Earnings Call Transcript - BOH Q2 2021

Janelle Higa, Head of Investor Relations

Thank you, 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. 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, we'll be referencing a slide presentation as well as the earnings release. A copy of the 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. Thank you, Janelle. Good morning or good afternoon, everyone. Thanks for joining us. As is our custom, we'll go through market conditions here in the islands, I'll then turn it over to Dean, who will walk you through our financials, and then Mary will touch on credit, and then we'd be happy to take your questions for the quarter. If you look at the unemployment slide here, you see that the economy here in the islands is steadily improving, really being driven by a nice improvement or regaining traction in the visitor industry as well as improvement in what we call the local economy. UHERO's economic pulse indicator, which is a high frequency aggregation of numerous data points, has basically the local economy now at 72% versus pre-pandemic levels. A quarter ago, I think we reported 62% to you, so it's nice improvement there. And you see all of this relating into better unemployment rate. So unemployment now is down to 7.7%, the fifth consecutive month of declines. The real estate market here in the islands, like many markets, is very strong. Oahu's single-family homes were up in terms of sales, 49% June versus June a year ago. Median sales prices were up 27% and inventories are very constrained. So median days on market are down 60% from a year ago to eight days and months of inventory is down 52% from a year ago to 1.2 months of inventory. The condominium sector here on Oahu, similar story, a little bit more muted, though, but sales up 134% June on June. Median sales price is up 9% and inventory conditions are very similar to the single-family home market. So a very strong real estate sector here on Oahu and generally throughout the Hawaiian Islands. The visitor industry, as I mentioned, is doing quite nicely. So you see this chart here really since the relaunch of our Safe Travels program, visitor arrivals have increased substantively basically now approaching pre-pandemic levels. Airlift is a great story. In June, actually, we had 1,027,000 seats into the islands, which is a 14.3% increase from June of 2019. And July and August forecasts are even more robust than that. So the airlines are doing their jobs. Arrivals are looking good. The most recent data we have from the Hawaii Tourism Authority has arrivals at 74% of 2019 levels, so pre-pandemic levels. Visitor days at 83% of pre-pandemic levels and expenditures at just under 80% of 2019 levels. And we have reason to believe that the summer June, July, and August should eclipse those numbers as well. Hotels are doing quite nicely. As of June, we're back up to about 97% of our room stock back in service. Occupancies are running at 77% statewide versus 84% pre-pandemic in 2019. Average daily rates were very robust at $320 for June versus $280 for the same month in 2019. So if you can believe RevPAR or revenue per available room is actually higher as of June of this year than it was in June of 2019 at $246 per available room versus $235 per available room in June of 2019. So very strong performance in the hotel sector. And forward bookings, just talking to a number of professionals in the industry, seem to be very strong as things stand right now. The COVID condition here in the islands is reasonably good. Rolling seven day averages have us in the top half of the country. Although we are concerned, like most other marketplaces, over the emergence of the delta variant. And vaccinations for the most part, have gone well. So we're in the 36 percentile of the country. And hopefully, obviously, like most marketplaces, we would love to get that number higher. So that's a synopsis of the marketplace. And now let me turn the call over to Dean, who will walk you through the financials.

