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Central Pacific Financial Corp (NYSE:CPF)

Q1 2013 Earnings Call

April 26, 2013, 1:00 p.m. ET

Executives

David Morimoto - SVP IR

John Dean - President and Chief Executive Officer

Denis Isono - EVP and Chief Financial Officer

Bill Wilson - EVP and Chief Credit Officer

Lance Mizumoto - EVP and Chief Banking Officer

Analysts

Joe Morford - RBC Capital Markets

Aaron Deer - Sandler O'Neill & Partners

Jackie Chimera - KBW

Operator

Good day and thank you for standing by and welcome to the Central Pacific Financial Corp. first quarter 2013 conference call. (Operator Instructions)

I would like to turn the call over to Mr. David Morimoto, Senior Vice President, Investor Relations. Please go ahead, Sir.

David Morimoto

Thank you, Chad, and thank you all for joining us as we review our financial results for the first quarter of 2013. With us today are John Dean, President and Chief Executive Officer, Dennis Isono, Executive Vice President and Chief Financial Officer, Bill Wilson, Executive Vice President and Chief Credit Officer, and Lance Mizumoto, Executive Vice President and Chief Banking Officer.

During the course of today's call, management may make forward-looking statements. While we believe these statements are based on reasonable assumptions, they involve risks that may cause actual results to differ materially from those projected. For a complete discussion of the risks related to forward-looking statements, please see our recent filings with the SEC.

And now I'll turn the call over to John.

John Dean

Thank you, David, and good morning everyone.

We're pleased to report that the positive momentum that we generated in 2012 has continued into the first quarter of this year. Excluding the reversal of our valuation allowance against our deferred tax asset, our earnings for the quarter increased by 41% over the previous quarter and by 30% over the same quarter last year. Our Chief Financial Officer, Dennis Isono, will provide more details of the deferred tax asset in his report.

We continue to make substantial progress in improving our credit risk profile primarily through the reduction of non-performing assets. This resulted in a further reduction of our allowance for loan in lease losses and a positive impact to earnings. Our efforts to strengthen our customer relationships and increase market share resulted in a solid net loan growth over the previous quarter as well as a stable quarter posit base.

Our capital position remains strong, supported by nine quarters of profitability and significant improvement in our asset quality.

We are encouraged by the stabilizing market conditions in Hawaii, which were reflected in renewed commercial activity, consumer loan demand, and a sustained volume of residential mortgage originations.

Turning to Hawaii's economy, key indicators also point toward positive growth in 2013 following a banner year for our visitor industry in 2012 with a 9.6% increase in arrivals and an 18.5% increase in visitor spending. Projections for 2013 continue to be optimistic, particularly from the Asian visitor market.

Construction activity has turned around in 2012 after five consecutive years of contraction. The value of building permits surged by 45% to $3.4 billion in 2012. And is projected to increase by 23.5% to $4.2 billion in 2013.

The unemployment rate in Hawaii for the month of March was at 5.1%, slightly down from the 5.2% in the prior two months compared to the national unemployment rate of 7.6%.

Real GDP increased by 1.1% in 2012. And is forecasted to increase by 3.5% in 2013. With the improving economic and market conditions in Hawaii, we're confident that we're well positioned to execute on our business plan in the coming year.

At this time, I would like to ask Dennis Isono, our Chief Financial Officer to review the highlights of our financial performance for the first quarter of this year. Dennis.

Dennis Isono

Thank you, John.

For the first quarter of 2013, we reported net income of $137.3 million or $3.25 per diluted share compared to net income of $12.4 million or $0.29 per diluted share reported last quarter. As John mentioned, our quarterly results included a non-cash income tax benefit of $119.8 million related to the reversal of a significant portion of the deferred tax asset valuation allowance. The valuation allowance was established against our net deferred tax assets during the third quarter of 2009. Excluding this income tax benefit, our net income for the quarter was $17.5 million or $0.41 per diluted share.

