Central Pacific Financial Corp. — Form 10-Q
Business context and period. The Hawaii bank holding company reported unaudited results for the quarter and six months ended June 30, 2013. Its principal subsidiary, Central Pacific Bank, operates 35 branches and 117 ATMs in Hawaii. Unless noted otherwise, amounts below are in U.S. dollars; financial statement amounts are in millions.
Financial results and position
- Second-quarter earnings: Net income was $14.3 million, or $0.34 per diluted share, versus $10.8 million, or $0.26, in Q2 2012. Income before taxes was $16.2 million.
- First-half earnings: Net income was $151.6 million, or $3.59 per diluted share, versus $24.3 million, or $0.58, in H1 2012. The 2013 result included a $119.8 million non-cash tax benefit from releasing much of the deferred-tax-asset valuation allowance. Excluding that benefit, management reported non-GAAP net income of $31.8 million, or $0.75 per diluted share.
- Interest income and margin: Q2 net interest income was $33.2 million, compared with $30.3 million a year earlier; taxable-equivalent net interest income was $33.7 million versus $30.5 million. Taxable-equivalent net interest margin was 3.23%, up from 3.17%. For H1, taxable-equivalent net interest income was $65.0 million versus $61.1 million, while margin declined to 3.15% from 3.20%.
- Other income and expenses: Other operating income was $17.8 million in Q2, up from $13.6 million, including $7.7 million of net gains on foreclosed-asset sales; H1 other operating income was $30.8 million versus $26.8 million. Operating expenses were $35.0 million in Q2 versus $39.7 million, and $67.8 million in H1 versus $74.9 million.
- Credit costs and asset quality: The provision for loan and lease losses was a credit of $0.2 million in Q2 and $6.8 million in H1, compared with credits of $6.6 million and $11.6 million in the corresponding 2012 periods. H1 net charge-offs were $2.5 million versus $6.7 million. Nonperforming assets fell to $60.9 million from $90.0 million at year-end 2012; the allowance was $87.1 million, or 3.67% of loans, versus $96.4 million, or 4.37%.
- Balance sheet and liquidity: Total assets were $4.71 billion, up from $4.37 billion at December 31, 2012. Gross loans and leases were $2.37 billion, up from $2.20 billion; deposits were $3.86 billion, up from $3.68 billion. Cash and cash equivalents were $137.2 million at June 30. H1 operating cash flow was $75.5 million; investing activities used $290.6 million and financing activities provided $174.9 million. Cash and cash equivalents decreased $40.2 million during H1.
- Debt and capital: Long-term debt was $108.3 million; the company reported no short-term borrowings. The bank had $23 million in FHLB long-term borrowings and no Federal Reserve discount-window advances. Company capital ratios were 21.55% Tier 1 risk-based, 22.83% total risk-based, and 14.24% leverage, all above stated “well-capitalized” thresholds. Shareholders’ equity was $642.0 million, up from $504.8 million.
Changes, outlook, and risks
- Compared with Q2 2012, Q2 2013 net income, net interest income, and other operating income increased; operating expenses and credit-loss provision charges decreased. The quarter’s foreclosed-asset sale gains were a significant contributor to noninterest income.
- The much higher H1 2013 net income primarily reflects the deferred-tax valuation-allowance reversal, rather than recurring operating performance. Management attributed underlying improvement to stronger net interest income and improving credit indicators.
- The company reported ten consecutive profitable quarters. Management said Hawaii economic conditions were improving, citing growth in tourism and real estate activity, and identified continued focus on reducing its efficiency ratio and growing its Hawaii market share. The filing provides no specific earnings or revenue guidance.
- The FDIC Compliance Memorandum of Understanding remained in effect, requiring improvements to compliance oversight, policies, monitoring, third-party controls, and overdraft practices. Management said substantial steps had been taken but could not assure when the bank would fully comply or when the MOU would end. A separate 2010 Written Agreement was terminated in February 2013.
- Credit risks include the company’s concentration in commercial real estate and construction lending and potential deterioration in Hawaii or California real estate, borrower condition, or the broader economy. Management cautioned that credit losses or allowance needs could rise even if economic conditions remain stable. The allowance depends on estimates and may prove insufficient.
- Mortgage-loan sale representations and warranties create repurchase exposure. The related reserve was $3.9 million at June 30, 2013, up from $3.6 million at year-end; the company repurchased approximately $1.8 million of loans during Q2.
- The company paid $13.0 million of previously deferred trust-preferred interest in March 2013 and resumed quarterly payments. It announced a $0.08-per-share common dividend in July, payable September 16, subject to board discretion and legal and regulatory restrictions.
- Management expected to call in Q4 2013 $10 million face value of trust-preferred securities acquired for $9 million; it expected to recognize a $1 million gain upon the call. Basel III capital rules were finalized after quarter-end, with phase-in beginning in 2015; the company was evaluating their impact.
- Unrealized losses on securities increased: accumulated other comprehensive loss was $16.8 million at June 30, versus $0.8 million at year-end. Management attributed securities’ unrealized losses primarily to interest-rate and market changes and said it did not consider them other-than-temporary impairments.
- Management stated that ordinary-course legal proceedings were not expected to have a material adverse effect. Forward-looking results remain exposed to regulatory, economic, interest-rate, real-estate, credit, and operational risks.
Important facts for investors to verify
- Whether recurring earnings and margins remain sound after excluding the $119.8 million tax benefit and considering foreclosed-asset sale gains.
- Progress toward satisfying the FDIC Compliance MOU and any further regulatory restrictions or costs.
- Credit migration, nonperforming assets, charge-offs, and allowance adequacy, particularly in commercial real estate and construction portfolios.
- Realizability of the $144.1 million net deferred tax asset and the assumptions supporting its valuation.
- Mortgage repurchase demands and losses, the planned trust-preferred call and gain, and the sustainability and regulatory permissibility of common dividends.
- Effects of interest-rate movements on net interest margin, securities values, and capital, including the impact of Basel III implementation.