Central Pacific Financial Corp. (CPF) Q4 2017 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the Central Pacific Financial Corp. Fourth Quarter 2017 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 like to turn the call over to Mr. David Morimoto, Executive Vice President, Chief Financial Officer. Please go ahead, sir.

Thank you, Anita, and thank you all for joining us as we review our financial results for the fourth quarter of 2017. With me this morning are, Catherine Ngo, President and Chief Executive Officer; and Anna Hu, 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 risks related to forward-looking statements, please refer to our recent filings with the SEC. And now, I'll turn the call over to Catherine.

Thank you, David, and good morning, everyone. We are pleased to report on a solid financial performance for the quarter as well as for the year 2017. Net income and earnings per share were adversely impacted by the revaluation of our company's net deferred assets, or DTA, in the fourth quarter, which resulted in a onetime reduction of $7.4 million and reflected in the company's income tax expense. David will provide more details on the impact of the DTA revaluation, which was due to the reduced corporate income tax rate as part of the recently implemented Tax Cuts and Jobs Act. We ended the year with strong loan and core deposit growth. Total loans increased by $134 million or 3.7% from the previous quarter and by $246 million or 7.0% from the same period a year ago. On a sequential quarter basis, as well as on a year-over-year basis, the key drivers in our loan portfolio growth were resi mortgages, consumer loans and commercial mortgages. Core deposits were up by $36 million or 0.9% on sequential quarter basis and by $278 million or 7.5% on a year-over-year basis. The key area of deposit growth from the previous quarter was in our demand deposits. From the same period a year ago, deposit growth was driven by demand deposits, savings and money market accounts. Asset quality continued to improve, with nonperforming assets declining significantly to 0.06% of total loans and leases. Our focus on generating quality credits, strengthening customer relationships and closely monitoring the economic and market conditions in Hawaii has allowed for quality asset growth throughout the year. Our capital plan and share repurchase program were successfully executed in 2017. Approximately 864,000 shares of our common stock were repurchased throughout 2017 via the open market at a total cost of $26.6 million dollars, representing 2.8% of the total shares issued and outstanding as of December 31, 2016. The quarterly cash dividend was increased for the previous quarter, from $0.18 to $0.19 per share or by 5.6%, and will be payable on March 15, 2018 to shareholders of record as of February 28, 2018. The economic outlook for Hawaii continued to be positive for 2018, following the solid performances of our leading economic indicators in 2017. The visitor industry enjoyed a strong year in 2017, with projected year-over-year increases in visitor arrivals by 4.9% and visitor expenditures by 6.6%. The current forecast for 2018 reflects continued increases in visitor arrivals by 2.3% and visitor expenditures by 3.9%. Job growth and the civilian workforce is projected to increase by 1.0% in 2017 over 2016 and the current forecast for 2018 is a continued steady growth rate at 0.9%. The unemployment rate in Hawaii dropped to a historic low of 2% in December of last year, compared to the national unemployment rate of 4.1% and is projected to be at 2.4% for the year 2018. Real personal income is projected to increase by 0.7% in 2017 and by 1.4% in 2018 over the previous year. While the construction cycle in Hawaii peaked in mid-2016, construction activity continued to be strong in 2017 and is expected to continue into 2018, with the addition of 2 large-scale resi developments in Central Oahu and several high-rise developments in Urban Honolulu. Real GDP is expected to increase by 1.1% in 2017 and projected to grow by 1.4% in 2018 over the previous year. The Honolulu Consumer Price Index is projected to increase by 2.5% in 2017 and 2.3% in 2018 over the previous year. At this time, I'll turn the call over to David to review the highlights of our financial performance. David?

