Bank of Hawaii Corp BOH
Q2 2013 Earnings Call Transcript
Transcript Call Date 07/22/2013

Operator: Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 Bank of Hawaii Corporation Earnings Conference Call. My name is Jackie and I'll be your coordinator today. At this time, all participants are in a listen-only mode. Following the prepared remarks there will be a question-and-answer session. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to, Ms. Cindy Wyrick, Director of Investor Relations. Please proceed.

Cindy Wyrick - IR: Thank you, Jackie, good morning, everyone. Thank you for joining us today as we review the financial results for the Bank of Hawaii second quarter 2013. Joining me this morning is our Chairman, President and CEO, Peter Ho; our Vice Chairman and Chief Financial Officer, Kent Lucien; and our Vice Chairman and Chief Risk Officer, Mary Sellers. The comments today will refer to the financial information included in this morning's announcement.

Before we get started, let me remind you that today's conference call will contain some forward-looking statements and while we believe our assumptions are reasonable there are a variety of reasons that the actual results may differ materially from those projected.

And now, I'd like to turn the call over to Peter Ho.

Peter S. Ho - Chairman, President and CEO: Great, thanks, Cindy. Good morning, everyone and thanks for joining us today. Bank of Hawaii delivered steady, consistent and positive result to the second quarter of 2013. Our loans grew 3% from the second quarter of last year due to strong commercial, indirect auto and certain other consumer loan growth partially offset by reductions in refinance sensitive loan categories namely residential mortgage and home equity loans. We continue to attract quality departments during the quarter with consumer and commercial deposit balances up 4% from last year.

Consumer and commercial demand deposits were up 13% and 10%, respectively, in the quarter. Asset quality as you would expect continue to trend positively and our expenses remained well controlled. At the end of the quarter, our balance sheet remains strong with high levels of liquidity, capital and reserves.

And now let me turn the call over to Kent, who will give you some more detail into the numbers.

Kent T. Lucien - Vice Chairman and CFO: Thank you, Peter, good morning. Net income for the second quarter was $37.8 million or $0.85 per share compared to $36 million or $0.81 per share in the first quarter and $40.7 million or $0.90 per share in the second quarter of 2012. Our return on assets in the second quarter was 1.12% and return on equity was 14.6%.

Our efficiency ratio was 60%, a reduction from 61.9% in the first quarter. Year-to-date net income was $73.7 million or $1.65 per share, compared to $84.6 million or $1.85 per share in 2012. Year-to-date return on assets is 1.10% and return on equity is 14.4%. Our year-to-date efficiency ratio is 60.9%.

In the last several weeks longer-term interest rates have increased. The most immediate impact to us is in our mortgage operation. In the second quarter, mortgage income was 5.8 million versus 6.4 million in Q1. Mortgage applications are trending lower into the third quarter, and so we would expect to see, still lower mortgage revenue in the second half. Longer-term, if rates continue at this level or even increase, we should see our net interest margin increase, but this will take time to be fully realized.

Our net interest margin in the second quarter was 2.77% compared to 2.82%, in the first quarter and 2.98% in the second quarter of 2012. The lower margin was primarily due to continued reinvestment in lower yielding securities and relatively high premium amortization. The investment portfolio reinvestment differential was 98 basis points in the second quarter. Premium amortization was 16.8 million, compared to 16.5 million in the first quarter.

Going forward, if mortgage and other prepayments slow then the premium amortization will correspondingly decrease. Also during the quarter, we amended and extended $200 million of private long-term repurchase agreements and thereby lowered the rate on those repos from 4.73% to 3.75%.

There is no credit provision in the second and first quarters compared to $0.6 million in the second quarter of 2012. However, our balance decreased by $2.3 million in the second quarter and by $2 million in the first quarter which equaled net charge-offs for the respective quarters. The credit provision for the second quarter of 2012 include net charge-offs of $3.8 million and $3.2 million decrease to the allowance. Our allowance for loan and lease losses at the end of the second quarter was $124.6 million or 2.1% of outstanding loan and leases.

