Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q, including the documents incorporated by reference herein, contains, and from time to time our management may make, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “might,” “should,” “could,” “predict,” “potential,” “believe,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would,” “annualized” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions, estimates and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.
A number of important factors could cause our actual results to differ materially from those indicated in these forward-looking statements, including the following: the impact of the ongoing COVID-19 pandemic and any other pandemic, epidemic or health-related crisis; the geographic concentration of our business; current and future economic and market conditions in the United States generally or in Hawaii, Guam and Saipan in particular; our dependence on the real estate markets in which we operate; concentrated exposures to certain asset classes and individual obligors; the effect of the current low interest rate environment or changes in interest rates on our business including our net interest income, net interest margin, the fair value of our investment securities, and our mortgage loan originations, mortgage servicing rights and mortgage loans held for sale; changes in the method pursuant to which LIBOR and other benchmark rates are determined or the discontinuance of LIBOR; the possibility of a deterioration in credit quality in our portfolio; the possibility we might underestimate the credit losses inherent in our loan and lease portfolio; our ability to maintain our Bank’s reputation; the future value of the investment securities that we own; our ability to attract and retain customer deposits; our inability to receive dividends from our bank, pay dividends to our common stockholders and satisfy obligations as they become due; the effects of severe weather, geopolitical instability, including war, terrorist attacks, pandemics or other severe health emergencies and man-made and natural disasters; our ability to maintain consistent growth, earnings and profitability; our ability to attract and retain skilled employees or changes in our management personnel; our ability to effectively compete with other financial services companies and the effects of competition in the financial services industry on our business; the effectiveness of our risk management and internal disclosure controls and procedures; our ability to keep pace with technological changes; any failure or interruption of our information and communications systems; our ability to identify and address cybersecurity risks; the occurrence of fraudulent activity or effect of a material breach of, or disruption to, the security of any of our or our vendors’ systems; the failure to properly use and protect our customer and employee information and data; the possibility of employee misconduct or mistakes; our ability to successfully develop and commercialize new or enhanced products and services; changes in the demand for our products and services; the effects of problems encountered by other financial institutions; our access to sources of liquidity and capital to address our liquidity needs; our use of the secondary mortgage market as a source of liquidity; risks associated with the sale of loans and with our use of appraisals in valuing and monitoring loans; the possibility that actual results may differ from estimates and forecasts; fluctuations in the fair value of our assets and liabilities and off-balance sheet exposures; the effects of the failure of any component of our business infrastructure provided by a third party; the potential for environmental liability; the risk of being subject to litigation and the outcome thereof; the impact of, and changes in, applicable laws, regulations and accounting standards and policies, including the enactment of the Tax Act (Public Law 115-97) on December 22, 2017; possible changes in trade, monetary and fiscal policies of, and other activities undertaken by, governments, agencies, central banks and similar organizations; our likelihood of success in, and the impact of, litigation or regulatory actions; our ability to continue to pay dividends on our common stock; contingent liabilities and unexpected tax liabilities that may be applicable to us as a result of the Reorganization Transactions; and damage to our reputation from any of the factors described above.
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The foregoing factors should not be considered an exhaustive list and should be read together with the risk factors and other cautionary statements included in our Annual Report on Form 10-K for the year ended December 31, 2020. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to update or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by applicable law.
Company Overview
FHI is a bank holding company, which owns 100% of the outstanding common stock of FHB, its only direct, wholly owned subsidiary. FHB was founded in 1858 under the name Bishop & Company and was the first successful banking partnership in the Kingdom of Hawaii and the second oldest bank formed west of the Mississippi River. The Bank operates its business through three operating segments: Retail Banking, Commercial Banking and Treasury and Other.
References to “we,” “our,” “us,” or the “Company” refer to the Parent and its subsidiary that are consolidated for financial reporting purposes.
Basis of Presentation
The accompanying unaudited interim consolidated financial statements of the Company reflect the results of operations, financial position and cash flows of FHI and its wholly owned subsidiary, FHB. All significant intercompany accounts and transactions have been eliminated in consolidation.
The accompanying unaudited interim consolidated financial statements of the Company have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and accompanying notes required by GAAP for complete financial statements. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect normal recurring adjustments necessary for a fair presentation of the results for the interim periods.
The accompanying unaudited interim consolidated financial statements of the Company should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 and filed with the U.S. Securities and Exchange Commission (the “SEC”).
Recent Developments regarding COVID-19 and the Hawaii and Global Economy
Overview
The COVID-19 pandemic has brought unprecedented challenges to businesses and economies around the world, particularly those in the United States. Our business has been, and continues to be, impacted by the recent and ongoing outbreak of COVID-19. There remains a high degree of uncertainty relating to the ongoing spread and severity of the virus and new variants, as well as the availability, distribution and use of effective treatments and vaccines. To the extent that the economy continues to be negatively impacted by the pandemic, our results will be affected. In light of the uncertainties and continuing developments discussed herein, the ultimate adverse impact of COVID-19 cannot be reliably estimated at this time, but it has been and is expected to continue to be material.
Hawaii Economy
Hawaii’s economy continues to be significantly impacted by COVID-19 and the responses to it. For an economy that is heavily dependent on tourism, the combination of various response measures to the COVID-19 pandemic – including the stay-at-home orders for local residents and the mandatory self-quarantine for visitors resulted in an unprecedented increase in Hawaii unemployment. The statewide seasonally adjusted unemployment rate was 9.0% in March 2021 compared to 2.6% in March 2020, according to the State of Hawaii Department of Labor and Industrial Relations, while the national seasonally adjusted unemployment rate was 6.0% in March 2021 compared to 4.4% in March 2020. Visitor arrivals and average daily visitor spending for the first three months of 2021 decreased by 60.1% and 18.2%, respectively, compared to the same period in 2020, according to the Hawaii Tourism Authority. While we may continue to see a gradual improvement in unemployment as local businesses and the Hawaii tourism industry continues to reopen in 2021 and the COVID-19 vaccine becomes more widely administered, the timing and extent of the return of air travel and the recovery of the Hawaii tourism industry is highly uncertain and beyond our control.
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The volume of home sales on Oahu has increased year-over-year. For the three months ended March 31, 2021, the volume of single-family home sales increased by 11.9%, while condominium sales increased by 32.5% compared to the same period in 2020, according to the Honolulu Board of Realtors. The median price of single-family home sales and condominium sales on Oahu was $915,000 and $455,000, respectively, or an increase of 17.3% and 5.8%, respectively, for the three months ended March 31, 2021 as compared to the same period in 2020. As of March 31, 2021, months of inventory of single-family homes and condominiums on Oahu remained low at approximately 1.3 and 2.9 months, respectively. Lastly, state general excise and use tax revenues decreased by 18.3% for the first three months of 2021 as compared to the same period in 2020, according to the Hawaii Department of Business, Economic Development & Tourism.
Legislative and Regulatory Developments
Actions taken by the federal government and the Federal Reserve and other bank regulatory agencies to partially mitigate the economic effects of COVID-19 and related containment measures will also have an impact on our financial position and results of operations. These actions are further discussed below.
The Federal Reserve has instituted a number of other measures, to mitigate the lasting impact from the COVID-19 pandemic, including the following:
● establishing a temporary repurchase agreement facility for foreign and international monetary authorities;
● committing to quantitative easing through large-scale asset-purchase programs;
● lowering the rate charged on its discount window and extending the length of the loans offered;
● increasing the frequency of engagement with currency swap lines with foreign central banks;
● expanding the collateral accepted by its Term Asset-Backed Securities Loan Facility; and
● introducing a number of additional facilities designed to enhance support for small and mid-sized businesses.
The U.S. government has also enacted certain fiscal stimulus measures in several phases to counteract the economic disruption caused by COVID-19, such as:
● The CARES Act, enacted on March 27, 2020, established, among other COVID relief programs, a $670 billion loan program (the “Paycheck Protection Program” or the “PPP”) for fully guaranteed loans (which may then be forgiven) to small businesses.
● The Consolidated Appropriations Act – 2021 (the “CAA”) extended the term of a number of initiatives under the CARES Act. One such example was the extension of the Small Business Administration’s (“SBA”) authority to make commitments under the PPP to March 31, 2021 or until the additional PPP funds were exhausted. The PPP Extension Act of 2021 later extended the covered period of the PPP to June 30, 2021.
● The American Rescue Plan Act of 2021 (“American Rescue Plan”), enacted on March 11, 2021, builds upon the measures established in the CARES Act and the CAA. Through this legislation, unemployment benefits were extended to September 6, 2021, eligible individuals received direct stimulus payments of up to $1,400, an additional $7 billion was added to the PPP, while expanding eligibility to include non-profit organizations previously excluded from the program, and funds were allocated for COVID-19 vaccines, testing and contact tracing.
We are continuing to monitor the potential development of additional legislation and further actions taken by the U.S. government.
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The State of Hawaii received at least $1.25 billion in federal aid from the CARES Act. We expect that the majority of this federal aid will be used to help fund state and county government response efforts to COVID-19. Additional federal funding is expected to provide for unemployment assistance, direct cash payments to Hawaii residents and funding to support local schools and colleges. The CAA provided an additional $1.7 billion in new federal funding, while extending the ability of the State of Hawaii and its local governments to use its previously received federal aid until December 31, 2021. The American Rescue Plan also provides an additional $2.2 billion of federal funding to the State of Hawaii.
Impact to our Operations
We saw a significant decrease in customer traffic in our branches in the past year. As a result, we strategically closed 26 of our branch locations on a temporary basis and closed four of them permanently in November 2020. As of March 2021, we reopened 19 of the temporarily closed branch locations in connection with the reopening of local businesses. The temporary (or in certain cases, permanent) closures of bank branches and the safety precautions implemented at reopened branches could result in consumers becoming more comfortable with technology and seeing less need for face-to-face interaction. Our business is relationship driven and such changes could necessitate changes to our business practices to accommodate changing consumer behaviors. We continue to provide service to all customers and operate our businesses on all islands of Hawaii, Guam and Saipan. Additionally, as part of our contingency plans, we have established a redundant operations center for our administrative operations. Many of our employees are working remotely and for those employees who are deemed essential and unable to work from home, we continue to emphasize the importance of practicing social distancing and good hygiene practices in the workplace.
Impact on our Financial Position and Results of Operations
Due to the widespread impact that COVID-19 is having on Hawaii’s economy, we expect that adverse economic conditions will continue. While its effects continue to materialize, the COVID-19 pandemic has resulted in a significant decrease in commercial activity throughout the State of Hawaii and nationally. This decrease in commercial activity has caused and may continue to cause our customers (including affected businesses and individuals), vendors and counterparties to be unable to meet existing payment or other obligations to us. As Hawaii’s economy continues to reopen, we expect that local consumption of goods and services will improve. Additionally, the timing and extent of the return of air travel and the recovery of the Hawaii tourism industry is highly uncertain and is dependent upon, among other things, the number of cases declining around the globe, in the United States and, in particular, in Hawaii, visitor receptiveness to Hawaii’s new pre-travel COVID-19 testing requirements, an extended period in which there is no subsequent “wave” of infections and the availability of a vaccine, treatment or testing, and tracking and tracing capabilities.
During this time of uncertainty, we remain committed to servicing our customers. The economic pressures and uncertainties arising from the COVID-19 pandemic have resulted in and may continue to result in specific changes in consumer and business spending and borrowing and saving habits, affecting the demand for loans and other products and services we offer. For example, certain industries may take longer to recover (particularly those that rely on travel or in-person foot traffic) as consumers may be hesitant to travel or return to full social interaction. We lend to customers operating in such industries including tourism, hotels/lodging, restaurants, entertainment and commercial real estate, among others. We will continue to closely monitor the impact that COVID-19 and the recession in Hawaii has on our customers and will adjust the means by which we assist our customers during this period of financial hardship. We are working with our customers impacted by COVID-19 by offering payment deferrals and forbearance on certain loan products.
The shut-down of Hawaii’s tourism industry, stay-at-home measures, the recession in Hawaii and record low interest rates will continue to have a negative impact on our financial position and results of operations. A continued decrease in interest rates, or sustained period of interest rates, would be expected to reduce our net interest margin, as, currently, our interest rate profile is such that we project net interest income will benefit from higher interest rates as our assets would reprice faster and to a greater degree than our liabilities, while in the case of lower interest rates, our assets would reprice downward and to a greater degree than our liabilities. Our net interest margin also may be reduced as a result of our participation in the PPP, with loans made thereunder that are not forgiven carrying an interest rate of 1%.
Our credit risk profile has also been, and we expect that it will continue to be, adversely impacted during this period of financial hardship for our customers. We also expect that we will see temporary decreases in non-interest income, partially driven by certain measures we have taken to assist customers during the COVID-19 pandemic.
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In light of volatility in the capital markets and economic disruptions, we continue to carefully monitor our capital and liquidity positions. As of March 31, 2021, the Company was “well-capitalized” and met all applicable regulatory capital requirements, including a Common Equity Tier 1 capital ratio of 12.82%, compared to the minimum requirement of 4.50%. We continue to anticipate that we will have sufficient capital levels to meet all of these requirements. Additionally, we continue to access our routine short-term funding sources, such as borrowings and repurchase agreements, and to assess longer-term funding sources. For additional discussions regarding our capital and liquidity positions and related risks, refer to the sections titled “Liquidity” and “Capital” in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).
