Central Pacific Financial Corp. (CPF) Q3 2012 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. Thank you for standing by and welcome to the Central Pacific Financial Corp. Third Quarter 2012 Conference Call and Webcast. [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 would like to turn the call over to Mr. David Morimoto, Senior Vice President, Investor Relations. Please go ahead, sir.

Thank you Justin, and thank you all for joining us as we review our financial results for the third 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'll turn the call over to John.

Thank you, David, and good morning, everyone. We are pleased to report that our company continued to make good progress on our 2012 business plan. Since our recapitalization in February 2011, we've realized 7 consecutive quarters of profitability. And year-to-date profitability in 2012 is up by 43% over the same period last year. Quarter-over-quarter, we continue to strengthen our balance sheet with a substantial reduction in non-performing assets. The continued improvement in our credit risk profile, once again resulted in a reduction of our allowance for loan and lease losses and a positive impact on earnings. Core earnings for the bank remain strong. The prolonged slow interest rate environment has been a challenge for our industry. In addition to pursuing loan production, we repositioned our investment portfolio to reduce net interest income volatility and to potentially improve our net interest margin and earnings in the longer-term. Our capital ratios remain strong in excess of the regulatory, well capitalized minimum levels. As the regulatory changes affecting capital and liquidity requirements under Basel III are being finalized we do not anticipate any major concerns due to our strong capital position. Turning to our local economy; growth in our visitor industry have continued at a brisk pace. The current forecast by the Department of Business and Economic Development and Tourism, in Hawaii, forecast increases in visitor arrivals and visitor spending in 2012 over 2011, of 8.6% and 15.1% respectively. The unemployment rate in Hawaii has decreased from 6.1% in August to 5.7% in September, which is the lowest it's been since December 2008. Other economic indicators, including job growth, real GDP and real personal income continue to reflect a modest and stable expansion in Hawaii’s economy. We are encouraged by the developing mixed use construction projects planned for Kaka’ako as well as for West and Central Oahu. Overall, with the economic conditions in Hawaii improving, we are well on track with your business plan for 2012, throughout all areas of our bank. At this time, I would like to ask Denis Isono, our Chief Financial Officer to review the highlights of our third quarter financial performance. Denis?

