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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[_] 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
PACIFIC CENTURY FINANCIAL 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 (Zip Code)
offices)
(808) 643-3888
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- ---------------------
Common Stock, $.01 Par New York Stock Exchange
Value
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 X No
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.[_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the closing price of said stock on the New York Stock
Exchange on December 31, 1998 ($24.38 per share): $1,958,347,831
As of February 23, 1999, 80,530,016 shares of Common Stock, $.01 par value,
of the registrant were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement relating to the Annual Meeting of
Shareholders to be held April 23, 1999, are incorporated by reference into
Part III of this Report.
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Part I
Item 1. Business
Pacific Century Financial Corporation (Pacific Century) was organized on
August 12, 1971, as the first bank holding company in the State of Hawaii.
Originally organized as Hawaii Bancorporation, Inc., its name was changed in
1979 to Bancorp Hawaii, Inc. and in 1997 changed to Pacific Century Financial
Corporation. The latter change in name was made to provide a more distinctive
and descriptive identity that reflects the Company's strategic goals to expand
its activities beyond Hawaii to Asia, the West and South Pacific, and the U.S.
Mainland.
Pacific Century provides a broad range of financial products and services to
customers in four market regions. These regions are Hawaii, the South and West
Pacific, Asia, and the U.S. Mainland. Pacific Century is the largest bank
holding company headquartered in the State of Hawaii. The principal
subsidiaries of Pacific Century are Bank of Hawaii and Pacific Century Bank,
N.A. (PCB).
In 1998, Pacific Century announced a new strategy called the "New Era." The
project's first steps were to rationalize Pacific Century's corporate
structure in an effort to reduce regulatory burden and streamline operations.
During the year, several subsidiaries were merged, closed or transferred.
. Pacific Century's two subsidiary banks on the U.S. Mainland, California
United Bank with operations in California and Pacific Century Bank, N.A.
with operations in Arizona, were merged during the third quarter of 1998.
Pacific Century Bank, N.A., the surviving entity, is headquartered in
Encino, California and targets small and middle-market commercial
businesses and retail customers through branch offices in both states.
. Bancorp Pacific, Inc. was merged into Bank of Hawaii during the third
quarter of 1998. The merger left First Savings and Loan Association of
America, F.S.B. (First Savings), with operations in Guam, as a subsidiary
of Pacific Century, merged Hawaii-based First Federal Savings and Loan
Association of America (First Federal) into Bank of Hawaii, and
eliminated Bancorp Pacific, Inc. The merger of First Federal consolidates
the Pacific Century depository institutions in the Hawaii market under
Bank of Hawaii. Following the merger, 19 branch locations of First
Federal in Hawaii were closed. In addition, First Savings acquired by
merger the operations of its wholly-owned subsidiary, Pacific Century
Capital Corporation, formerly Bancorp Finance of Hawaii--(Guam), Inc.
First Savings also converted from a Guam charter to a federal savings
bank charter.
. Pacific Century closed Realty and Mortgage Investors of the Pacific, Ltd.
in September 1998. With its activity focused on commercial real estate
lending in Hawaii, activity had been limited and its continuation not
practical.
. Finally, in the fourth quarter of 1998, Pacific Century Life Insurance
Corporation (PCLIC) and Pacific Century Agency, Inc. were contributed to
Bank of Hawaii where they remain as wholly-owned subsidiaries.
In December 1997, Bank of Hawaii International, Inc. (BOHI) announced the
signing of a definitive agreement to acquire Banque Paribas Pacifique in New
Caledonia and Banque Paribas Polynesie in French Polynesia. The acquisitions
were completed in the second quarter of 1998. The acquired banks were merged
into two of BOHI's existing subsidiaries, Bank of Hawaii-Nouvelle Caledonie
and Banque de Tahiti. Banque Paribas Pacifique reported assets of $238 million
and Banque Paribas Polynesie reported assets of $83 million as of May 31,
1998, the merger date.
In April 1998 Pacific Century changed its state of incorporation from Hawaii
to Delaware, by merging into a new wholly-owned subsidiary formed for that
purpose. This change was made to enable Pacific Century to take advantage of
the flexibility and other benefits of the Delaware corporate law.
Pacific Century's organization structure as of December 31, 1998 is included
in Exhibit 21.1. The percentages indicate the proportion of total assets that
each group of entities contributed to Pacific Century's
2
consolidated financial position at December 31, 1998. All subsidiaries are
wholly-owned except as otherwise noted for certain banks in the South Pacific
and for those entities whose directors own qualifying shares. Each entity is
consolidated with its immediate parent company except for three of the
affiliate banks in the South Pacific--Bank of Tonga, National Bank of Solomon
Islands and Pacific Commercial Bank, Ltd.--the investments in which are
accounted for under the equity method.
At December 31, 1998, Pacific Century and its subsidiaries employed 5,134
persons on a full-time or part-time basis.
The following is a brief description of each of Pacific Century's
subsidiaries.
Bank of Hawaii was organized under the laws of Hawaii on December 17, 1897,
and has been continuously in business since. Its headquarters are in Honolulu,
Hawaii, and its deposits are insured by the Federal Deposit Insurance
Corporation (FDIC). Bank of Hawaii is the largest full-service financial
institution in Hawaii with a statewide network of 59 regular branches and 13
supermarket branches. It is not a member of the Federal Reserve System.
Pacific Century and 14 directors of Bank of Hawaii (each of whom holds 125
qualifying shares each) own 100% of the outstanding shares. There are five
directors of Bank of Hawaii who do not hold qualifying shares. The legal
requirement for directors of Hawaii banks to hold qualifying shares was
eliminated in 1993.
Bank of Hawaii provides customary commercial banking services through branch
offices in the State of Hawaii and branches or representative offices in
Bahamas (Nassau), Republic of Fiji (Suva, Nadi, and Lautoka), Hong Kong, Japan
(Tokyo), South Korea (Seoul), Philippines (Manila, Cebu, and Davao),
Singapore, Taiwan (Taipei), American Samoa, Commonwealth of the Northern
Mariana Islands (Saipan), Federated States of Micronesia (Pohnpei, Kosrae, and
Yap), Guam, Republic of the Marshall Islands (Majuro), and Republic of Palau
(Koror). Bank of Hawaii also has subsidiary and affiliate banks in New
Caledonia, Papua New Guinea, French Polynesia, Tonga, Vanuatu, Solomon
Islands, and Samoa. Pacific Century Trust, a division of Bank of Hawaii,
operates offices in California, Arizona and Guam as well as Hawaii. Trust
assets under administration at year-end 1998 were $13.1 billion.
Bank of Hawaii owns all of the outstanding stock of Pacific Century Leasing,
Inc.; BOHI; Bank of Hawaii International Corp., New York; Pacific Century
Investment Services, Inc.; Bankoh Corporation; Pacific Century Advisory
Services, Inc.; Pacific Century Insurance Agency, Inc.; PCLIC; and Pacific
Century Agency, Inc. A brief discussion of these Bank subsidiaries follows:
Pacific Century Leasing, Inc. (PCL), formerly Bancorp Leasing of Hawaii,
Inc., formed in 1973, provides leasing and leasing services, mainly to the
commercial sector in Hawaii. PCL has several subsidiaries that are "specific
purpose leasing vehicles." These subsidiaries include S.I.L., Inc.; Arbella
Leasing Corp.; Pacific Century Leasing International, Inc.; and BNE Airfleets
Corporation. On a consolidated basis, PCL's assets represented 1.7% of Pacific
Century's total assets at year-end 1998.
BOHI was formed in 1968. BOHI holds equity interests in the following
foreign financial institutions (in the percentages indicated): Bank of
Hawaii--Nouvelle Caledonie-91%; Bank of Hawaii (PNG) Ltd.-100%; Banque de
Tahiti-92%; Bank of Tonga-30%; Banque d'Hawaii (Vanuatu), Ltd.-100%; National
Bank of Solomon Islands-51%; and Pacific Commercial Bank, Ltd.-43%, in Samoa.
BOHI's total assets represented 8.9% of Pacific Century's total assets at
year-end 1998.
Bank of Hawaii International Corp., New York (BOHICNY) was organized in 1982
as an Edge Act corporation. BOHICNY provides payment, clearing, and settlement
services with the New York Clearing House and Clearing House Interbank Payment
Service for both affiliated and unaffiliated banks. BOHICNY had total assets
representing 1.7% of Pacific Century's total assets at year-end 1998.
3
Pacific Century Investment Services, Inc. (PCIS), formerly Bancorp
Investment Group, Ltd., was formed in 1991 to provide full service brokerage
and other investment services originally as a subsidiary of Pacific Century
and, since 1994, as a wholly-owned subsidiary of Bank of Hawaii.
Bankoh Corporation was originally incorporated in 1984 as Hawaiian Hong Kong
Holdings, Ltd. and remained inactive until 1994. In 1994, the name was changed
to Bankoh Corporation, with minimal activity since its name change.
Pacific Century Advisory Services, Inc., formerly Bankoh Investment Advisory
Services Ltd., was reactivated in 1991 to provide advisory services for
businesses seeking to operate in Hawaii. The activity of this company remained
limited during 1998.
Pacific Century Insurance Agency, Inc., formerly Pan-Ocean Insurance Agency,
Inc., engages in general insurance agency, insurance sub agency and general
insurance brokerage business to the extent permitted under applicable federal
and state laws. Business activity began in late 1995 with limited activity in
1998.
Pacific Century Life Insurance Corporation, formerly Bancorp Life Insurance
Company of Hawaii, Inc., was incorporated in 1981 in the State of Arizona to
underwrite, as a reinsurer, the credit life and credit accident and health
insurance sold in conjunction with Bank of Hawaii's short-term consumer
lending activities. PCLIC became a wholly-owned subsidiary of Bank of Hawaii
in 1998.
Pacific Century Agency, Inc., formerly Bancorp Insurance Agency of Hawaii,
Inc., was formed in 1982 to act as an agent for the sale of all credit life
and credit accident and health insurance that is reinsured with PCLIC. Pacific
Century Agency, Inc. became a wholly-owned subsidiary of Bank of Hawaii in
1998.
Pacific Century also holds all of the outstanding stock, except as noted, of
the corporations listed below:
First Savings, a wholly-owned subsidiary of Pacific Century, operates in a
market area that includes the entire territory of Guam. First Savings operates
three full-service branches and three in-store branches in Guam. The FDIC
insures its deposits. First Savings' assets represented 1.2% of Pacific
Century's total assets at year-end 1998.
As mentioned earlier, Pacific Century Bank, N.A. (PCB) was merged with
California United Bank. In the merger, PCB's headquarters was designated as
Encino, California. Pacific Century and three of the directors of PCB (each of
whom holds 1,000 qualifying shares) own 100% of the outstanding shares of PCB.
PCB is organized under the laws of the United States. The FDIC insures its
deposits, and it is a member of the Federal Reserve System. PCB provides
customary commercial banking services through 20 branch offices in the State
of California and 9 branch offices in the State of Arizona. PCB had total
assets representing 7.6% of Pacific Century's total assets at year-end 1998.
In 1989, Pacific Century established a wholly-owned captive insurance
company, Pacific Century Insurance Services, Inc. (Pacific Century Insurance),
formerly Bancorp Hawaii Insurance Services, Ltd. With Pacific Century
Insurance's formation, Pacific Century became the first Hawaii corporation to
establish a Hawaii captive insurance company for its self-insurance needs.
Pacific Century Insurance provides bankers professional liability insurance
and workers compensation insurance exclusively to Pacific Century and its
subsidiaries and affiliates. Pacific Century Insurance's formation provides
Pacific Century with greater flexibility and stability in managing insurance
coverages and premium costs. Pacific Century Insurance also provides Pacific
Century with the opportunity to design self-insurance programs not otherwise
available in the conventional insurance market.
