Central Pacific Financial Corp (CPF) 2022 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the Central Pacific Financial Corp. Third Quarter 2022 Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. This call is being recorded and will be available for replay shortly after its completion on the website -- 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 and Chief Financial Officer. Please go ahead, sir.

Thank you, [Robin], and thank you all for joining us as we review the financial results of the third 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. As always, we appreciate your interest in Central Pacific Financial Corp. I'll start this morning with an update on the Hawaii market then turn it over to the team to share our strong third quarter financial results as well as other key updates.

The Hawaii tourism sector continues to perform well. Even with the summer travel season completed, we are still seeing visitor arrivals at 90% or greater compared to pre-pandemic levels from 2019. The majority of those visitors are from the U.S. mainland. International travel to Hawaii is starting to gradually pick up now that Japan has dropped travel restrictions and is fully opened. The weak yen does present some headwinds.

Despite that, we expect a recovery of Japanese visitors going into 2023 due to significant pent-up demand. This timely recovery will support Hawaii's overall economy, which could experience a moderate slowdown in other sectors in 2023. Visitor spending is strong, reaching $1.7 billion in August, an increase of 13.8% compared to the same month in 2019.

Hotel performance continues to improve with total statewide hotel occupancy at 77% and an average daily rate of $380 higher. Hawaii's employment and housing sectors are solid as well. Our statewide seasonally adjusted unemployment rate was at 4.1% in August 2022 and is forecasted by the University of Hawaii Economic Research Organization to remain fairly stable in 2023.

Housing prices in Hawaii remains very strong with the Oahu Median single-family home price at $1.1 million in September 2022, which is up 5% from the previous year. Like the rest of the nation, we have seen some moderation in home sales activity due to the significant rise in interest rates, resulting in less home buying power.

With that said, the Hawaii housing market remains healthy with strong demand and low inventory, making it less likely to experience a material downturn compared to most other U.S. markets. In the great financial recession, the Hawaii market fared better than most states. And with our continued strength, we believe this will once again be the case.

Now I'll turn it over to Arnold Martines, our President and Chief Operating Officer, to discuss our third quarter results. Arnold?

Thank you, Paul. In the third quarter, we continue to focus on strong quality and diversified asset growth. Our total loan portfolio increased by $121 million or 2.3% sequential quarter and 9% 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 has almost completely run off.

We were successful in continuing to grow our residential mortgage portfolio by $32 million during the quarter, given our strength in the purchase market and our strong relationships with real estate developers and builders. During the third quarter, we continued to execute on our mainland diversification strategy by selectively participating in mainland commercial real estate and C&I loan transactions and with the purchase of select consumer unsecured portfolios from our established lending partners.

In the mainland commercial market, we typically partner with larger mainland banks with whom we have relationships with. We participate in transactions primarily on the West Coast, ensuring that we are lending in markets that we understand and are comfortable with while maintaining our credit underwriting and concentration standards and limits. The consumer purchases during the quarter had a weighted average FICO score of 740.

Our net growth in mainland consumer purchase loans was $44 million in the third quarter. At September 30, our total mainland consumer purchase loan balances were approximately 8% of total loans, representing a mix of auto and unsecured consumer loans. We have a healthy loan pipeline and are working closely with our lending teams to ensure we manage future loan growth given the current operating environment and economic outlook.

In particular, we intend to reduce future mainland unsecured consumer loan purchases. On the deposit front, during the third quarter, we started to see some moderation in our deposit balances, which grew significantly during the pandemic. Total deposits declined by $65 million or 1% from the prior quarter. Hawaii has traditionally had a strong and stable core deposit base, which is less likely to be impacted by interest rate swings as compared to the broader nation.

CPB in particular, has a long loyal customer base, strong community ties and the opportunity to increase our market share. We have an experienced team that is focused on deposit gathering in the current environment. Finally, we continue to develop our Banking-as-a-Service fintech strategy while adjusting with the market environment to manage the evolving risks.

