Table of Contents

 

U N I T E D    S T A T E S

 

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

[ X ]     Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2008

 

or

 

[     ]     Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______________ to ______________

 

Commission File Number: 1-6887

 

BANK OF HAWAII CORPORATION

----------------------------------------------------------------------------------

(Exact name of registrant as specified in its charter)

 

      Delaware

 

    99-0148992

--------------------------

 

-----------------------------------------

(State of incorporation)

 

(I.R.S. Employer Identification No.)

 

130 Merchant Street, Honolulu, Hawaii

96813

-------------------------------------------------------

-------------

(Address of principal executive offices)

(Zip Code)

 

1-888-643-3888

----------------------------------------------------------------

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   X       No ___

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer                                                                                      Accelerated filer    ___

Non-accelerated filer __  (Do not check if a smaller reporting company)           Smaller reporting company  ___

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes __      No X

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

As of July 25, 2008, there were 47,766,792 shares of common stock outstanding.

 



Table of Contents

 

Bank of Hawaii Corporation

Form 10-Q

Index

 

 

 

 

Page

 

 

 

 

Part I - Financial Information

 

 

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

 

 

Consolidated Statements of Income – Three and six months ended
June 30, 2008 and 2007

 

2

 

 

 

 

 

Consolidated Statements of Condition – June 30, 2008,

 

 

 

December 31, 2007, and June 30, 2007

 

3

 

 

 

 

 

Consolidated Statements of Shareholders’ Equity – Six months ended

 

 

 

June 30, 2008 and 2007

 

4

 

 

 

 

 

Consolidated Statements of Cash Flows – Six months ended

 

 

 

June 30, 2008 and 2007

 

5

 

 

 

 

 

Notes to Consolidated Financial Statements (Unaudited)

 

6

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and
Results of Operations

 

15

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

45

 

 

 

 

Item 4.

Controls and Procedures

 

45

 

 

 

 

 

 

 

 

Part II - Other Information

 

 

 

 

 

 

Item 1A.

Risk Factors

 

45

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

45

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

46

 

 

 

 

Item 5.

Other Information

 

47

 

 

 

 

Item 6.

Exhibits

 

47

 

 

 

 

Signatures

 

48

 

1



Table of Contents

 

Bank of Hawaii Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

 

 

June 30,

 

 

 

June 30,

 

(dollars in thousands, except per share amounts)

 

2008

 

2007

 

2008

 

2007

 

Interest Income

 

 

 

 

 

 

 

 

 

Interest and Fees on Loans and Leases

 

$

97,959

 

$

112,026

 

$

202,372

 

$

222,324

 

Income on Investment Securities

 

 

 

 

 

 

 

 

 

Trading

 

1,209

 

1,357

 

2,369

 

2,975

 

Available-for-Sale

 

35,321

 

31,563

 

69,572

 

62,524

 

Held-to-Maturity

 

3,033

 

3,827

 

6,272

 

7,879

 

Deposits

 

204

 

96

 

399

 

154

 

Funds Sold

 

420

 

533

 

1,412

 

1,591

 

Other

 

489

 

364

 

915

 

697

 

Total Interest Income

 

138,635

 

149,766

 

283,311

 

298,144

 

Interest Expense

 

 

 

 

 

 

 

 

 

Deposits

 

20,238

 

33,701

 

47,703

 

67,076

 

Securities Sold Under Agreements to Repurchase

 

7,488

 

11,665

 

18,105

 

23,551

 

Funds Purchased

 

270

 

1,452

 

903

 

2,375

 

Short-Term Borrowings

 

12

 

91

 

46

 

178

 

Long-Term Debt

 

3,459

 

3,979

 

7,206

 

7,949

 

Total Interest Expense

 

31,467

 

50,888

 

73,963

 

101,129

 

Net Interest Income

 

107,168

 

98,878

 

209,348

 

197,015

 

Provision for Credit Losses

 

7,172

 

3,363

 

21,599

 

5,994

 

Net Interest Income After Provision for Credit Losses

 

99,996

 

95,515

 

187,749

 

191,021

 

Noninterest Income

 

 

 

 

 

 

 

 

 

Trust and Asset Management

 

15,460

 

16,135

 

30,546

 

31,968

 

Mortgage Banking

 

2,738

 

2,479

 

7,035

 

5,850

 

Service Charges on Deposit Accounts

 

12,411

 

11,072

 

24,494

 

22,039

 

Fees, Exchange, and Other Service Charges

 

17,176

 

16,556

 

33,277

 

32,617

 

Investment Securities Gains, Net

 

157

 

575

 

287

 

591

 

Insurance

 

5,590

 

4,887

 

12,720

 

11,102

 

Other

 

7,007

 

6,324

 

38,305

 

14,821

 

Total Noninterest Income

 

60,539

 

58,028

 

146,664

 

118,988

 

Noninterest Expense

 

 

 

 

 

 

 

 

 

Salaries and Benefits

 

45,984

 

44,587

 

101,457

 

89,993

 

Net Occupancy

 

11,343

 

9,695

 

21,786

 

19,506

 

Net Equipment

 

4,474

 

4,871

 

8,795

 

9,658

 

Professional Fees

 

2,588

 

2,599

 

5,201

 

5,142

 

Other

 

19,473

 

18,080

 

40,055

 

37,656

 

Total Noninterest Expense

 

83,862

 

79,832

 

177,294

 

161,955

 

Income Before Provision for Income Taxes

 

76,673

 

73,711

 

157,119

 

148,054

 

Provision for Income Taxes

 

28,391

 

25,982

 

51,622

 

52,990

 

Net Income

 

$

48,282

 

$

47,729

 

$

105,497

 

$

95,064

 

Basic Earnings Per Share

 

$

1.01

 

$

0.97

 

$

2.20

 

$

1.93

 

Diluted Earnings Per Share

 

$

1.00

 

$

0.95

 

$

2.18

 

$

1.89

 

Dividends Declared Per Share

 

$

0.44

 

$

0.41

 

$

0.88

 

$

0.82

 

Basic Weighted Average Shares

 

47,733,278

 

49,276,820

 

47,849,945

 

49,351,959

 

Diluted Weighted Average Shares

 

48,300,049

 

50,077,219

 

48,423,619

 

50,173,856

 

 

The accompanying notes are an integral part of the Consolidated Financial Statements (Unaudited).

 

2



Table of Contents

 

Bank of Hawaii Corporation and Subsidiaries

 

 

 

 

 

 

 

Consolidated Statements of Condition (Unaudited)

 

 

 

 

 

 

 

 

 

June 30,

 

December 31,

 

June 30,

 

(dollars in thousands)

 

2008

 

2007

 

2007

 

Assets

 

 

 

 

 

 

 

Interest-Bearing Deposits

 

$

6,056

 

$

4,870

 

$

130,732

 

Funds Sold

 

-

 

15,000

 

200,000

 

Investment Securities

 

 

 

 

 

 

 

Trading

 

94,347

 

67,286

 

123,591

 

Available-for-Sale

 

2,646,506

 

2,563,190

 

2,455,668

 

Held-to-Maturity (Fair Value of $255,905; $287,644; and $313,589)

 

260,592

 

292,577

 

327,118

 

Loans Held for Sale

 

11,183

 

12,341

 

13,527

 

Loans and Leases

 

6,518,128

 

6,580,861

 

6,566,126

 

Allowance for Loan and Lease Losses

 

(102,498

)

(90,998

)

(90,998

)

Net Loans and Leases

 

6,415,630

 

6,489,863

 

6,475,128

 

Total Earning Assets

 

9,434,314

 

9,445,127

 

9,725,764

 

Cash and Noninterest-Bearing Deposits

 

280,635

 

368,402

 

345,226

 

Premises and Equipment

 

117,323

 

117,177

 

122,929

 

Customers’ Acceptances

 

1,856

 

1,112

 

2,234

 

Accrued Interest Receivable

 

42,295

 

45,261

 

49,121

 

Foreclosed Real Estate

 

229

 

184

 

48

 

Mortgage Servicing Rights

 

30,272

 

27,588

 

29,112

 

Goodwill

 

34,959

 

34,959

 

34,959

 

Other Assets

 

429,266

 

433,132

 

413,175

 

Total Assets

 

$

10,371,149

 

$

10,472,942

 

$

10,722,568

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

Noninterest-Bearing Demand

 

$

1,876,782

 

$

1,935,639

 

$

1,896,335

 

Interest-Bearing Demand

 

1,666,726

 

1,634,675

 

1,755,646

 

Savings

 

2,781,082

 

2,630,471

 

2,923,168

 

Time

 

1,579,400

 

1,741,587

 

1,739,255

 

Total Deposits

 

7,903,990

 

7,942,372

 

8,314,404

 

Funds Purchased

 

69,400

 

75,400

 

90,650

 

Short-Term Borrowings

 

10,180

 

10,427

 

15,644

 

Securities Sold Under Agreements to Repurchase

 

1,028,518

 

1,029,340

 

910,302

 

Long-Term Debt (includes $121,326 carried at fair value as of June 30, 2008)

 

205,351

 

235,371

 

260,329

 

Banker’s Acceptances

 

1,856

 

1,112

 

2,234

 

Retirement Benefits Payable

 

29,478

 

29,984

 

43,892

 

Accrued Interest Payable

 

13,588

 

20,476

 

18,292

 

Taxes Payable and Deferred Taxes

 

250,125

 

278,218

 

277,516

 

Other Liabilities

 

91,105

 

99,987

 

80,499

 

Total Liabilities

 

9,603,591

 

9,722,687

 

10,013,762

 

Shareholders’ Equity

 

 

 

 

 

 

 

Common Stock ($.01 par value; authorized 500,000,000 shares;

 

 

 

 

 

 

 

issued / outstanding: June 2008 - 57,016,182 / 47,941,409;

 

 

 

 

 

 

 

December 2007 - 56,995,447 / 48,589,645;

 

 

 

 

 

 

 

and June 2007 - 56,927,022 / 49,440,204)

 

568

 

567

 

566

 

Capital Surplus

 

489,335

 

484,790

 

480,389

 

Accumulated Other Comprehensive Loss

 

(15,813

)

(5,091

)

(45,705

)

Retained Earnings

 

745,244

 

688,638

 

645,149

 

Treasury Stock, at Cost (Shares: June 2008 - 9,074,773;

 

 

 

 

 

 

 

December 2007 - 8,405,802; and June 2007 - 7,486,818)

 

(451,776

)

(418,649

)

(371,593

)

Total Shareholders’ Equity

 

767,558

 

750,255

 

708,806

 

Total Liabilities and Shareholders’ Equity

 

$

10,371,149

 

$

10,472,942

 

$

10,722,568

 

 

The accompanying notes are an integral part of the Consolidated Financial Statements (Unaudited).

 

3



Table of Contents

 

Bank of Hawaii Corporation and Subsidiaries

Consolidated Statements of Shareholders’ Equity (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accum.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Compre-

 

 

 

 

 

Compre-

 

 

 

 

 

Common

 

Capital

 

hensive

 

Retained

 

Treasury

 

hensive

 

(dollars in thousands)

 

Total

 

Stock

 

Surplus

 

Loss

 

Earnings

 

Stock

 

Income

 

Balance as of December 31, 2007

 

$

750,255

 

$

567

 

$

484,790

 

$

(5,091

)

$

688,638

 

$

(418,649

)

 

 

Cumulative-Effect Adjustment of a Change in Accounting Principle, Net of Tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115”

 

(2,736

)

-

 

-

 

-

 

(2,736

)

-

 

 

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

105,497

 

-

 

-

 

-

 

105,497

 

-

 

$

105,497

 

Other Comprehensive Income, Net of Tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in Unrealized Gains and Losses on Investment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities Available-for-Sale

 

(10,820

)

-

 

-

 

(10,820

)

-

 

-

 

(10,820

)

Amortization of Net Loss for Pension Plans and Postretirement Benefit Plan

 

98

 

-

 

-

 

98

 

-

 

-

 

98

 

Total Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

$

94,775

 

Share-Based Compensation

 

3,072

 

-

 

3,072

 

-

 

-

 

-

 

 

 

Net Tax Benefits related to Share-Based Compensation

 

1,304

 

-

 

1,304

 

-

 

-

 

-

 

 

 

Common Stock Issued under Purchase and Equity
Compensation Plans (276,946 shares)

 

8,478

 

1

 

169

 

-

 

(3,812

)

12,120

 

 

 

Common Stock Repurchased (923,330 shares)

 

(45,247

)

-

 

-

 

-

 

-

 

(45,247

)

 

 

Cash Dividends Paid

 

(42,343

)

-

 

-

 

-

 

(42,343

)

-

 

 

 

Balance as of June 30, 2008

 

$

767,558

 

$

568

 

$

489,335

 

$

(15,813

)

$

745,244

 

$

(451,776

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2006

 

$

719,420

 

$

566

 

$

475,178

 

$

(39,084

)

$

630,660

 

$

(347,900

)

 

 

Cumulative-Effect Adjustment of a Change in Accounting Principle, Net of Tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140”

 

5,126

 

-

 

-

 

5,279

 

(153

)

-

 

 

 

FSP No. 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction”

 

(27,106

)

-

 

-

 

-

 

(27,106

)

-

 

 

 

FIN 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”

 

(7,247

)

-

 

-

 

-

 

(7,247

)

-

 

 

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

95,064

 

-

 

-

 

-

 

95,064

 

-

 

$

95,064

 

Other Comprehensive Income, Net of Tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in Unrealized Gains and Losses on Investment
Securities Available-for-Sale

 

(12,316

)

-

 

-

 

(12,316

)

-

 

-

 

(12,316

)

Amortization of Net Loss for Pension Plans and Postretirement Benefit Plan

 

416

 

-

 

-

 

416

 

-

 

-

 

416

 

Total Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

$

83,164

 

Share-Based Compensation

 

2,748

 

-

 

2,748

 

-

 

-

 

-

 

 

 

Net Tax Benefits related to Share-Based Compensation

 

2,208

 

-

 

2,208

 

-

 

-

 

-

 

 

 

Common Stock Issued under Purchase and Equity
Compensation Plans (444,008 shares)

 

12,407

 

-

 

255

 

-

 

(5,312

)

17,464

 

 

 

Common Stock Repurchased (779,689 shares)

 

(41,157

)

-

 

-

 

-

 

-

 

(41,157

)

 

 

Cash Dividends Paid

 

(40,757

)

-

 

-

 

-

 

(40,757

)

-

 

 

 

Balance as of June 30, 2007

 

$

708,806

 

$

566

 

$

480,389

 

$

(45,705

)

$

645,149

 

$

(371,593

)

 

 

 

The accompanying notes are an integral part of the Consolidated Financial Statements (Unaudited).

 

4



Table of Contents

 

Bank of Hawaii Corporation and Subsidiaries

 

 

Consolidated Statements of Cash Flows (Unaudited)

 

 

 

 

Six Months Ended

 

 

 

June 30,

 

(dollars in thousands)

 

2008

 

2007

 

Operating Activities

 

 

 

 

 

Net Income

 

$

105,497

 

$

95,064

 

Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:

 

 

 

 

 

Provision for Credit Losses

 

21,599

 

5,994

 

Depreciation and Amortization

 

7,047

 

7,376

 

Amortization of Deferred Loan and Lease Fees

 

(1,058

)

(911

)

Amortization and Accretion of Premiums/Discounts on Investment Securities, Net

 

741

 

1,603

 

Share-Based Compensation

 

3,072

 

2,748

 

Benefit Plan Contributions

 

(1,078

)

(5,217

)

Deferred Income Taxes

 

(58,991

)

(35,400

)

Net Gain on Investment Securities

 

(287

)

(591

)

Net Change in Trading Securities

 

(27,061

)

40,589

 

Proceeds from Sales of Loans Held for Sale

 

261,820

 

179,139

 

Originations of Loans Held for Sale

 

(260,662

)

(180,724

)

Tax Benefits from Share-Based Compensation

 

(1,389

)

(2,229

)

Net Change in Other Assets and Other Liabilities

 

26,870

 

(21,360

)

Net Cash Provided by Operating Activities

 

76,120

 

86,081

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Investment Securities Available-for-Sale:

 

 

 

 

 

Proceeds from Prepayments and Maturities

 

494,209

 

301,327

 

Proceeds from Sales

 

195,000

 

-

 

Purchases

 

(789,666

)

(334,901

)

Investment Securities Held-to-Maturity:

 

 

 

 

 

Proceeds from Prepayments and Maturities

 

31,765

 

43,861

 

Net Change in Loans and Leases

 

53,692

 

9,239

 

Premises and Equipment, Net

 

(7,193

)

(4,380

)

Net Cash (Used in) Provided by Investing Activities

 

(22,193

)

15,146

 

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Net Change in Deposits

 

(38,382

)

291,010

 

Net Change in Short-Term Borrowings

 

(7,069

)

(102,426

)

Repayments of Long-Term Debt

 

(32,425

)

-

 

Tax Benefits from Share-Based Compensation

 

1,389

 

2,229

 

Proceeds from Issuance of Common Stock

 

8,569

 

12,500

 

Repurchase of Common Stock

 

(45,247

)

(41,157

)

Cash Dividends Paid

 

(42,343

)

(40,757

)

Net Cash (Used in) Provided by Financing Activities

 

(155,508

)

121,399

 

 

 

 

 

 

 

Net Change in Cash and Cash Equivalents

 

(101,581

)

222,626

 

Cash and Cash Equivalents at Beginning of Period

 

388,272

 

453,332

 

Cash and Cash Equivalents at End of Period

 

$

286,691

 

$

675,958

 

Supplemental Information

 

 

 

 

 

Cash Paid for:

 

 

 

 

 

Interest

 

$

80,852

 

$

105,555

 

Income Taxes

 

63,604

 

33,076

 

Non-cash Investing and Financing Activities:

 

 

 

 

 

Transfers from Investment Securities-Available-for-Sale to Trading

 

-

 

164,180

 

Transfers from Loans to Foreclosed Real Estate

 

110

 

138

 

 

The accompanying notes are an integral part of the Consolidated Financial Statements (Unaudited).

 

5



Table of Contents

 

Bank of Hawaii Corporation and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

 

Note 1.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

Bank of Hawaii Corporation (the “Parent”) is a bank holding company headquartered in Honolulu, Hawaii.  Bank of Hawaii Corporation and its Subsidiaries (the “Company”) provide a broad range of financial products and services to customers in Hawaii and the Pacific Islands (Guam, nearby islands, and American Samoa).  The Parent’s principal and only operating subsidiary is Bank of Hawaii (the “Bank”).  All significant intercompany accounts and transactions have been eliminated in consolidation.

 

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and accompanying notes required by GAAP for complete financial statements.  In the opinion of management, the consolidated financial statements reflect normal recurring adjustments necessary for a fair presentation of the results for the interim periods.

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes.  Actual results may differ from those estimates and such differences could be material to the financial statements.

 

Certain prior period amounts have been reclassified to conform to current period classifications.

 

These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.  Operating results for the six months ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008.

 

Fair Value Measurements

 

Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,” which became effective for the Company on January 1, 2008, established a framework for measuring fair value, while expanding fair value measurement disclosures.  SFAS No. 157 established a fair value hierarchy that distinguishes between independent observable inputs and unobservable inputs based on the best information available.  SFAS No. 157 expands disclosures about the use of fair value to measure assets and liabilities, the effect of these measurements on earnings for the period, and the inputs used to measure fair value.  In February 2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position (“FSP”) FAS 157-1 to exclude SFAS No. 13, “Accounting for Leases,” and its related interpretive accounting pronouncements that address leasing transactions, from the scope of SFAS No. 157.  In February 2008, the FASB also issued FSP FAS 157-2 to allow entities to electively defer the effective date of SFAS No. 157 for nonfinancial assets and liabilities, except for those items recognized or disclosed at fair value on an annual or more frequently recurring basis, until January 1, 2009.  The Company plans to apply the fair value measurement provisions of SFAS No. 157 to its nonfinancial assets and liabilities measured at fair value effective January 1, 2009.  The adoption of SFAS No. 157 had no impact on retained earnings and is not expected to have a material impact on the Company’s statements of income and condition.