Non-interest income for the second quarter was $48 million compared to $47.8 million in the first quarter and $46.8 million in the second quarter of 2012. The increase compared to the first quarter was primarily due to an increase in commercial real estate and loan syndication fees, debit interchange revenue and trust and asset management income, partially offset by a decrease in mortgage banking income. First half trust and asset management income tends to be somewhat higher due to tax service fees.

Year-to-date non-interest income was $95.8 million compared to $94.9 million in 2012. Non-interest expense totaled $81.2 million in the second quarter compared to $84.4 million in the first quarter and $80.7 million in the second quarter of 2012. The decrease compared to the first quarter was primarily due to seasonally lower payroll taxes and 401(k) contributions associated with incentive compensation accrued in 2012 and came in first quarter of 2013 and a decrease in separation expense.

Year-to-date non-interest expense was $165.6 million compared to $166 million in 2012. The effective income tax rate was 30.3% in the second quarter compared to 30.7% in the first quarter and 33% in the second quarter of 2012.

The lower rate in the second quarter of 2013, was due to a 1.1 million release of reserves for a prior year state tax on certain matter that was settled during the quarter.

Our investment portfolio now stands at $6.8 billion of which 41% is categorized AFS and 59% is HTM.

The average duration of the AFS portfolio is 2.96 years and overall portfolio duration is 3.98 years.

In the end of the second quarter, we repositioned approximately $250 million of securities from AFS to HTM and we plan to move another approximately $200 million during the quarter that would be the third quarter.

The total portfolio is comprised of 74% Ginnie Mae mortgages and SBA loans, 11% municipal securities, 9% treasuries and 6% corporates.

Loan balances were $5.9 billion at the end of the second quarter up $76 million compared to the end of the first quarter and up $188 million from the end of the second quarter of 2012. Commercial loans increased by $74 million in the second quarter. Deposits were $11.4 billion at the end of the second quarter, up $197 million compared to the end of the first quarter and down $99 million from the end of the second quarter of 2012, the higher deposits were mainly public deposits. Our shareholders' equity was $1 billion at the end of the second quarter. Our AFS portfolio was marked down in value by 46.6 million due to increasing interest rates. We paid out 20.2 million in dividends and continued our share repurchase program in the second quarter repurchasing 305,000 shares of common stock for $15 million.

Our Board declared a dividend of $0.45 per share for the second quarter. At the end of the second quarter, our tangible common equity to risk rated assets was 15.7% and our Tier 1 leverage ratio was 6.9%.

Now, I'll turn the call over to Mary Sellers.

Mary E. Sellers - Vice Chairman and Chief Risk Officer: Thank you, Kent. Net charge-offs for the second quarter totaled 2.3 million, up 324,000 on a linked-quarter basis and down $1.5 million year-over-year. The year-over-year improvement was driven off a $725,000 decrease in C&I net charge-offs and a $1.4 million decrease in residential mortgage net charge-offs. Non-performing assets totaled $36.4 million, down $1.9 million from last quarter and down $5.1 million year-over-year. The linked period decrease was primarily due to a $1.8 million decrease in residential mortgage non-accrual loans, while a year-over-year improvement was driven by $1.2 million decrease in construction non-accrual loans and the $3.9 million decrease in residential mortgage non-accrual loans. We continue to expect the level of non-performing assets to be impacted in the near-term due to the longer resolution timeframe for residential assets.

At quarter end, loans past due 90 days or more and still accruing interest totaled $10.6 million, down $1.1 million, on a linked quarter basis and up $3.4 million year-over-year. The linked period decrease was due to a $1.8 million decrease in home equity, which was partially offset by a $900,000 increase in residential mortgage loans. Restructured loans not included in non-accrual loans are loans past due 90 days or more, totaled $39.2 million at quarter end, up $9.1 million from the prior quarter and up $8.1 million year-over-year.

Residential mortgage loans modified to assist our customers in retaining their homes, accounted for $21.4 million of the total at quarter end. Residential mortgage and home equity loans past due more than 30 days but less than 90 days and still accruing interest decreased by $3.7 million on a linked quarter basis and increased $3 million year-over-year.

