Bank of Hawaii Corp (BOH) 2012 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Bank of Hawaii third quarter 2012 financial results conference call. My name is Towanda, and I will be your coordinator 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 Ms. Cindy Wyrick, Director of Investor Relations. Please proceed, ma'am.

Thank you Towanda, and good morning everyone. Thank you for joining us today. Also with me this morning is our Chairman, President and CEO, Peter Ho; our Vice Chairman and Chief Financial Officer, Kent Lucien; and our Vice Chairman and Chief Risk Officer, Mary Sellers. The comments today will refer to the financial information included in this morning's earnings announcement. 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, and now I'd like to turn the call over to Peter Ho.

Great. Thanks Cindy. Good morning everyone, and thank you for joining us this morning. Third quarter 2012 was another solid quarter for Bank of Hawaii. Fully diluted earnings per share and return on average assets were up for the quarter on a linked basis. Our average loans grew in nearly all loan categories, and our end-of-period performance was even better. Average core consumer and commercial deposits were up in the quarter, and our consumer checking count grew 6% for the third quarter. Risk metrics continued to improve across a number of indicators, and we see the economy continuing its move to the better here in Hawaii, and I'll chat a little bit about that towards the end of our comments. As is our practice, I'm going to ask Kent to review our finances for the quarter, and then I'll ask Mary to comment on credit quality that we saw in the quarter. So let me turn it over to you, Kent.

Thank you, Peter. Good morning. Net income for the third quarter was $41.2 million or $0.92, per share, compared to $40.7 million or $0.90 per share in the second quarter and $43.3 million or $0.92 per share in the third quarter of 2011. Our return on assets in the third quarter was 1.22% and return on equity was 16%. Year-to-date net income was $125.8 million, or $2.77 per share, compared to $120.8 million or $2.54 per share in 2011. Year-to-date return on assets was 1.23%, and return on equity was 16.5%. Our year-to-date efficiency ratio was 57.8%, a reduction from 58.9% in 2011. Our net interest margin in the third quarter was 2.98%, unchanged from the second quarter and down from 3.09% in the third quarter of 2011.

Year-to-date the net interest margin was 3.01%, compared to 3.16% last year. The lower margin is due mainly to the lower interest rate environment. There was no credit provision in the third quarter, compared to $628,000 in the second quarter and $2.2 million in the third quarter of 2011. The allowance decreased by $1.5 million in the third quarter, which equaled net charge-offs. The credit provision for the second quarter included net charge-offs of $3.8 million and a $3.2 million decrease to the allowance. Our allowance for loan and lease losses at the end of the third quarter was $131 million, or 2.3% of outstanding loan and leases. Non-performing assets were $40.3 million at the end of the third quarter, and represented 0.70% of loans. Included in non-performing loans are $25.5 million in residential mortgage loans as of the end of the third quarter.

Non-interest income for the third quarter was $52.4 million compared to $46.8 million in the second quarter and $50.9 million in the third quarter of 2011. The increase compared to the second quarter was primarily due to an increase in mortgage banking income. Year-to-date non-interest income was $147.3 million compared to $154.2 million in 2011. The decrease was primarily due to lower debit interchange revenue as a result of the Durbin Amendment, and $6.1 million in securities gains in 2011, partially offset by an increase in mortgage banking income. Non-interest expense totaled $84.9 million in the third quarter, compared to $80.7 million in the second quarter and $84 million in the third quarter of 2011.

The increase compared to the second quarter was primarily due to the launch of our new consumer credit card, higher profit-sharing and bonus accruals, and higher separation expense. Year-to-date, non-interest expense was $250.8 million compared to $263.8 million in 2011. The effective income tax rate was 32.6% in the third quarter, compared to 33% in the second quarter and 29.6% in the third quarter of 2011. The lower rate for the third quarter of 2011 was primarily due to a $1.8 million release of valuation allowance related to low income housing investments. Our investment portfolio now stands at $6.6 billion, and we have unrealized gains in the portfolio of $201 million. The average duration of the available for-sale portfolio is 2.26 years, and overall portfolio duration is 2.39 years.

