Central Pacific Financial Corp. (CPF) CEO Discusses Q2 2013 Results - Earnings Call Transcript

Jul.25.13 | About: Central Pacific (CPF)

Central Pacific Financial Corp. (NYSE:CPF)

Q2 2013 Earnings Conference Call

July 25, 2013 13:00 ET

Executives

David Morimoto - Senior Vice President, Investor Relations

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

Lance Mizumoto - Executive Vice President and Chief Banking Officer

Analysts

Aaron Deer - Sandler O’Neill

Joe Morford - RBC Capital Markets

Jacquelynne Chimera - KBW

Don Worthington - Raymond James

Operator

Good afternoon, and welcome to the Central Pacific Financial Corporation Second Quarter 2013 Conference 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. Please go ahead, sir.

David Morimoto - Senior Vice President, Investor Relations

Thank you, Maureen. Thank you all for joining us as we review our financial results for the second quarter of 2013. With us today are John Dean, President and Chief Executive Officer; Dennis Isono, EVP and Chief Financial Officer, Lance Mizumoto, EVP and Chief Banking Officer, and Bill Wilson, EVP 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 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 - President and Chief Executive Officer

Thank you, David, and good morning everyone. We are pleased to report another solid quarter of performance for Central Pacific Bank. Earnings for the quarter increased significantly over the same period a year ago. Meaningful improvements continued to be made to our credit risk profile, including further reductions in non-performing assets. In addition, recoveries on interest from loans previously held as non-accrual loans have had a positive impact to our net interest margin and net income for the quarter.

Loan growth continues to be positive as well as core deposit growth. Our efforts to expand customer relationships have continued to make a difference towards further strengthening our balance sheet. With our company’s strong capital position and earnings consistency over the past 10 quarters, our Board of Directors declared a quarterly cash dividend of $0.08 per share payable on September 16 of this year to shareholders of record at the close of business on August 30. Dividend payments on common shares were suspended in the first quarter of 2009, and we greatly appreciate the support of our shareholders while we navigate it through a financial turnaround and recovery.

Part of the company’s recovery plan, we initiated several major projects in investments to enhance our information technology systems this year, which will create sales and service efficiencies in the future and better position our company for growth. These initiatives include outsourcing our core IT systems operations, implementing a data warehouse, and installing a customer relationship management system, or CRM. These enhancements are expected to be completed in early 2014. And as a result, we expect our total other operating expense to be in the range of $34.5 million to $36 million per quarter over the next several quarters.

Turning to Hawaii’s economy, we are encouraged by improving market conditions which have been reflected and renewed commercial activity and consumer loan demand. Key indicators point toward a sustained growth for the remainder of the year. The visitor industry continues to lead our economic expansion and has expected to remain robust throughout the year supported by additional airline capacity. Visitor arrivals in spending in the first quarter of this year increased by 6.5% and 7.5% respectfully over the same period last year and are projected to increase 6.6% and 10.0% in 2013 over 2012. The surge in building permits by 45% last year will fuel construction activity in 2013 and generated an increase of 8.8% in construction jobs in the first quarter of this year over the previous year.

Pre-sales activity for residential projects had been indicative of a solid demand for new housing. General excise tax revenues increased in the first quarter by 6.6% over the same period last year. Hawaii’s unemployment rate dropped to 4.6% in June compared to the national unemployment rate of 7.6%. This is the lowest level of employment in our state since September 2008 nearly five years ago. With the improving economic and market conditions in Hawaii, we are confident moving forward with our business plans to increase quality lending and improve core earnings.

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

Dennis Isono - Executive Vice President and Chief Financial Officer

Thank you, John. For the second quarter of 2013 we reported net income of $14.3 million or $0.34 per diluted share compared to net income of $137.3 million or $3.25 per diluted share reported last quarter. As we previously announced our net income for the first quarter of 2013 included a non-cash income tax benefit of $119.8 million related to the reversal of a significant portion of a valuation allowance that we previously established against our net deferred tax assets. Excluding this income tax benefit, our net income for the first quarter of 2013 was $17.5 million or $0.41 per diluted share.

