Earnings Call Transcript - BOH Q3 2024

Operator, Operator

Good day and thank you for standing by. Welcome to the Bank of Hawaii Corporation Third 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, Senior Vice President, Investor Relations Director. Please go ahead.

Chang Park, Senior Vice President, Investor Relations Director

Good morning and good afternoon. Thank you for joining us today for our third 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 the actual results may differ materially from those projected. During the call this morning, we'll 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'd like to turn the call over to Peter.

Peter Ho, Chairman and CEO

Thanks, Chang, and good morning or good afternoon, everyone. Bank of Hawaii is pleased to report another solid performance in the third quarter of 2024. Net income and diluted earnings per share increased notably on a linked basis. Net interest income and NIM expanded for the second straight quarter. Fee income grew and operating expenses fell on a linked basis. Loans and deposits grew in the quarter, capital levels improved, and credit quality remains pristine. As is our custom, I will spend a little time highlighting market conditions in the islands, then I'll ask Brad to provide a few comments on credit quality, and Dean will provide further detail on our financials. The balance sheet performed well in the quarter with higher spot loan and deposit balances and stable average balances. Capital levels improved across all measures on top of the meaningful step-up in Q2. Deposits continue to perform well, up 2.8% on a linked spot basis and up modestly on an average linked basis. We are pleased to again hold the top deposit market share position in Hawaii for 2024 as measured by the FDIC Annual Summary of Deposits. Both the cost of interest-bearing and the cost of total deposits continued to track well, well below peer medians. Unemployment in Hawaii continues to track at 2.9%, well below the national average. Visitor arrivals continue to be impacted by lower Maui arrivals, but remain elevated from pre-pandemic levels. The same can be said for RevPAR. Oahu residential real estate continues to trend stable, with median sales prices up modestly for both single-family and condominiums on a year-to-date basis. Median days on market remain below 30 days. Now, let me turn the call over to Brad to discuss a few trends on credit.

Bradley Shairson, Chief Risk Officer

Thanks, Peter. As always, I'll start off with our lending philosophy. We focus on our core markets in Hawaii and the Western Pacific. This allows us to leverage our local expertise to make sound credit decisions. Additionally, we know our clients well. The majority of our loan book consists of long-standing relationships where about 60% of our clients, on both the commercial and consumer side, have been with us for over 10 years. This combination has greatly contributed to our historically strong credit performance and has resulted in a loan portfolio that is 93% Hawaii, 4% Western Pacific, and just 3% Mainland, where we support our clients that are doing business in both Hawaii and on the Mainland. As I walk through our current state, you'll notice there is little change quarter-over-quarter. The lending philosophy I just mentioned is reflected in our loan growth, which has been steady and organic. From 2019 through 2023, we averaged about 6.7% loan growth per annum. This year, however, loan growth has slowed due to suppressed demand from the high rate environment. On the consumer side, which represents 57% of our total loans or $8 billion, we are predominantly lending on a secured basis against real estate. 85% of our portfolio is comprised of 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 the portfolio is a combination of auto and personal loans where our average FICO scores are 733 and 759, respectively. Moving on to commercial, our portfolio size is $5.9 billion or 43% of our total loan book. The largest share of commercial is commercial real estate with $3.9 billion in assets, which equates to 28% of total loans. This book is well diversified across industries and carries a weighted average LTV of only 56%. Given that almost 80% of the bank's loan portfolio is real estate secured, let's look at the dynamics of the Hawaii real estate market. The real estate market in Oahu is very stable. Vacancy rates fluctuate little due to the strong Hawaiian economy and constrained supply. Industrial vacancy has continued to hover around its historic low, currently just 1.05% versus its 10-year average of 1.75%. At 13.57%, office vacancy is just over 1% higher than its 10-year average. Office conversions, a trend towards return to office and continuing office space reduction will likely keep vacancy rates low. Retail vacancy remains on par with historical averages. The ongoing high demand for housing is driving the multi-family vacancy rates down to now almost just 4%. Inventory remains constrained across the board with almost no growth over the past 10 years and office space coming down 10% over that same time period. Our CRE is well diversified among 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%. Individual loan exposure is managed carefully with low average loan sizes. Turning to our scheduled maturities, we have no maturity wall. Only 2.7% of loans are due to mature in Q4, 14% next year, and more than half of our loans mature 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 $84 million or 2.2%. And if we move that metric up to 85%, our CRE portfolio has less than $4 million of exposure. Looking at our credit metrics overall this past quarter compared to the linked quarter, metrics remain quite stable and asset quality remains strong. Net charge-offs remained low at $3.8 million or 11 basis points annualized, up 1 basis point from Q2. Non-performing assets have remained stable, increasing slightly to 14 basis points, delinquencies have also been stable, just 2 basis points higher than last quarter at 31 basis points overall. Criticized assets grew slightly as of quarter end, reaching 2.42%. However, one loan repaid in full subsequent to quarter end. Adjusting for that, the quarter-end criticized rate would have actually decreased slightly to 2.19%. As an update on the allowance for credit losses on loans and leases, the ACL ended the quarter at $147.3 million, down about $200,000 for the linked period and up $2.1 million year-over-year. The ratio of our ACLs outstanding was 1.06%, down 1 basis point from the prior quarter and up 2 basis points year-over-year. I will now turn this over to Dean for an update on our financials.