Dean Shigemura, Chief Financial Officer

Thank you, Peter. Growth from core customers remained solid in the second quarter. Core loans net of PPP waivers increased by $113 million or 1% in the quarter and by $250 million year-over-year. Waivers on PPP loans have accelerated and resulted in a net decline of $212 million in the quarter. Our strong deposit growth continued, increasing $613 million or 3.1% linked quarter and $2.7 billion or 16% year-over-year. With a loan-to-deposit ratio of 60%, our strong deposit base remains a stable source of liquidity. Together with our healthy cash balance of $910 million at the end of the quarter, we maintained significant flexibility for further loan and investment growth. And we continue to deploy liquidity to support net interest income, as well as mitigate the impact of near-term rate pressures. Consistent with this strategy, we added $1 billion of liquid and safe investments to the portfolio, increasing total balances to $8.5 billion. Net income for the second quarter was $67.5 million or $1.68 per common share, up from $59.9 million in the first quarter and $38.9 million in the second quarter of 2020. Net interest income in the second quarter was $123.5 million, up from $120.6 million in the first quarter and down from $126.7 million in the second quarter of 2020. Included in the second and first quarters' net interest income were $3.8 million and $0.9 million respectively of accelerated loan fees from PPP loan waivers. Included in the second quarter of 2020 net interest income was an interest recovery of $2.9 million. Adjusting for PPP loan forgiveness, net interest income was slightly higher than the first quarter as the impact from lower interest rates was offset by the deployment of liquidity. As Mary will discuss later, we recorded a negative provision for credit losses of $16.1 million this quarter. Non-interest income totaled $44.4 million in the second quarter, up from $43 million in the first quarter and down from $51.3 million in the second quarter of 2020. Included in the second quarter were gains of $3.7 million from the sale of investment securities. Included in the second quarter of 2020 was a gain of $14.2 million from the sale of our remaining Visa shares. Adjusting for these changes, the decrease from the first quarter was due to lower mortgage banking income, primarily from the impact of rate volatility on MSR valuations. In the second quarter, we reported an MSR impairment of $1.1 million versus a recovery of $2.2 million in the first quarter. Adjusting for the MSR valuations, mortgage banking income was up about $400,000 quarter-over-quarter. Partially offsetting the MSR valuation impairment were higher service charges and other transaction fees. The increase from the second quarter of 2020 was mainly due to an increase of $5.4 million from fees on deposit accounts and other service charges due to the reopening of the economy. We expect non-interest income will be approximately $42 million to $43 million per quarter for the remainder of the year from the increase in deposit fees, service charges, and other transaction fees from the improving economy. Non-interest expense in the second quarter totaled $96.5 million. The second quarter's expenses included charges of $3.2 million related to the early termination of repurchase agreements and term debt and a $3.1 million benefit from the sale of property. The termination of the repos and term debt allowed us to reduce our noncore funding, reposition some securities at a net gain, and increase our net interest income. With the improving economic provisioning and earnings outlook for 2021, accruals for corporate incentive compensation are back to pre-pandemic levels and were $3.2 million higher than the second quarter of 2020. In the second quarter of 2021, we also experienced higher levels of variable expenses from rising production, as well as continuing investments in innovation initiatives. The remaining core expenses were nearly flat with expenses from the second quarter of 2020 and overall expenses continue to be managed in a disciplined manner. Excluding one-time items, our normalized full year noninterest expense projection, including restoration of corporate incentives remains approximately $385 million with the third and fourth quarter expenses being approximately the same as the second quarter at $96 million to $97 million. The effective tax rate for the second quarter was 22.84%. Currently, we expect the effective tax rate for 2021 will be approximately 24%, driven by higher pretax income. Our return on assets during the first quarter was 1.23%, the return on common equity was 19.6%, and our efficiency ratio was 57.47%. Our net interest margin in the second quarter was 2.37%, a decline of 6 basis points from the first quarter. The decline in the margin in the second quarter reflects the ongoing impact from the strong deposit growth and lower rates, partially offset by deployment of liquidity. We expect the margin will decline approximately 5 to 6 basis points in the third quarter, primarily due to the continued deposit growth and the recent decrease in long-term rates then stabilize in the fourth quarter. Net interest income in the third quarter will be approximately flat to slightly higher than the second quarter. The increase in NII is expected from continued balance sheet growth, deployment of excess liquidity, and stable interest rates, but we remain asset sensitive and are well positioned for higher rates. These estimates exclude the impact of PPP loan prepayments, which have been volatile and unpredictable. We strengthened our capital levels through our very successful issuance of $180 million in preferred stock. The addition of preferred capital, together with our strong earnings, increased our Tier 1 capital and leverage ratios to 13.9% and 7.31% respectively, adding to our excess levels. We are well positioned for continued growth over and above the strong deposit growth of $4.4 billion we've already absorbed into our balance sheet since the beginning of 2020. During the second quarter, we paid out $27 million or 40% of net income in dividends. Our strong capital levels and income generation will enable us to restart the share repurchase program this month, which has been suspended since the first quarter of 2020. The remaining share buyback authority is $113 million. And finally, consistent with our improving income levels, our Board declared a dividend of $0.70 per common share for the third quarter of 2021, an increase of $0.03 per share. Now I'll turn the call over to Mary.

