Jul 27, 2017
Executives
Kevin Haseyama - IR Robert Harrison - Chairman & CEO Michael Ching - Executive VP, CFO & Treasurer Eric Yeaman - President & COO Ralph Mesick - Executive VP & Chief Risk Officer
Analysts
Steven Alexopoulos - JPMorgan Chase & Co. Ebrahim Poonawala - Bank of America Merrill Lynch Jacquelynne Bohlen - KBW Jared Shaw - Wells Fargo Securities David Rochester - Deutsche Bank AG Laurie Hunsicker - Compass Point Research & Trading David Eads - UBS Investment Bank
Operator
Good day, ladies and gentlemen and welcome to the First Hawaiian Inc. Q2 2017 Earnings Conference Call.
[Operator Instructions]. As a reminder, this conference is being recorded.
I would now like to introduce your host for today, Investor Relations manager, Mr. Kevin Haseyama.
Please go ahead.
Kevin Haseyama
Thank you Andrew. And thank you, everyone, for joining us as we review our financial results for the second quarter of 2017.
With me today are Bob Harrison, Chairman and CEO; Eric Yeaman, President and COO; Mike Ching, CFO and Treasurer; 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. Before I turn things over to Bob, I'd like to direct you to Slide 2 and remind you that we may make forward-looking statements during today's call that are subject to risks, uncertainties and assumptions.
For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, see our SEC filings, including our Form 10-K for the year ended December 31, 2016 which is available on our website and the SEC's website. We'll also discuss certain non-GAAP financial measures.
The appendix to this presentation contains reconciliations of these non-GAAP financial measures to comparable GAAP measures. And now I'll turn the call over to Bob, who'll provide you with second quarter highlights, starting on Slide 3.
Robert Harrison
Thank you, Kevin. Aloha, everybody and thanks for joining us today.
And I'm pleased to report we had another solid quarter as loans and deposits grew to record levels and total assets ended the quarter at a record $20.4 billion, that's the first time we've ever been over $20 billion. Local economy remains strong and our credit quality remained excellent.
Mike will go through the details of our financial results, so I'll just touch on a few highlights. Net income for the quarter was $56.9 million or $0.41 per diluted share.
Core net income was $57.2 million, the same $0.41 per diluted share. And yesterday, our Board of Directors declared a quarterly cash dividend of $0.22 per share, payable on September 8 to shareholders of record at the close of business on August 28, 2017.
Loans and deposits grew $281 million or 2.4% to a record $12.1 billion in the first [ph] quarter, while deposits increased $514 million or 3% to $17.5 billion. Eric will go into the details of the changes when he discusses the balance sheet.
Asset quality remains excellent with net charge-off ratio of 11 basis points and we remain well capitalized. Our efficiency ratio was 47.3% in the quarter and our profitability measures remained solid.
The return on average tangible assets was 1.22% and core return on average tangible assets was 1.23%. And our return on average tangible common equity was 14.89% and the core return on average tangible common equity was 14.96%.
Now I'll turn it over to Mike who will take you through our financial results.
Michael Ching
Thanks, Bob. So I'm starting on the summary income statement on Slide 4.
Bob just mentioned, but our net income for the quarter was $56.9 million or $0.41 per diluted share and core net income was $57.2 million, also $0.41 per diluted share. EPS was unchanged versus the prior quarter and $0.02 per share higher than the second quarter of 2016.
Turning to the next slide. Net interest income in the second quarter was $131.3 million, an increase of $1.9 million compared to the prior quarter.
Net interest margin for the quarter was 3.02%, an increase of 2 basis points from the prior quarter. Lower long term interest rates resulted in an increase in premium amortization in the investment securities portfolio of $1.4 million compared to the prior quarter.
Turning to Slide 6. Noninterest income was $48.9 million, a slight decrease of $0.5 million compared to the first quarter, primarily due to $1.3 million in death benefits from bank-owned life insurance recorded in the first quarter of 2017.
