Bank of Hawaii Corporation (BOH) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Matt Kesselhaut, and I work on Jason Goldberg's team covering the banks. We're pleased to welcome back Bank of Hawaii to this event. With us from the company for a fireside chat is Chairman, President and CEO, Peter Ho; Chief Risk Officer, Mary Sellers; and CFO, Dean Shigemura. While you guys didn't have to fly 12 hours from Hawaii this year, thank you for coming virtually. On the left-hand side, the audience should see a question tab, where they can input questions and someone from my team will relay to me to ask the team from Bank of Hawaii. Additionally, you should see audience-response questions. If the audience could begin answering those questions, that would be great.

The first ARS question is, what is your current position in shares of Bank of Hawaii? Overweight, long, marketweight, underweight/short and 4, not involved. While the audience answers that question, why don't we first start by discussing Hawaii's economy. While Hawaii was one of the best seats from a health perspective, COVID-19 still had a large impact on the Hawaiian economy. Can you discuss how your customers in Hawaii are doing given the shutdown in tourism in the recent lockdown?

Great. Thanks, Matt. And before I answer that important question, let me say thank you for having us to the conference and aloha, and good morning to everyone on the West Coast, and good afternoon to those on the East Coast. Yes. I think you hit the nail on the head, Matt. The headline issue for us is tourism, down greater than 90% for obvious reasons since the pandemic struck early in the first quarter. And we really have flatlined there as we've tried to protect the community from the advancement of the spread. That's generally been good for the health situation here in the islands, obviously, not so good for tourism. I've been involved in a lot of public-private types of discussions. And it feels like, we're going to get tourism up and running. The stay to date right now is October 1. I wouldn't be surprised if that slips a month. But I think, generally, it's pretty broad sentiment, both at the state level as well as at the county level. And obviously, within the private sector, to get that piece up and going again. The impact has been pretty dramatic. And so we saw unemployment spike in April and May to 23.8% and 23.5% respectively. Thankfully, early on in the pandemic, the state had a very good viral situation. So our local economy was able to kick in a bit, unemployment dipped in June and July to 13.9% and 13.1%. So unemployment actually is getting better. I hate to say 13.1% is better, but it is from a dimensional standpoint. And I mean -- and so that's where we are. We're hoping that as the race to a cure improves and that timeline gets shorter, we'll start seeing better local customer or consumer sentiment. And obviously, getting the economy back open to tourism in the islands is an important milestone for us. The one bright spot I'd say is that real estate values because of the dynamic obvious supply-demand situation we have here in the islands has held in pretty very -- actually very nicely. So ironically, Hawaii, Oahu, at least, which is about 80% of our market saw median home prices increase to an all-time high last month, $839,000. So seeing good stability in real estate value. Commercial, a bit more of a mixed bag there, tough to get comps on that because volume levels have really dropped off. But at least we're not seeing any real air pockets around the commercial front.

Great. That's very helpful. At the end of the second quarter, there was about 16% of your total loans in payment relief programs. More recently, are you seeing more or less request for assistance?

Yes. We've seen a real flattening in demand for deferral activity. And Mary has really been the one spearheading that effort. So Mary, you want to go ahead and chat on that. Take yourself off mute.

Sure. Thanks, Peter. Thanks, Matt. So as Peter mentioned, yes, the demand for payment relief release spiked in April and since then, it's really been very muted. But our deferral stand still at $1.9 billion or 16% of total loans and in large part, that is really driven off how we structured that. And what we were able to take advantage of really is the CARES Act, the ability to provide a lot of relief to our customers. And in large part, we were able to do that because 75% of the loans we provided relief to are secured by real estate with a 55% weighted average LTV. So we were really able to help these customers bridge. We also have about 78% of our customers on the commercial front, still paying interest. So given the structure of our deferral options for both our consumer and commercial portfolio, we're just now coming up really on the maturity of those options. But we have been talking to our customers. And at this point, indications are that we should see a significant amount of those come off and resume regular payments.

