Central Pacific Financial Corp. (CPF) Q4 2011 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the Central Pacific Financial Corporation Fourth Quarter 2011 Conference Call. [Operator instructions] This call is being recorded and will be available for replay shortly after its completion on the company’s website at www.centralpacificbank.com. I’d now like to turn the call over to Mr. David Morimoto, Senior Vice President, Investor Relations. Please go ahead sir.

Thank you, Lara, and thank you all for joining us as we review our financial results for the fourth quarter of 2011. With us today are John Dean, President and Chief Executive Office; Denis Isono, Executive Vice President and Chief Financial Officer; and Bill Wilson, Executive Vice President and Chief Credit Officer. Today’s comments may include forward-looking statements. While we believe our assumptions are reasonable, these statements are subject to risk that may cause actual results to differ materially from those projected. These risks are detailed in our filing with the SEC. Forward-looking statements are made as of today, and we do not update any forward-looking statements. And now, let’s turn the call over to our CEO, John Dean.

Thank you, David, and good morning, everyone. I’m pleased to report that we’ve recorded our fourth consecutive quarter of profitability. Our earnings continue to benefit from the significant progress we’ve made in improving our asset quality, and risk -- credit risk profile throughout the year. This improvement allowed us to substantially reduce our allowance for loan and lease losses throughout 2011. Reflecting on last year, our management employees did an outstanding job in the turnaround efforts of our company. In the first quarter of the year, we acquired new capital through private investors and raised our capital ratios beyond regulatory, well-capitalized levels. We also returned to profitability after 3 years of incurring annual net losses. The white's [ph] offering to legacy shareholders was fully subscribed and executed in the second quarter of last year. As a result of our progress through regulatory consent order that was in place since December of 2009, was terminated in May of 2011. The numerous accomplishments during a pivotal year for our company would not have been possible without the team effort of our entire organization, and the continued support of our customers and shareholders. Turning to our local economy, the encouraging increase in visitor arrivals and expenditures, at the beginning of 2011 was dampened by the national disaster in Japan and by the European crisis. However, with a strong increase in visitors from countries other than Japan and the U.S., a year-over-year increase of 2.1% in visitor arrivals is projected for last year. While our post quake arrivals from Japan have been rebounding, the continued uncertainty of the U.S. economy, has resulted in the forecast of 2.7% increase in visitor arrivals for this year, for the University of Hawaii Economic Research Organization. Construction activities projected to remain soft throughout 2012 after a projected 2% increase for last year. Public sector construction on a WAHU is expected to carry the weight of new projects for the state, and includes the governors, new day work projects for infrastructure improvements, and the WAHU mass transit project. Annual job growth NOI is expected to increase by 1.2% 2011 and by 1.7% in 2012. The unemployment rate hovered above the 6% level last year, and is expected to improve to 5.5% by the end of this year. We continue to be cautiously optimistic of the modest growth projected for 2012. This time, I’d like to ask Denis Isono, our Chief Financial Officer to review the highlights of our fourth quarter financial performance. Denis?

