First Hawaiian: Modest Cost Pressure Adds To Underwhelming Outlook (NASDAQ:FHB)

Shares of First Hawaiian (NASDAQ:FHB) have performed well since my last update back in November, returning around 19% in that time, as optimism over moderating headwinds has helped lift the entire regional bank sector.

Like most peers, First Hawaiian is definitely seeing pressure ease in terms of net interest income, and this should help revenue this year despite a tough outlook for credit growth. Beyond that, near-term positives are not in plentiful supply. I said last time out that investors would have to extend their outlook beyond 2024 here, and with somewhat disappointing cost guidance offsetting stability in the top line I don’t see any reason to change that view. With near-term capital returns potential likewise a bit so-so, prospective investors can probably afford to stay on the sidelines for the next few quarters.

NIM Now Stabilizing

Like peers, First Hawaiian is now starting to see interest margins stabilize as funding cost pressure moderates. This has been helped by management actions, with the bank selling around $500 million in low-yielding securities last quarter in order to reduce expensive fixed-term deposit balances. This will help lift net interest margin (“NIM”) this year, with Q1 guidance of circa 2.85% around 4bps above last quarter’s average and 10bps above the 2023 exit rate.

Loan growth remains weak as expected, with gross loans of around $14.35 billion basically flat on an end-of-period basis, as the high interest rate environment continues to negatively impact credit demand. Hawaiian house prices were modestly lower last year while overall transactions also fell, important here as residential mortgages account for a relatively meaty 30% of the loan book. While housing market metrics look stable-to-positive so far this year, guidance of low-single-digit loan growth points to tepid overall demand.

At $152 million, net interest income fell around 3% sequentially last quarter. While the outlook in terms of interest-earning balance growth remains muted, modest NIM expansion means that NII should grow from this level as relatively expensive deposits are paid down in Q1. In terms of headwinds, non-interest-bearing balances continue to fall, declining around 4% sequentially to end the year at just under $7.6 billion. At 35.5% of total balances, we are basically within a point or so of pre-COVID (and pre-stimulus) levels, so mix-shift should be a moderating issue.

On the asset side, First Hawaiian still has billions of dollars locked up in relatively low-yielding securities and fixed-rate loans that were taken on when interest rates were lower. Around $1.5 billion in fixed-rate cash flow is set to flow through this year, which should be a modest tailwind as this reprices to prevailing rates.

Cost Pressure To Hit Earnings

Expenses guidance looks slightly disappointing. While non-interest expense guidance of $500 million is technically flat versus 2023, remember last year contained a number of one-offs. This includes a FDIC special assessment charge that most banks reported last quarter relating to bank failures earlier in the year. Based on the underlying Q4 level of around $118 million, 2024 non-interest expense guidance essentially maps to around 5-6% growth. This comes despite inflation now moderating down to the higher-end of management’s 2-3% long-term expense growth guidance. With revenue looking flat-to-slightly down this year, this is likely to lead to a decline in pre-provision operating profit.

At the same time, it’s hard to make the case that credit costs will be a tailwind to net income this year. Cost of risk landed at around the 18-19bps mark in 2023, with the Q4 level roughly matching net charge-offs at around 16bps annualized. While asset quality is not something that generally concerns me here given the bank’s good track record, it’s also not likely to be a source of earnings upside either. Credit quality metrics are arguably weakening a touch, though again this looks more like a function of a strong base. Past due loans in areas like consumer lending, for example, headed higher last quarter but are in line with pre-COVID marks relative to total loans.

Similarly, areas of specific market concern, such as investor office lending, have yet to show up here in a bad way, with overall criticized commercial real estate loans coming in flat sequentially last quarter at 2.2% of total balances.

Few Catalysts Elsewhere

Taking the above as a whole, I think net income will decline by around mid-single-digits here this year. While most banks face tough comps, unfortunately I see few other catalysts here that could help the near-term investment case. In terms of valuation, FHB trades for $21.44 as I type, equal to ~1.8x tangible book value per share. While that looks fair given the bank’s mid-to-high teens return on tangible equity profile, it doesn’t really point to much upside either.

Similarly, capital returns potential also looks middling at best, at least in the short term. The $0.26 per share quarterly dividend is adequately covered and yields around 4.9%. That’s not bad as such, but similar yields are also available at larger peers like Citizens (CFG) and Regions (RF), not to mention from short-dated risk-free alternatives.

With regulatory capital levels looking solid, analysts wondered whether management might be open to stock buybacks. While there is authorization for a $40 million program here from the board, management understandably struck a note of caution on the Q4 earnings call given the events of last year. The bank’s unrealized securities losses don’t show up in terms of regulatory capital ratios, but with ~$530 million in AOCI losses and a further ~$470m in unrealized HTM losses, the adjusted tangible capital ratio remains a little thin here. That all said, an extra $40 million from buybacks would still only bring the shareholder yield up to around the 6.5% mark, which again isn’t particularly noteworthy compared to peers.

First Hawaiian is a solid regional bank that I continue to like from a quality angle, and on that basis the stock can still appeal to a certain type of long-term investor. That said, faced with weak near-term earnings, so-so capital returns potential and little-to-no short-term upside from multiple expansion, I think prospective investors can afford to wait a few quarters until the outlook brightens up again.