Earnings Call Transcript - BOH Q2 2025

Operator, Operator

Good day, and thank you for standing by. Welcome to the Bank of Hawaii Corporation Second Quarter 2025 Earnings Conference Call. 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 second quarter 2025 earnings conference call. Joining me today is our Chairman and CEO, Peter Ho; President and Chief Banking Officer, Jim Polk; CFO, Brad Satenberg; and Chief Risk Officer, Brad Shairson. Before we get started, I want to remind you today that today's conference call will contain some forward-looking statements. And while we believe our assumptions are reasonable, the actual results may differ materially from those projected. During the call today, 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 will turn the call over to Peter.

Peter S. Ho, CEO

Thanks, Chang, and good morning or good afternoon, everyone. Thanks for your interest in Bank of Hawaii. The second quarter of 2025 was another solid quarter for the bank. Earnings per share advanced for the fourth consecutive quarter. Net interest income and net interest margin expanded for the fifth consecutive quarter as our margin reversion continues towards more historical levels. Expenses were well controlled. Credit remains pristine. Capital advanced to 14.2% on a Tier 1 basis, while ROCE at 12.5%. I'll begin by quickly reviewing our core and long-standing operating strategy and then touch on conditions in our core Hawaii market. I'll then kick it over to Brad Shairson to discuss our credit profile, and then Brad Satenberg will expand a bit on the financials, and this is his first earnings call as officially our new CFO. As I think most of you know, Bank of Hawaii has a unique business model. Fundamentally, we lean into a unique marketplace in which four locally headquartered banks hold more than 90% of the market's FDIC-reported deposits. We've built a fortress market position by leveraging a best-in-market brand position, which enables us to deposit price attractively. This cost advantage has historically allowed us to generate strong returns on a superior risk-adjusted basis. We've been successful on both a short- and long-term basis, methodically building market share. For several quarters now, we've been successful in stemming deposit remix from lower or no-yield deposits to higher-yielding deposits while holding overall deposit levels relatively stable. This has helped us bring down both our cost of interest-bearing deposits and total cost of deposits. Concurrently, our fixed assets have been remixing into higher-yielding earning assets. In the quarter, $572 million in fixed/variable assets cash flowed off at a roll-off rate of 4% and into a roll-on rate of 6.3%. It is this slowing of deposit remix matched with the continued yield accretion in the fixed asset cash flow that has largely enabled us to drive up both net interest margin and net interest income for five quarters now. Assuming rates hold, we would anticipate that this trend will continue approaching more historic NIM levels, albeit with substantially higher earning asset levels than previously. Switching to local market conditions. Here, you can see that the employment picture in Hawaii continues to outperform the broader U.S. economy. The visitor industry remains solid with visitor expenditures up 6.5% year-to-date and arrivals up 2.8% through May. This growth is being driven by the U.S. continental market, both East and West and offset partially by lower international performance out of Japan and Canada. RevPAR continues to perform consistently. Residential real estate in the islands remains stable with single-family home prices rising modestly, while condo prices were off 0.5% year-to-date. And now let me turn the call over to Brad Shairson to talk about credit.

