UNITED STATESSECURITIES 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 September 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, $.01 Par Value; outstanding at October 22, 2004 – 52,968,560 shares
Bank of Hawaii Corporation
Form 10-Q
INDEX
Page
Part I. - Financial Information
Item 1.
Financial Statements (Unaudited)
Consolidated Statements of Income - Three and Nine months ended September 30, 2004 and 2003
3
Consolidated Statements of Condition - September 30, 2004, December 31, 2003, and September 30, 2003
4
Consolidated Statements of Shareholders’ Equity - Nine months ended September 30, 2004 and 2003
5
Consolidated Statements of Cash Flows - Nine months ended September 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
Part II. - Other Information
Unregistered Sales of Equity Securities and Use of Proceeds
33
Item 5.
Other Information
Item 6.
Exhibits
34
Signatures
35
2
Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Income (Unaudited)
Three Months EndedSeptember 30,
Nine Months EndedSeptember 30,
(dollars in thousands except per share amounts)
2004
2003
Interest Income
Interest and Fees on Loans and Leases
$
82,079
82,715
243,853
254,442
Income on Investment Securities - Available for Sale
24,543
16,483
67,134
58,761
Income on Investment Securities - Held to Maturity
6,370
6,407
20,057
11,773
Deposits
496
1,179
3,373
3,647
Funds Sold
108
248
702
1,834
Other
801
1,032
2,524
3,237
Total Interest Income
114,397
108,064
337,643
333,694
Interest Expense
8,990
10,284
26,750
38,040
Securities Sold Under Agreements to Repurchase
2,085
1,947
6,233
6,580
Funds Purchased
683
271
1,420
695
Short-Term Borrowings
15
26
43
75
Long-Term Debt
3,845
4,431
12,538
15,714
Total Interest Expense
15,618
16,959
46,984
61,104
Net Interest Income
98,779
91,105
290,659
272,590
Provision for Loan and Lease Losses
—
(3,500)
Net Interest Income After Provision for Loan and Lease Losses
294,159
Non-Interest Income
Trust and Asset Management
12,672
12,511
39,531
38,237
Mortgage Banking
1,711
5,888
6,496
12,232
Service Charges on Deposit Accounts
9,472
8,901
28,962
26,496
Fees, Exchange, and Other Service Charges
13,741
16,034
41,223
42,496
Investment Securities Gains (Losses)
639
(37)
1,809
Insurance
3,560
3,988
10,506
10,083
11,898
5,830
30,063
17,930
Total Non-Interest Income
53,054
53,791
156,744
149,283
Non-Interest Expense
Salaries and Benefits
46,566
45,731
139,256
139,871
Net Occupancy Expense
9,812
9,806
28,741
29,047
Net Equipment Expense
5,847
7,301
17,610
26,257
Information Technology Systems Replacement Project
4,349
21,871
21,965
21,690
66,730
57,425
Total Non-Interest Expense
84,190
88,877
252,337
274,471
Income Before Income Taxes
67,643
56,019
198,566
147,402
Provision for Income Taxes
24,576
19,332
71,468
50,880
Net Income
43,067
36,687
127,098
96,522
Basic Earnings Per Share
0.82
0.64
2.40
1.63
Diluted Earnings Per Share
0.78
0.61
2.26
1.56
Dividends Declared Per Share
0.30
0.19
0.90
0.57
Basic Weighted Average Shares
52,390,081
57,195,570
53,053,770
59,337,319
Diluted Weighted Average Shares
55,472,868
59,961,823
56,297,277
61,911,794
Bank of Hawaii Corporation and SubsidiariesConsolidated Statements of Condition
(dollars in thousands)
September 30,2004
December 31,2003
September 30,2003
(Unaudited)
Assets
Interest-Bearing Deposits
29,976
154,735
208,712
Investment Securities - Available for Sale
2,328,327
1,991,116
2,027,062
Investment Securities - Held to Maturity(Market Value of $624,587, $720,699, and $749,036)
630,276
727,233
754,659
25,000
Loans Held for Sale
18,595
9,211
23,144
Loans and Leases
5,815,575
5,757,175
5,570,405
Allowance for Loan and Lease Losses
(124,651)
(129,080)
(132,675)
Net Loans
5,690,924
5,628,095
5,437,730
Total Earning Assets
8,723,098
8,510,390
8,451,307
Cash and Non-Interest-Bearing Deposits
290,974
363,495
329,705
Premises and Equipment
149,698
160,005
163,277
Customers’ Acceptance Liability
920
1,707
1,077
Accrued Interest Receivable
36,074
32,672
33,210
Foreclosed Real Estate
208
4,377
8,757
Mortgage Servicing Rights
19,995
22,178
23,266
Goodwill
36,216
Other Assets
337,626
330,607
323,940
Total Assets
9,594,809
9,461,647
9,370,755
Liabilities
Non-Interest-Bearing Demand
1,898,602
1,933,928
1,846,030
Interest-Bearing Demand
1,471,836
1,356,330
1,269,227
Savings
2,991,386
2,833,379
2,760,418
Time
1,051,416
1,209,142
1,226,441
Total Deposits
7,413,240
7,332,779
7,102,116
682,630
472,757
646,890
69,755
109,090
90,520
11,939
12,690
14,796
Banker’s Acceptances Outstanding
Retirement Benefits Payable
62,976
61,841
63,281
Accrued Interest Payable
6,162
7,483
7,207
Taxes Payable and Deferred Taxes
249,265
207,101
195,628
Other Liabilities
88,596
138,999
101,179
252,619
324,068
324,301
Total Liabilities
8,838,102
8,668,515
8,546,995
Shareholders’ Equity
Common Stock ($.01 par value); authorized 500,000,000 shares;issued / outstanding: September 2004 - 81,710,695 / 53,021,591,December 2003 - 81,647,729 / 54,928,480,September 2003 - 81,568,791 / 55,985,364
813
807
Capital Surplus
413,696
391,701
385,694
Accumulated Other Comprehensive Income (Loss)
(5,698)
(5,711)
(2,799)
Retained Earnings
1,277,615
1,199,077
1,177,459
Deferred Stock Grants
(9,490)
(8,309)
(7,466)
Treasury Stock, at Cost (Shares: September 2004 - 28,689,104,December 2003 - 26,719,249, September 2003 - 25,583,427)
(920,229)
(784,433)
(729,935)
Total Shareholders’ Equity
756,707
793,132
823,760
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
13
Total Comprehensive Income
127,111
Common Stock Issued under Stock Plans and Related Tax Benefits (2,305,545 shares)
71,984
21,995
(434)
(1,181)
51,598
Treasury Stock Purchased (4,209,363 shares)
(187,394)
Cash Dividends Paid
(48,126)
Balance at September 30, 2004
Balance at December 31, 2002
1,015,759
806
372,192
11,659
1,115,910
(1,424)
(483,384)
(14,458)
82,064
Common Stock Issued under Stock Plans and Related Tax Benefits (1,143,267 shares)
25,491
1
13,502
(1,154)
(6,042)
19,184
Treasury Stock Purchased (8,166,579 shares)
(265,735)
(33,819)
Balance at September 30, 2003
Consolidated Statements of Cash Flows (Unaudited)
Operating Activities
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Depreciation and Amortization
15,688
23,405
Amortization of Deferred Loan and Lease Fees
(1,794)
(5,244)
Amortization and Accretion of Investment Securities
9,803
28,800
3,767
4,145
Deferred Income Taxes
14,001
16,844
Net (Gain) Loss on Investment Securities
37
(1,809)
Proceeds from Sales of Loans Held for Sale
308,485
635,163
Originations of Loans Held for Sale
(317,869)
(618,189)
Net Change in Other Assets and Liabilities
(15,919)
25,045
Net Cash Provided by Operating Activities
139,797
204,682
