UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2005
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from to
Commission File Number 1-6887
BANK OF HAWAII CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
99-0148992
(State of incorporation)
(IRS Employer Identification No.)
130 Merchant Street, Honolulu, Hawaii
96813
(Address of principal executive offices)
(Zip Code)
1-(888)-643-3888
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No
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 22, 2005 – 51,846,908 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, 2005 and 2004
3
Consolidated Statements of Condition – June 30, 2005, December 31, 2004 and June 30, 2004
4
Consolidated Statements of Shareholders’ Equity – Six months ended June 30, 2005 and 2004
5
Consolidated Statements of Cash Flows – Six months ended June 30, 2005 and 2004
6
Notes to Consolidated Financial Statements
7
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
10
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
34
Item 4.
Controls and Procedures
Unregistered Sales of Equity Securities and Use of Proceeds
Submission of Matters to a Vote of Security Holders
35
Item 6.
Exhibits
36
Signatures
37
Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Income (Unaudited)
Three Months Ended
Six Months Ended
June 30,
(dollars in thousands except per share amounts)
2005
2004
Interest Income
Interest and Fees on Loans and Leases
$
90,119
80,346
176,586
161,774
Income on Investment Securities - Available for Sale
27,987
21,745
55,306
42,591
Income on Investment Securities - Held to Maturity
5,527
6,711
11,352
13,687
Deposits
1,646
59
2,877
Funds Sold
165
177
240
594
Other
271
865
720
1,723
Total Interest Income
124,105
111,490
244,263
223,246
Interest Expense
13,577
8,560
25,181
17,760
Securities Sold Under Agreements to Repurchase
4,562
2,222
7,887
4,148
Funds Purchased
1,151
506
1,884
737
Short-Term Borrowings
45
13
77
28
Long-Term Debt
3,731
4,340
7,537
8,693
Total Interest Expense
23,066
15,641
42,566
31,366
Net Interest Income
101,039
95,849
201,697
191,880
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
14,058
12,995
28,680
26,859
Mortgage Banking
2,594
2,808
5,184
4,785
Service Charges on Deposit Accounts
9,569
9,540
19,748
19,490
Fees, Exchange, and Other Service Charges
15,211
14,243
29,047
27,482
Investment Securities Gains (Losses)
337
(37)
Insurance
4,330
4,926
10,118
9,584
4,575
10,373
9,875
15,527
Total Non-Interest Income
50,674
54,848
102,989
103,690
Non-Interest Expense
Salaries and Benefits
43,856
46,689
88,625
92,690
Net Occupancy Expense
9,189
9,543
18,734
18,929
Net Equipment Expense
5,377
5,799
10,848
11,763
20,582
23,094
41,660
44,765
Total Non-Interest Expense
79,004
85,125
159,867
168,147
Income Before Income Taxes
72,709
69,072
144,819
130,923
Provision for Income Taxes
26,280
24,840
52,868
46,892
Net Income
46,429
44,232
91,951
84,031
Basic Earnings Per Share
0.90
0.84
1.75
1.57
Diluted Earnings Per Share
0.87
0.79
1.69
1.48
Dividends Declared Per Share
0.33
0.30
0.66
0.60
Basic Weighted Average Shares
51,873,772
52,491,874
52,646,022
53,389,261
Diluted Weighted Average Shares
53,403,781
55,662,415
54,250,018
56,710,653
Consolidated Statements of Condition (Unaudited)
December 31,
(dollars in thousands)
Assets
Interest-Bearing Deposits
4,825
4,592
179,680
Investment Securities - Available for Sale
Held in Portfolio
2,396,204
2,483,719
2,275,272
Pledged as Collateral
117,947
Investment Securities - Held to Maturity
(Fair Value of $522,993, $585,836, and $663,534)
526,767
589,908
679,382
50,000
21,000
Loans Held for Sale
17,435
17,642
9,565
Loans and Leases
6,151,418
5,986,930
5,787,314
Allowance for Loan and Lease Losses
(101,587)
(106,796)
(124,904)
Net Loans
6,049,831
5,880,134
5,662,410
Total Earning Assets
9,163,009
8,996,995
8,806,309
Cash and Non-Interest-Bearing Deposits
293,115
225,359
339,486
Premises and Equipment
137,907
146,095
149,128
Customers’ Acceptance Liability
1,598
1,406
1,213
Accrued Interest Receivable
38,540
36,044
36,378
Foreclosed Real Estate
292
191
4,889
Mortgage Servicing Rights
18,239
18,769
20,819
Goodwill
34,959
36,216
Other Assets
372,031
305,116
294,331
Total Assets
10,059,690
9,766,191
9,688,769
Liabilities
Non-Interest-Bearing Demand
1,918,749
1,977,703
1,939,580
Interest-Bearing Demand
1,641,873
1,536,323
1,464,207
Savings
2,967,993
2,960,351
2,976,108
Time
1,198,143
1,090,290
1,089,393
Total Deposits
7,726,758
7,564,667
7,469,288
861,233
568,981
687,816
63,565
149,635
139,055
9,894
15,000
11,055
Banker’s Acceptances Outstanding
Retirement Benefits Payable
66,638
65,708
62,821
Accrued Interest Payable
8,617
7,021
7,169
Taxes Payable and Deferred Taxes
283,082
229,928
225,989
Other Liabilities
83,462
96,373
87,325
242,674
252,638
297,600
Total Liabilities
9,347,521
8,951,357
8,989,331
Shareholders’ Equity
Common Stock ($.01 par value); authorized 500,000,000 shares;issued / outstanding: June 2005 - 81,721,733 / 51,853,734,December 2004 - 81,711,752 / 54,960,857,June 2004 - 81,711,599 / 52,426,010
815
813
Capital Surplus
457,280
450,998
403,150
Accumulated Other Comprehensive Income (Loss)
(18,471)
(12,917)
(27,258)
Retained Earnings
1,339,119
1,282,425
1,251,689
Deferred Stock Grants
(7,166)
(8,433)
(9,391)
Treasury Stock, at Cost (Shares: June 2005 - 29,867,999,December 2004 - 26,750,895, June 2004 - 29,285,589)
(1,059,408)
(898,052)
(919,565)
Total Shareholders’ Equity
712,169
814,834
699,438
Total Liabilities and Shareholders’ Equity
Consolidated Statements of Shareholders’ Equity (Unaudited)
Accum.
Compre-
hensive
Deferred
Common
Capital
Income
Retained
Stock
Treasury
Total
Surplus
(Loss)
Earnings
Grants
Balance at December 31, 2004
Comprehensive Income:
Other Comprehensive Income, Net of Tax:
Change in Unrealized Gains and Losses onInvestment Securities
(5,554)
Total Comprehensive Income
86,397
Common Stock Issued under Stock Plans andRelated Tax Benefits (605,364 shares)
21,499
2
6,282
(610)
1,267
14,558
Treasury Stock Purchased (3,710,379 shares)
(175,914)
Cash Dividends Paid
(34,647)
Balance at June 30, 2005
Balance at December 31, 2003
793,132
807
391,701
(5,711)
1,199,077
(8,309)
(784,433)
(21,547)
62,484
Common Stock Issued under Stock Plans andRelated Tax Benefits (908,502 shares)
32,028
11,449
803
(1,082)
20,852
Treasury Stock Purchased (3,527,779 shares)
(155,984)
(32,222)
Balance at June 30, 2004
Consolidated Statements of Cash Flows (Unaudited)
Operating Activities
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Goodwill Impairment
1,257
Depreciation and Amortization
9,673
10,523
Amortization of Deferred Loan and Lease Fees, Net
(382)
(1,248)
Amortization/Accretion of Premiums/Discounts on Investment Securities, Net
4,692
6,830
2,572
2,444
Deferred Income Taxes
5,908
8,296
Net (Gain) Loss on Investment Securities
(337)
Proceeds from Sales of Loans Held for Sale
219,688
250,449
Originations of Loans Held for Sale
(219,481)
(250,803)
Net Change in Other Assets and Other Liabilities
(28,070)
11,323
Net Cash Provided by Operating Activities
87,471
118,382
Investing Activities
Proceeds from Sales and Redemptions of Investment Securities - Available for Sale
324,008
347,709
Purchases of Investment Securities - Available for Sale
(366,619)
(671,520)
Proceeds from Redemptions of Investment Securities - Held to Maturity
62,291
117,212
Purchases of Investment Securities - Held to Maturity
(70,238)
Net Increase in Loans and Leases
(167,091)
(29,567)
Premises and Equipment, Net
(1,485)
354
Net Cash Used by Investing Activities
(148,896)
(306,050)
Financing Activities
Net Increase in Demand Deposits
46,596
113,529
Net Increase in Savings Deposits
7,642
142,729
Net Increase (Decrease) in Time Deposits
107,853
(119,749)
Net Increase in Short-Term Borrowings
201,076
243,389
Repayments of Long-Term Debt
(9,964)
(26,468)
Proceeds from Issuance of Common Stock
15,772
23,380
Repurchase of Common Stock
Net Cash Provided by Financing Activities
158,414
188,604
Increase in Cash and Cash Equivalents
96,989
936
Cash and Cash Equivalents at Beginning of Period
250,951
518,230
Cash and Cash Equivalents at End of Period
347,940
519,166
(Unaudited)
Note 1. Summary of Significant Accounting Policies
Bank of Hawaii Corporation (the “Company”) is a bank holding company providing a broad range of financial products and services to customers in Hawaii and the Pacific Islands (Guam, nearby islands and American Samoa). The Company’s principal subsidiary is Bank of Hawaii (the “Bank”). All significant intercompany accounts and transactions have been eliminated in consolidation.
