Central Pacific Financial Corp. (NYSE:CPF)
Q4 2008 Earnings Call
January 29, 2009 1:00 pm ET
David Morimoto - Senior Vice President of Investor Relations
Ron Migita - Chairman, President & Chief Executive Officer
Dean Hirata - Vice Chairman & Chief Financial Officer
Blenn Fujimoto - Vice Chairman Hawaii Market
Curtis Chinn - Executive Vice President & Chief Risk Officer
Meg Keane - RBC Capital Markets
Bobby Bohlen - KBW
Dan Bandi - Integrity Asset Management
Good afternoon, ladies and gentlemen. Thank you for standing by. And welcome to Central Pacific Financial Corporation Fourth Quarter 2008 Conference Call. During today’s presentation, all parties will in a listening-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 its completion at the company’s website at www.centralpacificbank.com. I would now like to turn the conference over to Mr. David Morimoto, Senior Vice President of Investor Relations. Please go ahead, sir.
Okay. Thank you. Good morning, everyone. With us today are Ron Migita, Chairman, President and Chief Executive Officer; Dean Hirata, Vice Chairman and Chief Financial Officer; Blenn Fujimoto, Vice Chairman Hawaii Market; and Curtis Chinn, Executive Vice President and Chief Risk Officer.
Today’s call will refer to a slide presentation that can be found on our investor relations page of our website at www.centralpacificbank.com. Ron and Dean will begin by reviewing our fourth quarter results, and then we’ll open the call to questions.
During the course of today’s call management may make forward-looking statements, and while we believe these statements are based on reasonable assumption, they involve risks that may cause actual results to differ materially from those projected. For a complete discussion of the risk related to forward-looking statements, please see our earnings release issued this morning and our other recent documents filed with the SEC. And now I’ll turn the call over to Ron Migita.
Thank you, David and thank you all for joining us today to review Central Pacific Financial Corporation’s financial performance for the fourth quarter of 2008. I’ll be addressing some of the key highlights of our company and the marketplace, followed by our Chief Financial Officer, Dean Hirata, with the details of our fourth quarter financial results, and we will be very happy to answer any questions you may have at the end of our report.
I would like to start by recognizing the tremendous effort put forth by all of our employees during these challenging times. They have individually and collectively demonstrated their dedication to the success of our company, which played a critical role in our fourth quarter results, and I am confident that their commitment will continue to drive the successful execution of our plans and strategies in the coming year.
We are very pleased to have completed another profitable quarter with net income of $3.1 million or $0.11 per diluted share, for the quarter ended December 31, 2008. While the last two quarters of 2008 have been profitable, we still fully recognize the importance of carefully managing our business going forward in light of the meltdown in our financial industry.
We are closely monitoring the nation and Hawaiian economic climate in order to continue to proactively navigate through these unprecedented times. Cost containment continues to be in the forefront of the day-to-day management of our operations, and without losing sight of our long-term goals.
Beginning in 2008, voluntary reductions were made in Board and Executive compensation of 20% and 10% respectively. We have also re-evaluated our staffing model relative to our current situation, and we’ll be reducing our personnel costs by approximately 10% through a combination of selective restructuring in operations, including incentive plans and the elimination of vacant positions.
All operational expenses are being evaluated based on their alignment with, and its impact on our current business objectives. While we work to reduce our credit exposure in California, the housing and real estate markets there continue to be a challenge. Having aggressively downsized our California residential construction portfolio, we will continue to look for opportunities to further reduce our credit risk on the Mainland through individual loan sales, restructurings, and/or pay downs.
Although total non-performing assets increased from 2.41% of total assets in the third quarter to 2.56% in the fourth quarter, our net loan charge-offs decreased from $8.7 million to $7 million.
For the fourth quarter, we increased our provisions for loan and lease losses to $26.7 million, from $22.9 million in the third quarter of 2008. This increased our total allowance for loan and lease losses by almost $20 million and the ALLL now stands as a percentage of total loans and leases at 2.97% at December 31, 2008, up from 2.46% at September 30, 2008.
A key component of our balance sheet strategy is sustainable growth driven by core deposit funding. Focusing on this basic banking formula during these challenging times is a top priority. We have made significant progress in this effort, increasing our total deposits by $134.5 million from September 30 to December 31, 2008.
