Bank of Hawaii Corp (BOH) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the first-quarter 2013 Bank of Hawaii Corporation earnings conference call. My name is Philip and I will 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, Ms. Cindy Wyrick, Director of Investor Relations. Please proceed.

Thank you, Philip, and good morning, everyone. Thank you for joining us today as we review the financial results for the first quarter of 2013.

Joining me this morning is our Chairman, President, and CEO, Peter Ho; our Vice Chairman and Chief Financial Officer, Kent Lucian, and our Vice Chairman and Chief Risk Officer, Mary Sellers. 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 call will contain some forward-looking statements. And while we believe our assumptions are reasonable, there are a variety of reasons that actual results may differ materially from those projected. And now I'd like to turn the call over to Peter Ho.

Thanks, Cindy. Aloha, everyone. And thanks for listening in this morning. The continuing low rate environment provided for a challenging first quarter for Bank of Hawaii. As Kent will expand on shortly, our spread income was negatively impacted by lower reinvestment rates, noninterest income compared to the prior quarter was impacted by lower gains on sale levels, and lock activity in our residential urgent mortgage business, both of which were at exceptionally high levels last quarter.

Likewise, loan levels in Q1 were negatively impacted by refinance activity in both our residential mortgage and home equity portfolios. Certain other portfolios experienced what I would term modest growth.

Expenses were higher versus the prior quarter, resulting from normal seasonal elements and higher severance costs. On the positive side, average core consumer and business deposits continue to grow, capital levels remain robust, and credit quality, already a strong point for us, improved even further. And now let me turn the call over to Kent.

Thank you, Peter. Good morning. Net income for the first quarter was $36 million, or $0.81 per share, compared to $40.3 million, or $0.90 per share in the fourth quarter, and $43.8 million, or $0.95 per share in the first quarter of 2012. Our return on assets in the first quarter was 1.08% and the return on equity was 14.1%. Our net interest margin in the first quarter was 2.82% compared to 2.87% in the fourth quarter and 3.06% in the first quarter of 2012. The lower margin was primarily due to continued reinvestment in lower yield securities in our investment portfolio and relatively high premium amortization. The investment portfolio reinvestment differential was 101 basis points in Q1. Premium amortization was $16.5 million, compared to $14.1 million in Q1 2012.

There were no credit provisions in the first and fourth quarter compared to $0.4 million in the first quarter of 2012. Our allowance decreased by $2 million in the first quarter and by $2.1 million in the fourth quarter, which equaled net charge-offs for the respective quarter.

The credit provision for the first quarter of 2012 included net chargeoffs of $3.4 million and a $3 million decrease to the allowance. Our allowance for loan and lease losses at the end of the first quarter was $126.9 million, or 2.2% of outstanding loan and leases.

Noninterest income for the first quarter was $47.8 million compared to $53 million in the fourth quarter, and $48.1 million in the first quarter of 2012. The decrease compared to the fourth quarter was primarily due to a decrease in mortgage banking income.

First-quarter mortgage applications compared to Q4 2012 were down 7%. Lock loans were down 21% and the gain rate on lock loans was down 32%. Mortgage results were lower compared to Q4 2012, which was exceptional, but 25% ahead of Q1 2012. Noninterest expense totaled $84.4 million in the first quarter compared to $83.5 million in the fourth quarter and $85.2 million in the first quarter of 2012. The increase compared to the fourth quarter was primarily due to seasonally higher payroll taxes and 401(k) contributions associated with incentive, compensation accrued in 2012, and paid in the first quarter of 2013, and an increase in separation expense. The decrease compared to the first quarter of 2012 was primarily due to $1.2 million for our personal computer refresh program and lower net occupancy expense, as well as most other expense categories.

The effective income tax rate was 30.7% in the first quarter compared to 32.7% in the fourth quarter and 27.6% in the first quarter of 2012. The lower rate in first quarter of 2013 was primarily due to a lower level of pretax income and a relatively high level of low income housing credits. The lower rate in first quarter of 2012 was primarily due to a $2.7 million credit related to the sale of our equity interest in two leveraged leases.

