Central Pacific Financial Corp (CPF) 2022 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. And welcome to the Central Pacific Financial Corp. Second Quarter 2022 Conference Call. (Operator Instructions) This call is being recorded and will be available for replay shortly after its completion on the company's website at www.cpb.bank.

I'd like to turn the call over to Mr. David Morimoto, Senior Executive Vice President, Chief Financial Officer. Please go ahead.

Thank you, Jo. And thank you all for joining us as we review the financial results of the second quarter of 2022 for Central Pacific Financial Corp. With me this morning are Paul Yonamine, Chairman and Chief Executive Officer; Catherine Ngo, Executive Vice Chair; Arnold Martines, President and Chief Operating Officer; and Anna Hu, Executive Vice President and Chief Credit Officer.

We have prepared a supplemental slide presentation that provides additional details on our release and is available in the Investor Relations section of our website at cpb.bank. During the course of today's call, management may make forward-looking statements. While we believe these statements are based on reasonable assumptions, they involve risks that may cause actual results to differ materially from those projected. For a complete discussion of the risks related to our forward-looking statements, please refer to Slide 2 of our presentation.

And now I'll turn the call over to our Chairman and CEO, Paul Yonamine.

Thank you, David, and good morning, everyone. And as always, we appreciate your interest in Central Pacific Financial Corp. I'll start this morning with an update on the Hawaii market and then turn it over to the team to share our strong second quarter financial results as well as other key updates. The Hawaii economy has successfully recovered from the pandemic and has an excellent outlook despite national economic sentiments declining recently.

It is important to note that the Hawaii market is highly unique and has historically proven to be resilient during periods of national economic stress. The Hawaii economy is robust, and we believe will continue to perform well despite what happens in the broader Mainland economy.

Starting with the tourism sector month-to-date July 2022 average air arrival counts are exceeding 90% of pre-pandemic levels from 2019, even with significantly fewer international flights. It is projected that Japanese arrivals will continue to rise over the rest of this year and next. Visitor spending is strong with $1.56 billion total for the month of May, which was an increase of 10.6% compared to the same month in 2019.

Hotel performance continues to improve with total statewide hotel occupancy at 74% and an average daily rate of $340 in May. Hawaii's employment and housing metrics are solid as well. Our statewide unemployment rate was at 4.3% in June 2022 and is forecasted by the University of Hawaii Economic Research Organization to fall to 2.9% in 2023.

The housing market in Hawaii remains very strong with the Oahu median single-family home price at $1.1 million in June 2022, which is up 12% from the previous year. Other factors contributing to a favorable Hawaii economic outlook include a significant increase expected in Department of Defense military spending, which is already the second largest sector of Hawaii's economy with $7.7 billion in annual spending in 2020. Additionally, Honolulu's $9 billion-plus rail construction project continues to move forward with construction of the first phase completed and expected to be operational by year-end. Finally, $600 million in state funding was recently awarded for native Hawaiian housing, which will lead to significant home construction over the next 5 years.

Lastly, with the possibility of a national economic recession increasing, it is important to note that the Hawaii economy weathered the great financial recession better than most states. Hawaii's single-family median home price fell 11% between 2008 and 2011 compared to a 24% decline nationally. Additionally, Hawaii's unemployment rate peaked at 7% in 2009, whereas nationally it rose to 10% during the same time period. With Hawaii's continued strength, we anticipate Hawaii will again outperform the rest of the nation during this cycle.

Now I'll turn it over to Catherine, our Executive Vice Chair, to provide additional updates on our company. Catherine?

Thank you, Paul. Following on to Paul's remarks, with Hawaii's economic strength and our solid balance sheet, we believe Central Pacific is well-positioned for potential economic downturn. Our asset quality continues to be very strong with nonperforming assets to total assets remaining at 7 basis points as of June 30. Additionally, total criticized loans were less than 2% of total loans.

