Bank of Hawaii Corp (BOH) 2008 Q2 法說會逐字稿

Good day ladies and gentlemen. Welcome to the second quarter 2008 Bank of Hawaii Corporation earnings conference call. My name is Heather, and I will be your coordinator for today. At this time all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of today's conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's conference, Ms. Cindy Wyrick, Director of Investor Relations. Please proceed.

Hello, everyone. Thank you for joining us today as we review the Bank of Hawaii Corporation's financial results for the second quarter of 2008. With me this morning is our Chairman and CEO, Al Landon, our Vice Chairman and Chief Financial Officer, Kent Lucien, our Vice Chairman and Chief Banking Officer, Peter Ho, and Vice Chairman of Corporate Risk, Mary Sellers. My biggest mistake, Peter is now our President, congratulations, Peter, I didn't demote you. (laughter)

You had me holding my breath there for a second.

Comments today will include financial information that was included in the earnings announcement we released this morning. Before we get started let me remind you today's conference call will contain forward-looking statements, and while we believe our assumptions are reasonable, there are a variety of reasons the actual results may differ materially from those included today.

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

Thank you, Cindy. Good morning, everyone. Bank of Hawaii again delivered solid financial results in the second quarter of 2008. We achieved our major financial performance objectives. Our net interest income and margin expanded. We set aside some additional reserves for loan losses and strengthened our capital. Our credit profile remains strong, even as the Hawaii economy slows.

Before I comment on the economy, Kent will review some additional highlights of our second quarter results. Kent?

Thank you, Al. Good morning. Net income for the second quarter was $48.3 million, or $1.00 per share, compared to $0.95 per share in the second quarter of 2007, a 5% increase. Our return on average assets was 1.85%. Return on equity was 24.82%, and our efficiency ratio was 50.01%.

For the first six months of 2008, net income was $105.5 million, or $2.18 per share, up $10.4 million compared to 2007. You may recall that in the first quarter, we had the Visa IPO transaction, and an early buyout of an aircraft lease, offset with the accrual of various expenses, which netted together added approximately $0.20 per share to our results. Excluding the significant items, net income was $96 million, or $1.98 per share for the first half of 2008, compared to net income of $95.1 million, or $1.89 per share in 2007. This is a 4.8% increase.

In the second quarter, net interest income was $107.4 million, up 5 million from the first quarter, and up 8.3 million from the second quarter of 2007. The net interest margin was 4.41% this quarter, an increase of 24 basis points from the linked quarter, and up 29 basis points from last year. Net interest income benefited from a steeper yield curve, which resulted in lower funding and deposit costs, that more than offset lower asset yields.

Our effective cost of funds decreased 56 basis points in the second quarter, while the yield on earning assets declined by 18 basis points. Non-interest income for the second quarter was $60.5 million, down 25.6 million from the first quarter, and up 2.5 million compared to the second quarter of 2007. Excluding the significant items, non-interest income was virtually level with the first quarter. Increases in Trust and Asset Management income, fees, and other service charges, were offset by reductions in mortgage banking and insurance income. Year-to-date, non-interest income is up 2% versus 2007 excluding the significant items.

Mortgage banking, service charges, fee income, and insurance are all up, while Trust and Asset Management income is down 4%. Non-interest expense was $83.9 million in the second quarter, a decrease of 9.6 million from the first quarter. Excluding the first quarter significant items, non-interest expense was 83.2 million in the first quarter, and so our expenses increased approximately 1% sequentially.

Year-to-date, expenses are up 3%. A portion of this is due to higher occupancy expenses associated with the new branch in Waikiki. We are also seeing higher utility expenses system-wide. Our operating leverage was 5.1% in the quarter. Our efficiency ratio was 50.01% for the second quarter, compared to 49.62% reported in the first quarter, and 50.88% in the second quarter of last year. The provision for credit losses was 7.2 million.

Net charge-offs were 4.7 million, and we added 2.5 million to our reserve for credit losses. We did this to account for what we believe to be continued weakness in the airline industry, and our exposure via portion of the lease portfolio. Our airline/aircraft exposure was 81 million, and the associated loan loss reserve is 33 million. Our effective income tax rate was 37% versus 29% in the first quarter, and compared to 35% in the second quarter of 2007. The effective rate was lower in 2007, due to the settlement with the IRS regarding lease in/lease out transactions, and also foreign tax credits in that period.

