Ladies and gentlemen, thank you for standing by, and welcome to the Bank of Hawaii Corporation second quarter 2020 earnings conference call. At this time, operator in listen-only mode. After the speakers' presentation, there will be a question and answer session. To ask a question during that session, you will need to press star one on your telephone. As a reminder, this conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to Cindy Wyrick, Director of Investor Relations. Please go ahead.
Thank you, Carmen. 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. Now I'd like to turn the call over to Peter Ho.
Great. Thanks, Cindy. Good morning, everyone. Before I start our comments, let me just give you a little commentary on Hurricane Douglas, which came through the islands this weekend. Yesterday, Douglas actually missed the big island without actually going to a hurricane warning. Passed by both Oahu and Maui, where we were in a hurricane watch, but really had a somewhat nominal impact from the storm, and then thankfully cleared Kauai late last night, or actually early this morning.
From that standpoint, we obviously feel blessed and fortunate to have made it through this near miss, and given the circumstances, we'll certainly take that. Today marks Bank of Hawaii's six-month anniversary in our dealing with the COVID-19 pandemic, as our first executive all-hands meeting was held on January 27th of this year.
I have a notation in my Outlook calendar that describes that meeting as a meeting to discuss the virus in China. How things have changed in six months. As you know, COVID-19 has had a dramatic effect on nearly all aspects and walks of life globally and nationally. Hawaii certainly has been impacted no differently, and while we're one of the nation's best performing states by infection statistic to date, the consequences of the virus have been economically dramatic.
This past Friday, our board met to hold a regularly scheduled board meeting. At that meeting, I presented a six-month review of our COVID-19 response, and I thought before we get into the heart of our quarterly review, I'd share with you some of what I shared with them. I segmented my review into our core stakeholders, our community, our customers, our teammates, and of course, our shareholders.
From a community standpoint, we recognize that as a leading company in the islands for nearly 123 years, people expect us to take a leadership role and to give of ourselves freely in times of crisis and need. From a leadership standpoint, I and other members of our management team and board of directors are actively engaged in numerous philanthropic organizations, government-sponsored task forces, and private sector committees engaged in supporting and leading our community at this time.
Our foundation also made, early in the pandemic, a $3 million gift to the Hawaii Community Foundation to provide COVID-19 humanitarian, health, and economic support to the community. This is the largest corporate gift to date in the islands, and as was our hope, helped to spur further support from the corporate community.
I note that funding, as I mentioned, was provided directly from our foundation, whose capital base is separate and distinct from the bank. Finally, from a community standpoint, Bank of Hawaii Foundation recently released a study called COVID-19 in Hawaii: Facts and Insights. The study was performed by Anthology Research, a respected local market research company. It was based on live and online survey data from over 1,000 respondents, making it the largest study of its kind in Hawaii.
To date, we believe the study will help better inform the general community and help local policymakers make informed decisions. From a customer standpoint, we've been very active in providing real solutions and resources to many parts of our customer base. We made over 4,500 PPP loans totaling over $560 million. We've helped more than 17,000 people realign their loan terms in support of the near-term dislocations caused by the pandemic.
With numerous government stimulus and deferral programs afoot during the pandemic, we saw contact center volume spike 69% in the month of April, requiring enormous commitment and support from our contact center staff. Also, as customers have sheltered closer to home, we've seen unprecedented digital banking activity.
Thanks to many years of focus on our digital channels, we've been gratified to see year-to-date mobile deposit growth of 36%, online deposit account openings growth of 300%, online mortgage app growth of 142%, and online HELOC app growth of 79% year to date as compared to last year. As for our teammates, we've been able to hold FTE levels steady. With our cafeteria operations suspended, we've created a program called Meals to Go, preparing a weekly to-go meal available to all employees. To date, we've distributed nearly 13,000 meals, serving over 50,000 people.
We encourage our employees to share their meals with family, friends, and neighbors. Our employees' health is our paramount concern, and we spent over $280,000 on PPE and plan to spend ultimately approximately $2 million on plexiglass barriers and thermal scanning equipment. We've built a phone-based daily health screening app for our employees and are in the process of upgrading our filtration and air replenishment infrastructure to multiples of industry standard.
