Earnings Call Transcript - BOH Q2 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Bank of Hawaii Corporation Second Quarter 2020 Earnings Conference Call. At this time, all participants’ lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please follow the instructions provided by the operator. As a reminder, this conference is being recorded. I would now like to hand the conference over to Cindy Wyrick, Director of Investor Relations. Please go ahead.

Cindy Wyrick, Director of Investor Relations

Thank you, Carmen, and good morning, good afternoon, everyone. Thank you for joining us today. On the call with me this morning is our Chairman, President and CEO Peter Ho; our Chief Financial Officer, Dean Shigemura; and our Chief Risk Officer, Mary Sellers. 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 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. A copy of this presentation and release are available on our website, boh.com, under Investor Relations. And now, I'd like to turn the call over to Peter Ho.

Peter Ho, Chairman, President and CEO

Great. Thanks, Cindy. Good morning, everyone. Before I start our comments, let me just give you a little commentary on Hurricane Douglas, which came through the island this weekend. Yesterday, Douglas actually missed the Big Island, and a Hurricane warning was issued for both Oahu and Maui, where we were under a hurricane watch. Fortunately, the storm had a nominal impact in our area and cleared Hawaii late last night, or actually early this morning. So from that standpoint, we obviously feel blessed and fortunate to have made it through this near miss. Today marks Bank of Hawaii's six-month anniversary in dealing with the COVID-19 pandemic. Our first executive all-hands meeting was held on January 27 of this year. How things have changed in six months! As you know, COVID-19 has had a dramatic effect on nearly all aspects of life globally and nationally, and Hawaii has been impacted no differently. While we're one of the nation's best-performing states by infection statistics to date, the consequences of the virus have been economically dramatic. This past Friday, our board met to hold a regularly scheduled meeting. At that meeting, I presented a six-month review of our COVID-19 response, which I segmented into our core stakeholders: our community, customers, our teammates, and, of course, our shareholders. From a community standpoint, we recognize that as a leading company in the islands for nearly 123 years, people expect us to take a leadership role and give of ourselves freely in times of crisis and need. Our management team and board of directors are engaged in various philanthropic organizations and committees supporting our community during this time. Our foundation made a $3 million gift to the Hawaii Community Foundation for COVID-19 humanitarian, health, and economic support to the community, which is the largest corporate gift to date in the islands. We believe this will spur further support from the corporate community. The funding was provided by our foundation, which is separate from the bank. Recently, the Bank of Hawaii Foundation released a study called COVID-19 and Hawaii Facts and Insights, performed by a respected local market research company, with data from over 1,000 respondents, making it the largest study of its kind in Hawaii. We believe this study will help inform the general community and assist local policymakers in making decisions. From a customer standpoint, we’ve been active in providing solutions to many parts of our customer base. We made over 4,500 PPP loans totaling over $560 million and have helped more than 17,000 clients realign their loan terms amid the disruptions caused by the pandemic. With various government programs during the pandemic, we saw contact center volume spike 69% in April, requiring significant support from our contact center staff. Also, as customers sheltered at home, we witnessed unprecedented digital banking activity, with year-to-date mobile deposit growth of 36%, online deposit account openings growth of 300%, and online mortgage application growth of 142%. Our employees' health remains our top priority, and we have spent over $280,000 on PPE and plan to ultimately spend approximately $2 million on Plexiglas barriers and thermal scanning equipment. We’ve built a health screening app for employees and are upgrading our filtration systems to exceed industry standards. For shareholders, today, we have weathered the storm while maintaining solid financial and business results. Our market valuation continues to lead our marketplace. We continue gaining market share in both loans and deposits on a one-year basis. Finally, before I turn the call over to Mary, I wanted to briefly review the local Hawaiian economy. Unemployment in Hawaii increased from 2.4% in March to 23.8% in April and May due to stay-at-home and travel orders. It improved to 13.9% as the local economy partially reopened, aided by PPP and other federal stimulus. The direction of future unemployment will depend on new federal stimulus and the trend in infection rates. Fundamentally, Bank of Hawaii remains well-positioned with solid credit statistics, growing operations, and robust liquidity and capital levels. Now, let me turn the call over to Mary Sellers.