Investing Activities
Proceeds from Sales and Redemptions of Investment Securities Available for Sale
473,386
1,602,336
Purchases of Investment Securities Available for Sale
(818,969)
(1,391,205)
Proceeds from Redemptions of Investment Securities Held to Maturity
165,749
159,799
Purchases of Investment Securities Held to Maturity
(70,238)
(685,325)
Net Increase in Loans and Leases
(57,535)
(216,335)
Premises and Equipment, Net
(1,382)
(9,713)
Net Cash Used by Investing Activities
(308,989)
(540,443)
Financing Activities
Net Increase in Demand Deposits
80,180
223,792
Net Increase in Savings Deposits
158,007
225,199
Net Decrease in Time Deposits
(157,726)
(267,036)
Proceeds from Long-Term Debt
50,000
Repayments of Long-Term Debt
(96,449)
(115,484)
Net Increase (Decrease) in Short-Term Borrowings
169,787
(81,302)
Proceeds from Issuance of Common Stock
53,633
19,233
Repurchase of Common Stock
Cash Dividends
Net Cash Used by Financing Activities
(3,088)
(245,152)
Decrease in Cash and Cash Equivalents
(172,280)
(580,913)
Cash and Cash Equivalents at Beginning of Period
518,230
1,119,330
Cash and Cash Equivalents at End of Period
345,950
538,417
Non-Cash Investing Activity
In September 2004, the Company transferred a $4.0 million foreclosed real estate property to premises.
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”). 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 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 nine months ended September 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:
(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
490
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
(3,856)
(8,176)
Pro Forma Net Income 1
123,242
88,836
Earnings Per Share:
Basic-as reported
Basic-pro forma 1
2.32
1.50
Diluted-as reported
Diluted-pro forma 1
2.19
1.43
Weighted Average Fair Value of Options Granted During the Year 1
8.58
Assumptions:
Average Risk Free Interest Rate
4.25%
3.92%
Average Expected Volatility
32.32%
31.97%
Expected Dividend Yield
2.24%
3.07%
Expected Life
6.0 years
6.37 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:
Nine Months Ended September 30,
Defined Pension Benefits
Postretirement Benefits
Components of Net Periodic Benefit Cost:
Service Cost
741
930
Interest Cost
3,275
3,204
1,329
1,542
Expected Return on Plan Assets
(3,546)
(3,486)
Amortization of Unrecognized Net Transition Obligation
441
489
Actuarial (Gain) Loss
984
711
(468)
(198)
Total Components of Net Periodic Benefit Cost
713
429
2,043
2,763
There were no significant changes from the previously reported $1.8 million in contributions expected to be paid during 2004.
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.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
This report, including its Earnings Outlook, contains forward-looking statements concerning, among other things, the economic environment in the Company’s service area, the expected level of loan and lease 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 expects accelerated growth through improved customer service levels and 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 is working more closely with the others to improve the breadth of customer relationships. In developing the management team, the Company is assessing leadership talent, building leadership capabilities and maintaining a comprehensive succession plan. To improve efficiency, the Company is identifying opportunities and implementing changes that lower costs without negatively impacting customer service. In maintaining a discipline of dependable risk and capital management, the Company continually 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.
Allan R. Landon succeeded Michael E. O’Neill as Chairman and Chief Executive Officer of Bank of Hawaii Corporation and its principal subsidiary, Bank of Hawaii, on September 1, 2004. Mr. Landon, the company’s eighth chairman, will retain the title of President.
The Company utilizes various financial measures to evaluate its performance 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. Operating income is defined as income before provision for loan and lease losses and income taxes. Management also uses net income after capital charge as a key measure of the value the Company is creating for its shareholders. In evaluating the effectiveness of credit risk management, 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 (annualized) and the ratio of non-performing assets to total loans and foreclosed real estate.
For the third quarter of 2004, the Company’s diluted earnings per share was $0.78, an increase of $0.17 or 28% from diluted earnings per share of $0.61 for the third quarter of 2003. Net income for the third quarter of 2004 was $43.1 million, an increase of $6.4 million or 17% from net income of $36.7 million reported in the same prior year quarter.
For the nine months ended September 30, 2004, net income was $127.1 million, an increase of $30.6 million or 32% from the same prior year period. Diluted earnings per share were $2.26 for the first nine months of 2004, an increase of 45% from diluted earnings per share of $1.56 for the first nine months of 2003. The year-to-date return on average assets was 1.74%, an increase from 1.37% from the same period in 2003. The year-to-date return on average equity was 22.48%, an increase from 13.95% from the same period in 2003. For the nine months ended September 30, 2004 net income after capital charge was $50.7 million, compared to $8.7 million for the same prior year period. For additional information on net income after capital charge, refer to the section on “Business Segments.” Operating leverage for the first nine months of 2004 was 32.3% and the efficiency ratio was 56.4%.
Factors that had an impact on the comparability of year-to-year results include the effect of a negative provision for loan and lease losses that was recorded in the second quarter of 2004, non-core transactions and the Company’s ongoing stock repurchase program. Non-core transactions in the third quarter of 2004 included non-interest income of $5.2 million from a gain on the sale of assets at the end of a leveraged lease transaction. 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. Non-core transactions in the second quarter of 2004 included non-interest expense of $2.2 million related primarily to a legal settlement. The Company does not expect items such as these in the fourth quarter of 2004. Results for the third 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.”
10
Table 1 presents the Company’s financial highlights and performance ratios for the three and nine months ended September 30, 2004 and 2003.
