UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
ý Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2005
or
o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to
Commission File Number 1-6887
BANK OF HAWAII CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
99-0148992
(State of incorporation)
(IRS Employer Identification No.)
130 Merchant Street, Honolulu, Hawaii
96813
(Address of principal executive offices)
(Zip Code)
1-(888)-643-3888
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate by check mark whether the registrant is a shell company (as defined in Rule 126-2 of the Exchange Act).
Yes o No ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, $.01 Par Value; outstanding at October 21, 2005 – 51,316,630 shares
Bank of Hawaii Corporation
Form 10-Q
INDEX
Page
Part I. - Financial Information
Item 1.
Financial Statements (Unaudited)
Consolidated Statements of Income - Three and nine monthsended September 30, 2005 and 2004
3
Consolidated Statements of Condition – September 30, 2005,December 31, 2004 and September 30, 2004
4
Consolidated Statements of Shareholders’ Equity – Nine months endedSeptember 30, 2005 and 2004
5
Consolidated Statements of Cash Flows – Nine months endedSeptember 30, 2005 and 2004
6
Notes to Consolidated Financial Statements
7
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
10
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
34
Item 4.
Controls and Procedures
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
35
Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Income (Unaudited)
Three Months Ended
Nine Months Ended
September 30,
(dollars in thousands except per share amounts)
2005
2004
Interest Income
Interest and Fees on Loans and Leases
$
94,381
82,079
270,967
243,853
Income on Investment Securities - Available for Sale
28,482
24,543
83,788
67,134
Income on Investment Securities - Held to Maturity
5,109
6,370
16,461
20,057
Deposits
57
496
116
3,373
Funds Sold
935
108
1,175
702
Other
270
801
990
2,524
Total Interest Income
129,234
114,397
373,497
337,643
Interest Expense
15,766
8,990
40,947
26,750
Securities Sold Under Agreements to Repurchase
6,796
2,085
14,683
6,233
Funds Purchased
901
683
2,785
1,420
Short-Term Borrowings
50
15
127
43
Long-Term Debt
3,761
3,845
11,298
12,538
Total Interest Expense
27,274
15,618
69,840
46,984
Net Interest Income
101,960
98,779
303,657
290,659
Provision for Credit Losses
3,000
—
(3,500
)
Net Interest Income After Provision for Credit Losses
98,960
300,657
294,159
Non-Interest Income
Trust and Asset Management
14,052
12,672
42,732
39,531
Mortgage Banking
2,618
1,711
7,802
6,496
Service Charges on Deposit Accounts
10,046
9,472
29,794
28,962
Fees, Exchange, and Other Service Charges
15,394
13,741
44,441
41,223
Investment Securities Gains (Losses)
8
345
(37
Insurance
5,324
5,423
15,442
15,007
8,074
10,035
17,949
25,562
Total Non-Interest Income
55,516
53,054
158,505
156,744
Non-Interest Expense
Salaries and Benefits
44,366
46,566
132,991
139,256
Net Occupancy
9,896
9,812
28,630
28,741
Net Equipment
5,335
5,847
16,183
17,610
Professional Fees
5,689
3,428
11,645
10,632
19,310
18,537
55,014
56,098
Total Non-Interest Expense
84,596
84,190
244,463
252,337
Income Before Income Taxes
69,880
67,643
214,699
198,566
Provision for Income Taxes
25,051
24,576
77,919
71,468
Net Income
44,829
43,067
136,780
127,098
Basic Earnings Per Share
0.87
0.82
2.62
2.40
Diluted Earnings Per Share
0.85
0.78
2.55
2.26
Dividends Declared Per Share
0.33
0.30
0.99
0.90
Basic Weighted Average Shares
51,385,840
52,390,081
52,221,345
53,053,770
Diluted Weighted Average Shares
52,844,961
55,472,868
53,745,612
56,297,277
Consolidated Statements of Condition (Unaudited)
December 31,
(dollars in thousands)
Assets
Interest-Bearing Deposits
10,119
4,592
29,976
Investment Securities - Available for Sale
Held in Portfolio
2,381,462
2,483,719
2,328,327
Pledged as Collateral
172,500
Investment Securities - Held to Maturity(Fair Value of $475,884, $585,836, and $624,587)
485,041
589,908
630,276
10,000
21,000
25,000
Loans Held for Sale
18,095
17,642
18,595
Loans and Leases
6,202,546
5,986,930
5,815,575
Allowance for Loan and Lease Losses
(91,654
(106,796
(124,651
Net Loans
6,110,892
5,880,134
5,690,924
Total Earning Assets
9,188,109
8,996,995
8,723,098
Cash and Non-Interest-Bearing Deposits
296,152
225,359
290,974
Premises and Equipment
135,952
146,095
149,698
Customers’ Acceptance Liability
1,081
1,406
920
Accrued Interest Receivable
40,898
36,044
36,074
Foreclosed Real Estate
413
191
208
Mortgage Servicing Rights
18,049
18,769
19,995
Goodwill
34,959
36,216
Other Assets
369,622
305,116
337,626
Total Assets
10,085,235
9,766,191
9,594,809
Liabilities
Non-Interest-Bearing Demand
1,890,904
1,977,703
1,898,602
Interest-Bearing Demand
1,716,306
1,536,323
1,471,836
Savings
2,880,066
2,960,351
2,991,386
Time
1,269,310
1,090,290
1,051,416
Total Deposits
7,756,586
7,564,667
7,413,240
756,407
568,981
682,630
172,365
149,635
69,755
8,537
15,000
11,939
Banker’s Acceptances Outstanding
Retirement Benefits Payable
67,136
65,708
62,976
Accrued Interest Payable
9,416
7,021
6,162
Taxes Payable and Deferred Taxes
276,678
229,928
249,265
Other Liabilities
98,026
96,373
88,596
242,692
252,638
252,619
Total Liabilities
9,388,924
8,951,357
8,838,102
Shareholders’ Equity
Common Stock ($.01 par value); authorized 500,000,000 shares; issued / outstanding: September 2005 - 81,722,233 / 51,282,537,December 2004 - 81,711,752 / 54,960,857,September 2004 - 81,710,695 / 53,021,591
815
813
Capital Surplus
463,084
450,998
413,696
Accumulated Other Comprehensive Income (Loss)
(34,697
(12,917
(5,698
Retained Earnings
1,366,058
1,282,425
1,277,615
Deferred Stock Grants
(5,974
(8,433
(9,490
Treasury Stock, at Cost (Shares: September 2005 - 30,439,696,December 2004 - 26,750,895, September 2004 - 28,689,104)
(1,092,975
(898,052
(920,229
Total Shareholders’ Equity
696,311
814,834
756,707
Total Liabilities and Shareholders’ Equity
Consolidated Statements of Shareholders’ Equity (Unaudited)
Accum.
