Bank of Hawaii Q1 2023 Earnings Call Transcript

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April 24, 2023

There are 8 speakers on the call.

Operator

Good day, and thank you for standing by. Welcome to the Bank of Hawaii Corporation's First Quarter 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.

Operator

I would now like to hand the conference over to your speaker today, Jennifer Lam, Senior Executive Vice President, Treasurer and Director of Investor Relations. Please go ahead.

Speaker 1

Thank you. Good morning. Good afternoon, everyone. Thank you for joining us today. On the call with me this morning is our Chairman, President and CEO, Peter Ho Our Chief Financial Officer, Dean Shigemura and our Chief Risk Officer, Mary Sellers.

Speaker 1

Before we get started, let me remind you that today's conference call will contain some forward looking statements. While we believe our assumptions are reasonable, there are a variety of reasons the actual results may differ materially from those projected. During the call, we'll be referencing a slide presentation as well as the earnings release. A copy of the presentation and release are available on our website, boh.comunderinvestorrelations. And now, I'd like to turn the call over to Peter Ho.

Speaker 2

Thanks, Jennifer. Good morning or good afternoon, everyone. Thank you for your continued interest in Bank of Hawaii. Despite the drama and challenges of the past month and a half, Bank of Hawaii recorded solid results. Deposits grew on an average basis, but were down modestly on a spot basis.

Speaker 2

Loans grew across both commercial and consumer categories. Margins reflected the continued inversion of the yield curve. If the last few weeks have taught us anything, it is that business models matter. In banking, the quality of relationship as well as the diversity of relationship with WinOne's client base are both critical. At Bank of Hawaii, we believe our 125 year commitment to a community bank based model achieved both key factors.

Speaker 2

We've been focused on the Hawaii and West Pacific markets for many, many years now. This focus has allowed us to build uniquely longstanding relationships with our clientele, Relationships that work both ways. Additionally, our community based approach dictates that we focus not on any one sector or concentration, but rather on a whole community approach. This has enabled us to build both a mass market consumer business as well as a private bank business. This enabled us to serve very small businesses as well as established long tenured businesses in town.

Speaker 2

We also serve not just the state of Hawaii, but also component Municipalities throughout the state. It is this combination of quality and diversity of relationships in a market we've been serving for over 100 years that makes us different in challenging times. Given keen interest in liquidity and FundingSource, we thought we provide and reiterate critical knowledge on our operation, Which I'll be happy to do in a second. As is customary, Mary will follow with some updates on credit, which is a good story, and Dean will finish off with financials, So let me begin with just touching on our community bank approach. Basically, We use our 125 year old coveted brand, blend that with a true community bank focus and take advantage of both the broad and deep market penetration that we have here in Hawaii as well as in the West Pacific To create a diversified long tenured deposit base, strong levels of liquidity, as well as the diversified lower risk loan assets.

Speaker 2

Those assets then turn into results which create both exceptional credit quality as well as exceptional deposit performance. Speaking of deposits, really through our 125 year history in the islands, BankBoy has developed an exceptionally seasoned deposit base built one relationship at a time for many years and in neighborhoods and communities we uniquely understand. To begin with the marketplace, important to recognize that I think many of you on the phone already do, It is that Hawaii is truly a unique deposit marketplace, where 5 local institutions hold 97% of the bank deposits within the market. Our deposits are widely distributed. 98% of our deposits are fully FDIC insured.

Speaker 2

42% of our deposits are FDIC uninsured or uncollateralized. Deposit averages on the consumer side are $18,000 $133,000 on the commercial side. We have nice diversification within the deposit base, Consumer making up just under half of our overall deposits, commercial at 41.9% and public and other municipalities fill in the rest. And even within those segments, we have diversity. Looking at the government side or institutional side between agency state and county.

Speaker 2

Onto the consumer side, a nice blend of not only mass affluent to high net worth, but also mass market. And then on the commercial side, a nice mixture of industry sectors there. Our deposits are also highly operational in nature with over 50% of our deposits being demand deposits And 95% of our commercial deposits having 3.7 accounts per relationship on average and 71% of our consumer deposits having multiple deposit account relationships with Bank 4. In terms of deposit mix, you see that 31% of our deposits are non interest bearing. That's down from 33% a quarter ago.

