Earnings Call Transcript - BOH Q4 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to Bank of Hawaii Corporation Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would like now to turn the conference over to Cindy Wyrick, Director of Investor Relations. Please go ahead.

Cindy Wyrick, Director of Investor Relations

Thank you, and welcome everyone. Thank you for joining us today as we discuss the financial results for the fourth quarter and the full year of 2023. Joining me today is our CEO, Peter Ho; our CFO, Dean Shigemura; our Chief Risk Officer, Mary Sellers; Vice Chair and Deputy Risk Officer, Brad Shairson; and our Manager of Investor Relations, Chang Park. Before we get started, let me remind you that today's conference call will contain some forward-looking statements. While we believe our assumptions are reasonable, there are a variety of reasons that the actual results may differ materially from those projected. During the call, we'll be referencing a slide presentation as well as the earnings release. Both of these are available on our website, boh.com, under the investor relations link. And now I'd like to turn the call over to Peter Ho. Peter?

Peter Ho, CEO

Thanks, Cindy. Good morning or good afternoon, everyone. We appreciate your interest in Bank of Hawaii. Bank of Hawaii produced another solid financial performance for the fourth quarter of 2023. Average deposits grew for the second consecutive quarter, up 1% on a linked basis and up 1.8% year-over-year. Loans were again flat in the quarter. Margins ebbed in the quarter with NIM of 2.13%, flat to the second quarter. Expenses outside of the industry-wide FDIC special assessment were well controlled, and fee income was solid. Capital as measured by Tier 1, CET1, total capital and Tier 1 leverage continue to improve. Credit remains a strong story. I'll start off with some commentary on funding and liquidity and then touch on broader market conditions in Hawaii. I'll then hand the call over to Mary, as is our custom to discuss credit, and Dean will then share with you some more granular color on the financials. So let me touch a little bit on our deposits. I think as many of you know, we consider our deposit base to be the crown jewel of the franchise, built slowly over 125 years of our history in the islands, one relationship at a time. As most of you know, Hawaii is maybe the most unique deposit market in the country, where five locally headquartered banks hold 97% of the state's FDIC-reported deposits. As I mentioned, we have an amazing tenure in our deposit relationships, with 53% of our deposits having a tenure of 20 years or more, and 75% of our deposits having a tenure of 10 years or more. Despite the volatility created by the regional bank crisis in the first quarter of 2023, both average and spot balances have been steady and growing throughout the year. Further, non-interest bearing deposits have begun to stabilize, with average non-interest bearing deposits in December flat to November's month average. For the year, you can see Bank of Hawaii meaningfully outperformed banks nationally in deposit growth as shown in the 8-K data. I'd note too that we generated that performance without the usage of broker deposits. Deposit pricing relative to broader industry averages remains a strong story in terms of cost of interest-bearing deposits and total cost of funds, betas appear to be flattening. Additional sources of liquidity remain abundant. Now let me switch over to the marketplace. The Hawaiian economy, from a jobs perspective certainly, continues to outperform the broader market. And UHERO, our research entity at the University of Hawaii, forecasts continued stability. The visitor market continues to be impacted by the tragic Lahaina fires. Visitor spending and visitor days were down modestly in November compared to 2022 but up modestly excluding the Maui fire figures. The Japan market, which, as you know, has been slow to recover, is up 119% year-on-year, but it's still down 50% from pre-pandemic levels. We're seeing improvements in the Japan market. And actually, I think that represents some upside for us down later on into the year and into next year. As you can see from the chart here, hotels continue to perform well with RevPAR up steadily. Residential real estate on Oahu is stable, with median prices for single-family homes down 5% from a year ago in December. Condominiums, however, are up 1.5% on median. Inventory levels remain extremely tight, with average days on market of 18 days and 26 days for single-family homes and condos, respectively. Month supply inventory of 2.8 months and 3.2 months for single-family homes and condos, respectively. Now let me turn the call over to Mary Sellers. But before I do, let me congratulate Mary on her upcoming, much-deserved retirement this March 31st. Mary, I think as many of you on the call know, has been an outstanding member of our team, with the company, with BOH for 37 years, 18 of those years as our Chief Risk Officer. Mary, you've been truly amazing and I'd also like to welcome Brad. Brad joined us this past May—it seems like an indiscernible year at this point—but he's doing a terrific job and he'll be stepping into Mary's role shortly. Truly excited to have Brad on board. He brings with him a wealth of experience from places like Regions Bank, Union Bank, and MUFG, among other banks. So Brad, would you like to say a few words?

