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Bank of Hawaii 10-K 2005

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K


ý

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from                                to                                 

Commission File Number 1-6887


BANK OF HAWAII CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
(State of incorporation)
  99-0148992
(IRS Employer Identification No.)

130 Merchant Street, Honolulu, Hawaii
(Address of principal executive offices)

 

96813
(Zip Code)

1-(888)-643-3888
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
  Name of Each Exchange
on Which Registered

Common Stock, $.01 Par Value   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:
None


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

Yes ý    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.)

Yes ý    No o

The aggregate market value of the registrant's voting stock held by non-affiliates is approximately $2,343,380,801 based on the June 30, 2004 closing price of said stock on the New York Stock Exchange ($45.22 per share).

As of February 18, 2005, there were 53,463,015 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement relating to the Annual Meeting of Shareholders to be held April 29, 2005, are incorporated by reference into Part III of this Report.




Bank of Hawaii Corporation

Form 10-K


INDEX

   
   
  Page

Part I

 

Item 1.

 

Business

 

2
    Item 2.   Properties   7
    Item 3.   Legal Proceedings   7
    Item 4.   Submission of Matters to a Vote of Security Holders   7



Part II

 

Item 5.

 

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

9
    Item 6.   Selected Financial Data   10
    Item 7.   Management's Discussion and Analysis of Financial Condition and Results of Operations   11
    Item 7A.   Quantitative and Qualitative Disclosures About Market Risk   38
    Item 8.   Financial Statements and Supplementary Data   38
    Item 9.   Changes in and Disagreements With Accountants on Accounting and Financial Disclosure   80
    Item 9A.   Controls and Procedures   80
    Item 9B.   Other Information   82



Part III

 

Item 10.

 

Directors and Executive Officers of the Registrant

 

82
    Item 11.   Executive Compensation   82
    Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   82
    Item 13.   Certain Relationships and Related Transactions   82
    Item 14.   Principal Accountant Fees and Services   82



Part IV

 

Item 15.

 

Exhibits and Financial Statement Schedules

 

83

SIGNATURES

 

 

 

86

1


PART I

Item 1. Business

General

Bank of Hawaii Corporation (the "Company") is a Delaware corporation and a bank holding company.

The Company's banking subsidiary, Bank of Hawaii (the "Bank"), was organized under the laws of Hawaii on December 17, 1897 and has its headquarters in Honolulu, Hawaii. Its deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank is a member of the Federal Reserve System. The only other subsidiary of the Company is Bancorp Hawaii Capital Trust I, a grantor trust organized to effect a financing transaction.

Through the Bank, the Company provides a diversified range of banking financial services and products primarily in Hawaii and the Pacific Islands (Guam and nearby islands and American Samoa). The Bank's subsidiaries include Bank of Hawaii Leasing, Inc., Bankoh Investment Services, Inc., Pacific Century Life Insurance Corporation, Triad Insurance Agency, Inc., Bank of Hawaii Insurance Services, Inc., Pacific Century Insurance Services, Inc., Bankoh Investment Partners, LLC and Bank of Hawaii International, Inc. The Bank's subsidiaries are engaged in equipment leasing, securities brokerage and investment services, and insurance and insurance agency services.

The Company is aligned into the following business segments: Retail Banking, Commercial Banking, Investment Services Group, and Treasury and Other Corporate. Financial and other additional information about the Company's business segments are presented in Table 5 of the Business Segments section of Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") and Note 17 to the Consolidated Financial Statements in this report, which is incorporated by reference in this Item.

Information on foreign activities is presented in Table 9 of MD&A, which is incorporated by reference in this Item.

The Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports can be found free of charge on its internet site at http://www.boh.com as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (the "SEC"). The SEC maintains an internet site, http://www.sec.gov, that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The Company's Corporate Governance Guidelines; the charters of the Audit Committee, the Executive and Strategic Planning Committee, the Human Resources and Compensation Committee and the Nominating and Corporate Governance Committee; and the Code of Business Conduct and Ethics are available on the Company's website. Upon written request to the Corporate Secretary at 130 Merchant Street, Honolulu, Hawaii, 96813, the information is available in print to any shareholder.

The Company included the Chief Executive Officer and the Chief Financial Officer certifications regarding the Company's public disclosure required by Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1 and 31.2 of this report. Additionally, the Company filed with the New York Stock Exchange (the "NYSE") the Chief Executive Officer certification regarding the Company's compliance with the NYSE's Corporate Governance Listing Standards (the "Listing Standards") pursuant to Section 303A.12(a) of the Listing Standards. The certification was dated May 21, 2004 and indicated that the Chief Executive Officer was not aware of any violations of the Listing Standards by the Company.

Competition

The Company, the Bank and its subsidiaries are subject to substantial competition from banks, savings associations, credit unions, mortgage companies, finance companies, mutual funds, brokerage firms, insurance companies and other providers of financial services, including financial service subsidiaries of commercial and manufacturing companies. The Company also competes with certain non-financial institutions and governmental entities that offer

2



financial products and services. Some of the Company's competitors are not subject to the same level of regulation and oversight that is required of banks and bank holding companies.

Supervision and Regulation

The Company and the Bank are each extensively regulated under both federal and state law. The following information describes certain aspects of that regulation applicable to the Company and the Bank and does not purport to be complete. To the extent statutory or regulatory provisions are described, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions. Proposals to change the laws and regulations governing the banking industry are frequently raised in Congress, in state legislatures and before the various bank regulatory agencies. The likelihood and timing of any changes and the impact such changes might have on the Company or the Bank are impossible to determine with any certainty. A change in applicable laws or regulations, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on the business, operations and earnings of the Company and the Bank.

The Company

The Company is registered as a bank holding company ("BHC") under the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and is subject to the supervision of and to examinations by the Board of Governors of the Federal Reserve System (the "FRB"). The Company is also registered as a bank holding company under the Hawaii Code of Financial Institutions (the "Code") and is subject to the registration, reporting and examination requirements of the Code.

The BHC Act prohibits, with certain exceptions, a BHC from acquiring beneficial ownership or control of more than 5% of the voting shares of any company, including a bank, without the FRB's prior approval and from engaging in any activity other than those of banking, managing or controlling banks or other subsidiaries authorized under the BHC Act, or furnishing services to or performing services for its subsidiaries. Among the permitted activities is the ownership of shares of any company the activities of which the FRB determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

Under FRB policy, a BHC is expected to serve as a source of financial and management strength to its subsidiary banks and to commit resources to support its subsidiary banks in circumstances where it might not do so absent such a policy. This support may be required at times when the BHC may not have the resources to provide it. Under this policy, a BHC is expected to stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial adversity and to maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks.

Subject to certain limits, under the Riegle-Neal Interstate Banking and Branching Efficiency Act (the "Riegle-Neal Act") an adequately capitalized and adequately managed BHC may acquire control of banks in any state. An interstate acquisition may not be approved if immediately following the acquisition the BHC would control 30% or more of the total FDIC-insured deposits in that state (or such lesser or greater amount set by the state), unless the acquisition is the BHC's initial entry into the state. An adequately capitalized and adequately managed bank may apply for permission to merge with an out-of-state bank and convert all branches of both parties into branches of a single bank. An interstate bank merger may not be approved, if immediately following the acquisition, the acquirer would control 30% or more of the total FDIC-insured deposits in that state (or such lesser or greater amount set by the state), unless the acquisition is the acquirer's initial entry into the state. Banks are also permitted to open newly established branches in any state in which it does not already have banking branches if such state enacts a law permitting such de novo branching.

Hawaii has enacted a statute that authorizes out-of-state banks to engage in mergers with Hawaii banks or acquisitions of substantially all of their assets, following which any such out-of-state bank may operate the branches of the Hawaii bank it has acquired. The Hawaii bank must have been in continuous operation for at least five years unless it is subject to or in danger of becoming subject to certain types of supervisory action. This statute does not permit out-of-state

3



banks to acquire branches of Hawaii banks other than through an "interstate merger transaction" under the Riegle-Neal Act (except in the case of a bank that is subject to or in danger of becoming subject to certain types of supervisory action) or to open branches in Hawaii on a de novo basis.

Under the Gramm-Leach-Bliley Act, a BHC may elect to become a financial holding company and thereby engage in a broader range of financial and other activities than are permissible for traditional BHCs. In order to qualify for the election, all of the depository institution subsidiaries of the BHC must be well capitalized and well managed and all of its insured depository institution subsidiaries must have achieved a rating of "satisfactory" or better under the Community Reinvestment Act (the "CRA"). Financial holding companies are permitted to engage in activities that are "financial in nature" or incidental or complementary thereto as determined by the FRB. The Gramm-Leach-Bliley Act identifies several activities as "financial in nature," including, among others, insurance underwriting and sales, investment advisory services, merchant banking and underwriting and dealing or making a market in securities. The Company has not elected to become a financial holding company.

Bank of Hawaii

The Bank is subject to supervision and examination by the Federal Reserve Bank of San Francisco and the State of Hawaii Department of Commerce and Consumer Affairs Division of Financial Institutions. Depository institutions, including the Bank, are subject to extensive federal and state regulation that significantly affect their business and activities. Regulatory bodies have broad authority to implement standards and to initiate proceedings designed to prohibit depository institutions from engaging in unsafe and unsound banking practices. The standards relate generally to operations and management, asset quality, interest rate exposure, capital and executive compensation. The agencies are authorized to take action against institutions that fail to meet such standards.

Bankoh Investment Services, Inc., the broker dealer subsidiary of the Bank, is regulated by the National Association of Securities Dealers. The insurance subsidiaries, Bank of Hawaii Insurance Services, Inc., Triad Insurance Agency, Inc. and Pacific Century Insurance Services, Inc are incorporated in Hawaii and are therefore regulated by the Hawaii State Department of Insurance. Pacific Century Life Insurance Corporation is incorporated in Arizona and regulated by the Insurance Department of Arizona.

Capital Requirements

The Federal Reserve Board has issued substantially similar risk-based and leverage capital guidelines applicable to BHCs and banks that they supervise. Under the risk-based capital requirements, the Company and the Bank are generally required individually to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital is to be composed of common equity, retained earnings and qualifying perpetual preferred stock, less certain intangibles ("Tier 1 capital"). The remainder may consist of certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock, and a limited amount of the loan loss allowance ("Tier 2 capital") and, together with Tier 1 capital equals total capital ("Total capital"). At December 31, 2004, the Company's Tier 1 capital and Total capital ratios to total risk-weighted assets were 12.13% and 14.89%, respectively, and the ratios of Tier 1 capital and Total capital to total risk-weighted assets for the Bank were 10.25% and 12.99%, respectively.

In addition, each of the federal bank regulatory agencies has established minimum leverage capital ratio requirements for banking organizations. These requirements provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% for bank and bank holding companies that meet certain specified criteria, including that they have the highest regulatory rating and are not experiencing significant growth or expansion. All other banks and bank holding companies will generally be required to maintain a leverage ratio of at least 100 to 200 basis points above the stated minimum. The Company's leverage ratio at December 31, 2004 was 8.29% and the Bank's leverage ratio was 7.03%.

4



The Federal Reserve Board's risk-based capital standards explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution's ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution's overall capital adequacy. The capital guidelines also provide that an institution's exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a bank's capital adequacy. The Federal Reserve Board also has issued additional capital guidelines for certain bank holding companies that engage in trading activities. The Company does not believe that consideration of these additional factors will affect the regulators' assessment of the Company's or the Bank's capital position.

Dividend Restrictions

The Company is a legal entity separate and distinct from the Bank. The Company's principal source of funds to pay dividends on its common stock and to service its debt is dividends from the Bank. Various federal and state statutory provisions and regulations limit the amount of dividends the Bank may pay to the Company without regulatory approval, including requirements to maintain capital above regulatory minimums. The FRB is authorized to determine the circumstances when the payment of dividends would be an unsafe or unsound practice and to prohibit such payments. The right of the Company, its stockholders and creditors to participate in any distribution of the assets or earnings of its subsidiaries also is subject to the prior claims of creditors of those subsidiaries.

For information regarding the limitations on Bank dividends, see Note 9 to the Consolidated Financial Statements, which is incorporated by reference in this Item.

Transactions with Affiliates

The Bank is subject to restrictions under federal law that limit the transfer of funds or other items of value to the Company and any other non-bank affiliates in so-called "covered transactions." In general, covered transactions include loans and other extensions of credit, investments and asset purchases, as well as other transactions involving the transfer of value from the Bank to an affiliate or for the benefit of an affiliate. Unless an exemption applies, covered transactions by the Bank with a single affiliate are limited to 10% of the Bank's capital and surplus and, with respect to all covered transactions with affiliates in the aggregate, to 20% of the Bank's capital and surplus.

FDIC Insurance

The Bank's deposits are insured up to $100,000 per insured depositor by the Bank Insurance Fund ("BIF") of the FDIC. As an FDIC-insured bank, the Bank also is subject to FDIC insurance assessments. Currently, the amount of FDIC assessments paid by individual insured depository institutions ranges from zero to $0.27 per $100.0 of insured deposits, based on their relative risk to the deposit insurance funds, as measured by the institutions' regulatory capital position and other supervisory factors. The Bank currently pays the lowest premium rate based upon this risk assessment. However, the FDIC retains the ability to increase regular assessments and to levy special additional assessments.

In addition to deposit insurance fund assessments, beginning in 1997 the FDIC assessed BIF-assessable and Savings Association Insurance Fund ("SAIF")-assessable deposits to fund the repayment of debt obligations of the Financing Corporation ("FICO"). FICO is a government-sponsored entity that was formed to borrow the money necessary to carry out the closing and ultimate disposition of failed thrift institutions by the Resolution Trust Corporation. At December 31, 2004, the annualized rate established by the FDIC for both BIF-assessable and SAIF-assessable deposits was 1.46 basis points (hundredths of 1%).

Under federal law, deposits and certain claims for administrative expenses and employee compensation against insured depository institutions are afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the liquidation or other resolution of such an institution by any receiver appointed by regulatory authorities. Such priority creditors would include the FDIC.

5



Other Safety and Soundness Regulations

Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") the federal banking agencies possess broad powers to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution in question is "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," or "critically undercapitalized," as defined by the law. Under regulations established by the federal banking agencies, a "well capitalized" institution must have a Tier 1 capital ratio of at least 6%, a Total capital ratio of at least 10% and a leverage ratio of at least 5% and not be subject to a capital directive order. An "adequately capitalized" institution must have a Tier 1 capital ratio of at least 4%, a Total capital ratio of at least 8% and a leverage ratio of at least 4%, or 3% in some cases. As of December 31, 2004, the Bank was classified as "well capitalized." The classification of depository institutions is primarily for the purpose of applying the federal banking agencies' prompt corrective action provisions and is not intended to be, and should not be interpreted as a representation of overall financial condition or prospects of any financial institution.

The federal banking agencies' prompt corrective action powers (which increase depending upon the degree to which an institution is undercapitalized) can include, among other things, requiring an insured depository institution to adopt a capital restoration plan which cannot be approved unless guaranteed by the institution's parent company; placing limits on asset growth and restrictions on activities, including restrictions on transactions with affiliates; restricting the interest rates the institution may pay on deposits; prohibiting the payment of principal or interest on subordinated debt; prohibiting the holding company from making capital distributions without prior regulatory approval and, ultimately, appointing a receiver for the institution. Among other things, only a "well capitalized" depository institution may accept brokered deposits without prior regulatory approval.

As required by FDICIA, the federal banking agencies also have adopted guidelines prescribing safety and soundness standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not in compliance with any of such safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the prompt corrective action provisions described above.

Community Reinvestment and Consumer Protection Laws

In connection with its lending activities, the Bank is subject to a number of federal laws designed to protect borrowers and promote lending to various sectors of the economy and population. These include the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act and the CRA.

The CRA requires the appropriate federal banking agency, in connection with its examination of a bank, to assess the bank's record in meeting the credit needs of the communities served by the bank, including low- and moderate-income neighborhoods. Furthermore, such assessment also is required of any bank that has applied, among other things, to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch office. In the case of a bank holding company (including a financial holding company) applying for approval to acquire a bank or bank holding company, the Federal Reserve Board will assess the record of each subsidiary bank of the applicant bank holding company in considering the application. Under the CRA, institutions are assigned a rating of "outstanding," "satisfactory," "needs to improve" or "substantial non-compliance." The Bank was rated satisfactory in its most recent CRA evaluation.

6



Anti-Money Laundering Legislation

The Bank is subject to the Bank Secrecy Act and its implementing regulations and other anti-money laundering laws and regulations, including the USA PATRIOT Act of 2001. Among other things, these laws and regulations require the Bank to take steps to prevent the use of the Bank for facilitating the flow of illegal or illicit money, to report large currency transactions and to file suspicious activity reports. The Bank also is required to develop and implement a comprehensive ant-money laundering compliance program. The Bank also must have in place appropriate "know your customer" policies and procedures. Violations of these requirements can result in substantial civil and criminal sanctions. In addition, provisions of the USA PATRIOT Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing bank mergers and BHC acquisitions.

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 comprehensively revised the laws affecting corporate governance, accounting obligations and corporate reporting for companies, such as the Company, with equity or debt securities registered under the Securities Exchange Act of 1934. In particular, the Sarbanes-Oxley Act established: 1) new requirements for audit committees, including independence, expertise, and responsibilities; 2) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; 3) new standards for auditors and regulation of audits; 4) increased disclosure and reporting obligations for the reporting company and its directors and executive officers; and 5) new and increased civil and criminal penalties for violation of the securities laws.

Employees

At January 31, 2005, the Company and its subsidiaries had approximately 2,600 employees.


Item 2. Properties

The principal offices of the Company and each of its business segments are located in the Financial Plaza of the Pacific building in Honolulu, Hawaii. The Company and its subsidiaries own and lease other premises, consisting of branch offices and operating facilities located in Hawaii and the Pacific Islands which are primarily used by the Retail Banking and Commercial Banking business segments.


Item 3. Legal Proceedings

The Company and its subsidiaries are involved in various legal proceedings arising from normal business activities. In the opinion of management, after reviewing these proceedings with counsel, the aggregate liability, if any, resulting from these proceedings is not expected to have a material effect on the Company's consolidated financial position or results of operations.


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

No matter was submitted during the fourth quarter of 2004 to a vote of security holders through solicitation of proxies or otherwise.

7


Executive Officers of the Registrant:

All listed officers are executive officers of the Company and the Bank.

