Cindy Wyrick - EVP, IR Peter Ho - Chairman, President & Chief Executive Officer Kent Lucien - Vice Chairman & Chief Financial Officer Mary Sellers - Vice Chairman & Chief Risk Officer.

Brett Rabatin - Piper Jaffray Jeff Rulis - D.A. Davidson Ebrahim Poonawala - Bank of America Merrill Lynch Jacquelynne Bohlen - KBW Ken Zerbe - Morgan Stanley Aaron Deer - Sandler O'Neil Laurie Hunsicker - Compass Point John Moran - Macquarie Matthew Keating - Barclays.

Welcome to the Bank of Hawaii Corporation Third Quarter 2016 Earnings Conference Call. [Operator Instructions]. I would now like to introduce your host for today's conference call, Ms. Cindy Wyrick. You may begin, ma'am..

Thank you, Kevin. Good morning and good afternoon, everyone. Thank you for joining us today as we review the financial results for the third quarter of 2016. Joining me today is our Chairman, President and CEO, Peter Ho; our Vice Chairman and Chief Financial Officer, Kent Lucien and our Vice Chairman and Chief Risk Officer, Mary Sellers.

Comments today will refer to the financial information that was included in our earnings announcement this morning.

Before we get started, let me remind you that today's conference call will contain some forward-looking statements and while we believe our assumptions are reasonable there are a variety of reasons that the actual results may differ materially from those projected. And now I'd like to turn the call over to Peter Ho..

Thanks, Cindy. Good morning, everyone and thanks for joining us today. Once again we were very pleased with our financial results for the quarter. Loan balances grew 4.4% from the previous quarter due to strong growth in every loan category. Commercial loans grew to $3.5 billion at the end of the quarter, up 5.6% from the previous quarter.

Consumer loans grew to $5.2 billion, up 3.6% from the second quarter. Compared with the third quarter last year, total loans have increased 13.1% or just over $1 billion. We also continued to attract quality deposits during the quarter.

Total deposits grew 1.2% from the previous quarter and were up 6.7% or $870 million compared with the third quarter last year. Noninterest income grew both on a linked and year-over-year basis. Our liquidity and capital levels remain robust at the end of the third quarter and credit quality, already a strong point for us, remains stable.

Now let me turn the call over to Kent, who will provide some additional financial details and then Mary will comment on asset quality.

Kent?.

Thank you, Peter. Net income for the third quarter was $43.5 million or $1.02 per share, compared to $44.2 million or $1.03 per share in the second quarter and $34.3 million or $0.79 per share in the third quarter of last year.

The lower net income in the third quarter last year was largely due to impairment charges of $6.5 million, net of tax, related to our decision to dispose of our remaining aircraft leases. Our return on assets in the third quarter was 1.09%. The return on equity was 14.89% and our efficiency ratio was 57.58%.

Our net interest margin in the third quarter was 2.80%, down 5 basis points from the second quarter and up 3 basis points from the same period last year.

Net interest income in the third quarter of 2016 included the reversal of $750,000 in interest recovery income associated with a nonperforming loan which had been previously recorded in the second quarter. Adjusted for this item, the margin remained stable at 2.82%.

Premium amortization was $11.4 million in the third quarter, down from $11.5 million in the previous quarter and $14.2 million in the same quarter last year. The investment portfolio or investment differential was a negative 41 basis points this quarter. As Mary will discuss later, we recorded a credit provision of $2.5 million this quarter.

Noninterest income totaled $48.1 million in the third quarter of 2016, compared with $46.5 million in the previous quarter and $43.2 million in the same quarter last year. Mortgage banking income increased to $6.4 million in the third quarter, compared with $4.1 million in the second quarter and $3.3 million in the third quarter of last year.

You may recall that noninterest income in the second quarter of 2016 included a special trust service fee amount of $1.2 million and noninterest income in the third quarter last year included a charge of $1 million from the aircraft lease sale.

Noninterest expense totaled $87.5 million in the third quarter of 2016 compared with $86.1 million in the previous quarter and $91.9 million in the same quarter last year.

Noninterest expense during the previous quarter were partially offset by a net gain of $1.3 million from the sale of a real estate property and results for the third quarter last year included a $9.5 million impairment charge on several aircraft.

Noninterest expenses during the third quarter of 2016 continue to reflect higher levels of incentive compensation due to strong business growth. Also, Q3 expenses included a $1.4 million amortization of solar energy tax credit investments which benefit us on the tax line; this is up from $600,000 in Q2.