Our net charge-offs remained low at $1 million for the second quarter. Another key point to note is that our loan portfolio today is much more diversified across product lines and industries compared to our portfolio prior to the Great Recession. Additionally, our construction portfolio was nearly 30% of total loans in 2008 compared to just 3% of total loans today. We have maintained solid risk management discipline and are committed to supporting our clients and community.

Next, I'd like to share the really great news that was announced last month. We were pleased and honored to be named the #1 best bank in Hawaii by Forbes for 2022. The ratings were based on an independent survey of consumer satisfaction in the areas of digital and branch service, overall customer service and trust in our institution. Just 2.7% of all banks in the nation made the list for best-in-state rankings. This recognition is a reflection of the hard work that our team of dedicated employees perform each and every day to serve our customer and community needs.

I'd like now to turn the call over to Arnold Martines, our President and Chief Operating Officer. Arnold?

Thank you, Catherine. In the second quarter, through our successful business development efforts, our total loan portfolio increased by $127 million or 2.5% sequential quarter and 10% on an annualized basis. The growth was broad-based across most loan types, except for the C&I portfolio, which included decreases in PPP loans as that portfolio continues to wind down. We were successful in continuing to grow our residential mortgage and home equity portfolios by nearly $40 million during the quarter despite the rising rate environment due to our strength in the purchase market and key relationships with our real estate joint venture companies.

During the second quarter, we continued our Mainland diversification strategy with purchases of select consumer unsecured and auto portfolios from our established partners. The purchases during the quarter were all within our established credit criteria and had a weighted average FICO score of 735.

Our net growth in Mainland consumer purchase loans was $46 million in the second quarter. As of June 30, total Mainland consumer unsecured and auto purchase loans were approximately 7% of total loans. We also continue to selectively participate in Mainland commercial real estate or C&I loans. Our teams are focused on specific Mainland markets, primarily on the West Coast, where we have built considerable experience and expertise.

We believe these opportunities complement our Hawaii franchise nicely as it provides diversification and typically higher yields while fitting within our risk guidelines. We continue to target our total Mainland loan portfolio at approximately 15% of total loans. We have a healthy loan pipeline and with our strong sales management discipline and outstanding team of relationship managers, we are expecting our positive loan growth trend to continue throughout the remainder of 2022.

During the second quarter, core deposits grew $35 million or 0.6% from the prior quarter. Additionally, our average cost of total deposits in the second quarter held steady at just 6 basis points. Finally, Japan continues to be a key strategic focus area for us, given our strong relationships there. Via we started travel to Japan for business development and we'll continue to visit regularly.

Our Japan marketing efforts are doing well with our new Japanese website driving a significant increase in views and soon we will be launching our online banking service in Japanese to further attract Japan customers to our bank. Our initiatives are driving success with an increase in our deposits from the Japan market as well as a solid pipeline of opportunities.

I'll now turn the call over to David Morimoto, our Chief Financial Officer. David?

Thank you, Arnold. During the second quarter, we were able to successfully execute on a number of initiatives that positively impact shareholder value, including terminating and settling our defined benefit pension plan, which resulted in a onetime settlement charge of $4.9 million. Following the settlement, the company has no further defined benefit pension plan liability or ongoing pension expense recognition, which will save us about $700,000 annually.

Also, during the second quarter, we sold all of our VISA Class B shares for a gain on sale of $8.5 billion. On the branch and real estate front, we consolidated 2 of our smaller branches into nearby locations, bringing our total branch count as of June 30 to 28 branches. Another branch is scheduled to be consolidated into a nearby location in the third quarter.

We are also implementing other efficiency initiatives using technology and workflow automation that will allow us to scale our business while driving positive operating leverage. Finally, our Banking-as-a-Service FinTech strategy continues to progress well, and we are on track for the Swell at public launch later this quarter. We look forward to providing additional updates in the near future.

