First Hawaiian, Inc. (NASDAQ:FHB) Q2 2024 Earnings Conference Call July 26, 2024 1:00 PM ET

Company Participants

Kevin Haseyama - Investor Relations Manager
Bob Harrison - Chairman, President & Chief Executive Officer
Jamie Moses - Chief Financial Officer
Lea Nakamura - Chief Risk Officer

Conference Call Participants

Steven Alexopoulos - JPMorgan
David Feaster - Raymond James
Andrew Liesch - Piper Sandler
Kate Ashley - KBW
Timur Braziler - Wells Fargo Securities

Operator

Good day, and thank you for standing by. Welcome to the First Hawaiian Second Quarter 2024 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. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Kevin Haseyama, Investor Relations Manager. Please go ahead.

Kevin Haseyama

Thank you, Shannon. And thank you, everyone, for joining us as we review our financial results for the second 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 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 fhp.com in the Investor Relations section.

During today's call, we will be making statements -- 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.

Bob Harrison

Good morning, everyone.

I'll start by giving a quick overview of the local economy. Hawaii economy continues to perform well. The state unemployment rate has remained low, tourism is steady, and we enjoy a healthy construction industry. State-wide seasonally-adjusted unemployment rate for June was 2.9% compared to the national rate of 4.1%.

Through May, total visitor arrivals were down 4.1% and spending was down 4.9% compared to 2023 levels. The year-over-year decline was primarily due to the drop in visitors to Maui. On a year-to-date basis, Kauai and Hawaii island also saw small declines in arrivals. Japanese visitors continue to return to Hawaii, but the numbers remain well below pre-pandemic levels.

The housing market has remained relatively stable, despite reduced activity levels. In June, the median sales price for a single-family home on Oahu was $1.1 million, 6.7% higher than March of this year. The median sales price for condos on Oahu was $530,000, 3.9% below last year.

Turning to Slide 2, I'll give an overview of our second quarter results. Overall, we're very pleased with our strong financial performance. We had good loan production, improving deposit trends and a well-controlled cost of deposits at 1.7%. Credit quality remained excellent and several key credit metrics improved in the quarter. Our results also benefited from solid noninterest income and good expense discipline. Additionally, we believe that the trends we saw in the quarter put us in a good position for a strong second half of the year.

Turning to Slide 3, the balance sheet remains a source of strength. We continued to use the run-off in the investment portfolio to fund loan growth and reduce high-cost deposits. We also maintained ample liquidity. Our deposit mix continued to show signs of stability. The ratio of noninterest-bearing deposits to total deposits was unchanged from the prior quarter at 34%. We remain well-capitalized and our capital levels continued to grow during the quarter.

Turning to Slide 4, total loans grew by $39.7 million over the prior quarter. Overall, we had good production in several areas, led by draws on existing construction loans and new leasing opportunities. C&I production was driven by an increase of about $150 million in dealer flooring loans. This was partially offset by paydowns and payoffs of other C&I loans. In particular, we sold two criticized SNC loans at par that totaled $27.5 million. The decline in the consumer loan balances was due to runoff in the indirect auto portfolio.

Looking forward, the pipeline is strong, and we think the production will pick up in the second half of the year, weighted towards the fourth quarter. Our outlook for the full year is low-single-digit loan growth.

Now, I'll turn it over to Jamie.

Jamie Moses

Thanks, Bob.

Turning to Slide 5, total deposits were down $351 million, driven by a $216 million decline in total public deposits. Overall results in the second quarter continued to demonstrate the strength of our deposit franchise as we saw several positive trends that will -- that should put us in a good position for the second half of the year. The migration of noninterest-bearing deposits to higher-cost accounts slowed in the quarter and the ratio of noninterest-bearing deposits to total deposits remain a solid 34%, unchanged from the prior quarter. This favorable deposit mix contributed to our low 170 basis point total cost of deposits, which increased only 5 basis points in this quarter as compared to 9 basis point increase in the first quarter. Overall, deposit pricing in the local market has remained rational and we anticipate that these trends will continue to support our performance in the second half.

