First Hawaiian, Inc. Q1 FY2023 Earnings Call

Good day and thank you for standing by. Welcome to the First Hawaiian Incorporated Q1 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Kevin Haseyama. Please go ahead.

Thank you, Tanya. And thank you everyone for joining us as we review our financial results for the first quarter of 2023. With me today are Bob Harrison, Chairman, President and CEO; Jamie Moses, Chief Financial Officer; 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.

Good morning, everyone. And before I start our normal presentation, I’d like to recognize the efforts of our team members and the loyalty of our customers. The steady performance through the recent disruption in the banking industry really highlighted the strength of our balance sheet and the value of our relationship strategy. Moving on to an overview of the local economy, the Hawaii economy continues to do well. The statewide unemployment rate in March was 3.5%, the same as the national rate. Total visitor arrivals were 900,000 in March, only 3% below March 2019 arrivals. Our Japanese visitor arrivals were 40,000 or 70% below the March 2019 arrivals and we continue to expect a gradual return to more normalized levels. Most importantly, the visitor spend in March was $1.8 billion, 23% higher than March 2019. The housing market has remained stable. In March, the median single-family home price was about $1.1 million, which is about 5.8% below March of last year. The median sales price for condos on Oahu was $536,000, 4% higher than 2022. Turning to slide two, I will give an overview of our first quarter results. We started the year with a very good quarter. Net income of $66.8 million or $0.52 per share, as loans grew, we grew capital and credit quality remained excellent. Our return on tangible assets was 1.15% and return on average tangible common equity was 20.78%. We continue to maintain strong capital levels with a CET1 ratio of 11.97% and a total capital ratio of 13.09%. The Board maintained a quarterly dividend at $0.26. Turning to slide three, our balance sheet remains solid. In response to the recent volatility in the banking industry, we decided to increase our liquidity position using long-term FHLB borrowings and ended the quarter with about $866 million of cash and cash equivalents. The FHLB borrowing was for a term of 18 months and gives us flexibility in managing the liability side of the balance sheet. We continue to have a strong liquidity position, with a loan-to-deposit ratio of 67%, a stable core deposit base, steady cash flows from the investment portfolio, and ample access to additional funding from the FHLB and various Fed lending programs. The investment portfolio duration remained stable at 5.6 years and cash flows from the portfolio round about $65 million a month as we expected. Turning to slide four, period-end loans and leases were $14.2 billion, an increase of $129 million or 0.9% from the end of Q4. Loan growth was modest in the first quarter and we plan to focus our resources on supporting our relationship with customers. We expect loan growth to slow for the rest of the year and be in the low-to-mid single-digit range. Draws on existing lines such as construction, dealer flooring, and home equity will contribute to our growth. Now I will turn it over to Jamie.