Name

  Age
  Position

Allan R. Landon   56   Chairman and Chief Executive Officer since September 2004; President since December 2003; Chief Operating Officer from May 2004 to August 2004; Vice Chairman from February 2001 to December 2003; Chief Financial Officer from February 2001 to April 2004; and Director of Risk Management from April 2000 to January 2001; Chief Financial Officer, First American Corporation, September 1998 to February 2000.

Richard C. Keene

 

45

 

Vice Chairman and Chief Financial Officer since May 2004; Executive Vice President and Controller from January 2002 to April 2004; independent consultant for the Bank, April 2001 to December 2001; Chief Operating Officer and Controller, MaxRate.com, Inc., March 2000 to March 2001; Senior Vice President and Controller, Prudential Bank, September 1994 to March 2000.

Alton T. Kuioka

 

61

 

Vice Chairman, Commercial Banking since April 1997; Chief Lending Officer from April 1997 to January 2003.

William C. Nelson

 

57

 

Vice Chairman and Chief Risk Officer since January 2001; Managing Director, Bank of America Credit Products Group U.S. health care industry, January 2000 to January 2001; Executive Vice President, Bank of America credit risk management Asia Pacific region, September 1993 to December 1999.

David W. Thomas

 

53

 

Vice Chairman, Retail Banking since April 2001; Executive Vice President, Summit Bank, March 1999 to June 2001.

Donna A. Tanoue

 

50

 

Vice Chairman and Chief Administrative Officer since May 2004; Vice Chairman, Investment Services Group from April 2002 to April 2004; Financial services consultant for the Bank, September 2001 to March 2002; Chairman of the Federal Deposit Insurance Corporation, May 1998 to July 2001.

Brian T. Stewart

 

37

 

Executive Vice President and Controller since May 2004; Senior Vice President, Management Reporting from July 2002 to April 2004; Vice President and Finance Officer from November 2001 to June 2002; First Vice President and Controller, Pacific Century Bank, N.A. (a former subsidiary of the Company) from March 1999 to September 2001.

8



PART II


Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The common stock of the Company is traded on the New York Stock Exchange (NYSE Symbol: BOH) and quoted daily in leading financial publications. As of February 18, 2005, there were 8,140 common shareholders of record.

Information regarding the historical market prices of the Company's common stock and dividends declared on that stock are shown below.

    Market Prices, Book Values and Common Stock Dividends Per Share


 
  Market Price (MP) Range

   
   
 
  Book Value
(BV)

  Dividends
Declared

    Year/Period

  High

  Low

  Close


  2000   $ 23.19   $ 11.06   $ 17.69   $ 16.35   $ 0.71
  2001   $ 28.30   $ 16.88   $ 25.89   $ 17.03   $ 0.72
  2002   $ 31.05   $ 22.79   $ 30.39   $ 16.12   $ 0.73
 
2003

 

$

42.99

 

$

29.25

 

$

42.20

 

$

14.44

 

$

0.87
  First Quarter     31.50     29.25     30.80           0.19
  Second Quarter     35.90     30.75     33.15           0.19
  Third Quarter     35.55     32.92     33.58           0.19
  Fourth Quarter     42.99     33.69     42.20           0.30
 
2004

 

$

51.10

 

$

40.97

 

$

50.74

 

$

14.83

 

$

1.23
  First Quarter     47.45     41.75     46.33           0.30
  Second Quarter     46.84     40.97     45.22           0.30
  Third Quarter     48.07     43.55     47.25           0.30
  Fourth Quarter     51.10     46.80     50.74           0.33
 
The Board of Directors of the Company considers on a quarterly basis the feasibility of paying a cash dividend to its shareholders. General practice is to declare a dividend in the beginning of a quarter to be paid prior to the end of the quarter and is based, in part, on the expected earnings for the quarter. For additional information regarding the limitation on the Company's ability to pay dividends, see "Dividend Restrictions" under "Supervision and Regulations" in Item 1 of this report and Note 9 to the Consolidated Financial Statements, which is incorporated by reference in this Item.

    Issuer Purchases of Equity Securities


    Period

  Total Number of
Shares Purchased 1

  Average Price
Paid Per Share

  Total Number of
Shares Purchased as Part of Publicly Announced Plans or Programs

  Approximate Dollar Value
of Shares that May Yet Be
Purchased Under the Plans
or Programs 2


  October 1 - 31, 2004   200,602   $ 48.39   197,000   $ 103,342,794
  November 1 - 30, 2004   479,600     48.80   479,600     79,936,600
  December 1 - 31, 2004   353,893     49.65   350,500     62,535,414

     
  Total   1,034,095   $ 49.01   1,027,100      

     
1
The months of October and December included 3,602 and 3,393 mature shares, respectively, purchased from employees in connection with stock option exercises. These shares were not purchased as part of the publicly announced program. The shares were purchased at the closing price of the Company's common stock on the dates of purchase. No shares were purchased from employees in connection with stock option exercises in November.

2
The Company repurchased shares during the fourth quarter of 2004 pursuant to its ongoing share repurchase program that was first announced in July 2001. The Company announced an additional authorization for share repurchases of $100.0 million on January 24, 2005. As of February 18, 2005, $83.2 million remained of the $1,250.0 million total repurchase amount authorized by the Company's Board of Directors under the share repurchase program. The program has no set expiration or termination date.

9



Item 6. Selected Financial Data

    Summary of Selected Consolidated Financial Data 1


    (dollars in millions except per share amounts)

  2004

  2003

  2002

  2001

  2000


    At December 31,                              
    Balance Sheet Totals                              
  Net Loans   $ 5,880.1   $ 5,628.1   $ 5,216.2   $ 5,498.1   $ 8,992.9
  Total Assets     9,766.2     9,461.6     9,516.4     10,632.4     14,018.4
  Deposits     7,564.7     7,332.8     6,920.2     6,678.2     9,085.2
  Long-Term Debt     252.6     324.1     389.8     590.4     997.2
  Shareholders' Equity     814.8     793.1     1,015.8     1,247.0     1,301.4
 
Average Assets

 

 

9,745.5

 

 

9,377.5

 

 

9,961.2

 

 

12,693.7

 

 

14,058.0
  Average Loans and Leases     5,786.7     5,524.4     5,411.3     7,732.7     9,418.7
  Average Deposits     7,422.3     7,045.8     6,599.9     8,066.7     9,007.8
  Average Shareholders' Equity     761.0     900.1     1,183.5     1,344.1     1,234.6
 
Year Ended December 31,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Operating Results                              
  Interest Income   $ 455.0   $ 442.5   $ 516.5   $ 828.3   $ 1,032.4
  Net Interest Income     390.6     365.9     370.2     459.7     531.2
  Provision for Loan and Lease Losses     (10.0 )       11.6     74.3     142.9
  Net Income     173.3     135.2     121.2     117.8     113.7
  Basic Earnings Per Share     3.26     2.32     1.75     1.49     1.43
  Diluted Earnings Per Share     3.08     2.21     1.70     1.46     1.42
  Dividends Declared Per Share     1.23     0.87     0.73     0.72     0.71
 
Performance Ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Net Income to Average Total Assets (ROA)     1.78%     1.44%     1.22%     0.93%     0.81%
  Net Income to Average Shareholders' Equity (ROE)     22.78     15.02     10.24     8.76     9.21
  Net Interest Margin 2     4.32     4.23     3.99     3.91     4.08
  Efficiency Ratio 3     56.14     63.38     64.94     65.40     60.29
  Dividend Payout Ratio     37.73     37.50     41.71     48.32     49.65
  Average Equity to Average Assets     7.81     9.60     11.88     10.59     8.78
  Allowance to Loans and Leases Outstanding     1.78     2.24     2.67     2.81     2.67
  Tier I Capital Ratio     12.13     12.54     16.59     19.76     11.78
  Total Capital Ratio     14.89     15.81     19.96     23.29     14.64
  Leverage Ratio     8.29     8.43     10.34     11.20     9.10
 
Non-Financial Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Common Shareholders of Record at Year-End     8,171     9,561     10,550     10,937     8,438
  Basic Weighted Average Shares     53,232,815     58,338,566     69,385,745     78,977,011     79,551,296
  Diluted Weighted Average Shares     56,241,044     61,085,567     71,447,333     80,577,763     79,813,443
1
Comparison between years is affected by divestitures that occurred in 2001.

2
The net interest margin is defined as net interest income, on a fully-taxable equivalent basis, as a percentage of average earning assets.

3
The efficiency ratio is defined as non-interest expense divided by total revenue (net interest income and non-interest income).

10



Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This report, including the statements under the caption "2005 Outlook," contains forward-looking statements concerning, among other things, the economic and business environment in the Company's service area and elsewhere, credit quality, the expected level of loan and lease loss provisioning, and anticipated net income and other financial and business matters in future periods. The Company's forward-looking statements are based on numerous assumptions, any of which could prove to be inaccurate and actual results may differ materially from those projected for a variety of reasons, including, but not limited to: 1) unanticipated changes in business and economic conditions, the competitive environment, fiscal and monetary policies, or legislation in Hawaii and the other markets the Company serves; 2) changes in the Company's credit quality or risk profile which may increase or decrease the required level of allowance for loan and lease losses; 3) changes in market interest rates that may affect the Company's credit markets and ability to maintain its net interest margin; 4) changes to the amount and timing of the Company's proposed equity repurchases and repayment of maturing debt; 5) inability to achieve expected benefits of the Company's business process changes due to adverse changes in implementation processes or costs, operational savings, or timing; 6) real or threatened acts of war or terrorist activity affecting business conditions; and 7) adverse weather and other natural conditions impacting the Company and its customers' operations. Words such as "believes," "anticipates," "expects," "intends," "targeted" and similar expressions are intended to identify forward-looking statements but are not exclusive means of identifying such statements. The Company does not undertake any obligation to update forward-looking statements to reflect later events or circumstances.

Critical Accounting Estimates

The Company's Consolidated Financial Statements were prepared in accordance with U.S. generally accepted accounting principles and follow general practices within the financial services industry in which it operates. The most significant accounting policies followed by the Company are presented in Note 1 to the Consolidated Financial Statements, which is incorporated by reference in this Item. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements. Critical accounting estimates are defined as those that require assumptions to be made that are "highly uncertain" at the time the estimate was made and where the impact of the selection of the estimate or a change in the estimate from period to period would have a material impact on the financial statements. Based on the potential impact to the financial statements of the valuation methods, estimates, assumptions and judgments used, management identified the determination of the Allowance for Loan and Lease Losses (the "Allowance"), the valuation of mortgage servicing rights, the valuation of leased asset residuals and the valuation of pension and postretirement obligations to be the accounting estimates that are the most subjective and/or judgmental.

Allowance for Loan and Lease Losses

The Company maintains an Allowance in an amount adequate to cover management's estimate of probable credit losses as of a given balance sheet date. The Allowance is based on a range of loss estimates reflecting analyses of individual borrowers and historical loss experience, supplemented as necessary by credit judgment to address observed changes in trends, conditions, and other relevant environmental and economic factors, plus an amount for imprecision. The general component covers an inevitable imprecise measure relative to quantitative and judgmental estimates. The determination of the amount of the Allowance is a critical accounting estimate as it requires the use of estimates and significant judgment related to the amount and timing of expected future cash flows on impaired loans, estimated loss rates on homogenous portfolios and deliberation on economic factors and trends. It is possible that the end-of-period Allowance could have been reduced or increased if the Company had judged environmental and economic conditions and other factors and risks to be more or less favorable. For further discussion on the Allowance, see the "Corporate Risk Profile – Allowance for Loan and Lease Losses" section of this Item.

11



Mortgage Servicing Rights Valuation

When mortgage loans are sold with servicing retained, a servicing asset is established and accounted for based on estimated fair values. Such values are determined using discounted cash flow modeling techniques, which require management to make estimates and assumptions regarding the amount and timing of expected future cash flows, loan repayment rates, costs to service and interest rates that reflect the risk involved. Because the value of these assets is sensitive to changes in the estimates and assumptions made, the valuation of mortgage servicing rights is considered a critical accounting estimate. Had the Company assumed that interest rates would decrease and prepayment rates remain at record high levels as in 2003, then the value of the mortgage servicing rights could have been lower. Note 4 to the Consolidated Financial Statements, which includes further discussion on the accounting for these assets and a sensitivity analysis, is incorporated by reference in this Item.

Residual Valuation of Leased Assets

Lease financing receivables include a residual value component, which represents the estimated value of leased assets upon lease expiration. The valuation of lease residuals is considered a critical accounting estimate due to the subjectivity surrounding the future valuation. The determination of expected value at lease termination is derived from a variety of sources, including equipment valuation services, appraisals and publicly available market data on recent sales transactions on similar equipment. The length of time until termination and the cyclical nature of equipment values are important variables considered in making this determination. The Company updates its valuation analysis on an annual basis, or more often when events or circumstances warrant. When it is determined that a residual value is higher than the expected fair market value at lease expiration, the difference is recorded as an asset impairment. The Company is unable to predict future events or conditions that could result in future asset impairments. Note 3 to the Consolidated Financial Statements includes further discussion on the accounting for these assets and is incorporated by reference in this Item.

Pension and Postretirement Plans

The Company's pension and postretirement obligations and net periodic cost are actuarially determined based on the following key assumptions: discount rate, estimated future return on plan assets, and the health care cost trend rate. The discount rate was determined based upon the yield on high-quality, fixed-income investments and discount rates used by peer groups. The 2004 net periodic cost was determined using a discount rate of 6.25% and the pension and postretirement obligations at December 31, 2004 were determined using a discount rate of 6.00%. The estimated return on plan assets of 8.5% was based on historical trends and a building block approach taking into account the type of investments in the pension plan. The health care cost trend rate for 2004 was 6%. Historically, the health care cost trend rate experienced by the Company has been below 6%. In 2005, the health care cost trend rate will be 9% and decrease by 1% annually until reaching the ultimate trend rate of 5% in 2009. A 25 basis point increase in the discount rate would have decreased the total pension and postretirement net periodic cost in 2004 by $0.3 million and the benefit obligations at December 31, 2004 by $3.6 million. A 25 basis point decrease in the discount rate would have increased the 2004 pension and postretirement net periodic cost by $0.3 million and the benefit obligations by $3.8 million. A 1% change in the health care cost trend rate would have changed the 2004 net periodic postretirement cost by $0.4 million.

The estimated pension and postretirement net periodic cost for 2005 is $4.8 million based on a discount rate of 6%. A 25 basis point increase or decrease in the discount rate will decrease or increase, respectively, the total pension and postretirement net periodic cost by $0.3 million. Note 11 to the Consolidated Financial Statements includes further discussion on the accounting for these plans and is incorporated by reference in this Item.

Overview

In January 2004, the Company announced its 2004-2006 plan (the "Plan"), which continues to build on the objective of maximizing shareholder value over time. This objective was established in the previous three-year strategic plan.

12



The Plan consists of five key elements:

    Accelerate revenue growth in our island markets.
    Better integrate our business segments.
    Continue to develop our management teams.
    Improve operating efficiency.
    Maintain a culture of dependable risk and capital management.

In 2004, the Company exceeded the key financial objectives of the first year of the Plan. Revenue growth was accelerated through improved customer service and a more proactive and integrated sales culture across the Company. Additionally, the Company benefited from special income items, including gains on sales of assets, that totaled $11.9 million in 2004. Total revenue, consisting of net interest income and non-interest income, increased 5% in 2004 over 2003. Loans and leases were 4% higher and deposits were 3% higher at the end of 2004 as compared to the prior year.

Progress was made in 2004 to better integrate the Company's three primary business segments – Retail Banking, Commercial Banking and the Investment Services Group – through improved processes, training and communications. As a result, the needs of our customers are more effectively addressed and customer relationships are strengthened.

Effective September 1, 2004, Allan Landon was appointed Chairman of the Board and Chief Executive Officer of the Company, succeeding Michael O'Neill. In addition, several other changes successfully occurred within our management team in 2004 that reflects the depth of leadership talent that exists within the organization. The Company continually assesses leadership skills, builds capabilities and maintains a comprehensive succession plan.

Operating efficiency improved in 2004, as the Company continued to improve systems and processes. The efficiency ratio was 56.14% in 2004 compared to 63.38% in 2003. Operating leverage, which is defined as the relative change in income before the provision for loan and lease losses and income taxes, was 14.3% in 2004 (excluding the impact of the 2003 System Replacement cost).

The management of both risk and capital continued to be dependable and disciplined in 2004. The ratio of the Allowance to loans and leases outstanding was 1.78% and the leverage capital ratio was 8.29% at the end of 2004. For 2004, total shareholder return was 23%, defined as the increase in share price plus dividends divided by the share price at the beginning of the year.

The Company's net income for the year ended December 31, 2004 was $173.3 million, an increase of 28% from $135.2 million in 2003. Additional results for 2004 compared to 2003 were as follows:

    Diluted earnings per share were $3.08, an increase of 39%
    The net interest margin was 4.32%, an increase of nine basis points
    Return on average assets increased to 1.78% from 1.44%
    Return on average equity increased to 22.78% from 15.02%

The Company utilizes various financial measures to evaluate its performance against the objectives of the Plan, many of which were discussed above. There were several factors that had an impact on the comparability of the year-to-year results, including a return of $10.0 million to income from a release of the Allowance in 2004, special income and expense items in both years and the Company's ongoing share repurchase program. These items and the Company's overall financial results are more fully discussed in the following sections of this report.

13


Analysis of Statement of Income

Certain 2003 and 2002 information has been reclassified to conform to 2004 presentation.

Net Interest Income

Net interest income on a taxable equivalent basis increased $24.7 million or 7% from 2003. The increase in net interest income was mainly a result of higher income earned on the investment portfolio and lower expense paid on interest-bearing deposits. The investment portfolio, consisting primarily of mortgage backed securities, experienced an increase in interest income due to a reduction in prepayments in 2004. In addition, the investment portfolio had higher balances in 2004 over 2003 due to the Company's strategy to deploy a portion of its excess liquidity from short-term placements as well as growth in non-interest bearing deposit accounts into the investment portfolio. The increase in interest income from the investment portfolio was partially offset by a decrease in interest income on loans and leases. Loans and leases interest income decreased mainly due to the lower income earned on mortgage loans as a result of lower yields on mortgage loans in 2004 compared to 2003. The decrease in interest income from mortgage loans was partially offset by increased income from installment and home equity loans. These loan products experienced a 27% increase in average balances in 2004 due to promotions during the year. The decline in interest expense from interest-bearing deposits was mainly due to lower average rates paid on savings and time deposits. Lower funding costs were incurred on deposits as a result of Hawaii market conditions allowing the Company to maintain deposit rates stable throughout 2004. Slight increases in deposit rates occurred in the fourth quarter of 2004 and are expected to continue into 2005 provided the local deposit market interest rates continue to increase.

