Central Pacific Financial Corp. — Q2 2020 Form 10-Q
Business context and period: Hawaii-based bank holding company reporting the quarter and six months ended June 30, 2020. Results reflect the effects of COVID-19 on Hawaii’s economy, significant PPP lending, and adoption of the CECL expected-credit-loss standard on January 1, 2020.
Key financial results
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income | $49.3 million | $45.4 million | $97.1 million | $90.5 million |
| Provision for credit losses | $10.6 million | $1.4 million | $20.0 million | $2.7 million |
| Net income | $9.9 million | $13.5 million | $18.2 million | $29.6 million |
| Diluted EPS | $0.35 | $0.47 | $0.65 | $1.03 |
| Net interest margin, taxable-equivalent | 3.26% | 3.33% | 3.34% | 3.33% |
| Operating efficiency ratio | 60.76% | 65.09% | 62.29% | 62.76% |
Q2 pre-tax, pre-provision income was $26.5 million versus $23.8 million a year earlier; the six-month comparison was $49.8 million versus $51.3 million. Q2 and six-month operating income was pressured by credit-loss provisioning, while lower deposit funding costs and loan growth supported net interest income.
Financial position, cash flow, and capital
- Assets: $6.63 billion at June 30, up $620.3 million from year-end 2019.
- Loans: $5.00 billion before allowance, up 12.4% from year-end. PPP loans were $526.4 million net of deferred fees and costs; the allowance for credit losses was $67.3 million, or 1.50% of loans excluding PPP.
- Deposits: $5.79 billion, up $674.7 million. Core deposits increased 18.0% to $5.02 billion; management said PPP proceeds and funds returned from off-balance-sheet investments contributed to the increase.
- Liquidity: Cash and cash equivalents were $143.3 million at June 30. The bank had $1.67 billion undrawn on its $1.97 billion FHLB line, plus $54.6 million of unused Federal Reserve discount-window capacity. It had drawn $65.9 million under the PPP Liquidity Facility.
- Debt: Long-term debt was $167.5 million, including $51.5 million of subordinated debentures; no short-term borrowings were outstanding at quarter-end, compared with $150.0 million at December 31, 2019.
- Equity and capital: Total equity was $544.3 million. The bank’s regulatory capital ratios were 8.7% leverage, 12.2% Tier 1 risk-based, 13.3% total risk-based, and 12.2% CET1; the filing states these exceeded well-capitalized thresholds. The company elected the permitted two-year delay in reflecting CECL’s regulatory-capital effect.
- Six-month cash flows: Operating activities provided $57.1 million; investing activities used $589.6 million, mainly reflecting net loan originations; financing activities provided $572.9 million, largely from deposit growth.
Material changes versus comparable periods
- Net income declined 26.7% in Q2 and 38.3% for the first half year over year, principally as credit-loss provisions increased amid pandemic uncertainty.
- Q2 net interest income rose 8.6% on the reported GAAP basis; six-month net interest income rose 7.3%. Lower rates paid on deposits and borrowings partly offset lower asset yields. Q2 taxable-equivalent NIM declined 7 basis points year over year; the six-month margin was up 1 basis point.
- Total other operating income increased 5.9% in Q2, helped by mortgage banking, but declined 10.1% for the half-year, partly because the prior-year period included a $2.6 million MasterCard stock gain.
- Nonperforming assets increased to $4.7 million from $1.7 million at year-end; the nonaccrual-loan ratio was 0.09%. Net charge-offs were $2.9 million in Q2 and $4.2 million for the half-year.
- CECL adoption increased the opening loan allowance by $3.6 million and the off-balance-sheet credit reserve by $0.7 million, with a $3.2 million after-tax reduction to retained earnings.
Outlook, commentary, and risks
- COVID-19 and credit: The company reported $567.9 million of loan payment deferrals or forbearances at June 30, equal to 11.3% of loans (12.7% excluding PPP). Deferrals were continuing into Q3, and management expected further requests. Collection of accrued interest on deferred loans was uncertain; any required reversal could reduce future interest income.
- Economic exposure: Management cited Hawaii tourism declines, elevated unemployment, and risks to borrowers, collateral values, loan quality, fee income, liquidity, and capital. It identified $412 million of loans to industries considered particularly exposed to pandemic effects, equal to 9.2% of loans excluding PPP.
- Credit outlook: Management said adverse economic forecasts could require additional provisions. PPP loans are SBA-guaranteed and potentially forgivable, but the filing notes unresolved participation risks and liabilities.
- Liquidity and dividends: Management described liquidity and capital as strong but warned a deeper or longer downturn, deposit withdrawals, or credit losses could weaken them. The board declared a $0.23-per-share dividend in July; future dividends are not assured. Share repurchases were suspended in March 2020.
- Branch plan: In July, the company approved consolidation of four Oahu branches. It expects about $1.8 million in annual expense savings and approximately $1.7 million of pre-tax costs in Q3 and Q4 2020 combined.
- Strategy and unusual items: RISE2020 initiatives continued, with a new online and mobile banking launch planned for late August 2020. The filing reports a first-quarter $1.3 million gain related to a risk participation agreement. Management reported no material adverse expected effect from ordinary-course legal matters.
- Guidance: The filing provides no specific earnings or financial forecast; management emphasizes substantial uncertainty around the pandemic and its duration.
Important facts for investors to verify
- How many deferred borrowers resume payments, request extensions, or become delinquent after deferral periods end.
- Whether the $67.3 million loan allowance adequately reflects CECL assumptions, Hawaii economic forecasts, and concentrations in vulnerable industries.
- PPP forgiveness outcomes, fee recognition, and any liabilities associated with the company’s participation.
- Whether rapid deposit growth tied partly to PPP funds is retained as those funds are spent, and whether available liquidity facilities remain accessible.
- Future credit costs, net interest margin, and capital ratios under prolonged low rates or a deeper Hawaii downturn.
- Execution, timing, costs, and realized savings from branch consolidations and RISE2020 digital initiatives.