Noninterest expense shown on Slide 7 was $85.2 million in the second quarter, an increase of $0.9 million from the first quarter. Compared to the prior quarter, significant variances included an increase in our contracted services and professional fees of $2.1 million, primarily due to expenses related to system upgrades and product enhancements as well we had lower advertising and marketing expenses of $800,000.
Our efficiency ratio in the second quarter of 2017 was 47.3%, which continues to approximate our expected full year 2017 efficiency ratio. We're now looking at an efficiency ratio in the 47% to 48% range in 2018.
With that, I'll turn the call over to Eric to cover the balance sheet starting on Slide 8.
Eric Yeaman
Thanks, Mike. Total assets reached a record $20.4 billion at the end of the second quarter, an increase of $581 million compared to the end of the first quarter.
Investment securities decreased by about $133 million compared to March 31, as we utilize the portfolio runoff to fund strong loan growth in the quarter. Turning to Slide 9.
Total loans and leases grew by $281 million or 2.4%, to a record $12.1 billion at June 30. We saw growth in all segments of the portfolio with the largest growth in our C&I, construction, and residential loan portfolios.
C&I loans increased about $88 million, construction loans increased $86 million, and residential real estate loans grew by $57 million. We also saw consumer loans grow by $24 million with about $22 million of that growth coming from indirect auto.
Commercial real estate loans grew by about $13 million for the quarter. We believe that we can continue to prudently grow loans in the mid-to-high single digit range.
Turning to Slide 10, you can see that total deposits increased by $514 million or 3% to a record $17.5 billion at June 30th. Increases in savings, money market, and time deposits of $663 million were partially offset by a $149 million decrease in demand deposit balances.
Now I'll turn the call over to Ralph to cover asset quality.
Ralph Mesick
Thank you, Eric. On Slide 11, you'll see a positive trend on our asset quality which continued to show strong at quarter end.
Net charge-offs were $3.4 million for the quarter or 11 basis points on average loans and leases, it was 4 basis points lower than the prior quarter and 1 basis point higher than the second quarter of 2016. Nonaccrual loans were $7.7 million or around 6 basis points, unchanged from the prior quarter and 6 basis points lower year-over-year.
Delinquencies were $34.4 million or 29 basis points. This is up 1 basis point from the prior quarter and up 4 basis points year-over-year.
But I should note that across all loan categories, delinquencies at the end of June were lower than the peak levels of the prior 13 months. By quarter end, the delinquency rate for the indirect auto loan portfolio was 1.33% and the delinquency rate for the credit card portfolio was 1.03%.
In the second quarter, the provision expense was $4.4 million, about $100,000 less than the prior quarter. The allowance for loan and lease losses was $136.9 million at June 30.
The ratio of this reserve relative to total loans and leases was 113 basis points, and the current amount of the reserve covers our annualized net charge-offs more than 10x. With that, let me turn the call back over to Bob.
Robert Harrison
Turning to Slide 12. Hawaii's economy continued to perform well.
The state unemployment rate was 2.7% in June compared to 4.4% nationally. The visitor industry remains robust through the first 5 months of the year and year-to-date through May.
Visitor arrivals were up 4.2% versus last year to 3.8 million people. And more importantly, visitor spending was up to -- was $6.9 billion, an increase of 9.8% versus the same period last year.
Housing market remained sound. In the first half of the year, Oahu single-family homes sales were up 4.4% and the condominium sales were up 6% versus last year.
And year-to-date, the median home sales price on Oahu was $750,000, up 3.2% versus the same period last year. With that, we'll be happy to take any questions.
Operator
[Operator Instructions]. And our first question comes from the line of Steven Alexopoulos with JP Morgan.
Steven Alexopoulos
I want to start on the deposit side. If I look at the deposit detail, average time deposits were down in the quarter but then it looks like at period end it were up pretty strong.
