Central Pacific Financial Corp (CPF) 2007 Q4 法說會逐字稿

Good day, and welcome to the Central Pacific Financial Corporation fourth quarter earnings call. Today as call is being recorded. This call may contain forward-looking statements concerning the 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, plans, intends, expects, anticipates forecast 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 markets we serve. The impact of legislation affecting the banking industry, the impact of competitive products, servicing and 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 it's forward-looking statements. 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.

Thanks, and thanks to all of you that have joined us today to review Central Pacific Financial Corps. financial performance for the quarter ended, December 31, 2007. I have with me here today, Dean Hirata, our Chief Financial Officer; Blenn Fujimoto, our Hawaii Market Officer; and Curtis Chinn, our Chief Risk Officer. I'll be addressing the highlights of our Company and our marketplace including steps we're taking to manage our California loan portfolio. Curtis will then discuss the Company's commercial real estate loan portfolio. And Dean will then provide a detailed financial report of our fourth quarter and year end results. And after we've completed our remarks we'll be happy to take any questions that you have.

I want to start by telling you that Central Pacific Financial Corp. is in the process of performing a Statement of Financial Accounting Standards number 142, goodwill and other intangible assets impairment test on the goodwill of its subsidiary Central Pacific Bank. This is due to inherit volatility that we're all seeing in the financial markets. I want to make clear that any potential charge related to the impairment of acquisition related goodwill would be a noncash charge reducing net income in the current period but with no impact on cash flows, tangible book value, or regulatory capital. While our analysis of goodwill is ongoing, we're committed to completing it and issuing a final release in a timely manner. Although a potential impairment charge would reduce our net income, the fundamentals of our bank remain very strong.

Let me say a few words about our fourth quarter highlights. Central Pacific Financial Corp. today reported net income for the fourth quarter 2007 of $3.5 million, or $0.12 per diluted share excluding the potential impact of any goodwill impairment charge. This is compared to $18.8 million or $0.61 per diluted share reported in the fourth quarter of 2006 and $9.1 million or $0.30 per diluted share reported in the third quarter of 2007.

As we reported in our preannouncement on January 11, 2008, the fourth quarter of 2007 results include the following items. Credit cost of $32.9 million and an after-tax loss on an investment portfolio repositioning of $1 million or $0.04 per diluted share. For the year ended December 31, 2007, CPF reported net income of $53.8 million or $1.77 per diluted share excluding the potential impact of any goodwill impairment charge compared to $79.2 million or $2.57 per diluted share reported in 2006.

As we previously announced, our fourth quarter results were negatively impacted by increased credit costs due to continued deterioration in California's housing market. In spite of the recent -- the increased credit cost, we continue to be profitable and our capital base remains strong. Compared to December 31, 2006, our total deposits increased by 4.1%, loans and leases increased by 7.7%, and total assets grew by 4.4% to $5.7 billion as of December 31, 2007.

Let me say a few words about California. Although we cannot really predict when California's housing market will stabilize, we're working to stay ahead of any further deterioration specifically in the residential construction market. We continue to take an active approach to provide additional loan loss provisions and we've added the resources we need to determine the best strategy for dealing with each problem California residential construction loan. We've hired additional senior level personnel with real estate experience to manage our California operations. We've also retained outside real estate consultants. These experts will assist our efforts to achieve positive workouts and collections on credit issues in our California loan portfolio.

In Hawaii, we're not currently experiencing the challenging market conditions faced in California. And our Hawaii commercial and residential real estate loan portfolio continues to perform. The Hawaii market also continues to provide us with attractive opportunities for growth and market share expansion. The economy in Hawaii is expected to expand moderately in 2008. Job growth and real personal income growth are both forecasted to continue. Growth in tourism, which is our state's primary industry, has slowed as a result of the slowing in the national economy and the continued weakness in Japanese visitor arrivals. The visitor industry, which saw modest declines in arrivals and sluggish spending this year, is expected to be essentially flat in 2008 before increasing in 2009.