Selected Financial Data
Our financial highlights for the periods indicated are presented in Table 1:
Financial Highlights
Table 1
For the Three Months Ended
March 31,
(dollars in thousands, except per share data)
2021
2020
Income Statement Data:
Interest income
$
134,576
$
158,532
Interest expense
5,418
19,849
Net interest income
129,158
138,683
Provision for credit losses
—
41,200
Net interest income after provision for credit losses
129,158
97,483
Noninterest income
43,868
49,228
Noninterest expense
96,306
96,466
Income before provision for income taxes
76,720
50,245
Provision for income taxes
19,027
11,380
Net income
$
57,693
$
38,865
Basic earnings per share
$
0.44
$
0.30
Diluted earnings per share
$
0.44
$
0.30
Basic weighted-average outstanding shares
129,933,104
129,895,706
Diluted weighted-average outstanding shares
130,589,878
130,351,585
Dividends declared per share
$
0.26
$
0.26
Dividend payout ratio
59.09
%
86.67
%
Supplemental Income Statement Data (non-GAAP) (1) :
Core net interest income
$
129,158
$
138,683
Core noninterest income
43,868
49,143
Core noninterest expense
96,306
96,466
Core net income
57,693
38,803
Core basic earnings per share
0.44
0.30
Core diluted earnings per share
0.44
0.30
Other Financial Information / Performance Ratios (2) :
Net interest margin
2.55
%
3.12
%
Core net interest margin (non-GAAP) (1),(3)
2.55
%
3.12
%
Efficiency ratio
55.53
%
51.33
%
Core efficiency ratio (non-GAAP) (1),(4)
55.53
%
51.35
%
Return on average total assets
1.02
%
0.77
%
Core return on average total assets (non-GAAP) (1),(5)
1.02
%
0.77
%
Return on average tangible assets (non-GAAP) (11)
1.07
%
0.81
%
Core return on average tangible assets (non-GAAP) (1),(6)
1.07
%
0.81
%
Return on average total stockholders' equity
8.58
%
5.87
%
Core return on average total stockholders' equity (non-GAAP) (1),(7)
8.58
%
5.87
%
Return on average tangible stockholders' equity (non-GAAP) (11)
13.51
%
9.39
%
Core return on average tangible stockholders' equity (non-GAAP) (1),(8)
13.51
%
9.37
%
Noninterest expense to average assets
1.70
%
1.91
%
Core noninterest expense to average assets (non-GAAP) (1),(9)
1.70
%
1.91
%
(continued)
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(continued)
March 31,
December 31,
(dollars in thousands, except per share data)
2021
2020
Balance Sheet Data:
Cash and cash equivalents
$
1,262,810
$
1,040,944
Investment securities
6,692,479
6,071,415
Loans and leases
13,300,289
13,279,097
Allowance for credit losses for loans and leases
200,366
208,454
Goodwill
995,492
995,492
Total assets
23,497,596
22,662,831
Total deposits
20,133,681
19,227,723
Long-term borrowings
200,010
200,010
Total liabilities
20,813,966
19,918,727
Total stockholders' equity
2,683,630
2,744,104
Book value per share
$
20.68
$
21.12
Tangible book value per share (non-GAAP) (11)
$
13.01
$
13.46
Asset Quality Ratios:
Non-accrual loans and leases / total loans and leases
0.07
%
0.07
%
Allowance for credit losses for loans and leases / total loans and leases
1.51
%
1.57
%
Net charge-offs / average total loans and leases (10)
0.14
%
0.23
%
March 31,
December 31,
Capital Ratios:
2021
2020
Common Equity Tier 1 Capital Ratio
12.82
%
12.47
%
Tier 1 Capital Ratio
12.82
%
12.47
%
Total Capital Ratio
14.07
%
13.73
%
Tier 1 Leverage Ratio
7.90
%
8.00
%
Total stockholders' equity to total assets
11.42
%
12.11
%
Tangible stockholders' equity to tangible assets (non-GAAP) (11)
7.50
%
8.07
%
(1) We present net interest income, noninterest income, noninterest expense, net income, basic earnings per share, diluted earnings per share and the related ratios described below, on an adjusted, or “core” basis, each a non-GAAP financial measure. These core measures exclude from the corresponding GAAP measure the impact of certain items that we do not believe are representative of our financial results. We believe that the presentation of these non-GAAP measures helps identify underlying trends in our business from period to period that could otherwise be distorted by the effect of certain expenses, gains and other items included in our operating results. We believe that these core measures provide useful information about our operating results and enhance the overall understanding of our past performance and future performance. Investors should consider our performance and financial condition as reported under GAAP and all other relevant information when assessing our performance or financial condition. Non-GAAP measures have limitations as analytical tools and investors should not consider them in isolation or as a substitute for analysis of our financial results or financial condition as reported under GAAP.
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The following table provides a reconciliation of net interest income, noninterest income, noninterest expense and net income to their “core” non-GAAP financial measures:
GAAP to Non-GAAP Reconciliation
Table 2
For the Three Months Ended
March 31,
(dollars in thousands, except per share data)
2021
2020
Net interest income
$
129,158
$
138,683
Core net interest income (non-GAAP)
$
129,158
$
138,683
Noninterest income
$
43,868
$
49,228
Gains on sale of securities
—
(85)
Core noninterest income (non-GAAP)
$
43,868
$
49,143
Noninterest expense
$
96,306
$
96,466
Core noninterest expense (non-GAAP)
$
96,306
$
96,466
Net income
$
57,693
$
38,865
Gains on sale of securities
—
(85)
Tax adjustments (a)
—
23
Total core adjustments
—
(62)
Core net income (non-GAAP)
$
57,693
$
38,803
Basic earnings per share
$
0.44
$
0.30
Diluted earnings per share
$
0.44
$
0.30
Efficiency ratio
55.53
%
51.33
%
Core basic earnings per share (non-GAAP)
$
0.44
$
0.30
Core diluted earnings per share (non-GAAP)
$
0.44
$
0.30
Core efficiency ratio (non-GAAP)
55.53
%
51.35
%
(a) Represents the adjustments to net income, tax effected at the Company’s effective tax rate for the respective period.
(2) Except for the efficiency ratio and the core efficiency ratio, amounts are annualized for the three months ended March 31, 2021 and 2020.
(3) Core net interest margin is a non-GAAP financial measure. We compute our core net interest margin as the ratio of core net interest income to average earning assets. For a reconciliation to the most directly comparable GAAP financial measure for core net interest income, see Table 2, GAAP to Non-GAAP Reconciliation.
(4) Core efficiency ratio is a non-GAAP financial measure. We compute our core efficiency ratio as the ratio of core noninterest expense to the sum of core net interest income and core noninterest income. For a reconciliation to the most directly comparable GAAP financial measure for core noninterest expense, core net interest income and core noninterest income, see Table 2, GAAP to Non-GAAP Reconciliation.
(5) Core return on average total assets is a non-GAAP financial measure. We compute our core return on average total assets as the ratio of core net income to average total assets. For a reconciliation to the most directly comparable GAAP financial measure for core net income, see Table 2, GAAP to Non-GAAP Reconciliation.
(6) Core return on average tangible assets is a non-GAAP financial measure. We compute our core return on average tangible assets as the ratio of core net income to average tangible assets, which is calculated by subtracting (and thereby effectively excluding) amounts related to the effect of goodwill from our average total assets. For a reconciliation to the most directly comparable GAAP financial measure for core net income, see Table 2, GAAP to Non-GAAP Reconciliation.
(7) Core return on average total stockholders’ equity is a non-GAAP financial measure. We compute our core return on average total stockholders’ equity as the ratio of core net income to average total stockholders’ equity. For a reconciliation to the most directly comparable GAAP financial measure for core net income, see Table 2, GAAP to Non-GAAP Reconciliation.
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(8) Core return on average tangible stockholders’ equity is a non-GAAP financial measure. We compute our core return on average tangible stockholders’ equity as the ratio of core net income to average tangible stockholders’ equity, which is calculated by subtracting (and thereby effectively excluding) amounts related to the effect of goodwill from our average total stockholders’ equity. For a reconciliation to the most directly comparable GAAP financial measure for core net income, see Table 2, GAAP to Non-GAAP Reconciliation.
(9) Core noninterest expense to average assets is a non-GAAP financial measure. We compute our core noninterest expense to average assets as the ratio of core noninterest expense to average total assets. For a reconciliation to the most directly comparable GAAP financial measure for core noninterest expense, see Table 2, GAAP to Non-GAAP Reconciliation.
(10) Net charge-offs / average total loans and leases is annualized for the three months ended March 31, 2021.
(11) Return on average tangible assets, return on average tangible stockholders’ equity, tangible book value per share and tangible stockholders’ equity to tangible assets are non-GAAP financial measures. We compute our return on average tangible assets as the ratio of net income to average tangible assets. We compute our return on average tangible stockholders’ equity as the ratio of net income to average tangible stockholders’ equity. We compute our tangible book value per share as the ratio of tangible stockholders’ equity to outstanding shares. We compute our tangible stockholders’ equity to tangible assets as the ratio of tangible stockholders’ equity to tangible assets. We believe that these financial measures are useful for investors, regulators, management and others to evaluate financial performance and capital adequacy relative to other financial institutions. Although these non-GAAP financial measures are frequently used by shareholders in the evaluation of a company, they have limitations as analytical tools and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.
The following table provides a reconciliation of these non-GAAP financial measures with their most closely related GAAP measures for the periods indicated:
GAAP to Non-GAAP Reconciliation
Table 3
For the Three Months Ended
March 31,
(dollars in thousands, except per share data)
2021
2020
Income Statement Data:
Noninterest expense
$
96,306
$
96,466
Core noninterest expense
$
96,306
$
96,466
Net income
$
57,693
$
38,865
Core net income
$
57,693
$
38,803
Average total stockholders' equity
$
2,727,701
$
2,660,811
Less: average goodwill
995,492
995,492
Average tangible stockholders' equity
$
1,732,209
$
1,665,319
Average total assets
$
22,944,699
$
20,313,304
Less: average goodwill
995,492
995,492
Average tangible assets
$
21,949,207
$
19,317,812
Return on average total stockholders' equity (a)
8.58
%
5.87
%
Core return on average total stockholders' equity (non-GAAP) (a)
8.58
%
5.87
%
Return on average tangible stockholders' equity (non-GAAP) (a)
13.51
%
9.39
%
Core return on average tangible stockholders' equity (non-GAAP) (a)
13.51
%
9.37
%
Return on average total assets (a)
1.02
%
0.77
%
Core return on average total assets (non-GAAP) (a)
1.02
%
0.77
%
Return on average tangible assets (non-GAAP) (a)
1.07
%
0.81
%
Core return on average tangible assets (non-GAAP) (a)
1.07
%
0.81
%
Noninterest expense to average assets (a)
1.70
%
1.91
%
Core noninterest expense to average assets (non-GAAP) (a)
1.70
%
1.91
%
(continued)
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As of
As of
(continued)
March 31,
December 31,
(dollars in thousands, except share amount and per share data)
2021
2020
Balance Sheet Data:
Total stockholders' equity
$
2,683,630
$
2,744,104
Less: goodwill
995,492
995,492
Tangible stockholders' equity
$
1,688,138
$
1,748,612
Total assets
$
23,497,596
$
22,662,831
Less: goodwill
995,492
995,492
Tangible assets
$
22,502,104
$
21,667,339
Shares outstanding
129,749,890
129,912,272
Total stockholders' equity to total assets
11.42
%
12.11
%
Tangible stockholders' equity to tangible assets (non-GAAP)
7.50
%
8.07
%
Book value per share
$
20.68
$
21.12
Tangible book value per share (non-GAAP)
$
13.01
$
13.46
(a) Annualized for the three months ended March 31, 2021 and 2020.
Financial Highlights
Net income was $57.7 million for the three months ended March 31, 2021, an increase of $18.8 million or 48% as compared to the same period in 2020. Basic and diluted earnings per share were $0.44 per share for the three months ended March 31, 2021, an increase of $0.14 per share or 47% as compared to the same period in 2020. The increase in net income was primarily due to a $41.2 million decrease in the provision for credit losses (the “Provision”) and a $0.2 million decrease in noninterest expense, partially offset by a $9.5 million decrease in net interest income, a $7.6 million increase in the provision for income taxes and a $5.4 million decrease in noninterest income for the three months ended March 31, 2021.
Our return on average total assets was 1.02% for the three months ended March 31, 2021, an increase of 25 basis points from the same period in 2020, and our return on average total stockholders’ equity was 8.58% for the three months ended March 31, 2021, an increase of 271 basis points from the same period in 2020. Our return on average tangible assets was 1.07% for the three months ended March 31, 2021, an increase of 26 basis points from the same period in 2020, and our return on average tangible stockholders’ equity was 13.51% for the three months ended March 31, 2021, up from 9.39% for the same period in 2020. Our efficiency ratio was 55.53% for the three months ended March 31, 2021 compared to 51.33% for the same period in 2020.
Our results for the three months ended March 31, 2021 were highlighted by the following:
● Net interest income was $129.2 million for the three months ended March 31, 2021, a decrease of $9.5 million or 7% as compared to the same period in 2020. Our net interest margin was 2.55% for the three months ended March 31, 2021, a decrease of 57 basis points as compared to the same period in 2020. The decrease in net interest income was primarily due to lower yields in most loan categories and in our investment securities portfolio, partially offset by lower deposit funding costs and an increase in the average balances of our investment securities portfolio.
● The Provision was nil for the three months ended March 31, 2021, a decrease of $41.2 million as compared to the same period in 2020. The Provision for the three months ended March 31, 2020 stemmed from higher expected credit losses as a result of COVID-19 and its impact on Hawaii’s economy, key industries, businesses and our customers. In comparison, recording nil for the Provision for the three months ended March 31, 2021 stemmed from a decrease in the expected credit losses in the commercial real estate portfolio. The Provision is recorded to maintain the allowance for credit losses for loans and leases (the “ACL”) and reserve for unfunded commitments at levels deemed adequate to absorb lifetime expected credit losses in our loan and lease portfolio and off-balance sheet credit exposures as of the balance sheet date.
● Noninterest income was $43.9 million for the three months ended March 31, 2021, a decrease of $5.4 million or 11% as compared to the same period in 2020. The decrease was primarily due to a $2.2 million decrease in service charges on deposit accounts, a $2.0 million decrease in other noninterest income, a $1.1 million decrease in trust and investment services income, a $0.4 million decrease in credit and debit card fees and a $0.1 million decrease in
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the gains from the sale of available-for-sale investment securities, partially offset by a $0.3 million increase in other service charges and fees and a $0.1 million increase in bank-owned life insurance (“BOLI”) income.
● Noninterest expense was $96.3 million for the three months ended March 31, 2021, a decrease of $0.2 million as compared to the same period in 2020. The decrease in noninterest expense was primarily due to a $2.2 million decrease in card rewards program expense, a $0.9 million decrease in salaries and employee benefits expense, a $0.2 million decrease in advertising and marketing expense and a $0.1 million decrease in occupancy expense, partially offset by a $1.2 million increase in other noninterest expense, a $1.1 million increase in contracted services and professional fees, a $0.8 million increase in equipment expense and a $0.1 million increase in regulatory assessment and fees.
Hawaii’s economy continues to be significantly impacted by COVID-19 and the responses to it. For an economy that is heavily dependent on tourism, the combination of various response measures to the COVID 19 pandemic – including the stay-at-home orders for local residents and the mandatory self-quarantine for visitors resulted in an unprecedented increase in Hawaii unemployment. While we may continue to see a gradual improvement in unemployment as local businesses and the Hawaii tourism industry continues to reopen in 2021 and the COVID-19 vaccine becomes more widely administered, the timing and extent of the return of air travel and the recovery of the Hawaii tourism industry is highly uncertain and beyond our control. We continued to maintain high levels of liquidity and remained well-capitalized as of March 31, 2021.
● Total loans and leases were $13.3 billion as of March 31, 2021, an increase of $21.2 million from December 31, 2020. The increase was primarily due to an increase in PPP loans, partially offset by decreases in our Shared National Credits, dealer flooring portfolios, indirect automobile loans and other unsecured consumer loans.
● The ACL was $200.4 million as of March 31, 2021, a decrease of $8.1 million or 4% from December 31, 2020. This decrease was primarily due to the aforementioned lower expected credit losses in the commercial real estate portfolio. The ratio of our ACL to total loans and leases outstanding was 1.51% as of March 31, 2021, a decrease of six basis points compared to December 31, 2020.
