2023-05-12 08:18:49 ET
Summary
- Despite recent difficulties, the bank's strong liquidity, stable deposit flows, and cautious risk management instill confidence in its ability to navigate the current environment.
- While there are certain concerns to address, such as the equity to asset ratio and exposure to office loans, these issues are not considered structural.
- FHB's current valuation, with a forward price-to-earnings ratio of 8x, presents an appealing buying opportunity.
Thesis
The share price of First Hawaiian (FHB), like that of many other banks, has taken a hit during the recent turmoil. The 1Q23 results sent a clear message that NIM compression will continue in the next quarter (2Q23), which I believe led to a downward earnings revision by consensus. Although I think most people saw this coming given the higher-than-expected betas on deposits, hearing management say betas are likely to move higher than expected was a little surprising to me. Although rising deposit betas were a concern, it was reassuring to learn that other liquidity metrics, such as deposit flows and, more specifically, the noninterest deposit mix, remained largely stable and unaffected by March's events. I also think that the long-term underlying loan demand is still sound for FHB. Despite some worries regarding the loan book for office commercial real estate and the possible halt on shares buyback, I think the bank is holding up quite well. In particular, management is maintaining a cautious approach to balance sheet and credit risk management. The current valuation also offers a very compelling buying opportunity at 8x forward PE, which is the all-time low over the past 10 years. I recommend a buy rating for investors that have sufficient holding power to ride through this period.
1Q23 results highlight
FHB reported $0.52 in core EPS, a decrease of 10.6% in NII, and a rise of 7.2% in core fee income. The average growth of loans and deposits was 5.9% and -4.7%, respectively, while the efficiency ratio hit 54.8%. The reserve ratio was 1.03%, and the NIM was 3.11%. As of 1Q23, cash and equivalents amounted to $866 million, an increase of $339 million sequentially, and constituted 3.5% of total assets. Total borrowings at quarter's end increased from $75 million in 4Q22 to $750 million in 1Q23, while deposits declined by $408 million during the same time period. The bank had $8.2 billion in cash and short-term investments as of 1Q23.
Average deposits
Average deposits largely held in non-interest bearing deposits, checking, savings, and money market accounts at FHB institutions fell 4.7% from the previous year. Total deposits also declined to 21.3 billion on the backs of smaller retail, commercial, and public deposits. Although the decline was larger than I had anticipated, I do not believe the rate to be alarming. Importantly, the situation has stabilized since March 31. This is an important message as the operating the bank is a game of confidence. FHB needs to convince the market that everything is sound so that there will not be any bank runs. Also, I note that FHB is the largest bank in Hawaii , with vast majority of deposits within the footprint of Hawaii, as such there is a strong local branding and market position which should support further stability.
Average loans
The average loan from FHB grew by 5.9% during the period, and the ending balance grew by 3.7%. While dealer flooring balances remained relatively stable in 1Q23, growth in construction and home equity was led by draws on existing lines. I anticipate a further moderation in FY23 lending given the current market condition and rates. However, I do not think there is any structural damage to the underlying demand for loans. Since there is currently little overcapacity in Hawaii as vacancies have decreased, FHB should continue to see long-term loan demand for commercial real estate. Analyzing the loan portfolio of FHB, approximately one-third of the total loans consist of commercial real estate loans. Therefore, even in the absence of new demand, I anticipate that loan growth will be supported by the utilization of existing credit lines, including construction loans, dealer flooring, and home equity loans.
Capital/concerns
Despite FHB's healthy liquidity, the ratio of tangible common equity to tangible assets is only about 5.6% as of right now. Even though FHB has a healthy CET1 ratio of around 12%, I anticipate that management will wait to repurchase shares until the equity to asset ratio improves. The objective is to ensure FHB can fortify its capital structure before the expected reversal of unrealized securities losses associated with underwater securities nearing maturity. Concerns have also been raised about the proportion of FHB's loan portfolio that is comprised of office loans, which is around 6 percent. However, management has sent a positive signal to the market, saying that, after reviewing all commercial real estate credits over $5 million, they saw a net reserve release during the quarter. The quality of FHB's loan portfolio should now be more apparent to investors.
Conclusion
In conclusion, despite recent challenges and concerns, FHB remains resilient. The bank's strong liquidity, stable deposit flows, and cautious risk management provide confidence. While there are issues to address, such as the equity to asset ratio and exposure to office loans, I believe these are non-structural issues. With an attractive valuation of 8x forward PE, I recommend a buy rating for investors with a long-term perspective.
For further details see:
First Hawaiian: Everything Looks Fine