Oct 28, 2013
Executives
Cynthia G. Wyrick - Executive Vice President and Director of Investor Relations Peter S.
Ho - Chairman, Chief Executive Officer, President and Director of Bank of Hawali Kent T. Lucien - Vice Chairman, Chief Financial Officer and Director of Bank of Hawaii Mary E.
Sellers - Vice Chairman and Chief Risk Officer
Analysts
Casey Haire - Jefferies LLC, Research Division Nicholas Karzon - Crédit Suisse AG, Research Division Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division Jacquelynne Chimera - Keefe, Bruyette, & Woods, Inc., Research Division Joe Morford - RBC Capital Markets, LLC, Research Division Jeffrey Rulis - D.A. Davidson & Co., Research Division Brett D.
Rabatin - Sterne Agee & Leach Inc., Research Division Donald D. Destino - Harvest Capital Strategies LLC Matthew J.
Keating - Barclays Capital, Research Division
Operator
Welcome to the Third Quarter Bank of Hawaii Corporation Earnings Conference Call. My name is Christine, and I will be the operator for today's call.
[Operator Instructions] Please note that this conference is being recorded. I would now like to turn the call over to Ms.
Cindy Wyrick. You may begin.
Cynthia G. Wyrick
Good morning, and thank you, Christine. Thank you, everyone, for joining us today as we review the financial results for the third quarter of 2013.
Joining me this morning is Chairman, President and CEO Peter Ho; Vice Chairman and Chief Financial Officer, Kent Lucien; and Vice Chair and Chief Risk Officer, Mary Sellers. The comments today will refer to the financial information included in this morning's earnings announcement.
Before we get started, let me remind you that today's conference call will contain some forward-looking statements and while we believe our assumptions are reasonable, there are a variety of reasons that the actual results may differ materially from those projected. And now, I'd like to turn the call over to Peter Ho.
Peter S. Ho
Great, thanks, Cindy. Good morning, everyone, and thank you for joining us today.
Thanks also for your interest in Bank of Hawaii Corporation. We're quite pleased with our financial results for the third quarter.
Loan balances grew nearly 3% from the previous quarter with good consistency in almost every category. We also continued to attract quality deposits during the quarter.
Our core consumer and commercial deposit balances were up 2.4% in the second quarter. As a result of the balance sheet growth and steepening yield curve, net interest income increased and our net interest margin widened by 6 basis points from the previous quarter.
Liquidity and capital levels remained robust for us at the end of the third quarter and credit quality, as Mary will get into, remains a strong point for us. Now let me turn it over to Kent who has greater detail on the numbers.
Kent T. Lucien
Thank you, Peter. Good morning.
Net income for the third quarter was $37.7 million or $0.85 per share compared to $37.8 million or $0.85 per share in the second quarter and $41.2 million or $0.92 per share in the third quarter of 2012. Our return on assets in the third quarter was 1.09%, and return on equity was 15%.
Our efficiency ratio was 61%. Year-to-date net income was $111.4 million or $2.50 per share compared to $125.8 million or $2.77 per share in 2012.
Year-to-date return on assets was 1.09%, and return on equity was 14.6%. Our year-to-date efficiency ratio was 61%.
Our net interest margin in the third quarter was 2.83% compared to 2.77% in the second quarter and 2.98% in the third quarter of 2012. The higher margin was primarily due to lower premium amortization in our securities portfolio, loan growth and higher levels of asset repricing.
Premium amortization was $14.4 million this quarter compared to $16.8 million in the second quarter. Loans grew 2.5% sequentially, and the investment portfolio reinvestment differential was at positive 16 basis points.
During the quarter, we also amended and extended $125 million of private long-term repurchase agreements and thereby lowered the rate on those repos from 4.68% to 4.20%. So far this year, we have amended and extended $325 million of private long-term repos, and on average, have lowered the rate by 79 basis points.
There's no credit provision in the third quarter of 2013. Net charge-offs in the quarter were $900,000.
