Bank of Hawaii Q3 2008 Earnings Call Transcript

Oct.27.08 | About: Bank of (BOH)

Bank of Hawaii Corporation (NYSE:BOH)

Q3 2008 Earnings Call

October 27, 2008 2:00 pm ET

Executives

Cindy G. Wyrick - Senior Vice President, Corporate Secretary, Manager of Investor Relations

Allan R. Landon - Chairman of the Board, Chief Executive Officer

Kent T. Lucien - Vice Chairman of the Board, Interim Chief Financial Officer

Mary E. Sellers - Vice Chairman, Chief Risk Officer

Peter S. Ho - President, Chief Banking Officer

Analysts

Brett Rabatin - FTN Midwest

Andrea Jao - Barclays Capital

Erika Penala - Merrill Lynch

Terry Maltiff - Sandler O’Neill & Partners

Robert Bohlen - Keefe, Bruyette & Woods

Justin Maura - Lord Abbott

Brian Zabora - Stifel Nicolaus

Sirin Roylu - Blackrock Financial

John Flanagan - Analyst

Aaron Deer - Sandler O’Neill & Partners

Lisa Walker - Blackrock Financial

Operator

Good day, ladies and gentlemen, and welcome to the quarter three 2008 Bank of Hawaii Corporation earnings conference call. My name is Nora and I will be your coordinator on today’s call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Cindy Wyrick, Executive Vice President and Director of Investor Relations. Please proceed, Madam.

Cindy G. Wyrick

Thank you, Nora. Hello, everyone and thank you for joining us this morning as we review Bank of Hawaii’s financial results for the third quarter of 2008. With me this morning is our Chairman and CEO, Al Landon; our President and Chief Banking Officer, Peter Ho; our Vice Chairman and Chief Financial Officer, Kent Lucien; and Vice Chairman of Corporate Risk, Mary Sellers.

Our comments today will refer to the financial information that was included in the earnings announcement earlier this morning. 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 would like to turn the call over to Al Landon.

Allan R. Landon

Thanks, Cindy and good morning, everyone. Bank of Hawaii produced good financial results in the third quarter. As Kent will discuss, our results include the accounting impact of accepting the IRS program to resolve tax issues related to our legacy leasing business. We were fortunate to have that tax recovery which coincided with an increase in credit risk in the third quarter.

As a result of the economic slowing and credit market anxiety, we increased our allowance for loan losses and capital ratios. Bank of Hawaii enjoyed good credit availability and we moved to less expensive short-term funding and reduced our investment portfolio slightly.

When we introduced free checking in July, we also combined some demand deposit products to simplify our offerings. This resulted in a change in classifications of deposits on our balance sheet. Kent will comment on our deposit and balance sheet strategies after we highlight some important aspects of our incomes statement. Kent.

Kent T. Lucien

Thank you, Al. Good morning. Net income for the third quarter was $47.4 million, or $0.99 per share, compared to $47.8 million or $0.96 per share in the third quarter of 2007. Our net income to average assets was 1.82%, net income to equity was 24.17%, and our efficiency ratio was 54.05%.

For the first nine months of 2008, net income was $152.9 million, or $3.17 per share, up $10.1 million compared to 2007.

This quarter’s results included an $8.9 million net credit related to the pending resolution of our sale-in lease-out leverage lease matters with the IRS. These are commonly known as silos. This net credit reduced our net interest income by $4 million and reduced our tax provision by $12.9 million. We also increased the provision for loan losses above net charge-offs by $13 million. We increased our provision primarily due to increased risk in three specific loan exposures and to general risk from the weakening Hawaii and U.S. mainland economies.

Net interest income for the third quarter was down $3.6 million from the second quarter, mainly due to the $4 million charge related to the settlement of the silo leases just mentioned. This charge affected our net interest margin as well, which was 4.33% for the third quarter, compared to 4.41% in the second quarter. The silo adjustment reduced the margin by 17 basis points and therefore excluding this charge, our margin would have been 4.50%. Year-to-date, net interest income was up $17.4 million compared to the same period in 2007 and our margin increased 23 basis points to 4.30%. Net interest income improved because of lower funding and deposit costs that more than offset lower asset yields.

Non-interest income for the third quarter was $57 million, down $3.6 million from the second quarter and down $4.3 million compared to the third quarter of 2007. Increases in deposit fees were offset by reductions in mortgage banking and insurance income. Mortgage banking income was lower due to a $2.4 million valuation adjustment for our mortgage servicing rights. Insurance income was down $1.5 million due to the timing of contingent commission income.

Non-interest expense was $86.8 million in the third quarter, an increase of $2.9 million from the second quarter and up $5.3 million from the third quarter of last year. This quarter’s expenses included an accrual of $2 million for employee incentives. Year-to-date, non-interest expense was $264 million, up $20.7 million over last year. However, excluding the significant expense items as shown on table two of the press release, the increase would have been $8.4 million, or a 3.5% year over year increase. This is partially due to higher expenses associated with expanded service, including our new Waikiki branch, and also to higher utility and general operating expenses.

