Central Pacific Financial Corp (CPF) 2005 Q4 法說會逐字稿

Good day and welcome to the Central Pacific Financial Corporation fourth quarter earnings call. Today's call is being recorded. This call may contain forward-looking statements concerning projections of revenues, income, earnings per share, capital expenditures, dividends, the capital structure or other financial items concerning plans and objectives of management for future operations, concerning future economic performance or concerning any of the assumptions underlining or relating to any of the foregoing. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and may include the words "belief," "plans," "intends," "expects," "anticipates," "forecasts," or words of similar meaning. While we believe that our forward-looking statements and the assumptions underlying them are reasonably based, such statements and assumptions are by their nature subject to risk and uncertainties and thus could later prove to be inaccurate or incorrect. Accordingly, actual results could materially differ from projections from a variety of reasons to include, but not limited to, the impact of local, national, and the international economics and events on the Company's business and operations and on tourism, the military and other major industries operating within the Hawaii market, the impact of legislation affecting the banking industry, the impact of competitive products, services, pricing, and other competitive forces, movements in interest rates, loan delinquency rates and changes in asset quality generally, and trading of the Company's stock. For further information on factors which could cause actual results to materially differ from projections, please see the Company's publicly available Securities and Exchange Commission filings, including the Company's Form 10-K for the last fiscal year. The Company does not update any of its forward-looking statements. And at this time for opening remarks and introductions, I would like to turn the call over to Mr. Clint Arnoldus, Chief Executive Officer. Please go ahead, sir.

Thank you very much, Patty. Thank you very much and I'd like to thank all of you for joining us today to review Central Pacific Financial Corp.'s financial performance for the fourth quarter and for the year ended 2005. With me here today is our Chief Financial Officer, Dean Hirata. I'll first address the highlights of our Company and our marketplace and Dean will follow with a detailed financial report of the quarter and talk about our year end results.

I'm very happy to report that in the fourth quarter of 2005, Central Pacific Financial Corp. realized its fifth conservative quarter of record earnings with net income of $19.4 million. For the year 2005, net income of $72.5 million also reflects record earnings for the Company. Excluding nonrecurring merger expenses, net income increased by 73.6% and earnings per diluted share increased by 14.2% to $2.49 compared to the previous year.

Significant improvements were made in our key financial benchmarks through an ongoing focus on operational streamlining and investments into strengthening our core business units. For the year ended 2005, the Company's efficiency ratio improved to 47.27%, compared to 50.59% in the previous year, excluding nonrecurring merger expenses. Net interest margin for 2005 improved to 4.63% compared to 4.51% in 2004.

Solid gains have also been made on the balance sheet. As of December 31, 2005, compared to December 31,2004, the Company increased its total assets by 12.6% to $5.2 billion, net loans by 14.8% and deposits by 9.5%. We've continued to strengthen our commercial real estate lending in both Hawaii and in selected markets in California and in the Pacific Northwest. The August, 2005 acquisition of Hawaii Home Loans, Inc., which is one of the premier residential mortgage banking companies in Hawaii, has also added significantly to our growth, for which we'll realize its full impact this year.

Our deposit strategies to generate new market share with our flagship combined balance program and to manage interest rates within our entire suite of deposit products have yielded a stronger and more stable core deposit base to support our long-term franchise value. Asset quality remains very strong as our nonperforming assets represented 0.24% of total assets at year end compared to 0.23% at the previous year end.

Let's talk about the economy in Hawaii for a few minutes. The economic conditions here continue to be very positive, and 2005 represented the ninth conservative year of economic expansion. Our visitor industry has exceeded its forecast and visitor arrivals are now estimated to be 7.3 million in 2005. That represents a growth rate of 6.7%. This is the first time our state has surpassed the 7 million mark in annual visitors. Based on infrastructure capacity, visitor arrivals are projected to be at the 3% level in 2006.

The housing market and construction industry continue to be robust with activity in military projects and residential developments continuing at unprecedented levels. However, similar to nationwide trends, home prices are expected to grow at a more stable rate in 2006. The accelerating demands for affordable housing and resort development in Hawaii is expected to fuel a construction pipeline with exceptional activity in 2006 and beyond.