Great. Very helpful. And then just in your opinion, guys, like, how does this crisis compare to the 2008 financial crisis in terms of its impact on your customers? Are there any lessons you learned during that crisis that you're applying to the one today?

Yes. It's been a -- obviously, quite an experience, Matt. And I used to say that the GFC or the great financial crisis was really kind of the high watermark in terms of testing our portfolios. Frankly, I think this one is going to test us pretty good as well. The primary differences that we see are that unlike the financial crisis, which was really driven by the deflation of an asset bubble then obviously had an impact on the markets. Here, what we're seeing is markets holding in pretty quite well, actually. And really, where areas are being hit are areas or segments of our population and community that are just impacted by economic activity and unemployment, right? And so a little bit more of a barbell type of situation here. Fortunately, we are -- we tend to be more of a real estate secured business here at the bank. So that tends to hit -- to skew to that portion of the community that is less impacted and more reliant on the market side of the equation here. But I would say that in totality, this crisis is going to comp quite favorably to the great financial crisis, which people really, I think, generally hold as a high watermark. And fortunately, for us, we really took that opportunity coming up on a decade now to really revisit our portfolio construction. And so we took out of -- what was then a $6 billion loan portfolio, about $1 billion of activity, loan activity that didn't quite stand up to that challenge of the great financial crisis and use that as an opportunity to improve the credit quality of what was already a pretty high-quality portfolio. And we've had benefit of that to take into this scenario, and so far, things are holding in pretty well.

Great. In 2Q '20, Bank of Hawaii had a 25% increase in your allowance for credit losses, bringing your ACL coverage ratio to 147 basis points. What factors do you consider in determining your reserves? And how are you forecasting the return of tourism over the next year?

Yes. Mary, you want to handle that?

Sure. So Matt, it might be helpful if I had to mention the 3 paths that we consider when we are deriving our estimate for credit loss and the needed reserve. First, we really consider the state of containment of the virus, whether that's global, nationally, but clearly primarily in Hawaii. Because clearly, the ability to contain the virus really speaks to the level of economic activity we can enjoy in our community. And that's where we usually will leverage off the UHERO financial forecast. UHERO is the University of Hawaii Economic Research Organization. So they've been putting out updated forecasts for us. The second thing we're looking at and thinking hard about is really the availability of treatment protocols, the strength of those protocols and where we stand on a vaccine because we know this will impact really potentially the duration and tourism, in particular, in terms of really being able to stop this pandemic. And finally, we considered really what's government intervention. And so we all know and have talked about, it's really been unprecedented through this. And really there have been down 3 paths to. First, it's really been fiscal stimulus. We've seen unprecedented levels of liquidity flowing to impacted industry, PPP loans, we've seen economic stimulus payments and additional unemployment benefits. And then monetary policy has been accommodative. And probably last, but not least, really is the regulatory situation. Because they've really aligned with what was provided by Congress in the CARES Act that allowed us to offer unprecedented terms of relief to customers so that they can get through this. So in the second quarter we use the UHERO baseline forecast. Peter talked a little bit about where unemployment peaked up. Their forecast called for 27.3% unemployment in the second quarter. And as he mentioned, we were at about 20.3%. Their forecast also called for the third quarter to be at about 23.9% and the fourth quarter at 18.8% and then they had gradual improvement through 2021, ending the year at about 9.2% in total. So this was what we anchored off initially. So we performed better on some aspects of that as he talked about, with unemployment coming in at 13.9% in June and 13.1% in July. But then again, their forecast also looked at tourism returning at a very slow pace beginning in July and into the fourth quarter and really never achieving more than about 40% of where it was and pretty well sitting there for quite a while. So we considered all those things. So really a mixed bag. What we're really seeing is just a lot of uncertainty as we go into this process. And if I think about the vaccine and treatment, same thing, we have a lot of news coming out that seems positive, but still no definitive timeline on when a vaccine would be available and when it would be distributed. And finally, when you get to fiscal stimulus, that's -- I'm a little disheartened. That seems to be stuck. So not quite sure where that will be going. So again, just a lot of uncertainty into the path of this recovery. And as we think about that, we think it's really only prudent that we would continue to build reserves. And so without more and better clarity into that path, we would probably be building reserves at a level that you've been seeing.