 

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Table of Contents

 

Fair Value Option

 

SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115,” which became effective for the Company on January 1, 2008, provides entities with an option to report selected financial assets and financial liabilities, on an instrument by instrument basis, at fair value.  On January 1, 2008, the Company elected the fair value option for its subordinated notes, which are included in long-term debt on the Company’s Consolidated Statements of Condition.  In adopting the provisions of SFAS No. 159 on January 1, 2008, the Company adjusted the carrying value of the subordinated notes to fair value and recorded an after-tax cumulative-effect adjustment to reduce retained earnings by $2.7 million.  Prospectively, the accounting for the Company’s subordinated notes at fair value is not expected to have a material impact on the Company’s statements of income and condition.

 

Loan Commitments

 

U.S. Securities and Exchange Commission (the “SEC”) Staff Accounting Bulletin (“SAB”) No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings,” which became effective for the Company on January 1, 2008, requires entities to include the expected net future cash flows related to the servicing of the loan in the measurement of written loan commitments that are accounted for at fair value through earnings.  The expected net future cash flows from servicing the loan that are to be included in measuring the fair value of the written loan commitment is to be determined in the same manner that the fair value of a recognized servicing asset is measured under SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140.”  However, a separate and distinct servicing asset is not recognized for accounting purposes until the servicing rights have been contractually separated from the underlying loan by sale or securitization of the loan with servicing rights retained.  The impact of SAB No. 109 was to accelerate the recognition of the estimated fair value of the servicing rights related to the loan from the loan sale date to the loan commitment date.  The adoption of SAB No. 109 did not have a material impact on the Company’s statements of income and condition.

 

Future Application of Accounting Pronouncements

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities - an Amendment of FASB Statement No. 133.”  SFAS No. 161 expands disclosure requirements regarding an entity’s derivative instruments and hedging activities.  Expanded qualitative disclosures that will be required under SFAS No. 161 include: (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and related interpretations; and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  SFAS No. 161 also requires several added quantitative disclosures in financial statements.  SFAS No. 161 will be effective for the Company on January 1, 2009 and its adoption is not expected to impact the Company’s statements of income and condition.

 

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Table of Contents

 

Note 2.  Pension Plans and Postretirement Benefit Plan

 

The components of net periodic benefit cost for the Company’s pension plans and the postretirement benefit plan for the three and six months ended June 30, 2008 and 2007 are presented in the following table:

 

 

 

 

 

 

 

 

 

 

 

Pension Plans and Postretirement Benefit Plan (Unaudited)

 

 

 

 

Pension Benefits

 

 

 

Postretirement Benefits

 

(dollars in thousands)

 

2008

 

2007

 

 

2008

 

2007

 

Three Months Ended June 30,

 

 

 

 

 

 

 

 

 

 

Service Cost

 

$

-

 

$

-

 

 

$

89

 

$

155

 

Interest Cost

 

1,298

 

1,223

 

 

420

 

395

 

Expected Return on Plan Assets

 

(1,522

)

(1,373

)

 

-

 

-

 

Amortization of Prior Service Credit

 

-

 

-

 

 

(53

)

(50

)

Recognized Net Actuarial Losses (Gains)

 

270

 

450

 

 

(140

)

(75

)

Net Periodic Benefit Cost

 

$

46

 

$

300

 

 

$

316

 

$

425

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

 

 

 

 

 

 

 

 

 

Service Cost

 

$

-

 

$

-

 

 

$

179

 

$

310

 

Interest Cost

 

2,596

 

2,446

 

 

840

 

790

 

Expected Return on Plan Assets

 

(3,044

)

(2,746

)

 

-

 

-

 

Amortization of Prior Service Credit

 

-

 

-

 

 

(107

)

(100

)

Recognized Net Actuarial Losses (Gains)

 

540

 

900

 

 

(280

)

(150

)

Net Periodic Benefit Cost

 

$

92

 

$

600

 

 

$

632

 

$

850

 

 

The net periodic benefit cost for the Company’s pension plans and postretirement benefit plan are recorded as a component of salaries and benefits in the statements of income.  There were no significant changes from the previously reported $0.7 million that the Company expects to contribute to the pension plans and the $1.1 million that it expects to contribute to the postretirement benefit plan for the year ending December 31, 2008.  For the three and six months ended June 30, 2008, the Company contributed $0.3 million and $0.4 million, respectively, to its pension plans.  For the three and six months ended June 30, 2008, the Company contributed $0.3 million and $0.7 million, respectively, to its postretirement benefit plan.

 

Note 3.  Business Segments

 

The Company’s business segments are defined as Retail Banking, Commercial Banking, Investment Services, and Treasury.  The Company’s internal management accounting process measures the performance of the business segments based on the management structure of the Company.  This process, which is not necessarily comparable with similar information for any other financial institution, uses various techniques to assign balance sheet and income statement amounts to the business segments, including allocations of income, expense, the provision for credit losses (the “Provision”), and capital.  This process is dynamic and requires certain allocations based on judgment and other subjective factors.  Unlike financial accounting, there is no comprehensive authoritative guidance for management accounting that is equivalent to GAAP.

 

8



Table of Contents

 

Selected financial information for each business segment is presented below for the three and six months ended June 30, 2008 and 2007.

 

Business Segments Selected Financial Information (Unaudited)

 

 

Retail

 

Commercial

 

Investment

 

 

 

Consolidated

 

(dollars in thousands)

 

Banking

 

Banking

 

Services

 

Treasury

 

Total

 

Three Months Ended June 30, 2008

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

$

59,555

 

$

43,264

 

$

3,938

 

$

411

 

$

107,168

 

Provision for Credit Losses

 

2,571

 

4,652

 

(1

)

(50

)

7,172

 

Net Interest Income After Provision for Credit Losses

 

56,984

 

38,612

 

3,939

 

461

 

99,996

 

Noninterest Income

 

27,270

 

9,997

 

19,019

 

4,253

 

60,539

 

Noninterest Expense

 

(43,335

)

(23,544

)

(16,363

)

(620

)

(83,862

)

Income Before Provision for Income Taxes

 

40,919

 

25,065

 

6,595

 

4,094

 

76,673

 

Provision for Income Taxes

 

(15,140

)

(9,286

)

(2,440

)

(1,525

)

(28,391

)

Allocated Net Income

 

$

25,779

 

$

15,779

 

$

4,155

 

$

2,569

 

$

48,282

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets as of June 30, 2008

 

$

3,649,376

 

$

2,998,013

 

$

242,443

 

$

3,481,317

 

$

10,371,149

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2007 1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income (Loss)

 

$

55,606

 

$

40,668

 

$

3,466

 

$

(862

)

$

98,878

 

Provision for Credit Losses

 

1,258

 

2,115

 

-

 

(10

)

3,363

 

Net Interest Income (Loss) After Provision for Credit Losses

 

54,348

 

38,553

 

3,466

 

(852

)

95,515

 

Noninterest Income

 

26,790

 

8,033

 

19,454

 

3,751

 

58,028

 

Noninterest Expense

 

(41,109

)

(22,318

)

(15,519

)

(886

)

(79,832

)

Income Before Provision for Income Taxes

 

40,029

 

24,268

 

7,401

 

2,013

 

73,711

 

Provision for Income Taxes

 

(14,812

)

(9,061

)

(2,738

)

629

 

(25,982

)

Allocated Net Income

 

$

25,217

 

$

15,207

 

$

4,663

 

$

2,642

 

$

47,729

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets as of June 30, 2007 1

 

$

3,638,207

 

$

3,108,240

 

$

230,134

 

$

3,745,987

 

$

10,722,568

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2008

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income (Loss)

 

$

117,979

 

$

86,099

 

$

7,808

 

$

(2,538

)

$

209,348

 

Provision for Credit Losses

 

10,523

 

11,878

 

(1

)

(801

)

21,599

 

Net Interest Income (Loss) After Provision for Credit Losses

 

107,456

 

74,221

 

7,809

 

(1,737

)

187,749

 

Noninterest Income

 

55,817

 

32,246

 

37,280

 

21,321

 

146,664

 

Noninterest Expense

 

(87,104

)

(48,265

)

(33,226

)

(8,699

)

(177,294

)

Income Before Provision for Income Taxes

 

76,169

 

58,202

 

11,863

 

10,885

 

157,119

 

Provision for Income Taxes

 

(28,182

)

(21,587

)

(4,389

)

2,536

 

(51,622

)

Allocated Net Income

 

$

47,987

 

$

36,615

 

$

7,474

 

$

13,421

 

$

105,497

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets as of June 30, 2008

 

$

3,649,376

 

$

2,998,013

 

$

242,443

 

$

3,481,317

 

$

10,371,149

 

Six Months Ended June 30, 2007 1

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

$

110,025

 

$

79,698

 

$

6,991

 

$

301

 

$

197,015

 

Provision for Credit Losses

 

2,803

 

3,213

 

-

 

(22

)

5,994

 

Net Interest Income After Provision for Credit Losses

 

107,222

 

76,485

 

6,991

 

323

 

191,021

 

Noninterest Income

 

52,370

 

20,246

 

38,601

 

7,771

 

118,988

 

Noninterest Expense

 

(82,443

)

(45,238

)

(31,202

)

(3,072

)

(161,955

)

Income Before Provision for Income Taxes

 

77,149

 

51,493

 

14,390

 

5,022

 

148,054

 

Provision for Income Taxes

 

(28,539

)

(18,935

)

(5,324

)

(192

)

(52,990

)

Allocated Net Income

 

$

48,610

 

$

32,558

 

$

9,066

 

$

4,830

 

$

95,064

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets as of June 30, 2007 1

 

$

3,638,207

 

$

3,108,240

 

$

230,134

 

$

3,745,987

 

$

10,722,568

 

 

1 Certain prior period information has been reclassified to conform to the current presentation.

 

9



Table of Contents

 

Note 4.  Fair Value of Financial Assets and Liabilities

 

SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  SFAS No. 157 establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

 

Level 1:

Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

 

 

Level 2:

Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that are derived principally from or can be corroborated by observable market data by correlation or other means.

 

 

Level 3:

Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using discounted cash flow methodologies, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis as of June 30, 2008:

 

Assets and Liabilities Measured at Fair Value on Recurring Basis (Unaudited)

 

 

Quoted Prices in

 

 

 

Significant

 

 

 

 

 

Active Markets for

 

Significant Other

 

Unobservable

 

 

 

 

 

Identical Assets

 

Observable Inputs

 

Inputs

 

 

 

(dollars in thousands)

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

Investment Securities Trading

 

$

-

 

$

94,347

 

$

-

 

$

94,347

 

Investment Securities Available-for-Sale

 

1,676

 

2,619,814

 

25,016

 

2,646,506

 

Mortgage Servicing Rights

 

-

 

-

 

30,272

 

30,272

 

Other Assets

 

6,501

 

-

 

-

 

6,501

 

Net Derivative Assets and Liabilities

 

(80

)

371

 

326

 

617

 

Total Assets at Fair Value

 

$

8,097

 

$

2,714,532

 

$

55,614

 

$

2,778,243

 

 

 

 

 

 

 

 

 

 

 

Long-Term Debt

 

$

-

 

$

-

 

$

121,326

 

$

121,326

 

Total Liabilities at Fair Value

 

$

-

 

$

-

 

$

121,326

 

$

121,326

 

 

10



Table of Contents

 

For the three and six months ended June 30, 2008, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:

 

 

 

Investment

 

Mortgage

 

Net Derivative

 

 

 

 

 

Securities

 

Servicing

 

Assets and

 

 

 

Assets (Unaudited)        (dollars in thousands)

 

Available-for-Sale 1

 

Rights 2

 

Liabilities 3

 

Total

 

Three Months Ended June 30, 2008

 

 

 

 

 

 

 

 

 

Balance as of April 1, 2008

 

$

95,219

 

$

27,149

 

$

810

 

$

123,178

 

Realized and Unrealized Net Gains (Losses):

 

 

 

 

 

 

 

 

 

Included in Net Income

 

-

 

1,459

 

1,121

 

2,580

 

Included in Other Comprehensive Income

 

(200

)

-

 

-

 

(200

)

Purchases, Sales, Issuances, and Settlements, Net

 

(70,003

)

1,664

 

(1,605

)

(69,944

)

Balance as of June 30, 2008

 

$

25,016

 

$

30,272

 

$

326

 

$

55,614

 

 

 

 

 

 

 

 

 

 

 

Total Unrealized Net Gains Included in Net Income

 

 

 

 

 

 

 

 

 

Related to Assets Still Held as of June 30, 2008

 

$

-

 

$

2,201

 

$

326

 

$

2,527

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities (Unaudited)        (dollars in thousands)

 

Long-Term Debt 4

 

Total

 

 

 

 

 

Three Months Ended June 30, 2008

 

 

 

 

 

 

 

 

 

Balance as of April 1, 2008

 

$

128,932

 

$

128,932

 

 

 

 

 

Unrealized Net Gains Included in Net Income

 

(1,606

)

(1,606

)

 

 

 

 

Purchases, Sales, Issuances, and Settlements, Net

 

(6,000

)

(6,000

)

 

 

 

 

Balance as of June 30, 2008

 

$

121,326

 

$

121,326

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Unrealized Net Gains Included in Net Income

 

 

 

 

 

 

 

 

 

Related to Liabilities Still Held as of June 30, 2008

 

$

(1,416

)

$

(1,416

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment

 

Mortgage

 

Net Derivative

 

 

 

 

 

Securities

 

Servicing

 

Assets and

 

 

 

Assets (Unaudited)        (dollars in thousands)

 

Available-for-Sale 1

 

Rights 2

 

Liabilities 3

 

Total

 

Six Months Ended June 30, 2008

 

 

 

 

 

 

 

 

 

Balance as of January 1, 2008

 

$

218,980

 

$

27,588

 

$

113

 

$

246,681

 

Realized and Unrealized Net Gains (Losses):

 

 

 

 

 

 

 

 

 

Included in Net Income

 

-

 

(899

)

2,893

 

1,994

 

Included in Other Comprehensive Income

 

1,028

 

-

 

-

 

1,028

 

Purchases, Sales, Issuances, and Settlements, Net

 

(194,992

)

3,583

 

(2,680

)

(194,089

)

Balance as of June 30, 2008

 

$

25,016

 

$

30,272

 

$

326

 

$

55,614

 

 

 

 

 

 

 

 

 

 

 

Total Unrealized Net Gains Included in Net Income

 

 

 

 

 

 

 

 

 

Related to Assets Still Held as of June 30, 2008

 

$

-

 

$

653

 

$

326

 

$

979

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities (Unaudited)        (dollars in thousands)

 

Long-Term Debt 4

 

Total

 

 

 

 

 

Six Months Ended June 30, 2008

 

 

 

 

 

 

 

 

 

Balance as of January 1, 2008

 

$

129,032

 

$

129,032

 

 

 

 

 

Unrealized Net Gains Included in Net Income

 

(1,706

)

(1,706

)

 

 

 

 

Purchases, Sales, Issuances, and Settlements, Net

 

(6,000

)

(6,000

)

 

 

 

 

Balance as of June 30, 2008

 

$

121,326

 

$

121,326

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Unrealized Net Gains Included in Net Income

 

 

 

 

 

 

 

 

 

Related to Liabilities Still Held as of June 30, 2008

 

$

(1,512

)

$

(1,512

)

 

 

 

 

 

1 Unrealized gains and losses related to investment securities available-for-sale are reported as a component of other comprehensive income. 

2 Realized and unrealized gains and losses related to mortgage servicing rights are reported as a component of mortgage banking income in the statement of income. 

3 Realized and unrealized gains and losses related to written loan commitments are reported as a component of mortgage banking income in the statement of income. 

4 Unrealized gains and losses related to long-term debt are reported as a component of other noninterest income in the statement of income. 

 

There were no transfers in or out of the Company’s Level 3 financial assets and liabilities for the three and six months ended June 30, 2008.

 

11



Table of Contents

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

The Company also measures certain financial assets at fair value on a nonrecurring basis in accordance with GAAP.  For the three and six months ended June 30, 2008, there were no adjustments to fair value for the Company’s loans held for sale in accordance with GAAP.

 

Fair Value Option

 

On January 1, 2008, the Company elected the fair value option for its subordinated notes, which are included in long-term debt on the Company’s Consolidated Statements of Condition.  The table below reconciles the balance of the Company’s subordinated notes as of December 31, 2007 and January 1, 2008.

 

 

 

Balance as of

 

Net Loss

 

Balance as of

 

(Unaudited)                                 (dollars in thousands)

 

December 31, 2007 1

 

Upon Adoption

 

January 1, 2008

 

Long-Term Debt

 

$

124,822

 

 

$

4,210

 

$

129,032

 

Pre-Tax Cumulative-Effect of Adopting the Fair Value Option

 

 

 

 

4,210

 

 

 

Increase in Deferred Tax Asset

 

 

 

 

 

(1,474

)

 

 

After-Tax Cumulative-Effect of Adopting the Fair Value Option

 

 

 

 

$

2,736

 

 

 

 

1 Includes unamortized discount and deferred costs, which were removed from the statement of condition with the cumulative-effect adjustment to adopt the provisions of SFAS No. 159 on January 1, 2008.

 

The fair value option was elected for the subordinated notes as it provided the Company with an opportunity to better manage its interest rate risk and to achieve balance sheet management flexibility.  As of June 30, 2008, the subordinated notes no longer qualified as a component of Total Capital for regulatory capital purposes, due to the maturity being within 12 months from June 30, 2008.

 

Gains and losses on the subordinated notes subsequent to the initial fair value measurement are recognized in earnings as a component of other noninterest income.  For the three and six months ended June 30, 2008, the Company recorded a gain of $1.6 million and $1.7 million, respectively, as a result of the change in fair value of the Company’s subordinated notes.  Interest expense related to the Company’s subordinated notes continues to be measured based on contractual interest rates and reported as such in the statement of income.

 

The following reflects the difference between the fair value carrying amount of the Company’s subordinated notes and the aggregate unpaid principal amount the Company is contractually obligated to pay until maturity as of June 30, 2008.

 

 

 

 

 

 

 

Excess of Fair Value

 

 

 

Fair Value

 

Aggregate Unpaid

 

Carrying Amount

 

 

 

Carrying Amount as of

 

Principal Amount as of

 

Over Aggregate Unpaid

 

(Unaudited)              (dollars in thousands)

 

June 30, 2008

 

June 30, 2008

 

Principal Balance

 

Long-Term Debt Reported at Fair Value

 

$

121,326

 

$

118,971

 

$

2,355

 

 

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Note 5.  Lease Transaction

 

In March 2008, the lessee in an aircraft leveraged lease exercised its early buyout option resulting in an $11.6 million pre-tax gain for the Company.  This gain on the sale of the Company’s equity interest in the lease was recorded as a component of other noninterest income in the statement of income.  This sale also resulted in a benefit for income taxes of $1.4 million from the adjustment of previously recognized tax liabilities.  After-tax gains from this transaction were $13.0 million.

 

Note 6.  Income Taxes

 

The following is a reconciliation of the statutory federal income tax rate to the effective tax rate for the three and six months ended June 30, 2008 and 2007.