Dean Shigemura, CFO

Thank you, Brad. In the third quarter, our net interest income increased by $2.8 million and the net interest margin increased by 3 basis points. Continuing the trend from the second quarter. Linked quarter, the $2.8 million increase in net interest income was driven by cash flow repricing, an increase in earning assets, and balance sheet actions, including the reinvestment of securities portfolio runoff and repositioning our swap portfolio, partially offset by deposit mix shift. With regard to cash flow repricing, in the third quarter, our earning assets generated $513 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 reinvested into cash, such reinvestment would have generated incremental net interest income of approximately $3.6 million in the quarter from higher reinvestment yields. At the same time, deposit mix shift has continued to slow. With average non-interest bearing and low-yield interest-bearing deposit balances declining by $315 million linked quarter. This compares to a decline of $800 million in the same period of 2023. Assuming the majority of these balances shifted into higher-yielding interest-bearing deposits, such mix shift negatively impacted net interest income by $2.6 million in the third quarter. We expect our net interest income to continue to improve from the gradual decrease in the Fed funds rate; the initial 50 basis points of Fed easing is expected to ultimately add $1.2 million to our quarterly net interest income. In particular, total earning assets that were immediately impacted by changes in the Fed funds rate was approximately $7.6 billion at quarter end, consisting of floating rate loans and investment securities, interest rate swaps, and Fed funds. The 50 basis point decrease in Fed funds will reduce quarterly income from these rate-sensitive earning assets by approximately $9.6 million. At the same time, total rate-sensitive deposits that also immediately impacted by the change in the Fed funds rate were $9.7 billion at quarter end, which excludes non-interest bearing demand and deposit accounts yielding interest rates of 10 basis points or less. The 50 basis point decrease in the Fed funds rate will immediately increase quarterly net interest income by approximately $7.1 million with an expected long-term positive quarterly impact of approximately $10.8 million. The difference between the immediate and long-term impact is due to time deposits repricing upon maturity compared to savings and interest-bearing demand accounts, which can be repriced immediately. Thus, there will be an initial short-term negative impact to NII, then turn positive one to two quarters later as time deposits reprice lower. We are currently well positioned to reprice our time deposits and improve our margins, as 70% of total time deposits are scheduled to mature in the next six months and 88% of total time deposits are scheduled to mature in the next 12 months. In the third quarter, we took actions to adjust our balance sheet in response to changes in interest rates. This includes repositioning our swap portfolio by terminating $700 million notional shorter maturity swaps, with relatively higher fixed rates and executing $500 million notional of spot starting swaps at lower rates, as well as executing $300 million of forward starting swaps also at lower rates. The repositioning reduced our active pay fixed received flow interest rate swaps by $200 million to $2.8 billion notional and reduced the average fixed rate from 4.52% to 4.29%. The $300 million of forward starting, pay fixed received flow interest rate swaps have an average fixed rate of 3.03% and will become active in 2025 and 2026. In addition, we purchased $236 million of floating rate securities that have a positive 78 basis point spread to Fed funds to improve our net interest income and net interest margin. Our fixed-rate asset exposure was 53% at the end of the quarter, down from 73% at the end of 2022. We expect to continue to actively manage our interest rate swaps and securities portfolios to take advantage of opportunities in this changing rate environment. Non-interest income totaled $45.1 million in the third quarter, up $3 million from the second quarter, as customer derivatives sales, merchant mortgage, and loan transaction revenue and volumes improved. In the fourth quarter, we expect to recognize $2.3 million of a one-time charge related to the Visa Class B conversion ratio change. Adjusted for this item, we expect core non-interest income to be in the range of $44 million to $45 million in the fourth quarter as improved trends experienced in the third quarter continue in the fourth quarter. Reported and core expenses were $107.1 million in the third quarter. This compares to core expenses of $105.3 million in the second quarter which excludes a $2.6 million one-time, industry-wide FDIC special assessment, $800,000 of severance expenses, and $600,000 of other core expenses that are not expected to recur. Thus, the core expenses were up a modest $1.8 million linked quarter, primarily due to increases in salaries and benefits as we continue to manage our expenses in a disciplined manner. We continue to evaluate expense levels and expect normalized core expenses in 2024 to increase 1% to 1.5% from 2023 normalized expenses of $419 million. To summarize the remainder of our financial performance, in the third quarter, net income was $40.4 million, and earnings per common share was $0.93. An increase of $6.3 million and $0.12 per share respectively. Our return on common equity was 11.5%. We recorded a provision for credit losses of $3 million this quarter. The effective tax rate in the third quarter was 23.33%, and the tax rate for the full year of 2024 is expected to be 24.25%. We continue to grow our capital and maintain healthy excesses above regulatory minimum well capitalized requirements. Our Tier 1 capital ratio increased to 14.05% and total capital ratio increased to 15.11%. Our accumulated other comprehensive loss continues to decrease and was $335 million in the third quarter, down $39 million linked quarter and down $107 million from the same period last year. The decrease from the prior periods was primarily due to an increase in the fair value of our AFS investment securities caused by declining long-term interest rates as well as continued portfolio runoff. Our risk-weighted assets to total assets ratio continued to be well below peer median, reflecting the lower risk nature of our asset mix. During the third quarter, we paid out $28 million to common shareholders in dividends and $3.4 million in preferred stock dividends. Note that the dividends on the Series B preferred stock in the third quarter were a partial quarter's distribution. In the fourth quarter, the full dividend on the Series B will be $3.3 million or $5.3 million total for both the Series A and B. 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 fourth quarter of 2024. I'll turn the call back over to Peter.

