Bank of Hawaii Corporation

Good day and thank you for standing by. Welcome to the Bank of Hawaii Corporation's second quarter 2025 earnings conference call. At this time, all participants are in a 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, Cheng Park, Director of Investor Relations. Please go ahead.

Good morning and good afternoon. Thank you for joining us today for our second quarter 2025 earnings conference call. Joining me today is our Chairman and CEO, Peter Ho, President and Chief Banking Officer Jim Polk, CFO Brash at Merck, and Chief Risk Officer Brash Harrison. Before we get started, I want to remind you today that today's conference call will contain some forward-looking statements. And while we believe our assumptions are reasonable, the actual results may differ materially from those projected. During the call today, we'll be referencing a slide presentation as well as an earnings release. Both of these are available on our website, boh.com, under the investor relations link. And now I'll turn the call over to Peter.

Thanks, Chang, and good morning or good afternoon, everyone. Thanks for your interest in Bank of Hawaii. The second quarter of 2025 was another solid quarter for the bank. Earnings per share advanced for the fourth consecutive quarter. Net interest income and net interest margin expanded for the fifth consecutive quarter as our margin reversion continues towards more historical levels. Expenses were well controlled. Credit remains pristine. Capital advanced to 14.2% on a Tier 1 basis, while ROCE hit 12.5%. I'll begin by quickly reviewing our core and longstanding operating strategy, and then touch on conditions in our core Hawaii market. I'll then kick it over to Brad Sherrison to discuss our credit profile, and then Brad Sattenberg will expand a bit on the financials, and this is first earnings call as officially our new CFO. As I think most of you know, Bank of Hawaii has a unique business model. Fundamentally, we lean into a unique marketplace in which four locally headquartered banks own more than 90% of the market's FDIC-reported deposits. We've built a fortress market position by leveraging a best-in-market brand position, which enables us to deposit price attractively. This cost advantage has historically allowed us to generate strong returns on a superior risk-adjusted basis. We've been successful on both a short and long-term basis, methodically building market share. For several quarters now, we've been successful in stemming deposit remix from lower or no-yield deposits to higher-yielding deposits while holding overall deposit levels relatively stable. This has helped us bring down both our cost of interest-bearing deposits and total cost of deposits. Concurrently, our fixed assets have been remixing into higher-yielding earning assets. In the quarter, $572 million in fixed slash variable assets cash flowed off at a roll-off rate of 4% and into a roll-on rate of 6.3%. It is this slowing of deposit remix matched with the continued deal decreation in the fixed asset cash flow that has largely enabled us to drive up both net interest margin and net interest income for five quarters now. Assuming rates hold, we would anticipate that this trend will continue, approaching more historic NIM levels, albeit with substantially higher earning asset levels than previously. Switching to local market conditions, here you can see that the employment picture in Hawaii continues to outperform the broader U.S. economy. The visitor industry remains solid, with visitor expenditures up 6.5% year-to-date and arrivals up 2.8% through May. This growth is being driven by the U.S. continental market, both east and west, and offset partially by lower international performance out of Japan and Canada. RevPAR continues to perform consistently. Residential real estate in the islands remains stable, with single-family home prices rising modestly, while condo prices were off 0.5% year-to-date. And now let me turn the call over to Brad Sherrison to talk about credit. Brad?