Turning now to our financial results. Net income for the second quarter was $17.6 million or $0.64 per diluted share. Return on average assets was 0.96%, and return on average equity was 14.93%. The efficiency ratio was 64.7% in the second quarter. Net interest income for the second quarter was $53 million, which increased by $2 million from the prior quarter, primarily due to an increase in loan balances and yields.

The net interest margin increased to 3.05% compared to 2.97% in the prior quarter. Normalizing for the impact of PPP in both quarters net interest income increased by $3 million and the net interest margin increased 13 basis points sequential quarter.

With our asset-sensitive balance sheet, we are starting to see the favorable impact of the rising rate environment. We anticipate that our margin will trend up further in the second half of this year as loan yields rise and we manage our deposit pricing, which has historically had low beta re-pricing.

Second quarter other operating income was $17.1 million and included a onetime gain on sale of our VISA Class B shares. During the quarter, there was also a loss of bank-owned life insurance due to significant market volatility during the quarter. We have certain company-owned life insurance policies used to hedge our deferred compensation plans, therefore we also had an offsetting negative deferred compensation expense and other operating expenses.

Other operating expense for the second quarter was $45.3 million, which included the onetime settlement charge on our defined benefit pension plan. Our other operating expense lines trended back up slightly after being seasonally low in the first quarter. Going forward, we expect that quarterly recurring total other operating expense will be in the $41 million to $43 million range.

At June 30, our allowance for credit losses was $65.2 million or 1.23% of outstanding loans. In the second quarter, we recorded a $1 million provision for credit losses due to loan portfolio growth and net charge-offs. The effective tax rate increased slightly to 26% in the second quarter as a result of less tax only income. Going forward, we expect the effective tax rate to be in the 25% to 26% range.

Our capital position remained strong. And during the second quarter, we repurchased 174,000 shares at a total cost of $4.2 million or an average cost per share of $24.18. Additionally, our Board of Directors declared a quarterly cash dividend of $0.26 per share, which will be payable on September 15 to shareholders of record on August 31.

And now I'll return the call to Paul.

Thank you, David. To conclude, Central Pacific had another solid quarter and continues to be well positioned in all key areas, including liquidity, sensitivity, capital and asset quality. The environment continues to evolve rapidly, but with our asset-sensitive balance sheet, high-quality loan and investment portfolio as well as our strong capital base we expect to continue to deliver strong performance. We have a differentiated strategy that will enable us to expand and diversify our franchise, making us a leader in our market.

On behalf of our management team and employees, I'd like to personally thank you for your continued support and confidence in our organization. At this time, we'll be happy to address any questions you may have. Thank you. Back to you, Jo.

(Operator Instructions) So our first question comes from David Feaster from Raymond James.

I just wanted to start on deposits. It's great to see the continued noninterest-bearing growth. Just curious, any commentary you might have on the deposit front and trends you're seeing, whether you're starting to see some more rate pressures? Obviously, I mean, the Hawaiian economy tends to be much more rational. And then just any commentary on how you think about your ability to continue to drive core deposit growth and fund your loan growth with core deposits?

And now I'll have David Morimoto chime in as well. But we're very focused on making sure that we maintain our low-cost deposit base. We're going to really stay focused on our digital offering and we're hoping that a lot of our business development trips to Japan and trying to get more Japanese corporate and individual depositors here, which will naturally be low cost. These are 2 key strategies for us right now. We're not taking the higher-cost government deposit route just yet. We -- I think we have a very robust deposit pipeline.

Yes. And David, maybe I'll just add. The loan-to-deposit ratio is still at an attractive 80%. So we do have room to continue to grow loans while managing our deposit costs. In the first half of the year, we saw some good opportunities for loan growth, and we took advantage of that. And that's what you saw with loan growth outpacing deposit growth. We believe the -- as Paul mentioned, we believe there's some great opportunities to grow core deposits through our digital strategies in Hawaii, on the Mainland and in Japan.