Peter Ho, Chairman and CEO

Thanks, Dean. This concludes our prepared remarks. Now we'd be happy to entertain your questions.

Operator, Operator

Our first question comes from the line of Jeff Rulis with D. A. Davidson. Your line is now open.

Jeff Rulis, Analyst

Thanks. Good morning.

Peter Ho, Chairman and CEO

Good morning, Jeff.

Jeff Rulis, Analyst

Dean, maybe a couple of questions on the margin. One, were there any interest recoveries or one-timers in the margin this quarter? And then do you have the September average?

Dean Shigemura, CFO

In the quarter, there was maybe a small amount of actually reversals, but it was about $100,000, so nothing material. In terms of the margin in September, it was, I believe 2.17%.

Jeff Rulis, Analyst

I appreciate the detailed information on the effects of the rate cut. It seems to present a short-term challenge but is positive in the long run, with your core performance improving. Can you mitigate that short-term negativity, or do you expect margins to remain relatively flat over the next few quarters?

Dean Shigemura, CFO

Yes, we believe that the NII and margin will gently increase quarter-over-quarter. And as we laid out in our presentation, we're going to continue to see the asset repricing from the cash flows offset partially by some continued remix on the deposit side. We're continuing to actively manage our balance sheet, which includes buying or reinvesting some of our cash flows into securities as well as adjusting the interest rate swaps according to how rates trend. And then, with regard to the Fed funds rate cut, over the longer-term, we do think it will be accretive as laid out in the presentation as well. Initially, it will have a slight negative. But when you mix all that together, that's how we get to a generally rising NII and margin.

Jeff Rulis, Analyst

Great. Thanks, Dean. And maybe one last one. Brad, I appreciate your perspective on the very low comparative NPAs. I just want to continue monitoring the rise in non-accruals. Is there a specific sector contributing to this, or is it more general and widespread?

Bradley Shairson, Chief Risk Officer

No, so there wasn't really a sector that it came from in particular. I would say actually that the NPAs, the rise while not from a given sector, I would say that the little bit of an increase was caused by some non-core lending activities that were done historically quite a while back. But absolutely there's nothing systemic or broad-based in the portfolio. As I may have said before, if I were pressed on where there would be any weakness in the portfolio at all, it would be just a small sub-segment of a sector, and that would be the lodging area. So if we think about our lodging, what lodging is actually more dependent upon international visitors to Hawaii, and that's where if anything, we'd see a little bit of weakness in that area. But we have really strong sponsors that support those properties, and we feel really good about how we're positioned as well as the fact that the LTV of that portfolio is about 60%. So really just not seeing anything in the portfolio of any real concern. And as you know, I think I had mentioned last quarter that we're always working with our borrowers, and we do expect to see some resolutions through either refinancing, payoffs, or upgrades. And as mentioned, this payoff came in a little bit subsequent to quarter end. So that did bring our criticized back down to 2.19%. But yeah, so nothing systemic in the portfolio. I would say that the rationale or the reason that the criticized went up to 2.42% to start with was due to a single credit in the multi-family space. That credit had a little bit of deterioration in their operating results. But what I would say about that is that also has strong sponsorship, and our criticized for multifamily is 5.8% overall. So feel really good about that portfolio too.