Mary Sellers, Chief Risk Officer

Thank you, Dean. At the end of the quarter, customer loan balances on deferral were down 88% from their peak to 1.8% of total loans. You'll recall, given we had the capacity to do so, we elected to partner with our customers through this unprecedented event and provided extended relief primarily through principal deferrals on low margin real estate. Accordingly, 93% of loans remaining under deferral are secured with our consumer residential deferrals having a weighted average loan to value of 68% and our commercial deferrals having a weighted average loan to value of 46% with 97% continuing to pay interest. Return to payment performance for previously deferred loans has continued to be strong with less than 1% of these customers delinquent 30 days or more at the end of the quarter. Credit metrics remained strong and stable in the quarter. Net charge-offs were $1.2 million as compared with net charge-offs of $2.9 million in the first quarter and net charge-offs of $5.1 million in the second quarter of 2020. Nonperforming assets totaled $19 million, up $1.1 million for the linked period and down $3.7 million year-over-year. Loans delinquent 30 days or more were $29.8 million or 25 basis points of total loans, at quarter end down $10.1 million for the linked period and up $6.3 million from the second quarter of last year. Criticized exposure continues to decrease during the quarter, dropping from 2.6% of loans to 2.17% of total loans. As Dean noted, we recorded a negative provision for credit losses of $16.1 million. This included a negative provision to the allowance for credit losses of $16.8 million, which would net charge-offs of $1.2 million reduce the allowance to $180.4 million, representing 1.5% of total loans and leases, or 1.56% net of PPP balances. The decrease in the allowance is reflective of the most recent UHERO economic outlook and forecast for our market coupled with our credit risk profile. The allowance does continue to consider and provide for the potential downside risk inherent with the pandemic. The reserve for unfunded credit commitments was $4.5 million at the end of the quarter with a provision of $1.5 million made to fund the linked period increase. I'll now turn the call back to Janelle.

Janelle Higa, Head of Investor Relations

Thank you, Mary. This concludes our prepared remarks. We are now happy to answer any questions you may have.

Ebrahim Poonawala, Analyst, Bank of America

I guess maybe the first question just around capital. Dean, you mentioned plans to resume share buyback. Give us a sense of one, as you think about going through the authorization, is there a certain level in terms of overall capital payout that you're targeting? And what's the binding constraint when you think about the Tier 1 leverage ratio? Where you're trying to maintain those ratios as you think about capital return, and also just the possibility of a dividend hike in the back half of the year?

Dean Shigemura, Chief Financial Officer

So the kind of the measurements that we look at is the Tier 1 leverage ratio. We've stated in the past that we'd like to stay above 7%. So we'll probably keep a little bit of room above that but that would be one measurement that would be kind of in consideration for how much we do in buybacks. In terms of the dividends, we have stated in the past that we like to be roughly 50% of our net income in dividends over the long term. So that's kind of a target that we would head towards.

Peter Ho, Chairman, President and CEO

I would add that the opportunity to increase the dividend likely hinges on net interest income. If we see some relief in the rate environment, I believe there is potential for improvement. Currently, our fee income levels seem fairly stable for the remainder of the year, and we have a good grasp of our expenses as well. Therefore, it really is the rate environment that offers the potential upside for the dividend.

Ebrahim Poonawala, Analyst, Bank of America

And I guess just on the rate environment and the NII. So Dean, thanks again for the guidance, relatively clear. Two things, one, as we think about, just a reminder us what's the PPP fee remaining at the end of the second quarter and your expectations around whether or not most of it gets accreted this year?

Dean Shigemura, Chief Financial Officer

We have $14.5 million left in fees, which will pertain to both the 2020 and 2021 vintages. We expect elevated levels similar to the payoffs we saw in the second quarter, with some amounts possibly extending into 2022. However, most of the remaining balances should be resolved within the next two quarters.