Our allowance for loan and lease losses at the end of the third quarter was $123.7 million or 2.1% of outstanding loan and leases. Noninterest income for the third quarter was $45.1 million compared to $48 million in the second quarter and $52.4 million in the third quarter of 2012.
The decrease, compared to the second quarter, was primarily due to a decrease in mortgage banking income and a decrease in prepayment and syndication fees. Mortgage income was $4.1 million compared to $5.8 million in the second quarter and $11.7 million in the second quarter of 2012.
Year-to-date noninterest income was $140.9 million compared to $147.3 million in 2012. Noninterest expense totaled $83 million in the third quarter compared to $81.2 million in the second quarter and $84.9 million in the third quarter of 2012.
The increase compared to the second quarter was primarily due to an increase in separation expense and data processing services. The decrease compared to the third quarter of 2012 was primarily due to a decrease in salaries and benefits and lower net occupancy expense.
Year-to-date noninterest expense was $248.5 million compared to $250.8 million in 2012. The effective income tax rate was 28.9% in the third quarter compared to 30.3% in the second quarter and 32.5% in the third quarter of 2012.
The lower rate in the third quarter of 2013 was primarily due to a release of reserves related to the closing of a tax audit for prior years. Our investment portfolio now stands at $6.9 billion.
The average duration of the AFS portfolio is 2.76 years, and overall portfolio duration is 3.78 years. During the quarter, we repositioned approximately $325 million from AFS to HTM.
And so our investment portfolio is now 33% AFS and 67% HTM. Loans were $6 billion at the end of the third quarter, up $147 million or 2.5% compared to the end of the second quarter and up $224 million from the end of the third quarter of 2012.
Commercial loans increased by $78 million this quarter. Deposits were $11.6 billion at the end of the third quarter, up $159 million compared to the end of the second quarter and up $388 million from the end of the third quarter of 2012.
Our shareholders' equity was $1 billion at the end of the third quarter, and we paid out $20 million in dividends and continued our share repurchase program in the third quarter, repurchasing 165,000 shares of common stock for $8.9 million. Our board declared a dividend of $0.45 per share for the third quarter.
At the end of the third quarter, our tangible common equity to risk-weighted assets was 15.4%, and our Tier 1 leverage ratio was 6.95%. We plan to increase our Tier 1 leverage ratio to 7% by year end.
Now I'll turn the call over to Mary Sellers.
Mary E. Sellers
Thank you, Kent. Net charge-offs for the third quarter totaled $900,000, down $1.4 million on a linked-quarter basis and down $577,000 year-over-year.
Both the linked period and year-over-year improvement were due primarily to recoveries realized from residential mortgage and home equity loans moving through the foreclosure process. Nonperforming assets totaled $33.8 million, down $2.6 million from last quarter and down $6.5 million year-over-year.
Both the linked period and year-over-year decrease were due to reductions in residential mortgage nonaccrual loans. However, we continue to expect the level of nonperforming assets to be impacted in the near term due to the longer resolution time frame for residential assets.
At quarter end, loans past due 90 days or more and still accruing interest totaled $11.4 million, up $804,000 on a linked-quarter basis and up $3.9 million year-over-year. The linked period increase was due to a $584,000 increase in residential mortgage loans and $128,000 increase in home equity.
Restructured loans not included in non-accrual loans or loans past due 90 days or more totaled $39.8 million at quarter end, up $691,000 from the prior quarter and up $8.4 million year-over-year. Residential mortgage loans modified to assist our customers in retaining their homes accounted for $21.4 million of the total at the end of the quarter.
Residential mortgage and home equity loans past due more than 30 days but less than 90 and still accruing interest decreased by $2.6 million on a linked-quarter basis and $4.1 million year-over-year. We continue to see improvement in what we consider to be the higher-risk segments in our portfolio.
In total, these segments were down $1 million for the quarter and $11.3 million year-over-year. As Kent shared with you, we recorded no provision for loan and lease losses in the third quarter, which, given net charge-offs of $900,000, reduced the allowance to $123.7 million or 2.1% of outstanding loan and leases.
