First Hawaiian, Inc. Q3 FY2021 Earnings Call

Good day and thank you for joining us. Welcome to the First Hawaiian, Inc. Third Quarter 2021 Earnings Conference Call. At this moment, all participants are in a listen-only mode. After the speaker's presentation, we will have a question-and-answer session. I would now like to turn the conference over to Kevin Haseyama, Investor Relations Manager. Please proceed.

Thank you, Ashley. And thank you, everyone for joining us as we review our financial results for the third 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 one 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 will turn the call over to Bob.

Thank you, Kevin. Good morning, everyone. Thank you for being here today. I would like to begin with an update on the COVID situation in Hawaii. Like many areas, our economy's health is closely linked to our ability to manage the virus, and we have done quite well, with over 70% of the population fully vaccinated, and an impressive 92% of those over age 12 having received at least one dose. We experienced a surge in late August and early September due to the Delta variant, but as shown in the lower left, cases have generally decreased significantly. Hospital capacity is sufficient, which has eased concerns. The governor has announced that we will fully welcome back visitors starting November 1st, and all our elected officials are committed to keeping Hawaii open for tourism, so we expect to see an increase in visitor numbers. We have already begun to observe a slight rise in daily arrivals this month. As restrictions are lifted and tourists return, we anticipate a more normalized economy heading into the holiday season. Moving to our financials, total loans grew net of PPP paydowns. Our performance in the quarter was solid despite the impact of the Delta variant. Deposits continued to grow across all categories, and both non-interest income and expenses remained stable. Credit quality stayed excellent, and the diluted earnings per share was $0.50, with the Board maintaining the dividend at $0.26 per share. During the quarter, we also repurchased $21.6 million of common stock under our current repurchase program. Now, I will hand it over to Ravi to discuss the financials.

Thank you, Bob. Turning to slide four. Period end loans and leases were $12.8 billion, down $269 million from the end of Q2. Excluding the impact of PPP loans, total loans increased by $39 million. We had some good activity in several areas, but dealer flooring remained a headwind, declining another $103 million. Excluding the impacts of PPP repayments and dealer flooring balances, total loans grew about $142 million in the third quarter. Growth was driven by increases in residential, commercial real estate, and home equity. Looking ahead to the fourth quarter, we’re expecting net growth in loan balances, but because of the delayed recovery in dealer flooring, we now expect total loan balances ex-PPP to be flat to up 1% for the year. Turning to slide five. Total deposit balances ended the quarter at $22.1 billion, a $1.3 billion increase versus the prior quarter. This increase was driven by a $782 million increase in public deposits and a $503 million increase in consumer and commercial deposits. The increase in public deposits was almost entirely in operating account balances. Our cost of deposits fell 1 basis point to 6 basis points in the quarter. Turning to slide six. Net interest income was $132.6 million, a $1.1 million increase versus the prior quarter. The increase in net interest income was primarily due to higher average balances of investment securities and higher cash balances. Net interest margin was 2.36%, a 10-basis-point decrease from the previous quarter. In Q4, excluding the impact of excess liquidity and PPP loan forgiveness, we expect our net interest margin to decline for 2 basis points to 4 basis points. Turning to slide seven. Non-interest income in Q3 was $50.1 million, a $733,000 increase over the previous quarter. Non-interest income in the third quarter included a $2.3 million BOLI debt benefit. Non-interest expenses were $101 million, a $1.6 million increase versus the prior quarter and the efficiency ratio was 55.1%. And now, I will turn it over to Ralph to go over asset quality.

Thank you, Ravi. If you could turn to slide eight, I want to provide a few comments on asset quality. We continue to see good credit performance, realized credit costs remain low, and we released provision again this quarter. Net charge-offs were $602,000 in Q3, the annualized net charge-off rate is at 6 basis points year-to-date, lower than the levels we saw in the prior two years. NPA and 90-day past due loans were marginally down this quarter to 11 basis points, a 1 basis point decrease from the prior quarter. Criticized assets increased during the quarter, moving from 2.51% of total loans in Q2 to 2.98%. Loans 30 days to 89 days past due increased 13 basis points to 35 basis points at the end of Q3. The increase was attributed to the delay in the closing of an extension of a single CRE loan. Moving to slide nine. You see a roll forward of the allowance for the quarter by disclosure segments. The allowance for credit loss decreased by about $7.9 million to $161.2 million at the end of the quarter. This level equates to about 1.26% of all loans and 1.31% net of PPP loans. Our reserve for unfunded commitments increased by $3.3 million to $32.5 million. In Q3, we reported a $7.3 million release against the allowance through the balance changes and some improvement in consumer FICOs. Our outlook for the economy was unchanged, we anticipate the recovery started midyear will continue, but still maintain a COVID-related overlay, given uncertainty that could result in higher credit loss. These uncertainties include the effects of the new virus mutation on travel and leisure activity, as well as the impact of monetary and fiscal action. Let me now turn the call back to Bob.