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

 

June 30,

 

June 30,

 

 

(Unaudited)

 

2008

 

2007

 

2008

 

2007

 

 

Statutory Federal Income Tax Rate

 

35.00

  %

 

35.00

  %

 

35.00

  %

 

35.00

  %

 

 

Increase (Decrease) in Tax Rate Resulting From:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

State Income Tax, Net of Federal Income Tax

 

5.14

 

 

3.67

 

 

4.77

 

 

3.75

 

 

 

Foreign Tax Credits

 

-

 

 

(0.72

)

 

-

 

 

(1.08

)

 

 

Low Income Housing Investments

 

(0.10

)

 

(0.14

)

 

(0.21

)

 

(0.15

)

 

 

Bank-Owned Life Insurance

 

(0.85

)

 

(0.94

)

 

(0.85

)

 

(0.90

)

 

 

Leveraged Leases

 

(0.51

)

 

(1.15

)

 

(4.90

)

 

(0.50

)

 

 

Other

 

(1.65

)

 

(0.47

)

 

(0.95

)

 

(0.33

)

 

 

Effective Tax Rate

 

37.03

  %

 

35.25

  %

 

32.86

  %

 

35.79

  %

 

 

 

The lower effective tax rate for the six months ended June 30, 2008 compared to the six months ended June 30, 2007 was primarily due to the sale of the Company’s equity interest in an aircraft leveraged lease in March 2008.  The pre-tax gain from this sale would have resulted in an income tax expense of approximately $4.6 million, based on statutory income tax rates.  However, due to the timing of the sale of the Company’s equity interest and the adjustment of previously recognized income tax liabilities, this transaction resulted in a $1.4 million income tax benefit to the Company.  As a result, the total income tax benefit from this transaction was approximately $6.0 million and is reflected in the leveraged lease line item in the table above.

 

Note 7.  Contingencies

 

In October 2007, Visa, Inc. (“Visa”) announced that it had completed a series of restructuring transactions in preparation for its initial public offering (“IPO”) planned for the first quarter of 2008.  As part of this restructuring, the Company received approximately 0.9 million shares of restricted Class USA stock in Visa in exchange for the Company’s membership interests.  The Company did not recognize a gain or loss upon the receipt of Class USA shares in October 2007.  Visa completed its IPO in March 2008, resulting in the conversion of the Company’s Class USA shares to approximately 0.8 million shares of Class B common stock in Visa.  Visa exercised its option to mandatorily redeem approximately 0.3 million shares of the Company’s Class B common stock in Visa in exchange for cash, which resulted in the Company recording a $13.7 million gain in other noninterest income in the first quarter of 2008.  The Company’s remaining Class B shares (approximately 0.5 million) in Visa are restricted for a period of three years after the IPO or upon settlement of litigation claims, whichever is later.  The Company has not recognized a gain or loss on the remaining Class B shares in Visa.  Concurrent with its IPO, Visa funded an escrow account to cover litigation claims and settlements as discussed below.

 

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Table of Contents

 

In November 2007, Visa announced that it had reached an agreement with American Express, related to its claim that Visa and its member banks had illegally blocked American Express from the bank-issued card business in the United States.  The Company was not a named defendant in the lawsuit and, therefore, was not directly liable for any amount of the settlement.  However, according to an interpretation of Visa’s by-laws, the Company and other Visa U.S.A., Inc. (a wholly-owned subsidiary of Visa) members are obligated to indemnify Visa for certain losses, including the settlement of the American Express matter.  The Company’s indemnification obligation is limited to its proportionate interest in Visa U.S.A., Inc.  In December 2007, as a result of Visa’s agreement with American Express, the Company established a liability of $4.3 million for this indemnification obligation.  However, as a result of Visa’s IPO and funding of the escrow account, the Company reversed the $4.3 million liability previously established and recorded a credit to other noninterest expense in March 2008.

 

Other litigation covered by the Company’s indemnification of Visa and expected to be settled from the escrow account include: 1) a lawsuit filed by Discover Financial Services, Inc. (“Discover”) claiming that Visa prevented banks from issuing payment cards on the Discover network; 2) class action lawsuits filed on behalf of merchants who accept payment cards against Visa U.S.A., Inc. claiming that the setting of interchange is unlawful, among other claims; and 3) a consumer class action lawsuit against Visa U.S.A., Inc., Visa International, and MasterCard alleging unfair competition.  In December 2007, the Company established a liability of $1.3 million related to the indemnification of Visa in the Discover lawsuit.  However, as a result of Visa’s IPO and funding of the escrow account, the Company reversed the $1.3 million liability previously established and recorded a credit to other noninterest expense in March 2008.  Our indemnification of Visa, related to the costs of the class action lawsuits, if any, is expected to be funded from the Visa escrow account prior to any additional liability being incurred by the Company.

 

In addition to the Visa litigation, the Company is subject to various other pending and threatened legal proceedings arising out of the normal course of business or operations.  Management believes that current legal reserves are adequate and the amount of an incremental liability, if any, arising from these matters is not expected to have a material adverse effect on the Company’s financial condition or results of operations.

 

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Table of Contents

 


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

This report contains, and other written or oral statements made by the Company may contain, forward-looking statements concerning, among other things, the economic and business environment in our service area and elsewhere, credit quality, and other financial and business matters in future periods.  Our forward-looking statements are based on numerous assumptions, any of which could prove to be inaccurate and actual results may differ materially from those projected because of a variety of risks and uncertainties, including, but not limited to: 1) general economic conditions are less favorable than expected; 2) competitive pressure among financial services and products; 3) the impact of legislation and the regulatory environment; 4) fiscal and monetary policies of the markets in which we operate; 5) actual or alleged conduct which could harm our reputation; 6) changes in accounting standards; 7) changes in tax laws or regulations or the interpretation of such laws and regulations; 8) changes in our credit quality or risk profile that may increase or decrease the required level of our reserve for credit losses; 9) changes in market interest rates that may affect our credit markets and ability to maintain our net interest margin; 10) unpredicted costs and other consequences of legal or regulatory matters involving the Company; 11) changes to the amount and timing of proposed common stock repurchases; and 12) geopolitical risk, military or terrorist activity, natural disaster, adverse weather, public health, and other conditions impacting us and our customers’ operations.  For a detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements, refer to the section entitled “Risk Factors” in Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, and subsequent periodic and current reports, filed with the U.S. Securities and Exchange Commission (the “SEC”).  Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” and similar expressions are intended to identify forward-looking statements but are not exclusive means of

identifying such statements.  We do not undertake an obligation to update forward-looking statements to reflect later events or circumstances.

 

Overview

 

General

 

Bank of Hawaii Corporation (the “Parent”) is a bank holding company headquartered in Honolulu, Hawaii.  The Parent’s principal and only operating subsidiary is Bank of Hawaii (the “Bank”).

 

The Bank, directly and through its subsidiaries, provides a broad range of financial services and products primarily to customers in Hawaii and the Pacific Islands (Guam, nearby islands, and American Samoa).  References to “we,” “our,” “us,” or the “Company,” refer to the holding company and its subsidiaries that are consolidated for financial reporting purposes.

 

2007+ Plan

 

Our governing objective is to maximize shareholder value over time.

 

In January 2007, we introduced our 2007+ Plan (“Plan”) to our shareholders, customers, and employees.  Our Plan, which we continue to follow in 2008, focuses on five strategic themes:

 

·      Growth

 

·      Integration

 

·      People

 

·      Brand

 

·      Discipline

 

 

 


 

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Table of Contents


Plan Financial Objectives and Financial Results

 

Our Plan was prepared with the expectation that economic growth in Hawaii could slow in 2007 and beyond.  Our Plan was based on assumptions of moderate growth in revenues and consistent, positive operating leverage.  The following summarizes our Plan financial objectives compared with our financial results for the second quarter and first six months of 2008:

 

Plan Financial Objectives and Financial Results

 

 

Plan

 

Three
Months
Ended

 

Six Months
Ended

 

Performance
Ratios

 

Financial
Objectives

 

June 30,
2008

 

June 30,
2008

 

Average ROA

 

Above 1.70%

 

1.85 %

2.01 %

Average ROE

 

Above 25.00%

 

24.82 %

27.33 %

Efficiency

 

Approaching

 

 

 

Ratio

 

50.00%

 

50.01 %

49.80 %

Operating Leverage

 

Positive

 

(11.62) %

16.01 %

 

For the second quarter of 2008, net income was $48.3 million, an increase of $0.6 million or 1% from the second quarter of 2007.  Diluted earnings per share were $1.00, an increase of $0.05 or 5% from the second quarter of 2007.  Our strong performance in the second quarter of 2008 was primarily due to an increase in net interest margin and growth in substantially all noninterest income categories.  Our Provision for Credit Losses (the “Provision”) increased in the second quarter of 2008 compared to the same period in 2007.  Overall credit quality of our loans and leases remains solid despite a slowing economy and continued exposure to the airline industry.

 

For the first six months of 2008, net income was $105.5 million, an increase of $10.4 million or 11% from the first six months of 2007.  Diluted earnings per share were $2.18, an increase of $0.29 or 15% from the first six months of 2007.  Our strong financial performance for the first six months of 2008 was enhanced by two transactions recorded in the first quarter of 2008:

 

·      Pre-tax gains of $13.7 million resulting from the mandatory redemption of our Visa, Inc. (“Visa”) shares, as well as a $5.6 million reversal of previously recorded contingency accruals related to Visa legal matters; and

 

·      Pre-tax gains of $11.6 million resulting from the sale of our equity interest in an aircraft lease.  This sale also resulted in a net benefit for income taxes from the adjustment of previously recognized tax liabilities.  After-tax gains from this transaction were $13.0 million.

 

Partially offsetting these gains, were accruals for the following transactions recorded in the first quarter of 2008:

 

·      $9.0 million for employees related to cash awards to purchase our stock and earnings-based incentive compensation;

 

·      $1.0 million related to the call premium on our Bancorp Hawaii Capital Trust I Capital Securities (“Capital Securities”); and

 

·      $2.3 million in contributions to the Bank of Hawaii Charitable Foundation and other charitable organizations.

 

In addition, we increased our Allowance for Loan and Lease Losses (the “Allowance”) by recording a Provision of $21.6 million, which exceeded net charge-offs by $11.5 million for the first six months of 2008.  The increase in the Allowance, a result of our quarterly evaluation of the adequacy of the Allowance, reflects increased risk in our commercial aircraft leasing, small business, and unsecured consumer lending portfolios.

 

We also increased our reserves for legal contingencies by $3.0 million in the first six months of 2008.  This increase was due to our on-going evaluation of potential losses related to pending litigation, claims, and assessments.


 

16



Table of Contents

 

Table 1 presents our financial highlights for the three and six months ended June 30, 2008 and 2007 and as of June 30, 2008, December 31, 2007, and June 30, 2007.

 

Financial Highlights (Unaudited)

 

 

 

 

 

 

 

Table 1

 

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

 

June 30,

 

 

June 30,

 

(dollars in thousands, except per share amounts)

 

2008

 

2007

 

2008

 

2007

 

For the Period:

 

 

 

 

 

 

 

 

 

Net Interest Income

 

$

107,168

 

$

98,878

 

$

209,348

 

$

197,015

 

Total Noninterest Income

 

60,539

 

58,028

 

146,664

 

118,988

 

Total Noninterest Expense

 

83,862

 

79,832

 

177,294

 

161,955

 

Net Income

 

48,282

 

47,729

 

105,497

 

95,064

 

Basic Earnings Per Share

 

1.01

 

0.97

 

2.20

 

1.93

 

Diluted Earnings Per Share

 

1.00

 

0.95

 

2.18

 

1.89

 

Dividends Declared Per Share

 

0.44

 

0.41

 

0.88

 

0.82

 

 

 

 

 

 

 

 

 

 

 

Net Income to Average Total Assets

 

1.85

%

1.84

%

2.01

%

1.84

%

Net Income to Average Shareholders’ Equity

 

24.82

 

26.30

 

27.33

 

26.64

 

Efficiency Ratio 1

 

50.01

 

50.88

 

49.80

 

51.25

 

Operating Leverage 2

 

(11.62

)

0.13

 

16.01

 

3.90

 

Net Interest Margin 3

 

4.41

 

4.12

 

4.29

 

4.09

 

Dividend Payout Ratio 4

 

43.56

 

42.27

 

40.00

 

42.49

 

 

 

 

 

 

 

 

 

 

 

Average Loans and Leases

 

$

6,531,587

 

$

6,532,736

 

$

6,559,753

 

$

6,547,212

 

Average Assets

 

10,504,421

 

10,383,030

 

10,574,162

 

10,432,130

 

Average Deposits

 

7,958,171

 

7,810,089

 

7,955,360

 

7,865,469

 

Average Shareholders’ Equity

 

782,429

 

727,887

 

776,293

 

719,549

 

Average Shareholders’ Equity to Average Assets

 

7.45

%

7.01

%

7.34

%

6.90

%

 

 

 

 

 

 

 

 

 

 

Market Price Per Share of Common Stock:

 

 

 

 

 

 

 

 

 

Closing

 

$

47.80

 

$

51.64

 

$

47.80

 

$

51.64

 

High

 

57.37

 

55.00

 

57.37

 

55.00

 

Low

 

46.62

 

50.64

 

40.95

 

50.11

 

 

 

 

 

 

June 30,

 

December 31,

 

June 30,

 

 

 

 

 

2008

 

2007

 

2007

 

As of Period End:

 

 

 

 

 

 

 

 

 

Loans and Leases

 

 

 

$

6,518,128

 

$

6,580,861

 

$

6,566,126

 

Total Assets

 

 

 

10,371,149

 

10,472,942

 

10,722,568

 

Total Deposits

 

 

 

7,903,990

 

7,942,372

 

8,314,404

 

Long-Term Debt

 

 

 

205,351

 

235,371

 

260,329

 

Total Shareholders’ Equity

 

 

 

767,558

 

750,255

 

708,806

 

 

 

 

 

 

 

 

 

 

 

Non-Performing Assets

 

 

 

$

6,680

 

$

5,286

 

$

6,314

 

 

 

 

 

 

 

 

 

 

 

Allowance to Loans and Leases Outstanding

 

 

 

1.57

%

1.38

%

1.39

%

Leverage Ratio

 

 

 

7.04

 

7.04

 

7.02

 

 

 

 

 

 

 

 

 

 

 

Book Value Per Common Share

 

 

 

$

16.01

 

$

15.44

 

$

14.34

 

 

 

 

 

 

 

 

 

 

 

Full-Time Equivalent Employees

 

 

 

2,534

 

2,594

 

2,571

 

Branches and Offices

 

 

 

84

 

83

 

83

 

 

1 Efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and total noninterest income).

2 Operating leverage is defined as the percentage change in income before the provision for credit losses and the provision for income taxes. Measures are presented on a linked quarter basis.

3 Net interest margin is defined as net interest income, on a taxable equivalent basis, as a percentage of average earning assets.

4 Dividend payout ratio is defined as dividends declared per share divided by basic earnings per share.

 

 

17



Table of Contents

 

Recent Accounting Changes

 

We applied the provisions of the following new accounting pronouncements on January 1, 2008:

 

·                  Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements;”

·      SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115;” and

·      SEC Staff Accounting Bulletin (“SAB”) No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings.”

 

SFAS No. 157 had no impact on retained earnings and is not expected to have a material impact on our statements of income and condition. We have not made material changes to our valuation methodologies as previously disclosed in our financial statements included in our Annual Report on Form 10-K for

 

the year ended December 31, 2007. Our financial assets and liabilities do not require the use of a significant amount of unobservable (Level 3) inputs to estimate fair value.

 

SFAS No. 159 had the effect of reducing retained earnings by $2.7 million as of January 1, 2008, as we elected the fair value option for our subordinated notes. See Notes 1 and 4 to our Consolidated Financial Statements (Unaudited) for more information on our application of SFAS No. 157 and 159.

 

SAB No. 109 had the effect of accelerating gain recognition of the estimated fair value of the servicing rights related to the loan from the loan sale date to the loan commitment date. The implementation of SAB No. 109 did not have a material impact on our statements of income and condition.

 

18



Table of Contents

 

Analysis of Statements of Income

 

Net Interest Income

 

Average balances, related income and expenses, and resulting yields and rates, on a taxable equivalent basis, are presented in Table 2 for the three and six months ended June 30, 2008 and 2007.  An analysis of the change in net interest income, on a taxable equivalent basis, for the first six months of 2008 compared to the same period in 2007, is presented in Table 3.

 

Average Balances and Interest Rates - Taxable Equivalent Basis (Unaudited)

 

 

 

 

 

 

 

Table 2

 

 

 

Three Months Ended

 

Three Months Ended

 

Six Months Ended

 

Six Months Ended

 

 

 

June 30, 2008

 

June 30, 2007 1

 

June 30, 2008

 

June 30, 2007 1

 

 

 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

Average

 

Income/

 

Yield/

 

(dollars in millions)

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

Balance

 

Expense

 

Rate

 

Earning Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-Bearing Deposits

 

$

33.0

 

$

0.2

 

2.45

%

$

8.0

 

$

0.1

 

4.83

%

$

30.2

 

$

0.4

 

2.62

%

$

6.3

 

$

0.2

 

4.89

%

Funds Sold

 

81.9

 

0.4

 

2.03

 

40.6

 

0.5

 

5.19

 

110.1

 

1.4

 

2.54

 

60.8

 

1.6

 

5.20

 

Investment Securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading

 

97.6

 

1.2

 

4.96

 

137.1

 

1.4

 

3.96

 

96.7

 

2.4

 

4.90

 

149.5

 

3.0

 

3.98

 

Available-for-Sale

 

2,649.9

 

35.6

 

5.37

 

2,486.9

 

31.8

 

5.11

 

2,640.8

 

70.0

 

5.31

 

2,470.1

 

62.9

 

5.10

 

Held-to-Maturity

 

269.6

 

3.1

 

4.50

 

339.3

 

3.8

 

4.51

 

277.5

 

6.3

 

4.52

 

350.1

 

7.9

 

4.50

 

Loans Held for Sale

 

9.3

 

0.1

 

5.78

 

13.6

 

0.2

 

6.34

 

9.9

 

0.3

 

5.59

 

10.5

 

0.3

 

6.27

 

Loans and Leases 2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

1,060.7

 

14.3

 

5.42

 

1,053.3

 

19.5

 

7.43

 

1,062.9

 

30.9

 

5.84

 

1,064.6

 

39.3

 

7.44

 

Commercial Mortgage

 

663.0

 

10.1

 

6.15

 

620.0

 

10.6

 

6.85

 

656.0

 

20.5

 

6.30

 

618.3

 

20.9

 

6.82

 

Construction

 

177.3

 

2.5

 

5.76

 

253.8

 

5.0

 

7.93

 

188.5

 

5.9

 

6.27

 

249.7

 

9.8

 

7.95

 

Commercial Lease Financing

 

470.6

 

4.1

 

3.50

 

461.3

 

4.4

 

3.77

 

474.2

 

8.1

 

3.43

 

461.8

 

7.5

 

3.23

 

Residential Mortgage

 

2,509.1

 

38.2

 

6.09

 

2,499.5

 

38.3

 

6.12

 

2,514.2

 

76.8

 

6.11

 

2,497.9

 

76.5

 

6.12

 

Home Equity

 

968.7

 

14.1

 

5.86

 

941.4

 

17.9

 

7.62

 

969.8

 

30.1

 

6.24

 

941.8

 

35.6

 

7.62

 

Automobile

 

423.1

 

8.6

 

8.16

 

424.2

 

8.6

 

8.16

 

430.9

 

17.5

 

8.17

 

425.3

 

17.1

 

8.12

 

Other 3

 

259.1

 

5.9

 

9.11

 

279.2

 

7.5

 

10.83

 

263.3

 

12.3

 

9.43

 

287.8

 

15.3

 

10.75

 

Total Loans and Leases

 

6,531.6

 

97.8

 

6.01

 

6,532.7

 

111.8

 

6.86

 

6,559.8

 

202.1

 

6.18

 

