First Hawaiian Inc (FHB) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Hawaiian, Inc. Q3 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to turn the conference over to Kevin Haseyama. Sir, you may begin.

Thank you, Ashley, and thank you, everyone, for joining us as we review our financial results for the third quarter of 2017.

With me today are Bob Harrison, Chairman and CEO, who's calling in from Japan; Eric Yeaman, President and COO; Mike Ching, CFO and Treasurer; and Ralph Mesick, Chief Risk Officer.

We have prepared a slide presentation that we will refer to in our remarks today. The presentation is available for downloading and viewing on our website at fhb.com in the Investor Relations section.

Before I turn things over to Bob, I'd like to direct you to Slide 2 and remind you that we may make forward-looking statements during today's call that are subject to risks, uncertainties and assumptions. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, see our SEC filings, including our Form 10-K for the year ended December 31, 2016, which is available on our website and the SEC's website.

We will also discuss certain non-GAAP financial measures. The appendix to this presentation contains reconciliations of these non-GAAP financial measures to comparable GAAP measures.

And now I'll turn the call over to Bob, who will provide you with third quarter highlights, starting on Slide 3.

Thank you, Kevin, and hi, everyone, and thanks for joining us today. I'm pleased to report that we had a solid third quarter as loans, deposits and assets continued to grow at record levels. Our performance measures remained strong and our credit quality remained excellent. Mike will go through the details of our financial results so I'll just touch on a few highlights.

Net income for the quarter was $58.4 million or $0.42 per diluted share. Core net income was $57 million or $0.41 per diluted share. And our Board of Directors declared a quarterly cash dividend of $0.22 per share, payable on December 8 to shareholders of record at the close of business on November 27, 2017.

Loans and leases grew $87 million or 0.7% to $12.1 billion, while deposits increased $143 million or 0.8% to $17.6 billion. Eric will go over the details of the changes when he discusses the balance sheet.

Asset quality remains excellent with a net charge-off ratio of 13 basis points and we remain well capitalized.

Our efficiency ratio was 46% in the quarter and our profitability measures remained solid. The return on average tangible assets

(technical difficulty)

I think we may have lost Bob.

Yes, let's now continue where Bob left off. So return on average tangible assets was 1.21% and core return on average tangible assets was 1.18%. Return on average tangible common equity was 14.76% and our core return on average tangible common equity was 14.42%.

So turning to Slide 4. Net income for the quarter was $58.4 million or $0.42 per diluted share. Core net income was $57.0 million or $0.41 per diluted share. EPS was $0.01 higher versus the prior quarter and $0.04 higher than the third quarter of 2016.

Turning to Slide 5. Net interest income in the first -- in the third quarter was $133.3 million, an increase of $2 million compared to the prior quarter. The increase in net interest income was due to increases in average balances and yields on our loans and interest-bearing deposits in other banks, partially offset by higher average balances and rates on public deposits as well as lower average balances in yields on our investments.

Net interest margin for the quarter was 2.96%, a decrease of 6 basis points from the prior quarter, due primarily to higher public deposit costs and lower yields on our investments from higher premium amortization, partially offset by higher loan yields. Due to our strong relationship with the state of Hawaii as their primary depository, our public deposits increased by approximately $500 million as we continue to assist them with their banking and investment needs. While the impact of this was accretive to net interest income as we invested the excess liquidity into our investment book, it also reduced our NIM by approximately 6 basis points.

Turning to Slide 6. Noninterest income was $48.5 million, a decrease of $400,000 compared to the second quarter. We saw increases in most noninterest income areas with the exceptions being service charges on deposit accounts and other noninterest income. The decline in service charges on deposit accounts was primarily due to lower income from our analyzed checking accounts as we increased our earnings credit rate on July 1. Other income in the third quarter was $1.4 million lower than the second quarter. Third quarter included a $2.7 million gain from the sale of a bank property, while the second quarter included approximately $2.4 million from credit card incentives and recoveries. Swap fee income was also lower during the quarter by about $400,000 and other miscellaneous items made up for the remaining quarter-over-quarter difference.

Noninterest expense, shown on Slide 7, was $83.7 million in the third quarter, a decrease of $1.5 million from the second quarter. Compared to the second quarter, salaries and employee benefits decreased by $1.7 million, primarily due to equity compensation forfeitures due to retirements, a change in the estimate of certain compensation liabilities and higher deferred loan cost related to an increase in our mortgage loan volume.

