Bank of Hawaii Corporation (BOH) Q3 2007 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Quarter Three 2007 Bank of Hawaii Corporation Earnings Conference Call. My name is Michelle, and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. And I would now like to turn the presentation over to your host for today's call, Ms. Cindy Wyrick, Director of Investor Relations. Please proceed.

Hello everyone and thank you for joining us this morning, as we review Bank of Hawaii Corporation's financial results for the third quarter. With me this morning is our Chairman and CEO, Al Landon; Vice Chairman and Chief Financial Officer, Dan Stevens; Vice Chairman and Chief Banking Officer, Peter Ho; Vice Chairman and Chief Operating Officer, Dave Thomas; and Vice Chairman of Corporate Risk, Mary Sellers. The comments today will refer to financial information that was included in the earnings announcement this morning. Before we get started, let me remind you that today's conference call may 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 Al Landon. Al?

Thank you, Cindy. Good morning, everyone and thank you for joining us today. Third quarter of 2007 was another solid quarter for the Bank of Hawaii, highlighted by a positive operating leverage and a return on equity that continue to exceed 26%. Our bank performed well during the period of market turbulence in the third quarter. During the quarter, we increased non-interest revenue, controlled expenses, and maintained solid asset quality. Good credit profile at Bank of Hawaii reflects the stable economy in Hawaii and our disciplined approach to underwriting and portfolio management. Now I'd like to ask Dan to provide you with some additional information about our third quarter results. Following his comments, we will address your questions. Dan?

Thank you, Al. Hello, everyone. The third quarter of 2007 Bank of Hawaii's net income was $47.8 million compared to $47.7 million last quarter, and $46.9 million in the third quarter of last year. Diluted earnings per share were $0.96 in the third quarter. Our return on equity was 26%, and our return on assets was $1.79%. Net interest income was $98.6 million in the third quarter, $300,000 lower than last quarter, and $1.8 million lower than the third quarter of 2006. Though net interest income was down over the last quarter, the decrease caused by margin compression was substantially offset by increases in earning assets and deposits. The challenging rate environment we have experienced over this past several quarters has put less pressure on our margin this quarter as compared to prior quarters. A substantial portion of the decrease in our margins directly correlates for the short-term duration of most of the increases in average deposits of $206 million over the second quarter. The increase is attributable to two factors; an excess of short-term liquidity due to market turbulence and one large short-term savings deposit. As the duration of these deposits were considered to be short-term, the funds were invested in short-term assets at lower yields than we would have earned on loan equivalents. These factors were primary contributors in the reduction of our net interest margin of 9 basis points to 4.03% this quarter compared to last quarter. We have included analysis of the change in net interest income as Tables 6a and 6b to our earnings release. We also recorded a provision for credit losses of $4.1 million in the third quarter up from $3.4 million in the second quarter and $2.8 million in the third quarter of 2006. The $700,000 increase this quarter compared to last quarter was primarily due to increased losses in indirect auto and home equity loans in Sipan. Non-interest income for the third quarter was $61.2 million, a solid increase over the last quarter and over the third quarter of last year. The increase of $3.2 million over the last quarter was due both to, seasonal contingent insurance commission income and a $1 million increase in the net fair value of designated securities and hedged mortgage servicing rights. In fact, as last year's third quarter, the $4.4 million increase incurred in every category of non-interest income except for other; remember that last year's other income included a gain of $1.5 million and the sale of leased equipment. Non-interest expenses in the third quarter were $81.5 million or $1.6 million increase over both, the last quarter and the third quarter of last year. The increase over the last quarter was the result of increased net occupancy expense, insurance claims reserves and marketing expense. These increased expenses were due to timing of expenditures. Compared to last year, the higher level is attributable to annual salary increases. Our effective tax rate this quarter was 35.68% and included the benefit of tax credit-related to our investment in the State of Hawaii qualified high technology business improvement program. Tables 11A in our earnings release provide summaries of business segment performance. The Retail segment continues its solid performance as compared to the third quarter of last year, primarily due to higher fee income from transaction volume, growth in the number of transactional deposit accounts and interchange from debit card sales. The Commercial segment's performance was comparable to the third quarter of last year, and the Investment Services segment results decreased from last year's third quarter, as an increase in non-interest income for the segment was more than offset by increased salaries and other operating expenses. The rest of our operations are represented in the Treasury segment, which includes our corporate asset and liability management activities. Our credit quality remains strong. Non-performing assets were $4.3 million at the end of the quarter, down from $6.3 million last quarter and $5.4 million at the end of the third quarter of last year. Non-performing assets represent only 6 basis points of total loans at the end of the third quarter. Commercial non-performing assets were less than 1 basis point of outstanding loans, and our consumer portfolios also reflect solid credit quality. The two largest consumer portfolios, mortgage and home equity, have weighted average credit scores of 755 and 748 respectively. 94% of our residential mortgage portfolio has a loan-to-value ratio of 80% or less, and both portfolios have nominal delinquency and loss rates. And as a reminder, the Bank has not offered payment option addressed for weight mortgage loans or loans of negative amortization. Gross charge-offs in the third quarter were $5.9 million and recoveries were $1.8 million, resulting in net charge-offs of $4.1 million. Third quarter 2000 [ph] net charge-offs represented an annualized loss rate of 25 basis points. At the end of the second quarter, the allowance for loan and lease losses was $91 million, and represents 1.38% of loans, essentially unchanged from the prior quarter. We continue to evaluate the economic environment from the level of risk in our portfolio each quarter and recognized a provision for credit losses necessary to maintain the allowance in appropriate level. Outstanding loans increased nearly $34 million this quarter compared to last quarter, and totaled $6.6 billion at the end of the period. Average loans also increased by a similar $38 million across most of our portfolios. Period-end deposits decreased $439 million this quarter compared to last quarter to $7.9 billion. The decrease was largely as discussed previously, the result of both, temporary liquidity deposits into the Bank of Hawaii and a short-term large deposit. Average deposits on the other hand increased $206 million this quarter, related primarily to the factors outlined previously. Given the recent events in the mortgage market, it is important to note that our Investments Securities portfolio, which was just under $3 billion at September 30, 2007, included $323 million in non-agency mortgage-backed securities, all AAA-rated prime jumbo paper with an average loan-to-value ratio of 65%. We have no sub-prime or Alt-A securities in our non-agency mortgage-backed securities portfolio. We continued our share repurchase program by purchasing 550,000 shares during the third quarter, at a cost of approximately $28 million. Since quarter end, we have repurchased another 82,000 shares and our Board approved another $100 million in repurchase authorization. So our remaining authorization is approximately $120 million as of this morning. Finally, I want to mention that on Friday, our Board increased dividend to $0.44 per share. And Al, that concludes my comments.

