Bank of Hawaii Corp (BOH) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the second quarter 2011 Bank of Hawaii earnings conference call. My name is Fab and I'll be your Operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

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

Thank you, Fab, and good morning everyone. Thank you for joining us today to review our financial results for the second quarter of 2011. Joining me this morning is our Chairman, President and CEO Peter Ho, Vice Chairman and Chief Financial Officer Kent Lucien, and Vice Chairman and Chief Risk Officer Mary Sellers. Comments today will refer to the financial information included in the earnings announcement released 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 our assumptions are reasonable, there are a variety of reasons that the actual results may differ materially from those projected.

Now I'd like to turn the call over to Peter Ho.

Thanks, Cindy. Good morning and aloha, everyone. Thanks for joining us today. Bank of Hawaii had strong core operating results in the second quarter of 2011. We were pleased to see loan balances grow during the quarter. The positive balances remained solid.

Revenues continue to be challenged due to the interest rate environment and our conservative investment and liquidity posture. Operational expenses remained well-controlled. Asset quality remained stable and in line with the recovering Hawaii economy.

Our balance sheet remains quite strong with high levels of capital, liquidity, and reserves. We increased the amount of shares repurchased during the quarter. And our directors have authorized us an additional $120 million in repurchase activity.

Now I'd like to ask Kent to review some of the factors affecting our financial performance this quarter. And then Mary will comment on credit quality metrics. Kent?

Thank you, Peter. Good morning. Net income for the second quarter was $35.1 million or $0.74 per share. Compared to $42.4 million or $0.88 per share in the first quarter. And $46.6 million or $0.96 per share in the second quarter of 2010.

Included in this quarter's results was a $9 million charge for a legal settlement related to overdraft claims. There were no securities gains this quarter compared to $6.1 million in the first quarter, and $15 million in the second quarter of 2010. Our return on assets in the second quarter was 1.09% and return on equity was 13.9%.

Year-to-date net income was $77.5 million or $1.62 per share, compared to $99.3 million or $2.05 per share in 2010. We realized $6.1 million in securities gains this year, to date, compared to $35 million last year. Year-to-date the return on assets is 1.21%, and return on equity, 15.4%. Our net interest margin in the second quarter was 3.16%, compared to 3.24% in the first quarter, and 3.51% in the second quarter of 2010.

Year-to-date the net interest margin is 3.20%, compared to 3.61% last year. The lower margin is due to a lower interest rate environment and a large investment portfolio. The credit provision in the second quarter was $3.6 million, compared to $4.7 million in the first quarter. And $15.9 million in the second quarter of 2010.

The credit provision for the second quarter included net charge-offs of $6 million, and a $2.4 million decrease to the allowance. The credit provision in the first quarter equaled net charge-offs. And for the second quarter of 2010 included net charge-offs of $14.9 million, and a $1 million increase to the allowance. Our allowance for loan and lease losses at the end of the second quarter was $145 million, or 2.7% of outstanding loan and leases.

Non-performing assets were $34.2 million at the end of the second quarter, down $400,000 from the end of the first quarter, and down $9.1 million from the end of the second quarter of 2010. Included in non-performing loans are $24 million in residential mortgage loans as of June 30.

Non-interest income for the second quarter was $49.5 million compared to $53.9 million in the first quarter, and $68.9 million in the second quarter of 2010. The decreases were primarily due to realized gains in the securities portfolio, $6.1 million in the first quarter and $15 million in the second quarter of 2010.

Also contributing to the decrease compared to the second quarter of 2010 were lower overdraft fees. Year-to-date, non-interest income was $103.4 million, compared to $140.7 million in 2010. The decrease was primarily due to a $28.9 million decrease in securities gains and also lower overdraft fees.

Non-interest expense totaled $93.8 million in the second quarter, compared to $86.1 million in the first quarter, and $85.9 million in the second quarter of 2010. Excluding the legal settlement, non-interest expense would have been $84.8 million. Total salaries and benefits remained flat compared to the first quarter and included an accrual of $2 million for the bank's share appreciation program.

Partially offset by $1.7 million decrease in payroll taxes due to incentives paid in the first quarter. Included in the second quarter of 2010 was an accrual of $3.3 million for officer cash grants for the purchase of Company stock.

The effective income tax rate was 29.1% in the second quarter, compared to 32.6% in the first quarter of 2011, and 34.4% in the second quarter of 2010. The lower rate was primarily due to a release of reserves in the second quarter, due to the closing of the IRS audit for 2 tax years.