Our efficiency ratio increased to 54.05% this quarter compared to 50.01% last quarter, primarily the result of the reduction in net interest income related to the silo resolution and also to the $2 million employee incentive accrual. We increased the provision for credit losses this quarter to $20.4 million compared to $7.2 million last quarter. The provision exceeded net charge-offs of $7.4 million by $13 million.

Our effective income tax rate of 11.24% for the third quarter was impacted by the previously discussed credit of $12.9 million related to the silo tax resolution. Adjusted for the silo matter, the effective tax rate would have been 32.97% for the third quarter compared to 37.03% last quarter and 35.68% in the third quarter of 2007.

Turning now to the balance sheet, outstanding loans and leases totaled $6.54 billion at the end of the period, an increase of $21 million from the previous quarter, and $60 million lower than last year.

Average loans were down somewhat for the quarter as we continue to reduce our exposure in certain portfolios, such as construction, indirect auto, and unsecured consumer installment loans. Our construction loan portfolio is now $153.4 million compared to $168.7 million at the end of Q2.

Our investment securities portfolio was $2.9 billion at September 30, down $89 million from the second quarter. Our portfolio consists mainly of debt and mortgage-backed securities issued by GSEs. We do not own any subordinated debt, preferred stock, or common stock of Fannie Mae or Freddie Mac, and we don’t own any sub-prime or Alt-A securities.

Long-term debt was unchanged this quarter and short-term borrowings increased $202 million. Average deposit balance decreased by $186 million during the quarter due to a reduction in commercial escrow balances, as some large construction projects neared completion, and lower public deposits were due to the timing of bond payments.

We also continued to be conservative with respect to the pricing of timed deposits. Additionally, because we combined some product types when we introduced our free checking product in July, about $255 million of demand deposits were reclassified from non-interest bearing to interest-bearing accounts on our balance sheet.

Asset quality remained strong despite a slowing economy nationally and in Hawaii. Non-performing assets totaled $5.9 million at the end of the third quarter, down from $6.7 million at the end of June, though up from $4.3 million at the end of last year’s third quarter. As a percent of total loans and leases, non-performing assets are nine basis points.

Our accruing loans and leases past due 90 days and over were $5.4 million, or eight basis points. Our allowance for loan and lease losses is now $115.5 million, which represents 1.77% of total loans.

We continued our share repurchase program in the third quarter, purchasing 332,000 shares at a total cost of $16.2 million. At quarter end, our leverage ratio was 7.27%, up from 7.01% at June 30. Our immediate plan is to continue to build capital through earnings over the next few months. Accordingly, we have not repurchased any shares since mid-September.

Finally, our board declared a $0.45 per share dividend last Friday, an increase of $0.01 per share from the previous three quarters.

And now I’ll turn the call back to Alan.

Allan R. Landon

Thank you, Kent. As we indicated in our announcement, the Hawaii economy continues to slow. We provided some specifics on key measures in our announcement this morning but the Hawaii economy still is relatively better off than many other parts of the U.S.

In the last month, we have heard from clients that the slowing in Hawaii has accelerated and our customers are becoming more cautious. While loan losses increased, our delinquencies have remained at low levels. We expect to see consumer losses at current levels in the next quarter.

Commercial losses could increase, depending on the actions of a few borrowers for which we have increased reserves. Because of the lower visitor levels and other economic drivers, we anticipate modest slowing of our business and plan to maintain our conservative posture.

Our strategy is to use our resources, low leverage, strong capital generation, and talented personnel to manage our balance sheet and strengthen our delivery system during this slower period. We have good funding capacity and have avoided purchasing deposits, which have not been the least expensive source of marginal funding. We have good loan capacity although loan demand has decreased.

We are considering the various government programs that have been announced. Particularly we’re evaluating the treasury’s capital purchase program but we’ve not made a decision whether to participate. We have noticed that some programs are evolutionary and we plan to reach a conclusion closer to the due date for applications. In the meantime, we’ll continue to increase our capital ratios.

Now we’d be happy to respond to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Brett Rabatin of FTN Midwest.

Brett Rabatin - FTN Midwest

I guess I’m first surprised you guys are buying stock back here recently, I know you haven’t done any -- A, as you are evaluating that, is that a function of potential acquisitions? I can’t imagine -- I’m not sure why you would be too gung-ho to be getting involved in the tarp. And then secondly just you are going to grow your capital ratios. Aside from any government involvement, do you have a target now, a new target?

Allan R. Landon

We haven’t set a specific target. We are going to continue to let the ratios go up as we slow our repurchase. We stopped in the middle of September with repurchase and I think you did a very nice job of summarizing what we are considering as we look at the capital purchase program. But I’m thinking that there are sort of macro factors that are involved and we’ve got to watch those too. From just our bank standpoint right now, we feel pretty comfortable with our capital plan and strategy and as you know, Hawaii is a pretty concentrated market already so the likelihood of in-market acquisitions seems to be sort of an outlayer for us.