Thank you, Dan. Now we'll be happy to respond to any questions, you might have. Question And Answer

[Operator Instructions]. And your first question comes from the line of Andrea Jao of Lehman Brothers. Please proceed.

Good morning, everyone.

Good morning.

Good morning.

Last quarter LILO credit-to-net interest income contributed 5 bps I believe to margin expansion. So, this quarter I assume that went away and the drag on the margin was 5 bps?

Last year, last quarter above 5 bps was attributable to LILO. This quarter we've had a 2 to 3 bp drag on our margins based on this excess liquidity... short-term access liquidity in our deposits that I mentioned in my talk.

Okay. So, the rest of the 9 bp decrease is the LILO credit going away?

Yes.

Okay. And then, there has recently been disconnect between LIBOR and Fed fund. I was hoping you could talk a bit more about the impact on that, on the asset side of your balance sheet, on the funding side, and if this has been drag or a benefit to your margin?

As of this morning there is about 40-basis point spread between LIBOR and Fed funds, and the way our balance sheet is structured, it has a slightly beneficial impact, but not much. We are pretty well balanced in our balance sheet structure.

Okay, perfect. Thank you very much.

Your next question comes from the line of Jim Bradshaw of D.A. Davidson. Please proceed. Jim Bradshaw - D.A. Davidson & Co.: Good morning.

Hi, Jim. Jim Bradshaw - D.A. Davidson & Co.: Al, I have been seeing some of you competitors offering some... a bit more aggressive CD [Certificate of Deposit] rates than historically we've seen in your markets. Can you talk about what the deposit pricing market has been like over there recently?

We have noticed that too. Jim Bradshaw - D.A. Davidson & Co.: How fast.

I think deposits supply maybe tightening up a little bit, and that maybe what we are seeing. But we haven't seen it long enough to really reach any conclusions about it. It maybe just one institution or another at a point in time, feel like in the need for more funding. Jim Bradshaw - D.A. Davidson & Co.: Okay. And, I sort of, woven into said when I saw folks having thirstier demands or deposits, I wondered if we were seeing an increase in internal loan generation in the Islands. Just wanted your guess feel for how the pipeline looks compared to a quarter ago, and are you seeing anything unusual in payoff activity or as the economy gets a little tighter in some markets, or you start to see that payoff activity is beginning to stretch out or slowdown a bit too?

Peter would you like to... just give some comments there?

Sure, on the... in terms of funding, things seem to be relatively stable. E&I growth is pretty strong. On the pay-down side, we are seeing pay-downs in our dealer book. We've got a reasonably sized book of dealer loans and what we are seeing is that they are not purchasing inventory for '08 as aggressively as they have in years past and they really went beyond the '07 level. So, that's one factor that's a bit different from the quarters past. Now the other area on pay-down side that we are seeing some activity on is along the construction side, and our.... in our book, we've got a reasonably small construction portfolio. But we saw about a 35% pay-down rate annualized in the third quarter, which I think probably just follows from our positions, right now.

And your next question comes from the line of Brent Christ of Fox-Pitt, Kelton. Please proceed.

Good morning.

Good morning.