Jeff Rulis, Analyst

Okay. Thanks, Brad. Pretty consistent with the prior quarter. I appreciate it. I'll step back.

Operator, Operator

Thank you. Our next question comes from the line of Jared Shaw with Barclays. Your line is now open.

Jared Shaw, Analyst

Hi, good morning, good afternoon. Maybe just looking at the delta between end of period deposits and average, if you could just go back to maybe reminding us if there's any additional seasonality this quarter or should we be expecting that to be trending towards average here?

James Polk, President and Chief Banking Officer

Yeah, hi, this is Jim. I'll take that one. As we got to the end of the quarter, we saw some, what I’d characterize as unexpected large public deposits and maybe some seasonal build on both the commercial and the public side. We also had some really nice business that we won on the commercial that helped boost balances. As we get into the fourth quarter though, I think we'll see some moderation in that, probably a bit back towards the average that we saw in Q3 as some of the temporary deposits run off and actually some of the new business migrates from the commercial side of the business to the asset management side of the house.

Jared Shaw, Analyst

Okay. In terms of DDAs, do you believe this is a good level to start building from for those core DDAs? Have we reached the end of the decline, and could you provide an update on the forecasts for fourth quarter balances?

Peter Ho, Chairman and CEO

Yeah, Jared, this is Peter. I'm not sure we're ready to declare the end of that trend. The negative comp though has definitely shrunk as I think Dean pointed out to $315 million. What we actually measure is non-interest bearing as well as what we would classify as low-yield savings or other types of deposits. So that level has come down dramatically from five quarters ago, continue to do so. I think we may have another couple of quarters though of negative comps in front of us, my guess.

Jared Shaw, Analyst

Okay. Thanks. And then just finally, I guess going back to the question Jeff just asked on lodging. What's the total dollar exposure to that subset of lodging that maybe is more tied to the international visitor?

James Polk, President and Chief Banking Officer

That's a good question. I can't really connect a specific sub-segment to those that depend on it. Some hotels cater more to international visitors, but all hotels have some mix of that segment. So it's challenging to isolate it. However, I would say it represents a small portion of the $700 million in lodging that pertains to hotels focused on international visitors.

Bradley Shairson, Chief Risk Officer

Yeah. And by the way, the international segment is actually the best performing segment this year. So Japan visitor arrivals are up significantly, 38% plus spending up 28%. Obviously, that's coming off of a pretty low basis, but the improving foreign exchange relationship between the dollar and yen is having a positive impact there.

Dean Shigemura, CFO

And we still don't see a huge amount of criticized credits in that arena. It's about 15% of our lodging overall is criticized, and we have 62% weighted average LTV on those.

Jared Shaw, Analyst

Great. Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Andrew Liesch with Piper Sandler. Your line is now open.

Andrew Liesch, Analyst

Thanks. Good morning, everyone. Just a question on the loan growth here. Just curious if there's anything specific you can point to that drove the commercial real estate gains this quarter?

James Polk, President and Chief Banking Officer

This is Jim. I'll take it. It was a good mix. We’ve seen our pipelines and production increase nicely through Q3, with a decent combination of commercial mortgage and some construction. Overall, the pipelines are looking better at this time.

Peter Ho, Chairman and CEO

I would like to add that our experience typically shows that commercial lending activity tends to lead either out of a market or into an up cycle. We are beginning to see that commercial activity increased by 2% this quarter, while consumer lending is a bit slower. Therefore, we expect continued growth in the commercial segment, and we believe that consumer lending will eventually pick up, which should improve our overall loan growth numbers.

Andrew Liesch, Analyst

Got it. Do you think any changes in rates, people have come off the sidelines? Have you heard of projects being delayed in anticipation of that?

Peter Ho, Chairman and CEO

The commercial side seems to be, I won't say off to the races, but people are pretty constructive. And on the consumer side, I think people are waiting for rates to finally come down and frankly have been head-faked a couple of times for the past year. So we're still waiting to see that wave build.

Andrew Liesch, Analyst

Got it. Great. All my other questions have been asked and answered. I'll step back. Thank you.

Peter Ho, Chairman and CEO

Yeah, take care.

Operator, Operator

Thank you. I'd like to turn the call over to Chang Park for closing remarks.

Chang Park, Senior Vice President, Investor Relations Director

Thank you everyone today for your time and your continued interest in Bank of Hawaii. Please feel free to reach out to me if you have any additional questions. Thanks again, and have a good day.

Operator, Operator

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