Our investment portfolio now stands at $6.9 billion and we have unrealized gains in the portfolio of $145 million. The average duration of the AFS portfolio is 3.01 years and overall portfolio duration is 3.23 years.

Loans were $5.8 billion at the end of the first quarter, down $72 million compared to the end of the fourth quarter, and up $184 million from the end of the first quarter of 2012. Our mortgage loan portfolio decreased $74 million in Q1 as we sold all qualifying, salable mortgages produced in the period.

Deposits were $11.3 billion at the end of the first quarter, down $278 million compared to the end of the fourth quarter and up $631 million from the end of the first quarter of 2012. The lower deposits were mainly public deposits.

Our shareholders equity was $1.026 billion at the end of the first quarter, and we paid out $20.2 million in dividends, and continued our share repurchase program in the first quarter, repurchasing 137,000 shares of common stock worth $6.6 million. Our Board declared a dividend of $0.45 per share for the first quarter.

At the end of the first quarter, our tangible common equity to risk-weighted assets was 17%, and our Tier 1 leverage ratio was 6.9%. And now I'll turn the call over to Mary Sellers.

Thank you, Kent. Net charge-offs for the first quarter totaled $2 million, down $135,000 on a linked quarter basis and down $1.4 million year over year. The year-over-year improvement was primarily driven off a $1.7 million decrease in residential mortgage and home equity net charge-offs.

Nonperforming assets totaled $38.4 million, up $1.3 million from the last quarter and down $3 million year over year. The linked period increase was primarily due to a $3 million increase in residential mortgage nonaccrual loans. We continue to expect the level of nonperforming assets to be impacted in the near term, due to the longer resolution timeframe for residential assets.

At quarter end, loans past due 90 days or more and still accruing interest totaled $11.4 million, up $1 million on a linked quarter basis and $1.3 million year over year. The link period increase was due to a $1.8 million increase in home equity, which was partially offset by a $900,000 decrease in residential mortgage. Restructured loans, not included in nonaccrual loans or loans past due 90 days or more, totaled $30.1 million at quarter end, down $1.8 million from the prior quarter and up $526,000 year over year.

Residential mortgage loans modified to assist our customers in retaining their homes accounted for $19.6 million of that total at the end of the quarter.

We continue to see improvement in what we consider to be the higher risk segments in our portfolio. In total, these segments were down $783,000 for the quarter and $4.6 million year over year. And as Kent shared with you, we recorded no provision for loan and lease losses in the first quarter, which given net charge-offs of $2 million, reduced the allowance to $127 million, or 2.19% of total outstanding loans and leases.

Absent significant deterioration in the economy and with continued improvement or stability and credit quality, we continue to anticipate requiring a lower level of allowance going forward.

I'll now turn the call back to Peter.

Great. Thanks, Mary.

As I mentioned at the start of the call, our operating results continue to be negatively impacted by the low rate environment. This impacting spreads and, in some respect, altering how we would otherwise manage our loan portfolios.

Our sense, however, is that the likelihood of extended lower rates will diminish in correlation with improved economic activity at the national level. As that occurs, and as rates rise, we intend to be positioned to profit from it.

The Hawaiian economy continues to be a bright spot, and we believe strengthening construction activity led by growing housing demand and continued strength in the visitor industry will more than offset federal spend limitations and defense issues. Unemployment in Hawaii is now down to 5.1% statewide and 4.6% on Oahu.

Housing inventory is below three months, active listings right now are 20% lower on a year-on-year basis. The number of housing projects, however, are projected to begin construction within the next year. Visitor spending and arrivals are comping strongly against comps that were already in themselves quite impressive last year.

In short, we think the longer view remains impressive. As we work to that point you can count on Bank of Hawaii to focus on three things.

First, we will manage our risk, both credit and market, in a balanced and prudent manner. We will not put short-term temptations ahead of the long-term health of our 116-year-old franchise. Secondly, we will continue in our quest to thoughtfully improve efficiency throughout the organization. To give you some perspective, first-quarter noninterest expense, net of severance cost, was nearly $2 million lower than that of the first quarter 2012, and nearly $2.5 million lower than that of the first quarter of 2011.

