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Bank of Hawaii 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-12
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32
  6. Ex-32

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)

x

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the

 

quarterly period ended September 30, 2006

 

 

 

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

99-0148992

(State of incorporation)

(IRS Employer Identification No.)

 

 

130 Merchant Street, Honolulu, Hawaii

96813

(Address of principal executive offices)

(Zip Code)

 

1-888-643-3888

(Registrant’s telephone number, including area code)

 

 

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

Yes  x    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

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

Yes  o    No  x

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

Common Stock, $.01 par value; outstanding at October 20, 2006 – 49,698,331 shares

 




 

Bank of Hawaii Corporation
Form 10-Q
INDEX

    

 

 

 

 

Page

 

Part I - Financial Information

 

 

 

 

 

 

 

Item 1.

 

Financial Statements (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Consolidated Statements of Income – Three and nine months ended
September 30, 2006 and 2005

 

3

 

 

 

 

 

 

 

 

 

Consolidated Statements of Condition – September 30, 2006, December 31, 2005 and
September 30, 2005

 

4

 

 

 

 

 

 

 

 

 

Consolidated Statements of Shareholders’ Equity – Nine months ended
September 30, 2006 and 2005

 

5

 

 

 

 

 

 

 

 

 

Consolidated Statements of Cash Flows — Nine months ended
September 30, 2006 and 2005

 

6

 

 

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements (Unaudited)

 

7

 

 

 

 

 

 

 

Item 2.

 

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

 

16

 

 

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

39

 

 

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

39

 

 

 

 

 

 

 

Part II - Other Information

 

 

 

 

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

39

 

 

 

 

 

 

 

Item 5.

 

Other Information

 

40

 

 

 

 

 

 

 

Item 6.

 

Exhibits

 

40

 

 

 

 

 

 

 

Signatures

 

41

 

 

 




Bank of Hawaii Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

(dollars in thousands, except per share amounts)

 

2006

 

2005

 

2006

 

2005

 

Interest Income

 

 

 

 

 

 

 

 

 

Interest and Fees on Loans and Leases

 

$

110,065

 

$

94,381

 

$

313,824

 

$

270,967

 

Income on Investment Securities Available-for-Sale

 

31,949

 

28,482

 

94,010

 

83,788

 

Income on Investment Securities Held-to-Maturity

 

4,558

 

5,109

 

13,973

 

16,461

 

Deposits

 

50

 

57

 

148

 

116

 

Funds Sold

 

66

 

935

 

361

 

1,175

 

Other

 

272

 

270

 

816

 

990

 

Total Interest Income

 

146,960

 

129,234

 

423,132

 

373,497

 

Interest Expense

 

 

 

 

 

 

 

 

 

Deposits

 

28,464

 

15,766

 

72,753

 

40,947

 

Securities Sold Under Agreements to Repurchase

 

11,959

 

6,796

 

29,651

 

14,683

 

Funds Purchased

 

2,270

 

901

 

6,815

 

2,785

 

Short-Term Borrowings

 

82

 

50

 

212

 

127

 

Long-Term Debt

 

3,835

 

3,761

 

11,293

 

11,298

 

Total Interest Expense

 

46,610

 

27,274

 

120,724

 

69,840

 

Net Interest Income

 

100,350

 

101,960

 

302,408

 

303,657

 

Provision for Credit Losses

 

2,785

 

3,000

 

7,615

 

3,000

 

Net Interest Income After Provision for Credit Losses

 

97,565

 

98,960

 

294,793

 

300,657

 

Noninterest Income

 

 

 

 

 

 

 

 

 

Trust and Asset Management

 

14,406

 

14,052

 

43,791

 

42,732

 

Mortgage Banking

 

2,394

 

2,618

 

7,950

 

7,802

 

Service Charges on Deposit Accounts

 

10,723

 

10,046

 

30,550

 

29,794

 

Fees, Exchange, and Other Service Charges

 

16,266

 

15,394

 

46,666

 

44,441

 

Investment Securities Gains, Net

 

19

 

8

 

19

 

345

 

Insurance

 

6,713

 

5,324

 

16,423

 

15,442

 

Other

 

6,366

 

8,074

 

17,261

 

17,949

 

Total Noninterest Income

 

56,887

 

55,516

 

162,660

 

158,505

 

Noninterest Expense

 

 

 

 

 

 

 

 

 

Salaries and Benefits

 

43,133

 

44,366

 

133,730

 

132,991

 

Net Occupancy

 

9,998

 

9,896

 

29,017

 

28,630

 

Net Equipment

 

5,285

 

5,335

 

15,115

 

16,183

 

Professional Fees

 

2,638

 

5,689

 

5,665

 

11,645

 

Other

 

18,751

 

19,310

 

55,838

 

55,014

 

Total Noninterest Expense

 

79,805

 

84,596

 

239,365

 

244,463

 

Income Before Provision for Income Taxes

 

74,647

 

69,880

 

218,088

 

214,699

 