More importantly, we have strengthened our core deposit customer base with the introduction of new market-leading products such as our Free-Plus Checking, Super Savings Account, and You-Choose Debit Card rewards program.
As we reported earlier this month, we issued $135 million in senior preferred stock in connection with our participation in the US treasuries capital purchase program. This preferred stock carries an annual dividend of 5%, over the first five years with warrants to purchase up to approximately $1.6 million in CPF common stock.
There is a lot of scrutiny from Congress and the general public as to how the funds allocated to the capital purchase program will be effectively used as a credit and economic stimulus. We agree that the recipients of any and all investments on behalf of taxpayers must be held accountable.
With our commitment to Hawaii, we are pleased that the Treasury Department recognized that Central Pacific Bank was an ideal candidate for participation in the capital purchase program.
The capital purchase program was designed to allow the US Treasury to invest in healthy banks that play an important economic role in their respective communities. In the case of Central Pacific Bank, the issuance of the senior preferred stock strengthens our capital ratios on a pro forma basis as of December 31, 2008, well above the well-capitalized standards.
Combined with additional deposits, which we are aggressively targeting with market-leading products, our bank is in a strong position to continue playing a key role in supporting growth in our community.
In 2008, Central Pacific Bank was awarded the SBA lender of the year in our category for the fifth consecutive year. 56% of our business loans in 2008 were made through small businesses with annual revenues under $1 million. And 50% of our business loans were made in low-to-moderate income areas in our state. We are also a market leader in Hawaii for residential first mortgage originations totaling $1.5 billion for 2008, as well as in the area of financing affordable housing projects.
Given the unprecedented environment we face, we are required to make difficult decisions. Capital levels must be preserved to better support our customers during this economic downturn. For this reason and in the long-term interest of our shareholders, we have elected to suspend cash dividend payments. As the economic environment stabilizes, we will reassess our capital levels and future dividend payments.
The adversity in the economic climate of Hawaii has lagged behind the US Mainland economy. However, we are also expecting a slow recovery through the next few years. In 2008, we experienced a 10.6% decrease in total visitor arrivals and a 9.9% reduction in visitor spending.
The current forecast for 2009 is a continued decline in total visitor arrivals. Job growth was flat in 2008, and real personal income was down by two-tenths of 1% from the previous year. Hawaii’s unemployment rate is at 5.5% as we have had [inaudible] of business closures and bankruptcy filings.
In 2009, we expect the decline in payroll jobs by 1.4%, as well as seven-tenths of 1% decline in real personal income and in unemployment rate of 5.8%. Inflation based on the Honolulu consumer price index averaged 4.5% in 2008, and is currently forecasted to average 2.4% in 2009.
The primary issue in our state is the sustainability of jobs impacted by our visitor industry, construction activity, retail sales, and military spending. Looking ahead into 2009, there is no question that we’ll continue to face major challenges head-on. We will continue to focus on banking basics and delivering exceptional customer services and experiences at all touch points throughout our bank.
A new branding campaign will be launched in a few weeks to exemplify the commitment and fortitude of our war heroes who filed at Central Pacific Bank as a bank to serve the small businesses and people of Hawaii.
Now more than ever, we need to demonstrate tangible support for the communities we serve. I believe we are well positioned to meet the challenges in our competitive market with the successful new products mentioned earlier, together with an unparalleled commitment to service.
At this time, Dean Hirata, our Vice Chairman and Chief Financial Officer will be addressing the Company’s financial performance for the fourth quarter of 2008. Dean?
Thank you, Ron. Beginning on Slide 3, our net income during the fourth quarter of 2008, again, we posted a second consecutive quarter of profitability with net income of $3.1 million or $0.11 per diluted share.
In addition to reporting our second consecutive profitable quarter, we also grew total deposits by $134.5 million, or 3.6% from September 30, 2008. I’ll provide further details about the composition of our deposit base later in my presentation.
At December 31, 2008, we maintained our well capitalized designation for all regulatory capital ratios. As Ron previously mentioned, on January 9, 2009, we issued $135 million in senior preferred stock to the US Treasury in connection with our participation in the capital purchase program.
Including the newly raced capital, on a pro forma basis as of December 31, 2008, the capital ratios were as follows. Tier one risk-based capital of 13.46%, total risk-based capital of 14.73%, and a leverage capital of 11.37%.