Thanks, Peter. The Bank of Hawaii is dedicated to serving our community, lending in our core markets where our expertise allows us to make sound credit decisions. Most of our loan book is comprised of long-standing relationships with approximately 60% of clients in both commercial and consumer having been with us for over a decade. This combination has significantly contributed to our strong credit performance over the years, resulting in a loan portfolio that is 93% Hawaii, 4% Western Pacific, and just 3% mainland, where we support our clients who conduct business both in Hawaii and on the mainland. As I review our credit portfolio's second quarter performance, you will see that it has remained strong and consistent with recent quarters. Our loan book is balanced between consumer and commercial, with consumer representing a little over half of total loans at 56%, or $7.9 billion. We predominantly lend on a secured basis against real estate. 86% of our consumer portfolio consists of either residential mortgage or home equity with a weighted average LTV of just 48% and a combined weighted average FICO score of 800. The remaining 14% of consumer consists of auto and personal loans where our average FICO scores are 731 and 760 respectively. Moving on to commercial, our portfolio size is 6.1 billion or 44% of total loans, 72% is real estate secured with a weighted average LTV of only 55%. The largest segment of this book is commercial real estate with $4 billion in assets, which equates to 29% of total loans. Looking at the dynamics for real estate in Oahu, the state's largest market, a combination of consistently low vacancy rates and flat inventory levels continue to support a stable real estate market. Within the different segments, vacancy rates for industrial, office, retail, and multifamily are all below or close to their 10-year averages. Total office space has decreased about 10% over the past 10 years. This has been driven by conversions primarily to multifamily or lodging. This long-term trend of office space reduction along with return to office movement has brought the vacancy rate almost back to its 10-year average and well below national averages. Breaking down our CRE portfolio, it is well diversified across property types with no sector representing more than 7% of total loans. Our conservative underwriting has been consistently applied with all weighted average LTVs under 60%. Overall, it's a granular portfolio with low average loan sizes. And our scheduled maturities are fairly evenly spread out, with more than half of our loans maturing in 2030 or later. Looking at the distribution of LTVs, there isn't much tail risk in our CRE portfolio. Only 1.3% of CRE loans have greater than an 80% LTV. Turning to CNI, which comprises 11% of our total loans, you will notice that the book is extremely well diversified across industries, with modest average loan sizes. Additionally, only a small portion of these loans are leveraged. Turning to asset quality, credit metrics remain stable and the portfolio continues to perform well. Net charge-offs were just $2.6 million at seven basis points annualized, down six basis points from linked quarter and three basis points lower than a year ago. Non-performing assets were up a basis point from the linked quarter to 13 basis points and just two basis points higher than a year ago. Delinquencies ticked up by three basis points to 33 basis points this quarter and just four basis points higher than a year ago. And criticized loans dropped by two basis points to 2.06% of total loans, which is 17 basis points lower than a year ago. And the vast majority, 78% of those criticized assets, Our real estate secured with a weighted average LTV of 54%. As an update on the allowance for credit losses on loans and leases, the ACL ended the quarter at $148.5 million of $800,000 for linked quarter. The ratio of our ACL to outstanding ticked up one basis point to 1.06%. I will now turn this over to Brad Sattenberg for an update on our financials.

