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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13D OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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 0-15508
HAWAII NATIONAL BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
HAWAII 99-0250218
(State of incorporation) (IRS Employer Identification No.)
45 NORTH KING STREET, HONOLULU, HAWAII 96817
(Address of principal executive offices) (Zip Code)
(808) 528-7711
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange on
Title of Each Class on Which Registered
------------------- -------------------
None Not Applicable
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $1.00 Par Value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the 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 nonaffiliates of
the registrant as of February 28, 1998 was $3,577,054.
The number of shares outstanding of each of the registrant's classes of
common stock as of February 28, 1998 was:
Title of Class Number of Shares Outstanding
-------------- ----------------------------
Common Stock, $1 Par Value 711,000 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement relating to the Annual Meeting of
Shareholders to be held on April 21, 1998, are incorporated by reference under
Part III of this Report.
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PART I
ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
Hawaii National Bancshares, Inc. ("Bancshares"), whose principal office
is maintained at 45 North King Street, Honolulu, Hawaii, is a Hawaii
corporation. Bancshares is a bank holding company whose wholly owned subsidiary
is Hawaii National Bank ("HNB" or the "Bank"), a national banking association.
The main office of the Bank is also located at 45 North King Street,
Honolulu, Hawaii. While the Bank's customer base covers the entire State of
Hawaii, the principal market areas are the county of Honolulu on the island of
Oahu, which currently is served by ten of the Bank's branches; the county of
Hawaii, which is served by a branch in Hilo; and the county of Maui, which is
served by branches in Kahului and Kihei. The area of the county of Hawaii served
by the Bank's Hilo branch includes the area from the ocean to Haihai to Komohana
and Waianuenue. The area of the county of Maui served by the Bank's Kahului and
Kihei branches is located in the Wailuku, Kahului and Kihei corridor. The Bank
anticipates opening a branch in a new shopping complex called the "Moanalua
Ethnic Village" in Mapunapuna, Oahu in March 1998. (See ITEM 2. Properties).
The principal components of Hawaii's economy are the tourism industry,
government expenditures, agriculture, construction, manufacturing, retailing,
wholesaling, and service businesses.
HNB offers a full range of banking services to businesses as well as
individuals. These include personal and business checking accounts; savings
accounts; time deposits; automated teller equipment; commercial loans -
collateralized and uncollateralized; consumer loans for such things as
automobiles, household appliances, home improvements, and college aid; real
estate collateralized loans; bank credit cards; direct lease financing; foreign
exchange; commercial letters of credit; collections and discounts; safe deposit
boxes; travelers checks; money orders; cashier's checks; sale of United States
Savings Bonds; and night depository. The Bank does not have a trust department
and, therefore, does not perform any trust functions.
HNB's ability to extend its existing branch banking system is subject
to approval by the Office of Comptroller of the Currency ("OCC") in compliance
with applicable Hawaii law. Currently, Hawaii law generally permits a bank to
branch anywhere in the State. Recent federal legislation designed to expand
interstate branching and relax federal restrictions on interstate banking may
expand opportunities for bank holding companies. Hawaii has adopted
legislation effective June 1, 1997 which generally permits interstate mergers,
subject to certain restrictions. For a more detailed discussion of this federal
legislation and Hawaii's response, see the discussion following under the
heading "Supervision and Regulation - Bank - Recent Federal Banking Legislation
- - Interstate Banking and Branching."
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The Year 2000 is a serious issue which will affect virtually every
organization, including the Bank. The difficulty stems from the inability of
most computer programs to distinguish the year 1900 from the year 2000. The
challenge is especially critical to financial institutions since many processes,
such as interest accruals and payments, are date-sensitive. Nor is the problem
limited to just computer systems. The coming millenium will affect potentially
every system that has an embedded microchip, such as automated teller machines,
elevators and vaults, as well as third parties with whom the Bank does business.
The Bank is committed to addressing the Year 2000 issue in a timely and
responsible manner and has dedicated its internal resources to address this
issue. Management has completed an assessment of its mission-critical systems
and has implemented a program to monitor the Year 2000 efforts of its suppliers,
service providers and large corporate customers. In June 1998, the Bank will be
converting its computer system as part of its normal upgrade process to improve
efficiency and better serve its customers. The new system, which is Year 2000
compliant, will replace the current one used by the Bank to process its general
ledger and core applications, which will no longer be supported by the vendor in
the future. The cost for the new computer system is approximately $1,200,000,
which will be capitalized and depreciated over its useful life. The estimated
depreciation charges are expected to be offset by lower maintenance fees. The
costs for other systems are not anticipated to be material and will be accounted
for appropriately. Testing of hardware and software upgrades, system
replacements and other associated changes is expected to be well underway by
December 31, 1998.
COMPETITION
The banking business in Hawaii is highly competitive. There are five
other commercial banks doing general banking business and four savings and loan
associations doing business in Hawaii. The Bank actively competes for business
with other banks, savings and loan associations, credit unions, and individual
loan companies within its market areas. In varying degrees, the Bank also faces
competition from other types of financially oriented institutions which are
either lenders of money or credit, or accept savings or other deposits.
Insurance companies, investment management service firms and other business
firms, and individuals actively compete with the Bank's mortgage loan services.
In addition, foreign (non-Hawaii) banks currently conduct banking activities,
also performed by banks in Hawaii, except for retail deposit-taking.
As of December 31, 1997, HNB, with $258,721,000 in deposits,
$219,018,000 in loans, and $298,687,000 in total assets, ranked fifth among the
six commercial banks in Hawaii in all of the above measures.
EMPLOYEES
On December 31, 1997, HNB had 232 full-time employees and 7 part-time
employees. HNB considers its relations with its employees to be good.
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SUPERVISION AND REGULATION
Introduction
The following generally refers to certain significant statutes and
regulations affecting the banking industry. These references are only intended
to provide brief summaries and therefore, are not complete and are qualified by
the statutes and regulations referenced. In addition, due to the numerous
statutes and regulations which apply to and regulate the operation of the
banking industry, many are not referenced below.
BANCSHARES
General
As a bank holding company, Bancshares is subject to the Bank Holding
Company Act of 1956 ("BHCA"), as amended, which places Bancshares under the
supervision of the Board of Governors of the Federal Reserve System ("FRB"). In
general, the BHCA limits the business of bank holding companies to owning or
controlling banks and engaging in other activities related to banking. Certain
recent legislation designed to expand interstate branching and relax federal
restrictions on interstate banking may expand opportunities for bank holding
companies (for additional information see below under the heading "Bank - Recent
Federal Banking Legislation - Interstate Banking and Branching"). However, the
impact of this legislation on Bancshares is unclear at this time.
Holding Company Structure
FRB Regulation. Bancshares must obtain the approval of the FRB: (1)
before acquiring direct or indirect ownership or control of any voting shares of
any bank if, after the acquisition, it would own or control, directly or
indirectly, more than 5% of the bank's voting shares; (2) before merging or
consolidating with another bank holding company; and (3) before acquiring
substantially all of the assets of any additional banks. Until September of
1995, the BHCA also prohibited the acquisition by Bancshares of any such
interest in any bank or bank holding company located in a state other than
Hawaii, unless the laws of the state in which such bank was located expressly
authorized such acquisition. Now, subject to certain state laws, such as age and
contingency laws, a bank holding company that is adequately capitalized and
adequately managed may acquire the assets of an out-of-state bank without regard
to whether the transaction is prohibited by the laws of any state.
Bancshares files annual and quarterly reports and any other reports the
FRB may require from time to time. In addition, the FRB periodically examines
Bancshares and the Bank.
Holding Company Control of Nonbanks. With certain exceptions, the BHCA
prohibits bank holding companies from acquiring direct or indirect ownership or
control of voting shares in any company other than a bank or a bank holding
company, unless the FRB finds the company's business activities are incidental
to the business of banking or managing or controlling banks. When making this
determination, the FRB in part considers whether allowing
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a bank holding company to engage in those activities would offer advantages to
the public that would outweigh possible adverse effects.
The Economic Growth and Regulatory Paperwork Reduction Act of 1996
("Economic Growth Act") amended the BHCA to eliminate the requirement that a
bank holding company seek FRB approval before engaging de novo in permissible
nonbanking activities, if the holding company is well capitalized and meets
certain other criteria specified in the statute. A bank holding company meeting
the specifications is now required only to notify the FRB within 10 business
days after commencing any activity that is currently or at the time of
commencement included in the FRB's list of acceptable nonbanking activities.
The FRB has by regulation found certain activities incidental to the
business of banking. These activities include (1) operating an industrial loan
company, industrial bank, savings association, mortgage company, finance
company, trust company, credit card company or factoring company; (2) performing
certain data processing operations; and (3) providing investment and financial
advice. On the other hand, the FRB has concluded that certain other activities
are not incidental to the business of banking. These activities include real
estate brokerage and syndication, land development, property management,
underwriting of life insurance not related to credit transactions and, with
certain exceptions, securities underwriting and equity funding From time to
time, the FRB may add to or delete from the list of activities permissible for
bank holding companies.
Transactions With Affiliates. Bancshares and HNB are considered
affiliates within the meaning of the Federal Reserve Act, and transactions
between affiliates are subject to certain restrictions. Section 23A of the
Federal Reserve Act places limits on certain covered transactions. These covered
transactions include, subject to specific exceptions, loans by bank subsidiaries
to affiliates, investments by bank subsidiaries in securities issued by an
affiliate or the accepting of those securities as collateral, and the purchase
by a bank subsidiary of an affiliate's assets. Section 23B of the Federal
Reserve Act, among other things, restricts an institution from engaging in
certain transactions with certain affiliates unless the transactions are on
terms substantially the same, or at least as favorable, to the institution as
those prevailing at the time for comparable transactions with non-affiliated
companies.
Tie-In Arrangements. Bancshares and the Bank are prohibited from
engaging in certain tie-in arrangements in connection with any extension of
credit, sale or lease of property or furnishing of services. For example, with
certain exceptions, neither Bancshares nor its subsidiary may condition an
extension of credit to a customer on either (1) a requirement that the customer
obtain additional services provided by it or (2) an agreement by the customer to
refrain from obtaining other services from a competitor. In April of 1997, the
FRB adopted significant amendments to its anti-tying rules that: (1) remove
FRB-imposed anti-tying restrictions on bank holding companies and their non-bank
subsidiaries; (2) create exemptions from the statutory restriction on bank tying
arrangements to allow banks greater flexibility to package products with their
affiliates; and (3) establish a safe harbor from the tying restrictions for
certain foreign transactions. These amendments are designed to enhance
competition in banking and nonbanking products and allow banks and their
affiliates to provide more efficient and lower-cost service to customers.
However, the impact of the amendments on Bancshares and the Bank is unclear at
this time.
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State Law Restrictions. As a corporation incorporated under Hawaii
corporate laws, Bancshares may also be subject to certain limitations and
restrictions under applicable Hawaii laws.
Securities Registration and Reporting. The common stock of Bancshares
is registered as a class with the Securities and Exchange Commission ("SEC")
under the Securities Exchange Act of 1934. Thus, Bancshares is subject to the
periodic reporting and proxy solicitation requirements and the insider-trading
restrictions of that Act. The periodic reports, proxy statements, and other
information filed by Bancshares under that Act can be inspected and copied at or
obtained from the Washington, D.C. office of the SEC. In addition, the
securities issued by Bancshares are subject to the registration requirements of
the Securities Act of 1933 and applicable state securities laws, unless
exemptions are available.
Control Transactions
The Change in Bank Control Act of 1978, as amended, requires a person
(or group of persons acting in concert) acquiring "control" of a bank holding
company to provide the FRB with at least 60 days' advance written notice of the
proposed acquisition. Following receipt of this notice, the FRB has 60 days to
issue a notice disapproving the proposed acquisition, but the FRB may extend
this time period for up to an additional 30 days. An acquisition may be
completed before to the expiration of the disapproval period if the FRB issues
written notice of its intent not to disapprove the transaction.
In addition, any "company" must obtain the FRB's approval before
acquiring 25% (5% if the company is a bank holding company) or more of the
outstanding shares of Bancshares or otherwise obtaining control over Bancshares.
BANK
General
Despite some recent legislative initiatives to reduce regulatory
burdens, banking remains a highly regulated industry. Legislation enacted from
time to time may increase the cost of doing business, limit or expand
permissible activities, or affect the competitive balance between banks and
other financial and nonfinancial institutions. Proposals to change the laws and
regulations governing the operations and taxation of banks and other financial
institutions are frequently made in Congress, in state legislatures, and before
various bank regulatory agencies. In addition, there continue to be proposals in
Congress to restructure the banking system.
Some of the significant areas of bank regulation are generally
discussed below.
Regulation of National Banks
HNB, as a national banking association, is subject to primary
regulation and examination by the OCC. It is also subject to regulation by the
FRB and, to a more limited extent, by the Federal Deposit Insurance Corporation
("FDIC"). Federal statutes and regulations which govern HNB's operations relate
to required reserves against deposits, investments, loans,
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mergers and consolidations, borrowings, issuance of securities, payment of
dividends, establishment of branches, and other aspects of its operations. The
National Bank Act restricts HNB to performing commercial banking business and
engaging in activities incidental to the business of banking and prohibits HNB
from investing in equity securities, except in its fiduciary capacity. The OCC
also may prohibit a national bank from engaging in activities it considers
unsafe and unsound business practices.
The OCC charges each national bank under its supervision a semi-annual
assessment, which is based on a predetermined regulatory formula. Effective in
1998, the OCC has amended its assessment regulations so that a national bank
that receives a CAMELS rating of 3, 4, or 5 will be required to pay a surcharge
equal to 25% of the amount of the assessment that the bank would otherwise pay.
This increase is intended to offset the higher costs incurred by the OCC in
supervising banks with these ratings. The Bank does not expect to be subject to
the surcharge.
Regulation of Management
Federal law: (1) sets forth circumstances under which officers or
directors of a bank may be removed by the institution's federal supervisory
agency, (2) places restraints on lending by a bank to its executive officers,
directors, principal shareholders, and their related interests, and (3)
prohibits management personnel of a bank from serving as a director or in other
management positions of another financial institution whose assets exceed a
specified amount or which has an office within a specified geographic area.
Control of Financial Institutions
No person may acquire "control" of a bank unless the appropriate
federal agency has been given sixty days prior written notice and within that
time the agency has not disapproved the acquisition. Substantial monetary
penalties may be imposed for violation of the change in control or other
provisions of banking laws.
Recent Federal Banking Legislation
Interstate Banking and Branching. The Riegle-Neal Interstate Banking
and Branching Efficiency Act of 1994 ("Interstate Act") generally permits
nationwide interstate banking and branching by authorizing interstate branching
and relaxing federal law restrictions on interstate banking. Subject to certain
state laws, such as age and contingency laws, the Interstate Act allows
adequately capitalized and adequately managed bank holding companies to purchase
the assets of out-of-state banks (effective as of September 29, 1995).
Additionally, effective as of June 1, 1997, the Interstate Act permits
interstate bank mergers, subject to certain state laws, such as age and
contingency laws, unless the home state of either merging bank has "opted-out"
of these provisions by enacting "opt-out" legislation. States may also have
"opted-in" to these bank merger provisions early by enacting non-discriminatory
"opting-in" legislation permitting interstate mergers within their own borders
before June 1, 1997. The Interstate Act does allow states to impose certain
conditions on interstate bank mergers within their borders; for example, states
may require that the in-state merging bank exist for up to five years before the
interstate
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merger. Under the Interstate Act, states may also "opt-in" to de novo branching,
allowing out-of-state banks to establish de novo branches within the state.
Legislation adopted in Hawaii in June of 1996, effective June 1, 1997,
generally permits interstate mergers, subject to certain restrictions. Under
this legislation, a Hawaii state bank must exist for at least five years before
it can be acquired by an out-of-state bank. In addition, out-of-state banks that
do not already operate a branch in Hawaii may not establish de novo branches in
Hawaii or establish and operate a branch by acquiring a branch in Hawaii.
Additional legislation is currently being considered in Hawaii which would
repeal the existence requirements and de novo branching restrictions on June 1,
2000. However, the probability that this legislation will be adopted or amended
cannot be predicted at this time.
Effective October, 1997, the OCC, FDIC and FRB have adopted a rule under
the Interstate Act that prohibits a bank from establishing or acquiring branches
outside the bank's home state for the purpose of deposit production. The rule
provides guidelines for determining whether such bank is reasonably helping to
meet the credit needs of the communities served by these branches.
Regulatory Improvement. In 1994, Congress enacted the Community
Development and Regulatory Improvement Act ("Regulatory Improvement Act") with
the intent of, among other things, reducing the regulatory burden on financial
institutions. This Act is intended to streamline certain regulatory procedures
and relax certain regulatory compliance requirements. In addition, the
Regulatory Improvement Act specifically directs each federal banking agency to
review and streamline its regulations and written supervisory policies.
Other Significant Federal Banking Legislation
Federal Deposit Insurance Corporation Improvement Act of 1991 (the
"FDICIA"). FDICIA was enacted into law in late 1991. As required by FDICIA,
numerous regulations have been adopted by federal bank regulatory agencies,
including the following: (1) federal bank regulatory authorities have
established five different capital levels for banks and, as a general matter,
enable banks with higher capital levels to engage in a broader range of
activities; (2) the FRB has issued regulations requiring standardized
disclosures with respect to interest paid on deposits; (3) the FDIC has imposed
restrictions on the acceptance of brokered deposits by weaker banks; (4) the
FDIC has implemented risk-based deposit insurance premiums; and (5) the FDIC has
issued regulations requiring state chartered banks to comply with certain
restrictions with respect to equity investments and activities in which the
banks act as a principal.
FDICIA recapitalized the Bank Insurance Fund ("BIF") and required the
FDIC to maintain the BIF and Savings Association Insurance Fund ("SAIF") at
1.25% of insured deposits by increasing deposit insurance premiums as necessary
to maintain such ratio.
The Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA"). FIRREA became effective on August 9, 1989. Among other things, this
far-reaching legislation (1) phased in significant increases in the FDIC
insurance premiums paid by commercial banks; (2) created two deposit insurance
pools within the FDIC, one to insure
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commercial bank and savings bank deposits and the other to insure savings
association deposits; (3) for the first time, permitted bank holding companies
to acquire healthy savings associations; (4) permitted commercial banks that
meet certain housing-related asset requirements to secure advances and other
federal services from their local Federal Home Loan Banks; and (5) greatly
enhanced the regulators' enforcement powers by removing procedural barriers and
sharply increasing the civil and criminal penalties for violating statutes and
regulations.