Speaker 2

I note that the average for Bank of Hawaii non interest bearing between 2017 2019 was 31.2%. In terms of tenure, Banks Way has some of the longest tenured deposits in the industry. 51% of our deposits are with relationships over 20 years old, 23% 10 to 20 years old Only 26% under 10 years. So here on Slide 12, what you can see Is the deposit performance for really the past year and certainly the month of March has been Pretty darn flat. Really what you see on the left side is pretty good performance on a year on year basis through the Q1 And then looking more on a more micro basis on to the month of March, you see basically From the period with SVB and some other institutions falling into trouble Moving from actually $20,400,000,000 to $20,500,000,000 spot

Speaker 3

at the end of the year.

Speaker 2

By segment, our deposit balances on a linked basis have been pretty steady as well, whether it be consumer, commercial or public and other. And then moving on to deposit beta. Here you see that while deposit betas have moved up, I think at 15.9%, we represent pretty well relative to the industry as a whole. And on to deposit costs, deposit costs are rising, but in what appears to be a steady and measured manner at this point. So finally to finish off, in addition to a granular Diversified deposit base, we also maintain healthy liquidity backup lines totaling 8,200,000,000 with additional loans available for sales, securitization, repo or pledging of just under $2,000,000,000 for additional liquidity backup.

Speaker 2

So now let me turn the call over to Mary Sellers who will touch on credit and other assets.

Speaker 4

Thank you, Peter. Serving our island communities for 125 years has served us to conservatively manage the assets of the organization. Accordingly, our investment portfolio is invested in high quality securities, primarily U. S. Government agency and U.

Speaker 4

S. Government sponsored agencies. We take a similar approach to lending. We lend in markets we know to relationships we understand. And our loan portfolio reflects this with 94% of our portfolio in Hawaii and the West Pacific and 6% Mainland based, representing credit exposure for those relationships who have diversified assets or operations beyond Hawaii.

Speaker 4

We couple this with prudent underwriting and disciplined portfolio management, and we have a portfolio that is built on long tenured relationships, Diversified by asset class has appropriately sized exposures is 80% secured with real estate with a combined weighted average loan to value of 55% and has higher risk categories that are well contained. Our commercial real estate portfolio, which represents 28% of the total portfolio, is diversified across various asset types with office accounting for just 3% of total loans. The portfolio built on relationships with demonstrated experience and financial capacity has conservative weighted average loan to values across all asset types and a portfolio weighted average loan to value of 56%. Our office portfolio is diversified by asset class across our markets and carries a weighted average loan to value of 56%. 25% of the portfolio is primarily Class A properties in the Honolulu Central Business District.

Speaker 4

This segment has a 63% weighted average loan to value and 47% of the exposure is further supported by repayment guarantees. 3% of loans in the office segment are maturing through 2024. Tail risk in the commercial real estate portfolio remains modest with just 0.92% having an LTV greater than 80%. Our consistent conservative approach to underwriting is reflected in the consistently strong quality of our consumer loan portfolio and in turn portfolio. And our same consistent conservative approach is also reflected in the consistently strong quality of our commercial loan production and portfolio.

Speaker 4

Asset quality remained strong in the Q1 with net charge offs of $2,700,000 or 8 basis points annualized of total average loans and leases outstanding, up $800,000 for the linked period and up $1,200,000 year over year. Non performing assets were $12,100,000 Down $500,000 from year end and down $7,900,000 from the Q1 of 2022. All NPAs are secured with real estate with a weighted average loan to value of 57%. Loans delinquent 30 days or more remained stable on both the linked period and year over year at 23 basis points. Criticized loans as a percentage of total loans were 1.31% at the end of the quarter, remaining modestly below pre pandemic levels.

