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Bank of Hawaii Corporation (NYSE:BOH)

Q4 2013 Earnings Call

January 27, 2014, 6:00 PM ET

Executives

Cindy Wyrick - Executive Vice President and Director of Investor Relations

Peter Ho - Chairman, President and Chief Executive Officer

Kent Lucien - Vice Chairman and Chief Financial Officer

Mary Sellers - Vice Chair and Chief Risk Officer

Analysts

Ebrahim Poonawala - Bank of America Merrill Lynch

Aaron Deer - Sandler O'Neill

Jeff Rulis - D. A. Davidson

Nick Karzon - Credit Suisse

Jacky Chimera - KBW

Brett Rabatin - Sterne, Agee

Joe Morford - RBC Capital Markets

Operator

Welcome to the Fourth Quarter Bank of Hawaii Corporation Earnings Conference Call. (Operator Instructions) I will now turn the call over to Cindy Wyrick. You may begin.

Cindy Wyrick

Thank you, Alexandra. Good afternoon, everyone, and thank you for joining us today. Joining me this afternoon is Chairman, President and CEO, Peter Ho; our Vice Chairman and Chief Financial Officer, Kent Lucien; and Vice Chair and Chief Risk Officer, Mary Sellers. The comments today will refer to the financial information included in the earnings announcement released 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'd like to turn the call over to Peter Ho.

Peter Ho

Thanks, Cindy. Good afternoon, everyone, and thanks for joining us today. We're pleased with our financial results for the fourth quarter 2013. Overall loan demand was solid this quarter. Outstanding loan balances grew 1.5% from the previous quarter. We were especially pleased to see positive results in both our commercial and consumer portfolios this quarter, as we've been anticipating and hoping to see such.

We also continued to grow overall deposits during the quarter. Most importantly, core consumer and commercial deposit balances grew 2% for the fourth quarter. Due to our growing balance sheet and the steeper yield curve, net interest income increased from the fourth quarter and our net interest margin widened by 2 basis points. Liquidity and capital levels remained robust at year-end. Credit quality, aside from a single and isolated commercial credit situation, which has been fully provided for, remained stable.

And now, let me turn the call over to Kent to provide you further detail.

Kent Lucien

Thank you, Peter. Net income for the fourth quarter was $39.1 million or $0.88 per share compared to $37.7 million or $0.85 per share in the third quarter and $40.3 million or $0.90 per share in the fourth quarter of 2012. Our return on assets in the fourth quarter was 1.12%, and return on equity was 15.4%. Our efficiency ratio was 60%.

Full year 2013 net income was $150.5 million or $3.38 per share compared to $166.1 million or $3.67 per share in 2012. Year-to-date return on assets was 1.10%, and return on equity was 14.8%. Our year-to-date efficiency ratio was 60.7%.

Our net interest margin in the fourth quarter was 2.85% compared to 2.83% in the third quarter and 2.87% in the fourth quarter of 2012. The higher net interest margin was primarily due to lower premium amortization in our securities portfolio, continuing loan growth and higher levels of securities re-pricing.

Premium amortization was $13.8 million this quarter compared to $14.4 million in the third quarter. Average loans grew 2.7% sequentially, and the investment portfolio reinvestment differential was a positive 21 basis points.

There was no credit provision in the fourth quarter of 2013. Net charge-offs in the quarter were $8.2 million. Our allowance for loan and lease losses at the end of the fourth quarter was $115.5 million or 1.9% of outstanding loan and leases.

Non-interest income for the fourth quarter was $45.3 million compared to $45.1 million in the third quarter and $53 million in the fourth quarter of 2012. The decrease compared to the prior year was primarily due to a decrease in mortgage banking income. Mortgage income was $2.8 million compared to $4.1 million in the third quarter and $11.3 million in the fourth quarter of 2012. Year-to-date non-interest income was $186.2 million compared to $200.3 million in 2012.

Non-interest expense totaled $82.4 million in the fourth quarter compared to $83 million in the third quarter and $83.5 million in the fourth quarter of 2012. The decrease compared to the third quarter of 2013 as well as Q4 2012 was primarily due to lower salaries and benefit expense and occupancy costs. Year-to-date non-interest expense was $331 million compared to $334.3 million in 2012. Also, our separation expense was $2.1 million higher in 2013 versus 2012.

The effective income tax rate was 29% in the fourth quarter compared to 28.9% in the third quarter and 32.7% in the fourth quarter of 2012. The lower rate in the fourth quarter of 2013 was primarily due to the utilization of capital losses on the sale of low-income housing investment.

