I am excited to resume single ticker stock coverage, starting with First Hawaiian (FHB). Admittedly this is a bit of a left field candidate, but any fellow golf fans and PGA Tour followers may get the reason why I’m starting here – this time of the year seeing the players tee it up in back-to back tournaments in the state as part of a mini-Hawaiian swing. It’s a nice tonic for the post-Christmas blues and gets me thinking about the state’s “big two” banks, First Hawaiian and Bank of Hawaii.
These banks basically fly under the radar, getting very little attention from Seeking Alpha, Barron’s and the like. While that’s understandable, both have great core deposit franchises and I’d wager they are among the more profitable regional banks in the country. It’s true you won’t get rich quick owning them, though I’d argue that’s not necessarily a bad thing – slow-and-steady being an underrated quality for bank stocks. It also makes them reasonable dividend stock candidates considering what they are. First Hawaiian is the larger of the two (with total assets of around $25b), so I will open with it. I hope to cover Bank of Hawaii later in the year.
A Quality Core Deposit Franchise
Hawaii’s banking market is basically its own thing, and some industry dynamics that may apply to mainland banks don’t cross over to the islands. One of those is competition, with four banks in the state claiming 90%-plus of its deposits.
First Hawaiian has the largest share of those (around 35%). Its core deposits – demand, savings & money market – total approximately $20b, good for funding around 80% of its assets. Of that deposit base, non-interest-bearing (NIB) demand deposits represent around $9.4b, or over 40% of the total.
Not having to rely on CDs or other expensive forms of funding helps to prop up spread income margins. Like a lot smaller of banks First Hawaiian obviously lacks the fee income franchises of JPMorgan, Bank of America, Wells Fargo et al, so cheap funding is one of the few ways it can really stand out from the pack.
To pin some numbers on it, First Hawaiian’s reported deposit expense was just $13.6m in Q3’22. Call it around 25bp annualized on total deposits of $22b, notwithstanding the fact that Fed rate hikes are putting upward pressure on funding costs across the industry.
There’s more to say on First Hawaiian’s core business – its underwriting history being typically solid for one – but the long and short of it is that this is a very neat-and-tidy lender whose profitability typically runs well above average. Core return on tangible equity (ROTE) averaged around 15% between 2016 and 2021, and that includes a solid 10%-plus ROTE in 2020 – with that year obviously marked by higher levels of credit loss provisioning due to COVID as well as a hit from lower interest rates.
Higher Interest Rates Lifting The Top Line
Rate leverage was something that First Hawaiian had in spades heading into this tightening cycle (from memory I think it was the most asset sensitive bank I follow). The sticky deposit base was a big factor in that, but its loan book also skews more to commercial lending (~50% of the book) compared to Bank of Hawaii (~40%), and those loans are more likely to be floating rate.
With the Fed hiking over 400bp last year, net interest income (NII) has increased sharply. 9M’22 NII of $442m was up over 12% year-on-year, with 9M’22 net interest margin (NIM) of 2.65% up 20bp year-on-year.
Reported non-interest income has been more lackluster, declining high single-digits over the first nine months of last year. That was mainly due to lower BOLI income though, and fee income from retail and commercial banking operations – i.e. card fees, service charges, wealth management fees and so on – was actually up nicely.
For Q3’22, NII of $163m was up over 20% year-on-year and around 12% sequentially. NIM of 2.93% was up 33bp sequentially and 57bp year-on-year, helped by mix shift as management shuffled some of the investment securities pile into higher yielding loans. Loan yields were up 55bp year-on-year and around the same sequentially. All told, that drove year-on-year revenue growth of 14% and 7% respectively for Q3 and 9M’22.
Pre-provision operating profit (PPOP) was similarly up, clocking in at $246m for 9M’22. That was good for low single-digit growth on 9M’21, mainly due to lower non-interest income and double-digit operating cost growth. For Q3, operating leverage drove a circa 17% year-on-year and 20% sequential increase in PPOP, which came in at $96m for the quarter.
