Q2 2023 Bank of Hawaii Corp Earnings Call
Participants
Cynthia G. Wyrick
Dean Y. Shigemura; Vice Chair & CFO; Bank of Hawaii Corporation
Mary E. Sellers; Vice Chair & Chief Risk Officer; Bank of Hawaii Corporation
Peter S. Ho; Chairman, President & CEO; Bank of Hawaii Corporation
Andrew Brian Liesch; MD & Senior Research Analyst; Piper Sandler & Co., Research Division
Jeffrey Allen Rulis; MD & Senior Research Analyst; D.A. Davidson & Co., Research Division
Kelly Ann Motta; MD; Keefe, Bruyette, & Woods, Inc., Research Division
Presentation
Operator
Good day, and thank you for standing by. Welcome to the Bank of Hawaii Corporation Second 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, Cindy Wyrick, Director of Investor Relations. Please go ahead.
Cynthia G. Wyrick
Thank you. I'd like to welcome everyone, and thank you for joining us today as we discuss the financial results for the second quarter of 2023. Joining me today is our CEO, Peter Ho; our CFO, Dean Shigemura; our Chief Risk Officer, Mary Sellers; and the newest member of our IR team, [Chang Park]. 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 today, we will be referencing a slide presentation as well as the earnings release, both of which are available on our website, boh.com, under the Investor Relations tab.
And now I'd like to turn the call over to Peter Ho. Peter?
Peter S. Ho
Thanks, Cindy. Good morning or good afternoon, everyone. Thank you for your interest in Bank of Hawaii Corporation. I'll begin today's call with some general commentary on our results. I'll then hand the call over to Mary to cover [offline] credit, which is a great story and then Dean will get a little deeper into the financials.
We'd then be happy to entertain your questions. Bank of Hawaii delivered solid results for the second quarter of 2023. Total deposits grew in the quarter, and we enhanced our liquidity position substantially with cash and immediately available credit lines.
Credit remained a strength with NPAs and net charge-offs of 8 basis points and 4 basis points, respectively. We recorded earnings per share of $1.12 for the quarter. Net interest income was negatively impacted by higher interest rates and attendant higher borrowing costs. Fee income performed well during the quarter and expenses were controlled, both on a reported and normalized basis.
Given the environment, expense management will continue to be a particular focus of ours going forward. Deposit quality is obviously a critical factor in today's environment, but I thought I'd spend a little time reviewing Bank of Hawaii's exceptional deposit position.
Our deposit story really begins with the deposit marketplace, which is different from nearly all other deposit markets in the country. 97% of the State of Hawaii's deposit base as measured by the FDIC is held by 5 local banks, all headquartered within the State of Hawaii and all having served the local community for many, many years. Therefore, it's not surprising that the events of early March with SVB and Signature Bank had a rather muted impact on the Hawaii marketplace as compared to the broader national small bank marketplace.
We built our deposit franchise over our 125-year history, one relationship at a time. Our deposit base is well diversified and well tenured. 49% of our deposits are with consumer clients, 39% with commercial customers and 12% with municipalities. Even within these categories, we have further diversification by industry, income demographic and government agency or jurisdiction. More than half of our deposits are from clients with whom we've been doing business with for 20 years or longer.
Another 24% are from clients with whom we've been doing business with from between 10 and 20 years. Given this backdrop, it's not surprising that our deposit performance through both the first and second quarters has been quite stable. Additionally, we've been able to maintain deposit stability while also keeping funding costs reasonably controlled. Our deposit beta for Q2 was 21%. In terms of additional liquidity, we improved our cash and immediately available lines of credit positions substantially to $8.5 billion by quarter end.
Brokered deposits are yet another form of liquidity available to us, although we do not currently have broker deposits within our deposit mix as of quarter end given the stability of our deposit base and abundant backup liquidity in place. Brokered deposits, however, are a solid tertiary liquidity option for us. I'll finish off with a little color on the Hawaiian economy. Our visitor industry continues to perform well. Total visitor expenditures in May were up 19% from 2019 prepandemic levels. This level includes a still recovering Japan segment, which remains down 66% from pre-pandemic levels by spend. Hawaii single-family home prices were down 4.5% in June from a year ago at $1,050,000 Inventory, however, remains tight at 17 average days on market and -- 17 days on market and total inventory of 2.6 months. Hawaii's unemployment rate was down to 3% in June compared to 3.7% at year-end. And now let me turn the call over to Mary.