Loans were $5.8 billion at the end of the third quarter, up $111 million compared to the end of the second quarter, and up $434 million from the end of the third quarter of 2011. Deposits were $11.2 billion at the end of the third quarter, down $327 million compared to the end of the second quarter and up $1.2 billion from the end of the third quarter of 2011. The decrease compared to the second quarter was due to a reduction in government deposits. Our shareholders' equity was $1 billion at the end of the third quarter, and we paid out $20.3 million in dividends, and continued our share repurchase program in the third quarter, repurchasing 313,000 shares of Common Stock, or $14.5 million.

Because our balance sheet is slightly smaller and we retained some earnings, our Tier 1 leverage ratio increased to 6.8% from 6.6% at the end of the second quarter. On a year-to-date basis, share repurchases and dividends have totaled $126 million, which represents approximately 100% of year-to-date net income. Last Friday our Board declared a dividend of $0.45 per share for the third quarter. Our capital position remains strong, and at the end of third quarter, our tangible common equity to risk weighted assets was 17.4%, and now I'll turn the call over to Mary Sellers.

Thank you, Kent. Net charge-offs for the third quarter totaled $1.5 million, or 10 basis points of average loans, down $2.3 million on both a linked quarter and year over year basis. The decreases were primarily due to reductions in consumer net charge-offs, mainly in residential mortgage and home equity. Non-performing assets totaled $40.3 million at quarter end, compared to $41.5 million at the end of the second quarter and $37.8 million at the end of the third quarter of 2011. Residential non-accrual assets accounted for $25.5 million of the total at quarter end. The level of non-performing assets continues to be impacted in the near term by the longer resolution time frame for residential assets.

Loans past due more than 90 days and still accruing interest totaled $7.5 million, up $307,000 on a linked quarter basis and down $3.4 million year over year. The year over year decrease was due to a $3.7 million reduction in residential mortgage. Restructured loans not included in non-accrual loans or loans past due 90 days or more totaled $31.4 million at quarter end, up $302,000 from the prior quarter, primarily due to an increase in residential mortgage loan modifications. Residential mortgage and home equity loans past due more than 30 days but less than 90 days and still accruing interest totaled $21.6 million at the end of the quarter, up $4.5 million on a linked quarter basis and down $7.7 million year over year.

We continue to see improvement in what we consider to be the higher risk segments in our portfolio. In total these higher risk segments were down $2.3 million for the quarter and $13.1 million year over year. We previously included a segment of our residential homebuilding loans in what we considered and reported as higher risk; however, this segment has significantly decreased, and currently represents total exposure of less than $3 million. Accordingly, we no longer include these loans. We recorded no provision for loan and lease losses in the third quarter, which given net charge-offs of $1.5 million reduced the allowance to $131 million or 2.27% of outstanding loans and leases. With continued improvement or stability in the economy and credit quality, we anticipate that we may require a lower level of allowance going forward. I'll now turn the call back to Peter.

Great. Thank you, Mary. I mentioned earlier that the economy continues to improve in our core Hawaiian market. Let me give you some color around that. The visitor industry, which you all know is a very important segment of our overall economy, continues to perform very well. Arrivals year-to-date are up 10%. Spending is up 20%, and most of that growth is coming from the international segments. RevPAR and occupancy levels on Oahu are approaching pre-crisis levels. Our housing market continues to improve, the trend is positive there. Median home prices on Oahu are up 8.8% and inventory is now down to 3.3 months. We see neighbor island housing stock beginning to stabilize as well. Finally unemployment here in Hawaii is roughly 2 points better than that of the national average at 5.7%, and now we would be happy to respond to your questions.

Thank you.

(Operator Instructions)

Your first question comes from the line of Craig Siegenthaler with Credit Suisse.

Thank you, good evening.

Hi, Craig.

I just want to talk about the sustainability of your commercial growth. Really strong C&I and commercial real estate growth here. Can you talk about how sustainable that is kind of heading into the fourth quarter, because also some of your peers have talked about slowing commercial demand, really looking forward at the fiscal cliff, and potentially looking to come out of the election, too.

