First Hawaiian, Inc. (NASDAQ:FHB) Q2 2023 Earnings Call Transcript July 28, 2023 1:00 PM ET

Company Participants

Kevin Haseyama - Investor Relations Manager

Bob Harrison - Chairman, President and Chief Executive Officer

Jamie Moses - Chief Financial Officer

Lea Nakamura - Chief Risk Officer

Conference Call Participants

Steven Alexopoulos - JPMorgan

David Feaster - Raymond James

Kelly Motta - KBW

Andrew Liesch - Sandler O'Neill

Jared Shaw - Wells Fargo Securities

Operator

Good day, and thank you for standing by. Welcome to the First Hawaiian, Inc. Second 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. [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 2023.

With me today are Bob Harrison, Chairman, President and CEO; James 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.

Bob Harrison

Good morning, everyone. I'm pleased to welcome Lea Nakamura. Lea was recently promoted to Chief Risk Officer after holding a variety of positions in the bank, including Deputy Chief Risk Officer and Treasurer. Lea has over 30 years of banking experience, and I'm confident she'll do great in her new role.

I'll start with an overview of the local economy. The Hawaii economy continues to do well. The statewide seasonally-adjusted unemployment rate in June was 3%, which is lower than the national rate of 3.6%. Total visitor arrivals were 802,000 in May, which is 5.4% than May 2019 arrival number. Japanese visitor arrivals at 34,000 was 70% below than May '19 levels. Visitor spend in March was $1.7 billion, 19% higher than May 2019. The housing market has remained stable. In June, the median sales price for a single-family home on Oahu was $1.1 million or 4.5% June of last year. The median sales price for condos on Oahu was $510,000, 4.5% below 2022.

Turning to Slide 2. I'll give an overview of our second quarter results. Net income was $62.4 million or $0.49 per share. As loans grew, we continue to grow capital and credit quality remained excellent. Our return on average tangible assets was 1.05% and our return on average tangible common equity was 18.57%. We continue to maintain strong capital levels with the CET1 ratio of 12.05% and total capital of 13.17%. The Board maintained the quarterly dividend at $0.26.

Turning to Slide 3. Our balance sheet remains solid. In the second quarter, we brought down our excess liquidity by a little over $300 million as the recent disruptions in the banking industry calmed down. This enabled us to reduce some higher-cost short-term borrowings. We continue to have a strong liquidity position. As of June 30, our total available liquidity was $8.6 billion, which was over 100% of uninsured non-public deposits. The duration of our investment portfolio remained stable at 5.5 years, and cash flows from the portfolio were about $60 million per month as we had expected.

Turning to Slide 4. Period-end loans and leases were $14.4 billion, an increase of $142 million or 1% from the end of Q1. In the second quarter, about $130 million of completed construction loans were converted to CRE. And during the quarter, we also exited approximately $55 million of non-relationship shared national credits. We continue to believe that full year loan growth will be in the low to mid single-digit range.

Now I'll turn it over to Jamie.

Jamie Moses

Thanks, Bob, and good morning, everyone. Turning to Slide 5. Total deposit balances decreased by $203 million or 1% to $21.1 billion at quarter end. The retail and commercial deposits declined by $664 million or 3.4% in the second quarter. Commercial deposits declined by about $450 million and retail balances declined by about $214 million.

On a year-to-date basis, retail and commercial deposits are down $964 million or 4.9%. Public deposit balances increased by $461 million in the quarter, as public time -- excuse me, time deposit balances grew by $555 million, which was partially offset by a decline in public operating balances. Our total cost of deposits was 111 basis points in the second quarter, an increase of 29 basis points linked quarter due to higher rates paid and the shift in mix to higher rate deposit accounts.

Turning to Slide 6. Net interest income declined by $7.3 million from the prior quarter to $159.9 million. The decrease was primarily due to higher funding costs, partially offset by higher asset yields. Similarly, the net interest margin declined by 20 basis points to 2.91%. Throughout the end of the second quarter, the cumulative betas were 34.5% on interest-bearing deposits and 21% on total deposits. Looking forward, we anticipate that the NIM will decline by 15 to 20 basis points in the third quarter due to continued repricing and deposit migration.

On Slide 7, noninterest income was $47.3 million this quarter, a $1.7 million decline from the prior quarter. The decline was primarily due to lower BOLI income along with lower credit and debit card fee income. First quarter BOLI income included a $2 million debt benefit. Expenses were $120.9 million, $2.3 million or 2% higher than the prior quarter. The increase in expenses was driven by a $1.9 million increase in salaries and benefits, which included $2.9 million of separation and severance payments. We expect our overall annual expenses to be in line with our original outlook.

