Earnings Call Transcript - FHB Q2 2025

Operator, Operator

Thank you for joining us for the First Hawaiian Bank Inc. Second Quarter 2025 Earnings Conference Call. As a reminder, today’s program is being recorded. I would now like to introduce your host, Kevin Haseyama, Investor Relations Manager. Please proceed.

Kevin S. Haseyama, Investor Relations Manager

Thank you, Jonathan, and thank you, everyone, for joining us as we review our financial results for the second quarter of 2025. 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.

Robert Scott Harrison, Chairman, President and CEO

Thank you for joining us today. I'll start by giving a quick overview of the local economy. The statewide seasonally adjusted unemployment rate continued to drift lower and was 2.8% in June, compared to the national unemployment rate of 4.1%. Through May, total visitor arrivals were up 2.8% compared to last year as the strength in U.S. Mainland arrivals more than offset weakness in the Japanese and Canadian markets. Year-to-date, spending was $9 billion, up 6.5% compared to 2024. It's interesting to note, we went back and looked, and for the first 5 months of 2019 to the first 5 months of 2025, visitor arrivals are down 3.9%, but the spending is up over 24%. So while there have been fewer visitors, the spending is up substantially. Turning to Slide 2. We had a very strong second quarter. Our net income increased over 23% compared to the prior quarter. The improvements in our results compared to the last quarter were broad-based, driven by higher net interest and noninterest income, good expense control, and lower provision expense. Our results also include the impact of a change in California tax law that resulted in a net benefit of $5.1 million. Turning to Slide 3. The balance sheet remains solid. We continue to be well capitalized with ample liquidity. Loans and deposits were stable during the quarter, and we repurchased about 1 million shares at a total cost of $25 million. We had $50 million of remaining authorization under the approved 2025 stock repurchase plan. We resumed reinvesting the investment portfolio cash flows in the second quarter and we plan on maintaining the portfolio balance at its current level. Turning to Slide 4. Total loans increased about $59 million or 0.4% from the prior quarter. The largest increase was in the C&I portfolio, which was primarily due to a $125 million increase in dealer floor plan balances. This was largely offset by payoffs from several completed construction projects in our commercial real estate portfolio. Looking forward, we expect full-year loan growth will be in the low single digits. And now I'll turn it over to Jamie.

James M. Moses, Chief Financial Officer

Thanks, Bob. Turning to Slide 5. Total deposits increased slightly in the second quarter as growth in public deposits more than offset the decline in commercial and retail deposits. On the retail side, they were down $23 million in the quarter, and commercial deposits were down $127 million. The decline in commercial deposits was due to the normal operational fluctuations that we see in that book. Total public deposits increased by $166 million, all in operating accounts. There was no change in the balance of public time deposits. Total deposit costs fell by 4 basis points in the quarter, and our noninterest-bearing deposit ratio remained at 34%. On Slide 6, we see that net interest income was $163.6 million, $3.1 million higher than the prior quarter, and the NIM was 3.11% up 3 basis points compared to the prior quarter. The increase in the margin was driven entirely by lower deposit costs, primarily due to CD repricing. While we didn't see the anticipated benefit from fixed asset repricing in the second quarter, the underlying balance sheet dynamics driving the NIM remain intact, and we anticipate that the NIM in the third quarter will increase a couple of basis points to 3.13%. On to Slide 7, where noninterest income was $54 million in the quarter and benefited from a few items that went our way. We continue to expect that the recurring piece of noninterest income will be about $51 million per quarter. Expenses were better than expected in the first half of the year, but we expect them to tick up just a bit in the back half. We think expenses in the third quarter will be up around 2% on a linked quarter basis, and that full-year expenses will be better than originally expected at around $506 million. And now I'll turn it over to Lea.

Lea M. Nakamura, Chief Risk Officer

Thank you, Jamie. Moving to Slide 8. The bank continues to maintain its strong credit performance and healthy credit metrics. Credit risk remains low, stable, and well within our expectations. We are not observing any broad signs of weakness across either the consumer or commercial portfolios. Classified assets increased by $31.6 million on the quarter. These loans are well secured, and we continue to work closely with the borrowers. Quarter-to-date net charge-offs were $3.3 million or 9 basis points. Year-to-date, net charge-offs were $7.1 million. Our annualized year-to-date net charge-off rate was 10 basis points, 1 basis point lower than in the first quarter. Nonperforming assets and loans 90 days or more past due comprised 23 basis points of total loans and leases at the end of the second quarter, up 6 basis points from the prior quarter, resulting from an uptick in nonaccruals. Most of these were residential loans with low loan-to-value ratios, so we feel that the loss content in these loans is very low. Moving to Slide 9. We show our second quarter allowance for credit losses broken out by disclosure segments. The bank recorded a $4.5 million provision in the second quarter. The asset ACL increased by $1.2 million to $167.8 million, with coverage remaining flat at 1.17% of total loans and leases. We believe that we continue to be conservatively reserved and ready for a wide range of outcomes. Let me now turn the call back to Bob for any closing remarks.