Finally, we will accelerate our efforts to meaningfully improve what is already a world-class franchise in Bank of Hawaii, with thoughtful effort around improved customer service, improved utility in our products and services, and greater ease of use for our most important clients.

And now we'd be happy to take your questions.

(Operator Instructions). Joe Morford, RBC Capital Markets.

Thanks. Good morning, everyone.

Just wondered if you could comment on the mortgage origination pipeline at period end, and then also just what kind of mix you are seeing between refi activity and purchase, and are you expecting much of a further drop in gain on sale margins from first-quarter levels?

Joe, as to the gain, that has started to flatten out a bit here. It definitely came down during the first quarter, but it's starting to flatten out a little bit at this moment. Now, that's obviously subject to change, but that's what we are seeing right now.

On the composition, there is a bit more of a portfolio down as compared to salable. At the end of the period, there was about 36% portfolio and it had been 26% earlier. So I think refis are becoming a little bit less a part of the composition, the -- and the apps, those are also starting to flatten out a bit. So I think I quoted 7% decrease in Q1 versus Q4. That seems to have flattened out. But it's pretty early in the period. So I don't know if that's definitely a prediction at this moment.

Okay. But it's certainly helpful. I guess my follow-up would be, you gave the premium amortization number for the quarter of $16.5 million. I'd be curious what or how that compared with the fourth-quarter number and are you seeing any discernible change in the underlying trends here, particularly given that mortgage banking activity seemed to slow a fair bit in the quarter?

Yes. Q4 was nearly the same number so it's right around $16.5 million in Q4. And since such a large portion of the portfolio is mortgages, the amortization will really depend on how pre-paid speeds develop. So for example, if they begin to slow down, amortization will decline. So that is out there, it's a possibility. Whether that's what happens, we'll just have to see, but that's a possibility.

Okay. Thanks so much, Kent.

You're welcome.

Jeff Rulis, D.A. Davidson.

Thanks. Good morning. The expense reductions that you have implemented in Q1, have you put a number on what the potential cost savings of that would be?

I am struggling here because we have, but I'm not sure what we've discussed before. Kent, you want to --?

Yes. Let me put it this way. We did have a higher level of severance that we reported in Q1. That really should flip around by the end of the year. In other words, the saves associated with that, in particular, should be reversed by the end the year.

So we are pretty optimistic about expenses going forward. We had a lot of good programs in place and we are working at it on a continuous basis. So, as I said, we are pretty optimistic.

Okay. Just so I get you to understand it, right. We'll have the absence of the severance costs this quarter and then potentially that same amount off the core of comp expense?

Well, I didn't quite say we won't ever have more severance. That's always a possibility. But, for the salaries and benefits associated with this particular severance, that should be paid back within this year.

Okay. And then one question on just maybe the C&I and commercial real estate segments in the competitive environment. Would you point to the competition? Is it any part of loan demand being compressed or I guess production being down? Are you that sensing any of your competitors may be more financially stable than they previously were? What are you seeing out in the marketplace?

Well, it's competitive. That's for sure. The look at the commercial portfolio, we are up 9% on a year on year basis, based on end of period numbers. And we are modestly constructive in the first quarter. That was coming off of a 4% gain quarter in the fourth quarter. So a lot of transactions, really, we are pushing hard to get into the end of the year because of the uncertainty around the tax situation.

So, I'm still reasonably optimistic around commercial and -- C&I commercial mortgage, but I think it's going to be lumpy like it generally is and we have some strong quarters and we're going to have some flat quarters like we just experienced.

Okay. But no major change in the last, call it, year on the competition side?

No, the comp -- well, from a composition standpoint, it's been the local lenders, all of whom obviously are hungry for assets. What we haven't seen, and I think this is probably more to your question, is out-of-market competitors really dropping in so the model line, real estate folks that we had in the last cycle, still are nowhere on the radar screen. And the conduit market which, at one point, was down as low as $5 million, $10 million on mortgages is still pretty absent from the market.

Okay. Appreciate it. Thanks.

Nicholas Karzon, Credit Suisse.