At Central Pacific Bank we continue to expand our footprint throughout the state of Hawaii. Earlier this month we opened a new branch in Lahaina, Maui which offers the latest in banking technology. We've also made noticeable improvements to our branch network in Honolulu. We've completed the renovation of our Kalihi branch in December, expect to open a new and improved branch in Kapahulu in the coming months. We believe these improvements will provide our customers with increased convenience and will allow us to become a more visible part of the communities that we're serving. In total Central Pacific Bank currently has 39 branches across the state of Hawaii.

We're also moving forward with our community based banking strategies. This model is designed to increase our competitive posture and deposit gathering, particularly in the small business sector. In essence we decentralized our banking expertise and empowered our front line to become fully integrated within our marketplace. We'll continue to pursue opportunities to be first in market on products and services. We've done this with our flagship exceptional product, Remote Deposit Central, and our new Choice Checking product in October. These innovative initiatives provide Central Pacific Bank with a competitive advantage and an opportunity to attract new customers.

We're confident in the financial strength and outlook of our company. We know our dividend is important to our shareholders and quite frankly it's also important to us. That's why I want to underscore that we intend to maintain our dividend at current levels. In 2007 the Company's Board of Directors authorities the repurchase of up to 2.1 million shares of the Company's common stock. The Company completed the repurchase of these shares in December 2007. In January 2008 the Company's Board of Directors approved an additional stock repurchase plan in authorizing the Company to repurchase up to an additional 1.2 million shares. At this time, I'm going to turn the time over to our Chief Risk Officer, Curtis Chinn, who will discuss the Company's commercial real estate loan portfolio. Curtis.

Thank you, Clint. Good morning. At 12/31/07 Central Pacific commercial real estate portfolio totaled 2.4 billion which was evenly divided between the Hawaii market and the mainland. The credit quality of the bank's 1.2 billion Hawaii portfolio remains positive and is largely supported by the strength of the Hawaii economy. Over 60% of the portfolio consists of term loans, financing income producing properties. These loans are made to borrowers across diversified group.

At 12/31/07, our mainland portfolio totaled 1.2 billion with about 80% in the state of California and 10% in the state of Washington. Commercial construction and term financing totaled about $885 million of which $670 million is in the state of California. In aggregate, the credit quality of this segment remains favorable with less than 1% of the total classified. Our residential construction lending on the mainland totaled $323 million and includes roughly $150 million in land and acquisition development loans with the balance in vertical construction financing. California exposure represents about 95% or approximately $305 million. Loans made in the Inland Empire and the Central Valley region each total approximately $105 million.

At 12/31/07, approximately two-thirds of the bank's mainland residential construction loans were classified. This included 100%of those loans made within the Inland Empire and nearly 50% in the Central Valley region. Loans not classified in the Central Valley continued to be adequately supported by project fundamentals and sponsor liquidity. As Clint mentioned in his opening remarks, the bank is actively working to manage our residential construction loan risk on the mainland. We have hired senior level real estate managers and have retained outside real estate consulting groups to assist us with the collections and workout plan. Our plans include loan restructures, and note and/or asset sale. Strategically on the mainland our focus now on loan collections and problem resolutions. At this point I would like to turn the program over to Dean to discuss our financial results. Dean.

Thank you, Curtis. My discussion will cover the fourth quarter and full year 2007 consolidated financial highlights for Central Pacific Financial Corp. and it's subsidiaries. Fourth quarter 2007 net income was $3.5 million, excluding the potential impact of any goodwill impairment charge compared to $18.8 million for the fourth quarter of 2006 and $9.1 million for the third quarter of 2007. The decrease was primarily due to credit costs of $32.9 million in the current quarter as a result of downgrade of 24 loans totaling $201 million with exposure primarily to the California residential construction market.

