Bank of Hawaii Corp
NYSE:BOH
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Bank of Hawaii Corp
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Good day, and thank you for standing by. Welcome to the Bank of Hawaii Corporation's First Quarter 2023 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 today, Jennifer Lam, Senior Executive Vice President, Treasurer and Director of Investor Relations. Please go ahead.
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. 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. Good morning or good afternoon, everyone. Thank you for your continued interest in Bank of Hawaii. Despite the drama and challenges of the past 1.5 months, Bank of Hawaii recorded solid results. Deposits grew on an average basis but were down modestly on a spot basis. Loans grew across both commercial and consumer categories. Margins reflected the continued inversion of the yield curve.
If the last few weeks have taught us anything, it is that business models matter in banking, the quality of relationship as well as the diversity of relationship with one-to-one client base are both critical. At Bank of Hawaii, we believe our 125-year commitment to a community bank based model achieves both key factors. We've been focused on the Hawaii and West Pacific markets for many, many years now. This focus has allowed us to build uniquely long-standing relationships with our clientele, relationships that work both ways.
Additionally, our community-based approach dictates that we focus not on any one sector or concentration, but rather on a whole community approach. This has enabled us to build both a mass-market consumer business as well as a private bank business. It has enabled us to serve very small businesses as well as establish long-tenured businesses in town. We also serve not just a State of Hawaii, but also component municipalities throughout the state.
It is this combination of quality and diversity of relationships in a market we've been serving for over 100 years that makes us different in challenging times. Given keen interest in liquidity and funding source, we thought we'd provide and reiterate critical knowledge on our operation, which I'll be happy to do in a second.
As is customary, Mary will follow with some updates on credit, which is a good story and Dean will finish off with financials, and then we'll be happy to take your questions. So let me begin with just touching on our community bank approach. Basically, we use our 125-year-old coveted brand, blend that with a true community bank focus and take advantage of both the broad and deep market penetration that we have here in Hawaii as well as in the West Pacific to create a diversified long-tenured deposit base, strong levels of liquidity as well as the diversified lower risk loan assets.
Those assets then turn into results, which create both exceptional credit quality as well as exceptional deposit performance. Speaking of deposits, really through our 125-year history in the islands, Bank of Hawaii developed an exceptionally seasoned deposit base built one relationship at a time for many years and in neighborhoods and communities we uniquely understand.
To begin with the marketplace. Important to recognize that I think many of you on the phone already do, is that Hawaii is truly a unique deposit marketplace where 5 local institutions hold 97% of the bank deposits within the market. Our deposits are widely distributed. 98% of our deposits are fully FDIC-insured, 42% of our deposits are FDIC uninsured or uncollateralized. Deposit averages on the consumer side are 18,000 and 133,000 on the commercial side.
We have nice diversification within the deposit base, consumer making up just under half of our overall deposits, commercial of 41.9% and public and other municipalities fill in the rest. And even within those segments, we have diversity, looking at the government side or institutional side between agency, state and county. On to the consumer side, a nice blend of not only mass affluent or high net worth, but also mass market. And then on the commercial side, a nice mixture of industry sectors there.
Our deposits are also highly operational in nature, with over 50% of our deposits being demand deposits and 95% of our commercial deposits having 3.7 accounts per relationship on average and 71% of our consumer deposits having multiple deposit account relationships with Bank of Hawaii. In terms of deposit mix, you see that 31% of our deposits are noninterest-bearing. That's down from 33% a quarter ago. I'd note that the average for Bank of Hawaii noninterest-bearing between 2017 and 2019 was 31.2%.
In terms of tenure, Bank of Hawaii has some of the longest tenured deposits in the industry. 51% of our deposits are with relationships over 20 years old, 23% 10 to 20 years old, and only 26% under 10 years.
So here on Slide 12 what you can see is the deposit performance for really the past year and certainly the month of March pretty darn flat. Really, what you see on the left side is pretty good performance on a year-on-year basis through the first quarter and then looking more on a more micro basis on to the month of March, you see basically from that period with SVB and some other institutions falling in the trouble, moving from actually $20.4 billion to $20.5 billion spot at the end of the year.
By segment, our deposit balances on a linked basis have been pretty steady as well, whether it be consumer, commercial or public and other.