Now I'll turn it over to Lea.

Lea Nakamura

Thank you, Jamie. Moving to Slide 8. The bank maintained its strong credit performance and healthy credit metrics in the second quarter. Year-to-date net charge-offs were $6.8 million, and our annualized quarter two charge-off rate was 10 basis points, 1 basis point higher than in quarter one. Non-performing assets and loans 90 days or more past due were 11 basis points at the end of quarter two, down 2 basis points from the prior quarter.

Criticized assets increased to 93 basis points, with special mention assets at 52 basis points and classified assets at 41 basis points of total loans and leases. The bank recorded a $5 million provision for the quarter. Loans 30 to 89 days past due were $40.8 million or 28 basis points of total loans and leases at the end of quarter two, unchanged from the prior quarter.

Moving to Slide 9. We have a roll forward of the allowance for the quarter by disclosure segments. The reserve increased marginally this quarter, resulting from offsetting factors, including loan growth and improved economic outlook and an increase in the qualitative overlay on construction and home equity. The allowance for credit loss increased $1.5 million to $148.6 million. This level equates to 1.03% of total loans and leases. The reserve for unfunded commitments was unchanged at $36.2 million. The allowance anticipates cyclical losses consistent with the recession and includes a qualitative overlay for potential macroeconomic impacts not captured in our base model.

Turning to Slide 10. We provide a snapshot of our CRE exposure. CRE represents about 30% of our total loan portfolio outstandings. The overall credit portfolio -- sorry, the overall credit quality of this portfolio remains very good. The increase in criticized office loans in the second quarter was primarily due to two loans. One loan consists of a handful of small office properties in Downtown Honolulu and is being actively resolved. This loan is current and we are comfortable with the plan. The other loan is located in Downtown Los Angeles and is going through the sales process. We expect a full recovery on that loan. We continue to closely monitor this segment, given the implications of higher rates, credit tightening and recessionary headwinds.

Bob Harrison

Okay. Thank you, Jamie and Lea. Now I'll be happy -- we'll 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, everyone.

Bob Harrison

Good morning, Steve.

Jamie Moses

Hey, Steve.

Steven Alexopoulos

I want to start, so on the noninterest-bearing deposits, there was another quarter where you and the industry saw strong outflows, but I'm curious, how did this trend through the quarter? And are there any signs of the pace of outflows abating?

Jamie Moses

It's kind of hard to say for sure. I would suggest the way that we look at the data, we think that it is abating somewhat. And what I mean by that is, so far, what we've seen this quarter has been, on a relative basis, less outflow than what we saw through the three months in Q2. So I think if you're drawing -- if you're looking at a graph of where deposits have been going and you're drawing a trend line, I think you start to see that flatten out, at least so far in the quarter that's what we've seen.

Steven Alexopoulos

Okay. That's helpful. And on the margin then, so you've got 20 basis points this quarter, a little bit worse than what we thought coming into the quarter. Now you're saying down 15% to 20%, but I'm curious, I know you don't give longer-term guidance. But do you feel like we're getting pretty close to the bottom once we roll through? I know it's going to be contingent on what you just talked about, but if that trend line is starting to flat on the NIB outflows, do you think we might get some stability after the third quarter?

Jamie Moses

I do think that. And obviously, Steve, that's entirely contingent upon what happens with the Fed and rates and all that. But we do see that sort of the bottom of our guidance. We think that's probably about where it bottoms out, given sort of a stable forward outlook at this point. And that's probably like somewhere in the fourth quarter for us. So that's kind of how we're thinking about it and how we're planning going forward.

Steven Alexopoulos

That sounds good. And then just on loan growth, so I heard you Bob, the reiterating, the low to mid-single digit, which I'm a little surprised because you're running about 8% higher that's year-over-year. I know the comps are tougher because you had a very strong second half. But you're not expecting to have good momentum, good conversions decree, you're not expecting more momentum to continue. I'm surprised you're not at least pointing to mid-single-digit growth. Thanks.

Bob Harrison

Yeah. It's a tough one, Steve. We have a number of commercial real estate projects that are completing and going to get paid off. So a little bit, we're swimming upstream on that. And origination, to your point, has still been fine, but we are seeing in the next quarter to a fair number -- this quarter meaning Q3 and Q4, a fair number of commercial real estate payoffs. And so there is a balance there.

Steven Alexopoulos

Got it. And I saw you called out that you saw a good growth in the dealer. Where do dealer balances sit now versus historical? Just wondering how much room there might be for still an improvement there?

