Central Pacific Financial Corp Q1 FY2020 Earnings Call

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the Central Pacific Financial Corp. First Quarter 2020 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 company's website at www.cpb.com. I would like to turn the call over to Mr. David Morimoto, Executive Vice President and Chief Financial Officer. Please go ahead.

Thank you, Graham, and thank you all for joining us as we review the financial results of the first quarter of 2020 for Central Pacific Financial Corp. With me this morning are Paul Yonamine, Chairman and Chief Executive Officer; Catherine Ngo, President; Arnold Martines, Group Executive Vice President of Revenue, and Anna Hu, Executive Vice President and Chief Credit Officer. We've prepared a slide presentation that we'll refer to in our remarks today. The presentation 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 Paul.

Thank you, David, and good morning, everyone. As always, we appreciate your interest in Central Pacific Financial Corporation. The COVID-19 pandemic is top of mind for all of us. Overall, the state of Hawaii is doing a good job at managing and containing the pandemic. Hawaii was early to put in place stay-at-home orders and mandatory curfews and quarantine. Our residents, in general, are abiding by governmental orders as well as hygiene recommendations. Due to our geographic isolation, Hawaii was able to effectively lock down and protect the state from outside visitors with potential COVID-19 infection. We believe these measures will slow and contain the spread of the COVID-19 in the state and result in a faster recovery. However, with a complete tourism shutdown in Hawaii, we are seeing a dramatic impact on the state's economy. We are hopeful that we will start to see visitors returning to the island in late summer or early fall of this year, particularly from Asia as they are closer to recovery from the pandemic. Central Pacific Financial is committed to supporting our employees, customers, and community during this time of crisis. Our first focus is on our employees. Safety comes first and therefore we've temporarily closed 13 of our smaller branches to allow for adequate social distancing in our larger remaining branches. The staff from the temporarily closed branches have been redeployed to work at the remaining branches, assist other areas of the bank, or make customer telephone calls. The majority of our support staff, even at the executive level, have started working remotely on a full-time or rotating basis. We believe the actions we have taken to date will allow us to meet the needs of our customers and community while ensuring the safety of all employees. We want to assure you that we are prepared to handle this crisis. I personally led companies through prior crises including the 2011 Tōhoku earthquake, tsunami, and radiation effects while I was in Tokyo leading IBM Japan and the SARS outbreak in 2002 to 2004 while I was leading BearingPoint. Additionally, many of our key team members that helped us through the 2008 to 2009 financial crisis remain with the company and are applying the valuable lessons learned. Despite COVID-19, our RISE2020 initiatives are ongoing. The revitalization of our building headquarters is proceeding as we continue to support the local construction industry. We're also pushing ahead with our digital initiatives including the development of our new online and mobile banking platforms and the replacement of our ATMs. Digital technology is even more critical to our business during crises like this and will remain a high-priority strategy for our future. I'd like to turn the call over now to Catherine who will share more about our business continuity plan.

Thank you, Paul. Our business continuity plan includes a pandemic preventive plan, which we successfully activated in early March and is summarized on slides three and four of our presentation. As a result, we have not had disruption in our business. As Paul noted, our remote workforce plan has been rolled out with an overall smooth transition. We already have Virtual Private Network (VPN) technology capability over the last year, and we've expanded VPN access to over 70% of our employees. In addition to VPN, we are well set up with the latest technologies that enable our operations to continue efficiently. Our teams are using collaboration tools including Microsoft Teams and several other cloud-based software programs. For our customers, we continue to offer our current online and mobile banking tools, and we're making good progress on our new digital offerings as part of our RISE2020 initiative. Banking is deemed an essential service, and I've been so proud of how our CPB employees have risen to deliver exceptional service in these challenging times. I would like to reiterate that our employee and customer safety is our utmost priority. We're monitoring our employees' health and well-being closely. We're providing personal protective equipment for our frontline staff and have implemented precautionary measures to ensure social distancing in our branches and all work areas. I would like to turn the call over now to Arnold Martines, our Group Executive Vice President of Revenue, who will share how we are assisting our customers during this pandemic.