Net income for the quarter was $33.2 million. Net interest income for the quarter was $32.2 million compared to $30.7 million in the previous quarter. Our net interest margin was 3.23% and 3.06% for the same respective quarters. The sequential quarter increase in both our net interest income and our net interest margin was due to the recovery of interest on loans previously placed on non-accrual status totaling $1.7 million and an overall increase in our interest earning assets which included net increases in our loan and investment securities portfolios of $98.5 million and $69.4 million respectively.

We are again encouraged by the fact that we are able to meaningfully grow our loan and lease portfolio despite seeing $11.8 million reduction in our non-accrual loan balances. Lance Mizumoto will provide more insight into the loan growth later in this call. Our investment securities portfolio increased by $69.4 million during the quarter and totaled approximately $1.8 billion at June 30, 2013. We continued to evaluate various investment opportunities and strategies to improve the yield on our investment portfolio and strengthen our net interest margin.

During the quarter we’ve purchased $60 million non-agency commercial mortgage backed securities. Our municipal, corporate and non-agency mortgage backed securities grew to approximately to 21% of our investment securities portfolio at June 30, 2013 from 19% at March 31st. We also reported improvement in our net taxable equivalent yield to 2.12% from 2.08% for the quarter.

In an effort to further improve our net interest margin going forward we’ve recently repurchased outstanding trust preferred securities totaling $10 million with the floating rate interest of 3.25% over the three months LIBOR rate at a discount. We expect to recognize $1 million gain related to this transaction during the fourth quarter of 2013, the next available date that these securities can be called. In addition to repurchasing a portion of our outstanding trust preferred securities, we also repurchased the remaining outstanding warrants previously issued to the U.S. Treasury as part of our participation in the TARP program. This repurchase resulted in a gain of 76,000 during the quarter and upon completion of this transaction, the U.S. Treasury no longer owns any outstanding shares or any warrants to repurchase shares of our common stock.

Non-interest income for the quarter totaled $17.8 million, up from $13.0 million in the previous quarter. The sequential quarter increase was primarily due to higher net gains in sales of foreclosed asset of $7.1 million partially offset by lower unrealized gains on interest rate locks of $1.3 million and lower gains on sales of residential mortgage loans of $1.2 million reflecting the recent change in longer term interest rates.

Non-interest expense for the quarter totaled $35.0 million, up from $32.8 million in the previous quarter. The sequential quarter increase was primarily attributable to a higher provision for repurchased residential mortgage loans of $1.6 million and higher net credit related charges, which includes changes in our reserve for unfunded commitments and foreclosed asset expense of $1.1 million.

Our adjusted efficiency ratio for the quarter which excludes net gains on sales of foreclosed assets – foreclosed asset expense and the amortization of certain intangible assets was 76.7% compared to 72.7% in the previous quarter. In the second quarter of 2013, we recorded income tax expense of $1.9 million which was attributable to the income tax liability generated from the previously mentioned gain that we recognized on the sale of foreclosed property.

As of June 30, 2013, our net deferred tax assets totaled $144.1 million. In addition to reporting another strong quarter of profitability, we also continued to make progress in our ongoing efforts to improve our credit risk profile. During the quarter, we reported a credit to provision of loan losses of $0.2 million compared to a credit of $6.6 million in the previous quarter. The credit was a result of continued improvement in our asset quality as evidenced by a $14.4 million decrease in our non-performing assets from $75.3 million at March 31, 2013 to $60.9 million at June 30, 2013.

The decrease in non-performing assets was attributable to $18.3 million in reductions which were partially offset by $3.9 million in additions. The size reducing our non-performing assets, we also reported net recoveries during the quarter of $500,000 compared to net charge-offs of $3 million last quarter. The allowance for loan and lease losses as a percentage of total loans and leases decreased to 3.67% at June 30, 2013 from 3.82% at March 31, 2013.

