Bank of Hawaii Corporation

Good day, and thank you for standing by. Welcome to the Bank of Hawaii Corporation third quarter 2024 earnings conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Chang Park, Senior Vice President and Vessel Relations Director. Please go ahead.

Good morning and good afternoon. Thank you for joining us today for our third quarter 2024 earnings conference call. Joining me today is our Chairman and CEO, Peter Ho, President and Chief Banking Officer, Jim Polk, CFO, Dean Shigemura, Chief Risk Officer, Brad Sherrison, and our Deputy CFO, Brad Sattenberg. Before we get started, let me remind you that today's conference call will contain some forward-looking statements. And while we believe our assumptions are reasonable, there are a variety of reasons that the actual results may differ materially from those projected. During the call this morning, we'll be referencing a slide presentation as well as the earnings release. Both of these are available on our website, boh.com, under the Investment Relations link. And now, I'd like to turn the call over to Peter.

Thanks, Chang, and good morning or good afternoon, everyone. Bank of Hawaii is pleased to report another solid performance in the third quarter of 2024. Net income and the diluted earnings per share increased notably on a linked basis. Net interest income and NIM expanded for the second straight quarter. Fee income grew and operating expenses fell on a linked basis. Loans and deposits grew in the quarter, capital levels improved, and credit quality remains pristine. As is our custom, I will spend a little time highlighting market conditions in the islands. I'll then ask Brad to provide a few comments on credit quality, and Dean will provide further detail on our financials. The balance sheet performed well in the quarter with higher spot loan and deposit balances and stable average balances. Capital levels improved across all measures on top of the meaningful step up in Q2. Deposits continued to perform well, up 2.8% on a linked spot basis, and up modestly on an average length basis. We are pleased to again hold the top deposit market share position in Hawaii for 2024, as measured by the FDIC Annual Summary of Deposits. Both cost of interest bearing and cost of total deposits continue to track well, well below peer medians. Unemployment in Hawaii continues to track at 2.9%, well below the national average. Visitor arrivals continue to be impacted by lower Maui arrivals, but remain elevated for pre-pandemic levels. Same can be said for REVPAR. Wahoo residential real estate continues to trend stable, with median sales prices up modestly for both single-family and condominiums on a year-to-date basis. Median days on market remain below 30 days. Now let me turn the call over to Brad to discuss a few trends on credit.

Brad? Thanks, Peter. As always, I'll start off with our lending philosophy. We focus on our core markets in Hawaii and the Western Pacific. This allows us to leverage our local expertise to make sound credit decisions. Additionally, we know our clients well. The majority of our loan book is the long-standing relationships where about 60% of our clients on both the commercial and consumer side have been with us for over 10 years. This combination has greatly contributed to our historically strong credit performance and has resulted in a loan portfolio that is 93% Hawaii, 4% Western Pacific, and just 3% mainland, where we support our clients that are doing business in both Hawaii and on the mainland. As I walk through our current state, you'll notice there is little change quarter over quarter. The lending philosophy I just mentioned is reflected in our loan growth, which has been steady and organic. From 2019 through 2023, we averaged about 6.7% loan growth per annum, This year, however, loan growth has slowed due to suppressed demand from the high-rate environment. On the consumer side, which represents 57% of our total loans, or $8 billion, we are predominantly lending on a secured basis against real estate. 85% of our portfolio is comprised of residential mortgage or home equity with a weighted average LTV of just 48% and a combined weighted average FICO score of 800%. The remaining 15% of the portfolio is a combination of auto and personal loans where our average FICO scores are 733 and 759 respectively. Moving on to commercial, our portfolio size is $5.9 billion or 43% of our total loan book. The largest share of commercial is commercial real estate with 3.9 billion in assets, which equates to 28% of total loans. This book is well diversified across industries. and carries a weighted average LTV of only 56%. Given that almost 80% of the bank's loan portfolio is real estate secure, let's look at the dynamics of the Hawaii real estate market. The real estate market in Oahu is very stable. Vacancy rates fluctuate little due to the strong Hawaiian economy and constrained supply. Industrial vacancy has continued to hover around its historic low, currently just 1.05% versus its 10-year average of 1.75%. At 13.57%, office vacancy is just over 1% higher than its 10-year average. Office conversions, a trend towards return to office and continuing office space reduction will likely keep vacancy rates low. Retail vacancy remains on par with historical averages. The ongoing high demand for housing is driving the multifamily vacancy rates down to now almost just 4%. And inventory remains constrained across the board with almost no growth over the past 10 years, and office space coming down 10% over that same time period. Our CRE is well diversified among property types, with no sector being greater than 7% of total loans. Our conservative underwriting has been applied consistently with all weighted average LTVs between 50% and 60%. and individual loan exposure is managed carefully with low average loan sizes. Turning to our scheduled maturities, we have no maturity wall. Only 2.7% of loans are due to mature in Q4, 14% next year, and more than half of our loans mature in 2030 or later. Looking at the distribution of LTVs, the tail risk in our CRE portfolio for any loans with greater than 80% LTV totals $84 million, or 2.2%. And if we move that metric up to 85%, our CRA portfolio has less than $4 million of exposure. Looking at our credit metrics overall this past quarter compared to linked quarter, metrics remain quite stable and asset quality remains strong. Net charge-offs remained low at $3.8 million, or 11 basis points annualized, up one basis point from Q2. Non-performing assets have remained stable, increasing slightly to 14 basis points. Delinquencies have also been stable, just two basis points higher than last quarter at 31 basis points overall. Criticized assets grew slightly as of quarter end, reaching 2.42%. However, one loan repaid in full subsequent to quarter end. Adjusting for that, the quarter end criticized rate would have actually decreased slightly to 2.19%. As an update on the allowance for credit losses on loans and leases, The ACL ended the quarter at $147.3 million, down about $200,000 to the linked period, and up $2.1 million year-over-year. The ratio of our ACL to Outstandings was 1.06%, down one basis point from prior quarter, and up two basis points year-over-year. I will now turn this over to Dean for an update on our financials.