Bradley Shairson, Chief Risk Officer

Thanks, Peter. The Bank of Hawaii is dedicated to serving our community. Lending in our core markets where our expertise allows us to make sound credit decisions. Most of our loan book is comprised of long-standing relationships, with approximately 60% of clients in both commercial and consumer having been with us for over a decade. This combination has significantly contributed to our strong credit performance over the years, resulting in a loan portfolio that is 93% Hawaii, 4% Western Pacific and just 3% Mainland, where we support our clients who conduct business both in Hawaii and on the Mainland. As I review our credit portfolio's second quarter performance, you will see that it has remained strong and consistent with recent quarters. Our loan book is balanced between consumer and commercial, with consumer representing a little over half of total loans at 56% or $7.9 billion. We predominantly lend on a secured basis against real estate. 86% of our consumer portfolio consists of 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 14% of consumer consists of auto and personal loans, where our average FICO scores are 731 and 760, respectively. Moving on to commercial. Our portfolio size is $6.1 billion or 44% of total loans. 72% is real estate secured with a weighted average LTV of only 55%. The largest segment of this book is commercial real estate with $4 billion in assets, which equates to 29% of total loans. Looking at the dynamics for real estate in Oahu, the state's largest market, a combination of consistently low vacancy rates and flat inventory levels continue to support a stable real estate market. Within the different segments, vacancy rates for industrial, office, retail, and multifamily are all below or close to their 10-year averages. Total office space has decreased about 10% over the past 10 years. This has been driven by conversions primarily to multifamily or lodging. This long-term trend of office space reduction, along with the return to office movement has brought the vacancy rate almost back to its 10-year average and well below national averages. Breaking down our CRE portfolio, it is well diversified across property types with no sector representing more than 7% of total loans. Our conservative underwriting has been consistently applied with all weighted average LTVs under 60%. Overall, it's a granular portfolio with low average loan sizes. And our scheduled maturities are fairly evenly spread out with more than half of our loans maturing in 2030 or later. Looking at the distribution of LTVs, there isn't much tail risk in our CRE portfolio. Only 1.3% of CRE loans have greater than an 80% LTV. Turning to C&I, which comprises 11% of our total loans, you will notice that the book is extremely well diversified across industries with modest average loan sizes. Additionally, only a small portion of these loans are leveraged. Turning to asset quality. Credit metrics remain stable and the portfolio continues to perform well. Net charge-offs were just $2.6 million at 7 basis points annualized, down 6 basis points from the linked quarter and 3 basis points lower than a year ago. Nonperforming assets were up 1 basis point from the linked quarter to 13 basis points and just 2 basis points higher than a year ago. Delinquencies ticked up by 3 basis points to 33 basis points this quarter and just 4 basis points higher than a year ago, and criticized loans dropped by 2 basis points to 2.06% of total loans, which is 17 basis points lower than a year ago. And the vast majority, 78% of those criticized assets are real estate secured with a weighted average LTV of 54%. As an update on the allowance for credit losses on loans and leases, the ACL ended the quarter at $148.5 million, up $800,000 from linked quarter. The ratio of our ACL to outstandings ticked up 1 basis point to 1.06%. I will now turn this over to Brad Satenberg for an update on our financials.

