Central Pacific Financial Corp. (CPF) Q2 2012 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. Thank you for standing by. And welcome to the Central Pacific Financial Corp.’s Second Quarter 2012 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, Laura. And thank you all for joining us as we review our financial results for the second quarter of 2012. With us today are John Dean, President and Chief Executive Officer; Denis Isono, Executive Vice President and Chief Financial Officer; and Bill Wilson, Executive Vice President and Chief Credit Officer. During the course of today’s call, management may make forward-looking statements. While, we believe these statements are based on reasonable assumptions, they involve risks that may cause actual results to differ materially from those projected. For a complete discussion of the risks related to forward-looking statements, please see our recent filings with the SEC. And now, I will turn the call over to John.

Thank you, David, and good morning, everyone. In the second quarter, we continued to make solid progress toward our business objectives. And I’m pleased to report a six consecutive quarter of profitability since the re-capitalization of our company. Significant improvements continued to be made to our credit risk profile, resulting both in further reduction of our allowance for loan and lease losses, and in a positive impact to our earnings. Although, there are several large non-recurring expense items in the quarter, which will be covered in more detail in our financial report to follow. Core earnings improved over the same period last year. We also achieved solid growth on our balance sheet, both in loans and deposits, and our capital position remained strong. Overall, we are well on track with our business plan for 2012 throughout all areas of the bank. Our management and employees continue to focus on rebuilding our organization towards a full recovery. Turning to our local economy, our visitor industry has been the driver of Hawaii's economy, as it begins to gain momentum. We’re encouraged by the increasing visitor industry activity and expanding airline capacity, which has occurred since the beginning of the year, particularly in the international market. Year-over-year increases in total number of visitors to Hawaii returned to double-digit percentages in the three-month period from March to May, with gains of 12.9%, 11.3% and 12.2%, respectively. Visitor spending increased likewise in the same period by 18.9%, 26.7% and 17.5%. The unemployment rate in Hawaii has increased slightly to 6.4% from 6.3% in a prior month, but was down from January of this year where it was at 6.5%. With the surfacing of new mixed-use construction projects in Kaka'ako and residential developments in West and Central Oahu, together with the $5 billion elevated rail system and the positive trends in our visitor industry, the unemployment rate is expected to decline for the remainder of the year. A recent forecast by the State Department of Business and Economic Development for Tourism had the following year-over-year increases in 2012. 6.5% for visitor arrivals, 9% for visitor expenditures, 1.7% for real personal income, 1.5% for job growth and 2.2% for real GDP. At this time, I would like to ask Denis Isono, our Chief Financial Officer to review the highlights of our second quarter financial performance. Denis?