As we have seen over the past several quarters, our financial performance continues to benefit from improving credit profile. During the quarter, we further reduced our allowance for loan and lease losses, which resulted in a credit to the provision for loan and lease losses of $6.6 million. In the previous quarter, we had a similar credit of $2.3 million. The reduction was a result of continued improvement in our asset quality as evidenced by a $14.7 million decrease in our non-performing assets during the quarter and continued improvement in historical quarterly charge-off data used to calculate the allowance. Bill Wilson, our Chief Credit Officer will provide more details about our credit risk profile later in this call.

Net interest income for the quarter was $30.7 million compared to $29.4 million in the previous quarter. Our net interest margin was 3.06% and 3.00% for the same respective quarters. The sequential quarter increase in net interest income and net interest margin was primarily due to an overall increase in our interest bearing assets including a $70.7 million increase in our loan and lease portfolio.

Our investment securities portfolio decreased by $2.2 million during the quarter and totaled approximately $1.7 billion on March 31st, 2013. In an effort to improve the yield on our investment portfolio, we continue to evaluate various investment opportunities and strategies to strengthen our net interest margin. Our municipal and corporate securities increased by $7.4 million during the quarter. And accounted for approximately 18% of our investment securities portfolio at both March 31st, 2013 and December 31st, 2012.

Our loan and lease portfolio increased by $70.7 million during the quarter. And now stands at $2.3 billion at March 31st, 2013. We are again encouraged by the fact that we were able to meaningfully grow our loan and lease portfolio despite seeing a $14.1 million reduction in our non-accrual loan balances. We continue to evaluate and pursue opportunities to grow our loan portfolio in an attempt to improve our overall asset yields.

Non-interest income for the quarter totaled $12.5 million, down from $13.0 million in the previous quarter. The sequential quarter decrease was primarily due to lower gains on sales of residential mortgage loans of $1.9 million and lower rental income from foreclosed properties of $400,000. These were partially offset by higher unrealized gains in interest rate locks of $1.9 million.

Non-interest expense for the quarter totaled $32.2 million, which was virtually flat from the previous quarter. Expenditures for legal and professional services, net occupancy, amortization of intangible assets, computer software, charitable contributions, and FDIC insurance were all down from the previous quarter. However, these reductions were offset by higher net credit related charges of $1.9 million and higher sales and employee benefits of $0.7 million.

Our adjusted efficiency ratio for the quarter, which excludes foreclosed asset expense and the amortization of certain intangible assets was 72.7% compared to 81.7% in the previous quarter.

In the first quarter of 2013, we recorded a non-cash income tax benefit of $119.8 million related to the reversal of a significant portion of evaluation allowance that was established against our net deferred tax assets during the third quarter of 2009. As of March 31st, 2013, our net deferred tax assets totaled $129.8 million. The reversal of valuation allowance was done in accordance with generally accepted accounting principles. And was based on a number of factors including our ninth consecutive profitable quarter, our improved financial condition, and the likelihood that future tax earnings will utilize our deferred tax assets.

At March 31st, 2013, our capital ratios continued to exceed the levels required to be considered at well capitalized institutions for regulatory purposes. Our Q1 risk base capital, total risk base capital, and leverage capital ratios were 22.85%, 24.12%, and 14.86% respectively compared to 22.54%, 23.83%, and 14.32% respectively at December 31st, 2012.

That completes our financial summary. And I would now like to turn the call over to Bill who will provide additional background related to our credit risk profile.

Bill Wilson

Thank you, Dennis.

We continued to realize improvements in almost areas of our credit risk profile in the first quarter of 2013.

Non-performing assets totaled $75.3 million at the end of the first quarter compared to $90 million in the fourth quarter of 2012 and $205.6 million in the first quarter of 2012, or a year-over-year decrease of 63.4%. The first quarter decrease in non-performing assets was primarily attributable to $27.1 million in reductions, which were partially offset by $12.4 million in additions. The reductions are represented by $13 million in accounts returned to accrual status, $11.9 million in repayments, $1.2 million in sales of foreclosed properties, and $1 million in charge-offs.