We continue to see improvement in what we consider to be the higher risk segments in our portfolio. In total, these segments were down $8.1 million for the quarter and $12.6 million year-over-year. As Kent indicated, we reported no provision for loan to lease losses in the second quarter, which given net charge-offs of $2.3 million reduced the allowance to $124.6 million or 2.13% of outstanding loans and leases. With continued strengthening in the economy and continued improvement or stability in credit quality, we anticipate requiring a lower level of allowance going forward.

I'll now turn the call back to Peter.

Peter S. Ho - Chairman, President and CEO: Great. Thanks Mary. The Hawaiian economy continued its positive trend in the quarter. Visitor industry continues to be a source of strength for the Hawaiian economy. For the first five months of 2013, total visitor arrivals increased by 5.7% and visitor spending increased by 5.1% compared to the same period in 2012.

Oahu single-family home and condominium median prices rose 9% and 11%, respectively in June and are up 0.8% and 6.8% year-to-date. Sales volumes remain strong up 11% for single-family homes and 18% for condominiums year-to-date. And inventories remain at historically low levels at 2.7 months for both categories.

State-wide seasonally adjusted unemployment rate declined to 4.6% in June, down from 5.1% at year-end and significantly better than the national rate of 7.6%. We would anticipate the economy to be further augmented by the commencement of a number of both private and public sector construction projects set to take place in the next few years.

And now we would be happy to entertain your questions.

Transcript Call Date 07/22/2013

Operator: Joe Morford, RBC Capital Markets.

Joe Morford - RBC Capital Markets: Question on the margin, your comment in your release talked about benefiting from the trend higher in rates. Is that primarily going to be through lower premium amortization or do you anticipate in doing anything really different on the investment security side.

Kent T. Lucien - Vice Chairman and CFO: We really don’t anticipate doing too much differently in terms of what we are buying in the portfolio, but as I mentioned in my comments we are about minus 98 points in the quarter in terms of reinvestment. At present we are more or less neutral in terms of what we are buying versus the roll-off and so that combined with loan growth and further combined with lower premium amortization. That’s really the basis for my comment.

Joe Morford - RBC Capital Markets: And just kind of over time is that likely then kind of more of a fourth quarter event than third quarter you are suggesting?

Kent T. Lucien - Vice Chairman and CFO: I think there are still events to be determined as to what happens with rates. But I think it is possible to see some slight positive trending even as early as the third quarter. Now I'd really caution any thinking about dramatic change. These are going to be very modest kinds of numbers.

Joe Morford - RBC Capital Markets: Then lastly just can you talk a bit about the shift of securities from AFS to HTM did both this quarter and what's planned motivations there and so to partly to help manage the AOCI issue.

Kent T. Lucien - Vice Chairman and CFO: Yeah, definitely it's partly due to capital management I mean you always start with the fundamentals that these various securities we intend to hold to maturity. But in addition it will be good or better capital management for us relative to AOCI.

Operator: Aaron Deer, Sandler O'Neill & Partners.

Aaron Deer - Sandler O'Neill Partners: Just following up on the capital discussion it seems like you're still pretty comfortable with the share repurchases, but the stock haven’t come up now and I guess with some of the AOCI issues and such, I’m just wondering what, how comfortable are you with that going forward and are there any particular capital ratios that you’re keeping an eye on in particular?

Peter S. Ho - Chairman, President and CEO: I mean the basic strategy of returning is much capital to the shareholders as we can, I mean that’s still relevant. The ratios that we’re looking at Tier 1 leverage, we do want to get that number to 7%, we’re just a smidge under that as of the second quarter. But the other ratio we’re looking at is the risk weighted ratio which came down a little bit you saw in the second quarter due to a combination of loan growth and the AOCI charge. So, we’re looking at all those ratios in terms of our capital decisions. But I think the basic message is we’re still pressing forward with the share repurchase program. We wouldn’t anticipate any real changes in that.

Aaron Deer - Sandler O'Neill Partners: And then, Peter, you mentioned in your comments that there are some construction projects that are going to be coming on-line over the next couple of years and, obviously with inventories as low as they are, it seems like there's more demand than there is availability. I know that construction's not a big part of your book but, can you size kind of the opportunity that you see there, and what does that mean for pricing on your loan book?

