Central Pacific Financial Corp (CPF) 2006 Q3 法說會逐字稿

Good day everyone, and welcome to the Central Pacific Financial Corporation third quarter earnings call. Today's call is being recorded. Today's conference call may contain forward-looking statements concerning projections of revenue, 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 and 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 economies and events, including natural disasters 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 the price of the Company's stock.

For further information on factors that 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'd like to turn the call over to Mr. Clint Arnoldus, Chief Executive Officer.

Thanks, Abe. Good afternoon everyone and thank you for joining us today to review Central Pacific Financial Corp's financial results for the third quarter of 2006. With me here today to discuss the details of our financial performance is our CFO, Dean Hirata. but first I'd like to briefly review some of the highlights of our Company and the economic climate of our marketplace. I'm very pleased to report that Central Pacific Corp. realized another quarter of record earnings for the period ended September 30, 2006 with net income of $20.6 million, or $0.67 per diluted share. Our Company has achieved solid organic growth in both loans and deposits during the year, while enjoying strong credit quality and a stable net interest margin.

Loan production continues to be strong with growth coming from both our Hawaii and West Coast operations. Construction lending activity has been especially robust as a result of the current economic and market conditions and has contributed to an 11.8% increase in total loans compared to this same period last year. Loan quality continues to excel with the ratio of non-performing assets to total assets, improving to 15 basis points as compared to 28 basis points a year ago.

Market conditions for deposit gathering in Hawaii continue to be highly competitive. Consumer access to out of state deposit instruments has increased as has local competition from banks, credit unions, and other non-bank institutions. We've aggressively enhanced our product and promotional strategies to target retail deposit growth and key business segments, which contributed to a 9% increase in deposits compare to the same period last year. Our cost of funds increased modestly during the third quarter, matching the increase in our asset yields, and resulting in a stable annualized net interest margin of 4.56% for the quarter.

The overall economic climate in Hawaii remains stable but certainly not at the same robust levels we experienced in 2005. The economic outlook for Hawaii points to a higher inflation rate driven primarily by housing and energy costs. The annual inflation rate for 2006 is expected to be 5.2% based on a 6% annualized rate for the first half of this year, while the growth rate for real income is now expected to be 1% for the year.

The visitor industry remains stable with the revised projection of a 1.5% increase in visitor arrivals for 2006 over 2005. U.S. visitor arrivals are projected to increase by 2.9% while the Japanese visitor market is expected to be down by 7.4%. The Hawaii labor market is starting to show signs of leveling. Job growth is projected to be 2.5% for the year, compared to a growth rate of 3.2% in 2005. Unemployment is at 2.5% as of last month, which once again is the lowest in the nation.

Overall, the outlook for the local economy in 2006 remains positive. The key external economies that impact Hawaii being the main ones, U.S. and Japan, a projected GDP growth rates of 3.3%, and 2.5% respectively. While real estate sales activity in Hawaii has calmed down from the previous year, federal spending and construction activity remains stable with a healthy pipeline of building permits.

Moving forward, we continue to be optimistic about the Company's ability to increase market share through organic growth. We're capitalizing on the synergies of our recent business acquisitions which broadened our customer base and our product offerings. We recently broke ground on a new branch site on Oahu slated for completion in mid-2007 and have plans for another new branch to be opened on the island of Maui in late 2007.

I'd also like to comment on remarks I made last quarter. We discussed expanding our presence in California in light of anticipated funding challenges. While we still believe a transaction makes sense given our current activity, and the tremendous opportunities on the West Coast, we will be very diligent and highly selective to ensure that any deal we consider will be accretive to our earnings and present a good cultural fit to our organization.

At this time I'd like to turn the time over to our Chief Financial Officer, Dean Hirata, to review the details of our third quarter financial performance. Dean?

Thank you, Clint. In my discussion, we'll cover the third quarter of 2006 consolidated financial highlights for Central Pacific Financial Corp. and its subsidiaries.

Starting with a summary of our earnings. The third quarter 2006 net income was $20.6 million, an increase of 14.5% over the same quarter last year. The increase was primarily due to an increase in net interest income of $3.5 million, or up 7.1%, combined with a decrease in other operating expense of $1.1 million, or 3.5%. Net income was slightly up on a sequential quarter basis. On a diluted per share basis, net income was $0.67 for the current quarter, an increase of 15.5% over the same quarter last year, and 1.5% over the second quarter of 2006. On an operating earnings basis, which excludes non-recurring merger related charges inning occurred in 2005, net income increased by 2.4% and 7% and operating earnings per share increased by 3.1% and 5.4% for the 3thid quarter and first nine months of 2006 over the comparable 2005 periods.

