Prepared remarks
Thank you, Jonathan, and thank you, everyone, for joining us as we review our financial results for the third quarter of 2025. With me today are Bob Harrison, Chairman, President and CEO; Jamie Moses, CFO; and Lee Nakamura, Chief Risk Officer. We have prepared a slide presentation that we will refer to in our remarks today. The presentation is available for downloading and viewing on our website at fhb.com in the Investor Relations section. During today's call, we will be making forward-looking statements, so please refer to our Slide 1 for our safe harbor statement. We may also discuss certain non-GAAP financial measures. The appendix to this presentation contains reconciliations of these non-GAAP financial measurements to the most directly comparable GAAP measurements. And now I'll turn the call over to Bob.
Hello, everyone. Thank you, and thanks for joining us today, and I'll start by giving a quick overview of the local economy. The state unemployment rate continued to drift lower and was at 2.7% in August compared to the national unemployment rate of 4.3%. Through August, total visitor arrivals were up 0.7% compared to last year as strength in the U.S. Mainland arrivals more than offset weaknesses in Japanese and Canadian arrivals. Year-to-date, visitor spending was $4.6 billion, up 4.5% compared to the same period of last year. The housing market remains stable. The median single-family sales price on Oahu was $1.2 million in September, up 3.8% from last year. The median condo sales price on Oahu for September was $509,000, down 1.7% from the prior year. Before we move on, I wanted to discuss the federal government shutdown, and it's too early to measure the full impact on the Hawaii economy, but with a large civilian federal workforce, we expect that many families will begin to face financial hardship.
Through the Hawaii Bankers Association, all the local banks have asked affected families to contact their local bank to discuss available relief measures. Turning to Slide 2. We had another strong quarter as net income increased compared to the second quarter. The improvement relative to the prior quarter was driven by higher net interest and noninterest income, partially offset by a higher effective tax rate. As you might recall, our second-quarter results included the impact from a change in California tax law, which resulted in a net benefit of $5.1 million last quarter. The effective tax rate in the third quarter returned to a more normalized 23.2%. Turning to Slide 3. The balance sheet remains solid as we continue to be well capitalized with ample liquidity. We held the investment portfolio relatively flat and loans declined by $223 million. Average deposits were higher during the quarter, and we saw a surge at the end of the quarter due to inflows in public operating accounts, and Jamie will cover this in more detail in a little bit.
We also repaid the $250 million FHLB advance that matured in September. And during the quarter, we repurchased about 965,000 shares at a total cost of $24 million. We have $26 million of remaining authorization under the approved 2025 stock repurchase plan. Turning to Slide 4. Total loans declined by about $223 million in the quarter. The decline was primarily in C&I. Dealer flooring balances fell by $146 million and paydowns on lines of credit by several Hawaii corporate borrowers added about $130 million to the decline in the C&I balances. We're seeing strong originations so far in the fourth quarter and expect to end the year about flat to year-end 2024.
Thanks, Bob. Turning to Slide 5. Total deposits increased about $500 million in the third quarter. Commercial deposits increased $135 million and were partially offset by a $43 million decline in retail deposits in the quarter. The decline in retail deposits seems to be largely due to seasonality, where we have seen a pattern of declining balances in the third quarter, followed by growth in the fourth quarter. Total public deposits increased by $406 million, and all of that growth was in operating accounts. There was no change in the balance of public time deposits. In the fourth quarter, we expect seasonal increases in both retail and commercial deposits, while seeing outflows in public deposits. The total cost of deposits fell by 1 basis point and the ratio of noninterest-bearing deposits to total deposits was a strong 33%. On Slide 6, net interest income was $169.3 million, $5.7 million higher than the prior quarter.
The NIM in the third quarter was 3.19%, up 8 basis points compared to the prior quarter. The increase in the margin was primarily driven by higher asset yields as well as some nonrecurring items such as loan fees. The run rate NIM for the month of September was 3.16%, and we continue to expect positive NIM momentum in the fourth quarter, and our current thinking is that the margin will advance a few basis points from the September NIM. This guidance reflects the impact of our fourth-quarter loan and deposit outlook and additional 25 basis point rate cuts in both October and December.
Thank you, Jamie. Moving to Slide 8. The bank continued to maintain its strong credit performance and healthy credit metrics in the third quarter. Credit risk remains low, stable and well within our expectations. We are not observing any broad signs of weakness across either the consumer or commercial books. Classified assets increased $30.1 million due primarily to a single borrower, who is a long-time customer that we know well and are continuing to work closely with. Quarter-to-date net charge-offs were $4.2 million or 12 basis points of total loans and leases. Year-to-date net charge-offs were $11.3 million. Our annualized year-to-date net charge-off rate was 11 basis points or 1 basis point higher than in the second quarter. NPAs and 90-day past due loans were 26 basis points at the end of the third quarter, up 3 basis points from the prior quarter, resulting from a slight increase in nonaccruals. Moving to Slide 9. We show our third-quarter allowance for credit losses broken out by disclosure segment. The bank recorded a $4.5 million provision in the third quarter. The asset ACL decreased by $2.6 million to $165.30 million with coverage remaining at 117 basis points of total loans and leases. We believe that we continue to be conservatively reserved and prepared for a wide range of outcomes. And now we would be very happy to take your questions.
