Bank of Hawaii Corp (BOH) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Second Quarter 2006 Bank of Hawaii Corporation Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the conference over to our host for today's call, Ms. Cindy Wyrick, Investor Relations. Thank you. Please proceed.

Thank you very much and good morning, everyone. Thank you for joining us today as we review the financial results for the second quarter of 2006. Joining me today is our Chairman and CEO, Al Landon, our Vice Chairman and CFO, Rick Keene, Vice Chairman and Chief Operating Officer, David Thomas, Vice Chairman and Chief Banking Officer, Peter Ho, and Vice Chairman of Corporate Risk, Mary Sellers. The comments this morning will refer to the financial information included with our earnings announcement.

And before we get started and remind you that today's call will contain forward-looking statements. While we believe the assumptions we've made are reasonable, there are a variety of reasons that the actual results may differ materially from those projected, as outlined in today's release

And now I'd like to turn the call over to Al.

Thanks, Cindy, good morning and good afternoon everyone.

The second quarter of 2006 reflects strong underlying fundamentals at the Bank of Hawaii, even though we were disappointed by the surprise change in tax legislation that resulted in a $9 million reduction to our net income. We had good loan origination volumes this quarter in both our commercial and consumer portfolios. Our asset quality continues to be very solid. Non-interest revenue increased, and we did a good job controlling our expenses. The margin declined slightly more than we had expected, as our customers, just like most customers on the mainland, saw higher return uses of their cash. Average deposit balances decreased despite an increase in the number of customer accounts.

Now I'd like to ask Rick to provide you with some additional information about our second quarter results. Rick?

Thanks, Al. Hello, everyone.

For the second quarter of 2006, Bank of Hawaii's net income was $37.2 million, compared to $45.4 million last quarter and $46.4 million last quarter of last year. The diluted earnings per share was $0.73 in the second quarter. The return on equity was 21.7% and the return on assets was 1.47%.

As we previously announced, a significant item in the second quarter was the $8.8 million, one time charge that resulted from recently enacted tax law. We filed an 8-K related to this matter in June. The passage of this law repealed the exclusion from federal income tax of a portion of the income from foreign sales corporations. The charge primarily impacted the provision for income taxes, although it also included a $600,000 reduction in net interest income.

Without the charge, net income would have been just over $46 million. The return on equity would have been at 26.9%, and the return on assets would have been 1.8% for the quarter.

Net interest income was $99.9 million in the second quarter, $2.3 million, or 2% lower than last quarter and $1.2 million, or 1% lower than the second quarter of 2005. The decline in net interest income was due to higher funding costs in deposits and short-term borrowings. Like many banks this quarter, we experienced an increase in deposit rates and a shift of deposits in the higher costing time deposits. Average deposits in demand and savings accounts, both commercial and consumer, declined from the first quarter and these balances largely moved into time deposits as well as into managed cash accounts.

In addition to the change in mix, total average deposits declined $14 million for the quarter. And this was during a quarter in which we had strong loan growth. The loan growth in occurred in several commercial and consumer categories as originations were strong and of high quality. However the combination of solid loan growth and flat deposits resulted in a higher level of short-term funding. These factors, along with the tax law change are referred to earlier caused a decline in net interest income.

The same factors impacted our net interest margin. For the second quarter, the margin was 4.25% down 16 basis points from 4.41% last quarter. The decrease in our margin was somewhat more than we had anticipated, due largely to the increase in funding costs. We've included an analysis in the change in net interest income as Table 6 to the earnings release.

We recorded a provision for credit losses of $2.1 million in the second quarter, down from $2.8 million in the first quarter. The provision equaled net charge-offs in both quarters. In the second quarter of 2005, we did not record a provision.

