Bank of Hawaii
NYSE: BOH
3.8%
3.6%
3.5%
3.6%
3.6%
3.7%
3.7%
3.6%
3.8%
3.2%
3.3%
3.9%
4.2%
4.4%
4.3%
4.1%
3.9%
3.7%
2.8%
2.9%
3.0%
3.0%
2.8%
2.9%
2.8%
1.8%
1.8%
1.7%
2.0%
1.9%
2.0%
2.1%
2.4%
2.1%
1.8%
1.8%
1.9%
1.8%
1.4%
1.3%
1.1%
1.0%
0.9%
0.7%
0.8%
1.2%
1.0%
1.1%
1.1%
1.1%
1.9%
1.8%
1.9%
1.7%
1.7%
1.7%
1.7%
1.2%
1.7%
1.4%
1.5%
2.0%
2.4%
3.0%
3.1%
3.0%
2.9%
2.8%
2.0%
2.2%
1.8%
1.9%
1.7%
1.8%
1.7%
Net Interest Net Non-interest Pre-tax Income
EV/
Earning Assets
EV/
Deposits
EV/
EBT
EV/
Owner Earnings
Frost 0.16 0.17 8.59 5.56
BOK 0.14 0.19 9.15 5.15
Commerce 0.20 0.24 11.36 6.98
UMB Financial 0.15 0.18 14.98 6.68
Central Pacific
Financial
0.15 0.16 9.47 8.17
Minimum 0.14 0.16 8.59 5.15
Maximum 0.20 0.24 14.98 8.17
Median 0.15 0.18 9.47 6.68
Mean 0.16 0.19 10.71 6.51
Standard
Deviation
0.02 0.03 2.60 1.20
Variation 16% 16% 24% 18%
BOH 0.20 0.22 12.04 7.52
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Minimum Maximum Median Mean
Standard
Deviation
Variation
Net Interest Income 383 395 422 429 413 460 494 493 515 414 386 359 366 401 403 393 380 359 306 352 380 386 369 396 405 306 515 395 402 47 12%
Net Non-interest Expense 188 197 201 232 218 249 275 329 288 233 214 172 159 129 118 105 95 89 82 91 151 134 145 147 162 82 329 162 176 67 38%
Pre-tax Income 195 197 221 197 196 211 219 164 226 181 172 186 207 271 285 288 286 271 223 261 229 252 224 249 243 164 288 223 226 37 16%
Short-term Investments 1,358 1,664 1,286 865 730 845 563 579 487 259 870 1,314 390 275 46 21 90 99 697 395 384 267 225 321 487 21 1,664 487 581 446 77%
Securities 2,323 2,695 3,611 3,546 3,171 3,380 3,685 3,672 3,516 3,234 2,768 2,341 2,630 2,904 3,069 3,016 2,969 2,962 4,161 6,008 6,719 6,983 6,909 6,900 6,505 2,323 6,983 3,380 3,987 1,605 40%
Loans 6,484 6,602 6,991 7,394 7,655 8,354 8,930 9,422 9,445 9,544 8,125 5,623 5,640 5,876 6,195 6,458 6,650 6,631 6,246 5,563 5,441 5,775 5,978 6,481 7,481 5,441 9,544 6,602 6,999 1,298 19%
Total Earning Assets 10,165 10,961 11,889 11,805 11,556 12,578 13,177 13,673 13,447 13,038 11,763 9,277 8,660 9,055 9,310 9,495 9,708 9,692 11,105 11,966 12,545 13,025 13,113 13,702 14,473 8,660 14,473 11,805 11,567 1,726 15%
Non-interest bearing
1,135 1,232 1,325 1,386 1,403 1,566 1,781 2,098 2,088 2,011 1,886 1,556 1,754 1,929 1,973 1,950 1,892 1,742 1,994 2,240 2,596 3,024 3,389 3,688 4,040 1,135 4,040 1,929 2,067 748 36%
Interest-bearing Deposits 7,496 7,186 6,208 5,909 5,633 6,617 7,467 7,452 7,228 6,994 6,181 5,044 5,292 5,493 5,793 5,781 5,996 6,110 7,115 7,270 7,356 7,911 8,008 8,434 8,885 5,044 8,885 6,994 6,754 1,024 15%
Total Deposits 8,631 8,418 7,532 7,295 7,037 8,182 9,248 9,550 9,315 9,005 8,067 6,600 7,046 7,422 7,767 7,731 7,888 7,851 9,108 9,509 9,952 10,935 11,397 12,122 12,925 6,600 12,925 8,418 8,821 1,635 19%
Equity 683 785 893 971 1,026 1,071 1,109 1,161 1,210 1,235 1,344 1,184 900 761 731 696 730 783 877 1,013 1,020 1,023 1,018 1,052 1,084 683 1,344 1,018 974 184 19%
Return on Earning Assets
Net Interest Income 3.76% 3.60% 3.55% 3.64% 3.58% 3.66% 3.75% 3.61% 3.83% 3.18% 3.28% 3.87% 4.23% 4.43% 4.33% 4.13% 3.92% 3.71% 2.75% 2.94% 3.03% 2.96% 2.81% 2.89% 2.80% 2.75% 4.43% 3.61% 3.53% 0.50% 0.14
Net Non-interest Expense 1.85% 1.80% 1.69% 1.97% 1.88% 1.98% 2.09% 2.41% 2.14% 1.79% 1.82% 1.86% 1.84% 1.43% 1.27% 1.10% 0.98% 0.92% 0.74% 0.76% 1.20% 1.03% 1.10% 1.07% 1.12% 0.74% 2.41% 1.69% 1.51% 0.48% 0.32
Pre-tax Income 1.92% 1.80% 1.86% 1.67% 1.69% 1.68% 1.66% 1.20% 1.68% 1.39% 1.46% 2.01% 2.39% 3.00% 3.06% 3.03% 2.94% 2.79% 2.01% 2.18% 1.83% 1.93% 1.71% 1.82% 1.68% 1.20% 3.06% 1.83% 2.02% 0.54% 0.27
Leverage
Earning Assets/Equity 14.89 13.97 13.31 12.16 11.26 11.75 11.88 11.78 11.11 10.56 8.75 7.84 9.62 11.90 12.73 13.64 13.29 12.38 12.66 11.82 12.30 12.73 12.88 13.02 13.35 7.84 14.89 12.30 12.06 1.59 13%
RETURNS
Return on Equity 29% 25% 25% 20% 19% 20% 20% 14% 19% 15% 13% 16% 23% 36% 39% 41% 39% 35% 25% 26% 22% 25% 22% 24% 22% 13% 41% 23% 24% 8% 0.32
GROWTH
Net Interest Income 3% 7% 2% -4% 11% 7% 0% 4% -19% -7% -7% 2% 9% 1% -3% -3% -6% -15% 15% 8% 2% -4% 7% 2% -19% 15% 2% 1% 8% 14.43
Net Non-interest Expense 5% 2% 16% -6% 15% 10% 20% -12% -19% -8% -19% -8% -19% -8% -11% -9% -7% -7% 11% 66% -11% 8% 1% 10% -19% 66% -6% 1% 18% 25.76
Pre-tax Income 1% 12% -11% -1% 8% 4% -25% 38% -20% -5% 9% 11% 31% 5% 1% -1% -5% -17% 17% -12% 10% -11% 11% -2% -25% 38% 1% 2% 15% 7.64
Federal Funds and Other
Deposits
23% -23% -33% -16% 16% -33% 3% -16% -47% 235% 51% -70% -29% -83% -56% 335% 10% 606% -43% -3% -30% -16% 42% 52% -83% 606% -16% 36% 153% 4.18
Securities 16% 34% -2% -11% 7% 9% 0% -4% -8% -14% -15% 12% 10% 6% -2% -2% 0% 40% 44% 12% 4% -1% 0% -6% -15% 44% 0% 5% 16% 2.89
Loans 2% 6% 6% 4% 9% 7% 6% 0% 1% -15% -31% 0% 4% 5% 4% 3% 0% -6% -11% -2% 6% 4% 8% 15% -31% 15% 4% 1% 9% 8.70
Total Earning Assets 8% 8% -1% -2% 9% 5% 4% -2% -3% -10% -21% -7% 5% 3% 2% 2% 0% 15% 8% 5% 4% 1% 4% 6% -21% 15% 3% 2% 7% 4.11
Non-interest bearing
Deposits
9% 8% 5% 1% 12% 14% 18% 0% -4% -6% -17% 13% 10% 2% -1% -3% -8% 14% 12% 16% 16% 12% 9% 10% -17% 18% 9% 6% 9% 1.55
Interest-bearing Deposits -4% -14% -5% -5% 17% 13% 0% -3% -3% -12% -18% 5% 4% 5% 0% 4% 2% 16% 2% 1% 8% 1% 5% 5% -18% 17% 2% 1% 9% 8.01
Total Deposits -2% -11% -3% -4% 16% 13% 3% -2% -3% -10% -18% 7% 5% 5% 0% 2% 0% 16% 4% 5% 10% 4% 6% 7% -18% 16% 4% 2% 8% 4.05
Equity 15% 14% 9% 6% 4% 4% 5% 4% 2% 9% -12% -24% -15% -4% -5% 5% 7% 12% 15% 1% 0% 0% 3% 3% -24% 15% 4% 2% 9% 3.92
TABLE OF CONTENTS
DURABILITY 3
MOAT 5
QUALITY 7
CAPITAL ALLOCATION 8
VALUE 10
GROWTH 12
MISJUDGMENT 13
FUTURE 15
APPRAISAL 17
NOTES 19
SINGULAR DILIGENCE
Geoff Gannon, Writer Quan Hoang, Analyst
Tobias Carlisle, Publisher
OVERVIEW
Bank of Hawaii is the second largest
bank in the island state of Hawaii. From
1994 through 2015, Bank of Hawaii’s
deposit share in that state ranged from
about 27% (on the eve of the 2008
nancial crisis) to 32% today. Generally,
Bank of Hawaii has had a deposit share
of about 30%. In most U.S. states, no
bank has anywhere near 30% of all
deposits. Hawaii’s banking industry is
much more consolidated than the
banking industry in other U.S. states.
Bank of Hawaii was founded in 1893. It
opened its rst branch in Kauai in 1903.
Over the next 90 years, Bank of Hawaii
acquired many other Hawaiian banks.
For example, it bought First Bank of
Hilo – a four branch Hawaiian bank – in
1922. It bought Amalgamated Bank of
Maui in 1930. By 1995, the company
was called Hawaii Bancorporaon. It
had 31% deposit share in Hawaii. The
bank as it exists today is very similar to
what it looked like 20 to 25 years ago.
The big dierence is that Bank of
Hawaii sold o its non-Hawaiian assets.
During the 1980s and 1990s, Hawaiian
Bancorporaon grew outside the state
of Hawaii. At the peak of its expansion,
the bank had branches in the U.S.
mainland states of California, Arizona,
and New York. It also had foreign (that
is, non-U.S.) branches in 8 dierent
South Pacic naons. It even had 6
locaons in Asia. Hawaii has the closest
es to Asia of any U.S. state. Much of
Hawaii’s populaon are descendants of
Chinese immigrants. Hawaii is also a
popular desnaon for Japanese tourists. During the 1990s, Bank of Hawaii couldn’t
grow its revenue the way mainland banks could. It already had 30% of the Hawaiian
market. And Hawaii was no longer an especially fast growing economy. So, Bank of
Hawaii started buying loans outside of Hawaii. The company’s 1997 name change
from Hawaiian Bancorporaon to Pacic Century Financial is indicave of
management’s focus on external growth.
That focus came back to bite BOH. The late 1990s were a boom me for U.S. banks.
And especially for U.S. bank stocks. But not for Bank of Hawaii – or Pacic Century
Financial as it was then named. Net charge-os to loans were 0.34% in the year Bank
of Hawaii made the name change to Pacic Century. They rose from there. In 1998,
net charge-os were 0.70%. They rose to 0.78% in 1999. Then 0.94% in 2000. And
then 1.57% in 2001. The period 1997-2000 was hardly a trying me for the U.S.
economy. So, that was a lousy loan loss trend. Bank of Hawaii’s stock performed
badly. In 2000, it was the only big U.S. bank stock trading below book value. The
Chairman of the company resigned. And Michael O’Neil – the former Vice Chairman
and CFO of Bank of America – was made both Chairman and CEO. He was given the
task of turning the company around.
Michael O’Neil re-focused Bank of Hawaii on its core business. In 2002, Pacic
Century Financial changed its name to Bank of Hawaii. It sold o non-Hawaiian
Bank of Hawaii (NYSE: BOH) s One of the Biggest
Players in the Best Banking Market in the U.S.
SINGULAR DILIGENCE 1
Over the last 22 years, Bank of Hawaii has consistently held a 27% to
33% share of all deposits in Hawaii.
assets and closed branches. The bank
actually shrank itself by choice. In 2000,
Bank of Hawaii had $14 billion in total
assets. In 2004, it had just $9.7 billion
in total assets. So, the bank shrank at a
rate of about 10% a year for four
straight years. That really is a
disciplined approach to focus. Bank of
Hawaii’s best deposits had always been
in Hawaii. It had a relavely small
number of branches with a relavely
high amount of very low cost deposits
per branch. This was the bank’s real
franchise. So, cung away all of the
non-Hawaiian business really helped
the bank’s expense situaon. A bank’s
eciency can best be measured not as
analysts like to focus on in terms of
expense as a percent of revenue – but
instead in terms of expenses relave to
deposits. Banks don’t control their
revenues. Most banks make a lot of
money o interest. Well, the Fed sets
interest rates – banks don’t set interest
rates. So banks don’t have control over
revenue in the form of interest. What
banks do have complete control over is
their net operang expense. This is non
-interest expense less non-interest
income. In the long-run, this is the
number that maers. Bank of Hawaii
had net operang expenses of 1.79% of
earning assets in 2000. In 2007, net
operang expense at a percent of
earning assets was just 0.98%. That
made Bank of Hawaii one of the best
banks in America.
Bank of Hawaii is sll one of the best
banks in America. Not in terms of
growth potenal. And not in terms of
loan losses. But in terms of deposits.
Bank of Hawaii has one of the very best
deposit bases you’ll nd anywhere in
the world. Right now, Bank of Hawaii is
funded 91% by deposits. And 91% of
these deposits are what are called
“core deposits”. So, about 83% of Bank
of Hawaii’s balance sheet is supported
by core deposits. Core deposits are
scky. Customer retenon is 90% or
higher at many banks. They also tend
to be cheap. For example, 31% of Bank
of Hawaii’s deposits (which is 28% of
the bank’s balance sheet) is interest
free. Customers receive no interest on
these accounts. Since we know Bank of Hawaii’s net operang expense is less than
1% of deposits – an account that doesn’t pay interest, costs Bank of Hawaii less
than 1% in total. The U.S. government can’t borrow long-term – remember,
customers tend to leave their money with the same bank for 5 to 10 years – at less
than 1%. You don’t have to be a very good lender to make money if your funding is
cheap and scky.
Hawaii is the best banking industry in the country. Hawaiian banks tend to have the
highest liquidity – they have high customer deposits relave to their total balance
sheet – and the lowest cost of deposits of banks in any U.S. state. Bank of Hawaii
has the lowest cost of funding among Hawaiian banks. In fact, it has one of the
lowest costs of funding of any bank in the country. There are some banks with
lower costs of funding. Warren Bue owns Wells Fargo. Wells has a very low cost
of deposits. And we wrote about Frost – it’s sll our favorite bank – in a past issue
of Singular Diligence. So, yes, there are a few banks with a lower cost of funding
than Bank of Hawaii. But there are literally a few thousand banks with a higher cost
of funding. Every other Hawaiian bank has a higher cost of funding than BOH. As a
rule, Bank of Hawaii obtains its deposits at two-thirds the cost of the average
Hawaiian bank and half the cost of the average mainland bank. BOH’s net operang
expense divided by total earning assets is usually less than 1%. Other U.S. regional
banks – which are about the same size as BOH – have net operang expenses in the
1.5% to 3% range.
This obviously means BOH has higher returns on equity. Let’s use the boom period
of 2004 to 2007 as an illustraon. We can’t use the 2008-2016 period, because
interest rates were so low as to be meaningless. When analyzing banks, we have to
use some sort of “normal” interest rate level. Here, we’ll treat 2004 to 2007 as
normal. From 2004 through 2007, Bank of Hawaii generated a pre-tax return on
earning assets of 3%. It had 14 mes leverage. By this we mean earnings assets
were 14 mes shareholder’s equity. So, the pre-tax return on shareholder’s equity
was 14 mes 3% which is 42%. This translates into an aer-tax return on equity of
27%. Lately, the bank’s return on equity has been nowhere near this level. For
example, in 2015, BOH’s pre-tax return on earning assets was 1.7% instead of the
3% it earned in 2004 to 2007. This is because BOH is hurt by lower interest rates.
Remember, BOH doesn’t pay interest on 30% of its deposits – but it receives
interest on all of its assets. So, low interest rates benet borrowers at the expense
of a lender like BOH. In the medium-term, BOH will have very strong earnings
growth. This growth will be a one-me event caused by the Fed raising interest
rates. BOH’s return on earning assets can increase from about 1.7% to 3%. But, this
will only happen once. Aer that, BOH will grow no faster than the nominal GDP of
Hawaii. Hawaii can’t have high populaon growth in the future. It doesn’t have
enough available land. It’s simply too crowded to grow as fast as a sparsely
populated state like Texas. So, BOH will never be able to grow faster than 3% to 4%
a year. This is why Quan and I much prefer Frost over BOH. Both have great deposit
bases. Frost can grow its base quickly for a long me. BOH can’t. However, BOH can
use 80% to 90% of its earnings to buy back stock and pay dividends while sll
growing 3% to 4% a year. That doesn’t sound amazing. For example, BOH trades for
18 mes earnings right now. That’s an earnings yield of 5.6% (1/18 = 5.6%). Let’s
take 80% of that. That’s 4.5%. That’s all BOH can pay out in dividends and use for
buy backs right now. And then it can grow 3% to 4% a year. Let’s say 3%. That’s only
a 7.5% return in the stock. Is that beer than what the S&P 500 will do? Maybe. But
not a lot beer. However, there are two points to consider. One, BOH is under
earning its true potenal. Interest rates aren’t normal right now. It doesn’t maer
what BOH earns when the Fed Funds Rate is between 0% and 1%. What maers is
what BOH will earn when the Fed Funds Rate is between 3% and 4%. So, while it
looks like BOH is trading at a P/E of 18 – and it is, if interest rates stay where they
SINGULAR DILIGENCE 2
are forever – Quan and I actually think
BOH is trading at a “normalized” P/E of
just 11. So, imagine you have a stock
with a P/E of 11 paying out 80% of its
earnings in dividends and share
buybacks and growing 3% a year. That’s
not a bad stock. You’re talking about
something yielding more like 7% of
your purchase price in a combinaon of
dividends and buybacks plus growing
that yield by 3% each year. You’ve
found yourself a stock that can return
10% a year for the long-run. That’s
what BOH should look like in a normal
interest rate environment. On top of
that, BOH has an incredibly wide moat.
Banking is a predictable business.
Customers rarely ever switch banks.
And market share doesn’t change much
at all. In Hawaii, market share shis are
very small. It’s an incredibly
concentrated market. From 1994
through 2015, the same four banks –
First Hawaiian Bank, Bank of Hawaii,
American Savings Bank, and Central
Pacic Financial – have always
controlled between 90% and 92% of
the state’s deposits. As a group, their
deposit share almost never varies. In
fact, the acons of all other banks in
Hawaii really don’t maer. What
maers are just two pairs of banks. The
big two are: First Hawaiian Bank (36%
deposit share) and Bank of Hawaii
(32%). The medium two are: American
Savings Bank (12%) and Central Pacic
Financial (11%). Bank of Hawaii is very
insulated from competor acons. It is
in the banking industry which already
has sky high customer retenon – this
minimizes rivalry among rms. And
then the banking industry in Hawaii –
unlike most other states – is an
oligopoly. So, you have an oligopoly
where each of the oligopolists has a
very, very loyal customer base. Hawaii’s
populaon growth is low. So, new
branches are rarely opened in the
state. In fact, Bank of Hawaii has shrunk
its number of branches even while
increasing its amount of deposits. So,
it’s a wide moat stock. If interest rates
never rise, it’s a wide moat stock that
would be on a trajectory to return 7% a
year. If interest rates increase, it’ll then
be a wide moat stock on a trajectory to return 10% a year. And if you buy the stock
today and then hold the stock while the Fed raises interest rates – you’ll get a one-
me boost in reported earnings. Bank of Hawaii will be an acceptable but not
especially protable investment if the Fed never raises interest rates. Once the Fed
does raise rates, it’ll be a good long-term investment from that point on. And in the
medium-term – say from 2016 through 2021 – Bank of Hawaii is an excellent
speculaon on higher interest rates. The stock should provide excellent annual
returns during the 5-year period where interest rates increase at the fastest pace.
That me may be now. That part is speculave. But it adds to the stock’s appeal.
DURABILITY
Bank of Hawaii has a Perfectly Durable Compeve Posion and Low Cost of
Funding – However, its Leverage Rao and Loan Losses are Only Good, Not
Great
There are four big banks in Hawaii: First Hawaiian Bank (37% market share), Bank of
Hawaii (32%), American Savings Bank (13%), and Central Pacic Financial (11%).
The toughest test of their survival came in the 2007-2008 nancial crisis. First
Hawaiian, BOH, and American Savings Bank all did ne. Central Pacic was
essenally wiped out. Shareholders lost about 95% of their money during the crisis.
So, when tesng the durability of a Hawaiian bank we will be looking at the recent
nancial crisis. There was an earlier crisis in Hawaii – it was ed to the crash in
Japanese asset values (both land and stocks) in the late 1980s. And BOH itself had a
harder me in the late 1990s and early 2000s than it did in the nancial crisis of
2007-2008. But that was due to self-inicted wounds. BOH “di-worsied” into loans
and securies outside of Hawaii. Central Pacic’s collapse in the nancial crisis had
a similar di-worsicaon aspect to it. So, let’s start with that collapse now.
In 2007, CPF had $1.2 billion in construcon loans. That was 30% of its loan
porolio. This is a very, very high poron of a bank’s overall porolio to put in
construcon loans. Many banks make almost no construcon loans. CPF had made
the addional mistake of lending a lot of money in California instead of Hawaii. In
2007, CPF had 25% of its total loan porolio in California. Most of the loans in
California were construcon loans. In fact, a full 15% of CPF’s total loan porolio
was made up just of Californian construcon loans. Concentrang that much in
construcon is unusual. Concentrang that much in a single state is unusual. And –
probably the worst part – concentrang that much of your lending in a state where
you are not headquartered is especially unusual. In 2008 and 2009, CPF charged o
more than $600 million from a total loan porolio of only about $4 billion. Banks
are built to lose well over 10% of their total loan porolio. Bank of Hawaii is a fairly
conservave bank. It has very low cost funding. So, it is generang decent pre-loss
provision earnings right now. In a normal interest rate environment, BOH would be
earning really excellent pre-loss provision earnings. But, even BOH would start
reporng net losses if it wrote o around 4.5% of its total loans or more in a single
year. CPF charged o more like 15% of its loan porolio in just 3 years. Now, that
was one of the worst nancial crises in history. So, it is a good test of what the
worst case for a Hawaiian bank can look like. Even then, CPF’s losses were largely
the result of lending in California and lending in construcon. BOH is unlikely to do
this. Let’s take a moment to explain why.
This is what BOH’s then CEO said in 2008: “Our credit philosophy is to stay within
our market. I think to understand a lile bit about what’s important to Bank of
Hawaii and why we might approach this a lile bit dierently (it) would be good to
return just briey in history (to) 2000…the Bank of Hawaii was suering from some
prey poor nancial performance…What happened to us is when we grew beyond
our natural markets, we inevitably lost money. When we purchased loans outside
SINGULAR DILIGENCE 3
of our marketplace, we had a hard me
guring out how to make any prot for
our shareholders on that business…So
making sure we stay with proven
products, making sure we have
appropriate underwring standards
and monitoring processes are an
important part of our credit culture and
avoiding what we call mistakes of the
past.”
Bank of Hawaii is not the most
conservave bank in Hawaii. It had
higher loan loss charge-os than some
competors. However, BOH’s
residenal real estate lending – which
is a big part of the business – has fairly
conservave lending standards
compared to mainland banks. More
importantly, BOH is locally focused. The
bank’s loan porolio is 91% Hawaii, 5%
Guam, and just 3% U.S. mainland.
There is more compeon among
lenders – and more lending done by
banks with lax standards – on the
mainland than there is in Hawaii. The
Hawaiian bank oligopoly where two
banks have almost 70% of the market
and 4 banks have 90% of the market
puts less pressure on local banks to
make bad loans. This can be seen in
BOH’s mortgage lending. If we look at
the second quarter of 2007 – this is
close to the point where lending would
have been laxest during the crisis –
BOH’s residenal mortgage porolio
had a 60% loan to value rao. The
average FICO score was around 750.
