Central Pacific Financial Corp (CPF) 2006 Q2 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, 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 underlying 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 believe, planned, intend, expect, anticipate, forecast, or other words of similar meaning. While we believe that our forward looking statement and the assumption 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 the impact of local, national, and international economies and events on the Company's business and operations and on tourism, the military and other major industries operating within the Hawaiian 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 & Exchange Commission filing including the Company's Form 10K for the last fiscal year. The Company does not update any of it's forward looking statements.

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

Thanks, [Dixie]. Thank you all for joining us today to review Central Pacific Financial Corp.'s financial performance for the second quarter of 2006. Before getting into the details of our financial report by our CFO, Dean Hirata, I want to briefly review some of the highlights of our Company and the economic climate of our marketplace.

First of all I'm very pleased to report that Central Pacific Financial Corp. realized strong earnings for the second quarter ended June 30th, 2006. We focused much of our attention on strengthening our retail core deposit programs and building upon our strengths in residential and commercial real estate financing. Net income for the second quarter was $20.4 million and diluted earnings per share was $0.66 reflecting increases of 14.2% and 13.8% respectively over the same period last year. We've continued to expand our non-interest income opportunities which increased by 24.5% compared to the second quarter of 2005.

The rising interest rate environment and competitive offerings for time deposits have affected our market as well as our industry nationwide. Our strategy is to focus on core deposits through our flagship combined balance program, the exceptional account, have successfully maintained core deposit balances and continue to bring new customer relationships into our bank.

Total deposits increased by 4.5% from the same period a year ago and core--with core deposits increasing by approximately 1%. Loan production and asset quality continue to be strong supported by our enhanced sales infrastructure and a robust local economy. Total loans and leases increased by 15.1% compared to June 30th, 2005, while non-performing assets to total assets improved from 33 basis points to 19 basis points in the same time period. Return on average shareholder's equity improved to 11.71% for the quarter ended June 30th, 2006, compared to 10.95% in the same period last year.

Let me make a few comments about the economy here in Hawaii. The overall economic climate remains strong and robust compared to the exceptional growth experience of 2005, certain sectors of our economy are expected to stabilize for the remainder of this year. Some of the key revisions to forecast made in the previous quarter include stronger job growth and marginal reductions in visitor arrivals and real income growth.

Overall job growth is now expected to increase by 2.5% in 2006. Construction related jobs continue to be the driver for growth in our state with a projected increase of 7.7% for the year. Hawaii's unemployment rate inched upwards to 3.1% but continues to be one of the lowest in the United States. The average national unemployment rate remains at 4.6%.

Our visitor industry remains stable, however reduced airfare capacity is expected to influence the remaining quarters of the year. Visitor arrivals have been reforecasted to a 2.8% increase for 2006 compared to a 3.4% increase forecasted in the previous quarter. Real personal income growth is stabilized over 2005 and it's now projected to increase by 3% in 2006. Residential real estate prices and sales volume continue to plateau with further cooling expected over the next several years. The state's inflation rate forecast has not been revised and continues to be projected at 3.8% this year.

Overall, the outlook for the local economy in 2006 remains very positive. The key external economies that impact Hawaii namely the mainland United States and Japan continue to look favorable for the year. U.S. GDP increased by 4.8% on an annualized basis in the first quarter this year and GDP growth in Japan was 1.9% annualized for the first quarter of 2006. Federal spending and construction activity in Hawaii will continue to drive our economic activity and growth for 2006.

Moving forward, we continue to be optimistic on the Company's ability to increase market share through organic growth. We've been able to capitalize on the synergies of our recent business acquisitions and improve business development efforts with investments in our personnel and our infrastructure. We are well positioned in our marketplace to meet the competitive challenges and to take advantage of economic opportunities. Our strengths in selected lines of business have shown positive results including commercial real estate lending, retail core deposit gathering, and wealth management. I will continue our efforts to improve our competitive market advantage in superior personalized service. This time, I want to call upon our CFO, Dean Hirata to review the details of our second quarter financial performance. Dean?