Despite this decrease, the allowance for loan and lease losses as a percentage of non-accrual loans increased to 163% at June 30, 2013 from 133% at March 31. Lastly at June 30, 2013, our capital ratios continued to exceed the levels required to be quite considered a well capitalized institution for regulatory purposes. Our Tier 1 risk-based capital – total risk-based capital, leveraged capital ratios were 21.55%, 22.83% and 14.24% respectively compared to 22.16%, 23.43% and 14.36% respectively at March 31, 2013.

That completes our financial summary and I’d now like to turn the call over to Lance Mizumoto who will provide additional background related to our banking activity.

Lance Mizumoto - Executive Vice President and Chief Banking Officer

Thank you, Denis. As Denis mentioned earlier we are encouraged by the continued growth in our loan balances, which increased by $98.5 million in the second quarter over the first quarter of this year. Our loan production this quarter resulted in increases of $60.4 million in residential mortgages and $48 million in consumer loans. Our commercial loan balance was relatively flat do in part to reductions in non-performing loans and pay downs of existing loans. Approximately $11.8 million in non-accrual loans reduced from our loan portfolio which had to be offset by loan production.

Our solid growth in total deposits of $91 million was primarily due to increases in non-interest bearing and interest bearing checking as well as government time deposits. Core deposits increased by $30.7 million from the end of the previous quarter largely as a result of our efforts to strengthen our relationships with existing customers. Going forward, we remain optimistic for further growth in our loan portfolio evidenced by our strengthening commercial loan pipeline as well as the increased startup activity in private commercial and residential development projects in Hawaii.

We are seeing the activity in these projects pickup since the last quarter as they transitioned from the permitting phase to construction. As interest rates increased, we expect a reduction in residential mortgage refinance activity, which will impact our gain on sales and servicing fee income related to these loans. Overall, as the economic and market conditions in Hawaii are improving, we are confident that quality and credit opportunities will be increasing as well. We are working hard to expand our base of customer relations going forward.

That concludes my remarks. And I will turn the call back to John for his summary at this time. John?

John Dean - President and Chief Executive Officer

Thanks, Lance. To summarize, we are pleased with the company’s financial performance in the second quarter as we systematically progress toward a full recovery of our Bank. We are confident that the initiative was being executed to improve information management, operational processes, and overall efficiencies will better position us for quality growth in the future. We are also pleased to be back in a position to reinstate cash dividend payments and would like to again express our appreciation to our shareholders for their support and confidence. Thank you.

Question-and-Answer Session

Operator

Are you ready for the question-and-answer session sir?

John Dean

Yes.

Operator

We will now begin the session. (Operator Instructions) Our first question is from Aaron Deer with Sandler O’Neill. Please go ahead.

Aaron Deer - Sandler O’Neill

Hi, good morning everyone.

John Dean

Good morning Aaron.

Aaron Deer - Sandler O’Neill

John, you gave some helpful guidance on what’s your expectations are for non-interest expenses here. I am curious if you can give us a sense of how much of the current expense, what might be related to consultants are duplicative tax spend and that sort of thing that’s going to go away when these initiatives are complete. So, we get a sense of what kind of profit…

John Dean

Yes, I appreciate what you are going, Aaron. I can’t give you specific dollars, but obviously those costs you have mentioned are embedded in what I shared with you in terms as we make investments on the IT side to include the CRM and looking for other operational efficiencies. Maybe best if I just tell you where we are headed over the next few years and that’s the target efficiency ratio of 65%. And obviously that’s our focus and we have many initiatives underway where we think that’s very attainable.

Aaron Deer - Sandler O’Neill

Okay, that’s helpful. And then I was curious if you could talk a little bit about the variables that fit into the reserve calculation this quarter. I guess, I was a little surprised that given the very favorable improvement that you had in credit metrics that we didn’t see a larger reserve release, I was wondering if you could speak to that?

John Dean

Sure. And that’s why we have our Chief Credit Officer and the Head of Operations, Bill Wilson with us. Bill?

Bill Wilson

Good morning Aaron. Yes, I think in the methodology which has remained consistent, I guess two of the bigger factors I think that influenced the current quarter would be the loan growth. And then if you consider our NPAs to total loans, while it’s certainly improved markedly from where it had been a couple of years ago, it still remains elevated relative to our peer group. I think those are probably a couple of the driving factors that got us to the result we are.

