Central Pacific Financial Corp Q4 FY2020 Earnings Call

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to Central Pacific Financial Corp’s Fourth Quarter 2020 Conference Call. This call is being recorded and will be available for replay shortly after its completion on the company’s website at www.cpb.bank. Now, I would like to turn the call over to Mr. David Morimoto, Executive Vice President and Chief Financial Officer. Please go ahead.

Thank you, Matt. Thank you all for joining us as we review the financial results of the fourth 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, Executive Vice President and Chief Banking Officer; and Anna Hu, Executive Vice President and Chief Credit Officer. We have prepared a slide presentation that we will refer to in our remarks today. The presentation is available in the Investor Relations section of our website at cpb.bank.

Thank you, David and good morning everyone. As always, we appreciate your interest in Central Pacific Financial Corp. The start of 2021 is a very exciting time for Central Pacific. We are pleased to announce that we have successfully completed our RISE2020 initiative, which positions us extremely well in the current environment and for the future. Earlier this week, we had a grand opening for the fully renovated Central Pacific Plaza lobby, which features a modernized main branch, co-working space for small businesses and non-profits, and a large open lobby that welcomes the community and brings fresh new energy to downtown Honolulu. We also completed our RISE2020 milestone on digital banking with the new online and mobile banking platforms that launched in the third quarter and the completion of our full ATM network upgrade in the fourth quarter. You may have noticed that we have a fresh new look in our slide presentation this quarter. This is part of an exciting new brand design that we just launched. The new brand reflects both the company’s unique history and our bright future ahead. We had strong financial results for the fourth quarter and full year of 2020. While net income was impacted by one-time expenses and higher provisions for credit losses, our core pre-tax pre-provision earnings were solid. We continue to thoroughly review and regularly monitor our loan portfolio to appropriately manage the credit risk in the pandemic environment. During the fourth quarter, our total balance of loans on payment deferrals decreased significantly and was down to 3% of total loans, excluding PPP loans at year-end. Finally, our Board of Directors declared a quarterly cash dividend of $0.23 per share and approved a new share repurchase authorization. I’d like to now turn the call over to Catherine to provide an update on our state’s and company’s pandemic status. Catherine?

Thank you, Paul. The State of Hawaii continues to manage through the COVID-19 pandemic. We are vaccinating our residents as quickly as possible and have worked through the first tier of first responders and frontline medical workers. We have recently opened two mass vaccination sites in Honolulu, as we move to the next tier, which includes the elderly population. Our COVID infection rate in the State of Hawaii is currently the second-lowest in the nation on a per capita basis. The tourism economy remains open with the requirement for a negative COVID test to avoid quarantine. The daily visitor arrival counts have recently been in the 5,000 to 8,000 range per day, but this is still significantly down compared to a year ago. We are optimistic that with the mass vaccination initiative, we will start to see a Hawaii economic recovery in 2021.

Thank you, Catherine. In the fourth quarter, excluding PPP loan pay-offs of $112 million, the bank grew its loan portfolio by $46 million, driven by growth in commercial, construction, residential mortgages, HELOC, and commercial mortgages. Our residential lending team continues to outperform with record levels of production, resulting in $5.4 million in mortgage banking income for the quarter. For the 2020 year, mortgage banking income was $13.7 million, which was more than double the income from the previous year, augmented by over $1 billion in loan production. During the fourth quarter, we received and processed a significant amount of PPP forgiveness applications, which resulted in the recognition of $5.4 million in fee income. We continue to process PPP forgiveness applications and recently started accepting new PPP loan applications for both first draw and second draw loans from our business customers. Additionally, our team continues to engage and remain steadfast in our support of our customers and the broader business community impacted by COVID-19. Core deposits during the fourth quarter increased by $132 million, which is consistent with year-end seasonal inflows augmented by our front-line business development efforts. For the 2020 year, core deposits increased by $787 million. Additionally, our cost of total deposits declined by 4 basis points from the prior quarter and is now down to 9 basis points. Providing best-in-class digital technology for our customers remains the key priority for us. In 2020, we launched our new consumer mobile and online platforms and completed the rollout of our new ATM fleet. We are seeing strong adoption and utilization of these new digital tools by our customers.

