Bank of Hawaii (BOH) Q3 2024: Net Interest Margin Rises 3 bps as Deposit Mix Stabilizes

October 28, 2024 | By EarningsIQ Research

Bank of Hawaii’s third quarter showcased disciplined balance sheet management, with net interest margin expanding for a second straight quarter and deposit costs kept well below peers. Commercial loan momentum and resilient fee income offset continued headwinds from deposit remixing, while credit quality remained robust despite isolated asset quality upticks. Management signals a gently improving margin trajectory, but remains cautious on core deposit trends and consumer loan appetite as the rate cycle evolves.

Summary

• Deposit Cost Advantage: BOH’s cost of deposits remains well below peer medians, supporting margin stability.
• Commercial Lending Leads Recovery: Commercial pipelines are building, even as consumer demand lags in a high-rate environment.
• Margin Path Hinges on Fed Cuts: Forward outlook depends on time deposit repricing and the pace of Fed easing.

Business Overview

Bank of Hawaii (BOH) is a regional bank serving Hawaii and the Western Pacific, generating revenue from net interest income, fees, and other banking services. Its business is split between consumer banking (57% of loans, largely residential real estate) and commercial banking (43% of loans, led by commercial real estate and business lending). BOH’s model emphasizes local expertise, a conservative credit culture, and a high proportion of relationship-based, long-tenured clients.

Performance Analysis

BOH delivered a quarter of incremental improvement in net interest income (NII) and net interest margin (NIM), with NIM rising 3 basis points sequentially. This reflected higher asset yields from cash flow repricing and active balance sheet repositioning, including securities purchases and interest rate swap adjustments. Deposit costs remain a core advantage, with both total and interest-bearing deposit rates tracking well below industry medians.

Deposit growth was notable, with spot balances up 2.8%, though management flagged that some of this was driven by temporary public sector inflows and commercial wins that are expected to moderate in Q4. Fee income improved on better derivative sales and merchant activity, while operating expenses were contained, up modestly on a core basis. Credit quality held strong, with only isolated non-performing asset increases tied to legacy or non-core exposures, and criticized assets already trending back down post-quarter.

• Commercial Loan Growth Outpaces Consumer: Commercial balances rose 2% spot, while consumer demand remains muted pending rate relief.
• Deposit Mix Shift Slowing: Non-interest and low-yield balances declined by $315 million, a much smaller drop than prior quarters, easing NII headwinds.
• Asset Repricing Drives NII Upside: $513 million in quarterly maturities and prepayments were redeployed at higher yields, adding $3.6 million to NII.

Capital ratios improved further, with Tier 1 at 14.05% and total capital at 15.11%, while common dividends were maintained and no share repurchases occurred. Overall, BOH continues to demonstrate a low-risk, high-discipline operating profile in a challenging rate environment.

Executive Commentary

Strategic Positioning

1. Deposit Franchise and Cost Discipline

BOH’s low-cost deposit base remains a structural advantage, with cost of total deposits and interest-bearing deposits running well below peers. The bank’s top market share in Hawaii, as confirmed by FDIC data, underpins stable funding and supports ongoing margin resilience. Management continues to monitor deposit mix trends, flagging that while negative comp has shrunk, further runoff in non-interest and low-yield balances is likely over the next several quarters.

2. Commercial Lending Momentum

Commercial lending is leading BOH’s loan growth recovery, with pipelines and production up and a healthy mix across commercial mortgage and construction. Management expects this segment to continue building as local business sentiment improves. Consumer lending remains soft, with borrowers waiting for more rate certainty, but is expected to eventually follow as rates decline.

3. Active Balance Sheet Management

BOH is proactively managing rate risk through securities purchases and swaps, reducing fixed-rate asset exposure from 73% to 53% since 2022 and layering in forward-starting swaps to align with future maturities. This approach positions the bank to benefit from falling rates, with 70% of time deposits maturing in six months and 88% within a year, enabling repricing at lower costs as the cycle turns.

