Central Pacific Financial Corp. (CPF) Q3 2015 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Central Pacific Third Quarter Earnings Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Morimoto, Executive Vice President and Chief Financial Officer. Please go ahead.

Thank you, Keith. And thank you all for joining us as we review our financial results for the third quarter of 2015. With me this morning are Catherine Ngo, President and Chief Executive Officer; Lance Mizumoto, President and Chief Banking Officer; and Anna Hu, Senior Vice President and Interim 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 refer to our recent filings with the SEC. And now, I will turn the call over to Catherine.

Thank, you, David, and good morning, everyone. We are pleased to report on another solid quarter of financial performance, which resulted in net income of $12.2 million and diluted earnings per share of $0.38. Strong loan and deposit growth continued throughout the quarter, as well as a significant improvement in asset quality. David Morimoto will provide the financial details later on this call. We are also pleased to announce that our Board of Directors declared an increase in the company’s quarterly cash dividend by 16.7% or to $0.14 from $0.12 per common share. In addition, the Board approved a special cash dividend of $0.32 per share and both dividend payments will be payable on December 15, to shareholders of record as of November 30, this year. The company’s consistent profitability of strong capital position have also enabled us to enhance shareholder value to a successful share repurchase program. Year-to-date, as of the end of the third quarter, we repurchased approximately a 11.7% of our outstanding and issued common shares. Since the start of our share repurchase program in the first quarter of 2014, we have repurchased over 25% of our outstanding stock. Our current capital ratios remain in excess of the regulatory well capitalized minimum levels designated under Basel III. We attribute the improvement to our balance sheet and our credit risk profiles, primarily to the dedication and commitment of our entire CPV team. Our continued focus on expanding and strengthening customer relationship is taking us in the right direction, not only for the quarter, but for building a longer-term foundation for our organization. We are also fortunate to have some tailwind of our favorable economic climate employee. Key factors including our visitor industry and construction are on as planned and will help fuel better labor market conditions and household income. Through the first eight months of this year, visitor arrivals increased by 4.1% and visitor spending increased by 3.1% compared to the same period last year. Visitor arrivals are on track for a record year in 2015. The upturn in construction activity is now well established, driven primarily by new residential units. The value of building permits increased by 27% in the first-half of 2015 over the same period in 2014, and is projected to reach $5.5 billion in 2015. The unemployment rate for the same employee in September 2015 was 3.4% compared to 5.1% nationally, and reflected the lowest rate in Hawaii since March 2008. Non-agricultural jobs also as of September expanded by 1.4% over the same period last year. Other key projections for 2015 over the previous year include increases in real property income by 2.9%, real GDP by 2.8%, and Honolulu inflation rate by 0.6%. At this time, I would like to ask David Morimoto, our Chief Financial Officer to review the highlights of our third quarter financial performance. David?

