Bank of Hawaii Corp (BOH) 2022 Q2 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Bank of Hawaii Corporation Second Quarter 2022 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker, Jennifer Lam, Executive Vice President, Treasurer and Director of Investor Relations. You may begin.

Thank you. Good morning, good afternoon, everyone. Thank you for joining us today. On the call with me this morning 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 the actual results may differ materially from those projected.

During the call, we'll be referencing a slide presentation as well as the earnings release. A copy of the presentation and release are available on our website, boh.com, under Investor Relations.

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

Thanks, Jennifer, and good morning, everyone. Bank of Hawaii produced solid performance for the second quarter of 2022. Core loans grew at a higher linked rate than the prior quarter for the fifth consecutive quarter. Deposit growth was on target. Our deposit base, which is 92% core consumer and commercial by customer type and 94% core demand and savings by product type, is well positioned for rising rates. We're clearly seeing the benefits of our strategic investments in both our consumer and commercial businesses through increased production.

Margins expanded, efficiency increased and credit statistics improved in the quarter. I'll spend the next few minutes sharing with you conditions in Hawaii, our predominant market, and then turn the call over to Dean to cover the financials. Mary will then cover [tourism] and growth.

The Hawaiian economy continues to improve as tourism and overall business activity improve. Here, you see unemployment at 4.3% a range just north of national levels. This compares favorably to the 7.7% differential that existed early in the pandemic between Hawaii and the U.S. Mainland from an unemployment standpoint.

On the real estate front, sales activity cooled in June versus prior year levels on Oahu, although sales prices actually increased from prior year levels for both single-family homes, up 12%, and condominiums, up 16%. Month supply of sale housing inventory remains at suppressed levels, with 1.5 months of inventory for single-family homes and 1.6 months for condominiums.

Of note, current inventories are down 53% for single-family homes and 46% for condominiums as compared to pre-pandemic June 2019 inventory levels on Oahu. The visitor industry continues to improve with the month of May at 91.6% of 2019 levels by arrival and 110.6% of 2019 levels by visitor spend. Year-to-date numbers are 85% and 102.3% of 2019 arrivals and spend levels. This performance comes despite less than half of the international market, traditionally, 35% of our visitor market having yet to return as of yet.

Obviously, strong support from U.S. visitors is making up meaningfully for the shortfall. RevPAR levels across the state are actually ahead of 2019 levels as demand for travel and specifically travel to Hawaii remains high.

And now let me turn the call over to Dean to share the financial highlights. Dean?

Thank you, Peter. Our strong core loan growth continued in the second quarter. Core loans net of PPP paydowns increased by $434 million or 3.5% linked quarter and by $1.4 billion or 12.1% year-over-year. Growth was balanced across both commercial and consumer loan portfolios at 3.3% and 3.6% linked quarter, respectively, and 11.7% and 12.4% year-over-year. Core loan growth has accelerated over the last several quarters with double-digit annualized growth rates well above recent annual averages.

As Mary will discuss later, growth was achieved while maintaining our conservative underwriting and disciplined portfolio management practices, with our commercial and consumer loan portfolios remaining predominantly real estate secured. Deposits increased by $310 million or 1.5% linked quarter, providing a solid source of low-cost funding in a rising rate environment. We maintained our deposit pricing discipline during the quarter with average deposit cost of 7 basis points, an increase of just 2 basis points.

We also maintained our attractive and stable core deposit base with 94% of total deposits in checking and savings accounts. 92% of deposits are from core commercial and consumer customers and the remaining 8% in public deposits are predominantly government operating accounts. The quality of our deposit base is further demonstrated by the longevity of our deposit relationships with our customers.

Nearly 3/4 of our deposit customers have been with us for over 10 years and nearly half for more than 20 years. Noninterest income in the second quarter was $132.9 million. Interest income included $500,000 from PPP loans, and we recognized $1.1 million in interest recoveries. Adjusting for these, our core net interest income was $131.3 million, up $7.9 million or 6.4% from the first quarter. Compared to the year-earlier second quarter, core NII increased by $15.3 million or 13.2%.

