Central Pacific Financial Corp Q4 FY2022 Earnings Call

Good afternoon, ladies and gentlemen. Thank you for standing by. And welcome to the Central Pacific Financial Corp. Fourth 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 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, sir.

Thank you, Hannah, and thank you all for joining us as we review the financial results for the fourth quarter of 2022 for Central Pacific Financial Corp. With me this morning are Arnold Martines, our new President and Chief Executive 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 two of our presentation. And now I'll turn the call over to our President and CEO, Arnold Martines.

Thank you, David. Aloha, and good morning, everyone. We appreciate your interest in Central Pacific Financial Corp. As we normally do, I'll start with an update on the Hawaii market and a summary of our strong fourth quarter results. Then I'll turn it over to the team to provide additional detail and insights on our financial and credit metrics, as well as other key updates. The Hawaii tourism sector continues to perform well with visitor arrivals holding at about 90% of pre-pandemic levels. The majority of visitors are from the U.S. mainland. Visitors from Japan are about 20% of pre-pandemic levels, and we are optimistic that the Japan counts will continue to trend up as the country is now fully reopened, and the yen value has improved recently. The Japan government also upgraded its 2023 growth projections in December based on expectations for higher business expenditure, substantial wage hikes, and robust domestic demand. Japan may avoid the global growth slowdown, which will translate to greater visitors to Hawaii, helping offset a potential slowdown in domestic visitors. Hawaii visitor spending is strong, totaling $1.5 billion in November, an increase of 13.7% compared to the same month in 2019. Hotels in Hawaii continue to perform well, with total statewide wholesale occupancy at 71% and an average daily rate of $440 in December, up 4% from a year ago. Hawaii's employment and housing sectors remain solid. Our statewide seasonally adjusted unemployment rate was at 3.3% in November 2022, and is forecasted by the University of Hawaii Economic Research Organization to be fairly stable in 2023. Housing prices in Hawaii remain very strong, with a total Oahu median single-family home price at $1.1 million in 2022, which is up 11.6% from the previous year. Reflecting a national trend, home sales have cooled in 2022 due to rising mortgage rates. The number of single-family home sales was down 23% in 2022 compared to a year ago. We view this as more of a moderation in the market and believe the Hawaii housing market remains healthy with continued strong demand and low inventory. This combined with the fact that tourism is expected to remain strong and the Hawaii economy is also supported in a significant way by a huge and growing military presence, it is our strong belief that Hawaii is less likely to experience a material downturn compared to most other U.S. markets. Overall, we remain optimistic about the Hawaii market and believe CPF will continue to be successful as we remain focused on our strategic pillars, including home ownership, small business, digital adoption, and Japan market development. Moving to our financial results, we ended 2022 with solid loan and deposit growth, an increase in net interest income, and strong expense management, which resulted in an improved bottom line. Our total loan portfolio increased by $133 million or 2.5% sequentially. For the full year 2022, the loan portfolio grew by $454 million or 8.9%. The growth was diversified across all loan types as we continue to focus on prudent and appropriately priced asset growth. We have a healthy loan pipeline and anticipate continued strong loan growth in 2023 in all loan categories except Mainland, unsecured consumer. In Q4, we began to let our Mainland unsecured consumer loan portfolio runoff until the national economic outlook improves. With that said, we expect the runoff in our unsecured consumer book to moderate overall loan growth in 2023, which we expect to be in the mid-single digit percent range. During the fourth quarter, total deposits increased by $180 million or 2.7% from the prior quarter as we were successful in acquiring significant time deposits, which enabled us to reduce our borrowings and manage our funding costs. While deposit rates have increased somewhat, the Hawaiian market continues to be rational on deposit pricing. CPB's strong and stable core deposit base enables us to keep deposit repricing betas low, consistent with past tightening cycles. Going into 2023, we have already started to implement strategies to not only retain deposits but to garner a larger share of core deposits to fund our future asset needs. Finally, I'm personally very excited to start 2023 in my new role as President and CEO. I anticipate a smooth transition with our talented and experienced leadership team. Lastly, I could not be more proud of our exceptional group of employees who remain steadfast in our mission to help meet the needs of our customers and the broader community. I'll now turn the call back over to David Morimoto, our Chief Financial Officer.