And then moving on to deposit beta. Here, you see that while deposit betas have moved up, I think at 15.9% represent pretty well relative to the industry as a whole.
And on to deposit costs. Deposit costs are rising but in what appears to be a steady and measured manner at this point.
So finally, to finish off. In addition to a granular diversified deposit base. We also maintained healthy liquidity backup lines totaling $8.2 billion with additional loans available for sale, securitization, repo or pledging of just under $2 billion for additional liquidity backup.
So now let me turn the call over to Mary Sellers to touch on credit and other assets.
Thank you, Peter. Serving our ailing communities for 125 years has served us to conservatively manage the assets of the organization. Accordingly, our investment portfolio is invested in high-quality securities, primarily U.S. government agencies and U.S. government-sponsored agencies. We take a similar approach to lending. We lend in markets we know, to relationships we understand. And our loan portfolio reflects this with 94% of our portfolio in Hawaii and the West Pacific and 6% Mainland based, representing credit exposure for those relationships who have diversified assets or operations beyond Hawaii.
We couple this with prudent underwriting and disciplined portfolio management and we have a portfolio that is built on long-tenured relationships diversified by asset class, has appropriately sized exposures, is 80% secured with real estate with a combined weighted average loan to value of 55% and has higher risk categories that are well contained. Our commercial real estate portfolio, which represents 28% of the total portfolio, is diversified across various asset types, with office accounting for just 3% of total loans.
The portfolio built on relationships with demonstrated experience and financial capacity has conservative weighted average loan to values across all asset types and a portfolio weighted average loan-to-value of 56%. Our office portfolio is diversified by asset class across our markets and carries a weighted average loan-to-value of 56%. 25% of the portfolio is primarily Class A properties in the Honolulu Central Business District. This segment has a 63% weighted average loan-to-value and 47% of the exposure is further supported by repayment guarantees. 3% of loans in the office segment are maturing through 2024. Tail risk in the commercial real estate portfolio remains modest with just 0.92% having an LTV greater than 80%. Our consistent conservative approach underwriting is reflected in the consistently strong quality of our consumer loan portfolio and in turn, portfolio. And our same consistent conservative approach is also reflected in the consistently strong quality of our commercial production and portfolio.
Asset quality remained strong in the first quarter with net charge-offs of $2.7 million or 8 basis points annualized of total average loans and leases outstanding, up $800,000 for the linked period and up $1.2 million year-over-year. Nonperforming assets were $12.1 million, down $500,000 from year-end and down $7.9 million from the first quarter of '22.
All NPAs are secured with real estate with a weighted average loan-to-value of 57%. Loans delinquent 30 days or more remained stable on both the linked period and year-over-year at 23 basis points. Criticized loans as a percentage of total loans were 1.31% at the end of the quarter, remaining modestly below pre-pandemic levels. At the end of the quarter, the allowance for credit losses was $143.6 million, down $900,000 for the linked quarter and the ratio of the allowance to total loans and leases outstanding was 1.04%, down 2 basis points.
The reserve estimate utilized to UHERO's March 2023 forecast, which continues to call for economic slowing, but no recession in Hawaii. The reserve, however, does continue to consider the downside risk of a recession as well as the impacts of inflation and rising rates. The reserve for unfunded commitments was $7 million at the end of the quarter, up $200,000 for the linked period.
I'll now turn the call over to Dean.
Thank you, Mary. Net interest income was $136 million in the first quarter, negatively impacting the quarter's net interest income or 2 fewer days in the quarter, which reduced net interest income by approximately $1.6 million and early buyouts on leases, which reduced net interest income by $300,000. Adjusting for these items, our normalized net interest income for the first quarter was $137.8 million, a decrease of $2.9 million linked quarter and an increase of $12.7 million from the first quarter of 2022. The linked quarter decrease was primarily due to higher funding costs partially offset by loan growth and higher asset yields.
The increase from the first quarter of 2022 was primarily due to loan growth and increases in our asset yields, partially offset by higher funding costs. The inverted yield curve continues to pressure our net interest income and margin. We expect deposit betas will continue to rise from the 15.9% in the first quarter, driven in part by further mix shift from noninterest-bearing to interest-bearing savings and time deposits and the generally more competitive rate environment.
