Bank of Hawaii Corp (BOH) 2020 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Bank of Hawaii Corporation First Quarter 2020 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Cindy Wyrick, Director of Investor Relations. Please go ahead.

Thank you, Sarah. Good morning, good afternoon, everyone. Thank you for joining us today as we discuss the first quarter of 2020. On the call with me today is our Chairman, President and CEO, Peter Ho; our Chief Financial Officer, Dean Shigemura; and our Chief Risk Officer, Mary Sellers.

Before we get started, let me remind you that today's conference call will contain some forward-looking statements. And while we believe our assumptions are reasonable, there are a variety of reasons that the actual results may differ materially from those projected. During the call this morning, we'll be referencing a slide presentation that was included with our press release this morning. A copy of this presentation and the release are available on our website, boh.com, under the Investor Relations link.

And now I'd like to turn the call over to Peter Ho.

Thank you, Cindy. (foreign language), everyone, (foreign language) for joining us today. We hope this call finds you, your family and your colleagues in good health and in good stead. Given the depth and breadth of the COVID-19 crisis, we thought we'd break from the long-standing format of our earnings call. We will still cover Q1's results, but we'll bridge that commentary somewhat and place it subsequent to some commentary around the COVID-19 supplement, which you received as part of our press release today.

The supplement is intended to share with you how Hawaii has been impacted, how Bank of Hawaii is prepared for the COVID-19 crisis, how we are operating and performing through the crisis and how our liquidity, credit and capital positions stack up to the challenge at hand.

I'll begin by giving a broader overview. Dean will follow to discuss liquidity, Mary will discuss our credit metrics, and Dean will conclude with some thoughts on capital. We'll then spend a brief amount of time on Q1, and then we'd be happy to answer whatever questions you might have.

So I'm going to begin on the supplemental packet beginning on Page 2, with the overview. And basically, fundamentally, we view COVID-19 as a multifaceted crisis. Of course, it's a health crisis and it is certainly an economic crisis, but it is also a social crisis and even an ethical crisis. Given this, we believe long-term value will accrue to firms committed to balancing the needs of all stakeholders, customers, employees, shareholders, vendors and the community at large through this crisis. Without question, Hawaii faces substantive short-term and mid-term challenges. However, the long-term attractiveness of Hawaii as a place to live, as a place to visit and as a strategic military vantage point remains unchanged and intact.

Our liquidity, credit posture and capital base position us well. Our 123-year history, serving our island community, has prepared us well to deal with nature's setbacks as we have many times and to support our communities in their time of need.

Now let me turn to Page 3 of the deck. This will give you a sense for the infection activity here in the Hawaii market. And I think the bottom line is we've been relatively fortunate compared to some less fortunate parts of the country and the world. As of yesterday, we had 6 additional cases reported, bringing our total to date to 580 cases reported here in the State of Hawaii. Unfortunately, we've had 10 deaths result -- as a result of COVID-19.

If you look at the upper left chart on Page 3, you'll see that the actions taken by the Governor's office and the Mayor's office in the third week of March seem to have done the trick in terms of flattening the curve. And you'll see, by looking at the chart on the bottom right, that the number of new cases by day seems to be coming down at least for now.

If you go to Slide 4. This gives you a sense for our response timeline. And for whatever reason, we just identified this situation as something that we really needed to wrap our arms around and determine whether there was, in fact, a clear and present danger represented by this virus at the time coming out of China. By February 3, we've convinced ourselves that indeed there was, and that set off a pretty large purchase on our part of both PPE and sanitation products. Kind of through this early mid-March period, we were in active discussions with our Board of Directors and our Committee Chairs, talking about scenarios, talking about options that we might take in the event that this, at the time, coronavirus situation, later to be called the COVID-19 situation, accelerated. By March 10, we had a strategic implementation plan in place, and we're ready to roll that out by 3/18 or a week prior to the stay-at-home order by the city, we made the decision to transition Bank of Hawaii in all areas where we could do a work-from-home format. And then you see on March 25, 2 days after the work-from-home order went into place, we took down our branches in a pretty meaningful way.

If you go to Slide 5. Just to give you a sense for the primary objectives of our strategic implementation plan for COVID-19, really 3 pronged. Headlined, of course, by the safety of our employees being absolute paramount to all of our activities. And clearly, we're committed to providing for the essential needs of our customers and our community. And then thirdly, we recognize as an essential provider that we are providing services to other essential providers as well, and we need to be able to be solutioning a robust plan on their behalf as they continue to do their good work within our community.