With continued strengthening and stability in the economy and continued stability in credit quality, we anticipate requiring a lower level of allowance going forward. I'll now turn the call back to Peter.
Peter S. Ho
Great. Thank you, Mary.
Let me close by sharing with you some color on the local economy here in the Hawaiian Islands. In a nutshell, it remains a very positive story.
Visitor industry continued to be a good source of strength for the economy during the quarter, augmented by some other activity. For the first 8 months of 2013, visitor spending increased 5.1% from the record levels achieved in 2012.
Arrivals were also up 5.1%. And year-to-date, the visitor industry has contributed over $1 billion in state tax revenue.
That's up 5 -- $50 million from the same period last year. The housing market remains a good story for our marketplace.
Oahu single-family home and condominium median prices rose 6% and 8.9%, respectively, in September and year-to-date are up 3.3% and 5.4%. Home sales volumes are also up in a healthy way, up 7% for single-family and 16.5% for condominium.
Inventory levels are down to very low levels, 2.8 months for single-family homes and 3 months for condominiums. Sellers of homes in Hawaii are achieving a 98.5% of asking list price for single-family and 99.7% of list price for condominium.
So obviously, a very good seller's market. Unemployment is down to 4.3% in August.
It's down from 5.1% at year end, and I think as most of you know, down significantly from that of the national average. Finally, I guess what I would share is we believe we're in the earlier stages of what could be a pretty constructive construction expansion here in the Islands, just a number of private -- both private and public projects beginning to come online and we think that, that gives us an opportunity here in this marketplace to expand further into the economy.
And with that, we'd be happy to take whatever questions you might have.
Operator
[Operator Instructions] Our first question comes from Casey Haire from Jefferies.
Casey Haire - Jefferies LLC, Research Division
So a question, I guess, on the margin outlook. Just wondering, that premium amortization of $14.8 million, can we get -- expect some further downside from here going forward?
And then on the reinvestment yield, Kent, I believe you said plus 16 bps. Does that mean that new money is coming on around 240 or so?
Kent T. Lucien
So the answer to your first question is yes, we would expect the amortization to probably come down somewhat into the near term. It's all a function of a prepay speeds, which has -- have been slowing.
So that -- those conditions continue. So yes, the answer is yes to that.
And as to the reinvestment situation, 16 basis points was the differential in the third quarter, and let me see if I could find figures here, it's about 225 or so in terms of the current level of purchases in that neighborhood.
Casey Haire - Jefferies LLC, Research Division
Okay. And then just one more on the loan growth outlook.
Peter, you -- obviously, you sounded pretty good about some of the opportunities you see in the construction side of things. Coming off a very strong result by your standards in double digits, I mean, what kind of expectation of growth can we expect going forward?
Peter S. Ho
Yes. Well, I think that the year-on-year number in commercial, as you know, is pretty extraordinary by our standards.
So I'm not sure that I would anticipate us to maintain double-digit year-on-year numbers off into the future. But I do believe that there's a pretty good probability of continued solid loan growth for us down the commercial front.
Operator
Our next question comes from Nicholas Karzon from Crédit Suisse.
Nicholas Karzon - Crédit Suisse AG, Research Division
I guess, first, on the mortgage banking side. Can you give us some color around the volumes you saw this quarter, the gain on sale spread and then also the mix between refi and purchase in the quarter?
Kent T. Lucien
Yes. So in terms of new applications for the quarter, those were down 48% compared to the second quarter.
The gain on sale was 210 basis points. That's down about 20 basis points from Q2.
In terms of the composition, 54% are purchased and 46% refi.
Nicholas Karzon - Crédit Suisse AG, Research Division
And then I guess going into the NIM a little bit. We saw the NIM turn this quarter and saw the inflection there.
How close do you think we are to seeing the loan yield compression slow and potentially stabilize?
Kent T. Lucien
On the loan side?