Just in terms of the recent Fed rate cut, could you talk a little bit about how that kind of impacted your balance sheet dynamic in terms of the repricing at least in the couple of weeks since the Fed rate cut? How do you see that playing outside I guess over the next quarter or two in terms of the impact in the margin?

Well, as I mentioned on my comments, we've been dealing with a very difficult interest rate environment, given the structure of our balance sheet. The Fed fund cut and depending if they cut this month or wait until January, has a nominally beneficial impact on our margin. I think I had mentioned that when we were at the Lehman Brothers Conference; and so there is more of a positive impact because of the Fed fund cuts just based on the way our balance sheet is structured. But it's not huge. And also given just the uncertainty in the market, and the impact that could have on the yield curve or Fed decisions, we are kind of cautiously looking at this, saying it will nominally help us, but we are not looking at outside of volume increases in the business side to have a huge impact on our margin.

Got you. Okay. And then secondly, just from a credit-quality perspective, are you seeing anything in your book that would change? I guess you've been matching provision or with charge-offs for quite some time that would suggest that would change? Or in other words, do you see anything that would make you feel like you need to build reserves a little bit? I know you guys have a pretty healthy reserve level as it is.

We don't see anything on the horizon right now that will change our reserving approach or that would be that kind of observable data that we should do an increase. You know Mary anything you want to add to that?

No I would agree, Al. We revisited every quarter but I would agree, nothing on the horizon at this point.

Your next question comes from the line of Fred Cannon of KBW. Please proceed. Frederick Cannon - Keefe, Bruyette & Woods: Thanks and good morning. Just a follow up on the deposits. I notice that the savings balance... average saving balances were up about $200 million or so I believe, linked quarter, and the rate on those moved up. Was there any special kind of money market rate changes or anything you did in that category?

As I mentioned, a lot of our deposit increase was caused by a single customer deposit of about $200 million. $200 million of that was with us for most of the third quarter. $100 million still stays, but that's in the middle of third of September, that $200 million deposit left us. So that increase was largely due to that. And also as I mentioned, excess liquidity that came to the Bank of Hawaii during the height of the liquidity issues surrounding the sub-prime market. Frederick Cannon - Keefe, Bruyette & Woods: Okay. So that was in that category?

Yes. Frederick Cannon - Keefe, Bruyette & Woods: Okay and then right, the liquidity issue and that will come off okay.

Yes. Frederick Cannon - Keefe, Bruyette & Woods: And then just a general question, Al, on the capital management. I know you guys did increase your dividend by I think about $0.03. It was a little less on a percentage basis increase than we've seen in the last few years, and I was wondering if you could comment on your thought process, maybe any changes in your thought process regarding capital management?

No changes, Fred. On the capital management, the target or the approach we use, you are right, we had a choice between $0.03 and $0.04 and chose the way it's just looking at kind of all the economic indicators and anticipating what would happen next year. So our dividend portion of our capital return program should be in that 40% range looking forward.

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

Good morning.

Hi Erika.

You spoke about your confidence with your consumer portfolio, but is there anything on the corporate side that you are watching more closely?

On the C&I side, Erika?

Or anything non-consumer related?

Down the commercial line then. I would say that probably the portfolio that has the most scrutiny right now is our construction book, just given market conditions in the residential home building segment. That's a $254 million book of business for us and about just under 60% it's residential home builders. Looking at that... looking through that portfolio that we feel pretty good, most of that... most of that exposure is to kind of mid-market, mid-tier type product, and that product continues to move nicely in our marketplace.

Okay. And everything else for commercial-related is fine?

Yes.

Okay. Thanks for the time.

[Operator Instructions]. And your next is a follow-up from the line of Andrea Jao. Please proceed.

Hello, again. I believe the leverage ratio is at... it's below the 7% kind of benchmark that you have. This means that share purchases will be a fad slower than they have been in past quarters until, your leverage ratio goes back up to 7%?

Well, I think we are slightly under 695. Our capital leverage position at maintaining a 7% are based either on dividends or share repurchase, we are paying with that and we haven't change that. So, we are slightly under, but that's still our target.

Okay, perfect. And then --

We've may have been just touched below that at the end of the second quarter and when those things happen for us, any number of reasons, we'll just take a period of time and gradually work it back, the 7% target remains.

Okay. And my follow-up question would be, I know a small portion of your loan book. I believe it is in California, and correct me if I am wrong, but could you talk about that portion of loan book in... your comfort level then what you're seeing?

Andrea you are talking, I think about real estates, Andrea, commercial real estate. It is $15 million in exposure.

Okay.

Two credits, both in Southern California, one is a multi-family complex in Los Angeles; the other one is the retirement community in the Valley, both performing as we would anticipate. But it's a very small portion of our overall real estate portfolio on the commercial side.

Okay, perfect. Thank you very much.

And this does conclude the question-and-answer session. I will now turn it back to management for closing remarks.

I'd like to thank you everyone for joining us today. As always, if you have additional questions or need further clarification on any of the topic discussed today, please feel free to give me a call. Have a great day everyone.

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