Our investment portfolio now stands at $7 billion. The average duration of the AFS portfolio is 3 years and overall portfolio duration is 3.9 years. Loans were $6.1 billion at the end of the fourth quarter, up $89 million or 1.5% compared to the end of the third quarter and up $241 million or 4.1% from the end of the fourth quarter of 2012. Deposits were $11.9 billion at the end of the fourth quarter, up $307 million compared to the end of the third quarter and up $385 million from the end of the fourth quarter of 2012.

Our shareholders' equity was $1 billion at the end of the fourth quarter, and we paid out $20.1 million in dividends and continued our share repurchase program in the fourth quarter, repurchasing 86,000 shares of common stock for $5 million. Our board declared a dividend of $0.45 per share for the fourth quarter. At the end of the fourth quarter, our tangible common equity to risk-weighted assets was 15.5%, and our Tier 1 leverage ratio was 7.1%.

And I'll turn the call over to Mary Sellers.

Mary Sellers

Thank you, Kent. Net charge-offs for the fourth quarter totaled $8.2 million, up $7.3 million on a linked-quarter basis and up $6.1 million year-over-year. Both the linked period and year-over-year increase were due to a $6.6 million charge-off related the commercial loan in Guam. For the full year, net charge-offs were $13.4 million or 0.23% of total average loans and leases.

Non-performing assets totaled $39.7 million at the end of the year, up $5.8 million from the third quarter and up $2.6 million year-over-year, again due to the commercial loan in Guam. Accruing loans and leases past due 90 days or more totaled $9.9 million at year-end, down $1.5 million on a linked-quarter basis and down $551,000 year-over-year. Both decreases were due to reduction in residential mortgage loans.

Restructured loans not included in non-accrual loans or loans past due 90 days or more totaled $51.1 million at year-end, up $11.3 million from the third quarter and $19.3 million from the prior year. The increase was primarily due to the restructure of a Hawaii commercial loan, which is expected to be fully repaid during the first quarter of this year. Also included in the $51.1 million were $22.8 in residential mortgage loans modified to assist our customers in retaining their homes.

We continue to see improvement in what we consider to be the higher risk segments in our portfolio. In total, these segments were down $2 million for the quarter and $12 million for the year. As Kent shared, we recorded no provision for loan and lease losses in the fourth quarter, which, given net charge-offs of the $8.2 million, reduced the allowance to $115.5 million. We continue to estimate the required level of allowance based upon the economic environment, asset quality dynamics and portfolio growth and composition.

I'll now turn the call back to Peter.

Peter Ho

Thanks, Mary. Let me finish with a little commentary on Hawaiian economy, which continued to perform well. On the visitor front, 2013 is on track to be another record year for tourism in Hawaii. For the first 11 months of 2013, total visitor arrivals increased by 3% and delivered spending increase by 2.9% over the record level over the same period in 2012. While spending in arrival softened a bit late in the year, it's important to remember that 2013 is hopping off of three very strong years in both arrival and spending growth. Further we'll begin to see our China market benefit from direct air service from one carrier last year to three in 2014, with Air China and Hawaiian Airlines joining China Eastern.

The real estate market looks strong as well. Oahu single-family home and condominium median prices rose 4.8% and 4.6% in the year. And the volume of home sales was also strong, up 4.6% for single-family homes and 11.8% for condominiums. Inventories remained at very low levels, at currently 2.7 months for single-family and 2.9 months for condominiums. And average days on market were 20 and 21 days for single-family and condominiums respectively in 2013.

Construction activity should pick up in 2014, as progress on the city's rail project, more than over a dozen announced condominium projects and three major retail projects advance. The state-wide seasonally-adjusted unemployment rate declined to 4.4% in November, down from 5.1% in December of 2012 and significantly better than the national rate of 7%.

Thanks again for joining us. We'll be happy to respond to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Ebrahim Poonawala from Bank of America Merrill Lynch. Please go ahead.

Ebrahim Poonawala - Bank of America Merrill Lynch

I was wondering if first we could just start off in terms of you being upbeat regarding the local economy for the last couple of quarters now. And I'm just wondering with pretty strong loan growth this quarter, as we look out in the next year, should we expect loan growth to pick up for what we've seen in the fourth quarter?

Peter Ho

What's happened is I think our commercial environment has led the loan categories, because what's happening in our real estate market and what has been happening in our visitor segment. So I would imagine that we will continue to see similar trending on the commercial side, which as you noted has been strong from the past year or so.

