UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
OR
Commission file number 0-7949
BANCWEST CORPORATION
Registrant’s telephone number, including area code: (808) 525-7000
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed bySection 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 No
Indicate by check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act). Yes No x
As of April 30, 2004 the number of outstanding shares of each of the issuer’s classes ofcommon stock (all of which were beneficially owned by BNP Paribas) was:
BANCWEST CORPORATION AND SUBSIDIARIES
FORM 10-QMarch 31, 2004
INDEX
Exhibit 2 Agreement and Plan of Merger dated as of March 15, 2004 among BancWest Corporation, BW Newco, Inc. and Community First Bankshares, Inc.
Exhibit 12 Statement Regarding Computation of Ratios
Exhibit 31 Section 302 Certifications
Exhibit 32 Section 1350 Certifications
The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such periods. Such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for the full year. The interim financial information should be read in conjunction with BancWest Corporation’s 2003 Annual Report on Form 10-K.
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
BancWest Corporation and Subsidiaries
The accompanying notes are an integral part of these consolidated financial statements.
2
3
4
5
Descriptions of Operations
BancWest Corporation is a financial holding company headquartered in Honolulu, Hawaii and incorporated under the laws of the State of Delaware. Through our principal subsidiaries, Bank of the West and First Hawaiian Bank, we provide commercial and consumer banking services, engage in commercial, equipment and vehicle leasing and offer trust, investment and insurance products. BancWest Corporation’s subsidiaries operate 357 branches in the states of California, Hawaii, Oregon, Washington, Idaho, New Mexico and Nevada and in Guam and Saipan.
Basis of Presentation
We have prepared the accompanying financial data for the three months ended March 31, 2004 and 2003 pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations.
In the opinion of management, the accompanying condensed consolidated financial statements contain all normal and recurring adjustments necessary to present fairly our condensed consolidated financial position as of March 31, 2004, December 31, 2003 and March 31, 2003, condensed consolidated results of operations for the three months ended March 31, 2004 and 2003, and cash flows activities for the three months ended March 31, 2004 and 2003.
The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management’s best knowledge of current events and actions that may impact the Company in the future, actual results may be different from the estimates. Our critical accounting policies are those that affect our financial statements materially and involve difficult, subjective or complex judgments by management.
Descriptions of the significant accounting policies of BancWest Corporation and subsidiaries (“BancWest,” the “Company” or “we/our”) are included in Note 1 (Summary of Significant Accounting Policies) to the audited consolidated financial statements included in the Company’s 2003 Annual Report on Form 10-K. There have been no significant changes to these policies.
Reclassifications
Certain amounts in the financial statements for prior periods have been reclassified to conform with the current financial statement presentation. Such reclassifications did not have a material effect on the Consolidated Financial Statements.
Community First Acquisition
On March 16, 2004, BancWest announced that it signed an agreement to acquire Community First Bankshares, Inc. (Community First), a holding company that operates Community First National Bank (CFB). It is anticipated that the purchase transaction will close in the third quarter of 2004, subject to approval from Community First shareholders and federal and state banking regulators. Subsequently, CFB will be merged with and into Bank of the West and its branches will be integrated into Bank of the West’s branch network system. The acquisition of Community First will add 10 new states to Bank of the West’s footprint, as well as to our market share in California and New Mexico. CFB operates 155 branches in 12 states in the Southwest, Rocky Mountains, Great Plains and east to Minnesota, Iowa and Wisconsin. CFB’s retail operations in growing states will complement the Bank’s existing network in California, Nevada, New Mexico and the Pacific Northwest. At March 31, 2004 CFB had total assets of $5.5 billion, total deposits of $4.4 billion and loans of $3.3 billion. Following the acquisition, results of operations of Community First will be included in our Consolidated Financial Statements. The purchase price of approximately $1.2 billion will be paid in cash and accounted for as a purchase.
6
BancWest Corporation and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)(Continued)
Any portion of the changes in the fair value of a derivative designated as a hedge that is deemed ineffective is recorded in current period earnings; this amount was not material in the three months ended March 31, 2004 and 2003.
Fair Value Hedges
The Company has various derivative instruments that hedge the fair values of recognized assets or liabilities or of unrecognized firm commitments (“fair value” hedges). At March 31, 2004, the Company carried an interest rate swap of $2.7 million with a fair market value loss of $0.7 million that was categorized as a fair value hedge for a commercial loan. The Company receives 1-month LIBOR and pays a fixed rate of 8.32%. At March 31, 2003, the Company carried $2.8 million of such swaps with a fair market value loss of $0.8 million.
At November 20, 2002, BancWest Corporation executed a $150 million interest rate swap agreement with BNP Paribas to hedge the fair value of the 9.5% BancWest Capital I Quarterly Income Preferred Securities (the BWE Capital Securities) issued by BancWest Capital I. Following the adoption of FIN 46 (see Note 7), BancWest Capital I was deconsolidated, resulting in recognition of $150 million subordinated debt instead of the BWE Capital Securities. The terms of the subordinated debt mirror those of the BWE Capital Securities. Concurrent with the deconsolidation of BancWest Capital I, the Bank redesignated the interest rate swap to hedge the subordinated debt. The derivative instrument is highly effective and all changes in the fair value of the hedge were recorded in current-period earnings together with the offsetting change in fair value of the hedged item attributable to the risk being hedged. We pay 3-month LIBOR plus 3.69% and receive fixed payments at 9.5%. The fair market value loss of the swap was $0.5 million and a gain of $1.2 million at March 31, 2004 and 2003, respectively.
In addition, at March 31, 2004, the Company carried interest rate swaps totaling $77.9 million with a market value loss of $6.7 million that were categorized as fair value hedges for commercial and commercial real estate loans. The Company receives 6-month LIBOR and pays fixed rates from 3.56% to 7.99%. At March 31, 2003, the Company carried $126.6 million of such swaps with a market value loss of $11.8 million.
At March 31, 2004, the Company carried interest rate swaps and swaptions totaling $8.6 million with a market value gain of $0.6 million that were categorized as fair value hedges for repurchase agreements. The Company pays 3-month LIBOR and receives fixed rates ranging from 8.29% to 8.37%. At March 31, 2003, the Company carried $8.6 million of such swaps and swaptions with a market value gain of $0.8 million.
Cash Flow Hedges
At March 31, 2004, the Company carried interest rate swaps of $600 million with a fair market value gain of $48.3 million which are categorized as cash flow hedges, to hedge our LIBOR-based commercial loans. The hedges had a fair market value gain of $59.9 million at March 31, 2003. The interest rate swaps were entered into during 2001 and mature in 2006. We pay 3-month LIBOR and receive fixed rates ranging from 5.64% to 5.87%. The net settlement on the $600 million swaps has increased commercial loan interest income by $6.1 million from January 1, 2004 through March 31, 2004 and by $5.8 million from January 1, 2003 through March 31, 2003. The Company estimates net settlement gains, recorded as commercial loan interest income, of $23.5 million over the next twelve months resulting from these hedges.
At March 31, 2004, the Company carried interest rate swaps totaling $100 million with a fair market value gain of $1.3 million in order to reduce exposure to interest rate increases associated with short-term fixed rate liabilities. The swaps hedge forecasted transactions associated with short-term fixed rate liabilities. The swaps mature as follows: $70 million in 2013, $20 million in 2018 and $10 million in 2023. We pay fixed rates ranging from 3.65% to 4.58% and receive 3-month LIBOR. The effect on pre-tax income from these swaps for the three months ended March 31, 2004 was a loss of $0.8 million. The Company estimates a net increase to interest expense of $3.1 million over the next twelve months resulting from these hedges.
7
Free-standing Derivative Instruments
Free-standing derivative instruments include derivative transactions entered into for risk management purposes that do not otherwise qualify for hedge accounting. Interest rate lock commitments issued on residential mortgage loans intended to be held for resale are considered free-standing derivative instruments. Trading activities primarily involve providing various free-standing interest rate and foreign exchange derivative products to customers. Interest-rate derivative instruments utilized by the Company in its trading operations include interest-rate swaps, caps, floors and collars.
The following table summarizes derivatives held by the Company as of March 31, 2004, December 31, 2003 and March 31, 2003:
8
Our reportable segments are the ones we use in our internal reporting at Bank of the West and First Hawaiian Bank. Bank of the West’s segments operate primarily in California, Oregon, Washington, Idaho, New Mexico and Nevada. As discussed below, certain Bank of the West segments conduct business nationwide. Although First Hawaiian Bank’s segments operate primarily in Hawaii, it also has significant operations outside the state, such as leveraged leases, international banking and branches in Guam and Saipan.
