Bank of Hawaii - Earnings Call - Q3 2019

Transcript

Speaker 0

Ladies and gentlemen, thank you for standing by, and welcome to the Bank of Hawaii Corporation Third Quarter twenty nineteen Earnings Conference Call. At this time, all participants' lines are in a listen only mode. After the speakers' presentation, there will be a question and answer session. I would now like to hand the conference over to your speaker today, Director of Investor Relations, Cindy Wyrick. Ma'am, you may begin.

Speaker 1

Thank you, Demetrius. Good morning, good afternoon, everyone. Thank you for joining us today as we review the financial results for the 2019. Joining me today is our Chairman, President and CEO, Peter Ho our Chief Financial Officer, Dean Shigemura and our Chief Risk Officer, Mary Sellers. Before we get started, let me remind you that today's conference call will contain some forward looking statements.

And while we believe our assumptions are reasonable, there are a variety of reasons that the actual results may differ materially from those projected. And now I'd like to turn the call over to Peter Ho.

Speaker 2

Thanks, Cindy. Aloha, and good morning, everyone. Thanks for joining us today. The 2019 was yet another strong quarter for Bank of Hawaii. We had good financial performance.

Our asset quality remains solid, expenses were well controlled and our liquidity and capital levels remain strong. Our loans grew to $10,900,000,000 at the end of the quarter, up 1.1% from the previous quarter and up 6.4% from the third quarter last year. Deposits were $15,300,000,000 down from the previous quarter due to a decline in public deposits, which offset solid growth in our consumer book. Compared with the end of the third quarter last year, total deposits were up 3.4%. Now let me ask Dean to provide you with some additional details on our financial performance this quarter, and then Mary will comment on our asset quality.

Dean?

Speaker 3

Thank you, Peter. Net income for the 2019 was $52,100,000 or $1.29 per share. Our return on assets during the quarter was 1.17%. The return on equity was 16.02% and our efficiency ratio was 58.55%. Net income for the 2019 included the previously disclosed increase in our legal reserves of $6,000,000 or $0.11 per share related to the tentative settlement of a class action lawsuit regarding overdraft fees.

Adjusted for this legal reserve, our return on assets during the quarter was 1.27, the return on equity was 17.37%, and our efficiency ratio was 55.05%. Our net interest margin in the third quarter was 3.01%, down three basis points from the previous quarter and six basis points from the same quarter last year. Net interest income on a reported basis for the 2019 was $124,900,000 up $800,000 from the second quarter and up $2,000,000 from the third quarter of last year. The decline in the margin for the 2019 reflects the ongoing impact of the lower interest rate environment. Given the current challenging rate environment, we anticipate that the net interest margin for the fourth quarter will be lower by four to five basis points.

As Mary will discuss later, we recorded a credit provision of $4,300,000 this quarter. Noninterest income totaled $46,500,000 in the 2019 compared with $45,500,000 in the previous quarter and $41,500,000 in the same quarter last year. The 2019 included a negative charge of $500,000 related to a change in the Visa Class B conversion ratio. There were no significant items in noninterest income during the 2019 or the 2018. The increase in non interest income during 2019 reflects growth in mortgage banking revenue and higher levels of customer derivative activity.

We currently expect non interest revenue to be approximately $45,000,000 during the 2019, excluding a previously announced gain of $3,800,000 related to the early buyout of a leveraged lease. Non interest expense totaled $100,300,000 in the 2019, including the legal reserve, up from $92,700,000 in the previous quarter and $90,500,000 in the same quarter last year. There were no significant items in non interest expense during the 2019 or the 2018. Adjusted for the legal reserve, the higher levels of expenses primarily relates to higher compensation and other variable expenses due to increased business growth and continued investments in technology facilities and our people. Excluding the legal settlement, for the full year of 2019, we continue to expect expenses to be about 2% to 3% above our adjusted 2018 expenses of $365,000,000 The effective tax rate for the 2019 was 22.08% compared with 21.84% in the previous quarter and 18.75% in the same quarter last year.

The increase from the previous quarters is mainly due to a reduction in tax exempt municipal securities. For the fourth quarter, we expect the effective tax rate to be between 2223%, which includes a onetime increase of $2,100,000 related to tax adjustment items that will offset the previously disclosed $1,800,000 credit related to the early buyout of a leveraged lease. Our investment portfolio was $5,500,000,000 at the end of the third quarter. Premium amortization during the quarter was $6,400,000 up from $5,800,000 in the previous quarter and down from $8,800,000 in the same quarter last year. We purchased a total of $312,000,000 of investment securities during the quarter, which were primarily comprised of fixed rate mortgage backed securities.

