Bank of Hawaii Corporation (NYSE: BOH) Q4 2021 earnings call dated Jan. 24, 2022
Corporate Particpants:
Janelle Higa — Vice President, Investor Relations
Peter S. Ho — Chairman, President and Chief Executive Officer
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
Mary E. Sellers — Vice Chair and Chief Risk Officer
Analysts:
Andrew Liesch — Piper Sandler — Analyst
Kelly Motta — KBW — Analyst
Laurie Havener Hunsicker — Compass Point — Analyst
Presentation:
Operator
Good day, and thank you for standing by, and welcome to the Bank of Hawaii Corporation Fourth Quarter 2021 Earnings Conference Call. [Operator Instructions] After the presentation, there will be a question-and-answer session. [Operator Instructions]
I would now like to hand the conference over to Janelle Higa. Please go ahead.
Janelle Higa — Vice President, Investor Relations
Thank you, Carmen, and good morning, good afternoon, everyone. Thank you for joining us today. On the call with me this morning is our Chairman, President and CEO, Peter Ho; our Chief Financial Officer, Dean Shigemura; and our Chief Risk Officer, Mary Sellers.
Before we get started, let me remind you that today’s conference call will contain some forward-looking statements. And while we believe our assumptions are reasonable, there are a variety of reasons, the actual results may differ materially than those that are provided. During the call, we are — we will be referencing a slide presentation, as well as the earnings release. A copy of the presentation and release are available on our website, boh.com under Investor Relations.
And now I’d like to turn the call over to Peter Ho.
Peter S. Ho — Chairman, President and Chief Executive Officer
Great. Thank you, Janelle. Good morning or good afternoon, everyone. Thanks for your interest in Bank of Hawaii. So I think we started or we finished off the year, excuse me, with a pretty solid quarter that we’re pleased to share with you over the next few moments. I’ll begin as usual by giving you just a backdrop on the local marketplace and economy, I’ll then flip the call over to Dean, who’ll get into the financials, we’ll finish off with Mary on the credit side, although I will tell you that looks very good right now and should be a pretty short report, and then we’ll be happy to take whatever questions you folks may have.
So next slide. If you look at the slide on unemployment, what you see here is kind of nice steady improvement in the unemployment rate from what was a very distressed level back in April of 2020. I think unemployment now coming in at about 6%, most recently in November, and the forecast generally showed continued improvements as we move out from some of the impacts of both the Delta and Omicron viruses or variants.
On the next slide, you see real estate was a very good story in the islands in 2021. This is Oahu only information. The neighbor islands, Maui, Kauai, and the Big Island trending similarly. But for 2021, you see that on Oahu, single-family homes had a near record year, closed sales up almost 18%, median sales price up 19.3%, $990,000 for the year. I’d note that we pierced the million dollar level for median, single-family home sales prices in December of 2021, and there you see down in days on market. So just effective proxy for inventory looking pretty tight.
On the condominium side, their performance was as good, not quite as good as single-family’s, but volumes up 53% for the year, prices up 9%, and inventory levels similarly constrained as the single-family home market. I’ll finish with a little discussion on the visitor industry. Here you see daily arrivals in the gray bars or gray lines, that’s 2019, and the dark blue, that’s our performance over 2021. And I think the two takeaways here are that kind of ex any extreme surge situation, the visitor market performed exceptionally well.
So deep into the summer, call it the July-ish timeframe, we almost reached, actually we did reach parity in terms of arrivals with 2019 levels, which is really quite remarkable given that we still really haven’t seen the resumption of international travel yet. Deeper into the fourth quarter towards Christmas, in general, Christmas, the Christmas holiday season was a good one for the islands, but we have been impacted of late over the past month or so by Omicron, and you see kind of that re-dispersion of outcome as we get into more surge like environments.