Basis of Presentation
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the consolidated financial statements reflect normal recurring adjustments necessary for a fair presentation of the results for the interim periods.
Certain prior period amounts have been reclassified to conform to current period classifications.
These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s 2004 Annual Report on Form 10-K. Operating results for the six months ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.
The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities (“repos”). Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, repurchase agreements are accounted for as collateralized financing arrangements and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability in the Consolidated Statements of Condition while the securities underlying the agreements remain in the respective asset accounts. If the secured party can re-sell or re-pledge the securities, they are classified as pledged securities in the Consolidated Statements of Condition. If the secured party cannot resell or re-pledge the securities, they are not separately identified.
Stock-Based Compensation
As permitted by the Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), the Company currently accounts for share-based payments using the intrinsic value method permitted by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”) and related interpretations. Accordingly, the Company recognizes no compensation cost for employee stock options that were granted with an exercise price equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123:
(dollars in thousands except per share and option data)
2004 1
Net Income, as reported
Less: Total Stock-Based Employee Compensation Expense Associated with Stock Options Determined Under Fair Value Method for All Option Awards, Net of Related Tax Effects 2
(500
)
(1,161
(1,204
(2,672
Pro Forma Net Income
45,929
43,071
90,747
81,359
Earnings Per Share:
Basic-as reported
Basic-pro forma
0.89
0.82
1.72
1.52
Diluted-as reported
Diluted-pro forma
0.86
0.77
1.67
1.43
1 Prior period amounts restated to account for forfeitures and adjustment to dividend yield calculation.
2 A Black-Scholes option pricing model was used to determine the fair values of the options granted.
Recently Issued and Proposed Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004) (“SFAS No. 123(R)”),Share-Based Payment, which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB No. 25 and amends FASB Statement No. 95, Statement of Cash Flows. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense through the income statement based on their fair values at issue date. Pro forma disclosure will no longer be an alternative. On April 14, 2005, the Securities and Exchange Commission announced that it would provide for a phased-in-implementation process for SFAS No. 123(R). Under this process, the Company will be required to adopt SFAS No. 123(R) no later than the beginning of the first fiscal year that begins after June 15, 2005. The Company plans to adopt SFAS No. 123(R) on January 1, 2006.
The Company plans to adopt SFAS No. 123(R) using the “modified prospective” method. Under this method, awards that are granted, modified, or settled after January 1, 2006, will be measured and accounted for in accordance with SFAS No. 123(R). Also under this method, expense will be recognized in the income statement for unvested awards that were granted prior to January 1, 2006, based upon the fair value determined at the grant date under SFAS No. 123.
The adoption of SFAS No. 123(R) will have an impact on the Company’s results of operations, although it will have no impact on the Company’s overall financial position. Had the Company adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share shown in the table above.
8
In July 2005, the FASB issued an exposure draft, FASB Staff Position (“FSP”) No. FAS 13-a “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction” (“FSP 13-a”). Under FSP 13-a, a revision in the timing of expected cash flows of a leveraged lease may require a recalculation of the original lease assumptions. A material change in the net investment in a leveraged lease using different cash flow assumptions would be recognized as a gain or loss in the period in which the assumptions are revised. The Company has entered into leveraged lease transactions that are currently under various stages of review by the Internal Revenue Service (“IRS”). The outcome of these reviews may change the timing of cash flows from these leases which may result in gain or loss recognition. Management is currently evaluating the potential effect of the proposed recognition provisions of FSP 13-a.
Note 2. Business Segments
The information under the caption “Business Segments” in Management’s Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.
Note 3. Pension Plans and Postretirement Benefit Plan
The components of net periodic cost for the aggregated pension plans and the postretirement benefit plan for the three and six months ended June 30, 2005 and 2004 are presented in the following table:
Pension Benefits
Postretirement Benefits
Three Months Ended June 30,
Service Cost
285
247
Interest Cost
1,125
1,091
500
443
Expected Return on Plan Assets
(1,185
(1,182
Amortization of Unrecognized Net Transition Obligation
146
147
Recognized Net Actuarial Loss (Gain)
421
328
(41
(156
Total Net Periodic Cost
361
237
890
681
Six Months Ended June 30,
540
494
2,250
2,183
950
886
(2,370
(2,364
293
294
841
656
(83
(312
721
475
1,700
1,362
There were no significant changes from the previously reported $1.8 million in contributions expected to be paid during 2005.
9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
This report, including the statements under the caption “Financial Outlook,” contains forward-looking statements concerning, among other things, the economic and business environment in the Company’s service area and elsewhere, credit quality, the expected level of loan and lease loss provisioning, anticipated net income and other financial and business matters in future periods. The Company’s forward-looking statements are based on numerous assumptions, any of which could prove to be inaccurate and actual results may differ materially from those projected for a variety of reasons, including, but not limited to: 1) unanticipated changes in business and economic conditions, the competitive environment, fiscal and monetary policies, legislation in Hawaii and the other markets the Company serves, or the timing and interpretation of accounting standards; 2) changes in the Company’s credit quality or risk profile which may increase or decrease the required level of the reserve for credit losses; 3) changes in market interest rates that may affect the Company’s credit markets and ability to maintain the Company’s net interest margin; 4) changes to the amount and timing of the Company’s proposed equity repurchases and repayment of maturing debt; 5) real or threatened acts of war or terrorist activity affecting business conditions; and 6) 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
The Company is in the second year of its 2004-2006 plan (the “Plan”), which continues to build on the objective of maximizing shareholder value over time. This objective was established in the previous three-year strategic plan.
The Plan consists of five key elements:
• Accelerate revenue growth in our island markets
• Better integrate our business segments
• Continue to develop our management teams
• Improve operating efficiency
• Maintain a culture of dependable risk and capital management
During the first six months of 2005, the Company continued to meet the key financial objectives of the Plan. Total revenue, consisting of net interest income and non-interest income, for the first six months of 2005, increased 3% from the same prior year period. As of June 30, 2005, loans and leases outstanding increased 6% and deposits increased 3% compared to June 30, 2004.
The Company continues to better integrate the Company’s three primary business segments – Retail Banking, Commercial Banking and the Investment Services Group – through improved processes, training and communications. As a result, the needs of the Company’s customers are better addressed and customer relationships continue to strengthen.
The Company utilizes various financial measures to evaluate its performance against the objectives of the Plan, many of which are discussed below.
Operating efficiency improved in the first six months of 2005 compared to the same period in 2004, as the Company continues to improve processes. The efficiency ratio for the first six months of 2005 was 52.47% compared to 56.89% in the same period in 2004. Operating income, which is defined as the income before the provision for loan and lease losses and income taxes increased 13.7% in the first six months of 2005 compared to the same period in 2004.
