Central Pacific Financial Corp. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Central Pacific Financial is a Hawaii bank holding company operating Central Pacific Bank, with 32 branches and 75 ATMs in Hawaii at quarter-end. Unless noted, amounts below are in U.S. dollars.
Key financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $49.1 million | $45.6 million | $146.2 million | $136.1 million |
| Provision for credit losses | $14.7 million | $1.5 million | $34.6 million | $4.2 million |
| Other operating income | $11.6 million | $10.3 million | $31.1 million | $32.0 million |
| Other operating expense | $37.0 million | $34.9 million | $109.6 million | $105.4 million |
| Net income | $6.9 million | $14.6 million | $25.1 million | $44.1 million |
| Diluted EPS | $0.24 | $0.51 | $0.89 | $1.53 |
| Net interest margin | 3.19% | 3.30% | 3.29% | 3.32% |
Q3 pre-tax, pre-provision income was $23.7 million, versus $21.0 million a year earlier; the comparable nine-month figures were $67.7 million and $62.8 million. The efficiency ratio improved to 60.93% for Q3 and 61.82% year to date, from 62.48% and 62.67%, respectively. Q3 cash dividends declared were $0.23 per share.
Financial position, liquidity and cash flow
- Total assets were $6.65 billion at September 30, up $635.5 million from year-end 2019. Total loans were $5.03 billion, up 13.1%; this included $528.6 million of PPP loans outstanding, net of deferred fees.
- Total deposits were $5.68 billion, up $558.9 million from year-end. Core deposits rose 15.4% to $4.91 billion and represented 86.5% of deposits.
- The allowance for credit losses on loans was $80.5 million, or 1.60% of total loans and 1.79% excluding SBA-guaranteed PPP loans. Long-term debt was $101.5 million and short-term borrowings were $206.0 million. Shareholders’ equity was $543.9 million.
- Cash and cash equivalents were $95.2 million at September 30. For the nine months, operating cash flow was $40.4 million, investing cash use was $638.9 million, financing cash flow was $590.7 million, and cash decreased $7.8 million.
- Liquidity access included $1.26 billion undrawn on a $1.79 billion FHLB line and $59.2 million of unused Federal Reserve discount-window borrowing capacity. No PPPLF funds were drawn at quarter-end.
- At September 30, the bank’s regulatory capital ratios exceeded “well-capitalized” thresholds: leverage 8.6%, Tier 1 risk-based 12.5%, total risk-based 13.6%, and CET1 12.5%. The company also reported capital ratios above applicable minimums.
Material changes and management commentary
- Net income fell about 53% in Q3 and 43% for the nine-month period, principally reflecting the much higher credit-loss provision. Management attributed the increased provision to CECL lifetime-loss estimates and adverse COVID-19 economic forecasts, including Hawaii-specific projections.
- Net interest income increased as loan growth, including PPP lending, and lower funding costs more than offset reduced asset yields. The Q3 net interest margin declined 11 basis points year over year. PPP net interest income and fees contributed $3.4 million in Q3 and $5.9 million year to date.
- Nonperforming assets increased to $13.2 million from $1.7 million at December 31, 2019; nonaccrual loans were $13.1 million. Criticized loans reached $196.8 million, including $148.8 million special mention and $48.0 million classified, excluding PPP loans.
- COVID-19 payment deferrals declined to $290.8 million, or 5.8% of total loans (6.5% excluding PPP), from $567.9 million at June 30. The company anticipated new or extended deferral requests would continue at a slower pace through Q4. A $0.2 million reserve was recorded against accrued interest on loans in active deferral.
- The company funded more than 7,200 PPP loans totaling over $558 million and received over $21 million in gross processing fees. It had begun helping borrowers seek SBA forgiveness; management expected most loans to be forgiven but noted unresolved risks and liabilities.
- A federal criminal complaint alleged fraud in connection with a $10 million PPP loan originated in April. The company and bank were not parties to the complaint, were cooperating with authorities, and said they expected the SBA guarantee to remain effective and the loan to be repaid.
- Management described liquidity and capital as strong and believed they could withstand a COVID-related recession, while warning that a longer or deeper downturn, deposit withdrawals, credit losses, or weaker income could adversely affect liquidity, capital and results. Hawaii tourism and employment remained severely affected.
- Three in-store branches were consolidated during Q3; one additional branch closure was expected in Q4. The company forecast approximately $1.8 million in annual expense savings, with $0.3 million of Q3 costs and an expected additional $1.4 million of Q4 costs. The share-repurchase program remained suspended.
- After quarter-end, on October 20, the company issued $55 million of ten-year subordinated notes at a 4.75% fixed rate for five years, then three-month SOFR plus 456 basis points. The notes initially qualify as Tier 2 capital; proceeds were intended for general corporate purposes and capital flexibility. On October 27, the board declared a $0.23-per-share dividend.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Results remain sensitive to the duration and effects of COVID-19, especially Hawaii tourism, borrower repayment capacity, real estate values, unemployment, deposit behavior and government programs. Further provisions, charge-offs, reversals of accrued interest, asset impairments or reduced fee and interest income may result. Other identified risks include interest-rate changes, funding costs, PPP forgiveness and guarantees, and operational or control challenges from remote work. Management reported disclosure controls were effective and said no other material internal-control changes occurred beyond controls implemented for CECL adoption. Management did not expect ordinary-course legal proceedings to materially affect results or financial position.
Important facts for investors to verify
- Whether deferral balances, criticized loans, nonaccrual loans and credit-loss reserves continue to change as Hawaii’s economy and tourism recover.
- The adequacy of the $80.5 million loan allowance and the assumptions in the CECL economic forecasts.
- PPP forgiveness timing, fee recognition, and the outcome of the investigation involving the $10 million loan and related SBA guarantee.
- Whether deposits remain stable as PPP funds are spent, and how the bank uses its borrowing capacity and the new subordinated-note proceeds.
- Whether the announced branch savings are achieved, Q4 consolidation costs are incurred as expected, and the share-repurchase program or dividend policy changes.