First Hawaiian, Inc. Q4 FY2023 Earnings Call

Good day, and thank you for standing by. Welcome to the First Hawaiian, Inc. Q4 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, Kevin Haseyama, Investor Relations Manager.

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

Good morning, everyone. I'll start with a quick overview of the local economy. Overall, Hawaii has been resilient in spite of some headwinds. State payrolls were improving at a modest pace prior to the Maui wildfires, but we were certainly impacted by that disaster. Nevertheless, the statewide unemployment rate remains low. The seasonally adjusted unemployment rate for December was 2.9% compared to the national unemployment rate of 3.7%. The visitor industry has performed well on a year-to-date basis with the Maui visitor industry recovering faster than expected and visitors to the rest of the state reaching record levels. Through November, total visitor arrivals were 5% higher than last year and total spending was 6.2% higher. Arrivals from Japan continued to increase with year-to-date arrivals at 506,000, up over 220% from the prior year. The housing market remained relatively stable despite reduced activity. In December, the median sales price for a single-family home on Oahu was about $1 million, which was 5% below December 2022. Median sales prices for condominiums on Oahu were $510,000, 1.5% higher than the previous year. Turning to Slide 2, I'll discuss the highlights of our fourth quarter financial performance. We finished the year with a solid quarter. We continued to grow customer deposits. We believe that net interest margin has bottomed out and credit quality remains excellent. As I'll cover on the next slide, we took balance sheet actions that are immediately additive to earnings. Our return on average tangible assets was 0.81%, and return on average tangible common equity was 13.66%. We continue to maintain strong capital levels with a CET1 ratio of 12.39% and a total capital ratio of 13.57%. Turning to Slide 3, I wanted to go over the balance sheet actions we took in the fourth quarter that will reduce earning assets while adding to net interest income. In late December, we sold $526 million of low-yielding investment securities at a loss of $40 million. We intend to use those proceeds to reduce high-cost deposit balances starting in the first quarter. By eliminating the negative spread from this asset-liability combination, we will improve our net interest margin and generate higher net interest income off lower average earning assets. Capital ratio levels are high, and we have ample liquidity, so we continue to look for opportunities to optimize our balance sheet. We plan to bring down our cash levels to a more normalized range of around $500 million to $600 million. Separately, following the change Visa announced in late 2023 that improves the economics of selling Class B shares, we elected to sell our remaining shares for a gain of about $41 million. The shares were carried on our balance sheet at zero book value. Turning to Slide 4, period-end loans and leases were $14.4 billion, about $21 million higher than September 30. We had good growth in C&I loans, primarily driven by growth in dealer flooring. As we had anticipated, the decline in CRE loans was primarily due to the payoff of several completed construction projects. While there is a headwind for balances, it speaks to the quality of the projects, the strength of the sponsors, and the overall credit quality of the portfolio. The decline in consumer loans was primarily in indirect auto. Looking forward to 2024, we expect the full-year loan growth rate to be in the low single-digit range. Continued weak demand for residential loans and additional paydowns from our completed construction projects present headwinds to loan growth. Now I'll turn it over to Jamie.