Our core net interest margin increased by 13 basis points linked quarter to 2.44%. Our robust and consistent loan and deposit growth provides the foundation for sustainable growth in our NII and margin, which are being further bolstered by increasing interest rates. Our loan-to-deposit ratio remains low relative to regional and local peers. This affords us room to continue to grow our assets as well as greater pricing flexibility.

As we continue to grow, we maintained our balance sheet's asset-sensitive position to changes in interest rates and continue to benefit from higher rates. 60% of our earning assets will reprice or turnover in the next 2 years. In addition, sizable cash flows from both loan and deposit portfolios will also enable us to position the balance sheet for evolving interest rate environments.

In the second quarter of 2022, net income was $56.9 million and earnings per common share was $1.38. Net interest income in the second quarter was $132.9 million. As discussed earlier, core net interest income, which excludes PPP loan interest income and the quarter's interest recoveries, was $131.3 million, up $7.9 million linked quarter driven by strong core loan growth and rising interest rates. As Mary will discuss, we recorded a negative provision for credit losses of $2.5 million this quarter.

Noninterest income totaled $42.2 million in the second quarter, down $1.4 million from the first quarter. The decrease was primarily due to lower mortgage banking income and swap revenue, partially offset by higher service charges and other transactional fees. We expect noninterest income will be approximately $41 million to $42 million in the third quarter as higher transaction fees are expected to offset continued pressures on mortgage banking income and asset management fees.

Included in the third quarter's estimate is a onetime negative adjustment of approximately $900,000 or a change in the Visa Class B conversion ratio, which is reported as a contra revenue item in investment securities, gains and losses.

In the second quarter, we were able to maintain overall expense discipline while continuing with our innovation investments. Noninterest expense in the second quarter totaled $102.9 million, down $1 million from the first quarter. Included in the first quarter's expenses were seasonal payroll taxes and benefit expenses of $3.7 million related to annual incentive payouts made during the quarter. Adjusting for these items, the second quarter's expenses increased by $2.7 million linked quarter primarily due to annual merit increases and onetime cost of living adjustments, which began on April 1 as well as 1 extra workday during the quarter.

Our innovation investments continued during the quarter, while we were able to take advantage of opportunities to reduce expenses elsewhere.

For the full year of 2022, expenses will be approximately $415 million as inflation continues to pressure overall expenses. In addition, the third quarter expenses will be slightly higher than the fourth quarter due to seasonal payroll differences between the quarters.

Our return on assets during the second quarter was 1.0%, the return on common equity was 18.19%, and our efficiency ratio was 58.8%. Our net interest margin in the second quarter was 2.47%, up 13 basis points from the first quarter. As discussed earlier, core margin was 2.44%, also an increase of 13 basis points linked quarter. The increase in the margin during the second quarter reflects the ongoing impact of strong core loan growth and rising rates. We expect continued improvement in our core margin, with an increase of 6 to 7 basis points in the third quarter.

Our capital levels remained strong, and we are well positioned to support continued growth. Our CET1 and total capital ratios were 11.66% and 14.14%, respectively, with a healthy excess above regulatory minimum well-capitalized requirements. Despite robust loan growth, our risk-weighted assets relative to total assets are still well below levels of peers reflecting our lower risk profile and providing us with ample room to continue growing while maintaining strong capital levels.

Higher interest rates in the third quarter negatively impacted the valuation of our available-for-sale securities portfolio resulting in an AOCI adjustment and a reduction in our book and tangible common equity. However, this has no impact on our regulatory capital and capital distribution capabilities.

During the quarter, we paid out $28 million or 51% of net income available to common shareholders and dividends and $2 million in preferred stock dividends. We repurchased 131,000 shares of common stock for a total of $10 million. And finally, our Board declared a dividend of $0.70 per common share for the third quarter of 2022.

Now I'll turn the call over to Mary.

