Central Pacific Financial Corp. — Q3 2012 Form 10-Q
Business context and period: Unaudited results for the three and nine months ended September 30, 2012. The Hawaii bank holding company operates Central Pacific Bank, a 34-branch community bank focused on Hawaii lending and deposits.
Financial performance and condition
- Q3 earnings: Net income was $10.7 million ($0.26 diluted EPS), versus $11.6 million ($0.28) in Q3 2011.
- Nine-month earnings: Net income was $35.0 million ($0.83 diluted EPS), versus $24.5 million in 2011. Prior-year common earnings and EPS included an $85.1 million noncash TARP-exchange accounting gain; reported 2011 diluted EPS was $3.16.
- Income and margin: Q3 net interest income was $29.6 million, down slightly year over year; taxable-equivalent net interest margin was 3.02%, versus 3.05%. Nine-month net interest income was $90.3 million, up from $87.0 million; taxable-equivalent margin improved to 3.14% from 3.04%. Other operating income was $15.9 million in Q3 and $42.8 million year to date.
- Credit costs and asset quality: The loan-loss provision was a credit of $5.0 million in Q3 and $16.6 million for nine months, compared with credits of $19.1 million and $29.5 million, respectively, in 2011. Net charge-offs were $1.9 million in Q3 and $8.6 million year to date. Nonperforming assets declined to $140.3 million from $195.6 million at year-end 2011; the allowance was $96.9 million, or 4.59% of loans, versus $122.1 million, or 5.91%.
- Balance sheet and liquidity: Total assets were $4.31 billion, up $176.8 million from December 31, 2011. Deposits increased 5.2% to $3.62 billion. Cash and cash equivalents ended the nine-month period at $220.7 million, down $36.4 million. Operating cash flow was $42.7 million.
- Debt and capital: Long-term debt was $108.3 million, down from $158.3 million at year-end; FHLB borrowings were $36,000. Company capital ratios were 14.1% leverage, 23.3% Tier 1 risk-based, and 24.6% total risk-based, above well-capitalized thresholds. Shareholders’ equity was $501.0 million.
- Taxes: No income tax expense was recorded. A full valuation allowance remained against deferred tax assets; its balance was $148.3 million.
Material changes and unusual items
- Q3 portfolio repositioning: sold $124.7 million of lower-yielding available-for-sale mortgage-backed securities and reinvested in $133.2 million of held-to-maturity securities. Management cited a higher average yield (1.88% versus 0.60%) and reduced interest-income volatility; the transaction generated a $0.7 million net gain.
- Residential loan-sale gains rose to $4.7 million in Q3 from $1.2 million a year earlier, contributing to higher other operating income. Q3 operating expenses fell to $39.8 million from $48.8 million, partly because 2011 included a $6.2 million debt-extinguishment loss and a $1.2 million class-action settlement accrual.
- Customer-relationship and non-compete intangible assets were fully impaired in Q2, resulting in $0.9 million of charges. The mortgage repurchase reserve was $4.3 million, down from $6.8 million at year-end.
- The allowance for loan losses declined alongside improving credit indicators, but nonperforming assets included $49.1 million of troubled debt restructurings. A $25.7 million single-borrower California construction and development exposure accounted for most gross additions to nonperforming assets during the first nine months.
Outlook, commentary, and risks
- Management expected further near-term net interest margin compression, citing the prolonged low-rate environment and limited scope for further reductions in deposit costs.
- Management described Hawaii economic conditions as improving, supported by tourism, employment, and real estate indicators, but cautioned that real estate and borrower conditions could worsen. The company remains exposed to commercial real estate and construction lending, including in California.
- The bank’s FDIC/DFI Bank MOU was lifted on October 26, 2012. The company remained subject to a Federal Reserve/DFI Written Agreement restricting, absent regulatory consent, dividends, certain debt payments and borrowings, and share repurchases. A separate FDIC Compliance MOU, entered October 9, 2012, requires improvements to compliance oversight, controls, audits, and consumer-protection processes.
- Interest on trust-preferred securities had been deferred for 13 consecutive quarters; accrued interest was $11.2 million. Dividend and other payment restrictions remain relevant. Management said sustained profitability might allow it to begin reversing the deferred-tax-asset valuation allowance in fiscal 2013; this was conditional, not firm guidance.
- Other stated risks include regulatory compliance, further credit deterioration, deferred-tax-asset realization, mortgage repurchase demands, and economic or market disruptions. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether credit-quality improvement continues and whether provision credits remain sustainable given the reduced allowance and concentrated real estate exposures.
- Progress and consequences under the continuing Written Agreement and the new Compliance MOU, including any restrictions or additional regulatory actions.
- Whether the securities repositioning and lower funding costs offset asset-yield pressure and support net interest margin.
- Developments in deferred trust-preferred interest, dividend restrictions, mortgage repurchase claims, and the potential realization of deferred tax assets.
- Liquidity and capital trends, including deposit stability, contingent funding access, and the use of pledged assets.