Brad Shairson, Vice Chair and Deputy Risk Officer

Yes. Thanks, Peter. I would like to just take a moment to say that I feel fortunate to have had the opportunity to work for Mary for the past several months through our planned transition. I can see the incredible legacy that she'll be leaving behind. I also feel fortunate that under her leadership she will also be leaving behind a portfolio with such strong asset quality. I plan to do my best to continue in her footsteps and maintain that same disciplined approach to managing risk. All of that said, let's turn this back to Mary so she can do this one last time.

Mary Sellers, Chief Risk Officer

Thank you, Brad, and Peter, for your kind remarks. First, I must say, though, that credit for our strong and consistently strong credit quality goes to the entire team, particularly our line management, our relationship managers, and our credit team, as well as probably most importantly to our customers. Brad, I've enjoyed working with you during the transition. You've been a terrific partner. I'm pleased to leave it in your capable hands and I'm sure you'll do a terrific job. Now onto the usual stuff. First, Bank of Hawaii's lending philosophy is grounded in two fundamental tenants. We lend to long-standing relationships that we understand in our core markets of Hawaii and the West Pacific. We combine this with ongoing disciplined portfolio management, actively exiting those products or segments that have proven to be higher risk. This positions our portfolio for continued lower net charge-offs through different economic cycles. The loan portfolio is built on long-tenured relationships diversified by asset categories, with 59% consumer and 41% commercial, has appropriately sized exposures, and is 79% secured with real estate with a combined weighted average loan to value of 54%. Our commercial real estate portfolios, which represent 27% of the total loan portfolio, are diversified across various asset types. The portfolio, built on relationships with demonstrated experience and financial capacity, is conservatively leveraged with a weighted average loan to value of 55%. 23% of the portfolio is in the downtown Honolulu Central Business District. This segment has a weighted average loan to value of 60% and 43% of the exposure is further supported by repayment guarantees. 4% of the loans in the office segment are maturing through 2025. While not immune from the changing dynamics impacting the office market across the U.S., vacancy and rent have remained relatively resilient in the office market on Oahu, as conversions to alternative use continue to reduce overall inventory levels. In the last five years alone, approximately 1 million square feet of inventory have been removed and it's estimated an additional 300,000 square feet will be removed in the next several years. Hawaii's supply constraints, driven off its unique geography and onerous regulatory process, serve to create relative stability in our real estate markets over the long term and less volatility during periods of stress. This is particularly pronounced in the housing sector, where severely limited supply is compounded by the high cost of home ownership. These two factors together continue to drive consistent, strong rental demand. Tight market conditions continue to persist in the Oahu industrial market, with vacancy rates at historic lows, sub 1%. Supply constraints continue to also be an issue in this segment. Oahu's real estate market, whether it's supply chain disruptions, manufacturing shutdowns, backlog sea ports, or inflation, with vacancy and rents returning to pre-pandemic levels. Grocery and drug-anchored continue to outperform. Again, relatively flat inventory levels help to support stability in this segment over time. Despite the delay in the return of the Japanese tourist pre-pandemic levels, flat inventory levels helped to support occupancy and RevPAR levels in Oahu's lodging segment. The Hawaiian Islands remain a top five destination in terms of highest revenue per average room and average daily rate, with Oahu attracting more visitors than any other island in the state. In addition to the continued strength in our market's real estate fundamentals, we have just 8% of our commercial mortgage loans maturing in 2024, minimizing repricing risk in the portfolio. Tail risk in the commercial real estate portfolio remains modest, with just 0.4% having an LTV greater than 80%. Our construction portfolio represents 2% of total loans, with the majority being in low income or affordable housing, which continues to be chronically undersupplied in our markets. Asset quality remains strong in the fourth quarter. Net loan and lease charge-offs were $1.7 million or 5 basis points annualized of total average loan and lease outstandings, down $300,000 or 1 basis point from the linked quarter, and down $100,000 year-over-year. For the full year, net loan and lease charge-offs were $7.8 million or 6 basis points compared with $5.1 million or 4 basis points in 2022. Non-performing assets were $11.7 million or 8 basis points, stable from the third quarter and down $900,000 or 1 basis point year-over-year. All non-performing assets are secured with real estate with a weighted average loan to value of 56%. Loans delinquent 30 days or more increased modestly and remain low at 31 basis points at the end of the quarter. Criticized loans as a percentage of total loans were 1.93% at the end of the quarter, down 8 basis points from the linked quarter as we continue to see improved financial performance in a number of credits that had been slower to recover from the ancillary impacts of COVID. The allowance for credit losses on loans and leases was $146.4 million, up $1.1 million for the linked period and up $2 million year-over-year. The ratio of the allowance for credit losses to total loans and lease outstandings was 1.05% at the end of the quarter, up 1 basis point from the prior quarter and down 1 basis point year-over-year.