Non-interest income for the second quarter was $53.2 million, an increase over last quarter and over the second quarter of last year. Non-interest expenses in the second quarter were $78.7 million, $2.1 million lower than the first quarter and flat with the second quarter of last year. One change from the first quarter was lower compensation expense mainly due to some seasonal factors and in addition, as some legal disputes have been resolved, those resolution costs have decreased. We continue to improve our efficiency, achieving an efficiency ratio of a 51.5% this quarter, down from 52.2% last quarter and 52.1% in the same quarter last year.

Operating income improved slightly from the first quarter and by 2.2% compared to the second quarter of 2005.

Our effective tax rate is significantly higher than normal in the second quarter due to the large tax adjustments that I mentioned before. This was a nonrecurring adjustment and going forward the effective tax rate will return to its previous level of just under 37%.

Table 11 in the earnings release provides a summary of business segment performance. The retail segment continues its solid performance with a 50% return on its allocated equity, up from 44% a year ago on the strength of consistent consumer loan growth and higher fee income. The commercial segment carried the full impact of the tax charge and its return on allocated equity fell to 9% despite strong loan growth. The investment services segment improved its return to 24%, up from 18% last year also primarily due to higher loan balances. The rest of our operations are represented in the treasury segment, which had a return of a 13% in the second quarter.

Credit quality remains strong. Non-performing assets were $5.4 million at the end of the quarter, down slightly from last quarter, and down 51% from the end of the second quarter of last year. Non-performing assets represent only 8 basis points of total loans at the end of the second quarter. Gross charge-offs in the second quarter were $5.3 million, and recoveries were $3.2 million, resulting in net charge-offs of $2.1 million. Second quarter 2006 net charge-offs represented an annualized loss rate of 13 basis points.

At the end of the second quarter, the allowance for loan and lease losses was $91 million, and represented 1.41% of loans. We continue to evaluate the economic environment and the level of risk in our portfolio each quarter and recognize the provision for credit 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 amount at the end of last quarter. In the evaluation of the allowance for loan and lease 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.

Outstanding loans increased $195 million or 3% during the second quarter and totaled $6.4 billion at the end of the period. We had continued growth in our home equity portfolio and had solid residential mortgage volume. Most of the increase this quarter was in the commercial portfolio, which was up almost 7% over the first quarter. As I indicated earlier, the increases were experienced across the portfolio, with balances in each category of commercial loans increasing over last quarter.

As I mentioned, there was a shift in the mix of deposits in the second quarter, and average deposits declined $14 million from the first quarter. At period end, total deposits were $7.8 billion, down $381 million from last quarter. This period end decline was primarily due to a $312 million commercial deposit related to a real estate transaction that settled on the last day of March and was only on deposit for a few days.

While some deposit balances declined this quarter, we continue to grow the number of deposit accounts. The net number -- the net change, excuse me, in the number of accounts had been positive both consumer and commercial accounts every month this year. We continued our share repurchase program by repurchasing 500,000 during the second quarter at a cost of approximately $28 million.

Since quarter end, we've repurchased 80,000 additional shares. Last Friday, our Board authorized an additional $100 million for the share repurchase program which means the remaining authorization at approximately $151 million as of this morning. We plan to continue to make repurchases in a disciplined manner and our capital position continues to be strong.

We have revised our previous net income estimate of $187 million to reflect the impact of the unexpected tax charge that was taken this quarter. We currently expect 2006 net income to be approximately $178 million. Good credit quality is expected to result in a lower provision for credit losses than we previously estimated. However, net interest income is expected to be lower than we originally projected, due to the continued flatness of the yield curve and the shift in deposit mix that I commented on earlier. These expectations are based on several assumptions, including among other things, trends in interest rates and the appropriate level of the allowance for loan losses. And finally, I want to point out that last week our Board declared our third quarter dividend of $0.37 per share.

That concludes my comments, Al.

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

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Brett Rabatin with FTN Midwest. Please proceed.

Hi, everyone good morning.

Good morning, Brett.