Ebrahim Poonawala, Analyst, Bank of America

And did you say the second quarter of PPP fees were $3.8, the accelerated component?

Dean Shigemura, Chief Financial Officer

Yes, $3.8 the accelerated component.

Ebrahim Poonawala, Analyst, Bank of America

So there should be something there. And just one last question, Peter, regarding the macro outlook you shared. From what I understand, it seems like international travel is one area that’s still lacking. Is there anything else you think is necessary to fully reopen before we start seeing unemployment decrease from 6% back to pre-pandemic levels?

Peter Ho, Chairman, President and CEO

So I think international is yet to bounce back. So what's interesting is we're nearly back to full strength in terms of visitor traffic and that's without the international market, which historically is call it a third of our marketplace. The benefit of that travelers, they are a bit higher spending, so I think that's upside out there somewhere as the international traveler returns. And then the other piece of the visitor segment is the group business and incentive. And beginning to hear those types of excursions beginning to percolate up again. But as you can appreciate, there is a bit of a lag before we'll start to see that traffic back in. So I think international and group and incentive is effectively the next legs up for the visitor industry and I think probably a little bit of a higher margin product than what we're getting right now.

Jeff Rulis, Analyst, D.A. Davidson

Peter, just to follow-on to that and not to be overly, I guess, conservative. But just trying to get a sense for the local sentiment, if there is any likelihood of restrictions coming back on with the variant. And I know that around the July 4th holiday, it lifted the restrictions on vaccinated folks. But any underway or thoughts locally that need to be taken back up?

Peter Ho, Chairman, President and CEO

Well, obviously, we, in this marketplace, like just about every place else in the country, are concerned about what we're seeing from the variants and the case counts. I've not heard any discussion around reapplying some of our earlier remedies. So no, nothing that I'm aware of. But obviously, if things continue to trend as they have, we'll need to begin to think through those sorts of protocols, visitor, and just kind of general public. I would say, though, that the early indicators are, Jeff, that the majority of the case counts right now are community spread and some from travelers but generally, returning Hawaii residents back from mainland locations. And the incident of visitor to resident transmission has been very low and continues to be pretty low.

Jeff Rulis, Analyst, D.A. Davidson

Maybe just a housekeeping kind of maintenance stiff. Dean, I appreciate the guidance on expenses. Just noted the occupancy and data levels were pretty low linked quarter. I guess baked into that guidance, is that sustainable on those line items and I guess if there's anything to discuss on those, why they were at that level also helpful? Thanks.

Dean Shigemura, Chief Financial Officer

So the property sale came through in that line, so the $2.1 million. So you have to adjust for that. And then in the second quarter we did have a little bit better R&M expense level. So that's a little bit uncertain but those were kind of the two reasons why the occupancy level was much lower in the second quarter, but mainly driven by the property sale.

Andrew Liesch, Analyst, Piper Sandler

The question is on the securities purchases, you added a billion dollars. I was just curious what you purchased? And then with rates having come in, I mean what's the appetite for more purchases to continue?

Dean Shigemura, Chief Financial Officer

So we've been purchasing kind of what we've been in the past, which were mortgage-backed securities, we did purchase some corporates, those are kind of the two major categories, but more biased towards the mortgage backs. And the average rate that we got in the second quarter was about 1.5%. And then with the drop in the long-term rates, obviously, the current rates are lower. So we're trying to be a little bit more measured in terms of how we are investing the money this quarter but we're still deploying a lot of the liquidity that we do have on the balance sheet.

Andrew Liesch, Analyst, Piper Sandler

So I guess you had the $910 million in cash. Is there a level that you want to manage that down towards? And obviously loan growth will help with some of that and probably some deposit outflows. But what level would you hope to get this down to?

Dean Shigemura, Chief Financial Officer

It will likely be around $250 million to $300 million. This is because we have significant cash flow coming from the portfolio. In terms of liquidity, we will continue to generate plenty of cash flow that we can reinvest into loans for growth. Therefore, we can maintain a cash level that's lower than $900 million.