Good morning. I guess, first, it looked like the occupancy expense was down relatively significantly this quarter, even dropping out the expenses related to the American Samoa branch closures in the fourth quarter. Can you give us some help in thinking about that in terms of additional branch closures or how to think about that trend going forward?

Sure. This is an area that we are putting a lot of focus upon. We've been working at this for quite a while. That's included, really, the consolidation of three of our major facilities here into really two and leasing out the excess space to third parties.

In addition, we have reduced the number of branches in the system year on year about 7%. So it's really those two things that have produced that result.

Thank you. I guess changing gears a little bit, I was wondering if you've noticed any impact from the weakening yen on the tourism side. I think that roughly 18% of tourist arrivals are from Japan and I was wondering if that had any impact thus far this year.

And we have not seen that yet. Intuitively, you would think that would have an impact on at least spend. Having said that, the Japanese are pretty voracious international travelers and so that's going to impact them on a lot of destinations they're going to be interested in.

And so I think the key for us is just to market the heck out of the marketplace and land those bodies here.

Thanks. Thanks again for taking my questions this morning.

Casey Haire, Jefferies.

Good morning, everyone. Can you give some updated thoughts on the NIM outlook? It looks like loan yields still under pressure here, but the security deal is actually on the bottom in the AFS bucket. I was wondering, was that -- are you guys just taking advantage of some better reinvestment opportunities or we've kind of reached bottom there?

Well, I hesitate to say bottom. As I quoted in my prepared remarks, we are still reinvesting at a 100 point basis differential between what's rolling off and what we are purchasing. So to an extent that is continuing, which is likely to be the case here for the near term, there is still going to be pressure on the securities yield and, therefore, NIM. And to a degree, that will also apply to the loan portfolio.

I mean, the environment is such, for example, the 10-year treasury right around 1.7. That's actually a little bit lower than it was at the start of the year. We started to buoy up a little bit in the first quarter, but that's come back down. So as long as that's the environment, we think there's still going to be some pressure on NIM.

Got you. Okay. And just switching gears to capital. Off to a little bit slower start versus where you were last year, at 74% of earnings, should we expect capital to build -- capital ratios to build this year?

Well, maybe a little bit. So, for example, we would probably expect our Tier 1 leverage ratio to tick up to 7% in the second quarter. But the bigger picture, our strategy is still to return as much capital as we can to shareholders. It's true, we had a little bit less of a repurchase number in the first quarter. I think that really just gives us more opportunity to buy some more stock going forward.

Okay. And just lastly, the tax rate a little light. You guys have typically lived around 33%. Is that fair going forward?

Well, the rate itself rate is going to be a function of the level of income applied against kind of a fixed number of low-income housing credits and other tax credits. So we have energy tax credits, for example. So when you have a fixed number of credits and a lower level of pretax income, it will cause the rate to come down. So actually, to the extent income is going up and the rate goes up, that's probably a good thing.

Okay. So we are actually closer to where we were here in the first quarter than prior levels.

Yes. I think that's right.

Okay. Thank you.

Yes. Thank you.

Brett Rabatin, Sterne, Agee.

Hi. Good morning, everyone. Wanted to ask about expenses. I know you talked about achieving a similar level of expense reduction in 2013 to 2012 but that it would be more back end-oriented. Is that still the case and then could you give us any additional color around the level of mortgage banking expenses in the first quarter, if that declined any with a slightly lower level of production? It doesn't seem like expenses, net of the separation charges, were that lower.

Yes. So, the mortgage banking expenses are going to be back ended. So, really, we pay the comp -- majority of the comp on the [stellar] production in the prior quarter on a back-ended basis. So there is a bit of a lag in there. Expensewise, I think -- my suspicion is it's going to be difficult to get a sense on a specific reduction number not because we are not trending in that direction. We are. But because, as you know, there are certain upfront costs that come with achieving further expense reductions.

So we saw here in the first quarter that, ultimately, is going to result in lower expenses on a run rate basis, but we could very well likely see more severance costs out in the latter quarters. In general, though, I think that piece is going well.

