Good day and thank you for standing by. Welcome to the Bank of Hawaii Corporation Second Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [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, Cindy Wyrick, Director of Investor Relations. Please go ahead.

Thank you. I'd like to welcome everyone and thank you for joining us today as we discuss the financial results for the second quarter of 2023. Joining me today is our CEO, Peter Ho; our CFO, Dean Shigemura; our Chief Risk Officer, Mary Sellers and the newest member of our IR team [indiscernible]. 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 that the actual results may differ materially from those projected. During the call today, we will be referencing a slide presentation as well as the earnings release, both of which are available on our website boh.com under the Investor Relations tab. And now I'd like to turn the call over to Peter Ho.

Thanks, Cindy. Good morning or good afternoon everyone. Thank you for your interest in Bank Hawaii Corporation. I'll begin today's call with some general commentary on our results. I'll then hand the call over to Mary to cover off on credit, which is a great story. And then, Dean will get a little deeper into the financials. We'll then be happy to entertain your questions. Bank Hawaii delivered solid results for the second quarter of 2023. Total deposits grew in the quarter and we enhanced our liquidity position substantially with cash and immediately available credit lines. Credit remains a strength with NPAs and net charge-offs of 8 basis points and 4 basis points, respectively. We recorded earnings per share of $1.12 for the quarter. Net interest income was negatively impacted by higher interest rates and attendant higher borrowing costs. Fee income performed well during the quarter and expenses were controlled, both on a reported and normalized basis. Given the environment, expense management will continue to be a particular focus of ours going forward. Deposit quality is obviously a critical factor in today's environment, but I thought I'd spend a little time reviewing Bank of Hawaii's exceptional deposit position. Our deposit story really begins with our deposit marketplace, which is different from nearly all other deposit markets in the country. 97% of the State of Hawaii’s deposit base as measured by the FDIC is held by five local banks all headquartered within the State of Hawaii and all having served the local community for many, many years. Therefore, it's not surprising that the events of early March with SVB and Signature Bank had a rather muted impact on the Hawaii marketplace as compared to the broader national small bank marketplace. We've built our deposit franchise over a 125-year history, one relationship…

Thank you, Peter. Bank of Hawaii's lending philosophy is grounded in two fundamental tenants. Lending and markets we know and to longstanding relationships we understand. While growing the loan portfolio in a safe and measured way over time, our focus is on ongoing disciplined portfolio management. We consistently, actively exit those products or segments that proved to have higher risk profiles, creating outsized credit losses and volatility. In the consumer portfolio, these non-core segments included land and interest-only loans in our residential portfolios, purchased home equity pools, indirect auto loans originated in Oregon, our revolving personal flex line product, and our credit card portfolio. Similarly, in our commercial portfolio, we spent a number of years working out of a scored small business portfolio, a pool of non-relationship shared national credits, and a large ticket leasing portfolio. Concurrently, we're continually focused on optimizing the risk profile within our core portfolio by biasing the mix within it to those products and segments that have proven to carry lower risk. This disciplined management coupled with consistent conservative underwriting has proven itself through lower net charge-off rates over the years and positions our portfolio to continue to realize lower credit losses through different economic cycles. All of this is reflected in our portfolio construct today, which is built on long-tenured relationships, diversified by asset categories with 60% consumer and 40% commercial, appropriately sized exposures, and 79% secured with real estate with a combined weighted average loan to value of 55%. Our commercial real estate portfolio, which represents 27% of the total loan portfolio, is diversified across various asset types. The portfolio built on relationships with demonstrated experience and financial capacity is conservatively leveraged with a weighted average loan to value of 50%. Maturities across the commercial real estate portfolio remain very manageable with 10%…

Thank you, Mary. Net interest income was $124.3 million in the second quarter, a decrease of $11.6 million linked quarter. Net interest margin was 2.22%, a decrease of 25 basis points linked quarter. Linked quarter decreases in both net interest income and margin were primarily due to higher funding costs, partially offset by loan growth and higher asset yields as the inverted yield curve and higher short-term rates continue to pressure our income and margin. We continue to exercise deposit pricing discipline as evidenced by our deposit beta continuing to outperform that of peer banks. Nevertheless, deposit rates are expected to continue to rise and we also expect a continued moderate mix shift from non-interest bearing into interest-bearing savings and time deposits. As a result, we expect our cumulative deposit beta in this cycle will peak at approximately 30% in the fourth quarter, which, while higher than our historic beta of 20%, is still well below levels of peers. During the quarter we continued remixing our loans by shifting to a greater floating and variable rate exposure which now comprise approximately 60% of new loan originations, while allowing our investment portfolio to run off. In addition, we proactively add it on-balance sheet liquidity as a mitigant against higher for longer short-term rates, although the higher liquidity negatively impacted our margin by approximately 4 basis points. On the liability side, we added $1.25 billion of fixed-rate term funding at an average maturity of 2.5 years and average rate of 4.3%. And also increased our time deposit balances by $380 million at an average rate of 4.04%. In addition to our on-balance sheet actions, we added $200 million notional of pay fixed received float swaps in the quarter to hedge a portion of our fixed rate loan exposure. From an earning asset…