Due to the continuation of our strong business growth and investments in our business initiatives, we now expect our overall noninterest expenses to increase between 3% and 3.5% for the full year of 2016.

The effective income tax rate for the third quarter of 2016 was 29.84% compared with 29.77% in the previous quarter and 30.37% in the same quarter last year. The rate in the third quarter benefited from the release of federal and state tax reserves and increased energy tax credits.

As Peter mentioned, we continued to see good growth in our loan portfolio during the third quarter. As a result of loan growth continuing to outpace deposit growth, our investment portfolio continues to decrease and was $6 billion at the end of the third quarter.

The average duration of the AFS portfolio was 2.16 years and the duration for the total securities portfolio was 2.61 years at the end of the third quarter. Deposit growth also remains steady, with consumer deposits up 2.5% from the previous quarter and up 8.4% compared to last year.

Commercial deposits also grew during the quarter and were up 1% from the second quarter and up 6.5% compared to last year. Our shareholders equity was $1.16 billion at the end of the third quarter. We paid out $20.5 million or 47% of net income in dividends during the quarter and repurchased 204,000 shares of common stock for $14.3 million.

At the end of the third quarter our Tier 1 capital ratio was 13.40% and our Tier 1 leverage ratio was 7.25%. Finally, our Board declared a dividend of $0.48 per share in the fourth quarter of 2016. I'll now turn the call over to Mary..

Thank you, Kent. Net chargeoffs for the third quarter totaled $2.4 million or 0.11% annualized total average loans and leases outstanding. Comparatively, in the second quarter of 2016 net chargeoffs were $1.7 million or 0.09% annualized, while in the third quarter of 2015 net chargeoffs were $2 million or 0.10% annualized.

Net chargeoffs for the nine months ended September 30, 2016, were $347,000, compared with net chargeoffs of $4.7 million for the same period in 2015. The lower level of net chargeoffs in 2016 is primarily due to the full recovery related to the commercial client in Guam realized in the first quarter.

Nonperforming assets were $18.7 million at the end of the third quarter, compared with $16.3 million at the end of the second quarter and $29.5 million at the end of the third quarter of 2015. The year-over-year decrease is due to the resolution of the Guam commercial loan, coupled with other payoffs and restructured loans returned to accrual.

At the end of the third quarter, loans past due 90 days or more and still accruing interest were $5.6 million, down $3.1 million for the linked quarter and down $2.5 million year-over-year.

Restructured loans not included in nonaccrual loans or loans past due 90 days or more were $52.1 million at the end of the third quarter, down $78,000 from the second quarter and up $2.6 million from the third quarter of 2015.

Residential mortgage loans modified to assist our customers accounted for $19.8 million of the total at the end of the quarter. Consistent with the continued strength in the Hawaiian economy, our asset quality metrics and growth in the portfolio, the allowance for loan and lease losses increased $100,000 from the previous quarter to $104 million.

Given net chargeoffs of $2.4 million, a $2.5 million provision was recorded. As of September 30, the allowance represents 1.20% of total outstanding loans and leases, a decrease of 5 basis points from the previous quarter. The reserve for unfunded commitments remained unchanged at $6.6 million. I'll now turn the call back to Peter..

Great; thanks, Mary. The Hawaiian economy continued to perform well during the quarter. The statewide seasonally adjusted unemployment rate remains low at 3.3% in September compared to 5% nationally. Visitor industry also remains healthy. Visitor spending for the first eight months off 2016 increased 3%.

Visitor arrivals were up 2.6% compared to the same period last year, increased visitors from the Mainland, Japan and all other international markets more than offsetting the decline in visitors from Canada. Construction continues to be robust in both the private and public sectors and the real estate market remains strong.

Median price for a single-family home on Oahu, our primary market, increased 5.2% in the first nine months of 2016 and the median price of a condominium increased 8.7% compared to the same period in 2015. The volume of single-family home sales on Oahu during the first nine months of 2016 increased 4.8% and condominium sales increased 9%.

Months of inventory decreased to 2.9 months for single-family homes and 3 months for condominiums. The median days on market was 16 days for single-family homes and 20 days for condominiums. Obviously, as you can see, we're in a tight real estate market. Thanks again for joining us today and now we'd be happy to respond to your questions..

[Operator Instructions]. Our first question comes from Brett Rabatin with Piper Jaffray..

I guess, first, really impressive loan growth in the quarter.

Can you maybe just comment on the pipeline and what you think about the prospects for growth of similar pace going forward or if this is an outstanding quarter, especially in commercial?.

