Central Pacific Financial Corp. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. Central Pacific Financial is a Hawaii bank holding company whose principal subsidiary, Central Pacific Bank, operates 35 branches and 80 ATMs in Hawaii.
Financial performance and condition
- Earnings: Net income was $14.3 million, or $0.48 per diluted share, versus $13.1 million and $0.42 per diluted share in Q1 2017. Pretax income declined to $18.0 million from $19.9 million, while the effective tax rate fell to 20.5% from 34.2%, principally reflecting Tax Reform and a $0.7 million deferred-tax revaluation benefit.
- Revenue and margins: Net interest income was $42.3 million GAAP ($42.6 million on a taxable-equivalent basis), up 2% on the latter measure. Total revenue, defined as net interest income plus other operating income, was $51.3 million, essentially flat year over year. Taxable-equivalent net interest margin was 3.21%, down 9 basis points; the average rate paid on interest-bearing liabilities rose 21 basis points. The efficiency ratio worsened to 65.37% from 61.36%.
- Noninterest items: Other operating income fell 10.6% to $9.0 million, mainly due to lower bank-owned life insurance income and recoveries on previously charged-off loans. Operating expense rose 6.5% to $33.5 million, primarily from compensation costs and foreclosed-asset expense.
- Cash flow: Operating activities provided $29.3 million, investing activities used $78.2 million, and financing activities provided $32.3 million. Cash and cash equivalents declined $16.5 million during the quarter to $65.8 million.
- Balance sheet and funding: Total assets were $5.65 billion, up $27.6 million from year-end. Loans and leases were $3.82 billion, up 1.2%; deposits were $4.98 billion, up 0.5%. Short-term borrowings rose to $56.0 million from $32.0 million; long-term debt was unchanged at $92.8 million. The bank had $1.53 billion of undrawn FHLB capacity and $72.3 million of unused Federal Reserve discount-window capacity.
- Credit quality: The allowance for loan and lease losses was $49.2 million, or 1.29% of loans, versus $50.0 million at year-end. Q1 included a $0.2 million provision credit and $0.6 million of net charge-offs, compared with $1.2 million of net charge-offs in Q1 2017. Nonperforming assets were $3.4 million, down from $3.6 million.
- Capital and shareholder returns: Shareholders’ equity was $484.1 million, down from $500.0 million; tangible common equity was 8.54% versus 8.86%. Regulatory capital ratios remained above well-capitalized thresholds. The company repurchased 344,362 shares for $10.1 million and declared $0.19 per share in Q1 dividends. On April 24, the board declared a subsequent-quarter dividend of $0.21 per share.
Material changes and unusual items
- Higher loan and securities balances lifted interest income, but interest expense increased 68.6%, led by higher rates on large time deposits. Management reported the Federal Reserve raised its target range to 1.50%–1.75% in Q1 and expected further gradual increases during 2018, subject to economic conditions.
- Other comprehensive loss was $14.7 million, largely reflecting a $15.0 million after-tax decline in unrealized investment-security values. Consequently, comprehensive income was a loss of $0.4 million despite positive net income.
- The company early adopted ASU 2018-02 and adopted ASU 2016-01 in Q1. Accounting-standard adoption reclassified tax effects within equity; the filing reports no material net-income impact from these changes. ASC 606 adoption changed certain fee revenue and related expense presentation by approximately $0.1 million, with no net-income effect.
- Tax Reform reduced the federal statutory rate and the taxable-equivalent adjustment on tax-exempt securities. Q1 also included the $0.7 million deferred-tax true-up benefit noted above.
Outlook, commentary, and risks
- Management described Hawaii’s economic outlook as positive, citing strong visitor activity, low unemployment, and a firm real estate market. These are external indicators, not company earnings guidance; the filing provides no specific financial guidance.
- The company is concentrated in Hawaii and has significant real-estate lending exposure. A deterioration in Hawaii’s economy or property markets could weaken loan demand, asset quality, and earnings. Rising rates could affect both asset yields and deposit and borrowing costs; management noted rate changes can also alter securities values and mortgage prepayments.
- Management said its interest-rate simulation remained within established policy limits. Liquidity depends in part on continued access to deposits and borrowing facilities, which may be constrained by market conditions or the company’s financial position.
- Other stated risks include borrower deterioration, natural disasters, regulatory and legal developments, execution of efficiency initiatives, and maintaining effective internal controls. No material changes to previously disclosed risk factors were reported. Ordinary-course legal matters were not expected by management to have a material adverse effect.
- Management expects adoption of the credit-loss standard effective January 1, 2020 to require significant changes to credit-loss estimation processes; its financial impact was still under evaluation. The filing also states disclosure controls were effective and reports no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether deposit repricing and higher funding costs continue to pressure net interest margin.
- Whether expense growth and the higher efficiency ratio improve as management pursues efficiency initiatives.
- Trends in Hawaii real estate exposure, delinquencies, nonperforming assets, net charge-offs, and reserve adequacy.
- The effect of market-rate changes on securities-related AOCI, tangible equity, and liquidity.
- Capacity to sustain dividends and repurchases while maintaining capital and funding strength, including the effect of the subsequent $0.21 dividend declaration.