Earnings Call Transcript - CPF Q3 2025

Operator, Operator

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the Central Pacific Financial Corp. Third Quarter 2025 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. I would like to turn the call over to Mr. Jayrald Rabago, Senior Strategic Financial Officer. Please go ahead.

Jayrald Rabago, Senior Strategic Financial Officer

Thank you, Dustin, and thank you all for joining us as we review the financial results of the third quarter of 2025 for Central Pacific Financial Corp. With me this morning are Arnold Martines, Chairman, President and Chief Executive Officer; David Morimoto, Vice Chairman and Chief Operating Officer; Ralph Mesick, Senior Executive Vice President and Chief Risk Officer; Dayna Matsumoto, 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 earnings release and is available in the Investor Relations section of our website at cpb.bank. During the course of today's call, management may make forward-looking statements. While we believe these statements are based on reasonable assumptions, they involve risks that may cause actual results to differ materially from those projected. For a complete discussion of the risks related to our forward-looking statements, please refer to Slide 2 of our presentation. And now I'll turn the call over to our Chairman, President and CEO, Arnold Martines. Arnold?

Arnold Martines, Chairman, President and CEO

Thank you, Jayrald, and aloha to everyone joining us today. I want to begin by expressing our sincere gratitude for your continued interest and support of Central Pacific Financial Corp. We are pleased to report that our bank delivered strong results this quarter. We remain well positioned to pursue our strategic objectives while maintaining flexibility to navigate economic headwinds with a high-quality, well-capitalized balance sheet and strong liquidity. Our foundation is solid, and our focus is on exceptional customer experience, disciplined growth, sustainable profitability and long-term value for our shareholders. While Hawaii's economy is experiencing some softness in tourism due to U.S. trade policies, our market has historically proven resilient. Ongoing construction and military spending continue to provide meaningful support, helping to stabilize the local economy. This quarter, our results were highlighted by deposit and loan growth, margin expansion and the strategic consolidation of our operations center into our main headquarters, which positions us for improved collaboration among employees and future efficiencies. We also announced a strategic partnership with the Kyoto Shinkin Bank, strengthening economic ties between Hawaii and Japan's Kyoto region. This collaboration will create new opportunities for our small and midsized customers, enhancing growth prospects and reinforcing our commitment to supporting business development. At Central Pacific, our vision is to be a bank that people want to invest in, work for and partner with. For our employees, this means fostering a workplace where talent can thrive. For our customers, this means providing exceptional experience with safe, reliable and accessible financial solutions that help them achieve their goals. And for our shareholders, this means delivering consistent attractive returns, distributing income responsibly and building long-term value. Our governing objective is anchored in disciplined capital stewardship. Our strategy is focused on optimizing bottom line returns while maintaining a high level of liquidity and prudent levels of capital. We achieved this through thoughtful capital allocation, measured risk taking and ethical business practices. Operationally, we are building a resilient business model designed for steady returns rather than short-term gains. Our balance sheet strategy is focused on enhancing composition, improving risk-adjusted returns, shortening duration and increasing diversification across products and geographies. In essence, our focus is on four priorities: enhancing our products to better serve customers and capture growth opportunities, building the strongest team possible to execute our strategy effectively, strengthening the balance sheet to deliver durable profits and solid returns and growing the business prudently through disciplined programmatic strategies. We are confident that this approach positions Central Pacific for continued long-term success and value creation for our shareholders. With that, I'll turn the call over to David. David?

David Morimoto, Vice Chairman and Chief Operating Officer

Thank you, Arnold. Our balance sheet growth strategy continues to focus on deepening customer relationships and increasing market share within our core Hawaii market. As expected, in the third quarter, we reported solid net growth with loans increasing by $77 million and deposits by $33 million. The Hawaii loan portfolio saw growth in commercial, commercial mortgage and construction loan types, which was offset by runoff in residential mortgage and home equity. The Mainland loan portfolio also saw solid growth in commercial mortgage and construction. While this quarter's growth was led by Mainland activity, we anticipate a more balanced contribution between Mainland and Hawaii markets moving forward. We continue to operate within our historical range of Mainland loans, maintaining 15% to 20% of total loans in that segment. Average yields on total loans increased 5 basis points to 5.01% compared with the prior quarter. Our loan pipeline remains healthy, and we continue to expect full year loan growth in the low single-digit percentage range for 2025. Deposit growth of $33 million brought total deposits to $6.6 billion, reflecting both business development wins and deposit stabilization following recent interest rate volatility. While period-end noninterest-bearing DDA deposits experienced normal fluctuations, we are pleased to see continued growth in average noninterest-bearing deposits. The average rate paid on total deposits remained steady at 1.02% as the Fed rate cut occurred late in the quarter. Overall, these results demonstrate the continued strength and resilience of our balance sheet and our commitment to disciplined growth and long-term value creation for shareholders. With that, I'll turn the call over to Dayna.