Questions and answers
Our first question comes from David Feaster from Raymond James.
I wanted to discuss the growth outlook. We have experienced some headwinds with dealer floor plans and natural declines in commercial and industrial sectors. Could you first address how the pipeline is developing, the demand you're observing, and other opportunities you might explore to boost organic growth? I'm curious about any interest in full purchases or C&Is, and your current views on the pipeline, demand, and potential for accelerating organic growth.
David, this is Bob. I'll maybe start off, hand off to Jamie. So yes, the third quarter was a little unusual in that we saw some pretty significant paydowns in dealer floor plan. Part of that was one of our customers sold several franchises. So that impacted that negatively. But overall, we're still very bullish in that business. We're seeing very strong production in the pipeline. Some of that's already closed for the fourth quarter. Some of that's C&I, a lot of that is CRE. So we think we're going to have a very strong fourth quarter. And as we look to the future, we have considered pool purchases, but maybe I'll ask Jamie to just comment on that.
Yes. Thanks, Bob. I think we're looking at just in totality, as Bob said, I think we're looking at being able to get back to flat at the end of '25, roughly to where we were at the end of '24, which speaks to the strength of the pipeline that we see today. But to the broader question of pools and purchases, I think we always look at things. And to the extent that we feel like we have some level of expertise or knowledge in particular areas, we look maybe to carve out things that we have expertise in. So for example, maybe like a residential pool of Hawaii loans, right, might be something where we would think long and hard about purchasing or if there are opportunities around properties in Hawaii that we might look at as well. So for the most part, we see where we want to grow loans, but we're really looking for areas where we have some sort of expertise or niche knowledge around in order to be able to do that.
That's helpful. The core deposit growth was significant. Could you elaborate on that? You mentioned continued growth in core deposits, including some seasonal factors. Where are you seeing success in driving this core deposit growth? Also, considering we've built liquidity, how do you plan to deploy that liquidity in the upcoming months?
Yes, thank you, Dave. We anticipate that our total deposit balance will remain roughly unchanged by the end of the year compared to where we are now. We expect to see a shift in the mix of our deposits, as some public deposits may decrease in the fourth quarter but will likely be compensated by an increase in retail and commercial deposits. Our success is primarily driven by our retail and commercial teams who are actively engaging with customers and effectively strengthening relationships within the community. We are focusing on these relationship-building activities, and our achievements are largely attributed to the hard work of our teams on the ground.
To build on Jamie's response regarding our liquidity, we are no longer allowing the investment portfolio to decrease. Instead, we are maintaining it at a steady level. After several years of downsizing, we have resumed some purchases. We are keeping the portfolio steady in terms of duration and focusing on similar types of securities for acquisition.
That's helpful. For my final question, I appreciate the comments on margin. Given the strength of your core deposit base and the floating rate nature of some of your loans, I'm curious about managing deposit costs as the Fed cuts rates. There are many factors to consider, including liquidity deployment. With the potential for back book repricing and the liquidity deployment we're discussing, do you believe the margin can continue to expand even with possible Fed cuts next year?
I think that depends on the timing and the extent of those cuts. By the end of the year, it could be challenging to see net interest margin expansion. However, for now, we have enough loan growth to cover this, with around $1 billion of cash flows expected over the next 12 months. We anticipate a 125 basis point spread on the loans we are putting back on the books and a 200 to 250 basis point spread on the investment portfolio, which we are maintaining. There are many underlying dynamics, and those spreads will decline as the Fed reduces rates. But at this point, it seems we can still support further margin expansion, though there will eventually be a natural limit, around 1% or so from now, likely with four to five rate cuts. While we have a strong deposit base, it can only decrease to a certain point. Therefore, there is still potential to expand the net interest margin, largely depending on our loan generation capabilities.
And our next question comes from the line of Charlie Driscoll from KBW.
This is Charlie on for Kelly Motta, if you could remind us of your capital priorities, how you're viewing the buyback? And from an a perspective, the environment is obviously heating up. Just remind us of your strategy on that front?
Thank you, Charlie. Our capital priorities remain unchanged. We are focused on making loans that align with our credit criteria. We have a share buyback program with an authority of $100 million, and so far, we have repurchased $74 million worth. The remaining amount will depend on market conditions. The dividend is currently yielding well, but the payout ratio of earnings is relatively high, so we are unlikely to increase the dividend at this time.