Shifting now to the balance sheet, outstanding loans and leases totaled $6.52 billion at the end of the period, a decline of $61 million from the previous quarter, and 48 million lower than last year. The loan balances reflect the impact of more stringent underwriting standards, and a slowing Hawaiian economy. We continue to reduce our construction lending exposure which was $168.7 million at the end of the quarter, versus 190.5 million at the end of the first quarter, and compared to 261.5 million last year.

The indirect automobile portfolio was also reduced by 17 million during the quarter. Our investment securities portfolio was $3 billion at June 30, down 48 million from the first quarter. During the quarter, we also reduced our long term debt by 34 million. Period end deposits decreased 199 million this quarter to 7.9 billion. Average deposits were 7.96 billion, essentially unchanged from the first quarter, but up 148 million from the second quarter of 2007. The increase over the period year occurred largely in savings deposits, which increased $178 million.

Our focus in 2008 has been on enhancing checking and savings deposit products. Our new deposit products include free checking, mobile banking, online account opening, and an enhanced bonus rate savings account. Asset quality remains strong despite a slowing Hawaiian economy. Non-performing assets totaled 6.7 million at the end of the second quarter, compared to 6 million at the end of March, and 6.3 million at the end of last year's second quarter.

As a percent of total loans and leases, non-performing assets were 10 basis points, 1 basis point higher than the first quarter, and the same as the second quarter of 2007. Loans past due 90 days or more were $4.2 million, down 1.7 million from the first quarter. Our allowance for loan and lease losses is $102.5 million, which represents 1.57% of total loans. We continued our share repurchase program in the second quarter, albeit at a lower level. In the quarter, we purchased 220,000 shares, at a total cost of $11.4 million.

On May 15, we exercised our option to call the remaining 26.4 million trust preferred securities, which previously qualified as Tier 1 capital. Accordingly, we lowered the share repurchase level, in order to maintain our Tier 1 capital level. Since quarter end, we have purchased another 181,000 shares. At quarter end, our leverage ratio was 7.04%, up slightly from 6.99% at March 31. Also consistent with our conservative approach, we have decided to continue to reduce our leverage somewhat, and are now targeting a leverage ratio of 7.25% by the end of the third quarter, versus our previous target of 7%.

Finally our Board, consistent with the prior three quarters, declared a $0.44 per share dividend last Friday. And now, I will turn the call back to Al.

Thanks, Kent. In our earnings announcement this morning, we indicated that the Hawaii economy is slowing, consistent with the indications we discussed in our last two earnings calls. Visitor arrivals have decreased, due to fewer airline choices, higher prices, and economic uncertainties.

Hawaii unemployment has increased slightly, and we are seeing some companies reduce their workforce. While the number of home sales has decreased significantly, the value of homes has decreased only a slow amount in Honolulu. Prices on neighbor islands have decreased more, lead by vacation homes. As Kent mentioned, we have continued to decrease our exposure to higher risk loans and increased our reserves.

We expect to maintain our disciplined management of credit, as we evaluate new lending opportunities. Overall, the slowing economy has not had a major impact on the credit quality of our Hawaii portfolio. During the last year, we have conservatively managed our balance sheet. We are now adding new deposit products and improving our distribution systems, in anticipation of opportunities to add customer relationships.

We continue to see Bank of Hawaii's capital generation from income as strong. As Kent mentioned, we increased our capital target slightly. Given our margin expansion, we are maintaining our goals of positive operating leverage and earning 1.7% on assets, and 25% on equity.

Now we are open for questions.

Ladies and Gentlemen, (OPERATOR INSTRUCTIONS). Your first question comes from the line of Brent Christ with Fox-Pitt. Please proceed.

Good morning, guys.

Good morning.

With respect to the revised leverage ratio target, could you talk a little bit around the thought process, in terms of making that change in terms of just kind of what you are seeing I guess from a macro perspective, and then specifically any thoughts in terms of how you are going to get it up to 7.25, from I guess 7.02% at the end of this quarter, whether that is slowing the buyback a little bit, or further shrinking the balance sheet?

Sure. I think just in light of what is going on in the industry, and what the economy has been doing here, we thought a little bit of capital generation demonstration was appropriate, so rather than the 7% that we had talked about before, we thought taking it up to 7.25, and seeing how the economy looks was the prudent thing.

We accomplished that by replacing the equity, basically with the trust preferred shares, or shares that we repurchased or redeemed last quarter. We did that by slowing the repurchase program. We expect a more robust repurchase amount here in the third quarter, but probably slower than where we have been previous to the second quarter. So we will just gradually let it move up 0.25, and take a look at how things appear at that point.