Bradley S. Satenberg, CFO

Thanks, Brad. Before I discuss our financial results for the quarter, I want to acknowledge my predecessor, Dean Shigemura, and express gratitude for his exceptional leadership, guidance, and significant contributions to the bank over the last 26 years. I also want to congratulate him on his well-earned retirement. Now, regarding the financials for the quarter, we recorded a net income of $47.6 million and a diluted EPS of $1.06, which is an increase of $3.7 million and $0.09 per common share compared to the previous quarter. These increases were mainly due to the continued growth of our net interest income and net interest margin, which rose by $3.9 million and 7 basis points, respectively. As Peter noted, this marks the fifth consecutive quarter of expansion in both our NII and NIM. A key factor behind this improvement is the repricing of our fixed assets, where cash flows from our fixed-rate assets are rolling off at lower interest rates and being reinvested at higher current rates. This repricing added about $3.2 million to our NII during the quarter. However, this benefit was partially offset by a shift in our deposit mix, as deposits moved from noninterest-bearing and low-yielding accounts to higher-cost deposits. The deposit mix shift has slowed in recent quarters. In the second quarter, the mix shift was $59 million, resulting in a $500,000 negative impact on our NII. This is compared to a $37 million shift in the first quarter and $448 million in the same period last year. During the quarter, the cost of our deposits remained steady at 160 basis points compared to the prior quarter, and decreased by 21 basis points compared to the same time last year. Our beta in this recent downward cycle is at 29%. Our cost of certificates of deposit declined by 15 basis points this quarter, and we still see opportunities to further lower the rates on these deposits. Over the next three months, more than 51% of our CDs will mature at an average rate of 3.61%, and we expect most of these to reprice lower. With anticipated rate cuts later this year, we feel confident about our balance sheet position and our fixed asset ratio of 55%. With $7.3 billion in floating rate assets and $10.1 billion in interest rate-sensitive liabilities, we are well-prepared to adjust to any changes in the current interest rate landscape. We are also keeping a close eye on our swap portfolio. By the end of the quarter, we had $2.2 billion in active pay fixed received flow interest rate swaps with a weighted average fixed rate of 4%. Of these, $1.5 billion are hedging our loan portfolio, while $700 million are hedging our available-for-sale securities. Additionally, we have $600 million in forward starting swaps at a weighted average fixed rate of 3.1%. $200 million of these swaps will become active later this year, and the remaining $400 million will start in mid-2026. Noninterest income increased to $44.8 million in the quarter, compared to $44.1 million in the previous quarter. The current quarter's noninterest income included a one-time gain of roughly $800,000 related to a BOLI recovery, while the previous quarter had a $600,000 charge due to a Visa B conversion ratio change. After adjusting for these nonrecurring items, noninterest income dropped by $700,000 due to decreased customer derivative activity, but was partially offset by an increase in earnings from our trust services business. We expect noninterest income to range between $44 million and $45 million for the rest of the year. Noninterest expense was $110.8 million compared to $110.5 million in the previous quarter. This quarter's noninterest expense included a severance-related charge of $1.4 million, whereas the linked quarter had seasonal payroll and benefit expenses of $2.8 million and an FDIC special assessment reimbursement of $2.3 million. Excluding these items, noninterest expense dropped by $600,000 compared to the previous quarter, primarily due to lower incentive compensation and medical insurance costs, although this was slightly offset by annual merit increases that took effect in early April. The percentage increase in projected expenses remains at 2% to 3%. During the quarter, we set aside a provision for credit losses of $3.3 million, and our effective tax rate was 21.2%. The decrease in our tax rate this year is due to higher tax-exempt investment earnings and various discrete items. We now forecast our tax rate for the full year to be between 21% and 22%. Our capital ratios remained above the well-capitalized regulatory thresholds, with Tier 1 capital and total risk-based capital improving to 14.2% and 15.2%, respectively. As in the previous quarter, we paid dividends of $28 million on our common stock and $5.3 million on our preferred shares. We did not repurchase any shares of common stock during the quarter under our repurchase program, and $126 million is still available under the current plan. Lastly, our Board declared a dividend of $0.70 per common share that will be paid in the third quarter. Now I will pass the call back to Peter.

Peter S. Ho, CEO

Thanks, Brad. This concludes our prepared remarks, and now we'd be happy to take your questions.

Operator, Operator

And our first question comes from Jeff Rulis of D.A. Davidson.

Jeffrey Allen Rulis, Analyst

I wanted to check back in on the margin path. I think we've kind of talked about or you've referenced maybe a 250 margin by year-end, maybe not a Q4 average. But I want to see if that path is reasonable. And kind of the second part of that question is sort of the cost of funds sort of stalling out a little bit, and I think mentioned some CD opportunities, but particularly on that side, it sounds like the opportunity is on the earning asset yield, but sort of two parts. Sorry for the lengthy question.

Bradley S. Satenberg, CFO

Sure. This is Brad. I believe that a margin of 250 is achievable, and I don't foresee any obstacles in reaching that goal. We have now experienced our fifth consecutive quarter of growth in our net interest margin, and I expect that trend to persist. Regarding our cost of deposits, the spot rate at the end of the quarter was 1.58%. Our beta is currently at 29%, and after the repricing of CDs this quarter, we have the potential to gain about 15 to 25 basis points from that. I anticipate that our beta will rise above 30%, and assuming there are no rate cuts, we should see it move towards 35% this quarter.