So our hope for ’22 is that we’ll be certainly less, less impacted by surges, as well as we hope to begin seeing the return of the international traveler towards the back half of next year. And so most folks that I talk to within the industry feel pretty good. They felt great about the holiday season, great ADRs, great occupancy, fair amount of optimism looking into ’22, again, a lot of that predicated on the return of the international visitor towards the back half of the year. But a lot of sense that domestic visitors are eager to travel — eager to travel to Hawaii and increasingly used to just operating in kind of this viral environment. So that’s it for me on color from the marketplace.
And now let me turn the call over to Dean. Dean?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
Thank you, Peter. Growth from core customers remained solid in the fourth quarter. Core loans net of PPP waivers increased by $327 million or 2.8% linked quarter and by $710 million year-over-year or 6.2%. Waivers on PPP loans slowed in the fourth quarter and balances declined by $142 million. $127 million of PPP loans remained at the end of the year.
Net interest income in the fourth quarter was $126.4 million. Included in the fourth quarter net interest income was a one-time reduction of $900,000 for an adjustment to deferred mortgage loan fees. In the third and fourth quarters, total PPP loan interest income, which includes normal interests and amortized and accelerated loan fees were $7.9 million, $5.7 million respectively. Adjusting for the one-time charge and total PPP loan interest income, the fourth quarter’s core net interest income was $121.5 million, up $2.6 million or 2.2% linked quarter, driven by strong loan growth, assets shift from investments to higher yielding loans and repricing of our liabilities. This continued the upward trend in core net interest income experienced in the third quarter.
Our strong and stable — our strong and stable base of low cost deposits remain a readily available source of liquidity and will enable us to lag rising rates and continue growing our net interest income. 94% of our deposits are from core commercial and consumer customers, an increase from 91% at the end of 2020. On a year-over-year comparison, our non-interest-bearing demand balances increased 26.5% and comprised 36% of our total deposits.
In addition, less rate sensitive operating account balances as represented by total non-interest-bearing and interest-bearing demand accounts are nearly 60% of all deposits. In contrast, our time deposit balances decreased by 40% and now represent 5% of total deposits. Total deposit costs dropped 1 basis point to 6 basis points in the quarter. Our low cost core deposits in combination with our balance sheet’s asset sensitivity, low loan to deposit ratio of 60%, and strong cash flow, positions us well to take advantage of rising rates, while maintaining current income and funding sources for continued growth.
The 35% of our loans that are floating or adjustable rate loans provide additional rate sensitivity. In addition, our investment portfolio generates more than $500 million of — per quarter of cash flow available to be reinvested at higher rates. In 2021, Bank of Hawaii achieved record net income of $253.4 million and record earnings per common share of $6.25. Net income for the fourth quarter was $63.8 million and $1.55 per common share. Net interest income in the fourth quarter was $126.4 million.
As discussed earlier, adjusting for interest income on PPP loans and the one-time adjustment to the fourth quarter’s net interest income, core net interest income increased $2.6 million or 2.2% linked quarter, driven by strong core loan growth, free mix of assets into higher earning loans from investments and continued repricing of liabilities. As Mary will discuss later, we recorded a negative provision for credit losses of $9.7 million this quarter. Non-interest income totaled $42.6 million in the fourth quarter, up $1.2 million from the third quarter. The increase was due to higher deposit fees, service charges and other transaction fees from increased economic activity.
We expect the first quarter’s non-interest income will be approximately the same as the fourth quarter and increase to approximately $44 million by the end of the year. Mortgage banking income is expected to be lower due to higher interest rates and lower gain on sales spread, offset by improving service charges and transaction fees throughout the year. Non-interest expense in the fourth quarter totaled $101.7 million, up from $96.5 million in the third quarter. Included in the fourth quarter expenses was a one-time $1.2 million charge for an additional employee benefit that increased our vacation carryover limits. The third quarter included several one-time items, including a 3 — $6.3 million benefit from the sale of property, $3.8 million charge for repo early termination costs, and $1.2 million charge in extraordinary severance costs for a net reduction of $1.3 million in expenses.