On Slide 6, we see that net interest income was $152.9 million, $1.6 million lower than the prior quarter. The decline was primarily due to lower average balances of cash and investment securities than the prior quarter. The margin was up 1 basis point, as the benefits from asset repricing, changes in balance sheet mix and a maturing swap were partially offset by higher deposit costs. Looking forward, we expect the NIM in the third quarter to be relatively flattish. We continue to believe that the balance sheet repricing dynamics support an upward trend for the NIM, but the timing and pace of rate cuts will impact that absolute level.

Turning to Slide 7, noninterest income was $51.8 million, about $400,000 more than the prior quarter. Noninterest income in both the first and second quarters of this year included about $2 million of various insurance proceeds. So, we continue to expect quarterly noninterest income to be in the $49 million to $50 million range.

Noninterest expenses were $6.7 million lower than the prior quarter. Now recall that first quarter expenses included the $4.1 million FDIC special assessment. We continue to expect our quarterly expense run rate to be in the $125 million range.

And now, I'll turn it over to Lea.

Lea Nakamura

Thank you, Jamie.

Turning to Slide 8, our overall credit quality remained excellent and we saw improvement in a number of key credit metrics compared to the prior quarter. As Bob mentioned on a previous slide, we sold two criticized SNC loans at par for a total of $27.5 million in the second quarter. This action was part of our continuous credit monitoring and management process and we currently do not see any areas of credit concern in the portfolio.

Moving to Slide 9, we show our first quarter allowance for credit losses broken out by disclosure segments. The coverage ratio remains unchanged at 1.12%. We continue to stress test the portfolio and believe that we remain well covered.

Turning to Slide 10, we provide an updated snapshot of our CRE exposure. CRE represents approximately 30% of total loans and leases. Credit quality remains strong, with LTVs manageable and criticized loans continuing to comprise a very small portion of the portfolio.

Let me now turn the call back to Bob for any closing remarks.

Bob Harrison

Thank you, Lea. Thank you, Jamie.

All in all, we had a good quarter. We saw some very positive trends that will drive our performance in the second half of the year. Loan production is picking up. Deposits and deposit costs are stabilizing. Credit quality remains excellent. Expenses are well managed. And noninterest income is stable.

Now, we'd be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Steven Alexopoulos with JPMorgan. Your line is now open.

Steven Alexopoulos

Hi, everybody.

Bob Harrison

Good morning, Steve.

Steven Alexopoulos

I want to start, so, Bob, on the loan outlook, you're sticking with low single-digit. You're basically flat right now where you were at your-end. By my math, you need $300 million, $400 million of growth to get to low single-digit in the second half. Could you walk us through how you'll get there? Like, what will change that dramatically versus the first half?

Bob Harrison

Yeah. We saw some paydowns in the first half that we don't anticipate in the second half. That's part of it. We're not swimming upstream as much. We think that the rate of indirect runoff will slow. For residential, we think that will continue to be a challenge, candidly. So, we're not expecting much change there from what we saw in the first half. But on the commercial and C&I side, there's a number of transactions that are in the pipeline that we think are going to meaningfully add to our balances. You've also seen some of the comeback in dealer floorplan loans. Those are somewhat volatile, but that is seemingly coming back. If you -- so, I kid with Kevin and Jamie, you say it enough times, eventually it'll be true, which happens to be the case this quarter. But I think those are the real key areas; C&I, CRE, less so on the consumer side.

Steven Alexopoulos

Got it. Bob, could you help us understand, so if you look at the paydowns that occurred in the first half, just so we see what you're looking at, why you're confident they're not going to repeat again the second half, is it just maturities you had in the first half and you don't have the same degree in the second half? Just help us understand what gives you the confidence on the paydown side.

Bob Harrison

Yeah. We saw several loans pay off on the construction side in the first half. One of those we liked, which was this quarter we talked about it on the last call was that $24.5 million sub-standard multi-family deal that paid off. That was sooner than expected, but welcome. The couple of deals we just sold at par. We're not looking to prune the portfolio anymore at this time, so that is, again, helpful. We're not expecting too much in the way of construction completion during the second half of the year. So that continued build as the draws come in over the next six months will be helpful. So, those are really the things, Steve. The wildcard is still a little bit to dealer floorplan. It's hard to predict exactly what those balances will be.