Did you guys run a time-deposit promotion towards the end of the quarter?
Eric Yeaman
Well, what we saw at the end of the quarter was a pretty heavy inflow on both corporate and public side. Not necessarily driven -- that volume was not necessarily driven by the CD special, so to speak, but we did have a special going on.
Steven Alexopoulos
Okay, then how should we think about deposit cost in the third quarter?
Eric Yeaman
In the -- was that third quarter, Steve?
Steven Alexopoulos
Yes.
Michael Ching
Yes, deposit costs have been slightly increasing, we saw average cost deposits at 21 bps for Q2. I think that's up from Q1 we're about 19 bps -- 18 bps, excuse me, for the quarter.
We've been getting, I think similar to, perhaps some of the others in the market, we've been getting some growth in public to offset some of the lagging in core and trying to fund our loan growth, so public deposit market has become a bit more competitive in our market. And so if it continues in that range, then we might see -- at least on the public side, which is oriented towards time continue to uptick slightly.
Steven Alexopoulos
How would we think about the margin then in the third quarter with that said?
Eric Yeaman
Well, we're going to get another bump from -- a slight bump from the June rate increase on our margin. Outside of that or subsequent to that, unless we see further rate increases or steepening on the curve, I would expect the margin to be fairly stable to slightly up for Q3.
Steven Alexopoulos
Got you, okay. And then one final one.
Credit overall still looks very good. Just give us an update on the size of the indirect auto book?
And are you seeing any pressure at all in that portfolio?
Ralph Mesick
Yes, Steve, this is Ralph. The indirect auto portfolio is about $964 million.
It actually continues to perform very well and we've kind of stuck with our strategy on sticking to the higher end of the market with respect to credits.
Operator
And our next question comes from the line of Ebrahim Poonawala with Bank of America.
Ebrahim Poonawala
I just wanted to follow-up in terms of -- earlier in the quarter, you came up sort of with an updated efficiency ratio guidance for 2018, now you introduced the guidance of 47% to 48%. As we look at like, the expansion rate from 2Q, which was about $340 million that implies that assuming mid-single-digit revenue growth, we could see about a $20 million to $25 million bump in expenses into the $365 million range next year.
I just wanted to see outside of core expense growth, which I think you said about 2% to 3%, are there any big items that are going to come into the expansion rate? May be it is part of vendor contracts going away, if you could sort of give sort of some color around that?
Eric Yeaman
Yes, that's right. Ebrahim and maybe we've talked about before, the transitional services agreement which ties together a number of the contracts that we still share with our affiliate, Bank of the West.
Our largest contract within that structure is our FIS contract and that's going to term and we're working on that currently. But that's going to term in 2018.
As well a lot of the other contracts are back ended the latter half of this year and into '18 as well, and so that's the other sort of missing factor to the sort of normal core expense increase.
Steven Alexopoulos
And is the 47% to 48%, say you hit the midpoint of that range next year. From there on, like is that -- does that come back again?
Or is that sort of the -- once you fully absorb the public company standalone costs, that's the run rate to think of?
Eric Yeaman
Well, that's going to be whatever expense number is at that point, that's going to be in our base. EBIT comes back, we hope it comes back to revenue growth.
But from that point forward, we would expect to see the normal sort of year-over-year expense increase in the 2.5% range.
Ebrahim Poonawala
Got it, okay. And just so switching to the extend Bob, you comment on this.
That CCAR behind, it would be good to get sort of your views around potential for buybacks and if you think that could happen? Maybe, if there is another follow on offering, would you look to participate in that and buyback some stock?
Just overall thought processor on buy-backs and total payout would be helpful?
Robert Harrison
Sure, now thank you, Ebrahim. And I can talk about some of that.
So the holding company at Bank West Corp did have no objection to CCAR but as a separate bank holding company at FHI, any share repurchase would be subject to regulatory approval, not CCAR but regulatory approval. So we're certainly considering that and we're planned to, as we've talked about both on this call and one-on-ones in the market, that's very important to us.
