UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
OR
Commission file number 0-7949
BANCWEST CORPORATION
Registrant’s telephone number, including area code: (808) 525-7000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed bySection 13 or l5(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 [X] No [ ]
The number of shares outstanding of each of the issuer’s classes of common stockas of August 1, 2002 was:
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial StatementsBancWest Corporation and SubsidiariesCONSOLIDATED BALANCE SHEETS (Unaudited)
The accompanying notes are an integral part of these consolidated financial statements.
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BancWest Corporation SubsidiariesCONSOLIDATED BALANCE SHEETS, Continued (Unaudited)
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BancWest Corporation and SubsidiariesCONSOLIDATED STATEMENTS OF INCOME (Unaudited)
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BancWest Corporation and SubsidiariesCONSOLIDATED STATEMENTS OFCHANGES IN STOCKHOLDER’S EQUITY (Unaudited)
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BancWest Corporation and SubsidiariesCONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
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BancWest Corporation and SubsidiariesNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. Summary of Significant Accounting Policies
The accounting and reporting policies of BancWest Corporation and Subsidiaries (“BancWest,” the “Company” or “we/our”) conform with generally accepted accounting principles and practices within the banking industry. The following is a summary of significant accounting policies:
Consolidation
The consolidated financial statements of the Company include the accounts of BancWest Corporation (“BWE”) and its wholly-owned subsidiaries: Bank of the West and its wholly-owned subsidiaries (“Bank of the West”); First Hawaiian Bank and its wholly-owned subsidiaries (“First Hawaiian”); FHL Lease Holding Company, Inc. and its wholly-owned subsidiary; First Hawaiian Capital I; BancWest Capital I; and FHI International, Inc. All significant intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, all adjustments (which included only normal recurring adjustments) necessary for a fair presentation are reflected in the Consolidated Financial Statements.
Reclassifications
The 2001 Consolidated Financial Statements were reclassified in certain respects to conform to the 2002 presentation. Such reclassifications did not have a material effect on the Consolidated Financial Statements.
2. New Pronouncements
In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” SFAS No. 141, which supersedes Accounting Principles Board (“APB”) Opinion No. 16, “Business Combinations,” addresses financial accounting and reporting for business combinations. All business combinations in the scope of SFAS No. 141 are to be accounted for using the purchase method of accounting. Also included in the provisions of SFAS No. 141 are new criteria for identifying and recognizing intangible assets apart from goodwill and additional disclosure requirements concerning the primary reasons for a business combination and the allocation of the purchase price for the assets acquired and liabilities assumed. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001, as well as to all business combinations accounted for using the purchase method of accounting for which the date of acquisition is July 1, 2001 or later. The Company adopted the provisions of SFAS No. 141 concurrent with the acquisition of BancWest by BNP Paribas (the“BNP Paribas Merger”). See further discussion in Note 3.
In July 2001, the FASB also issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142, which supersedes APB Opinion No. 17, “Intangible Assets,” addresses the accounting and reporting for goodwill and other intangible assets acquired individually or with a group of other assets (but not those acquired in a business combination) at and subsequent to acquisition. Under the provisions of SFAS No. 142, goodwill and certain other intangible assets which do not possess finite lives will no longer be amortized into net income over an estimated life but rather will be tested at least annually for impairment based on specific guidance provided in the new standard. Intangible assets determined to have finite lives will continue to be amortized over their estimated useful lives and also continue to be subject to impairment testing. Application of the non-amortization provisions of this statement was effective with the BNP Paribas Merger. The remaining provisions of SFAS No. 142 were adopted by the Company effective January 1, 2002. Goodwill and other indefinite lived intangible assets were subjected to a transitional impairment test during the quarter ended March 31, 2002. As of March 31, 2002, we had no impairment on our goodwill. Had we amortized the goodwill arising from the BNP Paribas Merger, pre-tax amortization of goodwill of approximately $51.6 million (assuming an amortization period of 20 years) would have been recorded on the Company’s consolidated financial statements in the first six months of 2002. In addition, the year-to-date pre-tax amortization of goodwill related to the acquisition of United California Bank (“UCB”) from March 15, 2002, which would have amounted to $19.2 million, was not recorded.
