First Hawaiian, Inc. — Q2 2018 Form 10-Q
Business context and period. First Hawaiian is a bank holding company whose wholly owned bank operates in Hawaii, Guam and Saipan, with additional lending on the U.S. mainland. This unaudited filing covers the quarter and six months ended June 30, 2018; comparisons are with the same 2017 periods unless noted. Amounts below are in millions of dollars except per-share data and ratios.
Financial performance
- Q2 earnings: Net income was $69.1 million, up 21%; diluted EPS was $0.50, up from $0.41. Pretax income rose to $93.3 million from $90.5 million. Lower income-tax expense—$24.3 million versus $33.6 million—contributed materially to earnings growth; the effective tax rate was 26.0% versus 37.1%, reflecting the Tax Act rate reduction.
- First-half earnings: Net income was $137.0 million, up 21%; diluted EPS was $0.99 versus $0.81. The six-month effective tax rate was 26.0%, versus 37.0% in 2017.
- Net interest: Q2 net interest income increased 8% to $141.4 million; net interest margin expanded 16 basis points to 3.18%. For the first half, net interest income rose 8% to $281.1 million and margin increased 15 basis points to 3.16%. Higher loan balances and yields and improved securities yields outweighed higher deposit funding costs.
- Fees and expenses: Q2 noninterest income declined 2% to $49.8 million, while noninterest expense rose 6% to $91.9 million. First-half noninterest income fell 3% to $98.5 million and expense increased 6% to $182.5 million. Deposit service charges and bank-owned life insurance income were notable sources of fee-income weakness. Q2 efficiency ratio was 48.04%, compared with 47.81%.
- Credit costs: Provision for loan and lease losses was $6.0 million in Q2 and $12.0 million in the first half, up 37% and 35%, respectively. First-half net charge-offs were $8.6 million, or 0.14% of average loans, versus $7.5 million, or 0.13%. The allowance was $140.6 million, 1.11% of loans, compared with $137.3 million and 1.12% at year-end 2017.
- Comprehensive income: Q2 other comprehensive loss was $17.7 million, mainly from unrealized investment-security losses; first-half other comprehensive loss was $66.0 million. Consequently, first-half total comprehensive income was $71.1 million, versus $134.0 million in 2017.
Balance sheet, liquidity and capital
- Loans and assets: Loans and leases reached $12.64 billion, up 3% from December 31, 2017, led by commercial real estate, residential real estate and construction lending. Total assets were $20.48 billion, down slightly from $20.55 billion.
- Deposits and securities: Deposits were $17.40 billion, down 1% from year-end; savings balances grew, while business analyzed and public time deposits declined. Available-for-sale securities were $4.84 billion, down 8%, as maturities and paydowns funded loan growth. The portfolio had $214.1 million in gross unrealized losses, attributed by management to interest-rate changes rather than credit deterioration; no credit losses or other-than-temporary impairment were recorded. Management said it did not expect to sell the securities before recovery.
- Cash and funding: Cash and cash equivalents were $943.8 million at June 30, down $90.8 million during the first half. Operating cash flow was $180.0 million, investing cash outflow $106.6 million and financing cash outflow $164.3 million. Core deposits were $14.7 billion, or 85% of deposits. Available secured borrowing capacity was $1.4 billion at the FHLB and $712.8 million at the Federal Reserve.
- Debt: Long-term debt rose to $200.0 million from $34,000, following a $200 million FHLB advance at 2.79%, maturing in 2020 and secured by residential loans.
- Capital and shareholder returns: The company and bank were classified as well-capitalized. Company CET1 and total capital ratios were 12.19% and 13.23%, respectively; the Tier 1 leverage ratio was 8.61%. Total stockholders’ equity was $2.46 billion, down 3% from year-end, reflecting share repurchases, dividends and securities-related accumulated losses, partly offset by earnings. The company repurchased 2.97 million shares for $81.8 million in May; the secondary offering proceeds went to the selling shareholder, not the company. A quarterly dividend of $0.24 per share was declared in July.
Changes, outlook and risks
- Management attributed earnings growth chiefly to higher net interest income and the lower tax rate. Deposit costs rose as rates paid on interest-bearing deposits increased; management identified continued rate competition and deposit funding costs as relevant pressures.
- Hawaii’s economy was described as growing, supported by tourism, real estate and low unemployment. Management noted exposure to Hawaii and regional economic conditions, tourism, construction, affordability, rising interest rates and international conditions. It provided no specific forward earnings or financial guidance in the filing.
- Nonperforming assets increased to $13.8 million from $10.2 million at year-end, mainly due to two construction loans and higher residential nonaccrual balances; the ratio remained low at 0.11%. Management cited Hawaii’s lengthy judicial foreclosure process. Consumer lending accounted for most first-half net charge-offs.
- A customer class action concerning overdraft and other bank fees was being vigorously defended. The company could not reasonably estimate any potential loss and recorded no liability. Other proceedings were not expected by management to have a material effect.
- Unrecognized tax benefits totaled $141.9 million, including $93.9 million tied to California refund claims. The company said up to $107.5 million of tax and $5.6 million of accrued interest and penalties could decrease within 12 months through settlements or statute expirations; the timing and outcome remain uncertain.
- The company expects higher costs as it operates independently from BNP Paribas and transitions services to third parties; the transitional services agreement was scheduled to end December 31, 2018. The amount and timing of future vendor-cost increases were not estimable. BNP Paribas remained the beneficial owner of approximately 49% of shares.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing also describes future lease-accounting balance-sheet increases and an unquantified potential impact from the forthcoming CECL credit-loss standard.
Important facts for investors to verify
- Whether loan growth and higher asset yields continue to outpace rising deposit costs, and how that affects net interest margin.
- Whether credit provisioning, charge-offs and nonperforming assets remain consistent with management’s characterization of stable portfolio quality.
- The effect of interest rates on the securities portfolio, including unrealized losses, liquidity and any future need to sell securities.
- Deposit trends, particularly business and public time deposits, and the company’s ability to retain low-cost core funding.
- Developments in the overdraft-fee litigation, California tax claims and other contingent obligations.
- Actual stand-alone operating costs after the BNP Paribas services transition, and the implementation impacts of lease accounting and CECL.