Jeffrey Allen Rulis, Analyst

Perfect. Okay. And more of an other question is just on sort of balance sheet growth, based on loan growth. More of the question on securities, should loan growth be on a net base be modest? Do you see yourself continue to grow the securities balance from here?

Bradley S. Satenberg, CFO

Yes. Yes, I do think we're going to continue to see the securities portfolio grow. I mean, I think this quarter, the cash flows were about $170 million, and we invested in our investment portfolio about $270 million or $275 million. So we are increasing that portfolio when we see an opportunity if there is modest loan growth or if liquidity increases, we're using that excess liquidity at the moment to increase our investment portfolio.

Peter S. Ho, CEO

I want to touch on the diversity of what we're purchasing in the portfolio.

Bradley S. Satenberg, CFO

Yes, that's a good point. I would also add that we continue to sort of balance our purchases between fixed and floating rate. And so this quarter, it actually leaned more towards floating rate. I think 55% of our purchases are floating securities. And then the other portion, obviously, 45% are in fixed securities.

Operator, Operator

Our next question comes from Jared Shaw of Barclays.

Jared David Wesley Shaw, Analyst

I guess maybe just on C&I, any trends that we should be thinking about that to call out on the delta there this quarter? And how is commercial customer sentiment and pipelines and thoughts for the year there?

Peter S. Ho, CEO

Yes, I'll start, and Jim can specifically address C&I. We were somewhat disappointed with the performance of our commercial book this quarter. We saw a 6% year-on-year average in commercial loan positions, but when looking at the linked basis, it remained virtually flat, and this trend was consistent across the board. Commercial real estate, which had previously shown an 8% year-on-year performance, also showed no change. C&I experienced a significant decline, and construction activity has slowed down. This situation seems to be more structural rather than cyclical, though there may be opportunities for recovery. Overall, it was a challenging quarter, and I'm hopeful that as we gain more clarity regarding the environment, particularly with the tariff situation, we can start to align more closely with the year-on-year average in commercial loans. It was indeed a disappointing quarter for us in terms of commercial production. Jim, would you like to discuss C&I?

James C. Polk, President and Chief Banking Officer

Yes. I think what I would say is that we have seen pipelines continue to build from the beginning of the year. Obviously, it wasn't a terrific quarter, but I think it was driven by two things, right? The greater uncertainty that we saw in the market, which obviously impacted loan volumes or at least put what we put on the books. And then we just saw some unusually high level of prepayments on a couple of loans, which resulted in the decline. I think as we go forward and we begin to see the pipeline start to materialize, we'll move back into a modest level of growth as we move towards the end of the year.

Jared David Wesley Shaw, Analyst

On the deposit side, when we look at demand deposit accounts as a percentage of total deposits, it remains relatively stable. Should we expect it to hover around the 26% mark, moving in line with total deposit changes, or is there a possibility for it to increase or decrease?

Peter S. Ho, CEO

Well, yes, we've got a lot of effort and energy around building DDAs. Obviously, given the rate environment, those are high-margin products for us. I was encouraged that average NIBD for the quarter was up 1% on a linked basis as compared to minus 0.2% on a year-on-year average basis. So we are seeing some acceleration there. Whether we can get numbers well beyond that, I'm not sure. As much as we'd like to build demand deposits, all of our competitors would like to build demand deposits. So it's a pretty competitive, crowded space. So we'll see. I mean it's an important product for us, and we're going to do our best to try and make that an outsized component of our overall deposit base.

Operator, Operator

Our next question comes from Andrew Terrell of Stephens.

Robert Andrew Terrell, Analyst

I wanted to check in on expenses first. It sounds like still thinking that kind of 2% to 3% expense growth rate. It seems like that kind of implies a little bit of a step back in the back half of the year, a little bit of relief on expenses in the next couple of quarters. Just wanted to see if you could kind of confirm that and just maybe refine kind of back half expense expectations.