The reinvestment differential during the third quarter was a negative 36 basis points. The duration of the available for sale portfolio was two point nine years at the end of the 2019. The held to maturity portfolio duration was three point six years and the duration for the total investment securities portfolio was three point three years. Our total shareholders' equity was $1,300,000,000 at the end of the third quarter. Our Tier one capital ratio was 12.33%, and our Tier one leverage ratio was 7.32.

During the quarter, we paid out $26,300,000 or 51% of net income in dividends and repurchased 360,000 shares of common stock for a total cost of $29,900,000 We repurchased an additional 92,000 shares between October 1 and October 25 at a total cost of $7,800,000 And finally, our Board declared a dividend of $0.67 per share for the 2019. Now I'll turn the call over to Mary Sellers.

Speaker 0

Thank you, Gene.

Speaker 4

Net charge offs for the third quarter totaled $3,000,000 or 0.11% annualized of total average loans and leases outstanding as compared with net charge offs of $2,400,000 or 0.09% annualized in the 2019 and $3,300,000 or 0.13% annualized in the 2018. Non performing assets were $21,600,000 or 20 basis points at the end of the third quarter, down from 21,800,000 or 20 basis points at the end of the second quarter and up from $13,800,000 or 13 basis points at the end of the third quarter of last year. Loans past due ninety days or more and still accruing interest were 6,100,000 down $300,000 for the linked period and down $2,000,000 year over year. At the end of the quarter, restructured loans not included in non accrual loans or loans past due ninety days or more were $46,200,000 down 2,400,000 from the 2019 and down $3,300,000 from the 2018. The allowance for loan and leases totaled $108,900,000 at the end of the quarter, up 1,300,000 from the second quarter.

Accordingly, given net charge offs of $3,000,000 a credit provision of $4,300,000 was recorded. The ratio of the allowance to total loans and leases was 1% at the end of the quarter, unchanged for the linked period and down six basis points year over year. The total reserve for unfunded commitments was $6,800,000 at the end of the quarter, unchanged from the 2019 and the 2018. The allowance reflects the continued solid asset quality and composition of the bank's portfolio. At the end of the third quarter, 82% of consumer outstandings were supported by residential real estate with a weighted average loan to value of 5860% of our commercial outstandings were supported by commercial real estate with a weighted average loan to value of 55%.

Given the strength and resilience in our core Hawaiian Guam markets, where 97% of our assets are held, coupled with our ongoing credit discipline, we do not anticipate needing to reposition our portfolio for any turn in the economic cycle. I'll now turn the call back to Peter.

Speaker 5

Thanks, Mary.

Speaker 2

The Hawaii economy remains stable through the 2019. Our statewide unemployment rate in September was 2.7% and remains very low compared to the unemployment rate of 3.5% nationally. Visitor arrivals continue to increase and for the first eight months of twenty nineteen were up 5.2% compared to the same period in 2018. In spite of the strong growth in arrivals, we are continuing to see a modest decline in daily spend with total visitor spending down 0.5% compared with the same period in 2018, mostly due to lower international spend. Our real estate market also continued to remain active.

We had particularly strong growth in single family home sales during the third quarter, which increased by 8.7% over the same period in 2018. Year to date sales of single family homes are now at comparable levels with 2018 and median sales prices remain stable. Condominium sales, however, continue to soften through the third quarter. Year to date sales of condominiums declined 6.7% compared with the same period in 2018 and median sales prices are down 1%. Months of inventory at the end of the quarter were three point five months for single family homes and three point nine months for condominiums.

The year to date median number of days on market was twenty three days for a single family home and twenty six days for a condominium. Thanks again for joining us today and now we would be happy to respond to your questions.

Speaker 0

And our first question comes from Jeff Rulis with D. A. Davidson. You may proceed.

Speaker 6

Thanks. Good morning. Good morning, Jeff. A couple of questions on the expense side. Any way to talk about the kind of what the variable piece of the salaries being up?

What portion of that is tied to kind of increase in mortgage banking or the variable, if that's possible to kind of break that out?

Speaker 3

Well, if you look at the breakdown for salaries that we have in one of the tables, the increase quarter over quarter is mainly due to the additional workday. So that adds about $500,000 to the expenses. A lot of the rest of the increase in salaries and benefits is due to the elevated level of separation for the quarter.