Our investment portfolio now stands at $6.6 billion, and we have unrealized gains in the portfolio of $120 million. We continue to invest on a conservative basis with purchases of US Treasury notes, SBA floating rate securities and corporate bonds this quarter. The average duration of the AFS portfolio is 2.23 years.

Loan balances increased $25 million compared to the end of the first quarter. Mary will be commenting on changes in loan balances in a moment. Deposits were $10 billion at the end of the second quarter, up $67 million compared to the end of the first quarter, and up $654 million from the end of the second quarter of 2010.

We increased our wholesale funding with government entities by $128 million in the second quarter. Our average cost of public repurchase agreements is 8 basis points. Our shareholders equity remained flat at $1 billion. We paid out $21.4 million in dividends in the second quarter and we continued our share repurchase program in the second quarter, repurchasing 636,000 shares of common stock for $30 million.

Last Friday our Board declared a dividend of $0.45 per share for the third quarter. At the end of the quarter, we had $13.1 million remaining under our existing share repurchase program. The Board has increased the share repurchase authority by an additional $120 million.

The amount of repurchases in the future will depend on many factors, including the economy, the credit environment, and the value proposition for our shareholders. We will continue to update you quarterly on our capital management actions. Our capital position remains strong and at the end of the second quarter our QCE, the risk-weighted asset ratio, was 19.1%.

Now I'll turn the call over to Mary Sellers.

Thank you, Kent. Net charge-offs in the second quarter totaled $6 million, up $1.3 million on a linked quarter basis and down $9 million year-over-year. The linked period increase was due to a $1.5 million increase in home equity. The year-over-year decrease reflects reductions of $4.1 million and $4.8 million in the commercial and consumer portfolios, respectively. Non-performing assets totaled $34.2 million, down $436,000 from the first quarter, and $9.1 million year-over-year.

As Kent shared, residential mortgage non-accrual loans totaled $24 million at quarter end. The level of non-performing assets will continue to be impacted in the near term due to the longer resolution time frame for residential assets.

At quarter end, loans past due more than 90 days and still accruing interest totaled $7.8 million, up $2.2 million on a linked quarter basis and down $5.1 million year-over-year. The linked period increase was due to an increase in residential mortgage, largely due to 2 loans.

While the year-over-year decrease was due to reductions across all the consumer portfolios including a $3.2 million reduction in residential mortgage. Restructured loans, not included in non-accrual or loans past due 90 days or more totaled $28.2 million at quarter end, down $1.3 million from the prior quarter, due to the payoff of a $3 million commercial loan, offset by 2 residential mortgage loans totaling $1.5 million that were returned to accrual status based upon performance. Residential mortgage loans modified to assist our customers in retaining their homes accounted for $20.5 million of the total.

Consistent with the improving Hawaii economy, we continue to see improvement on a linked quarter and year-over-year basis in what we consider to be the higher risk segments of our loan portfolio. Our land loan portfolio totaled $20 million at the end of the second quarter, down $1.6 million on a linked quarter basis, and $10.3 million year-over-year.

As we've shared previously, in our residential mortgage and home equity portfolios, we consider loans originated after 2004 with current credit monitoring scores less than 600, and loan to value ratios greater than 70% to be at higher risk. At the end of the quarter, higher risk exposure in our residential portfolio totaled $23.7 million, down $1.8 million on a linked quarter basis, and up $2.4 million year-over-year.

In our home equity portfolio, higher risk exposure totaled $21.8 million, down $2 million on a linked quarter basis and $3.2 million year-over-year. At the end of the quarter, residential mortgage and home equity loans and lines delinquent 30 to 89 days totaled $22.6 million, down $2 million on a linked quarter basis and up $1.4 million year-over-year.

Commercial construction loans totaled $80.5 million at the end of the quarter, with $35.6 million in residential home-building exposure. Higher risk exposure totaled $16.2 million, up $1.5 million from the first quarter, and down $2.8 million year-over-year.

The provision for loan and lease losses was $3.6 million, which given net charge-offs of $6 billion reduced the allowance for loan and lease losses by $2.4 million to $145 million. Absent significant deterioration in the economy, we anticipate that we may require a lower level of allowance going forward.

With the improving Hawaii economy, we did see modest loan growth in both our commercial and consumer portfolios this quarter. Commercial loan outstandings were up $19.3 million on a linked period basis, driven off a $44 million increase in C&I outstandings related to existing customers making capital investments in their businesses.

Commercial mortgage outstandings were down $11.1 million at period end, primarily due to substantial expected linked quarter payoffs. Consumer loan outstandings were up $5.3 million on a linked quarter basis due a $22 million increase in residential mortgage portfolio, and substantial operating performance in our home equity and in direct auto.

I'll now turn the call back to Peter.

