CENTRAL PACIFIC FINANCIAL CORP quarterly report, Q1 FY2013

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Central Pacific Financial Corp. — Q1 2013 Form 10-Q

Business context and reporting period. The filing covers the three months ended March 31, 2013. Central Pacific Financial is a Hawaii bank holding company; its principal subsidiary, Central Pacific Bank, operates 35 branches and 114 ATMs in Hawaii and provides consumer, commercial, mortgage and other banking services. Comparisons below are with Q1 2012 unless otherwise noted.

Financial results and condition

  • Net income: $137.3 million, or $3.25 per diluted share, versus $13.5 million, or $0.32, a year earlier. Q1 2013 included a $119.8 million non-cash income tax benefit from reversing a significant portion of the deferred-tax-asset valuation allowance. Excluding that benefit, management reported non-GAAP net income of $17.5 million, or $0.41 per diluted share.
  • Interest income and margins: GAAP net interest income was $30.7 million versus $30.5 million. On a taxable-equivalent basis, net interest income was $31.2 million, up 2.0%; net interest margin declined to 3.06% from 3.23%, primarily reflecting lower asset yields in the low-rate environment. Interest expense fell 19.8% to $1.9 million.
  • Other income and expenses: Other operating income declined 5.7% to $12.5 million; residential mortgage loan-sale gains increased to $4.1 million from $3.0 million. Operating expense fell to $32.2 million from $35.2 million, partly due to lower legal and credit-related expenses, offset in part by higher salaries and intangible amortization.
  • Credit costs and asset quality: The loan-loss provision was a $6.6 million credit, compared with a $5.0 million credit in Q1 2012. Net charge-offs were $3.0 million versus $2.8 million. Nonperforming assets were $75.3 million at March 31, down from $90.0 million at December 31, 2012 and $205.6 million a year earlier. The allowance was $86.8 million, or 3.82% of loans and leases, and equaled 115.27% of nonperforming assets.
  • Balance sheet and funding: Total assets were $4.58 billion, up $210.7 million from year-end 2012. Loans and leases were $2.27 billion, up $70.7 million; deposits were $3.76 billion, up $83.9 million. Cash and cash equivalents were $214.5 million at quarter-end. Operating cash flow was $32.7 million; investing cash flow was negative $79.5 million and financing cash flow was positive $83.9 million.
  • Debt and liquidity: Long-term debt was $108.3 million; the company reported no short-term borrowings. The bank had $27 million of FHLB long-term borrowings and no advances outstanding under its $20.9 million Federal Reserve discount-window line. It maintained an $862.4 million FHLB credit line, subject to collateral and agreement terms. The holding company reported approximately $34.6 million of available cash.
  • Capital: Company capital ratios at March 31 were 22.85% Tier 1 risk-based, 24.12% total risk-based and 14.86% leverage; bank ratios were 21.7%, 22.9% and 14.0%, respectively. Both exceeded the filing’s thresholds for a “well-capitalized” designation.

Material changes versus comparable periods

  • Reported earnings rose sharply, but the increase was principally attributable to the $119.8 million tax benefit. Excluding it, earnings were $17.5 million versus $13.5 million.
  • Taxable-equivalent net interest income increased modestly, while net interest margin contracted by 17 basis points. Lower loan and securities yields were partly offset by lower funding costs and higher average loan balances.
  • Credit indicators improved year over year: nonperforming assets fell by $130.3 million, construction and development loans declined to $88.1 million from $147.6 million, and allowance coverage of nonperforming assets increased.
  • Total shareholders’ equity increased to $650.1 million from $504.8 million at December 31, 2012, primarily reflecting Q1 net income, including the tax-related benefit.

Outlook, risks and unusual items

  • Outlook: Management provided no specific earnings or revenue guidance. It intends to continue its recovery plan, improve asset quality and banking profitability, expand cross-selling, and improve efficiency. Management cited expected continued modest Hawaii economic growth, supported by tourism, but cautioned that forecasts are uncertain.
  • Tax item: The valuation-allowance reversal followed nine consecutive profitable quarters and improved financial condition, asset quality and capital ratios. The company reported a remaining valuation allowance of $14.3 million and a net deferred tax asset of $130.0 million. It expected the remaining allowance to offset income tax expense through 2013 and did not expect income tax expense before Q1 2014; realization of deferred tax assets remains dependent on future taxable income.
  • Regulation: The 2010 Written Agreement with the Federal Reserve Bank of San Francisco and Hawaii regulators was terminated on February 12, 2013. The bank’s separate FDIC Compliance MOU remained in effect, addressing compliance-management, consumer-protection, fair-lending and third-party oversight requirements. The company could not predict when it would be completed or terminated.
  • Capital actions: In March 2013, the company paid $13.0 million of deferred interest on subordinated debentures and related trust-preferred dividends, and resumed quarterly payments. Management was evaluating capital-management alternatives, including the possibility of cash dividends, but any action remained subject to board discretion and regulatory and contractual limits. The bank had not paid dividends to the holding company since September 2008.
  • Principal risks: Results remain exposed to Hawaii and California real estate conditions, commercial real estate and construction loan concentrations, borrower deterioration, interest-rate changes, regulatory compliance, and uncertainty in the broader economy. The filing also discusses mortgage-loan repurchase representations and warranties; the related reserve was $3.0 million at quarter-end. Management said ordinary-course legal matters were not expected to have a material adverse effect.

Most important facts for investors to verify

  1. How sustainable core earnings are after excluding the $119.8 million non-cash tax benefit, and whether the deferred tax assets are ultimately realized.
  2. Whether improvements in nonperforming assets, charge-offs and construction-loan exposure continue, and whether the $86.8 million allowance remains adequate.
  3. Progress toward satisfying the FDIC Compliance MOU and any continuing regulatory restrictions.
  4. Whether the bank can safely upstream capital and whether the board and regulators permit dividends or other capital actions.
  5. Whether net interest margin can stabilize as asset yields, funding costs and loan growth change.
  6. The potential effect of real estate weakness, mortgage repurchase demands and other credit or contingent exposures on future results.