Bank of Hawaii Corporation (NYSE:BOH) Q3 2022 Earnings Conference Call October 24, 2022 2:00 PM ET
Company Participants
Jennifer Lam – EVP, Treasurer and Director of IR
Peter Ho – Chairman, President and CEO
Dean Shigemura – VC and CFO
Mary Sellers – VC and Chief Risk Officer
Conference Call Participants
Jeffrey Rulis – D.A. Davidson & Co.
Kelly Motta – Keefe, Bruyette & Woods, Inc.
Andrew Liesch – Piper Sandler & Co.
Laurie Hunsicker – Compass Point
Operator
Good day, and thank you for standing by. Welcome to the Bank of Hawaii Corporation Third Quarter 2022 Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker’s presentation there’ll be a question-and-answer session. [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, Jennifer Lam, Senior Executive President and Treasurer, Director of Investor Relations. Please go ahead.
Jennifer Lam
Good morning. Good afternoon, everyone. Thank you for joining us today.
On the call with me this morning 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 the actual results may differ materially from those projected.
During the call, we’ll be referencing a slide presentation as well as the earnings release. A copy of the presentation and release are available on our website boh.com, under investor relations,
And now I’d like to turn the call over to Peter Ho.
Peter Ho
Thanks, Jennifer. Aloha, and good morning or good afternoon, everyone. Thanks for your continued interest in Bank of Hawaii.
Q3 was another solid quarter for the bank. Loan growth, net of PPP loans, registered another solid quarter, up 2.9% for the linked quarter and 12.7% year-over-year. Our growth was balanced across both consumer and commercial categories, and sourced predominantly from our core Hawaii and West Pacific markets. Production quality was strong.
Overall deposits were down 0.7% of the quarter on a linked basis resulting from lower public deposits. Consumer and commercial deposits were essentially flat in the quarter. Non-interest bearing demand deposits as a percentage of overall deposits remained steady at 35%. Deposit betas continued to perform quite well and our 64% loan-to-deposit ratio gives us funding and pricing flexibility.
While betas will naturally rise further as overall market rates peak, we believe the strong core nature of our deposit base, being 50% consumer and 42% commercial, the granularity of our deposits, with nearly half of our combined consumer and commercial deposit balances sitting in accounts sized under a $0.5 million. And the overall liquidity of the Hawaii deposit market positions us quite well.
Net interest income and net interest margins improved nicely in the quarter, as Dean will share with you in a moment. Recurring non-interest revenue was lower in the quarter. Much of the drop was as a result of sharply higher market interest rates in the quarter. Credit remains pristine.
During the quarter, we took a $6.9 million charge to terminate a lease entered into in 2000. Bank of Hawaii was active in the national leveraged lease market from 1987, to 2004. 2005 we made the strategic decision to exit this business and begin the orderly wind down of our portfolio. With the termination of this lease, I’m pleased to note that we have now effectively exited the leveraged lease business. As we look forward, higher rates and the specter of recession position as well on a relative basis, given the quality of our deposit franchise, our liquidity and our history of risk conservatism.
As is our custom I’ll share with you now some commentary on market conditions. Dean will follow with more detail on our financials, and Brian will close with some commentary on our risk position. We will be then happy to answer your questions.
So on this slide, you can see unemployment levels have actually reached a bit of a milestone. So unemployment as of September is now down to 3.5%. The significance of that is basically we are now at parity with the U.S. national average for the first time really since the beginning of pandemic.
Turning to the visitor market, which you see here is continued strong performance overall. And in particular with our US domestic visitor. You see in that light blue band down on the bottom, really the beginning of the return of Japanese visitors. So in October of this year, the government, the Japanese government basically opened the lanes to Japanese to make trips abroad again. And we’ve been able to experience that here in the islands, starting off slowly and I think perhaps that the yen conversion rate may impact the overall outcome. But nonetheless happy to see Japanese visitors returning to the islands and potentially a nice buffer against potential economic slowdown conditions on the U.S. Mainland.
On next slide, you see revenue per available room, RevPAR performing quite nicely versus last year and performing quite nicely versus even pre-pandemic levels. And then, finally, the local real estate market as demonstrated by the Oahu market for single family homes and condominiums.
Despite the spike in interest rates, recently continues to perform pretty well, bringing [ph] sales prices, September on September still positive for both single family homes as well as condominiums. Inventory and days on market slowing a bit, but still pretty tight conditions and still lower pretty meaningfully versus pre-pandemic levels.
So now let me turn the call over to Dean who will share with you some updates on our financials Dean?