Contracted services and professional fees also decreased by $1.6 million. As we previously reported, the second quarter expenses were elevated due to system upgrades and product enhancements. Also, advertising and marketing expenses increased by $800,000. The efficiency ratio in the third quarter of 2017 was 46%. So our outlook for the full year of 2017 is slightly revised. We expect to be right around 47% or slightly under. The outlook for the efficiency ratio in 2018, however, remains in the 47% to 48% range.

With that, I'll turn the call over to Eric to cover the balance sheet, starting on Slide 8.

Thanks, Mike. Total assets at the end of the third quarter were $20.6 billion, an increase of $192 million or 0.9% compared to the end of the prior quarter. During the quarter, investment securities increased by $188 million or 3.7% to $5.3 billion. Runoff during the quarter was approximately $225 million, and we purchased approximately $422 million of new securities, which had a positive spread differential of 20 basis points.

At the end of the third quarter, the duration of the investment portfolio was about 3.4 years compared to 3.5 years at the end of the second quarter.

Turning to Slide 9. Total loans and leases grew by $87 million or 0.7% to $12.15 billion in the third quarter. During the quarter, we experienced growth in all segments of the loan portfolio with the exception of C&I loans. Commercial real estate and residential real estate loans each grew by $80 million or 3.2% and 2%, respectively.

Construction loans increased $43 million or 7.7%, and consumer loans grew by $35 million or 2.3%. C&I loan balances decreased by about $141 million, primarily driven by pay-downs in dealer flooring balances due to strong auto sales in the quarter and several large prepayments in our mainland SNC portfolio.

On a year-to-date basis, total loans and leases are up $629 million or 5.5%. Looking forward, we have a healthy pipeline so we expect to meet our guidance of mid- to high single-digit loan growth for the full year.

Turning to Slide 10. You can see that total deposits increased by $143 million or 0.8% to $17.6 billion. We saw an increase in public deposits of $523 million, which was offset by a decline in nonpublic deposits of approximately $380 million. The decline in nonpublic deposit balances were primarily due to one large captive insurance customer's withdrawal of about $250 million and withdrawals related to several large project payments totaling approximately $115 million.

In addition, as rates on our sweep account products have become more attractive, we have seen commercial customers choosing to shift more deposit balances into the sweep accounts, which reside off balance sheet. As Mike previously mentioned, public deposits increased as we continue to work with the state and other local municipalities to meet their banking and investing needs. On a year-to-date basis, deposit balances are up $101 million or 4.8%.

Now I'll turn the call over to Ralph to cover asset quality.

Thank you, Eric. On Slide 11, we provide an overview of our asset quality that remained strong at quarter end. Credit costs continued to be low. Net charge-offs were $4.1 million for the quarter. On an annualized basis, this amounts to 13 basis points on average loans and leases. This is 2 basis points higher than the prior quarter and 1 basis point higher than the third quarter of 2016. Total nonperforming assets were $8.4 million or 7 basis points on total loans and leases and other real estate owned. This is unchanged from the prior quarter and down 2 basis points year-over-year. In the third quarter, the provision expense was $4.5 million. The allowance for loans and lease losses was $137.3 million at September 30. The ratio of this reserve relative to total loans and leases was 113 basis points, and the current amount of the reserve covers our annualized net charge-offs more than 8x.

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

Okay. Sorry about that, everyone. I dropped off the call with an update to my phone, but I'm back. Turning to Slide 12. You can see Hawaii's economy continues to perform well. The state unemployment rate was 2.5% in September compared to 4.2% nationally. And the visitor industry remained robust through the first 8 months of the year with year-to-date through August, visitor arrivals were 6.3 million, up 4.7% versus the same period last year. And visitor spending was $11.3 billion, an increase of 8.5% versus the same period last year.

And then another positive sign for the tourism industry, the airline seat capacity to Hawaii has received a boost from several airlines. On September 15, Japan Airlines resumed its daily direct flights from Tokyo to the Big Island, and then United announced that starting on December 20, it will increase the frequencies on 11 Hawaii routes from 4 mainland cities, increasing their capacity by just over 18%. And then earlier this month, Southwest Airlines announced plans to begin offering service to Hawaii some time in 2018.

And the real estate market remains sound, and in fact, the visitors from Japan are still very strong, which is why I'm over here in Japan. I come at least once a year to visit our customers, and we're seeing very good support from our Japanese market.

So with that, we're happy to take any questions.

(Operator Instructions) Our first question comes from Steven Alexopoulos of JPMorgan.