Yes, well I think it's a bit of an outstanding quarter, especially in commercial. We were a bit surprised, pleasantly surprised, by C&I growth in the quarter. That was a combination of both production as well as some fundings on our existing commitments.

Commercial mortgage just had an outstanding quarter and that was a little bit of a bulge in production. That segment had a good year, year to date; but the third quarter in particular was very strong here and that also reflected in our swap income, Brett.

Construction is really -- those were existing commitments and the fund-up in existing commitments. So I think 5.5% linked just commercial is going to be tough to replicate moving forward.

We would anticipate growth in the coming quarters, but I guess the caveat that I'd put out there is that we're probably near our high point in construction outstandings. So commitments have flattened out, as you might anticipate. Fundings are growing as product is being built and we're probably a quarter or two away from the turn there.

So what has been a pretty nice tailwind with construction lending now at $263 million, that's going to be begin to revert out, down towards our historic levels of, call it, $100 million. But overall good growth in commercial. We think there is more growth there, probably not at the same levels.

And you saw our consumer categories were very strong as well, we would expect to see continued growth there as well..

Okay. Then just mortgage banking, obviously strong quarter there as well. I assume that will be seasonally slower in 4Q. Any comments on the pace of that going forward? And just your thoughts on 3Q in terms of how much market share maybe you may have gained and mix, refi/purchase, etc..

Yes. Really it's a couple of components there. Market share, we have picked up market share which we're proud of. The mix of refi and purchase is about 50/50 now. So refi in a historic context is not as strong as it has been in previous years. I mentioned a little earlier in the call about the strength of the real estate market here.

So really our continued growth is going to be in large part driven by increases in purchase activity; that we think there's a good market for. It's also going to be spiked from time to time by project closings. We have a number of condominium projects that are closing out in the next year.

And in situations where we have a large amount of volume in those particular projects, that will also help spike our productivity or production there..

Our next question comes from Jeff Rulis with D.A. Davidson..

Maybe a question for Kent on the expense side.

That solar energy investment, was that in the Other line item?.

Yes, it was..

Okay. And then the occupancy was also up linked quarter.

Any color on the reason on that one?.

Yes. In Q2 we had sold a property on Maui and that obviously didn't repeat in Q3..

Okay, great, thank you. And then maybe one for Mary on the increase in nonaccruals on the residential -- I think it was on the residential mortgage side.

Anything noteworthy going through those numbers?.

Not really. We have one larger loan that moved to nonaccrual. We have about an 80% LTV on that. The customer has the property listed and we expect that to resolve in the normal course..

Okay.

But nothing systemic? Or the greater picture is still pretty sound on the credit side?.

Pretty sound, just really a one-off..

Our next question comes from Ebrahim Poonawala with Bank of America..

Peter, I wanted to follow up on C&I. Like, if I go back to last quarter it seemed like you were a little more cautious on C&I given we're late in the cycle. I recall you mentioning that -- expect that portfolio to be more or less stable in the near term. It feels like you feel a little more upbeat about that book today.

Just if you can help us reconcile that, that will be helpful..

Yes. No, I think that you have a good memory. My view on growth in C&I is it is going to be reasonably tepid for us. So there were some timing changes; there were some fund-ups late in the quarter. I think probably the more accurate place to look at C&I growth for us was in the averages.

If you look at the third quarter average we were up 1.4% and we're up year-over-year on average 2.1%. That to me is probably within the realm of where I would see C&I growth going forward..

One for Kent just in terms of the margin, I guess. We saw a pretty decent size drop in commercial loan yields this quarter. I am not sure if I missed something, but if you could tell us what is going on there and how we should think about the margin with or without a December rate hike..

Yes. We did have a correction on a recovery that had previously been recorded in Q2 and that correction flowed into the commercial mortgage line. So in total, but for that item, the margin really would have been flat Q2 to Q3. And maybe a little bit of hope going forward, but it would be very, very modest.

So we're probably still in the same general range into Q4..

If I can sneak in one last question around mortgage banking.

Were there any MSR writeups this quarter within that mortgage banking line item?.

Yes, there was. We had a $2.6 million impairment in Q2 and there was a $500,000 reversal here in Q3..

So $500,000 reversal and the rest was all origination and servicing?.

Yes, and loan sales, right..

Our next question comes from Jacque Bohlen with KBW..

Just to clarify on the solar tax credit, that $1.4 million, was there any expense in 2Q? Or was the $1.4 million a delta or was there something in 2Q as well?.