Thanks, Bob. Turning to Slide 5. Retail and commercial deposits increased by $405 million in total. Commercial deposits were up $243 million and retail deposits increased by $162 million, which allowed us to reduce our reliance on public time deposits. There was no material impact from any Maui recovery-related deposit flows. Total deposit balances declined by $179 million due to a $584 million decline in public deposits, $506 million of which were those higher-cost time deposits. The percentage of non-interest-bearing deposits to total deposits was a healthy 36%. We expect further reductions in the balances of higher-cost public time deposits starting in the first quarter. The rate of increase in deposit costs slowed down in the fourth quarter. Our total cost of deposits was 156 basis points, a 16 basis point increase from the prior quarter. Turning to Slide 6, net interest income declined by $5.4 million from the prior quarter to $151.8 million due to lower average earning assets and a lower net interest margin. The net interest margin declined by 5 basis points to 2.81%. As we discussed previously, we expect that the security sales and reduction in higher-cost deposit balances in Q1 will add about 10 basis points to the 2024 margin and improved net interest income. Our spot NIM in December was 2.75%. So looking forward, we projected NIM in the 2.85% range in Q1. Through the end of the fourth quarter, the cumulative betas were 44.6% on interest-bearing deposits and 28.6% on total deposits. On Slide 7, non-interest income was $58.3 million, $12.3 million more than the prior quarter. We had several significant non-recurring items that contributed to the increase. As mentioned previously, we sold a little over 120,000 shares of stock for a net gain of $40.8 million. We also recognized a net gain of $7.9 million from the sale of a branch property. These were partially offset by the $40 million loss on the previously mentioned sale of securities and another $1.3 million from other miscellaneous segments. Excluding these non-recurring items, non-interest income would have been $50.9 million in the fourth quarter. We expect non-interest income to run about $49 million to $50 million per quarter in 2024. Expenses were $142.3 million, $22.9 million more than the prior quarter. Similar to non-interest income, we had several non-recurring items that drove the increase. The largest item was the $16.3 million FDIC special assessment. We also had several smaller non-recurring expenses totaling about $7.3 million in the quarter. Excluding these items, non-interest expense was about $118.7 million in the fourth quarter. In 2024, we expect full-year expenses to be around $500 million, primarily due to continued investment in technology and infrastructure as well as some general inflation. Now I'll turn it over to Lea.

Thank you, Jamie. Moving to Slide 8. The bank maintained its strong credit performance and healthy credit metrics in the fourth quarter. While we have seen some modest deterioration in credit quality, our experience so far is well within our expectations. We are not observing any broad signs of weakness across either the consumer or commercial books, and we have sufficient loan loss coverage. Commercial criticized assets increased to 1.2% of total loans and leases, driven primarily by a single credit, which was downgraded to special mention, while classified assets fell 2 basis points to 19 basis points of total loans and leases. Year-to-date net charge-offs were $12.2 million. Our annualized year-to-date net charge-off rate was 9 basis points, 3 basis points higher than in the third quarter. Non-performing assets and 90-day past due loans were 15 basis points of total loans and leases at the end of the fourth quarter, up 2 basis points from the prior quarter. The bank recorded a $5.3 million provision for the quarter. Moving to Slide 9, we show our fourth quarter allowance for credit losses broken out by disclosure segments. The asset ACL increased $1.7 million to $156.5 million with coverage of 1 basis point to 1.09% of total loans and leases. Turning to Slide 10, we provide a snapshot of our commercial real estate exposure. CRE represents approximately 30% of total loans and leases. The CRE portfolio is well diversified across collateral types, well secured, and remains of high quality. Office exposures remained manageable at 5.2% of total loans and leases. We continue to closely monitor the CRE segment given the implications of the rate environment, credit tightening and recessionary headwinds and their follow-on impact to vacancy rates, debt service, and asset values. The credit quality of this portfolio remains very good. And now I'll turn it back over to Bob.

Thanks, Lea. In summary, we had a solid quarter. We believe we're well positioned to continue to perform well in a challenging environment. The security sale executed in December will enable us to pay down our higher-cost deposits and will immediately improve the margin and net income. Now we'd be happy to take your questions.

Thank you. Our first question comes from Steven Alexopoulos with JPMorgan. You may proceed.

Hi, everybody.

Hey, Steve.

Hi. Steve.

I want to start on the margin. You guys said $2.85 is what you expect for the first quarter. And Bob, you said you think you would hit a bottom on the margin. So I'm curious, once we get into the Fed starting to cut rates, where do you see the NIM trending because you are at the sensitive point, I believe.

