Earnings Call
First Hawaiian, Inc. (FHB)
Earnings Call Transcript - FHB Q2 2022
Operator, Operator
Good day and thank you for standing by. Welcome to the First Hawaiian Inc. Second Quarter 2022 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 Kevin Haseyama, Investor Relations Manager. The floor is yours.
Kevin Haseyama, Investor Relations Manager
Thank you, Carmen. And thank you everyone for joining us as we review our financial results for the second quarter of 2022. With me today are Bob Harrison, Chairman, President and CEO; and Ralph Mesick, Chief Risk Officer and Interim CFO. 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.
Bob Harrison, Chairman, President and CEO
Good morning, everyone. I will start by giving a brief local update. The Hawaii economy continues to benefit from the recovery in the tourism industry. In June, the statewide unemployment rate was 4.3%, compared to 3.6% nationally. Total visitor arrivals were 843,000 in June, 11% below June 2019 arrivals. A strong result considering the Japanese visitors were only 1.4% of the total, compared to over 13% in June 2019. This represents significant upside when Japanese arrivals return to more normalized levels. Importantly, the spend is up more than 12% over last year, which is what everyone wants, fewer visitors with the higher spend. While interest rates accounts have slowed in the housing market, continued demand and lack of supply have kept prices stable. In June, single family home sales were down 20% from last year with the median sales price of $1.1 million, which was 12% higher. Turning to slide two, we had a strong quarter reporting net income of $59.4 million and EPS of $0.46. Pre-provision net revenue was up $8.9 million quarter-over-quarter on higher net interest income. Our return on average tangible common equity was 18.79% and the Board maintained the dividend at $0.26. We had good growth in both loans and deposits and the balance sheet remains well positioned for rising rates and is well capitalized. During the quarter, we repurchased over 290,000 shares at an average price of $24.09 for $7 million. And finally, we successfully converted to our new core operating system, an important step in our digital transformation that we started a couple of years back. I want to make a few comments on the balance sheet and then provide more detail on loans and deposits. Turning to slide three, we saw good growth and a nice rotation on the balance sheet, which remains asset sensitive. We are highly liquid and well capitalized to support our business objectives. Total assets grew by 1.3% to $25.4 billion in the second quarter, and the asset mix improved with the deployment of cash into higher yielding loans. The balance sheet remains very asset sensitive with about $5.1 billion or 39% of the loan portfolio re-pricing within 90 days. It has been very responsive to the recent Fed rate hikes. Our liquidity position remains very strong, with a loan-to-deposit ratio of 58.7%, excess cash balances, and steady cash flows from the investment portfolio. We have ample liquidity to fund future loan growth. The investment portfolio has performed well during this period of volatile interest rates. The duration of the portfolio has remained stable at 5.6 years at the end of the second quarter, unchanged from year-end 2021. Cash flows from the portfolio continue to run between $100 million and $125 million per month. We continued to maintain strong capital levels after dividend payments and share repurchases. The common equity Tier 1 ratio was 11.9% at quarter end and the total capital ratio was 13.14%. Net of an AOCI adjustment, the securities book was flat at roughly $8.1 billion. In the quarter, we elected to reclassify $4 billion of the portfolio to held to maturity to reduce the accounting volatility associated with AOCI adjustments. Turning to slide four, period end loans and leases were $13.3 billion, an increase of $371 million or 2.9% from the end of Q1. Excluding PPP loans, total loans and leases increased by $434 million, or 3.4% compared to the prior quarter. We experienced growth in all portfolios with the largest increases in CRE, C&I, residential and home equity. As expected, the increase in the commercial book skewed toward our mainland markets, where the rebound of loan demand started earlier. On a year-to-date basis, total loans and leases are up $301 million or 2.3%. Excluding PPP loans, total loans and leases are up $474 million or 3.7%, in line with our full year outlook of mid-to-high single-digit growth, which remains unchanged. Turning to slide five, deposits increased by $331 million or 1.5% to $22.6 billion at quarter end. The increase was a result of a $439 million increase in public deposits, driven by a $458 million increase in operating account balances. That was partially offset by a $19 million decline in public time deposits. Non-public deposit balances declined about $108 million or less than 1%. Our cost of deposits remained low at 8 basis points, 3 basis points higher than the prior quarter. We anticipate more variability around deposit flows over the course of the year, but have a variety of options to fund loan growth, including a higher than normal cash balance. Now, I will turn it over to Ralph to cover the income statement and balance sheet.