On to Slide 6. Operationally, we, as I mentioned, brought the branch structure down from 68 branches through our entire Hawaii and West Pacific network, down to 31 branches. This is still providing us coverage in all our markets, even in our smallest markets. Here at the headquarters building, we brought our personnel count down from 1,300 people in the headquarters to about 250. So that's an 80% reduction, did that mid-March. We also set up a number of teams and location sites to perform certain forms of operational functions. The reason to do that, obviously, to create some redundancy in the event that we had situation subsequent.

So to give you an overview of how the workforce is confirmed right now for Bank of Hawaii. Approximately 60% of our workforce is working from home, quite effectively, I might add. 25% of our workforce is working on-site and 15% of our workforce is awaiting activation.

From an employee standpoint, on Slide 7, a number of programs implemented as a result of this crisis. Our on-site employees, the 250 employees that I mentioned to you earlier -- sorry, the 500 employees, I'm sorry, that I mentioned to you earlier, each received a monthly stipend of $500 to help support incidentals. Part-time employees earned $250 per month. We have a very tight process around COVID-19 incident management, really do that in conjunction with a terrific team of medical, industrial and cleaning professionals that we've retained on an advisory basis. Just today, we launched a web-based employee morale and engagement tool to give us a better sense for how our team is doing out there disbursed throughout our marketplaces, and I'm excited to get the feedback on that and see how that might help us improve engagement even further. For our on-site employees, we made sure that we had surplus sick leave available to ensure that people were not being incented to come to work if they didn't feel anything other than a 100% ready to go, physically and emotionally.

And then finally, our executive team is participating in a twice-daily video conference, one early in the morning and one later in the afternoon, just to ensure that we're all on the same page as we step through the situation.

Stepping to Slide 8, I'll talk a little bit about our commitment to our customers. Fundamentally, we're committed to providing full-service banking capabilities via our, albeit, revised physical layout, our work-from-home workforce and bringing the full force of our digital capabilities forward. We've invested a good amount of time and effort and money into our digital offerings over the past several years. And I'm pleased to say that we're beginning to see the real benefits of that in a situation like this.

Payment relief is being provided to both consumer and commercial customers, who are asking for it. I'm proud to say we processed over 2,100 PPP loans, totaling in excess of $525 million. We had upwards of 10% of our total workforce supporting this effort.

Last week, on the 15th, we electronically distributed 65,000 stimulus payments, totaling $112 million to our customers. As you can imagine, that caused quite a ripple effect through many of our operations. And then finally, we're committed to exploring emerging loan products, like the federal reserves, Main Street loan program as well as potentially our own emerging consumer products.

On Page 9, just to give you a sense for modifications. A total of 5,200 modifications made to date, that's both commercial as well as consumer, totaling 9.8% of our loan outstandings.

On Page 10, just a sense for what we're doing in the community. I think headlined by Bank of Hawaii Foundation's $3 million donation to the Hawaii Community Foundation to support Hawaii COVID-19 activities. We also fairly early on donated 1,200 N95 respirators, which we had ordered early on and then realized that those respirators were probably better placed elsewhere. And then in addition, we provided an additional $100,000 through financial support for additional PPE. We waived ATM fees at least through June, as we brought down the branch structure, and we've also divided line staff with broader authority to waive account level fees.

So as for economic impact on Page 11, I think we all would accept that this is in an unprecedented situation. And really, what is fascinating to me is this is indeed, I think, historic and that this is the first time the country has, in effect, pushed itself into a recession. In this case, to stave off a novel virus and to try to protect and save as many people as possible, which I think is exactly the right thing to do, but that's come with, obviously, its economic consequences. But it's also the first time that our country has implemented massive fiscal and monetary stimulus on the front end of a recession. So it will be very interesting to see how this plays out. As for Hawaii, we are, in fact, impacted like every other state in the country by the shelter-in-place, work-from-home, stay-at-home policies in place that's impacting our local economy greatly. A little bit differently from some other places is that, as a visitor destination, we're also being impacted by the self-imposed 14-day quarantine rule, which has brought tourism here in the state to virtually a standstill.

So if you turn to Page 12. This is a snapshot of the Hawaiian economy. This is per UHERO 2019 data. And you see that the leisure and hospitality industry is a big player in Hawaii. They represent 19% of total jobs in our marketplace. If we go to the GDP proportionality, leisure and hospitality dips a bit to 10%, but still a meaningful element. And then down into the personal income line, dips again to a 11%, but still a meaningful component of our marketplace. Fortunately, government and defense spending is equally, in some instances, a larger proportion of our economy. And for now, those pieces feel pretty stable.