Dean Shigemura
Thank you, Peter. We again realized strong loan growth in the quarter. Core loans net of PPP pay downs increased by $379 million, or 2.9% linked quarter, and by 1.5 billion or 12.7% year-over-year. Growth was again balanced across both commercial and consumer loan portfolios at 2.9% and 3% Link quarter respectively, and 11.6% and 13.4% year-over-year respectively. The robust double digit annualized growth trend has led to significant market share gains in our primary lending market, where we hold the largest market share.
As Mary will discuss later growth has — growth was achieved while maintaining our conservative underwriting and disciplined portfolio management practices, with our commercial and consumer loan portfolios remaining predominantly real estate secure. Deposits decreased by $137 million or 0.7% linked quarter, an increase by approximately $400 million or 1.9% from a year earlier. The link quarter decrease was primarily in our public deposits.
Overall, our deposit mix remained relatively unchanged for the quarter, with core deposits continuing to provide a stable source of low cost funding in a rising rate environment. More than 70% of our deposit customers have been with us for over 10 years and nearly half for more than 20 years. 93% of deposits are from core commercial and consumer customers and the remaining 7% consists of public deposits that are predominantly government operating accounts.
94% of total deposits are in court checking and savings accounts with 35% in non-interest bearing and only 6% in time deposits.
Our total deposit costs remain well contained with average total deposit costs of 20 basis points in the quarter, and a total deposit beta of 5% cycle-to-date. Net interest income in the third quarter was $141.7 million which included $200,000 from PPP loans. Adjusting for the PPP interest income, core net interest income was $141.4 million up 10.1 million or 7.8% linked quarter, and up $22.5 million or 19% from the third quarter of 2021, driven by continued strong loan growth and rising interest rates.
Net interest income and margin growth are being supported by our balance sheets, asset sensitive position that benefits from higher rates. 60% of our earning assets will reprice or turn over in the next two years with sizable cash flows from both loan and investment portfolios. The yield differential between new and maturing loans was approximately 85 basis points in the third quarter, and is expected to increase to approximately 110 basis points in the fourth quarter. The yield differential from investment runoff is 2.5% to 3% if we invested in securities and more than 3% if we invested in loans. These cash flows will support continuing growth in net interest income and enable us to position the balance sheet for evolving interest rate environments.
In the third quarter, we maintained overall expense discipline while continuing with our innovation investments. Non-interest expense in the third quarter totaled $105.7 million. Included in the third quarter expenses were severance expenses of $1.8 million as we continue to adjust our workforce for the evolving economic environment, and will lead to annualized savings of $2 million.
Adjusting for the one-time severance the third quarter’s expenses were $103.9 million, an increase of $1 million linked quarter, primarily due to our continued commitment to invest in our business. This was partially offset by our core expenses, which were slightly lower.
For the full year of 2022, expenses normalized for the $1.8 million severance expense in the third quarter will be approximately $415 million, which is unchanged from previous guidance, or approximately $417 million on a reported basis when including the severance. In the third quarter of 2022 net income was $52.8 million in earnings per common share it was $1.28.
Net interest income in the third quarter was $141.7 million. As discussed earlier core net interest income, which excludes PPP interest income was $141.4 million up $10.1 million linked quarter, driven by strong core loan growth and rising interest rates. As Mary will discuss later, we did not record a provision for credit losses this quarter.
Non-interest income totaled $30.7 million in the third quarter, down $11.5 million from the second. The third quarter’s income was impacted by a one-time $6.9 million charge related to the loss on sale of leased equipment and a $900,000 charge related to a change in the VISA Class B conversion ratio. The sale of the leased assets and termination of the last leveraged lease which was originated in 2000 competes our exit from the leveraged lease market with no remaining residual exposure.
There were two additional contra revenue items in other non-interest income totaling $1.1 million related to hedging of foreign currency deposits and a charge paid on collateral received related to customer swap transactions. There was no overall impact to income as equal and offsetting benefits were recognized in net interest income. Thus non-interest income was reduced by approximately $1.1 million and net interest income was higher by $1.1 million.
Market volatility and higher interest rates resulted in decreases in asset management fees, mortgage banking income and swap revenue. We expect non-interest income will be approximately $39 million in the fourth quarter. High rates and volatile market conditions continue to pressure mortgage banking income and asset management fees.
Our return on assets during the third quarter was 0.91%, the return on common equity was 16.98%, and our efficiency ratio was 61.37%. The changes from the prior quarter were primarily driven by the one-time items impacting the third quarter. Both reported and core net interest margin was 2.60% linked quarter, with linked quarter increases of 13 [ph] and 16 basis points respectively.