The following table reflects consolidated net income adjusted as though the adoption of SFAS Nos. 141 and 142 occurred as of the beginning of the three and six months periods ended June 30, 2002 and 2001:
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The estimated annual amortization expense for finite life intangible assets, primarily core deposit intangibles arising from the BNP Paribas Merger and the acquisition of UCB, is approximately $23 million (pre-tax) for each of the years from 2003 to 2007.
Goodwill increased in the six-month period ended June 30, 2002 due to the acquisition of UCB on March 15, 2002. The additional $1.3 billion of goodwill is reported in the Bank of the West operating segment.
In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” However, SFAS No. 144 retains the fundamental provisions of SFAS No. 121 for the recognition and measurement of the impairment of long-lived assets to be held and used and the measurement of long-lived assets to be disposed of by sale. The scope of SFAS No. 144 excludes goodwill and other non-amortizable intangible assets to be held and used as well as goodwill associated with a reporting unit to be disposed of. The provisions of SFAS No. 144 are effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 144 did not have a material effect on the Company’s Consolidated Financial Statements.
In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The principal difference between SFAS No. 146 and EITF Issue No. 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue No. 94-3, a liability for an exit cost as defined in EITF Issue No. 94-3 was recognized at the date of an entity’s commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of SFAS No. 146 is not expected to have a material effect on the Company’s Consolidated Financial Statements.
On July 1, 2002, the FASB issued an Exposure Draft (“ED”) of a proposed interpretation entitled “Consolidation of Certain Special-Purpose Entities, an Interpretation of ARB 51.” If issued in a final interpretation, the provisions of the ED would establish new guidance on the accounting and reporting for the consolidation of Special-Purpose Entities (“SPEs”). The primary objective of the ED is to require that an entity that has a controlling financial interest in an SPE consolidate the SPE’s assets, liabilities and results of operations in the entity’s own financial statements. If issued as is, the provisions of the ED may apply to the REFIRST, Inc. SPE that was created by a non-related third party to construct, finance and hold title to our administrative headquarters building (see our 2001 Annual Report on Form 10-K, page 35 “Special Purpose Entities” for additional information). The provisions of the final interpretation would apply beginning April 1, 2003. We are in the process of determining the financial impact of the adoption of this ED. However, if the proposal is adopted in substantially the same form, we would expect to record approximately $160 million of additional premises and equipment and $190 million in debt on the Consolidated Balance Sheet. In addition, we would record approximately $4 million in additional depreciation expense annually.
3. Mergers and Acquisitions
United California Bank Acquisition
On March 15, 2002, BancWest, a wholly-owned subsidiary of BNP Paribas, completed its acquisition of all of the outstanding stock of UCB from UFJ Bank Ltd. of Japan. On March 15, 2002, UCB had total assets of $10.1 billion, net loans of $8.5 billion, total deposits of $8.3 billion and a total of 115 branches. The preceding amounts do not include final purchase price accounting adjustments. The purchase price of approximately $2.4 billion was paid in cash and the transaction was accounted for as a purchase. BNP Paribas funded BancWest’s acquisition of UCB by providing $1.6 billion of additional capital to BancWest and by lending it $800 million. UCB was merged with and into Bank of the West on April 1, 2002. UCB had a strong presence in Southern California, which complements Bank of the West’s existing network in Northern California, the Pacific Northwest, New Mexico and Nevada. We expect to achieve cost savings for the combined company of approximately $75 million per year beginning in 2003. These cost savings are primarily in compensation and occupancy related expenses. Branches of UCB are expected to be fully integrated into the Bank of the West branch network system in the third quarter of 2002. Results of operations of UCB are included in our Consolidated Financial Statements beginning on March 15, 2002.