Brett Rabatin - FTN Midwest

Okay, and I had a ton of questions on credit, just let me ask one or two -- can you talk a little more about the very specific line exposures that you alluded to in the comments?

Allan R. Landon

I think Mary is just dying to get that question, Brett.

Mary E. Sellers

One of the clients who develops and manages retail centers that’s currently having some difficult refinancing debt maturities, given the illiquid capital markets. The second in our legacy leverage lease portfolio and there we have a conduit that has some structural issues. The actual lessee is quite strong but the structure itself is problematic. And then we have a construction loan on the mainland, one of our only two which in total are less than $10 million. The project is complete but sales have slowed. So all in all, we felt prudent to put some additional reserves against those exposures this quarter.

Brett Rabatin - FTN Midwest

Okay, and then Mary, there were some comments earlier about consumer losses at least at current levels going forward and maybe higher depending on the environment. Can you talk some about what you are seeing in the installment portfolio? Has the duration of those loans extended out and what you are seeing on the indirect auto as well?

Mary E. Sellers

We really haven’t seen much duration extension. We are pretty aggressive in our collection activities and don’t do much in terms of rewrite. In the indirect portfolio, we are starting to see the quality improve somewhat based on our underwriting debts we had instituted. You know, we’ve tightened that but given the unemployment picture, that’s just kind of an uncertainty moving out there.

Brett Rabatin - FTN Midwest

Okay. And then if I understood it correctly from the comments, the incentive accruals, are those essentially -- is there going to be a run-rate for that going forward or was the $2 million kind of more of a one-time deal for this quarter?

Allan R. Landon

We’re going to see what the fourth quarter looks like. [At this point], Brett, we’re apparently [all accrued up] off of what’s been for us a pretty good earnings year and we’ll see how the fourth quarter turns out, so we may have some variability in that part of the run-rate. That’s probably as much as I want to say right now without making promises to any of our employees who are listening.

Brett Rabatin - FTN Midwest

Okay, and then just one last quick one -- from a core margin perspective, impressive management of funding costs. The CDs, a little under 2.5% cost for the third quarter. Just given where assets are repricing and where you have now the funding costs, is it going to be difficult to stave off any margin pressure in 4Q or how are you looking at the margin?

Allan R. Landon

Kent, do you want to address that?

Kent T. Lucien

Yeah, I think the margin is pretty solid. Obviously in the third quarter we had good results and so we have very similar environment as we approach the fourth quarter, so I would anticipate a very similar kind of number.

Brett Rabatin - FTN Midwest

Okay. All right, great. Thanks for all the color.

Operator

Your next question comes from the line of Andrea Jao of Barclays Capital.

Andrea Jao - Barclays Capital

I was hoping to get more detail on what is going on with the different deposit categories. I know you spoke earlier about reclassifying some from non-interest bearing to interest-bearing demand, but deposits appeared a little weak this quarter. I was hoping to see what you were you seeing early into the fourth quarter and what you expected for these.

Allan R. Landon

Peter, do you want to --

Peter S. Ho

Sure. Al mentioned the product revisions that we put in place and really on that front, what we did was transition $254 million, $255 million from non-interest bearing to interest-bearing, and with the introduction of our free checking product, we wanted to make sure that we were adding value to all of our products. We made a decision to add what I think amounts to three basis points in annual rates to a new product, so that’s what is creating that repositioning.

You are seeing non-interest bearing -- if you were to true it up, you would add back the 254 and that would give you a variance of instead of minus $285 million, you’d look at more like minus $31 million.

On the interest-bearing side, that’s a recipient of the inverse of that situation and we have a variance on the balance sheet of $83 million, right? If you subtract it out, the product revision, you’d have a negative number but in that category, we also had a good amount of municipality activity. So for instance, we had one of the larger counties in the islands make a bond payment just at the end of the quarter, so basically our deposits in our government books fell about $72 million there as a result of that transaction. And we had a number of other transactions -- another county had $26 million. The aggregate of those types of transactions is about $116 million.

So the true number, there’s -- those transactions are going to come and go plus and minus for us quarter in and quarter out but if you trued that up and trued the product revision, interest bearing would be -- call it minus $50-ish million on an adjusted basis.

On the savings side, you will see a negative movement there, $42 million for the quarter on a linked basis. And there as we have seen in a number of other quarters, we have a good amount of commercial escrow business and a good amount of movement there, so we had about $86 million within the quarter of run-downs that we were anticipating. These are large deposit accounts that we had garnered through our commercial escrow area that we are now funding out as projects were being developed and nearing completion. So if you true that out, actually our savings balances negating out the run-down in the commercial escrow balances were actually up kind of in the $40 million range, mostly driven from our consumer side.

And then on the time side, you see that balances were pretty flat quarter on quarter and that’s the deposit decision that we’ve been -- we’ve had for a while now.

Allan R. Landon

Andrea, how did you like that? Pretty good analysis from Peter, huh?