Our allowance for loan and lease losses increased by almost $20 million, and the allowance as a percentage of total loans and leases stood at 2.97% at December 31, 2008, up from 2.46% at September 30, 2008.
Related to the increase in the allowance per loan and lease losses, the current quarter included total credit costs of $30 million, comprised of a provision for loan and lease losses of $26.7 million, write downs of loans held for sale of $1.3 million, foreclosed asset expense of $700,000, and an increase in the reserve for unfunded commitments of $1.3 million.
During the quarter, the Mainland loan portfolio decreased by $47 million due to loan pay downs, and stood at just over $1 billion or 26% of our total loan portfolio at December 31, 2008. I will discuss the breakdown of our loan portfolio in greater detail later in my presentation.
Turning to Slide 4, this slide provides a bar graph depiction of our net interest margin compared to our national peers. Our margin for the current quarter was 4.03%, compared to 4.07% in the third quarter of 2008.
The sequential quarter compression was primarily due to lower interest income, due to a decrease in loan yields. However, despite the current quarter compression, we continued to compare favorably to our national peers.
Turning to Slide 5, this provides a breakdown of our total loan portfolio by loan category at December 31, 2008, and respective changes during the quarter. Later in the presentation, I’ll provide additional detail into each category.
At December 31, 2008, our total loan portfolio was $4 billion. Our portfolio increased by $50 million during the quarter, or 1.2% from September 30, 2008. The Mainland portfolio decreased by $46.8 million and the Hawaii portfolio decreased by $3.2 million. On the Mainland, we saw decreases in our residential construction, commercial construction, and commercial mortgage portfolios of $24 million, $9 million, and $14 million respectively.
In Hawaii, we saw decreases in our commercial mortgage, residential mortgage, C&I, and other loan and lease portfolios. These decreases are partially offset by increases in our residential and commercial construction portfolios.
Turning now to Slide 6, which is our Mainland residential construction portfolio. Total outstanding at December 31, 2008, were $69 million. And as you can see, our two biggest exposures are in Fresno of $22 million, and Sacramento, of $20 million. Again, these two locations account for approximately 60% of the entire portfolio.
In the Fresno portion of the portfolio, we have two loans outstanding, one which is performing, and one which is not performing. We expect repayment on the non-performing loan to come from either a sale, a refinance, or a longer-term amortization.
In Sacramento, we have outstanding loans to three borrowers. These three loans are our non-performing at December 31, 2008. However, we have substantially written down the balances on all of these loans, and again, in all cases, we believe we are adequately secured in comparison to the remaining net book value. All loans created special mention or worse have been reappraised within the last six months.
Turning now to Slide 7, our Mainland commercial construction portfolio, this slide provides a break down by both property type as well as location in total outstanding of $419 million at December 31, 2008.
As you can see, our two biggest property-type exposures are office space, $139 million, or 33%, and retail space of $132 million, or 32%. Our two biggest geographic exposures in the state of California are Sacramento at $71 million or 17% and Riverside, $62 million or 15%.
We also have exposure in the state of Washington, totaling $69 million, or 16% of the portfolio. In Sacramento, we have eight project loans comprised of six for office space, one shopping center, and one warehouse. Six of the projects are completed, and in various stages of lease-up and/or sale, and two of the loans are on non-accrual.
One of the non-accrual loans is selling. However, there has been slow absorption. We are in the process of foreclosing on the other non-accrual loan. However, for both non-accrual loans, we believe our reserves are adequate to cover our remaining exposure.
Moving to Riverside, we have 10 loans outstanding. Five are entitled land for future development and five are construction loans. Of the land loans, two are non-performing, which total $8.5 million, of the other three, two are performing and the third has paid off since year-end. Of the construction loans, one is for an apartment complex; one is for office place, and three for retail projects.
The apartment complex is completed and leasing according to plan. The office project is in escrow, and the retail projects are in various stages of leasing and/or construction.
Turning now to Slide 8, which is our Mainland commercial mortgage portfolio, again, we show a break down by both property type and location, total outstanding of $553 million at December 31, 2008. And as you can see the portfolio is comprised predominantly of retail space of $245 million or 43%, and office properties of $131 million or 24%.
