Bank of Hawaii Corp (BOH) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Bank of Hawaii Corporation Second Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to hand the floor over to Cindy Wyrick, Director of Investor Relations. Please go ahead.

Thank you, Karen. Good morning and good afternoon, everyone. Thank you for joining us today as we review the financial results for the second quarter of 2017. Joining 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.

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

Thanks, Cindy. Good morning, or to our friends on -- in the Midwest and the East Coast, good afternoon. Thank you all for joining us today. The second quarter of 2017 was yet another solid quarter for Bank of Hawaii. We had a good financial performance with a rising net interest margin, sound asset quality, disciplined expense control and strong balance sheet growth. Our loans grew to $9.4 billion at the end of the quarter, an increase of 3% from the previous quarter. Commercial loans were up 2.1% while consumer loans were up 3.6%. Compared with the second quarter last year, total loans increased 12.7%. Total deposits grew 2.1% from the previous quarter and were up 8.4% compared with the second quarter last year.

In addition to the strong financial results, I'm pleased to announce that our Board of Directors has declared an increase in our dividend to $0.52 for the third quarter of 2017. This is the third increase in our dividend over the past 18 months.

Now let me turn the call over to Dean who'll provide you with some additional details on our financial performance, and then on to Mary who will touch on asset quality. Dean?

Thank you, Peter. Net income for the second quarter was $44.7 million or $1.05 per share compared to $51.2 million or $1.20 per share in the first quarter and $44.2 million or $1.03 per share in the second quarter of last year. The decline from the previous quarter was due to the Visa Class B shares sold during the first quarter. Our return on assets in the second quarter was 1.09%. The return on equity was 14.87%, and our efficiency ratio was 55.99%. Our net interest margin in the second quarter was 2.92%, up 3 basis points from the first quarter and up 7 basis points from the same quarter last year. Net interest income in the second quarter of last year included interest recoveries of $1 million, which had a positive impact of approximately 3 basis points on the net interest margin.

Premium amortization was $10.4 million in the second quarter, down from $10.6 million in the previous quarter and $11.5 million in the same quarter last year. The investment portfolio reinvestment differential was a positive 22 basis points this quarter. We purchased a total of $205.3 million of securities during the quarter, primarily comprised of fixed-rate mortgage-backed securities. As Mary will discuss later, we recorded a credit provision of $4.3 million this quarter.

Noninterest income totaled $45.2 million in the second quarter of 2017 compared with $55.9 million in the previous quarter and $46.5 million in the same quarter last year. There were no significant items in noninterest income during the second quarter of 2017. Noninterest income in the previous quarter included a gain of $12.5 million from the sale of Visa Class B shares. Noninterest income in the second quarter of last year included a service fee of $1.2 million resulting from the sale of trust real estate. Growth in noninterest income continues to be challenging due to the downward trend in overdraft fees, declining ATM fees resulting from changing customer preferences for cashless payment systems and expectations for lower gains on the sale of mortgages.

Noninterest expense totaled $88.2 million in the second quarter of 2017 compared to $88.6 million in the previous quarter and $86.1 million in the same quarter last year. While there were no significant items in the second quarter, it includes approximately $1 million in annual merit increases, which partially offset the $2.5 million in seasonal payroll-related expenses during the first quarter. Noninterest expense in the second quarter last year included a net gain of $1.3 million from the sale of bank-owned real estate property. For the full year of 2017, we currently expect expenses to be about 2% above our 2016 expenses, adjusted for real estate sales of $3.7 million.

The effective tax rate for the second quarter of 2017 was 31.32%, up from 29.72% in the previous quarter and 29.77% in the same quarter last year. The lower rate for the first quarter of 2017 was due to the adoption of an accounting change related to the exercise of stock options and vesting of restricted stock. The lower rate in the second quarter last year was primarily due to a release of state tax reserves. The effective tax rate for the second half of 2017 is expected to remain between 31% and 33%.

As Peter mentioned, we had good loan and deposit growth during the quarter. Our investment portfolio declined to $6.1 billion at the end of the quarter as average loan growth continued to exceed average deposit growth. The duration of the available-for-sale portfolio was 2.27 years at the end of the second quarter. The held-to-maturity duration was 3.46 years, and the duration of the total securities portfolio was 3.02 years.