Peter Ho, Chairman, President and CEO

Pipelines are looking strong for both consumer and commercial sectors. Commercial real estate had a solid quarter, and they expect a good second half of the year. Residential performance was robust, with a billion dollars in production during the first half, leading all local providers. This is a positive sign. With recent rate decreases, there is more activity in that sector, which is encouraging. Home equity is becoming more prominent again, and while indirect performance remained flat, given the current state of auto sales, it reflects a solid performance. These will be the key drivers moving forward. Construction may also show potential for growth as we initiate several affordable transaction types. What we are currently looking for are improvements in consumer categories and installment loans, as well as commercial and industrial sectors, both of which have faced challenges due to liquidity constraints in both commercial and consumer markets. Overall, I believe a mid-single digit growth rate over the next 12 months is reasonably attainable.

Jackie Bohlen, Analyst, KWB

Peter, I wanted to chat about the economy just a little bit. You gave some really great anecdotes there, which I love because it helps me get a sense for it, since you obviously have your feet on the ground. I just want to get a sense for how you view the rebound in tourism versus how you view the rebound in the economy overall. Obviously, I know they're interdependent but there's more to the economic rebound than just tourism. So I want to get your thoughts there.

Peter Ho, Chairman, President and CEO

So I would say that, obviously, the visitor industry is a big component of the local economy. But I think what we found through the pandemic is as big as it is, there are other factors that drive our local economy as well. And so construction driven by the health of the real estate sectors is in a good space, that's been helpful. The defense sector has been extremely strong and likely to get stronger given the geopolitical tensions in the Pacific here. And so those drivers, I think, have really been major contributors to the local economy getting back on its feet. And I think that in order for our economy to be at full strength, obviously, we need a healthy visitor segment. But there are other factors as well, and those factors seem to be doing well. The visitor front has been the velocity with which we've come back has really been surprising, at least to me, it has been surprising. And given variant notwithstanding, I think the opportunity for out of the next stage with the return of international travelers and the next stage with the return of group and incentive travelers bodes well for that important segment.

Jackie Bohlen, Analyst, KWB

And when you say group and incentive travelers, do you mean conferences and things like that, or is it a different type of travel you're talking about?

Peter Ho, Chairman, President and CEO

It's conferences. It's also large corporations rewarding star sales performers and things like that. It's a big segment of the industry.

Jackie Bohlen, Analyst, KWB

When considering the current economy and the unemployment rate, I understand this is a challenging topic to assess, but I would like to hear your perspective. Given the situation, do you think there are individuals who have not yet entered the workforce, possibly because their benefits are more advantageous than the income they would earn from working? Do you believe this is hindering the economy, or are we approaching a time when more people might start seeking employment?

Peter Ho, Chairman, President and CEO

Well, that's a $64,000 question, Jackie. I don't know. I mean, it is a fact that lots of small businesses and large businesses, in the visitor industry and elsewhere, are just having a tough time getting people to come back. And so you're right. Perversely, lack of demand, poor work is in a very perverse way, holding back the post-pandemic recovery. And whether the elimination or the reduction of federal and state subsidies will help that situation, I don't know. I mean you would think intuitively that it should. But I've also looked at a few reports that indicated, and I think half the states in the country have headed in that direction; they've not seen an overnight bounce back in worker supply. So it's the right question, and I just don't have as much clarity as I'd like to share with you.

Jackie Bohlen, Analyst, KWB

I completely understand. Hawaii is unique because it's an island, making it more difficult for people to move across state lines. I appreciate your understanding. Now, I’ll get technical regarding the quarter for one last point before I step back. Dean, I appreciate the accelerated amortization, and I wanted to confirm what the regular amortization portion of the fees was.

Dean Shigemura, Chief Financial Officer

Yes, it was $2.1 million.

Jackie Bohlen, Analyst, KWB

So the $2.1 million plus the $3.8 million?

Operator, Operator

And that's it for the question-and-answer session. We don't have any more questions in the queue. Presenters, I'm handing the call back to you.

Janelle Higa, Head 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 any additional questions or any further clarification on any of the topics discussed today. Thank you so much, everyone.

Operator, Operator

And that concludes our conference for today. Thank you for participation. Please, you may hang up now. Thank you so much.