Thank you, Ralph. This was another solid quarter, credit quality remained excellent. We’re continuing our investment in technology to improve our digital capabilities and our customer experience, and our balance sheet is well-positioned for rising rates. And with that, I’d like to open it up and take your questions.

Your first question comes from Ebrahim Poonawala with the Bank of America. Your line is open.

Good morning.

Good morning.

Good morning.

Regarding loan growth, you provided an update for the full year excluding PPP. Can you share your thoughts on whether the dealer finance book has reached its lowest point and what you anticipate for its recovery next year, considering that supply chain challenges may persist? Also, could you provide a reference point for the size of this book at its peak before the pandemic?

Thank you for the question. We received positive news today regarding the automotive sector from our dealer team. The head of GM's North America Business mentioned they are making progress on shipping pickups, starting with high-margin vehicles and working their way upwards. These companies are working tirelessly to resolve supply chain issues. While I can't specify our peak, the normal figure at the end of 2019 for our dealer flooring balances was around $860 million, and now we are significantly lower at $176 million. This means there is considerable room for growth. Year-to-date, we have seen a $460 million decrease in balances. It's difficult to determine the exact low point, as we had anticipated a slight increase that hasn't materialized due to ongoing supply chain challenges. We will continue to monitor this situation, and we hope car manufacturers can increase production volumes. There will still be a backlog to address with customers who have purchased vehicles in advance, which will delay the restoration of flooring balances. Recently, GM's head expressed a desire to see increased inventory within their dealer network, indicating a trend toward higher production. The timing of these developments remains to be seen. In terms of loan activity overall, we are observing a robust mainland performance. Our commercial and industrial usage for revolving lines has stabilized recently, while residential activity remains strong. An anecdotal note for this quarter is that a couple of large projects on Oahu are concluding, which may lead to a decline in commercial real estate construction balances. However, we expect this to be offset by the take-out loans on the residential side related to those same projects. There will be some shifts during the quarter, but it appears we are at a low point with potential for improvement. We will need to see how quickly the flooring business rebounds.

Thanks, Bob. In terms of economic activity, can you provide insight on slide two regarding COVID and the associated restrictions? Where do you believe we stand in terms of normalcy in the hospitality sector, especially as we approach the holiday season and winter? Are we fully operational, or will hotels be running at around 80% capacity? I'd appreciate some perspective on that.

Yeah. I certainly can’t predict what the holidays will bring, but the normal shorter season, which is what we’re in right now, September and October, we always see a drop-off in tourist arrivals from summer into the fall and then typically it builds back in the holidays as people take their vacation. I can’t think of any hotels that are still closed. I think everybody has tried to open, certainly the major ones, and they’re adjusting their staffing depending on what occupancy is. So everybody’s ready and we will just have to wait and see. As we’ve talked about in previous conversations, many, many families come to Hawaii every holiday season and we will just have to wait and see if they come this year and choose to travel. But I think the hotel rooms are booked, we just have to see if people show up.

Got it. And just one last question for Ravi, what was the end of period balance on PPP at the end of Q3 and how much in fees is left to be recognized?

Yeah. We have about a little over $500 million in terms of remaining balances, and sorry, Ebrahim, I missed the second part of the question there.

What are the fees tied to PPP that are left tied to that $500 million balance?

It’s $14.4 million.

$14.4 million and safe to assume that you expect the next two quarters, three quarters, most of that gets forgiven.

Yeah. I think, if we look at next quarter, I think the last couple of quarters is a good reflection of the pace we’ve been moving at. So I think over the next two quarters we should be through the majority of it.

Got it. Thanks for taking my questions.

Your next question comes from Steven Alexopoulos with JPMorgan. Your line is open.

Hi, everyone.

Good morning, Steve.

Good morning, Steve.