Thank you, Clint. In my discussion, we'll cover the second quarter of 2006 consolidated financial highlights for Central Pacific Financial Corp. and it's subsidiaries. Beginning with the summary of our earnings. Second quarter 2006 net income was $20.4 million, an increase of 14.2% over the same quarter last year. The increase was primarily due to an increase in net interest income of $3.7 million or up 7.5% and an increase in other operating income of $2.2 million or up 24.5%. On a sequential quarter basis, net income increased by $1.1 million or up 5.7%.

On a diluted per share basis net income was $0.66 for the current quarter, an increase of 13.8% over the same quarter last year, and 4.8% over the first quarter of 2006. 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.

Moving to the key performance ratios, based on net income for the second quarter of 2006, our return on assets was 1.57%, return on tangible equity was 22.17%, return on equity of 11.71%, our efficiency ratio of 47.76% and a net interest margin of 4.56%. Moving to the balance sheet, total loans and leases of $3.7 billion as of June 30, 2006, grew by $484 million or up 15% over June 30, 2005. On a link quarter basis, the increase was $69 million or up 1.9% unannualized.

Average loan balances increased by 1.6% sequentially. Based on the loan pipeline as of June 30, 2006, we are projecting stronger loan growth for the second half of the year in the commercial and real estate construction areas. The average yield on loans for the second quarter of 2006 increased by 75 basis points to 7.42% compared to the prior year due to the upward repricing of loans. On a link quarter basis, the increase was 22 basis points.

Total deposits of $3.7 billion as of June 30, 2006, increased by $158 million or up 4.5% over June 30, 2005. On a sequential quarter basis there was a decrease of $15 million. Declines in demand and time deposits during the second quarter were partially offset by growth in our flagship exceptional savings account. Although deposits were slightly down on a point-to-point comparison, average deposit balances increased by 1% sequentially.

Effective cost of interest bearing liabilities for the current quarter was 2.72%, an increase of 94 basis points over the prior year. On a link quarter bases, the increase was 31 basis points. We continue to have success promoting our flagship exceptional and business exceptional accounts. These accounts offer individuals and businesses a money-market account linked with a checking account affording the customers both a great rate combined with liquidity.

Additionally, our exceptional account is the only account offered by a major Hawaii financial institution that includes a rebate to customers on foreign ATM usage. Our recent promotions have generated significant connectivity at our branches and a healthy increase in net account relationships growth.

Now, looking at our earnings, the net interest margin of 4.56% for the second quarter 2006 decreased by nine basis points compared to same quarter last year and decreased by four basis points on a link quarter basis. The first quarter of 2006 included interest income totaling $662,000 related to the pay off of two non-accrual loans which contributed six basis points to the net interest margin. Similar to other banks in the local market, 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 strong local competition for time deposits. The provision for loan and lease losses totaled $525,000 for the current quarter compared to $1 million in the same quarter last year and $525,000 in the first quarter of 2006.

Other operating income was was $11 million for the current quarter, an increase of 24.5% over the second quarter of 2005. The increase was primarily due to service charges on deposit accounts, other service charges and fees, and gains on sales of loans from Central Pacific Home Loans. On a link quarter basis, other operating income was down 9.9 %, primarily due to a decline in gains on sales of loans of $1.1 million as first quarter sales activity benefited from the completion of both financing projects at the end of 2005 and the beginning of 2006.

Other operating expense was $31.5 million for the current quarter compared to $28.7 million in the same quarter last year and $33.8 million in the first quarter of 2006. The increase over the year ago period included the impact of the Central Pacific Home Loans acquisition in August 2005 of $770,000 and $711,000 in stock option expense. The decrease from the first quarter 2006 was primarily due to $2.2 million in retirement expenses in the previous quarter. The effective rate on income taxes was 34.3% for the current quarter compared to 35.14% in the same quarter last year and 35.65% in the first quarter of 2006. The decrease in the effective tax rate for the current quarter compared to the same quarter last year reflects approximately $458,000 in income tax benefits resulting from the resolution of certain items of an Internal Revenue Service audit.