The labor market in Hawaii remains extremely tight with the unemployment rates projected to be at 2.7% for 2005 and into 2006, as well. Payroll jobs are expected to also grow by 2.7% in 2005 and slightly slow to a 1.8% rate of growth in 2006. Real personal income is expected to post a strong growth rate for the second consecutive year of 4.3% in 2005. Growth in 2006, adjusted for a 3.7% inflation forecast, is projected to decelerate to 2.7%, as it may be unlikely to sustain such a high rate of growth. Overall, the outlook for the local economy in 2006 remains very positive with a combined strength of its three primary drivers -- the visitor industry, federal spending, and construction activity.

Moving forward, we continue to be optimistic for the new year in 2006. With the projected strength of Hawaii's economy, we set plans in motion to enhance our core business units. Key sales managers were added to our commercial and retail banking areas. Personal banking and wealth management services will be expanded to meet the needs of our market. Two new branch offices will be opening in Kailua and Pearl City on the island of Oahu in the first and third quarters of this year, respectively. The operational integration between Central Pacific Bank, Citibank and Hawaii Home Loans was successfully completed and we are well positioned as a stronger competitor in our marketplace.

We greatly appreciate the support we receive from our employees and communities, as well as the confidence of our shareholders in the past year, and we're looking forward to another banner year in 2006.

At this time, I'll turn the call over to our Chief Financial Officer, Dean Hirata. Dean is going to review the details of our fourth quarter and our year end financial performance. Dean?

Thank you,Clint. My discussion will cover the fourth quarter and the year 2005 consolidated financial highlights for Central Pacific Financial Corp. and its subsidiaries. Let me start with an earnings summary. Fourth quarter 2005 operating earnings, defined as net income adjusted for nonrecurring merger related expenses, was $19.4 million, an increase of 47.4% for the same quarter last year. The increase was primarily due to an increase of $6 million or 12.9% in net interest income and a $2.4 million or a 26.5% increase in other operating income. On a sequential quarter basis, there was a $7,000 or 3.8% decrease in operating earnings.

On a per share basis, operating earnings was $0.63 for the current quarter, an increase of 10.5% over the same quarter last year, and a 3.1% decrease compared to the third quarter of 2005. Operating earnings for 2005 was $75.8 million, an increase of 73.6% over 2004. On a per share basis, operating earnings for 2005 was $2.49, an increase of 14.2% over the prior year.

Moving now to key performance ratios. Key performance ratios based on operating earnings for the fourth quarter and the year 2005, respectively, were as follows. Return on assets of 1.52% and 1.55%. Return on tangible equity of 22.83% and 23.93%. Return on equity of 11.47% and 11.67%. And our efficiency ratio of 48.42% and 47.27%.

Moving now to the balance sheet. Total loans as of December 31, 2005 of $3.6 billion grew by 14.6% over December 31, 2004. On a linked quarter basis, the increase was $186.1 million or 5.5% unannualized. The average yield on loans for 2005 increased by 68 basis points to 6.75% compared to the prior year due to the upward repricing of loans. On a linked quarter basis, the increase was 22 basis points to 7.05%. Our total deposits of December 31, 2005 of $3.6 billion increased by 9.5% over December 31, 2004. On a sequential quarter basis, the increase was $171.4 million or 4.9% unannualized. The effective cost of interest bearing liabilities for the current year was 1.90%, an increase of 54 basis points over the prior year. On a linked quarter basis, the increase was 28 basis points to 2.23%. Our continued efforts to expand existing customer relationships and capture additional market share through our broader retail network and product sweep, are enhancing our core deposit base.

Moving now to the income statement, the net interest margin of 4.69% for the current quarter increased by 9 basis points over the same quarter last year, and by 9 basis points over the third quarter of 2005. The fourth quarter of 2005 included a $680,000 prepayment penalty on a government agency mortgage backed security. Excluding the prepayment penalty, the net interest margin was 4.63% for the fourth quarter of 2005 and 4.62% for the year ended December 31, 2005. The improvement in the sequential quarter net interest margin was driven by the upward repricing of our loan portfolio, 70% of which are variable rate loans, including prime floating loans totaling $1.2 billion. Deposit growth keeping pace with loan growth and the reallocation of assets into higher yielding loans. The provision for loan and lease losses for the current quarter totalled $1 million compared to $950,000 in the fourth quarter of 2004 and $1 million in the third quarter of 2005.