Turning to Page 13. Here, you see the economic forecast by UHERO. This came out at the end of March, so March 31, 2020. And what you see is a call for unemployment spike for the year 2020 of 13.7%. What I think is embedded in there is likely an unemployment rate for this second quarter of -- in excess of 25%, and then a feathering down from there over the course of the year.

Turning to Page 14. You'll see just other forecast data. On the left side, you see, in the dark blue, real GDP estimates, down 7.7% for the year 2020 forecast. And personal income level is down, a little bit more muted than minus 2.6%.

On Slide 15, we've tabled for you the anticipated federal release spend to our marketplace $6 billion, upwards of $60 billion, headlined by the Paycheck Protection Program, which I'm proud to say the Hawaii banks, I think, did a terrific job in delivering just over $2 billion to our marketplace through this program.

So I'll finish off my piece by -- I think stating the obvious, COVID-19, it's substantial. It's unprecedented. But we believe Bank of Hawaii is, in fact, well positioned. We have a seasoned management team. I can tell you, the 4 of us represented in this room have worked together for more than 20 years, and we're veterans of 9/11, we're veterans of the financial crisis, and now we're working through this viral situation. Got great liquidity, conservative loan portfolio, strong capital levels, perhaps most importantly, a preeminent market position.

So now let me turn the call over to Dean, who will talk about liquidity. Dean?

Thanks, Peter. On Slide 17, our liquidity remains strong, supported by a conservative investment portfolio and a solid deposit base. The high-quality composition of our investment portfolio, which represents approximately 30% of total assets, is a source of stored liquidity. Our deposits consisting of an exceptional core deposit base supports a low loan-to-deposit ratio, and we also maintain a deposit cost advantage relative to our national and Hawaii peers.

Slide 18 is a decomposition of our investment portfolio. The conservative construct of our investment portfolio enhances our liquidity. 94% of our investment securities are AAA-rated and 100% are a minimum A rated. This results in a portfolio that is highly liquid and can easily be utilized to secure additional funding. In addition, the government and agency securities provide secure and reliable monthly payments for continued balance sheet funding. In 2019, the average monthly cash flow was greater than $100 million.

Our strong deposit mix is shown on Slide 19. Our deposit base is characterized by a solid mix of customers and core deposit accounts that results in low cost and stable funding. Over 90% of balances are from core consumer and commercial customers, and nearly 90% of deposit balances are in core checking and savings accounts.

Our loan-to-deposit ratio, shown on Slide 20, is low, especially when compared to peers. Our long history of a relatively low ratio is driven by our strong and stable deposit base. And the low ratio provides added balance sheet flexibility to accommodate ample asset funding opportunities.

Slide 21 shows our deposit growth and deposit cost advantage history. We've grown our deposits through a number of different economic environments while maintaining our low-cost advantage, both significantly contributing to our profitability.

Now I'll turn it over to Mary.

Thank you, Dean. Beginning on Slide 22, Bank of Hawaii has 3 fundamental tenets that guide how we approach lending. We believe that these have proven to provided with -- provide us with a superior portfolio construction and performance outcome, allowing us to support our customers and community through difficult economic times. First, we lend to customers we know. Second, we lend to markets we understand. And third, we lend to communities we trust. These underpinnings coupled with conservative underwriting and disciplined portfolio management results in a portfolio that's diversified by category, a portfolio with appropriately sized exposure, a portfolio that is 73% secured by quality real estate with a combined weighted average loan-to-value of 57% and higher risk categories that are well contained.

Moving to Slide 23. Beginning with our geographic footprint, 92% of our portfolio is Hawaii-based, with 6% in the West Pacific and 2% on the Mainland. Our Mainland exposure represents credit extended to our customers who have diversified assets or operations beyond Hawaii.

On the next slide, we highlight how knowing our customers comes from the length of relationships we've enjoyed with them. 57% of consumer borrowers and 64% of commercial borrowers have had relationships with the bank for 10 or more years.

On Slide 25, granularity. We take a disciplined approach to managing our exposure limits, and this results in a granular commercial portfolio. 93% of loans are under $30 million, while 72% of loans are under $15 million.

Stepping to Slide 26. Our loan portfolio totals $11.4 billion and reflective of our Island economies is 60% consumer and 40% commercial, with 75% secured with quality real estate.