I want to start on Slide 7, the lower salaries and benefits you called out tied to the equity compensation forfeitures and the change in the incentive comp. Could you quantify that? I'm trying to get a sense of what expenses were ex those items. And are those -- is there any reduction to the run rate from this change you're talking about? Or will that go back to where it was previously?

Yes. Steve, this is Mike. So before, forfeitures were about $300,000 and the change in estimate was just about $650,000. The change in estimate did slightly affect the go-forward run rate, but not significantly.

Okay. But we're still expecting the efficiency ratio in that 47% to 48% range for next year, even though it's in a little lower run rate now?

That's right, that's right.

Okay. And then on the margin pressure, can you guys size the public deposit balances? How large are those?

Yes. Public -- Steve, this is Eric. It's about $2.9 billion at the end of the quarter, up from about $2.4 billion at the end of the third quarter -- I mean, the second quarter.

Okay. And how did the rate change on those that you pay?

Yes, so the rate increased probably from about -- let me see here. The time deposits, which were more oriented, went up from 73 bps during the second quarter to 110 in the third quarter.

Steve, this is Bob. On that, what we've seen is that it's gotten much more competitive in the Hawaii market as we talked about, I believe, on the second quarter call. And I think what we're at now is we've reached a new equilibrium. The new players in the market with ourselves, it's basically we're paying the same rates that you're seeing in the mainland markets for public deposits.

Okay. Bob, can you talk about outside of the public deposits, what the competitive environment's looking like in Hawaii for deposits?

Sure. And we talked about this a little bit at a recent conference. That while we're certainly exploring different deposit alternative -- deposit pricing alternatives with special rates from CDs, we haven't seen a lot of market share move to date with the special rates on CDs. So we're not seeing generally in the consumer side much movement in interest rates.

Got you, okay. And then, finally, putting this together, how are you guys thinking about the margin for the fourth quarter?

Steve, this is Mike. So we basically -- we think it's going to be pretty flat from here on out for the rest of the year. I think we have good reasons to think about our investment portfolio yield. I think you saw it come back a little bit in Q3. You see that increasing in Q4. And then I think Bob mentioned this with our public deposits. I think we've -- we feel like we do kind of stabilize at this point. And I do want to clarify that the rates I gave you were for the time deposits for our overall public deposits, it's -- it was about 99 bps in Q3 from 68 in Q2. We do have there, as I mentioned, their operating checking account with us as well.

Our next question comes from Ebrahim Poonawala of Bank of America Merrill Lynch.

Just wanted to follow up on the margin, Mike, if we can. So we expect margin to remain flat into the fourth quarter. But assuming we get a rate hike from the Fed in December, do you expect any positive lift to the margin in -- going into 1Q or not?

No, we do. If we get that lift in December as our history has shown us, it's been about a 5 to 6 basis point increase in the prior quarters where we had the lift. Aside from that, we would expect it to be stable unless there are further rate hikes.

Got it. So do we expect 5 to 6 bps if you get a December rate hike into 1Q? And...

That's what we've got in prior quarters.

Got it. And you still believe that that's a good sort of...

Yes. Ebrahim, this is Bob. We really haven't seen the change in our asset mix. So we're about 30% on LIBOR based and most of that are for our loans and most of that is 1-month LIBOR. So we do see kind of the immediate impact of any rate change. In previous quarters, that's been in that 5 to 6 basis point range. And certainly, we can't predict the future, but our asset mix hasn't changed markedly since that's happened. So we're comfortable in that range.

Understood. And just try to -- Mike, you mentioned the AFS book should see the yields go back up. Can you tell us like at what yield and duration you've been buying securities recently?

So during Q3, our new production was at 237. The runoff was at 217. So we had -- I do expect that spread to widen a little bit in Q4 as we look through some different asset classes. We did put on some municipal bonds earlier -- or in October. Nothing wildly meaningful, but slightly higher yields.

Ebrahim, this is Bob. And really, that was kind of a follow-on to our earlier discussions on looking to optimize our tax rate by looking to build out a portfolio of municipal bonds over time. So that process has started.

Understood. And just separately, can you quantify the payoffs that you received on the SNC book, which hurt loan growth this quarter?

Yes. It was probably -- first of all, what I would say, Ebrahim, this is Eric, that we actually did see some nice production as well. Production was up about $80 million. So we had pretty significant pay-downs, prepayments. I don't have the number off the top of my head, but you can get a sense as to what that was like just from those numbers I just shared.