Other operating income for the current quarter was $11.5 million, an increase of 26.5% over the fourth quarter of 2004. The increase was primarily due to service charges on deposit accounts, other service charges and fees, and gains on sale of loans in connection with Central Pacific Home Loans. On a linked quarter basis, other operating was consistent.

Other operating expense for the current quarter was $32.8 million compared to $35.4 million in the same quarter last year and $32.3 million in the third quarter of 2005. The fourth quarter of 2004 and the third quarter of 2005 included nonrecurring merger related expenses of $5.4 million and $3.5 million, respectively. Excluding merger related expenses, other operating expense increased by 13.9% on a linked quarter basis. The increase is primarily due to first, Central Pacific Home Loan's operating expense incremental increase of$1.3 million, an interest accrual of $714,000 on federal and state tax assessments, a vacation accrual of $790,000 and professional services of $635,000.

The effective rate on income taxes for the fourth quarter of 2005 was 35.34% compared to 30.81% in the fourth quarter of 2004 and 35.05% in the third quarter of 2005. The increase in the effective tax rate for the current quarter compared to the same quarter last year reflects the impact of state tax credits, generated from our investments and high technology businesses in Hawaii.

We'll now discuss our asset quality. Asset quality remains strong. Nonperforming assets at December 31, 2005 totalled $12.6 million or 24 basis points of total assets, up from $10.3 million a year ago. On a sequential quarter basis, nonperforming assets decreased from $14 million as of September 30, 2005. During the first quarter of 2006, we received a payoff of non-accrual loans from one bar totaling $3.4 million and also expect a payoff of $1.8 million from another bar in the first quarter of 2006 due to a recent bankruptcy court decision. Nonperforming assets are mainly comprised of loans fully secured by commercial and residential properties and no losses are anticipated at this time.

Loans delinquent for 90 days or more and still accruing interest total $7.9 million at December 31, 2005, compared to $393,000 a year ago and $10.2 million as of September 30, 2005. The increases compared to a year ago was due to a bar in -- that went into bankruptcy during the third quarter of 2005. The decrease on a sequential quarter basis was due to a commercial real estate loan that was brought current. Net loan charge-offs were $309,000 in the current quarter compared to net loan charge-offs of $126,000 in the fourth quarter of 2004 and net loan recoveries of $88,000 in the third quarter of 2005. The increase as compared to a year ago was due to higher charge-offs on overdrafts in connection with the overdraft protection program that was implemented in 2005 as well as higher recoveries of $450,000 in the fourth quarter of 2004. The increase on a sequential quarter basis was due to higher deal loan charge-offs of $300,000 and higher recoveries of $700,000 in the third quarter of 2005.

Shareholder equity at December 31, 2005 increased to $676.2 million or a tangible equity ratio of 6.85%.

The forecast for 2006 is as follows. Our net interest income growth will be driven by expected loan and deposit growth and a stabilized net interest margin in the 4.55% to 4.65% range. Balance sheet sensitivity is expected to be offset by strong balance sheet growth. Asset quality will continue to remain strong. Based on current economic and business conditions, management forecasts diluted operating earnings per share to increase 7 to 10% over 2005. This concludes the discussion of Central Pacific Financial's financial results for the fourth quarter and the year 2005. I'll now turn the call back over to Clint.

Thanks, Dean. This concludes our earnings report and our commentary for the fourth quarter of 2005 and the year ended 2005. We'd be very happy to address any questions that you might have at this time.

[OPERATOR INSTRUCTIONS] Our first question today is from Joe Morford from RBC Capital Markets.

Good afternoon, everyone.

Hi, Joe.

Hi, Joe.

Had a couple of questions. First, Dean, if you could talk a little bit more about expenses. You mentioned a couple of special issues this quarter like a vacation accrual, professional services, if you could give us a little more color on that. And then just better understanding what's a good run rate to build off of going forward and if there's any kind of seasonal increase that you might expect in the first quarter?

