Earnings Call Transcript - BOH Q4 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to Bank of Hawaii Corporation Fourth Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Chang Park, Director of Investor Relations. Please go ahead.

Chang Park, Director of Investor Relations

Good morning, and good afternoon. Thank you for joining us today for our fourth quarter 2024 earnings conference call. Joining me today is our Chairman and CEO, Peter Ho; President and Chief Banking Officer, Jim Polk; CFO, Dean Shigemura; Chief Risk Officer, Brad Shairson; and our Deputy CFO, Brad Satenberg. Before we get started, let me remind you that today's conference call will contain some forward-looking statements. And while we believe our assumptions are reasonable, there are a variety of reasons that actual results may differ materially from those projected. During the call today, we will be referencing our 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'll turn the call over to Peter.

Peter Ho, CEO

Thanks, Chang. Good morning and good afternoon, everyone. Thanks for joining the call. Bank of Hawaii posted yet another solid quarter to end 2024. Net interest income and net interest margin both improved, this for the third consecutive quarter. Net interest income grew just over 2% on a linked basis to $120.2 million. Non-interest income, excluding an adjustment to our Visa Class B shares was up modestly on a linked basis. Expenses were controlled quarter-over-quarter. Average deposits and average loans grew 1.3% and 1.1% on a linked basis to $20.8 billion and $14 billion, respectively. Average non-interest bearing deposits were up modestly in the quarter. Credit quality remained pristine in the quarter with net charge-offs and NPAs improving to 9 basis points and 14 basis points, respectively. Criticized loans improved from 2.42% last quarter to 2.1% this quarter. Capital levels have improved substantially from a year ago. I'll now take a moment to discuss the franchise and market conditions. Brad will then briefly touch on credit conditions, which, as I mentioned, look quite strong. And finally, Dean will dig a little deeper into the financials and then we'd be happy to take your questions. The Bank of Hawaii brand continues to perform well in our unique Hawaii market, holding the number one position in market share as shown in the latest FDIC annual summary of deposits as of June 2024. Bank of Hawaii leads in the deposit market share growth on both a short-term and long-term basis. Deposit growth remained measured in the quarter. Importantly, non-interest bearing demand plus other low-yield deposits stabilized nicely, trending positively in December on a rolling three-month average basis for the first time since June of 2022. Deposit funding costs fell for the first time this rate cycle on both an interest-bearing and total deposit cost basis. Economic conditions remain stable in Hawaii. Unemployment remains well below the national average. The visitor market remains stable, but continues to be impacted somewhat by the Maui market. Residential Oahu real estate trends remain positive. Now let me turn the call over to Brad.

Bradley Shairson, Chief Risk Officer

Thanks, Peter. So the Bank of Hawaii prioritizes serving our community, lending in our core markets where our expertise enables us to make sound credit decisions. The majority of our loan book is to long-standing relationships with about 60% of our clients on both the commercial and consumer sides, having been with us for over 10 years. This combination has greatly contributed to our strong credit performance for many years and has resulted in a loan portfolio that is 93% Hawaii, 4% Western Pacific and 3% Mainland where we support our clients that do business in both Hawaii and on the Mainland. As I walk through our credit portfolio's fourth quarter performance, you can see that it has remained strong and is consistent with prior quarters. Our loan book is balanced between consumer and commercial with consumer representing a little over half of total loans at 56% or $8 billion. We lend predominantly on a secured basis against real estate. 85% of our consumer portfolio is either residential mortgage or home equity with a weighted average LTV of just 48% and a combined weighted average FICO score of 800. The remaining 15% of consumer consists of auto and personal loans where our average FICO scores are 733 and 760, respectively. Moving on to commercial, our portfolio size is $6.1 billion or 44% of total loans. The largest share of commercial is commercial real estate with $4 billion in assets, which equates to 29% of total loans. This book is well-diversified across industries and carries a weighted average LTV of only 55%. Looking at the dynamics for Hawaiian real estate in Oahu, the largest market, you will see that a combination of consistent vacancy rates and little change in inventory supports a stable real estate market. Within the different segments, vacancy rates for industrial, retail and multifamily are all lower than their 10-year average and office is less than 1% above its 10-year average. Total office space has decreased about 10% over the past 10 years, driven by conversions. This long-term trend of office space reduction will likely continue to temper vacancy rates. Breaking down our CRE portfolio, it is well diversified amongst property types with no sector being greater than 7% of total loans. Our conservative underwriting has been applied consistently with all weighted average LTVs between 50% and 60%. Overall, it's a diverse portfolio with low average loan sizes. And our scheduled maturities spread well into the future with more than half of our loans maturing in 2030 or later. Looking at the distribution of LTVs, the tail risk in our CRE portfolio for any loans with greater than 80% LTV totals only 2% of CRE with only 0.2% over 85% LTV. Turning to our credit metrics. This past quarter compared to linked quarter, metrics remain quite stable and asset quality remains strong. Net charge-offs were $3.4 million at 10 basis points annualized, down 1 basis point from Q3 and up 5 basis points from a year ago. Non-performing assets are flat at 14 basis points quarter-over-quarter. Delinquencies have also been stable, ticking up 3 basis points to 34 basis points this quarter. Criticized assets dropped to 2.1% of total loans with 76% being real estate secured with a 56% LTV. On last quarter's earnings call, I noted that we had received a payoff after quarter end that had lowered our criticized ratio to 2.19% from quarter end of 2.42%. Criticized assets levels dropped an additional 9 basis points since then. As an update on the allowance for credit losses on loans and leases, the ACL ended the quarter at $148.5 million, that's up $1.2 million for the linked period and up $2.1 million year-over-year. The ratio of our ACL to outstandings was 1.06%, unchanged from prior quarter and up 1 basis point year-over-year. I will now turn this over to Dean for an update on our financials.