And as soon as we get to that point, we'll be communicating that, but long term we do know that our consistent and significant capital return policy is important for our shareholders. So we're looking to maintain our continued high dividend payout and we'll supplement that certainly with share repurchase but nothing to announce at this time.
Operator
And our next question comes from the line of Jackie Bohlen with KBW.
Jacquelynne Bohlen
Just moving over to the loan portfolio. You had good growth in the quarter, maybe you could talk about where pipeline stand right now?
And I know that you said that you feel good about mid- to high single digit growth. But is that'll just continue to be balanced throughout the year, if there any portfolios in particular that you're looking to?
Michael Ching
Yes, no I think, our view is -- we continue to feel that the pipeline is healthy. It's competitive out there on the pricing side.
And so we continue just to be very disciplined about how we approach our lending, given where we're in the cycle. That being said, Hawaii economy is doing well and the housing market's pretty robust so as a result of that, we still expect to see a reasonable loan growth over the next 6 to 12 months.
Robert Harrison
This is Bob, Jackie. The only thing I would add to that is in our construction portfolio, we do have projects that are in the funding stage now and as those finish and gets sold to the end buyer -- mainly condominium price.
If you will see some variability in that. And it's hard to predict when that will happen exactly as far as timing into a quarterly event, quarterly reporting event.
Jacquelynne Bohlen
And thinking about some of the single-family projects that are coming online from some, I believe it's Sierra Fortune that has won. What is the timeframe in which some of the people who would move into those homes would start looking for loans?
Eric Yeaman
Yes, our sense was second half of '17, don't know exactly when that will turn. Yes, but that was sort of the guidance that we got from them.
Jacquelynne Bohlen
Assuming that, that proves to be accurate and even if there is a bit of a lag. Is that something whereas the condo projects complete, maybe some of that could be still -- I guess that's more single-family than construction?
Eric Yeaman
Yes, it will be a slow ramp, Jackie, you know because on great construction, development takes a little bit of time. That said, the housing market here, there's still a real strong demand, demands outstripping supply.
So besides the refi market, the purchase side, there is a lot of real estate changing hands. So it still looks to be pretty strong.
Jacquelynne Bohlen
Okay and where are you seeing some of your new loan production coming on at versus the portfolio coupon?
Eric Yeaman
Oh, you mean in terms of ranges over years over -- yes, we're seeing overall -- the good news is we do have a lot 30% of our portfolio that sort of reprices with adjustments and rates. Loan -- the loan growth is coming in slightly lower due to the low long term rates and of course, our focus on higher-quality credits and those loans that are running off slightly higher.
Robert Harrison
But the yield on the loan portfolio overall for Q2 is up a couple of basis points over Q1. So it's hanging in there, not much but it's steady.
Operator
And our next question comes from the line of Jared Shaw with Wells Fargo Securities.
Jared Shaw
Maybe just following up on that when you like look at the impact of the March rate hike on asset yield in third, I'm sorry in the June quarter, it seems a little more modest. Should we expect to see the impact through asset yields of all in line with that with the June rate hike or could you see it expends more than we saw?
Eric Yeaman
Yesm that's about right, Jared. We did -- what we saw happening in the Q2 because of sort of pullback on the 10-year at an -- in adjustment to our premium amortization that took away about 3 bps.
If you compare it quarter-over quarter. But it does reset based on expected cash flow so looking out.
Jared Shaw
So those 30% loans that have some type of an adjustment feature. Are those -- what percentage of those were floors versus affordable at this point?
Robert Harrison
We don't have any floors, really throughout the portfolio, Jared. This is Bob.
Those were the good old days but not anymore.
Jared Shaw
Okay and then in terms of the loan growth in the loan portfolio. Could you share with us what percentage of growth was in the share of credential credits?
