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 March 31, 2007

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)

 

 

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.

As of April 27, 2007, there were 49,563,042 shares of common stock outstanding.

Bank of Hawaii Corporation

Form 10-Q

Index

Part I - Financial Information			Page
Item 1.	Financial Statements (Unaudited)
	Consolidated Statements of Income — Three months ended
	March 31, 2007 and 2006		3
	Consolidated Statements of Condition — March 31, 2007
	December 31, 2006, and March 31, 2006		4
	Consolidated Statements of Shareholders’ Equity — Three months ended
	March 31, 2007 and 2006		5
	Consolidated Statements of Cash Flows — Three months ended
	March 31, 2007 and 2006		6
	Notes to Consolidated Financial Statements (Unaudited)		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and
	Results of Operations		14
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		39
Item 6.	Exhibits		40
Signatures			41

 

Bank of Hawaii Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)

 

		Three Months Ended March 31,
(dollars in thousands, except per share amounts)		2007			2006
Interest Income
Interest and Fees on Loans and Leases		$	110,298		$	99,371
Income on Investment Securities
Trading		1,618			-
Available-for-Sale		30,961			30,835
Held-to-Maturity		4,052			4,757
Deposits		58			43
Funds Sold		1,058			125
Other		333			272
Total Interest Income		148,378			135,403
Interest Expense
Deposits		33,375			19,633
Securities Sold Under Agreements to Repurchase		11,886			7,890
Funds Purchased		923			1,893
Short-Term Borrowings		87			57
Long-Term Debt		3,970			3,728
Total Interest Expense		50,241			33,201
Net Interest Income		98,137			102,202
Provision for Credit Losses		2,631			2,761
Net Interest Income After Provision for Credit Losses		95,506			99,441
Noninterest Income
Trust and Asset Management		15,833			14,848
Mortgage Banking		3,371			2,987
Service Charges on Deposit Accounts		10,967			10,132
Fees, Exchange, and Other Service Charges		16,061			14,767
Investment Securities Gains, Net		16			-
Insurance		6,215			5,019
Other		8,497			4,819
Total Noninterest Income		60,960			52,572
Noninterest Expense
Salaries and Benefits		45,406			45,786
Net Occupancy		9,811			9,643
Net Equipment		4,787			5,028
Professional Fees		2,543			438
Other		19,576			19,923
Total Noninterest Expense		82,123			80,818
Income Before Provision for Income Taxes		74,343			71,195
Provision for Income Taxes		27,008			25,845
Net Income		$	47,335		$	45,350
Basic Earnings Per Share		$	0.96		$	0.89
Diluted Earnings Per Share		$	0.94		$	0.87
Dividends Declared Per Share		$	0.41		$	0.37
Basic Weighted Average Shares		49,427,810			50,813,676
Diluted Weighted Average Shares		50,263,296			52,135,386

 

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

3

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Bank of Hawaii Corporation and Subsidiaries

Consolidated Statements of Condition (Unaudited)

 

