UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2004
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to
Commission File Number 1-6887
BANK OF HAWAII CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
99-0148992
(State of incorporation)
(IRS Employer Identification No.)
130 Merchant Street, Honolulu, Hawaii
96813
(Address of principal executive offices)
(Zip Code)
1-(888)-643-3888
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.
Yes ý
No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, $.01 Par Value; outstanding at July 23, 2004 – 52,583,973 shares
Bank of Hawaii Corporation
Form 10-Q
INDEX
Page
Part I. - Financial Information
Item 1.
Financial Statements (Unaudited)
Consolidated Statements of Income - Three and six months ended June 30, 2004 and 2003
3
Consolidated Statements of Condition – June 30, 2004, December 31, 2003, and June 30, 2003
4
Consolidated Statements of Shareholders’ Equity – Six months ended June 30, 2004 and 2003
5
Consolidated Statements of Cash Flows – Six months ended June 30, 2004 and 2003
6
Notes to Consolidated Financial Statements
7
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
9
Item 3.
Quantitative and Qualitative Disclosures of Market Risk
32
Item 4.
Controls and Procedures
Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
33
Submission of Matters to a Vote of Security Holders
Item 5.
Other Information
34
Item 6.
Exhibits and Reports on Form 8-K
35
2
Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Income (Unaudited)
Three Months EndedJune 30,
Six Months EndedJune 30,
(dollars in thousands except per share amounts)
2004
2003
Interest Income
Interest and Fees on Loans and Leases
$
80,346
85,954
161,774
171,727
Income on Investment Securities - Held to Maturity
6,711
3,083
13,687
5,366
Income on Investment Securities - Available for Sale
21,745
19,815
42,591
42,278
Deposits
1,646
1,161
2,877
2,468
Funds Sold
177
822
594
1,586
Other
865
1,016
1,723
2,205
Total Interest Income
111,490
111,851
223,246
225,630
Interest Expense
8,560
13,309
17,760
27,756
Securities Sold Under Agreements to Repurchase
2,222
2,391
4,148
4,633
Funds Purchased
506
219
737
424
Short-Term Borrowings
13
25
28
49
Long-Term Debt
4,340
5,422
8,693
11,283
Total Interest Expense
15,641
21,366
31,366
44,145
Net Interest Income
95,849
90,485
191,880
181,485
Provision for Loan and Lease Losses
(3,500)
—
Net Interest Income After Provision for Loan and Lease Losses
99,349
195,380
Non-Interest Income
Trust and Asset Management
12,995
12,545
26,859
25,726
Mortgage Banking
2,808
6,061
4,785
6,344
Service Charges on Deposit Accounts
9,540
8,645
19,490
17,595
Fees, Exchange, and Other Service Charges
14,243
13,473
27,482
26,462
Investment Securities Gains (Losses)
(37)
587
1,170
Insurance
3,303
3,015
6,946
6,095
11,996
6,413
18,165
12,100
Total Non-Interest Income
54,848
50,739
103,690
95,492
Non-Interest Expense
Salaries and Benefits
46,689
47,711
92,690
94,140
Net Occupancy Expense
9,543
9,628
18,929
19,241
Net Equipment Expense
5,799
9,208
11,763
18,956
Information Technology Systems Replacement Project
10,105
17,522
23,094
18,742
44,765
35,735
Total Non-Interest Expense
85,125
95,394
168,147
185,594
Income Before Income Taxes
69,072
45,830
130,923
91,383
Provision for Income Taxes
24,840
15,796
46,892
31,548
Net Income
44,232
30,034
84,031
59,835
Basic Earnings Per Share
0.84
0.50
1.57
0.99
Diluted Earnings Per Share
0.79
0.48
1.48
0.95
Dividends Declared Per Share
0.30
0.19
0.60
0.38
Basic Weighted Average Shares
52,491,874
59,566,970
53,389,261
60,425,943
Diluted Weighted Average Shares
55,662,415
62,301,337
56,710,653
62,907,697
Consolidated Statements of Condition
(dollars in thousands)
June 30,2004
December 31,2003
June 30,2003
(Unaudited)
Assets
Interest-Bearing Deposits
179,680
154,735
307,552
Investment Securities - Held to Maturity (Market Value of $663,534, $720,699, and $555,878)
679,382
727,233
548,719
Investment Securities - Available for Sale
2,275,272
1,991,116
2,140,607
250,000
Loans Held for Sale
9,565
9,211
71,892
Loans and Leases
5,787,314
5,757,175
5,471,870
Allowance for Loan and Lease Losses
(124,904)
(129,080)
(137,974)
Net Loans
5,662,410
5,628,095
5,333,896
Total Earning Assets
8,806,309
8,510,390
8,652,666
Cash and Non-Interest-Bearing Deposits
339,486
363,495
297,868
Premises and Equipment
149,128
160,005
165,542
Customers’ Acceptance Liability
1,213
1,707
1,371
Accrued Interest Receivable
36,378
32,672
35,849
Foreclosed Real Estate
4,889
4,377
9,285
Mortgage Servicing Rights
20,819
22,178
24,841
Goodwill
36,216
Other Assets
294,331
330,607
327,296
Total Assets
9,688,769
9,461,647
9,550,934
Liabilities
Non-Interest-Bearing Demand
1,939,580
1,933,928
1,843,750
Interest-Bearing Demand
1,464,207
1,356,330
1,161,409
Savings
2,976,108
2,833,379
2,754,607
Time
1,089,393
1,209,142
1,381,083
Total Deposits
7,469,288
7,332,779
7,140,849
687,816
472,757
699,256
139,055
109,090
90,200
11,055
12,690
22,424
Current Maturities of Long-Term Debt
80,000
96,505
34,000
Banker’s Acceptances Outstanding
Retirement Benefits Payable
62,821
61,841
62,678
Accrued Interest Payable
7,169
7,483
9,755
Taxes Payable and Deferred Taxes
225,989
207,101
196,868
Other Liabilities
87,325
138,999
81,988
217,600
227,563
298,535
Total Liabilities
8,989,331
8,668,515
8,637,924
Shareholders’ Equity
Common Stock ($.01 par value); authorized 500,000,000 shares; issued / outstanding: June 2004 - 81,711,599 / 52,426,010, December 2003 - 81,647,729 / 54,928,480, June 2003 - 81,588,394 / 58,896,230
813
807
Capital Surplus
403,150
391,701
386,565
Accumulated Other Comprehensive Income (Loss)
(27,258)
(5,711)
12,412
Retained Earnings
1,251,689
1,199,077
1,151,623
Deferred Stock Grants
(9,391)
(8,309)
(8,168)
Treasury Stock, at Cost (Shares: June 2004 - 29,285,589, December 2003 - 26,719,249, June 2003 - 22,692,164)
(919,565)
(784,433)
(630,229)
Total Shareholders’ Equity
699,438
793,132
913,010
Total Liabilities and Shareholders’ Equity
Consolidated Statements of Shareholders’ Equity (Unaudited)
Total
CommonStock
CapitalSurplus
Accum.OtherCompre-hensiveIncome(Loss)
RetainedEarnings
DeferredStockGrants
TreasuryStock
Compre-hensiveIncome
Balance at December 31, 2003
Comprehensive Income:
Other Comprehensive Income, Net of Tax:
Change in Unrealized Gains and Losses on Investment Securities
(21,547)
Total Comprehensive Income
62,484
Common Stock Issued under Stock Plans and Related Tax Benefits (908,502 shares)
32,028
11,449
803
(1,082)
20,852
Treasury Stock Purchased (3,527,779 shares)
(155,984)
Cash Dividends Paid
(32,222)
Balance at June 30, 2004
Balance at December 31, 2002
1,015,759
806
372,192
11,659
1,115,910
(1,424)
(483,384)
753
60,588
Common Stock Issued under Stock Plans and Related Tax Benefits (992,802 shares)
21,785
1
14,373
(1,190)
(6,744)
15,345
Treasury Stock Purchased (5,107,779 shares)
(162,190)
(22,932)
Balance at June 30, 2003
Consolidated Statements of Cash Flows (Unaudited)
Operating Activities
Adjustments to Reconcile Net Income to Net Cash Provided (Used) by Operating Activities:
Depreciation and Amortization
10,523
17,344
Amortization of Deferred Loan and Lease Fees
(1,248)
(3,759)
Amortization and Accretion of Investment Securities
6,830
19,282
2,444
3,382
Deferred Income Taxes
8,296
7,672
Net (Gain) Loss on Investment Securities
37
(1,170)
Proceeds From Sales of Loans Held for Sale
250,449
372,187
Originations of Loans Held for Sale
(250,803)
(403,961)
Net Change in Other Assets and Liabilities
11,323
2,824
Net Cash Provided by Operating Activities
118,382
73,636
Investing Activities
Proceeds from Redemptions of Investment Securities Held to Maturity
117,212
109,183
Purchases of Investment Securities Held to Maturity
(70,238)
(428,287)
Proceeds from Sales and Redemptions of Investment Securities Available for Sale
347,709
1,004,004
Purchases of Investment Securities Available for Sale
(671,520)
(874,254)
Net Increase in Loans and Leases
(29,567)
(113,986)
Premises and Equipment, Net
354
(5,917)
Net Cash Used by Investing Activities
(306,050)
(309,257)
Financing Activities
Net Increase in Demand Deposits
113,529
113,694
Net Increase in Savings Deposits
142,729
219,388
Net Decrease in Time Deposits
(119,749)
(112,394)
Proceeds from Long-Term Debt
50,000
Repayments of Long-Term Debt
(26,468)
(107,250)
Net Increase (Decrease) in Short-Term Borrowings
243,389
(21,628)
Proceeds from Issuance of Common Stock
23,380
15,023
Repurchase of Common Stock
Cash Dividends
Net Cash Provided (Used) by Financing Activities
188,604
(28,289)
Increase (Decrease) in Cash and Cash Equivalents
936
(263,910)
Cash and Cash Equivalents at Beginning of Period
518,230
1,119,330
Cash and Cash Equivalents at End of Period
519,166
855,420
Note 1. Summary of Significant Accounting Policies
Bank of Hawaii Corporation (the “Company”) is a bank holding company providing a broad range of financial products and services to customers in Hawaii and the Pacific Islands (Guam, nearby islands and American Samoa). The Company’s principal subsidiary is Bank of Hawaii (the “Bank”). All significant intercompany accounts and transactions have been eliminated in consolidation.