6,547.2

 

222.0

 

6.82

 

Other

 

79.6

 

0.5

 

2.46

 

79.4

 

0.4

 

1.83

 

79.5

 

0.9

 

2.30

 

79.4

 

0.7

 

1.76

 

Total Earning Assets 4

 

9,752.5

 

138.9

 

5.71

 

9,637.6

 

150.0

 

6.23

 

9,804.5

 

283.8

 

5.80

 

9,673.9

 

298.6

 

6.20

 

Cash and Noninterest-Bearing Deposits

 

272.9

 

 

 

 

 

275.3

 

 

 

 

 

283.5

 

 

 

 

 

292.8

 

 

 

 

 

Other Assets

 

479.0

 

 

 

 

 

470.1

 

 

 

 

 

486.2

 

 

 

 

 

465.4

 

 

 

 

 

Total Assets

 

$

10,504.4

 

 

 

 

 

$

10,383.0

 

 

 

 

 

$

10,574.2

 

 

 

 

 

$

10,432.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-Bearing Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-Bearing Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand

 

$

1,617.0

 

1.2

 

0.29

 

$

1,581.0

 

4.1

 

1.03

 

$

1,615.7

 

3.4

 

0.43

 

$

1,591.7

 

8.3

 

1.05

 

Savings

 

2,805.5

 

6.5

 

0.94

 

2,627.8

 

12.6

 

1.93

 

2,748.6

 

15.8

 

1.15

 

2,633.8

 

25.1

 

1.92

 

Time

 

1,646.5

 

12.5

 

3.07

 

1,707.9

 

17.0

 

3.99

 

1,696.9

 

28.5

 

3.38

 

1,719.9

 

33.7

 

3.94

 

Total Interest-Bearing Deposits

 

6,069.0

 

20.2

 

1.34

 

5,916.7

 

33.7

 

2.28

 

6,061.2

 

47.7

 

1.58

 

5,945.4

 

67.1

 

2.28

 

Short-Term Borrowings

 

61.2

 

0.3

 

1.82

 

116.9

 

1.5

 

5.23

 

70.4

 

1.0

 

2.67

 

98.4

 

2.6

 

5.17

 

Securities Sold Under Agreements to Repurchase

 

1,060.2

 

7.5

 

2.81

 

1,040.6

 

11.7

 

4.46

 

1,112.2

 

18.1

 

3.24

 

1,055.1

 

23.5

 

4.46

 

Long-Term Debt

 

224.3

 

3.5

 

6.18

 

260.3

 

4.0

 

6.12

 

232.0

 

7.2

 

6.22

 

260.3

 

7.9

 

6.12

 

Total Interest-Bearing Liabilities

 

7,414.7

 

31.5

 

1.70

 

7,334.5

 

50.9

 

2.78

 

7,475.8

 

74.0

 

1.98

 

7,359.2

 

101.1

 

2.76

 

Net Interest Income

 

 

 

$

107.4

 

 

 

 

 

$

99.1

 

 

 

 

 

$

209.8

 

 

 

 

 

$

197.5

 

 

 

Interest Rate Spread

 

 

 

 

 

4.01

%

 

 

 

 

3.45

%

 

 

 

 

3.82

%

 

 

 

 

3.44

%

Net Interest Margin

 

 

 

 

 

4.41

%

 

 

 

 

4.12

%

 

 

 

 

4.29

%

 

 

 

 

4.09

%

Noninterest-Bearing Demand Deposits

 

1,889.2

 

 

 

 

 

1,893.4

 

 

 

 

 

1,894.2

 

 

 

 

 

1,920.1

 

 

 

 

 

Other Liabilities

 

418.1

 

 

 

 

 

427.2

 

 

 

 

 

427.9

 

 

 

 

 

433.3

 

 

 

 

 

Shareholders' Equity

 

782.4

 

 

 

 

 

727.9

 

 

 

 

 

776.3

 

 

 

 

 

719.5

 

 

 

 

 

Total Liabilities and Shareholders' Equity

 

$

10,504.4

 

 

 

 

 

$

10,383.0

 

 

 

 

 

$

10,574.2

 

 

 

 

 

$

10,432.1

 

 

 

 

 

 

1 Certain prior period information has been reclassified to conform to the current presentation.

2 Non-performing loans and leases are included in the respective average loan and lease balances. Income, if any, on such loans and leases is recognized on a cash basis.

3 Comprised of other consumer revolving credit, installment, and consumer lease financing.

4 Interest income includes taxable equivalent basis adjustments, based upon a federal statutory tax rate of 35%, of $239,000 and $236,000 for the three months ended June 30, 2008 and 2007, respectively, and $477,000 and $449,000 for the six months ended June 30, 2008 and 2007, respectively.

 

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Table of Contents

 

Analysis of Change in Net Interest Income - Taxable Equivalent Basis (Unaudited)

Table  3

 

Six Months Ended June 30, 2008

 

Compared to June 30, 2007

(dollars in millions)

Volume 1

Rate 1

Time 1

Total

Change in Interest Income:

 

 

 

 

Interest-Bearing Deposits

$                  0.3

$             (0.1)

$                  -

$               0.2

Funds Sold

0.9

(1.1)

-

(0.2)

Investment Securities

 

 

 

 

   Trading

(1.2)

0.6

-

(0.6)

   Available-for-Sale

4.4

2.7

-

7.1

   Held-to-Maturity 

(1.6)

-

-

(1.6)

Loans and Leases

 

 

 

 

   Commercial and Industrial

(0.1)

(8.5)

0.2

(8.4)

   Commercial Mortgage

1.2

(1.7)

0.1

(0.4)

   Construction

(2.1)

(1.9)

0.1

(3.9)

   Commercial Lease Financing

0.2

0.4

-

0.6

   Residential Mortgage

0.5

(0.2)

-

0.3

   Home Equity

1.0

(6.7)

0.2

(5.5)

   Automobile

0.2

0.1

0.1

0.4

   Other 2

(1.3)

(1.8)

0.1

(3.0)

Total Loans and Leases

(0.4)

(20.3)

0.8

(19.9)

Other

-

0.2

-

0.2

Total Change in Interest Income

2.4

(18.0)

0.8

(14.8)

 

 

 

 

 

Change in Interest Expense:

 

 

 

 

Interest-Bearing Deposits

 

 

 

 

   Demand

0.1

(5.1)

0.1

(4.9)

   Savings

1.1

(10.5)

0.1

(9.3)

   Time

(0.4)

(5.0)

0.2

(5.2)

Total Interest-Bearing Deposits

0.8

(20.6)

0.4

(19.4)

Short-Term Borrowings

(0.6)

(1.0)

-

(1.6)

Securities Sold Under Agreements to Repurchase

1.2

(6.7)

0.1

(5.4)

Long-Term Debt

(0.9)

0.2

-

(0.7)

Total Change in Interest Expense

0.5

(28.1)

0.5

(27.1)

 

 

 

 

 

Change in Net Interest Income

$                  1.9

$              10.1

$               0.3

$             12.3

 

1 The changes for each category of interest income and expense are allocated between the portion of changes attributable to the variance in volume, rate, and time for that category.

2 Comprised of other consumer revolving credit, installment, and consumer lease financing.

 


The increase in net interest income, on a taxable equivalent basis, and net interest margin was the result of lower funding costs and the effects of a steeper yield curve in 2008.   

 

Rates paid on interest-bearing deposits decreased by 94 basis points in the second quarter of 2008 and by 70 basis points in the first six months of 2008 compared to the same periods in 2007.  Also contributing to our lower funding costs was a decrease in rates paid on securities sold under agreements to repurchase by 165 basis points in the second quarter of 2008 and by 122 basis points in the first six months of 2008 compared to the same periods in 2007.  Decreased funding costs were reflective of lower short-term interest rates over this period.

 

Yields on our available-for-sale investment securities were 26 basis points higher in the second quarter of 2008 and 21 basis points higher in the first six months of 2008 compared to the same periods in 2007.  These increases reflected our ability to reinvest funds in higher yielding investment securities.  Partially offsetting the decrease in funding costs and higher yields on investment securities was a decrease in yields on our loans and leases.  Yields on our loans and leases decreased by 85 basis points in the second quarter of 2008 and by 64 basis points in the first six months of 2008 compared to the same periods in 2007.  Lower yields in our commercial and industrial and home equity loans were primarily driven by the decline in short-term interest rates over this period.

 


 

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Table of Contents


Despite the decrease in funding costs in 2008, average interest-bearing demand and savings deposit balances collectively increased by $213.7 million or 5% in the second quarter of 2008 and by $138.8 million or 3% in the first six months of 2008 compared to the same periods in 2007.  Increases in these categories were the result of customers moving their deposits to more liquid accounts.  The increase in savings deposit balances was also due to a successful Bonus-Rate Savings Plus campaign in the first quarter of 2008 which resulted in the opening of new accounts.  The growth in our average earning assets in 2008 from 2007 was largely funded from the increase in our interest-bearing deposits.  Although average loans and leases remained relatively stable from 2007, average investment securities, excluding trading securities, increased by $93.3 million or 3% in the second quarter of 2008 and by $98.1 million or 3% in the first six months of 2008 compared to the same periods in 2007.

 

Provision for Credit Losses

 

The Provision reflects our judgment of the expense or benefit necessary to maintain the appropriate amount of the Allowance.  We maintain the Allowance at levels adequate to cover our estimate of probable credit losses as of the end of the reporting period.  The Allowance is determined through detailed quarterly analyses of our loan and lease portfolio.  The Allowance is based on our loss experience, changes in the economic environment, as well as an ongoing assessment of our credit quality.  We recorded a Provision of $7.2 million in the second quarter of 2008 compared to a Provision of $3.4 million in the second quarter of 2007.  We recorded a Provision of $21.6 million in the first six months of 2008 compared to a Provision of $6.0 million in the first six months of 2007.  The higher Provision recorded in the second quarter of 2008 and the first six months of 2008, a result of our quarterly evaluation of the adequacy of the Allowance, reflects increased risk in our commercial aircraft leasing, small business, and unsecured consumer lending portfolios.  Our commercial aircraft leasing portfolio, in particular, has been adversely affected by high oil prices.  For further discussion on the Allowance, see the “Corporate Risk Profile – Reserve

for Credit Losses” section in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”). 

 

Noninterest Income

 

Noninterest income increased by $2.5 million or 4% in the second quarter of 2008 and by $27.7 million or 23% in the first six months of 2008 compared to the same periods in 2007, with the first six months of 2008 significantly impacted by the transactions described in the Overview above.

 

Trust and asset management income decreased by $0.7 million or 4% in the second quarter of 2008 compared to the same period in 2007, primarily due to a $0.8 million decrease in fees from accounts under management, which were adversely affected by the decline in the equity markets over this period.  Trust and asset management income decreased by $1.4 million or 4% in the first six months of 2008 compared to the same period in 2007, primarily due to a similar decrease in fees from accounts under management.  Total trust assets under administration were $12.1 billion as of June 30, 2008 and $13.2 billion as of June 30, 2007.   

 

Mortgage banking income increased by $0.3 million or 10% in the second quarter of 2008 compared to the same period in 2007.  This was primarily due to a $0.2 million increase in the estimated fair value of our mortgage servicing rights as a result of lower mortgage loan prepayment rates and a higher level of loan sales.  Loan sales were $117.0 million in the second quarter of 2008, a $10.6 million or 10% increase compared to the same period in 2007.  We were also favorably impacted by a $0.2 million change in the fair value of our derivative written loan commitments and forward sales commitments over this period of time.  Mortgage banking income increased by $1.2 million or 20% in the first six months of 2008 compared to the same period in 2007.  This was primarily due to a $1.9 million net increase in the gains related to derivative written loan commitments and a $0.9 million increase in the gain on sale of mortgage loans.  Loan sales were $261.8 million in the


 

21



Table of Contents


first six months of 2008, an $82.7 million increase compared to the same period in 2007.  The increase in mortgage loan sales were primarily due to higher refinancing activity in the first six months of 2008 compared to the same period in 2007, a result of lower interest rates on mortgage-based products.  These increases were partially offset by a $1.3 million decrease in the net change in the estimated fair value of our mortgage rights and our trading securities.

 

Service charges on deposit accounts increased by $1.3 million or 12% in the second quarter of 2008 and by $2.5 million or 11% in the first six months of 2008 compared to the same periods in 2007.  The increase in the second quarter of 2008 compared to the same period in 2007 was primarily due to a $1.2 million increase in account analysis fees on analyzed business checking accounts as a result of lower earnings credit rates on customer accounts.  Also contributing to the increase was a $0.3 million increase in overdraft fees as a result of fee schedule changes implemented in the third quarter of 2007, as well as an increase in the number of transactional deposit accounts.  The increase in the first six months of 2008 compared to the same period in 2007 was also attributable to a $1.9 million increase in account analysis fees and a $0.9 million increase in overdraft fees.

 

Fees, exchange, and other service charges increased by $0.6 million or 4% in the second quarter of 2008 and by $0.7 million or 2% in the first six months of 2008 compared to the same periods in 2007.  The increase in the second quarter of 2008 compared to the same period in 2007 was primarily due to a $0.5 million increase in debit card income resulting from higher transactional volume from new and existing debit cardholders.  The increase was also attributable to a $0.4 million increase in fees from facilitating interest rate swaps on behalf of our customers.  These increases were partially offset by a $0.3 million decrease in ATM fees as a result of lower transaction volume.  The increase in the first six months of 2008 compared to the same period in 2007 was primarily due to a $1.1 million increase in debit card income, partially offset

by a $0.6 million decrease in ATM fees.

 

Insurance income increased by $0.7 million or 14% in the second quarter of 2008 and by $1.6 million or 15% in the first six months of 2008 compared to the same periods in 2007.  The increase in the second quarter of 2008 was primarily due to a $0.5 million increase in both income from annuity and life insurance products and contingent commission income.  The increase in the first six months of 2008 compared to the same period in 2007 was primarily due to a $1.2 million increase in contingent commission income and a $0.9 million increase in income from annuity and life insurance products.

 

Other noninterest income increased by $0.7 million or 11% in the second quarter of 2008 and by $23.5 million in the first six months of 2008 compared to the same periods in 2007.  The increase in the second quarter of 2008 compared to the same period in 2007 was primarily due to the change in estimated fair value of our subordinated notes.  The increase in the first six months of 2008 compared to the same period in 2007 was primarily due to the $13.7 million gain from the mandatory redemption of our Visa shares and the $11.6 million gain on the sale of our equity interest in an aircraft lease in March 2008.  See Note 7 to the Consolidated Financial Statements (Unaudited) for more information on the mandatory redemption of our Visa shares.  See Note 5 to the Consolidated Financial Statements (Unaudited) for more information on the sale of our equity interest in the aircraft lease. 


 

22



Table of Contents


Noninterest Expense

 

Noninterest expense increased by $4.0 million or 5% in the second quarter of 2008 and by $15.3 million or 9% in the first six months of 2008 compared to the same periods in 2007.

Table 4 presents the components of salaries and benefits expense for the second quarter and first six months of 2008 and 2007.

 


 

Salaries and Benefits (Unaudited)

Table 4

 

 

Three Months Ended

 

 

Six Months Ended

 

 

June 30,

 

 

June 30,

(dollars in thousands)

2008

2007

 

2008

2007

Salaries

$         30,019

$      29,220

 

$      58,922

$     57,344

Incentive Compensation

4,122

3,794

 

10,389

7,413

Cash for Stock Grants

-

-

 

4,640

-

Share-Based Compensation

1,124

1,333

 

2,772

2,560

Commission Expense

1,992

2,161

 

3,865

4,154

Retirement and Other Benefits

3,499

3,365

 

8,725

7,134

Payroll Taxes

2,491

2,247

 

5,905

5,769

Medical, Dental, and Life Insurance

2,470

2,263

 

4,969

4,501

Separation Expense

267

204

 

1,270

1,118

Total Salaries and Benefits

$         45,984

$      44,587

 

$    101,457

$     89,993

 


Salaries and benefits expense increased in the second quarter of 2008 compared to the same period in 2007 primarily due to a $0.9 million increase in salaries from annual merit increases and related payroll taxes.  Also contributing to the increase in salaries and benefits expense was a $0.5 million reversal of our Money Purchase Plan forfeiture reserves made in the second quarter of 2007, which lowered 2007 expense.  

 

Salaries and benefits expense increased in the first six months of 2008 compared to the same period in 2007 primarily due to the accrual of $9.0 million related to cash awards to purchase our stock and earnings-based incentive compensation expense in the first quarter of 2008.  Of this amount, $4.6 million of the increase related to a change in our practice of equity compensation for senior management.  Instead of restricted stock, senior officers, other than executive officers, generally received or will receive cash grants to encourage them to purchase our common stock.  Of the $4.6 million accrual, we paid $2.3 million in cash to senior officers in the second quarter of 2008 with the remaining balance expected to be paid by December 31, 2008.  Salaries and benefits expense also increased over this period due to a $1.6 million increase in salaries from annual merit increases and related payroll taxes.  Also contributing to the increase in salaries and benefits expense was a $1.0 million reversal of our Money

Purchase Plan forfeiture reserves made during the first six months of 2007, which lowered 2007 expense. 

 

Net occupancy increased by $1.6 million or 17% in the second quarter of 2008 and by $2.3 million or 12% in the first six months of 2008 compared to the same periods in 2007.  The increase in the second quarter of 2008 compared to the same period of 2007 was primarily due to a $0.8 million increase in net rental expense related in part to a new branch and a $0.5 million increase in utilities expense.  The increase from the first six months of 2007 was also due to increases in net rental and utilities expenses.

 

Other noninterest expense increased by $1.4 million or 8% in the second quarter of 2008 compared to the second quarter of 2007.  The increase in other noninterest expense was primarily due to:

 

·     $0.4 million increase in merchant transaction and card processing fees due to higher volume;

 

·     $0.3 million increase in directors’ fees due to the change in market value of the directors’ deferred compensation plan assets;

 


 

23



Table of Contents


·     $0.3 million increase related to the reversal of typhoon-related accruals in the second quarter of 2007 for the Pacific Islands; and

 

·     $0.3 million increase in our airline mileage reward program expenses due to higher volume.

 

These increases in the second quarter of 2008 compared to the same period in 2007 were partially offset by a $0.6 million increase in the adjustment to reduce our captive insurance claim reserves. 

 

Other noninterest expense increased by $2.4 million or 6% in the first six months of 2008 compared to the same period in 2007.  The increase in other noninterest expense was primarily due to:

 

·      $3.0 million increase in our reserves for legal contingencies;

 

·      $1.0 million related to the call premium on our Capital Securities;

 

·     $2.3 million in contributions to the Bank of Hawaii Charitable Foundation and other charitable organizations;

 

·     $0.8 million increase in our airline mileage reward program expenses due to higher volume; and

 

·     $0.6 million increase in merchant transaction and card processing fees due to higher volume.

 

These increases in the first six months of 2008 compared to the same period in 2007 were partially offset by the reversal of $5.6 million in previously recorded Visa contingency accruals described in the Overview above. 

 

See Note 7 to the Consolidated Financial Statements (Unaudited) for more discussion on the reversal of our Visa contingency accruals. 

 

Provision for Income Taxes

 

See Note 6 to the Consolidated Financial Statements (Unaudited) for information on the provision for income taxes.


 

24



Table of Contents

 

Analysis of Statements of Condition

 

Investment Securities

 

Table 5 presents the amortized cost and estimated fair value of our available-for-sale and held-to-maturity investment securities as of June 30, 2008, December 31, 2007, and June 30, 2007.