Highlights (Unaudited)
Table 1
Earnings Highlights and Performance Ratios
15,904
10,887
48,126
33,819
Net Income to Average Total Assets (ROA)
1.77%
1.53%
1.74%
1.37%
Net Income to Average Shareholders’ Equity (ROE)
23.42%
16.69%
22.48%
13.95%
Net Interest Margin
4.39%
4.15%
4.29%
4.19%
Efficiency Ratio 1
55.45%
61.34%
56.40%
65.06%
Efficiency Ratio excluding System Replacement Costs
58.34%
59.88%
September 30,
Statement of Condition Highlights and Performance Ratios
Book Value Per Common Share
14.27
14.71
Allowance / Loans and Leases Outstanding
2.14%
2.38%
Average Equity / Average Assets
7.75%
9.82%
Employees (FTE)
2,655
2,764
Branches and offices
88
89
Market Price Per Share of Common Stock for the Quarter Ended:
Closing
47.25
33.58
High
48.07
35.55
Low
43.55
32.92
1 The efficiency ratio is defined as non-interest expense divided by total revenue (net interest income and non-interest income).
11
ANALYSIS OF STATEMENT OF INCOME
Net interest income on a taxable equivalent basis for the three and nine month periods ended September 30, 2004 increased from the comparable periods in 2003 by $7.7 million or 8% and $18.1 million or 7%, respectively. The increase in net interest income for the third quarter of 2004 from the third quarter of 2003 was the result of an increase in interest income from higher average balances of investments available for sale, installment and home equity loans. Offsetting this increase was a reduction in interest income from residential mortgage loans due to the lower interest rate environment. The increase in net interest income for the first nine months of 2004 from the same period in 2003 was primarily due to an increase in interest income from the investment portfolio resulting from higher yields on the available for sale portfolio and higher average balances of securities held to maturity. In addition, interest expense on deposits declined due to lower interest rates paid on savings and time deposits. Offsetting these positive factors was lower interest income from residential mortgages, due to the lower interest rate environment.
The net interest margin was 4.39% for the three months ended September 30, 2004, a 24 basis point increase from the comparable period in 2003. The improvement in the margin was attributable to an improvement in the yield on earning assets and lower average rates paid on interest-bearing deposits, partially offset by an increase in rates on other funding sources. The yield on earning assets increased 17 basis points quarter-to-quarter, led by an increase of 114 basis points in the yield on the investment portfolio, primarily consisting of mortgage-backed securities. In the third quarter of 2003, the yield on mortgage-backed securities was lower due to high levels of loan prepayments resulting from the declining interest rate environment. Offsetting the increased yield from investment securities was a decline in the average yield on the loans and leases outstanding of 26 basis points. This decline was primarily attributable to the lower interest rate environment which had a negative impact on the yield earned on residential mortgage loans. The rate on short-term borrowings increased, which was consistent with the Federal Reserve’s recent rate increases, while the average rate on long-term debt increased due to the maturity of $90.0 million in lower cost debt in the beginning of the third quarter 2004.
The net interest margin increased 10 basis points in the first nine months of 2004 compared to the same prior year period. The average rate paid on interest-bearing deposits declined by 31 basis points during this period in 2004 relative to 2003. Consistent with the increase in the three-month period, the yield on investment securities increased for the nine months ended September 30, 2004. This increase was partially offset by a decline in the average yield on loans and leases. This decline was primarily attributable to the lower interest rate environment which had a negative impact on the yield earned on residential mortgage loans. In addition, the Company offered a low initial introductory rate for the first six months on its installment loan portfolio.
Average earning assets for the first nine months of 2004 increased $355.9 million or 4% from the same period in 2003 mainly due to a $261.9 million increase in average loans and leases outstanding. The increase was primarily attributable to increases in installment and home equity loans, which increased 26%. For the first nine months of 2004, average interest-bearing liabilities increased $273.0 million or 4% from 2003, largely due to an increase in interest-bearing transactional deposit balances and securities repurchase agreements, offset by decreases in time deposits and long-term debt.
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.
12
Consolidated Average Balances and Interest Rates - Taxable Equivalent Basis (Unaudited)
Table 2
Three Months EndedSeptember 30, 2004
Three Months EndedSeptember 30, 2003
Nine Months EndedSeptember 30, 2004
Nine Months EndedSeptember 30, 2003
(dollars in millions)
AverageBalance
Income/Expense
Yield/Rate
Earning Assets
82.6
0.5
2.39%
224.7
1.2
2.08%
246.4
3.4
1.83%
230.2
3.7
2.12%
28.6
0.1
1.51
102.4
0.3
0.97
89.4
0.7
1.05
206.2
1.8
1.19
Investment Securities
Available for Sale
2,325.5
24.6
4.23
2,090.6
16.5
3.16
2,154.9
67.2
4.16
2,224.5
58.9
3.53
Held to Maturity
659.0
6.3
3.87
675.1
6.4
3.80
696.1
20.1
3.84
402.4
11.8
3.90
11.3
0.2
5.74
52.2
5.45
15.8
5.53
48.1
1.9
5.40
Commercial and Industrial
796.2
10.6
5.34
862.4
10.8
4.95
822.8
31.0
5.04
861.0
31.3
4.86
Construction
81.1
1.0
5.01
87.8
0.9
4.26
93.9
3.0
4.33
95.3
3.3
4.65
Commercial Mortgage
658.9
8.8
5.29
670.6
9.4
5.56
644.0
25.9
5.38
650.6
5.87
Residential Mortgage
2,282.6
32.1
5.62
2,298.8
36.2
6.30
2,293.9
97.6
5.67
2,281.1
111.2
6.50
Installment
722.7
15.2
8.38
558.6
12.8
9.09
691.5
44.1
8.51
532.2
39.2
9.85
Home Equity
583.7
7.1
4.83
448.1
5.6
4.99
536.0
19.0
4.74
441.8
16.9
5.11
Purchased Home Equity
155.2
1.7
4.29
132.6
2.20
179.5
6.2
4.59
158.2
5.3
4.51
Lease Financing
516.0
5.4
4.17
487.2
4.52
509.0
16.4
488.5
16.7
4.58
Total Loans and Leases
5,796.4
81.9
5.63
5,546.1
82.0
5.89
5,770.6
243.2
5,508.7
252.5
6.12
78.7
0.8
4.05
76.1
78.1
2.5
4.32
75.3
3.2
5.75
8,982.1
114.4
5.08
8,767.2
108.1
4.91
9,051.3
337.8
4.98
8,695.4
333.8
5.12
316.9
333.2
330.1
369.5
399.2
378.1
392.3
9,668.5
9,499.6
9,746.3
9,417.8
Interest-Bearing Liabilities
Demand
1,471.0
0.24
1,245.8
0.15
1,410.6
1,189.4
0.22
2,998.4
0.43
2,754.6
0.49
2,927.5
9.6
0.44
2,702.8
12.5
0.62
1,078.4
4.9
1.81
1,285.7
1.97
1,132.0
15.3
1.79
1,394.3
23.6
2.27
Total Interest-Bearing Deposits
5,547.8
9.0
5,286.1
10.3
0.77
5,470.1
26.8
0.65
5,286.5
38.0
0.96
816.9
2.8
1.36
827.8
2.3
1.08
920.2
7.7
1.12
763.3
7.4
1.29
246.8
3.8
6.22
325.7
4.4
5.43
294.8
362.3
15.7
5.79
Total Interest-Bearing Liabilities
6,611.5
15.6
0.94
6,439.6
17.0
6,685.1
47.0
6,412.1
61.1
1.27
98.8
91.1
290.8
272.7
Interest Rate Spread
4.14%
3.86%
4.04%
3.85%
Non-Interest-Bearing Demand Deposits
1,932.0
1,844.0
1,920.6
1,726.0
393.4
344.1
385.5
354.4
731.6
871.9
755.1
925.3
Analysis of Change in Net Interest Income - Taxable Equivalent Basis (Unaudited)
Table 3
Nine Months Ended September 30, 2004 Compared to September 30, 2003
Volume1
Rate 1
Change in Interest Income:
(0.5)
(0.3)
(0.9)
(0.2)
(1.1)
(1.9)
10.2
8.3
8.5
(1.3)
(1.2)
(1.5)
(0.1)
(0.4)
(2.3)
(2.7)
0.6
(14.2)
(13.6)
10.7
(5.8)
2.1
14.3
(23.6)
(9.3)
(0.8)
(0.7)
Total Change in Interest Income
(15.0)
4.0
Change in Interest Expense:
(3.9)
(2.9)
(4.4)
(8.3)
(2.6)
(8.6)
(11.2)
1.4
(3.2)
Total Change in Interest Expense
(4.1)
(10.0)
(14.1)
Change in Net Interest Income
23.1
(5.0)
18.1
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.