Well, we've seen strong commercial performance for a few quarters now. It's always tough because of the size of some of these loans to make predictions on a quarter-by-quarter basis, but I'd say directionally, we remain pretty optimistic that we can continue growth in the commercial segment. Really, our strategy has been to fill the void open by a lot of the monoline and national lenders that seem to have disappeared post-financial crisis, and we're also making a pretty big emphasis into what we would perceive to be kind of the mom-and-pop middle market here in the islands. They are having reasonably good traction in that segment.

Got it, and then just on a follow-up, if I look here at your reserve at around 2.3%, very high, one of the highest in my coverages, but your charge-offs are very low. Could we see the reserve drift materially lower here, or are you going to keep it at a higher level than most of your peers for longer here?

Well, as you know, we evaluate that every quarter, and I think you'll see a directionally consistent movement with the quality of our portfolio and the economy.

Got it. Since the quality is good and the economy is pretty strong relatively, do you think that could go lower?

I would agree.

It's possible.

Guys, thank you for taking my questions.

Yes, take care, Craig.

Your next question comes from the line of Ken Zerbe with Morgan Stanley.

Thank you. Just had a question on capital deployment. I know you guys have been pretty consistent with buybacks over the last several quarters, but it seems like, I think it was the last three quarters, buybacks trending a little bit lower than what they were prior to the last three quarters. Would you mind kind of, I guess, reiterating your philosophy on buybacks. I don't know if you can put any kind of magnitude in with your thought process, but that would be helpful.

Sure, Ken. Our philosophy is to return as much capital as we can reasonably return to the shareholders through dividends and buybacks. Obviously we need to retain enough capital for the business and the growth of the business, but as I mentioned in my comments we're right around 100% between dividends and repurchases, 100% of earnings on a year-to-date basis. So I think we've achieved that philosophy of returning as much capital as we can. Earlier in the year we had been in excess of 100%, and then we moved to 100%, and then here in this last quarter, a little bit less than 100%, but over the period, as I said, 100% of earnings.

Okay, that helps. I was probably shooting for 100% per quarter, but full year makes a lot of sense. The other question I had, just in terms of mortgage banking, was there anything that surprised you, because I think last quarter, or at least heading into this quarter, it felt like you were a little more cautious on mortgage banking. So certainly the results this quarter surprise to the upside, and I was wondering what changed in your view between then and now?

Well, we've been surprised now for about three years running, and just about every time we're about to declare that we've just seen the last refi boomlet, we see another refi boomlet, and I think the most recent one, driven by the Fed's most recent quantitative actions. So it was a nice surprise for us. I'm not ready to say that we won't see that again next quarter, or next year, but we'll see what happens out there in the rate environment.

But there's nothing that would actually make your results materially different from, let's call it the average bank?

No, I don't think so.

Perfect. Thank you very much.

Thank you.

Your next question comes from the line of Joe Morford with RBC Capital Markets. Please proceed.

Thanks. Good morning everyone.

Good morning, Joe.

I guess I was curious how much of the $1.5 billion of public and other deposits is specifically this public time, and how much more run-off are you looking to do, and related to that, I guess, what plans do you have for further shrinkage of the balance sheet?

Well that's going to vary from quarter to quarter, and it's a function, really, of the investment opportunities that we have. So to the extent that opportunities are limited, we're not likely to increase that category. On the other hand, to the extent we have some investment opportunities, or to the extent loan growth is increasing, then that category may actually increase. So a little bit of variation from period to period, and that's exactly what happened here in the third quarter.

Okay, that's helpful. Then just can you maybe talk about what kind of impact did MBS prepayments have in the quarter versus last quarter, and just overall how you feel about your ability to continue to hold the margin around this 3% level?

Yes. The run-off, which is really a function of MBS prepay speeds, it was $522 million in the quarter, and in the second quarter, that same figure had been $452 million. So prepaid speeds were higher in the third quarter. If we had reinvested at the same level as the run-off, we would have seen a lower margin, just because the reinvestment opportunities are lower as a function of the interest rate environment.

Okay, and then just more broadly speaking then, just holding this 3% level given your outlook for loan growth and the current investment opportunities you're seeing?