Speaker 4

At the end of the quarter, the allowance for credit losses was $143,600,000 down $900,000 for the linked quarter And the ratio of the allowance to total loan and leases outstanding was 1.04%, down 2 basis points. The reserve estimate utilized to Hiro's March 2023 forecast, which continues to call for economic slowing, but no recession in Hawaii. The reserve, however, does continue to consider the downside risk of a recession as well as the impacts of inflation and rising rates. The reserve for unfunded commitments was $7,000,000 at the end of the quarter, up $200,000 for the linked period. I'll now turn the call over to Dean.

Speaker 3

Thank you, Mary. Net interest income was $136,000,000 in the first quarter. Negatively impacting the quarter's net interest income were 2 fewer days in the quarter, which reduced net interest income by approximately 1,600,000 and early buyouts on leases, which reduced net interest income by $300,000 Adjusting for these items, Our normalized net interest income for the Q1 was $137,800,000 a decrease of $2,900,000 linked quarter and an increase of $12,700,000 from the Q1 of 2022. The linked quarter decrease was primarily due to higher funding costs, partially offset by loan growth and higher asset yields. The increase from the Q1 of 2022 was primarily due to loan growth and increases in our asset yields, partially offset by higher funding costs.

Speaker 3

The inverted yield curve continues to pressure our net interest income and margin. We expect deposit betas will continue to rise The 15.9% in the Q1, driven in part by further mix shift from non interest bearing to interest bearing savings and time deposits and the generally more competitive rate environment. To address these the challenges from the higher short term rates, Beginning in the Q4, we increased our term funding by $800,000,000 at a weighted average rate of 3.93 percent and also increased our longer term time deposit balances by $730,000,000 at a weighted average rate of 3.84%. In addition, we continue to remix our loans by shifting to greater floating and variable rate exposure, which comprised the majority of new originations in the quarter, while allowing our investment portfolio to run off and holding more cash on the balance sheet. From an earning asset perspective, net interest income and margin are being supported by strong cash flow and overall asset repricing at higher rates.

Speaker 3

With $2,900,000,000 of annual cash flows from maturities and pay downs of loans and investments, We have ample opportunity to redeploy funds into higher yielding assets, including cash. In addition to the strong cash flow, Another approximately $3,600,000,000 in assets are repricing annually, which provides additional rate sensitivity. In particular, the yield on maturities and paydowns of loans and investments in the Q1 was 4.1% and 2.1%, respectively. These cash flows were reinvested predominantly into new loans, which yielded approximately 5.9%. Run off may also be held in cash, which is yielding more than the run off, thus providing an attractive alternative while preserving liquidity.

Speaker 3

Non interest income totaled $48,700,000 in the Quarter. Included in the results was a $600,000 charge related to a change in the Visa Class B conversion ratio, which is reported as a contra revenue item in the investment securities gains losses. I should note that the remaining amount in the securities gains losses is due to the ongoing fee paid to counterparties from prior Visa Class B sales, Not from securities sales, which there were none in the quarter. Adjusting for this item, non interest income was 41,300,000 an increase of $100,000 linked quarter and lower by $2,200,000 from the Q1 of 2022. The decrease from the Q1 of 2022 was primarily due to lower revenue from mortgage banking customer derivative activity.

Speaker 3

Non interest income is expected to be $40,000,000 to $41,000,000 per quarter for the remainder of the year. During the Q1, as is our practice, we managed our expenses in a disciplined manner As economic conditions remain unclear, included in the Q1 of 20232022 were seasonal payroll taxes and benefits expenses from incentive payouts, which totaled $4,000,000 $3,700,000 respectively. In addition, 1st quarter expense also included severance expenses of 3,100,000 It should be noted that this will result in a $3,300,000 annual savings. Adjusting for the seasonal payroll and benefits expense in both years and severance expense in the Q1 of 2023, Normalized expenses in the Q1 were $104,900,000 an increase of $2,100,000 linked quarter and $4,700,000 from the Q1 of 2022. The increased linked quarter was primarily due the industry wide increase in FDIC insurance, which accounted for $1,500,000 and an increase of $500,000 in the statutory rate and the Hawaii state unemployment tax.

