Good day, and thank you for standing by. Welcome to the First Hawaiian, Inc third quarter 2021 earnings conference call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. If you require any further assistance please press star zero. I would now like to hand the conference over to Kevin Haseyama, investor relations manager. Please go ahead.
Thank you, Ashley. Thank you everyone for joining us as we review our financial results for the third quarter of 2021. With me today are Bob Harrison, Chairman, President, and CEO, Ravi Mallela, CFO, and Ralph Mesick, Chief Risk Officer. We have prepared a slide presentation that we will refer to in our remarks today. The presentation is available for downloading and viewing on our website at fhb.com in the investor relations section. During today's call, we'll be making forward-looking statements, so please refer to slide one for our safe harbor statement. We may also discuss certain non-GAAP financial measures. The appendix to this presentation contains reconciliations of these non-GAAP financial measurements to the most directly comparable GAAP measurements. Now I'll turn the call over to Bob.
Thank you, Kevin. Good morning, everybody. Thank you for joining us today. I'd like to start with an update on the COVID situation here in Hawaii. If you turn to slide two. Like many places, the health of our economy is directly related to our ability to control the virus, and we've done quite a good job on that. With over 70% of the population fully vaccinated and an impressive 92% of the population over age 12 has had at least one shot. We did have a surge in late August and early September related to the Delta variant, as you can see in the lower left there. That has, for the most part, come down, and our new case counts are dramatically lower. A lot of capacity in the hospital, so not a concern about that.
The governor has announced that we're going to be fully welcoming back visitors starting on November 1. Really in talking to all the mayors, both here on Oahu and the neighbor islands, all of our elected officials are very focused on keeping Hawaii open for tourism. We expect to see the numbers starting to increase. We've actually started to see a bit of an increase in daily arrivals starting this month. As the restrictions start to come off and tourists start to return, we expect more of a normalized economy as we come into the holiday season. Turning to slide three. Total loans grew net of PPP paydowns, and our results were solid in the quarter, despite all the noise of the Delta variant. Deposits continued to grow in all segments, while non-interest income and expenses were stable.
Credit quality remained excellent, and the diluted earnings per share was $0.50, and the board maintained the dividend at $0.26 per share. During the quarter, we also repurchased $21.6 million of common stock under our current repurchase program. With that, I'll turn it over to Ravi to go over the financials.
Thank you, Bob. Turning to slide four, period end loans and leases were $12.8 billion, down $269 million from the end of Q2. Excluding the impact of PPP loans, total loans increased by $39 million. We had some good activity in several areas, but dealer flooring remained a headwind, declining another $103 million. Excluding the impacts of PPP repayments and dealer flooring balances, total loans grew about $142 million in the third quarter. Growth was driven by increases in residential, commercial real estate, and home equity. Looking ahead to the fourth quarter, we're expecting net growth in loan balances. Because of the delayed recovery in dealer flooring, we now expect total loan balances ex PPP to be flat to up 1% for the year. Turning to slide five. Total deposit balances ended the quarter at $22.1 billion, a $1.3 billion increase versus the prior quarter.
This increase was driven by a $782 million increase in public deposits and a $503 million increase in consumer and commercial deposits. The increase in public deposits was almost entirely in operating account balances. Our cost of deposits fell 1 basis point to 6 basis points in the quarter. Turning to slide six. Net interest income was $132.6 million, a $1.1 million increase versus the prior quarter. The increase in net interest income was primarily due to higher average balances of investment securities and higher cash balances. Net interest margin was 2.36%, a 10 basis point decrease from the previous quarter. In Q4, excluding the impact of excess liquidity and PPP loan forgiveness, we expect our net interest margin to decline 2 to 4 basis points. Turning to slide seven. Non-interest income in Q3 was $50.1 million, a $733,000 increase over the previous quarter.
Non-interest income in the third quarter included a $2.3 million BOLI death benefit.
Non-interest expenses were $101 million, a $1.6 million increase versus the prior quarter, and the efficiency ratio was 55.1%. Now I'll turn it over to Ralph to go over asset quality.
Thank you, Ravi. If you could turn to slide eight, I want to provide a few comments on asset quality. We continue to see good credit performance. Realized credit costs remain low, and we released provision again this quarter. Net charge-offs were $602,000 in Q3. Annualized, the net charge-off rate is at 6 basis points year to date, lower than the levels we saw in the prior two years. NPA and 90-day past due loans were marginally down this quarter to 11 basis points, a 1 basis point decrease from the prior quarter. Criticized assets increased during the quarter, moving from 2.51% of total loans in Q2 to 2.98%. Loans 30 to 89 days past due increased 13 basis points to 35 basis points at the end of Q3. The increase was attributed to the delay in the closing of an extension of a single CRE loan.