Pacific Century Small Business Investment Company, Inc. (PCSBIC), formerly
Bancorp Hawaii Small Business Investment Company, Inc., was formed in
September 1983 in the State of Hawaii as a small business investment company.
In 1998, activity in PCSBIC remained limited with new investments totaling
$0.3 million. Total assets of PCSBIC were $2.1 million at year-end 1998.
4
PCFC Hawaii, Corporation was formed in 1998 for the single purpose of
holding a real estate investment. The investment was sold in late 1998 and the
company will be dissolved in 1999.
Regulation and Competition
Effect of Governmental Policies
The earnings of Pacific Century and its principal subsidiaries are affected
not only by general economic conditions, both domestically and
internationally, but also by the monetary and fiscal policies of the United
States and its agencies, particularly the Federal Reserve System, and foreign
governments and their agencies. The monetary policies of the Federal Reserve
System influence to a significant extent the overall growth of loans,
investments, deposits, interest rates charged on loans, and interest rates
paid on deposits. The nature and impact of future changes in monetary policies
are often not predictable. Flexibility is a key attribute in successfully
responding to these varied forces.
Competition
The financial services industry has become highly competitive. Pacific
Century and Bank of Hawaii compete with local Hawaii financial institutions,
and PCB competes with local financial institutions in Southern California and
Arizona. In addition, each of them competes with institutions located in the
major financial centers of the world. These financial institutions include not
only banks and savings associations, but also insurance companies, brokerage
houses, mortgage companies, consumer finance companies, credit unions, and
diversified financial services companies that provide many or all of the
services offered by commercial banks and savings institutions but operate
without a banking charter and thus free of most of the associated regulatory
requirements.
Seven commercial banks, three savings associations, approximately seven
deposit-taking financial services loan companies, approximately 114 credit
unions, and scores of mortgage companies and other financial services firms
serve the State of Hawaii. The State is also served by a large number of out-
of-state institutions and foreign banks. Bank of Hawaii is the largest Hawaii
based financial services firm operating in the market. Outside of Hawaii, Bank
of Hawaii's primary competition in the Pacific Basin comes from several major
U.S. Mainland and foreign banks that operate in those areas.
PCB competes in two distinct markets, Southern California and Arizona.
Southern California is served by at least 223 local commercial banks, at least
48 savings associations, and approximately 443 credit unions as well as
numerous other financial services firms of a wide variety of types, including
foreign banks and other foreign financial entities. Likewise, in the state of
Arizona, approximately 41 commercial banks, 7 savings associations, 71 credit
unions, and numerous other financial services firms conduct full-service
operations. PCB is approximately the 46th largest insured depository
institution and the twelfth largest insured depository institution in Southern
California and Arizona, respectively, as measured by deposits placed in
offices there.
Additional financial institution holding companies or their subsidiaries may
enter markets served by Pacific Century and thereby provide additional
competition. Likewise, if Pacific Century, Bank of Hawaii, PCB and their
respective subsidiaries pursue additional business opportunities, they will
encounter significant competition from other businesses, including ones not
associated with banks or financial institution holding companies.
Supervision and Regulation
Pacific Century is registered as a bank holding company under the Bank
Holding Company Act of 1956, as amended (the BHC Act) and, as such, is subject
to the Act and regulations issued thereunder by the Board of Governors of the
Federal Reserve System (the Board of Governors). Pacific Century is also
registered as a bank holding company under the Hawaii Code of Financial
Institutions (the Code) and, as such, is subject to the registration,
reporting, and examination requirements of the Code.
5
The BHC Act requires prior approval of the Board of Governors of the
acquisition by Pacific Century of more than 5% of the voting shares of any
bank or any other bank holding company. The statute has been eliminated,
effective September 29, 1995, which had prohibited the acquisition of more
than 5% of the stock of Pacific Century by a bank holding company whose
operations are principally conducted in a state other than Hawaii, and the
acquisition by Pacific Century of more than 5% of the stock of any bank
located in a state other than Hawaii unless the statutory law of the state in
which such bank is located specifically authorized such acquisition.
Accordingly, at the present time and subject to certain limits, the BHC Act
allows adequately capitalized and adequately managed bank holding companies to
acquire control of banks in any state. Thus, assuming it is judged to be
adequately capitalized and adequately managed, Pacific Century is no longer
disabled by the BHC Act from acquiring control of banks in any state, and bank
holding companies whose operations are principally conducted in states other
than Hawaii are no longer disabled by the BHC Act from acquiring control of
Pacific Century. An interstate acquisition may not be approved, however, if
immediately before the acquisition the acquirer controls an FDIC-insured
institution or branch in the state of the institution to be acquired, and if
immediately following the acquisition the acquirer would control 30 percent or
more of the total FDIC-insured deposits in that state; but a state may waive
the 30 percent limitation by statute, regulation, or order, or by certain
nondiscriminatory administrative approvals.
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. States retain the authority to
prohibit such mergers if between September 29, 1994 and June 1, 1997 they
enacted a statute expressly prohibiting them and that statute applies equally
to all out-of-state banks. An interstate merger may not be approved, however,
if immediately before the acquisition the acquirer controls an FDIC-insured
institution or branch in the state of the institution to be acquired, and if
immediately following the acquisition the acquirer would control 30 percent or
more of the total FDIC-insured deposits in that state; but a state may waive
the 30 percent limitation by statute, regulation, or order, or by certain
nondiscriminatory administrative approvals. Banks are also permitted to open
newly established branches in any state that expressly permits all out-of-
state banks to open newly established branches, if the law applies equally to
all banks.
Hawaii has enacted a statute which authorizes out-of-state banks to engage
in "interstate merger transactions" with (mergers and consolidations with and
purchases of all or substantially all of the assets and branches of) Hawaii
banks, 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 prior to such an acquisition, 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 banks to acquire branches of
Hawaii banks other than through an "interstate merger transaction" (except in
the case of a bank that is subject to or in danger of becoming subject to
certain types of supervisory action) nor to open branches in Hawaii on a de
novo basis.
The BHC Act prohibits, with certain exceptions, Pacific Century from
acquiring direct or indirect control of more than 5% of the voting shares of
any company that is not a bank or bank holding company and from engaging
directly or indirectly 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 Board of Governors determines to be so closely related to banking
or managing or controlling banks as to be a proper incident thereto. In making
this determination, the Board of Governors is required to weigh the expected
benefits to the public, such as greater convenience, increased competition, or
gains in efficiency, against the risks of possible adverse effects, such as
undue concentration of resources, decreased or unfair competition, conflicts
of interest, or unsound banking practices. The Board of Governors has adopted
regulations that specify various activities as being so closely related to
banking or managing or controlling banks as to be a proper incident thereto.
The exact nature and scope of such activities have been the subject of intense
national debate, and thus, they may change and become broader as they evolve
over time.
Under the policies of the Board of Governors, Pacific Century is expected to
act as a source of financial strength to its subsidiary banks and to commit
resources to support its subsidiary banks in circumstances where
6
it might not do so absent such a policy. It is the policy of the Board of
Governors that in serving as a source of strength to its subsidiary banks, a
bank holding company should stand ready to use available resources to provide
adequate capital funds to its subsidiary banks during periods of financial
adversity and should maintain the financial flexibility and capital-raising
capacity to obtain additional resources for assisting its subsidiary banks.
In 1989 Congress expanded the authority of bank holding companies to acquire
savings associations, subject to approval by the Board of Governors. Bank
holding companies may acquire healthy as well as failed or failing savings
associations in any state. Congress in 1989 restructured the regulation of the
savings and loan industry and its deposit insurance and provided a new
regulatory structure for the resolution of troubled and insolvent savings
associations. Congress in 1989 also permitted the FDIC to impose cross-
guarantee liability on insured institutions for any cost or loss incurred by
the FDIC in connection with the default by, or assistance to, a commonly
controlled institution.
By virtue of Section 23A of the Federal Reserve Act and Section 18(j) of the
Federal Deposit Insurance Act, Pacific Century and its subsidiaries are
"affiliates" of Bank of Hawaii and PCB and are subject to the provisions of
Section 23A, which limit the amount of and require substantial security for
loans and extensions of credit by Bank of Hawaii or PCB to, and investments
in, Pacific Century or certain of its subsidiaries and the amount of advances
to third parties collateralized by the securities and obligations of Pacific
Century or certain of its subsidiaries. Sections 23A and 18(j) are designed to
assure that the capital of depository institutions such as Bank of Hawaii and
PCB is not put at risk to support their non-bank affiliates. Also, Pacific
Century and its subsidiaries are prohibited from engaging in certain "tie-in"
arrangements in connection with extensions of credit or provision of property
or services.
Bank of Hawaii is subject to supervision and examination by the FDIC and the
Department of Commerce and Consumer Affairs of the State of Hawaii. PCB is
subject to supervision and examination by the Comptroller of the Currency and
in certain respects the FDIC.
Banks, including Bank of Hawaii and PCB, are subject to extensive federal
and (in the case of Bank of Hawaii) state statutes and regulations that
significantly affect their business and activities. Banks must file reports
with their regulators concerning their activities and financial condition and
obtain regulatory approval to enter into certain transactions. Banks are also
subject to periodic examinations by their regulators to ascertain compliance
with various regulatory requirements. Other applicable statutes and
regulations relate to insurance of deposits, allowable investments, loans,
acceptance of deposits, trust activities, mergers, consolidations, payment of
dividends, capital requirements, reserves against deposits, establishment of
branches and certain other facilities, foreign and international operations,
limitations on loans to one borrower and loans to affiliated persons, and
other aspects of the business of banks. Federal legislation has instructed
federal agencies to adopt standards or guidelines governing banks' internal
controls, information systems, internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, compensation and
benefits, asset quality, earnings and stock valuation, and other matters.
Legislation adopted in 1994 gives the federal banking agencies greater
flexibility in implementing standards on asset quality, earnings, and stock
valuation. Regulatory authorities have broad authority to initiate proceedings
designed to prohibit depository institutions from engaging in unsafe and
unsound banking practices.
Congress adopted legislation in 1991 to permit the FDIC to increase deposit
insurance assessment rates for insured banks and to levy emergency special
assessments against insured institutions. In response, the FDIC adopted a
premium schedule under which the actual assessment rate for a particular
institution depends in part upon the risk classification the FDIC assigns to
that institution. The FDIC may raise an institution's insurance premiums or
terminate insurance altogether upon a finding that the institution has engaged
in unsafe and unsound practices.
The Federal Deposit Insurance Corporation Improvements Act of 1991 (FDICIA)
requires the federal banking regulators to take "prompt corrective action" in
respect to depository institutions that do not meet minimum capital
requirements and imposes certain restrictions upon banks which meet minimum
capital
7
requirements but are not "well capitalized" for purposes of FDICIA. FDICIA
generally prohibits a depository institution from paying any dividend or
making any capital distribution or paying any management fee to its holding
company if the depository institution would thereafter be undercapitalized.
Undercapitalized institutions are subject to regulatory monitoring and may be
required to divest themselves of or liquidate subsidiaries. Holding companies
of such institutions may be required to divest themselves of such institutions
or divest themselves of or liquidate nondepository affiliates. Critically
undercapitalized institutions are prohibited from making payments of principal
and interest on subordinated debt and are generally subject to the mandatory
appointment of a conservator or receiver.
Further, a bank that is not well capitalized is generally subject to various
restrictions on "pass through" insurance coverage for certain of its accounts
and is generally prohibited from accepting brokered deposits and offering
interest rates on any deposits significantly higher than the prevailing rate.
