Good day, and thank you for standing by. Welcome to the Bank of Hawaii Corporation's First Quarter 2023 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jennifer Lam, Senior Executive Vice President, Treasurer and Director of Investor Relations. Please go ahead.

Thank you. 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. While we believe our assumptions are reasonable, there are a variety of reasons the actual results may differ materially from those projected. During the call, we'll 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.

Thanks, Jennifer. Good morning or good afternoon, everyone. Thank you for your continued interest in Bank of Hawaii. Despite the drama and challenges of the past 1.5 months, Bank of Hawaii recorded solid results. Deposits grew on an average basis, but were down modestly on a spot basis. Loans grew across both commercial and consumer categories. Margins reflected the continued inversion of the yield curve. If the last few weeks have taught us anything, it is that business models matter in banking, the quality of relationship as well as the diversity of relationship with one-to-one client base are both critical. At Bank of Hawaii, we believe our 125-year commitment to a community bank-based model achieves both key factors. We've been focused on the Hawaii and West Pacific markets for many, many years now. This focus has allowed us to build uniquely long-standing relationships with our clientele, relationships that work both ways. Additionally, our community-based approach dictates that we focus not on any one sector or concentration, but rather on a whole community approach. This has enabled us to build both a mass-market consumer business as well as a private bank business. It has enabled us to serve very small businesses as well as establish long-tenured businesses in town. We also serve not just a State of Hawaii, but also component municipalities throughout the state. It is this combination of quality and diversity of relationships in a market we've been serving for over 100 years that makes us different in challenging times. Given keen interest in liquidity and funding source, we thought we'd provide and reiterate critical knowledge on our operation, which I'll be happy to do in a second. As is customary, Mary will follow with some updates on credit, which is a good story and Dean will finish off…

Thank you, Peter. Serving our ailing communities for 125 years has served us to conservatively manage the assets of the organization. Accordingly, our investment portfolio is invested in high-quality securities, primarily U.S. government agencies and U.S. government-sponsored agencies. We take a similar approach to lending. We lend in markets we know, to relationships we understand. And our loan portfolio reflects this with 94% of our portfolio in Hawaii and the West Pacific and 6% Mainland-based, representing credit exposure for those relationships who have diversified assets or operations beyond Hawaii. We couple this with prudent underwriting and disciplined portfolio management and we have a portfolio that is built on long-tenured relationships diversified by asset class, has appropriately sized exposures, is 80% secured with real estate with a combined weighted average loan to value of 55% and has higher risk categories that are well contained. Our commercial real estate portfolio, which represents 28% of the total portfolio, is diversified across various asset types, with office accounting for just 3% of total loans. The portfolio built on relationships with demonstrated experience and financial capacity has conservative weighted average loan to values across all asset types and a portfolio weighted average loan-to-value of 56%. Our office portfolio is diversified by asset class across our markets and carries a weighted average loan-to-value of 56%. 25% of the portfolio is primarily Class A properties in the Honolulu Central Business District. This segment has a 63% weighted average loan-to-value and 47% of the exposure is further supported by repayment guarantees. 3% of loans in the office segment are maturing through 2024. Tail risk in the commercial real estate portfolio remains modest with just 0.92% having an LTV greater than 80%. Our consistent conservative approach underwriting is reflected in the consistently strong quality of our consumer loan portfolio…

Thank you, Mary. Net interest income was $136 million in the first quarter, negatively impacting the quarter's net interest income or 2 fewer days in the quarter, which reduced net interest income by approximately $1.6 million and early buyouts on leases, which reduced net interest income by $300,000. Adjusting for these items, our normalized net interest income for the first quarter was $137.8 million, a decrease of $2.9 million linked quarter and an increase of $12.7 million from the first quarter of 2022. The linked quarter decrease was primarily due to higher funding costs partially offset by loan growth and higher asset yields. The increase from the first quarter of 2022 was primarily due to loan growth and increases in our asset yields, partially offset by higher funding costs. The inverted yield curve continues to pressure our net interest income and margin. We expect deposit betas will continue to rise from the 15.9% in the first quarter, driven in part by further mix shift from noninterest-bearing to interest-bearing savings and time deposits and the generally more competitive rate environment. To address the challenges from the higher short-term rates, beginning in the fourth quarter, we increased our term funding by $800 million at a weighted average rate of 3.93% and also increased our longer-term time deposit balances by $730 million at a weighted average rate of 3.84%. In addition, we continue to remix our loans by shifting to greater floating and variable rate exposure, which comprised the majority of new originations in the quarter, while allowing our investment portfolio to run off and holding more cash on the balance sheet. From an earning asset perspective, net interest income and margin are being supported by strong cash flow and overall asset repricing at higher rates. With $2.9 billion of annual cash flows…

Great. Thank you, Dean. Thanks again for listening. Now, we’d be happy to take your questions.