14
No Provision for Loan and Lease Losses (“Provision”) was recorded for the three months ended September 30, 2004. This resulted in a third quarter reduction in the Allowance for Loan and Lease Losses (the “Allowance”) of $0.3 million, which was equal to the amount of net charge-offs. For further information on Allowance, refer to “Corporate Risk Profile - Allowance for Loan and Lease Losses.”
For the nine months ended September 30, 2004, a negative Provision of $3.5 million was recorded in the second quarter of 2004 as a result of improvement in credit quality and ongoing assessments of economic conditions and risk. The combination of the negative Provision and year-to-date net charge-offs of $0.9 million resulted in a year-to-date reduction in the Allowance of $4.4 million.
For further information on Credit Quality, refer to the section entitled “Corporate Risk Profile.”
Non-interest income decreased $0.7 million or 1% for the third quarter of 2004, but increased $7.5 million or 5% for the nine months ended September 30, 2004, from the comparable periods in 2003.
Trust and asset management income increased $1.3 million or 3% during the first nine months of 2004 compared to the same period in 2003. 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 higher investment advisory fees on money market assets from increased short-term interest rates.
Mortgage banking income decreased $4.2 million or 71% and $5.7 million or 47% for the three and nine months ended September 30, 2004, respectively, compared to the same periods in 2003. Mortgage banking income is sensitive to the interest rate environment and conditions in the real estate market. The declines primarily resulted from lower gains on the sale of mortgage loans in 2004, which were attributable to lower loan production. Mortgage loan production decreased 72% and 56% for the three and nine months ended September 30, 2004, respectively, compared to the same prior year periods due to the lower interest rate environment in 2003, which resulted in high refinancing activity. 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 $0.6 million or 6% and $2.5 million or 9% for the three and nine months ended September 30, 2004, respectively, compared to the same prior year periods. The increases were largely due to higher account analysis fees resulting from lower offsetting earnings credits. On a year-to-year comparison, overdraft fees also increased due to an increase in the number of transactional deposit accounts.
Fees, exchange, and other service charges decreased $2.3 million or 14% and $1.3 million or 3% for the three and nine months ended September 30, 2004, respectively, compared to the same periods in 2003. The third quarter of 2003 included a $3.1 million prepayment fee on a commercial real estate loan. Excluding the prepayment fee, income remained relatively flat in the third quarter of 2004 compared to the same period in 2003 and on a year-to-year basis increased $1.8 million due primarily to increased foreign exchange income and merchant transaction and card fees as a result of higher merchant sales volume.
Other non-interest income increased $6.1 million or 104% and $12.1 million or 68% for the three and nine months ended September 30, 2004, respectively, over the same periods in 2003. The quarter-to-quarter increase was attributable to a $5.2 million gain on the sale of assets at the end of a leveraged lease transaction. In addition to the gain, the increase for the first nine months of 2004 from the prior year was due to a $3.2 million distribution from a leasing partnership investment and a $2.5 million gain on the sale of a parcel of land in the second quarter of 2004.
Non-interest expense decreased $4.7 million or 5% and $22.1 million or 8% for the three and nine months ended September 30, 2004, respectively, compared to the same prior year periods. Included in non-interest expense in the third quarter and first nine months of 2003 were systems replacement costs of $4.3 million and $21.9 million, respectively. Excluding such systems replacement costs, total non-interest expense in 2004 was unchanged 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 $0.6 million for the first nine months of 2004 compared to the same period in 2003. Base salaries decreased $3.5 million or 4% from 2003 as a result of a 4% decrease in the number of employees. Also contributing to the decline were reductions in commission expense due to lower mortgage loan originations. Partially offsetting the decrease was the expense for restricted stock units.
Table 4 presents the components of salaries and benefits expense for the three and nine months ended September 30, 2004 and 2003.
Salaries and Benefits (Unaudited)
Table 4
Salaries
27,796
28,107
82,904
86,404
Incentive Compensation
4,383
4,033
11,459
10,617
2,671
763
8,800
4,087
Commission Expense
1,780
3,552
5,691
8,964
Retirement and Other Benefits
4,099
4,929
12,670
13,471
Payroll Taxes
2,415
2,288
8,948
8,445
Medical, Dental, and Life Insurance
2,064
1,641
6,304
5,390
Separation Expense
1,358
418
2,480
2,493
Total Salaries and Benefits
Net equipment expense declined $1.5 million or 20% and $8.6 million or 33% for the three and nine months ended September 30, 2004 compared to the same prior year periods. The decreases were mainly due to reduced depreciation expense and software license fees resulting from the systems replacement project.
Other non-interest expense increased $9.3 million or 16% for the first nine months of 2004 compared to the same period in 2003. As a result of the systems replacement project outsourcing, expense for technology services increased by $3.3 million for the first nine months of 2004. The increase in other non-interest expense was also due to a $2.2 million reserve recorded in the second quarter of 2004 related primarily to a legal settlement, as well as increased advertising cost and expenses 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 $55.0 million at September 30, 2004, a decrease of $99.8 million and $153.7 million from December 31, 2003 and September 30, 2003, respectively. The declines from 2003 were mainly due to the use of funds to reduce long term-debt, deploy into longer term assets and repurchase the Company’s stock.