Provision for Income Taxes

 

27,727

 

25,051

 

88,642

 

77,919

 

Net Income

 

$

46,920

 

$

44,829

 

$

129,446

 

$

136,780

 

Basic Earnings Per Share

 

$

0.95

 

$

0.87

 

$

2.58

 

$

2.62

 

Diluted Earnings Per Share

 

$

0.93

 

$

0.85

 

$

2.53

 

$

2.55

 

Dividends Declared Per Share

 

$

0.37

 

$

0.33

 

$

1.11

 

$

0.99

 

Basic Weighted Average Shares

 

49,586,947

 

51,385,840

 

50,180,280

 

52,221,345

 

Diluted Weighted Average Shares

 

50,506,267

 

52,844,961

 

51,226,763

 

53,745,612

 

 

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

3




Bank of Hawaii Corporation and Subsidiaries

Consolidated Statements of Condition (Unaudited)

 

 

 

September 30,

 

December 31,

 

September 30,

 

(dollars in thousands)

 

2006

 

2005

 

2005

 

Assets

 

 

 

 

 

 

 

Interest-Bearing Deposits

 

$

5,238

 

$

4,893

 

$

10,119

 

Funds Sold

 

 

 

10,000

 

Investment Securities Available-for-Sale

 

 

 

 

 

 

 

Held in Portfolio

 

1,973,719

 

2,333,417

 

2,381,462

 

Pledged as Collateral

 

678,914

 

204,798

 

172,500

 

Investment Securities Held-to-Maturity
(Fair Value of $385,891; $442,989; and $475,884)

 

397,520

 

454,240

 

485,041

 

Loans Held for Sale

 

15,336

 

17,915

 

18,095

 

Loans and Leases

 

6,489,057

 

6,168,536

 

6,202,546

 

Allowance for Loan and Lease Losses

 

(90,795

)

(91,090

)

(91,654

)

Net Loans and Leases

 

6,398,262

 

6,077,446

 

6,110,892

 

Total Earning Assets

 

9,468,989

 

9,092,709

 

9,188,109

 

Cash and Noninterest-Bearing Deposits

 

283,621

 

493,825

 

296,152

 

Premises and Equipment

 

127,521

 

133,913

 

135,952

 

Customers’ Acceptances

 

673

 

1,056

 

1,081

 

Accrued Interest Receivable

 

49,339

 

43,033

 

40,898

 

Foreclosed Real Estate

 

409

 

358

 

413

 

Mortgage Servicing Rights

 

18,995

 

18,010

 

18,049

 

Goodwill

 

34,959

 

34,959

 

34,959

 

Other Assets

 

386,709

 

369,175

 

369,622

 

Total Assets

 

$

10,371,215

 

$

10,187,038

 

$

10,085,235

 

Liabilities

 

 

 

 

 

 

 

Deposits

 

 

 

 

 

 

 

Noninterest-Bearing Demand

 

$

1,879,644

 

$

2,134,916

 

$

1,890,904

 

Interest-Bearing Demand

 

1,608,774

 

1,678,454

 

1,716,306

 

Savings

 

2,596,940

 

2,819,258

 

2,880,066

 

Time

 

1,601,765

 

1,274,840

 

1,269,310

 

Total Deposits

 

7,687,123

 

7,907,468

 

7,756,586

 

Funds Purchased

 

160,600

 

268,110

 

172,365

 

Short-Term Borrowings

 

11,290

 

9,447

 

8,537

 

Securities Sold Under Agreements to Repurchase

 

1,099,260

 

609,380

 

756,407

 

Long-Term Debt

 

265,268

 

242,703

 

242,692

 

Banker’s Acceptances

 

673

 

1,056

 

1,081

 

Retirement Benefits Payable

 

72,651

 

71,116

 

67,136

 

Accrued Interest Payable

 

18,659

 

10,910

 

9,416

 

Taxes Payable and Deferred Taxes

 

280,611

 

269,094

 

276,678

 

Other Liabilities

 

91,608

 

104,402

 

98,026

 

Total Liabilities

 

9,687,743

 

9,493,686

 

9,388,924

 

Shareholders’ Equity

 

 

 

 

 

 

 

Common Stock ($.01 par value); authorized 500,000,000 shares; issued / outstanding: September 2006 - 56,848,799 / 49,809,709; December 2005 - 56,827,483 / 51,276,286; and September 2005 - 81,722,233 / 51,282,537

 

566

 

565

 

815

 

Capital Surplus

 

471,908

 

473,338

 

463,084

 

Accumulated Other Comprehensive Loss

 

(49,422

)

(47,818

)

(34,697

)

Retained Earnings

 

605,976

 

546,591

 

1,366,058

 

Deferred Stock Grants

 

 

(11,080

)

(5,974

)

Treasury Stock, at Cost (Shares: September 2006 - 7,039,090; December 2005 - 5,551,197; and September 2005 - 30,439,696)

 

(345,556

)

(268,244

)

(1,092,975

)