BOH had solid loan to value and FICO
score standards in both its mortgage
lending and its home equity loans.
However, the home equity loan
porolio had much higher charge-os
than the mortgage porolio. We don’t
have a perfect explanaon for why this
would be. However, Hawaiian real
estate is expensive compared to the
rest of the country and also compared
to the income and spending levels of
homeowners in Hawaii. In other words,
the equity in a Hawaiian home is a
bigger potenal piggy bank for its
owner than say a similar home in
Missouri. In 2006, the market value of
the median single family home in Oahu
(which is BOH’s biggest market) was
$644,000. By the end of 2008, BOH’s average home equity loan would have been
backed by a FICO score of about 770 (which is quite good) and a loan to value rao
of about 70% (which is adequate though not excellent). The potenal for Hawaiians
to comfortably borrow anywhere from half to two-thirds of the value of a home
that is worth more than $600,000 means that Hawaiians would oen be tempted
to tap into something like $300,000 to $400,000 of purchasing power. During the
housing boom, prices were rising prey quick in most parts of the country. A 10%
increase in the value of a Hawaiian home could provide an addional borrowing
opportunity of more than $30,000 quite easily. This is what makes home equity
loans a lot more tempng when you live in a $650,000 home than when you live in
a $250,000 home. The higher the value of your home relave to the amount of
your annual income – the higher the addional borrowing potenal in a rising
housing market will be versus what you are accustomed to spending each year. This
is probably the explanaon for BOH’s problems in home equity during the crisis.
They weren’t unusual. Everyone had problems in this area.
BOH’s loan losses for the crisis were 0.24% in 2007, 0.43% in 2008, 1.43% in 2009,
0.94% in 2010, and then 0.40% in 2011. Commercial and industrial had a bad 2009-
2010. Losses in that area were 2.74% in 2009 and 2.49% in 2010. These basically
coincide – with the typical lag in loan losses to actual adverse events – with the
recession itself. BOH’s losses were exacerbated by airline loans. It also had some
construcon loan charge-os in 2009 that looked real bad – but most of those
charge-os were actually reversed in 2010 and BOH had no net losses in this area in
2011. So, the actual period 2009-2011 turned out – in retrospect – to not have
been that bad in BOH’s construcon lending. This wasn’t obvious to the bank’s
management in 2009 though. BOH charged o nearly 7% of its construcon loan
porolio in that one year. BOH’s construcon loans were never more than 4% of
the bank’s porolio. So loan losses – no maer how large – in construcon could
never threaten the bank’s overall health. The two key lending areas for BOH are
residenal mortgage and commercial and industrial lending in Hawaii. Most other
categories are too small to be relevant. And no other state is remotely relevant to
BOH’s performance.
I’ve spent almost all of this secon discussing the possibility of loan losses because
there are no other risks to BOH’s durability. The company’s securies porolio is
high quality and liquid. And the bank’s funding sources are scky, low-cost – and
frankly, among the best deposit bases in the country. BOH funds 83% of its earning
SINGULAR DILIGENCE 4
The same four banks have held more than 90% of all deposits in Hawaii
in each of the last 22 years.
assets (that’s loans plus securies) with
core deposits. The vast majority of
BOH’s $13.5 billion in total deposits
come from scky customer deposits
like savings accounts ($5.2 billion), non-
interest bearing checking ($4.3 billion),
and interest-bearing checking ($2.8
billion). Basically, checking accounts
provide $7.1 billion and savings
accounts provide $5.2 billion. That’s
$12.3 billion in what are really bank
customer (either household or
business) funds. These are scky. They
aren’t like me deposits (CDs) or
borrowings from other nancial
instuons. Total earning assets are
$14.8 billion. So, only $2.5 billion of
that is in the form of any kind of money
– CDs and other borrowings – that
could disappear during a nancial crisis.
Bank customers aren’t going to
abandon their bank even in a 2007-
2008 type situaon. BOH’s security
porolio is also liquid. About 67% of
securies mature within ve years and
97% of the porolio matures within 10
years. The annual cash ow coming o
this porolio is $1.4 billion. BOH
doesn’t need to access the market to
get more than $100 million a month
turning to cash from this porolio. The
bank is very liquid. Its deposit base is
excellent. So, the only potenal
problem is bad lending in the form of
self-inicted wounds. BOH’s own
history is a good example of what can
go wrong. The bank got itself into
trouble by 2000, despite having a
deposit base and compeve posion
in Hawaii that was very similar to what
it is today. All BOH changed from 2000
to today is its lending pracces and its
diversicaon outside of Hawaii.
Improving lending standards and
focusing completely on Hawaii is really
all it took to change a bank that was
perceived to be low quality in 2000 to
one that is perceived to be especially
high quality today.
MOAT
Except When They Make Bad Loans, All Hawaiian Banks Generate Above
Average Returns
Bank of Hawaii has a wide moat. An oligopoly of four banks – First Hawaiian, Bank
of Hawaii, American Savings Bank, and Central Pacic – control 90% of the
Hawaiian market for banking deposits. These same four banks have held between
90% and 92% of total deposits in every year for the last 22 years. So, this is a stable
monopoly. Bank of Hawaii is the second largest bank in Hawaii. However, it has the
strongest compeve posion by several measures. As menoned earlier, bank of
Hawaii funds about 83% of its earning assets with customer deposits. Most of these
deposits are scky transacon accounts. They are relaonship based accounts that
aren’t sensive to interest. About 50% of deposits are from households, 40% are
from businesses, and 10% are from governments and other instuons. More than
50% of Hawaiian households have an account with Bank of Hawaii. And almost 65%
of Hawaiian household use some sort of Bank of Hawaii product – deposit,
investment, or borrowing of some sort. Meanwhile, Bank of Hawaii’s penetraon
rate among Hawaiian businesses is even higher. More than 70% of Hawaii’s large
businesses have a banking relaonship with Bank of Hawaii. These relaonships
tend to be scky. Banks generally have retenon rates in the 80% to 90% range for
deposits. In other words, if a bank wins 100 new household depositors in 2016, it
will sll have about y of those accounts with the bank in 2021 at even a bank
that is only so-so in terms of customer retenon. At banks that are excellent at
customer retenon – like Frost in Texas – winning 100 new household depositors in
2016 will result in the bank sll having more than 50 of these accounts in 2026. It’s
not unusual for a depositor to stay with the same bank for between 5 and 10 years.
These are long-term relaonships. And compeon in Hawaii is lower than it is on
the mainland. Bank of Hawaii faces only 3 real competors. No mainland bank
competes in Hawaii anymore. Bank of America made an acquision to enter the
Hawaiian market several years ago. However, BofA failed to successfully integrate
the acquision and it closed the business down enrely within 5 years of making
the acquision. There are 3 banks – First Hawaiian, American Savings, and Central
Pacic – headquartered in Hawaii that compete with Bank of Hawaii. There are also
many credit unions. However, all 100 or so credit unions taken together have less
than 8% market share. So, they aren’t relevant to the compeve situaon.
Despite being the second largest bank in Hawaii – Bank of Hawaii has the best
compeve posion in the Hawaiian retail banking market. Bank of Hawaii has the
lowest cost of deposits of any Hawaiian bank. This is because the bank has more
basic checking and savings accounts that are used for working capital purposes for
households and businesses. These types of accounts tend to be scky. And the
customer is not usually focused on how much interest the account pays. In fact,
Bank of Hawaii tries to focus on service rather than interest rates. In general, BOH
pays the lowest rate of interest on each type of account versus its compeon.
However, BOH is the most convenient bank. BOH has the most branches and ATMs
in Hawaii. It is the ATM leader by far. BOH has 70 branches and 456 ATMs. The next
two biggest banks in Hawaii – First Hawaiian (the biggest by assets) and American
Savings have 300 ATMs and 130 ATMs respecvely. So, Bank of Hawaii has more
ATMs than its two largest competors combined. Bank of Hawaii has more ATMs
because it has exclusive relaonships with McDonalds, Costco, Safeway, and CVS
on Hawaii. Bank of Hawaii is the number one or number two bank almost
everywhere in the state. For example, there are 45 zip codes in the state of Hawaii.
In 82% of those zip codes, BOH is either the number one or number two in terms of
deposit share. Bank of Hawaii is also the largest bank in the state in terms of core
deposits. Quan and I consider the cost of core deposits – and especially household
SINGULAR DILIGENCE 5
and business checking and savings
accounts – to be the key determinant
of a bank’s funding advantage and
therefore its earning power relave to
the industry. BOH has 12% more core
deposits than First Hawaiian. It has 50%
more core deposits than the #3
(American Savings) and #4 (Central
Pacic) Hawaiian Banks combined. For
the years 2002 through 2015, we have
direct funding cost comparisons for
Bank of Hawaii, American Savings Bank,
and Central Pacic. Bank of Hawaii has
a forty basis point (0.40%) funding
advantage over Central Pacic and a
thirty-four basis point (0.34%) funding
advantage over American Savings Bank.
Even more remarkable, Bank of Hawaii
had a 0.21% lower cost of funding than
Wells Fargo from 2002 through 2015.
Wells Fargo is one of the lowest cost of
funding banks in all the United States.
These may sound like small advantages,
but if Bank of Hawaii has a 0.5%
funding cost advantage over the
average bank with more than $10
billion in assets and it leverages its
deposits 10 to 1 relave to
shareholder’s equity (as many banks
do) that is a 5% dierence in pre-tax
return on equity. Even aer taxes, that
is the dierence between a bank that
returns say 10% a year and a bank that
returns 13% a year. It’s a big dierence
caused by nothing other than a funding
cost dierence. And the numbers I just
gave you could vastly understate BOH’s
advantage in normal mes. The period
2002-2015 included many years (2008-
2015) with near zero rates. In 2007,
BOH’s funding cost advantage was
0.34% over American Savings, 0.65%
over Central Pacic, 1.06% over Wells
Fargo, and 1.39% over all banks with
more than $10 billion in assets.
BOH’s operang cost advantage is even
beer. This isn’t surprising. BOH is in
the best market – Hawaii – for
generang high amounts of deposits
per branch. And then BOH has the best
deposit base among the 4 banks that
make up Hawaii’s banking oligopoly. As
a result, BOH’s average deposits per
branch are $185 million. This is among
the highest total for any bank
anywhere in the U.S. It is probably more than 3 mes the amount a normal bank in
a normal part of the country would have. First Hawaiian has a terric operang cost
posion. In fact, First Hawaiian’s non-interest expenses relave to deposits are
oen lower than BOH’s. But American Savings and Central Pacic each have about
double the level of expenses per deposit that bank of Hawaii does. Overall, BOH
has averaged a 1% rao of net non-interest expenses to earning assets from 2005-
2015. During this same me period, most regional banks in the country had
operang expense levels in the 1.6% to 3.3% range. So, BOH has a sixty basis point
(0.6%) operang cost advantage over even some of the best run regional banks on
the mainland. Again, consider what leverage does. A rao of 10 deposit dollars for
1 equity dollar turns a 0.6% operang cost advantage into a 6% pre-tax return on
equity advantage. This would lead to more than a 4% advantage in aer-tax return
on equity. Coupled with BOH’s funding cost advantage, we are talking about a bank
that can easily earn a 17% return on equity in a year during which the average very
well run mainland regional bank earns just a 10% return on equity. BOH’s moat is
near perfect. There are no major mainland competors for Hawaiian deposits. The
last real incursion was Bank of America’s acquision of HonFed in the early 1990s.
Five years later, BofA exited the Hawaiian market. There is essenally no growth in
the Hawaiian banking industry. In fact, not only have there been no new
competors. There have also been no net new branches added by exisng
competors. Hawaii had 305 bank branches in 2000, in 2005 it was down to 285
branches, in 2010 the total was 284 branches, and today the state has just 279
branches. So, there is no threat of entry by new companies and no threat of
branches being added by exisng banks. Bank of Hawaii has perhaps the widest
moat of any U.S. bank. That is the good news. The bad news is that BOH’s
penetraon rate in the state of Hawaii is so high that it is now almost impossible for
BOH to add new customers. No Hawaiian bank has taken much market share from
its competors over the last 20-25 years. So, BOH’s moat is nearly perfect while its
opportunity for customer growth is nearly zero.
SINGULAR DILIGENCE 6
The four big Hawaiian banks often generate pre-tax returns on assets of
2% to 4% a year.
QUALITY
When Interest Rates are Normal,
Bank of Hawaii Can Generate
Returns of Equity Between 15% and
30%
Bank of Hawaii is a high-quality bank.
However, it is interest rate sensive.
With the Fed Funds Rate near zero,
Bank of Hawaii is now earning less than
it would earn in normal mes. For
example, Bank of Hawaii’s pre-tax
return on earning assets fell from 3.1%
in 2005 to just 1.7% last year. From
2004 through 2008, BOH’s pre-tax
return on assets ranged from 2.8% to
3.1%. In the 7 years since the Fed
slashed rates (2009-2015), BOH’s pre-
tax return on assets ranged from 1.7%
to 2.2%. Which is the beer gauge of
BOH’s normal earning power? Is it the
2004-2008 period where BOH
generated pre-tax return on assets of
about 3%? Or is it the 2009-2015
period during which BOH generated a
pre-tax returns on assets of about 2%
or less? Quan and I think that while the
truth may be something in between –
the 2004 to 2008 period is a much
beer approximaon of “normal” than
the 2009 to 2015 period. Why?
Let’s look at the net interest margin.
Net interest margin is the yield on a
bank’s earning assets – loans and
securies – less the interest cost of
funding those assets. So, if a bank pays
you 1% to get $100,000 of deposits
from you and then it turns around and
lends those $100,000 of deposits to a
local business at a rate of 4% a year –
the net interest margin would be 3%.
Historically, banks have made money
because they have a lower relave cost
of funding than any other
organizaons. Banks don’t need to
make loans at higher rates than other
rms do. Nor do they have to get beer
returns on their bonds than pension
funds, insurance companies, etc. make
on those investments. All banks have to
do is have a lower cost of funding than
the holders of the same assets – loans
and bonds – that they choose to own. If
we look at the U.S. banking industry
overall – it has had a net interest
margin of about 3.6% from 1996 through 2014. This is the interest margin only. It’s
not the economic margin. This is an important disncon. Because net interest
margin tends to be incredibly stable – but operang cost isn’t so stable. This means
that a bank with really low operang costs – non-interest expense less non-interest
income as a percent of total earning assets – will be squeezed during a period of
low interest rates. In fact, the best banks in the country might be at their relave
worst during a period of near zero interest costs. Bank of Hawaii is one of the best
banks in the country. But that is less obvious today – when interest rates are near
zero – than it was in the 2004-2008 period and then it will be again a few years
aer the Fed raises rates.
BOH’s net yield is mediocre. Net yield is the interest a loan pays less the charge-os
associated with those loans. So, one bank can have a higher net yield than another
bank if it has some combinaon of charging more on its loans or taking lower losses
on those loans. BOH doesn’t charge a lot for its loans. From 2002 through 2015,
BOH had a 0.53% lower gross yield than Central Pacic (the Hawaiian bank that
went under during the crisis) and 0.28% lower gross yield than American Savings
Bank. However, BOH’s net yield was somewhere between American Savings Bank
and Central Pacic. Overall, BOH has been a beer lender than Central Pacic –
which was a terrible lender that caused its own demise – and a worse lender than
American Savings Bank. American Savings Bank is quite a good lender. BOH has no
advantages as a lender over American Savings Bank. All of BOH’s advantages come
from its deposit gathering rather than from its lending.
Bank of Hawaii’s interest bearing demand deposits – so, basically household and
business checking accounts that pay interest – are very low cost sources of funding.
From 2003-2008 the rates BOH paid ranged from 0.21% to 1.01%. In general, BOH
paid rates that were 0.2 mes the Fed Funds Rate. In other words, when the Fed
Funds Rate was 1%, BOH tended to pay these depositors 0.2%. And then when the
Fed Funds Rate was 5%, BOH tended to pay these depositors 1%. Obviously, these
checking customers cared very lile about the amount of interest BOH was paying.
Other banks in the country paid more than BOH for deposits. Customers could have
moved to other banks or put their money in CDs if their goal was simply to get the
most interest on their money. This isn’t the main objecve for most BOH
customers. The customers are obviously more concerned about things like
convenient access to their money in Hawaii. Savings rates at BOH pay a higher rate
relave to the Fed Fund Rates. BOH pays about 0.5 mes the Fed Funds rate on its
savings account. This is in line with U.S. Bancorp (0.4 mes Fed Funds) and Wells
Fargo (0.54 mes Fed Funds). Finally, BOH has some me deposits (CDs) and other
SINGULAR DILIGENCE 7
Over the last 11 years, Bank of Hawaii’s pre-tax return on earning assets
has ranged from 1.7% to 3.1%.
borrowings. These generally cost a
bank about 110% of the Fed Funds
Rate. They are a very bad form of
funding. No bank can be high quality
while funding itself using a lot of me
deposits and other borrowings. BOH
uses relavely lile funding from such
sources. Overall, BOH’s weighted cost
of funding is about 0.4 mes the Fed
Funds Rate. In other words, when the
Fed Funds Rate is at 1%, BOH is paying
0.4% for its funding. When the Fed
Funds Rate is 2%, BOH is paying 0.8%.
At 3% Fed Funds, BOH would be paying
1.2%. At 4% Fed Funds, BOH would be
paying 1.6% for its funds. And at a 5%
Fed Funds, BOH would be paying 2%.
Quan and I probably consider a
“normal” Fed Funds Rate to be about
3% plus or minus 2%. In other words, a
“normal” interest rate cycle might have
a 1% Fed Funds Rate at the boom of
the bust and a 5% rate at the top of the
boom. Obviously, the Fed Funds Rate
has been lower than 1% at mes and
much, much higher than 5% at other
mes. But, when you’re looking at a
bank it makes sense to think about the
Fed Funds being maybe 2%, 3%, or 4%.
Not 0% or 6%. Not normally. We are
talking in absolute terms here. We can
switch to relave terms if that’s easier
to imagine. So, instead of saying the
Fed Funds would normally be 3% and
BOH’s cost of funding would normally
be 1.2% – we can simply ask how big
BOH’s funding cost advantage is over
other banks. That’s easy to answer.
BOH tends to have a 0.9% lower cost of
funding than other banks. When you
leverage this up at 10 mes deposits
per dollar of shareholder’s equity – you
get a 9% higher return on equity at
BOH than at other banks. This is from
funding costs alone. It does not
consider dierence in lending or in
operang costs. BOH is a mediocre
lender. It is an extraordinarily good
operator. BOH gets a full 1% relave
cost advantage over other banks in the
form of non-interest costs. Over the
last 10 years, BOH has had a 1% net
non-interest expense rao. First
Hawaiian has had a 0.91% non-interest
cost. Actually, if you look at BOH and
First Hawaiian as top er competors in Hawaii and American Savings and Central
Pacic as boom er competors – you see a paern. Together, BOH and FHB have
68% market share and 0.9% to 1% operang costs. American Savings and Central
Pacic combine for 24% market share and have 2% to 2.25% operang costs. The
biggest banks in Hawaii benet from economies of scale. Economies of scale – at
both the branch level and the corporate level – are very important in having a low
operang cost. BOH’s economies of scale at the branch level are among the very,
very best in the country. Bank of Hawaii has $185 million in deposits per branch.
The average bank on the U.S. mainland is happy to have even $60 million in
deposits per branch. In other words, BOH has 3 mes more deposits per branch
than most banks do. Most of BOH’s tremendous earning potenal comes from this
simple fact.
BOH’s actual return on equity depends on how much deposits it has relave to
equity. Deposits are relavely xed – customers decide how much to leave with
BOH. What BOH can change is the amount of equity it allows to build up without
paying out dividends to shareholders or buying back stock. BOH is not especially
conservave in this regard. Generally, BOH has used a 7% tangible equity rao. This
is equivalent to having 14 dollars in deposits – that is, $14 of customer money – for
every 1 dollar of owner money. As a result, BOH has tended to earn between 23%
and 42% in pre-tax return on equity. This translates into about a 14% to 28% aer-
tax return on equity. I think that’s a reasonable ROE to expect in the future. So, you
can assume BOH will earn about a 20% aer-tax ROE. It can do this even when the
average bank in the U.S. earns much closer to a 10% return on equity. BOH is the
best bank in Hawaii. Hawaii is the best banking market in the U.S. And the U.S. is
probably the best – or very, very close to the best – banking market in the world.
So, BOH is among the very best banks in the world. This is only in terms of
protability. BOH can easily earn a 20% ROE year aer year. It can’t easily grow.
CAPITAL ALLOCATION
Bank of Hawaii Buys Back its Own Stock and Pays a Dividend
Bank of Hawaii has a very high return on equity combined with very lile potenal
for growth. As a result, the bank chooses to pay out almost all of its earnings in
stock buybacks and dividends. From 2006 through 2015, BOH paid out 88 cents of
each dollar it earned in either share buybacks or dividends. BOH does have some
share diluon that these buybacks need to overcome. Gross diluon is about 1.1%
a year. However, net diluon – which includes the eect of share buybacks funded
through the use of proceeds from the exercise of stock opons – is more like 0.5% a
year. So, BOH’s buybacks start from a posion of needing to oset 0.5% in diluon
each year. The bank does this easily. So, it has been buying back more than 0.5% of
its shares each year for a long me. The result is a constantly declining share count.
As a result, EPS grows faster than net income. BOH has an execuve compensaon
plan that is mostly based on three metrics: 1) Return on equity, 2) Stock price-to-
book rao, and 3) The bank’s Tier 1 Capital Rao. Tier 1 Capital is basically a
leverage rao. It isn’t much dierent from using tangible shareholder’s equity as a
percent of total assets. If you think about what drives return on equity, the stock’s
price to book rao, and the er 1 capital rao – it’s really all return on assets.
Return on equity is simple to understand. Price to book for a stock tends to be
higher the higher that stock’s return on equity is. This is because the P/E rao is
oen more stable than the P/B rao. Highly leveraged and troubled stocks may
have lower P/B raos than stocks with lile leverage. And then nally you have the
er 1 capital rao. That is a measure where the higher equity is relave to assets –
the beer the measure will be. Taken together, the one driver that really improves
all 3 of these measures is having the highest possible ROA. So, I’m not sure how
dierent BOH’s compensaon plan would be if it simply used a pure ROA target.
SINGULAR DILIGENCE 8
Now, in reality, BOH’s management
may not run the bank purely to target
the highest possible compensaon for
themselves. They may not be that
raonal about their own interests. They
may rely more on rules. For example,
BOH tends to always have a rao of
about 7 cents of tangible equity for
every 1 dollar of total assets. This
seems like following a rule. And it
makes sense to do that because the
compensaon plan is somewhat
contradictory in this regard. It includes
higher Tier 1 capital as a good thing but
then it includes – at twice the weight –
a return on equity measure. ROE
benets from higher leverage. Tier 1
benets from lower leverage. But, the
compensaon plan weights ROE more
highly than Tier 1 capital. As a result,
the plan encourages rather than
discourages leverage. Yet, BOH keeps a
fairly normal rao of 7% tangible equity
to assets. In fact, I’d say 7% is the
normal rao for a regional bank like
BOH. Let’s take a second to compare
BOH’s capital levels to that of other
banks. BOH keeps its tangible equity
levels extraordinarily stable. That is
why I say that it seems the
management is just following a rule by
rote here. From 2005 to 2015, tangible
equity ranged from just 6.46% to 7.48%
of assets. The coecient of variaon
was 0.04. That’s unbelievable low
variaon in a variable you aren’t
targeng for complete stability. You
should accidentally have more wobble
in your capital levels than that. So, I
think BOH just asks itself how much
cash it has beyond the amount needed
to keep a 7% tangible equity rao at
the end of the year and then it just
earmarks the rest for dividends and
buybacks. What kind of levels do other
banks keep? Frost had a tangible equity
rao of roughly 7% from 2002-2007.
That was pre-crisis. Frost and BOH are
very, very similar in terms of funding.
They both have incredibly high deposits
per branch, very low interest costs, and
very stable pools of customer deposits.
In theory, these banks could have some
of the lowest tangible equity raos and
sll be safe as long as they used those
deposits to buy safe, short-term
securies. The liability side of their balance sheet is perfect. The risk is just on the
asset side. Prosperity – another bank in Texas – is more aggressive. It targets a
tangible equity rao between 4.5% and 7%. This is because Prosperity acquires
other banks. A 7% tangible equity rao will oen result in a Tier 1 Capital Level of
between 10% and 15%. This isn’t guaranteed. But, as a general rule, if you’re
comparing Tier 1 Capital Levels (which banks somemes menon) to the measure
Quan and I use instead (tangible equity to total assets) a 7% tangible equity rao is
like a 10% to 15% Tier 1 Capital Rao.