Okay. That makes sense. And then touching on the organic growth outlook. Could you maybe just touch a bit on demand. You talked about some of the economic trends in Hawaii, but just curious where you're seeing the most opportunities? How pipelines are trending, whether this quarter maybe saw some pull forward of demand just given rising rates? And then just any thoughts gain a growth outlook and the appetite to continue to supplement organic growth with pool purchases looking forward?

We're pretty optimistic about loan growth going into the second half of the year. Our pipeline is fairly robust, particularly we're seeing, you know continue to see a lot of activity in the commercial real estate area as well as resi, although we've seen somewhat of a drying up of the refi activity, we still see a nice pipeline in the purchase segment of resi. And we will continue to work with our established partners on the mainland on the consumer front, particularly in the auto category. So our expectation for the second half of the year is really -- we feel very good about it. Pipeline looks really, really healthy.

Okay. That makes sense. And then just switching gears to the expenses. I appreciate the third quarter guidance. Could you maybe just walk through some of the puts and takes with what's driving expense growth and where you're expecting growth. Obviously, there's a lot of investments, also inflationary pressures. Just I was hoping you might be able to walk us through some of the drivers and how much of the growth might be from Swell as that launch is approaching here at the end of the third quarter?

Again, the first quarter was seasonally low. We did see some slight uptick in other operating expenses in the second quarter. And again, we're guiding to roughly $41 million to $43 million per quarter for the next several quarters, and that the reason it slightly higher that guided slightly higher than the normalized second quarter is a result of deferred comp. So again, the deferred comp plan had a rough second quarter, and that was -- so deferred comp expense was lower than normal, and that was also reflected in the BOLI income and the other operating income section. So again, overall, we're guiding to roughly 41% to 43%. I think if you take it for the full year, it's going to be roughly 2% to 3% over 2021 is what we've been consistently guiding towards.

David, this is Paul. Let me just add to that. Now again, on the Swell investment, we are accounting for our investment under the cost method of accounting. We -- our equity stake is 19.9%. Our voting share position is 4.9%. So even if there were unexpected losses within the Swell organization, we will not be picking that up on our income statement. That's one thing on Swell. Just another thing to add to what David mentioned is that we've been very pleased with our ability on cost control. And I think it shows the most on our head count right now. We are at a very low head count level from say the past 4 years or so. And so we've had a lot of rigor in making sure that despite inflationary pressures that we stay on cost control.

Our next question comes from Andrew Liesch from Piper Sandler.

David, this question on the securities portfolio, was there any migration from AFS, how the maturity this quarter?

Yes. Andrew, we did move $330 million from AFS to HTM in the first quarter. And then you are correct, in the second quarter, we moved an additional $400 million. I think it was done in early May. So today, we're roughly -- I think today, we're roughly about 57% AFS, 43% HTM.

Okay. And then how should we look at the size of the securities portfolio going forward? It sounds like you've got some pretty good opportunities for both loan and deposit growth. So do you think it's going to stay around this size right here? Just kind of trying to get a handle on the balance sheet makeup right now.

Yes. Yes. Again, the investment portfolio is kind of the offset, right? It's the reserve of liquidity. So it's going to be a function of what we see with net loan and net deposit growth on a quarterly basis. Depending on what we see on those 2 fronts will increase or decrease the investment portfolio accordingly.

Got you. All right. That's helpful. And then with the deposit beta staying low and the improvement in loan yields that you're seeing, would it be reasonable to expect another 13 basis point increase in the margin this quarter, just given that we had a 75 basis point rate hike last month and I think they're looking like that for today as well?

Yes, Andrew, again, obviously, a lot of things in play, but with the June 75 and the additional 75 likely today, we are guiding to a similar sequential quarter increase in the core NIM, so plus 10 to 15 basis points sequential quarter.

Got it. Makes sense. Is there any pressure on deposit costs that you guys have seen?

We obviously saw -- did not see it in the second quarter. We were able to total deposit rates flat. With the 75 basis points in June and the additional 75 in July, we are starting to see some movement in deposit rates, deposit costs, which is expected. But again, we think we have quite a bit of room with total deposit costs at 6 basis points.