Thanks, Bob. Turning to slide five, deposit balances decreased by $408 million or 1.9% to $21.3 billion at quarter end, continuing the trend we have seen for the past three quarters. The outflow of retail and commercial deposits slowed to $300 million compared to $668 million in the linked-quarter. Commercial deposits declined by about $130 million, while retail balances declined by about $170 million. The retail and commercial deposits remain fairly evenly split at around 45% to 46% of total deposits. Our total cost of deposits was 82 basis points in the first quarter, an increase of 30 basis points from the prior quarter due to higher rates paid and the continued shift in mix to higher rate deposit accounts. On slide six, we provide a deeper dive into the deposit portfolio. Starting in the upper left, deposit levels remained stable following the financial events in early March through the end of the quarter. 50% of our deposits are covered by FDIC insurance. Considering that our public deposits are 100% collateralized and consist of Hawaiian Municipality accounts, we expect that 58% of our deposits would behave as if they were insured. The retail deposit portfolio has an average balance of about $22,000 and commercial deposits are well diversified by industry type with an average balance of just under $148,000. Finally, as the table on the lower right shows, we have cash and borrowing capacity equal to 94% of uninsured, uncollateralized deposits. If we were to move the collateral to the BTFP, we would gain another $700 million of borrowing capacity and our cash plus borrowing capacity would be over 100% of uninsured, uncollateralized deposits. To be clear, we don’t think we will need this type of liquidity capacity, but it is there in the event we do. Turning to slide seven, net interest income declined by $4.5 million from the prior quarter to $167.2 million. The decrease was primarily due to higher interest expenses on deposits and the additional borrowings in the quarter. Similarly, the net interest margin declined 4 basis points to 3.11%, primarily due to the impact of borrowings added in March. Excluding the impact of the borrowings, we estimate that the NIM would have been flat to up 1 basis point as the benefit of asset repricing and mix shift were largely offset by increases in deposit costs that were faster than anticipated. Through the end of the first quarter, the cumulative betas were 27% on interest-bearing deposits and 16% on total deposits. Looking forward, we anticipate that the NIM will decline by 10 basis points to 14 basis points in the second quarter, of which about 8 basis points is from the full quarter impact of the term borrowings taken out in the first quarter. Our guidance is based on the forward curve, which predicts a rate hike next week and then no further rate hikes in the quarter. Of course, this guidance is also predicated on balance sheet dynamics that could differ from our current expectations. Turning to slide eight, non-interest income was $49 million this quarter, a $900,000 increase over the prior quarter. BOLI income in the first quarter included approximately $2 million of debt benefit, partially offset by lower other income. We continue to expect quarterly non-interest income to be in the $48 million range. Expenses were $118.6 million, in line with our full year outlook and $4.6 million or 4.1% higher than the prior quarter. The increase in expenses was driven by an increase in salaries and benefits, which included $1 million less of deferred loan costs due to lower levels of loan originations; an additional $1.3 million of the increase was due to the higher FDIC assessment. We expect quarterly expenses for the rest of the year to be relatively flat to the first quarter. Now I will turn it over to Ralph.

Thank you, Jamie. Moving to slide nine. We are still seeing strong credit performance, and the bank’s asset quality metrics reflect that. Year-to-date net charge-offs were $3.2 million. The annualized charge-off rate was 9 basis points, 1 basis point higher than 2022. The bank recorded an $8.8 million provision for the quarter. NPAs and 90-day past due loans were 13 basis points at the end of Q1, up 2 basis points from the prior quarter. Criticized assets continued to decline, dropping to 49 basis points, 23 basis points lower than Q4. Loans 30 days to 89 days past due were $40 million or 28 basis points of total loans and leases at the end of Q1, 12 basis points lower than the prior quarter. Moving to slide 10, you see a roll forward of the allowance for credit loss via the disclosure segments. The allowance for credit loss increased $3.2 million to $147.1 million. The increase this quarter came from loan growth and an additional overlay for consumer loans. This was offset by improvements in the portfolio risk profile. The level of the allowance equates to 1.03% of all loans. The reserve for unfunded commitments increased $2.4 million to $36.2 million, an increase on undrawn exposures. The allowance anticipates cyclical losses consistent with the recession and includes a qualitative overlay for macroeconomic impacts not captured in our base model. I will note that the base model incorporates a forward view of risk based on the rating of individual loans. We have increased the frequency of our credit reviews this quarter and did a deep dive on all CRE credits over $5 million. Specifically, the review considered the potential impacts of credit events like upcoming maturities, rate resets, or tenancy rollover. There were no downgrades as a result of that review. Turning to slide 11, I wanted to provide a snapshot of the CRE exposure; it represents about 29% of loans. Portfolio monitoring in this segment will be a priority given the implications of higher rates, credit tightening, and recessionary headwinds. As you can see, the book is diversified across property types with a minimal amount of criticized assets. The weighted LTV is just under 60%, providing a good margin to absorb future stress. Note the office book is about 6% of loans. We have been in close contact with each of our borrowers in this book to update our risk ratings. At the quarter end, the risk profile remained healthy with only $5 million criticized. In the appendix, you will find some additional portfolio information on the construction book and the C&I book. For the construction portfolio, it’s primarily comprised of multifamily and for-sale housing by property type. Our weighted LTV on the construction book is 57% and criticized assets are about 10 basis points. Within the C&I book, exposure to higher volatility industries is modest. Auto dealers represent our highest industry-related exposure with about $601 million outstanding, about 76% of that amount relates to asset-based vehicle flooring. Let me now turn the call back over to Bob.