Thank you, Arnold. Turning to our earnings results, net income for the fourth quarter was $20.2 million or $0.74 per diluted share. Return on average assets was 1.09%. Return on average equity was 18.30%, and our efficiency ratio was 59.56% in the fourth quarter. For the full 2022 year, net income was $73.9 million or EPS of $2.68. Importantly, full year 2022 pretax, pre-provision income excluding PPP income increased by $29.1 million or 45% year-over-year. Net interest income for the fourth quarter was $56.3 million, an increase of $0.9 million from the prior quarter as our increase in loan balances and yields outpaced the increase in our funding costs. The reported net interest margin remained flat at 3.17%. When excluding the impact from PPP, the net interest margin increased by three basis points sequentially. Our total cost of deposits was 41 basis points in the fourth quarter. We continue to manage the positive repricing to product segmentation, and thus far our interest-bearing deposit repricing beta has been approximately 15%. Fourth quarter other operating income was $11.6 million, which increased by $2 million from the prior quarter, primarily due to higher BOLI income. This included certain non-recurring debt benefits totaling $0.6 million, as well as the higher income driven by equity market gains. Other operating expenses totaled $40.4 million in the fourth quarter, down $1.6 million from the prior quarter. The decrease was primarily driven by one-time lower occupancy and advertising costs totaling approximately $1 million. Our expense run rate will increase modestly in 2023 to the range of $40.5 million to $42.5 million per quarter as we continue to invest in our people, facilities, and technology. Despite that, we expect positive operating leverage, which will drive a lower efficiency ratio over time. Our effective tax rate declined to 24.9% in the fourth quarter as a result of higher 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 fourth quarter, we repurchased 241,000 shares at a total cost of $4.9 million for an average cost per share of $20.41. The Board of Directors approved a new annual share purchase authorization of up to $25 million for 2023. Additionally, our Board of Directors declared a quarterly cash dividend of $0.26 per share, which will be payable on March 15th to shareholders of record on February 28th. And now I'll turn the call over to Anna Hu, our Chief Credit Officer.

Thank you, David. Our asset quality remains solid in the fourth quarter. Our loan portfolio is strong and well diversified with over 75% real estate secured with a weighted average loan-to-value ratio of 63%. We continue with our conservative underwriting policies, including tight loan-to-value and concentration standards, and 83% of our loan portfolio is in Hawaii. For the lending we do on the U.S. Mainland, loans are typically commercial and commercial real estate participation with larger banks in markets we are familiar with, and our consumer purchases are from established lending partners. All Mainland loans meet our credit underwriting guidelines. We believe we have minimal exposure to sectors that could be impacted by an economic downturn. Our construction portfolio is just 3% of total loans, and our Mainland consumer unsecured portfolio is 3% of total loans. At December 31st, non-performing assets to total assets were 7 basis points, or $5.3 million. Total criticized loans were just 1.4% of total loans. Our net charge-offs were $1.7 million for the fourth quarter, which equates to 12 basis points annualized as a percent of average loans. Our allowance for credit losses was $63.7 million or 1.15% of outstanding loans. In the fourth quarter, we recorded a $0.6 million provision for credit losses due to loan portfolio growth and net charge-offs. Now, I'll turn the call back to Arnold.

Thank you, Anna. Central Pacific Bank had a great year in 2022, and we continue to be well-positioned to continue delivering strong performance in 2023. We have prudent and disciplined risk management and the right leadership team to move us forward as we continue to create shareholder value for our investors. 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.

The first question is from David Feaster with Raymond James. Please proceed.

Hey, good morning, everybody.

Hi, David.

Maybe just starting on the funding side and talking about some of the competitive dynamics that you're seeing in Hawaii. You talked about it being a more rational market, and that's what we've seen historically. Just curious how you think about deposit growth and the competitive dynamics there? And any other updates on your deposit initiatives that you've been working on, both from the Japanese and tech sides? And just any thoughts on deposit growth to fund the loan growth that you talked about?

Thanks, Dave. This is Arnold, and I'll start, and then David may want to add comments as well. As I mentioned earlier, we successfully brought in about $180 million, primarily from our time deposit campaigns in Q4. We view this as a positive outcome, as the time deposit rates we offered were better alternatives compared to the wholesale borrowing costs we were facing, despite the overall increase in deposit rates. The ongoing effects of the Federal Reserve's tightening and changes in the yield curve on deposit bonds are still to be determined. We are actively managing our funding sources to optimize our performance in this environment. Regarding our focus, we are committed to increasing our core deposits. Our development in Japan is progressing well; we now have about $1 billion in deposits there, an increase of about $22 million from the previous quarter. We are optimistic about the opportunities for attracting deposits from Japan as the market opens up. While it is a challenging environment, our team is effectively managing funding costs in the short term, and we believe we are well positioned in the long run. David, would you like to add anything?