Thank you, Catherine. During the first quarter, our teams remained focused on generating revenue even as the pandemic situation began to escalate. The bank grew total loans by $63 million or 1.4% sequentially. The loan growth primarily came from our residential and commercial mortgage loan categories. We were also able to grow core deposits by $45 million or 1.1% sequentially. Additionally, we were successful in reducing the average cost of total deposits by five basis points to 36 basis points. Going forward, we believe there are still opportunities for loan and deposit growth as our teams collaborate together to support our consumer and business customers through this unprecedented time. We have also moved quickly to implement a number of COVID-19 relief programs for our consumer and business customers. The relief programs are summarized on slides 5 to 7 of the presentation. For our customers, we are offering an employment disruption loan as well as consumer and residential mortgage loan payment deferral programs. For our business customers, we are an SBA-approved lender and are participating in the Paycheck Protection Program (PPP), which is part of the Federal CARES Act. We've seen tremendous demand for the Paycheck Protection Program and have made over 4,200 loans totaling nearly $490 million approved by the SBA. As a result of the PPP loan demand, it was necessary to redeploy employees to handle and assist with the loan processing, including augmenting the loan process by engaging outside resources to assist. Our PPP team is focused right now on funding the loans that were approved by the SBA, as well as prioritizing remaining applications that did not get processed in time under the initial funding and, of course, submitting the applications to the SBA when the lender portal reopens. We are staying in close contact with our customers through increased outreach efforts. Our bankers are having calls with our key customers as frequently as daily. We are monitoring our customers' financial health during this challenging time and providing guidance and resources they need to help them weather the storm. Furthermore, we are prudently making loan modifications for certain commercial customers to allow for deferral of loan principal and/or interest for a short term. As of April 16, we have made loan payment deferrals on approximately $300 million in total balances, which represents less than 7% of our total loan portfolio. I'd like to turn the call over now to Anna Hu, our Executive Vice President and Chief Credit Officer, to provide further detail on our credit and portfolio risk management.

Thank you, Arnold. Central Pacific Financial has had a prudent credit risk management philosophy which we believe will help us weather through this pandemic. Following our recovery from the great recession, we implemented a disciplined approach to credit that included tighter underwriting standards with a focus on making quality loans and maintaining a diversified portfolio. Our loan portfolio today is well diversified by product and by industry. While certain industries we lend to will be impacted by the pandemic, other industries and portfolios are expected to have limited impact. The primary industries that are likely to experience impact from the pandemic are summarized on slide 9 and include accommodation and food service, retail trade, wholesale trade, manufacturing, and healthcare. This comprises approximately $378 million or 8% of our total loan portfolio. A large portion of these balances are with well-established businesses that have weathered through the last downturn. Secondary industries that may also experience impacts include real estate management and other leasing, transportation, professional and administrative services, and other industries and services that total approximately $487 million or 11% of our total loan portfolio. These industries have thus far experienced little impact from COVID-19. Additional details on our primary and secondary industries can be found on slide 10. We also anticipate impacts on our consumer portfolio, which is approximately $560 million or 13% of our total loan portfolio. We're actively granting 90-day payment deferrals to these borrowers. Additional details on our consumer portfolio are shown on slide 11. We anticipate limited impacts on our residential, home equity, and investor commercial real estate loans. The weighted average loan-to-values in these portfolios are 60%, 58%, and 53%, respectively. These loans comprise approximately $35.1 billion or 68% of our total loan portfolio. Additional details on these portfolios can be found on slides 12 and 13. In the final week of March, we aggressively reviewed our commercial loan portfolio and reached out to our customers to determine the initial impact, if any, of COVID-19 on their businesses. Through this process, we identified borrowers likely to experience financial difficulty and proactively downgraded approximately $65 million in loans. These loans are primarily accounted for as part of the outstanding loan balance of the primary industries previously mentioned. It is important to note that all of these loans were performing prior to COVID-19. As part of our assessment for the downgrade, we reviewed management actions taken such as closing businesses, reducing expenses, monthly cash burn and access to cash liquidity, capital, and overall ability to weather through the pandemic in the near term. We further note that it is still early to reach any firm conclusions and that these loans that were downgraded did not include the expected positive impact from the Federal Subsidy Program. We are proactively working with our customers, and many have already applied and have been approved for the Paycheck Protection Program. Furthermore, we have also provided assistance for short-term payment deferrals as necessary. Additional details and breakdown by industry can be found on slide 14. Overall, our asset quality continues to remain strong. I'll turn the call over to David, our Executive Vice President and Chief Financial Officer.