Steven Alexopoulos

Right. Okay. And then, on the margin and NII outlook, so it looks like, based on the inflation data today, we will very likely get a rate cut in September. Help us think through what your updated thoughts are on NIM. Can you grow NIM, hold NIM flat with cuts? And can you grow net interest income, which is probably even more important, in the backdrop of the Fed cutting rates, I don't know, once per quarter or something like that?

Jamie Moses

Yeah. That's a great question, Steve. So, from a NIM perspective, I guess I would say that we expect the trajectory of the NIM to continue to rise, but if there is a rate cut just on an absolute level, the NIM will decline in the quarter that there is a rate cut. We still do have a slightly asset-sensitive balance sheet. And you'd also expect one month SOFR to lower itself in anticipation of rate cuts as well. So, the repricing of loans happens slightly ahead of the repricing of deposits. And so, you'll see a small decline in the NIM based on that. But then, the underlying dynamics of the balance sheet should allow us to actually increase NIM even through the backdrop of rate cuts, but at lower absolute levels.

Steven Alexopoulos

Okay. And what about your ability to grow net interest income if the Fed...

Jamie Moses

Right. So, net interest income, that's -- yeah, sorry about that, Steve. So, that will be dependent upon loan growth, continued rotation out of securities and into loans that could help us grow NII. But, on an apples-to-apples basis, the NII would decline in that scenario.

Bob Harrison

And just to add to that Jamie's comments, which I agree with 100%, is the stabilization of our deposit balances is a big part of that as well. And at some point, if they start going the other way, which they haven't yet, that would certainly be helpful.

Steven Alexopoulos

Okay. And then -- thank you. Just finally, on the securities portfolio, the yield really jumps out quite a bit how low it is. And I know you're not reinvesting there, which is a factor, but still $6 billion of securities or so. Have you guys looked into or seen quite a few banks do portfolio restructurings, too? You have the capital to pick up yield. What are your thoughts there? Thanks.

Bob Harrison

Yeah. Thanks, Steve. So, we're aware we've seen people do that out in the marketplace. We did that a little bit in the fourth quarter of last year, but we continue to think that the right move here is to sort of continue to run the securities balances down and just try to rotate that into loan growth at the moment. So, we're aware. We kind of weigh the costs and benefits of that. We understand why people do it. We understand the reasonings behind it. But at the moment, we're comfortable with how we are managing it, which is to just continue to run securities down and try to rotate that into loan growth.

Jamie Moses

Steve, there's one clarification we want to make with you as well that on the $1 million donation in Maui, along with the Federal Home Loan Bank, that did come from the bank, as it has to in that situation, but they triple matched us. So, we put in a $0.25 million and they put in $750,000. So, the total is $1 million. So, just to give you that additional detail.

Steven Alexopoulos

Got it. Okay. Thank you. All right. Thanks for taking my questions.

Operator

Thank you. Our next question comes from the line of David Feaster with Raymond James. Your line is now open.

David Feaster

Hi. Good morning, everybody.

Bob Harrison

Hey, David.

Jamie Moses

Good morning, David.

David Feaster

I just wanted to dig into maybe some of the core deposit trends. You laid out some of the dynamics that we saw in the quarter, public funds moving out, some of the pressures on retail and commercial deposits. But I was hoping you could maybe talk, too, about some of the movement that you saw throughout the quarter, kind of from early in the quarter through quarter end, and what gives you confidence that things are stabilizing?

Jamie Moses

Thanks, Dave. So, we saw most of the deposit outflow happen in the first part of the quarter. Now, we saw the same thing in first quarter as well, but the overall magnitude of the change, in particular on noninterest-bearing deposit side, was significantly less in Q2 than it was in Q1. And so, we continue to be cautious around that, but we think that the magnitude of the deposit shift changing the way it did is really -- makes us hopeful for the rest of the year. It gives us some confidence that we think that those dynamics are slowing for sure. And again, when you think about this in the context of the greater economy and rate cuts looming, we think that kind of the worst is over in terms of folks shifting out of noninterest-bearing into interest-bearing deposits.