On a diluted earnings per share basis net income was $0.12 for the current quarter, excluding the potential impact of any goodwill impairment charge compared to $0.61 for the fourth quarter of 2006 and $0.30 for the third quarter of 2007. Net income for 2007 excluding the potential impact of any goodwill impairment charge was $53.8 million compared to $79.2 million for 2006. The decrease was primarily due to the increased credit costs. On a diluted earnings per share basis, net income was $1.77 for 2007, excluding the potential impact of any goodwill impairment charge, compared to $2.57 for 2006.

Key performance ratios based on net income for the fourth quarter, 2007 and full year respectively were as follows. Return on assets of 25 basis points and 97 basis points. Return on tangible equity of 3.33% and 12.47%. Return on equity of 1.9% and 7.12%. An efficiency ratio of 51.44% and 47.8% and net interest margin of 4.15% and 4.33%. Total loans and leases of $4.1 billion as of December 31, 2007 grew by $296 million or 8% over December 31, 2006. On a link quarter basis, the increase was $69 million or 2% unannualized. Average loan balance is increased by 4% sequentially. The average yield on loans for the fourth quarter of 2007 was 7.35%. A decrease of 45 basis points compared to the prior year. On a link quarter basis, there was a decrease of 38 basis points. The decrease was primarily attributable to the reverse of interest related to certain nonaccrual loans totaling $1 million, lower real estate construction loans and increased competition in loan pricing.

Total deposits of $4 billion as of December 31, 2007 increased by $158 million or 4% over December 31, 2006, and increased 2% on a sequential quarter basis. We experienced growth in demand deposits of $34 million, interest bearing demand deposits of $19 million and time deposits of $45 million, partially offset by a decrease in savings and money market deposits of $38 million during the current quarter. The effective cost of interest bearing liabilities for the current quarter was 3.25%, an increase of 6 basis points over the prior year. On a link quarter basis the decrease was 17 basis points.

The net interest margin of 4.15% for the fourth quarter of 2007 decreased by 32 basis points from the same quarter last year and 14 basis points on a sequential quarter basis. The year-over-year compression in the net interest margin was primarily due to the previously-mentioned reverse of interest on nonaccrual loans and increased funding costs resulting in a shift of the composition of the deposit base into higher rate timed deposits. The sequential quarter compression was primarily due to a decrease in loan yields and the previously mentioned reversal of interest on nonaccrual loans. Excluding the effects of the reversal of interest on nonaccrual loans the net interest margin for the current quarter was 4.23%.

In December 2007, the Company executed an investment portfolio repositioning to reduce its interest rate exposure to declining market interest rates and improved it's prospective net interest income by approximately $1.7 million and net interest margin by 3 basis points. As discussed earlier in the call, the credit costs of $32.9 million, comprised of a provision for loan losses of $28.2 million and an increase to the reserve for unfunded commitments of $4.7 million for the current quarter resulted from the downgrade of 24 loans totaling $201 million.

The loans were broken out as follows. There were 13 residential construction loans, totaling $130 million, primarily in the Inland Empire and Central Valley. There were 9 land loans primarily related to residential construction projects totaling $69 million, again in the Inland Empire, and Central Valley and one land loan for mixed use development of $2 million in Washington. Due to continued market deterioration during the quarter, the collateral value that these loans have significantly declined and guaranteed liquidity has diminished. Other operating income was $11.4 million for the current quarter. An increase of 20% over the same quarter last year. The increase was primarily due to higher mortgage origination activity from Central Pacific home loans and increased income from bank owned life insurance. On a linked quarter basis other operating income was down 3% primarily due to higher income from bank owned life insurance.

Other operating expense was $35.2 million for the current quarter compared to $35.7 million in the same quarter last year and $31.6 million in the third quarter of 2007. The sequential quarter increase was primarily due to the increase in the reserve for unfunded commitments of $4.7 million and an accrual of interest related to certain tax contingency items totaling $1 million. The expected quarterly run rate is in the 31.5 [million] to $32.5 [million] range.