Thank you, Anna. On the finance side, we've implemented several steps to effectively manage through the current environment. We will ensure our capital and liquidity positions remain strong. From our past experience, we've developed robust capital and liquidity stress tests and comprehensive capital and liquidity contingency plans. We also decided to temporarily suspend our share repurchase program. We managed our expenses as well as protect our employees. We have implemented internal policies to temporarily suspend all business travel, large group meetings, meals, and entertainment. We've also reevaluated or postponed certain consulting projects and, finally, hiring of new employees is on an exception basis, and we are evaluating our compensation plans. I'd like to now briefly cover the company's financial results for the first quarter of 2020, which is summarized on slide 15. Net income for the first quarter of 2020 was $8.3 million or $0.29 per diluted share. Return on average assets in the first quarter was 0.55%, and return on average equity was 6.21%. Our earnings were impacted by a total provision for credit losses of $11.1 million recognized in the first quarter, which related to a new CECL methodology and the effects of the COVID-19 pandemic on the economic forecast. We also recorded a CECL day one impact of $3.6 million, which was an adjustment to our opening shareholders' equity. Our pretax provision earnings for the first quarter was $21 million. Net charge-offs in the first quarter totaled $1.2 million compared to net charge-offs of $2.3 million in the prior quarter. The charge-offs primarily came from the Hawaii consumer loan portfolio. At March 31, our allowance for credit losses was $59.6 million or 1.32% of outstanding loans. Net interest income for the first quarter was $47.8 million, which was relatively flat on a sequential basis, and the net interest margin remained stable at 3.43%. First quarter other operating income totaled $8.9 million compared to $9.8 million in the prior quarter. The decrease was primarily due to lower mortgage BOLI income driven by market volatility during the quarter. This was partially offset by additional fee income of $1.3 million related to an interest swap for a commercial real estate client. Other operating expenses for the first quarter were $36.2 million, which was flat to the prior quarter. Included in the total, there was lower deferred compensation expense due to market volatility, which was offset by a higher provision on off-balance-sheet credit exposures under CECL. The efficiency ratio increased to 63.9% in the first quarter compared to 62.8% in the prior quarter. The increase was primarily due to the decrease in other operating income. The effective tax rate was 25.3% in the first quarter. Going forward, we expect the effective tax rate to be in the 25% to 27% range. Now I'll return the call to Paul Yonamine.

Thanks, David. The global COVID-19 pandemic is an extremely challenging situation faced by all during this time. We want to assure you that Central Pacific is prepared and ready to handle this situation. We have a solid financial, credit, liquidity, and capital provision to enable us to weather the storm. We remain committed to our employees, customers, and the community and will continue to provide support to all of these areas. Earlier this month, we ran a highly successful community campaign sponsored by our CPB Foundation called 'Keep Hawaii Cooking.' Through this program, our foundation subsidized the cost of 10,000 takeout meals to local families struggling during this time. The purchase of these meals also provided much-needed support to our local restaurants. We're further looking at other potential initiatives to help our local economy, one of which is a campaign to continue communication and engagement with visitors, particularly from Japan, to keep Hawaii top of mind and encourage their return to Hawaii once the pandemic ends and recovery occurs. To conclude, we're very focused on flattening the curve with COVID-19, and we're pulling together as a company and community to beat this. On behalf of our management team, 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.

