CENTRAL PACIFIC FINANCIAL CORP quarterly report, Q2 FY2014

Central Pacific Financial Corp. — Q2 2014 Form 10-Q

Reporting period: Three and six months ended June 30, 2014; balance-sheet comparisons are with December 31, 2013. Central Pacific Financial is a Hawaii bank holding company; its subsidiary operates 37 branches and 113 ATMs in Hawaii. Dollar amounts below are in millions unless otherwise noted.

Financial performance

Metric	Q2 2014	Q2 2013	First half 2014	First half 2013
Net interest income, GAAP	$35.9	$33.2	$71.7	$63.8
Net interest margin, taxable-equivalent	3.35%	3.23%	3.33%	3.15%
Provision (credit) for loan losses	$2.0	$(0.2)	$0.7	$(6.8)
Other operating income	$12.0	$17.8	$22.1	$30.8
Other operating expense	$32.9	$35.0	$64.8	$67.8
Net income	$9.2	$14.3	$19.0	$151.6
Diluted EPS	$0.25	$0.34	$0.48	$3.59

Q2 taxable-equivalent net interest income increased 8.0% year over year; first-half net interest income on that basis rose 12.0%. Management attributed the gains mainly to loan growth and higher investment-security yields. Lower loan yields partly offset those benefits.
First-half 2013 net income included a $119.8 million non-cash tax benefit from releasing a deferred-tax-asset valuation allowance. Excluding it, first-half 2013 net income was $31.8 million and diluted EPS was $0.75.
Q2 other operating income fell 32.6%, chiefly because Q2 2013 included a $7.2 million gain on a foreclosed-property sale and higher residential mortgage loan-sale gains. Lower operating expenses partly offset the revenue decline.
Q2 2014 net charge-offs were $1.6 million, versus net recoveries of $0.5 million a year earlier. First-half net charge-offs were $0.9 million, versus $2.5 million in 2013.

Financial condition, cash flow and capital

At June 30, total assets were $4.73 billion; loans and leases were $2.79 billion, up $163.6 million (6.2%) from year-end. Deposits were $4.00 billion, up $66.4 million (1.7%).
Cash and cash equivalents were $87.0 million at June 30, versus $49.3 million at the start of the year. First-half operating cash flow was $35.6 million; investing activities provided $50.3 million and financing activities used $48.2 million.
Allowance for loan and lease losses was $83.6 million, or 2.99% of loans, compared with $83.8 million and 3.19% at year-end. Nonperforming assets were $42.1 million, down from $46.8 million; the allowance equaled 198.47% of nonperforming assets.
Nonaccrual loans were $36.9 million (1.32% of loans, versus 1.58% at year-end). Accruing troubled debt restructurings rose to $30.7 million from $23.3 million; none were more than 90 days delinquent. A $13.6 million exposure to one borrower was newly placed on nonaccrual.
Total liabilities were $4.16 billion, including $29.0 million of short-term borrowings and $92.8 million of long-term debt. FHLB borrowings were $34.4 million; the bank also maintained a $927.7 million FHLB credit line and a $45.0 million Federal Reserve discount-window line, with no discount-window advances outstanding.
Shareholders’ equity declined to $564.6 million from $660.1 million, principally reflecting $125 million of tender-offer and private share repurchases, additional repurchases, and $6.3 million in dividends, partly offset by earnings and other comprehensive income.
Company capital ratios remained above well-capitalized thresholds: leverage 11.6%, Tier 1 risk-based 17.1%, and total risk-based 18.3%. These were down from 13.7%, 20.3%, and 21.5% at year-end, primarily due to share repurchases.

Material changes and unusual items

The company repurchased 6.19 million shares for $125 million through a tender offer and purchases from its two largest shareholders, and bought back an additional 181,200 shares for $3.4 million under a new program. At June 30, $26.6 million remained available under that program.
Available-for-sale securities declined as the company sold approximately $162 million in Q2 as part of a balance-sheet optimization strategy. The sold securities had a 2.68% average yield and 5.7-year weighted-average life; the sale generated a $0.2 million gain.
Loans grew across residential mortgage, commercial, construction and consumer categories. The company also purchased participation interests in auto and student loans during May.
Other comprehensive income was $10.5 million in Q2 and $20.3 million for the first half, driven largely by unrealized investment-security gains; this improved accumulated other comprehensive income to $4.4 million from a $15.8 million loss at year-end.

Outlook, risks and contingencies

Management expected net interest margin to remain fairly stable in the near term, citing plans to shift assets toward higher-yielding loans, competitive pricing pressures, and efforts to shorten asset duration to mitigate interest-rate risk. No specific earnings or revenue guidance was provided.
Management described Hawaii economic indicators and real estate conditions as improving, while noting uncertainty around the broader economy, tourism, interest rates, and real estate markets. The company’s concentration in Hawaii and its real-estate-heavy lending make results sensitive to local economic and property-market deterioration.
The bank remained subject to a 2012 FDIC Compliance Memorandum of Understanding requiring improvements to compliance management, oversight, monitoring, audits, third-party controls and overdraft practices. The company could not say when the MOU would be terminated; noncompliance could lead to further restrictions, penalties or other regulatory action. The bank reported substantial progress and an “Outstanding” Community Reinvestment Act rating.
Management concluded disclosure controls and procedures were not effective because of a previously reported material weakness in controls over the allowance for loan losses. Remediation steps were underway, but management said several quarters of implementation may be needed before it can conclude the weakness is resolved.
The filing disclosed unregistered common shares held through the bank’s 401(k) plan. The company estimated 6,053 shares could be subject to rescission rights and did not believe the potential liability was material; it filed a new Form S-8 to register future plan sales.
Management said ordinary-course legal proceedings were not expected to have a material adverse effect. The filing also describes mortgage-loan repurchase exposure; the related reserve was $2.9 million, unchanged from year-end.
After quarter-end, the board declared a $0.10-per-share dividend, increased from $0.08, payable September 15, 2014, subject to the stated regulatory and other restrictions on dividends.

Most important facts for investors to verify

Underlying earnings trend: compare current results with prior periods after adjusting for the exceptional 2013 tax benefit and prior-year foreclosed-property gain.
Credit quality: monitor new nonaccrual additions, TDR growth, charge-offs, and whether the allowance remains adequate as loans expand.
Capital and shareholder returns: assess the effect of repurchases and dividends on capital ratios, liquidity, and capacity for further buybacks.
Regulatory and control status: track progress on the FDIC Compliance MOU and remediation of the material weakness in allowance-related controls.
Rate and market sensitivity: evaluate loan yields, deposit funding costs, securities repositioning, and Hawaii real estate and tourism trends against management’s stable-margin outlook.