BOH has no capital allocaon risk related to acquisions – because it just doesn’t
make any acquisions. There aren’t any acquision targets in Hawaii. Mainland
acquisions would be a mistake. There are really only 3 other banks BOH could
acquire in a synergisc way. And there would be regulatory concerns with any of
the big 4 Hawaiian banks – which control 90% or more of the state’s banking
industry – from merging with each other.
Before the 2007 nancial crisis, BOH returned essenally 100% of earnings. Its rule
was a 40% dividend payout rao and then it would dedicate about 50% of earnings
to share buybacks. BOH really doesn’t need more than 10% of its earnings from the
year to support what lile incremental growth in deposits it experiences each year.
There is some evidence that BOH’s capital allocaon in recent years is a response to
the crisis. In other words, when Quan and I say that BOH returns like 85% or more
of its earnings each year – we’re perhaps underesmang the future situaon. BOH
used to always return 90% to a lile over 100% of earnings each year. Most banks
de-leveraged since the crisis.
One huge dierence between BOH and other banks is how much of its own stock it
buys back each year. From 2000 through 2015, BOH bought back 46% of its shares
outstanding. This is a 4% annual decline in share count. The bank can connue this
indenitely. It doesn’t me share buybacks. So, what is happening here is just that
half of all earnings are being used to buy back stock. So, assume BOH has a 40%
dividend payout rate and a 90% to 100% earnings payout rao. That means the
bank will tend to use 50% to 60% of its earnings to buy back stock each year. There
is that 0.5% drag in employee stock opons I menoned at the start of this secon.
So, the only other queson is what BOH’s P/E rao is. Let’s say the P/E rao is 15.
That’s about a 6.67% earnings yield. Let’s say half of EPS is used to buy back stock.
That’s 6.67% less drag of 0.5% equals 6.17%. Half of that translates into a 3.08% net
share reducon per year. Mathemacally, the impact on EPS growth is always
slightly greater than the rate of reducon in the shares. For example, a 1% share
reducon causes a 1.1% EPS boost (1/0.99 = 1.011 not 1.01). So, let’s just pretend a
P/E of 15 is normal for BOH and that a constant share reducon rate of around 3%
a year will cause about a 3% a year growth in EPS beyond net income. This is a bit
SINGULAR DILIGENCE 9
Over the last 16 years, Bank of Hawaii bought back 46% of its shares
outstanding.
conservave. But, it’s a reasonable
approximaon. Your return in the stock
will then be Net Income Growth +
Dividend Yield + 3%. As I write this, the
dividend yield on the stock is 2.7%. A
3% annual EPS boost from stock
buybacks from now ll forever is
reasonable. So, 2.7% + 3% equals a
5.7% return from dividends and
buybacks. So, to decide whether or not
you should buy BOH stock you would
just take your own personal hurdle rate
– what you want to get from a buy and
hold forever stock – and then subtract
5.7% and ask yourself whether BOH can
grow net income by that amount.
So, assume your hurdle rate is 8% a
year. You take 8% minus 5.7% and you
get 2.3%. Can BOH grow companywide
net income by at least 2.3% a year
forever? Yes. What if your hurdle rate
is 10% a year? You take 10% minus
5.7% and you get 4.3%. Can BOH grow
companywide net income by 4.3% a
year? This queson is easy to model.
BOH is part of a stable oligopoly.
Financial services doesn’t really shrink
as a percent of GDP. So, the queson is
whether Hawaii will have nominal GDP
growth – that’s producvity growth
plus populaon growth plus inaon –
of 4.3% a year? That sounds
reasonable. Growth of less than 3% a
year is unreasonable. Growth of more
than 6% a year is also probably
unreasonable. Growth in the 4% to 5%
a year range seems achievable even if
BOH doesn’t benet from any
economies of scale that cause net
income to grow faster than earnings.
So, if you have a hurdle rate in the 10%
to 11% a year range for a buy and hold
investment – BOH is right on that
hurdle rate. This does not address the
issue of the Fed Funds Rate. This is the
investment poron of the decision
only. There’s also a speculave
component. You might have a big one-
me gain if the Fed Funds Rate goes
from less than 1% to something more
like 3%. BOH is interest rate sensive.
We’ll discuss this more in the value
secon of the issue. But, for now – just
know that even without the benet of
a higher Fed Funds Rate, it is
reasonable to buy BOH if you want a roughly 10% a year return out of a buy and
hold forever investment. That’s about what BOH is priced to return.
VALUE
Bank of Hawaii is Fairly Priced Based on Current Earnings and Cheap Based
on Normal Earnings
Bank of Hawaii is trading at between 7 and 8 mes our esmate of normal pre-tax
earnings. However, it is trading at about 12 mes last year’s pre-tax earnings. Why
is the dierence so big? Because of the Fed Funds Rate. For example, last year –
BOH had a yield of 4% on its loans. But at a 3% Fed Funds Rate, the yield on the
loan porolio would be about 6%. Likewise, the yield on BOH’s securies porolio
would be about 4% in normal mes. It was 2.2% last year. So, it is the yield side of
the earnings picture that changes depending on the Fed Funds Rate.
There is another way to think about normal earnings. We can pick a dierent
period in me and ask how much Bank of Hawaii actually earned in those years. For
example, we know that BOH earned a 3% pre-tax return on assets (so 2% aer-tax)
during the boom years of 2004 through 2007. This 3% return was prey stable. It
was 3% exactly in 2004, 3.06% in 2005, 3.03% in 2006, and then 2.94% in 2007.
Those were the boom years though. Quan and I have assumed BOH will earn just a
2.6% pre-tax return on its earning assets in normal mes. That is a lile under $400
million in pre-tax prots. At today’s price, that works out to a stock price of about
12 mes today’s pre-tax earnings but only about 7 mes our esmate of normal
pre-tax earnings.
How is BOH priced versus peers? It is more expensive than Frost – one of the two
biggest banks in Texas. BOH also has worse growth prospects than Frost – mainly
because Hawaii has worse growth prospects than Texas. So, if you have to choose
between buying BOH or buying Frost – buy Frost. Frost is priced at about 10 mes
last year’s pre-tax prot but less than 7 mes our esmate of normal pre-tax
earnings. It’s a lile cheaper than BOH. And Frost has much, much beer growth
prospects. BOK Financial is another stock Quan and I wrote about. It is the leading
bank in Oklahoma. It also has a big presence in Texas. BOK has much beer growth
prospects than Bank of Hawaii – because unlike Bank of Hawaii, BOK is a big
acquirer. It likes to start new businesses and to enter new states. It has oen been
successful doing this. The culture at BOK Is very dierent from the culture at BOH.
And, as a result, BOK has grown deposits by 11% a year over the last 22 years, 10%
a year over the last 15 years, and 8% a year over the last 10 years. This makes BOK
a growth stock even though it is mostly in the rather slow growing – compared to
Texas – state of Oklahoma. BOK is a big energy lender. It has 19% of its loans in the
energy category. And energy loans account for 11% of total earning assets.
Obviously, there was an oil price crash recently. So, this is a concern for some
investors. Quan and I aren’t very concerned. Even if BOK wrote o half of its energy
loans – and over the previous 20 years, it wrote o something ny like 0.2% a year
or less of all loans in this category – it would only destroy about 5% of total earning
assets. That would destroy the bank’s earnings for a me. But it wouldn’t cause the
bank to fail. BOK is prey cheap. It trades for about 5 mes normal pre-tax earnings
and about 9 mes last year’s pre-tax earnings. So, BOK is a smidge cheaper than
either BOH or Frost. However, BOK is riskier. It makes more energy loans. And its
growth potenal comes from entering new product lines and making acquisions.
Commerce is a Missouri based bank. Missouri is a slow growing state. It is
comparable to Hawaii in that way. This makes Commerce a good peer for BOH and
a bad peer for Frost. Commerce’s deposit growth was just 5% a year over the last
23 years. The bank is high quality. It’s also cheap. Commerce shares are priced at
SINGULAR DILIGENCE 10
about 11 mes last year’s pre-tax prot
and only about 7 mes normal pre-tax
prot. These are all good, cheap banks
we are talking about. I think Commerce
is probably the best direct comparison
to BOH. Quan probably likes Commerce
a lile more than BOH. I probably like
BOH a bit beer than Commerce. They
are priced similarly. And they have
similar growth prospects.
UMB is another Missouri based bank. It
gets most of its deposits from Kansas
City. Kansas City is also a really big
market for Commerce. UMB grew
deposits by 6% a year over the last 25
years. Again, this is prey slow growth
for a bank. It means UMB grows at only
about the rate of nominal GDP growth.
To be fair, Missouri’s nominal GDP
might have lagged U.S. GDP by a lile
bit – so UMB certainly kept pace with
the economy of Missouri. It didn’t
shrink relave to the market it operates
in. But, UMB is not a growth stock.
Central Pacic is the most obvious peer
for BOH. Central Pacic is a publicly
traded bank stock under the cker
“CPF”. It’s the fourth largest bank in
Hawaii with 11% deposit share (so BOH
is almost 3 mes the size of CPF). Like I
said, CPF is an obvious peer. But it’s not
actually a good peer. CPF went belly up
during the nancial crisis. It
parcipated in TARP. That parcipaon
required it to grant the government 10-
year warrants to purchase a ton of
shares at less than $13 a share despite
CPF stock starng that same year
(2007) at around $40 a share. CPF
raised even more funds in a 2011
private placement. The simple way of
looking at what Quan and I classify as
CPF’s ‘going belly up’ despite the bank
never being seized by the FDIC is that
its share price declined by more than
95% from the start of 2007. Losing 95%
of your shareholder’s wealth is basically
the same thing as failing. So, CPF prey
much failed during the crisis. The stock
is quite cheap on a price to earning
assets value. That’s an important
number. And Quan and I use it a lot
when comparing one bank to itself. It’s
a lile trickier when comparing BOH to
CPF – because BOH can always earn a
lot more on each dollar of deposits than CPF can. For example, Quan and I use 1.8%
as the normal pre-tax return on earning assets for CPF and 2.6% a year for the
normal pre-tax return on assets for BOH. This means that CPF is actually priced
higher than BOH in terms of normal earnings. So, CPF is more expensive than BOH
despite being a lower quality business. CPF has an inferior compeve posion.
Frost is a beer bank than BOH. It has a lower funding cost and a slightly higher
(1.4% versus 1.1%) operang cost than BOH. But, Frost has much greater growth.
Historically, deposit growth at Frost has been in the 9% to 10% range while deposit
growth at BOH was in the 3% to 4% range. This is a huge dierence. It’s an
especially huge dierence in valuaon for these two banks because of how high
their ROE is. Growth is very, very valuable for shareholders at both BOH and Frost
because it requires so lile retenon of earnings. BOK is a good bank. But it has
risks BOH doesn’t. So, we’ll set it aside as a possible higher risk. Frost is clearly
superior to BOH. CPF is an inferior peer. Yes, CPF is another Hawaiian bank. But, it’s
a much worse bank. That leaves the two Missouri banks – UMB and Commerce – as
the best peers for BOH. Commerce and BOH have similar growth prospects and
similar returns on earning assets. Quan thinks Commerce deserves a slightly higher
valuaon than BOH. I think BOH deserves a slightly higher valuaon than
Commerce. Let’s split the dierence and say BOH and Commerce should be priced
exactly the same.
What’s the right price? Banks are higher return businesses than rms in other
industries. There’s really no reason for a bank with the kind of ROE that BOH has to
be priced below an average stock. Historically, an average stock in the U.S. was
priced at 15 mes aer-tax earnings. BOH can grow between 3% and 4% a year. It
can return at least 80% of its earnings in dividends. At a normal type P/E of around
15, BOH would have a dividend yield plus stock buyback rate of at least 5% a year.
It would also grow at least 3% a year organically. So, that’s a return of at least 8% a
year. This gure could rise to closer to 10% a year depending on the exact
esmates you make. But, 8% a year is an adequate return for a fairly valued stock.
So, 15 mes normal earnings is a good appraisal level to pick for BOH. Quan and I
think the bank’s earning power is around $400 million in normal mes. Fieen
mes aer-tax earnings is the same thing as ten mes pre-tax earnings. So, a pre-
tax earning power of about $400 million a year deserves an enterprise value of
about $4 billion for the company. Right now, the company’s market cap is around
$3 billion. So, BOH is trading at about 75% of what it should be worth in a normal
interest rate environment.
SINGULAR DILIGENCE 11
Bank of Hawaii trades for 18 times today’s after-tax profits and 10-12
times normal after-tax profits.
could be some slight economies of scale at Bank of Hawaii. So, net income growth
could be a bit higher than deposit growth. In fact, that has almost always been the
very long-term trend for big banks in the U.S. This is mainly due to increased fee
income and economies of scale at the branch level. The greater the amount of
deposits per branch, the lower the bank’s operang cost per deposit. In fact, Hawaii
has fewer branches today than it did in the past. And Bank of Hawaii has said its
branches are too big. The average branch is 4,200 square feet. Management
believes branches of just 3,000 square feet are ideal. Having more ATMs and higher
use of ATMs, mobile banking, etc. by customers can help reduce the need for
square footage and employees at the branch level. These are the two big expenses
for a bank. How many deposits do you have per square foot? How many deposits
do you have per branch employee? The more the beer. I think there are some
long-term economies of scale in this area for Bank of Hawaii specically and for the
banking industry generally. So, I don’t think net income will grow any slower than
deposits – and I think it might grow faster. For that reason, I don’t think it makes
sense to assume net income growth of any less than 4% a year at Bank of Hawaii.
Let’s look at what that means for the value of this stock. Bank of Hawaii can make a
25% aer-tax ROE in a normal year. It can even make a 15% ROE in a bad year.
Quan and I think the bank can pay out somewhere between 80% and 85% of all
earnings through a combinaon of dividends and share buybacks. Employee
compensaon in the form of stock opons creates a 0.5% a year drag on the stock.
Actual stock opons are higher than this. However, proceeds from the exercise of
opons can – and are – put back into buying the stock. So, only the net impact
maers. The net result is a 0.5% annual drag on the stock. So, what will your total
return in BOH stock be? We start from a 0.5% a year annual hole. That is what
would happen if the bank neither increased earnings nor paid stock opons or
dividends. It would shrink 0.5% a year in per share value. But I think net income will
grow 4% a year. So, we go from a 0.5% a year hole to an immediate 3.5% a year
total return. Now, the rest of your total return in Bank of Hawaii depends enrely
on the price mulple you buy the stock at. We can put this in the form of an
equaon if you want. Total return is 3.5% plus 0.8 mes earnings yield. So, 3.5% is
the constant growth rate of the company’s net income growth less stock opons as
a diluve expense. And 0.8 is the constant rate at which BOH uses earnings to pay
dividends and buyback stock. So, what maers is how much you pay per dollar of
normal earnings. Let’s say you buy BOH stock at 15 mes normal aer-tax earnings.
Can we restate that as an earnings yield? Yes. One divided by 15 equals 6.67%. And
then BOH will retain up to 20 cents of each dollar of earnings. So, you only get the
other 80 cents per dollar of EPS paid out in dividends and buybacks. That means
GROWTH
Hawaii is a Slow Growing Economy
Over the last 13 years, Bank of Hawaii
grew its deposits by 5.8% a year. This is
a decent growth rate for a bank.
However, Hawaii is not a fast growth
state. Hawaii’s GDP has grown in line
with U.S. GDP from 1997 through
today. Populaon growth has also been
close to the U.S. naonal average. The
state’s populaon is forecast to grow a
lile over 0.7% a year over the next 25
years. So, assume real GDP growth per
capita of say 0.8% to 1.2% or so –
basically, 1% a year plus or minus a bit
– and inaon of say 2% to 4% a year.
You can have a range of nominal GDP
growth rates for Hawaii starng at
about 3.5% a year (0.7% populaon
growth plus 0.8% real GDP per capita
growth plus 2% inaon). The top end
of the range would be something like
6.9% using these numbers (4% inaon
plus 1.2% real GDP per capita growth
plus 0.7% populaon growth). In other
words, nominal GDP growth is unlikely
to be less than 3% a year or more than
7% a year. Deposit growth can be a
lile higher or a lile lower than
nominal GDP growth depending on
whether nancial services is growing as
a percent of total GDP. This can depend
on things like asset values. If houses
and stocks and bonds are all expensive
– then borrowing capacity can be high
relave to income and the actual
physical output of a place. In other
words, very low interest rates can
mean very high asset prices which can
mean very high indebtedness which
can mean bigger bank balance sheets.
Bank of Hawaii’s compound annual
growth rate in deposits was 4% a year
from 1994 through 2015. I think this is
the best esmate of future growth for
the bank. A conservave esmate
would be 3% a year. It’s very unlikely
deposits will grow less than 3% a year.
BOH has not gained or lost much
market share. It has had market share
of between 31% and 33% of all deposits
in Hawaii in each year of the last 20
years. So, if Hawaii grows deposits by
4% a year – Bank of Hawaii will also
grow deposits by 4% a year. There
SINGULAR DILIGENCE 12
In the past, Bank of Hawaii grew its companywide deposits by 5% to 6%
a year.
6.67% mes 0.8 equals 5.33%. Let’s
round that o to 5.3%. And then add
that to the net income growth less
opons diluon of 3.5% a year. We get
8.8% a year in total return if you buy
BOH at 15 mes normal earnings.
That’s not the stock’s price though.
Fieen mes normal aer-tax earnings
is 10 mes pre-tax earnings. Right now,
BOH is trading at about 7 mes
“normal” pre-tax earnings. Seven mes
pre-tax earnings is about 11 mes aer
-tax earnings. And 11 mes aer-tax
earnings works out to an earnings yield
of 9.09%. So, the equaon now would
look more like 3.5% plus 0.8(9.09%). If
we mulply 9.09% by 0.8 we get 7.27%.
So, add 3.5% to 7.3%, and you get
10.8% a year. That’s a good esmate of
your total return in BOH. But only if the
Fed Funds Rate was already 3% at this
moment. It’s not. So, BOH can’t return
anything like 10.8% a year ll the Fed
Funds Rate is raised to a “normal”
level. Let’s imagine it never is. Instead
BOH stock trades for a P/E of like 18.
One divided by 18 is 5.55%. And 5.55%
mes 0.8 equals 4.44%. So, our
equaon would now be 3.5% plus 4.4%
equals 7.9%. If the Fed never raises
interest rates – you’ll make between
7% and 8% a year in BOH stock. If the
Fed starts raising interest rates
immediately – and/or if you hold BOH
stock virtually forever – then you will
make more like 10% to 11% a year. It’s
hard to imagine a long-term buy and
hold return here of less than 7% a year
no maer how low interest rates are
for how long. And it’s hard to imagine a
long-term buy and hold return of more
than 11% a year no maer how quickly
the Fed raises rates. I think you could –
speculavely, as a trade – make a lot
more than 11% a year on BOH if you
buy it today and hold it through a series
of Fed Funds increases over several
years and then sell at a higher point in
the interest rate cycle. But this is a buy
and hold newsleer. If you buy BOH
stock today, I feel prey sure you’ll
make more than 7% a year and less
than 11% a year if you hold it forever.
Returns in the 8% to 10% a year range
seem most likely. This is a wide moat
stock. It’s in an oligopoly. It is ed to
interest rates in the opposite way of most of the stocks in your porolio (unless you
own a lot of banks and insurers). So, BOH is an excellent diversier. I think it’ll
return 8% to 10% a year. And I think the S&P 500 will denitely not return as much
as 8% to 10% a year if you buy it at today’s price. So, BOH can benet your porolio
by adding higher returns and more diversicaon. If you don’t own Frost – I’d buy
that stock rst. But, I would suggest BOH as a good buy and hold forever stock for
just about any porolio.
MISJUDGMENT
Bank of Hawaii is Not an Especially Conservave Lender
Bank of Hawaii is not the most conservave lender in Hawaii. During the nancial
crisis, there were four major banks in Hawaii. Central Pacic Financial essenally
failed. It lost 95% of its market value as a stock. And it had to take TARP funds from
the government. The other three Hawaiian banks – American Savings, First
Hawaiian, and Bank of Hawaii – all survived without needing bailout money. Of
those three banks, Bank of Hawaii had the highest loan losses during the crisis.
However, it is not like any of the three other banks had losses that came remotely
close to Central Pacic’s losses. Bank of Hawaii’s worst years had charge-os in the
1% to 2% range – which was not especially bad compared to mainland banks – and
Central Pacic had losses of just under 7%. Also, Bank of Hawaii is diversied in
terms of both its lending porolio specically and its earning assets generally. Bank
of Hawaii doesn’t normally have more than 60% of its assets in actual loans. The
other 40% of assets are securies. These are mostly rather short-term bonds.
Almost all of them are high quality bonds that mature within the next 10 years. So,
when Bank of Hawaii has loan losses of say 2% a year that translates into only
something like 1.2% of earning assets (2% mes 0.60 equals 1.2%). Bank of Hawaii
is also diversied in the sense that it’s about half a business bank and half a
household bank. The 2008 and 2009 period was unusual in that both households
and businesses were creang loan losses at the same me. Very oen this is not
the case in a recession. So, you have a housing bubble burst at a dierent me
from losses on commercial and industrial loans. Quan and I don’t think BOH is a
high-risk lender. It used to be when it operated outside of Hawaii. It’s very
dangerous for a bank to spread out over a large geographic area. And it’s very
dangerous for a bank to make loans far from home. Bank of Hawaii is now focused
enrely on Hawaii (and to a very small extent Guam). The bank’s loans are basically
just rather plain vanilla loans made to Hawaiian households and businesses. And
then the securies porolio is unrelated to Hawaii specically.
The worst year for Hawaiian banks was 2009. Bank of Hawaii had charge-os of
1.43% while American Savings charged o just 0.66% of loans and First Hawaiian
charged o 0.61% of loans. So, there is no doubt that both American Savings and
First Hawaiian had far lower loan losses than Bank of Hawaii. I don’t want to
present Bank of Hawaii as an especially conservave bank. It’s not. The bank has
acceptable – but not especially low – levels of leverage (tangible equity is a bit
higher relave to assets than at some banks) and loan charge-os (the bank’s
losses peaked at just 1.43% during the crisis). But American Savings and First
Hawaiian are more conservave lenders. Bank of Hawaii is very, very safe on the
funding side. It doesn’t need access to other people’s money. The bank can be run
using just scky customer deposits from local Hawaiian households and businesses.
Such funding is safe and reliable even in the worst moments of a nancial crisis. So,
Bank of Hawaii is an average bank on the lending side and a very safe bank on the
funding side. Overall, I consider it above average in safety. But, this above average
safety comes purely from the bank’s funding posion and from its focus on Hawaii.
Bank of Hawaii also makes fewer loans than some banks. For example, First
Hawaiian’s loans to earning assets rao was around 63% these last 5 years.
SINGULAR DILIGENCE 13
Meanwhile, Bank of Hawaii has only
had loans of about 50% of total
earnings assets during the years 2010
through 2015. This is probably due to
low loan growth relave to deposit
growth in the Hawaii market. The same
thing has happened on the mainland.
So, unless a bank makes a special eort
to grow loans – it would have a
declining rao of loans to earning
assets for the 2010-2015 period
relave to the 2004-2008 period. That’s
what happened at BOH. Bank of Hawaii
was lending out close to 70% of
available funds in the 2004-2008 boom.
But it has only lent out about 50% of
available funds in the 2010-2015 bust.
First Hawaiian’s loan mix is a lile
dierent from Bank of Hawaii. First
Hawaiian does more lending outside
Hawaii. It also makes more consumer
loans and slightly more commercial
loans than BOH. Bank of Hawaii makes
more mortgage and home equity loans.
That might have hurt BOH
disproporonately during the nancial
crisis. Normally, residenal mortgage
loans have very, very low charge-os.
But, BOH had a lot of charge-os on its
residenal mortgage loans during the
nancial crisis – because that crisis was
the result of a housing boom. BOH had
very good underwring results in
residenal mortgage and home equity
relave to mainland banks. The areas
with the worst losses for BOH during
the crisis were commercial and
industrial loans (charge-os of 2.74% in
2009 and 2.49% in 2010) and consumer
loans (charge-os of 3.19% in 2009 and
2.60% in 2010). Residenal mortgage
charge-os were 0.29% in 2009 and
0.50% in 2010. That’s excellent. Home
equity loans were a bit worse – but not
at all bad relave to home equity losses
at most mainland banks. BOH had
home equity charge-os of 1.26% in
2009 and 1.56% in 2010. So, BOH’s own
results in the crisis were hurt most by
problem loans in commercial and
industrial and consumer loans. Those
are short-term loans. They don’t
benet from government involvement
the way the residenal mortgage
market does. So, they were very
suscepble to a credit crunch for those
two years. BOH kept reporng posive
earnings even through the nancial crisis. During the next recession, the bank will
have charge-os in both commercial and industrial and consumer loans. But these
two categories together will only be at most 25% to 33% of Bank of Hawaii’s total
earning assets. Most of BOH’s loans are mortgages (residenal or commercial). And
– depending on the year – anywhere from 30% to 50% of BOH’s available funds are
put into securies instead of loans. So, losses in commercial and industrial and
consumer loans will be manageable. Whenever Hawaii has a recession, BOH will
have a bad year in those areas. But these charge-os will simply appear for a year
or two and then go down to manageable levels for the next 5 years or so – along
with the macroeconomic cycle on Hawaii. These are normal cyclical losses. They
aren’t a problem for a bank with BOH’s diversicaon in assets, strong funding
posion, and reasonable tangible equity levels.