We will now start the question-and-answer session. Our first question comes from David Feaster with Raymond James. Please go ahead.

You guys have been a big part of the approved PPP loans in Hawaii. Are you just accepting applications from new clients or just existing clients? Are you able to require deposit relationships with those loans, and regarding timing, I guess that a lot of those have already been approved. Do you think most of those fund in 2Q '20, so most of the fee revenue should come in next quarter?

Thank you, David, and I'd like to respond to all of that positively, but I don't want to take Arnold's thunder. He's been working night and day. So Arnold, why don’t you respond to that?

Sure. Thanks, Paul. I would say the supermajority of the applications we received were from our customers, but we do have non-customers that applied, and our position has been that the program is for the support of the business community. Thus, while we obviously support our customers, we are also supporting the broader community. With regard to the fees, it is amortized over the term of the loan, but we estimate that we are in the roughly $18 million range for fees at this point.

Okay. Terrific. And then David, I appreciate the color on some of the expense-saving opportunities, but how do you think about the RISE2020 initiatives? Just hearing your commentary, it sounds like things are progressing as planned, but are there any projects or investments that you might like to place on hold? Or broadly, how do you think about expenses since you have much expense leverage?

This is Paul. Let me start first by just once again explaining our RISE2020 initiative. It's largely two components. One is the technology play and the other is infrastructure. On the technology play, everything from our new online mobile platform, new ATMs, definitely converting all of our employees to become VPN ready, and also giving them collaboration tools, that was extremely timely and nothing has stopped us. As a matter of fact, we've been trying to accelerate that. In terms of infrastructure, as of February, we already started the demolition of our first floor, and so our plan is to continue down the path and complete the full renovation of our main building on the first floor. Having said that, there are pieces and components—for example, glass materials—that we're planning to place into the ninth floor of our building and many ancillary things that we feel we can postpone just to be prudent. But having said that, we do plan to push ahead on the first-floor renovation, which is the lion's share of our investment. Most of it is amortized over 39 years, and I believe personally that our target date of January 1, 2021, is going to be a real great celebration that we will have COVID-19 contained. Hopefully, the whole state and the city of Honolulu will be open for business, and we've taken a really positive view on it. But David, why don’t you provide any other information on expenses?

Sure. Thanks, Paul. So, David, as Paul mentioned, we are continuing with the major components of the RISE2020 initiative. What we will guide to on total other operating expenses is roughly in the $36 million to $38 million range, and obviously, as we said in our prepared remarks, we're trying to manage that to the lower end of the range.

Okay. That's helpful. And then I guess the last one for me on the allowance for loan losses, we saw a pretty big jump obviously to 132 basis points, but given where we are today and assuming that this might stick around a little bit longer, how do you think about additional reserve builds, and just kind of your overall thoughts on reserves? Any commentary you have would be helpful.

Okay. Thanks, David. As all banks, it's been a challenging quarter, implementing one of the largest bank accounting changes in the midst of a pandemic, but the team did a nice job implementing CECL. We looked at the situation as of March 31. We used a blend of economic forecasts at a time that did include some of the forecasts that came out in late March. We incorporated some of the downside that people were seeing with COVID, and we think we ended up with an appropriate allowance of 132 basis points of loans as of 3/31. Having said that, there have been subsequent forecasts that have come out in the first three weeks of April that have shown potential further downside. So to the extent that there is further deterioration in the economic environment, there would likely be additional reserve builds in the coming quarters, and we would think it's probably the second and third quarter.

David, this is Paul. Let me just add, clearly there is a lot of uncertainty on how COVID is all going to play out. As Arnold touched on, our bank has also been extremely focused on a lot of the federal subsidy programs like the PPP. We, as a bank, have overachieved in relation to our market share in the state of Hawaii and with some of the fees that we anticipate in Q2 and hopefully in Q3 with the additional $310 billion that Congress is considering to again put into the SBA, that we can achieve a lot of fees that we feel will help us to counter additional provisions as well.