Mary Sellers, Chief Risk Officer

Thank you, Peter. At the end of the quarter, the loan portfolio net of PPP balances totaled $11.3 billion, reflective of our island economies that remain 60% consumer and 40% commercial, with 76% secured by high-quality real estate and a combined weighted average loan-to-value of 56%. This conservative portfolio construction should provide a superior outcome and allow us to support our customers through these difficult economic times. Credit metrics remained strong and stable in the second quarter. Net charge-offs totaled $5.1 million, or 18 basis points annualized on average loans, which is an increase from the prior period and year-over-year. Non-performing assets totaled $22.7 million at the end of the period, an increase from the first quarter and the second quarter of last year. Criticized loans increased by $1.4 million to $201.6 million, or 1.71% of total loans. The credit provision was $40.4 million, which after net charge-offs of $5.1 million resulted in a $35.2 million increase in the allowance for credit losses. This increase reflects our best estimate of increased losses in our portfolio, considering current outlooks affected by COVID-19. At the end of the quarter, the allowance for credit losses to total loans was 1.47%. Through the end of the second quarter, we provided payment relief to over 17,000 customer accounts on loan balances totaling $1.9 billion or 16% of total loans outstanding. After peaking in April, we saw a significant decline in new requests for assistance. The consumer loans with payment deferrals are primarily secured by residential real estate, with 49% of customers making at least one payment in the second quarter. The commercial loans with payment deferrals are also primarily secured, and 92% of these customers made at least one payment in the second quarter. Certain industries, particularly retail and lodging, are facing significant challenges. Our retail segment totals $600 million or 5% of total loans, 91% secured by real estate. The lodging segment is $500 million or 4% of total loans, with 100% of unsecured exposure paying interest. Finally, for the restaurant and entertainment segment, this represents $100 million or 1% of total loans. I'll now turn the call back to Dean.

Dean Shigemura, Chief Financial Officer

Thank you, Mary. As Peter stated, this was a good quarter for us despite the challenging environment. We continued our trend of loan growth in the second quarter with balances increasing by $453 million quarter-over-quarter, and by over $1 billion year-on-year. The second quarter loan growth of 4% was driven by PPP loans. When normalizing for PPP loans, loans grew modestly by $16 million in the quarter. We expect moderate loan growth for the rest of the year. In the second quarter, we experienced a record increase in deposits of nearly $1.4 billion, or 8.5% quarter-over-quarter and $2 billion, or 12.5% year-on-year, continuing our long history of deposit growth. While some of this growth was driven by PPP loan funding, the growth predominantly came from our core consumer and commercial customers. We have reduced our public time deposits by $53 million to $610 million. Our deposit funding costs continued to decline during the quarter, providing us with flexibility for growth and profitability. Subject to market conditions, we continue to opportunistically reduce rates, and our solid and growing deposit base aids against our risk profile. We deployed some of our excess liquidity into our investment portfolio, increasing balances by $300 million to $6 billion while maintaining high credit quality. Our strong risk-based capital levels improved in the second quarter and remain well above the required minimums. We improved our CET 1 and Tier 1 capital ratios by 23 basis points to 12.04%. Our capital position remains strong, with significant amounts of capital in excess of regulatory requirements. Now, I’ll provide more details on our financial results. Net income in the second quarter of 2020 was $38.9 million, or $0.98 per share. Our net interest income increased to $126.7 million, up from the previous quarter and year-over-year. Our effective tax rate for the second quarter was 20.05%. We anticipate our return on assets to be 0.82%, and our return on equity at 11.58%. Our net interest margin for the second quarter was 2.83%. The decrease was primarily due to lower interest rates and heightened liquidity resulting from strong deposit growth. Our estimates assume that PPP loans are carried for a full 24 months, while we expect our net interest income to be flat going forward. Our board declared a dividend of $0.67 per share for the third quarter of 2020. Now I'll turn it back over to Peter.