Our two biggest geographic exposures are in Los Angeles, $222 million, or 40%; and the state of Washington, at $80 million, or 14%. For our retail exposure, all loans are performing. However, we continue to watch this portfolio closely in light of current economic conditions and its potential impact on the retail sector. For the office commercial exposure, we have 17 loans. One of the loans is classified and the rest of the loans are graded passed and performing.
Moving now to Slide 9, which is our Hawaii residential construction portfolio, total outstanding of $306 million at December 31, 2008. The majority of our Hawaii construction loans are structured with presale, pre-leasing requirements, minimum cash equity contributions, and recourse to individuals.
This portfolio is comprised of 85 loans with a current weighted average loan to value ratio of 67%. As you can see from the pie chart, $218 million or 60% of our exposure relates to single-family residential projects. As noted in the box on the left, a $29 million loan for an affordable condo project in Honolulu was paid off in January 2009. Overall, our Hawaii construction exposure is expected to be reduced in the next 12 months, as projects are scheduled to be completed and absorbed.
Turning now to Slide 10, which is our Hawaii commercial construction portfolio, total outstanding of $325 million at December 31, 2008. The portfolio is comprised of 97 loans, with a current weighted average loan-to-value ratio of 75%.
As you can see from the pie chart, this portfolio is well diversified. Our biggest exposure items are retail of $85 million, or 26%, industrial warehouses with $68 million at 21%, and storage facilities, with $45 million, or 14%.
Our retail projects are typically pre-leased and well located, and of your retail exposure, one loan represents more than $41 million, this loan is located in Lahaina, Maui, and it is completed, 85% leased, and the property is stabilized. The industrial warehouse projects are split between three loans. All three loans are for lot development for sale mostly to owner users on the island of Oahu.
Turning now to Slide 11, the Hawaii commercial mortgage portfolio with total outstanding of $840 million at December 31, 2008. Again, as you can see, the commercial mortgage portfolio is fairly granular. The average loan size is less than $2.5 million. This portfolio is also very seasoned as evidenced by the low-weighted average loan to value ratio, 51%, and average debt service cost ratio of 1.7%. As you can see from the pie chart, our three largest exposures are owner/user with $232 million, or 28%; retail with $120 million, or 14%; and office space with $116 million, or 14%.
Turning to Slide 12, which is our Hawaii residential mortgage portfolio, total outstanding of $917 million at December 31, 2008. Again, the vast majority of this portfolio is comprised of fixed-rate loans of $441 million or 48%, and ARMs of $271 million or 30% of the portfolio.
We have concerted underwriting as reflected by low-weighted average, loan-to-value ratios of 51%, high average FICO scores of 738, and very low delinquencies. As we discussed in the previous quarter, we have tightened our underwriting to include lowering maximum loan-to-value ratios without mortgage insurance to 85%.
We have also limited our portfolio lending to salable loans, and lastly, we do not have any sub-prime exposure in this portfolio.
Turning to Slide 13, the Hawaii C&I and other loan and lease types, at December 31, 2008, our C&I book was $305 million, our auto loans were $129 million, leases of $58 million, and consumer loans of $51 million.
The C&I portfolio is granular comprised of more than 3,300 loans and no major concentrations by industry-type. Over 86% of this portfolio is on Oahu.
Moving to Slide 14, and taking a look at our non-performing assets. As you can see, from the table our total non-performing asset balance increased by $11.2 million during the quarter. The increase was primarily due to the addition of one California commercial construction loan, totaling $10.4 million, secured by a retail project located in Orange County, and one California residential construction loan totaling $9.8 million, secure bade lot development project in Fresno.
Partially offsetting these additions were net-loan charge-offs during the quarter of $7 million. Net loan charge-offs as a comparison to the previous quarter was $8.7 million. In the Hawaii portfolio there are no significant changes in the non-performing asset totals, as these totals approximated the amounts as of September 30, 2008.
Turning now to Slide 15, with our continued focus on strengthening our asset quality, again, you know, during these challenging economic times, we remain focused on strengthening our asset quality. 76% of our non-performing asset balances are from Mainland loans, and as I mentioned earlier, this portfolio decreased by $47 million during the quarter, and the remaining balance is just over $1 billion, or 26% of the total loan portfolio.