Our asset quality remains strong. Non-performing assets at June 30, 2006, totaled $10 million and 19 basis points of total assets down from $16.1 million or 33 basis points a year ago. On a sequential quarter basis, non-performing assets increased from $6.1 million or 12 basis points as of March 31st, 2006. The increase in non-performing assets during the current quarter reflects the addition of two non-accrual loans totaling $4.6 million.

Subsequent to quarter end, we received a full pay off on one of the loans totaling $1.9 million and the other loan is expected to be paid in full in the fourth quarter of this year through the sale of the collateral. Non-performing 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 totaled $1.5 million at June 30, 2006 compared to $469,000 a year ago and $3 million as of March 31st, 2006. The decrease on a sequential quarter basis was due to the previously mentioned commercial real estate loan of $1.9 million which was paid in full in July 2006. Net loan charge-offs were $667,000 in the current quarter compared to net loan charge-offs of $966,000 in the year ago period, and net loan charge-offs of $405,000 in the first quarter of 2006.

The allowance for loan and lease losses was 1.43% of total loans and leases and is reflective of our solid asset quality ratios and the continued economic strengthen in our markets. Shareholders equity at June 30, 2006, increased to $698.8 million or a tangible equity ratio of 7.41%.

The concluding with our outlook for 2006, our net interest income growth will be driven by expected loan growth of 8 to 10%, deposit growth of 3 to 4%, and a stabilized net interest margin in the range of 4.5 to 4.6%. Balance sheet sensitivity due to continued flatness in the yield curve is expected to be offset by strong loan growth. Our asset quality is expected to remain strong. Based on current economic and business conditions, Management reaffirms it's forecast for 2006 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 second quarter of 2006. And I'll now turn the call back over to Clint.

Thanks, Dean. We'd be happy to entertain any questions you may have at this time.

[OPERATOR INSTRUCTIONS] And we'll go first to Brett Rabatin with FTN Midwest. Please go ahead.

Hi, good afternoon, gentlemen or good morning to you.

Hi, Brett.

Several questions for you. First off the-- on the margin guidance going forward, I can certainly get to the loan growth number and the deposits I guess that will factor in somehow, but I'm curious on the margin, if that's a function of loans comprising a much higher portion of earning assets going forward? If you could give us some color on the amount of securities that are-- or cash that you're receiving from the securities portfolio and just kind of given the competitive landscape for deposits on the island is why the margin wouldn't be a little softer the next few quarters?

Brett, your first with the impact of the loan and deposit growth, again, we do expect stronger loan growth in the second half of the year. But on the deposit side of the forecast is, that's a 3 to 4%, there will be a gap between the two that we expect to be more of a short-term for the remainder of the year, so the difference will be funded through our borrowings.

Now, secondly, as far as the shift that we've seen, we have seen the shift into-- from the core into the higher time deposits. However, we believe that going forward, we will not see this same shift for the remaining two quarters.

And is that for a particular reason?

Well, we've actually returned to the core levels that had existed in early 2001 before the Fed funds had dropped below 3% so again we feel going forward, we have a stable core base and we expect that will not have a significant impact on the margin.

Okay. And then secondly, if you could give any color if you said it, I missed it, Dean, that the amount of mortgage loans sold in the second quarter and sort of your expectations for the volumes going forward on that piece of business?

Again, we did have a strong first quarter at about $2.5 million. We expect going forward for the gains on sales to be somewhere in the range of 1.8 to $2 million on a normalized basis.

Okay. All right thank you, guys.

And we'll go next to Mike McMahon with Sandler O'Neill & Partners. Please go ahead.

Hi. Can you repeat that number on the gain on sale? I missed that. One point what?

1.8 to $2 million.

Okay. And can you remind us what the bulk financing projects were? That took place in the first quarter?

We have a number of joint ventures with top developers, real estate developers here and it was really just timing and when these projects came into the marketplace and what we do is take the tail end of their projects and provide mortgage financing for the retail buyers and it was really just how the projects happened to line up in coming to market. We don't expect to have that kind of concentration going forward.