Thank you, John. For the second quarter of 2012, we reported net income of $10.8 million or $0.26 per diluted share, compared to net income of $13.5 million or $0.32 per diluted share reported last quarter. The sequential quarter decrease was due to the recognition of a few non-recurring charges to non-interest expense during the quarter. I'll provide further details on this line -- on these items later in this call. As John previously mentioned, we benefited from a reduction in our allowance for loan and lease losses, which resulted in a credit provision for loan and lease losses of $6.6 million, compared to credit of $5.0 million in previous quarter. The result in our allowance was a -- the reduction in our allowance was a result of continued improvement in the historical quarterly charge-off data used to calculate the allowance and an overall improvement in the company's credit risk profile, as evidenced by the fact that we reduced our non-performing assets by $35.3 million during the quarter. Bill Wilson will report more details about our credit risk profile later in his report. Net interest income for the quarter was $30.3 million, compared to $30.5 million in the previous quarter, and our net interest margin was 3.17% and 3.23% for the same respective quarters. The sequential quarter decrease was primarily due to lower yields on our interest earning assets. During the quarter, our investment securities portfolio decreased by $14 million to approximately $1.6 billion, due primarily to maturities offset by purchases of municipal and corporate securities totaling $86.3 million. At June 30, 2012, our municipal and corporate securities accounted for less than 8% of our investments securities portfolio. However, we expect to gradually increase our investments -- portfolio allocation to investment grade and municipal and corporate securities over the coming quarters, as we continue to look for opportunities to improve the overall yield on our investment portfolio. Non-interest income for the quarter totaled $13.6 million, up from $13.2 million in the previous quarter. The sequential quarter increase was primarily attributable to higher gains on sales of residential mortgage loans. Non-interest expense for the quarter totaled $39.7 million, up from $35.2 million in the previous quarter. The sequential quarter increase was attributable to an accrual totaling $1.8 million related to the settlement of a legal proceeding against us. Higher amortization expense resulting from a $900,000 write-off of certain intangible assets, higher credit related charges of $1.1 million, and higher salaries and benefits of $1 million. These amounts were partially offset by a lower provision for repurchased residential mortgage loans of $1.4 million. Our adjusted efficiency ratio for the quarter, which excludes foreclosed asset expense, and the amortization of certain intangible assets was 80.4%, compared to 75.0% in the previous quarter. Our deferred -- our net deferred tax asset balance at June 30th totaled $155.1 million. Because we continue to have a full valuation allowance established against this entire amount, we did not recognized any income tax expense for the quarter. At June 30, 2012, our capital ratios continued to exceed the minimum levels required by both the memorandum of understanding that we entered into with our regulators and the levels required for well-capitalized regulatory designation. Our Tier 1 risk-based capital -- total risk-based capital and leverage capital totals were 23.04%, 24.32% and 14.12%, respectively, compared to 22.83%, 24.13% and 14.03%, respectively, at March 31, 2012. That completes our financial summary and I’d now like to turn the call over to Bill, who will provide additional background related to our credit risk profile. Bill?

Thank you, Denis. We continued to realize improvements in most areas of our credit risk profile in the second quarter of 2012. Non-performing assets totaled $170.3 million at the end of the second quarter, compared to $205.6 million in the first quarter of 2012 and $249.3 million in the second quarter of 2011, or a year-over-year decrease of 31.7%. The second quarter decrease in non-performing assets was primarily attributable to $38.9 million in reductions, which were partially offset by $3.7 million in additions. The reductions are represented by $24.4 million in repayments, $5.9 million return to accrual status, $3.1 million in the sales of foreclosed properties, $1.6 million in write-downs and $4 million in charge-offs. Non-performing construction and development loans totaled $103.3 million at the end of the second quarter, which comprised 60.7% of total non-performing assets and decreased from $126.3 million in the first quarter of 2012. Troubled debt restructuring totaled $67.6 million for the second quarter, a decrease of $13.2 million from the first quarter of 2012. Our TDRs are comprised of $38.9 million in residential mortgages, $22.5 million in Hawaii Commercial Real Estate and $6.2 million in other loans. Net charge-offs totaled $3.9 million in the second quarter, as compared to $2.8 million in the first quarter of 2012, and $2.3 million in the second quarter of 2011. Loans delinquent for 90 days or more still accruing interest totaled $505,000 in the second quarter, compared to $208,000 in the first quarter of 2012. Loans delinquent for 30 days or more still accruing interest decreased to $3.8 million in the second quarter from $6.2 million in the first quarter of 2012. The allowance for loan and lease losses as a percentage of total loans and leases decreased to 4.94% at the end of the second quarter from 5.49% in the first quarter of 2012. The allowance for loan and lease losses as a percentage of non-accrual loans was 93.9% at the end of the second quarter, compared to 80.4% at the first quarter 2012 and 80.8% at the second quarter 2011. As noted earlier in my remarks, our ongoing program which reduced non-performing assets and reduced our construction development credit risk exposure, demonstrated positive progress in the second quarter was a $35.3 million net decrease in non-performing assets and a $41.1 million net decrease in construction and development loans. We anticipate that we will able to continue our progress in improving asset quality over the balance of the coming year. That completes our credit quality review and I would now like to turn the call back to John.

Thank you, Bill. In summary, we continue to make significant progress since the re-capitalization of our company and we’re well on track to achieving our 2012 objectives. Our priorities continue to include, further improving our credit risk profile, enhancing our information management systems, maintaining a highly competitive sales and service structure, and expanding core earnings. At this time, we are happy to answer any questions you may have.