Basis of Presentation
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, the consolidated financial statements reflect all normal recurring adjustments necessary for a fair presentation of the results for the interim periods.
Certain prior period amounts have been reclassified to conform to current period classifications.
These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s 2003 Annual Report on Form 10-K. Operating results for the six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.
Stock-Based Compensation
The Company accounts for its stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. Generally, stock-based employee compensation expense associated with stock options is not reflected in net income as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation:
Six Months Ended June 30,
(dollars in thousands except per share and option data)
Net Income, as Reported
Add:
Stock-Based Employee Compensation Expense Associated with Stock Options Included in Reported Net Income, Net of Related Tax Effects
326
Less:
Total Stock-Based Employee Compensation Expense Associated with Stock Options Determined Under Fair Value Method for all Option Awards, Net of Related Tax Effects
(2,867)
(5,691)
Pro Forma Net Income 1
81,164
54,470
Earnings Per Share:
Basic-as reported
Basic-pro forma 1
1.52
0.90
Diluted-as reported
Diluted-pro forma 1
1.43
0.87
Weighted Average Fair Value of Options Granted During the Year1
8.58
Assumptions:
Average Risk Free Interest Rate
3.85%
Average Expected Volatility
31.94%
Expected Dividend Yield
3.07%
Expected Life
6.6 years
1 A Black-Scholes option pricing model was used to determine the fair value of the options granted.
Note 2. Business Segments
The information under the caption “Business Segments” in Management’s Discussion and Analysis is incorporated herein by reference.
Note 3. Pension Plans and Postretirement Benefits
Components of net periodic benefit cost for the aggregated pension plans and the postretirement benefits are presented in the following table.
Pension Benefits
Postretirement Benefits
Components of Net Periodic Benefit Cost:
Service Cost
494
620
Interest Cost
2,183
2,136
886
1,028
Expected Return on Plan Assets
(2,364)
(2,324)
Amortization of Unrecognized Net Transition Obligation
294
Actuarial (Gain) Loss
656
455
(312)
(132)
Total Components of Net Periodic Benefit Cost
475
267
1,362
1,842
There were no significant changes from the previously reported $1.8 million in contributions expected to be paid during 2004.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was enacted on December 8, 2003. The Act expands Medicare, primarily adding a prescription drug benefit for Medicare-eligible retirees starting in 2006. In May 2004, the Financial Accounting Standards Board issued Staff Position No. FAS 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“FSP 106-2”), that provides accounting guidance for the effects of the Act regarding prescription drug benefits under Medicare for sponsors of retiree health care benefit plans. The Company evaluated the impact of the Act in conjunction with the guidance provided in FSP 106-2 and it is not expected that the Medicare changes will have an effect on the Company’s postretirement benefit obligations.
8
Note 4. Information Technology Systems Replacement Project
In July 2002, the Company entered into contracts with Metavante Corporation to provide for technology services, including professional services to convert existing systems to Metavante systems. The conversion was completed in the third quarter of 2003 and the final payments were made in the second quarter of 2004. The following summarizes the change in the liability balance during the six months ended June 30, 2004:
Professional Fees
EmployeeTerminationBenefits
OtherAssociatedCosts 1
Liability Balance at December 31, 2003
1,002
471
513
1,986
Payments
(605)
(421)
(1,026)
Adjustments
(51)
51
Liability Balance at March 31, 2004
346
50
564
960
(346)
(50)
(564)
(960)
Liability Balance at June 30, 2004
1 Includes contract termination, equipment, excise tax and other costs.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This report, including the Earnings Outlook herein, contains forward-looking statements concerning, among other things, the economic environment in the Company’s service area, the expected level of loan loss provisioning, and anticipated net income, dividends, revenues and expenses during 2004 and beyond. The Company’s forward-looking statements are based on numerous assumptions, any of which could prove to be inaccurate and actual results may differ materially from those projected for a variety of reasons, including, but not limited to: 1) unanticipated changes in business and economic conditions, the competitive environment, fiscal and monetary policies, or legislation in Hawaii and the other markets the Company serves; 2) changes in the Company’s credit quality or risk profile which may increase or decrease the required level of allowance for loan and lease losses; 3) changes in market interest rates that may affect the Company’s credit markets and ability to maintain its net interest margin; 4) changes to the amount and timing of the Company’s proposed equity repurchases and repayment of maturing debt; 5) inability to achieve expected benefits of the Company’s business process changes due to adverse changes in implementation processes or costs, operational savings, or timing; 6) real or threatened acts of war or terrorist activity affecting business conditions; and 7) adverse weather and other natural conditions impacting the Company and its customers’ operations. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted” and similar expressions are intended to identify forward-looking statements but are not exclusive means of identifying such statements. The Company does not undertake any obligation to update forward-looking statements to reflect later events or circumstances.
OVERVIEW
In January 2004, the Company announced its 2004-2006 plan (the “Plan”), which continues to build on the objective of maximizing shareholder value over time that was established in the previous three-year strategic plan.
There are five key elements of the Plan: 1) accelerate revenue growth in our island markets; 2) better integrate our business segments; 3) continue to develop our management teams; 4) improve operating efficiency; and 5) maintain a culture of dependable risk and capital management. The Company plans to accelerate growth by improving customer service levels and developing a more proactive, integrated sales culture across the Company. In order to better integrate the Company’s three primary business segments - Retail Banking, Commercial Banking and Investment Services Group - each segment plans to work more closely with the others to improve the breadth of customer relationships. In continuing to develop the management team, the Company plans to assess leadership talent, build leadership capabilities and continue the development of a comprehensive succession plan. To improve efficiency, the Company plans to identify opportunities and implement changes that lower costs without negatively impacting customer service. In maintaining a discipline of dependable risk and capital management, the Company seeks to optimally balance risk, liquidity and capital. Risk will be managed in accordance with established tolerance levels while supporting business units in making value-adding risk/return decisions.
The Company utilizes various financial measures to evaluate its performance and against the objectives of the Plan. These measures include diluted earnings per share, return on average assets, return on average equity, efficiency ratio and operating leverage, which is defined as the impact of relative changes in revenues and expenses on operating income. Management also uses net income after capital charge as a key measure of the value the Company is creating for its shareholders. In managing risk, the Company looks at credit quality measures such as the ratio of the allowance for loan and lease losses to loans and leases outstanding, the ratio of net loan charge-offs to average loans outstanding and the ratio of non-performing assets to total loans and foreclosed real estate.
In the second quarter of 2004, the Company’s diluted earnings per share were $0.79, an increase of $0.10 or 14% from diluted earnings per share of $0.69 reported in the first quarter of 2004, and an increase of $0.31 or 65% from diluted earnings per share of $0.48 in the second quarter of 2003. Net income for the second quarter of 2004 was $44.2 million, an increase of $4.4 million or 11% from net income of $39.8 million in the previous quarter and an increase of $14.2 million or 47% from net income of $30.0 million reported in the same prior year quarter.
For the six months ended June 30, 2004, net income was $84.0 million, an increase of $24.2 million from the same prior year period. Diluted earnings per share were $1.48 for the first half of 2004, an increase of 56% from diluted earnings per share of $0.95 for the first half of 2003. The year-to-date return on average assets was 1.73%, an increase from 1.29% from the same period in 2003. The year-to-date return on average equity was 22.03%, an increase from 12.67% from the same period in 2003. Net income after capital charge was $31.6 million, compared to ($0.1) million for the first six months of 2003. For additional information, refer to the section on “Business Segments.”
