Central Pacific Financial Corp. (CPF) Q4 2013 Earnings Report, Transcript and Summary

Hello ladies and gentlemen. Thank you for standing by and welcome to the Central Pacific Financial Corp’s Fourth Quarter 2013 Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. [Operator Instructions]. This call is being recorded and will be available for replay shortly after the completion at 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, Steve [ph] and thank you all for joining us as we review our financial results for the fourth quarter of 2013. Joining us today are John Dean, President and Chief Executive Officer; Denis Isono, Executive Vice President and Chief Financial Officer; Lance Mizumoto, Executive Vice President and Chief Banking Officer; and finally Bill Wilson, Executive Vice President and Chief Credit and Operations 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 turn the call over to John.

Thank you, David and good morning everyone. We are pleased to report another solid financial performance in the fourth quarter, which contributed to a significantly improved year in 2013. Excluding a noncash differed tax asset reversal benefit that was recorded as income in the first quarter of 2013, our net income for the year increased by 8% over the previous year. We’re also pleased to announce the dividend payment to our shareholders for the third consecutive quarter. Since having to suspend dividend in 2009, our board of directors has declared divided of $0.08 per share, payable on March 17, 2014 to shareholders of record as of February 28th. With the improving market conditions in Hawaii, and our continued focus on our business plan initiatives throughout the year, we were able to generate significant growth on our balance sheet. As of December 31, 2013 total loans and leases increased by 19.4% over the same period in 2012. Shifting assets from securities investments to loans resulted in a positive impact to our net interest margin, reflected in a 10 basis point increase in the fourth quarter over the previous quarter. We continue to improve our credit risk profile and have come closer to normalizing our loan loss reserve levels as we have recorded a nominal provision for loan losses in the fourth quarter after recording a credit to our provision for loan losses in the past 11 quarters. I should now note that we are presently reviewing our methodologies to consider the improving trends in recent years and Bill Wilson can speak further to this review in the Q&A section. Nonperforming assets are down to 1% of total assets. Operational efficiencies have improved as reflected in the reduced efficiency ratio for the quarter and for the year. We continue to be focused on further improving our cost structure with our technology and process improvement plans for this year. Through a total team effort we’ve made significant progress through 2013. We remained focused on expanding quality relationships with our client. Many of the enhancements to our information management systems will be operational in the first half of this year and we’re confident that these investments in our infrastructure will deliver longer term benefits to our customers. Turning to Hawaii’s economy, while 2012 was a banner year for economic growth, we’re encouraged by the continued steady growth in the key economic indicators in 2013. As of the end of November 2013, visitor arrivals were up by 3.1% year-over-year. Increased airline capacity, including the recent entry, Air China into Hawaii this month will help expand Hawaii’s presence in the Pacific Rim. Solid growth in the construction industry is expected to continue in 2014. As of November 2013, over $2.4 billion in private building permits were in place, which included a 27% increase in the residential sector over the previous year. This pipeline is in addition to the $5.2 billion rapid transit system currently underway and other government contracts. The seasonally adjusted unemployment rate in Hawaii steady declined throughout the year and was at 4.5% in December 2013, compared to 5.1% a year ago. In comparison, the national seasonally adjusted unemployment rate was 6.7% in December 2013 and 7.9% a year ago. Overall, job growth was 1.6% in 2013, led by the construction and hospitality industries. With the projected stable growth in our visitor industry and robust construction activity, we are encouraged by the improving market conditions in Hawaii as we execute our business plans for 2014. At this time, I would 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 2013, we reported net income of $9.0 million or $0.21 per diluted, share compared to net income of $10.2 million or $0.24 per diluted share reported last quarter. The decrease was primarily due to an $800,000 provision for loan and lease losses, compared with a credit of $3.2 million reported for the prior quarter. Positively offsetting this change were increases in net interest income and other operating income and a decrease in other operating expense. Net interest income for the quarter was $35.5 million, compared to $33.8 million in the previous quarter. Our net interest