16
Investment securities totaled $3.0 billion at September 30, 2004, a $240.3 million increase from December 31, 2003 as a portion of excess liquidity was deployed into investment securities. At September 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 September 30, 2004 totaled $16.2 million or one percent of the total investment securities book value, compared to $16.6 million at December 31, 2003. The improvement, which was primarily related to mortgage-backed securities, was due to the change in the securities portfolio mix in which purchased securities yielded higher interest rates than those that have matured. The Company has both the intent and ability to hold the securities for the time necessary to recover the amortized cost. As of September 30, 2004, no investment security had been impaired for more than 12 months.
Table 5 presents the detail of the investment securities portfolio at September 30, 2004 and December 31, 2003.
Investment Securities (Unaudited)
Table 5
AmortizedCost
FairValue
At September 30, 2004
Securities Available for Sale:
Equity Securities
Debt Securities Issued by the U.S. Treasury and Agencies
58,795
59,560
Debt Securities Issued by States and Municipalities
7,587
7,785
Mortgage-Backed Securities
1,906,531
1,918,469
Other Debt Securities
338,562
342,508
2,311,480
Securities Held to Maturity:
90
97
630,186
624,490
624,587
At December 31, 2003
261
59,339
60,990
5,957
6,220
1,790,692
1,805,273
118,040
118,372
1,974,289
22,021
22,018
130
142
705,082
698,539
720,699
Loans held for sale, consisting of residential mortgage loans, totaled $18.6 million at September 30, 2004, $9.2 million at December 31, 2003 and $23.1 million at September 30, 2003. The changes in 2004 as compared to both periods in 2003 were a result of the impact of mortgage loan sales activity and production volume.
17
As of September 30, 2004, loans and leases outstanding were $5.8 billion, relatively unchanged compared to December 31, 2003 and an increase of $245.2 million from September30, 2003. Growth has continued in the consumer loan portfolios due to increased branch sales activities and higher utilization of home equity lines of credit. Although loan originations in the commercial portfolio have been strong, commercial loan balances were impacted by loan pay-offs from large corporate borrowers. Table 6 presents the composition of the loan portfolio by major categories and Table 7 presents the composition of consumer loans by geographic area.
Loan Portfolio Balances (Unaudited)
Table 6
June 30,2004
Domestic Loans
Commercial
755,455
776,815
816,246
843,895
648,991
643,382
639,354
629,225
104,709
98,916
101,321
92,343
447,005
447,673
435,934
426,839
Total Commercial
1,956,160
1,966,786
1,992,855
1,992,302
Consumer
2,261,814
2,257,624
2,320,410
2,329,321
609,981
559,225
467,019
446,032
143,300
162,730
212,514
109,814
Other Consumer
729,747
721,386
658,831
582,934
33,796
34,676
35,320
35,347
Total Consumer
3,778,638
3,735,641
3,694,094
3,503,448
Total Domestic Loans
5,734,798
5,702,427
5,686,949
5,495,750
Foreign Loans
80,777
84,887
70,226
74,655
5,787,314
Consumer Loans by Geographic Area (Unaudited)
Table 7
December 31,2003 1
September 30,2003 1
Hawaii
2,047,744
2,042,079
2,106,456
2,115,424
600,413
551,099
458,425
437,128
593,859
589,671
550,411
492,421
Guam
208,434
209,972
208,339
208,805
8,131
8,067
8,594
8,904
92,124
87,963
68,999
55,700
U.S. Mainland
Other Pacific Islands
5,636
5,573
5,615
5,092
1,437
59
77,560
78,428
74,741
70,160
Total Consumer Loans
1 Certain 2003 information has been reclassified to conform to 2004 presentation.
18
As of September 30, 2004, the Company’s portfolio of residential loans serviced for third parties totaled $2.7 billion, a decrease of $267.7 million and $419.2 million from December 31, 2003 and September 30, 2003, respectively. The carrying value of mortgage servicing rights was $20.0 million at September 30, 2004, a decrease of $2.2 million and $3.3 million from December 31, 2003 and September 30, 2003, respectively. Although mortgage prepayments have slowed from 2003, the decline in carrying value of mortgage servicing rights continued to be attributable to mortgage prepayments reflective of the low interest rate environment and decline in saleable production volume. Depending on loan type, recent prepayment speeds for Hawaii mortgages either approximated or were slightly higher than national averages.
As of September 30, 2004, deposits totaled $7.4 billion, an increase of $80.5 million from December 31, 2003 and $311.1 million from September 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
Nine Months Ended
September 30, 2004
December 31, 2003
September 30, 2003
Average Time Deposits
543,065
633,602
642,294
573,643
706,235
Short-Term Borrowings and Long-Term Debt
Short-term borrowings, including securities sold under agreements to repurchase, funds purchased and other short-term borrowings, totaled $764.3 million at September 30, 2004, an increase of $169.8 million from December 31, 2003 and flat with September 30, 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. Long-term debt, totaled $252.6 million at September 30, 2004, a decrease of $71.4 million and $71.7 million from December 31, 2003 and September 30, 2003, respectively. The decrease was due to a total of $90.0 million of privately placed notes that matured in 2004, $70.0 million of which matured in the third quarter of 2004. A portion was replaced with a $25.0 million Federal Home Loan Bank (the “FHLB”) advance. For additional information, refer to the section on “Corporate Risk Profile – Liquidity Management.”
The Company’s capital position remains strong. The 5% net reduction in capital from December 31, 2003 to September 30, 2004 is attributable to the Company’s continuing common stock repurchase program and dividends offset by earnings for the first nine 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 $130.9 million at September 30, 2004, an increase of $18.9 million and $23.0 million from December 31, 2003 and September 30, 2003, respectively.
19
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 that 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 nine months ended September 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.
Allocated net income, NIACC and RAROC for the Retail Banking segment decreased for the three and nine months ended September 30, 2004 as compared to the same periods in 2003. Net interest income declined 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. Non-interest income was lower mainly as a result of a decrease in mortgage banking income. The decrease in non-interest expense for the three months ended September 30, 2004 as compared to the same period in 2003 was mainly due to lower salary expense. The decrease in non-interest expense for the nine months ended September 30, 2004 as compared to the same prior year period was largely due to lower equipment expenses and no systems replacement costs. The increase in the economic provision was due to growth in the segment’s automobile and installment loan portfolios.
20
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 13 branches in the Pacific Islands.
The improvement in the segment’s financial measures for the three and nine months ended September 30, 2004 compared to the same periods in 2003 was primarily a result of an increase in non-interest income resulting from a gain on the sale of assets at the end of a leveraged lease transaction. In addition, the nine-month period benefited from higher account analysis fees as a result of lower offsetting earnings credit and a leasing partnership investment distribution. These positive trends were offset by the decline in net interest income due to the decrease in the earnings credit from funds transfer pricing on the segment’s deposit account balances reflective of lower interest rates.
