Bank of Hawaii Corp (BOH) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Bank of Hawaii Corporation 2006 fourth quarter earnings conference call. My name is Cammie, and it will be my pleasure to be your coordinator today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of this conference. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to the Director of Investor Relations, Ms. Cindy Wyrick. Please proceed, ma'am.

Thank you, Cammie. Hi, everyone, and thank you for joining us today. With me this morning is our Chairman and CEO, Allan Landon, our Vice Chairman and CFO, Rick Keene, Vice Chairman and Chief Operating Officer, Dave Thomas, Vice Chairman and Chief Banking Officer, Peter Ho, and Vice Chairman of Corporate Risk, Mary Sellers. The comments today will refer to the financial information included in the earnings announcement 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 are reasonable, there are a variety of reasons that the actual results may differ materially from those projected, as outlined in today's release.

Now I would like to turn the call over to Allan Landon.

Thanks Cindy, and good morning everyone. 2006 was a good year for the Bank of Hawaii, despite a challenging interest rate environment, and unexpected changes in tax legislation. We continued the momentum in growing our business with increased noninterest revenue, controlled core expenses, and positive operating leverage. Both loans and deposits grew during the year.

Our return on average equity improved to nearly 26%, and our efficiency ratio was just under 52%. Importantly, we accomplished these results without increasing risk. Our asset quality remains strong and stable.

Now I would like to ask Rick to provide you with some additional information about our 2006 and fourth quarter results. Following his comments, I will comment on our 2007+ plan, some management changes, and then we will be happy to respond to your questions. Rick?

Thanks, Al. Hello, everyone. Bank of Hawaii's net income for 2006 was $180.4 million compared to 2005's net income of $181.6 million. Diluted earnings per share for 2006 were $3.52, up 3.2% from $3.41 per share in 2005. The return on equity for 2006 was 25.9%, the return on assets was 1.76%, and operating income was up 3.1% in 2006 over 2005.

Fourth quarter 2006 net income was $50.9 million, or $1.01 per diluted share. This compares to 2005's fourth quarter earnings of $44.8 million, or $0.86 per share, and third quarter 2006 earnings of $46.9 million, or $0.92 per share. A positive factor contributing to the fourth quarter results were some tax adjustments that I will discuss later.

Net interest income was $100.2 million in the fourth quarter, relatively flat with the third quarter, but down from $103.5 million in the fourth quarter of 2005. For the full year, net interest income was $402.6 million, down about 1% from 2005. The reductions in net interest income from the comparable periods of last year were primarily due to the challenging interest rate environment the banks faced in 2006, and the related shift of funding sources.

In 2006, like most banks, we experienced an increase in deposit rates, and a shift of deposits by customers into higher-costing time deposits. Average deposits in demand and savings accounts declined in 2006, and these balances largely moved into time deposits, as well as into off-balance sheet managed cash accounts. While the deposits balances at the end of 2006 were higher than at the end of 2005, average total deposits were slightly lower in 2006 than in 2005.

Given the loan and deposit growth rates, we used a higher level of short-term funding in 2006, which also was a factor in our lower net interest income for the year. An analysis of the annual change in net interest income is provided on Table 6 of the earnings release. The same factors arising from the inverted yield curve affected our net interest margin in 2006.

For the year, the net interest margin was 4.25%, a decline of 13 basis points, from 4.38% in 2005. The fourth quarter net interest margin was 4.15%, a decline of 5 basis points from the third quarter. In comparing the 2006 results to the prior year, a noteworthy item is the provision for credit losses.

As most of you know, we began recording provision expense in the third quarter of 2005 for the first time in about three years. In 2006, we had a full year impact of provisioning. Our provision expense for 2006, which equalled net charge-offs, was $10.8 million, compared to $4.6 million in 2005, an increase of $6.2 million. In the fourth quarter, the provision was $3.1 million, compared to $2.8 million in the third quarter.

Noninterest income for 2006 was $216.2 million, up 3.3% from $209.3 million last year. This increase is attributable to year-over-year increases in almost all categories of noninterest income, including trust and asset management income, mortgage banking income, deposit service charges, and other fee-based income. Noninterest income in the fourth quarter of 2006 was $53.5 million, down $3.4 million from the third quarter.

This decline in noninterest income was primarily due to a third quarter gain of $1.1 million from the sale of leveraged lease assets, and a reduction in insurance income, which was due to the timing of commissions received from insurance carriers. Fourth quarter noninterest income was 5.3% higher than in the fourth quarter of 2005. Noninterest expenses of $321 million in 2006 were $6.7 million lower than in 2005.