We are focused on longer-term workouts and extensions to manage credit risks in our Mainland portfolio. We continue to perform monthly portfolio reviews for all commercial real estate and C&I portfolios.
We also continue to look for opportunities to further reduce credit risk in the Mainland through individual loan sales, restructurings, and/or pay downs. As I previously stated our current quarter provision for loan and lease losses exceeded net charge-offs by almost $20 million, which further strengthened our loan loss reserve to total loans ratio.
In moving to Slide 16, this slide provides a detailed breakdown of our deposit composition as of December 31, 2008. Total deposits, at December 31, 2008, were $3.9 billion, which was up $134.5 million or 3.6% from September 30, 2008.
As you can see from the pie chart, more than 70% of our deposit balances are comprised of demand, now money market, savings, and small time deposits. Broker CDs continue to represent only a small percentage of our total deposit base, accounting for only 3% of the total.
All of our government CDs, which represents 8% of our deposit base, is deposits from local municipalities that are fully collateralized. As shown in the bar graph, our deposit costs continue to compare favorably against our national peers.
Moving to Slide 17, and looking at our other operating income and expense and certain non-recurring items. The other operating income was $16.9 million during the current quarter, compared to $11.4 million in the fourth quarter last year, and $11.7 million during the third quarter of 2008.
The sequential quarter increase was primarily due to higher unrealized gains on interest-rate locks on residential mortgage loans, totaling $2.6 million and higher non-cash gains related to the ineffective portion of a cash flow hedge totaling $1.9 million. The non-cash gain related to the ineffective portion of a cash flow hedge was attributable to an increase in the fair value of an interest rate swap with a $400 million notional amount intended to hedge a portion of our prime floating loan portfolio.
Other operating expense was $43.6 million in the current quarter, compared to $35.2 million in the year-ago quarter, and $37.5 million during the third quarter of 2008. The sequential quarter increase was primarily due to higher credit-related charges, totaling $3.2 million, a non-cash mortgage servicing rights impairment charge totaling $3.4 million, recognition of a $2.8 million counter party loss on a financing transaction, and all of these are partially offset by lower salaries and benefits, totaling $4.1 million, primarily due to lower incentive compensation expense.
We also recognized federal and state tax credits related to solar leases. During the current quarter, we completed the financing of photovoltaic solar equipment, totaling $7.8 million. These leases qualify for state tax credits of 35%, and federal tax credits of 30%, and in the aggregate, these credits resulted in an after-tax benefit of approximately $4 million.
In moving to Slide 18, and looking at our efficiency ratio for the current quarter, it came in at 57.11%, compared to 57.71% for the third quarter of 2008. The ratio excludes foreclosed asset expense, asset write-down expense, and the recognition of the counter party loss.
As you can see from the graph, the current quarter efficiency ratio is comparable to sequential quarters, but remains elevated from historic levels, due to the recognition of the non-cash mortgage servicing rate impairment charge, higher FDIC insurance expense and higher cost associated with maintenance and disposition of Mainland assets. Excluding the mortgage servicing right impairment charge, our efficiency ratio for the current quarter was 52%.
In moving to Slide 19, and looking at our liquidity and capital position, the pie chart depicts the composition of our funding sources with deposits providing greater than 70% of our overall funding. We also have significant availability liquidity with access to additional borrowing capacity of approximately $1.1 billion.
And as I mentioned at the opening of my presentation, we maintained and improved upon our well capitalized regulatory designation for all capital ratios as of December 31, 2008. And again, with the capital we received in January of this year, these ratios were further strengthened due to our participation in the capital purchase program.
Moving to Slide 20, and in closing, looking at the summary of our results, and the outlook going forward. First, our fundamentals as you can see have strengthened, and continue to improve. We also reported our second consecutive quarter of profitability.
We further strengthened our allowance for loan and lease losses as a percent of total loans to 2.97%, and we continue to rigorously analyze our portfolio and current reserves to appropriately reflect current asset values.
Our capital ratios continue to exceed well capitalized regulatory requirements, and all ratios improved from the previous quarter, again, further strengthened with our participation in the capital purchase program.
Going forward, we remain focused on managing credit risk and strengthening our balance sheet. We continue to look for ways to grow our deposit base through our market-leading products and services, and we are committed to prudently managing our expenses in light of the current operating environment.