Our shareholders' equity increased to $1.2 billion at the end of the second quarter. During the quarter, we paid out $21.4 million or 48% of net income in dividends and repurchased 123,000 shares of common stock for $9.9 million. At the end of the second quarter, our Tier 1 capital ratio was 13.34%, and our Tier 1 leverage ratio was 7.37%.

Now I'll turn the call over to Mary Sellers.

Thank you, Dean. Net charge-offs for the second quarter totaled $3 million or 0.13% annualized of total average loans and leases outstanding. Comparatively, in the first quarter of 2017, we recorded net charge-offs of $3.6 million or 0.16% annualized, while in the second quarter of 2016, net charge-offs were $1.7 million or 0.9% annualized.

Nonperforming assets were $16.4 million at the end of second quarter, down $2.6 million from the first quarter and up $100,000 from the second quarter of 2016. Reductions this quarter were due to payoffs, restructured loans returned to accrual and sales of residential foreclosed real estate. At the end of the second quarter, loans past due 90 days or more and still accruing interest were $7 million, up $1.2 million for the linked period and down $1.7 million year-over-year. Restructured loans not included in nonaccrual loans or loans past due 90 days or more were $53.2 million at the end of the second quarter, up $200,000 from the first quarter of 2017 and up $1 million from the second quarter of 2016. Residential mortgage loans modified to assist customers accounted for $18.4 million of the total at the end of the quarter.

The second quarter was another very strong quarter from an underwriting standpoint. In the commercial mortgage portfolio, fundings had a weighted average loan to value of 61%, while in residential mortgage and home equity, the weighted average loan to value was 65%, with 53% of home equity originations in a first-lien position.

At the end of the quarter, the allowance for loan and lease losses totaled $106.4 million. Accordingly, given net charge-offs of $3 million, a credit provision of $4.3 million was recorded.

The ratio of the allowance to total loans and leases was 1.13 at the end of the quarter, down 2 basis points for the linked period and down 12 basis points year-over-year. The allowance reflects the continued strength of the company's asset quality and the Hawaii economy over this period as well as the mix and quality in loan growth. The total reserve for unfunded commitments was $6.8 million at the end of the quarter, up $250,000 from the first quarter of 2017 and 2016.

I'll now turn the call back to Peter.

Thanks, Mary. As Mary mentioned, the Hawaii economy continues to perform well, due in part to healthy labor market conditions and active construction pipeline in both private and public sectors, strong performance in Hawaii's tourism industry and increased home prices. The medium price for single-family home on Oahu, our primary market, increased 3.2% during the first half of 2017 and, the medium price of a condominium increased 3.6% compared with the same period last year. The volume of single-family home sales on Oahu increased 4.4% while condo sales increased 6%.

Months of inventory declined to a low of 2.7 months for a single-family home and 2.8 months for a condominium. The median number of days on market during the first half of 2017 was 16 days for a single-family home or a condominium. During the month of June, the median number of days on the market declined even further to 12 days for a single-family home and 13 days for a condominium.

For visitors, we also remained strong, with visitor spending increasing 9.8% during the first 5 months of this year and visitor arrivals up 4.2% over that same period. Spending by visitors is increasing due to the growth in arrivals as well as higher daily spending.

Year-to-date, all 4 of Hawaii's largest visitor markets, which includes the U.S. West, the U.S. East, Japan and Canada, are showing strong growth in spending compared with the first 5 months of last year. In addition, all 4 larger Hawaiian Islands saw growth in visitor arrivals and spending in May compared to a year ago.

Thanks again for joining us today. And now we'd be happy to take your questions.

(Operator Instructions) Our first question comes from the line of Brett Rabatin with Piper Jaffray.

Wanted to first ask about loan growth and just -- it continues to be better than we expected. And in the past, Peter, you've -- or maybe last quarter, you indicated maybe pulling back from some things just given the risk inherent in the system or what have you late in the cycle. But obviously, strong growth continues. Can you talk maybe about just the pipeline and then just the growth that you're experiencing? It was obviously a lot in CRE and resi won before this quarter.

