HonFed and the great estate: with a financial boost from the Bishop estate, is the...

HONFED AND THE GREAT ESTATE

WITH A FINANCIAL BOOST FROM THE BISHOP ESTATE, IS THE THIRD-LARGEST FINANCIAL SERVICES COMPANY IN HAWAII FINALLY OUT OF THE WOODS? How often do business proposals made half in jest end up in dead-serious negotiations? More

often than you might think. Take, for example, First Hawaiian Inc. Chairman, President and CEO Walter Dods Jr.'s off-the-cuff remark to former U.S. Treasury Secretary William Simon about buying First Interstate of Hawaii Inc. According to Dods, it was a casual comment, but it resulted in a binding agreement to purchase the bank's local operation for $140 million. Not long after the final numbers on that deal had been worked out, remarks by officials of H.F. Holdings, the parent company of Honfed Bank, made to trustees of the Bishop Estate led to intense negotiations concerning the organization's purchase of 23 percent of the state's third-largest financial institution, a deal representing $50 million.

But the deals have more in common than polite conversation. Another common thread running between Honfed and First Interstate is the ownership interest of WSGP International LP, the investment group led by Simon. Bishop Estate, in turn, also had previous ties to the Simon Group through its $15-million participation in the group's purchase of First Interstate in 1989. Prior to that deal, Simon had control of about 40 percent of First Interstate's island operation. "They (Smith, Barney, Harris Upham & Co., Honfed's investment bankers) half-jokingly told us, |Gee, since you got such a great deal from the First Interstate sale (to First Hawaiian), wouldn't you like to roll it over into Honfed?'" recalls Matsuo Takabuki, a Bishop Estate trustee. "Later, they approached us and asked if we would be interested in taking a piece of Honfed. So we told them if they were serious, let's take a look at the whole god-damned thing."

The "whole god-damned thing," in this case, represented the $50-million cash infusion by Hawaii's largest private estate to help Honfed meet new, tougher capital requirements established by Congress with the passage of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). The agreement was the latest in a sequence of events over the last four years intended to stabilize the fortunes of Honfed, the state's largest thrift.

A hectic history. Honfed's dilemma dated back to the early 1980s, when recession, high interest rates and a battered real estate market caused the firm, then known as Honolulu Federal Savings & Loan Association, to carry a large portfolio of problem loans. Those non-performing loans and faltering earnings resulted in less cash available for operating expenses and to meet tougher capital requirements by the regulators. In 1986, the Simon-led investor group cut a deal with the Federal Home Loan Bank of Seattle, the regulatory agency that oversees thrifts in Hawaii, to take over the troubled S&L. In addition to other incentives, the new owners were allowed to put on the books $107 million in goodwill to help it meet minimal capital requirements. (Goodwill is an accounting device that gives a dollar value to such intangible business assets as a company's longstanding relationship with customers and suppliers, or its sound reputation in the community.) Honfed was also given 25 years in which to replace the goodwill with hard assets.

But Congress had other ideas. Upset by the growing S&L fiasco, it passed the FIRREA legislation which set in place a whole slew of rules governing management of thrifts. Unfortunately for Honfed, one such regulation eliminated the practice of using intangible assets, including goodwill, to meet capital standards. Although Honfed had accelerated its payback schedule and had whittled its goodwill to below $80 million by mid-1989, there was still a lot of ground to cover. "In effect, the government welched on its deal with us," says Honfed Chairman Gerald Czarnecki, the Simon-picked appointee charged with the task of rebuilding the struggling thrift. "We thought we had a deal with the government and felt they should have honored it. They didn't, and we were forced to go out and find a whole bunch of capital."

Honfed was still searching for funds to meet the new regulatory requirements when the opportunity arose to buy the 19 Hawaii branches of San Francisco-based First Nationwide Bank, one of the largest thrifts in the nation and a subsidiary of the Ford Motor Co. Although the U.S. Office of Thrift Supervision approved the sale in October 1989, it required Honfed's parents to provide additional capital within 30 days of closing the merger. Consequently, H.F. Holdings submitted to the U.S. Securities and Exchange Commission a proposal to sell $121.6 million in preferred stock, with $90 million of the funds to fulfill its capital requirement. The SEC, however, held up the filing and subsequent sale of the stocks, pending submission of further information.

Those delays caused First Nationwide to reconsider its proposal, and it opted not to renew its agreement with Honfed after a March 31, 1990 deadline had passed. That opened the door for American Savings Bank, a subsidiary of Hawaiian Electric Industries, which subsequently purchased First Nationwide last October. "The ironic thing was that we had our capital in the bucket before they closed with American Savings, so they could have had their money faster if they had hung in with us," says Czarnecki. "It was a personal letdown for me because I had personally negotiated the deal, and had worked a year and a half on it."

Enter the great Estate. That disappointment would soon be overshadowed by Bishop Estate's cash infusion. When its financial experts first began looking at the numbers, however, two points became apparent to Bishop Estate representatives: The stock offering of $121.6 million was more than Honfed really needed and Honfed's real estate holdings, much of which had already been put on the auction block, were underpriced. "We went through a due diligence period when our entire staff looked closely at all the numbers given to us, particularly at the non-performing real estate loans," says Mitchell Gilbert, Bishop Estate's manager of financial assets. "Most of this real estate was in Hawaii and was grossly understated on their books, compared to what the market was willing to pay."