The effective tax rate for 2007 was 29.3% compared to 34.3% in 2006. The sequentially quarter -- the year end decrease reflects the disproportionate recognition of state and federal tax credits compared to taxable income for the current quarter and the recording of certain income tax true-up adjustments resulting in an income tax benefit of $2 million partially offset by the settlement of a tax contingency writeoff of $2.4 million. At December 31, 2007, non-performing assets totaled $61 million or 1.07% of total assets compared to $9 million or 16 basis points at December 31, 2006, and $31 million or 55 basis points at September 30, 2007.

Non-performing assets related specifically to the California residential construction sector was $58 million at December 31, 2007, or 1.01% of total assets. The sequentially quarter increase was primarily due to two land loans, one in California and one in Washington totaling $8.7 million, four residential construction loans in California, totaling $26 million that were placed on nonaccrual status. Specific reserves have been provided for all of these loans and these reserves are included in the current quarter provision discussed earlier. Loans delinquent for 90 days or more and still accruing interest totaled $0.9 million on December 31, 2007 compared to $0.9 million a year ago and $0.9 million as of September 30, 2007. Net loan chargeoffs were $8.7 million in the current quarter compared to $331,000 a year ago period.

This is the conference center. We're experiencing technical difficulty. Please stand by while we correct this. (OPERATOR INSTRUCTIONS) I'll turn the conference back over to Mr. Arnoldus. Go ahead.

I apologize. We've had some technical difficulties and we're not even sure at what point we lost our connection. Probably the best way to proceed is just to go into Q&A right now nd we'll fill you in as best we can. We just don't know where we lost you. I do apologize.

Thank you. (OPERATOR INSTRUCTIONS) We'll take our first question from Brett Rabatin with FTN Midwest.

Hi, everyone.

Hi, Brett. I don't know where you lost it.

You were talking about the credit quality and the loan portfolio and just going over some of the aspects of the California book and I really want to start with, I want to make sure I understood, I thought I heard mention that the movement into NPAs in the press release it indicates six California land loans to five borrowers for $34.7 million but then if I understood the commentary that you were talking about there was two loans in Washington for $8.7 million and then four loans in California and I missed the number. Can you guys walk me through what the right numbers are for the NPAs there.

Yes. Brett, this is Curtis.

Hey, Curtis.

The two loans in Washington aggregated $5 million.

So the rest was California?

Yes.

And were there six or four?

The total was six loans moving into NPA, two of which were Washington.

So there is four in California and two in Washington?

I'm sorry. That was one in Washington, the rest were California.

Okay. So five in California and one in Washington.

Yes. Sorry about that.

All right. So just FYI, I think you dropped off a little bit, maybe 30 seconds after discussing that. And I guess the other thing I caught right near the end was the -- you mentioned the provision in the fourth quarter included specific reserves. Can you tell me what that number was that you have set aside from provisioning in 4Q for the nonaccrual list, what your specific reserves are?

We're calculating that.

And while you're looking for that, if I also heard correctly, early in the call, you mentioned two-thirds of the residential portfolio in California, $323 million was classified, so A, is the classified total for residential then about $210 million or so, and if I understood correctly, if 100% loans in the Inland Empire are classified that would mean the Central Valley is significantly less or maybe 40% of that piece is classified. Can you walk me through how much of the total portfolio is classified and then each one of those segments?

Yes. You're right, the number is about $210 million is classified, 100% of the Inland Empire or $105 million. The Central Valley, the classified number is $48 million out of the 105, so that sounds like close -- a little less than 50%.

Okay. And so let me make sure I'm correct here. So 210 is the classified mainland. Did you give a number or did I miss it for total classified loans for the portfolio?

Total classified is 235.

235. So only about another 25 million out of the rest of the portfolio is classified.

Correct.