Speaker 6

Okay. All right. Thanks, Deane. And then the other question on the expense side is the just the rise in the net equipment line. Was there anything significant quarter to quarter?

It seemed like that popped up a bit.

Speaker 5

No.

Speaker 3

It reflects our continued investment and generally the IT space is what hits that line. And so we do have a number of projects that are being completed. So the depreciation is starting as well as some of the software costs.

Speaker 6

Got it. Okay. And maybe one for Mary. Just on the net charge offs, the type of loans that make up the net charge offs and if you comment if that's been a similar mix as past quarters?

Speaker 4

Yes, has. As expected, we continue to see our net charge offs primarily in our dealer and direct portfolios, while our home equity and residential mortgage portfolios remain in a modest recovery position.

Speaker 6

Okay. Thanks.

Speaker 0

And our next question comes from Ebrahim Poonawala with Bank of America. You may proceed.

Speaker 7

Good morning, guys.

Speaker 2

Good morning.

Speaker 7

Just first question, I wanted to follow-up on the margin guidance around I believe you said about four to five basis points of compression is what you expect in the fourth quarter. Can we talk to just in terms of how we should expect the margin to behave if we get multiple rate hikes? Do you see some leveling off? Or and if the Fed were to stop, let's say, December, do you expect the margin to essentially bottom out immediately after in the following quarter? If you could provide any color around that, that would be helpful.

Speaker 2

Abraham, did you say rate hikes or rate drops?

Speaker 7

Rate drops. Sorry if I misspoke.

Speaker 2

Rate drops. That's I was confused. That's what I thought. Okay. Got it.

Speaker 3

Yes. Okay. So the guidance I provided included an expected 25 basis point rate cut this week by the Fed. There's a potential for another cut in December, but it's too late in the year to impact us materially in the fourth quarter. But going forward, it's really the cuts at the short end of the curve have a minimal impact on us about one basis point.

It's really the shape of the curve that's going to impact us more. The flatness of the curve is what's pressuring our margin currently. So if we continue to see the long end stay low, the margin will probably stay at the lower end of this range here.

Speaker 7

Got it. And I'm sorry if I missed this. Did you say what are the new securities yields coming on at? Like what are the duration? What's the yield of new purchases that you expect to do?

Speaker 3

So the new duration the new securities that we're purchasing are coming on at generally, they're mortgage backed securities, so about $270,000,000 to $280,000,000 maybe a little bit higher now that the rates have been kind of creeping up. Duration is about, call it, four to five years.

Speaker 7

Got it, four to five years. And just on a separate moving away from the margin, Peter, if you could talk to in terms of expense leverage as we look into 2020, if the rate environment doesn't provide any relief, like you've done obviously a great job managing expenses, I would say over the last decade. Like are there opportunities within the bank where you see potential for cutting costs or the 2% to three percent expense inflation is something that we're going to have to live with even if the revenue environment worsens?

Speaker 2

Yes. So I think that we have been focused on that 2% to 3% absolute expense creep for, you pointed out, a long time now. We continue to think that that's the appropriate level for us. Obviously, if we see meaningful drop off in revenues, we'll have to respond to that. And unfortunately, what's been a component of expenses all along has been a fair amount of investment or reinvestment, if you will, into a number of efficiency moves down the digital path.

And so we are hopeful that irrespective of what happens on the revenue side moving forward, we'll begin or we'll increasingly begin to see the benefits of those investments take place.

Speaker 7

Understood. Thanks for taking my question.

Speaker 0

And our next question comes from Aaron Deer with Sandler O'Neill. You may proceed.

Speaker 5

Hi, good morning everyone. Peter, it seems like the Hawaii economy continues to hold up pretty well. I'm just curious to get your thoughts on kind of where pipeline stands today. And I guess year to date you guys have kind of been growing about 6% annualized. As you kind of look out into 2020, do you think that's a reasonable pace to maintain through at least the early part of next year?

Speaker 2

Yes. So I think that the crux of the question, Aaron, is around where we are in the cycle more than the health of the Hawaiian economy. Hawaiian economy, I think my view is it remains pretty darn stable. We do view ourselves to be later cycle, if you will. And so what begins to creep up has to do with credit selection and credit retention for that matter.

So we are seeing some elevated levels of exits, if you will, in

Speaker 5

our commercial

Speaker 2

portfolio. Obviously, that's putting some strain on our pay downs. Interesting statistic, the third quarter was our second best production quarter in the past eight quarters, but it was also our second highest payoff quarter in the past eight quarters. So we got the numbers we got on the commercial front. So I see that as a bit of a headwind, a touch of a headwind, market conditions remaining pretty solid.

