First Hawaiian, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; unaudited. First Hawaiian is a Honolulu-based bank holding company operating in Hawaii, Guam and Saipan. The company’s reporting entity changed on April 1, 2016 when Bank of the West was separated from BancWest. Pre-April 2016 comparisons are presented as if First Hawaiian had been a stand-alone entity, using allocations management considers reasonable; those results may not reflect actual stand-alone costs or future results.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income | $120.4m | $118.9m | $237.7m | $231.6m |
| Noninterest income | $46.4m | $52.1m | $119.9m | $107.7m |
| Noninterest expense | $78.5m | $81.2m | $163.5m | $159.9m |
| Net income | $54.9m | $54.6m | $120.4m | $108.7m |
| Diluted EPS | $0.39 | $0.39 | $0.86 | $0.78 |
| Net interest margin | 2.88% | 2.88% | 2.82% | 2.84% |
| Efficiency ratio | 47.04% | 47.47% | 45.72% | 47.14% |
Q2 net income rose 1% year over year; first-half net income rose 11%. Q2 pretax income was $86.4m versus $87.6m. First-half operating income benefited from higher net interest income, lower credit-loss provision and investment gains. The filing reports no separate total-revenue measure; net interest income plus noninterest income was $166.8m in Q2 and $357.6m for the first half.
- Q2 provision for loan and lease losses was $1.9m, down 16%; first-half provision was $2.6m, down 46%. First-half net charge-offs were $1.7m, or 0.03% of average loans, versus $3.3m, or 0.07%.
- First-half noninterest income included a $22.7m gain on sale of Visa Class B shares; total investment securities gains were $25.7m. Excluding specified items, reported core first-half net income was $105.9m versus $96.9m; core EPS was $0.76 versus $0.69. These are company-defined non-GAAP measures.
- Q2 noninterest expense fell 3%, largely reflecting a $2.1m decrease in card rewards expense following a change to debit-card reward-point terms. First-half expense increased 2%, including higher salaries, professional fees and IPO-related costs.
Balance sheet, liquidity and capital
- At June 30, 2016, total assets were $19.1bn, loans and leases $11.2bn, securities $4.6bn and deposits $16.1bn. Since year-end, loans grew 4%, securities grew 14% and deposits were nearly unchanged.
- Cash and cash equivalents were $1.3bn, down from $2.7bn at year-end, as cash was deployed into securities and lending and used for financing outflows. First-half operating cash flow was $139.8m; investing cash outflow was $943.4m and financing cash outflow was $514.6m.
- Liquidity sources included $4.6bn of available-for-sale securities and undrawn lines of credit of $594m at other U.S. institutions, $1.5bn at the FHLB and $656m at the Federal Reserve. The company reported $13.6bn of core deposits, 84% of total deposits.
- Short-term borrowings were $35.0m, down from $216.2m at year-end; long-term debt was $48,000. Deposits are the primary funding source. Time certificates of deposit of $250,000 or more totaled $2.6bn.
- Stockholders’ equity was $2.50bn, down 9% from year-end, mainly due to $363.6m of pre-reorganization distributions and a $30m dividend to BNPP, partly offset by earnings. The CET1 ratio was 12.45%, total capital ratio 13.58% and leverage ratio 8.42%; the company and bank were classified as well-capitalized. Ratios declined from year-end, primarily reflecting distributions.
Credit quality and material changes
- Nonaccrual loans and leases were $13.3m, or 0.12% of loans, versus $16.6m and 0.16% at year-end. Nonperforming assets were $13.5m, down 19%.
- The allowance was $136.4m, or 1.22% of loans, compared with $135.5m, or 1.26%, at year-end. Impaired loans increased to $64.0m from $44.1m, largely due to newly restructured commercial loans. TDR loans totaled $53.0m, up 80%; 95% were performing under modified terms and on accrual status.
- Loans are concentrated in Hawaii: 69% of the portfolio was located there at quarter-end. Management cited a strong local economy, tourism and construction activity, low unemployment and rising real-estate prices, while noting mixed construction indicators.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management said it expects incremental ongoing and one-time stand-alone/public-company expenses of approximately $14.5m–$17.0m per year in 2016, 2017 and 2018; actual costs may be higher. Transitional services from BNPP and affiliates are scheduled to end by December 31, 2018, with some services ending earlier.
- On August 9, 2016, after quarter-end, First Hawaiian completed a secondary IPO of 24.25m shares at $23 per share. The company received no proceeds; BNPP retained approximately 83% ownership. The shares began trading on Nasdaq on August 4 under ticker FHB.
- A pension-plan separation expected in Q4 2016 may require First Hawaiian Bank to contribute approximately $25m–$30m; the final amount depends on plan asset levels.
- Reorganization-related tax matters are significant: unrecognized tax benefits and related interest and penalties totaled $137.1m at June 30, including $93.9m related to California refund claims for 2005–2012. The company said up to $106.4m of tax benefits and $5.0m of interest and penalties could decrease within 12 months through settlements or statute expirations. Certain legacy liabilities related to Bank of the West or pre-reorganization operations remain unestimable; tax-sharing and indemnification arrangements apply.
- Management reported no material expected effect from pending legal proceedings. Credit, geographic concentration, interest-rate, liquidity, operational, cybersecurity, regulatory, transition-cost and BNPP-control risks remain relevant. The filing’s modeled 12-month net interest income impact was +5.7% for an immediate +100 bp rate shift, +10.8% for +200 bp and −6.3% for −100 bp; management cautioned these are simulations, not forecasts.
- Management noted that Hawaii’s economic performance could be affected by interest-rate movements, global political events including the U.K. vote to leave the EU, weakness and recession in Japan, underemployment, federal spending and the local construction pipeline. The company also expects CECL adoption to require a new lifetime expected-credit-loss allowance model; its impact was still under evaluation.
Investor verification priorities
- Confirm how the April 2016 separation and pre-separation allocated expenses affect comparability and the post-IPO cost base.
- Assess whether loan growth, declining nonaccruals and the 1.22% allowance remain consistent as the loan mix and local economic conditions change.
- Reconcile reported earnings with the Visa share-sale gain and other company-defined core adjustments; evaluate recurring fee-income trends.
- Monitor cash deployment, deposit mix and large time-deposit balances, pledged collateral, and the availability of disclosed borrowing facilities.
- Track settlement or indemnification outcomes for the reorganization-related tax claims and liabilities, and the final pension-plan contribution.
- Verify realized stand-alone expenses, BNPP transition-service exit progress, and the implications of BNPP’s continuing approximately 83% ownership after the IPO.