Central Pacific Financial Corp. — 2014 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2014; it also reports unaudited fourth-quarter results. Central Pacific is a Hawaii-focused bank holding company operating through Central Pacific Bank, with 36 branches and 110 ATMs. The bank provides commercial, mortgage, construction and consumer lending, deposits and related services. Its results are particularly exposed to Hawaii’s economy and real estate markets.
Financial highlights
| Metric | 2014 | 2013 |
|---|---|---|
| Net interest income | $143.4 million | $133.1 million |
| Other operating income | $43.8 million | $54.9 million |
| Net income | $40.5 million | $172.1 million |
| Diluted earnings per share | $1.07 | $4.07 |
| Net interest margin | 3.32% | 3.19% |
| Efficiency ratio | 70.93% | 74.20% |
| Operating cash flow | $71.4 million | $84.5 million |
| Total assets at year-end | $4.85 billion | $4.74 billion |
| Total deposits at year-end | $4.11 billion | $3.94 billion |
| Loans and leases at year-end | $2.93 billion | $2.63 billion |
- Profit and revenue: Pretax income was $60.8 million and income tax expense was $20.4 million. Fourth-quarter net income was $13.3 million, or $0.37 per diluted share. 2013 net income included a noncash $119.8 million tax benefit from releasing much of the deferred-tax-asset valuation allowance; excluding that benefit, 2013 net income was $52.3 million, or $1.24 per diluted share.
- Credit quality: The provision for loan and lease losses was a $6.4 million credit, versus an $11.3 million credit in 2013. Net charge-offs were $3.4 million, or 0.12% of average loans, compared with $1.3 million, or 0.05%, in 2013. The allowance was $74.0 million, 2.53% of loans, down from $83.8 million and 3.19%. Nonperforming assets fell to $42.0 million from $46.8 million; the allowance equaled 176.14% of nonperforming assets.
- Capital and shareholder returns: Company Tier 1 risk-based, total risk-based and leverage ratios were 16.97%, 18.24% and 12.03%, respectively, all above the then-applicable well-capitalized thresholds. Shareholders’ equity was $568.0 million, down from $660.1 million. The company repurchased $142.4 million of stock in 2014, paid $13.4 million in common dividends and declared $0.36 per share in dividends. Book value per share was $16.12.
- Debt and liquidity: Year-end short-term borrowings were $38.0 million and long-term debt was $92.8 million, principally subordinated debentures. The bank had a $945 million FHLB line, of which $907 million was undrawn, and a $33.3 million Federal Reserve discount-window line with no outstanding advances. The loan-to-deposit ratio was 71.3%, versus 66.8%. Cash and cash equivalents were $86.0 million, up from $49.3 million.
- Cash flows: Operating activities provided $71.4 million; investing activities used $83.1 million; financing activities provided $48.4 million. Financing cash flows included $174.1 million of net deposit growth, offset in part by substantial share repurchases and dividends.
Material changes versus the prior comparable period
- Net income declined sharply from 2013, primarily because 2013 included the large deferred-tax benefit. On an adjusted comparison excluding that benefit, 2014 net income was lower than 2013’s $52.3 million.
- Net interest income rose 7.7%, supported by loan growth and higher yields on taxable securities; net interest margin increased 13 basis points. Other operating income fell 20.2%, mainly because gains on foreclosed-asset and residential-loan sales were lower.
- Operating expenses fell 4.8%, including lower salaries and intangible amortization; software expense and branch consolidation costs increased. The efficiency ratio improved.
- Loans grew 11.5%, core deposits grew 6.9%, and nonperforming assets continued to decline. Real estate-related loans remained approximately 71.6% of the portfolio, with 86% of loans concentrated in Hawaii.
- Common equity was reduced by the tender offer, private repurchases from the two largest shareholders and the ongoing buyback program. The company repurchased approximately 16.7% of its shares outstanding at year-end 2013 during 2014.
Outlook, management commentary, risks and unusual items
- Management expected the Federal Reserve’s low-rate policy to persist through 2015, with net interest margin relatively unchanged initially and potential modest expansion as the economy recovered. This is management’s expectation, not formal earnings guidance.
- Management cited improving Hawaii conditions: visitor arrivals and spending reached records in 2014, unemployment improved, and local economic forecasts anticipated continued growth in 2015. It expected possible improvement in real estate but cautioned that this was not assured.
- Key risks include the high real estate and Hawaii concentration, borrower deterioration and collateral-value declines, interest-rate and funding-cost movements, competition, regulatory and compliance requirements, cybersecurity, and execution risks from technology outsourcing and efficiency initiatives.
- The allowance estimate is judgmental. In 2014 the company extended the historical loss look-back period for real-estate loans and revised elements of its reserve methodology; further deterioration or stronger loan growth could require renewed provisions.
- All identified regulatory agreements had been terminated by November 2014. The company nevertheless warned that regulators could impose future restrictions or higher capital requirements. New capital rules were being phased in, and management believed the company and bank would meet fully phased-in requirements.
- The company reported $2.7 million of mortgage-loan repurchase reserves and approximately $65.3 million of loans still subject to early-payment-default clauses. Certain 401(k) plan shares had been sold without SEC registration; the company estimated 2,383 shares could be subject to rescission rights and considered the potential liability immaterial.
- Ordinary-course lawsuits were not expected by management to have a material adverse effect. KPMG issued unqualified opinions on the financial statements and internal control; management also concluded disclosure controls were effective.
- After year-end, the board increased repurchase authority by $25 million, to $55 million. From January 2 through February 13, 2015, the company repurchased 473,829 shares for $9.3 million.
Important facts for investors to verify
- How sustainable earnings are after separating recurring operations from the unusually large 2013 tax benefit and variable gains on asset and loan sales.
- Whether loan growth, especially in residential, consumer and construction lending, is matched by underwriting quality, credit performance and an adequate allowance.
- How the revised allowance methodology and longer loss-history period affect reserve levels and reported credit costs.
- Whether deposit growth and available borrowing capacity remain sufficient as loans expand, and how interest-rate changes affect net interest margin and funding costs.
- The impact of continued buybacks and dividends on capital ratios, liquidity, book value and capacity to support the bank.
- Realization and potential ownership-change limitations on the $104.4 million net deferred tax asset and associated tax attributes.
- Progress and control risks associated with technology outsourcing, data and customer-management systems, and operational efficiency initiatives.