margin was 3.29% and 3.19% for the same respective quarters. The sequential quarter increase in our net interest income continues to be driven by our increasing interest earning assets which on average grew by 82.2 million. The net growth was reflected in average loans which increased by $114.1 million, offset by a decrease in our investment portfolio average of $36.8 million. The interest recoveries on loans previously placed on non-accrual status that had affected net interest income in prior quarters was only 300,000 and 600,000 for the fourth and third quarters respectively. The sequential quarter improvement in net interest margin was also attributable to an increase in the yield on the investment portfolio. Our loan and lease portfolio ended the year at $2.63 billion, an increase of $146.3 million from $2.48 billion at the end of the third quarter. We continue to be encouraged by our ability to meaningfully grow our loan and lease portfolio. Lance Mizumoto will provide more insight into the loan portfolio later in this call. Our investment securities portfolio decreased by $97.6 million during the quarter, ending the year at $1.66 billion. The taxable equivalent yield on our investment portfolio improved to 2.43% from 2.18% reported for the third quarter. The increase in yield was primarily driven by the slowing of premium amortization on our mortgage backed securities and the reinvestment of cash flow into higher yielding securities. During the quarter, we executed a bond swap where we sold lower yielding agency debentures and agency MBS and reallocated into higher yielding non-agency CMBS and RMBS, corporate bonds and agency CMBS. Non-interest income for the quarter totaled $12.2 million, up from $11.9 million in the previous quarter. The improvement was attributed to the $1 million gain on the extinguishment of $10 million in trust preferred debt and the investment securities gains resulting from the reposition of the investment portfolio mentioned earlier. This was partially offset by lower unrealized gains on loans held for sale and interest rate locks of $1.2 million. Non-interest expense for the quarter totaled $35.3 million, down from $36.5 million in the previous quarter. The sequential quarter decrease was primarily attributable to a premium paid on the repurchase of preferred stock of two subsidiaries of $1.9 million in the third quarter, which was offset by higher salaries and employee benefits of $1.2 million. The increase in salary and benefits included severance, early retirement and retention benefits totaling $1.8 million for the quarter, compared to $1.3 million in the previous quarter. The increase in salary and benefits were offset by lower legal and professional fee of $0.5 million. As we go forward, there will be additional accruals for the severance early retirement and retention benefits for employees with work through dates extending into 2014 Our adjusted efficiency ratio for the quarter, which excludes net gains and sales of foreclosed assets and investment securities, foreclosed asset expense and the amortization of certain intangible assets, was 72.50%, compared to 78.02% in the previous quarter. We continue to work toward improving our efficiency ratio as we progress in executing our cost improvement initiative developed in our benchmarking project earlier this year. In the fourth quarter of 2013, we recorded income tax expense of $2.6 million, compared to $2.2 million in the previous quarter. The income tax expense was attributable to higher pre-tax income that was forecast when we recognized a reversal of valuation allowance on the deferred tax asset in the first quarter. As of December 31, 2013, our net deferred tax asset totaled $138.1 million. We also continue to make progress improving our credit risk profile. During the quarter, we recorded provision for loan and lease loss of $800,000, compared to a credit of $3.2 million in the previous quarter. Non-performing assets ended the year at $46.8 million, a decrease of $12.2 million from the $59 million reported at the end of the third quarter. During the quarter, the largest non-performing loan on the Mainland was paid off, lowering NPA by $11.6 million. At the end of the year, the Mainland non-performing portfolio was down to $9.8 million of total NPA. The allowance for loan and lease losses as a percentage of total loans and leases decreased to 3.27% at December 31, 2013 from 3.43% at September 30, 2013. Our allowance for loan and lease losses as a percentage of non-performing assets grew to 183% at December 31, 2013 compared to 144% at September 30, 2013. Lastly, at December 31, 2013, our capital ratios continue to exceed the levels required to be considered well capitalized institution for regulatory purposes. Our Tier 1 risk-based capital, total risk-based capital and leverage capital ratios were 20.25%, 21.52% and 13.64% respectively, compared to 21.30%, 22.58% and 13.96% respectively at September 30, 2013. That completes our financial summary and I now I’d like to turn the call over to Lance Mizumoto, who will provide additional background related to our banking activity.