Dean Shigemura, CFO

Thank you, Mary. And congratulations on your upcoming retirement. To better balance our interest rate sensitivity profile, in the fourth quarter we added an additional $1 billion of notional pay-fixed received float interest rate swaps for a total of $3 billion notional. In addition, we continued to originate a greater proportion of floating and adjustable rate loans that hold more Fed funds sold. These actions have increased our floating rate assets exposure to 45% from 27% at the end of 2022 and positioned us well for this uncertain rate environment. Net interest income was $115.8 million in the fourth quarter, a decrease of $5.1 million linked quarter. As the regional bank crisis unfolded, we fortified our balance sheet in the second quarter by adding liquidity. As uncertainty decreased and our core deposits remained strong, we reduced the on-balance sheet liquidity in the third quarter by reducing wholesale and non-core funding by $2.2 billion. These actions reduced our balance sheet leverage and improved our capital position, but did reduce our earning asset base by $904 million on average in the fourth quarter. Net interest margin was stable linked quarter as asset repricing offset higher deposit costs. We continued to exercise deposit pricing discipline, while growing total balances, as evidenced by our deposit beta continuing to outperform that of peer banks. As of December 2023, our cumulative total deposit beta was 31.6%. We believe that our deposit betas have peaked in the fourth quarter as our deposit rates began to flatten and non-interest bearing deposits have stabilized at 27% to 28% of total deposits. In addition, lower cost and more granular consumer deposits increased on average by $129 million linked quarter. We expect this trend to continue into 2024. Our assets continue to reprice higher, supporting net interest income and margin growth. Annual maturities and paydowns of loan and deposit portfolios of $3 billion continue to provide an ongoing supplement to the $7.2 billion in assets, which includes our interest rate swap portfolio that reprices annually. The yield on maturities and paydowns of loans and investments in the fourth quarter was approximately 4.6% and 2.1%, respectively. These cash flows continue to be reinvested predominantly into new loans, which are yielding greater than 7.5% on average or held in cash at the Fed which earns an attractive yield and preserves liquidity. As a result of these cash flows repricing our assets higher, our overall asset yields have steadily increased and are expected to continue to increase as new asset yields are well in excess of the runoff yield. As a result of continued asset repricing, together with the peaking of our deposit beta, the margin is expected to increase by 2 basis points to 4 basis points in the first quarter of 2024. Non-interest income totaled $42.3 million in the fourth quarter, an increase of $1.3 million over the normalized third quarter results. Recall that the third quarter results included $14.7 million of gains from the termination of private repurchase agreements, partially offset by a net loss of $4.6 million from the sale of $159 million of AFS securities and an $800,000 charge related to a change in the Visa Class B conversion ratio. Market conditions improved in the quarter and transaction volumes were steady. As these conditions persist into 2024, we expect core noninterest income to be at similar levels as the fourth quarter in the first half of the year and continue to trend higher in the second half. During the fourth quarter, as is our practice, we managed our expenses in a disciplined manner as inflationary conditions continued. Expenses in the fourth quarter were $116 million, which included an industry-wide FDIC special assessment that resulted in a $14.7 million charge. In addition, in the fourth quarter, expense savings of $1.7 million were realized which are not expected to recur in 2024. Thus, the adjusted core expense level in the fourth quarter was $102.9 million. Third quarter expenses included severance expenses of $2.1 million and $400,000 of extraordinary expenses related to the Maui wildfires. Adjusting for these items, expenses in the third quarter was $103.1 million. Thus, core expenses linked quarter were modestly lower despite continued inflationary pressures. Expenses in 2024 are expected to be 2% to 2.5% higher than 2023 normalized expenses of $419 million. As a reminder, the first quarter's results will include seasonal expenses related to payroll taxes and benefits from incentive payouts, currently estimated at $3.5 million versus $3.7 million in the first quarter of 2023. To summarize the remainder of our financial performance, in the fourth quarter of 2023, net income was $30.4 million, and earnings per common share was $0.72, a decrease of $17.5 million and $0.45 per share, respectively. Our fourth results included the industry-wide FDIC special assessment which reduced EPS by $0.29 per common share. Our return on common equity was 9.55%. We recorded a provision for credit losses of $2.5 million this quarter. The effective tax rate in the fourth quarter was 23.25% and 24.62% for the full year. The tax rate for 2024 is expected to be approximately 24.5%. We continue to organically grow our capital from prior quarters, and we continue to maintain healthy excesses above the regulatory minimum well-capitalized requirements. Our risk-weighted assets to total assets ratio is well below peer median, reflecting the low-risk nature of our asset mix. During the fourth quarter, we paid out $28 million to common shareholders in dividends and $2 million in preferred stock dividends. We did not repurchase shares of common stock during the quarter under our share repurchase program. And finally, our board declared a dividend of $0.70 per common share for the first quarter of 2024. Now I'll turn the call back over to Peter.