Great. Very helpful. And on the commercial side, Bank of Hawaii has disclosed a 12% of your portfolio -- the industry is highly impacted by COVID-19. Are there any specific areas that you're more worried about than others?

Yes. So the 12% really breaks into 6% for retail and 4% for lodging and 2% for restaurant and entertainment. So that kind of gives you a little more granularity there, Matt. The retail, I think as we've disclosed in the past couple of quarters is actually pretty critical types of service stuff. So that generally has not been impacted too terribly by the pandemic. Our lodging, obviously, I talked about the state of tourism. It's taking it, frankly, on the chin, but these are generally very high-quality assets. And so -- with very well capitalized sponsors. So while the activity has not been great in that space, the support by sponsors and I think the intrinsic value of those assets have not been impacted too terribly as of yet. So that 6% and 4% slug are actually performing pretty well. Obviously, restaurant and entertainment is probably the weakest piece there. But again, that's a 2% element of the overall 12%. And even there, I mean, I wouldn't say that situation is great. But I don't see anything terribly imminent to the downside there either. So yes, that's -- the 12% you're talking about is probably the hotspot for risk for us and so far, generally, so good.

Bank of Hawaii is known for its conservative underwriting standards. Can you talk about your approach and the type of customers you focus on?

Well, we were fortunate to have the sort of market position that allows us pretty advantageous client selection. And what we found over the years, Matt, is that the larger, more well capitalized players that have dominant positions in our community and in our marketplace, also tend to be generally a little bit more conservative in their own cap structures. And so that's where we tend to play. And obviously, we try to be conservative in and of ourselves. But the fact of the matter is the nature of our clients is pretty conservative to begin with. So we're pretty well aligned there. And it's worked pretty well over the past 20 years now.

[Operator Instructions] Moving on to rates. On your earnings call, you've guided NIM to decline 6 to 7 basis points quarter-to-quarter in 3Q, due to the impacts of lower rates and additional liquidity, while NII is expected to be flat quarter-to-quarter. In terms of deposit costs, is there still room to lower deposit costs to help offset rate pressure?

Dean, you want to cover off on that?

Yes. So obviously, our rates are already pretty little. We manage that pretty closely. So I would say that there is some room, although we are kind of getting to the, I would say, the low point. However, interest-bearing savings and checking still have a few basis points to go. And the biggest opportunity is going to be in our time deposit book, which is not a big portion of our deposits. But given that in Q2, it was over 100 basis points, that should be coming down some in Q3.

Can you discuss the competition for public time deposits in Hawaii? Have you guys been backing away? And who's actually going after those type of deposits, if you are?

Yes. So in the public time space, we have been kind of backing away over the last several quarters. But I would say that the competition rate now, just given where the rates are, they do have the ability to go and purchase short-term securities from GSEs and government agencies. So I think that's where the outlet is for any kind of excess liquidity that the public -- the governments would have.

And then over the years, Bank of Hawaii has exhibited strong core deposit growth. Has growth been balanced between consumer and commercial deposits, where has the one category more recently outperformed another?

Yes. It's been pretty balanced, Matt. What we experienced through the great financial crisis was a real flight to quality, and we enjoyed a pretty meaningful surge in deposit activity. A similar situation here. And that has come really to both our commercial as well as our consumer customers. And interestingly, in this crisis, our smaller deposit accounts have actually grown pretty substantially as well. So you can see the savings rate taking place within the community.

Helpful. And then given your loan-to-deposit ratio of 6% to 8%, are there other balance sheet actions you're thinking to opportunistically reduce your funding cost?