For our shareholders, to date, we've been able to weather the storm while maintaining solid financial and business results. Our market valuation, as measured by price to book, continues to lead our marketplace. We continue to gain market share in both loans and deposits on a one-year basis through 3/31 of this year. We continue to fortify our balance sheet from credit losses in a measured, appropriate, and balanced way.
Before I turn the call over to Mary, who will brief you on credit quality, and then Dean, who will discuss our financials, I wanted to finish off with a quick review of the local Hawaiian economy. I'll just go You got that? Okay. Unemployment in Hawaii moved from 2.4% in March to 23.8% and 23.5% in April and May as the stay-at-home orders and travel quarantine orders went into place in the islands. June unemployment, however, improved dramatically to 13.9%, in part as a result of the partial reopening of the local economy, and in part due to the PPP and other federal stimulus programs. The green columns represent UHERO's most recent forecast, which is foundationally what we incorporate into our own risk and financial modeling.
As you can see, these numbers peak up in the following quarters. Ultimately, the direction of future unemployment will be impacted by whatever new federal stimulus comes about and the timing of such, as well as the trend in infection rates here in the islands, which will thus drive policy decisions around the rate of reopening. On the next slide, you'll see a longer-term forecast for unemployment. On the next page, you see GDP and personal income forecasts showing 2020 declines of 11% and 5%.
I think I'd apply the same contingencies on directionality of the accuracy of these forecasts at this time. Fundamentally, Bank of Hawaii remains well-positioned. We have solid credit statistics. Our base operation continues to grow in a challenged environment. Our liquidity and capital levels are robust. Now let me turn the call over to Mary Sellers.
Thank you, Peter. At the end of the quarter, the loan portfolio, net of PPP balances, totaled $11.3 billion. Reflective of our island economies, remained 60% consumer and 40% commercial, with 76% secured with high-quality real estate, with a combined weighted average loan-to-value of 56%. We believe this portfolio construction, built off conservative underwriting and disciplined portfolio management, will continue to provide a superior outcome and continue to allow us to support our customers and community through these difficult economic times.
Credit metrics remained strong and relatively stable in the second quarter. Net charge-offs totaled $5.1 million, or 18 basis points annualized on average loans, up $1.4 million for the linked period and up $2.8 million year-over-year. Non-performing assets totaled $22.7 million at period end, up $2.1 million from the first quarter and up $900,000 from the second quarter of 2019.
Criticized loans outstanding increased $1.4 million to $201.6 million, or 1.71% of total loans. The credit provision was $40.4 million, which after net charge-offs of $5.1 million, resulted in a $35.2 million increase in the allowance for credit losses. The increase is reflective of our best estimate of increased losses in the portfolio, given the company's credit risk profile and the current outlook and forecast for our market with the impact of COVID-19. As Peter noted, the estimate was anchored off UHERO's most recent baseline forecast but also considered the uncertainty of this path to recovery. At the end of the quarter, the ratio of the allowance for credit losses to total loans and leases was 1.47%, or 1.53% net of PPP loans.
The reserve for unfunded commitments was $2.5 million at the end of the period, down $800,000 from the first quarter and down $4.3 million from December 30th, 2019. Through the end of the second quarter, we've provided payment relief to over 17,000 customer accounts on loan balances totaling $1.9 billion, or 16% of total loan and leases outstanding. After peaking in April, we saw a significant decline in new requests for assistance from our customers, both consumer and commercial.
73% of the consumer loans with payment deferrals are secured with residential real estate, with a weighted average loan-to-value of 61%. 49% of these customers made at least one payment in the second quarter. 89% of the commercial loans with payment deferrals are secured, with a weighted average loan-to-value of 51%. 92% of these customers made at least one payment in the second quarter.
As previously discussed with COVID-19, a number of industries, particularly retail, lodging, and restaurant and entertainment, are facing significant challenges. In total, our commercial loan exposure to these industries remained flat for the linked period at 11% of total loans, exclusive of PPP. Our retail segment totals $600 million or 5% of total loans, with 91% secured by real estate, with a 54% weighted average loan to value.
