Central Pacific Financial Corp Q3 FY2023 Earnings Call

Good afternoon, everyone. Thank you for being here. Welcome to the Central Pacific Financial Corporation Third Quarter 2023 Conference Call. This call is being recorded and will be available for replay soon on the company's website. I will now hand the call over to Ms. Dayna Matsumoto, Group Senior Vice President and Director of Finance and Accounting. Please proceed.

Thank you, everyone, for joining us as we review the financial results of the third quarter of 2023 for Central Pacific Financial Corp. With me this morning are Arnold Martines, President and Chief Executive Officer; David Morimoto, Senior Executive Vice President and Chief Financial 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. 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 President and CEO, Arnold Martines.

Thank you, Dayna, and aloha, everyone. We appreciate your interest in Central Pacific Financial Corp. As we normally do, I'll start with an update on the Hawaii market, 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 wildfire in Lahaina, Maui in August was devastating, and I want to first thank our employees, customers and all of you for your continued support. While it will be a long road to recovery, Maui is strong and resilient. Central Pacific Bank is committed to servicing and supporting our Maui community to the fullest. We were fortunate that our Lahaina branch was unimpacted by the fires and reopened in late August, which enabled us to help meet the needs of the community. The Hawaii tourism industry has been affected by the Maui wildfires, with a significant drop in visitor arrivals to Maui in August compared to a year ago. With government officials now encouraging visitors back to Maui, we hope the negative impacts will be short-lived and that Maui visitor counts will return to normal. Fortunately, we continue to see increases in visitors to the other islands, and overall, the Hawaii state economy is expected to have limited impact. In the month of August, a total of 769,000 visitors came to the State of Hawaii, which was down 7% from a year ago and 83% of pre-pandemic levels. Total visitor spending was $1.58 billion in August, down 9% from a year ago, and up 5% from August 2019. Total statewide hotel occupancy in August was 74%, down 3% from a year ago, with an average daily rate of $370, down 4% from a year ago. Hawaii's statewide seasonally adjusted unemployment rate continued to decline to 2.8% in September, outperforming the national unemployment rate of 3.8%. Year-over-year statewide nonfarm payroll increased by 6,600 jobs or 1.1%. Unemployment claims may have surged following the fires, but are expected to gradually recede with government leaders focused on supporting businesses and reopening areas of West Maui unaffected by the fires to help restart the island's economy. Real estate values in Hawaii continue to hold up firmly. The Oahu median single-family home price remains at $1.1 million and the median condo sales price was $533,000 in September. While home sales volumes continue to be down year-over-year, there is still strong demand and limited inventory, with properties staying on the market for a median of 20 days. Forty-seven percent of single-family homes sold at or above the original asking price in September, indicating the sustained demand and strength of Hawaii real estate despite mortgage rates reaching levels higher than we've seen in the last 20 years. Strong construction activity in Hawaii continues to drive economic growth. Our governor recently issued an emergency proclamation on housing that will help accelerate housing development to address the lack of inventory and affordable housing in the state. Additionally, major infrastructure improvement projects as well as large federal military projects continue to be on the roadmap for the state. On top of this, Maui reconstruction efforts will be a priority and the state will need to balance construction worker demand with a likely increase in construction costs. In the third quarter, we continued our focus on growing relationship-based deposits and I'm pleased to say that we were once again successful in growing total deposits. As part of our strong risk management focus, we continue to moderate loan growth. But with that said, our loan portfolio churn is resulting in favorable repricing and deposit costs continue to be managed at levels lower than our peers. I'll now turn the call over to David Morimoto, our Chief Financial Officer.