Andrea Jao - Barclays Capital

That’s pretty detailed. I didn’t have to say a thing.

Peter S. Ho

I read your mind, Andrea.

Allan R. Landon

I would say two things I’d want to add, Andrea. We have been the beneficiary of some international deposits for quite a few years as a part of our strategy, sort of owing to the uniqueness of the Hawaii location. And as some of our international depositors looked at the economy and particularly the government response to that in the U.S. in the third quarter, I think without regard to which institution they were in, they decided to bring some of those deposits back to their home country, and so that had some impact on us.

And then we looked at very carefully at what was going on and our treasurer spent some time confirming credit availability that was accessible to us. When we looked at the cost of increasing deposit rates in the marketplace or borrowing wholesale, it helped our margin quite nicely in the third quarter and we felt confident enough in our lenders that we go ahead and do that. So we kept our deposit raising capacity pretty available here. We do see customers drawing down some of their excess liquidity and we suspect that that’s going to continue for a while but we think there’s plenty of room should we need the money to go out to our customers with attractive product offerings. We repositioned at the beginning of the quarter and while the interest we are paying on our deposits is not a very attractive rate right now, we can change that pretty quickly when the time becomes advantageous to do so.

Andrea Jao - Barclays Capital

Okay. Thank you. My follow-up question is on the fee income -- is on fee income line items. I was wondering how to think about what was recurring, what was not recurring to get a good run-rate. So clearly the $2.4 million in mortgage banking valuation adjustments don’t recur. I mean, is $3 million --

Allan R. Landon

That depends on the accounting gods, doesn’t it?

Andrea Jao - Barclays Capital

So is $2.5 million to $3 million a good run-rate, or do you expect less originations to continue to pressure the line items?

Allan R. Landon

Kent, do you want to respond to that?

Kent T. Lucien

Well obviously the MSR item is difficult to predict between the quarters and the negative item this quarter is -- I just wouldn’t anticipate that same result necessarily in the fourth quarter but who knows? I mean, the fundamental mortgage business, you know, it’s down. It’s down for everyone but we continue to be fairly solid in that category and we were pretty solid in the second quarter as well.

Allan R. Landon

Pricing in the Jumbo mortgage origination has been a little bit unusual here in Hawaii over the last quarter or two, Andrea, in that it’s less expensive than it appears to be in many mainland sources, so we’re just going to have to watch that but we decided not to deeply discount and play any larger role than just normal good service and customer relations would bring us there. And then there is a little bit of seasonality in the insurance line that looks like it will come to us in the fourth quarter when previously it had been in the third quarter.

Andrea Jao - Barclays Capital

Okay. Thank you so much.

Operator

Your next question comes from the line of Erika Penala.

Erika Penala - Merrill Lynch

I was just wondering, my questions were for Mary, if you could share with us what your early staged delinquencies are looking like quarter over quarter?

Mary E. Sellers

Actually, both our 30 to 59 day and 60 to 89 day are flat on a linked quarter basis, although there’s a modest move in the consumer piece and a downward drift in CNI. And we are actually down on a year-over-year basis but we do see some modest increase in the 1 to 29 day, which keeps us cautious.

Erika Penala - Merrill Lynch

And you spoke to the specific loan exposures that give you pause -- are there any broad categories that worry you more now? I mean, broad loan segment categories that worry you more now than it did a quarter ago?

Allan R. Landon

Yes.

Erika Penala - Merrill Lynch

Everything? Sorry, [gallow’s] humor.

Allan R. Landon

Well, it’s not quite that bad, Erika, but yeah, I think as we see, and I tried to touch on it, our customers are telling us that visitor arrival expectations here up until the holidays anyway are for fewer arrivals and that just continues further a trend. And so that sort of softens all of the economy. Auto sales continue to be down and you saw unemployment tick up a little bit in Hawaii and I think we are all cautious about that. It’s still only at 4.5%. I don’t mean to make light of only if you are in that 4.5% -- that’s no good place to be but compared to what we here about a market like California, where I think the number is approaching 8%, we are still relatively well off. So I think that and our underwriting posture, Mary mentioned the delinquencies -- we look reasonably good right now but we are a little more cautious, I think.

Erika Penala - Merrill Lynch

And on the mortgage side, clearly the demand from the consumer is waning but you know, you spoke that there were several mainland financial institutions that had come to Hawaii and now that they have -- no longer exist as they did, do you suspect that you could take advantage and climb back up in the lead tables in terms of origination, even if the pie is certainly much smaller?

Allan R. Landon

Eventually we think that will be the case. So far this year, there’s been an in-market competitor who has been very aggressive in putting those loans on their books. I haven’t seen any third quarter results, and they have been advantaged to the customers in pricing and when we looked at it, there just wasn’t any money in it at that level for us and we’ve been pretty faithful to if it doesn’t have something for the shareholder in it, then we are not going to put the risks on the balance sheet, so that’s the decision we’ve made. Hopefully those prices will adjust here in the marketplace and normalize and then that will have some upside for us.