David Feaster

All right. That's great color. And then maybe somewhat of a difficult question to answer because there are a lot of moving parts, but I'm just curious, how do you think about the size of the balance sheet going forward. Obviously, we talked about loan growth improving, and maybe to the extent that we do get core deposit growth, would you expect to reduce higher-cost funding and use securities cash flows to fund growth and the balance sheet maybe remain relatively stable or even decline? I'm just kind of curious, how do you think about it?

Bob Harrison

Yeah, Dave, maybe I'll start and then hand it off to Jamie. So, we see that shrinkage slowing as deposit runoff is slowing. And that's what really drives it for us. We aren't in a situation with 70% loan-to-deposit ratio where we're stretching and doing outside funding, market-based funding, to be able to fund loan growth. So, as the securities portfolio runs off and the deposits stabilize, that should give us a floor on the really where the balance sheet is at. But, Jamie, anything you'd add to that?

Jamie Moses

Yeah. No, I think you said it really well, Bob.

David Feaster

Okay. That makes sense. And then, last one for me. Just wanted to touch on the HELOC side. Look, that's the largest portion of your NPAs. I just wanted to get a sense of what you're seeing in that book and maybe how do you think about the mortgage portfolio as well? And I know you mentioned that things are stable, but just any thoughts on the housing market more broadly?

Bob Harrison

Maybe I'll start and see if Lea has any comments to add. The housing market is just so strong here. It's really -- we saw pricing continue to move up. There's very little supply coming on market. What is out there is still getting multiple, multiple bids. So, we're not seeing the need to really any of the borrowers to discount. And so, we're not seeing that as an issue, but specific to the HELOC, I'll defer to Lea.

Lea Nakamura

As far as credit quality, we continue to monitor it closely, but we're not seeing anything within the portfolio that we feel is outside of what we would normally expect. So at this point, we're quite comfortable still with the portfolio and how it's performing.

Bob Harrison

Yeah. But it's not easy out there. Unemployment is low, but it's still -- we live in a high cost state, and that's the balance. There's still some stress in a number of people's daily lives for income.

David Feaster

Yeah. Okay.

Bob Harrison

We'll work through it.

David Feaster

Yeah. Thanks, everybody.

Operator

Thank you. Our next question comes from the line of Andrew Liesch with Piper Sandler. Your line is now open.

Andrew Liesch

Hey, guys. Good morning. Question on capital here. It continues to build these last several quarters now above the CET1 ratio of 12% that you've been targeting over the long-term. So, what are your thoughts on the buyback? And then, the dividend has been at this level for some time. Just curious, sort of the capital return thoughts?

Bob Harrison

Yeah. Thank you, Andrew. Great question. Maybe starting with the dividend, we had started out when we went public almost eight years ago to the day now that with a relatively high dividend payout of roughly 50%. And so, we're still at that 50%, 54%, 55%, we're very comfortable with. We think that's a very solid payout. We'll certainly look at that as income grows over time. But we are going to start looking in the second half of the year, as I think we talked about earlier for restarting the buybacks. There's still people out there, I won't name names, but there's still people out there that are still doing marks and looking at us kind of oddly, in my opinion, but I won't delve into that. So, we still think it's a prudent time to have adequate capital. But at some point in the second half of the year, you can look to us to restart the buybacks.

Andrew Liesch

Got it. All right. That's helpful. And then among your deposit commentary earlier, sorry if I missed it, but the public funds, is that reduction there just planned, because you don't necessarily need that funding? And I guess, how do you think those trends -- how those funds will trend over the balance of the year with any seasonality?

Jamie Moses

Yeah, Andrew. This is Jamie. So, the public -- most of that decline in public deposits was in public time deposits, which is what we use to sort of fund any gaps that we find on the balance sheet at any given point in time. And so, we would continue to see -- we would expect to continue to see that decline over time. And in terms of seasonality, I don't -- we don't see much in the way of seasonality in the other operating public accounts. It's much more of inflows and outflows based on whatever operations are happening at the time with those entities.

Andrew Liesch

Got it. Very helpful. Thanks for taking the questions here. I'll step back.

Operator

Thank you. [Operator Instructions] Our next question comes from the line of Kate Ashley with KBW. Your line is now open.

Kate Ashley

Hi, this is Kate on for Kelly Motta.

Bob Harrison

Hey, Kate. Good morning.