Kent T. Lucien - Vice Chairman and CFO: Well, the construction book today is just over $100 million. That book has been up as high as several $100 million in the past. We are a pretty conservative and choosy construction lender, particularly in the vertical construction space. So, I would anticipate that there's meaningful upside in that construction portfolio over the next few years, call it. I think the real opportunity for us is, in the ancillary activity surrounding a robust construction environment. So, that's C&I lending. That's supporting a lot of the trades and businesses that support construction and development here in the state. I guess, the last piece to this would be, and this is probably extending out a few years, would be the opportunity to increase our purchase residential mortgage segment, which is – purchase is a growing percentage of our originations and mortgage. The problem is, inventory levels are so low right now, that it's just very difficult to get much volume there. So between the condominiums coming up and some potential single-family home developments further out into several years out, that's a meaningful statement of the overall housing market, here in Oahu.

Operator: Nicholas Karzon, Credit Suisse.

Nicholas Karzon - Credit Suisse: I guess first just I'm thinking about the potential magnitude of the premium amortization decline. Can you give us an idea of how the mechanics of that calculation work?

Kent T. Lucien - Vice Chairman and CFO: Well, first of all we estimate the amortization each month, and so it's a monthly determination. The first step in the process is an estimate in the mortgage area as to prepayment speed. That is then combined with any actual pay downs on individual securities. Other fixed tenor securities the amortization is a known number it's basically a straight line. So, the greatest variable would be the prepayment rate on mortgages.

Nicholas Karzon - Credit Suisse: And then second quick question, and this goes back to I think your comments on net interest margin earlier. I noticed that the yield on residential mortgages ticked up a little bit quarter-over-quarter. Is there something unusual there or is the average yield actually improving quarter-over-quarter?

Kent T. Lucien - Vice Chairman and CFO: Yes, it changed by 4 basis points. Part of that is that the balances came down. So, we weren't putting on a lot of new mortgages in the period. And so that would be the major change.

Operator: Casey Haire, Jeffries.

Casey Haire - Jeffries: I had a question on the expense side another good quarter of expense leverage here. I was just wondering with some pretty positive NIM commentary from you guys for the first time in a while, have we kind of reached the end of the line here or is there more to come?

Peter S. Ho - Chairman, President and CEO: On the expense side.

Casey Haire - Jeffries: Yes.

Peter S. Ho - Chairman, President and CEO: Well I'll kick off and Kent can clean up. I think as you know Casey we don’t have a prescribed percentage that we are going after. Our view is that we ought to be able to want to control expenses and potentially even reduce expenses irrespective of the environment that we find ourselves in. So, we think that there is further expense opportunity but it's going to be measured and it's going to be somewhat lumpy because as you know some times it takes some expenditure to create longer term expenditure. But to answer your question longer term we do see expenses as an opportunity.

Casey Haire - Jeffries: Then on the loan front obviously the commercial bucket had a pretty good quarter. How are pipelines today are they still strong or are they need to backfill a little bit?

Peter S. Ho - Chairman, President and CEO: The pipe still looks pretty good and I think the headliner certainly this quarter and for the past several quarters has been our commercial mortgage business which has just performed exceptionally well. When I was hardened to see this quarter was we are beginning to see good C&I growth. We are beginning to see good activity within the C&I space. So, good balance there and I think we’ve got some pretty reasonable opportunities coming out.

Casey Haire - Jeffries: And just one more, the liability restructuring that you guys did on the repo side, at what point, was that early in the quarter, late in the quarter and is there a more opportunity for that going forward? Thank you.

Kent T. Lucien - Vice Chairman and CFO: Yeah, I was pretty early in the quarter and there is some additional opportunity it’s very modest though. The private repos, the total of $600 million, and we did $200 million in the quarter and then maybe another $100 million, but the differential in rates is probably much smaller than what I quoted in the second quarter.

Operator: Jeff Rulis, D. A. Davidson.