(Operator Instructions) Our next question comes from Laurie Hunsicker from Compass Point.

I was hoping to go back to just some comments you made in your prepared remarks. And Arnold, I think you were speaking. I just want to make sure I heard this right. You plan to have 15% of your loan book in Mainland loans, is that correct?

No. So it's been consistent throughout the quarters in the past. We target around 15% of Mainland to total loans. So -- and that's a combination of consumer CRE and SNCs. So that's our target, 15% of total loans on the Mainland.

Okay. Great. And maybe you can talk about that because I know your Mainland auto was running about 2%. Your Mainland unsecured was about 4% of loans and then your Mainland SNC was like 2% or 3%. So maybe I'm missing a (inaudible) or perhaps can you refresh us on what those actual balances are? Maybe starting with the SNC, what's Hawaii, what's Mainland? And I don't know if it's for you or for Anna or David, but if you can just help us maybe on some of those balances and then same thing? Yes, go ahead.

No, so Laurie, yes, I think Anna can help with that information for you. Anna?

Okay. So Laurie, yes, this is Anna. Starting with, I guess, your question on Mainland's mix. Our total Mainland mix is running about $184 million.

Okay. And then do you have Hawaii...

Oh, yes. For the Hawaii's mix, it's about $77 million.

$77 million, right. And then...

So our total -- yes. Okay. Go ahead. Are they going to...

Then I was going to say on the...

Total consumer. Okay, going to commercial real estate. Yes. Our total commercial real estate on the Mainland is about $309 million. So that represents about just under 6% of our total loan portfolio.

Got it. And then your consumer Mainland...

Consumer Mainland is $378 million.

Okay. And -- sorry, and what piece of that is auto versus Mainland unsecured?

Okay. So Mainland auto is $126 million. And then Mainland unsecured is $252 million.

$252 million. Okay. And then just more broadly, when you think about areas that you're going to focus on growth in terms of that target, that 15% target, is it across the board you're going to be taking it up at sort of a closed rate? Or how do you think about that?

You're referring to how the percentages will change to the total portfolio, Laurie?

Correct. Yes. I think...

Okay. Yes. So I'd say that it's going to stay fairly around the percentages that we have today. It's pretty much stayed around there in the past as well. We try to manage between the 3 product categories and ensure that we maintain kind of the same amounts of exposures.

Got it. Got it. And then just thing on loans, can you just give us a refresh in terms of where you are on office exposure, what that total looks like? Any color you can give us around office, also office Mainland versus office Hawaii? And then same question I guess on leverage loans and I just that leverage loans where you are on that?

Okay. Sure. This is Anna, Laurie. So for office, on our total commercial mortgage book, it's running about $189 million. So that represents about 15% of that commercial mortgage book and about 3.6% of our total portfolio. So the weighted average LTV on that entire book is 57%. And then breaking it down...

And then how much...

Yes.

Yes, Please go ahead.

Okay. I was going to break it down into Hawaii and Mainland for you. So for office, the Hawaii portion is a $110 million, and that represents about 8% of our total book. Our total commercial mortgage book I should say, and then about 2.1% of our total loans with a weighted average LTV of 62%.

And then going up to Mainland then the balance is $79 million. And that's about 6% of our total commercial mortgage book, 1.5% of our total loans with a weighted average LTV of 49%.

Okay. And then on the leveraged loan side, do you have a refresh on that?

Sure. On our leveraged loans, it's relatively small. It's about $30 billion as of June 30. That represents about 0.6% of our total loan book.

Maybe just -- that's super helpful. And maybe just circling back on the Swell Elevate as you think to start this, and I guess, Paul, this is more a question for you. I know that was target a 650 average FICO as we've seen some banks pull back from this type of lending. Is there any plans to sort of tweak that? And I definitely appreciate that you're going to start small, hold it and watch it.