Thank you, Brad. In the third quarter, our net interest income increased by $2.8 million, and the net interest margin increased by three basis points, continuing the trend from the second quarter. Length quarter, the $2.8 million increase in net interest income was driven by cash flow repricing, an increase in earning assets, and balance sheet actions, including the reinvestment of securities portfolio runoff, and repositioning our swap portfolio, partially offset by deposit mix shift. With regard to cash flow repricing, in the third quarter, our earning assets generated $513 million of cash flows from maturities and prepayments. Assuming that all of these cash flows from loans were reinvested into like products and cash flows from securities reinvested into cash, Such reinvestment would have generated incremental net interest income of approximately $3.6 million in the quarter from higher reinvestment yields. At the same time, deposit mix shift has continued to slow, with average non-interest bearing and low yield interest bearing deposit balances declining by $315 million in quarter. This compares to a decline of $800 million in the same period of 2023. Assuming the majority of these balances shifted into higher yielding interest-bearing deposits, such mixed shift negatively impacted net interest income by 2.6 million in the third quarter. We expect our net interest income to continue to improve from the gradual decrease in the Fed funds rate. The initial 50 basis points of Fed easing is expected to ultimately add 1.2 million to our quarterly net interest income. In particular, total earning assets that were immediately impacted by changes in the Fed funds rate was approximately 7.6 billion at quarter end, consisting of floating rate loans and investment securities, interest rate swaps, and Fed funds. The 50 basis point decrease in Fed funds will reduce quarterly income from these rate sensitive earning assets by approximately 9.6 million. At the same time, Total rate sensitive deposits that were also immediately impacted by the change in the Fed funds rate were 9.7 billion at quarter end, which excludes non-interest bearing demand and deposit accounts yielding interest rates of 10 basis points or less. The 50 basis point decrease in the Fed funds rate will immediately increase quarterly net interest income by approximately 7.1 million with an expected long-term positive quarterly impact of approximately 10.8 million. The difference between the immediate and long-term impact is due to time deposits repricing upon maturity compared to savings and interest-bearing demand accounts, which can be repriced immediately. Thus, there will be an initial short-term negative impact to NII, then turn positive one to two quarters as time deposits reprice lower. We are currently well positioned to reprice our time deposits and improve our margins as 70% of total time deposits are scheduled to mature in the next six months and 88% of total time deposits are scheduled to mature in the next 12 months. In the third quarter, we took actions to adjust our balance sheet in response to changes in interest rates. This includes repositioning our SWOT portfolio by terminating 700 million notional shorter maturity swaps with relatively higher fixed rates and executing 500 million notional of spot starting swaps at lower rates, as well as executing 300 million of forward starting swaps, also at lower rates. The repositioning reduced our active pay fixed received flow interest rate swaps by 200 million to $2.8 billion notional and reduced the average fixed rate from 4.52% to 4.29%. The $300 million of forward starting pay fixed received float interest rate swaps have an average fixed rate of 3.03% and will become active in 2025 and 2026. In addition, we purchased $236 million of floating rate securities that have a positive 78 basis points spread to Fed funds to improve our net interest income and net interest margin. Our fixed rate asset exposure was 53% at the end of the quarter, down from 73% at the end of 2022. We expect to continue to actively manage our interest rate swaps and securities portfolios to take advantage of opportunities in this changing rate environment. Non-interest income totaled $45.1 million in the third quarter, up $3 million from the second quarter. As customer derivative sales, merchant, mortgage, and loan transaction revenue and volumes improved. In the fourth quarter, we expect to recognize $2.3 million of a one-time charge related to the Visa Class B conversion ratio change. Adjusted for this item, we expect core non-interest income to be in the range of $44 to $45 million in the fourth quarter, as improved trends experienced in the third quarter continue in the fourth quarter. Reported and core expenses were $107.1 million in the third quarter. This compares to core expenses of $105.3 million in the second quarter, which excludes a $2.6 million one-time industry-wide FDIC special assessment, $800,000 of severance expenses, and $600,000 of other core expenses that are not expected to recur. Thus, the core expenses were up a modest $1.8 million linked quarter, primarily due to increases in salaries and benefits, as we continue to manage our expenses in a disciplined manner. We continue to evaluate expense levels and expect normalized core expenses in 2024 to increase 1% to 1.5% from 2023 normalized expenses of $419 million. To summarize the remainder of our financial performance, in the third quarter, net income was $40.4 million and earnings per common share was $0.93. an increase of 6.3 million and 12 cents per share respectively. Our return on common equity was 11.5%. We recorded a provision for credit losses of 3 million this quarter. The effective tax rate in the third quarter was 23.33%, and the tax rate for the full year of 2024 is expected to be 24.25%. We continue to grow our capital and maintain healthy excesses above regulatory minimum well-capitalized requirements. Our tier one capital ratio increased to 14.05% and total capital ratio increased to 15.11%. Our accumulated other comprehensive loss continues to decrease and was 335 million in the third quarter, down 39 million link quarter and down $107 million from the same period last year. The decrease from the prior periods was primarily due to an increase in the fair value of our AFS investment securities caused by declining long-term interest rates as well as continued portfolio runoff. Our risk-weighted assets to total assets ratio continued to be well below peer median reflecting the low-risk nature of our asset mix. During the third quarter, we paid out $28 million to common shareholders in dividends and $3.4 million in preferred stock dividends. Note that the dividends on the Series B preferred stock in the third quarter was a partial quarters distribution. In the fourth quarter, the full dividend on the Series B will be $3.3 million, or $5.3 million total for both the Series A and B. We did not repurchase shares of common stock during the quarter under our share repurchase program. And finally, our board declared a dividend of $0.70 per common share for the fourth quarter of 2024. I'll turn the call back over to Peter.

