Central Pacific Financial Corp. — Q3 2017 Form 10-Q
Business context and reporting period
Unaudited results for the quarter and nine months ended September 30, 2017; balance-sheet comparisons are with December 31, 2016. Central Pacific Financial is a Hawaii bank holding company. Its full-service bank operated 35 branches and 81 ATMs in Hawaii, with lending concentrated in the state.
Financial performance and condition
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income | $42.0m | $39.4m | $124.9m | $118.2m |
| Net income | $11.8m | $11.5m | $36.9m | $34.8m |
| Diluted earnings per share | $0.39 | $0.37 | $1.20 | $1.11 |
| Net interest margin (taxable-equivalent) | 3.25% | 3.25% | 3.28% | 3.29% |
| Efficiency ratio | 64.99% | 65.34% | 63.88% | 65.46% |
- Q3 revenue was $51.6m, comprising net interest income of $42.0m and other operating income of $9.6m. Operating expense was $33.5m. For the first nine months, revenue was $152.3m and operating expense was $97.3m.
- Nine-month cash flow: operating activities provided $76.6m; investing activities used $199.7m; financing activities provided $147.1m. Cash and cash equivalents increased $23.9m to $108.3m.
- At September 30, assets were $5.57bn, loans and leases $3.64bn, deposits $4.93bn, and shareholders’ equity $509.8m. Deposits rose 6.9% and loans and leases rose 3.2% from year-end 2016.
- Allowance for loan and lease losses was $51.2m, or 1.41% of loans, versus $56.6m and 1.61% at year-end. Nine-month net charge-offs were $2.9m, compared with $1.1m in 2016; nonperforming assets declined to $6.0m from $9.2m.
- No short-term borrowings remained at quarter-end, versus $135.0m at year-end 2016. Long-term debt was $92.8m. The bank had $1.49bn undrawn on its FHLB line and $71.9m of additional unused Federal Reserve discount-window capacity.
- The company’s tangible common equity ratio was 9.11%, down from 9.29% at year-end. The company and bank reported regulatory capital ratios above the stated “well capitalized” thresholds; the bank’s total risk-based capital ratio was 15.9%.
Material changes versus comparable periods
- Net income and diluted EPS increased year over year for both the quarter and nine-month period. Higher average loan and securities balances and improved asset yields supported net interest income; higher deposit costs, particularly on large time deposits, offset some of the benefit. Nine-month net interest margin edged down 1 basis point.
- Other operating income fell 3.8% for the nine months, including a $1.64m realized securities loss from a second-quarter portfolio repositioning. The company sold $97.7m of lower-yielding securities and reinvested proceeds in longer-duration securities at a higher average yield.
- Operating expenses increased 1.3% for the nine months, led by salaries, legal and professional fees, and entertainment and promotions. The efficiency ratio improved year over year.
- Loan growth reflected increases in commercial mortgage, residential mortgage, auto, and home-equity balances; other consumer and commercial/financial/agricultural balances declined. Core deposits increased 6.5%.
- The company repurchased 697,483 shares for $21.3m during the first nine months. It declared dividends of $0.52 per share for the period; a $0.18-per-share dividend was declared October 24, 2017.
Outlook, commentary, risks, and unusual items
- No company earnings or financial-target guidance is provided. Management described Hawaii’s economy and visitor industry as positive but noted projected slower state economic growth. It said the local real-estate market remained strong but offered no assurance that strength would continue.
- Management identified interest-rate sensitivity as a key market risk. The Federal Reserve had raised its target range twice in 2017, and management noted a possible further increase in December 2017. Rising rates could also increase deposit costs; the company’s interest-rate simulations were within policy limits at quarter-end.
- The company’s business is concentrated in Hawaii and exposed to local real estate, tourism, military and other major industries, as well as broader economic conditions and natural disasters. Management also cited credit quality, funding competition, regulatory and legal developments, and execution of efficiency initiatives among forward-looking risks.
- Control issue: Disclosure controls and procedures were deemed not effective because of a previously reported material weakness related to completeness and accuracy of data used in the allowance model. Remediation and independent review were underway, but management said it would evaluate successful implementation at year-end before concluding the weakness was remediated.
- The second-quarter securities repositioning produced a $1.6m realized loss. A second-quarter SERP settlement and related deferred-tax adjustment resulted in $0.9m of additional income-tax expense. Q3 BOLI income included a $0.4m death benefit.
- Management said ordinary-course legal matters were not expected to have a material adverse effect. The company reported a $2.7m valuation allowance against its net deferred tax asset and expected the remaining $36.4m net asset to be realizable. It also disclosed $2.7m of unfunded low-income housing investment commitments.
Most important facts for investors to verify
- Whether the allowance-model material weakness is remediated and whether model inputs, assumptions, and credit-loss estimates remain reliable.
- Whether higher deposit pricing continues to pressure net interest margin, earnings, and deposit growth.
- Whether increased net charge-offs, changes in criticized/substandard loans, or Hawaii real-estate weakness could require higher provisions.
- The performance and interest-rate exposure of the repositioned securities portfolio, including unrealized losses and the portfolio’s longer duration.
- Whether capital, liquidity, dividend and repurchase plans remain sustainable under adverse economic or funding conditions.