Thank you, John. For the fourth quarter of 2011, we reported net income of $12.1 million or $0.29 per diluted share compared to net income of $11.6 million or $0.28 cents per diluted share reported last quarter. As John mentioned, we benefited from a significant reduction in our allowance for loan and lease losses, resulting in a credit supervision for loan and lease losses of $11.2 million. As we have seen throughout 2011, the reduction in our allowance is primarily due to improvements in our credit risk profile, as our loan portfolio continues to show signs of stabilization. During the quarter, non-performing assets were reduced by $27.7 million to $195.6 million in December 31st, 2011. Nonperforming assets were $223.3 million at September 30th, 2011. Our ALLL as a percentage of total loans, decreased from 7.0% at September 30th, 2011 to 5.9% at December 31st, 2011. Similarly, the ratio of our ALLL to nonperforming assets decreased slightly from 64% in September 30th, 62% at December 31st, 2011. Bill will provide more details about our credit position later in this call. Net interest income for the quarter was $30.8 million compared to $29.8 million in the previous quarter. Our net interest margin was 3.25% and 3.05% for the same respective quarters. We are seeing gradual improvement in both our net interest income and net interest margin as we continue to deploy -- to redeploy our excess liquidity into higher-yielding assets and reduce our overall funding cost. The reduction in our funding cost was largely due to the previously reported prepayment of $121 million in long-term borrowings at the Federal Home Loan Bank of Seattle in the third quarter. Those borrowings carried a weighted average interest rate of 4.36%. During the quarter, we increased our investment securities portfolio by $26 million to approximately $1.5 billion. We continue to use an investment strategy which concentrates on the purchases of agency debentures and MBS securities with relatively short duration. Non-interest income for the quarter totaled $15.2 million up from $11.5 million in the previous quarter. The sequential quarter increase was primarily due to higher gains on sales of residential mortgage loans of $2.5 million and the recognition of a $1 million gain on the sale of investment securities. This was partially offset by lower unrealized gains and outstanding interest rate locks of $1.1 million. Non-interest expense for the quarter totaled $45.2 million down from $48.8 million at previous quarter. The sequential quarter decrease was primarily attributable to the recognition of a $6.2 million prepayment penalty related to the previously mentioned pay down of Federal Home Loan bank borrowings in the third quarter. A lower accrual for our contribution to the Central Pacific Bank Foundation of $1.5 million and a settlement of a class action lawsuit related to our previous policies for assessing overdraft fees totaling $1.2 million, also in the third quarter. Partially offsetting these items were increased net credit related charges, which includes changes in the reserve for unfunded commitment, foreclosed asset expense, and a write down of loans held for sale of $4.6 million, and higher salaries and employee benefits of $1.5 million in the fourth quarter. Our adjusted efficiency ratio for the quarter, which excludes foreclosed asset expense and write downs of loans held for sale was 92% compared to 99.1% in the previous quarter. Because we continued to have a full valuation allowance established against our net deferred tax assets, we did not recognize any income tax expense for the quarter. At December 31, 2011, our Tier 1 risk-based capital -- total risk-based capital and leverage capital ratios all improved to 22.94%, 24.24% and 13.8% respectively. This compares to 22.63%, 23.94% and 13.19% respectively at September 30th, 2011. Our capital ratios continue to be well in excess of the minimum levels required by both the memorandum of understanding, that we entered into with our regulators and the levels required for a well-capitalized regulatory designations. This completes our financial summary. I’d like now to turn the call over to Bill who will provide additional background related to our credit risk position.

Thank you, Denis. We continue to realize significant improvements to our credit risk profile in the fourth quarter of 2011. Net charge-offs is totaled $10.1 million in the fourth quarter, as compared to $4.4 million in the third quarter of 2011 and $25.2 million in the fourth quarter of 2010. Non-performing assets is totaled $195.6 million at the end of the fourth quarter compared to $223.3 million in the third quarter of 2011 and $302.8 million in the fourth quarter of 2010 or a year-over-year decrease of 35.4%. The fourth quarter decrease was attributable to $26.3 million in repayments, $6.2 million in restored to accrual status, $5.2 million in charge-offs and partially offset by $11.9 million of additions to non-performing assets. Non-performing construction and development loans is totaled $123.1 million at the end of the fourth quarter, which represented 62.9% of the total non-performing assets and decreased from $146.5 million in the third quarter of 2011. Total construction and development loans were $148.4 million at the end of the fourth quarter or 7.2% of the total loan portfolio. This represented a decrease of $32.9 million from the third quarter of 2011 and a decrease of $151.5 million from the fourth quarter of 2010 or a year-over-year decrease of 50.5%. A $21.9 million allowance for loan-and-lease losses in this portfolio segment which held at the end of the fourth quarter, representing 14.8% of the total construction and development loan balance. Troubled debt restructuring is totaled $84.4 million for the fourth quarter. An increase of $3.9 million from the third quarter of 2011. Of this, $76.1 million or 90% of our TDRs are a non-accrual status. Our TDRs are comprised of $41.6 million in residential mortgages, $41.8 million in Hawaii commercial real estate, and $1 million in other loans. Loans delinquent for 90 days or more still accruing interest totaled $28,000 in the fourth quarter compared to $40,000 in the third quarter of 2011. Loans delinquent for 30 days or more still accruing interest increased to 5.4 million in the fourth quarter from $4.5 million in the third quarter of 2011. The allowance for loan and lease losses as a percentage of total loans and leases decreased to 5.91% at the end of the fourth quarter from 6.96% of the third quarter of 2011. The allowance for loan and lease losses as a percentage of non-accrual loans was 100% at the end of the fourth quarter compared to 89.3% at the third quarter of 2011 and 91.8% at fourth quarter 2010. Our ongoing program to reduce non-performing assets and reduce our construction and development credit risk exposure, continued to show positive progress through the fourth quarter. In 2012, we remained focused on maintaining our progress on improving our credit risk profile. That completes our credit quality review, and I would now like to turn the call back to John.