Total Shareholders’ Equity

 

683,472

 

693,352

 

696,311

 

Total Liabilities and Shareholders’ Equity

 

$

10,371,215

 

$

10,187,038

 

$

10,085,235

 

 

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

4




Bank of Hawaii Corporation and Subsidiaries

Consolidated Statements of Shareholders’ Equity (Unaudited)

 

 

 

 

 

 

 

 

Accum.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Compre-

 

 

 

Deferred

 

 

 

Compre-

 

 

 

 

 

Common

 

Capital

 

hensive

 

Retained

 

Stock

 

Treasury

 

hensive

 

(dollars in thousands)

 

Total

 

Stock

 

Surplus

 

Loss

 

Earnings

 

Grants

 

Stock

 

Income

 

Balance at December 31, 2005

 

$

693,352

 

$

565

 

$

473,338

 

$

(47,818

)

$

546,591

 

$

(11,080

)

$

(268,244

)

 

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

129,446

 

 

 

 

129,446

 

 

 

$

129,446

 

Other Comprehensive Income, Net of Tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in Unrealized Gains and Losses on

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment Securities Available-for-Sale

 

(1,604

)

 

 

(1,604

)

 

 

 

(1,604

)

Total Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

127,842

 

Common Stock Issued under Share-Based Compensation Plans and Related Tax Benefits (730,432 shares)

 

30,766

 

1

 

(1,430

)

 

(13,764

)

11,080

 

34,879

 

 

 

Common Stock Repurchased (2,194,534 shares)

 

(112,191

)

 

 

 

-

 

 

(112,191

)

 

 

Cash Dividends Paid

 

(56,297

)

 

 

 

(56,297

)

 

 

 

 

Balance at September 30, 2006

 

$

683,472

 

$

566

 

$

471,908

 

$

(49,422

)

$

605,976

 

$

 

$

(345,556

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2004

 

$

814,834

 

$

813

 

$

450,998

 

$

(12,917

)

$

1,282,425

 

$

(8,433

)

$

(898,052

)

 

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

136,780

 

 

 

 

136,780

 

 

 

$

136,780

 

Other Comprehensive Income, Net of Tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in Unrealized Gains and Losses on

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment Securities Available-for-Sale

 

(21,780

)

 

 

(21,780

)

 

 

 

(21,780

)

Total Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

115,000

 

Common Stock Issued under Share-Based Compensation Plans and Related Tax Benefits (803,278 shares)

 

33,268

 

2

 

12,086

 

 

(1,353

)

2,459

 

20,074

 

 

 

Common Stock Repurchased (4,478,932 shares)

 

(214,997

)

 

 

 

 

 

(214,997

)

 

 

Cash Dividends Paid

 

(51,794

)

 

 

 

(51,794

)

 

 

 

 

Balance at September 30, 2005

 

$

696,311

 

$

815

 

$

463,084

 

$

(34,697

)

$

1,366,058

 

$

(5,974

)

$

(1,092,975

)

 

 

 

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

5




Bank of Hawaii Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

(dollars in thousands)

 

2006

 

2005

 

Operating Activities

 

 

 

 

 

Net Income

 

$

129,446

 

$

136,780

 

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

 

 

 

 

 

Provision for Credit Losses

 

7,615

 

3,000

 

Goodwill Impairment

 

 

1,257

 

Depreciation and Amortization

 

12,292

 

14,056

 

Amortization of Deferred Loan and Lease Fees

 

(2,350

)

(496

)

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

 

3,086

 

7,139

 

Share-Based Compensation

 

4,017

 

3,892

 

Deferred Income Taxes

 

19,475

 

8,911

 

Net Gain on Investment Securities

 

(19

)

(345

)

Proceeds from Sales of Loans Held for Sale

 

242,040

 

346,950

 

Originations of Loans Held for Sale

 

(239,461

)

(347,403

)

Tax Benefits from Equity Based Compensation

 

(5,416

)

 

Net Change in Other Assets and Other Liabilities

 

(29,641

)

(6,342

)

Net Cash Provided by Operating Activities

 

141,084

 

167,399

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Proceeds from Redemptions of Investment Securities Available-for-Sale

 

344,866

 

503,818

 

Purchases of Investment Securities Available-for-Sale

 

(464,103

)

(613,559

)

Proceeds from Redemptions of Investment Securities Held-to-Maturity

 

76,183

 

103,534

 

Purchases of Investment Securities Held-to-Maturity

 

(20,250

)

 

Net Increase in Loans and Leases

 

(326,376

)

(230,975

)

Premises and Equipment, Net

 

(5,900

)

(3,913

)

Net Cash Used in Investing Activities

 

(395,580

)

(241,095

)

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Net (Decrease) Increase in Deposits

 

(220,345

)

191,919

 

Net Increase in Short-Term Borrowings

 

384,213

 

203,693

 

Proceeds from Long-Term Debt

 

25,000

 

 

Repayments of Long-Term Debt

 

(2,500

)