Bob Harrison

I have that here somewhere, but I know we're still several hundred million below the 2019 year-end. I think it was $850 million give or take, in 2019, and where we are today, Jamie?

Jamie Moses

I think it's just under -- it may be right around 700 -- just under $700 million. So yeah, Steve, I think we have -- I think there's probably a good -- as Bob said, right, I think there's probably at least a couple of hundred million dollars worth of room there, given historicals.

Bob Harrison

The question is, does it go back to the way it was before? And you probably saw an article on the Wall Street Journal yesterday saying probably not. I tend to agree with that. The industry has changed. But I do feel that the new number is, given that we don't have a huge difference in the amount of lines and availability to our customers, is higher than where we are today, but it's probably not where we ended 2019.

Steven Alexopoulos

Okay. Thanks for answering 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, Dave.

David Feaster

Maybe just following up on your commentary about the upcoming maturities and stuff. I'm just curious, could you quantify that for us? How much you have expected to roll off maybe in the next six to 12 months where roll-off rates are? And then where maybe repricing tends to be or as well as new loan yield add-on rates?

Jamie Moses

So Dave, just to clarify, are you -- you're talking about securities or loans?

David Feaster

Loans.

Jamie Moses

Got it. Okay. Yeah. So I mean -- so I think what you're really asking is essentially a NIM question here, right? That's what you're trying to get at, right? So I appreciate you trying to ask it a different way. But -- so I think the NIM guidance is the NIM guidance. We're seeing -- we'll call it like adds to the portfolio in totality. We're seeing sort of -- on the commercial side, a little bit higher in sort of the low 7s on the -- we're still adding to a very few amount of residential mortgages. Those are sort of high 6s now versus where they've been in the past. But those are sort of the roll-on rates at the moment. And to be fair to all that, we are seeing, in general, we're seeing a better ability for us to dictate pricing, structure and credit today than we were in the past, right? A little bit more of a buyer's market rather than a seller's market today.

David Feaster

That's terrific. And ultimately, what I'm trying to figure out is kind of where does the core NIM stabilize, like as we look forward? So maybe on the other side of the coin, I guess on the deposit front, how is new account growth going? Where are you seeing good opportunities to take share and acquire new clients? And then just any thoughts on on-core deposit growth going forward, the strategy to continue to drive that? And where new money yields are on interest-bearing deposits?

Bob Harrison

Yeah. A number of questions in there, Dave. So let me pick off a couple of them. First of all, on new accounts -- new deposit accounts, like I think most banks in your coverage, we're very actively going after new accounts. That's been successful. We are trying to do that in a number of different ways, not just marketing, but more value to the customer. We're upgrading our mobile offering this month -- later this month or next -- actually next month, in August. And so all those things, I think that's been successful. So really trying to grow that core operating account type of deposit.

On -- the lending side is very interesting. To Jamie's point, it's been much more disciplined on how we're going after business. We've seen rates and terms move back to what I think is more sustainable levels. People with being very aggressive and low rates for long periods of time, that's kind of gone now as liquidity is more dear, and we're really seeing more of a balance. For example, we have not been very active in indirect lending for the last four-plus years. That line item was down almost exactly $300 million over that period. We just didn't see it being accretive at the time. We love the business. It's something we've been in for a long time, but it just didn't make sense there for a while. Now you're starting to see that. And especially to Jamie's point, on the commercial side, a more reasonable market out there.

David Feaster

That's -- and then just -- where are you seeing, I guess, new deposit -- interest-bearing deposit costs coming on?

Jamie Moses

So it's a tough question because that -- it's sort of -- they come on at different rates for different types of customers that we have. In general, Dave, what we're trying to do is, right, we are trying -- every day, we're trying to go out and grab new customers. And it's not -- at the moment, that's not really through some promotional offer that we're really offering on, especially on liquid side of things, right? And so this is part of the reason why you've seen the runoff in balances that we have, right? So every day, we're focused on acquiring new customers and turning those customers into relationships and then taking care of the existing relationships that we have on our balance sheet. And so to the extent that it's not a relationship that has been here for a while, we're kind of thinking sort of letting some of that -- some of those deposits kind of run off the balance sheet, while taking care of our core customers.

So it's kind of a -- it's a tough question that there being some customers, obviously -- our best customers are getting, say, higher exception rates and yields in their liquid portfolios. Our less best customers are getting lower rates. And of course, that's dependent upon account size and things of that nature in there as well. So it's kind of a continued management of managing the entire balance sheet and managing the relationships that we have, both on the acquisition side and the current relationships that we have.

Bob Harrison

We talked about this starting a year ago, Dave, that for our larger balance commercial and personal customers, we really start taking care of them early, and now it's just kind of going through the rest of the balance sheet. We're getting to the earlier question from Steve, we're getting close to the end on that, I think.