Thank you, John. For the third quarter of 2012, we reported net income of $10.7 million or $0.26 per diluted share compared to the net income of $10.8 million and $0.26 per diluted share reported last quarter. As John previously mentioned, we benefited from a reduction in our allowance for loan and lease losses which resulted in a credit to the provision for loan and lease losses of $5.0 million, compared to credit of $6.6 million reported in the last quarter. The reduction was a result of continued improvement in the historical quarterly charge-off data used to calculate the allowance and a $30 million decrease in our non-performing assets during the quarter. Bill Wilson will provide more details about our credit risk profile later in this call. Net interest income for the quarter was $29.6 million compared to $30.3 million in the previous quarter. Our interest margin was 3.02% and 3.17% for the same respective quarters. The sequential quarter decrease was primarily due to lower yields on interest earning assets resulting from the depressed interest rate environment. We expect to see continued pressures on our net interest margin during the fourth quarter of 2012 and into 2013 as rates remain at these low levels. Additionally, the accounting for an interest rate swap we terminated in September 2009 affected net interest income. When we terminated the interest rate swap, the accounting rules required recognizing the gain using the effective yield method. The rules provided a gain of $5 million to be recognized at the time of termination and an amortization of the remaining gain over the original life of the interest rate swap. Since the original agreement with tours[ph] in January 2013, the effective yield method accounting will affect the next 2 quarters. The adjustments for the next 2 quarters will now material with lower net interest income by roughly $500,000 per quarter. During the quarter our investment securities portfolio increased by $30.3 million to approximately $1.66 billion. In September, we completed an investment portfolio repositioning to help reduce net interest income volatility and enhance the potential for perspective earnings and an improved net interest margin. We sold $125 million in available for sale mortgage backed securities with an average net yield of 0.60% and reinvested the proceeds in $133 million of similarly typed investment securities with an average net yield of 1.88%. The mortgage backed securities sold had higher interest rate coupons and faster prepayment speeds than the mortgage securities purchase. A pretax gain of $700,000 was recognized on the transaction. At September 30, 2012, our municipal and corporate securities accounted for approximately 12% of our investment securities portfolio. We expect to gradually increase our investment allocation to these sectors over the coming quarters, as we continue to look for our opportunities to improve the overall yield on our investment portfolio. As John mentioned earlier, despite the fact that we reduced our non performing assets by $30 million during the quarter, our loan and lease portfolio increased by $9 million and now stands at $2.11 billion at September 30, 2012. We continue to evaluate and pursue opportunities to grow loan portfolio in an attempt to improve our overall asset yield. Non-interest income for the quarter, totaled $15.9 million, up from $13.6 million in the previous quarter. The sequential quarter increase was primarily attributable to higher gains on sales of residential mortgage loans of $1.3 million and the investments securities gain mentioned earlier. Non-interest expense for the quarter totaled $39.8 million, up from $39.7 million in the previous quarter. The sequential quarter increase was attributable to higher net credit related charges of $4.8 million, partially offset by an accrual of $1.8 million liquidity in the second quarter related to the settlement of a legal proceeding against us. Our reduction in our reserve for repurchased residential mortgage loan totaled $1.3 million and lower legal and professional services of $1.0 million. Our adjusted efficiency ratio for the quarter, which excludes foreclosed asset expense and the amortization of certain intangible assets was 78.5% compared to 80.4% in the previous quarter. Our net deferred tax asset balance at September 30, 2012, totaled $148.3 million, because we continue to have a full valuation allowance established against this entire amount we did not recognize any income tax expense for the quarter. As we have communicated previously, we continue to work toward reporting 8 quarters of profitability before we can consider reversing this valuation allowance. With this quarter’s results we continue to anticipate reversing of significant portion of this valuation allowance in the first quarter of 2013. At September 30, 2012 our capital ratios continued to exceed minimum levels required by both the Memorandum of Understanding that we entered into with our regulators and the levels required for a well capitalized regulator designation. Our Q1 total risk based capital and leverage capital ratios were 23.34%, 24.63% and 14.06% respectively, compared to 23.04%, 24.32% and 14.12% respectively on June 30, 2012. That completes our financial summary, and I would 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 continue to realize improvements in most areas of our credit risk profile in the third quarter of 2012. Non-performing assets totaled $140.3 million at the end of the third quarter, compared to $170.3 million in the second quarter of 2012 and $223.3 million in the third quarter of 2011 or a year-over-year decrease of 37.2%. The third quarter decrease in non-performing assets was primarily attributable to a $33 million reduction which were partially offset by $3 million in additions. The reductions are represented by $11.9 million in sales of foreclosed properties, $11.7 million returned to accrual status, $5.1 million in repayments, $2.2 million in write downs and $2.2 million in charge-offs. Non-performing construction and development loans totaled $88.5 million at the end of the third quarter representing a decrease of $14.8 million or 14.3% from the second quarter of 2012. These non-performing construction and development loans comprise 63.1% of total nonperforming assets. Total debt restructurings totaled $73.9 million for the third quarter, an increase of $6.3 million from the second quarter of 2012. Non-accrual TDRs totaled $49 million and accruing TDRs totaled $24.9 million. Our TDRs are comprised of $37.2 million in residential mortgages, $30.8 million in Hawaii commercial real estate and $5.9 million in other loans. Net charge-offs totaled $1.9 million in the third quarter, as compared to $3.9 million in the second quarter of 2012 and $4.4 million in the third quarter of 2011. Loans delinquent for 90 days or more still accruing interest totaled $508,000 for the third quarter compared to $505,000 in the second quarter of 2012. Loans delinquent for 30 days or more still accruing interest increased to $5.7 million from the third quarter from $3.8 million in the second quarter of 2012. The allowance for loan and lease losses as a percentage of total loans and leases decreased to 4.59% at the end of the third quarter from 4.94% in the second quarter of 2012. The allowance for loan and lease losses as a percentage of non-accrual loans was 104.3% at the end of the second quarter, compared to 93.9% at the second quarter 2012 and 89.3% at third quarter 2011. As noted earlier in my remarks, our ongoing program to reduce non-performing assets and reduce our construction, development, credit risk exposure demonstrated positive progress to the third quarter with a $30 million net decrease in non-performing assets at a $14.8 million net decrease in construction and development loans. We anticipate that we will be able to continue our progress in improving asset quality over the final quarter of this year. That completes our credit quality review. I would now like to turn the call back to John.