Thanks, Bill. In summary, the progress achieved by our organization last year provides a strong momentum to meet the challenges that lie ahead in this New Year. We look forward to 2012 with a continued focus on strengthening our customer relationships, developing new business, and improving core earnings. At this time, we’d be happy to answer any questions you may have.

We will now begin the question and answer session. [Operator instructions]. And our first question comes from Joe Morford of RBC.

John, congratulations on all the improvements you made last year.

Thanks, Joe.

Two questions, first is just on the outlook for the margin. Obviously, it had a nice pop this quarter, but you’ve now deployed a lot of your excess liquidity. Maybe you have a bit more FLV event that’s maturing. But your funding calls were already down a lot while earning asset yields continue to erode. So, do you think you can hold this level for the margin or might we see some gradual compression through 2012?

Yes. Let me pass it over to Denis, Joe, if I may, our CFO. Denis?

Yes. Joe, we’re expected to pretty much hold where we are. We see a little bit of opportunity to lower our cost of funds a little bit. But it’s pretty much going to hold right about where we are now.

Okay. And the other question was on expenses, can you talk about the reason for the increase Mortgage Putback Provision this, quarter? And going forward, if you can -- excluding some of the noise we saw in the fourth quarter. What would be a good run rate to build off the total level of expenses in the first quarter?

I’m going to turn it to Bill if I can, Joe.

I can speak to the mortgage repurchase. I think I’ll pass it over to Denis to talk the last part of your question. On the mortgage repurchase provision, the provision amount itself actually was a small reduction quarter-on-quarter. The increase in the provision reflected the charge-offs that were taken from that provision in the quarter.

The second part, Joe, again of the question?

It’s just kind of what’s a good run rate for total level of expenses in the first quarter given some of the noise we saw this quarter?

Yes. We’re looking at a run rate between $36 million and $38 million.

The next question is from Joe Gladue of B. Riley.

I guess I’d like to follow up on one of Joe’s questions about the net interest margin a little bit more. You’re still generating a good amount of deposits and I guess in the third quarter, most of that, I guess really replaced the home-loan bank borrowings that you repaid. But have you continued to generate that amount of deposits I guess -- just wondering what the outlook is for deploying those deposits at decent margins.

I’ll start and then -- pass it over to Denis. I don’t think were just similar for many of the financial institutions in the country today, Joe, in the sense that just where the yield curve is. So I think anyone is going to struggle in terms of good margin, at least in the near future this year, and probably through ’13. So we continue to see growth in our core deposits, and obviously, we’ll look at either redeploying them, not just into what I would say loan assets, but also in terms of the investment portfolio. So I don’t have maybe -- as a prediction in terms of what that might be of the specific impact on the margin. But obviously, where challenge is -- all other financial institutions given where we are with this yield curve. Denis?

That’s pretty much it, Joe. There’s not much more we’re going to add. We’ll look at -- to play as much as we can into loans, and as fallback into the investment portfolio as we can liquidate or can find the volume in loans.