4. Conservative Credit Culture

The bank’s loan book remains highly secure, with 80% real estate collateralization, low average loan-to-value (LTV) ratios, and minimal tail risk in commercial real estate (CRE). Isolated upticks in criticized assets and non-performing loans were tied to legacy or non-core exposures, not systemic sector issues. The lodging segment, while watched, is supported by strong sponsors and improving international visitor trends.

5. Fee Income Diversification

Fee income saw broad-based improvement, with particular strength in commercial banking and customer derivatives, offsetting only minor one-time volatility. Management expects elevated fee income to persist above historical levels, with limited reliance on foreign exchange swings.

Key Considerations

BOH’s Q3 results reinforce its position as a disciplined, low-risk operator with levers for incremental improvement as rates normalize. The bank’s strategic focus on core markets, conservative underwriting, and active asset-liability management provides resilience, but also exposes it to the timing and pace of Fed easing and local economic cycles.

Key Considerations:

• Deposit Beta Remains Favorable: Low deposit costs support margin, but ongoing remixing and runoff in non-interest balances could pressure NII if not offset by asset repricing.
• Commercial Lending Pipeline Strength: Commercial activity is rebounding faster than consumer, providing a near-term growth lever as business confidence returns.
• Active Repricing Opportunity: Large share of time deposits maturing in the next 12 months enables margin expansion as rates decline.
• Credit Risks Well Contained: Asset quality remains strong with limited sectoral vulnerabilities; legacy and non-core exposures are not systemic.
• Expense Growth Disciplined: Core expense guidance trimmed to 1% to 1.5% for the year, with Q4 run-rate expected to remain stable.

Risks

Key risks include continued runoff in non-interest-bearing deposits, which could pressure funding costs if not offset by asset repricing or core deposit inflows. Consumer loan demand remains subdued, potentially delaying a full loan growth recovery. Isolated credit deterioration in lodging or multifamily segments could worsen if tourism or economic conditions reverse, though current exposures are well-collateralized and supported by strong sponsors. Prolonged higher rates or a slower-than-expected Fed easing cycle would delay margin tailwinds and test BOH’s ability to sustain incremental NII growth.

Forward Outlook

For Q4 2024, BOH guided to:

• Core non-interest income of $44 to $45 million, adjusted for a $2.3 million one-time Visa charge
• Normalized core expenses in the $107 million range, with full-year growth of 1% to 1.5% over 2023

For full-year 2024, management maintained guidance:

• Core expense growth of 1% to 1.5% versus $419 million in 2023

Management highlighted several factors that will shape results:

• Gradual NII and NIM improvement as asset repricing and time deposit maturities align with Fed easing
• Spot deposit balances expected to moderate as temporary inflows run off in Q4

Takeaways

BOH’s third quarter reflects a steady hand on margin, credit, and expense management, with commercial lending and fee income providing offsets to lingering deposit remix headwinds.

• Margin Upside Hinges on Rate Path: The bank’s NIM trajectory is tied to the pace of Fed cuts and ability to reprice time deposits lower in 2025.
• Loan Growth Recovery Remains Mixed: Commercial lending is leading, but a consumer rebound is needed for full-scope growth.
• Investors Should Watch Deposit Trends: Core deposit stability and remix pace will be key to sustaining NII momentum as the rate environment shifts.

Conclusion

Bank of Hawaii continues to deliver disciplined execution in a challenging environment, leveraging its deposit franchise, conservative credit culture, and active balance sheet management to drive incremental improvement. The outlook is constructive but hinges on the timing of Fed easing and core deposit trends, with commercial lending and fee income providing near-term support.

Industry Read-Through

BOH’s results highlight the growing importance of deposit franchise quality and active balance sheet management among regional banks, particularly as the industry navigates ongoing rate volatility and shifting funding costs. The bank’s ability to hold deposit costs below peers and actively reprice assets offers a template for margin defense, while its conservative credit approach underscores the value of local expertise and relationship-driven lending in limiting asset quality surprises. For the broader banking sector, commercial lending recovery and disciplined expense management are emerging as key differentiators, while consumer loan demand remains a watchpoint as rate uncertainty persists.

BOH Financials Regional Banks Deposits Commercial Lending Net Interest Margin Credit Quality Balance Sheet