Factors that had an impact on the comparability of year-over-year results include the effect of the Company’s ongoing stock repurchase program, non-core transactions in the second quarter of 2004 that impacted both non-interest income and non-interest expense and the negative provision for loan and lease losses. Non-core transactions in the second quarter of 2004 included non-interest income of $3.2 million from a leasing partnership distribution that was dissolved and a $2.5 million gain realized on the sale of a parcel of land. Also included was non-interest expense of $2.2 million for a legal accrual, which was primarily for the settlement of litigation, and a $1.0 million discretionary contribution to the Bank of Hawaii Charitable Foundation. In addition, results for the second quarter of 2003 were significantly affected by the costs associated with the systems replacement project. These items are further discussed in the section on “Analysis of Statement of Income.”
Management believes operating leverage and the efficiency ratio measures are more meaningful when the second quarter 2004 non-core transactions and the systems replacement costs incurred in 2003 are excluded. Excluding the aforementioned items, operating leverage for the first six months of 2004 was 14% and the efficiency ratio for the second quarter of 2004 was 57% compared to 60% in second quarter 2003.
Table 1 presents the Company’s financial highlights and performance ratios for the three and six months ended June 30, 2004 and 2003.
10
Highlights (Unaudited)
Table 1
Earnings Highlights and Performance Ratios
15,804
11,370
32,222
22,932
Net Income to Average Total Assets (ROA)
1.80%
1.27%
1.73%
1.29%
Net Income to Average Shareholders’ Equity (ROE)
24.28%
12.93%
22.03%
12.67%
Net Interest Margin
4.17%
4.12%
4.23%
4.21%
Efficiency Ratio 1
56.49%
67.55%
56.89%
67.01%
Efficiency Ratio excluding System Replacement Costs
60.39%
60.68%
June 30,
Statement of Condition Highlights and Performance Ratios
Book Value Per Common Share
13.34
15.50
Allowance / Loans and Leases Outstanding
2.16%
2.52%
Average Equity / Average Assets
7.84%
10.16%
Employees (FTE)
2,683
2,879
Branches and offices
89
91
Market Price Per Share of Common Stock for the Quarter Ended:
Closing
45.22
33.15
High
46.84
35.90
Low
40.97
30.75
1 The efficiency ratio is defined as non-interest expense divided by total revenue (net interest income and non-interest income).
ANALYSIS OF STATEMENT OF INCOME
Net interest income on a taxable equivalent basis for the three and six month periods ended June 30, 2004 increased from the comparable periods in 2003 by $5.4 million and $10.4 million, respectively, or 6% for both periods. The increase in net interest income from the prior year was primarily a result of a decrease in interest expense due to lower average interest rates paid on deposits, particularly time deposits, short-term borrowings and long-term debt. The decrease in interest expense was partially offset by a decline in interest income, largely due to lower interest earned on residential mortgage loans, which declined approximately 14% and 13%, respectively, for the three and six months ended June 30, 2004, from the same periods in 2003.
Average earning assets in the first six months of 2004 increased $427.3 million or 5% from the same period in 2003 primarily due to a $267.8 million increase in average loans outstanding (primarily consumer loans) and a $227.2 million increase in the investment securities portfolio. In the first six months of 2004, average interest-bearing liabilities increased $324.3 million or 5% from 2003, largely due to an increase in interest-bearing deposits and securities repurchase agreements.
11
The net interest margin was 4.17% for the three months ended June 30, 2004, a five basis point increase from the comparable period in 2003. The net interest margin increased two basis points in the first six months of 2004 compared to the same prior year period. The improvement in margin for both periods of 2004 was primarily attributable to lower average rates paid on interest-bearing liabilities which lowered the Company’s cost of funds. The lower average rate paid on interest-bearing liabilities was partially offset by the decline in average yield on earning assets, primarily loans.
Average balances, related income and expenses, and resulting yields and rates are presented in Table 2. An analysis of change in net interest income is presented in Table 3.
Consolidated Average Balances and Interest Rates - Taxable Equivalent Basis (Unaudited)
Table 2
Three Months EndedJune 30, 2004
Three Months EndedJune 30, 2003
Six Months EndedJune 30, 2004
Six Months EndedJune 30, 2003
(dollars in millions)
AverageBalance
Income/Expense
Yield/Rate
Earning Assets
408.8
1.6
1.62%
212.4
1.2
2.19%
329.2
2.8
1.76%
233.0
2.5
2.14%
71.3
0.2
267.3
0.9
1.23
120.1
0.6
259.0
1.22
Investment Securities
Held to Maturity
709.8
6.8
3.80
324.8
3.1
3.85
714.8
13.8
263.7
5.4
4.14
Available for Sale
2,148.9
21.7
4.05
2,316.9
19.8
3.42
2,068.7
42.5
4.12
2,292.6
42.3
3.69
20.7
0.3
5.54
81.6
1.1
5.43
18.1
0.5
5.45
46.0
5.38
Commercial and Industrial
828.0
10.2
4.97
834.6
10.0
4.81
836.2
20.3
4.89
860.4
20.5
Construction
100.4
83.0
4.50
2.0
99.1
2.4
4.83
Commercial Mortgage
638.9
8.6
5.39
682.5
10.1
5.93
636.5
17.2
5.42
640.5
19.2
6.03
Residential Mortgage
2,281.8
32.2
5.65
2,295.1
37.3
6.50
2,299.6
65.5
5.70
2,272.1
75.0
6.60
Installment
700.4
14.5
8.34
535.6
13.6
10.18
675.7
28.8
518.8
26.4
10.27
Home Equity
534.6
6.1
4.63
442.7
5.6
5.06
511.9
11.9
4.68
438.6
11.2
5.17
Purchased Home Equity
178.8
1.9
4.16
162.3
4.96
191.8
4.6
4.70
171.2
Lease Financing
510.1
4.38
482.6
5.3
4.42
505.5
11.0
4.35
489.1
4.62
Total Loans and Leases
5,773.0
80.0
5.56
5,518.4
84.8
6.16
5,757.6
161.3
5.62
5,489.8
170.5
6.24
78.1
4.45
75.3
1.0
5.41
77.8
1.8
74.9
2.2
9,210.6
111.5
4.86
8,796.7
111.9
5.09
9,086.3
223.3
4.93
8,659.0
225.7
5.23
306.3
325.6
316.9
328.6
376.4
385.9
382.4
388.7
9,893.3
9,508.2
9,785.6
9,376.3
Interest-Bearing Liabilities
Demand
1,390.2
0.17
1,169.4
0.7
0.25
1,380.1
0.16
1,160.7
1.5
2,911.5
0.43
2,744.1
4.5
0.65
2,891.6
6.4
0.44
2,676.5
9.0
0.68
1,129.5
4.9
1.74
1,427.1
8.2
2.28
1,159.1
10.3
1.79
1,449.4
2.40
Total Interest-Bearing Deposits
5,431.2
0.63
5,340.6
13.4
1.00
5,430.8
17.8
0.66
5,286.6
27.7
1.06
1,082.5
2.7
1.02
810.2
2.6
1.30
972.4
730.5
5.1
1.41
317.3
4.3
5.48
371.5
5.84
319.1
5.46
380.9
11.3
5.94
Total Interest-Bearing Liabilities
6,831.0
15.6
0.92
6,522.3
21.4
1.31
6,722.3
31.3
0.94
6,398.0
44.1
1.39
95.9
90.5
192.0
181.6
Interest Rate Spread
3.94%
3.78%
3.99%
3.84%
Non-Interest-Bearing Demand Deposits
1,940.2
1,695.3
1,914.8
1,666.2
389.4
358.7
381.5
359.7
732.7
931.9
767.0
952.4
12
Analysis of Change in Net Interest Income - Taxable Equivalent Basis (Unaudited)
Table 3
Six Months Ended June 30, 2004 Compared to June 30, 2003
Volume 1
Rate 1
Change in Interest Income:
(0.6)
(0.7)
(0.3)
(1.0)
8.8
(0.4)
8.4
(4.4)
0.4
(0.2)
(0.1)
(1.9)
(2.0)
0.8
(10.3)
(9.5)
7.2
(4.8)
(1.1)
(19.3)
(9.2)
0.1
(0.5)
Total Change in Interest Income
14.1
(16.5)
(2.4)
Change in Interest Expense:
(3.3)
(2.6)
(3.0)
(3.9)
(6.9)
(2.1)
(7.8)
(9.9)
7.4
(7.6)
(1.7)
(2.7)
Total Change in Interest Expense
3.6
(16.4)
(12.8)
Change in Net Interest Income
10.5
10.4
1 The changes for each category of interest income and expense are divided between the portion of changes attributable to the variance in volume or rate for that category
A negative Provision for Loan and Lease Losses (“Provision”) of $3.5 million was recorded for the three months ended June 30, 2004 as a result of improvement in credit quality and ongoing assessments of economic conditions and risk. The combination of the negative Provision and the net recoveries resulted in a reduction in the Allowance for Loan and Lease Losses (“Allowance”) of $2.3 million in the second quarter of 2004. No Provision was recorded in the previous seven quarters. For further information on Credit Quality, refer to the section entitled “Corporate Risk Profile.”
