CENTRAL PACIFIC FINANCIAL CORP quarterly report, Q3 FY2013

Central Pacific Financial Corp. — Q3 2013 Form 10-Q

Business context and reporting period

Central Pacific Financial Corp. is a Hawaii bank holding company whose principal subsidiary, Central Pacific Bank, operates 35 branches and 112 ATMs in Hawaii. This unaudited filing covers the quarter and nine months ended September 30, 2013; balance-sheet comparisons are with December 31, 2012. Amounts below are in millions unless otherwise indicated.

Financial performance and condition

Metric	Q3 2013	Prior comparable period	Nine months 2013	Prior comparable period
Net interest income	$33.8	$29.6	$97.6	$90.3
Net income	$10.2	$10.7	$161.8	$35.0
Diluted EPS	$0.24	$0.26	$3.83	$0.83
Other operating income	$11.9	$17.0	$42.8	$43.9
Other operating expense	$36.5	$40.9	$104.3	$115.8

• Q3 net interest margin was 3.19%, up from 3.02%; nine-month margin was 3.16%, versus 3.14%. Taxable-equivalent net interest income was $34.3 million for Q3 and $99.3 million year to date.
• Nine-month net income includes a $119.8 million non-cash benefit from releasing part of the deferred-tax-asset valuation allowance. Excluding that benefit, management reported non-GAAP net income of $42.0 million, or $1.00 diluted EPS. The GAAP income statement records a $115.7 million net tax benefit for the nine-month period after subsequent-period tax expense.
• Operating cash flow was $69.7 million for the first nine months, versus $42.7 million in 2012. Investing used $388.5 million and financing provided $238.3 million; cash and cash equivalents fell by $80.5 million to $96.9 million.
• At September 30, total assets were $4.74 billion, net loans and leases $2.40 billion, deposits $3.91 billion, and total equity $653.5 million. Since year-end 2012, loans and leases grew 12.7% and deposits grew 6.1%.
• Short-term borrowings were $28.0 million and long-term debt was $108.3 million. The bank reported unused lines of credit of $47.3 million at the Federal Reserve discount window and a $907.8 million FHLB line; FHLB advances outstanding totaled approximately $28.0 million short-term and $18.5 million long-term.
• Company capital ratios were 21.3% Tier 1 risk-based, 22.6% total risk-based, and 14.0% leverage; the bank’s respective ratios were 20.1%, 21.4%, and 13.1%. Both exceeded “well-capitalized” regulatory thresholds.

Material changes versus prior periods

• Quarterly net income and EPS declined year over year despite higher net interest income, primarily as other operating income fell 30.0%, including lower gains on residential loan and foreclosed-asset sales.
• Year-to-date GAAP earnings rose sharply, principally because of the tax valuation-allowance release; management’s adjusted result excluding that benefit was $42.0 million, compared with $35.0 million GAAP net income in the prior-year period.
• Nonperforming assets declined to $59.0 million from $90.0 million at year-end 2012. The allowance for loan and lease losses fell to $85.2 million from $96.4 million, or 3.43% of loans versus 4.37% at year-end. Nine-month net charge-offs were $1.2 million, compared with $8.6 million.
• Accumulated other comprehensive loss widened to $13.7 million from $0.8 million, largely reflecting unrealized losses on investment securities. The company transferred $101.7 million of available-for-sale securities to held-to-maturity during the period and reported no available-for-sale securities sales in 2013 year to date.
• The company resumed payments on trust-preferred obligations in March after paying $13.0 million of deferred interest and related dividends. It declared a $0.08-per-share quarterly common dividend in October, payable in December.

Outlook, management commentary, risks and unusual items

• Management described improving Hawaii economic and real-estate conditions, including stronger tourism, employment and Oahu home sales, but cautioned that global and U.S. uncertainty and real-estate weakness could impair borrowers and asset quality. The company has significant commercial real-estate and construction lending exposure.
• The bank remains subject to an FDIC Compliance Memorandum of Understanding requiring improvements to compliance oversight, policies, monitoring, third-party controls and overdraft practices. Management said substantial steps had been taken but could not predict when full compliance or termination would occur. The separate 2010 Written Agreement with the Federal Reserve and Hawaii regulators was terminated in February 2013.
• A staff right-sizing and technology-efficiency program is underway, expected to eliminate approximately 100 positions and continue into 2014. Estimated severance charges total $4.0 million: $1.3 million accrued in Q3, with $1.6 million expected in Q4 2013 and $1.1 million in 2014. Management warned of possible system errors or delays, reduced productivity, employee turnover and customer attrition during implementation.
• In October, the company purchased the remaining trust-preferred securities and common stock of CPB Capital Trust I and called the securities. The filing also describes an expected $1.0 million gain related to its earlier $9.0 million purchase of $10.0 million face-value trust-preferred securities, to be recognized when callable in Q4.
• Management expects continued profitability, but provided no specific earnings or revenue guidance. It noted that future credit costs depend on economic conditions, borrower performance and collateral values. Legal proceedings in the ordinary course were not expected by management to have a material adverse effect.
• The filing cites interest-rate risk, regulatory and compliance requirements, tax-asset realizability, mortgage repurchase demands, and execution risks from operational changes. Management stated that disclosure controls were effective and that there were no material quarterly changes in internal control over financial reporting.

Important facts for investors to verify

• How much of the $161.8 million nine-month GAAP profit is attributable to the nonrecurring tax benefit, and whether underlying profitability is sustained.
• Trends in nonperforming assets, criticized loans, recoveries, and allowance adequacy as the loan book grows and remains concentrated in real estate.
• Progress toward meeting the FDIC Compliance MOU and any effects of continuing regulatory restrictions.
• Actual costs, timing and operational or customer impacts of the staffing and technology initiatives.
• Liquidity and funding needs, including deposit stability, use of borrowing lines, and the sustainability of common dividends.
• Whether the anticipated trust-preferred transaction gain was recognized as expected and how the securities call affected debt and earnings.