First Hawaiian, Inc. Q2 FY2021 Earnings Call

Thank you, Anne. And thank you, everyone, for joining us as we review our financial results for the second quarter of 2021. With me today are Bob Harrison, Chairman, President and CEO; Ravi Mallela, CFO; and Ralph Mesick, Chief Risk Officer. We have prepared a slide presentation that we will refer to in our remarks today. The presentation is available for downloading and viewing on our website at fhb.com in the Investor Relations section. During today's call, we will be making forward-looking statements, so please refer to Slide 1 for our safe harbor statement. We may also discuss certain non-GAAP financial measures. The appendix to this presentation contains reconciliations of these non-GAAP financial measurements to the most directly comparable GAAP measurements. And now I'll turn the call over to Bob.

Thank you, Kevin. Good morning, and thanks for joining us today. I'd like to start with a quick update on the State of Hawaii. This is Slide 2 in the deck. We continue to see a steady increase in visitor arrivals and are approaching pre-pandemic levels with almost 100% being from the Mainland US. Restrictions on transpacific travel were further eased starting on July 8th when individuals vaccinated in the Mainland US were also allowed to enter Hawaii without a pre-travel COVID test. The economy continues to recover as the unemployment rate fell to 7.7% in June, a 15-month low and the housing market remains strong. We are continuing to make progress towards the goal of having 70% of the population vaccinated, at which point, all COVID restrictions are expected to be removed according to statements by the governor. Similar to the rest of the country, we have seen increases in new cases recently and the test positivity rate, which authorities are closely monitoring. Turning to Slide 3, I'll briefly go over our second quarter results. We had a very good quarter. We saw a broad based pickup in loan activity, strong deposit growth, a rebound in noninterest income while credit quality remained excellent. Total loans grew by $151 million, excluding the impact of PPP loan paydowns with growth coming in multiple categories. Deposit growth continued to be driven by commercial and consumer deposits. Diluted EPS was $0.67 and the Board maintained the dividend at $0.26 per share. We also repurchased $22.4 million of common stock under the current share repurchase program. And now I'll turn it over to Ravi to go over the financials.

Thanks, Bob. Turning to Slide 4. Period end loans and leases were $13.1 billion, down $197 million from the end of Q1. PPP balances declined $348 million. Excluding PPP balances, commercial and industrial lending declined by $209 million, primarily due to a $179 million decrease in dealer flooring balances. Excluding the impacts of PPP forgiveness and dealer flooring balances, total loans grew $330 million or 2.8% in the second quarter. We were pleased to see good growth this quarter in many categories, including commercial real estate, construction and residential loans, each growing by over $100 million. The loan pipeline is building and we reiterate our view that full year loan growth excluding PPP will be in the low single digit range. Turning to Slide 5, total deposit balances ended the quarter at $20.8 billion, a $701 million increase versus the prior quarter. This was driven by a $769 million increase in consumer and commercial deposits and partially offset by a $67 million decrease in public deposits. Our cost of deposits fell 1 basis point to 7 basis points in the quarter. Turning to Slide 6, net interest income was $131.5 million, a $2.3 million increase versus the prior quarter. The increase in net interest income was primarily due to higher average balances of investment securities and lower balances and rates on time deposits. Net interest margin was 2.46%, a 9 basis point decrease from the previous quarter. Core asset and liability repricing contributed about 4 basis points of net interest margin compression, while excess liquidity caused about 8 basis points of additional compression. Just a reminder, we currently consider excess liquidity as balances over $500 million. The decline in net interest margin was partially offset by higher income due to the higher balance of PPP loans forgiven versus the prior quarter, which increased net interest margin by about 3 basis points. In Q3, excluding the impact of excess liquidity and PPP loan forgiveness, we expect our net interest margin to decline 3 to 5 basis points. Turning to Slide 7, noninterest income in Q1 was $49.4 million, a $5.5 million increase over the previous quarter. Noninterest income was driven by a nice increase in credit and debit card fees and merchant services interchange, which in total contributed $2.2 million to the increase this quarter. Other service charges increased $1.5 million, of which approximately $1 million was from one-time fees generated by our commercial customers. Swap fees increased $800,000 and bank owned life insurance and trust income increased $900,000 this quarter. Noninterest expenses were $99.4 million, $3.1 million higher than the previous quarter. The increase was driven by a one-time charge of $1.2 million in salaries and benefits and $1.4 million in higher card rewards expenses, which was due to higher activity. The remaining increase was primarily driven by higher sales incentives paid in the quarter. The efficiency ratio was 54.7%. On a year-to-date basis, expenses are running about 4.1% higher than the same period last year. However, we continue to expect full year expenses to be about 7% higher than in 2020. And now I'll turn it over to Ralph to go over asset quality.