Thank you, Catherine. Net income for the fourth quarter of 2017 was $4.3 million or $0.14 per diluted share compared to net income of $11.8 million or $0.39 per diluted share reported last quarter. Return on average assets in the fourth quarter was 31 basis points and return on average equity was 3.35%. As mentioned by Catherine, our fourth quarter results were negatively impacted by an estimated onetime $7.4 million charge for the revaluation of our net deferred tax asset. Excluding the impact of tax reforms, our fourth quarter results were generally in line with our expectations. Finally, while we did take the onetime charge in the fourth quarter, we will benefit beginning of 2018 from the reduction in the federal corporate tax rate to 21%. Net interest income increased by $0.8 million sequential quarter and our reported net interest margin increased by 2 basis points to 3.27%. The sequential quarter increases in net interest income and net interest margin were primarily the result of an increase in loan balance and increases in investment and loan yields. During the fourth quarter, we recorded a credit to the provision for loan and lease losses of $0.2 million compared to a credit of $0.1 million recorded in the prior quarter. Net charge-offs in the fourth quarter totaled $1 million as compared to net charge-offs of $1.5 million in the prior quarter. At December 31, our allowance for loan and lease losses was $15.0 million or 1.33% of outstanding loans and leases. Fourth quarter 2017 other operating income totaled $9.0 million. Other operating expense for the fourth quarter totaled $34.5 million. Current quarter other operating expense was primarily negatively impacted by a $0.8 million nonrecurring expense for onetime bonuses paid to all nonexecutive employees in December 2017. The efficiency ratio for the fourth quarter was 66.5% and was negatively impacted by the nonrecurring bonuses paid. In the fourth quarter, our effective tax rate was 75.6% due to the onetime reevaluation charge on our net deferred tax assets. With tax reform, we expect our effective tax rate to approximate 23% to 25%, going forward. During the fourth quarter of 2017, we repurchased 167,000 shares of common stock at an average cost per share of $31.47. We have also repurchased an additional 68,000 shares month-to-date in January at an average cost of $30.35 per share. That completes the financial summary. And now I'll return the call to Catherine.

Thank you, David. We are encouraged by the favorable economic and market conditions going into the new year as well as the progress being made in operational process improvement and the continued focus on our customer relationships. I am confident that we are on track with our business plan to continue strengthening our organization. I would like to take this opportunity to thank our employees, customers and shareholders for their continued support and confidence in our organization as we work towards achieving our 2018 goals. At this time, we will be happy to address any questions you may have.

[Operator Instructions]. The first question today comes from Brett Rabatin with Piper Jaffray.

I guess first, just talk about the loans you added in the fourth quarter and maybe talk about the production and just what the outlook is for '18, and if you'll do stuff on the mainland and kind of what you think you'll be growing in 2018 and kind of what the gulf growth is?

Sure, Brett. First, speaking to the quarter-over-quarter growth and in the loan portfolio, we saw growth really across all of the asset classes, with the exception of our construction portfolio. And that reduction in construction portfolio related to the completion of a couple of projects here in Hawaii, including a condo tower here in downtown Honolulu. As far as the Mainland growth in the fourth quarter, the growth largely related to loans to existing customers. As I say going forward, looking at 2018 loan growth, first, I would expect growth over the full year to be in the mid-single digit range, and across all of our asset classes and seeing growth both in Hawaii and on the Mainland.

Okay, that's good color. And then, wanted just to ask with the tax cut, you've been managing the expense base, flat to lower the past two years. Are there investments that you're going to be making in 2018 as a function of lower tax rate? Or can you give us some thoughts on maybe the expense base and what you hope to achieve with operating leverage this year?

Sure. So first with regard to the tax savings, we did announce at the end of last year that we were moving up the minimum wages for our lower level employees. And that increase in hourly wages results to about an $800,000 increase to comp and benefits. So if you think about -- and the other operating expense for the coming year, we have moved it up by $500,000, and so the range, you can expect the range to be in the $32 million to $34 million range. And with salaries and benefits, again being a component of that loan bump in the range.

Okay, great, and then I guess one last one. Mortgage banking, fee income was obviously down in 2017 as a function -- there's a lot of that. What's the outlook for the mortgage banking operation as you see it? And then, what drivers do you have for fee income in '18?

Okay, sure. Let me take the question on mortgages, and then I'll turn it to David to discuss fee income. But first of all, to the mortgage projection that we saw in the fourth quarter is a healthy $230 million. And I mentioned earlier the completion of one of the condo towers in downtown Honolulu. So that drove an increase in production into -- in the fourth quarter of 2017. Looking ahead to the first quarter of 2018, we expect protection to be in the $150 million to $175 million range. Let me turn it to David to -- the fee income question.