Compre-
hensive
Deferred
Common
Capital
Income
Retained
Stock
Treasury
Total
Surplus
(Loss)
Earnings
Grants
Balance at December 31, 2004
Comprehensive Income:
Other Comprehensive Income, Net of Tax:
Change in Unrealized Gains and Losses on Investment Securities
(21,780
Total Comprehensive Income
115,000
Common Stock Issued under Stock Plans and Related Tax Benefits (803,278 shares)
33,268
2
12,086
(1,353
2,459
20,074
Treasury Stock Purchased (4,478,932 shares)
(214,997
Cash Dividends Paid
(51,794
Balance at September 30, 2005
Balance at December 31, 2003
793,132
807
391,701
(5,711
1,199,077
(8,309
(784,433
13
127,111
Common Stock Issued under Stock Plans and Related Tax Benefits (2,305,545 shares)
71,984
21,995
(434
(1,181
51,598
Treasury Stock Purchased (4,209,363 shares)
(187,394
(48,126
Balance at September 30, 2004
Consolidated Statements of Cash Flows (Unaudited)
Operating Activities
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Goodwill Impairment
1,257
Depreciation and Amortization
14,056
15,688
Amortization of Deferred Loan and Lease Fees and Premium, Net
(496
(1,794
Amortization/Accretion of Premiums/Discounts on Investment Securities, Net
7,139
9,803
3,892
3,767
Deferred Income Taxes
8,911
14,001
Net (Gain) Loss on Investment Securities
(345
37
Proceeds from Sales of Loans Held for Sale
346,950
308,485
Originations of Loans Held for Sale
(347,403
(317,869
Net Change in Other Assets and Other Liabilities
(6,342
(14,079
Net Cash Provided by Operating Activities
167,399
141,637
Investing Activities
Proceeds from Sales and Redemptions of Investment Securities-Available for Sale
503,818
473,386
Purchases of Investment Securities-Available for Sale
(613,559
(818,969
Proceeds from Redemptions of Investment Securities-Held to Maturity
103,534
165,749
Purchases of Investment Securities-Held to Maturity
(70,238
Net Increase in Loans and Leases
(230,975
(57,535
Net Increase in Premises and Equipment
(3,913
(1,382
Net Cash Used by Investing Activities
(241,095
(308,989
Financing Activities
Net Increase in Demand Deposits
93,184
80,180
Net (Decrease) Increase in Savings Deposits
(80,285
158,007
Net Increase (Decrease) in Time Deposits
179,020
(157,726
Net Increase in Short-Term Borrowings
203,693
169,787
Proceeds from Long-Term Debt
Repayments of Long-Term Debt
(10,000
(96,449
Proceeds from Issuance of Common Stock
20,195
51,793
Repurchase of Common Stock
Net Cash Provided (Used) by Financing Activities
139,016
(4,928
Increase (Decrease) in Cash and Cash Equivalents
65,320
(172,280
Cash and Cash Equivalents at Beginning of Period
250,951
518,230
Cash and Cash Equivalents at End of Period
316,271
345,950
Non-Cash Investing Activity:
In September 2004, the Company transferred a $4.0 million foreclosed real estate property to premises and equipment.
(Unaudited)
Note 1. Summary of Significant Accounting Policies
Bank of Hawaii Corporation (the “Company”) is a bank holding company providing a broad range of financial products and services to customers in Hawaii and the Pacific Islands (Guam, nearby islands and American Samoa). The Company’s principal subsidiary is Bank of Hawaii (the “Bank”). All significant intercompany accounts and transactions have been eliminated in consolidation.
Basis of Presentation
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the consolidated financial statements reflect normal recurring adjustments necessary for a fair presentation of the results for the interim periods.
Certain prior period amounts have been reclassified to conform to current period classifications.
These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s 2004 Annual Report on Form 10-K. Operating results for the nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.
The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities (“repos”). Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, repurchase agreements are accounted for as collateralized financing arrangements and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability in the Consolidated Statements of Condition while the securities underlying the agreements remain in the respective asset accounts. If the secured party can re-sell or re-pledge the securities, they are classified as pledged securities in the Consolidated Statements of Condition. If the secured party cannot resell or re-pledge the securities, they are not separately identified.
Stock-Based Compensation
As permitted by the Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), the Company currently accounts for share-based payments using the intrinsic value method permitted by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”) and related interpretations. Accordingly, the Company recognizes no compensation cost for employee stock options that were granted with an exercise price equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123:
(dollars in thousands except per share and option data)
2004 1
Net Income, as reported
Less:
Total Stock-Based Employee Compensation Expense Associated with Stock Options Determined Under Fair Value Method for All Option Awards, Net of Related Tax Effects 2
(482
(813
(1,682
(3,482
Pro Forma Net Income
44,347
42,254
135,098
123,616
Earnings Per Share:
Basic-as reported
Basic-pro forma
0.86
0.81
2.59
2.33
Diluted-as reported
Diluted-pro forma
0.84
0.76
2.51
2.20
1 Prior period amounts restated to account for forfeitures and adjustment to dividend yield calculation.
2 A Black-Scholes option pricing model was used to determine the fair values of the options granted.
Recently Issued and Proposed Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”),Share-Based Payment, which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB No. 25 and amends FASB Statement No. 95, Statement of Cash Flows. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense through the income statement based on estimated fair value at issue date. Pro forma disclosure will no longer be an alternative. On April 14, 2005, the Securities and Exchange Commission announced that it would provide for a phased-in-implementation process for SFAS No. 123(R). Under this process, the Company will be required to adopt SFAS No. 123(R) no later than the beginning of the first fiscal year that begins after June 15, 2005. The Company plans to adopt SFAS No. 123(R) on January 1, 2006.
The Company plans to adopt SFAS No. 123(R) using the “modified prospective” method. Under this method, awards that are granted, modified, or settled after January 1, 2006, will be measured and accounted for in accordance with SFAS No. 123(R). Also under this method, expense will be recognized in the income statement for unvested awards that were granted prior to January 1, 2006, based upon the fair value determined at the grant date under SFAS No. 123.
The adoption of SFAS No. 123(R) will have an impact on the Company’s results of operations, although it will have no impact on the Company’s overall financial position. Had the Company adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share shown in the table above.
In July 2005, the FASB issued an exposure draft, FASB Staff Position (“FSP”) No. FAS 13-a “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction” (“FSP 13-a”). Under FSP 13-a, a revision in the timing of expected cash flows of a leveraged lease may require a recalculation of the original lease assumptions. A material change in the net investment in a leveraged lease using different cash flow assumptions would be recognized as a gain or loss in the period in which the assumptions are revised. The Company has entered into leveraged lease transactions that are currently under various stages of review by the Internal Revenue Service (“IRS”). The outcome of these reviews may change the timing of cash flows from these leases which may result in gain or loss recognition. Management is currently evaluating the potential effect of the proposed recognition provisions of FSP 13-a.
Note 2. Business Segments
The information under the caption “Business Segments” in Management’s Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.
Note 3. Pension Plans and Postretirement Benefit Plan
The components of net periodic cost for the aggregated pension plans and the postretirement benefit plan for the three and nine months ended September 30, 2005 and 2004 are presented in the following table:
Pension Benefits
Postretirement Benefits
Three Months Ended September 30,
Service Cost
247
Interest Cost
1,126
1,092
475
443
Expected Return on Plan Assets
(1,183
(1,182
Amortization of Unrecognized Net Transition Obligation
147
Recognized Net Actuarial Loss (Gain)
427
328
(42
(156
Total Net Periodic Cost
370
238
850
681
Nine Months Ended September 30,
810
741
3,376
3,275
1,425
1,329
(3,553
(3,546
440
441
1,268
984
(125
(468
1,091
713
2,550
2,043
There were no significant changes from the previously reported $1.8 million in total annual contributions expected to be paid during 2005.
9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
This report, including the statements under the caption “Financial Outlook,” contains, and other statements made by the Company may contain, forward-looking statements concerning, among other things, the economic and business environment in the Company’s service area and elsewhere, growth in the lending portfolio, credit quality, anticipated net income and other financial and business matters in future periods. The Company’s forward-looking statements are based on numerous assumptions, any of which could prove to be inaccurate and actual results may differ materially from those projected for a variety of reasons, including, but not limited to: 1) unanticipated changes in business and economic conditions, the competitive environment, fiscal and monetary policies, taxing authority interpretations, legislation in Hawaii and the other markets the Company serves, or the timing and interpretation of accounting standards; 2) changes in the Company’s credit quality or risk profile which may increase or decrease the required level of reserve for credit losses; 3) changes in market interest rates that may affect the Company’s credit markets and ability to maintain the Company’s net interest margin; 4) unpredictable costs and other consequences of legal or regulatory matters involving the Company, including those identified in Exhibit 99.1; 5) changes to the amount and timing of the Company’s proposed equity repurchases; 6) real or threatened acts of war or terrorist activity affecting business conditions; and 7) adverse weather, public health and other natural conditions impacting the Company and its customers’ operations. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted” and similar expressions are intended to identify forward-looking statements but are not exclusive means of identifying such statements. The Company does not undertake any obligation to update forward-looking statements to reflect later events or circumstances.
OVERVIEW
The Company is in the second year of its 2004-2006 plan (the “Plan”), which continues to build on the governing objective of maximizing shareholder value over time. This objective was established in the previous three-year strategic plan.