Non-performing construction and development loans totaled $26.1 million at the end of the first quarter representing a decrease of $20.8 million or 44.4% from the fourth quarter of 2012. These non-performing construction development loans comprised 34.6% of total non-performing assets.

Troubled debt restructurings totaled $66 million for the first quarter, a decrease of $2.5 million from the fourth quarter of 2012. Non-accrual TDRs totaled $23.2 million. And accruing TDRs totaled $42.8 million. Our TDRs are comprised of $32.2 million in residential mortgages, $27.5 million in Hawaii commercial real estate, and $6.3 million in other loans.

Net charge-offs totaled $3 million in the first quarter of 2013 as compared to net recoveries of $1.8 million in the fourth quarter of 2012. And as compared to net charge-offs of $2.8 million in the first quarter of 2012.

We did not have any loans delinquent for 90 days or more still accruing interest in the first quarter compared to $503,000 in the fourth quarter of 2012. Loans delinquent for 30 days or more still accruing interest decreased to $8.8 million in the first quarter from $10.4 million in the fourth quarter of 2012.

The allowance for loan and lease losses as a percentage of total loans and leases decreased to 3.82% at the end of the first quarter from 4.37% in the fourth quarter of 2012. The allowance for loan and lease losses as a percentage of non-accrual loans was 133.1% at the end of the first quarter as compared to 121.5% at the fourth quarter of 2012 and 80.4%, the first quarter of 2012.

As noted earlier in my remarks, our ongoing program to reduce non-performing assets and reduce our construction and development credit risk exposure demonstrated positive progress in the first quarter with a $14.7 million net decrease in non-performing assets and a $20.8 million decrease in construction development loans. We anticipate that we will be able to continue our progress in improving asset quality over the balance of the coming year.

That completes our credit quality review. And I would now like to turn the call over to Lance Mizumoto, our Chief Banking Officer.

Lance Mizumoto

Thanks, Bill.

We've been seeing a growing optimism from our business and consumer clients since the last quarter of 2012 that has carried over into the first quarter of this year. Our loan production for the quarter was spread across the board with commercial, consumer, and residential mortgage balances increasing from the previous quarter. Our commercial real estate balance was down due in part to reductions in non-performing loans and some pay-downs of existing loans.

Our solid deposit growth was primarily due to increases in non-interest bearing and interest bearing checking as well as government time deposits.

Going forward, we are encouraged by our strengthening commercial loan pipeline as well as the increase start-up activity in private commercial and residential development projects in Hawaii. As John mentioned in his remarks, a spike in building permits during 2012 should materialize into projects in the coming year.

Overall, market conditions in Hawaii are improving. And the business community seems to have more confidence in our economy. We are prepared to move ahead in the highly competitive market to meet the needs of our customers and to expand market share.

And at this time, I'm like to turn it back to John for his closing remarks. John.

John Dean

Thank you, Lance.

In summary, we're pleased with the company's financial performance in the first quarter as we remain on track with our business plan toward a full recovery of Central Pacific. We still have work to do in improving our operational processes and efficiencies as well as enhancing our information management systems. However, we believe to be well positioned to maintain our positive momentum going forward. And to meet the challenges in the coming year.

At this time, we are pleased to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from Joe Morford with RBC Capital Markets.

Joe Morford - RBC Capital Markets

Thanks. Good morning, everyone.

John Dean

Good morning, Joe.

Joe Morford - RBC Capital Markets

I guess first I wonder if you could talk a little bit more about how the loan pipeline built through the quarter looked fairly broad based, but you know. And also based on where you stood at period end, how are you feeling about the outlook and is C&I still likely to be the biggest driver here?

John Dean

Hi, Joe. John. But what I’m going to do is turn it over to Lance, Lance Mizumoto who’s our Chief Banking Officer. Lance?

Lance Mizumoto

Joe, we’re cautiously optimistic about the steady growth in our loan pipeline and as we mentioned before, we see an uptick in the Hawaii economy. We also see construction activity starting to pick up and as a result, we believe that we’ll benefit from new projects that will be coming on board.