To address the challenges from the higher short-term rates, beginning in the fourth quarter, we increased our term funding by $800 million at a weighted average rate of 3.93% and also increased our longer-term time deposit balances by $730 million at a weighted average rate of 3.84%. In addition, we continue to remix our loans by shifting to greater floating and variable rate exposure, which comprised the majority of new originations in the quarter, while allowing our investment portfolio to run off and holding more cash on the balance sheet.
From an earning asset perspective, net interest income and margin are being supported by strong cash flow and overall asset repricing at higher rates. With $2.9 billion of annual cash flows from maturities and paydowns of loans and investments, we have ample opportunity to redeploy funds into higher-yielding assets, including cash. In addition to the strong cash flow, another approximately $3.6 billion in assets are repricing annually, which provides additional rate sensitivity.
In particular, the yield on maturities and paydowns of loans and investments in the first quarter was 4.1% and 2.1%, respectively. These cash flows were reinvested predominantly into new loans, which yielded approximately 5.9%. Runoff may also be held in cash, which is yielding more than the runoff, thus providing an attractive alternative while preserving liquidity. Noninterest income totaled $40.7 million in the first quarter.
Included in the results was a $600,000 charge related to a change in the Visa Class B conversion ratio, which is reported as a contra revenue item in the investment securities gains, losses. I should note that the remaining amount in the securities gains, losses is due to the ongoing fee paid to counterparties from prior Visa Class B sales, not from security sales, which there were none in the quarter. Adjusting for this item, noninterest income was $41.3 million, an increase of $100,000 linked quarter and lower by $2.2 million from the first quarter of 2022. The decrease from the first quarter of 2022 was primarily due to lower revenue from mortgage banking customer derivative activity.
Noninterest income is expected to be $40 million to $41 million per quarter for the remainder of the year.
During the first quarter, as is our practice, we managed our expenses in a disciplined manner as economic conditions remain unclear. Included in the first quarter of 2023 and 2022 were seasonal payroll taxes and benefits expenses from incentive payouts, which totaled $4 million and $3.7 million, respectively. In addition, first quarter expense also included severance expenses of $3.1 million. It should be noted that this will result in a $3.3 million of annual savings. Adjusting for the seasonal payroll and benefits expense in both years and severance expense in the first quarter of 2023, normalized expenses in the first quarter were $104.9 million, an increase of $2.1 million linked quarter and $4.7 million from the first quarter of 2022. The increase linked quarter was primarily due to the industry-wide increase in FDIC insurance, which accounted for $1.5 million and an increase of $500,000 in the statutory rate in the Hawaii State unemployment tax. Notably, the remaining increase after accounting for these factors was just $100,000 linked quarter.
Compared to the first quarter of 2022, the increase in normalized expenses was due to the aforementioned FDIC insurance increase, which accounted for $1.7 million as well as the increase in the unemployment tax of $500,000. The remaining expense increase of $2 million from the first quarter of 2022 was well under the annual rate of inflation.
For the full year of 2023, we continue to expect expenses will increase by approximately 3% over the 2022 normalized base of $415 million. While inflation continues to pressure expenses, other actions are being taken that moderate expense growth through the rationalization of operations and slowing of hiring.
To summarize the remainder of our financial performance, in the first quarter of 2023, net income was $46.8 million, and earnings per common share was $1.14. Our return on common equity was 15.79%, and our efficiency ratio was 63.34%. We recorded a credit provision of $2 million this quarter. The effective tax rate for the first quarter was 25.4%. The increase in the effective tax rate on a linked-quarter basis was due to the nonrecurring benefit from the leverage lease terminations received in the fourth quarter and an unfavorable discrete tax item in the first quarter. The year-over-year increase was primarily due to lower benefits from tax credit investments. The effective tax rate in the first quarter of 2022 also included benefits from leverage leases that have since been terminated.
The tax rate for the full year of 2023 is expected to be approximately 24.5%, which does not include the recognition of low income housing tax credit benefits expected in 2023 due to the uncertainty around the timing of the recognition of such credits.
Our capital remains well above regulatory well-capitalized guidelines. Our CET1 and Tier 1 capital ratios were 10.9% to 12.1%, respectively, with a healthy excess above the regulatory minimum well-capitalized requirements.
During the first quarter, we paid out $28 million to common shareholders in dividends and $2 million in preferred stock dividends. We repurchased 150,000 shares of common stock for a total of $9.9 million.