Thank you, Arnold. At year end, the loan portfolio totaled $4.96 billion, with 55% consumer and 45% commercial. During the quarter, we continued to monitor the loan portfolio and provided support to our customers as they continue to navigate through the ongoing changes in the marketplace. We assisted our customers by providing additional loan payment deferrals as needed, and we were pleased to see a significant number of borrowers resume making their monthly loan payments. At quarter end, the total balance of loans on payment deferrals declined to $120 million, or 3% of the total loan portfolio, excluding PPP balances. Our redeferral rate was 15% and was primarily driven by residential loans, where payment deferrals were extended to nine months. During the quarter, we saw a significant decline in consumer loans on deferral as customers returned to making loan payments. Of the approximately 4,200 consumer loans that returned to payments, only 7% were granted short-term loan modifications, with 93% resuming payment at contractual terms. In the commercial and commercial real estate loan portfolios, the total balance of loans on payment deferrals declined to $47 million, or 1% of the total loan portfolio, excluding PPP balances. The highest exposure by industry continues to be real estate and rental and leasing totaling $33 million, a decline of $14 million in the sequential quarter. The loans in the real estate and rental and leasing industry are supported by low loan-to-value ratios. The majority of these borrowers are expected to resume making loan payments at the end of their six-month loan payment deferrals. Loan payment deferrals for our high-risk industries totaled $12 million, or 0.3% of the total loan portfolio, excluding PPP balances. As of January 20th, our total balance of loans on payment deferrals decreased further to $101 million, or 3% of total loans, excluding PPP balances. Additional details on our loan payment deferrals can be found on Slides 20 and 21. During the quarter, criticized loans declined by $4.5 million sequential quarter to $192 million, or 4.2% of the total loan portfolio, excluding PPP balances. Special mention loans declined by $6.3 million to $142 million, or 3.1% of the total loan portfolio excluding PPP balances, and classified loans increased by $1.7 million to $50 million, or 1.1% of the total loan portfolios, excluding PPP balances. We sold a classified and non-accrual commercial real estate loan at par of $4.2 million and settled a payoff of another classified and non-accrual commercial real estate and commercial loan at 92 or $2.9 million. Approximately 32% of special mention balances and 10% of classified balances also received PPP loans. Additional details on loans rated special mention and classified can be found on Slides 22 and 23.

Thank you, Anna. Net income for the fourth quarter of 2020 was $12.2 million, or $0.43 per diluted share. Return on average assets in the fourth quarter was 74 basis points, and return on average equity was 8.87%. For the full 2020 year, net income was $37.3 million, or $1.32 per diluted share. Return on average assets was 0.58%, and return on average equity was 6.85%. Pre-tax pre-provision earnings for 2020 were $88.2 million compared to $84.2 million in 2019. 2020 pre-tax pre-provision earnings were the highest CPF has generated since the Great Recession. Our 2020 earnings were impacted by higher provision for credit loss expense due to the current COVID-19 pandemic. Additionally, in the fourth quarter, there were several one-time expenses which totaled $5.9 million. Net interest income for the fourth quarter was $51.5 million, which increased from the prior quarter due to accelerated recognition of PPP fee income as PPP loans were forgiven by the SBA. Net interest income included $6.3 million in PPP net interest income and net loan fees compared to $3.4 million in the prior quarter. The net interest margin increased to 3.32% in the fourth quarter compared to 3.19% in the prior quarter. The increase was due to the aforementioned PPP fee income recognition. The NIM normalized for PPP was 3.17 in the fourth quarter compared to 3.26 in the prior quarter. The decrease is due to lower loan and investment yields and the new subordinated debt interest expense. Fourth quarter other operating income totaled $14.1 million compared to $11.6 million in the prior quarter. The increase was primarily due to higher mortgage banking income of $1.1 million sequential quarter. Additionally, in the current quarter, we realized a gain on sale of securities of $0.2 million compared to a loss on sale of securities of $0.4 million in the prior quarter. Other operating expense for the fourth quarter was $45.1 million, which was an increase of $8.1 million compared to the prior quarter. The increase was largely driven by one-time expenses totaling $5.9 million, which related to employee incentives and benefits, branch consolidation costs, litigation settlement, debt prepayment fees, and other one-time expense accruals.

