First Hawaiian, Inc. (NASDAQ:FHB) Q3 2024 Earnings Conference Call October 25, 2024 1:00 PM ET

Company Participants

Kevin Haseyama - IR Manager
Bob Harrison - Chairman, President and CEO
Jamie Moses - CFO
Lea Nakamura - CRO

Conference Call Participants

David Feaster - Raymond James
Andrew Liesch - Piper Sandler
Jared Shaw - Barclays
Kelly Motta - KBW
Anthony Elian - JPMorgan
Timur Braziler - Wells Fargo Securities

Operator

Thank you for standing by, and welcome to First Hawaiian Inc's Third Quarter 2024 Earnings Conference Call. [Operator Instructions]

I would now like to hand the call over to Investor Relations Manager, Kevin Haseyama. Please go ahead.

Kevin Haseyama

Thank you, Lateef, and thank you everyone for joining us as we review our Financial Results for the third quarter of 2024. With me today are Bob Harrison, Chairman, President and CEO; Jamie Moses, Chief Financial Officer; and Lea Nakamura, Chief Risk Officer.

We prepared a slide presentation that we will refer to in our remarks today. The presentation is available for downloading and viewing on our website at fhb.com in the Investor Relations section. During today's call, we will be making forward-looking statements, so please refer to Slide 1 for our safe harbor statement. We may also discuss certain non-GAAP financial measures. The appendix to this presentation contains reconciliations of these non-GAAP financial measurements to the most directly comparable GAAP measurements.

And now, I'll turn the call over to Bob.

Bob Harrison

Thank you, Kevin.

I'll start by giving a quick overview of the local economy. The overall Hawaii economy continues to be resilient. While Maui continues its recovery for the wildfires, the rest of the states have seen relatively stable tourism numbers and a low unemployment rate.

The statewide seasonally adjusted unemployment rate for September was 2.9%, compared to the national rate of 4.14 -- 4.1%. Through August, total visitor arrivals were down 2.2% and spending was down 2.3% compared to 2023 levels for the same period.

Housing market remains stable. In September, the median sales price for a single-family home on Oahu was $1.1 million, 6% higher than last September. And the median sales price for condos on Oahu was 518,000, 2.8% below the previous year.

Turning to Slide 2, I'll give an overview of our third-quarter results. We're really pleased that the momentum we saw building in the second quarter carried over to the third quarter. Deposit balances flattened out and deposit costs were up only 1 basis point from the second quarter. Unexpected loan payoffs were a headwind for loans in the third quarter, but credit quality remained excellent and assets repriced up, driving margin expansion. Non-interest income continued to be solidified and we continued to exercise good discipline on expenses.

During the quarter we released $3.8 million of tax reserves we recorded in connection with our 2016 separation from BNPP. This increased expenses for the third quarter by $3.8 million and reduced income tax expense by the same amount, resulting in no impact to net income.

Turning to Slide 3, I'll go over some balance sheet highlights. The investment portfolio runoff is still being used to fund loan growth and reduce high-cost deposits. We continue to have ample liquidity. We had a $500 million FHLB advance mature in the third quarter and took out a new $250 million 12-month advance at a lower rate.

The balance sheet remains well capitalized and our capital levels continue to grow due to strong earnings and a favorable AOCI change. Because of our strong and growing capital levels, we intend to resume share repurchases in the fourth quarter.

Turning to Slide 4. Total loans were down $119 million compared to the prior quarter and while construction loans grew as expected and we had good activity in the C&I and CRE portfolios, unexpected payoffs in those portfolios were a headwind in the third quarter. The pipeline in the fourth quarter remains strong, but due to those payoffs in the third quarter, full-year loan growth will be relatively flat.

Now I'll turn it over to Jamie.

Jamie Moses

Thanks, Bob, and good morning everyone.

On Slide 5, we see that the positive deposit trends we saw in the second quarter continued in Q3. Total deposits were down $91 million driven by a $112 million decline in total public deposits. Retail and commercial deposits stabilized and were slightly up compared to the prior quarter. Commercial deposits increased $112 million and that was partially offset by a $91 million decline in retail deposits.

The migration of noninterest-bearing deposits to higher cost accounts continued to taper and the ratio of noninterest-bearing deposits to total deposits remains a solid 34% unchanged from the prior quarter.

Deposit costs also continued to level off and our total cost of deposits only increased 1 basis point from the prior quarter. We have been proactively managing deposit rates in anticipation of the Fed rate cut and we saw our September cost of deposits decrease by 1 basis point to 171 basis points from 172 basis points in August.