Erika Penala - Merrill Lynch

Okay. Thanks for your time.

Operator

Your next question comes from the line of [Terry Maltiff] of Sandler O’Neill Asset Management.

Terry Maltiff - Sandler O’Neill & Partners

My questions were asked and already answered, so thank you.

Operator

Your next question comes from the line of Robert Bohlen of KBW.

Robert Bohlen - Keefe, Bruyette & Woods

When I think about you guys and using tarp and looking at your business model and looking at your capital and everything, I was wondering if you could walk me through maybe what a positive usage for tarp would be for Bank of Hawaii as you guys go through and determine if you will participate or not.

Allan R. Landon

Well, we are still acclimating to the new world of government ownership, so we think that a positive use would be to increase share value. Now, the guidance that comes out says that you should take the money and increase lending but not add risk, and we think we’ve been pretty thoughtful about lending and controlling our risk profile, so initially just the shareholder economics of this don’t seem terribly compelling. On the other hand, we don’t have the perspective on the marketplace and the global economy that you get from Washington or New York, and our perspective would be that these programs are created for a reason and sometimes having a back-stop of capital behind you is a good thing to do. We’ve got good capital generation capabilities. You can see what we are doing with our share repurchase program and as we lower that, our capital generation looks pretty strong for us. So it’s a matter of what can we do to lever that money that’s consistent with the intent of the program and value-adding for our shareholders while making sure that we are good banking citizens and stay in the right category of regulatory oversight.

But I don’t mean to be too cryptic about that, Bobby, but we are just continuing to weigh it. We talked with our board about that Friday and those are some of the factors that we considered. We went ahead and approved some authorization to buy back shares and increased our dividends, just in the event that we go ahead business as normal but we’ll decide here in the next week or two whether participation is the better part of all of this.

Robert Bohlen - Keefe, Bruyette & Woods

Okay, that was actually very helpful, the way you walked through it.

Allan R. Landon

Okay, thanks.

Robert Bohlen - Keefe, Bruyette & Woods

Thank you.

Operator

Your next question comes from the line of Justin [Maura] of Lord Abbott.

Justin Maura - Lord Abbott

Staying on that theme, Al, as I’m calculating it and correct me if I’m wrong here, you guys can build about 30 basis points a quarter of tangible equity, just taking your run-rate of net income less divs -- does that sound about right?

Justin Maura - Lord Abbott

We have been a little bit more conservative, I think about 100 basis points a year, so we are in the same league.

Justin Maura - Lord Abbott

Okay, fair enough. So just again thematically, I presume you would think that’s a cheaper way to go, so to speak, and can build capital quickly versus the government alternative, although that’s not particularly expensive capital but you wonder what strings are attached, I guess. Is that fair?

Allan R. Landon

I think yeah, that’s a good summarization. We just look at our costs of capital and the government program for us at this stage of the evolution of that program would appear to be somewhere upper six, low seven effective rate when you use the accounting that gets applied. And that is fairly cheap versus what we think is a cost of equity, maybe even a cost of debt out there in the marketplace. So the initial teaser rate on that looks pretty good and internally, we said gee, if we take 3% now and we can have an internal generation rate of 1% a year, 3%, three years we’ve internally refunded that, we say that doesn’t seem to be terribly risky but I did comment that these programs appear to have some evolutionary nature to them. Maybe that’s the concerning part of this.

On the other hand, it seems rather fashionable right now to have government ownership, so maybe that’s the better part. You can tell we don’t have a clear resolve on this and we’re a little bit old-fashioned. We sort of believe that shareholders should be -- well, I’ll stop there. I’ll get myself in trouble.

Justin Maura - Lord Abbott

But it’s -- I presume as part of your evolutionary comment, you couldn’t take down the government’s capital and then turn around and keep buying back stock, right?

Allan R. Landon

Well, that’s the way it’s been announced and that would sure seem contrary to the intent of the plan and frankly, if government announced a plan that would allow banks to do that, then we wouldn’t participate on principal, I think.

Justin Maura - Lord Abbott

Okay. Just a little more color on the three credit identification -- one you said was a retail developer that is showing a little signs of stress?

Mary E. Sellers

They actually performance wise have been continuing to generate strong cash flow but they have debt maturities that they are really unable to finance at this point.

Justin Maura - Lord Abbott

And sorry, Mary, if you mentioned, are each of these roughly about the same in terms of size to you guys or --

Mary E. Sellers

Two are a little bit larger than the third but in the same neighborhood.

Justin Maura - Lord Abbott

Okay, and the structure of the leveraged lease, what is it? Are there capital calls or something on the securitization or what is it that’s making that stressed?

Allan R. Landon

There’s a conduit in the middle that has other operations than we’ve participated in and so it’s drafted money out. That’s the structural problem that we would talk about just kind of generally, Justin.

Justin Maura - Lord Abbott

Okay. All right, thanks, guys.

Operator

Your next question comes from the line of Brian Zabora of Stifel Nicolaus.

