Bank of Hawaii Corp (BOH) 2006 Q3 法說會逐字稿

Good day, Ladies and Gentlemen. Thank you for your patience and welcome to the Third Quarter 2006 Bank of Hawaii Corporation earnings conference call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the presentation over to your host for today's call, Cindy Wyrick from Investor Relations. Please proceed, ma'am.

Hello, everyone, and thank you for joining us today. Joining me is our Chairman and CEO, Al Landon; Vice Chairman and CFO, Rick Keene; Vice Chairman and Chief Operating Officer, Dave Thomas; and Vice Chairman and Chief Banking Officer, Peter Ho. Our comments today will refer to the financial information which was included in the earnings release issued earlier this morning.

Before we get started let me remind you that today's conference call will contain some forward-looking statements. And while we believe the assumptions that 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 let me turn the call over to Al Landon.

Thanks, Cindy. Good morning, everyone. To begin our discussion today, I would like to take a moment to thank all of you who contacted us to see if our employees and families had safely made it through the earthquake last week. We really appreciated your concern and good wishes. I'm happy to report that all but one of our branches were open and serving customers last Monday. Although we're still monitoring the effects of the earthquake, we don't expect an adverse impact on our operations or financial condition.

Moving on to the press release, we're pleased with our financial results for the third quarter of 2006 which included good loan volumes, strong asset quality, stable net interest income despite a challenging rate environment, as well as growth in non-interest revenue and a continuation of good expense control. The return on average equity increased to 27.09% for the quarter and our efficiency ratio declined to 50.75%.

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

Thanks, Al. Hello, everyone.

For the third quarter of 2006, Bank of Hawaii's net income was $46.9 million, compared to $37.2 million last quarter and $44.8 million in the third quarter of last year. Diluted earnings per share were $0.93 in the current -- in the third quarter. The return on equity was just over 27% and the return on assets was 1.8%. To help explain the increase from the second quarter, I wanted to remind you that earnings in the second quarter were impacted by the $8.8 million mostly after-tax charge that resulted from a change in tax law. This adjustment was discussed last quarter. Without this adjustment, second quarter net income would have been approximately $46 million.

Net interest income was was $100.4 million in the third quarter, $0.5 million higher than last quarter but $1.6 million lower than the third quarter of 2005. The increase in net interest income over last quarter was driven by this quarter's loan growth. The decline in net interest income from last year was due to higher funding costs. Like most banks, the increase in loan yields was out paced by an increase in interest rates on deposits resulting from the shift of balances out of demand and savings deposits into higher costing time deposits. These factors along with the current interest rate environment continued to pressure our net interest margin.

For the third quarter, the margin was 4.2%, down five basis points from last quarter. For the first nine months of 2006, the margin was down seven basis points compared to the same period last year. We've included an analysis of the change in net interest income as table six to our earnings release. We recorded a provision for credit losses of $2.8 million in the third quarter compared to $2.1 million in the second quarter and $3 million in the third quarter of last year. The provision equals net charge-offs in each quarter of this year. For the first nine months of 2006, the provision for credit losses was $7.6 million compared to $3 million last year. We resumed recording a provision for credit losses in the third quarter of last year. Non-interest income for the third quarter was $56.9 million, a 7% increase over last quarter and a 2% increase over the third quarter of last year. This quarter's increase was primarily the result of higher insurance income and service charges on deposits. The increase in insurance income was a result of the timing of commission income from insurance carriers while the increase in service charges on deposits was primarily due to increases in the number of transactional deposit accounts. Also included in non-interest income were gains realized on the sale of assets that had been under leverage leases. These gains totaled $1.1 million in the third quarter this year and $3.4 million in the third quarter of last year. Non-interest expenses in the third quarter were $79.8 million, up slightly over last quarter but down 6% from the third quarter of last year. Last year's third quarter included $3.8 million in legal costs. The efficiency ratio was 50.75% this quarter, down from last quarter and the third quarter of last year. Operating income improved 4% from the second quarter and 6% compared to the third quarter of 2005. Our effective tax rate was 37.14% for the third quarter, down from last quarter which was impacted by the tax law change that I mentioned earlier.

Table 11 in our earnings release provides a summary of business segment performance. The retail segment continues its solid performance with a 49% return on its allocated equity this quarter, up from 42% a year ago on the strength of consistent consumer loan growth and higher fee income. The return on allocated equity in the commercial segment rebounded this quarter to 41% after carrying the impact of the tax law change in the second quarter. Average loans in the commercial segment increased nearly $153 million in the third quarter compared to the same quarter last year. The investment services segment improved its return to 28% up from 8% in the third quarter of last year, a result of strong trust and asset management fees and reduced expenses.