Dean Shigemura, CFO

Thanks, Brad. We expanded our net interest income and net interest margin for the third consecutive quarter. Net interest income for the fourth quarter was $120.2 million, an increase of $2.6 million or 2.2% from the previous quarter and net interest margin expanded to 2.19%. During the quarter, our NIM initially decreased in October, primarily due to the negative short-term impact of the 50 basis-point Fed funds rate cut in September. Also negatively impacting the margin were higher cost commercial and public deposits that were carried over from the third quarter and ran off in October and November. NIM improved to 2.26% by December, driven by repricing of asset cash flows, a decrease in average cost of total deposits to 1.67% and slowing of our non-interest bearing and low-cost deposit remix. With regard to cash-flow repricing, in the fourth quarter, our earning assets with fixed rates generated $518 million of cash flows from maturities and prepayments. Assuming that all of these cash flows from loans were reinvested into like products and cash flows from securities were reinvested into cash, such reinvestment generated incremental net interest income of approximately $2.8 million in the quarter from higher reinvestment yields. Spreads on new loans improved after bottoming in October as mid and longer-term interest rates increased. We expect the wider loan spreads to continue into the first quarter. At the same time, the deposit mix-shift has continued to slow with average non-interest bearing and low-yield interest bearing deposit balances declining by $105 million linked quarter. This compares to the decline of $627 million and $315 million in the same period of 2023 and linked quarter, respectively. Assuming the majority of these balances shifted into higher yielding interest bearing deposits, such mix shifts negatively impacted net interest income by $900,000 in the fourth quarter, down from the negative $2.6 million impact in the third quarter. The cumulative impact of fixed-rate asset cash-flow repricing over 2024 has added nearly $16 million to quarterly net interest income as of the fourth quarter of 2024, while the cumulative cost of deposit remix over the same-period has decreased quarterly net interest income by $10 million, but at a slowing pace. The income spread between asset and deposit repricing are expected to continue to compound over the next several years, thus widening the cumulative impact and incrementally growing net interest income and margin. Total deposit costs decreased by 10 basis points linked quarter. When measuring the deposit cost from the start of the Fed funds cuts in September, deposit rates had fallen by 24 basis points by the end-of-the quarter, and further reductions are expected in the first quarter as the full impact of the fourth quarter Fed funds rate reductions are realized. We have reduced deposit rates across all interest-bearing products and are well-positioned to reprice our time deposits and improve our margin as 71% of total time deposits are scheduled to mature in the next six months and 95% of total time deposits are scheduled to mature in the next 12 months. We continue to strategically position our balance sheet for a range of rate outcomes. We have reduced our rate-sensitive assets to $7 billion, while our rate-sensitive interest bearing deposits remain at $10 billion. We intend to continue to closely manage the interest rate sensitivity of our balance sheet to ensure that we are well positioned for a variety of rate environments. In the fourth quarter, we actively managed our interest rate swaps and securities portfolio to take advantage of opportunities as interest rates shifted. This included repositioning our swap portfolio by terminating $1 billion notional shorter maturity swaps with relatively higher fixed rates and executing $200 million notional starting swaps at lower rates. The repositioning reduced our active pay fixed received flow interest rate swaps by $800 million to $2 billion notional and reduced the fixed rate from 4.29% to 4.03%. We also maintained the $300 million of forward-starting pay fixed received flow interest rate swaps that were executed in the third quarter. These forward-starting swaps have an average fixed rate of 3.03% that will become active in 2025 and 2026. During the quarter, we purchased an additional $233 million of floating rate securities that have a positive 98 basis point spread to Fed funds, improving our interest income and margin. Our fixed rate asset exposure is 57% at the end of the quarter, down from 73% at the end of 2022. Net interest income and margin are expected to continue to increase as a result of the balance sheet actions together with the continued asset cash-flow repricing, slowing deposit remix and benefits from lower Fed funds rates. Non-interest income totaled $43 million in the fourth quarter, which included a previously disclosed $2.4 million of a one-time charge related to the Visa Class B conversion ratio change. Adjusting for this charge, fourth quarter non-interest income was $45.4 million, an increase of $300,000 linked quarter as revenue from trust services, customer derivatives and deposit service charges improved. In 2025, non-interest income is expected to be $44 million to $45 million in the first quarter and increased over the year as revenues from Trust services, merchant services and other transaction volume continued to steadily improve. Expenses were $107.9 million in the fourth quarter. This compares to expenses of $107.1 million in the third quarter. The increase was primarily due to higher medical costs that are not expected to repeat. For the full year of 2024, expenses were well managed. Normalized expenses were $426 million after adjusting for one-time extraordinary expenses of $3.1 million, an increase of just 1.7% from 2023 normalized expenses. Expenses will continue to be a focus in 2025 with core expenses projected to increase 1% to 2% from 2024. In addition, we've allocated an additional 1% of expenses to invest in revenue enhancing initiatives. Thus the total expenses are expected to increase 2% to 3% from 2024. As a reminder, the first quarter's expenses will include the seasonal bump in benefits and payroll taxes from the payment of incentives, currently estimated at $2.5 million. To summarize the remainder of our financial performance, in the fourth quarter, net income was $39.2 million and earnings per common share was $0.85. Our return on common equity was 10.3%. Adjusting for the previously mentioned Visa conversion ratio change, earnings per common share was $0.90 and return on common equity was 10.9%. We recorded a provision for credit losses of $3.8 million this quarter. The effective tax rate for the fourth quarter was 24% and the tax rate on the full-year of 2024 was 24.19%. The effective tax rate in 2025 is expected to be approximately 24%. We continue to maintain healthy excesses above regulatory minimum well capitalized requirements. Our Tier-1 capital ratio was 13.95% and total capital ratio was 15%. Our risk-weighted assets to total assets ratio continued to be 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 $5.3 million in preferred stock dividends. As a reminder, the dividends paid on the Series B preferred shares in the fourth quarter was a full quarter's distribution, an increase of $1.8 million from the third quarter's partial quarter amount. 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 2025.