Thank you, Arnold. Turning to our earnings results. Net income for the third quarter was $13.1 million or $0.49 per diluted share. Return on average assets was 0.70%. Return on average equity was 10.95%, and our efficiency ratio was 63.91%. During the third quarter, we continued to strengthen our balance sheet and liquidity positions with a quarter-end cash position in excess of $400 million and total deposit growth of $69 million. Average total deposit balances also grew by $63 million in the sequential quarter. Our loan portfolio remained relatively flat during the quarter as we selectively grew certain portfolios with appropriate risk-reward opportunities and continued to add to other portfolios while managing runoff. We remain on hold with our Mainland unsecured consumer portfolio as we continue to monitor the national economic outlook and the ongoing performance of consumer lending. We remain nimble and well-positioned for future opportunities when the operating environment improves. Net interest income for the third quarter was $51.9 million and decreased by $0.8 million from the prior quarter, primarily due to higher funding costs. The quarter-over-quarter decrease in net interest income continues to narrow as assets reprice upward and the pace of deposit cost increases stabilizes. The net interest margin was 2.88% in the third quarter, a decline of 8 basis points sequentially. Our total cost of deposits was 108 basis points in the third quarter, and our cycle-to-date total deposit repricing beta was 21%, which remains within our expectations. With the current higher-for-longer interest rate forecast, the pay-fixed received float interest rate swap that we put on last year continues to increase in value and will support our future earnings. The swap payments will begin on March 31, 2024, and it is currently 340 basis points in the money on a notional balance of $115.5 million. Third-quarter other operating income was $10 million, which decreased by $0.4 million from the prior quarter, primarily due to lower BOLI income driven by equity market volatility and offset by lower deferred compensation expense. Other operating expenses totaled $39.6 million in the third quarter, a decrease of $0.3 million from the prior quarter. The decrease was primarily due to lower salaries and employee benefits related to deferred compensation as well as the ongoing management of our FTE count. Our effective tax rate was 24.9% in the third quarter, and we continue to expect it to be in the 24% to 25% range going forward. Our Board of Directors declared a quarterly cash dividend of $0.26 per share, which will be payable on December 15th to shareholders of record on November 30th. During the third quarter, we repurchased a nominal 4,500 shares at a weighted average price of $16.7. And now I'll turn the call over to Anna Hu, our Chief Credit Officer.

Thank you, David. Our asset quality remained strong in the third quarter, with nonperforming assets at 9 basis points of total assets and criticized loans at 1.09% of total loans. Our loan portfolio continues to be well-diversified by loan type and industry sectors. Over 75% of the loan portfolio is real estate secured with a weighted average loan-to-value of 60%. Our commercial real estate portfolio represents 25% of total loans and is diversified across all asset types, with 5% of this portfolio maturing over the next 12 months. Our CRE office and retail exposure remains low at 3.5% and 4.5% of total loans, respectively. The office portfolio has a weighted average loan-to-value of 55% and 73 weighted average months to maturity. The retail portfolio has a weighted average loan-to-value of 65% and 64 weighted average months to maturity. The US Mainland loan portfolio declined in the third quarter to 16% of total loans, which included a continued decrease in the Mainland consumer portfolio to $345 million or 6% of total loans as of September 30th. Our loan exposure to the Lahaina, Maui area was a manageable $111 million or 2% of total loans before the wildfires in August. Since then, balances have paid down slightly to $107 million or 1.9% of total loans. We estimate that $78 million of the total Lahaina, Maui loans outstanding were not impacted by the fires as of September 30th. Additional updates continue to be collected from our borrowers. Insurance, FEMA and unemployment benefit assistance processing also continues. To support our borrowers, we have provided three to six-month loan payment deferrals and have granted total deferrals on 142 loans totaling $32.7 million in balances. Overall, at this time, we do not anticipate material credit impacts from the Maui wildfire and will continue to monitor the situation. Net charge-offs were $3.9 million for the third quarter, which equates to 28 basis points annualized as a percent of average loans. The increase in net charge-offs was primarily from our maintenance unsecured consumer portfolio, which has lower recoveries. We believe the losses are leveling off due to the seasoning of the portfolio and performance remains within our original expectations. Our allowance for credit losses was $64.5 million or 1.17% of outstanding loans. In the third quarter, we recorded a $4.5 million provision for credit losses on loans primarily due to net charge-offs, and a $0.4 million provision for unfunded commitments, resulting in a total provision for credit losses of $4.9 million during the quarter. Overall, given our strong risk management culture and history of conservative underwriting policies, our loan portfolio remains well positioned to withstand near-term pressures from the environment. We continue to monitor the economic environment closely and are being selective and thoughtful about the loans we're adding to our portfolio. Now I'll turn the call back to Arnold.

Thank you, Anna. In summary, we continue to execute on our strategies as we navigate the current environment. Our liquidity, capital, and credit remain solid, and our teams continue to focus on building relationships and serving our community. 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.

And we will take our first question from Andrew Liesch with Piper Sandler.

I just want to take a look at the margin here, kind of right in line with the guidance. Are you still thinking that between north of 380 is a good place to be here before maybe it bottoms out and maybe stabilizes next year?

I'll just say good morning to you, and then I'll pass it on to David.