The results of each segment are determined by our management accounting process, which assigns balance sheet and income statement items to each reporting segment. The net interest income of each segment includes the results of the respective bank’s transfer pricing process, which assesses an internal funds charge on all segment assets and a funds credit on all segment liabilities. The internal charges and credits assigned to each asset and liability are intended to match the maturity, repayment and interest rate characteristics of that asset or liability. With the exception of goodwill, assets are allocated to each business segment on the basis of assumed benefit to their business operations. Goodwill is assigned on the basis of projected future earnings of the segments. The process of management accounting is dynamic and subjective. There is no comprehensive or authoritative guidance which can be followed. Changes in management structure and/or the allocation process may result in changes in allocations and transfers. In that case, results for prior periods would be (and have been) reclassified for comparability. Results for 2003 have been reclassified to reflect changes in the transfer pricing methodology and noninterest income and expense allocation methodology applied in 2004.
Bank of the West
Bank of the West manages its operations through three business segments: Regional Banking, Commercial Banking and Consumer Finance.
Regional Banking
Regional Banking seeks to serve a broad customer base by furnishing a wide range of retail and commercial banking products. Deposit products offered by this segment include checking accounts, savings deposits, market rate accounts, individual retirement accounts and time deposits. Regional Banking utilizes its branch network as its principal funding source. Bank of the West’s telephone banking service, a network of automated teller machines and the online eTimeBanker service provide retail customers with other means of accessing and managing their accounts.
Through its branch network, this business segment originates a variety of consumer loans, including direct vehicle loans, lines of credit and second mortgages. In addition, Regional Banking originates and holds a portfolio of first mortgage loans on one- to four-family residences. Through its commercial banking operations conducted from its branch network, Regional Banking offers a wide range of commercial banking products intended to serve the needs of smaller community-based businesses. These include in-branch originations of standardized loan and deposit products for businesses with relatively simple banking and financing needs. Regional Banking also provides a number of fee-based products and private banking services including trust, insurance and investment services.
More complex and customized commercial banking services are offered through the segment’s Business Banking Centers which serve clusters of branches and provide lending, deposit and cash management services to companies operating in the relevant market areas. Business Banking Centers support commercial lending activities for middle market business customers in locations throughout California, as well as Portland, Oregon, Reno and Las Vegas, Nevada and Albuquerque, New Mexico.
The Regional Banking Segment also includes a Pacific Rim Division which offers multilingual services through a branch network in predominately Asian American communities in California, with specialized domestic and international products and services for both individuals and companies.
Commercial Banking
The Commercial Banking Segment is comprised of several divisions: Commercial Banking Division, Agribusiness Banking Division, Real Estate Industries Division and Specialty areas. The Commercial Banking Division supports business clients with revenues between $25 million and $500 million. The Commercial Banking Division focuses on relationship banking including deposit generation as well as lending activities. The Agribusiness Banking Division serves all agribusiness and rural commercial clients. The Real Estate Industries Division provides construction financing to large regional and national real estate developers for residential and commercial projects. Interim and permanent financing is available on these commercial real estate projects.
9
The Commercial Banking Segment also includes specialty areas: Church Lending, Small Business Administration (SBA), Health Care, Leasing, Credit Union, Government, Correspondent Banking, Cash Management Services and Capital Markets. Equipment leasing is available through the Company’s commercial offices, branches, brokers across the nation and its subsidiary, Trinity Capital. Trinity specializes in nationwide vendor leasing and servicing programs for manufacturers in specific markets.
All areas within the Commercial Banking Segment focus on cross-sell opportunities. The Commercial Banking Segment also provides trade finance and functions as an agent in commercial, agribusiness and real estate syndication transactions.
Consumer Finance
The Consumer Finance Segment targets the origination of auto loans and leases in the western United States, and recreational vehicle and marine loans nationwide, with emphasis on originating credits at the high end of the credit spectrum. These loans and leases are originated through a network of auto dealers and recreational vehicle and marine dealers serviced by sales representatives located throughout the country. This segment also includes Bank of the West’s wholly-owned subsidiary, Essex Credit Corporation, which focuses on the origination of marine and recreational vehicle loans directly with customers. In February 2004, Essex began retaining certain types of loans in its own portfolio. In previous years, Essex sold substantially all of its loans to investors on a servicing released basis. Essex has office locations throughout the United States.
First Hawaiian Bank
First Hawaiian manages its operations through the following business segments: Retail Banking, Consumer Finance, Commercial Banking and Financial Management.
Retail Banking
First Hawaiian Bank’s Retail Banking Segment operates through 56 banking offices located throughout Hawaii. First Hawaiian Bank also operates three branches in Guam and two branches in Saipan.
The focus of First Hawaiian Bank’s retail/community banking strategy is primarily in Hawaii, where it had a 40% market share of the domestic bank deposits of individuals, corporations and partnerships in the state as of December 31, 2003. Thanks to its significant market share in Hawaii, First Hawaiian Bank already has product or service relationships with a majority of the households in the state. Therefore, a key goal of its retail community banking strategy is to build those relationships by cross-selling additional products and services to existing individual and business customers.
In pursuing the community banking markets in Hawaii, Guam and Saipan, First Hawaiian Bank seeks to serve a broad customer base by furnishing a range of retail and commercial banking products. Through its branch network, First Hawaiian Bank generates first-mortgage loans on residences and a variety of consumer loans, consumer lines of credit and second mortgages. Through commercial banking operations conducted from its branch network, First Hawaiian Bank offers a wide range of banking products intended to serve the needs of smaller, community-based businesses. First Hawaiian Bank also provides a number of fee-based products and services such as annuities and mutual funds, insurance and securities brokerage. The First Investment Center department of First Hawaiian Bank makes available annuities, mutual funds and other securities through BancWest Investment Services, Inc., a registered broker-dealer, member NASD/SIPC. Both First Hawaiian Bank and BancWest Investment Services are affiliates under the common control of BancWest Corporation.
To complement its branch network and serve these customers, First Hawaiian Bank operates a system of automated teller machines, a 24-hour phone center in Honolulu and a full-service internet banking system.
Consumer Lending offers many types of loans and credits to consumers, including lines of credit (uncollateralized or collateralized) and various types of personal and automobile loans. First Hawaiian Bank also provides indirect consumer automobile financing on new and used autos by purchasing finance contracts from dealers. First Hawaiian Bank’s Dealer Center is the largest commercial bank automobile lender in the State of Hawaii. First Hawaiian Bank is the largest issuer of MasterCard® credit cards and VISA® credit cards in Hawaii.
10
Real Estate Lending-Residential makes residential real estate loans, including home-equity loans, to enable borrowers to purchase, refinance, improve or construct residential real property. The loans are collateralized by mortgage liens on the related property, substantially all located in Hawaii. First Hawaiian Bank also originates residential real estate loans for sale on the secondary market.
Commercial Lending is a major lender to small and medium-sized businesses in Hawaii and Guam. Lending services include receivable and inventory financing, term loans, for equipment acquisition and facilities expansion and trade financing letters of credit. To support the cash management needs of both commercial banking customers and large private and public deposit relationships maintained with the Company, First Hawaiian Bank operates a Cash Management Department which provides a full range of innovative and relationship-focused cash management services.
Real Estate Lending-Commercial provides interim construction, residential development and permanent financing for commercial real estate projects, including retail facilities, warehouses and office buildings. The Bank also does lease-to-fee conversion financing for condominium associations and cooperatives.
International Banking Services provides international banking products and services through First Hawaiian Bank’s branch system, its Japan Business Development Department in Honolulu, a Grand Cayman branch, three Guam branches, two branches in Saipan and a representative office in Tokyo, Japan. First Hawaiian Bank maintains a network of correspondent banking relationships throughout the world. First Hawaiian Bank’s trade-related international banking activities are concentrated in the Asia-Pacific area.
Leasing provides leasing services for businesses from heavy equipment to office computer and communication systems.
Financial Management
The Financial Management Segment offers a full range of trust and investment management services, and also seeks to reinforce customer relationships developed by or in conjunction with the Retail Banking Segment. The Financial Management Segment provides asset management, advisory and administrative services for estates, trusts and individuals. It also acts as trustee and custodian of retirement and other employee benefit plans. At March 31, 2004, the Trust and Investments Division had approximately 3,965 accounts with a market value of $8.8 billion. Of this total, $6.5 billion represented assets in nonmanaged accounts and $2.3 billion were managed assets.