Okay. And in terms of the timing, did I hear you correctly though that you wanted to get it up to those levels in the next quarter?

I think that is probably a general target, Brett, but we will see what happens here with stock values. But we would plan to stay in the market as we have, what has our phrase been, in an orderly and disciplined manner.

Got you. And then a question on credit quality. I guess you have built reserves for a couple quarters here, and specifically cited the airline portfolio as part of the rationale, but if you back out the specific airline allocation, I guess it puts kind of the reserve on the remainder of the portfolio at about 110 basis points give or take, if my math is correct, and just trying to get your thoughts on any future desires to build the reserves across some of the other portfolios?

Mary, do you want to address that?

Brent, the one thing you need to keep in mind when you look at our reserve coverage, is the amount of residential mortgage we carry on our portfolio. That total amount of consumer book compared to commercial, so if I do some adjustments I am probably at about 157 on the commercial book.

Okay, got you. Okay, and then just kind of in general thoughts on needing to, or desires to provide in excess of charge-offs over the foreseeable future?

We are just going to take a look at it every quarter as we have been. We have got a pretty specific methodology that we follow that looks at the economic indicators, as well as levels of recent charge-offs, and we will focus on it every quarter. Right now, we are comfortable with where we see the allowance , but as the economy changes or indicators change, we will just adjust accordingly. That said, we don't see anything right now that would require a major move in reserve levels,

Okay, thanks a lot.

Sure.

Your next question comes from the line of Brett Rabatin from FTN Midwest. Please proceed.

Hello, everyone.

Good morning.

Wanted to first ask on just the local economy, I am curious if with the hotel occupancy rates going from mid-70's down to 73 I think I hear recently seasonally adjusted, and probably 70% in June, have you guys stress tested your CRE portfolio from a hotel perspective? And I am just curious if what you are seeing in terms of a little softer economy, if you sort of run a stress test in the portfolio for the credit we are seeing last quarter?

Mary do you want to talk about stress testing?

Sure. Near and dear subject to my heart. We run stress tests across all of our portfolios, Brett, to include our commercial real estate portfolio. I would say that we have pretty nominal exposure to the hotel industry, roughly 40 million in total.

Okay. And then with what you saw in the quarter on the indirect auto portfolio, with losses being a little lighter, was that a reflection of just being aggressive in the past couple quarters with recognizing softer trends, or can you give any direction on why the loss rates and Q2 were lower on auto type facilities?

Two things I would cite. The one, we have been tackling the underwriting in that portfolio for the past two years, so I think we are starting to see some of that, and then the second quarter is always historically the low point for net charge-offs in our consumer book.

Okay.

And Mary, as you look forward would you expect to be able to stay at the second quarter charge-off rate, or is that likely to move back up a little bit in the third quarter?

I would expect some migration back up through the remainder of the year. People tend to get tax refunds, stimulus checks, et cetera, that kind of pull-down the second quarter number.

Okay, and then a question on balance sheet management, and just the margin was obviously very strong in the quarter which was great, and the CD cost, the almost 3% costs in CDs, you have managed that down over 60 basis points linked quarter. I am just curious what you see the competitive environment like, and if you expect the cost of funds to continue to be a positive relative to the margin, and if not, if you will be doing things on the asset side from a decline securities perspective, or just balance sheet management in general?

Well, we are going to pay close attention to both what is going on here competitively, as well as our own balance sheet. This has been a good time to focus on transaction accounts that carry a lower cost. I would expect to see us increase our total funding, and probably increase the rates that we pay on CDs. We will probably use more CD specials, Brett, to lengthen the maturity of that source of funds, so if the market gives us an opportunity.

We like the margin where it is right now, and of course the issue will be how do we preserve that through yield curve changes, and what we would expect to do is try to lengthen on the timed deposit side a little bit, and then we think that there may be some opportunities to further increase our number of our amount and number of transaction accounts. We just introduced a free checking product that seems to be quite well received, and we are optimistic that continued promotion of that will help us grow transaction accounts as well.

Okay, and then just lastly, any quick commentary you might have on I have heard locally that maybe Hawaiian Airlines will be able to help pick up the slack in the air lift reduction, and that they might have like 15% extra capacity potential. I didn't know if you guys had seen anything about that, or had any thoughts about visitor trends going forward, after what we have seen the past two or three months?

Well we know that Hawaiian is interested in filling up capacity opportunities. They ordered some new planes, and that is a well run company by the way, in a pretty tough industry, but they are focused on ways to expand arrivals into Hawaii, whether they come from the mainland or come from overseas, so we are optimistic there are always longer term kinds of forecasts to revert, but it seems like the folks at Hawaiian are nicely focused on what they can do to improve our visitor arrivals here.