● We continued to invest in high-grade investment securities, primarily collateralized mortgage obligations issued by the Government National Mortgage Association (“Ginnie Mae”), the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). The total fair value of our investment securities portfolio was $6.7 billion as of March 31, 2021, an increase of $621.1 million or 10% from December 31, 2020. The increase was primarily due to purchases in this portfolio as we invested excess liquidity into securities.
● Total deposits were $20.1 billion as of March 31, 2021, an increase of $906.0 million or 5% from December 31, 2020. The increase in total deposits was primarily due to a $653.0 million increase in demand deposit balances, a $305.4 million increase in money market deposit balances and a $121.1 million increase in savings deposit balances, partially offset by a $173.5 million decrease in time deposit balances.
● Total stockholders’ equity was $2.7 billion as of March 31, 2021, a decrease of $60.5 million or 2% from December 31, 2020. The decrease in stockholders’ equity was primarily due to a net unrealized loss in the fair value of our investment securities net of tax of $75.0 million, dividends declared and paid to the Company’s stockholders of $33.8 million and share repurchases of $9.5 million, partially offset by earnings for the period of $57.7 million.
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Analysis of Results of Operations
Net Interest Income
For the three months ended March 31, 2021 and 2020, average balances, related income and expenses, on a fully taxable-equivalent basis, and resulting yields and rates are presented in Table 4. An analysis of the change in net interest income, on a fully taxable-equivalent basis, is presented in Table 5.
Average Balances and Interest Rates
Table 4
Three Months Ended
Three Months Ended
March 31, 2021
March 31, 2020
Average
Average
Average
Income/
Yield/
Average
Income/
Yield/
(dollars in millions)
Balance
Expense
Rate
Balance
Expense
Rate
Earning Assets
Interest-Bearing Deposits in Other Banks
$
938.7
$
0.2
0.10
%
$
516.8
$
1.6
1.25
%
Available-for-Sale Investment Securities
Taxable
5,949.9
22.1
1.49
4,033.2
21.2
2.10
Non-Taxable
278.0
1.3
1.80
—
—
—
Total Available-for-Sale Investment Securities
6,227.9
23.4
1.50
4,033.2
21.2
2.10
Loans Held for Sale
9.2
0.1
2.46
15.8
0.1
1.70
Loans and Leases (1)
Commercial and industrial
3,026.7
20.4
2.74
2,776.2
24.6
3.56
Commercial real estate
3,385.2
24.9
2.98
3,433.2
34.6
4.05
Construction
746.8
5.8
3.16
538.5
5.7
4.27
Residential:
Residential mortgage
3,696.1
34.7
3.76
3,721.2
37.7
4.05
Home equity line
822.0
5.7
2.80
887.4
7.7
3.50
Consumer
1,323.7
17.7
5.43
1,611.7
23.0
5.75
Lease financing
241.8
1.8
3.02
223.2
1.6
2.85
Total Loans and Leases
13,242.3
111.0
3.39
13,191.4
134.9
4.11
Other Earning Assets
58.0
0.3
1.79
57.0
0.7
5.30
Total Earning Assets (2)
20,476.1
135.0
2.66
17,814.2
158.5
3.57
Cash and Due from Banks
294.0
327.4
Other Assets
2,174.6
2,171.7
Total Assets
$
22,944.7
$
20,313.3
Interest-Bearing Liabilities
Interest-Bearing Deposits
Savings
$
5,975.1
$
0.6
0.04
%
$
5,090.4
$
3.3
0.26
%
Money Market
3,530.0
0.4
0.05
3,064.8
4.6
0.61
Time
2,288.5
3.0
0.53
2,534.7
7.7
1.23
Total Interest-Bearing Deposits
11,793.6
4.0
0.14
10,689.9
15.6
0.59
Short-Term Borrowings
—
—
—
401.7
2.8
2.88
Long-Term Borrowings
200.0
1.4
2.76
200.0
1.4
2.77
Total Interest-Bearing Liabilities
11,993.6
5.4
0.18
11,291.6
19.8
0.71
Net Interest Income
$
129.6
$
138.7
Interest Rate Spread
2.48
%
2.86
%
Net Interest Margin
2.55
%
3.12
%
Noninterest-Bearing Demand Deposits
7,709.5
5,853.4
Other Liabilities
513.9
507.5
Stockholders' Equity
2,727.7
2,660.8
Total Liabilities and Stockholders' Equity
$
22,944.7
$
20,313.3
(1) Non-performing loans and leases are included in the respective average loan and lease balances. Income, if any, on such loans and leases is recognized on a cash basis.
(2) Interest income includes taxable-equivalent basis adjustments of $0.4 million and nil for the three months ended March 31, 2021 and 2020, respectively.
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Analysis of Change in Net Interest Income
Table 5
Three Months Ended March 31, 2021
Compared to March 31, 2020
(dollars in millions)
Volume
Rate
Total (1)
Change in Interest Income:
Interest-Bearing Deposits in Other Banks
$
0.7
$
(2.1)
$
(1.4)
Available-for-Sale Investment Securities
Taxable
8.2
(7.3)
0.9
Non-Taxable
1.3
—
1.3
Total Available-for-Sale Investment Securities
9.5
(7.3)
2.2
Loans and Leases
Commercial and industrial
2.0
(6.2)
(4.2)
Commercial real estate
(0.5)
(9.2)
(9.7)
Construction
1.8
(1.7)
0.1
Residential:
Residential mortgage
(0.3)
(2.7)
(3.0)
Home equity line
(0.5)
(1.5)
(2.0)
Consumer
(4.0)
(1.3)
(5.3)
Lease financing
0.1
0.1
0.2
Total Loans and Leases
(1.4)
(22.5)
(23.9)
Other Earning Assets
0.1
(0.5)
(0.4)
Total Change in Interest Income
8.9
(32.4)
(23.5)
Change in Interest Expense:
Interest-Bearing Deposits
Savings
0.5
(3.2)
(2.7)
Money Market
0.6
(4.8)
(4.2)
Time
(0.7)
(4.0)
(4.7)
Total Interest-Bearing Deposits
0.4
(12.0)
(11.6)
Short-term Borrowings
(1.4)
(1.4)
(2.8)
Total Change in Interest Expense
(1.0)
(13.4)
(14.4)
Change in Net Interest Income
$
9.9
$
(19.0)
$
(9.1)
(1) The change in interest income and expense not solely due to changes in volume or rate has been allocated on a pro-rata basis to the volume and rate columns.
Net interest income, on a fully taxable-equivalent basis, was $129.6 million for the three months ended March 31, 2021, a decrease of $9.1 million or 7% compared to the same period in 2020. Our net interest margin was 2.55% for the three months ended March 31, 2021, a decrease of 57 basis points from the same period in 2020. The decrease in net interest income, on a fully taxable-equivalent basis, was primarily due to lower yields in most loan categories and lower yields in our investment securities portfolio, partially offset by lower deposit funding costs and higher average balances in our investment securities portfolio during the three months ended March 31, 2021. Yields on our loans and leases were 3.39% for the three months ended March 31, 2021, a decrease of 72 basis points as compared to the same period in 2020. We experienced a decrease in our yields from total loans primarily due to decreases in adjustable rate commercial and industrial and commercial real estate loans, which are typically based on the LIBOR. Decreases in the yield on commercial and industrial loans also stemmed from our participation in the PPP, as these loans have a fixed interest rate of one percent per annum. For the three months ended March 31, 2021, the average balance of our investment securities portfolio increased $2.2 billion or 54% to $6.2 billion. The yield in our investment securities portfolio was 1.50% for the three months ended March 31, 2021, a decrease of 60 basis points from the same period in 2020. Deposit funding costs were $4.0 million for the three months ended March 31, 2021, a decrease of $11.6 million or 74% compared to the same period in 2020. Rates paid on our interest-bearing deposits were 14 basis points for the three months ended March 31, 2021, a decrease of 45 basis points compared to the same period in 2020.
The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is affected by changes in the prime interest rate. The prime rate began in 2020 at 4.75%. During 2020, the prime rate decreased 150 basis points in March to end the first quarter at 3.25%, where it remained as at the end of the first quarter of 2021. As noted above, our loan portfolio is also impacted by changes in the LIBOR. At March 31, 2021, the one-month and three-month U.S. dollar LIBOR interest rates were 0.11% and 0.19%, respectively, while at March 31, 2020, the one-month and three-month U.S. dollar LIBOR interest rates were 0.14% and 0.24%, respectively. The target range for the federal funds rate, which is the cost of immediately available overnight funds, began 2020 at 1.50% to 1.75%. During 2020, the target range for the federal funds rate decreased 150 basis points in March to end the first quarter
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at 0.00% to 0.25%, where it remained as at the end of the first quarter of 2021. In March 2021, the Federal Reserve indicated that it expects to maintain the targeted federal funds rate at current levels through 2022. The decrease in the target range for the federal funds rate in 2020 was largely an emergency measure by the Federal Reserve aimed at mitigating the economic impact of COVID-19.
Provision for Credit Losses
The Provision was nil for the three months ended March 31, 2021, which represented a decrease of $41.2 million compared to the same period in 2020. The decrease in the Provision was primarily due to an adjustment during the three months ended March 31, 2020, which stemmed from higher expected credit losses as a result of COVID-19 and its impact on Hawaii’s economy, key industries, businesses and our customers. In comparison, recording nil for the Provision for the three months ended March 31, 2021 stemmed from a decrease in the expected credit losses in the commercial real estate portfolio. We recorded net charge-offs of loans and leases of $4.6 million and $6.1 million for the three months ended March 31, 2021 and 2020, respectively. This represented charge-offs of 0.14% and 0.19% of average loans and leases, on an annualized basis, for the three months ended March 31, 2021 and 2020, respectively. The ACL was $200.4 million as of March 31, 2021, a decrease of $8.1 million or 4% from December 31, 2020 and represented 1.51% of total outstanding loans and leases as of March 31, 2021 compared to 1.57% of total outstanding loans and leases as of December 31, 2020. The reserve for unfunded commitments was $34.1 million as of March 31, 2021, compared to $30.6 million as of December 31, 2020. The Provision is recorded to maintain the ACL and the reserve for unfunded commitments at levels deemed adequate by management based on the factors noted in the “Risk Governance and Quantitative and Qualitative Disclosures About Market Risk — Credit Risk” section of this MD&A.
Noninterest Income
Table 6 presents the major components of noninterest income for the three months ended March 31, 2021 and 2020:
Noninterest Income
Table 6
Three Months Ended
March 31,
Dollar
Percent
(dollars in thousands)
2021
2020
Change
Change
Service charges on deposit accounts
$
6,718
$
8,950
$
(2,232)
(25)
%
Credit and debit card fees
14,551
14,949
(398)
(3)
Other service charges and fees
8,846
8,539
307
4
Trust and investment services income
8,492
9,591
(1,099)
(11)
Bank-owned life insurance
2,389
2,260
129
6
Investment securities gains, net
—
85
(85)
n/m
Other
2,872
4,854
(1,982)
(41)
Total noninterest income
$
43,868
$
49,228
$
(5,360)
(11)
%
n/m – Denotes a variance that is not a meaningful metric to inform the change in noninterest income for the three months ended March 31, 2021 to the same period in 2020.
Total noninterest income was $43.9 million for the three months ended March 31, 2021, a decrease of $5.4 million or 11% as compared to the same period in 2020.
Service charges on deposit accounts were $6.7 million for the three months ended March 31, 2021, a decrease of $2.2 million or 25% as compared to the same period in 2020. This decrease was primarily due to a $1.4 million decrease in overdraft and checking account fees, a $0.4 million decrease in account analysis service charges and a $0.3 million decrease in checking account service fees.
Credit and debit card fees were $14.6 million for the three months ended March 31, 2021, a decrease of $0.4 million or 3% as compared to the same period in 2020.
Other service charges and fees were $8.8 million for the three months ended March 31, 2021, an increase of $0.3 million or 4% as compared to the same period in 2020.
Trust and investment services income was $8.5 million for the three months ended March 31, 2021, a decrease of $1.1 million or 11% as compared to the same period in 2020. This decrease was due to a $0.7 million decrease in business cash management fees, a $0.2 million decrease in tax services fees and a $0.2 million decrease in trust service fees.
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BOLI income was $2.4 million for the three months ended March 31, 2021, an increase of $0.1 million or 6% as compared to the same period in 2020.
Net gains on the sale of investment securities were nil for the three months ended March 31, 2021, a decrease of $0.1 million as compared to the same period in 2020.
Other noninterest income was $2.9 million for the three months ended March 31, 2021, a decrease of $2.0 million or 41% as compared to the same period in 2020. This decrease was primarily due to a $1.4 million decrease in customer-related interest rate swap fees and a $1.1 million decrease in market value adjustments on mutual funds purchased, partially offset by a $0.7 million increase in volume-based incentives.
Noninterest Expense
Table 7 presents the major components of noninterest expense for the three months ended March 31, 2021 and 2020:
Noninterest Expense
Table 7
Three Months Ended
March 31,
Dollar
Percentage
(dollars in thousands)
2021
2020
Change
Change
Salaries and employee benefits
$
43,936
$
44,829
$
(893)
(2)
%
Contracted services and professional fees
17,188
16,055
1,133
7
Occupancy
7,170
7,243
(73)
(1)
Equipment
5,491
4,708
783
17
Regulatory assessment and fees
2,034
1,946
88
5
Advertising and marketing
1,591
1,823
(232)
(13)
Card rewards program
4,835
7,015
(2,180)
(31)
Other
14,061
12,847
1,214
9
Total noninterest expense
$
96,306
$
96,466
$
(160)
—
%
Total noninterest expense was $96.3 million for the three months ended March 31, 2021, a decrease of $0.2 million as compared to the same period in 2020.
Salaries and employee benefits expense was $43.9 million for the three months ended March 31, 2021, a decrease of $0.9 million or 2% as compared to the same period in 2020. This was primarily due to a $4.3 million increase in payroll and benefit costs being deferred as loan origination costs and a $0.4 million decrease in incentive compensation. This was partially offset by a $1.4 million increase in other compensation, a $1.0 million increase in base salaries and related payroll taxes, a $0.7 million increase in temporary help expenses and a $0.4 million increase in retirement plan expenses.
Contracted services and professional fees were $17.2 million for the three months ended March 31, 2021, an increase of $1.1 million or 7% as compared to the same period in 2020. This increase was primarily due to a $1.0 million increase in outside services, primarily attributable to marketing and new customer services, and a $0.3 million increase in contracted data processing expenses, primarily related to system upgrades and product enhancements.
Occupancy expense was $7.2 million for three months ended March 31, 2021, a decrease of $0.1 million or 1% as compared to the same period in 2020.
Equipment expense was $5.5 million for the three months ended March 31, 2021, an increase of $0.8 million or 17% as compared to the same period in 2020. This increase was primarily due to a $0.6 million increase in technology-related license and maintenance fees and a $0.3 million increase in furniture and equipment depreciation expense.