Thank you, David. In summary, Central Pacific continues to make positive forward progress on our strategy, while at the same time managed well through the COVID-19 pandemic. We have a solid financial, credit, liquidity and capital position. As the economic recovery gradually begins, we remain committed to supporting our employees, customers and the community. On behalf of our management team and employees, thank you for your continued support and confidence in our organization. At this time, we will be happy to address any questions you may have. Thank you. Back to you, operator.

First question comes from David Feaster of Raymond James. Please go ahead.

Hi, good morning everybody.

Hey, David.

Hi.

I wanted to start out on growth. Exclusive of PPP, loan growth was better than expected and it was great to see. And it seems like originations might be accelerating. Just curious what you are seeing on the loan demand front? How your pipeline is looking? And just maybe some expectations in terms of growth near-term and kind of is this mid-single digit rate reasonable for 2021?

Yes, thanks David. And as I’ve always touched on in prior quarters, one of the biggest changes of I think this past year has been, we fundamentally really changed the mindset, introducing a more sales culture and naturally we still have the practice and stance around credit, of course. But Arnold Martines has been really driving a lot of what we call our pipeline management. And Arnold, you probably have a good view on what kind of loan growth we can expect going forward. So maybe you can comment on that.

Yes, thanks. Thanks Paul. First of all, we’re very optimistic for 2021. Although there are still impacts here from COVID, we are looking forward to better days as we move into the year. And so our loan pipeline looks good as does our deposit pipeline as we move into the first half of the year. So we expect loan growth to be in the mid-to-high single digits.

And also David, this is Paul again. We have been very fortunate with a robust Hawaii residential market, and many new homeowners have been quite interested in the level of services that CPB has to offer, and we’re really gaining a lot of market share, especially on purchase mortgages.

Okay, that’s good color. And then maybe just elsewhere, where are you seeing strength and like within by segment? Can you just talk about the competitive landscape and what kind of pay-offs and pay-downs that that assumes? And then lastly, it was just kind of interesting to see the pretty decent growth out of the U.S. mainland, just curious your thoughts on the Hawaiian Islands versus the U.S. mainland growth?

Yes, I think, well before touching on the mainland, locally, I mean, given the type of coverage we achieved, especially with the PPP loans, that established a lot of new relationships for us and translated to many new opportunities. The real estate market, as referred to earlier, remains very strong. A third factor is really around this new mindset and culture that I think we have that’s driving a lot more business. It remains very competitive, but again, I think this organization has really stepped up a lot more and as Arnold touched on, it’s mid to high single-digit growth going forward. We feel pretty comfortable about that. Naturally, Hawaii is still facing specific challenges compared to the mainland, particularly given the downturn in the tourism industry. However, we’re really hopeful that with the vaccine and the heard immunity, it is expected that in the latter part of the year, tourists will come back and we’ll be able to resume even more exciting opportunities.

Alright, that’s helpful. And then just kind of following up on your – you guys were immensely successful in the PPP program and really – like you said, it’s driving a lot of customer acquisition. Just curious your appetite – you guys are already taking some applications, just curious your appetite for this next round of PPP and maybe kind of the volumes that you could expect out of there and whether you’re focused on using that as another customer acquisition tool?

Yes. So, we did have a really good effort last year. As you know, we did about 7,200 loans for over $550 million. So we’re looking very positively at this data as really tailwinds for us to be able to build new business relationships in the market. So, we have started taking in new PPP applications in this current round. We have received over 3,000 applications. Most of them are second draw applications.

And this is Paul. I might add that we are stipulating that companies coming to us with new applications do need to be customers of CPB, and we are already seeing many companies converting to CPB as a result, many thanks to our employees who did a great job on the first round of PPP. So, absolutely, David, this is one of the few ways of bringing new money into the state. We are, again, using technology, getting the teams together to step it up and ensure that we bring more money into the state, and I think the community and our customers and prospective customers are aware of that.

That’s sort of it. Thank you.

Sure. Thanks, David.

Thank you. Next question is from Andrew Liesch with Piper Sandler. Please go ahead.

Hey everyone. Good morning.

Good morning.

Hey Andrew.

Just wanted to talk about the consumer deferrals; you had, obviously, had some good comments this morning. But in the past, you referenced maybe something tying this with the higher unemployment rate. With how things have trended, have a lot of these concerns been alleviated or is there anything on the horizon that you see that might give you some pause?