Securities and Insurance Services, through a wholly-owned subsidiary of First Hawaiian Bank, First Hawaiian Insurance, Inc., provides insurance brokerage services for personal, business and estate insurance needs to its customers. First Hawaiian Insurance offers insurance needs analysis for individuals, families and businesses, as well as life, disability and long-term care insurance products.
The Private Banking Department within First Hawaiian Bank’s Financial Management Segment provides a wide range of private banking service products to high-net-worth individuals.
11
The table below presents information about the Company’s operating segments as of or for the periods indicated. The “Other BancWest” category in the table below consists principally of BancWest Corporation (Parent Company), FHL Lease Holding Company, Inc. and BancWest Investment Services (“BWIS”). The reconciling items are principally consolidating entries to eliminate intercompany balances and transactions. The following table summarizes significant financial information, as of March 31, 2004 and 2003 for our reportable segments:
[Continued from above table, first column(s) repeated]
12
Prior to February 2004, leases of vehicles to customers were treated as finance leases, as they qualified for such treatment under Statement of Financial Accounting Standards (SFAS) No. 13, Accounting for Leases. Beginning in February 2004, our automobile leases are treated as operating leases, as we no longer obtain residual insurance on an individual lease basis.
Operating lease rental income for leased assets, primarily vehicles, is recognized on a straight-line basis. Related depreciation expense is recorded on a straight-line basis over the life of the lease taking into account the estimated residual value of the leased asset. On a periodic basis, leased assets are reviewed for impairment. Impairment loss is recognized if the carrying amount of leased assets exceeds fair value and is not recoverable. The carrying amount of leased assets is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the lease payments and the estimated residual value upon the eventual disposition of the equipment. Vehicle lease receivables are written off when 120 days past due.
The following table shows future minimum lease receivables under leases with terms in excess of one year as of March 31, 2004:
We performed the impairment testing of goodwill required under SFAS No. 142 in the fourth quarter of 2003. No impairment of goodwill was found. The impairment analysis was performed using a discounted cash flows model. The table below provides the breakdown of goodwill by reportable segment and the change during the year.
Amortization of intangible assets was $5.8 million for each of the three-month periods ended March 31, 2004 and 2003. The estimated annual amortization expense for finite-lived intangible assets, primarily core deposit intangibles arising from previous mergers, is approximately $23 million (pre-tax) for each of the years from 2004 to 2008.
Our finite-lived intangible assets substantially consist of core deposit tangible assets. The gross carrying amount, accumulated amortization and net book value of these intangible assets are detailed below.
13
In January 2003, the FASB issued Financial Interpretation No. (FIN) 46,Consolidation of Variable Interest Entities — An Interpretation of ARB No. 51.FIN 46 established new guidance on the accounting and reporting for the consolidation of variable interest entities (VIEs). In December 2003, the FASB issued Financial Interpretation No. (FIN) 46 (Revised December 2003),Consolidation of Variable Interest Entities — An Interpretation of ARB No. 51 (FIN 46R). The application of FIN 46R replaces FIN 46 and applies to companies who have not adopted FIN 46 with VIEs for financial statement periods ending after December 15, 2003. The principal objective of FIN 46 is to require the primary beneficiary of a VIE to consolidate the VIE’s assets, liabilities and results of operations in the primary beneficiary’s own financial statements. The Company adopted the consolidation provisions of FIN 46 on July 1, 2003 consolidating one VIE formed prior to February 1, 2003. However in December 2003, our relationship with this VIE changed and it is no longer being consolidated. In the fourth quarter of 2003, BancWest also ceased consolidating two trusts, which were included in the consolidated financial statements presented prior to October 1, 2003.
On June 23, 1997 and October 20, 2000, the Company formed two trusts, First Hawaiian Capital I (FH Trust) and BancWest Capital I (BWE Trust) (the Trusts), respectively. The Trusts issued preferred and common capital securities. The purpose of these entities is to allow for the issuance of preferred capital securities that qualify for inclusion in Tier 1 regulatory capital. Historically, these trusts have been consolidated and the related trust preferred securities have been treated as Tier 1 capital under Federal Reserve rules and regulations. The Company began deconsolidating the Trusts as a result of the adoption of FIN 46 in the preparation of its financial statements on October 1, 2003.
BWE Trust is a Delaware business trust, which was formed in 2000 and exchanged $150 million of its BWE Capital Securities as well as all outstanding common securities of BWE Trust, for 9.5% junior subordinated deferrable interest debentures of the Corporation. The Corporation sold the $150 million of BWE Capital Securities to the public. At March 31, 2004, the BWE Trust’s total assets were $155.9 million, comprised primarily of the Corporation’s junior subordinated debentures. The BWE Capital Securities and the debentures will mature on December 1, 2030, but on or after December 1, 2005 are subject to redemption in whole or in part at par plus accrued interest. They are solely, fully and unconditionally guaranteed by the Corporation, representing the Company’s maximum liability for the securities.
FH Trust is a Delaware business trust which was formed in 1997, issued $100 million of its Capital Securities (the “FH Capital Securities”) and used the proceeds to purchase junior subordinated deferrable interest debentures of the Corporation. The FH Capital Securities accrue and pay interest semiannually at an annual interest rate of 8.343%. The FH Capital Securities are mandatorily redeemable upon maturity date of July 1, 2027. However, they are subject to redemption on or after July 1, 2007, in whole or in part (subject to a prepayment penalty) as provided for in the governing indenture. At March 31, 2004, the FH Trust’s total assets were $105.2 million, comprised primarily of the Corporation’s junior subordinated debentures. The debentures and the associated interest expense make up the Company’s maximum exposure to losses for this trust.
As of October 2003, effective with the adoption of Financial Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46) as it relates to the Trusts, BancWest no longer consolidates the Trusts. This deconsolidation had no material impact on the total assets or liabilities of the Corporation. The Federal Reserve Board issued temporary guidance which indicated that the preferred capital securities can still be included as part of Tier 1 Capital. The Federal Reserve Board will review the regulatory implications of any accounting treatment changes and will provide further guidance if necessary or warranted.
The Company has identified investments that meet the definition of a VIE under FIN 46 but do not meet the requirements for consolidation. The Company owns several limited partnership interests in low-income housing developments in conjunction with the Community Reinvestment Act. Limited partners do not participate in the control of the partnerships’ businesses. The general partner exercises the day-to-day control and management of the projects. The general partners have exclusive control over the partnerships’ businesses and have all of the rights, powers, and authority generally conferred by law or necessary, advisable or consistent with accomplishing the partnerships’ businesses. FIN 46 indicates that if an entity (e.g., limited partner) cannot sell, transfer, or encumber its interests in the VIE without the prior approval of an enterprise (e.g., general partner), the limited partner is deemed to be a de facto agent for the general partner. BancWest is considered to be a de facto agent for the general partner where BancWest has a limited partnership interest over 50%. BancWest is not the primary beneficiary for these partnerships or for those where its interest is less than 50%. The business purpose of these entities is to provide affordable housing within the Company’s service area in return for tax credits and tax loss deductions. Our subscription amount for these investments as of March 31, 2004 is approximately $93.4 million with approximately $30.4 million as the residual contribution outstanding. We are not obligated to fund deficiencies of the limited partnerships and our maximum exposure to losses is limited to our subscription amount. Bargain purchase options are available for
14
the general partners to purchase the Company’s portion of interests in the limited partnerships. These commitments were entered into from 1991 through 2004.
The Company sponsors a noncontributory defined benefit pension plan, which is a merger of two separate plans. The first plan, for First Hawaiian employees, was frozen at December 31, 1995. As a result of that freeze, there are no further benefit accruals for First Hawaiian employees in the merged plan. The second plan, for Bank of the West employees, was a cash balance pension plan. The merged employee retirement plan (“ERP”) continues to provide cash balance benefit accruals for eligible Bank of the West employees.
The Company also sponsors an unfunded excess benefit pension plan covering employees whose pay or benefits exceed certain regulatory limits, unfunded postretirement medical and life insurance plans, and, for certain key executives, an unfunded supplemental executive retirement plan (“SERP”).