Restrictions on Capital Distributions
Dividends paid by HNB to Bancshares are a material source of
Bancshares' cash flow. Various federal statutory provisions limit the amount of
dividends HNB is permitted to pay to Bancshares without regulatory approval. FRB
policy further limits the circumstances under which bank holding companies may
declare dividends. For example, a bank holding company should not continue its
existing rate of cash dividends on its common stock unless its net income is
sufficient to fully fund each dividend and its prospective rate of earnings
retention appears consistent with its capital needs, asset qualify, and overall
financial condition.
If, in the opinion of the applicable federal banking agency, a
depository institution under its jurisdiction is engaged in or is about to
engage in an unsafe or unsound practice (which, depending on the financial
condition of the institution, could include the payment of dividends), the
agency may require, after notice and hearing, that the institution cease and
desist from that practice. In addition, the FRB and the FDIC have issued policy
statements which provide that insured banks and bank holding companies should
generally pay dividends only out of current operating earnings.
Under the National Bank Act, national banks may only pay dividends
without advance approval of the OCC, if the total of all dividends declared by
the national bank in any calendar year will exceed the sum of its net profits
(as defined) for that year plus its retained profits for the preceding two
calendar years, less any required transfers to capital in excess of par value.
The National Bank Act also prohibits national banks from paying dividends that
would be in an amount greater than net profits then on hand (as defined) after
deducting losses and bad debts (as defined). The amount available for dividend
distribution by the Bank as of December 31, 1997, was approximately $2,102,000.
Capital Requirements
Capital Adequacy Requirements. The FRB, the FDIC, and the OCC
(collectively, the "Federal Banking Agencies") have adopted risk-based capital
guidelines for banks and bank holding companies that are designed to make
regulatory capital requirements more sensitive to differences in risk profiles
among banks and bank holding companies and account for off-balance sheet items.
The guidelines are minimums, and the federal regulators have noted that banks
and bank holding companies contemplating significant expansion programs should
not allow expansion to diminish their capital ratios and should maintain ratios
in excess of the minimums. Failure to achieve and maintain adequate capital
levels may give rise to supervisory action through the issuance of a capital
directive to ensure the maintenance of required capital levels.
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The current guidelines require all federally-regulated banks to
maintain a minimum risk-based total capital ratio equal to 8%, of which at least
4% must be Tier 1 capital. Tier 1 capital includes common shareholders' equity,
qualifying perpetual preferred stock, and minority interests in equity accounts
of consolidated subsidiaries, but excludes goodwill and most other intangibles
and the allowance for loan and lease losses. Tier 2 capital includes the excess
of any preferred stock not included in Tier 1 capital, mandatory convertible
securities, hybrid capital instruments, subordinated debt and intermediate
term-preferred stock, and general reserves for loan and lease losses up to 1.25%
of risk-weighted assets. The Bank has not received any notice indicating that it
will be subject to higher capital requirements.
Under these guidelines, banks' assets are given risk-weights of 0%,
20%, 50% or 100%. In addition, certain off-balance sheet items are given credit
conversion factors to convert them to asset equivalent amounts to which an
appropriate risk-weight will apply. These computations result in the total
risk-weighted assets. Most loans are assigned to the 100% risk category, except
for first mortgage loans fully secured by residential property and, under
certain circumstances, residential construction loans (both carry a 50% rating).
Most investment securities are assigned to the 20% category, except for
municipal or state revenue bonds (which have a 50% rating) and direct
obligations of or obligations guaranteed by the United States Treasury or United
States Government Agencies (which have a 0% rating).
The Federal Banking Agencies have also implemented a leverage ratio,
which is equal to Tier 1 capital as a percentage of average total assets less
intangibles, to be used as a supplement to the risk-based guidelines. The
principal objective of the leverage ratio is to place a constraint on the
maximum degree to which a bank may leverage its equity capital base. The minimum
required leverage ratio for top-rated institutions is 3%, but most institutions
are required to maintain an additional cushion of at least 100 to 200 basis
points. Any institution operating at or near the 3% level is expected to have
well-diversified risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity and good earnings, and in general, to be a strong
banking organization without any supervisory, financial or operational
weaknesses or deficiencies. Any institutions experiencing or anticipating
significant growth would be expected to maintain capital ratios, including
tangible capital positions, well above the minimum levels.
Regulations adopted by the Federal Banking Agencies as required by
FDICIA impose even more stringent capital requirements. The regulations require
the OCC and other Federal Banking Agencies to take certain "prompt corrective
action" when a bank fails to meet certain capital requirements. The regulations
establish and define five capital levels: (1) "well-capitalized," (2)
"adequately capitalized," (3) "undercapitalized," (4) "significantly
undercapitalized" and (5) "critically undercapitalized." To qualify as
"well-capitalized," an institution must maintain at least 10% total risk-based
capital, 6% Tier 1 risk-based capital, and a leverage ratio of no less than 5%.
Increasingly severe restrictions are imposed on the payment of dividends and
management fees, asset growth and other aspects of the operations of
institutions that fall below the category of being "adequately capitalized"
(which requires at least 8% total risk-based capital, 4% Tier 1 risk-based
capital, and a leverage ratio of at least 4%). Undercapitalized institutions are
required to develop and implement capital plans acceptable to the appropriate
federal regulatory agency. Such plans must require that any company that
controls the undercapitalized institution must provide certain guarantees that
the institution will
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comply with the plan until it is adequately capitalized. As of December 31,
1997, neither Bancshares nor HNB were subject to any regulatory order,
agreement, or directive to meet and maintain a specific capital level for any
capital measure.
FDIC Insurance
Generally, customer deposit accounts in banks are insured by the FDIC
for up to a maximum amount of $100,000. The FDIC has adopted a risk-based
insurance assessment system under which depository institutions contribute funds
to the BIF and the SAIF based on their risk classification. The FDIC assigns
institutions a risk classification based on three capital groups and three
supervisory subgroups. The capital groups are "well capitalized," "adequately
capitalized," and "undercapitalized." The three supervisory subgroups are Group
"A" (for financially sound institutions with only a few minor weaknesses), Group
"B" (for those institutions with weaknesses which, if uncorrected, could cause
substantial deterioration of the institution and increase risk to the deposit
insurance fund), and Group "C" (for those institutions with a substantial
probability of loss to the fund absent effective corrective action).
On September 30, 1996, the Deposit Insurance Funds Act of 1996 ("Funds
Act") was enacted. The Funds Act provides, among other things, for the
recapitalization of the SAIF through a special assessment on all depository
institutions that hold SAIF insured deposits. The one-time assessment was
designed to place the SAIF at its 1.25 reserve ratio goal.
The Funds Act, for the three year period beginning in 1997, subjects BIF
insured deposits to a Financing Corporation ("FICO") premium assessment on
domestic deposits at one-fifth the premium rate (approximately 1.3 basis points)
imposed on SAIF insured deposits (approximately 6.5 basis points). In addition,
service debt funding on FICO bonds for the first half of 1997 is expected to
result in BIF insured institutions paying .64 cents for each $100 of assessed
deposits, and SAIF insured institutions paying 3.2 cents on each $100 of
deposits. Beginning in the year 2000, BIF insured institutions will be required
to pay the FICO obligations on a pro-rata basis with all thrift institutions;
annual assessments are expected to equal approximately 2.4 basis points until
2017, to be phased out completely by 2019.
Until further action by the FDIC, BIF premiums will be maintained at
their current level. Accordingly, institutions in the lowest risk category will
continue to pay no premiums, and other institutions will be assessed based on a
range of rates, with those in the highest risk category paying 27 cents for
every $100 of BIF insured deposits. Rates in the SAIF assessment schedule,
previously ranging from 4 to 31 basis points, have recently been adjusted by 4
basis points to a range of 0 to 27 basis points (as of October 1, 1996). As of
December 31, 1997, HNB qualified for the lowest risk category.
The Funds Act provides for the merger of the BIF and SAIF on January 1,
1999, only if no thrift institutions exist on that date. It is expected that
Congress will address comprehensive legislation on the merger of the funds and
elimination of the thrift charter during the 1997 session.
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EFFECTS OF GOVERNMENT MONETARY POLICY
Bancshares and HNB are affected not only by general economic conditions,
but also by the monetary and fiscal policies of the United States government and
its various agencies, particularly the Federal Reserve Board. In its role of
implementing the national monetary policy, the Federal Reserve Board has the
power to regulate the national supply of bank credit through such methods as
open market operations in the United States government securities market,
control of the discount rate on bank borrowings, and establishment of reserve
requirements against bank deposits. These means are used in varying combinations
and have an influence over the growth of bank loans, investments, and deposits.
They may also affect interest rates charged on loans or paid on deposits. The
nature and timing of future changes in monetary policies and their impact on HNB
are not predictable. As a consequence of the extensive regulation of commercial
banking activities in the United States, HNB's business is particularly
susceptible to being affected by Federal legislation and regulations which may
have the effect of increasing the cost of doing business or limiting permissible
activities.
STATISTICAL DISCLOSURES
Guide 3 of the "Guides for the Preparation and Filing of Reports and
Registration Statements" under the Securities Exchange Act of 1934 sets forth
certain statistical disclosures in the "Description of Business" section of bank
holding company filings. The statistical information requested is presented in
the following tables. The tables and information contained therein have been
prepared by Hawaii National Bancshares, Inc. and have not been audited or
reported upon by Bancshares' independent certified public accountants.
<PAGE> 13
I. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES
AND INTEREST DIFFERENTIAL
The following table shows the condensed consolidated average balance sheets, an
analysis of interest income/expense and the average yield/rate for each major
category of interest-bearing assets and interest-bearing liabilities at December
31 for the year indicated.
Hawaii National Bancshares, Inc. & Subsidiary
Table I-A and I-B
Condensed Consolidated Average Balance Sheets,
Interest Income and Expense, and Yields and Rates
(in thousands)
<TABLE>
<CAPTION>
1997 1996
----------------------------------- ----------------------------------
ASSETS INTEREST INTEREST
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------- ------- ---- ------- ------- ----
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Federal funds sold and securities
purchased under agreement to resell $ 12,529 $683 5.45% $17,005 $907 5.33%
Investment securities-
Held-to-maturity 47,996 2,841 5.92% 46,878 2,683 5.72%
Available-for-sale 1,724 120 6.96% 1,495 107 7.16%
-------- ------- ---- ------- ------- -----
Total investment securities 49,720 2,961 5.96% 48,373 2,790 5.77%
-------- ------- ---- ------- ------- -----
Assets held in trading account - - - - - -
Loans and leases-
Domestic 206,780 18,910 9.14% 207,289 18,658 9.00%
-------- ------- ---- ------- ------- -----
Foreign - - - - - -
Total loans and leases 206,780 18,910 9.14% 207,289 18,658 9.00%
-------- ------- ---- ------- ------- -----
Other 402 21 5.22% 402 21 5.22%
-------- ------- ---- ------- ------- -----
Total interest-earning assets 269,431 $22,575 8.38% 273,069 $22,376 8.19%
Cash and due from banks 15,291 ======= ==== 15,261 ======= ====
Premises and equipment 3,740 4,050
Other assets 1,742 1,310
-------- -------
Total assets $290,204 $293,690
======== ========
</TABLE>
<TABLE>
<CAPTION>
1995
--------------------------------
ASSETS INTEREST
AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE
------- ------- ------
<S> <C> <C> <C>
Interest-earning assets:
Federal funds sold and securities
purchased under agreement to resell $ 9,482 $ 555 5.85%
Investment securities-
Held-to-maturity 43,772 2,301 5.26%
Available-for-sale 1,526 93 6.09%
------- ------- -----
Total investment securities 45,298 2,394 5.29%
------- ------- -----
Assets held in trading account - - -
Loans and leases-
Domestic 215,492 19,684 9.13%
------- ------- -----
Foreign -- -- --
Total loans and leases 215,492 19,684 9.13%
------- ------- -----
Other 179 7 3.91%
------- ------- -----
Total interest-earning assets 270,451 $22,640 8.37%
Cash and due from banks 15,665 ======= =====
Premises and equipment 4,271
Other assets 916
--------
Total assets $291,303
========
</TABLE>
<PAGE> 14
LIABILITIES AND
SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
1997 1996
-------------------------------- ---------------------------------
INTEREST INTEREST
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------- ------- ---- ------- ------- ----
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits and liabilities:
Deposits -
Interest-bearing demand $ 27,246 $ 430 1.58% $ 27,248 $ 488 1.79%
Savings 102,803 2,800 2.72% 114,833 3,365 2.93%
Time 69,343 3,386 4.88% 63,647 3,110 4.89%
Foreign -- -- -- -- -- --
-------- -------- ---- -------- -------- ----
Total interest-bearing deposits 199,392 6,616 3.32% 205,728 6,963 3.38%
-------- -------- ---- -------- -------- ----
Federal funds purchased 172 9 5.23% 38 2 5.26%
Short-term borrowings-
Domestic 864 46 5.32% 751 39 5.19%
Long-term debt-
Domestic -- -- -- -- -- --
-------- -------- ---- -------- -------- ----
Total interest-bearing deposits
and liabilities 200,428 6,671 3.33% 206,517 7,004 3.39%
-------- ---- -------- ----
Noninterest-bearing demand deposits 59,294 57,539
Other liabilities 2,694 2,530
-------- -------
Total liabilities 262,416 266,586
Shareholders' equity 27,788 27,104
-------- -------
Total liabilities and
shareholders' equity $290,204 $ 293,690
======== =========
Net interest income and
margin on earnings assets $ 15,904 5.90% $ 15,372 5.74%
======== ==== ========= ====
</TABLE>
<TABLE>
<CAPTION>
1995
------------------------------------
INTEREST
AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE
------- ------- -----
<S> <C> <C> <C>
Interest-bearing deposits and liabilities:
Deposits -
Interest-bearing demand $ 28,728 $ 579 2.02%
Savings 117,275 3,447 2.94%
Time 57,615 2,923 5.07%
Foreign -- -- --
------- -------- -----
Total interest-bearing deposits 203,618 6,949 3.41%
------- -------- -----
Federal funds purchased 370 23 6.22%
Short-term borrowings-
Domestic 2,136 133 6.23%
Long-term debt-
Domestic -- -- --
------- -------- -----
Total interest-bearing deposits
and liabilities 206,124 7,105 3.45%
-------- -------
Noninterest-bearing demand deposits 56,066
Other liabilities 2,770
--------
Total liabilities 264,960
Shareholders' equity 26,343
--------
Total liabilities and
shareholders' equity $291,303
========
Net interest income and
margin on earnings assets $ 15,535 5.74%
======== =====
</TABLE>
<PAGE> 15
The following table sets forth the dollar amount of changes in interest income
and expense and the changes in dollar amounts attributable to (a) changes in
volume (change in volume times old rates), (b) changes in rate (change in rate
times new volume), and (c) changes in rate/volume (change in rate times change
in volume). In this table, the dollar change in rate/volume is prorated to
volume and rate proportionally. Nonaccruing loans and leases have been included
in computation of average loans and leases.
Hawaii National Bancshares, Inc. & Subsidiary
Table I-C
Analysis of Change in Interest Earned and Paid
Due to Changes in Volume and Rates
1997-1996 and 1996-1995
(in thousands)
<TABLE>
<CAPTION>
1997 Compared to 1996 1996 Compared to 1995
Increase (Decrease) Due to: Increase (Decrease) Due to:
----------------------------------- -----------------------------------
Net Net
Increase Increase
Volume Rate (Decrease) Volume Rate (Decrease)
-------- -------- ----------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Interest Earned on:
Federal funds sold and securities
purchased under agreement to resell ($239) $15 ($224) $440 ($88) $352
Investment securities-
Held-to-maturity 64 94 158 163 219 382
Available-for-sale 16 (3) 13 (2) 16 14
------- ------- ------- ------- ------- -------
Total investment securities 80 91 171 161 235 396
------- ------- ------- ------- ------- -------
Interest from trading account -- -- -- -- -- --
Loans and leases-
Domestic (46) 298 252 (749) (277) (1,026)
Foreign -- -- -- -- -- --
------- ------- ------- ------- ------- -------
Total loans and leases (46) 298 252 (749) (277) (1,026)
------- ------- ------- ------- ------- -------
Other -- -- -- 9 5 14
------- ------- ------- ------- ------- -------
Total interest-earning assets ($205) $404 $199 ($139) ($125) ($264)
======= ======= ======= ======= ======= =======
</TABLE>
<PAGE> 16
<TABLE>
<CAPTION>
1997 Compared to 1996 1996 Compared to 1995
Increase (Decrease) Due to: Increase (Decrease) Due to:
-------------------------------- --------------------------------
Net Net
Increase Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------- -------- --------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Interest Paid on:
Deposits-
Interest-bearing demand $ -- ($58) ($58) ($30) ($61) ($91)
Savings (353) (212) (565) (72) (10) (82)
Time 278 (2) 276 306 (119) 187
Foreign -- -- -- -- -- --
----- ----- ----- ----- ----- -----
Total interest-bearing deposits (75) (272) (347) 204 (190) 14
----- ----- ----- ----- ----- -----
Federal funds purchased 7 -- 7 (21) -- (21)
Short-term borrowings-
Domestic 6 1 7 (86) (8) (94)
Long-term debt-
Domestic -- -- -- -- -- --
----- ----- ----- ----- ----- -----
Total interest-bearing deposits
and interest-bearing liabilities (62) (271) (333) 97 (198) (101)
----- ----- ----- ----- ----- -----
Increase (decrease)
in net interest income ($143) $675 $532 ($236) $73 ($163)
===== ===== ===== ===== ===== =====
</TABLE>
<PAGE> 17
II. INVESTMENT SECURITIES PORTFOLIO
The following table presents the carrying value of the portfolio of investment
securities at December 31 of each of the past three years.
Hawaii National Bancshares, Inc. & Subsidiary
Table II-A
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Securities held-to-maturity:
U.S. Treasury and Other U.S. Government Agencies $47,481 $47,930 $44,993
States and Political Subdivisions -- -- 1,000
------- ------- -------
$47,481 $47,930 $45,993
======= ======= =======
Securities available-for-sale:
Equity Securities $ 1,760 $ 1,487 $ 1,497
======= ======= =======
</TABLE>
Note: See Notes 1 and 2 of the Notes to the Consolidated Financial Statements.
The following table presents the maturities of investment securities excluding
securities which have no stated maturity at December 31, 1997, and the weighted
average yields.
Hawaii National Bancshares, Inc. & Subsidiary
Table II-B
(in thousands)
<TABLE>
<CAPTION>
After One After Five
Within But Within But Within After
One Year Five Years Ten Years Ten Years Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Treasury and Other U.S.