Such banks and their holding companies are also required to obtain regulatory
approval before retaining senior executive officers.
Subject to certain exceptions, FDICIA (as modified in 1992) restricts
certain investments and activities as principal by state banks (including Bank
of Hawaii) and requires the federal banking regulators to prescribe standards
for extensions of credit secured by real estate or made to finance
improvements to real estate, loans to bank insiders, regulatory accounting and
reports, internal control reports, independent audits, and other matters, and
requires that insured depository institutions generally be examined on-site by
federal or state personnel at least once every twelve months.
Federal legislation enacted in 1992 affords the federal banking agencies
limited discretion to provide relief from certain regulatory requirements to
depository institutions doing business or seeking to do business in an
emergency or major disaster area. The Omnibus Budget Reconciliation Act of
1993 affects the amortization of intangible assets by banks, requires
securities dealers (including banks) to adopt mark-to-market accounting with
respect to certain of their securities in calculating income taxes, and
establishes a preference for depositors in liquidations of FDIC-insured banks.
Bills are now pending or expected to be introduced in the United States
Congress that contain proposals for altering the structure, regulation, and
competitive relationships of the nation's financial institutions. If enacted,
these bills could increase or decrease the cost of doing business, limit or
expand permissible activities (including activities in the insurance and
securities fields), or affect the competitive balance among banks, savings
associations, credit unions and other financial institutions. Some of these
bills would broaden the powers of bank holding companies, permit affiliations
among banks, insurance companies, and securities firms or between banks and
nonfinancial companies, reduce regulatory burdens on financial institutions,
address aspects of competitive imbalance between credit unions and other
regulated financial institutions, promote more open financial markets for U.S.
banks and financial companies in foreign nations, limit the prerogative of
regulators to expand the range of permissible activities for banks,
particularly in the field of insurance, eliminate or revise the features of
the specialized savings-association charter, and realign the structure and
jurisdiction of various financial institution regulatory agencies. Whether or
in what form any such legislation may be adopted or the extent to which the
business of Pacific Century might be affected thereby cannot be predicted.
Item 2. Properties
Pacific Century and its subsidiaries own and lease premises primarily
consisting of operating facilities, the majority of which are located in
Hawaii. Bank of Hawaii owns five significant properties, the largest of which
are condominium units in the Financial Plaza of the Pacific (FPP) in which the
Bank's main branch and administrative offices are located. Portions of the FPP
are owned in fee simple or leased. The capital leases are for portions (less
than 12%) of the FPP. Details of the capital leases are included in the long
term debt footnote. Additionally, Bank of Hawaii owns a five story office
building in downtown Honolulu, the former headquarters of First Federal
Savings and Loan; a two-story building near downtown Honolulu which houses
data processing and certain other operational functions; a parcel of land in
downtown Honolulu; and Hale O Kapolei, a 248,000
8
square feet operations facility in the Kapolei area on Oahu. Hale O Kapolei was
completed and placed in service in 1995. Interest expense of $1,500,000 was
capitalized while Hale O Kapolei was under construction in 1995.
Item 3. Legal Proceedings
Note J to the Audited Financial Statements included in Item 8 of this report.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of 1998 to a vote of
security holders through the solicitation of proxies or otherwise.
Executive Officers of Registrant:
Name Age Position
---- --- --------
Lawrence M. Johnson....... 58 Chairman and Chief Executive Officer of
Pacific Century and the Bank of Hawaii (the
Bank) since August 1994.
Richard J. Dahl........... 47 President of Pacific Century and the Bank
since August 1994; Chief Operating Officer
of Pacific Century since April 1997 and the
Bank since August 1995.
Alton T. Kuioka........... 55 Vice Chair of Pacific Century since April
1997; Vice Chair of the Bank since June
1994; Chief Lending Officer of Pacific
Century since April 1997 and the Bank since
August 1995.
Mary P. Carryer........... 51 Vice Chair of Pacific Century and the Bank
since November 1997.
David A. Houle............ 51 Executive Vice President of Pacific Century
since April 1997; Treasurer and Chief
Financial Officer of Pacific Century since
December 1992; Executive Vice President and
Chief Financial Officer of the Bank since
February 1994.
9
Part II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Common Stock Listing
The common stock of Pacific Century Financial Corporation, is traded over
the counter on the New York Stock Exchange and quoted daily in leading
financial publications.
NYSE Symbol: BOH
Market Prices, Book Values, and Common Stock Dividends--Table 2 included in
Item 7 of this report.
Item 6. Selected Financial Data
Year-End Summary of Selected Consolidated Financial Data--Table 24 included
in Item 7 of this report.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operation
Overview
Performance Highlights
Pacific Century Financial Corporation (Pacific Century) reported earnings of
$107.0 million in 1998, compared to $139.5 million in 1997 and $133.1 million
in 1996. The decline in 1998 earnings is attributed to special charges in the
second quarter, that included a pre-tax restructuring charge of $19.4 million
($12.6 million after tax) and a significant increase in the provision for loan
losses (for additional information refer to sections on "Restructuring and
Redesign Program" and "Credit Risk--Reserve for Loan Losses"). Excluding the
restructuring charge, 1998 earnings were $119.6 million, a 14.3% decrease from
1997.
Basic earnings per share were $1.33 in 1998, compared to $1.75 in 1997 and
$1.63 in 1996. On a diluted per share basis, operating earnings were $1.32 in
1998, compared to $1.72 and $1.62, in 1997 and 1996, respectively.
Performance ratios in 1998 were also impacted by the special charges. In
1998, return on average assets (ROAA) decreased to 0.72% and return on average
equity (ROAE) declined to 9.21%. ROAA was 0.98% in 1997 and 1.00% in 1996,
while ROAE was 12.57% and 12.43% in 1997 and 1996, respectively.
Pacific Century has accounted for all of its business acquisitions under the
purchase method, which results in the recording of goodwill and other
intangible assets. These intangible assets are amortized over various periods
as a non-cash charge to operating income. Operating results under a tangible
performance basis excludes from reported earnings the after tax impact of
amortization of all intangibles, including goodwill. On a tangible performance
basis, Pacific Century's earnings were $121.7 million in 1998, $150.7 million
in 1997 and $141.3 million in 1996. On a per share basis, tangible diluted
earnings per share were $1.50 in 1998, compared to $1.86 and $1.71 in 1997 and
1996, respectively.
Tangible ROAA for Pacific Century was 0.83% in 1998 and 1.07% in both 1997
and 1996. Tangible ROAE was 12.84%, 15.78%, and 14.45% in 1998, 1997, and
1996, respectively.
Net interest income (on a taxable equivalent basis) in 1998 increased $52.9
million over 1997 of which approximately $39.5 million was attributed to a
rise in net average earning assets, while $13.4 million was attributed to a
widening in net interest margin.
Total assets were just over $15 billion at December 31, 1998, a slight
increase from year-end 1997. Average assets increased 4.4% in the year-to-year
comparison to $14.9 billion in 1998 mostly from a 5.5% growth in average
loans.
10
Non-performing assets, exclusive of accruing loans past due 90 days or more,
were $137.5 million, or 1.40% of total loans, at year-end 1998, compared to
$97.1 million, or 1.02% of total loans, at year-end 1997. The year-to-year
increase in non-performing assets is largely accounted for by a rise in the
commercial and industrial category and the foreign loan category, which
reflects the 1998 Banque Paribas acquisitions (see section on "Acquisitions
and Strategic Alliances").
The reserve for loan losses totaled $211.3 million at the end of 1998,
representing 2.19% of loans outstanding, compared to $174.4 million and 1.88%,
respectively at year-end 1997. Net charge-offs in 1998 were $65.7 million, or
0.70% of average loans, compared to $30.2 million and 0.34%, respectively, in
1997. For the year ended December 31, 1998, provisions for loan losses of
$84.0 million were charged to income, up from $30.3 million in 1997.
11
Performance Highlights
Table 1
(in millions of dollars except per share amounts)
1998 1997 Five-
---------------- -------- Year
Percent Compound
Earnings Measures Amount Change Amount Growth
- ----------------- -------- ------- -------- --------
Net Income................................. $ 106.96 (23.3)% $ 139.49 (4.2)%
Basic Earnings Per Share................... 1.33 (24.0) 1.75 (3.1)
Diluted Earnings Per Share................. 1.32 (23.3) 1.72 (3.0)
Average Assets............................. 14,870.7 4.4 14,242.3 3.4
Average Loans.............................. 9,422.3 5.5 8,929.7 6.2
Average Deposits........................... 9,549.7 3.3 9,248.0 4.9
Average Shareholders' Equity............... 1,160.8 4.6 1,109.3 5.4
Excluding the Effects of Intangibles/1/
Tangible Net Income...................... 121.70 (19.2) 150.67 (2.4)
Tangible Basic Earnings Per Share........ 1.52 (19.6) 1.89 (1.3)
Tangible Diluted Earnings Per Share...... 1.50 (19.4) 1.86 (1.3)
Five-Year
Performance Ratios 1998 1997 Average
- ------------------ ----- ----- ---------
Return on Average Assets................................ 0.72% 0.98% 0.92%
Return on Average Equity................................ 9.21 12.57 11.64
Average Equity to Average Assets Ratio.................. 7.81 7.79 7.93
Loan Loss Reserve to Loans Outstanding.................. 2.19 1.88 1.97
Tier I Capital Ratio.................................... 9.42 9.34
Total Capital Ratio..................................... 11.47 11.65
Leverage Ratio.......................................... 7.48 7.21
Excluding the Effects of Intangibles/1/
Tangible Return on Average Assets..................... 0.83 1.07 1.01
Tangible Return on Average Equity..................... 12.84 15.78 14.26
- --------
/1/ Intangibles include goodwill, core deposit and trust intangibles, and other
intangibles.
12
Market Prices, Book Values and Common Stock Dividends
Table 2
Market Price (MP) Range High MP as
----------------------------- a Percent
Year/Period High Low Book Value (BV) of BV Dividend
- ----------- ------ ------ --------------- ---------- --------
1994.......................... $17.38 $12.07 $11.55 150% $.52
====== ====== ====== === ====
1995.......................... $18.57 $12.44 $12.76 146% $.54
====== ====== ====== === ====
1996.......................... $22.00 $16.57 $13.34 165% $.58
====== ====== ====== === ====
1997.......................... $28.06 $20.31 $14.02 200% $.63
First Quarter................. 23.19 20.56 .15
Second Quarter................ 23.94 20.31 .15
Third Quarter................. 27.13 23.19 .16
Fourth Quarter................ 28.06 23.50 .17
1998.......................... $25.88 $14.75 $14.76 175% $.66
First Quarter................. 25.13 20.31 .16
Second Quarter................ 25.88 23.56 .16
Third Quarter................. 24.06 14.75 .17
Fourth Quarter................ 24.38 15.50 .17
Other Events
The Asian economic crisis, which began in mid-1997 has impacted many
countries in the region in which Pacific Century conducts business. Some of
those countries affected have experienced a significant devaluation of their
currencies relative to the U.S. dollar, as well as higher volatility in
interest rates and a general tightening of credit. Although most Asian
currencies ended 1998 somewhat improved or stabilized, financial uncertainty
still remains. Pacific Century is carefully following developments in the
region, monitoring its credit exposure in those countries experiencing
financial difficulties, and taking action on credit reserves as appropriate
under the circumstances.
Asia continues to play an important part of Pacific Century's longer term
strategy of developing a comprehensive franchise and customer base across the
Pacific. Additional information regarding Asian events are included in the
"International Operations" section of this report.