Thanks, Brad. And before I jump into our financial results for the quarter, I'd like to take a moment to recognize my predecessor, Dean Shigemura, and thank him for his outstanding leadership, mentorship, and invaluable contributions to the bank over the past 26 years. I also want to congratulate him on a well-deserved retirement. Now moving into the financials for the quarter, we reported net income of $47.6 million and a diluted EPS of $1.06, an increase of $3.7 million and 9 cents per common share compared to the linked quarter. These increases were primarily driven by the continued expansion of our net interest income and net interest margin, which increased by $3.9 million in seven basis points, respectively. As Peter mentioned, this is the fifth consecutive quarter that we expanded both our NII and NIM. A primary reason for this improvement is our fixed asset repricing, whereby cash flows from our fixed-rate assets are rolling off at lower interest rates and being reinvested at higher current rates. During the quarter, this repricing contributed approximately $3.2 million to our NII. Partially offsetting this benefit is the deposit remix, which represents deposit shifting from non-interest-bearing and low-yielding deposits to higher-cost deposits. The deposit mix shift has moderated during the past several quarters, and during the second quarter, the mix shift was $59 million and had a $500,000 negative impact on our NII. This compares to a mix shift of $37 million during the first quarter and $448 million during the same period last year. During the quarter, the cost of our deposits remained stable at 160 basis points compared to the linked quarter, and declined by 21 basis points compared to the same period last year. Our beta on this recent downward cycle is currently at 29%. During the quarter, our cost of CDs declined by 15 basis points, and we believe that an opportunity still exists to continue to reprice down these deposits. During the next three months, over 51% of our CDs will mature at an average rate of 3.61%, and we anticipate that the majority of these CDs will reprice lower. With rate cuts forecast for later this year, we are comfortable with our balance sheet position and our fixed asset ratio of 55%. And with $7.3 billion of floating rate assets and $10.1 billion of interest rate sensitive liabilities, we believe that we are well positioned to navigate any changes in the current interest rate environment. We are also closely monitoring our swap portfolio. At the end of the quarter, we had $2.2 billion of active pay fixed received float interest rate swaps at a weighted average fixed rate of 4%. One and a half billion of these swaps are hedging our loan portfolio, while 700 million are hedging our AFS securities. In addition, we have $600 million of forward starting swaps at a weighted average fixed rate of 3.1%. 200 million of these swaps will become active later this year, while the remaining $400 million will start in the middle of 2026. Non-interest income increased to $44.8 million during the quarter compared to $44.1 million in the linked quarter. Non-interest income during the current quarter included a one-time gain of approximately $800,000 related to a bully recovery, while the linked quarter included a $600,000 charge related to a VCB conversion ratio change. Adjusting for these non-core items, non-interest income declined by $700,000 due to lower customer derivative activity, partially offset by an increase in earnings in connection with our trust services business. We are forecasting that non-interest income will be between $44 and $45 million for the remainder of the year. Non-interest expense was $110.8 million compared to $110.5 million during the prior quarter. Included in non-interest expense this quarter was a severance-related charge of $1.4 million, while the linked quarter included seasonal payroll taxes and benefit expenses of $2.8 million and an FDIC special assessment reimbursement of $2.3 million. Excluding the impact of these items, non-interest expense was down $600,000 compared to the prior quarter. This change was primarily due to lower incentive compensation and medical insurance charges partially offset by our annual merit increases that took effect in early April. The percentage increase in forecasted expenses remains unchanged at 2% to 3%. During the quarter, we recorded a provision for credit losses of $3.3 million, and our effective tax rate was 21.2%. The decline in our tax rate during the year is being caused by higher tax-exempt investment earnings as well as certain discrete items. We now expect our tax rate for the full year to be between 21% and 22%. Our capital ratios remained above the well-capitalized regulatory thresholds during the quarter with Tier 1 capital and total risk-based capital improving to 14.2% and 15.2% respectively. And consistent with the linked quarter, we paid dividends of $28 million on our common stock and $5.3 million on our preferreds. We did not repurchase any shares of common stock during the quarter under our repurchase program. As a reminder, $126 million remains available under the current plan. And finally, our board declared a dividend of $0.70 per common share that will be paid during the third quarter. Now I'll turn the call back over to Peter.

Thanks, Brad. This concludes our prepared remarks, and now we'd be happy to take your questions.

Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. And our first question comes from Jeff Roulis of DA Davidson. Your line is open.

Thanks. Good morning. Hey, Jeff. Wanted to check back in on the margin path. I think we've kind of talked about or you've referenced maybe a 250 margin by year end, maybe not a Q4 average. But I want to see if that path is reasonable. And kind of the second part of that question is sort of the cost of funds sort of stalling out a little bit. And I think mentioned some CD opportunities. But particularly on that side, it sounds like the opportunities on the earning asset yield, but sort of two parts. Sorry for the lengthy question.

Sure. This is Brad. I think as far as the NIM, I do think 250 is an achievable number. I don't see anything that's going to get in the way of that path. I mean, again, this was our fifth consecutive quarter of expanding our NIM, and I think that's going to continue. As it relates to our cost of deposits, You know, our spot rate at the end of the quarter was at 158. And I do think our beta, you know, it is at 29%. I think after the CD repricing this quarter, I think we've got the opportunity to pick up about 15 to 25 basis points on that CD repricing. I think our beta is going to be, you know, north of 30. And so I think we're going to see this quarter, assuming no rate cuts, you know, a continued beta that continues to move towards 35%.

Perfect. Okay. Thanks.

