2023-08-04 17:54:06 ET
Summary
- First Hawaiian shares have been caught up in the wider regional bank sell-off and are currently down around 20% YTD.
- Although the deposit base is resilient, higher funding costs and a weak growth outlook are nonetheless resulting in a soft near-term earnings outlook.
- The current dividend yield is now over 5%. Even if FY24 EPS declines around 15% versus FY22 levels, the payout ratio isn't heading much above 60%.
This is an uncomfortable period for regional bank stocks, with earnings coming under pressure from higher funding costs, yield curve inversion and weakening demand for credit. Connected to this, and although not exactly an 'unknown' prior to the sell-off, unrealized losses on the industry's investment securities pile have also come in to sharp focus in recent quarters, with many of the weaker players ultimately paying a heavy price for their positioning heading into this period of rapid interest rate hikes.
Like most of its peers, shares of First Hawaiian (NASDAQ: FHB ) have performed poorly year-to-date, returning a double-digit loss on the back of industry-wide fears that took off with the failure of Silicon Valley Bank back in March. Performance has been materially better than close peer Bank of Hawaii (NYSE: BOH ), but slightly worse than the peer group to varying degrees depending on which index you use.
While First Hawaiian has clearly been battered and bruised by recent developments, the market dynamics of Hawaii should mean that this is squarely a question of earnings rather than something more sinister. Granted, that's not exactly a very positive statement, but with these shares offering a safe-looking dividend yield in excess of 5%, income seekers may be more tolerant of a softer near-term operating environment.
A Differentiated Deposit Base
Without wanting to rehash old news, many banks with a high level of investment securities have found themselves sitting on large unrealized losses as rising interest rates have reduced their fair value. Should enough depositors of any such bank decide they need a safer home for their cash, those losses could well have to be crystallized, potentially spelling existential trouble for said institution. Although not an unknown prior to Q1 2023, this came into much sharper focus following the failure of Silicon Valley Bank late in Q1.
First Hawaiian looks like it might be one of the more questionable regional banks. It had already transferred a big slug of its investment pile into the 'held-to-maturity' pile, thereby reducing more AOCI losses, but its total pile of investment securities still amounted to around 30% of its asset base at the end of Q2. As a result, unrealized losses undoubtedly equate to a fairly significant portion of its tangible shareholders' equity. This could represent a big problem for the bank if it is forced to crystallize those losses, say in response to depositors seeking to remove their cash.
Fortunately for investors, where First Hawaiian separates itself is in the nature of its deposits. I have pointed this out in prior coverage of the stock, but the banking market in Hawaii is highly concentrated and the top two players enjoy very sticky core deposits. With a low-30s percentage share, First Hawaiian is the top deposit gatherer in the state. That always made the type of run that has hobbled certain mainland regional banks much less likely here, despite surface level similarities. With that, total deposits at FHB amounted to $21.1B at the end of Q2, which was less than 1% below its Q1 period-end level.
Softer Earnings On The Cards
The most pressing issue for First Hawaiian is that its earnings outlook has deteriorated significantly in recent months. Although the deposit base is pretty resilient, the bank is by no means immune to industry-wide pressures such as higher funding costs. With that, non-interest bearing demand deposits fell 6% quarter-on-quarter on a period-end basis (to $8.1B). They have fallen around 8% since the start of the year on the same basis. Combined money market and time deposits have risen by just over 10% over the same timeframes (to just over $7B on a period-end basis). These deposits are also costing First Hawaiian more due to rising interest rates, with the bank paying a blended annualized rate of 2.5% in Q2 versus 1.85% in Q1.
What's more, the yield First Hawaiian earns on its investment securities pile actually fell 3bps sequentially in Q2 (to 2.06%). Loan growth was 1% QoQ on a period-end and average balance basis, with the average yield up 26bps to 5.22%, but that wasn't enough to offset the headwinds just outlined. Net interest income ("NII") fell 4.5% QoQ to $160m, with net interest margin ("NIM") declining 20bps sequentially to 2.91%.