Brian Zabora - Stifel Nicolaus

Just a quick question on the over-provision -- you’ve detailed the three credit. I was wondering if you could break down the $13 million over-provision between those three loans -- maybe not exactly the loans or in aggregate -- and then how much you set aside for kind of the general risk or the weakening economy?

Allan R. Landon

No.

Brian Zabora - Stifel Nicolaus

Okay, fair enough.

Allan R. Landon

I hope you don’t mind me kidding with you, but thank you first of all for the comment “over-provision”. We’ll leave that as your words, not ours. We were fortunate to be able to do that and while we use a formula to calculate roughly what our exposures are, I wouldn’t feel that it’s precise enough to give anybody those details. We tend to think of our entire allowance as available to absorb losses in the event that something should come upon us unexpectedly, and that’s the primary way we think about it.

Brian Zabora - Stifel Nicolaus

Okay, and just a quick question on the margin -- you talk about in the second quarter kind of defending the margin, a very completely different scenario. We thought rates would be going up, not doing down. But you made your comments on fourth quarter margin but what are your thoughts as far as defending the margin, or maybe doing some strategies to maybe give up some near-term expansion or for a longer term -- margin at a higher level longer term?

Allan R. Landon

Sure. That was part of our deposit pricing decision, actually, and as you observed, the environment has changed, the interest rate forecast has changed and so our team watches that pretty closely and when we get a clear signal that it is time to extend liabilities, that’s probably what we will do. And we’ve been a little bit skeptical both about return and credit on investment, so we just have let the investment side of our balance sheet come in a little bit here over the last quarter. We’ll keep an eye on that. We think eventually there will be some clarification there and there will probably be some asset or particular liability extension opportunities and we’ll pursue them when we think it’s the right time.

Brian Zabora - Stifel Nicolaus

Great. Thank you very much.

Operator

Your next question comes from the line of [Sirin Roylu] of Blackrock Financial.

Sirin Roylu - Blackrock Financial

I have a quick question and I guess -- I’m not sure if I’m going to be able to get the answer, full answer but regarding those three loans that were put on a special watch, can you give a bit of better color on how much -- of the current reserve, how much does it cover the loan? So basically it’s probably not 100% but how much over-provided those loans are? And then any detail on how big those loans are? And then on the construction loans, one of the two, what’s your overall exposure to this retail development, both in Hawaii as well as a percentage of total loans?

Allan R. Landon

I have banned Mary from saying anything more about them.

Sirin Roylu - Blackrock Financial

Okay.

Allan R. Landon

We think we are adequately reserved, given where we stand right now. And none of these loans are of such a size that they stand out in the evaluation of the company or our financial performance going forward. So they are all manageable. We are a loss averse company so any loss would be disappointing to us but right now we think based on what we see, we’ve been pretty conservative but prudent in providing a reserve for these overall and we’ll see how the credit market goes. If credit loosens up, the one company should be able to refinance just fine. They are a solid company with a great reputation and -- but we are just going to have to see what the fourth quarter brings us.

Sirin Roylu - Blackrock Financial

Okay. And then another quick one on the conduit -- is that off your balance sheet and --

Allan R. Landon

Oh, it’s somebody else’s conduit. We just bought into it and as we watched what was going on here in the credit markets, closer examination tells us that it’s not a direct flow from the ultimate lessor of the property to us as the financier. And so we’ve got some structural things in that that our team is going to have to work on over the course of the next six months.

Sirin Roylu - Blackrock Financial

You’re not the back stop, right? If that conduit gets in trouble, you are not liable to go in and start providing financial support, are you?

Allan R. Landon

No, no, no -- this is a purchase deal. I’m afraid you may be looking at this as more complicated than it is. A salesperson came to Hawaii and enticed our leasing people to invest in this lease. When things look good, we were told this is a great structure and now there’s a little bit of stress in the economy and it’s not such a great structure.

Sirin Roylu - Blackrock Financial

Okay, and then last question on the margin -- you mentioned that the jumbo rates in Hawaii are still below those in mainland, and then you also said that there had been an in-market competitor that’s been very aggressive in pricing. Is that the main reason? And I was wondering if you could, you know who that bank is, if you can name it, if you can’t --

Allan R. Landon

We can’t. We don’t -- we’re trying to describe the market, not the other banks and I’m sure there’s a broad range of prices or rates on jumbo loans around the country but we just look at some of the published rate sheets from some of the larger mortgage lenders on the mainland and see a disparity between what they are quoting and what appears on the rate sheets of the banks in Hawaii. And so when we look at our own pricing and profitability for those loans, we ask if we want to put on assets with residential real estate credit risk at that yield and our calculations say not right for us.

Sirin Roylu - Blackrock Financial

Thank you.

Operator

Your next question comes from the line of John Flanagan.

John Flanagan - Analyst

Al, I’m very shocked at the degree of decline in August arrivals. I wonder if you’ve seen it that soft in recent years. Are there any hotels or resort properties that are kind of extended in this environment that could be problems for you guys?