In Hawaii, the current consensus forecast for growth in real gross state
product ranges from 1% to 2% for 1999, following a multi-year trend of slow
growth that began in the early 1990's. While this projected rate of growth
still remains low, there were some positive economic signs which developed in
1998. A recent strengthening of the Japanese yen is expected to have a
positive effect on Hawaii's tourism and retail sectors. Also, in 1998, Pacific
Century's residential mortgage originations rose to $1.06 billion, the highest
level recorded by any mortgage lender in the State of Hawaii.
Acquisitions and Strategic Alliances
Recognizing the risks of operating in only one economy, Pacific Century's
long standing strategy calls for expanding outside of Hawaii, with emphasis on
key Pacific locations. In May 1998, Pacific Century further developed this
strategy by acquiring Banque Paribas Pacifique in New Caledonia and Banque
Paribas Polynesie in French Polynesia. Subsequent to the merger, the
operations of both acquired banks were consolidated into Pacific Century
subsidiaries located in the same region. As of the acquisition date, Banque
Paribas Pacifique and Banque Paribas Polynesie had total assets of
approximately $238 million and $83 million, respectively.
13
In April 1998, Pacific Century completed its purchase of approximately $20
million (U.S. dollar equivalent) in 6.375% convertible notes issued by the
Bank of Queensland. The Bank of Queensland is an independent bank operating in
northeastern Australia. Pacific Century has entered into a strategic alliance
agreement with the Bank of Queensland that will further expand its geographic
reach in the Pacific Rim.
In January 1999, Pacific Century acquired Triad Insurance Agency, Inc.
(Triad), a major Hawaii-based property/casualty insurance agency. In Hawaii,
Triad represents a number of large U.S. property/casualty insurance companies
for whom it acts as a servicing agent. The merger will expand Pacific
Century's range of financial services that it can offer to customers.
Restructuring and Redesign Program
On February 17, 1998, Pacific Century announced a restructuring and redesign
program to accelerate expense reduction, improve efficiency and enhance
revenues. In the initial phase, the plan called for the merger of First
Federal Savings and Loan Association of America (First Federal) into Bank of
Hawaii and the rationalization of traditional branch delivery channels in the
State of Hawaii. The First Federal merger was completed on September 30, 1998
resulting in the closure of 19 thrift branches during the fourth quarter.
Additionally, to further reduce delivery channel redundancy, eight Bank of
Hawaii branches were also closed during the year, bringing the total bank and
thrift branches closed in 1998 to 27.
In August 1998, Pacific Century's U.S. Mainland operations were merged into
one nationally chartered entity. California United Bank, acquired in 1997, and
Pacific Century Bank, N.A. located in Phoenix, Arizona, were consolidated
under the name Pacific Century Bank, N.A. with its headquarters in Southern
California.
Also, as part of the restructuring plan, Bank of Hawaii's credit card
services functions were outsourced in the fourth quarter of 1998 to a third
party vendor.
In connection with these actions, a pre-tax restructuring charge of $19.4
million was taken against second quarter earnings. The restructuring charge
consists of direct and incremental costs that are primarily associated with
closing facilities and reducing staff. Through December 31, 1998, $9.8 million
of the restructuring accrual has been utilized. Pacific Century believes that
the year-end 1998 restructuring accrual of $9.6 million is adequate to
complete the above mentioned initiatives.
Pacific Century's restructuring program will continue in 1999 with a
comprehensive redesign process to increase revenues and further improve
efficiency. Pacific Century has contracted with a nationally recognized
corporate redesign specialist to assist in this activity. The redesign
timeline calls for a six month process review and idea development phase that
will begin in March 1999 followed by a twelve month implementation phase.
Forward-Looking Statements
This report contains forward-looking statements regarding Pacific Century's
beliefs, estimates, projections and assumptions. Although Pacific Century
believes that its expectations are based on reasonable assumptions, there can
be no assurance that such assumptions will ultimately materialize. Forward-
looking statements are contained in various sections of this report including
those covering the Overview, International Operations, Market Risk, Year 2000,
and European Economic and Monetary Union. These forward-looking statements are
subject to risks and uncertainties, and accordingly, actual results could
differ significantly from those stated or implied by such forward-looking
statements. Factors that might cause differences to occur include, but are not
limited to, economic conditions in the markets Pacific Century serves and
those that impact Hawaii, the U.S. Mainland and Asian economies, fluctuations
in interest rates, changes in currencies of Asian Rim and South Pacific
countries relative to the U.S. dollar, credit quality, and changes in
applicable federal, state, and foreign income tax laws and regulatory and
monetary policies, and the nature and level of competition. Additional
forward-looking statements that could significantly differ from estimates
include uncertainties relating to Pacific Century's efforts to prepare its
systems and technology for Year 2000 readiness, as well as uncertainties
relating
14
to the ability of third parties with whom Pacific Century has business
relationships to address Year 2000 issues in a timely and adequate manner.
Line of Business Financial Review
Pacific Century is a financial services organization that maintains a broad
presence throughout the Pacific region and operates through a unique trans-
Pacific network of locations. Pacific Century's activities are conducted
primarily through 180 branches and representative and extension offices
(including branches of affiliate banks). Its staff of approximately 5,100
employees provide diverse financial products and services to individuals,
businesses, governmental agencies and financial institutions.
Pacific Century assesses the financial performance of its operating
components primarily in accordance with geographic areas of operations. For
business segment reporting, Pacific Century has aligned its operations into
the following four major geographic segments: Hawaii, the Pacific, Asia, and
the U.S. Mainland. In addition to these segments, there is also a segment for
Treasury and Other Corporate. This segment includes corporate asset and
liability management activities and the unallocated portion of various
administrative and support units. Although operating units are generally
aligned geographically for business segment financial reporting, in certain
cases units are grouped in accordance with functional activities rather than
by geographic market.
Business segment results are determined based on Pacific Century's internal
financial management reporting process and organization structure. The
financial management reporting process uses various techniques to allocate and
transfer balance sheet and income statement amounts between business units,
including allocations for overhead, loan loss provision, and capital. In its
business segment financial reporting process, Pacific Century utilizes certain
accounting practices that differ from generally accepted accounting
principles. These practices and other key elements of Pacific Century's
business segment financial reporting process are described in Note Q to the
Consolidated Financial Statements.
The table in Note Q presents the line of business financial report for each
of Pacific Century's major market segments for the year ended December 31,
1998. Because the market segment financial report is prepared in accordance
with accounting practices that could differ from generally accepted accounting
principles, the amounts reflected therein may not agree with the corresponding
amounts reported in the Consolidated Financial Statements and Management
Discussion and Analysis of Operations.
In addition to the performance measurements in the line of business
financial report, Pacific Century also utilizes risk-adjusted return on
capital (RAROC) to assess business segment performance. RAROC is the ratio of
net income to risk-adjusted equity. Equity is allocated to business units
based on various risk factors inherent in the operations of each unit. A
second performance measurement is net income after capital charge (NIACC).
NIACC is net income available to common shareholders less a charge for
allocated capital. The cost of capital is based on the estimated minimum rate
of return expected by the financial markets. The minimum rate of return
consists of the following components: the long-term government bond rate plus
an additional level of return for the average risk premium of an equity
investment adjusted for the company's market risk. Over the past few years the
cost of capital has fluctuated between 12% to 15%.
Hawaii Market
Pacific Century's oldest and largest market is Hawaii, where operations are
conducted primarily through its principal subsidiary, Bank of Hawaii. Bank of
Hawaii was established in 1897, and today it is the largest bank headquartered
in the State of Hawaii offering a wide array of financial products and
services. Bank of Hawaii operates through 72 branches in Hawaii, including
both traditional full-service branches and in-store locations.
Within the Hawaii segment, line of business results are divided into retail
and commercial operating units. Retail operating units sell and service a
broad line of consumer financial products. These units include consumer
deposits, consumer lending, residential real estate lending, auto financing,
credit cards, and private and institutional services (trust, mutual funds, and
stock brokerage).
15
In addition to offering traditional branch banking services, Bank of Hawaii
has actively introduced new electronic based products and services that
provide enhanced customer convenience. These products and services include: PC
Home Banking; Bankoh Bill Pay (an electronic bill payment service); e-Bankoh
(a nationally recognized service that enables customers to bank on the
internet); an ATM network with 492 machines, some of which provide enhanced
functionality; 13 super-market branches; and six business service centers (a
unique product that offers depository and change services to shopping center
merchants through conveniently located dispensing machines).
In the business banking area, Bank of Hawaii is a major commercial lender
and maintains a significant presence throughout the State. Commercial
operating units in the Hawaii market include small business, middle market,
cash management and commercial real estate.
For the year ended December 31, 1998, the Hawaii segment contributed $48.6
million in net income. RAROC for this segment was 13% in 1998. Total assets in
the Hawaii segment were $5.3 billion at year-end 1998.
Pacific Market
Pacific Century has maintained a presence in the Intra-Pacific region for
nearly 40 years, where it offers financial products and services to both
retail and commercial customers. Today, this market spans island nations
across the West and South Pacific. Pacific Century is the only United States
financial institution to have such a broad presence in this region. This
unique franchise positions Pacific Century for future growth.
Pacific Century serves the West Pacific through branches of both Bank of
Hawaii and First Savings and Loan Association of America (First Savings). Bank
of Hawaii's operation in the West Pacific consists of three branches in Guam
and two branches in the Commonwealth of the Northern Marianas Islands
(Saipan), as well as branches in the Federated States of Micronesia (Yap,
Pohnpei, and Kosrae), the Republic of the Marshall Islands (Majuro) and the
Republic of Palau (Koror). First Savings operates in Guam from three
traditional branches and three in-store locations.
Pacific Century's presence in the South Pacific includes branches of Bank of
Hawaii and various subsidiary and affiliate banks. The Bank of Hawaii
locations in this region consist of three branches in Fiji and two branches in
American Samoa. Pacific Century's subsidiary banks in the South Pacific are
located in French Polynesia, New Caledonia, Papua New Guinea, and Vanuatu.
Additionally, Pacific Century maintains an investment in affiliate banks
located in Samoa, Solomon Islands and Tonga. As of December 31, 1998, these
subsidiary and affiliate banks had a total of 29 and 20 branches,
respectively. Pacific Century's largest markets in the South Pacific are in
French Polynesia and New Caledonia.
Net income in the Pacific segment was $23.0 million for the year ended
December 31, 1998. RAROC for this segment was 11% including the amortization
of intangibles. Total assets in the Pacific segment stood at $2.4 billion at
year-end 1998.
Asia Market
Asia is a market that Pacific Century has developed over the last 20 years.
Pacific Century operates in Asia through Bank of Hawaii branches in Hong Kong,
Japan, Singapore, South Korea and Taiwan and a representative office with
extensions in the Philippines.
Pacific Century's business focus in Asia is correspondent banking and trade
financing. Activities include letters of credit, remittance processing,
foreign exchange, cash management, export bill collection, and working capital
loans. The lending emphasis is on short-term loans based on cash flows.
Pacific Century's network of locations in the Pacific and its presence on the
U.S. Mainland help customers facilitate the flow of business and investment
transactions across Asia-Pacific.
16
For the year ended December 31, 1998, net income in the Asia segment was
$13.7 million. RAROC for this segment was 14% in 1998. As of year-end 1998,
total assets in the Asia segment were $1.0 billion.
For additional information on Asia, see the "International Operations"
section in this report.