Yeah. Maybe just a couple of points. We're fortunate, obviously, to have a strong core deposit franchise that provides over $6 billion in stable, relatively low-cost funding. As Arnold mentioned, in the current rate cycle, we are proactive in using CD specials to retain some more rate-sensitive balances with CPB while also attracting new deposit balances at reasonable cost. Our deposit pricing strategies that we're implementing in this rate cycle are very similar to what we used in the 2015-2018 rising rate cycle. Those strategies were successful then, and we expect similar results. I think finally, if you exclude government deposits from the sequential quarter growth, customer deposits grew $85 million or 5.3% linked-quarter annualized, and I think that's pretty good performance in this operating environment.

No, absolutely. Relating this to loan growth and improved pricing, how do you view rate sensitivity and the trajectory of net interest margin moving forward? As we maintain discipline on the deposit side with increasing beta in a more rational market, while assets continue to reprice higher, I'm curious about your ability to protect the margin and the net interest margin trajectory as we progress throughout the year.

Yeah. Hey, David. It's David again. Yeah. We did achieve 3 basis points of core sequential quarter NIM expansion. Obviously, the velocity of the NIM expansion has been slowing as we've been seeing throughout the industry. The guidance for net interest margin right now is 310 to 320, so it's guiding to a flattish NIM going forward.

Okay. That makes sense. And then, just wanted to get your updated thoughts on the Swell Banking as a Service initiative and where we are there. Your thoughts on expansion at this point and whether Elevate sale impacts that partnership at all?

Sure. Good question, David. Swell is currently in pilot testing. It's – like it's an invitation-only, so the app is available, it's operating, but we're only inviting customers from the Swell waitlist to join. And it's in beta testing. There are about a hundred customers that are currently on the platform. We're actually preparing to do a little bit of a wider launch in the first half of 2023. We're going to do a lot of test marketing and customer acquisition beginning in the first half of this year. But as we've talked about over the last several quarters, we've really slowed down the rollout of Swell as a result of what we've been seeing in the broader FinTech market. Obviously, there's been a lot of turmoil in the market. The operating environment is not the greatest for launching new FinTech initiatives. So, we've decided to slow down, and we're observing what's happening in the FinTech marketplace. The Swell strategy has pivoted slightly. Rather than just broad customer acquisition, we're now focused on looking for profitable customers. So, rather than millions of unprofitable customers, we're looking for a smaller number, a hundred thousand or profitable customers. We think that's a better business model than what we've been seeing more broadly in the FinTech space.

Yeah. I think that makes complete sense. But does the sale of Elevate impact that partnership at all, or is it kind of a non-event?

Yeah. Sorry. I forgot about that part, Dave. So, as you know, Elevate is looking to be sold to Park Cities Asset Management. Park Cities Asset Management is the private equity money behind Swell. So, Park Cities has a long history of working with Elevate prior to the Swell initiative, and then Park Cities was the largest outside investor in the Series A round of Swell. So, Park Cities is a very familiar entity to Elevate, Swell, and CPB. So, it does not affect the plans for Swell going forward.

Okay. Terrific. Thanks, everybody.

Thanks, David.

Thanks, David.

Thank you, Mr. Feaster. The next question is from Andrew Liesch with Piper Sandler. Please proceed.

Hey, everyone. Good morning.

Hi, Andrew.

I want to discuss the deposit mix. A significant portion of the increase came from our successful CD campaign. How should we view deposits moving forward? Should we expect them to align with loan growth as they did this quarter, and do you think there will be a greater focus on CDs? Additionally, over time, do you anticipate the mix of CDs and non-interest-bearing deposits returning to pre-COVID levels? I'm curious about how you envision changes in the funding mix.

Yeah. Andrew, this is Arnold. I'll start by just saying that I think, near term, we're probably going to see a 50/50 mix of time deposits and core. Core coming really from new acquisitions, new customer acquisitions, tough market right now. As I mentioned earlier, I don't see this as a near-term dynamic that every bank has to manage through. I don't see this as a longer-term issue. I think we're going to get back to where we were pre-pandemic as the Fed starts to ease rates in the future. But it's going to be a little bit of a journey, and we're just going to manage that effectively in the near term. I'm not sure if David wants to add anything.

Just maybe one additional point, Andrew. On DDA, there's obviously a lot of interest in DDA. DDA as a percent of total deposits at the end of 2019, so pre-pandemic, was 28% of total deposits. At the end of last year, it was 31%. So, there's a 3% differential to pre-pandemic. That's about $200 million in deposits. We think our baseline DDA ratio should be higher than pre-pandemic due to our outperformance on PPP lending. So, we're thinking maybe we have $50 million or $100 million more normalization on DDA balances, and obviously we're doing everything we can to keep that to the lower end of that range.

Gotcha. That's really helpful color. Thank you. And then, just related to that your margin guide, is that for the quarter or for the next several quarters or for the year? Just curious what that 310 to 320 range is good for?