The net interest margin was 4.32% in 2004, a nine basis points increase from 2003. The improvement in the margin was attributable to the improvement in the average yield earned on the available for sale investment portfolio due to a reduction in prepayments in 2004. In addition, there was a 23 basis point decline in the average rate paid on interest-bearing deposits, primarily savings and time deposits which lowered the Company's cost of funds. The impact of the growth in balances in the installment loan category was partially offset by lower yields earned due to loan promotions in the beginning of the year which had low six-month introductory rates. The introductory rates began to reset in the fourth quarter of 2004.

In 2003, net interest income on a taxable equivalent basis decreased by $4.4 million or 1% from 2002. The decrease in net interest income was primarily a result of the lower interest rate environment, in particular the interest rates earned on mortgage loans and short-term investments. The lower level of interest income was partially offset by a reduction in interest expense, including a reduction in interest paid on deposits, which declined by 44% in spite of a 5% increase in average interest-bearing deposits, and interest paid on short and long-term borrowings, which decreased due to a reduction in the borrowings.

Average interest earning assets in 2003 decreased $617.2 million, or 7%, from 2002 primarily due to an $872.7 million decrease in the Company's investment in interest-bearing deposits which was used for share repurchases and debt reductions. Average interest-bearing liabilities in 2003 decreased $536.3 million or 8% from 2002 mainly due to reductions in short-term borrowings and long-term debt.

The net interest margin was 4.23% in 2003, a 24 basis point increase from 3.99% in 2002. The improvement was attributable to the Company deploying non-maturing deposits into higher yielding securities along with reductions in time deposits, short-term borrowings and debt, all of which lowered the Company's cost of funds.

14



Average balances, related income and expenses, and resulting yields and rates are presented in Table 1. An analysis of the change in net interest income is presented in Table 2.

Consolidated Average Balances and Interest Rates - Taxable Equivalent Basis   Table 1

 
  2004

  2003

  2002

 
 
(dollars in millions)

  Average
Balance

  Income/
Expense

  Yield/
Rate

  Average
Balance

  Income/
Expense

  Yield/
Rate

  Average
Balance

  Income/
Expense

  Yield/
Rate


Earning Assets                                                
Interest-Bearing Deposits   $ 189.7   $ 3.5   1.83%   $ 227.3   $ 4.8   2.12%   $ 1,100.0   $ 20.0   1.82%
Funds Sold     85.6     1.0   1.24     162.9     1.9   1.18     213.8     3.5   1.64
Investment Securities                                                
  Available for Sale     2,227.8     93.7   4.21     2,142.8     77.9   3.64     2,028.9     104.4   5.15
  Held to Maturity     675.7     26.2   3.88     487.6     19.0   3.89     311.7     16.9   5.43
Loans Held for Sale     15.8     0.9   5.58     39.5     2.2   5.48     120.2     8.0   6.65
Loans and Leases 1                                                
  Commercial and Industrial     810.4     42.3   5.22     860.3     41.9   4.87     1,024.1     52.0   5.08
  Construction     99.3     4.5   4.56     96.3     4.4   4.56     151.5     8.3   5.45
  Commercial Mortgage     639.1     34.5   5.40     644.8     37.4   5.81     598.7     40.0   6.68
  Residential Mortgage     2,296.7     129.9   5.66     2,295.0     145.6   6.34     2,334.4     164.3   7.04
  Installment     703.2     59.6   8.47     548.8     52.6   9.59     408.3     45.1   11.05
  Home Equity     560.3     27.4   4.88     444.6     22.5   5.05     393.4     22.9   5.81
  Purchased Home Equity     168.2     7.4   4.41     144.7     5.9   4.10     2.5      
  Lease Financing     509.5     21.5   4.21     489.9     22.3   4.55     498.4     25.8   5.17

Total Loans and Leases     5,786.7     327.1   5.65     5,524.4     332.6   6.02     5,411.3     358.4   6.62

Other     73.8     2.8   3.78     75.7     4.3   5.61     91.5     5.6   6.14

Total Earning Assets 2     9,055.1     455.2   5.03     8,660.2     442.7   5.11     9,277.4     516.8   5.57

Cash and Non-Interest Bearing Deposits     314.6               328.4               313.2          
Other Assets     375.8               388.9               370.6          
   
           
           
         
Total Assets   $ 9,745.5             $ 9,377.5             $ 9,961.2          
   
           
           
         
Interest-Bearing Liabilities                                                
Interest-Bearing Deposits                                                
  Demand   $ 1,433.1     3.2   0.22   $ 1,215.7     2.5   0.20   $ 1,014.7     4.3   0.42
  Savings     2,945.3     13.2   0.45     2,723.9     15.7   0.58     2,263.4     29.4   1.30
  Time     1,114.8     20.3   1.82     1,352.3     29.3   2.17     1,765.5     50.6   2.87

Total Interest-Bearing Deposits     5,493.2     36.7   0.67     5,291.9     47.5   0.90     5,043.6     84.3   1.67

Short-Term Borrowings     884.0     11.3   1.27     724.2     9.0   1.24     1,390.2     32.7   2.35
Long-Term Debt     284.2     16.4   5.78     352.7     20.1   5.71     471.3     29.3   6.21

Total Interest-Bearing Liabilities     6,661.4     64.4   0.97     6,368.8     76.6   1.20     6,905.1     146.3   2.12

Net Interest Income         $ 390.8             $ 366.1             $ 370.5    
         
           
           
   
  Interest Rate Spread               4.06%               3.91%               3.45%
  Net Interest Margin               4.32%               4.23%               3.99%

Non-Interest-Bearing Demand Deposits

 

 

1,929.1

 

 

 

 

 

 

 

1,753.9

 

 

 

 

 

 

 

1,556.3

 

 

 

 

 
Other Liabilities     394.0               354.7               316.3          
Shareholders' Equity     761.0               900.1               1,183.5          
   
           
           
         
Total Liabilities and Shareholders' Equity   $ 9,745.5             $ 9,377.5             $ 9,961.2          
   
           
           
         
1
Non-performing loans are included in the respective average loan balances. Income, if any, on such loans is recognized on a cash basis.

2
Interest income includes taxable-equivalent basis adjustment based upon a statutory tax rate of 35%.

15


Analysis of Change in Net Interest Income - Taxable Equivalent Basis   Table 2

 
  Year Ended December 31,
2004 Compared to 2003

  Year Ended December 31,
2003 Compared to 2002

 
 
 
 
 
(dollars in millions)
  Volume 1
  Rate 1
  Total
  Volume 1
  Rate 1
  Total
 

 
Change in Interest Income:                                      
Interest-Bearing Deposits   $ (0.7 ) $ (0.6 ) $ (1.3 ) $ (18.0 ) $ 2.8   $ (15.2 )
Funds Sold     (1.0 )   0.1     (0.9 )   (0.7 )   (0.9 )   (1.6 )
Investment Securities                                      
  Available for Sale     3.2     12.6     15.8     5.6     (32.1 )   (26.5 )
  Held to Maturity     7.2         7.2     7.7     (5.6 )   2.1  
Loans Held for Sale     (1.3 )       (1.3 )   (4.6 )   (1.2 )   (5.8 )
Loans and Leases                                      
  Commercial and Industrial     (2.5 )   2.9     0.4     (8.0 )   (2.1 )   (10.1 )
  Construction     0.1         0.1     (2.7 )   (1.2 )   (3.9 )
  Commercial Mortgage     (0.3 )   (2.6 )   (2.9 )   2.8     (5.4 )   (2.6 )
  Residential Mortgage     0.1     (15.8 )   (15.7 )   (2.7 )   (16.0 )   (18.7 )
  Installment     13.6     (6.6 )   7.0     14.0     (6.5 )   7.5  
  Home Equity     5.7     (0.8 )   4.9     2.8     (3.2 )   (0.4 )
  Purchased Home Equity     1.0     0.5     1.5     0.1     5.8     5.9  
  Lease Financing     0.9     (1.7 )   (0.8 )   (0.4 )   (3.1 )   (3.5 )

 
Total Loans and Leases     18.6     (24.1 )   (5.5 )   5.9     (31.7 )   (25.8 )

 
Other     (0.1 )   (1.4 )   (1.5 )   (0.9 )   (0.4 )   (1.3 )

 
Total Change in Interest Income     25.9     (13.4 )   12.5     (5.0 )   (69.1 )   (74.1 )

 
Change in Interest Expense:                                      
Interest-Bearing Deposits                                      
  Demand     0.5     0.2     0.7     0.7     (2.5 )   (1.8 )
  Savings     1.2     (3.7 )   (2.5 )   5.1     (18.8 )   (13.7 )
  Time     (4.7 )   (4.3 )   (9.0 )   (10.4 )   (10.9 )   (21.3 )

 
Total Interest-Bearing Deposits     (3.0 )   (7.8 )   (10.8 )   (4.6 )   (32.2 )   (36.8 )

 
Short-Term Borrowings     2.1     0.2     2.3     (11.9 )   (11.8 )   (23.7 )
Long-Term Debt     (3.9 )   0.2     (3.7 )   (6.9 )   (2.3 )   (9.2 )

 
Total Change in Interest Expense     (4.8 )   (7.4 )   (12.2 )   (23.4 )   (46.3 )   (69.7 )

 
Change in Net Interest Income   $ 30.7   $ (6.0 ) $ 24.7   $ 18.4   $ (22.8 ) $ (4.4 )

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

Provision for Loan and Lease Losses

Based on continued strength in the economic environment, improvement in the credit quality of the loan portfolio, lower than anticipated net charge-offs during 2004 and management's ongoing assessment of the portfolio, the Company returned $10.0 million to income from a release of the Allowance in 2004. No provision was recorded in 2003.

Based on current conditions, the Company estimates a $10.0 million Provision for Loan and Lease Losses ("Provision") for 2005. However, the actual amount of the Provision depends on determinations of credit risk that are made near the end of each quarter.

Non-Interest Income

The increase in non-interest income in 2004 compared to 2003 was mainly due to increased trust and asset management fees, service charges on deposit accounts and other income, partially offset by a decrease in mortgage banking income.

16



Table 3 presents the major components of non-interest income.

Non-Interest Income   Table 3

 
  Year Ended December 31,
  Percent Change
 
 
 
(dollars in thousands)
  2004
  2003
  2002
  2004 to 2003
  2003 to 2002

Trust and Asset Management   $ 53,465   $ 50,996   $ 55,733   5%   (8)%
Mortgage Banking     8,012     15,556     18,866   (48)   (18)
Service Charges on Deposit Accounts     39,117     35,938     32,617   9   10
Fees, Exchange, and Other Service Charges     54,907     56,221     51,594   (2)   9
Investment Securities Gains (Losses)     (794)     1,789     615   (144)   191
Insurance     19,241     19,145     17,710   1   8
Other Income:                          
  Income from Bank-Owned Life Insurance     7,336     7,301     4,397     66
  Gain on the Sale of Assets from a Leveraged Lease     5,232     1,100       376   100
  Leasing Partnership Distribution     3,218           100  
  Gain on the Sale of Land     2,454           100  
  Other     12,906     10,674     16,803   21   (36)

Total Other Income     31,146     19,075     21,200   63   (10)

Total Non-Interest Income   $ 205,094   $ 198,720   $ 198,335   3%   –%

Trust and asset management income comprises fees earned for the management and administration of assets. The fees are generally based on the market value of the assets that are managed. Total assets under administration were $11.5 billion, $10.0 billion and $9.2 billion (adjusted for sale of corporate trust business in the first quarter of 2004) at December 31, 2004, 2003 and 2002, respectively. The increase in trust and asset management income in 2004 from 2003 is consistent with the increase in equity markets which led to an increase in the Company's average market value of assets under management. In addition, trust and management income increased due to higher advisory fees on money market assets. The increase in trust and asset management income was partially offset by a decline in corporate account revenue due to the sale of the corporate trust business. Conversely, due to unfavorable stock market conditions, trust and asset management income declined in 2003 from 2002. Although the stock market experienced some recovery in 2003, it did not recover to peak levels of early 2002 and short-term interest rates declined throughout 2003.

Mortgage banking income comprises fees from loan originations, gains from sales of loans and net servicing income. Net servicing income is defined as income earned for servicing loans less the amortization of mortgage servicing rights. Mortgage banking income is highly influenced by the level and direction of mortgage interest rates. Mortgage banking income declined in 2004 as compared to 2003 largely as a result of a 50% decrease in mortgage loan production. Mortgage interest rates hit record lows in 2003, which led to a record year for production. The decreased production volume in 2004 combined with competitive sales margins and a change in the mix of production to more variable rate loans led to lower gains on sale of loans. Gains from the sale of loans declined $13.2 million and other fees declined $2.9 million in 2004 from 2003. However, the decline in re-financings benefited the Company as loan prepayments declined by 68% resulting in an increase in net servicing income of 87%. In 2003, net servicing income declined $10.5 million compared to 2002 due to increased mortgage servicing rights amortization as a result of the high level of prepayments. In 2002, a $4.4 million market value gain was realized reversing a December 31, 2001 valuation loss in loans held for sale.

Service charges on deposit accounts have increased each year due to core account growth as reflected by a 13% and 16% increase in average demand deposits in 2004 and 2003, respectively. In addition, overdraft fees increased from fee and policy initiatives that were implemented in 2004 and at the end of 2002.

Fees, exchange, and other service charges are primarily comprised of fees from ATMs, merchant servicing activity and other loan fees and service charges. ATM and merchant servicing activity experienced growth in each period. In 2003, a $3.0 million prepayment fee on a commercial real estate loan was recognized.

17


Income from bank-owned life insurance increased in 2004 and 2003 as a result of approximately $40.0 million in additional policies purchased at the end of 2002. Other income increased in 2004 mainly because of $11.9 million of special income items that consisted of a $5.2 million gain on the sale of assets at the end of a leverage leased transaction in the third quarter, a $3.2 million distribution from a leasing partnership and a $2.5 million gain from a sale of parcel of land in the second quarter and a $1.0 million gain on the sale of the corporate trust business in the first quarter. In 2002, other income included higher income from mutual fund and securities sales.

Non-Interest Expense

The decrease in non-interest expense in 2004 compared to 2003 was largely attributable to the completion of the Systems Replacement Project in the third quarter of 2003. This project, which began in 2002, involved the conversion of the Company's key systems, including loans and deposits, to a third party systems provider. Conversion expenses of $21.9 million and $13.6 million were incurred in 2003 and 2002, respectively. The new system resulted in better customer service and convenience and an improvement in the Company's efficiency. The project resulted in decreased salaries, depreciation, equipment maintenance and software license fees, partially offset by an increase in data services expense. Note 16 of the Consolidated Financial Statements, which is incorporated by reference in this Item, presents the costs incurred on the Systems Replacement Project in 2003 and 2002.

Table 4 shows the major components of non-interest expense.

Non-Interest Expense   Table 4

 
   
   
   
  Percent Change
 
  Year Ended December 31,
 
 
 
 
  2004 to 2003
  2003 to 2002
(dollars in thousands)
  2004

  2003

  2002


Salaries and Benefits:                          
  Salaries   $ 110,851   $ 114,376   $ 123,601   (3)%   (7)%
  Incentive Compensation     15,458     15,747     12,871   (2)   22
  Stock-Based Compensation     11,726     9,215     4,553   27   102
  Commission Expense     7,682     10,797     9,113   (29)   18
  Retirement and Other Benefits     15,900     14,353     14,134   11   2
  Payroll Taxes     11,063     10,454     10,894   6   (4)
  Medical, Dental, and Life Insurance     8,354     7,371     8,008   13   (8)
  Separation Expense     3,265     3,967     3,389   (18)   17

Total Salaries and Benefits     184,299     186,280     186,563   (1)  

Net Occupancy Expense     38,347     38,980     39,149   (2)  
Net Equipment Expense     23,926     33,652     41,253   (29)   (18)
Restructuring and Other Related Costs             2,364     (100)
Information Technology Systems Replacement Project         21,871     13,628   (100)   60
Other Expense:                          
  Professional Services     16,658     15,033     19,727   11   (24)
  Delivery and Postage Services     10,123     9,983     10,584   1   (6)
  Data Services     9,666     6,271     1,847   54   240
  Other     51,421     45,805     54,134   12   (15)

Total Other Expense     87,868     77,092     86,292   14   (11)

Total Non-Interest Expense   $ 334,440   $ 357,875   $ 369,249   (7)%   (3)%

18


Total salaries and benefits in 2004 declined $2.0 million from 2003 which was relatively unchanged from 2002 levels, however components have varied each year. The number of employees declined 3% in 2004 and 7% in 2003, primarily because of the Systems Replacement Project, which led to the decline in base salaries. Offsetting the decline in base salaries in both years were increases in stock-based compensation, which increased due to restricted stock grants in 2004 and 2003 and restricted stock units awarded in 2003. Incentive compensation increased in 2003 compared to 2002 because of the achievement of performance goals in several lines of business and the improvement in the Company's overall performance. Consistent with the trends in mortgage banking income, commission expense declined $3.1 million in 2004 from an increased level in 2003. In 2003, the Company recognized a $2.5 million curtailment gain on its post-retirement benefits due to the termination of life insurance benefits. The Company also recognized expense for its frozen defined benefit plan in 2004 and 2003, while in 2002, due to the plan's funding status, it generated income.

Net equipment expense declined due to reduced depreciation expense and software license fees resulting from the Systems Replacement Project.

Professional fees declined from 2002 levels as the Company continued to monitor and manage expenses more efficiently. The increase in professional fees in 2004 from 2003 was mainly due to added professional services relating to the Company's mutual funds and an increase in audit fees. Other expense increased in 2004 due to a legal settlement accrual of $2.2 million. In 2003, other expenses were reduced due to a $2.5 million gain on the sale of foreclosed real estate and a gain on the transfer of an affinity mileage program.

Income Taxes

The 2004 provision for income taxes reflected an effective tax rate of 36.1%, compared to effective rates of 34.6% and 35.4% in 2003 and 2002, respectively. For additional information regarding tax expense, including a reconciliation of the effective tax rate to the statutory tax rate, refer to Note 13 to the Consolidated Financial Statements, which is incorporated by reference in this Item.