Okay. Would another way of saying that is you just had stronger loan sales volume in the first quarter, or --

Yes, actually, this is Blenn Fujimoto, Vice Chairman. I actually would say that we've had a lot of projects. By nature projects, as they close especially condo projects, you have spikes in volume as they complete. We do anticipate as Clint mentioned, we have several joint ventures of some developers here in Hawaii and they have some long term subdivision projects will go-- which will go over several years, so we expect that volume, even though the mortgage activity in the state may soften, we believe because of the joint ventures we will capture more of the front end of these projects on a long term basis.

Okay, very good. And what rate are you paying on your exceptional savings account now or is that a tiered rate?

It's a tiered rate.

And where does it average currently or rough ballpark, back of the envelope?

The average rate is about 2.75%.

Okay. And borrowings I would assume would be at a market rate. How about CD's? Where's the competitive landscape in Hawaii for CD's now, say a six-month, $75,000 CD. Is it over 5%?

It's somewhere between 4.5 to 4.75%.

Okay. And I'm just a follow-up on Brett's question about the margin. If I heard you correctly, you expect that that gap that you'll have to fill through borrowings is a temporary gap and perhaps through a little richer earning asset mix, you'll still be able to maintain or have a slightly increasing margin. Did I hear that correctly?

Correct. We'll also have cash flow from our securities portfolio. Between 20 to $30 million per month.

Okay. Very good. Thank you.

We'll go next to Fran--Fred Cannon with KBW. Please go ahead.

Hi, good afternoon. Just a couple follow ups really. I wanted to go back to the mortgage banking operation and kind of get more color on how that's going. I believe you said that you thought gain on sale would accelerate in the second quarter from the 1.45 million to 1.8, 1.2 but I notice that the long [inaudible] for sale on the balance sheet were down to 25 million versus 34 at the end of March, so I was wondering if you're seeing a change trend or you're expecting better gain on sale margins?

That fluctuates quite a bit based on the projects that come on board on a month-to-month basis, so we're at the run rate that we expected for our mortgage operation.

Okay and the gain on sale margins you expect to be stable ?

Yes, we do.

Okay, I also notice that the MSR on the balance sheet ticked down just a bit from the end of the first quarter to the end of the second quarter, I was wondering if there was a -- given that interest rates were rising during the quarter I was a little bit surprised by that. Do you have any color on that?

No. There wasn't anything unusual in the account.

Okay. And finally, any update on your West Coast loan origination activities?

Well, we continue to get great results on the West Coast because of the team that we have there and their longstanding relationships that go back in some cases 25 years and we're in a good position to be able to benefit from what that market has to offer, so we feel very good on the origination side and again, I remind you that's just a commercial real estate for us. The challenge for us is to get some funding help from California and we're looking at various strategies in that regard and expect that we'll have a strategy that we can talk about fairly soon.

Great. Thanks.

And we'll go next to Brent Christ from Fox-Pitt Investment Bank. Please go ahead.

Hi, guys, a couple quick questions. First, in terms of the increase in the savings and money market accounts, it looked like the yield-- or the cost on that ticked up quite a bit more than it has the past couple quarters. Is that just a function of greater penetration with the exceptional accounts?

I think it's a combination of that and again, as rates have started to move back up, just the consumers looking more at their various alternatives.

Okay. Secondly, in terms of the loan growth, it seemed like you had a bit of a pick up in Hawaii versus kind of flattish balances for the past couple quarters. Could you talk about how the pipeline is in Hawaii versus California at the end of the quarter?

I can say that in the construction area, that's one good thing that's fairly easy to predict in terms of your pipeline because once the project starts, you can pretty much forecast your fundings through the rest of the year and actually for the next 18 months in most of these projects. And both in Hawaii and California, we see a fairly strong construction activity continuing, especially the neighbor islands down on the West Coast. As Dean mentioned it's a little harder to predict on the deposit side but it's something that we feel we can address in the next quarter.