Regulatory assessment and fees were $2.0 million for the three months ended March 31, 2021, an increase of $0.1 million or 5% as compared to the same period in 2020.
Advertising and marketing expense was $1.6 million for the three months ended March 31, 2021, a decrease of $0.2 million or 13% as compared to the same period in 2020.
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Card rewards program expense was $4.8 million for the three months ended March 31, 2021, a decrease of $2.2 million or 31% as compared to the same period in 2020. This decrease was primarily due to a $1.8 million decrease in priority rewards card redemptions and a $0.3 million decrease in credit card cash reward redemptions, as a result of decreased activity due to COVID-19 and its impact on our customers.
Other noninterest expense was $14.1 million for the three months ended March 31, 2021, an increase of $1.2 million or 9% as compared to the same period in 2020. This increase was primarily due to a $1.1 million increase in software depreciation, partially offset by a $0.3 million decrease in pension-related expenses.
Provision for Income Taxes
The provision for income taxes was $19.0 million (an effective tax rate of 24.80%) for the three months ended March 31, 2021, compared with the provision for income taxes of $11.4 million (an effective tax rate of 22.65%) for the same period in 2020. The increase in the effective tax rate was primarily from the recognition of a tax benefit for the period ended March 31, 2020, due to a state tax settlement with BNP Paribas USA, Inc. related to periods during which the Company was included in the state combined returns of BNP Paribas USA, Inc. A similar tax benefit was not recognized during the three months ended March 31, 2021.
Analysis of Business Segments
Our business segments are Retail Banking, Commercial Banking and Treasury and Other. Table 8 summarizes net income from our business segments for the three months ended March 31, 2021 and 2020. Additional information about operating segment performance is presented in “Note 17. Reportable Operating Segments” contained in our unaudited interim consolidated financial statements.
Business Segment Net Income
Table 8
Three Months Ended
March 31,
(dollars in thousands)
2021
2020
Retail Banking
$
46,637
$
27,027
Commercial Banking
21,362
7,276
Treasury and Other
(10,306)
4,562
Total
$
57,693
$
38,865
Retail Banking. Our Retail Banking segment includes the financial products and services we provide to consumers, small businesses and certain commercial customers. Loan and lease products offered include residential and commercial mortgage loans, home equity lines of credit, automobile loans and leases, personal lines of credit, installment loans and small business loans and leases. Deposit products offered include checking, savings and time deposit accounts. Our Retail Banking segment also includes our wealth management services.
Net income for the Retail Banking segment was $46.6 million for the three months ended March 31, 2021, an increase of $19.6 million or 73% as compared to the same period in 2020. The increase in net income for the Retail Banking segment was primarily due to a $21.5 million decrease in the Provision and a $11.0 million increase in net interest income, partially offset by a $8.0 million increase in the provision for income taxes, a $2.8 million decrease in noninterest income and a $2.2 million increase in noninterest expense. The decrease in the Provision was primarily due to the adjustment during the three months ended March 31, 2020 stemming from higher expected credit losses as a result of COVID-19 and the expected impact that it would have on our customers. The increase in net interest income was primarily due to an increase in loan fees and lower transfer pricing charges as a result of lower average yields in our loan portfolio. The increase in the provision for income taxes was primarily due to the increase in pretax income. The decrease in noninterest income was primarily due to decreases in overdraft and checking account fees and trust and investment services income. The increase in noninterest expense was primarily due to higher overall expenses that were allocated to the Retail Banking segment, partially offset by a decrease in salaries and benefits expense.
Commercial Banking. Our Commercial Banking segment includes our corporate banking, commercial real estate loans, commercial lease financing, automobile loans and auto dealer financing, business deposit products and credit cards that we provide primarily to middle market and large companies in Hawaii, Guam, Saipan and California.
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Net income for the Commercial Banking segment was $21.4 million for the three months ended March 31, 2021, an increase of $14.1 million as compared to the same period in 2020. The increase in net income for the Commercial Banking segment was primarily due to a $22.8 million decrease in the Provision, partially offset by a $4.3 million increase in the provision for income taxes, a $2.6 million decrease in net interest income and a $1.8 million decrease in noninterest income. The decrease in the Provision was primarily due to the adjustment related to COVID-19 in 2020 and the expected impact that it would have on our customers. The increase in the provision for income taxes was primarily due to the increase in pretax income. The decrease in net interest income was primarily due to a decrease in credit card loan income. The decrease in noninterest income was primarily due to a decrease in customer-related interest rate swap fees.
Treasury and Other. Our Treasury and Other segment includes our treasury business, which consists of corporate asset and liability management activities, including interest rate risk management. The assets and liabilities (and related interest income and expense) of our treasury business consist of interest-bearing deposits, investment securities, federal funds sold and purchased, government deposits, short- and long-term borrowings and bank-owned properties. Our primary sources of noninterest income are from bank-owned life insurance, net gains from the sale of investment securities, foreign exchange income related to customer driven currency requests from merchants and island visitors and management of bank-owned properties in Hawaii and Guam. The net residual effect of the transfer pricing of assets and liabilities is included in Treasury and Other, along with the elimination of intercompany transactions.
Other organizational units (Technology, Operations, Credit and Risk Management, Human Resources, Finance, Administration, Marketing and Corporate and Regulatory Administration) provide a wide range of support to our other income earning segments. Expenses incurred by these support units are charged to the applicable business segments through an internal cost allocation process.
Net loss for the Treasury and Other segment was $10.3 million for the three months ended March 31, 2021, an increase in loss of $14.9 million as compared to the same period in 2020. The increase in the net loss was primarily due to a $17.9 million increase in net interest expense and a $3.1 million increase in the Provision, partially offset by a $4.7 million increase in the benefit for income taxes and a $2.4 million decrease in noninterest expense. The increase in net interest expense was primarily due to lower earnings credits as a result of lower average yields in our loan portfolio, partially offset by a decrease in transfer pricing charges as a result of lower yields on our deposit portfolio. The increase in the Provision was primarily due to the increase in the reserve for unfunded commitments. The increase in the benefit for income taxes was primarily due to the increase in pretax loss. The decrease in noninterest expense was primarily due to lower overall expenses that were allocated to the Treasury and Other segment, partially offset by increases in salaries and employee benefits expense, software depreciation, contracted services and professional fees, equipment expense, supplies and pension-related expenses.
Analysis of Financial Condition
Liquidity
Liquidity refers to our ability to maintain cash flow that is adequate to fund operations and meet present and future financial obligations through either the sale or maturity of existing assets or by obtaining additional funding through liability management. We consider the effective and prudent management of liquidity to be fundamental to our health and strength. Our objective is to manage our cash flow and liquidity reserves so that they are adequate to fund our obligations and other commitments on a timely basis and at a reasonable cost.
Liquidity is managed to ensure stable, reliable and cost-effective sources of funds to satisfy demand for credit, deposit withdrawals and investment opportunities. Funding requirements are impacted by loan originations and refinancings, deposit balance changes, liability issuances and settlements and off-balance sheet funding commitments. We consider and comply with various regulatory and internal guidelines regarding required liquidity levels and periodically monitor our liquidity position in light of the changing economic environment and customer activity. Based on periodic liquidity assessments, we may alter our asset, liability and off-balance sheet positions. The Company’s Asset Liability Management Committee (“ALCO”) monitors sources and uses of funds and modifies asset and liability positions as liquidity requirements change. This process, combined with our ability to raise funds in money and capital markets and through private placements, provides flexibility in managing the exposure to liquidity risk.
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Immediate liquid resources are available in cash, which is primarily on deposit with the Federal Reserve Bank of San Francisco (the “FRB”). As of March 31, 2021 and December 31, 2020, cash and cash equivalents were $1.3 billion and $1.0 billion, respectively. Potential sources of liquidity also include investment securities in our available-for-sale portfolio. The carrying value of our available-for-sale investment securities were $6.7 billion and $6.1 billion as of March 31, 2021 and December 31, 2020, respectively. As of March 31, 2021 and December 31, 2020, we maintained our excess liquidity primarily in collateralized mortgage obligations issued by Ginnie Mae, Fannie Mae and Freddie Mac. As of March 31, 2021, our available-for-sale investment securities portfolio was comprised of securities with a weighted average life of approximately 5.4 years. These funds offer substantial resources to meet either new loan demand or to help offset reductions in our deposit funding base. Liquidity is further enhanced by our ability to pledge loans to access secured borrowings from the FHLB and the FRB. As of March 31, 2021, we have borrowing capacity of $2.0 billion from the FHLB and $1.2 billion from the FRB based on the amount of collateral pledged.
Our core deposits have historically provided us with a long-term source of stable and relatively lower cost of funding. Our core deposits, defined as all deposits exclusive of time deposits exceeding $250,000, totaled $19.0 billion and $17.9 billion as of March 31, 2021 and December 31, 2020, which represented 94% and 93%, respectively, of our total deposits. These core deposits are normally less volatile, often with customer relationships tied to other products offered by the Company, however, deposit levels could decrease if interest rates increase significantly or if corporate customers increase investing activities and reduce deposit balances.
The Company’s routine funding requirements are expected to consist primarily of general corporate needs and capital to be returned to our shareholders. We expect to meet these obligations from dividends paid by the Bank to the Parent. Additional sources of liquidity available to us include selling residential real estate loans in the secondary market, taking out short- and long-term borrowings and issuing long-term debt and equity securities. At the start of the pandemic, we increased our liquidity position through additional public time deposits in anticipation of a surge in funding needs due to our participation in the PPP and other additional liquidity needs. While our public time deposits have since decreased from the fourth quarter of 2020, we have continued to maintain strong levels of liquidity as of March 31, 2021.
Investment Securities
Table 9 presents the estimated fair value of our available-for-sale investment securities portfolio as of March 31, 2021 and December 31, 2020:
Investment Securities
Table 9
March 31,
December 31,
(dollars in thousands)
2021
2020
U.S. Treasury and government agency debt securities
$
175,724
$
171,421
Mortgage-backed securities:
Residential - Government agency
133,894
160,462
Residential - Government-sponsored enterprises
800,920
447,200
Commercial - Government agency
527,516
599,650
Commercial - Government-sponsored enterprises
1,134,175
932,157
Collateralized mortgage obligations:
Government agency
1,845,098
1,933,553
Government-sponsored enterprises
2,075,152
1,826,972
Total available-for-sale securities
$
6,692,479
$
6,071,415
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Table 10 presents the maturity distribution at amortized cost and weighted-average yield to maturity of our available-for-sale investment securities portfolio as of March 31, 2021:
Maturities and Weighted-Average Yield on Securities (1)
Table 10
1 Year or Less
After 1 Year - 5 Years
After 5 Years - 10 Years
Over 10 Years
Total
Weighted
Weighted
Weighted
Weighted
Weighted
Average
Average
Average
Average
Average
Fair
(dollars in millions)
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Value
As of March 31, 2021
Available-for-sale securities
U.S. Treasury and government agency debt securities
$
—
—
%
$
41.5
0.84
%
$
84.0
1.03
%
$
52.2
1.66
%
$
177.7
1.17
%
$
175.7
Mortgage-backed securities (2) :
Residential - Government agency
—
—
129.9
2.34
—
—
—
—
129.9
2.34
133.9
Residential - Government-sponsored enterprises
—
—
288.1
2.36
509.3
1.28
—
—
797.4
1.68
800.9
Commercial - Government agency
—
—
444.6
2.11
78.7
1.76
—
—
523.3
2.06
527.5
Commercial - Government-sponsored enterprises
—
—
68.3
1.96
632.9
1.48
478.8
1.67
1,180.0
1.58
1,134.2
Collateralized mortgage obligations (2) :
Government agency
35.0
1.87
1,407.4
1.71
375.8
1.18
—
—
1,818.2
1.60
1,845.1
Government-sponsored enterprises
49.7
2.07
1,102.7
1.29
929.5
1.37
—
—
2,081.9
1.34
2,075.2
Total available-for-sale securities as of March 31, 2021
$
84.7
1.99
%
$
3,482.5
1.70
%
$
2,610.2
1.35
%
$
531.0
1.67
%
$
6,708.4
1.57
%
$
6,692.5
(1) Weighted-average yields were computed on a fully taxable-equivalent basis.
(2) Maturities for mortgage-backed securities and collateralized mortgage obligations anticipate future prepayments.
The fair value of our available-for-sale investment securities portfolio was $6.7 billion as of March 31, 2021, an increase of $621.1 million or 10% compared to December 31, 2020. Our available-for-sale investment securities are carried at fair value with changes in fair value reflected in other comprehensive income or through the Provision.
As of March 31, 2021, we maintained all of our investment securities in the available-for-sale category recorded at fair value in the unaudited interim consolidated balance sheets, with $3.9 billion invested in collateralized mortgage obligations issued by Ginnie Mae, Fannie Mae and Freddie Mac. Our available-for-sale portfolio also included $2.6 billion in mortgage-backed securities issued by Ginnie Mae, Freddie Mac, Fannie Mae and Municipal Housing Authorities and $175.7 million in debt securities issued by the U.S Treasury and government agencies (US International Development Finance Corporation bonds).
We continually evaluate our investment securities portfolio in response to established asset/liability management objectives, changing market conditions that could affect profitability and the level of interest rate risk to which we are exposed. These evaluations may cause us to change the level of funds we deploy into investment securities and change the composition of our investment securities portfolio.
Gross unrealized gains in our investment securities portfolio were $70.5 million and $97.1 million as of March 31, 2021 and December 31, 2020, respectively. Gross unrealized losses in our investment securities portfolio were $86.4 million and $10.7 million as of March 31, 2021 and December 31, 2020, respectively. The increase in unrealized loss in our investment securities portfolio was primarily due to higher market interest rates as of March 31, 2021, relative to December 31, 2020, resulting in a lower valuation. The increase in unrealized loss positions was primarily related to our commercial mortgage-backed securities, mortgage-backed securities and collateralized mortgage obligations, the fair values of which are sensitive to changes in market interest rates.
We conduct a regular assessment of our investment securities portfolio to determine whether any securities are impaired. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and the ACL is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through the ACL is recognized in other comprehensive income. For the three months ended March 31, 2021, we did not record any credit losses related to our investment securities portfolio.
We are required to hold non-marketable equity securities, comprised of FHLB stock, as a condition of our membership in the FHLB system. Our FHLB stock is accounted for at cost, which equals par or redemption value. As of both March 31, 2021 and December 31, 2020, we held FHLB stock of $18.1 million, which is recorded as a component of other assets in our unaudited interim consolidated balance sheets.
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See “Note 2. Investment Securities” contained in our unaudited interim consolidated financial statements for more information on our investment securities portfolio.