Peter Ho, CEO

Thanks, Dean. This concludes our prepared remarks. Now we'd be happy to entertain whatever questions you might have.

Operator, Operator

Thank you. Our first question comes from the line of Jeff Rulis from D.A. Davidson.

Jeff Rulis, Analyst

Thanks. Good morning.

Peter Ho, CEO

Good morning, Jeff.

Jeff Rulis, Analyst

Dean, could you provide some insight on the margin? I understand that the 2.26% for December is a decent starting point. From there, can you clarify if there are any one-time factors, or is that a solid rate that we can adjust based on the positive influences you mentioned that carry into this year?

Dean Shigemura, CFO

Yes. The fourth December margin of 2.26% was a clean number. As you mentioned, it serves as a solid starting point for the first quarter. In addition, we will see asset repricing continue, along with some benefits from the last repricing due to our Fed funds cut affecting our deposits.

Jeff Rulis, Analyst

Right. It sounded as if you're active in some deposit rate lowering that so far this year as well.

Dean Shigemura, CFO

Yes, yes.

Jeff Rulis, Analyst

Thank you. I wanted to check in on the loan growth pipeline. Peter, I would appreciate an update on that, as well as your thoughts on any potential impact from recent mergers and acquisitions on the island and the ASB sale. It may be too early to tell, but if you could incorporate that into the pipeline discussion, it would be helpful. There may be no impact at all as well.