 

Investment Securities (Unaudited)

 

Table 5

 

 

 

Amortized

 

Fair

 

(dollars in thousands)

 

Cost

 

Value

 

June 30, 2008

 

 

 

 

 

Available-for-Sale:

 

 

 

 

 

Debt Securities Issued by the U.S. Treasury and Government Agencies

 

$

1,648

 

$

1,676

 

Debt Securities Issued by States and Political Subdivisions

 

47,885

 

47,811

 

Debt Securities Issued by U.S. Government-Sponsored Enterprises

 

250,776

 

249,863

 

Mortgage-Backed Securities Issued by

 

 

 

 

 

U.S. Government-Sponsored Enterprises

 

2,007,001

 

2,003,432

 

Non-Agencies

 

323,935

 

309,222

 

Total Mortgage-Backed Securities

 

2,330,936

 

2,312,654

 

Other Debt Securities

 

34,339

 

34,502

 

Total

 

$

2,665,584

 

$

2,646,506

 

Held-to-Maturity:

 

 

 

 

 

Debt Securities Issued by States and Political Subdivisions

 

$

6

 

$

6

 

Mortgage-Backed Securities Issued by U.S. Government-Sponsored Enterprises

 

260,586

 

255,899

 

Total

 

$

260,592

 

$

255,905

 

 

 

 

 

 

 

December 31, 2007

 

 

 

 

 

Available-for-Sale:

 

 

 

 

 

Debt Securities Issued by the U.S. Treasury and Government Agencies

 

$

3,295

 

$

3,325

 

Debt Securities Issued by States and Political Subdivisions

 

47,620

 

47,910

 

Debt Securities Issued by U.S. Government-Sponsored Enterprises

 

294,223

 

295,464

 

Mortgage-Backed Securities Issued by

 

 

 

 

 

U.S. Government-Sponsored Enterprises

 

1,678,828

 

1,684,471

 

Non-Agencies

 

312,973

 

304,440

 

Total Mortgage-Backed Securities

 

1,991,801

 

1,988,911

 

Other Debt Securities

 

228,421

 

227,580

 

Total

 

$

2,565,360

 

$

2,563,190

 

Held-to-Maturity:

 

 

 

 

 

Debt Securities Issued by States and Political Subdivisions

 

$

6

 

$

6

 

Mortgage-Backed Securities Issued by U.S. Government-Sponsored Enterprises

 

292,571

 

287,638

 

Total

 

$

292,577

 

$

287,644

 

June 30, 2007 1

 

 

 

 

 

Available-for-Sale:

 

 

 

 

 

Debt Securities Issued by the U.S. Treasury and Government Agencies

 

$

4,041

 

$

4,017

 

Debt Securities Issued by States and Political Subdivisions

 

47,550

 

46,801

 

Debt Securities Issued by U.S. Government-Sponsored Enterprises

 

333,125

 

330,820

 

Mortgage-Backed Securities Issued by

 

 

 

 

 

U.S. Government-Sponsored Enterprises

 

1,529,642

 

1,493,675

 

Non-Agencies

 

336,921

 

326,544

 

Total Mortgage-Backed Securities

 

1,866,563

 

1,820,219

 

Other Debt Securities

 

258,337

 

253,811

 

Total

 

$

2,509,616

 

$

2,455,668

 

Held-to-Maturity:

 

 

 

 

 

Debt Securities Issued by States and Political Subdivisions

 

$

30

 

$

30

 

Mortgage-Backed Securities Issued by U.S. Government-Sponsored Enterprises

 

327,088

 

313,559

 

Total

 

$

327,118

 

$

313,589

 

 

1 Certain prior period information has been reclassified to conform to the current presentation.

 

 

 


The carrying value of our investment securities, excluding trading securities, was $2.9 billion as of June 30, 2008 and December 31, 2007, and $2.8 billion as of June 30, 2007. Investment securities with a carrying value of $1.8 billion

as of June 30, 2008 and 2007, and $1.7 billion as of December 31, 2007, which approximates fair value, were pledged to secure deposits of governmental entities and


 

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Table of Contents


securities sold under agreements to repurchase. Investment securities pledged where the secured party has the right to sell or repledge the investment securities were $727.7 million as of June 30, 2008, $650.4 million as of December 31, 2007, and $772.3 million as of June 30, 2007.

As of June 30, 2008, the par value of our callable debt and mortgage-backed securities issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation were as follows:


 

Investment Securities Issued by the Federal National Mortgage Association
and the Federal Home Loan Mortgage Corporation (Unaudited)

 

Table 6

 

(dollars in thousands)

 

Par Value

 

June 30, 2008

 

 

 

Debt Securities Issued by U.S. Government-Sponsored Enterprises

 

 

 

Federal National Mortgage Association

$

 

209,807

 

Federal Home Loan Mortgage Corporation

 

15,000

 

Subtotal

 

224,807

 

Mortgage-Backed Securities Issued by U.S. Government-Sponsored Enterprises

 

 

 

Federal National Mortgage Association

 

997,144

 

Federal Home Loan Mortgage Corporation

 

907,835

 

Subtotal

 

1,904,979

 

Total

$

 

2,129,786

 

 


As of June 30, 2008, we did not own any preferred stock of the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation.

 

As of June 30, 2008, all of our mortgage-backed securities issued by private issuers (“non-agencies”) were prime jumbo, AAA-rated, with an average current amortized loan-to-value ratio of 59%. As of June 30, 2008, 97% of the fair value of our mortgage-backed securities issued by non-agencies was originated prior to 2006.

Loans past due 90 days or more, underlying the mortgage-backed securities issued by non-agencies, represented approximately 56 basis points of the par value outstanding or approximately $1.8 million as of June 30, 2008. As of June 30, 2008, there were no “sub-prime” or “Alt-A” securities in our mortgage-backed securities portfolio.

 

Table 7 presents our temporarily impaired investment securities as of June 30, 2008, December 31, 2007, and June 30, 2007.


 

Temporarily Impaired Investment Securities (Unaudited)

 

Table 7

 

 

 

Temporarily Impaired

 

Temporarily Impaired

 

 

 

 

 

 

 

Less Than 12 Months

 

12 Months or Longer

 

Total

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

Gross

 

 

 

 

 

Unrealized

 

 

 

Unrealized

 

 

 

Unrealized

 

(dollars in thousands)

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

Fair Value

 

Losses

 

June 30, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt Securities Issued by States and

 

 

 

 

 

 

 

 

 

 

 

 

 

Political Subdivisions

 

$

30,207

 

$

(214

)

$

573

 

$

(14

)

$

30,780

 

$

(228

)

Debt Securities Issued by U.S.

 

 

 

 

 

 

 

 

 

 

 

 

 

Government-Sponsored Enterprises

 

164,315

 

(1,062

)

887

 

(10

)

165,202

 

(1,072

)

Mortgage-Backed Securities Issued by

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Government-Sponsored Enterprises

 

1,079,508

 

(16,204

)

121,512

 

(3,646

)

1,201,020

 

(19,850

)

Non-Agencies

 

140,517

 

(4,267

)

147,233

 

(10,800

)

287,750

 

(15,067

)

Total Mortgage-Backed Securities

 

1,220,025

 

(20,471

)

268,745

 

(14,446

)

1,488,770

 

(34,917

)

Total Temporarily Impaired Investment Securities June 30, 2008

 

$

1,414,547

 

$

(21,747

)

$

270,205

 

$

(14,470

)

$

1,684,752

 

$

(36,217

)

December 31, 2007

 

$

150,249

 

$

(616

)

$

1,325,002

 

$

(21,445

)

$

1,475,251

 

$

(22,061

)

June 30, 2007

 

$

679,516

 

$

(7,455

)

$

1,878,594

 

$

(62,165

)

$

2,558,110

 

$

(69,620

)

 

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Table of Contents


Our temporarily impaired investment securities and related gross unrealized losses increased as of June 30, 2008 compared to December 31, 2007 primarily due to a rise in interest rates on mortgage-based products over this period of time. This rise in interest rates on mortgage-based products adversely affected the fair value of our mortgage-backed securities. The decrease in our temporarily impaired investment securities and related gross unrealized losses as of June 30, 2008 compared to June 30, 2007 was primarily due to the run-off and pay-downs on investment securities as well as decreasing interest rates on mortgage-based products over this period of time.

 

The gross unrealized losses reported for mortgage-backed securities are primarily related to investment securities issued by U.S. government-sponsored enterprises, such as the Federal National Mortgage Association and Federal Home Loan

Mortgage Corporation. The gross unrealized losses reported for mortgage-backed securities also include investment securities issued by non-agencies. We do not believe that the investment securities that were in an unrealized loss position as of June 30, 2008, which was comprised of 172 securities, represent an other-than-temporary impairment. Total gross unrealized losses were primarily attributable to changes in interest rates, relative to when the investment securities were purchased, and not due to the credit quality of the investment securities. We have both the intent and ability to hold the investment securities for a period of time necessary to recover the amortized cost.

 

Loans and Leases

 

Table 8 presents the composition of our loan and lease portfolio by major categories.


 

Loan and Lease Portfolio Balances (Unaudited)

 

Table 8

 

 

 

June 30,

 

March 31,

 

December 31,

 

September 30,

 

June 30,

 

(dollars in thousands)

 

2008

 

2008

 

2007

 

2007 1

 

2007 1

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

$

1,052,319

 

$

1,079,772

 

$

1,054,355

 

$

1,065,258

 

$

1,065,155

 

Commercial Mortgage

 

680,784

 

650,638

 

634,483

 

627,329

 

619,668

 

Construction

 

168,678

 

190,521

 

208,670

 

254,062

 

261,478

 

Lease Financing

 

471,443

 

465,945

 

481,882

 

478,988

 

480,358

 

Total Commercial

 

2,373,224

 

2,386,876

 

2,379,390

 

2,425,637

 

2,426,659

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

Residential Mortgage

 

2,509,133

 

2,530,207

 

2,508,261

 

2,510,313

 

2,505,073

 

Home Equity

 

966,108

 

967,146

 

972,995

 

953,713

 

938,261

 

Automobile

 

413,338

 

430,920

 

443,011

 

440,525

 

425,672

 

Other 2

 

256,325

 

264,188

 

277,204

 

269,727

 

270,461

 

Total Consumer

 

4,144,904

 

4,192,461

 

4,201,471

 

4,174,278

 

4,139,467

 

Total Loans and Leases

 

$

6,518,128

 

$

6,579,337

 

$

6,580,861

 

$

6,599,915

 

$

6,566,126

 

 

1 Certain prior period information has been reclassified to conform to the current presentation.

2 Comprised of other revolving credit, installment, and lease financing.

 


Loans and leases represent our largest category of interest earning assets and the largest source of revenue.

 

The decrease in total commercial loans and leases from December 31, 2007 was primarily due to a $40.0 million decrease in construction loans and a $10.4 million decrease in lease financing due to the exercise of an early buy-out option by one of our aircraft lessees in March 2008. This was partially offset by a $46.3 million increase in commercial mortgage loans from December 31, 2007. The changes in construction and commercial mortgage loans from December 31, 2007 were consistent with our strategy to reduce our construction

lending exposure and to grow our commercial secured mortgage loan portfolio. The decrease in consumer loans and leases from December 31, 2007 was in all categories except mortgage lending, consistent with a slowing economy in Hawaii and our continued disciplined underwriting approach.

 

The decrease in total commercial loans and leases from June 30, 2007 was primarily due to a $92.8 million decrease in construction loans and a $12.8 million decrease in commercial and industrial loans. This was partially offset by a $61.1 million increase in commercial mortgage loans from


 

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Table of Contents


June 30, 2007.  As previously noted, our strategy has been to reduce our construction lending exposure and to grow our commercial secured mortgage portfolio.  The slight increase in total consumer loans and leases from June 30, 2007 was primarily due to a $27.8 million increase in home equity loans and a $4.1 million increase in residential mortgage loans, reflecting lower trending interest rates over this period of time. This was partially offset by a $14.1 million decrease in other

consumer loans, reflecting the effects that the slowing economy in Hawaii has had on consumers, and a $12.3 million decrease in automobile loans, reflecting a reduction of risk given the lower demand for automobile loans.

 

Table 9 presents the composition of our loan and lease portfolio by geographic area and by major categories.


 

Geographic Distribution of Loan and Lease Portfolio (Unaudited)

 

Table 9

 

 

 

June 30,

 

March 31,

 

December 31,

 

September 30,

 

June 30,

 

(dollars in thousands)

 

2008

 

2008

 

2007 1

 

2007 1

 

2007 1

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

Hawaii

 

 

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

$

705,468

 

$

718,457

 

$

695,141

 

$

677,242

 

$

669,887

 

Commercial Mortgage

 

597,322

 

564,719

 

548,423

 

531,920

 

522,844

 

Construction

 

157,642

 

178,958

 

197,762

 

239,765

 

246,612

 

Lease Financing

 

62,623

 

55,498

 

55,697

 

51,839

 

52,445

 

Mainland U.S. 2

 

 

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

200,618

 

205,122

 

202,203

 

233,931

 

229,231

 

Commercial Mortgage

 

4,808

 

4,953

 

5,129

 

5,569

 

5,709

 

Construction

 

9,045

 

10,278

 

9,932

 

14,088

 

14,866

 

Lease Financing

 

389,573

 

391,303

 

395,419

 

396,471

 

397,307

 

Guam

 

 

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

71,340

 

74,736

 

75,239

 

64,063

 

74,799

 

Commercial Mortgage

 

74,226

 

76,220

 

76,301

 

85,098

 

86,449

 

Construction

 

1,991

 

1,285

 

976

 

209

 

-

 

Other Pacific Islands

 

 

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

15,942

 

16,693

 

17,771

 

18,535

 

19,140

 

Commercial Mortgage

 

2,365

 

2,529

 

2,629

 

2,776

 

2,815

 

Foreign 3

 

 

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

58,951

 

64,764

 

64,001

 

71,487

 

72,098

 

Commercial Mortgage

 

2,063

 

2,217

 

2,001

 

1,966

 

1,851

 

Lease Financing

 

19,247

 

19,144

 

30,766

 

30,678

 

30,606

 

Total Commercial

 

2,373,224

 

2,386,876

 

2,379,390

 

2,425,637

 

2,426,659

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

Hawaii

 

 

 

 

 

 

 

 

 

 

 

Residential Mortgage

 

2,281,164

 

2,296,061

 

2,269,670

 

2,269,128

 

2,260,948

 

Home Equity

 

912,467

 

911,064

 

915,820

 

895,629

 

877,251

 

Automobile

 

282,843

 

294,410

 

308,706

 

313,712

 

312,716

 

Other 4

 

189,087

 

193,915

 

201,323

 

190,775

 

191,151

 

Mainland U.S. 2

 

 

 

 

 

 

 

 

 

 

 

Home Equity

 

31,881

 

35,445

 

37,878

 

39,870

 

43,563

 

Automobile

 

49,792

 

48,667

 

40,679

 

30,632

 

16,269

 

Guam

 

 

 

 

 

 

 

 

 

 

 

Residential Mortgage

 

219,757

 

225,503

 

230,017

 

232,238

 

235,206

 

Home Equity

 

18,413

 

17,148

 

15,671

 

14,531

 

13,526

 

Automobile

 

72,428

 

78,403

 

83,491

 

84,849

 

84,190

 

Other 4

 

33,078

 

34,679

 

36,767

 

37,765

 

37,325

 

Other Pacific Islands

 

 

 

 

 

 

 

 

 

 

 

Residential Mortgage

 

8,212

 

8,643

 

8,574

 

8,947

 

8,919

 

Home Equity

 

3,347

 

3,489

 

3,626

 

3,683

 

3,921

 

Automobile

 

8,275

 

9,440

 

10,135

 

11,332

 

12,497

 

Other 4

 

34,157

 

35,588

 

39,090

 

41,166

 

41,985

 

Foreign 3

 

 

 

 

 

 

 

 

 

 

 

Other 4

 

3

 

6

 

24

 

21

 

-

 

Total Consumer

 

4,144,904

 

4,192,461

 

4,201,471

 

4,174,278

 

4,139,467

 

Total Loans and Leases

 

$

6,518,128

 

$

6,579,337

 

$

6,580,861

 

$

6,599,915

 

$

6,566,126

 

 

 

1 Certain prior period information has been reclassified to conform to the current presentation.

2 For secured loans and leases, classification as Mainland U.S. is made based on where the collateral is located.  For unsecured loans and leases, classification as Mainland U.S. is made based on the location where the majority of the borrower’s business operations are conducted.

3 Loans and leases classified as Foreign represents those which are recorded in the Company’s international business units.

4 Comprised of other revolving credit, installment, and lease financing.

 

28



Table of Contents

 

Our commercial and consumer lending activities are concentrated primarily in Hawaii and the Pacific Islands.  Our commercial loan and lease portfolio to borrowers based on the mainland U.S. includes participation in shared national credits and leveraged lease financing.  Our consumer loan and lease portfolio includes limited lending activities on the mainland U.S.

 

 

Other Assets

 

Table 10 presents the major components of other assets as of June 30, 2008, December 31, 2007, and June 30, 2007.

 

 


 

Other Assets (Unaudited)

 

 

 

 

 

Table 10

 

 

 

June 30,

 

December 31,

 

June 30,

 

(dollars in thousands)

 

2008

 

2007

 

2007

 

Bank-Owned Life Insurance

 

$

192,716

 

$

188,888

 

$

184,909

 

Federal Home Loan Bank and Federal Reserve Bank Stock

 

79,635

 

79,494

 

79,415

 

Low Income Housing and Other Equity Investments

 

33,176

 

36,376

 

25,932

 

Accounts Receivable

 

20,747

 

26,748

 

24,416

 

Federal Tax Deposit

 

61,000

 

61,000

 

61,000

 

Other

 

41,992

 

40,626

 

37,503

 

Total Other Assets

 

$

429,266

 

$

433,132

 

$

413,175

 


The decrease in other assets from December 31, 2007 was primarily due to a $6.0 million decrease in accounts receivable due to the receipt of sales proceeds from a real estate transaction which occurred in the fourth quarter of 2007.   A $3.2 million decrease in low income housing and other equity investments, due to current year amortization, also contributed to the decrease in other assets.  Partially offsetting this decrease was a $3.8 million increase in Bank-Owned Life Insurance (“BOLI”) assets from current year earnings.

 

The increase in other assets from June 30, 2007 was primarily due to a $7.8 million increase in BOLI assets, a $7.2 million increase in low income housing and other equity investments, and a $4.5 million increase in other assets.  The increase in low income housing and other equity investments was primarily due to $14.7 million in funding of new low income housing investments during the second half of 2007, partially offset by $7.5 million in amortization.  The increase in other assets was primarily due to higher balances in customer-related receivable accounts which have equal and off-setting amounts recorded in other liabilities.

 

We continue to maintain the federal tax deposit with the Internal Revenue Service (the “IRS”) relating to their review of our Lease In-Lease Out (“LILO”) and Sale In-Lease Out (“SILO”) transactions.  The placement of the deposit with the

IRS limited the potential accrual of additional interest, the rate on which is higher than alternative funding costs.

 

Deposits

 

As of June 30, 2008, total deposits were $7.9 billion, a decrease of $38.4 million or less than 1% from December 31, 2007 and a decrease of $410.4 million or 5% from June 30, 2007.  Core deposit balances (comprised of noninterest-bearing demand, interest-bearing demand, and savings accounts) increased by $123.8 million or 2% from December 31, 2007 and decreased by $250.6 million or 4% from June 30, 2007.

 

The increase in our core deposit balances from December 31, 2007 was primarily due to customers moving their balances to more liquid accounts.  This is consistent with the Bank’s strategy to emphasize growth in core deposits.  A contributing market factor for this increase was the volatility in the financial markets and a decline in the equity markets over this period of time.

 

The decrease in our core deposit balances from June 30, 2007 was primarily due to short-term commercial deposits that were largely withdrawn in the third quarter of 2007.