Thanks, Denis. The increase in total loans by $146.3 million in the fourth quarter over the previous quarter end through the increases of $85.1 million in consumer loans, $42.3 million in residential mortgages and $30.5 million in commercial loans, offset by a $13.7 million decrease in commercial mortgages. Year-over-year, the $426.7 million increase in total loans was also spread among our consumer, residential mortgage, and commercial loan portfolios with a growth of $167 million, $204 million and $153 million respectively. Our focus on expanding and strengthening our customer relationships, as well as our consumer loan promotions have resulted in generating meaningful new business throughout the year. Our core deposits have remained stable and we a realized the steady growth in total deposits of $255.4 million year-over-year. This deposit growth is also the result of building quality customer relationships. Going forward, we are encouraged by the increasing construction and development activity in Hawaii. In addition to the building permits in place, as John mentioned in his economic overview, there is a high interest by developers for property acquisitions and new projects, particularly in the residential condominium market. With improving market conditions in Hawaii, a healthy commercial loan pipeline and a stable deposit base, we’re confident in continuing to expand our loan portfolio with quality assets in the coming year. That completes my summary on our business development activity. And I will now turn the call back to John for his closing remarks. John?

Thank you, Lance. In summary, 2013 has been a significant milestone. It’s the third consecutive year of increasing profitability since the Company’s turnaround. Dividends were reinstated in the second quarter, supported by our earnings’ consistency and strong capital position. Our asset quality has been restored to near normalized levels and we continue to have a strong inflow of quality credits. We’ve started numerous projects to strengthen our information management systems, as well as to streamline our operational efficiencies. We have a lot more work ahead, and I believe we’re on the right track, at the right pace for the long-term success of our company. I’d like to again express our appreciation to our shareholders and customers for their continued support and confidence. At this time, we’ll be happy to address any questions you may have. Thank you.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Joe Morford from RBC Capital Markets.

I guess, just a couple of questions on the loan growth. The consumer portfolio has been very strong last two quarters. Is that primarily home equity, credits and also on the commercial side, is there much contribution from shared national credit participations in the quarter?

Joe its John, I am going to turn it over to Lance. But, you’re right. There is some --what we would call national credits involved in that loan growth. But let Lance detail.

Good morning Joe, this is Lance. In the fourth quarter we took advantage of an opportunity to purchase a couple of auto loan portfolios. That totaled about $44 million - $45 million, but we did run a consumer loan campaign locally that generated pretty material amount of production. So again we are optimistic that our consumer portfolio growth going forward will continue to be healthy and we are going to try and continue to rely more on the local market than we would on the Mainland market. So we just saw this is an opportunity. On the shared national credit side, during the fourth quarter, we generated about $21 million in shared national credits. So again, just like with the consumer loan portfolio directionally, we intend to rely less on purchase portfolios of shared national credits and rely more on the local markets for growth.

I want to add a little bit to help you and others there, Joe, because 20% is a very, very strong growth number and Lance can correct me, but roughly if you look at last year, about half of that growth came local and the rest would be in the shared national credits in the purchase of some portfolios. So we think 10% double digit local is still an excellent result for us. Is it close?

That’s right.

And thinking about that 10% type of growth; would you be looking similar to what we saw in the fourth quarter to fund a lot of that with maturing investments, securities and should we see kind of a similar decline in investment portfolios as you see in growth and loans and generally is there a certain level of the securities portfolio that you’re targeting, say a certain percentage of assets or something?

On the first question, it’s easy, yes. You will see some movement out of our investment portfolio and we’re going to head towards averages in terms of loan-to-deposit ratio or a break in the -- you are going to see a continued growth in loans and a decline in the investment portfolio in the coming months and next couple of years.

