Central Pacific Financial Corp (CPF) 2006 Q1 法說會逐字稿

Good day and welcome to the Central Pacific Financial Corporation first 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 related 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 "believes," "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 risks and uncertainties and thus could later prove to be inaccurate or incorrect. Accordingly, actual results could materially differ from projections for a variety of reasons to include, but not limited to, the impact of local, national, and 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.

At this time for opening remarks and introductions, I will turn the conference over to Mr. Clint Arnoldus, Chief Executive Officer. Please go ahead, sir.

Thank you very much, Erica. Thanks to all of you for joining us today to review Central Pacific Financial Corp.'s financial performance for the first quarter of 2006. Let me start with some of the highlights of our Company and our marketplace. Our Chief Financial Officer, Dean Hirata will follow me with a more detailed financial report for this quarter.

I am very pleased to report that Central Pacific Financial Corp realized another solid quarter as reflected in its financial performance. Through selective market share growth in the robust segments of our community combined with expertise developed in-house and through recent strategic acquisitions, we were able to generate another quarter of very strong earnings. Net income for the quarter increased by 12.4% over the same period in 2005, despite the recognition of 2.2 million in nonrecurring expenses, which Dean is going to be covering in more detail.

Diluted earnings per share increased by $0.04 to $0.63 per share from the same period a year ago. Non-interest income increased by 31.5% from the first quarter of the previous year fueled by our wholly-owned subsidiary Central Pacific HomeLoans, which continues to be one of the market leaders in residential mortgage origination in Hawaii.

The Company also realized solid gains in its balance sheet in a highly competitive market for loans and deposits. Total loans and leases increased by 11.9% and total assets by 9.9% compared to the first quarter of 2005. Total deposits increased by 8.8% over the same period last year. We have continued our market share growth strategy of aggressively pursuing retail core deposit acquisition and maintaining our position as the market leader in commercial real estate lending.

Net interest margin remained relatively stable compared to the first quarter of 2005, increasing by one basis point. However, compared to the previous quarter, net interest margin decreased by 9 basis points. The deposit market has become especially competitive in Hawaii in the past three months as it has across the nation. But we have committed to expanding our core deposit base to strengthen our long-term franchise value.

Significant improvements were made on the quality of our already strong credit portfolio. Non-performing assets decreased by 38.4% from the same period a year ago representing 12 basis points in total assets compared to 21 basis points. The Hawaii economy has been exceptional in 2005. Although it will be tough to match that performance in 2006, the key indicators continue to be positive for strong economic activity. Our visitor industry is expected to remain stable following a record-setting year in 2005. Hotel occupancy rates are high and capacity limited. However, visitor arrivals are forecasted to increase from the US and Japan by 3.4% and 3.9% respectively in 2006.

Residential and construction activity should remain stable with military and commercial construction still expected to increase. Building permits and commitments to build in 2006 are estimated at $4.6 billion or a 9% increase over 2005. Job growth is expected to expand by 3% this year. That is slightly less than the 3.7% growth rate in 2005. Unemployment in Hawaii is projected to reach another record low at 2.6% compared to 2.8% last year. Real personal income should continue to grow at a stable rate of 3.2% compared to a 3.7% growth rate in 2005.

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 remainder of 2006. We've invested in building our lines of businesses, particularly in the areas of commercial real estate lending, small business, retail core deposit gathering, and wealth management to meet the needs of our target markets. We opened our thirty-eighth branch office in Kailua two months ago and are currently constructing our thirty-ninth branch in Pearl City. With the recent acquisitions of Citibank in 2004 and Hawaii HomeLoans in 2005, we now have the critical mass to compete directly with our larger competitors while still preserving personalized service as our competitive advantage. We are confident that our success in penetrating new retail customer households with aggressive core deposit initiatives and expanding our presence in the business segment have strengthened our franchise value in our marketplace.

At this time I'd like to call on our Chief Financial Officer, Dean Hirata who will review the details of our first quarter financial performance.

Thank you Clint. My discussion will cover the first quarter of 2006 consolidated financial highlights with Central Pacific Financial Corp and its subsidiaries.

Starting first with the earnings. Our first quarter 2006 net income was $19.3 million, an increase of 12.4% over the same quarter last year. The increase was primarily due to an increase of net interest income of $5.9 million or up 12.7% and an increase in other operating income of $2.9 million, or up 31.2%. On a sequential quarter basis, net income decreased by 100,000 or 0.5%. On a per share basis, net income was $0.63 for the current quarter, an increase of 6.8% over the same quarter last year and equal to the fourth quarter of 2005. The net income for the first quarter of 2006 included an after-tax charge of $1.3 million or $0.04 per diluted share in retirement expenses for a former senior executive.