The Plan consists of five key elements:
• Accelerate revenue growth in our island markets
• Better integrate our business segments
• Continue to develop our management teams
• Improve operating efficiency
• Maintain a culture of dependable risk and capital management
During the first nine months of 2005, the Company continued to meet the key financial objectives of the Plan. Results for the first nine months of 2005 compared to the same period in 2004 were as follows:
• Diluted earnings per share were $2.55, an increase of 12.8%
• The net interest margin was 4.36%, an increase of seven basis points
• Return on average assets increased to 1.83% from 1.74%
• Return on average equity increased to 24.72% from 22.48%
As of September 30, 2005, loans and leases outstanding increased 7% and deposits increased 5% compared to September 30, 2004. Total revenue, consisting of net interest income and non-interest income, for the first nine months of 2005, increased 3% from the same prior year period resulting in growth in operating income, defined as revenue less non-interest expense, of 12%. The Company’s net income for the first nine months of 2005 was $136.8 million, an increase of 7.6% from $127.1 million reported in the same prior year period.
The Company continues to better integrate its three primary business segments – Retail Banking, Commercial Banking and the Investment Services Group – through improved processes, training and communications. As a result, customer’s needs are better addressed and relationships continue to strengthen.
Operating efficiency improved in the first nine months of 2005 compared to the same period in 2004, as the Company continues to improve processes. The efficiency ratio for the first nine months of 2005 was 52.90% compared to 56.40% in the same period in 2004.
Risk and capital continue to be managed in a dependable and disciplined manner. As of September 30, 2005, the ratio of non-accrual loans to total loans was 0.12% and the leverage ratio was 6.98%.
The Company’s overall financial results are more fully discussed in the following sections of this report.
Table 1 presents the Company’s financial highlights for the three and nine months ended September 30, 2005 and 2004.
11
Highlights (Unaudited)
Table 1
For the Period:
Net Income to Average Total Assets (ROA)
1.74
%
1.77
1.83
Net Income to Average Shareholders’ Equity (ROE)
24.61
23.42
24.72
22.48
Net Interest Margin 1
4.30
4.39
4.36
4.29
Efficiency Ratio 2
53.72
55.45
52.90
56.40
Average Assets
10,196,047
9,668,495
10,004,968
9,746,283
Average Loans and Leases
6,170,302
5,796,350
6,087,629
5,770,642
Average Deposits
7,833,638
7,479,776
7,756,789
7,390,682
Average Shareholders’ Equity
722,758
731,583
739,721
755,075
Average Equity to Average Assets
7.09
7.57
7.39
7.75
At Period End:
Allowance to Loans and Leases Outstanding
1.48
2.14
Dividend Payout Ratio
37.80
37.57
Leverage Ratio
6.98
7.69
Book Value Per Common Share
13.58
14.27
Employees (FTE)
2,591
2,655
Branches and Offices
85
88
Market Price Per Share of Common Stock for the Quarter Ended:
Closing
49.22
47.25
High
54.44
48.07
Low
47.44
43.55
1 The net interest margin is defined as net interest income, on a fully-taxable equivalent basis, as a percentage of average earning assets.
2 The efficiency ratio is defined as non-interest expense divided by total revenue (net interest income and non-interest income).
12
ANALYSIS OF STATEMENT OF INCOME
Net interest income on a taxable equivalent basis for the three and nine month periods ended September 30, 2005 increased $3.2 million or 3% and $13.0 million or 4%, respectively, from the comparable periods in 2004.
The net interest margin for the three months ended September 30, 2005 was 4.30%, a nine basis point decrease from the same prior year period due to increases in short term borrowing rates. The net interest margin for the first nine months of 2005 was 4.36%, a seven basis point increase from the same period in 2004 due to higher yield on investment securities and loans.
The increase in net interest income was primarily a result of higher income earned on the investment securities and loan portfolios. The increase in interest income on the investment securities portfolio was due to an increase in yields and average balances.
Interest income on commercial and industrial and home equity loans increased primarily due to higher average yields earned, which was consistent with increases in benchmark interest rates (e.g., prime), and an increase in average balances due to growth in the Hawaii economy as well as successful home equity loan promotions.
Partially offsetting these positive increases in interest income was an increase in interest expense resulting from selective increases in rates paid on interest-bearing deposits. The Company’s average interest-bearing deposit rates increased by 30 basis points for the nine months ended September 30, 2005 compared to the same prior year period.
Average balances, related interest income and expenses and resulting yields and rates are presented in Table 2. An analysis of change in net interest income is presented in Table 3.
Consolidated Average Balances and Interest Rates - Taxable Equivalent Basis (Unaudited)
Table 2
September 30, 2005
September 30, 2004
Average
Income/
Yield/
(dollars in millions)
Balance
Expense
Rate
Earning Assets
6.4
0.1
3.55
82.6
0.5
2.39
5.8
2.69
246.4
3.4
105.7
0.9
3.54
28.6
1.51
47.5
1.2
3.30
89.4
0.7
1.05
Investment Securities
Available for Sale
2,574.2
28.5
4.43
2,325.5
24.6
4.23
2,536.3
83.9
4.41
2,154.9
67.2
4.16
Held to Maturity
507.5
5.1
4.03
659.0
6.3
3.87
541.8
16.5
4.05
696.1
20.1
3.84
17.0
0.3
5.82
11.3
0.2
5.74
15.1
0.6
5.66
15.8
5.53
Loans and Leases 1
Commercial and Industrial
984.2
6.38
815.1
10.7
5.27
946.6
43.3
6.12
835.5
31.2
5.00
Construction
186.4
3.0
6.35
81.1
1.0
5.01
150.7
6.7
5.97
93.9
4.33
Commercial Mortgage
560.2
8.4
5.95
658.9
8.8
5.29
588.3
25.8
5.85
644.0
25.9
5.38
Residential Mortgage
2,352.3
33.7
5.73
2,280.8
32.1
5.62
2,341.0
99.3
5.65
2,292.7
97.6
5.67
Other Revolving Credit and Installment
742.6
15.9
8.52
705.6
8.53
739.7
46.4
8.39
680.0
43.9
8.62
Home Equity
758.2
12.2
6.40
583.7
7.1
4.83
718.9
32.5
6.04
536.0
19.0
4.74
Purchased Home Equity
88.7
2.71
155.2
1.7
102.8
2.4
3.15
179.5
6.2
4.59
Lease Financing
497.7
4.5
516.0
5.4
4.17
499.6
13.9
3.72
509.0
16.4
Total Loans and Leases
6,170.3
94.1
6.07
5,796.4
81.9
5.63
6,087.6
270.3
5.93
5,770.6
243.2
79.4
1.35
78.7
0.8
66.6
1.99
78.1
2.5
4.32
Total Earning Assets 2
9,460.5
129.3
5.44
8,982.1
114.4
5.08
9,300.7
373.6
5.36
9,051.3
337.8
4.98
316.1
316.9
312.5
419.4
369.5
391.8
378.1
10,196.0
9,668.5
10,005.0
9,746.3
Interest-Bearing Liabilities
Demand
1,730.7
2.9
0.66
1,471.0
0.24
1,672.5
6.9
0.56
1,410.6
1.9
0.19
2,890.2
5.3
0.73
2,998.4
3.2
0.43
2,944.1
14.5
2,927.5
9.6
0.44
1,241.9
7.6
2.42
1,078.4
4.9
1.81
1,172.3
19.5
2.22
1,132.0
15.3
1.79
Total Interest-Bearing Deposits
5,862.8
1.07
5,547.8
9.0
0.64
5,788.9
40.9
0.95
5,470.1
26.8
0.65
953.2
7.7
3.22
816.9
2.8
1.36
828.4
17.6
2.84
920.2
1.12
242.7
3.8
6.19
246.8
6.22
244.7
6.16
294.8
12.5
Total Interest-Bearing Liabilities
7,058.7
27.3
1.53
6,611.5
15.6
0.94
6,862.0
69.8
6,685.1
47.0
102.0
98.8
303.8
290.8
Interest Rate Spread
3.91
4.14
4.00
4.04
Net Interest Margin
Non-Interest-Bearing Demand Deposits
1,970.9
1,932.0
1,967.9
1,920.6
443.7
393.4
435.4
385.5
722.7
731.6
755.1
1 Non-performing loans are included in the respective average loan balances. Income, if any, on such loans is recognized on a cash basis.