Loans and Leases
Table 11 presents the composition of our loan and lease portfolio by major categories as of March 31, 2021 and December 31, 2020:
Loans and Leases
Table 11
March 31,
December 31,
(dollars in thousands)
2021
2020
Commercial and industrial:
Commercial and industrial excluding Paycheck Protection Program loans
$
1,962,672
$
2,218,266
Paycheck Protection Program loans
1,158,764
801,241
Total commercial and industrial
3,121,436
3,019,507
Commercial real estate
3,396,233
3,392,676
Construction
739,271
735,819
Residential:
Residential mortgage
3,715,676
3,690,218
Home equity line
805,746
841,624
Total residential
4,521,422
4,531,842
Consumer
1,283,779
1,353,842
Lease financing
238,148
245,411
Total loans and leases
$
13,300,289
$
13,279,097
Total loans and leases were $13.3 billion as of March 31, 2021, an increase of $21.2 million or less than 1% from December 31, 2020 with increases in commercial and industrial loans, commercial real estate loans and construction loans. The increase in total loans and leases was primarily due to our participation in the PPP which had a total amortized cost basis of $1.2 billion as of March 31, 2021. It is possible that the effects of COVID-19 on the economy could result in less demand for our loan products.
Commercial and industrial loans are made primarily to corporations, middle market and small businesses for the purpose of financing equipment acquisition, expansion, working capital and other general business purposes. We also offer a variety of automobile dealer flooring lines to our customers in Hawaii and California to assist with the financing of their inventory. Commercial and industrial loans were $3.1 billion as of March 31, 2021, an increase of $101.9 million or 3% from December 31, 2020. This increase was primarily due to an increase in PPP loans totaling $357.5 million, partially offset by decreases in our Shared National Credits and dealer flooring portfolios during the three months ended March 31, 2021.
Commercial real estate loans are secured by first mortgages on commercial real estate at loan to value (“LTV”) ratios generally not exceeding 75% and a minimum debt service coverage ratio of 1.20 to 1. The commercial properties are predominantly apartments, neighborhood and grocery anchored retail, industrial, office, and to a lesser extent, specialized properties such as hotels. The primary source of repayment for investor property and owner occupied property is cash flow from the property and operating cash flow from the business, respectively. Commercial real estate loans were $3.4 billion as of March 31, 2021, an increase of $3.6 million or less than 1% from December 31, 2020.
Construction loans are for the purchase or construction of a property for which repayment will be generated by the property. Loans in this portfolio are primarily for the purchase of land, as well as for the development of commercial properties, single family homes and condominiums. We classify loans as construction until the completion of the construction phase. Following completion of the construction phase, if a loan is retained by the Bank, the loan is reclassified to the commercial real estate or residential real estate classes of loans. Construction loans were $739.3 million as of March 31, 2021, an increase of $3.5 million or less than 1% from December 31, 2020.
Residential real estate loans are generally secured by 1-4 unit residential properties and are underwritten using traditional underwriting systems to assess the credit risks and financial capacity and repayment ability of the consumer. Decisions are primarily based on LTV ratios, debt-to-income (“DTI”) ratios, liquidity and credit scores. LTV ratios generally do not exceed 80%, although higher levels are permitted with mortgage insurance. We offer fixed rate mortgage products and variable rate mortgage products with interest rates that are subject to change every year after the first, third, fifth or tenth year, depending on the product and are based on LIBOR. Variable rate residential mortgage loans are underwritten at fully-indexed interest
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rates. We generally do not offer interest-only, payment-option facilities, Alt-A loans or any product with negative amortization. Residential real estate loans were $4.5 billion as of March 31, 2021, a decrease of $10.4 million or less than 1% from December 31, 2020. This decrease was primarily due to a decrease in home equity lines of $35.9 million, partially offset by an increase in residential mortgages of $25.5 million during the three months ended March 31, 2021.
Consumer loans consist primarily of open- and closed-end direct and indirect credit facilities for personal, automobile and household purchases as well as credit card loans. We seek to maintain reasonable levels of risk in consumer lending by following prudent underwriting guidelines, which include an evaluation of personal credit history, cash flow and collateral values based on existing market conditions. Consumer loans were $1.3 billion as of March 31, 2021, a decrease of $70.1 million or 5% from December 31, 2020. The decrease in consumer loans was primarily due to decreases in indirect automobile loans and other unsecured consumer loans.
Lease financing consists of commercial single investor leases and leveraged leases. Underwriting of new lease transactions is based on our lending policy, including but not limited to an analysis of customer cash flows and secondary sources of repayment, including the value of leased equipment, the guarantors’ cash flows and/or other credit enhancements. No new leveraged leases are being added to the portfolio and all remaining leveraged leases are running off. Lease financing was $238.1 million as of March 31, 2021, a decrease of $7.3 million or 3% from December 31, 2020. The decrease in lease financing was reflective of a weak demand for new business equipment and vehicles in the Hawaii market.
See “Note 3. Loans and Leases” and “Note 4. Allowance for Credit Losses” contained in our unaudited interim consolidated financial statements and the discussion in “Analysis of Financial Condition — Allowance for Credit Losses” of this MD&A for more information on our loan and lease portfolio.
The Company’s loan and lease portfolio includes adjustable-rate loans, primarily tied to Prime and LIBOR, hybrid-rate loans, for which the initial rate is fixed for a period from one year to as much as ten years, and fixed rate loans, for which the interest rate does not change through the life of the loan. Table 12 presents the recorded investment in our loan and lease portfolio as of March 31, 2021 by rate type:
Loans and Leases by Rate Type
Table 12
March 31, 2021
Adjustable Rate
Hybrid
Fixed
(dollars in thousands)
Prime
LIBOR
Treasury
Other
Total
Rate
Rate
Total
Commercial and industrial
$
196,587
$
1,381,487
$
—
$
1,544
$
1,579,618
$
35,047
$
1,506,771
$
3,121,436
Commercial real estate
232,559
1,924,462
324
851,333
3,008,678
125,698
261,857
3,396,233
Construction
66,708
536,528
28
28,096
631,360
3,474
104,437
739,271
Residential:
Residential mortgage
17,519
164,936
81,025
57,898
321,378
337,039
3,057,259
3,715,676
Home equity line
346,174
—
6,872
—
353,046
452,670
30
805,746
Total residential
363,693
164,936
87,897
57,898
674,424
789,709
3,057,289
4,521,422
Consumer
283,895
14,083
1,208
105
299,291
76
984,412
1,283,779
Lease financing
—
—
—
—
—
—
238,148
238,148
Total loans and leases
$
1,143,442
$
4,021,496
$
89,457
$
938,976
$
6,193,371
$
954,004
$
6,152,914
$
13,300,289
% by rate type at March 31, 2021
9
%
30
%
1
%
7
%
47
%
7
%
46
%
100
%
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Tables 13 and 14 present the geographic distribution of our loan and lease portfolio as of March 31, 2021 and December 31, 2020:
Geographic Distribution of Loan and Lease Portfolio
Table 13
March 31, 2021
U.S.
Guam &
Foreign &
(dollars in thousands)
Hawaii
Mainland (1)
Saipan
Other
Total
Commercial and industrial
$
1,984,919
$
905,124
$
219,130
$
12,263
$
3,121,436
Commercial real estate
2,179,458
816,665
399,909
201
3,396,233
Construction
367,376
365,721
6,174
—
739,271
Residential:
Residential mortgage
3,594,254
1,449
119,973
—
3,715,676
Home equity line
777,435
—
28,311
—
805,746
Total residential
4,371,689
1,449
148,284
—
4,521,422
Consumer
949,335
17,031
315,869
1,544
1,283,779
Lease financing
77,833
143,363
16,952
—
238,148
Total Loans and Leases
$
9,930,610
$
2,249,353
$
1,106,318
$
14,008
$
13,300,289
Percentage of Total Loans and Leases
74%
17%
8%
1%
100%
(1) For secured loans and leases, classification as U.S. Mainland is made based on where the collateral is located. For unsecured loans and leases, classification as U.S. Mainland is made based on the location where the majority of the borrower's business operations are conducted.
Geographic Distribution of Loan and Lease Portfolio
Table 14
December 31, 2020
U.S.
Guam &
Foreign &
(dollars in thousands)
Hawaii
Mainland (1)
Saipan
Other
Total
Commercial and industrial
$
1,755,804
$
1,042,318
$
193,829
$
27,556
$
3,019,507
Commercial real estate
2,180,829
809,493
402,142
212
3,392,676
Construction
333,112
398,218
4,489
—
735,819
Residential:
Residential mortgage
3,568,827
1,662
119,729
—
3,690,218
Home equity line
811,964
—
29,660
—
841,624
Total residential
4,380,791
1,662
149,389
—
4,531,842
Consumer
1,001,868
18,993
331,255
1,726
1,353,842
Lease financing
80,670
149,934
14,807
—
245,411
Total Loans and Leases
$
9,733,074
$
2,420,618
$
1,095,911
$
29,494
$
13,279,097
Percentage of Total Loans and Leases
73%
18%
8%
1%
100%
(1) For secured loans and leases, classification as U.S. Mainland is made based on where the collateral is located. For unsecured loans and leases, classification as U.S. Mainland is made based on the location where the majority of the borrower's business operations are conducted.
Our lending activities are concentrated primarily in Hawaii. However, we also have lending activities on the U.S. mainland, Guam and Saipan. Our commercial lending activities on the U.S. mainland include automobile dealer flooring activities in California, participation in the Shared National Credits Program and selective commercial real estate projects based on existing customer relationships. Our lease financing portfolio includes commercial leveraged and single investor lease financing activities both in Hawaii and on the U.S. mainland. However, no new leveraged leases are being added to the portfolio and all remaining leveraged leases are running off. Our consumer lending activities are concentrated primarily in Hawaii and, to a smaller extent, in Guam and Saipan.
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Table 15 presents certain contractual loan maturity categories and the sensitivities of those loans to changes in interest rates as of March 31, 2021:
Maturities for Selected Loan Categories (1)
Table 15
March 31, 2021
Due in One
Due After One
Due After
(dollars in thousands)
Year or Less
to Five Years
Five Years
Total
Commercial and industrial
$
833,986
$
2,058,821
$
228,629
$
3,121,436
Construction
173,543
445,067
120,661
739,271
Total Selected Loans
$
1,007,529
$
2,503,888
$
349,290
$
3,860,707
Total of loans with:
Adjustable interest rates
$
897,901
$
1,058,949
$
254,128
$
2,210,978
Hybrid interest rates
131
29,390
9,000
38,521
Fixed interest rates
109,497
1,415,549
86,162
1,611,208
Total Selected Loans
$
1,007,529
$
2,503,888
$
349,290
$
3,860,707
(1) Based on contractual maturities.
Credit Quality
We perform an internal loan review and grading or scoring procedures on an ongoing basis. The review provides management with periodic information as to the quality of the loan portfolio and effectiveness of our lending policies and procedures. The objective of the loan review and grading or scoring procedures is to identify, in a timely manner, existing or emerging credit quality issues so that appropriate steps can be initiated to avoid or minimize future losses.
For purposes of managing credit risk and estimating the ACL, management has identified three portfolio segments (commercial, residential and consumer) that we use to develop our systematic methodology to determine the ACL. The categorization of loans for the evaluation of credit risk is specific to our credit risk evaluation process and these loan categories are not necessarily the same as the loan categories used for other evaluations of our loan portfolio. See “Note 4. Allowance for Credit Losses” contained in our unaudited interim consolidated financial statements for more information about our approach to estimating the ACL.
The following tables and discussion address non-performing assets, loans and leases that are 90 days past due but are still accruing interest, impaired loans and loans modified in a TDR.
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Non-Performing Assets and Loans and Leases Past Due 90 Days or More and Still Accruing Interest
Table 16 presents information on our non-performing assets and accruing loans and leases past due 90 days or more as of March 31, 2021 and December 31, 2020:
Non-Performing Assets and Accruing Loans and Leases Past Due 90 Days or More
Table 16
March 31,
December 31,
(dollars in thousands)
2021
2020
Non-Performing Assets
Non-Accrual Loans and Leases
Commercial Loans:
Commercial and industrial
$
593
$
518
Commercial real estate
937
80
Construction
579
2,043
Total Commercial Loans
2,109
2,641
Residential Loans:
Residential mortgage
6,999
6,441
Total Residential Loans
6,999
6,441
Total Non-Accrual Loans and Leases
9,108
9,082
Other Real Estate Owned ("OREO")
—
—
Total Non-Performing Assets
$
9,108
$
9,082
Accruing Loans and Leases Past Due 90 Days or More
Commercial Loans:
Commercial and industrial
$
1,365
$
2,108
Commercial real estate
1,054
882
Construction
89
93
Total Commercial Loans
2,508
3,083
Residential Loans:
Home equity line
4,975
4,818
Total Residential Loans
4,975
4,818
Consumer
2,024
3,266
Total Accruing Loans and Leases Past Due 90 Days or More
$
9,507
$
11,167
Restructured Loans on Accrual Status and Not Past Due 90 Days or More
$
39,831
$
16,684
Total Loans and Leases
$
13,300,289
$
13,279,097
Ratio of Non-Accrual Loans and Leases to Total Loans and Leases
0.07
%
0.07
%
Ratio of Non-Performing Assets to Total Loans and Leases and OREO
0.07
%
0.07
%
Ratio of Non-Performing Assets and Accruing Loans and Leases Past Due 90 Days or More to Total Loans and Leases and OREO
0.14
%
0.15
%
Table 17 presents the activity in Non-Performing Assets (“NPAs”) for the three months ended March 31, 2021:
Non-Performing Assets
Table 17
(dollars in thousands)
Three Months Ended March 31, 2021
Balance at beginning of period
$
9,082
Additions
2,577
Reductions
Payments
(367)
Return to accrual status
(226)
Transfers to loans held for sale
(1,840)
Charge-offs/write-downs
(118)
Total Reductions
(2,551)
Balance at end of period
$
9,108
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The level of NPAs represents an indicator of the potential for future credit losses. NPAs consist of non-accrual loans and leases and other real estate owned. Changes in the level of non-accrual loans and leases typically represent increases for loans and leases that reach a specified past due status, offset by reductions for loans and leases that are charged-off, paid down, sold, transferred to held for sale classification, transferred to other real estate owned or are no longer classified as non-accrual because they have returned to accrual status as a result of continued performance and an improvement in the borrower’s financial condition and loan repayment capabilities.
Total NPAs were $9.1 million as of both March 31, 2021 and December 31, 2020. The ratio of our NPAs to total loans and leases and other real estate owned was 0.07% as of both March 31, 2021 and December 31, 2020. During the three months ended March 31, 2021, construction non-accruals loans decreased by $1.5 million, offset by increases in commercial real estate non-accrual loans of $0.9 million, residential mortgage non-accrual loans of $0.6 million and commercial and industrial non-accrual loans of $0.1 million.
As of March 31, 2021, commercial real estate non-accrual loans were $0.9 million, an increase of $0.9 million from December 31, 2020. This increase was due to the addition of a $0.9 million commercial real estate loan.