Government Agencies $18,988 5.77% $28,493 6.12% -- -- -- -- $47,481 5.98%
======= ==== ======= ==== ==== ==== ==== ==== ======= ====
</TABLE>
At December 31, 1997, the Company had no investment securities with aggregate
carrying values exceeding 10% of shareholders' equity.
Hawaii National Bancshares, Inc. & Subsidiary
Table II-C
(in thousands)
<TABLE>
<CAPTION>
Security Carrying Market
Issuer Rating Value Value
------ ------ ----- -----
<S> <C> <C> <C>
-- -- -- --
</TABLE>
<PAGE> 18
III. LOAN AND LEASE PORTFOLIO
The following table presents the outstanding domestic loans and leases at
December 31 of each of the five years indicated.
Hawaii National Bancshares, Inc. & Subsidiary
Table III-A
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Real Estate -
Residential and commercial $136,072 $130,642 $133,847 $138,264 $132,505
Construction 2,617 2,572 4,558 3,108 5,243
Loans to U.S. banks -- -- -- -- --
Commercial, industrial and agricultural 70,956 64,805 66,021 67,484 66,188
Consumer* 7,613 7,674 7,255 7,076 7,923
All other loans 453 557 248 241 266
Lease financing 1,307 1,013 1,165 1,241 1,546
-------- -------- -------- -------- --------
Total Loans and Leases $219,018 $207,263 $213,094 $217,414 $213,671
======== ======== ======== ======== ========
</TABLE>
Note: *Loans to individuals for household, family and other personal
expenditures.
<PAGE> 19
The following table presents maturity and interest rate sensitivity data for all
loans and leases, except real estate - residential and commercial, consumer
loans, all other loans, and lease financing, at December 31, 1997.
Hawaii National Bancshares, Inc. & Subsidiary
Table III-B
Loan and Lease Maturity and
Interest Rate Sensitivity Data
December 31, 1997
(in thousands)
<TABLE>
<CAPTION>
After One After
One Year Year through Five
or Less Five Years Years Total
--------- ------------ ------ -------
<S> <C> <C> <C> <C>
Commercial, industrial and agricultural $50,893 $16,190 $3,873 $70,956
Real estate - construction 2,617 - - 2,617
Foreign - - - -
------- ------- ------ -------
$53,510 $16,190 $3,873 73,573
Real estate - residential and commercial 136,072
Consumer 7,613
All other loans 453
Lease financing 1,307
-------
Total loans and leases $219,018
========
Loans with fixed or predetermined
interest rates $6,211 $3,094 $2,144 $11,449
Loan with floating or adjustable
interest rates 47,299 13,096 1,729 62,124
------- ------- ------ -------
$53,510 $16,190 $3,873 $73,573
</TABLE>
<PAGE> 20
Risk Elements (See Management's Discussion and Analysis)
The following table presents information related to loans and leases accounted
for on a nonaccrual basis, accruing loans and leases which are contractually
past due ninety days or more as to principal and/or interest payments, and
restructured loans and leases at December 31 for the years indicated.
Hawaii National Bancshares, Inc. & Subsidiary
Table III-C(1)
Nonaccrual, Past Due, and Restructured Loans and Leases
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Nonaccrual loans and leases
Domestic
Real estate $2,478 $1,972 $5,142 $ 771 $ 924
Commercial, industrial and agricultural 1,304 1,208 1,064 555 --
Consumer -- -- -- -- --
All other loans -- -- -- -- --
Lease financing -- -- -- -- --
Foreign -- -- -- -- --
------ ------ ------ ------ ------
Total $3,782 $3,180 $6,206 $1,326 $ 924
====== ====== ====== ====== ======
Loans and leases past due 90 days or more
Domestic
Real estate $ - $ 134 $ 393 $ 841 $ 439
Commercial, industrial and agricultural 399 56 -- 1,365 169
Consumer 25 22 21 35 26
All other loans -- -- -- -- --
Lease financing -- -- -- -- --
Foreign -- -- -- -- --
------ ------ ------ ------ ------
Total $ 424 $ 212 $ 414 $2,241 $ 634
====== ====== ====== ====== ======
Restructured loans and leases
Domestic
Real estate $ -- $ -- $ -- $ -- $ --
Commercial, industrial and agricultural -- -- -- -- 52
Consumer -- -- -- -- --
All other loans -- -- -- -- --
Lease financing -- -- -- -- --
Foreign -- -- -- -- --
------ ------ ------ ------ ------
Total $ -- $ -- $ -- $ -- $ 52
====== ====== ====== ====== ======
</TABLE>
<PAGE> 21
The following table presents information related to loans and
leases on a nonaccrual basis for the year ended December 31, 1997.
Hawaii National Bancshares, Inc. and Subsidiary
Table III-C(2)
Nonaccrual Loan and Lease Information
Year Ended December 31, 1997
(in thousands)
<TABLE>
<CAPTION>
Domestic Foreign Total
-------- ------- -----
<S> <C> <C> <C>
Interest income which would have
been recorded if loans and
leases had been current $ 441 $ -- $441
===== ==== ====
Interest income recorded during
this period $ -- $ -- $ --
===== ==== ====
</TABLE>
Note: See Notes 1 and 5 of the Notes to the Consolidated Financial Statements
and Table III-C(1).
Hawaii National Bancshares, Inc. and Subsidiary
Impaired Loans
December 31, 1997
(in thousands)
<TABLE>
<CAPTION>
Present value of
expected future Fair value of
cash flows loan's collateral Total
---------------- ----------------- -----
<S> <C> <C> <C>
Real estate $ 365 $2,124 $2,489
Commercial, industrial and agricultural 382 922 1,304
----- ------ ------
Total Impaired Loans $ 747 $3,046 $3,793
===== ====== ======
</TABLE>
<PAGE> 22
IV. SUMMARY OF LOAN AND LEASE LOSS EXPERIENCE
The following table presents the Company's loan and lease loss experience at
December 31 for the years indicated.
Hawaii National Bancshares, Inc. & Subsidiary
Table IV-A
Year Ended
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Average loans and leases outstanding $206,780 $207,289 $215,492 $213,729 $217,025
======== ======== ======== ======== ========
Loan and lease loss reserve summary-
Balance at beginning of year $ 3,067 $ 3,096 $ 3,422 $ 3,129 $ 2,783
-------- -------- -------- -------- --------
Loans and leases charged off:
Real estate 146 194 112 81 35
Commercial, industrial and agricultural 487 1,266 837 350 86
Consumer 136 71 155 69 33
All other loans -- -- -- -- --
Lease financing -- -- -- -- --
-------- -------- -------- -------- --------
Total loans and leases charged off 769 1,531 1,104 500 154
-------- -------- -------- -------- --------
Recoveries on loans and leases charged off:
Real estate 11 -- -- 1 2
Commercial, industrial and agricultural 158 651 62 9 10
Consumer 11 41 16 18 7
All other loans -- -- -- -- --
Lease financing -- -- -- -- 1
-------- -------- -------- -------- --------
Total recoveries on loans
and leases charged off 180 692 78 28 20
-------- -------- -------- -------- --------
Net charge-offs 589 839 1,026 472 134
Provision charged to expense 720 810 700 765 480
-------- -------- -------- -------- --------
Balance at end of year $ 3,198 $ 3,067 $ 3,096 $ 3,422 $ 3,129
======== ======== ======== ======== ========
Ratio of net charge-offs
to average loans and leases outstanding 0.28% 0.40% 0.48% 0.22% 0.06%
======== ======== ======== ======== ========
</TABLE>
<PAGE> 23
The Company has allocated a portion of the allowance for loan and lease losses
according to the amount deemed to be reasonably necessary to provide for the
possibility of losses being incurred within the various loan and lease
categories. The following table presents the allocation of the reserve amounts
to the related outstanding loan and lease balances at December 31 for the years
indicated. In 1994, the Company adopted a new reserve allocation method which
took into account differences in risk classifications. In 1995, the reserve
methodology was refined further to analyze each credit for loss potential which
was over $50,000 and had been placed on nonaccrual.
Hawaii National Bancshares, Inc. & Subsidiary
Table IV-B
Allocation of the Reserve for Loan and Lease Losses to
Outstanding Loans and Leases
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
--------------------------- ---------------------------- ----------------------------
Percent Percent Percent
Loans/Leases Loans/Leases Loans/Leases
in Each in Each in Each
Category Category Category
Reserve to Total Reserve to Total Reserve to Total
Amount Loans/Leases Amount Loans/Leases Amount Loans/Leases
------- ------------ -------- ------------- -------- --------------
<S> <C> <C> <C> <C> <C> <C>
Commercial, industrial
and agricultural $1,576 32% $1,373 31% $1,365 31%
Real estate
-construction 1 1% 3 1% 245 2%
Real estate
-residential
and commercial 654 62% 657 63% 560 63%
Consumer 493 4% 469 4% 347 3%
All other loans 9 - 11 - - -
Lease financing 10 1% 9 1% 14 1%
Foreign - - - - - -
Loans to U.S. Banks
under repurchase
agreement - - - - - -
General reserve 455 N/A 545 N/A 565 N/A
------ --- ------ --- ------ ---
Consolidated $3,198 100% $3,067 100% $3,096 100%
====== === ====== === ====== ===
</TABLE>
<TABLE>
<CAPTION>
1994 1993
------------------------- -------------------------
Percent Percent
Loans/Leases Loans/Leases
in Each in Each
Category Category
Reserve to Total Reserve to Total
Amount Loans/Leases Amount Loans/Leases
-------- ------------ --------- -------------
<S> <C> <C> <C> <C>
Commercial, industrial
and agricultural $1,713 31% $892 31%
Real estate
-construction 276 1% 7 2%
Real estate
-residential
and commercial 579 64% 294 62%
Consumer 346 3% 375 4%
All other loans - - - -
Lease financing 13 1% 15 1%
Foreign - - - -
Loans to U.S. Banks
under repurchase
agreement - - - -
General reserve 495 N/A 1,546 N/A
------ --- ------ ---
Consolidated $3,422 100% $3,129 100%
====== === ====== ===
</TABLE>
<PAGE> 24
The following table sets forth by major category the ratio of net loans and
leases charged-off to total average loans and leases outstanding for the years
indicated.
Hawaii National Bancshares, Inc. & Subsidiary
Table IV-C
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Real estate 0.06% 0.09% 0.05% 0.04% 0.01%
Commercial, industrial and agricultural 0.16% 0.30% 0.36% 0.16% 0.04%
Consumer 0.06% 0.01% 0.07% 0.02% 0.01%
All other loans 0.00% 0.00% 0.00% 0.00% 0.00%
Leasing 0.00% 0.00% 0.00% 0.00% 0.00%
---- ---- ---- ---- ----
Total 0.28% 0.40% 0.48% 0.22% 0.06%
==== ==== ==== ==== ====
</TABLE>
<PAGE> 25
V. DEPOSITS
The following table presents the average amount and average rate paid on
deposits for the years indicated. The following table presents for the years
indicated:
Hawaii National Bancshares, Inc. & Subsidiary
Table V-A
Average Deposits by Type
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------ ------------------------ ---------------------------
Amount Rate Amount Rate Amount Rate
--------------- ---------- ------------------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing demand $59,294 -- $57,539 -- $56,066 --
Interest-bearing demand 27,246 1.58% 27,248 1.79% 28,728 2.02%
Savings 102,803 2.72% 114,833 2.93% 117,275 2.94%
Time 69,343 4.88% 63,647 4.89% 57,615 5.07%
Foreign - -- - -- -- --
-------- -------- --------
Total $258,686 $263,267 $259,684
======== ======== ========
</TABLE>
The following table presents the maturity distribution of domestic time
certificates of deposit issued in amounts of $100,000 or more at December 31 for
the years indicated.
Hawaii National Bancshares, Inc. & Subsidiary
Table V-B
Maturity Distribution of Domestic Time Certificates
of Deposit of $100,000 or More
(in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
3 months or less $28,622 $26,525 $25,213
Over 3 months through 6 months 17,544 17,122 11,492
Over 6 months through 12 months 2,666 4,154 4,842
Over 12 months 221 144 --
------- ------- -------
$49,053 $47,945 $41,547
======= ======= =======
</TABLE>
Note: At December 31, 1997, 1996, and 1995, public time deposits totaled
$32,001,000; $32,192,000; and $30,197,000, respectively.
<PAGE> 26
VI. RETURN ON EQUITY AND ASSETS
The following table presents for the years indicated:
1. Return on average assets (net income divided by average total assets);
2. Return on average equity (net income divided by average shareholders'
equity);
3. Dividend payout ratio (dividends per share divided by net income per share);
4. Average equity to average assets ratio (average shareholders' equity divided
by average total assets).
Hawaii National Bancshares, Inc. & Subsidiary
Table VI
Operating, Dividend, and Capital Ratios
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
1.Return on average assets 0.22% 0.24% 0.36%
2.Return on average equity 2.34% 2.62% 3.96%
3.Dividend payout ratio 16.30% 15.00% 10.20%
4.Average equity to average assets ratio 9.58% 9.23% 9.04%
</TABLE>
<PAGE> 27
ITEM 2. PROPERTIES
Bancshares maintains its office at the same location in Honolulu as the
Bank's main office.
The Bank's premises are leased for varying periods to 2024 with renewal
options ranging from 3 to 20 years. Rent expense was $2,493,000 in 1997;
$2,366,000 in 1996 and $2,294,000 in 1995, net of sublease income of $56,000 in
1997, $59,000 in 1996 and $46,000 in 1995. Premise leases extend for varying
periods up to 27 years and provide for periodic renegotiation of rents based
upon a percentage of the appraised value of the leased property. At December 31,
1997, the aggregate minimum rental commitments under all non-cancelable leases
were as follows: 1998 - $2,438,000; 1999 - $2,332,000; 2000 - $2,213,000; 2001-
$2,145,000; 2002 -$1,791,000; and thereafter to 2024 - $22,913,000 (aggregate
$33,832,000). Additional information is provided in Note 9 of the Notes to the
Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
The Bank is party to legal actions from time to time as part of its
normal course of business. Management, after consulting with counsel on these
matters, believes the outcome of these cases will not have a materially adverse
effect upon Bancshares' or the Bank's financial position, results of operations
or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted for a vote of security holders in the fourth
quarter of 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDERS MATTERS.
MARKET INFORMATION
Bancshares' common stock is not actively traded and is not listed on any
exchange. Management is not aware of any broker/dealer who formally makes a
market in its common stock. However, based upon quotations obtained from Dow
Jones Telerate and actual transactions known to Bancshares, the price of
Bancshares' common stock during 1997 has ranged between $34.00 to $38.00 and
during 1996 from $33.00 to $36.00. Bancshares' book value per share at December
31, 1997 and 1996 was $39.86 and $39.10, respectively. Neither the book value
nor its trading price may be indicative of the value of Bancshares' common
stock.
<PAGE> 28
NUMBER OF EQUITY HOLDERS
As of February 28, 1998, there were 1,269 common shareholders of record.
Bancshares' transfer agent is HNB.
DIVIDENDS
Bancshares paid cash dividends on its common stock in the amount of
$0.15 per share on February 17, 1998, and on February 14, 1997 and 1996.
Bancshares' dividend policy is to retain the majority of its earnings to finance
future growth and build a strong capital base. Cash dividends are subject, among
other things, to certain limitations under applicable national banking laws as
described in Note 10 of the Notes to the Consolidated Financial Statements.
ITEM 6. SELECTED FINANCIAL DATA
A summary of operations and selected financial data for the five years
ended December 31 is presented as follows:
<PAGE> 29
ITEM 6. SELECTED FINANCIAL DATA
HAWAII NATIONAL BANCSHARES, INC.
& SUBSIDIARY
SUMMARY OF OPERATIONS AND OTHER SELECTED FINANCIAL DATA
for the five years ended December 31
(in thousands except for per share data)
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Interest income $ 22,575 $ 22,376 $ 22,640 $ 20,179 $ 20,933
Interest expense 6,671 7,004 7,105 5,300 6,063
-------- -------- -------- -------- --------
Net interest income 15,904 15,372 15,535 14,879 14,870
Provision for loan and lease losses 720 810 700 765 480
-------- -------- -------- -------- --------
Net interest income after provision
for loan and lease losses 15,184 14,562 14,835 14,114 14,390
Other income 2,734 2,445 2,336 2,348 2,478
Other expenses 16,909 15,865 15,507 15,085 15,272
-------- -------- -------- -------- --------
Income before income taxes and cumulative
effect of change in accounting principle 1,009 1,142 1,664 1,377 1,596
Income tax provision 358 431 620 505 670
-------- -------- -------- -------- --------
Income before cumulative effect of change
in accounting principle 651 711 1,044 872 926
Cumulative effect of change in method
of accounting for income taxes -- -- -- -- 350
-------- -------- -------- -------- --------
Net income $ 651 $ 711 $ 1,044 $ 872 $ 1,276
======== ======== ======== ======== ========
Earnings Per Common Share (basic and diluted):
Earnings before cumulative effect of
accounting change $ 0.92 $ 1.00 $ 1.47 $ 1.23 $ 1.30
Cumulative effect of change in
accounting principle -- -- -- -- 0.49
-------- -------- -------- -------- --------
Earnings per common share $ 0.92 $ 1.00 $ 1.47 $ 1.23 $ 1.79
======== ======== ======== ======== ========
Cash dividends per share $ 0.15 $ 0.15 $ 0.15 $ 0.15 $ 0.15
======== ======== ======== ======== ========
OTHER SELECTED FINANCIAL DATA:
Total assets $298,687 $296,025 $299,590 $290,256 $306,407
Investment securities $ 49,241 $ 49,417 $ 47,490 $ 46,419 $ 44,437
Loans and leases, net of allowance for
possible loan and leases losses $215,821 $204,195 $209,998 $213,993 $210,542
Deposits $258,721 $264,594 $268,906 $260,973 $278,168
Shareholders' equity $ 28,342 $ 27,797 $ 27,193 $ 26,243 $ 25,478
Book value per share $ 39.86 $ 39.10 $ 38.25 $ 36.91 $ 35.83
</TABLE>
<PAGE> 30
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE
RESULTS OF OPERATIONS
In reviewing this discussion, reference should be made to the
accompanying table of analysis of operations, the financial statements, and
selected financial data presented elsewhere in this report.