In connection with the March 2002 acquisition of United California Bank (“UCB”), the Company assumed the pension and postretirement obligations of UCB. UCB employees participated in a noncontributory final pay defined benefit pension plan, an unfunded excess benefit pension plan covering employees whose pay or benefits exceed certain regulatory limits, an unfunded postretirement medical plan, and a 401(k) savings plan. In addition, certain key executives were eligible for a supplemental pension benefit if they met certain age and service conditions. The UCB plans were curtailed on June 30, 2003. The Company integrated UCB employees into the Company’s existing benefit plan structure on July 1, 2003. UCB employees were guaranteed the benefits they acquired through the UCB plans up to the curtailment date. The curtailment reduced the projected benefit obligation of the UCB retirement plan by $29.5 million measured as of July 1, 2003, which did not exceed the unrecognized net loss as of that date. The projected benefit obligation related to the UCB supplemental plan decreased by $2.9 million due to the curtailment. This exceeded the unrecognized loss in that plan resulting in a curtailment gain of $0.15 million during 2003. Special benefits were provided to UCB participants meeting certain age and service requirements; this is reflected as a termination benefit and is included in the pension liability. The special benefits were accounted for as an adjustment to goodwill as a purchase accounting adjustment due to the business combination of UCB with Bank of the West. The benefit obligations assumed by the Company in connection with the acquisition and the effect of the curtailment have been reflected in the table below.
The following table sets forth the components of the net periodic benefit cost (credit) for March 31, 2004 and 2003:
The following table sets forth the components of the net periodic benefit cost (credit) for our funded plans for March 31, 2004 and 2003:
15
Contributions
BancWest expects to contribute $2.5 million to its defined benefit pension plans and $2.5 million to its other post retirement benefit plans in 2004.
On April 27, 2004, BancWest announced that it signed an agreement to acquire USDB Bancorp in a cash transaction valued at $245 million. USDB Bancorp is a holding company that operates Union Safe Deposit Bank, which has 19 branches in California. It is anticipated that the purchase transaction will close in the third quarter of 2004, subject to approval from USDB Bancorp shareholders and federal and state banking regulators. Subsequently, Union Safe Deposit Bank will be merged into Bank of the West. As a purchase transaction, the results of operations of Union Safe Deposit Bank will be included with that of BancWest subsequent to the consummation of the transaction.
16
BancWest Corporation and Subsidiaries MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
Certain matters contained in this filing are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Our forward-looking statements (such as those concerning our plans, expectations, estimates, strategies, projections and goals) involve risks and uncertainties that could cause actual results to differ materially from those discussed in the statements. Readers should carefully consider those risks and uncertainties in reading this report. Factors that could cause or contribute to such differences include, but are not limited to:
Our forward-looking statements are based on management’s current views about future events. Those statements speak only as of the date on which they are made. We do not intend to update forward-looking statements, and, except as required by law, we disclaim any obligation or undertaking to update or revise any such statements to reflect any change in our expectations or any change in events, conditions, circumstances or assumptions on which forward-looking statements are based.
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. Our actual results could differ from the results contemplated by these forward-looking statements due to certain factors, including those discussed in Item 2 and elsewhere in this report.
17
BancWest Corporation and Subsidiaries MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
OVERVIEW
BancWest Corporation (www.bancwestcorp.com) is a financial holding company with assets of $38.9 billion. It is a wholly owned subsidiary of Paris-based BNP Paribas. BancWest is headquartered in Honolulu, Hawaii, with an administrative headquarters in San Francisco, California. Its principal subsidiaries are Bank of the West (296 branches in California, Oregon, New Mexico, Nevada, Washington state and Idaho) and First Hawaiian Bank (61 branches in Hawaii, Guam and Saipan).
Acquisitions
On March 16, 2004, BancWest announced that it signed an agreement to acquire Community First Bankshares, Inc. (Community First), a holding company that operates Community First National Bank (CFB) in a cash transaction valued at $1.2 billion. It is anticipated that the purchase transaction will close in the third quarter of 2004, subject to approval from Community First shareholders and federal and state banking regulators. Subsequently, CFB will be merged with and into Bank of the West and its branches will be integrated into Bank of the West’s branch network system. See Note 2 of the Company’s Notes to Unaudited Consolidated Financial Statements.
Initiatives
BancWest has continued to implement a series of initiatives that are designed to improve customer service and expand our physical footprint by branch expansion and mergers and acquisitions. The focus of the Company is to promote long-lasting customer service relationships through upgrading technology and enhancing existing and implementing new training vehicles. BancWest strives for a “high touch” personalized marketing position, promoting brand recognition through logos and community outreach. BancWest is expanding its line of financial services to its customers through internal initiatives as well as mergers and acquisitions. This includes insurance services that it will attain through Community First.
To remain competitive, Bank of the West’s Regional Banking segment offers “Free Checking” to assist in business development and customer experience activities. This product was developed to assure that customers are finding the right checking product to meet their needs. Bank of the West has also launched a new electronic check service (“ECS”) for merchant services through its relationship with NOVA Information Systems. Merchant Services is the process of accepting, processing and settling payments for businesses. The Company provides the payment processing equipment, technology, reporting and reconciliation services merchants need to conduct business. ECS offers almost instant verification of fund availability when checks are swiped through the merchant’s check reader. ECS offers next day funding to merchants without having to make deposits in a branch.
Key among the elements of the Company’s profitability has been the interest rate environment, from both a deposit and loan pricing standpoint. As an industry, banks and other financial intermediaries have seen net interest margins decline over the past year principally as a result of the absolute level and shape of the yield curve. We manage the interest rate and market risks intrinsic in our asset and liability balances, while ensuring ample liquidity and diverse funding.
Financial Overview
First quarter 2004 as compared to first quarter 2003
BancWest reported net income of $113.1 million, compared with $102.1 million, an increase of 10.7%. Net interest income was $321.0 million, up 1.8% compared to $315.2 million. This increase was primarily due to growth in average earning assets, partially offset by a lower net interest margin for the quarter. Average loans and leases increased by $1.9 billion; average investment securities increased by $1.9 billion. The Company increased its consumer lending and purchased residential mortgage loans and securities while commercial borrowing was still relatively slow. The net interest margin decreased 51 basis points (1% equals 100 basis points) from
18
4.49% last year to 3.98% as a declining interest rate environment caused rates on interest earning assets to decrease more rapidly than rates paid on funding sources. Noninterest income was $101.4 million, an increase of 7.0% compared to $94.8 million in the first quarter of 2003. The increase was primarily due to increased service charges on deposit accounts and other service charges and fees. The Company’s strategy to increase noninterest income included growth in average deposit balances, repricing efforts in account analysis as well as growth in investment product sales and merchant services. The Company also focused on niche markets where the Company would have a competitive advantage in growing its portfolio related to equipment leasing, SBA, church and healthcare lending. Noninterest expense was $218.9 million compared to $220.7 million, a decrease of 0.8%. Cost savings from staff reductions, offset by the increased cost of healthcare , resulted in a decrease in noninterest expense of $1.8 million from the first quarter of 2003.
BancWest had total assets of $38.9 billion at March 31, 2004, an increase of 1.5% from December 31, 2003 and 11.5% from March 31, 2003. Investment securities totaled $6.0 billion, an increase of 1.7% from December 31, 2003 and 33.2% from the same period in 2003. Loans and leases totaled $26.2 billion, up 2.0% from December 31, 2003 and 9.0% from a year ago. Deposits were $26.7 billion, up 1.3% from December 31, 2003 and 9.9% from a year ago.
BancWest’s nonperforming assets were 0.58% of loans, leases and foreclosed properties at March 31, 2004, an improvement from 0.59% at December 31, 2003 and 0.98% at March 31, 2003. The provision for loan and lease losses was $18.9 million for the first quarter of 2004, compared to $22.7 million for the quarter ended a year ago. BancWest’s allowance for loan and lease losses was 1.51% of total loans and leases at March 31, 2004, compared to 1.52% of total loans and leases at December 31, 2003 and 1.65% at March 31, 2003.
MONETARY POLICY AND ECONOMIC CONDITIONS
Our earnings and businesses are affected not only by general economic conditions (both domestic and international), but also by the monetary policies of various governmental regulatory authorities of (i) the United States and foreign governments and (ii) international agencies. In particular, our earnings and growth may be affected by actions of the Federal Reserve Board in connection with its implementation of national monetary policy through its open market operations in United States Government securities, control of the discount rate and establishment of reserve requirements against both member and non-member financial institutions’ deposits. These actions have a significant effect on the overall growth and distribution of loans and leases, investments and deposits, as well as on the rates earned on loans and leases or paid on deposits. It is difficult to predict future changes in monetary policies.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in our Consolidated Financial Statements and accompanying notes. We believe that the judgments, estimates and assumptions used in the preparation of our Consolidated Financial Statements are appropriate given the factual circumstances as of March 31, 2004. We have established policies and procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. However, given the sensitivity of our Consolidated Financial Statements to these accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition.