Our credit quality remains very strong. Non-performing assets were $5.4 million at the end of the quarter, comparable with last quarter and down 34% from the third quarter of last year. Non-performing assets represented only eight basis points of total loans at the end of the third quarter. Gross charge-offs in the third quarter were $4.8 million and recoveries were $2 million resulting in net charge-offs of $2.8 million. The third quarter net charge-offs represented an annualized loss rate of 17 basis points, a decrease from 84 basis points in the same period in 2005. At the end of the third quarter, the allowance for loan and lease losses was $91 million and represented 1.4% of loans. We continue to evaluate the economic environment and the level of risk in our portfolio each quarter and recognize a provision for credit losses as necessary to maintain the allowance at an appropriate level.

Our exposure to the air transportation industry as summarized in table eight. This exposure was down slightly from the amounts 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 $47 million during the third quarter, compared to the prior quarter and totaled almost $6.5 billion at the end of the period. We again had growth in our home equity portfolio and had solid residential mortgage volume, but like last quarter, most of the loan growth was in the commercial portfolio which was up almost 2% over the second quarter. The increases were experienced across the portfolio. Average loans were up up $153 million over last quarter, again primarily in the commercial portfolio, but were partially offset by some commercial loan pay-offs late in the quarter. Average deposits were flat compared to the second quarter. At quarter end, total deposits were $7.7 billion, down $79 million from last quarter. The decline occurred primarily in business, demand balances and in savings balances as customers continued to seek higher rates of return. While deposit balances declined this quarter, we continue to grow the number of deposit accounts which helped boost transaction-based fee income.

We continued our share repurchase program by purchasing purchasing 950,000 shares during the third quarter at a cost of approximately $47 million. At quarter end we have repurchased 123,000 additional shares. Our remaining authorizations was approximately $103 million as of this morning. And we continue to make repurchases in a disciplined manner.

Our capital position continues to be strong. We continue to expect 2006 net income to be approximately approximately $178 million. 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 wanted to point out that last week, our board declared a quarterly dividend of $0.41 per share with an increase of 10.8% over last quarter's dividend.

And that concludes my comments, Al.

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

[OPERATOR INSTRUCTIONS] And your first question is from the line of Brett Rabatin with FTN Midwest. Please proceed.

Good morning, gentlemen.

Hi, Brett.

A couple questions for you. First off, wanted to get a little more in the core deposit trends, if you could. It sounds like in the comments you had prepared and in the press release, it sounds like you're thinking that overall deposit levels may be stabilizing. End of period balances on your core trends were a little lower. Can you give us any thoughts on number of accounts? You mentioned the growth in accounts, number of accounts you've opened and just any indication to us on why core deposit trends might be stabilizing?

I wish we could tell you, Brett, that we knew and that we were locked in! We've seen a little bit of relaxation at the top end in pricing pressure on CDs as the quarter went on. The decrease -- Rick, any color on where that came at the end of the quarter?

Well, we saw some across the board. We saw some decrease in consumer but not nearly as much as what we saw last quarter so I would say that that did stabilize greatly. We saw some in commercial, and that looks to be pretty routine, a pretty routine type of a fluctuation and then we saw some decline in public funds which we had an increase and a decrease in public funds during the quarter. And overall, I think on a net basis those were down at the end of the period as well. I think that was probably the biggest segment of it.

Okay, public funds.

Number of accounts being originated, Brett. We've never disclosed that. Dave, I think it's accurate to say we had pretty consistent flow. There's no significant increase or change in the amount of new account openings throughout the quarter.

No. Our new account openings have remained pretty consistent and we've shown growth in that for a number of years and continue to stay on that growth path. Just as interest rates have increased though, the average balance in the consumer checking accounts have gone down as a result of people seeking better places to get return on their money.

Okay. And then secondly, you mentioned the C&I payments toward the end of the quarter impacting the loan growth. Obviously end of period balances not as strong as averages. Any additional color on the pipeline and potential for loan growth to be better than low single digit in the next quarter or two?

The pipe for the quarter, for Q3, Brett, was pretty solid. We liked what we saw there. On a period, end of period basis, where we flattened a little bit was on the prepayments or on the payments. We're looking -- generally what we expect is a four to five year turn on our commercial portfolio. So that would get you to a 20%, 25% turn rate. For the quarter, we were a little bit higher for Q3. For Q4, I think generally our experience is prepayments or pay downs are -- tend to clip up towards the end of the year. So I'm not sure that we would anticipate that to moderate for Q4.