The most significant component of expense that declined in 2006 was legal fees. In the second half of 2005, legal fees were incurred for a mutual fund investigation that was dismissed before the end of 2005. Compounding the impact of these fees in 2006, there were some insurance recoveries made related to those legal expenses. The 2006 reduction in expenses also reflect an ongoing focus on efficiency and expense management.

Fourth quarter noninterest expenses of $81.6 million were 1.8 million higher than in the third quarter. The fourth quarter increase was due to two discretionary expenses. First, a bonus of $1.5 million related to the successful completion of the 2004 to 2006 plan, that will be paid to over 650 employees who are not participants in any other incentive program, and second, a $1.5 million donation to the Bank of Hawaii Charitable Foundation that will be used to further the bank's support of our island communities.

For the fourth quarter, the efficiency ratio was 53.1%, compared to 53.9% in the fourth quarter of last year. For the year, the efficiency ratio was 51.9%, compared to 53.2% in 2005. The 2006 effective tax rate was 37.17% compared to 36.11% for 2005. The increase was primarily due to the tax charge in the second quarter related to a change in tax law, partially offset by positive adjustments that were recognized in the fourth quarter.

The effective tax rate for the fourth quarter of 2006 was 26.19%, compared to 37.14% in the third quarter. The lower tax rate in the fourth quarter was due to accrual adjustments for some tax matters that were resolved in the fourth quarter, and adjustments that resulted from the completion of the 2005 tax return. Also, a tax benefit of $3.6 million was recognized from the reduction of an accrual related to a LILO leveraged lease.

Table 11 of our earnings release provides a summary of business segment performance. Each of our business segments had higher returns on allocated equity in the fourth quarter of 2006 than in the fourth quarter of last year. For the full year, the 2006 return on allocated equity for the retail segment increased over 2005, as a result of consumer loan growth and higher noninterest income. The full year results for the commercial segment declined in 2006 and 2005, due to the impact of the second quarter tax charge. The full-year results for the investment services segment increased over 2005, due to higher fee income and a reduction in noninterest expenses.

The rest of our operations, including corporate level expenses, and interest rate risk management are represented in the Treasury and Other segment, which had income in excess of the cost of capital of 23% in the fourth quarter. The NIACC measure for the total company was $96.9 million in 2006, an increase of 9% from last year. Credit quality continues to be very good. At the end of 2006, nonperforming assets totalled $6.4 million, up from $5.4 million at the end of September, and down from $6.5 million at the end of 2005.

Nonperforming assets represented 10 basis points of total loans at the end of 2006. Gross charge-offs in the fourth quarter totalled $5.8 million, and recoveries were $2.7 million, resulting in net charge-offs of $3.1 million. For the year, net charge-offs were $10.8 million, compared to $22 million in 2005.

Net charge-offs in 2005 were impacted by a $10 million charge-off of a national air carrier that declared bankruptcy. This credit had been specifically reserved for. Net charge-offs represented a loss rate of 17 basis points in 2006. Without the charge-off of the air carrier, net charge-offs would have represented 20 basis points in 2005.

The allowance for loan and lease losses was $91 million at the end of the year, consistent with the third quarter and with the end of last year. The allowance represented 1.37% of loans at the end of 2006. We will continue to evaluate the economic environment and the level of risk in our portfolio each quarter, and recognize a provision for credit losses that is necessary to maintain the allowance at an appropriate level.

We had a solid quarter of loan and deposit growth. At year-end, loans totalled $6.6 billion, and were $134 million higher than at the end of the third quarter, and $455 million, or 7.4% higher than at the end of 2005. Commercial loans increased by $105 million, or 4.4% over the third quarter, while consumer loans increased $29 million, or about 1% over the third quarter. Compared to the end of last year, commercial loans increased $362 million, or 17%, and consumer loans increased $93 million, or 2.3%.

The increases over last year were experienced in all categories of commercial loans. The consumer loan increases were primarily in residential mortgage and home equity loans. A lot of the fourth quarter loan activity occurred in the latter part of the quarter. Average loan balances were $31 million higher in the fourth quarter over the third quarter, and average loan balances were $265 million higher for the full year of 2006 over 2005.