[Operator Instructions] We have a question from Andrew Liesch from Piper Sandler..

Just curious, Dean, how should we be thinking about the margin from here? It seems like you kind of have some caution around rising deposit costs. But longer term, it's still some asset repricing. So how do you think the margin is going to react over the course of the next week?

Yes. Right now, we're expecting the Fed to increase rates next week and then possibly another one, but pause from that point on. But when you look at that compared to what the futures are expecting, we're actually looking at a higher for longer kind of rate environment and then version carrying through to sort of the middle of next year. So based on that, we're looking at the margin coming down in the second quarter and then really bottoming up towards the end of this year before increasing into the next year, assuming the rates do come down on the short end towards the tail end of 2024.

Got it. Any level of where that could -- what we expect it's going to tail out there, where do you think it will bottom?

We're looking at right now, at least in the second quarter, similar decline as we saw in the first quarter. And then from there, it will start to...

Grow.

Yes.

Certainly. And then I just got a question on the short-term borrowings that you are -- that you added, it looks like those came on earlier in the quarter just based on the average balance. I'm just curious, what was the rationale for adding those? Is it just to add some liquidity? Any color behind that would be helpful.

So we did take down some longer-term funding. And again, that's part of our kind of mitigant, if you will, against the higher for longer rates. And then second of all, we did want to hold a little bit more liquidity on the balance sheet, both on the -- in terms of fed funds sold.

We have a question from Kelly Motta from KBW.

I was hoping to get a bit more color on the securities portfolio. I think it's extended out some. But could you provide us with the expected duration on both the available for sale and HTM securities at this time?

Yes. The -- in total, the portfolio is about 5.4 years duration. The AFS is 3.8. HTM is 6.4. And to kind of give you more color, we're with the increase in rates, the cash flows and kind of prepayments have already in effect bottomed out. And so we're really effectively at the contractual payment level. So we don't expect any more slowdown or extension in the portfolio from rate movements higher. And therefore, there is -- if rates were to move lower, that -- those cash flows could increase in short duration.

Got it. Understood. And obviously, a lot going on this quarter. It looks like you repurchased maybe a little bit of shares this quarter. Just wondering how you feel about capital at these levels? And what kind of the outlook is for managing capital going ahead?

Yes. Kelly, I think that given the environment that we find ourselves in at this point as well as some level of uncertainty around where regulatory levels will push out in the kind of intermediate term, I think, we're going to be pretty judicious around capital. That's not to say that we've suspended any form of capital programs at all. But I think from a guideline standpoint, we're probably going to be more judicious than not around capital management.

Got it. And maybe last question for me, and then I'll step back and let others in. But I saw the Moody's downgrade. Just wondering if this is something that you've been in discussion with them and how that works? And any implications of that if there are any to how you run your business?

We don't anticipate any implications to that. Obviously, we were disappointed to see the downgrade, especially after having just been affirmed on January 12 with Aa3 rating. But we took a one level downgrade on our long-term deposit rating from Aa3 to A1 with a stable outlook. So not what we had previously, but still a high mark for us. So we don't anticipate any operational -- meaningful operational outcomes from that.

Certainly. One more, if I can just sneak it on, just tacking on to that. Is there a level of deposit rating where you would -- obviously, you're at very high level still right now, but that would start to create greater conversations with some of your depositors just as somebody who doesn't -- hasn't ever looked at those ratings. Just trying to understand it a little bit better.

Tough to say. Generally, ratings discussions haven't come into play and in dealing with our depositors. So not in our best past practice, no.

And we have a question from Jeff Rulis with D.A. Davidson.

Dean, I wanted to follow up on -- maybe get back to -- you mentioned your expectations for the beta to exceed the 59. Just wanted to kind of see if you've got an updated through-the-cycle expectation is question one. And then the second part of that is just have you seen customer rate requests, have those eased in as we've proceeded into April? I'll leave it there.

