Bank of Hawaii (BOH) Q2 2024: $165M Preferred Raise Lifts Capital Ratios, Margin Inflects Higher

2024-07-22 | By EarningsIQ Research

Bank of Hawaii’s second quarter marked a turning point as net interest margin ticked up after sustained pressure, aided by disciplined deposit management and a $165 million preferred capital raise that sharply strengthened capital ratios. Stable credit quality and a unique, low-cost deposit base continue to underpin resilience, while management signals cautious optimism for modest loan growth and margin improvement in the second half. With asset repricing and expense control in focus, BOH is positioning for a lower-rate environment while leveraging its core franchise strengths.

Summary

• Capital Strengthening: Oversubscribed $165 million preferred raise boosts regulatory ratios and supports growth capacity.
• Margin Inflection: Net interest margin stabilizes, with asset yields outpacing deposit cost increases for the first time in several quarters.
• Disciplined Forward Stance: Management eyes modest loan growth and expense control, preparing for a lower-rate environment.

Business Overview

Bank of Hawaii is a regional bank focused on traditional lending, deposit gathering, and wealth management, anchored in the Hawaiian Islands and Western Pacific. The business is split between consumer lending (58% of loans, mainly residential and home equity) and commercial lending (42%, with commercial real estate as the largest subsegment). BOH’s business model emphasizes relationship banking, low-cost core deposits, and conservative credit underwriting in its core local markets.

Performance Analysis

Net interest income and margin both reversed recent declines, with net interest income up modestly and net interest margin rising five basis points sequentially. This inflection was driven by asset repricing, as maturing loans and securities were reinvested at higher yields, offsetting still-elevated deposit cost pressures. Deposit levels and loan balances remained broadly stable, though commercial loan growth provided a small lift, while consumer lending continued to contract due to rate sensitivity and competitive dynamics, especially from credit unions.

Non-interest income was steady but subdued, with management expecting a slight uptick in the second half as market conditions improve, particularly in wealth management. Expenses were tightly managed despite a $2.6 million FDIC special assessment and some severance-related costs, with core expenses up 2% sequentially due to annual merit increases. The preferred capital raise was a standout, materially lifting Tier 1 and total capital ratios and positioning BOH for future growth.

• Deposit Franchise Advantage: Non-interest-bearing deposits stabilized at $5.3 billion, demonstrating BOH’s unique local market strength and cost advantage over mainland peers.
• Credit Quality Remains Pristine: Net charge-offs and non-performing assets remain near historic lows, with no systemic deterioration in any loan segment.
• Expense Control Focus: Management continues to target normalized expense growth of just 1-2% for 2024, aided by ongoing efficiency efforts.

In sum, the quarter showcased BOH’s ability to defend margin and capital while maintaining exceptionally strong credit quality, setting the stage for cautious growth as macro and rate conditions evolve.

Executive Commentary

Strategic Positioning

1. Capital Raise as Growth Enabler

The $165 million preferred stock issuance, oversubscribed with 90% institutional participation, sharply increased BOH’s Tier 1 capital ratio to 13.99%. This move was explicitly designed to “position us to grow further,” according to management, signaling readiness to capture incremental lending opportunities as market conditions improve. The timing also reflects a proactive approach ahead of potential regulatory or market shifts.

2. Margin Management in a Shifting Rate Environment

BOH’s margin stabilization is the result of disciplined deposit pricing and asset repricing, with management expecting “very modest, flat to slightly higher” margin in the second half. The bank is preparing for rate cuts, modeling only a slight NII headwind even in more aggressive deposit repricing scenarios, and expects asset yields to remain a tailwind as older loans roll off and are replaced at higher rates.

3. Credit Discipline and Local Market Focus

Credit quality is underpinned by a relationship-driven, in-market lending model, with 92% of loans in Hawaii and 60% of clients with BOH for over a decade. The loan book remains heavily real estate secured, with low loan-to-value ratios and high FICO scores, and commercial real estate exposure is diversified with no sector above 7% of total loans. Management sees no signs of systemic credit stress, with recent upticks in criticized assets attributed to isolated credits.

