2023-11-07 12:45:18 ET
Summary
- Higher than expected net interest margin helped deliver an overall beat for First Hawaiian in Q3.
- NIM will contract in Q4, but pressure from higher deposit costs is abating and management is fairly confident that this will mark a trough.
- The outlook for loan growth remains weak, but asset repricing can still drive some expansion in net interest income in 2024. Credit quality remains excellent with little cause for concern.
- Management is looking to rebuild capital and so buybacks are on ice in the near term, but with a 5.5% dividend yield, these shares offer an okay yield until the bank is in a stronger position to resume growth.
Contracting net interest margin and weak loan growth were my main concerns with First Hawaiian ( FHB ) when I last covered the stock after Q2 earnings. Credit quality was less of a worry to me, with the extent of unrealized losses on its investment securities also a little lower on my list of pressing issues.
The stock has dipped around 7% since then including dividends. While the above headwinds continue to play out for the bank, there were some positives to take away from Q3 results and follow-up commentary from management. With a slightly clearer outlook heading into Q4 and a sense that the worst may be behind it with respect to at least some of its issues, these shares continue to look like a reasonable value to me, and I maintain my Buy rating.
Q3 Better Than Expected
First Hawaiian recorded a better than expected Q3, with EPS of $0.46 beating consensus by three cents, or 7%, driven by higher than expected revenue. Net interest income ("NII") landed at a little over $157 million, which was only around $2.8 million, or 2%, lower than Q2, marking a deceleration on the 4.5% sequential decline posted in Q2. That was driven by better than expected net interest margin ("NIM"), which at 2.86% was only 5bps down from Q2 and around 10-15bps higher than anticipated.
First Hawaiian Net Interest Income & Net Interest Margin
There were few surprises elsewhere. Provisioning expenses were again low at $7.5 million, or 5bps as a portion of total loans, with the bank recording a 5bps build in its loss allowance due to possible losses linked to the Maui wildfires.
Maui exposure is not a major concern as far as credit losses are concerned. Although the bank has around $1.7 billion in total exposure (mostly in real-estate secured loans), only a small portion of this will actually be in the impacted areas. This will shrink even more as you strip out insurance-protected property, assets not impacted by the fires and so on. Management's estimate at this point is a little over $9 million in fire-related losses.
A bigger concern would be a more prolonged economic hit, possibly through lower levels of tourism. I would note that despite a good performance prior to the fires, visitor arrivals in August and September were 7% below same-month 2022 levels, with August visitor spend around 9% lower on the same basis. Still, I don't think this is likely to be a major problem for the bank.
NIM Contraction Expected In Q4
NIM performance was much better than expected and drove the overall income and EPS beat. There is good news and bad news here. The bad news is that NIM is still seen falling to the mid-270bps range in Q4, with some one-off factors in Q3 keeping it higher than anticipated. Management flagged that September NIM was already down to 2.79%, and a fall into the 2.75% area would take it to the low-end of the 15-20bps decline that was originally penciled in for Q3.
Regular readers will know that the main reason I like the Hawaiian banks is because they have rock solid core deposit franchises. Despite declining sequentially by around $310 million, non-interest bearing balances of $7.96 billion still account for around 37% of First Hawaiian's deposit mix, with its cycle-to-date deposit beta still only around 25%. At the end of the day, clients still need to keep a certain level of cash in these kinds of transaction accounts, so there is a limit to how far NIB balances will fall. Total deposits increased by around $400 million in Q3, or 2% sequentially, and while there is still mix/pricing pressure, this will moderate now that the Fed looks to be finished hiking. The good news is that management is increasingly bullish that NIM will indeed bottom around the mid-270bps level in Q4.
Loan Growth Weak As Expected
Soft loan growth is one of the main concerns with banks in general, but First Hawaiian faces a particularly tepid outlook as its loan book skews around 30% to residential mortgages. Mortgage costs have soared while average sales prices are only moderately lower, making for a very weak demand outlook. Gross loans were essentially flat on an end-of-period sequential basis, and management expects that to be the case in Q4 too.
Despite this, the bank still has some positive NII drivers. Around $1.5 billion of fixed-rate loans will reprice over the next 12 months, and that will lift interest income through higher yields even if total balances stagnate. A further $700 million in maturing investment securities will have the same effect, even if this simply sits as cash on the balance sheet. While earning-asset growth will be muted, stability in terms of funding costs and some upside potential from repricing assets means that the overall income outlook is a bit clearer now than it was a few months back.
Relatively Few Concerns Elsewhere
Two issues I wasn't overly concerned about at First Hawaiian were credit quality and the large unrealized losses in its investment securities portfolio. In terms of the former, construction loans and investor-owned commercial real estate, in particular office loans, have been major areas of concern for the market. First Hawaiian has around $5 billion in CRE and construction loans on its balance sheet, equivalent to around 35% of its total loan book and a heavy 3.8x tangible common equity ("TCE"). Office loans in isolation are around 5% of total loans and circa 0.6x TCE.
Now, criticized office loans actually fell to just 1.7% in Q3 following the payoff of a loan on a property in Downtown Los Angeles, while criticized construction loans are running at just 10bps right now. Charge-offs actually fell sequentially and non-performing loans remain at just 0.10% of the book, covered around 11x by loan loss reserves. I expect the peak charge-off rate here to be well below the peer group average in any case and there remains little cause for concern on this point. I would also note that loan-to-value ratios across its CRE and construction portfolio are also sub-60% providing a nice buffer if needed.
Unrealized losses on its investment securities are a slightly different issue. First Hawaiian currently holds around $2.7 billion in available-for-sale ("AFS") securities and a further $4.1 billion in held-to-maturity ("HTM") securities. Unrealized losses on its AFS holdings have led to a steep increase in AOCI losses on its balance sheet, which in turn has led to a reduction in tangible common equity ("TCE"). Because of the nature of its deposit franchise, First Hawaiian hasn't faced the kind of problems that SVB and certain other banks faced earlier in the year, but it still has to grapple with the opportunity cost of having a chunk of assets tied up in low-yielding securities that would otherwise be generating much higher interest income. To put some numbers on this, the bank only earned 2.14% annualized on its investment securities in Q3 compared to over 5.3% on its cash deposits.
Furthermore, AOCI losses have depressed TCE to around 5.7% of total tangible assets, and that ratio would decline much further if you were to factor in its unrealized HTM losses. On that measure at least, the bank's capital position looks a little thin, which is why management has ruled out share buybacks in favor of rebuilding capital. Now, these issues will resolve in time given that around $225 million worth of investment securities are maturing each quarter, but it might be a slow burner.
First Hawaiian stock trades for $18.70, down from around $20.50 at prior coverage. That puts it at around 1.75x TCE, which looks reasonable given 2024 EPS estimates of $1.71 map to a circa 15%-plus return on TCE next year. In the meantime, the current $0.26/share quarterly dividend is now yielding just over 5.5% versus 5.1% last time out. While it remains hard to see any near-term catalysts for the stock, if your time horizon extends out beyond 2024 then these shares look like a good deal. At that point the bank should be in a better position to return to growth.
For further details see:
First Hawaiian: Margin Pressure Easing