Dean, you want to comment on that?

Yes. So we currently have -- we are looking at long-term debt, some other fixed rate liabilities. However, that is a pretty small portion of our balance sheet. It's only about 3%. But we are looking at that. We've taken some action in Q2 and we'll continue to look at that going forward.

And with the excess liquidity on your balance sheet, how are you thinking about deploying it? Are you reinvesting in securities or holding off for a better entry point?

Yes. So we take a very balanced approach to that. So we did have quite a bit of liquidity at the end of the second quarter. It was about $800 million in our Fed funds sold position. We'd like to bring that down. However, given the rates on the reinvestment on the portfolio side being at about 1%. So we're pretty cautious on what we do with the money. We will continue to reinvest that into the portfolio to the extent that we have excess liquidity, but we plan on still having a pretty significant cash position going forward.

Very helpful. And through 2Q, Bank of Hawaii has originated $562 million of PPP loans. In terms of forgiveness of these loans, how are you thinking about the timeline of forgiveness?

Yes. That's an evolving story, Matt, as I'm sure you can appreciate through your affiliation with the industry. We, frankly, have not put a lot of faith in the timing of the acceleration of the fee accrual there. And we see it probably as a 2021 event. So the answer is we never really anticipated much in the -- through the course of 2020. And that's looking to be the case. And probably we'll see something happen as we get into the first, second quarter of next year.

Great. Very helpful. And then you have clients who either pay down draw lines during 3Q '20?

Yes. That was a pretty -- that was a situation pretty specific to the early month of the pandemic. We really haven't seen much in the way of people just dropping down lines to build liquidity. We've actually seen a little bit of -- mostly activity the other way.

And in terms of loan growth going forward, what are key areas of loan growth for you guys? Other areas of softness that you're avoiding at the moment due to elevated competition or due to asset quality concerns?

Well, I'd say in the commercial space, we're not a big C&I lender to begin with. There's not much activity there. And obviously, we would be pretty cautious into the unsecured space in this environment. We're always looking to do quality commercial real estate deals, where we've got a very conservative LTV with a great asset. But deal flow has been pretty slow there, as I think it's probably true across the country. On the consumer side, res lending is doing well. Home equity is competitive. We're -- we've always played at the more conservative end of the indirect space. And interestingly, there actually is still activity in that space as well. That area, we're seeing some growth. We're concentrating on the highest levels of quality in that space. But we're starting to see some impact from just dealers just not being able to secure new car inventory. Probably, as you know, we don't have a credit card portfolio. We do have a smaller direct portfolio kind of installment lending, unsecured. And that book is shrinking as we would anticipate. And as, frankly, we would intend in this environment.

And more recently, as economic conditions have stabilized? Have you seen a pickup in your loan pipeline?

It's been steady, certainly not spectacular. So I think for the second quarter, we had pretty good performance on the commercial front. A good amount of that, frankly, were deals that were already in the pipeline prior or just kind of at the very early stages of COVID. And I think that the pandemic has really had an impact on deal flow. So what we're trying to do on the commercial front is, basically keep loan balance steady up slightly. On the consumer side, I think we've got some opportunity because the areas where we're intending or seeing loan declines are kind of the skinny side of our overall consumer portfolio.

And auto has been an area of growth for you guys. How would you characterize competition and the types of customers you're going after? Are these new customers? Or are they more from prior relationships?

They're prior relationships, and we'll be active in that business to the extent that there are high-quality borrowers entering into that space. And obviously, we're not unique in having that viewpoint. So it's a pretty competitive space.

Very helpful. And then for the remainder of 2020, you've guided quarterly noninterest expense to be flat with 2Q '20. Can you talk about the expense levers you've been able to pull to offset revenue pressure? Is there any expense efficiency initiatives underway?