Okay. That's helpful. I guess along the same lines, what are you hearing from your customers? What's the pulse of it? It sounds like you're actually expecting some potential loan growth, but what are you hearing from your clients? At what point do you think they start feeling the pressure?

David, you'll see in our addendum, we have a very diverse portfolio of loans. The majority of it I think we're in a really good place, especially with the low loan-to-values in our real estate-based clients. Clearly, the companies that are very focused on tourism—whether it be hotels or restaurants—who have completely shut down operations, there is tremendous concern. The city and county, the mayor has just announced a stay-at-home mandate extension to the end of May. So clearly, that has huge implications for those businesses. There is a lot of concern there, and not quite much light at the end of the tunnel yet. Hawaii is doing a great job in comparison to most states in the United States. Some companies are constantly optimistic, yet the situation is quite tough. What we've been doing is reaching out to all of those customers, trying to really understand the business, and seeing how the bank can help, and we plan to continue doing that.

Our next question will come from Jackie Bohlen with KBW. Please go ahead.

Hi. Good morning, everyone. Just one more quick question on Hawaii, before I change topics. I think it may have been in your prepared remarks, Paul, you mentioned that you're hopeful for visitors to return in late summer to early fall. Is that something that came from one of the local organizations like Hawaii Tourism Authority, or is that just an internal hope?

I'd like to say it's a little bit of everything, Jackie. Nothing is very definitive yet. I mean our major markets, whether it be Japan or the Mainland US, have their challenges today. So it's not just Hawaii. The whole ecosystem has to work, and yet Hawaii today, with infections of a little under 600 and 400 recovered, and our daily new infections, I think generally the state and the city have been doing a pretty good job at containing it. But the concern is naturally on the markets that we depend on for tourism. Our view right now is: wouldn’t it be wonderful if the State of Hawaii can position itself as one of the safer tourist destinations globally? In that situation, I think people would be willing to pay a premium to come to Hawaii, and it really boils down to the tenacity of state government. That is something that even our bank, and all the banks actually in Hawaii, are working very closely with the state and city government, providing ideas, new initiatives, new hygiene protocols, and providing ideas from new technology to try to make the tourism experience a positive one. We're hopeful by the end of the third quarter, early fourth quarter that we can start seeing a gradual rise in tourism.

And is it reasonable to assume that the people of Hawaii would be able to return to their new normal in advance of that, because the state has done such a great job of really containing the virus? Also, given your status as an island state, you more than any other state in the US really call it those places everywhere have been able to keep people from introducing the virus again. Is that a fair assumption?

Again, Jackie, the city's stay-at-home mandate has just been extended until May 31, and looking at all of the activity in Mainland US right now, I think it is a fair assumption that a lot of businesses will be able to start moving towards normalcy from early June.

Okay. Thank you. That's wonderful color and very helpful. Just looking in terms of growth, understanding that everybody is essentially at home through the majority of the second quarter at a minimum, how are your customers thinking about that? Is it all just coming from businesses that are looking for help through the PPP, or are there other ways for growth that I am not thinking of?

You know, Jackie, during a pandemic, there still are winners. Grocery stores, for example, and companies providing health and safety type services and whatnot. So again, those are reflected in our portfolio as well. But there are clearly businesses that are also benefiting from what's happening today. But having said that, the vast majority of companies—especially in the tourism sector—facing the shutdown on business, the recent CARES Act subsidies are critical. This is why CPB has invested so much time and energy in making sure we bring those PPP dollars to small businesses. We processed 4,200 applications with $490 million. We averaged little over $100,000 per application, and that was just critical during these times, Jackie.

Okay. Thank you. And just one last one for me and then I'll step back. Just wondering what the expectation is for mortgage banking in the near term? Was the swing between quarters purely driven by the MSR market, or was it a function of volume?