At year end, deposits totalled $8 billion, and were $336 million, or 4.4% higher at the end of the third quarter, and $116 million, or 1.5% higher than at the end of 2005. We experienced balanced growth in the major deposit categories from the third quarter. The year-over-year growth was driven by time deposits. While end of period deposit balances were higher over the third quarter and over the prior year, average deposit balances were relatively flat for the quarter and the year. But we are encouraged by the growth that we experienced in the latter part of the fourth quarter.

While competition for deposits remains, pricing in our markets appears to be more reasonable than it was in the second and third quarters. Our capital position continues to be strong, end of year capital exceeded our 7% target, in anticipation of some accounting changes that will reduce capital as of January 1, 2007.

We continued our share repurchase program by purchasing 338,000 shares during the fourth quarter at a cost of $17 million. Remaining repurchase authorization is approximately $87 million as of this morning. We plan to continue to make repurchases in a disciplined manner. And finally, last Friday our Board declared a dividend of $0.41 a share.

In summary, we achieved another year of solid results in 2006, and successfully concluded our 2004 to 2006 plan. And that concludes my comments, Al.

Thank you, Rick. As many of you may recall, the elements of the plan we announced in 2004 were focused on revenue growth, integration, management development, efficiency, and risk and capital management.

Before I discuss our 2007 plan, I would like to comment on some of the financial goals we set in January of 2004, January of 2004, I can say that. [laughter] When we announced our 2004 through 2006 plan three years ago, we set those performance expectations for 2006. We indicated that we expected net income of $178 million, and earnings per share of $3.39. We actually earned $180 million, and $3.52 per share.

Our plan anticipated return on assets of 1.65%, return on equity of 24%, and an efficiency ratio of 53%. Our actual results were return on assets of 1.76, return on equity of nearly 26%, and an efficiency ratio below 52%. We have many employees and former employees who listen in on our calls. I want to thank all of you for delivering what you set.

The 2007 plan built on the themes established in 2004, continuing to emphasize growth in revenue, integration of service delivery and business units, development of our people, enhancement of the Bank of Hawaii brand, and maintaining our discipline in managing risk and financial performance. The 2007+ Plan is based on achieving moderate growth in revenue, and consistent, positive operating leverage. It does not contemplate expansion beyond our current footprint.

Our plan was developed in phases, starting with assessments by each business unit. Not surprisingly, these assessments showed our business units were performing pretty well. Although there are some improvement opportunities. Where appropriate, business units proposed initiatives to improve that future performance. These initiatives were reviewed by a planning team, 15 of our best business leaders. The plan that resulted is intended to sustain and improve our solid financial performance, and maintain our lower appetite for risk, consistent with our forecasted economic environment.

The Hawaii economy in 2007 is expected to remain solid, with continued growth in personal income, low unemployment, stable tourism, normal job growth, and lower inflation. The main constraint limiting growth in the Hawaii economy is capacity. Based on a stable economy, and the return to a more traditional interest rate environment later in 2007, we anticipate our financial results in 2007 will include a return on assets above 1.7%, a return on equity above 25%, and an improving efficiency ratio. We do not plan to change capital ratios or the mix between dividends and share repurchases.

You probably noted our announcement that we are making some changes in our management team. I want to welcome Mark Rossi, who will be joining us soon. Mark adds valuable banking, business, and legal experience to our team. Donna Tanoue and Cindy Wyrick are assuming new roles. Donna will be focusing on building business and community relationships, an important element of our plan.

Later this quarter, Rick Keene plans to leave Bank of Hawaii for an important management job. Rick, hopefully with a little less stress, with another organization here in Honolulu. We have initiated a search for a new CFO. I want to thank Rick and Neal Hocklander, who completed his job at Bank of Hawaii last month, for all they have contributed to our success.

And now we are happy to respond to your questions.

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

Good morning, gentleman.

Hi Brett.

A couple questions for you. First off, I wanted to ask you obviously the average balances versus end of period. There were some different numbers there. Can you give us a sense of how much excess liquidity you might have had at the end of the quarter, if you had any large short time deposits? I noticed that funds sold was [$50] million at the end of the quarter. If you can give us a sense of any irregularity, in terms of just balances were a little higher at the end of the quarter, or if that indeed was what you would call some better core balance sheet growth toward the end of the fourth quarter?

Brett, we did have some pickup toward the end of the fourth quarter. It wasn't abnormal. That's pretty typical, I think, out here toward the end of the year. We get a little bit greater liquidity. It's probably a little bit larger than we expected, but then the holdover in to January has been larger than we had expected, too.