[Operator Instructions] And our first question comes from Joe Morford of RBC Capital Markets.

I guess first couple of questions on credits, unless I missed it. Can you tell us what the classified assets did in the quarter and then maybe update us on the status of the large mainland loan that they went into non-performance last quarter?

Sure. Classified assets are down about $50 million in the quarter. And the large asset that moved to non-performing in the first quarter is currently in negotiations with a potential settlement prior to year-end.

Great. And then foreclosed property expense back up to $2.5 million as far as this quarter. How did that breakout between any loss on the OREO sales, on write-downs, on updated appraisals and ongoing operating expense and, John, what do you see as a good run rate going forward to this one?

Well, that’s a tough one. We did have -- in the write-down as I mentioned earlier we wrote-down $1.6 million in OREO write-downs in the quarter. The rest of that question, I just don’t have that information in my fingertips. Can we get back to you later, Joe?

No problem. Maybe instead then any current thoughts on the margin going forward given the ongoing pressure on loan and investment yields, and based on this quarter looks like maybe funding cost may finally be starting to bottom out?

Okay. I’ll take that one, Joe. And that just like all other banks, we’re going to continue be under pressure. In terms of the margin going forward. Longer-term, we see opportunities obviously as Bill and his team continue do good job and lowering our NPAs, again 170 this quarter, that’s going to help as we invest those moneys at any rate above zero. And then loan growth, we did have -- I saw good loan growth this quarter. You got to take in account that a large part of that loan growth is catching up on whatever build us to runoff to non-accruals. We’ve got put that back on before we get to zero. So, we think we had a good quarter. We think the pipeline is good. But like all other banks, we’re going to continue to be under pressure just given the yield curve and the competitive nature of the market today for good credits.

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

Let me follow-up a little bit on Joe’s last question on the margin just seeing a still increasing liquidity balances on the balance sheet. You think there’ll be enough, I guess loan growth to maybe redeploy some of that liquidity?

But it’s going to be functional. So the growth – you have to look not just as you know the margin but also net interest income, the balance sheet is growing and expense growing little bit faster on the deposit side that’s going to have -- on margin it’s going to have a negative impact not necessarily in terms of net interest income. So, it’s hard to predict loan growth going forward and in part, it’s going to be a function of the economy here. And as I mentioned in my comments Joe, we’re cautiously optimistic in terms of what we see in the state of Hawaii. There is a lot of -- tourism is the primary engine, it looks very good right now. But typically, you are looking for construction to follow and that engine while there’s construction going on its not as strong as it has been in the past or as we’d like to see. So with that, we have to look for other opportunities within this market, but at the same time being prudent. So, Lance, who is here on this call with us, he would tell you that the pipeline looks good, a lot of works been done and we think we made good progress this past quarter. So, I am going to use the term again if I may. We’re cautiously optimistic in terms are going forward. But I can’t tell you to the extent that we are going to be able to sop up all that excess liquidity. We have also done some work if you look and what we talk about Denis, in terms beyond investment portfolio is looking at munis and corporates and I think that’s about 8% today. And we’re going to see some growth in that which should also positively impact our margin.

Okay. Just wondering if you could, I guess, give a little more detail on the intangible for write-off during the quarter, what was that?

Only it just a -- it’s an investment we made in prior years that obviously as we go into to clean up the balance sheet if I may, that we don’t see revenues from that to justify keeping it and so we just accelerated the write-off of that intangible.

And the next question is from Aaron Deer of Sandler O'Neill & Partners.

I think my questions are mostly follow-ups. And one is, you mentioned the pipeline -- can you give us a sense of where that stated period relative to March 31?

I apologize and -- voice, we didn’t pick up at the beginning.

Sorry, just looking to see if I could give where the pipeline stands today maybe relative to three months ago?

In terms of the pipeline?

Yes.

I am going to have the Lance Mizumoto who is with us. He is our Chief Banking Officer, in terms of -- he just gave me thumbs up, but maybe Lance, you can spend a minute on the pipeline.