Robert Scott Harrison, Chairman, President and CEO

Thank you, Jamie, and Lea. Now I'd be happy to take your questions.

Operator, Operator

And our first question for today comes from the line of Liam Coohill from Raymond James.

Liam Joseph Coohill, Analyst

This is Liam on for David. Just wanted to start out with C&I driving growth in the quarter and taking into account the low single-digit outlook moving forward, how is the pipeline in terms of C&I? And is that the largest contributor? And I'm also curious on the CRE side, are we seeing increasing demand from those borrowers? Appreciate any color you might have.

Robert Scott Harrison, Chairman, President and CEO

Most of the growth in commercial and industrial (C&I) came from our dealer floor plan, and we've observed it returning to our anticipated levels. For the quarter, it reached approximately $786 million, which is an increase of about $125 million from the previous quarter. While car sales have slightly decreased, there's still some uncertainty regarding tariffs, making it difficult to predict how those balances will shift, although we expect minimal fluctuation. Regarding commercial real estate, we initially believed some commercial construction loans would extend into mini-permanent loans, but they did not, which indicates strong credit quality; however, it poses a challenge for our balances. We still have many of those loans being processed, but it's more challenging to forecast their payoff timelines. Consequently, we adjusted our guidance from a low to mid-single-digit range to low single digits for the full year, anticipating these factors.

Liam Joseph Coohill, Analyst

I appreciate that. You mentioned the impact of tariffs; how have you been seeing that balance with the improvement in tourism spending on the islands? Do you think it’s relatively even between the two factors, or has the increase in tourism spending outstripped tariff concerns at this point? Have there been any changes in softness of concerns compared to last quarter?

Robert Scott Harrison, Chairman, President and CEO

Really no change. The only impact we really see from tariffs is the uncertainty it gives our car dealers. They're still not exactly sure what those tariffs will be. I don't think it's had much of an impact on tourism. Japanese and Canadian tourism is down. I think primarily for the Japanese, it's a little bit slower economy and their exchange rate is still fairly weak for them. But U.S. West and all of the Continental U.S. has been strong, and that's what led to the increase in arrivals and almost certainly the increase in spend.

Liam Joseph Coohill, Analyst

Great. And just last one for me. We did see the repurchases of some shares in the quarter. Just wondering what your capital priorities are at this stage as we move into the back half of the year?

James M. Moses, Chief Financial Officer

Yes, I believe our capital priorities continue to be consistent. We would like to focus on organic growth opportunities. It's important for us to maintain a stable dividend. Additionally, we are considering share repurchases, and I anticipate that we will utilize more of our repurchase authority in the latter half of the year. So, that's likely where we will focus our efforts.

Operator, Operator

And our next question comes from the line of Andrew Terrell from Stephens.

Robert Andrew Terrell, Analyst

Maybe just to piggyback off of the last question around capital priorities. I mean, so I'm looking back, your capital position is stronger than it's been in a while. You've got a lot of capital, the loan growth outlook is maybe a little bit lower following this quarter. I'm curious how these things play together into your thought process on M&A and whether M&A makes more sense for you guys at this juncture? And maybe if you could just kind of update us on your thought process there and if it does or doesn't make sense for you?

Robert Scott Harrison, Chairman, President and CEO

Sure. This is Bob. I think that's something we always look at. We're not averse to considering options, but we don't have anything we're looking at currently, but we're always out there talking to people as far as potentials for doing things with our capital. We're very comfortable with the capital levels. It's a little bit higher than we had guided to in years past. It was closer to 12%. We have increased the allowance. We do think there will be a rotation as Jamie was getting to out of securities and back into lending. And when that happens, that can eat up the capital fairly quickly. So we want to make sure we maintain enough capital for loan growth.

Robert Andrew Terrell, Analyst

Yes. Makes sense. And maybe just one for Jamie. Going back to the comments around the margin, and I appreciate the guidance for 3Q. That's helpful. What impacted or anything we should be aware of that impacted loan yields in the second quarter and kind of mitigated what I thought would be a little bit better in kind of fixed repricing? Just any color you can provide on the underlying dynamics there would be helpful.

James M. Moses, Chief Financial Officer

Yes. I think it was really a mix issue. We had significant payoffs in the construction book and increases in the commercial and industrial book. There was a timing differential where higher margin loans were paid off and replaced by relatively lower margin loans. Overall, the situation still indicates that as fixed-rate cash flows exit the books and are replaced by higher-yielding assets, the net interest margin should increase over time. It was just an unusual quarter regarding the mix of these items.