Too early for us to declare a trend, so we are not going to do that. But I think we were pleased to see the growth in balances, and we are optimistic as a result of the retention so far this year. In terms of an amount, I think it is pretty hard to quantify. Certainly, there is some that is core growth, but then there is a little bit that I think the additional year end activity that you referred to.

Rick, or Peter, Dave, anything you want to add to that?

No, I don't have anything to add.

Okay.

Okay. And then just secondly, will there be any other tax items going forward? You mentioned the LILO transactions. Does this take into account also the SILO transactions, and obviously you mentioned the 158, so it sounds like that will be in the first quarter's results as well, in terms of the change in equity?

Yes, it will be in the first quarter. I wish we could tell you that there were no more tax items. If you are following what is going on legislatively, there continue to be discussions about using changes in lease tax benefits to pay for other tax adjustments, tax reductions, I think small business was the latest thing that I saw.

And then the courts and the IRS just continue to try to work their way through how this issue will affect taxpayers. So I am quite reluctant to make any specific observation. Rick, I think you are in the same camp, aren't you?

Yes, I'm in the same camp. There are some equity adjustments that will come through in the first quarter that we talked about in our Q, related to the leveraged leases. The item in the fourth quarter that was related to leveraged lease was a separate accrual than what would come through the equity adjustment in the beginning of the year, but I agree with Al, it's a moving target right now, and we're trying to stay on top of it the best we can.

The fourth quarter item that Rick referred to, related to one LILO lease, we have not made any adjustments in our recorded liability for SILO transactions.

That's correct.

Okay, great. One last question. Obviously very successful on the last plan that you guys did, 2004 to 2006. I am assuming that you might place your most difficult challenge in that plan being the revenue growth, and I was curious to hear any thoughts on where you are looking for revenue growth in your new plan, whether it might increased market share in certain lending arenas, or if you could just expound on any revenue growth thoughts you had, in terms of how you intend to grow going forward?

I think you are accurate in the challenges of revenue growth, at least that's what I see here. Dave and Peter, would you guys want to comment on specific areas that you see as growth opportunities as we go into the plan?

This is Dave, I will say that as we look in the arena of consumer banking, we are going to continue to focus on further developing relationships with our customers. We have discussed things like cross-sell measures in the past. It's not a specific goal that we focus on, but it's an outcome that we continue to monitor.

And we will continue to focus on our existing customer relationships and look for ways to deepen those relationships, expand them through providing additional products and services to those customers. That will be a primary focus for us. It's an area with our sales culture we continue to improve, and we will just continue to focus on becoming better at executing on that sales culture and building those relationships.

On the commercial side, this is Peter Ho. On the commercial side,I think the first thought that I would make, from a lending standpoint we are not looking to expand outside out of our core Hawaii and/or Pacific island market. We have identified a number of what I would call lending segments within our core market, that I think we have got some market share opportunity in.

From a deposit standpoint, we have been pretty successful historically, in assessing out and exploiting particular deposit niches. We have a few identified and I would be happy to share that with you offline. So that's on the commercial side.

On the investment side, as you know, we have put a lot of effort over the past couple of years into building that business, and we are happy with the number of the process and people upgrades that we have made there. We think we have a little more work to do on the investment product side, particularly in the equity arena as do a number of banks, and we are working on that, and hopefully finally have some resolution on that some time this year. That would be the growth initiative on the investment side.

Thanks, Peter. Without putting too much pressure on anybody, I would say we have had great success in growing our business space in our small business arena, and I would expect Kathy and the team would be able to continue that momentum. It's been very well received in the marketplace, and we have got good product development efforts there. I am optimistic about that area as well.

Okay, great. Thanks for all the color.

Sure.

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

Good morning.

Hi, Jim.

The deposit growth number was nice this quarter. Wondered if you could give me a little bit better feel. Were there any national CD gathering efforts in there, and/or on the DEA side, is that new accounts that you are winning, or bigger balances at existing customers?

Jim, we don't do any national deposit gathering efforts at all.

Good.

So there's been nothing that we have undertaken in that regard. In fact, we try to stay away from those most sensitive of time deposits. We have continued to see good, new account origination, both in the business and the consumer sector in the transaction accounts.