		March 31,			December 31,			March 31,
(dollars in thousands)		2007			2006			2006
Assets
Interest-Bearing Deposits		$	5,594		$	4,990		$	5,171
Funds Sold		97,000			50,000			328,000
Investment Securities
Trading		158,469			-			-
Available-for-Sale
Held in Portfolio		1,672,893			1,846,742			2,268,644
Pledged as Collateral		765,639			751,135			280,560
Held-to-Maturity (Fair Value of $340,636; $360,719; and $417,938)		349,663			371,344			433,021
Loans Held for Sale		19,238			11,942			22,754
Loans and Leases		6,507,152			6,623,167			6,246,125
Allowance for Loan and Lease Losses		(90,998		)	(90,998		)	(91,064		)
Net Loans and Leases		6,416,154			6,532,169			6,155,061
Total Earning Assets		9,484,650			9,568,322			9,493,211
Cash and Noninterest-Bearing Deposits		365,517			398,342			422,436
Premises and Equipment		123,309			125,925			143,392
Customers’ Acceptances		839			1,230			729
Accrued Interest Receivable		49,477			49,284			44,149
Foreclosed Real Estate		462			407			358
Mortgage Servicing Rights		27,005			19,437			18,468
Goodwill		34,959			34,959			34,959
Other Assets		405,739			373,909			370,347
Total Assets		$	10,491,957		$	10,571,815		$	10,528,049
Liabilities
Deposits
Noninterest-Bearing Demand		$	1,973,631		$	1,993,794		$	2,377,355
Interest-Bearing Demand		1,618,615			1,642,375			1,674,294
Savings		2,648,495			2,690,846			2,716,572
Time		1,712,196			1,696,379			1,378,880
Total Deposits		7,952,937			8,023,394			8,147,101
Funds Purchased		72,400			60,140			55,930
Short-Term Borrowings		3,462			11,058			2,025
Securities Sold Under Agreements to Repurchase		1,050,393			1,047,824			957,166
Long-Term Debt		260,308			260,288			242,730
Banker’s Acceptances		839			1,230			729
Retirement Benefits Payable		48,363			48,309			71,708
Accrued Interest Payable		17,893			22,718			11,882
Taxes Payable and Deferred Taxes		293,326			277,202			273,088
Other Liabilities		81,005			100,232			84,612
Total Liabilities		9,780,926			9,852,395			9,846,971
Shareholders’ Equity
Common Stock ($.01 par value; authorized 500,000,000 shares; issued / outstanding: March 2007 - 56,930,753 / 49,638,731; December 2006 - 56,848,609 / 49,777,654; and March 2006 - 56,858,558 / 50,970,829)		566			566			566
Capital Surplus		478,123			475,178			467,678
Accumulated Other Comprehensive Loss		(27,356		)	(39,084		)	(65,668		)
Retained Earnings		620,034			630,660			565,702
Treasury Stock, at Cost (Shares: March 2007 - 7,292,022; December 2006 - 7,070,955; and March 2006 - 5,887,729)		(360,336		)	(347,900		)	(287,200		)
Total Shareholders’ Equity		711,031			719,420			681,078
Total Liabilities and Shareholders’ Equity		$	10,491,957		$	10,571,815		$	10,528,049

 

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

4

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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 as of December 31, 2006		$	719,420		$	566		$	475,178		$	(39,084	)	$	630,660		$	-		$	(347,900	)
Cumulative-Effect Adjustment of a Change in Accounting Principle, Net of Tax:
SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140”		5,126			-			-			5,279			(153		)	-			-
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”		(27,106		)	-			-			-			(27,106		)	-			-
FIN 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109”		(7,247		)	-			-			-			(7,247		)	-			-
Comprehensive Income:
Net Income		47,335			-			-			-			47,335			-			-			$	47,335
Other Comprehensive Income, Net of Tax:
Change in Unrealized Gains and Losses on Investment Securities Available-for-Sale		6,241			-			-			6,241			-			-			-			6,241
Amortization of Prior Service Credit and Net Actuarial Loss		208			-			-			208			-			-			-			208
Total Comprehensive Income																							$	53,784
Common Stock Issued under Share-Based Compensation Plans and Related Tax Benefits (255,918 shares)		8,160			-			2,945			-			(3,044		)	-			8,259
Common Stock Repurchased (394,247 shares)		(20,695		)	-			-			-			-			-			(20,695		)
Cash Dividends Paid		(20,411		)	-			-			-			(20,411		)	-			-
Balance as of March 31, 2007		$	711,031		$	566		$	478,123		$	(27,356	)	$	620,034		$	-		$	(360,336	)
Balance as of December 31, 2005		$	693,352		$	565		$	473,338		$	(47,818	)	$	546,591		$	(11,080	)	$	(268,244	)
Comprehensive Income:
Net Income		45,350			-			-			-			45,350			-			-			$	45,350
Other Comprehensive Income, Net of Tax:
Change in Unrealized Gains and Losses on Investment Securities Available-for-Sale		(17,850		)	-			-			(17,850		)	-			-			-			(17,850		)
Total Comprehensive Income																							$	27,500
Common Stock Issued under Share-Based Compensation Plans and Related Tax Benefits (393,036 shares)		16,014			1			(5,660		)	-			(7,299		)	11,080			17,892
Common Stock Repurchased (697,974 shares)		(36,848		)	-			-			-			-			-			(36,848		)
Cash Dividends Paid		(18,940		)	-			-			-			(18,940		)	-			-
Balance as of March 31, 2006		$	681,078		$	566		$	467,678		$	(65,668	)	$	565,702		$	-		$	(287,200	)