Thank you, Ravi. If you could turn to Slide 8, I'll make a few comments on credit. Asset quality continues to hold up and the recovery is underway with a strong return of Mainland tourists. In Q2, the net charge-offs for the quarter were $1.1 million, well below the $4.6 million recorded in the prior quarter. Our year-to-date annualized net charge-off rate is at 9 basis points, significantly lower than the levels in 2020 and 2019. The bank recorded a negative $35 million provision for the quarter. Non-performing assets and 90-day past due loans were marginally down this quarter with a 2 basis point decrease from the prior quarter to 12 basis points. Criticized assets continued to decline as well, dropping from 3.47% of total loans in Q1 to 2.51% in Q2. Loans 30 to 89 days past due declined 5 basis points to 22 basis points at the end of Q2. Moving to Slide 9, you see a roll forward of the allowance for the quarter by disclosure segments. The $35 million negative provision we recorded this quarter came on a more optimistic outlook and improvement in the portfolio credit quality. The allowance decreased by $31.2 million to $169.1 million, which is 1.29% of all loans and 1.38% net of the PPP loans. And with that, I'll turn the call over to Bob.

Thanks, Ralph. Finally, you may have seen the announcement last week regarding the addition of two new directors to the Board, Kelly Thompson and Jim Moffat. Their combined expertise in the areas of technology, strategic planning, risk management and e-commerce will provide valuable insight and guidance as we execute our digital transformation. As I mentioned on our last call, we introduced a redesigned fhb.com website and a new mobile banking app that includes features such as third-party account integration and personal financial highlights. The improvements have been well received as the number of visitors to our website has increased, and they are staying longer with higher levels of engagement. We have also seen an over 500% increase in active users for our new personal financial management tool, Money Map versus our previous offering. I also want to mention that our core conversion initially targeted for the third quarter of this year is being pushed back to the first part of 2022. And with that, we'd be happy to take your questions.

We have our first question from Steven Alexopoulos from J.P. Morgan.

I wanted to start, so Bob, as we've seen other parts of the US reopen, increased sales have been strong at companies, which has been great for deposit growth for banks but not so much for loan growth. As Hawaii increasingly comes back online, can you walk us through how this could or really should impact the loan portfolio? And what do we need to see to move up from the low single-digit guidance?

What we have started to see and this is what we talked about, I believe, in certainly the last call, maybe the last couple of calls is we're seeing the loan growth on the Mainland first and we're expecting to see the loan growth in Hawaii coming later, and that's with the exception of residential. Residential has been very strong here in Hawaii as it is in many parts of the country. The challenge here is staying ahead of the runoff. The commercial real estate construction has been somewhat in Hawaii as we have a number of projects that are ongoing and then on the Mainland as well. As we look forward, we're really going to see, as Hawaii gets back to work and people are spending more money, we've seen the activity numbers on the loan side, we think that there will be a recovery in the consumer area, credit cards have started, indirect lending will follow once there are a few more cars to purchase. I think that will be the first things that we'll see. And then later on, we'll see businesses kind of run through these high deposit balances they have and return to managing their money and doing some borrowing as well. This will take a little while after the recovery starts.

Bob, one thing I caught my eye was on one slide where you talked about home prices being up over 20% in one of the markets. And I know the zoning issues have been tough in Hawaii, right? Locals don’t want to give up more land for development. But just given the price increase, I know you're involved with some of this. Are there more calls for more supply, which I think would benefit you guys? Is there any traction on that side?