The key performance ratios based on net income for the third quarter of 2006 was a return on assets of 1.56%, return on tangible equity of 21.44%, return on equity of 11.52%, and efficiency ratio of 47.03%, and a net interest margin of 4.56%. Moving to the balance sheet, total loans and leases of $3.8 billion as of September 30, 2006, grew by $398.5 million, or up 11.8% over September 30, 2005. On a link quarter basis, the increase was $75.8 million or up 2.1% unannualized. Average loan balances increased by 2.2% unannualized on a sequential quarter basis.

Based on the loan pipeline as of September 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 third quarter of 2006 increased by 95 basis points to 7.78% compared to the prior year due to the upward repricing of loans. On a link quarter basis, the increase was 36 basis points. Total deposits of $3.8 billion as of September 30, 2006, increased by $271.7 million, or up 7.9% over September 30, 2005 excluding brokered deposits.

On a sequential quarter basis, there was an increase of $74.4 million or a 2% unannualized. The increase was primarily due to organic growth in all deposit categories, except non-interest bearing demand deposits, led by growth in our flagship exceptional savings accounts. Average deposit balances increased sequentially by 0.7% unannualized. The effective cost of interest liabilities for the current quarter was 3.03%, an increase of 108 basis points over the prior year. On a link quarter basis, the increase was 31 basis points.

We continue to have success promoting our exceptional and business exceptional accounts. These accounts offer individuals and businesses a money market account linked with a checking account. Again, affording the customer both a great rate combined with liquidity. In addition, 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 promotion has generated significant account activity at our branches and a healthy increase in net account relationships growth.

The net interest margin of 4.56% for the third quarter of 2006 decreased by 4 basis points compared to the same quarter last year, and was unchanged on a link quarter basis. The provision for loan and lease losses totalled $300,000 for the current quarter, compared to $1 million in the same quarter last year, and $525,000 in the second quarter of 2006, reflecting the improvement in our asset quality.

Other operating income was $10.5 million for the current quarter, a decrease of 8.1% compared to the third quarter of 2005. The decrease was primarily due to a 30% decline in mortgage origination activity from Central Pacific home loans. On a link quarter basis, other operating income was down 3.8%, primarily due to a decrease in mortgage origination activity, partially offset by an increase in bank loan life insurance income.

Other operating expense was $31.2 million for the current quarter, compared to $32.3 million in the same quarter last year, and $31.5 million in the second quarter of 2006. Excluding the impact of non-recurring merger related expenses incurred in the third quarter of 2005, other operating expense increased by 8.3% over the year ago period, reflecting the impact of the Central Pacific Home Loans acquisition in August 2005, and stock option expense of $632,000. The decrease from the second quarter of 2006 was primarily due to a decrease in legal and professional fees.

The effective rate on income taxes was 35.86% for the current quarter, compared to 35.05% in the same quarter last year, and 34.38% in the second quarter of 2006. The increase in the effective tax rate on a link quarter basis reflects $458,000 in income tax benefits resulting from the resolution of certain items of an Internal Revenue Service audit in the second quarter of 2006.

Our asset quality remains strong. Non-performing assets at September 30, 2006, totalled $8 million or 15 basis points of total assets, down from $14 million or 28 basis points a year ago. On a sequential quarter basis, non-performing assets decreased from $10 million and 19 basis points as of June 30, 2006.

The decrease in non-performing assets during the current quarter reflects the full payoff on a commercial real estate loan of $1.9 million. 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 $2.8 million at September 30, 2006, compared to $10.2 million a year ago and $1.5 million as of June 30, 2006. Net loan charge-offs were $603,000 in the current quarter compared to net loan recoveries of 88,000 in the year ago period and net loan charge-offs of 667,000 in the second quarter of 2006.

The launch for loan and lease losses was 1.40% of total loans and leases, and is reflected of our solid asset quality ratios and the continued economic strength in our markets. Shareholders equity at September 30. 2006, increased to $722.9 million, or a tangible equity ratio of 7.76%. The outlook for 2006 is as follows. Our net interest income growth will be driven by expected loan growth of 7% to 9%, deposit growth of 4% to 6%, and a stabilized net interest margin in the range of 4.5% to 4.6%. Balance sheet sensitivity due to an inverted to flat yield curve is expected to be offset by strong loan growth in the fourth quarter. Asset quality is expected to remain strong.

So based on current economic and business conditions, management is forecasting diluted earnings per share for 2006 in the range of $2.62 to $2.67, excluding the retirement expenses for a former senior executive recorded in the first quarter of 2006 diluted earnings per share for 2006 is forecasted in the range of $2.66 to $2.71 or 7% to 9% over diluted operating earnings per share for 2005. This concludes the discussion on Central Pacific Financial's financial results for the third quarter of 2006 and I'll now turn the call back over to Clint.

