Q4 2023 First Hawaiian Inc Earnings Call
Participants
Jamie M. Moses; Vice Chairman of Finance Group & CFO; First Hawaiian, Inc.
Kevin Haseyama; Strategic Planning & IR Manager; First Hawaiian, Inc.
Lea M. Nakamura; Executive VP & Chief Risk Officer of Risk Management Group; First Hawaiian, Inc.
Bob Harrison; Chairman of the Board, President & CEO; First Hawaiian, Inc.
Andrew Brian Liesch; MD & Senior Research Analyst; Piper Sandler & Co., Research Division
Christian Matthew DeGrasse; Research Analyst; Goldman Sachs Group, Inc., Research Division
Kelly Ann Motta; MD; Keefe, Bruyette, & Woods, Inc., Research Division
Steven A. Alexopoulos; MD and Head of Mid-Cap & Small-Cap Banks; JPMorgan Chase & Co, Research Division
Timur Felixovich Braziler; Associate Analyst; Wells Fargo Securities, LLC, Research Division
Presentation
Operator
Good day, and thank you for standing by. Welcome to the First Hawaiian, Inc. Q4 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, Kevin Haseyama, Investor Relations Manager.
Kevin Haseyama
Thank you, Josh, and thank you, everyone, for joining us as we review our financial results for the fourth quarter of 2023.
With me today are Bob Harrison, Chairman, President and CEO; Jamie Moses, Chief Financial Officer; and Lea Nakamura, Chief Risk Officer.
We have prepared a slide presentation that we will refer to in our remarks today. The presentation is available for downloading and viewing on our website at fhb.com in the Investor Relations section.
During today's call, we will be making forward-looking statements. So please refer to Slide 1 for our safe harbor statement. We may also discuss certain non-GAAP financial measures. The appendix to this presentation contains reconciliations of these non-GAAP financial measurements to the most directly comparable GAAP measurements. And now I'll turn the call over to Bob.
Bob Harrison
G Good morning, everyone. I'll start with a quick overview of the local economy. Overall, Hawaii has been resilient in spite of some headwinds. State payrolls were improving at a modest pace prior to the Maui wildfires but we're certainly impacted by that disaster. Nevertheless, state unemployment rate remains low. The seasonally adjusted unemployment rate for December was 2.9% compared to the national unemployment rate of 3.7%.
The visitor industry has performed well on a year-to-date basis with the Maui visitor industry recovering faster than expected and visitors to the rest of the state reaching record levels. Through November, total visitor arrivals were 5% higher than last year and total spend was 6.2% higher. Arrivals from Japan continued to increase with year-to-date arrivals at 506,000, up over 220% from the prior year.
The housing market remained relatively stable despite reduced activity. In December, the median sales price for a single-family home on Oahu was right about $1 million, which was 5% below December 2022. Median sales prices for condos on Oahu was $510,000, 1.5% higher than the previous year.
Turning to Slide 2. I'll discuss the highlights of our fourth quarter financial performance. We finished the year with a solid quarter. We continued to grow customer deposits. We believe that net interest margin has bottomed out and credit quality remains excellent. As I'll cover on the next slide, we took balance sheet actions that are immediately additive to earnings. Our return on average tangible assets was 0.81%, and return on average tangible common equity was 13.66%. We continue to maintain strong capital levels with a CET1 ratio of 12.39% and total capital ratio of 13.57%.
Turning to Slide 3. I wanted to go over the balance sheet actions we took in the fourth quarter that will reduce certain assets while adding to net interest income. In late December, we sold $526 million of low-yielding investment securities in the loss of $40 million. We intend to use those proceeds to reduce high-cost deposit balances starting in the first quarter. By eliminating the negative spread from this asset-liability combination, we will improve our net interest margin and generate higher net interest income off lower average earning assets.
