UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2006

OR

for the transition period from                         to                        

Commission File Number 1-6887

BANK OF HAWAII CORPORATION

(Exact name of registrant as specified in its charter)

 

1-888-643-3888

(Registrant’s telephone number, including area code)

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

 

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

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  x    No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes  o    No x

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 o

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

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

 

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

Yes  o    No x

The aggregate market value of the registrant’s outstanding voting common stock held by non-affiliates on June 30, 2006 (the last business day of the registrant’s most recently completed second fiscal quarter), determined using the per share closing price on that date on the New York Stock Exchange of $49.60, was approximately $2,480,825,146. There was no non-voting common equity of the registrant outstanding on that date.

As of February 13, 2007, there were 49,724,711 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement relating to the Annual Meeting of Shareholders to be held on April 27, 2007, are incorporated by reference into Part III of this Report.

Bank of Hawaii Corporation

						Page
Index
Part I		Item 1.		Business		2
		Item 1A.		Risk Factors		7
		Item 1B.		Unresolved Staff Comments		9
		Item 2.		Properties		9
		Item 3.		Legal Proceedings		9
		Item 4.		Submission of Matters to a Vote of Security Holders		9
Part II		Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities		11
		Item 6.		Selected Financial Data		13
		Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operation		14
		Item 7A.		Quantitative and Qualitative Disclosures About Market Risk		41
		Item 8.		Financial Statements and Supplementary Data		41
		Item 9.		Changes in and Disagreements With Accountants on Accounting and Financial Disclosure		82
		Item 9A.		Controls and Procedures		82
		Item 9B.		Other Information		85
Part III		Item 10.		Directors, Executive Officers, and Corporate Governance		85
		Item 11.		Executive Compensation		85
		Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		85
		Item 13.		Certain Relationships and Related Transactions, and Director Independence		85
		Item 14.		Principal Accounting Fees and Services		85
Part IV		Item 15.		Exhibits, Financial Statement Schedules		86
signatures						88

 

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Part I

Item 1. Business

General

Bank of Hawaii Corporation (the “Parent”) is a Delaware corporation and a bank holding company (“BHC”).

The Parent’s banking subsidiary, Bank of Hawaii (the “Bank”), was organized under the laws of the state of Hawaii on December 17, 1897 and has its headquarters in Honolulu, Hawaii. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”). The Bank is a member of the Federal Reserve System. The only other direct subsidiary of the Parent is Bancorp Hawaii Capital Trust I, a grantor trust, organized to issue trust preferred securities.

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

The Company is aligned into the following business segments: Retail Banking, Commercial Banking, Investment Services, and Treasury. Financial and other additional information about the Company’s business segments are presented in the Analysis of Business Segments section of Management’s Discussion and Analysis of Financial Condition and Results of Operation (“MD&A”), including Table 5, and Note 11 to the Consolidated Financial Statements, which is incorporated herein by reference.

Information on the Bank’s limited foreign activities is presented in Table 9 of MD&A, which is incorporated herein by reference.

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

The Company included the Chief Executive Officer and the Chief Financial Officer certifications regarding the Company’s public disclosure required by Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1 and 31.2 of this report. Additionally, the Company filed with the New York Stock Exchange (the “NYSE”) the Chief Executive Officer certification regarding the Company’s compliance with the NYSE’s Corporate Governance Listing Standards (the “Listing Standards”) pursuant to Section 303A.12(a) of the Listing Standards. The certification was dated May 19, 2006 and indicated that the Chief Executive Officer was not aware of any violations of the Listing Standards by the Company.

Competition

The Company is subject to substantial competition from banks, savings associations, credit unions, mortgage companies, finance companies, mutual funds, brokerage firms, insurance companies, and other providers of financial services, including financial service subsidiaries of commercial and manufacturing companies. The

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Company also competes with certain non-financial institutions that offer financial products and services. Some of the Company’s competitors are not subject to the same level of regulation and oversight that is required of banks and BHCs, and competitors, through alternative delivery channels such as the internet, may be based outside of the local markets in which we serve. The Company competes based primarily on its reputation in the Company’s key markets, its extensive branch network, its service levels, and its knowledge of local trends and conditions.

Supervision and Regulation

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

The Parent

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

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

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

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

In addition, under provisions of the Code enacted to authorize interstate branching under the Riegle-Neal Act, out-of-state banks may engage in mergers with Hawaii banks or acquisitions of substantially all of their assets, following which any such out-of-state bank may operate the branches of the Hawaii bank it has acquired. The Hawaii Commissioner of Financial Institutions is authorized to waive the federal limit on concentration of FDIC-insured

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deposits. This statute also permits out-of-state banks to acquire branches of Hawaii banks and to open branches in Hawaii on a de novo basis.

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

Bank of Hawaii

The Bank is subject to supervision and examination by the Federal Reserve Bank of San Francisco and the State of Hawaii Department of Commerce and Consumer Affairs Division of Financial Institutions. Depository institutions, including the Bank, are subject to extensive federal and state regulation that significantly affects their business and activities. Regulatory bodies have broad authority to implement standards and to initiate proceedings designed to prohibit depository institutions from engaging in activities that represent unsafe and unsound banking practices or constitute violations of applicable laws, rules, regulations, administrative orders, or written agreements with regulators. The standards relate generally to operations and management, asset quality, interest rate exposure, capital, and executive compensation. The agencies are authorized to take action against institutions that fail to meet such standards, including the assessment of civil monetary penalties, the issuance of cease-and-desist orders, and other actions.

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

Capital Requirements

The FRB has issued substantially similar risk-based and leverage capital guidelines applicable to BHCs and banks that they supervise. Under the risk-based capital requirements, the Company and the Bank are each generally required to maintain a minimum ratio of total capital to risk-weighted assets of 8%. At least half of the total capital is to be composed of common equity, retained earnings, and qualifying perpetual preferred stock, less certain intangibles (“Tier 1 Capital”). The remainder may consist of certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock, and a limited amount of the allowance for loan and lease losses (“Tier 2 Capital”) and, together with Tier 1 Capital, equals total capital (“Total Capital”). Risk weighted assets are calculated by taking assets and credit equivalent amounts of off-balance-sheet items and assigning them to one of several broad risk categories, according to the obligor, or, if relevant, the guarantor or the nature of the collateral. The aggregate dollar value of the amount in each category is then multiplied by the risk weight associated with that category. As of December 31, 2006, the Company’s ratios of Tier 1 Capital and Total Capital to total risk-weighted assets were 9.99% and 11.92%, respectively, and the Bank’s ratios of Tier 1 Capital and Total Capital to total risk-weighted assets were 9.91% and 11.84%, respectively.

In addition, each of the federal bank regulatory agencies has established minimum leverage capital ratio requirements for BHCs and banks. These requirements provide for a minimum leverage ratio of Tier 1 Capital to adjusted quarterly average assets equal to 3% for BHCs and banks that meet certain specified criteria, including that they have the highest regulatory rating and are not experiencing significant growth or expansion. All other BHCs and banks will generally be required to maintain a leverage ratio of at least 100 to 200 basis points above the stated minimum. As of December 31, 2006, the Company’s leverage ratio was 7.06% and the Bank’s leverage ratio was 7.01%.

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

Dividend Restrictions

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

For information regarding the limitations on Bank dividends, see Note 10 to the Consolidated Financial Statements, which is incorporated herein by reference.