Adjusting for these items in both quarters, normalized non-interest expenses in the fourth quarter was $100.5 million, an increase of $2.7 million over the linked quarter. The main drivers of the increase were higher medical insurance costs and incentive accruals. Medical costs have increased and are trending toward pre-pandemic historic norms. Incentive accruals increased linked quarter to bring the full-year incentives back to 2019 levels.
Comparing the full-year 2021 normalized expenses to the pre-pandemic year of 2019, we continue to demonstrate expense discipline. Normalized expenses between 2019 and 2021 were up $16 million or 2.1% annualized less than the 2.8% annualized inflation rate over that period. To provide some additional clarity on how we’re thinking about those normalized expenses. In 2021, normalized expenses were $390 million after adjusting for $3.7 million in expenses from one-time items. These one-time items included $7 million of early termination costs for repos, $3 million for extraordinary severance expenses, $1.9 million related to our mass issuance of contactless debit cards, and the aforementioned $1.2 million charge for the increase in our vacation rollover, partially offset by $9.4 million benefit from the sale of two properties. Normalized expenses in 2019 were $374 million after adjusting for $5.3 million of 1. — of one-time costs comprised of a $6 million increase in legal — in the legal reserve, and $600,000 of one-time up losses and impairments, partially offset by $600,000 benefit from the sale of property, and a benefit of $800,000 from a one-time excise tax refund.
Continued expense discipline kept our combined core and volume related expenses flat to slightly lower, and the increase in normalized expenses between 2019 and 2021 were primarily driven by significant strategic innovation investments that are resulting in balance sheet growth and market share growth. In 2022, we’re continuing with our strategic innovation investments with an additional 2.8% of total expenses to further our market share and revenue growth. We expect core expenses will increase approximately 2.3%. Expenses will also increase 0.8% from an additional one-time inflation adjustment of 2.5% to our normal annual merit increases, reflecting the higher cost of living being experienced by our employees.
Together with the continued strategic innovation investments, we expect total expenses will increase 5.9% over 2021’s normalized expenses of $390 million. As a reminder, in the first quarter, we estimate that the seasonal payroll tax and benefit expenses related to the payment of annual incentives will be approximately $3 million compared with the approximately $2 million in the first quarter of 2021. Our return on assets during the fourth quarter was 1.12%, return on common equity was 17.4%, and our efficiency ratio was 60.18%.
Our net interest margin in the fourth quarter was 2.34%, an increase of two basis points from the third quarter. The increase in the margin during the fourth quarter reflects a more favorable balance sheet mix driven by strong loan — core loan growth, partially offset by lower PPP loan waivers. Excluding total PPP loan interest income and the one-time charge for the deferred mortgage loan fees mentioned earlier, the core margin was 2.24%, an increase of seven basis points linked quarter.
Excluding the impact of PPP loan interest income, we — we expect continued improvement in core margin with increases of three basis points to five basis points per quarter 2022 due to continued loan and deposit growth and higher interest rates. Our capital level remains strong and is well positioned to support continued growth. Our CET1 and total risk-based capital ratios were 12.12% and 14.81% respectively with a healthy excess above minimum well capitalized requirements. During the fourth quarter, we paid out $28 million or 45% of net income available to common shareholders in dividends and $2 million in preferred stock dividends. We repurchased 87,000 shares of common stock for a total of $7.3 million. And finally, our Board declared a dividend of $0.70 per common share for the first quarter of 2022.
Now I’ll turn the call over to Mary.
Mary E. Sellers — Vice Chair and Chief Risk Officer
Thank you, Dean. Credit metrics remained very strong for the fourth quarter. Net loan and lease charge-offs were $700,000 or two basis points annualized compared with net charge-offs of $1.2 million or four basis points in the third quarter and net recoveries of $300,000 in the fourth quarter of 2020.