Business Segments

The Company's business segments are defined as Retail Banking, Commercial Banking, Investment Services Group, and Treasury and Other Corporate. The management accounting process measures the performance of the business segments based on the management structure of the Company and is not necessarily comparable with similar information for any other financial institution. This process uses various techniques to assign balance sheet and income statement amounts to the business segments, including allocations of overhead, the Provision and capital. This process is dynamic and requires certain allocations based on judgment and subjective factors. Unlike financial accounting, there is no comprehensive, authoritative guidance for management accounting that is equivalent to U.S. generally accepted accounting principles. Results for prior periods have been reclassified to facilitate comparability with the 2004 presentation.

The business segments are primarily managed with a focus on performance measures, including net income after capital charge ("NIACC") and risk adjusted return on capital ("RAROC"). NIACC is net income less a charge for the cost of allocated capital. The cost of allocated capital is determined by multiplying management's estimate of the shareholder's minimum required rate of return on capital invested (currently 11%) by the segment's allocated equity. The Company assumes a cost of capital that is equal to a risk-free rate plus a risk premium. RAROC is the ratio of net income to risk-adjusted equity. Equity is allocated to each business segment based on an assessment of its inherent risk. The net interest income of the business segments reflects the results of a funds transfer pricing process that matches assets and liabilities with similar interest rate sensitivity and maturity characteristics and reflects the allocation of net interest income related to the Company's overall asset and liability management activities on a proportionate basis. The basis for the allocation of net interest income is a function of management decisions and assumptions that are subject to change based on changes in current interest rate and market conditions. The Provision charged to the Treasury and Other Corporate segment represents changes in the level of the Allowance. The Provision recorded in the Retail Banking, Commercial Banking and Investment Services Group segments represents actual net charge-offs of these segments.

19


On a consolidated basis, the Company considers NIACC a measure of shareholder value creation. For the year ended December 31, 2004, consolidated NIACC was $67.6 million, compared to $20.7 million in 2003, a result of improved financial performance and more efficient use of capital.

Financial results for each of the segments are presented in Table 5 and Note 17 of the Consolidated Financial Statements, which is incorporated by reference in this Item.

The following table summarizes NIACC and RAROC results for the Company's business segments:

Business Segment Selected Financial Information   Table 5

(dollars in thousands)

  Retail
Banking

  Commercial
Banking

  Investment
Services
Group

  Treasury
and Other
Corporate

  Consolidated
Total

 

 
Year Ended December 31, 2004                                
Allocated Net Income   $ 68,575   $ 55,828   $ 8,382   $ 40,554   $ 173,339  
Allowance Funding Value     (605 )   (2,653 )   (25 )   3,283      
GAAP Provision     10,446     3,232     47     (23,725 )   (10,000 )
Economic Provision     (14,054 )   (10,528 )   (370 )   (8 )   (24,960 )
Tax Effect of Adjustments     1,559     3,681     129     7,566     12,935  

 
Income Before Capital Charge     65,921     49,560     8,163     27,670     151,314  
Capital Charge     (22,157 )   (19,905 )   (5,209 )   (36,458 )   (83,729 )

 
Net Income (Loss) After Capital Charge (NIACC)   $ 43,764   $ 29,655   $ 2,954   $ (8,788 ) $ 67,585  

 
RAROC (ROE for the Company)     33%     27%     17%     22%     23%  

 
Year Ended December 31, 2003                                
Allocated Net Income   $ 72,436   $ 49,823   $ 7,567   $ 5,369   $ 135,195  
Allowance Funding Value     (595 )   (3,987 )   (32 )   4,614      
GAAP Provision     6,909     8,415     (5 )   (15,319 )    
Economic Provision     (11,932 )   (12,120 )   (432 )   (25 )   (24,509 )
Tax Effect of Adjustments     2,079     2,846     174     3,969     9,068  

 
Income (Loss) Before Capital Charge     68,897     44,977     7,272     (1,392 )   119,754  
Capital Charge     (22,715 )   (21,889 )   (5,032 )   (49,405 )   (99,041 )

 
Net Income (Loss) After Capital Charge (NIACC)   $ 46,182   $ 23,088   $ 2,240   $ (50,797 ) $ 20,713  

 
RAROC (ROE for the Company)     33%     23%     16%     (1)%     15%  

 
Year Ended December 31, 2002                                
Allocated Net Income   $ 64,923   $ 34,097   $ 10,489   $ 11,671   $ 121,180  
Allowance Funding Value     (835 )   (6,035 )   (28 )   6,898      
GAAP Provision     4,061     24,902     75     (17,422 )   11,616  
Economic Provision     (11,754 )   (14,397 )   (485 )   (17 )   (26,653 )
Tax Effect of Adjustments     3,155     (1,654 )   162     3,901     5,564  

 
Income Before Capital Charge     59,550     36,913     10,213     5,031     111,707  
Capital Charge     (21,951 )   (24,460 )   (5,134 )   (78,696 )   (130,241 )

 
Net Income (Loss) After Capital Charge (NIACC)   $ 37,599   $ 12,453   $ 5,079   $ (73,665 ) $ (18,534 )

 
RAROC (ROE for the Company)     30%     17%     22%     6%     10%  

 

Retail Banking

The Company's Retail Banking segment offers a broad range of financial products and services to consumers and small businesses. Loan and lease products include residential mortgage loans, home equity lines of credit, automobile loans and leases and installment loans. Deposit products include checking, savings and time deposit accounts. The Retail Banking segment also provides merchant services to its small business customers. Products and services from

20



the Retail Banking segment are delivered to customers through 74 Hawaii branch locations and 500 ATMs, e-Bankoh (on-line banking service), and a 24-hour telephone banking service. Also included in the segment is Bankoh Investment Services, Inc., a full service brokerage offering equity, mutual fund, life insurance and annuity products.

The Retail Banking segment's financial measures in 2004 remained relatively consistent with 2003, although net interest income and non-interest income declined, offset by a decrease in non-interest expense. The decrease in net interest income was mainly a result of lower earnings credit from funds transfer pricing on the segment's deposit account balances, reflective of the lower interest rate environment. During 2004, the segment experienced steady growth in its indirect auto, direct personal and home equity portfolios, partially offsetting the effect of the lower earnings credit on deposit accounts. The decrease in non-interest income primarily resulted from lower gains on the sale of mortgage loans due to lower production and related sales volume and competitive market conditions. The segment's decrease in non-interest expense was primarily due to reductions in technology and operations support, depreciation and software costs attributable to the Systems Replacement Project. The increase in the Provision was primarily due to increased charge-offs in the segment's growing loan portfolios.

The improvement in the segment's financial measures in 2003 as compared to 2002 was primarily due to an increase in net interest income as well as a decrease in non-interest expense and Systems Replacement Project costs. These positive trends were partially offset by an increase in the Provision. The increase in net interest income for the segment was reflective of higher average loan balances, largely a result of strong growth in the segment's auto, direct personal, small business and home equity portfolios, augmented by a purchase of home equity loans in December 2002. Also contributing to the increase in net interest income was lower interest expense on deposit accounts, reflective of the lower interest rate environment in 2003. The decrease in non-interest expense was primarily due to reductions in technology support, depreciation and advertising costs. The increase in the Provision was primarily due to increased charge-offs in the segment's growing loan portfolios.

Commercial Banking

The Commercial Banking segment offers products including corporate banking and commercial real estate loans, lease financing, auto dealer financing, deposit and cash management products and property and casualty insurance products. Lending, deposit and cash management services are offered to middle-market and large companies in Hawaii. Commercial real estate mortgages are focused on customers that include investors, developers and builders primarily domiciled in Hawaii. The Commercial Banking unit also includes the Company's operations at its 12 branches in the Pacific Islands.

The improvement in the segment's financial measures for 2004 compared with 2003 was primarily due to an increase in non-interest income and a decrease in capital charge, partially offset by a decrease in net interest income. The increase in non-interest income is a result of a gain on the sale of assets at the end of a leveraged lease transaction, a leasing partnership investment distribution and increased insurance income. This was offset by a decrease in net interest income due to a decrease in the earnings credit from funds transfer pricing on the segment's deposit account balances reflective of lower interest rates. Total non-interest expense declined in 2004 from 2003 because of decreases in salaries and lower allocated expenses from support units within the Company. The charge for capital decreased because of the refinement of credit risk factors.

The improvement in the segment's financial measures for 2003 compared to 2002 was a result of a decrease in non-interest expense and an increase in non-interest income, moderately offset by lower net interest income. The increase in non-interest income was attributable to an increase in prepayment fees on commercial real estate loans, insurance income and other fees. The decline in non-interest expense was due to cost management initiatives that reduced staffing levels and other direct expenses as well as the realization of benefits from the System Replacement Project, and reduced allocated expenses from support units within the Company.

21



Investment Services Group

The Investment Services Group includes private banking, trust services, asset management, and institutional investment advice. A significant portion of this segment's income is derived from fees, which are generally based on the market values of assets under administration. The private banking and personal trust group assists individuals and families in building and preserving their wealth by providing investment, credit and trust expertise to high-net-worth individuals. The asset management group manages portfolios and creates investment products. Institutional sales and service offers investment advice to corporations, government entities and foundations.

The improvement in the segment's key financial measures for 2004 was a result of an increase in non-interest income. Non-interest income increased because of growth in trust and asset management fee income resulting from improved market conditions and an increase in other income due to the sale of the corporate trust business. These positive trends were offset by increases in both direct and allocated non-interest expense. The increase in non-interest expense was primarily due to increased professional fees relating to the Company's mutual funds.

The decline in the segment's financial measures for 2003 as compared to 2002 was primarily due to a decrease in non-interest income. Non-interest-bearing deposit balances decreased, resulting in a decline in net interest income. The decline in non-interest income was due primarily to a decrease in trust and asset management fee income, which resulted from declines in the value of assets under management and from decreased sales and fee income. The decrease in non-interest expense was mainly due to a decrease in outside service fees and commissions.

Treasury and Other Corporate

The primary income earning component of this segment is Treasury, which consists of corporate asset and liability management activities, including interest rate risk management and foreign exchange business. This segment's assets and liabilities (and related net interest income) consist of interest bearing deposits, investment securities, federal funds sold and purchased, government deposits and short-and long-term borrowings. The primary source of foreign exchange income relates to customer driven currency requests from merchants and island visitors. The net residual effect of transfer pricing of assets and liabilities is included in Treasury, along with eliminations of inter-company transactions.

This segment also includes divisions (Technology and Operations, Human Resources, Finance, Credit and Risk Management and Corporate and Regulatory Administration) that provide a wide-range of support to the other business segments. Expenses incurred by these support units are charged to the business segments through an internal cost allocation process. Results for this segment in 2003 and 2002 include the System Replacement Project costs that were not incurred by or allocated to the other business segments and the residual costs associated with 2001 restructuring activities.

The improvement in the segment's financial measures in 2004 compared to 2003 was primarily due to an increase in net interest income and the absence of System Replacement Project costs. The increase in net interest income was due to the impact of the lower cost of funding deposits by the Treasury unit and higher average balances in the investment portfolio. NIACC was also favorably impacted by a lower capital charge due to the reduction of the Company's excess capital as a result of the continuing share repurchase activity.

The improvement in the segment's financial measures in 2003 compared to 2002 was primarily due to a significant decline in the capital charge. Continued share repurchase activity had led to the reduction of excess capital, thereby lowering the related charge for capital. Partially offsetting the positive impact of the reduction of excess capital was an increase in expenses for the Systems Replacement Project and other non-interest expenses not allocated to the other business segments. In 2002, results for this segment included restructuring related costs resulting from branch closures in the Pacific Islands and the completion of the 2001 divestitures. The negative amount in the Provision reflects the overall reduction in the Allowance.

22


Balance Sheet Analysis

Investment Securities

The Company's investment portfolio is managed in an effort to provide liquidity and interest income, offset interest rate risk positions and provide collateral for various banking activities. As of December 31, 2004, the portfolio totaled $3.1 billion, compared with $2.7 billion as of December 31, 2003. The increase reflected the deployment of excess liquidity into investment securities versus short-term placements. The investment securities portfolio was in an unrealized loss position of $15.1 million or 0.5% of total amortized cost at December 31, 2004. The Company believes the loss is temporary. See Note 2 to the Consolidated Financial Statements, which is incorporated by reference in this Item, for further information.

See Table 6 for the maturity distribution, market value and weighted-average yield to maturity of investment securities.

Supplementary Data - Maturity Distribution, Market Value and
Weighted-Average Yield to Maturity of Investment Securities
  Table 6

(dollars in millions)

1 Year
or Less

  Weighted Average Yield
  After 1 Year-5 Years
  Weighted Average Yield
  After 5 Years-10 Years
  Weighted Average Yield
  Over 10 Years
  Weighted Average Yield
  Total
  Weighted Average Yield
  Approximate Market Value

Maturity Distribution Based on Amortized Cost                                    
December 31, 2004                                                      
Held to Maturity                                                      
  Obligations of
States and
Political
Subdivisions 1
$   –%   $ 0.1   8.9%   $   –%   $   –%   $ 0.1   8.9%   $ 0.1
  Mortgage-Backed Securities 2                     589.8   4.1     589.8   4.1     585.7

Total Held to Maturity     – %     0.1   8.9%       – %     589.8   4.1%     589.9   4.1%     585.8
 
     
     
     
     
     
Available for Sale Securities 3                                                      
  U.S. Treasury Securities     – %     0.6   5.0%     0.2   5.2%       – %     0.8   5.1%     0.9
  U.S. Government Agencies         10.8   3.3     21.5   2.1     5.4   3.4     37.7   2.6     38.0
  Obligations of States and Political Subdivisions 1   1.8   7.5     2.3   5.3     3.8   5.4           7.9   5.9     8.1
  Mortgage-Backed Securities 2         6.9   6.0     45.8   4.4     2,037.8   4.7     2,090.5   4.7     2,099.0
  Other Debt Securities   9.7   2.3     328.9   3.7                 338.6   3.7     337.7

Total Available for Sale Securities   11.5   3.1%     349.5   3.7%     71.3   3.8%     2,043.2   4.7%     2,475.5   4.5%     2,483.7
 
     
     
     
     
     
Total Investment Securities                                                      
  December 31, 2004 $ 11.5       $ 349.6       $ 71.3       $ 2,633.0       $ 3,065.4       $ 3,069.5
 
     
     
     
     
     
  December 31, 2003 $ 55.9       $ 69.1       $ 135.5       $ 2,441.0       $ 2,701.5       $ 2,711.8
 
     
     
     
     
     
  December 31, 2002 $ 38.6       $ 24.8       $ 134.9       $ 2,276.1       $ 2,474.4       $ 2,523.2
 
     
     
     
     
     
1
Weighted-average yields on obligations of states and political subdivisions are generally tax-exempt and are computed on a tax-equivalent basis using a federal income tax rate of 35%.

2
Contractual maturities do not anticipate reductions for periodic paydowns.

3
Weighted-average yields on available for sale securities are based on amortized cost.

Loans and Leases

Loans and leases represent the largest category of interest earning assets and the largest source of revenue. The Company's loan portfolio, which is divided into commercial and consumer components, increased 4% to $6.0 billion at December 31, 2004 from 2003. Table 7 presents the geographic distribution of the loan and lease portfolio based on the location of borrower and Table 8 presents maturities and sensitivity of loans to changes in interest rates

23



The commercial loan portfolio is comprised of commercial and industrial loans, commercial mortgages, construction loans and lease financing. Commercial and industrial loans are extended primarily to corporations, middle market and small businesses. The purpose of these loans is for working capital needs, acquisitions, equipment or other expansion projects. Although the primary market is Hawaii, there are some borrowers from the continental United States ("Mainland") that are principally shared national credits. Commercial mortgages and construction loans are offered to real estate investors, developers and builders primarily domiciled in Hawaii. Commercial mortgages are secured by real estate. The source of repayment for investor property is cash flow from the property, for owner-occupied property it is operating cash flow from the business. Construction loans are for the purchase or construction of a property for which repayment will be generated by the property. Lease financing consists of direct financing leases and leveraged leases. During 2004, the Company experienced a high level of commercial loan pay-offs. This heightened pay-off activity was the result of liquidity generated by many of the Company's customers from improved profitability and asset sales. In spite of the pay-off activity, the commercial loan portfolio increased by 2% in 2004 compared to 2003.

The consumer loan portfolio is comprised of residential mortgage loans, home equity loans, personal credit lines, direct installment loans and indirect auto loans and leases. These products are offered generally in the markets the Company serves through the branch network. The residential mortgage portfolio continued to experience prepayments throughout 2004; however, despite lower origination volume in 2004 as compared to 2003, the portfolio remained at the same level as 2003. The home equity and other consumer loan portfolios increased 41% and 14%, respectively, from 2003 primarily due to increased customer demand as residential property values and consumer income increased in Hawaii. The Company used targeted marketing campaigns and promotions as well as improved service standards to make loans available to creditworthy customers. The Company expects to see continued growth in these portfolios in 2005. By contrast, the purchased home equity portfolio, which is comprised of Mainland borrowers, did not meet the Company's yield expectations and continues to run-off with no new purchases in 2004. Note 3 to the Consolidated Financial Statements, which is incorporated by reference in this Item, presents the composition of the loan and lease portfolio by major loan categories. For additional information, refer to the "Corporate Risk Profile – Credit Risk" section of this Item.

Geographic Distribution of Loan and Lease Portfolio   Table 7

(dollars in thousands)

  Total
  Hawaii
  Mainland
U.S.

  Guam
  Other Pacific
Islands

  Foreign

Commercial                                    
  Commercial and Industrial   $ 892,164   $ 688,295   $ 95,469   $ 62,350   $ 25,371   $ 20,679
  Commercial Mortgage     602,678     479,389     34,337     83,972     4,980    
  Construction     122,355     115,851     2,843     3,511     150    
  Lease Financing     479,100     49,570     397,073     292     2     32,163

Total Commercial     2,096,297     1,333,105     529,722     150,125     30,503     52,842

Consumer                                    
  Residential Mortgage     2,326,385     2,073,696         216,519     2,987     33,183
  Home Equity     657,164     646,372         10,792        
  Purchased Home Equity     122,728         122,728            
  Other Consumer     751,821     579,905         149,637     22,279    
  Lease Financing     32,535     32,535                

Total Consumer     3,890,633     3,332,508     122,728     376,948     25,266     33,183

Total Loans and Leases   $ 5,986,930   $ 4,665,613   $ 652,450   $ 527,073   $ 55,769   $ 86,025

Percentage of Total Loans and Leases     100%     78%     11%     9%     1%     1%

24


Maturities and Sensitivities of Loans to Changes in Interest Rates 1   Table 8

 
  December 31, 2004
   
 
 
   
(dollars in thousands)

  Due in One Year or Less
  Due After One to Five Years 2
  Due After Five Years 2
  Total

Commercial and Industrial   $ 462,366   $ 225,787   $ 183,332   $ 871,485
Construction     61,199     33,264     27,892     122,355

Total   $ 523,565   $ 259,051   $ 211,224   $ 993,840

1
Based on contractual maturities.

2
As of December 31, 2004, loans maturing after one year consisted of $337.1 million with floating rates and $133.2 million with fixed rates.