Moving to Slide 27, we'll detail the consumer portfolio. The consumer portfolio totaled $6.8 billion with 83% secured by well-margin real estate. The largest segment, residential mortgage, has 0.2% of outstandings with a monitoring FICO less than 700 and a loan-to-value greater than 80. In the home equity portfolio, 3.3% of outstandings have a monitoring FICO less than 700 and a loan-to-value greater than 80. Our indirect portfolio, which is 10% of the consumer book, has 4.2% of outstandings with a FICO less than 700 and a DTI greater than 45%. And the balance of the consumer portfolio is primarily comprised of the direct installment loans with 1.1%, having a monitoring score less than 700 and currently 30 days or more past due.

Moving to Slide 28, and our commercial portfolio. 58% of the portfolio is comprised predominantly of Hawaii real estate with strong sponsorship and equity. 90% of the portfolio has a loan-to-value of less than or equal to 75%. Criticized exposure is 4%. The C&I segment is seasoned Hawaii-centric and non-levered. 1.3% of outstandings are levered and criticized. The Construction segment totals 5%, has a 61% weighted LTV and is concentrated in low income or workforce housing. And our leasing portfolio is 2%, with granular Hawaii leases accounting for 61%. 37% is legacy national large ticket leases, all for investment-grade rail companies.

Turning now to Slide 29. As Peter commented earlier, the Hawaii and West Pacific markets have been impacted by the COVID-19 event, with a number of industries, particularly retail, lodging, and restaurant and entertainment-related facing the greatest challenge. In our portfolio, exposure to these industries represents 11% of total outstandings.

Moving to Slide 30. Retail exposure is 5% of total loans. 88% is secured by real estate, with a 52% weighted average loan-to-value. Only 4.2% of the portfolio is either unsecured or not an essential business.

Turning to Slide 31. Lodging represents 5% of total loans. 71% is real estate secured, 84% has a loan-to-value of less than or equal to 65%. And 95% of unsecured outstandings are to global hotel and timeshare brands that maintain significant deposit and ancillary business with us.

And then finally, on Slide 32, finishing with the restaurant and entertainment segment. This represents 1% of total loans, 39% is secured with real estate with a weighted average loan-to-value of 63%. Criticized exposure is 6%, 52% of which is secured with real estate.

I'll now turn the call to Dean.

Thanks, Mary. Turning to Slide 33. We maintained strong capital levels that are substantially above the well-capitalized minimums. Our capital structure is simple, all common equity with no preferred securities or other forms of hybrid capital. In addition, we have a long demonstrated and strong history of dividends.

As shown on Slide 34, we maintain our capital levels well in excess of minimums required. Our common equity Tier 1 capital ratio is nearly twice the well-capitalized minimum. Our strong capital position is further supported by our comparatively low level of risk assets.

Slide 35. We have a long and unbroken history of dividends. Bank of Hawaii was one of the few banks that maintained and paid its dividend throughout the financial crisis. And our Board declared a dividend of $0.67 per share for the second quarter of 2020.

Now I'll turn it back over to Peter.

Okay. So that concludes the COVID-19 supplement. We're happy to answer your questions. But before we do that, we thought we'd give you just some [group's] thoughts on how Q1 went, which actually prior to the viral situation, was trending towards pretty good outcome for us. So Dean, you want to touch on that?

Sure. Net income for the first quarter was $34.7 million or $0.87 per share. Our return on assets was 0.77%, the return on equity was 10.64% and our efficiency ratio was 55.96%. Our net interest margin in the first quarter was 2.96%, up 1 basis point from the fourth quarter and down 16 basis points from the first quarter of 2019.

Net interest income on a reported basis in the quarter was $126 million, up $2.1 million from the previous quarter and up $1.1 million from the first quarter last year. For the second quarter of 2020, we expect our net interest margin will be about 1 to 2 basis points lower than the first quarter.

As Mary will discuss later, we recorded a credit provision of $33.6 million this quarter. Noninterest income totaled $46.1 million in the first quarter of 2020, down $1.6 million from the previous quarter and up $2.4 million from the first quarter of last year. Noninterest income in the previous quarter included a gain of $3.8 million related to an early buyout of a leveraged lease. And noninterest income in the first quarter of last year, included a $1.4 million commission related to insurance products. Adjusted for these items, the increase compared with the fourth quarter and first quarter of last year were largely due to significant growth in customer derivative activity.

Strong mortgage banking revenue during the fourth -- during the first quarter was partially offset by an impairment of the mortgage servicing portfolio. For the second quarter of 2020, we expect noninterest revenue to decline due to lower levels of customer derivative activity and certain fee waivers that we are offering through June in order to assist our customers during the COVID-19 pandemic. Noninterest expenses in the first quarter totaled $96.3 million, an increase of $3.2 million from the previous quarter and from the same quarter last year. Noninterest expense for the first quarter of 2020 included seasonal payroll expenses of approximately $3.1 million and severance expenses of $4.7 million that were partially offset by elimination of corporate incentive accruals. There were no significant items during the fourth quarter of 2019. The first quarter of 2019 included seasonal payroll expenses of approximately $2.7 million.