2 Interest income includes taxable-equivalent basis adjustment based upon a statutory tax rate of 35%.
14
Analysis of Change in Net Interest Income - Taxable Equivalent Basis (Unaudited)
Table 3
Nine Months Ended Sept. 30, 2005 Compared to Sept. 30, 2004
Volume1
Rate 1
Change in Interest Income:
(4.4
1.1
(3.3
(0.4
4.2
16.7
(4.6
(3.6
(0.1
12.1
2.3
1.4
3.7
(2.3
2.2
2.0
(0.3
(1.2
7.5
6.0
13.5
(2.2
(1.6
(3.8
(2.5
15.2
11.9
27.1
(1.5
Total Change in Interest Income
17.9
35.8
Change in Interest Expense:
5.0
13.1
14.1
(0.8
9.9
Total Change in Interest Expense
(2.1
24.9
22.8
Change in Net Interest Income
20.0
(7.0
13.0
1 The changes for each category of interest income and expense are divided between the portion of changes attributable to the variance in volume or rate for that category.
For the three and nine months ended September 30, 2005, the Company recorded a $3.0 million Provision for Credit Losses (“Provision”). Before this quarter, the Company had not recorded a Provision expense since the quarter ended June 30, 2002. For information on the reserve for credit losses, refer to the “Corporate Risk Profile – Reserve for Credit Losses” section of this report.
Non-interest income increased $2.5 million or 5% and $1.8 million or 1% for the three and nine months ended September 30, 2005, respectively, from the comparable prior year periods. Table 4 presents the components of non-interest income.
Non-Interest Income (Unaudited)
Table 4
Percent
Change
53
20
n.m.
(2
Other Income:
Gain on the Sale of Leased Assets
3,604
5,437
(34
4,941
5,750
(14
Income from Bank-Owned Life Insurance
1,524
1,602
(5
4,500
5,169
(13
Leasing Partnership Distribution
3,218
Gain on the Sale of Land
2,454
2,946
2,996
8,501
8,971
Total Other Income
(20
(30
1
n.m. – not meaningful.
Trust and asset management income is comprised of fees earned for the management and administration of customers’ invested assets. The fees are generally based on the market value of the assets that are managed. Trust and asset management income increased $1.4 million or 11% and $3.2 million or 8%, respectively, for the three and nine months ended September 30, 2005 compared to the same periods in 2004. The increase in fee income was primarily due to an improvement in the market value of assets and an increase in investment advisory fees on money market assets.
Mortgage banking income increased $0.9 million or 53% and $1.3 million or 20% for the three and nine months ended September 30, 2005, respectively, compared to the same periods in 2004. The growth in the third quarter of 2005 from the third quarter of 2004 was primarily a result of higher gains on the sale of mortgage loans in 2005, which was attributable to an increase in the volume of mortgage loans sold. On a year-to-date comparison, the increase was largely due to lower amortization of servicing rights as a result of a slowdown in prepayments.
Fees, exchange and other service charges increased $1.7 million or 12% and $3.2 million or 8%, respectively, for the three and nine months ended September 30, 2005 compared to the same prior year periods. These increases were primarily due to an increase in loan fees and higher merchant card transaction income, resulting from increased transaction volume.
Other non-interest income decreased $2.0 million or 20% and $7.6 million or 30%, respectively, for the three and nine months ended September 30, 2005 compared to the same prior year periods. The decrease in other non-interest income for the three months ended September 30, 2005 was due to a reduction in gain from the sale of leveraged lease assets. The decline for the first nine months of 2005 from the same prior year period was due to a $3.2 million distribution from a leasing partnership investment and a $2.5 million gain realized on the sale of a parcel of land, both occurring in the second quarter of 2004, and the previously mentioned decline in gain from the sale of leveraged lease assets.
16
Non-interest expense was relatively unchanged for the three months ended September 30, 2005 compared to the same prior year period. Cost savings in salaries and benefits and net equipment expenses were offset by increased professional fees. For the nine months ended September 30, 2005, non-interest expense decreased by $7.9 million or 3% compared to the same prior year period primarily as a result of lower salaries and benefits and net equipment expenses. Table 5 presents the components of non-interest expense.
Non-Interest Expense (Unaudited)
Table 5
Three Months EndedSeptember 30,
Nine Months EndedSeptember 30,
Salaries and Benefits:
Salaries
27,652
27,993
(1
)%
80,521
83,307
(3
Incentive Compensation
4,385
4,383
12,078
11,459
1,855
2,671
(31
5,398
8,800
(39
Commission Expense
1,864
1,780
6,397
5,691
Retirement and Other Benefits
4,512
4,099
13,717
12,670
Payroll Taxes
2,091
2,415
7,749
8,948
Medical, Dental, and Life Insurance
1,805
2,064
5,859
6,304
(7
Separation Expense
202
1,161
(83
1,272
2,077
Total Salaries and Benefits
(4
(9
(8
66
Other Expense:
Data Services
2,988
2,680
8,783
7,637
Delivery and Postage Services
2,502
2,567
7,357
7,649
13,820
13,290
38,874
40,812
Total Other Expense
Salaries and benefits expense decreased $2.2 million or 5% and $6.3 million or 4%, respectively, for the three and nine months ended September 30, 2005 compared to the same prior year periods. Base salaries decreased as a result of a decline in the number of employees. In addition, stock-based compensation decreased as a result of fewer restricted stock units outstanding in 2005.
Net equipment expense decreased by $0.5 million or 9% and $1.4 million or 8%, respectively, for the three and nine months ended September 30, 2005 compared to the same prior year periods as a result of lower depreciation expense.
Professional fees increased by $2.3 million or 66% and $1.0 million or 10%, respectively, for the three and nine months ended September 30, 2005 compared to the same prior year periods. The increases were primarily a result of the previously announced charges of $3.8 million for legal fees and other expenses relating to the mutual fund business as described in the Company’s press release dated September 30, 2005, excerpts from which are included in Exhibit 99.1 hereto and incorporated herein by reference.
17
The effective tax rate for the three and nine months ended September 30, 2005 was 35.85% and 36.29%, respectively, compared to 36.33% and 35.99% in the comparable periods of 2004. The increase in the rate for the nine months ended September 30, 2005 compared to the same prior year period was largely due to a goodwill impairment charge in the first quarter of 2005, which was not tax deductible.
BALANCE SHEET ANALYSIS
Short-Term Earning Assets
Short-term earning assets, which consist of interest-bearing deposits and funds sold, totaled $20.1 million at September 30, 2005, a decrease of $5.5 million from December 31, 2004 and a decrease of $34.9 million from September 30, 2004.
Investment securities totaled $3.0 billion as of September 30, 2005, a $34.6 million decrease from December 31, 2004 and a $80.4 million increase from September 30, 2004. At September 30, 2005 investment securities with a book value of $1.6 billion were pledged to secure deposits of government entities and $172.5 million was pledged to secure certain repos.
Table 6 presents the details of the investment securities portfolio at September 30, 2005 and December 31, 2004.
Investment Securities (Unaudited)
Table 6
Amortized
Fair
Cost
Value
At September 30, 2005
Securities Available for Sale:
Debt Securities Issued by the U.S. Treasury and Agencies
102,304
102,293
Debt Securities Issued by States and Municipalities
28,505
28,416
Mortgage-Backed Securities
2,120,445
2,101,625
Other Debt Securities
328,564
321,628
2,579,818
2,553,962
Securities Held to Maturity:
70
73
484,971
475,811
475,884
At December 31, 2004
38,551
38,942
7,958
8,081
2,090,510
2,098,994
338,495
337,702
2,475,514
90
96
589,818
585,740
585,836
18
Table 7 presents temporarily impaired investment securities as of September 30, 2005 and December 31, 2004.
Temporarily Impaired Investment Securities (Unaudited)
Table 7
Temporarily ImpairedLess Than 12 Months
Temporarily Impaired12 Months or Longer
Fair Value
Gross Unrealized Losses
56,666
(225
434
57,100
(230
Debt Securities Issued by State and Municipalities
21,060
(172
1,600,563
(17,080
649,073
(18,576
2,249,636
(35,656
Foreign Bonds
294,167
(6,277
24,283
(811
318,450
(7,088
Total Temporarily Impaired Investment Securities:
1,972,456
(23,754
673,790
(19,392
2,646,246
(43,146
December 31, 2004
1,184,863
(10,374
284,389
(4,774
1,469,252
(15,148
The total gross unrealized losses on temporarily impaired investment securities at September 30, 2005 represented 1% of the amortized cost of investment securities. These unrealized losses were primarily attributable to increases in intermediate interest rates during the first nine months of 2005 relative to long-term interest rates which has impacted the market prices of mortgage-backed-securities. The Company intends to hold the securities for the time necessary to recover the amortized cost value.
