Turn of the Century

Two years after Pacific Century Financial Corp. cooked up its New Era Redesign strategy, the company introduces a new leader with new ideas

February, 2001

In the early 1970s, Michael O’Neill would carry a cash-filled briefcase onto a one-engine aircraft that routinely transported him across South Vietnam. The job—delivering payroll every month to major contractors scattered across the jungles—was his first experience with banking.

“I was, I guess, foolish, because I was literally carrying money around,” O’Neill says. “I would go to Chase, get the piasters and put them in a briefcase. At one time, they said ‘Do you want to handcuff yourself to the briefcase?’ I told them, ‘I don’t think so! They’ll chop my hand off!’”

Those Vietnam deliveries were an early lesson about risk and risk mitigation, and it prepared O’Neill well for his banking career. Today, Mike O’Neill, 54, faces what may be the biggest challenge of his professional life. On Nov. 3, 2000, O’Neill became chairman and chief executive officer of Bank of Hawaii and its holding company, Pacific Century Financial Corp. His mission: to revive a proud company that witnessed its share price and market position battered by a decade-long slowdown in Hawaii, coupled with financial turmoil in Asia.

From the moment he arrived in Hawaii, O’Neill has used every opportunity he can to repeat his management mantra: shareholder value, shareholder value, shareholder value. “Shareholder value is the lynchpin to everything,” he says.

This motto of business life is all the more apt, given that he joined Bankoh in the wake of the resignation of Lawrence M. Johnson, who stepped down last August after 42 years at the bank. Johnson left, as he promised shareholders and investors he would, after Pacific Century Financial’s share price continued to slide despite a year and a half of painful cuts and “reengineering.”

Last year, BOH fluctuated from a high of $22.75 per share in June to a low of $11.25 in October, a 40 percent drop from its 10-year high of $27 in December 1997. Pacific Century’s $81.1 million net earnings for the first nine months of 2000 fell 15 percent compared to $95.4 million over the same period in 1999. Basic earnings per share were $1.02 in the first nine months of 2000, down from $1.19 per share in the same period a year earlier.

Today, O’Neill oversees territory that is more impenetrable than any Southeast Asian jungle. Pacific Century Financial is a 104-year-old institution comprised of 200 Bank of Hawaii branches and subsidiaries in Hawaii and the Asia Pacific region. The company’s operations in the U.S. mainland had included 19 branches in California and nine in Arizona. That was before the company on Dec. 27 agreed to sell its Arizona bank branches to Zions Bancorp. for more than $20 million.

“This is one complex, sophisticated company,” O’Neill says. “This is not your run-of-the-mill regional bank—it looks like a money center. What I have to deal with is a geographically disposed company with different product lines.”

He doesn’t have much time to decide where he wants to take Pacific Century Financial. O’Neill gave himself and top managers 120 days to review current operations and formulate a revised strategy for growth. Once that review period ends in mid-March, O’Neill is expected to unveil his plan in early April.

Shareholders, particularly institutional investors, are giving O’Neill room to run. “People know me and know what I’ve done in the past and I think I’ve established some credibility in Wall Street,” he says. O’Neill boosted his position with financial markets after promising, on the day of his appointment, that he would purchase $10 million in Pacific Century Financial shares. He purchased 676,688 shares of the company stock for between $14 and $15.25 each between Nov. 6 and Nov. 17.

One week after O’Neill stepped into the chairman’s office, 1.1 million shares of BOH traded hands, almost triple the company’s daily average. In fact, the stock closed as high as $15.56 during O’Neill’s first 30 days in office.

If O’Neill’s record is any indication, he’ll have a good chance of restoring Pacific Century Financial’s lost luster. As chief financial officer for Continental Bank in the early 1990s, O’Neill helped boost the bank’s stock price from $9 per share in 1991 to $38.75 per share in 1994. That was when Bank of America purchased Continental Bank.

“We needed his help,” recalls Tom Theobald, former vice chairman of Citicorp and chairman of Continental Bank. He and O’Neill both had worked at Continental Bank from 1974 to 1988, and again from 1989 through the 1994 acquisition. “We recruited him back and he was quickly made the chief financial officer,” Theobald says. “He helped us a great deal in maintaining a top quality credit standard. Mike also had a great deal of efficiency for the bank through analysis of cost structure and ways to improve it.”

As chief financial officer of Bank of America from 1995 to 1998, O’Neill also quadrupled the bank’s share price from $23 to a high of $80.