Hawaii National Bancshares, Inc. & Subsidiary
Analysis of Results of Operations
(in thousands)
<TABLE>
<CAPTION>
Year Ended December 31 1997 vs 1996
------------------------------- ---------------------
Increase Percent of
1997 1996 1995 (Decrease) Change
------- -------- ------- --------- ----------
<S> <C> <C> <C> <C> <C>
Interest Income:
Interest and fees on loans
and leases $18,910 $18,658 $19,684 $252 1.4%
Interest on federal funds sold 683 907 555 (224) -24.7%
Interest on investment securities 2,841 2,683 2,301 158 5.9%
Other 141 128 100 13 10.2%
------- ------- ------- ---- -----
Total interest income 22,575 22,376 22,640 199 0.9%
------- ------- ------- ---- -----
Interest Expense:
Deposits 6,616 6,963 6,949 (347) -5.0%
Federal funds purchased 9 2 23 7 350.0%
Interest on short-term borrowings 46 39 133 7 17.9%
------- ------- ------- ---- -----
Total interest expense 6,671 7,004 7,105 (333) -4.8%
Net interest income 15,904 15,372 15,535 532 3.5%
Provision for loan and lease losses 720 810 700 (90) -11.1%
------- ------- ------- ---- -----
Net interest income after provision
for loan and lease losses 15,184 14,562 14,835 622 4.3%
------- ------- ------- ---- -----
Other Income:
Service charges on deposit accounts 1,097 1,110 1,086 (13) -1.2%
Other service charges, collection and exchange
charges, commissions and fees 1,635 1,320 1,231 315 23.9%
Gain (loss) on available-for-sale securities - (10) 19 10 -100.0%
Gain on investment securities held-to-maturity 2 25 - (23) -92.0%
------- ------- ------- ---- -----
2,734 2,445 2,336 289 11.8%
------- ------- ------- ---- -----
Other Expenses:
Salaries and employee benefits 8,765 8,132 7,722 633 7.8%
Occupancy expense of bank premises 3,689 3,511 3,381 178 5.1%
Equipment expense 982 853 777 129 15.1%
Computer services 571 729 690 (158) -21.7%
Other operating expenses 2,902 2,640 2,937 262 9.9%
------- ------- ------- ---- -----
16,909 15,865 15,507 1,044 6.6%
------- ------- ------- ---- -----
Income before income taxes 1,009 1,142 1,664 (133) -11.6%
Income Tax Provision 358 431 620 (73) -16.9%
------- ------- ------- ---- -----
Net income $651 $711 $1,044 ($60) -8.4%
======= ======= ======= ==== =====
</TABLE>
<TABLE>
<CAPTION>
1996 vs 1995
------------------------
Increase Percent of
(Decrease) Change
---------- -----------
<S> <C> <C>
Interest Income:
Interest and fees on loans
and leases ($1,026) -5.2%
Interest on federal funds sold 352 63.4%
Interest on investment securities 382 16.6%
Other 28 28.0%
------- ------
Total interest income (264) -1.2%
------- ------
Interest Expense:
Deposits 14 0.2%
Federal funds purchased (21) -91.3%
Interest on short-term borrowings (94) -70.7%
------- ------
Total interest expense (101) -1.4%
Net interest income (163) -1.0%
Provision for loan and lease losses 110 15.7%
------- ------
Net interest income after provision
for loan and lease losses (273) -1.8%
------- ------
Other Income:
Service charges on deposit accounts 24 2.2%
Other service charges, collection and exchange
charges, commissions and fees 89 7.2%
Gain (loss) on available-for-sale securities (29) -152.6%
Gain on investment securities held-to-maturity 25 -
------- ------
109 4.7%
------- ------
Other Expenses:
Salaries and employee benefits 410 5.3%
Occupancy expense of bank premises 130 3.8%
Equipment expense 76 9.8%
Computer services 39 5.7%
Other operating expenses (297) -10.1%
------- ------
358 2.3%
------- ------
Income before income taxes (522) -31.4%
Income Tax Provision (189) -30.5%
------- ------
Net income ($333) -31.9%
======= ======
</TABLE>
<PAGE> 31
Hawaii National Bancshares, Inc. ("Bancshares") through its wholly owned
subsidiary, Hawaii National Bank ("HNB" or the "Bank"), maintains a diverse
portfolio of assets ranging from the core business of loans and leases to
investment securities. The interest-earning assets of the Bank are financed
through a combination of interest-bearing and interest-free sources. In keeping
with management's goals of managing risk and improving long-term profitability
to shareholders, the Bank continues to emphasize conservative credit
underwriting, diversification of revenue sources, and controlled growth.
Preserving credit quality, maintaining a liquid and interest rate sensitive
balance sheet and building a strong capital position continue to have high
priorities.
This report and other filings and communications made by Bancshares and
HNB may contain, from time to time, certain forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. Among other
things, these forward-looking statements may be contained in periodic filings
made to the Securities and Exchange Commission ("SEC"), press releases, and oral
statements made by executive officers of Bancshares or HNB. By their very
nature, forward-looking statements, such as forecasts or projections of future
performance or statements of management's plans and objectives, are subject to
various risks and uncertainties that could cause actual results to differ
materially from those indicated. These include, but are not limited to: global,
national and local economic conditions; increased competition from bank and
nonbank institutions; governmental regulation; the timing and magnitude of
interest rate changes; trends in credit quality, liquidity and capital
resources; changes in consumer and business behavior; developments in
technology; and other risk factors. When relying on forward-looking statements,
investors and others should carefully consider these and other uncertainties,
whether or not the statements are described as forward-looking. Unless
explicitly stated otherwise, forward-looking statements made by Bancshares or
HNB are intended to apply only at the time they are made. Both Bancshares and
HNB undertake no obligation to publicly revise or update these forward-looking
statements to reflect subsequent events.
LOCAL ECONOMY
In 1997, Hawaii continued to struggle through a prolonged economic
slowdown which began in 1990. The gross state product is estimated to have grown
by a little more than 1% in 1997, virtually unchanged from the prior year, and
substantially below the robust 3.7% estimated for the nation. During the year,
the trend in corporate downsizings, failures, and migrations to other states
continued, boosting the State's unemployment rate in December nearly 1% above
the national rate, and making 1997 the fifth consecutive year that Hawaii has
lost jobs. Bankruptcies and foreclosures continued to mount in 1997, surpassing
the records set in 1996 by 44% and 11%, respectively. While home resales
increased during the year, prices continued to slide. The median price for a
single-family home on Oahu in 1997 was 8% lower, compared to 1996, while the
condominium median was 14% below the prior year. In the commercial real estate
area, relatively high vacancy rates continued to depress property values in
1997.
<PAGE> 32
In 1998, Hawaii will be entering its eighth year of an economic slump,
which ranks as one of the longest for any U.S. regional economy since World War
II. With its close ties to Asia, the outlook for the coming year is less than
positive. The well-publicized economic problems in Japan and other Asian
countries, combined with sharply weaker currencies, have made Hawaii's
tourist-based and capital-poor economy both less attractive as a vacation
destination and as a place for foreign investment. Tourism is Hawaii's largest
industry generating about one-quarter of the gross state product and employing
an estimated 25% of the State's workforce. One-third of the State's annual
tourists are from Asia, of which the Japanese represent the largest segment.
Since last year, Japanese arrivals have declined and those that are coming to
Hawaii are spending less as a result of the weaker yen. Another major market is
Korea, which the Hawaii Visitors and Convention Bureau expects to plunge by as
much as 80% in 1998 due to the collapse of the Korean won. Likewise, business is
falling from Indonesia, Thailand, the Philippines and other Asian countries,
which have undergone severe currency devaluations. These grim prospects for
tourism have already prompted several local companies in other industries to
initiate unprecedented layoffs. Finally, given the dramatic decline in
purchasing power of many Asian nations, it would be optimistic to look to that
part of the world as a source of foreign capital to revive Hawaii's ailing
construction and real estate industry.
OVERVIEW
The consolidated net income of Hawaii National Bancshares, Inc. and
Hawaii National Bank (collectively, the "Company") was $651,175 in 1997,
compared to $711,223 in 1996 and $1,043,935 in 1995. Earnings per share were
$0.92, $1.00, and $1.47 in 1997, 1996 and 1995, respectively.
The 1997 earnings represented a decline of $60,048 or 8.4% from the
prior year. While revenues increased, higher costs associated with expanding the
branch network and reductions in the carrying costs of certain properties in
other real estate owned, resulted in lower profits for the year.
Net income decreased by $332,712 or 31.9% in 1996, due to lower net
interest income, a higher provision for loan and lease losses and the full
year's effect of the Maui branches, which were acquired in mid-1995 from the
former Bank USA, N.A., partly offset by a reduction in Federal Deposit Insurance
Corporation ("FDIC") insurance premiums.
In recent years, the weak local economy has resulted in higher levels of
nonaccrual loans and leases and those past due 90 days or more (collectively,
referred to as "noncurrent loans and leases"). As of year-end 1997, noncurrent
loans and leases increased to $4,206,000, representing 1.9% of total loans and
leases, compared to $3,392,000, or 1.6%, as of the same date in 1996. Net
charge-offs declined to $589,619 in 1997, compared to $838,999 in 1996.
At December 31, 1997, total assets stood at $298,686,778, an increase
from $296,025,258 at December 31, 1996. Loans and leases grew 5.7% to a record
$219,018,348 at December 31, 1997. Deposits decreased 2.2% to $258,720,805 at
December 31, 1997, due to a large deposit withdrawal related to a customer's
real estate
<PAGE> 33
investment. Shareholders' equity increased 2.0% to $28,341,813 at year-end
1997. Leverage and risk-based capital ratios exceeded regulatory capital
requirements by a substantial margin at December 31, 1997 and 1996.
OUTLOOK FOR 1998
Looking ahead to 1998, the Company anticipates that its operating
results for the year may be substantially below those reported for 1997, due to
the execution of certain strategic initiatives and the prospects for increased
fall-out from the Asian financial crisis on the local business community.
As part of its long-range planning, the Company has implemented several
initiatives in the last few years with the objective of increasing the Bank's
franchise value and improving long-term profitability to shareholders. These
initiatives include, among other things, expanding the branch network and
merging the operations of HNB's data processing provider, Computer Systems
International, Ltd. ("CSI"), into the Bank. While these actions may have an
adverse impact on the results of operations for 1998, these steps are designed
to position the Bank to improve future profitability by strengthening the Bank's
ability to effectively compete in the rapidly changing financial services
industry, enhance service quality and promote greater operating efficiencies.
Management believes the cornerstone of a community bank is its branch
system. While other financial institutions have been closing offices, HNB has
expanded into areas where the demographics for small business and future
population growth appear favorable. Since 1995, HNB has opened 3 new branches: 2
on Maui (Kihei and Kahului) and 1 in Pearl City, Oahu. The Bank anticipates
opening its first "in-store branch" in the Moanalua Ethnic Village on Oahu in
March 1998. These new facilities provide the Bank with an opportunity to expand
its loan and deposit base. Based on past experience, initially, new branches
adversely impact earnings until the volume of business grows to cover overhead
expenses.
In order to be competitive in today's market, HNB recognizes that it
must become a lower-cost provider. The Bank's strategy to accomplish this
objective is to leverage technology to gain operating efficiencies and drive
down costs. In keeping with its long-term plan, the operations of CSI, an
affiliated bank service company, were merged into HNB, effective October 1,
1997. While the effect of bringing this function inhouse may increase overhead
costs in the short-run, the anticipated efficiencies that accrue over time will
enable the Bank to significantly reduce costs in other areas, without
compromising customer service. The new Information Systems Department is
currently in the process of upgrading the Bank's computer hardware and software.
The installation of the new system will lower maintenance costs, offsetting the
estimated depreciation charges, and provide the technology to expand the Bank's
product line. When this project is completed, the department may explore
revenue-generating opportunities outside of the Bank. Prior to being acquired by
HNB, CSI provided data processing services to other financial institutions in
Hawaii and developed several software programs that were used, at one time, by
approximately 100 different clients, including the U.S. Navy, Chase Manhattan
Bank, Federal Home Loan Bank of Cincinnati,
<PAGE> 34
Fiserv, Inc., University of Virginia, City of Minneapolis, and various other
institutions and companies worldwide.
Besides the initiatives described above, the Company's performance in
1998 is expected to be significantly affected by the turmoil in Asia and its
backlash on Hawaii, which is still growing. As a community bank, HNB's market
area is concentrated in Hawaii, and management continues to believe that its
banking activities should remain in the State. Many of the Bank's customers are
family enterprises and closely held businesses, which have already been hit hard
by the weak local economy prior to the crisis in Asia. During the first quarter
of 1998, the Bank will be increasing its provision for loan and lease losses by
an additional $90,000 over the first quarter of 1997. The appropriateness of
continuing such an increase will be re-evaluated at least quarterly.
There is no assurance that the Bank will be able to achieve its
objectives, nor is it possible to predict whether future changes in regulatory,
economic and competitive changes will cause the Company or the Bank to revise
its operating strategy. The operating results of the Company and Bank are
expected to remain dependent upon general economic conditions and other external
factors for the foreseeable future.
RESULTS OF OPERATIONS
Net Interest Income
HNB derives the majority of its earnings from net interest income, the
difference between what the Bank earns on interest-earning assets such as loans
and leases, federal funds sold and investment securities and what it pays on
interest-bearing liabilities such as interest-bearing deposits, federal funds
purchased and short-term borrowings. Net interest income is affected mainly by
changes in the volume and the mix of interest-earning assets and
interest-bearing liabilities and in the yields earned and the rates paid based
on those assets and liabilities.
Net interest income increased to $15,903,944 in 1997, compared to
$15,372,384 in 1996 and $15,534,686 in 1995. The 3.5% increase in 1997 was
primarily due to an improvement in net interest margin. During 1996, a lower
average balance of loans and leases and a lower average loan and lease yield,
partly offset by a reduction in the average balance of short-term borrowings,
resulted in a 1.0% decrease in net interest income. Net interest margin was
5.90%, 5.63% and 5.74% for 1997, 1996 and 1995, respectively.
Total interest income increased to $22,574,669 in 1997 versus
$22,376,745 in 1996 and $22,640,331 in 1995. The higher interest revenue
reported in 1997 was attributable to an increase in average asset yields. The
average yield on interest-earning assets rose from 8.19% in 1996 to 8.38% in
1997. The increase was due to generally higher market interest rates, which
included a 25 basis point increase in the prime rate in March 1997. The decline
in interest income in 1996 was mainly due to a lower average balance of loans
and leases and a lower average loan and lease yield. Interest income foregone on
nonaccrual loans and leases amounted to $441,000, $464,000 and $318,000 in 1997,
1996 and 1995, respectively.
<PAGE> 35
Total interest expense decreased to $6,670,725 in 1997, compared to
$7,004,361 and $7,105,645 in 1996 and 1995, respectively. The 4.8% decline in
1997 was primarily due to lower average rates paid on deposits, which declined
to 3.32% from 3.38% in 1996. During 1997, the Bank continued to experience a
migration from lower costing savings into higher costing time deposits. The
average rates paid on savings and time deposits during the year were 2.72% and
4.88%, respectively. The improvement of 1.4% in 1996 was due to a lower average
aggregate balance of federal funds purchased and short-term borrowings which
declined from $2,506,000 in 1995 to $789,000 in 1996.
Other Income and Other Expenses
In addition to interest income, the Bank has various sources of other
income which include service charges on deposit accounts; other service charges,
collection and foreign exchange charges, commissions and fees; and gains and
losses on investment securities. Other income grew from $2,336,523 in 1995 to
$2,445,479 in 1996, and to $2,734,128 in 1997. This represents an increase of
$108,956 or 4.7% in 1996 and $288,649 or 11.8% in 1997. The increase in 1996
reflected improved fee income generation on loan and deposit accounts. The 1997
increase was attributable to data processing fees of $350,000 paid to HNB by
another financial institution. The contract with this institution ended in
December 1997. The gains on investment securities held-to-maturity in 1997 and
1996 were premiums paid to the Bank for securities which were called. During
1996, an equity security available-for-sale with a carrying cost of $10,000 was
written off after the issuer ceased operations. In 1995, the Bank acquired
$2,103,358 in U.S. agency securities from the former Bank USA which were
classified as available-for-sale. These securities were subsequently sold,
generating proceeds of $2,122,073. The gross realized gain was $18,715 based on
the specific identification method.
Other expenses consist of salaries and employee benefits, occupancy
expense of bank premises, equipment expense, computer services and other
operating expenses. Other expenses totaled $16,908,897 in 1997, $15,865,640 in
1996 and $15,507,274 in 1995. The increase of $1,043,257 or 6.6% in 1997 was
primary due to the establishment of a new branch in Pearl City, the merger of
CSI into the Bank, and writedowns in the carrying values of certain properties
in other real estate owned. The increase of $358,366 or 2.3% in 1996 was
primarily due to the opening of two new branches on Maui in 1995, partly offset
by a reduction in FDIC premiums.
Salaries and employee benefits increased $632,848 or 7.8% in 1997,
compared to an increase of $410,376 or 5.3% a year earlier. The growth in this
category reflects several factors including: (1) an increase in staff due to the
merger of CSI, the opening of the Pearl City Branch in 1997 and two branches on
Maui in 1995; (2) rising costs for health benefits; (3) higher pension expense;
and (4) normal merit and inflationary adjustments, which were adopted to keep
the Bank's compensation packages competitive.
Occupancy expense of bank premises rose $177,908 or 5.1% in 1997 versus
an increase of $129,663, or 3.8%, in the previous year. The increase in 1997 was
attributable to the addition of the Pearl City Branch and CSI's office rent. The
increase in 1996 was due to the two new branches on Maui.
<PAGE> 36
Equipment expense increased $129,162 or 15.1% in 1997 and $76,219 or
9.8% in 1996. The increase in 1997 was primarily due to repairs for furniture,
fixtures and equipment. The increase in 1996 resulted largely from higher
depreciation charges.
Computer services were obtained from CSI, a bank service corporation
formed to provide data processing services to financial institutions, including
the Bank. On August 31, 1997, CSI became wholly owned by the Bank when CSI
purchased into treasury stock the other 50% interest from an affiliate of a
director. Effective October 1, 1997, CSI's operations were merged into the Bank
and CSI was liquidated, which resulted in additional assets and liabilities of
approximately $1,400,000. Charges for data processing service were $571,000 in
1997, $729,000 in 1996 and $690,000 in 1995. The merger of CSI's operations into
the Bank will eliminate these fees in the future, but increased costs may be
experienced in salaries and employee benefits and occupancy costs until
anticipated efficiencies are realized.
Other operating expenses increased $261,768 or 9.9% in 1997 and
decreased $296,617 or 10.1% in 1996. The increase in 1997 was primarily due to
writedowns approximating $138,000 of certain properties in other real estate
owned as a result of declines in market value (see Loan Portfolio Risk Elements
and Other Real Estate Owned). The decrease in 1996 was principally due to a
decline in FDIC insurance rates. Also included in other operating expenses for
1996 were adjustments to the Bank's investment in CSI which was accounted for
under the equity method prior to August 31, 1997. The Bank's equity in losses of
CSI was $59,000 and $200,000 in 1996 and 1995, respectively. At December 31,
1996, the Bank's investment in CSI was reduced to zero.