Moving to slide nine, you see a roll forward of the allowance with a quarter by disclosure segments. The allowance for credit loss decreased by about $7.9 million to $161.2 million at the end of the quarter. This level equates to about 1.26% of all loans and 1.31% net of PPP loans. Our reserve for unfunded commitments increased by $3.3 million to $32.5 million. In Q3, we recorded a $7.3 million release against the allowance due to balance changes and some improvement in consumer FICOs. Our outlook for the economy was unchanged. We anticipate the recovery started mid-year will continue but still maintain a COVID-related overlay given uncertainties that could result in higher credit losses. These uncertainties include the effects of the new virus mutations on travel and leisure activity, as well as the impacts of monetary and fiscal actions. Let me now turn the call back to Bob.
Thank you, Ralph. This was another solid quarter. Credit quality remained excellent. We are continuing our investment in technology to improve our digital capabilities and our customer experience, and our balance sheet is well positioned for rising rates. With that, I'd like to open it up and take your questions.
As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Your first question comes from the line of Ebrahim Poonawala with Bank of America. Your line is open.
Good morning.
Morning.
I guess just on loan growth, you mentioned the full year update ex PPP. Just give us a sense of one, Bob, do you think the dealer finance book has bottomed out year? Just the pace of where you see it going back to next year, understanding that all the supply chain issues may not be resolved. What was this book at the peak of pre-pandemic? Just to get a reference point of how large this can go back again. Maybe if you could start there.
Sure. Thanks, Eb. Good question. In fact, saw some good news today on automotive news that our dealer team shared with us. The head of GM's North America business said they're making good progress on shipping pickups. They're going to start with their high margin vehicles and work their way from there. These are very big companies, and they're certainly working nonstop day and night to straighten out the supply chain. Our peak, I'm not sure about, but kind of the latest normal number would be the end of 2019, and our dealer flooring balances were $860 million plus a little bit. Now we're substantially less, $176 million. There's quite a bit of room. Just this year, we're down $460 million in balances year to date. You can't really pick the bottom on this.
We had thought it would have already started to increase a bit, obviously, but it seems like we're at a bottom with some potential upside. We'll just have to wait and see, primarily on the flooring business and see how soon that comes back.
Got it. Thanks, Bob. Just in terms of economic activity, you provide some color on slide two around COVID and the restrictions. Give us a sense of just where you think we are in terms of normalcy, hospitality sector, when you think about the holiday season going into the winter. Are we all there? Are we going to be at this 80% capacity in terms of how many of the hotels would have been fully open? Just give us some perspective around that.
Yeah. I certainly can't predict what the holidays will bring. The normal shoulder season, which is what we're in right now, September into October, we always see a drop off in tourist arrivals from summer into the fall. Typically it builds back in the holidays as people take their vacations. I can't think of any hotels that are still closed. I think everybody's tried to open, certainly the major ones, and they're adjusting their staffing depending on what occupancy is. Everybody's ready, and we'll just have to wait and see. As we've talked about in previous conversations, many families come to Hawaii every holiday season, and we'll just have to wait and see if they come this year and choose to travel. I think the hotel rooms are booked, just have to see if people show up.
Got it. Just one last question, if I can sneak one for Ravi. What was the end of period balance on PPP at the end of 3Q, and how much in fees is left to be recognized?
Yeah, we have a little over $500 million in terms of remaining balances. Sorry, Ebrahim, I missed the second part of the question there.
What are the fees tied to PPP that are left tied to that $500 million balance?
It's $14.4 million.
Safe to assume that you expect the next two, three quarters, most of that gets forgiven?
Yeah, I think if we look at next quarter, I think, the last couple of quarters is a good reflection of the pace we've been moving at. I think over the next two quarters, we should be through the majority of it.
Got it. Thanks for taking my questions.
Your next question comes from Steven Alexopoulos with JPMorgan. Your line is open.
Hi, everyone.
Morning, Steven.
Morning, Steven.
I wanted to start and drill down a little bit on C&I. If we take PPP loans and dealer loans, and we put those aside, can you talk about the change you saw in the C&I pipeline in the quarter? Any notable increase in commitments? What was line utilization? I know you said it was stable.
Ralph, do you have the line utilization number?