“Mike is fond of saying ‘Let’s do fact-based planning as opposed to assertion-based planning,’” says Mike Murray, who also worked with O’Neill at both Continental Bank and Bank of America. “People with double-digit IQs are in trouble up there (Hawaii), because he likes to surround himself with people who are smart, practical and get things done.” Murray retired as Bank of America’s president of global corporate and investment banking. He, O’Neill, Theobald and other senior management had cleaned up Continental’s balance sheets prior to its 1994 acquisition by Bank of America. O’Neill’s chances for success have been significantly strengthened by Pacific Century Financial’s painful, two-year reengineering program, better known as New Era Redesign (see Hawaii Business, January 1999). New Era focused on cutting costs—900 positions were eliminated—and improving Bank of Hawaii’s efficiency ratio, a standard measure of expenses in relation to earned revenue. New Era ended Sept. 30, 2000.

Richard Dahl, president of Pacific Century, and other senior executives acknowledge that they waited too long to begin a tough analysis of Pacific Century Financial’s cost structure and market strategy. As was the case at many Hawaii companies in the mid-1990s, bank executives assumed the economic downturn was going to be short-term, as earlier slumps had been. Instead, it was a protracted slowdown. That became clear when Asian financial markets suffered through a meltdown in late 1997.

The bank by that time knew it had no choice but to return to basics. “Bank of Hawaii had been around for a 100 years,” Dahl says. “We were pieced together based on local laws, federal laws and geographic issues. Our foundation was strong, but the house was built as add-ons because of these laws. We couldn’t do leasings at the bank and had to go through subsidiaries. We couldn’t do foreign lending through the bank, we had to go with subsidiaries.”

As part of New Era’s two-tiered scheme, bank employees in 1998 submitted individual recommendations, of which 1,200 were considered. “We started with 6,000 ideas and boiled it down,” Dahl says. Phase One of New Era involved a hiring freeze for 1998 and 1999; outsourcing of credit and debit card operations; branch consolidations in Hawaii; and the merger of Bank of Hawaii and First Federal Savings & Loan Association of America, which Pacific Century acquired in 1990.

Phase Two of New Era propelled Pacific Century Financial to the forefront of high-tech banking. Its results today are evident. Not only can bank customers conduct transactions via Internet, phone and automated teller machines, but they also are among the first in the nation to use a new virtual teller service linking customers to employees on a separate floor. Thirty bank concierges will be added throughout Hawaii’s branches this year to boost customer service.

Pacific Century Financial executives had anticipated that by the end of 2000, New Era was expected to cut Bank of Hawaii’s cost-efficiency ratio to 55 percent. That would have been down from an average 60.5 percent over the first nine months of 2000, which in turn was down from 68.3 percent in the same period a year earlier. A cost-efficiency ratio of 55 percent means Bank of Hawaii spends 55 cents of every dollar earned.

New Era aside, however, high on Pacific Century Financial’s housekeeping list is the need to polish its credit standing. Bank of Hawaii’s chief credit officer, Bob Paris, announced his retirement more than a year ago. The bank on Jan. 9 named former Bank of America executive, William Nelson, to the new position, now called chief risk officer.

UBS Warburg analyst Robert S. Patten had predicted that O’Neill would name someone to the position who is familiar with his management style. “It will be someone Mike will know from Bank of America days,” Patten predicts. “The investment community will recognize it, and this will build the credibility of the bank.”

According to third quarter reports for 2000, unrecoverable loans totaled $63.8 million, which rose 72 percent from $37 million in the same period in 1999. Provisions for loan losses in 2000 were $117.1 million, compared to $40.1 million the previous year. Analysts also say there has been an attempt to shift away from syndicated loans and move toward relationship loans. Syndicated, or participation loans, involve large and small banks, each contributing to a common loan. Syndicated loans also allowed Pacific Century Financial to rub elbows with bigger banks although, says Rosalind Looby, analyst for Credit Suisse First Boston: “Ultimately, the little ones can get screwed. They typically don’t have a relationship with the client.” Dahl says non-accrual loans—no longer earning interest—comprise the majority of bad loans by Pacific Century Financial. They mainly were for warehouses, smaller retail outlets and hotels. Non-accrual loans rose $214.5 million on Sept. 31, 2000, up from $148.9 million over the same period in 1999.