For the second quarter of 2020, we expect our total noninterest expenses will be lower by approximately 10% from the first quarter. Our investment portfolio increased to $5.7 billion. The duration of the portfolio was 2.8 years at the end of March, and premium amortization during the quarter was $6.2 million.

During the first quarter, we repurchased 156,400 shares of common stock for a total of $14 million. Due to the uncertainty related to the COVID-19 pandemic, we suspended the share repurchase program in mid-March. Our shareholders' equity was $1.33 billion at the end of the first quarter. Our Tier 1 capital ratio was 11.85%, and our Tier 1 leverage ratio was 7.14%.

Now I'll turn the call over to Mary.

Thank you, Dean. Based upon the CECL standard, the allowance for credit loss was $138.2 million as of the end of the first quarter, a $29.8 million increase from our January 1, 2020 implementation date and $28.2 million increase from December 31, 2019. Given net charge-offs of $3.7 million, a provision of $33.6 million was recorded. The increase in the allowance is reflective of management's best estimate of incurred losses over the life of our portfolio -- loans in our portfolio, given the company's credit risk profile, the economic outlook and forecast for our market with the changing global pandemic as well as the unprecedented front-end intervention with fiscal monitoring and regulatory program.

The first quarter's estimate was anchored on UHERO's March 31, 2020 forecasts, which estimated Hawaii will realize 13.7% unemployment for the full year 2020, with job loss peaking at the end of the second quarter, followed by a very gradual reopening of the economy through the latter part of the year. The bank's CECL methodology reflects updated portfolio segmentation and use of the company's net charge-off experience through the Great Recession. The ratio of the allowance for credit losses to total loans and leases was 1.22% at March 31 compared with 0.99% at January 1, 2020, and 1% at December 31, 2019. The reserve for unfunded commitments was $3.3 million for the first quarter compared with $3.5 million at January 1, and $6.8 million at December 31, 2019.

Thanks, Mary. So I know we took a fair amount of time this morning, but we thought it was important to not only update you on the quarter's results, but also just what's been happening out here and with Bank of Hawaii and the COVID-19 crisis.

So thank you for your interest in Bank of Hawaii. We'd be happy to answer your questions at this time.

(Operator Instructions) Our first question comes from the line of Ebrahim Poonawala with Bank of America.

So I guess, first of all, thank you very much for all the details in the slide disclosure, it's very helpful. I guess just in terms of -- not sure it's for Mary or yourself, how do we think about the reserve build when you look at results going from 1% to 1.22%. If you can talk to us in terms of -- I mean when I look at the forecast that you provided, the macro forecast, feels like a pretty decent bounce back next year is what's baked in. Is that kind of what's your underlying expectations around how things play out and we start to get close to normal towards the end of the year into next year? So if you can talk through just what the assumptions went through because -- and tell me if this is right or wrong, but when I compare results today versus what happened in the great financial crisis when the reserve ratio went from like 1.38% to, I think, 2.76%, almost doubled over a period of 2 years. Like should we just see a gradual increase in reserves until there's more clarity to the magnitude that we saw in 1Q?

Yes, Ebrahim, I think that's very reasonable to expect. Of course, we would, as noted, expect a reserve build if this continues, and the magnitude of that would really be dependent on what we see into the next quarter.

And so your forecast today is based on the Slide 14, where things kind of bounce back. If that's what informed your CECL reserve? Is that accurate?

Yes, that is.

Yes, but it's actually muted a bit.

We did mute the recovery down a bit from what the UHERO forecast was going into 2021.

Yes. So we sensitized the reemergence a bit, but probably directionally correct. That's right.

Got it. So is that -- I guess the conclusion that Peter -- and it's all about credit right now for the bank, so sorry to kind of go on with it. But is it safe to assume like -- I was looking at 2009, 2010, the bank lost about 200 to 230 basis points in terms of charge-offs. That today, you don't expect this to be as bad or probably half of as bad as '08, '09 was kind of the working assumption right now at the bank?