As of March 31, 2021, commercial and industrial non-accrual loans were $0.6 million, an increase of $0.1 million or 14% from December 31, 2020. This increase was primarily due to additions in commercial and industrial loans totaling $0.2 million, partially offset by payments and charge-offs.
As of March 31, 2021, construction non-accrual loans were $0.6 million, a decrease of $1.5 million or 72% from December 31, 2020. This decrease was primarily due to a $1.8 million transfer to loans held for sale, partially offset by $0.3 million in additions.
The largest component of our NPAs continues to be residential mortgage loans. The level of these NPAs can remain elevated due to a lengthy judicial foreclosure process in Hawaii. As of March 31, 2021, residential mortgage non-accrual loans were $7.0 million, an increase of $0.6 million or 9% from December 31, 2020. This increase was primarily due to additions of residential mortgage non-accrual loans totaling $1.1 million, partially offset by payments of $0.2 million, returns to accrual status of $0.2 million and charge-offs of $0.1 million. As of March 31, 2021, our residential mortgage non-accrual loans were comprised of 37 loans with a weighted average current LTV ratio of 50%.
Other real estate owned represents property acquired as the result of borrower defaults on loans. Other real estate owned is recorded at fair value, less estimated selling costs, at the time of foreclosure. On an ongoing basis, properties are appraised as required by market conditions and applicable regulations. As of both March 31, 2021 and December 31, 2020, there were no other real estate owned.
Loans and Leases Past Due 90 Days or More and Still Accruing Interest. Loans and leases in this category are 90 days or more past due, as to principal or interest, and are still accruing interest because they are well secured and in the process of collection.
Loans and leases past due 90 days or more and still accruing interest were $9.5 million as of March 31, 2021, a decrease of $1.7 million or 15% as compared to December 31, 2020. Consumer loans and commercial and industrial loans that were past due 90 days or more and still accruing interest decreased by $1.2 million and $0.7 million, respectively, during the three months ended March 31, 2021. This was partially offset by increases of $0.2 million in commercial real estate loans and $0.1 million in home equity lines that were past due 90 days or more and still accruing interest during the three months ended March 31, 2021.
Impaired Loans. A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. For a loan that has been modified in a TDR, the contractual terms of the loan agreement refers to the contractual terms specified by the original loan agreement, not the contractual terms specified by the modified loan agreement.
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Impaired loans were $49.2 million and $25.8 million as of March 31, 2021 and December 31, 2020, respectively. These impaired loans had a related ACL of $16.9 million and $2.4 million as of March 31, 2021 and December 31, 2020, respectively. The increase in impaired loans during the three months ended March 31, 2021 was due to increases in consumer loans of $15.8 million, residential mortgage loans of $4.9 million, commercial and industrial loans of $2.1 million and commercial real estate loans of $1.4 million, partially offset by a decrease in construction loans of $0.7 million. The change in the impaired loans balance includes charge-offs and paydowns. For the three months ended March 31, 2021 and 2020, we recorded charge-offs of $0.4 million and $0.6 million, respectively, related to our total impaired loans. Our impaired loans are considered in management’s assessment of the overall adequacy of the ACL.
If interest due on the balances of all non-accrual loans as of March 31, 2021 and 2020 had been accrued under the original terms, approximately $0.1 million in additional interest income would have been recorded during both the three months ended March 31, 2021 and 2020, respectively. Actual interest income recorded on these loans was $0.1 million for the three months ended March 31, 2021, compared to nil for the same period in 2020.
COVID-19 Financial Hardship Relief Programs
Certain borrowers have been unable to meet their contractual payment obligations because of the adverse effects of COVID-19. To help mitigate these effects, we have been offering various relief programs to assist customers who are experiencing financial hardship due to COVID-19. For example, for certain residential mortgage and commercial loans, various relief options were available on a case-by-case basis, including payment deferrals for up to six months. For certain consumer loans, loan assistance was being offered in the form of payment deferrals for up to three months, which extended the term of the loan by the number of months deferred, and interest continued to accrue on the principal balance. The short-term modifications for payment deferrals, extensions of repayment terms, or delays in payment described above that are insignificant and made on a good faith basis in response to borrowers impacted by COVID-19 who were current prior to any relief are not required to be accounted for and disclosed as TDRs under GAAP. See “Note 4. Allowance for Credit Losses” in the notes to our unaudited interim consolidated financial statements for further discussion on short-term modifications.
Table 18 presents information on our loans and leases that received payment deferrals under our COVID-19 financial hardship relief programs as of March 31, 2021:
Loans and Leases that Received Payment Deferrals under COVID-19 Financial Hardship Relief Programs
Table 18
March 31, 2021
Number of Loans
Amortized
(dollars in thousands)
and Leases
Cost Basis
Loans and Leases that Received Payment Deferrals under COVID-19 Financial Hardship Relief Programs
Commercial and industrial
958
$
654,178
Commercial real estate
414
1,136,547
Construction
29
54,436
Lease financing
57
10,788
Residential mortgage
1,433
592,613
Consumer
19,965
228,961
Total Loans and Leases that Received Payment Deferrals under COVID-19 Financial Hardship Relief Programs
22,856
$
2,677,523
Total Loans and Leases
$
13,300,289
Ratio of Loans and Leases that Received Payment Deferrals under COVID-19 Financial Hardship Relief Programs to Total Loans and Leases
20.1
%
In addition to the relief programs described above, we are also participating in the PPP offered by the SBA. The PPP is intended to help small businesses impacted by the COVID-19 pandemic by providing “fully forgivable” loans for up to $10 million to cover payroll expenses, including employee benefits, and can also be used for various other eligible expenses. PPP loans have a fixed interest rate of one percent per annum and a maturity date of up to five years, with the ability to prepay the loan in full without penalty. The first payment is deferred until the date the SBA remits the borrower’s loan forgiveness amount to the Bank, or if the borrower does not apply for loan forgiveness, 10 months after the end of the borrower’s loan forgiveness covered period. Interest will continue to accrue during the initial deferment period. The borrower may apply with the Bank for loan forgiveness of the amount due on the loan in an amount equal to payroll, employee benefits, and other eligible expenses incurred, subject to limitations, in accordance with the PPP and CARES Act, as amended by the PPPF Act and CAA. Because the purpose of the PPP is to help small businesses keep their workers employed and paid, if the business spends less than 60% of loan proceeds on payroll costs, uses the loan proceeds for non-payroll costs that are not eligible expenses, or significantly reduces its employee count or compensation levels without qualifying for other exceptions, a portion of the loan will not be forgiven, and the business will be required to repay that portion of the loan to the Bank over the remaining term of the loan.
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Table 19 presents information on our PPP loans outstanding as of March 31, 2021 to borrowers operating in industries we consider to be the most impacted by the COVID-19 pandemic (“high impact industries”) and all other industries:
PPP Loans Outstanding to Borrowers by Industry
Table 19
March 31, 2021
Number
Amortized
(dollars in thousands)
of Loans
Cost Basis
PPP Loans Outstanding to Borrowers by Industry
High Impact Industries:
Food service
1,052
$
200,519
Automobile dealers
76
62,667
Retail
810
72,049
Hospitality/Hotel
174
81,303
Transportation
247
43,105
Total PPP Loans Outstanding to Borrowers Operating in High Impact Industries
2,359
459,643
All other industries (1)
6,665
699,121
Total PPP Loans Outstanding (2)
9,024
$
1,158,764
Total Loans and Leases
$
13,300,289
Ratio of PPP Loans Outstanding to Borrowers Operating in High Impact Industries to Total Loans and Leases
3.5
%
Ratio of PPP Loans Outstanding to Total Loans and Leases
8.7
%
(1) “All other industries” represent borrowers that received PPP loans that did not operate in the five high impact industries listed above, which is primarily comprised of the construction, health care, professional services, and administrative and support services industries.
(2) Outstanding loan balances are reported net of deferred loan costs and fees of $2.4 million and $25.4 million, respectively, at March 31, 2021.
Loans Modified in a Troubled Debt Restructuring
Table 20 presents information on loans whose terms have been modified in a TDR as of March 31, 2021 and December 31, 2020:
Loans Modified in a Troubled Debt Restructuring
Table 20
March 31,
December 31,
(dollars in thousands)
2021
2020
Commercial and industrial
$
4,583
$
2,298
Commercial real estate
7,635
7,126
Construction
716
—
Total commercial
12,934
9,424
Residential mortgage
11,929
7,553
Total residential
11,929
7,553
Consumer
15,763
—
Total
$
40,626
$
16,977
Loans modified in a TDR were $40.6 million as of March 31, 2021, an increase of $23.6 million from December 31, 2020. This increase was primarily due to increases in consumer loans of $15.8 million, residential mortgages of $4.4 million and commercial and industrial loans of $2.3 million. As of March 31, 2021, $39.8 million or 98% of our loans modified in a TDR were performing in accordance with their modified contractual terms and were on accrual status.
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Generally, loans modified in a TDR are returned to accrual status after the borrower has demonstrated performance under the modified terms by making six consecutive timely payments. See “Note 4. Allowance for Credit Losses” contained in our unaudited interim consolidated financial statements and “Analysis of Financial Condition — COVID-19 Financial Hardship Relief Programs” for more information and a description of the modification programs that we currently offer to our customers.
As noted above, we have been providing our borrowers with opportunities to defer payments, or portions thereof. In the absence of intervening factors, such short-term modifications made on a good faith basis are not categorized as troubled debt restructurings, nor are loans granted payment deferrals related to COVID-19 reported as past due or placed on non-accrual status (provided the loans were not past due or on non-accrual status prior to the deferral).
Allowance for Credit Losses for Loans and Leases & Reserve for Unfunded Commitments
We adopted the provisions of Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments on January 1, 2020. This guidance changed the accounting for credit losses from an “incurred loss” model, which estimates a loss allowance based on current known and inherent losses within a loan portfolio to an “expected loss” model, which estimates a loss based on losses expected to be recorded over the life of the loan portfolio.
Effective January 1, 2020, we recorded a pre-tax cumulative effect adjustment to increase the ACL by $0.8 million and to increase the reserve for unfunded commitments by $16.3 million. The Company’s ACL under CECL is significantly more dependent on the quantitative model and less on the qualitative assessment, compared to the previous incurred loss model. The increase in the ACL was primarily related to our indirect auto, commercial real estate and consumer loan products. This was partially offset by the decrease in the ACL related to our commercial and industrial, home equity lines and residential real estate loan products. These directional changes were predominantly due to differences between the loss emergence periods previously used under the incurred loss methodology and the remaining life of the loan as required under CECL. The large increase to our reserve for unfunded commitments was primarily due to an increase in utilization rates estimated using our CECL methodology.
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Table 21 presents an analysis of our ACL for the periods indicated:
Allowance for Credit Losses
Table 21
Three Months Ended March 31,
(dollars in thousands)
2021
2020
Balance at Beginning of Period
$
208,454
$
130,530
Adjustment to Adopt ASC Topic 326
—
770
After Adoption of ASC Topic 326
208,454
131,300
Loans and Leases Charged-Off
Commercial Loans:
Commercial and industrial
(963)
(201)
Commercial real estate
(66)
—
Total Commercial Loans
(1,029)
(201)
Residential Loans:
Residential mortgage
(98)
—
Home equity line
—
(8)
Total Residential Loans
(98)
(8)
Consumer
(6,541)
(8,597)
Total Loans and Leases Charged-Off
(7,668)
(8,806)
Recoveries on Loans and Leases Previously Charged-Off
Commercial Loans:
Commercial and industrial
215
220
Commercial real estate
3
—
Construction
166
110
Total Commercial Loans
384
330
Residential Loans:
Residential mortgage
17
135
Home equity line
24
122
Total Residential Loans
41
257
Consumer
2,655
2,083
Total Recoveries on Loans and Leases Previously Charged-Off
3,080
2,670
Net Loans and Leases Charged-Off
(4,588)
(6,136)
Provision for Credit Losses - Loans and Leases
(3,500)
40,849
Balance at End of Period
$
200,366
$
166,013
Average Loans and Leases Outstanding
$
13,242,270
$
13,191,426
Ratio of Net Loans and Leases Charged-Off to Average Loans and Leases Outstanding (1)
0.14
%
0.19
%
Ratio of Allowance for Credit Losses for Loans and Leases to Loans and Leases Outstanding
1.51
%
1.24
%
(1) Annualized for the three months ended March 31, 2021 and 2020.
Tables 22 and 23 present the allocation of the ACL by loan and lease category, in both dollars and as a percentage of total loans and leases outstanding as of March 31, 2021 and December 31, 2020:
Allocation of the Allowance for Credit Losses by Loan and Lease Category
Table 22
March 31,
December 31,
(dollars in thousands)
2021
2020
Commercial and industrial
$
27,322
$
24,711
Commercial real estate
51,691
58,123
Construction
10,552
10,039
Lease financing
3,197
3,298
Total commercial
92,762
96,171
Residential mortgage
38,471
40,461
Home equity line
6,668
7,163
Total residential
45,139
47,624
Consumer
62,465
64,659
Total Allowance for Credit Losses for Loans and Leases
$
200,366
$
208,454
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Allocation of the Allowance for Credit Losses by Loan and Lease Category (as a percentage of total loans and leases outstanding)
Table 23
March 31,
December 31,
2021
2020
Allocated
Loan
Allocated
Loan
ACL as
category as
ACL as
category as
% of loan or
% of total
% of loan or
% of total
lease
loans and
lease
loans and
category
leases
category
leases
Commercial and industrial
0.88
%
23.47
%
0.82
%
22.74
%
Commercial real estate
1.52
25.54
1.71
25.55
Construction
1.43
5.56
1.36
5.54
Lease financing
1.34
1.79
1.34
1.85
Total commercial
1.24
56.36
1.30
55.68
Residential mortgage
1.04
27.93
1.10
27.78
Home equity line
0.83
6.06
0.85
6.34
Total residential
1.00
33.99
1.05
34.12
Consumer
4.87
9.65
4.78
10.20
Total
1.51
%
100.00
%
1.57
%
100.00
%
As of March 31, 2021, the ACL was $200.4 million or 1.51% of total loans and leases outstanding, compared with an ACL of $208.5 million or 1.57% of total loans and leases outstanding as of December 31, 2020. The level of the ACL was commensurate with the adverse impacts that COVID-19 is having on the Hawaii and global economy.
Net charge-offs of loans and leases were $4.6 million or 0.14% of total average loans and leases, on an annualized basis, for the three months ended March 31, 2021, compared to net charge-offs of $6.1 million or 0.19% of total average loans and leases, on an annualized basis, for the three months ended March 31, 2020. Net charge-offs in our commercial lending portfolio were $0.6 million for the three months ended March 31, 2021. Net recoveries in our commercial lending portfolio were $0.1 million for the three months ended March 31, 2020. Net charge-offs in our residential lending portfolio were $0.1 million for the three months ended March 31, 2021. Net recoveries in our residential lending portfolio were $0.2 million for the three months ended March 31, 2020. Net charge-offs in our consumer lending portfolio were $3.9 million and $6.5 million for the three months ended March 31, 2021 and 2020, respectively. Net charge-offs in our consumer portfolio segment include those related to credit cards, automobile loans, installment loans and small business lines of credit and reflect the inherent risk associated with these loans.