Peter Ho, CEO

Thanks, Dean. That concludes our prepared remarks. We'll be happy to take your questions.

Operator, Operator

Thank you. The first question comes from Jeff Rulis with D.A. Davidson. Your line is now open.

Jeffrey Rulis, Analyst

Thanks. Good morning. Peter, I think you mentioned the increase – well, the non-interest-bearing deposits at spot quarter-end up, up considerably. I think you mentioned, pretty flat November to December. I just want to kind of get a sense for, was that still need to, like Maui fire-related, insurance payouts or anything that kind of came in early part of the quarter that led to that increase in noninterest-bearing?

Peter Ho, CEO

Yeah, Jeff, the quarter-end spot, as you know, December oftentimes is kind of a funny quarter-end because it is a year-end. And we saw probably, I want to say, $300 million to $400 million of stuff just kind of pop in and out. Some of that was in noninterest bearing, which is in part why you saw that jump up. Kind of the better number to look on just to understand the spot, I think, is the average NIBD for the quarter was just about $5.7 billion and that compares to $5.8 billion for the third quarter. So a real flattening there. And I would anticipate, Jeff, at least our early insight into this quarter, that number feels to be pretty stable.

Jeffrey Rulis, Analyst

Okay. So if I look at that average balance and you would not anticipate then some outflows of, again, kind of Maui-related. Was there any temporary in that? Or do you think the average is kind of balanced that out and from here it's…

Peter Ho, CEO

Yes, we're hopeful that we can maintain that average NIBD balance of called $5.7 billion. Overall balances, I think we're running about $20.6 right now. If we came through the quarter $20.6 billion, that would have surprised me on average balances. And yes, you're right, we do have—there's probably $200 million to $300 million of Maui-related aid that's kind of flowing in and out of our balance sheet. And so, a little unpredictable, some of it in the NIB, most of it earning some quarterly yield though, thankfully for them.