 

29



Table of Contents

 

Table 11 presents the composition of our savings deposits as of June 30, 2008, December 31, 2007, and June 30, 2007.

 

Savings Deposits (Unaudited)

 

 

 

 

 

Table 11

 

 

 

June 30,

 

December 31,

 

June 30,

 

(dollars in thousands)

 

2008

 

2007

 

2007

 

Money Market

 

$

1,045,790

 

$

1,061,808

 

$

1,378,722

 

Regular Savings

 

1,735,292

 

1,568,663

 

1,544,446

 

Total Savings Deposits

 

$

2,781,082

 

$

2,630,471

 

$

2,923,168

 

 

Table 12 presents our average balance of time deposits of $100,000 or more for the three months ended June 30, 2008, December 31, 2007, and June 30, 2007, and for the six months ended June 30, 2008 and 2007.

 

Average Time Deposits of $100,000 or More (Unaudited)

 

Table 12

 

 

 

Three Months Ended

 

Six Months Ended

 

(dollars in thousands)

 

June 30, 2008

 

December 31, 2007

 

June 30, 2007

 

June 30, 2008

 

June 30, 2007

 

Average Time Deposits

 

$

948,729

 

$

983,389

 

$

960,960

 

$

978,908

 

$

973,817

 


 

Borrowings and Long-Term Debt

 

Borrowings, including funds purchased and other short-term borrowings, were $79.6 million as of June 30, 2008.  This represented a decrease of $6.2 million or 7% from December 31, 2007 and a decrease of $26.7 million or 25% from June 30, 2007.  These decreases were due to a reduction in short-term funding needs.

 

Long-term debt was $205.4 million as of June 30, 2008.  This represented a decrease of $30.0 million or 13% from December 31, 2007 and a decrease of $55.0 million or 21% from June 30, 2007.  The decrease in long-term debt from December 31, 2007 was primarily due to the redemption of our remaining $26.4 million in Capital Securities and $6.0 million in subordinated notes in the second quarter of 2008.  This was partially offset by the adoption of SFAS No. 159 on January 1, 2008, which resulted in a $4.2 million carrying value

 

adjustment to fair value on our subordinated notes.  See Notes 1 and 4 to the Consolidated Financial Statements (Unaudited) for more information on our adoption of SFAS No. 159.  The decrease in long-term debt from June 30, 2007 was primarily due to the maturity of a $25.0 million Federal Home Loan Bank of Seattle (“FHLB”) advance in the third quarter of 2007 and the redemption of our remaining Capital Securities and subordinated notes.  Further discussion on borrowings is included in the “Corporate Risk Profile – Liquidity Management” section of MD&A.

 

Securities Sold Under Agreements to Repurchase

 

Table 13 presents the composition of our securities sold under agreements to repurchase as of June 30, 2008, December 31, 2007, and June 30, 2007.

 


 

Securities Sold Under Agreements to Repurchase (Unaudited)

 

 

 

 

 

Table 13

 

 

 

June 30,

 

December 31,

 

June 30,

 

(dollars in thousands)

 

2008

 

2007

 

2007

 

Government Entities

 

$

378,518

 

$

429,340

 

$

310,302

 

Private Institutions

 

650,000

 

600,000

 

600,000

 

Total Securities Sold Under Agreements to Repurchase

 

$

1,028,518

 

$

1,029,340

 

$

910,302

 



Securities sold under agreements to repurchase as of June 30, 2008 were relatively unchanged from the balance as of December 31, 2007.  The increase in securities sold under

agreements to repurchase from June 30, 2007 was due to additional placements with government entities and private institutions that provided for sources of liquidity used to repay


 

30



Table of Contents


long-term debt, a more expensive source of funds.  As of June 30, 2008, the weighted average maturity was 82 days for our securities sold under agreements to repurchase with government entities and 8.93 years for securities sold under agreements to repurchase with private institutions, subject to the private institutions’ right to terminate agreements at earlier specified dates which could decrease the weighted average maturity to 311 days.  As of June 30, 2008, $425.0 million of securities sold under agreements to repurchase placed with private institutions were indexed to the London Inter Bank Offering Rate (“LIBOR”) with the remaining $225.0 million at fixed interest rates.  If the agreements with private institutions are not terminated by the specified dates, the interest rates on the agreements become fixed, at rates ranging from 2.98% to 5.00%, for the remaining term of the respective agreements.  As of June 30, 2008, the weighted average interest rate for outstanding agreements with private institutions was 2.74%.

 

Shareholders’ Equity

 

As of June 30, 2008, shareholders’ equity was $767.6 million, an increase of $17.3 million or 2% from December 31, 2007 and a $58.8 million or 8% increase from June 30, 2007.  The increase in shareholders’ equity from December 31, 2007 was primarily due to current period earnings of $105.5 million, partially offset by $45.2 million in common stock repurchases and $42.3 million in cash dividends paid.  Further discussion on our capital structure is included in the “Corporate Risk Profile – Capital Management” section of MD&A.

 

Analysis of Business Segments

 

Our business segments are Retail Banking, Commercial Banking, Investment Services, and Treasury.  Our internal management accounting process measures the performance of the business segments based on the management structure of the Company.  This process, which is not necessarily comparable with similar information for any other financial institution, uses various techniques to assign balance sheet and income statement amounts to the business segments, including allocations of income, expense, the Provision, and capital.  This process is dynamic and requires certain allocations based

on judgment and other subjective factors.  Unlike financial accounting, there is no comprehensive authoritative guidance

for management accounting that is equivalent to GAAP.

 

We evaluate several performance measures of the business segments, the most important of which are net income less a charge for the cost of allocated capital (“NIACC”) and risk adjusted return on capital (“RAROC”).  The cost of allocated capital is determined by multiplying our estimate of a shareholder’s minimum required rate of return on the cost of capital invested (10% for 2008, 11% for 2007) by the segment’s allocated equity.  We assume a cost of capital that is equal to a risk-free rate plus a risk premium.  RAROC is the ratio of economic net income to risk-adjusted equity.  Equity is allocated to each business segment based on an assessment of its inherent risk.  The net interest income of the business segments reflect the results of a funds transfer pricing process that matches assets and liabilities with similar interest rate sensitivity and maturity characteristics and reflects the allocation of net interest income related to our overall asset and liability management activities on a proportionate basis.  The basis for the allocation of net interest income is a function of our assumptions that are subject to change based on changes in current interest rates and market conditions.  Funds transfer pricing also serves to transfer interest rate risk to Treasury.  However, the other business segments have some latitude to retain certain interest rate exposures related to customer pricing decisions within guidelines.  Allocated net income for each business segment includes a Provision.  For business segment reporting purposes, the Provision is reversed and is replaced by an economic provision.  The economic provision is a statistically derived estimate of annual expected credit losses over an economic cycle.

 

We consider NIACC to be a measure of shareholder value creation.  Our consolidated NIACC was $29.9 million for the second quarter of 2008 compared to $26.6 million for the same period in 2007.  The increase in NIACC in the second quarter of 2008 was primarily due to an increase in net interest income and noninterest income, partially offset by an increase in noninterest expense and the provision for income taxes.  Our consolidated NIACC was $73.5 million for the first six months of 2008 compared to $52.8 million for the same period


 

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in 2007.  The increase in NIACC for the first six months of 2008 was primarily due to an increase in net interest income as well as the previously noted gains related to Visa and the sale of our equity interest in an aircraft lease.  This was partially offset by accruals made in the first quarter of 2008 related to employee incentives, charitable contributions, the call premium on our Capital Securities, and legal contingency accruals.  The increase in the Provision did not impact NIACC since it is replaced by an economic provision.  For the second

quarter of 2008 and for the first six months of 2008, the economic provision was relatively unchanged compared to the same periods in 2007.

 

Tables 14a and 14b summarize our NIACC and RAROC for the second quarter of 2008 and for the first six months of 2008 compared to the same periods in 2007.

 


 

Business Segments Selected Financial Information (Unaudited)

 

Table 14a

 

 

 

Retail

 

Commercial

 

Investment

 

 

 

 

 

Consolidated

 

(dollars in thousands)

 

Banking

 

Banking

 

Services

 

Total

 

Treasury

 

Total

 

Three Months Ended June 30, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

$

59,555

 

$

43,264

 

$

3,938

 

$

106,757

 

$

411

 

$

107,168

 

Provision for Credit Losses

 

2,571

 

4,652

 

(1

)

7,222

 

(50

)

7,172

 

Net Interest Income After Provision for Credit Losses

 

56,984

 

38,612

 

3,939

 

99,535

 

461

 

99,996

 

Noninterest Income

 

27,270

 

9,997

 

19,019

 

56,286

 

4,253

 

60,539

 

Noninterest Expense

 

(43,335

)

(23,544

)

(16,363

)

(83,242

)

(620

)

(83,862

)

Income Before Provision for Income Taxes

 

40,919

 

25,065

 

6,595

 

72,579

 

4,094

 

76,673

 

Provision for Income Taxes

 

(15,140

)

(9,286

)

(2,440

)

(26,866

)

(1,525

)

(28,391

)

Allocated Net Income

 

25,779

 

15,779

 

4,155

 

45,713

 

2,569

 

48,282

 

Allowance Funding Value

 

(221

)

(865

)

(14

)

(1,100

)

1,100

 

-

 

Provision for Credit Losses

 

2,571

 

4,652

 

(1

)

7,222

 

(50

)

7,172

 

Economic Provision

 

(1,945

)

(3,257

)

(82

)

(5,284

)

(1

)

(5,285

)

Tax Effect of Adjustments

 

(150

)

(196

)

36

 

(310

)

(387

)

(697

)

Income Before Capital Charge

 

26,034

 

16,113

 

4,094

 

46,241

 

3,231

 

49,472

 

Capital Charge

 

(4,749

)

(4,036

)

(1,444

)

(10,229

)

(9,328

)

(19,557

)

Net Income (Loss) After Capital Charge (NIACC)

 

$

21,285

 

$

12,077

 

$

2,650

 

$

36,012

 

$

(6,097

)

$

29,915

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RAROC (ROE for the Company)

 

55

40

28

45

19

%

25

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets as of June 30, 2008

 

$

3,649,376

 

$

2,998,013

 

$

242,443

 

$

6,889,832

 

$

3,481,317

 

$

10,371,149

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2007 1

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income (Loss)

 

$

55,606

 

$

40,668

 

$

3,466

 

$

99,740

 

$

(862

)

$

98,878

 

Provision for Credit Losses

 

1,258

 

2,115

 

-

 

3,373

 

(10

)

3,363

 

Net Interest Income (Loss) After Provision

 

 

 

 

 

 

 

 

 

 

 

 

 

  for Credit Losses

 

54,348

 

38,553

 

3,466

 

96,367

 

(852

)

95,515

 

Noninterest Income

 

26,790

 

8,033

 

19,454

 

54,277

 

3,751

 

58,028

 

Noninterest Expense

 

(41,109

)

(22,318

)

(15,519

)

(78,946

)

(886

)

(79,832

)

Income Before Provision for Income Taxes

 

40,029

 

24,268

 

7,401

 

71,698

 

2,013

 

73,711

 

Provision for Income Taxes

 

(14,812

)

(9,061

)

(2,738

)

(26,611

)

629

 

(25,982

)

Allocated Net Income

 

25,217

 

15,207

 

4,663

 

45,087

 

2,642

 

47,729

 

Allowance Funding Value

 

(155

)

(824

)

(10

)

(989

)

989

 

-

 

Provision for Credit Losses

 

1,258

 

2,115

 

-

 

3,373

 

(10

)

3,363

 

Economic Provision

 

(1,823

)

(3,167

)

(83

)

(5,073

)

-

 

(5,073

)

Tax Effect of Adjustments

 

266

 

694

 

34

 

994

 

(361

)

633

 

Income Before Capital Charge

 

24,763

 

14,025

 

4,604

 

43,392

 

3,260

 

46,652

 

Capital Charge

 

(5,083

)

(4,356

)

(1,529

)

(10,968

)

(9,047

)

(20,015

)

Net Income (Loss) After Capital Charge (NIACC)

 

$

19,680

 

$

9,669

 

$

3,075

 

$

32,424

 

$

(5,787

)

$

26,637

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RAROC (ROE for the Company)

 

54

36

%

33

44

11

%

26

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets as of June 30, 2007 1

 

$

3,638,207

 

$

3,108,240

 

$

230,134

 

$

6,976,581

 

$

3,745,987

 

$

10,722,568

 

 

1 Certain prior period information has been reclassified to conform to the current presentation.

 

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Table of Contents

 

Business Segments Selected Financial Information (Unaudited)

 

Table 14b

 

 

 

Retail

 

Commercial

 

Investment

 

 

 

 

 

Consolidated

 

(dollars in thousands)

 

Banking

 

Banking

 

Services

 

Total

 

Treasury

 

Total

 

Six Months Ended June 30, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income (Loss)

 

$

117,979

 

$

86,099

 

$

7,808

 

$

211,886

 

$

(2,538

)

$

209,348

 

Provision for Credit Losses

 

10,523

 

11,878

 

(1

)

22,400

 

(801

)

21,599

 

Net Interest Income (Loss) After Provision

 

 

 

 

 

 

 

 

 

 

 

 

 

  for Credit Losses

 

107,456

 

74,221

 

7,809

 

189,486

 

(1,737

)

187,749

 

Noninterest Income

 

55,817

 

32,246

 

37,280

 

125,343

 

21,321

 

146,664

 

Noninterest Expense

 

(87,104

)

(48,265

)

(33,226

)

(168,595

)

(8,699

)

(177,294

)

Income Before Provision for Income Taxes

 

76,169

 

58,202

 

11,863

 

146,234

 

10,885

 

157,119

 

Provision for Income Taxes

 

(28,182

)

(21,587

)

(4,389

)

(54,158

)

2,536

 

(51,622

)

Allocated Net Income

 

47,987

 

36,615

 

7,474

 

92,076

 

13,421

 

105,497

 

Allowance Funding Value

 

(397

)

(1,710

)

(27

)

(2,134

)

2,134

 

-

 

Provision for Credit Losses

 

10,523

 

11,878

 

(1

)

22,400

 

(801

)

21,599

 

Economic Provision

 

(4,088

)

(6,492

)

(165

)

(10,745

)

(1

)

(10,746

)

Tax Effect of Adjustments

 

(2,234

)

(1,360

)

71

 

(3,523

)

(492

)

(4,015

)

Income Before Capital Charge

 

51,791

 

38,931

 

7,352

 

98,074

 

14,261

 

112,335

 

Capital Charge

 

(9,528

)

(8,133

)

(2,919

)

(20,580

)

(18,285

)

(38,865

)

Net Income (Loss) After Capital Charge (NIACC)

 

$

42,263

 

$

30,798

 

$

4,433

 

$

77,494

 

$

(4,024

)

$

73,470

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RAROC (ROE for the Company)

 

55

48

25

48

38

%

27

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets as of June 30, 2008

 

$

3,649,376

 

$

2,998,013

 

$

242,443

 

$

6,889,832

 

$

3,481,317

 

$

10,371,149

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2007 1

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

$

110,025

 

$

79,698

 

$

6,991

 

$

196,714

 

$

301

 

$

197,015

 

Provision for Credit Losses

 

2,803

 

3,213

 

-

 

6,016

 

(22

)

5,994

 

Net Interest Income After Provision for Credit Losses

 

107,222

 

76,485

 

6,991

 

190,698

 

323

 

191,021

 

Noninterest Income

 

52,370

 

20,246

 

38,601

 

111,217

 

7,771

 

118,988

 

Noninterest Expense

 

(82,443

)

(45,238

)

(31,202

)

(158,883

)

(3,072

)

(161,955

)

Income Before Provision for Income Taxes

 

77,149

 

51,493

 

14,390

 

143,032

 

5,022

 

148,054

 

Provision for Income Taxes

 

(28,539

)

(18,935

)

(5,324

)

(52,798

)

(192

)

(52,990

)

Allocated Net Income

 

48,610

 

32,558

 

9,066

 

90,234

 

4,830

 

95,064

 

Allowance Funding Value

 

(300

)

(1,582

)

(20

)

(1,902

)

1,902

 

-

 

Provision for Credit Losses

 

2,803

 

3,213

 

-

 

6,016

 

(22

)

5,994

 

Economic Provision

 

(3,692

)

(6,441

)

(164

)

(10,297

)

(1

)

(10,298

)

Tax Effect of Adjustments

 

440

 

1,780

 

68

 

2,288

 

(697

)

1,591

 

Income Before Capital Charge

 

47,861

 

29,528

 

8,950

 

86,339

 

6,012

 

92,351

 

Capital Charge

 

(10,167

)

(8,835

)

(3,062

)

(22,064

)

(17,506

)

(39,570

)

Net Income (Loss) After Capital Charge (NIACC)

 

$

37,694

 

$

20,693

 

$

5,888

 

$

64,275

 

$

(11,494

)

$

52,781

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RAROC (ROE for the Company)

 

52

37

32

43

9

%

27

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets as of June 30, 2007 1

 

$

3,638,207

 

$

3,108,240

 

$

230,134

 

$

6,976,581

 

$

3,745,987

 

$

10,722,568

 

 

1 Certain prior period information has been reclassified to conform to the current presentation.


Retail Banking

 

Retail Banking offers a broad range of financial products and services to consumers and small businesses.  Loan products include residential mortgage loans, home equity lines of credit, personal lines of credit, and installment loans.  Deposit products include checking, savings, and time deposit accounts.  Retail Banking also provides merchant services to its small

business customers.  Products and services from Retail Banking are delivered to customers through 72 Hawaii branch locations, 417 ATMs throughout Hawaii and the Pacific Islands, e-Bankoh (on-line banking service), a 24-hour customer service center, and a mobile banking service.  This segment also offers retail property and casualty insurance products.

 


 

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Table of Contents


Financial measures improved for the second quarter of 2008 compared to the same period in 2007 primarily due to higher net interest income and noninterest income, partially offset by higher noninterest expense.  The $3.9 million increase in net interest income was primarily due to a reduction in funding costs and growth in average loan balances.  These positive factors were partially offset by a decrease in average deposit balances.  The $0.5 million increase in noninterest income was primarily due to higher fee income from an increase in the number of transactional deposit accounts as well as debit card transactions.  Noninterest expense increased by $2.2 million primarily due to higher debit card and occupancy expense.  Retail Banking’s economic provision and capital charge remained relatively unchanged in the second quarter of 2008 compared to the same period in 2007.

 

Financial measures improved for the first six months of 2008 compared to the same period in 2007 primarily due to an increase in net interest income and noninterest income, partially offset by higher noninterest expense.  The $8.0 million increase in net interest income was primarily due to lower funding costs on the segment’s deposit portfolio, and growth in average loan balances.  These positive factors were partially offset by a decrease in average deposit balances.  The $3.4 million increase in noninterest income was primarily due to higher fee income from the growth in transaction volume and in the number of transactional deposit accounts.  Also contributing to the increase in noninterest income was higher interchange income from debit card transactions and an increase in mortgage banking income.  Noninterest expense increased by $4.7 million primarily due to increased debit card, occupancy, and salaries expense, as well as higher allocated expenses related to earnings-based incentive compensation accruals that were recorded in the first quarter of 2008.  Retail Banking’s capital charge decreased slightly for the first six months of 2008 compared to the same period in 2007 primarily due to a decrease in the capital charge rate.

 

Commercial Banking

 

Commercial Banking offers a broad range of financial products and services including corporate and commercial real estate

loans, lease financing, auto dealer financing, automobile loans and leases, deposit and cash management products, and wholesale property and casualty insurance products.  Lending, deposit, and cash management services are offered to middle-market and large companies in Hawaii.  Commercial real estate mortgages are focused on customers that include investors, developers, and builders domiciled in Hawaii.  Commercial Banking also includes international banking and operations at our 12 branches in the Pacific Islands.