So we see growth there, and I think we saw a little bit of pickup in average balance in the fourth quarter as well. We have got one situation kind of in savings accounts where out in one of the west Pacific islands, one of the big manufacturers have closed up their plant, and so their workforce is shrinking, and that has reduced some of the savings accounts that have come with the laborers that were working in that business.

Okay. And then, Rick, the tax rate for '07, you think, assuming there is no unusual items is more like back at the 37% range?

Yes, that's what, I would go back and look out, if you pull out, exclude fourth quarter, exclude second quarter, and look back over the last few quarters, that is probably going to keep with a pretty standard run rate, I think. Second quarter was unusual because of the tax charge, and fourth quarter was a little unusual because it's a trueup. The other quarters should be pretty consistent.

And then the last thing I had a question about was the retirement benefits payable number has been 70, 72 million or so for the last several quarters, down to 48 million this quarter. Anything unusual in that line?

Not that I know of. I will need to check and get back to you on that, Jim.

Okay. Thanks.

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

Good afternoon, everyone.

Hi, Andrea.

Let's start with expenses. It looks if we back out the $1.5 million from employee costs, and the $1.5 million for the Foundation, you probably still have other nonrecurring items there. What would you consider normal run rate for this quarter for expenses? Is it closer to, like, 77, or between 77 and 78?

I would say probably between, just using a round number, I would say around 79. I think that there are always some unusual items up and down. We did have these $3 million worth of items. If you back those out, we would be around 78, 79. I think that's probably, many of the others items kind of wash. So I think that is probably a pretty good core expense run rate for this quarter.

Do you grow off that run rate in coming quarters? I know in the past you have mentioned a run rate closer to $81 million.

Do we grow off that? That's probably accurate.

Fair enough. A question for Peter, if I may. Peter, could you give us a little more color in what's going on in the C&I book, in terms of loan demand? A nice pick-up in the quarter and a period end basis. And also on commercial mortgage, where there was a decrease, did you have payoffs in that book?

First of all, on the C&I side, we got some nice pickup this year from our middle market unit. Last year, we added some senior level leadership into that area, and we have also add lenders into that area, and were rewarded nicely from a growth standpoint. The corporate book, as it has over the past several years, has continued to do well for us.

On the commercial mortgage side, the Q4 results were down really as a result of payoffs, some large payoffs that we had for the quarter. The production however, for the year and for the quarter was pretty solid there, and we have a few initiatives in there to try and boost our opportunities there.

Great. Thank you very much.

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

Good morning, everyone.

Hi, Mike.

I wanted to follow on the C&I growth in the quarter. I just heard a lot of it perhaps came from the middle market side. Would that imply it was fairly broad-based, and not any one or two or three unusually large loans that went on?

C&I for the quarter, Mike, for Q4 had a couple of large, well, what I would call a good-sized bridge loans, which should be around for anywhere from three to six months. And then for we also had, call it, what I will say is 10 to $15 million of short-term borrowings, kind of over year end from certain corporate clients, that we have seen some paydowns off of. So for the quarter, C&I was pretty spiky, all pretty much based in the December month end.

Okay. On the CRE book, I know there is a general trend of payoffs on commercial real estate, but I'm wondering, is there more of a payoff trend in the fourth quarter for the usual real estate cycle? In other words, is it conceivable that payoffs, while they may continue in the CRE portfolio, would be at a lower level in the first quarter?

You are talking on the commercial mortgage side, Mike?

Yes, yes.

Looking at the quarter-to-quarter numbers, the fourth quarter was our largest payoff quarter. I am not sure that I would call it a trend, we just happened to have a number of loans that refinanced out, or otherwise sold off.

Peter, isn't there a little bit of seasonality in that fourth quarter paydown, particularly in real estate collateralized transactions? Not a whole lot?

Not a whole lot, not that we have observed. The numbers would point that way, I can't think of anything anecdotally though, that would push that other than just payoffs.

Okay. Okay, finally, maybe I missed it, but Rick, have you discussed the margin outlook at all? And if not, could you, please? Get the crystal ball out?

No.

Yes, get the crystal ball out. Mike, do you want to specify what is going to happen with yield curve movement?

Yes. I will do that offline, however.

[laughter] You know we, we are seeing a deceleration there in the margin changes, and I am hopeful that some of the pricing pressure on deposits here in the market has reduced, and that that will bring us closer to a little bit more stability than we saw during 2006, but I am reluctant to make any real prediction there. You can kind of follow the trend of quarter-to-quarter, and I think Rick mentioned it was, what, 5 basis points change here in the fourth quarter.