Transactions with Affiliates

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

FDIC Insurance

The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC. The DIF was created by the merger of the Bank Insurance Fund (“BIF”) and Savings Association Insurance Fund (“SAIF”) provided for in the Federal Deposit Insurance Reform Act of 2005 (“FDIRA”), as enacted in February 2006. This legislation also increased insurance coverage for retirement accounts to $250,000 and indexed the insurance levels for inflation, among other changes. In addition, as a result of the FDIRA, the FDIC has adopted a revised, risk-based assessment system to determine assessment rates to be paid by member institutions, such as the Bank. Under this revised assessment system, risk is defined and measured using an institution’s supervisory ratings, combined with certain other risk measures, including certain financial ratios and long-term debt issuer ratings. The annual risk based assessment rates for 2007 range from $0.05 to $0.43 per $100 of insured deposits. The FDIRA also provided for a one-time assessment credit, to be allocated among member institutions. The FDIC one-time assessment credit may be used to offset future deposit insurance assessments beginning in 2007.

In addition to DIF assessments, beginning in 1997 the FDIC assessed BIF-assessable and SAIF-assessable deposits to fund the repayment of debt obligations of the Financing Corporation. The Financing Corporation is a government-sponsored entity that was formed to borrow the money necessary to carry out the closing and ultimate disposition of failed thrift institutions by the Resolution Trust Corporation. As of January 1, 2007, the annualized rate of risk-adjusted deposits, established by the FDIC for all DIF-assessable deposits, was 1.22 basis points (hundredths of 1%). For the year ended December 31, 2006, the Bank’s Financing Corporation insurance assessment expense was $1.1 million.

Under federal law, deposits and certain claims for administrative expenses and employee compensation against insured depository institutions are afforded a priority over other general unsecured claims against such an institution,

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including federal funds and letters of credit, in the liquidation or other resolution of such an institution by any receiver appointed by regulatory authorities. Such priority creditors would include the FDIC.

Other Safety and Soundness Regulations

Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) the federal banking agencies possess broad powers to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” as defined by the law. Under regulations established by the federal banking agencies, a “well capitalized” institution must have a Total Capital ratio of at least 10%, a Tier 1 Capital ratio of at least 6%, a leverage ratio of at least 5%, and not be subject to a capital directive order. An “adequately capitalized” institution must have a Total Capital ratio of at least 8% and Tier 1 Capital and leverage ratios of at least 4%. As of December 31, 2006, the Bank was classified as “well capitalized.”  The classification of depository institutions is primarily for the purpose of applying the federal banking agencies’ prompt corrective action provisions and is not intended to be, and should not be, interpreted as a representation of overall financial condition or prospects of any financial institution.

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

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

Community Reinvestment and Consumer Protection Laws

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

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

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Bank Secrecy Act / Anti-Money Laundering Laws

The Bank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA PATRIOT Act of 2001. Among other things, these laws and regulations require the Bank to take steps to prevent the use of the Bank for facilitating the flow of illegal or illicit money, to report large currency transactions, to file suspicious activity reports, and to implement appropriate compliance programs, training, risk assessments, and “know your customer” programs. Violations of these requirements can result in substantial civil and criminal sanctions. In addition, provisions of the USA PATRIOT Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and BHC acquisitions.

Privacy Requirements

Federal banking regulators, pursuant to GLBA, have enacted regulations limiting the ability of banks and other financial institutions to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with non-affiliated third parties.

Employees

As of January 31, 2007, the Company had approximately 2,600 employees.

Item 1A. Risk Factors

There are a number of risks and uncertainties that could cause our financial results and condition to differ materially from expected results.

Changes in business and economic conditions, in particular those of Hawaii and the Pacific Islands (Guam and nearby islands and American Samoa) could lead to lower revenue, lower asset quality, and lower earnings.

Our business and earnings are closely tied to general business and economic conditions, particularly the economies of Hawaii and the Pacific Islands, which are heavily influenced by tourism, government, and other service-based industries. Factors that could affect the general economy include geopolitical risks, such as real or threatened acts of war or terrorism, higher energy costs, reduced consumer or corporate spending, natural disasters or adverse weather, public health issues, and the normal cyclical nature of the economy. A sustained economic downturn could adversely affect the quality of our assets, credit losses, and the demand for our products and services, which could lead to lower revenue and lower earnings.

Changes in interest rates could adversely impact our results of operations.

Our earnings are highly dependent on the spread between the interest earned on loans, leases, and investment securities and the interest paid on deposits and borrowings. Changes in market interest rates impact the rates earned on loans, leases, and investment securities and the rates paid on deposits and borrowings. In addition, changes to market interest rates could impact the level of loans, leases, investment securities, deposits, and borrowings, and the credit profile of existing loans and leases. Interest rates may be affected by many factors beyond our control, including general economic conditions, and the monetary and fiscal policies of various governmental and regulatory authorities. Changes in interest rates may negatively impact our ability to attract deposits, originate loans and leases, and achieve satisfactory interest rate spreads which could adversely affect our financial condition or results of operations.

Our reserve for credit losses may not be adequate to cover actual loan and lease losses.

The risk of nonpayment of loans and leases is inherent in all lending activities, and nonpayment, if it occurs, may have an adverse effect on our financial condition or results of operation. We maintain a reserve for credit losses to absorb estimated probable credit losses inherent in the loan and lease and commitment portfolios as of the balance

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sheet date. In determining the level of the reserve for credit losses, management makes various assumptions and judgments about the loan and lease portfolio. If our assumptions are incorrect, the reserve for credit losses may not be sufficient to cover losses, which could adversely affect our financial condition or results of operations.

Many of our loans are secured by real estate in Hawaii and Guam. If these locations experience an economic downturn that impacts real estate values and customers’ ability to repay, loan and lease losses could exceed the estimates that are currently included in the reserve for credit losses.

Our operations are subject to extensive regulation.

Our operations are subject to extensive regulation by federal and state governmental authorities. The regulations are primarily intended to protect depositors, customers and the banking system as a whole. Failure to comply with all applicable regulations could lead to severe penalties and damage to our reputation. Furthermore, the regulatory environment is constantly undergoing change and the impact of changes to laws and regulations, the interpretation of such laws or regulations, or other actions by regulatory agencies could make regulatory compliance more difficult or expensive for us.

Competition may adversely affect our business.

Our future growth and success depends on our ability to compete effectively. We compete for deposits, loans, leases, and other financial services with a variety of competitors, including banks, thrifts, credit unions, mortgage companies, broker dealers, and insurance companies all of which may be based in or out of Hawaii and the Pacific Islands. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. Failures to effectively compete, innovate, and make effective use of available channels to deliver our products and services could adversely affect our financial condition or results of operations.

Our liquidity is dependent on dividends from the Bank.

The Bank’s ability to pay dividends to the Parent is limited by various statutes and regulations. It is possible, depending upon the financial condition of the Bank and other factors that the Federal Reserve Board could assert that payment of dividends from the Bank to Parent would be an unsafe or unsound practice. In the event the Bank was unable to pay dividends to the Parent, dividends on our common stock which we pay to shareholders could be adversely affected. Failure to pay dividends or a reduction in the dividend rate could have a material adverse effect on the market price of our common stock.

An interruption or breach in security of our information systems may result in a loss of customers.

We rely heavily on communications and information systems to conduct our business. In addition, we rely on third parties to provide key components of our infrastructure, including loan, deposit and general ledger processing, internet connections, and network access. Any disruption in service of these key components could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our operations. Furthermore, any security breach of our information systems or data, whether managed by us or by third parties, could harm our reputation or cause a decrease in the number of customers that choose to do business with us.

Reputational and legal risk.

