CENTRAL PACIFIC FINANCIAL CORP annual report, FY2015

Full document

Central Pacific Financial Corp. — FY 2015 Form 10-K

Business context and reporting period. Central Pacific Financial Corp. is a Hawaii-based bank holding company operating Central Pacific Bank. It provides commercial banking, lending, deposit, mortgage, trust and related services through 36 branches and 103 ATMs. This summary covers the fiscal year ended December 31, 2015; comparative figures are for FY 2014 unless otherwise noted.

Financial results and position

  • Profitability: Net income was $45.9 million, or $1.40 diluted EPS, versus $40.5 million, or $1.07, in 2014. Return on average assets was 0.92% (0.85%); return on average equity was 8.91% (6.80%). Fourth-quarter 2015 net income was $10.9 million and diluted EPS was $0.34, compared with $13.3 million and $0.37 in fourth-quarter 2014.
  • Revenue and margins: Net interest income was $149.5 million, up 4.3%; reported net interest margin was 3.30%, down from 3.32%. Other operating income fell 11.0% to $39.0 million. Total revenue, defined by the company as net interest income plus other operating income, was $188.5 million. The efficiency ratio improved to 69.61% from 70.93%.
  • Credit costs and asset quality: The company recorded a $15.7 million provision credit, versus a $6.4 million credit in 2014; management reported total credit costs of a $16.0 million credit. Net recoveries were $4.9 million, compared with $3.4 million of net charge-offs in 2014. Nonperforming assets declined to $16.2 million from $42.0 million; nonaccrual loans were $14.3 million. The allowance was $63.3 million, or 1.97% of loans, versus $74.0 million, or 2.53%.
  • Balance sheet and growth: Year-end assets were $5.13 billion, up 5.7%; loans and leases were $3.21 billion, up 9.5%; deposits were $4.43 billion, up 7.9%. Core deposits rose 8.3% to $3.58 billion and represented 80.8% of deposits. Shareholders’ equity declined 12.9% to $494.6 million, primarily reflecting share repurchases and dividends.
  • Cash flow: Operating activities provided $74.5 million; investing activities used $315.1 million; financing activities provided $234.8 million. Cash and cash equivalents ended the year at $80.2 million, down from $86.0 million.
  • Debt and liquidity: Short-term borrowings were $69.0 million and long-term debt was $92.8 million, principally subordinated debentures. The bank had $1.15 billion available under its $1.22 billion FHLB line and $40.8 million available at the Federal Reserve discount window; neither facility had material unused-capacity restrictions identified in the supplied text. The year-end loan-to-deposit ratio was 72.4%.
  • Capital: Company and bank exceeded well-capitalized regulatory thresholds. At year-end, company CET1, Tier 1 risk-based and total risk-based ratios were 12.8%, 14.4% and 15.7%; bank ratios were 14.1%, 14.1% and 15.3%. Tangible common equity to tangible assets was 9.51%, down from 11.52%.

Material changes versus 2014

  • Net income improved largely because the provision credit increased, net interest income rose, and operating expenses declined. Lower yields on loans and taxable securities partly offset loan-volume growth.
  • Other operating income decreased by $4.8 million, including a $1.9 million investment-securities loss versus a $0.2 million gain in 2014. Operating expenses decreased by $1.6 million; higher software and intangible amortization costs partly offset reductions in salaries, foreclosed-asset costs and other items.
  • Loan growth was broad-based, led by residential mortgages, commercial lending and consumer loans. Real-estate-related loans remained about 71% of the portfolio, and 86.4% of loans were concentrated in Hawaii.
  • The company repurchased 4.12 million shares for $93.3 million and paid $26.1 million in common dividends. FY 2015 dividends declared were $0.82 per share, including a $0.32 special dividend.

Outlook, risks and unusual items

  • Outlook: Management expected the federal funds rate and deposit rates to remain low during 2016, and expected net interest margin to remain relatively unchanged, with modest expansion possible as the economy recovered. Management cited improving Hawaii tourism, employment and real estate conditions; these are expectations, not company earnings guidance.
  • Interest-rate sensitivity: The company’s model estimated one-year net interest income would rise 0.22% under a 200-basis-point increase and fall 4.52% under a 100-basis-point decrease, assuming no balance-sheet growth. Management cautioned that these are assumption-dependent estimates, not forecasts.
  • Key risks: Geographic concentration in Hawaii and a high real-estate loan concentration expose results to local economic, tourism, property-value and construction downturns. Other disclosed risks include borrower credit deterioration, allowance-estimation uncertainty, deposit competition and funding costs, interest-rate movements, regulatory changes, cybersecurity and operational disruption, and competition.
  • Unusual/comparability items: FY 2013 net income included a $119.8 million non-cash tax benefit from reversing much of the deferred-tax-asset valuation allowance; reported 2013 net income of $172.1 million is therefore not directly comparable with 2015. In 2015, a securities-portfolio repositioning generated a $1.9 million realized loss; proceeds were reinvested in longer-duration, higher-yielding securities.
  • Contingencies and controls: Management said ordinary-course litigation was not expected to have a material adverse effect and anticipated no material losses from off-balance-sheet commitments. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting; management also reported effective disclosure controls and internal controls.

Investor verification priorities

  1. Review the allowance methodology and sustainability of repeated provision credits, especially given real-estate concentration and the decline in allowance coverage as a share of total loans.
  2. Verify loan quality trends, including nonperforming assets, criticized commercial real-estate exposures, restructurings and subsequent-period charge-offs or recoveries.
  3. Assess the durability of loan and core-deposit growth, funding mix, large time-deposit maturities and available borrowing capacity.
  4. Evaluate the effects of interest-rate changes and the longer-duration securities repositioning on margin, liquidity and securities values.
  5. Reconcile capital returns—repurchases and ordinary and special dividends—with the decline in equity and tangible common equity ratio, and confirm regulatory constraints on future distributions.
  6. Examine deferred-tax-asset realization assumptions and the effect of the 2013 tax benefit when comparing earnings across years.