I think it's going to be a function of rates. We've seen rates come down. Most recently we've seen rates come down specifically into the mortgage-back space, which as you know, is an area that we've been reasonably active in. So I put great kudos to the team for maintaining the margins that we've been maintaining, but I think ultimately you've got to look at the broader rate environment to get a sense for what we're looking at moving forward.

Okay, that's helpful. Thanks.

Yes.

Your next question comes from the line of Aaron Deer with Sandler O'Neill & Partners. Please proceed.

Good morning, everyone.

Good morning, Aaron.

Following up on kind of Joe's question with respect to margin and outlook. One of the items in the quarter was the repos. Looks like the cost of those came up quite a bit with the balances coming down. I'm just wondering what remains in there, what's kind of the average term, and what are your thoughts with letting that come down further as a funding source?

Yes, so when the short-term rolled off in the period, those obviously would have been at the lowest rate, and so the remaining repos are really the private term repos, and so you saw that the average rate went up to 3.3% in the category. So those still have, and I forget the actual figure, but they still have several years left of term on them.

Okay, and then did non-interest DDA, looked like those were also down in the quarter. I'm just wondering, were those balances then tied also to the municipal CDs, or what do you suppose drove that lower in the quarter?

Non-interest DDAs, I'm looking at average balances were up 2%. This is overall demand in business on average, and up 1% in consumer on average. End of period business demand, you're right were down about 1%. So I think, Aaron, that it's just kind of a natural spikiness in the commercial portfolio that drove that, but nothing directional.

Okay, fair enough and then was there any mortgage sales in the quarter that would have impacted your mortgage number this quarter?

You mean specials?

No, in terms of were there any gains on mortgage sold?

You mean on securities?

Well, on mortgages specifically. I mean, everything was retained that you originated during the quarter?

No. Virtually all of the saleable conforming mortgages were in fact sold in the period. We had a little bit higher level of retained mortgages in the second quarter as compared to the third quarter, but the vast majority of what we produced that were saleable were in fact sold.

Okay, and then how was the pricing on that better at this quarter relative to last quarter as well?

The pricing has improved.

Okay, thanks for your help.

Yes.

Your next question comes from the line of Casey Haire with Jefferies. Please proceed.

Hi, good morning guys.

Good morning.

Just a question on the expense side of things. I know you guys had some efficiency initiatives that you guys working on. Just wondering if you could give us some updated commentary as to where they are. I saw $1 million of severance this quarter. Can we expect some leverage in the comp line? Just trying to figure out where you guys are in that process.

Yes. The process continues. I think we're making good progress on the initiatives that are under way. They are really multi-year initiatives. You probably notice that occupancy expense, for example, came down in the period. We would expect that trend to continue. So I think that the general effort and results of improving efficiency is something we're going to continue to work on, and we would expect to see going forward.

So, I mean, you guys think you guys can improve from your efficiency ratio this quarter, even in the tough revenue environment?

Well, the ratio itself obviously is tricky, because the revenue can change as a function of the environment, but the absolute dollars, as compared to this period, as I mentioned in my comments, we did have some, let's call it one-time expenses that you wouldn't expect to see going forward. So that would include the startup of the credit card business. I mentioned that we increased some of our bonus accruals and the severance item.

Okay, and just so on the credit card product, can you talk about how much investment is left on that launch process, and then longer term what you ultimately expect that business to grow to be?

Yes. So the period, we had about $800,000 of expenses. We have some more, but not of that dimension into the fourth quarter, and the outlook for the business, maybe Peter can comment on that.

Sure. Well we're moving at a measured pace on the credit card rollout. We're really excited to have that as part of our product suite, but it's a new product, or a product that we haven't had in our arsenal for about a decade now. We're working the kinks out operationally, we're working the kinks out from a marketing standpoint. I'd like to accelerate that in the coming quarters. In terms of opportunity, when we had this portfolio previously, it was a significant consumer portfolio for us. So over a period of time, a good period of time, we would anticipate that we could rebuild to that level again.

Okay, thank you.

Your next question comes from the line of Brett Rabatin with Sterne, Agee. Please proceed.

Hi, good morning.

Good morning.