Thank you, Ralph. We don’t have any closing comments, so we look forward to your questions. Kevin? Tanya? Sorry.

Certainly. Please hold for our next question. And our first question will come from Steven Alexopoulos of JPMorgan. Your line is open.

Hi, everybody.

Hi, Steve.

Hi, Steve.

So I wanted to start on the deposit side. We know deposits came down and, Bob, you started off by thanking your loyal customers. But what exactly happened at the bank in the immediate aftermath of Silicon Valley Bank? Did you see any of the uninsured deposits leave the bank? Did you require much handholding or did customers panic? It seems like things were more to a business as usual, but I’d love to hear the color on that.

Thank you for the question, Steve. We mobilized our team quickly, and I want to remind you that most of our deposits are in Hawaii. In those areas, we have strong relationships with our customers who trust us. Our first action was to reach out to our bankers, informing them of the situation and asking them to connect with their customers, which they did successfully. We had some accounts that reduced their balances, but overall, it was minimal. This crisis was unique due to the rapid withdrawal of deposits, but from the onset of the crisis to the end of the quarter, we didn’t notice significant changes. This likely reflects the fact that our larger depositors weren’t particularly anxious when we engaged with them. There were some small adjustments, with a few owners directing their management teams or property managers to move a tiny amount of deposits, but overall, the impact was very slight.

Okay. And Bob, following up on that, so it was pretty steady on the deposit base and hearing that I am surprised how much liquidity you built in the quarter. Or is that just because it’s a very conservative bank, abundance of caution and how long do you plan to hold this liquidity down?

Well, you are correct that we are a very conservative bank and there is a concern there that we want to make sure, should something happen, that we are ready for. We are looking at that, Jamie, maybe turn it over to you to better answer Steve’s question.

Yes, we will continue to keep an eye on that. We secured an 18-month borrowing following the weekend of the signature crisis due to market uncertainty. We wanted to ensure our stability, which is why we took that step. We will keep track of how things develop over time, and eventually, I anticipate that we will begin to reduce some of that liquidity. The timing of that will depend on market conditions and our balance sheet situation.

And a bit of a regulatory response. I know we are all kind of waiting to see what happens next week and what the market response will be to that. So for some near-term to medium-term period of time, we are going to be a little more cautious.

Yeah. You are obviously sitting on a ton of capital. So how do you think about that? Do you be more conservative there and pause buybacks for the time being?

Well, we didn’t repurchase any shares during the quarter and we are still below our target of the 12% common equity Tier 1. So until we get there, we are really on pause. It seems like a good time to retain a bit more capital as well.

I don’t know if I could just ask one last one. I appreciate all the color on the office market, the office exposure. How does that break out? But is that all in Hawaii or is some of that on the mainland and what are the dynamics of the Hawaiian office market?

Maybe I will start and turn it over to Ralph. It’s really interesting. The dynamics of the Hawaiian office market are unique. We moved into this building over 26 years ago, and this is the last new building built in the central business district in Honolulu. So there has not been any new construction. We have had one building by a large REIT get taken out, and it’s getting repurposed into apartments, and the second one is under consideration for that. So very little overcapacity here, but Ralph, maybe you can answer the broader question.