Yes. So we are serially focused on figuring out ways to bring down our overall expense structure. I think that the change in transaction activity through COVID is, obviously, an outcome of the pandemic itself. But it also, I think, is going to change transaction outcomes permanently as well. So yes, we do see opportunities to rethink our branch structure, for instance, we've been fortunate to have been investing in our digital platforms for several, several years now. I think the fruits of that come to bear. So yes, there are a lot of things happening. Nothing that I think I'm really ready to speak to directly. We understand the situation, and I feel pretty confident that we've got some leverage pull there.

And during the shutdown, can you talk about the type of engagement you've seen in those digital channels?

Yes. So I think COVID has brought into bold relief, a whole bunch of things in our society. I think that the value and convenience of digital channels is a really big component of that. So we've seen -- our experience has been that in branch, transacting is down about 50% across the board. And that's amazingly consistent by community that we serve within our marketplace. And the beauty to digital is that, I think it's enabled us to drive volumes that would not otherwise have been possible with that steep of decline in traffic, right? So for instance, deposit account openings in our branches are down 51%, which makes sense because our traffic is down 50%. But the outcome of overall deposit openings for us is only down 13%, obviously, made up by a big uptick in surge in online deposit openings. I'll give you another example. Res lending, which has had a very solid year to begin with, our traditional sales force is up 36%, but our overall volumes are up 51%, a lot of that driven by what we call our SimpliFi Mortgage lending platform. So lots of great examples there on ways in which digital and our investment in digital has helped us to overcome kind of the contraction in physical activity.

Yes. And a lot of mainland being has talked about rolling out online offerings. Have you noticed these type of online offerings in Hawaii and increased competition from other banks?

Well, yes, we have for quite a while. So it's not a new phenomenon. I think that obviously, banks are realizing with COVID, the power of digital and I think it's changing behaviors pretty dramatically. But probably the best example I can give you is Quicken Loans is probably the category killer in online mortgage lending nationwide, no different here. There, we've got a pretty heady advantage on them from a purchase standpoint. But in the refi space, they compete pretty effectively with us. There, we've always had about a 10% volume premium on them, historically. As we look at 2020 year-to-date, that premium lead has held. So I think to answer your question, Matt. Yes, I mean the incursion of digital competitors nationally has been in place for a while now. We've obviously invested to take that on. And at least so far, COVID really hasn't changed the slope of our effectiveness of dealing in that space.

When it comes to upgrading technology, if you outsource it, do you work with 1 vendor? Or do you partner with fintechs? Can you talk about that?

Yes. We have -- our approach is kind of planet and satellites. So we're an FIS bank. They provide great core services to us. We've got a great relationship with them. I can't think of a provider for just basic nuts and bolts core processing that could do a bad job for us. So that piece of the equation is very stable. What has changed is the SaaS environment and the software-as-a-service environment and the ability just to pull conversions directly down from the Internet has dramatically changed the industry. And so we are very active in determining where it makes sense for us to stay with our core provider and there are numbers of instances where it makes sense for us to do that. There are also instances where it makes sense for us to go with a third-party provider. And as I mentioned, I think that the new software environment makes things much, much easier to transact transitions in platforms, depending upon having that good, solid foundation in place to begin with.

And do you talk about potentially reducing your branch footprint further. But you've also continued to refresh and modernize branches across your footprint with your branch of tomorrow program. Can you talk about this program and what it is? Are you making branches smaller, more efficient?

Yes. We're making -- I think, reflect the operational and consumer demand reality of where we sit today. I think COVID has only accelerated that. So we're not anti-branch by any stretch of the imagination here at Bank of Hawaii. We think that the branches still play an awfully meaningful role, but they will play a smaller role, frankly, transactionally they will play a bigger role from an advice giving and servicing standpoint. And our new branches that we've been on this for almost 5 years now and have had good success with the new branches that we've put out there in terms of really meeting the demands of our customers. That, I think, has served us well into the scenario where we're likely going to have fewer branches coming out of COVID than we had going into COVID.

Helpful. Helpful. [Operator Instructions] Moving on to fee income. Can you talk about the trends you're seeing in your fee income businesses and if there's any strategic initiatives underway to help accelerate growth?