Capital ratio levels are high, and we have ample liquidity, so we continue to look for opportunities to optimize our balance sheet. We plan to bring down our cash levels to a more normalized range of around $500 million to $600 million. Separately, following the change Visa announced in late 2023 that improved the economics of selling Class B shares, we elected to sell our remaining shares for a gain of about $41 million. The shares were carried on our balance sheet at zero book value.
Turning to Slide 4. Period-end loans and leases were $14.4 billion, about $21 million higher than September 30. We had good growth in C&I loans, primarily driven by growth in dealer flooring. As we had anticipated, decline in CRE loans was primarily due to the payoff of several completed construction projects. While there is a headwind for balances, it speaks to the quality of the projects, the strength of the sponsors and overall credit quality of the portfolio. The decline in consumer loans was primarily in indirect auto.
Looking forward to 2024, we expect the full year loan growth rate to be in the low single-digit range. Continued weak demand for residential loans and additional pay downs from our completed construction projects present headwinds to loan growth. Now I'll turn it over to Jamie.
Jamie M. Moses
Thanks, Bob. Turning to Slide 5. Retail and commercial deposits increased by $405 million in total. Commercial deposits were up $243 million and retail deposits increased by $162 million which allowed us to reduce our reliance on public time deposits. There was no material impact from any Maui recovery-related deposit flows. Total deposit balances declined by $179 million due to a $584 million decline in public deposits, $506 million of which were those higher cost time deposits.
The percentage of noninterest-bearing deposits to total deposits was a healthy 36%. We expect further reductions in the balances of higher cost public time deposits starting in the first quarter.
The rate of increase in deposit costs slowed down in the fourth quarter. Our total cost of deposits was 156 basis points, a 16 basis point increase from the prior quarter.
Turning to Slide 6. Net interest income declined by $5.4 million from the prior quarter to $151.8 million due to lower average earning assets and a lower net interest margin. The net interest margin declined by 5 basis points to 2.81%. As we discussed previously, we expect that the security sales and reduction in higher cost deposit balances in Q1 will add about 10 basis points to the 2024 margin and improve net interest income. Our spot NIM in December was 2.75%. So looking forward, we projected NIM in the 2.85% range in Q1.
Through the end of the third quarter -- fourth quarter, the cumulative betas were 44.6% on interest-bearing deposits and 28.6% on total deposits.
On Slide 7, noninterest income was $58.3 million, $12.3 million more than the prior quarter. We had several significant nonrecurring items that contributed to the increase. As mentioned previously, we sold a little over 120,000 shares of Visa B stock for a net gain of $40.8 million. We also recognized a net gain of $7.9 million from the sale of a branch property. These were partially offset by the $40 million loss on the previously mentioned sale of securities and another $1.3 million from other miscellaneous items.
Excluding these nonrecurring items, noninterest income would have been $50.9 million in the fourth quarter. We expect noninterest income to run about $49 million to $50 million per quarter in 2024.
Expenses were $142.3 million, $22.9 million more than the prior quarter. Similar to noninterest income, we had several nonrecurring items that drove the increase. The largest item was the $16.3 million FDIC special assessment. We also had several smaller nonrecurring expenses totaling about $7.3 million in the quarter. Excluding these items, noninterest expense was about $118.7 million in the fourth quarter.
In 2024, we expect full year expenses to be around $500 million, primarily due to continued investment in technology and infrastructure as well as some general inflation. Now I'll turn it over to Lea.
Lea M. Nakamura
Thank you, Jamie. Moving to Slide 8. The bank maintained its strong credit performance and healthy credit metrics in the fourth quarter. While we have seen some modest deterioration in credit quality, our experience so far is well within our expectations. We are not observing any broad signs of weakness across either the consumer or commercial books, and we have sufficient loan loss coverage.
Commercial criticized assets increased to 1.2% of total loans and leases, driven primarily by a single credit, which was downgraded to special mention, while classified assets fell 2 basis points to 19 basis points of total loans and leases. Year-to-date net charge-offs were $12.2 million. Our annualized year-to-date net charge-off rate was 9 basis points, 3 basis points higher than in the third quarter.