The management of both risk and capital continues to be dependable and disciplined in 2005. As of June 30, 2005, the ratio of non-accrual loans to total loans was 0.16% and the leverage ratio was 7.18%.
The Company’s net income for the first six months of 2005 was $92.0 million, an increase of 9% from $84.0 million reported in the same prior year period. Additional results for the first six months of 2005 compared to the same period in 2004 were as follows:
• Diluted earnings per share were $1.69, an increase of 14%
• The net interest margin was 4.39%, an increase of 16 basis points
• Return on average assets increased to 1.87% from 1.73%
• Return on average equity increased to 24.78% from 22.03%
The Company’s overall financial results are more fully discussed in the following sections of this report.
Table 1 presents the Company’s financial highlights for the three and six months ended June 30, 2005 and 2004.
11
Highlights (Unaudited)
Table 1
For the Period:
Net Income to Average Total Assets (ROA)
1.87
%
1.80
1.73
Net Income to Average Shareholders’ Equity (ROE)
25.98
24.28
24.78
22.03
Net Interest Margin 1
4.36
4.17
4.39
4.23
Efficiency Ratio 2
52.07
56.49
52.47
56.89
Average Assets
9,969,243
9,893,303
9,907,845
9,785,603
Average Loans and Leases
6,090,149
5,772,926
6,045,609
5,757,647
Average Deposits
7,747,331
7,371,388
7,717,729
7,345,645
Average Shareholders’ Equity
716,767
732,652
748,344
766,950
Average Equity to Average Assets
7.19
7.41
7.55
7.84
At Period End:
Allowance to Loans and Leases Outstanding
1.65
2.16
Dividend Payout Ratio
37.71
38.22
Leverage Ratio
7.18
7.16
Book Value Per Common Share
13.73
13.34
Employees (FTE)
2,561
2,683
Branches and offices
86
89
Market Price Per Share of Common Stock for the Quarter Ended:
Closing
50.75
45.22
High
51.30
46.84
Low
43.82
40.97
1 The net interest margin is defined as net interest income, on a fully-taxable equivalent basis, as a percentage of average earning assets.
2 The efficiency ratio is defined as non-interest expense divided by total revenue (net interest income and non-interest income).
12
ANALYSIS OF STATEMENT OF INCOME
Net interest income on a taxable equivalent basis for the three and six month periods ended June 30, 2005 increased $5.2 million and $9.8 million, respectively, or a 5% change for both periods compared to the same periods in 2004. The net interest margin for the three months ended June 30, 2005 was 4.36%, a 19 basis point increase from the same prior year period. The net interest margin for the first six months of 2005 was 4.39%, a 16 basis point increase from the same period in 2004. The increase in net interest income was primarily a result of higher income earned on the investment securities and loans portfolio. The increase in interest income on the investment securities portfolio was due to an increase in average balances resulting from better utilization of the Company’s liquidity and reduction in prepayments on mortgage-backed securities. Interest income on commercial and industrial loans increased primarily due to higher average yields earned, which was consistent with increases in benchmark interest rates, and an increase in average balances. Home equity loans experienced higher interest income due to re-pricing of initial introductory rates to fully indexed rates and increases in the average balance outstanding resulting from promotions. Partially offsetting these positive increases in interest income was an increase in interest expense due mainly to the increase in short-term interest rates. As a result of the Federal Reserve increasing short-term interest rates, the average federal funds rate was 172 basis points higher for the six months ended June 30, 2005 compared to the same prior year period. In comparison, the Company’s average interest-bearing deposits rates increased by 22 basis points.
Average balances, related interest income and expenses and resulting yields and rates are presented in Table 2. An analysis of change in net interest income is presented in Table 3.
Consolidated Average Balances and Interest Rates - Taxable Equivalent Basis (Unaudited)
Table 2
June 30, 2005
June 30, 2004
Average
Income/
Yield/
(dollars in millions)
Balance
Expense
Rate
Earning Assets
6.0
2.36
408.8
1.6
1.62
5.4
0.1
2.17
329.2
2.8
1.76
23.1
0.2
2.86
71.3
0.99
17.9
2.68
120.1
0.6
Investment Securities
Available for Sale
2,542.5
28.0
4.41
2,148.9
21.8
4.06
2,517.0
55.4
2,068.7
42.6
4.13
Held to Maturity
544.1
5.5
709.8
6.7
3.78
559.3
11.4
714.8
13.7
3.83
15.1
5.72
20.7
0.3
5.54
14.1
0.4
5.57
18.1
0.5
5.45
Loans and Leases 1
Commercial and Industrial
945.0
14.3
6.07
845.2
10.3
4.90
924.8
27.5
5.99
844.8
20.4
4.86
Construction
140.9
2.1
5.91
100.4
0.9
3.80
132.5
3.7
5.69
2.0
4.05
Commercial Mortgage
599.3
8.8
5.89
638.9
8.6
5.39
602.6
17.4
5.81
636.5
17.2
5.42
Residential Mortgage
2,343.9
33.1
5.64
2,281.8
32.2
5.65
2,338.0
65.7
5.62
2,299.6
65.5
5.70
Other Revolving Credit and Installment
739.6
15.4
8.37
683.2
14.4
8.51
738.2
30.5
8.32
667.1
28.7
8.67
Home Equity
719.0
10.8
6.01
534.6
6.1
4.63
699.0
20.2
5.83
511.9
11.9
4.68
Purchased Home Equity
103.3
0.8
3.06
178.8
1.9
4.16
110.0
1.8
3.32
191.8
4.6
4.70
Lease Financing
499.2
4.7
3.74
510.1
5.6
4.38
500.5
9.4
3.81
505.5
11.0
4.35
Total Loans and Leases
6,090.2
90.0
5,773.0
80.0
5.56
6,045.6
176.2
5.86
5,757.6
161.3
66.3
1.64
78.1
4.45
60.1
0.7
2.42
77.8
Total Earning Assets 2
9,287.3
124.2
5.35
9,210.6
111.5
9,219.4
244.4
5.32
9,086.3
223.3
4.93
305.8
306.3
310.6
316.9
376.1
376.4
377.8
382.4
9,969.2
9,893.3
9,907.8
9,785.6
Interest-Bearing Liabilities
Demand
1,667.3
2.4
0.58
1,390.2
0.17
1,642.9
4.1
0.50
1,380.1
1.1
0.16
2,970.8
4.8
0.65
2,911.5
3.1
0.43
2,971.5
9.2
0.62
2,891.6
6.4
0.44
1,159.0
2.20
1,129.5
4.9
1.74
1,137.0
2.11
1,159.1
1.79
Total Interest-Bearing Deposits
5,797.1
13.6
0.94
5,431.2
0.63
5,751.4
25.2
0.88
5,430.8
17.8
822.9
5.8
2.81
1,082.5
2.7
1.02
764.9
9.9
2.60
972.4
242.7
6.16
317.3
4.3
5.48
245.6
7.5
6.15
319.1
5.46
Total Interest-Bearing Liabilities
6,862.7
1.35
6,831.0
15.6
0.92
6,761.9
1.27
6,722.3
31.3
101.1
95.9
201.8
192.0
Interest Rate Spread
4.00
3.94
3.99
Net Interest Margin
Non-Interest-Bearing Demand Deposits
1,950.2
1,940.2
1,966.4
1,914.8
439.5
389.4
431.2
381.5
716.8
732.7
748.3
767.0
1 Non-performing loans are included in the respective average loan balances. Income, if any, on such loans is recognized on a cash basis.
2 Interest income includes taxable-equivalent basis adjustment based upon a statutory tax rate of 35%.
14
Analysis of Change in Net Interest Income - Taxable Equivalent Basis (Unaudited)
Table 3
Six Months Ended June 30, 2005 Compared to June 30, 2004
Volume1
Rate 1
Change in Interest Income:
(3.3)
(2.7)
(0.8)
(0.4)
9.7
12.8
(3.1)
(2.3)
(0.1)
5.0
7.1
1.0
1.7
(1.0)
1.2
(0.9)
2.9
(1.1)
3.3
8.3
(1.6)
(1.2)
(2.8)
(1.5)
9.1
14.9
(0.7)
Total Change in Interest Income
11.1
10.0
21.1
Change in Interest Expense:
3.0
2.6
(0.2)
7.2
7.4
6.2
(2.2)
Total Change in Interest Expense
(3.2)
14.5
11.3
Change in Net Interest Income
(4.5)
9.8
1 The changes for each category of interest income and expense are divided between the portion of changes attributable to the variance in volume or rate for that category.