A couple of questions for you. First off, a housekeeping issue. On the other expense line item, was there any gains in other real estate that would have caused that number to dip a little than otherwise what would it have been?

No, we really don't have any other real estate out there that we have any transactions in at all.

Okay, so then as it relates to that, we keep having these numbers where we talk about how expense run rate seems to be pretty good, and then obviously you guys have been able to manage expenses more tightly than at least I've expected. So I guess I have to ask the question again. Is the expense run rate in the Q2 kind of a good run rate going forward or can you give us any color on -- on efforts to continue to mitigate expense growth from here?

Well, I think I've commented before that I thought a good run rate for us is in the $80 to $82 million range. And last year we were at $79 million. And I thought that was a little out of balance. But we're going to be out of balance sometimes. Sometimes we may be a little up, sometimes a little down. This quarter we're down. I think expenses this quarter were really solid. There wasn't anything unusual in them. So actually was a pretty good quarter. I think there are ongoing efforts, as we've said many times, to continue to look at expenses and manage expenses and I think that's what's reflected here. But I still think that we're probably at the low end of the run rate.

And then secondly, and share buybacks continue and I'm just curious if there are any thoughts on the 7% leverage ratio and if there might be any revisions to that target range over time given continued buyback activity?

We've said that we would try to hold that 7%. We're going to take a look at in the next three-year plan, but I wouldn't expect it's going to move dramatically lower than that.

And then one other question and I'll jump back into queue. The deposit accounts, you mentioned in the press release and in your comments that the deposit accounts had increased, both the consumer and commercial. Can you give us a rough number of what that increase was or any color on that?

It's been healthy in all months, but we -- That's the number that can bounce around and I don't know that we've got enough for the number of counts is meaningful enough to give precise details. I think the trend is probably as far as we want to go.

Okay, great. Thank you.

Sure.

Your next question comes from the line of Jim Bradshaw with D.A. Davidson. Please proceed.

Good morning. Thank you.

Hi Jim.

Hi, Al. A couple of questions. First off, on C&I Growth, that is about as strong a quarter as you have had an on-time in C&I. sIs that the advance rate going up or are you getting nice customer wins or a mix of both?

This is Peter Ho. Actually a mix of both. It was a very strong production quarter for us.

Good. And on the home equity side, is that internally generated stuff, or did you purchase some loans this quarter?

This is Dave Thomas. This is all in market originations for us. We've not done any more purchases.

Great. Okay. Good. Can you comment on delinquency trends? Are you seeing any signs at all that credit quality is beginning to stop improving here?

No, not at all. We continue to enjoy [a low] delinquency rate and pay rates and charge-off rates.

That's great. And then last question from me, probably I guess for Rick. Excluding the impacts from the tax law change, in interest income, was the margin in June better or worse than the average?

It was about on the average second half of the quarter was pretty much on average. Yes, that's about right.

So is another rate hike perhaps this quarter and the one you got late in the quarter margin you think will be fairly stable in Q3?

That's what we're looking at right now, you know, last quarter I said it would probably go down some in the second quarter.

Right.

And then bounce up a bit in the second half of the year. And we're still looking for that to be the case although it probably isn't going to bounce back up quite to the level that I thought it was before. We're probably looking somewhere around 430 or so for the rest of the year. But, you know, if you can tell me what the Fed is going to do and what our local competitors are going to do, we can probably pinpoint that a little bit better. But that's what we're looking at right now.

And are you assuming the Fed does another 25 in that?

Right now, it looks like they're not going to. That's what were baking in to our model.

Okay, perfect. Thanks a lot. I appreciate your answers.

Thank you.

Your next question comes from the line of Mike McMahon with Sandler O'Neill and Partners.

Good morning, everyone.

Hi, Mike.

Following up on the C&I question, you've characterized your quarters before as having strong or good or robust C&I originations which you did again today. Is it also the case that the growth resulted from lower payoffs? Or was the originations just so much stronger?