Yeah. And I would say that the Hawaii market actually has seen vacancies come down, because of those buildings going under conversion and there’s actually a third building that’s being converted to a hotel. So it’s a pretty healthy market. I think we have a mainland property owner that has property here and on the mainland, who says this is the healthiest market he’s in. We have about 43% of the office portfolio on the mainland, Steve.

Got it. Okay. Terrific color. Thanks for taking my questions.

Yeah.

One moment for our next question. And our next question will come from David Feaster of Raymond James. Your line is open.

Hey. Good morning, everybody.

Good morning.

Good morning, David.

Maybe more specifically going back to the deposit side, just specifically on the non-interest-bearing front, it seems like the turmoil we’ve had is really just a wake-up call to a lot of clients regarding the rates being offered and really accelerated migration. I am just curious whether you have seen NIB balances start to stabilize here early in the second quarter or do you expect to see continued migration? And then just how do you think about that composition over time? I mean, do you think we can hold around 40% where we are or do you think we kind of regress back to maybe where we were in pre-pandemic?

Yeah. Thanks, David. So it’s a good question. We don’t know for sure. We have so far held up pretty tightly with 41% of the balances, as you noted being non-interest-bearing. We think that’s a pretty good number. Pre-pandemic, that number was 3%. So there’s obviously a chance that it could go back there. I think there are some reasons to believe that maybe we can do better than that overall through time, but it’s really kind of anyone’s guess around that. We are close with our customers. We have done a good amount of segmenting work trying to figure out which customers truly are rate dependent and which customers value a different sort of value proposition with us. So it’s a good number for now, but could go down in the future; we are pretty pleased with the performance overall in the first quarter for sure.

Okay. That’s helpful. Maybe just at a high level, the Hawaiian market has always been viewed as a relatively insulated deposit market, right? And it seems like that’s holding up so far, just the betas that you have seen, you are doing really well, as well as some of the others on the island. I just want to get a sense of the competitive dynamics maybe from your standpoint. Has technology expansion kind of impacted that insulation at all as we look at this going forward, and are you starting to see any more competition from outsiders at all? I am just curious about the competitive landscape in that relative insulation of the local market.

Yeah. A really good question. As we look at it, first of all, competition is always there and as we saw in the most recent events in early March that money can move very, very quickly. So we have to stay close to our customers, to Jamie’s point, and I think we have done that certainly with our large deposit customers and our corporate customers. Not having any non-Hawaii headquartered banks here helps candidly because all of us have fairly low loan-to-deposit ratios. So the need to compete for deposits to fund outsized loan growth, as we have talked about in the past, doesn’t exist. So it’s a little more measured in that respect. But you have to be taking care of your customers. You have to understand, to Jamie’s point, what the value proposition is. There are people that have decided to move certainly within our bank. We saw about $110 million move to our money market accounts during the quarter. So clearly, customers have decided to make some of that movement. And that’s the right thing to do, right? We need to work with them and see what the right answer is for them. It has continued to be relatively well behaved in the medium and smaller dollar based, although we are starting to see some migration into CDs, as we expected, which is kind of where it was in a higher interest rate environment several years ago. Jamie or Ralph, anything you would add to that?

No. I think you covered it well, Bob.

Okay. No. That’s good color. And then maybe just touching on the growth side. Just kind of hearing the categories that you brought up with construction, dealer flooring, and home equity. Is it safe to say that Hawaii is primarily going to be the driver of growth? Is there still an appetite for West Coast CRE participation at all? Are there any good risk-adjusted returns on that space? And then just kind of an update maybe on the housing side and mortgages and what you are seeing on the housing market and your portfolio in Hawaii?