We are beginning to see traction on the consumer front, non-residential mortgage consumer front, nice growth in installment lending, nice growth in dealer and direct lending, good car sales in the islands this year. So hopefully, what had been a bit of a lagging strength pulls up a little bit closer to how commercial lending has fared over the past year or so.

And I think the last component is going to be residential mortgage. And there, we're hopeful that we may begin to see growth in resi mortgages on our balance sheet for the reason that we just aren't going to be pushing that through the for-sale mechanism as much as we had in the past. As gains on sale reduce and frankly as overall volumes reduce, it just may make more sense for us to put those loans on to our balance sheet. So there is a potential to see growth there.

So I think the answer to your question, we're looking for continued growth certainly in line with what we've seen on the commercial side and potentially some uptick on both the residential and consumer side.

Ebrahim Poonawala - Bank of America Merrill Lynch

I guess just tied to then in terms of anything about sort of mortgage banking earnings looking out, should the fourth quarter be sort of a sustainable run rate even if the balance sheet more of the volume going higher or should that drop off even more?

Peter Ho

Well, the problem with the most stable element of our mortgage income is our servicing income, and that's, call it, $2 million a quarter. So we're comfortable with an $8 million per year mark. And anything above and beyond that is going to be a function of what happens in the for-sale market for us, which as you point out, has been pretty sluggish of late.

Ebrahim Poonawala - Bank of America Merrill Lynch

And if I could, one last question on reserve release, it seems like a pace of reserve release actually linked in the fourth quarter. I'm just wondering as we look out more than sort of a year-end catch up, as you updated your model, should we again return to a more slower pace of reserve release? I'm just trying to get a handle on when do we actually start seeing a provisioning built tied to loan growth as we move forward?

Mary Sellers

Well, I think it's hard to predict to future to determine exactly when that will occur. But as you indicated, it's a function of the growth in our portfolio, economic dynamics and asset quality metrics. So we got to play those each quarter and as they will play out this year.

Peter Ho

We're getting closer to provisioning, but we're not quite there yet.

Operator

We have a question from Aaron Deer from Sandler O'Neill. Please go ahead.

Aaron Deer - Sandler O'Neill

Mary, a question for you on the Guam loan. I'm guessing it's just kind of a one-off situation, but I was wondering if you could let us know what business (inaudible) borrower and if there's any collateral on that credit and then what your expectations are in terms of the potential for any additional right terms of recoveries on that?

Mary Sellers

Well, I can share that it's a 15-year clients of ours that had a shift in their business model. It is an evolving situation. As Peter indicated, we are truly reserved for the balance and that's really for the potential downside, just given the uncertainty of the situation.

Aaron Deer - Sandler O'Neill

And then, Kent, you mentioned the tax rate being a little lower this year, had to do with low-income housing investment. Is that truly kind of a one small thing or do you expect that kind of given the investments that you've made that you're going to continue with something akin to this if sort of rates tread on this or is it going to bounce back to the 31%, 32% level?

Kent Lucien

Yeah, good question, Aaron. I think I've been providing guidance in the 30% to 35% range. And I think probably the way to think about it going forward is more in the 28% to 32% range just taking account of some of the investments we've made and some of the things we're planning. So that's the range that I would give you.

Operator

Jeff Rulis from D. A. Davidson is on line with a question. Please go ahead.

Jeff Rulis - D. A. Davidson

Just a question back on the mortgage banking, I guess, is there a lag in the expense side of that should mortgage banking approach that $8 million a year run rate? Is there a greater benefit still to play out on the cost side of that, or has that been in check than adjusted?

Kent Lucien

That's a bit of an evolving situation. Longer-term, there is clearly an expense opportunity just by virtue of the fact that commercial is going to be lower. One of the challenges that we have, though, is as we came out of the volume scenario that we came out of with the refinance, obviously there was a fair amount of deferred stuff just taking care of the administrative standpoint. So there is a bit of a lag there from a labor standpoint.

The other element that we are working through is determining exactly how QM is going to affect our marketplace. And so you've probably noted, but there're a number of vantage fronts to figure out what the additional resource requirements are going to be around QM and how do we continue to make all the good loans we want to make in that new environment. So we're stepping our way through that. I think longer-term, there is opportunity, but that may not play out for a whole.

Jeff Rulis - D. A. Davidson

And then we've seen a little pickup in the share repurchase in January relative to the Q4 rate. Any change in strategy or is it just the timing thing?