The key performance ratios based on net income for the first quarter of 2006, excluding the retirement expenses as discussed previously were as follows. Return on assets of 1.59%; return on taxable equity of 23.7%; return on equity of 12.01%; and an efficiency ratio of 47.11%.

Now looking at our balance sheet, our total loans and leases of $3.6 billion as of March 31, 2006 grew by $385 million, or up 11.9% over March 31, 2005. On a linked quarter basis, the increase was $67.7 million or up 1.9% un-annualized. The current quarter was impacted by higher-than-expected loan prepayments as well as the payoff of $12.2 million in nonaccrual and delinquent loans. Average loan balances for the quarter increased by 2.7% sequentially. The average yield on loans for the first quarter of 2006 increased by 77 basis points to 7.2% compared to the prior year due to the upward compression of loans. On a linked quarter basis, the increase was 15 basis points.

Total deposits of $3.6 billion as of March 31, 2006 increased by $297 million, or up 8.8% over March 31, 2005. On a sequential quarter basis, the increase was $37 million. The slower growth in deposits during the current quarter was attributed in part to seasonal fluctuations specifically in our titled and escrow deposit accounts. Although our deposits were flat on a point-to-point comparison, average deposit balances increased by 2.8% sequentially. The effective cost of interest-bearing liabilities for the current quarter was 2.41%, an increase of 82 basis points over the prior year and on a linked quarter basis the increase was 18 basis points.

Our continued efforts to expand existing customer relationships and capture additional market share through our broader retail network and product suite are enhancing our core deposit base. We continue to have success with our flagship deposit product, the exceptional account, a money market account linked with a checking account affording the customer both a great rate combined with liquidity.

Looking now at the margin for the quarter, the interest margin of 4.6% for the first quarter of 2006 increased by one basis point over the same quarter last year and decreased by 9 basis points as compared to the fourth quarter of 2005. The current quarter included interest income totaling $662,000 related to the payoff of two nonaccrual loans, which contributed 6 basis points to the net interest margin. The compression in the net interest margin reflected a shift in the composition of deposits from savings and money market accounts into higher-rate time deposits as a result of the strong local competition for time deposits.

The provision for loan and lease losses totaled $525,000 for the current quarter compared to $917,00 in the first quarter of 2005 and $1 million in the fourth quarter of 2005. Other operating income was $12.2 million for the current quarter, an increase of 31.2% over the first quarter of last year. 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 HomeLoans partially offset by a decrease in investment securities gains. On a linked quarter basis, other operating income was up 6%. Other operating expense was $33.8 million for the current quarter compared to $30.9 million in the same quarter last year and $32.8 million in the fourth quarter of 2005. The current quarter, as we've discussed earlier, included a $2.2 million charge to retirement expenses, $492,000 in stock options expense in connection with the adoption of FAS 123R, and $929,000 in interest accruals on tax-related contingencies.

The first quarter of 2005 included nonrecurring merger-related expenses of $1.5 million and the fourth quarter of 2005 included $714,000 in interest accruals on tax-related contingencies. Excluding these nonrecurring expenses, other operating expense decreased by 5% on a sequential quarter basis.

The effective rate on income taxes was 35.65% for the first quarter of 2006 compared to 27.54% in the same quarter last year and 35.34% in the fourth 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 in high technology businesses in Hawaii.

Our asset quality remains strong. Non-performing assets at March 31 2006 totaled $6.1 million or 12 basis points of total assets, down from $9.9 million or 21 basis points a year ago. On a sequential quarter basis, non-performing assets decreased from $12.6 million, or 24 basis points as of December 31, 2005.

During the first quarter of 2006, we received a full payoff of two nonaccrual loans totaling $5.2 million. Non-performing assets are mainly comprised of loans 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 totaled $3 million at March 31, 2006 compared to $7 million a year ago and $7.9 million as of December 31, 2005. The decrease on a sequential quarter basis was due to the payoff of a commercial real estate loan of $7 million. Included in these loans as of March 31, 2006 is a potential problem loan of $1.9 million secured by commercial real estate and no loss is anticipated at this time.