The Year 2000 is a serious issue which will affect virtually every
organization, including the Bank. The difficulty stems from the inability of
most computer programs to distinguish the year 1900 from the year 2000. The
challenge is especially critical to financial institutions since many processes,
such as interest accruals and payments, are date-sensitive. Nor is the problem
limited to just computer systems. The coming millenium will affect potentially
every system that has an embedded microchip, such as automated teller machines,
elevators and vaults, as well as third parties with whom the Bank does business.
The Bank is committed to addressing the Year 2000 issue in a timely and
responsible manner and has dedicated its internal resources to address this
issue. Management has completed an assessment of its mission-critical systems
and has implemented a program to monitor the Year 2000 efforts of its suppliers,
service providers and large corporate customers. In June 1998, the Bank will be
converting its computer system as part of its normal upgrade process to improve
efficiency and better serve its customers. The new system, which is Year 2000
compliant, will replace the current one used by the Bank to process its general
ledger and core applications, which will no longer be supported by the vendor in
the future. The cost for the new computer system is approximately $1,200,000,
which will be capitalized and depreciated over its useful life. The estimated
depreciation charges are expected to be offset by lower maintenance fees. The
costs for other systems are not anticipated to be material and will be accounted
for appropriately. Testing of hardware and software upgrades, system
replacements and other associated changes is expected to be well underway by
December 31, 1998.
<PAGE> 37
Income Tax Provision
The Company's federal and state income tax provision decreased to
$358,000 in 1997, compared to $431,000 in 1996 and $620,000 in 1995. The
effective tax rates for those years were 35.5%, 37.7%, and 37.3%, respectively.
The lower effective rate for 1997 reflected the utilization of tax benefits
arising from the acquisition and liquidation of CSI. The increase in the
deferred tax assets was primarily due to the net operating loss carryforwards
generated by CSI which will be utilized to offset the Company's future taxable
income.
FINANCIAL CONDITION
Deposits
Deposits traditionally have been the principal source of HNB's funds for
use in lending, meeting liquidity requirements and making investments. The
maintenance of a stable and low cost deposit base is, therefore, an important
factor in the Bank's asset and liability management plan and essential to the
achievement of its profit goals. The Bank's strategy for attracting new deposits
and retaining its current base focuses on achieving customer satisfaction and
building long-term relationships. The Bank offers a variety of deposit products
which are marketed to residents of Hawaii. No deposits are placed by or through
a broker. At December 31, 1997, total deposits were $258,720,805, representing a
decrease of $5,873,575 or 2.2% from total deposits of $264,594,380 at December
31, 1996. The decline was primarily due to a customer's withdrawal of
$15,500,000 from a savings account for a real estate investment which was
anticipated by the Bank.
The following table presents the distribution of the Bank's deposit
accounts at December 31 for the years indicated.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
1997 1996 1995
-------------------- --------------------- ---------------------
Amount % Amount % Amount %
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Noninterest-bearing demand $ 69,463,341 26.9% $ 59,989,127 22.7% $ 66,331,301 24.7%
Interest-bearing demand 27,907,474 10.8 28,144,031 10.6 29,316,390 10.9
Savings 91,167,206 35.2 110,032,161 41.6 113,736,751 42.3
Time 70,182,784 27.1 66,429,061 25.1 59,521,343 22.1
------------ ---- ------------ ---- ------------ -----
Total deposits $258,720,805 100.0% $264,594,380 100.0% $268,905,785 100.0%
============ ======= ============ ====== ============ ======
</TABLE>
Noninterest-bearing demand deposits ended 1997 at $9,474,214 above the
balance reported at year-end 1996. The growth in these deposits are important to
the Bank because they represent an interest-free source of funds which enhances
net interest margin. Interest-bearing demand deposits at year-end 1997 were
essentially unchanged, compared to the same date in 1996. In recent years, as
consumers have grown more knowledgeable about financial matters, they have
tended to use these accounts primarily for current transaction purposes.
Generally, excess funds not needed in the immediate future are transferred to
higher yielding deposit accounts or invested in other financial instruments.
Time deposits increased by
<PAGE> 38
$3,753,723 over year-end 1996 levels, partly offsetting a decline in savings
deposits of $18,864,955. During 1997, customers continued to shift their funds
from savings to time deposits to take advantage of higher rates. The average
rates paid on savings and time deposits during the year were 2.72% and 4.88%,
respectively. Since December 31, 1995, time deposits, as a percentage of total
deposits, have grown from 22.1% to 27.1% at December 31, 1997. Meanwhile, over
the same period, savings deposits have declined from 42.3% to 35.2%. In the
absence of other mitigating factors, this change in the deposit mix raises the
cost of deposits to the Bank. Included in time deposits are certificates of
deposits ("CD") purchased by the State of Hawaii, its counties and other
government agencies. Historically, these CDs have been a stable source of funds
for the Bank and are considered to be core deposits. At December 31, 1997, 1996
and 1995, public time deposits totaled $32,001,000, $32,192,000, and
$30,197,000, respectively, representing 12.4%, 12.2% and 11.2% of the Bank's
total deposits.
Investment Security Portfolio
Investment securities consist principally of short and intermediate term
debt instruments issued by the U.S. Treasury and other U.S. government agencies.
The Bank is also a stockholder in the Federal Reserve Bank and the Federal Home
Loan Bank of Seattle ("FHLB"). The Bank has no zero coupon bonds, collateralized
mortgage obligations or stripped mortgage-backed securities.
The Bank had no trading securities at December 31, 1997 and 1996. The
book and fair values of investment securities held-to-maturity at December 31,
1997, were $47,481,373 and $47,540,000, respectively, compared to $47,929,910
and $48,007,000 at December 31, 1996. There were no sales from the
held-to-maturity portfolio in 1997 or 1996. At December 31, 1997, the book and
fair value of investment securities available-for-sale was $1,760,103, compared
to $1,487,003 at December 31, 1996. During 1997 and 1996, there were no
transfers between the held-to-maturity, available-for-sale and trading
categories.
Loan and Lease Portfolio
At December 31, 1997, total loans and leases stood at $219,018,348,
marking a new milestone for the Bank, and representing an increase of
$11,755,609 or 5.7% from the level reported at December 31, 1996. The growth in
the portfolio was primarily due to increases in real estate and commercial
loans.
Real estate loans increased to $138,689,235 at year-end 1997, $5,474,998
higher than the level at year-end 1996. Most of the growth occurred in family
residential and commercial property loans. Commercial, industrial and
agricultural loans ended the year at $70,956,494, an increase of $6,152,193 from
December 31, 1996. Consumer loans, which consist of loans to individuals for
household, family and other personal expenditures, were $7,612,614 at year-end
1997, little changed from the $7,674,104 reported for the same date a year
earlier. At December 31, 1997, direct financing leases and other loans totaled
$1,307,313 and $452,692, respectively, compared to $1,013,049 and $557,048 at
December 31, 1996.
<PAGE> 39
Loan Concentrations
The Bank has no significant concentrations of credit risk with any
individual party; however, the Bank's lending is concentrated on the island of
Oahu. The Bank has no foreign loans in its portfolio.
At December 31, 1997, real estate loans totaled $138,689,235, accounting
for 63.3% of the loan and lease portfolio. Included in this category are family
residential, construction and commercial property loans which at year-end 1997
amounted to $107,180,757; $2,616,724; and $28,891,754, respectively. While low
mortgage rates combined with lower prices have made housing in Hawaii more
affordable than it has been in years, the residential real estate market, in
general, is expected to remain soft until confidence levels in the local economy
improve. In the commercial area, lease rents are expected to remain under
pressure due to relatively high vacancies. Accordingly, commercial property
values could continue to erode in 1998.
Risk Elements and Other Real Estate Owned
Noncurrent loans and leases consist of loans and leases that are past
due for 90 days or more and still accruing interest, and loans and leases that
have ceased to accrue interest ("nonaccrual loans and leases"). At December 31,
1997, noncurrent loans and leases increased to $4,206,000, representing 1.9% of
loans and leases outstanding, compared to $3,392,000, or 1.6%, at December 31,
1996. The increase was primarily attributable to three real estate loans which
were placed on nonaccrual. Most of the credits in the noncurrent category are
collateralized by real estate. There were no restructured loans or leases as of
December 31, 1997 or 1996.
Generally, at the time a loan is placed on nonaccrual, it is considered
impaired. In evaluating loans for impairment or placement on nonaccrual, the
Bank applies its normal loan review procedures. Among other things, this
analysis includes reviewing: 1) the loan's payment history as compared to the
contractual terms of the note or credit agreement; 2) the financial condition of
the borrower, including an assessment of the prospects for repayment of the
loan; 3) a reevaluation or reappraisal of the underlying collateral; 4) the
loan's current risk rating; and 5) the credit file and loan documents. Loans
with an insignificant delay or shortfall in the amount of payments are not
considered impaired. Examples of insignificant delays or shortfalls may include,
depending upon the specific facts and circumstances, those that are associated
with a temporary stoppage in operations due to equipment failure or a natural
disaster, or due to tight cash flows during the off-peak season of a business.
Recurring shortfalls or delays in payments and/or extended delinquency periods
may provide evidence that a delay or shortfall is significant. In these
circumstances, the loan is reviewed for impairment. Loans collectively evaluated
for impairment by the Bank include smaller balance commercial loans, real estate
loans and consumer loans which are not included in total impaired loans. The
Bank considers a loan to have a "small balance" when the outstanding principal
balance is $50,000 or less. For information on the Bank's accounting policies
for nonaccrual and impaired loans, including income recognition and charge-offs,
and the required financial statement disclosures, please refer to Notes 1 and 5
to the Consolidated Financial Statements.
<PAGE> 40
Other real estate owned ("OREO"), which is included in other assets, is
generally composed of properties acquired through foreclosure proceedings in
settlement of debts previously contracted. These assets are recorded at the
lower of cost or fair market value based on current appraisals less estimated
selling costs. Any excess of the carrying amount of the loan over the fair
market value of the assets, net of estimated disposal costs, is charged against
the allowance for loan and lease losses at the time of transfer. Subsequent to
transfer, any losses on disposition or writedowns as a result of declines in the
market value of specific properties are recorded as a charge to other expenses,
which reduces current earnings. During 1997, a periodic re-evaluation of certain
OREO properties indicated lower values due to a sluggish real estate market.
Accordingly, the Bank reduced its carrying costs for those assets with a charge
to other expenses of approximately $138,000 that directly impacted current
earnings. At December 31, 1997, OREO totaled $1,668,000 or 0.56% of total
assets, compared to $1,219,000, or 0.41% of total assets, at December 31, 1996.
The portfolio consisted at year-end of two commercial properties, a
single-family home and a residential condominium.
The following table presents information on noncurrent loans and leases,
restructured loans and leases and OREO at December 31 for the years indicated:
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Noncurrent loans and leases
Past due 90 days or more $ 424,000 $ 212,000 $ 414,000 $2,241,000 $ 634,000
Nonaccrual 3,782,000 3,180,000 6,206,000 1,326,000 924,000
---------- ---------- ---------- ---------- ----------
Total $4,206,000 $3,392,000 $6,620,000 $3,567,000 $1,558,000
========== ========== ========== ========== ==========
Restructured loans and leases $ -- $ -- $ -- $ -- $ 52,000
========== ========== ========== ========== ==========
OREO $1,668,000 $1,219,000 $1,162,000 $ 938,000 $ 150,000
========== ========== ========== ========== ==========
Note: Impaired loans are included in nonaccrual loans and leases.
- --------------------------------------------------------------------------------------------------------
</TABLE>
Potential Problem Loans
The Bank has an internal grading and review system for the purpose of
identifying risk and controlling potential problem credits. Loans and leases are
risk graded on an ongoing basis by the responsible lending officer. This grade
is subsequently confirmed by an independent Loan Review Department, which
publishes a monthly report listing the credits graded, their potential
weaknesses and the reasons for the assigned grades. These reports are reviewed
by management and a committee of the Board of Directors and a response to any
comments by the Loan Reviewer is required from the lending officer.
Provision and Allowance for Loan and Lease Losses
The provision for loan and lease losses is based upon management's
evaluation as to the adequacy of the allowance for loan and leases losses
("allowance" or "reserve") to absorb potential losses in the portfolio. The
adequacy of the allowance is reviewed at least quarterly by management and
approved by the Board of Directors, and more frequent analyses may be performed
if warranted. In appraising the adequacy of the allowance, management considers
<PAGE> 41
historical loss experience, the value and adequacy of collateral, levels of and
trends in nonperforming loans and leases, loan concentrations, the growth and
composition of the portfolio, the review of monthly delinquency reports, the
results of examinations of individual loans and leases and/or evaluation of the
overall portfolio by senior credit personnel, internal auditors, and regulatory
agencies, trend of interest rates and general economic conditions. Furthermore,
as part of the review process, each credit which is over $50,000 and has been
placed on nonaccrual is individually assessed for loss potential. When a loan
reaches this stage, it is also the Bank's practice to obtain a current
evaluation or appraisal of the collateral.
During 1997, the Bank provided $720,000 for possible loan and lease
losses, compared to $810,000 and $700,000 in 1996 and 1995, respectively. Gross
charge-offs for 1997, 1996 and 1995 were $769,141, $1,531,106 and $1,103,875,
respectively. Of these losses, 49% was attributable to three commercial loans in
1997; 63% to two commercial loans in 1996 and 58% to one commercial loan in
1995. Recoveries totaled $179,522 in 1997, $692,107 in 1996, and $78,672 in
1995. In 1996, a nonaccrual loan was repaid, generating net proceeds of $545,000
which were credited to the allowance for loan and lease losses as a recovery of
an amount previously charged off in 1995. Net charge offs declined to $589,619
in 1997, compared to $838,999 in 1996 and $1,025,203 in 1995. The ratio of net
charge offs to average loans and leases for those years were 0.28%, 0.40%, and
0.48% respectively.
At December 31, 1997, the allowance for loan and lease losses stood at
$3,197,815, representing 1.46% of total loans and leases outstanding, compared
to $3,067,434 or 1.48%, at year-end 1996. As of the same date, the reserve
provided coverage of 76.0% of noncurrent loans and leases versus 90.4% at
December 31, 1996. The majority of the credits in the noncurrent category are
collateralized by real estate.
While there were some indications in the early part of 1997 that
Hawaii's economy may be close to bottoming out, the growing problems in Japan
and the Asian currency devaluations that occurred later in the year eliminated
any prospects for a recovery in the foreseeable future. Accordingly, management
has increased the provision for loan and lease losses from $180,000 for the
first quarter of 1997 to $270,000 for the first quarter of 1998. The
appropriateness of continuing such an increase will be re-evaluated at least
quarterly.
Liquidity Management
The objective of liquidity management is to provide sufficient cash
flows at a reasonable cost to accommodate fluctuations in deposit levels, fund
operations, provide for customers' credit needs, and meet obligations and
commitments on a timely basis. The Bank relies on both assets and liabilities to
satisfy its liquidity requirements.
The principal sources of asset-based liquidity for the Bank are cash and
cash equivalents. At December 31, 1997, these resources totaled $22,628,962 or
7.6% of total assets, compared to $33,276,700 or 11.2% at December 31, 1996. The
decrease was primarily due to an decline in federal funds sold which was used to
finance the Bank's loan growth and a large savings withdrawal. (See "Loan and
Lease Portfolio" and Deposits.") In
<PAGE> 42
order to generate additional liquidity and reduce interest rate risk, the Bank's
current strategy is to sell its fixed-rate mortgage loan originations in the
secondary market to government instrumentalities like the Federal Home Loan
Mortgage Company and the Federal National Mortgage Association.
On the liability side of the balance sheet, deposits historically have
been the primary source of liquidity for HNB. The Bank places a high priority on
attracting and retaining a stable base of core deposits and, thus, does not
actively solicit large time certificates of deposits or deposits from outside of
the Bank's market area. Furthermore, no deposits are sold or placed through
brokers. The State of Hawaii, City and County of Honolulu, and other public
agencies are important providers of funds. At December 31, 1997, 1996, and 1995,
public time deposits represented 12.4%, 12.2% and 11.2%, respectively, of the
total deposit base.
In recent years, one of the most important consumer trends has been the
migration of household financial assets out of deposits and into direct
investment vehicles, such as mutual funds. As a result, federal funds purchased
and FHLB advances are anticipated to become a more significant source of funds
for the Bank in the future. While borrowings are a reliable source of funds from
a liquidity standpoint, they have a higher cost than deposits which puts
downward pressure on net interest income. The Bank has a diverse funding base
which includes federal funds lines with other banks, the discount facilities of
the Federal Reserve, and advances from the FHLB. The line of credit with the
FHLB is equal to 10.0% of total assets, including a cash management agreement
line of 5.0%. In addition, the Bank can utilize the FHLB's Community Investment
Program ("CIP") to finance affordable housing projects and commercial loans at
rates 10 to 20 basis points below posted FHLB rates for comparable maturities.
Advances under the CIP program are not counted under the Bank's committed line;
however, there is a $10,000,000 per year cap on new advances, which is subject
to waiver. At year-end 1997, drawings under federal funds lines and advances
from the FHLB aggregated $8,000,000. There were no purchased federal funds or
FHLB borrowings outstanding at December 31, 1996.
Operating activities provided net cash of $304,769 in 1997, $2,214,134
in 1996 and $3,060,597 in 1995. The decline in 1997 was primarily due to higher
outlays to suppliers and employees. Loan originations, net of principal
repayments, accounted for a significant portion of the net cash used in
investing activities of $13,128,310 in 1997. Comparatively, in 1996 and 1995,
proceeds from loan sales contributed largely to the net cash provided by
investing activities of $2,880,677 and $1,739,085, respectively. Financing
activities provided net cash of $2,175,803 in 1997, due primarily to a
short-term advance from the FHLB and a net increase in federal funds purchased,
partly offset by a net decrease in deposits due to a large savings withdrawal.
Lower corporate checking and escrow fund accounts resulted in a decline in
noninterest-bearing demand deposits, which contributed to the net cash used in
financing activities of $4,476,820 in 1996. In 1995, net cash provided by
financing activities was $7,248,756, due primarily to the assumption of deposits
from the former Bank USA.
<PAGE> 43
Market Risk
The information contained in this section contains certain
forward-looking statements with regards to quantitative and qualitative
disclosures required to comply with the SEC's rule relating to market risk.
These disclosures involve a number of assumptions about hypothetical changes in
interest rates, anticipated behavior by other parties in response to those
hypothetical changes in interest rates, and various other estimates and factors,
which could cause actual results to differ materially from those projected.