I'd also say, as Mary mentioned, that we don't foresee any strategic repositionings in any of our portfolios. So we have that as a bit of a tailwind at our back. So where that all aggregates to, in our view, looking forward into next year, it's kind of a mid single digit loan growth factor. I think historically, of in the recent past, we've been talking about a mid to higher single digit level. I think I'd probably place our sentiment around the mid space more than the higher mid.

But I mean, we'll see where we go from here.

Speaker 5

Sure. It seems reasonable. And then on the deposit side, obviously, this quarter this past quarter, you had some outflows out of the public deposits. But presumably, you see some uptick here heading into year end. And then as we get into 2020, the deposit costs, it looks like those have started to come down some.

Is it your expectations kind of based on where the competitive market stands now that there's going to be more room to bring down deposit costs and maybe help give some relief to the margin next year?

Speaker 2

Yes, I hope so. So you covered a lot of real estate there, Aaron. So yes, and really kind of a lot of what we're thinking about these days, as you might imagine. Deposit wise, we were down on a linked basis 1%, but note that that decline really came out of our public book. So our core commercial and consumer deposit base, consumer in particular performed well on a linked basis.

And I think the important thing is that all three of those businesses, public consumer and commercial, were up over 3% on a year on year basis. And we consider that to be about where we want to be right now because as you alluded to the rate environment is just so darn uncertain. And so where we're positioned right now is to take advantage of our liquidity position and our loan to deposit position, which is the strongest in our market and try and take a pretty darn conservative approach to pricing because to be honest, we can't figure out whether rates are going to go up or go down. Our best course is to remain relatively conservative on the pricing front and relatively conservative on the term front against the deposits that we're putting out there.

Speaker 5

Okay. And then just a quick one for Dean. You guys had a fair bit of noise this year, guess, the first quarter than a couple of items in this coming in the fourth quarter in tax line. Prospectively for 2020, should we be thinking about a kind of 21%, 22% range for the effective tax rate?

Speaker 3

Right now, it's hard to say. We haven't completed our budget yet. We're still going through the process. So I would not want to give guidance yet.

Speaker 5

Okay. All right. Thanks for taking my questions.

Speaker 2

Thanks, Arun.

Speaker 0

And our next question comes from Jackie Bohlen with KBW. You may proceed. Hi everyone. Good morning.

Speaker 2

Hi Jackie.

Speaker 8

I just wanted to Peter, just kind of more broadly in terms of the economy, kind of understanding where we're at in the cycle. If you could talk about you mentioned in your prepared remarks, both visitor spending that has been coming down a little bit and then also a softening in the condo market and just some of the drivers of that and getting slower construction and condos as part of it, but just any thoughts you have on that and then how that equates into what you're thinking about in terms of where we are in the cycle understanding we're probably pretty later?

Speaker 2

Yes. I think you just I think you hit it on the head. The both the visitor industry as well as the real estate market here have been chugging along quite nicely for a pretty extended period of time now. And I think what we're seeing in the numbers is basically comping off of what's been years of growth and a little frankly, a little flattening of activity. So real estate, I would still call our market to be stable, although not growing terribly much at this point.

Given where we are from an underwriting standpoint, the way we're positioned balance sheet wise, that's a pretty reasonable outcome from what we see at this point of the cycle. On the visitor front, a couple of things are working against us. I mentioned that we're just working against a larger and larger denominator, number one. But remember that dollar strength has been around for several years now. And that's beginning I think that's beginning to show up in the international numbers.

So spending as well as days has been soft internationally. I think what we're seeing is a little bit of relative trade to potentially other more valuable marketplaces like Europe versus Hawaii for some of our Canadian, Australian, non Japanese customers. The Japanese yen actually has traded pretty strongly over the past several years. So that's been a benefit to us, but we're watching that pretty closely as well. So that's kind of how I would view the visitor industry and the market as a whole.

Speaker 0

Okay. Thank you. That's great color. And then just one last one

Speaker 8

for me, probably for Mary. Do you have any color that you can provide on how you're thinking about CECL and where the reserve might trend? Or if you're not disclosing at this point when you expect to?

