Central Pacific Financial Corp. — Q2 2015 Form 10-Q
Business context and period. Central Pacific Financial is a Hawaii bank holding company whose subsidiary operates 36 branches and 110 ATMs statewide. This unaudited filing covers the quarter and six months ended June 30, 2015; comparisons are with the same 2014 periods unless stated otherwise. Dollar amounts below are in millions unless noted.
Financial performance and condition
- Q2 earnings: Net income was $12.3 million, or $0.39 diluted EPS, versus $9.2 million, or $0.25, a year earlier. For the first half, net income was $22.7 million and diluted EPS was $0.68, versus $19.0 million and $0.48.
- Revenue and margins: Q2 net interest income was $37.3 million GAAP ($37.8 million taxable-equivalent), up 3.8% on a taxable-equivalent basis. First-half taxable-equivalent net interest income was $74.6 million, up 2.5%. Net interest margin declined to 3.32% in Q2 from 3.35%, and to 3.30% for the half from 3.33%. Q2 other operating income fell 32.3% to $8.1 million; first-half other operating income fell 12.8% to $19.3 million.
- Expenses and returns: Q2 operating expense was $32.5 million, down 1.3%; first-half expense was $66.5 million, up 2.6%. Return on average assets was 1.00% for Q2 and 0.92% for the half, compared with 0.77% and 0.80%, respectively, in 2014.
- Credit and asset quality: The company recorded a $7.3 million Q2 provision credit and a $10.1 million first-half credit, compared with provisions of $2.0 million and $0.7 million in the corresponding 2014 periods. First-half net recoveries were $3.0 million versus net charge-offs of $0.9 million. Nonperforming assets decreased to $32.1 million from $42.0 million at year-end 2014; nonaccrual loans were 0.89% of loans, down from 1.33%. The allowance was $66.9 million, or 2.23% of loans, compared with $74.0 million, or 2.53%, at year-end.
- Balance sheet and liquidity: Total assets were $4.97 billion, up $114.9 million from December 31, 2014. Loans and leases were $3.01 billion, up 2.5%; deposits were $4.18 billion, up 1.8%. Cash and cash equivalents were $81.5 million at June 30. Six-month operating cash flow was $27.6 million, investing cash flow was negative $125.6 million, and financing cash flow was positive $93.5 million.
- Debt and capital: Short-term borrowings rose to $157.0 million from $38.0 million; long-term debt was $92.8 million. The bank had a $1.2 billion FHLB credit line, with $1.0 billion undrawn, and $27.5 million of additional Federal Reserve discount-window availability. Company capital ratios were 10.44% leverage, 14.47% Tier 1 risk-based, 15.73% total risk-based, and 11.91% CET1; management said these exceeded well-capitalized thresholds. Shareholders’ equity declined to $488.8 million from $568.0 million, principally reflecting share repurchases and dividends.
Material changes and unusual items
- Growth in average loans supported higher net interest income, but lower asset yields compressed net interest margin amid the low-rate environment.
- Other income was affected by $1.9 million of securities losses in Q2, versus gains of $0.2 million in Q2 2014. The company sold $119.4 million of securities and reinvested proceeds in mortgage-backed securities; the stated objective was to improve profitability.
- First-half repurchases totaled 3.95 million shares at a cost of approximately $89.3 million, excluding fees; $24.2 million remained authorized. A separate secondary offering by existing shareholders generated no proceeds for the company. The company declared a $0.12-per-share dividend in April and declared another $0.12 dividend in July, payable in September.
- Q2 charitable contributions increased by $2.0 million, primarily from a contribution to the Central Pacific Bank Foundation. Lower employee-benefit expense included a $2.4 million one-time reversal of a former executive retirement-benefit accrual.
- Executive leadership changes became effective July 1, 2015, including A. Catherine Ngo becoming CEO and David S. Morimoto becoming CFO.
Outlook, commentary and risks
- Management expected the federal funds target rate to remain low throughout 2015 and anticipated continued Hawaii real estate improvement, while cautioning that the outlook was not assured. No quantified earnings or revenue guidance is provided in the filing.
- Management remained focused on lowering the efficiency ratio and growing share in Hawaii; initiatives included outsourcing data-center and item-processing functions, consolidating two Waikiki branches, and developing data warehouse and customer relationship management systems.
- Key exposures include Hawaii and, to a lesser extent, California economic and real estate conditions; borrower deterioration and loan losses; tourism and federal spending, including possible reductions in Hawaii military personnel; interest-rate and securities-market changes; regulatory developments; and the company’s ability to execute efficiency initiatives. Management cited continuing macroeconomic uncertainty, including concerns involving Greece and China.
- Mortgage-loan repurchase and representation-and-warranty exposure remained: the reserve was $2.6 million, with approximately $78.0 million of sold loans still subject to early-payment-default clauses. Management noted estimates depend on investor demands, appeal outcomes, and loss severity. Ordinary-course legal proceedings were not expected by management to have a material adverse effect.
Important facts for investors to verify
- Whether credit improvement and net recoveries are sustainable, and whether the $66.9 million allowance remains adequate as loan growth and portfolio mix change.
- How the securities portfolio repositioning affects future yield, realized gains or losses, and accumulated other comprehensive income.
- Whether loan growth can offset further margin pressure and higher short-term borrowing costs.
- The effects of share repurchases, dividends, capital requirements, and regulatory or legal restrictions on capital and liquidity.
- Whether management’s efficiency initiatives reduce expenses despite higher software and intangible-asset amortization costs.