And then just lastly on the provisioning, if you're assuming the $178 million of guidance still and where you stand with the first three quarters, when I look at Q4, is it logical to assume that provisioning might be lighter in the fourth quarter or are there other revenue trends that you see picking up in Q4?

I don't think we have any forecast that suggests there is going to be a significant change in our provisioning levels. It's basically been kind of recurring retail charge-offs that have hit us and the variable has been recoveries. So I don't think there's anything that tells us there should be a change there. Other than that, I think we're anticipating what I call sort of normal seasonal patterns here as we get into the fourth quarter, Brett.

Okay, thank you very much.

Your next question is from Jim Bradshaw with D.A. Davidson. Please proceed.

Good morning.

Hi, Jim.

Could you, Al or Rick, could you talk a little bit about the balance sheet moves and the repo agreements and paying down some other short-term stuff and boosting your securities and maybe sort of weave that into how you think you're positioned now for rate moves as we move forward?

Yes. Rick? You want to -- ?

Yes.

Give some color?

We could take a look at the balance sheet. The investment portfolio, we've considered changes in the portfolio and restructuring some of the portfolio but frankly given where we think rates are going to go, it seems prudent right now that the right approach would be to continue to reinvest as that portfolio liquidates and just keep turning things back into the portfolio. We're keeping it relatively short consistent with the philosophy we've had for a long time on that portfolio, but we've tried to keep it at or around roughly the same level we had it at. On the repo side, we have ramped up our repos a bit, mainly just in the current rate environment and trying to manage our funding as we've been successful over the last two quarters in generating commercial loan growth and as you can see on average it was up about $150 million in the quarter. We've used repos, relatively short-term repos to try to help fund that just to try to manage through the rate cycle.

Jim, I think we've got ourselves positioned now pretty much asset neutral. Not a real strong sense of where rates are going to go, if anywhere, but I suppose maybe a slight bias to expect out there four to six months that we -- a little greater opportunity for short-term rates to decrease than anything else, but we're not making any strong bets on where things are going to go.

Probably makes sense I guess at this point, doesn't it? Can you talk a little bit about -- are you seeing, looked like your consumer charge-offs staying -- actually improved a little bit but staying pretty flat. Are you seeing material change in delinquency rates and mainly in your consumer portfolio?

Dave?

No, our consumer portfolio has been very stable and our consumer direct loans, we've seen just some modest improvement in delinquency. And in our auto portfolio, we've seen just some modest decrease or increase I guess in the delinquency rate but nothing substantial.

Okay, good. Appreciate it. Thanks very much. Great quarter, you guys.

Thanks, Jim.

Your next question is from the line of Brent Christ with Fox-Pitt Kelton.

Good morning, a couple quick questions. The first, it looks like the buyback activity picked up a little bit this quarter, and could you just talk about your views on capital management going forward? It seems like you're now slightly below your 7% leverage ratio target and what your thoughts are there?

I don't think we've got any changed thoughts on capital management. We continue to be capital efficient, I think. We picked up a little bit. That's sort of a function of liquidity at the holding company as well as price opportunities, but going forward, we would expect to continue our pattern of returning through share repurchases, whatever we don't need to support growth in the balance sheet and that's not an exact precise art of saying it's this number at the end of the quarter and we'll buy shares exactly to equal that. It varies a little bit from week to week, Brent.

Got you. And then a follow-up on the fee income side, you mentioned that the increase in service charges and some account adds on the deposit side. Was there anything else driving that link quarter increase, whether it's changes in pricing or some of your processes? Because it was pretty significant.

I think the biggest driver on the deposit side was the number of transactional accounts. I think there was possibly just some timing issues on when some of the volume came through, but I think that the volume , the number of accounts was the main driver. Overall on the income statements, on the non-interest income side, you know, I mentioned insurance income which was something we see every other quarter or so. We had transactional volume in debit card transactions, ATM transactions, that sort of thing that drove some service fees, but I think really transactions seem to be the biggest driver.

Okay, great. Thanks a lot.

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

Hello, and once again, congratulations on a nice quarter.

Thanks, Mike.

You had year-over-year expense declines and I know you had the higher legal costs a year ago. You had a slight increase this quarter and am I correct that you would expect that operating expenses going forward would -- are more likely to increase than continue to decrease? You've rung out most of the efficiencies with still some to go but the majority is in rung out?

Mike, we never say never on expense decreases, but I think you've got the probability assessed pretty accurately.

Okay. And my other questions were answered. Thank you very much.