BancWest estimates it will incur expenses associated with exiting certain branches, operational centers and technology platforms of pre-merged Bank of the West, as well as certain other conversion and restructuring expenses, totaling approximately $15 million. Approximately $8.8 million of these costs were incurred during the first six months of 2002. Exit costs associated with UCB were considered as part of the purchase accounting for the acquisition. BancWest has established a severance reserve of approximately $40.5 million to cover approximately 600 employees throughout the organization whose positions will be eliminated as a result of the acquisition. In addition to the severance reserve, we recorded the following restructuring reserves: $34.2 million for losses on subleases, $8.5 million for contract cancellations, $1.5 million for relocation and other. In the three months ended June 30, 2002, we made the following adjustments to the reserves: $1.2 million increase for severance, $7.0 million decrease for losses on subleases and $5.4 million increase for contract cancellations. In addition, the reserves were reduced in the first six months of 2002 as follows: $6.5 million for severance payments, $.6 million for sublease loss amortization, $3.5 million for contract cancellation payments and $.3 million for relocation payments. These amounts are estimates and subject to change, as more information becomes available.
The following unaudited pro forma financial information for the three and six months ended June 30, 2002 and 2001 assumes that the UCB acquisition occurred as of January 1, 2001, after giving effect to certain adjustments. The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the results of operations which may occur in the future or that would have occurred had the UCB acquisition been consummated on the date indicated.
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BNP Paribas Merger
On December 20, 2001, Chauchat L.L.C., a Delaware limited liability company (“Merger Sub”), merged with and into BancWest pursuant to an Agreement and Plan of Merger, dated as of May 8, 2001, as amended and restated as of July 19, 2001, by and among BancWest, BNP Paribas, and the Merger Sub (the “Merger Agreement”). The Merger Sub was a wholly-owned subsidiary of BNP Paribas. At the effective time of the BNP Paribas Merger, all outstanding shares of common stock, par value $1 per share (“Company Common Stock”), of BancWest were cancelled and converted solely into the right to receive $35 per share in cash. Pursuant to the Merger Agreement, each share of Class A common stock, par value $1 per share, owned by BNP Paribas and French American Banking Corporation, a wholly-owned subsidiary of BNP Paribas, remained outstanding as one share of Class A Common Stock and all of the units of the Merger Sub were cancelled without any consideration becoming payable therefor. Concurrent with the BNP Paribas Merger, the par value of the Class A common stock was changed to $.01. As a result of the BNP Paribas Merger, BancWest became a wholly-owned subsidiary of BNP Paribas.
The BNP Paribas Merger significantly affected our financial statements. “Push-down” accounting was required for this business combination. Essentially, this resulted in three major changes to our balance sheet:
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4. Impaired Loans
The following table summarizes impaired loan information as of and for the six months ended June 30, 2002 and 2001 and as of and for the year ended December 31, 2001:
We consider loans to be impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. For a loan that has been restructured, the contractual terms of the loan agreement refer to the terms of the original loan agreement. Not all impaired loans are necessarily placed on nonaccrual status; for example, restructured loans performing under restructured terms beyond a specific period may be classified as accruing, but may still be deemed impaired. Impaired loans without a related allowance for credit losses are generally collateralized by assets with fair values in excess of the recorded investment in the loans. We generally apply interest payments on impaired loans to reduce the outstanding principal amount of such loans.
5. Derivative Financial Instruments
At June 30, 2002, we carried $600 million of interest rate swaps, categorized as cash flow hedges, with a fair market value of $31.0 million. We pay 3-month LIBOR on these cash flow hedges and receive fixed rates ranging from 5.64% to 5.87%. These interest rate swaps hedge LIBOR-based commercial loans and were initiated to help offset a reduction in commercial loan interest income resulting from a decrease in interest rates. The $600 million of interest rate swaps were entered into in 2001 and mature in 2006. The net settlement on the $600 million of interest rate swaps increased commercial loan interest income by $6.5 million from March 16, 2002 through June 30, 2002. We estimate net settlement gains, recorded as commercial loan interest income, of $19 million over the next twelve months resulting from these cash flow hedges.
In addition to the cash flow hedges described above, we have various derivative instruments that hedge the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value” hedge). Any portion of the changes in fair value of derivatives designated as a hedge that is deemed ineffective is recorded in current period earnings; this amount was not material in 2002.
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6. Operating Segments
As of June 30, 2002, we had two reportable operating segments: Bank of the West and First Hawaiian. The Bank of the West segment includes UCB from March 15, 2002 and operates primarily in the continental United States. The First Hawaiian segment operates primarily in the State of Hawaii.