Okay. And maybe we can circle back offline about some of this stuff, but I -- I just not sure -- I'm just not sure if I understand, you're talking about still buying back stock in the press release, at least when you preannounced earnings and you indicated you're going to -- you have a 1.2 million shares to repurchase and I realize your capital levels are not constricted currently, but with about 5% of the total portfolio or a little more than that classified, I'm not sure if I understand the reasoning behind continuing to buy back stock. Can you walk me through the decision process there and how you're looking at capital?

Brett, this is Dean. Again, just starting with the 1.2 million shares. There's strictly an authorization. And again, we are looking to preserve capital as we discuss, due to the uncertainty in the overall market conditions in the California housing market. But at the same time, we do have a buyback program in place. But again, our focus is on preserving capital. And again, that authorization is just what's in place. We do not anticipate buying back shares at the levels that we have been buying it back though, than what we did in the fourth quarter. Again it's strictly an authorization, just to give us the ability to buyback shares. Because, again, we do have confidence in the outlook.

Okay. And then did you guys calculate a number for the specific reserves?

Yes. Brett. That was about $12 million, specific reserves.

Okay. Great. Thank you for all of the color.

Our next question comes from Joe Morford with RBC Capital Markets.

Thanks. Good afternoon, everyone.

Hi, Joe.

I guess first just following up on Brett's question, clarify a bit further. The five land loans in California that came in, are they all Inland Empire, were some in the Central Valley or what kind of geographic representation do you have there?

Hang on one second.

Okay. And maybe while you're looking for that, the other question on the credit was the $2 million C&I charge-off in Hawaii, if you could just give us a little color on that. Was it real estate related business or just kind of a one off on something?

For the C&I.

For the C&I chargeoff. Was it real estate related or?

No.

Okay.

I'm sorry, Joe your first question again?

I was curious. Five land loans that came into NPA from California in the fourth quarter, where in California? Was it Inland Empire, was it Central Valley or was it kind of a mix?

It was mixed.

Okay. And then the last question is just can you tell us a bit more about the people you've hired to kind of help you work out this portfolio, where they've come from and kind of specifically how they're tasked to work this out. To downsize this portfolio, are you now more willing to consider short sales or bulk sales, how are you going to go about this going forward?

Well, in terms of the additional people we've hired, we've brought in one gentleman who is a former Chief Credit Officer, actually two who are former Chief Credit Officers, both community banks as well as large banks in Southern California and other states in the Western region. We've also brought in someone with a fairly expensive work out background in Southern California in real estate. In terms of the specific strategy, as I mentioned, we are looking at restructuring and refinancing where it makes sense. We would look at loan sales and asset sales. We would consider on an individual basis, and we may also look at both but we're evaluating our options at this point.

Joe, I would add to those people that we brought in, three of them I have worked with earlier in my career and the real estate market that was also in trouble in the late '80s, early '90s, so I've seen them function and know the quality of work they can do so they're a significant addition to us to bring further insight into what we need to do in California.

Okay. That's great. Thanks for the help.

Next we'll go to Brent Christ with Fox-Pitt.

Good morning, guys.

Hi, Brent.

To the extent you're considering any loan sales or bulk asset sales, what type of haircuts are you seeing out there in the marketplace in terms of what people are willing to pay for some of these properties?

That range is pretty broad.

I guess, on the low end, in terms of a deeper haircut?

It depends on if you're looking at individual sales or bulk sales.

I guess--.

On a bulk sale, we saw, I mean it's 20 to 40% on the $1. $0.20 to $0.40 on the $1. But we wouldn't be doing anything at that level, but that's kind of an indicator we got on a bulk sale.

We were able to consummate one sale in the fourth quarter on that transaction. We received $0.875 on the $1.

That's helpful. And then a couple of other quick questions. In terms of the goodwill process, could you talk a little bit about the timing from your perspective when you think that may be complete and the factors that you're incorporating into the analysis?