Deposits

Total deposits were $7.6 billion at December 31, 2004, a 3% increase over the prior year-end. Increases were experienced in demand and savings deposits while time deposits continued to decline as the Company continued to reduce these higher cost funds. The year-to-date average time deposits of $100,000 or more was $0.6 billion and $0.7 billion in 2004 and 2003, respectively. See Note 6 to the Consolidated Financial Statements, which is incorporated by reference in this Item, for additional deposit information.

Borrowings

Short-term borrowings include securities sold under agreements to repurchase ("repos"), funds purchased, commercial paper, and other short-term borrowings. The Company continued to reduce higher cost long-term debt in 2004 by replacing only $25.0 million of the $90.5 million in privately-placed notes that matured during the year. The source of funds to repay the long-term debt was deposit growth, repos and other short-term borrowings. See Notes 7 and 8 to the Consolidated Financial Statements, which are incorporated by reference in this Item, for more information on short-term borrowings and long-term debt.

Foreign Activities

During 2004, the Company continued to hold U.S. dollar placements and securities issued by foreign entities, as a tax efficient investment structure to generate foreign source earnings. The Company has foreign tax credits available to reduce the tax rate on this income.

The Company's foreign lending included both local currency and cross-border lending. Local currency loans are those that are funded and will be repaid in the currency of the borrower's country. Cross-border lending, on the other hand, involves loans that will be repaid in a currency other than that of the borrower's country. This type of lending involves greater risk because the borrower's ability to repay is additionally dependent on changes in the currency exchange rate. Credit limits have been established for each country. These credit limits are monitored and reviewed on a regular basis.

25



Table 9 presents, for the last three years, a geographic distribution of international assets for which the Company has cross-border exposure exceeding 0.75% of total assets.

Geographic Distribution of Cross-Border International Assets 1   Table 9

(dollars in thousands)

  Government and Other
Official Institutions

  Banks and Other
Financial Institutions

  Commercial
and Consumer

  Total

At December 31, 2004:                        
Netherlands                        
  Investment Securities   $   $ 102,075   $   $ 102,075
  Deposits         2,344         2,344
  Loans and Leases             12,729     12,729

Total Netherlands         104,419     12,729     117,148

Australia                        
  Investment Securities         75,871         75,871
  Deposits         290         290
  Loans and Leases             12,615     12,615

Total Australia         76,161     12,615     88,776

All Others 2                        
  Investment Securities         150,019         150,019
  Deposits         2,167         2,167
  Loans and Leases     67     4,017     80,151     84,235

Total All Others     67     156,203     80,151     236,421

Total   $ 67   $ 336,783   $ 105,495   $ 442,345

At December 31, 2003:                        
United Kingdom   $   $ 100,951   $ 9,509   $ 110,460
All Others     200     163,328     77,021     240,549

Total   $ 200   $ 264,279   $ 86,530   $ 351,009

At December 31, 2002:                        
United Kingdom   $   $ 160,811   $ 9,658   $ 170,469
Germany         100,296     292     100,588
Singapore         100,095         100,095
Netherlands         85,296     12,700     97,996
All Others     337     138,294     65,023     203,654

Total   $ 337   $ 584,792   $ 87,673   $ 672,802

1
This table details cross-border outstandings by country that individually amounted to 0.75% or more of consolidated total assets. Cross-border outstandings are defined as foreign monetary assets that are payable to the Company in U.S. dollars or other non-local currencies, plus amounts payable in local currency but funded with U.S. dollars or other non-local currencies. Cross-border outstandings include loans, acceptances, interest-bearing deposits with other banks, other interest-bearing investments, and other monetary assets.

2
At December 31, 2004, the significant items comprising All Others category included cross-border outstandings of $66.7 million in United Kingdom, $50.9 million in Sweden and $49.9 million in Switzerland.

Corporate Risk Profile

Credit Risk

Credit Risk is defined as the risk that borrowers or counter parties will not be able to repay their obligations to the Company. Credit exposures reflect legally binding commitments for loans, leases, banker's acceptances, financial and standby letters of credit and overnight overdrafts.

The Company's asset quality continued to improve in 2004 as evidenced by lower levels of internally criticized loans, non-performing assets and a continued lower trend in the level of net charge-offs. The ratio of non-performing assets to

26



total loans and foreclosed real estate was 0.23% at December 31, 2004 as compared to 0.55% at December 31, 2003. As a percentage of average loans, 2004 net charge-offs were 0.09% as compared to 0.25% for 2003.

The Company's improved credit risk profile relative to a year ago reflects sustained expansion and strength in the Hawaii and mainland economies with disciplined underwriting and portfolio management. The quality of the portfolio of Hawaii-based loans continued to improve, primarily due to the expanding local economy led by construction and real estate industries and record levels of domestic tourism. Strong credit quality in the Mainland portfolio reflected prior years' strategy of shifting to borrowers and industries believed to have a lower risk profile and targeted reductions in large borrower concentrations. In addition, ongoing portfolio management results in early identification and disengagement, when possible, from weakening credits. In the consumer portfolios, performance was satisfactory despite higher net charge-offs as a result of seasoning in Hawaii and reduced collections in American Samoa. Residential real estate continued to be supported by a strong housing market.

Although the overall credit risk profile continued to improve, the domestic legacy airline carriers continued to experience a higher risk profile with current negative trends. Outstandings to legacy carriers as of December 31, 2004 were $21.3 million and are included in the United States national passenger carriers total, as shown on Table 10. Volatile oil prices have had a pronounced impact on already struggling domestic legacy airline carriers who have a less competitive business model in the current environment. In addition, $28.5 million of the domestic regional carrier outstandings provide feeder route service for or have a material dependency on legacy carriers.

In the Guam portfolio, which is sensitive to tourism and military spending, economic indicators trended upward in 2004 although some uncertainty continued to exist. Tourism had rebounded and there have been announced increases in military spending and presence. As of December 31, 2004, internally classified exposure declined from December 31, 2003 due to strategic reduction along with some borrower improvement. Targeted lending to select commercial borrowers is active, while consumer loans are leading portfolio growth.

Total syndicated exposure of $789.8 million at December 31, 2004 decreased $136.1 million or 15% from 2003. The decrease reflected disengagements and pay-offs in the printing / publishing and the hotel industries. At December 31, 2004, the largest syndicated loan outstanding totaled $25.0 million to a Hawaii shopping center operator while the second largest was $21.0 million to a Hawaii-based hotel operator. The 10 largest syndicated credits had outstandings totaling $138.7 million down from $169.7 million as of December 31, 2003. Of the top 10 exposures, 49% reflected loans to Hawaii-based borrowers, primarily real estate investors / developers. Of the total syndicated exposure as of December 31, 2004, a $4.0 million undrawn syndicated letter of credit was internally classified, representing less than 1% of total syndicated unfunded commitments. The letter of credit exposure was to an airline operating under Chapter 11 bankruptcy and is 50% cash-secured.

27


The Company's other large concentrations at December 31, 2004 included five exposures larger than $25.0 million. The borrowers are major companies, of which three have Hawaii operations. Three exposures that totaled $195.6 million or 65% of the total were commercial paper backup lines to investment grade companies and were undrawn. The remaining two exposures were collateralized by securities and real estate and were substantially funded.

Table 10 summarizes concentrations of credit exposures.

Selected Concentrations of Credit Exposure   Table 10

 
  December 31, 2004

   
 
 
   
 
  Dec. 31, 2003 1
Total
Exposure

(dollars in thousands)

  Outstanding

  Unused
Commitments

  Total
Exposure


Air Transportation                        
  United States Regional Passenger Carriers   $ 41,057   $ 11,707   $ 52,764   $ 59,231
  United States National Passenger Carriers     39,594         39,594     37,259
  Passenger Carriers Based Outside United States     25,910         25,910     31,549
  Cargo Carriers     13,771         13,771     14,405

Total Air Transportation   $ 120,332   $ 11,707   $ 132,039   $ 142,444

Guam                        
  Hotel   $ 6,014   $   $ 6,014   $ 17,733
  Other Commercial     143,819     42,467     186,286     184,129
  Consumer     376,948     13,486     390,434     288,831

Total Guam   $ 526,781   $ 55,953   $ 582,734   $ 490,693

Syndicated Exposure   $ 201,359   $ 588,399   $ 789,758   $ 925,864

Other Large Borrowers 2   $ 109,921   $ 192,481   $ 302,402   $ 336,748

Exposure includes loans, leveraged leases and operating leases.

1
For three borrowers, reclassifications occurred between Regional and National Carriers. Syndicated Exposure was restated.

2
Other Large Borrowers is defined as exposure with commitments of $25.0 million and greater, excluding those collateralized by cash and those separately identified as Air Transportation, Guam and Syndicated Exposure.

Non-Performing Assets

Non-performing assets ("NPAs") consist of non-accrual loans and loans held for sale and foreclosed real estate. The net decrease in NPAs at December 31, 2004 from December 31, 2003 included $5.7 million of loans that returned to accrual status, $16.6 million of payments and pay-offs and $4.7 million of charge-offs. The decrease in non-performing assets in 2004 also included a $4.0 million transfer of a Company occupied foreclosed real estate property to premises. Against a backdrop of improving economic conditions and positive resolution of several borrowers, additions to NPAs of $14.5 million decreased $7.4 million from the prior year level, charge-offs from NPAs of $4.7 million decreased $2.2 million, and payments of $16.6 million increased $1.6 million. Total additions also included $8.8 million of residential real estate that had predominantly paid-off as of December 31, 2004.

At December 31, 2004, the ratio of non-performing assets to total loans and foreclosed real estate was 0.23%, a decline from 0.55% at December 31, 2003. As of December 31, 2004, 42% of total NPAs were concentrated in commercial loans (15% in commercial mortgage) and 55% were secured by residential mortgage. This compares to the prior year concentrations of 55% in commercial loans (29% in commercial mortgage) and 29% secured by residential mortgage. NPAs in Guam were reduced nearly 60% to $5.1 million from $12.7 million in 2003 primarily due to payments from a number of commercial borrowers. As a percentage of total NPAs, Guam exposure represented 37% in 2004, a decline from 40% in 2003.

Loans Past Due 90 Days or More and Still Accruing Interest

Accruing loans past due 90 days or more totaled $2.1 million at December 31, 2004, a decrease of $1.4 million or 40% from December 31, 2003. The decrease generally reflected improvement in residential mortgages in Guam and Hawaii, due to improving economic conditions in Guam and a solid economy and strong housing market in Hawaii.

28


Table 11 presents a five-year history of non-performing assets and accruing loans past due 90 days or more.

Consolidated Non-Performing Assets and Accruing Loans Past Due 90 Days or More Table 11

 
  December 31,

 
 
(dollars in thousands)

  2004

  2003

  2002

  2001

  2000


Non-Performing Assets                              
Non-Accrual Loans                              
  Domestic Loans                              
    Commercial                              
      Commercial and Industrial   $ 683   $ 6,015   $ 5,912   $ 18,888   $ 55,362
      Commercial Mortgage     2,106     9,337     20,323     16,301     60,040
      Construction             529     9,290     6,369
      Lease Financing     2,973     2,181     4,047     755     443

    Total Commercial     5,762     17,533     30,811     45,234     122,214

    Consumer                              
      Residential Mortgage     7,688     9,354     13,898     15,281     21,821
      Home Equity     218     460     263     139     914
      Other Consumer                 135     16

    Total Consumer     7,906     9,814     14,161     15,555     22,751

  Total Domestic Loans     13,668     27,347     44,972     60,789     144,965

  Foreign Loans                     33,493

Total Non-Accrual Loans     13,668     27,347     44,972     60,789     178,458

Loans Held for Sale                 1,712    

Foreclosed Real Estate     191     4,377     9,434     17,174     4,526

Total Non-Performing Assets   $ 13,859   $ 31,724   $ 54,406   $ 79,675   $ 182,984

Accruing Loans Past Due 90 Days or More                              
Domestic Loans                              
  Commercial                              
    Commercial and Industrial   $ 52   $ 725   $ 162   $ 137   $ 5,031
    Commercial Mortgage             298         1,298
    Lease Financing         117            

  Total Commercial     52     842     460     137     6,329

  Consumer                              
    Residential Mortgage     387     1,430     641     3,715     3,272
    Home Equity             10     66    
    Purchased Home Equity     183                
    Other Consumer     1,433     1,210     693     893     5,648
    Lease Financing     30         14     56     363

  Total Consumer     2,033     2,640     1,358     4,730     9,283

Total Domestic Loans     2,085     3,482     1,818     4,867     15,612

Foreign Loans                     3,181

Total Accruing and Past Due   $ 2,085   $ 3,482   $ 1,818   $ 4,867   $ 18,793

Total Loans and Leases   $ 5,986,930   $ 5,757,175   $ 5,359,004   $ 5,657,100   $ 9,238,435

Ratio of Non-Accrual Loans to Total Loans     0.23%     0.48%     0.84%     1.07%     1.93%

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

 

 

0.23%

 

 

0.55%

 

 

1.01%

 

 

1.40%

 

 

1.98%

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

 

 

0.27%

 

 

0.61%

 

 

1.05%

 

 

1.49%

 

 

2.18%

29


Table 12 presents foregone interest on non-accrual loans.

Foregone Interest on Non-Accrual Loans   Table 12

 
  Year Ended December 31,
 
 
(dollars in thousands)

  2004
  2003
  2002
  2001
  2000

Interest Income That Would Have Been Recorded Under Original Terms:                              
  Domestic   $ 2,123   $ 2,829   $ 5,344   $ 6,510   $ 10,183
  Foreign                 4,175     2,847
Interest Income Recorded During the Current Year:                              
  Domestic     532     1,336     1,927     1,592     3,356
  Foreign                 1,086     679

Allowance for Loan and Lease Losses

The Company maintains an Allowance adequate to cover management's estimate of probable credit losses inherent in its loan and lease portfolios as of a given balance sheet date. The Allowance is based on a range of inherent loss estimates derived from a comprehensive quarterly analysis of historical loss experience, plus an amount for credit management judgment reflecting the evaluation of the impact of environmental factors on portfolio performance, plus an amount for imprecision of estimates. Note 1 to the Consolidated Financial Statements, which is incorporated by reference in this Item, describes the methodologies used to develop the Allowance.

The Allowance was $106.8 million at December 31, 2004, a decrease of $22.3 million from December 31, 2003. Based on continued strength in the economic environment, improvement in the credit quality of the loan portfolio, lower than anticipated net charge-offs during 2004 and management's ongoing assessment of the portfolio, the Company returned $10.0 million to income from a release of the Allowance in 2004. In addition, $6.8 million was reclassified to other liabilities from the Allowance relating to the allowance for unfunded commitments (discussed in more detail in the next section). See Note 3 to the Consolidated Financial Statements, which is incorporated by reference in this Item, for changes in the Allowance during the last five years.

The ratio of the Allowance to total loans and leases outstanding was 1.78% at December 31, 2004 down from 2.14% at September 30, 2004 and down from 2.24% at December 31, 2003. If the allowance for unfunded commitments had been reclassified at either September 30, 2004 or December 31, 2003, the ratio of the Allowance losses to total loans and leases outstanding would have been 2.03% and 2.12%, respectively.

Net charge-offs for 2004 of $5.5 million or 0.09% of total average loans, decreased from $13.8 million or 0.25% of total average loans in 2003. Net charge-offs in 2004 included recoveries of $8.2 million from divested businesses and 2003 net charge-offs included $5.2 million of charge-offs for the remaining portfolio balances of certain Pacific Island locations where operations were previously discontinued. Adjusted for activity from these divested or discontinued operations, net charge-offs for 2004 of $13.7 million or 0.24% of total average loans, increased from $8.6 million or 0.16% of total average loans in 2003. This increase was in other consumer loans, driven by seasoning in organic growth in Hawaii and reduced collections in American Samoa.

Beginning with the fourth quarter 2004, the Company revised its allocation of the components of the Allowance as a result of current accounting interpretations. Specific risk factors previously considered and included in the general component have been allocated to the credit judgment segment in order to present total reserve allocations for a given risk element. The general component now provides solely for imprecision in the Company's process for estimating probable loss inherent in the portfolio.

While management has allocated a portion of the Allowance to specific loan categories, the adequacy of the Allowance must be considered in its entirety. The Allowance is considered adequate by management at December 31, 2004, based on an ongoing analysis of estimated probable credit losses, credit risk profiles, economic conditions, coverage ratios and other relevant factors.

30



Allowance allocations by loan category are presented in Table 13.

