Bank of Hawaii Corporation (BOH) Q3 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. And welcome to the Bank of Hawaii Corporation Third Quarter 2019 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Director of Investor Relations, Cindy Wyrick. Ma'am, you may begin.

Thank you, Demetrius. Good morning, good afternoon, everyone. Thank you for joining us today as we review the financial results for the third quarter of 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.

Thanks, Cindy. Aloha, and good morning, everyone. Thanks for joining us today. The third quarter of 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 remained strong. Our loans grew to $10.9 billion 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 $15.3 billion, down from 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?

Thank you, Peter. Net income for the third quarter of 2019 was $52.1 million 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 third quarter of 2019 included the previously disclosed increase in our legal reserves of $6 million 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 3 basis points from the previous quarter and 6 basis points from the same quarter last year. Net interest income on a reported basis for the third quarter of 2019 was $124.9 million, up $800,000 from the second quarter and up $2 million from the third quarter of last year. The decline in the margin for the third quarter of 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 4 to 5 basis points. As Mary will discuss later, we recorded a credit provision of $4.3 million this quarter. Non-interest income totaled $46.5 million in the third quarter of 2019 compared with $45.5 million in the previous quarter and $41.5 million in the same quarter last year. The third quarter of 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 non-interest income during the second quarter of 2019 or third quarter of 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 million during the fourth quarter of 2019, excluding a previously announced gain of $3.8 million related to the early buyout of a leveraged lease. Non-interest expense totaled $100.3 million in the third quarter of 2019, including the legal reserve, up from $92.7 million in the previous quarter and $90.5 million in the same quarter last year. There were no significant items in non-interest expense during the second quarter of 2019 or the third quarter of 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 million. The effective tax rate for the third quarter of 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 22% and 23%, which includes a one-time increase of $2.1 million related to tax adjustment items that will offset the previously disclosed $1.8 million credit related to the early buyout of a leveraged lease. Our investment portfolio was $5.5 billion at the end of the third quarter. Premium amortization during the quarter was $6.4 million, up from $5.8 million in the previous quarter, and down from $8.8 million in the same quarter last year. We purchased a total of $312 million 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 2.9 years at the end of the third quarter of 2019. The held-to-maturity portfolio duration was 3.6 years. And the duration for the total investment securities portfolio was 3.3 years. Our total shareholders' equity was $1.3 billion at the end of the third quarter, our Tier 1 capital ratio was 12.33% and our Tier 1 leverage ratio was 7.32%. During the quarter, we paid out $26.3 million or 51% of net income in dividends, and repurchased 360,000 shares of common stock for a total cost of $29.9 million. We repurchased an additional 92,000 shares between October 1st and October 25th at a total cost of $7.8 million. And finally, our Board declared a dividend of $0.67 per share for the fourth quarter of 2019. Now, I'll turn the call over to Mary Sellers.

Thank you, Dean. Net charge-offs for the third quarter totaled $3 million or 0.11% annualized of total average loans and leases outstanding, as compared with net charge-offs of $2.4 million or 0.9% annualized in the second quarter of 2019, and $3.3 million or 0.13% annualized in the third quarter of 2018. Non-performing assets were $21.6 million or 20 basis points at the end of the third quarter, down from $21.8 million or 20 basis points at the end of the second quarter, and up from $13.8 million or 13 basis points at the end of the third quarter of last year. Loans past due 90 days or more and still accruing interest were $6.1 million, down $300,000 for the linked period and down $2 million year-over-year. At the end of the quarter, restructured loans not included in non-accrual loans or loans past due 90 days or more were $46.2 million, down $2.4 million from the second quarter of 2019 and down $3.3 million from the third quarter of 2018. The allowance for loan and leases totaled $108.9 million at the end of the quarter, up $1.3 million from the second quarter. Accordingly, given net charge-offs of $3 million, a credit provision of $4.3 million 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 6 basis points year-over-year. The total reserve for unfunded commitments was $6.8 million at the end of the quarter, unchanged from the second quarter of 2019 and the third quarter of 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 58%, and 60% 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 Hawaii and 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 turns in the economic cycle. I'll now turn the call back to Peter.

Thanks, Mary. The Hawaii economy remains stable through the third quarter of 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 2019 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 remained stable. Condominium sales, however, continued 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 3.5 months for single-family homes and 3.9 months for condominiums. The year-to-date median number of days on market was 23 days for a single-family home and 26 days for a condominium. Thanks again for joining us today. And now, we’ll be happy to respond to your questions.