I’ll start and then turn it to Anna for detail. But yes, you will have noted in the supplemental deck on Slide 20, just the improvement in the numbers for consumer deferrals and you see now that we’re just at $2.3 million and a 149 deferrals. And if you compare that to where we were last year, we were at a high at one point of over 4,000 consumer deferrals. So I think the reason for the improvement is certainly we had stimulus money coming into Hawaii. But the other is, there is some return of tourism and we reported earlier on the numbers, and so we do see visitors back and local residents out at restaurants. This of course increases employment levels and then the ability of consumers to repay on debt. The last thing I’ll share is that while we expected of those 4,000 consumers that were on deferral to need some kind of assistance or a repayment plan, there were really just a small number, maybe 300, that requested the repayment plans. All the others went back to payments per the contractual terms on the note.

Got it. Okay, that’s really helpful and encouraging. Thanks. I just want – then continuing on to mortgage banking, that line item is pretty strong this quarter. How is that pipeline shaping up? It sounds like there has been some good progress on the purchase side, taking market share. Yes, how do you see that business playing out for the next two quarters?

Yes. So – this is Arnold. It looks really, really good. In the fourth quarter, we had total originations of about $354 million, and that’s compared to $330 million in the third quarter. We believe the first quarter originations will be roughly $240 million and we anticipate the gain on sale income although to decrease, and the reason for that is because the spreads are starting to normalize, and we plan to shift some of the production, the originations to our portfolio. So that’s our plan for the first – going into the first quarter.

Got it. Did you say $350 million for the fourth quarter or $250 million?

For the fourth quarter, it was $354 million.

Got it, great. And then one other question, Arnold, you referenced some new digital products and services that looking forward to update us on. Anything you can maybe tease us with right now? What are the things that you are looking to launch or expand?

You know we are going to keep that for discussion later in future quarters. But stay tuned, we have some exciting things coming.

I thought that might be the response. Thanks for taking my questions. I’ll step back. Thank you.

Thank you.

Thank you. Next question from Jackie Bohlen of KBW, please go ahead.

Hi, good morning everyone.

Hi, Jackie.

Good morning.

Hi, just wanted to start with expenses. You made tremendous progress on RISE2020 and now that a lot of that work has been behind you and you’re going to start seeing more of the revenue benefits. Just wondering how you’re thinking about expenses both from a baseline to start with now that those costs are behind you, but also from just as you continue to implement these strategies, what kind of other growth we might see as offsetting some of that?

Yes. Hey Jackie, it’s David. I’ll start there. So, the fourth quarter total expenses were roughly $45 million, as we’ve discussed. There was about $6 million in there that we deem one-time, and it’s on a normalized basis. So, fourth quarter was roughly $39 million. What we’re guiding to going forward is a range of $39 million to $41 million. So a slight uptick from where we were in the fourth quarter on a normalized basis. And I know you mentioned that the RISE expenses are behind us. What I will state is that much of the RISE expense, the dollar RISE expense was capitalized. It was – a lot of it was in the building. And so while the work on RISE2020 is behind us, some of that expense is leading into the expense forecast going forward as we start amortization.

So Jackie, as we, and this is Paul Yonamine. As we mentioned before, for example, like the investment on the building infrastructure, it’s amortized over 39 years and we always take that into all of our forecasts. You know the other thing is that we were able to put in technologies that may be 10, 15 years ago used to cost an arm and a leg. Nowadays, everything is cloud-based and we’re able to go with best-in-class technology. But going forward, you pay for the licenses. But needless to say, those license costs also drive the top line. It becomes more accretive to us, especially as we get stickier with our customers. So again, RISE2020, the actual investment, so to speak, is behind us. We’re going to be recognizing costs, but we anticipate a lot of that to be very accretive for us in driving revenue.

Okay, thank you. That’s very helpful. And I mean I would guess that based on, and I realize that this was a very long-term guidance and there is inflation and everything else. So, the variance between the $39 million to $41 million versus the historical $36 million to $38 million that we had spoken about in many, many quarters past, is that primarily just the amortization and then general vesting compensation and everything else or is there anything else built into that?