Andrew, yes, we are pleased with the margin performance right within management's prior guidance. I think the guidance for the next couple of quarters, we're lowering the guidance range by a nickel, so $2.75 to $2.85 range, but we're cautiously optimistic that we can stay above 280. And then as far as the trough in the NIM, I think if the Fed stands pat in the fourth quarter, we're projecting the NIM trough probably in the first quarter. If there is additional tightening, that may get pushed out to the second quarter. So first half of 2024 trough for the NIM.

Is it just the liabilities repricing faster than you thought pushing down the NIM guide?

Yes, it's being cautious. Again, it's being cautious and we're hopeful that we can stay above 280.

And then on loan growth, balance is stable. You guys have been talking about stable balances for a while, stable-ish. Is that kind of the right place to look at it here, continued pay-offs of the Mainland book based on pretty good production locally in Hawaii? I guess, how is the pipeline for the Hawaii production, and is that going to be sufficient enough to offset those pay downs?

Yes, you're right. We are continuing to moderate loan growth. We're being very selective. Again, David mentioned it in his prepared comments that we're looking for risk-reward balance in this environment. I would just add that despite the fact that we're remaining flattish, we do have about $150 million to $170 million of churn every quarter. And we are replacing that with market rate loans. So I think the repricing from that aspect as well as the overall repricing of our loan portfolio will help us over the next few quarters.

And Arnold, if I may add, Andrew, to give you some color, new loan yields in the third quarter, the weighted average was 7.5%, and that compares to the portfolio yield of 4.5%. So significant upward repricing, similar in the investment portfolio. New investment yields, opportunities to the extent where we're investing is roughly 6% versus the portfolio investment yield of 2.10. So as Arnold mentioned, nice repricing opportunities in the asset side of the balance sheet.

And we will take our next question from David Feaster with Raymond James.

Maybe just kind of following up on the higher for longer environment. I'm curious how do you think about balance sheet management, assuming we stay here in a higher for longer environment? You guys built some liquidity this quarter? And I appreciate the margin discussion in the short run. But assuming we stabilize in the first quarter and hit that trough, again, assuming we stay in this higher for longer type of environment, how do you think about the pace of margin expansion given the repricing dynamics that you talked about and hopefully stabilizing funding costs?

Yes, I think the margin expansion would be moderate to begin with. But I think the wildcard there will be our ability to stabilize deposit balances and have them start to grow more consistently and start to see growth in more core deposit categories. So if we can stabilize and start growing core deposits, that may give us the opportunity to grow the loan portfolio a little more, returning to more normal type of loan growth, and that will help the NIM expand. So a lot of it depends on what happens on the liability side.

Could you discuss some of the trends you're observing in core funding? We're seeing increased migration, and I would like to know more about the underlying trends, the current state of core deposit pricing, and your outlook on deposit balances in your discussions with clients and your strategy to gain market share?

Like the industry, we've been — the deposit remix has continued. The positive here is we see the rate of change starting to moderate and slow. DDA balances, as a percent of total, are returning back to 2019 levels. So the risk of migration is diminishing. And I think that's what gives us some cautious optimism on the net interest margin. As far as deposit flows, it is like everywhere; the battle for core deposits is real. We are grateful that we have great customer relationships and we've been fortunate to deepen some of those relationships, while we have been able to grow some new relationships, and we expect that to continue.

Regarding credit, I wanted to address the stabilization you've mentioned in the consumer segment. I'm curious about the loan sales that occurred this quarter and how you are approaching credit and asset quality management. Are you anticipating any further loan sales? Additionally, as you assess your overall portfolio, what areas are you monitoring more closely, and do you have any concerns about proactively managing credit in the future?

David, we'll turn to Anna to respond to your questions.

So with regards to a broader outlook, we continue to focus on consumer. We have been focused on watching the Mainland consumer performance, but we are also watching the Hawaii performance. There's also the Lahaina, Maui wildfire, in which we are continuing to work with our customers. We're not expecting significant impact there but we are monitoring the return of tourism and just a general outlook for that island specifically with regards to our consumer portfolio. The rest of the portfolio continues to do well. We are not concerned with any aspects of the different product types that we currently have. So overall, that's — yes, the focus is really on consumer, both Mainland and Hawaii.

And there are no further questions at this time. So I will now turn the call back to Mr. Arnold Martines for closing remarks.

Thank you, everyone, for participating in our earnings call for the third quarter of 2023. We look forward to future opportunities to update you on our progress.

And ladies and gentlemen, this concludes today's call, and we thank you for your participation. You may now disconnect.