Nonperforming assets and 90-day past due loans were 15 basis points of total loans and leases at the end of the fourth quarter, up 2 basis points from the prior quarter. And lastly, the bank recorded a $5.3 million provision for the quarter.
Moving to Slide 9, we show our fourth quarter allowance for credit losses broken out by disclosure segments. The asset ACL increased $1.7 million to $156.5 million with coverage up 1 basis point to 1.09% of total loans and leases.
Turning to Slide 10. We provide a snapshot of our commercial real estate exposure. CRE represents approximately 30% of total loans and leases. The CRE portfolio is well diversified across collateral types, well secured and remains of high quality. Office exposures remained manageable at 5.2% of total loans and leases. We continue to closely monitor the CRE segment given the implications of the rate environment, credit tightening and recessionary headwinds and their follow-on impact to vacancy rates, debt service and asset values. The credit quality of this portfolio remains very good. And now I'll turn it back over to Bob.
Bob Harrison
Thanks, Lea. In summary, we had a solid quarter. We believe we're well positioned to continue to perform well in a challenging environment. The security sale executed in December will enable us to pay down our higher cost deposits and will immediately improve the margin and net income. Now we'd be happy to take your questions.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from Steven Alexopoulos with JPMorgan.
Steven A. Alexopoulos
I want to start on the margin. You guys said 2.85% is what you expect for the first quarter. And Bob, you said you think you would hit a bottom on the margin. So I'm curious, once we get into the Fed starting to cut rates, where do you see the NIM trending because you are asset sensitive, I believe.
Jamie M. Moses
That's right. I call it sort of moderately asset sensitive off of a flat balance sheet, look, and that still continues to be the case, Steve. The dynamics of the balance sheet today, as it exists, though, we continue to see securities portfolio runoff. And when you look through the numbers there, that's something like a [220] yield in totality in the portfolio. So we expect about $600 million in cash flow throughout the year off of that.
And when you're funding things on the margin, it's 5% or so with public time deposits. That's a pretty significant tailwind in terms of how the margin goes. So when we look at the way that the Fed -- or sorry, the forward curve looks in terms of Fed cuts, it's also kind of laid out later in the year. So we think, generally speaking, the dynamics of the balance sheet allow for the NIM to continue to grind higher over the course of the year. Even with that -- even with the way that the forward curve looks.
Steven A. Alexopoulos
Okay. That's positive. Could we go a little bit deeper with that. So you guys are not one of the highest deposit rate payers, right? It's a function of our market. But in order to get NIM grinding higher. What's your assumption because I don't know if you're seeing competitors test the market for lower rates already or not. But how quick could you lower your deposit rates once the Fed does start coming down?
Jamie M. Moses
Yes. So we have a pretty -- the deposit rates, our deposit customer segments are pretty well defined at the moment. And a very large chunk of our customers saw immediate increases to their deposit rates on the way up, and they expect to see those same things on the way down. The amount of that is slightly smaller than what our floating rate assets are. So we are technically asset sensitive there. But we do think that a pretty large chunk of those deposits will reprice lower immediately.
And again, Steve, right, the dynamics on the balance sheet, we also have another almost $1.5 billion of fixed rate cash flow that we expect kind of comes off this year as well. And so that gets repriced up higher to today's rates even as the Fed is coming down, these rates are still higher than where those were put on. So again, it's not really about asset sensitive or liability sensitive. It's more about kind of dynamics we see on the balance sheet. And there's going to be a function of some lower earning assets as well, but a higher NIM grind over time.
Steven A. Alexopoulos
Got it. If I could ask 1 other question, totally different topic. So it was nice to see the dealer growth in the quarter. Curious where are those balances? And is there still room to catch up? Or is that now the new normal, like where those balances sit today?