Jeffrey Rulis, Analyst

Got it. Okay. Dean, could you clarify if the cost of that hedge impacts the margin by a few basis points in terms of what was added in the quarter? Was that significant?

Dean Shigemura, CFO

It was accretive in terms of net interest income of about $5 million, so it did help us, but it does kind of neutralize or hedge our exposure at the short end.

Jeffrey Rulis, Analyst

Okay. So it was a short-term benefit and also balances out going forward. I guess the bigger question then, kind of you've mentioned the first quarter expectations. Could you just frame up, Dean, should we see the second half of a cut or two or maybe kind of range bound if it's more than that, how you think margin generally trends all things being equal?

Dean Shigemura, CFO

Yes, all things equal, we expect the margin from short-term changes in rates, we expect to be neutral. But what we're expecting is the asset side to grow—to increase from the just the asset repricing that we have, the cash flow coming off and be invested at much higher yields.

Andrew Liesch, Analyst

Thanks. Hi, everyone. Dean, just a clarification question on the swaps here. Do you have what the pay and receive rates are right now?

Dean Shigemura, CFO

We haven't disclosed it, and the average tenor is approximately 2.5 years. And just to clarify on the previous question, the $5 million is based on the $3 billion of total—the total interest income from the $3 billion.

Peter Ho, CEO

The incremental in the quarter was $1 billion, right?

Dean Shigemura, CFO

Of swaps, yes.

Andrew Liesch, Analyst

Got it. All right. And then to start—also clarification on the margin commentary with the Fed's cutting rates gradually should be pretty neutral to the margin, was that correct?

Dean Shigemura, CFO

Yes.

Andrew Liesch, Analyst

Okay. And then just on the expense guide. Is that really just inflationary pressures pushing it higher, or is there anything else in the operating cost that we should be aware of as we look into 2024 as far as their own projects or other alternative cost-saving opportunities?

Dean Shigemura, CFO

It's generally going to be inflationary pressures. There are some projects that are coming online, but generally it's going to be merit increases and the like for that, for the increase. Of course, we're continuing to look for opportunities to reduce the expenses as has always been our practice.

Peter Ho, CEO

Andrew, let me ask you, on your question on margin, I just want to understand the context of the question. Was it, as the Fed or if and as the Fed reduces short rates, what will the impact be on our NIM? Is that the question?

Andrew Liesch, Analyst

Yes. I think it's pretty clear that flat or no change in the rate environment with the repricing, we have a few basis points of expansion. But if the Fed starts to lower the short end, what does that mean to the margin? Is there enough repricing differential on what's maturing and being reinvested to offset maybe any of the adjustable available rate product?

Peter Ho, CEO

Yes. I mean, the way I think about it, and Dean you can clean up whatever I say here, is that kind of higher for longer would work, it would be, okay, it would kind of leave our margins stable up modestly. Fed cutting rates, let's just call it conservatively, over time would obviously hurt the floating portion of our earning assets. But then over time results in lower funding costs. So we think—kind of the upshot of that over a reasonably short period of time, adjustment period, is that we've seen an improvement in our NIM.

Andrew Liesch, Analyst

Yeah. Got it. All right. That makes sense. Very helpful. Thanks for taking the questions.

Operator, Operator

Please stand by for the next question. The next question comes from Andrew Liesch with Piper Sandler. Your line is now open.

Kelly Motta, Analyst

Hi, thanks so much for the question. I hate to beat a dead horse here with the margin, but I just want to make sure I'm understanding what you both are saying correctly. It seems like it's clear, higher for longer, you'll continue to level up on margin. It seems like with some moderate cuts, am I understanding correctly, Dean, you still think it'll continue to go up initially, or could we at least in the first quarter or two see some compression as that variable rate portion at now about 45% resets lower immediately to that change in rates? Just trying to square away both of your comments there.

Dean Shigemura, CFO

Yes, and the way we look at it is, I've separated out the floating rate assets from what is repricing in the cash flow. So the asset repricing from cash flows is going to continue to increase our margin. The floating rate assets offsetting the decrease in what we—on the liability side, the deposit side, we would be bringing down our deposits as well and the rates. So those two would move lower with an opportunity to reduce that further.