The financial results of our operating segments are presented on an accrual basis. There are no significant differences between the accounting policies of the segments as compared to the Company’s Consolidated Financial Statements. We evaluate the performance of these segments and allocate resources to them based on net interest income and net income. There are no material intersegment revenues.
The tables below present information about our operating segments as of or for the three and six months ended June 30, 2002 and 2001, respectively:
The reconciling items in the tables above are primarily intercompany eliminations.
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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: (1) global, national and local economic and market conditions, specifically with respect to changes in the United States economy; (2) the level and volatility of interest rates and currency values; (3) government fiscal and monetary policies; (4) credit risks inherent in the lending process; (5) loan and deposit demand in the geographic regions where we conduct business; (6) the impact of intense competition in the rapidly evolving banking and financial services business; (7) extensive federal and state regulation of our business, including the effect of current and pending legislation and regulations; (8) whether expected revenue enhancements and cost savings are realized within expected time frames; (9) risk and uncertainties regarding the purchase of UCB, including: a) the possibility of customer or employee attrition following the UCB transaction; b) lower than expected revenues following the UCB transaction; and c) problems or delays in bringing together UCB with BancWest/Bank of the West; (10) matters relating to the integration of our business with that of past and future merger partners, including the impact of combining these businesses on revenues, expenses, deposit attrition, customer retention and financial performance; (11) our reliance on third parties to provide certain critical services, including data processing; (12) the proposal or adoption of changes in accounting standards by the Financial Accounting Standards Board (“FASB”), the Securities and Exchange Commission (“SEC”) or other standard setting bodies; (13) technological changes; (14) other risks and uncertainties discussed in this document or detailed from time to time in other SEC filings that we make; and (15) management’s ability to manage risks that result from these and other factors. 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.
GAAP, OPERATING AND CASH EARNINGS
We analyze our performance on a net income basis determined in accordance with generally accepted accounting principles (“GAAP”), as well as on an operating basis before merger-related, integration and other nonrecurring costs and/or the effects of the amortization of intangible assets. We refer to the results as “operating” and “cash” earnings, respectively. Operating earnings, cash earnings and operating cash earnings (the combination of the effect of adjustments for both cash and operating results), as well as information calculated from them and related discussions, are presented as supplementary information in this analysis to enhance the readers’ understanding of, and highlight trends in, our core financial results excluding the effects of discrete business acquisitions and other transactions. We include these additional disclosures because this information is both relevant and useful in understanding the performance of the Company as management views it. Operating earnings and cash earnings should not be viewed as a substitute for net income as determined in accordance with GAAP. Merger-related and integration costs, amortization of intangible assets and other items excluded from net income to derive operating and cash earnings may be significant and may not be comparable to those of other companies.
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BancWest Corporation and SubsidiariesCONSOLIDATED FINANCIAL HIGHLIGHTS (Unaudited)
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NET INCOME
The following table compares net income, operating earnings, cash earnings and operating cash earnings for the three and six months ended June 30, 2002 to the same periods in 2001:
Net income and cash earnings increased for the three months ended June 30, 2002 compared to the same period in 2001, primarily due to higher net interest income, resulting from higher average earning assets and a lower rate paid on funding sources. Also contributing to the increase in our net income and cash earnings in the second quarter of 2002 over the same period in 2001 was increased contribution from our Bank of the West operating segment, including the operations of UCB for the entire quarter.
The increases in net income, operating earnings, cash earnings and operating cash earnings for the first six months of 2002 compared to the same period in 2001 was primarily due to the acquisition of UCB on March 15, 2002, partially offset by the after-tax net effect of $14.9 million related to the Concord security gain, additional provision for credit losses and other nonrecurring items in 2001. The cessation of the amortization of goodwill in 2002 due to changes to GAAP (see Note 2 to our Consolidated Financial Statements on pages 7 and 8) also contributed to the increase in net income and operating earnings.
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NET INCOME, Continued
The table below shows the return on average total assets, the return on average tangible assets and the return on average stockholder’s equity for the first six months of 2002 compared to the same period in 2001. The return on average tangible assets is defined as operating cash earnings as a percentage of average total tangible assets.