The Swell of fintech, which, we invested in and are serving as a bank sponsor launched an alpha pilot earlier this month, we are excited to have this roll app off the ground and will continue to grow slowly and steadily while we learn and iterate.

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

Thank you, Arnold. Turning to our earnings results, net income for the third quarter was $16.7 million or $0.61 per diluted share. Return on average assets in the third quarter was 0.91% and return on average equity was 14.49%. The efficiency ratio was 64.6% in the third quarter.

Net interest income for the third quarter was $55.4 million, which increased by $2.4 million from the prior quarter as our increase in loan balances and yields outpaced the increase in our funding costs, the net interest margin increased by 12 basis points to 3.17% in the third quarter. Our total cost of deposits was 14 basis points, increasing from the historic loan of 6 basis points.

We continue to manage deposit pricing through product segmentation and thus far, our interest-bearing deposit repricing beta has been less than 10%. Third quarter other operating income and other operating expense normalized from the previous quarter, which included a one-time gain on sale of our Visa Class B shares of $8.5 million and a one-time $4.9 million settlement charge on our defined benefit pension plan termination.

We continue to focus on managing our expenses to drive positive operating leverage. During the third quarter, we consolidated another branch as planned, which brought our total branch compound to 27 branches. There were one-time branch closing costs of $0.4 million this quarter. In 2022, we consolidated 3 branches with total estimated future annual expense savings of $0.9 million.

At September 30, our allowance for credit losses was $64.4 million or 1.19% of outstanding loans. In the third quarter, we recorded a $0.4 million provision for credit losses due to loan portfolio growth and net charge-offs. Our asset quality continues to be strong with non-performing assets to total assets at 6 basis points as of September 30. Additionally, total criticize loans were just 1.4% of total loans.

Our net charge-offs were $1.6 million for the third quarter. Our loan portfolio is well diversified with total construction at 3% of total loans and minimal exposure to sectors that could be impacted in a downturn. Our effective tax rate was 26% in the third quarter and continues to be on the higher end of our range as a result of less tax exempt BOLI income. Going forward, we expect the effective tax rate to be in the 25% to 26% range.

Our capital position remains strong. And during the third quarter, we repurchased 218,000 shares at a total cost of $4.9 million or an average cost per share of $22.33. Additionally, our Board of Directors declared a quarterly cash dividend of $0.26 per share, which will be payable on December 15 to shareholders of record on November 30.

I'll now return the call to Paul.

Thank you, David. Central Pacific had another solid quarter and continues to be well positioned to continue to deliver strong performance. We have prudent and disciplined risk management and the right leadership to drive us forward and continue to excel despite external market challenges that may come. On behalf of our management team and employees, I'd like to personally thank you for your continued support and confidence in our organization [00:12:28].

I'd like to end with a personal note. After 4 great years at Central Pacific Bank, I have made the decision to retire at the end of the year. Effective January 1, 2023, I will become Chairman Emeritus of the bank and the holding company. Arnold Martines, currently President and Chief Operating Officer of CPF and CPB will become Chief Executive Officer of both entities as well as being named to both Boards.

Catherine Ngo, another valued member of the Executive Committee is also retiring as Executive Vice Chair and will become Chair of both Boards. In fact, I'd like to ask Catherine to say a few words now.

Thank you, Paul. The past 12 years with this company have been both exciting and gratifying from our recapitalization to our recovery that followed and with our recent transformation through RISE 2020. It has been an honor to serve the bank with Paul, Arnold, David and the rest of our exceptional team of leaders and employees.

The bank has been transformed during this time to better support our employees, customers and the community. I look forward to my new role as Board Chair and to continuing to work with Arnold in supporting the bank, particularly on our women-owned business initiatives as well as President of the Bank Foundation. Paul?