For the three and six months ending June 30, 2005, the Company recorded no Provision for Loan and Lease Losses (“Provision”). The Company returned to income $3.5 million from a release of a portion of the allowance for loan and lease losses in the second quarter of 2004. For information on the reserve for credit losses, refer to “Corporate Risk Profile – Reserve for Credit Losses” section of this report.
Non-interest income decreased $4.2 million or 8% and $0.7 million or 1% for the three and six months ended June 30, 2005, respectively, from the comparable prior year periods primarily due to $5.7 million special income items that occurred in the second quarter of 2004 as shown on Table 4 below.
15
Non-Interest Income (Unaudited)
Table 4
Percent
Change
(8)
1
n.m.
(12)
Other Income:
Income from Bank-Owned Life Insurance
1,509
1,800
(16)
2,976
3,567
(17)
Leasing Partnership Distribution
3,218
Gain on the Sale of Land
2,454
3,066
2,901
6,892
6,288
Total Other Income
(56)
(36)
(1)
n.m. - - not meaningful.
Trust and asset management income increased $1.1 million or 8% and $1.8 million or 7%, respectively, for the three and six months ended June 30, 2005 compared to the same periods in 2004. The increase in fee income was due to an improvement in market conditions, which resulted in an increase in the average market value of assets under management, and an increase in investment advisory fees on money market assets.
Mortgage banking income declined $0.2 million and increased $0.4 million, respectively, for the three and six months ended June 30, 2005, or an 8% change for both periods compared to the same periods in 2004. The decline from the second quarter of 2004 was primarily a result of lower gains on the sale of mortgage loans in 2005, which was attributable to a 21% decrease in mortgage loan originations due to the low interest rate environment in the second quarter of 2004. On a year-to-date comparison, the increase was largely due to higher net servicing income as a result of slowdown in prepayments.
Fees, exchange and other service charges increased $1.0 million or 7% and $1.6 million or 6%, respectively, for the three and six months ended June 30, 2005 compared to the same prior year periods. This increase was primarily due to higher merchant card transaction income, resulting from increased transaction volume and higher loan fees, partially offset by a decrease in foreign exchange income.
Insurance income decreased $0.6 million or 12% and increased by $0.5 million or 6% for the three and six months ended June 30, 2005, respectively, compared to the same periods in 2004. The decline from the second quarter of 2004 was a result of lower premium income. On a year-to-date comparison, the increase was primarily due to higher annuity and life insurance product income.
Other non-interest income decreased $5.8 million or 56% and $5.7 million or 36%, respectively, for the three and six months ended June 30, 2005 compared to the same prior year periods. The decline was due to a $3.2 million distribution from a leasing partnership investment and a $2.5 million gain realized on the sale of a parcel of land, both occurring in the second quarter of 2004.
Non-interest expense decreased $6.1 million or 7% and $8.3 million or 5%, respectively, for the three and six months ended June 30, 2005 compared to the same prior year periods. Table 5 presents the components of non-interest expense.
16
Non-Interest Expense (Unaudited)
Table 5
Salaries and Benefits:
Salaries
26,616
27,904
(5)
52,669
55,108
(4)
Incentive Compensation
3,725
3,260
7,693
7,076
1,828
3,233
(44)
3,543
6,129
(42)
Commission Expense
2,281
2,284
4,533
3,911
Retirement and Other Benefits
4,437
4,214
9,205
8,571
Payroll Taxes
2,205
3,103
(29)
5,658
6,533
(13)
Medical, Dental, and Life Insurance
1,823
2,136
(15)
4,054
4,240
Separation Expense
941
555
70
1,270
1,122
Total Salaries and Benefits
(6)
(7)
Other Expense:
Professional Services
3,361
4,175
(20)
6,946
8,257
Delivery and Postage Services
2,397
(2)
4,855
5,082
Data Services
2,908
2,480
17
5,707
4,805
19
11,916
13,985
24,152
26,621
(9)
Total Other Expense
(11)
Salaries and benefits expense decreased $2.8 million or 6% and $4.1 million or 4%, respectively, for the three and six months ended June 30, 2005 compared to the same prior year periods. Base salaries decreased as a result of a decline in the number of employees. In addition, stock-based compensation decreased as a result of fewer restricted stock units outstanding in 2005.
Net equipment expense declined by $0.4 million or 7% and $0.9 million or 8%, respectively, for the three and six months ended June 30, 2005, compared to the same prior year periods as a result of lower technology expense.
Other non-interest expense decreased $2.5 million or 11% and $3.1 million or 7%, respectively, for the three and six months ended June 30, 2005 compared to the same periods in 2004. The decrease in the three months ended June 30, 2005 from the same prior year period was largely related to a $2.2 million legal settlement during the second quarter of 2004. The decrease for six months ended June 30, 2005 compared to the same prior year period was due to the aforementioned settlement and lower professional fees.
The effective tax rate for the three and six months ended June 30, 2005 was 36.14% and 36.51%, respectively, compared to 35.96% and 35.82% in the comparable periods of 2004. The increase was largely due to a goodwill impairment charge in the first quarter of 2005, which was not tax deductible.
BALANCE SHEET ANALYSIS
Short-Term Earning Assets
Short-term earning assets which consist of interest-bearing deposits and funds sold totaled $54.8 million at June 30, 2005, an increase of $29.2 million from December 31, 2004 and a decrease of $124.9 million from June 30, 2004. The decline from June 30, 2004 was mainly a result of more effective management of liquidity.
Investment securities totaled $3.0 billion as of June 30, 2005, a $32.7 million decrease from December 31, 2004 and a $86.3 million increase from June 30, 2004. At June 30, 2005 investment securities with a book value of $1.5 billion were pledged to secure deposits of government entities and $117.9 million was pledged to secure certain repos.
Table 6 presents the details of the investment securities portfolio at June 30, 2005 and December 31, 2004.
Investment Securities (Unaudited)
Table 6
Amortized Cost
Fair Value
Securities - Available for Sale:
Debt Securities Issued by the U.S. Treasury and Agencies
68,620
68,906
Debt Securities Issued by States and Municipalities
19,863
20,090
Mortgage-Backed Securities
2,092,440
2,094,429
Other Debt Securities
333,552
330,726
2,514,475
2,514,151
Securities - Held to Maturity:
90
94
526,677
522,899
522,993
December 31, 2004
38,551
38,942
7,958
8,081
2,090,510
2,098,994
338,495
337,702
2,475,514
96
589,818
585,740
585,836
18
Table 7 presents temporarily impaired investment securities as of June 30, 2005 and December 31, 2004.
Temporarily Impaired Investment Securities (Unaudited)
Table 7
Temporarily Impaired
Less Than 12 Months
12 Months or Longer
GrossUnrealizedLosses
Debt Securities Issued by the U.S.Treasury and Agencies
11,368
(76)
Debt Securities Issued byState and Municipalities
4,605
(21)
638,193
(3,690)
680,896
(11,459)
1,319,089
(15,149)
Foreign Bonds
223,239
(2,313)
49,189
(914)
272,428
(3,227)
Total Temporarily ImpairedInvestment Securities
877,405
(6,100)
730,085
(12,373)
1,607,490
(18,473)
1,184,863
(10,374)
284,389
(4,774)
1,469,252
(15,148)
The gross unrealized losses on temporarily impaired investment securities at June 30, 2005 represented less than 1.0% of the total amortized cost of total investment securities. These unrealized losses were primarily attributable to an increase in interest rates during the first six months of 2005 and are believed to be temporary.
Loans held for sale, consisting of residential mortgage loans, totaled $17.4 million at June 30, 2005, $17.6 million at December 31, 2004 and $9.6 million at June 30, 2004. The change from June 30, 2004 was a result of the impact of mortgage loan sales activity and production volume.