That's helpful. And then I guess, like circling back to the deposit rate conversation. The pricing has been rational and anticipating some cuts, like we've been hearing some changes in expectations from banks. Maybe just put some numbers around how you're thinking about betas on the way down?
Yes. We refer to it as beta in relation to our rate-sensitive portfolio. We still have approximately $4.5 billion in that deposit portfolio. We've had significant success with previous rate cuts, seeing betas of around 90% to 95% linked to a Federal Reserve rate cut. We believe this will gradually decrease with each subsequent cut. For the next rate reduction, we estimate a beta of about 90%, then 88% for the following one, and around 85% for the next. We still see potential to lower deposit costs, particularly when the Fed decreases rates, although our ability to do so is diminishing, it's still relatively high at this time.
Great. And then I guess, just like a little bit of detail with the margin expansion and the 50 basis points of additional costs, are you assuming any loan purchases in that or...
No loan purchases in that. That's just what we're looking at in terms of looking at our pipelines and talking with the teams over the past month or so, we just expect to have really strong loan growth here in the fourth quarter.
And our next question comes from the line of Anthony Elian from JPMorgan.
Jamie, just a follow-up on NIM. Just a follow-up on NIM. Slide 5 to 6, you saw a really nice tailwind from loan repricing and looks like every one of your loan yields increased from the prior quarter. I'm just wondering how much of a tailwind is left from loan repricing, maybe in 4Q and beyond, just given the outlook for rate cuts on the forward curve?
Yes. So I think there's still a tailwind there. I guess I'll start with that. But then as we look out, we have $1 billion of fixed-rate cash flows coming off of the portfolio over the next 12 months. And right now, we think that, that's repricing higher at like a 125 basis point spread at the moment. So there's still a pretty significant tailwind there. Now the 125 basis points, that's an average. And more the Fed cuts, the tighter that spread gets for sure. But there is still an ability to reprice those cash flows higher. On the investment portfolio, where we're seeing $500 million to $600 million of runoff over the next 12 months, we're getting like a 225 to 250 basis point spread on those purchases. So there's still a really significant sort of balance sheet role impact that we're seeing. That should be a tailwind not only in the fourth quarter, but into the first and second quarters as well.
Now again, all of this is dependent upon being able to replace those cash flows with loan growth. And we think we can do that, but it will be dependent upon that sort of loan growth trajectory. And to the extent that we don't get the loan growth, we would consider other things we would consider maybe increasing the size of the investment portfolio. It's not our preferred option. But there are things that we would do to manage the balance sheet and to try to manage that NIM to continued expansion or at least sort of trying to keep it flat as we get those third and fourth and fifth anticipated rate cuts.
Okay. And then my follow-up, I think you pointed to $54 million of fee income in 4Q. Just what are the areas or headwinds you expect to decline this quarter? Is it just the two items you called out on Slide 7?
Yes. I think that's right, Tony. Yes. It's not really headwinds. It's just we kind of got some good positive surprises here in the third quarter and wouldn't necessarily expect that to continue into the fourth.
Yes. And to add to that, we have been kind of messaging more in the 51% to 52% range. And now just given the strength of the overall fee business, we're moving that up to 54% as kind of our expected run rate.
And our next question comes from the line of Matthew Clark from Piper Sandler.
Just to close out the NIM discussion, do you have the spot rate on deposits at the end of September?
That was 136 basis points end of September.
Okay. And then the negative migration you saw in substandard this quarter. Can you just speak to what drove that increase?
So it's primarily that single loan to our long-time customers. And we're not really worried about loss or anything like that. We work closely with the customer. We just feel it's prudent to continue to update the ratings as we see the financials.
Okay. I may have missed it, but the type of customer and the situation there?
We didn't share that one, Matt. So we'd rather not. It's a small town.
Understood. Regarding the capital question, I don't think you provided a complete update on the M&A aspect. I might have missed it, but could you share any new insights on the M&A discussions you're involved in and whether there have been significant changes since last quarter?
No, unchanged. We're still open to talking to people and we certainly consider the right opportunity, but no change from previous guidance and discussion.
Our next question comes from Timur Braziler from Wells Fargo.
Jamie, your comment on total deposits, I want to make sure I heard that right. Is it flat for 4Q or flat for the year?
It's flat third quarter to fourth quarter. So we expect public to run out in the fourth quarter a little bit, while we increased retail and commercial.
And then maybe back to Matt's last question. Just more specifically, Mainland M&A. It sounds like that's been something that's at least on the table more recently? Just is that still the case? And maybe just remind us if that is the case, kind of what you'd be looking at as far as criteria goes?
No change to what I said. Timur, I think the only thing would be it would only be mainland M&A for us because with our HHI market share here, there's nothing we'd be able to do in Hawaii. So but no change. We're certainly open to talking to people and would consider the right opportunity.