Allan R. Landon

Yes, John, it seemed to fall off pretty significantly and anecdotally, depending on who we talk with, we see an extension of that at least up until the holiday season. When we talk with our resort customers who are in most cases deposit customers, we see a broad range of information from those who have been running in the 90s on occupancy percentage down to those that I think are bearing the brunt of this.

That’s the color I would provide. Peter, you get a chance to touch base with people in the marketplace too. What are you hearing, anything in addition to that for John?

Peter S. Ho

No, I think that’s the right color on the topic. One of the other pieces that we are seeing is that the larger operators, the operators with rewards programs are faring a good amount better than some of the smaller independents that have cropped up over the past several years, so in our client base, we tend to be banking the larger hotel companies, the more name companies, if you will. We are not seeing quite as much downside as I think there may be in the marketplace.

John Flanagan - Analyst

Also, could I ask Cindy if Nordstrom’s has opened, and how it looks?

Cindy G. Wyrick

Yes, John, it is and I have been very patriotic in supporting them.

John Flanagan - Analyst

Have you? That hasn’t helped the stock.

Allan R. Landon

Cindy is doing as much as we will let her do. We’re happy to have them here in town but you know, they get caught, I’m sure, just like everybody else -- when arrivals slow down, it makes everybody a little less confident.

John Flanagan - Analyst

Their timing doesn’t look fabulous.

Allan R. Landon

Well, I suspect they are a long-term investor in this. I can appreciate how their team must feel right now because as you observed, the arrivals have slowed down and that’s got to be hurting business but long-term, it’s a nice facility and we are optimistic it is going to do well for the folks at Nordstrom and for us here in Hawaii too.

John Flanagan - Analyst

Good. Thanks a lot.

Allan R. Landon

Are you going to come out and see us, John?

John Flanagan - Analyst

I’m trying to but the market goes another 200 points, I may have to forget it.

Allan R. Landon

If it goes another 200 points, room rates will be even cheaper. It’s probably a better time to come.

John Flanagan - Analyst

That depends on where I’d be staying.

Allan R. Landon

We’ll get ourselves in trouble here.

John Flanagan - Analyst

I don’t want one of those little dinky motels.

Allan R. Landon

Okay, we gotcha.

John Flanagan - Analyst

Thanks a lot.

Operator

Your next question comes from the line of Aaron Deer of Sandler O’Neill.

Aaron Deer - Sandler O’Neill & Partners

Most of my questions were answered but maybe just a couple -- with regulators having recently completed their annual [SNIC] review, I was wondering if you could give us an update on the performance of that portfolio, and what is that down to at this point?

Mary E. Sellers

We’re down to about -- let me just double-check my quote before I -- we are down to about $440 million in outstandings. We’ve actually been down over the past two years versus the industry total that’s been climbing at double-digit rates. And the quality of our portfolio is well below that that was disclosed within the national markets.

Allan R. Landon

Well better than --

Mary E. Sellers

I’m sorry, yes. That’s what I mean. Whoops.

Allan R. Landon

Just to make sure everybody understands our directional sense.

Aaron Deer - Sandler O’Neill & Partners

Okay, very good. And then trust and asset management fees were down some -- how reflective is that of what’s been going on at market values as we step through the end of the quarter and what are you expecting in that business for the fourth quarter?

Kent T. Lucien

There’s some seasonality in Q3, so that’s $500,000 variance from Q2 on tax services, first of all, so that gives you call it an $800,000 delta on a linked basis. And our sense is the majority of that is market decline. We did have some assets just roll off out of the firm but most of it is market decline and for the fourth quarter, I think we’d anticipate to see the trend in trust fee revenue trend out of the overall markets.

Aaron Deer - Sandler O’Neill & Partners

Okay, great. Thank you, all.

Operator

Your next question comes from the line of Lisa Walker of Blackrock Financial.

Lisa Walker - Blackrock Financial

I just had a follow-up on your comment on the evolutionary nature of the tarp, the capital injections, and is that that you don’t know what the final outcome as far as what the requirement or what the -- what it will look like to the participants or -- I just wonder what -- and I’m wondering if you think it will be more positive or negative or you just don’t -- or it’s just uncertain is what you are talking about when you say evolutionary?

Allan R. Landon

I think it’s just uncertain to us. You know, the -- well, there’s just several ways to look at it. Let’s just say that insurance companies get invited in and that changes the mix and intent of this a little bit. I’ll try to I think keep it as we are thinking about it. The original intent was to help credit availability. We feel we have sufficient resources to meet the credit needs in the marketplace. Then there was a lot of talk about well, this is the right thing to do and it should be a back-stop and deepen capital resources and we would think most banks should participate. It doesn’t -- it isn't clear to us yet that that’s exactly the case, and so we are just going to watch, try to get as much insight as we can.

As I said before, our motivation for participating would be what’s in the best interest of our shareholders long-term, and so we have to find a way to add value and we only want to do that if we can participate to the intent of the program. I mean, it’s government money, right, and that seems to me the responsible thing to do.