And, and more of a other question is just on sort of balance sheet growth. I, you know, well, based on loan growth, more of the question on securities, should loan growth be on the net base, be modest? Do you see yourself continue to grow the securities balance from here?

Yeah, I do think we're going to continue to see the securities portfolio grow. I mean, I think this quarter the cash flows were about $170 million, and we invested in our investment portfolio about $270 or $275 million. So we are increasing that portfolio when we see an opportunity. If there is modest long growth or if liquidity increases, we're using that excess liquidity at the moment to increase our investment portfolios. I want to touch on the diversity of what we're purchasing in the portfolio. Yeah, that's a good point. I would also add that, you know, we continue to sort of balance our purchases between fixed and floating rate. And so this quarter, it actually leaned more towards floating rate. I think 55% of our purchases are in our floating securities. And then the other portion, obviously, 45% are in fixed securities.

Thanks, Brad. I'll step back. Appreciate it. Thanks, Jeff.

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

Hey, thanks. Good morning. Good morning, Jared. I guess maybe just on CNI, any trends that we should be thinking about to call out on the delta there this quarter and how is commercial customer sentiment and pipelines and thoughts for the year there.

Yeah, Jerry, maybe I'll start, and Jim can specifically speak to CNI. On the commercial book, we were, frankly, a little disappointed with performance this quarter. We took a 6% year-on-year average commercial loan position, but on a linked basis, just about flat. And that was really... pretty much across the board. CRE, which had been an 8% performer on a year-on-year basis, was flat. As you pointed out, CNI was down pretty substantively. And construction took a bit of a pause, and I think that's a little bit of a more structural than cyclical situation. I think there is some opportunity there. So yeah, it was an off-quarter. I'm hoping that if and as we get a little more clarity around the environment with the tariff situation and the like, we can begin to resemble more the year-on-year average loan basis in commercial. But yeah, you're not incorrect. It was a little bit of a disappointing quarter commercial production-wise for us. And Jim, you want to touch on CNI?

Yeah, I think what I would say is that, you know, we have seen pipelines continue to build from the beginning of the year. Obviously, it wasn't a terrific quarter, but I think it was driven by 2 things, right? The greater uncertainty that we saw in the market, which obviously impacted loan volumes, or at least put what we put on the books. And then we just saw some unusually high level of prepayments on a couple loans, which resulted in the decline. I think as we go forward and we begin to see the pipeline start to materialize, we'll move back into a modest level of growth as we move towards the end of the year.

Okay. All right. Thanks for that. And then on the deposit side, If we look at DDAs as a percentage of deposits, it's staying pretty flat. Is that how we should maybe think about it, staying right around the 26% level, and as total deposits move, DDAs sort of stick with that? Or is there a potential opportunity for those to move higher or lower?

Well, yeah, we've got a lot of effort and energy around building DDAs. Obviously, given the rate environment, those are high-margin products for us. I was encouraged that average NIBD for the quarter was up 1% on a length basis as compared to minus 0.2% on a year-on-year average basis. So we are seeing some acceleration there. Whether we can get numbers well beyond that, I'm not sure. As much as we'd like to build demand deposits, all of our competitors would like to build demand deposits. So it's a pretty competitive crowded space. So we'll see. I mean, it's important. It's an important product for us, and we're going to do our best to try and make that an outsized component of our overall deposit base.

Okay, thanks for taking the questions. Yep, thank you. Thank you.

And our next question comes from Andrew Terrell of Stevens. Your line is open.

Hey, good morning. Morning, Andrew. I wanted to check in on expenses first. It sounds like you're still thinking that 2% to 3% expense growth rate. It seems like that kind of implies a little bit of a step back in the back half of the year, a little bit of relief on expenses in the next couple of quarters. I just wanted to see if you could kind of confirm that and just maybe refine kind of back half expense expectations.

Yeah, I think that's right. I mean, I think obviously the first quarter was elevated. The second quarter, we had a severance charge of about $1.4 million. So I do think it will take a step back the second half of the year. We still feel comfortable with the 2% to 3% increase from the prior year. And so, yeah, I think you should see expenses come down from where they were during the first six months of the year.