And this is Bob, again, Ebrahim. What we look to for that and the same thing with the pay-downs in the dealer portfolio, it really is due to the strong credit that we're seeing the companies have access to the capital markets or other alternatives for the SNC market. And for the dealers, just the strong sales have brought down the inventory levels that we think will build again through the fourth quarter as they normally do.

Understood. And one last question, if I may. If the parent company and we see another offering from BNP, could you talk about your appetite or ability to buy back stock as part of that offering?

Yes, that's something we can't really comment on because that's part of our regulatory process. But as you recall, and I think we've mentioned this on one-on-ones but maybe not on an earnings call is that while we do have in our capital plan various capital actions for First Hawaiian, Inc., the capital plan was for BancWest Corp. and thus any separate actions for First Hawaiian, Inc. would require separate just confirmation from the Fed. And as such, we won't comment on it until it actually happens.

Our next question comes from Dave Rochester of Deutsche Bank.

On the loans real quick, it was good to hear about the pipeline for next quarter. Was just wondering, as you look ahead into next year, do you think this mid- to high single-digit pace that you've talked about for this year could actually be good for next year as well?

Yes. Hi Dave, this is Eric. We're actually looking at more of a mid-single-digit range for next year at this point. We see things still relatively strong on the residential real estate and consumer side. We see some slowing on the commercial side. We think that C&I, and including the dealer, will be about stable. CRE will be up slightly. Construction will be relatively lumpy. So if we sort of put all that together, we're really looking at a mid-single-digit range for next year.

Okay, that's great color. And then on the deposit side, how are you thinking about deposit growth going forward to next year? Just given the headwind of the shift to the sweep accounts that you mentioned earlier, are you thinking deposit growth to be able to cover the loan growth or maybe come just a little bit short of that?

No, that's our forecast right now as we're looking for deposit growth to fund loan growth.

Okay, great. And just a bigger picture question on expenses. I was just wondering how the negotiations are going on the contracts you're working through and if you have any updated timing on when some of that might hit the P&L.

It's going well, Dave. So actually, we did recently finalize our extension with FIS, which I think we previously mentioned was the largest contract underlying the TSA. And the impact to our expenses will be in line with the range that we had previously forecasted. So continuing to work through the contracts in an efficient manner. And our projections are still as we originally forecast. All of that is still included in that 47% to 48% efficiency for next year.

So the FIS contract, will that hit in 4Q? Or is that a first half of next year type of event?

This is next year, late next year.

Got it, okay. And just one last one on the NIM real quick. You mentioned the securities yield is going up in 4Q. Was there any securities premium and pickup this quarter that might have impacted those yields? And do we get that online, I guess, into 4Q?

Yes, yes. There was a -- this premium am increased by about $300,000 from Q2. I'm hopeful. We saw the prepay speeds slow during Q3, and I think you've all seen sort of an uptick in the 10-year recently. So that should have the impact of slowing some of the prepays as well.

Our next question comes from Jared Shaw of Wells Fargo Securities.

Just following up on the expense side. Is most of the change as we go is -- any major initiatives planned beyond what you've spoken about before transitioning to an independent company that we should plan on the expenses? Or is most of that pickup just the recovery of the salaries this quarter and maybe some reallocation of the contracted services?

No, that's right, Jared. I mean, we're continuing to invest in the business where we think it's prudent. But most of that, as you mentioned, is the transition cost.

Okay. And then on the municipal deposit side, it seems like it's much more, as you said, much more competitive on the price side than the consumer market. Is that a business that's still worth it to stay in? Are you getting other avenues of revenue from that business sign other than the deposit base? And then as a follow-on to that, should we expect to see the pricing increase keep pace with future rate hikes as we go into 2018, if we see future rate hikes?

Yes. Jared, this is Bob. Maybe I can start on it and then have Mike finish up. We do quite a bit with the state. We always have not only with the depository. We also have the purchasing card contract with them that has been with us for many years now. So we do have a relationship with them. From the funding side, we also feel that current rates are still competitive relative to alternatives. So we're still comfortable with the way that the business is with the state overall. But Mike can talk to a little bit more the actual pricing side of that.

Yes. And I think I previously mentioned is I think we have somewhat stabilized from -- on the pricing side as we look out a bit. Even with -- I think if we do get another rate hike in December, Bob alluded to some of the other services we hope to stay with. We do help them with just overall cash management as well based on their own liquidity needs and some of that's making it's way into Q4 as we expect some of our public deposits to taper off based on their liquidity needs. But we're also working with them on other sort of sweep products, some of our sweep products to help them manage their cash as well.

