First Hawaiian, Inc. Q3 FY2024 Earnings Call

Thank you for standing by, and welcome to First Hawaiian Inc's Third Quarter 2024 Earnings Conference Call. I would now like to hand the call over to Investor Relations Manager, Kevin Haseyama. Please go ahead.

Thank you, Lateef, and thank you everyone for joining us as we review our Financial Results for the third quarter of 2024. With me today are Bob Harrison, Chairman, President and CEO; Jamie Moses, Chief Financial Officer; and Lea Nakamura, Chief Risk Officer. We 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. I'll start by giving a quick overview of the local economy. The overall Hawaii economy continues to be resilient. While Maui continues its recovery from the wildfires, the rest of the state has seen relatively stable tourism numbers and a low unemployment rate. The statewide seasonally adjusted unemployment rate for September was 2.9%, compared to the national rate of 4.1%. Through August, total visitor arrivals were down 2.2% and spending was down 2.3% compared to 2023 levels for the same period. The housing market remains stable. In September, the median sales price for a single-family home on Oahu was $1.1 million, 6% higher than last September. The median sales price for condos on Oahu was $518,000, 2.8% below the previous year. Turning to Slide 2, I'll give an overview of our third-quarter results. We're really pleased that the momentum we saw building in the second quarter carried over to the third quarter. Deposit balances flattened out, and deposit costs were up only 1 basis point from the second quarter. Unexpected loan payoffs were a headwind for loans in the third quarter, but credit quality remained excellent, and assets repriced upwards, driving margin expansion. Non-interest income continued to solidify, and we maintained good discipline on expenses. During the quarter, we released $3.8 million of tax reserves we recorded in connection with our 2016 separation from BNPP. This increased expenses for the third quarter by $3.8 million and reduced income tax expense by the same amount, resulting in no impact on net income. Turning to Slide 3, I'll go over some balance sheet highlights. The investment portfolio runoff is still being used to fund loan growth and reduce high-cost deposits. We continue to have ample liquidity. We had a $500 million FHLB advance mature in the third quarter and took out a new $250 million 12-month advance at a lower rate. The balance sheet remains well-capitalized and our capital levels continue to grow due to strong earnings and favorable AOCI changes. Because of our strong and growing capital levels, we intend to resume share repurchases in the fourth quarter. Turning to Slide 4. Total loans were down $119 million compared to the prior quarter and while construction loans grew as expected and we had good activity in the C&I and CRE portfolios, unexpected payoffs in those portfolios were a headwind in the third quarter. The pipeline in the fourth quarter remains strong, but due to those payoffs in the third quarter, full-year loan growth will be relatively flat. Now I'll turn it over to Jamie.

Thanks, Bob, and good morning everyone. On Slide 5, we see that the positive deposit trends we noticed in the second quarter continued in Q3. Total deposits were down $91 million driven by a $112 million decline in total public deposits. Retail and commercial deposits stabilized and were slightly up compared to the prior quarter. Commercial deposits increased by $112 million, partially offset by a $91 million decline in retail deposits. The migration of noninterest-bearing deposits to higher-cost accounts continued to taper, and the ratio of noninterest-bearing deposits to total deposits remains a solid 34%, unchanged from the prior quarter. Deposit costs also continued to level off, and our total cost of deposits only increased 1 basis point from the prior quarter. We have been proactively managing deposit rates in anticipation of the Fed rate cut, and we saw our September cost of deposits decrease by 1 basis point to 171 basis points from 172 basis points in August. Turning to Slide 6, I'll go over net interest income and the margin. Net interest income was $156.7 million, $3.9 million higher than the prior quarter. The margin was up 3 basis points, primarily due to the asset repricing dynamics that we've detailed on prior calls and stable deposit costs. Looking forward, we expect the NIM to decline modestly in the fourth quarter and be around 2.9%. On Slide 7, non-interest income and expenses are detailed. The income was $53.3 million, about $1.5 million more than the prior quarter. The increase in non-interest income was due to higher volume-driven credit and debit card fees and higher BOLI income, partially offset by lower other income. As a reminder, that other income line included about $2 million of insurance recoveries in the prior quarter. Non-interest expenses were $4.1 million higher than the prior quarter. And as Bob mentioned, we recognized a $3.8 million expense in the third quarter that was offset equally by a $3.8 million reduction in income taxes, having no impact on net income. Excluding that, expenses in the third quarter were essentially flat to the second quarter. We continue to expect full-year expenses to be in the $500 million range. And now I'll turn it over to Lea.