Thank you, Catherine. Net income for the third quarter of 2015 was $12.2 million, or $0.38 per diluted share compared to net income of $12.3 million or $0.39 per diluted share reported last quarter. While net income declined slightly sequential quarter, the quality of earnings improved in the third quarter as the credit provision was $3.6 million as compared to the credit provision of $7.3 million last quarter. Return on average assets in the third quarter was 0.98% and return on average equity was 9.91%. Net interest income increased by $0.5 million, or 1.4% sequential quarter as average interest earning assets increased while the yield on average interest earning assets remain relatively stable. While reported net interest margin declined to 3.31% from 3.32% last quarter, on a normalized basis, the core NIM was relatively flat at roughly 3.30% over the last two quarters. Non-interest income decreased by $1.7 million, or 21% sequential quarter. The increase was primarily driven by the $1.9 million pre-tax loss again last quarter on the investment portfolio repositioning. Total non-interest expense was relatively flat sequential quarter. Salaries and employee benefits increased by $2 million, as last quarter we had the $2.4 million reversal of an accrual for four more executives we hired in benefits. The $2.2 million sequential quarter decline in the other category was primarily driven by the $2 million decline in chartable contributions. In the second quarter, we made a $2 million contribution to the CPB Foundation. The efficiency ratio improved to 67.55% from 71.47% last quarter, as a result of the nonrecurring items noted above – noted previously. Our effective tax rate in the third quarter was 36.1% versus 39.2% last quarter. We would expect our normalized effective tax rate to approximate 35% to 37% going forward. During the quarter, we recorded a credit to the provision for loan and lease losses of $3.6 million compared to a credit of $7.3 million recorded in the prior quarter. The credit to provision for the loan and lease losses was primarily attributable to improving trends in credit quality during the quarter. Nonperforming assets declined by $18.1 million, or 56% sequential quarter and we recorded that recoveries of $3.4 million during the third quarter. Catherine mentioned, we increased our regular quarterly cash dividend by 16.7% to $0.14 per share, and we also declared a special cash dividend of $0.32 per share. We decided to pay the special cash dividend as we determined that Internal Revenue Code Section 382 relocations will prevent us from buying back shares in the open market for the remainder of 2015. So our buyback program is on hold through the remainder of this year. IRC 382 has a provision that will allow share repurchases to resume in 2016, and we expect to reestablish our buyback program early next year. That completes the the financial summary. And now I’ll turn the call over to Lance.

Thank you, David, and good morning, everyone. Our overall loan and deposit growth has been on track with our business plan for the quarter, as well as on a year-to-date basis. We continue to benefit from the economic upturn and improving market conditions, as well as the hard work of our employees. As of September 30, 2015, total loans increased by $95.4 million, or by 3.2%, compared to the end of the previous quarter and on a year-over-year basis, total loans increased by 7.9%, or by $226.7 million. The sequential quarter growth in loan balances was driven by increases in commercial mortgages of $41.8 million, or by 6%; residential mortgages of $33.3 million, or by 2.5%; and an increase of $23 million, or 6.2% in our consumer loan portfolio. Our commercial and industrial loan balances increased slightly by $6.9 million, or 1.4%. Construction loan balances declined by $8.2 million to a 9.8%, due to the timing of pay downs and new business bookings, as the construction projects we have financed have since been successfully completed. While we continue to see a robust construction activity in Hawaii, we’ll continue to be prudent in providing financing in this sector. Total deposits on a sequential quarter basis increased by $48.2 million, or by 1.2%. Checking and savings balances grew by $32.8 million, or by 1% of which $32.3 million of this growth was in non-interest bearing demand deposit accounts. Time deposits accounted for the remainder of our deposit growth with an increase of $15.4 million, or 1.5%. On a year-over-year basis, total deposits were up by $182.4 million, or by 4.5% and core deposits increased by $124.5 million, or 3.8%. Significant milestones have been attained in enhancing our service delivery channels. The deployment of our automated tellers sales and service platform was completed in all of our 36 branches this month. The conversion of our debit cards to the EMV chip technology was also completed this month. Going forward, we’re encouraged by the improving market conditions fueled by the positive economic activity in Hawaii. The low interest in rate environment continues to support real estate purchase activity and overall we’re confident in achieving the objectives of our business development plan for 2015. That completes my summary. And I’ll now turn the call back over to Catherine for her closing remarks. Catherine?

Thank you, Lance. Inclosing, I would like to recognize the upwards of our CPB team and continuing to execute on our strategic plan, both our business development as well as for enhancing our bank’s infrastructure. I would also like to welcome our two new Directors on the CPF and [Bancorp] whom we announced on September 16. Wayne Kamitaki, CEO of Maui Varieties, Limited and Saedene Ota owner and creative director of Sae Design, Inc. We look forward to their valuable contribution to our mission and strategic objectives going forward. And, of course, our appreciation goes out to our customers and shareholders for their continued support and confidence, as we work towards achieving our goals. At this time, we’ll be happy to address any questions you may have.