Thank you. At this time, we’ll conduct the question-and-answer session. [Operator Instructions] Our first question comes from the line of Jeff Rulis with D.A. Davidson. Your line is open.

Thanks. Good morning.

Hi, Jeff.

Maybe a question for Dean. Just on the funding costs, I guess, the cost of funds for the quarter at 1.08%. How does that compare at the end of the quarter. What was that number? And then if you have it as well though, the monthly June margin overall?

Yes, the funding costs overall -- are you talking about the -- just on the liability side or...

Just the cost of -- For the first quarter, what was that at the quarter end, just spot rate?

[123] (ph)

Yes, [123] (ph) -- and then -- so the margin for the quarter or for the month was 2.14%. But keep in mind that when you adjust for the liquidity that we brought on during the quarter, that number is actually more like 2.20%. So the liquidity did have an impact on our margin during the month.

Got you. Okay.

Later in the quarter.

Later in the quarter, yes.

Yes. Okay. I wanted to circle back on the expenses. A pretty specific guide in the third quarter or the fourth quarter. And Peter, in kind of the prepared remarks, it seem to suggest a little more possibly could lean on that or manage that somewhat lower. I don't know if that changes. I think you've said for the full year guidance was expenses up 3% off of 2022 core base. Has that changed at all? Or is that more of a further out into 2024? Or am I just reading into commentary about cost management?

Yes, Jeff, we're -- so we are looking at expenses candidly. We see that line item as one of the controllable items that we have in an environment where margins and rates are challenged. And if fee income is likely to be what it's going to be. So this is kind of a reasonable place for us to look. I would anticipate to see some impact of expense reductions later into this year. So certainly, by the fourth quarter and then into next year. I'm not quite ready to kind of provide guidance on what those levels would be, but lower.

Okay. Yes. Just wanted to check in on that. I appreciate it. And just the last one on -- Peter, you've also provided -- and sorry, this is clunky. You've kind of -- you've talked about a capital build if just the securities portfolio matures. I can't remember it was a TCE. It was a one to two year organically where that could build. Could you update us on kind of where you sit on that process or that direction of TCE?

Not quite clear on the TCE piece. I mean, generally, Jeff, that we're looking to build capital through, obviously, earnings retention, as well as taking a good hard look at the asset base of the company. And candidly, the liquidity that we've built is running a little counter to capital build, if you will. And I think that was obviously for good reason, coming out of SVB, Signature situation in March. The reality though is, our deposit base has been incredibly stable, and we have a pretty good-sized war chest of immediately available backup line of credit. And so, the lever that may be available at this point is to bring down some of that $1.7 billion in cash that we're holding, which would improve capital slowly over time. And so, really our capital plan is, I would characterize it as an organic one at this point, with an emphasis on retaining earnings as well as managing the overall size of the balance sheet.

Great. Okay. I’ll step back. Thanks.

Thanks, Jeff.

Thank you. One moment for our next question. Our next question comes from the line of Andrew Liesch with Piper Sandler. Your line is open.

Hey, good morning everyone.

Good morning, Andrew.

Just a quick question on this liquidity build that came on later in the quarter. Has all that been deployed into earning assets? Or there is still some investments to be made on that front?

It's primarily sitting in Fed funds sold right now. So, readily available liquidity on balance sheet for us. The yield we're earning -- it's at the Fed, so we're earning fed funds effective. We're also looking at the -- in terms of investments, that's where we're placing the funds?

Got it. So I mean, it seems -- it sounds like that the net effect on the margin will be lower, but on net interest income, maybe you're picking up a little bit NII. Yes. Is that right?

Right. Yes.

Yes. So it's -- that's exactly right. It's dilutive to margin, accretive to NII and dilutive to capital.

Got you. All right. And then on loan growth going forward. It seems like you had some pretty good gains on the commercial side. I'm just curious what drove that. And then looking out, I mean, how do you expect the total portfolio trend just modest, like low to mid-single-digit growth?