Okay. That's a good point. And then, Bob, your starting comment on expecting many families will face potentially some real hardships here from a prolonged government shutdown. I guess that comment and then looking at the last few UHERO report, which is calling for a mild recession over the course of the next year. I mean, is that any different really from kind of the operating trends on the island over these last couple of years? Does that change the way that you guys are thinking about the local economy and, I guess, more pointed just how much of that is already factored in, in the reserving that you have, particularly on the consumer side.
Yes. Maybe I'll start and ask Lee, if she has any additional comments. Really no change. We think that the local economy is resilient. I mean people are not the first time this has happened. It's been a little while since there's been a shutdown that's affected salaries and all that. But we just want to make sure, and that's why we want to do it with all the banks here. I want to make sure we're open and people know they can approach us if there's a need. But we've had just very few inquiries, Lee, maybe if you have any additional comments.
Not really. We haven't seen any effects in the credit metrics yet. However, we are always cautious and take this into consideration when determining the appropriate valuation for the ACL.
To address consumer credit metrics, Lee mentioned earlier that credit cards and indirect channels are performing well. Therefore, there is nothing noticeable at this point, Timur.
And our next question comes from the line of Jared Shaw from Barclays.
Everybody. Following up on that, when considering the impact of federal spending other than military in Hawaii, are you at all concerned that it could be affected by changes in federal priorities? Or is it still primarily focused on defense? So, while we are currently facing the shutdown, do you still believe that the long-term contribution of federal government spending in Hawaii will remain unchanged?
Yes, Jared, this is Bob. Totally agree. The long-term trend is defense-focused, and it's going to be very strong. I'm heading down to Guam for next week, and the spend there is phenomenal and the projects on deck here are very, very strong. So we're not expecting that our core federal employee workforce is pretty stable. The largest employer being the Pearl Harbor and naval shipyard, which has been identified as a key resource in the Navy. So really stable to improving, I guess, would be the long-term view.
Okay. In discussions with your floor plan dealers, what are their expectations for auto sales volume in the coming year? Are they anticipating a slowdown in purchasing activity? Additionally, would this potentially be advantageous for you with floor plans if inventories remain in stock longer?
Certainly, we have really great customers with strong credit, so we'd love to see higher balances with those same customers. The discussions haven't been as much around next year. It's really been more topical about tariffs and the impacts of tariffs and different manufacturers are picking up some of the impacts of those additional costs. Others, I think we'll start based on the conversations we're having, we'll start to soon start passing those through to customers. And so there's a fair amount of uncertainty still on the end impact of the tariffs that started at the beginning of this year and what consumers will do with potentially higher price points and how that will affect demand. If it slows down demand maybe not in the next year, but even into the fourth quarter first and second quarters of 2026. That would definitely help us.
Okay. And then just finally for me. Have you seen any change in sort of pricing behavior from some of the change in ownership of other Hawaii competitors over the last year? It sounded like earlier in the year, there wasn't really any big change, but are you seeing any change in how they're approaching pricing in the markets?
Yes. We haven't seen any change in the market as far as competitive dynamics or pricing.
And our next question comes from Janet Lee from TD Securities.
Hello. Regarding M&A, could you remind us of your current stance on potential opportunities you might be considering? What would be a sensible approach in the Mainland?
I don't have much to add to our earlier comments. The only point is that in the Western states, we're open to discussing opportunities and considering the right fit, but there's nothing more to share at this moment.
Okay. Got it. Fair. I think people are entertaining the idea of residential mortgage coming back if the rate comes down to the 5 handle, is was that something that would be helpful to your market or perhaps not because it's more of a supply issue. How should I think about the positive impact from that point on your residential?
Yes, Janet, that's a good question. I believe that as rates decrease, we will see more activity. You are right that there are some supply constraints to consider. However, I think this will be beneficial for balances, and there should be some promising opportunities. So, ultimately, regarding the mortgage business, if rates drop a bit more, we may experience increased activity in that area, which should be positive.
Got it. I apologize if this has already been addressed, but regarding the $130 million paydown on corporate lines, is this a result of seasonality returning, a one-off occurrence, or indicative of a significant quarter for paydowns?
No, it wasn't necessarily seasonal. These were earlier draws for specific purposes, and now that those are settled, they are being repaid. It was unusual that several occurred in the same quarter, but the borrowing and repayment processes were normal. The draws didn't happen in the same quarter, but the repayments did, which is why we didn't highlight it on the way up, but we are mentioning it now that it has been repaid.
And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Kevin Haseyama for any further remarks.
Thank you. We appreciate your interest in First Hawaiian, and please feel free to contact me if you have any additional questions. Thanks again for joining us, and have a good weekend.
Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.