We will now begin the question-and-answer session. [Operator Instructions]. The first question come from Joe Morford of RBC Capital Markets. Please go ahead.

Thanks. Good morning, everyone. Good solid quarter.

Thank you, Joe Morford.

I’m – I was just wondering looking past the near-term restrictions, how should we think about the tradeoff between share repurchases and dividends in 2016? And related to that is, is this special dividend likely to be considered on a quarterly basis, or will it be more of an annual decision based on a level or targeted level of capital return?

Sure. Let me take that. So what we have said publicly before is that, you can think of our dividend payments to be in the 35% to 40% range payout ratio, and then the yield 2% to 2.5% range, with that repurchases on top of that to eliminate incremental retained earnings for the year. The reason that we’re announcing the special cash dividend for this quarter is the 12 revenue code [indiscernible] provision that David referenced earlier, and therefore with that limiting our ability to repurchase shares in Q4. Starting 2016, there is going to be the ability to repurchase shares. And so we expect in 2016 that we will continue with that cash dividend in the range as I mentioned earlier and then repurchases. So back in the market repurchasing shares to eliminate the incremental retained earnings for the year.

Well, if I may add, Joe, as we roll forward the tradeoff between open market repurchases versus special cash dividends will be – at ongoing evaluation and obviously, the decision would be a function of market valuation, as we dependent upon where the stock is trading down really to determine that which way we go.

Right. Okay, understand. And then, I guess, question for Lance. Did the quarter include any purchases on the loan side? And how does the pipeline look going forward? And just in general, how you are feeling about the competitive environment on the lending side?

Good morning, Joe. I think, we had few purchases on the Mainland front. There was about a $25 million purchase of an auto loan approval. And, again, these represent more opportunistic situations, and then the balance of that came from a couple of syndicated credits. I would like to add though that as far as on a year-to-date basis that 88% of our loans were originated in Hawaii and only 12% came from the Mainland. So, I think, we need to put that in perspective. As I look at the pipeline going to Florida, I’m cautiously optimistic again about our volume and I think that we’re going to have a strong quarter in the third quarter that was better than the two quarters combined for the first-half of the year, I’m looking for a further strengthening of the pipeline in the fourth quarter.

And then any comments competitively, Lance, how well you are seeing?

Yes, it continues to be a very competitive environment, both with respect to pricing and some cases structure. But as I think, again, we’ve been competing effectively and retaining our customers and adding new prospects.

Great. Thanks so much.

Thank you.

Thanks, Joe.

The next question is from John Moran of Macquarie. Please go ahead.

Hey, guys, how is it going?

Good morning, John.

Good morning.

Yes. So maybe just following up on that, do you guys happen to have, Lance, the new production yields and then any movement in the securities book? And obviously, you’ve done a pretty good job on a core basis kind of hanging into the 3.30% level on margin, maybe you could give us a little help on the expectation or outlook there?

Yes, I would say overall in the third quarter that our yields have been trending downwards. And I think I’ll defer to, David, looking at the specific percentages or rates on both the loan portfolio and investment portfolio.

Okay. Thanks, Lance. John, in the third quarter, the weighted average rate on new loan origination was about $3.40 million, which is quite significant below the portfolio yield. I would say that the third quarter origination is tend to be shorter duration more adjustable rate origination that has been the norm. So I wouldn’t say that $3.40 million is an indication of what we would expect going forward. It was just a type of net being that we saw in the third quarter. The investment portfolio we basically we did a – we had a couple of purchases generally reinvesting cash flow, the new purchase we did, our average yields there was probably about $2.50 million, which is probably about 10 basis points below the portfolio average. And then I think overall on the net interest margin, we were pleased with the relative stability in the margin. And, again, that – what’s helping us is the growth, obviously the growth in the loan portfolio, and the ability to reallocate assets from investments into higher yielding loans.