Speaker 3

Notably, the remaining increase after accounting for these factors was just $100,000 in the quarter. Compared to the Q1 of 2022, the increase in normalized expenses was due to the aforementioned FDIC insurance increased, which accounted for $1,700,000 as well as the increase in the unemployment tax of 500,000 The remaining expense increase of $2,000,000 from the Q1 of 2022 was well under the annual rate of inflation. For the full year of 2023, we continue to expect expenses will increase by approximately 3% over the 2022 normalized base of $415,000,000 While inflation continues to pressure expenses, other actions are being taken that moderate expense growth through the rationalization of operations and slowing of hiring. To summarize the remainder of our financial performance, in the Q1 of 2023, Net income was $46,800,000 and earnings per common share was 1.14 Our return on common equity was 15.79 percent and our efficiency ratio was 63.34%. We recorded a credit provision of $2,000,000 this quarter.

Speaker 3

The effective tax rate for the Q1 was 25.4%. The increase in effective tax rate on a linked quarter basis was due to The non recurring benefit from the leverage lease terminations received in the 4th quarter and unfavorable discrete tax item in the Q1. The year over year increase was primarily due to lower benefits from tax credit investments. The effective tax rate in the Q1 of 2022 also included benefits from leverage leases and have since been terminated. The tax rate for the full year of 2023 is expected to be approximately 24.5%, which does not include the recognition of low income housing tax credit benefits expected in 2023 due to the uncertainty around the timing of the recognition of Our capital remains well above regulatory well capitalized guidelines.

Speaker 3

Our CET1 and Tier 1 capital ratios were 10.9% to 12.1%, respectively, to common shareholders and dividends and $2,000,000 in preferred stock dividends. We repurchased 150,000 shares of common stock for And finally, our Board declared a dividend of $0.70 per common share for the Q2 of 2023. I'll turn the call back over to Peter.

Speaker 2

Great. Thank you, Dean. Thanks again for listening in. I would be happy to take your questions.

Operator

We have a question from Andrew Liesch from Piper Sandler. Your line is open.

Speaker 5

Hi, good morning. How are you guys?

Speaker 2

Good, Drew. How are you?

Speaker 5

Good, thanks. Just curious, Dean, how should we be thinking about the margin from here? It seems like that you kind of have some caution around rising deposit costs, but Longer term, it's still from asset repricing. So how

Speaker 2

do you think the

Speaker 5

margin is going to react over the course of the next year?

Speaker 3

Yes. Right now, we're Expecting the Fed to increase rates next week and then possibly another one, but pause from that point on. But when you look at that compared to what the futures are expecting, we're actually looking at a higher for longer kind of rate environment And the inversion carrying through to sort of the middle of next year. So based on that, we're looking at the margin coming down In the Q2, and then really bottoming out towards the end of this year, before increasing into the next year, Assuming the rates do come down on the short end towards the tail end of 2024.

Speaker 5

Got it. Any level where that could what we expect it's going to tail out there? Where do you think it will bottom?

Speaker 3

We're looking at right now, at least in the second quarter, similar Decline as we saw in the Q1. And then from there, it will start to Yes.

Speaker 5

Certainly. And then I just got a question on the short term borrowings that you added, it looks like those came on Maybe earlier in the quarter just based on the average balance. I'm just curious, what was the rationale for adding those? Is it just to add some liquidity? Any color behind that would be helpful.

Speaker 3

So we did take down some longer term funding. And again, that's part of our Kind of mid again, if you will, against the higher for longer rates. And then second of all, we did want to hold a little bit more On the balance sheet, both on the in terms of Fed funds sold.

Speaker 5

Got it. All right. Thanks. That covers my questions. I'll step back.

Speaker 2

Thank you.

Operator

Thank you. One moment for our next question. We have a question from Kelly Motta from KBW. Your line is open.