I wanted to start then drill down a little bit on C&I, if we take PPP loans and dealer loans and we put those aside, can you talk about the change you saw in the C&I pipeline in the quarter? Any notable increase in commitments and what was line utilization? I know you said it was stable?

Ralph, do you have the line utilization number?

Yeah. It was a shade over 20% and I think what we saw pre-COVID it was probably around 30%. We’ve probably gone down into the mid-teens at the low point. So it started to come back a bit there.

We are noticing some activity in the corporate sector, although it's not significant. The activity has been somewhat subdued. We have had a few payoffs, but not as many as we had hoped, as these transactions have moved to capital markets or mergers and acquisitions within that portfolio. Overall, it has remained quite stable. There's been a modest amount of new growth, and I believe the market is present. We will see what the next few months hold, as deal-making usually picks up at the start of the year, but we will just have to wait and see.

Okay. That’s helpful. And then maybe for, Ravi, you have built a pretty sizable cash position here, it looks like the guidance you’re expecting more deposit than loan growth over the near-term. Now that rates have moved up a bit, has this changed your appetite? Should we expect more of that liquidity to move into the securities book or do you anticipate this cash balance building further here?

We have grown our securities portfolio by about $1 billion this quarter, bringing it close to $8 billion. We are looking at the overall balance sheet and would appreciate seeing some loan growth to assist with our current liquidity levels. However, we will need to approach it gradually. At this stage, we feel reasonably comfortable with our securities level. As we begin to deploy some of that liquidity, we hope to see those balances decrease. For now, we are satisfied with our securities level, knowing it may fluctuate, but we will need to manage that liquidity over time.

Okay.

And it is Bob, Steve. The only thing I would add to that is you saw a large increase in the public operating accounts, is that relationship with the various municipalities in the state has been very fluid. Just the amount of cash they have coming in and going out is hard to predict.

Got it. Okay. And then, Bob, just a final one, I mean, just about every bank is talking about wage pressure here and I have been paying a lot of attention to the situation in Hawaii, but is that a pressure point and could this impact your expense growth over the next year? Thanks.

Yes, that’s a good question, Steve. We are experiencing similar issues. Our jobless rate did decrease yesterday from 7% to 6.6%. While there are still individuals searching for jobs, there is significant hiring activity occurring. Consequently, we are experiencing some wage pressure, which we have been navigating for more than a year in our business. While I can’t guarantee we won’t encounter this issue, it is challenging to predict its impact moving forward.

Okay. Okay. Thanks for all the color.

Your next question comes from David Feaster with Raymond James. Your line is open.

Hi. Good morning, everybody.

Good morning.

Good morning, David.

I noticed some positive growth in commercial real estate during the quarter. I am curious about where you are seeing the strength, particularly in comparing the U.S., mainland, and Hawaiian markets. Additionally, could you share your insights on the competitive dynamics you are observing? We've heard about increased competition in terms of pricing, as well as structural and standards aspects, so I'm interested in your perspective on the commercial real estate landscape.

Yeah, this is Bob. I’ll start and ask Ralph to add some comments. We’ve continued to see pricing pressure in Hawaii, although not much in terms of structure. Activity has been significantly higher on the mainland, especially on the West Coast, where we have several direct relationships and connections with other banks. It seems that there are quite a few transactions happening there that we’ve been able to be part of. I anticipate that we will see increased volume over time, although there will be some challenges, particularly with a couple of large projects being paid off in the fourth quarter on the commercial real estate construction side. Ralph, do you have anything to add?

No. I would say that on the mainland where we’ve seen pretty good activity right now. Most of what we’re doing there is sort of institutional quality type real estate, institutional type players. So I think in terms of weakening of terms, it’s not that big of an issue as it would be maybe in the smaller loan market.

Okay. That’s helpful. And then maybe just touching on fee income and getting some of your thoughts on the puts and takes there, just on card fees, which have pretty much recovered back to where we were in the trust department and the trends you’re seeing there? And then just appreciate the color on the BOLI benefit, but have seen several other banks add the BOLI, just curious your appetite for BOLI here too?

Please, Ravi, go ahead.

Sure, I think I'll address them one at a time, David. It’s been encouraging to see the increase in credit card and debit card fee income, especially with the activity we've had over the summer. There was a slight decline, which I would attribute to entering the shoulder season and possibly some impact from the Delta variant. However, the numbers are strong, and we expect that to remain steady throughout the rest of the year and into the vacation season. In terms of trust and investment income, we've seen it be very strong and stable, with the core revenue coming from recurring sources, which has been a solid area of growth for us over the past year or so. Regarding BOLI, we believe we are at the upper limit of what we can have in our portfolio from a capital perspective. Therefore, we don’t plan to add to our BOLI portfolio, but we do anticipate it will perform well and consistently in this environment going forward.