NET INTEREST INCOME
The following table compares net interest income on a taxable-equivalent basis for the three and six months ended June 30, 2002 to the same periods in 2001:
The increase in net interest income for the three months ended June 30, 2002 over the same period in 2001 was primarily due to an increase in average earning assets of 62.2%, or $10.6 billion, and a 134-basis-point decrease (1% equals 100 basis points) in the rate paid on funding sources, offset by a 135-basis-point decline in the yield on average earning assets. In addition, lower cost of funds resulted from higher average noninterest-bearing deposits, which increased by $2.7 billion, or 87.4%, in the second quarter of 2002 over the same period in 2001.
The increase in net interest income for the six months ended June 30, 2002 over the same period in 2001 was primarily due to an increase in average earning assets of 40.8%, or $6.9 billion, and a 143-basis-point decline in the rate paid on funding sources, offset by a 143-basis-point decline in the yield on average earning assets. The lower cost of funds is also a result of higher average noninterest-bearing deposits, which increased by $1.8 billion, or 58.7%, in the first six months of 2002 over the same period in 2001.
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NET INTEREST INCOME, Continued
The following table compares the net interest margin for the three and six months ended June 30, 2002 to the same periods in 2001:
In the three-month period ended June 30, 2002, as compared to the same period in 2001, the net interest margin decreased by 1 basis point, primarily due to the decline in the rate paid on funding sources of 134 basis points and a decrease in the yield on average earning assets of 135 basis points. The effects of the reduction of key interest rates by the Federal Reserve are primarily responsible for the decline in yields and rates.
The net interest margin for the first six months of 2002 is the same as the first six months of 2001. The Federal Reserve’s benchmark Federal Funds rate changed eleven times in the period from January 2001 through December 2001. For further discussions of the impact that the changing interest environment has had on the rate paid on deposits, see page 21.
Our cost of funds was lowered by an increase in average noninterest-bearing deposits in the three and six months ended June 30, 2002 as compared to the same periods in 2001. The percentage of average noninterest-bearing deposits to total average deposits increased to 24.5% and 23.7% over 21.6% and 21.3%, for the three and six months ended June 30, 2002 and 2001, respectively.
The following table compares average earning assets, average loans and leases and average interest-bearing deposits and liabilities for the three and six months ended June 30, 2002 to the same periods in 2001:
The increase in average earning assets was primarily due to increases in average loans and leases. The increase in average loans and leases was primarily due to the growth of our Bank of the West operating segment’s loan and lease portfolio, including the UCB acquisition in the first quarter of 2002. Also contributing to the increase in average loans and leases were the branch acquisitions in Guam and Saipan in the fourth quarter of 2001.
The increase in average interest-bearing deposits and liabilities was due to increases in interest-bearing deposits, short-term borrowings and long-term debt. Expansion of our customer deposit base, primarily from our Bank of the West operating segment and the UCB acquisition, contributed to the increase.
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The following table sets forth consolidated average balance sheets, an analysis of interest income/expense and average yield/rate for each major category of interest-earning assets and interest-bearing liabilities for the periods indicated on a taxable equivalent basis. The tax equivalent adjustment is made for items exempt from Federal income taxes (assuming a 35% tax rate for 2002 and 2001) to make them comparable with taxable items before any income taxes are applied.
[Additional columns below]
[Continued from above table, first column(s) repeated]
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INVESTMENT SECURITIES
Held-to-Maturity
There were no held-to-maturity investment securities at June 30, 2002 and December 31, 2001. The following table presents the amortized cost, unrealized gains and losses, and fair values of held-to-maturity investment securities as of June 30, 2001:
Available-for-Sale
The following table presents the amortized cost, unrealized gains and losses, and fair values of available-for-sale investment securities as of the dates indicated:
Gross realized gains and losses on available-for-sale investment securities for the six months ended June 30, 2002 and 2001 were as follows:
Gains and losses realized on the sales of available-for-sale investment securities are determined using the specific identification method. Realized gains on the sale of investment securities for the six months ended June 30, 2001 include $18.5 million in pre-tax gain on the sale of Concord stock in the second quarter of 2001. This gain is in addition to the $41.3 million pre-tax gain recognized upon recordation of the Concord stock as an available-for-sale security. See section below, “Concord Security Gain,” for more information.