As a financial institution, HNB's core business includes making loans,
purchasing investments and accepting deposits. These activities leave the Bank's
net interest income exposed to movements in interest rates. This category of
market risk is called interest rate risk. (See also "Net Interest Income,"
"Liquidity Management" and "Shareholders' Equity and Capital Resources".)
The Bank has an Asset and Liability Management Committee, which is
responsible for managing the Bank's interest rate risk exposure. The objective
of the Committee is to reduce the vulnerability of net interest income, the
major source of the Bank's earnings, to interest rate fluctuations. This is
accomplished by striving to match maturity and repricing dates of assets and
liabilities. All of the Bank's financial instruments (i.e., investments, loans
and leases, deposits, borrowings, etc.) are entered into for purposes other than
trading. No derivative financial instruments such as futures, options or
interest rate swaps are used for hedging or speculative purposes.
The Bank uses a simulation model to measure the projected increase or
decrease in net interest income that may result from possible changes in
interest rates. The model covers all financial instruments and allows the Bank
to analyze the effects of embedded options by varying the interest rate
scenarios, prepayment rates on loans, runoff rates for deposits, etc.
Most financial instruments, including those applicable to HNB, are
generally priced, directly or indirectly, in relation to the U.S. Treasury yield
curve which, by definition, represents the risk-free rate. If U.S. Treasury
rates declined instantaneously by 10% at December 31, 1997, and remained at
those levels, the Bank's net interest income for the year would decrease by
approximately 0.06% from the base or flat-rate scenario. Conversely, if U.S.
Treasury rates increased by the same magnitude as of the identical date, net
interest income for the year would rise by approximately 0.70% from the base
case.
The results of these projections are highly dependent upon two key
assumptions: loan prepayment rates and the rate-sensitivity of nonmaturity
deposits, such as demand and savings accounts. The prepayment assumptions were
obtained from Bloomberg, the FHLB and the Office of Thrift Supervision. The
repricing assumptions for nonmaturity deposits were based upon the Bank's
historical experience and consistent with industry trends. Other key assumptions
include: (1) the Bank maintains its present size; (2) funds are reinvested into
the same instruments; and (3) spread relations remain constant. Finally, in
interpreting these results, it is important to note that they exclude, among
other things, the effects of competition, which have, and will continue to have,
a significant impact on the Bank's net interest income.
<PAGE> 44
Shareholders' Equity and Capital Resources
Management believes that a strong capital position serves three basic
purposes: (1) it inspires public confidence; (2) provides a safety cushion
against unforeseen operating losses; and (3) establishes a solid foundation for
future growth.
Shareholders' equity totaled $28,341,813 at year-end 1997, an increase
of $544,525 or 2.0% over the previous year-end balance. The growth in equity was
achieved through retention in earnings after payment of cash dividends. Book
value per share increased from $39.10 at December 31, 1996, to $39.86 at
December 31, 1997.
The Company is subject to risk-based capital guidelines which are used
by bank regulatory agencies to evaluate capital adequacy. Under this system,
assets and off-balance sheet items are assigned to one of four risk-weight
categories to calculate a risk-weighted asset base. The rules require a minimum
Tier 1 capital ratio of 4.0% of risk-weighted assets and a minimum total capital
ratio of 8.0% of risk-weighted assets. Tier 1 capital generally consists of
common shareholders' equity less goodwill, while total capital includes in
addition to Tier 1 capital, the allowance for possible loan and lease losses,
subject to certain limitations, and subordinated debt. In addition to the
risk-based capital ratios, the banking regulators have established a minimum
leverage ratio of Tier 1 capital to average quarterly total assets of 3.0%. In
order to be considered well-capitalized by the bank regulatory agencies, an
institution must have at minimum a 5.0% leverage ratio, a Tier 1 risk-based
capital ratio of 6.0% and a total capital ratio of 10.0%. At December 31, 1997,
the Company's Tier 1 and total capital ratios were 13.5% and 14.8%,
respectively, compared to 14.0% and 15.2% at December 31, 1996. At year-end 1997
and 1996, the Company's leverage ratio was 9.9% and 9.5%, respectively.
In evaluating the Company's capital position, management considers the
present and anticipated needs of Bancshares and HNB, current and projected
market conditions, interest rate risk exposure, bank regulatory requirements,
and other relevant factors. Management believes that capital continues to be
adequate to meet the present needs of both Bancshares and HNB. In planning for
the future, management conducts periodic evaluations as to the overall adequacy
of capital, and the need and desirability of raising capital is reviewed. The
current strategy is to generate capital through retention of earnings. Should
asset growth exceed earnings retention, several alternatives for raising capital
are available. Bancshares could sell additional stock, as it did in 1991 with a
$2,950,000 private placement, or issue new debt and downstream the proceeds as
capital to the Bank. Bancshares may also borrow up to 30% of its capital without
prior approval of the Federal Reserve System. Based on year-end 1997 figures,
this would amount to $8,502,544.
Effects of New Accounting Standards
The Company adopted Statement of Financial Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," as amended by Statement No. 127, "Deferral of the Effective
Date of Certain Provisions of FASB Statement No. 125 - An Amendment of FASB
Statement No. 125," on January 1, 1997. Statement No. 125 applies a
control-oriented, financial components
<PAGE> 45
approach to financial-asset-transfer transactions whereby the Company (1)
recognizes the financial and servicing assets it controls and the liabilities it
has incurred, (2) derecognizes financial assets when control has been
surrendered, and (3) derecognizes liabilities once they are extinguished. The
adoption of this Statement did not have a material impact on the consolidated
financial statements of the Company.
In addition, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share," in 1997. Since there was no change in
the computation and presentation of earnings per share for the Company from
previous years, the adoption of this Statement did not have a material impact on
the consolidated financial statements of the Company.
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130 "Reporting Comprehensive Income" and
No. 131, "Disclosures about Segments of an Enterprise and Related Information,"
which is effective for fiscal years beginning after December 15, 1997. Statement
No. 130 establishes standards for reporting and display of comprehensive income
and its components in the financial statements. Statement No. 131 requires that
information be provided about the different types of business activities in
which an enterprise engages and the different economic environment in which it
operates. Since the Company has no items of other comprehensive income and does
not have separate operating segments, the adoption of these Statements is not
expected to have a material impact on the consolidated financial statements of
the Company.
In February 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits" which is effective for fiscal
years beginning after December 15, 1997. The Statement revises and standardizes
the employers' disclosures about pension and other postretirement benefit plans,
but does not change the measurement or recognition of those plans. The Company
will adopt this Statement when it becomes effective, which will require
modification of the Company's pension plan disclosure.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements, notes, and supplementary data
thereto called for by this item and the report of independent certified public
accountants are provided in item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
<PAGE> 46
PART III
The following information contained in items 10 to 13, except for the
"Compensation Committee Report," is incorporated herein by reference from
various pages of Bancshares' Proxy Statement for the 1998 Annual Meeting of
Shareholders ("Proxy Statement").
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding "Directors and Executive Officers" of Bancshares
located on page 2, 3 and 15 of the Proxy Statement is incorporated by reference.
Information regarding "Compliance of Section 16(a) Filing requirements"
located on page 15 of the Proxy Statement is incorporated by reference.
ITEM 11: EXECUTIVE COMPENSATION
Information regarding "Executive Compensation" located on pages 5-9 of
the Proxy Statement is incorporated by reference.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information regarding "Principal Shareholders and Ownership by
Management" is located on pages 11-15 of the Proxy Statement is incorporated by
reference.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding "Related Transactions" located on pages 10-11 of
the Proxy Statement is incorporated by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES, AND
REPORTS ON FORM 8-K
(a) (1) Financial Statements
Hawaii National Bancshares, Inc. and Subsidiary:
Report of Independent Accountants
Consolidated Balance Sheets at December 31, 1997 and 1996
Consolidated Statements of Income for the
years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the
years ended December 31, 1997, 1996 and 1995
Notes to the Consolidated Financial Statements
<PAGE> 47
(2) Supplementary Financial Statement Schedules
Schedules to the consolidated financial statements required by
Article 9 of Regulation S-X are not required under the related
instructions or are inapplicable, and therefore have been
omitted.
(3) Exhibits
See index to exhibits to this Form 10-K.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of
1997.
<PAGE> 48
[COOPERS & LYBRAND LETTERHEAD]
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors
Hawaii National Bancshares, Inc.
We have audited the accompanying consolidated balance sheets of Hawaii National
Bancshares, Inc. and Subsidiary as of December 31, 1997 and 1996, and the
related consolidated statements of income and changes in shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Hawaii National
Bancshares, Inc. and Subsidiary as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
Honolulu, Hawaii
January 21, 1998
<PAGE> 49
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
----------------------
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
ASSETS:
Cash and due from banks $ 22,628,962 $ 17,276,700
Federal funds sold -- 16,000,000
------------ ------------
Cash and cash equivalents 22,628,962 33,276,700
Investment securities (Notes 1 and 2) -
Held-to-maturity (fair value of $47,540,000
in 1997 and $48,007,000 in 1996) 47,481,373 47,929,910
Available-for-sale 1,760,103 1,487,003
Loans and leases, net of allowance for possible
loan and lease losses of $3,197,815 in 1997 and
$3,067,434 in 1996 (Notes 4 and 5) 215,820,533 204,195,305
Premises and equipment (Note 6) 3,539,379 3,900,122
Other assets 7,456,428 5,236,218
------------ ------------
Total assets $298,686,778 $296,025,258
============ ============
LIABILITIES:
Deposits (Note 7) -
Noninterest-bearing demand $ 69,463,341 $ 59,989,127
Interest-bearing demand 27,907,474 28,144,031
Savings 91,167,206 110,032,161
Time 70,182,784 66,429,061
------------ ------------
Total deposits 258,720,805 264,594,380
Federal funds purchased 4,000,000 --
Short-term borrowings (Note 8) 5,000,000 843,974
Other liabilities 2,624,160 2,789,616
------------ ------------
Total liabilities 270,344,965 268,227,970
------------ ------------
Commitments (Notes 9 and 14)
SHAREHOLDERS' EQUITY (Note 10):
Common stock, par value $1 per share;
Authorized - 10,000,000 shares
Issued and outstanding - 711,000 shares
in 1997 and 1996 711,000 711,000
Capital in excess of par value 12,147,676 12,147,676
Retained earnings 15,483,137 14,938,612
------------ ------------
Total shareholders' equity 28,341,813 27,797,288
------------ ------------
Total liabilities and shareholders' equity $298,686,778 $296,025,258
============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE> 50
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
----------------------
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans $ 18,816,427 $ 18,556,817 $ 19,561,816
Interest on investment securities -
Taxable 2,840,723 2,645,750 2,225,749
Exempt from Federal income tax -- 37,750 75,500
Interest on Federal funds sold 682,988 906,607 554,816
Interest on direct financing leases 93,084 101,754 121,878
Other 141,447 128,067 100,572
------------ ------------ ------------
Total interest income 22,574,669 22,376,745 22,640,331
------------ ------------ ------------
INTEREST EXPENSE:
Deposits 6,616,100 6,963,425 6,949,033
Federal funds purchased 9,517 1,739 23,822
Short-term borrowings 45,108 39,197 132,790
------------ ------------ ------------
Total interest expense 6,670,725 7,004,361 7,105,645
------------ ------------ ------------
Net interest income 15,903,944 15,372,384 15,534,686
PROVISION FOR LOAN AND LEASE LOSSES (Note 5) 720,000 810,000 700,000
------------ ------------ ------------
Net interest income after provision for
loan and lease losses 15,183,944 14,562,384 14,834,686
------------ ------------ ------------
OTHER INCOME:
Service charges on deposit accounts 1,097,175 1,109,880 1,086,312
Other service charges, collection and
exchange charges, commissions and fees 1,634,983 1,320,599 1,231,496
Gain on investment securities held-to-maturity 1,970 25,000 --
Gain (loss) on investment securities
available-for-sale -- (10,000) 18,715
------------ ------------ ------------
2,734,128 2,445,479 2,336,523
------------ ------------ ------------
OTHER EXPENSES:
Salaries and employee benefits 8,765,285 8,132,437 7,722,061
Occupancy expense of bank premises 3,688,922 3,511,014 3,381,351
Equipment expense 981,836 852,674 776,455
Computer services (Note 3) 570,669 729,098 690,373
Other operating expenses (Note 13) 2,902,185 2,640,417 2,937,034
------------ ------------ ------------
16,908,897 15,865,640 15,507,274
------------ ------------ ------------
Income before income taxes 1,009,175 1,142,223 1,663,935
INCOME TAX PROVISION (Note 11) 358,000 431,000 620,000
------------ ------------ ------------
Net income $ 651,175 $ 711,223 $ 1,043,935
============ ============ ============
EARNINGS PER COMMON SHARE (basic and diluted) $ 0.92 $ 1.00 $ 1.47
============ ============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE> 51
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
----------------------
<TABLE>
<CAPTION>
CAPITAL IN
COMMON EXCESS OF RETAINED
STOCK PAR VALUE EARNINGS TOTAL
<S> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1995 $ 711,000 $ 12,135,655 $ 13,396,754 $ 26,243,409
Cash dividends paid ($.15 -- -- (106,650) (106,650)
per share)
Adjustment to capital in
excess of
par value -- 12,021 -- 12,021
Net income for the year -- -- 1,043,935 1,043,935
------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1995 711,000 12,147,676 14,334,039 27,192,715
Cash dividends paid ($.15 -- -- (106,650) (106,650)
per share)
Net income for the year -- -- 711,223 711,223
------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1996 711,000 12,147,676 14,938,612 27,797,288
Cash dividends paid ($.15 -- -- (106,650) (106,650)
per share)
Net income for the year -- -- 651,175 651,175
------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1997 $ 711,000 $ 12,147,676 $ 15,483,137 $ 28,341,813
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE> 52
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
----------------------
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Interest and fees received $ 22,517,632 $ 22,409,739 $ 22,588,077
Interest paid (6,737,675) (6,986,316) (6,921,257)
Service charges, collection and
exchange charges, commission
and fees received 2,732,159 2,430,479 2,317,808
Cash paid to suppliers and employees (17,888,614) (15,233,320) (14,114,951)
Income taxes paid (318,733) (406,448) (809,080)
------------ ------------ ------------
Net cash provided by operating
activities 304,769 2,214,134 3,060,597
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of investment
securities held-to-maturity 28,958,535 36,998,815 19,932,559
Purchase of investment securities
held-to-maturity (28,508,028) (38,910,664) (20,995,308)
Purchase of investment securities
available-for-sale (273,100) -- (2,111,058)
Proceeds from sale of investment
securities available-for-sale -- -- 2,122,073
Net increase in loans and leases made
to customers (16,678,877) (56,551) (1,119,353)
Proceeds from sale of loans 4,247,230 5,319,000 4,427,468
Capital expenditures (211,827) (309,438) (447,163)
Proceeds from sale of equipment -- 33,899 154,867
Purchase of other real estate owned (850,743) (194,384) (225,000)
Proceeds from sale of other
real estate owned 188,500 -- --
------------ ------------ ------------
Net cash provided by (used in)
investing activities (13,128,310) 2,880,677 1,739,085
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in demand deposits and
savings accounts (9,627,297) (11,219,123) (3,064,270)
Net increase in time deposits 3,753,724 6,907,718 2,935,114
Net increase (decrease) in federal
funds purchased 4,000,000 (58,765) (480,000)
Proceeds from short-term borrowings 4,156,026 -- 4,000,000
Repayment of short-term borrowings -- -- (4,097,261)
Proceeds from deposit acquisitions -- -- 8,061,823
Dividends paid (106,650) (106,650) (106,650)
------------ ------------ ------------
Net cash provided by (used in)
financing activities 2,175,803 (4,476,820) 7,248,756
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (10,647,738) 617,991 12,048,438
CASH AND CASH EQUIVALENTS AT BEGINNING OF
YEAR 33,276,700 32,658,709 20,610,271
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 22,628,962 $ 33,276,700 $ 32,658,709
============ ============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE> 53
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
---------------------------
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Net income $ 651,175 $ 711,223 $ 1,043,935
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation on bank premises and
equipment 589,936 564,460 480,109
Provision for loan and lease losses 720,000 810,000 700,000
Amortization of deferred loan fees (228,066) (317,073) (280,960)
Loan fees 289,596 184,196 267,803
Deferred income taxes 58,000 85,000 (39,000)
Write-down of other real estate owned 137,884 -- --
Amortization of goodwill (88,000) -- --
Reduction of investment in
Computer Systems International, Ltd. -- 59,000 200,000
Gain on investment securities (1,970) (15,000) (18,715)
Changes in -
Interest receivable (118,566) 165,871 (40,161)
Interest payable (66,950) 18,045 184,388
Other assets (1,569,764) (148,941) (332,888)
Other liabilities (68,506) 97,353 896,086
----------- ----------- -----------
Total adjustments (346,406) 1,502,911 2,016,662
----------- ----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 304,769 $ 2,214,134 $ 3,060,597
=========== =========== ===========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Transfer from loans to real estate
acquired through foreclosure $ 775,000 $ 175,330 $ 168,364
=========== =========== ===========
Loan issued for sale of other
real estate owned $ -- $ 137,282 $ --
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE> 54
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Hawaii National Bancshares, Inc. was incorporated on September 29, 1986 under
the laws of the State of Hawaii for the purpose of becoming a bank holding
company for Hawaii National Bank. Hawaii National Bank operates thirteen
branches in the State of Hawaii and offers a full range of banking services to
businesses as well as individuals. The Bank's primary source of revenue is
providing loans to customers.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of income and expenses during the reporting period. Actual
results could differ from those estimates.
The accounting and reporting policies of Hawaii National Bancshares, Inc. and
Subsidiary ("Company") conform with generally accepted accounting principles and
practices within the banking industry. The following is a summary of the
significant accounting and reporting policies:
CONSOLIDATION -
The consolidated financial statements of the Company include the accounts of
Hawaii National Bancshares, Inc. ("Parent") and its wholly-owned subsidiary,
Hawaii National Bank ("Bank"). All significant intercompany balances and
transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS -
Cash and cash equivalents include cash on hand, amounts due from banks and
federal funds sold. Generally, federal funds are purchased and sold for
one-day periods.
Federal regulatory requirements provide for maintenance of average cash
reserves. Such reserve requirements are computed on a bi-weekly basis and
amounted to $300,000 at December 31, 1997.
INVESTMENT SECURITIES -
Investment securities consist principally of debt instruments issued by the
U.S. Treasury and other U.S. government agencies and shares held by the
Company in capital stock of the Federal Home Loan Bank of Seattle ("FHLB")
and the Federal Reserve Bank ("FRB"). The
<PAGE> 55
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
investments in the FHLB and FRB are required to be maintained by the
Company, are carried at cost and can only be sold back at par value to the
FHLB, FRB or to another member institution.