As of June 30, 2005, loans and leases outstanding were $6.2 billion, an increase of $164.5 million and $364.1 million from December 31, 2004 and June 30, 2004, respectively. Total commercial loans increased as loan originations continue to strengthen and outpace payoff activity. Consumer loans increased primarily as a result of increases in home equity outstanding from successful loan promotions in a strong Hawaii residential real estate market. Table 8 presents the composition of the loan portfolio by major categories and Table 9 presents the composition of consumer loans by geographic area.
Loan Portfolio Balances (Unaudited)
Table 8
March 31,
Commercial
997,762
918,878
909,264
800,893
563,979
609,689
602,678
643,382
165,772
107,403
122,355
98,916
471,600
468,349
479,100
479,488
Total Commercial
2,199,113
2,104,319
2,113,397
2,022,679
Consumer
2,347,877
2,342,062
2,326,385
2,286,618
739,161
694,261
657,164
559,225
93,806
109,632
122,728
162,730
742,834
734,836
734,721
721,386
28,627
30,680
32,535
34,676
Total Consumer
3,952,305
3,911,471
3,873,533
3,764,635
6,015,790
Consumer Loans by Geographic Area (Unaudited)
Table 9
Hawaii
2,120,033
2,120,747
2,110,147
2,071,073
726,313
682,351
646,980
551,099
558,396
558,712
559,135
554,995
Guam
221,886
215,600
210,563
209,972
8,636
8,431
7,631
8,067
108,357
100,599
98,309
87,963
U.S. Mainland
Other Pacific Islands
5,958
5,715
5,675
5,573
4,212
3,479
2,553
76,081
75,525
77,277
78,428
Total Consumer Loans by Geographic Area
As of June 30, 2005, the Company’s portfolio of residential loans serviced for third parties totaled $2.5 billion. In the second quarter of 2005, prepayment speeds increased as interest rates decreased, which resulted in a lower market value of the mortgage servicing rights. Recent prepayment speeds for Hawaii mortgages continued to either approximate or be slightly higher than national averages.
Table 10 presents the changes in the carrying value of mortgage servicing rights, net of valuation allowance.
20
Mortgage Servicing Rights (Unaudited)
Table 10
Year Ended
Balance at Beginning of Period
22,178
Originated Mortgage Servicing Rights
2,247
3,895
Purchased Servicing Rights
21
235
Valuation Allowance
Amortization
(2,798)
(7,526)
Balance at End of Period
Fair Value at End of Period
20,886
22,154
Other Assets and Other Liabilities
Table 11 presents the major components of other assets and other liabilities.
Other Assets and Other Liabilities (Unaudited)
Table 11
Other Assets:
Bank-Owned Life Insurance
147,346
144,370
141,370
Federal Home Loan Bank and Federal Reserve Bank Stock
79,415
53,847
78,713
Low Income Housing Investments
32,786
34,597
38,083
Accounts Receivable
21,414
25,568
26,053
Federal Tax Deposit
43,000
48,070
46,734
10,112
Total Other Assets
Other Liabilities:
Incentive Plans Payable
7,246
12,090
6,582
Insurance Premiums Payable
7,425
7,940
8,294
Reserve for Unfunded Commitments 1
4,576
6,800
Self Insurance Reserve
5,779
6,366
6,189
58,436
63,177
66,260
Total Other Liabilities
1 Prior to December 31, 2004, the reserve for unfunded commitments was a component of the allowance for loan and lease losses. As of June 30, 2004, the reserve for unfunded commitments was $5.4 million.
During the second quarter of 2005, a deposit was placed with the IRS relating to a review by the IRS of the Company’s tax positions for certain leveraged lease transactions. The placing of the deposit will prevent further accrual of potential interest related to the timing of tax payments for these transactions. The Company believes its tax position related to these transactions was proper based on applicable statutes, regulations and case laws at the time the transactions were entered into. The Company believes it has adequate reserves for these tax exposures as of June 30, 2005.
As of June 30, 2005, deposits totaled $7.7 billion, an increase of $162.1 million and $257.5 million from December 31, 2004 and June 30, 2004, respectively. The increase in the balances of interest-bearing demand deposits was due to an increase in the number of consumer and business accounts. Time deposits growth was a result of customers transferring excess account balances to higher rate time deposits. In 2005, time deposits rates have gradually increased.
Average time deposits of $100,000 or more is presented in Table 12.
Average Time Deposits of $100,000 or More (Unaudited)
Table 12
Average Time Deposits
631,831
543,382
570,738
610,546
589,100
Securities sold under agreements to repurchase totaled $861.2 million at June 30, 2005 an increase of $292.3 million from December 31, 2004 and $173.4 million from June 30, 2004. The increases were due to additional placements received from government entities and $100.0 million in repos placed with a private entity in June 2005. The private repos are comprised of two $50.0 million tranches at floating interest rates tied to the London International Bank Offering Rate (“LIBOR”). The repos interest rates averaged 2.66% at June 30, 2005. The term of the repos is 10 years, with the private entity having the right to terminate the transactions in two years. If the agreements are not terminated the rate becomes fixed at 3.85% for the remaining eight years.
Table 13 presents the composition of securities sold under agreements to repurchase.
Securities Sold Under Agreements to Repurchase (Unaudited)
Table 13
Government Entities
761,233
Private Entities
100,000
Total Securities Sold Under Agreements to Repurchase
Short-Term Borrowings and Long-Term Debt
Short-term borrowings, including funds purchased, totaled $73.5 million at June 30, 2005, a decrease of $91.2 million from December 31, 2004 and a decrease of $76.7 million from June 30, 2004, primarily due to effective short-term liquidity management. Long-term debt totaled $242.7 million at June 30, 2005, a decrease of $10.0 million and $54.9 million from December 31, 2004 and June 30, 2004, respectively. The decreases were due to the maturity of $10.0 million in Federal Home Loan Bank (“FHLB”) advances and $70.0 million of matured private placement debt which was replaced with a $25.0 million FHLB advance. For additional information, refer to the “Corporate Risk Profile – Liquidity Management” section of this report.
The Company’s capital position remains strong. The net reduction in capital from December 31, 2004 to June 30, 2005 is attributable to the Company’s continuing common stock repurchase program and to dividends paid, partially offset by net earnings for the first six months of 2005. A further discussion of the Company’s capital is included in the “Corporate Risk Profile – Capital Management” section of this report.
Guarantees
The Company’s standby letters of credit totaled $109.1 million at June 30, 2005, an increase of $6.8 million from December 31, 2004 and a decrease of $6.5 million from June 30, 2004.
22
BUSINESS SEGMENTS
The Company’s business segments are defined as Retail Banking, Commercial Banking, Investment Services Group and Treasury and Other Corporate. The Company’s internal management accounting process measures the performance of the business segments based on the management structure of the Company. This process, which is not necessarily comparable with similar information for any other financial institution, uses various techniques to assign balance sheet and income statement amounts to the business segments, including allocations of interest income and expense overhead, the Provision and capital. This process is dynamic and requires certain allocations based on judgment and subjective factors. Unlike financial accounting, there is no comprehensive, authoritative guidance for management accounting that is equivalent to U.S. generally accepted accounting principles. Results for prior periods have been reclassified to conform to current period classifications.
The business segments are primarily managed with a focus on performance measures, including net income after capital charge (“NIACC”) and risk adjusted return on capital (“RAROC”). NIACC is net income less a charge for the cost of allocated capital. The cost of allocated capital is determined by multiplying management’s estimate of a shareholder’s minimum required rate of return on capital invested (currently 11%) by the segment’s allocated equity. The Company assumes a cost of capital that is equal to a risk-free rate plus a risk premium. RAROC is the ratio of net income to risk-adjusted equity. Equity is allocated to each business segment based on an assessment of its inherent risk. The net interest income of the business segments reflects the results of a funds transfer pricing process that matches assets and liabilities with similar interest rate sensitivity and maturity characteristics and reflects the allocation of net interest income related to the Company’s overall asset and liability management activities on a proportionate basis. The basis for the allocation of net interest income is a function of management decisions and assumptions that are subject to change based on changes in current interest rate and market conditions. Funds transfer pricing also serves to transfer interest rate risk to the Treasury segment. However, the other business segments have some latitude to retain certain interest rate exposures related to customer pricing decisions within guidelines. The Provision charged to the Treasury and Other Corporate segment represents changes in the level of the reserve for credit losses. The Provision recorded in the Retail Banking, Commercial Banking and Investment Services Group segments represents actual net charge-offs of these segments.