Our accounting policies are discussed in detail in the notes to the Consolidated Financial Statements, Note 1 (Summary of Significant Accounting Policies) of our 2003 Annual Report on Form 10-K. Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. We have identified the following accounting estimates that we believe are material due to the levels of subjectivity and judgment necessary to account for uncertain matters or where these matters are particularly subject to change.
19
20
CONSOLIDATED FINANCIAL HIGHLIGHTS (Unaudited)
21
RESULTS OF OPERATIONS
Net Interest Income
Net interest income increased 1.8% to $321.0 million as compared to $315.2 million.
The increase in net interest income was principally the result of a $3.9 billion, or 13.8%, increase in average earning assets. The increase in our average earning assets was primarily the result of growth in loans from originations and purchases, leases and investment securities within Bank of the West and First Hawaiian Bank. The increase in average earning assets was partially offset by a 51 basis point reduction in our net interest margin. The continuing effect of historically low interest rates has reduced the yield on earning assets as well as rates paid on sources of funds.
Net Interest Margin
The net interest margin decreased by 51 basis points due primarily to the effects of the decreasing interest rate environment. While the decreasing rate environment reduced our yield on earning assets by 76 basis points to 5.17% from 5.93%, it also decreased our rate paid on sources of funds by 25 basis points to 1.19% from 1.44%. Also offsetting the decrease in the yield on average earning assets, average noninterest-bearing deposits maintained by retail and commercial customers in both banks increased by $0.8 billion, or 12.6%. Higher yielding average domestic time deposits decreased $0.1 billion, or 1.8% due to the low interest rate environment.
Average Earning Assets
Growth in Bank of the West’s loan and lease portfolio and higher levels of investment securities in both banks, are primarily responsible for the increase in average earning assets. Higher levels of foreign interest bearing deposits in other banks also contributed to the increase in average earning assets. The $1.9 billion, or 7.9%, increase in average total loans and leases was primarily due to increased consumer lending and residential mortgages. Consumer loans continue to grow due to strength in the consumer market and the low interest rates on consumer products. As commercial lending was relatively slow during the past year, funds were used to purchase residential mortgages as well as investment securities. Consequently, average total investment securities also increased to $6.0 billion, up $1.9 billion, or 45.7%.
Average Loans and Leases
The increase in average loans and leases was primarily due to growth in Bank of the West. Average consumer loans within Bank of the West increased approximately $1.2 billion, or 22.7%, primarily due to growth in financing for autos, recreational vehicles and pleasure boats, while loan purchases increased the average residential mortgage portfolio. Bank of the West’s average residential real estate loans have increased by $0.6 billion.
Average Interest-Bearing Deposits and Liabilities
The increase in average interest-bearing deposits and liabilities was primarily due to an increase in average long-term debt, average short-term borrowings and growth in our customer deposit base. Average deposits increased due to growth in the demand deposit and interest-bearing checking, regular, money market savings and foreign deposit portfolios. These increases were partially offset by a decrease in average time deposits. Short and long term borrowings from the Federal Home Loan Bank also increased average short-term borrowings and average long-term debt.
22
Table 1: Average Balances, Interest Income and Expense, and Yields and Rates (Taxable-Equivalent Basis)
The following table sets forth the condensed consolidated average balance sheets, an analysis of interest income/expense and average yield/rate for each major category of earning assets and interest-bearing deposits and liabilities for the years indicated on a taxable-equivalent basis. The taxable-equivalent adjustment is made for items exempt from Federal income taxes (assuming a 35% tax rate for March 31, 2004 and 2003) to make them comparable with taxable items before any income taxes are applied.
23
Noninterest Income
The following table reflects the key components of the change in noninterest income for the three months ended March 31, 2004, as compared to the same period in 2003:
As detailed in the table above, total noninterest income was $101.4 million, an increase of $6.6 million or 7.0%.
Service charges on deposit accounts were $40.8 million, an increase of $3.8 million. The increase is primarily attributed to an increase in average deposit balances of approximately 9.5%, higher fee income from overdraft and nonsufficient fund transactions and higher servicing fee income as a result of repricing efforts in account analysis.
Other service charges and fees were $38.0 million, an increase of $6.4 million. The increase is primarily due to increased revenue resulting from a concentrated effort in growing the sales of investment products, higher rental income from automobile operating leases as we began accounting for our auto leases as operating leases beginning in February 2004 (see Note 5 to the Consolidated Financial Statements), higher non-yield-related fees on commercial loans, higher loan servicing fees and higher merchant services fees resulting from an increase in the number of retail merchant accounts and higher retail sales volume.
Net securities gains totaled $0.4 million, compared to a net gain of $1.9 million. The higher gains in 2003 were due to portfolio restructuring activities.
Other noninterest income totaled $11.9 million, a decrease of $2.8 million, primarily attributed to lower gains on the sale of residential loans due to lower loan volume, lower gains on the sale of foreclosed property and lower income from the sale of loans in the Essex subsidiary as Essex began to keep specific types of loans in its portfolio rather than selling them. These decreases were partially offset by increased revenue from derivative sale activities and miscellaneous assets.
Noninterest Expense
The following table reflects the key components of the change in noninterest expense for the three months ended March 31, 2004 as compared to the same period in 2003:
24
As the table above shows in detail, total noninterest expense was $218.9 million, a decrease of $1.8 million.
Salaries and wages expenses were $83.5 million, a decrease of $1.2 million. The decrease is primarily attributable to a lower full-time equivalent employee count and a reduction in temporary services.
Employee benefits expense was $36.2 million, a decrease of $1.4 million, primarily due to lower pension and retirement plan expense as a result of reduced costs and lower recognized actuarial loss. The decrease was partially offset by increases in other benefits, primarily healthcare.
Advertising and promotion expenses were $6.3 million, an increase of $1.1 million, primarily the result of higher advertising expenses related to media outdoor and CD campaigns to promote brand recognition.
OPERATING SEGMENTS
Our operations are managed principally through our two major bank subsidiaries, Bank of the West and First Hawaiian Bank. Bank of the West operates primarily in California, Oregon, Washington, Idaho, New Mexico and Nevada. It also conducts business nationally through its Consumer Finance Division as well as its Essex Credit Corporation and Trinity Capital subsidiaries. First Hawaiian Bank’s primary base of operations is in Hawaii, Guam and Saipan. It also has significant operations extending to California through its automobile dealer flooring and financing activities.
The Regional Banking Group’s net income increased $4.4 million, from $30.8 million to $35.2 million. Net interest income increased $1.5 million or 1.2%. This increase was driven by a 9.4% increase in average loans, offset by a decline in demand deposit transfer pricing margins. Noninterest income increased $4.3 million, or 11.1%, driven by a repricing in our fee structure, an increase in investment sales volume and increased penalty fees collected on commercial real estate loans in this period. Noninterest expense increased $1.9 million, or 1.8%. Noninterest expense increased due to higher costs associated with employee benefits. The provision for loan and lease losses decreased $3.1 million due to higher recoveries of previously charged off loans. The growth in deposit balances was driven by core deposits, offset by a decline in certificates of deposits.
25
The Commercial Banking segment’s net income increased $0.4 million or 1.1% from $37.2 million to $37.6 million. Net interest income decreased $3.2 million or 4.0%. The decrease in net interest income is a result of a 100 basis point drop in the transfer pricing margin for money market savings and demand deposits, despite an increase in average balances. The change in transfer pricing methodology on money market accounts contributed to the margin decrease. The margins on loans and leases remained constant as compared to last year. Noninterest income increased $2.7 million or 23.9%. The increase is related to non-yield related loan fees and trading derivatives as well as unexpected early lease contract termination fees. Noninterest expense decreased $ 0.9 million or 3.0%.
Average loan and lease balances increased by 5.8% to $7.3 billion, and average deposit balances increased by 15.8% to $3.4 billion.
The Consumer Finance segment’s net income was $14.4 million compared to $14.6 million. Net interest income was $53.0 million, compared to $49.7 million, an increase of 6.6%. Noninterest income has remained flat. Noninterest expense increased from $15.3 million to $17.0 million.
