First Hawaiian, Inc. — 2017 Form 10-K
Business context and period. This annual report covers the fiscal year ended December 31, 2017; quarterly figures are unaudited. First Hawaiian is a Honolulu-based bank holding company operating First Hawaiian Bank, with 62 branches in Hawaii, Guam, and Saipan. Hawaii accounted for 83% of deposits and 70% of loans. BNP Paribas (BNPP) beneficially owned approximately 62% of the company at year-end.
Financial results and condition
| Metric | 2017 | 2016 | Change / context |
|---|---|---|---|
| Net interest income | $528.8 million | $491.7 million | Up 8%; net interest margin rose to 2.99% from 2.88%. |
| Provision for loan losses | $18.5 million | $8.6 million | Higher provision; net charge-offs increased to $16.7 million from $8.6 million. |
| Noninterest income | $205.6 million | $226.0 million | Down 9%, primarily because the 2016 Visa share-sale gain did not recur. |
| Noninterest expense | $347.6 million | $337.3 million | Up 3%, including higher compensation, regulatory fees, and occupancy costs. |
| Income before taxes | $368.4 million | $371.8 million | Down 1%. |
| Net income / diluted EPS | $183.7 million / $1.32 | $230.2 million / $1.65 | Both down 20%; 2017 includes a $47.6 million Tax Act charge. |
| Core net income / diluted EPS (non-GAAP) | $230.4 million / $1.65 | $217.1 million / $1.56 | Up 6%; excludes specified items, including the Tax Act charge. |
Quarterly result. Fourth-quarter 2017 net income was $11.7 million, or $0.08 per diluted share, versus $56.6 million, or $0.41, in fourth-quarter 2016. The 2017 quarter included $47.6 million of Tax Act-related income tax expense and $3.7 million of employee compensation associated with the Tax Act.
Balance sheet and funding. At December 31, 2017, assets were $20.5 billion, gross loans and leases $12.3 billion, deposits $17.6 billion, and stockholders’ equity $2.5 billion. Year over year, assets increased 5%, loans 7%, and deposits 5%. Deposits were the principal funding source; noninterest-bearing deposits were $6.1 billion. The company reported no short-term borrowings at year-end and only $34,000 of long-term debt.
Liquidity and cash flows. Cash and cash equivalents were $1.03 billion, compared with $1.05 billion at year-end 2016; available-for-sale securities totaled $5.23 billion. The company reported $269.8 million of operating cash flow, $971.1 million of cash used in investing activities, and $683.9 million of financing cash flow in 2017. It reported $1.8 billion of FHLB borrowing capacity and $688.7 million of Federal Reserve borrowing capacity, none drawn at year-end. Core deposits were $14.7 billion, or 83% of total deposits.
Margins, efficiency, and returns. Net interest margin improved to 2.99%. The efficiency ratio was 47.32%, compared with 46.99%; the prior-year ratio benefited from securities-sale gains. Return on average assets declined to 0.92% from 1.19%, and return on average equity to 7.24% from 8.96%. Core efficiency ratio was 47.02% and core return on average assets was 1.16% (both non-GAAP).
Credit quality and capital. Nonaccrual loans and leases were 0.08% of total loans, unchanged from 2016. The allowance was $137.3 million, or 1.12% of loans, versus 1.18%; net charge-offs rose to 0.14% of average loans from 0.08%. The Bank was classified as well-capitalized: CET1 ratio 12.37%, total capital ratio 13.42%, and Tier 1 leverage ratio 8.47%. Company ratios were 12.45%, 13.50%, and 8.52%, respectively.
Shareholder distributions. The company declared $0.88 per share in dividends in 2017 and paid $122.8 million. The reported payout ratio was 66.67%, affected by the one-time tax charge. In January 2018, the board declared a $0.24 quarterly dividend, payable March 9, 2018, subject to applicable requirements.
Material changes and unusual items
- Loan growth and higher investment-security balances drove higher net interest income; deposit funding costs rose 58% to $42.0 million as rates and interest-bearing balances increased.
- The $47.6 million Tax Act revaluation charge raised the effective tax rate to 50.13% from 38.10% and materially reduced reported earnings. Management said the Tax Act was expected to have a net positive economic impact overall, but its effects remained subject to interpretation and further guidance.
- Noninterest income fell mainly because a $22.7 million gain on the sale of Visa Class B shares was recorded in 2016 and did not recur. 2017 other income included a $6.9 million real-estate sale gain.
- Available-for-sale securities had $122.9 million of gross unrealized losses at year-end, versus $101.1 million in 2016, largely reflecting higher market rates. Management reported no intent or expected need to sell affected securities before recovery and recognized no other-than-temporary impairment.
- Management corrected immaterial prior-period classifications between card-fee income and card-reward and occupancy expenses; it reported no effect on prior-period net income or EPS.
- The company disclosed a customer class action alleging improper overdraft-fee practices. It disputes wrongdoing, is defending the case, and said it could not reasonably estimate a potential loss; no liability was recorded. Management said other pending or threatened matters were not expected to have a material aggregate effect.
Outlook, risks, and contingencies
Management described Hawaii’s 2017 economy as growing, supported by tourism, real estate, employment, and personal-income conditions. It cited record visitor activity and continued loan demand, while monitoring housing affordability, construction capacity, U.S. and Japanese economic conditions, interest rates, and regulatory developments. The filing provides no specific 2018 earnings or revenue guidance.
- Key exposures include concentration in Hawaii and other island markets, real estate collateral, tourism and military-related economic activity, and commercial lending. Approximately 60% of loans were real-estate-related; 70% of loans were in Hawaii.
- Interest-rate and deposit-pricing risk could affect net interest income and margin. Management’s dynamic simulation estimated that an immediate parallel 200-basis-point rate increase would raise 12-month net interest income by 6.3%; a 100-basis-point decrease would reduce it by 4.8%. These are scenario estimates, not forecasts.
- BNPP control carries governance, regulatory, related-party, and potential conflict-of-interest risks. The transition-services agreement was scheduled to end December 31, 2018; management anticipated additional stand-alone operating costs, whose actual amount could exceed estimates.
- BNPP-related legal settlements create conditions for certain subsidiaries’ continued reliance on regulatory exemptions, including the QPAM exemption; the filing said operations were not expected to be disrupted while the exemption request was pending.
- Other risks include cybersecurity and third-party service disruptions, regulatory and compliance costs, natural disasters, and possible liabilities from the 2016 reorganization. The filing says the ultimate outcome or amount of certain reorganization-related contingencies cannot be determined.
- Unrecognized tax benefits were $141.3 million at year-end. The company noted that up to $107.6 million of tax benefits and $5.4 million of interest and penalties could decrease within 12 months, subject to settlements and statute expirations; timing and outcome are uncertain.
Important facts for investors to verify
- Reconcile the $47.6 million Tax Act charge, deferred-tax revaluation, and the distinction between GAAP net income and management’s non-GAAP core results.
- Review loan growth, rising consumer charge-offs, allowance coverage, real-estate and geographic concentrations, and the status of the overdraft-fee litigation.
- Assess deposit mix and pricing, liquidity capacity, securities unrealized losses, and sensitivity to changing interest rates.
- Confirm regulatory approval and capital-plan conditions for dividends after the second quarter of 2018, and the Bank’s ability to upstream dividends to the parent.
- Track BNPP’s ownership, the end of transitional services, stand-alone cost trends, and the status of BNPP-related exemptions and contingent liabilities.