 

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

5

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Bank of Hawaii Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

 

		Three Months Ended March 31,
(dollars in thousands)		2007				2006
Operating Activities
Net Income		$	47,335				$	45,350
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities:
Provision for Credit Losses		2,631					2,761
Depreciation and Amortization		3,695					4,317
Amortization of Deferred Loan and Lease Fees		(384			)		(952				)
Amortization and Accretion of Premiums/Discounts on Investment Securities, Net		806					1,060
Change in Fair Value of Mortgage Servicing Rights		1,367					-
Investment Trading Gains		(1,574			)		-
Share-Based Compensation		1,335					1,355
Deferred Income Taxes		(34,226			)		3,359
Net Gain on Investment Securities		(16			)		-
Proceeds from the Prepayment of Investment Securities Trading		7,285					-
Proceeds from Sales of Loans Held for Sale		72,793					80,948
Originations of Loans Held for Sale		(80,089			)		(85,787				)
Tax Benefits from Share-Based Compensation		(1,512			)		(3,932				)
Net Change in Other Assets and Liabilities		(11,244			)		(6,314				)
Net Cash Provided by Operating Activities		8,202					42,165
Investing Activities
Proceeds from the Prepayment and Maturity of Investment Securities Available-for-Sale		157,784					100,326
Purchases of Investment Securities Available-for-Sale		(145,196			)		(139,998				)
Proceeds from the Prepayment and Maturity of Investment Securities Held-to-Maturity		21,485					20,956
Net Decrease (Increase) in Loans and Leases		71,049					(79,450				)
Premises and Equipment, Net		(1,079			)		(13,796				)
Net Cash Provided by (Used In) Investing Activities		104,043					(111,962				)
Financing Activities
Net (Decrease) Increase in Deposits		(70,457			)		239,633
Net Increase in Short-Term Borrowings		7,233					128,184
Tax Benefits from Share-Based Compensation		1,512					3,932
Proceeds from Issuance of Common Stock		5,352					10,725
Repurchase of Common Stock		(20,695			)		(36,848				)
Cash Dividends Paid		(20,411			)		(18,940				)
Net Cash (Used In) Provided by Financing Activities		(97,466			)		326,686
Net Increase in Cash and Cash Equivalents		14,779					256,889
Cash and Cash Equivalents at Beginning of Period		453,332					498,718
Cash and Cash Equivalents at End of Period		$	468,111				$	755,607
Supplemental Information
Cash paid for:
Interest		$	55,066				$	32,229
Income taxes		3,489					4,364
Non-cash investing and financing activities:
Transfers from investment securities — available-for-sale to trading		164,180					-
Transfers from loans to foreclosed real estate		462					359

 

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 (the “Parent”) is a bank holding company headquartered in Honolulu, Hawaii.  Bank of Hawaii Corporation and its Subsidiaries (the “Company”) provide a broad range of financial products and services to customers in Hawaii and the Pacific Islands (Guam, nearby islands, and American Samoa).  The Parent’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, 2006.  Operating results for the three months ended March 31, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

Hybrid Financial Instruments

Effective January 1, 2007, the Company adopted the provisions of 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, “Accounting for Derivative Instruments and Hedging Activities.”  Concurrently, the Company adopted the provisions of SFAS No. 133, Implementation Issue No. B40, “Embedded Derivatives:  Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets.”  In Implementation Issue No. B40, the Financial Accounting Standards Board (the “FASB”) concluded that a securitized interest in prepayable financial assets would not be subject to the bifurcation requirements of SFAS No. 155, provided that the securitized interest met certain criteria.  The adoption of SFAS No. 155 and SFAS No. 133, Implementation Issue No. B40 did not have a material impact on the Company’s statements of income and condition.