Thanks, Dean. This concludes our prepared remarks. Now we'd be happy to entertain your questions.

Thank you. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Jeff Rulis with DA Davidson. Your line is now open.

Thanks. Good morning. Good morning, Jeff. Dean, maybe a couple questions on the margin. One, were there any interest recoveries or one-timers in the margin this quarter, and then do you have the September average?

In the quarter, there was maybe a small amount of actually reversals, but it was like about 100,000, so nothing material. In terms of the margin in September, it was, I believe, 217,000.

Okay, got it. And just sort of summarizing, I appreciate that. I got a lot of detail on the puts and takes of the rate cut impact. Sounded like a near-term headwind, a positive thereafter. Your core is climbing higher. Just the expectations of can you negate that negative in the short run, or is it a flattish outlook on the margin in the next couple quarters?

Yes, we believe that the NII and margin will gently increase quarter to quarter. And as we laid out in our presentation, we're going to continue to see the asset repricing from the cash flows also partially by some continued remix on the deposit side. And we're continuing to actively manage our balance sheet, which includes buying or reinvesting some of our cash flows into securities, as well as adjusting the interest rate swaps according to how rates trend. And then with regard to the Fed funds rate cut, over the longer term, we do think it'll be accretive. as laid out in the presentation as well. Initially, it'll have a slight negative, but when you mix all that together, that's how we get to a gently rising NII and margin.

Great. Thanks, Dean. And maybe one last one. Brad, you know, you talked, I appreciate the philosophy and very low comparative NPAs. I just want to continue to track the increase in non-accruals. Is there a sector that that came from, or was it pretty granular and widespread?