Thank you, Bill. In summary we're very pleased with the continued progress we're making on our business plan toward a full recovery of our company. Our priorities continue to be on further improving our credit risk profile, enhancing our information management systems, maintaining a highly competitive sales and service structure and improving core earnings. At this time, we're happy to answer any questions you may have.

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

Couple of questions. First, just a quick one on the securities restructuring, is that something you are considering doing additional restructurings going forward or is this more of kind of a one off?

This is going to be one off, Joe. We got an opportunity for getting, selling a portion of higher coupon [indiscernible] prepaying NBSs and we bought lower coupon slower prepaid so an opportunity just to realize the gain.

Right, okay. The other question was just wondering if you could talk bit more about some of the foreclosed property expenses and I guess specifically why this is still running high actually may increase given the balances continue to decline and then also with the write down of assets this quarter just curious how many properties does that involve and what are you generally seeing in terms of values on updated appraisals and things like them.

So we are going to get that one to Bill.

That was kind of a compound question but I think I got most of it. The number of properties was fairly large a lot of fair amount of granularity during the quarter as far as disposals happen. We are achieving generally at or above carrying values on most of our disposals. We still do have a couple of larger NPAs in the portfolio both in the loan section and [indiscernible] loan section and in the [indiscernible] section and where we do tend to see some higher costs generally as a result of valuation adjustments in those larger assets.

Did that answer your question, Joe?

A little, I guess so it sounds like then some of those right downs were just with a couple of these larger properties?

For the most part, yes.

And then just the overall level this foreclose asset expense 2.9 million, is that likely to start trending down given the decline of the balances and maybe broadly speaking to just talk about overall expectation for expense levels going forward?

I would think on the foreclosed assets expense, we should probably see that trend down, the pipeline as far as asset disposals would suggested the additional expenses should continue to decrease over time.

Our next question comes from Aaron Deer with Sandler O'Neill & Partners.

Obviously, this rate environment is making it tough on the asset yields and I am wondering with respect to the new loans that you are putting on the books. Can you just talk a little bit about the pricing that you're able to get in the market both on commercial real estate, fixed and floating rates, BNI[ph] and also the residential loans putting up?

Aaron, its John here, and I am going to start and turn it over to Bill, who sees quite a bit in the in terms of the management loan committee, but this is a very competitive market in terms of good quality assets but no different from the rest of the United States I think, where the demand for good quality loans is great and obviously there is just not that much in terms of availability but maybe Bill you can drill down a little bit on that pricing we are seeing.

So I think as John said that the pricing is competitive. We are seeing most of our commercial real estate clients are opting for fixed rates and we think it’s in their best interest to take advantage of rates today. Obviously we contemplate what the environment looks like a few years out in the underwriting process, so that we don't have any major surprises or don’t anticipate major surprises into the future. On the other hand, we are also seeing a number of our smaller C&I clients where we are able to introduce our variable pricing which is obviously a plus to the portfolio.

That answers the question?

Well, I'm trying to understand looking at the yield compression that we are seeing on the loan book and trying to see where that could continue to go moving forward given the mix of assets we are [putting] on. So I'm just trying to assume where are loans pricing now relative to loans that are coming off from maturing or what's been replaced?