Ralph Mesick, Chief Risk Officer and Interim CFO
Thank you, Bob. Moving to slide six, you see that our asset-sensitive balance sheet benefited from the increase in interest rates. Net interest income increased $11.2 million over the prior quarter to $145.1 million. Excluding PPP fees and interest, net interest income increased $13.2 million. The increase was primarily due to higher yields on securities and loans, and higher average loan balances. The net interest margin increased 18 basis points to 2.6%. Since the balance of unamortized PPP fees is deminimis, it will have a material impact on the NIM going forward. At 39% of the loan portfolio re-pricing within 90 days, our balance sheet remains well positioned to benefit from rising interest rates. We expect the NIM to increase by 25 to 30 basis points in the third quarter. Turning to slide seven, non-interest income was $44.1 million this quarter, a $2.8 million increase over the prior quarter. Activity-based revenue continues to do well, and trust and investment services income remained stable in spite of market volatility. BOLI income continued to be negatively impacted by the volatility in bond yields and equity markets. When this volatility subsides, we expect BOLI income to return to historical levels of $3 million to $3.5 million per quarter. This would align with our expectation of $47 million to $48 million per quarter. Going to slide eight. Non-interest expense was $109.2 million, $5.1 million higher than the prior quarter. Most of this increase had been expected with a ramp-up in implementation costs ahead of the core system conversion and the start of the new system-related expenses. These increases have been built into the most recent guidance. Compensation-related expenses increased by $1.7 million as we saw the full quarter impact of merit increases, a reduction in capitalized salaries related to the core project, and the hiring of temporary help to support us through the May system conversion. Contracted services were up $1.5 million, largely due to non-recurring consulting fees. Equipment costs increased by $1.8 million, and the increase was primarily related to the new core services contract. Looking ahead to the second half of the year, we anticipate that expenses will be between $113 million and $114 million per quarter, slightly higher than our original outlook. The largest drivers behind this increase are higher compensation costs due to inflationary adjustments and additional post-core conversion costs. Turning to slide nine, I will make a few comments on credit. Asset quality remained strong. In Q2, net charge-offs were $2.3 million, about $300,000 lower than Q1. Our year-to-date annualized net charge-off rate is 8 basis points, lower than the rates over the last three years. NPAs and 90-day past due loans remained low at 10 basis points, flat from the prior quarter. Criticized assets continued to decline, dropping from 1.29% of total loans in Q1 to 0.91% in Q2. The Bank recorded a $1 billion asset provision for the quarter. Loans 30 days to 89 days past due were $54.7 million or 41 basis points of total loans and leases at the end of Q2. The level of past dues were elevated at the end of the quarter as we implemented some operational changes related to the conversion. By mid-July, we saw a significant improvement with nearly half of the reported past dues being cleared, bringing us back in line with the levels we saw at the end of the first quarter. Moving to slide 10, you see a roll forward of the allowance for the quarter by disclosure segments. The allowance for credit loss decreased $1.3 million to $148.9 million. The level equates to 1.12% of all loans and 1.13% net of PPP loans. The reserve for unfunded commitments was $29 million. While reserve levels have decreased as we moved through the post-pandemic reopening, they remain elevated to account for the macroeconomic uncertainties. Let me now turn the call back to Bob for closing remarks.
Bob Harrison, Chairman, President and CEO
Thanks, Ralph. So to summarize, in spite of the volatility in the national economy, Hawaii has experienced good visitor arrivals this summer and the local economy is doing well. At the Bank, we have a good outlook for the second half of 2022 and beyond as we have a balance sheet that is well positioned for growth with good liquidity, strong capital and excellent credit quality. Now, we would be happy to take your questions.
Operator, Operator
Thank you. Our first question comes from Steven Alexopoulus with J.P. Morgan. Please go ahead.