Yes. First, on the two expenses that you referred to. On the vacation accrual, these were additional accruals that were set up in connection with the merger between Central Pacific and Citibank. At the time of the merger, Citibank paid off the accrued vacation so that additional liability was set up this year to those employees that are now part of the Company. And on the second item, the professional services, this relates to additional legal fees of about $300,000, as well as a consulting project that is geared towards revenue enhancements, as well as improvements in our overall efficiency, so again, those two totalled the $635,000. Excluding the incremental increase that I talked about in terms of Central Pacific Home Loans and again the interest accrual, that was also a nonrecurring items on these federal and state tax assessments. So excluding these items, that would be a run rate, going forward.

Okay. And is there much of a seasonal increase for benefits, accruals or payroll taxes or anything we should expect in the first quarter?

No.

Okay. And then secondly, I just wondered if you could talk a little bit more about the growth you saw this quarter in the mainland, the type of business, the type of production that you saw and just general comments about the pricing environment.

Yes. The mainland environment isn't changed from previous quarters that we've reported. We continue to have a very closely defined focus in that market. It's all commercial real estate and through our seasoned team of bankers that have 20-year relationships with very established developers in California, we continue to see growth opportunities and the loans continue to be underwritten very tightly. We have very tight loan to value requirements, debt service requirements, guarantors, the pricing is -- it is a competitive market. We're seeing a little bit of softness, but nothing that will materially change anything that we've reported in the past. So it's, it's continuing to go forward strongly.

And how much of the growth is California relative to the Northwest at this point?

California is still dominant. California is a three-year operation and the Northwest is just closing in on a year, so California's 61%. The Pacific Northwest is 14. Hawaii is 25.

Great, thanks so much.

Our next question will be from Mike McMahon from Sandler O'Neill & Partners.

Hi Clint and Dean.

Hi Mike.

A couple of easy ones here first. You indicated you had a $3.4 million payoff on the NPAs already received and you are expecting another one of $1.-- what was that?

$1.8 million.

Okay.

And these are two separate bars.

Okay. And the tax rate was up in the quarter from a year ago, and maybe I heard this backwards, but you indicated that it was down because of your investment in tax credits. I think the tax rate was up this quarter from a year ago.

The state tax credits from our investments and high technology businesses, those credits were recognized in the fourth quarter of last year.

Okay.

2004. And that accounts for the increase as compared to the 35% in the fourth quarter of 2005.

Okay. I did hear that backwards, I apologize. What would you expect the tax rate going forward in '06 to be?

In the range of 35 to 36%.

Okay. And you generated about $2.5 million in loan sale gains in the quarter. Was that all from your mortgage banking operation?

Yes.

And are you ready to disclose originations and loan sale activity at this point or did I miss it in the release?

No, the overall integration with Central Pacific Home Loans will be completed in the middle of the first quarter and at that time, we'll have a better run rate with regards to both, not only on the income but on the expense side. So we're not disclosing any numbers during this call.

Would you care to give us any general guidance on what we would expect going forward, then? On that item? And if you want to defer until the first quarter, that's fine.

Yes. I'll defer it to the first quarter earnings call.

And let's see. I didn't understand the interest accrual on the state and federal tax assessments. Is that an ongoing thing or a one-time thing?

It's related to specific years that the, both the IRS as well as the state have completed their audits on. And in connection with the assessments, there was an -- there was interest that was accrued on those assessments.

Well, I can assume that's not a recurring thing?

Correct.

Very good, thank you.

And we have a question from Brett Rabatin from RTN Midwest Securities.

Hey, guys, good afternoon. Or good morning.

Hi, Brett.

Couple questions. First off, wanted to ask you about the DDA growth this quarter. In the period for I don't know what averages were, but DDA was obviously very strong in terms of end of period growth. Can you talk about that and were there any short-term moneys in at the end of the year?

I'll start off. We have a number of very good relationships with local title companies, and we saw some strong year end activity with them that increased those numbers and we continue to push the market for DDA growth that comes as a natural follow-on to a lot of other products that we sell. So we're seeing new accounts, commercial as well as retail, and seeing some DDA growth through that activity, as well.