The single biggest potenal risk to BOH is a Hawaiian housing bubble. Land is scarce
in Hawaii. Homes are already much, much more expensive than on the mainland. A
very long period of low interest rates combined with interest in buying land by
people from the U.S. mainland, Japan, etc. can cause a bubble in land prices. It
happened before. The real price of a Hawaiian home doubled in value from 1981 to
1991. But then the real price of a Hawaiian home declined ever so slightly for the
full period of 1991 to 2001. That’s shocking. A ten-year decline of any kind in the
real value of homes is unusual. It happens as a result of a bubble. So, you have a
doubling in real value – more like a tripling in nominal value – from 1981 to the
peak in 1991 and then a aening out in real value from the period 1991 to 2001. It
was a twenty-year boom and bust cycle. That can happen. This most recent decline
in housing prices was modest by Hawaiian standards. We have the same situaon
here with Bank of Hawaii’s history as we do with Frost’s history in Texas. For
Hawaii, the 2007-2009 nancial crisis was not the worst economic moment in
decades the way it was for most of the U.S. Hawaii had an early 1990s period – in
the wake of the Nikkei bubble in Japan – that was worse. Texas’s worst period
followed the oil bust of the 1980s that came about as a result of the energy crisis
induced oil bubble in the 1970s. So, you had an oil bubble in Texas in the 1970s and
1980s. And you had a land bubble in Hawaii in the 1980s and 1990s. Those are the
best tests of banks in those states. Bank of Hawaii made it through Japan’s asset
price bubble and then it made it through America’s asset price bubble. Look at the
bank’s results in these two periods. They are a beer gauge of BOH’s resiliency
than any hypothecal future scenario I could create. My one suggeson would be
to watch for a serious housing bubble in Hawaii. If Hawaii has a 1980s-style housing
bubble – you may want to consider selling BOH. Otherwise, Bank of Hawaii is a
stock to buy and hold forever.
SINGULAR DILIGENCE 14
In 2009 and 2010, Bank of Hawaii had higher net charge-offs than both
First Hawaiian Bank and American Savings Bank.
FUTURE
Bank of Hawaii Will Be a Good
Enough Stock if Rates Stay Low and
a Great Stock if the Fed Raises Rates
Bank of Hawaii’s ve-year future
depends on what the Federal Reserve
decides to do with interest rates. If the
Fed Funds Rate is near zero in 2021,
Bank of Hawaii may only return
something like 8% a year over the next
5 years. However, if the Fed Funds Rate
is as high as 3% a year in 2021, Bank of
Hawaii could return something closer
to 13% a year. Why?
How much Bank of Hawaii earns
depends on the level of interest rates.
While BOH might not change its
dividend very much depending on how
much it earns – it will change how
much it spends on share buybacks. So,
BOH’s earnings at the end of the ve-
year period will be dierent depending
on interest rates. But, BOH’s share
count will also be dierent depending
on what interest rates look like. The
more BOH earns, the more it will spend
on share buybacks. Right now, BOH is
trading at about 18 mes its current
earnings. This is a 5.5% earnings yield.
However, BOH is only trading at 11 to
12 mes its normal earnings. So, that’s
an earnings yield of more like 8%. BOH
doesn’t need to retain any earnings
when it doesn’t grow. Quan and I have
assumed that BOH’s deposits will not
grow at all between now and 5 years
from now if the Fed Funds Rate rises to
at least 3% by then. Rising interest
rates will tend to move some deposits
from non-interest bearing to interest
bearing. An economy that is ‘running
hot’ will also tend to limit deposit
growth. It’s conservave to assume
BOH won’t grow deposits. But, we
know that if BOH doesn’t grow deposits
– it certainly won’t retain any earnings.
BOH doesn’t want to have a higher
rao of tangible equity to total assets
than it does right now. The only way
not to de-leverage when deposits
aren’t growing is to pay out every cent
of earnings in either dividends or share
buybacks.
Let’s put aside share buybacks for a moment. Quan and I think BOH would – simply
through the increase in the Fed Funds rate – increases its earnings to almost $400
million pre-tax by 2021. At a P/E of 15, Bank of Hawaii stock would be fairly valued
around $100 a share. Going from about $70 a share to about $100 a share in price
over ve years results in a 7% return. So, stock price appreciaon alone can drive
7% annual returns at BOH. Dividends and share buybacks would add another 6% or
so in returns. So, the total return in BOH would be about 13% over 5 years in a
constantly rising interest rate environment.
What if interest rates stay near zero? A lot of things change. Bank of Hawaii would
grow its deposits faster. Quan and I think deposit growth would be in the 3% to 4%
range if interest rates don’t rise at all. When BOH grows, it does need to retain
some earnings to keep leverage from increasing. For example, if deposit growth is
in the 3% to 4% range – Bank of Hawaii would probably retain 80% to 85% of its
EPS. Everything else would be paid out in dividends and share buybacks. Today’s
price is 18 mes earnings. BOH has some drag due to employee compensaon in
the form of stock opons. Once we net that out, we get a combinaon of dividends
plus a reducon in the share count that is equivalent to a 4.5% payout to
shareholders. The whole company would be growing 3% to 4% a year though. So,
you have 4.5% plus 3% to 4%. That gives you a total return of 7.5% to 8.5%.
It’s possible to come up with a scenario where BOH stock returns as lile as 7% a
year over the next 5 years. It’s also possible to come up with a scenario where BOH
stock returns as much as 14% a year over the next 5 years. It’s very dicult to come
up with ways the stock could do worse than 7% a year or beer than 14% a year.
So, if you buy BOH today and hold the stock through 2021 – you can expect a total
return in the 7% to 14% range. Quan and I think this is beer than what the S&P
500 oers. In fact, we’d say that the boom end of BOH’s range of reasonably
possible returns is higher than what the S&P 500 is priced to return. It’s unlikely the
S&P 500 will return 7% a year or beer over the next 5 years. This is simply because
interest rates are very, very low right now and the S&P 500 is very, very expensive
on a price-to-normal earnings basis. If interest rates rise, the earnings mulple on
the S&P 500 is likely to decline. Unlike BOH, there is no oseng mechanism in
place for non-nancial stocks to grow the ‘E’ part of the P/E rao at the same me
higher interest rates are pung pressure on the ‘P’ part. Higher interest rates will
benet BOH stock. Those same higher interest rates will hurt most other stocks. So,
BOH – along with other interest rate sensive banks like Frost – are an excellent
diversier. They are likely to rise in price while all the other stocks in your porolio
are falling in price. That’s why Quan and I would say that if you don’t already own a
bank stock – you should go out and buy Frost right now. If you already own Frost –
SINGULAR DILIGENCE 15
Over the next 5 years, Bank of Hawaii stock might return anywhere
from 8% and 13% a year.
you should add BOH to your porolio.
Frost and BOH are both very interest
rate sensive. They benet from rising
interest rates. Most of your net worth –
whether it is in the form of non-
nancial stocks, bonds, or a house –
will be hurt by higher interest rates. So,
if there is a wide moat business that is
helped rather than hurt by rising
interest rates – you should add that to
your porolio. Frost is a beer stock
than Bank of Hawaii. But Frost and
Bank of Hawaii are both wide moat
banks that benet from rising interest
rates. So, both bank stocks belong in
your porolio. What the Fed does
maers. But, don’t obsess about
whether the Fed raises rates this
month, next month, or the month aer
that. Just worry about what interest
rates look like today and what interest
rates are likely to look like in ve years.
Don’t buy into BOH or Frost planning to
hold them for less than ve years. But
do buy into both BOH and Frost. These
stocks provide the diversicaon you
need. Your porolio is badly exposed to
the risk of higher interest rates. These
two banks will zag when the rest of
your porolio zags. BOH is likely to
outperform the S&P 500 over the next
5 years. And it’s certain to perform
dierently from the S&P 500. That’s a
big benet. So, BOH is – despite not
having as bright a future as Frost does –
a bank stock I would recommend to
literally any investor. The one caveat is
the same caveat we always make in a
Singular Diligence issue. We are
recommending BOH as a ve-year
investment – not as a ve-month trade.
Don’t buy this stock unless you commit
to holding it through 2021.
SINGULAR DILIGENCE 16
Price-to-Appraisal: 76%
SINGULAR DILIGENCE 17
Bank of Hawaii Owner
(in millions)
Earning Assets
Short-term Investments $691
+ Securities $6,229
+ Loans $7,940
= Earning Assets $14,860
Funding
Free Funding $2,796
+ Interest-bearing Demand
$4,876
+ Savings $5,138
+ Time $1,208
+ Other Borrowings $843
= Total Funding $14,860
Funding Mix
Free Funding 19%
+ Interest-bearing Demand
33%
+ Savings 35%
+ Time Deposits 8%
+ Other Borrowings 6%
= Total Funding 100%
Assumptions
Yield on Earning Assets 5.20%
Fed Funds 3.00%
Cost of Interest-bearing
0.60%
Cost of Savings 1.50%
Time Deposits 3.30%
Cost of Other Borrowings 3.30%
Weighted Average Cost of
Free Funding 0.00%
+ Interest-bearing Demand
0.20%
+ Savings 0.52%
+ Time Deposits 0.27%
+ Other Borrowings 0.19%
= Cost of Funding 1.17%
Return on Earning Asset
Yield on Earning Assets 5.20%
- Cost of Funding 1.17%
- Net charge-offs 0.29%
- Operating Costs 1.12%
= Return on Earning Assets 2.62%
Pre-tax Owner Earnings
Earning Asset $14,860
* Return on Earning Assets 2.62%
= Pretax Owner Earnings $389
EV/
Earning Assets
EV/
Deposits
EV/
EBT
EV/
Owner Earnings
Frost 0.16 0.17 8.59 5.56
BOK 0.14 0.19 9.15 5.15
Commerce 0.20 0.24 11.36 6.98
UMB Financial 0.15 0.18 14.98 6.68
Central Pacific Financial 0.15 0.16 9.47 8.17
Minimum 0.14 0.16 8.59 5.15
Maximum 0.20 0.24 14.98 8.17
Median 0.15 0.18 9.47 6.68
Mean 0.16 0.19 10.71 6.51
Standard Deviation 0.02 0.03 2.60 1.20
Variation 16% 16% 24% 18%
BOH (Market Price) 0.20 0.22 12.04 7.52
BOH (Appraisal Value) 0.26 0.29 15.81 10.00
Geo Gannon, Writer
Geo is a writer, blogger, podcaster, and interviewer. He has wrien hundreds of
arcles for Seeking Alpha and GuruFocus. He hosted the Gannon On Invesng
Podcast, The Investor Quesons Podcast, and The Investor Quesons Podcast
Interview Series. He wrote the Gannon On Invesng newsleer in 2006 and two
GuruFocus newsleers from 2010-2012. In 2013, he co-founded The Avid Hog
(the predecessor to Singular Diligence) with Quan Hoang. Geo has been blogging
at Gannon On Invesng since 2005.
Quan Hoang, Analyst
Quan is a stock analyst. Quan won rst prize in Vietnam’s Naonal Olympiad in
Informacs in 2006. He graduated from Manhaanville College in 2012 with a B.A.
in nance and a minor in math. In 2013, Quan co-founded The Avid Hog (the
predecessor to Singular Diligence) with Geo Gannon.
Tobias Carlisle, Publisher
Tobias Carlisle is the founder and managing director of Eyquem Investment
Management LLC, and serves as porolio manager of the Eyquem Fund LP and the
separately managed accounts.
He is best known as the author of the well regarded website Greenbackd, the
book Deep Value: Why Acvists Investors and Other Contrarians Bale for
Control of Losing Corporaons (2014, Wiley Finance), and Quantave Value: a
Praconer’s Guide to Automang Intelligent Investment and Eliminang
Behavioral Errors (2012, Wiley Finance). He has extensive experience in
investment management, business valuaon, public company corporate
governance, and corporate law.
Prior to founding Eyquem in 2010, Tobias was an analyst at an acvist hedge fund,
general counsel of a company listed on the Australian Stock Exchange, and a
corporate advisory lawyer. As a lawyer specializing in mergers and acquisions he
has advised on transacons across a variety of industries in the United States, the
United Kingdom, China, Australia, Singapore, Bermuda, Papua New Guinea, New
Zealand, and Guam. He is a graduate of the University of Queensland in Australia
with degrees in Law (2001) and Business Management (1999).
ABOUT THE TEAM
SINGULAR DILIGENCE 18
NOTES
Bank of Hawaii
NYSE: BOH
SINGULAR DILIGENCE 19
N1
Overview
Bank of Hawaii: A Durable Franchise in an Isolated Island
Bank of Hawaii holds about 30-32% of total deposits in Hawaii over the last 22 years
- BOH was founded in 1893
o By
Charles Montague Cooke
Joseph Ballard Atherton
Cook’s brother-in-law
Peter Cushman Jones
Cook’s business partner
o The bank opened its first branch in Kauai
In 1903
o Acquired First Bank of Hilo
In 1922
First Bank of Hilo had 4 branches
o Amalgamated Bank of Maui
In 1930
o Through acquisitions and organic expansion, it became Hawaii
Bancorporation
The biggest bank in Hawaii
Had 31% deposit market share in Hawaii
In 1995
31%
31%
32%
32%
31%
30%
31%
30%
29%
30%
29%
28%
28%
28%
27%
29%
31%
31%
33%
32%
33%
32%
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Bank of Hawaii's Deposit Market Share
N2
- Hawaii Bancorporation pursued growth outside of Hawaii
o In the 1980s and 1990s
o The bank had operations in
California
Arizona
New York
8 countries across the South Pacific
6 Asian locations
o BOH faced with virtually no revenue growth in Hawaii
1
BOH entered syndicated lending
=> Entered syndicated lending
Built a $3 billion portfolio at some point
o BOH bought loans outside of Hawaii
2
o The outward-looking expansion strategy was reflected by the name change to
Pacific Century Financial
3
In 1997
- Loan losses started increasing
o Net charge-offs were
1997: 0.34%
1998: 0.70%
1999: 0.78%
2000: 0.94%
2001: 1.57%
- In 2000, BOH was the only U.S. bank that was trading below book value
o BOH’s chairman resigned
o Michael E. O’Neill was named Chairman and CEO of BOH
O’Neill was the former Vice Chairman and CFO of Bank of America
- The new management embarked on a turnaround program
o With a focus on “avoiding mistake of the past”
o Refocused on the Hawaii market
The name was changed to Bank of Hawaii
In 2002
Sold assets and closed branches outside of Hawaii
Total assets reduced
2000: $14 billion
2004: $9.7 billion
o Reduce operating costs
N3
Net operating cost/Earning assets
2000: 1.79%
2007: 0.98%
- BOH became one of the most profitable banks in the U.S.
o BOH has one of the lowest funding costs base among U.S. banks
Deposits represent 91% of BOH’s total earning assets
91% of BOH’s deposits are core deposit
31% of BOH’s deposits are noninterest-bearing
Hawaii is a service-based economy
Tourism: 15-17%
o Some estimated tourism and related businesses account
for 1/3 of the economy
4
Defense: 8-10%
o Hawaii is in a strategic location
In the middle of the pacific ocean
Tourism and defense represent about 25% of the economy
=> strong liquidity in the economy
Hawaii is a deposit-rich market
Traditionally, Hawaii has been the lowest cost of deposits in the
country
5
BOH has the lowest funding cost among Hawaiian banks
Has the most core deposits
Has the most number of branches
Has the most number of ATMs
o More than the next two competitors combined
BOH’s cost of deposits is generally 1/3 less than local competitors’
6
Less than ½ that of mainland competitors
Only Frost has lower cost of funding than BOH
o BOH has low operating cost
Net operating/earning assets is about 1%
Small Hawaiian banks has more than 2% net operating cost/earning
assets
Most U.S. regional banks has net operating cost between 1.6 and 3% of
earnings assets
o Was able to make 3% pre-tax return on earning assets
During 2004-2007
With 14x leverage, pre-tax ROE is 42%
N4
After-tax ROE is 27%
- In 2015, BOH made only 1.68% pre-tax return on earning assets
o BOH’s cheap funding make it sensitive to interest rates
o BOH may benefit from higher interest rates
- BOH’s weakness is growth
o Hawaii is a low-growth state
o Realistic expectation: 3-4% growth
- BOH’s attractions
o BOH can return 80-90% of its earnings
While growing 3-4%
o BOH has a wide moat
4 banks in Hawaii hold 90-92% since 1994
Current deposit market share
First Hawaiian Bank: 36%
BOH: 32%
American Savings Bank: 12%
Central Pacific Financial: 11%
BOH is the second largest bank
But has the most core deposits
- BOH is currently trading at about 18x earnings
o $68 per share
o BOH can be a good bet on higher interest rates
1
“The company's recent credit problems have been a disappointment to investors,
particularly in light of the progress Bank of Hawaii appeared to be making with a cost-
saving and revenue enhancement program that will have been Mr. Johnson's last major
initiative.
When asked whether, if he had to do it all over again, he would push the bank to
enter syndicated lending, a business that caused credit blips at many large banks last
quarter, Mr. Johnson suggested that the bank did not have that much of a choice.
"We were faced with virtually no revenue growth from our primary market,
Hawaii," he said. This pressure caused the bank to take advantage of opportunities
that included "a degree of risk that was unacceptable," he said.
But the choice was clear. "If we hadn't done that, we probably would have been
acquired."” – Bank of Hawaii Chairman to Quit, True to His Word, Laura Mandaro,
American Banker, 23 August 2000
N5
2
“Our credit philosophy is to stay within our market. I think to understand a little bit
about what's important credit to Bank of Hawaii and why we might approach this a little
bit differently would be good to return just briefly in history -- in 2000, when Cindy and
I and a number of the management joined the bank, the Bank of Hawaii was
suffering from some pretty poor financial performance. In fact, at that time, we
were the only bank in the country that was selling for less than book value, and
we embarked on a turnaround program.
The most important and significant part of that turnaround program was the
correction of an elevated credit risk. And the point of going into that is that we all
remember how hard it is, how it hurts your reputation. We know that you can't defy
gravity or the marketplace, but within that you can do better or worse, and we have a
team that is focused on, as we say, "Avoiding the mistakes of the past."
What happened to us is when we grew beyond our natural markets, we inevitably
lost money. When we purchased loans outside of our marketplace, we had a hard
time figuring out how to make any profit for our shareholders on that business.
When we took large risks, when our portfolio lacked granularity, or when we got into
unproven trends -- what do you call them -- sale in, lease out transactions -- silo
transactions. We've still got a little bit of that legacy in our portfolio, we're pretty well
reserved for it, but building those reserves was pretty painful.
So making sure we stay with proven products, making sure we have appropriate
underwriting standards and monitoring processes are an important part of our credit
culture and avoiding what we call the mistakes of the past.” – Allan Landon, BOH’s
former CEO, KBW Regional Bank Conference, 27 February 2008
3
“Mr. Johnson, 60, is leaving a company that -- despite its best efforts at a turnaround --
has been beset by one series of problems after another since the 1997 Asian financial
crisis.
Over the last three decades Bank of Hawaii has grown from a community bank
seeking to expand in its local market of Hawaii, where it now holds the No. 1
market position, to a company with a string of branches and alliances across the
South Pacific and Pacific Rim.
Much of that expansion occurred when Mr. Johnson held senior management roles. He
presided over the expansion on the U.S. mainland with the 1997 acquisition of
CU Bancorp of Encino, Calif., and in Guam with the acquisition of First Federal
N6
Savings and Loan Association of America. He also forged several alliances with
foreign financial institutions in the Pacific.
To reflect its increasingly outward-looking expansion strategy, the holding company
traded in its Bancorp Hawaii Inc. name for Pacific Century Financial in 1997.” –
Bank of Hawaii Chairman to Quit, True to His Word, Laura Mandaro, American Banker,
23 August 2000
4
“Unidentified Audience Member: What is the sensitivity on the economy in Hawaii
relative to the tourism?
Peter Ho, BOH’s CEO: Well, you saw up on the slide that it's 16% of the overall
economy, but the estimate is that the multiplier effect to that is significantly
greater. So tourism and the related businesses I think I have seen estimates as
high as a third of the overall economy pivots with that industry.” – Merrill Lynch
Banking and Financial Service Conference, 11 November 2009
5
“Customer loyalty is another dynamic, it's a bit different in our marketplace versus
what you find in the boarder markets here in the mainland. The likelihood to
recommend their bank to others higher in Hawaii than the national average,
length of time or loyalty to their primary institutions. As you see in this chart,
significantly different than what you find in the national marketplace.
I think the real reason behind this is Hawaii is less of a transient population base
than what you would find in certainly a number of the Western states here in the
mainland. Take all of these attributes, put them together and what you find in Hawaii is
that the Hawaii Banks as a group have a substantial cost of funding advantage
over the US mainland.” – Peter Ho, BOH’s CEO, Sandler O’Neill & Partners, 06 March
2012
6
“One of the great underpinnings of our banking market in Hawaii is the deposit cost
advantage that we have versus the broader US mainland. Here you see that both
currently and historically, the Hawaii banks have a distinct deposit cost advantage
over our mainland brethren, and in fact, Bank of Hawaii of has an advantage over
the local marketplace in Hawaii.
We generally have deposits that are about a third less in cost than our local
competition, and a little bit less than half that of our mainland competitors.
We do that by focusing our brand on safety, on convenience, and on community. From
a convenience standpoint, you see here that we lead the marketplace in terms of total
N7
number of branches, the most in the state. There are 45 ZIP codes in the state of
Hawaii. If you look at all 45 of those, Bank of Hawaii has the number one or
number two market share position in 82% of those ZIP codes.
Convenience wise, we're also the market leader in terms of the number of ATM
machines by a pretty wide margin you'll see there on that bar chart. Perhaps
more importantly is the strategic relationships that we have built in terms of ATM
placement with companies of the like of Safeway, McDonald's and Long's CVS.
I'd also mention that we very recently entered into a three-year agreement with a
company called China Union Pay. China Union Pay is the Chinese equivalent of Visa.