David Feaster

That's great. But maybe following up on some of your commentary on the loan side, Bob, I'm just curious where are you -- with liquidity being paramount and some other folks pulling back and you still being open for business, where are you seeing good risk-adjusted returns? Where -- how is demand from your clients? Where are you seeing opportunities? And I guess if you had to peg, how much of your growth would you expect to come from the Mainland versus Hawaii?

Bob Harrison

Yeah. I'll start maybe with the end of that question. We're right about 24% of our loans on the Mainland now. As we've talked about in previous calls, we assumed that would go up a little bit sooner than the Hawaii loans, although it is keeping pace, percentage point or so. We are seeing the dealer balances because the portfolio is larger on the Mainland. That will be a little bit stronger on the Mainland than here in Hawaii. But we do see that coming back up in California a couple of weeks ago. The domestic manufacturers seem to be ahead of the foreign manufacturers on bringing back supply. So I think that's been helpful. I think the other -- all the manufacturers by year-end will be closer to where they want to be on that. So that will rebalance to whatever the new -- the new normal is by year-end as far as floor plan outstandings.

On the commercial real estate side, to Jamie's point, better pricing, better structure, that's both here in Hawaii as well as on the Mainland. So if you're open for business, which we are, we were going to be more particular, but you really can't get a better structured transaction and higher pricing. And so we're looking at that. Where it's going to be slow, not surprisingly, is residential, home equity, I think will slow down a bit, credit cards on balance should hold its own. But the consumer side, I think, will be a bit slower than the commercial side.

David Feaster

That's helpful. Thank you.

Operator

Thank you. Our next question comes from the line of Kelly Motta with KBW. Your line is now open.

Kelly Motta

Hi. Thanks for the question. I apologize. Joining a little bit late, so I apologize if this has been already asked. But it seems like you're doing a pretty bang-up job with expenses that have been really within the range you've been looking for. But just with the challenging headwinds for margin that you've been discussing at least near term, is there any additional room on the expense side? I know you're already directing a lot of attention there. And as we look ahead, is this still a good range and still looking for the same kind of level of expenses that you have at this point? Thanks.

Bob Harrison

Hey Kelly, this is Bob. Yes, we're always focused on expenses. We have been investing more, clearly in our technology and our people. Getting good people like many other places has been a challenge. So we have made adjustments there. That, we think is really a long-term investment, much like our technology. So now that we've kind of gotten there, I think we're closer to being more of a status quo on our salary and benefits type expenses. But on a broader level, maybe I'll turn that over to Jamie.

Jamie Moses

Yeah. Thanks, Kelly. I mean, I think the way to think about it for the rest of this year is that coming into 2023, we knew that we had to make certain investments to improve our digital offerings, to improve things on that side of operational efficiencies, that sort of stuff on -- in the house. And whether or not the NIM is going to be lower or in the back half of the year, we still feel like we need to make those investments for this year. So our guide on the year that we gave upfront is still -- we still think that's where we're going to be.

As Bob said, we are always looking at expenses, but we were pretty tight this year on how we were managing those, what I would call, expenses that are sort of non-strategic. So we're feeling strongly that we need to continue the trend that we were on from an expense perspective this year. And then after that, we'll -- we're heading into budgeting season and things right now. So we'll obviously be looking at that, but not really to give any guidance sort of into 2024 at the moment.

Kelly Motta

Got it. And maybe a final question for me. I think in your prepared remarks, you said something about exiting some six or Mainland kind of club deals. As you look ahead to where loan growth is going to be coming from, what's the appetite for continued growth on the Mainland?

Bob Harrison

Yeah. Kelly, it's really -- I look at that as almost two different questions. I think there is clearly why we exited those relationships -- well, they weren't relationships, they were just credit-only deals. And we're really -- as we look at the scarcity and value of liquidity and capital, we really wanted to focus on relationships. And whether those relationships are here in Hawaii, which is our home, and we want to do as much of that as we possibly can. And we also have relationships in the US mainland. So it really is more of a focus on where we can add value and where there's more than maybe just a credit relationship as opposed to where the domicile is.

Kelly Motta

Got it. Appreciate it. Thanks so much.

Operator

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

Andrew Liesch

Hi, everyone. Just a couple of housekeeping items for me. The non-interest income is like $47 million to $48 million, still the right range we should be thinking about?

Jamie Moses

You got it.

Andrew Liesch

Got it. And then the tax rate for a couple of quarters was slightly below where I was forecasting. What should we be using on that front?