Robert Andrew Terrell, Analyst

Understood. If I may ask one more question. You mentioned that $51 million of fee income appears to be a core figure, with both credit and debit card fees and service charges increasing this quarter. There seems to be a usual trend of strength carrying over into the third quarter as well. Can you clarify if this is your view of what is core in the long term? How should we expect fee income to look in the third quarter?

James M. Moses, Chief Financial Officer

I believe fee income for the third quarter will be in the range of $51 million to $52 million. That's likely where we will end up. Occasionally, we experience various market-related events that require us to revalue certain obligations, such as pension and BOLI obligations. When the market improves from one quarter to the next, we tend to see small increases in these figures. This quarter, we experienced a few of these occurrences in the vicinity of $2 million, which we anticipate. While these events are unpredictable, I think the $51 million to $52 million range is a reliable estimate for the third quarter.

Operator, Operator

And our next question comes from the line of Kelly Motta from KBW.

Kelly Ann Motta, Analyst

Regarding the tax rate, I noticed the increase in your deferred tax assets this quarter that was mentioned in the release. Jamie, could you update us on how this change in tax law affects your tax rate outlook for this year and the future?

James M. Moses, Chief Financial Officer

Yes, you got it, Kelly. So where normally we would say we would outlook at like 23% for our effective tax rate. The outlook for the rest of the year is 23.2% on that tax rate.

Kelly Ann Motta, Analyst

Okay. So fairly immaterial, got it. Okay. And moving on the deposit costs. You've done such a great job getting your deposit costs down in the first round of rate cuts. It seems like there's a declining benefit after future cuts. But when those do come, wondering how you're thinking about deposit betas on the next round of cuts. You are asset sensitive, but that would be a nice offset.

James M. Moses, Chief Financial Officer

Yes. So we have talked in the past about declining betas related to tax cuts. I don't think we're fully there yet at the moment. I think we probably have a few more rounds available to us before that starts to become a real issue. I would say that from the perspective of a rate cut, if we were a 95 beta or so on our rate-sensitive deposits over the last 2 cuts, that maybe drops to 90 or so over the next couple of cuts. So we still feel pretty strongly that we'll be able to pass through a large portion of those cuts to those rate-sensitive customers. But after maybe another 1% or so, the beta will decline over time on that. So I think 90% is an okay number for the next 1 or 2.

Kelly Ann Motta, Analyst

Great. Got it. And then last for me, just a higher picture question. Loan growth this quarter, really nice C&I, but you had the construction paydowns. It seems like the outlook is a little bit lower than at the start of the year, still quite good. As you look ahead kind of more broadly speaking, what do you think are the main factors that would get increased activity among your client base to really pick up? And over the longer term, what's a more normalized growth rate? Do you think more mid-single digits would be something that could be achievable longer term without the payoff headwinds? Thank you.

Robert Scott Harrison, Chairman, President and CEO

Yes, Kelly, this is Bob. I'm a little reluctant to look out longer term, just as most banks were following the economies of the areas we're in. So that's kind of making a bigger forecast that I'm comfortable with. But just to talk maybe a little more specifically about what happened this quarter, one of the reasons we lowered our guidance just a tad was that we had thought some of these construction loans were going to go into mini perm and if the takeout market is as strong as it is and they're getting paid off, that does affect that. How much will U.S. floor plan continue to grow? Hard to tell. But pre-COVID, I think we were at $859 million in total and now we're $786 million. So we're getting close to what pre-COVID numbers were. So the amount of increase will likely slow down. So it's really the interplay between those two. The teams are out there. They're calling on people. There's good pipelines developing, but it's just hard to, at this point, put that into a number between now and year-end other than what we've done in the past year, and I don't think we'd be comfortable commenting.

Kelly Ann Motta, Analyst

Got it. Maybe just last follow-up on those construction loans getting taken out. Where are you seeing the most competition coming in? Is it from the local banks in Hawaii getting more aggressive on pricing, larger insurance companies, large banks?

Robert Scott Harrison, Chairman, President and CEO

No, this is the end of construction where normally, before COVID, loans would be taken out immediately. Post-COVID, they sometimes linger in a mini-permanent status for a while, which has always been a characteristic of those loans. Now, we are observing a return to normalcy, with institutional buyers, including insurance companies and others, taking out those loans upon completion of construction. It was never intended to be a permanent loan for us, so it does not involve other local banks.

Operator, Operator

And our next question comes from the line of Jared Shaw from Barclays.

Jared David Wesley Shaw, Analyst

Could you provide insights on the current spreads for commercial and industrial loans? Are they remaining stable, or are you experiencing some compression due to competition?