Great, thank you, Catherine. I thoroughly enjoyed my time at CPB and will continue to serve on the Board and as an adviser to Arnold, particularly in the areas of technology and Japan market development. The bank has been through a transformative stage, a RISE 2020 program that included the $40 million renovation of our headquarter building.

Our online mobile banking and ATM upgrades and the total corporate rebrand set us on a solid path to becoming a digital-first bank to help us excel in a rapidly changing banking paradigm. My thanks to the leadership team and Board for their support in particular my appreciation and gratitude to Arnold, David and Catherine for their partnership and support the past 4 years. And in closing, let me say that I can think of no better bankers than Arnold Martines to lead this great institution into the future.

At this time, we'll be happy to address any questions you may have. Thank you very much.

Our first question comes from the line of Andrew Liesch with Piper Sandler. (Operator Instructions).

And Paul, congratulations on your retirement and Arnold and Catherine on your new role, certainly well-deserved for all of you great to see, question on the mainland commercial real estate that was added in the quarter. It sounds like all of that was participation. Is that correct?

I'm just curious how the underwriting is -- you guys go through your own underwriting after being sourced the deal and then what sort of LTVs and maybe geographies of this as well? Just kind of more detail on how these loans are sourced?

Yes Andrew, this is Arnold. Yes, thanks for the question. It's a combination of participations with banks on the mainland, but it's also Hawaii-based customers that we've had long-time relationships with that have diversified real estate investments in Hawaii as well as on the mainland.

And then as far as the underwriting for participations are, clearly, we do our own independent underwriting reinsure that the -- transactions are aligned with what we expect and what our standards are. So in any but I hope that answers your question. And by the way, we apologize for the noise behind us. It seems like there's some things going on outside hopefully that's passed.

Well, I'm not hearing anything. So hopefully, it's not coming through for anybody else. I guess my other question is on the Hawaii growth. Obviously, it was stronger on the mainland and you had some good residential growth in the state. But on the commercial side of CRE and C&I, was there anything that's causing you to pull back or is this just maybe just normal trends from your customers?

We're seeing normal trends. There's no reason at this point for us to pull back on specifically when we talk about commercial real estate transactions or C&I as well as residential. Those are fairly -- those are areas that we look at, and we expect to be stable, especially in Hawaii, given the lack of inventory in resi and as well as the -- on the real estate side, just the stability here. There's only so much inventory that's available in Hawaii.

Our next question comes from the line of David Feaster with Raymond James.

Congratulations, Paul and Catherine on the retirement and Arnold, congratulations on the promotion -- excited for you all. I'm just curious if we could start on the deposit side. Just curious some of the deposit trends you're seeing. And then if you could touch on the -- especially on the noninterest-bearing flows?

How much of that was from migration within the book towards interest-bearing or cash burn and clients? Is there any seasonality to those flows? And then just curious whether you've seen any deceleration in the outflow of noninterest-bearing?

I'll have David here answer that question.

During the third quarter, we did see a drop in noninterest-bearing deposits. And that was primarily related to some large corporate depositors that had built up a decent amount of excess liquidity. And the money was in just in DDA as market rates were really low for projected period of time and then with the Fed increasing rates as rapidly as they did with money market rates approaching 2%.

We did see some of that money leave the balance sheet. Some of it went into other interest-bearing accounts, but some of it did leave the balance sheet. The good news there is that we have seen the face of that -- those types of large corporate outflows, it has slowed. So hopefully, we've put a lot of that behind us in the third quarter.

Okay. And then maybe just touching on seeing on deposits, listing [00:20:30] on 2 aspects of it, I'm curious how the Shaka digital deposits are trending and how flows are turning in that and how rates and betas are within the digital deposits. And then Paul, I know you've spent a lot of time working on this Japanese deposit initiative. Curious if there's any updates on that and whether you're starting to see some fruits from all those efforts.