We are trying to figure out where it’s going too and we are trying to reverse that as best we can. Just at a more macro level, it’s just not the loan portfolio as you know it’s the investment portfolio and I'm sure you saw as we did the article in The Journal a few days back, where all banks across the country are under pressure. And so obviously on the investment side, we see pressure as you look at the agencies, MBSs, CMOs as we look in as we have grown our municipals, our corporates, we are seeing an increased compression in terms of the yields on those products. Where is it going? As we look forward, we are trying to do as best we can to look for niches in the marketplace. You’ll see good progress made by us in the consumer loan portfolio and hopefully we will be able to continue to grow that through this year and into next year which has a higher yield but frankly it’s a matter of looking for niches and opportunities while at the same time maintaining the quality standards that we need to in this institution. So I don't have an easy answer for you other than we are all challenged and we are trying to be very disciplined but also as best we can look for opportunities that might still exist within our marketplace. Obviously NPA run-off has been wonderful for us but that impacts loan growth and we do have a portfolio on the mainland mostly California, a good portfolio that was around $200 million and that's been running off at a faster rate than we had forecasted. So Bill, you want to add or Denis? I think that's, and obviously you have another question, I don't know what I can add to that.

And then maybe on the other side of the balance sheet, there's an opportunity to maybe, to help preserve margins. I know you still have $100 million or so in trust preferred, any thoughts on paying that down or more that you can do on the fund end side?

Yes we are still under the MOU and we've got to focus on that and doing what's right to get out from under our MOU with the regulators. So until that happens obviously, the focus is not what are we going to do with the capital and while we have excess capital, I think everyone is aware and we've discussed in the past that we have a deferred tax asset, call it a tax loss carry forward that could be realized in the first quarter of next year. If that is realized obviously there is going to be an additional significant amount of capital coming into CPF. And so the alternatives we have and we are looking at but no decisions, one would be buying back some or all of the troughs[ph], another would be a cash dividend, a one-time cash dividend. Another would be stock repurchase. No decisions have been made. Our focus now is let's get out from under the order and assuming that does occur and when it occurs, we would look probably to those 3 strategies or a combination or a mix of them in terms of addressing our capital position.

Our next question comes from Joe Gladue of B. Riley.

Let me follow-up on that last discussion and ask when is your next comprehensive exam?

I don't think anything is determined in terms of when our next exam is. I don't know if we'd share it with you. Typically, I am not saying for ourselves but typically for a bank that’s under regulatory order rather than annual review it’s every 6 months. We believe we made good progress. We're continuing to focus on what we need to address the issues raised by the MOU. We think we've made good progress to the extent that we move from a consent order to an MOU. We are in line with the requirements of the MOU and addressing anything else is outstanding. So we're consciously optimistic but obviously that's up to the regulators in terms of when they want to make their decisions and hopefully when they do it, it will be positive towards us. I would like to mention though as we go forward with our strategy while there are certain requirements under the MOU, to-date we don’t feel that we've been impaired or slowed at all because of the regulatory order.

Can I just ask about the loan pipeline and where you see demand in what segments going forward?

In terms of the, John again here, pipeline I think we made excellent progress and as I mentioned early in the question that I addressed this morning. Bill's to my left here, so I am in trouble but he and his team have done a wonderful job of reducing NPAs. I want to be approximate but if you look at NPAs going back when I arrived 2 almost 3 years ago, we peaked at about a $0.5 billion, in the first 12 months we reduced them roughly to $300 million, last year it was a little below $200 million, it popped up first quarter but then down to $170 million now $140 million. We have made wonderful progress in addressing the NPA portfolio, but please appreciate while we have been doing or I should say Bill and his team an excellent job, Lance Mizumoto, our Chief Banking Officer; the faster he runs to put on assets obviously he is challenged by Bill’s performance. In addition and I did mention earlier while we have announced we are exiting the mainland in terms of business development, we made a decision that we were going to continue to manage a portfolio, a good portfolio that was on the mainland; that was we believe well originally at about $200 million and thought we could keep that stable. We believe that has run down to about $175 million, maybe $185 million in terms of this past quarter. As we now forecast out and with other banks aggressively looking for loan opportunities that probably will run down in the coming quarters. So the challenge is the pipeline, if you look at it, consumer loans are up over the quarter. C&I are up in terms of commercial, industrial mortgage, residential. And I think it’s the commercial mortgages that are down and some of that is pay ups that we saw that we think we see growing back in the coming quarters. So we feel good about the pipeline. I think Lance and his team have done an excellent job in putting a team together where we were out of the market for 3 years, 4 years, but unfortunately we were challenged not only because of very competitive market, we are also challenged in the sense of as I mentioned to you both on the reduction of NPAs and they run-off of our mainland book.