Okay, thanks for the color.

Sure.

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

Good morning, everyone.

Hi, Andrea.

First a question on deposits. Last quarter you had the large commercial demand deposits which came in. I was wondering if that had already left the bank?

Yes, that was an international deposit actually, Andrea, and it was just under 70 million just prior to the quarter end last quarter, and by the quarter end Q2 that was down to about 2 million, so that was a big chunk of the rundown in spot balances that you saw.

Okay. Good. Do you guys still expect commercial and commercial real estate to kind of contribute to loan growth, as indirect construction and leasing kind of run-off?

I would say, Andrea, that we would anticipate the construction book to continue to come down a bit, just based on what is happening out here in the marketplace. You will notice that our commercial mortgage, or our permanent mortgage book on the commercial side performed quite nicely from a volume standpoint. We think there is more opportunity there, because it seems as though a lot of the business that had traditionally over the past couple of years went into the conduit markets, are really starting to open up for us, so it is really construction versus permanent mortgage on the growth side.

And on the retail side?

On the retail side, on the residential mortgage front, obviously, transactions are down so that is impacting our business somewhat volume-wise, but then similar to the commercial side, we are also seeing less competition out there. Countrywide is not as aggressive as they had been. IndyMac was a pretty large lender out here, First Magnus was a large lender, and even Wells Fargo seems to be getting a good bit more conservative at the larger end of the market.

So you think those portfolios would hold steady in coming quarters?

That is our thought.

Okay. And the follow-up was a question for Mary. If you could remind us, what mortgage, what residential mortgage and what home equity products is offering in portfolioing, as well as the LTVs for the book of business, and if you have the numbers, the delinquencies?

Sure. On the residential mortgage front, we do not offer Alt-A non-traditional type products. If you look at our portfolio, 95% has an LTV less than 80%. Of the 5% that is greater than 80, which is only 2.6 million of that, it is not covered by mortgage insurance. We are very conservative in the type of products we offer, and in our underwriting standards. We do have an interest-only product that is under written very conservatively, and it's underwritten for a fully amortizing payment, and in fact the credit steps on that tend to be stronger than the balance of our portfolio.

In terms of our home equity portfolio, a similar type of profile right now, we have topped out our maximum LTV on our home equity at 85%, and we require the Bank of Hawaii hold the first position on that. If I look about 75% of our portfolio has LTVs less than 80%, and in terms of what is over 90%, that is only about $18 million.

Okay. And did I understand you correctly that you require first position on your entire home equity book?

Anything over 80%.

Okay. So how much of the book would you say are first liens versus second liens?

About 80%. We don't have a totally complete data, and we have to make a few assumptions but we are running about 80%.

Okay. Thank you very much.

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

Good morning. My questions have been asked.

Hi, Erika.

Hi, my questions have been asked. Thank you.

Sure.

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

Thanks and good morning.

Hi, Fred.

Hi. Just two questions. Most of mine have been answered. First, I was wondering if we could get some color on the available for sale portfolio? I noticed that the yield on the portfolio went up linked quarter and year-over-year. So I was wondering kind of what you are reinvesting in, and also I notice that there was a negative OCI mark, about 20 million, and I was wondering if that was related completely to rate issues and not to credit issues?

Kent, do you want to tackle that? We don't have much color in our AFS portfolio, Fred, (laughter)

(laughter)

It is pretty plain vanilla stuff.

Yes. The majority of the portfolio of course is mortgage backed securities by the GSEs. That would be about 2.5 billion out of the 3 billion. Obviously, we take a very conservative approach to reinvestment, and we will continue that approach. The 10.8 million that you saw in the comprehensive income, is interest rate results and not credit.

Great. Thanks. That was helpful. Also I was wondering if you could talk a little bit about the leases, and in particular, I see you guys had a recovery on the LILO lease, I think about 1.5 million, and I was wondering if there is any update on the current situation on the SILOs as well?

Nothing significant on the SILOs. We are still in discussion with the Internal Revenue Service on that matter, so nothing to report. The LILOs of course were settled with the service last year, and so that was the reason for that lower effective rate last year.

Yes, that was a 2007 accounting event, right, Kent?

Yes. On the LILO. Yes, and the SILOs are still to be resolved.

Could you remind us what exposure you have on the SILOs?