 

Financial measures improved for the second quarter of 2008 compared to the same period in 2007 primarily due to an increase in net interest income and noninterest income.  The $2.6 million increase in net interest income was primarily due to a reduction in funding costs along with growth in our International Banking deposit portfolio.  The $2.0 million increase in noninterest income was primarily due to higher account analysis fees as a result of lower earnings credit rates on customer accounts, income from facilitating interest rate swaps on behalf of our customers, and fee income on our wholesale property and casualty insurance products.  Noninterest expense increased by $1.2 million primarily due to higher salaries and benefits, other operating, and allocated expenses.

 

Financial measures improved for the first six months of 2008 compared to the same period in 2007 primarily due to an increase in noninterest income and net interest income.  The $12.0 million increase in noninterest income was primarily due to the $11.6 million gain on the sale of our equity interest in an aircraft lease, higher account analysis fee income, and fee income on our wholesale property and casualty insurance products.  The $6.4 million increase in net interest income was primarily due to a reduction in funding costs along with growth in our International Banking deposit portfolio.  Noninterest expense increased by $3.0 million primarily due to higher salaries and benefits, other operating, and allocated expenses.  The increase in the Provision allocated to the segment was primarily due to a $2.1 million recovery recorded in 2007 related to a leveraged lease with a major airline, which lowered 2007 expense.


 

34



Table of Contents


Investment Services

 

Investment Services includes private banking, trust services, asset management, and institutional investment advisory services.  A significant portion of this segment’s income is derived from fees, which are generally based on the market values of assets under management.  The private banking and personal trust group assists individuals and families in building and preserving their wealth by providing investment, credit, and trust services to high-net-worth individuals.  The asset management group manages portfolios and creates investment products.  Institutional sales and service offers investment advice to corporations, government entities, and foundations.  This segment also provides a full service brokerage offering equities, mutual funds, life insurance, and annuity products.

 

Financial measures decreased for the second quarter of 2008 compared to the same period in 2007 primarily due to an increase in noninterest expense.  The $0.8 million increase in noninterest expense was primarily related to salaries and benefits.  Net interest income was higher due to a reduction in funding costs and due to a shift in balances from lower margin time deposit accounts into savings accounts.  The decline in noninterest income was primarily due to lower mutual fund investment advisory fees, a result of the lower market value of assets under administration.

 

Financial measures decreased for the first six months of 2008 compared to the same period in 2007 primarily due to a decrease in noninterest income and an increase in noninterest expense.  The $1.3 million decrease in noninterest income was primarily due to lower mutual fund investment advisory fees, a result of the lower market value of assets under administration.  The $2.0 million increase in noninterest expense was primarily due to higher salaries and benefits and allocated expenses related to earnings-based incentive compensation accruals that were recorded in the first quarter of 2008.

 

Treasury

 

Treasury consists of corporate asset and liability management activities, including interest rate risk management and a foreign exchange business.  This segment’s assets and liabilities (and related interest income and expense) consist of interest-bearing deposits, investment securities, federal funds sold and purchased, government deposits, and short- and long-term borrowings.  The primary sources of noninterest income are from BOLI and foreign exchange income related to customer driven currency requests from merchants and island visitors.  The net residual effect of the transfer pricing of assets and liabilities is included in Treasury, along with eliminations of intercompany transactions.

 

NIACC decreased slightly for the second quarter of 2008 compared to the same period in 2007 primarily due to a higher provision for income taxes, which was partially offset by higher net interest income and noninterest income.  The $1.3 million increase in net interest income was primarily due to a reduction in loan funding charges allocated to the business segments, partially offset by an increase in the average balance of available-for-sale investment securities and decreases in the cost of securities sold under agreements to repurchase and funds purchased.  The $0.5 million increase in noninterest income was primarily due to the change in the estimated fair value of our subordinated notes.  The $0.3 million increase in the capital charge for the second quarter of 2008 was primarily due to an increase in excess equity held by the Company.  The increase in RAROC for the second quarter of 2008 compared to the same period in 2007 was primarily due to lower allocated equity to the segment in 2008.

 

Financial measures improved for the first six months of 2008 compared to the same period in 2007 primarily due to a $13.6 million increase in noninterest income which was primarily due to the $13.7 million gain from the mandatory redemption of our Visa shares.  This increase was partially offset by a $2.8 million decrease in net interest income, and a $5.6 million increase in noninterest expense.   The $2.8 million decrease in net interest income was primarily due to a reduction in loan funding charges allocated to the business segments, partially offset by an increase in the average balance of available-for-sale investment securities and a decrease in the cost of securities sold under


 

35



Table of Contents


agreements to repurchase.  The $5.6 million increase in noninterest expense was primarily due to several accruals (cash awards to purchase our stock, legal contingencies, and a contribution to the Bank of Hawaii Charitable Foundation and other charitable organizations), partially offset by the reversal of the previously recorded contingency accruals related to Visa.  The capital charge increased by $0.8 million for the second quarter of 2008 compared to the same period in 2007 primarily due to an increase in excess equity held by the Company.

 

Other organizational units (Technology, Operations, Marketing, Human Resources, Finance, Credit and Risk Management, and Corporate and Regulatory Administration) included in Treasury provided a wide-range of support to our other income earning segments.  Expenses incurred by these support units are charged to the business segments through an internal cost allocation process.

 

Corporate Risk Profile

 

Credit Risk

 

Our overall credit risk position remained solid during the second quarter of 2008, with low, albeit increasing, levels of non-performing assets.  Our credit risk profile reflects our continued disciplined underwriting approach.  During the second quarter of 2008, signs of slowing in the Hawaii economy became more prominent.  Reduced airline capacity and the exit of cruise ships from the local market are resulting in lower visitor arrivals.  Trends in the construction and real

estate industries are also softening.  Unemployment levels are trending upward from record low levels.  With higher oil prices resulting in rising energy prices as well as food costs, inflation is expected to be higher than in prior periods.  The slowing economy in Hawaii may result in higher delinquencies and loss rates in our loan and lease portfolio, with the primary impact expected in our small business and unsecured consumer lending portfolios.

 

Table 15 summarizes our air transportation credit exposure.  As of June 30, 2008, included in our commercial lending portfolio are nine leveraged leases on aircraft that were originated in the 1990’s and prior.  Outstanding credit exposure related to these leveraged leases was $72.3 million as of June 30, 2008.  Our air transportation credit exposure decreased in the first quarter of 2008 due to the previously mentioned sale of our equity interest in an aircraft lease.  However, relative to our total loan and lease portfolio, domestic air transportation carriers continue to demonstrate a higher risk profile due to fuel costs, pension plan obligations, and marginal pricing power.  We believe that higher fuel costs, coupled with a slowing mainland economy, will place additional pressure on the financial health of air transportation carriers for the foreseeable future.  In the evaluation of the Reserve for Credit Losses (the “Reserve”), we continue to consider the ongoing financial concerns about the air transportation industry.


 

Air Transportation Credit Exposure 1 (Unaudited)

 

 

 

 

 

 

 

Table 15

 

 

 

June 30,

 

March 31,

 

December 31,

 

September 30,

 

June 30,

 

(dollars in thousands)

 

2008

 

2008

 

2007

 

2007

 

2007

 

Passenger Carriers Based In the United States

 

$

60,603

 

$

61,190

 

$

64,947

 

$

64,867

 

$

65,607

 

Passenger Carriers Based Outside the United States

 

7,161

 

7,258

 

19,078

 

19,162

 

19,246

 

Cargo Carriers

 

13,568

 

13,472

 

13,390

 

13,326

 

13,279

 

Total Air Transportation Credit Exposure

 

$

81,332

 

$

81,920

 

$

97,415

 

$

97,355

 

$

98,132

 

 

1 Exposure includes loans, leveraged leases, and operating leases.

 

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Table of Contents

 

Non-Performing Assets

 

Table 16 presents information on non-performing assets (“NPAs”) and accruing loans and leases past due 90 days or more.

 

Non-Performing Assets and Accruing Loans and Leases Past Due 90 Days or More (Unaudited)

 

Table 16

 

 

 

June 30,

 

March 31,

 

December 31,

 

September 30,

 

June 30,

 

(dollars in thousands)

 

2008

 

2008

 

2007

 

2007 1

 

2007 1

 

Non-Performing Assets

 

 

 

 

 

 

 

 

 

 

 

Non-Accrual Loans and Leases

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

$

1,119

 

$

794

 

$

598

 

$

359

 

$

265

 

Commercial Mortgage

 

-

 

-

 

112

 

123

 

130

 

Lease Financing

 

329

 

504

 

297

 

-

 

914

 

Total Commercial

 

1,448

 

1,298

 

1,007

 

482

 

1,309

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

Residential Mortgage

 

3,784

 

3,235

 

2,681

 

3,237

 

3,844

 

Home Equity

 

1,189

 

1,187

 

1,414

 

436

 

899

 

Other 2

 

30

 

31

 

-

 

-

 

214

 

Total Consumer

 

5,003

 

4,453

 

4,095

 

3,673

 

4,957

 

Total Non-Accrual Loans and Leases

 

6,451

 

5,751

 

5,102

 

4,155

 

6,266

 

Foreclosed Real Estate

 

229

 

294

 

184

 

105

 

48

 

Total Non-Performing Assets

 

$

6,680

 

$

6,045

 

$

5,286

 

$

4,260

 

$

6,314

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing Loans and Leases Past Due 90 Days or More

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

$

-

 

$

24

 

$

-

 

$

-

 

$

-

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

Residential Mortgage

 

2,601

 

3,892

 

4,884

 

639

 

188

 

Home Equity

 

201

 

328

 

413

 

115

 

60

 

Automobile

 

625

 

865

 

1,174

 

734

 

397

 

Other 2

 

756

 

725

 

1,112

 

944

 

761

 

Total Consumer

 

4,183

 

5,810

 

7,583

 

2,432

 

1,406

 

Total Accruing Loans and Leases Past Due 90 Days or More

 

$

4,183

 

$

5,834

 

$

7,583

 

$

2,432

 

$

1,406

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Loans and Leases

 

$

6,518,128

 

$

6,579,337

 

$

6,580,861

 

$

6,599,915

 

$

6,566,126

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of Non-Accrual Loans and Leases to Total Loans and Leases

 

0.10

0.09

0.08

0.06

0.10

%

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of Non-Performing Assets to Total Loans and Leases and Foreclosed Real Estate

 

0.10

%

0.09

%

0.08

%

0.06

%

0.10

%

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of Commercial Non-Performing Assets to Total Commercial Loans and Leases

 

0.06

%

0.05

%

0.04

%

0.02

%

0.05

%

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of Consumer Non-Performing Assets to Total Consumer Loans and Leases and Foreclosed Real Estate

 

0.13

%

0.11

%

0.10

%

0.09

%

0.12

%

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of Non-Performing Assets and Accruing Loans and Leases Past Due 90 Days or More to Total Loans and Leases

 

0.17

%

0.18

%

0.20

%

0.10

%

0.12

%

 

 

 

 

 

 

 

 

 

 

 

 

Quarter to Quarter Changes in Non-Performing Assets
Balance at Beginning of Quarter

 

$

6,045

 

$

5,286

 

$

4,260

 

$

6,314

 

$

5,836

 

Additions

 

2,900

 

2,614

 

1,866

 

662

 

2,279

 

Reductions

 

 

 

 

 

 

 

 

 

 

 

Payments

 

(630

)

(386

)

(256

)

(1,741

)

(804

)

Return to Accrual Status

 

(943

)

(944

)

(214

)

(787

)

(473

)

Sales of Foreclosed Real Estate

 

-

 

-

 

(161

)

(48

)

(326

)

Charge-offs/Write-downs

 

(692

)

(525

)

(209

)

(140

)

(198

)

Total Reductions

 

(2,265

)

(1,855

)

(840

)

(2,716

)

(1,801

)

Balance at End of Quarter

 

$

6,680

 

$

6,045

 

$

5,286

 

$

4,260

 

$

6,314

 

 

1 Certain prior period information has been reclassified to conform to the current presentation.

2 Comprised of other revolving credit, installment, and lease financing.

 

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Table of Contents


The changes in NPAs by category from December 31, 2007 and June 30, 2007 reflect normal delinquency and resolution activity consistent with the slowing economy in Hawaii.

 

Included in NPAs are loans and leases that we consider impaired. Impaired loans and leases are defined as those which we believe it is probable we will not collect all amounts due according to the contractual terms of the loan or lease agreement, as well as those loans or leases whose terms have been modified in a troubled debt restructuring. Impaired loans were $0.2 million as of June 30, 2008 and less than $0.1 million as of December 31, 2007. We had no impaired loans and leases as of June 30, 2007.

 

Credit quality in our commercial and mortgage-related consumer lending portfolios remained solid in the second quarter of 2008. Residential mortgage and home equity lending comprise the largest components of our consumer lending portfolio. As of June 30, 2008, the weighted average credit score for our residential mortgage loans was 756, with a

significant portion of this portfolio having a loan-to-value ratio of 80% or less. As of June 30, 2008, the weighted average credit score for our home equity loans was 747, with the majority of the portfolio having a loan-to-value ratio of 80% or less.

 

Loans and Leases Past Due 90 Days or More and Still Accruing Interest

 

The changes in loans and leases past due 90 days or more and still accruing interest from December 31, 2007 and June 30, 2007 reflect normal delinquency and resolution activity consistent with the slowing economy in Hawaii. We do not expect to incur material losses on these loans.

 

Due to the low volume of NPAs and accruing loans and leases past due 90 days or more, we anticipate some degree of variability in the balances in these categories from period to period and do not consider modest changes to be indicative of significant asset quality trends.


 

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Table of Contents

 

Reserve for Credit Losses

 

Table 17 presents the activity in our Reserve for the three and six months ended June 30, 2008 and 2007.

 

Reserve for Credit Losses (Unaudited)

 

 

 

 

 

 

 

Table 17

 

 

 

 

Three Months Ended
June 30,

 

 

Six Months Ended
June 30,

 

(dollars in thousands)

 

2008

 

2007 1

 

2008

 

2007 1

 

Balance at Beginning of Period

 

$

105,167

 

$

96,167

 

$

96,167

 

$

96,167

 

Loans and Leases Charged-Off

 

 

 

 

 

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

(1,396

)

(738

)

(2,785

)

(1,543

)

Lease Financing

 

(142

)

-

 

(276

)

(22

)

Consumer

 

 

 

 

 

 

 

 

 

Residential Mortgage

 

(133

)

(47

)

(133

)

(47

)

Home Equity

 

(473

)

(240

)

(1,279

)

(342

)

Automobile

 

(2,187

)

(2,346

)

(5,102

)

(5,428

)

Other 2

 

(1,954

)

(1,849

)

(4,757

)

(4,481

)

Total Loans and Leases Charged-Off

 

(6,285

)

(5,220

)

(14,332

)

(11,863

)

Recoveries on Loans and Leases Previously Charged-Off

 

 

 

 

 

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

Commercial and Industrial

 

201

 

315

 

1,187

 

592

 

Commercial Mortgage

 

-

 

36

 

-

 

121

 

Lease Financing

 

2

 

6

 

5

 

2,087

 

Consumer

 

 

 

 

 

 

 

 

 

Residential Mortgage

 

17

 

54

 

95

 

189

 

Home Equity

 

26

 

55

 

47

 

120

 

Automobile

 

700

 

713

 

1,496

 

1,384

 

Other 2

 

667

 

678

 

1,403

 

1,376

 

Total Recoveries on Loans and Leases Previously Charged-Off

 

1,613

 

1,857

 

4,233

 

5,869

 

Net Loans and Leases Charged-Off

 

(4,672

)

(3,363

)

(10,099

)

(5,994

)

Provision for Credit Losses

 

7,172

 

3,363

 

21,599

 

5,994

 

Balance at End of Period 3

 

$

107,667

 

$

96,167

 

$

107,667

 

$

96,167

 

 

 

 

 

 

 

 

 

 

 

Components

 

 

 

 

 

 

 

 

 

Allowance for Loan and Lease Losses

 

$

102,498

 

$

90,998

 

$

102,498

 

$

90,998

 

Reserve for Unfunded Commitments

 

5,169

 

5,169

 

5,169

 

5,169

 

Total Reserve for Credit Losses

 

$

107,667

 

$

96,167

 

$

107,667

 

$

96,167

 

 

 

 

 

 

 

 

 

 

 

Average Loans and Leases Outstanding

 

$

6,531,587

 

$

6,532,736

 

$

6,559,753

 

$

6,547,212

 

 

 

 

 

 

 

 

 

 

 

Ratio of Net Loans and Leases Charged-Off to

 

 

 

 

 

 

 

 

 

Average Loans and Leases Outstanding (annualized)

 

0.29

%

0.21

%

0.31

%

0.18

%

Ratio of Allowance for Loan and Lease Losses to Loans and Leases Outstanding

 

1.57

%

1.39

%

1.57

%

1.39

%

 

1 Certain prior period information has been reclassified to conform to the current presentation.

2 Comprised of other revolving credit, installment, and lease financing.

3 Included in this analysis is activity related to the Company’s reserve for unfunded commitments, which is separately recorded in other liabilities in the Consolidated Statements of Condition (Unaudited).

 


We maintain a Reserve which consists of two components, the Allowance and a Reserve for Unfunded Commitments (“Unfunded Reserve”).  The Reserve provides for the risk of credit losses inherent in the loan and lease portfolio and is based on loss estimates derived from a comprehensive quarterly evaluation.  The evaluation reflects analyses of individual borrowers and historical loss experience,

supplemented as necessary by credit judgment that considers observable trends, conditions, other relevant environmental and economic factors.

 

The level of the Allowance is adjusted by recording an expense or recovery through the Provision.  The level of the Unfunded Reserve is adjusted by recording an expense or recovery in


 

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Table of Contents


other noninterest expense.  The Provision exceeded net charge-offs of loans and leases for the second quarter of 2008 by $2.5 million and by $11.5 million for the first six months of 2008.  The increase in the Allowance during the first six months of 2008 reflects increased risk in our commercial aircraft leasing, small business, and unsecured consumer lending portfolios.

 

Although we determine the amount of each component of the Allowance separately, the Allowance as a whole was considered appropriate by management as of June 30, 2008, based on our ongoing analysis of estimated probable credit losses, credit risk profiles, economic conditions, coverage ratios, and other relevant factors.

 

The Reserve for Unfunded Commitments

 

The Unfunded Reserve remained unchanged from December 31, 2007 and June 30, 2007.  The process used to determine the Unfunded Reserve is consistent with the process for determining the Allowance, as adjusted for estimated funding probabilities or loan and lease equivalency factors.

 

Market Risk

 

Market risk is the potential of loss arising from adverse changes in interest rates and prices.  We are exposed to market risk in the normal course of conducting our business activities.  Financial products that expose us to market risk include investment securities, loans and leases, deposits, debt, and derivative financial instruments.  Our market risk management process involves measuring, monitoring, controlling, and adjusting levels of risk that can significantly impact our statements of income and condition.  In this management process, market risks are balanced with expected returns in an effort to enhance earnings performance, while limiting volatility.  In the management of market risks, activities are categorized into “trading” and “non-trading.”

 

Our trading activities include trading securities that are used to manage the market risk exposure of our mortgage servicing rights which are recorded at estimated fair value on the statement of condition.  Our trading activities also include

foreign currency and foreign exchange contracts that expose us to a small degree of foreign currency risk.  Foreign currency and foreign exchange contracts are primarily executed on behalf of our customers and at times for our own account.  We also enter into interest rate swap agreements with customers to assist them in managing their interest rate risk.  However, we mitigate this risk by entering into equal and offsetting interest rate swap agreements with third parties.