Yes, Jackie, it’s what you mentioned and then it’s also a little bit of incremental investment in ourselves in further digital opportunities and in strategic areas of our team. We continue to build and invest in ourselves, as Paul mentioned, obviously to drive our future revenue. But that’s kind of the delta there.

Okay, thank you. And then just one last one, on the new buyback authorization, just curious on your thoughts regarding when you might look at starting that if it was more just to keep the flexibility on the table or if it’s something that’s in active discussion right now?

Yes. Jackie, it’s more of the former. We wanted to have the authorization in place, so it’s there for our use in the future. We are not restarting repurchases at this time, but we are hopeful that we will be able to later this year, and it will be somewhat a function of better visibility on the Hawaii economic recovery and the strengthening of our profitability. We did get a bit of good news on the economy this morning on the Hawaii, the state unemployment rate came out at 9.3%, which was down from mid-10%s in November and it’s dramatically down from – it peaked at 24% in April of last year and now we’re down to 9%. So that obviously is some good news.

Great. Thank you and congratulations everyone on having the renovated Plaza behind you. That must be really exciting, I guess. I, for one, can’t wait to see it in person once we are all up and traveling again.

Thanks, Jackie.

Thanks, Jackie.

Hey, Jackie. Just for your information, in addition to the earnings supplement on our IR webpage, there is an analyst package on the revitalization of the Plaza and our new online mobile banking platform.

Okay, great. I’ll look for that and take a look at those sites. Thank you.

Thanks Jackie.

Next question is from Laurie Hunsicker of Compass Point. Please go ahead.

Yes, hi. Thanks. Good morning.

Good morning, Laurie.

Anna, I wondered if I could start with you. So you mentioned that as of January 20th, deferrals were down even further to $101 million and I just wondered if you had a high-level breakdown in terms of the $101 million, what was the corresponding on consumer, on commercial, and if you have it on CRE, C&I, if you have it on residential consumer?

Yes, sure. I’ll start with residential that came down to $53 million and the commercial real estate came down to $40 million for C&I, down to $6 million, and consumer came down a little bit at $2 million.

Okay, $2 million. Okay, great. I mean your deferral trends are fabulous. So David, maybe just a question for you, as you all sit with very thick reserves ex-PPP, you are 183 basis points. Is it conceivable given what you’ve said on loan growth, given where your charge-offs are, and certainly this is making assumptions around COVID, but is it conceivable that we could be seeing you run at, round numbers at $3 million per quarter loan loss provision, how do you think about that?

Yes. Laurie, as we normally respond to this question, the quarterly provisioning is going to be a function of economic forecasts, net charge-offs, and loan migration trends, basically the performance of the portfolio. Again, we’re cautiously optimistic on the economic forecast front with the reduction in the unemployment rate. So I think it’s just going to be directionally consistent with what we see with the economic forecasts and our loan portfolio performance.

Okay. Okay, and then around NIM, stripping out the PPP, would you strip out just the $3 million to arrive at the 3.17%? In other words, you had $6.3 million of PPP in your net interest income this quarter, but $3 million was sort of the immediate recognition of forgiveness. I assume that – I did it round numbers and I came up with 3.18%. So, I’m assuming that for the 3.17%, you used $3 million, is that correct?

No, we used the $6.3 million, the number that’s in the earnings release.

You used the full $6.3 million to get down to 3.17%, okay.

Yes.

Okay, thanks for clarifying that. And then just the last question. So, three of the branches you closed were in-store branches. Can you just remind us of your 31 branches, how many are in-store branches, and just how you’re thinking about in-store branching?

So, Laurie, hi, it’s Catherine. So as you know we closed 3 of the 4 in-store branches, and the reason for that was those in-store branches were particularly small. We were not able to provide for the social distancing. But the other one in-store branch is larger, and we do intend to continue to operate that one.

Okay. So just to clarify, of your total 31 branches, you only have one branch left that’s in-store.

That’s in-store – that’s correct.

Got it. Okay, perfect. Thank you. I will leave it there.

Thanks, Laurie.

Thank you.

This concludes our question-and-answer session. I now like to turn the conference over to Mr. Paul Yonamine for any closing remarks. Please go ahead.

Great. Thank you very much to all of you for joining us this morning, and we look forward to further engaging with all of you. Thank you very much. Goodbye.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.