Non-performing assets totaled $19 million or 15 basis points, down $1.6 million or two basis points from the third quarter and flat year-over-year. Loans delinquent 30 days or more were $28.5 million or 23 basis points at the end of the quarter, flat for the linked period and down $8 million or eight basis points year-over-year. And criticized loan exposure represented 2.23% of total loans, down 11 basis points for the linked period and down 40 basis points from the fourth quarter of 2020.
As Dean noted, we recorded a negative provision for credit losses of $9.7 million this quarter. This included a negative provision to the allowance for credit losses on loan and leases of $9.4 million, which with net charge-offs of $700,000 reduced the allowance to $157.8 million, 1.29% of total loans and leases or 1.3% net of PPP balances. The decrease in the allowance reflects the most recent UHERO economic outlook and forecast for our market coupled with our credit risk profile. The allowance continues to provide for the uncertainty and potential down risk associated with the pandemic.
At year-end, customer loan balances on deferral were down 98% from their peak to 0.4% of total loans. As you’ll recall, given we have the capacity to do so, we elected to partner with our customers and provide extended relief, primarily through principal deferrals on low margin real estate. 100% of the loans remaining on deferral are secured with our commercial deferrals having a weighted average loan to value of 51% and our consumer deferrals having a weighted average loan to value of 66%. 100% of our commercial loans continue to pay interest, and our return to payment performance remained strong with less than 1% of these customers delinquent 30 days or more.
I’ll now turn the call back to Peter.
Peter S. Ho — Chairman, President and Chief Executive Officer
Great. Thank you, Mary. So that’s our prepared remarks. We’re happy to answer whatever questions you folks may have.
Questions and Answers:
Operator
Thank you. [Operator Instructions] We have a question from Andrew Liesch with Piper Sandler. Your line is open.
Andrew Liesch — Piper Sandler — Analyst
Hi, good morning, everyone.
Peter S. Ho — Chairman, President and Chief Executive Officer
Hi, Andrew.
Andrew Liesch — Piper Sandler — Analyst
Dean, question on the margin guidance, 3 bps to 5 bps per quarter assuming higher rates, how many rate hikes does that assume in this forecast?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
Yeah, we — we are assuming three rate hikes starting in March, and then in — on the long end, looking at about a 2% 10-year.
Andrew Liesch — Piper Sandler — Analyst
Got it. Okay, that’s helpful. And then on Slide 9, the adjustable makes that 10% of the loan portfolio. I guess what’s the timing of that repricing, is it after 90 days, six months, how does that break out?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
It’s — it varies over several years, but the average is roughly about three years. There is about $400 million in two years and less.
Andrew Liesch — Piper Sandler — Analyst
Okay, got it. And then I guess similar question on the fixed rate loans, I mean, how many of those — that 55% [Phonetic], how many of that reprices in the first year?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
That’s embedded in the cash flow, so that’s about, I would estimate about the two book to be about $1.5 billion or $2 billion.
Andrew Liesch — Piper Sandler — Analyst
Okay, got it, got it. And then just a clarification question on the fee income guide for this quarter building the $44 million in the fourth quarter, is that a similar level to the total reported, so the $42.6 million including the securities, the net loss on securities or should we be backing that out?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
Could you repeat that again?
Andrew Liesch — Piper Sandler — Analyst
So the reported fee income number for the fourth quarter was $42.6 million, you said for the first quarter something similar, is that the number we should be using the $42.6 million?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
Yes, yes. Sorry.
Andrew Liesch — Piper Sandler — Analyst
Okay, got it. That covers all my questions. Thanks so much.
Peter S. Ho — Chairman, President and Chief Executive Officer
Thank you.
Operator
Our next question comes from Kelly Motta with KBW. Your line is open.