Thank you, Dean. Our loan portfolio construct reflects our strategy of lending in markets we understand, people we know, and communities we trust. These underpinnings, coupled with consistent conservative underwriting and disciplined portfolio management, resulted in a loan portfolio that is diversified by category as appropriately-sized exposures and is 80% secured by quality real estate with a combined weighted average loan-to-value of 56%.

Credit performance continued to improve and remained very strong in the second quarter. Net loan and lease charge-offs were $600,000 or 2 basis points of average loans and leases annualized compared with 5 basis points in the first quarter and 4 basis points in the second quarter of last year. Nonperforming assets totaled $15.5 million or 12 basis points at the end of the quarter, down 4 basis points for both the linked period and year-over-year. All nonperforming assets are secured with real estate, with a weighted average loan-to-value of 58%.

Loans delinquent 30 days or more remained stable at $27.5 million or 21 basis points, while down $2.2 million or 4 basis points year-over-year. And criticized loan exposure represented just 1.3% of total loans, down 30 basis points from the prior quarter, driven by continued sustained improvement in the financial performance of those customers who had been most impacted by COVID. The quality of our loan production in the second quarter remained strong. 76% of commercial production was secured, with quality real estate modestly leveraged.

Our commercial mortgage production had a weighted average loan to value of 63%, and construction production had a weighted average loan-to-value of 61%. 78% of the quarter's consumer production was secured with real estate, again, conservatively leveraged. Residential mortgage and home equity production had weighted average loan-to-value and combined weighted average loan-to-values of 65% and 58%, respectively. 76% of our home equity production was in a first lien position. FICO scores for all our consumer production remained very strong and consistent.

Portfolio monitoring metrics also remain very strong. Our commercial mortgage and construction portfolios have weighted average loan to value of 57% and 63%, respectively. Residential mortgage and home equity portfolios have weighted average loan to values or combined LTVs of 57% and 52%, respectively. 72% of the home equity portfolio is in a first lien position. And again, monitoring FICOs remained very strong.

As Dean noted, we recorded a negative provision for credit losses of $2.5 million this quarter. This included a negative provision for the allowance for credit losses of $2.9 million which, with net charge-offs, reduced the allowance by $3.5 million to $148.5 million or 1.15% of total loans and leases.

The decrease in the allowance reflects the improving economic outlook and forecast for our market, coupled with our credit risk profile, while continuing to consider the broader economic uncertainty and downside risk of a recession. The reserve for unfunded commitments was $5.6 million at the end of the quarter, up $400,000 for the linked period.

I'll now turn the call back to Peter.

Thanks, Mary. As you can see, it was another solid quarter for Bank of Hawaii. We remain well positioned for whatever market and economic conditions present in the near future. We remain, as always, committed to the principles of consistency, conservatism and capital efficiency as highlighted in the chart on your screen.

And now we'd be happy to take your questions.

(Operator Instructions) Our first question comes from the line of Andrew Liesch with Piper Sandler.

Peter, I just want to start on the loan side here. You referenced the challenged housing supply. Just kind of curious what's driving that growth, along with the home equity growth? And then where does the pipeline stand on the commercial side as well? You continue to put up really good loan growth. I'm just curious where pipelines stand? And what is driving this growth that you guys are able to put up?

Yes. So I think I threw a bit of a comment on the -- on my opening remarks around really some of our strategic efforts, really, I think, showing up nicely in this quarter, Andrew. So maybe beginning with the commercial side.

What we saw commercial-wise was all of our growth, for the most part, came out of our middle-market small business units. And I think, as you know, that's really -- traditionally Bank of Hawaii is considered more of a large corporate lender. And really, in the past 5 years, I'd say, it really begin to emphasize building up that kind of that mid-market, small business segment.

And in this quarter, basically, large corporate was flat loan production. But our small business unit, middle market unit generated about 7% loan growth, which kind of got us to that 3% number. So that obviously was very satisfying to us as we've been building this area.

We've staffed up middle market about 45% with lenders and support staff over the past couple of years and have been fortunate to pick up a number of real, well-known lenders in their particular marketplaces, which has had a big impact as well.