Yes, that's a very complicated topic as it is in many cities. I think the first thing a lot of people are focused on, certainly the county-level government is focused on better managing the Airbnb and the VRBO since that takes supply out of the local market. I think that's the first step in many counties here in Hawaii are very focused on, especially here on Oahu and to a lesser extent, on Maui. The next thing is you've seen a couple of large projects that were approved some time ago, and those are accelerating their development plans. So given that the market is so strong, they’re trying to push that ahead. Lastly, we are also seeing continued interest in high-rise residential condominiums here on Oahu. Several of those projects that have been talked about are moving ahead strongly. So altogether, that helps. Looking at land reform and the way we have our zoning process for agriculture to urban, that's a longer-term topic.

Maybe a final question for Ravi. On the securities book, you saw quite a bit of growth again this quarter. I'm curious what's the yield on what you were able to add in the quarter? And given this bit of a step down in rates, do you have less of an appetite here to continue adding?

Sort of the new volume rates have been coming in at around $120 million to $140 million depending on the duration of the securities we're buying. I think we're up to about $6.9 billion in balances on the investment security side. It will really depend on what's available. Certainly, it’s a lever we can use to manage liquidity during this time. But we don't want to grow the portfolio too much when we feel, as Bob had mentioned earlier in the call, that as loan growth starts to pick up, we want to take advantage of those opportunities and deploy our liquidity towards those loan opportunities. So right now, we feel very comfortable with where we are around $6.9 billion; maybe it might tick up a little bit, but it will really depend on what the environment is like going forward.

And Steve, maybe a follow-on to my earlier answer there, a key point I forgot to make is, for our dealer flooring, we're down right about $570 million from the four-year average balance ending 2019, and that's all supply driven. The amount of capacity and committed lines is out there hasn’t really changed that much. So as you see a recovery in that product, the manufacturer's ability to deliver cars, you'll see a pretty strong recovery both here in Hawaii and on the mainland in that particular portfolio.

And I guess the million-dollar question there is do dealers return inventory levels to where they were, which I don't think anybody knows at this point, but I hear you that it should get better from where it is. Thanks for taking my questions.

Our next question comes from the line of Jackie Bohlen from KBW.

I wanted to start with the expenses and just get a little bit of background on what drove the shift in the systems conversion timing?

Maybe a little bit of background on expenses. I think we talked a bit about the drivers quarter-over-quarter. I think the delay in the core implementation didn't really change our outlook for 2021 expenses. So we feel pretty comfortable with that 7% guidance that we gave. And I think when we look to 2022, we'll certainly give guidance as we typically do at the end of the year.

Was the shift in the conversion timing caused by internal factors or external factors?

It really is a conversation we're having with our technology partner, and we're cautious, and things were a little behind where we had wanted them to be. So we just want to be very sure we could do this successfully and want to give ourselves a little more time. The other issue is we just weren't comfortable doing the conversion in the fourth quarter. It's just that the fourth quarter brings in a whole bunch of other externalities that we didn't want to have to worry about.

And then just in terms of the employee base and kind of where you sit today versus what you would consider full employment aside from the separate matters which I'm assuming relate to the past announcements. But just wondering where you stand and how any recruitment efforts that you might be having are going just as everything kind of wakes back up?

We didn't let anybody go as we closed 40% of our branches during COVID. We just redirected them to other areas of the bank. Having said that, we also didn't replace people necessarily as normal attrition took place, people moving, retiring, etc. So we're still out there even though we don't have huge needs; we're always out there trying to find the right employees, and it's difficult right now. It's just a tough environment to do that depending on what job, of course, different jobs have different challenges. But we've been moderately successful, but it is not easy right now, a challenge that I think everybody in the market is facing.

And are your recruitment efforts geared toward any one place in the spectrum, meaning more entry-level positions versus kind of middle or upper management, or is it more broad-based?

I think it's probably more entry-level positions and there are certain specialized areas. Of course, we're always looking for certain people in the technology area, and that's always a challenge. Any time we can find someone with that skill set, we tend to grab them right away. But it's typically more entry level.

Our next question comes from the line of Ebrahim Poonawala from Bank of America.

I have a question about dealer finance. We've seen another decline. Bob, based on your earlier comments, do you think those balances have stabilized? Is there potential for significant improvement in the second half of the year, or is it mostly a 2022 issue at this point?