Joe Morford - RBC Capital Markets

Okay.

John Dean

Another question on that, Joe?

Joe Morford - RBC Capital Markets

Well, I guess a related question too, you know, a number of the other banks we follow have commented that the competitive environment has really ratcheted up quite a bit in the last say six to eight weeks with more aggressive pricing and increased give on underwriting standards. Are you seeing some of that out there as well? I mean, I noticed your loan yields were actually up in the quarter and so maybe you’re actually able to drive some higher pricing?

John Dean

It’s also shift, as you look in terms of the mix. This is John, I’ll turn it back to Lance in a second. The other would be everything that Lanced mentioned. In addition though, we’re seeing growth in the consumer loan portfolio and if you take our residential mortgage, excuse me, residential commercial mortgage side, I guess through the year we’ll see growth – I’ll turn it to Lance. We see growth in that portfolio too. Lance?

Lance Mizumoto

Yes, we, again, we are seeing some growth both in the local C&I market as well as the commercial real estate, particularly, again, with construction activity picking up and also on our income property loans. I think, again, given the pipeline of our residential mortgages combined with the commercial real estate and C&I, as well as consumer, we see a pretty healthy pipeline business.

Joe Morford - RBC Capital Markets

Have the competitions been pretty stable or have you noticed any…

Lance Mizumoto

No, the competition certainly has been – it’s been a highly competitive market as you mentioned both in pricing as well as loan structures. There is a loosening of credit standards that we’re seeing. I don’t think it’s that much different from the national market. So we see the same type of conditions prevailing in the local market.

Joe Morford - RBC Capital Markets

Okay, thanks very much.

Operator

Our next question comes from Aaron Deer with Sandler O’Neill and Partners.

Aaron Deer - Sandler O'Neill & Partners

Good morning, guys.

John Dean

Good morning, Aaron.

Aaron Deer - Sandler O'Neill & Partners

Denis, maybe if you can follow up on Joe’s question. It sounds like some of the, maybe some of the pickup in the loan yields stems from the types of credit that are being originated. But I’m wondering is there was anything else in this past quarter with respect to interest recoveries or prepayment that also might have been influenced to the margin?

Denis Isono

Yeah, nothing in the way of interest – cash interest of any material amount, Aaron.

Aaron Deer - Sandler O'Neill & Partners

Okay, so this is kind of a reasonable run rate going forward, recognizing that there’s a lot of other influences still happening?

Denis Isono

Yes.

Aaron Deer - Sandler O'Neill & Partners

Okay. And then is there – it sounds like there might still be some, at least the minimum amount of allowance remaining for the DTA. Can you tell us what that amount is and what kind of circumstances will allow you to recover any remaining?

John Dean

I’ll turn it to Bill on the allowance. Oh, the DTA, excuse me.

Lance Mizumoto

Actually Aaron, there’s actually two elements of it. The first element is the California deferred tax asset. We don’t have any volume in California to generate [inaudible] to reverse their reserve. So that reserve is still there. There is also a component of the reserve that hasn’t been reversed, which reflects out approximation of what we will utilize in terms of tax benefits for the rest of this year. The tax – the accounting rules require us to reverse everything but – they’ll allow us to recognize, to retain as part of that reserve, the deferred tax asset for 2013 because we’re doing it in the beginning of the year.

Aaron Deer - Sandler O'Neill & Partners

So does that mean that we should expect a zero tax rate for the remainder of the year and then a normalized tax rate in 2014?

Lance Mizumoto

That’s correct.

Aaron Deer - Sandler O'Neill & Partners

Okay, good, that’s helpful. And as we look out to 2014, is something in say the 35% range, is that kind of an effective tax rate we should think about as a normalized level?

Lance Mizumoto

Yes, we use that as a proxy for our projections as well.

