Bank Of Hawaii Stock: Poised To Benefit From Higher Interest Rates (NYSE: BOH)
As recently covered First Hawaiian (FHB), Bank of Hawaii (NYSE: BOH) stocks have been fairly flat since the last coverage. The valuation didn’t really look convincing at the time, and with the post-COVID recovery also looking a bit lackluster, I guess a quiet period here shouldn’t be so surprising.
Although the bank’s operating performance has been a bit sluggish, we are seeing at least some growth in core lending, and interest rate hikes have also been very much in evidence since the start of this week. This should serve the bank well as we move forward into 2022, although I was a bit concerned that increasingly pessimistic economic growth forecasts would put a damper on this part of the story.
These stocks still don’t look cheap on common bank valuation metrics like normalized PE and P/TBV, but again, they rarely do. While I wouldn’t rule out the quiet period here continuing in the short term, and there are other headwinds to consider, “more of the same” can work very well in the long term, with return to mid-single-digit core earnings growth and a dividend yield of 3.35% sufficient to generate acceptable returns for dividend investors.
Results still a little pedestrian
The reported numbers continue to look a little weak, with revenue nearly flat sequentially at $168.9 million in the fourth quarter. Within this, net interest income (“NII”) decreased by a shade sequentially on a reported basis, primarily due to lower interest income from the Paycheck Protection Program as these loans continue to decline in the balance sheet.
Non-interest expense also increased, rising more than 5% sequentially and 3% year-on-year to $101.7 million in the fourth quarter, driving the efficiency ratio above 60% for the quarter.
With revenue still sluggish and expenses rising, quarterly operating income before provision (“PPOP”) was also predictable, falling 6% sequentially to $67.3 million. And that was pretty much the story for 2021 as a whole – rather weak income, due to a combination of low interest rates and sluggish non-interest income, facing spending higher operating. Unsurprisingly, PPPP for the full year was also low, as expected, at $275 million versus $306.9 million in 2020.
The provisioning, however, continued to be a boon to net income, with the releases contributing $9.7 million to pretax profit in the fourth quarter and $50.5 million for the whole of year. This contributed to annual EPS of $6.25, compared to $3.86 in 2020.
Ongoing core loan growth
Although the numbers released by the bank make the recovery here a little slow, we are at least seeing signs of underlying growth. Core loans (i.e. excluding PPP balances) rose again for one, rising 2.8% sequentially and 6.2% year-on-year in the fourth quarter to 12.1 billion. dollars. It was also the third consecutive quarter of accelerating core loan growth – with core loans posting sequential growth of 2.4% and 1% in Q3 and Q2 respectively.
This resulted in a slight increase in the “base” NII (i.e. excluding PPP interest income and certain one-time charges), which increased 2.2% sequentially to $121.5 million in the fourth trimester. With PPP loan balances down to just $126.8 million at the end of last year (about 1% of total end-of-period loans), this run-off should present only a modest headwind. in 2022.
The economic recovery is fairly well established at this point, having experienced a slight wobble due to the impact of the Omicron wave on the state’s tourism economy. COVID restrictions are easing to the point of non-existence for domestic visitors, while the resumption of international travel is expected to accelerate later in the year. The state’s housing market also continues to look very strong. All told, I expect core loan growth (and subsequent NII growth) to show through in the results released this year.
Ready to benefit from higher interest rates
Loan growth should be a boon for the NII this year, but the bank will also see an increase in interest rates now that the tightening has really begun. Fixed rate loans make up a large part of the mix here (around 65%), but the bank has a very sticky deposit base which will give it the ability to capture higher margins. Moreover, a current loan-to-deposit ratio of 60% combined with the ongoing maturing of loans/investment securities suggests that it will have no problem recycling capital into higher-yielding assets.
The bank’s standard sensitivity disclosure indicates an immediate 100 basis point hike in rates, resulting in an annual rise of about 7.9% in the NII, with a more gradual change of the same magnitude resulting in an increase of 3. 1% of the NII.
While I expect to see tangible improvement in the NII based on a combination of loan growth and higher interest rates, there are some headwinds to consider, at least in the short term.
First, and like many banks, management expects a significant increase in annual operating expenses this year – somewhere in the 6% zone, as inflation ripples through wage growth and bank invests in technology. The latter should at least support future growth, but in the short term it will weigh somewhat on the PPPP and net profits.
Second, supply obviously won’t provide the same pop to the bottom line as last year. The bank’s allowance for credit losses is still about 30 basis points above immediate pre-COVID levels (1.29% vs. a “day 1” ACL of 0.99%), so there is room to maintain small impairment charges in the future, but vis-à-vis 2021 this line will obviously be a drag on net income and EPS this year.
Still a good choice for dividend investors
The immediate term might continue to be a little disappointing in terms of revenue, but that’s not something I see continuing in the medium term. On the one hand, the bank has always been very strong in terms of expense control, registering a CAGR of around 3% in the five years before COVID. Growth in operating expenses should moderate in 2023, returning to its historical trend thereafter. A corporate tax hike also seems out of place – something I was a bit cautious about last time.
With that, I expect annualized growth in the dividend per share of at least 5-6% over the next five years, consisting of the following:
- Mid-single-digit annualized revenue growth, driven by mid-single-digit annualized loan growth, higher interest rates and modest non-interest revenue growth.
- Operating expenses are expected to increase 6% in FY22, slow to 4% in FY23 and return to more moderate historical growth levels thereafter.
- The above will lead to single-digit annualized PPOP growth – broadly in line with pre-COVID trends – with lower net income and EPS growth due to the normalization of provision levels from FY22, offset to a small extent by the cumulative effect of share buybacks (in the case of EPS).
- The above will lead to EPS of around $7.40 by 2026, with a dividend payout ratio of around 50% – broadly in line with its historical level.
While not the most exciting outlook in the world, the above works out pretty well for income investors given the current yield of 3.35%. To buy.