As of September 30, 2005, loans and leases outstanding were $6.2 billion, an increase of $215.6 million and $387.0 million from December 31, 2004 and September 30, 2004, respectively. Total commercial loans increased as loan originations remained strong. Consumer loans increased primarily as a result of increases in home equity outstandings from successful loan promotions in a strong Hawaii residential real estate market. Table 8 presents the composition of the loan portfolio by major categories and Table 9 presents the composition of consumer loans by geographic area.
19
Loan Portfolio Balances (Unaudited)
Table 8
June 30,
Commercial
968,146
1,000,554
911,843
792,400
574,034
563,581
602,678
648,991
190,603
165,772
122,103
104,457
468,378
471,600
479,100
479,063
Total Commercial
2,201,161
2,201,507
2,115,724
2,024,911
Consumer
2,370,717
2,345,483
2,324,058
2,290,940
778,723
739,161
657,164
609,981
81,076
93,806
122,728
143,300
743,764
742,834
734,721
712,647
27,105
28,627
32,535
33,796
Total Consumer
4,001,385
3,949,911
3,871,206
3,790,664
6,151,418
Consumer Loans by Geographic Area (Unaudited)
Table 9
Hawaii
2,141,715
2,119,843
2,109,785
2,078,817
766,571
726,313
646,372
600,413
557,876
559,840
561,904
546,540
Guam
222,173
219,716
208,626
206,514
8,651
8,636
8,239
8,131
112,848
108,357
98,309
92,124
U.S. Mainland
Other Pacific Islands
6,829
5,924
5,647
5,609
3,501
4,212
2,553
1,437
73,040
74,637
74,508
73,983
Total Consumer Loans
As of September 30, 2005, the Company’s portfolio of residential loans serviced for third parties totaled $2.5 billion. The increase in interest rates as of September 30, 2005 resulted in a higher market value of the mortgage servicing rights. Recent prepayment speeds for Hawaii mortgages were approximately the same or slightly higher than national averages.
Table 10 presents the changes in the carrying value of mortgage servicing rights, net of valuation allowance.
Mortgage Servicing Rights (Unaudited)
Table 10
Year Ended
Balance at Beginning of Period
22,178
Originated Mortgage Servicing Rights
3,529
3,895
Purchased Servicing Rights
30
235
Valuation Allowance
Amortization
(4,279
(7,526
Balance at End of Period
Fair Value at End of Period
23,326
22,154
Other Assets and Other Liabilities
Table 11 presents the major components of other assets and other liabilities.
Other Assets and Other Liabilities (Unaudited)
Table 11
Other Assets:
Bank-Owned Life Insurance
148,870
144,370
142,972
Federal Home Loan Bank and Federal Reserve Bank Stock
79,415
53,847
79,242
Low Income Housing Investments
30,528
34,597
37,114
Accounts Receivable
21,094
25,568
22,782
Federal Tax Deposit
43,000
46,715
46,734
Total Other Assets
Other Liabilities:
Incentive Plans Payable
12,090
9,502
Insurance Premiums Payable
7,189
7,940
6,598
Reserve for Unfunded Commitments 1
4,513
6,800
Self Insurance Reserve
6,167
6,366
6,203
70,261
63,177
66,293
Total Other Liabilities
1 Prior to December 31, 2004, the reserve for unfunded commitments was a component of the allowance for loan and lease losses. As of September 30, 2004, the reserve for unfunded commitments component was $6.7 million.
During the second quarter of 2005, a deposit was placed with the IRS relating to a review by the IRS of the Company’s tax positions for certain leveraged lease transactions. The placing of the deposit will prevent further accrual of potential interest related to the timing of possible tax payments as a result of these transactions. The Company believes its tax position related to these transactions was proper based on applicable statutes, regulations and case laws at the time the transactions were entered into. The Company believes it has adequate reserves for potential tax exposures as of September 30, 2005.
As of September 30, 2005, deposits totaled $7.8 billion, an increase of $191.9 million and $343.3 million from December 31, 2004 and September 30, 2004, respectively. Deposit growth continued primarily in interest-bearing demand and time deposits.
Average time deposits of $100,000 or more are presented in Table 12.
21
Average Time Deposits of $100,000 or More (Unaudited)
Table 12
Sept. 30, 2005
Dec. 31, 2004
Sept. 30, 2004
Average Time Deposits
675,216
543,382
543,065
632,351
573,638
Securities sold under agreements to repurchase totaled $756.4 million at September 30, 2005, an increase of $187.4 million from December 31, 2004 and $73.8 million from September 30, 2004. The increases were due to additional placements received from government entities and $150.0 million in repos placed with private entities in 2005. The private repos are at floating interest rates tied to the London Inter-Bank Offer Rate (“LIBOR”) and the average rate was 2.82% at September 30, 2005. The private repos each have a term of 10 years, with the private entities having the right to terminate those agreements totaling $100.0 million in two years and the right to terminate those agreements totaling $50.0 million in three years and quarterly thereafter. If the agreements are not terminated, the rates become fixed at 3.85% to 4.05% for the remaining terms.
Table 13 presents the composition of securities sold under agreements to repurchase.
Securities Sold Under Agreements to Repurchase (Unaudited)
Table 13
Government Entities
606,407
Private Entities
150,000
Total Securities Sold Under Agreements to Repurchase
Short-Term Borrowings and Long-Term Debt
Short-term borrowings, including funds purchased, totaled $180.9 million at September 30, 2005, an increase of $16.3 million from December 31, 2004 and an increase of $99.2 million from September 30, 2004. Long-term debt totaled $242.7 million at September 30, 2005, a decrease of $9.9 million from December 31, 2004 and September 30, 2004. The decrease was due to the maturity of $10.0 million Federal Home Loan Bank (“FHLB”) advances that matured in the first quarter of 2005. For additional information, refer to the “Corporate Risk Profile – Liquidity Management” section of this report.
The Company’s capital position remains strong. The net reduction in capital from December 31, 2004 to September 30, 2005 was attributable to the Company’s continuing common stock repurchase program and to dividends paid, partially offset by net earnings for the first nine months of 2005. A further discussion of the Company’s capital is included in the “Corporate Risk Profile – Capital Management” section of this report.
Guarantees
The Company’s standby letters of credit totaled $103.1 million at September 30, 2005, an increase of $0.8 million from December 31, 2004 and a decrease of $27.8 million from September 30, 2004.
22
BUSINESS SEGMENTS
The Company’s business segments are defined as Retail Banking, Commercial Banking, Investment Services Group and Treasury and Other Corporate. The Company’s internal management accounting process measures the performance of the business segments based on the management structure of the Company. This process, which is not necessarily comparable with similar information for any other financial institution, uses various techniques to assign balance sheet and income statement amounts to the business segments, including allocations of interest income, expense overhead, the Provision and capital. This process is dynamic and requires certain allocations based on judgment and subjective factors. Unlike financial accounting, there is no comprehensive, authoritative guidance for management accounting that is equivalent to U.S. generally accepted accounting principles. Results for prior periods have been reclassified to conform to current period classifications.
The Company evaluates several performance measures of the business segments, the most important of which are net income after capital charge (“NIACC”) and risk adjusted return on capital (“RAROC”). NIACC is economic net income less a charge for the cost of allocated capital. The cost of allocated capital is determined by multiplying management’s estimate of a shareholder’s minimum required rate of return on the cost of capital invested (currently 11%) by the segment’s allocated equity. The Company assumes a cost of capital that is equal to a risk-free rate plus a risk premium. RAROC is the ratio of economic net income to risk-adjusted equity. Equity is allocated to each business segment based on an assessment of its inherent risk. The net interest income of the business segments reflects the results of a funds transfer pricing process that matches assets and liabilities with similar interest rate sensitivity and maturity characteristics and reflects the allocation of net interest income related to the Company’s overall asset and liability management activities on a proportionate basis. The basis for the allocation of net interest income is a function of management decisions and assumptions that are subject to change based on changes in current interest rate and market conditions. Funds transfer pricing also serves to transfer interest rate risk to the Treasury segment. However, the other business segments have some latitude to retain certain interest rate exposures related to customer pricing decisions within guidelines. The GAAP Provision recorded in the Retail Banking, Commercial Banking and Investment Services Group segments represents actual net charge-offs of these segments. The GAAP Provision charged to the Treasury and Other Corporate segment represents changes in the level of the reserve for credit losses. The business segments are charged an economic provision which is a statistically derived estimate of average annual expected credit losses over an economic cycle, adjusted for the period presented.