Net loan charge-offs were $405,000 in the current quarter compared to net loan recoveries of $3,000 in the year-ago period and net loan charge-offs of $809,000 in the fourth quarter of 2005. The increase as compared to a year ago was due to higher recoveries a year ago and the decrease on a sequential quarter basis was due to lower dealer loan and consumer loan charge-offs. Shareholders equity at March 31, 2006 increased to $286.5 million or a tangible equity ratio of 7.24%.

The outlook for 2006 is as follows. Our net interest income growth will be driven by expected loan and deposit growth in the range of 8 to 10% and a stabilized net interest margin in the 4.5 to 4.6% range. Balance sheet sensitivity is expected to be offset by strong balance sheet growth. Our asset quality is expected to remain strong. Based on current economic and business conditions, management reaffirms its forecast for 2006 of 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 first quarter of 2006. I will now turn the call back over to Clint.

Thanks Dean. This concludes our earnings report and commentary for the first quarter of 2006. In addition to Dean and myself, we have with us today Blenn Fujimoto, who is a Vice Chairman of the bank and will also be available to address any questions you have at this time.

(OPERATOR INSTRUCTIONS) Mike McMahon with Sandler O'Neill & Partners.

Hi gentlemen. Nice quarter. A couple easy ones for you. Can we expect a decline in personnel expense or compensation in the second quarter with presumably lower payroll taxes? Does it have much of an impact for your Company as some others?

There is a slight impact. But as I said, it is not going to have a big impact on the expense for the second quarter.

There was 900,000 of interest accrual on various tax-related contingencies. Can you please either refresh my memory or give me some color on that. Should that be an ongoing expense hopefully for a short period of time?

The interest expense on these contingencies relate to contingencies related back to Citibank pre-acquisition. We've provided a reserve for these potential contingencies. As we thought of that, we did have to record a catch-up adjustment from the merger date, which was back in September 2004 through the end of the first quarter. On a go-forward basis, we expect the expense to be approximately $220,000 per quarter. This would be for not only the former Citibank contingencies, but for any other contingencies that we had on a combined basis.

Okay, Thank you. A final question if you are prepared to give it. What was the volume of loans originated from the mortgage banking operation and the volume sold? Or I can defer that question to next quarter.

The volume was roughly on the mortgage is approximately 200 million. Excuse me. Mortgage volume on a monthly basis, is approximately – I'd say 100 million. We roughly sell off 80% of those mortgages.

So – you were breaking up. It was 100 million a month roughly. Would that imply 300 million in the quarter? Or did you say 200 million?

For the first – seasonally, the first quarter is generally lower, probably closer to 200 in the first quarter. On a go-forward basis, we're probably looking at a 100 million per month. We roughly sell off 80% of that volume.

Great. Thank you very much.

Brett Rabatin with FTN Midwest.

Good morning. Or good afternoon. A couple questions for you. First off, can you talk some – you mentioned the 8 to 10% balance sheet growth. Can you talk some about how much of that will be mainland focused. How much of the balance sheet today is tied to the mainland. Any thoughts going forward – we've talked some in the past about potentially selling commercial real estate production on the mainland as your funding base. Going forward it gets a little tighter to grow. Any thoughts on those three things?

I'll talk about that for a minute. California we see as an operation that continues to add a very solid contribution to our bank. Going forward you touched on our obvious challenge. That is how we keep that funded. Because they have been very successful in what our officers have done to penetrate that market. Our officers are professionals that have worked in that market their entire careers. They are doing direct relationship loans and have 20-plus years experience, most of them, working with very key developers in California. We continue to expect to see very strong loan demand based on those relationships and a continuing contribution to our bank and loan growth. The challenge, obviously, is keeping it funded. We have various strategies that we are looking at right now. The most immediate would be entering a program where we would sell off some of that production if we find that we're unable to keep it funded from Hawaii. In the longer term we have to come up with a funding resolution out of California. We are looking at various strategies related to that as we speak.

The future growth in terms of deposits – that's easy because all we have is loan production officers on the mainland. We're going to continue with our programs here in Hawaii that have been very successful, which is this Exceptional Account that we've talked about in this call and previous calls. It continues to be our flagship product. We have our officers all incented to produce deposits and think we've got a good focus in that area. Expect to continue to perform.

In terms of our loan growth, it's very competitive in every market where we function. We continue to see very solid contribution out of the mainland. In Hawaii we continue to be suffering from prepayment experience. On a gross basis, we're experiencing good loan growth. But on a net basis after the prepayments, we continue to see Hawaii as a fairly flat market right now.