Okay. All right. And I guess, speaking of loans, again, you had another nice decrease in the construction segment, but still manage to -- I guess show some over-all growth in the portfolio. Just wondering if -- as the construction portfolio gets smaller and smaller when you think that that segment will flatten out and I guess allow for I guess more noticeable growth in the overall portfolio?

Well we have to look at the NPAs in that portfolio and Bill could probably give you the specifics of that. But while we continue to reduce the NPAs which will continue to reduce that sector of the loan portfolio, we’re still looking for business in construction and development. So while there’s not -- there’s a paucity of lending opportunities in the sector in Hawaii today, doesn't mean there won’t be some that we won’t be able to participate in. So growth in other portfolio, I think we showed good progress last year. Appreciate we were out of the market for 2, 3 years, and it takes time to rebuild relationships in terms of being proactive and calling, and looking out not only for new business, but looking for opportunities to our existing client base. So while you don’t see the numbers growing significantly, in fact we were just up a little bit over third quarter I believe, I think we’ll show relative market this year, some good progress. And with that -- I don’t know if you want the specific numbers from Bill. Bill, you want to -- in terms of the NPAs with regard to maybe -- I don’t know if you have Hawaii there and mainland.

I just got details -- actually out of the presentation up on the website, but most of our NPAs on the construction side in Hawaii and residential construction, books are very clean on the commercial construction side. Like John mentioned, it’s more a reflection of the levels of business activities in the current environment.

Okay. All right. I guess I’d also like to follow up on Joe’s other question just about expenses just with, I guess, a question about the contributions to the charitable fund. Should we consider that more of an, I guess, ongoing quarterly event? Or is that something that’s going to, I guess, regress to more of a once a year kind of thing?

I’m going to use Joe Morford’s comment earlier, a lot of noise fourth quarter. If you look at the 4 quarters, there’s a lot of noise in the numbers as we reposition the bank. So wherever we could, we invested last year and this year and years to come. So, obviously, the foundation is an acceptable benefit, the bank as it remains involved in the community here. But look to that asset as primarily as one where we’re looking in terms of the yield on those, that foundation, in terms of giving back to the community. So I don’t see us necessarily making the kind of contributions this year that we made last year. It wasn't just a foundation in third and fourth quarter. If you go back to third quarter, we pre-paid the Federal Home Loan Bank of Seattle. It was a 100, 136? 130, what?

120.

120, excuse me. I was close there. But we pre-paid that. I think there was a charge of $6.2 million, $6.3 million in the third quarter. So, a lot of one-time hits. So what I’m trying to leave you with is we’re positioning not just for ’12, but ’13 and ’14. And the contribution this fourth quarter, past fourth quarter and third quarters were part of that overall positioning of the bank for the future.

Okay. All right. I’ll ask one more and then step back. Just wondering if you could tell us what the 30 to 89-day delinquencies were at the end of the quarter.

The 30...

30 to 89.

Yes, 30-day, 30 to 90 were $5.4 million.

The next question is from Aaron Deer of Sandler, O’Neill & Partners.

I also want to extend my congratulations on a really remarkable turnaround you guys managed this past year. Following up on the outlook for growth, can you give any kind of in terms of where the pipeline or new business stood at the end of the year relative of where it was at September 30?

Well, I think best to comment on the pipeline is that, you compare the pipeline at CPF at the end of last year versus 12 months ago, I think we’ve made significant progress, but again appreciate in those familiar with just when you’re in the special corporate lending, the time it takes to reposition institution that was primary focused on survival and in working the NPAs out of the bank. So, Bill and then Lance who heads up corporate banking for us, Lance Mizumoto, would tell you that last year, and we expect into this year that we’ll see account officers rolling out of those departments and back into the line. So you’re not going to see the numbers that we’re releasing, obviously, but I’d leave you with excellent progress made and refocusing the bank from a defensive position. And when I say offense, then I’d say cautiously, but proactive now in the market in calling. But we can only do so much in terms of that portfolio. Obviously it’s going to be a function of the economy. It’s going to be a function of loan demand. And again it’s direct to the country that this day too it is struggling in terms of loan growth.