Great. Thank you, Mary. Major economic metrics in Hawaii further improved during the quarter, led by a rapidly improving visitor industry. Hotel occupancy, hotel revenue, visitor arrivals and visitor spending all continue to show signs of improvement.

As expected, Japanese visitor arrivals decreased from the March natural disasters in Japan. However, this is more than offset by strong visitor arrivals from other markets. It's interesting to note that 40% of our visitor spending now comes from international travelers.

Of the international segment, Japan comprises 37% of the international segment. While other countries, including China, Korea, Canada, Australia, and New Zealand, comprise 63% of the international segment, and are indeed the fastest-growing segment in terms of visitor spending.

The Hawaii Tourism Authority is anticipating visitor activity to remain strong for the second half of the year due to increased airlift out of Asia, Australia and New Zealand and the establishment of the China Eastern Airline service from Honolulu to Shanghai beginning next month. This marks the first regularly scheduled direct lift from the People's Republic of China.

And in my estimation it's a significant event. Other positive signs in Hawaii include stabilization of the overall job growth, the overall job market, as well as decreasing unemployment. The housing market on Oahu remains stable. Inventory levels remain stable. Although we're seeing a bit of softness in the neighbor island markets.

Now we would be happy to entertain your questions.

(Operator Instructions) Craig Siegenthaler, Credit Suisse.

First, on the roughly $1.5 billion of reclassified securities from available-for-sale to held-to-maturity, what type of securities were involved in the shift? And what was the main driver here? Was part of the driver long-term asset liability matching? Was it trying to drive this more stable NIM near term? Maybe you can just give us some color there.

Yes, Craig. Actually, we undertook that change mainly last quarter. The composition of the held-to-maturity portfolio is very similar to the AFS portfolio; there's no difference in the types of securities in the 2 portfolios.

We really made that change based upon our liquidity situation, and the fact that we intended to hold these securities to maturity, so we merely reflected that in the reclass.

And is there a duration difference between the 2 portfolios? You said basically they own the same security. I'm just wondering, excluding the accounting differences, is the duration within both those portfolios about the same? And what is that?

It's a little bit longer in the HDM than the AFS. The AFS is about 2.23 years and the HDM is about 2.7 years, or so. So there's a little bit of a difference.

And in terms of competition, are you allowed to disclose what that is to us? Is that a lot of that Ginnie Maes?

It has a little bit more Ginnie Maes than Treasuries.

When I look at the 8 basis points, I believe it was, compression in the loan yield quarter over quarter, I'm just wondering if you could help us understand. What was the driver there? Was it between really competition on new loans, some other issues like if there's any swap runoffs? And then also the impact from LIBOR and other interest rates being down in the second quarter.

It's mainly the environment. Interest rates fell roughly 50 basis points or so between the first and the second quarter. That's going to affect virtually every category. You saw it a little bit in the mortgage line; saw mortgage interest rates go down. And it just reflected the environment.

Brett Rabatin, Sterne Agee.

Wanted to ask about capital and the buyback going forward. First of all, is the leverage ratio the appropriate capital ratio we should be thinking about? And then if it is, 7% used to be where you targeted that. And then I'm curious about the pace of the buyback going forward.

We're looking at a lot of different dimensions in terms of capital management. I would dissuade you from focusing on one particular ratio compared to any other determinant. We've taken all these things into account in sizing the repurchase activity. Essentially, we are buying back relative to the earnings we're generating, so the capital we're generating, less the dividends we're paying.

Then on a quarter-by-quarter basis we'll make a decision based on the environment, economy, credit environment, whether to go beyond that or not. And in the second quarter we decided to go a little bit beyond that.

I also wanted to ask Mary, as it relates to the credit leverage going forward. It sounded like the body language there was the provision could be flat to even negative going forward, if credit continued to improve. Mary, can you give a little more color around pace of credit improvement?

We're looking at this point more at the economic environment. Our credit quality remains relatively stable. We've seen improvement very definitely year-over-year. But it's anticipated that absent deterioration, we would continue to look at requiring a lower loan reserve.

Can the pace accelerate in terms of the decline?

I think you recognize our management style to be pretty measured and consistent, and we look to apply that to potential reserve releases.

Joe Morford, RBC Capital Markets.

Wondered if you could comment about the pipeline at period end in the commercial portfolio going into the third quarter? It sounds like a fair amount of the activity the past few months came from existing customers. Did you see an increase in line usage, as well?

A bit, but that wasn't anywhere near what made up the growth in outstandings. It was really a good amount of reinvestment back into our client businesses, a few transactions on top of that. We don't speak specifically to the pipeline, but I would say that activity, both on the C&I as well as on the commercial mortgage front, looked pretty good going into the second half of the year.