7

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Mortgage Servicing Rights

Effective January 1, 2007, the Company adopted the provisions of 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.  In adopting the provisions of SFAS No. 156, the Company recorded an increase in the value of mortgage servicing rights of $8.0 million and a net of tax increase in retained earnings of $5.1 million.  Also, as permitted by SFAS No. 156, the Company reclassified investment securities with a carrying value of $164.2 million from the available-for-sale portfolio to the trading portfolio.  Concurrently, the Company reclassified unrealized losses of $5.3 million, net of tax, previously recorded as a component of accumulated other comprehensive loss, to retained earnings.  The net after-tax cumulative-effect adjustment to adopt the provisions of SFAS No. 156 was to reduce retained earnings by $0.2 million as of January 1, 2007.  The Company also adopted the fair value measurement provisions of SFAS No. 156 in subsequent re-measurements of the mortgage servicing rights.

For the three months ended March 31, 2007, the Company’s entire trading portfolio, comprised of mortgage-backed securities, was used to offset changes in the fair value of the mortgage servicing rights.  These trading securities are carried at fair value on the Company’s statement of condition, with realized and unrealized gains and losses recorded as a component of mortgage banking income in the statement of income.

Leveraged Leases

Effective January 1, 2007, the Company adopted the provisions of FASB 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, “Accounting for Leases.”  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.  During the years 1998 through 2002, the Company entered into one leveraged lease transaction known as a Lease In/Lease Out transaction and five Sale In/Lease Out transactions that are currently under various stages of review by the Internal Revenue Service (the “IRS”).  Management expects that the outcome of these reviews will change the expected timing of cash flows from these leases.  In adopting the provisions of FSP No. 13-2, the Company recorded an after-tax cumulative-effect adjustment to reduce retained earnings by $27.1 million.  This adjustment represents a $42.7 million reduction of the carrying value of lease financing balances and a reduction of deferred income taxes of $15.6 million.  Subsequent changes in the assumption of expected cash flows that results in a material change in the net investment of a leveraged lease will be recorded as a gain or loss in the period in which the assumption is changed.

Income Taxes

Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.”  FIN 48 establishes a recognition threshold and measurement for income tax positions recognized in the Company’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.”  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.  In adopting the provisions of FIN 48, the Company recorded an after-tax cumulative-effect adjustment to reduce retained earnings by $7.2 million.

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Future Application of Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which is effective for the Company on January 1, 2008.  SFAS No. 157 established a framework for measuring fair value, while expanding fair value measurement disclosures.  SFAS No. 157 established a fair value hierarchy that distinguishes between valuations obtained from sources independent of the Company and those from the Company’s own unobservable inputs that are not corroborated by observable market data.  SFAS No. 157 also expands disclosures about the use of fair value to measure assets and liabilities in interim and annual periods subsequent to initial recognition.  The disclosures focus on the inputs used to measure fair value and for recurring fair value measurements using significant unobservable inputs, and the effect of the measurements on earnings for the period.  Management is currently evaluating the effect that the provisions of SFAS No. 157 will have on the Company’s statements of income and condition.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115,” which is effective for the Company on January 1, 2008.  SFAS No. 159 provides entities with an option to report selected financial assets and financial liabilities at fair value, with the objective of reducing both the complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently.  Management is currently evaluating the effect that the provisions of SFAS No. 159 will have on the Company’s statements of income and condition.

Note 2.  Mortgage Banking

For the three months ended March 31, 2007 and 2006, the Company’s mortgage banking income was comprised of the following:

Mortgage Banking Income (Unaudited)

 

		Three Months Ended  March 31,
(dollars in thousands)		2007			2006
Servicing Income		$	1,570		$	1,586
Gains on the Sale of Residential Mortgage Loans		1,029			1,351
Change in Fair Value of Mortgage Servicing Rights		(1,367		)	-
Investment Trading Gains		1,574			-
Mortgage Loan Fees		548			535
Gains on Derivative Financial Instruments		22			110
Amortization of Mortgage Servicing Rights		-			(481		)
Other		(5		)	(114		)
Total Mortgage Banking Income		$	3,371		$	2,987

 

The Company’s portfolio of residential mortgage loans serviced for third parties was $2.5 billion as of March 31, 2007 and 2006.  The Company’s mortgage servicing activities includes collecting principal, interest, and escrow payments from borrowers; making tax and insurance payments on behalf of the borrowers; monitoring delinquencies and executing foreclosure proceedings; and accounting for and remitting principal and interest payments to investors.  The Company’s residential mortgage loan servicing portfolio is comprised primarily of fixed rate loans concentrated in Hawaii.