Yes. In terms of our betas, historically, we were at 20%. In this cycle, understanding the magnitude and the velocity of the increases, we can see that the betas could rise between 20% to 25%. It's kind of what we're thinking there will be. In terms of exceptions, they -- I don't see any real changes. I mean, we still do get exception requests for deposits. And that's all incorporated into the what we're expecting in terms of betas.

Got it. And Dean, while I've got you, do you have a March margin average, what that was for the month of March?

For the margin, let me see, I do have it. It was 37.

Okay. I appreciate it. And maybe one last one, Peter, and it’s a strange one here. I guess just some noise about regulators changing treatment of unrealized losses. Does that alter your strategy at all? Or do you really give that any attention. Any thought on just addressing that part of the unrealized loss treatment?

I guess, Jeff, we're -- we certainly have a heightened awareness around maybe the differences in AFS treatment for smaller banks versus larger banks. And the prospects of smaller banks having potentially to migrate to that level. And I think where we stand on that is kind of not knowing where things stand there. We likely will begin to think through various scenarios on how we could in force to move to that level to get there. Our preliminary view is that we would be able to do that organically over a period of time, kind of given operating assumptions that we think are reasonable at this point. So nothing -- obviously, nothing has been set in stone, a fair amount of discussion around the topic. And I guess we're trying to stay as flexible as possible kind of within that discussion.

And on that front, in addition to the deposit balance, and I appreciate the almost by week or the month of March balances certainly hadn't been impacted and actually up since SVB. I don't know if you've had any customers that can take that second link and look at that. Have you had any customers or larger maybe public deposits look at the potential securities losses. Had you have to address that and walk people through the outcomes there?

I would say, in general, what people are interested in is more the deposit stability of the franchise. And obviously, that -- the proof is in the pudding there. Kind of the discussion around unrealized losses and the like is a little bit more esoteric, certainly for the majority of our deposit base. And generally, when we have the discussion with more sophisticated levels, I think there's a reasonable level of understanding there. So no, I mean, the topic itself has not resulted in meaningful deposit outflow for us.

We have a follow-up from Andrew Liesch with Piper Sandler.

The follow-up question here. Just to clarify something on the expense guide. So 3% on that $415 million is about 207 -- 427. Does that include the severance this quarter? So on a more run rate basis, it's actually lower than that?

Yes. It would include the severance.

And we also have a follow-up one moment. With Kelly Motta from KBW.

I apologize if I missed this as part of the prepared commentary, but your fee guidance appears to be slightly better than what you had in January. What's the drivers of that better fee outlook going ahead? Just trying to understand.

Yes. It's generally a more stable outlook in the economy. We are seeing some transactional volumes increase and general kind of market conditions, the stability in the markets, I think, is helping us to achieve a better outcome on the fee side.

Got it. And then also your loan growth was still all considering like very healthy this quarter. Wondering what you're seeing in your markets and how you're balancing that with the funding aspect of things and what the drivers of loan growth should be going forward?

Yes. Well, what really augments or has augmented the loan growth, Kelly, has been basically amortization of the securities book, which basically can accommodate growth in the mid-single-digit level. I would suspect that the annualized rate that we saw in the first quarter for loan growth might be a high watermark as we move forward for a couple of reasons. One, it feels like commercial borrowers are beginning to pull back a little bit just kind of with the, I think, heightened uncertainty in the marketplace and spectre of recession. Then obviously, I think as rates have kind of taken hold the consumer front, I think, is slowing a bit as well. So I guess I would say that loan growth still would be potentially in the mid-single-digit range, but probably ranging towards lower end of the mid-single digits at this point, and that is pretty adequately supported by securities runoff.

We also have a follow-up from Jeff Rulis with D.A. Davidson.

One more for Mary. Just on the criticized pickup linked quarter. Any color as to where that was? I think you've mentioned that 80% of the total criticized is in CRE. Just wanted to see what that linked quarter addition to that balance was?

Jeff, it was actually across a number of customers. Generally, what we saw were various idiosyncratic issues, either they face supply chain or permitting delays. They had slower repositioning post COVID or they were just looking at higher operating expenses. Our latching component does continue to be the biggest piece of that. We did get some upgrades this quarter, but we still have several large exposures there where they're really dependent on Japanese and international travelers returning.

And I'm showing no other questions in the queue. I would like to turn the call back to management for any closing remarks.

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 clarification on any of the topics discussed today. Thank you, everyone.

This concludes today's conference call. Thank you for participating. You may now disconnect.