We certainly have seen evidence from pricing by competitors that what was going on in the middle of the year with runup in rates has certainly slowed down now. In fact, some evidence that rates are pulling back a little bit in certain of the deposit categories. So that may be a help to us. We will just have to see what happens with the mix between short-term and long-term, Mike.

And how would you describe your remaining repricing liabilities? Are they getting fairly close to market, or --?

Rick, Mike just asked how we would describe our remaining repricing liabilities? Are they getting close to market?

I think they have still got some room to get close to market, they have gotten closer. We are talking about the investment portfolio?

No, the liability, the borrowings and CDs that perhaps have yet to reprice up to market?

Okay. Yes, those are getting close to market. Sorry, I stepped out of the room for a second. On the liability side, yes, they are getting the close to market. We had used pretty short-term fundings throughout the year, and so as those have repriced and been renegotiated, those are pretty close to market.

Okay, thank you.

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

Good morning, everybody.

Hi, Erika.

I just wanted to ask about asset quality. Is that echo on my line, or is everyone hearing that echo?

We are hearing something, because your question didn't come through very clearly. I don't know if you can hear me.

Is this better?

Yes.

I apologize for that. I wanted to touch upon asset quality, and put Mary in the hot seat. The quarterly increases in both losses and nonperformers, how much of that was attributable to affected customers following the earthquake, or is it really just generally related to normalizing credit trends?

We actually didn't realize any losses from the earthquake situation on the big island. Some of that, if you look at our NPA number and our charge-off number, that's pretty much a fluctuation we have seen quarter over quarter. So a little uptick in nonaccruals in the mortgage portfolio. Those have been resolving with no loss though, over the past year, and I expect that to continue.

Okay. And also, the 2007+ plan, noted that an anticipation in loan losses in terms of an increase is likely. Going forward is the concern more towards the consumer or towards commercial book?

We see really, just continued loss rates in the neighborhood of what we've realized against the larger asset base, as well as a decreasing recovery trend, given we haven't had a lot of charge-offs through the commercial book over the past couple of years.

Okay. Thank you, I appreciate the time.

Your next question comes from the line of Brent Christ with Fox-Pitt, please go ahead.

Good morning.

Good morning.

A couple quick questions. First, in terms of the new 2007+ Plan, could you talk a little bit about the internal growth thresholds that you guys used in making the decision not to contemplate expansion beyond your current footprint?

Yes. We would think of ourself as being able to grow sort of with the economy. I would call it a moderate rate. Maybe in that 5 to 6% category, just over a longer period of time. When we look at the Hawaii economy here in the last several years, that seems to be pretty doable from our perspective, and then maintaining pretty good discipline over our expense levels. As you know, we have been able to continuously reduce our expenses. We are not forecasting that is going to happen.

So kind of a combination of sort of mid-single digits or better in revenues, and very low-single digits on expenses. That's kind of the calculation that we use. That's affected, clearly, by changes in the yield curve, and what it does to margin. You saw, certainly, in 2006 that it contracted our margin.

At some point in time, we believe that that will correct itself, return to a more normal yield curve, and will be a benefit that will come back. We don't know when that will be, and that's kind of an element of our rather conservative plan here as we look at 2007. But over the longer term, it's got to improve itself, is our belief.

Just to clarify, is this plan for 2007 kind of into the foreseeable future? Was there any reason you didn't come up with a 2007 through 2009 plan?

Yes. Our cycle has been three years. I suspect it's as much to do with the, no, I don't suspect, I know it's as much to do with the yield curve as anything. Depending on when that normalizes itself, and how, that may change our thinking on the plan, and we may become a little bit more aggressive with things. But for what we see right now, pretty conservative, stick to our knitting is the right answer for us?

Got you. In terms of trying to find a replacement for Rick, can you talk a little bit about whether that's going to be a solely external candidate, or if you are going to consider internal people as well, and then your thoughts on the timing there?

Rick tells me there is no replacement, [laughter], he's irreplaceable. We certainly appreciate what Rick has helped us with. We have engaging a search firm, we are looking around the country. We are not ruling out anybody here locally in our bank or outside, but what we see is that the area of financial management, just like we did when we hired Mark to help us in the legal and administrative area, is continuing to increase in complexity.

And so our thought, if we are going to add staff at this point adding at the senior level, and bringing some additional experience into our team is probably the preferable way. That is kind of how thematically how we are going about it.