It's David again. So, on the Shaka we continue to do well with the Shaka. We continue to add new accounts -- but it has been going down at a slow and steady pace. So I think we're probably at about 4,000 accounts, Shaka accounts. And we continue to run initiatives to drive more activity there. The rate sensitivity of that account has been -- we have not changed anything on the rate profile of Datacom.

So it's still where you have -- we pay a modest amount of interest. I think its 3 basis points of interest unless -- but if you do the qualifying activities, 15 debit card transactions a month with the direct deposit, then the bonus interest rate is 1%. So it's a decent interest-bearing checking account, if you do it to the qualifying activity. So we haven't made any changes to that the bonus rate in the current rate environment thus far. I'll turn it to Paul for the Japan question.

Yes.

I'm sorry.

No, go ahead.

Yes so -- the yen rate today is JPY 151 and that presents considerable headwinds for people to transfer money into the United States at this moment. I would have to say that we've had a great run up on Japan deposits even during the pandemic. Those individuals who deposited monies with us last year, they love us. And -- but the scenario today is that there is tremendous pent-up demand for a lot of the Japanese who live in Hawaii.

I think they have to go through this emotional roller coaster, right, because there's been such a significant strengthening of the dollar. We think as we go into next year, that that will kind of ease up. And when it does, I think the one key takeaway for a lot of Japanese is that they shouldn't have all their assets here, and we're hoping that they will look to dollar deposits.

And at that time with products like Shaka digital products or people who don't live here in Hawaii, I think it's going to be a very attractive platform. So again, in the short-term, some headwinds that we know that the Japanese will be back here, that there's tremendous interest in shifting assets to the U.S., and we hope we can really capitalize on that.

And how much is -- that's good color. How much is in the Shaka digital deposits now?

David, it's about 4,000. So it's about $1,000 average balance. The good news there is what we're seeing is engagement by the Shaka customers increase over time. It's as normal, right? When people open an account, it takes them a little bit of time to move their direct deposit and then start making it their primary checking account -- but we're now starting to see that engagement with the Shaka customers, which is good.

And David, this is Paul. But more importantly, we're basically really penetrating the younger set of customers. And that was a critical piece of strategy for our Shaka offering. So this is something that we did to invest into the future.

Yes and that's perfect dovetail. I wanted to touch on Swell. I know we're planning on a fourth quarter soft launch. Just curious where we are in that process? How it's going and any updates on the evolution of that business?

Yes David, it's David again. So we move -- in October, we moved from the Swell friends and family pilot to the Swell alpha pilot. So that's where we're inviting the people from the Swell waitlist to open their Swell account. So we're just at the beginning of the Alpha pilot.

And as we'll probably stay in the Alpha pilot to mid to late November, and then we're going to start a more, broad public launch. So what we plan to do -- the public launch probably late November, early December timeframe. And that's where it will be a much larger set of customers coming in.

And how is it gone so far? I mean is there any update on how it's gone, how -- whether there's, been any issues or just curious how it's going in your early feedback?

Yes, no, it's as expected. You do pilots to learn bigger things out, make sure everything is working as expected before you do the larger public launch. So we went through that process with the friends of family learned and innovated through that process and that now we're doing the same thing through the alpha pilot. But it's going -- exactly as expected.

This is Paul and I might just add, with the changing economic climate, especially in the Continental U.S. that we have become a little more rigid on our credit policies. And so, we are focused more on customers invited customers with FICO scores north of 720 and the initial mail grants that we're planning right now.

(Operator Instructions) Our next question comes from the line of Laurie Hunsicker with Compass Point.

And Paul, Arnold and Catherine, I just want to echo my congratulations, too. Just going back to your Japanese strategy, and Paul, I'm hoping you can help us think about it. And I'm sorry if I missed this piece. #1, can you just remind us what Japanese deposits are at the moment and then, Paul, as you transition into a different role?

Can you take us through how the Japanese strategy might change as we look to 2023? I know you've been active in traveling there. Can you just help us think about that?