Okay. And then on the tax rate, I know you're continuing to start to layer in some of the muni purchases. Have your thoughts changed at all with some of the discussions coming out of Washington in terms of continuing to grow that versus waiting to see if we see any meaningful tax reform? Or should we still expect that you modestly add to the muni book?

Yes. No, we're going to continue to try to help ourselves. Just based on, frankly, the market for munis, we're not going to be piling on a lot in a short period anyway. So we're -- I'd love to. I think we'll be a -- we'll be able to benefit if there is a tax reform, given that we are a full taxpayer. But we're going to continue to execute on our strategy, looking at municipal bonds as well as looking at low-income housing opportunities.

In regards to this -- I'm sorry, this is Bob. Just to add to that, Jared, is that the pace at which we're building the muni portfolio versus the speed at which the taxi reform tax cut is going through Congress, they will finish, if they're true to their word, before the holidays, much sooner than we'll have a meaningful municipal portfolio that will significantly affect the tax rate.

Sure, sure. And then if there -- if we don't see anything or barring any change in the actual tax code, is 38% still a good level to use for 2018?

I think we're going to be able to pull that down. That's the objective, Jared.

(Operator Instructions) And our next question comes from the line of Jackie Bohlen of KBW.

Just wanted to clarify comments from the prepared remarks about increased, I'm having a hard time reading my writing, earnings credit that started on July 1, what that was regards to.

Yes. So this is the rate that we provide to mostly our commercial customers to offset some of their service charges. And so we increased the crediting rate that we provide to them. So it had the impact of reducing some of the noninterest income.

And then how do you see that playing out in future quarters? Does it establish a new run rate in this quarter or might there be more adjustments going forward?

Well, we established a new run rate this quarter, so no further adjustments. A lot of this is tied to market rates as well, so depending on the movement of rates.

So fees were pretty outside of the purchase -- or the gain on the sale of the building fees. We're at a pretty good rate this quarter, run rate going forward?

Yes, that's right, Jackie.

Our next question comes from Laurie Hunsicker of Compass Point.

Wondered if we could go back to the public deposits. What is the split on the $2.9 billion between what's checking and what's time?

We were up $400 million to $500 million in checking and the rest is in time.

Okay. And then how do we think about the seasonality in that? In other words, can you take us through sort of generally where the peak and the trough is and how we should think about that, i.e. property taxes are doing and so forth? How should we think about that?

I think that's hard for us to predict. A lot of it's based on, obviously, the -- not only the state for us, but the other municipalities. And the city and county of Honolulu has some large deposits out there to other banks. And somewhat based on their liquidity needs, funding needs, sometimes they'll put up bond issuances. It's hard for us to comment on that.

And Laurie, this is Bob. The other issue going on with that is we've mentioned in previous calls for, really, the last 12 months that market has gotten much more competitive. And while we had a larger market share it in the previous years, now it's pretty well spread amongst many of the banks within our market. So part of it is how competitive we are to gain those deposits on the time deposit side versus in the past and correspond issues and tax receipts are all part of that mix as well. But it really is a harder market to predict on our side.

Okay, great. And then just going back to the C&I. What was the actual period-end balance on your dealer floor plan loans?

Yes. So total dealer flooring was about $862 million, which was down about $75 million for the quarter. And that's split between Hawaii, mainland and Guam.

Okay. And -- okay. Into the dealer floor plan piece that's in California, how much...

Yes, the mainland piece ended at about $517 million.

$517 million, okay, great. And then same thing with SNC. Where did you end there?

SNC, total SNC ended up at about $1.5 billion. The mainland piece was about $1.1 billion.

$1.1 billion, okay, great. And then just going over to the real estate sale. What -- was that a branch or what was that?

It was a portion of our operations service center property and it was in connection with the rail project that's ongoing in Hawaii.

Okay. I mean, because you own your headquarters and you own the vast majority of your buildings, is that correct?

That's right. Well, that's correct. We own our headquarters and we own about sort of 40% of our branches.

Okay. And any plans to potentially sell that before we potentially get a change in taxes? Or how do you -- how are you thinking about that? Or you're not?

No, we don't have any plans to do that.

I think we're done at this time. Doesn't sound like we have any more questions. So this is Kevin. I just wanted to thank everybody for joining us on today's call, and we appreciate your interest in First Hawaiian. Thank you.

Thank you, everyone.

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