The Consumer Finance Segment remains very competitively priced in the indirect lending market. Though noninterest income remained flat, income decreased due to lower gains on sales of loans through our Essex subsidiary, offset by an increase in other operating income as a result of originating operating leases rather than finance leases (see Note 5 to the Consolidated Financial Statements). In 2004, Essex began to keep in its portfolio specific types of loans, rather than selling substantially all loans as it had done in the past. Noninterest income was favorably impacted as a result of recording lease payments as noninterest income on all auto leases recorded as operating leases according to Statement of Financial Accounting Standards No. 13 starting in February 2004. Noninterest expense increased by 11.1%. However, expenses as a percentage of average assets remained constant. The noninterest expense increase was primarily due to an increase in the cost of employee salaries and benefits.
Average assets were $8.1 billion compared to $7.1 billion, an increase of 14.3%. This increase is primarily due to increased indirect loan production. The provision for credit losses increased $2.1 million due to a $1.0 billion increase in average loans.
The Retail Banking Group’s net income decreased to $16.7 million, down $1.6 million, or 8.7%. Net interest income decreased $0.9 million or 1.6%, primarily due to a decrease in the net interest margin, which was negatively impacted by the effects of a lower interest rate environment. Noninterest income increased $0.4 million, or 2.3%, primarily from increased fees on deposit accounts, partially offset by a gain on the sale of foreclosed property in 2003. Noninterest expense increased $1.3 million, or 3.0%, primarily due to increased allocated corporate expenses. The provision for loan and lease losses decreased $0.3 million or 21.4%. The decrease in nonperforming assets and lower charge offs have reduced the provision for loan and lease losses.
Average assets increased 9.7%, primarily due to increases in residential and commercial loans. Average assets also increased due to the purchase of the First Hawaiian Center building. Average deposits increased 7.0% primarily due to an increase in core deposits, partially offset by a decrease in time certificates of deposit.
26
Consumer Finance’s net income decreased to $9.3 million, down $0.3 million, or 3.1%. Net interest income was $20.7 million compared to $18.5 million, an increase of 11.9%. This was the result of increased interest income on higher loan balances. Noninterest income decreased $2.2 million or 21.8%. The decrease was caused by lower gains on the sale of mortgages. Noninterest expense remained flat. The provision for loan and lease losses decreased $0.2 million or 10.5%. The decrease reflects lower charge offs and improved credit quality.
Average assets increased 3.0%, primarily due to increases in consumer and dealer flooring loans.
Commercial Banking’s net income increased to $6.0 million, up $0.5 million, or 9.1%. Net interest income increased $0.3 million or 3.6%, primarily due to higher fees from loans that were paid off in 2004. Noninterest income increased $0.3 million or 18.8%, primarily due to an increase in loan servicing fees. Noninterest expense remained relatively flat. The provision for loan and lease losses increased $0.2 million, primarily due to a recovery on a loan previously charged off in 2003.
Average assets decreased 5.8%, primarily due to a decrease in loans.
The Financial Management Group’s net income of $0.7 million was unchanged from 2003. Noninterest income increased by $0.3 million, primarily due to higher investment management fees. Investment fees were positively impacted by the upturn in the equity markets. Noninterest expense increased by $0.2 million, primarily due to increases in salaries and employee benefits.
INVESTMENT SECURITIES
The Company focuses on the following four objectives for its investment portfolio:
The recent and relatively large increases in the portfolio are directly related to the high deposit growth that has been experienced over the past two years. Because of the resultant high degree of liquidity that must be invested, the current investment strategy is focused primarily on managing overall interest rate risk and maximizing earnings.
27
Held-to-Maturity
There were no held-to-maturity investment securities at March 31, 2004, December 31, 2003 or March 31, 2003.
Available-for-Sale
Amortized cost and fair value of available-for-sale investment securities at March 31, 2004, December 31, 2003 and March 31, 2003 were as follows:
Proceeds from the sales of available-for-sale investment securities portfolio were $56.4 million and $101.1 million for the three months ended March 31, 2004 and 2003, respectively.
Gains and losses realized on the sales of available-for-sale investment securities are determined using the specific identification method. Gross realized gains and losses on available-for-sale investment securities for the periods indicated were as follows:
28
LOANS AND LEASES
The following table sets forth the loan and lease portfolio by major categories and loan and lease mix at March 31, 2004, December 31, 2003 and March 31, 2003:
We continue to diversify our loan and lease portfolio, both geographically and by industry. Our overall growth in loan and lease volume came primarily from our Mainland United States operations. The loan and lease portfolio is the largest component of earning assets and accounts for the greatest portion of total interest income. There was a $2.2 billion, or 9.0%, increase in total loans and leases from March 31, 2003 and a $507.4 million, or 2.0% increase compared to December 31, 2003.
When comparing the current period to March 31, 2003 there was an increase of $1.4 billion, or 21.5%, in consumer loans due to continued strength in the consumer market. Consumer loans consist primarily of open-and closed-end direct and indirect credit facilities for personal, automobile, recreational vehicle, marine, and household purchases. This increase was partially offset by a decrease of $196 million, or 4.2%, in commercial lending resulting from run off. Total real estate loans increased $1.1 billion or 10.4% from March 31, 2003 primarily from growth in residential and commercial real estate lending.
Total loans and leases increased slightly from December 31, 2003. This increase was mainly driven by increases in residential real estate and consumer lending. Total real estate loans increased $0.3 million, or 3.1%, and consumer loans increased $0.3 million, or 4.3%, in the period ending March 31, 2004 compared to December 31, 2003. These increases were partially offset by declines in commercial, financial and agricultural lending and lease financing.
Our mix of loans and leases has remained similar to our portfolio in the period ending March 31, 2003 with a few exceptions. We have decreased exposures in certain commercial, financial and agricultural loans in response to concentration levels from 19.3% on March 31, 2003 to 16.9% on March 31, 2004. Our portfolio of consumer loans has increased while lease financing has decreased slightly. This shift is due to changes in the consumer market and attractive interest rates on consumer lending. Low interest rates on consumer products have turned consumers away from leasing to purchasing.
Loan concentrations are considered to exist when there are amounts loaned to multiple borrowers engaged in similar activities, which would cause them to be similarly impacted by economic or other conditions. At March 31, 2004, we did not have a
29
concentration of loans greater than 10% of total loans which is not otherwise disclosed as a category of loans as shown in the table above.
Off-balance-sheet commitments were as follows at March 31, for the years indicated:
NONPERFORMING ASSETS AND RESTRUCTURED LOANS
Nonperforming assets at March 31, 2004, December 31, 2003 and March 31, 2003 are as follows:
30
Nonperforming assets at March 31, 2004 were $153.2 million, or 0.58% of total loans and leases and other real estate owned (OREO) and repossessed personal property, compared to 0.59% at December 31, 2003 and 0.98% at March 31, 2003.
Nonperforming assets at March 31, 2004 decreased by $81.8 million, or 34.8%, from March 31, 2003 and increased $2.1 million, or 1.4%, from December 31, 2003. The decrease in nonaccrual loans from the previous year was primarily due to resolution of problem relationships in commercial lending and decreases in nonaccrual real estate loans and lease financing. Foreign nonperforming assets decreased at March 31, 2004 by $3.2 million, or 36.0%, from March 31, 2003. However, our overall foreign loan portfolio, composed primarily of loans in Guam and Saipan, represents a relatively small component (1.3%) of our total loan portfolio at March 31, 2004. The increase in nonperforming assets from December 31, 2003 is primarily due to an increase in nonperforming commercial real estate loans of $6.4 million or 15.4 %.
We generally place a loan or lease on nonaccrual status when we believe that collection of principal or interest has become doubtful or when loans and leases are 90 days past due as to principal or interest, unless they are well secured and in the process of collection. We may make an exception to the general 90-day-past-due rule when the fair value of the collateral exceeds our recorded investment in the loan.
While the majority of consumer loans and leases are subject to our general policies regarding nonaccrual loans, substantially all past-due consumer loans and leases are not placed on nonaccrual status because they are charged off upon reaching a predetermined delinquency status varying from 120 to 180 days, depending on product type.
When we place a loan or lease on nonaccrual status, previously accrued and uncollected interest is reversed against interest income of the current period. When we receive a cash interest payment on a nonaccrual loan, we apply it as a reduction of the principal balance when we have doubts about the ultimate collection of the principal. Otherwise, we record such payments as income.
Nonaccrual loans and leases are generally returned to accrual status when they: (1) become current as to principal and interest and have demonstrated a sustained period of payment performance or (2) become both well secured and in the process of collection.