[Operator Instructions] And our first question comes from Jeff Rulis with DA Davidson. You may proceed.

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, are the variable -- if that's possible to kind of break that out?

Well, if you look at the breakdown for salaries that we have it in one of the tables, the increased quarter-over-quarter is mainly due to the additional work day. So, that adds about $0.5 million to the expenses. And a lot of the -- rest of the increase in salaries and benefits is due to the elevated level of separation for the quarter.

And then, the other question on the expense side is that just the rise in the net equipment line was there to make significant quarter-to-quarter. That seemed like that popped up a bit.

No. It reflects our continued investment. And generally the IT space is what hits that line. And so, that we do have a number of projects that are being completed. So, the depreciation is starting as well as some of the software costs.

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

Yes, it 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.

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

First question, I wanted to follow-up on the margin guidance around -- I believe you said about 4 basis points to 5 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, and if the Fed were to stop, let's say, in 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.

Ebrahim, just rate hikes or rate drops?

Rate drops? Sorry, if I misspoke.

Sure. Rate drops. I was confused. That's what I thought. Yes. Okay. So, the guidance I provided included an expected 25 basis-point rate cut this week by the Fed. There is 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 -- cuts at the short end of the curve have a minimal impact on us about 1 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 stayed low, the margin will probably stay at the lower end of this range here.

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

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

Got it. Four or 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 3% expense inflation is something that we're going to have to live with even if the revenue environment worsens?

Yes. So, I think that we have been focused on that 2% to 3% absolute expense creep for, as you pointed out, a long time now. We continue to think that that's the appropriate level for us. Obviously, if we see a meaningful drop off in revenue, 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 of, 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 increasingly begin to see the benefits of those investments take place.

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

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 kind of have been growing it 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?

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 our commercial portfolio. Obviously, that's putting some strain on our paydowns. Interesting statistic -- the third quarter was our second best production quarter in the past eight quarters. 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 at 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 in the next year, it's kind of a mid-single-digit loan growth factor. I think, historically and kind of in the recent past, we've been talking about a mid to higher single digit level. I think, that probably placed our sentiment around the mid space more than the higher mid. But, we'll see where we go from here.

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 you're 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 is going to be more room to bring down deposit costs, and maybe help give some relief to the margin next year?

Yes. I hope so. So, you covered a lot of real estate there. And so, yes, and really kind of a lot of what we're thinking about these days, as you might imagine. The 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 the rates are going to go up or go down. So, 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.

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

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 a guidance yet.

Okay. All right. Thanks for taking my questions.

Thanks, Aaron.

And our next question comes from Jackie Bohlen with KBW. You may proceed.

So, 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 I'm guessing lower 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.

Yes. I think you hit it on the head. 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 flattening of activity. So, real estate, I would still call our market to be stable, although not growing terribly much at this point. And given where we are from an underwriting standpoint and where 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, 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 have been soft internationally. And I think, what we're seeing is a little bit of a relative trade to potentially other more valuable marketplaces, like Europe versus Hawaii for -- sort 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 in the market as a whole.

And then, just one last one 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?

Sure, Jackie. Well, we've completed several parallel runs, and to-date, we are not seeing any material impact in the conversion to CECL. And it really reflects our portfolio composition and the fact 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, we 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.

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

Thanks. Hi. Good morning. I just wondered if we could go back over to deposits. Do you have the piece what's the public time?

Public time is $665 million. Right? $665 million?

Yes.

Okay. And then, how are you thinking about that bucket going forward, both the $665 million and the $1.3 billion of total?

$1.294 billion, 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 $1.3 billion, 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.

Okay. And then, I thought -- I mean, you took your cost of deposits down in every single category. Is there any planned reduction that has maybe happened early in the fourth quarter that we’ll continue to see that trend or how should we be thinking about that?

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

Okay. Maybe just -- sorry, just one more question, asked another way. If we look at your core deposits, so axing out all CDs, so 88% of your deposits here are core, and those are 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?

Well, I 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.

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

Yes. It was $6.4 million -- $6.2 million.

$6.2 million? Okay.

$6.4 million -- sorry, $6.4 million.

$6.4 million? Okay, great. Thanks. I'll leave it there.

Okay, Laurie. Thanks.

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

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?

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 50% of our dividends -- 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.

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 just the cycle doesn't really impact how you think about capital strategy?

Well, it's a good question and 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 -- versus quarterly buyback decisioning today, and we continue to believe the stock remains an attractive vehicle for us to repurchase. And I think, we see that often in the near future as well.

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

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.

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