I would like to ask one more question just on the TDRs. It looks like there was a sizable increase in restructured, I mean performing TDRs this quarter, just is that, a lot of that shift from non-performing TDRs into performing or were there I guess a lot of new restructured loans?

This is Bill. Yes, I think what we are seeing the increase in TDRs are some of the AB type note restructures that have now seasoned, and A notes are coming back on. I think as you know the TDR rules are still evolving and they are somewhat complex but we would see that restructured still accruing interest will probably increase and I think in my comments this morning, I noted that with some of the NPA reductions were results of some loans returning to accrual status and almost all of those end up in that particular category. So I would anticipate that that outline item will see an increase going forward.

Our next question comes from Jacque Chimera of KBW.

Looking through the consumer portfolio, that held steady for probably call it the last 2 years or so and it had a really nice pop in the quarter, what types of loans are driving that growth?

John here, Jacque, regular consumer loans is, again I want to from a macro big picture level, this is an organization that in terms of our branch network was very focused on deposit gathering, client service and doing an excellent job there; what we've been doing over the last 12 to 18 months is really putting programs in place, software, decision engine and Bill can speak to it in more detail, if you like in terms of what we've done. But the focus has been to cross sell into that segment, so not just as a source of deposits for C&I, for our mortgage originations that we book, but more in terms of those clients, we've got the primary relationship, let’s focus also on consumer loans and Bill just handed me a note in terms of its consumer term loans, I believe they are roughly around 5 years, Bill? Five years and obviously a much better yield than we are getting elsewhere in the marketplace; I would say around 5%.

Okay, so this is less so maybe something new in the quarter and moreso just all of the work you've been doing over the last year, a little bit more than you are starting to pay some nice dividend for you?

It’s a result of the work and Bill has worked with David Hudson on the retail side and really to put the systems in place and the software you need to include a decision engine, they can both drill down on this for you now if you like and we are starting to see some of the benefits of that. So it’s really a long term plan that we are starting now to see some results in this past quarter.

I am sorry if you've said this already and I just missed it, the decision engine that you are putting in place, is that something that hit this past quarter?

Yes, which is basically for smaller credits you really, you need more automation and a decision engine being an analysis, a way to analyze small dollar amount loans for consumers and it assists us in the decision making process and obviously it’s a more efficient process and it’s a quicker response time for our clients.

So this is a category of growth we could see in future quarters as well then?

Yes, David Hudson is here and he’s smiling as I mentioned that we are looking to him for growth in this area.

And probably it will continue to be an advantageous yield driver for you?

Yes, should be, I fully expect, it matters what you mean by advantageous yield, in this market 5% for us is an advantageous yield.

And then maybe last question is just kind of a little housekeeping one, and I know in the prior quarter you had said that there were 2 quarters worth of bonus accruals in there, the current quarter is that more of a good run rate going forward assuming the targets continue to be met?

Yes, that should be the regular under normal run rate.

The next question comes from Ross Haberman from the Haberman Management Corporation.

Quick question. How big is your deferred tax asset at the moment?

That’s $148 million.

And you're saying none of that is on the balance sheet because it's all a set aside with an allowance?

Yes, as a reserve set of offsetting that deferred tax asset.

So you're saying hypothetically if that went on the balance sheet it would add $3.50 a share if my math is right?

Yes, roughly.

Our next question comes from Brian Roman from [indiscernible].

Ross just asked one of my questions relating to the DTA, just could you elaborate on the timing issue about when it could be recognized. Would it be recognized all at once. Would it be used to lower the tax rate over some period of time if we could talk about that?