For the nine months ended September 30, 2004 compared to the same prior year period, non-interest expense declined largely 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 decreased for the three and nine months ended September 30, 2004 compared to the same periods in 2003. In the third quarter of 2004, net interest income increased primarily due to higher deposit balances. For the three and nine months ended September 30, 2004 compared to the same periods in 2003, non-interest income increased because 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. These positive trends were offset by increases in both direct and allocated non-interest expense. The increase in non-interest expense was primarily due to increased professional fees relating to the Company’s mutual funds.
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.
21
This segment also includes divisions (Technology, Operations, Human Resources, Finance, Credit and Risk Management and Corporate and Regulatory Administration) that provide a wide-range of support 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 and nine months ended September 30, 2004, compared to the same periods in 2003, was primarily due to an increase in net 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. 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.
22
Business Segment Selected Financial Information (Unaudited)
Table 9a
RetailBanking
CommercialBanking
InvestmentServicesGroup
Treasuryand OtherCorporate
ConsolidatedTotal
Three Months Ended September 30, 2004
51,347
33,978
2,893
10,561
2,121
(847)
(1)
(1,273)
49,226
34,825
2,894
11,834
22,430
15,399
12,762
2,463
71,656
50,224
15,656
14,297
151,833
(43,605)
(23,092)
(13,559)
(3,934)
(84,190)
28,051
27,132
2,097
10,363
(10,379)
(10,062)
(776)
(3,359)
(24,576)
Allocated Net Income
17,672
17,070
1,321
7,004
Allowance Funding Value
(166)
(621)
(6)
793
GAAP Provision
Economic Provision
(3,584)
(2,467)
(86)
(6,138)
Tax Effect of Adjustments
602
1,456
179
2,271
Income Before Capital Charge
16,645
14,591
1,262
6,702
39,200
Capital Charge
(5,441)
(4,828)
(1,339)
(8,516)
(20,124)
Net Income (Loss) After Capital Charge (NIACC)
11,204
9,763
(77)
(1,814)
19,076
RAROC (ROE for the Company)
33%
10%
20%
23%
Total Assets at September 30, 2004
3,711,048
2,295,916
124,929
3,462,916
Three Months Ended September 30, 2003 1
53,167
34,126
2,672
1,140
2,451
3,549
(5)
(5,995)
50,716
30,577
2,677
7,135
25,629
12,656
12,196
3,310
76,345
43,233
14,873
10,445
144,896
(36)
(4,313)
(4,349)
(47,267)
(22,966)
(12,083)
(2,212)
(84,528)
29,042
20,267
2,790
3,920
(10,746)
(7,366)
(1,032)
(188)
(19,332)
18,296
12,901
1,758
3,732
(152)
(940)
(7)
1,099
(3,014)
(3,147)
(98)
(12)
(6,271)
264
199
41
1,817
2,321
17,845
12,562
1,689
641
32,737
(5,797)
(5,657)
(1,238)
(11,272)
(23,964)
12,048
6,905
451
(10,631)
8,773
34%
24%
15%
2%
17%
Total Assets at September 30, 2003
3,512,927
2,257,905
111,474
3,488,449
23
Table 9b
Investment ServicesGroup
Treasury and OtherCorporate
Nine Months Ended September 30, 2004
151,155
101,648
8,572
29,284
7,455
1,630
47
(12,632)
143,700
100,018
8,525
41,916
67,833
38,060
40,101
10,750
211,533
138,078
48,626
52,666
450,903
(131,382)
(69,339)
(39,641)
(11,975)
(252,337)
80,151
68,739
8,985
40,691
(29,656)
(25,436)
(3,324)
(13,052)
(71,468)
50,495
43,303
5,661
27,639
(442)
(2,045)
(20)
2,507
(10,489)
(8,065)
(279)
(18,839)
1,286
3,138
93
3,749
8,266
48,305
37,961
5,502
21,257
113,025
(16,696)
(15,233)
(3,919)
(26,465)
(62,313)
31,609
22,728
1,583
(5,208)
50,712
32%
27%
22%
Nine Months Ended September 30, 2003 1
158,498
103,479
8,627
1,986
4,620
6,721
(11,336)
153,878
96,758
8,632
13,322
71,938
29,756
37,537
10,052
225,816
126,514
46,169
23,374
421,873
(986)
(23)
(333)
(20,529)
(21,871)
(136,145)
(70,274)
(36,457)
(9,724)
(252,600)
Income (Loss) Before Income Taxes
88,685
56,217
9,379
(6,879)
(32,814)
(20,453)
(3,470)
5,857
(50,880)
Allocated Net Income (Loss)
55,871
35,764
5,909
(1,022)
(465)
(3,181)
3,669
(8,623)
(9,241)
(334)
(21)
(18,219)
1,653
2,109
134
2,845
6,741
Income (Loss) Before Capital Charge
53,056
32,172
5,681
(5,865)
85,044
(17,052)
(16,522)
(3,761)
(39,011)
(76,346)
36,004
15,650
1,920
(44,876)
8,698
21%
(6)%
14%
24
FOREIGN OPERATIONS
The countries in which the Company maintains its largest exposure on a cross-border basis include Netherlands, Australia and United Kingdom. Table 10 presents as of September 30, 2004, December 31, 2003 and September 30, 2003, a geographic distribution of the Company’s cross-border assets for selected countries. The primary components of cross-border assets as of September 30, 2004 were investment securities of $333.0 million and loans of $108.9 million.
Geographic Distribution of Cross-Border International Assets (Unaudited) 1
Table 10
Country
December 31, 2003 2
September 30, 2003 2
Australia
86,358
36,283
36,917
Netherlands
122,958
42,229
91,876
United Kingdom
69,681
110,460
59,734
All Others
199,901
162,037
117,716
478,898
351,009
306,243
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.
Generally, the Company’s asset quality continued to improve during the quarter as evidenced by lower levels of internally criticized loans, non-performing assets and a reduced level of net loan charge-offs. The ratio of non-performing assets to total loans and foreclosed real estate at September 30, 2004 was 0.27%, reduced from 0.55% at December 31, 2003. Net loan charge-offs (annualized) for the first nine months of 2004 as a percent of average loans outstanding were 0.02%, a decline from 0.25% from the same prior year period, due in large part to a $6.0 million recovery in the second quarter of 2004. Excluding this recovery, the 2004 year-to-date ratio would have been 0.16%. For the third quarter 2004, net charge-offs were $0.3 million or 0.02% (annualized) of average loans outstanding, reflecting charge-offs primarily of consumer and small business loans, offset by commercial loan recoveries.