They have 2.1 billion cards in circulation, 300 million of which are active, and they have
taken an interest in Hawaii and came to us, basically, to see if we could partner in
supporting each other in our respective markets. An interesting transaction that I think
should bear fruit for us in off into the future.” – Peter Ho, BOH’s CEO, Credit Suisse
Small- and Mid-Cap Conference, 15 September 2010
N8
Durability
Hawaiian Banks Are Generally Conservative
Of the top 4 banks, only Central Pacific Financial failed during the Great Recession
- Biggest Negative:
o BOH had higher charge-offs than First Hawaiian Bank and American Savings
Bank
- BOH is durable thanks to
o Current financial position
o Conservative lending
o Industry structure
- BOH is very safe for the next 5 years
o BOH gets most of its funding from stable, sticky core deposits
(As of March 31, 2016)
Total deposits: $13.5 billion
Noninterest-bearing demand: $4.3 billion
Interest-bearing demand: $2.8 billion
Savings: $5.2 billion
Time: $1.2 billion
Other borrowings: $0.8 billion
Total earning assets: $14.8 billion
So, core deposits represent
91% of total deposits
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
2007 2008 2009 2010 2011 2012
Pre-tax Return on Earning Assets
First Hawaiian Bank Bank of Hawaii
American Savings Bank Central Pacific Financial
N9
83% of earning assets
There’s only $2 billion of less sticky liabilities
Time deposit
Other borrowings
o Earning assets are safe
Investment portfolio: $6.3 billion (43% of earning asset)
Duration: 3.4 years
Most of the portfolio has contractual maturities within 5 years
o 1-5 years: $4.3 billion
67% of the portfolio
o 5-10 years: $1.8 billion
29% of the portfolio
o Over 10 years: $0.2 billion
3% of the portfolio
Annual cash flow running off the portfolio: $1.4 billion
The investment portfolio has low credit risk
o Mortgage-backed securities: 63% of the portfolio
($4 billion)
Issued by U.S. government agencies
Mostly comprised of securities issued in 2008 or later
Credit ratings of these MBS were all AAA-rated
Loan portfolio: $8.1 billion (55% of earning assets)
Commercial: $3.3 billion (40%)
o Commercial and Industrial: $1.2 billion (15%)
o Commercial Mortgage: $1.7 billion (21%)
o Construction: $0.2 billion (2%)
o Commercial lease financing: $0.2 billion (2%)
Consumer: $4.8 billion (60%)
o Residential mortgage: $2.9 billion (36%)
o Home equity: $1.1 billion (14%)
o Automobile: $0.4 billion (5%)
o Other: $0.3 billion (4%)
86% of the loan portfolio is from
o Commercial and Industrial
o Commercial Mortgage
o Residential mortgage
o Home equity
N10
Most of the loans are in Hawaii
Hawaii: 91%
Guam: 5%
Other Pacific Islands: 1%
U.S. Mainland: 3%
BOH’s lending practice is conservative, as discussed below
- BOH has conservative lending practice
o BOH’s securities portfolio has high credit quality
Never had exposure to subprime mortgage or Alt-A securities
Invests in AAA-rated securities
Example:
As of Q2 007
Non-agency MBS portfolio: $337 million
1
o 11% of the securities portfolio
o AAA-rated jumbo prime paper
o Average loan to value: 65%
o Weighted average FICO score: 740
As of Q2 2008, BOH had $3 billion investment securities portfolio
2
86% of the portfolio were securities issued by
o Fannie Mae
o Freddie Mac
o Ginnie Mae
o All are senior debts
Non-agency portfolio: $309 million
o Loan-to-value: 54%
o BOH’s credit philosophy: stay within Hawaii
3
In 2000: BOH was suffering from pretty poor financial performance
The only bank selling for less than book value
=> Embarked on a turnaround program
Correction of an elevated credit risk
o Focused on “avoiding the mistakes of the past”
Grew beyond its natural market
Bought loans outside of its marketplace
o The main types of loans BOH makes are
Commercial and Industrial: currently 15% of the loan portfolio
Commercial Mortgage: 21%
About ½ is owner-occupied
N11
Residential mortgage: 36%
Home equity: 14%
o Loan decisions are based on
Loan-to-value ratio
Commercial mortgage: < 75%
4
Residential mortgage: < 80%
5
o Residential mortgage loans are mostly fixed-rate loans
concentrated in Hawaii
6
o No subprime or Alt-A loans
Home equity: < 80%
Debt-to-income ratio
Debt service coverage ratio
>= 1.2x for commercial mortgage loans
Credit score
BOH is far less concerned about losing one borrowing customer than
about maintaining credit quality
7
o BOH is very selective on construction loans
The book is typically kept below $250 million
8
Under $100 million in a down cycle
Strong construction activities only have an indirect impact on BOH
More consumer loans
More C&I loans
More residential mortgage loans
When BOH makes construction loans, it makes sure LTV to stay low
Example:
As of 2007 Q2
9
o BOH had about $250 million construction loans
o 50% of construction portfolio is exposure to home builders
Weighted average loan to value: 60%
o BOH has low charge-offs in mortgage loans
Since 2001, net charge-offs/average loans were
Commercial mortgage
o Min: -0.56%
o Max: 0.27%
o Median: -0.01
o Mean: -0.02%
o Standard deviation: 0.20%
N12
o Variation: -8.86
Residential mortgage
o Min: -0.11%
o Max: 0.50%
o Median: 0.01%
o Mean: 0.08%
o Standard deviation: 0.17%
o Variation: 2.18
Home equity
o Min: -0.12%
o Max: 1.56%
o Median: 0.08%
o Mean: 0.40%
o Standard deviation: 0.55%
o Variation: 1.37
BOH is focused on mortgage loans in Oahu
80% of the economic value of the state is headquartered or
located in Oahu
2 segments for real estate in Hawaii
10
o Resort residential market
Mainly on the neighbor islands
Kauai
Maui
The Big Island
Buyers are out-of-town buyers
Second home type buyer
There was a good amount of building over the 2003-
2007 period
o Traditional middle-market clientele
Predominately on Oahu
Predominantly Hawaii-based buyers
Supply is constrained by building permits
=> there wasn’t a development bubble
Residential real estate price declined from peak to bottom
11
o In Oahu: 12%
Median single family home price in Oahu
2006: $644,000
N13
Bottomed at $580,000-$590
o In the neighbor islands: more than 20%
o Declined more than 20% on the neighbor islands
BOH maintained low LTV and high FICO score
Example:
As of Q2 2007:
o Residential mortgage portfolio
12
$2.5 billion in mortgages
Manage $5 billion
Retain $2.5 billion
Sells $2.5 billion
90% of the portfolio was in the state of Hawaii
The rest in the Pacific Island division
o Most of that in Guam
Have avoided some market temptations, irrational
exuberance
Have stuck with traditional offering products
Underwritten to the Fannie Mae guidelines
Very high weighted average FICO scores
The weighted average loan-to-value: 61%
o Secondary mortgage
13
Home equity portfolio is a prime portfolio strategy
Booked through BOH’s retail channels
$938 million outstanding
$2 billion in commitments
14% of total loan portfolio
Weighted average FICO score: 755 at origination
Monitoring score: 770
80% having FICO scores greater than 720
Combined loan-to-value of the portfolio is 69% at
origination
As of Q3 2007:
o The weighted average FICO scores were
14
Mortgage: 755
Home equity: 748
o 94% of residential mortgage portfolio has a loan to value
ratio of 80% or less
N14
As of Q4 2008
o 96% of first mortgages have loan to values below 80%
based on origination values
15
Weighted average monitoring FICO score: 757
o Home equity:
Monitoring FICO score: 770
Combined loan to value: 69%
As of Q2 2009
o Commercial mortgage outstanding: $788 million
16
$317 million in owner-occupied mortgages
Average $990,000
Weighted average loan to value: 72%
Average current debt service coverage: 1.3
$471 million in investor exposure
Emphasize on cash flow to loan debt service
requirements
o After considering vacancy, property
expenses and stressing interest rates
Average loan to value: 57%
Average current debt service coverage: 1.4x
As of Q4 2009
o Commercial mortgage outstanding: $841 million
17
Owner-occupied: $316 million
Average: $1 million
Weighted average LTV: 72%
Average current debt service coverage: 1.3x
Investor loans: $525 million
Average: $1.5 million
Weighted average LTV: 57%
Average debt service coverage: 1.4x
o BOH’s peak net charge-offs/average loan was
2007: 0.24%
2008: 0.43%
2009: 1.43%
2010: 0.94%
2011: 0.40%
o The main problems were
N15
Commercial and Industrial:
Net charge-offs/average loans
o 2007: 0.20%
o 2008: 0.61%
o 2009: 2.74%
o 2010: 2.49%
o 2011: 0.72%
o 2012: -0.04%
The high level of charge-offs was likely due to airline exposure
18
Construction loan
Net charge-offs/average loans
o 2007: 0.00%
o 2008: 1.11%
o 2009: 6.92%
o 2010: -5.29%
o 2011: 0.00%
Construction loan was always less than 4% of the loan portfolio
Most of charge-offs in 2009 were recovered in 2010
o Perhaps thanks to BOH’s focus on low LTV
Home Equity
Net charge-offs/average loans
o 2007: 0.08%
o 2008: 0.24%
o 2009: 1.26%
o 2010: 1.56%
o 2011: 1.17%
o 2012: 0.70%
o 2013: 0.43%
o 2014: 0.00%
It’s unclear why home equity loans performed much worse than
residential mortgage loans
Auto
Net charge-offs/average loans
o 2007: 0.08%
o 2008: 0.24%
o 2009: 1.26%
o 2010: 1.56%
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o 2011: 1.17%
o 2012: 0.70%
o 2013: 0.43%
o 2014: 0.00%
Auto loans were less than 7% of the loan portfolio
There was weakness in automobile loans
Weakness in automobile loans
19
o Dealers in Hawaii have faced double-digit sales declines
For the last 2 years
=> more aggressive on sales
BOH supported a little bit of their bad habit
o BOH is tightening
Visiting with its dealers
Letting them know BOH is concentrating on top-tier
sectors
Regardless of the volume
Dealers always argued that if you don’t take
the lower-quality paper, they won’t be able to
share the high-quality with you
o BOH performed well in 2009 despite 1.43% net charge-offs
Net charge-offs/average earning assets: 0.80%
pre-charge-offs profit/average earning assets: 3.41%
=> pre-tax return on average earning assets: 2.61%
1.43% net charge-offs/average loans is better than the industry’s
average of 2.49%
- Hawaii’s banking landscape is safe
o 4 banks hold over 92.1% market share
First Hawaiian Bank (FHB): 36.5%
BOH: 32.1%
American Savings Bank (ASB): 12.6%
Central Pacific Financial (CPF): 10.9%
o FHB and ASB are conservative
FHB’s strategy is very similar to that of BOH
20
Net charge offs/average loans of these banks were lower than BOH’s
FHB
o 2007: 0.32%
o 2008: 0.36%
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o 2009: 0.61%
o 2010: 0.73%
o 2011: 0.41%
o 2012: 0.25%
o 2013: 0.10%
ASB
o 2007: 0.17%
o 2008: 0.11%
o 2009: 0.66%
o 2010: 0.61%
o 2011: 0.49%
o 2012: 0.24%
o 2013: 0.09%
o Only CPF had problem
It made a lot of construction loans
$1.2 billion in 2007
30% of the loan portfolio
It made a lot of loans in California
Net loan and leases in California was $1 billion in 2007
o 25% of its loan portfolio
Of the loans in California, $625 million were construction loans
o 15% of the loan portfolio
CPF went belly up during the 2008-2009 financial crisis
Total net charge-offs were over $600 million from 2008 to 2011
o For a loan portfolio of about $4 billion
Since early 2007, CPF’s shareholders lost over 95%
o The pressure for banks to do the wrong thing is low in Hawaii
o The risk of residential real estate development bubble is low
Land is limited in Hawaii
But supply is constrained due to building permits
Residential real estate price declined only 12% from peak to bottom in
Oahu
- BOH currently make 1.69% pre-loan-loss pre-tax return on earning assets
o Made 3.11% pre-loan-loss pre-tax return on earning assets in 2004-2009
o BOH now has 1.31% allowance for loan losses/period-end loans
Or 0.68% of earning assets
o For BOH to lose money, net charge-offs/earning asset must exceed 2.37%
N18
Or net charge-offs/loans must exceed 4.59%
3.2 times higher net charge-offs/loans in 2009
1
“Our Non-Agency mortgage-backed security holdings is $337 million in Non-Agency
MBS. It's about 11% of our total portfolio. They are all AAA rated jumbo prime paper.
The average loan to value is just over 65%, and the weighted average FICO score
is 740.” – Dan Stevens, BOH’s former CFO, Lehman Brothers Global Financial
Services Conference, 12 September 2007
2
“The investment securities portfolio, $3 billion. We have Fannie Freddie, Ginnie.
86% of the portfolio would be those three issuers. We -- they're all senior debt.
We don't -- as I mentioned, we don't have any subordinated debt or preferred stock or
any stock and those entities. We do have a non-agency portfolio that's $309 million.
It would be AAA mortgage backed securities with a loan-to-value of 54%.” – Kent
Lucien, BOH’s CFO, Lehman Brothers Global Financial Services Conference, 08
September 2008
3
“Our credit philosophy is to stay within our market. I think to understand a little bit
about what's important credit to Bank of Hawaii and why we might approach this a little
bit differently would be good to return just briefly in history -- in 2000, when Cindy and
I and a number of the management joined the bank, the Bank of Hawaii was
suffering from some pretty poor financial performance. In fact, at that time, we
were the only bank in the country that was selling for less than book value, and
we embarked on a turnaround program.
The most important and significant part of that turnaround program was the
correction of an elevated credit risk. And the point of going into that is that we all
remember how hard it is, how it hurts your reputation. We know that you can't defy
gravity or the marketplace, but within that you can do better or worse, and we have a
team that is focused on, as we say, "Avoiding the mistakes of the past."
What happened to us is when we grew beyond our natural markets, we inevitably
lost money. When we purchased loans outside of our marketplace, we had a hard
time figuring out how to make any profit for our shareholders on that business.
When we took large risks, when our portfolio lacked granularity, or when we got into
unproven trends -- what do you call them -- sale in, lease out transactions -- silo
transactions. We've still got a little bit of that legacy in our portfolio, we're pretty well
reserved for it, but building those reserves was pretty painful.
N19
So making sure we stay with proven products, making sure we have appropriate
underwriting standards and monitoring processes are an important part of our credit
culture and avoiding what we call the mistakes of the past.” – Allan Landon, BOH’s
former CEO, KBW Regional Bank Conference, 27 February 2008
4
“Commercial mortgages and construction loans are offered to real estate investors,
developers, builders, and owner-occupants primarily domiciled in Hawaii. These loans
are secured by first mortgages on real estate at loan-to-value ("LTV") ratios
deemed appropriate based on the property type, location, overall quality, and
sponsorship. Generally, these LTV ratios do not exceed 75%. The commercial
properties are predominantly developments such as retail centers, apartments,
industrial properties and, to a lesser extent, more specialized properties such as hotels.
Substantially our entire commercial mortgage loans are secured by properties located
in our primary market area.
In the underwriting of our commercial mortgage loans, we obtain appraisals for the
underlying properties. Decisions to lend are based on the economic fundamentals of
the property and the creditworthiness of the borrower. In evaluating a proposed
commercial mortgage loan, we primarily emphasize the ratio of the property's
projected net cash flows to the loan's debt service requirement. The debt service
coverage ratio normally is not less than 120% and it is computed after deducting
for a vacancy factor and property expenses as appropriate. In addition, a personal
guarantee of the loan or a portion thereof is sometimes required from the principal(s) of
the borrower.” – BOH 2015 10-K
5
“We offer a variety of first mortgage and junior lien loans to consumers within our
markets with residential home mortgages comprising our largest loan category. These
loans are generally secured by a primary residence and are underwritten using
traditional underwriting systems to assess the credit risks and financial capacity and
repayment ability of the consumer. Decisions are primarily based on LTV ratios,
debt-to-income ("DTI") ratios, liquidity, and credit scores. LTV ratios generally do
not exceed 80%, although higher levels are permitted with mortgage insurance.
We offer variable rate mortgage loans with interest rates that are subject to change
every year after the first, third, fifth, or seventh year, depending on the product and are
based on the London Interbank Offered Rate ("LIBOR"). Variable rate mortgage loans
are underwritten at fully-indexed interest rates. We do not offer payment-option
facilities, sub-prime or Alt-A loans, or any product with negative amortization. We will
selectively offer interest-only mortgage loans through our Private Banking channel.
Home equity loans are secured by both first and second liens on residential property of
the borrower. The underwriting terms for the home equity product generally
permits borrowing availability, in the aggregate, up to 80% of the value of the
collateral property at the time of origination. We offer fixed and variable rate home
N20
equity loans, with variable rate loans underwritten at fully-indexed interest rates. Our
procedures for underwriting home equity loans include an assessment of an applicant's
overall financial capacity and repayment ability. Decisions are primarily based on LTV
ratios, DTI ratios, and credit scores. We do not offer home equity loan products with
reduced documentation.” – BOH 2015 10-K
6
“The consumer loan and lease portfolio is comprised of residential mortgage loans,
home equity lines and loans, indirect auto loans and leases, and other consumer loans
including personal credit lines, direct installment loans, and rewards-based consumer
credit cards. These products are generally offered in the geographic markets we
serve. Although we offer a variety of products, our residential mortgage loan
portfolio is primarily comprised of fixed-rate loans concentrated in Hawaii. We
also offer a variety of home equity lines and loans, usually secured by second
mortgages on residential property of the borrower. Automobile lending activities include
loans and leases secured by new or used automobiles. We originate automobile loans
and leases on an indirect basis through selected dealerships. Direct installment loans
are generally unsecured and are often used for personal expenses or for debt
consolidation.” – BOH 2015 10-K
7
“As you can tell from Dan's comments, we have been very disciplined about our
approach to residential lending. We have been just as disciplined in our approach
to commercial lending, especially when it comes to land and construction
lending, where our Bank's ancient history has not been as successful as we
would like to have our future be.
We have maintained very prudent underwriting standards, conservative loan-to-
value ratio requirements, including cash equity, as well as sponsorship and
guarantees. We expect binding presales contracts, and we prequalify buyers who
participate in the residential for-sale projects.
I would tell you that we are far less concerned about losing one borrowing
customer than we are about maintaining our credit quality. So if you have listened
to our reports for the last few quarters, we have talked openly about pruning our
credit users from our portfolio. And I will tell you that that will continue as we go
through uncertain times. But frankly, we have very few borrowers that we have
concerns about the stability or the repayment capability from.” – Allan Landon, BOH’s
former CEO, Lehman Brothers Global Financial Services Conference, 12 September
2007
8
“Our construction lending book is probably our smallest commercial book. So we will
flex in a down cycle under $100 million in construction loans, but we will only
N21
flex up to $200 million, $250 million. So construction doesn't have that meaningful of
an impact into that loan category for us, but it has an impact for us because of the
way that it helps to stimulate the economy.
So what we see is when the construction sector is healthy in Hawaii, we see
more consumer loans, we see more C&I lending. We see, obviously, residential
mortgages coming on the backside of these construction residential projects.
And that is really where we see the impact.” – Peter Ho, BOH’s CEO, KBW Boston
Regional Bank Conference, 25 February 2015
9
“About 50% of our construction portfolio is exposure to home builders. It is very
solid, the weighted average loan to value is about 60%. The profile of the portfolio
includes some national builders as well as some large local builders. In terms of
exposure to what I'd call the higher risk segment, which is kind of high-end
luxury second homes, we have about 25 million in outstanding among the five
borrowers.” – Marry Sellers, BOH’s Chief Risk Officer, 2007 Q2 Earnings Transcript,
23 July 2007
10
“For us it's really two segments for the state of Hawaii. The resort residential
market, which exists predominantly on the neighbor islands so that would be
Kauai, Maui, and the Big Island, has been challenged probably similar to what you
see in other Western markets on mainland US. That buyer is predominantly an out-
of-town buyer, a second home type buyer. In that area there was a good amount
of building over the past five-plus years.
The other segment is what we would consider to be the more traditional middle-
market clientele, predominately on Oahu, predominantly Hawaii-based buyers. In
that segment prices have remained reasonably stable, down call it single digits,
because there simply wasn't the availability of inventory over this last cycle to
create any kind of supply bubble. So it really depends on which market you are
talking about.
For the Bank of Hawaii the predominant marketplace that we play in is in the kind
of nuts and bolts basic Oahu residential home buyer. We have a small exposure on
the commercial construction lending sign on the neighbor islands to those resort
developments and a small exposure on the residential mortgage side to that product as
well.” – Peter Ho, BOH’s CEO, Merrill Lynch Banking and Financial Service
Conference, 11 November 2009
11
“On balance, residences in Hawaii, Oahu is where most of the people are, 70%
of the people are there and 12% has been peak to bottom the depreciation in
N22
residential real estate. On the neighbor islands, where the population is smaller,
we have a larger percentage that have been impacted by investors. And so we have a
larger depreciation percentage there in excess of 20%.” – Allan Landon, BOH’s
Former CEO, Macquarie Securities Small- and Mid-Cap Conference, 15 June 2010
12
“Our residential mortgage portfolio, which is a big part of our business, we have about
$2.5 billion in mortgages on our balance sheet. We manage $5 billion, we take about
$2.5 billion of those mortgages and put them through a conduit into the secondary
market; we retain about $2.5 billion on our balance sheets; and we service all $5 billion
of those mortgages.
We believe that these are very high-quality. 90% of the portfolio was in the state of
Hawaii, with the rest in the Pacific Island division, and most of that in Guam. We
believe we have avoided some market temptations, irrational exuberance in the
residential portfolio, and we have stuck with traditional offering products, which are
underwritten to the Fannie Mae guidelines. And our portfolio loans, as you can see,
have very high weighted average FICO scores, both on an originating basis and a
monitoring basis.
In addition to monitoring the FICO scores of our borrowers, we also track current loan
to value. And the entire portfolio was weighted at 61%, including the 2000, 2006
and 2007 vintages, which are the most current.” – Dan Stevens, BOH’s former CFO,
Lehman Brothers Global Financial Services Conference, 12 September 2007
13
“Our secondary mortgage also has a high-quality portfolio. Our home equity
portfolio is a portfolio that is a prime portfolio strategy, not a subprime strategy,
and it's basically booked through our retail channels that we have in the
Hawaiian Islands. We currently have $938 million outstanding, about $2 billion in
commitments, and it represents about 14% of our total loan portfolio. And the
geographic mix mirrors our residential mortgages, with 90% in the state of Hawaii, 10%
in our West Pacific islands.
The weighted average FICO score for the entire portfolio is 755 at origination, so
better, which you would expect, than the residential, our first mortgages. And the
weighted average monitoring score is 770 today. The quality of our originations
continues to be strong, with 80% having FICO scores greater than 720, so very,
very strong ratings. Utilization rates are low, about 45%. On a combined loan-to-value
of the portfolio is 69% at origination.” – Dan Stevens, BOH’s former CFO, Lehman
Brothers Global Financial Services Conference, 12 September 2007
N23
14
“The two largest consumer portfolios, mortgage and home equity, have
weighted average credit scores of 755 and 748 respectively. 94% of our
residential mortgage portfolio has a loan to value ratio of 80% or less and both
portfolios have nominal delinquency and loss rates, and as a reminder, the bank has
not offered payment option adjustable rate mortgage loans for loans of negative
amortization.” – Dan Stevens, BOH’s former CFO, 2007 Q3 Earnings Conference Call,
22 October 2007
15
“Our loan portfolio is diversified and reflective of our strong market position and
longstanding customer relationships. Residential mortgages are the largest single
component of our consumer portfolio. We offer our customers traditional products
underwritten conservatively to their financial repayment capacity. 96% of our first
mortgages have loan to values below 80% based upon origination values and the
weighted average monitoring FICO score was 757 at the end of December.
Similarly, the weighted average monitoring FICO score for our home equity
portfolio was 770 and the combined loan to value was 69%.” – Mary Sellers, BOH’s
Chief Risk Officer, Sandler O’Neill & Partners Financial Services Conference, 03 March
2009
16
“Commercial mortgage outstandings were $788 million as of the end of the quarter,
and included $317 million in owner occupant mortgages and $471 million in investor
exposure. The average owner occupant commercial mortgage is $990,000, with the
current weighted average loan to value of 72% and average current debt service
coverage of 1.3 times. These loans are underwritten based upon the cash flow of the
business, given the real estate asset is utilized in the business operation with the real
estate evaluated as a secondary repayment source. Investor commercial mortgage
loans are underwritten based upon the economic viability of the property and the
overall financial wherewithal of the borrowers. Emphasis is placed on the ratio of
the cash flow to the loans debt service requirements after considering vacancy,
property expenses, and stressing interest rates. Our average commercial investor
mortgage is $1.4 million with a current weighted average loan to value of 57%
and average current debt service coverage of 1.4 times.” – Marry Sellers, BOH’s
Chief Risk Officer, 2009 Q2 Earnings Conference Call, 27 July 2009
17
“Commercial mortgage outstandings were $841 million at the end of the quarter up
$64 million on a link quarter basis and $101 million year-over-year, due in large part to
the par purchase of $47.5 million in season loans in December. These loans are all to
borrowers in our markets. Commercial mortgage out standings include $316 million in
owner occupant loans and $525 million in investor loans. The average owner
occupied commercial mortgage loan is $1 million with a current weighted
average loan to value of 72% and average current debt service coverage of 1.3
times. These loans render it based upon the cash flow of the business given the real
estate is utilized in the business operation, with the real estate evaluated as a
N24
secondary source of repayment. Investor commercial mortgage loans are under
written based upon the economic fundamentals of the property and the overall financial
where with all of the borrower. Emphasis is placed on the ratio of cash flow to the loan
debt service requirements after considering vacancy, property expenses, and stressing
the interest rates. Our average commercial mortgage investor loan is $1.5 million
with a current weighted average loan to value of 57% and average debt service
coverage of 1.4 times.” – Marry Sellers, BOH’s Chief Risk Officer, 2009 Q4 Earnings
Conference Call, 25 January 2010
18
“Given very low levels of internally classified assets in our C&I portfolio, we have no
specific concerns at this time. These portfolio outstandings total $482 million. The risk
component in this portfolio is primarily airline exposure, which we've discussed
in detail in the past.” – Marry Sellers, BOH’s Chief Risk Officer, 2007 Q4 Earnings
Call Transcript, 28 January 2008
19
“The one area that we talk about is having some weakness in automobile loans, the
dealers in Hawaii have faced double-digit sales declines for the last two years.
That has forced them to be more aggressive on sales, and, unfortunately, I think
we supported a little bit of their bad habit. So that elevated our charge-offs through
2007. It's going to continue into 2008. Our forecast, since this is a consumer area, look
pretty much, for the four quarters of '08, likely looked in the fourth quarter of 2007.
We are tightening one more time and going around visiting with our dealers
about the mix of paper that we purchase from them, letting them know that we're
going to be concentrating on top-tier sectors, regardless of the volume, which is
always their argument if you don't take the lower-quality paper, then we won't be
able to share the higher-quality with you, and if that's the deal we have to make,
that's the deal we'll make.” – Allan Landon, BOH’s former CEO, KBW Regional Bank
Conference, 27 February 2008
20
“Let me now turn to the banking market in Hawaii. Four major competitors in the
Hawaii market. Ourselves, First Hawaiian Bank, which is a little bit larger than us.