Yes. Sure. It was a surprisingly strong quarter for us. And so I would notch this as probably being half correct on high single-digit loan growth because the spot growth was 3%. On average though, average growth was 2.2% for the quarter. So I think in reality, Brett, somewhere in between there. If you look at the average growth on commercial, it was a little underpowered in the first quarter. We think that actually should pick up a bit for the balance of the year. But other consumer, meaning home equity and indirect and installment, just continue to be very strong as well as residential mortgage, which had a good performance on the balance sheet. And that's on top of selling about $100 million of production for the quarter. So yes, we're happy with the 3 points, although I think we're still thinking higher single digit as we move forward here. And that's really what's reflected in the average numbers.

Okay. Fair enough. And then on the funding base. Was just curious. I saw the public funds was up linked quarter. Can you talk maybe about if that has an impact on your funding costs going forward in terms of increases or how you're thinking about your deposit betas and your cost of funds?

Yes. The -- we saw an opportunity in the second quarter to increase our market share in the public deposit side. It is a bit more expensive, but we don't expect that to have a material impact on the rest of our deposit base.

I would add that we are seeing some recalibration on the commercial side of our deposit bases, I think, as I mentioned a couple of calls ago. As a lot of these large-construction condominium projects burn off, fortunately, we are the recipient of a lot of those funds held in escrow. And so we saw, gee, almost a couple hundred million dollars of volume disappear this past quarter in commercial deposits. Could be a bit more of that but not a lot more, I don't think. But that's going to create kind of a restepping for our commercial deposit base. The consumer base continues to perform really strong, but I do think we've got a bit of a reset here on the commercial side.

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

Peter, touching on the deposits again. The movements that you had in between commercial, and I'm just looking at -- for some of the public deposits you were able to gather, is that what's driving the shift within the individual accounts? Meaning that we saw CDs tick up and savings and money markets move down during the quarter.

Well, I think that we're seeing -- overall, we're seeing pretty good performance across most deposit categories. I would say that when you look at the market share position that we have on the time side, we think that we have some opportunity just to kind of get to a natural fair share position there. So yes, you're -- I think you're correct from that standpoint. In terms of where the funds are coming from, the second quarter is a little tough to use analyzing on a linked basis because of the rundown that we experienced in both commercial and consumer deposits in Q2 because of tax payments. But -- so I tend to -- for Q2 in particular, I tend to look at a year-on-year delta basis. And there, when you look at the year-on-year, still 76% of our deposit growth came from commercial and consumer deposits, with 24% coming from the government side or the institutional side so I think we're still looking for balanced growth along all categories and all customer segments. It just happens that, I think, in Q2, as Dean mentioned, we had some good opportunity late in the quarter to pick up on the institutional side. And we are seeing good success with our time initiatives.

Okay. That's very helpful. And Dean, what are -- what was the timing of the securities purchased in the quarter?

It was spread out through the quarter. There wasn't any real peaks or valleys, so pretty even across the quarter.

Okay. And are you still looking at deploying some excess liquidity that way?

It will be dependent on the loan growth versus the deposit growth. The funding from the deposits will mainly come from -- I mean, the loans will come mainly from the deposits. But to the extent that it exceeds the deposit growth, we'll pull it down from the investments. But at this point, I would expect it to be flat to maybe even a flattish, I guess, is the way I would characterize it.

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

Question on the expense front. Dean, if I heard you right, I think you said you expect expenses up 2% on the year. They're pretty much flat year-to-date. So -- and by my math, that implies a pretty steep ramp in the third quarter up to a little above $92 million. Is that correct? And is some of these branch square-foot optimization, are these -- is the cost of them back loaded towards the back half of the year?

Yes. Casey, it's Peter. We're probably in the early stages of picking up the savings on the branch rationalization or the branch modernization, as we like to think about it. So we have 3 new branches up and running starting, I guess, back in -- last November. And by the end of the year or early into next year, we'll have an additional 3 branches. And these are basically cutting our square footage in half from a total square footage standpoint but keeping customer-facing square footage at about 80% of the prior locations. So yes, we're definitely seeing some pickup, some upside from an expense standpoint there. Last year, we were chatting about kind of a 3% view on expense growth. I think 2% is probably the new 3%. And the reason why it's trending up in part is because if you look at the components of our expenses, one thing that stands out is software costs and data charges are moving up. And part of that is the investment initiatives that we're putting in place to make ourselves a little more supportive of a self-service digital environment for our customer base. So yes, you're right. Expenses have been well controlled, but we do have some investments coming through the pipeline, I think, in the next couple of quarters that may have the opportunity to kick those -- to kick the expense line up a bit.