Investment securities are classified in one of three categories and are
accounted for as follows: 1) investment securities that the Company has the
positive intent and ability to hold to maturity are classified as
held-to-maturity and reported at amortized cost; 2) investment securities
that are bought and held principally for the purpose of selling them in the
near term are classified as trading securities and reported at fair value,
with unrealized gains and losses included in earnings; and 3) investment
securities not classified as either held-to-maturity securities or trading
securities are classified as available-for-sale and reported at fair value,
with unrealized gains and losses, if any, excluded from earnings and
reported in a separate component of shareholders' equity.
Gains and losses realized on the disposition of investment securities are
determined using the specific identification method.
Premiums and discounts are recognized in interest income using the interest
method over the period to maturity.
LOANS HELD FOR SALE -
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated market value in the aggregate. Net
unrealized losses are recognized through a valuation allowance charged to
income.
LOANS AND LEASES -
Loans are carried at face value less undisbursed funds, unearned income and
payments received. Loan origination fees net of direct costs of origination
are deferred and accounted for as an adjustment of the yield. Commitment
fees are deferred and amortized over the commitment term.
Equipment acquired by the Company for its leasing operations is accounted
for on the financing method with income recognized over the life of the
lease based upon a level rate of return on the unrecovered investment.
<PAGE> 56
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
A loan is considered impaired, based on current information and events, if
it is probable that the Company will be unable to collect the scheduled
payments of principal or interest when due according to the contractual
terms of the loan agreement. The measurement of impaired loans is generally
based on the present value of expected future cash flows discounted at the
loan's effective interest rate or the fair value of the collateral if the
loan is collateral-dependent.
ALLOWANCE FOR POSSIBLE LOAN AND LEASE LOSSES -
The allowance for possible loan and lease losses ("allowance") is maintained
at a level which, in management's judgment, is adequate to absorb future
losses. Estimates of future loan and lease losses involve judgment and
assumptions as to various factors which, in management's judgment, deserve
current recognition in estimating such losses and in determining the
adequacy of the allowance. Principal factors considered by management
include the historical loss experience, the value and adequacy of
collateral, the level of nonperforming loans and leases, loan
concentrations, the growth and composition of the portfolio, the review of
monthly delinquency reports, the results of examinations of individual loans
and leases and/or evaluation of the overall portfolio by senior credit
personnel, internal auditors, and regulatory agencies, trend of interest
rates and general economic conditions.
The allowance is established through charges to earnings in the form of a
provision for loan and lease losses. Increases and decreases in the
allowance due to changes in the measurement of impaired loans are included
in the provision. Loans continue to be classified as impaired unless they
are brought fully current and the collection of scheduled interest and
principal is considered probable. Loans collectively evaluated for
impairment include smaller balance commercial loans, real estate loans and
consumer loans $50,000 or less which are not included in the total impaired
loans.
Losses on loans and leases are charged to the allowance when collectibility
becomes doubtful and the underlying collateral, if any, is inadequate to
liquidate the outstanding debt. Generally, when a commercial loan is on
nonaccrual status for more than 120 days, it is charged off unless it is
well collateralized. When a real estate loan is placed on nonaccrual status,
the underlying collateral is reevaluated or reappraised. If the loan balance
exceeds the value of the collateral, the under-collateralized portion of the
loan is charged off. Loans to individuals for household, family and other
personal expenditures ("consumer loans") are generally charged off when they
are delinquent for more than 90 days unless a recent record of regular full
payments for the last two months is evident. Direct financing leases are
charged off when they are delinquent for more than 90 days.
<PAGE> 57
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
Recoveries on loans and leases previously charged off are added to the
allowance.
INCOME RECOGNITION ON IMPAIRED AND NONACCRUAL LOANS -
Loans and leases, including impaired loans, are generally classified as
nonaccrual if they are past due as to maturity or payment of principal or
interest for over 90 days, unless such loans and leases are
well-collateralized and in the process of collection. If a loan or a portion
of a loan is classified as doubtful or is partially charged off, the loan is
classified as nonaccrual. Loans that are on a current payment status or past
due less than 90 days may also be classified as nonaccrual if repayment in
full of principal and/or interest is in doubt. Loans may be returned to
accrual status when all principal and interest amounts contractually due
(including arrearages) are reasonably assured of repayment within an
acceptable period of time, and there is a sustained period of repayment
performance by the borrower in accordance with the contractual terms of
interest and principal.
When a loan is placed on nonaccrual status, unpaid interest accrued in the
current year is reversed against current earnings, and interest accrued in
the prior years is charged against the allowance for possible loan and lease
losses. Subsequent collections of interest and principal are generally
applied as a reduction to principal outstanding. When the future
collectibility of the recorded loan balance is expected, interest income is
recognized on a cash basis. If a nonaccrual loan had been partially charged
off, recognition of interest on a cash basis is limited to that which would
have been recognized on the recorded loan balance at the contractual
interest rate. Cash interest receipts in excess of that amount are recorded
as recoveries to the allowance until prior charge-offs have been fully
recovered.
PREMISES AND EQUIPMENT -
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed on the straight-line method over the shorter of
estimated economic lives or lease terms of 5-35 years for buildings and
improvements and 3-25 years for furniture and equipment.
Expenditures for maintenance, repairs and minor renewals are charged to
expense; expenditures for betterments are capitalized. Property retired or
otherwise disposed of is removed from the appropriate asset and related
accumulated depreciation accounts. Gains and losses on sale of assets are
reflected in current earnings.
57
<PAGE> 58
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
OTHER REAL ESTATE OWNED -
Assets acquired for debts previously contracted are recorded at fair market
value less estimated disposal costs. Any excess of the carrying amount of
the loan over the fair market value of the asset is charged against the
allowance for possible loan losses at the time of transfer. Subsequent to
transfer, any losses on disposition or writedowns as a result of declines in
market value of specific properties are charged against current earnings.
Real estate acquired through foreclosure sale, deed-in-lieu of foreclosure,
and bank property for which banking use is no longer contemplated are
classified as other real estate owned and is included in other assets.
Operating income and expenses incurred on these properties are reflected in
current earnings.
INTEREST INCOME -
Interest is accrued daily on the principal balance of loans outstanding,
except for loans placed on nonaccrual status.
PENSION PLAN -
The Company's funding policy is to contribute annually an amount not less
than the minimum required by the Employee Retirement Income Security Act of
1974 plus additional amounts which may be approved by the Company. Funding
requirements are actuarially determined using the entry age normal method.
For financial reporting purposes, the Company utilizes the projected unit
credit actuarial method.
INCOME TAXES -
Deferred income taxes reflect the future tax consequences of differences
between the tax bases of assets and liabilities and their financial
reporting amounts at each year end.
FAIR VALUES OF FINANCIAL INSTRUMENTS -
The following methods and assumptions were used by the Company in estimating
the fair value of financial instruments:
Cash and due from banks: The carrying amounts reported in the consolidated
balance sheet for cash and short-term instruments approximate fair values.
Federal funds sold: The carrying amounts of federal funds sold approximate
their fair values.
<PAGE> 59
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
Investment securities: Fair values of investment securities are based on
quoted market prices or dealer quotes, where available. If quoted market
prices are not available, fair values are based on quoted market prices of
comparable instruments.
Loan and leases: For variable-rate loans that reprice at least quarterly and
with no significant change in credit risk, fair values are based on carrying
values. The fair values of other types of loans, such as fixed-rate loans
and variable-rate loans that reprice infrequently, are estimated using
discounted cash flow analyses, which utilize interest rates currently being
offered for loans with similar terms to borrowers of similar credit quality.
The carrying amount of accrued interest approximates its fair value.
Deposits: The fair values of demand deposits (e.g., interest and noninterest
checking, passbook savings, and certain types of money market accounts) are,
by definition, equal to the amount payable on demand at the reporting date
(i.e., their carrying amounts). Fair values of fixed-rate certificates of
deposit are estimated using a discounted cash flow calculation that applies
interest rates currently being offered on certificates to a schedule of
aggregated expected monthly maturities on time deposits.
Short-term borrowings: The carrying amounts of federal funds purchased and
other short-term borrowings approximate their fair values.
Off-balance sheet commitments: The fair values of off-balance sheet
commitments are estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties.
PER SHARE DATA -
Per share data is based on the weighted average number of shares of common
stock outstanding which was 711,000 in 1997, 1996 and 1995. Although the
Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share," in 1997, there was no change in the computation and
presentation of earnings per share for the Company from previous years.
Therefore, the adoption of this Statement did not have a material impact on
the consolidated financial statements of the Company.
RECLASSIFICATION -
Certain balances in the 1995 and 1996 financial statements have been
reclassified to conform with the 1997 presentation. These reclassifications
have no effect on net income as previously reported.
<PAGE> 60
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
NEW PRONOUNCEMENTS -
The Company adopted Statement of Financial Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," as amended by Statement No. 127, "Deferral
of the Effective Date of Certain Provisions of FASB Statement No. 125 - An
Amendment of FASB Statement No. 125," on January 1, 1997. Statement No. 125
applies a control-oriented, financial-components approach to
financial-asset-transfer transactions whereby the Company (1) recognizes the
financial and servicing assets it controls and the liabilities it has
incurred, (2) derecognizes financial assets when control has been
surrendered, and (3) derecognizes liabilities once they are extinguished.
The adoption of this Statement did not have a material impact on the
consolidated financial statements of the Company.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 "Reporting Comprehensive Income" and
No. 131, "Disclosures about Segments of an Enterprise and Related
Information," which is effective for fiscal years beginning after December
15, 1997. Statement No. 130 establishes standards for reporting and display
of comprehensive income and its components in the financial statements.
Statement No. 131 requires that information be provided about the different
types of business activities in which an enterprise engages and the
different economic environment in which it operates. Since the Company has
no items of other comprehensive income and does not have separate operating
segments, the adoption of these Statements is not expected to have a
material impact on the consolidated financial statements of the Company.
<PAGE> 61
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
2. INVESTMENT SECURITIES
Comparative amortized cost and fair value of investment securities at December
31, 1997, 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
(IN THOUSANDS)
<S> <C> <C> <C> <C>
1997
Securities held-to-maturity -
U.S. Treasury and other
U.S. government agencies $47,481 $ 96 $ 37 $47,540
======= ======= ======= =======
Securities available-for-sale -
Equity securities $ 1,760 $ -- $ -- $ 1,760
======= ======= ======= =======
1996
Securities held-to-maturity -
U.S. Treasury and other
U.S. government agencies $47,930 $ 148 $ 71 $48,007
======= ======= ======= =======
Securities available-for-sale -
Equity securities $ 1,487 $ -- $ -- $ 1,487
======= ======= ======= =======
1995
Securities held-to-maturity -
U.S. Treasury and other
U.S. government agencies $44,993 $ 206 $ 76 $45,123
States of the U.S. and
political subdivisions 1,000 42 -- 1,042
------- ------- ------- -------
$45,993 $ 248 $ 76 $46,165
======= ======= ======= =======
Securities available-for-sale -
Equity securities $ 1,497 $ -- $ -- $ 1,497
======= ======= ======= =======
</TABLE>
<PAGE> 62
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
The amortized cost and fair value of investment securities at December 31, 1997,
by contractual maturity, excluding securities which have no stated maturity,
were as follows:
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
(IN THOUSANDS)
<S> <C> <C>
Securities held-to-maturity -
Due within one year $18,988 $19,008
Due after one but within five years 28,493 28,532
Due after five but within ten years -- --
Due after ten years -- --
------- -------
$47,481 $47,540
======= =======
</TABLE>
Investment securities with an aggregate book value of $39,489,000, $48,000,000
and $44,020,000 at December 31, 1997, 1996 and 1995, respectively, were pledged
as collateral for U.S. government and public funds on deposit and for other
purposes required by law.
3. INVESTMENT IN COMPUTER SYSTEMS INTERNATIONAL, LTD.
Computer services were obtained from Computer Systems International, Ltd. (CSI),
a company formed to provide data processing services to financial institutions,
including the Bank. On August 31, 1997, CSI became wholly-owned by the Bank when
CSI purchased into treasury stock the other 50% interest from an affiliate of a
director. Effective October 1, 1997, CSI's operations were merged into the Bank
and CSI was liquidated. Charges for data processing services provided by CSI,
prior to CSI becoming wholly-owned by the Bank, amounted to $571,000, $729,000
and $690,000 in 1997, 1996 and 1995, respectively.
Prior to August 31, 1997, the Bank's investment in CSI was accounted for under
the equity method. The Bank's equity in losses of CSI amounted to $59,000 and
$200,000 in 1996 and 1995, respectively. The Bank's investment in CSI was
written off as of December 31, 1996.
<PAGE> 63
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
4. LOANS AND LEASES
Loans and leases outstanding at December 31, 1997 and 1996 are summarized as
follows:
<TABLE>
<CAPTION>
1997 1996
BOOK VALUE FAIR VALUE BOOK VALUE FAIR VALUE
<S> <C> <C> <C> <C>
Real estate -
Family residential $107,180,757 $111,439,938 $104,791,169 $107,358,364
Construction 2,616,724 2,616,724 2,572,102 2,572,201
Commercial property 28,891,754 29,748,904 25,850,966 26,768,768
Commercial, industrial
and agricultural 70,956,494 70,977,512 64,804,301 64,659,442
Individuals for household,
family and other
personal expenditures 7,612,614 7,621,309 7,674,104 7,685,184
All other loans 452,692 452,692 557,048 557,048
------------ ------------ ------------ ------------
217,711,035 222,857,079 206,249,690 209,601,007
Direct financing leases 1,307,313 1,307,313 1,013,049 1,013,049
------------ ------------ ------------ ------------
219,018,348 224,164,392 207,262,739 210,614,056
Less allowance for
possible loan and
lease losses 3,197,815 -- 3,067,434 --
------------ ------------ ------------ ------------
$215,820,533 $224,164,392 $204,195,305 $210,614,056
============ ============ ============ ============
</TABLE>
Loans to officers, directors and their affiliates amounted to $36,000 and
$81,000 at December 31, 1997 and 1996, respectively.
There were no loans pledged as collateral for U.S. government funds on deposit
at December 31, 1997 and 1996.
At December 31, 1997 and 1996, the Company serviced loans for others amounting
to $50,350,000 and $49,064,000, respectively. There were no loans held for sale
at December 31, 1997 and 1996.
At December 31, 1997 and 1996, the undisbursed portion of loans amounted to
$2,688,000 and $2,719,000 respectively.
<PAGE> 64
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
During fiscal 1996, the Company sold loans amounting to $3,819,000, including a
$2,673,000 impaired loan, to an affiliate of a director. No gain or loss was
recognized on the sale of these loans.
At December 31, 1997 and 1996, the Company's investment in vehicle and equipment
direct financing leases consisted of the following:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Minimum lease payments receivable and
guaranteed residual values $ 1,574,401 $ 1,123,450
Unearned income (267,088) (110,401)
-------------- --------------
$ 1,307,313 $ 1,013,049
============= =============
</TABLE>
As of December 31, 1997, the future minimum lease payments to be received from
direct financing leases are as follows for the years ending December 31:
<TABLE>
<CAPTION>
<S> <C>
1998 $ 631,000
1999 415,000
2000 230,000
2001 179,000
2002 119,000
--------------
$ 1,574,000
==============
</TABLE>
<PAGE> 65
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
5. ALLOWANCE FOR POSSIBLE LOAN AND LEASE LOSSES
An analysis of the allowance for possible loan and lease losses for the years
ended December 31, 1997, 1996 and 1995 is presented below:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Balance, beginning of year $ 3,067,434 $ 3,096,433 $ 3,421,636
Provision charged to operations 720,000 810,000 700,000
Recoveries credited to allowance 179,522 692,107 78,672
Loans and leases charged off (769,141) (1,531,106) (1,103,875)
-------------- ------------- --------------
Balance, end of year $ 3,197,815 $ 3,067,434 $ 3,096,433
============= ============ =============
</TABLE>
Nonaccrual loans amounted to approximately $3,782,000 and $3,180,000 at December
31, 1997 and 1996, respectively. There was no interest income recognized on
nonaccrual loans in 1997, 1996 and 1995. Had these loans performed in accordance
with their original terms, interest income of $441,000, $464,000 and $318,000
would have been recorded in 1997, 1996 and 1995, respectively.
The following table presents information related to impaired loans as of and for
the year ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Impaired loans $ 3,793,000 $ 3,074,000
Impaired loans with related allowance for
loan losses calculated under SFAS No. 114 1,528,000 1,424,000
Total allowance on impaired loans 374,000 253,000
Average impaired loans 3,584,000 3,970,000
</TABLE>
Impaired loans without a related allowance for loan losses are generally
collateralized by assets with fair values in excess of the recorded investment
in the loans. Interest payments on impaired loans are applied to principal.
There was no interest recognized on impaired loans in 1997 and 1996. During
fiscal 1997 and 1996, certain loans were written down by approximately $287,000
and $516,000, respectively, to the fair value of the collateral.
<PAGE> 66
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
6. PREMISES AND EQUIPMENT
Premises and equipment as of December 31, 1997 and 1996 are summarized as
follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Buildings and improvements $ 3,265,979 $ 3,222,823
Furniture and equipment 6,815,328 6,691,803
---------------- --------------
10,081,307 9,914,626
Less accumulated depreciation 6,541,928 6,014,504
---------------- --------------
$ 3,539,379 $ 3,900,122
=============== ==============
</TABLE>
Depreciation expense on premises and equipment amounted to $589,936, $564,460
and $480,109 in 1997, 1996 and 1995, respectively.
7. DEPOSITS
Time certificates of deposit include certificates of $100,000 or more
aggregating $49,053,000 at December 31, 1997 and $47,945,000 at December 31,
1996. Interest expense on such certificates was $2,432,000, $2,197,000 and
$2,137,000 in 1997, 1996 and 1995, respectively.
At December 31, 1997, the scheduled maturities of time deposits were as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
1998 $ 67,358,000
1999 2,825,000
----------------
$ 70,183,000
===============
</TABLE>
<PAGE> 67
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
Variable rate deposits limited to three withdrawals or less per month are
classified as savings deposits. At December 31, 1997 and 1996, such deposits
aggregated $27,860,000 and $42,241,000, respectively.