Mary E. Sellers
Thank you, Peter. Bank of Hawaii's lending philosophy is grounded in 2 fundamental tenets, lending in markets we know and to long-standing relationships we understand. While growing the loan portfolio in a safe and measured way over time, our focus is on ongoing, disciplined portfolio management. We consistently actively exit those products or segments that prove to have higher risk profiles, creating outsized credit losses and volatility.
In the consumer portfolio, these noncore segments included land and interest-only loans in our residential portfolios, purchased home equity pools, indirect auto loans originated in Oregon, our revolving personal flex line product and our credit card portfolio. Similarly, in our commercial portfolio, we spent a number of years working out of a scored small business portfolio, a pool of nonrelationship shared national credits and a large ticket leasing portfolio. Concurrently, we're continually focused on optimizing the risk profile within our core portfolio by biasing the mix within it to those products and segments that have proven to carry lower risk. This disciplined management, coupled with consistent conservative underwriting has proven itself through lower net charge-off rates over the years and positions our portfolio to continue to realize lower credit losses through different economic cycles.
All of this is reflected in our portfolio construct today, which is built on long-tenured relationships diversified by asset categories with 60% consumer and 40% commercial, appropriately sized exposures and 79% secured with real estate with a combined weighted average loan-to-value of 55%. Our commercial real estate portfolio, which represents 27% of the total loan portfolio is diversified across various asset types. The portfolio built on relationships with demonstrated experience and financial capacity is conservatively leveraged with a weighted average loan-to-value of 50%. Maturities across the commercial real estate portfolio remain very manageable with 10% maturing prior to 2025. Our office portfolio is 2.7% of total loans and granular and has a weighted average loan-to-value of 56%.
26% of the portfolio is in the downtown 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 the loans in the office segment are maturing through 2024. Tail risk in the commercial real estate portfolio remains modest with just 0.8% having an LTV greater than 80%. Our construction portfolio represents 2% of total loans, with the majority of this in low income or affordable housing, which continues to be chronically undersupplied in our markets.
Credit quality remained strong in the first quarter with net charge-offs of $1.4 million or 4 basis points annualized of total average loans and lease outstandings, down 4 basis points for the linked quarter and up 2 basis points year-over-year. Nonperforming assets were $11.5 million or 8 basis points down 1 basis point from the first quarter and down 4 basis points year-over-year. All nonperforming assets are secured with real estate with a weighted average loan-to-value of 57%. Loans delinquent 30 days or more remained stable at 22 basis points at the end of the quarter.
Criticized loans as a percentage of total loans were 1.47%, up modestly for the linked quarter and year-over-year, but comparable to 4Q 2019. At the end of the quarter, the allowance for credit losses was $145.4 million, up $1.8 million for the linked quarter and the ratio of the allowance to total loans and lease outstandings was flat at 1.04%. Given there were no significant changes in the economic forecast from the University of Hawaii Economic Research Organization, stable asset quality and modest growth.
The allowance does continue to consider downside risk, including higher unemployment, inflation and interest rates as well as the general uncertainty in our environment. The reserve for unfunded commitments was $6.3 million, down $700,000 for the linked period.
I'll now turn the call over to Dean.
Dean Y. Shigemura
Thank you, Mary. Net interest income was $124.3 million in the second quarter, a decrease of $11.6 million linked quarter. Net interest margin was 2.22%, a decrease of 25 basis points linked quarter. Linked quarter decreases in both net interest income and margin were primarily due to higher funding costs, partially offset by loan growth and higher asset yields as the inverted yield curve and higher short-term rates continue to pressure our income and margin. We continue to exercise deposit pricing discipline as evidenced by our deposit beta continuing to outperform that of peer banks.