Okay, great. And just any updated thoughts on the NIM outlook? Dean, you mentioned that the reinvestment was positive 22 basis points. How is that shaping up in the third quarter and the early going here?

I think the NIM will have some marginal increases mainly due to the mix change as we increase our loan balances. In addition, the shorter-duration-type assets of floating-rate securities and loans will benefit from the increases at Fed funds. So based on those 2 things, we do expect some modest increases in the NIM. We'll see more material increases if the longer-term rates start increasing and the curve starts to steepen.

Okay, great. And just last one for me, the construction book. I think you guys had talked previously about that one as some of the projects finish up and pay down. Are you expecting that to be about $150 million by year-end? Is that still the expectation?

Yes. That's -- I think we'll definitely breach $200 million, and the $150 million is probably a reasonable goal. But the good news is projects we're invested in are paying off on time and they have all been successful projects for us.

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

Peter, you mentioned -- I guess, outlined the economy. I guess, one of the challenges of that is a tight labor pool. If you could just comment on sort of talent acquisition, retention and the challenges out there that's kind of expense related, I guess, could you see a material impact on your expense outlook on that front?

I think so. So we're down to 2.7% unemployment here in the islands, and that number has been stable for a bit now. So that clearly creates challenges for us. I think we've been -- the brand's been able to attract talent pretty nicely. But there are definitely some trouble spots that are not unique to Bank of Hawaii. So technology acquisition is difficult and expensive. Compliance and risk talent is expensive and difficult to get our hands on. Fortunately, we're in reasonable shape in both of those areas. But you're right, those have the ability to require a higher expense line and salaries and potentially to some one-time pops in retention bonuses and the like.

Got you. And then maybe one for Mary. Just maybe the net charge-off rate has been very similar the last couple of quarters. I guess, any commentary on your expectations of that level on a net basis going forward?

I think given the quality of our portfolio and the strength of originations, that it should be fairly consistent.

And our next question comes from the line of Aaron Deer with Sandler O'Neill.

Wanted to follow up, Dean, on your commentary regarding the margin. I noted that the average Fed fund balances were down a couple hundred million from quarter-to-quarter and end of period it continued to trend higher. Just given -- it seems like generally positive margin trends generally, does that kind -- will you have a rebuild of some of your cash on the balance sheet that's going to be a little bit of a headwind at least just heading into the third quarter on the margin?

What happens at the end of the quarter, we do get a little bit -- I don't want to call it a surge, but we do get an increase in deposits, which then translates at a period-end basis to a higher cash level. Having said that, we are continuing to reinvest at the moment. And again, it will just depend on the loan and deposit growth throughout the quarter, whether we adjust the cash balances or not.

Okay. Very good. And then, Mary, on the -- just curious on the auto book. There's kind of an increase in concern here in the -- with some of the main loan lenders anyway that some of the auto paper is getting a little overextended into subprime. What kind of trends are you seeing in your auto book? And are there any concerns that you have on that portfolio going forward?

Well, we've always historically originated very modest levels of subprime paper. We look to ensure that our customers can actually repay their loans. And so it's averaged about 2% on an origination front. As we talked about last quarter, we did get a little overextended in Guam where we see a loss rate that's about 70 basis points higher than Hawaii. And we also had some challenges in our mix with used. We've made adjustments over the past year. So we think we've curtailed that, but we will see some of that flow through over the next few quarters.

Okay. That's helpful. And then just one last question. The C&I looked kind of flattish in the quarter. Just curious to know where line usage stood in the first -- getting traction and bringing on some new commitments there.

Yes. Aaron, it's Peter. Pretty stable. It was a flat quarter for C&I. I'd note, though, that C&I is up 5%, 6% on a year-over-year basis. But I think -- and I think I've said this before. I think we're pretty deep in the cycle to see a lot of C&I growth. We don't carry a shared national credit portfolio. So all of -- most of our C&I is really acquisition, debt -- modestly levered acquisition debt for end-market transactions. And I think just given where we are in the cycle, that trend is probably gone for the here and now. So what I would anticipate is the C&I bucket is probably going to be flattish to up modestly from here on out.

(Operator Instructions) Our next question comes from the line of Laurie Hunsicker with Compass Point.