Hey Brett, as you mentioned, mortgage banking income did taper off during the second half of last year. That was due to a couple of things, one, the price competition in the local market was -- did intensify a little; and then it was also due to product mix. There was less government loans that we saw come through in the second half of the year, and those tend to be the higher margin loans. And then finally in the fourth quarter, we did portfolio slightly higher percentage of our production than we historically have during the fourth quarter, we portfolio just over 50% of production. On the positive side, during the fourth quarter, the purchase percentage of our originations was just under 80%, was purchase mortgage. So we view that as a positive going forward, in what appears to be, possibly a rising rate environment.

The next question comes from Laurie Hunsicker with Compass Point.

I just want to go back to sort of the tax one for reinvestment and expenses. I just want to make sure I've got this right. So if we were thinking about kind of where we were running, which was about $32.5 million to $33 million of all in expenses, and now you're $32 million to $34 million, $800,000 in salary and benefits, there's probably an additional, I don't know, call it, $400,000 maybe additional. So your basic expense increase, round numbers is about $1.2 million. Am I thinking about that the right way?

I think that's generally right, Laurie.

Okay. And then just specifically as it pertained to the advertising expense line, how should we be thinking about that? It was a pretty big jump up in this quarter.

Yes, Laurie, that line item tends to be a little lumpy. It's a function of when we're doing activities in advertising, when we're doing production. So it has been bouncing around a lot. So we kind of look at it more on an annual basis. And on an annual basis, I think it's been -- if you look at it year-over-year, it's been pretty flattish.

Okay. And I mean, was some of that related to the core deposit campaign that you did?

Yes.

And how should we be thinking about that core deposit campaign?

So some of the expenses for the core deposit campaign came through in the third quarter and there may have been some that made it into the fourth quarter. So you're right there. And then how to look at it going forward, that's something that we do on a periodic basis. It's not something that we do regularly. The decision on whether we would do another or -- another similar campaign, is really, largely a committee decision. So I'm not sure if something will be done in the future, but that's something that's always an option for us. We see those campaigns as a good way to bring in new Exceptional account customers. And the Exceptional account is our flagship product. So it is something that we do on a periodic basis.

Okay. And then, can you maybe just talk a little bit about, obviously linked quarter, your CD is over 100, had a pretty big jump. Can you just talk about how we should be thinking about the margin around your deposit campaign and around -- just around the CD ramp, how should we be thinking about that for 2018?

Sorry, Laurie, when you say large CDs, there was a large chunk, our large CDs, over $100,000, actually declined, sequential quarter.

So I'm looking at the rate, and the duration of those I have, your $956 million, costing 102, and now they're $974 million, costing 113 basis points.

Got it. Got it.

Right. So they're still, I mean, they're still round numbers, 20% of your deposits. But just -- I mean, I guess more from the standpoint of how we're thinking about it and then also along the same lines, can you update us on where you are with public funds? I think the number was getting around $700 million.

Yes. So again, I think the best way to look at the deposit portfolio and rate sensitivity is to segment the portfolio. So at 12/31, the core deposit portfolio was roughly $4 billion, with the weighted average rate of 7 basis points. And a rate beta over the last 12 months of 1%. So that portfolio is very low costing and it continues to exhibit a lower rate beta. However, at 12/31, the large CD portfolio that you are referencing totaled $965 million, weighted average rate of 1.13%. And that portfolio, over the last 12 months, has a rate beta of 92%. So it's very rate sensitive. So as we discussed last quarter, that portfolio is primarily comprised of a public fund portfolio, government deposit portfolio. So we are looking to -- looking at ways to reduce our reliance on the higher beta deposits, so the public fund portfolio did shrink sequential quarter, and it was roughly $685 million at year-end.

Okay, great. And then, if we could just jump over to loan loss provision. Obviously, your credit is pristine. But how do we think about, to the extent that you are putting on good loan growth, you grew 14% just this quarter, how should we be thinking about the loan loss provision in 2018?

Anna, do you want to take that?