So really, the strategic growth is as a result of now really having really 2 businesses, a large corporate business that is going to grow and has grown nicely, but just kind of had an off-quarter this quarter. But our middle market business really taking shape and having a great quarter this quarter. And hopefully, they'll both have good quarters next quarter.

But I think the point is, if one falters a little bit, the other one generally tends to pick up, and that's what we're starting to see in the consistency of our commercial numbers over the past several, several quarters.

On the consumer side, yes, the run-up in rates, obviously, has had an impact on our mortgage businesses, home equity and residential. But a lot of the growth you saw for Q2 was kind of backlog or pipeline that had been built prior to some of that rate increase.

So we think that we will likely see a downturn in application volumes, certainly in residential mortgage, probably in home equity as well. Although I would say that as people are hesitant to refi first mortgages on a cash out refi basis, that tends to push business to home equity as well as incent people with existing home equity lines to fund up their existing lines.

But overall, I think we remain pretty constructive on loan growth, at least for the next couple of quarters out. The continued loan growth in consumer, continued loan growth in commercial consumer really being driven by -- despite kind of some headwinds in the rate market and the pipeline, really being offset, if you will, by a number of channel improvements that we've made over the past couple of years, online, wholesale, private banking.

Those are all market vectors that really hadn't been available to us in the past that are really starting to show at some level of scale at this point and giving us nice growth despite potentially a drop-off because of rates.

Got it. That's really helpful. And then, Dean, just on the margin outlook. You mentioned 6 to 7 basis points in the third quarter. What are some of the assumptions behind that? Does that assume a rate hike next week or I mean later on this week. And why wouldn't that expansion be stronger given that we just had a 75 basis point rate hike just last month?

Yes. So we're assuming 75 for the -- this week and then maybe another 50 after that, sometime in the third -- this quarter. So it is based on kind of a flattish to maybe even a little bit around 3% on the 10-year, and then continued loan growth. So that's how we got to that number.

Got you. Are you seeing rising funding costs that might slow that smaller pace of expansion?

A little of that, but mainly it's going to be kind of a flattish on the long end, but we're continuing to realize some benefits on that. But the benefits from that will just continue throughout the next several quarters and years. The short end is a little bit more instantaneous. So that's how we got to the 6 to 7.

Our next question comes from the line of Kelly Motta with Bank of America.

This is Kelly Motta with KBW. Great quarter. Just wondering, this may be a question for Mary. Peter, you mentioned in the prepared remarks credit metrics across the board are good, the tick down in criticized delinquencies. Just wondering if there's anything that you may be watching a bit more closely that isn't showing up necessarily in reported credit metrics yet?

Actually, no, we're not really seeing any early signs of any deterioration. Of course, we have our eye on our consumer book, given the impact of rising rates and inflation. But everything still looks good there.

In our commercial portfolio, our client base is very strong financially and, as you know from the metrics, have a lot of financial capacity and depth to weather this. But we're continually really streaming through that to see if there's any segment we should be more concerned about.

Got it. And then turning to funding costs, back to funding costs. With the increase you saw this quarter, it looks like there was also a mention public deposits. Can you just remind me what the seasonality with those are as well as if we were to kind of parse them out, I assume those are a bit higher cost or even priced a bit faster? What -- how your core deposit base performed in terms of change in cost this quarter?

Yes. So just to kind of start at the top, the seasonality in public deposits, we do have a bump in February and August. That's mainly due to property tax receipts. So those come to us mostly. And then in terms of costs, we did increase some of the balances on our public side.

What we saw is that the -- with the rising rates, market rates, we were able to pick up some public deposits at a lower cost than our funding costs. So we thought that was an attractive move for that.

And overall, what we're seeing is still a pretty muted deposit rate environment locally. The kind of the -- no one has an increase of public or published rates, I should say, locally. There are some movements at the very top end of the market, but that's to be expected, and that's well within our plan.