Good morning, Aaron. This is Lance. If I look at the pipeline, I would say that our pipeline compared to the last quarter is higher. We’ve seen some run-offs or pay-downs. But I think that we’ve seen some growth in both the commercial real estate and C&I portfolio of the pipelines.

Okay. Thanks, Lance. And on the expenses, you noted the amortization. I’m wondering that the legal accrual which has this forum, I guess another just a one-time thing and it won’t be recurring and maybe if you just confirm that. And then absent some of those items that were discussed that OREO expense in the quarter, the legal, the amortization. When you back out at around $32 million in the second quarter for kind of core expenses. Is that going to bring those down at this point or is that going to, kind of, flattish and you’re going to grow into that in a revenue side, what are your thoughts there?

I’ll let Denis start.

Okay. On the legal fees, yeah, that is a one-time accrual for a liability we incurred. And the expense item, we’re expecting it to kind of stay at that level once it gets down there 32 to 35 somewhere in there, as we go forward.

But longer term obviously if you look at our efficiency ratio, it’s not where it need to be. And but as Denis said, going forward this year, we don’t see any significant reductions. But if you look at a lot of the programs we have in place, I mentioned at the management information systems, automating some of the paper we have in place today. We’ve got a lot of work to do, in terms of improving that efficiency ratio. It’s not all going to come on expense side. It can’t as you pointed out, Aaron. We’re going to have to look for revenue growth too, to get there. But to get down into the 50s is a long-term plan and so over the next few years.

Okay. That’s great. And then just lastly on the capital front, first any sense of timing on the DTA recapture and when that does come back you are going have, just be pretty significantly over-capitalized. Thoughts and how you might manage that down to a rationale level given aside from just growing organically?

Yes, Aaron. Right now, we’re working on the return of the DTA and we’re looking at sometime in the first part of next year for that to happen, likely in the first quarter. As far as the capital issues we’re humming around this to look at that and analyze that as a team and driving out whether -- figure out what the options are. Right now, we’re kind of limited because of the regulatory orders that we’re under.

So as Denis said, publicly got the MOU, but you know as well as ourselves, there is obviously available to us as the purchasing of back of our shares. Another would be as large cash dividend. So, we’ll consider it but frankly, the focus has been more on getting the bank in a stronger position from a strong balance sheet, fortress balance sheet and improving earnings. And then will be next year, when that DTA becomes available. We think.

And the next question is from Jackie Chimera of KBW.

Just to follow-up quickly on Aaron’s question on the DTA, when you -- and I know it’s all speculative at this point, when you say 1Q, '13 would you expect to partial recovery at that point or would you expect the full recovery?

We’re working on that now with our accountants. We focused on timing. And as we look at it forward, we’re not sure how much of that will come forward -- will get recognized. It could be all of it, could be a majority of it, could be a little of it.

We’d like all of it. We’re working towards that. But as Denis said we just don’t know at this point in time.

Yes, that make sense. I know that, we’ve seen this smattering of many different types of that so. And was there anything unusual in the salary increase linked quarter?

I’ll take it. It was a through-up of a bonus accrual primarily one-time. And so we have done very well this year in the plan. And if we can hit certain hurdles and not until certain hurdles are hit, would we consider payouts. So that’s where it is. And it’s again tied to a plan we believe we’ll be achieving. So really it was a true up for first and second quarter.

Okay. So then third quarter, would go back to more at the 1Q level perhaps a little higher assuming things are still moving along and you have the third quarter’s bonus in there?

Certainly, we’re doing well. I would say if you take that what we did in the second quarter divide by two is what you might get in the third quarter.

And then I am not sure, if you will able to do this. But are you able to provide any just very generic color surrounding the legal accrual you had in the quarter maybe what type of legal action?

No. I preferred not to, Jackie, other than to assure you that it’s a one-time event and so it’s not operating, and it should not be recurring. And it’s clean up some things in this organization that occurred in prior years.

[Operator Instructions] Showing no further questions, I will turn the conference back over to John Dean for closing remarks.

Thank you. Thank you very much everyone for participating in our earnings call for the second quarter 2012. And we look forward to future opportunities to update you on our progress. Have a good day.

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