Bob Harrison
Well, Steve, maybe I'll take this one. First, that if you say it enough times, eventually, it's true. So finally, we saw some nice lift in dealer floor plan in Q4, as you saw. The bulk of that is in the Mainland portfolio. It really is driven by -- that has bigger commitments out there, but also driven by a manufacturer base. The domestics have done a better job of bringing back supply the -- more of the "imports." Foreign producers have been lagging a bit, but it has been very helpful. So we are seeing those balances grow.
So the balance at the end of the year was $563 million in total. That's still just about $300 million less than it was at the end of 2019. So just to give you some perspective. Yes, roughly the same commitments, the same basic dealer group. It won't go back to that. None of us expect it will go back to that. But certainly, there is still some room there.
Operator
Our next question comes from Andrew Liesch with Piper Sandler.
Andrew Brian Liesch
Just on the expense guidance there, a little bit steeper ramp-up than I was expecting. I guess where are you seeing most of that pressure come in? Is it really just inflation? Is it vendor contracts? Where is a lot of that expense guide coming from?
Bob Harrison
Andrew, we were hoping you were going to ask that question. So -- and we figured someone will. And it really comes down to -- and we've talked about this in pieces and maybe I'll take a couple of minutes to try to wrap it together and give you a better idea of what we been doing for the last couple of years and what we're continuing to invest in.
So we're always trying to be very thoughtful on how we're spending our money. And we really have been focused on ever since our core conversion and part of that to enhance our strategy across really 3 different pillars, and that's data, technology and people.
So with what we've been doing over the last couple of years is we've built out a pretty sophisticated data and analytics platform. We've also increased our capabilities with a lot of different things, including AI. As I think we've talked about before, we've already incorporated AI into our consumer lending, and that's been very positive for us. But we're also making strides in our digital offerings. We did the conversion of our online consumer banking last summer, it went very well. We are going to open or put in place a new digital account opening platform in probably midyear of this year. And we've built out our in-house engineering capabilities, which is really based on OpenAI architecture. And then finally, we're putting in a new CRM.
So all of that has been done. We feel most of those investments are in place. As that kind of comes into the income statement, it rises our costs a little bit more than we thought. You can see our employment numbers are basically flat. So we are adding more people, but we are investing in our people because we have put in place a pretty sophisticated engineering team to be able to do things in-house. And so why are we doing all that? We think that's really going to position us well for the future. To be competitive in our market and our unique deposit market to give our customers a lot more options going forward than we have done in the past, and I think really be a first mover in the market.
So that's driving a lot of it, same number of people, a number of investments in platforms and technology that is really at the end of that and then some inflation, et cetera, in there as well. But Jamie, anything you would add to that?
Jamie M. Moses
I think that's a really good summary, Bob. The only other thing to add, Andrew, is we recognize the number is probably a little bit higher than what you were expecting and others have been expecting. But we think it's important that we do invest in those things. And as Bob kind of alluded to in his comments -- commentary, over time, this rate of growth should come down because these investments ought to be able to create scale and efficiencies for us. So that's part of the investment that we've been making and we'll continue to make this year as well.
Bob Harrison
And just to add to that, good point, Jamie. As we finish up the new stuff, we will be sunsetting the outdated systems and improving our operating methods and everything else to bring down our costs and optimize our expenses. So we are in kind of the transition between having invested in new platforms and as those mature, rolling off the old stuff. So there's a little bit of that going on in 2024 as well, which builds into that number.
Andrew Brian Liesch
Got it. Got it. So I guess once you move past, what would be -- do you think is like a natural level of expense growth for the company then?
Jamie M. Moses
Yes. I mean I think that's probably natural level, 2%, 3%, something like that would be the natural level, inflationary sort of expectations. That's in the future like when we get past this in 2024.
Operator
Our next question comes from Timur Braziler with Wells Fargo.
Timur Felixovich Braziler
Looking at the expectations for cash flows off of the bond book at $600 million, how much of that is going to be used to continue working down some of the higher cost funding? And I guess at what point does that stop and you actually start reinvesting some of those proceeds back into the bond book?