And lastly, we also continue to serve our community by supporting Hawaii’s small businesses, and promoting homeownership through our position as one of the leading residential mortgage lenders in Hawaii.
This concludes my review of Central Pacific’s financial results for the fourth quarter of 2008, and I’ll now open up the call to questions.
(Operator instructions) Our first question is from Joe Morford - RBC Capital Markets.
Meg Keane - RBC Capital Markets
Hi, this is actually [Meg Keane] calling on Joe Morford’s team. We just wondering if you had a normalized run rate going forward for expenses?
Dean, that’s a question for you.
On a normalized basis, we anticipate a range of between $35 to $36 million.
Meg Keane - RBC Capital Markets
Great and other than that, did you guys have MPA sales in the quarter? And if so, what sort of values were you looking at with those?
Could you repeat your question?
Meg Keane - RBC Capital Markets
Sorry. We were also wondering if you had sales of MPAs in the quarter and what sort of values you saw with those.
Hi, this is Curtis Chinn. No, we had no loan sales in the quarter.
Meg Keane - RBC Capital Markets
And are you guying looking for that going forward? Are there prospects of that?
We’ll look at that on a opportunistic basis, but we’re not planning any more bulk sales.
Our next question is from Bobby Bohlen - KBW.
Bobby Bohlen - KBW
On the deposits the growth looks fairly good and some of your reports from some of your local competitors also showed strong deposit growth. Is this net new accounts or are we seeing more balances, as even the consumer tries to get more liquid, maybe just some color on what we’re seeing going on with the deposits.
Thank you, Bobby. I’m going to ask Blenn Fujimoto to respond to your question here.
Hi, Bobby, this is Blenn Fujimoto. We actually saw a combination of new account growth as well as existing customers adding to their balances. We did launch a couple of new products during though quarter.
Our Super Savings product, which is a promotional rate, 3%, we were able to gain some good new account growth in that area. This year we have had our Free-Plus checking account, which is still a premium rate on that, but we expect this product where they have to do 15 debit card transactions during the month to receive their premium rate.
We believe this type of product will bring a new core, people who use this with our primary bank, so we have seen some good growth in that during the quarter also. So an answer to your question here, we have seen growth in both the business as well as consumer in this past quarter. And we expect that probably to continue through this first quarter also.
Bobby Bohlen - KBW
I also have another question. There was recently an article I believe, in one of the local papers talking about the refinance activity going on in the island. And you guys are one of the larger players in the mortgage market. I was wondering if you could give us a little bit of color on what we’re seeing with the refinance market.
Yeah, we have had some significant growth in refinances. We’re probably looking at about triple the volume that we normally do in terms of our run rate. We expect that to continue probably for the next 90 days, and probably that will drop back to more normalized levels at that point.
Bobby Bohlen - KBW
And with the refinance, are you looking, you did say that you were only doing originations of salable mortgages. Would you guys be looking to sell more of those mortgages or keep them on balance sheet at this time?
We’re looking to sell almost 100% of those mortgages.
Our next question comes from Dan Bandi - Integrity Asset Management.
Dan Bandi - Integrity Asset Management
Thanks for taking my call. I was wondering if you guys could on page 5 of the slide deck, would you be able to go down those categories for us, and just give us the 60 to 90-day delinquencies and the change since last quarter for those categories or for some grouping of those categories?
Yeah, I can take that. I have aggregate numbers of the delinquencies not including the non-performers, at quarter-end we were at about $24 million or 59 basis points. Prior quarter we were at $23 million and 57 basis points in aggregate.
(Operator instructions) I am show nothing further questions at this time.
Okay. Well thank you very much for your questions this morning, and for participating in our earnings call. I believe there are few businesses, banking or otherwise that are not anxious to close the books on 2008.
However, on behalf of the management team at Central Pacific Bank, I can say with confidence that through managing the challenges, we experienced this last year, we created a much stronger, wiser, and tougher management deem than we have ever had.
I can also say with confidence that we all look forward to 2009 with great anticipation of creating an even stronger bank for our shareholders, customers, employees, and the communities we serve and support. Thank you very much, and have a nice day. Bye-bye.
That does conclude today’s call. You may now disconnect your line.
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