And where the SNC portfolio stands now at the end of the quarter?
Eric Yeaman
Yes, the SNC portfolio ended the quarter about $1.5 billion. And that was up $180 million, the mainland SNC was $1.1 billion, an increase of about $63 million.
Operator
And our next question comes from the line of Dave Rochester with Deutsche Bank.
David Rochester
Back on your efficiency guidance range of 47% to 48%, sorry if I didn't catch this earlier. But if you sum up all the new contracts you were talking about expecting coming online over the next year or so.
How much more incremental transitional expense are you assuming comes into the run rate within that efficiency range? Just trying to understand how much more of the transitional expense you're assuming in that range?
Eric Yeaman
It's really hard to pinpoint the number because this one's variability both in the timing as well as the sort of the actual new contracts that we enter into. So we haven't provided that in the past.
What we do expect to see an increase in 2018 from 2017.
David Rochester
Got you. And then what's the interest rate back drop that you're assuming in that?
Any kind of curve steep and/or more rate hikes anything like that?
Eric Yeaman
So from our standpoint, the way we look at it, it's still relatively flat unfortunately. We don't have any predictions on the longer end of the curve, I'd like to think we get a couple more Fed rate hikes in next -- in 2018.
But it's hard to predict on the steepening end curve.
David Rochester
Got you. So do you have -- was it 1 or 2 rate hikes in that efficiency range for next...
Eric Yeaman
Two.
David Rochester
Okay, Got you. And then what are your thoughts on funding the loan growth going forward?
Are you thinking the deposit growth should also like cover the loan growth? And roughly what level of deposit growth are you expecting over the next year?
I know you get the mid- to high-single-digit guidance on the loan side, I was just curious what your thoughts are on the deposit site?
Eric Yeaman
Yes, we're going to still be looking to fund our loan growth through deposits which should obviously, mean that our deposit growth is going to have to measure up to the loan growth. So we're picking in and if we can get deposit growth at around 4% bip and that'd be about right.
Operator
And our next question comes from the line of Laurie Hunsicker with Compass Point.
Laurie Hunsicker
Just going back over to loans for a minute, I just want to make sure that was right. So the total SNC was $1.5 billion which means your Hawaii SNC doubled, you went to $200 million to $400 million, is that correct?
Eric Yeaman
No, our Hawaii SNC went up about $130 million. Yes, that's about right.
Laurie Hunsicker
Okay, okay. And where do you see taking that eventually?
How do you think about that?
Robert Harrison
The Hawaii piece Laurie or just overall?
Laurie Hunsicker
The Hawaii piece.
Robert Harrison
I mean, the Hawaii piece, we'd like to do as much as we find attractive transactions, we'll do them here in Hawaii and that's our home market and that's where we plan to continue our focus. So we don't have any guidelines around that.
Eric Yeaman
Yes and yes generally, we're the leads on those.
Robert Harrison
Right.
Laurie Hunsicker
Okay, okay. And then do you have an update on your dealer floor plan loans?
What that total is? And how much is in California?
Eric Yeaman
Yes, total dealer was at $937 million and of that $577 million was on the mainline. That's just the flooring piece, Laurie.
Laurie Hunsicker
Great, no, perfect. And then just to go back to what Steven was asking on the indirect auto, the $964 million, would you have a FICO on that?
Michael Ching
So roughly 70% of the book is what we call sort of A paper which should be about 680 and about 11% of the book would be what we've kind of consider I think lower near prime and sub prime, that's generally under 630.
Laurie Hunsicker
Okay, that's helpful. Okay and then just thinking about and your credit is so great.
But just thinking about loan loss provisioning, I know last quarter in terms of the reserves to loans, you would indicate it you likely wouldn't go below 1.15% and you're now at 1.13%. Are you thinking about that differently?
Has that moved down? I mean, how are -- or is that just going to bounce around kind of at this level.
Or how should we be thinking about that from a provision standpoint?