Nevertheless, deposit rates are expected to continue to rise, and we also expect a continued moderate mix shift from noninterest-bearing into interest-bearing savings and time deposits. As a result, we expect our cumulative deposit beta in this cycle will peak at approximately 30% in the fourth quarter which while higher than our historic beta of 20% is still well below levels of peers. During the quarter, we continued remixing our loans by shifting to a greater floating and variable rate exposure, which now comprise approximately 60% of new loan originations, while allowing our investment portfolio to run off.
In addition, we proactively added on balance sheet liquidity as a mitigant against [higher] for longer short-term rates, although the higher liquidity negatively impacted our margin by approximately 4 basis points. On the liability side, we added $1.25 billion of fixed rate term funding at an average maturity of 2.5 years and average rate of 4.3% and also increased our time deposit balances by $380 million at an average rate of 4.04%. In addition to our on-balance sheet actions, we added $200 million notional of pay fixed receive float swaps in the quarter to hedge a portion of our fixed rate loan exposure.
From an earning asset perspective, net interest income and margins are being supported by strong cash flow and overall asset repricing and higher rates. With $2.8 billion of annual cash flows from maturities and paydowns of loans and investments, we have ample opportunity to redeploy funds into higher-yielding assets. In addition to strong cash flow, loans and securities repricing, the added liquidity and interest rate swaps resulted in a further approximately $4.8 billion in assets that are repricing annually, which provides additional rate sensitivity.
The yield on fixed rate maturities and paydowns of loans and investments in the second quarter was 3.8% and 2.1%, respectively. These cash flows continue to be reinvested predominantly into new loans, which are yielding approximately 7% or held in cash at the Fed, which preserves liquidity and is currently yielding 5.25%. Noninterest income totaled $43.3 million in the second quarter. Included in the results was a $1.5 million gain from the sale of the low-income housing tax credit investment. The first quarter results included $600,000 charge related to a change in the Visa Class B conversion ratio which is reported as a contra revenue item in investment securities gains losses.
Adjusting for these items, noninterest income was $41.7 million in the second quarter, an increase of $400,000 linked quarter and lower by $400,000 from the second quarter of 2022. Trends in transaction activity and asset management fees have improved off of lower levels, and we are starting to see modest growth. Core noninterest income is expected to be $41 million to $42 million per quarter for the remainder of the year which is higher than our prior guidance.
However, there will be a noncore charge of $800,000 in the third quarter from a further adjustment to the Visa Class B conversion ratio. This $800,000 charge is not included in the core noninterest income guidance. During the second quarter, as is our practice, we managed our expenses in a disciplined manner as inflationary conditions continued. Expenses in the second quarter was $104 million. Included in the first quarter were severance expenses of $3.1 million and seasonal payroll taxes and benefit expenses from incentive payouts, which totaled $4 million.
Adjusting for the severance and seasonal payroll benefits and expenses in the first quarter, expenses in the second quarter decreased by $800,000 linked quarter and were up $1.1 million from the second quarter of 2022. The year-over-year increase of 1.1% is well under the annual rate of inflation and included a considerable increase to the FDIC insurance rate as well as annual employee merit increases. Expenses in the third quarter are expected to be approximately the same as the second quarter, but are expected to trend lower in the fourth quarter. While inflation continues to pressure expenses, reduced hiring, delaying noncore projects and other actions are being taken that moderate expense growth.
To summarize the remainder of our financial performance, in the second quarter of 2023, net income was $46.1 million, and earnings per common share was $1.12. Our return on common equity was 14.95% and our efficiency ratio was 62.07%. We recorded a provision for credit loss of $2.5 million this quarter. The effective tax rate in the second quarter was 24.57%, and the rate for the full year of 2023 is expected to be approximately 24.5%.
our capital remains well within regulatory well-capitalized levels with all regulatory capital ratios increasing from the prior quarter. We continue to maintain healthy excesses above the regulatory minimum, well-capitalized requirements. During the second quarter, we paid out $28 million to common shareholders in dividends and $2 million in preferred stock dividends. 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 third quarter of 2023. Now we'll be happy to take your questions.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from the line of Jeff Rulis with D.A. Davidson.
Jeffrey Allen Rulis
Maybe a question for Dean. Just on the funding costs. I guess the cost of funds for the quarter at [1.08%]. How does that compare at the end of the quarter. What was that number? And then if you have it as well the monthly June margin overall.