Lisa Walker - Blackrock Financial

And it’s your thought that they -- it will limit your ability to be flexible in actions that you want to take currently?

Allan R. Landon

Well you know, our capital management program includes a share repurchase and we’ve been able to maintain annual dividend increases here. That program has worked pretty well for us and for our shareholders and you are limited in both of those if you participate in the tarp. Plus it makes the government when you weigh in the warrants, if you take the maximum in our case approaching a 25% shareholder. The initial intent is that they are not an active shareholder and they are not going to participate in the management. That’s the initial intent, so we’re just cautious about it. You got any insight for us?

Lisa Walker - Blackrock Financial

Well, I’d be interested in your view on what the names that we’ve seen that have come out today, it doesn’t seem the same as what we saw in the first round, and some of the names -- I know Secretary Paulsen had said he’s looking at strong banks, which I think that’s why we’re talking, but then I think the list I saw today doesn’t imply that that’s exclusively what they are looking at.

Allan R. Landon

Well, I can’t comment on that. We just want to make sure if we do anything, people say well, there’s another strong bank that got some additional capital.

Lisa Walker - Blackrock Financial

Thank you.

Operator

Your next question comes from the line of Andrea Jao from Barclays.

Andrea Jao - Barclays Capital

Hello again. A couple of follow-up questions -- first, how do we think about the tax rate for full-year ’08, given that there have been some significant non-recurring items this quarter and I think also in the first quarter, right? So what does that imply for how much more taxes you need to recognize in the fourth quarter? And then how do you think of the tax rate in ’09?

Kent T. Lucien

Obviously the first and third quarters were unusual. Perhaps the second quarter would be more representative of a typical period without so much of these special items. So that might be one way to look at it.

And as to 2009, I don’t really have any other comments, other than again maybe the second quarter is the best indicator.

Andrea Jao - Barclays Capital

Okay, and then my follow-up question I was hoping you could share with us your outlook for the interest rate environment and the economy both for the remainder of ’08 and into ’09? And then given those assumptions, do you think your balance sheet will continue to shrink even through 2009?

Allan R. Landon

Andrea, I want to help you but I don’t know that we’ve got any great insight into anything. I’ll tell you, we are prepared for whatever reasonably may come along with the expectation that it might not even be reasonable in what comes along. You know, the conventional wisdom is short rates get reduced here in the near-term. I think we would probably follow that conventional wisdom and then you know, there are just a lot of forces at work out there. We’re going to have an election and you brought up tax policy -- we’re not in favor of tax increases for banks, by the way, and we’ll have to see. There are just too many factors for us to say. I will tell you that we will allow our balance sheet to move in either direction, depending on what we think will be best for the long-term and what’s in balance with the demands in our marketplace. We’re not going to force lending and we are not going to back away from opportunities to put good loans on the books.

Andrea Jao - Barclays Capital

Okay. Thank you.

Operator

Your next question comes from the line of Justin Maura of Lord Abbott.

Justin Maura - Lord Abbott

Sorry to lengthen this call -- one question I forgot was on the bonuses, on the $2 million. Al, back in the first quarter, I think it was, with the Visa winnings or MasterCard there, rather, you had set some aside. Was the business tracking better than you guys had budgeted out at that time, requiring the additional $2 million? Or what’s the little extra oomph there?

Allan R. Landon

Yeah, back in the first quarter, we had a different interest rate scenario and so it looked like we were going to get a disproportionate share of our annual earnings in the first quarter and so that’s why we accrued up there. And now we are looking at what the economy and performance looks like into next year and so we just got ourselves accrued up here at the end of the third quarter, not knowing what comes our way. We’ve been pretty conservative in terms of how we manage the company and when we get a little bit of positive news on the income side, why we try to share that with our employees when we can, or at least indicate that’s our intent.

Justin Maura - Lord Abbott

Fair enough. Thank you, guys.

Operator

And your next question is a follow-up question from Robert Bohlen of KBW.

Robert Bohlen - Keefe, Bruyette & Woods

Just quickly, deposit insurance assessments, what are you seeing in those in terms of that?

Allan R. Landon

Kent.

Kent T. Lucien

It’s going to go up. It’s going to be a more expensive item for us going forward. I mean, they are talking about perhaps a doubling of the assessment.

Robert Bohlen - Keefe, Bruyette & Woods

Okay, so that could be pretty significant throughout the other expenses line?

Kent T. Lucien

Well, it’s going to be important to us, yes.

Robert Bohlen - Keefe, Bruyette & Woods

Okay. All right, that was it. Thank you.

Operator

You have no further questions. I would now like to turn the presentation back over to management for closing remarks.

Cindy G. Wyrick

I would like to thank everyone for joining us today and for your interest in the Bank of Hawaii. As always, if you have additional questions or need further clarification, please feel free to contact me, 808-694-8430. Have a great day.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes your presentation and you may now disconnect. Have a great day.

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