Turning to Slide 6, I'll go over net interest income and the margin. Net interest income was $156.7 million, $3.9 million higher than the prior quarter. The margin was up 3 basis points, primarily due to the asset repricing dynamics that we've detailed on prior calls and stable deposit costs. Looking forward, we expect the NIM to decline modestly in the fourth quarter and be around 2.9%.

On Slide 7, non-interest income and expenses are detailed. The income was $53.3 million, about $1.5 million more than the prior quarter. The increase in non-interest income was due to higher volume-driven credit and debit card fees and higher BOLI income, and that was partially offset by lower other income. As a reminder, that other income line included about $2 million of insurance recoveries in the prior quarter.

Non-interest expenses were $4.1 million higher than the prior quarter. And as Bob mentioned, we recognized a $3.8 million expense in the third quarter, that was offset equally by a $3.8 million reduction in income taxes, having no impact on net income. Excluding that, expenses in the third quarter were essentially flat to the second quarter. We continue to expect full-year expenses to be in the $500 million range.

And now I'll turn it over to Lea.

Lea Nakamura

Thank you, Jamie.

Moving to Slide 8, the bank maintained its solid credit performance in the third quarter. Our credit risk metrics remain strong and stable and well within our expectations. We are not observing any broad signs of weakness across either the consumer or commercial books, and we are very comfortable with our loan loss coverage levels.

Classified assets increased by $64.6 million due mostly to -- sorry, due mostly to a couple of downgrades. The recently downgraded loans are well collateralized and we believe that the potential for loss is extremely limited.

Moving to Slide 9, we show our third-quarter allowance for credit losses broken out by disclosure segments. The asset ACL increased by $3.2 million to $163.7 million with coverage increasing 3 basis points to 115 basis points of total loans and leases.

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

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

Bob Harrison

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of David Feaster of Raymond James. Your question, please, David.

David Feaster

Hi, good morning, everybody.

Bob Harrison

Good morning.

Jamie Moses

Good morning, David.

David Feaster

I just -- I wanted to follow up on the growth side. I mean, appreciate the color on the growth outlook. And obviously, it sounds like this quarter was really impacted by payoffs and pay downs. I'm curious, how does the pipeline look in? Where are you seeing opportunities for growth? And, just kind of maybe touch on the competitive landscape as well and where you're seeing new origination yields.

Bob Harrison

Yes, great question, Dave, thanks for that. We had expected third quarter to be mostly flat and then with the payoffs that came in below that, obviously. We think the opportunities are really continue to be in the commercial real estate space both here in Hawaii and on the primarily the West Coast and also in our dealer floor plan area.

So, some growth here in Hawaii. We're onboarding a new relationship now actually. But there's also some opportunities we have on the West Coast. I think really those two to begin with are the top opportunities. The consumer side is still going to be soft. There's not a lot of action in residential or home equity. So we're really looking to the C&I and commercial to see the growth.

David Feaster

Okay. And then just thinking about the earning asset repricing and remixing side. I'm curious, how do you -- like, could you just touch on kind of the securities cash flows, the roll-off rates that are coming there, the loan cash flows and what you're seeing there and just kind of how you think about -- again, where are new loan yields -- where are you able to put new loan yields on especially with this cut coming in?

Jamie Moses

Right. Yes, thanks, David. It's Jamie. So we continue to see about $400 million per quarter of fixed-rate cash flows coming off the books. And so that repricing dynamic there. So that's coming off, let's say, in the 4.5% range or so, new loans coming on with the rate cuts maybe in the 6.5% to 7% range, something like that.

In total, I think that's probably the way to think about that in Q4. That dynamic itself is probably 2 basis points to 3 basis points to the good for the NIM in Q4. So that's the dynamics there. We think when we really look at it, our guidance is based off of another rate cut in November. And then we have the similar dynamics of that $6 billion of loans that reprice based off of that and about $4.5 billion of deposits that will reprice off of any sort of rate cut news as well. So, we're getting to like maybe a 2 basis point decline in Q4 on the NIM.

David Feaster

Okay. Perfect. And then maybe just touching on your ability exclusive of those index deposits, how are you -- how are the conversations you're having with repricing deposits lower? What's kind of the new add-on rate for new deposit growth? And is there any other ways to maybe help accelerate the margin side? I mean, with rates coming down, is there any change in the appetite for securities restructuring or anything like that?