Reputational harm could result from our actual or alleged conduct in a variety of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues, or inadequate protection of customer information. We use significant resources to comply with our various regulatory requirements, including the requirements of the Sarbanes-Oxley Act of 2002, and any failure to comply could result in reputational harm or significant legal or remediation costs. Damage to our reputation could adversely affect our ability to retain and attract new customers. In addition, new litigation or changes in existing litigation, claims and assessments, environmental liabilities and costs involved in resolving or defending against any such matters could have a negative effect on our financial condition or results of operations.

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Changes in accounting standards or in income tax laws or interpretations could materially affect our financial condition or results of operations.

Our accounting policies and methods are fundamental to how we report our financial condition and results of operations. Some of these policies require use of estimates and assumptions that may affect the value of our assets, liabilities, and financial results. Periodically, new accounting standards are issued or revisions made to existing standards that may change the methods governing the preparation of our financial statements. Similarly, new tax legislation could be enacted or interpretations of existing tax laws could change causing an adverse effect to our financial condition or results of operations.

Our performance depends on attracting and retaining key employees and skilled personnel to operate our business effectively.

There are a limited number of qualified personnel in the markets we serve, so our success depends in part on the continued services of many of our current management and other key employees. Hawaii’s current low unemployment rate also contributes to the difficulty of attracting and retaining qualified employees at all management and staffing levels. Failure to maintain our key employees and maintain adequate staffing of qualified personnel could adversely impact our operations and our ability to compete.

Item 1B. Unresolved Staff Comments

Not Applicable.

Item 2. Properties

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

Item 3. Legal Proceedings

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

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

No matter was submitted during the fourth quarter of 2006 to a vote of security holders through solicitation of proxies or otherwise.

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Executive Officers of the Registrant:

Listed below are executive officers of the Parent as of February 13, 2007.

Name		Age		Position
Allan R. Landon		58		Chairman and Chief Executive Officer since September 2004; President since December 2003; Chief Operating Officer from May 2004 to August 2004; Vice Chairman from February 2001 to December 2003; Chief Financial Officer from February 2001 to April 2004.
Peter S. Ho		41		Vice Chairman and Chief Banking Officer since January 2006, areas of responsibility include Commercial Banking and Investment Services; Vice Chairman, Investment Services from April 2004 to December 2005; Executive Vice President, Hawaii Commercial Banking Group from February 2003 to April 2004; Executive Vice President, Corporate Banking Division Manager from January 2002 to January 2003.
Richard C. Keene		47		Vice Chairman and Chief Financial Officer since May 2004; Executive Vice President and Controller from January 2002 to April 2004; as disclosed in the Company’s Form 8-K, filed with the SEC on January 22, 2007, Mr. Keene will be leaving the Company in the first quarter of 2007.
Mark A. Rossi		58		Vice Chairman, Chief Administrative Officer and Corporate Secretary since February 2007; President of Lane Powell from July 2004 to January 2007; Partner of Lane Powell Spears Lubersky, LLP from April 1996 to July 2004.
Mary E. Sellers		50		Vice Chairman and Chief Risk Officer since July 2005; Executive Vice President, Director of Risk Management from June 2003 to June 2005; Executive Vice President, Credit Review Manager from January 2002 to June 2003.
Donna A. Tanoue		52		Vice Chairman since February 2007; Vice Chairman, Corporate and Regulatory Administration and Chief Administrative Officer from April 2004 to January 2007; Vice Chairman, Investment Services from April 2002 to April 2004; independent consultant for the Bank, September 2001 to March 2002.
David W. Thomas		55		Vice Chairman and Chief Operating Officer since January 2006, areas of responsibility include Retail Banking and Technology and Operations; Vice Chairman, Retail Banking from April 2001 to December 2005.

 

10

Part II

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

Market Information, Shareholders, and Dividends

The common stock of the Parent is traded on the New York Stock Exchange (NYSE Symbol: BOH) and quoted daily in leading financial publications. As of February 13, 2007, there were 7,869 common shareholders of record.

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

Market Prices, Book Values, and Common Stock Dividends Per Share
		Market Price Range												Dividends
Year/Period		High			Low			Close			Book Value			Declared
2006		$	55.15		$	47.00		$	53.95		$	14.45		$	1.52
First Quarter		55.15			51.40			53.31						0.37
Second Quarter		54.51			48.33			49.60						0.37
Third Quarter		50.75			47.00			48.16						0.37
Fourth Quarter		54.59			47.54			53.95						0.41
2005		$	54.44		$	43.82		$	51.54		$	13.52		$	1.36
First Quarter		50.95			44.33			45.26						0.33
Second Quarter		51.30			43.82			50.75						0.33
Third Quarter		54.44			47.44			49.22						0.33
Fourth Quarter		53.19			47.21			51.54						0.37
2004		$	51.10		$	40.97		$	50.74		$	14.83		$	1.23

 

The Parent’s Board of Directors considers on a quarterly basis the feasibility of paying a cash dividend to its shareholders. Under the Parent’s general practice, dividends are declared upon completion of a quarter and are paid prior to the end of the subsequent quarter. Dividends declared are based, in part, on the expected earnings for the subsequent quarter. For additional information regarding the limitation on the Parent’s ability to pay dividends, see “Dividend Restrictions” under “Supervision and Regulation” in Item 1 of this report and Note 10 to the Consolidated Financial Statements, which are incorporated herein by reference.

Issuer Purchases of Equity Securities
Period		Total Number of  Shares Purchased 1		Average Price  Paid Per Share			Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs 2
October 1 - 31, 2006		146,104		$	48.86		145,000			$	101,381,786
November 1 - 30, 2006		109,270		52.06			105,000			95,914,431
December 1 - 31, 2006		90,222		52.19			87,500			91,346,370
Total		345,596		$	50.74		337,500

 

1         The months of October, November, and December 2006 included 1,104, 4,270, and 2,722 mature shares, respectively, purchased from employees in connection with stock option exercises. These shares were not purchased as part of a publicly announced program. The shares were purchased at the closing price of the Parent’s common stock on the dates of purchase.

2         The Company repurchased shares during the fourth quarter of 2006 pursuant to its ongoing share repurchase program that was first announced in July 2001. As of February 13, 2007, $80.7 million remained of the $1.55 billion total repurchase amount authorized by the Parent’s Board of Directors under the share repurchase program. The program has no set expiration or termination date.

Employee Compensation Plan Information

For information on the Company’s Equity Compensation Plan Information, see Item 12 of this report, which is incorporated herein by reference.

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Performance Graph

The following graph shows the cumulative total return for the Parent’s common stock compared to the cumulative total returns for the Standard & Poor’s (“S&P”) 500 Index and the S&P Banking Index. The graph assumes that $100 was invested on December 31, 2001 in the Parent’s common stock, the S&P 500 Index, and the S&P Banking Index. The cumulative total return on each investment is as of December 31 of each of the subsequent five years and assumes reinvested dividends.