Sure. Thanks, Mike.

Your next question is from the line of Andrea Jao with Lehman Brothers.

Good morning, everyone.

Hi, Andrea.

First question, is it safe to assume that insurance and other income pulled back next quarter as well as other expenses which, you know, for reasons you've mentioned are elevated?

I think it's, yes, safe to assume. Every other quarter or so, we see a blip in insurance income. So I do expect that will drop down some next quarter. On the expense side, we've been running basically what Mike was saying. We've been running at a clip of somewhere in the $79 to $81 million range over the last two or three quarters and I still think that's a little low for our run rate so I do expect that to pop-up a little bit.

Okay. How about other income?

Other income?

Yes.

Other income has various things in it. One of the things I mentioned was that it had the gain on a sell of the leverage lease asset, but typically we've been pretty consistent there. Each quarter we'll have something come through so I don't really expect to see a big change in that line item.

Got you. My follow-up question is regarding the margin. I believe that the per charge rate on the margin by three bits last quarter so the margin would have been $428 if I'm not mistaken?

Yes, that's right.

So margin compression this quarter was more in the eight bit area; is that correct? Is that the right way to look at it?

That would be the right way to look at it, yes. That did have an impact on us to some extent last quarter. I think you're right. I think it was three basis points.

Do you think margin compression will be a little more modest next quarter or kind of in line with this quarter, given what you're seeing in competitive trends in your market right now?

My expectation right now is that we're going to continue to see consistent pressure on the margin next quarter that we saw this quarter. So I would expect another five or so basis points, but right now in the rate environment we're in, it's kind of hard to predict that, but that's my current expectation.

Andrea, be careful on writing that five down. Rick is pretty good at forecasting but we don't hold him to a basis point or two here.

Our forecast was down quite a bit this year as you can imagine.

Competition and what goes on in the interest rate markets will probably have a fair amount to do with that, so a little bit more downside pressure but to estimate number of basis points is pretty tricky for us to do, Andrea.

No, of course. I understand that. Last question. Construction was pretty strong this quarter. If you don't mind giving a little more color?

On the construction side?

Yes.

The construction side is mostly the build out of projects that have been in the queue for a while. You'll see if you look at the year-to-date growth levels, we're pretty strong for the year in that particular category. So we would anticipate that number to moderate, Andrea, going forward, with not a whole lot of new pipeline in on the project side. That's about what I would say for that line item.

Perfect. Very helpful. Thank you.

Your next question is from the line of Fred Cannon with KBW.

Thanks and I'm glad to hear everything is okay over there regarding the earthquake. That's good news. I was wondering, Al, if you could give us a little overview of how the economy feels over there, particularly the real estate sector, if it feels like it's slowing like we've seen in some of the west coast markets or do you continue to feel pretty good about it?

Sure, Fred. The real estate market, I would say is split between what's going on in the commercial marketplace and residential. Residential has plateaued. It's been a little bit more stable in terms of price increases in the last six months. We've seen clearly a slow down in purchase transactions. The inventory of new homes has gone up, although the start rate for new homes has come down a little bit, so supply will, we think, adjust to a line. We don't see tremendous downside pressure. It's a little bit more of what I would call a normal market now, and no real signs of factors that will change that over the near term. Commercial side continues to be pretty strong, although I would say we're sort of late cycle in development of condominiums here in town and so we've been a little bit more cautious in approaching financing opportunities with condominium developments. Office space, warehouse space, other commercial activity continues to be pretty strong but seems reasonably balanced with demand here in the economy.

Okay. Are you seeing any sign of Japanese investment in real estate in Hawaii?

No. We haven't seen any appreciatable change here for quite awhile.

Okay, kind of a one -- two quick follow-up questions here. I was a little bit confused about the discussion of the deposit fees. I thought at one point in time, Dave said that the growth in accounts has been pretty steady and then Rick said that the deposit fee increase was a result of the growth in number of accounts. I'm just a little confused with what's going on there.

I would say to clarify that, we have consistently grown the number of accounts for probably the last three years, Fred, and what we wanted to communicate is there hasn't been any variation in that number of additions. It's been at a steady rate and so what we meant was that the growth continues and that continued to support increased fees.

But the pick up this quarter in growth then it seems to occur, could we attribute that to the fact that you've got lower balances in the average account which often generates a little bit more fees?

That's exactly right.

Okay. And then finally, Rick, just the tax rate. This is a fairly normal quarter. Is the 37% appropriate on an ongoing basis or will it come back down? I think it used to be around 36%.

Well we're expecting about where it is right now to continue at least in the short-term.