And finally, our Board declared a dividend of $0.70 per common share for the second quarter of 2023.
Now, I'll turn the call back over to Peter.
Great. Thank you, Dean. Thanks again for listening. Now, we’d be happy to take your questions.
[Operator Instructions] We have a question from Andrew Liesch from Piper Sandler..
Just curious, Dean, how should we be thinking about the margin from here? It seems like you kind of have some caution around rising deposit costs. But longer term, it's still some asset repricing. So how do you think the margin is going to react over the course of the next week?
Yes. Right now, we're expecting the Fed to increase rates next week and then possibly another one, but pause from that point on. But when you look at that compared to what the futures are expecting, we're actually looking at a higher for longer kind of rate environment and then version carrying through to sort of the middle of next year. So based on that, we're looking at the margin coming down in the second quarter and then really bottoming up towards the end of this year before increasing into the next year, assuming the rates do come down on the short end towards the tail end of 2024.
Got it. Any level of where that could -- what we expect it's going to tail out there, where do you think it will bottom?
We're looking at right now, at least in the second quarter, similar decline as we saw in the first quarter. And then from there, it will start to...
Grow.
Yes.
Certainly. And then I just got a question on the short-term borrowings that you are -- that you added, it looks like those came on earlier in the quarter just based on the average balance. I'm just curious, what was the rationale for adding those? Is it just to add some liquidity? Any color behind that would be helpful.
So we did take down some longer-term funding. And again, that's part of our kind of mitigant, if you will, against the higher for longer rates. And then second of all, we did want to hold a little bit more liquidity on the balance sheet, both on the -- in terms of fed funds sold.
We have a question from Kelly Motta from KBW.
I was hoping to get a bit more color on the securities portfolio. I think it's extended out some. But could you provide us with the expected duration on both the available for sale and HTM securities at this time?
Yes. The -- in total, the portfolio is about 5.4 years duration. The AFS is 3.8. HTM is 6.4. And to kind of give you more color, we're with the increase in rates, the cash flows and kind of prepayments have already in effect bottomed out. And so we're really effectively at the contractual payment level. So we don't expect any more slowdown or extension in the portfolio from rate movements higher. And therefore, there is -- if rates were to move lower, that -- those cash flows could increase in short duration.
Got it. Understood. And obviously, a lot going on this quarter. It looks like you repurchased maybe a little bit of shares this quarter. Just wondering how you feel about capital at these levels? And what kind of the outlook is for managing capital going ahead?
Yes. Kelly, I think that given the environment that we find ourselves in at this point as well as some level of uncertainty around where regulatory levels will push out in the kind of intermediate term I think we're going to be pretty judicious around capital. That's not to say that we've suspended any form of capital programs at all. But I think from a guideline standpoint, we're probably going to be more judicious than not around capital management.
Got it. And maybe last question for me, and then I'll step back and let others in. But I saw the Moody's downgrade. Just wondering if this is something that you've been in discussion with them and how that works? And any implications of that if there are any to how you run your business?
We don't anticipate any implications to that. Obviously, we were disappointed to see the downgrade, especially after having just been affirmed on January 12 with Aa3 rating. But we took a one level downgrade on our long-term deposit rating from Aa3 to A1 with a stable outlook. So not what we had previously, but still a high mark for us. So we don't anticipate any operational -- meaningful operational outcomes from that.
Certainly. One more, if I can just sneak it on, just tacking on to that. Is there a level of deposit rating where you would -- obviously, you're at very high level still right now, but that would start create greater conversations with some of your depositors just as somebody who doesn't -- hasn't ever looked at those ratings. Just trying to understand it a little bit better.
Tough to say. Generally, ratings discussions haven't come into play and in dealing with our depositors. So not in our best past practice, no.
And we have a question from Jeff Rulis with D.A. Davidson.
Dean, I wanted to follow up on -- maybe get back to -- you mentioned your expectations for the beta to exceed the 59. Just wanted to kind of see if you've got an updated through-the-cycle expectation is question one. And then the second part of that is just have you seen customer rate requests, have those eased in as we've proceeded into April? I'll leave it there.
Yes. In terms of our betas, historically, we were at 20%. In this cycle, understanding the magnitude and the velocity of the increases, we can see that the betas could rise between 20% to 25%. It's kind of what we're thinking there will be.