Jeff Rulis - D.A. Davidson & Company: Peter, just a follow-up on that last C&I comment. You are seeing some activity, is that new production or line draws and then even specifically if you had the current level of line utilization, what is that currently versus where it's been last quarter or eight quarters past?

Peter S. Ho - Chairman, President and CEO: Not a real perceptible change in line utilization and I don't think that’s the number that we have divulged in the past, but most of the C&I activity has been centered around M&A activity here in the local marketplace and a fair amount of businesses just spending capital to get in preparation for what they view as a better economic environment and a more active environment.

Jeff Rulis - D.A. Davidson & Company: Then this has sort of touched on a little bit on the portfolio balance of the residential mortgage category, I guess with sort of slowing refi and an increase in purchase activity, albeit, limited you're approaching a bottom on the actual balance in the portfolio, or do you get a sense that run-off will continue for a little while?

Kent T. Lucien - Vice Chairman and CFO: Well, we'd like to see things bottom out here. As we look at the numbers going back several quarters, we had so much activity in Qs 3 and 4 and, we're just – at least in our shop, we're just now catching our breath and getting that activity in place. Likely, that's the case, at least throughout our local marketplace. So, we would anticipate as refinance activity slows, there is a reasonable opportunity for us to create a bottom in both the resi book as well as potential home equity book.

Operator: Jackie Chimera, KBW.

Jacquelynne Chimera - KBW: Looking to the unsettled tax matter that you had talked about, do you have any more of those that are kind of sitting in the backburner that might pop up over the next few quarters?

Kent T. Lucien - Vice Chairman and CFO: That's always possible. I mean, just the nature of the tax area where resolutions take many, many years. So, this particular items goes back over five years. So, it's always possible, very difficult to predict, and nearly impossible to specify timing.

Jacquelynne Chimera - KBW: And Kent just to make sure that I heard you correctly, that was $250 million that were moved into held to maturity this quarter and then 2Q. And then $200 million that are moving in 3Q, right?

Kent T. Lucien - Vice Chairman and CFO: Yes, that’s right.

Jacquelynne Chimera - KBW: And then I guess just lastly if you don't mind providing an update on how the traction in the credit card portfolio has been?

Kent T. Lucien - Vice Chairman and CFO: It's been very good. It's balances are now up over $4 million. So, we quadrupled our portfolio, Jackie. But the real number for us is we have opened upwards of 6,000 accounts. So, the product has been very well received by our client base, people are very satisfied with the features and benefits. We have few other products coming out in the near future. So, it's just been very good augmentation to our product line. And we think as I've told you before, I think longer term is going to be a very successful product for us, but it's just going to take a while to season up dollar-wise.

Operator: Brett Rabatin, Sterne, Agee.

Brett Rabatin - Sterne, Agee: Wanted to maybe follow-up on the premium amort just one more time. With the $16.8 million that’s about 100 basis points on your current portfolio and between 2011 and '12, you were kind of running at $13 million or $14 million premium amortization I was just curious if you think it might fall below that with sort of how you see things can and then I was curious if you were buying Ginnie's at premiums or kind of you talked about not being neutral from a reimbursement perspective. Could you maybe clarify a little bit on what you are buying?

Kent T. Lucien - Vice Chairman and CFO: I wouldn’t get too carried away with the opportunity in the amortization space I think directionally it is going to be positive for us but it's not just not going to be as big initially as we may have seen in earlier periods. So I don’t know if that helps you very much. But we are talking about pretty modest, but directionally positive changes.

Brett Rabatin - Sterne, Agee: Would it be fair to assume then like $2 million to $3 million reduction as those pre-paid speeds slow would sort of be the pace kind of given what sort of line premiums still average amortize versus accelerated pre-pay speed?

Kent T. Lucien - Vice Chairman and CFO: That number over several months is possible. If you want to go out much longer you can think about a little bit bigger number and but I just didn’t want you to think that it's going to go half, it's not. In terms of what we are buying, we are buying little bit more in the municipal space, little bit more in the corporate space. We are going to bring down the mortgage a little bit. So slight reduction in that area. As I mentioned, probably neutral now in terms of roll off and the roll off yield in the second quarter was about 2.5% and that's kind of what we're averaging out between the various investment categories right now.