In addition to that, there was some falloff of those balances, subsequent to year end, but the, again, the growth in core deposits during the quarter were due to our business exceptional campaign as well as a totally free checking direct mail campaign and various CD promotions. Again, we still feel very positive in terms of the overall core deposit growth in the 8 to 10% range going forward.

Okay, and I apologize, but I'm going to have to run you guys through expenses one more time. The legal and consulting were $635,000 and aggregate additional this quarter, is that what you said, I'm sorry --

Yes.

And then there was -- and obviously you had the state, the tax high technology $714,000. How much were the additional accruals from Citibank?

That's the vacation accrual at $790,000.

$790,000, okay. All right. And -- so there's no other state tax assessments coming in terms of that was kind of a catchup accrual?

That's correct.

Okay. And you had extremely strong balance sheet growth in the fourth quarter, but you continue to make a provisioning of about a million. Is that a, you've got obviously still a high reserve level. Is the million dollar provisioning, assuming that loan growth even slows, is there any reason to expect a different provision going forward assuming credit costs are well-behaved?

Yes. Again on the loan loss provision, we did -- it is reported as a result of the strong asset quality as well as the strength of our economy which are the main factors that we look at going forward. So we do look a the provision on a quarterly basis and we recognize that, that going forward, due to the improvement in the asset quality that I talked about that we anticipate in the first quarter, we will be looking at the provision -- the corresponding provisioning in the first quarter.

Okay, and if I read that right, it sounds like it could go up some. Feel pretty strong just given that you're growing still.

Right.

Okay. And then lastly, assuming, tangible capital's not necessarily an issue, per se, but at some point would you ever make your loan production offices in the mainland, would those ever be basically for loans that you originate and fill with a secondary market, or do you think you'll continue to have those loans put on the balance sheet?

We are looking at that very issue right now. Certainly we want to have a secondary market program. We've hired people that have strong contacts in that secondary market, and we also have a very -- a number of very strong relationships with corresponding banks that can buy those loans. So if we ever got into a real tight situation in terms of being able to fund those loans, we would have another mechanism to sell them off. Which is -- which will become more and more of our activity going forward. We're going to be having stronger secondary market activity.

Okay, great. Thank you.

This is Dean, again. If I could go back to your question with regards to the provision because if I heard your correct you asked whether the provision would increase as a result of the continued growth in our loan portfolio. At this point, we don't anticipate that the provision would be any higher than the current levels. And again, the reasons for that is although we do expect the portfolio to grow, we talked about the improvement in asset quality in the first quarter which would offset part of that growth. So again, at this point, we don't anticipate the provision increasing.

If I could just add to that. All of our early warning systems that we have in place to monitor asset quality look very, very solid. Just to underscore what Dean is saying.

And we will go next to Fred Cannon from KBW.

Thanks and good morning.

Morning.

Hi, Fred.

Most of my questions have been answered so I'll have a couple of cleanup things. On the special item in the net interest income, I want to make sure I understand that you received a prepayment penalty because a security that you had in your AFS portfolio was paid off and that runs through net interest income, is that right?

That's right. The specific security is a Fannie Mae, delegated underwriting and servicing program for a Dutch bond that has a make whole provision in connection with the payoff. So that resulted in the prepayment penalty at the time that the investment was called.

Okay, great. And naturally, that would run through net interest income because it's part of that security.

Yes.

Okay. And then on the -- and then you have the one time -- the thing in the expenses that you did consider fully at one time was the accrual on the state and federal tax assessments, right?

Right. In addition to that, the other one-time expenses would be the vacation accrual of $790,000 as well as the incremental professional services of $635,000.

And none of those three you would expect to reoccur in the first quarter, is that right?

That's right.

Okay, great. Sorry we all had to ask you that. The mortgage company, I take it you've got the gain on sales of $2.5 million. Did you retain some of the production from the mortgage company? Or did you just, essentially all of it?

Yes. We retained about 20% of the overall production.

Okay. Okay. Great. And then, just two other small questions. One is on the DDA growth which you discussed which was related to title companies, were there some related expenses and not interest expense related to those title deposits?

No.

Okay. Was there related loans that with skinnier spreads than normal related to those or not?

No, pure DDA activity.