Allocation of Allowance for Loan and Lease Losses   Table 13

(dollars in thousands)

  2004

  2003

  2002

  2001

  2000


Domestic Loans                              
  Commercial                              
    Commercial and Industrial   $ 21,802   $ 33,724   $ 43,465   $ 57,520   $ 90,047
    Commercial Mortgage     9,119     16,303     16,488     16,056     27,500
    Construction     1,381     2,342     2,681     5,252     6,000
    Lease Financing     41,011     24,247     20,519     19,992     3,700

  Total Commercial     73,313     76,616     83,153     98,820     127,247

  Consumer                              
    Residential Mortgage     5,483     4,800     6,371     9,004     8,300
    Home Equity     1,900     959     600     1,276     371
    Purchased Home Equity     607     899            
    Other Consumer     19,825     14,349     15,029     12,885     14,503
    Lease Financing     203     312     400     459     626

  Total Consumer     28,018     21,319     22,400     23,624     23,800

Total Domestic Loans     101,331     97,935     105,553     122,444     151,047

Foreign Loans     436     719     718     644     73,332
General 1     5,029     30,426     36,582     35,891     21,868

Total Allocation of Allowance for
Loan and Lease Losses
  $ 106,796   $ 129,080   $ 142,853   $ 158,979   $ 246,247

1
Includes both foreign and domestic general reserves.

 
2004
2003
2002
2001
2000
 





 
Alloc. Allow. as % of loan category
Loan category as % of total loans and leases
Alloc. Allow. as % of loan category
Loan category as % of total loans and leases
Alloc. Allow. as % of loan category
Loan category as % of total loans and leases
Alloc. Allow. as % of loan category
Loan category as % of total loans and leases
Alloc. Allow. as % of loan category
Loan category as % of total loans and leases

Domestic Loans                    
  Commercial                    
    Commercial and Industrial 2.50% 14.56% 4.13% 14.18% 4.97% 16.33% 4.92% 20.68% 3.70% 26.34%
    Commercial Mortgage 1.51 10.07 2.55 11.11 2.79 11.03 2.51 11.33 2.44 12.18
    Construction 1.13 2.04 2.31 1.76 2.10 2.38 3.10 3.00 1.95 3.33
    Lease Financing 9.18 7.46 5.56 7.57 4.80 7.97 4.72 7.49 0.80 5.03

  Total Commercial 3.59 34.13 3.84 34.62 4.11 37.71 4.11 42.50 2.94 46.88

  Consumer                    
    Residential Mortgage 0.24 38.30 0.21 40.30 0.30 39.77 0.37 42.85 0.32 27.74
    Home Equity 0.29 10.98 0.21 8.11 0.14 7.99 0.39 5.83 0.13 3.06
    Purchased Home Equity 0.49 2.05 0.42 3.69 3.47
    Other Consumer 2.64 12.56 2.18 11.44 3.05 9.21 3.22 7.07 2.02 7.79
    Lease Financing 0.62 0.54 0.88 0.62 1.16 0.64 1.18 0.69 1.47 0.46

  Total Consumer 0.73 64.43 0.58 64.16 0.68 61.08 0.74 56.44 0.66 39.05

Total Domestic Loans 1.72 98.56 1.72 98.78 1.99 98.79 2.19 98.94 1.90 85.93

Foreign Loans 0.51 1.44 1.02 1.22 1.11 1.21 1.07 1.06 5.64 14.07

Total 1.78% 100.00% 2.24% 100.00% 2.67% 100.00% 2.81% 100.00% 2.67% 100.00%

31


Allowance for Unfunded Commitments

In the fourth quarter of 2004, the Company reclassified $6.8 million from the Allowance to other liabilities, representing the estimate for probable credit losses inherent in unfunded commitments to extend credit. Unfunded commitments to extend credit reflect bankers acceptances, financial and standby letters of credit, commercial letters of credit, overnight overdrafts, and credit cards where the Company has issued a loss guarantee on behalf of its customers. The process used to determine the allowance for unfunded commitments remains consistent with the process for determining the Allowance as adjusted for estimated funding probabilities or loan equivalency factors. The allowance for unfunded commitments at December 31, 2003 was $6.9 million.

Market Risk

Market risk is the potential of loss arising from adverse changes in interest rates and prices. The Company is exposed to market risk as a consequence of the normal course of conducting its business activities. Financial products that expose the Company to market risk include investment securities, loans, deposits, debt and derivative financial instruments. The Company's market risk management process involves measuring, monitoring, controlling and managing risks that can significantly impact the Company's financial position and operating results. In this management process, market risks are balanced with expected returns in an effort to enhance earnings performance and shareholder value, while limiting the volatility of each. The activities associated with these market risks are categorized into "trading" and "other than trading."

The Company's trading activities include foreign currency and foreign exchange contracts that expose the Company to a minor degree of foreign currency risk. These transactions are primarily executed on behalf of customers and at times for the Company's own account.

The Company's "other than trading" activities include normal business transactions that expose the Company's balance sheet profile to varying degrees of market risk. The Company's primary market risk exposure is interest rate risk. A key element in the process of managing market risk involves oversight by senior management and the Board of Directors as to the level of such risk assumed by the Company in its balance sheet. The Board of Directors reviews and approves risk management policies, including risk limits and guidelines and delegates oversight functions to the Asset Liability Management Committee ("ALCO"). The ALCO, consisting of senior business and finance officers, monitors the Company's market risk exposure and, as market conditions dictate, modifies balance sheet positions. The ALCO may also direct the use of derivative instruments.

Interest Rate Risk

The Company's balance sheet is sensitive to changes in the general level of interest rates. This interest rate risk arises primarily from the Company's normal business activities of making loans and taking deposits. Many other factors also affect the Company's exposure to changes in interest rates, such as general economic and financial conditions, customer preferences, and historical pricing relationships.

The earnings of the Company and the Bank are affected not only by general economic conditions, but also by the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve System. The monetary policies of the Federal Reserve System influence to a significant extent the overall growth of loans, investments and deposits; the level of interest rates earned on assets and paid for liabilities; and interest rates charged on loans and paid on deposits. The nature and impact of future changes in monetary policies are generally not predictable.

A key element in the Company's ongoing process to measure and monitor interest rate risk is the utilization of a net interest income ("NII") simulation model. This model is used to estimate the amount that NII will change over a one-year time horizon under various interest rate scenarios. These estimates are based on assumptions on the behavior of loan and deposit pricing, prepayment speeds on mortgage-related assets, and principal amortization and maturities

32



on other financial instruments. The model's analytics includes the effects of embedded options. While such assumptions are inherently uncertain, management believes that these assumptions are reasonable. As a result, the NII simulation model captures the dynamic nature of the balance sheet and provides a sophisticated estimate rather than a precise prediction of NII's exposure to higher or lower interest rates.

Table 14 presents, as of December 31, 2004, 2003 and 2002, the estimate of the change in NII from a gradual 200 basis point increase or decrease in interest rates, moving in parallel fashion for the entire yield curve, over the next 12-month period relative to the measured base case scenario for NII.

Market Risk Exposure to Interest Rate Changes   Table 14

 
  December 31,
 
  2004
Interest Rate Change
(in basis points)

  2003
Interest Rate Change
(in basis points)

  2002
Interest Rate Change
(in basis points)

 
 
(dollars in thousands)
  -200
  200
  -200
  200
  -200
  200

Estimated Exposure as a Percent of
Net Interest Income
    (6.5)%     2.0%     (4.8)%     4.0%     (3.75)%     7.66%
Estimated Exposure to Net Interest Income   $ (25,388)   $ 7,812   $ (17,565)   $ 14,638   $ (13,884)   $ 28,360

To enhance and complement the results from the NII simulation model, the Company also reviews other measures of interest rate risk. These measures include the sensitivity of market value of equity and the exposure to basis risk and non-parallel yield curve shifts. There are inherent limitations to these measures however; used along with the NII simulation model the Company obtains better overall insight for managing its exposure to changes in interest rates.

In managing interest rate risks, the Company uses several approaches to modify its risk position. Approaches that are used to shift balance sheet mix or alter the interest rate characteristics of assets and liabilities include changing product pricing strategies, modifying investment portfolio characteristics, or using financial derivative instruments. The use of financial derivatives, as detailed in Note 14 to the Consolidated Financial Statements, which is incorporated by reference in this Item, has been limited over the past several years.

Liquidity Management

Liquidity is managed in an effort to ensure that the Company has continuous access to sufficient, reasonably priced funding. Funding requirements are impacted by loan refinancings and originations, liability settlements and issuances and off-balance sheet funding commitments. The Company considers and complies with various regulatory guidelines regarding required liquidity levels and periodically monitors its liquidity position in light of the changing economic environment and customer activity. Based on periodic liquidity assessments, the Company may alter its assets, liabilities and off-balance sheet positions. The Company's ALCO monitors sources and uses of funds and modifies asset and liability positions as liquidity requirements change. This process, combined with the Company's ability to raise funds in money and capital markets and through private placements, provides flexibility in managing the exposure to liquidity risk.

In an effort to ensure that its liquidity needs are met, the Company actively manages both the asset and liability sides of the Statement of Condition. The primary sources of liquidity are available-for-sale investment securities, interest bearing deposits and cash flows from loans and investments, as well as the ability to sell or securitize certain assets. With respect to liabilities, liquidity is generated through growth in deposits, repos and other funding. During 2004, the Company continued to use funds to repurchase stock (see "Capital Management") and reduce debt where possible. In 2004, a total of $90.5 million in privately-placed notes matured and only $25.0 million was replaced by an advance from the Federal Home Loan Bank. In addition, excess liquidity was deployed into longer term assets.

33



Off-Balance Sheet Arrangements, Commitments and Aggregate Contractual Obligations

The Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities ("SPEs"), which would have been established for the purpose of facilitating off-balance sheet arrangements. As of December 31, 2004, the Company was not involved in any material unconsolidated SPE transactions.

The Company's commitments and contractual obligations as of December 31, 2004 are summarized in Table 15. See the following Notes to the Consolidated Financial Statements which are incorporated by reference in this Item for additional information.

        Note 5 – Premises and Equipment and Other Assets and Liabilities
        Note 7 – Short-Term Borrowings
        Note 8 – Long-Term Debt
        Note 14 – Derivatives
        Note 15 – Fair Values of Financial Instruments

Commitments   Table 15

 
  Amount of Commitment Expiration Per Period
   
(dollars in thousands)

  Less Than One Year
  Greater Than One Year
  Total


Commitments to Extend Credit   $ 770,674   $ 1,692,151   $ 2,462,825
Standby Letters of Credit     87,137     15,167     102,304
Commercial Letters of Credit     32,223     5,270     37,493
Foreign Exchange and Mortgage Loan Forward Contracts     201,515         201,515

Total Commitments   $ 1,091,549   $ 1,712,588   $ 2,804,137

Contractual Obligations    

 
  Payments Due By Period

   
(dollars in thousands)

  Less Than
One Year

  1 - 3 Years

  4 - 5 Years

  After
5 Years

  Total


Deposits   $ 7,155,810   $ 290,746   $ 88,147   $ 29,964   $ 7,564,667
Short-Term Borrowings     733,616                 733,616
Banker's Acceptances     1,406                 1,406
Long-Term Debt     10,000     27,500     124,760     81,425     243,685
Capital Lease Obligations     605     1,210     1,330     28,576     31,721
Operating Leases     12,572     20,036     12,503     68,624     113,735
Purchase Obligations     21,286     29,936     21,343     6,213     78,778
Pension and Post Retirement Contributions     1,800     3,800     4,100     12,400     22,100

Total Contractual Obligations   $ 7,937,095   $ 373,228   $ 252,183   $ 227,202   $ 8,789,708

The Company obtains funding through repos, federal funds and commercial paper. The Company issues commercial paper in various denominations with maturities of generally 90 days or less.

Repos are financing transactions, under which securities are pledged as collateral for short-term borrowings. These transactions are normally with governmental entities. Historically, these governmental entities have provided a stable source of funds.

34



The Bank is a member of the Federal Home Loan Bank of Seattle (the "FHLB"), which provides an additional source for short and long-term funding. Borrowings from the FHLB were $87.5 million and $68.5 million at the end of 2004 and 2003, respectively.

Additionally, the Bank maintains a $1.0 billion senior and subordinated bank note program. Under this facility, the Bank may issue additional notes provided that the aggregate amount outstanding does not exceed $1.0 billion. Subordinated notes outstanding under this bank note program totaled $124.8 million and $124.7 million at the end of 2004 and 2003, respectively.

The largest purchase obligation included in the above table is an outsourcing agreement for technology services. Total payments over the remaining term (through 2010) of this contract will be approximately $55.0 million. Other contracts included in purchase obligations consist of service agreements for the Company's asset management system, ATM system and cash management system.

Capital Management

The Company and the Bank are subject to regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can cause certain mandatory and discretionary actions by regulators that, if undertaken, could have a material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative and qualitative measures. These measures were established by regulation to ensure capital adequacy. At December 31, 2004 and 2003, the Company and the Bank were well capitalized under this regulatory framework. There have been no conditions or events since December 31, 2004 that management believes have changed either the Company's or the Bank's capital classifications. Note 9 to the Consolidated Financial Statements, which is incorporated by reference in this Item, provides additional information about the regulatory capital framework and the Company's capital amounts and ratios.

As of December 31, 2004, $31.4 million of the 8.25% Capital Securities that mature in 2026 were outstanding. These securities qualify as Tier I capital for regulatory accounting purposes, but are classified as long-term debt in the Consolidated Statements of Condition. In addition, the Company had subordinated debt of $99.8 million at the end of 2004 that qualifies as Total capital for regulatory purposes.

At year-end 2004, the Company's shareholders' equity was $814.8 million, an increase of $21.7 million or 3% from year-end 2003. The increase in shareholders' equity resulted from current year earnings of $173.3 million and stock issuances, and the related tax effect, under various stock-based employee benefit plans which totaled $160.0 million. These increases were partially offset by stock repurchases that totaled $238.1 million and dividends paid of $66.3 million. Table 16 presents a five-year history of activities and balances in the Company's capital accounts, along with key capital ratios.

During 2004, the Company's Board of Directors approved additional authorizations of $150.0 million to repurchase shares of common stock under the share repurchase program. In January 2005, an additional $100.0 million authorization was approved. These authorizations, combined with the Company's previously announced authorization of $1,000.0 million, brings the total authorized repurchase amount to $1,250.0 million. From the beginning of the share repurchase program in July 2001 through December 31, 2004, the Company had repurchased a total of 34.9 million shares and returned a total of $1,087.5 million to its shareholders at an average cost of $31.13 per share. From January 1, 2005 through February 18, 2005, the Company repurchased an additional 1.6 million shares at an

35



average cost of $48.19 per share for a total of $79.3 million. Remaining buyback authority was $83.2 million at February 18, 2005.

Equity Capital   Table 16

 
 
  December 31,

 
(dollars in thousands)

  2004

  2003

  2002

  2001

  2000

 

 
Change in Shareholders' Equity                                
Net Income   $ 173,339   $ 135,195   $ 121,180   $ 117,795   $ 113,661  
Dividends Paid     (66,326 )   (50,589 )   (50,635 )   (56,567 )   (56,471 )
Dividend Reinvestment Program     4,416     3,292     2,893     2,819     3,261  
Stock Issued for Acquisition                 1,299      
Stock Repurchases     (238,077 )   (329,978 )   (332,217 )   (195,687 )   (16,992 )
Other 1     148,350     19,453     27,526     75,997     45,567  

 
Increase (Decrease) in Shareholders' Equity   $ 21,702   $ (222,627 ) $ (231,253 ) $ (54,344 ) $ 89,026  

 
Regulatory Capital                                
Shareholders' Equity   $ 814,834   $ 793,132   $ 1,015,759   $ 1,247,012   $ 1,301,356  
Add: 8.25% Capital Securities of Bancorp
Hawaii Capital Trust I
    31,425     31,425     31,425     100,000     100,000  
  Minority Interest                     4,536  
Less: Goodwill     36,216     36,216     36,216     26,676     163,867  
  Unrealized Valuation and Other Adjustments     5,251     10,771     27,205     22,967     2,500  

 
Tier I Capital     804,792     777,570     983,763     1,297,369     1,239,525  
Allowable Reserve for Loan Losses     83,292     78,147     74,969     83,001     132,821  
Subordinated Debt     99,808     124,709     124,658     148,423     172,142  
Unrealized Gains on Available for Sale Equity Securities     31     66     132          
Investment in Unconsolidated Subsidiary                     (3,446 )

 
Total Capital   $ 987,923   $ 980,492   $ 1,183,522   $ 1,528,793   $ 1,541,042  

 
Risk-Weighted Assets   $ 6,633,082   $ 6,200,831   $ 5,929,613   $ 6,564,111   $ 10,524,878  

 
Key Regulatory Capital Ratios                                
Average Equity/Average Assets Ratio     7.81%     9.60%     11.88%     10.59%     8.78%  
Tier I Capital Ratio     12.13%     12.54%     16.59%     19.76%     11.78%  
Total Capital Ratio     14.89%     15.81%     19.96%     23.29%     14.64%  
Leverage Ratio     8.29%     8.43%     10.34%     11.20%     9.10%  
1
Includes unrealized valuation adjustments for investment securities, foreign currency translation, pension liability adjustment, stock issuances under employee benefit plans and tax benefits related to stock option exercises.

36


Recent Accounting Pronouncements and Developments

Note 1 to the Consolidated Financial Statements, which is incorporated by reference in this Item, discusses the expected impact of new accounting standards recently issued or proposed but not yet required to be adopted.

Fourth Quarter Results and Other Matters

Net income in the fourth quarter of 2004 increased $7.6 million or 19.6% from the comparable period in 2003. Diluted earnings per share for the fourth quarter of 2004 were $0.82, an increase of $0.16 or 24% from $0.66 per diluted share for the same prior year period. The return on average assets for the fourth quarter of 2004 improved to 1.89% from 1.66% in the comparable period in 2003. Return on average equity for the fourth quarter of 2004 improved to 23.63% from 18.59% in the same quarter last year.

Net interest income on a taxable equivalent basis for the fourth quarter of 2004 increased $6.6 million or 7% from the fourth quarter of 2003 as a result of higher yields on investment securities.

The net interest margin was 4.40% for the fourth quarter of 2004, a five basis point increase from 4.35% in the same prior year quarter. The net interest margin improvement from the prior year quarter was a result of increased earning assets, mainly investment securities.

Due to continued strength in the economic environment, improvement in the credit quality of the loan portfolio, lower than anticipated net charge-offs during 2004 and management's ongoing assessment of the portfolio, the Company returned $6.5 million to income from a release of the Allowance ($4.1 million or $0.07 per diluted share after taxes).

Non-interest income was $48.4 million for the fourth quarter, a decrease of $1.1 million or 2% from the same period in 2003. The decrease was largely due to declines in gains on sales of mortgage loans.

Non-interest expense for the fourth quarter of 2004 was $82.1 million, a decrease of $1.3 million or 2% from the comparable period in 2003. The decrease was primarily due to a reduction in salaries and benefits related to incentive compensation and separation expenses. In addition, the fourth quarter of 2003 included higher stock-based compensation expense that was offset by a curtailment gain on post-retirement benefits.

During the fourth quarter of 2004, the Company repurchased 1.0 million shares of common stock at a total cost of $50.3 million under its share repurchase program. The average cost was $49.01 per share repurchased during the quarter.

37


Table 17 presents the Company's 2004 and 2003 quarterly results of operations.

Consolidated Quarterly Results of Operations   Table 17

 
  Three Months Ended
2004

  Three Months Ended
2003

(dollars in thousands except per share amounts)

  Dec.

  Sept.

  June

  Mar.

  Dec.

  Sept.

  June

  Mar.