Nicholas Karzon - Crédit Suisse AG, Research Division
Yes.
Kent T. Lucien
The mortgage loan side?
Nicholas Karzon - Crédit Suisse AG, Research Division
No, the loan portfolio as a whole.
Kent T. Lucien
That's about 3 basis points.
Peter S. Ho
Yes, that's a tough question to answer because the velocity of loans that we're putting onto the balance sheet's changed and the loan volume that's changed pretty significantly down the mortgage side, which would be the bulk of our longer-term assets. So I guess my thought to that would be we are certainly decelerating in terms of losing spread, but it's not clear exactly when we're going to turn.
Operator
Our next question comes from Aaron Deer from Sandler O'Neill and Partners.
Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division
I guess, following up on Nicholas' question, maybe another way of asking it is how -- on the new loans that you're booking today, how does the pricing on those compare to, say, what you're booking 6 months or a year ago?
Kent T. Lucien
Well, it depends on the category. So -- yes, so on the commercial -- and obviously, you can understand our hesitation in talking pricing here, Aaron.
So on the resi side...
Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division
You don't have to give specific numbers. I mean, just in terms of what kind of -- to the extent that you're still seeing pricing pressure from competition, I'm just trying to gauge where we are in that?
Kent T. Lucien
Right. So here's what I would say.
On the saleable residential mortgage side, we're clearly up in terms of yield versus last year. On the Jumbo residential mortgage side, we're up as well, but that's probably the most competitive spot in the residential mortgage space.
On the commercial front, I would say that certainly for commercial real estate loans of good quality and reasonable size, there's a good amount of pressure competitively although we're looking to hurdle, at a minimum, 200 basis points on like riskless assets. And then on the C&I side, that's really all over the place.
But in general, C&I lending is squarely in the LIBOR space versus base. And spreads really are dependent on the deal -- the types of transaction, but competitive.
Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division
Okay, that's helpful. I appreciate that.
And then just quickly on the capital side. The share buybacks have been slowing this year relative to last and I expect that as something with both the stock price being much higher, as well as the deferred positive growth trends you're seeing.
So I'm just wondering, when I look at the Tier 1 ratio, it seems like it's kind of been hanging in the 6 75%, 70% level. Is it fair to assume that, that's kind of a floor for where you guys want to have your capital levels going forward?
Kent T. Lucien
Well, maybe I'll correct you on one thing, but the capital actions really haven't reflected the price of the stock. I mean, some of the reduced capital and buybacks has solely been a function of trying to get to a 7% Tier 1 leverage ratio.
So what we saw in the third quarter was deposits grew, the balance sheet was bigger because of that and so a little bit less in terms of buybacks. So that's really the determinant here.
We're going to continue to try to get to the 7% leverage ratio by the end of the year.
Operator
Our next question comes from Ebrahim Poonawala from Bank of America
Operator
Our next question comes from Jackie Chimera from KBW.
Jacquelynne Chimera - Keefe, Bruyette, & Woods, Inc., Research Division
I wondered if you could touch on the timing of the impact into expenses from a compensation standpoint just on the slowdown in mortgage banking and when do you'll see that reflected there as well?
Peter S. Ho
Yes. Well, I think, intuitively, as volumes fall, you should expect some offset in expenses, Jackie.
The challenge, though, I think, is that the whole industry's changing pretty rapidly in the residential mortgage space. I mean, the thoughts were on qualified mortgages and what are the impacts there, some of the pricing changes that we're seeing in salable versus Jumbo and the transition from refinanced to purchased.
And frankly, purchase in a pretty tight purchase market here in the Islands has us really thinking about where we want to take this business. So what I would say is we're really exploring how best to create value out of our mortgage business.
The market is changing pretty meaningfully, and of course, having the right expense structure is going to be in place. But that's not altogether clear exactly what that is at this point for us.
Jacquelynne Chimera - Keefe, Bruyette, & Woods, Inc., Research Division
Okay. And then another expense question, quickly.
The separation expense, you've had some of that for the last couple of quarters. Is there anything unusual in there?