Steven Alexopoulus, Analyst
Hi, everybody.
Bob Harrison, Chairman, President and CEO
Hey, Steve.
Ralph Mesick, Chief Risk Officer and Interim CFO
Good morning, Steve.
Steven Alexopoulus, Analyst
I like to start on the deposit side. So you guys reported strong deposit growth in the quarter in the backdrop where many other banks are showing deposits running off. Curious, was that intentional, in other words, were you out there in the market competing for deposits or was it just flow related just coming in from the public side?
Bob Harrison, Chairman, President and CEO
Yeah. Maybe I will start and ask Ralph to add to it, Steve. So primarily it was the operating balances at the State of Hawaii. We have been their depository for quite some time and they just got money on balance sheet with us. The public time deposits went down over the quarter, but we did see a substantial increase in the public operating account, the DDA account. We saw a slight decrease in all the consumer IPC deposits, but nothing more than normal movement.
Steven Alexopoulus, Analyst
Okay. That’s helpful.
Ralph Mesick, Chief Risk Officer and Interim CFO
We don’t have a lot.
Steven Alexopoulus, Analyst
If you look at the loan-to-deposit ratio, it's quite low. How do you view the funding for loan growth for the rest of the year? Do you anticipate the loan-to-deposit ratio increasing, or do you plan to keep it stable?
Bob Harrison, Chairman, President and CEO
So we think it should be moving up. We have a lot of cash on the balance sheet higher than normal. I think it’s right about $1.3 billion, yeah, and that’s higher than we would normally and certainly higher than pre-pandemic levels. So it starts with being able to fund that rotation out of cash into loans there and then with, obviously, the roll off of the investment portfolio of $100-plus million a month.
Steven Alexopoulus, Analyst
Got you. Okay. That’s helpful. And then on the margin, I appreciate the NIM guide for the third quarter. What’s the deposit beta that you are assuming underneath the NIM guide and do you still expect this similar through the cycle beta as of the prior cycle?
Ralph Mesick, Chief Risk Officer and Interim CFO
Yeah. Steve, this is Ralph. Right now we are assuming about a 20% deposit beta.
Steven Alexopoulus, Analyst
Got you. Okay. And any change to the through the cycle. I think the last time it would be about similar to the last cycle?
Ralph Mesick, Chief Risk Officer and Interim CFO
Yeah. Right now we are looking at it probably being similar to the last cycle and a lot of that has to just do with the level of liquidity in the marketplace right now in this local market.
Steven Alexopoulus, Analyst
Got you.
Ralph Mesick, Chief Risk Officer and Interim CFO
Particularly.
Steven Alexopoulus, Analyst
Okay. That’s helpful. And just, finally, any updates on the CFO search? Thanks.
Bob Harrison, Chairman, President and CEO
Yeah. No. And I meant to mention that, we really appreciate Ralph continuing as Interim. We are still working with Korn Ferry to identify the right candidate. But we haven’t done that yet. But we are working very hard with them to make that happen.
Steven Alexopoulus, Analyst
Okay. Thanks for taking all my questions.
Bob Harrison, Chairman, President and CEO
Thank you.
Operator, Operator
Thank you. One moment for our next question please. We have a question from David Feaster with Raymond James. Please go ahead.
David Feaster, Analyst
Hey. Good morning, everybody.
Bob Harrison, Chairman, President and CEO
Good morning, David.
Ralph Mesick, Chief Risk Officer and Interim CFO
Hi, David.
David Feaster, Analyst
You are following up on the margin question, and it's clear that you are very sensitive to rates. We have experienced significant margin expansion and continue to benefit from higher rates, with another increase of 75 basis points that should contribute positively. Rate sensitivity is inherent for your business model and the strength of your core deposit franchise. As you consider managing this rate sensitivity, do you have any plans over the next few quarters to potentially secure some higher rates and reduce sensitivity? If so, what strategy would you take?
Ralph Mesick, Chief Risk Officer and Interim CFO
Yes, I will begin. This is Ralph. Currently, when we consider the balance sheet, we have three main strategies: working with clients through the swap program and client derivatives, managing the securities portfolio, and engaging in balance sheet hedging activities. At this moment, we would likely ease into any changes in positioning rather than trying to time the market. We have executed a few received fixed swaps in the past quarter and will likely explore options for additional swaps or callers.