It's hard to predict. The two factors we talked about, first of all, congratulations on your promotion. That's great news. And to address the question, the hard part is trying to pick when manufacturing capacity will increase and demand will moderate. So we haven't seen either of those come back, although you're starting to see the semiconductor issue that affects so many manufacturers. It looks like the semiconductor companies are starting to pivot towards making more chips for cars, which should help in the back half. The question will be, is that going to be enough to keep up with the demand that still seems to be quite strong? What we're hearing and talking to a whole bunch of our customers, our customers are kind of a mix of the conversations between the West Coast and here, and they expect to see some return in the back half of the year, but nobody is predicting it gets back to normal inventory levels until probably early 2022.

And just in terms of, I guess, quickly when you think about fee revenue, we've seen a fair amount of recovery, I guess, close to pre-pandemic levels. How are you thinking about the outlook for fee revenue activity and customer activity as it impacts fees?

Maybe I can start and I'll hand it off to Ravi. I think the missing piece we're seeing here, and of course, a lot of that’s activity driven, which Ravi can speak to, is we don't have our international travelers back yet and that won't be until the end of this year, early next year, primarily Japan but also Canada. That has been in the past over 20% of our travelers and generally higher spending travelers. So that's a positive indication for later. But Ravi, maybe you can address what's happening there.

Certainly, we saw a nice uptick in credit and debit card fees along with merchant services interchange. That's really a reflection of economic activity here. Frankly, it's hard to get a dinner reservation these days in Honolulu. To the extent that that continues on and we continue to see that level of activity, I think we feel very good about that line item continuing to support our fee income for the rest of the year. Some of the other lines, other service charges, we talked about the number of one-time fees generated by our commercial customers, we typically see those quarter-over-quarter, there are always one-time opportunities for us, and we continue to expect to see those types of one-time items over the course of the year. Trust and investment income has been strong and consistent over the course of the year. And certainly, we feel that, that really will continue. The bank-owned life insurance, we saw a recovery this quarter, primarily due to some investments we have that are marked to market in the portfolio. As long as rates stay relatively stable, we feel pretty good about that line too. And swap income had a nice little pickup this quarter. I think that's a reflection, hopefully, as we start to see more loan growth on the commercial side. We'll see swap income continue to rebound from where it was previously. When you put all those things together, we feel pretty good about a range of $47 million to $49 million for the next quarter.

Our next question comes from the line of David Feaster from Raymond James.

I appreciate the commentary on the pipeline in the prepared remarks. I just kind of wanted to follow up on that. You get a sense of some of the puts and takes with loan growth. I mean we talked about the dealer floor plan, but how have originations trended and how have payoffs and pay downs been an offset to that? And just the composition of the pipeline, is it similarly well balanced like we saw the growth in the quarter or were there any segments that you're seeing notable strength?

A couple of things, maybe, this is Bob, David. And maybe I'll comment and ask Ralph to make a couple of comments. We're seeing some transitions in our dealer portfolio, some customers who are selling and new customers are buying and we've been fortunate to be able to help them with those transitions. So that has led to some nice line growth in that area and some loan growth as well, although, given the depressed level of flooring balances, that's an opportunity for later more than it is for today. We're also seeing some good commercial real estate activity, both here and to a lesser extent on the West Coast. So that is ongoing. And then with that commercial real estate activity is on the construction side, deals that have been in place for some time that are now funding. We're expecting several of the projects that we're lending on to finish up later this year. This is the part of the construction cycle where they're actually doing their draws. Before it was more of the equity going in and now it's actually the bank money finishing the project before they go into sales. But Ralph, anything you want to add to that?

No, I think that pretty much sums up the areas that we're seeing growth.

I just want to follow up on your comments on construction. I was just curious, how much of the growth this quarter is drawing on prior commitments versus new deals? And just how do you approach underwriting construction projects in light of the inflationary pressures on both building materials and labor in this environment?

I believe that earlier this year, some projects experienced delays due to efforts to manage costs. This situation is likely to resolve itself, but it may lead to a temporary increase in activity. We are starting to see the loans we originated begin to fund, and we are also closing new loans at a steady pace. Interestingly, we are noticing an increase in aggressive takeout activity. Previously, we would hold onto an apartment loan until the project stabilized, but now we are seeing borrowers paying us off once the project is finished. We are even seeing requests to refinance before the project is complete, which suggests there is a sufficient supply of credit available in the market.