Other than the loans listed, we were not aware of any significant potential problem loans where possible credit problems of the borrower caused us to seriously question the borrower’s ability to repay the loan under existing terms. Loans past due 90 days or more and still accruing interest totaled $29.0 million at March 31, 2004, a decrease of $0.4 million or 1.3%, from December 31, 2003, but an increase of $5.6 million, or 23.7%, from March 31, 2003. The decrease at March 31, 2004 compared to December 31, 2003 was primarily due to commercial real estate loans offset by an increase in commercial, financial and agricultural loans. The increase at March 31, 2004 compared to March 31, 2003 was primarily due to commercial, financial and agricultural loans, partially offset by a decrease in past due real estate loans. All of the loans that are past due 90 days or more and still accruing interest are, in our judgment, adequately collateralized and in the process of collection.
31
PROVISION AND ALLOWANCE FOR LOAN AND LEASE LOSSES
The following table sets forth the activity in the allowance for loan and lease losses for the periods indicated:
The provision for loan and lease losses for the first three months ended March 31, 2004 was $18.9 million, a decrease of $3.8 million, or 16.9%, compared to the same period in 2003. The provision for loan and lease losses is based upon our judgment as to the adequacy of the allowance for loan and lease losses (the “Allowance”) to absorb probable losses inherent in the portfolio as of the balance sheet date. The Company uses a systematic methodology to determine the adequacy of the Allowance and related provision for loan and lease losses to be reported for financial statement purposes. The determination of the adequacy of the Allowance is ultimately one of judgment, which includes consideration of many factors, including, among other things, the amount of problem and potential problem loans and leases, net charge-off experience, changes in the composition of the loan and lease portfolio by type and location of loans and leases and in overall loan and lease risk profile and quality, general economic factors and the fair value of collateral.
Our approach to managing exposure to credit risk involves an integrated program of setting appropriate standards for credit underwriting and diversification, monitoring trends that may affect the risk profile of the credit portfolio and making appropriate adjustments to reflect changes in economic and financial conditions that could affect the quality of the portfolio and loss probability. The components of this integrated program include:
32
Compared to the same quarter a year ago, net charge-offs were $3.4 million higher during the first quarter of 2004. While an improvement in credit quality resulted in lower charge-offs, primarily in the commercial, financial and agricultural category, recoveries were higher in 2003. This was the result of a $13.6 million dispute resolution with UFJ Bank Ltd. of Japan in conjunction with charge-offs that were disputed during the acquisition of United California Bank in 2002. See Note 2 to the Consolidated Financial Statements in the 2003 Form 10-K for further information.
In our judgment, the Allowance was adequate to absorb losses inherent in the loan and lease portfolio at March 31, 2004. However, changes in prevailing economic conditions in our markets could result in changes in the level of nonperforming assets and charge-offs in the future and, accordingly, changes in the Allowance. We will continue to closely monitor economic developments and make necessary adjustments to the Allowance accordingly.
DEPOSITS
Deposits are the largest component of our total liabilities and account for 45.2% of total interest expense. At March 31, 2004, total deposits were $26.7 billion, an increase of 1.3% over December 31, 2003 and an increase of 9.9% over March 31, 2003. The increase was primarily due to the growth in our customer deposit base, primarily in Bank of the West, as well as various deposit product programs that we initiated. The decrease in all of the rates paid on deposits reflects the lower interest rate environment, caused primarily by rate decreases by the Federal Reserve’s Open Market Committee. Additional information on our average deposit balances and rates paid is provided in Table 1: Average Balances, Interest Income and Expense, and Yields and Rates (Taxable-Equivalent Basis).
CAPITAL
Stockholder’s equity totaled $4.4 billion at March 31, 2004, an increase of $135.0 million, or 3.2%, from December 31, 2003 and $429.0 million, or 10.8%, from March 31, 2003. The increase between December 31, 2003 and March 31, 2004 was primarily due to net income earned by the Company during the first quarter of 2004 and net unrealized gains on securities available-for-sale. The increase between March 31, 2003 and March 31, 2004 was primarily due to net income earned during the twelve month period.
33
Capital adequacy regulations require the Company’s depository institution subsidiaries to maintain minimum amounts of Tier 1 Capital and Total Capital and minimum ratios of Tier 1 Capital and Total Capital to risk-weighted assets, respectively, and of Tier 1 Capital to average assets (leverage). These amounts and ratios as of March 31, 2004 are set forth below:
We elected to become a financial holding company in 2001. Because of this election, only our depository institution subsidiaries are subject to various regulatory capital requirements administered by the Federal banking agencies. If these subsidiaries fail to meet minimum capital requirements, the Federal agencies can initiate certain mandatory actions. Such regulatory actions could have a material effect on the Company’s financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, our depository institution subsidiaries must each meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. These capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
INCOME TAXES
Our effective income tax rate (exclusive of the tax equivalent adjustment) for the three months ended March 31, 2004 and 2003 was 38.8%.
Lease-in/lease-out (“LILO”) transactions have recently been subject to review on a nation-wide basis by the Internal Revenue Service (“IRS”) to determine whether the tax deductions connected with such transactions are allowable for U.S. federal income tax purposes. The Company has entered into several LILO transactions, which have been the subject of an audit by the IRS. In April 2004, the Company received a Revenue Agent’s Report (“RAR”) which disallowed all deductions associated with the LILO transactions. In order to avoid potential future interest and penalties, the Company anticipates paying, under protest, the amounts claimed by the IRS in the RAR. The Company continues to believe that it properly reported its LILO transactions and will contest the results of the IRS’s audit. At the present time, the Company cannot predict the outcome of this issue.
LIQUIDITY MANAGEMENT
Liquidity refers to our ability to provide sufficient short- and long-term cash flows to fund operations and to meet obligations and commitments, including depositor withdrawals and debt service, on a timely basis at reasonable costs. We achieve our liquidity objectives with both assets and liabilities. Further, while liquidity positions are managed separately by the Company and its two subsidiary banks, both short-term and long-term activities are coordinated between the two subsidiary banks.
We obtain short-term, asset-based liquidity through our investment securities portfolio and short-term investments which can be readily converted to cash. These liquid assets consist of cash and due from banks, interest-bearing deposits in other banks, federal funds sold, trading assets, securities purchased under agreements to resell, available-for-sale investment securities and loans held for sale. Such assets represented 21.1% of total assets at the March 31, 2004, compared to 21.3% at December 31, 2003 and 18.7% at March 31, 2003.
34
Intermediate- and longer-term asset liquidity is primarily provided by regularly scheduled maturities and cash flows from our loans and investment securities. Additional liquidity is available from certain assets that can be sold, securitized or used as collateral for borrowings from the Federal Home Loan Bank such as consumer and mortgage loans.
We obtain short-term, liability-based liquidity primarily from deposits. Average total deposits increased by 9.5% to $26.4 billion at March 31, 2004, primarily due to continued expansion of our customer base in the Western United States. Average total deposits funded 68.9% and 69.4% of average assets for the quarter ended March 31, 2004 and the year ended December 31, 2003, respectively.
We also obtain short-term and long-term liquidity from ready access to regional and national wholesale funding sources, including purchasing federal funds, selling securities under agreements to repurchase, lines of credit from other banks and credit facilities from the Federal Home Loan Bank. The following table reflects immediately available borrowing capacity at the Federal Reserve Discount Window and the Federal Home Loan Bank and securities available for selling under repurchase agreements:
Offshore deposits in the international market provide another available source of funds.
Funds taken in the intermediate- and longer-term markets are structured to avoid concentration of maturities and to reduce refinancing risk. We also attempt to diversify the types of instruments issued to avoid undue reliance on any one market or funding source.
Liquidity for the parent company is primarily provided by dividend and interest income from its subsidiaries. Short-term cash requirements are met through liquidation of short-term investments. Longer-term liquidity is provided by access to the capital markets or from transactions with our parent company, BNP Paribas.
Our ability to pay dividends depends primarily upon dividends and other payments from our subsidiaries, which are subject to certain limitations as described in Note 16 to the Audited Consolidated Financial Statements included in the Company’s 2003 Annual Report on Form 10-K.
Our borrowing costs and ability to raise funds are a function of our credit ratings and any change in those ratings. The following table reflects the ratings of Bank of the West and First Hawaiian Bank as of March 31, 2004:
35
Cash Flows
The following is a summary of our cash flows for the three months ended March 31, 2004 and 2003. (There is more detail in the Consolidated Statements of Cash Flows.)