Sure. So just traditional deposit transaction fees took a pretty dramatic hit that was reflected in -- really mostly in Q2. So took really an unprecedented hit in volume levels there, which resulted in lower fees. Should see a meaningful resumption there. So that's a positive. Our residential lending volumes -- our pipeline right now, Matt, I can tell you is 2.5x greater than where it was at the end of 2019. So we've got record levels going on there. That should -- gain on sale is still very strong. So it should allow us to not only generate balance sheet growth, but also fee income growth. I would caution, though, that the first couple of quarters had very strong swap activity on our commercial real estate side. I mentioned that activity has waned a bit with the pandemic. And so that's going to be a bit of an offset. Dean, am I missing anything there?

No. I think you've captured everything.

Great. In the longer term, how do you accelerate growth? Is it a matter of upgrading technology? Would you consider doing something inorganic, like a bolt-on acquisition?

No. I think that in terms of marketplace and product, we don't see right now the need for a bolt-on acquisition, Matt. Really, I think it's a matter of providing additional convenience to the products and services we already provide. So our investment platform is pretty traditional. I think there's an opportunity to digitize that and generate volume levels there. I think that our debit platform is not contactless. I think there's probably an opportunity there. Frankly, we're a bit laggard there. So we're very anxious to kind of get the best in market there. And then really, a lot of our efforts have gone into the home lending side and the residential lending side through our SimpliFi platform. And there, I think we've had great success, but I think there's a lot more opportunity there on top of that.

Very helpful. And then in terms of capital, Bank of Hawaii is very well capitalized with a CET1 ratio of 12.04% versus a minimum of 6.5%. Can you talk about your capital priorities? Is there a target CET1 ratio you're trying to run at?

Well, Matt, I think in this environment, it's these environments that capital is meant to support. And so as you mentioned, we do have a fortress balance sheet from a capital standpoint. We're very proud of that. We're very happy to have that situation. We're a high ROE bank to begin with. So we generate a lot of capital relative to our capital requirements. So our primary use for capital right now is safety and soundness. And so Mary mentioned that we've been very active in provisioning against the uncertain condition that COVID has presented to us likely in the near-term until we see a lot of that uncertainty wind out. We'll continue to do that. That's going to be our primary lever for our capital. Paying the dividend is something that is awfully important to us. We were one of the few banks that was able to pay its dividend straight through the financial crisis. So obviously, that's important to us. We know that's important to our shareholders. And to the extent that this pandemic allows us to do that, we would intend to continue to do that. I guess what that leaves is share repurchase. As you know, we suspended that activity with the onset of the pandemic. And boy, I know that the entire management team wishes we would be in in that program right now because we think the stock price is awfully attractive. But we are where we are, and safety and soundness is going to rule the day. And at some point, we will get back to share repurchase, but that's not at the top of our priority list right now.

Yes. And then in terms of restarting your buyback, what would need to happen? What economic indicators are you looking at?

So I'll start, Mary and Dean, feel free to jump in. I think that, number one, the uncertainty issues got to resolve itself. So until we see an improvement in volatility and uncertainty, we're likely to continue to want to hang on to capital to the extent that we kind of need to. Once that begins to unwind, I think that opens the pathway to repurchases. As I mentioned, safety and soundness is by far our biggest priority. Paying the dividend is right up there as well. So the repurchase kind of gets crowded out. We generate a lot of capital, so that's been a big part of our story. And as the world begins to return to a more normal environment, we would hope to and intend to resume that activity as well.

Great. With that, we'll wrap up. Thank you today, bank of Hawaii. And hopefully, next year, we'll see you all in person, or maybe I'll come and fly to Hawaii.

We would like that, Matt.

Yes. I'd like to come to Hawaii also.

Well, either way, we'll come visit you and you come visit us. Well, thank you so much.

No. Thank you, guys. Very informative. Thank you.