Full service organization, strategy very similar to that of our own. Owned by BNP
Paribas through their US subsidiary BancWest Corp. American Savings Bank is
number three in the market place, they are roughly half our size, operate using a
thrift charter, and are own by HEI Industries, which is the local electric utility in
Hawaii. The fourth player in our market is Central Pacific Bank, which similar to
us, is publicly owned and traded on the NYSE. The market is split amongst these
four players. On this pie chart here you that see ourselves and First Hawaiian Bank
hold about two-thirds of the market share in deposits for banks in Hawaii, the balance
N25
of the third is controlled or managed by Central Pacific Bank and ASB, American
Savings Bank.
Delinquencies in Hawaii, at least on least on the mortgage line, have performed
substantially better than that of the US average, and our own delinquencies have
performed even better than that. Generally a pretty conservative culture with
respect to credit in Hawaii. One of the great underpinnings of our banking market
in Hawaii is the deposit cost advantage that we have versus the broader US
mainland. Here you see that both currently and historically, the Hawaii banks
have a distinct deposit cost advantage over our mainland brethren, and in fact,
Bank of Hawaii of has an advantage over the local marketplace in Hawaii.” – Peter
Ho, BOH’s CEO, Credit Suisse Small- and Mid-Cap Conference, 15 September 2010
N26
Moat
The Banking Industry in Hawaii Is a Stable Oligopoly
Four banks hold about 90-92% market share in Hawaii for the last 22 years
- Biggest Negative:
o No negative
- Michael Porter Questions
o (-) means low
o (=) means medium
o (+) means high
o For the industry
Is the threat of new entrants high or low?
(-) The number of bank offices in Hawaii have declined
o 2000: 305
o 2005: 285
o 2010: 284
o 2015: 279
Is the bargaining power of buyers high or low?
(+) Borrowers care about rates and terms
Is the threat of substitutes high or low?
(-) No threat of substitutes
Online banking isn’t a threat
Is the bargaining power of suppliers high or low?
0%
20%
40%
60%
80%
100%
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
First Hawaiian Bank Bank of Hawaii
American Savings Bank Central Pacific Financial
N27
(=) Suppliers of money
o Low for checking accounts
o High for CDs
Is the rivalry within the industry high or low?
(+) banks compete aggressively for loans
o For the company
Is the threat of new entrant different for this company specifically?
(-) the threat is lower in Hawaii than in the U.S. mainland
Is the bargaining power of buyers different for this company
specifically?
(-) BOH focus more on relationships
o Makes few construction loans
Is the threat of substitutes different for this company specifically?
(-) no threat of substitutes
Is the bargaining power of suppliers different for this company
specifically?
(-) Time deposit is just 9% of total deposits
Is the rivalry within the industry different for this company specifically?
Competition is less intense in Hawaii than in the U.S. mainland
BOH focuses more on relationship-based banking
o Focus on core deposits
o Doesn’t compete on rates
- Customer retention: Core deposit customers are sticky
o Core deposits represent 91% of total deposits
83% of earning assets
About 50% of deposits come from the consumer side
40% of deposits are from the commercial side
The rest is from institutional and government deposits
o Core deposits are relationship-based
Most of commercial and consumer deposits are relationship-oriented
1
Day-to-day type stuff
Just working capital for families and small businesses
o Isn’t impacted by interest rates
o Hawaiian customers are stickier
Taking customers from other banks isn’t easy in Hawaii
2
The consumer community in Hawaii is reasonably conservative
3
A very high Asian percentage
N28
=> attractive deposit market for BOH
Word-of-mouth and customer stickiness are higher in Hawaii than in the
U.S. mainland
4
5
Hawaii is less of a transient population base than in other states
=> Hawaii banks as a group have as substantial cost of funding
advantage
- Customer acquisition: not important for BOH
o BOH has great penetration
Touch over 50% of all of the households in Hawaii on a deposit basis
6
2/3 of all of the households from a total product basis
o Deposit
o Investment, or
o Borrowing
Over 70% of Hawaii’s large businesses have relationship with BOH
7
Gathering new consumer households is challenging
8
BOH has such a large penetration
=> concentrate on existing customers
o Expand those relationships
- Margin protection: BOH has low funding cost and operating cost
o BOH has the lowest funding cost
BOH typically has 1% lower cost of funding than the average U.S.
mainland bank
9
BOH has more demand deposits
o And is the pricing leader
BOH got the lowest cost of deposits in Hawaii
10
A significant amount of transaction accounts
Position as the pricing leader
Emphasize service over rate
Focus on getting on savings and demand deposits
o (Called transaction accounts)
BOH is the lowest payer of interest
11
Value proposition:
o Convenience
More locations
More ATMs
More ways to access BOH
o Dependability
N29
Ways to generate BOH’s funding advantage
12
Terrific market positioning
o 56% of total retail households
o 70% of the small businesses in Hawaii
o There are 45 zip codes in Hawaii
BOH has the #1 or #2 market share position in 82%
of those zip codes
13
Convenience
o Largest branch network
70 branches
In good locations
o Has the largest ATM network
More ATMs than the next 2 competitors combined
BOH: 456
First Hawaiian Bank: 300
American Savings Bank: 130
Also has advantage in partnerships
Exclusive ATM alliances with
o McDonald’s
o Costco
o CVS
o Longs
o Safeway
BOH has the biggest core deposit market share
Example:
As of 2013 Q2
o BOH has 12% more core deposit than First Hawaiian Bank
o BOH has 50% more core deposit than Central Pacific Bank
and American Savings Bank combined
BOH’s funding cost advantage over peers
= median (each peer’s funding cost – BOH’ funding cost)
o (since 2002 – the year BOH refocus on Hawaii)
American Savings Bank: 0.34%
Central Pacific Financial: 0.40%
U.S. Bancorp: 0.51%
Wells Fargo: 0.21%
All banks with more than $10 billion assets: 0.51%
N30
All banks between $1 billion and $10 billion assets: 0.80%
In 2007, BOH’s funding cost advantage over peers was
American Savings Bank: 0.34%
Central Pacific Financial: 0.65%
U.S. Bancorp: 1.23%
Wells Fargo: 1.06%
All banks with more than $10 billion assets: 1.39%
All banks between $1 billion and $10 billion assets: 1.24%
BOH’s deposit cost advantage would come under threat only if
somebody in the marketplace did something dumb
14
The last time: 2000
o BOH was far more aggressive then
o The last guy that screwed it up was BOH
o BOH has low operating cost
BOH’s average deposit per branch: $185 million
Net non-interest expense/Average earning assets
BOH
o 10-year average: 1.00%
o 2015: 1.12%
First Hawaiian Bank
o 10-year average: 0.91%
o 2014: 0.51%
American Savings Bank
o 10-year average: 2.00%
o 2015: 1.84%
Central Pacific Financial:
o 10-year average: 2.24%
o 2015: 2.01%
Most regional banks have between 1.6% and 3.3% in net operating cost
(Based on a sample of about 50 publicly trade local banks)
- Moat evaluation
o Barrier to entry: High
There’s no major mainland competitors in the deposit gathering arena
in Hawaii
Bank of America entered the market in early 90s
15
By acquiring the old HonFed
o (an S&L)
N31
The acquisition was challenging
o It wasn’t a contiguous acquisition
o No cost synergies
o No marketing synergies
o Significant time difference
Bank of America exited after 5 years
The number of bank offices in Hawaii have declined
2000: 305
2005: 285
2010: 284
2015: 279
The competitive landscape is stable
16
4 major banks hold about 92% of deposit market share
o Since 1994
About 100 credit unions
o Impact of new entrant
Little
o Rivalry among existing firms
Much lower than in the U.S. mainland
4 banks hold about 92% of deposit market share
Since 1994
The Hawaii market is rationally competitive
17
None of the mainland’s deposit-gatherers active in Hawaii
- Conclusion: BOH has a wide moat
1
“I think that the consumer deposits are probably the stickiest, because a lot of
that money is just working capital for families and small businesses, and that
obviously doesn't -- is not as impacted by rate, if you will. A portion of our
commercial deposits are at slight risk, obviously, because there's just so much in
corporate coffers right now. So there's an element to that. But by and large, most of
our deposits, both consumer as well as commercial, are pretty relationship-
oriented, pretty kind of day-to-day type stuff. So we feel good about that.” – Peter
Ho, BOH’s CEO, Barclays Global Financial Services Conference, 10 September 2014
2
“And then this is a great time for us to deepen our customer relationships. We have a
good share of the market. Taking customers from other banks isn't as easy maybe
in Hawaii. We found that there's a great stickiness that's rather surprising almost,
how much loyalty customers show to our banks. At least if you've banked on the
N32
mainland, it's surprising in Hawaii. So making sure that we reinforce that
characteristic of our customer base is important for us.” – Allan Landon, BOH’s former
CEO, DA Davidson & Co Financial Services Conference, 08 May 2008
3
“You'll see from this chart that ourselves and Bank of Hawaii have about two-thirds of
the marketplace. We are the leader in terms of core deposits. We have a 20%
advantage over First Hawaiian in core funding and a 40% advantage over Central
Pacific and American Savings Bank combined. We've been able to attract good
deposit growth since the financial crisis. Hawaii has a good amount of liquidity, a
number of the businesses there are service-oriented, a number of them cash-
oriented businesses because of the visitor industry.
The consumer community is reasonably conservative, a very high Asian
percentage, so an attractive deposit market for us. We've been able to comp
favorably with our deposit product versus the number of the money market products.
And finally, I'd say that our brand is playing quite nicely into the current environment.” –
Peter Ho, BOH’s CEO, KBW Regional Bank Conference, 24 February 2010
4
“Customer loyalty, a bit different in Hawaii than what you find in the broader US
mainland market. Likelihood to recommend their bank to a friend, higher in
Hawaii. Likelihood to stay with their primary bank, higher -- significantly higher in
Hawaii than the national average. I think, for the most part, the reason behind this is
Hawaii is a bit less of a transient market than what you'd find in many parts of
certainly the western states of the United States.
Bring all of this together to generate a very attractive cost of funding base for all of the
participants in the state of Hawaii, including ourselves.” – Peter Ho, BOH’s CEO, KBW
Regional Bank Conference, 01 March 2012
5
“Customer loyalty is another dynamic, it's a bit different in our marketplace versus
what you find in the boarder markets here in the mainland. The likelihood to
recommend their bank to others higher in Hawaii than the national average,
length of time or loyalty to their primary institutions. As you see in this chart,
significantly different than what you find in the national marketplace.
I think the real reason behind this is Hawaii is less of a transient population base
than what you would find in certainly a number of the Western states here in the
mainland. Take all of these attributes, put them together and what you find in Hawaii is
that the Hawaii Banks as a group have a substantial cost of funding advantage
over the US mainland.” – Peter Ho, BOH’s CEO, Sandler O’Neill & Partners, 06 March
2012
N33
6
“We touched in excess of 50% of all of the households in the State of Hawaii on
a deposit basis. More like two-thirds of all of the households in the state from a
total product basis. I have got a great staff, long-standing staff well versed in Hawaii
as well as a lot of great technical expertise.” – Peter Ho, BOH’s CEO, Sandler O’Neill &
Partners Financial Services Conference, 06 March 2012
7
“Commercial banking is another important segment. Here we have large share of the
market. Over 70% of Hawaii's large businesses have relationships with Bank of
Hawaii.” – Allan Landon, BOH’s former CEO, Fox-Pitt, Kelton Small & Mid-Cap
Conference, 17 June 2019
8
“It's a real fundamental area of focus for us in terms of trying to deepen the shared
wallet with our existing customers. We have such a large penetration in the market
that gathering new consumer households is a bit challenging for us, and so we
concentrate on our existing customers and do what we can to expand those
relationships. And we've seen slow but steady growth in terms of customer
relationships over the past few years, and we're going to continue focusing on that.” –
Dave Thomas, BOH’s former COO, 2006 Q1 Earnings Conference Call, 24 April 2006
9
“The chart that's on the screen goes back -- I guess it covers almost 10 years
here, and shows a comparison --the yellow line is sort of the national average of
costs of banks' deposit-based funding. That contrasts with the two other lines. The
blue line is the Hawaii market, and the green line is Bank of Hawaii. We have a mix
that is a little bit heavier weighed toward demand deposits, plus we're the pricing
leader, which helps us keep our advantage of funding about 100-plus basis
points, lower than the average bank. We may have one of the lower costs of funding
-- deposit funding in the country.” – Allan Landon, BOH’s former CEO, KBW Regional
Bank Conference, 27 February 2008
10
“We've got the lowest cost of deposits in Hawaii right now, owing in large part
to a significant amount of transaction accounts, demand deposit accounts, non-
interest bearing accounts, as well as our position as sort of the pricing leader. So
we are the low rate deposit institution. We emphasize service over rate.
Our focus on growth is going to be to continue to concentrate on savings and
demand deposits. What I'll call transaction accounts rather than time accounts. We're
going to see a natural migration. We've built, like most other banks, a customer self-
selection model that allows customers to move pretty fluidly into time deposits. Those
have value to us compared to our other sources of funding, but not as significant a
value as our traditional savings and demand deposit accounts.
N34
So with our delivery channel, we're going to continue to emphasize that focus on
growing demand and savings accounts, use time deposits then as sort of the
balancing mechanism between our transaction deposit funding base and our
wholesale deposit base, or our wholesale funding base.” – Allan Landon, BOH’s
former CEO, KBW Regional Bank Conference, 28 February 2007
11
“We are the low payer of interest, the lowest interest rates you get in Hawaii.
Our value proposition is convenience and dependability, so the more locations, the
more ATMs, the more ways to access us.” – Allan Landon, BOH’s former CEO, DA
Davidson & Co Financial Services Conference, 08 May 2008
12
“We generate our funding advantage in a number of ways. Convenience obviously is
an important part of our overall brand strategy. We also have terrific market
positioning with 56% of total retail households and 70% of the small businesses
in Hawaii. In terms of convenience, we have the largest branch network. Not only
that we have the most branches, but I'd mention that we have branches in the real
estate locations that you'd want to be in. From an ATM perspective, we also are the
market leader in convenience there, and there not only do we have a quantity
advantage, but also an advantage in partnerships. We're the exclusive provider
for McDonald's, Costco, CVS, Longs and Safeway. This slide here gives you a
sense for our brand awareness in the marketplace, you see that we're at least by this
study advantaged versus the competition.” – Peter Ho, BOH’s CEO, KBW Regional
Bank Conference, 24 February 2010
13
“From a convenient standpoint, you see here that we are best in market in terms of
the total number of branches. We have 72 branches in the State of Hawaii. From a
market position standpoint, there are 45 neighborhoods of [goods] in the State of
Hawaii. So, if you take a look at those 45 and go by deposit position, Bank of
Hawaii has a number one or a number two market position in 82% of those
neighborhoods. So, a good performance across a broad base of the community in
Hawaii.
Our convenience advantage extends over to the electronic side. We have a pretty
significant lead in terms of the total number of ATMs in Hawaii versus our
competitors. We also have exclusive alliances with some pretty important
retailers, exclusive ATM alliances with the likes of Safeway, McDonald's and
Longs CVS.” – Peter Ho, BOH’s CEO, Macquarie Securities Small- and Mid-Cap
Conference, 15 June 2010
14
“Unidentified Audience Member: Is there any reason to think that you're a deposit cost
advantage in the Hawaii system, would any time come under threat?
N35
Allan Landon, BOH’s former CEO: I think the only way that that would happen is if
somebody in the marketplace really did something dumb. The last time that that
happened was back in 2000, and Bank of Hawaii was far more aggressive then.
The last guys that screwed it up was us. (Laughter) We have no interest in doing
that again. As I mentioned, we're fortunate not to have any mainland deposit
gatherers in the islands right now, so we would have to see some intrusion from
outside or some imbalance. You saw First Hawaiian is growing their deposits. They
have a very conservative loan to deposit ratio too.” – Lehman Brothers Global Financial
Services Conference, 08 September 2008
15
“I guess the last time one of the large banks entered into our marketplace was
mid-'90s, call it, when BofA acquired the old HonFed, which was an S&L, and
operated that for several years. And I think had a difficult time dealing with the
overwater considerations. So I think it's -- all mergers and acquisitions are somewhat
challenging. I think that the fact that you simply can't see a contiguous acquisition
in Hawaii because of the overwater considerations make things soft.
So things like marketing synergies that you might get from moving from one spot
to another spot contiguously here in the Western part of the United States
doesn't play it easily, and significant time difference changes, just span of
control issues, I think. And in many ways, that plays in the opposite way as we work
abroad, right. It's just challenging to manage operations 2,500 miles away with not
a lot of contiguous opportunity to make those operations closer is what we found
and ultimately decided to abandon.” – Peter Ho, BOH’s CEO, Sandler O’Neill &
Partners Financial Services Conference, 08 March 2011
16
“It is a marketplace literally surrounded by 2,300 miles of ocean. So we are a bit
isolated. We basically run the marketplace with four major banks. So ourselves, First
Hawaiian, $14.5 billion; First Hawaiian, 17-point-something billion; ASB and CPV, about
half that size. Right?
So First Hawaiian and Bank of Hawaii hold about two-thirds of the deposit market
share; ASB and CPV hold the other third. If you put the credit unions in, they would
be more aligned to ASB and CPV in size. In total, there are about 100 credit unions in
Hawaii. Okay.
So obviously that is a pretty cozy competitive set. It is a competitive set that has
battled with each other for decades. Not too much in the way of mergers and
acquisitions, given the marketplace, the changed dynamics there. So the
competitive side, the supply side is -- has been pretty stable for a number of
years.
N36
On the demand side, the population base is growing slowly, so about 1% a year; a
very high percentage of wealth in the islands for various reasons. So, a good amount of
demand for banking services and products. Deposits have always grown at a rate
higher than that of loans in the islands. And so that in some ways has really put a
buffer on deposit pricing to begin with. So you put all of that together and you get
the -- how shall I term this? -- the most attractive deposit market for the industry in
the country.” – Kent Lucien, BOH’s CFO, KBW Boston Regional Bank Conference, 25
February 2015
17
“The Hawaii market is competitive, but I would tell you rationally competitive.
One of the unique features of Hawaii is that we have none of the mainland's
deposit-gatherers active in Hawaii.” – Allan Landon, BOH’s former CEO, KBW
Regional Bank Conference, 27 February 2008
N37
Quality
The Focus on Low-Cost Funding Makes Bank of Hawaii Sensitive to Interest
Rates
BOH’s profitability declined by almost 50% since 2004
- Biggest Negative:
o BOH’s profitability is sensitive to interest rates
- Michael Porter Questions
o (-) means low
o (=) means medium
o (+) means high
o For the industry
Can the industry charge a high price?
(=) The industry charge a stable “Net Interest Spread” over cost
of money
Does the industry have low costs?
(-) Banks have the lowest cost of money
o Lower cost of money than pension funds or bond funds
Does the industry have low need for assets?
(+)The industry is capital-intensive
o Rely on high leverage
o Leverage depends on regulatory capital ratios
o For the company
3.0%
3.1%
3.0%
2.9%
2.8%
2.0%
2.2%
1.8%
1.9%
1.7%
1.8%
1.7%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
BOH's Pre-tax Return on Earning Assets
N38
Can the company charge a higher or lower price than the industry?
(=) BOH’s yield on earning assets is mediocre
Does the company have higher or lower cost than the industry?
(-) BOH has lower cost than the industry
o Low cost of funding
o Low operating cost
Does the company have more or less need for NTA than the industry?
(-) BOH maintains 7% Tangible Equity to Earning Assets ratio
- The industry’s net interest margin is very stable
o Net interest margin = yield on earning assets – cost of funding earning assets
o Based on data of all FDIC-insured institutions
o Net interest margin was about 3.6% in the 1996-2014 period
Min: 3.14%
Max: 4.06%
Median: 3.60%
Mean: 3.61%
Standard deviation: 0.30%
Variation: 0.08 (very stable)
o NIM is stable because the industry have lower cost of money than competitors
Banks can get funding from
Non-interest bearing deposit
o free
Time deposit
o Cost less than Fed funds
Other borrowings
Bank’s average net operating cost is
Banks with assets over $10 billion: 1.1%
Banks between $1 billion and $10 billion: 1.83%
=> Banks total cost of money is about 1-2% more than Fed funds
Not far from risk-free rates
1954-2014 Median (10-year treasury yield – Fed funds) is 1.06%
=> Banks have lower costs than competitors
Bond funds
Pension funds
Etc.