Yes. Kelly, we see that. I mean, with mega rate increase one in the books, pretty good discipline in the marketplace. As Dean indicated, you're always going to have some extraordinary large depositors who quite rightfully are going to ask for more yield, and that's to be expected, I think.

But in general, the broader deposit marketplace is feeling pretty good. Now we've got likely another 75 basis point increase coming through shortly. And our hope is that kind of likely yields will have to lift a bit, but still hopefully in a disciplined manner.

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

Just staying with where Kelly was on public deposits, the $1.647 billion, how much of that was time? And then if you have a comparable number in terms of last quarter's $1 billion before for how much public's time?

Public time, sorry?

Yes.

Yes. So it's kind of lumpy, as Dean alluded to. But this quarter, public time was 4 20. Last quarter, public time was 25, and the quarter last year, so 6 30 '21. Our public time was 3 48.

Okay. Got it. And then do you have a blended cost on your -- on all of your public deposits that you could share with us?

We do, but I don't know if we have it on us right now.

Okay. No worries. Tax rate, how should we be thinking about that? That jumped around a little bit. How should we be thinking about that for next year?

I think 23% is still a good number. It did tick up a little bit this -- or second quarter due to some discrete items -- but right now, we're looking at for the full year '23 this year and then probably into next year.

Okay. Okay. Great. And then just more macro. This was really for all 3 of you. If you could give us a refresh on where we are? The signals are starting to flash. Just where we are on 2 categories, office and leverage lending? And any details you could provide, us, just refreshing us on those books? How much is Hawaii versus Mainland? Anything that you can share as far as office LTVs?

Yes. I'll just say office and leverage are very small portfolios for us. And Mary, you have the details on that?

Sure. In terms of leverage, as we disclosed, it's 2.4% of total C&I at the end of the second quarter. It includes 7 borrowers with average exposure of about $4.6 million. We don't have any criticized exposure in that portfolio.

Mainland represents about 20% -- 7% of total leverage or 7 basis points of C&I. The Mainland exposure is a global vacation ownership and timeshare company with a significant presence here. We enjoy an 8-figure deposit relationship. And their leverage is roughly around 4x at this -- Hawaii is the balance...

I'm sorry. You said 27% was Mainland?

Yes.

Time's really -- just clarifying. Go ahead.

Okay. Hawaii is the balance of that or about 1.35% of total C&I. The largest exposure there accounts for 54% of that or 1.3% of total C&I. It is a company that operates a sundry and convenience store here and is owned by a long-established family with significant financial capacity and depth. Also enjoy a large relationship, and their current leverage is about 1.6x.

And then do you -- that's super helpful.

Leverage is about 1.6x.

Great. And then do you -- that's super helpful. Do you have the office retail?

Sure. Sure. It is the smallest segment in our commercial mortgage portfolio that represents 11% of the total commercial mortgage book. The weighted average LTV on the portfolio is 57%. Average loan is $1.8 million. In terms of geographic dispersion, 15% is Mainland. And that's extended to a couple of key relationship customers who have diversified commercial mortgage book.

The weighted average LTV on the portfolio is 57%. Average loan is $1.8 million. In terms of geographic dispersion, 15% is Mainland, and that's extended to a couple of key relationship customers who have diversified portfolios. Their collateral pools generally tend to be in supply-constrained submarkets and have an LTV of 45%.

The 85% balance on -- in Hawaii is predominantly in Hawaii with -- is in Hawaii with 5% in Guam. 59% is on Oahu. 22% of that is Class A office downtown space with a 66% weighted average LTV. There have been changing dynamics in the Class A space. A number of properties have been converted into other use. So vacancy is really at its lowest rate in the last 10 years. And in terms of other kind of segmentation there, we've got about 20% that is in medical government type tenant.

I'm so sorry. So 20% overall in medical government?

Yes.

Okay. That's great. And then when you -- go ahead.

I'm sorry, go ahead.

I was just going to say when you said some of it is getting repurposed, converted into other use, do you mean some of the office space is getting converted into condos? Is that what you meant? Or what do you mean by that?

That's been happening in the downtown area, which has created more limited supply and help to stabilize vacancy and rents.