Interest Income   $ 117,371   $ 114,397   $ 111,490   $ 111,756   $ 108,827   $ 108,064   $ 111,851   $ 113,779
Interest Expense     17,440     15,618     15,641     15,725     15,475     16,959     21,366     22,779

Net Interest Income     99,931     98,779     95,849     96,031     93,352     91,105     90,485     91,000
Provision for Loan and Lease Losses     (6,500 )       (3,500 )                  
Investment Securities Gains (Losses)     (757 )       (37 )       (20 )   639     587     583
Non-Interest Income     49,107     53,054     54,885     48,842     49,457     53,152     50,152     44,170
Non-Interest Expense     82,103     84,190     85,125     83,022     83,404     88,877     95,394     90,200

Income Before Income Taxes     72,678     67,643     69,072     61,851     59,385     56,019     45,830     45,553
Provision for Income Taxes     26,437     24,576     24,840     22,052     20,712     19,332     15,796     15,752

Net Income   $ 46,241   $ 43,067   $ 44,232   $ 39,799   $ 38,673   $ 36,687   $ 30,034   $ 29,801


Basic Earnings Per Share

 

 

$0.86

 

 

$0.82

 

 

$0.84

 

 

$0.73

 

 

$0.70

 

 

$0.64

 

 

$0.50

 

 

$0.49
Diluted Earnings Per Share     $0.82     $0.78     $0.79     $0.69     $0.66     $0.61     $0.48     $0.47

Net Income to Average Total Assets (ROA)

 

 

1.89%

 

 

1.77%

 

 

1.80%

 

 

1.65%

 

 

1.66%

 

 

1.53%

 

 

1.27%

 

 

1.31%
Net Income to Average Shareholders' Equity (ROE)     23.63%     23.42%     24.28%     19.98%     18.59%     16.69%     12.93%     12.42%
Efficiency Ratio 1     55.37%     55.45%     56.49%     57.31%     58.41%     61.34%     67.55%     66.44%
1
The efficiency ratio is defined as non-interest expense divided by total revenue (net interest income and non-interest income).

2005 Outlook

The Company currently estimates that its net income for 2005 should be approximately $174.0 million to $177.0 million. An important element in the estimation process is the appropriate level of the Allowance. An analysis of credit quality is performed quarterly to determine the adequacy of the Allowance. The results of this analysis determine the timing and amount of the Provision. In addition, based on current economic conditions, the Company expects that further credit quality improvement may occur and, as a result, the Allowance may be further reduced. Accordingly, the net income estimates include a $10.0 million Provision for 2005. This Provision estimate results in a $20.0 million change in pretax income from 2004, which included a return of $10.0 million to income from a release of the Allowance. Earnings per share and return on equity projections continue to be dependent upon, among other things, the terms and timing of share repurchases.


Item 7A. Quantitative and Qualitative Disclosures About Market Risk

See the Market Risk section in the Management's Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of this report.


Item 8. Financial Statements and Supplementary Data

Consolidated Quarterly Results of Operations – See Table 17 included in Item 7 of this report.

38



Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders
Bank of Hawaii Corporation

We have audited the accompanying consolidated statements of condition of Bank of Hawaii Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Bank of Hawaii Corporation and subsidiaries at December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Bank of Hawaii Corporation and subsidiaries' internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2005 expressed an unqualified opinion thereon.

                          Ernst & Young LLP

Honolulu, Hawaii
February 25, 2005

39


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Income


 
  Year Ended December 31,

(dollars in thousands except per share amounts)

  2004
  2003
  2002

Interest Income                  
  Interest and Fees on Loans and Leases   $ 327,953   $ 334,793   $ 366,366
  Income on Investment Securities – Available for Sale     93,528     77,793     104,261
  Income on Investment Securities – Held to Maturity     26,204     18,956     16,774
  Deposits     3,480     4,816     20,020
  Funds Sold     1,058     1,919     3,503
  Other     2,791     4,244     5,614

Total Interest Income     455,014     442,521     516,538

Interest Expense                  
  Deposits     36,743     47,473     84,348
  Securities Sold Under Agreements to Repurchase     9,353     7,939     30,173
  Funds Purchased     1,815     944     1,030
  Short-Term Borrowings     82     92     1,489
  Long-Term Debt     16,431     20,131     29,267

Total Interest Expense     64,424     76,579     146,307

Net Interest Income     390,590     365,942     370,231
Provision for Loan and Lease Losses     (10,000 )       11,616

Net Interest Income After Provision for Loan and Lease Losses     400,590     365,942     358,615

Non-Interest Income                  
  Trust and Asset Management     53,465     50,996     55,733
  Mortgage Banking     8,012     15,556     18,866
  Service Charges on Deposit Accounts     39,117     35,938     32,617
  Fees, Exchange, and Other Service Charges     54,907     56,221     51,594
  Investment Securities Gains (Losses)     (794 )   1,789     615
  Insurance     19,241     19,145     17,710
  Other     31,146     19,075     21,200

Total Non-Interest Income     205,094     198,720     198,335

Non-Interest Expense                  
  Salaries and Benefits     184,299     186,280     186,563
  Net Occupancy Expense     38,347     38,980     39,149
  Net Equipment Expense     23,926     33,652     41,253
  Restructuring and Other Related Costs             2,364
  Information Technology Systems Replacement Project         21,871     13,628
  Other     87,868     77,092     86,292

Total Non-Interest Expense     334,440     357,875     369,249

Income Before Income Taxes     271,244     206,787     187,701
Provision for Income Taxes     97,905     71,592     66,521

Net Income   $ 173,339   $ 135,195   $ 121,180

Basic Earnings Per Share     $3.26     $2.32     $1.75
Diluted Earnings Per Share     $3.08     $2.21     $1.70
Dividends Declared Per Share     $1.23     $0.87     $0.73
Basic Weighted Average Shares     53,232,815     58,338,566     69,385,745
Diluted Weighted Average Shares     56,241,044     61,085,567     71,447,333

See accompanying notes to Consolidated Financial Statements.

40


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Condition


 
(dollars in thousands)

  December 31,
2004

  December 31,
2003

 

 
Assets              
Interest-Bearing Deposits   $ 4,592   $ 154,735  
Investment Securities – Available for Sale     2,483,719     1,991,116  
Investment Securities – Held to Maturity
(Market Value of $585,836 and $720,699)
    589,908     727,233  
Funds Sold     21,000      
Loans Held for Sale     17,642     9,211  
Loans and Leases     5,986,930     5,757,175  
  Allowance for Loan and Lease Losses     (106,796 )   (129,080 )

 
    Net Loans     5,880,134     5,628,095  

 
Total Earning Assets     8,996,995     8,510,390  

 
Cash and Non-Interest-Bearing Deposits     225,359     363,495  
Premises and Equipment     146,095     160,005  
Customers' Acceptance Liability     1,406     1,707  
Accrued Interest Receivable     36,044     32,672  
Foreclosed Real Estate     191     4,377  
Mortgage Servicing Rights     18,769     22,178  
Goodwill     36,216     36,216  
Other Assets     305,116     330,607  

 
Total Assets   $ 9,766,191   $ 9,461,647  

 
Liabilities              
Deposits              
  Non-Interest-Bearing Demand   $ 1,977,703   $ 1,933,928  
  Interest-Bearing Demand     1,536,323     1,356,330  
  Savings     2,960,351     2,833,379  
  Time     1,090,290     1,209,142  

 
Total Deposits     7,564,667     7,332,779  

 
Securities Sold Under Agreements to Repurchase     568,981     472,757  
Funds Purchased     149,635     109,090  
Short-Term Borrowings     15,000     12,690  
Banker's Acceptances Outstanding     1,406     1,707  
Retirement Benefits Payable     65,708     61,841  
Accrued Interest Payable     7,021     7,483  
Taxes Payable and Deferred Taxes     229,928     207,101  
Other Liabilities     96,373     138,999  
Long-Term Debt     252,638     324,068  

 
Total Liabilities     8,951,357     8,668,515  

 
Commitments and Contingencies (See Notes 10 and 15)              
Shareholders' Equity              
Common Stock ($.01 par value); authorized 500,000,000 shares;
issued / outstanding: December 2004 – 81,711,752 / 54,960,857,
December 2003 – 81,647,729 / 54,928,480
    813     807  
Capital Surplus     450,998     391,701  
Accumulated Other Comprehensive Income (Loss)     (12,917 )   (5,711 )
Retained Earnings     1,282,425     1,199,077  
Deferred Stock Grants     (8,433 )   (8,309 )
Treasury Stock, at Cost (Shares: December 2004 – 26,750,895,
December 2003 – 26,719,249)
    (898,052 )   (784,433 )

 
Total Shareholders' Equity     814,834     793,132  

 
Total Liabilities and Shareholders' Equity   $ 9,766,191   $ 9,461,647  

 

See accompanying notes to Consolidated Financial Statements.

41


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Shareholders' Equity


 
(dollars in thousands)

  Total
  Common
Stock

  Capital
Surplus

  Accum.
Other
Compre-
hensive
Income
(Loss)

  Retained
Earnings

  Deferred
Stock
Grants

  Treasury
Stock

  Compre-
hensive
Income

 

 
Balance at December 31, 2001   $ 1,247,012   $ 806   $ 367,672   $ 22,761   $ 1,055,424   $ (7,637 ) $ (192,014 )      
Comprehensive Income                                                  
  Net Income     121,180                 121,180           $ 121,180  
  Other Comprehensive Income, Net of Tax:                                                  
    Change in Unrealized Gains and Losses on Investment Securities     4,237             4,237                 4,237  
    Change in Foreign Currency Translation Adjustments     (582 )           (582 )               (582 )
    Change in Pension Liability Adjustment     (14,757 )           (14,757 )               (14,757 )
                                             
 
  Total Comprehensive Income                                             $ 110,078  
                                             
 
Common Stock Issued under Stock Plans and Related Tax Benefits (1,650,313 shares)     41,521         4,520         (10,059 )   6,213     40,847        
Treasury Stock Purchased (11,838,800 shares)     (332,217 )                       (332,217 )      
Cash Dividends Paid     (50,635 )               (50,635 )              

       
Balance at December 31, 2002     1,015,759     806     372,192     11,659     1,115,910     (1,424 )   (483,384 )      

       
Comprehensive Income                                                  
  Net Income     135,195                 135,195           $ 135,195  
  Other Comprehensive Income, Net of Tax:                                                  
    Change in Unrealized Gains and Losses on Investment Securities     (16,434 )           (16,434 )               (16,434 )
    Change in Pension Liability Adjustment     (936 )           (936 )               (936 )
                                             
 
  Total Comprehensive Income                                             $ 117,825  
                                             
 
Common Stock Issued under Stock Plans and Related Tax Benefits (1,683,424 shares)     40,115     1     19,509         (1,439 )   (6,885 )   28,929        
Treasury Stock Purchased (9,762,079 shares)     (329,978 )                       (329,978 )      
Cash Dividends Paid     (50,589 )               (50,589 )              

       
Balance at December 31, 2003     793,132     807     391,701     (5,711 )   1,199,077     (8,309 )   (784,433 )      

       
Comprehensive Income                                                  
  Net Income     173,339                 173,339           $ 173,339  
  Other Comprehensive Income, Net of Tax:                                                  
    Change in Unrealized Gains and Losses on Investment Securities     (5,519 )           (5,519 )               (5,519 )
    Change in Pension Liability Adjustment     (1,687 )           (1,687 )               (1,687 )
                                             
 
  Total Comprehensive Income                                             $ 166,133  
                                             
 
Common Stock Issued under Stock Plans and Related Tax Benefits (5,280,205 shares)     159,972     6     59,297         (23,665 )   (124 )   124,458        
Treasury Stock Purchased (5,243,458 shares)     (238,077 )                       (238,077 )      
Cash Dividends Paid     (66,326 )               (66,326 )              

       
Balance at December 31, 2004   $ 814,834   $ 813   $ 450,998   $ (12,917 ) $ 1,282,425   $ (8,433 ) $ (898,052 )      

       

See accompanying notes to Consolidated Financial Statements.

42


Bank of Hawaii Corporation and Subsidiaries
Consolidated Statements of Cash Flows


 
 
             Year Ended December 31,

 
(dollars in thousands)

  2004

  2003

  2002

 

 
Operating Activities                    
  Net Income   $ 173,339   $ 135,195   $ 121,180  
  Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:                    
      Provision for Loan and Lease Losses     (10,000 )       11,616  
      Depreciation and Amortization     20,829     28,802     34,562  
      Amortization of Deferred Loan and Lease Fees     (2,006 )   (6,167 )   (8,229 )
      Amortization and Accretion of Investment Securities     12,248     33,462     24,153  
      Deferred Stock Grants     5,610     6,693     5,089  
      Deferred Income Taxes     16,647     39,873     47,581  
      Net (Gain) Loss on Investment Securities     794     (1,789 )   (615 )
      Proceeds from Sales of Loans Held for Sale     403,708     741,127     1,230,948  
      Originations of Loans Held for Sale     (412,139 )   (710,220 )   (814,357 )
      Net Change in Other Assets and Liabilities     51,092     51,430     7,653  

 
  Net Cash Provided by Operating Activities     260,122     318,406     659,581  

 

Investing Activities

 

 

 

 

 

 

 

 

 

 
  Proceeds from Sales and Redemptions of Investment Securities Available for Sale     828,694     1,841,031     1,286,836  
  Purchases of Investment Securities Available for Sale     (1,341,026 )   (1,601,274 )   (1,590,059 )
  Proceeds from Redemptions of Investment Securities Held to Maturity     205,629     193,741     183,073  
  Purchases of Investment Securities Held to Maturity     (70,238 )   (692,292 )   (23,488 )
  Net (Increase) Decrease in Loans and Leases     (246,833 )   (405,777 )   278,605  
  Premises and Equipment, Net     (2,920 )   (11,838 )   (15,360 )

 
  Net Cash Provided (Used) by Investing Activities     (626,694 )   (676,409 )   119,607  

 

Financing Activities

 

 

 

 

 

 

 

 

 

 
  Net Increase in Demand Deposits     223,768     398,793     379,635  
  Net Increase in Savings Deposits     126,972     298,160     597,556  
  Net Decrease in Time Deposits     (118,852 )   (284,335 )   (735,250 )
  Proceeds from Long-Term Debt     25,000     50,000      
  Repayments of Long-Term Debt     (96,430 )   (115,717 )   (200,595 )
  Net Increase (Decrease) in Short-Term Borrowings     139,079     (238,971 )   (979,983 )
  Proceeds from Issuance of Common Stock     104,159     29,540     36,432  
  Repurchase of Common Stock     (238,077 )   (329,978 )   (332,217 )
  Cash Dividends     (66,326 )   (50,589 )   (50,635 )

 
  Net Cash Provided (Used) by Financing Activities     99,293     (243,097 )   (1,285,057 )

 

Effect of Exchange Rate Changes on Cash

 

 


 

 


 

 

(582

)

 
Decrease in Cash and Cash Equivalents     (267,279 )   (601,100 )   (506,451 )
Cash and Cash Equivalents at Beginning of Period     518,230     1,119,330     1,625,781  

 
Cash and Cash Equivalents at End of Period   $ 250,951   $ 518,230   $ 1,119,330  

 

Non-Cash Investing Activity

In September 2004, the Company transferred a $4.0 million foreclosed real estate property to premises.

During the years ended December 31, 2004, 2003, and 2002, interest payments of $64.9 million, $82.8 million, and $162.3 million, respectively, and income tax payments of $5.2 million, $23.8 million and $11.2 million, respectively, were made.

See accompanying notes to Consolidated Financial Statements.

43


Note 1 – Summary of Significant Accounting Policies

Bank of Hawaii Corporation (the "Company") is a bank holding company providing a broad range of financial products and services to customers in Hawaii and the Pacific Islands (Guam, nearby islands and American Samoa). The majority of the Company's operations consist of customary commercial and consumer banking services including, but not limited to, lending, leasing, deposit services, trust and investment activities, brokerage services, insurance products and trade financing.

The accounting and reporting principles of the Company conform to U.S. generally accepted accounting principles ("GAAP") and prevailing practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results may differ from those estimates and such differences could be material to the financial statements.

Certain prior period amounts have been reclassified to conform to current year presentation.

The following is a description of the significant accounting policies of the Company:

Consolidation

The Consolidated Financial Statements of the Company include the accounts of the Company and its subsidiaries. The Company's principal subsidiary is Bank of Hawaii (the "Bank"). All significant intercompany accounts and transactions have been eliminated in consolidation.

The Company has investments in low income housing projects and sponsors the Bank of Hawaii Charitable Foundation. These entities are not consolidated in the Company's financial statements. The Company also has investments in leveraged leases, as discussed in Note 3.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash and non-interest-bearing deposits, interest-bearing deposits and funds sold. All amounts are readily convertible to cash and have maturities less than ninety days.

Investment Securities

Investment securities are accounted for according to their purpose and holding period. Debt securities that may not be held to maturity and marketable equity securities are classified as securities available for sale and are reported at fair value, with unrealized gains and losses, after applicable taxes, reported as a component of cumulative other comprehensive income. Debt securities that management has the positive intent and ability to hold to maturity are classified as held to maturity and are reported at amortized cost. Trading securities are those securities acquired for the purpose of funding the Company's liabilities associated with certain compensation plans. These securities are included in Other Assets and are carried at fair value with unrealized holding gains and losses recognized currently in non-interest income. Non-marketable equity securities (Federal Reserve Bank and Federal Home Loan Bank stock) are accounted for at cost and included in Other Assets.

The estimated fair value of a security is determined based on current quotations. Declines in the value of debt securities and marketable equity securities that are considered other than temporary are recorded in non-interest income. Realized gains and losses are recorded in non-interest income using the specific identification method.

44



Loans Held for Sale

Loans held for sale, principally mortgage loans, are valued on an aggregate basis at the lower of carrying amount or fair value. Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in non-interest income.

Loans and Leases

Loans are reported at the principal amount outstanding, net of unearned income. Interest income is recognized on an accrual basis. Loan origination fees, certain direct costs, unearned discounts and premiums are deferred and amortized into interest income as an adjustment to yield using methods that approximate the effective yield method over the term or estimated life of the loan. Non-refundable fees and direct loan origination cost related to loans held for sale are deferred and recognized as a component of the gain or loss on sale. Loan commitment fees are generally deferred and amortized into interest income over the commitment period. Other credit-related fees are recognized as fee income, a component of non-interest income, when earned.

Direct financing leases are carried at the aggregate of lease payments receivable plus estimated residual value of the leased property, less unearned income. Leveraged leases, which are a form of financing leases, are carried net of non-recourse debt. Unearned income on direct financing and leveraged leases is amortized over the lease term by methods that approximate the interest method. Residual values on leased assets are reviewed regularly for other than temporary impairment.