The other question was loans were up but investments were up, as well. I suspect tied to the growth in deposits. That looked really mostly coming from the public accounts. Just curious what term and rate you're paying on those or getting on that. And was there specific investments, purchases tied to that?

Yes, those are going to be pretty low-cost deposits. And there's an interplay between the wholesale funding and public deposits. Some of the public entities switch back and forth between those categories. Typically, the wholesale funding is 7 basis points to 8 basis points, something like that. The deposit costs are not going to be too much different than that.

Aaron Deer, Sandler O'Neill & Partners.

If I can follow up on Craig's line of questioning regarding the margin. I'm curious, given the shift in asset mix that you've had, what your expectations are for the margin going forward, and now that you're getting a little bit more traction on the loan side, if that mix improves enough to start seeing some stabilization or even improvement in the margin going forward. Or if there's any opportunity to reduce funding costs at this point.

The margin's really going to be a function of at least 3 variables -- the amount of liquidity that we're maintaining, the interest rate environment, and loan growth. We saw a little bit of growth in the second quarter. To the extent we can increase the composition of the loans versus investments, that will help.

And then the first point, which I made, was liquidity. To the extent we reduce any liquidity and put that to work on investments, that can also help. Having said that, we're working against a pretty tough rate environment. The environment has come down quite a bit.

For example, the 10-year Treasury, compared to when we last spoke in April, it's been down about 56 basis points or so. So it would be good to be able to maintain the margin, but we'll have to see how the environment develops. Certainly, the other 2 factors, liquidity and loan growth, can help.

But all else equal, it sounds like some of those environmental factors are offsetting, or more than offset your abilities on the other 2 fronts.

I'm not going to say more or less, but you can tell they're offsetting factors. It would be nice to be able to maintain the margin, but that's conditional upon the environment and what happens with loans and liquidity.

Now that we've got some clarity on the interchange rules, I'm curious. Historically, interchange fees have represented something like $6 million per quarter. I'm wondering what your thoughts are in terms of what that drops down to going forward.

And if that's all going to come in the fourth quarter or if we see some of that start to happen in the third quarter, or next year, how that plays out going forward.

The new rules take effect October 1, so it's really a fourth-quarter item. The exact impact to us is difficult to say. The rules really impact the cap and the actual rate is not known or finalized as provided by the network providers.

But having said that, probably the best way to think about it is on an annualized basis. We probably stand to lose between $12 million to $14 million in interchange revenue under the new arrangement. That's a lower number than I probably mentioned previously. I think we were talking about probably $18 million.

Annually.

On an annualized basis.

And you mentioned that as a revenue number. Are there associated costs that could also go down with that, that would help to offset the drop on the revenue side?

It's hard to say at this moment. Those are possibilities. But I'm just not prepared to say that at this moment.

Joe Gladue, B. Riley.

I'd like to drill down a little bit on the residential mortgage and home equity lines. With the increase in net charge-offs in those portfolios and it looks like there was an increase in 90-day past dues in some of those portfolios, as well. Wonder if you could give us a little more color on what the trends are there and what's driving them?

I think the issue becomes on a $3.1 billion portfolio when the numbers are running a $2 million, if we have a few more loans move one direction or the other, we'll see some swings quarter to quarter. Within those 2 portfolios, we're seeing really pretty stable performance. It reflects the unemployment rate that's remained at 6%.

If we look at our early-stage delinquencies in those 2 portfolios, they are down on a linked quarter $2 million, up year-over-year $1.4 million. It could be 2 or 3 loans that really swing it at this point. I think we'll see a little bit of that volatility quarter-to-quarter around those numbers, but pretty consistent, at least for the time.

While you mentioned it, I was going to ask about the early-stage delinquencies and overall total for that number. Where is the trend in that from first quarter to second quarter?

For the total portfolio, including commercial, it was $33.4 million in 2Q. That's down $2.8 million on a linked quarter and down $7.1 million year-over-year. Consumer makes up the bulk of that at $31 million; it's down $410,000 for a quarter basis, at $1.9 million year-over-year. And out of that $31 million, home equity and consumer make up $22.6 million.

In the other non-interest expense line, of course the $9 million settlement was in there. But after removing that, it looked like there was about a $1.7 million decline from first quarter to second quarter. Was there any specific thing driving that?

We had, had an operating loss in the first quarter that was a little bit higher than usual and we didn't see that in the second quarter.

Erika Penala, Bank of America - Merrill Lynch.

My first question is on the run rate for your overdraft fees. Is the shift in overdraft policy already reflected in your previous guidance of down $14 million year-over-year when you're talking about the annualized run rate?