Okay. Great. Thanks so much.

Thanks, Fred.

Your next question is from the line of Erika Penala with Merrill Lynch.

Good morning, everybody.

Good morning.

If I could just ask Peter to provide more detail on the progress being made in terms of increasing commercial loan market share, and perhaps talk about areas that have been more promising and areas that have been perhaps disappointing?

I'm sorry. I didn't catch the last -- the tail end of that.

Oh, I'm sorry. If you could also address the areas that need more work going forward.

Sure. Well, as we discussed, I guess a few months back, where we see growth opportunities in our commercial business is more towards the middle market and the lower end of the marketplace, so as you look at our loan outstandings, what we've been concentrating on is more the lease financing sides, small ticket leasing which we've been pleased with the kick up at least in the last quarter production wise, as well as more owner occupied type real estate transactions. So we're seeing evidence of that perhaps not as quickly as we would like, but if you look at the third quarter in our commercial mortgage segment, 85% of our funding productivity in mortgages came out of areas other than our commercial real estate area which would indicate more owner occupied- type activity. So, I think the answer to your question is we're seeing signs of encouragement in our commercial strategy, but like just about everything else, we would like to see it happen faster.

And I also wanted to know where the Company was in terms of contacting borrowers potentially affected by the earthquake to assess financial need or inquire about insurance coverage?

Oh. We just have -- I think our contacts have been kind of at two levels; commercially, checking first of all to make sure that our customers were okay and we found pretty good response there. About everybody lost a day's worth of revenue because the systems, you know, the basic shopping was down for Sunday. A little bit of predictable damage and clean up work. Ceiling tile seems to be the favorite issue for everybody, and unless you were right close to it. Then on -- excuse me, retail or consumer customers, it's mostly been anecdotal as they have been contacting us, coming into the branches. We haven't received any flow of information about damage to residential properties or anything there. I'm sure we have some customers that have been affected but as we found in other situations, the population here tends to be pretty resilient and pretty focused on meeting their financial obligations. We'll monitor it and if something comes up that needs attention, we'll look at what kind of relief would be necessary but right now, we don't see anything about a week into it. Dave, anything you want to add-on the consumer side?

No, that's a good summary.

Peter, anything on commercial?

Nope. Nominal damage.

Okay, I appreciate the time. Thank you.

Thanks, Erica.

[OPERATOR INSTRUCTIONS] Your next question is a follow-up from Brett Rabatin with FTN Midwest.

Hi, guys. Just had a follow-up on the number of FTE's, this is the first time I can recall in the past couple quarters that FTE 's have moved up a little and so I'm just curious if that's all back office or if you guys are trying to expand some on the various islands? Or any thoughts on that and just kind of your expansion plans in the near term and kind of how you see growth of the franchise.

I would say that for the last year or more, we have had a higher level of vacant positions, Brett, than we would have aspired to. We've been concerned that advancing service quality is a challenge if we have too few workers. I think in a couple of areas, we got a little bit of relief from the competition and so we were able to add a few more folks in important areas. Front line is the most important but we try to keep a balance between that and operational support. So I don't think there's any particular driver of one area or another and it's not linked with trying to put more people into certain sectors of our marketplace here. It's really opportunistic where we can find the resources and add them to our team. Dave, anything you want to add? Most of the changes I think are in the retail segment.

No. That's a good summary. We've just been working hard to hire and then retain good quality employees and we've had a little bit better luck in the last quarter on the retention side.

If you know of any good telephone service operators that would like to come to Paradise, send them on out!

Okay. Great. That's good color, guys. Thank you.

Okay.

Your next question is another follow up from Andrea Jao with Lehman Brothers.

Hi. It's me again. Just wanted to come back and ask Peter for an update in terms of investment services and what the initiatives he has going on and if he's happy with the product sets as they stand?

Good question. We continue to get nice, what I would call, solid improvement on the trust fee side. As you know, we're looking to that area as a source of growth for the organization. I'm comfortable -- I think we're comfortable with a number of the organizational pieces that we've put in place. People pieces in the past couple of years. As we look forward, I think we have some fine tuning to do on the product side. We feel very good about the -- our money market and fixed products. I think we need some breadth build out on the equity side. So I would look in the next -- call it 12 months, for some movement there. So I think that's probably the next piece in the puzzle for that business.

Perfect. Thank you.

There are no further questions in the queue at this time.

I'd like to thank everyone for joining us today. As always if you have any additional questions or need clarification on any of the topics we discussed today, please call me at 808-537-8430. Take care and have a great day, everyone!

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