James M. Moses, Chief Financial Officer

Jerry, this is Jamie. They are remaining quite stable. Overall, we have a weighted average roll-on in the mid- to upper-six range across the books. So, I would describe the spreads as mostly stable.

Jared David Wesley Shaw, Analyst

Okay. And then can you just walk through a little bit on the investment securities with the decline in yield this quarter? And you talked about sort of reinvesting some of those cash flows. What are you purchasing in terms of yield and duration? And should we expect to see some recovery in the securities yield? Or is it staying lower here?

James M. Moses, Chief Financial Officer

Yes. You can expect a pickup of around 2.25% on the assets we are acquiring compared to what is maturing. We're experiencing a roll-off of about 2% in that segment, while we plan to add assets yielding between 4% and 4.25%. We aim to keep the duration stable within the portfolio. We will be replacing the cash flows that are maturing with similar types of assets that we are rolling off, particularly mortgage securities that have strong structures and offer features that ensure a limited prepayment window, maintaining a duration around 5.

Jared David Wesley Shaw, Analyst

Okay. All right. Regarding credit, I realize we're discussing low numbers. However, the growth in residential mortgage nonperformers over the last few quarters has been significant compared to previous periods. What is causing this weakness? I understand there may not be substantial loss content, but what is contributing to the underlying concerns with consumers in this area?

Robert Scott Harrison, Chairman, President and CEO

Jared, this is Bob. Maybe I'll start, and then Lea can add some comments. The consumer at the, say, the lower end is getting a little stretched. Their savings as they accumulated during COVID have gone away, and it's just getting a little bit tougher. Lea, I think you'd mentioned on collateral, but anything you want to add?

Lea M. Nakamura, Chief Risk Officer

No, not really. I mean the portfolio is performing as we expected, so we were pleased for a very long time with the performance, and we continue to be very pleased and confident with the portfolio.

Robert Scott Harrison, Chairman, President and CEO

Yes. For a very long time, we had zero, so anything above that will seem significant. However, we are not worried about it in terms of losses, as Lea mentioned.

Operator, Operator

And our next question comes from the line of Timur Braziler from Wells Fargo.

Timur Felixovich Braziler, Analyst

Maybe just keeping to the line of commentary on credit, the increase in commercial criticized assets. Can you just help us reconcile kind of that increasing trend versus still really strong level of charge-offs? And how do you see that ultimately playing out? Do you think that is going to somehow correlate to maybe an uptick in charge-off activity again off of a really low base? Or do you think that ultimately, they just end up curing themselves?

Lea M. Nakamura, Chief Risk Officer

For the most part, borrowers will resolve their own issues. We already know of one that paid off right after the quarter ended, and another one we expect to pay off as well. As you pointed out, the base is so low that just one loan changing can have a significant impact as a percentage. We approach these situations with the understanding that some may experience difficulties. However, by staying close to the borrower, we can be confident that the outcomes will be very favorable.

Timur Felixovich Braziler, Analyst

And then, sorry, go ahead.

Lea M. Nakamura, Chief Risk Officer

No, we are confident in our book. The book is strong.

Timur Felixovich Braziler, Analyst

Okay. And maybe following up on the completed construction loans being refi-ed away. I'm just trying to get the magnitude here of what's coming due from a construction completion standpoint? And then similarly on the CRE side for those resets that are approaching, I'm just wondering if you're seeing an increased level of competition from some of those potentially being refi-ed away as well here?

Robert Scott Harrison, Chairman, President and CEO

Yes, Tim. I don't have the specific numbers for what’s ahead. We had three loans pay off in the quarter, which contributed to that paydown for several others. As for refinancing, we are not observing additional competition. Regarding new deals, pricing had widened a bit during COVID. It is returning closer to pre-COVID spreads, but it remains solid and seems appropriate for the risks that we are underwriting.

James M. Moses, Chief Financial Officer

Yes. Tim, yes, I think maybe we'll see some balance sheet growth. We're going to keep the bond book stable where it's at, and we should see some loan growth in the back half of the year. So I would expect a larger balance sheet by year-end.

Robert Scott Harrison, Chairman, President and CEO

To add to Jim's comments, some factors that have hindered us over the past several years include our indirect book, which was over $1 billion pre-COVID, specifically $1 billion to $1.1 billion, but has now decreased to $600 million. Over the last 5.5 years, it has dropped by more than $500 million. However, this has now stabilized, and the market is looking reasonable, so we no longer face that headwind. There is a slight headwind in residential lending, as is the case for all banks, but the volume of new business is limited as things mature. On the commercial side, as Jamie mentioned, we are optimistic about the opportunities available and are actively reviewing potential deals, feeling good about our pipeline.

Operator, Operator

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Kevin Haseyama for any further remarks.

Kevin S. Haseyama, Investor Relations Manager

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 have a good weekend.

Operator, Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.