there between the prepayments and the continuance of loan growth in commercial.

Brett, I think embedded in your question was a reference to competition.

Yes.

We do have here in Hawaii occasionally some important large developments that probably go beyond the lending level for Bank of Hawaii alone. So out-of-state lenders do come to participate in those. We have not, as a rule, seen any dramatic change in that.

There maybe is a little bit more tendency, as our Bank has gotten a little bit more aggressive, for us to participate or be a service agent on the front end of those. So we might take a $20 million piece and a group or a large lender take the remaining portion of that. And we are working hard to make sure we're effective in that network. I think generally good results; but on balance we've tried to avoid the concentration risk that comes from being the main bank or having the large share of exposure on those big projects out here.

Okay. Any thoughts on -- obviously the credit is stellar given that you guys have pulled the horns in on what you do and who you'll lend to. Is there any thought on expanding the parameters of the loan portfolio? I don't necessarily mean that has to go mainland. But any thoughts on changing the dynamics of what credits you look for in order to bolster growth, given kind of the Hawaii markets?

I think we're still very focused on our island market share. We take a look regularly at opportunities to use our deposit base more effectively. But we haven't found anything significant where our ability to compete justifies the risk that we would take. So we're in a high liquidity market and enjoying it. It limits the expectation of growth in the commercial categories. But for us, it controls the credit risk; and that is the driving feature, I think.

Great. Thanks, guys.

Joe Morford, RBC Capital Markets.

I just had a question, recognizing that deposit rates in Hawaii have tended to be a little more stable, right now do you see anything going forward changing that? Have some of the smaller players started to run any promotions to mess with that? Or maybe there's some non-bank players offering more aggressive money market rates? Kind of you're outlook for deposit pricing.

Dave, do you want to address it from the retail perspective?

Sure. As Al has mentioned a couple of different times, the high liquidity in the marketplace not only impacts our balance sheet, but it impacts all of our major competitors. Therefore we don't see on the horizon any change in posture regarding the overall deposit rates or the level of competitiveness for deposits.

Obviously there are some small niche players that, in an effort to be attractive and try to grow their balance sheet, offer more aggressive rates. But I mean these are smaller players that might only have one or two locations in the state.

In addition to that we constantly have the pressure of the credit union market, which is extremely competitive here, with over 110 active credit unions in the state. But again individually each one is a pretty small player. So I guess a longwinded answer is we don't see anything on the horizon that really concerns us about a sharp change or a change in direction with where the interest rates have been most recently.

Joe, at some point in time the market changes will be enough that deposit rates will have to go up. We have been fortunate so far in the market; and I think our position here in Hawaii competitively allows us to be in the leadership segment of what happens with the market there. We will watch it closely, because we want to be a reasonable value for our customers as well as our shareholders. So count on us to keep a good finger on it. The deposit structure we have now works well, so we want to keep that intact.

Understand. Okay, thanks very much.

Andrea Jao, Lehman Brothers.

Couple of follow-up questions. First, could you share with us your latest outlook with respect your air transport portfolio?

Bill?

Our outlook is continuance, slow but steady reduction in the size of that portfolio. We have been witnessing that for a few quarters now at a very slow rate. But many of these obligations are longtailed obligations that don't have maturities in the near-term, but they are diversified among a number of carriers, among a number of aircraft types. And we feel like we've recognized the risk very well and have done so for some time, and have properly reserved against that risk. So I'd say it's steady and slightly decreasing over a period of time, Andrea.

Okay, thank you. My next follow-up question is, you've already touched on a few components of your three-year plan, and I asked this last quarter also; do you intend to share with us an update?

I'm not sure I understand, Andrea. An update on our three-year plan?

You have bettered some of the metrics there. For example, leverage ratio, we know that would approach 7% by the second quarter. You're already below 53% in terms of efficiency. You exceeded ROE (indiscernible) targets.

We're not quite halfway through yet, our three-year plan. We've been fortunate to get there earlier in some of our metrics than a linear calculation would suggest. We'll wait until later this year, and until we have a little bit clearer line of sight into what 2006 might bring. If we see that 2006 would give us a better result than what our three-year plan showed. And again, for those who aren't familiar with it, our three-year plan covers 2004 through 2006. So '06 is the last year. As we get better sight there, we will give you an update if one is appropriate.