Kelly Motta — KBW — Analyst
Hi, thank you so much for the question. I think just piggying back off of Andrew’s question on the NIM. Just wondering with deposit costs and the betas embedded in that, about how many rate hikes do you think need to come through until you get an impact to your deposit costs, just given that Hawaii continues to lag there?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
Yeah. I would say that the way we have it modeled is the overall betas are about 20% over the complete cycle, and just given our construction of our deposit base, we’re going to be lagging initially out of the gate. So it’s probably towards the middle part of the year, anything, where we’ll be seeing deposit increases after the second rate hike.
Peter S. Ho — Chairman, President and Chief Executive Officer
Yeah, I’d say, I just add to Dean’s thought. There are probably several layers to our deposit betas. So number one, I think everyone recognizes that Hawaii is one of the best or certainly one of the better deposit marketplaces in the country. So that’s going to give us some stickiness, our — us and our competitive set. The other thing I’d point to is that we’ve got — our loan to deposit ratio now sits at 60%. So we always want to be competitive, we always want to maintain market share, but there is at least as of right now no compelling need to build, we’re even hold deposits per se. So that’s going to — and that will obviously play into our pricing decisions. And then finally, when you look at the composition of our deposit base, I think 95% of the bases is core checking and savings, and a similar number are in consumer and commercial versus public types of client bases. So that too will help us maintain pricing over the intermediate term.
Kelly Motta — KBW — Analyst
Thank you so much for all the color. Just to follow up on the public deposits, with the roll-off that happened this quarter, how much of that was maybe seasonal versus part of your effort to roll off maybe some higher cost funding?
Peter S. Ho — Chairman, President and Chief Executive Officer
That was — we are — we are intending to bring down the public book as rates rise, but the $298 million that rolled off in public was mostly kind of transactional. We had some kind of tax payments that were — that came in at the end of the prior quarter, that left shortly after in the fourth quarter and those types of transactions. So, I would characterize that for your question as more seasonal than structural.
Kelly Motta — KBW — Analyst
Got it. That’s super helpful. I’ll step back. Thanks so much for the question.
Peter S. Ho — Chairman, President and Chief Executive Officer
You’re welcome.
Operator
Thank you. [Operator Instructions] Our next question is from Laurie Hunsicker with Compass Point. Your line is open.
Laurie Havener Hunsicker — Compass Point — Analyst
Great. Hi, thanks. Good morning.
Peter S. Ho — Chairman, President and Chief Executive Officer
Hi, Laurie.
Laurie Havener Hunsicker — Compass Point — Analyst
I wondered — Dean, if you could take us back to expenses, I really appreciate how you laid out everything and you laid out core, that’s super helpful. I guess as we roll forward and we think about 2023, I think most of us are driving our price targets off of 2023. Are we apt to see you go back to somewhat of a slower growth that we’ve seen you employ in times gone by or how should we be thinking about that? In other words, you’re going to be back to that 2%, 2.5% CAGR or are you more apt to repeat the 5.9% growth that you’re expecting in 2022?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
Yeah. So in 2023, we haven’t spent much time there, but in looking at how we broke down ’22, the 2.3%, it seems to be a reasonable starting point, but we also are intending to continue with our strategic investments into ’23.
Peter S. Ho — Chairman, President and Chief Executive Officer
Yeah, Laurie, let me — I’d add to what Dean’s shared. I would say that our expense built for ’22 is really three pieces, right. It’s a core component of 2.4%, which frankly is on the high side for us, and I think reflects just kind of inflationary pressures on all different types of expenses, both personnel and otherwise. And then we also built into this year a decision to on a one-time basis plus up our overall employee base by 2.5%. So our merit for the year, kind of our normal merits, call it 2.5%, we made the decision to plus up another 2.5% to give our employees in 2022, a 5% merit increase for obvious reasons, right. I mean, we just think with inflation being a real number out there, we just want our people to be in as good shape [Phonetic] as possible fiscally.