Peter Ho, CEO

We experienced reasonable loan growth this quarter, mainly driven by commercial lending, while consumer lending has been relatively stable. I anticipate this trend will continue unless we see some relief on rates, which could potentially elevate levels. The positive aspect is that our commercial portfolio remains robust, so we wouldn't be surprised to see similar performance in the upcoming quarter as we did in the fourth quarter. Regarding the competitive landscape, we haven't observed any significant changes, so it's probably too early to draw any conclusions. Additionally, we do not expect much change in the near future.

Jeff Rulis, Analyst

Okay. Thanks, Peter. I'll step back.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from the line of Jared Shaw from Barclays. Please go ahead.

Jared Shaw, Analyst

Hey, good morning, everybody.

Peter Ho, CEO

Hey, Jared.

Jared Shaw, Analyst

I guess a few things. Maybe when you look at the movement on the hedges this quarter, are you still targeting sort of a 60% fixed-rate mix in that fixed to float or is that coming down with these moves?

Peter Ho, CEO

No, I think where we ended the quarter at about 57% is where we're at least in the near-term looking to remain. Obviously, if rates do shift quite significantly, we could change it. But right now, it is 57%.

Jared Shaw, Analyst

Okay. So that's a good level then you keep going.

Peter Ho, CEO

Yes.

Jared Shaw, Analyst

Looking at the office portfolio, 36% of it will be due next year. What discussions have you had with those borrowers? What's the expectation for renewals? Are you seeing an increase in equity contributions? What is the outlook?

Peter Ho, CEO

So I'll just really quickly say that we're not seeing any issue with any of those renewals. So at this point, everything looks really good and strong on office. And really just, I guess to speak about credit in general, as you can tell, it was kind of a boring quarter, which I guess is a good thing. But we're really seeing just good stability overall, both on commercial and consumer and that includes our CRE portfolio and of course, which then includes office space. So no real issues there.

Dean Shigemura, CFO

And I think the maturity is by my recollection, I think it's 39% by 2027. So it's not quite as concentrated as what you wanted there, Jared. But still, I mean, we do have some payoffs coming up in the next couple of years. And as Brad mentioned, we're feeling pretty good about that.

Jared Shaw, Analyst

Okay. All right. Thanks. And then just I guess finally for me, looking at capital continues to be very robust on the regulatory side. What would have to happen, I guess, for you to be more active with the buyback here.

Peter Ho, CEO

We have a clearer understanding of credit, the economy, and interest rates. I'm quite pleased with the capital build over the past year, which aligns well with the current environment. However, I should mention that we see significant opportunities for increased variability across these factors. As long as this trend continues, we are likely to postpone any buybacks for the foreseeable future.

Bradley Shairson, Chief Risk Officer

If we don't see any changes in the credit economy or interest rates, then capital ratios are likely to continue to build through 2025.

Dean Shigemura, CFO

Yes, through retained earnings is probably accurate less dividends.

Jared Shaw, Analyst

Okay. Great. That was what I had. Thank you.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from the line of Andrew Liesch from Piper Sandler Company.

Andrew Liesch, Analyst

Hey, good morning, everyone. Thanks for taking the questions here. Just a follow-up on the revenue enhancing initiatives that you've mentioned in the expense section, in the expense outlook. I mean, what sort of initiatives might this include?

Peter Ho, CEO

I don't want to get into the specifics, but it is directed at our commercial and wealth areas, but definitely accretive to the earnings stream this year and then into next.

Andrew Liesch, Analyst

Got it. Is it like software upgrades just to make them more efficient and then enhance revenue that way, just kind of?

Peter Ho, CEO

Let me address that. We've been focusing on expanding our wealth operations to match the market scale of our consumer and commercial sectors, and we've seen good progress over the last couple of years. In the fourth quarter, our trust and broker sales revenues increased by just over 9% compared to the previous year, which is encouraging. As Dean mentioned, we have some interesting plans for 2025 that should further improve our performance, although I can't share specific details at this time. We're excited about the potential in this area.

Andrew Liesch, Analyst

Got it. You've covered all my other questions. I'll step back. Thanks.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from the line of Andrew Tyrrell from Stephens. Please go ahead.

Andrew Tyrrell, Analyst

Hey, good morning.

Peter Ho, CEO

Hi, Andrew.

Andrew Tyrrell, Analyst

If I can go back to some of the margin briefly, regarding the $2 billion of swaps that are active and remaining, can you remind us how much is allocated to the securities portfolio compared to the loan portfolio?

Dean Shigemura, CFO

In terms of the allocation, it's about $600 million against $700 million for the AFS and $1.3 billion for the loan portfolio?