(10,000

)

Tax Benefits from Equity Based Compensation

 

5,416

 

 

Proceeds from Issuance of Common Stock

 

21,341

 

20,195

 

Repurchase of Common Stock

 

(112,191

)

(214,997

)

Cash Dividends Paid

 

(56,297

)

(51,794

)

Net Cash Provided by Financing Activities

 

44,637

 

139,016

 

 

 

 

 

 

 

(Decrease) Increase in Cash and Cash Equivalents

 

(209,859

)

65,320

 

Cash and Cash Equivalents at Beginning of Period

 

498,718

 

250,951

 

Cash and Cash Equivalents at End of Period

 

$

288,859

 

$

316,271

 

 

 

 

 

 

 

Supplemental Information

 

 

 

 

 

Cash paid for:

 

 

 

 

 

Interest

 

$

112,975

 

$

67,445

 

Income taxes

 

63,487

 

20,657

 

 

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

6




 

Bank of Hawaii Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

Note 1.           Summary of Significant Accounting Policies

Basis of Presentation

Bank of Hawaii Corporation and its subsidiaries (the “Company”) provides a broad range of financial products and services to customers in Hawaii and the Pacific Islands (Guam, nearby islands and American Samoa).  The Company’s principal subsidiary is Bank of Hawaii (the “Bank”).  All significant intercompany accounts and transactions have been eliminated in consolidation.

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

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

These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.  Operating results for the nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

Recently Issued Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140.”  SFAS No. 155 permits, but does not require, fair value accounting for hybrid financial instruments that contain an embedded derivative that would otherwise require bifurcation in accordance with SFAS No. 133.  SFAS No. 155 also eliminates the temporary exemption for interests in securitized financial assets provided for by SFAS No. 133, Implementation Issue D1.  As a result, the Company will be required to evaluate its interests in securitized financial assets to determine whether its interest is a free standing derivative or a hybrid financial instrument that may be subject to the bifurcation requirements of SFAS No. 133.  If the Company’s interest in a securitized financial asset is determined to contain an embedded derivative, that financial instrument is eligible to be accounted for under the fair value accounting provisions of SFAS No. 155.  SFAS No. 155 is effective for all financial instruments acquired or issued after December 31, 2006 as well as to those hybrid financial instruments that had been previously bifurcated under SFAS No. 133.  As of September 30, 2006, the Company did not have any hybrid financial instruments which were bifurcated under SFAS No. 133.  As a result, the adoption of SFAS No. 155 is not expected to have a material impact on the Company’s results of operations and financial condition.

7




In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140.”  SFAS No. 156 requires all separately recognized servicing assets and liabilities to be initially measured at fair value, if practicable.  Following the initial measurement at fair value, the Company is permitted to choose to either subsequently measure servicing assets at fair value and report changes in fair value in earnings, or amortize the servicing assets in proportion to and over the period of estimated net servicing income or loss and periodically assess for impairment.  The Company expects that the after-tax cumulative-effect adjustment, as of January 1, 2007, will be to increase retained earnings by approximately $7.0 million.  The Company also expects to adopt the fair value measurement provisions of SFAS No. 156 in subsequent re-measurements of the servicing asset.

In June 2006, the FASB issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.”  FIN No. 48 establishes a recognition threshold and measurement for income tax positions recognized in the Company’s financial statements in accordance with SFAS No. 109.  FIN No. 48 also prescribes a two-step evaluation process for tax positions.  The first step is recognition and the second is measurement.  In evaluating a tax position for recognition, the Company judgmentally evaluates whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of related appeals or litigation processes, based on the technical merits of the position.  If the tax position meets the more-likely-than-not recognition threshold, the tax position is measured and recognized in the Company’s financial statements as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate resolution.  As required by the provisions of FIN No. 48, the Company plans to adopt the provisions of the Interpretation on January 1, 2007.  Management is currently evaluating the effect that the provisions of FIN No. 48 will have on the Company’s results of operations and financial condition.

In July 2006, the FASB issued Staff Position (“FSP”) No. 13-2 “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction,” which amends SFAS No. 13.  Under the provisions of FSP No. 13-2, a material revision in the timing of expected cash flows of a leveraged lease requires a recalculation of the original lease assumptions.  As required by the provisions of FSP No. 13-2, the Company plans to adopt the provisions of this Staff Position on January 1, 2007 by recording an after-tax cumulative-effect adjustment to retained earnings for any leases that have been determined to have an expected change in the timing of cash flows.  After adoption, a subsequent change in the assumption of expected cash flows that results in a change in the net investment of a leveraged lease shall be recorded as a gain or loss in the period in which the assumption is changed.  The Company has entered into one leveraged lease transaction known as a Lease In/Lease Out (“LILO”) and five Sale In/Lease Out (“SILO”) transactions that are currently under review by the Internal Revenue Service (the “IRS”).  The IRS review of the LILO transaction has progressed further than the review of the SILO transactions. The outcome of these reviews may change the expected timing of cash flows from these leases which would subject these leases to the provisions of FSP No. 13-2.  Based on current discussions with the IRS, the estimated after-tax cumulative-effect reduction to retained earnings as of January 1, 2007 could be as much as $5.0 million for the LILO and as much as $18.0 million for the SILOs.