1.7% is unsecured and deferred, and 99.9% of the unsecured exposure continues to pay interest. The lodging segment is $500 million or 4% of total loans. 77% is real estate secured, with 85% having a loan to value of less than or equal to 65%. 0.4% is unsecured and deferred, and 100% of our unsecured exposure continues to pay interest. Finishing with the restaurant and entertainment segment, this segment is $100 million or 1% of total loans.
39% is real estate secured with a weighted average loan to value of 63%. $23.5 million is unsecured and deferred, with an average exposure of $400,000. 96.9% of the unsecured exposure continues to pay interest. I'll now turn the call back to Dean. uncertain.
Thank you, Mary. As Peter stated, this was a good quarter for us despite the challenging environment. We continued our trend of loan growth in the second quarter, with balances increasing by $453 million linked quarter and by over $1 billion year-over-year. The second quarter loan growth of 4% was driven by $543 million of PPP loans. Normalizing out the PPP loans and repayments on line draws resulting from the COVID pandemic, loans grew modestly by $16 million in the quarter, and we expect moderate loan growth for the rest of the year. In the second quarter, we experienced a record increase in deposits of nearly $1.4 billion or 8.5% linked quarter, and $2 billion or 12.5% year-over-year, continuing our long history of deposit growth.
While deposits resulting from PPP loan fundings and consumer economic impact payments contributed to the growth, deposit growth in the quarter came predominantly from our core consumer and commercial customers, who increased their balances by nearly $1.2 billion or 7.4%. In addition, we have reduced our public time deposits by $53 million in the quarter to $610 million. Our deposit funding costs continued to decline during the quarter, ending at approximately 16 basis points.
The low cost continues to provide us with flexibility for growth and profitability and is a mitigant against the impact of lower interest rates. Subject to market conditions, we continue to opportunistically reduce the rates. With a comparatively low loan-to-deposit ratio of 68%, our solid and growing deposit base provides additional asset funding opportunities and pricing flexibility while reducing our funding risk profile against risk assets.
A portion of the excess liquidity was deployed into our investment portfolio and increased balances by $300 million- $6 billion. We maintained the high credit quality and liquidity by adding AAA-rated securities with reliable monthly cash flows. AAA-rated securities represent 95% of the portfolio balances and 100% are A-rated or better. The duration of the portfolio was 3.11 years at the end of the quarter and well within our risk tolerances.
The investment portfolio remains a stable and secure source of liquidity for funding for our balance sheet. Our strong risk-based capital levels improved in the second quarter and remain substantially above the well-capitalized minimums. We added to our excess capital levels, improving our CET1 and Tier 1 capital ratios by 23 basis points to 12.04%. Our capital position was further enhanced by a reduction in risk assets, which decreased to 55% of total assets.
We continue to hold significant amounts of capital in excess of minimum regulatory and well-capitalized levels. Our Tier 1 capital consists of $552 million more of pre-tax dollars than is required to remain well capitalized and $826 million above the regulatory minimum. These represent funds that can be deployed for growth or loss mitigation. I'll provide additional details on our financial results. Net income in the second quarter of 2020 was $38.9 million, or $0.98 per share.
Net interest income on a reported basis in the quarter was $126.7 million, up $700,000 from the previous quarter and up $2.6 million from the second quarter last year. Included in the second quarter net interest income was an interest recovery of $2.9 million. As Mary discussed, we recorded a credit provision of $40.4 million this quarter.
Non-interest income totaled $51.3 million in the second quarter of 2020, up $5.2 million from the previous quarter, and up $5.9 million from the second quarter last year. Non-interest income in the second quarter included a gain of $14.2 million from the sale of our remaining Visa shares. Adjusted for the Visa sale, lower non-interest income was due to lower deposit fees, other service charges, and customer derivative revenue.
For the third quarter of 2020, we expect non-interest revenue to be approximately $37 million-$38 million. Challenges continue due to lower levels of customer activity during the ongoing disruptions from the COVID-19 pandemic. Non-interest expenses in the second quarter totaled $88.9 million, a decrease of $7.4 million from the previous quarter, and a decrease of $3.8 million from the same quarter last year.