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Mortgage servicing rights are recognized as assets when mortgage loans are sold and the rights to service those loans are retained.  As of December 31, 2006, the Company recorded its mortgage servicing rights at their relative fair values on the date the loans were sold and were carried at the lower of the initial recorded value, adjusted for amortization, or fair value.  As of January 1, 2007, the Company adopted the provisions of SFAS No. 156 which requires all separately recognized servicing assets to be initially measured at fair value, if practicable.  As of January 1, 2007, the Company identified its entire balance in mortgage servicing rights as one class of servicing assets for this measurement.  The changes in the value of the Company’s mortgage servicing rights for the three months ended March 31, 2007 were as follows:

Mortgage Servicing Rights (Unaudited)

 

(dollars in thousands)		Three Months Ended March 31, 2007
Balance as of December 31, 2006		$	19,437
Cumulative-Effect of a Change in Accounting Principle		8,007
Balance as of January 1, 2007		$	27,444
Origination of Mortgage Servicing Rights		928
Changes in Fair Value:
Due to Change in Valuation Assumptions1		(574		)
Other Changes in Fair Value2		(793		)
Balance as of March 31, 2007		$	27,005

 

1  Principally reflects changes in discount rates and loan repayment rate assumptions, mostly as a result of changes in interest rates.

2 Represents changes due to the realization of expected cash flows over time.

The Company estimates the fair value of its mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income.  The model uses factors such as loan repayment rates, costs to service, ancillary income, impound account balances, and interest rate assumptions in its calculations.  Risks inherent in the valuation of mortgage servicing rights include changes in interest rates, higher than expected loan repayment rates, and the delayed receipt of cash flows, among other factors.  The key assumptions used in estimating the fair value of the Company’s mortgage servicing rights as of March 31, 2007 were as follows:

(Unaudited)		As of March 31, 2007
Weighted-Average Constant Prepayment Rate1		12.12	%
Weighted-Average Life (in years)		5.73
Weighted-Average Note Rate		5.81	%
Weighted-Average Discount Rate		8.57	%

 

1  Represents annualized loan repayment rate assumption.

The fair value of the Company’s mortgage servicing rights is sensitive to changes in interest rates and their effect on loan repayment rates.  In a declining interest rate environment, the fair value of mortgage servicing rights decreases while the fair value of the Company’s risk management instruments generally increases.  For the three months ended March 31, 2007, the Company used mortgage-backed securities in its trading portfolio to manage the change in fair value of the mortgage servicing rights.  Changes in the fair value of the mortgage servicing rights as well as changes in the fair value of the trading portfolio are recorded in mortgage banking income.  For the three months ended March 31, 2007, the Company recorded investment trading gains of $1.6 million from its risk management instruments to offset the $1.4 million decline in value of its mortgage servicing rights over this same period.  For the three months ended March 31, 2007, there were no realized investment trading gains or losses.

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A sensitivity analysis of the Company’s fair value of mortgage servicing rights to changes in the constant prepayment rate and the discount rate is presented in the following table.

Sensitivity Analysis (Unaudited)

 

		As of
(dollars in thousands)		March 31, 2007
Constant Prepayment Rate
Decrease in fair value from 25 basis points (“bps”) adverse change		$	(1,024	)
Decrease in fair value from 50 bps adverse change		(2,635		)
Discount Rate
Decrease in fair value from 25 bps adverse change		(244		)
Decrease in fair value from 50 bps adverse change		(495		)

 

This analysis generally cannot be extrapolated because the relationship of a change in one key assumption to the change in the fair value of the Company’s mortgage servicing rights may not be linear.  The calculation of the fair value of mortgage servicing rights is dynamic in nature, in that changes in one key assumption may result in changes in other assumptions, which may magnify or counteract the sensitivity analysis presented in the table above.