Okay. That’s helpful, guys. Great color. And then just last one for me, asset quality has been phenomenal. You guys do a great job there. Just wanted to touch on the modest uptick, I mean, it’s small, but just the uptick in criticized and past due balances and your thoughts on overall asset quality here?

Sure. Dave, this is Ralph. The increase in the criticized loans is about $62 million. And really, that was around, I think, about five credits, shared national credits that got downgraded during the exams that are conducted at the Asian banks. Now we look at those credits, we don’t see much lost potential there. These companies have really good financial flexibility, sound businesses and I think it really sort of a different perspective maybe that the regulators had from the banks. So nothing, I don’t think really happening there. I think this trend that we’ve seen can kind of continue to improve. And then on the past due side, that was really kind of an administrative delinquency on one loan and we’re at 35 basis points. So, just one loan could create quite a bit of a change in that statistic.

Was there anything within those five credits that indicated any trends or similarities within the industry, or was it just an isolated case?

No. They are in higher risk areas, but the trends are probably improving. The regulators review those deals annually. They were downgraded to a special mention, which means there's potential weakness, although it may not be well-defined. We downgraded those credits and have reserves for them. Therefore, we are quite comfortable with the asset quality picture right now.

Okay. That’s helpful. Thank you.

Your next question comes from Andrew Liesch with Piper Sandler. Your line is open.

Good morning, everyone.

Good morning.

Good morning.

Good morning.

Just want to touch on expenses here; pretty well controlled and I know you pushed off the timing of the conversion into next year. It sounds like there might be some inflationary pressures. But how should we be looking at the expense base and expense growth for next year? I think you were guiding to 7% for 2021, which all seems reasonable? I mean how should we look at it going into next year?

Yeah. Andrew, this is Ravi. I will comment a little bit on that. Typically, we don’t provide 2022 guidance yet. But I will make some comments about sort of how we see the future in terms of our expense profile. Bob alluded to sort of inflationary pressure that we’ve seen, particularly in wages and particular in some very specific categories that are high in demand. So that’s one area. I think we’ve talked about this in the past, our continuing investment in technology, it’s a big part of our goals for the future and we are going to continue to invest in technology to be competitive. Another area just to talk about is just the core. I think we will see, as we get closer and closer to the implementation of core, we’re going to see training costs continuing on. And when we eventually go live, we will see that the capitalization of the development cost start to roll into the expense line in the form of amortization of the core itself. So that’s some guidance or color, not guidance, but just some color on where we think things are going for the future.

Got it. Makes sense. Is there any time you can provide on the conversion?

Andrew, this is Bob. We’re looking at the first half of next year still and trying to pull that in. We’re feeling very good about where we’re at. But since we’ve delayed it, we don’t want to jinx ourselves by being too specific. But we’re feeling very good about where we’re at and the progress we’ve made and we didn’t want to do it in the fourth quarter candidly because it just didn’t seem like a good idea relative to year-end.

Understandable. Makes sense there. And then, just with the rapid deposit growth, some of these obviously public funds that may go the other direction at some point, but that put some pressure on capital ratios. How should we be looking at the buyback? I know you guys have wanted to be consistent with share repurchases, but how should you be looking at that asset growth versus the buyback right now?

Yeah. Maybe I can start. This is Bob and ask Ravi if he has any comments as well. Something we’re looking at in our budgeting process. Clearly, we’re hopeful that we will see loan growth come back next year with just some of the lines of credit that we have both for our corporate customers and certainly our flooring line customers. And that amount of capital that we’re holding above our target will kind of get absorbed into the loans portfolio through risk-weighted assets. And on that planning process, we will look at our profitability. We know that we’ve been a very steady capital return bank and that’s something that’s very important to us. Certainly, the dividend is critically important to us, and we’re not seeing any changes in that. We will just have to decide how much capital we will have left after we’re investing in our technology and look to maintain the share repurchase program. But we don’t have any idea at this point on what the level would be or what we’re looking at in that. Ravi?

I didn’t have anything to add.

Got it. All right. Thank you for taking the questions and I will step back.