8




In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R).”  This standard requires the Company to recognize in its statement of condition an asset for a plan’s overfunded status or a liability for a plan’s underfunded status.  The Company has two pension plans and a postretirement benefit plan (the “Plans”) which are subject to the provisions of SFAS No. 158.  SFAS No. 158 also requires that the Company measure the Plans’ assets and obligations that determine its funded status as of the end of the fiscal year and to recognize those changes in the year in which the changes occur as a component of other comprehensive income, net of taxes.  The adoption of SFAS No. 158, effective December 31, 2006, is expected to result in an addition to other comprehensive income, net of tax, of between $2.0 million and $6.0 million.

In September 2006, the FASB ratified the consensus reached by the Emerging Issues Task Force (“EITF”) on Issue No. 06-5, “Accounting for Purchases of Life Insurance — Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.”  FASB Technical Bulletin No. 85-4 requires that the amount that could be realized under the insurance contract as of the date of the statement of financial position should be reported as an asset.  Since the issuance of FASB Technical Bulletin No. 85-4, there has been diversity in practice in the calculation of the amount that could be realized under insurance contracts.  EITF Issue No. 06-5, which is effective January 1, 2007, concludes that the Company should consider any additional amounts (e.g., cash stabilization reserves and deferred acquisition cost taxes) included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized in accordance with FASB Technical Bulletin No. 85-4.  The adoption of EITF Issue No. 06-5 is not expected to have a material impact on the Company’s results of operations and financial condition.

Note 2.           Recently-Enacted Legislation

In May 2006, the Tax Increase Prevention and Reconciliation Act (“TIPRA”) was enacted by Congress effective January 1, 2007, which resulted in the repeal of the exclusion from federal income taxation of a portion of the income from foreign sales corporations.  The Company has two leveraged leases that were affected by this legislation.  SFAS No. 13, “Accounting for Leases,” requires that the cumulative-effect of a change in a significant assumption affecting the net income recorded over the entire term of a lease, such as a change in tax law, be recognized as a cumulative-effect adjustment to the lease in the period in which the change occurs.  Accordingly, during the second quarter of 2006, the Company recorded a charge of $8.8 million to reflect the cumulative-effect of the change in tax law.  The charge was comprised of a $0.6 million reduction of lease interest income and an increase of $8.2 million in the provision for income taxes.  TIPRA is not expected to materially increase the Company’s provision for income taxes in future periods.

9




Note 3.           Share-Based Compensation

The Company adopted SFAS No. 123(R), “Share-Based Payment,” on January 1, 2006 using the “modified prospective” method.  Under this method, stock-based awards that are granted, modified, or settled after December 31, 2005, are measured and accounted for in accordance with SFAS No. 123(R).  Also under this method, expense is recognized for unvested awards that were granted prior to January 1, 2006, based upon the fair value determined at the grant date under SFAS No. 123, “Accounting for Stock-Based Compensation.”  Prior to the adoption of SFAS No. 123(R), the Company accounted for share-based compensation under the intrinsic value method as permitted by APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations.  Accordingly, the Company previously recognized no compensation expense for employee stock options that were granted with an exercise price equal to the fair value of the underlying common stock on the date of grant.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123(R) in 2005.

 

 

 

Three Months Ended

 

Nine Months Ended

 

(dollars in thousands, except per share data) 

(Unaudited)

 

September 30, 2005 1

 

September 30, 2005 1

 

Net Income, as reported

 

$

 

44,829

 

$

136,780

 

Add:

Share-Based Employee Compensation Expense Included in

 

 

 

 

 

 

 

Reported Net Income, Net of Related Tax Effects

 

 

847

 

 

2,479

 

Less:

Share-Based Employee Compensation Expense Determined

 

 

 

 

 

 

 

Under Fair Value Method, Net of Related Tax Effects 2

 

 

(1,358

)

 

(4,193

)

Pro Forma Net Income

 

$

44,318

 

$

135,066

 

 

 

 

 

 

 

 

Basic Earnings Per Share — As Reported

 

$

0.87

 

$

2.62

 

Basic Earnings Per Share — Pro Forma

 

 

0.86

 

 

2.59

 

Diluted Earnings Per Share — As Reported

 

 

0.85

 

 

2.55

 

Diluted Earnings Per Share — Pro Forma

 

 

0.84

 

 

2.51

 

 

 

 

 

 

 

 


1    Prior period amounts restated to account for forfeitures and adjustment to dividend yield calculations.

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

 

There was no material impact to the Company’s income before provision for income taxes and net income from the adoption of SFAS No. 123(R) on January 1, 2006.  Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options and the vesting of restricted stock as operating cash flows in the Consolidated Statements of Cash Flows.  SFAS No. 123(R) requires that the cash flows from the tax benefits resulting from tax deductions in excess of the compensation expense recognized for those stock options and restricted stock (excess tax benefits) to be reported as financing cash flows.  An excess tax benefit of approximately $5.4 million is classified as financing cash inflows for the nine months ended September 30, 2006.