Bob Harrison

Yes. Maybe I'll start on that, Dave, and hand it over to Jamie. So, on the way up, we were very clear with our deposit customers that we were going to give them the full benefit of rate increases basically immediately. And that on the way down, we've adjusted accordingly. And so those have been the conversations we've been having with them over the last couple of years and that's really borne out and really transparent with folks and walking them through that.

So as far as onboarding new deposits, of course, we're always trying to onboard new relationships, which includes operating accounts and people's personal accounts. So there's an element of noninterest-bearing in that along with interest-bearing.

So -- but to further your question, maybe I'll turn it over to Jamie.

Jamie Moses

Yes. I think Bob summarized the deposit piece of that pretty well. We -- those deposits are not specifically indexed, but that's our -- the expectation of our customers. I think the teams have been really good, really proactive talking to them and everybody seems to understand sort of what the deal is on those. And so I think that's a -- that's been a good story for us for sure.

And then in terms of securities restructure, I mean, we see others do that. We understand why they do it. From my perspective, I think the share buyback this quarter is probably sort of a better use of, I don't know, reduction in capital, if you want to think about a securities restructure that way. We think maybe that's a better way to return capital to the shareholders at least this quarter. And we'll continue to look at those things, but with a trajectory of continued declines in rates, maybe we'd rather just have that accretion to tangible book value on the securities portfolio rather than try to remix it or do something different on the asset/liability side.

David Feaster

I think that makes a lot of sense. Thanks, everybody.

Operator

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

Andrew Liesch

Hi everyone, good morning. Thanks for taking the questions. I want to -- just a question on the provision in the quarter and it looked like you build the reserve for the consumer and the home equity books. Just curious what might be behind that. Doesn't sound like there's anything concerning so curious on the reserve build.

Lea Nakamura

I don't think it was particularly about consumer. FICO scores did go marginally lower, but we actually have some -- we have some pieces of the book that we're spending a little more time looking at, like environmental. But it wasn't particularly about any one particular part of the book per se. We're not actually that concerned about our home equity position. Is that..

Bob Harrison

Yes. To add to these comments, I think it's -- we're very well secured in those portfolios. So it's really not that it's just as we do our modeling, we thought it was appropriate to tweak some of the coefficients as we looked at that and, that's how it ended up. There is a -- primarily a quantitative side, but there's also a qualitative side to the model.

Andrew Liesch

Got it. Helpful. And then, Jamie, the $500 million of expenses for the full year, I would assume that includes the $3.8 million tax reversal in this quarter. I guess then if you look at how -- you'll give more detailed guidance on the January call. But if you just look at the natural rate of expense growth, given a lot of the investments that you've made lately, I mean, what do you think a better or a natural expense growth rate is with all these investments now?

Jamie Moses

Yes. That's a good question, Andrew. And as you said..

Bob Harrison

We're in the budget process right now, Andrew.

Jamie Moses

That's right. That's right. We're in the budget process. So, we'll have a lot more guidance around that next year. But I think we've been pretty clear that the way that we've been thinking about it is we've made some strong investments. Those investments now are able to create efficiencies for us that weren't there before.

And so, that we think our sort of natural growth rate of expenses is much more in line with what you would consider a sort of normal banking industry growth rate. So we expect to be kind of in line with that on a go-forward basis in general, and so that's pretty significantly lower than the 5.5%, 6% that we've seen over the past two years, three years.

Andrew Liesch

Got it. Good to hear. Thanks for taking the questions. I will step back.

Operator

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

Jared Shaw

Thanks. Good morning. Maybe just going back to the loan growth and the payoff activity you discussed this quarter, what's really driving that? Is that -- are you seeing other banks taking -- coming in and being aggressive for customers? What's sort of driving the elevated level of paydown, payoff activity, especially on the C&I side?

Bob Harrison

Sure. Thanks, Jared. Good question. This is Bob. So what happened? There was a couple of deals we were participating with others, and we weren't the lead on in the floor plan area in the Mainland and maybe our pricing was a little bit higher as a group than someone else that came in and replaced it. So it was really a more aggressive Mainland lender and this was a pretty broadly syndicated four or five-bank deal.

So we weren't the lead, but that's what happens sometimes. We're big boys and girls and you just have to be competitive in the market. And this is a very high-quality name or names plural that, that's just the way it goes. So maybe in some sub-segments of what we're doing, there's more competition. But nothing that doesn't make sense is just that's what happens some days.

Jared Shaw

Yes. Okay, got it. And then when you call out sort of the ability or the outlook for floor plan growth, I'm assuming that's sort of self-originated versus participation? And is that and are you able -- is that just getting bigger with existing customers or are you actively out trying to take market share? Are you expanding sort of the geographic footprint of that business?