While the margin will continue to benefit from higher rates, reinvestment, mix shifts and long growth, accelerating deposit betas will temper increases. Thus we expect growth in margin will be approximately five basis points in the fourth quarter. The effective tax rate in the third quarter was 20.7%. As part of the aforementioned sale to the leased equipment, we recognized a tax benefit of $1.8 million that reduced our tax provision in the third quarter. The tax rate in the fourth quarter is expected to be approximately 23%.
As market conditions continue to evolve, we are maintaining our strong capital and liquidity levels, both positioned to support continued growth opportunities. Our loan to deposit ratio remains low relative to regional and local peers and affords us room to continue growing our assets while maintaining greater pricing flexibility.
Our capital levels remain strong. Our CET 1 and total capital ratios were 11.42% and 13.82% respectively, with a healthy excess above the regulatory minimum well capitalized requirements. Despite robust loan growth, our risk-weighted assets relative to total assets are still well below the levels of our peers, reflecting our lower risk profile and providing us with ample room to continue growing, while maintaining strong capital levels.
During the quarter, approximately $1.3 billion in market value of securities were transferred from the available for sale portfolio to the held to maturity portfolio in order to reduce the sensitivity of the ALCI [ph] to higher interest rates. During the third quarter, we paid out $28 million or 55% of net income available to common shareholders in dividends and $2 million in preferred stock dividends. We repurchased 187.5 thousand shares of common stock for a total of $15 million.
And finally, our Board declared a dividend of $0.70 per common share for the fourth quarter of 2022.
Now I’ll turn the call over to Mary.
Mary Sellers
Thank you, Dean. Our loan portfolio construct with 97% in Hawaii and Guam assets continues to reflect our strategy of lending in markets we know and to people who we understand — we know. These underpinnings, coupled with consistent conservative underwriting and disciplined portfolio management result in a loan portfolio that is diversified by categories, has appropriately sized exposures and is 80% secured by quality real estate with a combined weighted average LTV of 56%.
Credit performance remained very strong in the third quarter. Net loan and lease charge-offs were $1.1 million or three basis points of average loans and leases annualized, compared with two basis points in the second quarter, and four basis points in that third quarter of last year. Non-performing assets totaled $15.5 million or 10 basis points at the end of the quarter, down two basis points for the linked period and down seven basis points year-over-year. All non-performing assets are secured with real estate with a weighted average loan to value of 58%.
Loans delinquent 30 days or more totaled $24 million or 18 basis points, down $3.6 million or three basis points from 2Q and down $4.3 million or five basis points year-over-year. And criticized loan exposure represented just 1.12% of total loans down 18 basis points from the prior quarter and 119 basis points year-over-year, driven by continued sustained improvements in the financial performance of those customers who had been most impacted by COVID.
The quality of our loan production remained strong. Year-to-date 68% of commercial production is secured with quality real estate conservatively leveraged. Commercial mortgage production has a weighted average loan to value of 59% and construction production has a weighted average loan to value of 74%. 78% of year-to-date consumer production is secured with real estate, again conservatively leveraged. Residential mortgage and home equity production of weighted average loan to values and combined weighted average loan to values of 64$ and 59% respectively.
74% of home equity production is in first lien. Similarly, FICO scores for all our consumer production remain very strong and consistent. Portfolio monitoring metrics also remain very strong. Our commercial mortgage construction portfolios — our commercial mortgage and construction portfolios have weighted average loan to values of 56% and 63% respectively, and our residential mortgage and home equity portfolios have weighted average loan to values or combined loan to values of 57% and 52% respectively.
72% of the home equity portfolio is in a first lien position. And monitoring FICOs remain very strong. At the end of the quarter, the allowance for credit losses was $146.4 million, down $2.1 million for the linked quarter, and the ratio of the allowance to total loans and leases outstanding was 1.1%, down five basis points from the prior quarter. The decrease in coverage this quarter is driven off the return of international visitors and the continued reduction in the impact of COVID on travel and economic activity in our core markets.
The reserve continues to consider the downside risk of a recession and the impacts of inflation and rising interest rates. The reserve for unfunded credit commitments was $6.5 million at the end of the quarter, up $900,000 for the linked period.
I’ll now turn the call back to Peter.
Peter Ho
Thanks, Mary. Thank you again for your interest and we’ll be happy to answer your questions at this time.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions]. And one moment for our first question. And our first question comes from Jeff Rulis from D.A. Davidson. Your line is now open.
Jeffrey Rulis
Thanks, good morning.
Peter Ho
Good morning, Jeff.