There was an item in Q2; it was about $750,000 in Q2..

And Kent, what is the typical range in that? Understanding that it can fluctuate just in any given quarter..

Well, a year ago it had been $400,000, so we ramped up the number and amounts of investment in this space. It is very high yielding investment after-tax. It is just that the pretax takes a hit. The benefits are all in the tax line; but like I said, on an after-tax basis it is high yielding..

Do you have any tax guidance or expectations for where the tax rate could go in 4Q?.

Yes. Typically given a very wide range on this and we were a little bit south of 30% in Q3. On the very short term Q4 we're going to be a little bit north of 30%..

Okay.

Does that include expectations that your investment in solar credits will continue in 4Q?.

Yes. It takes everything into account..

Our next question comes from Ken Zerbe with Morgan Stanley..

Actually just want to take a little more of a conceptual question on the whole tax credit investment. Some of your peers invest much more aggressively in tax credits, right? Some probably less so. You've obviously been increasing your tax credit investment.

And not just fourth quarter, but when you look out to 2017, 2018, like, is there a case to be made for a substantially greater investment in -- whether it is solar or other types of tax credit investments?.

I would say not a huge opportunity. I think there is opportunities, but they are going to be limited to the types of things that we're currently doing. So they are going to be limited to the solar investments; they are going to be limited to low-income housing investments.

The things that have been done by Bank of Hawaii way, way back such as leasing, leveraged leasing and that sort of thing, it's just not likely to be the type of thing we're going to do going forward..

Okay. So long term tax rate, long term expense related to tax credit amortization shouldn't really change much is my suspicion, given your answer..

Yes, I think that is right..

Okay. Then second question is just in terms of the provision. I understand credit; no deterioration in the underlying trends. But obviously as you work through some of the recoveries last few quarters your provision has gone from negative to positive, creeping upwards.

At some point do you envision a point where the reserve ratio actually starts to stabilize? And is that something we would expect near term or does it still have quite a ways to go if -- given, if credit remains at current good levels?.

I think you would expect it to continue to stabilize at this point..

Because it is not really stabilizing yet. I guess that is what I was asking. You're down about 5 basis points per quarter.

Are you saying you would expect it to stabilize around the 1.2% level?.

Well, we don't work around a number, Ken. Typically where we're at this point is -- the constant is the quality of the portfolio and the variable is the growth in our loan portfolio. And you are right, I think that the large recoveries on the commercial front have likely run their course.

So where we provision at really is going to be a function of where our growth rate is on the lending side..

Yes, I just wanted to make sure that the underlying credit trends, whether you do a three-year lookback or five-year lookback, that you have actually hit stabilization in terms of the improvement in your lookback factors, if you will. Now it's going to be driven by loan growth rather than the model based on prior credit experience.

But it sounds like it is..

It is based on many, many inputs of a model -- and multiple models, actually..

Our next question comes from Aaron Deer with Sandler O'Neil..

Just a couple of follow-up questions. You gave the breakout of the MSR adjustment in the quarter. I wondered if you could also give what the level is now of your ongoing servicing income and then what the volume was of loans sold in the quarter..

The basic servicing income is going to be approximately $2 million per quarter. Then your second question was the quantity of -- I think bulk sales is probably your question. We sold $44 million in Q3. They would be over and above the normal flowthrough sale. So we do two things, we flow mortgages to third parties and then we also do bulk sales.

And this quarter there were $44 million sold..

And then also, Peter, it sounded like higher draws on the C&I commitments.

Can you give a sense where the line usage stood in this latest quarter relative to recent quarters?.

Line utilization, that percentage actually hasn't changed much just because the denominator is so large, as we have a lot of large corporate lines. But I will say that the delta in usage towards the end of the quarter was in the plus $25 million range..

Okay. And then just out of curiosity, I suspect you guys are still planning to recognize some Visa gains early in the new year.

Is that still the plan?.

Yes, that is the plan..

[Operator Instructions]. Our next question comes from Laurie Hunsicker with Compass Point..

Just wondered quickly, Kent, if you can give us the number for loan service for others?.

I'm sorry, I didn't quite understand the question..

Loan service for other institutions..

What the total balance was. By comparison it was $2.6 billion to $2 billion last quarter..

We service about $2 billion, $2.5 billion for Fannie and Freddie..

$2.5 billion..

About $2.5 billion..

Okay. So you are basically now carrying at 84 basis points, up from 75 last quarter..