Aaron Deer - Sandler O’Neill

Okay, I will step back and come back again if other questions don’t get addressed.

Operator

Our next question is Joe Morford, RBC Capital Markets. Please go ahead.

Joe Morford - RBC Capital Markets

Thanks. Good morning John.

John Dean

Good morning Joe. How are you?

Joe Morford - RBC Capital Markets

Very well, thanks. I’m wondering if you could talk about the decision to reinstate the dividend relative to perhaps say, a share buyback program and how should we think about your capital allocation priorities going forward beyond supporting organic growth?

John Dean

We look at the reinstatement of the cash dividend, Joe as the first step, not a – so beginning of a process. We still have a high level of NPAs, so we are not rushing in terms of to look for deploying our excess capital, but we have under consideration, we’ll continue to work towards, I think as I’ve mentioned earlier one would be the repayment of TRUPS, I think you are aware we did pay, I think $10 million we bought, $10 million of TRUPS last quarter. The other areas that we are looking at and under consideration would be a one-time cash dividend and that is still on the table. And then lastly would be the purchase of shares going forward, but we wouldn’t be able to begin that until February of next year and that’s a result of the DTA, Deferred Tax Asset and making sure that we protect that. And if you have the details on that one, I’m going to turn it over to Denis, our CFO. Does that answer to the question?

Joe Morford - RBC Capital Markets

No, the answer is fine, thanks very much. The other question was just if we could talk a bit more about the loan growth in the quarter in the residential mortgage activity, the types of products you are following and also maybe a little more color on the commercial loan activity which you suggest the pipeline is building there?

John Dean

Sure. I am going to turn it, Joe over to Lance Mizumoto who headed up all of our lending functions. Lance?

Lance Mizumoto

Hi, Joe.

Joe Morford - RBC Capital Markets

Hi.

Lance Mizumoto

Most of our portfolio of loans are in the jumbo type loans. And I think most of them are fixed rate. We have some adjustable rate mortgages put forward as well but it’s a very smaller amount. And in terms of the commercial loan pipeline, well we were flat again this past quarter. We anticipate with the construction activity I alluded to both in residential and commercial construction that we would see opportunities going forward.

John Dean

Other questions in the loans, Joe.

Joe Morford - RBC Capital Markets

May be just a traditional C&I activity and kind of conference the businesses there that you may see little more activity there?

Lance Mizumoto

We anticipate more activity again as construction activity increases. There is a multiplier effect when construction activity picks up, a number of our customers that are subcontractors for example seek more capital or financing for expansion purposes, so we anticipate most of that activity picking up going forward.

Joe Morford - RBC Capital Markets

Okay, understand. That makes more sense. Thanks.

John Dean

Thank you, Joe.

Operator

Our next question is Jacquelynne Chimera, KBW. Please go ahead.

Jacquelynne Chimera - KBW

Hi, good morning everyone.

John Dean

Good morning, Jacquelynne.

Jacquelynne Chimera - KBW

It sounds looking to that 65% target that you have what rate environment are you assuming?

John Dean

On the specifics, even Denis, I’ll turn it over to David Morimoto, but obviously with the overall rise in the treasury I know it’s come back a little bit. We are expecting not at the short end any changes going forward, but in the 3, 5, 10 year and in the 30 year mortgage we are projecting a pickup and in terms of the specific rates we forecasted over the past three years. David?

David Morimoto

Hey, Jackie, the forecast over the next several years is pretty consensus, so it’s a relatively flat on the front end, so not much any monitory policy tightening, but we were forecasting a bit of a steepening of the yield curve, so I think the terminal rate of the next two to three years on the 10 year I think we forecasted it getting closed to 4%.

Jacquelynne Chimera - KBW

Okay so that 65 target does incorporate some rate lift and NIM lift and all of that as well?

David Morimoto

That’s correct.

John Dean

That’s right. But I think what we have you’d see as David mentioned is a consensus out there today.

Jacquelynne Chimera - KBW

No, definitely we’d all like to see higher rates.

John Dean

Immigrate.