The other major component to our expense reduction program is in facilities as Kent mentioned. And there, too, you have some frontloaded costs that go into bringing in new tenants. Not to disclose any transactions, we can't at this point, but we have a few of those in the hopper right now. And that will take some upfront costs that ultimately will result in some pretty meaningful cost savings for us.

So directionally, I think if you look at the past couple of years, probably that's not a bad trend line, but recognize that there is going to be some intra-year, intra-quarter lumpiness just on getting those expenses to fruition.

Okay. That's good color. And then the other thing I was hoping to get a little more flavor around was, Kent, some thoughts around -- you mentioned earlier what the 10-year was today versus year-end. Last quarter, you talked about reinvesting in 110 basis points below the current portfolio yield. Any thoughts on what you are doing today? Any change in strategy and is that still the level you are seeing in reinvestment activity?

Unfortunately, it is about the same level and the only exception to that is we are ever so slightly bringing down the composition of the portfolio down for mortgages and into some of the other categories, such as municipal securities and some corporate bonds. So those are small items, but directionally, can help a little bit in terms of offsetting the environmental direction.

Okay. Great. Thanks for the color.

You are welcome.

Aaron Deer, Sandler O'Neill & Partners.

Good morning, everyone. I think most of my questions have been addressed. Just a couple of quick follow-ups. One is with respect to the loan growth. Are you getting any meaningful traction at this point from your credit card program than? And I was wondering if you could just update us on what kind of account growth you are there seeing in line usage and where your marketing efforts stands?

We are getting incredible period on period growth from -- in the credit card portfolio. The unfortunate thing is we are starting from a pretty darn small number, so we are up to, I want to say, $3 million in outstandings, much better performance in terms of account growth and so we think we've got a great product on our hands. It's going to take us a while to get its meaningfulness to the operation up obviously. But we think it's a great product and we are working hard to figure out some balance transfer strategies, because we think the product fits quite nicely into our customer base.

Have you started marketing that through direct mail or similar efforts or is it still mostly just kind of cross-selling the branches.

I think we are transitioning right about now from our soft opening phase to more active marketing so we are hopeful around that.

Okay. And it didn't sound like from your earlier comments that this sequester is having much impact on economic activity in the state.

Not yet. So we have not really noticed any meaningful downshift that can be attributed to the sequester. Tough to tell what happens in the next, call it 12 to 18 months. But I think we are cautiously optimistic that whatever impact nets out of sequester, that will be likely more than offset by what's still a very robust visitor market. And what's looking like a much longer construction component in the economy.

That's great. Okay. Thanks for taking my questions.

Jacque Chimera, KBW.

Hi. Good morning, everyone. Peter, you actually had a great segue into my question which was about construction. I know the last time we talked you said it was picking up. I wondered if you could provide a little more color on that.

Well, sure. I quoted the housing numbers earlier in the call. And so, from an inventory standpoint, housing inventory is just at a very, very low level. We are beginning to see a good amount of pressure on price points as a result of that. And Hawaii is already a very high cost-of-living state to begin with. So there is a lot of pressure.

Frankly, there is a lot of policy pressure at the government level to help release this pressure. We've got, gee, no fewer than a half-dozen construction -- housing construction projects on the books. These have been very well received in the marketplace. We are active with two of the probably most high-profile of the six and those have effectively sold out by a pretty wide margin today. So a lot of demand there, a good amount of infrastructure -- housing infrastructure on the books and hopefully we'll see how long that plays out.

Okay. And for the last couple of quarters, you had strong growth in the auto portfolio. Do you have anything in place right now to drive those loans or is it just more demand that's been picking up?

It's a combination of demand has been picking up, albeit from a pretty low level, historically speaking, as well as, we just put -- we have placed a lot of resources into that area and we have got just some very good leadership happening in that space right now.

And then, just one last quick one. In the past, you have said that attrition is how you deal with a lot of the branch closures and just some of the initiatives. How does that reconcile to the severance charge you had in the quarter?