Non-Performing Loans and Leases

Generally, commercial loans are placed on non-accrual status upon becoming contractually past due 90 days or more for principal or interest (unless well secured and in the process of collection), when terms are renegotiated below market levels, or where a substantial doubt about full repayment of principal and or interest is evident. Residential, home equity, and small business loans are placed on non-accrual status when any extension of credit is contractually past due 120 days for principal or interest or upon taking a partial charge-off, or where a substantial doubt about full repayment of principal or interest is evident.

When a loan is placed on non-accrual status, the accrued and unpaid interest receivable is reversed and the loan is accounted for on the cash or cost recovery method until qualifying for return to accrual status. A loan may be returned to accrual status when all delinquent interest and principal become current in accordance with the terms of the loan agreement.

Loans are charged-off when it is probable that a loss has been incurred and when it is possible to make a reasonable estimate of the loss. For commercial loans, a charge-off is determined on a judgmental basis after due consideration of the debtor's prospects for repayment and the fair value of collateral is deemed deficient. For residential mortgage and home equity loans, a partial charge-off is required at 120 days delinquent if the estimated fair value (sales price minus all costs to acquire title, to hold and to sell) is less than the loan balance. Other consumer loans are charged-off upon becoming past due 120 days.

Allowance for Loan and Lease Losses

The Allowance for Loan and Lease Losses (the "Allowance") is a valuation allowance for estimated probable credit losses inherent in the loan and lease portfolio as of a given balance sheet date. In accordance with accounting and regulatory guidance, the Company maintains an Allowance adequate to cover management's estimate of probable credit losses. The Allowance is composed of an Allocated and a General component. The Allocated component covers a range of loss estimates based on analyses of individual borrowers and historical loss experience, supplemented as necessary by credit judgment to address observed changes in trends, conditions, and other relevant environmental and economic factors. The General component covers a measure for imprecision relative to quantitative and judgmental estimates that will inevitably be imprecise. Changes to the absolute level of the Allowance are recognized through

45



charges or credits to the Provision for Loan and Lease Losses (the "Provision"). Losses represent a charge or reduction to the Allowance while recoveries are credited or added back. Credit exposures covered by the Allowance are defined as funded or outstanding amounts of loans and leases.

The Allocated component is further divided between baseline and credit judgment segments. Baseline loss estimates reflect a "bottoms-up" approach based on a quarterly evaluation of individual commercial borrowers for impairment in accordance with Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan" as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures" ("SFAS No. 114"). Identification of specific borrowers for review is based on non-accrual status and those identified by management as exhibiting above average levels of risk.

The baseline segment also includes analyses of historical loss patterns in various loan pools that have been grouped based on similar risk characteristics for collective evaluation of impairment in accordance with SFAS No. 5, "Accounting for Contingencies." Commercial loan pools are collectively evaluated for impairment based on line-of-business and internal risk rating segmentation and exclude those loans impaired under SFAS No. 114. Loss estimates are calculated based on an analysis of historical risk rating migrations to loss. Consumer and small business loan pools reflect aggregation of similar products based on geography. A range of loss estimates is calculated based on historical rolling average loss rates, credit score band or tier-based loss rates and average delinquency flows to loss.

The credit judgment segment supplements the baseline and is based on assessments of portfolio performance not reflected in the historical analyses. Evaluation of these environmental and economic factors results in a range of probable loss from which the amount of credit judgment is set. Beginning with the fourth quarter of 2004, specific risk factors previously considered in the General component were allocated to the credit judgment in order to present total reserve allocations for a given risk element. Relevant factors include, but are not limited to, concentrations (geographic, large borrower, and industry), economic trends and conditions, changes in underwriting standards, experience and depth of lending staff, and trends in delinquencies, loan impairment, and net charge-offs. In addition, the Company uses a variety of other tools to estimate probable losses including, but not limited to, a rolling quarterly forecast of asset quality metrics; stress testing; and performance indicators based on the Company's own experience, peers or other industry sources.

The General component addresses imprecision in the estimation process that results from several sources including, but not limited to, delayed information as well as interpretation of that information. Management has determined that a reasonable measure of confidence/imprecision would reflect a range of no less than 2.5% to a high of 10.0% of the Allocated reserve (excluding specific reserves determined in accordance with SFAS No. 114). An alternative measure considered is a range from 0.05% to 0.15% of total loans. Management recognizes that a measure of imprecision is in-and-of itself highly subjective and is based on collective experience. Management also recognizes that the level of the General component may vary from period to period.

While management allocates the Allowance to specific loan categories, the entire Allowance is available to the total loan and lease portfolio.

Allowance for Unfunded Commitments

The allowance for unfunded commitments is a component of Other Liabilities and represents the estimate for probable credit losses inherent in unfunded commitments to extend credit. Unfunded commitments to extend credit include bankers acceptances, financial and standby letters of credit, commercial letters of credit, overnight overdrafts, and credit cards where the Company has issued a loss guarantee on behalf of its customers to facilitate card issuance. The process used to determine the allowance for unfunded commitments is consistent with the process for determining the Allowance as adjusted for estimated funding probabilities or loan equivalency factors. The allowance for unfunded commitments is increased or decreased through the Provision.

46



Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight line method over lives of three to fifty years for premises and improvements, and three to ten years for equipment.

Foreclosed Real Estate

Foreclosed real estate consists of properties acquired through foreclosure proceedings or acceptance of a deed-in-lieu of foreclosure. These properties are carried at the lower of cost or fair value based on current appraisals less selling costs. Losses arising at the time of acquiring such property are charged against the Allowance. Subsequent declines in property value are recognized through charges to non-interest expense.

Mortgage Servicing Rights

Mortgage servicing rights are recognized as assets when mortgage loans are sold and the rights to service those loans are retained. The assets are recorded at their relative fair values on the date the loans are sold and are carried at the lower of the initial recorded value, adjusted for amortization, or fair value. The assets are amortized in proportion to and over the period of estimated net servicing income.

An impairment analysis is performed on a monthly basis by estimating the fair value of the mortgage servicing rights and comparing that value to the carrying amount. The assets are stratified by certain risk characteristics, primarily loan type and note rate. The Company estimates the fair value using a discounted cash flow model to calculate the present value of estimated future net servicing income. The model uses factors such as loan prepayment rates, costs to service, ancillary income, impound account balances and interest rate assumptions in its calculations.

Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Goodwill is assessed at least annually for impairment in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. There was no impairment of goodwill in 2004, 2003 or 2002.

Asset Impairments

Under Company policy, which is in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, long-lived assets are evaluated for impairment based on their future use. For an asset that is to be held and used, an impairment loss, which is measured as the difference between the carrying amount and fair value of the asset, is recognized only if the carrying value of the long-lived asset is not recoverable from its undiscounted cash flows. For a long-lived asset to be disposed of by sale, the asset is measured at the lower of its carrying amount or fair value less cost to sell and depreciation is ceased. There was no impairment of long-lived assets in 2004, 2003 or 2002; however, in 2003 and 2002 depreciation was accelerated on assets related to the systems replacement project, as further discussed below.

Information Technology Systems Replacement Project

In 2003, the Company completed the Information Technology Systems Replacement Project, which was accounted for under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. The costs associated with this project included employee termination benefits, costs to terminate contracts, asset abandonments and professional fees. Termination benefits for employees not required to render service beyond a minimum retention period were recognized at fair value at the communication date. Termination benefits for employees that were required to render service beyond a minimum retention period were recognized ratably over the remaining service period. Costs to terminate a contract before the end of its term were recognized and measured at fair value when the contract

47



terminated. Professional fees were expensed ratably over the conversion period. Depreciation expense on assets abandoned was accelerated and recognized over the shortened life.

Income Taxes

The Company files a consolidated federal income tax return with the Bank and its subsidiaries. Deferred income taxes are provided to reflect the tax effect of temporary differences between financial statement carrying amounts and the corresponding tax basis of assets and liabilities. Deferred taxes are calculated by applying enacted statutory tax rates and tax laws to future years in which temporary differences are expected to reverse. The impact on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that the rate change is enacted. A deferred tax valuation reserve is established if it is more likely than not that a deferred tax asset will not be realized.

The Company's tax sharing policy provides for the settlement of income taxes between each relevant subsidiary as if the subsidiary had filed a separate return. Payments are made to the Company by subsidiaries with tax liabilities, and subsidiaries that generate tax benefits receive payments for those benefits as used.

Earnings Per Share

Basic earnings per share ("EPS") is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the dilutive impact of stock options and uses the average share price during the period in determining the number of incremental shares to be added to the weighted average number of common shares outstanding. There were no adjustments to net income (the numerator) for purposes of computing basic EPS. A reconciliation of the weighted average common shares outstanding for computing diluted EPS for 2004, 2003 and 2002 follows:

 
Weighted Average Shares

 
2004

  2003

  2002


Denominator for Basic EPS 53,232,815   58,338,566   69,385,745
Dilutive Effect of Stock Options and Restricted Stock 3,008,229   2,747,001   2,061,588

Denominator for Diluted EPS 56,241,044   61,085,567   71,447,333

Risk Management Instruments

The Company has authorization from its Board to use derivative financial instruments as an end-user in connection with its risk management activities and to accommodate the needs of customers. The Company has not qualified for any of the hedge accounting methods (i.e., fair value, cash flows or net investment in foreign operations) addressed under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No. 133"). All risk management derivative instruments are carried at fair value and the associated unrealized gains and losses are recognized currently in non-interest income. Over the past few years, the Company has not used interest rate swaps as a risk management tool. During 2004, 2003 and 2002, only limited use of foreign exchange contracts was required to mitigate foreign currency risk. Mortgage loan forward commitments are utilized to mitigage interest rate risk.

Stock-Based Compensation

The Company has employee and director stock option plans that are more fully described in Note 12. The Company accounts for its stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25") and related interpretations. Generally, stock-based employee compensation expense is not reflected in net income as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net

48



income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123").

(dollars in thousands except per share and option data)

  2004

  2003 1

  2002 1

 

 
Net Income, as reported   $ 173,339   $ 135,195   $ 121,180  
  Add:   Stock-Based Employee Compensation Expense Associated
with Stock Options Included in Reported Net Income, Net
of Related Tax Effects
        543     644  
  Less:   Total Stock-Based Employee Compensation Expense
Associated with Stock Options Determined Under Fair
Value Method For All Option Awards, Net of Related Tax
Effects 2
    (4,307 )   (9,573 )   (9,752 )

 
Pro Forma Net Income   $ 169,032   $ 126,165   $ 112,072  

 
Earnings per share:                  
  Basic-as reported   $ 3.26   $ 2.32   $ 1.75
  Basic-pro forma   $ 3.18   $ 2.16   $ 1.62
  Diluted-as reported   $ 3.08   $ 2.21   $ 1.70
  Diluted-pro forma   $ 3.01   $ 2.07   $ 1.57
Weighted Average Fair Value of Options                  
  Granted During the Year 2   $ 12.25   $ 8.89   $ 7.98
Assumptions:                  
  Average Risk Free Interest Rate     4.37%     3.96%     4.90%
  Average Expected Volatility     32.15%     32.04%     31.41%
  Expected Dividend Yield     3.10%     3.21%     3.16%
  Expected Life     5.8 years     6.4 years     6.5 years
1
Prior period amounts restated to account for forfeitures and adjustment to dividend yield calculation.

2
A Black-Scholes option pricing model was used to determine the fair values of the options granted.

Stock Repurchases

Shares of the Company's common stock that are repurchased are recorded at cost.

Advertising Costs

The Company recognizes its advertising costs as incurred. Advertising costs were $5.5 million, $4.6 million, and $6.0 million in 2004, 2003 and 2002, respectively.

International Operations

The Bank has operations that are conducted in the Pacific Islands that are denominated in U.S. dollars. These operations are classified as domestic.

Recent Accounting Standards

In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123 (revised 2004) ("SFAS No. 123(R)"), Share-Based Payment, which is a revision of SFAS No. 123. SFAS 123(R) supersedes APB No. 25 and amends FASB Statement No. 95, Statement of Cash Flows. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense through the income statement based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) is effective as of the beginning of the first interim period that begins after June 15, 2005.

49



SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods:

    1.
    A "modified prospective" method under which compensation cost is recognized beginning with the effective date of SFAS No. 123(R) based on (a) the requirements of SFAS No. 123(R) for all share-based payments granted after the effective date and (b) the requirements of SFAS No. 123 for all share-based awards granted to employees prior to the effective date of the SFAS No. 123(R) that remain unvested on the effective date.
    2.
    A "modified retrospective" method includes the requirements of the modified prospective method described above, but also permits entities to restate the financial statements of (a) all prior periods presented or (b) prior interim periods of the year of adoption, based on the amounts previously used in the pro forma disclosure under SFAS No. 123.

The Company plans to adopt SFAS No. 123(R) using the modified prospective method on July 1, 2005.

As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using the intrinsic value method of APB No. 25 and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R) will have an impact on the Company's results of operations, although it will have no impact on the Company's overall financial position. The Company expects to recognize an expense of approximately $1.5 million in 2005 relating to unvested stock options outstanding as of December 31, 2004. The Company may grant additional stock options in 2005, however, an estimate of the fair value cannot be measured at this time. Had the Company adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share in Note 1. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow required under current guidelines. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. The Company cannot estimate what those amounts will be in the future because it depends on when employees exercise stock options.

50


Note 2 – Investment Securities

The following presents the details of the investment securities portfolio:

(dollars in thousands)

  Amortized
Cost

  Gross
Unrealized
Gains

  Gross
Unrealized
Losses

  Fair
Value



 

 

 

 

 

 

 

 

 

 

 

 

 
At December 31, 2004                        
Securities Held to Maturity                        
Debt Securities Issued by States and Municipalities   $ 90   $ 6   $   $ 96
Mortgage-Backed Securities     589,818     2,295     (6,373 )   585,740

Total   $ 589,908   $ 2,301   $ (6,373 ) $ 585,836


Securities Available for Sale

 

 

 

 

 

 

 

 

 

 

 

 
Debt Securities Issued by the U.S. Treasury and Agencies   $ 38,551   $ 406   $ (15 ) $ 38,942
Debt Securities Issued by States and Municipalities     7,958     150     (27 )   8,081
Mortgage-Backed Securities     2,090,510     15,195     (6,711 )   2,098,994
Other Debt Securities     338,495     1,229     (2,022 )   337,702

Total   $ 2,475,514   $ 16,980   $ (8,775 ) $ 2,483,719


At December 31, 2003

 

 

 

 

 

 

 

 

 

 

 

 
Securities Held to Maturity                        
Debt Securities Issued by the U.S. Treasury and Agencies   $ 22,021   $   $ (3 ) $ 22,018
Debt Securities Issued by States and Municipalities     130     12         142
Mortgage-Backed Securities     705,082     3,500     (10,043 )   698,539

Total   $ 727,233   $ 3,512   $ (10,046 ) $ 720,699


Securities Available for Sale

 

 

 

 

 

 

 

 

 

 

 

 
Equity Securities   $ 261   $   $   $ 261
Debt Securities Issued by the U.S. Treasury and Agencies     59,339     1,651         60,990
Debt Securities Issued by States and Municipalities     5,957     263         6,220
Mortgage-Backed Securities     1,790,692     20,975     (6,394 )   1,805,273
Other Debt Securities     118,040     458     (126 )   118,372

Total   $ 1,974,289   $ 23,347   $ (6,520 ) $ 1,991,116


At December 31, 2002

 

 

 

 

 

 

 

 

 

 

 

 
Securities Held to Maturity                        
Debt Securities Issued by the U.S. Treasury and Agencies   $ 20,860   $ 39   $   $ 20,899
Debt Securities Issued by States and Municipalities     165     16         181
Mortgage-Backed Securities     208,695     6,241         214,936

Total   $ 229,720   $ 6,296   $   $ 236,016


Securities Available for Sale

 

 

 

 

 

 

 

 

 

 

 

 
Equity Securities   $ 249   $   $   $ 249
Debt Securities Issued by the U.S. Treasury and Agencies     76,291     2,449         78,740
Debt Securities Issued by States and Municipalities     7,306     349         7,655
Mortgage-Backed Securities     2,143,193     39,339     (280 )   2,182,252
Other Debt Securities     17,696     609         18,305

Total   $ 2,244,735   $ 42,746   $ (280 ) $ 2,287,201

51


The following presents an analysis of the contractual maturities of the investment securities portfolio as of December 31, 2004:

(dollars in thousands)

  Amortized Cost

  Fair Value


Securities Held to Maturity            
Due After One Year Through Five Years   $ 90   $ 96
Mortgage-Backed Securities     589,818     585,740

Total   $ 589,908   $ 585,836


Securities Available for Sale

 

 

 

 

 

 
Due in One Year or Less   $ 11,410   $ 11,494
Due After One Year Through Five Years     342,587     341,817
Due After Five Years Through Ten Years     25,561     25,930
Due After Ten Years     5,446     5,484

      385,004     384,725
Mortgage-Backed Securities     2,090,510     2,098,994

Total   $ 2,475,514   $ 2,483,719

Investment securities of $1.5 billion and $1.4 billion carrying value which approximated fair value, were pledged to secure deposits of governmental entities and repurchase agreements at December 31, 2004 and 2003, respectively.

Gross gains and losses and proceeds from sales of securities available for sale for the years ended December 31, 2004, 2003 and 2002 were as follows:

(dollars in thousands)

  2004

  2003

  2002


Gross Gains on Sales of Securities   $ 318   $ 1,838   $ 615
Gross Losses on Sales of Securities     (1,112 )   (49 )  

Net Gains (Losses) on Sales of Securities Available for Sale   $ (794 ) $ 1,789   $ 615

The following presents temporarily impaired investment securities as of December 31, 2004:

 
  Less Than 12 Months
  12 Months or Longer
  Total
 
(dollars in thousands)

  Fair Value
  Gross
Unrealized
Losses

  Fair Value
  Gross
Unrealized
Losses

  Fair Value
  Gross
Unrealized
Losses

 

 
Debt Securities Issued by the U.S. Treasury and Agencies   $ 10,860   $ (15 ) $   $   $ 10,860   $ (15 )
Debt Securities Issued by State and Municipalities     762     (27 )           762     (27 )
Mortgage-Backed Securities     999,130     (8,310 )   284,389     (4,774 )   1,283,519     (13,084 )
Foreign Bonds     174,111     (2,022 )           174,111     (2,022 )

 
Total Temporarily Impaired Investment Securities   $ 1,184,863   $ (10,374 ) $ 284,389   $ (4,774 ) $ 1,469,252   $ (15,148 )