Central Pacific Financial Corp. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Central Pacific Financial is a Hawaii bank holding company; its subsidiary, Central Pacific Bank, operates 36 branches and 111 ATMs in Hawaii. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial performance and condition
- Q3 earnings: Net income was $8.2 million, or $0.23 per diluted share, versus $10.2 million, or $0.24, in Q3 2013. For the first nine months, net income was $27.2 million, or $0.71 per diluted share, versus $161.8 million, or $3.83. The 2013 year-to-date result included a $119.8 million deferred-tax valuation-allowance benefit; excluding it, 2013 net income was $42.0 million, or $1.00 per diluted share.
- Interest income and margin: Q3 interest income was $37.1 million and net interest income was $35.5 million, compared with $35.6 million and $33.8 million, respectively, a year earlier. Taxable-equivalent net interest margin was 3.30%, up from 3.19%. For the first nine months, net interest income was $107.2 million, versus $97.6 million; taxable-equivalent margin was 3.32%, versus 3.16%.
- Other income and expenses: Other operating income was $11.5 million in Q3, down 3.9% year over year; first-nine-month income was $33.6 million, down 21.4%, principally reflecting lower gains on foreclosed-property and residential-loan sales. Operating expense was $35.2 million in Q3 and $100.1 million year to date, down 3.5% and 4.0%, respectively.
- Credit costs: The provision for loan and lease losses was a credit of $1.7 million in Q3 and $1.0 million for the first nine months. The allowance was $82.8 million, or 2.88% of loans, versus $83.8 million and 3.19% at year-end 2013. Net recoveries were $0.6 million year to date.
- Balance sheet and liquidity: Total assets were $4.75 billion, broadly unchanged from year-end 2013. Loans and leases rose 9.3% to $2.87 billion; deposits increased 2.8% to $4.05 billion. Cash and cash equivalents were $90.1 million at period-end. The bank had no FHLB or Federal Reserve discount-window advances outstanding; available lines were $934.6 million and $34.4 million, respectively, subject to collateral and access conditions.
- Debt and capital: Long-term debt was $92.8 million; short-term borrowings were zero, versus $8.0 million at December 31, 2013. Company Tier 1 risk-based, total risk-based and leverage capital ratios were 17.2%, 18.5% and 11.9%, respectively, down from 20.3%, 21.5% and 13.7% at year-end. The company and bank remained above the stated “well-capitalized” thresholds.
- Cash flow: For the first nine months, operating cash flow was $62.5 million, investing cash flow was $13.5 million and financing cash flow was negative $35.3 million. Cash and cash equivalents increased $40.8 million during the period.
Material changes versus comparable periods
- Q3 net income declined 19%; year-to-date reported income fell sharply because 2013 included the one-time $119.8 million tax benefit. Excluding that benefit, 2013 year-to-date net income was $42.0 million.
- Loan growth and the 2013 bond-swap strategy supported higher net interest income and margin. Average loan yields declined, partly offsetting volume growth.
- Year-to-date other operating income was lower, especially gains on foreclosed-property sales; 2013 included a $7.2 million gain on a U.S. Mainland construction asset.
- During 2014, the company repurchased 6.19 million shares for approximately $125 million through a tender offer and purchases from its two largest shareholders, plus $3.4 million under a separate repurchase plan. Shares outstanding fell to 35.9 million from 42.1 million at year-end 2013. These repurchases were a primary reason capital ratios and shareholders’ equity declined.
- Nonperforming assets decreased to $45.3 million from $46.8 million, and the ratio of nonperforming assets to loans and other real estate improved to 1.57% from 1.77%. However, nonaccrual commercial loans rose, and accruing troubled debt restructurings increased to $29.9 million from $23.3 million.
Outlook, risks and unusual items
- Management expected net interest margin to remain fairly stable near term, while continuing to shift earning assets from securities toward higher-yielding loans and selectively shorten asset duration. Lower market rates could pressure net interest income and margin.
- Management described Hawaii’s economic outlook as generally improving, citing lower unemployment and modest visitor-spending growth, but noted dependence on Hawaii’s economy, tourism and real estate. Deterioration in Hawaii or California property markets, borrower stress, interest-rate movements and broader economic or political uncertainty could adversely affect results and credit quality.
- The bank remained subject to a 2012 FDIC Compliance MOU covering compliance management, consumer protection, third-party oversight and related controls. The bank believed it had met the requirements, but could not assure when the MOU would be terminated; noncompliance could result in additional restrictions or penalties.
- Management concluded disclosure controls were not effective because a previously reported material weakness in internal control over financial reporting remained under remediation. Corrective actions included strengthened allowance-calculation checks and independent review; management said several quarters may be needed to assess remediation.
- The company declared a $0.10-per-share dividend in October 2014, payable December 15, subject to board discretion and legal, regulatory and contractual limits. It also had $26.6 million remaining under its 2014 share-repurchase authorization at September 30.
- Q3 income tax expense included a $0.9 million tax-return true-up. The filing also disclosed a potential rescission right related to 6,053 unregistered shares held through the bank’s 401(k) common-stock fund; management estimated the potential liability was not material. Ordinary-course legal proceedings were not expected by management to have a material adverse effect.
Key facts for investors to verify
- Whether the FDIC Compliance MOU is terminated and whether the material weakness in financial reporting controls is fully remediated.
- Loan growth, credit migration and trends in nonaccrual commercial loans, accruing TDRs, and allowance adequacy.
- Whether stable net interest margin guidance holds as market rates, asset mix and loan yields change.
- The sustainability of earnings excluding one-time items, particularly the 2013 deferred-tax benefit and prior-period asset-sale gains.
- Capital and liquidity after dividends and any further repurchases, including restrictions on bank dividends to the holding company.
- Potential mortgage-loan repurchase demands and the adequacy of the $3.1 million representation-and-warranty reserve.