No, so there wasn't really a sector that it came from in particular. I would say actually that the NPAs, the rise, while not from a given sector, I would say that the little bit of an increase was caused from some non-core lending activities that were done historically quite a while back. But absolutely, there's nothing systemic or broad-based in the portfolio. As I may have said before, if I were really pressed on where there would be any weakness in the portfolio at all, it would be just a small subsegment of a sector, and that would be the lodging area. So if we think about our lodging, what lodging is actually more dependent upon international visitors to Hawaii? And that's where, if anything, we'd see a little bit of weakness in that area. But we have really strong sponsors that support those properties, and we feel really good about how we're positioned, as well as the fact that the LTV in that portfolio is about 60%. So really just not seeing anything in the portfolio of any real concern. And as you know, I think I had mentioned last quarter, that we're always working with our borrowers and we do expect to see some resolutions through either refinancing payoffs or upgrades. And as mentioned, this payoff came in a little bit subsequent to quarter end. So that did bring our criticized back down to 2.19%. But yeah, so nothing systemic in the portfolio. I would say that the rationale or the reason that the criticized went up to 2.42% to start with was due to a single credit in the multifamily space. That credit, a little bit of deterioration in their operating results. But what I would say about that is that also has strong sponsorship and, you know, are criticized for multifamily is 5.8% overall. So feel really good about that portfolio too.

Okay. Thanks, Brad. Pretty consistent with that. the prior quarter. Appreciate it. I'll step back.

Thank you. Our next question comes from the line of Jared Shaw with Barclays. Your line is now open.

Hi, good morning. Good afternoon. Maybe just looking at the delta between end-to-period deposits and average, if you could just go back to maybe reminding us if there's any additional seasonality this quarter or... Should we be expecting that to be trending towards average here?

Yeah. Hi, this is Jim. I'll take that one. You know, as we got to the end of the quarter, we saw some what I characterize as unexpected large public deposits and maybe some seasonal build on both the commercial and the public side. We also had some really nice business that we won on the commercial that, you know, helped boost balances. As we get into the fourth quarter, though, I think we'll see some moderation in that, probably a bit back towards the average that we saw in Q3 as some of the temporary deposits run off and actually as some of the new business migrates from the commercial side of the business to the asset management side of the house.

Okay. And then in terms of looking at DDAs, is this sort of a good level, you think, to start building from on those core DDAs? Have we seen the end of diminishment and maybe an update of how early looking the fourth quarter balances are on there?

Yeah, Jared, this is Peter. I'm not sure we're ready to declare the end of that trend. The negative comp, though, has definitely shrunk as I think Dean pointed out to 315. What we actually measure is non-interest-bearing as well as what we would classify as low-yield savings or other types of deposits. And that level has come down dramatically from five quarters ago, continues to do so. I think we may have another couple of quarters, though, of negative comps in front of us, my guess.

Okay, thanks. And then just finally, I guess going back to the question Jeff just asked on lodging, what's the total dollar exposure rate? to that subset of lodging that maybe is more tied to the international visitor?

Well, that's a good question. I can't really tie a sub-segment to those dependent on it. There are certain hotels, obviously, that would be more catering to international visitors, but all hotels, of course, have some sort of mix to that segment. So it's really hard to really isolate But what I would say, it's a fraction of the 700 million that we have in lodging that would really relate to hotels focused on international visitors.

And by the way, the international segment is actually the best performing segment this year. So Japan visitor arrivals are up significantly. 38% plus spending up 28%. Obviously, that's coming off of a pretty low basis, but I think the improving foreign exchange relationship between the dollar and yen is having a positive impact there.

And we still don't see a huge amount of criticized credits in that arena. It's about 15% of our lodging overall. is criticized, and we have 62% weighted average LTP on those. Great. Thank you.

Thank you. Our next question comes from the line of Andrew Laish with Piper Sandler. Your line is now open.

Thanks. Good morning, everyone. Question on the loan growth here. Just curious if there's anything specific you can point to that drove the commercial real estate gains this quarter.

This is Jim. I'll take it. No, it was really a nice mix. So we've seen our pipelines build, both pipelines and production build nicely through Q3. And it was a nice mix of commercial mortgage, a little bit of construction on it. But overall, I think pipelines are just feeling better at this point in time.

Yeah, I'd say, I'd just chime in, Andrew, that I think... Our experience is usually that commercial lending activity leads out of a market or into an up cycle. We're starting to see that commercial activity on a spot basis was up 2% in the quarter, consumer lagging a bit there. And so we would continue to anticipate build in the commercial segment. And I think at some point consumer is going to begin to tail up, which will give us hopefully a better overall loan growth aggregate number.

Got it. Do you think any changes in rates, people have come off the sidelines? Have you heard of projects being delayed in anticipation of that?

The commercial side seems to be, I won't say off to the races, but people are pretty constructive. And on the consumer side, I think people are waiting for rates to finally come down and frankly have been head faked a couple of times in the past. So we're still waiting to see that wave build.