Wanted to go back to mortgage banking. I was wondering if you could comment on just the growth of that platform, how much you invested in it. Obviously it's driven today by a lot of refi activities, we're thinking about 2013, and if you just use the MBA forecasts, what proportion is purchase versus refi, and maybe you can give us any color on what you've done to grow that platform to give us some idea of what '13 might look like?

Well, it's a good question, Brett. That business has always been a major thrust for the organization. I think that our volume has been advantaged by the complexion of the market of recent. It's much more of a refi market than a purchase market, which I think benefits us different from some competitors in the marketplace. We do not have strategic relationships with the realty brokerage community, but we do have an awful lot of embedded customers who have been able to take advantage of lower rates. So that's been beneficial to us. We've had the benefit of having a very stable leadership team and salesforce, which obviously is accretive to any high volume environment, and that's exactly what we've been through the past couple of years.

So the market, and the drivers of the market, I think have played well to our strengths. Moving forward, one, I think fundamentally we have to assess what the probability is that we are going to see enough rate erosion to create another spark in refinance activity. Our sense is probably not, and probably as the housing market heats up here in the islands, or it gets better here in the islands, proportionately you're going to see more purchase activity than refi activity, and that doesn't necessarily play to our sweet spot. So I'm somewhat heartened by the results, and I think we've got a great platform, but I think things will align pretty well to get us there. As we think forward we may not be able to maintain that level of activity.

Sure, okay. That's good color, and then wanted to ask Peter on the commercial real estate portfolio, you had good growth in that business. Can you just talk about what you're seeing in terms of rate and terms out there? Is that platform still being able to grow because of a dearth of competition, or is that more a function of activity increasing?

I think several quarters ago I would have said a dearth of competition. I think that what's happening is the national segment is still not present in the market, and on top of that we're beginning to see a fair amount of activity, and more than people just nibbling around the edges from a transaction standpoint. There remains a big segment of resort and hotel inventory that was moved to problem loan status through the crisis that will represent future opportunity as we move forward as those assets reprice and those assets hopefully fall into quality relationships of the organization, of our organization. So we feel pretty good about that, and I said earlier that we think the commercial lending represents pretty good opportunity for us moving forward.

Okay, great. Thanks for all of the color.

Yes.

Your next question comes from the line of Joe Gladue with B. Riley.

Hi, good morning.

Good morning.

First off, just wanted to touch base. The other non-interest income line was up, I guess, almost $2 million, pretty substantial margin from the -- compared to second quarter. Just wondering what that was.

So the mortgage banking results were quite a bit better in the third quarter as compared to the second quarter. So in the third quarter the income was $11.7 million and in the second quarter had been $7.6 million. So that's the major source of the difference between the two periods.

Well, yes, but in just the catch-all other non-interest income category, that was up to about $6 million.

I see, I understand your question now. Yes, we did have some bank-owned life insurance income in the third quarter that we did not have in the second quarter. That was merely a function of some anniversary periods that we had achieved, and so the income in that category was higher than the second quarter, but it was not a huge amount.

Okay, and I guess I want to go back a little bit to the deposits, just want to make sure I understand. I'm showing that period end non-interest bearing deposits were down almost 4%, about 3.9%. I know you said that business DDAs were down 1%. Were part of it the public funds in non-interest bearing accounts, or was there anything else going on there?

I'm looking at demand both interest bearing and non-interest bearing down $16 million in business, up $22 million in consumer. That's on a period end basis and positive on an average basis. So I think that may be and, Kent is looking at a number now, but that may be in our institutional segment.

Okay, because, yes, I guess I'm showing period end being down about $120 million from $3.1 million to $2.9 million.

Yes, there was a decrease in the public non-interest deposits of about $75 million.

All right. That clears that up. All right, that was all I had. Thanks.

Okay, thanks.

Your next question comes from the line of Jeff Rulis with D.A. Davidson. Please proceed.

Hi, this is Samonas, filling in for Jeff.

Hi there.

I just had a quick question on the mortgage activity, and if it's continued into the fourth quarter.

Activity has certainly continued into the fourth quarter.

Okay, and how can we look at the expenses from the increase in activity from what you were expecting?

Expenses relating to mortgage activity in particular?

Yes.