Jamie M. Moses
I think the cash flow is coming off, we're going to do 2 things, right? So number 1 is immediately to pay off higher cost deposits to the extent we can. And then the other side of that is fund loan growth as well. So to the extent that -- we love to have a higher rate of loan growth, to the extent that, that happens, we could -- that could be part of the story as well. But I think for us, at the moment, it's really kind of paying off those public time deposits that we have. So those tend to be -- those are in sort of the 5% range right now. And even if you take -- I don't know if take a little bit of credit risk in the bond book, the yields are something like [530], [540], if you want. So you have -- the spread there between the funding cost and the yield is not very high. And so we're not really excited in reinvesting in the bond book right now when we'll be funding that on the margins of 5%. So for now, it's kind of just kind of [run off mode].
Timur Felixovich Braziler
Okay. That's helpful. And then maybe looking at the linked quarter reduction in noninterest bearing, I'm just wondering if there's any visibility to how much excess liquidity you think is within that line item and how much additional mix shift we may get out of noninterest-bearing into some of the interest-bearing accounts over the next 2 quarters or so?
Jamie M. Moses
Yes, we don't know, Timur. We started pre-pandemic. We were at about 36% noninterest-bearing to total deposits, and that's where we're at right now. So I wouldn't say that it can't go lower from here. Anything is -- obviously, anything is possible. We would expect to see -- in an elevated rate environment, we would expect to see some continued migration. We're monitoring that. We're looking through that, and that's obviously part of asset liability management decisions that we'll make throughout this year and on a go-forward basis. We could see some migration -- continued migration on that, but we think it's -- we think that the sort of rate of deceleration has changed and should be less rapid on a go forward.
Timur Felixovich Braziler
Great. I guess last for me, just TCE rebounded north of 6% here, regulatory capital looks pretty good. Any reconsideration for buyback or any incremental thoughts on initiating a buyback?
Bob Harrison
Timur, this is Bob. Yes, we did get approval from the Board for a $40 million buyback plan for 2024. So that is available to us. And that will be certainly something we're considering. We are above the kind of 12% CET1 number that we've been talking about the last several years. There's still -- we feel a reasonable amount of uncertainty in the environment. We're not yet up on a year from the failures of those 3 banks. So we're going to be a little bit cautious, but we're certainly very aware of being comfortable with our capital levels, having the ability to do share repurchase during 2024. And we're just going to continue to look at that and evaluate it as we go through the year.
Operator
(Operator Instructions) Our next question comes from Kelly Motta with KBW.
Kelly Ann Motta
Maybe I don't think we talk yet much about credit, obviously, metrics remain really strong. Just wondering what you're watching at this stage, any changes in how you're viewing certain portfolios? And any kind of expectations for what credit normalization could look like over the next 2 years or so?
Bob Harrison
Kelly, great question, and maybe I'll start and then turn it over to Lea. We're watching that very closely. Some of the office issues we talked about midyear last year have been resolved. There's still no -- that's area of high attention that we are [paid even though] on the credit side, but also the line officers. We continue to stay very close to the customers in the commercial side, but in particular, the commercial real estate.
As I mentioned in the comments, there is some normal functioning going on. We are getting paid off from construction deals. They had moved from construction into mini [firm] as they got fully leased up, which for a little while there, a couple of years ago, as you recall they were just getting paid off as soon as construction completed. So it's now back to a more normal environment to me, which is healthy.
On the rest of the commercial side, we're still seeing strength in a lot of the areas that we talked about. Consumer, we are starting to see a little bit of weakness for the indirect and cards, but kind of back to normal in a sense. And maybe a last comment before I turn it over to Lea is as she mentioned in her comments, just to highlight, we haven't really seen a lot of impact from Maui. So something as well we're watching closely. But Lea, anything you'd add to that?