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

(OPERATOR INSTRUCTIONS) And we'll go to our first question, this is Brett Rabatin, I believe it is, FTN Midwest. Please go ahead.

Hey Clint, hi Dean, how are you guys doing?

Good Brett.

Couple questions for you, first off, if you could just give us some additional color on the yields for the quarter, I notice the loan portfolio yields were up 36 basis points. One is were there any prepayment penalties in that increase? And then secondly on the securities portfolio, it was down about 17 basis points, if you could just talk about the securities portfolio activity during the third quarter and where you saw that portfolio in the next quarter or two.

Brett, in response to your first question with regards to any additional items relating to prepayment fees, there was a small amount, but that was -- but nothing of significance that would affect -- have a significant impact on the margin.

And then secondly, on the portfolio, the duration continues to be at 3.1 years as compared to 3.3 years as of the end of the second quarter, and again, we expect it to stabilize around 3 years going-forward. So no significant changes in the composition of our investment securities portfolio.

Okay. And then if I read your -- if I read your commentary correctly on the margin, it sounds like you expect that you'll have an increase in loan concentration relative to earning assets to offset conditional pressure on funding costs in the next quarter or two, so the margin will be stabilized as a result of that. Is that a fair assessment?

Yes, that's a fair assessment.

Are you seeing on the on the exceptional account, I noticed that the in the period DDA was lower as you mentioned, but the money market is higher. Are you seeing some cannibalization or movement to the exceptional account from the non-interest bearing, are you seeing cannibalization in general towards your flagship product?

With respect to the decrease that we saw on our non-interest bearing accounts, 40 million of that was again in retail DDAs that due to again, consolidation of our existing deposit products, those customers were moved into an interest bearing DDA account. So that accounted for about 40 million there. As far as cannibalization, we have not seen any significant cannibalization as a result of the growth in our exceptional account.

Okay. And then this lastly on the mortgage banking, the commentary in the press release about the 20% lower trends in the third quarter and that kind of being the run rate going-forward, can you talk about that trend in 3Q, were there any changes in personnel, just what's going on in Hawaii home loans, I realize in Kauai some of the speculators are out? But just any additional on the 20% decrease would be -- would be good if you had any.

This is Blenn Fujimoto, Vice Chairman Hawaii Market, I'll answer that question. The mortgage market, we do anticipate it, like you mentioned, the run rate to be lower in terms of what's happening in the third quarter. There has been some reduction in personnel as a result of the lower volume, which improved the profitability of that unit.

We do anticipate for next year the mortgage markets changing in the sense of while we expect the run rate to be lower, there'll be some volatility, because much of our mortgage volume is based on projects going-forward, and those projects will be completing some time next year, so you'll see some spikes in it, so it may not be a real level volume, but we have to speak to volume overall to the -- at the run rate that we're currently experiencing the third quarter.

This is Dean again. So as far as originations, we're forecasting about $60 million a month and in terms of the mortgage banking income, $1.2 to $1.4 million on a quarterly basis. So this is a decrease from the $1.8 to $2 million that we had forecasted in the second quarter earnings call.

All right. Okay, thank you very much, gentlemen.

Thank you, our next question goes to Joe Morford at RBC Capital Markets. Please go ahead.

Thanks. Good afternoon guys. I guess, Clint, a question you referenced in your commentary about possible acquisition in California, and, I guess the comments last quarter suggested maybe something was imminent. I just wondered, did something fall through? And just in general, what are the types of things, what's the type of company you'd be looking to buy here?

Okay. In answer to part of your question, nothing fell through. This has been something that -- a strategy that we've been contemplating for a while. We did have recently a strategic planning session with our board and agreed that we would start looking at specific opportunities that are out there. And we're finding in the current marketplace, that it's going to in all likelihood require us to take a little longer look at that market.

We want to see where multiples on banks go, we want to see, ultimately, where the housing real estate market in California goes. So we're just taking a more measured look. Two things for certain. It has to be accretive. And we have found that that 's been a little bit of a challenge on the front end. And that's an absolute requirement for us. We will not take anything that looks like it's -- that will be dilutive to our financial performance. And equally as importantly, it's got to be a cultural fit. And we found that there are a few challenges out there in that regard as well.

So, we're just taking a very deliberate effort. We know we have to go there, and for many reasons, funding is one of them but we also -- I think the California economy would give us an opportunity to diversify our concentrations a bit in our loan segment and we also believe in -- that that's a very, very appealing market on a long term basis and it gives us some good diversification from our activities here in Hawaii.

And you have a loan production offices up in the Northwest as well. Are you considering deals up there at all?

No, we're not at this time. But we have two loan production offices up there.

Okay. The second question is separate is probably for Dean. I was just -- you referenced the decline in expenses this quarter was primarily due to professional service, professional legal fees. I was just -- any color on what's driving that and more importantly, what's -- what can we expect in that line item going-forward?