U.S. Mainland Market
During 1998, Pacific Century's two Mainland bank subsidiaries were merged
into one nationally-chartered entity, under the name Pacific Century Bank,
N.A. (PCB). PCB provides financial products and services through 20 branches
in Southern California and 9 branches in Arizona. PCB's emphasis is on
providing asset based lending and related services for small and middle market
businesses. Additionally, PCB also assists Pacific Century in expanding
relationships with customers who have an interest in the Asia-Pacific region.
In early 1999 PCB opened a China marketing office.
In addition to the operations of PCB, the U.S. Mainland segment also
includes operating units for large corporate lending and leasing. The large
corporate lending unit targets businesses that have interests in the Asia-
Pacific region and businesses in certain specialized industries. Leasing
activities consist of providing financing to businesses largely for aircraft,
vehicles and equipment.
In 1998, the U.S. Mainland segment contributed $26.8 million in net income,
which included tax benefits of $13.5 million from low income housing tax
credits and investment tax credits. RAROC for this segment was 10% in 1998
including the amortization of intangibles. As of December 31, 1998, total
assets in the U.S. Mainland segment were $2.6 billion.
Treasury and Other Corporate
The primary operations in this segment is Treasury, which consists of
corporate asset and liability management activities including investment
securities, federal funds purchased and sold, government deposits, short and
long-term borrowings, and derivative activities for managing interest rate and
foreign currency risks. Additionally, the net residual effect of transfer
pricing assets and liabilities is included in Treasury, as is any corporate-
wide interest rate risk.
Other corporate items included in this segment consist of the operations of
insurance and other non-bank subsidiaries, unallocated overhead expenses, and
the residual effect of allocating the economic provision.
The Treasury and Other Corporate segment reflected a net operating loss of
$5.2 million in 1998. Included in the 1998 results is a pre-tax restructuring
charge of $19.4 million. At year-end 1998 this segment held $3.7 billion in
total assets, most of which were in Treasury.
Statement of Income Analysis
Comparability between periods in the Consolidated Statements of Income is
impacted by the 1998 acquisitions of Banque Paribas Pacifique and Banque
Paribas Polynesie. In addition, the July 1997 purchase of California United
Bank, the March 1997 acquisition of Indosuez Niugini Bank, Ltd., the March
1997 acquisition of deposits from Home Savings of America, and the May 1996
purchase of majority ownership in Banque de Tahiti and Banque de Nouvelle
Caledonie also affect the comparison between periods.
Net Interest Income
Net interest income (taxable equivalent basis) was $577.2 million in 1998,
up from $524.3 million in 1997 and $483.4 million in 1996. The increase
relative to 1998 is largely due to the acquisitions, which have helped to grow
average earning assets and widen the net interest margin. Average earning
assets were $13.7 billion in 1998 and $13.2 billion in 1997, reflecting a
year-over-year increase of $495 million and $772 million, respectively. In
1998, the average net interest margin on earning assets rose to 4.22% from
3.98% in 1997 and
17
3.90% in 1996. The improvement in net interest margin relative to 1998 and
1997 results from both a rise in the average yield on earning assets and a
drop in the average rate paid on interest-bearing liabilities. Presented in
Table 3 are the average balances, yields, and rates paid for the years ended
December 31, 1998, 1997 and 1996.
In 1998, the average yield on earning assets improved to 8.05% from 7.97%
and 7.93% in 1997 and 1996, respectively and reflects Pacific Century's
efforts to remix the portfolio to higher yielding assets. The average rate
paid on interest-bearing liabilities decreased to 4.67% in 1998, from 4.76%
and 4.78% in 1997 and 1996, respectively, reflecting the decline in market
interest rates.
Provision for Loan Losses
The provision for loan losses was $84.0 million in 1998, up from $30.3
million in 1997 and $22.2 million in 1996. The larger 1998 loan provision
primarily reflects a $26.9 million rise in gross loan charge-offs relating
mostly to the foreign category and a build up of reserves to cover the
increase in non-performing assets. For further information on credit quality,
refer to the section on "Credit Risk--Reserve for Loan Losses."
18
Consolidated Average Balances, Income and Expense
Summary, and Yields and Rates
(Taxable Equivalent)
Table 3
1998 1997 1996
-------------------------- -------------------------- -------------------------
Average Income/ Yields/ Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rates Balance Expense Rates Balance Expense Rates
--------- -------- ------- --------- -------- ------- --------- ------- -------
(in millions of dollars)
Earning Assets
Interest-Bearing
Deposits.............. $ 508.8 $ 36.7 7.21% $ 486.3 $ 33.1 6.80% $ 579.9 $ 42.0 7.24%
Investment
Securities--Held to
Maturity
--Taxable............ 890.6 67.7 7.60 1,220.4 81.8 6.71 1,078.1 70.4 6.53
--Tax-Exempt......... 11.8 1.7 14.34 12.5 1.8 14.55 13.0 1.8 14.08
Investment
Securities--Available
for Sale.............. 2,769.3 171.0 6.17 2,452.0 158.8 6.48 2,288.7 148.0 6.46
Funds Sold............. 69.7 3.8 5.45 76.4 3.8 4.99 92.1 4.0 4.39
Loans /1/
--Domestic........... 7,669.7 643.8 8.39 7,389.4 607.7 8.22 7,099.9 579.7 8.17
--Foreign............ 1,752.6 130.4 7.44 1,540.3 129.2 8.39 1,253.7 107.6 8.58
Loan Fees.............. 45.3 34.4 29.7
--------- -------- ----- --------- -------- ----- --------- ------ -----
Total Earning
Assets............ 13,672.5 1,100.4 8.05 13,177.3 1,050.6 7.97 12,405.4 983.2 7.93
Cash and Due From Banks. 590.1 545.1 462.8
Other Assets............ 608.1 519.9 427.0
--------- --------- ---------
Total Assets....... $14,870.7 $14,242.3 $13,295.2
========= ========= =========
Interest-Bearing
Liabilities
Domestic Deposits
--Demand............. $ 2,114.8 55.7 2.64 $ 1,945.3 52.9 2.72 $ 1,726.6 47.2 2.73
--Savings............ 783.9 18.5 2.35 865.5 21.4 2.48 937.0 23.7 2.53
--Time............... 2,780.7 145.4 5.23 2,858.7 157.0 5.49 2,465.0 133.5 5.42
--------- -------- ----- --------- -------- ----- --------- ------ -----
Total Domestic..... 5,679.4 219.6 3.87 5,669.5 231.3 4.08 5,128.6 204.4 3.98
Foreign Deposits
--Time Due to Banks.. 596.1 40.4 6.78 718.7 43.6 6.06 733.5 46.4 6.33
--Other Time and
Savings............. 1,176.1 57.9 4.92 1,079.0 48.2 4.47 745.0 37.9 5.09
--------- -------- ----- --------- -------- ----- --------- ------ -----
Total Foreign...... 1,772.2 98.3 5.55 1,797.7 91.8 5.10 1,478.5 84.3 5.70
--------- -------- ----- --------- -------- ----- --------- ------ -----
Total Deposits..... 7,451.6 317.9 4.27 7,467.2 323.1 4.33 6,607.1 288.7 4.37
Short-Term Borrowings.. 3,072.9 162.6 5.29 2,868.7 156.8 5.47 2,809.6 150.2 5.35
Long-Term Debt......... 676.5 42.7 6.32 725.5 46.4 6.39 1,029.2 60.9 5.91
--------- -------- ----- --------- -------- ----- --------- ------ -----
Total Interest-
Bearing
Liabilities....... 11,201.0 523.2 4.67 11,061.4 526.3 4.76 10,445.9 499.8 4.78
--------- -------- ----- --------- -------- ----- --------- ------ -----
Net Interest Income..... 577.2 3.38 524.3 3.21 483.4 3.15
----- ----- -----
Spread on Earning
Assets................. 4.22% 3.98% 3.90%
----- ----- -----
Demand Deposits
--Domestic............. 1,650.4 1,516.8 1,371.5
--Foreign.............. 447.7 264.0 194.2
--------- --------- ---------
Total Demand
Deposits.......... 2,098.1 1,780.8 1,565.7
Other Liabilities....... 410.8 290.8 212.7
Shareholders' Equity.... 1,160.8 1,109.3 1,070.9
--------- --------- ---------
Total Liabilities &
Equity............ $14,870.7 $14,242.3 $13,295.2
========= ========= =========
Provision for Loan
Losses................. 84.0 30.3 22.2
Net Overhead............ 329.0 275.1 256.8
-------- -------- ------
Income Before Income
Taxes.................. 164.2 218.9 204.4
Provision for Income
Taxes.................. 56.6 78.5 70.2
Tax Equivalency
Adjustment/2/ ......... 0.6 0.9 1.1
-------- -------- ------
Net Income.............. $ 107.0 $ 139.5 $133.1
======== ======== ======
/1/Includes non-accrual loans.
- --------
/2/Based upon a statutory tax rate of 35%.
19
Non-Interest Income
In 1998, total non-interest income was $211.8 million, compared to $187.8
million in 1997 and $164.5 million in 1996. Non-interest income on a year-to-
year basis increased 12.8% in 1998 and 14.2% in 1997. The incremental non-
interest income attributed to the acquisitions were approximately $15.0
million and $5.5 million in 1998 and 1997, respectively. Table 4 presents the
details of non-interest income for the last five years.
Trust income for 1998 totaled $55.9 million, up from $52.2 million in 1997
and $49.8 million in 1996. In 1997, the trust operation was merged into Bank
of Hawaii and the division was renamed Pacific Century Trust (PCT). This
merger has created the synergism for new opportunities through coordinated
marketing and packaging of trust services. This opportunity was further
developed in 1998 through organizational changes that positioned relationship
officers to deliver a wider array of financial services to satisfy the growing
needs of customers. While trust income showed a 7.1% increase in 1998, total
trust assets administered by PCT increased to $13.1 billion at year-end 1998,
up from $12.5 billion at year-end 1997 and $11.4 billion at year-end 1996. The
Pacific Capital family of mutual funds and Hawaiian Tax Free Trust, which are
managed by PCT, have continued to experience growth. At December 31, 1998, the
aggregate balance of these funds stood at $3.1 billion, compared to $2.6
billion and $2.2 billion at year-end 1997 and 1996, respectively.
Service charges on deposit accounts increased to $35.5 million, compared to
$29.4 million in 1997 and $26.7 million in 1996. The acquisitions accounted
for approximately $3.1 million of the increase between 1998 and 1997.
Fees, exchange and other service charges increased to $77.9 million in 1998,
from $67.1 million in 1997 and $58.9 million in 1996. Approximately $5.1
million of the increase between 1998 and 1997 was due to the acquisitions.
Income generated from international activities include letters of credit and
acceptance fees, profit on foreign currency, and exchange fees. Collectively,
income from these sources totaled $29.1 million in 1998, a 5.8% increase over
1997.
Mortgage servicing fees increased to $7.9 million in 1998 from $7.1 million
in 1997 and $6.6 million in 1996. This increase reflects Bank of Hawaii's
emphasis on residential mortgage lending and secondary market sales
activities. Pacific Century's mortgage servicing portfolio grew to $2.05
billion at year-end 1998 from $1.65 billion at year-end 1997.
Also included in fees, exchange and other service charges are fees earned
through Pacific Century's ATM network. During 1998, Pacific Century continued
to expand its ATM network, ending the year with 492 machines, an increase from
480 at year-end 1997. Fees generated by this network totaled $10.4 million in
1998, compared to $9.6 million in 1997, and $8.6 million in 1996. The majority
of Pacific Century's ATMs are located in Hawaii (418) with the remainder in
the West Pacific (28), South Pacific (26), and the U.S. Mainland (20). ATM
usage has increased steadily over the years averaging more than 2.1 million
transactions per month in 1998, compared to more than 1.9 million transactions
per month in 1997.