Bob Harrison

Not expanding the geographic footprint, but new customers, well, some new customers and some additional lines of existing customers.

Jared Shaw

Okay.

Bob Harrison

So, mix of both. I'm not trying to evade the question, but it is truly a mix of both.

Jared Shaw

Got it. Got it. Okay. And then in terms of the buyback, I guess how aggressive should we think you are with whittling away at that existing authorization and should we be looking at a near-term CET1 target, or what's going to be the driving factor on the pace of the buyback?

Bob Harrison

Well, we have the -- as we mentioned earlier in the year, authorization for the $40 million and we expect that's where we'll stay.

Jared Shaw

Okay. So once that's done, then not looking to reload it.

Bob Harrison

For 2024, we tend to look at it…

Jared Shaw

Oh, okay.

Bob Harrison

So yes, no, that's -- that -- we do it annually. So that's our annual outlook. And that's part of our planning process for 2025 is we certainly look at capital levels. In the past, we talked about a minimum 12% CET1 and clearly, we're above that. So that's part of the discussion we're having internally and we'll have with the board and the various regulators.

Jared Shaw

Got it. Thank you.

Operator

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

Kelly Motta

Hi, good morning. Thanks for the question. Your expenses were really well controlled and I appreciate the full year color. I know it might be a bit early with where you are in the budgeting process, but, given the investments you've made with like the core conversion and what you're doing on the ground, how should we be thinking about the natural growth rate of expenses from here and thoughts around positive operating leverage ahead with the current outlook for rates?

Bob Harrison

Thanks for the question, Kelly. Maybe I'll start and pass it over to Jamie. So we're deep into that. There's always -- in our budgeting process, there's always a lot of good investment opportunities internally that we look at and we have to just see how those stack up relative to where we want to be. And we think that Jamie's earlier comments, I'll let him speak for himself in a second here. We just want to be disciplined as we go forward now that we've made those significant investments.

Jamie Moses

Yes. Thanks, Bob. Yes, Kelly, I think from an expense perspective, I think that our growth targets around expenses are going to be much lower than they have been over the past few years given the dynamics that Bob talked about, and also when we consider the positive operating leverage scenario, right, that you just brought up.

And so the challenge for a spread-based bank is that when you expect rates to go down, we have a -- there's probably an expectation that net interest income is going to go down as well, which creates challenges around positive operating leverage, as you know and is part of the reason for the question, I'm sure.

And so we're going to do everything that we can to try to minimize that drop in margin. We're going to try to grow loans prudently, manage our balance sheet as well as possible and be very proactive on the funding side as well and try to extend our advantages that we have in our markets to be able to do that and to try to create that positive operating leverage that you're talking about.

So in a down rate environment, tough in general probably to do that. But I think we're in a good position to be able to take advantage of our market and where we're at. And so, I think it's -- I think we're well-positioned to perform pretty well next year. Awesome.

Kelly Motta

Awesome. Thank you, Jamie. That's really helpful. And I believe in your prepared remarks, you talked about some exception pricing where you were maybe pretty generous on the way up or more generous on the way up with offering rate. And conversely, you have some pretty ample room to cut with rate cuts. I apologize, I may have missed it, but have you quantified at all the magnitude of that piece of the deposit portfolio?

Jamie Moses

Yes, we have. So that's about $4.5 billion of deposits that is not directly tied to an index, but that we control the pricing on. And with the expectation that we'll be able to drive that pricing down along with the Fed rate cuts that we price those customers and those deposits up on the way up and we feel pretty strongly that we'll be able to price those down when rates go down as well.

Kelly Motta

Got it. Maybe a final one for me. The fee income came in really, really strong this quarter. It looks like there was particularly strong uptick in credit and debit card fees, as well as a bit of an increase in BOLI. So I'm hoping you could give some color around the drivers of that. And if there was any fully death benefits in there, it looks like that number has jumped around a little.

Jamie Moses

Yes, no death benefits in the quarter. That's sort of market-driven. Generally speaking, when rates drop, we'll kind of get a pop in that line. So in the fourth quarter, depending on what happens, we're sort of expecting that to be kind of flat. And so with that, I think we're probably $50 million plus in fourth quarter in fee income, somewhere in that $50 million to $51 million probably. We're seeing some good growth in particular in the card portfolios that you noted. And so we've seen some strength there and we probably continue to expect that to happen.

Kelly Motta

Great. Nice quarter, guys. I'll step back.