Would it be fair to assume – obviously in the first quarter, the mainland was comprised of the loan growth you had. Would it be fair to assume that a majority of the growth going forward would still be then comprised of mainland growth. I want to get, if you have it available, how much of your loan portfolio is mainland tied presently.

The first quarter was heavy contribution from the mainland. Your observation is correct. Going forward, we don't expect to see the kind of prepayment activity we've had. We expect to see a little bit more balance coming out of Hawaii so that we're seeing balanced loan growth going forward for both markets.

I would add that construction lending has been strong in Hawaii. Typically those loans will fund over 12 or 18 month. So we see healthy pipelines right now in Hawaii. As Clint mentioned, we expect the pay-downs to slow. The conduit lending is slowing a little bit here too.

Do you have an estimate of how much of your portfolio is mainland right now?

73% is in Hawaii and 27% combined California and Pacific Northwest. So mainland is at about – just over $900 million.

Okay. That's helpful color on what is going on there. Secondly, I want to ask – obviously the credit quality – you've had a reduction in MPAs and your provision with [rollover] on a year-over-year basis, it looks like, given your commentary, you're probably going to continue to have pristine credit quality. I am curious if you're – when I look at the way you're probably doing your analysis from a provisioning perspective and a reserve buildup, it would seem to follow that you probably would have additional minimal provisions going forward. Is there something missing? Or is that a likelihood in the next few quarters as well?

We have very strong confidence in the disciplines that we have in our credit underwriting. We are very strict about our loan-to-values, our debt service coverage ratios, getting quality guarantees on our loans. As you've seen, when we have had loans that have given us problems, we've always been able to get out of them ultimately through the liquidation of real estate collateral. We don't see anything changing that going forward. We have a very strong strategic commitment to pristine credit quality.

Okay. Maybe I didn't ask the question correctly. I was hoping to get – when I look at your reserve and your provision this quarter and your credit quality, it seems to me you'll probably continue to have minimal provisions going forward. I guess I am asking, is there anything that would change that. Or is there something I am missing in terms of that analogy?

No there is – actually I was hoping I had addressed your question. It just took a long u-turn getting it. We expect to continue with what you've seen historically. We don't anticipate having to make any significant reserve adjustments going forward.

Okay. Maybe we can follow-up on that. Lastly, I was curious on the margin going forward. You've given a guidance range of 450 to 460. It seems like it could be a little lower the next quarter or two. I am curious if – obviously you've given a range. But it seems like it might move down a few basis points. Is there anything that would give you an idea that it might move up a little bit or that it could be flat in the next couple quarters?

Currently we're slightly asset sensitive. As far as the future growth, we do anticipate that it will come on and be slightly lower on the incremental margin. However, with our focus on growing our core deposits, we believe that this will offset some of that compression. Overall we don't expect the margin to expand as a result, we said, of Hawaii coming on at a lower incremental margin. As far as any excessive risk to a flattening versus an inverted yield curve, we don't show any risk in that area. We feel very confident within the 4.5 to 4.6% range keeping in mind that the current quarter at 4.6 after adjusting for the [chaos] and the nonaccrual loans, came in at about 4.54%.

Okay, great. Congratulations on the quarter.

Joe Morford with RBC Capital Markets.

Could you talk a little bit about the mix of loan growth that you saw in the first quarter relative to yearend – whether it was commercial real estate, residential, construction or what have you.

We continue to see strong growth in commercial real estate. That is our flagship product. It's where we have a market leadership position here in Hawaii. We've got really solid officers with background in those areas. In looking at our overall book for the quarter, the real estate construction was 22.5% of our book. Residential represented 22.5% as well. Commercial mortgage loans were 34.9. Our [CNA P&I] was 13.7. The other was 6.4% to make that complete. We don't see anything going forward that is going to cause those percentages to change materially.

Those were end-of-period percentages?

Yes.

Okay. We noticed the amortization of core deposit premium dipped down maybe 600,000 or 700,000 or so from its recent run rate in the quarter. What drove that? I assume that this is the new run rate going forward.

As far as the valuation itself, there was no change to the overall valuation. It was anticipated that the expense would come down beginning in 2006. The expense is higher in the initial years. Then it starts to drop off in subsequent years. We do anticipate that the expense would be at these levels for the remainder of the year.

Does it drop down again in '07?

A further dropdown, but not as significant as between '05 and '06. But it is on a declining balance methodology.