8. SHORT-TERM BORROWINGS
At December 31, 1997 and 1996, short-term borrowings were composed of the
following:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
U.S. Treasury tax and loan collections $ 1,000,000 $ 843,974
Advances from FHLB 4,000,000 --
------------- -----------
$ 5,000,000 $ 843,974
============= ===========
</TABLE>
The U.S. Treasury tax and loan collections on deposit bear interest (5.25% at
December 31, 1997 and 5.15% at December 31, 1996) and are due on demand. The
Bank maintains a line of credit with FHLB equal to 10% of total assets,
including a cash management agreement line of 5%.
9. LEASE COMMITMENTS
The Company is obligated, under long-term leases of bank premises, for minimum
annual rentals plus property taxes, insurance and maintenance. These leases
extend over varying periods to 2024 with renewal options ranging from 3 to 20
years. Most of the leases provide for periodic renegotiation of rents based upon
a percentage of the appraised value of the leased property.
<PAGE> 68
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
At December 31, 1997, the aggregate minimum rental commitments under
noncancelable leases are as follows for the years ending December 31:
<TABLE>
<CAPTION>
LEASE
RENTAL
<S> <C>
1998 $ 2,438,000
1999 2,332,000
2000 2,213,000
2001 2,145,000
2002 1,791,000
Thereafter 22,913,000
---------------
$ 33,832,000
==============
</TABLE>
Where future rentals are subject to renegotiation, the minimum amounts shown
above are based on the latest rents.
Rent expense was $2,493,000 in 1997, $2,366,000 in 1996 and $2,294,000 in 1995,
net of sublease income of $56,000 in 1997, $59,000 in 1996 and $46,000 in 1995.
The Company leases bank and office premises from affiliated parties under leases
expiring in 2024. Rent paid to affiliates on these leases amounted to $1,263,000
in 1997, 1996 and 1995.
10. SHAREHOLDERS' EQUITY
Regulatory Capital Requirements -
The Company is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken, could
have a direct material effect on the Company's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Company must meet specific capital guidelines that
involve quantitative measures of the Company's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The Company's capital amounts and classifications are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
<PAGE> 69
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
Quantitative measures established by regulation to ensure capital adequacy
require the Company to maintain minimum amounts and ratios (set forth in the
tables below) of Total and Tier 1 capital to risk-weighted assets, and of
Tier 1 capital to average assets. Management believes, as of December 31,
1997 and 1996, that the Company met all capital adequacy requirements to
which it is subject.
<TABLE>
<CAPTION>
TO BE WELL CAPITALIZED
UNDER PROMPT
FOR CAPITAL ADEQUACY CORRECTIVE
ACTUAL PURPOSES ACTION PROVISIONS
----------------------------- ---------------------------- -----------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
(in thousands) (in thousands) (in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
DECEMBER 31, 1997
Total Capital (to Risk
Weighted Assets) $30,969 14.8% > $16,765 > 8.0% > $20,956 > 10.0%
- - - -
Tier l Capital (to Risk
Weighted Assets) $28,342 13.5% > $ 8,382 > 4.0% > $12,574 > 6.0%
- - - -
Tier l Capital (to
Average Assets) $28,342 9.9% > $11,478 > 4.0% > $14,348 > 5.0%
- - - -
DECEMBER 31, 1996
Total Capital (to Risk
Weighted Assets) $30,293 15.2% > $15,926 > 8.0% > $19,908 > 10.0%
- - - -
Tier l Capital (to Risk
Weighted Assets) $27,797 14.0% > $ 7,963 > 4.0% > $11,945 > 6.0%
- - - -
Tier 1 Capital (to
Average Assets) $27,797 9.5% > $11,764 > 4.0% > $14,705 > 5.0%
- - - -
</TABLE>
As of December 31, 1997 and 1996, the Company was categorized as well
capitalized under the applicable federal regulations. To be categorized as
well capitalized, the Company must maintain minimum ratios as set forth in
the table above. There are no conditions or events since that notification
that management believes have changed the Company's category.
<PAGE> 70
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
RESTRICTIONS ON RETAINED EARNINGS -
Dividends that may be paid on the Company's common stock, as and when
declared by the Board of Directors, are largely dependent upon the amount of
dividends paid to the Company by its bank subsidiary. Federal law currently
establishes limits on the amount of dividends that may be paid in any one
year by the bank subsidiary without the prior approval of the Comptroller of
the Currency. Such dividends are limited to bank net earnings for the year
in which the dividend is declared together with earnings of the preceding
two years as defined in the Comptroller's regulations, less any required
statutory transfers of retained earnings to capital in excess of par value.
At December 31, 1997, retained earnings of the Bank available for dividends
without prior approval of the Comptroller of the Currency amounted to
$2,102,000.
11. INCOME TAXES
The provision for income taxes for 1997, 1996 and 1995 consisted of the
following:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Current -
Federal $ 283,000 $ 295,000 $ 555,000
Hawaii 17,000 51,000 104,000
--------- --------- ---------
300,000 346,000 659,000
--------- --------- ---------
Deferred -
Federal 47,000 69,000 (32,000)
Hawaii 11,000 16,000 (7,000)
--------- --------- ---------
58,000 85,000 (39,000)
--------- --------- ---------
$ 358,000 $ 431,000 $ 620,000
========= ========= =========
</TABLE>
<PAGE> 71
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
At December 31, 1997 and 1996, the components of the net deferred tax asset were
as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 943,000 $ 20,000
Loan and lease losses 934,000 884,000
Interest on nonaccrual loans 126,000 138,000
Deferred loan fees and related origination costs 100,000 107,000
Tax credits 100,000 --
Investment in Computer Systems International, Ltd. -- 402,000
Other 23,000 32,000
-------------- --------------
2,226,000 1,583,000
-------------- --------------
Deferred tax liabilities:
Tax over book depreciation (682,000) (769,000)
Excess pension contributions over expenses (120,000) (120,000)
Direct financing leases capitalized for tax (104,000) (166,000)
Deferred gain on fixed assets (45,000) (45,000)
FHLB stock dividends (83,000) --
Other (12,000) --
-------------- --------------
(1,046,000) (1,100,000)
-------------- --------------
1,180,000 483,000
Valuation allowance -- (422,000)
-------------- --------------
Net deferred tax asset $ 1,180,000 $ 61,000
============== ==============
</TABLE>
As a result of the Company becoming the sole stockholder of CSI in 1997, the
Company recorded $1,047,000 of deferred tax assets relating to net operating
loss carryforwards of $2,753,000 generated by CSI and $130,000 of tax credits.
In 1997, the Company utilized $325,000 of these net operating loss carryforwards
and $30,000 of these tax credits to partially offset taxable income.
The valuation allowance decreased $422,000 in 1997 and increased $23,000 in
1996. In 1997, the deferred tax asset and related valuation allowance associated
with the Company's investment in CSI were reversed. In addition, certain net
operating loss carryforwards were utilized in 1997.
<PAGE> 72
A reconciliation of the Company's effective tax rate with the statutory Federal
income tax rate is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Statutory Federal income tax rate 34.0% 34.0% 34.0%
State franchise tax, net of Federal tax benefit 5.6 5.5 5.5
Amortization of goodwill (3.0) -- --
Change in valuation allowance (2.0) 2.0 4.6
Stock dividends -- (2.5) (1.4)
Tax-exempt interest income -- (1.1) (1.6)
Other, net 0.9 (0.2) (3.8)
----- ----- -----
35.5% 37.7% 37.3%
===== ===== =====
</TABLE>
At December 31, 1997, the Company had net operating loss and research and
experimentation tax credit carryforwards that were generated by CSI which expire
in the following years:
<TABLE>
<CAPTION>
NET
OPERATING TAX
LOSS CREDITS
<S> <C> <C>
2005 $ 98,000 $ --
2006 129,000 --
2007 59,000 --
2008 745,000 --
2009 10,000 --
2010 505,000 --
2011 213,000 --
2012 669,000 100,000
---------- --------
$2,428,000 $100,000
========== ========
</TABLE>
12. PENSION PLAN
The Company has a noncontributory defined benefit pension plan covering
substantially all employees. Pension benefits are based upon specified
percentages of employee compensation accumulated during each year of service.
<PAGE> 73
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
Net pension expense for 1997, 1996 and 1995 was composed of the following:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Service cost representing benefits
earned during the year $ 246,278 $ 233,162 $ 166,611
Interest cost on projected benefit
obligation 354,863 333,025 328,762
Return on plan assets - actual (183,690) (137,621) (566,771)
Net amortization and deferral (123,801) (165,094) 199,273
--------- --------- ---------
Total net pension expense $ 293,650 $ 263,472 $ 127,875
========= ========= =========
</TABLE>
The funded status of the plan and prepaid pension cost at December 31, 1997 and
1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Actuarial present value of projected benefit obligation, based
upon employment service to date and current salary levels -
Vested employees $ 4,660,035 $ 3,935,270
Nonvested employees 91,624 69,690
----------- -----------
Accumulated benefit obligation 4,751,659 4,004,960
Additional amounts related to projected salary increases 842,491 765,662
----------- -----------
Projected benefit obligation 5,594,150 4,770,622
Plan assets available for benefits consisting of U.S.
government and agencies bonds and money market funds 4,456,778 4,054,127
----------- -----------
Deficiency of plan assets over projected benefit
obligation at end of year (1,137,372) (716,495)
Unrecognized differences in actual plan assets and projected
benefit obligations from that assumed 1,573,432 1,162,609
Prior service cost not yet recognized in pension cost 268,466 295,313
Unrecognized net asset at January 1, 1986 being
amortized over 16 years (292,352) (365,440)
----------- -----------
Prepaid pension cost included in other assets $ 412,174 $ 375,987
=========== ===========
</TABLE>
<PAGE> 74
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
The actuarial computation of projected benefit obligations was based upon a
discount rate of 7.0% at December 31, 1997 and 1995, and 7.25% at December 31,
1996 and a rate of increase in compensation levels of 5.0% in 1997, 1996 and
1995. The expected long-term rate of return on plan assets was 7.5% in 1997,
1996 and 1995.
In 1996, the mortality assumption was changed to the 1983 Group Annuity
Mortality table which resulted in an increase in the plan's accumulated benefit
obligation.
The Company established a supplemental executive retirement plan (SERP) which is
a nonqualified unfunded pension plan covering a select group of senior
executives. The SERP provides a retirement benefit payable in the form of a life
annuity to the participants which is based on a specified percentage of the
participant's final average earnings less basic retirement and social security
benefits. The Company recognized an actuarially determined SERP pension expense
of $36,000, $27,000 and $25,500 in 1997, 1996 and 1995, respectively.
The Company also has a deferred compensation plan established under Section
401(k) of the Internal Revenue Code covering substantially all employees.
Contributions to the plan by participating employees are voluntary and based on
a specified percentage of each covered employee's salary.
13. SUPPLEMENTARY INCOME STATEMENT INFORMATION
Other operating expenses for 1997, 1996 and 1995 included the following:
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Stationery and office supplies $ 403,491 $ 394,198 $ 326,084
Insurance 286,427 253,991 253,338
Advertising 257,070 219,950 161,107
Other 1,955,197 1,772,278 2,196,505
------------- ------------- --------------
Total other operating expenses $ 2,902,185 $ 2,640,417 $ 2,937,034
============ ============ =============
</TABLE>
Repairs and maintenance expenditures included in occupancy expense and equipment
expense amounted to $644,690, $517,428 and $506,272 in 1997, 1996 and 1995,
respectively.
<PAGE> 75
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
14. FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts and fair values of the Company's financial instruments held
or issued for purposes other than trading at December 31, 1997 and 1996 were as
follows:
<TABLE>
<CAPTION>
CARRYING FAIR
AMOUNT VALUE
<S> <C> <C>
1997
Cash and due from banks $ 22,628,962 $ 22,628,962
Investment securities:
Held-to-maturity 47,481,373 47,540,000
Available-for-sale 1,760,103 1,760,103
Loans and leases, net 215,820,533 224,164,392
Deposits -
Demand deposits and savings 188,538,021 188,538,021
Time 70,182,784 70,294,820
Federal funds purchased 4,000,000 4,000,000
Short-term borrowings 5,000,000 5,000,000
1996
Cash and due from banks 17,276,700 17,276,700
Federal funds sold 16,000,000 16,000,000
Investment securities:
Held-to-maturity 47,929,910 48,007,000
Available-for-sale 1,487,003 1,487,003
Loans and leases, net 204,195,305 210,614,056
Deposits -
Demand deposits and savings 198,165,319 198,165,319
Time 66,429,061 66,554,865
Short-term borrowings 843,974 843,974
</TABLE>
<PAGE> 76
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK -
The Bank is a party to financial instruments with off-balance sheet risk
entered into in the normal course of business to meet the financing needs of
its customers. These financial instruments which are held for purposes other
than trading include commitments to extend credit, standby and commercial
letters of credit. Those instruments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amounts recognized in the
consolidated balance sheets. The Bank's exposure to credit loss in the event
of nonperformance by the other party to the financial instrument is
represented by the contractual amount of those instruments. The Bank manages
the credit risk of counterparty defaults in these transactions by limiting
the total amount of outstanding arrangements, by monitoring the size and
maturity structure of the off-balance sheet portfolio and by applying
uniform credit standards for all of its credit activities. Since many of the
commitments to extend credit may expire without being drawn upon, the total
commitment amount does not necessarily represent future cash requirements.
The Bank evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Bank upon
extension of credit, is based on management's credit evaluation of the
counterparty. Collateral held varies but may include accounts receivable,
inventory, property, plant, equipment and income-producing commercial
properties.
Off-balance sheet commitments held for purposes other than trading at
December 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
CONTRACT AMOUNT
1997 1996
<S> <C> <C>
Commitments to extend credit $ 68,287,000 $ 60,769,000
Standby letters of credit 1,880,000 2,644,000
Commercial letters of credit 802,000 2,140,000
</TABLE>
The fair values of off-balance sheet financial instruments at December 31,
1997 and 1996 were estimated using fees currently charged to enter into
similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. At
December 31, 1997 and 1996, the fair values of commitments to extend credit
amounted to $50,000 and $30,000, respectively, and the fair values of
letters of credit amounted to $28,000 and $40,000, respectively.
<PAGE> 77
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
CONCENTRATION OF CREDIT RISK -
The Company has no significant concentrations of credit risk with any
individual party, however the Bank's lending is concentrated on the island
of Oahu in the State of Hawaii.
15. CONDENSED FINANCIAL INFORMATION OF HAWAII NATIONAL BANCSHARES, INC. (PARENT
COMPANY ONLY)
Condensed financial information of Hawaii National Bancshares, Inc. (Parent
Company Only) as of December 31, 1997 and 1996 and for the years ended December
31, 1997, 1996 and 1995 consists of the following:
BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Assets:
Cash on deposit with Hawaii National Bank $ 110,136 $ 122,267
Investment in Hawaii National Bank 28,231,677 27,675,021
----------- -----------
$28,341,813 $27,797,288
=========== ===========
Shareholders' Equity:
Common stock $ 711,000 $ 711,000
Capital in excess of par value 12,147,676 12,147,676
Retained earnings 15,483,137 14,938,612
----------- -----------
$28,341,813 $27,797,288
=========== ===========
</TABLE>
<PAGE> 78
HAWAII NATIONAL BANCSHARES, INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
----------
STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Dividends from Hawaii National Bank $ 147,750 $ 147,750 $ 147,750
Operating expenses 53,231 48,248 37,356
---------- ---------- ----------
Income before equity in undistributed
income of bank subsidiary 94,519 99,502 110,394
Equity in undistributed income of Hawaii
National Bank 556,656 611,721 933,541
---------- ---------- ----------
Net income $ 651,175 $ 711,223 $1,043,935
========== ========== ==========
</TABLE>
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
<S> <C> <C> <C>
Cash flows from operating activities:
Dividends from Hawaii National Bank $ 147,750 $ 147,750 $ 147,750
Cash paid to suppliers (53,231) (48,248) (37,241)
----------- ----------- -----------
Net cash provided by operating 94,519 99,502 110,509
activities
Cash flows from financing activities:
Dividends paid (106,650) (106,650) (106,650)
----------- ----------- -----------
Net cash used in financing activities (106,650) (106,650) (106,650)
----------- ----------- -----------
Net (decrease) increase in cash (12,131) (7,148) 3,859
Cash at beginning of year 122,267 129,415 125,556
----------- ----------- -----------
Cash at end of year $ 110,136 $ 122,267 $ 129,415
=========== =========== ===========
Reconciliation of net income to net cash
provided by operating activities:
Net income $ 651,175 $ 711,223 $ 1,043,935
Adjustments to reconcile net income to
net cash provided by operating activities:
Undistributed earnings of subsidiary (556,656) (611,721) (933,541)
Decrease in prepaid expenses -- -- 115
----------- ----------- -----------
Net cash provided by operating $ 94,519 $ 99,502 $ 110,509
activities =========== =========== ===========
</TABLE>
In the above condensed financial information, the Parent's investment in Hawaii
National Bank is accounted for by the equity method.
<PAGE> 79
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 17th day of
March 1998.
HAWAII NATIONAL BANCSHARES, INC. (Registrant)
By /s/ K.J. Luke
---------------------------------
K.J. Luke
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated:
<TABLE>
<CAPTION>
Signatures Title Date
---------- ----- ----
<S> <C> <C>
Principal Executive Officer:
/s/ K.J. Luke Chairman of the Board,
- ------------------------------- Director and Chief
K.J. Luke Executive Officer March 17, 1998
Chief Financial and Accounting
Officer:
/s/ Ernest T. Murata Vice President, Treasurer March 17, 1998
- ------------------------------- and Assistant Secretary
Ernest T. Murata
A Majority of the Board of
Directors:
/s/ Warren K.K. Luke Director March 17, 1998
- -------------------------------
Warren K.K. Luke
/s/ Gordon J. Mau Director March 17, 1998
- -------------------------------
Gordon J. Mau
</TABLE>
<PAGE> 80
INDEX TO EXHIBITS
Exhibit No. Exhibit
- ----------- -------
3.1 Articles of Incorporation of Bancshares - Incorporated by reference
to Exhibit 3.1 of Bancshares' Annual Report on Form 10-K for the
fiscal year ended December 31, 1991 filed with the Securities and
Exchange Commission.
3.2 Amended and Restated Bylaws of Bancshares - Incorporated by reference
to Exhibit 3.3 of Bancshares' Annual Report on Form 10-K for the
fiscal year ended December 31, 1995 filed with the Securities and
Exchange Commission.
10.1 Supplemental Executive Retirement Plan - Incorporated by reference to
Exhibit 10.1 of Bancshares' Annual Report on Form 10-K for the fiscal
year ended December 31, 1994 filed with the Securities and Exchange
Commission.
21 Subsidiaries of Bancshares: The only subsidiary of Bancshares is
Hawaii National Bank, a National Banking Association.
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
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0
0
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</TABLE>