Got you. And then just lastly, in terms of the charge-offs and provisioning, it seemed like charge-offs were a little in excess of provision. What's kind of your thoughts on the reserve levels going forward assuming no major underlying change in credit quality?

We expect the allowance to remain at these levels.

On a dollar or percentage?

Percentage.

Percentage. Okay. Thank you.

And we'll go next to [Steve Skinikarelio] from [Black Rock]. Please go ahead.

Hi, guys. Just wanted to follow up with regard to the deposit and funding strategies going forward. Just looking at that 3 to 4% growth. Just wanted to dig into that a little bit and kind of get from you what are some of the things that could happen positively that makes that a low number for the year and I was interested hearing more what are some of the strategies you can do? You mentioned California, you mentioned your exceptional accounts, any promotions there? What are some of the things that you guys can do to ramp that up a little bit and make it better?

Well actually there's two parts of that. On the retail side of our bank we continue to do very well with our exceptional account and bringing in consumer deposit. That's something we expect to continue. What we've had is really the fluctuation in the commercial deposit. A lot of it is a result of what's happened in the title and escrow type of accounts but we believe there's opportunities in some of the people that's been placing money in alternative investments that there's room for us to really look at bringing some of that money back if we can place it a little bit more aggressively in that area.

The good news too is that we're actually growing a number of business accounts and we actually are taking market share in bringing over accounts, unfortunately the balances in the larger accounts that moved to alternative investments, but we feel there's opportunity to bring some of that money back also.

And then the strategies in California, anything detail on that?

I think we can share right now as I say, we expect to be able to talk about that in more detail in reasonably near future.

Okay, great. Great thanks a lot.

And we'll go next to Joe Morford from RBC Capital Markets. Please go ahead.

Thanks so much. Most of my questions have been answered so just a couple follow ups. First, recognizing that in more of the growth this quarter did come out of Hawaii market, can you talk about the mix of that growth by product? Was it still largely commercial real estate and maybe construction as well?

That's correct. Most of it has been in a lot of the projects that we've had on and are starting to fund which we expect to continue through the rest of the year and next year.

Our pipeline is showing some pretty strong growth that we'll see in our C and I loan book as well for the remainder of the year.

By second half of the year we'll show some growth in the C & I lending.

Okay. Alright and then lastly, just can you talk about title in escrow, deposit flows during the quarter and how they compare now versus where we were three months ago?

That area has shown this year quite a bit of volatility and that's something that's been very hard for us to predict. We've been doing very well like I mentioned earlier in growing the retail deposits as well as the commercial deposits but the volatility in the escrow has been something that will probably continue because of project-by-project those things change and swing quite a bit from month-to-month.

And roughly can you remind us roughly how big either on a percentage or dollar amount what your title and escrow deposits be averaging?

It should approximately $175 million.

Okay. Super. Thanks so much.

[OPERATOR INSTRUCTIONS] And we'll go next to Jackie Reeves from Ryan Beck. Please go ahead.

Good morning. I just wanted to clarify the confidence with respect to the strong pipeline in the second half of the year and the commercial and commercial real estate. Is that largely to do with the pipeline that you were citing or was there additional color that you provided and I may have not heard.

Actually, the pipeline that we know that's already going to be funding through the rest of this year and next year, and not including things that we expect to be putting on the books the remaining part of the year. That's just the existing pipeline.

Thank you very much.

And we'll go next to a follow up from Brett Rabatin from FTN Midwest. Please go ahead.

Two follow-ups. First, I want to make sure I understood why the loan growth in the second quarter was not that it was weak but it was a little lower than your trends have been and it's obviously a function of California and so I wanted to get some color, additional color if possible on was that pay downs? I'm not sure if I quite understand if you could give us a little more on the gross versus the net increase for the quarter.

Brett, as you know, those real estate projects are always difficult to keep on an even closing rate throughout the year, so they will tend to-- we can have heavy quarters and light quarters and that's really what affected us this last quarter. We just didn't have as many closings on deals, but our pipeline is very strong for the year. We'll close the year strongly.

