First Hawaiian, Inc. — Third Quarter 2016 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2016. First Hawaiian is a Honolulu-based bank holding company serving Hawaii, Guam and Saipan, with Retail Banking, Commercial Banking, and Treasury and Other segments. The company completed its IPO in August; shares began trading on Nasdaq under FHB. The offering was a sale by its parent, not a primary issuance, so First Hawaiian received no proceeds. BNP Paribas retained approximately 83% ownership. Results before the April 1, 2016 reorganization are presented on a combined basis and include allocated expenses; management cautions those results may not represent the company as a stand-alone public entity.
Key financial metrics
Dollar amounts below are in millions, except per-share data and ratios.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $122.7 | $113.6 | $360.4 | $345.1 |
| Net interest margin | 2.87% | 2.72% | 2.84% | 2.80% |
| Provision for loan losses | $2.1 | $2.6 | $4.7 | $7.4 |
| Noninterest income | $48.7 | $56.5 | $168.6 | $164.2 |
| Noninterest expense | $82.8 | $79.4 | $246.3 | $239.3 |
| Net income | $53.2 | $54.9 | $173.6 | $163.6 |
| Diluted EPS | $0.38 | $0.39 | $1.24 | $1.17 |
| Efficiency ratio | 48.31% | 46.67% | 46.56% | 46.98% |
Balance sheet at September 30, 2016: Total assets were $19.89 billion, loans and leases $11.40 billion, available-for-sale securities $5.36 billion, deposits $16.97 billion, and stockholders’ equity $2.52 billion. Cash and cash equivalents were $1.18 billion, down from $2.65 billion at year-end 2015, as excess liquidity was deployed largely into securities. Short-term borrowings were $9.2 million and long-term debt $41,000. The company reported $2.9 billion in unused borrowing capacity from the FHLB and Federal Reserve.
Cash flow for the first nine months: Operating activities provided $179.1 million; investing activities used $1.93 billion, reflecting securities purchases and loan growth; financing activities provided $275.1 million. Cash and cash equivalents decreased by $1.47 billion. Net charge-offs were $5.2 million, or 0.06% of average loans on an annualized basis.
Capital and asset quality: The company and bank were classified as well-capitalized. At September 30, the company’s CET1 and total capital ratios were 12.48% and 13.59%, respectively; the leverage ratio was 8.41%. Nonperforming assets were $10.2 million, or 0.09% of loans and other real estate owned, down from $16.8 million at year-end. Nonaccrual loans were 0.08% of loans. The allowance was $135.0 million, or 1.18% of loans, versus 1.26% at year-end.
Material changes versus comparable periods
- Q3 net income fell 3% year over year, mainly because noninterest income declined 14% and expenses rose 4%; higher net interest income and a lower credit-loss provision partly offset the decline.
- Nine-month net income rose 6%. Net interest income increased 4%, and the provision fell 36%; noninterest income also increased, partly due to securities gains.
- Loan growth was 6% from year-end to $11.4 billion, including increases in commercial and industrial, construction, residential real estate, and consumer lending. Deposits rose 6% to $17.0 billion. Securities increased 33% to $5.4 billion as liquidity was redeployed; interest-bearing deposits at other banks fell to $804 million from $2.35 billion.
- Stockholders’ equity fell 8% from year-end, largely reflecting $363.6 million of pre-reorganization distributions and $57.9 million of dividends, partly offset by earnings. Capital ratios also declined, with management attributing the change primarily to the distributions.
- Q3 dividends declared were $0.20 per share; nine-month dividends were $0.42 per share. A further $0.20 quarterly dividend was declared in October for payment in December.
Outlook, commentary, risks and unusual items
- Outlook and costs: No specific earnings or revenue guidance is provided. Management expects incremental ongoing and one-time stand-alone and separation costs of $14.5 million to $17.0 million per year for 2016, 2017 and 2018. Actual costs could be higher; the transitional services agreement is scheduled to end December 31, 2018. Management also expects a $25 million to $30 million pension-plan contribution related to a planned spin-off, anticipated in Q4 2016.
- Interest-rate sensitivity: The company’s 12-month simulation estimated net interest income would rise 4.5% under an immediate +100-basis-point parallel rate shift and 8.3% under +200 basis points, but decline 6.8% under -100 basis points. These are scenario estimates, not forecasts, and depend on assumptions about rates, deposits, prepayments, and balance-sheet changes.
- Regional and operating risks: Lending is concentrated in Hawaii (70% of loans). Management cited potential effects from interest-rate changes, local construction growth and housing affordability, tourism and economic conditions, geopolitical events, competition, cybersecurity and system disruptions, and reliance on service providers. Hawaii’s economy was described as strong, supported by tourism, construction, low unemployment, and rising real estate prices.
- Unusual income and expenses: Nine-month noninterest income included a $22.7 million gain on sale of Visa Class B shares. In connection with that sale, the company recorded a $7.9 million derivative liability tied to possible changes in Visa’s conversion ratio. BOLI income included death benefits of $3.8 million for the nine months. IPO-related one-time expenses were $5.6 million for the nine months, including $3.1 million in Q3. Q3 expenses also included costs from Tropical Storm Darby.
- Tax and contingencies: Unrecognized tax benefits and related interest and penalties totaled $136.9 million at September 30, including $93.9 million associated with California refund claims for 2005–2012. The company said up to $106.4 million of tax benefits and $5.1 million of related interest and penalties could decrease within 12 months through settlements or statute expirations. Management did not expect pending legal proceedings to have a material effect, but stated that contingent liabilities related to the reorganization cannot currently be estimated.
- Credit trends: Troubled debt restructurings increased 77% to $52.2 million; 98% were performing under modified terms and on accrual status. Impaired loans rose to $60.4 million. Management said nonperforming assets declined, while noting consumer credit losses and Hawaii foreclosure timelines as relevant considerations.
Important facts for investors to verify
- How much of future earnings growth is driven by recurring net interest income versus securities gains, BOLI death benefits, and other one-time items?
- Whether deposit costs rise faster than loan and securities yields, and how actual results compare with the disclosed interest-rate sensitivity scenarios.
- Credit performance as loan balances grow, particularly construction lending, consumer charge-offs, impaired loans, and the expanding TDR balance; also assess whether the 1.18% allowance remains adequate.
- The realized cost of operating as a stand-alone public company, transition-service exit costs, and the timing and amount of the expected pension contribution.
- Resolution of the California tax claims and other tax exposures, and any material liabilities arising from the April 2016 reorganization.
- BNP Paribas’s continuing majority ownership and planned sale of its controlling interest over time, subject to market conditions and other considerations.