Other operating income in 1998 was $38.4 million, an increase of 6.7% over
last year. Comparatively, other operating income was $36.0 million in 1997 and
$27.7 million in 1996. With a lower level of recoveries recorded in 1998, cash
basis interest declined to $1.3 million, compared to $3.7 million in 1997, and
$2.6 million reported in 1996. Cash basis interest includes interest collected
on loans written-off or interest collected on non-accrual loans that relate to
prior years.
Sales of investment securities in 1998 resulted in a net securities gain of
$4.1 million, compared to net gains of $3.1 million and $1.4 million in 1997
and 1996, respectively.
20
Non-Interest Income
Table 4
Years Ended December 31
----------------------------------------------------
1998 1997 1996 1995 1994
-------------- -------------- ------ ------ ------
Percent Percent
Amount Change Amount Change Amount Amount Amount
------ ------- ------ ------- ------ ------ ------
(in millions of dollars)
Trust Income............... $ 55.9 + 7.1% $ 52.2 + 4.8% $ 49.8 $ 49.5 $ 48.6
Service Charges on Deposit
Accounts.................. 35.5 + 20.7 29.4 + 10.1 26.7 25.9 28.3
Fees, Exchange and Other
Service Charges
Card Fees................ 13.7 + 3.8 13.2 + 23.4 10.7 7.3 8.3
Letters of Credit and
Acceptance Fees......... 10.6 - 4.5 11.1 + 9.9 10.1 8.8 7.8
Profit on Foreign
Currency................ 14.8 + 21.3 12.2 + 37.1 8.9 6.5 4.3
ATM...................... 10.4 + 8.3 9.6 + 11.6 8.6 7.7 6.6
Mortgage Servicing Fees.. 7.9 + 11.3 7.1 + 7.6 6.6 4.3 2.9
Exchange Fees............ 3.7 - 11.9 4.2 + 23.5 3.4 3.9 4.0
Payroll Services......... 1.1 - 31.3 1.6 - 33.3 2.4 2.1 2.1
Cash Management.......... 2.4 +200.0 0.8 -- 0.8 1.0 1.1
Other Fees............... 13.3 + 82.2 7.3 - 1.4 7.4 5.7 5.4
Other Operating Income
Other Income............. 37.1 + 14.9 32.3 + 28.7 25.1 19.6 23.4
Cash Basis Interest...... 1.3 - 64.9 3.7 + 42.3 2.6 1.3 3.4
Investment Securities Gains
(Losses).................. 4.1 + 32.3 3.1 +121.4 1.4 2.5 (17.8)
------ ------ ------ ------ ------ ------ ------
Total.................. $211.8 + 12.8% $187.8 + 14.2% $164.5 $146.1 $128.4
====== ====== ====== ====== ====== ====== ======
Non-Interest Expense
Total non-interest expense for 1998, 1997 and 1996 was $540.7 million,
$462.9 million and $421.3 million, respectively. In 1998 and 1997, non-
interest expense increased 16.8% and 9.9%, respectively, which includes the
effects of the acquisitions and for 1998 reflects a pre-tax restructuring
charge of $19.4 million. The incremental increase in non-interest expense due
to the acquisitions was approximately $34.2 million in 1998 and $32.4 million
in 1997, including the amortization of intangibles. Excluding the effects of
the restructuring charge and the acquisitions, non-interest expense increased
by approximately 5.2% in 1998 and 2.2% in 1997. When fully implemented in the
first half of 1999, the restructuring actions relative to branch
rationalization and credit card servicing will improve efficiency and reduce
operating costs by an expected $22 million annually on a going forward basis.
In 1998, the effects of expense reductions from restructuring related mergers
and other initiatives were insignificant.
Salaries and pension and other employee benefit expense totaled $250.5
million, $226.7 million and $208.0 million in 1998, 1997 and 1996,
respectively. Approximately $14.6 million and $13.8 million of the increase
relative to 1998 and 1997, respectively is accounted for by the acquisitions.
Excluding the effects of the acquisitions, these expenses increased 4.1% in
1998 and 2.3% in 1997. The Year 2000 project also contributed to the increase
in salaries and benefits for 1998.
Net occupancy and equipment expense for 1998 increased to $95.8 million from
$85.2 million in 1997 and $73.4 million in 1996. Included in the 1998 total
were $1.7 million in non-recurring charges attributed to equipment and premise
write-offs. Additionally, approximately $4.7 million of the increase in 1998
is explained by the acquisitions. Comparison between 1997 and 1996 is affected
by a $2.7 million write-off relating to the 1997 closure and demolition of a
downtown Honolulu building.
21
Other operating expense increased to $174.5 million in 1998 from $149.5
million in 1997 and $138.4 million in 1996. Approximately $14.8 million and
$15.5 million of the increase relative to 1998 and 1997, respectively, was due
to the acquisitions, including the amortization of intangibles. In addition,
1998's other operating expense was also impacted by a $3.7 million write-down
of a real estate investment, and a $2.7 million loss related to an equipment
lease termination, which was offset by an equal amount of tax savings. The
comparison between 1997 and 1996 is affected by a $2.8 million loss recognized
in 1996 on the early termination of a leveraged lease.
Legal and professional fees increased to $35.8 million in 1998 from $23.4
million in 1997 and $17.7 million in 1996. The increase for 1998 is primarily
attributed to consulting and other professional fees including those related
to the Year 2000 project.
Pacific Century utilizes the efficiency ratio as a tool to manage non-
interest income and expense. The efficiency ratio is derived by dividing non-
interest expense by net operating revenue (net interest income plus non-
interest income before securities transactions). For 1998, 1997 and 1996, the
efficiency ratio was 68.9%, 65.4% and 65.3%, respectively. Excluding the
restructuring charge and amortization of all intangibles, the efficiency ratio
was 64.3%, 63.4% and 63.8% in 1998, 1997 and 1996, respectively.
Non-Interest Expense
Table 5
Years Ended December 31
--------------------------------------------------
1998 1997 1996 1995 1994
-------------- -------------- ------ ------ ------
Percent Percent
Amount Change Amount Change Amount Amount Amount
------ ------- ------ ------- ------ ------ ------
(in millions of dollars)
Salaries.................... $194.5 +12.3% $173.2 + 8.8% $159.2 $142.1 $138.0
Pension and Other Employee
Benefits.................... 56.0 + 4.7 53.5 + 9.6 48.8 43.6 42.4
Net Occupancy Expense....... 46.8 + 0.2 46.7 +18.5 39.4 41.1 37.4
Net Equipment Expense....... 49.0 +27.3 38.5 +13.2 34.0 31.7 30.5
Other Operating Expense
Legal and Professional.... 35.8 +53.0 23.4 +32.2 17.7 15.6 18.2
Stationery and Supplies... 11.1 + 3.7 10.7 -- 10.7 9.3 8.8
Amortization of Intangible
Assets................... 17.4 +27.9 13.6 +38.8 9.8 8.4 9.3
Other..................... 110.3 + 8.3 101.8 + 1.5 100.3 71.2 75.3
Restructuring Charge........ 19.4 N.M. -- -- -- -- --
Minority Interest........... 0.4 -73.3 1.5 + 7.1 1.4 1.1 0.5
------ ----- ------ ----- ------ ------ ------
Total................... $540.7 +16.8% $462.9 + 9.9% $421.3 $364.1 $360.4
====== ===== ====== ===== ====== ====== ======
Income Taxes
The 1998 tax provision reflects an effective tax rate of 34.6%, compared to
36.0% and 34.5% in 1997 and 1996, respectively. The effective tax rate in 1998
was impacted by the previously mentioned equipment lease termination loss of
$2.7 million that provided an equivalent amount of tax benefits. Pacific
Century's tax structure is complex given the various foreign and domestic
locations in which it operates. Pacific Century utilizes low income housing
tax credits, municipal securities, and lease financing to manage its tax
liability.
In recent years, low income housing credits have been Pacific Century's main
vehicle for reducing the effective tax rate. Pacific Century's low income
housing investments increased $5.0 million to $69.6 million at year-end 1998
and provided tax credits of $10.0 million in 1998. Pacific Century's tax-
exempt securities portfolio continues to decline and had only a minimal impact
on the effective tax rate in 1998.
22
Pacific Century also continued to pursue lease financing to defer tax
payments. Consisting of both direct and leveraged leases, the leasing
portfolio grew 6.8% during 1998.
Tax planning at Pacific Century is structured to minimize the impact of the
alternative minimum tax (AMT). At the end of 1998, Pacific Century was not
subject to the AMT.
Balance Sheet Analysis
Loans
Loans comprise the largest category of earning assets for Pacific Century
and produce the highest level of earnings. At year-end 1998, loans outstanding
grew to $9.9 billion, a 3.7% increase from $9.5 billion at year-end 1997.
Comparability between periods is impacted by approximately $211 million of
loans acquired in the May 1998 Banque Paribas acquisitions. Excluding the
effects of the acquisitions, total loans in 1998 increased by 1.5%.
Pacific Century's objective is to maintain a diverse loan portfolio in order
to spread credit risk and reduce exposure to economic downturns that may
impact different markets and industries. The composition of the loan portfolio
is regularly monitored to ensure diversity as to loan type, geographic
distribution, and industry and borrower concentration.
Table 6 presents the composition of the loan portfolio by major loan
categories.
Commercial and Industrial Loans
At December 31, 1998, commercial and industrial loans (C&I) totaled $2.6
billion, up 22.6% from year-end 1997. The proportion of C&I loans to the total
loan portfolio increased to 26.2% at year-end 1998, from 22.2% at year-end
1997. This growth is primarily attributed to a $383.4 million increase in the
U.S. Mainland C&I portfolio.
C&I loans consist of loans made for commercial, financial, and agricultural
purposes and involves lending on both a secured and unsecured basis.
Collateral requirements vary, but are based on Pacific Century's underwriting
and collateral policies to ensure that consistent credit quality standards are
maintained.
The geographic distribution of C&I loans is concentrated in the U.S.
Mainland and Hawaii representing 59.2% and 33.1% of the loan portfolio,
respectively, as of year-end 1998. In Hawaii, Bank of Hawaii is a major
commercial lender and maintains a significant presence throughout the State.
Bank of Hawaii provides continuing support to the entire business community in
Hawaii by offering a wide range of products and services. At year-end 1998,
C&I loans in Hawaii totaled $853.2 million. In the U.S. Mainland market, C&I
lending totaled $1.5 billion at year-end 1998, up 33.6% over year-end 1997,
and is comprised largely of small and middle market business loans that were
originated by Pacific Century's U.S. Mainland subsidiary bank, as well as
loans to Fortune 500 industrial and service companies and the media and
communication industry.
Real Estate Loans
At year-end 1998, Pacific Century's total real estate loans (excluding
construction) were $3.8 billion, 6.2% below year-end 1997. This portfolio
consists of loans that are secured by residential as well as commercial
properties. Although real estate mortgage loans still continue to comprise the
largest portion of the loan portfolio, their level of representation has
declined from 43.1% of total loans at year-end 1997 to 39.0% at year-end 1998.
The largest component of the real estate loan portfolio consists of loans
secured by 1-to-4 family residential properties. At $2.7 billion, this
portfolio declined $39.5 million from year-end 1997, and represented 27.4% of
total loans outstanding at year-end 1998. More than 90% of these loans are
secured by real estate in Hawaii (see Table 7). Pacific Century originates
residential mortgages on both a fixed-rate and adjustable-rate basis. Most of
23
the fixed-rate products are sold in the secondary mortgage market, while
adjustable-rate mortgages are generally held in Pacific Century's loan
portfolio. Included in the residential mortgage total at year-end 1998 were
$260 million in available for sale loans. In recent years, Pacific Century has
focused on residential mortgage lending in Hawaii as an attractive line of
business. In 1998, residential mortgage originations by Bank of Hawaii totaled
$1.06 billion, the highest dollar amount ever originated by a mortgage lender
in the State of Hawaii. Comparatively, Bank of Hawaii originated $571 million
in residential mortgage loans in 1997.