Speaker 6

Hi, thanks so much for the question. I was hoping to get a bit more Color on the securities portfolio, I think it's extended out some, but could you provide us with the expected duration on

Speaker 3

is about 5.4 years duration. The AFS is 3.8, HTM is 6.4. And to kind of give you more color, we are with the increase in rates, the cash flows and kind of prepayments have already In effect, bottomed out. And so we're really effectively at the contractual payment level. So we don't expect any more slowdown or extension In the portfolio from rate movements higher, and therefore, there is if rates were to move lower, Those cash flows could increase in short durations.

Speaker 6

Got it. Understood. And obviously a lot going on this quarter. It looks like you repurchased maybe a little bit of shares this quarter. Just wondering How you feel about capital at these levels and what kind of the outlook is for managing capital going ahead?

Speaker 2

Yes. Kelly, I think that given the environment that we find ourselves in at this point, as well as Some level of uncertainty around kind of where regulatory levels will push out in the kind of intermediate term. I think we're going to be pretty judicious around capital. That's not to say that we've suspended any form of capital programs at all, but I think a guideline standpoint, we're probably going to be more judicious than not around capital management.

Speaker 6

Got it. And maybe last question for me and then I'll step back and let others in. But I Saw the Moody's downgrade. Just wondering if this is something that you've been in discussion with them and how that works and any implications That if there are any, to how you run your business?

Speaker 2

We don't anticipate any implications for that. Obviously, we were disappointed To see the downgrade, especially after having just been affirmed on January 12, the AA3 rating. But we took a one Level downgrade on our long term deposit rating from AA3 to A1 with a stable outlook. Not what we had previously, but still a high mark for us. So we don't anticipate any operational meaningful operational outcomes from that.

Speaker 6

Certainly. One more if I can just sneak it on just tacking on to that. Is there a level of deposit rating where you would Obviously, you're at very high level still right now, but that would start to create greater conversations with some of your depositors, just as somebody who doesn't hasn't ever looked at those ratings, Just trying to understand it a little bit better.

Speaker 2

Tough to say. Generally, Ratings discussions haven't come into play in dealing with our depositors. So No, not in our past practice, no.

Speaker 6

Great. Thanks. I'll step back. Appreciate all the color.

Speaker 2

Thank you, Kelly.

Operator

Thank you. And we have a question from Jeff Rulis with D. A. Davidson, your line is open.

Speaker 7

Thanks. Good morning. Dean, I wanted to follow-up on Let me get back to you mentioned your expectations for the beta to exceed the 59%. Just wanted to kind of see if you've got an updated Through the cycle expectation is part is question 1. And then the second part of that is just have you seen Customer rate requests, have those eased, and as we've proceeded into April?

Speaker 7

Thanks. I'll leave it there.

Speaker 3

Yes. In terms of our betas, historically, we were at 20%. In this cycle, understanding the magnitude and the velocity of the increases, we can see that the betas Could rise between 20% to 25%. It's kind of what we're thinking there will be. In terms of exceptions, I don't see any real changes.

Speaker 3

I mean, we still do get exception requests for deposits And that's all incorporated into the what we're expecting in terms of betas.

Speaker 7

Got it. And Dean, while I've got you, do you have a March margin average, what that was for the month of March?

Speaker 3

For the margin? Let me see, I do have it. It was 37.

Speaker 7

Okay. I appreciate it. And maybe one last one, Peter, in a Strange one here. I guess just some noise about regulators changing treatment of unrealized losses. Has that All through your strategy at all or you really give that any attention?

Speaker 7

Any thought on just addressing that part of the Unrealized loss treatment?

Speaker 2

I guess, Jeff, We certainly have a heightened awareness around maybe the differences in AFS treatment for smaller banks versus larger banks and the prospects of smaller banks having potentially to migrate to that level. And I think where we stand on that is kind of not knowing where things stand there. We likely will begin to think through various scenarios on Now we could, if forced to move to that level, get there. Our preliminary view is that we would be able to do that organically over a period of time, Kind of given operating assumptions that we think are reasonable at this point. So nothing Obviously, nothing has been set in stone, a fair amount of discussion around the topic.