- BOH’s net yield on earning asset is mediocre
o Net yield = (interest income – charge-offs)/average earning assets
N39
o Based on the average difference in net yield on earning assets since 2002
BOH’s net yield is
0.33% lower than American Savings Bank
0.34% higher than Central Pacific Financial
o Mainly because CPF had big losses in crisis years
0.11% higher than all FDIC-insured institutions
0.33% higher than FDIC-insured institutions with more than $10
billion assets
o Based on the average difference in yield since 2002
BOH’s loan yield is
0.28% lower than American Savings Bank
0.53% lower than Central Pacific Financial
BOH’s net loan yield is
0.47% lower than American Savings Bank
0.54% higher than Central Pacific Financial
- BOH’s quality comes from its low cost of funding
o Deposits are 91% of total liabilities
o Low-cost core deposits are 91% of total deposits
83% of total earning assets
o BOH’s funding sources as a % of average earning assets
(as of March 31, 2016)
Noninterest-bearing deposits, liabilities, and equity: 33%
Interest-bearing demand deposits: 18%
Savings: 35%
Time deposit: 8%
Other borrowings: 6%
Mostly repos
o Interest-bearing demand deposit and savings have low costs
Interest-bearing demand deposit
Rates were
o 2003: 0.21%
o 2004: 0.22%
o 2005: 0.61%
o 2006: 0.98%
o 2007: 1.01%
o 2008: 0.33%
Cost less than 20% of Federal fund rates (FFR)
N40
o 2003: 18% of FFR
o 2004: 17% of FFR
o 2005: 19% of FFR
o 2006: 20% of FFR
o 2007: 20% of FFR
o 2008: 17% of FFR
Savings
Rates were
o 2003: 0.58%
o 2004: 0.45%
o 2005: 0.70%
o 2006: 1.41%
o 2007: 1.97%
o 2008: 1.02%
Cost less than 50% of Federal fund rates (FFR)
o 2003: 51% of FFR
o 2004: 33% of FFR
o 2005: 22% of FFR
o 2006: 28% of FFR
o 2007: 39% of FFR
o 2008: 53% of FFR
Many banks pay about 50% of FFR for these types of deposits
U.S. Bancorp: 40% of FFR
Wells Fargo: 54% of FFR
o Time deposit and other borrowings cost slightly more than Fed funds
About 110% of FFR
o => BOH’s cost of funding is less than 40% of FFR
= 18% * 20% + 35% * 50% + 14% * 110% = 36.5%
o The industry’s liabilities consist of
(Based on McKinsey report in 2012)
Free funding: 22%
Noninterest-bearing deposit
Equity
Interest-bearing deposits: 37%
On average cost about 75-80% of fed funds
Other liabilities: 41%
Cost much more than fed funds
N41
=> the industry’s cost of funding would exceed 70% of fed funds
22% * 0% + 37% * 75% + 41% * 100% = 69%
o => BOH’s funding cost advantage is more than 30% of FFR
3% FFR results in more than 0.90% cost advantage
Other things equals, 0.90% cost advantage results in ROE of about 9%
higher than average
o Example in 2005
Average FFR: 3.21%
BOH’s cost of funding: 1.07%
Banks with more than $10 billion assets: 2.30%
=> 1.23% cost advantage for Commerce
- Low funding sources make BOH more sensitive to interest rates than the industry
o Example:
Net interest margin = yield on earning assets – cost of funding
(NIM)
BOH’s NIM:
2006: 4.25%
2014: 2.85%
2015: 2.81%
All FDIC-insured institutions
2006: 3.31%
2014: 3.14%
Banks with more than $10 billion assets:
2006: 3.12%
2014: 3.01%
o There’s not much room for BOH to reduce its cost of low-cost funding
Interest expense/Earning assets were
2006: 1.79%
2015: 0.26%
o BOH’s yield on earning assets declined more sharply as FFR declined
Example:
C&I
o 2006: 7.36%
o 2015: 3.18%
Commercial Mortgage
o 2006: 6.73%
o 2015: 3.79%
N42
Residential Mortgage
o 2006: 5.97%
o 2015: 4.10%
Home Equity
o 2006: 7.42%
o 2015: 3.62%
Similarly, yield on the securities portfolio declined
2006: 4.83%
2015: 2.19%
Commerce is interest rate neutral in the short run
48% of its loan portfolio have fixed rates
90% of its securities portfolio have fixed rates
=> 63% of earning assets have fixed rates
o This can reverse as FFR increase
- Low operating cost gives BOH another 1% advantage
o BOH
10-year average: 1.00%
2015: 1.12%
o First Hawaiian Bank (FHB)
10-year average: 0.91%
2014: 0.51%
o American Savings Bank (ASB)
10-year average: 2.00%
2015: 1.84%
o Central Pacific Financial (CPF)
10-year average: 2.24%
2015: 2.01%
o BOH + FHB = 68% market share
o ASB + CPF = 24% market share
o => BOH + FHB enjoy more than 1% operating cost advantage over the rest of
the market
- BOH was able to make good ROE
o Made 1.65% return on earning assets (ROEA) in its worst year
2015
o Made 3% ROEA in 2004-2007
o BOH maintain about 7% tangible equity to total assets ratio
Equivalent to a leverage ratio of more than 14
N43
Results in
23% pre-tax ROE in its worst year
42% pre-tax ROE in a normal year
- 8 dimensions of quality
o Relative size
Great relative size to depositors and borrowers
o Focus
BOH is focused on Hawaii
o Customer engagement
BOH has a deeper level of relationship than peers
10-year average noninterest income
BOH: $219 million
First Hawaiian Bank: $172 million
American Savings Bank: $62 million
Central Pacific Financial: $51 million
10-year total noninterest income/10-year total earning assets
BOH: 1.84%
First Hawaiian Bank: 1.38%
American Savings Bank: 1.19%
Central Pacific Financial: 1.13%
o Cross-selling
BOH tries to sell more products to existing customers
o Retention
Very high
o Words of mouth
Possibly good
o Reinvestment rate
BOH has the most branches and ATMs in Hawaii
BOH has the highest level of noninterest expenses
10-year average noninterest expenses
o BOH: $339 million
o First Hawaiian Bank: $283 million
o American Savings Bank: $166 million
o Central Pacific Financial: $150 million
o Stock’s popularity
Short-interest: 10.82%
Share turnover: 141%
N44
3-month average daily volume: 236 thousand shares
Float: 42 million shares
N45
Capital Allocation
Facing Low Growth, Bank of Hawaii Returned Most of its Earnings to
Shareholders
Over the last 10 years, BOH returned 88% of its earnings to shareholders
- Biggest Negative: No negative
- Annual share dilution is about 0.45%
o Over the last 10 years
Gross dilution: 1.12% annually
Net dilution: 0.45% annually
Include the effect of share buyback using proceeds from
exercises of stock options
- Compensation include
o Base salary
o Short-term incentive compensation
Paid by cash
The CEO and other NEOs participate in the Executive Incentive Plan
(EIP)
EIP provides for a maximum incentive pool of 3% of BOH’s net income
At the beginning of each year, each executive is allocated a maximum
% of the incentive pool
For 2015
o Peter Ho, CEO: 30%
($26)
$2
$45
$56
$72
($36)
$3
$30
$19
$29
$130
$100
$62
$1
$25
$112
$81
$40
$64
$53
$77
$82
$85
$86
$87
$85
$82
$81
$80
$78
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Retained Earnings Share Repurchase Dividends
N46
o Kent Lucien, CFO: 12%
o Mary Sellers, CRO: 12%
o Mark Rossi, Chief Administrative Officer: 12%
o Wayne Hamano, Chief Commercial Officer: 8.5%
Target award for the CEO: 100% of base salary
Minimum payout: 50%
o Achieved only if the company is in the third quartile of peer
performance
Maximum payout: 250%
Performance metrics include
Return on equity (30% weight)
Stock Price-to-Book Ratio (30% weight)
Tier 1 Capital Ratio (20% weight)
o Long-term Incentive Compensation
Paid by performance shares
Restricted stock grants
Restricted stock units
Based on 3-year performance
Performance metrics include
Return on equity (40% weight)
Stock Price-to-Book Ratio (40% weight)
Tier 1 Capital Ratio (20% weight)
To achieve full payout
Top quartile performance in all 3 metrics must occur
To achieve any payout
Top two quartile performance must occur
- BOH is very much a return-oriented company
1
o ROA and ROE are important
o Of the 3 performance metrics, ROE and Tier 1 Capital Ratio are controllable
These 2 ratio has inverse relationship
Higher Tier 1 Capital ratio means lower leverage
=> reduce ROE
ROE has higher weight
o It’s unclear why BOH include P/B in its compensation decision
P/B is uncontrollable
- BOH maintains 7% tangible equity to total assets
o Don’t see a great deal of benefit from operating at a lower ratio
2
N47
o From 2005 to 2015
Min: 6.46%
Max: 7.48%
Median: 6.98%
Mean: 6.95%
Standard Deviation: 0.29%
Variation: 0.04 (extremely stable)
o 7% tangible equity to total assets is adequate
Similar to Frost’s level in 2002-2007
Prosperity: between 4.5% and 7% tangible equity to total assets
7% tangible equity to total assets can result in 10-15% tier 1 capital
ratio
- BOH doesn’t make any acquisition
o No acquisition inside Hawaii
Likelihood of in-market acquisitions seems an outlier to BOH
3
Hawaii is already a pretty concentrated market
o No acquisition outside of Hawaii
BOH wants to have competitive advantage in the market it enters
The lack of contiguity is a challenge for BOH to expand in the mainland
4
It’s hard to justify acquisitions outside of BOH’s market
5
High risks
BOH is far more interested in making sure it operates efficiently
Cheap acquisition isn’t always a great value
6
No competitive advantage by managing a Mainland business
from Honolulu
- Return almost 100% of earnings
o In 2007
BOH returned more than 90% of earnings
7
40% dividend payout ratio
50% of generated capital is available for share repurchases
o BOH’s formula before the financial crisis
8
Add earnings to its capital
Subtract a little bit to cover growth
Return the rest in the form of
Dividends, or
Share repurchase
BOH returned almost 100% of income to shareholders
9
N48
o BOH stopped its share repurchase in September 2008
(but still maintained dividends)
To improve capital ratio
BOH reinitiated the share repurchase program two years later
During Q3 2010
o BOH returned 83% of total earnings over the last 3 years
Despite depressed margins
Total income: $474 million
Total cash return: $395 million
o BOH returned 88% of total earnings over the last 10 years
Total income: $1,685 million
Total cash return: $1,490 million
o Historically return about half-half, dividends and share repurchases
10
40-50% dividend payout rate
The rest is share repurchase
o BOH doesn’t time share repurchase
Since 2000, BOH repurchased 46% of its outstanding shares
The number of outstanding shares declined 4% annually
2000: 79,612,178 shares
2015: 43,282,153 shares
1
“Andrea Jao, Analyst, Cowen: Peter, could you remind us what -- in terms of your
long-term strategy, what profitability metrics you are targeting versus the current
metrics that you're showing right now?
Peter Ho, BOH’s CEO: Andrea, I'm going to take a stab at your first question, and then
I'll ask Kent to talk about the sizing issue. As you know and as I think most of you know,
we are very much a return-oriented company. So the metrics that are meaningful
to us are a return on assets, return on shareholders equity is an important metric
to us. We are going to do everything within our capacity, within the environment that
we find ourselves in, to maximize those objectives.” – BOH 2010 Q3 Earnings
Conference Call, 25 October 2010
2
“The 7% turned out to work pretty good for us, Fred, as you recall, that was kind of
an interim level that we set, and we have evaluated different alternatives to operate
at a lower level, and in the end, we didn't see a great deal of benefit from trying to
do that, and we like the capital levels we have right now. We have spent some time
talking with our Board about it.
N49
And so for the basis of this plan, we think the 7% level is just about where we want
to be. We may vary up or down a few basis points off of that, just because it's a
balance between with a we do in the repurchase market, and as you'll see here,
January 1st, some accounting entries, that's kind of where we are planning to stay.” –
Allan Landon, BOH’s former CEO, 2006 Q4 Earnings Conference Call, 22 January
2007
3
“Brett Rabatin, Analyst: Well, you had good results relative to the environment so
everybody is off trying to figure out who is getting the TARP, I guess. Speaking of that, I
guess I'm very surprised you guys are -- you're buying stock back here recently. I know
you haven't done any. A., as you are evaluating that, is that a function of potential
acquisitions? I can't imagine. I'm not sure why you would be too gung-ho to be getting
involved in the TARP. And then secondly, just, you are going to grow your capital
ratios. Aside from any government involvement, do you have a target now? A new
target?
Allan Landon, BOH’s former CEO: No, we haven't set a specific target. We're going to
continue to let the ratios go up as we slow our repurchase. We stopped in the
middle of September with repurchase, and I think you did a very nice job of
summarizing what we're considering as we look at the capital purchase program. But
I'm thinking that there are sort of macro factors that are involved, and we've got watch
those, too. From just our bank standpoint, right now we feel pretty comfortable with our
capital plan and strategy. And as you know, Hawaii is a pretty concentrated market
already, so the likelihood of in-market acquisitions seems to be sort of an outlier
to us.” – BOH’s 2008 Q3 Earnings Conference Call, 27 October 2008
4
“We take a look regularly at ways to expand our business and expanding organically in
a moderate growth economy does require exactly that careful attention to detail that
Mike mentioned. When we look at expanding beyond our current market territory,
we look at it at about four levels. We start with assessing the markets and their
individual attractiveness. So, we have to have an attractive market, we have to
have a market where Bank of Hawaii can be competitive. Our brand is rather
unique, our name is rather unique. There are we believe mainland markets where that
will -- the brand will work quite well. So, when we find an attractive market and one
where we compete, the third criteria is a reasonable price of entry and in the
current environment, we have not found an opportunity where that would work for us
very well. And then, the first criteria and long-term the one I think probably most
important to shareholders is the ability to integrate and operate efficiently and we
have got to develop our people a little more, our technology a little more. We
have the handicap of 2,500 miles of ocean between us and any market. So that
lack of contiguity is a little bit of a challenge for us. So, requires us to be especially
N50
careful when we look at off-island expansion as we call it.” – Allan Landon, BOH’s
former CEO, Sandler O’Neill & Partners Financial Services, 06 March 2007
5
“Erika Penala, Analyst: And I guess -- another question is if the opportunities for Bank
of Hawaii to buy banks out of receivership presents itself, would you care to go back
Mainland or given that your concentration in Hawaii from a deposit standpoint? Or is
that a nonstarter? [ laughter ]
Allan Landon, BOH’s former CEO: It is a pretty interesting question. You know for us, it
is about building value. And we try to keep a focus shareholders first, but then balance
that with community and customers and employees. And when we look at the risks
associated with going outside of our market in an expansion, especially an
acquisition, it just seems hard right now to justify that.
In fact, I'll go one step further. As you look at the quarterly results and you see the good
will impairments showing up, I think it really has to question whether it has ever made a
whole lot of sense to try to grow aggressively that way. So we have always left that as
an option, if it builds value. We will give consideration to it. We know that there are
going to be lower price, and probably some institutions under stress.
We have got a strong solid, well-prepared management team. So could there be some
place where our brand works, in combination of attractive pricing and good market? I
guess we wouldn't rule it out. But I will tell you, we are far more interested in making
sure that our bank operates efficiently, and we got the workforce aligned, and the
market and the program set for our markets right now.” – BOH’s 2008 Q4 Earnings
Conference Call, 26 January 2009
6
“Unidentified Audience Member: Kind of on a different vein, but you did a terrific job of
avoiding the temptation of coming back over to the Mainland when some of your
competitors took the other route. Is there a period of time or an economic incentive that
would, with all things going on with the FDIC and whatnot, that would lead you to
consider kind of branching back over stateside?
Allan Landon, BOH’s former CEO: Sure. We pay attention to possible opportunities. We
remind each other that cheap isn't always a great value. So we use the same
forecasts that we used when the economy was healthy. First of all, it has to be an
attractive market. At one time, Las Vegas looked like a very attractive market. That
has revealed itself to be a little bit different right now and there may be an interim zone
there.
N51
Our Bank of Hawaii brand needs to work. To have any leverage, you need to be able
to move in with Bank of Hawaii and have some appeal. I mentioned Las Vegas earlier
because there are 100,000 people who have Hawaii connections who live in the
greater Las Vegas area. That is the largest concentration outside of Hawaii.
You have to be able to enter at a reasonable price we think and as I said, free
may not be a good value in some cases. And then you have to be able to manage
it from Hawaii in our view and that is a particular challenge. I can think of no
competitive advantage by managing a Mainland business from Honolulu. You
may be able to overcome the hurdles with the right team being integrated with a local
team.
Right now, it just seems like that is too far to stretch and it just is difficult for us to
see anything that is going to generate value for shareholders out of that
approach. So I have tried to never say never because you don't know what
opportunities will come your way and we do watch for them, but we have no plans right
now and we are going to continue to apply those tests maybe even more rigorously
now than we did before.” – Fox-Pitt, Kelton Small & Mid-Cap Conference, 17 June 2009
7
“We expect to continue our capital management program in 2007. We plan to maintain
a simple leverage ratio of about 7%. We have been at that level for about the last year
now. We expect to use 90% or more of our generated capital to pay dividends and
to repurchase common stock. We expect our dividend payout ratio to be
approximately 40% annually. That means that about 50% of our generated capital
or possibly more is available to be returned through share repurchases.” – Allan
Landon, BOH’s former CEO, Sandler O’Neill & Partners Financial Services Conference,
06 March 2007
8
“That fact primarily drives our decision to stay a little bit more focused on the risk
management or disciplined side of the business. We keep our liquidity high. If you saw
the statistics there, our investment portfolio is about the same size as our loan portfolio
now, at least if you put cash in short-term investments in there. Shift a little bit from
credit risk to investment risk, we've continued to increase our capital. Years ago we
would tell people that our formula was to add our earnings to our capital,
subtract a little bit to cover growth and return the rest in the form of dividends or
share repurchase program. As the crisis became obvious, we suspended the
share repurchase program and we've been off of that now for about 18 months.”
– Allan Landon, BOH’s former CEO, KBW Regional Bank Conference, 24 February
2010
9
“Our capital management strategy has been to -- the last couple of years has been to
increase capital during the crisis. It's all internal generation. So, we've not issued
N52
capital, and as I mentioned earlier, we did not participate in the Troubled Asset
program from the government. We had a formula of returning about 100% of our
income to shareholders through dividends and share repurchases. 2008, we
suspended our share repurchase program, we've maintained our dividend $0.48 -
- $0.45 per quarter throughout that entire period as we have maintained our
profitability. So, we had no quarters where we had a loss. All of our capital is common
equity. Only $37 million, a small amount is in goodwill. So, it is essentially all tangible,
no hybrids, no preferred or trust preferred stock.” – Allan Landon, BOH’s former CEO,
Macquarie Securities Small- and Mid-Cap Conference, 15 June 2010
10
“While as you mentioned, capital and the deployment of capital and the return of
capital are critically important elements of our strategy. And so, as Peter had
mentioned, we have a very healthy dividend and the policy is 40% to 50% of
earnings. And at this point, everything else that we are earning is being returned
to shareholders in the form of share repurchases.
In fact, we are going beyond our current earnings such as right now, we are at about
125% of earnings. That particular kind of repurchase activity is not forever
sustainable obviously. But we can go awhile at that pace. Longer term,
approaching a 100%, is not impossible, it can't be literally 100% but close to it.
There is no particular metric that would represent a floor for us. We would like to
look at tangible common to risk weighted as a relevant measurement and it's a
little bit under 18%. So we think we have plenty of capital for this purpose and it's likely
to be an important part of the strategy going forward.” – Kent Lucien, BOH’s CFO,
Sandler O’Neill & Partners Financial Services Conference, 06 March 2012
N53
Value
Bank of Hawaii is Cheap Based on Normal Earnings
Bank of Hawaii is trading at around 7 times pre-tax normal earnings
- Biggest Negative:
o Low growth makes BOH’s high ROE less valuable
- Key inputs
o Share price: $68 per share
o Outstanding shares: 43.04 million
o Market cap: $2,927 million
o EV: $2,927
o Short-term investments: $691 million
o Securities: $6,229 million
o Loans: $7,940 million
o Earning Assets: $14,860 million
o Deposit: $13,335 million
Noninterest-bearing demand: $4,227 million
Interest-bearing demand: $2,762 million
Savings: $5,138 million
Time: $1,208 million
o Other borrowings: $843 million
- Normal pre-tax earnings is at least $389 million
o Assumption
11.7
7.5
6.6
Current Conservative Estimate 2004-2007 Level
Price/Pre-tax Earnings
N54
Fed fund rates (FFR): 3%
Cost of interest-bearing demand deposits: 0.60%
Or 20% of Fed funds
Interest-bearing demand deposits cost less than 20% of Federal
fund rates (FFR)
o 2003: 18% of FFR
o 2004: 17% of FFR
o 2005: 19% of FFR
o 2006: 20% of FFR
o 2007: 20% of FFR
o 2008: 17% of FFR
Cost of savings: 1.5%
Or 50% of Fed funds
Savings cost less than 50% of Federal fund rates (FFR)
o 2003: 51% of FFR
o 2004: 33% of FFR
o 2005: 22% of FFR
o 2006: 28% of FFR
o 2007: 39% of FFR
o 2008: 53% of FFR
Time deposit and other borrowing cost about 3.3%
110% of FFR
At 3% FFR, 50% of noninterest-bearing demand deposits may turn into
interest-bearing demand deposits
=> $2,114 million noninterest-bearing demand deposits
Slightly higher than the $1.9 billion level BOH had in 2004-2007
o => funding mix is
Free funding: $2,796 million
19%
Interest-bearing demand deposits: $4,876 million
33%
Savings: $5,138 million
35%
Time deposits: $1,208 million
8%
Other borrowings: $843
6%
N55
o Cost of funding is 1.17%
0.6% * 33% + 1.5% * 35% + 3.3% * 8% + 3.3% * 6% = 1.17%
o When FFR is 3%, BOH can make at least 5.2% yield on earning asset
Yield was 5.44% in 2005
FFR was 3.21% in 2005
Yield in 2005 were dragged down by low FFR in previous year
o 2002: 1.67%
o 2003: 1.13%
o 2004: 1.35%
At 3% FFR, BOH can easily make
6% yield on loan
o Yield on loan in 2015 was 4.02%
FFR: 0.09%
4% yield on securities
o Yield on securities in 2015 was 2.19%
o Duration of the securities portfolio: 3.4 years
If loan is 60% of earning assets
o Average yield is 6% * 60% + 4% * 40% = 5.2%
Loan/earning assets were between 65% and 68% in 2003-2008
o 25-year average net charge-offs/earning assets: 0.29%
Net charge-offs/earning assets is likely to stay low in near future
o Net operating cost: 1.12%
This is the number in 2015
10-year average is only 1.00%
There are cost cutting opportunities
Example:
Reducing branch size
1
o BOH’s branches average 4,700 square feet today
72 branches
Total 340,000 square feet
o The management think this is too big
o They can bring down to 3,000 square feet per branch
Transition from analog to physical
o Deploying envelope free deposit taking ATM machines
o Can migrate 50% of branch depositors to ATM machines
To be conservative, we still use 1.12% net operating cost
o Pre-tax return on earning asset is 2.62%
N56
5.2% - 1.17% - 0.29% - 1.12% = 2.62%
o This is a low estimate
BOH made about 3% return on earning assets in 2004-2007
2004: 3.00%
2005: 3.06%
2006: 3.03%
2007: 2.94%
o 2.62% pre-tax ROEA results in $389 million pre-tax normal earnings
- BOH’s current valuation
o EV/2015 EBT: 12
o EV/Normal EBT: 7.5
- Peer comparison
o Frost (CFR)
Frost is a strong franchise in Texas
Frost grew deposits by 9-10% annually
For over 20 years
Frost has the lowest funding cost
Has a lot of noninterest-bearing deposits
o 41% of total deposits
Frost’s current valuation
Share price: $63
Market Cap: $3,905 million
Preferred stock: $144 million
EV: $4,050 million
EV/Earning Assets: 0.16
EV/Deposit: 0.17
EV/2015 EBT: 8.59
EV/Normal EBT: 5.56
Using 2.81% ROEA
o BOK Financial (BOKF)
BOK is leading regional peer in Oklahoma
Deposit breakdown by states
o Oklahoma: 54%
o Texas: 25%
o Colorado: 7%
o New Mexico: 6%
N57
o Arizona: 4%
o Kansas City: 3%
o Kansas: 1%
BOK has a strong focus on fee-based business
Fee incomes are 50% of revenue
o Brokerage & trading: 10% of revenue
o Mortgage banking: 10% of revenue
o Transaction card: 10% of revenue
o Trust fees: 9% of revenue
o Service charges: 7.1%
o Other: 3.6%
BOK also sees fee-based businesses as a key to getting banking
customers
Deposit grew 10.5% annually over the last 22 years
9.8% over the last 15 years
8.2% over the last 10 years
There’s big concern about BOKF’s energy portfolio
19.2% of total loan outstanding
10.6% of total earning assets
BOK’s current valuation
Share price: $60.31
Market Cap: $3,990 million
Preferred stock: $0 million
EV: $3,990 million
EV/Deposit: 0.19
EV/2015 EBT: 9.15
EV/Normal EBT: 5.15
Using 2.71% ROEA
o Commerce Bancshares (CBSH)
Commerce operates in
Missouri: 8.64% market share
o 13.76% market share in Kansas City
o 8.45% market share in St. Louis
Kansas: 5.28% market share
Central Illinois
o 0.30% market share
N58
Tulsa, Oklahoma
o 1.55% market share
Oklahoma City
o 0.15% market share
Denver, Colorado: 0.25% market share
Commerce has a strong focus on fee-based business
Mortgage banking
Trust
Card processing
Fee incomes are 40% of revenue
Higher than most banks
Commerce also see fee-based businesses as a key to getting banking
customers
Deposit grew 5.3% annually over the last 23 years
4.8% over the last 15 years
6.2% over the last 10 years
Commerce’s current valuation
Share price: $47.55
Market Cap: $4,591 million
Preferred Stock: $145 million
EV: $4,736 million
EV/Deposit: 0.24
EV/2015 EBT: 11.36
EV/Normal EBT: 6.98
Using 2.91% ROEA
o UMB Financial (UMBF)
UMB gets 63% of its deposits from Kansas City
Has 18.7% market share in this market
o #1
o Next top players are
Commerce: 13.04%
Bank of America: 9.71%
U.S. Bancorp: 6.14%
UMB lends very conservatively
Its net charge-offs in its worst year was just 0.57%
Deposit grew 5.94% annually over the last 25 years
N59
4.75% over the last 20 years
5.93% over the last 15 years
9.81% over the last 10 years
UMB’s current valuation
Share price: $55.45
Market Cap: $2,744 million
Preferred stock: $0 million
EV: $2,744 million
EV/Earning Assets: 0.15
EV/Deposit: 0.18
P/2015 EBT: 14.98
P/Normal EBT: 6.68
Using 2.28% ROEA
o Central Pacific Financial (CPF)
CPF is the 4
th
largest bank in Hawaii
11% deposit market share
CPF went belly up during the 2008-2009 financial crisis
Total net charge-offs were over $600 million from 2008 to 2011
o For a loan portfolio of about $4 billion
Had to participate in TARP
o In January 2009
o Sold 135,000 shares of the TARP preferred stock
And a 10-year warrant to purchase up to 1,585,748
shares
Exercise price: $12.77 per share
o Share price was about $40 in 2007
Had to raise $325 million through a Private placement
o In February 2011
Since early 2007, CPF’s shareholders lost over 95%
CPF’s current valuation
Share price: $22.91
Market Cap: $712 million
Preferred stock: $0 million
EV: $712 million
EV/Earning Assets: 0.15
EV/Deposit: 0.16
N60
P/2015 EBT: 9.47
P/Normal EBT: 8.17
Using 1.82% ROEA
- Among peers
o Frost is the superior peer
Lower funding cost
Slightly higher operating cost
Frost: 1.40%
BOH: 1.12%
Greater growth
Frost: 9-10%
BOH: 3-4%
Frost is cheaper
o BOK has higher risk
Higher energy exposure
Higher upside
Greater growth
Cheaper
o UMB and Commerce are close peer
These are both leading banks in low growth states
BOH and Commerce has close ROEA profile
Since 2002
o BOH’s funding cost advantage over Commerce
Median: 0.03%
Mean: 0.12%
o BOH’s net yield disadvantage to Commerce
Median: 0.18%
Mean: 0.03%
BOH has slightly higher operating cost
o BOH: 1.12%
10-year average: 1.00%
o Commerce: 1.03%
Our assumption of ROEA
o BOH: 2.62%
o Commerce: 2.91%
o This gap is bigger than the gap in operating cost
Main reason: we’re more conservative on BOH
N61
We assume a lower yield for BOH
o BOH: 5.2%
o Commerce: 5.5%
EV/Deposit can be a better comparison tool for this pair
Commerce’s potential growth is higher than BOH
Commerce: 4-5%
BOH: 3-4%
Commerce deserve a higher EV/Deposit than BOH
Current EV/Deposit
o Commerce: 0.24
o BOH: 0.22
o Central Pacific Financial is an inferior peer
CPF has higher funding cost
About 0.30% higher over the period since 2002
0.65% higher in 2007
CPF has higher operating cost
2015
o BOH: 1.12%
o CPF: 2.01%
10-year average
o BOH: 1.00%
o CPF: 2.24%
CPF has higher charge-offs
Failed in 2008-2011
BOH is cheaper than CPF
EV/Normal EBT
o BOH: 7.52
o CPF: 8.17
- BOH deserves 15x earnings
o BOH can grow 3-4%
While returning 80-85% of earnings
o 15x earnings implies yield between 5.33% and 5.66%
Adding 3-4% result in total return between 8.33% and 9.66%
1
“I think the -- well a number of the expenses that we were able to take out of the Bank
over the past several years admittedly were somewhat lower hanging pieces of fruit.