Speaker 4

Sure, Jackie. Well, we've completed several parallel runs and to date we're not seeing any material impact in the conversion to CECL. And it really reflects our portfolio composition and the fact that it's heavily weighted to assets with historically very low charge off rates and some reallocation within the reserve composition based on the life of loan concept. Clearly, won't know until we actually implement and what the conditions are at that point. But so far, it doesn't look to be a big issue for us.

Speaker 0

Okay, great. Thank you.

Speaker 2

Thanks, Jackie.

Speaker 0

And our next question comes from Laurie Hensicker with Compass Point. You may proceed.

Speaker 9

Thanks. Hi, good morning. Just wondered if we could go back over to deposits. Do you have the piece that's the public time?

Speaker 2

Public time is six sixty five, right?

Speaker 3

Six sixty five? Yes.

Speaker 9

Okay. And then how are you thinking about that bucket going forward, both the $665,000,000 and the 1,000,000,000 point dollars of total?

Speaker 2

$1,294,000,000 right. Well, so the way that we look at that portfolio is about half of that are operational effectively relationships that we have with the various municipalities in our marketplace. The other half are time, less relationship, very price sensitive, right, rate sensitive. And so I would say that for half of the 1,000,000,000 point dollars we would like to retain and or grow that business because it's good sticky business for us. For the other half, when rates are low, they tend to be good value sources of funding for us.

As rates elevate as they did last year, not so much because obviously municipalities have a fiduciary obligation to get the highest rate they can in whatever markets they can get those rates. So that's basically how we think about it, Laurie.

Speaker 9

Okay. And then I saw I mean you took your cost of deposits down in every single category. Is there any planned reduction that is maybe happened early in the fourth quarter that will continue to see that trend? Or how should we be thinking about that?

Speaker 3

Yes. I mean, manage the rate pretty closely and we'll where we have opportunities continue to reduce the rates.

Speaker 9

Okay. Or maybe just sorry, just one more question on this. Asked another way, if we look at your core deposits, ex ing out all CDs, so 88% of your deposits here are core and those were costing 29 basis points. And obviously, you've got a huge chunk of non interest bearing. But in other words, as we think about where that cost could trend down to, how should we think about that?

Speaker 3

Well, don't know what the ultimate low point would be, but I would say that the trend would be lower subject to our local market competition.

Speaker 9

Okay. Okay. And one more question on margin here. Do you have the premium amortization number for this quarter? Comparatively it was 5.8% last quarter?

Speaker 3

It was 6.4% this quarter. Point 2%.

Speaker 9

Sorry. Point

Speaker 3

4%. Sorry. 6604. 4

Speaker 9

Okay, great. Thanks. I'll leave it there.

Speaker 3

Okay, Larry. Thanks.

Speaker 0

And we have a follow-up question from Ebrahim Poonawala with Bank of America. You may proceed.

Speaker 7

Hey guys, just a quick follow-up on capital return, Peter. Like when you think about buyback activity going forward, you obviously raised the dividend. But just talk to us in terms of capital payout and capital ratios. Do you expect to sort of manage the bank to where the ratios are? Or should we expect excess capital return in excess of earnings to occur over the next few quarters?

Speaker 2

No, we wouldn't and haven't for quite some time returned capital in excess of our earnings. Generally, our policy is and has been for a long time, 50% over time, percent of our dividends our dividends is 50% of our earnings and the remaining balance to growth and stock buyback to up to 100% of earnings. That's the way we think about it.

Speaker 7

And Peter, do you think about the valuation stock price when you're thinking of it where given how you talked about sort of where we are in the cycle, is there any desire to maintain excess capital right now or the cycle doesn't really impact how you think about capital strategy?

Speaker 2

Well, it's a good question. It's a question we seem to have gotten a fair amount over the years and less and less more recently. So yes, I mean, the economic conditions, the condition of our own balance sheet and capital needs, our growth prospects as well as what we how we view the intrinsic value of our stock clearly play into our quarterly buyback decisioning, Board's quarterly buyback decisioning. To date and we continue to believe that the stock remains an attractive vehicle for us to repurchase. And I think we see that often in the near future as well.

Speaker 7

Got it. Thank you.

Speaker 6

Ladies

Speaker 0

and gentlemen, this now concludes our Q and A portion of today's call. I would like to turn the call to Cindy Wyrick for any closing remarks.

Speaker 1

I'd like to thank everyone again for joining us today and for your continued interest in Bank of Hawaii. As always, please feel free to contact me if you have additional questions or need further clarification on any of the topics discussed today. Thanks everyone again and have a great day.

Speaker 0

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone have a great day.