And I'd just like to shift gears to the technology. I mean what you guys have been doing is pretty impressive, and you talked a lot about it being this open API structure. I'm just curious, how do you think about fintech as an opportunity to leverage that and play into this? And whether there's even any partnerships or investments that you guys can make in fintech and embed that in your platform? Just any thoughts on that front.

Dave, that's something we look at very closely. We certainly are looking to probably partner first and invest at some point in the future. We aren't quite at that stage yet, but we are very actively looking at ways to partner with different fintechs and non-fintechs, but other technology partners to do things that they can do faster, better and much less expensively than we can.

David, this is Ravi, and maybe I'd just add that the open API architecture that we're building towards actually gives us a tremendous amount of flexibility. We are building towards a capability where the fintechs and the products that they have available to us, we'll be able to partner quickly with them so that we have the best of breed when we have our infrastructure set up, we'll be able to partner with the best-of-breed fintechs and work with them closely.

Our next question comes from the line of Andrew Liesch from Piper Sandler.

Question on the allowance and the negative provision reserve ratio is still above the day one CECL level. But is this now a level where you're comfortable where you think you’d grow into it at this point, or do you think there could be other reserve releases at some point down the line?

I believe we need to assess whether the current rebound, which is better than we expected, is sustainable. It's important to determine how this affects our business clients and households in the coming quarters. With the increase in infection rates due to the variant, we need to monitor the situation closely. Additionally, we want to understand the impact once stimulus and relief programs end, particularly if our consumers can maintain their strength. It's difficult to predict right now, but the recent data shows a significant recovery, and the outlook is getting better.

And then Ravi, I think you said, excluding the impact of excess liquidity and the PPP forgiveness expect looking for the margin to be down 3 to 5 basis points. On that liquidity front, I mean, I know it's still somewhat early in the quarter, but what have you seen so far? Has that been alleviated at all what flow are you seeing there?

I think over the course of the quarter, we mentioned commercial and consumer deposits were up quarter-over-quarter. To the extent that we see PPP loan forgiveness continuing at a pretty good clip, some of that money is going to flow back onto our balance sheet in the form of liquidity. It’s a little early to say where liquidity levels are going to go, but certainly, as we mentioned before, we have quite a bit of capital. We have plenty of room on the balance sheet for loan growth. When we see those opportunities come, we're going to be able to take advantage of it.

Our next question comes from Jared Shaw from Wells Fargo.

I guess, with loan growth and the sort of persistent headwinds from flooring, any change in your appetite to retain or book more residential loans, maybe beyond what we saw this quarter but as a percentage of the loan book for a longer period of time?

I think it will be a reflection of what we see sort of in the marketplace. The marketplace is, I think, slowly starting to move towards more of a purchase market. As that market shifts from purchase and refinance, we'll see the reflection on the balance sheet of either retaining more loans or selling. Certainly, the bump here, $106 million quarter-over-quarter in residential was good for us and we like those loans. We like the quality of those loans. When we feel it's appropriate, we'd like to put those on the balance sheet.

Just to add to that, given where pricing is at, the average price of a home is quickly moving out of Freddie and Fannie category here in Hawaii. A lot of the new loan origination is not able to be sold at least for Freddie or Fannie.

And then on expenses, I guess, first, looking back into your full year guidance that sort of assumes dollars of expenses stay relatively flat from where we are here even with some of those items that were called out. As we look with the move of the timing of the core conversion, were there any expenses associated with delaying that, that are in '21, or will the expense, sort of the main expense of that conversion move now from '21 to '22?

I believe there are many factors at play here. Some aspects will certainly shift into 2021. For instance, we are training our frontline staff a bit more extensively, which is one of the impacts. This approach benefits us now, but we will need to allocate those funds at some point. Additionally, we are extending some current relationships with technology providers to ensure we meet our goals next year. There will be various fluctuations involved. Nonetheless, we remain confident that our guidance for 2021 is solid, and when we assess these fluctuations, they do not significantly affect this year.

And do you have a date set for the conversion or is that still to be determined?

We're still working on that with our technology partner, but looking for Q1 of 2022, if everything works out well.