If that doesn't really come into the severance charge because -- for the very reason that you bring up. And usually what we do, because we have approaching 20% attrition -- 15%, 20% attrition in our branch system, as we move a branch or close a branch, and domicile those accounts into other branches, what we'll do is move the staff along with those accounts. And what that does is it gives us a much better retention level on customers -- many of whom, obviously, have come to know and like these individuals. It takes us a little longer to achieve the expense savings, but with the attrition rate what it is, we do achieve the expense savings over time.

So those are voluntary separations -- you know, people just leaving to do other things. Interestingly, with the visitor industry doing as well as it's doing, that's a real competitive factor for us in hiring and retaining talent. But it doesn't really fall so much into the severance category, which is more for managerial and mid-level positions, frankly.

Okay. Great. Thank you for the color. I appreciate it.

Ken Zerbe, Morgan Stanley.

Thanks. I guess with NIM compression being top of mind, can you just remind us on the duration and your ability to reduce the $756 million of repo funding that you have?

So the repos generally have fixed terms. I'm talking about the private repos now, not public repos. And the opportunity, quite frankly, is to see if we can extend some of those out. And that's a possibility for us going forward. So nothing to report on that, but on the public side, we have a lot of flexibility based upon how we bid on repo opportunities. So over the last really two quarters, we have been bidding in such a way that we have been reducing the repo balance in favor of more deposit balances. And some fixed term liabilities so we probably noticed on the balance sheet, we have $175 million of term debt on the balance sheet. Did that answer your question, Ken?

I guess it does. I see that it is coming down sequentially, but it's still fairly high yield. I just didn't know how long that was going to -- it looks like the yield was 3.7% and accounts for almost all your -- or the vast majority of your funding costs. Just didn't know how quickly your bidding (multiple speakers)

It still has some term remaining so it varies between two and five years. But, as I started to mention, we did have some flexibility to extend some of those in exchange for lower rates. So we'll see if we actually are able to execute on that going forward.

Okay. No, that's helpful. And then the other question I had, just in terms of the mortgage banking portfolio, do you know what is the main difference between the loans that you are selling versus the typical industry average that you guys saw, specifically your gain on sale margins come down so much more than the average bank this quarter?

Hard to quote on average banks because I don't know exactly what their experience is, but I think, in general, the gain on sale in 2012 and, in particular, towards the end of the year, was way out of this world, quite frankly. Very high levels of gain. And that's influenced by everything that we hear and read about the Fed and their activity in the mortgage market; the high level of refi activity, which has had an influence on how competitors operate in the market. All those things coalesced to produce very high gains on sale, upwards of 2, 2.5 times kind of historic levels. And that's kind of backed off of it here into the first quarter.

So whether we are unique in that regard, I just don't know. But that's been our experience.

Yes. The only thing I would add to that is timing wise, different banks recognize their gains at different times. We recognize on the front end of the lock, which given the high activity late last year against the high margin, just gave us a real outside result, which was great last quarter and not as good this quarter.

Got you. Okay. And then, just final question, was there any losses -- or hedging losses in those $6 million or is this a fairly decent run rate for you going forward?

I don't think there were any hedging losses in the period. So it's pretty typical.

All right. Thank you very much.

Matthew Keating, Barclays.

Yes. Thank you. I guess, jumping back to expenses, could you please quantify the impact of the seasonally elevated payroll and related expenses this quarter? Thanks.

It's about $3 million.

Okay. Great. And I also appreciated the color on the securities reinvestment yields. Could you talk about your average loan yield on new loan production this quarter, relative to the 4.36% average loan yield that you saw for the quarter overall? Thanks.

Can you share which category you're interested in?

I guess, say, commercial -- C&I.

C&I came in at 3.75% for the quarter. That feels a little -- that feels stable to maybe coming down a bit. Construction is in at 4%, which feels about right. And then, obviously, I'm sorry -- commercial mortgage was 4%, which feels about right. And then, construction is going to be all over the place because those are generally fixed rate loans -- or floating rate loans; excuse me.

Got you. Okay. And then, finally, could you talk about the decisions to delay the American Samoa exit for another year, just what drove that? Thank you.