Bradley S. Satenberg, CFO

Yes, I think that's right. I mean I think, obviously, the first quarter was elevated. The second quarter, we had a severance charge of about $1.4 million. So I do think it will take a step back in the second half of the year. We still feel comfortable with the 2% to 3% increase from the prior year. And so yes, I think you should see expenses come down from where they were during the first six months of the year.

Robert Andrew Terrell, Analyst

Great. I appreciate it. And then I also just wanted to check in just kind of on capital priorities. I know you've got a buyback out there. We've talked about some securities restructuring at a certain point in time. But I just wanted to take your temperature on what makes sense or kind of what you're thinking about from a capital standpoint today.

Peter S. Ho, CEO

Yes, I think we are likely to hold off on buybacks until we have better clarity regarding the economy and the future interest rate trajectory. We don't have any significant plans for securities repurchases at the moment. However, if we identify certain income opportunities, we would consider reinvesting those gains into securities repositioning. To summarize, there is nothing dramatic planned, but we will pursue opportunities to enhance our income stream and stabilize the balance sheet as they arise.

Operator, Operator

Our next question comes from Kelly Motta of KBW. We do not have any significant plans regarding securities repurchases at this time. However, we are considering the potential to reallocate certain income opportunities into securities repositioning. To sum it up, we are not planning anything dramatic, but we will pursue opportunities that help us manage our balance sheet more smoothly as they arise.

Kelly Ann Motta, Analyst

If I could, I'd like to circle back on the components of margin, specifically the expected cash flows off of the securities book and loans fixed and adjustable resetting expectations over the back half of the year. Do you have the expected cash flows on that just so we can manage NII assumption from here?

Bradley S. Satenberg, CFO

I believe the cash flows will be around $550 million in total. These are contractual and do not involve any acceleration of prepayments. Therefore, I think we can expect about $550 million. Looking at the first and second quarters, combined, there have been some minor fluctuations in both periods, but overall, that's likely a fair average for what we can anticipate. The reinvestments should remain stable unless there are changes in interest rates, which could result in a slight shift.

Kelly Ann Motta, Analyst

Got it. Regarding expenses and the decrease in the run rate for the second half of the year, how much of that involves delaying certain investments until 2026 and beyond? Also, since expenses are generally well-managed, are there any specific actions being taken to further control costs? I'm looking to understand the various factors at play in the second half of the year as expenses decrease.

Peter S. Ho, CEO

Yes, Kelly, I'll start with that. Perhaps Brad can help clarify any confusion. However, we are not reducing our investment expenditures; that is not part of our plan, and I don’t see any environmental reason to change that. We have many innovative ideas that will require capital investment, and we are prepared to invest in those to achieve a strong return. Regarding overall expense reduction, we are applying discipline to this every quarter. You may have noticed the severance expenses this quarter, which resulted from some restructuring we undertook. I expect we might see some additional restructuring in the third and fourth quarters, but nothing significant—just an indication of our commitment to continually seek ways to reduce organizational expenses.

Kelly Ann Motta, Analyst

Got it. That's helpful. And then in terms of overall deposit flows, deposits were down this quarter. Can you remind us any seasonality in there? And being that deposits will likely be the driver of the size of the balance sheet, just kind of overall expectations in terms of the outlook for deposit growth from here?

Peter S. Ho, CEO

Yes. I think there is some seasonality into the quarter, the second quarter as well as, frankly, the third quarter. When we look at the past four years of deposit balances intra-year, the second and third quarters are kind of the shoulder quarters, if you will. As far as what we're expecting for the balance of the year, frankly, I would anticipate that if we come out flat from where we are, but improve to Jared's question a few minutes ago around the componentry, hopefully laying a little bit deeper into NIBD, that's about where we would think would be an appropriate place for us to end up.

Chang Park, Director of Investor Relations

Thank you, everyone, for joining us today and for your continued interest in Bank of Hawaii. 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, and you may now disconnect.