In the second quarter, we accrued $1.1 million in special bonuses, which ended in June, for employees working on site. In addition, we accrued $2 million in corporate incentives, which is down from $5.5 million accrued in the second quarter of 2019. Non-interest expense in the first quarter of 2020 included seasonal payroll expenses of $3.1 million and severance expenses of $4.7 million that were partially offset by the elimination of corporate incentives.
For the remainder of 2020, we expect our quarterly non-interest expenses to be flat with the second quarter at approximately $89 million. The effective tax rate for the second quarter was 20.05%. We estimate the rate will be approximately 20%-21% for the remainder of the year. Our return on assets was 0.82%. The return on equity was 11.58%, and our efficiency ratio was 50%.
Our net interest margin in the second quarter was 2.83%, down 13 basis points from the first quarter, and down 21 basis points from the second quarter of 2019. The decrease was primarily due to lower interest rates and much higher levels of liquidity due to strong deposit growth, partially offset by seven basis points from the interest recovery.
After adjusting for the interest recovery, we expect our net interest margin will decline by approximately six to seven basis points in the third quarter from the continued impact of lower rates and additional liquidity. However, net interest income is expected to be approximately flat with the second quarter net of the interest recovery, as loan growth and asset mix change are expected to mitigate the impact of the lower margin. Our estimates conservatively assume PPP loans are carried for a full 24 months.
Shareholders' equity was $1.35 billion at the end of the second quarter. During the second quarter, we paid out $26.8 million, or 68% of net income in dividends, and our share repurchase program remains suspended. Finally, our board declared a dividend of $0.67 per share for the third quarter of 2020. Now I'll turn it back over to Peter.
Great. Thanks, Dean. Thank you for your interest in Bank of Hawaii today, and now we'd be happy to entertain whatever questions you might have.
Thank you. As a reminder, to ask questions, you will need to press star one on your telephone. To withdraw your question, press the pound or hash key. Please stand by while we compile the Q&A roster. Our first question is from Casey Haire with Jefferies. Please go ahead.
Yeah, thanks. Good morning, everyone. Good to hear that Hurricane Douglas did not do any damage. Good to hear.
You're in the close one, Casey.
Yeah. Did you get any surfing in, Peter?
No. I hung that thing up a long time ago, my friend.
Understood. Just teasing. Okay. Maybe start on credit quality, Mary. Some of the slides, very helpful in terms of the forecast. Obviously could take a couple more years before we get back to normal, but as you guys think about your reserve build, taking it up again this quarter, we're all looking at when tourism is open up to the island and the governor just pushed it back a month. Can you just frame it around that in terms of what your forecasts assume for when the islands are open again to tourism and just some sensitivities around there as we try to think about reserve build going forward?
Sure. Well, we anchored off UHERO, which really had the tourism industry opening very gradually late into the third quarter with very little occupancy occurring in 2020, really being pushed out into 2021. Even at that point, really being at 40%-50% of where we were in 2019.
Okay. In terms of the visitors back in 2021, does it assume 50% return to pre-pandemic levels, just trying to size what you guys are baking in, or UHERO is baking in?
pre-pandemic was about 80% occupancy. At 40%-50%, you'd be at about half.
Sorry, I missed that. All right. On the PPP loans for two years, you guys. Should we assume that means that the cash balances, you guys are going to run with that liquidity for that same amount of time? Just following up on the NIM, the investment securities yields, what are the reinvestment rates currently? If we don't get any relief on yields, how long will it take for the securities book to bottom?
Okay. I think there are four questions in there. Thank you.
No, I'm sorry. I'm sorry.
The PPP loans, cash deposits, those have already started running off. If you compare the amount of loans versus what we identified as the deposits, which were about $200 million. We expect that to continue to run off and probably into the third, maybe trickling into the fourth quarter, but expecting it to run off in the third quarter. In terms of the margin for the investment portfolio, the reinvestment yield is roughly about 1%, the kind of securities that we're buying. Roughly 1%. Where it would bottom out, it would take a while for it to bottom out. I would say maybe a year for it to hit a lower level.