Yes. For a couple of reasons. So first of all, the portfolio -- our portfolios have changed pretty dramatically from '08/'09 to 2019/2020. So you'll know that we've taken -- really moved the commercial portfolio more towards a secured nature. And then on the consumer front, really pushed the portfolios away from -- well we're never sub-prime but closer to sub-prime types of products than previously. So for instance, we used to have a pretty substantial shared national credit portfolio, frankly, which contained the bulk of our commercial charge-offs, which weren't actual charge-offs, but were basically losses incurred through the sale of those pieces of paper. So that is a difference that was there in 2008, 2009. It's just nonexistent in our portfolio today. We used to have a much larger book of leveraged leases, aircraft leases that are, as you can tell from the lease line are pretty much nonexistent in fact. I think our leverage portfolio is down to investment-grade railcars.

Then on the consumer side, we had a $200 million -- I want to say, $200-plus million small business score product that performed pretty poorly through the financial crisis. That number is -- that basically became a legacy product. And I think we only have like $20 million or something left to that portfolio. So that was another big percent or a big charge-off line item for us.

Land loans was another area where I think we had upwards of $50 million, mostly on the neighbor islands, took a fair amount of a haircut there. And then finally, on the indirect space, we used to lend a lot deeper into the indirect space than we do today. There were losses there. So when we segment -- resegment the portfolios, for what they are today vis-à-vis what they were and then reapply loss rates, Ebrahim, it's kind of -- we get what we get.

Another note is that we were very aggressive in '08 and '09 in taking things to charge-off. And in fact, we actually, as you probably saw the numbers subsequent to the recession, saw a good amount of -- in particular, secured types of assets generate pretty sizable recoveries. So yes, you're right, there is a differential. But I think there's pretty good documentation behind what -- why that differential exists today versus the financial crisis.

That's helpful. And I guess just one bigger picture question, Peter. You've isolated portfolios around leisure industry and such. But I guess the perception and our understanding is that the Hawaiian economy and a lot of peripheral industries, be it professional services, et cetera, live of tourism and visitor spending. Talk to us just in terms of, from a business standpoint, I'm sure you sit in many sort of chamber of commerce type committees locally, what's the view in terms of the island recovering from a tourism perspective over the next 6 to 12 months?

Well, I think that the most pressing issue is to continue on with the health trend that we're experiencing because nothing could be worse than Hawaii as a marketplace being -- I don't want to name names, but being like some other visitor areas that are not having the same quality of outcomes that we're having. Those situations can create not just short-term recovery issues, but long-term branding issues. So I think it's really important, and the consensus that I'm getting from the business community is making sure that we have a positive health outcome is critical, making sure that we have the resident testing and contact tracing capabilities in our marketplace so that we can emerge in the way that's going to make our visitors as well as residents, of course, feel safe and confident as business resumes, is another important element. And that is something that, to some extent, we can control here in our islands, but a lot of that is science and federal as well and resource capability as well. So I think that there is a desire to be up and running by the end of the year. My guess is that's going to be a pretty slow transition, likely intended to be. So I think what will happen is we're going to begin to pick up the local economy as our shelter-in-place and work-from-home policies adjust, and I think they're likely to adjust based on the numbers we have. That should create some economic lift for us. But you're right, the visitor industry is 10% of GDP and indirectly a larger percentage, as you point out. And that will get back to normal. But I think the caution there is it should only go back to normal when it's appropriate to do so.

Our next question comes from the line of Casey Haire with Jefferies.

Quick question on the guidance for 2Q, specifically. Can you speak to what's getting NIM down only 1 to 2 basis points? Is it -- do you have more room on deposit costs or securities yields holding up? Just some color there. Yes, just for now.

Yes. You've kind of nailed 2 of the factors. One is that we are able to lower our deposit costs. The other is, the portfolio yield is hanging in there despite the lower rates. And the other thing is the -- a little bit of a mix shift, more loans versus -- relative to investments. So kind of those 3 things are kind of helping us support the NIM at this point.

Okay. And so are you -- so how can security yields be holding up, just given the shape of the curve? I mean -- and then also, I'm assuming if PPP continues to be a loan growth driver, that would be NIM dilutive, no?

Yes. And I should clarify, none of the -- the NIM guidance does not include the PPP loans that we're going to be booking in the second quarter. In terms of the investment portfolio, what has happened is the mortgage spreads have widened out quite a bit. So it's kind of held up the yield on the portfolio as well as prepayments haven't been as high as we had expected. So those 2 things are kind of holding up the yield on the investment portfolio.

Okay. Understood. And then on the expense side, expenses down 10%, what is the key contributor there?

A lot of it has to do with discretionary expenses. One -- obvious one would be like travel, you can't travel. So that's going to go away. But there's other categories that are coming down, including...

Variable comp.