Thank you, Jamie. Moving to Slide 8, the bank maintained its solid credit performance in the third quarter. Our credit risk metrics remain strong and stable and well within our expectations. We are not observing any broad signs of weakness across either the consumer or commercial books, and we are very comfortable with our loan loss coverage levels. Classified assets increased by $64.6 million due mostly to a couple of downgrades. The recently downgraded loans are well collateralized, and we believe that the potential for loss is extremely limited. Moving to Slide 9, we show our third-quarter allowance for credit losses broken out by disclosure segments. The asset ACL increased by $3.2 million to $163.7 million with coverage increasing 3 basis points to 115 basis points of total loans and leases. Turning to Slide 10, we provide an updated snapshot of our CRE exposure. CRE represents approximately 30% of total loans and leases. Credit quality in this portfolio remains strong with LTVs manageable and criticized loans continuing to comprise only a small portion. Let me now turn the call back to Bob for any closing remarks.

I don't have any closing remarks. Thank you for your participation. We welcome any questions you have.

Our first question comes from David Feaster of Raymond James. Please go ahead, David.

Hi, good morning, everybody.

Good morning.

Good morning, David.

I just wanted to follow up on the growth side. I appreciate the information on the growth outlook. Obviously, it sounds like this quarter was really impacted by payoffs and paydowns. I'm curious how the pipeline looks and where you are seeing opportunities for growth, and maybe touch on the competitive landscape as well and where you're seeing new origination yields.

Yes, great question, David. We had expected third quarter to be mostly flat, and then with the payoffs that came in below that, obviously. We believe the opportunities continue to be in the commercial real estate space both here in Hawaii and primarily on the West Coast, as well as in our dealer floor plan area. We are seeing some growth here in Hawaii and onboarding a new relationship now. Additionally, there are opportunities we have on the West Coast. I think really those two areas to begin with are the top opportunities. The consumer side is still going to be soft; there's not a lot of action in residential or home equity. So we're really looking to the C&I and commercial to see the growth.

Okay. And then, thinking about the earning asset repricing and remixing side, could you touch on the securities cash flows, the roll-off rates that are coming there, the loan cash flows and what you're seeing, as well as where you expect new loan yields to be, especially with this cut coming in?

Right. Yes, thanks, David. We continue to see about $400 million per quarter of fixed-rate cash flows coming off the books, and that's the repricing dynamic. So that's coming off, let's say, in the 4.5% range, with new loans coming on with the rate cuts maybe in the 6.5% to 7% range, something like that. Overall, I think that's probably the way to think about that in Q4. That dynamic itself is likely 2 to 3 basis points favorable for the NIM in Q4. Our guidance is based off of another rate cut in November, affecting about $6 billion of loans and approximately $4.5 billion of deposits that will also reprice.

Okay, perfect. And then just considering your ability exclusive of those indexed deposits, how are the conversations you're having about repricing deposits lower? What are the new add-on rates for new deposit growth? Are there other ways to maybe help accelerate the margin side?

Yes. Maybe I'll start, David, and pass it over to Jamie. On the way up, we were clear with our deposit customers that we were going to give them the full benefit of rate increases basically immediately. On the way down, we've adjusted accordingly. These have been the conversations we've been having with them over the last couple of years, and that has proven to be effective; we have been transparent walking them through that. As far as onboarding new deposits, we're always trying to onboard new relationships, which include operating accounts and personal accounts. So there’s an element of noninterest-bearing alongside interest-bearing. To further your question, maybe I'll turn it over to Jamie.

Yes, I think Bob summarized the deposit piece of that pretty well. Those deposits are not specifically indexed, but that's our expectation of our customers. I believe our teams have been really proactive talking to them, and everybody seems to understand the situation. In terms of securities restructuring, we see others do that and understand their reasons. From my perspective, the share buyback this quarter may be a better use of reducing capital; returning capital to shareholders this quarter seems more beneficial. We’ll continue to evaluate, but with continued declines in rates, it might be better to maintain accretion to tangible book value on the securities portfolio rather than remix it or modify asset/liability management.