Speaker 2

And I guess we're trying to stay as flexible as possible kind of within that discussion.

Speaker 7

And on that front, in addition to the deposit balance, and I appreciate The almost by week or the month of March balances certainly hadn't been impacted and actually up since SVB, I don't know if you've had any customers that can take that second link and look at that. Have you had any customers Or larger maybe public deposits look at the potential securities losses. Have you had to address that or Walk people through the outcomes there? Thanks.

Speaker 2

I would say in general, What people are interested in is more the deposit stability of the franchise. And obviously, the proof is in the pudding there. Kind of the discussion around unrealized losses And the like is a little bit more esoteric certainly for the majority of our deposit base. And generally, when we have a discussion with more sophisticated levels, think there's a reasonable level of understanding there. So, no, I mean the topic itself has not resulted in meaningful deposit outflow for us.

Speaker 7

Okay, great. Thanks, Peter.

Operator

Thank you. One moment. We have a follow-up from Andrew Liesch with Piper Sandler. Your line is open.

Speaker 5

Hi, thanks for taking the follow-up question here. Just to clarify something on the expense guide. So 3% on that 415,000,000 It's about $207,000,000 Does that include the severance this quarter? So on a more run rate basis, it's actually lower than that?

Speaker 3

Yes, it would include the severance.

Speaker 5

Got it. That's all I had. Thanks so much.

Speaker 2

Thanks, Andrew.

Operator

Thank you. And we also have a follow-up, one moment, with Kelly Motta from KBW. Your line is open.

Speaker 6

Hi. Thanks for letting me jump back in. I apologize if I missed this as part of the prepared commentary, but Your fee guidance appears to be slightly better than what you had in January. What's the drivers of that better fee outlook going ahead? Just trying to understand.

Speaker 3

Yes. It's generally a more stable Outlook in the economy, we are seeing some transactional volumes increase And general kind of market conditions, the stability in the markets, I think is helping us to Achieve a better outcome on the fee side.

Speaker 6

Got it. And then also your loan growth was So, all considering like very healthy this quarter, wondering what you're seeing in your markets and How you're balancing that with the funding aspect of things and what the drivers of loan growth should be going forward?

Speaker 2

Yes. Well, what really augments or has augmented the loan growth, Kelly, has been Basically amortization of securities book, which basically can accommodate growth in the mid single digit level. I would suspect that the annualized rate that we saw in the Q1 for loan growth Might be a high watermark as we move forward for a couple of reasons. 1, feels like commercial borrowers are beginning to Pull back a little bit, just kind of with the, I think, heightened uncertainty in the marketplace and the spectrum of recession. Then obviously, I think as rates have kind of taken hold, the consumer front, I think It's slowing a bit as well.

Speaker 2

So I guess I would say that loan growth still would be Potentially in the mid single digit range, but probably ranging towards the lower end of the mid single digits at this point. And that is Pretty adequately supported by securities runoff.

Operator

We also have a follow-up from Jeff Rulis with D. A. Davidson. Your line is open.

Speaker 7

Thanks. One more for Mary. Just on the criticized pickup Wink quarter, any color as to where that was? I think you've mentioned that 80% of the total Criticized is in CRE. Just wanted to see what that linked quarter addition to that balance was?

Speaker 4

Jeff, it was actually across a number of customers. Generally, what we saw were various idiosyncratic issues, Either they face supply chain or permitting delays, they had slower repositioning post COVID Or they were just looking at higher operating expenses. Our lodging component does continue to be the biggest piece of that. We did get some upgrades this quarter, but we still have several large exposures there where they're really dependent on Japanese and international travelers returning.

Speaker 7

Okay. Thank you.

Operator

Thank you. And I'm showing no other questions in the queue. I'd like to turn the call back to management for any

Speaker 1

I'd like to thank everyone for joining us today and for your continued interest in Bank of Hawaii. Please feel free to contact me if you have any additional questions or need further clarification on any of the topics discussed today. Thank you everyone.

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Bank of Hawaii Q1 2023
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