Yes, variable comp is a big one that we already took down in the first quarter. And then some of the seasonal expenses that we had in the first quarter will, of course, not repeat itself, and then as well as the separation. But it's going to be a lot of the discretionary expenses coming down.

Okay. Very good. And then just switching back to the credit discussion. So the loan modifications that you guys outlined on Slide, was it, 9 there, how much of that -- can you just give some color as to what exactly you are doing? And then how much of that is -- is that -- I'm assuming that is largely concentrated in your -- sort of your worry spots, lodging, retail, restaurant and entertainment sector of the portfolio?

So in the commercial portfolio, it's predominantly within our commercial mortgage business. And a lot of that is really we're just seeing a number of our clients looking for principal relief, and that really allows them some flexibility for the uncertainty and also to accommodate some of their customers that -- and tenants that may need relief. In the consumer side, residential mortgage and home equity are about 10% of the total and -- indirect and the other direct are about 11%.

Okay. And just last one, just on the CECL reserve build scenario. Did -- like, I think someone mentioned that unemployment is predicated on unemployment spiking at 24% or peaking at 24%, 25%. I mean, it sounds like we're there right now. So I'm just curious, is there -- did any of the reserve build outlook -- was it based on a sort of a down case scenario, given that it feels like we're -- the base case is where we are right now? And my point is it doesn't feel like it allows for much incremental downside from here.

No. We really leveraged off where we were at that point in time. And clearly, we'll look forward as we do next quarter to see where we are and the impact and magnitude of what's happening.

Our next question comes from the line of Jeff Rulis with D.A. Davidson.

Just to reframe maybe that last question. So kind of getting into the day 2 adjustment, I guess, it's just -- is that a March 31 provision versus April 20? And just try to frame up if you had expectations for a worsening environment, it plays out and we maybe back off from the worst fears, I guess, 2Q provisioning. If you could kind of frame up what that looks like in the event of how that's lowered or maintained in some fashion?

I think that's pretty difficult. Really, we'll need to really move into 2Q and see what the magnitude and duration aspect looks at that point.

Yes. I think that one of the challenges, Jeff, is that, classically, we're modeling against trends, right? And right now, we're modeling against trends as well as outcomes, right? So by outcome, I mean -- so it's hard for us to model with exact certainty when the work-from-home, stay-at-home policy directive will be lifted. And if it is lifted sooner that has a positive impact on the local economy, if it's lifted later, it has more of a negative impact. It's hard to tell now when the travel quarantine will be lifted. And if it's lifted earlier that means that more visitors will come into the market, if it's later fewer visitors will come into the market. So the approach that we've taken is on a quarter-by-quarter basis, we're making our best-case assessment based on the information that we have available to us at our best guess for near-term outcomes as best as possible. But it just -- it does create a little bit more choppiness, I think, in how we approach provisioning than perhaps in past and not because that's our intent, but that's, I think, because of the environment we find ourselves in.

Right. Lots of variables. Maybe just 2 quick ones for Dean. So the premium amortization, you mentioned about $6 million, a little over $6 million in the first quarter. Again, baked in that margin guide is expectations for that to sustain at that level or increase, decrease given the margin guide?

The expectation is it will increase some.

Okay. And then the follow-on. Just on the fee income side, that other, I think, $10 million for -- was pretty high. And I think you maybe alluded to customer derivative activity. Is that what was in there? And subsequent, I guess, you talked about maybe that tails off in the second quarter?

Yes. Yes. It is in that line item.

Our next question comes from the line of Jackie Bohlen with KBW.

Looking to the drop that you had in FTE, looking point-to-point from 12/31 to 3/30, that roughly, call it, 30 people or so. Is that the extent of what we discussed on last quarter's call? Or is there more to come from that?

I'm not sure I understand the question. What are you asking?

Well, you had the severance charges in the quarter, and then you had a decrease in FTE. Before any of the pandemic happened, there was the discussion of some what you were doing to work through expenses for the year. And so I'm wondering if all of that has been done, and that's reflected in the March 30 -- March 31st FTE? Or if there's more to come from that? And if there's been any change to how you're thinking about that in light of the pandemic that's going on?

Yes. Well, so there's a lot to impact there to what you're asking. So first of all, we have not cut back any staff as a result of the pandemic, which is to me, that's an important piece of knowledge to understand. Secondly, the 30 FTE reduction is largely incidental to the severance charge that we took in Q2. The severance charges that we took in Q2 was largely the result of several executive-level or senior-level positions that we are repositioning that will result in pretty meaningful salary savings for us, but do not really represent a meaningful change in FTE. So it's kind of the wrong personnel category to compare against.