Okay. Very good. Thanks. Sorry, go ahead.
No, I was just going to ask you if there were other questions that you had then.
No. There was a bunch in there. All right. I'll step back. Thanks, guys.
Thanks, Casey.
Thank you. Our next question comes from Ebrahim Poonawala with Bank of America Securities. Please go ahead.
I just wanted to follow up on the margin, Dean. I guess if you go back last quarter, I think at the time, again, recognizing there's a lot of volatility, but I think your guidance was one to two basis points of margin compression looking out. As you look at what happened in the margin in second quarter, close to mid 270s with expenses accrual recovery. When I look at your guidance for the third quarter, just talk to us in terms of has anything changed in terms of what you were thinking about asset yields back in Q3 versus today? Is all of this attributable just to the excess liquidity that you will see because of deposit growth and PPP?
What happened was we had not expected the LIBOR rates, so the short end to come down as much as it did over the quarter. We expected that to drift lower throughout the rest of the year. That came down about 70-80 basis points in the quarter. That changed the results quite a bit. In terms of the liquidity, that did impact us. About half of the drop was due to liquidity in additional deposits. The guidance that I provided, six to seven on a normalized basis, does take into account some further reductions due to rate and then some additional from the liquidity side.
Some build up.
Some build up of liquidity. Yeah.
Got it. That does include PPP. Could you remind us what the PPP fees are outstanding? If we assume all of this comes back, how much is PPP fees remaining at the end of the second quarter?
Well, my forecast assumes that we don't see.
Prepayments
prepayments, and therefore we do not accelerate the recognition of the fees.
Sure.
That's all built into that forecast.
Understood. I was just asking what the total origination fees were, which are outstanding. I can follow up later. Just as a separate question, Peter, if we can just talk about the deferral trends comparing $1.9 billion at the end of second quarter versus $1.1 billion when you reported 1Q results. Just talk to us, you provided some good color around the characteristics of these borrowers.
When we think about the customer deferral trends, your peer provided some stats around how many of them went back to paying status over the last few months. Just give us a sense about what you think will happen in terms of the commercial borrowers going back to paying, and do we need a full-fledged reopening of tourism and the economy in order to get there?
Let me ask Mary to start, and I can chime in. Mary?
Sure. In our approach to providing relief to the customers, we really took advantage of the CARES Act, which allowed us to be very flexible in what we were doing. We provided six months of relief that aligned with what the GSEs were doing. As we've noted, 92% of our commercial deferral customers are making their payments, and 49% on consumer. In our discussions with them, it appears that many did take it strictly as a precautionary measure and an ability to really build some liquidity during the period. I think the majority of ours are secured, and so clearly working with them, should they need to continue to have some sort of relief, would be very manageable.
Ebrahim, I guess the only thing I would add there is, I think that the deferral activity is maybe not a great indicator of future economic health or credit consequence because of what Mary just described, which is a lot of, frankly, reasonably healthy borrowers, I think out of a fit of conservatism, and understandably so, chose to ask and were granted some form of deferral.
Probably the more interesting space is in the criticized segment, which is where, at least from our standpoint, we're driving that more from the standpoint of understanding what the base liquidity level is of our borrowers moving forward, and with a view that, gee, this whole thing could take a year plus to resolve.
To the extent that they have the kind of capital and liquidity to support that obviously results in one form of rating, and if not, another form of rating.
Got it. That makes sense, Peter. Just to that, if I can ask one last question. Just when we think about the resiliency of the Hawaiian economy, if tourism fails to open over the next few months in any meaningful way, just talk to us in terms of, one, the ability of the economy, the local government to withstand that pain. Is there a break point where you think where a lot of these borrowers who have the liquidity, maybe you can manage through another three months in a lockdown mode where things start sort of falling off a cliff, like something that you would worry about in terms of duration?
Well, you asked a lot of items there. I think that the easiest data point to point to is the delta in unemployment from early pandemic to mid-pandemic dropped pretty substantially. That was a result of the partial reopening. Moving from a shelter in place to a partial reopening without any visitors into the islands, number one, and number two, kind of the effects of PPP and stimulus checks and UI plus-ups and the like. I think our ability to withstand the crisis net of bringing visitors in, but with some form of federal stimulus, might be a little bit north of what we experienced in the April, May to June timeframe. You're right. I think for the economy to get back on a full footing will require a resumption of visitor inflow.