Okay. There's no offsetting expense to you from DDA--

Just a few lunches to tell them thank you.

Okay. Finally, the guidance you gave with the 7 to 10%, I take that that's based, we should base that off the operating number that, that you've reported of 249, right?

Yes.

So 249 plus 7 to 10% is your guidance for this year?

Yes.

Great. Thanks for that. Much appreciate it.

Thank you.

Just a reminder, if you do have a question today, it's star 1. Again, star 1 for questions. We will go next to Kerstin Ramstrom from Bear Stearns.

Hi, how are you guys this morning?

Good. How are you Kerstin?

Good. I have a couple of questions relating to non-interest income. I noticed that your service charges on deposits were up this quarter. Could you talk about the trends that you're seeing in NSF fees?

Part of the increase again relates to the check card program that I referred to and the overall, the trends have been, beginning in the second quarter when this product was also introduced into the former Citibank deposit customers. So we did see an increase and we feel that the overall trend going forward is that we anticipate it remaining at these levels for the fourth quarter.

That's for the NSF fees?

Right.

Okay. And then what, what drove the decrease in other service charges, did I miss that? Did you talk about that?

The -- other service charges -- there wasn't any one specific item. And basically these are fees we receive from our ATMs, loan processing, loan servicing and other brokage fees. No one particular category that accounted for the overall decrease.

Okay. And I've got to take a stab at this completely dead horse. On the expense side, the vacation accrual, I assume, was in the salary and benefits line? And the state tax assessment, I assume, was in the other line, correct?

Correct.

So even if I take out the tax assessment from the other line, that line item went from about $4.5 million up to about $6 million quarter over quarter. Was there anything else special in there or was that increase based on CPHL?

Yes. The other significant item in there is the amortization of mortgage servicing rights of that additional amortization in connection with CPHL. And again that acquisition occurred in mid August.

Do you break that out?

We do, but it's a combined figure with both the existing mortgage banking operation and CPHL at the time of the acquisition. So I don't have a separate number just for CPHL.

Do you have an amortization, an MSR amortization number contained in that line item?

Yes. For the fourth quarter, the amortization was approximately $850,000.

Okay. Do you have an allowance for your MSR?

No.

Okay. What was it in the third quarter?

It was $578,000.

578. Okay. Great. That's a big help. Thank you.

And we have a follow-up question from Mike McMahon from Sandler O'Neill & Partners.

Clint, I wanted to follow-up on an earlier question where you said you were looking to perhaps start selling some of your commercial real estate production from the mainland.

Yes.

And when presumably would we see some gain on sale from that? Is that something that's likely to occur this quarter?

No. Our preference still, because of the quality and the spread on these loans, is to keep them. What would drive that activity would be, really where we don't have the core deposits at the level we'd like to continue funding them. So we don't anticipate being in that position in the first quarter.

Okay. Thank you.

And we have a follow-up question from Fred Cannon from KBW.

Thanks, Dean. I just wanted to follow up on what you just said about the amortization, the MSR. Did you say that goes through non-interest expense?

Yes.

And is there servicing fee income that you get that goes through non-interest income? Like most large mortgage companies would have?

That's correct.

Okay. And then did you have any valuation change to the MSR during the quarter?

No.

And then the servicing fee income, the way you guys account for it would go through other service charges and fees and non-interest and income lines.

Yes.

And then you get the amortization down in other expenses?

Right.

Okay. Is there a reason most companies net those two in non-interest income. Is that an option for you guys or is this the way you're going to do the accounting moving forward?

Yes, this is the way we're going to account for it going forward.

Okay. All right. Thank you.

Thanks.

That does conclude our question and answer session. At this time, I would like to turn the call back over to our speakers for any additional or closing remarks.

I would like to thank everyone for their continuing interest in our Company. We're looking forward to 2006 being a very good year. If we haven't already individually, we wish you all a happy new year. Thank you.

This concludes today's conference. If you would like to listen to an audio replay, you can do so by dialing 1-888-203-1112 and entering the access code 6042454. The replay of today's call will be available starting today at 6 p.m. Central Time and ending on Tuesday, January 31 at midnight, Central Time. You may now disconnect. We do appreciate your participation. Thank you .