Just to give you some background on the goodwill, the goodwill was created at the time of the merger between Central Pacific Bank and Citibank going back to the fourth quarter of 2004. Again, which represented the excess of the purchase price of the book value of Citibank at that time. We're not in the process of doing a fair evaluation of the Company to determine if in fact the goodwill is impaired and we expect the analysis to take approximately two to three weeks.

Okay. And we'd have some type of announcement at that point should there be an impairment?

Yes.

Got you. Okay. And then just lastly, in light of the recent moves by the Fed, how are you guys thinking about your net interest margin going forward and your ability to pass along some of the lower rates in the form of lower deposit costs?

The overall decline in the interest rate environment, it will have a slight negative impact during net interest margin as our assets do initially reprice faster than our liabilities. One of the things we did in January of this year is that we did enter into a prime swap, about $400 million where we are receiving fixed and paying floating, and again this is to reduce just our overall asset sensitivity to that part of the portfolio. In addition, we will look at lowering rates where we can on certain of our deposit products.

And what was the rate on that swap?

We're receiving 6.25% fixed for 5 years and paying prime floating.

Got you. Okay. Thanks.

(OPERATOR INSTRUCTIONS) We do have a question from Fred Cannon with KBW.

Thanks. Just a couple of follow-ups. I wanted to -- on the potential goodwill impairment, is the issue primarily because the West Coast loan production offices were part of CBBI and there was associated goodwill and is that what would be driving a potential writedown?

The analysis has really been driven by the fact that our market cap is below the book value.

Oh,.

And as part of that, the test for impairment, there is a step one and step two and the fact that the market cap is below book value then requires us to move to step two which is the fair valuation that we're now in the process of completing.

So you have to do a new fair valuation of the CBVI goodwill; is that right.

Yes.

Secondly, if you could just -- maybe Clint could address the overall West Coast strategy at this point in time. Kind of two parts, one is that the construction portfolio you're putting into a runoff mode it appears, what about the -- I guess that's -- and I wanted to make -- find out if that was just the West Coast construction or the entire West Coast loan outstandings that are being put in this runoff mode? And secondly, how you plan to kind of strategically move forward on the West Coast following this kind of workout time period?

Well, the runoff is in the residential construction in California. We're trying to come up with the best alternative that we can to get that off of our books and so that's an ongoing process and this real estate consulting firm that we mentioned in our comments is going to play an integral part on that and in fact we have a call with them with our first pass tomorrow so that's -- as I say, that's an ongoing process but that's something that is certainly in our short-term goals with that portfolio. In terms of going forward, we continue to believe that California plays an important role in our future. I think the question is in what format. And the timing of getting into that format. So that's something we are meeting with our Board of Directors about this month and so we'll be able to answer that in more detail on the next quarterly call.

And at this point, Clint, you remain committed to the loan production offices or you're looking strategically at various alternatives?

We're looking strategically at various alternatives.

Thanks very much.

You bet.

And gentlemen there appears there are no further questions in the queue.

Okay. I don't know how big of of an audience I'm speaking to at this point. I know we had some problems but those of you still on, I want to thank you for participating in our call. A couple of things I would just like to reiterate in conclusion. Central Pacific Financial Corporation is very well capitalized and fundamentally solid and we're prepared for some of the challenges that have -- we've encountered in California. Going forward in 2008, we're going to continue to actively manage our exposure in that California market. But the Hawaii market is healthy. We're going to continue to create and execute innovative deposit gathering strategies and we're going to continue to work hard to expand our footprint in the communities that we live and work in and we believe here in this Company, our employees are the best in the state and I'm confident that we'll be able to work successfully together to do what is best for our customers and our shareholders and our communities. Thank you, again, for your interest in our Company.

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 4155913. Again, that phone number is 888-203-1112 and access code 4155913. The replay of today's call will be available starting this evening at 6:00 p.m. Central time and ending on Thursday, February 7, 2008, at midnight Central time. You may now disconnect. Thank you.

Thank you.