David Feaster, Analyst
Okay. Regarding asset quality, the macro economy is quite volatile at the moment, but you maintain a conservative approach to credit and have excellent asset quality. I'm interested to know if there are specific aspects you're monitoring more closely, and your overall perspective on credit. Are there any signs of concern you've noticed? Additionally, what feedback are you receiving from your clients? Are they still making investments, or are you beginning to detect any cautiousness in their behavior due to the current uncertainties?
Bob Harrison, Chairman, President and CEO
Yeah. Let me start. This is Bob and maybe hand it off to Ralph. So we haven’t seen any indications yet tangible evidence. As Ralph mentioned in his remarks, we saw a little blip in just collections on one consumer portfolio that’s been addressed. But, generally, where we see weakness in the consumer side, we foresee it in credit cards and indirect lending and that hasn’t happened as of yet. More broadly, to answer your other question, we have seen a couple of projects pause on the mainland that we were looking at. But nothing here locally; what we have seen locally is, people are continuing to invest. But, Ralph, turn it over to you, if you have any comments.
Ralph Mesick, Chief Risk Officer and Interim CFO
Yeah. I would just say that, we had the opportunity with the pandemic to really front load, and I think CECL was good for that purpose. So I think we have embedded a lot of the expectation of stress into the reserve today. And then when we look at the portfolio, we had the opportunity as well to really take a real deep dive. So I think we feel pretty good about what we have in the portfolio. And I would say that, where we would probably see the most stress given the current situation is going to be smaller consumer and small business loans. And again, I think, as we look at the reserve, we have taken I think a pretty big overlay to support any stress we see there.
David Feaster, Analyst
Okay. And then just last one from me, maybe just with the core conversion completed, could you talk about some of the immediate benefits of this; you mentioned some operational changes. And then just curious what’s next on the docket, you have done a phenomenal job on the tech front, just curious whether there’s any other upcoming investments or partnerships that you might be interested in and what initiatives are next up on the tech front?
Bob Harrison, Chairman, President and CEO
I thought we were going to get a quarter off, Dave. So, we had to answer that question.
David Feaster, Analyst
What have you done pretty lately?
Bob Harrison, Chairman, President and CEO
That's correct. We're still working through some follow-up tasks for the core project. The main goal was to automate several of our manual processes, and that has mostly been accomplished. We're currently addressing the remaining components. Looking ahead, we have an ambitious roadmap that our COO, Chris Dods, has outlined for us, and we will be executing that throughout the remainder of this year and into next year, with many developments on the horizon. However, I would prefer to provide a more detailed answer next quarter when more of those initiatives are underway, as right now we're just finalizing the core conversion and allowing our team a bit of a breather.
David Feaster, Analyst
Are we looking at maybe more internal efficiency improvement or outward growth initiatives or is it again just don’t want to talk about it yet?
Bob Harrison, Chairman, President and CEO
It’s both. Clearly, we are always trying to be more efficient in what we are doing, but at the same time, what we are looking at is provide more convenience for the customer. And one has in, for example, with the core conversion we were able to enhance our online account opening. And we are going to be spending more time on that going forward to further enhance that, but that’s one of the benefits we have got just with the core conversion and that’s an example of the things we are continuing to be doing over time.
David Feaster, Analyst
Correct. Thanks everybody.
Operator, Operator
One moment for our next question. Our next question is from Andrew Liesch with Piper Sandler. Please go ahead.
Andrew Liesch, Analyst
Hey. Good morning, everyone.
Bob Harrison, Chairman, President and CEO
Good morning.
Andrew Liesch, Analyst
Just want to follow up on the loan growth guidance still seems intact, but how does the pipeline fit today, and I guess, what’s the makeup of the pipeline? Is it still more weighted towards commercial real estate and C&I and then any comments around what you are seeing in the dealer flow in book would also be appreciated?