Dean Y. Shigemura
Yes, the funding costs overall -- are you talking about the -- just on the liability side or just...
Jeffrey Allen Rulis
For the first quarter, what was that at the quarter end, just spot rate?
Peter S. Ho
1.23.
Dean Y. Shigemura
Yes, 1.23. And then your -- so the margin for the quarter or for the month was 2.14%. But keep in mind that when you adjust for the liquidity that we brought on during the quarter, that number is actually more like 2.20%. So the liquidity did have an impact on our margin during the month.
Peter S. Ho
Later in the quarter.
Dean Y. Shigemura
Later in the quarter, yes.
Jeffrey Allen Rulis
Okay. I wanted to circle back on the expenses, a pretty specific guide in the third quarter or the fourth quarter. And Peter, in kind of the prepared remarks, it seem to suggest a little more possibly could lean on that or manage that somewhat lower. I don't know if that changes. I think you've said for the full year guidance was expenses up 3% off of '22's core base. Has that changed at all? Or is that more of a further out into '24? Or am I just reading into commentary about cost management?
Peter S. Ho
Yes, Jeff, we're -- so we are looking at expenses candidly. We see that line item as one of the controllable items that we have in an environment where margins and rates are challenged. And if fee income is likely to be where it's going to be, so this is kind of a reasonable place for us to look. I would anticipate to see some impact of expense reductions later into this year, so certainly, by the fourth quarter, and then into next year. I'm not quite ready to kind of provide guidance on what those levels would be but lower.
Jeffrey Allen Rulis
Okay. Yes. Just wanted to check in on that. I appreciate it. And just the last one on -- Peter, you've also provided -- and sorry, if this is clunky. You've kind of -- you've talked about a capital build. It's just the securities portfolio matures. I can't remember if it was a TCE. It was a 1- to 2-year organically where that could build. Could you update us on kind of where you sit on that process or that direction of TCE?
Peter S. Ho
Not quite clear on the TCE piece. I mean generally, Jeff, that we're looking to build capital through obviously earnings retention as well as taking a good, hard look at the asset base of the company. And candidly, the liquidity that we've built is running a little counter to capital build, if you will. And I think that was obviously for good reason, coming out of the SVB, Signature situation in March. The reality though is our deposit base has been incredibly stable, and we have a pretty good-sized war chest of immediately available backup lines of credit.
And so the lever that may be available at this point is to bring down some of that $1.7 billion in cash that we're holding, which would improve capital slowly over time. And so really, our capital plan is, I would characterize it as an organic one at this point, with an emphasis on retaining earnings as well as managing the overall size of the balance sheet.
Operator
(Operator Instructions) Our next question comes from the line of Andrew Liesch with Piper Sandler.
Andrew Brian Liesch
Just a quick question on this liquidity build that came on later in the quarter. Has all that been deployed into earning assets? Or there's still some investments to be made on that front?
Dean Y. Shigemura
It's primarily sitting in Fed funds sold right now. So readily available liquidity on balance sheet for us. The yield we're earning -- it's at the Fed. So we're earning fed funds effective. We're also looking at the -- in terms of investments, that's where we're placing the funds.
Andrew Brian Liesch
Got it. So I mean it seems -- it sounds like that the net effect on the margin will be lower, but on net interest income, maybe you're picking up a little bit NII. Yes. Is that right?
Dean Y. Shigemura
Right. Yes.
Peter S. Ho
Yes. So it's -- that's exactly right. It's dilutive to margin -- accretive to NII and dilutive to capital.
Andrew Brian Liesch
Got you. All right. And then on loan growth going forward, it seems like you had some pretty good gains on the commercial side. I'm just curious what drove that. And then looking out, I mean, how do you expect the total portfolio trend just modest, like low to mid-single-digit growth?
Peter S. Ho
Yes. I think we had a good C&I quarter. I'm not sure that's necessarily replicable in the coming quarters. So we had growth in both commercial as well as consumer. And what I would anticipate is likely loan growth to be flat at this point moving forward. It just seems like the consumers slowed down a bit based on rate, seems like commercial clients are sitting on their hands a bit on transactions. Hopefully, we'll see that change as more positive signals come out of the economy, hopefully. But for now, feels reasonably muted, I think.