Lea M. Nakamura
No, I don't really have much to add. What I will say, though, is we actually are quite pleased with the performance of the portfolio even in this environment. We continue to watch certain pieces very carefully because you hear about the headline numbers and you think about how it impacts your borrowers. But so far, we really haven't seen the kind of, I guess, weakness that we thought we would at this time in the cycle.
Kelly Ann Motta
I really appreciate all the color here, guys. Maybe 1 more from me. Just wondering if you've evaluated the regulatory proposals on interchange and overdraft and kind of if you started to make any preliminary estimates on what the impact could be to you and if you're doing any changes with your fee structure in response to that?
Bob Harrison
On the interchange side, we haven't done a full analysis, Kelly. I mean, it's something we're looking at, something we don't agree with, basically, in principle, and we're supporting the [ABA's] position and the stand they are taking in that. So I think that's important. We're evaluating it from a mid-sized bank coalition perspective as well and will likely support it, but -- the ABA's position because -- but having said that, we're also starting to do the analysis of what it would be because we have to be responsive to it.
It is in the rule-making process, which means it will take some time to come into effect and not knowing exactly what the final outcome will be. We're still kind of waiting to get a better idea because doing the analysis, I think, is fairly straightforward once we have an idea of what the final will be.
Operator
Our next question comes from Christian DeGrasse with Goldman Sachs.
Christian Matthew DeGrasse
Putting the public deposits to the side for a second, can you maybe provide some context on how your commercial and retail deposit rates have performed alongside the rising rate cycle and how you expect repricing to react relative to that when rates ultimately start to fall?
Jamie M. Moses
Yes. For the most part, again, I guess, Christian, I'll just kind of go back into it, we have kind of a few different segments the way we think about in both the retail and the commercial side of the world. And there's a segment or a portion of balances that's rate sensitive, and there's a portion that's there for operating accounts and DDA working capital, that kind of thing.
And so on the way up, they got the benefit of rates on the way up pretty much in a 100% kind of beta scenario. And so on the way down, that the expectations are very similar that we would be able to reduce those rates as well. Again, the portion of deposits that we have that are in that 100% beta is probably -- like if you think about it around numbers, it's probably like 80% of what our floating rate loans are. So in a kind of a down rate scenario, there will be an immediate reprice of loans that are -- that is a little bit higher than what our deposits are, but a substantial amount of those deposits will also tick down as well.
So in totality, we kind of just think that, that's where we're at in terms of the mix, and we'll be able to manage those rates down over time pretty well.
Bob Harrison
And just to add to Jamie's comments, as I think we talked about, it's been several quarters. We were talking to our customers, our -- low segments, the high net worth, less affluent, corporate when we were increasing rates on the way out. And we've continued those conversations, the expectation is when rates go the other way, that there won't be a lag, that we will be working with them on the way down as well. So that's been very well communicated by our bankers to the customers. So we think that's a doable thing. We are not seeing much deposit pressures in the market, to be honest.
Operator
Our next question comes from Andrew Liesch with Piper Sandler.
Andrew Brian Liesch
Sorry to keep bringing up expenses. But what's the quarterly trajectory, how do you expect these costs to play out this year?
Jamie M. Moses
So it's always slightly elevated Q1, just extra taxes and things like that, just true-up things happened in Q1, but in totality is probably going to be generally flat across the year. And so that's kind of the way that we have it, looked into my model of it. So generally pretty flat, maybe slightly elevated Q1.
Andrew Brian Liesch
Got it. So more seasonally adjusted stuff during the first quarter, then more of the investment starting to ramp up and then offset some of those seasonal adjustments as they fall off as the year goes on?
Jamie M. Moses
Yes, I think that's a pretty good way of looking at it.
Operator
Thank you. I would now like to turn the call back over to Kevin Haseyama for any closing remarks.
Kevin Haseyama
Thank you. We appreciate your interest in First Hawaiian, and please feel free to contact me if you have any additional questions. Thanks again for joining us, and enjoy the rest of your day.
Operator
Thank you. Thank you for your participation. You may now disconnect.
