Like recently mated First Hawaiian (FHB), Bank of Hawaii (NYSE: BOH) stocks have remained fairly flat since last reporting. Valuation didn’t look particularly compelling at the time, and with the post-COVID recovery also looking a bit lackluster, a quiet spell here shouldn’t come as too much of a surprise, I think.
While the bank’s operational performance has been a little sluggish, we are seeing at least some core lending growth coming through and as of earlier this week rate hikes are now also very strong with us. That should serve the bank well as we move through 2022, although I was concerned that increasingly pessimistic economic growth forecasts could dampen that part of the story.
These stocks still don’t look cheap by standard bank valuation metrics like normalized P/E and P/TBV, but again, they rarely do. While I wouldn’t rule out the lull in the lull here in the short term, and there are some other headwinds to consider, “more of the same” can work well over the long term, with a return to mid-single-digit core earnings growth and a dividend yield of 3.35%, which is enough to generate acceptable returns for income investors.
Results still a bit pedestrian zone
Reported numbers continue to look a bit weak, with fourth-quarter revenue of $168.9 million, flat from the previous quarter. Therein, net interest (“NII”) income was slightly lower sequentially sequentially, primarily due to lower interest income from the Paycheck Protection Program as these loans continue to be off the balance sheet.
Noninterest expenses also increased over 5% sequentially and 3% year-on-year to $101.7 million in the fourth quarter, driving the efficiency ratio for the quarter to over 60%.
As revenue is still sluggish and expenses are rising, quarterly operating income before provisions (“PPOP”) was also expectedly weak, falling 6% sequentially to $67.3 million. And that was pretty much the story for 2021 as a whole — weak earnings due to a combination of low interest rates and sluggish noninterest earnings offset by higher operating expenses. Unsurprisingly, full-year PPOP was also predictably weak, raking in $275 million versus $306.9 million in 2020.
However, accruals continued to be a boon to the bottom line, as disclosures contributed $9.7 million to pretax profit for the fourth quarter and $50.5 million for the full year. This contributed to full-year EPS of $6.25, up from $3.86 in 2020.
Core loan growth is coming through now
While the figures reported by the bank make the recovery appear a bit slow here, we at least see signs of underlying growth. Core loans (ie, excluding PPP balances) increased again by an amount, increasing 2.8% sequentially and 6.2% year-on-year in the fourth quarter to $12.1 billion. This was also the third consecutive quarter of accelerating core loan growth – with core loans posting sequential growth of 2.4% and 1% in Q3 and Q2, respectively.
This led to an increase in “core” NII (ie, excluding PPP interest income and some one-time charges) which rose 2.2% to $121.5 million in the fourth quarter. With PPP loan balances down to just $126.8 million at the end of last year (about 1% of total loans at the end of the period), that wind-down should pose only a modest headwind in 2022.
The economic recovery is fairly well established at this point, having experienced a bit of a wobble due to the impact of the Omicron wave on the state’s tourism-heavy economy. COVID restrictions are being eased to the point of non-existence for domestic visitors, while the international travel recovery is expected to gather momentum later in the year. The state’s housing market also continues to look very strong. Overall, I expect core credit growth (and subsequent NII growth) to show through in reported results this year.
Ready to take advantage of higher interest rates
Credit growth should be a boon for NII this year, but the bank will also benefit from higher interest rates after tightening begins in earnest. Fixed-rate loans make up a large chunk of the mix here (around 65%), but the bank has a very firm deposit base that gives it room to generate higher margins. Furthermore, a current loan-to-deposit ratio of 60% combined with ongoing loan/deposit maturity suggests that it will have no problem recycling capital into higher-yielding assets.
The bank’s standard sensitivity disclosure shows an immediate 100 basis point upward move in interest rates, pushing the annual NII up by about 7.9%, with a more gradual shift of the same magnitude resulting in a 3.1% increase in the NII.
While I expect a notable improvement in the NII due to a combination of credit growth and higher interest rates, there are some headwinds to consider, at least in the near term.
First, like many banks, management expects annual operating expenses to rise significantly this year — somewhere in the 6% range, as inflation impacts wage growth and the bank invests in technology. The latter should at least support future growth, but in the near term it will weigh somewhat on PPOP and net earnings.
Second, the deployment obviously won’t bring the same boost to the bottom line as it did last year. The bank’s allowance for loan losses is still around 30 basis points above immediate pre-COVID levels (1.29% vs 0.99% ACL on day one), leaving room for continued low impairments going forward, but versus 2021 That line will obviously weigh on net income and earnings per share this year.
Still a good pick for dividend investors
Immediate term may continue to be a bit overwhelming in terms of earnings, but I don’t see that mid-term. For one, the bank has historically been very solid in terms of cost controls, posting a CAGR of around 3% in the five years leading up to COVID. Operating cost growth should moderate in 2023 and return to its historical trend thereafter. A corporate tax hike also appears to be off the table — something I was a little cautious about last time.
With that, I expect annual dividend growth of at least 5-6% per share over the next five years, broken down as follows:
- Annual earnings growth in the mid-single digits, driven by annual credit growth in the mid-single digits, higher interest rates and modest growth in noninterest income.
- Operating expenses are expected to rise 6% in FY22, slowing growth to 4% in FY23 and returning to more subdued historical growth levels thereafter.
- The above will result in mid-single-digit annual PPOP growth – broadly in line with pre-COVID trends – with lower net income and EPS growth due to normalization of provision levels from FY22, driven to a small extent by the offsetting the cumulative effect of share buybacks (in the case of EPS).
- The above is projected to result in about $7.40 in EPS through 2026, with a dividend payout ratio of about 50% — which is broadly in line with historical levels.
While it’s not the most exciting prospect in the world, given the current yield of 3.35%, the above works pretty well for income investors. Buy.