Well we're going to see obviously higher commission expense. We're also going to see higher overtime expense in salaries as a result of the processing to the tune of several hundred thousand dollars is probably the anticipation.

Okay, thank you, and then just a quick question on the earning asset mix. I see that you've reduced your securities portfolio by quite a big amount. I was just wondering if you could give some color on where the reduction, what type of securities it came in, and what a target mix of securities the earning assets might be for you going forward?

Yes. So most of the reduction would have been in the Ginnie Mae category. Ginnie Maes are about 75% of the portfolio, and so that's a typical mix for us. It could be a little bit of fluctuation, but that's pretty much the way to look at it.

Okay, that's all for me. Thanks.

Thank you.

Your next question comes from the line of Jacque Chimera with KBW. Please proceed.

Hi, good morning everyone.

Hi, Jacque.

I just had a quick question as it relates to the OCC guidance that came out. I realize this is probably not material for you, but just looking at the consumer loans and the treatment of Chapter 7 bankruptcy filings when those loans are performing, how does that affect you?

Hi, Jacque. We've already accounted for that in our current policy on charge-offs.

Okay. So there's already procedures in place for bankruptcy filings and no effect whatsoever from the new guidance?

Yes.

Okay, great. That was my only question, thank you.

Thank you.

(Operator Instructions)

Your next question comes from the line of Russell Gunther with Banc of America Merrill Lynch. Please proceed.

Hi, good morning.

Hi, Russell.

So question for me back on the expenses. I appreciate the color that you gave. In light of the fact that of the efficiency initiatives you're working on are multi-year initiatives, absent the $1 million pickup from the separation expense this quarter, would 3Q be a good run rate for the near term or would you expect any incremental volatility in the fourth quarter?

Well, I think we've touched on a number of things that could move that, including mortgage activity and that type of thing, but if you take that out and you adjust for the credit card start up which I mentioned was about -- the delta was about $800,000, it's a good starting point. Obviously to the extent initiatives are accumulating, the forward numbers are going to be different than that base. Once you make those adjustments, it's a pretty good base.

Okay, and so would you expect then, based on where you are within those efficiency initiatives then, that there would be some offset to that run rate?

Yes, I think that part of the challenge is there's usually some upfront cost to every efficiency initiative, so it's tough to give you a quarterly run rate, so we may well have future severance expense costs that will eat into achieved efficiencies. There's also some seasonality behind the accrual of bonuses for us, because generally, we tend to set our bonus levels at some fraction of what we hope to pay out during the year based on what we see inter-year in terms of performance. So that number may or may not just kind of bounce around moving forward.

Okay. So if I understand, or do I understand this, so the seasonality would have been this quarter, then from the bonus accrual?

Yes, that's correct.

Seasonally higher, okay, great. I appreciate the color there, and then just lastly back on the commercial loan growth, your comments on starting to see increased activity. Is that relating to the resort and hotel sector, or other sectors where you're seeing that, maybe just talk to where that pickup's coming from.

We are seeing a level, a reasonable level of resort hotel transactional activity that definitely play into our growth numbers, but we're also seeing just an overall pickup in general business activity, which is fueling both the commercial mortgage as well as C&I portfolios down into our middle market sector.

Okay, great. Thanks guys.

Yes.

Your next question comes from the line of Brian Zabora with Stifel Nicolaus. Please proceed.

Thanks, good morning.

Hi, Brian.

A question on residential mortgage loan yields. They were pretty flat in the quarter, still pretty strong at [4.70%]. Refinance activity is picking up. Do you see that still maintaining around a [4.70%], or could we see that decline in coming quarters?

It's possible for that number to decline with the generally lower rates, and mortgage spreads in particular are tightening. So longer term, it's possible that that yield could also come down.

Okay. Was there any prepayments this quarter that helped the margins in the third quarter, just on residential mortgage loan yields?

Not that I'm aware of.

Okay, thanks for taking my question.

With no further questions, I would now like to hand the conference over to Ms. Cindy Wyrick for closing remarks.

Thank you 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 discussed today, please feel free to contact me. Take care and have a great day.

Thank you for joining today's conference. That concludes the presentation. You may now disconnect and have a great day.