CUMULATIVE TOTAL RETURN
Based upon an initial investment of $100 on December 31, 2001
with dividends reinvested

 

		Dec-2001					Dec-2002					Dec-2003					Dec-2004					Dec-2005					Dec-2006
Bank of Hawaii Corporation			$	100				$	120				$	171				$	212				$	221				$	238
S&P 500 Index			$	100				$	78				$	100				$	111				$	117				$	135
S&P Banking Index			$	100				$	99				$	125				$	143				$	141				$	164

 

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Item 6. Selected Financial Data

Summary of Selected Consolidated Financial Data
(dollars in millions, except per share amounts)		2006			2005			2004			2003			2002
Year Ended December 31,
Operating Results
Net Interest Income		$	402.6		$	407.1		$	390.6		$	365.9		$	370.2
Provision for Credit Losses		10.8			4.6			(10.0		)	-			11.6
Net Income		180.4			181.6			173.3			135.2			121.2
Basic Earnings Per Share		3.59			3.50			3.26			2.32			1.75
Diluted Earnings Per Share		3.52			3.41			3.08			2.21			1.70
Dividends Declared Per Share		1.52			1.36			1.23			0.87			0.73
Performance Ratios
Net Income to Average Total Assets		1.76		%	1.81		%	1.78		%	1.44		%	1.22		%
Net Income to Average Shareholders’ Equity		25.90			24.83			22.78			15.02			10.24
Net Interest Margin 1		4.25			4.38			4.32			4.23			3.99
Operating Leverage 2		3.13			10.54			26.33			3.75			(36.58		)
Efficiency Ratio 3		51.87			53.15			56.14			63.38			64.94
Dividend Payout Ratio 4		42.34			38.86			37.73			37.50			41.71
Average Shareholders’ Equity to Average Assets		6.80			7.29			7.81			9.60			11.88
Allowance to Loans and Leases Outstanding		1.37			1.48			1.78			2.24			2.67
Tier 1 Capital Ratio		9.99			10.36			12.13			12.54			16.59
Total Capital Ratio		11.92			12.70			14.89			15.81			19.96
Leverage Ratio 5		7.06			7.14			8.29			8.43			10.34
As of December 31,
Balance Sheet Totals
Net Loans and Leases		$	6,532.2		$	6,077.4		$	5,880.1		$	5,628.1		$	5,216.2
Total Assets		10,571.8			10,187.0			9,766.2			9,461.6			9,516.4
Total Deposits		8,023.4			7,907.5			7,564.7			7,332.8			6,920.2
Long-Term Debt		260.3			242.7			252.6			324.1			389.8
Total Shareholders’ Equity		719.4			693.4			814.8			793.1			1,015.8
Average Assets		10,241.4			10,023.7			9,745.5			9,377.5			9,961.2
Average Loans and Leases		6,369.2			6,104.4			5,786.6			5,525.6			5,411.4
Average Deposits		7,731.0			7,766.5			7,422.3			7,045.8			6,599.9
Average Shareholders’ Equity		696.3			731.1			761.0			900.1			1,183.5
Non-Financial Data
Common Shareholders of Record at Year-End		7,888			7,940			8,171			9,561			10,550
Basic Weighted Average Shares		50,176,685			51,848,765			53,232,815			58,338,566			69,385,745
Diluted Weighted Average Shares		51,178,943			53,310,816			56,241,044			61,085,567			71,447,333

 

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

2         The operating leverage is defined as the percentage change in income before provision for credit losses and provision for income taxes. The operating leverage for 2002 was affected by divestitures that occurred in 2001.

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

4         The dividend payout ratio is defined as dividends declared per share divided by basic earnings per share.

5         The Company’s leverage ratio as of December 31, 2006, as previously disclosed in the Company’s earnings release on January 22, 2007, has been corrected to exclude the adjustment to initially adopt FASB Statement No. 158 from Tier 1 capital to comply with recently issued regulatory requirements.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

Forward-Looking Statements

This report contains forward-looking statements concerning, among other things, the economic and business environment in the Company’s service area and elsewhere, credit quality, and other financial and business matters in future periods. The Company’s forward-looking statements are based on numerous assumptions, any of which could prove to be inaccurate and actual results may differ materially from those projected because of a variety of risks and uncertainties, including, but not limited to: 1) general economic conditions are less favorable than expected; 2) competitive pressure among financial services and products; 3) the impact of legislation and the regulatory environment; 4) fiscal and monetary policies of the markets in which the Company serves; 5) any actual or alleged conduct which could harm the Company’s reputation; 6) changes in accounting standards; 7) changes in tax laws or regulations or the interpretation of such laws and regulations; 8) changes in the Company’s credit quality or risk profile that may increase or decrease the required level of reserve for credit losses; 9) changes in market interest rates that may affect the Company’s credit markets and ability to maintain its net interest margin; 10) unpredicted costs and other consequences of legal or regulatory matters involving the Company; 11) changes to the amount and timing of the Company’s proposed equity repurchases; and 12) geopolitical risk, military or terrorist activity, natural disaster, adverse weather, public health and other conditions impacting the Company and its customers’ operations. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included under the section entitled “Risk Factors” in Part I of this report. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted” and similar expressions are intended to identify forward-looking statements but are not exclusive means of identifying such statements. The Company does not undertake an obligation to update forward-looking statements to reflect later events or circumstances.

Critical Accounting Estimates

The Company’s Consolidated Financial Statements were prepared in accordance with U.S. generally accepted accounting principles and follow general practices within the industries in which it operates. The most significant accounting policies followed by the Company are presented in Note 1 to the Consolidated Financial Statements, which is incorporated herein by reference. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. Critical accounting estimates are defined as those that require assumptions or judgments to be made based on information available as of the date of the financial statements. Certain policies inherently have a greater reliance on the use of estimates. Those policies have a greater possibility of producing results that could be materially different than reported if there is a change to any of the estimates, assumptions, or judgments made by management. Based on the potential impact to the financial statements of the valuation methods, estimates, assumptions, and judgments used, management identified the determination of the reserve for credit losses, the valuation of mortgage servicing rights, the valuation of leased asset residual values, the valuation of pension and postretirement obligations, and the determination of income tax expense and liability to be the accounting estimates that are the most subjective and/or judgmental.

Reserve for Credit Losses

A consequence of lending activities is that we may incur losses. The amount of such losses will vary from time to time depending upon the risk characteristics of the loan and lease portfolio as affected by economic conditions, including rising interest rates, and the financial performance of borrowers. The Company maintains a reserve for credit losses which consists of the Allowance for Loan and Lease Losses (the “Allowance”) and a Reserve for Unfunded Commitments (the “Unfunded Reserve”). The reserve for credit losses provides for the risk of credit losses inherent in the credit extension process and is based on a range of loss estimates derived from a comprehensive quarterly evaluation, reflecting analyses of individual borrowers and historical loss experience, supplemented as necessary by credit judgment to address observed changes in trends, conditions, and other relevant environmental and economic factors, plus an amount for imprecision of estimates. The Allowance is increased or decreased through the provisioning process. There is no exact method of predicting specific losses or amounts that ultimately may be charged-off on particular segments of the loan and lease portfolio.

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The determination of the amount of the reserve for credit losses is a critical accounting estimate as it requires the use of estimates and significant judgment related to the amount and timing of expected future cash flows on impaired loans and leases, estimated loss rates on homogenous portfolios, and deliberation on economic factors and trends. On a quarterly basis, senior-level committees approve specific credit and reserve-related activities. Also, on a quarterly basis, the Audit Committee of the Board of Directors reviews and approves the reserve for credit losses prior to final affirmation by the Board of Directors. Note 3 to the Consolidated Financial Statements, which includes further discussion and information on the reserve for credit losses, is incorporated herein by reference.