Sure. Maybe just, yeah. So to start with the CRE piece, much of the growth we expect to see in CRE will be partially Hawaii and a good chunk of it is in the West Coast because we are in construction deals, mostly multifamily in both places. So that is based in Hawaii and West Coast draws we are expecting. I am not sure how many new deals will be out there, and that’s why we are guiding toward really seeing more activity in our existing credits to borrow. We saw virtually no growth, as you can see in the deck, in our dealer floor plan in the first quarter. My expectation is that will change over the course of the year and we will start to see some growth in that as factory production increases. There’s still demand out there, but I think that will be tempered as people are concerned about recession. So that should lead to an increase in dealer floor plan balances. Anything else you would add to that, Ralph?

Not really, Bob.

And sorry, I didn’t cover off on residential. The trends here are very similar to what you are seeing on the mainland; very virtually no refinancing, given the rate environment. Sales have slowed; you are getting the time to make multiple offers and the time to close is more than a few days where it was in the heyday not that long ago. So that part is more normal. We are expecting lower residential volumes here in Hawaii for some period of time.

But no change in the health of your borrowers? I mean, just looking at your NPAs and everything is pretty steady. I am just curious, as you look at your borrowers, no change or anything from that?

No. We haven’t seen that. No. We haven’t seen that.

Okay. That’s great. Thanks everybody.

One moment for our next question. Our next question will come from Andrew Liesch of Piper Sandler. Your line is open.

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

Good morning.

Just keeping on the credit theme, I was kind of surprised the provision came in nearly $9 million. I was curious if you can talk to some of the ins and outs there because just the metrics all look pretty solid.

Yeah. Andrew, this is Ralph. We had basically three things happened. I think the primary reason it went up was loan growth. We did do a little bit of additional overlay in the consumer book. Nothing specific there, just kind of a general concern about what we are going to be looking at over the next 12 months. And then that was a little bit offset by the overall risk rating in the portfolio actually improved in the quarter. So I think it was pretty much in line with what we would have anticipated just on growth, to be honest.

Got it. All right. That’s helpful. And then on the securities portfolio, would it be safe to assume that it’s kind of in a runoff mode right now, you are not going to be looking to add too much to it?

That’s exactly the right way to think about it, Andrew.

Got it. You have covered all my other questions. I will get back. Thank you.

One moment for our next question. And our next question will come from Kelly Motta, KBW. Your line is open.

Hi, thank you so much for the question. I think kind of carrying on with the last line of questioning. Can you provide us with what the outlook is for cash flows off the securities portfolio for the remainder of the year?

Yeah.

Yes.

Sorry, Kelly, was there any more question?

No. If that’s how you intend to fund loan growth looking ahead.

Yeah.

But just any color on that as well?

Yeah. No. That’s right. Yeah. Thanks, Kelly. So, in the first quarter, it was about $65 million a month in cash flow that came off. We expect that it’s going to be about that much for the rest of the year. There are seasonal things that happen. Now there’s not a ton of mortgage activity, obviously, in the world, but Q1 is sort of like a seasonal low in terms of people moving and things like that. So there’s a reason to expect maybe there’s a little bit more cash flow from the portfolio, but $65 million a month seems like a pretty decent number to think about.

Got it. Thank you. And I appreciate the guidance for next quarter with the margin. Assuming that the Fed pauses after next week, what’s kind of the outlook for margin ahead from that more broadly as deposit costs catch up? Should we be anticipating additional pressure or do you think the greatest kind of headwinds are this upcoming quarter or two and can level off thereafter?

The main factor will be changes in Federal Reserve policy and the direction of short-term interest rates. Additionally, what happens with our balance sheet and specific needs related to loan growth will play a significant role. Currently, we are considering a 27% cumulative beta, but we previously indicated that it could reach 30% throughout the economic cycle. There are reasons to believe it might be even higher, but it's difficult to provide a precise answer without a clear understanding of the movements within the balance sheet related to loan growth and securities activity. Ultimately, these two factors will determine where the margin heads next.

Thanks so much, Jamie.

Yeah.

All my questions have been asked and answered, so I will get back. Thanks again.

Thanks, Kelly.

One moment for our next question. And our next question will come from Jared Shaw of Wells Fargo. Your line is open.