Kate Ashley

So just to back on the margin, so came in a bit better than you'd expected last quarter. I was just wondering if you could walk us through any differences from what you were initially expecting versus what we saw.

Jamie Moses

Yeah. I think the last quarter we talked about slowing noninterest-bearing deposit migration. And generally speaking, I would say, that was the thing that came in better than what we had modeled through the range of outcomes that we were giving as forming our guidance. And so, that was the thing that kind of came in better for us than anticipated. And so that still continues to inform the guide. As we go forward, that will be the pace of noninterest-bearing deposit, inflows and outflows will really determine sort of the shape of the NIM along with loan growth. And of course, if rate cuts happen, that will impact as well.

Kate Ashley

Great. That's helpful. I'll step back. Thank you.

Operator

Thank you. Our next question comes from the line of Timur Braziler with Wells Fargo Securities. Your line is now open.

Timur Braziler

Hi. Good morning.

Jamie Moses

Good morning.

Bob Harrison

Hey, Timur.

Timur Braziler

Just curious what the pace of bond repricing is over the next couple of quarters. And if you can give us a sense of kind of the runoff rate for what's coming due?

Jamie Moses

Are you specifically talking about the securities portfolio, Timur?

Timur Braziler

Yeah.

Jamie Moses

Yeah. So, we have about -- we're running off at about $50 million a month or so in the securities book. So that's a $600 million total throughout the year. And those are coming off, in that [2.15%, 2.25%] (ph) range depending on the bond, the runoff is roughly in line with what the portfolio yield is.

Timur Braziler

Okay. Got it. And then maybe looking at the linked quarter increase in dealer floorplan, I mean, that was a nice little bump there. But your comments maybe suggest that one quarter don't make a trend. Can you just maybe give us a sense of what's going on within that industry and why maybe the results this quarter don't portend to a rebound in that space?

Bob Harrison

We think there -- this is, Bob. So, we think there's going to be a natural rebuilding over time. I mean, the dealers were able to have very attractive environment there for a while with very high demand and low supply. And now we're seeing demand moderate a bit and supply increase. So that's why you're starting to see inventories rebuild on the lot. There's some specific manufacturers, specific things that we could go into. But I think more broadly, it really is that as the economy slows and people slow down on their willingness and ability to buy cars and production continues to improve after all the slowdowns that we saw in the pandemic, that's why you're seeing balances kind of come back, balances for us come back as inventory levels increase.

Timur Braziler

Okay. And I guess why -- with that statement, why don't you think this trend is sustainable? Why do you think there's still a little bit of volatility?

Bob Harrison

It just is, they -- the various manufacturers have not put a lot of programs out there just because they enjoyed very solid margins. And so, as inventory has built up in some of the various manufacturers lines, I think there will be pressure. And we're starting to hear that. I'll be up in California next week to meet with our customers up there. There will be pressure on the manufacturers to create incentive programs to help the dealers move inventory. And that's kind of the normal cycle. It just comes and goes, and it's that kind of give and take that kind of back to the pre-COVID normalcy. And we will have to find out where that leaves us as far as inventory balances on a new run rate basis.

Timur Braziler

Got it. And then just last for me, looking at Slide 10, multifamily criticized, you had mentioned that the loan discussed last quarter, that sub-standard loan had been paid off, but it looks like the criticized balances there actually ticked up a little bit. Did something backfill that sale and just maybe talk more broadly about what you're seeing within that multifamily space?

Bob Harrison

Yeah. I think if you go back a couple more pages, you'll see that it was -- the one that paid off was multifamily construction. And so that went to zero. What page is that, Lea?

Lea Nakamura

[indiscernible] is in the appendix. It is on Slide 16. Construction. But the change in the multifamily criticized is mostly the denominator actually went down slightly. So, there was no change in the actual numerator or the amount of criticized. The percentage just changed slightly because of the denominator decreasing slightly on the quarter.

Bob Harrison

Yeah. And the payoff is shown on Slide 16, Timur.

Timur Braziler

Got it. Great. Thanks for the questions.

Operator

Thank you. And I'm currently showing no further questions at this time. I'd like to hand the call back over to Kevin Haseyama for closing remarks.

Kevin Haseyama

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

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