4. Wealth and Fee Income as Growth Levers

Wealth management and trust businesses are areas of targeted investment, with management aiming to grow these faster than traditional banking. Fee income remains constrained by weak mortgage and swap activity, but upside exists if rate cuts spur more transaction volume, especially in wealth and brokerage.

5. Expense Rigor and Operational Efficiency

BOH continues to demonstrate tight expense discipline, adjusting for one-time items and severance to maintain normalized expense growth at or below 2%. The organization is actively evaluating further efficiency opportunities, especially as it integrates new leadership in finance and banking operations.

Key Considerations

This quarter underscores BOH’s core strengths—capital, credit, and cost control—while highlighting the measured approach to growth in a unique, insular market.

Key Considerations:

• Deposit Cost Plateau: Deposit cost increases are slowing, which could provide incremental margin relief if the trend holds into the back half.
• Commercial Lending Momentum: The commercial loan pipeline has grown since the start of the year, supporting expectations for modest loan growth despite consumer softness.
• Consumer Lending Headwinds: Consumer loan balances continue to decline, particularly in residential and auto, due to rate sensitivity and credit union competition.
• Fee Income Upside Tied to Rates: Improvement in fee income is contingent on rate-driven volume increases, especially in mortgage and swap activity.
• Capital Deployment Optionality: Elevated capital levels provide flexibility for selective growth, but management is signaling caution and discipline in deployment.

Risks

Key risks include ongoing pressure from deposit competition, especially from credit unions, and the potential for margin compression if asset yields peak before deposit costs subside. Consumer lending remains challenged, with little near-term relief unless rates fall meaningfully. External shocks to the Hawaiian economy—such as further fallout from the Lahaina fires or a sharp tourism downturn—could impact credit and deposit stability. Regulatory changes or unexpected credit events, while not visible in current metrics, remain background risks.

Forward Outlook

For Q3 2024, Bank of Hawaii guided to:

• Net interest margin flat to slightly higher, with incremental improvement expected from asset repricing.
• Stable to modestly higher net interest income, barring significant deposit remixing or rate volatility.

For full-year 2024, management maintained guidance:

• Normalized expense growth of 1-2% over 2023 levels.
• Tax rate near 24.5% for the year.

Management highlighted several factors that could impact results:

• Deposit mix and pricing dynamics as the rate environment shifts.
• Potential for modest loan growth, especially on the commercial side, with consumer lending remaining rate-dependent.

Takeaways

BOH’s second quarter reflects a franchise at an inflection point, with margin and capital tailwinds positioning the bank for cautious growth despite ongoing consumer headwinds.

• Capital Buffer Boost: The preferred raise gives BOH balance sheet flexibility and supports confidence in measured asset growth.
• Margin and Credit Stability: Margin improvement and pristine credit quality reinforce BOH’s differentiated local-market model and risk profile.
• Watch for Loan Growth and Fee Upside: Investors should monitor the pace of commercial loan growth, deposit cost trends, and any rate-driven rebound in fee income through year-end.

Conclusion

Bank of Hawaii delivered a quarter of stabilization and strategic positioning, with margin inflection, strong capital, and credit resilience at the forefront. Disciplined execution and a unique local franchise underpin cautious optimism for the balance of 2024.

Industry Read-Through

BOH’s results highlight the ongoing advantage of strong local deposit franchises in a period of national deposit cost pressure. Regional banks with stable, low-cost core deposits and conservative credit cultures are better positioned to weather rate transitions and economic uncertainty. The capital raise trend among regionals signals a sector-wide move to preemptively bolster regulatory ratios and support selective growth. Margin stabilization at BOH may foreshadow similar inflections for other banks with asset repricing tailwinds, but consumer lending remains broadly challenged across the industry, especially where credit unions are aggressive competitors. Expense discipline and targeted fee growth in wealth management are emerging as critical levers for regional banks navigating a slow-growth environment.

BOH Financials Banking Margin Capital Credit Deposits Hawaii