Jacquelynne Chimera - KBW

Then I had a TARP repurchase that occurred in the quarter thinking about that from an income standpoint and I apologize for my ignorance on this. So, since the redemption happens in 4Q will it continued to be a portion of your interest expense until that point?

John Dean

I am going to turn it over to Denis, Denis Isono Jackie.

Denis Isono

Yeah, it remains part of the accrued liability expense for the interest, because it’s still outstanding. We just can’t redeem until an interest call date which is October 7.

Jacquelynne Chimera - KBW

Okay. But the gain on that was booked in the quarter.

Denis Isono

No, it gets booked in the – it hasn’t been booked yet.

Jacquelynne Chimera - KBW

Oh, that books at the time of closing as well?

Denis Isono

That’s correct.

John Dean

Did that answer the question?

Jacquelynne Chimera - KBW

Yes, yes it does very well. And then I think most or everything else and just to clarify the taxes that were paid in the quarter that’s just because you have that real gain which caused your income to be higher than the projections you had last quarter when you did the DTA reversal?

Denis Isono

That’s exactly correct.

Jacquelynne Chimera - KBW

Okay, great. That was all I had. Thank you.

John Dean

Thank you, Jackie.

Operator

(Operator Instructions) Our next question is Don Worthington, Raymond James. Please go ahead.

Don Worthington - Raymond James

Good morning everyone.

John Dean

Good morning Don.

Don Worthington - Raymond James

On the DTA, you mentioned what the balance was at the end of the quarter, what’s the valuation allowance at the end of June?

John Dean

I will turn it Denis again Don in terms of the balance. Denis?

Denis Isono

I think we are going to hold on for a minute. I think we are working on it.

Don Worthington - Raymond James

Okay.

Denis Isono

This is $9.6 million.

Don Worthington - Raymond James

$9.6 million. Okay. And then in terms of loan recoveries those have been pretty good and pretty much offset charge offs are more than offset charge-offs this quarter. Do you expect more of that going forward or I guess what’s your look is for more recoveries?

John Dean

We will turn it over to Bill. Bill Wilson.

Bill Wilson

Hi, good morning. It’s Bill, I would imagine that we would continue to see reasonable loan recoveries, obviously coming out of the environment we did in the last couple of years but then with the passage of time I think that should taper off and start to look more like peer group averages.

Don Worthington - Raymond James

Okay, alright. Thank you.

John Dean

Thank you, Don.

Operator

Our next question is a follow-up from Aaron Deer, Sandler O'Neill. Please go ahead.

Aaron Deer - Sandler O'Neill

Hi guys just a quick question on the margin, it looks like the benefit from interest recoveries this quarter was somewhere around 16 basis points. I guess that puts you kind of flattish with where you were in the prior quarter and of course you have been able to deploy…

John Dean

I think we got one basis point pickup, didn’t we?

Aaron Deer - Sandler O'Neill

Right, yes, and so...

John Dean

I got it, well it’s hard to do today Aaron.

Aaron Deer - Sandler O'Neill

No, that’s fair, so it’s – I am just wondering with given where the rate environment has gone recently and your expectations for growth. Can we continue to see some additional modest gains or what are your thoughts there?

John Dean

It’s going to be a function of loan growth and it’s really a shift in the portfolio. And what I mean by that is to the extent that and we are cautiously optimistic in terms of the loan growth as we substitute loan assets for our investment assets, we think we have the possibility to continue to improve that margin. But as you know we are all financial institutions continue to be into a margin squeeze even with their recent up-tick in rates on the longer end. So, cautiously optimistic we can continue to improve, but I don’t think you are going to see significant improvement in that over time. At least until there is a further strengthening on the long end of the yield curve.

Aaron Deer - Sandler O'Neill

Alright, okay, good I appreciate you taking my questions.

John Dean

Thank you, Aaron.

Operator

Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to John Dean for any closing remarks.

John Dean - President and Chief Executive Officer

Thank you. Let me just thank everyone again for participating in our earnings call for the second quarter of 2013. We look forward to future opportunities to update you on our progress. Have a good day.

Operator

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

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