The originations were stronger. It's a good question, though. Our payoffs actually were lighter for Q2 vs. Q1. Generally, our commercial portfolio runs at about a five-year loan portfolio turnover. So that would imply a 20% number for Q2 we came in at about 15%. So if you take -- if you kind of normalize back to a five-year figure, you could probably take a couple of points off of the growth rate, still very strong at 3% for the quarter, 3 plus% for the quarter.

And do you care to make a general comment about loan growth expectations for the year, given you had the strong quarter? I'm not sure what quarter makes a trend, but it is a very positive number.

Well, we've had good growth in the first quarters on the commercial side and it's a bit early to call on the third quarter, but we like what we see.

We're all looking into the crystal ball, Mike. It's only so clear.

I understand. And last, professional fees were up in the quarter. What happened there and what's the trend going forward.

Actually, professional fees are pretty -- that's a pretty good number of professional fees. Last quarter we had a reversal that took professional fees down. And that was a true up from some of the growth we had at the end of the year from the SEC matter. So that reduced our professional fees in the first quarter. So the second quarter number is a good number.

And even if there is a deposit mix change, total deposit cost of 128 and a quarter is awfully nice compared to many others. Keep up the good work. Thank you.

Thanks, Mike.

Your next question comes from the line of Andrea Jao with Lehman Brothers. Please proceed.

Good morning.

Good morning, Andrea.

In your guidance you mentioned that credit costs would be lower than expected. I believe your original projections for loan loss provisioning are $17 million. Could you give us an idea of how much lower you think credit costs would be this year?

Enough to write about in the release. We're not -- I don't think were comfortable enough giving a number. That bounces around and it's low enough now, Andrea, that a very small difference could show up percentage wise statistically.

Okay. Fair enough. Going forward, if good loan growth continues, do you expect funding to be -- to come from short-term borrowings?

There will probably be some of that. But we would also expect to continue to work on deposits. That's our preferred source of funding. When we get a large increase like we had in the second quarter, we may fund it temporarily with borrowed funds, some of that staying very short term. But then we'll take a look at where we think rates are going and other alternatives as we go into the year.

Sure. But doesn't that imply in the near term a little more margin pressure? Right?

Perhaps, but we've got other assets and some other things on the balance sheet we can do.

Okay, perfect. Thank you.

Your next question comes from the line of Brent Christ with Fox-Pitt. Please proceed.

Good morning.

Good morning.

A question on the deposit side. You next mentioned the mix shift pressuring the marginal little bit. But it also look like the costs of your deposits rose a little more rapidly this quarter than has been the case in the past few. Are there any kind of broad based pricing changes that you made that you're seeing in the competitive environment that cause you to be a little bit more aggressive on the funding side?

I think just sort of normal reaction to customer expectations, Brent, from everybody, you know, as money becomes more valuable, customers pay more attention to that. The marketplace, we'll see as we learn more exactly what happened there, but we suspect that the market was sort of moving in tandem. But you're right. We did see an acceleration in that pricing. Dave, anything you want to add to that?

I guess what I would emphasize your comment, Al, that as rates have gone up the value of idle dollars becomes more apparent to customers. And it's important for all of us in this market in terms of the financial institutions to do what we can to offer a competitive rate. And there have been many quarters that we've see the Fed increase that we've not seen significant moments in the deposit rates than have in this quarter. Deposit rates moved pretty much in tandem with short-term interest rates on a national basis

Do you think that was more a function of just tie in are keeping up with customer expectations or was someone bucking the trend? I know Hawaii has been very rational in terms of deposit pricing for if somebody bucking the trend and you had to keep up?

We didn't see any significant, your term, bucking the trend. What we would say is [irrational] behavior. There are always an episode here or there. And we try to watch that. But nothing enough in the quarter for us to say, gee, the market has changed or there is some significant new factor there. We're always vulnerable to the pull of higher yields from other sources. But so far, we kind of kept the economy in balance here. I would emphasize that's what we intend to do is balance the interests of our shareholders as well as our customers. So that we keep those two at an appropriate equilibrium.