Valuation of Mortgage Servicing Rights

When mortgage loans are sold with servicing rights retained, a servicing asset is established and accounted for based on estimated fair values. Once mortgage servicing rights have been recorded, they must be periodically evaluated for “impairment.” Under current accounting guidance, impairment occurs when the current estimated fair value of mortgage servicing rights is less than the book value. The current estimated fair value is determined using discounted cash flow modeling techniques, which requires management to make estimates and assumptions regarding the amount and timing of expected future cash flows, loan repayment rates, costs to service, and interest rates that reflect the risk involved. The value of the Company’s mortgage servicing rights is sensitive to changes in the estimates and assumptions made. Had the Company assumed lower long-term interest rates and higher loan repayment rates, the value of the mortgage servicing rights could have been lower than recorded in the Company’s Consolidated Statements of Condition. Note 4 to the Consolidated Financial Statements, which includes further discussion and information on mortgage servicing rights, including a sensitivity analysis, is incorporated herein by reference.

Residual Valuation of Leased Assets

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

Pension and Postretirement Benefit Plans

The Company’s pension and postretirement benefit obligations and net periodic benefit cost are actuarially determined based on the following key assumptions: discount rate, estimated future return on plan assets, and the health care cost trend rate. The determination of the pension and postretirement benefit obligations and net periodic benefit cost is a critical accounting estimate as it requires the use of estimates and judgment related to the amount and timing of expected future cash out-flows for benefit payments and cash in-flows for maturities and returns on plan assets. Changes in estimates and assumptions related to mortality rates and future health care costs could also have a material impact to the Company’s financial condition or results of operations. The discount rate is used to determine the present value of future benefit obligations and the net periodic benefit cost. The discount rate used to value the future benefit obligation as of each year-end is the rate used to determine the periodic benefit cost in the following year. The discount rate of 5.80% used for the December 31, 2006 valuations was determined based on match-funding maturities and interest payments on corporate bonds available in the market place to projected cash flows for future benefit payments. In determining the net periodic benefit cost, the Company lowered the discount rate to 5.75% in 2006 from 6.00% used in 2005 and 6.25% used in 2004, reflecting the decline in market interest rates during these periods. The estimated return on plan assets of 8.5% was based on historical trends and a building block approach taking into account the type of plan assets in the pension plan. The health care cost trend rate for 2006 was 8% and is assumed to decrease annually until reaching the ultimate trend rate of 5% in 2010. A 25 basis point decrease in the discount rate would have increased the total pension and postretirement net periodic benefit

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cost for the year ended December 31, 2006 by approximately $0.3 million and the benefit obligations as of December 31, 2006 by $3.8 million. A 25 basis point increase in the discount rate would have decreased the total pension and postretirement net periodic benefit cost for the year ended December 31, 2006 by approximately $0.3 million and the benefit obligations as of December 31, 2006 by $3.6 million. A 1% change in the health care cost trend rate would have changed the 2006 net periodic benefit cost by approximately $0.5 million.

The estimated pension and postretirement net periodic benefit cost for the year ending December 31, 2007 is $2.9 million, based on an assumed discount rate of 5.8%. A 25 basis point change in the discount rate for 2007 would change the total pension and postretirement net periodic benefit cost by approximately $0.2 million. Note 12 to the Consolidated Financial Statements, which includes further discussion and information on the Company’s pension and postretirement benefit plans, is incorporated herein by reference.

Income Taxes

The Company determines its liabilities for income taxes based on current tax regulation and interpretations. Congress, tax authorities, and courts can and do change tax policy. Accordingly, previously estimated liabilities are regularly reevaluated and adjusted, through the provision for income taxes. This process requires the use of judgments and estimates. The impact of changes in such estimates is not subject to quantification.

Overview

2004 – 2006 Plan

In January 2004, the Company introduced its 2004 – 2006 Plan. The key elements to that plan were to accelerate revenue growth, better integrate business segments, develop the management team, improve efficiency, and maintain a discipline of dependable risk and capital management.

The table below presents the 2006 Plan, as established in January 2004, compared to actual results for the year ended December 31, 2006:

		2006
(dollars in millions)		Plan			Actual
Year Ended December 31,
Operating Results
Net Income		$	178.4		$	180.4
Performance Ratios
Net Income to Average Total Assets		1.66		%	1.76		%
Net Income to Average Shareholders’ Equity		23.78			25.90
Net Interest Margin 1		4.12			4.25
Efficiency Ratio 2		52.84			51.87
Tier 1 Capital Ratio		10.73			9.99
Leverage Ratio 3		7.00			7.06

 

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

2         The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income and noninterest income).

3         The Company’s leverage ratio as of December 31, 2006, as previously disclosed in the Company’s earnings release on January 22, 2007, has been corrected to exclude the adjustment to initially adopt FASB Statement No. 158 from Tier 1 capital to comply with recently issued regulatory requirements.

Successful completion of the Company’s 2004 – 2006 Plan was highlighted by the following:

·       Total revenues, consisting of net interest income and noninterest income, increased over the three-year period, despite a challenging interest rate environment. Total revenues were $618.8 million, $616.4 million, and $595.7 million for the years ended December 31, 2006, 2005, and 2004, respectively.

·       The Company continued to better integrate its business segments. In 2005, the Retail Banking segment began an integration process with the Company’s technology and operations functions. This change resulted in a more coordinated effort in having technology support the Company’s branch network. Also in 2005, the

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Investment Services segment began an integration process with the Commercial Banking segment. This change enabled the Company to better service high net worth individuals among commercial banking customers and provided for an added opportunity to more effectively service its customers.

·       Management has emphasized the importance of recognizing that the Company’s leaders drive the business through identifying, nurturing, and retaining talented people. Progress has been made in leader identification, employment, and retention that included the expansion of the Company’s Managing Committee to include five Senior Executive Vice Presidents.

·       Management has worked diligently to control expenses while striving to improve service levels to customers. The Company’s efficiency ratio was 51.87%, 53.15%, and 56.14% for the years ended December 31, 2006, 2005, and 2004, respectively.

·       Management has successfully maintained a discipline of dependable risk and capital management. The Company’s ratio of non-performing assets to total loans and leases, foreclosed real estate, and other investments was 0.10%, 0.11%, and 0.23% as of December 31, 2006, 2005, and 2004, respectively. The Company’s leverage ratio was 7.06%, 7.14%, and 8.29% for the years ended December 31, 2006, 2005, and 2004, respectively. Furthermore, in the absence of viable options to redeploy excess cash, the Company has continued to provide returns to its shareholders under its share repurchase program. During the three-year period ended December 31, 2006, the Company returned nearly $603.6 million to shareholders at an average cost of $47.72 per share.

2007+ Plan

The Company’s vision: Exceptional people building exceptional value for customers, our island community, shareholders, and each other.

The Company’s governing objective: To maximize shareholder value over time.

In January 2007, the Company introduced its 2007+ Plan to its shareholders, customers, and employees. The Company’s plan for 2007 and beyond is evolutionary – building on the themes that were prominent in the
2004 – 2006 Plan. The 2007+ Plan emphasizes growth in revenues, integration of service delivery and business units, development of people, enhancement of the Bank of Hawaii brand, and discipline in managing risk and financial performance. The 2007+ Plan does not contemplate near-term expansion beyond the Company’s current footprint.

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

The Company’s 2007+ Plan was prepared with most economic indicators for Hawaii showing modest improvements as capacity constraints affecting tourism and the workforce limit economic growth. Personal income growth is expected to improve slightly, although inflation in the Company’s key markets is expected to exceed national levels. Housing prices are expected to remain stable as new home building slows. Commercial real estate demand is also expected to remain strong.