Kent Lucien

That's really a timing thing. We worked pretty hard in the fourth quarter to make sure that we get the Q1 leverage target that we've talked about previously. So we've done that. And so we would expect to see the repurchase activity step up quite a bit going forward compared to what we did in the fourth quarter.

Jeff Rulis - D. A. Davidson

It looks like the insurance line item is kind of taken off a little bit since the first half of the year of 2013. Anything driving that or would you expect further growth in that category?

Kent Lucien

Insurance income? If you're referring to the [ph] Bovey, we did have a pickup in the fourth quarter compared to a year ago and compared to the third quarter. [ph] Bovey, things happen and people unfortunately that pass away and that's how [ph] Bovey works. So we had some of that happen in the fourth quarter, but that's very difficult to predict.

Jeff Rulis - D. A. Davidson

Not on the [ph] Bovey, but insurance line item, non-interest income?

Kent Lucien

So it was $2.3 million in the fourth quarter, $2.2 million in the third quarter. So very, very comparable.

Operator

Nick Karzon from Credit Suisse is on line with a question. Please go ahead.

Nick Karzon - Credit Suisse

I guess first to start off on the other on non-interest expense, it looks like it stepped up a little bit quarter-over-quarter and the professional fees are also a little bit higher. I was wondering if those are related to the stress passed or some items that were a little bit immune to the fourth quarter?

Kent Lucien

Not really the stress passed per se. We're basically fund that with internal resources. We did spend some more money on advertising in the fourth quarter compared to the third quarter. And we had a little bit higher operating losses in the fourth quarter compared to the third quarter. The other line is pretty standard stuff.

Nick Karzon - Credit Suisse

As a follow-up, I was looking at the trajectory on the loan yields. And loan yields have come down about 2 basis points to 3 basis points a quarter. I mean the second and the third quarters fell a little bit further in the fourth quarter at 12 basis points. So wondering if there's any kind of guidance you can give in terms of what the new yields are kind of in the fourth quarter and what you're seeing in the first quarter. It might help us think about the trajectory there.

Kent Lucien

Yeah, good point. The yields came down about 12 basis points sequentially, but of that was associated with timing of fees. So there're fees associated with loans that are released in the interest income. And so there can be some timing. There was some more income in the third quarter compared to the fourth quarter. We also had a interest recovery in the third quarter that did not repeat in the fourth quarter. When you strip that out and the change was about 6 basis points negative, so we're still trending down. And what we saw into the fourth quarter was in terms of the average of new loan yields versus what was paid from insured was a minus 47 basis points.

Now that number actually is less compared to the third quarter, which had been 75 basis points. So still negative, but a smaller negative. And again, that's all related to the 6 basis point compression in the fourth quarter.

Nick Karzon - Credit Suisse

Just on the premium amortization comments that you made earlier, I was wondering if you could give us the premium amortization as it just relates to the MDS security portion of the portfolio?

Kent Lucien

I don't think we've been releasing that.

Nick Karzon - Credit Suisse

$8.7 million in the third quarter.

Kent Lucien

Okay. I'm looking at my notes here. The third quarter MDS amortization was $8.3 million and it was $7 million in the fourth quarter.

Operator

Jacky Chimera from KBW is on line with a question. Please go ahead.

Jacky Chimera - KBW

Just a quick follow-up on the premium again, are we nearing a bottom on that or do you think there's a little bit more room to go in future quarters, assuming rates continue to move up a bit?

Kent Lucien

Yeah. We might see some small negatives here, but I think we are kind of approaching the flat line, a pretty big change here between third and fourth quarter. I wouldn't necessarily predict the same amount going forward. But there's some small opportunity.

Jacky Chimera - KBW

That was a really good color you gave on the loan portfolio with the difference between what the loans were going on and where the portfolio was currently priced. Can you have that information for the securities stock?

Kent Lucien

As a matter of fact, I do. So I mentioned that it was a positive 21 basis points. What we put on in the fourth quarter average 2.26%. What came off was 2.05%.

Jacky Chimera - KBW

I noticed there was an increase in leases this quarter and it's been a little bit of time since we've seen that. Any sort of new lending that's going on or was there just kind of fluctuations in the portfolio?

Kent Lucien

Well, it's actually a positive trend. And so in our lease portfolio, we really have two portfolios going. One is a legacy leverage lease portfolio, which we're watching amortized to nothing. And then we have an equipment leasing operation and portfolio that we're trying to grow, because it's a solid operating business for us. And so what you saw in the fourth quarter, Jacky, was really about $12 million in new business coming on, a lot of related to what's happening on the construction side here in the island as compared to a couple of million dollars last year.