Also included in the residential real estate portfolio are home equity
credit lines. The total available credit under these lines was $476.8 million
at year-end 1998, compared to $480.6 million at year-end 1997. Outstandings
declined to $261.2 million at year-end 1998 from $263.7 million at year-end
1997. Home equity credit lines are underwritten primarily based on the
borrower's repayment ability rather than the value of the underlying property.
The commercial real estate portfolio (excluding construction loans) totaled
$1.1 billion at year-end 1998, a decrease of 15.9% from year-end 1997.
Approximately 68% of these loans were secured by commercial real estate in
Hawaii. The commercial real estate portfolio is diversified in the type of
property securing the obligations, including loans secured by tract and land
development for residential housing, hotels, retail facilities, and commercial
offices.
Total commercial construction loans increased to $276.3 million at year-end
1998, compared to $268.1 million at year-end 1997. These loans are secured
primarily by properties located in Hawaii, which accounted for 61% of such
loans at December 31, 1998. Because construction lending is considered to
generally involve greater risk than financing on improved properties, Pacific
Century utilizes tighter underwriting and disbursement standards. The majority
of these loans are underwritten based on the projected cash flows of the
completed project, rather than the value of the underlying property, and
generally require a committed source for permanent financing.
Loan Portfolio Balances
Table 6
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(in millions of dollars)
Domestic Loans
Commercial and Industrial....... $2,579.7 $2,104.3 $1,806.7 $1,902.2 $1,830.8
Real Estate
Construction--Commercial...... 276.3 268.1 212.3 199.6 114.2
--Residential........... 23.5 12.9 23.6 33.7 39.7
Mortgage--Commercial.......... 1,139.1 1,354.5 1,227.8 1,308.8 1,241.0
--Residential............. 2,699.4 2,738.9 2,635.3 2,702.4 2,849.9
Installment..................... 763.0 891.6 849.3 817.3 741.6
Lease Financing................. 554.5 519.4 437.8 392.9 378.1
-------- -------- -------- -------- --------
Total Domestic.............. 8,035.5 7,889.7 7,192.8 7,356.9 7,195.3
Foreign Loans
Banks and Other Financial
Institutions................... 158.2 207.7 281.8 268.7 299.0
Commercial and Industrial....... 1,281.5 1,074.9 923.2 513.6 364.2
All Others...................... 378.8 326.1 301.5 13.2 33.5
-------- -------- -------- -------- --------
Total Foreign............... 1,818.5 1,608.7 1,506.5 795.5 696.7
-------- -------- -------- -------- --------
Total Loans................. $9,854.0 $9,498.4 $8,699.3 $8,152.4 $7,892.0
======== ======== ======== ======== ========
24
Installment Loans
Total installment loans (excluding residential mortgages and home equity
loans) were $763.0 million, down 14.4% from year-end 1997. At year-end 1998,
installment loans consisted of credit cards and consumer loans (e.g., auto
loans and unsecured credit lines). Consumer loans totaled $485.0 million as of
December 31, 1998, compared to $602.9 million as of December 31, 1997. In
1998, Pacific Century sold the majority of its guaranteed student loan
portfolio.
The credit card portfolio balance was $278.0 million at year-end 1998, a
decrease of 3.7% from year-end 1997. At year-end 1998, 0.77% of the credit
card portfolio (based on balances) were more than 90 days delinquent, compared
to 0.43% at year-end 1997. In the fourth quarter of 1998, the credit card
servicing function at the Bank of Hawaii was outsourced to a third party
vendor. This action will improve efficiency and reduce operating costs.
Leasing Activities
At year-end 1998, leases outstanding increased to $554.5 million, up 6.8%
from year-end 1997. This increase is attributed to a 25.7% growth in the U.S.
Mainland portfolio. Pacific Century's lease portfolio is diversified,
consisting primarily of leases on equipment, automobiles, trucks, ships,
aircraft, and computers.
Lending in the International and South Pacific Markets
Pacific Century's International Market predominately consists of Asia where
the business emphasis is primarily on correspondent banking, trade finance and
working capital loans for companies that have business interests in the Asia-
Pacific markets. The majority of International loans are short-term and are
largely based on Pacific Century's traditional focus on relationships. Foreign
loans in both the International and South Pacific Markets at the end of 1998
totaled $1.8 billion, an increase of 13.0% over year-end 1997. This increase
reflects approximately $211 million in loans acquired in the May 1998 Banque
Paribas acquisitions. Excluding the acquisitions, total foreign loans as of
December 31, 1998, would have remained nearly unchanged from year-end 1997. At
year-end 1998 foreign loans represented 18.5% of the total loan portfolio,
compared to 16.9% at year-end 1997.
Foreign loans in the South Pacific totaled $1.1 billion at December 31,
1998, an increase of 42.5% over $766.8 million at year-end 1997. This increase
is mostly accounted for by the Banque Paribas acquisitions. A large portion of
the South Pacific loan portfolio is in two subsidiary banks, Banque de Tahiti
and Bank of Hawaii--Nouvelle Caledonie, which in the aggregate held total
loans of $1.0 billion at the end of the current year.
At December 31, 1998, outstanding foreign loans to borrowers in the
International/Asia Market totaled $690.5 million, down from $818.6 million and
$738.6 million at December 31, 1997 and 1996, respectively. In addition,
outstanding commitments represented by open letters of credit and unused loan
commitments relative to borrowers in Asia were approximately $367 million at
year-end 1998. Additional information on Asian credit exposure and recent
Asian economic events are contained in the "International Operations" section
of this report.
25
Geographic Distribution of the Loan Portfolio
A geographic distribution of the loan portfolio is presented in Table 7
based on the geographic location of borrowers. Although loans in Hawaii still
constitute the highest geographic lending concentration, their proportion to
the total loan portfolio has declined to 50.2% at December 31, 1998 from 54.8%
at December 31, 1997. At year-end 1998, the percentage of U.S. Mainland loans
to total loans increased to 23.1% from 19.7% at year-end 1997.
The amounts reflected in the West Pacific include Guam and other locations
in the region where both Bank of Hawaii and First Savings have branches. Loan
balances in the South Pacific reflect the U.S. dollar equivalent balances of
subsidiary banks in French Polynesia, New Caledonia, Papua New Guinea, Vanuatu
and Bank of Hawaii branches in Fiji. Loan balances in American Samoa make up
the remainder of loans in the South Pacific region.
Geographic Distribution of Loan Portfolio/1/
Table 7
Total
Year-End West South U.S. Asia
1998 Hawaii Pacific Pacific Mainland and Other
-------- -------- ------- -------- -------- ---------
(in millions of dollars)
Commercial and Industri-
al..................... $2,579.7 $ 853.2 $182.5 $ 17.4 $1,525.9 $ 0.7
Real Estate
Construction--Commer-
cial................. 276.3 169.3 14.3 -- 92.7 --
- --Residential........... 23.5 22.1 1.3 0.1 -- --
Mortgage--Commercial.. 1,139.1 772.6 199.0 9.4 158.1 --
- --Residential........... 2,699.4 2,451.2 228.5 1.5 18.2 --
Installment............. 763.0 571.7 144.9 26.6 19.8 --
Foreign................. 1,818.5 35.5 -- 1,092.5 -- 690.5
Lease Financing......... 554.5 65.9 6.7 -- 462.8 19.1
-------- -------- ------ -------- -------- ------
Total............... $9,854.0 $4,941.5 $777.2 $1,147.5 $2,277.5 $710.3
-------- -------- ------ -------- -------- ------
Percentage of Total..... 100.0% 50.2% 7.9% 11.6% 23.1% 7.2%
======== ======== ====== ======== ======== ======
- --------
/1/ Loans classified based upon geographic location of borrowers.
Investment Securities
Pacific Century's investment portfolio is managed to provide liquidity and
interest income, offset interest rate risk positions and provide collateral
for cash management needs. At December 31, 1998, available-for-sale securities
increased to $3.0 billion from $2.6 billion at December 31, 1997. U.S.
government and agency mortgage-backed securities, as a percentage of the total
available-for-sale securities portfolio increased in 1998, while U.S.
government and agency debt securities decreased. Securities held to maturity
were $653 million at year-end 1998, down $567 million from year-end 1997.
Maturities of U.S. government and agency securities, as well as prepayments in
the mortgage-backed securities portfolio accounted for this decline. At year-
end 1998, the held to maturity portfolio consisted of debt securities
primarily with remaining contractual maturities of less than five years. Table
18 presents the maturity distributions, market value and weighted-average
yield to maturity of securities.
Deposits
As of December 31, 1998, total deposits were $9.6 billion, a 0.3% decline
from the year earlier date. During 1998, domestic deposits decreased $71
million, while foreign deposits increased $40 million. Comparability is
impacted by the May 1998 Paribas acquisitions, which added approximately $253
million to foreign deposits.
26
Excluding the acquisitions, total deposits at December 31, 1998 declined by
approximately 3.0% from year-end 1997. Competition for deposits by banks and
other financial institutions, as well as securities brokerage firms, continues
to impact the ability to attract and retain deposits.
Table 22 presents average deposits by type for the five years ended December
31, 1998.
Borrowings
Short-term borrowings, including funds purchased and securities sold under
agreements to repurchase (repos), totaled $3.3 billion at December 31, 1998,
compared to $3.2 billion at year-end 1997. The largest portion of short-term
borrowings consist of repos. Repos are offered to governmental entities as an
alternative to deposits and are supported by the same type of collateral. At
year-end 1998 repos were $2.0 billion, down from $2.3 billion at year-end
1997. This decline was more than offset by a $232 million increase in funds
purchased in 1998 and a $131 million increase in other short-term borrowings.
Included in short-term borrowings at December 31, 1998, were $127 million in
commercial paper.
Long-term debt on December 31, 1998 totaled $586 million, down from $706
million on December 31, 1997. This decline primarily results from a $65
million reduction in borrowings from the Federal Home Loan Bank of Seattle
(FHLB) and a $60 million reduction in private placement notes. FHLB borrowings
were $223 million at December 31, 1998, compared to $288 million at December
31, 1997. Private placement notes totaled $90 million and $150 million at
year-end 1998 and 1997, respectively. The year-over-year change in FHLB
borrowings and private placement notes reflect maturities. Also included in
long-term debt at year-end 1998 were $119 million in 6.875% subordinated notes
that mature in 2003 and $100 million in 8.25% Capital Securities that mature
in 2026.
International Operations
Pacific Century maintains an extensive international presence in the Asia-
Pacific region that provides opportunities to take part in lending,
correspondent banking and deposit-taking activities in these markets. These
activities are facilitated through Bank of Hawaii branches, a representative
office with extensions and full service subsidiary/affiliate banks. This
network of locations across Asia-Pacific enables our customers to facilitate
trade and investment between the U.S. Mainland, Asia, and the Pacific Islands.
Pacific Century divides its international business into two areas: the
International Market, which is Asia related and the Pacific Market, which
comprises the South and West Pacific Divisions.