Sure so Laurie, 16 quarters ago, when I first stepped in as CEO, I think we were hovering around $650 million in terms of Japanese deposits. And today, we're just a little south of about $1 billion. So we've made very good progress over the last 4 years. But there's still tremendous potential. COVID was the step back the strong dollar has been headwinds as well.

But now in my new role from January, where Arnold has to do all the earnings calls, and I'm going to have time to spend more time in Japan. And still as a Board member, the CPB as an adviser to Arnold and Arnold's request of me to really do some rain making in Japan. I'm going to have a lot more time to focus on that market. And I know what my marching orders are to go out and get low cost deposits. So that's where I'm going to spend a lot of time on it, hope I'm successful Laurie.

Okay, okay great. I hope you are, too. Okay, great. I guess shifting over -- oh, I'm sorry, go ahead. No okay shifting - over to consumer. You mentioned that you are going to reduce unsecured consumer mainland. And I'm showing that number is about $310 million. Can you help us think a little bit about where that reduction is going to occur, what that book looks like maybe by the back end of next year? Just how you're thinking about that? Sure.

Go ahead, finish your question.

I was just going to say and then with respect to Swell Elevate because, obviously, that's also mainland so that is starting to grow. Can you help us think about the targets there over the course of the next year, how you're thinking about that? Initially, I think there was a Swell Elevate target of $8 million by the end of this year, and you backed off on that, which was great. But maybe help us think about that a little bit more?

What does your target look like for quarters from now? And then probably just one more question sort of folded in. I mean your credit is spectacular. The only place you really had charge-offs has been in consumer. And so maybe help us think about that a little bit, especially with the backdrop of continued chatter out there from CEO and CFOs across the board saying very, very concerned about unsecured consumer lending?

And maybe just help us think about those 3 pieces. In other words, with that unsecured consumer book will look like over the course of the next year, what Swell Elevate will look like and then how you're thinking about charge-offsetting?

We'll try our best to respond to your questions. So this is -- I'll just start by saying that, obviously, we recognize the headwinds. Overall, our portfolios are performing very, very well, including our consumer portfolios. We think the probability of a recession is higher at this point.

And as a result, we're taking a look at what we plan to do in the future and to start to modify a moderate certain loan categories. So I'm going to ask Anna maybe to start off with talking about consumer and to respond specifically to your questions about where we see that category going in the future. And then we'll pass it on to David to talk a little bit about Swell and kind of the numbers that we're looking at in the future. So Anna

This is Anna. So with regards to your question on our $310 million consumer unsecured, we do expect to moderate that portfolio. As Arnold mentioned, we are expecting headwinds to come our way. That would just be through natural runoff on a monthly, quarterly basis. Where we may look to add is really on the auto side. We have historically performed very well in auto.

And our overall expectation is to maintain somewhere in the 8% range as to where we currently are with regards to our mainland consumer book. And then shifting over to the charge-offs, we're expecting charge-offs to increase, of course, given market conditions, but we are expecting it to be at an acceptable level.

And that's primarily due to our higher credit underwriting standards. As mentioned, again, in this last quarter, our average -- weighted average FICO score was 740, and we expect to maintain high credit underwriting standards going forward as well. I'll now turn it over to David to talk about our Swell Elevate side.

Yes, you're correct. The original goals, for Swell was $8 million in cash, the deposit accounts and $8 million in lines of credit. By the end of this year -- we took that back to $4 million each. And we're -- that's still the target for year-end. We'll see if we get there or not. The timing of the public launch has been pushed back by a few weeks. But as we've always said, we're going to start slowly. We're going to learn and we're going to iterate.

I think what's been good about the process we've gone through this last year is, obviously, there's been a lot of turmoil with the existing neo banks out there. And it's given us an opportunity to observe and learn. And what we're doing now is we're targeting accounts -- and customers that we believe will be profitable customers. So we -- our business and the Swell business plan now is to target fewer accounts, but try to make them profitable.