 

Our non-trading activities include normal business transactions that expose our balance sheet to varying degrees of market risk.  Our primary market risk exposure is interest rate risk.  A key element in the process of managing market risk involves oversight by senior management and the Board of Directors as to the level of such risk.  The Board of Directors reviews and approves risk management policies, including risk limits and guidelines, and delegates oversight functions to the Asset/Liability Management Committee (“ALCO”).  The ALCO, consisting of senior business and finance officers, monitors market risk exposure and, as market conditions dictate, modifies positions as deemed appropriate.  The ALCO may also direct the use of derivative financial instruments to manage market risk.

 

Interest Rate Risk

 

The objective of the interest rate risk management process is to maximize net interest income while operating within acceptable limits established for interest rate risk and maintaining adequate levels of funding and liquidity.

 

Our statement of condition is sensitive to changes in the general level of interest rates.  This interest rate risk arises primarily from normal business activities of gathering deposits and extending loans and leases.  Many other factors also affect exposure to changes in interest rates, such as general economic and financial conditions, customer preferences, historical pricing relationships, and repricing characteristics of financial instruments.

 

Our earnings are affected not only by general economic conditions, but also by the monetary and fiscal policies of the U.S. government and its agencies, particularly the Board of


 

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Table of Contents


Governors of the Federal Reserve System (the “FRB”).  The monetary policies of the FRB influence, to a significant extent, the overall growth of loans, investment securities, deposits as well as the level of interest rates earned on assets and paid for liabilities.  The nature and impact of future changes in monetary policies are generally not predictable.

 

In managing interest rate risk, we, through the ALCO, measure short-term and long-term sensitivities to changes in interest rates.  The ALCO utilizes several techniques to manage interest rate risk, which include shifting balance sheet mix or altering the interest rate characteristics of assets and liabilities, changing product pricing strategies, or modifying characteristics of our investment securities portfolio.  We are also authorized to use derivative financial instruments.  However, our use of derivative financial instruments has been limited over the past several years due to the natural on-balance sheet hedge arising out of offsetting interest rate exposures from loans and investment securities with deposits and other interest bearing liabilities.  In particular, the investment securities portfolio is utilized to manage the interest rate exposure and sensitivity to within the guidelines and limits established by the ALCO.  For example, we continue to utilize our trading portfolio to offset the change in estimated fair value of our mortgage servicing rights.  Natural and offsetting hedges reduce the need to employ off-balance sheet derivative financial instruments to hedge interest rate risk exposures.  Expected movements in interest rates are also considered in managing interest rate risk.  Thus, as interest rates change, we may use different techniques to manage interest rate risk.

 

A key element in our ongoing process to measure and monitor interest rate risk is the utilization of an asset/liability simulation model.  This model is used to estimate and measure the balance sheet’s sensitivity to changes in interest rates. 

These estimates are based on assumptions regarding the behavior of loan and deposit pricing, repayment rates on mortgage-based assets, and principal amortization and maturities on other financial instruments.  The model’s analytics include the effects of standard prepayment options on mortgages and customer withdrawal options for deposits.  While such assumptions are inherently uncertain, management believes that these assumptions are reasonable.  As a result, the simulation model attempts to capture the dynamic nature of the balance sheet and provide a sophisticated estimate rather than a precise prediction of exposure to changes in interest rates.

 

We utilize net interest income simulations to analyze short-term income sensitivities to changes in interest rates.  Table 18 presents, as of June 30, 2008 and 2007, an estimate of the change in net interest income during a quarterly time frame that would result from a gradual 100 and 200 basis point increase or decrease in interest rates, moving in a parallel fashion over the entire yield curve, over the next 12-month period, relative to the measured base case scenario for net interest income without any change in strategy.  Based on the net interest income simulation as of June 30, 2008, our net interest income sensitivity to changes in interest rates as of June 30, 2008 was greater than our sensitivity to changes in interest rates as of June 30, 2007 due to the decline in interest rates.  In lower rate scenarios, limited deposit repricing will adversely impact overall net interest income.  In higher rates scenarios, liabilities are expected to reprice slightly faster than assets.  Additionally, to analyze the impact of changes in interest rates in a more realistic manner, non-parallel rate scenarios are also simulated.  These non-parallel rate scenarios indicate that net interest income may decrease from the base case scenario should the yield curve become flat or inverted for a period of time.  Conversely, if the yield curve should steepen further, net interest income may increase.


 

41



Table of Contents

 

Net Interest Income Sensitivity Profile (Unaudited)

 

 

 

 

 

 

 

Table 18  

 

 

Change in Net Interest Income Per Quarter

(dollars in thousands)

 

June 30, 2008

 

June 30, 2007

 

Change in Interest Rates (basis points)

 

 

 

 

 

 

 

 

 

+200

 

$

(539

)

(0.5

)  %

$

(199

)

(0.2

)  %

+100

 

(108

)

(0.1

)

(99

)

(0.1

)

-100

 

(1,185

)

(1.1

)

(298

)

(0.3

)

-200

 

(2,478

)

(2.3

)

(1,093

)

(1.1

)

 

 

 

 

 

 

 

 

 

 


We also use a Market Value of Portfolio Equity (“MVPE”) sensitivity analysis to estimate the net present value change in our assets, liabilities, and off-balance sheet arrangements from changes in interest rates.  The MVPE was approximately $1.8 billion as of June 30, 2008 and approximately $1.9 billion in June 30, 2007.  Table 19 presents, as of June 30, 2008 and 2007, an estimate of the change in the MVPE sensitivity that would occur from an instantaneous 100 and 200 basis point increase or decrease in interest rates, moving in a parallel fashion over the entire yield curve.  The MVPE sensitivity increased as of June 30, 2008, compared to June 30, 2007, primarily as a result of lower interest rates and a steeper yield curve.

Further enhancing the MVPE sensitivity analysis are value-at-risk, key rate analysis, duration of equity, exposure to basis risk, and non-parallel yield curve shifts.  There are inherent limitations to these measures; however, used along with the MVPE sensitivity analysis, we obtain better overall insight for managing our exposure to changes in interest rates.  Based on the additional analyses, we estimate our greatest exposure is in scenarios where medium-term and long-term rates rise while short-term rates remain unchanged and when the spread between U.S. Treasury and LIBOR rates decrease (“spread narrowing”).

 


 

Market Value of Equity Sensitivity Profile (Unaudited)

 

 

 

 

 

 

 

Table 19  

 

 

 

Change in Market Value of Equity

(dollars in thousands)

 

June 30, 2008

 

June 30, 2007

 

Change in Interest Rates (basis points)

 

 

 

 

 

 

 

 

 

+200

 

$

(185,348

)

(10.6

)  %

$

(162,316

)

(8.6

)  %

+100

 

(79,522

)

(4.5

)

(77,137

)

(4.1

)

-100

 

(17,573

)

(1.0

)

19,358

 

1.0

 

-200

 

(153,445

)

(8.7

)

(50,923

)

(2.7

)

 


Liquidity Management

 

Liquidity is managed in an effort to ensure that we have continuous access to sufficient, reasonably priced funding to conduct our business and satisfy obligations in a normal manner.

 

Cash and noninterest-bearing deposits, interest-bearing deposits, and funds sold provide us with readily available liquid resources.  Investment securities in our available-for-sale portfolio are also a near-term source of asset liquidity, although we do not have the intent to sell such investment securities that are currently in a gross unrealized loss position. 

Asset liquidity is further enhanced by our ability to sell residential mortgage loans in the secondary market.

 

Core deposit balances have historically provided a sizable source of relatively stable and low-cost funds.  We are also able to utilize funds purchased, short-term borrowings, and securities sold under agreements to repurchase as a mechanism to fund growth in our loan and lease portfolio.

 

We are a member of the FHLB, which provides an additional source of short-term and long-term funding.  Outstanding borrowings from the FHLB were $50.0 million as of June 30, 2008 and December 31, 2007 with a weighted average


 

42



Table of Contents


interest rate of 4.00% and $75.0 million as of June 30, 2007 with a weighted average interest rate of 3.73%.

 

Additionally, a $1.0 billion senior and subordinated bank note program is available.  Under this program, we may issue additional notes provided that the aggregate amount outstanding does not exceed $1.0 billion.  The unpaid principal amount of our subordinated notes outstanding under this bank note program was $119.0 million as of June 30, 2008 and $124.9 million as of December 31, 2007 and June 30, 2007.  These subordinated notes bear a fixed interest rate of 6.875% and will mature in March 2009.

 

Capital Management

 

The Parent and the Bank are subject to regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can cause certain mandatory and discretionary actions by regulators that, if undertaken, could have a material effect on our financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Parent and the Bank must meet specific capital guidelines that involve quantitative and qualitative measures.  These measures were established by regulation to ensure capital adequacy.  As of June 30, 2008, the Parent and the Bank were “well capitalized” under this regulatory framework.  There have been no conditions or events since June 30, 2008 that management believes have changed either the Parent’s or the Bank’s capital classifications.

 

As of June 30, 2008, the fair value of our subordinated notes of $121.3 million, recorded as a component of long-term debt on our statements of condition, no longer qualified as a component of Total Capital for regulatory capital purposes

due to the maturity of our subordinated notes being within 12 months from June 30, 2008.  During the second quarter of 2008, we redeemed our remaining $26.4 million of Capital Securities which were recorded as a component of long-term debt in our statements of condition.

 

As of June 30, 2008, our leverage ratio was 7.04%.  We actively manage our capital toward a leverage ratio that is adjusted periodically in consideration of market conditions.  We are currently targeting a leverage ratio of 7.25% by the end of the third quarter of 2008.  Our ability to manage toward this leverage ratio is aided by our strong capital structure, strong earnings and core deposit base, alternative sources of liquidity, and our ongoing share repurchase program.

 

For the first six months of 2008, 0.9 million shares of common stock were repurchased under our share repurchase program at an average cost of $48.96 per share, totaling $42.7 million.  From the beginning of our share repurchase program in July 2001 through June 30, 2008, we repurchased a total of 45.2 million shares of common stock and returned nearly $1.6 billion to our shareholders at an average cost of $35.35 per share.  From July 1, 2008 through July 25, 2008, we repurchased an additional 181,000 shares of common stock at an average price of $45.19 per share for a total of $8.2 million, resulting in remaining buyback authority under our share repurchase program of $43.4 million.

 

In July 2008, our Board of Directors declared a quarterly cash dividend of $0.44 per share on our outstanding shares.  The dividend will be payable on September 15, 2008 to our shareholders of record at the close of business on August 29, 2008.


 

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Table 20 presents our regulatory capital and ratios as of June 30, 2008, December 31, 2007, and June 30, 2007.

 

Regulatory Capital and Ratios (Unaudited)

 

 

 

 

 

Table 20

 

 

 

 

June 30,

 

December 31,

 

June 30,

 

 

(dollars in thousands)

 

2008

 

2007

 

2007

 

 

Regulatory Capital

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

$

767,558

 

$

750,255

 

$

708,806

 

 

Add:

Capital Securities of Bancorp Hawaii Capital Trust I

 

-

 

26,425

 

26,425

 

 

Less:

Cumulative Change in Fair Value of Financial Liabilities

 

 

 

 

 

 

 

 

 

Accounted for Under the Fair Value Option

 

(1,838)

 

-

 

-

 

 

 

Goodwill

 

34,959

 

34,959

 

34,959

 

 

 

Postretirement Benefit Liability Adjustments

 

8,398

 

8,647

 

6,798

 

 

 

Net Unrealized Losses on Investment Securities

 

 

 

 

 

 

 

 

 

Available-for-Sale

 

(12,207)

 

(1,388)

 

(34,527)

 

 

Tier 1 Capital

 

738,246

 

734,462

 

728,001

 

 

Allowable Reserve for Credit Losses

 

84,898

 

88,716

 

91,368

 

 

Qualifying Subordinated Debt

 

-

 

24,982

 

24,976

 

 

Unrealized Gains on Investment Securities Available-for-Sale

 

57

 

59

 

9

 

 

Total Regulatory Capital

 

$

823,201

 

$

848,219

 

$

844,354

 

 

 

 

 

 

 

 

 

 

 

Risk-Weighted Assets

 

$

6,769,036

 

$

7,089,846

 

$

7,304,650

 

 

 

 

 

 

 

 

 

 

 

Key Regulatory Capital Ratios

 

 

 

 

 

 

 

 

Tier 1 Capital Ratio

 

10.91

%

10.36

%

9.97

 

%

Total Capital Ratio

 

12.16

 

11.96

 

11.56

 

 

Leverage Ratio

 

7.04

 

7.04

 

7.02

 

 


 

Off-Balance Sheet Arrangements, Credit
Commitments, and Contractual Obligations

 

Off-Balance Sheet Arrangements

 

We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as variable-interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements.

 

Contractual Obligations

 

Our contractual obligations have not changed materially since previously reported in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

Credit Commitments

 

Our credit commitments as of June 30, 2008 were as follows:


 

Credit Commitments (Unaudited)

 

 

 

 

 

 

 

 

 

Table 21

 

 

 

Less Than

 

 

 

 

 

After 5

 

 

 

(dollars in thousands)

 

One Year

 

1-3 Years

 

4-5 Years

 

Years

 

Total

 

Unfunded Commitments to Extend Credit

 

$

631,818

 

$

389,616

 

$

270,468

 

$

1,262,582

 

$

2,554,484

 

Standby Letters of Credit

 

81,522

 

4,830

 

-

 

-

 

86,352

 

Commercial Letters of Credit

 

27,326

 

-

 

-

 

-

 

27,326

 

Total Credit Commitments

 

$

740,666

 

$

394,446

 

$

270,468

 

$

1,262,582

 

$

2,668,162

 

 

44



Table of Contents

 

Item 3.            Quantitative and Qualitative Disclosures About Market Risk

 

See the “Market Risk” section of MD&A.

 

Item 4.            Controls and Procedures

 

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of June 30, 2008.  Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2008.  There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the second quarter of 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

Part II - Other Information

 

Item 1A.         Risk Factors

 

There are no material changes from the risk factors set forth under Part 1, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

Item 2.            Unregistered Sales of Equity Securities and Use of Proceeds

 

The Parent’s repurchases of equity securities for the second quarter of 2008 were as follows:

 

Issuer Purchases of Equity Securities (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Number of Shares

 

Approximate Dollar Value

 

 

 

 

 

 

 

 

 

Purchased as Part of

 

of Shares that May Yet Be

 

 

 

Total Number of

 

 

Average Price

 

 

Publicly Announced Plans

 

Purchased Under the

 

Period

 

Shares Purchased 1

 

 

Paid Per Share

 

 

or Programs

 

Plans or Programs 2

 

April 1 - 30, 2008

 

90,623

 

 

$

50.06

 

 

87,500

 

 

$

58,593,379

 

May 1 - 31, 2008

 

58,340

 

 

55.14

 

 

52,500

 

 

55,702,692

 

June 1 - 30, 2008

 

80,464

 

 

51.40

 

 

80,000

 

 

51,590,035

 

Total

 

229,427

 

 

$

51.82

 

 

220,000

 

 

 

 

 

1 The months of April, May, and June 2008 included 3,123, 5,840, and 464 shares, respectively, purchased from employees in connection with income tax withholdings related to stock option exercises. These shares were not purchased as part of the publicly announced program. The shares were purchased at the closing price of the Parent’s common stock on the dates of purchase.

2 The Parent repurchased shares during the second quarter of 2008 pursuant to its ongoing share repurchase program that was first announced in July 2001. As of July 25, 2008, $43.4 million remained of the total $1.65 billion total repurchase amount authorized by the Parent’s Board of Directors under the share repurchase program. The program has no set expiration or termination date.

 

45



Table of Contents

 

Item 4.            Submission of Matters to a Vote of Security Holders

 

At the annual shareholders meeting held on April 25, 2008, the following matters were submitted to a vote of the shareholders:

 

a.

 

Amendment of the Company’s Certificate of Incorporation to Provide for Annual Election of All Directors

 

 

 

 

 

 

 

 

Votes cast for:

 

42,032,311

 

 

 

Votes cast against:

 

838,424

 

 

 

Abstentions:

 

105,009

 

 

 

 

 

 

 

b.

 

Election of Directors *

 

 

 

 

 

 

 

 

 

 

 

S. Haunani Apoliona

 

 

 

 

 

Votes cast for:

 

42,227,859

 

 

 

Votes withheld:

 

747,885

 

 

 

 

 

 

 

 

 

Mary G. F. Bitterman

 

 

 

 

 

Votes cast for:

 

42,249,547

 

 

 

Votes withheld:

 

726,197

 

 

 

 

 

 

 

 

 

Michael J. Chun

 

 

 

 

 

Votes cast for:

 

42,451,794

 

 

 

Votes withheld:

 

523,950

 

 

 

 

 

 

 

 

 

Clinton R. Churchill

 

 

 

 

 

Votes cast for:

 

42,404,738

 

 

 

Votes withheld:

 

571,006

 

 

 

 

 

 

 

 

 

David A. Heenan

 

 

 

 

 

Votes cast for:

 

42,267,558

 

 

 

Votes withheld:

 

708,186

 

 

 

 

 

 

 

 

 

Robert Huret

 

 

 

 

 

Votes cast for:

 

42,433,876

 

 

 

Votes withheld:

 

541,868

 

 

 

 

 

 

 

 

 

Allan R. Landon

 

 

 

 

 

Votes cast for:

 

42,322,129

 

 

 

Votes withheld:

 

653,615

 

 

 

 

 

 

 

 

 

Kent T. Lucien

 

 

 

 

 

Votes cast for:

 

42,338,293

 

 

 

Votes withheld:

 

637,451

 

 

 

 

 

 

 

 

 

Martin A. Stein

 

 

 

 

 

Votes cast for:

 

42,332,737

 

 

 

Votes withheld:

 

643,007

 

 

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Table of Contents

 

 

 

Donald M. Takaki

 

 

 

 

 

Votes cast for:

 

42,388,904

 

 

 

Votes withheld:

 

586,840

 

 

 

 

 

 

 

 

 

Barbara J. Tanabe

 

 

 

 

 

Votes cast for:

 

42,416,415

 

 

 

Votes withheld:

 

559,329

 

 

 

 

 

 

 

 

 

Robert W. Wo, Jr.

 

 

 

 

 

Votes cast for:

 

42,410,072

 

 

 

Votes withheld:

 

565,672

 

 

 

 

 

 

 

c.

 

Ratification of Ernst and Young LLP as independent registered public accountants for the fiscal year ending December 31, 2008.

 

 

 

 

 

 

 

 

Votes cast for:

 

41,931,142

 

 

 

Votes cast against:

 

970,174

 

 

 

Abstentions:

 

74,427

 

 

* The directors are elected by a plurality of the votes cast; therefore, votes cast in the election could not be recorded against or as an abstention, nor could broker non-votes be recorded.

 

Item 5.            Other Information

 

None.

 

Item 6.            Exhibits

 

A list of exhibits to this Form 10-Q is set forth on the Exhibit Index and is incorporated herein by reference.

 

47



Table of Contents

 

Signatures

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

Date:

July 30, 2008

Bank of Hawaii Corporation

 

 

 

 

 

 

 

By:

/s/ Allan R. Landon

 

 

 

Allan R. Landon

 

 

Chairman of the Board and

 

 

Chief Executive Officer

 

 

 

 

 

 

 

By:

/s/ Kent T. Lucien

 

 

 

Kent T. Lucien

 

 

Chief Financial Officer

 

48



Table of Contents

 

Exhibit Index

 

 

Exhibit Number

 

 

 

12

 

Computation of Ratio of Earnings to Fixed Charges (Unaudited)

 

 

 

31.1

 

Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) Under the Securities Exchange Act of 1934

 

 

 

31.2

 

Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) Under the Securities Exchange Act of 1934

 

 

 

32

 

Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002