The Company’s more favorable credit risk position relative to a year ago reflects a continued strategy that shifted to borrowers and industries believed to have a lower risk profile, reduced large borrower concentrations and an improving U.S. economy. In addition, ongoing portfolio management is intended to result in early identification and disengagement from deteriorating credits. Despite record-high oil prices, overall risk in the portfolio of Hawaii-based loans also continues to improve, primarily due to a local economy that remains satisfactory with some positive trends in real economic measures.
25
Although the overall credit risk profile continued to improve, the domestic legacy airline carriers have a higher risk profile with current negative trends. Outstandings to legacy carriers as of September 30, 2004 were $19.0 million and are included in the United States National Passenger Carriers total, as shown on Table 11 below. Record-high oil prices are having a pronounced impact on already struggling domestic legacy airline carriers, who have a less competitive business model in the current environment. In the evaluation of the Allowance, the Company considered the current financial strain on airlines which offset the impact of the improvement in other components of the loan portfolio. Concentration of credit exposure to selected components of the portfolio is included in Table 11.
Selected Concentrations of Credit Exposure (Unaudited)
Table 11
Dec. 31, 2003 1
Sept. 30, 2003 1
Outstandings
UnusedCommitments
TotalExposure
Air Transportation
United States Regional Passenger Carriers
44,602
12,903
57,505
59,231
59,866
United States National Passenger Carriers
37,771
37,259
37,684
Passenger Carriers Based Outside United States
28,540
31,549
31,670
Cargo Carriers
13,771
14,405
Total Air Transportation
124,684
137,587
142,444
143,625
Hotel
9,348
17,733
17,768
Other Commercial
156,592
40,868
197,460
184,129
183,115
308,689
12,968
321,657
288,831
277,521
Total Guam
474,629
53,836
528,465
490,693
478,404
Syndicated Exposure
186,214
604,141
790,354
925,864
918,503
Other Large Borrowers 2
81,394
216,632
298,026
336,748
350,897
Exposure includes loans, leveraged leases and operating leases.
1 For three borrowers, reclassifications occurred between Regional and National Carriers. Syndicated Exposure was restated.
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 Guam, which is sensitive to tourism and military spending, economic indicators are trending upward although some uncertainty continues to exist. Tourism has rebounded to pre-September 11, 2001 levels and the announced increases in military spending and presence are encouraging. As of September 30, 2004, internally classified exposure was reduced by 29% 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.
Two of the Company’s top ten syndicated loan outstandings (totaling $60.1 million) as of June 30, 2004 were paid off during the third quarter, reducing concentrations in large borrowers. At September 30, 2004, the Company’s largest syndicated loan outstanding totaled $21.0 million for a new hotel construction on the island of Maui and the second largest syndicated loan outstanding totaled $17.1 million to a local residential real estate builder. The ten largest syndicated loans outstanding at September 30, 2004 totaled $118.8 million or 64% of total syndicated loans. Of this amount, 66% reflected loans to major borrowers with operations in Hawaii of which 63% was in the real estate sector. No syndicated outstandings were internally classified.
The Company’s other large borrowers include six 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 three 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. NPAs decreased by $15.7 million or 50% from December 31, 2003 to $16.0 million as of September 30, 2004, primarily due to the partial charge-off and disengagement of a Hawaii business, a loan pay-off in Guam, the transfer of a Company occupied foreclosed real estate property to premises.
NPAs in Guam as of September 30, 2004 were $8.4 million, a decrease of $4.3 million or 34% from December 31, 2003. The improvement reflects a loan pay-off and positive resolutions in residential mortgages. One real estate secured borrower represented 64% of Guam’s total NPAs.
Impaired loans totaled $6.9 million at September 30, 2004, a decrease of $9.1 million or 57% from $16.0 million at December 31, 2003. These loans had a related Allowance that totaled $0.6 million at September 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 $5.0 million at September 30, 2004, an increase of $1.5 million from December 31, 2003. The increase was due to an increase in past due residential mortgage loans and personal unsecured lines of credit, partially offset by positive resolutions of prior period amounts. Loss rates on residential mortgage loans in the Hawaii portfolio continue to be negligible.
Refer to Table 12 for further information on non-performing assets.
27
Consolidated Non-Performing Assets and Accruing Loans Past Due 90 Days or More (Unaudited)
Table 12
March 31,2004
Non-Accrual Loans
775
680
6,009
6,015
7,856
5,552
5,649
7,388
9,337
10,977
1,913
1,948
1,962
2,181
2,388
8,240
8,277
15,359
17,533
21,221
7,278
7,688
7,685
9,354
9,669
251
306
406
460
497
7,529
7,994
8,091
9,814
10,166
Total Non-Accrual Loans
15,769
16,271
23,450
27,347
31,387
4,889
4,416
Total Non-Performing Assets
15,977
21,160
27,866
31,724
40,144
Accruing Loans Past Due 90 Days or More
65
707
725
688
693
117
753
712
1,409
842
2,588
698
595
1,430
2,027
107
1,533
1,142
1,180
1,210
1,059
57
4,250
1,929
1,882
2,640
3,193
Total Accruing and Past Due
5,003
2,641
3,291
3,482
3,888
5,714,996
Ratio of Non-Accrual Loans to Total Loans
0.27%
0.28%
0.41%
0.48%
0.56%
Ratio of Non-Performing Assets to Total Loans and Foreclosed Real Estate
0.37%
0.49%
0.55%
0.72%
Ratio of Non-Performing Assets and Accruing Loans Past Due 90 Days or More to Total Loans
0.36%
0.61%
0.79%
Quarter to Quarter Changes in Non-Performing Assets
Balance at Beginning of Quarter
41,952
Additions
2,094
3,909
3,293
2,340
3,199
Reductions
Payments
(1,386)
(4,232)
(4,555)
(3,416)
(1,782)
Return to Accrual
(1,122)
(2,700)
(1,444)
(839)
(1,464)
Sales of Foreclosed Assets
(682)
(147)
(310)
(4,418)
(1,025)
Charge-offs/Write-downs
(88)
(3,536)
(842)
(2,087)
(736)
Transfer to Premises
(3,999)
Total Reductions
(7,277)
(10,615)
(7,151)
(10,760)
(5,007)
Balance at End of Quarter
28
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 September 30, 2004 decreased by $4.4 million from December 31, 2003, reflecting the combination of a $3.5 million negative Provision in the second quarter and net loan charge-offs totaling $0.9 million. The reduction in the Allowance was based on improvement in credit quality and ongoing assessments of economic conditions and risk. The ratio of the Allowance to total loans and leases outstanding decreased 10 basis points from 2.24% at December 31, 2003 due to the decrease in the Allowance and to an increase in average loans outstanding. A summary of the Allowance is presented in Table 13.
The $0.3 million reduction in the Allowance from the prior quarter is equal to net loan charge-offs, as no provision was recorded. Loan charge-offs in the third quarter of 2004 of $5.0 million were partially offset by recoveries of $4.7 million.