Through the International Banking Group of Bank of Hawaii and Pacific
Century Bank, N.A., Pacific Century offers international banking services to
its corporate and financial institution customers in most of the major Asian
financial centers with support from its New York and Honolulu operations. Bank
of Hawaii's offices that offer these services are located in Hong Kong, the
Philippines (Manila, Cebu, and Davao), South Korea, Singapore, Japan, Taiwan,
and New York. The International Banking Group of Bank of Hawaii continues to
focus on correspondent banking and trade-related financing activities and
lending to customers with which it has a direct relationship.
The South Pacific Region consists of investments in subsidiary banks in
French Polynesia, New Caledonia, Papua New Guinea, Vanuatu, and Bank of Hawaii
branch operations in Fiji and American Samoa. Since American Samoa is U.S.
dollar based, its operation is included as domestic. Additionally, Bank of
Hawaii has interests in affiliate banks located in Samoa, Solomon Islands and
Tonga.
The Banks in the French territories are currently operating under a
management contract with Credit Lyonnais due to expire in 1999. The managers
of those areas have a direct reporting line to the South Pacific Manager at
Bank of Hawaii who is responsible for all operations in the French
Territories. The operations of subsidiaries and affiliates are evaluated on a
similar basis as branch offices. Exposure to foreign currency
27
fluctuations is in large measure limited to the unhedged positions of Pacific
Century's capital investment in these subsidiaries. The largest South Pacific
subsidiary operations are in the French territories of French Polynesia and
New Caledonia.
The West Pacific Division includes Bank of Hawaii branches in Guam and in
other locations in the region. Since the U.S. dollar is used in these
locations, the Company's operations in the West Pacific are not considered
foreign for financial reporting purposes.
Table 8 provides a summary of assets, liabilities, operating revenue, and
net income for Pacific Century's International Operations for the last three
years. Operating results in 1998 reflected a net loss of $0.8 million,
compared to net income of $10.2 million in 1997 due to significantly higher
foreign loan loss provisions (see "Credit Risk--Reserve for Loan Losses").
Pacific Century controls its risk exposure to international lending by
evaluating the political and economic factors that bear on a country's ability
to meet its foreign debt obligations. Based on these analyses, credit limits
(both short and long term) are established for each country to minimize and
control risk in the international portfolio. These credit limits are monitored
and reviewed on a regular basis so that risks and exposures are understood and
properly assessed. Pacific Century's strategy for foreign lending is to deal,
on a direct basis, primarily with countries and companies that have a strong
trade and investment interest in Hawaii and Asia-Pacific region.
Pacific Century's foreign lending consists of 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.
Cross-border interbank placements and loans were $760.2 million at year-end
1998. Table 9 presents, for the last three years, a geographic distribution of
international assets for which Pacific Century has cross-border exposure
exceeding 0.75% of total assets.
The countries in Asia to which Pacific Century maintains its largest credit
exposure on a cross-border basis include South Korea, Japan and Taiwan. At
December 31, 1998, cross-border credit exposure in Japan, South Korea, and
Taiwan were $355 million, $265 million and $124 million, respectively,
compared to $390 million, $413 million and $121 million, respectively, at
December 31, 1997. In Japan and Taiwan, despite pressures from neighboring
countries, the high levels of foreign exchange reserves have helped to
maintain relative economic stability. At Pacific Century, all exposures
relating to South Korea, Japan, Taiwan, Hong Kong, the Philippines and
Malaysia ended both December 31, 1998 and 1997 on a performing status.
With the implementation of the International Monetary Fund (IMF)
restructuring plan in late 1997 and throughout 1998, South Korea's foreign-
exchange reserves have significantly improved and rating agencies have
gradually raised South Korea's sovereign rating back to investment grade. Our
experience and history in the country continue to give us confidence in our
ability to manage our exposure in South Korea. Pacific Century's lending in
South Korea is focused on trade-related activities and is mostly short-term in
nature. Most of the South Korean loans are to financial institutions (e.g.,
national and regional banks) or to the top five major conglomerates. In the
first quarter of 1998, Pacific Century exchanged $83.5 million of short-term
loans to Korean banks into government guaranteed loans. These loans mature
over three years and bear interest at 2.25% to 2.75% over the six-month London
Interbank Offering Rate. During 1998, there were no charge-offs taken on any
South Korean loan.
Within Asia, the two most problematic economies for Pacific Century remain
Thailand and Indonesia. The financial and liquidity problems in Thailand and
Indonesia required the intervention of the IMF. Pacific Century's cross-border
credit assets in Thailand and Indonesia at December 31, 1998 were
approximately $24 million and
28
$17 million, respectively, compared to $74 million and $21 million,
respectively, at year-end 1997. In the first quarter of 1998, $5.7 million in
U.S. dollar denominated Thai finance company loans were exchanged for Thai
baht denominated government deposits. Charge-offs relative to Thai exposures
in 1998 totaled $22.1 million, while recoveries were $5.2 million. Total Thai
non-performing credits at December 31, 1998 were $7.6 million, down from $17.6
million at year-end 1997. With respect to Indonesia, non-performing credits
totaled $0.7 million at December 31, 1998. During 1998, $12.6 million in
exposures to Indonesian banks were converted to sovereign risk in conjunction
with a government sponsored plan to support the local banking system. The
converted loans mature over four years. Overall at the end of 1998, the IMF
has praised the steps that Thailand has taken to recover from its economic
turmoil. Indonesia remains volatile as it attempts to sort through its
economic and political problems.
In view of the risks, Pacific Century increased its provision for loan
losses in 1998 as more fully discussed in the section on "Credit Risk--Reserve
for Loan Losses." Pacific Century continues to monitor its international
activities on a country by country basis as events evolve and will take such
actions as appropriate. Pacific Century believes that it has prudently managed
its exposure in Asia and has dealt with the known situations. However, because
of the uncertainties, it is difficult to accurately predict the impact of the
turmoil in Asia on the economies of Hawaii and the U.S. Mainland, changes in
currencies of Pacific region countries relative to the U.S. dollar, changes in
interest rates, and changes in applicable U.S. and foreign regulatory and
monetary policy. Moreover, it is not known what, if any, further impact there
will be on Pacific Century's Asian exposure resulting from future events.
Summary of International Assets, Liabilities, and Income and Percent of
Consolidated Totals
Table 8
1998 1997 1996
----------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- -------
(in millions of dollars)
Average Assets.............. $3,426.6 23.0% $3,005.1 21.1% $2,752.6 20.7%
Average Liabilities......... 3,348.8 24.4 2,523.3 19.2 2,687.6 22.0
Operating Revenue........... 287.9 21.9 215.9 17.4 192.1 16.8
Net Income (Loss)........... (0.8) N.M. 10.2 7.3 8.1 6.1
29
Geographic Distribution of Cross-Border International Assets/1/
Table 9
Government Commercial
and Other Banks and and
Official Other Financial Industrial
Institutions Institutions/2/ Companies Total
------------ --------------- ---------- --------
(in millions of dollars)
at December 31, 1998
Japan........................ $ -- $223.7 $131.1 $ 354.8
South Korea.................. 85.8 94.4 84.7 264.9
Taiwan....................... -- 41.6 82.3 123.9
All Others/3/ ............... 39.9 400.5 188.7 629.1
------ ------ ------ --------
$125.7 $760.2 $486.8 $1,372.7
====== ====== ====== ========
at December 31, 1997
South Korea.................. $ -- $219.7 $193.5 $ 413.2
Japan........................ -- 253.1 136.8 389.9
Taiwan....................... 57.5 39.5 23.8 120.8
All Others................... 48.4 322.9 154.5 525.8
------ ------ ------ --------
$105.9 $835.2 $508.6 $1,449.7
====== ====== ====== ========
at December 31, 1996
South Korea.................. $ -- $253.0 $122.4 $ 375.4
Japan........................ -- 196.0 115.8 311.8
Taiwan....................... -- 108.6 18.2 126.8
Thailand..................... -- 74.2 47.4 121.6
All Others................... 1.0 300.0 69.8 370.8
------ ------ ------ --------
$ 1.0 $931.8 $373.6 $1,306.4
====== ====== ====== ========
- --------
/1/ In this table, 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. Monetary assets include loans,
acceptances, and interest-bearing deposits with other banks.
/2/ Includes U.S. dollar advances to foreign branches and affiliate banks
which were used to fund local currency transactions. Totals for 1998, 1997
and 1996 were $411.1 million, $419.9 million and $327.9 million,
respectively.
/3/ At December 31, 1998, the all others category included cross-border
outstandings of $62.2 million in French Polynesia and $50.4 million in New
Caledonia. The currency of both of these countries is the Pacific franc.
Corporate Risk Profile
Credit Risk
Non-Performing Assets and Past Due Loans
Non-performing assets (NPAs) consist of non-accrual loans, restructured
loans and foreclosed real estate. These assets, which generally have more than
a normal risk of loss, totaled $137.5 million at year-end 1998, compared to
$97.1 million at the end of 1997, and $83.2 million at the end of 1996. While
increasing from the prior year-end, the level of NPAs peaked at the end of the
third quarter at $151.5 million, with much of the increase resulting from
portfolios in the French territories.
At year-end 1998, the ratio of NPAs to outstanding loans rose to 1.40%.
Comparatively the ratio was 1.02% and 0.96% for 1997 and 1996, respectively.
Table 10 presents Pacific Century's NPAs and ratio of NPAs to total loans for
the last five years.
30
In order to minimize credit losses, Pacific Century strives to maintain high
underwriting standards, identify potential problem loans early and work with
borrowers to cure delinquencies. Moreover, charge-offs, if required, are taken
promptly and reserve levels are maintained at adequate levels. Pacific
Century's policy is to place loans on non-accrual status when a loan is over
90 days delinquent, unless collection is likely based on specific factors such
as the type of borrowing agreement and/or collateral. At the time a loan is
placed on non-accrual, all accrued but unpaid interest is reversed against
current earnings.
Total non-accrual loans rose to $131.9 million at year-end 1998, up 47.7%
over year-end 1997. Higher non-accrual balances in the foreign and commercial
loan categories accounted for most of this increase. Relative to the end of
1998's third quarter, non-accrual loans reflected a decrease of $8.7 million.
At December 31, 1998, foreign loans on non-accrual were $57.5 million,
compared to $39.9 million at December 31, 1997 and $22.3 million at December
31, 1996. The increase relative to 1998 primarily reflects a $26.5 million
rise in non-accrual loans in the South Pacific from $22.4 million at year-end
1997 to $48.9 million at year-end 1998. New Caledonia accounts for most of the
higher non-accruals in the South Pacific, reporting a year-to-year increase of
$24.5 million from $5.0 million at year-end 1997 to $29.5 million at year-end
1998. In French Polynesia non-accrual loans remained relatively flat at $15.4
million at December 31, 1998, compared to $15.5 million at the year earlier
date. Included in the non-accrual totals for both New Caledonia and French
Polynesia were the effects of the Banque Paribas acquisitions.
In Asia, loans reported as non-accrual at December 31, 1998 were
approximately $8.6 million, down from $17.6 million at December 31, 1997.
Additional information relative to Asian exposure is contained in the
"International Operations" section of this report.
C&I loans classified as non-accrual totaled $28.2 million at year-end 1998,
an increase from $10.7 million and $20.9 million at year-end 1997 and 1996,
respectively. Contributing to the 1998 increase was the addition of a Hawaii-
based loan of $12.3 million for which partial charge-offs were taken in 1998.
At December 31, 1998, non-accrual loans secured by real estate totaled $44.7
million, or 33.9% of total non-accrual loans; with the majority of these loans
secured by residential real estate in Hawaii. Non-performing residential
mortgages (excluding construction loans) totaled $36.4 million at year-end
1998, compared to $32.9 million at year-end 1997, reflecting a year-over-year
increase of $3.5 million. Although residential mortgage non-accruals have
increased, ch