Jamie Moses

I think 24% to 24.5% is a good number on the tax rate.

Andrew Liesch

Got you. Thank you. You've covered everything else I wanted to ask about.

Jamie Moses

All right Andrew. Thank you, Andrew.

Operator

[Operator Instructions] Our next question comes from the line of Jared Shaw with Wells Fargo Securities. Your line is now open.

Jared Shaw

Hey, everybody. Thanks for taking my questions. Maybe starting with -- or going back to the shared national credit discussion, the exits that you talked about this quarter, were those sales or were those natural runoffs? And if they were sales, was there a loss on that?

Bob Harrison

They were -- good question, Jared. They were sales, but at par.

Jared Shaw

Okay. And then in the commentary, you talked about the office criticized loans. I think you had said that they were -- one of them was Downtown LA, but I thought last quarter we talked, you said that your LA office was more West LA and not Downtown. Can you just give an update on what your non-Hawaii office -- current office exposure looks like geographically?

Bob Harrison

Connecting we said last quarter to what we said right now, they were both correct. We had one loan in Downtown LA and the majority of the rest are in West LA. So what's really being resolved is this one loan in Downtown LA. As far as broader office, it really hasn't changed from what we talked about last time is primarily those gateway cities on the West Coast, several of which are our credit tenants. And so the lease is set up to be -- it's a loan, but it really is tied into a specific credit tenant. And we're very comfortable with that or a couple that are very high net worth individuals that have shown strong support in the past. So we're very comfortable with the rest of the office portfolio. These two popped up and they're being addressed.

Jared Shaw

Okay, thanks. And then when I look at Slide 9 and the growth in the provision for construction and home equity, I don't know, I guess, how does that square with what you were talking about in terms of very good employment trends and very strong valuations and it seems like construction projects and residential, there would be very little, I guess, lost content in Hawaii at this point. What's driving the higher -- the need for higher provision in those sectors?

Lea Nakamura

So I can answer that. This is Lea. So with respect to construction, what we did in the -- both the first quarter and the second quarter is we took a deep dive into our investor CRE and construction portfolios. And in the second quarter, we actually re-underwrote the portfolios based on current NOIs and interest rates and cap rates. And it really was -- with respect to construction, it really was more about the Mainland multifamily where they're still under construction and the metrics are still good today, but we have a little bit of uncertainty as to what the market would look like in a year or 18 months.

And then with respect to home equity, it was about -- we looked at the portfolio, we looked at the pool, the sub-pool where there was very large utilization and they were coming off of the teaser rates. And so there's just a little bit of concern about the increase in the interest expense that these particular loans will be facing. So it's not a specific -- I don't think it's in contrast to anything we've said before about the economy. It's just these subpockets.

Bob Harrison

And Lea brings up an excellent point I forgot to mention earlier, Jared, that we re-underwrote the entire CRE -- investor CRE portfolio over -- anything over $5 million in balance during the quarter -- during the second quarter. Current interest rates, current cap rates, really looking at what the risks are and the stress is, and we didn't regrade anything.

Lea Nakamura

Right.

Bob Harrison

So that's -- we did that basically two quarters in a row, just to make ourselves feel comfortable.

Jared Shaw

Great. Thanks. And then on the construction loans that are rolling on to permanent, are those rates negotiated from prior -- sort of prior before the rate hikes? Are those coming on at lower rates? Or are those coming on at current market rates when they go to permanent?

Bob Harrison

Most all the construction loans. I can't think of any that are fixed rates. So they're all floating rates. Now the difference in the floating rates from when they were put on versus something that would be put on today is, as my earlier comments, is a little more spread today than there was 12 or 18 months ago. But all those are at floating rates.

Jared Shaw

Okay. And then finally for me, and I appreciate you taking the questions, when we look at sort of terminal beta on interest-bearing deposits is 45%, sort of a good ballpark to be looking at?

Jamie Moses

I think that's okay, Jared. Part of the issue with that is it really depends on what happens with deposits, right, to the extent that we're funding the balance sheet with either borrowings or deposits, right, that beta sort of can change, right, depending on how that looks. So I think that's an okay number to use. I think that's an okay number to use for now. And we're going to see how that moves as we go throughout the quarter. And again, that's -- sorry, quarter and back half of the year, and that's just going to be sort of dependent upon, again, right, what -- how we end up funding the balance sheet.

Jared Shaw

Great. Thanks very much.

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.

Bob Harrison

I have one last comment. This is Bob. I'd like to wish Jamie a happy birthday today, and welcome, second earnings call and all that. Kevin?

Kevin Haseyama

Thanks, everyone. 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 enjoy the rest of your day.

Operator

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