Concord Security Gain
The $41.3 million pre-tax securities gain that was recognized in the first quarter of 2001 relates to the merger between Star System, Inc. (“Star”) and Concord EFS, Inc. (“Concord”) on February 1, 2001. All of the outstanding shares of Star were exchanged for Concord shares in the merger. Prior to that merger, BancWest’s shares of Star System, Inc., were reported on our Consolidated Balance Sheet in other assets due to certain provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.”
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LOANS AND LEASES
The following table sets forth the loan and lease portfolio by major categories and loan and lease mix at June 30, 2002, December 31, 2001 and June 30, 2001:
The loan and lease portfolio is the largest component of earning assets and accounts for the greatest portion of total interest income. The increase in loans and leases as of June 30, 2002, as compared to December 31, 2001, was primarily due to the acquisition of UCB on March 15, 2002 and growth in our Bank of the West operating segment. Our net loans and leases increased by 58.2% to $23.8 billion over December 31, 2001 and 65.8% over June 30, 2001.
Total commercial, financial and agricultural loans at June 30, 2002 increased by 105.4%, or $2.5 billion, over December 31, 2001 and 100%, or $2.5 billion, over June 30, 2001. The increase in this category was primarily due to the UCB acquisition.
Total real estate-commercial loans at June 30, 2002 increased by 62.8%, or $1.9 billion, over December 31, 2001 and 72.0%, or $2.0 billion, over June 30, 2001, primarily due to growth in our Bank of the West operating segment, including loans acquired with UCB.
Total real estate-construction loans at June 30, 2002 increased by 132.9%, or $617.3 million, over December 31, 2001 and 161.2%, or $667.6 million, over June 30, 2001, primarily due to the UCB acquisition.
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LOANS AND LEASES, Continued
Total real estate-residential loans at June 30, 2002 increased by 101.6%, or $2.3 billion, over December 31, 2001 and 104.7% over June 30, 2001, primarily due to the UCB acquisition.
Total consumer loans at June 30, 2002 increased 36.7%, or $1.6 billion, over December 31, 2001 and increased 48.7%, or $2.0 billion, over June 30, 2001. Consumer loans consist primarily of direct and indirect automobile, recreational vehicle, marine, credit card and unsecured financing. The increase in consumer loans at June 30, 2002 as compared to December 31, 2001 and June 30, 2001 was primarily a result of growth in our Bank of the West operating segment and the acquisition of UCB.
The lease financing portfolio increased by .2%, or $4.8 million, over December 31, 2001, and increased 5.1%, or $110.8 million, over June 30, 2001 primarily due to growth in our Bank of the West operating segment.
Our foreign loans are principally in Guam and Saipan. Foreign loans as of June 30, 2002 decreased $512,000, or .1%, over December 31, 2001 and increased $50.5 million, or 15.1%, over June 30, 2001. The increase over June 30, 2001 was primarily due to our branch acquisition in November 2001.
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 June 30, 2002, we did not have a concentration of loans greater than 10% of total loans which is not otherwise disclosed as a category of loans as shown in the above table.
DEPOSITS
Deposits are the largest component of our total liabilities and account for the greatest portion of total interest expense. At June 30, 2002, total deposits were $24.1 billion, an increase of 65.0% over June 30, 2001. The increase was primarily due to the growth in our customer deposit base, primarily in the Bank of the West operating segment, especially the UCB acquisition, as well as various deposit product programs that we initiated. Contributing to the increase were the First Hawaiian branch acquisitions in Guam and Saipan from the Union Bank of California.
The decrease in all of the rates paid on deposits reflects falling rates in 2001, caused primarily by actions of the Federal Reserve’s Open Market Committee. During the 12-month period from July 1, 2001 to June 30, 2002, the benchmark federal funds rate decreased five times totaling 200 basis points. The rates paid on deposits reflect this rapidly changing interest rate environment at different speeds, due to the repricing characteristics of each type of deposit. Time deposits, which generally reprice more slowly than other deposits, do not yet fully reflect the sharp decreases in interest rates implemented in 2001, while money market and savings deposits, which can be repriced more rapidly, are more reflective of the decrease in the interest rate environment. The deposits in the foreign category are a mixture of time, savings and other interest-bearing deposits; therefore, its rate reflects both types of repricing characteristics. Additional information on our average deposit balances and rates paid is provided in the table on pages 17 and 18.