Peter Ho, Chairman, President and CEO

Great. Thanks, Dean. Thank you for your interest in Bank of Hawaii today. Now we’d be happy to entertain whatever questions you might have.

Operator, Operator

Thank you. Our first question is from Casey Haire with Jefferies. Please go ahead.

Casey Haire, Analyst

Yes. Thanks. Good morning, everyone. Good to hear that Hurricane Douglas did not do any damage. To start on credit quality, Mary. Some of the slides are very helpful in terms of the forecast. As you think about your reserve build, what are you all looking at in terms of when tourism opens back up to the island? Can you frame it around that in terms of what your forecasts assume regarding the islands' re-opening and sensitivities around that?

Mary Sellers, Chief Risk Officer

Sure. UHERO is forecasting a gradual reopening of the tourism industry late into the third quarter, with very little occupancy expected in 2020, and really being pushed out into 2021. At that point, occupancy would be at about 40% to 50% of where we were in 2019.

Casey Haire, Analyst

Okay. In terms of visitors returning in 2021, does it assume 50% return to pre-pandemic levels? Or just trying to size what you are baking in or UHERO is baking in?

Mary Sellers, Chief Risk Officer

So, pre-pandemic was about 80% occupancy; at 40% to 50%, you would be at about half.

Casey Haire, Analyst

All right. On the PPP loans for two years, should we assume that means your liquidity will run with that same amount of time? And regarding the NIM, what are the current reinvestment rates for investment securities? If there is no relief on yields, how long will your securities book take to bottom out?

Dean Shigemura, Chief Financial Officer

On PPP loans, cash deposits have started running off. If you compare the amount of loans versus deposits, we expect this to continue into the third quarter. The reinvestment yield for the investment portfolio is roughly about 1%. It would take about a year or two for the portfolio to reach lower levels.

Casey Haire, Analyst

Very good. Thank you.

Peter Ho, Chairman, President and CEO

Thanks, Casey.

Operator, Operator

Thank you. Our next question comes from Ebrahim Poonawala with Bank of America Securities. Please go ahead.

Ebrahim Poonawala, Analyst

I wanted to follow up on the margin deal. Last quarter, your guidance was 1 to 2 basis points of margin compression looking ahead. Does anything change based on your view of asset yields amid the excess liquidity? What's your outlook?

Dean Shigemura, Chief Financial Officer

The LIBOR rates fell more than expected during the quarter, impacting our results significantly. About half of the drop was driven by increased liquidity and additional deposits. Our guidance does take into account further reductions due to rates and liquidity.

Ebrahim Poonawala, Analyst

Understood. And how much PPP fees remain at the end of the second quarter?

Dean Shigemura, Chief Financial Officer

My forecast assumes no prepayments and that we do not accelerate the recognition of the fees.

Ebrahim Poonawala, Analyst

Got it. Can we also talk about the deferral trends—$1.9 billion in the second quarter vs. $1.1 billion in the first quarter? What should we expect for commercial borrowers over time without a full reopening of tourism?

Peter Ho, Chairman, President and CEO

Mary, can you start, then I'll chime in.

Mary Sellers, Chief Risk Officer

We’ve provided relief by leveraging the CARES Act. Our discussions suggest many borrowers didn't need the deferral strictly and are managing their liquidity well.

Peter Ho, Chairman, President and CEO

Deferral activity may not be a perfect indicator of future credit health due to the quality of borrowers we've granted deferrals. Engagement with borrowers during this time is essential to understanding their liquidity going forward.

Ebrahim Poonawala, Analyst

Understood. If tourism fails to open, what’s the outlook based on the local government’s ability to withstand the impact?

Peter Ho, Chairman, President and CEO

We saw a significant drop in unemployment due to partial reopening and federal stimulus. Continued federal support may allow us to withstand the economic disruptions. The state holds a strong credit rating, but we need to monitor the national infection rates significantly.