The financial results for each of the business segments for the three and six months ended June 30, 2005 and 2004 are discussed below and are presented in Table 14a and 14b.
Retail Banking
The Company’s Retail Banking segment offers a broad range of financial products and services to consumers and small businesses. Loan and lease products include residential mortgage loans, home equity lines of credit, automobile loans and leases and installment loans. Deposit products include checking, savings and time deposit accounts. The Retail Banking segment also provides merchant services to its small business customers. Products and services from the Retail Banking segment are delivered to customers through 73 Hawaii branch locations, 500 ATMs, e-Bankoh (on-line banking service) and a 24-hour telephone banking service. Also included in the segment is Bankoh Investment Services, Inc., a full service brokerage offering equities and bonds, mutual funds, life insurance and annuity products.
23
The improvement in the segment’s key financial measures for the three months ended June 30, 2005 as compared to the same period in 2004 was primarily due to an increase in net interest income resulting from higher earnings credit rate on the segment’s deposit portfolio. Also contributing to the positive trend was a decrease in non-interest expense due to lower advertising, professional services and allocated expenses.
The improvement in the segment’s key financial measures for the six months ended June 30, 2005 as compared to the same period in 2004 was primarily due to an increase in net interest income and non-interest income. The rise in net interest income was due to higher earnings credit on the segment’s deposit portfolio, as well as deposit and loan portfolio growth. The increased non-interest income was largely due to policy initiatives, growth in the number of transactional deposit accounts and greater insurance and annuity sales volume. Also contributing to this segment’s improvement was the decrease in non-interest expense due to lower professional services, consumer credit insurance and allocated expenses.
Commercial Banking
The Commercial Banking segment offers products including corporate banking and commercial real estate loans, lease financing, auto dealer financing, deposit and cash management products and property and casualty insurance products. Lending, deposit and cash management services are offered to middle-market and large companies in Hawaii. Commercial real estate mortgages are focused on customers that include investors, developers and builders primarily domiciled in Hawaii. The Commercial Banking unit also includes the Company’s operations at its 12 branches in the Pacific Islands.
The improvement in the segment’s financial measures for the three and six months ended June 30, 2005 compared to the same periods in 2004 was a result of an increase in net interest income and a decrease in non-interest expense, partially offset by lower non-interest income. The increase in net interest income was due primarily to higher deposit balances and higher earnings credit rates. The decrease in non-interest income was primarily due to the distribution from a leasing partnership investment in the second quarter of 2004. The decline in non-interest expense was primarily due to lower staffing levels.
Investment Services Group
The Investment Services Group includes private banking, trust services, asset management and institutional investment advice. A significant portion of this segment’s income is derived from fees, which are generally based on the market values of assets under management. The private banking and personal trust group assists individuals and families in building and preserving their wealth by providing investment, credit and trust expertise to high-net-worth individuals. The asset management group manages portfolios and creates investment products. Institutional sales and service offers investment advice to corporations, government entities and foundations.
The improvement in the segment’s key financial measures for the three and six months ended June 30, 2005 compared to the same periods in 2004 was due to increases in both net interest income and non-interest income. Trust and asset management fee income increased largely due to improved market conditions which resulted in an increase in the average market value of assets under management and an increase in investment advisory fees on money market accounts. The increase in net interest income primarily resulted from a transfer of private and consumer banking relationships between this segment and the Retail segment. Non-interest expense increased slightly period over period.
24
Treasury and Other Corporate
The primary income earning component of this segment is Treasury, which consists of corporate asset and liability management activities, including interest rate risk management and foreign exchange business. This segment’s assets and liabilities (and related net interest income) consist of interest-bearing deposits, investment securities, funds sold and purchased, government deposits and short- and long-term borrowings. The primary source of foreign exchange income relates to customer driven currency requests from merchants and island visitors. The net residual effect of transfer pricing of assets and liabilities is included in Treasury, along with eliminations of inter-company transactions.
This segment also includes divisions (Technology and Operations, Human Resources, Finance, Credit and Risk Management and Corporate and Regulatory Administration) that provide a wide-range of support to the other business segments. Expenses incurred by these support units are charged to the business segments through an internal cost allocation process.
The decrease in the segment’s key financial measures for the three and six months ended June 30, 2005 as compared to the same periods in 2004 was primarily due to decreases in both net interest income and non-interest income. Net interest income decreased due to the impact of the higher cost of funding by the Treasury unit. Income earned on higher average balances in the investment portfolio partially offset the reduction. The sale of a parcel of land in 2004 was the primary reason for the reduction in non-interest income. The reduction in non-interest expenses was a result of a legal settlement during the second quarter of 2004 and reduced stock-based compensation as compared to the same prior year periods.
25
Business Segment Selected Financial Information (Unaudited)
Table 14a
Investment
Retail
Services
and Other
Consolidated
Banking
Group
Corporate
Three Months Ended June 30, 2005
54,212
35,525
3,222
8,080
3,531
236
(3,767)
50,681
35,289
11,847
25,080
8,735
14,229
2,630
75,761
44,024
17,451
14,477
151,713
(42,569)
(21,019)
(13,692)
(1,724)
(79,004)
33,192
23,005
3,759
12,753
(12,281)
(8,400)
(1,391)
(4,208)
(26,280)
Allocated Net Income
20,911
14,605
2,368
8,545
Allowance Funding Value
(168
(601)
775
GAAP Provision
Economic Provision
(3,435)
(2,432)
(103)
(5,971)
Tax Effect of Adjustments
27
1,035
40
1,107
2,209
Income Before Capital Charge
20,866
12,843
2,299
6,659
42,667
Capital Charge
(5,424)
(4,562)
(1,428)
(8,296)
(19,710)
Net Income (Loss) After Capital Charge (NIACC)
15,442
8,281
871
(1,637)
22,957
RAROC (ROE for the Company)
42
31
26
Total Assets at June 30, 2005
3,789,519
2,533,496
192,378
3,544,297
Three Months Ended June 30, 2004
49,524
33,583
2,832
9,910
2,587
2,730
(8,816)
46,937
30,853
2,833
18,726
24,388
12,141
12,985
5,334
71,325
42,994
15,818
24,060
154,197
(44,560)
(22,928)
(13,226)
(4,411)
(85,125)
26,765
20,066
2,592
19,649
(9,903)
(7,423)
(959)
(6,555)
(24,840)
16,862
12,643
1,633
13,094
(148)
(688)
842
(3,510)
(2,821)
(99)
(3)
(6,433)
396
288
39
2,951
3,674
16,187
12,152
1,566
8,068
37,973
(5,485)
(5,129)
(1,307)
(8,231)
(20,152)
10,702
7,023
259
(163)
17,821
33
Total Assets at June 30, 2004
3,693,382
2,331,951
114,038
3,549,398
Table 14b
Six Months Ended June 30, 2005
106,562
70,087
6,111
18,937
7,016
652
(7,667)
99,546
69,435
6,112
26,604
49,322
20,266
28,855
4,546
148,868
89,701
34,967
31,150
304,686
(85,618)
(43,579)
(26,911)
(3,759)
(159,867)
63,250
46,122
8,056
27,391
(23,403)
(16,999)
(2,981)
(9,485)
(52,868)
39,847
29,123
5,075
17,906
(331)
(1,202)
1,545
(6,941)
(4,890)
(193)
(12,026)
2,013
76
2,267
4,450
39,685
25,696
4,945
14,049
84,375
(10,880)
(9,198)
(2,769)
(18,324)
(41,171)
28,805
16,498
2,176
(4,275)
43,204
Six Months Ended June 30, 2004
99,681
67,602
5,645
18,952
2,477
48
(11,359)
94,347
65,125
5,597
30,311
45,403
22,573
27,426
8,288
139,750
87,698
33,023
38,599
299,070
(87,777)
(46,072)
(26,256)
(8,042)
(168,147)
51,973
41,626
6,767
30,557
(19,230)
(15,381)
(2,504)
(9,777)
(46,892)
32,743
26,245
4,263
20,780
(277)
(1,425)
(14)
1,716
(6,906)
(5,598)
(12,702)
684
1,682
3,570
5,995
31,578
23,381
4,163
14,702
73,824
(11,255)
(10,395)
(2,590)
(17,950)
(42,190)
20,323
12,986
1,573
(3,248)
31,634
CORPORATE RISK PROFILE
Credit Risk
Credit Risk is defined as the risk that borrowers or counterparties will not be able to repay their obligations to the Company. Credit exposures reflect legally binding commitments for loans, leases, banker’s acceptances, financial and performance standby letters of credit and overnight overdrafts.