Yes. I think we had a good C&I quarter. I'm not sure that's necessarily replicable in the coming quarters. So we had growth in both commercial as well as consumer. And what I would anticipate is, likely loan growth to be flat at this point moving forward. It just seems like the consumers slowed down a bit based on rate, seems like commercial clients are sitting on their hands a bit on transactions. Hopefully, we'll see that change as more positive signals come out of the economy, hopefully. But for now, feels reasonably muted, I think.

Got you. Thanks for taking the question. I will step back.

One moment for our next question. Our next question comes from the line of Kelly Motta with KBW. Your line is open.

Hi. Good morning. Thanks for the questions. I think -- I really appreciate the color around deposits and the updated outlook for deposit betas. And I believe in the commentary you suggested some continued pressure on noninterest-bearing deposits. Just wondering what your outlook incorporates in terms of noninterest-bearing run off into a higher rate accounts and kind of where those could bottom in terms of a percentage of deposits, as well as timing? Is this really the last quarter of it? Or could there be a continuation, assuming we get another rate hike or two?

Yes. The guidance around the beta, it does incorporate the mix shift, so some drawdown on the noninterest-bearing into interest-bearing deposits. So that was at 30% peaking in the fourth quarter. We're looking at it. Right now, we're at 29% noninterest-bearing mix coming down to maybe 27% -- 26%, 27%.

Yes, Kelly, that would put us at about, interestingly, the midpoint between the pre-pandemic levels, which were, call it, 30%-ish. And kind of the 2007 levels where rates, obviously, were higher kind of the mid-20s. And so not knowing which -- kind of which base we'll head to kind of we're thinking that's about a right way to handicap it. So, we do see some mix shift continuing into this quarter, the third quarter, potentially into the fourth. I would mention, however, that we have seen some flattening -- a bit flattening around that decline. It looks like June was down just over 1%, which compares to on-average of the past year, down kind of like 2% per month. So that was an improvement and July is looking pretty flat right now. So, we still have a few days left to the month. But if that holds true, that probably would be our best performance in about a year on a monthly basis.

Got it. That's super helpful. And then in terms of the margin, the commentary of margin being about [2.14%] (ph) for the month of June, which incorporates some of the liquidity build that you had. Can you just remind us when you put on -- you took on those fixed rate borrowings and threw on the cash in terms of the timing of that. Just wondering if that's fully reflected in that June margin? And then kind of from here, as we look out, given your expectations for [NIV] (ph) declines and the commentary around deposit beta, how we should be thinking about the margin on a go-forward basis, assuming another rate hike or two?

Yes. Okay. So the term funding was placed, I would say, right in the middle part of May, so kind of right in the middle of the quarter. So the June margin at 2.14% would have reflected the full impact of that liquidity. So that's -- so when -- as you look out into the -- towards the end of the year, we do expect the margin to bottom in the fourth quarter and kind of decelerating from what we saw in the second quarter. So, kind of a gradual decrease and then bottoming in the fourth.

Got it. I appreciate that. And you said you put on some swaps during the quarter. Can you just provide us a bit more color just trying to get some sense on how to model around that? I may have missed the amount of that, so that would just be helpful in terms of modeling?

Sure. They were -- it was $200 million notional towards the end of the quarter that we put on, so it's a pay fixed received flow swap, hedging some of our fixed rate loans. So about a two year, 2.5-year type of term.

Okay. Got it. Maybe last one for me, if I could sneak it in. With capital, I know you said you're in the rebuild mode. Just in terms of the dividend, I think you reiterated the $0.70 dividend around earnings. But just wondering how you guys feel about this level? Obviously, the earnings have come down a bit with the margin. I'm wondering how you're feeling in terms of the comfort level of the payout at this stage.

Yes. So Kelly, so the dividends, obviously, are strategic to us and our desire is to maintain our dividend levels. Of course, that's earnings willing -- and interest rates willing, inflation and credit and all those factors. And so, our process is to assess that with our Board at the end of every quarter. And for now, our desire is to maintain that level.

Thank you so much. I’ll step back.

Yes. Take care.

Thank you. That concludes the question-and-answer session. At this time, I would like to turn the call back to Cindy Wyrick for closing remarks.

Thank you, everyone, again, for joining us today and for your continued interest in Bank of Hawaii. As always, please feel free to reach out to either Chang or me if you have any additional questions or if you need further clarification on any of the topics discussed today. Thanks, everyone. Have a good day.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.