Employee and director share-based compensation expense recognized for stock options and restricted stock was $4.0 million and $4.2 million for the nine months ended September 30, 2006 and 2005, respectively.  The related income tax benefit recognized was $1.7 million and $1.8 million for the nine months ended September 30, 2006 and 2005, respectively.

10




Director Stock Compensation Program

The Company has a Director Stock Compensation Program that annually grants shares of restricted common stock (“Restricted Shares”) and stock options to purchase common shares to each non-employee director.  The exercise price of the stock options is based on the closing market price of the shares on the date that the options are granted.  The Restricted Shares and the stock options are generally not transferable.  The total number of shares authorized for awards under the Director Stock Compensation Program was 471,900 as of September 30, 2006.

Stock options granted in 2005 and 2006 vest ratably over three years and expire at the earliest of 1) three months after termination of the director’s membership on the Company’s Board of Directors (the “Board”) for any reason other than death or disability; 2) one year after termination of the director’s membership on the Board due to death or disability; or 3) ten years after the date of grant.  The Restricted Shares vest after three years or upon death or disability, if earlier.

Stock options granted prior to 2005 are immediately exercisable and expire ten years from the date of grant. However, the shares received upon exercise of the stock options (“Option Shares”) are restricted.  The restriction period for both Restricted Shares and Option Shares continues as long as the director remains on the Board.  If an optionee ceases to serve as a director prior to the end of his or her term, for any reason other than death, disability or change in control of the Company, the Option Shares will be redeemed by the Company at the exercise price and any unexercised options and restricted shares are forfeited.  As of September 30, 2006, there were 214,571 stock options and 28,263 Restricted Shares outstanding under this program.

Employee Stock Option Plans

The Company’s employee stock option plans are shareholder approved and administered by the Compensation Committee of the Board.  Awards under the employee stock option plans may include stock options, stock appreciation rights, restricted stock and restricted stock units.  The total number of shares authorized for awards under the 2004 Employee Stock Option Plan is 1.7 million as of September 30, 2006.

Stock Options

Stock options provide grantees the option to purchase shares of common stock at a specified exercise price and, generally, expire ten years from the date of grant.  Stock option grants include incentive and nonqualified stock options whose vesting may be based on a service period and/or Company performance measures.  Generally, options granted prior to December 2005 had vesting terms of one or three years.  Options granted in December 2005 and in prior years were fully vested as of December 31, 2005.  The exercise prices were equal to the fair value of the shares on the dates the options were granted.  The Company recognizes compensation expense, measured as the fair value of the stock option on the date of grant, on a straight-line basis over the vesting period.

The fair value of each stock option award is estimated on the date of grant using a Black-Scholes option pricing model that uses the assumptions noted in the following table.  Expected volatilities are based on the historical volatility of the Company’s common stock over the expected term of the options, excluding the interim years 2000-2003.  The Company uses historical data to estimate option exercise and employee termination within the option pricing model.  The expected term of stock options granted is derived from the output of the option pricing model and represents the period of time that stock options granted are expected to be outstanding.  The risk-free rate for periods within the contractual life of the stock option is based on the U.S. Treasury yield curve in effect at the date of grant.

11




 

 

 

Nine Months Ended

 

 

 

September 30,

 

(Unaudited)

 

2006

 

2005

 

Weighted Average Fair Value of Stock Options Granted

 

$

11.99

 

$

9.58

 

Assumptions:

 

 

 

 

 

Average Risk-Free Rate

 

4.92

%

3.90

%

Average Expected Volatility

 

22.07

%

22.70

%

Expected Dividend Yield

 

2.73

%

2.80

%

Expected Life

 

5.6 years

 

5.6 years

 

 

The following table presents the activity related to stock options under all plans for the nine months ended September 30, 2006.

 

 

 

 

 

 

Weighted Average

 

Aggregate

 

 

 

 

 

Weighted

 

Remaining

 

Intrinsic

 

 

 

Stock

 

Average

 

Contractual Term

 

Value

 

(Unaudited)

 

Options

 

Exercise Price

 

(in years)

 

(in thousands)

 

Stock Options Outstanding at January 1, 2006

 

3,011,653

 

$

29.71

 

 

 

 

 

Granted

 

24,101

 

54.31

 

 

 

 

 

Exercised

 

(605,632

)

26.77

 

 

 

 

 

Forfeited or Expired

 

(5,980

)

36.37

 

 

 

 

 

Stock Options Outstanding at September 30, 2006

 

2,424,142

 

30.66

 

5.8

 

$

42,417

 

Stock Options Exercisable at September 30, 2006

 

2,386,331

 

30.33

 

5.8

 

42,554

 

 

The total intrinsic value (i.e., the amount by which the fair value of the underlying common stock exceeds the exercise price of a stock option on exercise date) of stock options exercised during the nine months ended September 30, 2006 and 2005 were $10.8 million and $15.2 million, respectively.