Management expects continued funding cost pressure in Q3, while loan growth looks set to moderate given that the high-end of FY23 consensus (mid-single-digit growth) lands around 3ppt lower than the H1 2023 year-on-year performance (8% YoY growth in H2). That means a weaker NIM going forward, with management guiding for a 15bps to 20bps contraction in Q3. With NII over 75% of the top line that further means a softer earnings outlook ahead.
One bright spot is asset quality. Despite jitters around commercial real estate and so on, credit quality does at least remain solid and appears unlikely to materially threaten earnings. Net charge-offs were 1bp higher QoQ at 0.10%, while non-performing loans were 1bp lower QoQ at 0.09%. Commercial criticized assets were up 20bps QoQ but off a very low base, and at 52bps that ratio remains below the year-ago figure.
Dividend Looks Solid, But No Near-Term Growth
As per above, management expects a 15-20bps decline in NIM in Q3. Responding to analysts questions on whether that marks a bottom, management guidance is for stabilizing NIM in Q4:
I do think that. And obviously, Steve, that's entirely contingent upon what happens with the Fed and rates and all that. But we do see that sort of the bottom of our guidance. We think that's probably about where it bottoms out, given sort of a stable forward outlook at this point. And that's probably like somewhere in the fourth quarter for us. So that's kind of how we're thinking about it and how we're planning going forward.
Jamie Moses, First Hawaiian CFO, Q2 2023 Earnings Call
On flat-ish earning asset growth that would mean around $150m in Q3 and Q4 NII. Management still expects operating expenses to land around 4.5% higher YoY versus the Q4 2022 run rate figure, which would imply a quarterly figure of around $118m for Q3 and Q4. Assuming pretty flat non-interest income, provisioning expenses and a normal tax rate leads me to H2 2023 net income of around $116m, or $58m on average for Q3 and Q4. Call that quarterly EPS of around $0.45, which is about where analysts land according to Seeking Alpha . Adding that to H1 EPS ($1.01) also implies that my full-year EPS estimate of $1.91 is going to be around 8% lower than FY22. Analysts don't expect much improvement next year, with their FY24 EPS estimate of $1.76 basically mapping to that Q3/Q4 2023 run rate. That implies around 15% lower EPS versus FY22.
While the above means that near-term growth will be non-existent, the dividend does at least look pretty secure here. First Hawaiian pays out $0.26 per quarter, so even with EPS heading lower in Q3 and Q4 the payout ratio is still only going to be around 60%. That's absolutely fine for a bank like this because (1) FHB doesn't have high growth prospects that require a heap of retained earnings and (2) even $0.45 in quarterly EPS maps to a pretty high return on tangible equity of around 16%. Or said differently, First Hawaiian can pay out a relatively high portion of its earnings to investors because it typically earns relatively high returns on what it does retain.
First Hawaiian: Return On Tangible Equity (2017 - 1H 2023)
FHB stock trades for $20.50 at the time of writing. The $0.26 per share quarterly payout maps to a yield of 5.1%. The current stock price further maps to a little over 1.9x current tangible book value per share ("TBVPS") and 11.5x current FY24 EPS estimates. The former multiple looks quite high, but remember the bank would still be earning around 16-17% on TBVPS if FY24 EPS estimates prove reasonable. Its premium to tangible book is not out of line on that basis, but I'm not calling for multiple expansion here either. Eventually, FHB should be able to put its retained earnings to use in growing per-share profits. Even if that went to stock buybacks it would be good for around 3-4% annualized growth at the current share price, and higher still if it could fund modest organic growth at its current rate of return.
Along with the current mid-single-digit dividend yield I do think the above will ultimately be good for 9-10% annualized returns in the long run, but that is with the caveat that the near-term earnings outlook looks quite weak. In the meantime a secure 5%-plus dividend could appeal to income investors. Buy.
For further details see:
First Hawaiian: Earnings Outlook Softens, But The Dividend Looks Sound