The decrease in the ACL during the first quarter of 2021 was primarily due to lower expected credit losses in the commercial real estate portfolio. However, we retained a COVID-19 related overlay as a component of the ACL as Hawaii’s economy continues to be significantly impacted by COVID-19. As noted earlier, a significant number of our customers (primarily individuals and small businesses) have taken advantage of payment deferral programs in assisting them while they may be temporarily unemployed or while their businesses have closed. We continue to closely monitor the impact of COVID-19 on our tourism industry and the re-opening of the Hawaii economy under new guidelines. While we have begun to see and may continue to see a gradual improvement in unemployment as local businesses and the Hawaii tourism industry continues to reopen in 2021 and the COVID-19 vaccine becomes more widely administered, the timing and extent of the return of air travel and the recovery of the Hawaii tourism industry is highly uncertain and beyond our control.
As of March 31, 2021, while the allocation of our ACL to our commercial, residential and consumer portfolio segments was slightly lower as compared to December 31, 2020, the ACL was considered adequate based on our ongoing analysis of estimated expected credit losses, credit risk profiles, current economic outlook, coverage ratios and other relevant factors. We will continue to monitor factors that drive expected credit losses including COVID-19 and the impact on the Hawaii economy, local businesses and our customers. See “Note 4. Allowance for Credit Losses” contained in our unaudited interim consolidated financial statements for more information on the ACL.
Goodwill
Goodwill was $995.5 million as of both March 31, 2021 and December 31, 2020. Our goodwill originated from the acquisition of the Company by BNP Paribas in December of 2001. Goodwill generated in that acquisition was recorded on the balance sheet of the Bank as a result of push down accounting treatment, and remains on our consolidated balance sheets.
The Company’s policy is to assess goodwill for impairment at the reporting unit level on an annual basis or between annual assessments if a triggering event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Impairment is the condition that exists when the carrying amount of a reporting unit exceeds its fair value. There was no impairment in our goodwill for the three months ended March 31, 2021. Future events, including the ongoing impacts of the COVID-19 pandemic, that could cause a significant decline in our expected future cash flows or a significant adverse change in our business or the business climate may necessitate taking charges in future reporting periods related to the impairment of our goodwill.
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Other Assets
Other assets were $567.9 million as of March 31, 2021, a decrease of $35.6 million or 6% from December 31, 2020. This decrease was primarily due to a $49.7 million decrease in interest rate swap agreements, partially offset by a $13.7 million increase in current tax receivables and deferred tax assets.
Deposits
Deposits are the primary funding source for the Bank and are acquired from a broad base of local markets, including both individual and corporate customers. We obtain funds from depositors by offering a range of deposit types, including demand, savings, money market and time.
Table 24 presents the composition of our deposits as of March 31, 2021 and December 31, 2020:
Deposits
Table 24
March 31,
December 31,
(dollars in thousands)
2021
2020
Demand
$
8,175,075
$
7,522,114
Savings
6,141,161
6,020,075
Money Market
3,642,604
3,337,236
Time
2,174,841
2,348,298
Total Deposits (1)
$
20,133,681
$
19,227,723
(1) Public deposits were $1.4 billion as of March 31, 2021, a decrease of $269.1 million or 16% compared to December 31, 2020.
Total deposits were $20.1 billion as of March 31, 2021, an increase of $906.0 million or 5% from December 31, 2020. The increase in deposit balances stemmed primarily from a $634.7 million increase in non-public demand deposit balances, a $348.4 million increase in non-public savings deposit balances and a $305.4 million increase in non-public money market deposit balances, partially offset by a $227.3 million decrease in public savings deposit balances. We increased our liquidity position in anticipation of a surge in funding needs, primarily due to our participation in the PPP.
Long-term Borrowings
Long-term borrowings were $200.0 million as of both March 31, 2021 and December 31, 2020. The Company’s long-term borrowings included $200.0 million in FHLB fixed-rate advances with a weighted average interest rate of 2.73% and maturity dates ranging from 2023 to 2024. Long-term borrowings mature in excess of one year from the unaudited interim consolidated balance sheet date.
As of both March 31, 2021 and December 31, 2020, the available remaining borrowing capacity with the FHLB was $2.0 billion. The FHLB fixed-rate advances and remaining borrowing capacity were secured by residential real estate loan collateral as of March 31, 2021 and December 31, 2020.
Pension and Postretirement Plan Obligations
We have a noncontributory qualified defined benefit pension plan, an unfunded supplemental executive retirement plan, a directors’ retirement plan (a non-qualified pension plan for eligible directors) and a postretirement benefit plan providing life insurance and healthcare benefits that we offer to our directors and employees, as applicable. The noncontributory qualified defined benefit pension plan, the unfunded supplemental executive retirement plan and the directors’ retirement plan are all frozen to new participants. On March 11, 2019, the Company’s board of directors approved an amendment to the SERP to freeze the SERP. As a result of such amendment, effective July 1, 2019, there are no new accruals of benefits, including service accruals. To calculate annual pension costs, we use the following key variables: (1) size of the employee population, length of service and estimated compensation increases; (2) actuarial assumptions and estimates; (3) expected long-term rate of return on plan assets; and (4) discount rate.
Pension and postretirement benefit plan obligations, net of pension plan assets, were $127.6 million as of March 31, 2021, a nominal increase from December 31, 2020. This increase was primarily due to net periodic benefit costs for the three months ended March 31, 2021 of $2.6 million, offset by payments of $2.1 million.
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See “Note 15. Noninterest Income and Noninterest Expense” contained in our unaudited interim consolidated financial statements for more information on our pension and postretirement benefit plans.
Foreign Activities
Cross-border outstandings are defined as loans (including accrued interest), acceptances, interest-bearing deposits with other banks, other interest-bearing investments and any other monetary assets which are denominated in dollars or other non-local currency. As of both March 31, 2021 and December 31, 2020, there were no aggregate cross-border outstandings in other countries which amounted to 0.75% to 1% of our total consolidated assets. Additionally, there were no cross-border outstandings in excess of 1% of our total consolidated assets as of both March 31, 2021 and December 31, 2020.
Capital
The bank regulators currently use a combination of risk-based ratios and a leverage ratio to evaluate capital adequacy. The Company and the Bank are subject to the federal bank regulators’ final rules implementing Basel III and various provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Capital Rules”).
The Capital Rules, among other things impose a capital measure called “Common Equity Tier 1” (“CET1”), to which most deductions/adjustments to regulatory capital must be made. In addition, the Capital Rules specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain specified requirements.
Under the Capital Rules, the minimum capital ratios are as follows:
● 4.5% CET1 capital to risk-weighted assets,
● 6.0% Tier 1 capital (that is, CET1 capital plus Additional Tier 1 capital) to risk-weighted assets,
● 8.0% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets, and
● 4.0% Tier 1 capital to average quarterly assets.
The Capital Rules also require a 2.5% capital conservation buffer designed to absorb losses during periods of economic stress. The capital conservation buffer is composed entirely of CET1, on top of these minimum risk weighted asset ratios, effectively resulting in minimum ratios of (i) 7% CET1 to risk-weighted assets, (ii) 8.5% Tier 1 capital to risk-weighted assets, and (iii) 10.5% total capital to risk-weighted assets.
As of March 31, 2021, the Company’s capital levels remained characterized as “well capitalized” under the Capital Rules. Our regulatory capital ratios, calculated in accordance with the Capital Rules, are presented in Table 25 below. There have been no conditions or events since March 31, 2021 that management believes have changed either the Company’s or the Bank’s capital classifications.
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Regulatory Capital
Table 25
March 31,
December 31,
(dollars in thousands)
2021
2020
Stockholders' Equity
$
2,683,630
$
2,744,104
Less:
Goodwill
995,492
995,492
Accumulated other comprehensive (loss) income, net
(43,435)
31,604
Common Equity Tier 1 Capital and Tier 1 Capital
$
1,731,573
$
1,717,008
Add:
Qualifying allowance for credit losses and reserve for unfunded commitments
169,681
172,950
Total Capital
$
1,901,254
$
1,889,958
Risk-Weighted Assets
$
13,509,716
$
13,769,885
Key Regulatory Capital Ratios
Common Equity Tier 1 Capital Ratio
12.82
%
12.47
%
Tier 1 Capital Ratio
12.82
%
12.47
%
Total Capital Ratio
14.07
%
13.73
%
Tier 1 Leverage Ratio
7.90
%
8.00
%
Total stockholders’ equity was $2.7 billion as of March 31, 2021, a decrease of $60.5 million or 2% from December 31, 2020. The decrease in stockholders’ equity was primarily due to a net unrealized loss in the fair value of our investment securities of $75.0 million, dividends declared and paid to the Company’s stockholders of $33.8 million and share repurchases of $9.5 million, partially offset by earnings for the period of $57.7 million during the three months ended March 31, 2021.
In February 2021, the Company announced a stock repurchase program for up to $75.0 million of its outstanding common stock during 2021. The timing and amount of stock repurchases, if any, are influenced by various internal and external factors.
In April 2021, the Company’s Board of Directors declared a quarterly cash dividend of $0.26 per share on our outstanding shares. The dividend will be paid on June 4, 2021 to shareholders of record at the close of business on May 24, 2021.
Off-Balance Sheet Arrangements and Guarantees
Off-Balance Sheet Arrangements
We hold interests in several unconsolidated variable interest entities (“VIEs”). These unconsolidated VIEs are primarily low income housing tax credit investments in partnerships and limited liability companies. Variable interests are defined as contractual ownership or other interest in an entity that change with fluctuations in an entity’s net asset value. The primary beneficiary consolidates the VIE. Based on our analysis, we have determined that the Company is not the primary beneficiary of these entities. As a result, we do not consolidate these VIEs.
Guarantees
We sell residential mortgage loans on the secondary market, primarily to Fannie Mae or Freddie Mac. The agreements under which we sell residential mortgage loans to Fannie Mae or Freddie Mac contain provisions that include various representations and warranties regarding the origination and characteristics of the residential mortgage loans. Although the specific representations and warranties vary among investors, insurance or guarantee agreements, they typically cover ownership of the loan, validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing the loan, compliance with loan criteria set forth in the applicable agreement, compliance with applicable federal, state and local laws and other matters. As of March 31, 2021 and December 31, 2020, the unpaid principal balance of our portfolio of residential mortgage loans sold was $2.0 billion and $2.2 billion, respectively. The agreements under which we sell residential mortgage loans require delivery of various documents to the investor or its document custodian. Although these loans are primarily sold on a non-recourse basis, we may be obligated to repurchase residential mortgage loans or reimburse investors for losses incurred if a loan review reveals that underwriting and documentation standards were potentially not met in the origination of those loans. Upon receipt of a repurchase request, we work with investors to arrive at a mutually agreeable resolution. Repurchase demands are typically reviewed on an individual loan by loan basis to validate the claims made by the investor to determine if a contractually required repurchase event has occurred. We manage the risk
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associated with potential repurchases or other forms of settlement through our underwriting and quality assurance practices and by servicing mortgage loans to meet investor and secondary market standards. For the three months ended March 31, 2021, there were two residential mortgage loan repurchases totaling $0.6 million and there were no pending repurchase requests.
In addition to servicing loans in our portfolio, substantially all of the loans we sell to investors are sold with servicing rights retained. We also service loans originated by other mortgage loan originators. As servicer, our primary duties are to: (1) collect payments due from borrowers; (2) advance certain delinquent payments of principal and interest; (3) maintain and administer any hazard, title or primary mortgage insurance policies relating to the mortgage loans; (4) maintain any required escrow accounts for payment of taxes and insurance and administer escrow payments; and (5) foreclose on defaulted mortgage loans, or loan modifications or short sales. Each agreement under which we act as servicer generally specifies a standard of responsibility for actions taken by the Company in such capacity and provides protection against expenses and liabilities incurred by the Company when acting in compliance with the respective servicing agreements. However, if we commit a material breach of obligations as servicer, we may be subject to termination if the breach is not cured within a specified period following notice. The standards governing servicing and the possible remedies for violations of such standards vary by investor. These standards and remedies are determined by servicing guides issued by the investors as well as the contract provisions established between the investors and the Company. Remedies could include repurchase of an affected loan. For the three months ended March 31, 2021, we had no repurchase requests related to loan servicing activities, nor were there any pending repurchase requests as of March 31, 2021.
Although to-date repurchase requests related to representation and warranty provisions and servicing activities have been limited, it is possible that requests to repurchase mortgage loans may increase in frequency as investors more aggressively pursue all means of recovering losses on their purchased loans. However, as of March 31, 2021, management believes that this exposure is not material due to the historical level of repurchase requests and loss trends and thus has not established a liability for losses related to mortgage loan repurchases. As of March 31, 2021, 97% of our residential mortgage loans serviced for investors were current. We maintain ongoing communications with investors and continue to evaluate this exposure by monitoring the level and number of repurchase requests as well as the delinquency rates in loans sold to investors.
Contractual Obligations
Our contractual obligations have not changed materially since previously reported as of December 31, 2020.
Future Application of Accounting Pronouncements
For a discussion of the expected impact of accounting pronouncements recently issued but not adopted by us as of March 31, 2021, see “Note 1. Organization and Basis of Presentation — Recent Accounting Pronouncements” to the unaudited interim consolidated financial statements for more information.
Risk Governance and Quantitative and Qualitative Disclosures About Market Risk
Managing risk is an essential part of successfully operating our business. Management believes that the most prominent risk exposures for the Company are credit risk, market risk, liquidity risk management, capital management and operational risk. See “Analysis of Financial Condition — Liquidity” and “—Capital” sections of this MD&A for further discussions of liquidity risk management and capital management, respectively.
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Credit Risk
Credit risk is the risk that borrowers or counterparties will be unable or unwilling to repay their obligations in accordance with the underlying contractual terms. We manage and control credit risk in the loan and lease portfolio by adhering to well-defined underwriting criteria and account administration standards established by management. Written credit policies document underwriting standards, approval levels, exposure limits and other limits or standards deemed necessary and prudent. Portfolio diversification at the obligor, industry, product, and/or geographic location levels is actively managed to mitigate concentration risk. In addition, credit risk management includes an independent credit review process that assesses compliance with commercial, real estate and consumer credit policies, risk ratings and other critical credit information. In addition to implementing risk management practices that are based upon established and sound lending practices, we adhere to sound credit principles. We understand and evaluate our customers’ borrowing needs and capacity to repay, in conjunction with their character and history.
Management has identified three categories of loans that we use to develop our systematic methodology to determine the ACL: commercial, residential and consumer.