Okay. Rick, could you comment as to where you are going to be moving to?

No, I can't comment on that right now.

Okay. Last quick question, just details. In terms of Other fees line, it looked to be somewhat abnormally low this quarter on a sequential basis, even if you back out the leveraged lease gains last quarter. Was there anything notable causing that to be a little weak this quarter?

No, I think it was just a variety of things. It wasn't anything in particular or anything big.

Okay, thanks a lot.

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

I think most of my questions have already been asked. A couple quick ones on the 2007+ Plan. Wondering if there is any anticipation of changing the capital levels from, you have been running around the 7% level for a while, and what the thought process was during the planning stage, in terms of capital allocation, and where you are on capital?

Yes. The 7% turned out to work pretty good for us, Fred, as you recall, that was kind of an interim level that we set, and we have evaluated different alternatives to operate at a lower level, and in the end, we didn't see a great deal of benefit from trying to do that, and we like the capital levels we have right now. We have spent some time talking with our Board about it.

And so for the basis of this plan, we think the 7% level is just about where we want to be. We may vary up or down a few basis points off of that, just because it's a balance between with a we do in the repurchase market, and as you'll see here, January 1st, some accounting entries, that's kind of where we are planning to stay.

Thanks. And then, as I think you alluded to, the plan is relatively conservative given the challenges you currently face, and the yield curve, et cetera, your financial goals are not really above where they were in terms of ROE or ROA in'06.

I was wondering if you could talk to us about the thought process as you have developed the plan, and maybe why you must have rejected going out of market and some other alternatives? Just a little bit of thought process about staying conservative at this point in time.

Sure. While we have no acquisitions in our plan, and haven't had for some period of time, we do take a look at it, and reach a conclusion of whether we should stay with that model. What we do is look at the attractiveness of various markets that we might enter, our ability to compete, and right now, enhancing our Bank of Hawaii brand here in Hawaii, rather than trying to prepare it for an alternative market, is certainly our best strategy.

Then we take a look at the cost to enter those marketplaces, and our ability to integrate and manage. And what we have seen is that fairly high costs to go off island, as we would say, and a pretty long reach for us. We are still working on developing our management team here internally.

We have had real good success building on a patient basis, and a few outside additions here and there, and that's kind of the model that we think makes sense for us in the economy going forward, Fred.

Okay, thanks. And finally on that, I know you do have some investments off the Hawaiian islands in Guam and some other places, I know Guam in particular is seeing some pretty good growth now. Are you anticipating to stay the course in those non-Hawaiian markets that you are in?

Yes, the Guam economy, it's in some ways a little bit too early to tell, because the major expansion that's expected in Guam, probably starts a couple years from now, but the military is going to do a great deal of development in Guam, and we think on balance, that's got to be positive for the economy, and for our opportunities there. So that, we see right now as having some expansion upside, we are very careful and thoughtful about the risk out there, because it is a small economy, and there's certainly danger of overheating.

Then the other markets are traditionally more stable, and have different economic characteristics. Saipan, I referred to an outflow of accounts, not necessarily so much in balances, and that just has to do with the Garvin production industry out there, and the economy sort of readjusting itself to some subsidy moves. We don't see anything that would cause us to expand or contract in those other islands, with the exception of what happens with military buildup in Guam.

Great. Thanks, Al. Good luck with your new plan!

Thanks, Fred.

Your next question is a follow-up question from the line of Brett Rabatin with FTN Midwest. Please proceed.

Hi, guys. Just speaking of military buildup, I was curious about if you heard anything in the past week or so on the Stryker force in Hawaii, and if they have made some sort of decision on what's going to happen to that?

Well, the Stryker decision is kind of the ongoing controversy, between the military's need to have training grounds, and various interests in Hawaii's concern about the impact on the environment, and use of some of our land. The latest that I recall is that the military has received permission to proceed with training after having been put on hold for a while. I think that's kind of an interim position while it gets reviewed for permanent status, but I don't know of anything new in the last week, Brett.

Okay, great. Thanks, guys.

Next question is a follow-up question from the line of Andrea Jao with Lehman Brothers.

Hello, again. I was hoping you could give a little color on deposit migration, and given that you already note there's some pullback in deposit costs, if that has slowed as well.