Got it. That’s helpful. And then the other one that I had – was just around the OpEx run rate. I think, last quarter we had discussed a $32 million to $34 million kind of quarterly target a bit better than that on a core basis here this quarter. Do you guys see room to kind of continue to riddle down there? And do you have an efficiency target kind of longer-term?

And so on the op expense – that expense, you can expect that to be in the $32 million to $34 million, so in the line with what we have communicated earlier. And then what was the second question?

Efficiency target?

Oh, yes, thank you. So the – on the efficiency target, the Q4 number that we expect to be is mid to high-60% range. And longer-term, of course, we expect to bring that down as we continue to grow revenue and then leverage the investments that we’ve made in our technology and at the side of our efficiency. So the wild project that Lance mentioned the rollout of our branch system that is utilized by our total loan [indiscernible] also our centralized group. We do expect to see efficiencies coming out of that initiative that was just completed this quarter. So there were full rollout to the 36 branches completed this quarter.

Hey, terrific. Thanks very much.

Thanks, John.

[Operator Instructions] The next question comes from Jackie Chimera of KBW. Please go ahead. Jackie Chimera - Keefe, Bruyette & Woods, Inc.: Hi, good morning, everyone.

Good mourning, Jackie.

Good morning. Jackie Chimera - Keefe, Bruyette & Woods, Inc.: Actually where do you stand on the infrastructure and [Technical Difficulty] volume?

I didn’t touch the question.

Sorry, Jackie, could you repeat the question? Jackie Chimera - Keefe, Bruyette & Woods, Inc.: Sorry. [Technical Difficulty] the efficiency and the infrastructure part that you have, where do we stand on those, and what’s left to complete after what was done in this quarter?

Sure. So as I mentioned the branch project is complete and rolled out to our branch network and the operation front. The other project that we have talked about in earlier calls is our enterprise data warehouse and that bills continues on and will be completed sometime next year. However, the analytics that we have been applying since probably three, four quarters back, we’ll continue to invest in and continue to use in the coming quarters even spending rollout a bit, the completed enterprise data warehouse. Jackie Chimera - Keefe, Bruyette & Woods, Inc.: And do you have many – some examples of just, I know, it’s hard to quantify efficiency improvements that you are seeing from that, but maybe kind of one-off examples of how the growth in the project is benefiting the overall organization?

Sure. I’ll give you one example and that is been our direct mail campaign for pre-approved personal loan these are unsecured loans and by applying an analytics and it’s not just to our customer base, but also to prospects dividend that we have access to third-party data who are able to apply the analytics to try this the customers that of course are and accessible credit worthiness. But also that are likely to return to the offers. So for example in earlier our pre-approved campaigns we may have been sending mail out to individuals was very high credit ratings, but did not tend to respond to the offer. And so we’re able with the analytics target such that the response rate is much higher percentage and we’ve proven that in the last couple of pre-approved mail campaigns with the increased and not only response rate, but how we set the interest rate on those loans. So we could be far more targeted on interest rate and increasing therefore the yield on those loans. Jackie Chimera - Keefe, Bruyette & Woods, Inc.: Okay so it sounds it benefits to both expenses in that you have a lower cost of mailing and then potentially even some NIM benefits as you more – and risk benefits would be more appropriately priced to loans?

That’s right. Jackie Chimera - Keefe, Bruyette & Woods, Inc.: Okay, and then recoveries you have very sizable recoveries in the quarter and excellent improvement in credits. And how many my question is kind of twofold how many recoveries do you think remain in the pool and also was the improvement I’m sorry if I missed this in prepared remarks. But was the improvement due to a movement out of the bank or was it due to just renewal from nonperforming status?

And, yes so on the recovery on numbers let me tell you [indiscernible]. On the recovery was due to one significant large recovery from Hawaii operating business that we were able to recover from. Jackie Chimera - Keefe, Bruyette & Woods, Inc.: And do you have more of that or kind of and not necessarily on the books any longer, but recoveries that you think you might be able to got in the future does that pool still exist or is that getting pretty low now?