The second quarter included some professional fees in connection with a consultant that we're using to take a look at our overall non-interest income but specifically in the fee area, I wouldn't expect we won't have that charge going forward. But that was the primary reason for the decrease between the second and third quarter.

Okay. So this is a good run rate then to build off of?

Yes.

Okay. Great, thanks.

And we'll go next to Brent Christ at Fox-Pitts. Please go ahead.

Good morning, guys.

Good morning, Brett.

A couple quick questions. First in terms of talking about the deal and wanting any potential transaction that you might consider to be accretive, what time frame are you talking about accretion over and would you be willing to take on any kind of near term dilution?

No, we wouldn't. We wouldn't be willing to take on any near term dilution. It has to be accretive from the outset.

Okay. Okay. Next question, on the mortgage business, you mentioned paring back a little bit in terms of head count there and I was just wondering maybe how many people that number's gone from, and to and if there's a little bit more on the expense side that you might be able to take out given the more cautious revenue projections?

This is Blenn Fujimoto, I'll answer that question. We basically cut back approximately 10% of the staff in the mortgage area. Basically, representing back office support staff for that operation.

Okay. Is there additional leverage there to cut down the cost base a little bit?

In the future if the volumes continue to decline, yes, we would look at that.

Okay. Then last question. It looks like your provision was a little bit less than charge-offs for the second quarter in a row. Talk about your comfort with reserve levels and do you think that that can come down a little bit from here?

As far as the launch ratio and the decrease in the overall provision, again that was again reflective of the improvement in the asset quality. And assuming that our asset quality trends continue, we would expect that the allowance ratio could trend down going-forward.

Okay. Great. Thanks a lot.

(OPERATOR INSTRUCTIONS) We'll go next to Fred Cannon at KBW Investments. Please go ahead.

Thanks and good morning. I'm glad to hear that everything's okay after the earthquake over there.

Yes. Just got bounced around a little, that's all.

I was wondering if we could get some more color on the loan growth. In particular, the construction activity that you're involved in. I believe you cited in the press release that about three quarters of the growth has come from the mainland.

And in particular, you cited, I think in the comments earlier, that a lot of the growth is coming in construction portfolios. I was wondering you can kind of segment that out for us and give us some color on the amount of your growth that is in mainland construction and particularly residential versus non-residential.

Okay. Let me first just give you a breakdown geographically of our overall loan book. We have 72% of that concentrated in Hawaii, 24% in California, and 4% in the Pacific Northwest. And in terms of the percent of growth at that -- the growth by geography it's been 23% in Hawaii, 68% in California, and 9% at the Pacific Northwest. Now, construction lending is certainly one of our key areas of expertise and an area where we feel comfortable in.

And that has constituted a significant segment of the growth. Real estate construction overall is 27.2% of our overall loan portfolio. And we see that market stabilizing. It certainly slowed down as you know. We don't see it significantly dropping off from this point so we see that kind of a concentration being fairly consistent going forward.

I guess, Clint, the real question is, what -- given what some of the trends we're seeing in California in residential construction, if you could let us know the percent of the activity and the growth that's coming kind of from residential construction in California and how you're trying to position yourself there?

We have -- we also have with us Curtis Chinn, our Chief Credit Officer, who's running a lot of these balance sheet analysis programs for us and I'm going to let him address that question.

Hi, Fred, this is Curtis Chinn. With respect to your question, yes, we have had some pretty good growth in construction on the mainland. And it's split between residential and commercial. Most of the commercial is retail. In terms of the percentage breakdown since the start of the year, I don't have that figure. But more of the growth has been in residential and primarily in the inland empire, Riverside and San Bernardino counties. The category of single family, mostly entry level and or first or second move up.

We stay away from high end, we stay away from high rise condo. in terms of the commercial in retail construction, again more of that has been in the inland empire where we're seeing most of the population growth and a lot of job movement going out to that area.

Okay. Great. That's very helpful, thank you.

You're welcome.

(OPERATOR INSTRUCTIONS) And Mr. Arnoldus, we have no other questions in the queue at this time, so I'd like to turn the call back to you for any closing comments, sir.

Thank you, I'd like to thank all of you for participating today. We thank you for your interest in our Company. And we look forward to continuing at these consistent results going forward.

Thank you. That does conclude today's conference, if you would like to listen to a replay of this call, you may do so by dialing 888-203-1112 and entering access code 6228144. Again, the phone number is 888-203-1112 and access code 6228144. The replay of today's call will be available starting this evening at 6:00 p.m. Central Time and ending on Tuesday, October 31st at midnight, Central Time. Again, available from 6:00 p.m. tonight Central Time through October 3st midnight. You may now disconnect. Thank you very much.