Are you referring to the booked rate on servicing rights?.

Correct. In other words the loan service for others that corresponds with your MSRs..

Yes, I am not sure I can confirm that number. We can follow up with you..

Okay, that would be great. Then on to tax rate; I appreciate your fourth quarter guidance. Can you help us think a little bit about how that should be for next year? I think on the last call you had given us 30% to 35% which was a wide range.

How should we be thinking about that for 2017?.

Yes, I am going to stick with that wide range and I will tell you why. It is as much a function of the level of income as the tax credit that we have been talking about. For example, to the extent our pretax income increases, with a relatively fixed amount of tax credits the rate is going to go up.

So it is not its own number absent the level of income. So I have to give you a wide range there, the point being that with changes in interest rates and other factors the income level can be different..

Sure, absolutely.

I mean if we were to think about it more as a shelter going forward, is it safe to say that it doesn't really change too much from this rate, in other words from this level, as you continue to build on the credit line?.

Well, I am not sure I understand that question. But the point I was trying to make earlier was that the credits and other offsets to the statutory rate are relatively flat. Not exactly flat; they can increase as we discussed, attributable to energy investments and such. But that number can be offsetting a pretty -- a changeable statutory number.

So the effective rate therefore can move quite a bit..

Can move, right. Absolutely. I will follow up with you off-line. Just one more question. If you could comment a little bit on the loan growth in the commercial side in terms of how much was on the U.S. Mainland..

I don't know if any -- was it?.

I am not sure for the quarter, but in total we have $71 million on the Mainland..

That would be the total balance..

Yes..

Yes, $71 million out of $3.489 billion. So the point being is the vast majority of our loan production, both commercial and consumer, is either state of Hawaii or Guam which is the other major market for us..

Our next question comes from John Moran with Macquarie..

I have got actually one more and I apologize for this, on mortgage. $44 million in bulk sales this quarter. I was wondering if you had that number for 2Q..

I do. It is $82 million..

Okay, $82 million in 2Q; great. Then just on OpEx, I think I heard you guys say -- and it is just based on how things have tracked so far this year -- so it's being increased a little bit in terms of outlook to 3% to 3.5% increase. I think you guys talked about 3% a year in the past.

So just wondering if it is a 4Q kind of thing or if that is longer term and then if you could give us a quick update on the technology and business initiatives..

Yes. That is really referring to the full-year 2016 and therefore the delta would be reflected in Q4. So that is really not a comment on beyond 2016..

On the business initiatives, John, those are going well. So a couple of projects afoot. One is the opportunity to increase our deposit penetration through our ATM fleet. We have refleeted our branches with envelope-free ATM machines. That initiative is going quite nicely.

In fact last week I think we reached an all-time high point for us -- and the initiative is about a year and a half old now -- in terms of the percentage of people using the ATMs to make their deposits. Making good headway in our branch refresh project.

Later this month we will -- actually next month -- be opening our Pearl City branch which we're pretty proud. That is a completely new format. Really the takeaway there is we have reduced the footprint by about one-third but increased the customer service space by a couple hundred feet.

How we do that is obviously by pulling back on operations space that has really been rendered obsolete as a result of the digitization of a lot of our back office..

Anything on deck for 2017 in terms of initiatives? Or is it more of the same in terms of the new branch format and then finishing the rollout of ATM? It sounds like it's finished..

Yes, more of the same of that as well as a lot of nice initiatives coming into the stream in the next year or so on our -- what I would say are our digital platforms..

Our next question comes from Matthew Keating with Barclays..

My question relates to the level of investment spending the Bank is doing in its various business initiatives. If you look at the efficiency ratio, it has been obviously below average recently, in the 57%, 57.5% range.

So as you contemplate continued investments for the business, do you think the efficiency ratio can continue to grind lower? Or are we at a level you're comfortable with here, with future improvements in the efficiency ratio really driven by the broader interest rate environment? Thanks..

There are so many inputs into that ratio -- not the least of which being revenue and production -- I think that is a tough one to figure out. But I do think that the initiatives that we have afoot, one, are very high return in nature and, two, represent both efficiency opportunities as well as customer experience opportunities.

So the ability to generate a transaction at a lower cost and at a higher level of customer satisfaction is really what we're trying to drive to here..

I'm not showing any further questions at this time. I would like to turn the call back over to Cindy..

Thanks again, Kevin. I would like to thank everyone for joining us today and for your continued interest in Bank of Hawaii. Have a great day, everyone..

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day..