I think it’s getting pretty low. Jackie Chimera - Keefe, Bruyette & Woods, Inc.: Right. And then the nonperforming loans did that come down, because of payoffs or did it come done because they’ve moved up to accrual status.?

Our lines and automated are back to accrual status. Jackie Chimera - Keefe, Bruyette & Woods, Inc.: Okay, just consistent payments.

Correct. Jackie Chimera - Keefe, Bruyette & Woods, Inc.: Okay great, those are my questions. Thank you very much.

Thanks Jackie.

Thanks, Jackie.

The next question is from Aaron Deer of Sandler O’Neill Partners. Please go ahead. Aaron Deer - Sandler O’Neill Partners: Hi, good morning guys.

Good morning.

Good morning. Aaron Deer - Sandler O’Neill Partners: Hi, I unfortunately I missed your prepared remarks so forgive me if you covered this. But David you mentioned and I think in response to Joe’s question regarding the tradeoff between repurchases versus special dividends you mentioned the tax consideration was that part of – is that a means to protect deferred tax asset is that what that is?

Yes, that’s correct Aaron, yes we did have a short couple of sentences on it in the prepared remarks. But as a result of the private equity exit earlier this year basically their share is kind of go into what’s called a new public group. And so we have a – it’s the same 382 limitations that we got will be might fall off. So our tax advisors have advised us that to avoid A or shift that we should put the open market by that program on hold to 12/31/15 fortunately the 382 rules do have a what’s just called a small redemption exemption that allows us to reinstated the repurchase program in 2016. and so we would anticipate that we would reinstated in 2016 and that would allow us to continue to buyback shares next year. Aaron Deer - Sandler O’Neill Partners: Okay, helpful. Thank you and then a question for Lance, on the purchase component this quarter it kind of goes $25 million just the auto and then the two short credits that was that something different and if so. Can you give kind of the size of those and what maybe what and dispensed as well.?

I think the total amount in the Mainland purchase is about $40 million, $41 million for the quarter. And as I mentioned before, the $25 million of that gives on the auto loan portfolio. I think the two loans that we purchased on the Shared National Credits front was a transportation company and one was a consumer-related company. Aaron Deer - Sandler O’Neill Partners: Okay, right. Thanks for the added color. I’ll step around.

Thanks, Aaron.

Thanks, Aaron.

The next question comes from Don Worthington of Raymond James. Please go ahead.

Thank you. Good morning, everyone.

Good morning, Don.

Just kind of getting back to provisions and reserves kind of reserves to total loans ratio that you’re comfortable with, and I guess, what I’m truing to get as whether there could be more recoveries or negative provisions going forward?

Let me start and then – there’s – and more detail, I may turn it over to Anna. But – so as you know, in the calculation of the reserve, it’s not just a flat shot of the the current quarter, but a reflection of trend And so, as we continue to see improvement in trends on the economy and in credit quality, I think, you can expect the – that reserves to be directionally consistent with those improving trends. So I would expect over the longer-term that you will see our reserve being more in line with our peer groups.

Okay. Sounds good. And then, Lance, in terms of loan growth, do you think it’s possible to achieve double-digit growth, again, next year?

That would be very challenging, Don, despite the fact that the economy is very robust. You’ve seen over the past few years, our strong – our growth has been – it has been in the double-digit arena. I think, what I’m concerned about going forward is the level of, again, Mainland purchase, as opposed to organic growth. And we’ve again continued to try to manage the amount that we purchased on the Mainland. So, yes, I think the double-digit growth, while it’s good. I don’t think it’s sustainable in the long run, and as we try to continue to manage Mainland purchases going forward, you won’t see at that same level.

Okay. Great. Thank you.

Thank you.

Thanks, Don.

That concludes our question-and-answer session. I would like to turn the conference back over to Catherine Ngo for any closing remarks.

Thank you very much for participating in our earnings call for the third quarter of 2015. We look forward to future opportunities to update you on our progress.

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