Note 3.  Pension Plans and Postretirement Benefit Plan

The components of net periodic benefit cost for the Company’s pension plans and the postretirement benefit plan for the three months ended March 31, 2007 and 2006 are presented in the following table:

Pension Plans and Postretirement Benefit Plan (Unaudited)

 

		Pension Benefits						Postretirement Benefits
		Three Months Ended March 31,
(dollars in thousands)		2007			2006			2007			2006
Service Cost		$	-		$	-		$	155		$	290
Interest Cost		1,223			1,170			395			480
Expected Return on Plan Assets		(1,373		)	(1,261		)	-			-
Amortization of Unrecognized Net Transition Obligation		-			-			-			147
Prior Service Credit		-			-			(50		)	-
Recognized Net Actuarial Loss (Gain)		450			469			(75		)	(36		)
Total Net Periodic Benefit Cost		$	300		$	378		$	425		$	881

 

The net periodic benefit cost for the Company’s pension plans and postretirement benefit plan are recorded as a component of salaries and benefits in the statements of income.  There were no significant changes from the previously reported $7.7 million that the Company expects to contribute to the pension plans and the $1.3 million that it expects to contribute to the postretirement benefit plan for the year ending December 31, 2007.  For the three months ended March 31, 2007, the Company has contributed $129,000 to its pension plans and $217,000 to its postretirement benefit plan.

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Note 4.  Income Taxes

The following is a reconciliation of the Federal statutory income tax rate to the Company’s effective tax rate for the three months ended March 31, 2007 and 2006.

		Three Months Ended
		March 31,
(Unaudited)		2007		2006
Statutory Federal Income Tax Rate		35.00	%	35.00	%
Increase (Decrease) in Tax Rate Resulting From:
State Taxes, Net of Federal Income Tax		3.83		1.86
Foreign Tax Credits		(1.43	)	-
Low Income Housing Investments		(0.17	)	(0.19	)
Bank-Owned Life Insurance		(0.85	)	(0.71	)
Leveraged Leases		0.14		0.50
Other		(0.19	)	(0.16	)
Effective Tax Rate		36.33	%	36.30	%

 

Income earned by the Company is subject to U.S. Federal taxation and to state and territorial taxation in Hawaii and Guam.  Small amounts of income are subject to taxation by other states and territories as well as some foreign countries.  With immaterial exceptions, the Company has resolved the issues raised during the income tax examinations by taxing authorities for years prior to 1998.  The Company is currently appealing two issues raised by the IRS in the examination of tax returns filed for 1998 through 2002.  The Company’s appeals are related to one leveraged lease transaction known as a Lease In/Lease Out transaction and five Sale In/Lease Out transactions.  The IRS is currently in the process of examining tax returns filed for 2003 and 2004.  The State of Hawaii is currently in the process of examining the years 2002 through 2004.

On January 1, 2007, the Company adopted FIN 48 to clarify accounting for uncertainty in recognizing income tax.  FIN 48 requires the Company to record a liability, referred to as an unrecognized tax benefit (“UTB”), for the entire benefit when it believes a position taken in a past or future tax return has a less than 50% chance of being accepted by the taxing or adjudicating authority.  If the Company determines the likelihood of a position being accepted is greater than 50%, but less than 100%, the Company records a UTB for the amount it believes will not be accepted by the taxing authority.  Prior to adopting FIN 48, the Company had effectively recorded, in various other accounts, the equivalent of UTBs of $116.4 million.  The adoption of FIN 48 resulted in an increase in the UTB to $130.6 million, of which $7.2 million was recorded as an adjustment of retained earnings, largely due to interest that could be payable.  Of the $130.6 million UTB, $29.3 million, if reversed, would have an impact on the Company’s effective tax rate.  As of March 31, 2007, there were no material changes in the Company’s liability for UTBs.  With respect to the Company’s appeals of its leveraged lease transactions, it is reasonably possible that the amount of the liability for UTBs may decrease if facts and circumstances related to the appeals change within the next twelve months.  However, management is currently not able to estimate a range of possible change in the amount of the liability for UTBs recorded as of March 31, 2007. 