I know you had some branch closures that are pending -- that are happening.
Peter S. Ho
No, I think you characterized it pretty accurately. It's been somewhat of a consistent theme for us kind of in certain quarters.
And I think, as you know, the way that we look at expense management is really a little bit more of a serial approach than an episodic or program-type approach. And so we're constantly reviewing various operations in the organization, trying to see where there are efficiency opportunities.
And when we come up upon some of those opportunities, that's when you see a bulge in severance expense. So this quarter was a little on the higher end, but probably directionally not too unusual for us moving forward.
Operator
Our next question comes from Joe Morford from RBC Capital Markets.
Joe Morford - RBC Capital Markets, LLC, Research Division
I guess I was, first, curious. The deposit growth from the quarter was quite strong again.
Anything particularly driving that? Or anything kind of different going on this quarter?
Peter S. Ho
Clearly, we're not doing anything on the pricing side because our deposit -- our cost of deposits is pretty darn low at this point. To be honest with you, we've been rather surprised at the strength of our deposit performance over the past, I'll call it, the past year.
And so when we look at the source of those deposits, some of it's coming in certainly through just market increase as the economy's doing well here in the Islands. But to be honest with you, a lot of it's coming through from market share gains and that makes us feel good about the brand.
But it's certainly not coming through as a result of us pricing up for deposits. So it's a -- yes.
Joe Morford - RBC Capital Markets, LLC, Research Division
Okay, wouldn't have thought so, but -- and then just on the credit side, the charge-offs, extremely low this quarter. I was just kind of curious about the pipeline for additional recoveries.
And maybe along with that, just the release talked about still some -- alluded to some softness in residential mortgage in the neighboring islands. I'm just kind of curious for an update on where that stands?
Mary E. Sellers
I think you'll see a pretty consistent trend as we move forward over the next few quarters in our residential book. If you look, gross charge-offs are running pretty consistent and that tends to come from our Neighbor Island portfolio, but we also are working through our pipeline of foreclosed assets and we'll see a steady stream from that, putting it on par with what you're seeing.
Operator
Our next question comes from Jeff Rulis from D.A. Davidson & Company.
Jeffrey Rulis - D.A. Davidson & Co., Research Division
Peter, just to kind of follow up a question or 2 on your economic comments. It sounded pretty positive.
I guess, the first question, could we assume that the sort of government shutdown didn't have much of a negative effect on what you're seeing so far?
Peter S. Ho
I -- just anecdotally, I think it did have an impact. So we still had reasonably positive results, but probably offset somewhat by the effects out of Washington.
So we've got a pretty heavy reliance on national parks here in the state and they are major visitor attractions so -- Pearl Harbor was closed for 2 weeks. National Volcano Park was closed for a couple of weeks.
So I think that clearly was not good for business and it's really tough to figure out what impact -- what's happening in Washington is having on consumer sentiment with respect to taking a vacation in Hawaii. So I think it's having an impact, it's just not having enough of an impact to change pretty strong statistics in the visitor industry for us right now.
Jeffrey Rulis - D.A. Davidson & Co., Research Division
Okay. And then your comments on the construction business, that's more of, I guess, an indirect benefit of just overall activity other than -- I mean, you guys don't like to book real construction activity, at least on the sort of residential side or is that -- are you looking to capture some activities directly in that business?
Peter S. Ho
Yes, that's a really good nuance. We, I think in our peak in the last cycle took, our construction book up to a little over $200 million.
That's the business that we're in to support some of the finest real estate clients in this marketplace. It's not really a business that we look to for generating loan growth per se.
So right, the construction activity, I think, from Bank of Hawaii standpoint is going to play into our opportunities through just general economic expansion, as well as supporting a lot, just a lot, of businesses that support the construction trades.
Operator
Our next question comes from Brett Rabatin from Sterne Agee.
Brett D. Rabatin - Sterne Agee & Leach Inc., Research Division
Wanted to ask about the tax rate and just thinking about that going forward. I know there were a couple of things that impacted it this quarter.