Okay. So those salary savings, are they reflected in the 10% reduction that you're anticipating in 2Q? Or will some of that flow in later in the year or 2?

There's some in Q2 and then some in Q3 and 4.

Okay. Would you say the bulk is in Q2? Or would you expect the bulk to be in Q3, Q4?

I would say it's evenly spread out.

Okay. Okay. And just for clarification purposes, Peter, you mentioned that 15% of your staff is awaiting activation. What does that mean?

That means that they are -- for an example, we have certain branch activities that we basically need to have backups in case we have people calling in sick or people that aren't able to work because none of the schools are in session. That means that we have operational staff in critical areas like vault or items processing, where we have the same need for redundancy. So because of lots of just day-to-day things being so different, like people, frankly, lower-income people having to figure out what to do with their kids who are supposed to be in school, and because of the fact that people are getting sick out there, unfortunately, with this virus, we felt a very strong need to have a good amount of redundancy so that we can maintain our operations straight through the situation.

Okay. That's helpful. And then just one -- last one for me and then I'll step back. In terms of the PPP loans that you have, the 2,100 that you discussed that have been processed. What amount is approved? Or are those all approved?

They're all approved -- all of those loans have guarantee numbers from the SBA.

Okay. And what general loan size should we think about, realizing that it's a range of loan sizes, when trying to calculate the fee that you would expect to receive and amortize over the life of the loan?

Oh, I don't even know what that the number is.

216...

I think the fee range is 1% to 3%, I think, Mike -- I don't know this, Jackie, but I think if you point at the middle that probably is good a guess as any.

Up about 250.

Our next question comes from the line of Laurie Hunsicker with Compass Point.

Dean, my first question is for you. Just wondered how we should be thinking about the tax rate here?

The tax rate, we're about 20% to 21% in Q2.

Okay. Great. All right. And then, Mary, I just wondered -- just a couple of things. First, I just want to make sure oil exposure is 0. Is that correct?

That's correct.

Okay. And then multifamily -- go ahead, I'm sorry.

I'm sorry, I just wanted to clarify. So we have no classic oil and gas exposure. We do have some retail, like service station exposures. And we do have some natural gas exposure that's a little bit different.

Yes. Got it. Okay. Perfect. Of your CRE book, your $2.6 billion or so, how much of that is multifamily?

It's about 47%.

47% is multifamily. Okay, great. And then just, I guess, last question, Peter. Just going back to what Ebrahim was asking regarding the Hawaii economy. I just wondered if you could talk a little bit to sort of the tangential effect of tourism. In other words, as we think -- and I love this breakdown, it's super helpful, whether you want to talk about GDP by industry or personal income by industry or jobs by industry, just how we think more broadly about the tangential impact of tourism as we're thinking sort of encompassing everybody from, for example, the cleaners that service the hotels. What would the percentage look like if we took sort of a broader swipe on tourism?

Yes. So I think that the numbers somewhat speak for themselves. The biggest impact of this unprecedented pullback in tourism is the effect on jobs because it's a job heavy industry. And you can't get away from the fact that a big, big percentage of the sates job, job ranks come out of this industry. So that has been an absolute problem and it is a crisis for us that we have to deal with. What also is likely true, and I don't know this -- I don't know the specifics around this, but many of these jobs tend to be lower-wage jobs as well. And so there's a bit of a disproportionate outcome when you get to how many jobs have been lost and what's the reduction of personal income. How that will play through to the economy is somewhat tough to tell. But the way we think about it is the hit to our Community is substantial. And so we're very active around trying to support the Community from a contribution standpoint and then support the Community from a product standpoint, it's going to help those -- that exact ranking for -- classification of people. The -- I think the other thing you're getting at is what's the indirect impact on the visitor industry, 20% of jobs, 10% of personal income, 10% of GDP? Yes, it's a big number. I mean there's no getting around that. And so, yes, certainly, professional services is going to be impacted, real estate and trades is going to be impacted because these workers live and sleep someplace. So I don't mean to isolate GDP at 10% and jobs at 19% and personal income at 11%. Those are the direct numbers. And there is absolutely an indirect correlation to visitor activity that's going to have a meaningful negative impact on the state, for sure.

This concludes today's question-and-answer session. I would now like to turn the call back to Cindy Wyrick for closing remarks.

I'd like to thank all of you for joining us today and for your continued interest in Bank of Hawaii. As always, please feel free to contact me if you have additional questions or need further clarification on any of the topics discussed today. Thanks, everyone. Stay safe.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.