Bob Harrison, Chairman, President and CEO
Sure. Andrew, this is Bob. I’ll start off with your question and then ask Ralph to add some comments. What we observed is a significant growth in commercial real estate, primarily on the mainland this quarter. We continue to have a strong pipeline for the current quarter, although it’s a bit mixed in Hawaii, leaning more towards the mainland this quarter, but we still see a solid pipeline for Hawaii as we approach the quarter's end. We expect to see some growth in commercial and industrial as well, along with continued activity in residential on HELOCs. For the dealer segment, we have seen gradual gains each quarter this year, showing signs of recovery. However, I don’t anticipate broad-based volume increases from manufacturers until closer to year-end or possibly into 2023. Ralph, do you have anything to add?
Ralph Mesick, Chief Risk Officer and Interim CFO
No. Not really.
Andrew Liesch, Analyst
Got you. And then the residential in the HELOC, is that local or is that in the mainland?
Bob Harrison, Chairman, President and CEO
Yeah. We are only doing those products within our geographic footprint.
Andrew Liesch, Analyst
Okay. That’s right. All right. You have covered all my other questions. I will step back. Thanks.
Bob Harrison, Chairman, President and CEO
Thank you.
Operator, Operator
Thank you. One moment for our next question please. Our next question comes from Kelly Motta with KBW.
Kelly Motta, Analyst
Good morning. Thank you for the question. I would like to revisit the net interest margin and the deposit side. You experienced a significant inflow of public deposits this quarter, and I am curious about the seasonality, the re-pricing of the public deposit book, and your net interest margin guidance. Specifically, how does it account for potential outflows related to seasonality? I would like to ensure the balance sheet is properly adjusted.
Ralph Mesick, Chief Risk Officer and Interim CFO
Yeah, this is Ralph. I would say that public deposits are operating accounts. They are likely to remain in a certain range moving forward, and we have been collaborating with them during the pandemic to encourage them to invest some of that money in alternative asset classes or short-term investments to help us reduce leverage on the balance sheet. I believe this trend will continue. At this time, we do not expect to enter the public time deposit space. When we look at the balance sheet, considering the cash position, the run-off of securities, and the level of high-quality assets, we should be able to support loan growth while absorbing some deposit losses and maintaining our margin. So, we feel confident about the NIM guidance right now.
Kelly Motta, Analyst
Okay. Thanks. Thanks for that. And then maybe lastly, most of my questions have been asked and answered. Just on the buyback that the back in the market this quarter. I am wondering about your appetite for further share repurchases going forward? Thanks.
Bob Harrison, Chairman, President and CEO
Yeah. Kelly, this is Bob. So that’s something capital return to shareholders is very important to us, that’s probably to keep our strong dividend. One of the issues as we talked about, I believe last quarter and maybe even at the fourth quarter call is, anticipating this higher loan growth and we have retained our internal guide of looking for our 12% common equity Tier 1. So we will probably see muted buybacks for at least a good chunk of this quarter until we get a better feel for what the loan growth is going to be, because we do want to make sure we retain and maintain the strong capital level. Later in the year, we will certainly be looking at that regularly and maybe that will change, but for now, we are really going to be focusing on growing quality loans and supporting that with a good amount of capital.
Kelly Motta, Analyst
Got it. That’s all from me. Thanks so much.
Bob Harrison, Chairman, President and CEO
Yeah. You bet.
Operator, Operator
Thank you. One moment for our next question. All right. We have a question from Laurie Hunsicker with Compass Point. Please go ahead.
Laurie Hunsicker, Analyst
Yeah. Hi. Thanks. Good morning.
Bob Harrison, Chairman, President and CEO
Good morning.
Laurie Hunsicker, Analyst
Ralph, I have a question going back to margin. I feel like we are all asking about margin. But the 25-basis-point to 30-basis-point guide, is that core ex-PPP. In other words, I am looking at your PPP fees for about 3 basis points on margins. So are you thinking that as the 250 starting point or at 260 headline, how are you thinking about that?
Ralph Mesick, Chief Risk Officer and Interim CFO
Yeah. I think the 25 basis points would be of PPP. PPP is going to be a pretty small contributor going forward.
Bob Harrison, Chairman, President and CEO
That’s up to 260.
Laurie Hunsicker, Analyst
Up to 260.