Right, okay. Lastly, can you help update us on your plans for additional branch openings in the islands later this year. Thanks.

I mentioned the two that we have planned in my comments. In addition to that we have a branch in Lahaina, Maui that will be opening. We have a plan strategically to – we have ten prime locations that we've identified. We'll be periodically whittling that list down. It's a challenge in Hawaii from two standpoints. One is our very low unemployment rate and being able to staff these branches. Secondly, the costs are accelerating fairly dramatically to build a branch. So we're being very selective about where we go, as we always have been. These kind of pressures cause us to have even greater discipline. We will be consistently opening one to two branches a year. Oahu will be getting a big concentration of those remaining ten that we have identified.

Okay, great. Thanks so much.

Kerstin Ramstrom with Bear Stearns.

Thank you. Could you talk a little bit about your approach with [Bolley]. I noticed that popped up quite a bit this quarter. I didn't know if that was going to be ongoing. Have you purchased some more?

We did purchase some additional Bolley during the quarter. But we don't anticipate any additional purchases going forward.

Did you buy that at the beginning of the quarter? Are we going to see a bigger impact from that next quarter?

We bought it towards the beginning of the quarter.

Got it. What is the percentage fixed versus floating of your loan portfolio?

Fixed is about 30%. Floating is 70%.

In terms of the 260,000 in stock awards this quarter, is that a one-time thing for bonuses and whatnot? Or is that going to be a recurring cost during the year?

It's a one-time expense for 2006. This relates to stock that was awarded to directors as part of a combination of the retainer and the fees that they receive for the board meetings.

Okay, great. Thank you.

Fred Cannon with KBW.

Good morning. I was a little bit – [inaudible] a little more color on the loan – outlook for loan growth. I was a little surprised that prepayments would ramp up during the period when rates were rising. Do you have any comments? Was that a few specific things? Do you think it is something that should ebb? And also the pipeline on loans.

I can answer that. Basically, the prepayments resulted in the term debt area on the real estate side. That is expected to taper off. That is really mainly conduit lending that has taken up the term debt. The pipeline, as I mentioned, going forward is very strong. We have a lot of commitments out there in our real estate portfolio, which should fund within the next 12 to 18 months. We feel very confident about those fundings going forward.

Okay, thanks. I notice that the loans held for sale were about cut in half from the end of the year to the end of this quarter. Is that any indication that there may be a slowdown on the mortgage banking side?

No, that is not a reflection of the mortgage loan activity. We talked about we did have a stronger March as compared to the first two months in the quarter. We expect it to continue going forward.

Great. Thanks. Congratulations.

(OPERATOR INSTRUCTIONS) Jacky Reeves with Ryan Beck.

Thank you. I want to follow-up with the exceptional account and ask if you have some additional color such as average balances, the number of accounts. Could you shed some light on how that has progressed from when you've had a long-set initiative to current trends.

The exceptional account, as Dean mentioned, is our flagship account. It's an account we've had for approximately three years – six years in total. It's something that we run two major campaigns during the year. It is an account that attracts the higher-balance type client. Average balances – it's really – let's see how much is proprietary in this. The [actual] account that we look at to bring in a higher balance type account. Our campaigns are usually driven by the higher retail type balances. We have an attraction this quarter of a DVD promotion. We usually give a gift tied to this campaign. It builds over time. Our average balances normally start, I'm going to say, in the 25,000 average balance. These accounts normally build into the mid five figure range.

So from the beginning of this, you've seen that average balance continue to grow. Is that what you're saying?

Yes. It builds over time. Usually those are all targeted to new customers into our bank. It builds over time. The attraction of this – it's a package product. We try and tie in all their relationships into one account.

And the two major campaigns for the year – you said there is one going on now. Is it now and around the holidays? Or does that rotate from year-to-year depending upon [inaudible]?

We target one towards the beginning of the year and one towards the latter of the year.

Thank you.

We have no further questions in the queue at this time. I'd like to turn the conference back to our speakers for additional or closing remarks.

Thank you all for your interest in our Company. You can be assured we are working hard and following our disciplines that have produced the kind of results that the Bank has had so far. We look forward to a very successful 2006.

This concludes today's conference. If you would like to listen to an audio replay of this call, you can do so by dialing 888/203-1112 and entering access code 3164899. The replay of today's conference will be available starting this evening at 6:00 pm central time and ending Tuesday, May 2 at midnight central time. You may disconnect. Thank you.