Would it be fair to assume that the tax rate on an ongoing basis is lower than it was the first half of this year?
Kent T. Lucien
Well, I don't know about that last comment, Brett. But it can't be episodic as we demonstrated here in the third quarter.
We had a situation where we closed out some audits on uncertain tax matters were accordingly released. That brought us down to under 38%.
I still have to guide you at between 30% and 35% as an effective rate going forward. Hopefully, at the low end of that would be a way to think about things.
But -- so nothing that happened this quarter really changes anything longer term.
Brett D. Rabatin - Sterne Agee & Leach Inc., Research Division
Okay. And then the other follow-up was just around premium amortization and I know it was down, I think, from $16.1 million to $14.8 million this quarter.
Can you talk about what might be kind of an ongoing level for premium amortization, excluding what might be accelerated to just cash flow from the portfolio coming in faster than expected?
Kent T. Lucien
Well, maybe if I give you a few more facts, it'll help a little bit. The amortization in this quarter was $14.3 million.
And of that, $8.7 million was due to amortization for mortgage-backed securities. And that number had been $10.7 million in Q2.
So, really, the major change is in the mortgage space. There are limits.
You're not going to get that number down by half. That's unrealistic.
And you're really not going to be able -- and the amortization for other types of securities, any premium associated with a treasury note, it's just not going to change as a function of interest rates. So I can't really give you a number for Q4 or beyond other than to say directionally and it's likely to be a little bit lower into the fourth quarter.
Operator
Our next question comes from Don Destino from Harvest Capital.
Donald D. Destino - Harvest Capital Strategies LLC
Sorry, I thought I took myself out. I was going to basically ask Brett's question about run rate amortization.
Let me just ask the one more nuance I was going to add to my question was, which is can you tell us what the premium is, the premium that needs to be amortized in the current securities portfolio?
Kent T. Lucien
No, we haven't released that.
Operator
Our next question comes from Matthew Keating from Barclays.
Matthew J. Keating - Barclays Capital, Research Division
It's nice to see some modest growth in the residential mortgage book this quarter. As we kind of enter a period where refinancings will be challenged, can you talk about what impact that typically has on your on-balance sheet residential mortgage portfolio?
Peter S. Ho
Sure. That, ironically, has a positive impact on residential mortgage outstandings.
So as refis -- as the attractiveness of selling through refi comes down with gain on sale coming down, there's probably a natural move towards portfolio-ing a higher proportion of residential mortgages for us. So that's accretive to outstandings.
The other thing that happens is that as refi activity slows, just the natural churn at the bottom of our portfolio slows as well. So kind of a dual stage impact there.
And I think the bottom line to that is whereas we see resi mortgages outstandings fall recently precipitously in the past several quarters, we'll probably see a flattening of that going forward.
Matthew J. Keating - Barclays Capital, Research Division
Great. And just one last question on expenses.
You've had a pretty good track record over the past 2 to 3 years of reducing the absolute dollar number of expenses. Is that a goal you guys continue to shoot for at the moment?
Peter S. Ho
It is. We had been -- I think for the past couple of years, we've been running with -- from a soft goal of, call it, 2% per year.
I think as we look forward, we still believe we can reduce expenses on an absolute basis. That 2% may shrink a bit though, really as an offset not to expense management but really is an accommodation to investing a little bit more on opportunities that we see and what we view as an expanding marketplace here.
So yes, still bringing it down absolutely, but maybe not at the same rate of the past couple or 3 years.
Operator
[Operator Instructions] We have no further questions at this time.
Cynthia G. Wyrick
Thank you, Christine. I'd like to thank everyone for joining us today and for your continued interest in Bank of Hawaii.
And as always, please feel free to contact me if you have any additional questions or need further clarification on any of the topics we discussed today. Have a great day, everyone.
Operator
Thank you, ladies and gentlemen. This conclude today's conference.
Thank you for participating. You may now disconnect.