Yeah. It was a shade over 20%, and I think what we saw pre-COVID, it was probably around 30%. We'd probably gone down into the mid-teens at the low point. It's starting to come back a bit there.
Yeah.
Yeah.
We're seeing some activity in the corporate area. Not a huge amount, but we're seeing some activity in that area. It's been muted. We've seen a couple payoffs, just not that we wanted them, but it's just that the transactions have occurred that either they went to capital markets or mergers and acquisitions in that portfolio. It's been fairly stable. We haven't seen a huge amount of new growth, a modest amount. I think that market is there, and we'll see what the next few months bring as deal-making typically starts in the beginning of the year, but we'll just have to wait and see.
Okay. That's helpful. Maybe for Ravi, you built a pretty sizable cash position here, and it looks like the guidance you're expecting more deposit than loan growth over the near term. Now that rates have moved up a bit, has this changed your appetite? Should we expect more of that liquidity to move into the securities book, or do you anticipate this cash balance building further here?
As you know, just looking at the data, we've grown that securities portfolio about $1 billion this quarter, and it's pretty close to $8 billion. We certainly look at the balance sheet in totality, and we'd love to see loan growth kind of help us with those liquidity levels that we have currently. We'll have to take it sort of piece by piece. I think we're probably feeling pretty comfortable with our level of securities at this stage. I think as we start to see some of that liquidity get deployed, we'd like to see those balances come down. At this point, we feel comfortable with our securities level, plus or minus a little bit, but we're going to have to work through that liquidity over time.
Okay.
It is Bob, Steve. The only thing I would add to that is you saw a large increase in the public operating accounts is that a relationship with the various municipalities and the state has been very fluid. Just the amount of cash they have coming in and going out is hard to predict.
Got you. Okay. Bob, just a final one. I mean, just about every bank's talking about wage pressure here, and I haven't been paying a lot of attention to the situation in Hawaii. Is that a pressure point, and could this impact your expense growth over the next year? Thanks.
Yeah. Great question, Steve. We're seeing some of the same issues here. We did see our jobless rate tick down yesterday. It went from 7% down to 6.6%. There are still some people looking for jobs, but there's still a lot of activity out there, a lot of people trying to hire. There is some wage pressure, and we've been going through that, quite frankly, over the last year plus in our business. I'm not going to say we won't face it, but it's hard to predict exactly what that would be going forward.
Okay. Thanks for all the color.
Your next question comes from David Feaster with Raymond James. Your line is open.
Hey, good morning, everybody.
Morning, David.
Morning.
You saw some nice growth in CRE in the quarter. I'm just curious maybe where you're seeing strength, and maybe if you could compare and contrast the U.S. and the mainland and the Hawaiian markets and also just maybe give us a pulse of the competitive dynamics that you're seeing. We hear a lot more competition from a pricing standpoint, also seeing some on structure and standards as well. Just curious what you're seeing in CRE.
This is Bob, David. Maybe I'll start and ask Ralph to add some comments. We've continued to see pressure here in Hawaii on pricing. We haven't seen it too much on structure. It's been much more active in the mainland, primarily the West Coast, where we have relationships with some direct relationships and a lot of relationships with other banks, and it just seems to be quite active that people are doing transactions up there that we've been able to participate in. I expect we'll see more volume here over time, but there will be some headwinds, as I mentioned earlier, with a couple large projects here paying off in Q4 on the CRE construction side. Ralph, anything you'd add to that?
I would say that on the mainland where we've seen pretty good activity right now. Most of what we're doing there is sort of institutional quality type real estate, institutional type players. I think in terms of weakening of terms, it's not as big of an issue as it would be maybe in the smaller loan market.
Okay. That's helpful. Maybe just touching on fee income and getting some of your thoughts on the puts and takes there, just on card fees, which have pretty much recovered back to where we were in the trust department and the trends you're seeing there. Just appreciate the color on the BOLI benefit, but have seen several other banks add to BOLI. Just curious your appetite for BOLI here too.
Please, Ravi, go ahead.
I think maybe I'll just take them in pieces, David. This is Ravi. I think it's been nice to see the credit card and debit card fee income pick up as we've seen quite a bit of activity here over the summer. We saw, I'd just characterize it as a small dip as a result of, as Bob mentioned, sort of going into the shoulder season and maybe a little bit of impact of the Delta virus in activity. Again, strong numbers there, and we expect that to trend pretty consistently with what we'll hopefully see in the rest of the year in the vacation season.