We do not intend to do that again next year. We hope not to have to do that again next year, I should say, and that’s worth, call it 74 basis points on the 5.9% increase. And then from an initiative standpoint, we’ve got a pretty aggressive/healthy agenda on initiatives. And they all — what I’m really super excited about is they all are types of spend that can get into the revenue and value and experience, customer experience bloodstream pretty quickly. So there’s not a whole lot of infrastructure built in these, these are all kind of application types of things. And that 2.8% or $10.9 million is I would say that’s on the heavy side. I think we’re going to continue to have initiative spend in ’23, but probably not at that same level.
And if we do have it at that same level or higher, it certainly will be substantiated by operating performance that we see in real time, right. So I guess if I reverse that out, what I would say is that probably ’23 expenses, you’re going to lose the 74 basis points on that one-time inflation plus up, right, and the initiatives are going to come in at, at a half [Phonetic] to a third less [Phonetic], core maybe hopefully depending what inflation does, but call it 2.4%, call that flat. And I think we end up with, call it a kind of a estimated back of the envelope, ’23 of, call it, three and three quarters percent [Phonetic] to four and a quarter percent increase or something for the year, something like that. That makes sense to you.
Laurie Havener Hunsicker — Compass Point — Analyst
Yeah, very, very helpful. And then do you have any branch rationalization plans for next year or the year after, how are you thinking about that?
Peter S. Ho — Chairman, President and Chief Executive Officer
Yeah. We took a big one last year. So — you recall last year, we took a $5.2 million charge to close out our supermarket branches, which were good performers, but they were highly transactional. And as more of our customers have moved to digital channels, they became, I don’t want to call them superfluous, but not as necessary as previously historically, right. And so that basically, that $5 million charge equates to roughly a $5 million savings annually and that was in the bloodstream for ’21, Dean?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
Partially in 2020 and then the rest of it in 2021.
Peter S. Ho — Chairman, President and Chief Executive Officer
2021.
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
Yeah.
Peter S. Ho — Chairman, President and Chief Executive Officer
So that was a big chunk. I would say there are opportunities on the margin for further branch rationalization, but I think we’re getting close to being comfortable with the square footage we’ve got out there right now. That’s not to say there aren’t just overall efficiency opportunities in the branches through just ways to digitize versus being physically present, those types of things, and I think we’ve got a number of efficiency efforts across the organization and external to the branches.
Laurie Havener Hunsicker — Compass Point — Analyst
Great, very helpful. Dean, question — question for you on tax rate obviously low at 17%, it was noisy, came in at 22% for the full-year, how should we be thinking about 2022?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
Yeah, the tax, I would say it’s going to be 23% as a estimate.
Laurie Havener Hunsicker — Compass Point — Analyst
23%. Okay, that’s helpful. And then just last question, I just wanted some clarification, Slide 7, where you lay out the PPP, how much of the $7.9 million, the PPP income that came in, in the third quarter was from PPP gains? I’m assuming the $7.9 million included just some of that interest income, but just wondering what the actual game piece was and then how much is remaining on the unamortized piece?
Dean Y. Shigemura — Vice Chair and Chief Financial Officer
So in the third quarter, it was 5. — I think you’re talking about the accelerated component, and that’s $5.9 million in the third quarter, $4.9 million in the fourth quarter, and then we have $2.4 million remaining.
Laurie Havener Hunsicker — Compass Point — Analyst
Perfect, great. Thanks for taking my questions.
Peter S. Ho — Chairman, President and Chief Executive Officer
Thanks, Laurie.
Operator
Thank you. And I’m not showing any further questions in the queue. I will pass it back the call to Ms. Higa for final remarks.
Janelle Higa — Vice President, Investor Relations
I’d like to thank everyone for joining us today and for your continued interest in Bank of Hawaii. Please feel free to contact me if you have any additional questions or need further clarifications on any of the topics discussed today. Thank you so much, everyone.
Operator
[Operator Closing Remarks]