Great. Thank you. I appreciate it. And then I also just wanted to check in just kind of on capital priorities. I know you've got a buyback out there. We've talked about some securities restructuring at a certain point in time, but just wanted to take your temperature on what makes sense or kind of what you're thinking about from a capital standpoint today.

Yeah, so I think we're probably going to maintain our hold position on buybacks until we get a little better clarity around both the economy and the rate path forward. Around securities repurchases, we're not, we don't have anything significant planned there, but certainly to the extent that we pick up certain income opportunities, the opportunity to, you know, reconstitute those gains into securities, Repositioning is something that we think about. So probably the way I'd frame that is nothing dramatic at all, but opportunistically as we see opportunities in our income stream to help kind of smooth the balance sheet, that's what we would pursue.

Understood. Okay. Thank you for taking the questions. Take care.

Thank you. And as a reminder, if you have a question, please press star 1-1. And our next question comes from Kelly Mata of KBW. Your line is open.

Hey, good morning. Thanks for the question. If I could, I'd like to circle back on the components of margins, specifically the expected cash flows off of the securities book and loans fixed and adjustable payments. resetting expectations over the back half of the year. Do you have the expected cash flows on that, just so we can manage NII assumptions from here?

I would say the cash flows are going to be in the range of $550 million in total. I think these are contractual. It's not an acceleration of prepayments or anything like that. So I think $550 million is probably what to expect. And as far as what they're coming off at, I think What you saw in the first and the second quarter, if you took those together, I think there have been some minor blips in both periods. But if you look at them together, I think that's probably a reasonable average of what they'll come off at. And then the reinvestments, obviously, should be stable unless there are changes in interest rates. And then, obviously, we'll see a slight shift based on that.

Got it. Thanks for that. And then... switching over as a follow-up to the expenses and the run rate coming down in the back half of the year, how much of that may be pushing off certain investments into 2026 and beyond versus are there any, you know, because expenses are otherwise well-controlled, anything you're doing to help mitigate expenses here and cost containment efforts just to get a sense of the moving parts of the back half of the year coming down?

Yeah, Kelly, I'll begin on that. Maybe Brad can clean up whatever mess I create. But I think that, no, we're not curtailing investment expenditures. That, frankly, is not in the plan, and I don't see environmentally the need to do that. We've got a lot of interesting ideas and thoughts out there that are going to require some capital investment, and we're happy to do that and garner a quality return around those. In terms of just bringing down expenses in general, that is, frankly, a discipline that we're deploying in every quarter. And you did notice the severance in the quarter. That really was a result of some restructuring that we've done. I would anticipate that we'll probably see some more of that in the third and fourth quarter, but nothing major, but really just kind of reflective of our intent to always be looking to figure out ways to bring down expenses to the organization.

Got it. That's helpful. And then in terms of overall deposit flows, deposits were down this quarter. Can you remind us any seasonality in there? And being that deposits will likely be the driver of the size of the balance sheet, just kind of overall expectations in terms of the outlook for deposit growth from here.

Yeah, I think that there is some seasonality into the quarter, the second quarter, as well as, frankly, the third quarter. When we look at the past four years of deposit balances in for a year, the second and third quarter are kind of the shoulder quarters, if you will. As far as what we're expecting for the balance of the year, frankly, I would anticipate that if we come out flat from where we are but improve to Jared's question a few minutes ago around the componentry, hopefully laying a little bit deeper into NIBD. That's about where we would think would be an appropriate place for us to end up.

Thanks, Peter. I appreciate the caller. I'll step back.

Yep. Thanks, Kelly.

Thank you. This concludes our question and answer session. I'd like to turn it back to Chang Park for closing remarks.

Thank you everyone for joining us today and for your continued interest in Bank of Hawaii. As always, please feel free to reach out to me if you have any additional questions. Thank you.

This concludes today's conference call. Thank you for participating and you may now disconnect.