And the next question comes from Aaron Deer with Sandler O'Neill.

I guess following up on Joe’s question with respect to the earning asset mix, Denis, maybe a good one for you, but as you kind of see that mix transition, is there any reason why we shouldn’t expect to see continued margin improvement or is there any other anticipated actions or noise in the numbers that would cause it to drift lower from where we are today?

Aaron, this is Denis. Thanks for the question. No, we expect that continuing trend to lower the investments securities portfolio, growing the loan portfolio and with the margins seen [ph] to grow, continue to grow.

Okay, then on the expense fronts, I guess excluding the -- I guess about $1.8 million aid into nonrecurring comp related items there. Taking that out, noninterest expenses were about $33.4 million. It still seems like there is probably, I’m guessing about $1.5 million or so outsized expenses in there, given the various initiatives that you guys still have underway. Is that -- am I thinking about that number about right, in terms of what we might get back down to in terms of a run rate operating expense level?

Yes. For the target we’ve got for other operating expenses between 34.5 and 36; but it’s a longer term target. So we got to – there was some noise in there because for the next couple of quarter there will be incrementally more accrual for the REITs and for the early retirement as well as the reduction in force.

So as Denis mentioned and we are going to see some expenses related to the early retirement program and the REITs. I think the other, and it is difficult for us and why we got sort of a range in there, is that we have several technology initiatives this year. And it’s always easy to tell but we know what the expenses on those initiatives are, and we are outsourcing DP to Pfizer. We are building a data warehouse; we are putting in a customer relation management system. We should pick up we think very good operational efficiencies as we move more and more from a paper driven to a digital driven organization. It’s fairly hard to be specific of how much we will pick up at the savings. So while we are very optimistic, it’s still going to be a little cloudy for the next 12 to 18 months as to the specific savings.

And then just one last question on the capital levels. I guess, I know you guys are eager to kind of right size where you are and obviously the organic growth that you are seeing is helping with that. But to the extent that if your private equity shareholders decided to do some sort of secondary and you took advantage of that by doing some repurchases in that, what amount do you anticipate you could repurchase? I guess when I’m looking at your excess capital, it seems like you usually have a $100 million to $150 million in excess there that you could use for buybacks. Is that -- am I thinking about those numbers in the right range?

To our large equity shareholders, I’m not going to speak for them, Aaron. You will have to give them a call. But I would say and we have been very open in prior calls that we believe we do have an opportunity in terms of the -- I would call it excess capital in the existing institution today. Our focus is really working with the regulators today to -- because that doesn’t [ph] require regulatory approval with our regulators. So that’s where we are today. We think we’re making good progress but really I don’t have much more to share other than that at the moment.

Thank you. [Operator Instructions]. The next question comes from Jackie Chimera with KBW.

I wondered if the $1 million gain on the debt extinguishment in the quarter, is that -- is there any tax treatments on that or does that all fall to the bottom line?

If I could – Jackie, I’m going to pass that one to Denis.

Jackie, that’s taxable income.

Okay. And then my next question, kind of digging into the loan loss reserve and how to think about provisioning going forward, my assumption is and please correct me if I’m wrong that this small provision that was get [ph] in the quarter was related to the substantial loan growth. So I just want to know how you think about it in light of, I know you mentioned that you’re going to take a look at methodology but you have a declining California loan portfolio, your credit metrics continue to improve, NPAs are down and you have really strong coverage of your NPLs.

I’m going to start if I can. Then I’m going to pass it over to our Chief Credit Officer Jackie, Bill Wilson. But one is we did have strong loan growth. Obviously that’s going to impact the methodology and the provisioning. I think also though and I’ll let Bill speak to this -- as you know the ALLL by most institutions today is a very complex process and it’s very historical driven based on prior quarters in prior performance. And where we are today and the progress we have made, we’re really trying to say that we have the right -- we have the right methodology in place today is there -- are there enhancements that we could make in the methodology and that’s where we’re at now. With that background, Bill?