The financial results for each of the business segments for the three and nine months ended September 30, 2005 and 2004 are discussed below and are presented in Table 14a and 14b.
Retail Banking
The Company’s Retail Banking segment offers a broad range of financial products and services to consumers and small businesses. Loan and lease products include residential mortgage loans, home equity lines of credit, automobile loans and leases and installment loans. Deposit products include checking, savings and time deposit accounts. The Retail Banking segment also provides merchant services to its small business customers. Products and services from the Retail Banking segment are delivered to customers through 72 Hawaii branch locations, 500 ATMs, e-Bankoh (on-line banking service) and a 24-hour telephone banking service. Also included in the segment is Bankoh Investment Services, Inc., a full service brokerage offering equities and bonds, mutual funds, life insurance and annuity products.
23
The improvement in the segment’s key financial measures for the three and nine months ended September 30, 2005 as compared to the same periods in 2004 was primarily due to increases in both net interest income and non-interest income. The increase in net interest income was the result of higher earnings credit on the funds transfer pricing of the segment’s deposit portfolio as well as increased loan and deposit balances. The increase in non-interest income was primarily due to policy initiatives and growth in the number of deposit accounts, along with increased mortgage banking income. Non-interest expense declined for the nine months ended September 30, 2005 as compared to the same period in the prior year primarily due to lower allocated expenses from support units within the Company.
Commercial Banking
The Commercial Banking segment offers products including corporate banking and commercial real estate loans, lease financing, auto dealer financing, deposit and cash management products and property and casualty insurance products. Lending, deposit and cash management services are offered to middle-market and large companies in Hawaii. Commercial real estate mortgages are focused on customers that include investors, developers and builders primarily domiciled in Hawaii. The Commercial Banking unit also includes the Company’s operations at its 12 branches in the Pacific Islands.
The improvement in the segment’s financial measures for the three and nine months ended September 30, 2005 compared to the same periods in 2004 was a result of an increase in net interest income and a decrease in non-interest expense, partially offset by lower non-interest income. The increase in net interest income was due primarily to higher deposit balances and higher earnings credit on the funds transfer pricing on the segment’s deposit portfolio. The decrease in non-interest income was primarily due to the distribution from a leasing partnership investment in the second quarter of 2004 and a higher gain on the disposal of leased equipment recognized in the third quarter of 2004 compared to the same quarter in 2005. The reduction in non-interest expense was primarily due to lower salaries expense.
Investment Services Group
The Investment Services Group includes private banking, trust services, asset management and institutional investment advice. A significant portion of this segment’s income is derived from fees, which are generally based on the market values of assets under management. The private banking and personal trust group assists individuals and families in building and preserving their wealth by providing investment, credit and trust expertise to high-net-worth individuals. The asset management group manages portfolios and creates investment products. Institutional sales and service offers investment advice to corporations, government entities and foundations.
The decline in the segment’s key financial measures for the three months ended September 30, 2005 compared to the same period in 2004 was primarily due to previously announced charges related to the mutual fund business. Increases in both net interest income and non-interest income partially offset the increased expenses. Trust and asset management fee income increased largely due to improved market conditions which resulted in an increase in the average market value of assets under management and an increase in investment advisory fees on money market accounts. The increase in net interest income primarily resulted from a transfer of private and consumer banking relationships between this segment and the Retail segment.
The improvement in the segment’s key financial measures for the nine months ended September 30, 2005 compared to the same period in 2004 was due to increases in both net interest income and non-interest income. Trust and asset management fee income increased largely due to improved market conditions which resulted in an increase in the average market value of assets under management and an increase in investment advisory fees on money market accounts. The increase in net interest income primarily resulted from a transfer of private and consumer banking relationships between this segment and the Retail segment. Non-interest expense increased period over period primarily due to legal and other expenses.
24
Treasury and Other Corporate
The primary income earning component of this segment is Treasury, which consists of corporate asset and liability management activities, including interest rate risk management and foreign exchange business. This segment’s assets and liabilities (and related net interest income) consist of interest-bearing deposits, investment securities, funds sold and purchased, government deposits and short- and long-term borrowings. The primary source of foreign exchange income relates to customer driven currency requests from merchants and island visitors. The net residual effect of transfer pricing of assets and liabilities is included in Treasury, along with eliminations of inter-company transactions.
This segment also includes divisions (Technology and Operations, Human Resources, Finance, Credit and Risk Management and Corporate and Regulatory Administration) that provide a wide-range of support to the other business segments. Expenses incurred by these support units are charged to the business segments through an internal cost allocation process.
The decrease in the segment’s key financial measures for the three and nine months ended September 30, 2005 as compared to the same periods in 2004 was primarily due to a decrease in net interest income. Net interest income decreased due to the impact of the higher cost of funding deposits by the Treasury unit. Income earned on higher average balances in the investment portfolio partially offset the reduction. In addition, for the nine-month period ended September 30, 2005, non-interest income was lower in 2005 due to the sale of a parcel of land in 2004. Non-interest expenses decreased due to reduced stock-based compensation and separation expenses. In addition, for the nine-month period, non-interest expense declined due to a legal settlement in 2004.
25
Business Segment Selected Financial Information (Unaudited)
Table 14a
Investment
Retail
Services
and Other
Consolidated
Banking
Group
Corporate
Three Months Ended September 30, 2005
56,549
36,017
3,223
6,171
GAAP Provision
10,564
(10,510
Net Interest Income After GAAP Provision
53,603
25,453
16,681
25,595
13,385
14,097
2,439
79,198
38,838
17,320
19,120
154,476
(44,517
(22,025
(15,683
(2,371
(84,596
34,681
16,813
1,637
16,749
(12,832
(6,327
(606
(5,286
(25,051
Allocated Net Income
21,849
10,486
1,031
11,463
Allowance Funding Value
(178
(586
769
Economic Provision
(3,364
(2,410
(105
(5,880
Tax Effect of Adjustments
221
(2,800
41
1,066
Income Before Capital Charge
21,474
15,254
962
5,325
43,015
Capital Charge
(5,569
(4,645
(1,548
(8,113
(19,875
Net Income (Loss) After Capital Charge (NIACC)
15,905
10,609
(2,788
23,140
RAROC (ROE for the Company)
42
36
Total Assets at September 30, 2005
3,829,656
2,538,084
184,757
3,532,738
Three Months Ended September 30, 2004
51,329
33,967
2,889
10,594
2,121
(847
(1,273
49,208
34,814
2,890
11,867
22,430
15,350
12,812
2,462
71,638
50,164
15,702
14,329
151,833
(43,605
(23,019
(13,632
(3,934
(84,190
28,033
27,145
2,070
10,395
(10,372
(10,069
(766
(3,369
(24,576
17,661
17,076
1,304
7,026
(166
(621
(6
793
(3,584
(2,467
(86
(6,138
602
1,456
179
2,271
16,634
14,597
1,245
6,724
39,200
(5,441
(4,824
(1,344
(8,515
(20,124
11,193
9,773
(99
(1,791
19,076
33
Total Assets at September 30, 2004
3,711,048
2,295,901
124,943
3,462,917
26
Table 14b
Nine Months Ended September 30, 2005
163,111
106,105
9,334
25,107
9,962
11,216
(18,177
153,149
94,889
9,335
43,284
74,917
33,651
42,952
6,985
228,066
128,540
52,287
50,269
459,162
(130,135
(65,604
(42,594
(6,130
(244,463
97,931
62,936
9,693
44,139
(36,235
(23,326
(3,586
(14,772
(77,919
61,696
39,610
6,107
29,367
(509
(1,788
(17
2,314
(10,304
(7,300
(298
(17,905
315
(787
117
5,871
5,516
61,160
40,951
5,908
19,372
127,391
(16,449
(13,842
(4,317
(26,436
(61,044
44,711
27,109
1,591
(7,064
66,347
Nine Months Ended September 30, 2004
151,010
101,569
8,533
29,547
7,455
1,630
47
(12,632
143,555
99,939
8,486
42,179
67,833
37,923
40,238
10,750
211,388
137,862
48,724
52,929
450,903
(131,382
(69,092
(39,888
(11,975
(252,337
80,006
68,770
8,836
40,954
(29,602
(25,450
(3,269
(13,147
(71,468
50,404
43,320
5,567
27,807
(442
(2,045
2,507
(10,489
(8,065
(279
(18,839
1,286
3,138
93
3,749
8,266
48,214
37,978
5,408
21,425
113,025
(16,696
(15,218
(26,465
(62,313
31,518
22,760
1,474
(5,040
50,712
32
27
CORPORATE RISK PROFILE
Credit Risk
Credit Risk is defined as the risk that borrowers or counterparties will not be able to repay their obligations to the Company. Credit exposures reflect legally binding commitments for loans, leases, banker’s acceptances, financial and performance standby letters of credit and overnight overdrafts.