In terms of exceptions, they -- I don't see any real changes. I mean, we still do get exception requests for deposits. And that's all incorporated into the what we're expecting in terms of betas.
Got it. And Dean, while I've got you, do you have a March margin average, what that was for the month of March?
For the margin -- let me see, I do have it. It was 37.
Okay. I appreciate it. And maybe one last one, Peter, and it’s a strange one here. I guess just some noise about regulators changing treatment of unrealized losses. Does that alter your strategy at all? Or do you really give that any attention. Any thought on just addressing that part of the unrealized loss treatment?
I guess, Jeff, we're -- we certainly have a heightened awareness around maybe the differences in AFS treatment for smaller banks versus larger banks. And the prospects of smaller banks having potentially to migrate to that level. And I think where we stand on that is kind of not knowing where things stand there. We likely will begin to think through various scenarios on how we could in force to move to that level to get there. Our preliminary view is that we would be able to do that organically over a period of time, kind of given operating assumptions that we think are reasonable at this point.
So nothing -- obviously, nothing has been set in stone, a fair amount of discussion around the topic. And I guess we're trying to stay as flexible as possible kind of within that discussion.
And on that front, in addition to the deposit balance, and I appreciate the almost by week or the month of March balances certainly hadn't been impacted and actually up since SVB. I don't know if you've had any customers that can take that second link and look at that. Have you had any customers or larger maybe public deposits look at the potential securities losses. Had you have to address that and walk people through the outcomes there?
I would say, in general, what people are interested in is more the deposit stability of the franchise. And obviously, that -- the proof is in the pudding there. Kind of the discussion around unrealized losses and the like is a little bit more esoteric, certainly for the majority of our deposit base. And generally, when we have the discussion with more sophisticated levels, I think there's a reasonable level of understanding there. So no, I mean, the topic itself has not resulted in meaningful deposit outflow for us.
We have a follow-up from Andrew Liesch with Piper Sandler.
The follow-up question here. Just to clarify something on the expense guide. So 3% on that $415 million is about 207 -- 427. Does that include the severance this quarter? So on a more run rate basis, it's actually lower than that?
Yes. It would include the severance.
And we also have a follow-up one moment. With Kelly Motta from KBW.
I apologize if I missed this as part of the prepared commentary, but your fee guidance appears to be slightly better than what you had in January. What's the drivers of that better fee outlook going ahead? Just trying to understand.
Yes. It's generally a more stable outlook in the economy. We are seeing some transactional volumes increase and general kind of market conditions, the stability in the markets, I think, is helping us to achieve a better outcome on the fee side.
Got it. And then also your loan growth was still all considering like very healthy this quarter. Wondering what you're seeing in your markets and how you're balancing that with the funding aspect of things and what the drivers of loan growth should be going forward?
Yes. Well, what really augments or has augmented the loan growth, Kelly, has been basically amortization of the securities book, which basically can accommodate growth in the mid-single-digit level. I would suspect that the annualized rate that we saw in the first quarter for loan growth might be a high watermark as we move forward for a couple of reasons.
One, it feels like commercial borrowers are beginning to pull back a little bit just kind of with the, I think, heightened uncertainty in the marketplace and spectre of recession. Then obviously, I think as rates have kind of taken hold the consumer front, I think, is slowing a bit as well. So I guess I would say that loan growth still would be potentially in the mid-single-digit range, but probably ranging towards lower end of the mid-single digits at this point, and that is pretty adequately supported by securities runoff.
We also have a follow-up from Jeff Rulis with D.A. Davidson.
One more for Mary. Just on the criticized pickup linked quarter. Any color as to where that was? I think you've mentioned that 80% of the total criticized is in CRE. Just wanted to see what that linked quarter addition to that balance was?
Jeff, it was actually across a number of customers. Generally, what we saw were various idiosyncratic issues, either they face supply chain or permitting delays. They had slower repositioning post COVID or they were just looking at higher operating expenses. Our latching component does continue to be the biggest piece of that. We did get some upgrades this quarter, but we still have several large exposures there where they're really dependent on Japanese and international travelers returning.
And I'm showing no other questions in the queue. I would like to turn the call back to management for any closing remarks.
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 any additional questions or need further clarification on any of the topics discussed today. Thank you, everyone.
This concludes today's conference call. Thank you for participating. You may now disconnect.