Let me give you the facts on this. Our overdraft income in the second quarter was $5.1 million. In the equivalent period last year it was $10.1 million.

And that's fully reflective of the shift in overdraft policy?

Yes.

Was there anything unusual in the fees exchanges and other services line? I notice that it was $16.7 million this quarter, and that was running a little bit lower for the previous 2 quarters. Was there something unusual there or is that a run rate that could carry out for the remainder of the year?

There's a little bit higher in the debit card income. We received about $900,000 of a profit sharing income amount that probably wouldn't be expected to go forward.

And also, Peter, I just wanted to ask about some of your comments with regards to looking at the pipeline for the second half of the year. You mentioned that there were some deals and reinvestments back to the businesses that your clients were doing in the second quarter. Do you think that this type of reinvestment could continue at this same pace? I'm asking, indirectly if the C&I loan growth that we saw this quarter is something that we could expect to continue for the next 2.

I think that the likelihood is that there will be a little more balance between commercial mortgage and C&I. I think C&I lending was up over 5% for the quarter, so that's probably not sustainable. Just a great quarter for the corporate folks.

But commercial mortgage was uncharacteristically off in the quarter. So I think the combination of the 2 should give us a pretty reasonable outcome in the next couple quarters.

Jeff Rulis, D.A. Davidson.

Peter, just a quick follow-up on that comment. I was going to ask about the commercial mortgage actually showing net runoff in the quarter. So just a timing issue or was anything reclassed there?

We had a couple of large mortgages come off right at the end of the quarter. And we had been going back and forth on these pieces of business, obviously trying to retain them, but in the end lost them to institutional providers. And that's what happened in the quarter.

And then on the margin, do you have monthly averages for the NIM?

We don't provide monthly results.

Jackie Chimera, KBW.

I missed this in your prepared remarks. You said that the direct flights from China into Honolulu were going to start sometime in the next quarter?

Yes.

And has the Hawaii Tourism Authority done any projections on what kind of an increase we're going to see in visitor arrivals following that?

From China?

Yes.

I think the anticipation for this year is 88,000.

And then I can't remember the exact terminology, but the ATM-like machines that you have in place with the partnership that you have, will that provide any benefit to the Company?

You're talking about our affiliation with China UnionPay, which is the largest card provider in China. What that relationship is about is helping China UnionPay improve their brand here on the islands. They anticipate that Chinese visitors will become an increasingly significant part of the visitor segment here in Hawaii. And what they're doing is helping us with marketing resources.

Other than what we traditionally earn through our ATM networks on international transactions, there's no special provision there. But they are helping us to build out our Chinese capabilities in the electronic banking space.

So more an advertising, marketing benefit than income item.

Right.

And then just as a follow-up to someone else's question, I'm not sure who asked it, but you said that there's a few large mortgages that have come off at the quarter. I know that in the mainland we're seeing a lot of competition from some larger institutions that are getting into spaces that they may not traditionally have been into, just because of smaller loans.

Are you seeing that in Hawaii at all, any pressure on commercial pricing because of that? I know they're not really involved in your market at all but I'm just wondering if that had anything to do with it.

I think that those institutions that you're talking about, we've seen down as low as, call it, $20 million. So I guess that trend continues. We've not seen them, at least as of yet, dip below into the more middle market segments.

So it's a non-issue for you then, right now?

Yes, I hope so.

(Operator Instructions). Casey Haire, Jefferies.

One more question on the margin. Regarding the new loan production this quarter, can you give us a sense of what yield that came with relative to the 492 on average?

I can't break that out for you, but it's going to be typical of the composition you see on average for the period.

Any sense on the securities yield?

As I mentioned, the reinvestment rates are lower today than they were 3 months ago. So that is a tough interest rate environment to get the same yield today as you got several months ago.

And then just lastly, the FDIC insurance, that's down due to the new calculation?

Yes.

Is that a good run rate going forward or is there some more bleed?

I think that the figure for this quarter is pretty typical of what we're going to see into the future.

Bryce Rowe, Robert W. Baird.

I just wanted to follow up on the debit interchange question. Are you guys contemplating any deposit product changes to offset that lost revenue?

We are contemplating potential changes to pricing and promotion and features. Although, frankly, we've just not come to any conclusion on what to do with that, if anything.

There are no further questions in the queue. I would now like to turn the call back over to Management for closing comments.

Thank you, Fab. I'd like to thank everyone for joining us today and for your continued interest in the Bank of Hawaii. As always, if you have any additional questions or need further clarification on any of the topics we discussed today, please feel free to contact me. Thanks, everyone. Have a great day.

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