Oh, let's see. Our net recorded investment, if I recall correctly is under 100 million, and we have done some provisioning in connection with accounting changes over the last year and a half, Fred. I think it was at the beginning of 2007, so notwithstanding the court settlements out there, we think that we are fairly well protected at this point. Of course, as Kent said, we continue to talk to the IRS, and what looks good today shouldn't be construed as a prediction of the future, but at this point, we think we are comfortable where we are.

Great. Thanks very much.

Yes.

Your next question is from the line of Aaron Deer with Sandler O'Neill.

Hi, good morning everyone.

Hi, Aaron.

Just a quick follow-up on the air transport leases. I know it is small, it is just like a little over 1% of your portfolio, but I was wondering if you could provide any detail on the I guess it would give us some comfort that the reserve there is adequate, given what is going on in that market?

(laughter) I wish we could promise you we had it all figured out. Equity interest and those leases and I think we have got 10 different leases, totaling about $80 million. The domestic passenger carrier portion of that is about $60 million, against which we are a little over 50% reserved. We have got a mix of large aircraft and regional jets in there, and a mix, I believe, we must have eight carriers in that segment of the portfolio, from I want to say a relatively stronger to not quite as strong.

I don't know how you describe mainland air carriers, in terms of strength, but we have got a mix across the spectrum. And as we take a look at it, that is really a challenging business for the folks in it. We think for where we ought to be right now, but that depends on what happens with future fuel prices, and so many other variables out there, Aaron, that is maybe as bold as I ought to be in saying anything. We just continue to look at it every quarter, and we will adjust as we see needs arise.

Sure. Fair enough. No, that is helpful, Al and all my other questions have been asked, so thank you.

Okay.

Your next question comes from the line of Julienne Cassarino, Prospector Partners. Please proceed.

Hello. Good afternoon.

Hi.

Hi. I was wondering, I just wanted to clarify your answer to Andrea Jao's question about the first lien position in the home equity portfolio. Did you say 80% of the home equity portfolio is first lien?

Actually, I am glad you asked this question, because I should clarify. I confused two things. We do not have complete data on our lien position, and we are in the process of building that out, but in terms of us originated through our retail networks, 80% is originated through our retail network. 20% is originated through a broker channel.

Okay, those are all in Hawaii, right? Those are all properties in Hawaii?

It is all in Hawaii. We do, you recall on home equity have a small piece of mainland portfolio left, that has a run-off from a portfolio purchase several years ago, down to about 30 million.

And we purchased that, Mary, in maybe 2002? Or something like that?

Yes.

So pretty seasoned at this point.

Pretty seasoned.

Okay, so 30 million of the total home equity portfolio is on the mainland, and in run-off mode right now?

Right.

And the broker, I guess I am just curious why do you need brokers to originate home equity loans on the islands?

(laughter) I could give lots of of attempted clever answers at that. It is just a traditional part of the business network out here, and we are happy to originate directly, but it seems that we get competition from brokers, and that is just a part of the origination network. Peter, anything you want to add to that?

No, I think that is it.

Every banker probably thinks they need no brokers, but it doesn't work quite that way here.

Okay, well thank you very much.

Sure.

(OPERATOR INSTRUCTIONS). Your next question is a follow-up from the line of Andrea Jao with Lehman Brothers. Please proceed.

Hello, again.

Hi.

Fees exchange and other service charges were up 1.1 million in the quarter. Could you talk about the drivers there, and at that level, is sustainable in coming quarters?

Andrea, the bulk of that growth for the quarter was in our commercial area, and those fees were kind of split between syndication and [admit] agent fees, as well as some swap fees, so I would anticipate that the swap fee income should continue. We have got a pretty good pipeline there. The syndication fees may wind down over the course of the year, about half and half.

Okay, and then insurance should bounce back next quarter. Is that strong every other quarter, right?

We hope so.

That has been the cycle.

Are there non-recurring items in Other income and Other expenses that we should be aware about?

The only one I can think of, is we annually adjust our reserves for self-insurance on the expense side in the second quarter, and so that would have reduced our expenses between 0.5 a million and 1 million. Kent, I can't remember the exact number, but it is in that range, Andrea.

Okay. Thank you very much.

Kent says it is 1, Andrea.

There are no further questions in queue at this time, I would like to turn the call back over to Cindy Wyrick for closing remarks.

I would like to thank everyone for joining us today, and for your continued interest in the Bank of Hawaii. As always, if you have additional questions or need further clarification on any of the topics we discussed today, please feel free to contact me at 808-694-8430. Have a good day, everyone.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Have a great day.