Yeah. Generally, it's for the next couple of quarters. That's what we're looking at. Obviously, an operating environment is very volatile and a lot of things can change, but that's what we're guiding for the next couple of quarters, Andrew.

Certainly, that makes sense. And then good to see the new buyback. I guess, how active do you intend to be? You've been pretty active the last couple of quarters. Is a similar pace of repurchases reasonable, or I guess kind of how are you looking at that?

Yeah. I would say similar. We've been repurchasing about 200 to 250 thousand shares per quarter, spending roughly about $5 million on repurchases combined with $7 million in quarterly cash dividends. So that's roughly the 60% return of net income that we've been targeting.

Gotcha. That is really helpful. Thank you for all my questions. I'll step back. Thanks.

Thanks, Andrew.

Thank you, Mr. Liesch. The next question is from Laurie Hunsicker with Compass Point. Please proceed.

Yeah. Hi. Good morning. Just maybe circling back to where David was asking on Swell, can you quantify a little bit more where your Swell balances are as of December 31st? It sounds like there are not a lot there. But when you talk about ramping it up in 2023, what does that look like? And then, I guess off of that, I thought you were ceasing Mainland unsecured consumer. So, is this pilot testing then just in Hawaii, or help us think about that? Thanks.

So, Laurie, this is Arnold. Good morning. I'll start with the Mainland unsecured consumer before handing it over to David to discuss Swell. As I mentioned earlier, we are suspending Mainland consumer unsecured purchases until we see an improvement in the national economic outlook. Therefore, there will be a full suspension of Mainland consumer unsecured in the near term. However, in Hawaii, we remain very active in the consumer market and we're also looking into auto loans, which we consider to be an acceptable risk based on our past experiences during the last recession when the data points indicated good performance. Overall, we are open to auto loans, but for now, we will continue the suspension of Mainland unsecured consumer purchases until the national outlook improves. Now, I will turn it over to David to discuss Swell.

Just to clarify, when Arnold mentioned suspending Mainland unsecured, he was referring to the purchase side. We're not suspending Swell; we are continuing its careful and gradual rollout. At the end of the year, we had fewer than a hundred customers using the platform, with aggregate deposit balances likely under 20,000 and loan balances below 5,000. These figures are quite small at this stage. We plan to conduct some test marketing in the first half of 2023, but we do not expect the balances to be significant. That’s our current status. We're not suspending Swell. Do you have any follow-up questions about Swell?

Yeah. So, in other words, I guess as we think looking out to 2023, and you said you would ramp it up, that you're obviously not going to stay at 5,000 in loans. I guess, the question is, what are you taking that to? Are you taking it to $5 million? Are you taking it to $25 million? How are you thinking about that?

Laurie, I would say that Swell balances are not going to exceed $10 million anytime soon.

Perfect. That's what I was looking for. Okay. That's helpful. And then, just on the unsecured Mainland consumer book that I have that at $310 million at September, what is that as of December 31st? And then, can you help us think about, I mean, your credit is pristine outside of consumer? The consumer piece, it looks like you had $1.07 million of charge-offs. $1.03 million of it came from consumer. Can you help us think about, of that $1.03 million, how much came from the Mainland piece? So just what is your Mainland unsecured consumer at December 31st and then, can you help us think about how much of the Mainland charge-offs were in total? Thanks.

Hi, Laurie. Good morning. So, for our consumer unsecured book at the end of the fourth quarter, it was just about $316 million. So, we did increase slightly from the 310 we talked about at the end of the third quarter, and that was because we had a couple of orders in place that we did need to fulfill. But we did go ahead and really suspend any additional purchases for the rest of the quarter. With regards to the charge-offs, about $900,000 is from the Mainland consumer book. The breakdown was about $200,000 in auto, about $280,000 in home improvement, and about $450,000 in our unsecured consumer. And that's all related to the Mainland consumer.

Perfect. That's great. Thank you. And then just going back to margin, David, do you have a spot margin for December?

Yes. In December, the spot was 317, which remained consistent with the full quarter. To provide more detail, the costs for spot interest-bearing deposits in December were 73 basis points, representing a month-over-month increase of 10 basis points. Meanwhile, December loan yields were 420, reflecting a month-over-month increase of 12 basis points. All of this data supports the stable net interest margin guidance that we provided.

Perfect. That's helpful. Thank you. I'll leave it there.

Thanks, Laurie.

Thank you, Ms. Hunsicker. There are no additional questions waiting at this time. So, I will turn the call over to Arnold Martines for any further remarks.

Thanks a lot. Thank you very much for participating in our earnings call for the fourth quarter of 2022. We look forward to future opportunities to update you on our progress.

That concludes today's call. Thank you for your participation. You may now disconnect your lines.