Okay, thank you.

Brian Harvey, Fox-Pitt, Kelton.

Thanks a lot, guys. Just had two follow-ups; try to be quick on this. Al, can you help me understand the $1.9 million reduction in loan commitments, why doesn't that run through as a reduction in expenses?

If I understand it, it does run through as a reduction. We run that through the allowance line.

Well, in effect, the off-balance sheet, both the change in the on-balance sheet allowance and the off-balance sheet reserve that sits in at other liabilities, the net effect of that would run through the provision line. So, in theory, yes, it would impact the income statement. But if you look at those two in total, in fact, if you look at one of our tables, we have that broken out as a, we call it a reserve for credit losses, and that's comprised of two pieces; the allowance for loan losses and the off-balance sheet reserve for commitment. The off-balance sheet reserve went down by $1.9 million. The net charge-offs certainly impacted the overall allowance, but the overall allowance did not come down by the full amount of the net charge-offs.

So you have a netting effect going on there, in effect, through the provisional line of the income statement. What we do is look at that holistically. We look at the overall portfolio. We do our analysis around that together. We don't do a separate analysis for the off- balance sheet. We'll look at it holistically and determine what we feel is appropriate for a provision to let losses. This quarter we had a zero provision, but it's broken out component-wise between those two reserves.

So there is nothing running through the expense line?

That is right.

I may have confused you, Brian, there. I thought the question was did we get a reduction in that allowance as a result of the charge-off or through the cancellation of a commitment. And it was through the commitment or exposure reduction, not through recognizing a loss. That is the question I tried to answer, and then hopefully Rick's explanation helps you appreciate the impact on the income statement.

The last question I had is just -- maybe Rick, you could help me with the load yield. They seem to be only up about 7 basis points one quarter, despite some of the pretty aggressive moves by the Fed. Can you make any comments about that? I'm just looking sort of linked-quarter.

A lot of our pricing is variable, so it would move up some. I don't know if all of our pricing is going up in direct proportion to the Fed. It's also due to the timing on when some of the loan comes on or when the mix comes on. We had some loans come on right at the end of last quarter which would tend, if you look at it quarter-over-quarter, is going to not necessarily be in direct proportion to the Fed change.

Do you just think it's somewhat related to timing?

I think some of it is related to timing. On the residential side it's probably related to the timing of sales out of the portfolio. On the commercial side I think it is timings based on when loans came on last quarter as well as this quarter.

Thank you.

(OPERATOR INSTRUCTIONS) Campbell Chaney, Sanders Morris Harris.

I'm just trying to reason through your $10 million provision. Can you give us some color on how much of that is a function of your projected loan growth for the year? And possibly the airline industry, if that were to improve the second half of the year, that could have an impact on your provision assumptions as well? Just trying to get some idea of where the pressure points are for a $10 million provision.

What we would look at, when we put that together, Campbell, is kind of what our normal quarterly net charge-off rate might be. If you go back in time and look at it over a little longer horizon, a $5 million per quarter number was not unreasonable. It seemed to me to be sort of our best average. And that is the best data we have.

In terms of improving airline, from your lips to God's ears, as they say. But I don't think that that would have a significant impact on what we would do for the provision here in the second half of the year. We've reserved at the level we feel is appropriate given the current economics and our portfolio. We would not intend to replace that portfolio sort of no matter how good or otherwise it gets.

No, you answered it fine. Just the net charge-offs, I was just trying to understand your thinking behind that.

As we have tried to indicate we're going to have to look at that quarter by quarter. The rules on that are getting tighter and tighter. We're doing everything we can to be as precise as we can in the calculation. And yet it's one that you have to make right at the time; and making an estimate out there in the future is a little bit difficult to do.

Understood. Thank you.

With no further questions I'd like to turn the presentation back over to Cindy Wyrick.

I'd like to thank everyone for joining us today. As always if you have additional questions or need further clarification on any of the issues we have discussed today, please feel free to call me. My number is 808-537-8430. Thanks, everyone, again. Have a great day.

Ladies and gentlemen, this concludes today's presentation. You may now disconnect. Have a great day.