I'd say with trust and investment income, it's been very strong and very stable, and I'd say the core pieces of income coming from the trust investment income side has been really from recurring revenue sources which has been a good, sort of solid, consistent place of growth for us for I'd say the last year and a half. Just talking a little bit about BOLI. From our perspective, we're probably from a capital perspective sort of at the top end for the amount of BOLI that we can have in our portfolio. We don't expect to add to the BOLI portfolio itself, but we expect it to perform pretty well over time and pretty consistently, at least in this environment.
Okay. That's helpful. That's great color. Just last one from me. Asset quality has been phenomenal. You guys do a great job there. Just wanted to touch on the modest uptick. It's small, but just the uptick in criticized and past due balances and your just thoughts on overall asset quality here.
Sure. Dave, this is Ralph. The increase in the criticized loans was about $62 million. Really that was around, I think, about five credits, Shared National Credit that got downgraded during the exams that are conducted at the agent banks. When we look at those credits, we don't see much loss potential there. These companies have really good financial flexibility, sound businesses. I think it really is sort of a different perspective maybe that the regulators had from the banks. Nothing I don't think really happening there. I think this trend that we've seen can kind of continue to improve. Then on the past due side, that was really kind of an administrative delinquency on one loan, and we're at 35 basis points, just one loan could create quite a bit of a change in the statistic.
Was there anything within those five credits that was any trends or similar industries, or was it just kind of one-offs?
They're kind of in those high-risk areas. Actually, the trends are probably improving. The regulators come in annually, and they look at those deals. They were downgraded to a special mention, which essentially means there's potential weakness, and I think not necessarily a well-defined weakness. Again, we've downgraded those credits, we have reserved for those credits. We're pretty comfortable with the asset quality picture right now.
Okay. That's helpful. Thank you.
Your next question comes from Andrew Liesch with Piper Sandler. Your line is open.
Morning, everyone.
Morning.
Morning.
Just want to touch on expenses here. They're pretty well controlled. I know you pushed out the timing of the conversion into next year, and it sounds like there might be some inflationary pressures, but how should we be looking at the expense base and expense growth for next year? I think you're guiding to 7% for 2021, which all seems reasonable. How should we look at it going into next year?
Andrew, this is Ravi. I'll comment a little bit on that. Typically, we don't provide 2022 guidance yet. I'll make some comments about sort of how we see the future in terms of our expense profile. Bob alluded to sort of inflationary pressure that we've seen particularly in wages, in particular in some very specific categories that are high in demand. That's one area I think we've talked about this in the past, our continuing investment in technology. It's a big part of our goals for the future, and we're going to continue to invest in technology to be competitive. Another area just to talk about is just the core.
I think we'll see as we get closer and closer to the implementation of core, we're going to see training costs they will continue on. When we eventually go live, we'll see that the capitalization of the development cost start to roll into the expense line in the form of amortization of the core itself. That's some guidance or clear, or not guidance, but just some color on where we think things are going for the future.
Got it. Makes sense. Is there any timing that you can provide on the conversion?
Yeah, Andrew, this is Bob. We're looking at the first half of next year still and trying to pull that in. We're feeling very good about where we're at, but since we've delayed it, we don't want to jinx ourselves by being too specific. We're feeling very good about where we're at and the progress we're made. We didn't want to do it in the fourth quarter, candidly, because it just didn't seem like a good idea relative to year-end.
Understandable. Makes sense there. Then just with the rapid deposit growth, some of it's obviously public funds that may go the other direction at some point, but that puts some pressure on capital ratios. How should we be looking at the buyback? I know you guys have wanted to be consistent with share purchases, but how should we be looking at that asset growth versus the buyback right now?
Yeah, maybe I can start on this, Bob, and ask Ravi if he has any comments as well. It's something we're looking at in our budgeting process, clearly. We're hopeful that we'll see loan growth come back in next year with just some of the lines of credit that we have, both to our corporate customers and certainly our flooring line customers, and that amount of capital that we're holding above our target will kind of get absorbed into the loans portfolio through risk-weighted assets. In that planning process, we're going to look at our profitability. We know that we've been a very steady capital return bank, and that's something that's very important to us. Certainly, the dividend is critically important to us, and we're not seeing any changes in that.
We'll just have to decide how much capital we'll have left after we're investing in our technology and look to maintain the share repurchase program. We don't have any idea at this point of what the level would be or what we're looking at on that. Ravi?
I didn't have anything to add.
Got it. Well, thank you for taking the questions, and I'll step back.