I was actually going to add to Paul's comments to elaborate on those, but that was a perfect segue. The volume in Q1 was, I would say, seasonably low. In prior years, we've seen the dip, but I will share with you that in Q2, the pipeline looks really good, and we are projecting about $220 million in production. A lot of that goes to some things we talked about earlier regarding the unique nature of our mortgage business. A lot of it is purchase, and we have joint ventures with key developers and other agencies here, so that will continue to drive growth in the mortgage business, not just in Q2 but for the rest of the year.

Okay. Thank you. And then, this might be a technical question for David just on the difference between MSR and if that was the primary driver of 1Q.

Yes, that's correct, Jackie. The MSR amortization increased sequentially by about $800,000.

Our next question will come from Laurie Hunsicker with Compass Point. Please go ahead.

Just wanted to start first of all on the income statement. Do you guys wonder about a loss of $19,000 for the quarter versus its been running about $600 or so per quarter? How should we be thinking about that?

Yeah Laurie, that was an impact of the equity market volatility. So we have a BOLI policy that's used as an indirect funding source/hedge for our employee deferred program. The assets inside of the BOLI policy are equity mutual funds. That policy declined in value by roughly $600,000, and we had our normal BOLI policies with income of roughly $600,000. So they kind of offset each other and that's what resulted in roughly $0 income in the first quarter. Assuming we don't have another downturn in the equity market, if things stay stable, we would expect BOLI income to return to the $500,000 to $600,000 quarterly range going forward.

Okay. That's helpful. And then within your net interest income this quarter, were there any non-accrual loan recoveries like you had last quarter?

It was negligible this quarter.

Okay. Good. And then just shifting over to credit, I guess was the norm. Thank you for the detail on slide 9. Your primary industries that you outlined as potentially being more at risk from COVID-19—it looks like obviously the majority of that C&I. Can you toss out of the $378 million, is there any real estate securities to that and if you know percentage or dollar on that $378 million?

I am sorry, this is Anna. I won't say between the primary and secondary industries, $325 million of it is real estate securities.

Okay. Between those $325 million. Okay. That's helpful. And then this is kind of more macro I guess both Anna and David for you. In terms of construction lending, can you just give us a refreshed update? Just whatever your 2%, your $101 million just sort of an outlook.

Sorry, you're breaking up. Can you restart please your question?

Sure. Can you hear me now? Just very high level, if you can just help us think about your construction book, as that's what really hurt you during the last downturn. You had 28% of your loan book in construction lending back at the end of '07, and today that's 2%. But can you just help us think about what are the differences in your construction book today versus back then outside of the obvious, which is size? Thanks.

Hi Laurie. Our construction book today is very different. Back 10 years ago, we were doing a lot of land development, residential, and construction development. What we have today is very focused on supporting the middle market with affordable condo builds that we have here in Hawaii, primarily Oahu. So that's where the difference is in the portfolio. We're not in what we were doing 10 years ago.

Okay. And then your $101 million, is that all Hawaii-based?

Yes. All Hawaii-based.

Okay. And versus the last go-around, it was mainly in the Mainland, is that correct?

A lot of it was on the Mainland, correct.

And then if you have it, do you happen to remember what LTDs were back then versus today?

Laurie, they probably started from 60% to 65%, but they ended up upside on obviously once we had a fair share. But I guess it is a much different exposure. As you said, it was almost 30% of the portfolio. It was over a $1 billion in construction at that time, and today it was I think it peaked at $1.1 billion, and today it's $100 million, but much different risk profile in the loan portfolio.

Right, coupled with the fact that your loans were a lot smaller. Okay. Perfect. I'll leave it there. Thank you so much.

This concludes our question-and-answer session. I'd like to turn the conference back over to Paul Yonamine, Chairman and CEO, for any closing remarks.

Okay. Thank you very much for participating in our earnings call for the first quarter of 2020. We look forward to future opportunities to update you on our progress. Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.