Hi Laurie. So for 2018, I think a couple of quarters ago, you had asked whether we were at an inflection point, and we are just about there, at the point of inflection, where we do expect to look for and support the loan growth that we see within our portfolios, as well as the net charge-offs.

The next question comes from Don Worthington with Raymond James.

During the quarter, were there any loans that you purchased?

Yes. So there was an auto portfolio purchase in the $32 million range.

I'm sorry, $42 million?

$32 million.

$32 million, okay. And is that in the mainland portfolio?

That's right.

Okay. And then kind of following up on the previous question regarding deployment of the benefit of lower taxes, do you think that might impact dividends and/or repurchases going forward, more so than what you've been doing?

Yes. Hi, Don. Yes, I would anticipate, with tax reform, it obviously, all else being equal, increases earnings by roughly 10% to 15%. I think as we've already announced, we've increased our minimum wage so that the company is evaluating a list of options for reinvestment back into the business, possibly accelerating some projects that have been on our calendar. Obviously no decisions have been made, but I would anticipate that a portion of that would be reinvested, and then the remainder will deploy consistent with our past practice in a capital plan. We'll continue to pay a payout ratio and a dividend yield comparable to our peers. And then, to the extent that it makes sense, based on stock price, we'll continue the open market share repurchase program.

[Operator Instructions]. The next question comes from Aaron Deer with Sandler O'Neill.

This is Thomas Gagan [ph] on for Aaron Deer. So just since you just were mentioning stock repurchases, we were just wondering, the repurchases flowed from the prior quarter end, does this reflect any price sensitivity or any other considerations?

Thomas, I think we were executing along the plan to largely, eliminate -- retain their earnings. So I think the third quarter might have been a slightly higher quarter for repurchases. So I think that was part of what led to the slope slowing. And then the second part is just the blackouts. We do use a 10b5-1 plan to cover us over the blackout periods for earnings. And sometimes, we have to set our parameters in the 10b5-1 plans in advance. And sometimes the way we set those parameters result in a slowing of repurchases. So I wouldn't read too much into it.

And then, just turning to the margin, we noticed that it ticked up a little bit this quarter. And we are just wondering if we've seen an inflection point, and that we could expect continuing widening from here?

I think that's something to be seen, Thomas. We were very pleased with the sequential quarter widening in the fourth quarter. And we're highly focused on the matching up of repricing on interest earning assets and interest bearing liabilities is something that we -- that asset liability, I mean, we monitor this closely. I will say that the change, the tax reform, will negatively impact the margin by 2 basis points because of our municipal bond portfolio, so we have to factor that in. I think for the time being, the guidance on the NIM is probably flattish to where it's been over the next couple of quarters.

Great. Thank you for the information on that. And just one follow-up question, kind of related to that. What were the yields on the new loan production? And how is competition in the current rate environment affecting this?

I'll take that one, on the loans. So the yields coming in, in the fourth quarter were 3.85%, and that compares with the average on portfolio yield of 4.01%. And then as far as competition, I would say that there does continue to be strong competition in the market and that does include on loan pricing terms.

The next question comes from Jackie Bohlen with KBW.

This is actually Schalise Vancura on for Jackie. Most of my questions have been asked, but I just wanted to go back to -- you had mentioned the minimum wage increase. Do you expect that, that will help lessen some of the pressure from the low unemployment rate?

It certainly will help. But I will say that the other banks have responded similarly. And so they have also bumped up their hourly rates. But we continue to focus on wages, certainly, but other ways to continue to retain our good employees, and wage of course, being an important component of that.

Okay. And then, just with the December rate hike, have you seen any additional pressure from consumers on deposit, pricing or anything like that?

David, do you want to take that?

Schalise, yes, there has been some upward pressure on CD rates, shorter-term CD rates. So there has been and there continues to be some movement on the shorter-term CD rates, both retail and commercial. However, as we mentioned, the $4 billion core deposit portfolio continues to hold in at 7 basis points. So that's been beneficial.

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

Thank you for participating in our earnings call for the fourth quarter of 2017. We look forward to future opportunities to update you on our progress. Thank you.

This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.