That's correct. I consider it to be somewhat moderately asset-sensitive with a flat balance sheet. This situation remains unchanged, Steve. Currently, we continue to see a runoff in our securities portfolio. When analyzing the numbers, the total yield in that portfolio is around 220. We anticipate generating about $600 million in cash flow throughout the year from that. With funding coming in at about 5% through public time deposits, this creates a significant boost to our margin. As we assess the forward curve regarding potential Fed cuts later in the year, we believe the overall balance sheet dynamics will enable the net interest margin to continue to gradually improve over the year, despite the outlook of the forward curve.

Okay. That's positive. Could we go a little bit deeper with that? So you guys are not one of the highest deposit rate payers, right? It's a function of our market. But in order to get NIM grinding higher. What's your assumption because I don't know if you're seeing competitors test the market for lower rates already or not. But how quick could you lower your deposit rates once the Fed does start coming down?

We currently have well-defined customer segments for our deposit rates. Many of our customers experienced immediate increases in their deposit rates as they rose, and they anticipate similar changes when rates decline. The decrease in deposit rates will be somewhat smaller than the increase in our floating rate assets, which means we are technically asset-sensitive. However, we believe a significant portion of these deposits will reprice downwards quickly. Additionally, we have nearly $1.5 billion of fixed rate cash flow expected to be repriced higher to current rates this year. Even with the Fed reducing rates, these rates remain above where they were initially set. The situation is not strictly about being asset-sensitive or liability-sensitive; rather, it's about the dynamics we observe on the balance sheet. There will also be some impact from lower earning assets, but we anticipate a stronger performance over time.

Got it. Thanks. If I could ask one other question, totally different topic. So it was nice to see the dealer growth in the quarter. Curious where those balances are, and is there still room to catch up or is that now the new normal, like where those balances sit today? Thanks.

Well, Steve, maybe I'll take this one. First, if you say it enough times, eventually it's true. So finally, we saw some nice lift in dealer floor plan in Q4, as you saw. The bulk of that is in the Mainland portfolio. It really is driven by larger commitments, but also influenced by a manufacturer base. The domestic producers have done a better job of improving supply compared to the imports, which have been lagging a bit, but this has been very beneficial. We are seeing those balances grow. The balance at the end of the year was $563 million in total, which is still about $300 million less than it was at the end of 2019, just to give you some perspective.

Still some room.

Yeah, roughly the same commitment, the same basic dealer group. It won't go back to that. None of us expect it will go back to that. But certainly, there is still some room there. Thanks for taking my questions.

Thank you. One moment for questions. Our next question comes from Andrew Liesch with Piper Sandler. You may proceed.

Hey. Good morning, everyone. Thanks for taking my questions.

Hi, Andrew.

Just on the expense guidance there, a little bit steeper ramp-up than I was expecting. I guess where are you seeing most of that pressure come in? Is it really just inflation? Is it under contracts? Where is a lot of that expense guide coming from?

We were anticipating your question, Andrew. It truly comes down to our focused investment strategy, which we've discussed in parts over the years. Let me take a moment to summarize what we've been working on and our ongoing investments. We're being very thoughtful about our spending, especially since our core conversion, which has enhanced our strategy across three main areas: data, technology, and people. Over the past couple of years, we've developed a sophisticated data and analytics platform and expanded our capabilities, particularly in AI. We have already integrated AI into our consumer lending, and the results have been positive. Additionally, we are improving our digital services. Last summer, we successfully converted our online consumer banking, and we plan to implement a new digital account opening platform around mid-year. We've also strengthened our in-house engineering capabilities based on open AI architecture and are introducing a new CRM system. Most of these investments are now in place, but they've slightly raised our costs. Employment numbers are flat; while we are adding more staff, we are investing in our team by establishing a skilled engineering group for in-house development. We believe these efforts will position us favorably for the future, allowing us to be competitive in our unique deposit market and offer our customers more options than in the past, potentially making us a first mover in the industry. This is leading to various costs associated with personnel, technology investments, and some inflation. Jamie, do you have anything to add?