Jeffrey Rulis
Be interested in sort of tracking interest bearing deposit average rate that increased. Is that in line with your expectations? Just really looking for some color about how you’re approaching? Is it, one-off customer requests or anything that led to that increase linked quarter? I think you mentioned a 5% cycle debate — cycle-to-date beta. So just trying to check in on the interest bearing cost increase.
Dean Shigemura
Yeah, in terms of the beta cycle-to-date, it’s pretty much in line in terms of what we had been expecting, and how we’re managing the overall deposits. Clearly, the more interest rate sensitive customers tend to be our higher end customers. And those are where we’re having to pay up a little bit more than the average rate. However the total portfolio, deposit portfolio itself has been kind of been well in line with what we had been expecting to-date. And the RAC rates have been very muted in terms of increases.
So it’s really kind of being driven by the market, increases in rates, the rapid rise in rates, and where we’re having to adjust our deposit prices.
Peter Ho
Yeah, Jeff, maybe I’ll just add that, overall I’d say we’re pretty — we’re actually more than satisfied with kind of where the betas are falling out at this point. That’s not to say that with the sudden and rapid increase in rates, that there isn’t some latent deposit pricing to follow. But kind of where we stand right now, we feel pretty good about where we are beta wise.
Jeffrey Rulis
Thanks. Just on a related — just the deposit balances. Any thoughts on looking at 2023? And is the idea just to simply maintain balances? It looks like the public funds side is — those balances are moving around a bit. But what would you couch deposit growth on net — for ’23, either specific or just generally speaking, how should we think about balances?
Peter Ho
I think that, well, I think given where we are from a loan to deposit standpoint, we don’t feel obviously intense pressure on the pricing side. And frankly, that may impact balances somewhat. So kind of I think where we are aspirationally, around deposits for the next — the next several quarters, is flat to up modestly, would be a pretty good outcome for us while still being able to maintain and improving margins.
Jeffrey Rulis
Right, and maybe one last one, Peter on the — just the buyback and again, I’m sure you get asked a lot about that. The PCE ratio generally hasn’t been a concern of yours. It’s there’s just checking about buyback appetite in the general capital level. Any thoughts on that front?
Peter Ho
I think given where our currency is, right now, we’re very anxious to be buying. So we will be active again this quarter. We’re tempered a bit by, as you allude to, some of the capital considerations, as well as just kind of overall economic conditions. We’ve got a great portfolio of asset burning assets. But we just can’t get away from the fact that given where rates have gone, we’ll just have to see in the next couple of quarters, what that means for us from an overall economic standpoint.
But I think the bottom line, Jeff is we want to be an active purchaser of our stock at these prices, for sure. And we’ve got the liquidity and earning power to do that.
Jeffrey Rulis
All right, appreciate it. Thanks.
Peter Ho
Thank you.
Operator
And thank you. And one moment for our next question. And we do please ask that you limit yourself to one question and one follow-up. And our next question comes from Kelly Motta from KBW. Your line is now open.
Kelly Motta
Hey, good morning. Thanks so much for the question. Loan growth was really strong this past quarter. Just wondering, especially to with the return of foreign tourism, as you look out what your expectation is for growth on a go forward basis.
Peter Ho
Yeah, so good question, Kelly. So we were nearly 12% annualized this quarter. So we were obviously happy to generate that kind of growth. It was done in market, great quality assets. But as we look forward, I think, maybe tipping a little bit towards a potential U.S. Mainland slowdown, and potentially a little bit slower return to visitor from the Japan market because of the dollar-yen situation.
I think we’re more comfortable is in kind of the higher single digit to potentially just touching on double digit annualized kind of loan growth at this point.
Kelly Motta
Got it. That makes sense. And then kind of circling back to the previous question on in terms of how to fund the growth. Can you remind us how much — what the cash flows are off your securities book? And if it seems like if deposit growth is kind of flattish, maybe down slightly? Do you intend to fund incremental loan growth with the cash flows off of the securities book, as well as if you could provide a roll off yield of the security folks that would be really helpful?
Peter Ho
Yeah, so in the third quarter investment, runoff was about $263 million. And then what we have projected out is roughly, it’s $900 million. So we did take into account the higher rates that there might be a touch slower going forward. But in general, if you look at the third quarter, most of the loan growth was funded by the — most of it was funded by the investment portfolio. And that would be the plan if deposits were flat. In terms of the runoff yield, it was about 1.9%.
Kelly Motta
Do you expect similar yield of similar runoff yields going forward at least in 4Q?
Peter Ho
Very similar. I mean, it might be, you know, basis point or two higher, but generally around there. I would say 1.90% to 2%.
Kelly Motta
Got it. Maybe just one housekeeping item for me. Would your fee guidance, that’s inclusive of the VISA class B payments. Is that correct?