We would expect to see continued migration at a decelerating rate from transaction accounts to time accounts. Certainly the, what I will call rationalization rates on time accounts will help that. The market, the market rates seem to have been a little bit more stable in the last few months than they were sort of in the midyear period, when we had the biggest acceleration in time rates. And so I think people who tend to do that, go back to a higher rate, tend to do that quickly when the rates occur, when the rate changes occur, and then it dissipates over time.

I think it's really going to be a function of what happens with the yield curve going forward, and what our competitors do. We look at it on a regular basis and the factor that really is the wild card there is, is anyone else coming into the marketplace from a deposit gathering standpoint? Right now, we see stability there, but that's your advantage, why then, you are always focused on that.

I don't know if that's helpful color, Andrea. That's what I would say. Dave, Peter, Rick, anything you would want to add to that?

I agree with that.

That's very helpful. My follow-up question, let's change gears a little and take about, so you are not looking outside for acquisitions, that means your efforts can be focused on developing your franchise in-state. Could you remind us what you are doing with respect to your branch network, and perhaps to take advantage of the growth opportunities in the neighbor islands?

Sure. Neighbor islands, we have changed our management and business model just a touch there. We have put senior officers in charge of sort of the geographic or county area, on the big island, and in Maui County.

We earlier had asked Jim Polk to go out to Guam, and he is overseeing our Pacific Islands division. And so we are putting just a little bit more responsibility for that geographic territory on those leaders. Roberta on the big island, and Kevin over in Maui. These are all seasoned professionals, who I think are going to give us a lift by giving them more responsibility over the marketplace.

In the branches, we are just continuing with our program Dave started a number of years ago. It's not fast enough for what the retail folks want, and it's balanced off against what we think we can afford of renovating our branches that need it, sort of being the priority of who needs it most. We opened up a new branch out in the western part of Oahu last year. That's going a little bit better than what we had expected in terms of deposit growth.

We're going to continue to assess where there might be opportunities, but they are going to be pretty marginal, a branch or two here and there over the next plan period would be about as much as we would expect. We have got more branches than I think most of the banks here in the Hawaiian islands, and don't see a whole lot of lift from additional territory being put under branches.

We are going to continue to look at our branch structure and philosophy as we fix these up. You are more vulnerable in in-store branches turnover, and I think we'll see some location changes associated with our in-store branching efforts over the next couple of years, but I wouldn't expect to see too many additional locations being opened. Dave, Peter, anything you want to add?

That summarizes it well for the branch number.

Perfect. Very helpful. Thank you.

Sure. Andrea, I would say it's expensive to renovate a branch out here in Hawaii. The real estate cost goes all the way through that part of the process.

[OPERATOR INSTRUCTIONS] Your next question is a follow-up from the line of Erika Penala with Merrill Lynch.

Just one more question on credit quality, if I may. Mary, if you were to pick one product that will cycle out over the next 12 to 24 months, and not necessarily for Bank of Hawaii solely, but for the industry as a whole, what product line would you pick, and why does this concern you the most?

Well, I would probably say that the industry consensus and focus is on real estate. I think within Hawaii, there has been some moderating in sales and values, but I don't see that going into any sort of a more negative trend for us. I think that nationally has very different dynamics depending on the market. In our portfolio, there is actually no segment in particular that concerns me at this point.

And what does the early indicators in terms of credit quality for home equity look like right now?

Our home equity portfolio is very strong. Our credit scores are 700 plus, and they continue to improve in our monitoring scores, as well as our origination scores.

Okay. I appreciate you guys letting me ask a second question. Thank you.

Sure.

At this time, there are no more questions in queue. I would now like to turn the call back over to Ms. Cindy Wyrick for closing remarks.

I have one follow-up, an answer to Jim Bradshaw's question on the pension liability. I just wanted to comment that really, Jim, that relates back to the adoption this quarter, of FAS 158, and we talked about 158 back in the Q, and you'll see there's two components of that. There is one component of that, there is one component that is a current funding component and kind of a trueup of the liability that comes through the statement of equity, which is what you see in the equity statement here in the package. There is another component of that, though, whereby we have prepaid pension assets recorded, and we had a liability recorded, both on a gross basis. And then 158, we netted the asset over against the liability, and that's the biggest factor in that balance sheet drop in that liability line. If there are any follow-up questions on that, we can catch them later. I just wanted to say that while we had the call going.

Thank you, Rick. I want to thank everyone for joining us today. As always, if you have additional questions or need further clarification, please feel free to give me a call. Thanks, everyone.

Thank you for attending today's conference. This concludes the presentation. You may now disconnect. Good day.