Aaron Deer - Sandler O'Neill & Partners

Okay. And then lastly, the capital position is obviously much stronger with the reversal on the DTA. John, can you talk about what, you know, how you and the board are thinking about reinstating the dividends, maybe any thoughts on special dividends we might see going forward?

John Dean

Sure, Aaron. As I mentioned, I believe in the last earnings call, first we were focused on recapturing – or I should say bringing back the deferred tax asset, which happened in the first quarter. We’re not looking at our capital position and then looking at several different alternatives given the capital position. One would be a pay down of some or all of the [inaudible]. Another one would be a one-time cash dividend. The third would be a reinstatement of the quarterly cash dividend. And it may be some combination of any two or three of the above, not necessarily one versus another.

Fourth, stock repurchase, given the DTA and the tax implications of that, we would not be able to consider that, any stock repurchases until, I believe, February of 2014. So there – those are the considerations and I think over the coming weeks, a month or two we’ll make a decision in terms of what, if anything we’d like to do in terms of our capital position, which is, as you’re well aware of, very, very strong.

Aaron Deer - Sandler O'Neill & Partners

Sure, that’s great. Congratulations on a good quarter and thanks for taking my questions.

John Dean

Oh no, thank you, Aaron. It was an excellent quarter with great team effort.

Operator

Thank you. Our next question comes from Jackie Chimera with KBW.

John Dean

Good morning, Jackie.

Jackie Chimera - KBW

Hi, good morning, everyone. I wanted to touch base on some of the credit metrics, they continue to be excellent and I know that that’s what driving the reverse provision, but I wanted to focus on the text in the press release, which I know we’ve discussed on past calls, just that historical charge-off rate. So is that something where because we’re moving further and further away from some of the large outside charge offs, we could see reverse provisioning continue through the year because of that?

John Dean

Let me turn it over, Jackie, to Bill Wilson, our Chief Credit Officer.

Bill Wilson

Good morning, Jackie. It’s Bill.

Jackie Chimera - KBW

Hi, Bill.

Bill Wilson

Yeah, the historical charge off rate is one of the factors in the methodology. But in addition to the historical methodology, we – our methodology also incorporates sort of a forward-looking assessment of current conditions and likely conditions. So it’s a combination of the two. And then of course, as new lending increases, that too then has a reserve component associated with it. So all those kind of play into the calculation of the allowance on a given quarter.

Jackie Chimera - KBW

So as I look at it, you know, you’re obviously very well covered on the MPLs, which do continue on a quarterly basis to come down. So to the extent that future quarters look similar to this quarter, the provisioning would reflect that?

Bill Wilson

I think if future quarters look like this quarter, the answer would be yes. It would probably suggest that there should be some reduction.

Jackie Chimera - KBW

Okay. And touching on expenses, the professional costs have come down significantly. Is that – is the first quarter a good run rate for you or was there anything unusual in there?

John Dean

I’m going to turn it over to Denis, Denis Isono, Jackie.

Denis Isono

Yeah, there was nothing unusual in there in this quarter, that’s why it’s lower.

Jackie Chimera - KBW

Okay, so just as credit continues to improve, we should see that trend downward and the last quarter was just a really meaningful decline for you?

Denis Isono

Yes.

Jackie Chimera - KBW

Okay. And how about occupancy? Did anything happen in there?

Denis Isono

Nothing in particular. You might note though we’re going to be [inaudible] has been moved and we’re opening up [inaudible], so there will be some impact. Going forward, there will be some impact to the occupancy, Jackie.

Lance Mizumoto

Yeah, this quarter, Jackie, we opened a new branch and relocated another one so you’ll see a little movement due to those changes.

Jackie Chimera - KBW

Okay. Thanks. Those were my questions. Thank you very much.

John Dean

Oh, you’re welcome, Jackie.

Operator

There appears to be no further questions at this time so I’d like to turn the conference back over to John Dean for any closing remarks.

John Dean

Thank you, Chad. I just want to thank everyone for participating in our earnings call for the first quarter of 2013 and we look forward to future opportunities to update you on our progress.

Operator

The conference has now concluded. Thank you for your participation.

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