Your next question comes from Jared Shaw with Wells Fargo. Your line is open.

Hi. Good morning, guys. Thanks for taking the questions.

Good morning.

Good morning.

Looking at loan growth to achieve the 1% ex-PPP growth target this year, it seems like there's a ramp-up in the fourth quarter. How should we consider residential mortgages as part of that, as they have certainly increased as a percentage of the overall portfolio? Will they play a bigger role in the lending narrative moving forward?

Yeah, Jared. Good morning. This is Bob. In the fourth quarter, we expect to see an increase in residential lending due to three large projects that are wrapping up, with a couple currently in escrow for residential loans we’ve approved for customers. These will close in the next few weeks as the projects finish, providing a notable boost to our normal volume. Like many other areas, we’re experiencing a slight slowdown in refinance activity, while new purchases remain stable except for these projects. Therefore, residential lending should be quite strong in Q4.

Okay. Thanks. And then shifting to the reopening of the state, you touched on a little bit of the labor market. But is there enough labor capacity in the state to sort of handle a full reopening or that require maybe some return of people that may have left the state at the beginning of COVID?

Yeah. To be honest, I don’t have a great answer for you on that. To be determined, we had our unemployment rate. Kevin, was it 2% or something before, the low point. And now we’re at 6.6%, 2%, 2.5%, below 3% and now we’re at 6.6%. So we’re still quite a few workers out there that are looking for jobs and will that be sufficient to absorb the demand of the return to tourism. I don’t know to be candid with you.

Okay. And then, just finally for me, when you’re looking at the NIM guidance, Ravi you’re saying that, excluding the excess liquidity, what is the excess liquidity that we should be thinking of at this point?

It’s hard to say...

Just the dollar value there. Yeah.

Yeah. It’s hard to say; I think last quarter it was about 8 basis points impact of excess liquidity. If we start to some of those, as Bob mentioned, those public deposits move off, certainly the impact of excess liquidity coming from that part of the deposit base will decline, but we’ve also seen pretty good strong growth in commercial and consumer deposits. So it will really depend on what happens in the next quarter or two.

Okay. Thanks. Thanks a lot.

Your next question comes from Laurie Hunsicker with Compass Point. Your line is open.

Great. Thanks. Good morning.

Good morning, Laurie.

I was wondering if you could provide some details about the $2.1 million in litigation costs.

Yeah. I can touch on that. This is Bob. Good morning, Laurie. And there just some commercial dispute we had with our vendor and we didn’t feel they were performing to our expectations and so unfortunately it got into litigation, but we should have that resolved, we’re hopeful very soon.

Okay. And then when I look at that other expense line, the $16.2 million, even netting out that $2.1 million, it’s still looks high, was there any other one-time items in that bucket to think about?

Nothing specific, Laurie. I mean a lot of small little things, in particular a couple of catch-up items that we had, but nothing specific.

Okay. I mean, I guess, if we were to think about where that line would run, is it going to run closer to sort of $13 million a quarter give or take or how should we think about that?

It’s hard to say, there’s a lot of sort of small items that are in that line. I think $13 million isn’t such a bad number in terms of what we expect it to be, but it will just depend on sort of one-time items that might show up in the quarter itself.

Okay. Great. That’s helpful. And then, tax rate, how should we would be thinking about that for next year?

I think barring anything else that happens out there with respect to policy. I think relatively consistent with where we are, maybe trending a little bit downward. We continue to engage in low-income housing tax credits as an opportunity to manage our effective tax rate. And so as we sort of roll into new opportunities there, we will start to see that kick down a little bit. But that takes time as we build that portfolio.

Okay. Great. And then last question for me, deferrals, I didn’t see a deferral update in your deck or in your press release; I am hoping you could give us the number. I know it was incredibly low last quarter at $35 million. Just wondered if you had an updated number on the?

Yeah. I think what’s left now, Laurie, this is Ralph, is about $16 million.

$16 million. Okay. And do by chance have a split in terms of what’s commercial versus what…?

Yeah. I don’t. But it’s almost exclusively residential mortgage.

Perfect. Okay. Thank you very much.

There are no further questions at this time. I will now turn it over to Kevin Haseyama.

Thank you. We appreciate your interest in First Hawaiian and please feel free to contact me if you have any additional questions. Thanks again for joining us and enjoy the rest of your day.

This concludes today’s conference call. You may now disconnect.