Non-interest income increased $4.1 million or 8% and $8.2 million or 9% for the three and six months ended June 30, 2004, respectively, from the comparable periods in 2003.
Trust and asset management income increased $0.5 million and $1.1 million, respectively, for the three and six months ended June 30, 2004, or 4% for both periods compared to the same periods in 2003. The increase in fee income was due to an improvement in market conditions resulting in an increase in the average market value of assets under management.
Mortgage banking income is sensitive to the interest rate environment and to conditions in the real estate market. Mortgage banking income decreased $3.3 million or 54% and $1.6 million or 25% in the three and six months ended June 30, 2004, respectively, compared to the same periods in 2003. The declines primarily resulted from lower gains on the sale of mortgage loans in 2004, which were attributable to lower loan production in 2004 than in 2003. Partially offsetting the lower gains was a reduction in the amortization of mortgage servicing rights due to a decrease in loan prepayments in 2004.
Service charges on deposit accounts increased $0.9 million or 10% and $1.9 million or 11% in the three and six months ended June 30, 2004, respectively, compared to the same prior year periods. The increase was largely due to higher account analysis fees resulting from lower offsetting earnings credits. Overdraft fees also increased in 2004 in part due to the increase in the number of transactional deposit accounts.
Other non-interest income increased $5.6 million or 87% and $6.1 million or 50% in the three and six months ended June 30, 2004, respectively, over the same periods of 2003. The second quarter increase was primarily due to a $3.2 million distribution from a leasing partnership investment that was dissolved and a $2.5 million gain realized on the sale of a parcel of land. Also contributing to the year-to-date change from 2003 was a $0.7 million gain realized in the first quarter of 2004 related to the sale of the corporate trust business.
Non-interest expense for the three months ended June 30, 2004 declined $10.3 million or 11% compared to the same period in 2003. For the first six months of 2004, non-interest expense declined $17.4 million or 9% compared to the same 2003 period. Included in non-interest expense in 2003 were systems replacement costs of $10.1 million and $17.5 million for the three and six months ended June 30, 2003, respectively. Excluding systems replacement costs, non-interest expense in 2004 remained flat compared to the same prior year periods. Refer to Note 4 to the Consolidated Financial Statements for additional information on the systems replacement project.
Salaries and benefits expense decreased $1.5 million for the first six months of 2004 compared to the comparable period in 2003. Base salaries decreased $3.2 million or 5% from 2003 largely due to a 7% decrease in the number of employees. Also contributing to the decline were reductions in commission expense due to reduced mortgage loan originations and lower separation expense. Partially offsetting the decrease was expense for restricted stock units awarded in the second half of 2003 and in April 2004.
14
Table 4 presents the components of salaries and benefits expense for the three and six months ended June 30, 2004 and 2003.
Salaries and Benefits (Unaudited)
Table 4
Salaries
27,904
29,783
55,108
58,297
Incentive Compensation
3,260
2,993
7,076
6,584
Stock Based Compensation
3,233
2,206
6,129
3,324
Commission Expense
2,284
2,925
3,911
5,412
Retirement and Other Benefits
4,214
4,091
8,571
8,542
Payroll Taxes
3,103
2,708
6,533
6,157
Medical, Dental, and Life Insurance
1,679
4,240
3,749
Separation Expense
555
1,326
1,122
2,075
Total Salaries and Benefits
Net equipment expense declined $3.4 million or 37% and $7.2 million or 38% in the three and six months ended June 30, 2004 compared to the same periods in 2003. The decrease was mainly due to reduced depreciation expense and software license fees resulting from expense savings from the systems replacement project.
Other non-interest expense increased $4.4 million or 23% and $9.0 million or 25% in the three and six months ended June 30, 2004 compared to the same periods in 2003. This increase was partially due to the cost of technology services, which were outsourced as a result of the systems replacement project. During the second quarter of 2004, a $1.0 million discretionary contribution was made to the Bank of Hawaii Charitable Foundation and a legal accrual of $2.2 million was recorded, largely related to the settlement of a lawsuit. In addition, for the first six months of 2004, expenses were incurred for professional services relating to the Company’s mutual funds.
BALANCE SHEET ANALYSIS
Short-Term Earning Assets
Short-term earning assets, consisting of interest-bearing deposits and funds sold, totaled $179.7 million at June 30, 2004, compared to $154.7 million at December 31, 2003 and $557.6 million at June 30, 2003. The decline from June 30, 2003 was mainly due to the use of funds to repurchase the Company’s stock and reduce debt.
Investment securities increased 9% from December 31, 2003 due to increased liquidity. At June 30, 2004 and December 31, 2003 investment securities with a book value of $1.5 billion and $1.4 billion, respectively, were pledged to secure deposits of public (government) entities and repurchase agreements.
Changes in interest rates influence the fair market values of certain investment securities, including mortgage-backed securities, which can result in temporary gross unrealized losses. The gross unrealized losses on temporarily impaired investment securities that had been impaired for less than 12 months as of June 30, 2004 totaled $51.4 million, or 2% of the total investment securities book value, compared to $16.6 million at December 31, 2003. The increase was primarily related to mortgage-backed securities, which were impacted by an increase in interest rates from December 31, 2003. The Company has both the intent and ability to hold the securities for the time necessary to recover the amortized cost. As of June 30, 2004, no investment security had been impaired for more than 12 months.
15
Table 5 presents the detail of the investment securities portfolio at June 30, 2004 and December 31, 2003.
Investment Securities (Unaudited)
Table 5
AmortizedCost
FairValue
At June 30, 2004
Securities Held to Maturity:
Debt Securities Issued by the U.S. Treasury and Agencies
15,018
15,010
Debt Securities Issued by States and Municipalities
130
138
Mortgage-Backed Securities
664,234
648,386
663,534
Securities Available for Sale:
Equity Securities
61,091
62,144
6,733
6,849
1,915,649
1,899,171
Other Debt Securities
308,635
307,105
2,292,111
At December 31, 2003
22,021
22,018
142
705,082
698,539
720,699
261
59,339
60,990
5,957
6,220
1,790,692
1,805,273
118,040
118,372
1,974,289
Loans held for sale, consisting of residential mortgage loans, totaled $9.6 million at June 30, 2004, $9.2 million at December 31, 2003, and $71.9 million at June 30, 2003. The decrease from June 30, 2003 was a result of higher mortgage loan sales activity.
16
As of June 30, 2004, loans and leases outstanding were $5.8 billion, comparable to December 31, 2003 and an increase of $72.3 million from March 31, 2004 and $315.4 million from June 30, 2003. Continued growth has occurred in the consumer loan portfolios. During the second quarter of 2004, commercial loan originations increased 7% from the first quarter of 2004, however higher repayments more than offset the increase. Table 6 presents the composition of the loan portfolio by major loan categories and Table 7 presents the composition of consumer loans by geographic area.
Loan Portfolio Balances (Unaudited)
Table 6
March 31,2004
Domestic Loans
Commercial
776,815
793,293
816,246
808,503
643,382
650,566
639,354
689,759
98,916
91,002
101,321
83,583
447,673
442,590
435,934
416,920
Total Commercial
1,966,786
1,977,451
1,992,855
1,998,765
Consumer
2,257,624
2,254,654
2,320,410
2,222,003
559,225
510,378
467,019
450,273
162,730
191,066
212,514
145,588
Other Consumer
721,386
671,893
658,831
554,795
34,676
34,816
35,320
33,972
Total Consumer
3,735,641
3,662,807
3,694,094
3,406,631
Total Domestic Loans
5,702,427
5,640,258
5,686,949
5,405,396
Foreign Loans
84,887
74,738
70,226
66,474
5,714,996
Consumer Loans by Geographic Area (Unaudited)
Table 7
December 31,2003 1
June 30,2003 1
Hawaii
2,042,079
2,042,032
2,106,456
2,019,280
551,099
502,261
458,425
441,167
589,671
557,234
550,411
466,101
Guam
209,972
207,174
208,339
197,577
8,067
8,117
8,594
9,106
87,963
75,675
68,999
52,615
U.S. Mainland
Other Pacific Islands
5,573
5,448
5,615
5,146
59
78,428
73,800
74,741
70,051
Total Consumer Loans
1 Certain 2003 information has been reclassified to conform to 2004 presentation.
17
As of June 30, 2004, the Company’s portfolio of residential loans serviced for third parties totaled $2.7 billion, a decrease of $0.2 billion and $0.6 billion from December 31, 2003 and June 30, 2003, respectively. The carrying value of mortgage servicing rights was $20.8 million at June 30, 2004, a decrease of $1.4 million and $4.0 million from December 31, 2003 and June 30, 2003, respectively. Although mortgage prepayments have slowed from 2003, the decline in carrying value of mortgage servicing rights continued to be attributable to higher mortgage prepayments reflective of the low interest rate environment. Recent prepayment speeds for Hawaii mortgages continued to approximate national averages.