Got it. Got it. Great. All my other questions have been asked and answered. I'll step back. Thank you. Yep. Take care.

Thank you. As a reminder, to ask a question at this time, please press star 1-1 on your touchstone telephone. Our next question comes from the line of Kelly Mata with KBW. Your line is now open.

Hi. Thanks for the question. Okay. I would like to circle back to expenses. I appreciate, I think you said, 1.5% to 2% growth. You had a couple of separation expenses and FDIC charges in there. Is there any way you could clarify what you're looking for for Q? Is it about $109 million? Just with all the one-timers, I'm just trying to understand what exactly that implies here.

Yeah, I guided actually to one to one and a half percent for the full year. So it's actually slightly lower than what I had mentioned last quarter. But yeah, if you do the math, it does imply a higher end of about 109 in the fourth quarter, which is very high. So there's a... likely to be on the lower end of that range of guidance. But there wasn't anything in the third quarter. There were some pluses and minus one-time items, but they all kind of netted out. So, you know, the guidance for the full year of one to one and a half is good, is a good number.

And, okay, so one to one and a half relative to about 419. The 419, yes. Okay. Got it.

So what's the 109 in the quarter? 109 is more going to be closer to the 107 or less in the quarter.

Okay. So similar to what we saw in Q3? Yeah. Is that another way? Okay. Yeah. Awesome. That's helpful. And on the fee side, I appreciate you giving guidance. It was elevated in Q3. I was wondering how much of that is related to volatility with the Japanese currency and what a good run rate for that is.

Yeah, Kelly, it's Peter. There's about a million dollars in what I would call kind of one-timish extraneous opportunity. But the balance of that feels recurring today. The foreign exchange revenue really isn't significantly playing into the deltas here at all. I think longer term, that's a good opportunity for us, but it's not really having an impact. It's really, we're seeing just kind of across the board better fee performance. The commercial bank did have a good fee quarter for the third quarter, and that's kind of playing into the million dollar extraordinary piece. But on balance, we would expect fee income to be somewhat elevated from historic levels moving forward.

Got it. That's helpful. And then, you know, I really appreciate all the color on the margin and the moving parts. Just a point of clarification on slide 29. I just want to make sure I'm understanding this correctly. That short-term NII impact of $2.5 million, that's just from the, you know, immediate repricing of rate-sensitive, you know, assets and deposits. It doesn't include any of that impact of, you know, cash flows being reinvested at higher rates, which gets you to that gentle NII lift. Is that the right way to think about it?

That's correct. That page specifically is speaking to the impact of Fed funds alone to the variable assets. Right. and then longer term to the variable liabilities deposits.

Awesome. Maybe just a couple more for me. The borrowings, you have other debt of $560 million. I think that's HLB. Can you remind me what the term is on that and how you're thinking of that? Is that going to Any thoughts on paying that down or is that going to kind of remain here and support the size of the balance sheet at least near term?

Yeah, it's about two to three years to maturity roughly. And then the rate on that funding is 4.13%. So it's still relatively, for us, a good source of stable funding at a fixed rate. And as the rates change, you know, we are going to also be looking at that and making adjustments to that if optimal.

So that funding will be rate dependent, Kelly.

Okay, thanks. Very last one, if I could just slip it in. You may have covered this in your prepared remarks about the swaps, and I may have missed it, but The $300 million of forward starting SOPs, when does that roll on and what is the peak notional active?

They start in 25 and 26, so mid-25 to early 26, and the rate on that is 3.03%. But between now and then, you know, we are still going to manage the position, and that's That's how we're looking at managing our rate sensitivity on the short end as well. So it will vary between now and then from the $2.8 billion.

And it's also important to note that the forward swaps are set to coincide with the maturity of $300 million of notional AFS swaps as well. So it really won't impact the total exposure there. Yeah, that's a good point.

Yeah, I mean, just a broader picture, we're sitting at 53% fixed float as of the third quarter. Assuming that kind of the concept of continuing lower rates holds, we would anticipate taking that fixed float position more towards the 58, 59% range to take advantage of the slope of the yield curve.

That's super helpful. I'll step back. Thank you for all the questions here.

Thank you, Kelly.

Thank you, and I'm currently showing no further questions at this time. I'd like to turn the call back over to Chang Park for closing remarks.

Thank you, everyone, today for your continuous interest in Bank of Hawaii. Please feel free to reach out to me if you have any additional questions. Thanks again, and have a good day.

This concludes today's conference call. Thank you for your participation. You may now disconnect.