Operator

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

Anthony Elian

Hi, everyone. Just a few follow-up questions from me. Back to the payoffs, do you have in dollars how much the payoffs weighed on your loan growth in the third quarter in dollars?

Bob Harrison

We don't have that on. This is Bob. I don't have that deep -- do you have that, Jamie? We can get it to you.

Jamie Moses

Yes, we can get it to you. It's probably in the neighborhood of $90 million, $95 million. Something like that is probably the unexpected payoff number that we saw.

Anthony Elian

Okay, got it. And then my follow-up, the Slide 6, you call out the non-interest-bearing remaining stable from the prior quarter. Is this -- do you think the bottom for non-interest-bearing deposits as a percentage of total or do you think there could be some continued declines from here in the percentage? Thank you.

Jamie Moses

Yes, thanks. So the percentage has been pretty stable now for the last..

Bob Harrison

Couple of quarters.

Jamie Moses

Yes, last couple of quarters, last six months or so. So good trends there. We're hopeful that that's the case. And we hope that as we move forward, we're able to take market share in those areas. And of course, like, part of deposit gathering is in that non-interest bearing space. So we're hoping that we can sort of stem that number and keep that in that 34% range. That's about where we were, I think, ahead of the..

Bob Harrison

2019.

Jamie Moses

Yes, in the 2019, ahead of the pandemic. So seems like a decent spot to think about it that way. So yes, I think that's the -- that's our outlook. We don't know for sure, but the trending has been good in that direction.

Anthony Elian

Thank you.

Operator

[Operator Instructions] Our next question comes from the line of Timur Braziler from Wells Fargo Securities. Please go ahead, Timur.

Timur Braziler

Hi, good morning, everyone.

Bob Harrison

Good morning.

Timur Braziler

Just maybe -- sorry to keep following up on this. But just the expectation for loan growth versus payoff cadence, I guess, the fixed-rate loan kind of repricing schedule, how much could that be impacted by payoff cadence? Are those kind of mutually exclusive? Are you expecting that everything that rolls off is brought back on at that incremental 200 basis points, 250 basis points of spread, or is there some risk to that dynamic if payoffs stay elevated?

Jamie Moses

Yes. Thanks, Timur. So, that $400 million cash flow forecasted would be sort of independent of these, I'll call them unexpected payoffs that we see. And so there is -- there would be risk to that number if there were more unexpected large payoffs that happened in the fourth quarter. Of course, they're unexpected for a reason.

And so we aren't forecasting that. But that full cash flow repricing that we talked about $400 million in the quarter, we would expect that to -- if you assume we're flat in loans for the quarter, we would expect that to be repriced up to that 250 basis point level or so.

Timur Braziler

Got it. And then the FHLB advance that was rolled into that $250 million, what was the rate on that?

Jamie Moses

4.14, I think was the exact rate on that. So there's -- when we think about that maturing advance, we're thinking about asset-liability management, as well as sort of income dynamics and what other opportunities there are in the market for funding, as well as our liquidity metrics. And so, of course, we have a -- you have a little bit more of term associated with that FHLB borrowing and so that helps our liquidity metrics as well.

Timur Braziler

Last one on the margin for me, just looking at securities yields linked quarter, it looked like those stepped down a decent amount in 3Q. I'm just wondering what the dynamic is there and how we should think about the roll-off, roll-on of the cash flows going forward?

Bob Harrison

Yes. So in the securities portfolio, we do have a small amount of floating-rate loans there. So maybe that's like $600 million, $700 million or so. And so, when rates drop, you'll see a small dynamic in there as well. So that's that 3 basis point to 4 basis point drop in the quarter that you see.

Generally speaking, we are not reinvesting in the portfolio at this time. So, the -- if rates continue to go down, you're likely to see the rate in that securities portfolio to go down as well. However, right, when those loans -- or when those securities come off in that 1.75%, 2% range every quarter, we don't have to fund those with 4.5% FHLB fundings, for example. So there's a positive income dynamic associated with running off that portfolio.

Timur Braziler

Great. And then just last question for me, maybe for Lea. Just it looks like classified assets were a little bit higher 2x versus second quarter. Just any kind of color on what drove the increase in classified assets.

Lea Nakamura

So it was primarily in multifamily and it was really just a handful of performing loans. These are actually well collateralized, but, in this rate environment, they don't really have the level of cash flows that we would prefer to see. But we don't actually believe that these loans are indicative of any kind of trend in the portfolio and the loans are performing.

Timur Braziler

Great. Thank you for the questions.

Operator

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

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 participating. You may now disconnect.