Michael Ching
So I would say the reserve is really an estimate of our expected credit loss. That's not really going to be said as a percentage of the loans.
And right now we always budget for credit cost and if that stays sort of consistent with what, how we've budgeted, you're going to sort of see the reserve and I think the provisions be somewhat level. And then I think if you look at the reserve relative to our asset quality metrics, it's very strong right now.
Laurie Hunsicker
Okay, okay. And then on the noninterest income.
And the other, other line there was a pretty big jump link quarter. Is there anything nonrecurring in that?
Eric Yeaman
No, not necessarily. I think the other line has very sidearms, we didn't have a small recovery there but nothing very sizable.
Laurie Hunsicker
Okay and the expenses and I know a couple of folks have hit on this but just thinking about, this quarter obviously, we saw the higher contracted services and the product enhancements meaning as we look and you said, this is really going to start to ramp in the fourth quarter. The guidance that you gave way, way back when -- in terms of your ramp, is that really going to start in the fourth quarter?
Or some of it is going to bring over into the third quarter. How should we be thinking about that?
Eric Yeaman
Yes, we're still generally expecting a pick up in the latter half of the year. Again, that's based on when a lot of these contracts mature in term.
Our -- we continue to revise our estimates as we get closer to the contract renegotiation dates. So as we look outwards, we still think the expenses in the latter half of the year compared to the first half will be flat to slightly up.
Laurie Hunsicker
Okay and then latter half of the year. So in other words, just we wouldn't look a linked quarter, in other words we're looking from -- here we said at June $85 million roughly or slightly less starting on your IPO cost.
And we think about September, that is likely to be another $0.5 million increase or potentially could we see a start to ramp up at that point?
Robert Harrison
It's between flat to $2.5 million.
Laurie Hunsicker
Okay and then in terms of the complete rework of your contracts, when that's all fully digged into the run rate. Your quarterly run rate is going to be closer to $90 million, $91 million, give or take?
I realize there's a lot of moving parts, I just -- I'm just trying to find tune out a little bit.
Eric Yeaman
I don't think we're quite there yet in those estimates, Laurie. But we're still looking at the 47% to 48% by the time we get to the full year 2018.
Laurie Hunsicker
Only efficiency guide. Okay, that's fair.
Okay and then tax rate. Can you help us think about that a little bit?
Eric Yeaman
Yes, we're still looking at around 38% for the full year. We're -- we talked about tax strategies.
We're starting to execute on those, it's going to take a bit of time, a bit of plan, a bit of runway, before we get some meaningful decreases in our tax rate. And again, we're looking at local housing investments as well as, perhaps, introducing immunities into our investment portfolio.
That's going to take some time.
Operator
And our next question comes from the line of David Eads with UBS.
David Eads
There is just one for me, I think most of them have been addressed. You mentioned the public fund deposit to be getting a bit unisection.
I'm just kind of curious if you could give a little bit more collar on what's going on there. You've pointed to that there's been -- some of the peers have talked about that as well.
It seems like that's been area where things have come in quite a bit at the end of the quarter. Is it just funds coming from other banks or is it funds increase for some reasons overall, I'm just kind of curious of the dynamic there?
Eric Yeaman
The capacity has increased over the past quarter in terms of what's coming off from the state in the other municipalities. Pricing has become competitive amongst the banks, so, for that money.
David Eads
And is that an area where you would look to grow further? Or are you kind of comfortable with where you are now, there?
Eric Yeaman
Well, we want to continue to fund the loan growth with deposit growth. And that's part of our mix.
Operator
And I'm showing no further questions. So with that, I would like to turn the conference back over to Investor Relations manager, Kevin Haseyama.
Kevin Haseyama
We appreciate your interest in First Hawaiian. And thank you for joining us on today's call.
Goodbye.
Robert Harrison
Thanks, everybody.
Operator
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program.
And you may all disconnect. Everyone, have a wonderful day.