Deposit Costs To Rise Further, But No Real Concerns On Funding
Deposit betas are obviously an important consideration for lenders right now. One interesting facet with respect to the Hawaiian names is the potential impact of technology and mobile banking. This has come on leaps and bounds since the last cycle and it’s never been easier to shop around for better deals on deposits.
So far at least there is little sign of that having much of an impact. Costs on total interest-bearing deposits were up 33bp on the start of the year as of Q3’22 (versus a hike in the Fed funds rate of over 300bp), and even with deposit cost growth set to accelerate in Q4’22 the beta on interest-bearing deposits is expected to be sub-20%. The year-end 2022 cumulative beta on total deposits is expected to land around the 10% mark.
NIB demand deposit balances have also remained relatively resilient having grown significantly during COVID. Management put the sequential decline in NIB balances at 1% in Q3’22, albeit that was a week after period-end and doesn’t show in the reported figures. Ditto with overall deposit balances, which were down over 2% sequentially in the reported numbers. This was driven by a small number of accounts and had somewhat reversed just after the end of the quarter.
Post-COVID normalization of deposit balances would not exactly be unexpected. The main thing I’d note on that is that liquidity is ample, with a loan/deposit ratio around 62% and cash & investment securities comprising around 35% of total earning assets. All told I don’t really have any worries on that score.
Looking ahead, there are obviously a few moving parts to consider. Firstly, First Hawaiian remains quite asset sensitive, with a 100bps parallel shift in the yield curve expected to lift NII by over 6%. NIM expansion will slow in 2023 but will still be a tailwind to income in terms of the year-on-year comp.
On loan growth, Q3’22 performance appears unusually strong, with loan balances up over 3% sequentially to $13.7b. First Hawaiian has dealer floorpan financing operations, and those balances are coming back nicely having been suppressed by COVID-related supply chain issues (chip shortages hitting inventory levels). While this explains part of the outsized loan growth, commercial real estate and C&I lending looked solid even without it.
Elsewhere, residential real estate lending looks nailed on for a slowdown given where mortgage rates and current house prices are at. This is a chunky part of the loan book (~38%) and could contribute to overall lower credit growth this year. All said and done, I’m pencilling in around $710m in FY’23 NII. That would be good for around 15% year-on-year growth, with PPOP growth running ahead on cost leverage.
On credit quality, there’s not a whole to say except it remains exceptional. Asset quality and provisioning is bound to normalize given the bank reported a small release over 9M’22, and that will be a small drag on near-term net income and EPS growth. As for the broader macro picture, slowdown/recession fears are building, though I’m not too concerned, and even in a relatively bad scenario I expect the bank to be able to add to retained earnings. The Fed u-turning on hikes to the point of cutting is obviously another risk, though perhaps an unlikely one.
What Does The Market Think?
First Hawaiian stock trades at $26.56 at time of writing, putting it at around 2.8x Q3’22 tangible book value per share (TBVPS) and circa 13x and 11.5x my FY’22 and FY’23 EPS estimates respectively. The dividend yield is a shade under 4% based on the $0.26 per share quarterly payout.
I value bank stocks on a combination of P/TBVPS, discounted earnings growth and, in this case, a simple dividend discount model. With that, a 2.8x multiple on TBVPS looks steep, though in the context of its ROTE profile is probably fair. Likewise, the market currently seems to be pricing in long-term annualized core income growth of around 3-4%. That looks okay to me, and on a modified DDM model (i.e. total distributable cash flow, with buybacks) a fair value at the current price requires similar underlying growth to work.
Summing It Up
I can’t say that First Hawaiian is knockout cheap right now, but where I think it does have above-average potential is as a solid dividend stock. Funding growth doesn’t require that much capital here, plus there’s so only so much to go after anyway. The bank hasn’t been around long enough to establish much of a track record on its distribution (French giant BNP Paribas owned it for years), but peer Bank of Hawaii has a great one, and I hope to see that translate over to here in time.
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