Brett Rabatin - Sterne, Agee: Then, the other question I had, I know I've asked about this before, but I saw that Hawaii got the first $250 million for the rail project last month, so, I was just curious any update on in fact, might that project, might benefit you guys and if so, can you make loans on the various companies that are going to be doing that?

Kent T. Lucien - Vice Chairman and CFO: Yeah, Brett, we think that the potential stimulus created by the rail over the next several years is going to be quite meaningful and we in fact – our lending are our active with a number of companies that are a part of that project.

Operator: Matt Keating, Barclays.

Matthew Keating - Barclays: I just had a few follow-up questions on the mortgage banking business, it was helpful to hear your commentary that applications were trending lower I guess as you moved into 3Q, could you just provide some quantification around that perhaps relative to 7% application decline you experienced last quarter?

Kent T. Lucien - Vice Chairman and CFO: Yeah, so the figure I quoted was revenue which is really a combination of servicing income and any gain on the mortgages sold. In terms of applications into the third quarter, probably the way to think about it is, between 35% to 45% kind of reduction in volume. It's early into the period, so it's hard to give you a definite figure. That's why I've given you a range, but that's kind of what we're seeing so far.

Matthew Keating - Barclays: Now, it sounds like you're making progress in transiting more to a purchased mortgage mix. Could you just provide, I guess, of your production in 2Q, what was the mix between purchase and refinance?

Peter S. Ho - Chairman, President and CEO: It's about 80-20 refi to purchase.

Matthew Keating - Barclays: I guess, you mentioned that the impact on the securities book, could you just update us on what the AFS net unrealized gain was at the end of the second quarter?

Kent T. Lucien - Vice Chairman and CFO: I think it's zero now or slightly negative, but that's in the AFS. The total securities, the gain is about – and this is an estimate, $6 million in that neighborhood, but AFS is – there's really no unrealized gain at this point.

Matthew Keating - Barclays: Got you, and I'm sure you're probably tired of answering this question but, any signs you had of any impact from sequestration yet on a ground in Hawaii yet or is it much the same as last quarter.

Peter S. Ho - Chairman, President and CEO: It's much the same as last quarter. I guess, some of the bigger pieces are shipyards. So, we have one of the largest navy shipyards in the Pacific. That has been designated for no meaningful change which was a positive. Schofield Barracks which is a big army base here in the state, basically has been designated for about the same level of troops, so that was a plus. We got about – I want to say 18,000 federal workers here in the state that were just notified of a one day a week furlong. So, I guess if you do the math they are at the 20% reduction in wages. So, that has yet to play out. Our sense is that yes, the sequestration is going to have some level of impact to Hawaii but unlikely to completely overwhelmed, the progress we are making on the visitor (in camp) potential construction side.

Operator: John Moran, Macquarie Capital.

John Moran - Macquarie Capital: Just a quick one on taxes. If I back out the $1.1 million reserve, I get an effective rate of kind of around 32%. And then in the press release you guys had alluded to some low income, housing deals and other tax credits that are in place here. Is there anything that would suggest maybe that 32% grind structurally lower as we progress through this year as 32 kind of the place that you think (checks out)?

Kent T. Lucien - Vice Chairman and CFO: Well, that’s a good place to start. And the effective rate can really vary depending on the level of income, because the credit amounts are fixed. And so if income goes up the rate will go up. And contrary-wise if income goes down, the effective rate could be lower. That’s the way to think about it.

John Moran - Macquarie Capital: Do you happen to have the dollar amount of permanent differences handy?

Kent T. Lucien - Vice Chairman and CFO: I do not.

Operator: At this time we have no further questions. Ms. Cindy Wyrick you may proceed.

Cindy Wyrick - IR: I'd like to thank everyone for joining us today and for your continued interest in Bank of Hawaii. As always if you have any additional questions or need further clarifications, please feel free to give me call at any time. Thanks to everyone. Have a great day.

Operator: Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.