Secondly, any update on how the early response has been to your rollout with your agreement with the MDNA offer to issue the Visa and AMEX cards?

This is Dave Thomas. It's been very positive. We've seen good application flows. And the, I guess even more important, just the reaction and comments from our customers in terms of broadening expending the choice of products that we are offering has met with a lot of positive news from our customers.

And then lastly, on the other fee line, was there anything lumpy in there?

Little bit higher than has been. It's a little bit higher. There's nothing terribly big in there. The only thing that I would comment on really is that there's a gain in there on the MasterCard IPO. A lot of banks have been reporting that. It's less than $1 million, though, there's nothing else in there of any substance.

It was under a million, though?

Yes.

Thanks a lot.

Your next question comes on the line of Fred Cannon with KBW. Please proceed.

Thanks. Good morning.

Good morning, Fred.

One question on the funding the loan growth that you're saying, just a follow-up question, is do you see the ability fund the incremental growth with the run-off securities portfolio, where we might start to see an increasing loan to value -- I mean loan to deposit ratio?

I suppose, yes. Back when I mentioned I think it was Andrea asked about that, that we had some loan balance sheet the things that we would take a look at. Certainly the maturities in our investment portfolio give us some liquidity there. And we mix that into the equation, Fred, in terms of what is the best way to fund that.

Great. Okay. Just two other quick follow-ups. One is in the CD market, what do you have to price at these days to bring in new money into the bank in terms of CDs? Over here it seems to be well north of 5%.

You know, I don't have our current rate sheets in front of me. But where we're seeing most of the pricing action is still kind of short in the one year and around that market and around that range. And we're not -- I don't recall is being that high. The I don't know exactly where the rate is, but it doesn't -- I don't see -- I don't see those kind of rates in that short-term CD. And that's where we're seeing most of the action.

You haven't had to go over 5% and a year or less CD?

I don't see that in our rates and over the weekend, Fred, I was opening the mail from the competitors that come to our residents, and none of them were over 5%.

Okay, that's hard to not to see 5% in --

I hope that's helpful to you.

That helps. Finally, on the acceleration in the loan growth, do you attribute any of that to kind of the growth that you're sitting in Hawaii? Can you comment on any real estate markets and business activity over there?

Well, the vast majority of the loan growth for the quarter is linked to Hawaii and to a lesser extent to our Guam operation. We've been conservative on our real estate underwriting side. And I guess what I'd say is we're starting to see some movement in both the more established high-quality clients in our portfolio. I'm not sure that really speaks to the economic trend, though.

Okay. And who was the price competition for loans?

Competitive.

Okay, great thanks very much.

There are no bargains over here on that. No relief.

Thanks, Al.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Campbell Chaney with Sanders Morris Harris. Please proceed.

Good morning, everyone. Al, you used to give us an update on the Hawaiian economies? Can you give us an idea of the employment trends are, is the overall economy strengthening, weakening? Is it stable? Do you see new investment dollars maybe from Japan or other countries starting to come in and make a big capital investments in the area?

I'll give some general comments, Campbell, on what I see and anybody else here can add in. Tourism is the marginal driver and that continues to be strong. We set records last year and we're maintaining those levels, or seeing a slight increase, and depending on the month and the sector.

Housing prices, which have been rapidly increasing in the prior years seemed to have stabilized a little bit this year. And we would expect that that would not have a great appreciation going forward. By the same token, the supply of new homes entering the markets is limited, so we don't see a lot of risk of a downfall. At least in the more reasonable priced homes.

Commercial construction continues to be strong. Maybe picking up a little bit as office space is limited, as well as some other commercial space constraints.