Jacky Chimera - KBW

So that's something we could see pick up this year as construction continues to grow?

Kent Lucien

Yeah, hopefully. And generally the way that these transactions work there, they're pretty heavily back-loaded to the third and fourth quarter.

Operator

Brett Rabatin from Sterne, Agee is on line with a question. Please go ahead.

Brett Rabatin - Sterne, Agee

I wanted to ask, if I could, just a little more color on expense for 2014 and maybe anything around branch structure. Do you guys have any plans of change the network this year, are there any kind of initiatives that you're looking at in terms of expenses going into the next year?

Peter Ho

Well, I think Kent has been pretty explicit in his guidance on expenses. What we would aspire to would be 1% annual reduction in absolute expenses. We still think that that's a pretty reasonable target from an operating standpoint as well as from a financial opportunity standpoint. The branch side, we still think there is opportunity there. The opportunities get a little bit more complex in that there's probably less opportunity to hold down a branch in a particular area that's strategic for us or meaningful for us.

So really what the opportunities are now are more just some wide opportunities. So where we have communities that are important communities for us and the population trend has moved in a certain direction, what we're really looking to do is how do we add facilities in one part of the community and then take down the legacy facilities after-effects. And so those are the opportunities both create a service value for our clients as well as a financial belt to lower expenses for us. But it's just more complex and tougher to get done in short order.

Brett Rabatin - Sterne, Agee

And the other thing I was curious about was back on mortgage banking, the originations in the quarter again on sale margin and how much you expect QM to potentially impact going forward?

Kent Lucien

This is my recollection, so I maybe off-foot a point or two. I believe the gain on sale averaged about 178 basis points in the quarter. So that'll be quite a bit lower than it had been in Q3 or a year ago, close to 300 basis points a year ago. In terms of new applications into the quarter, they were down 5.6% sequentially and applications were down 42% compared to a year ago. I mean that's the biggest leading indicator of mortgage volume.

Mary Sellers

QM right now, as Peter said, we're looking to approach QM with the idea that we will continue to make all the good loans to QM within our market. It's a significant asset class for us. Kind of mid-QM or non-QM, I should say, is really primarily on to TTR component. So we're really waiting to see how it plays out, but we're prepared to do non-QM mortgages into our portfolio.

Operator

Joe Morford from RBC Capital Markets is on line with a question. Please go ahead.

Joe Morford - RBC Capital Markets

Really everything has been asked, so just a couple of quick follow-ups. One, just on the buyback, when you talk about stepping that up again here this year, is that just with the existing capital that you're generating each quarter or would you be considering doing some sort of preferred offering or something that could help support that activity?

Peter Ho

Well, my comments were really in reference to the capital that we're currently generating. I mean never say never on some other source, but that's really not in our current thinking.

Joe Morford - RBC Capital Markets

And then I wasn't sure if I heard one of the responses on expenses right, but did you talk about what came out of expenses or kind of mortgage production related cost this quarter and is this run rate fully reflected and we might see some further reductions here in the first quarter?

Peter Ho

Yeah, Joe, I think that we have an opportunity to see a longer-term further reductions in expenses, more in line with production levels in mortgage. But as Mary was alluding to, we're still pretty early in the QM process and we want to see what sort of additional operating burden that puts on us as we try to do as much production as we can in this new world.

Operator

Casey Haire from Jefferies is on line with a question. Please go ahead.

Unidentified Analyst

Hey, guys. This is actually [ph] Jonathan Mahan for Casey. I was wondering in regarding to your color on margin, can you give us an additional color as to how we should be thinking about the margin going forward in 2014?

Peter Ho

Well, we've seen in a couple of quarters a modest positive increase in the margin. And it's really a function of the things I mentioned, loan growth, lower amortization, re-pricing securities. And so to the extent those conditions continue, it's possible for the margin to expand, albeit at a modest level. Now if conditions change, if interest rates should reverse course m ore than they have in the last few days, that could change what I just said. But overall, I think it's possible to see a positive, albeit modest increase.

Unidentified Analyst

Okay, great. And then just to go back to a question earlier on the other expense line, you guys just said that there was some higher advertising cost this quarter. Were those included in the other line?

Peter Ho

Yes.

Operator

And we have no further questions at this time.

Mary Sellers

Thank you, Alexandra, and thank you everyone for joining us this afternoon and for your continued interest in Bank of Hawaii. As always, if you have additional questions or need further clarification on any of the topics we've discussed today, please give me a call. Thanks so much again and have a great evening.

Operator

Thank you, ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.

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