Commercial lending is further categorized into four distinct classes based on characteristics relating to the borrower, transaction and collateral. These classes are: commercial and industrial, commercial real estate, construction and lease financing. Commercial and industrial loans are primarily for the purpose of financing equipment acquisition, expansion, working capital and other general business purposes by medium to larger Hawaii based corporations, as well as U.S. mainland and international companies. Commercial and industrial loans are typically secured by non-real estate assets whereby the collateral is trading assets, enterprise value or inventory. As with many of our customers, our commercial and industrial loan customers are heavily dependent on tourism, government expenditures and real estate values. Commercial real estate loans are secured by real estate, including but not limited to structures and facilities to support activities designated as retail, health care, general office space, warehouse and industrial space. Our Bank’s underwriting policy generally requires that net cash flows from the property be sufficient to service the debt while still maintaining an appropriate amount of reserves. Commercial real estate loans in Hawaii are characterized by having a limited supply of real estate at commercially attractive locations, long delivery time frames for development and high interest rate sensitivity. Our construction lending portfolio consists primarily of land loans, single family and condominium development loans. Financing of construction loans is subject to a high degree of credit risk given the long delivery time frames for such projects. Construction lending activities are underwritten on a project financing basis whereby the cash flows or lease rents from the underlying real estate collateral or the sale of the finished inventory is the primary source of repayment. Market feasibility analysis is typically performed by assessing market comparables, market conditions and demand in the specific lending area and general community. We require presales of finished inventory prior to loan funding. However, because this analysis is typically performed on a forward looking basis, real estate construction projects typically present a higher risk profile in our lending activities. Lease financing activities include commercial single investor leases and leveraged leases used to purchase items ranging from computer equipment to transportation equipment. Underwriting of new leasing arrangements typically includes analyzing customer cash flows, evaluating secondary sources of repayment, such as the value of the leased asset, the guarantors’ net cash flows as well as other credit enhancements provided by the lessee.
Residential lending is further categorized into the following classes: residential mortgages (loans secured by 1-4 family residential properties and home equity loans) and home equity lines of credit. Our Bank’s underwriting standards typically require LTV ratios of not more than 80%, although higher levels are permitted with accompanying mortgage insurance. First mortgage loans secured by residential properties generally carry a moderate level of credit risk, with an average loan size of approximately $363,000. Residential mortgage loan production is added to our loan portfolio or is sold in the secondary market, based on management’s evaluation of our liquidity, capital and loan portfolio mix as well as market conditions. Changes in interest rates, the economic environment and other market factors have impacted, and will likely continue to impact, the marketability and value of collateral and the financial condition of our borrowers which impacts the level of credit risk inherent in this portfolio, although we remain in a supply constrained housing environment in Hawaii. Geographic concentrations exist for this portfolio as nearly all residential mortgage loans and home equity lines of credit are for residences located in Hawaii, Guam or Saipan. These island locales are susceptible to a wide array of potential natural disasters including, but not limited to, hurricanes, floods, tsunamis and earthquakes. We offer home equity lines of credit with variable rates; fixed rate lock options may be available post-closing. All lines are underwritten at 2% over the fully indexed rate. Our procedures for underwriting home equity lines of credit include an assessment of an applicant’s overall financial capacity and repayment ability. Decisions are primarily based on repayment ability via debt-to-income ratios, LTV ratios and an evaluation of credit history.
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Consumer lending is further categorized into the following classes of loans: credit cards, automobile loans and other consumer-related installment loans. Consumer loans are either unsecured or secured by the borrower’s personal assets. The average loan size is generally small and risk is diversified among many borrowers. We offer a wide array of credit cards for business and personal use. In general, our customers are attracted to our credit card offerings on the basis of price, credit limit, reward programs and other product features. Credit card underwriting decisions are generally based on repayment ability of our borrower via DTI ratios, credit bureau information, including payment history, debt burden and credit scores, such as FICO, and analysis of financial capacity. Automobile lending activities include loans and leases secured by new or used automobiles. We originate the majority of our automobile loans and leases on an indirect basis through selected dealerships. Our procedures for underwriting automobile loans include an assessment of an applicant’s overall financial capacity and repayment ability, credit history and the ability to meet existing obligations and payments on the proposed loan or lease. Although an applicant’s creditworthiness is the primary consideration, the underwriting process also includes a comparison of the value of the collateral security to the proposed loan amount. We require borrowers to maintain full coverage automobile insurance on automobile loans and leases, with the Bank listed as either the loss payee or additional insured. Installment loans consist of open and closed end facilities for personal and household purchases. We seek to maintain reasonable levels of risk in installment lending by following prudent underwriting guidelines which include an evaluation of personal credit history and cash flow.
In addition to geographic concentration risk, we also monitor our exposure to industry risk. While the Bank, our customers and our results of operations could be adversely impacted by events affecting the tourism industry, we also monitor our other industry exposures, including, but not limited to, our exposures in the oil, gas and energy industries. As of March 31, 2021 and December 31, 2020, we did not have material exposures to customers in the oil, gas and energy industries.
Market Risk
Market risk is the potential of loss arising from changes in interest rates, foreign exchange rates, equity prices and commodity prices, including the correlation among these factors and their volatility. When the value of an instrument is tied to such external factors, the holder faces market risk. We are exposed to market risk primarily from interest rate risk, which is defined as the risk of loss of net interest income or net interest margin because of changes in interest rates.
The potential cash flows, sales or replacement value of many of our assets and liabilities, especially those that earn or pay interest, are sensitive to changes in the general level of interest rates. In the banking industry, changes in interest rates can significantly impact earnings and the safety and soundness of an entity.
Interest rate risk arises primarily from our core business activities of extending loans and accepting deposits. This occurs when our interest earning loans and interest bearing deposits mature or reprice at different times, on a different basis or in unequal amounts. Interest rates may also affect loan demand, credit losses, mortgage origination volume, pre- payment speeds and other items affecting earnings.
Many factors affect our exposure to changes in interest rates, such as general economic and financial conditions, customer preferences, historical pricing relationships and repricing characteristics of financial instruments. Our earnings are affected not only by general economic conditions, but also by the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The monetary policies of the Federal Reserve can influence the overall growth of loans, investment securities and deposits and the level of interest rates earned on assets and paid for liabilities.
Market Risk Measurement
We primarily use net interest income simulation analysis to measure and analyze interest rate risk. We run various hypothetical interest rate scenarios and compare these results against a measured base case scenario. Our net interest income simulation analysis incorporates various assumptions, which we believe are reasonable but which may have a significant impact on results. These assumptions include: (1) the timing of changes in interest rates, (2) shifts or rotations in the yield curve, (3) re-pricing characteristics for market rate sensitive instruments on and off-balance sheet, (4) differing sensitivities of financial instruments due to differing underlying rate indices and (5) varying loan prepayment speeds for different interest rate scenarios. Because of limitations inherent in any approach used to measure interest rate risk, simulation results are not intended as a forecast of the actual effect of a change in market interest rates on our results but rather as a means to better plan and execute appropriate asset liability management strategies to manage our interest rate risk.
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Table 26 presents, for the twelve months subsequent to March 31, 2021 and December 31, 2020, an estimate of the changes in net interest income that would result from ramps (gradual changes) and shocks (immediate changes) in market interest rates, moving in a parallel fashion over the entire yield curve, relative to the measured base case scenario. Ramp scenarios assume interest rates move gradually in parallel across the yield curve relative to the base case scenario. Shock scenarios assume an immediate and sustained parallel shift in interest rates across the entire yield curve, relative to the base case scenario. The base case scenario assumes that the balance sheet and interest rates are generally unchanged. We evaluate the sensitivity by using a static forecast, where the balance sheets as of March 31, 2021 and December 31, 2020 are held constant.
Net Interest Income Sensitivity Profile - Estimated Percentage Change Over 12 Months
Table 26
Static Forecast
Static Forecast
March 31, 2021
December 31, 2020
Ramp Change in Interest Rates (basis points)
+100
6.3
%
6.4
%
+50
3.2
3.2
(50)
(1.6)
(1.7)
(100)
(2.4)
(2.5)
Immediate Change in Interest Rates (basis points)
+100
12.4
%
12.4
%
+50
6.3
6.3
(50)
(2.9)
(3.0)
(100)
(4.7)
(4.4)
The table above shows the effects of a simulation which estimates the effect of a gradual and immediate sustained parallel shift in the yield curve of −100, −50, +50 and +100 basis points in market interest rates over a twelve-month period on our net interest income.
Currently, our interest rate profile is such that we project net interest income will benefit from higher interest rates as our assets would reprice faster and to a greater degree than our liabilities, while in the case of lower interest rates, our assets would reprice downward and to a greater degree than our liabilities.
Under the static balance sheet forecast as of March 31, 2021, our net interest income sensitivity profile is relatively unchanged in higher and lower interest rate scenarios compared to similar forecasts as of December 31, 2020. The sensitivity outcomes described above are primarily due to the impact of holding a larger federal funds position being offset by market interest rates being higher as of March 31, 2021 as compared with December 31, 2020. A larger federal funds position has the effect of magnifying the impact of higher interest rate scenarios. Higher market interest rates have the effect of lower prepayments on loans and investment securities. Because market interest rates remain near an interest rate floor, this dampens the impact of the lower interest rate scenarios for both ramp and shock scenarios.
The comparisons above provide insight into the potential effects of changes in interest rates on net interest income. The Company believes that its approach to interest rate risk has appropriately considered its susceptibility to both rising and falling rates and has adopted strategies which minimize the impact of such risks.
We also have longer term interest rate risk exposures which may not be appropriately measured by net interest income simulation analysis. We use market value of equity (“MVE”) sensitivity analysis to study the impact of long-term cash flows on earnings and capital. MVE involves discounting present values of all cash flows of on-balance sheet and off-balance sheet items under different interest rate scenarios. The discounted present value of all cash flows represents our MVE. MVE analysis requires modifying the expected cash flows in each interest rate scenario, which will impact the discounted present value. The amount of base case measurement and its sensitivity to shifts in the yield curve allow management to measure longer term repricing option risk in the balance sheet.
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Limitations of Market Risk Measures
The results of our simulation analyses are hypothetical, and a variety of factors might cause actual results to differ substantially from what is depicted. For example, if the timing and magnitude of interest rate changes differ from those projected, our net interest income might vary significantly. Non parallel yield curve shifts such as a flattening or steepening of the yield curve or changes in interest rate spreads would also cause our net interest income to be different from that depicted. An increasing interest rate environment could reduce projected net interest income if deposits and other short-term liabilities re-price faster than expected or faster than our assets re-price. Actual results could differ from those projected if we grow assets and liabilities faster or slower than estimated, if we experience a net outflow of deposits or if our mix of assets and liabilities otherwise changes. For example, while we maintain relatively high levels of liquidity, a faster than expected withdrawal of deposits out of the bank may cause us to seek higher cost sources of funding. Actual results could also differ from those projected if we experience substantially different prepayment speeds in our loan portfolio than those assumed in the simulation analyses. Finally, these simulation results do not consider all the actions that we may undertake in response to potential or actual changes in interest rates, such as changes to our loan, investment, deposit, funding or hedging strategies.
Market Risk Governance
We seek to achieve consistent growth in net interest income and capital while managing volatility arising from changes in market interest rates. The objective of our interest rate risk management process is to increase net interest income while operating within acceptable limits established for interest rate risk and maintaining adequate levels of funding and liquidity.
To manage the impact on net interest income, we manage our exposure to changes in interest rates through our asset and liability management activities within guidelines established by our ALCO and approved by our board of directors. The ALCO has the responsibility for approving and ensuring compliance with the ALCO management policies, including interest rate risk exposures. The objective of our interest rate risk management process is to maximize net interest income while operating within acceptable limits established for interest rate risk and maintaining adequate levels of funding and liquidity.
Through review and oversight by the ALCO, we attempt to engage in strategies that neutralize interest rate risk as much as possible. Our use of derivative financial instruments, as detailed in “Note 11. Derivative Financial Instruments” to the unaudited interim consolidated financial statements, has generally been limited. This is due to natural on balance sheet hedges arising out of offsetting interest rate exposures from loans and investment securities with deposits and other interest-bearing liabilities. In particular, the investment securities portfolio is utilized to manage the interest rate exposure and sensitivity to within the guidelines and limits established by the ALCO. We utilize natural and offsetting economic hedges in an effort to reduce the need to employ off-balance sheet derivative financial instruments to hedge interest rate risk exposures. Expected movements in interest rates are also considered in managing interest rate risk. Thus, as interest rates change, we may use different techniques to manage interest rate risk.
Management uses the results of its various simulation analyses to formulate strategies to achieve a desired risk profile within the parameters of our capital and liquidity guidelines.
In addition, our business relies upon a large volume of loans, derivative contracts and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR to establish their interest rate and/or value. In 2017, the U.K. Financial Conduct Authority announced that it would no longer compel banks to submit rates for the calculation of LIBOR after 2021. The administrator of LIBOR has stated it will extend publication of the most commonly used U.S. Dollar LIBOR settings to June 30, 2023 and to cease publishing other LIBOR settings on December 31, 2021. The U.S. federal banking agencies issued guidance strongly encouraging banking organizations to cease using U.S. dollar LIBOR as a reference rate in new contracts as soon as practicable and in any event by December 31, 2021. It is not possible to know whether LIBOR will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR or what the effect of any such changes in views or alternatives may have on the financial markets for LIBOR-linked financial instruments. The full impact of alternatives to LIBOR on the valuations, pricing and operation of our financial instruments is not yet known; however, the primary instruments that may be impacted include loans, securities and derivatives indexed to LIBOR that mature after December 31, 2021. We have established a working group, consisting of key stakeholders from throughout the Company, to monitor developments relating to LIBOR uncertainty and changes and to guide the Bank’s response. This team is currently working to ensure that our technology systems are prepared for the transition, our loan documents that reference LIBOR-based rates have been appropriately amended to reference other methods of interest rate determinations and internal and external stakeholders are apprised of the transition.
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Operational Risk
Operational risk is the risk of loss arising from inadequate or failed processes, people or systems, external events (such as natural disasters), or compliance, reputational or legal matters, including the risk of loss resulting from fraud, litigation and breaches in data security. Operational risk is inherent in all of our business ventures and the management of that risk is important to the achievement of our objectives. We have a framework in place that includes the reporting and assessment of any operational risk events, and the assessment of our mitigating strategies within our key business lines. This framework is implemented through our policies, processes and reporting requirements. We measure and report operational risk using the seven operational risk event types projected by the Basel Committee on Banking Supervision in Basel II: (1) external fraud; (2) internal fraud; (3) employment practices and workplace safety; (4) clients, products and business practices; (5) damage to physical assets; (6) business disruption and system failures; and (7) execution, delivery and process management. Our operational risk review process is also a core part of our assessment of material new products or activities.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Risk Governance and Quantitative and Qualitative Disclosures About Market Risk.”
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