Operator
(Operator Instructions) Our next question comes from the line of Kelly Motta with KBW.
Kelly Ann Motta
I think -- I really appreciate the color around deposits and the updated outlook for deposit betas. And I believe in the commentary you suggested some continued pressure on noninterest-bearing deposits. Just wondering what your outlook incorporates in terms of noninterest-bearing run off into a higher rate accounts and kind of where those could bottom in terms of a percentage of deposits as well as timing? Is this really the last quarter of it? Or could there be a continuation assuming we get another rate hike or 2?
Dean Y. Shigemura
Yes. The guidance around the beta, it does incorporate the mix shift. So some drawdown on the noninterest-bearing into interest-bearing deposits. So that was at 30% peaking in the fourth quarter. We're looking at it -- right now, we're at 29% noninterest-bearing mix coming down to maybe 27% -- 26%, 27%.
Peter S. Ho
Yes, Kelly, that would put us at about interestingly the midpoint between the pre-pandemic levels, which were, call it, 30%-ish and kind of the '07 levels where rates obviously were higher kind of the mid-20s. And so not knowing which kind of -- which base we'll head to kind of we're thinking that's about a right way to handicap it. So we do see some mix shift continuing into this quarter, the third quarter, potentially into the fourth.
I would mention, however, that we have seen some flattening -- a bit flattening around that decline. It looks like June was down just over 1%, which compares to on average of the past year down kind of like 2% per month. So that was an improvement, and July is looking pretty flat right now. So we still have a few days left to the month. But if that holds true that probably would be our best performance in about a year on a monthly basis.
Kelly Ann Motta
Got it. That's super helpful. And then in terms of the margin, the commentary of margin being about 2.14% for the month of June, which incorporates some of the liquidity build that you had. Can you just remind us when you put on -- you took on those fixed rate borrowings and threw on the cash in terms of the timing of that. Just wondering if that's fully reflected in that June margin? And then kind of from here, as we look out, given your expectations for NIB declines and the commentary around deposit beta, how we should be thinking about the margin on a go-forward basis, assuming another rate hike or 2?
Dean Y. Shigemura
Yes. Okay. So the term funding was placed, I would say, right in the middle part of May, so kind of right in the middle of the quarter. So the June margin at 2.14% would have reflected the full impact of that liquidity. So that's -- so when -- as you look out into the -- towards the end of the year, we do expect the margin to bottom in the fourth quarter and kind of decelerating from what we saw in the second quarter. So kind of a gradual decrease and then bottoming in the fourth.
Kelly Ann Motta
Got it. I appreciate that. And you said you put on some swaps during the quarter. Can you just provide us a bit more color just trying to get some sense on how to model around that. I may have missed the amount of that, so that would just be helpful in terms of modeling?
Dean Y. Shigemura
Sure. They were -- it was $200 million notional towards the end of the quarter that we put on. So it's a pay fixed receive flow swap, hedging some of our fixed rate loans. So about a 2-year, 2.5-year type of term.
Kelly Ann Motta
Okay. Got it. Maybe last one for me, if I could sneak it in. With capital, I know you said you're in the rebuild mode. Just in terms of the dividend, I think you reiterated the $0.70 dividend around earnings. But just wondering how you guys feel about this level? Obviously, the earnings have come down a bit with the margin. I'm wondering how you're feeling in terms of the comfort level of the payout at this stage.
Peter S. Ho
Yes. So Kelly, so the dividends, obviously, are strategic to us and our desire is to maintain our dividend levels. Of course, that's earnings willing -- and interest rates willing, inflation and credit and all those factors. And so our process is to assess that with our Board at the end of every quarter. And for now, our desire is to maintain that level.
Operator
That concludes the question-and-answer session. At this time, I would like to turn the call back to Cindy Wyrick for closing remarks. .
Cynthia G. Wyrick
Thank you, everyone, again, for joining us today and for your continued interest in Bank of Hawaii. As always, please feel free to reach out to either Chang or me if you have any additional questions or if you need further clarification on any of the topics discussed today. Thanks, everyone. Have a good day.
Operator
Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.