N62
So, yes, it does get tougher. But what we are looking at moving forward are whole
system changes which have the -- that are, one, expensive, and two are challenging. I
mean it's tough to do these things.
But three, if we can do it we end up with a better product, a product that the consumer
will like even more at lower cost. So we are talking about our branch footprint today
is 340,000 square feet, 72 branches, that is 4,700 square feet per branch, that is
way too big per branch, okay. And that is not even an optimal environment to be
serving people out of.
Now fortunately for us we have -- most of those 72 branches are on leases and we
have this normal distribution of leases rolling off kind of off into the future and so the
opportunity to bring down expenses through bringing that 4,700 down to 3,000,
3,000-plus, saving money, creating a more efficient footprint for our people to be
working in, so saving FTE cost, providing a nicer experience for our customers,
so improving our brand.
Those types of things have the ability to generate tremendous cost savings off over the
next several years. The transition from physical to virtual, the transition from
analog to digital is another big opportunity. So we are I guess in the past six
months begun deploying envelope free deposit taking ATM machines.
So something -- a phenomenon that is actually been obviously this mainland --
this larger mainland market for quite some time has been successful. We are
actually introducing that into the Hawaii market. And when you consider the fact
that potentially you can migrate 50% of branch depositors to those machines
versus to tellers, that is a big capacity build for us and a big potential cost
savings/capacity rework to more revenue producing types of activities.” – Peter Ho,
BOH’s CEO, Merrill Lynch Banking and Financial Services Conference, 18 November
2015
N63
Growth
Bank of Hawaii Can Grow its Deposits by 3-4% Annually
Bank of Hawaii grew its deposits by about 5-6% annually
- Biggest Negative:
o Hawaii is a low-growth economy
- Hawaii economy
o Hawaii’s total personal income breakdown by counties
The city and county of Honolulu: 76%
Hawaii: 10%
Kauai: 4%
Maui and Kalawao: 10%
o Tourism and defense make up about 25% of Hawaii’s GDP
Tourism: 15-17%
Some estimates tourism and related businesses account for 1/3
of the economy
1
Share of total visitor expenditures
o (in 2014)
o U.S. West: 33.4%
o U.S. East: 25.0%
o Japan: 16.0%
o Canada: 7.2%
o Others: 17.2%
6.33%
5.22%
5.76%
5-year 10-year 13-year
BOH's Annual Compounding Growth Rate of Deposit
N64
U.S.’s share of visitor expenditures have consistently declined
o U.S. West
2004: 38.0%
2014: 33.4%
o U.S. East
2004: 29.1%
2014: 25.0%
Japan’s share of visitor expenditures stayed around 16%
Other countries’ share of visitor expenditures have increased
o Canada
2004: 4.1%
2014: 7.2%
o Others
2004: 10.5%
2014: 17.2%
Defense: 8-10%
Hawaii is in a strategic location
o In the middle of the pacific ocean
Hawaii would benefit from the U.S.’s increased focus on the Asia-
Pacific region
o Annual population growth is forecast to grow at 0.77% annually
Population was
1970: 762,920
1980: 967,710
1990: 1,113,491
2000: 1,213,519
2010: 1,363,731
2014: 1,419,562
2040: 1,718,900 (expected)
o According to forecast by Department of Business,
Economic Development and Tourism (BDEDT)
Annual growth rate was
1970-1980: 2.41%
1980-1990: 1.41%
1990-2000: 0.86%
2000-2010: 1.17%
N65
2010-2014: 1.01%
2010-2040: 0.77% (expected)
o According to a forecast by BDEBT
The population of active-duty military personnel
decrease gradually from its 2010 level to the 2000-
2010 average level
Projected annual population growth rate
Honolulu: 0.4%
Hawaii County: 1.6%
Maui County: 1.4%
Kauai County: 1.1%
Neighbor Island population as % of the state total
2010: 29.9%
2040: 36.4%
Assumption
The fertility rate stays at the 2007-2009 level
The survival rate improves
o Hawaii’s GDP growth was in line with U.S. GDP growth
Hawaii outperformed the U.S. GDP up until the late 80s
2
Driven by
o The development of the visitor industry
o A good amount of growth in military and defense
But underperformed in the 90s
There was a Japanese capital inflow bubble and burst
There was deflation in house price
o House price index in Hawaii was
1991: 259.09
2000: 231.89
o Consumer price index in Honolulu was
1991: 148.0
2000: 176.3
Hawaii’s GDP/U.S. GDP was stable since 1997
1997: 0.43%
2000: 0.39%
2003: 0.41%
2006: 0.44%
N66
2009: 0.45%
2012: 0.44%
2014: 0.43%
Compounding annual growth rate was
Since 1997
o Hawaii: 4.2%
1997: $37.9 billion
2014: $76.2 billion
o U.S.: 4.2%
1997: $8,788 billion
2014: $17,616 billion
Since 2000
o Hawaii: 4.5%
2000: $164 billion
2014: $284 billion
o U.S.: 3.78%
2000: $10,472 billion
2014: $17,616 billion
o Hawaii’s deposit growth is consistent with its GDP growth
CAGR of deposits since 1994: 3.9%
1994: $17.1 billion
2015: $157 billion
CAGR of deposits since 2001: 5.3%
Hawaii: 5.3%
o 2001: $18.6 billion
o 2015: $157 billion
o BDEBT forecast Hawaii’s real GDP to grow at 1.7% in the 2010-2040 period
This can be a conservative estimate
BDEBT assumed only 1% tourism growth in real terms
Population is expected to grow at 0.77% annually
o Hawaii’s nominal GDP may grow at 3-4%
1-2% real GDP growth
2% inflation
o Total deposit in Hawaii may grow at 3-4%
- It’s hard for BOH to gain market share
o BOH’s market share has been around 31-33% for 20 years
- BOH’s past deposit growth was
N67
o 2002-2007: 3.63% annually
2002: $6,600 million
2007: $7,888 million
o 2007-2015: 6.37% annually
2007: $7,888 million
2015: $12,925 million
Strong growth over this period was driven by
Market share gain
o 2007
First Hawaiian Bank: 31%
BOH: 28%
American Savings Bank (ASB): 17%
Central Pacific Financial (CPF): 15%
o 2015
First Hawaiian Bank: 36%
BOH: 32%
American Savings Bank: 13%
Central Pacific Financial: 11%
Low interest rates
o ASB has been losing market share consistently
1994: 21%
1999: 21%
2004: 18%
2009: 15%
2015: 13%
o CPF market share stayed within 11-15% range
Had higher market share when interest rates were
high
- 3-4% long-term growth is a realistic expectation for BOH
o BOH can make 25% after-tax ROE in a normal year
15% after-tax ROE in a bad year
o => can return 80-85% of earnings to shareholders
1
“Unidentified Audience Member: What is the sensitivity on the economy in Hawaii
relative to the tourism?
N68
Peter Ho, BOH’s CEO: Well, you saw up on the slide that it's 16% of the overall
economy, but the estimate is that the multiplier effect to that is significantly
greater. So tourism and the related businesses I think I have seen estimates as
high as a third of the overall economy pivots with that industry.” – Merrill Lynch
Banking and Financial Service Conference, 11 November 2009
2
“So the history, if we go way back, the big macro view is that until the late 80s,
the State grew at a premium to gross national product. And that was really driven
in part by the development of the visitor industry, which really kicked in in the
late 50s, as well as by a good amount of growth in military and defense. Because
Hawaii -- the basic attributes of the marketplace are just an awfully beautiful place, very
good hospitality inventory, stock, and a very safe place to be. So on the visitor side
that's the case.
On the military side, it's all of that. So it's a pleasant place to be, as well as just
an awfully strategic place to be, because we're literally smack in the middle of the
Pacific, the number one industrial zone, or economic zone, in the world today, and
we're US soil. We're the 50th state.
So up until the 80s, late 80s, growing in excess of GDP. Nineties was a different
story; 90s was a retrenchment. There was a Japanese capital inflow bubble that
burst, and we had to live through that. And so, 90s was not so good. But, really,
post-9/11 we've continued to grow in excess of national GDP. And a lot of that is a
resumption of the visitor industry and being perceived as a safe place. And I
think a lot of that is built up in military resources, with the global war on terror.” –
Peter Ho, BOH’s CEO, KBW Boston Regional Bank Conference, 26 February 2014
N69
Misjudgment
Is Bank of Hawaii Less Conservative than Peers?
Bank of Hawaii had higher net charge-offs than First Hawaiian Bank and American
Savings Bank in 2009 and 2010
- Biggest Negative:
o BOH had higher net charge-offs than FHB and ASB
- The biggest risk is that BOH expands outside of Hawaii
o BOH pursued growth outside of Hawaii in the 1980s and 1990s
o BOH was in
1
California
Arizona
New York
8 countries across the South Pacific
6 Asian locations
o BOH faced with virtually no revenue growth in Hawaii
2
BOH entered syndicated lending
=> Entered syndicated lending
Built a $3 billion portfolio at some point
o BOH bought loans outside of Hawaii
3
o Loan losses started increasing
Net charge-offs were
1997: 0.34%
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
2007 2008 2009 2010 2011 2012
Net charge-offs to Average Loans and Leases
First Hawaiian Bank Bank of Hawaii
American Savings Bank Central Pacific Financial
N70
1998: 0.70%
1999: 0.78%
2000: 0.94%
2001: 1.57%
o BOH was the only U.S. bank in 2000 that were trading below book value
o The current management team has no intention to expand outside of Hawaii
BOH hasn’t acquired any bank since 2000
Despite available opportunities during the Great Recession
Current CEO, Peter Ho, is still young
Only 50 years old
- BOH has higher net charge-offs than First Hawaiian and American Savings Bank
o 2007
BOH: 0.24%
FHB: 0.32%
ASB: 0.17%
o 2008
BOH: 0.43%
FHB: 0.36%
ASB: 0.11%
o 2009
BOH: 1.43%
FHB: 0.61%
ASB: 0.66%
o 2010
BOH: 0.94%
FHB: 0.73%
ASB: 0.61%
o 2011
BOH: 0.40%
FHB: 0.41%
ASB: 0.49%
o 2012
BOH: 0.19%
FHB: 0.25%
ASB: 0.24%
o FHB makes much more loans than BOH
Both had near 70% Loan to Earning Assets ratio in 2004-2008
N71
Since 2010, FSB’s Loan to Earning Assets were around 63%
BOH’s Loan to Earning Assets were less than 50%
In 2014
FSB had
o $10 billion loans
o $5 billion securities
BOH had
o $6.5 billion loans
o $6.9 billion securities
BOH’s typical loan mix
Commercial loans: 20%
Commercial real estate: 20%
Residential real estate: 50%
Consumer loans: 10%
FHB’s typical loan mix
Commercial loans: 25%
Commercial real estate: 23%
Residential real estate: 35%
Consumer and other loans: 17%
FHB does make loans outside of Hawaii
4
FHB relies on time deposits than BOH
These signs indicate that BOH is more conservative
But the charge-offs numbers say the other way around
o The big difference between BOH and ASB is in loan mix
ASB makes much more residential mortgage loans
And less home equity loan
In 2007
BOH
o Residential real estate: 38%
o Home equity: 15%
o Consumer loan: 11%
o Commercial real estate: 13%
o Commercial loan: 23%
ASB
o Residential real estate: 75%
o Home equity: 5%
o Consumer loan: 2%
N72
o Commercial real estate: 7%
o Commercial loan: 11%
BOH’s real estate loan had the lowest charge-offs
In 2009
o Commercial mortgage: 0.27%
o Residential mortgage: 0.29%
o Home equity: 1.26%
o C&I: 2.74%
o Consumer loan: 3.19%
In 2010
o Commercial mortgage: 0.24%
o Residential mortgage: 0.50%
o Home equity: 1.56%
o C&I: 2.49%
o Consumer loan: 2.60%
- It’s surprising that real estate loans are the safest loan category
o Land is scarce in Hawaii
5
6,400 square miles of land
Only 26% of Oahu is zoned urban
o House price is very high in Hawaii
Median single family home price in Oahu
2006: $640,000
2014: $675,000
Starter home in Oahu is about $500,000
Median sales price for condominium is $350,000
o One may expect BOH is vulnerable to real estate bubble
Happened in 1980s
Home price index more than tripled
o (Source: Federal Reserve Bank of St. Louis)
o 1981: 83.95
o 1991: 259.09
Adjusted for inflation, home price index doubled
o 1981: 51.54
o 1991: 98.56
Then there was home price deflation in 1990s
Home price index declined slightly
o 1991: 259.09
N73
o 2001: 251.35
Adjusted for inflation, home price index declined almost 20%
o 1991: 98.56
o 2001: 79.32
Home price index more than doubled from 2001 to 2007
2001: 251.35
2007: 534.86
Adjusted for inflation, home price index almost double
2001: 79.32
2007: 137.19
o One may expect a deep decline after 2007
But home price index bottomed at 442.54
Less than 18% decline from the peak
o It’s unclear why there wasn’t a steeper decline
o Possible explanations
Hawaiian banks were conservative
Home price increases weren’t driven by credit
Hawaiian banks didn’t make much more residential real estate
loan during 2002-2007 period
o BOH’s residential mortgage
2002: $2,334 million
2007: $2,488 million
o American Savings Bank
2002: $2,347 million
2007: $3,065 million
o Central Pacific Financial
2004: $711 million
(no comparable data for 2002 because CPF
merged with CB Bancshares in 2004)
2007: $1,238 million
Supply is constrained in Oahu
2 segments for real estate in Hawaii
6
o Resort residential market
Mainly on the neighbor islands
Kauai
Maui
The Big Island
N74
Buyers are out-of-town buyers
Second home type buyer
There was a good amount of building over the 2003-
2007 period
o Traditional middle-market clientele
Predominately on Oahu
Predominantly Hawaii-based buyers
Supply is constrained by building permits
=> there wasn’t a development bubble
Residential real estate price declined from peak to bottom
7
o In Oahu: 12%
o In the neighbor islands: more than 20%
o Declined more than 20% on the neighbor islands
Median single family home price in Oahu bottomed at $580,000-
$590,000
- Can BOH gain market share?
o The top 4 banks hold about 90-92% market share since 1994
o First Hawaiian Bank has been gaining market share consistently
1994: 28%
1999: 29%
2004: 30%
2009: 32%
2015: 36%
o American Savings Bank has been losing market share consistently
1994: 21%
1999: 21%
2004: 18%
2009: 15%
2015: 13%
o Central Pacific Financial market share stayed within 11-15% range
Had higher market share when interest rates were high
o BOH gained market share over the last 10 years
BOH’s market share was stable about 30-31% from 1994-2003
Declined to 27% in 2008
BOH tend to pay low rates for interest-bearing deposit
8
o Focus on getting core deposits
N75
BOH’s weak deposit growth during 2004-2008 was due to higher
interest rates
Increased market share to 32% in 2015
Central Pacific Financial failed
o This is the only aggressive bank
o Its market share declined
2008: 15%
2015: 11%
o BOH and FHB have significant advantage over ASB and CPF
Lower funding cost
Lower operating cost
About 1% advantage
BOH may have chance to gain market share
Just like FHB
1
“A little bit more background to put our bank in perspective. It's useful, I think, to look
back a little bit. In 2000, the Bank of Hawaii was an underperformer. We changed
management and changed philosophies. We were the only bank in the country at
that time that was selling below book value.
So we put together a plan to address that. We realigned our strategy to focus on our
core markets in Hawaii and the Pacific islands I mentioned. We look at the
attractiveness of the markets and our ability to compete in those markets as the
selection points for where we want to do business.
We also changed our culture of risk and capital management to focus on a far more
disciplined approach to credit risk and other risks, be very thrifty in the use of capital
and return it where we can't deploy it effectively, and to focus on efficiency.
The chart we have got up now shows our operating performance for the period 2001
through '03. This included a period of divesting unproductive assets. We were in
California, Arizona, New York, eight countries across the South Pacific, and six
Asian locations that we said goodbye to during that period of time. Shrunk our
balance sheet from 15 billion down to 9 billion in assets. And you can see
improved our earnings per share -- our growth rate was nearly 20% during that three-
year period. And turned around our anemic equity return, which was 8.8% in 2001,
getting it up to at least in average of 15%, and, importantly for us, turning into positive
operating leverage.” – Allan Landon, BOH’s former CEO, Lehman Brothers Global
Financial Services Conference, 12 September 2007
N76
2
“The company's recent credit problems have been a disappointment to investors,
particularly in light of the progress Bank of Hawaii appeared to be making with a cost-
saving and revenue enhancement program that will have been Mr. Johnson's last major
initiative.
When asked whether, if he had to do it all over again, he would push the bank to
enter syndicated lending, a business that caused credit blips at many large banks last
quarter, Mr. Johnson suggested that the bank did not have that much of a choice.
"We were faced with virtually no revenue growth from our primary market,
Hawaii," he said. This pressure caused the bank to take advantage of opportunities
that included "a degree of risk that was unacceptable," he said.
But the choice was clear. "If we hadn't done that, we probably would have been
acquired."” – Bank of Hawaii Chairman to Quit, True to His Word, Laura Mandaro,
American Banker, 23 August 2000
3
“Our credit philosophy is to stay within our market. I think to understand a little bit
about what's important credit to Bank of Hawaii and why we might approach this a little
bit differently would be good to return just briefly in history -- in 2000, when Cindy and
I and a number of the management joined the bank, the Bank of Hawaii was
suffering from some pretty poor financial performance. In fact, at that time, we
were the only bank in the country that was selling for less than book value, and
we embarked on a turnaround program.
The most important and significant part of that turnaround program was the
correction of an elevated credit risk. And the point of going into that is that we all
remember how hard it is, how it hurts your reputation. We know that you can't defy
gravity or the marketplace, but within that you can do better or worse, and we have a
team that is focused on, as we say, "Avoiding the mistakes of the past."
What happened to us is when we grew beyond our natural markets, we inevitably
lost money. When we purchased loans outside of our marketplace, we had a hard
time figuring out how to make any profit for our shareholders on that business.
When we took large risks, when our portfolio lacked granularity, or when we got into
unproven trends -- what do you call them -- sale in, lease out transactions -- silo
transactions. We've still got a little bit of that legacy in our portfolio, we're pretty well
reserved for it, but building those reserves was pretty painful.
N77
So making sure we stay with proven products, making sure we have appropriate
underwriting standards and monitoring processes are an important part of our credit
culture and avoiding what we call the mistakes of the past.” – Allan Landon, BOH’s
former CEO, KBW Regional Bank Conference, 27 February 2008
4
“Harrison acknowledges that First Hawaiian does, indeed, have clients on the
mainland. “Do we do anything in France or in Europe? No. Do we have some stuff
on the mainland? The answer is yes. We do some loans for customers that are here
and have operations on the mainland and for some of the big national chains that have
business here in Hawaii. But if you look at the growth in our commercial loan
portfolio over the last several years, the vast majority of that was right here in
Hawaii.” Even in 2012, he says, most of that 31 percent growth was local
business.” – First Hawaiian Bank and Bank of Hawaii Share More Differences than
Similarities, Dennis Hollier, Hawaii Business, August 2013
5
“I should make one other point, and that is, share with you something that you already
know, and that is that Hawaii is a very small place, 6,400 square miles of land,
made even smaller by a number of attributes, the topography of the location, as
well as the fact that much of the ocean-front land in Hawaii is either conservation
or owned privately by large landed estates.
…
I talked about real estate being scarce in the Islands. Here, this chart here, gives you a
sense for just how much scarcity of real estate there is. Well, if you look at the red
zones in here, that represents all of the urban zone land in the State of Hawaii. So
if you take an already confined location like Hawaii, and apply the zoning that's been
put in place what you end up with is an acreage of about 26% available for
development.” – Peter Ho, BOH’s CEO, Morgan Stanley Financials Conference, 11
June 2013
6
“For us it's really two segments for the state of Hawaii. The resort residential
market, which exists predominantly on the neighbor islands so that would be
Kauai, Maui, and the Big Island, has been challenged probably similar to what you
see in other Western markets on mainland US. That buyer is predominantly an out-
of-town buyer, a second home type buyer. In that area there was a good amount
of building over the past five-plus years.
The other segment is what we would consider to be the more traditional middle-
market clientele, predominately on Oahu, predominantly Hawaii-based buyers. In
that segment prices have remained reasonably stable, down call it single digits,
because there simply wasn't the availability of inventory over this last cycle to
create any kind of supply bubble. So it really depends on which market you are
talking about.
N78
For the Bank of Hawaii the predominant marketplace that we play in is in the kind
of nuts and bolts basic Oahu residential home buyer. We have a small exposure on
the commercial construction lending sign on the neighbor islands to those resort
developments and a small exposure on the residential mortgage side to that product as
well.” – Peter Ho, BOH’s CEO, Merrill Lynch Banking and Financial Service
Conference, 11 November 2009
7
“On balance, residences in Hawaii, Oahu is where most of the people are, 70% of
the people are there and 12% has been peak to bottom the depreciation in
residential real estate. On the neighbor islands, where the population is smaller,
we have a larger percentage that have been impacted by investors. And so we have a
larger depreciation percentage there in excess of 20%.” – Allan Landon, BOH’s
Former CEO, Macquarie Securities Small- and Mid-Cap Conference, 15 June 2010
8
“We've got the lowest cost of deposits in Hawaii right now, owing in large part to
a significant amount of transaction accounts, demand deposit accounts, non-
interest bearing accounts, as well as our position as sort of the pricing leader. So
we are the low rate deposit institution. We emphasize service over rate.
Our focus on growth is going to be to continue to concentrate on savings and
demand deposits. What I'll call transaction accounts rather than time accounts. We're
going to see a natural migration. We've built, like most other banks, a customer self-
selection model that allows customers to move pretty fluidly into time deposits. Those
have value to us compared to our other sources of funding, but not as significant a
value as our traditional savings and demand deposit accounts.
So with our delivery channel, we're going to continue to emphasize that focus on
growing demand and savings accounts, use time deposits then as sort of the
balancing mechanism between our transaction deposit funding base and our
wholesale deposit base, or our wholesale funding base.” – Allan Landon, BOH’s
former CEO, KBW Regional Bank Conference, 28 February 2007
N79
Future
Bank of Hawaii Can Give Good Return on Investment in all interest rates scenarios
Bank of Hawaii promises potential return of 8% to 13.5% over the next 5 years
- Biggest Negative:
o Interest rates may stay low longer than expected
- Expectation for the next 5 years
o BOH will stay within Hawaii
And maintain a wide moat
o Demand for loan will increase
Securities portfolio is still 43% of earning assets
BOH’s yield on earning asset will improve as it makes more loans
o BOH will have lower growth than other banks that we analyzed
o BOH will return all excess cash to shareholders
There would be no change in leverage
Tangible common equity to asset is now 7.03%
BOH’s normal level is 7%
- if Federal fund rates is 3% in 2021
o BOH’s total deposit may not grow
Similar to the 2004-2008 period
Total deposit
4.5%
6.0%
3.5%
0.0%
0.0%
7.5%
Near-zero rates 3% Fed fund rates
Yield Growth Multiple expansion
N80
o 2004: $7,422 million
o 2008: $7,851 million
Noninterest-bearing deposit
o 2004: $1,929 million
o 2008: $1,742 million
Interest-bearing deposit
o 2004: $5,493 million
o 2008: $6,110 million
o BOH can return 100% of its earnings
Current price is about
18x current earnings
o 5.5% yield
11.6x normal earnings
o 8.6% yield
Earnings will improve as interest rates increase
=> yield on cash distribution will improve from 5.5%
Let’s assume it add 6% to total return
o BOH can make $389 million EBT
At 15x P/E, share price will be $97.15
(before the impact of share buyback)
The appreciation in share price creates 7.4% annual return
From current price of $68 per share
o => total return is 13.4% over the next 5 years
- If Federal fund rates stay near zero for the next 5 years
o BOH’s total deposit will growth about 3-4%
In line with Hawaii’s nominal GDP growth
Or BOH can grow faster if it can gain market share
Like it did since 2008
o Annual deposit growth was 7.4%
2008: $7,851 million
2015: $12,925 million
o BOH can return 80-85% of earnings while growing 3-4%
Current price is 18x current earnings
Implies yield con cash distribution between 4.4% and 4.7%
N81
o Multiple may not shrink
If FFR stay near zero, 18 P/E isn’t a high price
o Adding 3-4% growth => total return is between 7.4% and 8.7%
- Conclusion
o BOH isn’t as attract as Frost at current price
o But BOH has the widest moat