Consolidated Allowance for Loan and Lease Losses (Unaudited)
Table 13
Balance at Beginning of Period
137,974
129,080
142,853
Loans Charged-Off
227
3,328
1,132
3,942
3,314
149
574
549
529
379
607
352
226
319
39
690
1,416
173
201
114
464
4,268
4,564
6,784
13,487
13,492
45
50
109
167
Total Loans Charged-Off
4,950
8,828
8,280
19,893
20,022
Recoveries on Loans Previously Charged-Off
1,206
1,245
551
3,431
2,942
1,093
151
31
1,933
105
94
955
207
304
455
805
912
101
154
129
51
1,502
1,703
1,494
4,868
4,163
80
52
Foreign
519
6,469
424
7,038
568
Total Recoveries on Loans Previously Charged-Off
4,697
10,047
2,981
18,964
9,844
Net Loan Recoveries (Charge-Offs)
(253)
1,219
(5,299)
(929)
(10,178)
Balance at End of Period
124,651
124,904
132,675
Average Loans Outstanding
5,796,350
5,772,926
5,546,154
5,770,642
5,508,778
Ratio of Net Loan Charge-Offs to Average Loans Outstanding (annualized)
0.02%
(0.08)%
0.38%
0.25%
Ratio of Allowance to Loans and Leases Outstanding
2.16%
29
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 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 September 30, 2004, December 31, 2003 and September 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 $2.2 million increase in NII per quarter. The Company’s balance sheet continues to be asset-sensitive.
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
(6.1
)%
%
(4.8
(5.6
4.6
Estimated Exposure to Net Interest Income Per Quarter
(5.9
)
2.2
(4.4
(5.1
4.2
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.
30
The Bank is a member of the FHLB, which provides an additional source of short-and long-term funding. Outstanding borrowings from the FHLB were $87.5 million at September 30, 2004, compared to $68.5 million at December 31, 2003 and September 30, 2003. The increase from 2003 was from an additional $25.0 million advance that bears a 3.2% interest rate and matures in 2007.
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 September 30, 2004, December 31, 2003 and September 30, 2003.
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 September 30, 2004, shareholders’ equity totaled $756.7 million, a 5% net decrease from December 31, 2003. The decrease in shareholders’ equity during the first nine months 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 nine months ended September 30, 2004, 4.1 million shares of common stock were repurchased at an average cost of $44.54 per share, totaling $182.1 million. From the beginning of the share repurchase program in July 2001 through September 30, 2004, the Company repurchased a total of 33.9 million shares and returned a total of $1,037.1 million to shareholders at an average cost of $30.59 per share. From October 1, 2004 through October 22, 2004, the Company repurchased an additional 80,000 shares of common stock at an average cost of $49.11 per share for a total of $3.9 million, resulting in remaining buyback authority under the existing repurchase program of $108.9 million.
In October 2004, the Company’s Board of Directors declared a cash dividend of $0.33 per share on the Company’s outstanding shares. The dividend will be payable on December 14, 2004 to shareholders of record at the close of business on November 29, 2004.
Table 15 presents the regulatory capital and ratios as of September 30, 2004, December 31, 2003 and September 30, 2003.
Regulatory Capital and Ratios (Unaudited)
Table 15
Regulatory Capital
8.25% Capital Securities of Bancorp Hawaii Capital Trust I
31,425
Unrealized Valuation and Other Adjustments
10,784
10,771
12,747
Tier I Capital
741,132
777,570
806,222
Allowable Reserve for Loan Losses
80,604
78,147
75,432
Subordinated Debt
99,798
124,709
124,696
Unrealized Gains on Available for Sale Equity Securities
66
86
Total Regulatory Capital
921,586
980,492
1,006,436
Risk Weighted Assets
6,404,282
6,200,831
5,977,306
Key Regulatory Capital Ratios
Average Equity/Average Assets Ratio
7.57%
9.60%
9.18%
Tier I Capital Ratio
11.57%
12.54%
13.49%
Total Capital Ratio
14.39%
15.81%
16.84%
Leverage Ratio
7.69%
8.43%
8.52%
Economic Outlook
Hawaii’s economy continued to expand during the third quarter of 2004. Tourism remains strong and is on track to establish 2004 as a record year in terms of total visitors. Hawaii’s unemployment rate fell below 3%, the lowest in the country, as job growth continued in excess of 2%. Real estate transactions and valuations continued to increase and military housing privatization initiatives are expected to augment private construction growth, beginning in the fourth quarter of 2004. These trends are expected to drive capital spending forward for several more years. A rise in core inflation in the Honolulu consumer price index (CPI) from around 1.5% to 3% during the first half of 2004 may indicate the state economy is approaching full employment. However, Hawaii’s real personal income growth remains stable at 2% to 3% in 2004, as it has since 1997.
Earnings Outlook
The Company currently anticipates net income for the full year of 2004 will be approximately $166 million to $168 million. Based on present conditions, the Company does not expect to record a Provision during the fourth quarter 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 average 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 Financial Conditions and Results of Operations-Market Risk.
Item 4. Controls and Procedures
The Company’s management, including the Chief Executive Officer and Chief Financial Officer, evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)) as of September 30, 2004. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2004. There were no significant changes in the Company’s internal controls over financial reporting that occurred during the third quarter of 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Items 1, 3 and 4 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 Price PaidPer Share
Total Number ofShares Purchasedas Part of PubliclyAnnounced Program 2
Approximate Dollar Valueof Shares that May YetBe Purchased Under theAnnounced Program 2
July 1 - 31, 2004
220,200
45.21
220,000
134,328,852
August 1 - 31, 2004
445,359
46.48
113,630,097
September 1 - 30, 2004
16,025
47.17
112,874,160
681,584
46.08
681,384
1 The July period included 200 shares 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 date of purchase.
2 The Company announced authorizations of additional share repurchases of $100.0 million and $50.0 million on July 26, 2004 and April 27, 2004, respectively.
Item 5. Other Information
Item 6. Exhibits
Exhibit Index
Exhibit Number
10.1 Key Executive Change-in-Control Severance Agreement dated June 25, 2004 for R.C. Keene
10.2 Executive Change-in-Control Severance Agreement dated June 25, 2004 for B.T. Stewart
12 Statement Regarding Computation of Ratios
31.1 Rule 13a-14(a) Certifications
31.2 Rule 13a-14(a) Certifications
32 Section 1350 Certification
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: October 27, 2004
BANK OF HAWAII CORPORATION AND SUBSIDIARIES
By:
/s/ Allan R. Landon
Allan R. Landon
Chairman, Chief Executive Officer and President
/s/ Richard C. Keene
Richard C. Keene
Chief Financial Officer
EXHIBIT INDEX
36