Bob Harrison, Chairman, President and CEO
Right. Right. And I am aware that PPP is, as I look at. Okay. Just wanted to clarify. Okay. And then on non-interest income, your guide, did that assume anything in terms of change to overdraft and NSF fees or how are you thinking about that? So this is Bob. We believe that area will remain flat, as you have seen our reported results have declined over the past few years, and we do not expect much growth in that segment. Therefore, we are not counting on it. What we perceive, as Ralph mentioned, is that as market volatility decreases, we anticipate a return to a more normalized BOLI income for non-interest income.
Laurie Hunsicker, Analyst
Right. Yes. I appreciate that. 3 to 3.5. That’s helpful. But so your overdraft and NSF fee is that then something you probably are going to address in 2023 or?
Ralph Mesick, Chief Risk Officer and Interim CFO
Well, that’s something...
Laurie Hunsicker, Analyst
Is it something...
Bob Harrison, Chairman, President and CEO
Obviously a lot happening on that nationally and we are following that. We are looking at alternatives. Candidly, during the core conversion isn’t the time to be changing structure is like that, but we are looking at it and we haven’t made any decisions yet as far as any potential changes. But we are certainly recreating it.
Laurie Hunsicker, Analyst
Got it. Got it. Okay. And then on expenses, I appreciate your guide there, can you help us think about with that, obviously you had a lot of moving parts driving your expenses higher this year, but how we should be thinking about expense growth into 2023?
Bob Harrison, Chairman, President and CEO
Yeah. Laurie, this is Bob again. That’s a little far out for us right now. Certainly, we are comfortable with the guide that Ralph gave of $113 million to $114 million for the next two quarters, but we will have to wait till later in the year to get a really an outlook for 2023.
Laurie Hunsicker, Analyst
Okay. Okay. And then just last question I had was with the warning light starting to flash, can you give us a refresh just on two loan categories your office, as well as leverage lending. Can you just refresh us on what those look like and remind us what’s Hawaii based versus mainland based?
Bob Harrison, Chairman, President and CEO
Sure. Happy to. Total office is about $884 million, about a third of that is small balance CRE. We call that small balance being under $5 million. So very often that’s mixed use partly owner-occupied, et cetera. The mainland exposure is $373 million, with about $150 million of that being in transactions involving collateral pools with multiple properties, so less tenant concentration, a lot of cross-collateralization, et cetera. The Hawaii exposure is $466 million and that includes a lot of that small balance loans and in Guam we have about $45 million, all of which is small balance loans. Of that portfolio about $2.9 million is classified. So very, very small number. Moving to...
Laurie Hunsicker, Analyst
Okay.
Bob Harrison, Chairman, President and CEO
Go ahead.
Laurie Hunsicker, Analyst
Did you have an LTV on that?
Ralph Mesick, Chief Risk Officer and Interim CFO
We don’t think that that’s really, I think the better approach is to take a look at what the loan classifications are and they are really about $2.9 million.
Bob Harrison, Chairman, President and CEO
Yeah. And then, yeah, we are always looking at this and looking at the stressing the tenancy, the rollover risk, the concentration, all of that. So we are very comfortable with that and then we also have within our reserve an overlay in the CRE space for any potential stresses that may come up, maybe seeing some of that today, but we don’t see a lot of it here within our markets. Moving over to leverage loans, as you know, I mean, there’s not a common definition for that and so we are trying to piggyback off of, I think, the OCC definition, which is 6 times debt commitments, not outstanding debt commitments to EBITDA and using that metric we have $39 million at quarter end and all are past rated. And just to remind you, is about this time in 2019 we did sell off over $400 million of our snick portfolio, some of which included leverage line data as well. So we really took that number down in 2019.
Laurie Hunsicker, Analyst
Great. Thanks for the color.
Operator, Operator
Thank you. And I am not showing any further questions in the queue. I am going to turn it back to Mr. Haseyama for his final thoughts.
Kevin Haseyama, Investor Relations Manager
Thanks Carmen. 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 nice weekend.
Operator, Operator
Thank you. And this concludes today’s conference call. Thank you for participating and you may now disconnect.