That makes a lot of sense. Thanks, everybody.

Thank you. Our next question comes from the line of Andrew Liesch of Piper Sandler. Your question, please, Andrew.

Hi everyone, good morning. Thanks for taking the questions. I want to ask about the provision in the quarter; it looks like you built the reserve for the consumer and home equity books. Just curious what's behind that. I don't sense anything concerning, so I'm curious about the reserve build.

I don't think it was particularly about consumer. FICO scores did go marginally lower, but we have some aspects of the portfolio we're spending a little more time examining, like environmental concerns. However, this doesn't point to any significant issues within any specific part of the portfolio per se. We're not worried about our home equity position.

To add to these comments, I believe we're very well secured in those portfolios. It's not that there are any significant concerns; it’s simply that as we perform our modeling, we deemed it appropriate to adjust some coefficients in our analysis. There’s primarily a quantitative aspect, but there’s also a qualitative aspect to the model.

Got it. That’s helpful. And then, Jamie, the $500 million expense target for the full year includes the $3.8 million tax reversal in this quarter. For more detailed guidance in January, what do you consider to be the natural growth rate of expenses considering the various investments you’ve made? What would that rate look like?

That's a good question, Andrew. As you mentioned, we are currently in the budgeting process.

Yes, we’re in the budgeting season right now, Andrew.

Right, we will have more guidance next year. We've been clear that with our strong investments, these investments can now create efficiencies that previously didn't exist. We anticipate our natural expense growth rates going forward to align more with typical banking industry growth rates, which are significantly lower than the 5.5% to 6% rate we've experienced over the past couple of years.

Got it. Good to hear. Thanks for answering my questions.

Thank you. Our next question comes from the line of Jared Shaw of Barclays. Your line is open, Jared.

Thanks. Good morning. I'm going to go back to the loan growth and the payoff activity you discussed this quarter. What’s driving that? Are other banks becoming aggressive with customers? What’s fueling the elevated level of paydown and payoff activity, especially on the C&I side?

Sure. Thanks, Jared, that's a good question. So what happened was there were a couple of deals in which we were participating with others, and we were not the lead in the floor plan area on the Mainland. Our pricing was slightly higher than a more aggressive lender that stepped in and took over. It was a broadly syndicated deal involving four or five banks, and we just weren't the lead. This is what happens sometimes. We are competitive in the market, and in some sub-segments, there is increased competition. However, this is nothing out of the ordinary.

Got it. Then, when you talk about the potential for floor plan growth, I'm assuming that's centered on self-originated versus participation. Are you able to expand that business with existing customers, or are you actively pursuing market share with new clients?

We are not expanding our geographic footprint, but we are bringing on new customers along with some additional lines for existing clients. It’s truly a mix of both.

Understood. Lastly, regarding the buyback, how aggressive do you plan to be with that existing authorization? Should we anticipate a near-term CET1 target, or what will influence the buyback pace?

As previously mentioned, we have authorization for $40 million, and we expect to adhere to that amount.

Okay. So once that's done, no plans to reload it.

For 2024, we tend to evaluate it annually as part of our planning process for 2025. We’re certainly assessing our capital levels, and in the past, we indicated a minimum CET1 of 12%, which we remain above. That's part of our internal discussions and considerations with the board and various regulators.

Thank you for the insight.

Thank you. Our next question comes from the line of Kelly Motta of KBW. Please go ahead, Kelly.

Hi, good morning. I appreciate the controlled expenses and the guidance for the full year. I know it might be early considering where you are in the budgeting process, but based on the investments you've made, like the core conversion and other initiatives, how should we view natural expense growth rates moving forward and potential for operating leverage ahead considering the current outlook for rates?

Thanks for the question, Kelly. Maybe I’ll start and pass it over to Jamie. We are in the midst of evaluating investment opportunities internally. We must see how they align with our goals and remain disciplined in our approach following significant investments.

Thanks, Bob. Yes, Kelly, from an expense perspective, our targets for growth will be much lower than they have been over the past few years, considering these factors Bob mentioned. However, the challenge for a spread-based bank is when we expect rates to decline, net interest income may also decrease, complicating our goal of achieving positive operating leverage. We will do our best to minimize the drop in margin, grow loans cautiously, manage our balance sheet judiciously, and leverage competitive advantages in our markets, positioning ourselves to perform well next year.