Sure. We had planned to exit out of that marketplace at the end of March -- the end of the quarter. And we were asked -- I don't want to say the last minute, but as we approached that date, by the government to extend out our departure. And because, one, in doing that, frankly, it would not create a heck of a lot of financial hardship for us at all. Secondly, because I think there were actually some reasonable reasons for the government's request. And, thirdly, and not the least of which, this is a market that we've been in for over 40 years. And we need to make whatever departures and movements that we do right by the community that we serve for that period of time.

And so those are really the factors that drove the delay. We are working actively with the government at this point to ensure or improve the probability as much as possible that, as we get to the end of the first quarter next year, we are in a position to make that final move. So that's where we are and that's some color behind why we've extended.

Make sense. And this is just one final question. Could you please provide some color on the public [price] into deposit runoff? Was that something intentional that you wanted to seek out or is it more seasonal in nature or sort of what is going on there? Thanks.

Yes. Well, we chose to not aggressively bid on some situations just to balance -- excuse me, manage the balance sheet. So we have a lot of flexibility in how we price public deposits and that's the main reason.

Got you. Thank you.

Erin Davis, Morningstar.

Hello, and good morning. I just wanted to dig down a little bit deeper on cost savings and strategy. You mentioned that you saw an underlying decline in costs in the first quarter and that you are hopeful that mainland economy improvement will begin to bring up interest rates. But I wonder if you'll be looking for more aggressive cuts if rates remain low or if you'd rather wait and sit it out and avoid making any significant changes to your business.

That's a good question. I guess my view is that margin pressure, which has largely been driven by the rate environment, is something that banks have a pretty high probability of having to live with for a pretty extended period of time here. So -- and I think we might have said this before, but our strategy is not to outwait the rate environment. So therefore, we have a need to take what's already a pretty efficient cost structure and make it even more efficient.

If you look at what we've been able to do the past couple of years, it's been in kind of the 2% per year level against operating expenses. And that's a level that we would like to operate at moving forward.

So, one, no, we don't plan on just kind of stopping here and waiting for the environment to get better. But, two, we are trying very hard to make sure that we are balancing our expense reduction program against the franchise and the need to the franchise at Bank of Hawaii.

So it's kind of a balancing act. I think we've got some more opportunity there, but these are things to do kind of one step at a time, I think, if you are doing them effectively.

Okay. That's helpful. Thank you.

You're welcome.

(Operator Instructions). Bryce Rowe, Robert Baird.

Thanks. Just a follow-up on the discussion about the public deposits. Kent, we have seen an inflow of public deposits seasonally in the second quarter of the last couple of years. Given the discussion about pricing those public deposits, should we assume that we will not see an inflow this year?

I really don't know. It all depends on our needs here. Depends on how big we want the balance sheet to be, what the loan situation is, what the investment situation is. So I really can't give you a blanket prediction on that.

Okay. So, if we were to assume a static environment relative to what it looks like today, would your answer change at all?

No, not really. I mean, it's one of those things that we can vary depending upon what we need to do. So if we need the funding, we can arrange that. If we don't, we probably won't. So there's a lot of flexibility in that.

Okay. Thank you.

(Operator Instructions). Erika Penala, Bank of America.

Yes. Good morning. I just had one follow-up question. I think that most of the market would agree with your comments that the rate environment will stay lower for longer, but it seems like the message from the Fed with regard to the big banks stress test is that they are starting to worry a little bit more about interest rate risk. Would the stress test process for the midsized banks starting in October 2013, are you thinking about the management of your bond portfolio differently going into that test?

You know, we've been pretty conservative on this category all along. We are definitely mindful of the stress test. We are in the midst of that as we speak. So we are definitely aware of that particular point of view. But yes, we've been very conservative on the asset side of the balance sheet for quite a while now.

The change, though, probably is a little more on the liability side. So you see a little bit more extension on some of our liabilities. And that's something we may continue to do. And, really, it is in deference to the very risks that you're talking about.

Okay. Thank you for taking my question.

You are welcome.

That concludes all the questions that we have at the moment.

I'd like to thank everyone for joining us today and for your continued interest in 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.

Have a great day, everyone.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation and you may now disconnect. Have a great day.