Okay, so that is helpful. And then on the -- in terms of the margin, I would just kind of reconcile the guidance that is kind of flattish going forward. I’m curious about in the fourth quarter, the yield on your taxable securities prompted I think over 30 dips sequentially obviously pretty steep. I’m wondering if there was premium amortization or something in there that might decline here going forward on what kind of yield your getting on the new investments in that book?

I’m sorry, Aaron. Could you -- for some reason we’re having a bit of trouble hearing you. Could you repeat the question?

Sure. I’m curious about the yield on your taxable securities. It was down pretty meaningfully in the fourth quarter. I’m wondering if there was premium amortization or something that caused that to be a steeper drop than we might have seen otherwise. And then going forward, can you give us a sense of what kind of yields you’re getting in that portfolio now?

Sure. Let me pass it over to David who is with us. David Morimoto our treasurer.

Aaron, yes, in the fourth quarter, we did see a pick up like most banks did in the amortization on the MBS and CMO portfolio. During the fourth quarter, we also executed a bond swap trade where we went down a coupon to try to better manage the premium amortization risk going forward. So we think the down in coupon trade will help mitigate that risk going forward. So, we’re pretty comfortable that we can try to stabilize the investment portfolio yields at its current level. As far as new purchases, they are coming in pretty close to where the portfolio yield is currently. We’re in the low 2% range on new purchases on average.

That answered it, Aaron?

Yes, it sure did. And then just one final question. If you can give us an update on where the recoverable value of the DTA allowance stood at year-end?

At year-end? It’s $162 million.

And the next question comes from Jacky Chimera of KBW.

I’m just looking to -- I know there’s dip on the non-interest expense but looking to the run rate in the salaries, was that true-up of that year-end or did that also incorporate some salary increases for employees?

I’m going to turn it over to Denis in terms of the question. Denis?

Yes. That was just kind of a true-up on some of the incentive plans that we have.

Okay. So, is that roughly 14.5 million, 15 million levels that we’ve been prior quarters, more of a go-forward level?

Yes. It’s probably closer to where we’ll be.

Okay. And then, I know you have 15 million in the FHLB borrowings that are set to mature in the next few years, I believe. What’s the current rate on those?

This would be the remaining FHL federal home loan bank borrowing?

Yes.

I’d say, David?

Jacky, there is a 50 million that was on the book at year-end. But it actually matured in January, earlier this month. It was yielding about 60 basis points.

Okay. Great. And then just one last question, I wanted to see just given the fluctuation and the gain on sale income that you have in between the 2 quarters. And I know in the prior quarter you’d made the decision to portfolio a lot of loans that you might have otherwise sold. What plays into that decision to portfolio versus sell?

I think as you manage the balance sheet in terms of yields, and again, I am going to go back to what I said earlier with it, the earlier question, which is everyone is challenged today in terms of the overall yield curve. And I should’ve said earlier that the challenge is not just the yield curve but as you go out on the yield if they’ve got any additional -- or better pricing, obviously, you get more and more duration risk. So I don’t know if Denis has something to add to it or not, but obviously, we’re in a process of trying to continue to position of the bank not just for this year but over the next 2, 3 years managing both the risk and the portfolio but also to include duration risk. Denis?

Yes. I really don’t have much more to add to that. During the quarter though, Jacky, we just used the numbers, we’ve originated about $337 million and we portfolio just $66 million and we sold the rest. And that’s what drove the gain on sale up.

The originated $337 million, and I’m sorry, you kept how much?

$66 million.

Do you happen to have those numbers from the prior quarter originations on what you kept?

Yes, the third quarter origination is 258 and the portfolio is 114. We’ve portfolio a lot more in the third quarter.

This concludes our question-and-answer session. I would now like to turn the conference back over to John Dean for any closing remarks.

Thanks, Lara. I would just like to thank everyone for participating in our fourth quarter 2011 earnings call. And we look forward to feature opportunities to update you on our progress. Have a good day.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.