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NONPERFORMING ASSETS
Nonperforming assets at June 30, 2002, December 31, 2001 and June 30, 2001 are as follows:
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NONPERFORMING ASSETS, Continued
Nonperforming assets at June 30, 2002 were $251.4 million, or 1.04%, of total loans and leases and other real estate owned and repossessed personal property (“OREO”), compared to .91% at June 30, 2001. Nonperforming assets at June 30, 2002 were .74% of total assets, compared to .68% at June 30, 2001.
Nonperforming assets at June 30, 2002 increased by $132.0 million, or 110.5%, from December 31, 2001. The increase in nonaccrual loans was primarily due to commercial, financial and agricultural loans and real estate-commercial loans in our Bank of the West operating segment. The increase was primarily due to the acquisition of UCB, partially offset by lower nonperforming assets in the First Hawaiian operating segment.
Nonperforming assets at June 30, 2002 increased by $119.5 million, or 90.6%, from June 30, 2001. The increase was primarily attributable to increases in nonaccrual commercial, financial and agricultural loans and real estate-commercial loans, which were partially offset by decreases in nonaccrual consumer and lease financing loans.
We generally place a loan or lease on nonaccrual status when we believe that collection of principal or income has become doubtful or when loans and leases are 90 days past due as to principal or income, 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 or when other factors indicate that the borrower will shortly bring the loan current.
While the majority of consumer loans and leases are subject to our general policies regarding nonaccrual loans, certain 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 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 $28.2 million at June 30, 2002, an increase of $10.1 million, or 56.0%, from June 30, 2001. Loans past due 90 days or more and still accruing interest increased by $7.4 million, or 35.5%, from December 31, 2001 to June 30, 2002. The increase was primarily due to higher commercial, financial and agricultural loans, which was partially offset by a decrease in real estate-residential and foreign 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.
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PROVISION AND ALLOWANCE FOR CREDIT LOSSES
The following table sets forth the activity in the allowance for credit losses for the periods indicated:
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PROVISION AND ALLOWANCE FOR CREDIT LOSSES, Continued
The provision for credit losses for the first six months of 2002 was $42.9 million, a decrease of $15.4 million, or 26.5%, compared to the same period in 2001. The decrease in the provision for credit losses for the first six months of 2002 compared to the same period in 2001 primarily reflects the $22.8 million in additional provision for credit losses that we recorded in the first six months of 2001 in response to macroeconomic events.
The provision for credit losses is based upon our judgment as to the adequacy of the allowance for credit 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 credit 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:
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Charge-offs were $72.9 million for the first six months of 2002, an increase of $27.8 million, or 61.6%, over the same period in 2001. The increase was primarily due to charge-offs in commercial, financial and agricultural loans, consumer loans and lease financing in the first six months of 2002. The higher charge-offs resulted from the larger loan portfolio of our Bank of the West operating segment, including the UCB acquisition.
For the first six months of 2002, recoveries increased by $6.6 million, or 109.5%, compared to the same period in 2001. The increase in recoveries was primarily in commercial, financial and agricultural loans and lease financing.
Net charge-offs for the first six months of 2002 were 0.59% (annualized) compared to 0.55% (annualized) for the same period in 2001.
The Allowance decreased to 1.69 times nonperforming loans and leases (excluding 90 days or more past due accruing loans and leases) at June 30, 2002 from 1.74 times at June 30, 2001. The decrease in the ratio is principally due to an increase in nonperforming loans and leases, primarily in our Bank of the West operating segment following the acquisition of UCB.
In our judgment, the Allowance was adequate to absorb losses inherent in the loan and lease portfolio at June 30, 2002. 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 those specific items mentioned above in particular and make necessary adjustments to the Allowance accordingly.
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NONINTEREST INCOME
The following table reflects the key components of the change in noninterest income for the three and six months ended June 30, 2002, as compared to the same periods in 2001:
N/M — Not Meaningful.
