One thing’s for sure, quality isn’t going to be an issue when it comes to the Hawaiian banks. First Hawaiian (FHB) is just about the largest of the bunch with $25.5b in assets (Bank of Hawaii being a very close second), and they don’t get the love they deserve from the wider investing community in my view. In a way, that’s understandable. Earnings quality and safety only take you so far – the interplay between growth and value being crucial too – although when it comes to bank stocks I do place a bit more of a premium on the former. In that sense there really aren’t too many better names out there, certainly among the regional players.
As if to underscore the “quality isn’t enough” line, returns have been pretty lackluster here recently, with First Hawaiian stock significantly trailing the wider market and its regional bank peers last year. While you could argue that was always likely in a recovery year – “riskier” names will naturally outperform – there is a bit more to it than that, and shareholder returns are pretty muted even against pre-COVID times.
Depending on your view, then, “more of the same” might be good or bad. This is a real Steady Eddie – and will quietly plod along earning a 15%-plus ROTE. It also offers a relatively nice dividend too, and I can see that appealing to conservative-minded investors (certainly not a bad way to approach long-term investing in bank stocks). The valuation isn’t especially exciting, though, with the shares currently trading on a suitably rich P/TBV ratio.
Hurt By Low Rates, Excess Liquidity
First Hawaiian is very much your bread-and-butter bank, and like most banks, it has felt the pinch from the combination of low interest rates and excess liquidity. Earning asset yields have fallen from somewhere in the 3.65% area pre-COVID to 2.36% as of Q3 2021. Deposit costs have fallen too, of course, it’s just that it was always in a strong position there to begin with on account of the Hawaiian banking market. The net result is that the bank’s net interest margin has contracted significantly, and that has put pressure on spread income. Surging deposits and weak loan demand haven’t helped either.
Okay, the above is not really a unique story – a lot of regionals can’t lean on non-interest sources of income like the big money center banks can. But when your top line is dominated by interest income, and when typically fatter net interest margins provide a chunk of the ‘quality angle’ investment case, then it’s important to mention it.
Net interest income was $132.6m in Q3, increasing slightly on a sequential basis ($131.5m in Q2) as management added around $1b to the investment securities pile. Pre-provision operating profit (“PPOP”) was virtually flat, though, coming in at around the $81.5m area. Loan growth likewise came in pretty muted, with total loans and leases at around $12.8b at the end of Q3. That was down around 2% sequentially, but more like flat if you take out PPP loans. Residential mortgages and HELOCs put in solid growth, offset by weak C&I dragged down by floor plan lending (supply chain issues have crushed auto dealer inventories). Deposits increased another $1.3b to $22.1b, with the already low quarterly cost of deposits falling 1bp to 6bp.
Asset Quality Remains Excellent
I figure that by now the story with regards credit quality doesn’t need much extra commentary. Like most banks, First Hawaiian held up exceptionally well in the downturn and released a slug of provisions through the income line last year, but in truth this was a very safe bank even before all that (it massively outperformed its peer group for asset quality during the final crisis, for instance). In Q3, non-performing loans and accruing loans 90 days-plus past due again fell as a proportion of total loans (to just 0.11%), which suffice to say remains well below historical levels. The allowance for loan losses stood at 1.26%, with its CET1 ratio in excess of 12.5%.
Looking ahead, I think it’s fair to say that First Hawaiian is not going to set the world alight. Now, I will add a caveat here in that I don’t mean this in a bad way as such. Boring retail banks with funding cost advantages that post a juicy ROTE will do me fine. That said, there are some headwinds right now. Unemployment in the state is in the 5.5% area, albeit that is down from above 6% fairly recently. Tourism is obviously pretty important to the local economy too (visitor spending is in the 20% of GDP area). Recent COVID fears won’t help, then, but hopefully loan growth will still trend a bit higher this year. The current low loan-to-deposit ratio means it should be well placed if demand does pick up.
On a more fundamental basis, there’s really only so much growth on the table. At the end of the day this is a market-leading Hawaiian bank that skews heavily toward residential real estate (around 40% of the loan book is in residential mortgages and HELOCs). PPOP growth in the years before COVID was virtually flat, with loan growth somewhere in the mid-single-digit area. On the plus side, the bank should enjoy a nice pop if (or rather, when) interest rates move higher. A shock 100bps move in rates would boost net interest income by 14% as per the most recent analysis, while a gradual change would still produce a 7% move. A corporate tax hike also looks less likely than it did not so long ago.
Stock Probably Fair Value
While the stock doesn’t look especially cheap right now, I can’t say it’s massively overvalued either. The shares closed 2021 in the $27.30 area, equal to around 2x TBV per share and 13x estimated 2021 EPS. 2022 net income will probably come under a bit of pressure as reserve releases won’t provide the boost they did last year, while there’s upward pressure on the expense line too. Still, the dividend is decent, currently yielding around 3.8%, and the bank is basically a capital returns machine – $650m shipped off to shareholders via dividends and buybacks in the three years before COVID. I do expect that to continue, with earnings growth in the mid-single-digit area leading to high single-digit returns in the long run.
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