Like recently covered First Hawaiian (FHB), Bank of Hawaii (NYSE: GOD) shares have been pretty flat since last coverage. The valuation didn’t exactly look compelling back then, and with the post-COVID recovery also looking a bit lackluster I guess a quiet period here shouldn’t be all that surprising.
While the bank’s operating performance has been a bit pedestrian, we are at least seeing some core loan growth coming through, and interest rate hikes are also now very much with us as of earlier this week. That should serve the bank nicely as we move through 2022, though I have been a bit concerned that increasingly pessimistic economic growth forecasts might put a dampener on that part of the story.
These shares still don’t look cheap on the usual bank valuation metrics like normalized PE and P/TBV, but then again they rarely do. While I wouldn’t rule out the quiet spell continuing here in the near-term, and there are some other headwinds to consider, ‘more of the same’ can work out just fine over the long run, with a return to mid-single-digit core earnings growth and a 3.35% dividend yield enough to drive acceptable returns for dividend investors.
Results Still A Bit Pedestrian
Reported numbers continue to look a little bit on the soft side, with revenue virtually flat sequentially at $168.9m in the fourth quarter. Within that, net interest income (“NII”) was down a shade sequentially on a reported basis, mainly due to lower Paycheck Protection Program interest income as those loans continue to fall off the balance sheet.
Non-interest expenses were also up, rising over 5% sequentially and 3% year-on-year to $101.7m in Q4, and that drove the efficiency ratio above 60% for the quarter.
With revenue still sluggish and expenses ticking up, quarterly pre-provision operating profit (“PPOP”) was also predictably soft, falling 6% sequentially to $67.3m. And that was pretty much the story for 2021 as a whole – softish revenue, due to a combination of low interest rates and sluggish non-interest income, meeting higher operating expenses. Unsurprisingly, full-year PPOP was also predictably weak, coming in at $275m versus $306.9m in 2020.
Provisioning continued to be a boon to the bottom line, though, with releases contributing $9.7m to pre-tax earnings in Q4 and $50.5m for the year as a whole. That contributed to full-year EPS of $6.25, up from $3.86 in 2020.
Core Loan Growth Now Coming Through
While the bank’s reported numbers make the recovery here look a little slow, we are at least seeing signs of underlying growth. Core loans (i.e. excluding PPP balances) were up again for one, increasing 2.8% sequentially and 6.2% year-on-year in Q4 to $12.1bn. That was also the third straight quarter of accelerating core loan growth – with core loans putting in sequential growth of 2.4% and 1% in Q3 and Q2 respectively.
That drove an uptick in ‘core’ NII (i.e. excluding PPP interest income and some one-time charges), which increased 2.2% sequentially to $121.5m in Q4. With PPP loan balances down to just $126.8m at the end of last year (around 1% of total period-end loans), that run-off should only present a modest headwind in 2022.
The economic recovery is pretty well established at this point, having experienced a slight wobble due to the impact of the Omicron wave on the state’s tourism-heavy economy. COVID restrictions are easing to the point of non-existence for domestic visitors, while the recovery in international travel should pick up momentum later in the year. The state’s housing market also continues to look very strong. All said, I’m expecting core loan growth (and subsequent NII growth) to shine through into reported results this year.
Ready To Benefit From Higher Interest Rates
Loan growth should be a boon to NII this year, but the bank will also see a pop from higher interest rates now that tightening has kicked off in earnest. Fixed-rate loans are a big part of the mix here (around 65%), but the bank has a very sticky deposit base that will give it scope to capture higher margins. Furthermore, a current loan-to-deposit ratio of 60% combined with ongoing loans/investment securities maturation suggests it won’t have a problem recycling capital into higher-yielding assets.
The bank’s standard sensitivity disclosure has a 100bps immediate upward shift in rates driving annual NII around 7.9% higher, with a more gradual shift of the same magnitude resulting in a 3.1% boost to NII.
The Outlook
While I do expect to see a tangible improvement in NII based on a combination of loan growth and higher interest rates, there are a couple of headwinds to consider, at least in the near term.
Firstly, and like a lot of banks, management is guiding for a significant uptick in annual operating expenses this year – somewhere in the 6% area as inflation feeds through into wage growth and the bank invests in technology. The latter should support future growth at least, but in the near-term it will weigh somewhat on PPOP and net earnings.
Secondly, provisioning obviously won’t provide the same pop to the bottom line it did last year. The bank’s allowance for credit losses is still around 30bps higher than immediate pre-COVID levels (1.29% versus a ‘day 1’ ACL of 0.99%), so there’s scope for continuing low impairment charges going forward, but vis-a-vis 2021 that line will obviously be a drag on net earnings and EPS this year.
Still A Fine Choice For Dividend Investors
The immediate term might continue to be a tad on the underwhelming side in terms of earnings, but that’s not something I see continuing over the medium term. For one, the bank has historically been very solid in terms of expense control, seeing a CAGR of around 3% in the five years pre-COVID. Operating expense growth should moderate in 2023, returning to its historical trend thereafter. A corporate tax hike also looks off table – something I was a bit cautious on last time.
With that, I’m expecting at least 5-6% annualized per-share dividend growth over the next five years, with that consisting of the following:
- Mid-single-digit annualized revenue growth, driven by mid-single digit annualized loan growth, higher interest rates and modest growth in non-interest income.
- Operating expenses to grow 6% in FY22, moderating to 4% growth in FY23 and a return to more muted historical growth levels thereafter.
- The above to lead to mid-single-digit annualized PPOP growth – broadly in line with pre-COVID trends – with net earnings and EPS growth lower due to normalizing provision levels from FY22, offset to a small degree by the cumulative effect of share buybacks (in the case of EPS).
- The above to lead to EPS of circa $7.40 by 2026, with a roughly 50% dividend payout ratio – broadly in line with its historical level.
Although it isn’t the most exciting outlook in the world, the above works out just about fine for income investors given the current yield of 3.35%. Buy.