As the table above shows in detail, noninterest income increased by 10.8% for the three months ended June 30, 2002 and decreased 15.3% for the six months ended June 30, 2002 compared to the same periods in 2001. Significant items include the following:
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NONINTEREST EXPENSE
The following table reflects the key components of the change in noninterest expense for the three and six months ended June 30, 2002 as compared to the same periods in 2001:
As the table above shows in detail, noninterest expense increased by 54.9% and 30.3% for the three and six months ended June 30, 2002, respectively, compared to the same periods in 2001. In addition to the factors noted below, the increase in noninterest expense for the three and six months ended June 30, 2002, compared to the same periods in 2001, was primarily due to the UCB acquisition. Factors causing the increase include the following:
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INCOME TAXES
Our effective income tax rates (exclusive of the tax equivalent adjustment) for the three and six months ended June 30, 2002 were 39.1% and 39.2%, as compared to 38.7% and 39.3%, respectively, for the same periods in 2001.
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.
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, securities purchased under agreements to resell and investment securities. Such assets represented 15.9% of total assets at June 30, 2002 compared to 16.7% at December 31, 2001.
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 or securitized, such as consumer and mortgage loans.
We obtain short-term liability-based liquidity primarily from deposits. Average total deposits for the six months ended June 30, 2002 increased 40.4% to $20.4 billion, over the year ended December 31, 2001, primarily due to continued expansion of our customer base in the Western United States and the acquisition of UCB. Average total deposits funded 71% of average total assets for the six months ended June 30, 2002 and 75% for the year ended December 31, 2001.
We also obtain short-term liquidity from ready access to regional and national wholesale funding sources, including issuing our own commercial paper, purchasing federal funds, selling securities under agreements to repurchase, arranging lines of credit from other banks and obtaining credit facilities from the Federal Home Loan Banks. Additional information on short-term borrowings is provided in Note 10 to the Consolidated Financial Statements on pages 57 and 58 of our 2001 Annual Report on Form 10-K. 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.
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 and the ability to obtain resources from BNP Paribas.
NONAUDIT SERVICES PROVIDED BY AUDITORS
In the period from January 1 to August 9, 2002, our audit committee has approved up to $1.1 million in fees related to non-audit services provided by our independent public accountants, PricewaterhouseCoopers, L.L.P. These fees relate primarily to assistance in the integration efforts of Bank of the West with UCB.
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CAPITAL
Stockholder’s equity was $3.799 billion at June 30, 2002, an increase of 89.8% over $2.002 billion at December 31, 2001. Compared to June 30, 2001, stockholder’s equity at June 30, 2002 increased by $1.718 billion, or 82.6%. The increase was primarily due to the issuance of additional Class A common shares in connection with the UCB acquisition.
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 June 30, 2002 are set forth below:
Due to the election to become a financial holding company done concurrently with the BNP Paribas Merger, only the Company’s depository institution subsidiaries are subject to various regulatory capital requirements administered by the Federal banking agencies. If they fail to meet minimum capital requirements, these 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, the Company’s 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.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
INTEREST RATE RISK MEASUREMENT AND MANAGEMENT
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 our 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.
The Asset/Liability Committees of the Company and its 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. Other than commitments to purchase and sell foreign currencies and mortgage-backed securities and certain interest rates swaps and options, interest rate derivatives are not entered into for trading purposes.
We also enter into customer accommodation interest rate swaps and foreign exchange spot and forward 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.
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INTEREST RATE RISK MEASUREMENT AND MANAGEMENT, Continued
The Company models its net interest income in order to quantify its 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 and down in 100 basis-point increments. Each account-level item is repriced according to its respective contractual characteristics, including any imbedded 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, swaptions, 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 100 basis-point incremental increases and decreases in interest rates on the Company’s consolidated net interest income over the 12 months beginning July 1 and January 1, 2002 is shown below:
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 benchmark rates.
SIGNIFICANT ASSUMPTIONS UTILIZED AND INHERENT LIMITATIONS
The net interest income changes for each interest rate scenario presented above include assumptions based on accelerating or decelerating mortgage and installment 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’ historic 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.
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PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Exhibits
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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.
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EXHIBIT INDEX