So maybe 100,000 accounts but have the majority of them be profitable, maybe a business model than having 1 million accounts that are unprofitable. So that's kind of what we're focused on. As far as the targets for next year, it's very difficult to say. I think what we've always said, Laurie, is we're not going to accelerate growth unless we find a sweet spot, a strategy that leads to profitable Swell customers.

And Swell CPB and Elevate are all aligned in that objective. So the growth will be stronger if we find that sweet spot of profitable customers. Otherwise, it will be rather slow and we'll be learning and iterating.

Okay. And so -- but so just to quantify, I mean, are we looking at $10 million by the end of next year? Are we looking at $50 million or $100 million, just rough, rough numbers, so that we can think about -- think about credit risk, how we think about that?

Yes again, I don't think it's going to be $100 million. I think it would be south of that. I think most of next year is going to be the team running cohort tests, where we target different cohorts of the striver target market. And again, like we're trying to find the sweet spot. So I think that's the process we'll be going through much of 2023.

And I think the final thing to mention, Laurie is, and I know we've talked about this at length. But again, we do have the credit guarantee from Elevate that is cash secured on our balance sheet.

Laurie, this is Arnold, I'll just...

That's hard, too, right? Because just Elevate is sitting at $1 a share I mean, right, so the better, I don't know, I'm sorry, go ahead. I didn't mean to cut you off?

Yes no problem, Laurie. I know that there's a slight delay. But I wanted to add that Swell is one product initiative that we're doing. Obviously, we have a very strong discipline overall for the bank's balance sheet. And so at the end of the day, we are going to manage consumer concentration globally, right, holistically for the bank.

And so from the extent that we grow Swell, other parts -- other sources of consumer will reduce other sources of consumer to maintain a strong risk management discipline and stay true to our concentration standards and limits.

So I just wanted to put that out there that we are still going to manage our balance sheet effectively. We're not going to allow one product to -- or I should say, we're not going to have the consumer category grow to a point where it's a huge concentration on our balance sheet.

Okay, okay great. And just one more question, if I could, different subject altogether, your funding is fabulous, your core deposits are fabulous. Can you help us think about maybe just if you could quantify over the next several quarters, how you think about margin in terms of basis points, deposit pricing? Obviously, at some point, it catches up when the Fed slows, right? So maybe help us think a little bit about when margin might peak and how you're thinking about that?

Yes Laurie, so the third quarter -- yes, we were very pleased with the core deposit betas. So the interest-bearing deposit beta in the third quarter was 9%. Total deposit beta was 6% and our average earning asset beta was 21%, and that's what led to the 12 basis points of sequential NIM expansion.

We are targeting to continue to see NIM expansion for the next couple of quarters, and we're currently in the budget process. So we're currently thinking the NIM may peak in mid-2023 is what we're looking at.

Right.

Yes Laurie, this is Paul. And before I end the call, I just wanted to respond again to your comment about Elevate share price being $1 right now. There is enough cash at Elevate. Again, the arrangement is that they place deposits with us where we have a security interest in them. And we are in the driver's seat on volume of direct mail, which is the key driver for a lot of the loan origination.

So we're going to be taking a very close look at that. I think I also mentioned in past calls that to our terms and conditions with Elevate, we do have right to the lending management platform. So even in the event that there were any issues with the viability of the company, I think CPB is in a very secure position. So I just wanted to point that out, okay?

So with that, I think there might be one more question there, okay, not there.

Yes, sir, the question we had actually dropped back and if you would like to continue.

Okay, we'll turn it back to you, Paul.

Okay well, so with that, thank you very much, everyone, for participating in our earnings call for the third quarter of 2022. We look forward to future opportunities to update you on our progress. Thank you.

And with that, we will end today's Central Pacific Financial Corp Conference Call. Thank you for your participation. You may now disconnect your line.