Analysis of Statements of Income

Net Interest Income

Net interest income, on a taxable equivalent basis, decreased by $4.2 million from the year ended December 31, 2005 to the year ended December 31, 2006. The decrease in net interest income was primarily due to increased funding costs. Rates paid on demand and savings accounts increased, as some customers shifted deposits from

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demand and savings accounts to higher rate time deposits and into off-balance sheet managed cash accounts. Also contributing to the Company’s higher funding costs were increased levels of securities sold under agreements to repurchase. Partially offsetting the increase in the Company’s funding costs was an increase in yields on loans and investment securities and an increase in average loans and leases. Like many other financial institutions during the year ended December 31, 2006, the Company’s net interest income was negatively impacted by the yield curve which was flat or inverted throughout the year.

The Company’s net interest margin decreased by 13 basis points from the year ended December 31, 2005 to the year ended December 31, 2006. The decrease in the Company’s net interest margin was primarily due to the impact that the flat or inverted yield curve has had on the Company’s mix of funding sources and related rates paid for the year ended December 31, 2006.

Average loans and leases increased by $264.8 million or 4% from the year ended December 31, 2005 to the year ended December 31, 2006, with growth in substantially all loan and lease categories. Yields on total loans and leases increased by 64 basis points from the year ended December 31, 2005 to the year ended December 31, 2006. Average balances in investment securities remained relatively unchanged from the year ended December 31, 2005 to the year ended December 31, 2006; however, yields increased by 43 basis points in the Company’s available-for-sale portfolio and by 29 basis points in the Company’s held-to-maturity portfolio, reflecting a rise in interest rates over this period.

Average interest bearing liabilities increased by $259.4 million or 4% from the year ended December 31, 2005 to the year ended December 31, 2006, primarily due to an increase in securities sold under agreements to repurchase, time deposits, and short-term borrowings. Although average deposits remained relatively unchanged from the year ended December 31, 2005 to the year ended December 31, 2006, there was significant movement in balances within the Company’s deposit products. Average noninterest bearing demand, interest-bearing demand, and savings balances collectively decreased by $322.5 million from the year ended December 31, 2005 to the year ended December 31, 2006. Over this same period, average time deposits increased by $287.0 million as customers sought higher rate deposit products. Customers also used their off-balance sheet managed cash accounts as a means of obtaining higher rates. Strong growth in loans and leases required the Company to utilize securities sold under agreements to repurchase and short-term borrowings as a funding mechanism. The Company’s average long-term debt balances, the costliest of interest-bearing liabilities, remained relatively unchanged from the year ended December 31, 2005 to the year ended December 31, 2006.

Net interest income, on a taxable equivalent basis, increased by $16.7 million or 4% from the year ended December 31, 2004 to the year ended December 31, 2005. The increase in net interest income was primarily due to higher average balances and yields earned on the Company’s loans and investment securities. Partially offsetting the increase in interest income was a rise in funding costs on various interest-bearing deposit products and securities sold under agreements to repurchase, reflecting a rise in short-term interest rates during 2005.

The Company’s net interest margin increased by six basis points from the year ended December 31, 2004 to the year ended December 31, 2005. The improvement in the Company’s net interest margin was attributable to the increase in the average balances and yields earned on loans and investment securities, partially offset by an increase in the Company’s cost of funds.

Average loans and leases increased by $317.7 million or 5% from the year ended December 31, 2004 to the year ended December 31, 2005, with growth in substantially all loan and lease categories. Yields on total loans and leases increased by 38 basis points from the year ended December 31, 2004 to the year ended December 31, 2005. Average balances on the Company’s investment securities portfolio increased by $165.8 million from the year ended December 31, 2004 to the year ended December 31, 2005. Yields increased by 27 basis points in the Company’s available-for-sale portfolio and by 20 basis points in the Company’s held-to-maturity portfolio from the year ended December 31, 2004 to the year ended December 31, 2005, reflecting a rise in interest rates over this period.

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Average interest-bearing liabilities increased by $219.7 million or 3% from the year ended December 31, 2004 to the year ended December 31, 2005, primarily due to an increase in interest-bearing demand deposits associated with the introduction of a new product as well as growth in existing product average balances. Average short-term borrowings and securities sold under agreements to repurchase decreased slightly from the year ended December 31, 2004 to the year ended December 31, 2005. However, these decreases were offset by higher rates reflecting a rise in the short-term interest rate environment. The rates paid on securities sold under agreements to repurchase and short-term borrowings increased by 175 basis points and 200 basis points, respectively, from the year ended December 31, 2004 to the year ended December 31, 2005.

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

Consolidated Average Balances and Interest Rates – Taxable Equivalent Basis																											Table 1
		2006										2005										2004
		Average		Income/				Yield/				Average		Income/				Yield/				Average				Income/				Yield/
(dollars in millions)		Balance		Expense				Rate				Balance		Expense				Rate				Balance				Expense				Rate
Earning Assets
Interest-Bearing Deposits		$          5.4			$    0.2				3.92	%		$          7.1			$    0.2				3.07	%			$   189.7				$    3.5				1.83	%
Funds Sold		15.2			0.8				5.06			39.3			1.3				3.38				85.6				1.0				1.24
Investment Securities
Available-for-Sale		2,598.8			127.5				4.91			2,545.6			114.0				4.48				2,227.8				93.7				4.21
Held-to-Maturity		417.6			18.3				4.37			523.7			21.4				4.08				675.7				26.2				3.88
Loans Held for Sale		9.7			0.6				6.38			20.4			0.8				4.03				15.8				0.9				5.57
Loans and Leases 1
Commercial and Industrial		987.8			72.7				7.36			953.8			59.8				6.27				834.6				43.2				5.17
Construction		197.3			16.2				8.19			138.6			8.8				6.35				85.7				3.8				4.39
Commercial Mortgage		598.5			40.3				6.73			582.6			34.8				5.97				639.1				34.5				5.40
Residential Mortgage		2,450.4			146.3				5.97			2,346.8			133.6				5.70				2,290.6				129.6				5.66
Other Revolving Credit and Installment		711.6			64.7				9.09			740.4			62.7				8.46				691.5				59.3				8.58
Home Equity		922.2			68.4				7.42			844.2			49.8				5.91				735.7				35.2				4.79
Lease Financing		501.4			16.3				3.25			498.0			18.3				3.67				509.5				21.5				4.21
Total Loans and Leases		6,369.2			424.9				6.67			6,104.4			367.8				6.03				5,786.7				327.1				5.65
Other		79.4			1.1				1.45			69.8			1.3				1.81				73.8				2.8				3.78
Total Earning Assets 2		9,495.3			573.4				6.04			9,310.3			506.8				5.44				9,055.1				455.2				5.03
Cash and Noninterest-Bearing Deposits		301.2										313.0											314.6
Other Assets		444.9										400.4											375.8
Total Assets		$ 10,241.4										$ 10,023.7											$ 9,745.5
Interest-Bearing Liabilities
Interest-Bearing Deposits
Demand		$ 1,615.5			15.6				0.96			$ 1,667.0			10.1				0.60				$ 1,433.1				3.2				0.22
Savings		2,680.3			38.3				1.43			2,928.6			20.5				0.70				2,945.3				13.2				0.45
Time		1,484.8			49.8				3.35			1,197.8			27.8				2.32				1,114.8				20.3				1.82
Total Interest-Bearing Deposits		5,780.6			103.7				1.79			5,793.4			58.4				1.01				5,493.2				36.7				0.67
Short-Term Borrowings		177.7			8.8				4.97			144.5			4.7				3.25				151.8				1.9				1.25
Securities Sold Under Agreements to Repurchase		932.4			42.2				4.52			699.0			21.2				3.03				732.2				9.4				1.28
Long-Term Debt		249.8			15.4				6.15			244.2			15.0				6.15				284.2				16.4				5.78
Total Interest-Bearing Liabilities		7,140.5			170.1				2.38			6,881.1			99.3				1.44				6,661.4				64.4				0.97
Net Interest Income					$ 403.3										$ 407.5												$ 390.8
Interest Rate Spread									3.66	%									4.00	%											4.06	%
Net Interest Margin									4.25	%									4.38	%											4.32	%
Noninterest-Bearing Demand Deposits		1,950.4										1,973.1											1,929.1
Other Liabilities		454.2										438.4											394.0
Shareholders’ Equity		696.3										731.1											761.0
Total Liabilities and Shareholders’ Equity		$ 10,241.4										$ 10,023.7											$ 9,745.5

 

1         Non-performing loans and leases are included in the respective average loan and lease balances. Income, if any, on such loans and leases is recognized on a cash basis.