Okay so it wasn't a function of credits going to long term fixed rate financing from other intermediaries? It was more just that some deal didn't close in the second quarter and that may, if anything, lead credence to those loans closing in 3Q so those volumes should pick up?

Right.

Okay. And then the other thing was I want to make sure I understood precisely the question regarding the reserve going forward, Dean. I think you mentioned that you thought that the reserve level would remain the same on a percentage basis, is that correct?

Yes.

And so would it-- with the absence of loan loss recoveries and with the continuation of growth, I'm obviously assuming that the provision would increase quite a bit in the second half of the year unless again you had recoveries?

Yes. Again, Brett when I said these levels, it's really looking at just the overall adequacy as opposed to the straight percentage itself. I mean, basically it's probably going to run in a range of anywhere from 1.4 to 1.43%. So I would say we're at the higher end of the range in terms of our asset quality. I don't expect the provision to change over the next two quarters.

Okay. And then just, I'm sorry, [inaudible] you don't expect the provisions to increase?

That's correct.

But the reserves not going to decrease either on a relative basis?

Well, it could come down a little but it will be somewhere like I say in the range of 1.4 to 1.43. It has decreased from where it was beginning at the start of the year.

Okay.

That's also like I said, it's primarily a reflection of our strong asset quality and again, even with the increase in the non-performance that we saw in the second quarter, we did have one of them did pay off and the other we expect to pay off in the fourth quarter of this year.

And that brings me to my last question as sort of an additional add on. You mentioned reserve adequacy, given very strong asset quality, I guess I'm curious why the reserve level wouldn't decrease more? I mean it seemed like it's more than -- I know you have a higher concentration of real estate related credits, but any additional color on the reserve? It seems higher than piers anyway given your credit quality.

Again, the reserve, although we do have a strong asset quality, it really is primarily a function of the higher concentration in our commercial real estate portfolio.

Okay, fair enough. Thank you.

And we'll go to a follow up from [Steve Skinikarelio] from [Black Rock]s. Please go ahead.

Hi, guys, just one more. In mentioning the stronger loan growth for the second half, 8 to 10%, in total and then deposit growth 3 to 4%, right now your loan deposit ratio is about 100%. I just wanted to check in with you kind of what's your comfort range in terms of that loan deposit ratio? I know you said you feel kind of the deposits growth is kind of temporarily suppressed here, but in the near term, what is your comfort level for that loan deposit ratio?

Our policy limit would be up to 115%. Naturally, we do want the ratio to come down but like I say, for the short term, the loan fundings will out pace the deposit growth but yet we just see that as a short term challenge.

Got you. But that could give you some breathing room in the interim period here?

Correct.

Got you. Great. Thanks a lot.

And we'll go to another follow up from Brent Christ with Fox-Pitt Investment Bank. Please go ahead.

Hi, just a quick one, guys. On the expense side, could you talk a little bit about the sequential increase in staff expenses is that related to some recent hires or higher headcount or just some incentive comp in the numbers this quarter?

Yes, again the-- our salaries and benefits for the quarter really did not include any unusual items, unlike the first quarter of this year. And we see that as a fairly good number going forward.

Okay. I guess if you back out the one timer out of the first quarter though it was up probably 4 to 5% sequentially. Was there anything specific driving that?

You mean between the first and the second quarter?

Right.

No.

Okay. Great. Thanks a lot.

[OPERATOR INSTRUCTIONS] And it appears we have no further questions in the queue. I'd like to turn the call back over to the speakers for any additional or closing remarks.

Thank you very much for your participation in our earnings call today and we appreciate your interest in our Company and look forward to future discussions with you. You can call any one of us if you have follow up questions. Thank you.

And ladies and gentlemen, this does conclude today's conference. If you would like to listen to an audio replay of this call, you can do so by dialing 1-888-203-1112 and enter access code 4820432. The replay of today's call will be available starting this evening at 6:00 p.m. Central time and ending on Tuesday, August 1st at midnight Central time. Thank you.