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

Dean, just a follow up on the margin. I guess, the reported up 13 basis points. What part of that -- or what portion of that was from interest recoveries?

It was about 2 basis points.

Okay. And the 2 44 core excludes that? Is that -- is that right? Okay.

It's the basis points from the interest recovery, one from PPP loans.

Yes. Right. Do you have a June monthly margin? What the margin was for the month of June?

We do, but we don't normally disclose on a monthly basis.

Okay to assume the trends was upward throughout the quarter?

Yes, it was. It was.

Got it. Maybe, Peter, a question on the international visitors. And any thoughts on kind of resumption of activity there. I guess that you could throw out differences in -- of the domestic spend.

But locally, what are the kind of the headwinds there? And what are the expectations for some -- I mean, the numbers are great and coming back, but we still haven't seen the international side as much. So any thoughts on that end?

Yes. It's going to be -- it may be a while, Jeff. So Canada, Japan, Korea, and kind of a smattering of other countries make up the international segment. That, together generates about 35% of arrivals and 35% of spend.

And what we have happening right now is that number is less than half of what it is -- what it has been traditionally kind of headlined by the Japanese who are down over 90% and the Koreans were down not quite as bad as that but pretty bad. Kind of offsetting that, Canadians are kind of effectively have bounced back at this point so that's positive. And Australians are kind of newly able to lead their country. And we're seeing good traction there.

So I think that it's Japan and Korea is kind of anybody's guess. I think that the combination of both kind of health issues and conditions -- and I understand Japan is kind of, again, starting to have some viral issues, COVID issues. But I also think it's also just policy, right?

And I can only imagine that the domestic Japanese visitor industry quite appreciate having all of their residents in-house, if you will. So I don't know. I mean, I think eventually, the business will come back. That's for sure. We know that. But kind of predicting which quarter might be a little bit more of a fool's area than perhaps we thought previously.

When I talk to hotel professionals, a number of them are kind of thinking kind of beginning first quarter next year. And I think probably the sentiment had previously been kind of summer to later '22. So that's a bit of a pushout. But kind of if we kind of zoom out a bit and take a look at the macro environment. We've got so much domestic traffic right now that it almost is somewhat of a blessing that we don't have the international market back as strong as, obviously, eventually we want because I'm just not sure where we would put all of those people. I mean we're at 92% in June by arrivals and over 100% by visitor spend.

So the way I look at it is the international market is going to get back. I can only imagine that certainly the Japanese visitor is really anxious to get back to Hawaii, which, as you know, they've got a deep and long-standing love affair with. And potentially, if we start to see a little softening in the U.S. domestic side, that might be kind of a nice fold in for us as we move forward.

One moment for our next question. We have a follow-up question from the line of Andrew.

Yes, just a question here on capital and the buyback. I know that regulatory ratios are where you focus the most on. But with the TCE ratio below 5%, what's the appetite to continue buying back shares here?

Yes. I mean the buyback still continues to be an important part of our capital management program. Right now, the -- even though we've taken another reduction in our capital because of the AOCI component, it still hasn't affected our capital distribution plans, continue to expect kind of a modest repurchase program going forward, similar to the levels that we had in the last several quarters.

We have a follow-up question from the line of Kelly with KBW.

Just a really small housekeeping item. With your fee guidance, I caught that it excludes the Visa across the share adjustment. Last quarter, I think it was 42 to 43. I assume that also was excluding the Visa adjustment, but I just wanted to clarify if you do model that out.

Yes. Just when you say excluded, the 41 to 42 includes the adjustment. So therefore, on a normalized basis, it would be 42 to 43. So roughly the same guidance that we had in previous quarters.

Thank you. I'm showing no further questions in the queue. I would now like to turn the call back over to Jennifer for closing remarks.

Thank you. I'd like to thank everyone for joining us today and for your continued interest in Bank of Hawaii. Please feel free to contact me if you have additional questions or need further clarifications on any of the topics discussed today. Thank you, everyone.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.