Central Pacific Financial Corp. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011. The company is a Hawaii bank holding company; its principal subsidiary, Central Pacific Bank, operates 34 branches and 120 ATMs in Hawaii.
Financial performance and condition
Unless stated otherwise, amounts are in millions.
| Metric | Q2 / June 30, 2011 | Comparable period / prior date |
|---|---|---|
| Net income (loss) | $8.2; diluted EPS $0.20 | Q2 2010: loss $16.1; diluted loss per share $12.01 |
| First-half net income (loss) | $12.9; diluted EPS $3.15 reported, or $0.38 excluding the TARP exchange accounting gain | First half 2010: loss $176.3; diluted loss per share $119.18 |
| Net interest income | Q2 $29.0 GAAP; $29.1 taxable-equivalent. First half $57.2 GAAP; $57.4 taxable-equivalent. | Taxable-equivalent: Q2 2010 $29.3; first half 2010 $64.6 |
| Net interest margin | 3.04% in Q2 and first half | Q2 2010: 2.90%; first half 2010: 3.06% |
| Total assets | $4,131.7 | December 31, 2010: $3,938.1 |
| Loans and leases | $2,046.7 gross; $1,879.8 net of allowance | December 31, 2010 gross: $2,169.4 |
| Deposits | $3,230.3 | December 31, 2010: $3,132.9 |
| Equity | $433.8 total; $423.8 shareholders’ equity | December 31, 2010 total: $76.1 |
| Cash and cash equivalents | $453.5 at period end | $790.7 at beginning of first half |
| Operating cash flow | $27.7 in first half | First half 2010: $83.4 |
- First-half taxable-equivalent net interest income declined 11.2%, mainly as average loans contracted; lower funding costs and a larger securities portfolio partly offset the decline. Q2 net interest margin improved year over year, while the first-half margin edged down.
- First-half cash flows were $27.7 provided by operations, $534.4 used in investing and $169.4 provided by financing. The net decrease in cash and cash equivalents was $337.3.
- Total short- and long-term borrowings were approximately $410.5 at June 30, versus $662.3 at year-end 2010. Long-term debt was $409.1; short-term borrowings were $1.4. FHLB advances were $300.8, with about $345.9 of the FHLB line undrawn, subject to availability.
- Regulatory capital improved substantially after recapitalization. At June 30, company ratios were 13.1% leverage, 22.5% Tier 1 risk-based and 23.8% total risk-based; bank ratios were 12.3%, 21.1% and 22.4%, respectively. The bank’s MOU requires at least an 8% leverage ratio.
- Nonperforming assets fell to $249.3 from $302.8 at year-end, but remained elevated. Nonaccrual loans were $206.5; the allowance for loan and lease losses was $166.9, or 8.16% of loans and 66.95% of nonperforming assets. First-half net charge-offs were $15.6.
Material changes versus prior periods
- Profitability returned: the company reported two consecutive profitable quarters. Q2’s $8.2 net income compared with a $16.1 loss a year earlier; first-half net income was $12.9 versus a $176.3 loss.
- First-half 2011 common-share earnings include an $85.1 noncash accounting benefit from exchanging Treasury preferred stock and accrued dividends for common shares and a warrant. The benefit did not increase total shareholders’ equity or regulatory capital. First-half 2010 included a $102.7 noncash goodwill impairment charge.
- Credit costs improved: the provision was a credit of $8.8 in Q2 and $10.4 for the first half, versus charges of $20.4 and $79.2 in the corresponding 2010 periods. Net charge-offs also declined year over year.
- Loans contracted 5.7% from year-end, led by reductions in construction and development and commercial real estate lending. Available-for-sale securities increased to $1,400.4 from $702.5 as liquidity was redeployed.
- Deposits increased 3.1% from year-end. The company completed a $325 million private placement and a $20 million rights offering, exchanged Treasury preferred stock for common stock, and reported shareholders’ equity of $423.8 versus $66.1 at year-end.
Outlook, risks and unusual items
- Outlook: No company-specific earnings or financial guidance was provided. Management described Hawaii’s economy as showing signs of recovery, with modest improvement expected in 2011 and stronger growth in 2012, but emphasized uncertainty. Hawaii tourism was stronger overall, while Japanese visitor activity weakened after the earthquake and tsunami. California’s recovery remained modest, with weak real estate and labor markets. The filing noted that these economic forecasts are external projections, not company guidance.
- Regulation: The bank’s 2009 Consent Order was lifted in May and replaced by a Bank MOU, but asset-quality, classified-asset, lending, management and dividend restrictions remain. The company also remains subject to a Federal Reserve/DFI Written Agreement and a separate Bank Secrecy Act MOU. Noncompliance could lead to further restrictions, penalties or other enforcement action.
- Credit and concentration risk: The loan portfolio retains elevated commercial real estate and construction exposure. Management warned that deteriorating Hawaii or California property values, borrower stress, loan maturities or renewed economic weakness could increase delinquencies, charge-offs and provisions. The company planned to continue reducing Mainland exposure and selected real estate lending.
- Funding and distributions: The company had approximately $46.4 million of standalone cash, but did not expect bank dividends in the foreseeable future because the bank had a $468.0 million accumulated deficit. Cash dividends were restricted. Interest on trust-preferred-related junior subordinated debentures had been deferred for eight consecutive quarters; $6.7 million was accrued. Regulatory approval may be sought to pay deferred amounts.
- Mortgage repurchases: The reserve for residential mortgage repurchase losses was $6.7, up from $5.0 at year-end. Repurchase activity and uncertainty could require further reserve increases.
- Legal contingency: A putative class action alleges improper overdraft practices and fees. The company was discussing resolution but could not estimate potential costs. Management said other ordinary-course litigation was not expected to have a material adverse effect.
- Tax and unusual accounting: No income tax expense was recorded, reflecting a full valuation allowance against net deferred tax assets; the allowance was $172.4. The TARP exchange drove reported first-half EPS materially above underlying earnings. No goodwill remained after the 2010 impairment.
Most important facts for investors to verify
- Whether credit quality continues to improve, particularly construction and commercial real estate exposures, nonperforming assets and charge-offs—and whether the $166.9 allowance remains adequate.
- Whether the bank and holding company satisfy all Bank MOU, Written Agreement and BSA MOU requirements, and whether restrictions on dividends and other actions change.
- Underlying earnings excluding the $85.1 TARP exchange accounting gain, alongside net interest income, margin and expense trends.
- Liquidity and funding access, including the availability of FHLB advances, collateral requirements and the company’s ability to meet holding-company obligations without bank dividends.
- Future mortgage repurchase demands and reserve adequacy, as well as developments and potential costs in the overdraft class action.