As of June 30, 2004, deposits totaled $7.5 billion, a $136.5 million increase from December 31, 2003 and a $328.4 million increase from June 30, 2003. The Company’s deposit growth continued to be primarily in demand and savings deposits, while higher cost time deposits have been reduced.
The average time deposits of $100,000 or more is presented in Table 8.
Average Time Deposits of $100,000 or More (Unaudited)
Table 8
Three Months Ended
Six Months Ended
June 30, 2004
December 31, 2003
June 30, 2003
Average Time Deposits
570,738
633,602
727,953
589,100
739,640
Borrowings
Short-term borrowings, including securities sold under agreements to repurchase, funds purchased and other short-term borrowings, totaled $0.8 billion at June 30, 2004 and 2003, compared to $0.6 billion at December 31, 2003. The increase in short-term borrowings from December 31, 2003 was due to higher placements received from public (government) entities in the form of securities sold under agreements to repurchase. For additional information, refer to the section on “Corporate Risk Profile – Liquidity Management.”
The Company’s capital position remains strong. The 12% net reduction in capital from December 31, 2003 to June 30, 2004 is attributable to the Company’s common stock repurchase program and dividends offset by earnings for the first six months of 2004. A further discussion of the Company’s capital is included in the “Corporate Risk Profile – Capital Management” section of this report.
Guarantees
The Company’s standby letters of credit totaled $115.6 million at June 30, 2004.
18
BUSINESS SEGMENTS
The Company’s business segments are defined as Retail Banking, Commercial Banking, Investment Services Group and Treasury and Other Corporate. The management accounting process measures the performance of the operating segments based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. Various techniques are used to assign balance sheet and income statement amounts to the business segments, including allocations of overhead, the Provision and capital. This process is dynamic and requires certain allocations based on judgment and subjective factors. Unlike financial accounting, there is no comprehensive, authoritative guidance for management accounting that is equivalent to accounting principles generally accepted in the United States.
The business segments are managed with a focus on performance measures, including risk adjusted return on capital (“RAROC”) and net income after capital charge (“NIACC”). RAROC is the ratio of net income to risk-adjusted equity. Equity is allocated to each business segment based on an assessment of its inherent risk. NIACC is net income less a charge for allocated capital. The cost of capital is determined by multiplying management’s estimate of the shareholder’s minimum required rate of return on capital invested (11% for 2004 and 2003) by the segment’s allocated equity. The Company assumes a cost of capital that is equal to a risk-free rate plus a risk premium of an equity investment in the Company. The net interest income of the business segments reflects the results of a funds transfer pricing process that matches assets and liabilities with similar interest rate sensitivity and maturity characteristics and reflects the allocation of net interest income related to the Company’s overall asset and liability management activities on a proportionate basis. The basis for the allocation of net interest income is a function of management decisions and assumptions which are subject to change based on changes in current interest rate and market conditions. The Provision recorded in the Retail Banking, Commercial Banking and Investment Services Group segments represents actual net charge-offs of these segments. The Provision charged to the Treasury and Other Corporate segment primarily represents the change in the level of the Allowance and also includes recoveries from the divested businesses.
The financial results for the three and six months ended June 30, 2004 and 2003 are discussed below and are presented in Table 9a and Table 9b, respectively.
Retail Banking
The Company’s Retail Banking segment offers a broad range of financial products and services to consumers and small businesses. Loan and lease products include residential mortgage loans, home equity lines of credit, automobile loans and leases and installment loans. Deposit products include checking, savings and time deposit accounts. The Retail Banking segment also provides merchant services to its small business customers. Products and services from the Retail Banking segment are delivered to customers through 74 Hawaii branch locations and over 500 ATMs, e-Bankoh (on-line banking service) and a 24-hour telephone banking service. Also included in the segment is Bankoh Investment Services, Inc., a full service brokerage offering equities, mutual funds, life insurance and annuities.
The NIACC and RAROC for the Retail Banking segment decreased for the three and six months ended June 30, 2004 as compared to the same periods in 2003. The segment experienced lower net interest income, non-interest income and a higher economic provision. The decrease in net interest income was primarily due to the decrease in the earnings credit from funds transfer pricing on the segment’s deposit account balances, reflective of lower interest rates. The lower non-interest income was primarily a result of reduced mortgage banking income, partially offset by higher service charges on deposit accounts. The increase in the economic provision was primarily due to seasoning in the segment’s automobile and installment loan portfolios. The decrease in non-interest expense was mainly due to lower net equipment expense and no systems replacement cost.
19
Commercial Banking
The Commercial Banking segment offers products including corporate banking and commercial real estate loans, lease financing, auto dealer financing, deposit and cash management products and property and casualty insurance products. Lending, deposit and cash management services are offered to middle-market and large companies in Hawaii. Commercial real estate mortgages are focused on customers that include investors, developers and builders primarily domiciled in Hawaii. The Commercial Banking unit also serves customers through its 14 branches in the Pacific Islands.
The improvement in the segment’s financial measures for the three months and six months ended June 30, 2004 compared to the same periods in 2003 was a result of an increase in non-interest income, partially offset by lower net interest income and a decrease in non-interest expense. The increase in non-interest income was primarily due to higher account analysis fees resulting from lower offsetting earnings credit and from a leasing partnership investment distribution in the quarter ended June 30, 2004. The decrease in net interest income was primarily due to the decrease in the earnings credit from funds transfer pricing on the segment’s deposit account balances reflective of lower interest rates. The decline in non-interest expense was primarily due to lower allocated expenses.
Investment Services Group
The Investment Services Group includes private banking, trust services, asset management, and institutional investment advice. A significant portion of this segment’s income is derived from fees, which are generally based on the market values of assets under management. The private banking and personal trust group assist individuals and families in building and preserving their wealth by providing investment, credit and trust expertise to high-net-worth individuals. The asset management group manages portfolios and creates investment products. Institutional sales and service offers investment advice to corporations, government entities and foundations.
The segment’s key financial measures remained relatively unchanged for the three months ended June 30, 2004 compared to the same period in 2003. Net interest income increased primarily due to higher deposit and loan balances, and non-interest income increased as a result of an increase in trust and asset management fee income due to an improvement in market conditions. These positive trends were offset by increases in both direct and allocated non-interest expense. The increase in direct non-interest expense was due to increased professional fees, partially offset by no systems replacement costs.
The segment’s financial measures remained flat for the six months ended June 30, 2004 compared to the same period in 2003. The increase in non-interest income was attributable to a combination of an increase in trust and asset management fee income due to an improvement in market conditions and an increase in other income due to the sale of the corporate trust business in first quarter 2004. The increase in non-interest expense was primarily due to increased professional fees, partially offset by no systems replacement costs.
20
Treasury and Other Corporate
The primary income earning component of this segment is Treasury, which consists of corporate asset and liability management activities, including interest rate risk management and foreign exchange business. This segment’s assets and liabilities (and related net interest income) consist of interest-bearing deposits, investment securities, federal funds sold and purchased, government deposits and short and long-term borrowings. The primary source of foreign exchange income relates to customer driven currency requests from merchants and island visitors. The net residual effect of transfer pricing of assets and liabilities is included in Treasury, along with eliminations of inter-company transactions.
This segment also includes divisions that provide a wide-range of support (Technology, Operations, Human Resources, Finance, Credit and Risk Management and Corporate and Regulatory Administration) to the other income earning segments. Expenses incurred by these support units are charged to the business segments through an internal cost allocation process. Results for this segment in 2003 include the systems replacement costs that were not incurred by or allocated to the Retail, Commercial and Investment Services Group segments.
The improvement in the segment’s key financial measures for the three months and six months ended June 30, 2004, compared to the same periods in 2003, were primarily due to an increase in net interest income and non-interest income and no systems replacement costs. The increase in net interest income was due to the impact of the lower cost of funding deposits by the Treasury unit. The increase in non-interest income was due to a gain realized in the second quarter of 2004 from the sale of a parcel of land. This segment’s NIACC was also favorably impacted by a lower capital charge due to the reduction of the Company’s excess capital as a result of the continuing share repurchase activity.
