Central Pacific Financial Corp. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Central Pacific Financial is a Hawaii bank holding company; its subsidiary, Central Pacific Bank, operated 34 branches and 117 ATMs in Hawaii. Dollar amounts below are in millions unless otherwise noted.
Financial performance and condition
- Q2 earnings: Net income was $10.8 million, or $0.26 per diluted share, versus $8.2 million and $0.20 a year earlier. First-half net income was $24.3 million, or $0.58 per diluted share, versus $12.9 million in 2011. The prior-year first-half common earnings and EPS included an $85.1 million noncash TARP exchange accounting gain; reported 2011 diluted EPS was $3.15.
- Interest income and margin: Q2 interest income was $32.5 million, down from $34.2 million; net interest income was $30.3 million, up from $29.0 million. Taxable-equivalent net interest margin rose to 3.17% from 3.04%. First-half net interest income was $60.8 million versus $57.2 million, and taxable-equivalent margin was 3.20% versus 3.04%.
- Other income and expenses: Q2 other operating income increased to $13.6 million from $10.9 million, led by residential loan-sale gains. Operating expense was $39.7 million versus $40.5 million. First-half operating income was $26.8 million versus $23.4 million, and expense was $74.9 million versus $78.1 million.
- Credit costs and asset quality: The company recorded a loan-loss provision credit of $6.6 million in Q2 and $11.6 million for the first half. The allowance was $103.8 million, or 4.94% of loans, down from $122.1 million and 5.91% at year-end 2011. Nonperforming assets declined to $170.3 million from $195.6 million; the ratio to loans, loans held for sale and other real estate fell to 7.81% from 8.99%. Net charge-offs were $6.7 million in the first half, compared with $15.6 million in the 2011 period.
- Balance sheet and funding: Total assets were $4.23 billion, up $94.2 million from year-end. Loans and leases were $2.10 billion, up $36.7 million; deposits were $3.56 billion, up $118.8 million. Shareholders’ equity rose to $480.5 million from $456.4 million. Long-term debt was $108.3 million, down from $158.3 million; short-term borrowings were nil.
- Cash flow and liquidity: First-half operating cash flow was $28.1 million; investing activities used $180.4 million, largely reflecting securities purchases; financing provided $68.7 million. Cash and cash equivalents ended the period at $173.5 million, down $83.6 million during the half. The bank had $40 million of FHLB long-term borrowings, no short-term FHLB or Federal Reserve discount-window advances, and reported an $808.4 million FHLB borrowing capacity. CPF separately reported $44.2 million of cash available for holding-company obligations.
- Capital: At June 30, the bank’s leverage, Tier 1 risk-based and total risk-based capital ratios were 13.4%, 21.9% and 23.2%, respectively; all exceeded the stated well-capitalized thresholds. The bank MOU requires an 8% minimum leverage ratio.
Material changes and unusual items
- Net interest income improved as lower funding costs and reduced long-term borrowings more than offset lower asset yields. The company attributed the margin improvement partly to redeploying excess liquidity into investment securities.
- Nonperforming assets declined overall, though gross additions included $25.7 million of California construction and development loans to one borrower. Residential and commercial mortgage balances increased while construction and development loans contracted.
- Q2 included $0.9 million of impairment charges for customer-relationship and non-compete intangibles, which were fully impaired, and $2.0 million of accruals related to two legal proceedings. First-half salaries and benefits increased $3.8 million year over year.
- First-half 2011 earnings comparisons are distorted by the $85.1 million noncash TARP exchange accounting gain. The Treasury sold its remaining common shares in April 2012; it retained a warrant for 79,288 shares, and the company received no proceeds from the Treasury sales.
Outlook, risks and contingencies
- Management said it would continue its recovery plan, emphasizing asset quality, profitability in banking operations, cross-selling, operating efficiency and competition in Hawaii. It reported a sixth consecutive profitable quarter and said it believed it was materially complying with regulatory agreements, while cautioning that full compliance and termination dates could not be assured. No numerical earnings guidance was provided.
- The bank remains subject to an FDIC/DFI Memorandum of Understanding; the holding company remains subject to a Federal Reserve/DFI Written Agreement. Restrictions include limits on dividends, debt actions and share repurchases without regulatory consent. The bank’s $414.1 million accumulated deficit prevents it from paying dividends until eliminated; the company said bank dividends were not expected for the foreseeable future.
- The company had deferred interest on $105 million of trust-preferred securities-related debentures for 12 consecutive quarters and had accrued $10.3 million of interest. Deferral is permitted for up to 20 consecutive quarters under the terms described; restrictions apply during the deferral.
- Management cited continued uncertainty in global and U.S. economies and real estate markets, concentrated Hawaii real-estate exposure, borrower stress, possible further credit migration, and uncertainty in loss-reserve estimates. It noted that worsening Hawaii or California markets could raise delinquencies, charge-offs and provision needs. The deferred-tax-asset valuation allowance was $155.1 million; management said realization remained uncertain given the cumulative three-year loss position.
- Mortgage repurchase exposure remained a contingency: the reserve was $5.8 million at June 30, and management anticipated additional make-whole demands. The filing also describes ordinary-course legal matters; management said their ultimate disposition was not expected to materially adversely affect the financial statements.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It said there were no material changes to the risk factors previously disclosed in the 2011 Form 10-K.
Important facts for investors to verify
- Whether nonperforming assets and construction/commercial real-estate credit exposure continue to decline, especially the California single-borrower exposure.
- Whether allowance levels remain adequate as loans mature and collateral values or borrower conditions change.
- Progress toward compliance with the Bank MOU and Written Agreement, and the practical effect of dividend, debt and repurchase restrictions.
- Trends in core deposits, cash and borrowing availability, including holding-company liquidity and deferred trust-preferred interest.
- Future mortgage repurchase demands and legal outcomes, and whether deferred tax assets become realizable.
- Whether reported profitability persists apart from credit-provision credits, mortgage-sale gains and other unusual or nonrecurring items.