Again, if you would like to ask a question, please press star one on your telephone. Your next question comes from Jared Shaw with Wells Fargo. Your line is open.
Hi, good morning, guys. Thanks for taking the questions.
Morning.
Maybe looking at loan growth, to hit that target for the 1% ex PPP growth this year, it seems like we'd be seeing a ramp up in fourth quarter. How should we be thinking about resi mortgages as part of that? It's certainly grown as a percentage of the overall portfolio. Is that going to be a bigger part of the lending story going forward?
Yeah, Jared, good morning. This is Bob. Certainly for fourth quarter, we're going to see a bump in residential for no other reason other than there's actually three large projects completing that are actually, a couple of them in escrow now as far as the residential loans we've approved for customers that will be closing in the next several weeks as those projects are completed. That by itself will be a pretty significant boost on top of the normal volume that goes through. Like many places, we're seeing a little bit of a slowdown in refinance and pick up other than these projects completing and new purchases. In addition to that, we have this kind of special one-off situation with these three projects completing. Residential should be quite strong in Q4.
Okay. Thanks. Shifting to the reopening of the state, you touched on a little bit of the labor market, but is there enough labor capacity in state to sort of handle a full reopening? Will that require maybe some return of people that may have left the state at the beginning of COVID?
Yeah. To be honest, I don't have a great answer for you on that. To be determined. We had our unemployment rate, Kevin, was it 2% or something before? At the low point. Now we're at 6.6%, 2.5%, below 3%, and now we're at 6.6%. There's still quite a few workers out there that are looking for jobs. Will that be sufficient to absorb the demand of the return to tourism? I don't know, to be candid with you.
Okay. Just finally for me, when you're looking at the NIM guidance, Ravi, and you're saying that excluding the excess liquidity, what is the excess liquidity that we should be thinking of at this point?
It's hard to say.
Dollar value. Yeah.
Yeah. It's hard to say. I think last quarter, it was about 8 basis points impact of excess liquidity. If we start to see some of those, as Bob mentioned, those public deposits move off, certainly the impact of excess liquidity coming from that part of the deposit base will decline. We've also seen pretty good strong growth in commercial and consumer deposits. It'll really depend on what happens in the next quarter or two.
Okay. Thanks a lot.
Your next question comes from Laurie Hunsicker with Compass Point. Your line is open.
Great. Thanks. Good morning.
Morning, Laurie.
I wondered if you could just give us a little color, the $2.1 million in litigation costs, what that was?
Yeah, I can touch on that. This is Bob. Morning, Laurie. That's just some commercial dispute we had with a vendor, and we didn't feel they were performing to our expectations. Unfortunately it got into litigation, but we should have that resolved, we're hopeful, very soon.
Okay. Then when I look at that other expense line, the $16.2 million, even netting out that $2.1, it still looks high. Was there any other one-time items in that bucket to think about?
Nothing specific, Laurie. I mean, a lot of small little things. In particular, a couple of catch-up items that we had, but nothing specific.
Okay. I guess if we were to think about where that line would run, is it going to run closer to sort of $13 million a quarter, give or take? How should we think about that?
It's hard to say. There's a lot of sort of small items that are in that line. I think 13 isn't such a bad number in terms of what we expect it to be, but it'll just depend on sort of one-time items that might show up in the quarter itself.
Okay, great. Thanks. That's helpful. Tax rate, how should we be thinking about that for next year?
I think barring anything else that happens out there with respect to policy, I think relatively consistent with where we are, maybe trending a little bit downward. We continue to engage in Low-Income Housing Tax Credit as an opportunity to manage our effective tax rate. As we sort of roll into new opportunities there, we'll start to see that tick down a little bit. But that takes time as we build that portfolio.
Okay, great. Last question from me, deferrals. I didn't see a deferral update in your deck or in your press release. I'm hoping you can give us a number. I know it was incredibly low last quarter at $35 million. Just wondered if you had an updated number on that.
I think what's left now, Laurie, this is Ralph, is about $16 million.
$16 million. Okay. Do you by chance have a split in terms of what's commercial versus?
Yeah, I don't, but it's almost exclusively residential mortgage.
Perfect. Okay. Thank you very much.
There are no further questions at this time. I will now turn it over to Kevin Haseyama.
Thank you. We appreciate your interest in First Hawaiian, and please feel free to contact me if you have any additional questions. Thanks again for joining us and enjoy the rest of your day.
This concludes today's conference call. You may now disconnect.