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

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Analysis of Change in Net Interest Income – Taxable Equivalent Basis								Table 2
		Year Ended December 31,						Year Ended December 31,
		2006 Compared to 2005						2005 Compared to 2004
(dollars in millions)		Volume 1		Rate 1		Total		Volume 1		Rate 1		Total
Change in Interest Income:
Interest-Bearing Deposits		$            –		$            –		$            –		$        (4.7	)	$         1.4		$        (3.3	)
Funds Sold		(1.0	)	0.5		(0.5	)	(0.8	)	1.1		0.3
Investment Securities
Available-for-Sale		2.4		11.1		13.5		14.0		6.3		20.3
Held-to-Maturity		(4.5	)	1.4		(3.1	)	(6.1	)	1.3		(4.8	)
Loans Held for Sale		(0.5	)	0.3		(0.2	)	0.2		(0.3	)	(0.1	)
Loans and Leases
Commercial and Industrial		2.2		10.7		12.9		6.7		9.9		16.6
Construction		4.4		3.0		7.4		2.9		2.1		5.0
Commercial Mortgage		0.9		4.6		5.5		(3.2	)	3.5		0.3
Residential Mortgage		6.1		6.6		12.7		3.1		0.9		4.0
Other Revolving Credit and Installment		(2.5	)	4.5		2.0		4.2		(0.8	)	3.4
Home Equity		4.9		13.7		18.6		5.6		9.0		14.6
Lease Financing		0.1		(2.1	)	(2.0	)	(0.5	)	(2.7	)	(3.2	)
Total Loans and Leases		16.1		41.0		57.1		18.8		21.9		40.7
Other		0.1		(0.3	)	(0.2	)	(0.1	)	(1.4	)	(1.5	)
Total Change in Interest Income		12.6		54.0		66.6		21.3		30.3		51.6
Change in Interest Expense:
Interest-Bearing Deposits
Demand		(0.3	)	5.8		5.5		0.6		6.3		6.9
Savings		(1.9	)	19.7		17.8		(0.1	)	7.4		7.3
Time		7.7		14.3		22.0		1.6		5.9		7.5
Total Interest-Bearing Deposits		5.5		39.8		45.3		2.1		19.6		21.7
Short-Term Borrowings		1.2		2.9		4.1		(0.1	)	2.9		2.8
Securities Sold Under Agreements to Repurchase		8.5		12.5		21.0		(0.5	)	12.3		11.8
Long-Term Debt		0.4		–		0.4		(2.4	)	1.0		(1.4	)
Total Change in Interest Expense		15.6		55.2		70.8		(0.9	)	35.8		34.9
Change in Net Interest Income		$        (3.0	)	$        (1.2	)	$        (4.2	)	$       22.2		$        (5.5	)	$       16.7

 

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

Provision for Credit Losses

The Provision for Credit Losses (the “Provision”) reflects management’s judgment of the expense or benefit necessary to establish the appropriate amount of the Allowance. The Provision is determined through detailed quarterly analyses of the loan and lease portfolio. During the year ended December 31, 2006, the Company recorded a Provision of $10.8 million. The Provision for the year ended December 31, 2006, equaled net charge-offs.  The Provision is based on the Bank’s loss experience, changes in the economic environment, as well as management’s ongoing assessment of credit quality. The Company recorded a Provision of $4.6 million for the year ended December 31, 2005 and returned $10.0 million to income from a release of the Allowance for the year ended December 31, 2004. For further discussion on the Allowance, see the “Corporate Risk Profile – Allowance for Loan and Lease Losses” section in MD&A.

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Noninterest Income

Table 3 presents the major components of noninterest income for the years ended December 31, 2006, 2005, and 2004.

Noninterest Income										Table 3
		Year Ended December 31,						Percent Change
(dollars in thousands)		2006		2005		2004		2006 to 2005		2005 to 2004
Trust and Asset Management		$    58,740		$    56,830		$    53,465		3	%	6	%
Mortgage Banking		10,562		10,399		8,012		2		30
Service Charges on Deposit Accounts		41,756		39,945		39,117		5		2
Fees, Exchange, and Other Service Charges		62,441		59,588		54,907		5		9
Investment Securities Gains (Losses), Net		172		341		(794	)	(50	)	n.m.
Insurance		20,388		19,643		19,241		4		2
Other Income:
Income from Bank-Owned Life Insurance		6,090		6,037		7,336		1		(18	)
Gain on the Sale of Leased Assets		2,708		5,084		6,076		(47	)	(16	)
Leasing Partnership Distribution		17		18		3,218		(6	)	n.m.
Gain on the Sale of Land		–		–		2,454		n.m.		n.m.
Other		13,302		11,429		12,062		16		(5	)
Total Other Income		22,117		22,568		31,146		(2	)	(28	)
Total Noninterest Income		$  216,176		$  209,314		$  205,094		3	%	2	%

 

n.m. – not meaningful

Trust and asset management income is comprised of fees earned from the management and administration of trust and other customer assets. The fees are generally based on the market value of the assets that are managed. Total trust assets under administration were $12.6 billion, $12.5 billion, and $11.5 billion as of December 31, 2006, 2005, and 2004, respectively. The increases in trust and asset management income is consistent with the performance of the equity markets which led to an increase in the Company’s average market value of trust assets under management. Trust and asset management income also increased due to higher advisory fees on mutual fund assets managed by the Bank for the year ended December 31, 2006.

Mortgage banking income is comprised primarily of gains from sales of residential mortgage loans and net servicing income. Net servicing income is income earned for servicing loans less the amortization of mortgage servicing rights. Mortgage banking income is highly influenced by the level and direction of mortgage interest rates and the strength of the housing market. Mortgage banking income for the year ended December 31, 2006 was slightly higher than that recorded for the year ended December 31, 2005. This increase in mortgage banking income was due to a decline in the amortization of mortgage servicing rights, as a result of lower loan prepayments, partially offset by a decrease in loan origination and lower gain on sale, reflecting a slowdown in the housing market and refinancing activity. Residential mortgage loan origination was $0.8 billion and $1.0 billion for the years ended December 31, 2006 and 2005, respectively. Mortgage banking income increased for the year ended December 31, 2005 compared to the year ended December 31, 2004 primarily as a result of a decline in the amortization of mortgage servicing rights attributable to lower loan prepayments. Residential mortgage loan originations were $1.0 billion for the year ended December 31, 2004.