I hesitate a little bit to think too much of that as a State of Hawaii issue, because irrespective of whether the state decides to amend its quarantine rule or not, I think the real issue is what's happening nationally and somewhat globally from an infection standpoint. That probably has a bigger factor in driving more of the demand side of the equation.
I just think as long as we're in this uptick mode nationally, the outlook for the visitor industry is not terribly buoyant. To the extent that we can, as a nation, get that back under control, I think things kind of take over from there. As it relates to your question on the resiliency of the State of Hawaii government, the state actually has a relatively high credit rating relative to the other 49 states.
We'll just have to see, like every other municipality. As of right now, there isn't a sense that things will be shutting down imminently.
Got it. I know that was a lot. Thanks. Appreciate the color. Thank you.
Yep.
Thank you. Our next question comes from Jeffrey Rulis with D.A. Davidson. Please go ahead.
Thanks. Good morning. Hey, John, a couple questions on the maybe on the noninterest income. Dean, appreciate the guidance there, but wanted to dig a little deeper. The Visa position, is that gone at this point?
Yeah.
Yeah. Okay. I think that had an associated kind of carry cost to it. Is that, barring other investment securities gains, losses, that's more of a neutral event going forward?
No. The shares that we sold were ones that we just held on our balance sheet. What's represented now in the income statement is the previous sale. We do still have that swap in place.
As they're still Class B.
Yeah, Class B. Yeah.
When the shares convert, that will go away.
I see. Okay. Thank you. On the service charge, again, I guess baked into your guidance is a little lower run rate, wanted to kind of see how that maybe progressed or sort of built through the quarter. I don't know if there was some, April was a pretty void of any activity, it slowly began to perk up. I guess more to Peter is the strategy there. I don't know if there were fee waivers, when is the appropriate time to kind of bring that back in, and when do you kind of get back to some level of, some of that's activity driven by the consumer, wanted to see if there's anything on your end that the pace of that build going forward.
Yeah.
Thanks.
Yeah. It's a good question, Jeff. Q1 to Q2, we saw about a $6.5 million reduction in those sorts of fees. Okay. That would be OD, that would be FX, that would be ATM.
ATM
merchant services. The very transactional debit interchange. As a baseline, I would probably subtract that number out moving forward. You're right, I think that those numbers kind of generally reflect a pretty draconian stay-at-home posture from an economic activity standpoint. You're right. As the quarter progressed and as the economy opened up a bit, we did see some levitation in those levels that was driven by volume levels increasing. We actually, as of 6/30, have reinstituted our ATM fees, which is actually the only fee that we waived during that period. Some fees will float up, some not so much. Like foreign exchange probably won't move up until we start getting foreign visitors back into the marketplace.
I think it's reasonable to think that $6.5 million downward delta could replenish just in the current state, maybe by a third, I'd call it, something like that.
Great.
Is that helpful?
Okay. Yeah, that is. That's perfect. Then maybe just last one for Mary. The NPA additions in the quarter, any comment on were those pre-COVID stressed or just the makeup of what came in?
It was one residential loan that actually was having challenges pre-COVID. We have entered into a repayment plan, and it should go back on accrual in the first quarter of 2021.
Great. Thank you.
Yep.
Thank you. Our next question comes from Andrew Liesch with Piper Sandler. Please go ahead.
Hi. Good morning, everyone.
Hey, Andrew.
Hi. Just a question just revolving around the provisioning going forward, and just how much of the provision is driven by the UHERO unemployment rate forecast? Because we saw the nice drop here in June. If that continues and if it levels out here or trends lower, below what their latest forecast is, how should we look at the provisioning going forward if the unemployment rate does appear to be below what they're forecasting?
We did base it on UHERO, so it is driven off that. We did have a bias, too, for the uncertainty in that recovery. I wouldn't expect that we'd need to continue to build the reserve at the same level moving forward. Of course, in this unprecedented period, we'd want to continue to build reserves. It's prudent.