Cash received from stock option exercises for the nine months ended September 30, 2006 and 2005 were $16.3 million and $15.1 million, respectively.  The tax benefit realized for the deductions related to the stock option exercises were $4.2 million and $5.6 million for the nine months ended September 30, 2006 and 2005, respectively.

The Company reissues treasury stock to satisfy stock option exercises.

Restricted Stock

Restricted Stock provides grantees with rights to shares of common stock upon completion of a service period or achievement of Company performance measures.  During the restriction period, all shares are considered outstanding and dividends are paid on the Restricted Stock.  The Restricted Stock vests over periods ranging from three to ten years from the date of grant, although accelerated vesting was provided for in certain grants, based on the attainment of defined Company performance measures.  The Company recognizes compensation expense, measured as the quoted market price of the Restricted Stock on the date of grant, on a straight-line basis over the vesting period for service period vesting, plus additional recognition of the costs associated with accelerated vesting based upon projected attainment of Company performance measures.  Restricted Stock is forfeited if an employee terminates prior to vesting.

As of September 30, 2006, unrecognized compensation cost related to unvested Restricted Stock was $7.0 million.  The cost is expected to be recognized over a weighted average period of 2.2 years.  The total grant date fair value of Restricted Stock which vested during the nine months ended September 30, 2006 and 2005 was $4.0 million and $5.2 million, respectively.

12




The following table presents the activity for Restricted Stock for the nine months ended September 30, 2006.

(Unaudited)

 


Number of Shares

 

Weighted Average
Grant-Date Fair Value

 

Unvested as of December 31, 2005

 

306,747

 

$

41.36

 

Granted

 

55,575

 

52.98

 

Vested

 

(96,548

)

41.73

 

Forfeited

 

(19,017

)

37.25

 

Unvested as of September 30, 2006

 

246,757

 

$

44.15

 

 

Restricted Stock Units

Restricted Stock Units (“RSUs”) entitle grantees to a cash payment based upon the fair value of the Company’s common stock at the time the award vests.  During the vesting period, the participant is entitled to dividend equivalent payments equal to dividends declared on the Company’s common stock.  Expenses associated with RSUs are considered share-based compensation expense and are recognized over the vesting period.  The primary RSU grant was made in 2003.  Under this grant, with the achievement of certain performance objectives, 50% of the grant vested April 30, 2004 and the remaining 50% vested March 31, 2005.  For certain grantees, the original award is supplemented with additional RSUs after the original vesting period, based upon the achievement of certain additional performance objectives.  Total expense recognized by the Company for RSUs for the nine months ended September 30, 2006 and 2005 was $0.4 million and $1.5 million, respectively.

The following table presents the activity for RSUs for the nine months ended September 30, 2006 and 2005.

(Unaudited)

 

Number of Units

 

Balance as of December 31, 2005

 

15,000

 

Granted

 

5,625

 

Vested

 

(15,000

)

Balance as of September 30, 2006

 

5,625

 

 

 

 

 

Balance as of December 31, 2004

 

114,000

 

Vested

 

(97,500

)

Forfeited

 

(1,500

)

Balance as of September 30, 2005

 

15,000

 

 

Note 4.           Business Segments

The Company’s business segments are defined as Retail Banking, Commercial Banking, Investment Services Group, and Treasury and Other Corporate.  The Company’s internal management accounting process measures the performance of the business segments based on the management structure of the Company.  This process, which is not necessarily comparable with similar information for any other financial institution, uses various techniques to assign balance sheet and income statement amounts to the business segments, including allocations of interest income, expense overhead, the provision for credit losses and capital.  This process is dynamic and requires certain allocations based on judgment and other subjective factors.  Unlike financial accounting, there is no comprehensive, authoritative guidance for management accounting that is equivalent to GAAP.  Previously reported results have been reclassified to conform to the current organizational reporting structure.

13




 

Selected financial information for each segment is presented below for the three and nine months ended September 30, 2006 and 2005.

Business Segment Selected Financial Information (Unaudited)

 

 

 

 

 

 

 

Investment

 

Treasury

 

 

 

 

 

Retail

 

Commercial

 

Services

 

and Other

 

Consolidated

 

(dollars in thousands)

 

Banking

 

Banking

 

Group

 

Corporate

 

Total

 

Three Months Ended September 30, 2006

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

$

59,397

 

$

33,996

 

$

4,293

 

$

2,664

 

$

100,350

 

Provision for Credit Losses

 

2,609

 

480

 

 

(304

)

2,785

 

Net Interest Income After Provision for Credit Losses

 

56,788

 

33,516

 

4,293

 

2,968

 

97,565

 

Noninterest Income

 

25,243

 

11,929

 

17,344

 