Hey, everybody. Good morning. Thanks for the questions.

Hi, Jared.

Maybe just circling back on the office side. When you look at that 43% that’s on the mainland, I am assuming that’s shared national credits. Any geographic concentration and can you give us some stats on the average size of those properties or average size of that total loan and maybe some of the bigger cities that they are in?

I will provide some details. This is Ralph speaking. I don’t have specific information about the average size, but these properties are primarily multi-tenant office buildings located mainly in California and the West Coast, particularly the Pacific Northwest, where we have a few properties. In the Pacific Northwest, we have a couple of credit tenant deals that amortize over the lease term with strong counterparties. In California, we are mainly in West L.A. We have noticed a trend of people moving out of downtown L.A. into West L.A., which has led to good absorption for the office properties we financed, especially through the fourth quarter of last year. Overall, we feel confident about the situation. The sponsors we are working with have relatively low leverage, and we've had conversations with them to understand their perspectives. As mentioned, we conducted a thorough review of our commercial real estate book last quarter, and we feel optimistic about our office portfolio.

So the feeling is that those sponsors as those come for renewal have access to equity to be able to supplement if needed versus selling or looking at some other type of a workout?

Yeah. In fact, one of our larger customers, they had actually deleveraged right ahead of the pandemic. It was just kind of a coincidence, but they are in pretty good shape. They actually will be looking for properties, I think, over the next year.

Okay. Regarding the deposit beta performance, it has been really good. What are the expectations for terminal beta? Any thoughts on whether it has increased at all?

I think we discussed some potential factors that could affect the changes on the balance sheet. Generally, we should expect it to be higher, but we cannot determine the exact terminal beta at this time. Ultimately, it will depend on our funding needs driven by loan growth and similar factors. I wish I could provide a specific number, but currently, we do not have that information, and it will really depend on what we observe on the balance sheet.

Okay. Thanks. And then just finally for me, what was the rate on the FHLB advance?

That was 4.7%.

One moment for our next question. And our next question will come from Christian DeGrasse of Goldman Sachs. Your line is open, Christian.

Hey. Good morning. Thanks for the question.

Hey, Christian.

Hi, Christian.

So following up on the March rate cuts later towards the end of the year, can you talk about how the balance sheet is positioned for lower rates and how you see maybe both deposit pricing as well as the margin relative to how they have performed in this rising rates?

I think it’s going to be pretty similar. We would expect, if we have rate cuts, that 40% of our loan portfolio within 90 days will reprice right down with those rate cuts. But then we also have a decent amount of balances on the balance sheet that we have some customers who are rate sensitive, that we moved into similar type rates as you would see from a government money market perspective, and then those would come down as well. I think my guess would be that the NIM would probably compress slightly in a down rate scenario. But, again, it will be sort of dependent on what happens in terms of the balance sheet and loan growth. But I’d expect a slight compression in a rates down scenario.

And then just following up, I mean, can you share how you guys think about adding hedges, whether there are swaps or floors and whether that would be your strategy at all?

We are continuing to look at that and think about that. At the moment, with uncertainty really around where rates are going and uncertainty around capital and requirements, we are really trying to balance the net interest income risk versus what I will call AOCI capital risk. So, again, I wouldn’t expect lots of large movements in that area. It’s something that we are considering and something that we are looking at and talking about consistently. But we don’t have a real strong view at the moment on what we would be trying to protect in the first order of business.

To add to Jamie’s comments, we have been proactive in implementing rate increases for our depositors, particularly for our high net worth and corporate clients. We are also willing to adjust those rates down if necessary when rates decrease. This approach is essential for maintaining our relationships with customers, ensuring they receive benefits while also managing their needs as rates potentially decline later this year.

Understood. Thank you.

And I’m showing no further questions. I would now like to turn the conference back to Kevin for closing remarks.

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. Thank you for participating. You may now disconnect.