The Company’s credit risk position remained generally stable during the first six months of 2005. The Company continued to observe lower levels of internally criticized loans, non-performing assets and loans charged-off. The ratio of non-accrual loans to total loans at June 30, 2005 was 0.16%, slightly reduced from 0.23% at December 31, 2004. Net loan charge-offs (annualized) for the first six months of 2005 as a percent of average loans outstanding was 0.25%, an increase from 0.02% from same prior year period, due to a $6.0 million recovery of a previously charged-off loan from the divested Asia business in the second quarter of 2004.
The risk profile of the Hawaii and Guam-based loan portfolios continued to improve, primarily due to the expanding local economies led by the construction and real estate industries and record levels of tourism.
Outstandings related to the aircraft operations of domestic legacy carriers as of June 30, 2005 were $19.3 million and are included in the United States National Passenger Carriers total, as shown in Table 15 below. Relative to the Company’s total portfolio, domestic legacy airline carriers continued to demonstrate a higher risk profile with negative trends due to sustained high oil prices. In the evaluation of the reserve for credit losses, the Company considered the current financial strain on airlines, which offset the impact of the improvement in other components of the loan portfolio.
Air Transportation Credit Exposure 1 (Unaudited)
Table 15
Dec. 31, 2004
Unused
Outstanding
Commitments
Exposure
United States Regional Passenger Carriers
41,556
7,191
48,747
54,981
58,491
United States National Passenger Carriers
37,638
37,377
37,581
Passenger Carriers Based Outside United States
22,249
25,910
30,325
Cargo Carriers
13,475
13,771
14,122
Total Air Transportation
114,918
122,109
132,039
140,519
1 Exposure includes loans, leveraged leases and operating leases.
Non-Performing Assets
Non-performing assets (“NPAs”) consist of non-accrual loans, foreclosed real estate and other investments. NPAs decreased by $2.9 million from December 31, 2004 to $10.9 million as of June 30, 2005.
Impaired loans totaled $1.8 million at June 30, 2005, a decrease of $2.0 million from $3.8 million at December 31, 2004. Impaired loans had a related allowance for loans of less than $0.1 million at June 30, 2005 and December 31, 2004.
Loans Past Due 90 Days or More and Still Accruing Interest
Accruing loans past due 90 days or more were $4.9 million at June 30, 2005, an increase of $2.9 million from December 31, 2004. The increase was primarily due to a commercial mortgage in Guam that was past its maturity, but current in payments. In early July 2005, the maturity date of this loan was formally extended.
Refer to Table 16 for further information on non-performing assets and accruing loans past due 90 days or more.
Consolidated Non-Performing Assets and Accruing Loans Past Due 90 Days or More (Unaudited)
Table 16
Non-Accrual Loans
430
470
683
680
1,739
1,922
2,106
5,649
1,586
2,418
2,973
1,948
3,755
4,810
5,762
8,277
6,035
7,503
7,688
156
185
218
306
6,191
7,906
7,994
Total Non-Accrual Loans
9,946
12,498
13,668
16,271
183
Other Investments
682
Total Non-Performing Assets
10,920
13,365
13,859
21,160
Accruing Loans Past Due 90 Days or More
29
52
2,213
2,243
693
2,272
712
1,310
604
387
698
32
1,417
1,433
1,142
30
57
2,727
2,091
2,033
1,929
Total Accruing Loans Past Due 90 Days or More
4,949
4,363
2,085
2,641
Ratio of Non-Accrual Loans to Total Loans
0.21
0.23
0.28
Ratio of Non-Performing Assets to Total Loans,Foreclosed Real Estate and Other Investments
0.18
0.22
0.37
Ratio of Non-Performing Assets and Accruing LoansPast Due 90 Days or More to Total Loans
0.26
0.29
0.27
0.41
Quarter to Quarter ChangesIn Non-Performing Assets
Balance at Beginning of Quarter
15,977
27,866
Additions
3,088
2,796
5,164
3,909
Reductions
Payments
(5,097)
(2,202)
(6,435)
(4,232)
Return to Accrual
(392)
(698)
(456)
(2,700)
Sales of Foreclosed Assets
(129)
(206)
(147)
Charge-offs/Write-downs
(261)
(185)
(3,536)
Total Reductions
(5,533)
(3,290)
(7,282)
(10,615)
Balance at End of Quarter
Reserve for Credit Losses
The Company’s reserve for credit losses is comprised of two components, which are the Allowance for Loan and Lease Losses (“Allowance”) and the Reserve for Unfunded Commitments (“Unfunded Reserve”). The Unfunded Reserve was reclassified on a prospective basis at December 31, 2004, from the Allowance to other liabilities in the Company’s Consolidated Statements of Condition.
The Company maintains the Allowance at a level adequate to cover management’s estimate of probable credit losses inherent in its lending portfolios. The Unfunded Reserve is maintained at an adequate level to cover management’s estimate of probable credit losses inherent in unfunded commitments to extend credit. The adequacy of the Allowance and the Unfunded Reserve is based on a comprehensive quarterly analysis of historical loss experience, supplemented by judgmental expectations of portfolio performance and economic conditions as of a given balance sheet date.
The Allowance declined by $5.2 million at June 30, 2005 from December 31, 2004 primarily due to net loan charge-offs of $7.4 million. The ratio of the Allowance to loans and leases outstanding was 1.65% at June 30, 2005, a decrease of 13 basis points from December 31, 2004 primarily due to the increase in loans outstanding.
The Unfunded Reserve declined by $2.2 million from December 31, 2004 primarily due to the cancellation of a letter of credit to an air transportation company.
The Allowance and the Unfunded Reserve are both increased and decreased through the Provision. After considering net charge-offs, the changes in the Allowance and the Unfunded Reserve resulted in no Provision being recorded for the six months ended June 30, 2005.
A summary of the reserve for credit losses is presented in Table 17.
Consolidated Reserve for Credit Losses (Unaudited)
Table 17
109,906
127,185
113,596
129,080
Loans Charged-Off
581
3,328
1,155
3,715
574
379
607
67
319
382
464
406
201
291
4,564
9,128
9,219
63
64
Total Loans Charged-Off
5,629
8,828
11,426
14,943
Recoveries on Loans Previously Charged-Off
211
1,245
753
2,199
151
840
435
130
162
189
304
295
598
101
140
120
154
1,166
1,703
2,453
3,366
71
Foreign
6,469
6,545
Total Recoveries on Loans Previously Charged-Off
1,886
10,047
3,993
14,267
Net Loan Recoveries (Charge-Offs)
(3,743)
1,219
(7,433)
(676)
Balance at End of Period 1
106,163
124,904
Components
101,587
Reserve for Unfunded Commitments 2
Total Reserve for Credit Losses
Average Loans Outstanding
Ratio of Net Loan (Recoveries) Charge-Offs to Average Loans Outstanding (annualized)
0.25
(0.08)
0.02
Ratio of Allowance to Loans and Leases Outstanding 2
1 Included in this analysis is activity related to the Company’s reserve for unfunded commitments, which is separately recorded in other liabilities in the Consolidated Statements of Condition.
2 The reclassification of the reserve for unfunded commitments to other liabilities occurred in the fourth quarter of 2004 on a prospective basis. Thus, June 30, 2004 allowance for loan and lease losses and reserve for unfunded commitments were reported together. At June 30, 2004, the reserve for unfunded commitments was $5.4 million.
Market Risk
Market risk is the potential of loss arising from adverse changes in interest rates and prices. The Company is exposed to market risk as a consequence of the normal course of conducting its business activities. Financial products that expose the Company to market risk include investment securities, loans, deposits, debt and derivative financial instruments. The Company’s market risk management process involves measuring, monitoring, controlling and managing risks that 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.”