Peter Ho
Yes.
Kelly Motta
That’s an all-in number.
Peter Ho
Yes.
Kelly Motta
Thank you. I will step back. Appreciate the time.
Peter Ho
Thanks Kelly.
Operator
Thank you. And thank you, and one moment for our next question. And our next question comes from Andrew Liesch from Piper Sandler. Your line is now open.
Andrew Liesch
Hey, good afternoon, everyone. Good morning, everyone. Thanks for taking my question. I’m looking at the expense guide into next year. So just maybe about $104 million here in the fourth quarter. Is that a good jumping off point? I think in the past you’ve mentioned, like normal annual inflation in cost of about 4%. Is that how we should be looking at 2023?
Peter Ho
Yeah, I think So Andrew, netting out the severance, actually, that we took this quarter. So coming off of the 4.15% run base that we have been quoting for a while for the ’22 year.
Andrew Liesch
Got you. All right, that’s helpful. And then actually you know what you covered all the other questions I have. Thanks so much for that.
Peter Ho
Thank you.
Operator
And thank you. And our next question comes from Laurie Hunsicker from Compass Point. Your line is now open.
Laurie Hunsicker
Yeah. Hey, thanks. Good morning. I just wanted to go back to expenses, just on page 12 of your deck, the $1.3 million here of innovation, was that one time and also the $2 million of annual savings, I guess through three branch closures, did any of that actually start this quarter or? Or that starts into next quarter?
And I guess Andrew touched on it a little bit with the 104. I’m just trying to understand it a little better.
Peter Ho
Yeah, let me first start with the 2 million that is not related to branch closures. That is related to some of the adjustments we made to our workforce. And the savings actually will start mainly in 2003. Some of the exits are occurring in the fourth quarter. So really the run rate is going to be impacted in 2023.
In terms of the $1.3 million investment, it’s part of our ongoing program to continue to reinvest into the company, and kind of position us for the future.
Laurie Hunsicker
So that continues, or I guess maybe asked a different way, so the cost savings that you’re going to get from the branch closures, it’s not in that $2 million number. I guess what is that? Or is that just going to be reinvested? It doesn’t — it doesn’t actually go to the bottom line.
Peter Ho
So the $2 million, Laurie, what — I’m just trying to understand what you’re referencing there.
Laurie Hunsicker
No…
Dean Shigemura
The $2 million yeah, the $2 million savings is not related to the branch closure.
Laurie Hunsicker
Right. But then you just closed three branches in the quarter, correct?
Dean Shigemura
No, we did not.
Laurie Hunsicker
Okay, I was looking — I thought you went from 54 down to 51 branches. You know what, I can follow up with you offline. Just one more very quick question for me. In terms of your public deposit of $1.5 billion, how much of that was time?
Dean Shigemura
Public deposits were at $180 million. Yeah, so time went from one-eight [ph] to 180.
Peter Ho
Yeah. Okay. Great. I’ll follow up with you on branches offline. Thank you very much. Thank you.
Operator
And thank you. And our next question comes from Kelly Motta from KBW. Your line is now open.
Kelly Motta
Hey, thank you so much for the follow up. I appreciate all the commentary around margin and deposit betas. Just wondering if we could take it out a bit further in terms of where we think NII and margin should peak and kind of — I think you had said five basis points of margin expansion this quarter. Do you think we can get further expansion into 2023? Any color around peak margin, timing and amount would be helpful?
Dean Shigemura
Because of the uncertainty in the interest rates, it’s hard to project out. But just — this is going to be a very long term commentary. But as we get past kind of where the rates settled in, because of the way our balance sheet is constructed, you know, we will continue to see some repricing of our assets, especially because of the fixed rate nature. It may settle in that plus two basis points, but near term, it could move around some.
Peter Ho
So I think that the thought Kelly is that, certainly in the 2023. We probably our guess is that we’ll continue to see expansion of the NIM but probably at a slower rate as our deposit costs start to catch up to the rapid increase in rates, and as our assets which as Dean pointed out are largely fixed, repriced at a higher, that just kind of a naturally higher yield.
Kelly Motta
Got it. Thank you. Thank you so much for the additional question. I really appreciate it.
Peter Ho
Yes.
Operator
And thank you. And I am showing no further questions. I would now like to turn the call back over to Jennifer Lam for closing remarks.
Jennifer Lam
I’d like to thank everyone for joining us today and for your continued interest in Bank of Hawaii. Please feel free to contact me if you have any additional questions or need further clarification on any of the topics we discussed today. Thank you everyone.
Operator
This concludes today’s conference call. Thank you for participating. You may now disconnect.
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