Andrew Tyrrell, Analyst

Got it. Okay. And then if I go back to just some of the repricing benefits, and I appreciate all the color there. But if I just think about what you guys have experienced over the past year, call it, that $16 million of quarterly repricing. Margin wise, that's right at 30 basis points of NIM. So I guess if we're expecting that to continue, plus you should have some deposit repricing benefits carrying forward into 1Q, you're starting margins at a good level. Do you think you can exit 2025 at, call it, a 2.5% or better type margin?

Peter Ho, CEO

Andrew, it's Peter here. I think there is a potential trend, but many factors need to align for that to occur. From our perspective on Net Interest Income, we're satisfied with the variety of opportunities we've identified to enhance that figure. The turnover of our balance sheet is promising and continues to build positively. With the interest rate cuts we implemented in the latter part of last year, we're pleased with how the market has reacted and with the pricing on our own portfolio. While I’m not ready to make any definitive predictions, I believe our outlook is generally accurate. However, as I mentioned, several things must go right for this to materialize.

Andrew Tyrrell, Analyst

Yes, certainly. And I can appreciate that. On the CD portfolio, I think in the presentation, you guys called out it was close to half of the time deposits repriced or matured in the first quarter or will mature in the first quarter. It called that cost or so. What's the current offering rate for you guys right now? And what would you expect these CDs to reprice during the first-quarter?

Dean Shigemura, CFO

So the current offering is around 3…

Peter Ho, CEO

Directionally we want to come down, but obviously, you can appreciate that we're not going to get specifically into direct pricing, Andrew.

Andrew Tyrrell, Analyst

Okay, fair enough. Lastly, did you just have the medical costs in fourth quarter, the dollar amount that you guys called out in the release?

Peter Ho, CEO

$1.4 million. I'm sorry, 2.2…

Dean Shigemura, CFO

It's $1.5 million. The increase was about $1.5 million.

Andrew Tyrrell, Analyst

Okay. Thank you for taking the questions.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from the line of Kelly Motta from KBW.

Kelly Motta, Analyst

Good morning. I would like to shift back to the loan sector, as you've experienced two strong quarters of growth. Could you share what you're observing in terms of the pipelines? It seems you have a positive outlook for Net Interest Income growth into next year. How much of that outlook is influenced by potential growth in the loan sector?

James Polk, President and Chief Banking Officer

Yeah. This is Jim. I'll address the pipeline side. We began to see significant growth in the commercial pipelines around the second quarter of last year, which contributed to a strong third quarter and an especially robust fourth quarter. That was our best production quarter since 2002. Deal flow remains active, and we anticipate ongoing growth in the commercial loan space. Overall, we feel confident. Additionally, it was a really good mix of commercial and industrial and commercial real estate along with various asset classes related to core clients who have strong credit underwriting statistics. We feel positive about that and believe it will keep us on track for mid-single digit growth as we head into the next year.

Peter Ho, CEO

Yes, I would like to add that we are hopeful for ongoing loan growth that would enhance our net interest income. However, our main focus regarding net interest income is on the diversity of opportunities in that area. Loan growth would certainly contribute if we achieve it, but deposit growth, considering the recent changes in the yield curve, would be highly beneficial for us. Additionally, the turnover in our balance sheet and the reduction in federal funds create various options for us to enhance net interest income.

Kelly Motta, Analyst

Got it. That's helpful. I think you might have some FHLB maturing this year. I'm wondering how you are planning to manage that, especially if deposit growth could help pay down some of that or if you are considering taking on some new self-funding asset replacement.

Bradley Shairson, Chief Risk Officer

Yes. We don't have any maturities this year. The first maturities are in 2026.

Peter Ho, CEO

We do have the opportunity to prepay to the extent we wanted to.

Bradley Shairson, Chief Risk Officer

Right. Yes. And that's something we actively monitor because the current rates are 4.13. So it still contributes positively to net interest income. As we approach the maturity, we may consider repositioning that. However, the first maturity is in 2026.

Kelly Motta, Analyst

Got it. Thank you. I will step back. Nice quarter, guys.

Peter Ho, CEO

Thank you. End of Q&A.

Operator, Operator

Thank you. At this time, I would now like to turn the conference back over to Chang Park for closing remarks.

Chang Park, Director of Investor Relations

Thank you for joining us today. And as always, please feel free to reach out to me if you have any additional questions. Thank you.

Operator, Operator

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