That’s very helpful. In your prepared remarks, you noted some exceptional pricing during the rate increases, and conversely, you have some capacity to cut with reductions in rates. Have you quantified the magnitude of that part of the deposit portfolio?

Yes, we have. That equates to about $4.5 billion in deposits that are not directly tied to an index, but which we control pricing on. We are confident in our ability to reduce rates in line with anticipated Fed cuts, similar to how we increased them previously.

Great, thank you. Regarding fee income, it notably increased this quarter, particularly in credit and debit card fees, with a slight uptick in BOLI. Could you elaborate on the drivers behind that? Were there any significant death benefits in that line?

No death benefits were recorded in the quarter; growth in that line is primarily market-driven. When rates drop, we expect some enhancements in that category. Thus, for the fourth quarter, we anticipate fee income to be around $50 to $51 million, bolstered by good performance in the card portfolios.

That sounds promising. Nice quarter, everyone. I’ll step back.

Thank you. Our next question comes from the line of Anthony Elian of JPMorgan. Please go ahead, Anthony.

Hi everyone. I have a few follow-up questions. To revisit the payoffs, do you have an estimate for how much they impacted your loan growth in the third quarter?

We don't have that with us. Jamie, do you have that number? We can provide it afterward.

Yes, we can get it to you. It's likely in the neighborhood of $90 million to $95 million. That's the figure for the unexpected payoff we experienced.

Understood. Moving to Slide 6, you mentioned that non-interest-bearing deposits remained stable from the prior quarter. Do you consider this the lowest point for non-interest-bearing deposits as a percentage of total, or could there be future declines?

Yes, thanks. The percentage has remained stable for the past couple of quarters, around six months. We are optimistic that this will continue moving forward and hope to regain some market share in those areas. Non-interest-bearing deposits are crucial to our deposit gathering efforts.

Appreciate the insights.

Our next question comes from Timur Braziler from Wells Fargo Securities. Please go ahead, Timur.

Hi, good morning, everyone.

Good morning.

I apologize for focusing on the loan growth and payoff expectations. How much could the fixed-rate loan repricing schedule be impacted by the payoff cadence? Are those processes independent of one another or do you anticipate that all of that rolls off will be reinvested at that higher spread?

Thanks, Timur. The $400 million cash flow forecast is independent of unexpected payoffs we have observed. There could be risk to that forecast if we experience more unexpected large payoffs in Q4. However, we haven't planned for that risk. The full cash flow repricing we discussed, at a projected $400 million for the quarter, would be expected to reach the 250-basis-point level or so if we remain flat in loans for the quarter.

Understood. Regarding the FHLB advance that was rolled into that $250 million, what rate did that carry?

The exact rate on that was 4.14%. When we consider that maturing advance, we evaluate asset-liability management along with income dynamics and other funding opportunities in the market, while also taking our liquidity metrics into account. Having that term linked to the advance can help with our liquidity ratios.

Lastly, regarding margin, the securities yields seemed to step down significantly in Q3. Could you clarify this dynamic and how we should view the roll-off, roll-on of the associated cash flows going forward?

Yes, in the securities portfolio, we do have a small number of floating-rate loans. So when rates drop, you tend to see a minor reduction there. That's likely responsible for the 3 to 4-basis-point drop in the quarter. Generally, we are not reinvesting in that portfolio currently. Therefore, if rates continue to decline, the rates within the securities portfolio will likely reduce as well. However, when those securities, averaging 1.75% to 2%, mature each quarter, we don't need to fund those at 4.5% from the FHLB, leading to a positive income adjustment from that portfolio runoff.

Thank you. Lastly, regarding classified assets, they appeared to be notably higher, around double compared to the second quarter. Could you provide further insight into what contributed to that increase in classified assets?

The increase primarily occurred within multifamily, stemming from a handful of performing loans. These loans are well collateralized, but given the current rate environment, their cash flows aren't at the level we would prefer. We don't believe these loans indicate any trend within the portfolio, as they remain performing.

Great. Thank you for the insights.

I would now like to turn the conference back to Kevin. Sir?

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 have a good weekend.

This concludes today's conference call. Thank you for participating. You may now disconnect.