Central Pacific Financial Corp. — 2018 Form 10-K
Business context and period. This annual report covers the fiscal year ended December 31, 2018; it is not a standalone fourth-quarter filing. Central Pacific Financial is a Hawaii-based bank holding company operating Central Pacific Bank, with 35 branches and 78 ATMs. Results are substantially tied to Hawaii’s economy, tourism and real estate markets.
Financial performance and position
| Metric | 2018 | 2017 |
|---|---|---|
| Net interest income | $173.0 million | $167.7 million |
| Net income | $59.5 million | $41.2 million |
| Diluted earnings per share | $2.01 | $1.34 |
| Net interest margin | 3.22% | 3.28% |
| Total assets | $5.81 billion | $5.62 billion |
| Loans and leases | $4.08 billion | $3.77 billion |
| Total deposits | $4.95 billion | $4.96 billion |
| Shareholders’ equity | $491.7 million | $500.0 million |
- Earnings and margins: Net income rose 44%, principally because income tax expense fell to $18.8 million from $34.6 million. The 2017 comparison included a $7.4 million one-time, noncash charge to revalue deferred tax assets following federal tax reform. Pretax income increased about 3%. Net interest income grew 3.2%, while the net interest margin contracted 6 basis points as deposit and borrowing costs rose.
- Revenue and expenses: Other operating income increased to $38.8 million from $36.5 million. Operating expenses increased 2.8% to $134.7 million, primarily reflecting higher compensation, technology, ATM/debit-card and equipment costs. The reported efficiency ratio improved to 63.59% from 64.19%.
- Credit quality: The loan-loss provision was a $1.1 million credit, versus a $2.7 million credit in 2017. Allowance for loan and lease losses declined to $47.9 million, or 1.17% of loans, from $50.0 million, or 1.33%. Nonperforming assets fell to $2.7 million from $3.6 million; net charge-offs were $1.0 million. A $4.5 million recovery on a mainland land loan contributed to recoveries in the construction category.
- Cash flow and liquidity: Operating activities generated $103.5 million; investing activities used $211.1 million and financing activities provided $127.6 million. Cash and cash equivalents ended the year at $102.2 million. The loan-to-deposit ratio rose to 82.4% from 76.1%. The bank had $1.18 billion available under its FHLB line and $73.9 million of unused Federal Reserve discount-window borrowing capacity.
- Debt and capital: Year-end short-term borrowings were $197.0 million and long-term debt was $122.2 million, including $50.0 million of FHLB advances and $72.2 million of subordinated debentures. The company and bank exceeded applicable capital requirements; the bank’s year-end CET1 ratio was 12.7%. Shareholders’ equity declined partly because of $32.8 million in share repurchases and $24.1 million in dividends. The annual dividend declared was $0.82 per share.
Material changes versus the prior year
- Loans grew 8.2% to $4.08 billion, while total deposits edged down 0.2%; core deposits rose 0.6% to $4.02 billion. FHLB borrowing increased as the company funded loan growth and replaced some government time deposits.
- Interest expense increased 70% to $25.3 million, driven by higher deposit rates and borrowing costs. Average rates paid on interest-bearing liabilities rose 26 basis points.
- Net income and EPS benefited materially from the lower federal tax rate and the absence of the 2017 deferred-tax revaluation charge; the increase should not be read as entirely recurring operating growth.
- Available-for-sale securities had $25.2 million of gross unrealized losses at year-end, compared with $11.1 million a year earlier. The company attributed declines mainly to interest rates and market volatility and reported no intent or expected need to sell before recovery.
- The company redeemed $20 million of trust preferred securities in December 2018 and redeemed another $20 million in January 2019.
Outlook, commentary and risks
- Management described Hawaii’s economy as continuing to grow, though more slowly than in 2017, and expected the local real estate market to remain strong in 2019, while cautioning that this was not assured. The filing gives no company-specific earnings or revenue guidance.
- Management expected deposit rates to remain relatively steady in 2019, citing the Federal Reserve’s January 2019 statement that future rate moves would be patient and data-dependent.
- Credit and geographic concentration are key risks: 73.7% of loans were real-estate-related and 88.8% were concentrated in Hawaii. A downturn in property values, tourism or the broader local economy could weaken borrowers and collateral values.
- Other cited risks include rising funding costs and interest-rate sensitivity, the transition away from LIBOR for loans and debt, natural disasters, cybersecurity incidents, regulatory changes and competition. A parallel 100-basis-point rate increase was estimated to raise one-year net interest income 1.37%; a 100-basis-point decrease was estimated to reduce it 3.34%, subject to modeling assumptions.
- CECL was scheduled for adoption on January 1, 2020. Management had not estimated its financial impact and anticipated substantial implementation work and possible changes to credit-loss reserves.
- The company changed LIHTC investment accounting to the proportional amortization method and retrospectively reclassified related amortization from operating expense to income tax expense; the change did not affect net income, balance sheets or cash flows. The company also adopted lease accounting on January 1, 2019, recording a $55.9 million right-of-use asset and lease liability.
- Management said ordinary-course legal matters were not expected to have a material adverse effect. The auditor reported effective internal control over financial reporting; the company changed auditors from KPMG to Crowe in 2018 following a competitive review.
Investor verification priorities
- Assess normalized earnings and tax expense, separating recurring operating performance from the 2017 tax charge and 2018 tax benefits.
- Review allowance adequacy and credit trends, including the large construction-loan recovery and the high Hawaii real-estate concentration.
- Monitor deposit mix, government time-deposit maturities, rising funding costs and reliance on FHLB advances.
- Evaluate capital after dividends and buybacks, dividend capacity at the bank, and the effect of the January 2019 debt redemption.
- Track unrealized securities losses, CECL implementation and LIBOR transition exposure; confirm the effects of the 2019 lease-accounting adoption.