Foreclosed real estate loans amounted to $5.1 million at Sept. 30, 2000, compared to $4.6 million at the end of 1999. By the end of the first nine months of 2000, the foreclosed real estate portfolio consisted of 42 properties, mainly residential properties in Hawaii.

“The good news is that the housing formation rate is the highest in 25 to 30 years. People are getting homes,” Dahl says. He projects that Bank of Hawaii did mortgage lending worth about $800 million in 2000, down from a $1 billion high in 1998 and 1999. “In those years, about 80 percent of our business was refinanced,” he says. In addition to its loan portfolio, Bank of Hawaii’s credit card portfolio consists of 148,000 consumer and business accounts worth $226 million. The bank’s executives on Dec. 20, 2000, announced the sale of its credit card operations to American Express Centurion Bank. As part of the credit card transfer—scheduled to be completed by the second quarter of this year—American Express will tout a card marketing program with Bank of Hawaii’s West Pacific and Hawaii branches and with Pacific Century Bank in California.

One area that O’Neill is expected to closely monitor is the Asia Pacific region. Under the company’s Pacific Rim Expansion strategy over the past decade, Pacific Century Financial had acquired branches and subsidiaries in Japan, Singapore, Hong Kong, Korea, Taiwan, Philippines and Thailand. Total loans to Asian businesses—including their U.S. mainland subsidiaries—reached a high of $1.8 billion in December 1997. Then the Asian recession hit and investors began questioning Bank of Hawaii’s Asia Pacific strategy. The bank has a two-part regional strategy. In Asia, it focuses on correspondent banking and trade financing. It isn’t involved in retail banking, as is the case in Hawaii, the U.S. mainland and in most of the Pacific Islands.

In the South Pacific, Pacific Century oversees banks in French Polynesia, New Caledonia, Vanuatu, Papua New Guinea, and Solomon Islands. The company had held minority stakes in Tonga and Samoa since the 1970s, but on Jan. 5 sold its 30 percent interest in the Bank of Tonga and its 42 percent share of Pacific Commercial Bank of Samoa to Australian company Westpac Banking Corp.

There still are three Bank of Hawaii branches in Fiji and 17 branches in the Republic of the Marshall Islands, Federated States of Micronesia, the Republic of Palau, and in the U.S. possessions of Guam and the Northern Marianas. Net income for the Pacific region for the first three quarters of 2000 totaled $19.2 million, a 13.9 percent increase from the previous year’s $16.8 million.

When Pacific Century Financial aggressively promoted its Pacific Rim strategy in the past decade, bank leaders positioned these locations for low-risk, fee-based transactions, with Hawaii as their anchor. Analyst Looby says: “The big question is whether or not O’Neill will continue to run the Pacific Rim Strategy or abandon it. The problem is there are not enough big banks interested in purchasing banks throughout the Pacific.” She says there also are political implications to consider, as Pacific Century sometimes is the largest, if not the only, bank in some of the smaller island nations.

What O’Neill does with Asia Pacific operations is anyone’s guess, but if he does cut back, it won’t be because he lacks first-hand knowledge of the region. His father, a construction executive, raised the family in Southeast Asia and Europe. O’Neill even spent a summer on Guam, where his father helped to develop the main tourist area, Tumon.

After graduating from Princeton University in 1969, O’Neill received a master’s in business administration from University of Virginia and served as a lieutenant in the United States Marine Corps until 1971. The following decade with Continental Bank assigned him to Brussels, Hong Kong and London with wife, Trish, and sons Pete and Ted. He then served as a London-based independent consultant, with clients in the Middle East, Asia, Europe and the U.S. mainland.

O’Neill has declined to comment on what changes he might make at Pacific Century Financial. But he does say that he must move quickly, and that he will implement changes with locally based talent if possible. That was one of the first questions that senior managers asked him last November.

Much attention was focused on Dahl, who continues as Pacific Century Financial’s president and chief operating officer. Although Dahl had been a high-profile candidate for O’Neill’s position, the two appear to have developed a good working relationship.

Still other changes are expected. And when they take place, the record suggests that O’Neill may be able to pull off the moves without causing a lot of anxiety in the company or in financial markets. Says Mike Murray, O’Neill’s former colleague at Continental Bank and Bank of America, “Mike can induce people to make painful changes without gettingmad at him. I don’t know if it’s his Irish charm, or what, but he’s a guy with substantial intelligence. He’s a Teflon manager.”

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