The Company recognizes interest and penalties, if any, accrued related to the liability for UTBs in the provision for income taxes.  To the extent interest and penalties are ultimately not assessed, amounts accrued as part of the liability for UTBs would be adjusted in the Company’s provision for income taxes.  As of January 1, 2007, after recording the cumulative-effect adjustment, the Company had accrued $21.7 million for the payment of possible interest and penalties.  For the three months ended March 31, 2007, the Company recorded $0.6 million in interest in the Company’s provision for income taxes.  As of March 31, 2007, the Company had a liability for UTBs of $22.3 million primarily related to the payment of interest and to a significantly lesser extent penalties.

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Note 5.  Business Segments

The Company’s business segments are defined as Retail Banking, Commercial Banking, Investment Services, and Treasury.  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 income, expense, the provision for credit losses, and capital.  This process is dynamic in nature 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.

Selected financial information for each segment is presented below as of and for the three months ended March 31, 2007 and 2006.

Business Segment Selected Financial Information (Unaudited)

 

		Retail			Commercial			Investment						Consolidated
(dollars in thousands)		Banking			Banking			Services			Treasury			Total
Three Months Ended March 31, 2007
Net Interest Income		$	58,870		$	33,787		$	4,440		$	1,040		$	98,137
Provision for Credit Losses		3,332			(689		)	-			(12		)	2,631
Net Interest Income After Provision for Credit Losses		55,538			34,476			4,440			1,052			95,506
Noninterest Income		26,690			11,640			19,402			3,228			60,960
Noninterest Expense		(42,958		)	(20,545		)	(16,434		)	(2,186		)	(82,123		)
Income Before Provision for Income Taxes		39,270			25,571			7,408			2,094			74,343
Provision for Income Taxes		(14,530		)	(9,209		)	(2,741		)	(528		)	(27,008		)
Allocated Net Income		$	24,740		$	16,362		$	4,667		$	1,566		$	47,335
Total Assets as of March 31, 2007		$	3,947,884		$	2,676,379		$	224,734		$	3,642,960		$	10,491,957
Three Months Ended March 31, 2006
Net Interest Income		$	57,690		$	33,742		$	4,405		$	6,365		$	102,202
Provision for Credit Losses		2,494			421			-			(154		)	2,761
Net Interest Income After Provision for Credit Losses		55,196			33,321			4,405			6,519			99,441
Noninterest Income		24,115			8,408			17,746			2,303			52,572
Noninterest Expense		(41,960		)	(20,104		)	(16,942		)	(1,812		)	(80,818		)
Income Before Provision for Income Taxes		37,351			21,625			5,209			7,010			71,195
Provision for Income Taxes		(13,819		)	(7,948		)	(1,927		)	(2,151		)	(25,845		)
Allocated Net Income		$	23,532		$	13,677		$	3,282		$	4,859		$	45,350
Total Assets as of March 31, 2006		$	3,879,333		$	2,527,387		$	200,199		$	3,921,130		$	10,528,049

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This report may contain, and other statements made by the Company in connection with this report may contain, forward-looking statements concerning, among other things, the Company’s business outlook, the economic and business environment in the Company’s service areas and elsewhere, credit quality 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) general economic conditions are less favorable than expected; 2) competitive pressure among financial services and products; 3) the impact of legislation and the regulatory environment; 4) fiscal and monetary policies of the markets in which the Company serves; 5) changes in accounting standards; 6) changes in tax laws or regulations or the interpretation of such laws and regulations; 7) changes in the Company’s credit quality or risk profile that may increase or decrease the required level of reserve for credit losses; 8) changes in market interest rates that may affect the Company’s credit markets and ability to maintain its net interest margin; 9) unpredictable costs and other consequences of legal, tax, or regulatory matters; 10) changes to the amount and timing of proposed common stock repurchases; and 11) geopolitical risk, military or terrorist activity, natural disaster, adverse weather, public health and other conditions impacting the Company and its customers’ operations.  For a detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements, refer to the section entitled “Risk Factors” in Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, and subsequent periodic and current reports, filed with the U.S. Securities and Exchange Commission.  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 an obligation to update forward-looking statements to reflect later events or circumstances.