21
Business Segment Selected Financial Information (Unaudited)
Table 9a
RetailBanking
CommercialBanking
InvestmentServicesGroup
Treasuryand OtherCorporate
ConsolidatedTotal
Three Months Ended June 30, 2004
49,568
33,607
2,844
9,830
2,587
2,730
(1)
(8,816)
46,981
30,877
2,845
18,646
24,388
12,188
12,938
5,334
71,369
43,065
15,783
23,980
154,197
(44,560)
(23,009)
(13,145)
(4,411)
(85,125)
26,809
20,056
2,638
19,569
(9,919)
(7,421)
(976)
(6,524)
(24,840)
Allocated Net Income
16,890
12,635
1,662
13,045
Allowance Funding Value
(148)
(688)
(6)
842
GAAP Provision
Economic Provision
(3,510)
(2,821)
(99)
(3)
(6,433)
Tax Effect of Adjustments
396
288
39
2,951
3,674
Income Before Capital Charge
16,215
12,144
1,595
8,019
37,973
Capital Charge
(5,485)
(5,134)
(1,302)
(8,231)
(20,152)
Net Income (Loss) After Capital Charge (NIACC)
10,730
7,010
293
(212)
17,821
RAROC (ROE for the Company)
33%
26%
14%
28%
24%
Total Assets at June 30, 2004
3,693,382
2,331,968
114,021
3,549,398
Three Months Ended June 30, 2003 1
53,139
34,394
2,635
317
1,321
1,022
(2,343)
51,818
33,372
2,660
26,613
8,302
12,355
3,469
78,431
41,674
14,990
141,224
(368)
(90)
(9,647)
(10,105)
(45,238)
(23,884)
(12,145)
(4,022)
(85,289)
Income (Loss) Before Income Taxes
32,825
17,790
2,755
(7,540)
(6,465)
(1,019)
3,833
(15,796)
Allocated Net Income (Loss)
20,680
11,325
1,736
(3,707)
(161)
(1,100)
(7)
1,268
(2,901)
(3,031)
(108)
(5)
(6,045)
644
1,150
42
401
2,237
Income (Loss) Before Capital Charge
19,583
9,366
1,663
(4,386)
26,226
(5,683)
(5,418)
(1,255)
(13,275)
(25,631)
13,900
3,948
408
(17,661)
595
38%
19%
15%
(12)%
13%
Total Assets at June 30, 2003
3,487,565
2,242,905
97,414
3,723,050
22
Table 9b
Six Months Ended June 30, 2004
99,807
67,671
5,679
18,723
2,477
48
(11,359)
94,473
65,194
5,631
30,082
45,403
22,660
27,338
8,289
139,876
87,854
32,969
38,371
299,070
(87,777)
(46,247)
(26,082)
(8,041)
(168,147)
52,099
41,607
6,887
30,330
(19,277)
(15,376)
(2,548)
(9,691)
(46,892)
32,822
26,231
4,339
20,639
(277)
(1,425)
(14)
1,716
(6,906)
(5,598)
(193)
(12,702)
684
1,682
3,570
5,995
31,657
23,367
4,239
14,561
73,824
(11,255)
(10,405)
(2,580)
(17,950)
(42,190)
20,402
12,962
1,659
(3,389)
31,634
31%
25%
18%
27%
22%
Six Months Ended June 30, 2003 1
105,331
69,353
5,955
846
2,169
3,173
(5,342)
103,162
66,180
6,188
46,310
17,100
25,342
6,740
149,472
83,280
31,297
12,928
276,977
(950)
(23)
(334)
(16,215)
(17,522)
(88,878)
(47,308)
(24,374)
(7,512)
(168,072)
59,644
35,949
6,589
(10,799)
(22,068)
(13,087)
(2,438)
6,045
(31,548)
37,576
22,862
4,151
(4,754)
(313)
(2,241)
(17)
2,571
(5,609)
(6,094)
(236)
(10)
(11,949)
1,389
1,910
93
1,029
4,421
35,212
19,610
3,991
(6,506)
52,307
(10,865)
(2,523)
(27,740)
(52,383)
23,957
8,745
1,468
(34,246)
(76)
35%
20%
(9)%
1Certain 2003 information has been reclassified to conform to 2004 presentation.
23
FOREIGN OPERATIONS
The countries in which the Company maintains its largest exposure on a cross-border basis include Netherlands, United Kingdom and Australia. Table 10 presents as of June 30, 2004, December 31, 2003 and June 30, 2003, a geographic distribution of the Company’s cross-border assets for selected countries. The primary components of cross-border assets as of June 30, 2004 were investment securities and interest-bearing deposits of $296.5 million and $178.5 million, respectively.
Geographic Distribution of Cross-Border International Assets (Unaudited) 1
Table 10
Country
December 31, 2003 2
June 30, 2003 2
Australia
80,561
36,283
38,002
Netherlands
142,242
42,229
92,590
United Kingdom
110,095
110,460
135,969
All Others
245,422
162,037
172,534
Total Cross - Border International Assets
578,320
351,009
439,095
1 Cross-border outstandings are defined as foreign monetary assets that are payable to the Company in U.S. dollars or other non-local currencies, plus amounts payable in local currency but funded with U.S. dollars or other non-local currencies. Cross-border outstandings include loans, acceptances, interest-bearing deposits with other banks, other interest-bearing investments and other monetary assets.
2 Certain 2003 information has been reclassified to conform to 2004 presentation.
Because the U.S. dollar is used in the Pacific Island Division locations (Guam and American Samoa, which are U.S. territories, and other nearby islands), these operations are not considered foreign for financial reporting purposes.
CORPORATE RISK PROFILE
Credit Risk
Credit Risk is defined as the risk that borrowers or counterparties will not be able to repay their obligations to the Company. Credit exposures reflect legally binding commitments for loans, leases, banker’s acceptances, financial and standby letters of credit and overnight overdrafts.
The Company’s asset quality improved as evidenced by lower levels of internally criticized loans and non-performing assets. The ratio of non-performing assets to total loans and foreclosed real estate was 0.37% at June 30, 2004, a decrease from 0.55% at December 31, 2003. Net charge-offs were in a net recovery position of $1.2 million for the second quarter 2004. Net charge-offs for the first six months of 2004 (annualized) as a percent of average loans outstanding were 0.02%, compared to 0.18% in the same prior year period.
The Company’s more favorable credit risk position relative to a year ago reflects the portfolio strategy which shifted to borrowers and industries believed to have a lower risk profile, reduced large borrower concentrations and an improving mainland economy. In addition, ongoing portfolio management is intended to result in early identification and disengagement from deteriorating credits.
Overall risk in the portfolio of Hawaii-based loans has been improving, primarily due to a local economy that remains satisfactory with some positive trends in real economic measures.
24
Although the Company’s overall credit risk profile continued to improve, two components, air transportation and Guam, continued to carry higher risk characteristics than the overall portfolio. Information about these components are included in Table 11. The air transportation industry has a higher risk profile as some domestic carriers continue to struggle financially. As of June 30, 2004, 10% of the Company’s total air transportation outstandings were internally classified, an improvement from 16% at December 31, 2003.
Selected Concentrations of Credit Exposure (Unaudited)
Table 11
Dec. 31, 2003 1
June 30, 2003 1
Outstandings
UnusedCommitments
TotalExposure
Air Transportation
United States Regional Passenger Carriers
45,308
13,183
58,491
59,231
59,702
United States National Passenger Carriers
37,581
37,259
37,557
Passenger Carriers Based Outside United States
30,325
31,549
31,794
Cargo Carriers
14,122
14,405
14,739
Total Air Transportation
127,336
140,519
142,444
143,792
Hotel
15,614
17,733
42,806
Other Commercial
146,872
42,441
189,313
184,129
183,765
306,002
12,075
318,077
288,831
265,851
Total Guam
468,488
54,516
523,004
490,693
492,422
Syndicated Exposure
265,908
636,293
902,201
912,896
930,118
Other Large Borrowers 2
62,734
216,048
278,782
336,748
372,924
Exposure includes loans, leveraged leases and operating leases.
1 For three borrowers, reclassifications have occurred between Regional and National Carriers. Syndicated Exposure has been restated to include a purchased participation.
2 Other Large Borrowers is defined as exposure with commitments of $25.0 million and greater, excluding those collateralized by cash and those separately identified as Air Transportation, Guam and Syndicated Exposure.
In the Guam portfolio, which is sensitive to tourism and military spending, economic indicators are positive although some uncertainty continues to exist. As of June 30, 2004, internally classified exposure was reduced by 12% from December 31, 2003. This reduction was achieved through strategic reduction and some borrower improvement. Targeted lending to select commercial borrowers is active, while the consumer lending business is leading the portfolio growth.
At June 30, 2004, the Company still has some significant credit exposures to commercial borrowers. The Company’s largest syndicated loan outstanding totaled $39.2 million to a local trust and the second largest syndicated loan outstanding totaled $21.0 million for new hotel construction on Maui. The ten largest syndicated loans outstanding totaled $164.7 million or 62% of total syndicated loans and consisted mainly of loans in the hospitality and real estate industries. No syndicated outstandings were internally classified.
The Company’s other large borrowers include five exposures of $25.0 million and greater. The borrowers are major companies, most with Hawaii operations. Three exposures are commercial paper backup lines to investment grade companies and are undrawn. The remaining two exposures have their loans collateralized by real estate and other assets and are substantially funded.
Non-Performing Assets
Non-performing assets (“NPAs”) consist of non-accrual loans and foreclosed real estate. As of June 30, 2004, NPAs have decreased by $10.6 million from December 31, 2003 to $21.2 million, primarily due to the partial charge-off and disengagement of a Hawaii business, a loan pay-off in Guam and the return to accrual status of Hawaii residential mortgage loans.