Just to echo what John was saying, the loan growth in the fourth quarter was greater than previous quarters and therefore had an associated reserve factor to it. The ALLL methodology enhancements that we made in 2010 were certainly appropriate for the portfolio at that time. Since that time we believe we’re realizing the benefits, the improvements we have made in our underwriting and portfolio of management processes since 2010. As we went through 2013, we saw increasing signs of additional enhancements to our allowance methodology, maybe appropriate to better reflect the risk inherent to the more recent advantages of our lending activities and we’re currently working on that analysis and so we’ll hope to see some results from that in the near future.

And how far back -- just based on your current methodology as it stands today, how far back is your look back on credit losses?

We look back -- current methodology looks back eight quarters on real-estate secured and four quarters on non-real estate secured.

Okay. And then I guess just lastly, I’m not sure who to direct this one to, but looking at the DTA and your assumptions as you went into the quarter when you reverse the valuation allowance, obviously your earnings have been very strong through the year as you’ve had some taxable income come through. What’s changed in what you are able to produce in 2013 versus what you thought you were going to do as you entered the year?

John, it’s a question for you. What you are saying is what caused the earnings in excess of what we originally forecasted?

Basically yes.

I think several factors, as you know we have several initiatives in place and those were started earlier in 2013. Obviously our margin ended up doing better than we realized. Some of that was loan growth that exceeded the original forecast or expectations. So certainly Lance and his team have done an excellent job this year, and as you know better than I as you move more of your assets from the investment securities to the loan, you have got the benefit there. I think on the non-interest expense side it’s been lumpy for two -- I have said this before -- it’s been lumpy for two, three years, as we’ve cleaned up things and I would say clean up the portfolio. And I think that we were fortunate in getting closer and closer sooner to what I would call a core operating run rate and so some of our operational efficiencies ended up being ahead of plan. So those were some of the factors that caused us to have earnings above our earlier estimate. And Denis wanted to add that or?

I think that’s probably, largely margin because of improved results.

Does that answer it Jackie?

So, basically almost every line item has exceeded expectations throughout the year versus where you stood maybe a year ago from today?

The answer is yes.

Okay.

Thank you. And your next question is from Don Worthington from Raymond James.

You mentioned that the decrease in NPAs was I guess largely attributable to one Mainland property. How much was that?

Turn it to Bill Wilson.

Sure. It was a single asset on the Mainland that reduced NPAs by $11.6 million.

Okay. $11.6 million was that one property?

Correct.

Okay. And then in terms of charge-offs, recoveries, do you see the opportunity for I guess more net recoveries going forward?

It’s Bill again. I would hope so. I think we saw a pretty good performance in 2013 in terms of our recoveries and that was with the passage of time, you can only have recoveries to the extent that you’ve had charge-offs and we have reducing charge-offs. But I think there may still be some to be collected in 2014.

Okay. And then I noticed you were opening a branch in Kauai. Do you have other branch plans going forward?

Hey Don, this is Lance Mizumoto. We do have plans for another branch. We’ve identified another side on Oahu. So we are optimistic on further expansion but obviously not at an aggressive pace.

Okay.

That branch on Oahu would be subject to regulatory approval.

Thank you. And a next question is a follow up from Aaron Deer from Sandler O'Neill.

Hey guys, just a quick question on the tax rate. Obviously this past year there was a lot of noise in that line. As I kind of look at what -- in the securities book and other opportunities for some tax savings, what kind of effective rate are you looking at for 2014?

Yeah, we are looking at about a 35% effective rate, Aaron. This is Denis.

Thank you. And as there are no more questions at the present time, I would like to turn the conference back over to John Dean for any closing remarks.

Thank you very much for participating in our earnings call for fourth quarter 2013 and we look forward to future opportunities to update you on our progress. Have a good day.

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