So Andrew Liesch, just to emphasize, the reduction to 13.9%, I guess, played somewhat into our provisioning. Because UHERO actually didn't revise their Q3 and Q4 unemployment estimate, which were kind of back in the 20% range, that's really what's baked into our provisioning. I guess I would say as we think forward to future provisioning, my sentiment is that our unemployment, if you want to use that as kind of a guideline, 13.9 feels like a little bit of an overreaction to the downside.
Likely, we'll probably see unemployment levels in between that 13.9 and that 24-ish number in the earlier months. I don't think that the end of provisioning is in store for us anytime soon, although I guess I would say that Q2 was probably a pretty meaningful number for us.
Okay. Thank you. That's really helpful. Just on operating expenses, it seemed like some of those were lower just with fewer transactions, less customer activity. How much customer activity would that need to increase for expenses to get back to maybe the run rate that you were at like a year or so ago? Heard your comments in response to Jeff about maybe some of those transactions coming back by about a third. Do we need to have tourism come back fully for a higher run rate in expenses, or can we stay below $90 million for the foreseeable future?
Yeah. The level of transactions did impact the expenses. I wouldn't say it's going to be a very material increase as the transactions do come back, but it'll probably drift closer to $90 million if we get something above 50% kind of return, kind of economic activity on the fee side. Some increase, but not much.
Okay. Thanks. That's very helpful.
Yeah, Andrew, I think the expense side is going to be kind of that upward or downward, that upward delta, I'll call it, is going to be driven more by our provisioning activity versus economic activity. The economic activity, as you point out, has some impact, but it's pretty small. It's like $1 million or something.
Yeah.
Yeah.
Okay.
Frankly, it's really-
providing okay, it's really just the provision and just the accruals that way, maybe through salaries and benefits that have the bigger effect on expenses?
Yeah. It's really variable comp, but yeah, that's right.
Okay. All right. Thank you. I'll step back.
Yep.
Thank you. Our next question is from Jackie Bohlen with KBW. Please go ahead.
Hi. Good morning.
Hi, Jackie.
Dean, I was wondering, how did premium amortization behave between this quarter and last quarter?
It did go up by, I believe, $1.3 million to about $7.5 million. It did increase quite a bit.
Okay
on a percentage basis. That's reflective of just the market. With the mortgage rates being where they are, there's a lot of refi activity.
Okay. What are you assuming next quarter in the margin guidance you provided?
In terms of premium, I don't have that.
Yeah.
Yeah. I don't have exactly what we factored in, but it is assuming a higher premium for the quarter.
Okay. That's all I needed is just a ballpark and kind of what you were thinking in that. Okay. Thank you. This one, Peter, it's probably for you. I'm just wondering if you could provide an update on kind of where you're standing in terms of longer term reinvestments that you've been doing. If any of that has been paused, if any of it is going ahead. Also how customer behavior, and you gave great statistics on digital adoption, how that might be impacting any future efficiency projects you have in the works.
Yeah. I guess I would say, Jackie Bohlen, that the situation with COVID-19 has in some ways accelerated a lot of the direction that we were heading in anyway. As you know, we've made a lot of investment to date in our digital platforms, and continue to do so. I think we'll continue to do so simply because they generate return for us.
They either generate more revenue or they help us make things more efficient. At this point, fortunately, we got most of the fat end of the investment curve in already from an investment standpoint. We do have some kind of tangential investments to make. We have some larger decisions to make, call it a year plus out, hopefully outside of this horizon.
Ultimately, the idea is that we generate more revenue there, so that's a positive, and that probably doesn't get in the way of our investment-making decision, even in this environment. As it relates to footprint, which I think is what you're probably driving towards. Pre-pandemic, we were at 68 branches. We skinny that down to 31 into the teeth of the pandemic, and now we've widened out back to about 40.
We're going to see what happens moving forward from a customer transaction standpoint in the branches, because we've seen that activity fall pretty precipitously. Our guess is that once things go back to quote "normal," that will result in some upward shift in visitor traffic back to the branches. I think that there's probably a fair number of folks who now that they've been exposed to our digital capabilities, probably remain digital customers.