Overview

2007+ Plan

In January 2007, the Company introduced its 2007+ Plan to its shareholders, customers, and employees.  The 2007+ Plan emphasizes growth in revenues, integration of service delivery and business units, development of people, enhancement of the Bank of Hawaii brand, and discipline in managing risk and financial performance.  The 2007+ Plan does not contemplate near-term expansion beyond the Company’s current footprint.

The Company’s 2007+ Plan is based on moderate growth in revenues and consistent positive operating leverage.  Performance objectives include an annual return on assets above 1.7%, return on equity above 25%, and an efficiency ratio approaching 50%, and is based on a stable economy and a return to a more traditional interest rate environment.  The Company’s 2007+ Plan will be reevaluated periodically and updated as market events dictate.

Earnings Summary

The Company began 2007 with strong financial performance for the three months ended March 31, 2007.  The Company had strong growth in noninterest income while maintaining discipline in increases to noninterest expense.  These positive factors offset the continued compression on net interest margin the Company has experienced as a result of the inverted to flat yield curve during 2006 and into the first quarter of 2007.  Overall credit quality of the Company remains stable and the Hawaii economy remains strong.

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The Company’s net income for the three months ended March 31, 2007 was $47.3 million or $0.94 per diluted share compared to net income for the three months ended March 31, 2006 of $45.4 million or $0.87 per diluted share.

The Company’s return on average assets was 1.83% and 1.82% for the three months ended March 31, 2007 and 2006, respectively.  The Company’s return on average shareholders’ equity was 27.00% and 26.13% for the three months ended March 31, 2007 and 2006, respectively.

The Company’s efficiency ratio was 51.62% and 52.22% for the three months ended March 31, 2007 and 2006, respectively.   The Company maintained positive operating leverage for the three months ended March 31, 2007.  Operating leverage, which is defined as the change in income before the provision for credit losses and the provision for income taxes, for the three months ended March 31, 2007 compared to the three months ended March 31, 2006 was 4.08%.

The improvement in the Company’s performance ratios was due to growth in total revenues, consisting of net interest income and noninterest income, despite a challenging interest rate environment.  Total revenues were $159.1 million and $154.8 million for the three months ended March 31, 2007 and 2006, respectively.

As of March 31, 2007 and 2006, the ratio of the allowance for loan and lease losses to loans and leases outstanding was 1.40% and 1.46%, respectively.  The Company’s non-performing assets decreased slightly from $5.9 million as of March 31, 2006 to $5.8 million as of March 31, 2007.

As of March 31, 2007 and 2006, the Company’s leverage ratio was 6.80% and 7.19%, respectively.  The lower leverage ratio as of March 31, 2007 was primarily due to the adoption of three new accounting pronouncements on January 1, 2007.

Recent Accounting Changes

The Company adopted the following accounting pronouncements on January 1, 2007:

·                  The provisions of SFAS No. 156, “Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140,” were adopted by the Company on January 1, 2007.  The adoption of SFAS No. 156 had the effect of increasing mortgage servicing rights and retained earnings by $8.0 million and $5.1 million, respectively, as of January 1, 2007.  Also, as permitted by SFAS No. 156, the Company reclassified investment securities with a carrying value of $164.2 million from the available-for-sale portfolio to the trading portfolio.  Concurrently, the Company reclassified unrealized losses of $5.3 million, net of tax, previously recorded as a component of accumulated other comprehensive loss, to retained earnings.  The net after-tax cumulative-effect adjustment to adopt the provisions of SFAS No. 156 was to reduce retained earnings by $0.2 million as of January 1, 2007.

·                  The provisions of FASB 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,” were adopted by the Company on January 1, 2007.  The adoption of FSP No. 13-2 had the effect of reducing lease financing balances and retained earnings by $42.7 million and $27.1 million, respectively, as of January 1, 2007.

·                  The provisions of FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,” were adopted by the Company on January 1, 2007.  The adoption of FIN 48 had the effect of increasing deferred tax liabilities and reducing retained earnings by $7.2 million as of January 1, 2007.

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