The Company’s credit risk position remained stable during the first nine months of 2005. The Company continued to observe lower levels of internally criticized loans and non-performing assets. Following the bankruptcy announcement of a national air carrier in the third quarter of 2005, the Company charged-off its entire exposure of $10.0 million to this borrower and has no material exposure to any other air carrier currently in bankruptcy. This credit exposure was fully reserved.
The ratio of non-accrual loans to total loans at September 30, 2005 was 0.12%, down from 0.23% at December 31, 2004. Annualized net loan charge-offs for the first nine months of 2005 as a percent of average loans outstanding was 0.45%, an increase from 0.02% from the same prior year period primarily due to the $10.0 million charge-off mentioned above and a $6.0 million recovery of a previously charged-off loan from the divested Asia business in 2004. Excluding this charge-off, the 2005 year-to-date ratio would have been 0.23%.
The risk profile of the Hawaii and Guam-based loan portfolios continued to improve during the third quarter, primarily due to the expanding local economies led by the construction and real estate industries and record levels of tourism despite sustained high oil prices.
Outstandings related to the aircraft operations of domestic legacy carriers as of September 30, 2005 were $9.4 million and are included in the United States National Passenger Carriers total, as shown in Table 15 below. Relative to the Company’s total portfolio, domestic legacy airline carriers continued to demonstrate a higher risk profile with negative trends due to sustained high oil prices. In the evaluation of the reserve for credit losses, the Company considered the current financial strain on airlines, which offset the impact of the improvement in other components of the loan portfolio.
Air Transportation Credit Exposure 1(Unaudited)
Table 15
Unused
Outstanding
Commitments
Exposure
United States Regional Passenger Carriers
41,206
1,656
42,862
54,981
57,505
United States National Passenger Carriers
27,816
37,377
37,771
Passenger Carriers Based Outside United States
21,573
25,910
28,540
Cargo Carriers
13,240
13,771
Total Air Transportation Credit Exposure
103,835
105,491
132,039
137,587
1 Exposure includes loans, leveraged leases and operating leases.
Non-Performing Assets
Non-performing assets (“NPAs”) consist of non-accrual loans, foreclosed real estate and other investments. NPAs decreased by $5.6 million from December 31, 2004 to $8.3 million as of September 30, 2005.
Impaired loans totaled $1.6 million at September 30, 2005, a decrease of $2.2 million from $3.8 million at December 31, 2004. Impaired loans had a related Allowance of less than $0.1 million at September 30, 2005 and December 31, 2004.
28
Loans Past Due 90 Days or More and Still Accruing Interest
Accruing loans past due 90 days or more were $3.2 million at September 30, 2005, an increase of $1.1 million from December 31, 2004. The increase was due to past due residential mortgage loans and personal unsecured lines of credit, partially offset by positive resolutions of prior period amounts. Loss rates on residential mortgage loans in the Hawaii portfolio were negligible.
Refer to Table 16 for further information on non-performing assets and accruing loans past due 90 days or more.
Consolidated Non-Performing Assets and Accruing Loans Past Due 90 Days or More (Unaudited)
Table 16
Non-Accrual Loans
471
430
775
1,555
1,739
2,106
5,552
1,586
2,973
1,913
2,030
3,755
5,762
8,240
5,083
6,034
7,688
7,278
156
218
251
5,124
6,190
7,906
7,529
Total Non-Accrual Loans
7,154
9,945
13,668
15,769
292
Other Investments
Total Non-Performing Assets
8,250
10,920
13,859
15,977
Accruing Loans Past Due 90 Days or More
52
65
2,213
688
2,222
753
1,545
1,310
387
2,588
83
183
97
1,479
1,417
1,433
1,533
51
3,158
2,727
2,033
4,250
Total Accruing Loans Past Due 90 Days or More
4,949
5,003
Ratio of Non-Accrual Loans to Total Loans
0.12
0.16
0.23
0.27
Ratio of Non-Performing Assets to Total Loans, Foreclosed Real Estate and Other Investments
0.13
0.18
Ratio of Non-Performing Assets and Accruing Loans Past Due 90 Days or More to Total Loans
0.26
0.36
Quarter to Quarter Changes in Non-Performing Assets
Balance at Beginning of Quarter
13,365
21,160
Additions
919
3,088
5,164
2,094
Reductions
Payments
(1,326
(5,097
(6,435
(1,386
Return to Accrual
(2,007
(392
(456
(1,122
Sales of Foreclosed Assets
(206
(682
Charge-offs/Write-downs
(256
(44
(185
(88
Transfer to Premises
(3,999
Total Reductions
(3,589
(5,533
(7,282
(7,277
Balance at End of Quarter
29
Reserve for Credit Losses
The Company’s reserve for credit losses is comprised of two components, the Allowance for Loan and Lease Losses (“Allowance”) and the Reserve for Unfunded Commitments (“Unfunded Reserve”). The Unfunded Reserve was reclassified on a prospective basis at December 31, 2004 from the Allowance to other liabilities in the Company’s Consolidated Statements of Condition.
The Company maintains the Allowance at a level adequate to cover management’s estimate of probable credit losses inherent in its lending portfolios. The Unfunded Reserve is maintained at an adequate level to cover management’s estimate of probable credit losses inherent in unfunded commitments to extend credit. The adequacy of the Allowance and the Unfunded Reserve is based on a comprehensive quarterly analysis of historical loss experience, supplemented by judgmental expectations of portfolio performance and economic conditions as of a given balance sheet date.
The Allowance and the Unfunded Reserve are both increased and decreased through the Provision. After considering net charge-offs, the changes in the Allowance and the Unfunded Reserve resulted in a $3.0 million Provision being recorded for the three and nine months ended September 30, 2005.
The Allowance declined by $15.1 million at September 30, 2005 from December 31, 2004 primarily due to net loan charge-offs of $20.4 million partially offset by the $3.0 million Provision. The ratio of the Allowance to loans and leases outstanding was 1.48% at September 30, 2005, a decrease of 30 basis points from December 31, 2004.
The Unfunded Reserve declined by $2.3 million from December 31, 2004 primarily due to the cancellation of a letter of credit to an air transportation company.
A summary of the reserve for credit losses is presented in Table 17.
Consolidated Reserve for Credit Losses (Unaudited)
Table 17
106,163
124,904
113,596
129,080
Loans Charged-Off
620
227
1,775
3,942
574
10,049
607
130
226
512
690
173
723
464
4,488
4,268
13,617
13,487
45
69
109
Total Loans Charged-Off
15,319
4,950
26,745
19,893
Recoveries on Loans Previously Charged-Off
528
1,206
1,281
3,431
146
1,093
240
1,933
94
529
162
190
207
485
805
154
126
281
1,322
1,502
3,775
4,868
58
80
Foreign
519
7,038
Total Recoveries on Loans Previously Charged-Off
2,323
4,697
6,316
18,964
Net Loan Charge-Offs
(12,996
(253
(20,429
(929
Balance at End of Period 1
96,167
124,651
Components
91,654
Reserve for Unfunded Commitments 2
Total Reserve for Credit Losses
Average Loans Outstanding
Ratio of Net Loan Charge-Offs to Average Loans Outstanding (annualized)
0.02
0.45
Ratio of Allowance to Loans and Leases Outstanding 2
1 Included in this analysis is activity related to the Company’s reserve for unfunded commitments, which is separately recorded in other liabilities in the Consolidated Statements of Condition.