Service charges on deposit accounts increased from the year ended December 31, 2005 to the year ended December 31, 2006, primarily due to overdraft fees resulting from an increase in the number of transactional deposit accounts. This was partially offset by lower account analysis fees on analyzed business accounts as a result of increased earnings on analyzed checking accounts. The increase in service charges on deposit accounts from the year ended December 31, 2004 to the year ended December 31, 2005 was also due to an increase in the number of transactional deposit accounts.

Fees, exchange, and other service charges are primarily comprised of merchant service activity, fees from ATMs, and other loan fees and service charges. Fees, exchange, and other service charges increased from the year ended December 31, 2005 to the year ended December 31, 2006, primarily due to higher interchange income as a result of new debit cards issued as well as an increase in transaction volume from existing debit cardholders. The increase in

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fees, exchange, and other service charges from the year ended December 31, 2004 to the year ended December 31, 2005 was primarily due to increased merchant transactions, and card and loan fees, partially offset by a decrease in foreign currency income.

Insurance income is comprised of the income derived from the Company’s retail and wholesale insurance businesses. The increase in insurance income from the year ended December 31, 2005 to the year ended December 31, 2006 was primarily due to higher benefits of lower loss experience of customers who insure with the Company’s wholesale insurance business. Insurance income remained relatively unchanged from the year ended December 31, 2004 to the year ended December 31, 2005.

The other component of other noninterest income increased from the year ended December 31, 2005 to the year ended December 31, 2006 primarily due to higher mutual fund and securities income. The other component of other noninterest income remained relatively unchanged from the year ended December 31, 2004 to the year ended December 31, 2005.

Noninterest Expense

Table 4 presents the major components of noninterest expense for the years ended December 31, 2006, 2005, and 2004.

Noninterest Expense										Table 4
		Year Ended December 31,						Percent Change
(dollars in thousands)		2006		2005		2004		2006 to 2005		2005 to 2004
Salaries and Benefits:
Salaries		$  110,203		$  108,286		$  111,362		2	%	(3	)%
Incentive Compensation		17,150		16,145		15,458		6		4
Share-Based Compensation		5,322		6,118		11,726		(13	)	(48	)
Commission Expense		7,168		8,112		7,682		(12	)	6
Retirement and Other Benefits		17,212		17,962		15,900		(4	)	13
Payroll Taxes		9,791		9,748		11,063		–		(12	)
Medical, Dental, and Life Insurance		7,900		8,027		8,354		(2	)	(4	)
Separation Expense		1,711		1,912		2,754		(11	)	(31	)
Total Salaries and Benefits		176,457		176,310		184,299		–		(4	)
Net Occupancy		38,976		38,273		38,347		2		–
Net Equipment		20,127		21,541		23,926		(7	)	(10	)
Professional Fees		6,854		15,702		14,212		(56	)	10
Other Expense:
Data Services		13,029		12,128		10,364		7		17
Delivery and Postage Services		10,049		9,812		10,123		2		(3	)
Other		55,470		53,876		53,169		3		1
Total Other Expense		78,548		75,816		73,656		4		3
Total Noninterest Expense		$  320,962		$  327,642		$  334,440		(2	)%	(2	)%

 

Total salaries and benefits remained relatively unchanged from the year ended December 31, 2005 to the year ended December 31, 2006. Base salaries increased from the year ended December 31, 2005 as a result of annual increases, and incentive compensation increased as a result of a $1.5 million bonus related to the successful completion of the 2004 – 2006 Plan. Offsetting these increases were the decline in share-based compensation and lower commission expense resulting from a decrease in residential mortgage loan originations. Total salaries and benefits decreased by 4% from the year ended December 31, 2004 to the year ended December 31, 2005, primarily due to lower share-based compensation associated with restricted stock units and lower base salaries as a result of a 3% decline in the number of employees. Partially offsetting the decline in expenses from the year ended December 31, 2004 to the year ended December 31, 2005 was an increase in retirement and other benefits due to increased expense for actuarially determined benefits as a result of a change in the assumed discount rate.

The Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” on January 1, 2006 using the modified prospective method. Prior to the adoption of SFAS No. 123(R), the Company accounted for share-based compensation under the intrinsic value method as permitted by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and related

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interpretations. Note 13 to the Consolidated Financial Statements provides further information on the Company’s adoption of SFAS No. 123(R) and is incorporated herein by reference.

Professional fees decreased for the year ended December 31, 2006 primarily due to the reduction of legal fees as a result of the conclusion of various legal matters. Professional fees increased from the year ended December 31, 2004 to the year ended December 31, 2005, primarily due to increased legal fees and other expenses resulting from the now resolved investigation by the U.S. Securities and Exchange Commission (the “SEC”) related to alleged market timing and/or excessive trading in a mutual fund family to which the Bank serves as a registered investment adviser. In the fourth quarter of 2005, the SEC terminated its investigation without formal action being taken against the Bank. Partially offsetting the increase in legal fees for the year ended December 31, 2005 was a decrease in other professional fees, primarily consulting fees.

Other noninterest expense increased from the year ended December 31, 2005 to the year ended December 31, 2006 primarily due to higher data services and mileage program travel expenses. The increase in noninterest expense from the year ended December 31, 2004 to the year ended December 31, 2005 was primarily due to a goodwill impairment charge of $1.3 million recorded in the first quarter of 2005 relating to the Bank’s insurance business.

Income Taxes

The Company’s provision for income taxes reflected an effective tax rate of 37.17%, 36.11%, and 36.09% for the years ended December 31, 2006, 2005, and 2004, respectively. The higher effective tax rate for the year ended December 31, 2006 was primarily due to legislative changes impacting foreign sales corporations, and the resolution of a tax issue with the Internal Revenue Service (the “IRS”). For additional information regarding the Company’s provision for income taxes, including a reconciliation of the effective tax rate to the federal statutory tax rate, refer to Note 14 to the Consolidated Financial Statements, which is incorporated herein by reference.

Analysis of Business Segments

The Company’s business segments are Retail Banking, Commercial Banking, Investment Services, and Treasury. The Company’s internal management accounting process measures the performance of the business segments based on the management structure of the Company. This process, which is not necessarily comparable with similar information for any other financial institution, uses various techniques to assign balance sheet and income statement amounts to the business segments, including allocations of income, expense, the Provision and capital. This process is dynamic and requires certain allocations based on judgment and other subjective factors. Unlike financial accounting, there is no comprehensive, authoritative guidance for management accounting that is equivalent to U.S. generally accepted accounting principles.

The Company evaluates several performance measures of the business segments, the most important of which are net income after capital charge (“NIACC”) and risk adjusted return on capital (“RAROC”). NIACC is economic net income less a charge for the cost of allocated capital. The cost of allocated capital is determined by multiplying management’s estimate of a shareholder’s minimum required rate of return on the cost of capital invested (currently 11%) by the segment’s allocated equity. The Company assumes a cost of capital that is equal to a risk-free rate plus a risk premium. RAROC is the ratio of economic net income to risk-adjusted equity. Equity is allocated to each business segment based on an assessment of its inherent risk. The net interest income of the business segments reflects the results of a funds transfer pricing process that matches assets and liabilities with similar interest rate sensitivity and maturity characteristics and reflects the allocation of net interest income related to the Company’s overall asset and liability management activities on a proportionate basis. The basis for the allocation of net interest income is a function of management decisions and assumptions that are subject to change based on changes in current interest rate and market conditions. Funds transfer pricing also serves to transfer interest rate risk to the Treasury. However, the other business segments have some latitude to retain certain interest rate exposures related to customer pricing decisions within guidelines. The business segments are charged an economic provision which is a statistically derived estimate of average annual expected credit losses over an economic cycle.

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