NPAs in Guam as of June 30, 2004 were $9.1 million, a decrease of $3.6 million or 28% from December 31, 2003. The improvement primarily reflects payments from a number of commercial borrowers.
Impaired loans totaled $6.7 million at June 30, 2004, a decrease of $9.3 million or 58% from $16.0 million at December 31, 2003. These loans had a related Allowance that totaled $0.6 million at June 30, 2004, a decrease of $0.3 million from December 31, 2003.
Loans Past Due 90 Days or More and Still Accruing Interest
Accruing loans past due 90 days or more were $2.6 million at June 30, 2004, a decrease of $0.8 million from December 31, 2003. The improvement was primarily a result of having a lower number of residential mortgage loans past due and offsetting activity on commercial loans.
Refer to Table 12 for further information on non-performing assets.
26
Consolidated Non-Performing Assets and Accruing Loans Past Due 90 Days or More (Unaudited)
Table 12
September 30,2003
Non-Accrual Loans
680
6,009
6,015
7,856
8,832
5,649
7,388
9,337
10,977
11,216
1,948
1,962
2,181
2,388
2,423
8,277
15,359
17,533
21,221
22,471
7,688
7,685
9,354
9,669
10,196
306
406
460
497
7,994
8,091
9,814
10,166
Total Non-Accrual Loans
16,271
23,450
27,347
31,387
32,667
4,416
8,757
Total Non-Performing Assets
21,160
27,866
31,724
40,144
41,952
Accruing Loans Past Due 90 Days or More
707
725
695
523
693
702
117
712
1,409
698
1,430
2,027
1,817
84
107
98
1,142
1,180
1,210
1,059
368
57
1,929
1,882
2,640
3,193
2,386
Total Accruing and Past Due
2,641
3,291
3,482
3,888
2,909
5,570,405
Ratio of Non-Accrual Loans to Total Loans
0.28%
0.41%
0.48%
0.56%
0.60%
Ratio of Non-Performing Assets to Total Loans and Foreclosed Real Estate
0.37%
0.49%
0.55%
0.72%
0.77%
Ratio of Non-Performing Assets and Accruing Loans Past Due 90 Days or More to Total Loans
0.61%
0.79%
0.82%
Quarter to Quarter Changes in Non-Performing Assets
Balance at Beginning of Quarter
44,217
Additions
3,909
3,293
2,340
3,199
11,603
Reductions
(4,232)
(4,555)
(3,416)
(1,782)
(4,279)
Return to Accrual
(2,700)
(1,444)
(839)
(1,464)
(7,556)
Sales of Foreclosed Assets
(147)
(310)
(4,418)
(1,025)
(672)
Charge-offs/Write-downs
(3,536)
(842)
(2,087)
(736)
(1,361)
Total Reductions
(10,615)
(7,151)
(10,760)
(5,007)
(13,868)
Balance at End of Quarter
27
The Company maintains an Allowance adequate to cover management’s estimate of probable credit losses inherent in its lending portfolios based on a comprehensive quarterly analysis of historical loss experience supplemented by judgmental expectations of portfolio performance and economic conditions as of a given balance sheet date.
The Allowance at June 30, 2004 totaled $124.9 million, a decrease of $4.2 million from December 31, 2003. The ratio of the Allowance to total loans and leases outstanding was 2.16% at June 30, 2004, a decrease from 2.24% at December 31, 2003 and 2.52% at June 30, 2003. A summary of the Allowance is presented in Table 13. Loan charge-offs in the second quarter of 2004 of $8.8 million were more than offset by recoveries of $10.0 million, resulting in a net recovery position of $1.2 million for the quarter. The higher than normal level of recoveries resulted from a $6.0 million recovery from a previously charged-off Asia loan. Based on further improvement in credit quality and ongoing assessments of economic conditions and risk, a negative Provision of $3.5 million was recorded in the second quarter of 2004. The combination of the negative Provision and the net recoveries resulted in a $2.3 million reduction in the Allowance during the second quarter of 2004. No Provision was recorded in the previous seven quarters, resulting in a reduction of the Allowance equal to net charge-offs in those periods.
Consolidated Allowance for Loan and Lease Losses (Unaudited)
Table 13
Balance at Beginning of Period
127,185
129,080
140,028
142,853
Loans Charged-Off
3,328
387
565
3,715
2,182
574
400
529
379
228
325
607
340
319
145
687
464
1,376
201
90
291
4,564
4,655
3,619
9,219
6,708
36
64
Total Loans Charged-Off
8,828
6,115
5,653
14,943
11,741
Recoveries on Loans Previously Charged-Off
1,245
954
1,819
2,199
151
689
840
74
435
55
955
304
254
598
457
101
140
103
1,703
1,342
3,366
2,669
71
53
Foreign
6,469
76
6,545
143
Total Recoveries on Loans Previously Charged-Off
10,047
4,220
3,599
14,267
6,862
Net Loan Recoveries (Charge-Offs)
1,219
(1,895)
(2,054)
(676)
(4,879)
Balance at End of Period
124,904
137,974
Average Loans Outstanding
5,772,926
5,742,368
5,518,401
5,757,647
5,489,783
Ratio of Net Loan Charge-Offs to Average Loans Outstanding (annualized)
(0.08)%
0.13%
0.15%
0.02%
0.18%
Ratio of Allowance to Loans and Leases Outstanding
2.23%
Market Risk
Market risk is the potential of loss arising from adverse changes in interest rates and prices. The Company is exposed to market risk as a consequence of the normal course of conducting its business activities. Financial products that expose the Company to market risk include investment securities, loans, deposits, debt and derivative financial instruments. The Company’s market risk management process involves measuring, monitoring, controlling and managing risks that can significantly impact the Company’s financial position and operating results. In this management process, market risks are balanced with expected returns in an effort to enhance earnings performance and shareholder value, while limiting the volatility of each. The activities associated with these market risks are categorized into “trading” and “other than trading.”
29
The Company’s trading activities include foreign currency and foreign exchange contracts that expose the Company to a minor degree of foreign currency risk. These transactions are primarily executed on behalf of customers and at times for the Company’s own account.
The Company’s “other than trading” activities include normal business transactions that expose the Company’s balance sheet profile to varying degrees of market risk.
Interest Rate Risk
The Company’s balance sheet is sensitive to changes in the general level of interest rates. This interest rate risk arises primarily from the Company’s normal business activities of making loans and taking deposits. Many other factors also affect the Company’s exposure to changes in interest rates, such as general economic and financial conditions, customer preferences and historical pricing relationships.
Table 14 presents, as of June 30, 2004, December 31, 2003 and June 30, 2003, the estimate of the change in net interest income (“NII”) that would result from a gradual 200 basis point decrease or increase in interest rates, moving in parallel fashion over the entire yield curve, over the next 12-month period, relative to the measured base case scenario for NII. The 200 basis point increase would equate to an average increase of $2.7 million increase in NII per quarter. The Company’s balance sheet continues to be asset-sensitive. The resulting estimated NII exposure is within the guidelines approved by the Company’s Asset Liability Management Committee.
Market Risk Exposure to Interest Rate Changes (Unaudited)
Table 14
Interest Rate Change(in basis points)
-200
+200
Estimated Exposure as a Percent of Net Interest Income
(5.0)%
2.8%
(4.8)%
4.0%
(2.5)%
5.9%
Estimated Exposure to Net Interest Income Per Quarter
3.7
(2.3)
In managing interest rate risk, the Company uses several approaches to modify its risk position. Approaches that are used in an effort to shift balance sheet mix or alter the interest rate characteristics of assets and liabilities include changing product pricing strategies, modifying investment portfolio characteristics, or using financial derivative instruments. The use of financial derivatives has been limited over the past several years.
Liquidity Management
Liquidity is managed in an effort to ensure that the Company has continuous access to sufficient, reasonably priced funding to conduct its business in a normal manner.
The Bank is a member of the Federal Home Loan Bank of Seattle (the “FHLB”), which provides an additional source of short and long-term funding. Outstanding borrowings from the FHLB were $62.5 million at June 30, 2004, compared to $68.5 million at December 31, 2003 and $76.5 million at June 30, 2003. The decrease from 2003 was due to maturities.
Additionally, the Bank maintains a $1 billion senior and subordinated bank note program. Under this facility, the Bank may issue additional notes provided that the aggregate amount outstanding does not exceed $1 billion. Subordinated notes outstanding under this bank note program totaled $124.7 million at June 30, 2004, December 31, 2003 and June 30, 2003.
In the second quarter of 2004, $20.0 million of privately placed notes matured and were not replaced. An additional $70.0 million of privately placed notes matured in July 2004 and were not replaced. Repayment came from existing liquidity.
30
Capital Management
The Company and the Bank are subject to regulatory capital requirements administered by the federal banking agencies. The Company’s objective is to hold sufficient capital on a regulatory basis to exceed the minimum guidelines of a “well-capitalized” financial institution, while over the long term optimize shareholder value, support asset growth, reflect risks inherent in its markets, provide protection against unforeseen losses and comply with regulatory requirements.