2,371

 

56,887

 

Noninterest Expense

 

(43,030

)

(19,739

)

(15,432

)

(1,604

)

(79,805

)

Income Before Provision for Income Taxes

 

39,001

 

25,706

 

6,205

 

3,735

 

74,647

 

Provision for Income Taxes

 

(14,430

)

(9,682

)

(2,296

)

(1,319

)

(27,727

)

Allocated Net Income

 

24,571

 

16,024

 

3,909

 

2,416

 

46,920

 

Total Assets at September 30, 2006

 

$

3,931,334

 

$

2,692,163

 

$

219,715

 

$

3,528,003

 

$

10,371,215

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2005

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

$

56,537

 

$

34,602

 

$

4,651

 

$

6,170

 

$

101,960

 

Provision for Credit Losses

 

2,946

 

10,564

 

 

(10,510

)

3,000

 

Net Interest Income After Provision for Credit Losses

 

53,591

 

24,038

 

4,651

 

16,680

 

98,960

 

Noninterest Income

 

24,136

 

12,329

 

16,611

 

2,440

 

55,516

 

Noninterest Expense

 

(43,068

)

(20,155

)

(19,002

)

(2,371

)

(84,596

)

Income Before Provision for Income Taxes

 

34,659

 

16,212

 

2,260

 

16,749

 

69,880

 

Provision for Income Taxes

 

(12,954

)

(5,974

)

(836

)

(5,287

)

(25,051

)

Allocated Net Income

 

21,705

 

10,238

 

1,424

 

11,462

 

44,829

 

Total Assets at September 30, 2005

 

$

3,830,473

 

$

2,512,802

 

$

209,222

 

$

3,532,738

 

$

10,085,235

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2006

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

$

175,788

 

$

100,725

 

$

13,175

 

$

12,720

 

$

302,408

 

Provision for Credit Losses

 

6,965

 

1,218

 

999

 

(1,567

)

7,615

 

Net Interest Income After Provision for Credit Losses

 

168,823

 

99,507

 

12,176

 

14,287

 

294,793

 

Noninterest Income

 

74,149

 

28,242

 

52,651

 

7,618

 

162,660

 

Noninterest Expense

 

(126,851

)

(58,892

)

(48,886

)

(4,736

)

(239,365

)

Income Before Provision for Income Taxes

 

116,121

 

68,857

 

15,941

 

17,169

 

218,088

 

Provision for Income Taxes

 

(42,965

)

(34,263

)

(5,889

)

(5,525

)

(88,642

)

Allocated Net Income

 

73,156

 

34,594

 

10,052

 

11,644

 

129,446

 

Total Assets at September 30, 2006

 

$

3,931,334

 

$

2,692,163

 

$

219,715

 

$

3,528,003

 

$

10,371,215

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2005

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

$

163,084

 

$

102,305

 

$

13,161

 

$

25,107

 

$

303,657

 

Provision for Credit Losses

 

9,962

 

11,216

 

(1

)

(18,177

)

3,000

 

Net Interest Income After Provision for Credit Losses

 

153,122

 

91,089

 

13,162

 

43,284

 

300,657

 

Noninterest Income

 

70,742

 

29,285

 

51,493

 

6,985

 

158,505

 

Noninterest Expense

 

(126,816

)

(58,457

)

(53,059

)

(6,131

)

(244,463

)

Income Before Provision for Income Taxes

 

97,048

 

61,917

 

11,596

 

44,138

 

214,699

 

Provision for Income Taxes

 

(35,908

)

(22,949

)

(4,290

)

(14,772

)

(77,919

)

Allocated Net Income

 

61,140

 

38,968

 

7,306

 

29,366

 

136,780

 

Total Assets at September 30, 2005

 

$

3,830,473

 

$

2,512,802

 

$

209,222

 

$

3,532,738

 

$

10,085,235

 

 

14




Note 5.           Pension Plans and Postretirement Benefit Plan

The components of net periodic benefit cost for the aggregated pension plans and the postretirement benefit plan for the three and nine months ended September 30, 2006 and 2005 are presented in the following table:

 

 

Pension Benefits

 

Postretirement Benefits

 

(dollars in thousands)

(Unaudited)

 

2006

 

2005

 

2006

 

2005

 

Three Months Ended September 30,

 

 

 

 

 

 

 

 

 

Service Cost

 

$

 

$

 

$

290

 

$

270

 

Interest Cost

 

1,170

 

1,126

 

480

 

475

 

Expected Return on Plan Assets

 

(1,261

)

(1,183

)

 

 

Amortization of Unrecognized Net Transition Obligation

 

 

 

147

 

147

 

Recognized Net Actuarial Loss (Gain)

 

469

 

427

 

(36

)

(42

)

Total Net Periodic Cost

 

$

378

 

$

370

 

$

881

 

$

850

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30,

 

 

 

 

 

 

 

 

 

Service Cost

 

$

 

$

 

$

870

 

$

810

 

Interest Cost