Just wondered if I could follow up specifically as it pertains to loans in the commercial real estate side. Linked quarter, you were up 21%. How should that trend going forward given your overall guide? And I just wondered if also you could refresh us on your overall guide. I think last quarter, as it pertained to the commercial portfolio loan, you said we're looking for low single-digit growth there. Is your thinking that's going to be a bit higher?

Yes. Actually, I think our guidance on loan growth has been high single digit overall and probably consumer leading that increase. So yes, I mean, commercial, we're thinking mid- to high single digit. I think the way to think about commercial mortgage is really, it's probably the leader of the pack for our commercial loan book. It's true there's probably a bit of a curtailment in deal flow at this point in the cycle. But we're still getting good growth in commercial mortgages. And that's coming predominantly through refinancing opportunities. So I think the last report I saw, about 26% of our production was from new deals if you will, and the balance of that was really coming from refi. So to the extent that we can continue to be successful in the local marketplace in real estate, I think that commercial mortgage has a chance to continue to perform pretty well, but maybe not at the same level that it did this quarter. This quarter is a pretty exceptional number for us.

Okay. And so just to be clear though, that is a raise from where you were last quarter in terms of last quarter. I'm just talking about the commercial portfolio only. Your low to single-digit growth is now mid- to high single digit. That's...

Yes. Yes. I think that we were always kind of mid to high-ish on the commercial side.

Okay. Okay. And then within your commercial real estate book, is any of that purchase this quarter?

Purchase activity in -- yes, 20% of the activity.

Well, I don't understand what...

Well, purchase, our customers purchasing, we didn't buy any loans.

That's clear now. Yes. So it's all originated. Okay. Okay. Good. And then also on auto, just wanted to follow up to Aaron's question. Your overall FICO in your $484 million book, what is that?

Our overall what? I'm sorry.

Your FICO score on your auto book. What is that currently?

I think the weighted FICO rate now is, let's see, is 692.

,

692. Okay. And how much of that is below 660?

Below, I don't have that number handy. I could get it for you later, Laurie.

Okay. That's great. And then just one other number that I wanted. Your assets -- your AUM.

$9 billion.

$9 billion? Okay.

Yes.

And then where generally do you see that going? Is there going to be an emphasis...

Yes. I mean, that's an area that we have historically had a fair amount of ambition to build out, whether it's through our broker-dealer or through our trust company. But I have to say that, that $9 billion has been a pretty consistent number for an awfully long time. So I think we had aspirations to build that, but that's been one of the elusive spots for us from a business opportunity standpoint, Laurie.

Okay, great. And then just last question. Going back to expenses, your other, other line that was $15.7 million this quarter, about $1 million above the March quarter run rate. Was there anything nonrecurring in that?

Well, I wouldn't characterize it as nonrecurring, but we did recognize the increase in our reserve for unfunded commitments in that line. So that $250,000 is included in there.

And our next question comes from the line of Matthew Keating with Barclays.

Dean, I'd like for you to follow up on the question from earlier on deposit betas. I know you talked about wanting to get more aggressive on the public deposit side this quarter. But just thinking out longer term, I think Bank of Hawaii exhibited around a 20% to 30% deposit beta during the last interest rate sort of tightening cycle when the industry was close to the 50%. Do you think that's still a reasonable expectation? Or has anything changed in the market where you think deposit betas might be higher this time around?

Our current expectation is it will still be above that 20%, 25% beta over the longer term. The CD book is more opportunistic for us. So the core deposits, we still continue to expect that same type of beta over the term.

Okay. And at this point, no real pressure from retail depositors for higher rates at this point?

No.

Really.

Yes.

Yes.

Right. Okay. And then I guess, maybe if you could comment too on whether you've reached any conclusions about selling Visa shares in the first quarter of next year. I know last quarter, you mentioned you're still contemplating that whether you wanted to move forward on that front?

Yes. At this point, we're considering holding the remaining shares that we have. There are some risks associated with the conversion ratio and still to be determined when that date actually is. So we are holding back on the remaining amounts.

And that concludes our question-and-answer session for today. I would like to turn the conference back over to Bank of Hawaii management for any closing comments.

Thank you, everyone, for joining us today and for your continued interest in Bank of Hawaii. As always, feel free to contact me if you have any additional questions or need further clarification on any of the topics discussed today. Thanks, everyone, and have a great day.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day.