At June 30, 2004, shareholders’ equity totaled $699.4 million, a 12% net decrease from December 31, 2003. The decrease in shareholders’ equity during the first half of 2004 was primarily attributable to the Company’s repurchase of its common stock under the repurchase program and dividends offset by earnings.
During the six months ended June 30, 2004, 3.4 million shares of common stock were repurchased at an average cost of $44.24 per share, totaling $150.7 million. As of June 30, 2004, the Company repurchased a total of 33.2 million shares since July 2001, under the share repurchase program, totaling $1,005.7 million at an average cost of $30.27 per share. In July 2004, the Company’s Board of Directors increased the authorization under the share repurchase program by an additional $100.0 million. This authorization, combined with the Company’s previously announced authorizations of $1,050.0 million, brings the total repurchase authority to $1,150.0 million. Subsequent to June 30, 2004 through July 23, 2004, 160,000 shares were repurchased at an average cost of $45.50 per share for a total of $7.3 million, resulting in remaining buyback authority under the existing repurchase program of $137.0 million.
In July 2004, the Company’s Board of Directors declared a quarterly cash dividend of $0.30 per share on the Company’s outstanding shares. The dividend will be payable on September 15, 2004 to shareholders of record at the close of business on August 30, 2004.
Table 15 presents the regulatory capital and ratios as of June 30, 2004, December 31, 2003 and June 30, 2003.
Regulatory Capital and Ratios (Unaudited)
Table 15
Regulatory Capital
8.25% Capital Securities of BancorpHawaii Capital Trust I
31,425
Unrealized Valuation and Other Adjustments
(10,776)
10,771
27,958
Tier I Capital
705,423
777,570
880,261
Allowable Reserve for Loan Losses
79,889
78,147
76,332
Subordinated Debt
99,787
124,709
124,683
Unrealized Gains on Available for Sale Equity Securities
66
113
Total Capital
885,147
980,492
1,081,389
Risk Weighted Assets
6,346,134
6,200,831
6,044,941
Key Capital Ratios
Average Equity/Average Assets Ratio
7.41%
9.60%
9.80%
Tier I Capital Ratio
11.12%
12.54%
14.56%
Total Capital Ratio
13.95%
15.81%
17.89%
Leverage Ratio
7.16%
8.43%
9.29%
31
Economic Outlook
Based on projected visitor counts, tourism in Hawaii may reach record high levels during the summer of 2004. Total visitor counts were up 9% year-to-date through May 2004 and up 13% in June 2004 compared to last year. Growth in tourism is a result of the continued strength in domestic visitors to Hawaii and increased international visitors, partially due to the improving Japan economy and favorable yen/dollar exchange rates. Hotel revenues rose 6%, matched by growth in overall business receipts, during the State’s fiscal year ending in June 2004.
Hawaii’s seasonally-adjusted unemployment rate declined to 3% in May 2004, one percentage point below a year ago, as labor markets tightened. Seasonally-adjusted payrolls grew at a 1.7% annualized rate in the most recent six-month period, and were up 2.1% on a year-over-year basis in May 2004.
Hawaii real estate investment continues to dominate near-term growth prospects. Home sales volumes in Honolulu have grown at annual rates of more than 15% since 1997 and record volumes are expected to be reached this summer. Military housing privatization is anticipated to double annual homebuilding on Oahu beginning in the fourth quarter of 2004. Overall, construction employment is expected to return to early-1990s cyclical peaks.
Honolulu’s semiannual inflation rate for the first half of 2004 is expected to repeat the 3% recorded in the second half of 2003, up from 1% a year earlier. Strong China, Eastern Asia and Southern California economies, and recoveries in Northern California and the Pacific Northwest, put Hawaii at the center of regional economic strength once again.
Earnings Outlook
The Company currently anticipates net income for the full year of 2004 will be approximately $163 million to $167 million. Based on present conditions, the Company does not expect to record a Provision for the remainder of 2004. However, the actual amount of the Provision depends on determinations of credit risk that are made near the end of each quarter. Earnings per share and return on equity projections continue to be dependent upon the terms and timing of share repurchases.
Item 3. Quantitative and Qualitative Disclosures of Market Risk
See Management’s Discussion and Analysis of Results of Operations and Financial Condition-Market Risk.
Item 4. Controls and Procedures
The Company’s management, including the Chief Executive Officer, President and Chief Operating Officer and Chief Financial Officer, evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a - 15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)) as of June 30, 2004. Based on this evaluation, the Chief Executive Officer, President and Chief Operating Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective. There were no significant changes in the Company’s internal controls over financial reporting that occurred during the second quarter of 2004 that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.
Part II. - Other Information
Items 1 and 3 omitted pursuant to instructions.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Issuer Purchases of Equity Securities
Period
Total Number ofShares Purchased 1
Average Price PaidPer Share
Total Number ofShares Purchasedas Part of PubliclyAnnounced Program 2, 3
Approximate Dollar Valueof Shares that May YetBe Purchased Under theAnnounced Program 2, 4
April 1 - 30, 2004
1,179,817
43.83
1,091,800
89,240,654
May 1 - 31, 2004
814,446
43.90
812,969
53,548,915
June 1 - 30, 2004
210,466
44.16
210,000
44,274,238
2,204,729
43.89
2,114,769
1 The April period included 88,017 shares purchased from employees in connection with the vesting of restricted stock. The May and June periods included 1,477 and 466 shares, respectively, purchased from employees in connection with stock option exercises. These shares were not purchased as part of the publicly announced program. The shares were purchased at the closing price of the Company’s common stock on the dates of purchase.
2 The Company announced an authorization of additional share repurchase of $50.0 million and $200.0 million on April 27, 2004 and September 29, 2003, respectively.
3 In May 2004, the Company purchased 644,069 shares from the Chairman and CEO of the Company at a volume weighted average price of $44.26, totaling $28.5 million.
4 In July 2004, the Company announced an authorization of additional share repurchase of $100.0 million under the announced program.
Item 4. Submission of Matters to a Vote of Security Holders
At the annual shareholders meeting held on April 23, 2004, the following matters were submitted to a vote of the shareholders.
a. Election of Directors - Four directors were elected to the Board of Directors as follows: *
S. Haunani Apoliona
Votes cast for:
47,063,521
Votes withheld:
948,929
Michael J. Chun
47,229,237
783,213
Allan R. Landon
46,138,609
1,873,841
Barbara J. Tanabe
47,277,087
735,363
b. Election of Directors – Three directors whose terms in office were expiring were re-elected to the Board of Directors as follows: *
Mary G.F. Bitterman
45,859,105
2,153,345
Martin A. Stein
45,960,790
2,051,660
Robert W. Wo, Jr.
46,540,989
1,471,461
c. Approval of Bank of Hawaii Corporation 2004 Stock and Incentive Compensation Plan **
32,139,354
Votes cast against:
8,597,372
Broker non-votes:
6,350,190
Abstentions:
925,534
d. Election of an Independent Auditor - Ernst & Young, LLP
45,692,457
2,216,493
103,500
* The directors are elected by a plurality of the votes cast; therefore, votes cast in the election could not be recorded against or as an abstention, nor could broker non-votes be recorded.
** A broker non-vote had no effect on this proposal and an abstention had the same effect as a vote against the proposal.
Item 5. Other Information
The Company announced on July 26, 2004 it has elected Allan R. Landon, currently President and Chief Operating Officer, to succeed Michael E. O’Neill as Chairman and Chief Executive Officer, effective September 1, 2004.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibit Index
Exhibit Number
Bank of Hawaii Corporation 2004 Stock and Incentive Compensation Plan(incorporated by reference from Appendix C to the Company's Definitive Proxy Statement on Schedule 14A for the 2004 Annual Meeting of Shareholders, as filed on March 18, 2004)*
Form of Retention Agreement dated May 3, 2004 with certain Managing Committee Members*
Statement Regarding Computation of Ratios
31.1
Rule 13a - 14(a) Certifications
31.2
Section 1350 Certification
* Management contract or compensatory plan or arrangement.
b. The following reports on Form 8-K were filed during the quarter ended June 30, 2004:
Filed April 27, 2004 under Item 5 of Form 8-K, regarding President Allan R. Landon to add responsibility of Chief Operating Officer and announcement of new senior management appointments.
Filed May 11, 2004, under Item 5 of Form 8-K, regarding Bank of Hawaii Corporation buys block of shares from its Chairman and Chief Executive Officer.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date:
July 28, 2004
By:
/s/ Michael E. O’Neill
Michael E. O’Neill
Chairman of the Board and Chief Executive Officer
/s/ Allan R. Landon
President and Chief Operating Officer
/s/ Richard C. Keene
Richard C. Keene
Chief Financial Officer
EXHIBIT INDEX
Bank of Hawaii Corporation 2004 Stock and Incentive Compensation Plan(incorporated by reference from Appendix C to the Company’s Definitive Proxy Statement on Schedule 14A for the 2004 Annual Meeting of Shareholders, as filed on March 18, 2004)*