I don't think that the numbers bounce back to pre-pandemic levels, and that obviously creates some efficiency opportunities for us down the path.
Okay. I would guess that the evaluation of that, assuming we have resolution on the virus, could be put in with some of the larger decisions you were talking about in about a year or so?
Yeah. I think those are always ongoing conversations. Yeah, I think we won't really know what the true transaction volumes will look like in our branches until we get to some more normal state of activity.
Okay. Makes sense. Great. Thank you for all the detail. I appreciate it.
Yeah.
Thank you so much. As a reminder, ladies and gentlemen, to ask a question, just press star then one. Our next question is from Laurie Hunsicker with Compass Point. Please go ahead.
Yeah. Hi, good morning.
Hey, Laurie.
Dean, I wondered if we could just go back to the margin guidance that you were giving of down six to seven basis points next quarter. Were you doing that off of the headline then of 283, or were you backing out the interest recovery book, coming off of a 277 or 276 margin?
Yeah. It was off of the adjusted.
If you did the calculation, it puts us at about a 2.7% margin.
Perfect. Okay. The other question that I had was. I appreciate that you're not including any of the PPP forgiveness fees in your margin. Of your $562 million, what are the total fees that you expect over the life of those loans?
In total, it's about $18 million.
$18 million. Okay. That's great. Mary, just a question for you. Office exposure, where do you guys stand, and do you have an LTV on that?
I do. It's 12% of our total commercial mortgage book, and the weighted average LTV is 59%.
Okay, great. Then same question on leverage loans. Do you have a dollar amount? Then also maybe help us think about how much of that is GovCon, government contract.
We have $54 million in leveraged exposure. It's 3% of our total C&I. 26% is I mean, sorry, 74% is kind of essential businesses. I don't think any is really related to government contracts.
Okay. That's helpful. Then I guess just kind of going back, maybe, Peter, this is more a question for you. Can you help us think about what your target is for your reserves to loans?
Well, we don't actually target. That would be kind of different from how we set the reserve. The reserve, actually, it's really a function of what the reserve requirement that creates your provision. That's really not targeted as much as it is a calculation around what we're seeing environmentally. Obviously, it's a function of what are the markets that we lend money into looking like?
What are the reasonable and supportable prospects moving forward within a one-year timeframe against what's the intrinsic quality of our loan portfolio. Actually, we're fortunate in that we have a lower risk asset profile as a percentage of total earning asset than most banks, which gives us a little bit of intrinsic advantage in terms of being able to afford the provision and other things that earnings support, if you will.
Okay. Again, just looking at this, but looking at your reserves ex the PPP, you're at 153, 154, something like that. You had a huge Visa gain this quarter. If we looked at your loan loss provision of $40.4 million, if you hadn't had that Visa gain, would you have thought about that number differently? I realize there's some softness in terms of there's massive unknowns, right? I'm just trying to understand directionally, as you said, look, maybe it comes down. I obviously appreciate there's a lot of unknowns. I'm just trying to think about how much maybe the Visa gain played in or just even directionally how you're thinking about where you're comfortable with that number.
Yeah.
Maybe I'm asking this question twice, but yeah, thanks.
Yeah. No. The answer to the first question is no. Our provisioning and our reserving really didn't have anything to do with our decision to either take or not take the Visa gain. That's an investment that we've had for many, many years, and actually have been in the process of selling portions of that investment for years now.
From a provisioning standpoint, I guess what I would say is that these are uncertain times, there's a certain level of inaccuracy that's just built into everyone's provisioning. For those companies that have the ability, the earning capacity to provision in a healthy way, I think that's probably a smart thing to do. You saw that in the quarter. It was a large number, it wasn't a number driven by any potential earning outcome whatsoever, really. It's kind of a separate analysis.
Okay, great. Thanks. I'll leave it there.
Cool.
Thank you. I'm not showing any further questions in the queue. I would like to turn the call back to Cindy Wyrick for any final remarks.
I'd like to thank everyone 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 clarifications on any of the topics discussed today. Thanks, everyone.
Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.