But is there any thought about moving up the FICO chain as you start this? Or are you still thinking about the same, you would be targeting an average 650 FICO? How do you think about that?

Yes. Thanks, Laurie. I may have been remiss in not commenting on this in the past, but I am on the Swell board by the way. And so I'm very proactive in all of the discussions at the Swell level. And naturally, Anna Hu, who's here today, was instrumental in creating their credit policy. And I am as a Board member and also as a bank sponsor, we will make sure that there is adherence to our credit policy. And so that might be a little bit different what some of the other FinTech companies out there in their relationship with the banks.

And thanks for bringing up that point on FICO scores because our plan over the next 2 to 3 quarters is to limit our exposure at about $8 million. And as we've said all along, we're going to start small. We're going to take a look at KPI dashboard on a daily basis and make sure that we iterate, we pivot and we can very well adjust FICO scores or any other criteria as we see fit, especially if it starts to exceed 6% default rate where Elevate is essentially giving us a preferred security interest and a deposit that will be made to CPB.

So we're protected on defaults to 6%, and we'll manage it accordingly. So if at any time we see those defaults exceeding 6%, we're going to pivot on a lot of our lending criteria. Does that make sense?

Okay. And so you're still the -- I mean, yes, it does make sense, and definitely, I hear you, but I think also, I remain concerned Elevate has a market cap of $60 million. And so I guess it does beg a bigger question of if it stays within those parameters and then you grow it, I mean, I guess just circling back to FICO, the 650 FICO, is that still unchanged in terms of your average target? Or have you moved the needle at all on that?

Yes. And that's not really the target per se, but that's a minimum threshold that we plan to start off the process, again, to really start small and iterate. And if that 650 starts -- we start to see a lot of defaults, Laurie, obviously, we're going to ratchet it up, and we have all of the authority and ability to do so. I think the key is going to be around execution.

And this is where myself on the Board taking a look at the KPI dashboard on a daily basis and really our ability to execute. I think in the last 4 years and this sounds rather self-fulfilling. But whether it be RISE2020 or the guidance we've been giving to the street or PPP loans, we've executed, and this is not going to be any different. We, as a management team, will make sure that we're not going to be betting our franchise on some disaster out in the Mainland on going with consumer unsecured. So you have our assurance on that.

Okay. Okay. David, maybe just last question, if we could go back to expenses. I just want to make sure that I understand this. So you had 2 branches, obviously, that closed in the quarter. Were there onetime branch closure cost in that number in that other expense number? And if so what were they or maybe they were in occupancy, I'm not sure?

Yes. Laurie, there was onetime branch closure expenses of about $300,000 in the second quarter.

Of about $300,000. Okay. So I guess -- so if I'm netting out your defined benefit, I'm netting out the branch closures, I mean, we're basically at $40 million on a quarterly run rate, which is pretty substantially below your guide of $41 million to $43 million. So can you help us think a little bit -- and I realize somebody already touched on this in their Q&A too. But can you just help us think about where you're actually spending money, especially as you've got another branch that's consolidating in 3Q is where is that then coming from? Or how we should be thinking about that in terms of our line items?

Yes, in that guide, Laurie, there is an assumption of a normalization of deferred comp expense and BOLI income. So in the second quarter, our normal bank home life insurance earned about $0.5 million, but the deferred hedge BOLI loss about $1.5 million. So there was about $1.5 million in reduced other operating income and reduced other operating expense. So in that guide, there is an assumption that the equity markets stabilize and deferred comp expense returns to a more normal run rate. So that's probably the biggest delta to the numbers you're talking about.

That concludes the Q&A session on today's call. I will now refer you back to Paul Yonamine for further remarks.

Great. Thanks. Thank you very much, everyone, for participating in our earnings call for the second quarter of 2022. We look forward to future opportunities to update you on our progress. Thank you.

That concludes today's Central Pacific Financial Corp. Second Quarter Earnings Call. You may now disconnect your line to end.