This is Denis Isono. We expect to, one of the requirements? Let me give you some background. One of the requirements from our audit is to recognize that deferred tax asset is to demonstrate 8 quarters of profitability. So we're at 7 now and that’s why we're looking in the first quarter as being an opportunity to recognize that DTA. We will take pretty much all of it, save a part that relates to California taxes and to reversing that reserve some time during the first quarter.

So that’s one of the small advantages of California having been a high tax state?

No, because we've done a lot less business in California today than we built at it. It probably won't get recognized.

Okay. So it’s a first quarter event is what you are describing assuming you are profitable in the first quarter?

No, I am John jumping in, it’s not for sure in the first quarter. We are working towards that and it’s a very complex transaction involving the accounting and involving other approvals that are required to get those done, so it’s a goal, it’s an opportunity we are going to go after it but not for sure.

But if you remain profitable for the foreseeable future it’s sometime in 2013 you could speak to that with a higher degree of confidence, don’t you think?

Yes.

Next question, the consent order went to an MOU, MOU has been there for how long?

Well it’s been there probably I am guessing and we can get the info and David get it back to you, but I am going to guess it’s about 6 months, 8 months.

Okay, fine and what are the parameters profitability or capital parameters inside the MOU that you have to achieve and then they will tell you have achieved them?

The public requirements of the MOU have to do typically with capital well in excess of their requirement. I think they have got 8% we are at 13%, but I am guessing we can get it to you so well in excess of that. The other Bill would have and that has to do with the Tier 1 capital to allowance for loan leases, classified assets. David what do they want us at again please 40%.

50%.

50 and we are at 27%. So we are well in excess of that so we are making very good progress.

Okay, on the California loan portfolio, 2 California questions. One is you said the $200 million at the current run rate, how long that’s going to stick for you?

When I said it not a 200, I think I said for the ending quarter, now it’s below that, that was our initial.

I am sorry.

Yes, no I just want to correct, I think it’s around $185 million and we don't know, we have no interest in running that portfolio off, we would like to maintain it and we spend a lot of money in losses building that over a period of time. The question is trying to forecast with that would be in terms of going forward. When I say California portfolio, mainland portfolio, when I said 185 I am talking about a good portfolio in terms of performing assets that we would like to keep on the book. The total portfolio would be in excess of that and I think it’s around $240 million, $245 million.

Well, that was my next question. How big is the non performing asset portfolio related to the mainland?

Yes, so that would be allowed 45 and again within a few million dollars and David can get you the specific numbers but its 45, I think and we've got OREO[ph] also in addition of around another $9 or $10 million.

So it’s somewhere between 50 million and 60 million. So, I think you said you are at $140 million in non-performing assets, so this is 40% or so is still on the mainland.

Next question. I have a few more, so excuse me. Or just a commentary about capital, how big as it trups [ph] at this point, is that what you clarify as long term debt on the balance sheet?

Yes, this is, at September 30 its $105 million.

And what's the coupon on that?

It’s a floater.

Brian, this is David, the trups are at a weighted average rate of 3 month LIBOR plus 265 is the margin, the weighted average margin and Brian, you know if you like we can circle back with you on some of these more clean up questions.

Okay, no I have another question, it’s sort of more straight down in the middle, or it’s a comment and a question that relates to your efficiency ratio and I have asked this question in the past, is in the mid 80s and understandably 6 points of it or so relates to asset clean up but it’s probably still significantly too high for an institution of your size, probably should be closer to 69, 70 and previously you've said you are going to grow it to that or you hope to grow, but you are not really talking about that so how are you going to get from kind of 79% to 69% of core efficiency ratio?

Yes and we can pick this up later as David mentioned in terms of drilling down rather than holding others if there's other people on the queue. I mean there's a long answer but obviously there's I would say if there's no easy solution to that and there's a 101 things that you've got to do and so rather than trying to drill down on all the projects we have in place, I just say that we are fully cognizant of some of the challenges and have been and will continue to address them going forward.

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

So, I just want to thank everyone who has joined us for participating in our earnings call for the third quarter of this year. We look forward to future opportunities to update you on our programs.

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