The decrease in cash and cash equivalents in the first quarter of 2004 was primarily due to increased loan volume, through direct origination and loan purchases, as well as the purchase of investment securities. The increases in these portfolios were primarily funded by an increase in customer deposits of $340.1 million and additional borrowings. The decrease in the first quarter of 2003 was primarily due to the purchase of investment securities.
RECENT ACCOUNTING STANDARDS
We have adopted numerous new or modifications to existing standards, rules or regulations promulgated by various standard setting and regulatory bodies. Chief among these are the federal financial institutions regulators, the SEC and the FASB. The following section highlights important developments in the area of accounting and disclosure requirements. This discussion is not intended to be a comprehensive listing of the impact of all standards and rules adopted.
On March 9, 2004 the SEC released a Staff Accounting Bulletin: No. 105,Application of Accounting Principles to Loan Commitments, which provides guidance pertaining to interest rate locks of loan commitments accounted for as derivative instruments. It states that cash flows pertaining to mortgage servicing should not be included in the value of the derivative.
In December 2003, the Accounting Standards Executive Committee of the AICPA issued Statement of Position No. 03-3 (“SOP 03-3”), Accounting for Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-3 addresses the accounting for differences between the contractual cash flows and the cash flows expected to be collected from purchased loans or debt securities if those differences are attributable, in part, to credit quality. SOP 03-3 requires purchased loans and debt securities to be recorded initially at fair value based on the present value of the cash flows expected to be collected with no carryover of any valuation allowance previously recognized by the seller. Interest income should be recognized based on the effective yield from the cash flows expected to be collected. To the extent that the purchased loans experience subsequent deterioration in credit quality, a valuation allowance would be established for any additional cash flows that are not expected to be received. However, if more cash flows subsequently are expected to be received than originally estimated, the effective yield would be adjusted on a prospective basis. SOP 03-3 will be effective for loans and debt securities acquired after December 31, 2004. The Company anticipates that the implementation of SOP 03-3 will require significant loan system and operational changes to track credit related losses on loans purchased starting in 2005. We are still assessing the impact it will have on the Consolidated Financial Statements.
In December 2003 the Financial Accounting Standards Board (FASB) issued SFAS No. 132 (revised 2003) Employers’ Disclosures about Pensions and Other Postretirement Benefits (SFAS 132 (revised 2003)), an amendment of FASB Statements No. 87, Employers’ Accounting for Pensions, No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. This Statement retains the disclosure requirements contained in FASB Statement No. 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits, which it replaces. It requires additional disclosures to those in the original Statement 132 about describing the types of plan assets, investment strategy, measurement date(s), plan obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. This Statement amends APB Opinion No. 28, Interim Financial Reporting,to require interim-period disclosure of the components of net periodic benefit cost and, if significantly different from previously disclosed amounts, the amounts of contributions and projected contributions to fund pension plans and other postretirement benefit plans. This Statement is effective for fiscal years ending after December 15, 2003. The interim-period disclosures required by this Statement are effective for interim periods beginning after December 15, 2003. Disclosure of information about foreign plans and estimated future benefit payments required by SFAS 132 (revised 2003) shall be effective for fiscal years
36
ending after June 15, 2004. The adoption of SFAS 132 (revised 2003) required enhanced disclosure and did not impact our consolidated financial position, results of operations or cash flows.
37
BancWest Corporation and Subsidiaries QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk Measurement and Management
Interest rate risk, one of the leading risks in terms of potential earnings impact, is an essential element of being a financial intermediary. The Company’s net interest income is subject to interest rate risk to the extent our interest-bearing liabilities (primarily deposits and borrowings) mature or reprice on a different basis than its interest-earning assets (primarily loans and leases and investment securities). When interest-bearing liabilities mature or reprice more quickly than interest-earning assets during a given period, an increase in interest rates could reduce net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, a decrease in interest rates could have a negative impact on net interest income. In addition, the impact of interest rate swings may be exacerbated by factors such as our customers’ propensity to manage their demand deposit balances more or less aggressively or to refinance mortgage and other consumer loans depending on the interest rate environment. Short and long-term market rates may change independent of each other resulting in changes to the slope and absolute level of the yield curve.
The Asset/Liability Committees of the Company and our major subsidiaries are responsible for managing interest rate risk. The Asset/Liability Committees generally meet monthly or quarterly. The committees may recommend changes to a particular subsidiary’s interest rate profile to their respective Board of Directors, should changes be necessary and depart significantly from established policies.
Our exposure to interest rate risk is managed primarily by taking actions that impact certain balance sheet accounts (e.g., lengthening or shortening maturities in the investment portfolio, changing asset and/or liability mix - including increasing or decreasing the amount of fixed and/or variable instruments held by the Corporation – to adjust sensitivity to interest rate changes) and/or utilizing instruments such as interest rate swaps, caps, floors, options or forwards.
Derivatives entered into for trading purposes include commitments to purchase and sell foreign currencies as well as certain interest rate swaps and options. We also enter into customer accommodation interest rate swaps and foreign exchange spot and forward contracts as well as contracts to offset either the customer’s counter-position or our foreign currency denominated deposits. These contracts basically offset each other and they do not expose us to material losses resulting from interest rate or foreign currency fluctuations.
The Company and its subsidiaries use computer simulation models to evaluate net interest income in order to quantify exposure to changes in interest rates. Generally, the size of the balance sheet is held relatively constant and then subjected to interest rate shocks up in 100-basis-point increments and down in a 50 basis-point increment. Each account-level item is repriced according to its respective contractual characteristics, including any embedded options which might exist (e.g., periodic interest rate caps or floors or loans and leases which permit the borrower to prepay the principal balance of the loan or lease prior to maturity without penalty). Derivative financial instruments such as interest rate swaps, caps or floors are included as part of the modeling process. For each interest rate shock scenario, net interest income over a 12-month horizon is compared against the results of a scenario in which no interest rate change occurs (flat rate scenario) to determine the level of interest rate risk at that time.
The projected impact of incremental increases and a 50 basis-point decrease in interest rates on the projected Company’s consolidated net interest income over the 12 months beginning April 1, 2004 is shown below.
Because of the absolute low level of interest rates in 2004, modeling a 200 and 100-basis-point decrease was deemed impractical. The changes in the models are due to differences in interest rate environments which include the absolute level of interest rates, the shape of the yield curve, and spreads between various benchmark rates.
38
BancWest Corporation and Subsidiaries QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
Significant Assumptions Utilized and Inherent Limitations
The significant net interest income changes for each interest rate scenario presented above include assumptions based on accelerating or decelerating mortgage and non-mortgage consumer loan prepayments in declining or rising scenarios, respectively, and adjusting deposit levels and mix in the different interest rate scenarios. The magnitude of changes to both areas in turn are based upon analyses of customers’ behavior in differing rate environments. However, these analyses may differ from actual future customer behavior. For example, actual prepayments may differ from current assumptions as prepayments are affected by many variables which cannot be predicted with certainty (e.g., prepayments of mortgages may differ on fixed and adjustable loans depending upon current interest rates, expectations of future interest rates, availability of refinancing, economic benefit to borrower, financial viability of borrower, etc.).
As with any model for analyzing interest rate risk, certain limitations are inherent in the method of analysis presented above. For example, the actual impact on net interest income due to certain interest rate shocks may differ from those projections presented should market conditions vary from assumptions used in the analysis. Furthermore, the analysis does not consider the effects of a changed level of overall economic activity that could exist in certain interest rate environments. Moreover, the method of analysis used does not take into account the actions that management might take to respond to changes in interest rates because of inherent difficulties in determining the likelihood or impact of any such response.
The following estimated net fair value amounts of interest rate derivatives held for trading purposes have been determined by the Company using available market information and appropriate valuation methodologies:
39
BancWest Corporation and Subsidiaries CONTROLS AND PROCEDURES
Item 4. Controls and Procedures
As of the filing date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s chairman and chief executive officer and its chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, its chairman and chief executive officer and its chief financial officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.
There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation.
40
BancWest Corporation and Subsidiaries EXHIBITS AND REPORTS ON FORM 8-K
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
The Exhibits listed below are filed or incorporated by reference as part of this Report.
41
BancWest Corporation and Subsidiaries EXHIBITS AND REPORTS ON FORM 8-K (Continued)
SIGNATURE
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.
42
EXHIBIT INDEX
43