I think that's a really good summary, Bob. The only other thing to add, Andrew, is we recognize the number is probably a little bit higher than what you were expecting and others have been expecting. But we think it's important that we do invest in those things. And as Bob kind of alluded to in his commentary, over time, this rate of growth should come down because these investments ought to be able to create scale and efficiencies for us. So that's part of the investment that we've been making and we'll continue this year.

And just to add to that, good point, Jamie. As we finish up the new stuff, we will be sunsetting the outdated systems and improving our operating methods and everything else to bring down our costs and optimize our expenses. So we are kind of in the transition between having invested in new platforms and as those mature and rolling off old stuff. So there's a little bit of that going on in 2024 as well, which builds into that number.

Got it. So I guess once you move past, what would be a natural level of expense growth for the company then?

Yeah. I mean I think that's probably natural level 2%, 3%, something like that would be the natural level, inflationary sort of expectations. That's in the future like when we get past this in 2024.

Great. That’s very helpful. I’ll step back. Thanks.

Thank you. One moment for questions. Our next question comes from Timur Braziler with Wells Fargo. You may proceed.

Hi. Good morning. Looking at the expectations for cash flows off of the bond book at $600 million, how much of that is going to be used to continue working down some of the higher-cost funding? And I guess at what point does that stop and you actually start reinvesting some of those proceeds back into the bond book?

I believe our cash flow is decreasing, and we plan to take two actions. First, we want to prioritize paying off our higher-cost deposits as much as possible. Secondly, we aim to support loan growth as well. If we can achieve a higher rate of loan growth, that could become part of our strategy. Currently, our main focus is on paying off public time deposits, which are around 5%. Even considering a bit of credit risk in the bond portfolio, the yields are around 530 to 540. The difference between our funding costs and the yield isn't very significant, so we aren't particularly eager to reinvest in the bond portfolio right now, given that we would be funding it at about 5%. For the time being, we are mostly in a run-off mode.

Okay. That's helpful. And then maybe looking at the linked quarter reduction in non-interest bearing, I'm just wondering if there's any visibility to how much excess liquidity you think is within that line item and how much additional mix shift we may get out of non-interest-bearing into some of the interest-bearing accounts over the next two quarters or so?

We started before the pandemic with about 36% of our total deposits being non-interest-bearing, which is still where we are now. While it’s possible for that percentage to decrease further, in a high-rate environment, we anticipate some continued movement. We are closely monitoring this situation as it will influence our asset liability management decisions for this year and beyond. Although we may observe some ongoing shift, we believe that the pace of decrease will be slower moving forward.

Great. I guess last for me, just TCE rebounded north of 6% here, regulatory capital looks pretty good. Any reconsideration for buyback or any incremental thoughts on initiating a buyback?

Yes, we received approval from the Board for a $40 million buyback plan for 2024, which is available to us and something we are considering. We are above the 12% CET1 number we have discussed in recent years. However, we still see a reasonable amount of uncertainty in the environment and have not yet reached a year since the failures of those three banks. Therefore, we will proceed with caution, while also ensuring we are comfortable with our capital levels and have the capacity for share repurchases in 2024. We will continue to assess this as the year progresses.

Great. Thanks for the questions.

Thank you. One moment for questions. Our next question comes from Kelly Motta with KBW. You may proceed.

Hi. Thank you so much for the question.

Hey, Kelly.

Maybe I don't think we talk yet much about credit, obviously, metrics remain really strong. Just wondering what you're watching at this stage, any changes in how you're viewing certain portfolios? And any kind of expectations for what credit normalization could look like over the next two years or so?

