Central Pacific Financial Corp. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. Central Pacific Financial is a Hawaii-based bank holding company whose principal subsidiary, Central Pacific Bank, operates 35 branches and 103 ATMs in Hawaii.
Financial performance and position
- Profitability: Net income was $47.0 million, or $1.50 per diluted share, versus $45.9 million, or $1.40 per diluted share, in 2015. Return on average assets was 0.90%; return on average equity was 9.16%.
- Revenue and margins: Net interest income rose 5.6% to $158.0 million, primarily from loan growth. Net interest margin eased to 3.27% from 3.30%. Other operating income increased to $42.3 million; total operating revenue was $200.3 million. The efficiency ratio improved to 66.69% from 68.92%.
- Credit costs and asset quality: The company recorded a $5.5 million credit to the loan-loss provision, compared with a $15.7 million credit in 2015. Net charge-offs were $1.2 million. Nonperforming assets declined to $9.2 million from $16.2 million; the allowance was $56.6 million, or 1.61% of loans, compared with $63.3 million, or 1.97%, a year earlier.
- Balance sheet and growth: Total assets were $5.38 billion, loans and leases $3.52 billion, deposits $4.61 billion, and shareholders’ equity $504.7 million. Loans increased 9.8% and deposits 3.9%; core deposits increased 3.7% to $3.71 billion.
- Cash flow and liquidity: Operating activities provided $76.5 million; investing activities used $277.2 million; financing activities provided $204.9 million. Cash and cash equivalents ended the year at $84.3 million. The loan-to-deposit ratio was 76.5%, up from 72.4%. The bank had $1.28 billion available under its FHLB line and $63.7 million available at the Federal Reserve discount window.
- Debt and capital: Short-term borrowings were $135.0 million; long-term debt was $92.8 million, principally subordinated debentures. Company and bank total risk-based capital ratios were 15.5% and 15.0%, respectively; both were above well-capitalized thresholds. The company’s tangible common equity ratio was 9.29%.
Material changes versus 2015
- Net income rose modestly, while net interest income benefited from higher average loan balances. Interest expense increased 41.2%, reflecting higher rates on large time deposits and borrowings; margin narrowed slightly.
- The provision credit was smaller than in 2015, while improving asset quality supported continued reserve releases. The allowance methodology was revised in the fourth quarter, including consolidating 128 loan segments into nine, extending the historical lookback, and eliminating the unallocated reserve.
- Operating expenses increased 5.1%, mainly because of higher salaries and benefits. Pension expense included a $3.8 million actuarial loss following a pension de-risking transaction.
- Other income included a $3.5 million gain on the sale of a former branch property. The company repurchased 796,822 shares for $18.2 million and paid $18.6 million in common dividends. Regular quarterly dividends increased to $0.16 per share in the third quarter.
Outlook, risks, and unusual matters
- Management expected Hawaii’s economy and real estate market to remain positive in 2017, citing tourism, employment, and property-market trends. It anticipated gradual Federal Reserve rate increases, market rate volatility, and a moderate rise in the yield curve. The filing gives no specific earnings or revenue guidance.
- Key exposures include Hawaii’s concentrated economy and the real estate-linked portfolio: approximately 72.8% of loans were real estate-related, and 88.7% were concentrated in Hawaii. A regional downturn, weaker collateral values, or borrower stress could raise credit losses.
- Interest-rate changes may affect funding costs, asset yields, and mortgage servicing rights. Management’s one-year model estimated net interest income sensitivity of +0.31% for a 200-basis-point rate increase and -4.36% for a 100-basis-point decrease; the filing cautions these are assumption-dependent estimates, not forecasts.
- Internal controls: Management identified a material weakness in controls over the completeness and accuracy of data used in the allowance calculation. Management and the independent auditor concluded internal control over financial reporting was ineffective as of year-end; the auditor issued an adverse opinion on controls. The weakness was not reported to have caused a material financial-statement misstatement, and the auditor gave an unqualified opinion on the financial statements. Remediation efforts, including outside consultant support, were underway.
- Ordinary-course legal matters were assessed by management as not expected to have a material adverse effect. Off-balance-sheet commitments to extend credit were $825.3 million; standby letters of credit and guarantees were $16.1 million.
Important facts for investors to verify
- Progress and independent validation of remediation for the allowance-related material weakness, and whether it is fully resolved.
- Allowance adequacy and asset-quality trends as the loan portfolio grows, especially real estate, construction, and Hawaii exposures.
- Whether deposit pricing and borrowing costs outpace loan and securities yields as interest rates change.
- Liquidity, funding concentration, and the terms and availability of FHLB and Federal Reserve facilities.
- Whether the $3.5 million property-sale gain and $3.8 million pension settlement loss affect comparisons of recurring earnings, and how capital returns and dividends develop.