In the meantime, Honfed continued to liquidate its real estate holdings both on the mainland and in Hawaii. Currently, Honfed now owns only a 728-acre parcel in North Ogden, Utah (which it has been trying to develop into a residential subdivision since 1974). The $11-million sale of its 15-story Honfed Tower on Kapiolani Boulevard to First Hawaiian Bank was announced last month. The effects of Honfed's real estate divestiture program have manifested themselves in its earnings reports. Honfed's third-quarter 1990 earnings of $21 million represent an increase of $13.4 million over the previous quarter and more than double the earnings logged for third quarter 1989. "That's one of the reasons we felt the stock offering was more than was necessary," adds Takabuki. "We knew the sale of these real estate holdings would bring substantial equity to meet the regulator's equity requirements."

Negotiations between Bishop Estate trustees and Honfed representatives moved quickly over the next few months. One concern was to fashion a deal that would not violate the tax-exempt status of the Estate; consequently, Bishop's investment took the form of $45 million in preferred stock, with $5 million going into the holding company, H.F. Holdings. Simon told Institutional Investor, a national financial services trade publication, that the investment gave Bishop Estate 23 percent ownership of Honfed, still now enough for the non-profit institution to maintain a passive role in the business. With Bishop Estate's cash infusion, Honfed has been able to boost its equity base by $81.6 million since the start of 1990, which puts it in compliance with the capital requirements established by the FIRREA legislation.

Back to basics. For the first time in five years, and thanks in large part to the Bishop Estate, Honfed can now fine-tune its business plan without the distractions of a financial crisis. But as Honfed tip-toed its way through a minefield of regulatory requirements, and disposed of its real estate holdings, that business plan went through a dramatic transformation. Last November, Honfed notified creditors of its intent to dissolve its real estate arm, Honvest Corp. The notification marked Honfed's departure from real estate development, which was a key element of its business stategy as late as 1988. "When I first got here, part of our plan was to develop our real estate arm so that in a three- to five-year period, over a third of our income would come from real estate development," says Czarnecki. "We had assembled a high-caliber real estate development company, and had intended to become a significant player in real estate development."

According to Czarnecki, it was essentially the tightening regulatory environment and FIRREA that nixed that strategy. "The legislation changed us and changed the kind of business plans we had," he adds. While new legislation did not prohibit thrifts from venturing into real estate, it did make the move highly uneconomical. In effect, the new capital requirements eliminated leverage or debt ratio, and required lending institutions to have a dollar of capital for every dollar invested in real estate development.

With regulatory constraints making it difficult for Honfed to follow through with its original business plan, Czarnecki and his management team refocused their attention on consumer banking. As part of the re-strategizing effort, Honfed President and COO Chuck Armstrong announced last June a major reorganization of its branches into nine "target" areas, with a bank executive responsible for each area. Armstrong described it as a "flattening of the organizational chart," to decentralize management and force its people closer to the markets they serve. "We are a consumer bank, and that's always been our primary strength," Czarnecki says. "So our new business plan is a return to basics. Honfed was one of the first banks in the country to have ATMs (automatic teller machines). It was one of the first to have NOW accounts (interest-earning personal checking accounts) when they were an oddity in the business. We have made a renewed commitment to providing mortgage and auto loans, deposit product opportunities--fairly traditional kinds of banking services."

Consumer banking may seem a bit tame for Honfed after the high drama of the 1980s, but you won't hear Czarnecki complaining. Besides, there may be other "developments" waiting in the wings for Honfed. With Simon--known for his high-powered wheeling and dealing--at the ownership helm, one wonders how long he will be willing to hold onto Honfed. One investment analyst casts the cynical comment that Simon did not buy the thrift simply because he was interested in running one. "The man is heading an investment group and when any investment is ripe, he will sell," the analyst predicts.

Both Czarnecki and Simon Group representatives, however, deny that Honfed is on the auction block. "We are just delighted with management and the performance of Honfed Bank," says Preston Martin, chairman and CEO of H.F. Holdings and former chairman of the Federal Home Loan Bank Board. "To us it's a jewel in our financial holdings, and we have no intention of selling it." But Martin also acknowledges that the partnership did not intend to sell First Interstate either. Rather, it was "an opportunity that just presented itself." And if that opportunity does not pan out because of concerns by the U.S. Justice Department (see story, page 22), some speculate other developments could evolve rapidly. With the Simon Group and now Bishop Estate holding interests in both Honfed and First Interstate, rumors have circulated that the owners might merge the two.

Bishop Estate's Takabuki suggests such a marriage is not unthinkable. "If the deal (First Hawaiian/First Interstate) doesn't happen, then we go on our merry way. Maybe we will merge First Interstate with Honfed," surmises Takabuki. "If Bancorp can do it with FirstFed, why couldn't we? We'd get a hell of a big bank out of it." Then Takabuki laughs, suggesting that he is teasing--but it may be only half in jest.

PHOTO : Honfed's Czarnecki