Thank you for the question, Kelly. I'll start off and then hand it over to Lea. We are monitoring the situation closely. Many of the office-related issues we discussed last mid-year have been addressed. However, this remains a critical area of focus for us, not just in terms of credit but also for our line officers. We are maintaining close connections with our commercial clients, particularly in commercial real estate. As I noted earlier, there are signs of normalcy returning. We are seeing payoffs from construction projects that have transitioned into mini-perm loans as they have become fully leased. Previously, projects were cleared as soon as construction finished, but now things seem to have normalized, which I consider a healthy development. On the broader commercial front, we continue to see strength in many areas we previously mentioned. In consumer lending, we are witnessing a slight decline in indirect lending and credit card performance, but overall conditions are returning to normal. Lastly, as Lea pointed out earlier, we have not observed significant impacts from the situation in Maui, which is something we are keeping a close eye on. Lea, do you have anything to add?

No, I don't really have much to add. What I will say, though, is we actually are quite pleased with the performance of the portfolio even in this environment. We continue to watch certain pieces very carefully because you hear about the headline numbers and you think about how it impacts our borrowers. But so far, we really haven't seen the kind of weakness that we thought we would at this time in the cycle.

I really appreciate all the color here, guys. Maybe one more from me. Just wondering if you've evaluated the regulatory proposals on interchange and overdraft and kind of if you started to make any preliminary estimates on what the impact could be to you and if you're doing any changes with your fee structure in response to that?

On the interchange side, we haven't conducted a full analysis yet. It's something we are examining and fundamentally disagree with, supporting the ABA's position on the standard. This is significant as we are also assessing it from the perspective of a mid-size bank coalition and will likely lend our support. However, while the ABA is taking a firm stance, we are starting to analyze the potential implications since we need to be responsive. The rule-making process will take time, and we do not yet know the final outcome. We are awaiting a clearer understanding because the analysis should be relatively straightforward once we have details on what the final regulations will entail.

Great. Thank you. I’ll step back. Most of my questions have been asked and answered. Appreciate it.

Thank you. One moment for questions. Our next question comes from Christian DeGrasse with Goldman Sachs. You may proceed.

Hi. Thanks for the question. Putting the public deposits to the side for a second, can you maybe provide some context on how your commercial and retail deposit rates have performed alongside the rising rate cycle and how you expect repricing to react relative to that when rates ultimately start to fall?

For the most part, Christian, I'll revisit this topic. We look at our operations through several segments on both the retail and commercial sides. There are parts of our balances that are sensitive to rates, as well as portions designated for operating accounts and working capital. When rates were increasing, these accounts benefited fully from that rise. We expect to similarly decrease the rates as they fall. Approximately 80% of our floating-rate loans align with the deposits that are experiencing this 100% response to rate changes. In a scenario of declining rates, loans will reprice immediately to be slightly higher than our deposits, but a significant portion of those deposits will also decrease. Overall, we believe we can manage the adjustments to rates effectively over time.

And just to add to Jamie's comments, as I think we talked about it several quarters ago. We were talking to our customers or those segments, the high net worth, mass affluent, corporate, when we were increasing rates on the way out. And we’ve continued those conversations, the expectation is when rates go the other way, that there won’t be a lag, that we will be working with them on the way down as well. So that’s been very well communicated by our bankers to the customers. So we think that’s a doable thing. We are not seeing much deposit pressures in the market, to be honest.

Great. Thank you.

Thank you. One moment for questions. Our next question comes from Andrew Liesch with Piper Sandler. You may proceed.

Hey. Thanks for taking the follow-up here. Sorry to keep bringing up expenses. But what's the quarterly trajectory, how do you expect these costs to play out this year?

So it's always slightly elevated in Q1, just extra taxes and things like that, just true-up things happen in Q1, but in totality is probably going to be generally flat across the year. And so that's kind of the way that we have it looked into my model of it. So generally pretty flat, maybe slightly elevated.

Got it. So more seasonally adjusted stuff during the first quarter, then more of the investment starting to ramp up and then offset some of those seasonal adjustments as they fall off as the year goes on?

Yeah, I think that's a truly good way of looking at it.

Got it. Okay. Thanks so much. I appreciate it.

Yeah.

Thank you. I would now like to turn the call back over to Kevin Haseyama for any 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.

Thank you for your participation. You may now disconnect.