2 The reclassification of the reserve for unfunded commitments to other liabilities occurred in the fourth quarter of 2004 on a prospective basis. Thus, September 30, 2004 allowance for loan and lease losses and reserve for unfunded commitments were reported together. At September 30, 2004, the reserve for unfunded commitments was $6.7 million.
Market Risk
Market risk is the potential of loss arising from adverse changes in interest rates and prices. The Company is exposed to market risk as a consequence of the normal course of conducting its business activities. Financial products that expose the Company to market risk include investment securities, loans, deposits, debt and derivative financial instruments. The Company’s market risk management process involves measuring, monitoring, controlling and managing risks that could significantly impact the Company’s financial position and operating results. In this management process, market risks are balanced with expected returns in an effort to enhance earnings performance and shareholder value, while limiting the volatility of each. The activities associated with these market risks are categorized into “trading” and “other than trading.”
31
The Company’s trading activities include foreign currency and foreign exchange contracts that expose the Company to a minor degree of foreign currency risk. These transactions are primarily executed on behalf of customers and, at times, for the Company’s own account.
The Company’s “other than trading” activities include normal business transactions that expose the Company’s balance sheet profile to varying degrees of market risk.
Interest Rate Risk
The Company’s balance sheet is sensitive to changes in the general level of interest rates. This interest rate risk is a form of market risk and arises primarily from the Company’s normal business activities of making loans and taking deposits. Many other factors also affect the Company’s exposure to changes in interest rates, such as general economic and financial conditions and historical pricing relationships.
Table 18 presents, as of September 30, 2005 and 2004, the estimate of the change in net interest income (“NII”) that would result from a gradual 200 basis point decrease or increase in interest rates, moving in parallel fashion over the entire yield curve, over the next 12-month period, relative to the measured base case scenario for NII. The 200 basis point increase would equate to an average increase of $1.8 million in NII per quarter. The Company’s balance sheet continues to be asset-sensitive based on a parallel increase in rates over the entire yield curve over the next 12-month period.
Market Risk Exposure to Interest Rate Changes (Unaudited)
Table 18
Interest Rate Change(in basis points)
-200
200
Estimated Exposure as a Percent of Net Interest Income
(3.9
1.8
(6.1
Estimated Exposure to Net Interest Income Per Quarter
(3,958
1,827
(5,921
2,232
The Company uses several approaches to manage its interest rate risk in an effort to shift balance sheet mix or alter the interest rate characteristics of its assets and liabilities. These approaches can include changing product pricing strategies, modifying investment portfolio characteristics, or using financial derivative instruments. The use of financial derivatives has been limited over the past several years.
Liquidity Management
Liquidity is managed in an effort to ensure that the Company has continuous access to sufficient, cost effective funding to conduct its business and meet its obligations as they become due in a normal manner.
The Bank is a member of the FHLB, which provides an additional source of short- and long-term funding. Borrowings from the FHLB were $77.5 million at September 30, 2005, compared to $87.5 million at December 31, 2004 and September 30, 2004. The decrease was due to a $10.0 million advance that matured in the first quarter of 2005.
Additionally, the Bank maintains a $1.0 billion senior and subordinated bank note program. Under this facility, the Bank may issue additional notes provided that the aggregate amount outstanding does not exceed $1.0 billion. Subordinated notes outstanding under this bank note program totaled $124.8 million at September 30, 2005 and December 31, 2004 and $124.7 million at September 30, 2004.
Capital Management
The Company and the Bank are subject to regulatory capital requirements administered by the federal banking agencies. The Company’s objective is to hold sufficient capital on a regulatory basis to exceed the minimum guidelines of a “well capitalized” financial institution, while over the long term optimize shareholder value, support asset growth, provide protection against unforeseen losses and risks inherent in its markets and comply with regulatory requirements.
At September 30, 2005, shareholders’ equity totaled $696.3 million, a 15% decrease from December 31, 2004. The decrease in shareholders’ equity during the first nine months of 2005 was primarily attributable to the Company’s repurchase of its common stock under the repurchase program and to dividends paid, partially offset by earnings.
During the nine months ended September 30, 2005, 4.4 million shares of common stock were repurchased under the repurchase program at an average cost of $48.01 per share, totaling $212.3 million. From the beginning of the share repurchase program in July 2001 through September 30, 2005, the Company repurchased a total of 39.4 million shares and returned a total of $1.3 billion to its shareholders at an average cost of $33.03 per share. From October 1, 2005 through October 21, 2005, the Company repurchased an additional 75.0 thousand shares of common stock at an average cost of $48.66 per share for a total of $3.6 million, resulting in remaining buyback authority under the share repurchase program of $46.6 million.
In October 2005, the Company’s Board of Directors declared a quarterly cash dividend of $0.37 per share on the Company’s outstanding shares. The dividend will be payable on December 14, 2005 to shareholders of record at the close of business on November 30, 2005.
Table 19 presents the regulatory capital and ratios as of September 30, 2005, December 31, 2004 and September 30, 2004.
Regulatory Capital and Ratios (Unaudited)
Table 19
Regulatory Capital
Add:
8.25% Capital Securities of Bancorp Hawaii Capital Trust I
31,425
Unrealized Valuation and Other Adjustments
(16,528
5,251
10,784
Tier 1 Capital
709,305
804,792
741,132
Allowable Reserve for Credit Losses
86,700
83,292
80,604
Qualifying Subordinated Debt
74,876
99,808
99,798
Unrealized Gains on Available for Sale Equity Securities
Total Regulatory Capital
870,881
987,923
921,586
Risk-Weighted Assets
6,926,535
6,633,082
6,404,282
Key Regulatory Capital Ratios
Tier 1 Capital Ratio
10.24
12.13
11.57
Total Capital Ratio
12.57
14.89
14.39
8.29
Financial Outlook
The Company currently estimates net income for the full year of 2005 will be approximately $179.0 million to $181.0 million. The Company performs a quarterly analysis of credit quality to determine the adequacy of the reserve for credit losses. The results of this analysis determine the timing and amount of the Provision.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Management’s Discussion and Analysis of Financial Condition and Results of Operations-Market Risk.
Item 4. Controls and Procedures
The Company’s management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)) as of September 30, 2005. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2005. There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Part II. - Other Information
Items 1, 3, 4 and 5 omitted pursuant to instructions.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Total Number of
Shares Purchased
Approximate Dollar Value
as Part of Publicly
of Shares that May Yet Be
Average Price
Announced Plans or
Purchased Under the Plans
Period
Shares Purchased 1
Paid Per Share
Programs
or Programs 2
July 1 - 31, 2005
101,934
52.84
100,000
83,779,272
August 1 - 31, 2005
412,126
50.78
411,700
62,873,017
September 1 - 30, 2005
254,493
50.18
251,000
50,279,404
768,553
50.85
762,700
1 The months of July, August and September included 1,934, 426 and 3,493 mature shares, respectively, purchased from employees in connection with stock option exercises. These shares were not purchased as part of the publicly announced program. The shares were purchased at the closing price of the Company’s common stock on the dates of purchase.
2 The Company repurchased shares during the third quarter of 2005 pursuant to its ongoing share repurchase program that was first announced in July 2001. As of October 21, 2005, $46.6 million remained of the total $1.35 billion total repurchase amount authorized by the Company’s Board of Directors under the share repurchase program. The program has no set expiration or termination date.
Item 6. Exhibits
Exhibit Index
Exhibit Number
Statement Regarding Computation of Ratios
31.1
Rule 13a-14(a) Certifications
Section 1350 Certification, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1
Excerpt from Bank of Hawaii Corporation Press Release dated September 30, 2005
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: October 26, 2005
By:
/s/ Allan R. Landon
Allan R. Landon
Chairman of the Board,
Chief Executive Officer and President
/s/ Richard C. Keene
Richard C. Keene
Chief Financial Officer
EXHIBIT INDEX