Our next question comes from the line of Laurie Hunsicker from Compass Point.

Just wondered how your credit is looking. I didn’t see any deferral numbers in any of your deferrals last quarter that was very, very low at $81 million. Can you just give us an update on where we are with deferrals?

Right now, we're at $35 million in deferrals. And of that, I think it's about $21 million is residential mortgages. So that's down from, I think, $2.4 billion we had on the books of loans that had been granted deferrals last year.

And then I just wondered if we could go back on the PPP loans, I appreciate all the detail. The $23 million is the remaining unamortized piece of PPP. How much is that round one? Or how should we think about the pace of that forgiveness, is the majority of that $23 million potentially forgiven in the back half of this year? How should we be thinking about that?

It's a little hard to say when we think it's going to be coming out. I think round one and the balances related to that are around $2 million. Round two, which came in partnership with round one, is really low. The bulk of it really came in the latest round in Q1. To the extent that we get the forgiveness pipeline going, which is what we did at the start of Q2 as we shifted our attention to helping our customers go through the forgiveness process, it'll just take time and we’ll just have to see how it plays out.

Just to add to Ravi's answer, what we're doing is kind of a barbelling, because the easier forgiveness is for loans of $150,000 and under. We've been very engaged with those customers. For the very larger loans, which have more sophisticated CFO and accounting staff, it's been easier to work with them. We're kind of in the group in the middle, so it's taking a little bit more hand-holding, and we'll just have to work through that with the customers.

And then just on a last question, as we put all of that together, and we look past PPP, we're kind of three quarters out or whatever the number is, and there's still obviously some challenges on margin. If our core margin is running at $2.35, is that the right way to be thinking about this or is there a better guide you can give us on that?

I think it will depend on a number of different factors. It will depend on what we see with respect to the loan portfolio, our appetite for investment securities, and deploying some of that liquidity going forward and just general levels of liquidity. So it's probably a good number to start from, but from there, things could change, go up or down depending on what we see.

Our next question comes from the line of Jackie Bohlen.

I just wanted a refresher on capital targets and ratios. I know the ratio didn't really change much quarter-to-quarter but I feel like the economy is rapidly evolving. So just an update on how you think about the capital ratios you're targeting and if the quarter's pace of repurchases was a pretty indicative level?

Jackie, this is Bob. Maybe I'll start and hand it over to Ravi. We haven't changed any of our targets. We're still looking at common equity Tier 1 at 12%. We’re still well above that, as you can tell. As Ralph had mentioned, it's a little hard to predict as far as where the credit quality will continue at this level or if there will be challenges as the stimulus wears off and various other things. Lastly, we'd love to see that capital being used to support loan growth, and it's a little bit early to figure that out. But Ravi, anything to add?

Jackie, I'd just add that I think we mentioned during the call that we did about $22.4 million in share repurchases in the quarter. We think that's a pretty good pace for the quarter and kind of puts us in line with the $75 million of share repurchases that we are authorized to do in the year. Given where capital levels are, we feel confident about kind of moving through that consistently over the course of the year.

Anne, I think we have one more question from Brock Vandervliet in the queue.

So we have one more question from Brock Vandervliet from UBS.

This is Sean filing on for Brock. Going back to credits and clean recovery. What should we think about in terms of the non-performing loans profile the next couple of quarters?

The non-performing asset profile, is that what you said, Sean?

The non-performing loans?

I think as we thought through this going in, we would have anticipated taking provisions and seeing those provisions eventually sort of flow into losses. You look at where the level of non-performing loans are today, they're very low. At this point, if that trend continues, we're not going to see a lot of losses this year, not to the extent that we saw. But as I said, we have to kind of see how strong this recovery is and what happens with our consumers and households once the stimulus programs go away. We're prepared to take quite a bit of loss in the provision today. I think as you look at about 138 basis points net of PPP, that's fairly large. It's something that would be indicative of more of a recessionary sort of level of provisioning.

Thank you. And now I will turn the call over back to Kevin Haseyama.

Thanks, everyone, for joining us today. We appreciate your interest in First Hawaiian, and please feel free to contact me if you have any additional questions. With that, enjoy the rest of your day, and have a good weekend.

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