Ebrahim Poonawala, Analyst

Got it. Appreciate the detailed responses.

Operator, Operator

Thank you. Our next question comes from Jeff Rulis with D.A. Davidson. Please go ahead.

Jeff Rulis, Analyst

Thanks. I have a couple questions on the non-interest income. Dean, regarding the Visa position, is that gone at this point?

Dean Shigemura, Chief Financial Officer

Yes.

Jeff Rulis, Analyst

I assume any associated carry cost isn't an issue anymore? What's the strategy with service charges going into the future?

Peter Ho, Chairman, President and CEO

We saw about a $6.5 million reduction in various types of fees from Q1 to Q2. As the state reopens, volumes may begin to gradually increase.

Jeff Rulis, Analyst

Got it. And the NPA additions—were these stresses from pre-COVID?

Mary Sellers, Chief Risk Officer

It was one residential loan that faced challenges before COVID; we've set up a repayment plan to return it to accrual in Q1 2021.

Operator, Operator

Our next question comes from Andrew Liesch with Piper Sandler. Please go ahead.

Andrew Liesch, Analyst

Hi, good morning, everyone. Peter, can you elaborate on provisioning going forward and how much it ties to the UHERO unemployment rate forecast?

Mary Sellers, Chief Risk Officer

We did base our decision on UHERO. The level of uncertainty in recovery may reduce provisioning going forward, but we want to build reserves during this period.

Peter Ho, Chairman, President and CEO

The estimates we have account for some uncertainties, but excessive provisioning is being executed for stability during uncertain times.

Andrew Liesch, Analyst

Thank you. That clarity is helpful. On operating expenses, how much customer activity would need to increase to return expenses to previous run-rates?

Peter Ho, Chairman, President and CEO

I believe the increase will not be substantial; expenses will align more with transaction volumes moving forward but will likely remain below $90 million for the foreseeable future.

Dean Shigemura, Chief Financial Officer

The increase is tied more to provisioning activity rather than transaction levels, but operational activity will gradually adjust as conditions improve.

Operator, Operator

Thank you. Our next question comes from Jackie Bohlen with KBW. Please go ahead.

Jackie Bohlen, Analyst

Hi, good morning. Dean, how did premium amortization behave between this quarter and last quarter?

Dean Shigemura, Chief Financial Officer

It increased by about $1.3 million to around $7.5 million due to market conditions and refinancing activity.

Jackie Bohlen, Analyst

Thank you. And Peter, could you provide an update on your long-term reinvestment strategies and customer behavior's impact on efficiency projects?

Peter Ho, Chairman, President and CEO

COVID has accelerated some of our digital investment initiatives. We’ve made significant strides already and will continue to make investments that generate returns. Our branch transaction volumes have diminished, and we anticipate ongoing discussions about branch efficiency as digital engagement grows.

Operator, Operator

Thank you. Our final question comes from Laurie Hunsicker with Compass Points. Please go ahead.

Laurie Hunsicker, Analyst

Morning. Dean, was the margin guidance of down 6 to 7 basis points based on the headline NIM or adjusted margin?

Dean Shigemura, Chief Financial Officer

It was based on the adjusted margin.

Laurie Hunsicker, Analyst

Perfect. Also, how does your provision for PPP fees structure over time?

Dean Shigemura, Chief Financial Officer

In total, we expect about $18 million in fees over the life of those loans.

Laurie Hunsicker, Analyst

Great. And Mary, what's your office exposure in terms of LTV?

Mary Sellers, Chief Risk Officer

It's 12% of our commercial mortgage book, and the weighted average LTV is 59%.

Laurie Hunsicker, Analyst

Okay, thank you.

Cindy Wyrick, Director of Investor Relations

I'd like to thank everyone for joining us today and for your continued interest in Bank of Hawaii. Please feel free to contact me if you have additional questions or need further clarifications on the topics discussed today. Thanks, everyone.

Operator, Operator

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