Employment, I noticed over the weekend that for the first time in what, 24 months, Hawaii did not have the lowest unemployment rate in the States. I think South Dakota beat us by 0.1 there. But were still right at 3%, as I recall. The labor supply is tight. One of the things that we think about in expense control is the fact that we've got lots of open positions. And it's a real challenge to our people to continue the high level of service quality with vacant positions. So we're kind of constrained by a labor supply in some regards.

As far as investments from international sources, I don't think we're seeing any significant pattern there. You know, we'll find a real estate transaction here or there where maybe one foreign borrower sells to another, but there is an equal number of that move from domestic to domestic or foreign to domestic. And I haven't seen in isolation there.

Military spending continues to be a significant effect. The military presence in Hawaii is strong. And I think growing. They're certainly continuing their very successful efforts to modernize the military forces, C17s have arrived, the Striker Brigade is staffing up equipment. And that is a significant component of our economy as well.

So kind of a broad run down there, Campbell. Anything from the rest of the group here that we should mention on?

Maybe one follow-up. Our commercial construction, do you see -- who are the borrowers? Are these domestic borrowers planting a flag in Hawaii for the first time or are these kind of the existing Hawaiian businessman who are just expanding?

I'd say it's a combination of both.

Combination of both. Great. That's great color. Thanks a lot.

Sure.

Our next questions is a follow-up question from Brett Rabatin with FTN Midwest. Please proceed.

Hi, guys. I just wanted to ask a follow-up on the margin and sort of forward thinking. When I look at the second quarter, it looked like you guys have 300 million of CDs repricing and quite a bit of loans repricing. So I was kind of looking at your numbers from an [ALCO] perspective. It looks like you have more liabilities repricing in the third quarter. I guess I'm just curious on some additional color, Rick, could you give any on the margin being up other than it's a function of moving securities into loans and may be pulling down some of the liquidity, so to speak, in terms of Fed funds purchased and what not?

Well, it's a variety of things. You're right, if you look at the changes that took place in the second quarter, you're seeing deposit rates going up more significantly than loan rates. And that's just a function of the market. But as we look forward, were looking at various scenarios, Al mentioned a couple, were looking at a couple of sources of liquidity from the balance sheet. And we're also looking at different types of funding. There are some repo transactions that we're looking at and some other things that we're looking at that we think will better enable us to manage the margin going into the third quarter. So there's just a variety of things, a variety of was going on.

Okay. And if I can gauge you guys' sentiment correctly, it sounds like youo're more interested in still growing the overall balance sheet as opposed to necessarily optimizing the funding asset mix. Is that a fair comment or --

We're interested in growing net income after our capital charge. And whatever way the market gives us best to do that is where we're headed. Right now, we're encouraged by the loan growth, and that means more investment here in Hawaii. And so we're going to try to focus on meeting that need. But that's because we think that's the best way to improve our profitability. We're going to stay focused on running it for the profitability over the long term.

Okay. You guys are [INAUDIBLE] user of capital. And lastly the securities portfolio, the AFS yield was 490 in the second quarter. Depending on how you look at it, it's to be viewed as better than peer. Any color on that portfolio in terms of how you're positioning the for rates at this point?

We're expecting pretty stable rates, so we have pulled back a little bit on our reinvesting, but for the most part we're reinvesting as it runs off each month. And as we do that, we're getting a little bit better yield. And we think that looking ahead at a stable rate environment or at least a more stable rate environment is probably not a bad thing to do.

So a duration, 3.5, 4 years something like that?

Yes, 3.5.

I'm sorry?

Yes right at 3.5.

Okay. Thank you.

Ladies and gentlemen, we are showing no more questions at this time. I would like to turn the call back over to our speakers.

I'd like to thank everyone for joining us today, and as always if you have any additional questions or need further clarification, please feel free to call me. And have a great day, everyone.

Thank you for your participation in today's conference. This concludes our presentation. You may now disconnect. Have a good day.