Peter Ho, CEO

Yes. But you're right, there is a timing issue, right. Because as soon as the Fed drops rates, that will contractually drop margins—certain margins on our earning assets, and it will take us a period of time to bring down those rates within our deposit book. So there could be that intermediary period, Kelly, but we do think that over reasonable short order, we should be able to kind of get margin expansion out of lower interest rates.

Kelly Motta, Analyst

Got it. And I appreciate the commentary that the average tenor of the swaps is 2.5 years. Can you help me understand how that impacts that AOCI accretion back to capital? I think that may have muted some of the benefit to tangible book value this quarter. It's the right way to think about it—we'll start seeing a greater portion of that come back, provide rates move lower after that 2.5 year average tenor is up, just trying to better understand kind of the cadence of how that will impact that back of AOCI.

Dean Shigemura, CFO

So the swaps, about $1.3 billion of swaps are hedging the AFS portfolio, so not the entire $3 billion. And so, when—it's approximately about 30% of a hedge, so it does mitigate the movement up or down and then over time as you recognize that will reduce, the 30% will fall over time if we did nothing. Now it is going to be a more active program, but 30% right now is the hedge.

Kelly Motta, Analyst

Okay. Got it. Maybe switching to the balance sheet and loan growth. Just wondering, if you look out to the next year, how we should be thinking about your expectations for loan growth on the island, as well as what we could potentially see coming out of Maui, both with—how that potentially impacts the tourism impact, as well as just the rebuild there and how that fits into that loan growth expectation?

Peter Ho, CEO

Well, let's talk about Maui first. I think most of the funding coming into Maui right now and activity is around relief efforts today. The rebuild of Maui is still a long way off, Kelly. So probably—it's probably just not even constructive to hypothesize what economic impact that might have at this time, but from a visitor perspective, the state is performing well. Maui is coming back a lot faster than people had anticipated. At least that's the kind of anecdotal that I get from that part of the state. So I don't think that there's going to be too much of a shortfall activity-wise coming out of any form of tourism shortfall generated by the wildfires over the next several months. And then just in terms of the ability for the long-term stimulus impact of the rebuild of Lahaina to kick in, I think that's still a ways off because we just don't—we don't even really have a design yet on what all that project potentially could or would look like. So again, probably just too early to determine.

Kelly Motta, Analyst

Got it. Thanks for the color. And then I guess excluding Maui, how should we be thinking about the outlook for growth next year.

Peter Ho, CEO

Yes, we think that loan growth, similar to last quarter's view, is going to be reasonably tepid. I mean, unless the Fed just gets really aggressive with rate cuts, which we're not anticipating. I think that the consumer is still going to be impacted somewhat by what they perceive to be higher rates. Interestingly, mortgage rates in the low sixes don't seem to be too terribly outside of historical norm if you go back years and years, but still I think that's having a negative impact on demand on the consumer front. We did have a reasonably good C&I quarter, so there is activity in the marketplace. Construction had a reasonable quarter as well, though that's a small portfolio with a lot of our low-income housing projects. But we're really kind of the big driver of our commercial portfolios, commercial real estate. And people there are—the market's doing fine, but transactionally, I think people are just kind of sitting on their hands for now and waiting to see which way interest rates take out, which way the recession or the economy shakes out—recession or expansion or just kind of soft landing. So I wouldn't anticipate a whole lot of activity before—until maybe the backend of this year.

Kelly Motta, Analyst

Got it. I appreciate all the color. I'll step back. Thanks again.

Operator, Operator

That concludes the question-and-answer session. At this time, I would now like to turn the call back to Cindy Wyrick for closing remarks.

Cindy Wyrick, Director of Investor Relations

Thank you again, everyone, for joining us today and for your continued interest in Bank of Hawaii. As always, please feel free to reach out to either Chang or to me if you have any additional questions or need further clarification on any other topics discussed today. Thanks again, everyone, and have a great day.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.