The Company’s trading activities include foreign currency and foreign exchange contracts that expose the Company to a minor degree of foreign currency risk. These transactions are primarily executed on behalf of customers and at times for the Company’s own account.
The Company’s “other than trading” activities include normal business transactions that expose the Company’s balance sheet profile to varying degrees of market risk.
Interest Rate Risk
The Company’s balance sheet is sensitive to changes in the general level of interest rates. This interest rate risk is a form of market risk and arises primarily from the Company’s normal business activities of making loans and taking deposits. Many other factors also affect the Company’s exposure to changes in interest rates, such as general economic and financial conditions and historical pricing relationships.
Table 18 presents, as of June 30, 2005, December 31, 2004 and June 30, 2004, the estimate of the change in net interest income (“NII”) that would result from a gradual 200 basis point decrease or increase in interest rates, moving in parallel fashion over the entire yield curve, over the next 12-month period, relative to the measured base case scenario for NII. The 200 basis point increase would equate to an average increase of $1.8 million in NII per quarter. The Company’s balance sheet continues to be asset-sensitive based on a parallel increase in rates over the entire yield curve over the next 12-month period.
Market Risk Exposure to Interest Rate Changes (Unaudited)
Table 18
Interest Rate Change
(in basis points)
-200
+200
Estimated Exposure as a Percent of Net Interest Income
(4.7)
(6.5)
(5.0)
Estimated Exposure to Net Interest Income Per Quarter
(4,779)
1,830
(6,347)
1,953
(4,823)
2,701
The Company uses several approaches to manage its interest rate risk in an effort to shift balance sheet mix or alter the interest rate characteristics of its assets and liabilities. These approaches can include changing product pricing strategies, modifying investment portfolio characteristics, or using financial derivative instruments. The use of financial derivatives has been limited over the past several years.
Liquidity Management
Liquidity is managed in an effort to ensure that the Company has continuous access to sufficient, cost effective funding to conduct its business and meet its obligations as they become due in a normal manner.
The Bank is a member of the FHLB, which provides an additional source of short- and long-term funding. Borrowings from the FHLB were $77.5 million at June 30, 2005, compared to $87.5 million at December 31, 2004 and $62.5 million at June 30, 2004. The decrease from December 31, 2004 was due to a $10.0 million advance that matured in the first quarter of 2005.
Additionally, the Bank maintains a $1.0 billion senior and subordinated bank note program. Under this facility, the Bank may issue additional notes provided that the aggregate amount outstanding does not exceed $1.0 billion. Subordinated notes outstanding under this bank note program totaled $124.8 million at June 30, 2005 and December 31, 2004 and $124.7 million at June 30, 2004.
Capital Management
The Company and the Bank are subject to regulatory capital requirements administered by the federal banking agencies. The Company’s objective is to hold sufficient capital on a regulatory basis to exceed the minimum guidelines of a “well capitalized” financial institution, while over the long term optimize shareholder value, support asset growth, provide protection against unforeseen losses and risks inherent in its markets and comply with regulatory requirements.
At June 30, 2005, shareholders’ equity totaled $712.2 million, a 13% decrease from December 31, 2004. The decrease in shareholders’ equity during the first six months of 2005 was primarily attributable to the Company’s repurchase of its common stock under the repurchase program and to dividends paid, partially offset by earnings.
During the six months ended June 30, 2005, 3.7 million shares of common stock were repurchased under the repurchase program at an average cost of $47.41 per share, totaling $173.5 million. From the beginning of the share repurchase program in July 2001 through June 30, 2005, the Company repurchased a total of 38.6 million shares and returned a total of $1.3 billion to its shareholders at an average cost of $32.67 per share. From July 1, 2005 through July 22, 2005, the Company repurchased an additional 75,000 shares of common stock at an average cost of $52.90 per share for a total of $4.0 million, resulting in remaining buyback authority under the share repurchase program of $85.1 million.
In July 2005, the Company’s Board of Directors declared a quarterly cash dividend of $0.33 per share on the Company’s outstanding shares. The dividend will be payable on September 15, 2005 to shareholders of record at the close of business on August 29, 2005.
Table 19 presents the regulatory capital and ratios as of June 30, 2005, December 31, 2004 and June 30, 2004.
Regulatory Capital and Ratios (Unaudited)
Table 19
Regulatory Capital
Add:
8.25% Capital Securities of Bancorp Hawaii Capital Trust I
31,425
Less:
Unrealized Valuation and Other Adjustments
(301)
5,251
(10,776)
Tier 1 Capital
708,936
804,792
705,423
Allowable Reserve for Credit Losses
86,673
83,292
79,889
Qualifying Subordinated Debt
74,870
99,808
99,787
Unrealized Gains on Available for Sale Equity Securities
Total Regulatory Capital
870,495
987,923
885,147
Risk–Weighted Assets
6,915,245
6,633,082
6,346,134
Key Regulatory Capital Ratios
Tier 1 Capital Ratio
10.25
12.13
11.12
Total Capital Ratio
12.59
14.89
13.95
8.29
Financial Outlook
The Company’s earnings estimate of approximately $176.0 million to $179.0 million in net income for the full year of 2005 remains unchanged. The Company performs a quarterly analysis of credit quality to determine the adequacy of the reserve for credit losses. The results of this analysis determine the timing and amount of the Provision. Earnings per share and return on equity projections continue to be dependent upon, among other things, the terms and timing of share repurchases.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Management’s Discussion and Analysis of Financial Condition and Results of Operations-Market Risk.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
The Company’s management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)) as of June 30, 2005. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2005. There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the first six months of 2005 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Changes in Internal Controls over Financial Reporting
None.
Part II. - Other Information
Items 1, 3 and 5 omitted pursuant to instructions.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Period
Total Number ofShares Purchased 1
Average PricePaid Per Share
Total Number of SharesPurchased as Part ofPublicly AnnouncedPlans or Programs
Approximate Dollar Value ofShares that May Yet BePurchased Under the Plans or Programs 2
April 1 - 30, 2005
627,100
45.45
121,411,025
May 1 - 31, 2005
483,968
48.77
475,000
98,242,976
June 1 - 30, 2005
187,559
49.22
186,500
89,063,461
1,298,627
47.23
1,288,600
1 The months of May and June included 8,968 and 1,059 mature shares, respectively, purchased from employees in connection with stock option exercises. These shares were not purchased as part of the publicly announced program. The shares were purchased at the closing price of the Company’s common stock on the dates of purchase.
2 The Company repurchased shares during the second quarter of 2005 pursuant to its ongoing share repurchase program that was first announced in July 2001. As of July 22, 2005, $85.1 million remained of the total $1.35 billion total repurchase amount authorized by the Company’s Board of Directors under the share repurchase program. The program has no set expiration or termination date.
Item 4. Submission of Matters to a Vote of Security Holders
At the annual shareholders meeting held on April 29, 2005, the following matters were submitted to a vote of the shareholders:
a. Election of Directors to the Board of Directors: *
Peter D. Baldwin:
Votes cast for:
45,418,466
Votes withheld:
1,642,067
Michael J. Chun:
46,303,311
757,222
Robert Huret:
46,308,099
752,434
Donald M. Takaki:
45,639,136
1,421,397
b. Approval of Bank of Hawaii Corporation Amended and Restated Director Stock Compensation Plan **
35,517,651
Votes cast against:
2,895,297
Broker non-votes:
7,840,865
Abstentions:
806,720
c. Ratification of Selection of an Independent Registered Public Accounting Firm - Ernst & Young, LLP
45,399,381
1,577,434
83,718
* 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 6. Exhibits
Exhibit Index
Exhibit Number
10.1
Bank of Hawaii Corporation Amended and Restated Director Stock Compensation Plan - Restricted Stock Agreement for April 29, 2005 Grant
10.2
Bank of Hawaii Corporation Amended and Restated Director Stock Compensation Plan - Stock Option Agreement for April 29, 2005 Grant
Statement Regarding Computation of Ratios
31.1
Rule 13a-14(a) Certifications
31.2
Section 1350 Certification, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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 27, 2005
By:
/s/ Allan R. Landon
Allan R. Landon
Chairman of the Board,
Chief Executive Officer and President
/s/ Richard C. Keene
Richard C. Keene
Chief Financial Officer
EXHIBIT INDEX
38