Dayna Matsumoto, Executive Vice President and Chief Financial Officer

Thanks, David. In the third quarter, we reported net income of $18.6 million or $0.69 per diluted share. Excluding $1.5 million in onetime pretax office consolidation costs, adjusted net income was $19.7 million or $0.73 per diluted share. ROA was 1.01% and ROE was 12.89%, underscoring disciplined execution in the current environment. Net interest income rose 2.5% from the prior quarter to $61.3 million, and net interest margin expanded 5 basis points to 3.49%, primarily driven by higher average yields on loans. There was approximately $230 million in loan portfolio runoff in the third quarter. Our weighted average new loan yield this quarter was 6.9% as compared to our portfolio yield of 5.0%. The investment portfolio also has runoff of about $30 million per quarter, which we are currently reallocating to fund loan growth. We are not planning at this time to do any further material investment securities or loan portfolio restructuring as we believe our profitability is strong and will be further enhanced over time through ongoing repricing. For the fourth quarter, we are guiding to $62 million to $63 million in net interest income and a net interest margin increase of 5 to 10 basis points. Total other operating income was $13.5 million, up $0.5 million from last quarter, primarily driven by higher investment services income from the Wealth Management Group. There is some seasonality in the revenue from Wealth with the third quarter usually being strong. Additionally, BOLI income benefited again this quarter from favorable market movements. Our normalized fourth quarter guidance for total other operating income is $12 million to $13 million. Total other operating expenses were $47.0 million, up $3.1 million from the previous quarter. During the quarter, we recorded a net $1.5 million onetime expense related to the consolidation of our operations center, which included a $2 million write-off of fixed assets, partially offset by a lease accounting credit. Going forward, we expect to realize total annual savings from reduced lease operating and maintenance expenses of approximately $1 million. Additionally, salaries and employee benefits increased by $2.1 million due to higher incentive accruals and commissions tied to stronger production. Our guidance for total other operating expense is $45 million to $46 million, which anticipates similar levels of incentive accruals in the fourth quarter. During the third quarter, we repurchased approximately 78,000 shares at a total cost of $2.3 million, and we have $23 million remaining in repurchase authorization as of September 30. Additionally, fourth quarter to date through October 27, we have repurchased about 127,000 shares at a cost of $3.7 million. The Board increased the fourth quarter dividend by 3.7% to $0.28 per share. The dividend is payable on December 15 to shareholders of record as of November 28. Finally, on October 1, we notified holders of our subordinated debt notes that we will redeem the full $55 million outstanding at par on the upcoming call date of November 1. The subordinated notes, which were fixed for the first 5 years at 4.75%, would have repriced to floating rate at SOFR plus 456 basis points on November 1. Our current target CET1 ratio is in the range of 11% to 12% and our TCE ratio in the range of 7.5% to 8.5%. We plan to deploy our capital first by continuing our quarterly cash dividend with about a 40% payout ratio. Then our priority is to fund accretive loan growth and opportunistically continue share repurchases. Overall, we have a healthy capital position and are optimizing our capital structure to provide sustainable long-term value for our shareholders while continuing to maintain prudent capitalization levels to protect against downside macroeconomic scenarios. I'll now turn the call over to Ralph.

Ralph Mesick, Senior Executive Vice President and Chief Risk Officer

Thank you, Dayna. Our risk appetite is informed by our strategic goal of delivering acceptable risk-adjusted returns while maintaining a high level of solvency. We seek accretive growth, balance and diversification. Credit risk is measured and evaluated against expected results and established guidelines and limits. In the third quarter, we continued to maintain strong credit performance and asset quality. Credit costs stayed within an expected range and the level of NPAs, past due loans and criticized assets remained low. Net charge-offs were $2.7 million or 20 basis points annualized on average loans with consumer book losses continuing to trend downward. Nonperforming assets totaled $14.3 million or 19 basis points of total assets, down 1 basis point from the last quarter. Past due loans over 90 days decreased to $1.5 million, representing just 3 basis points of total loans. Criticized loans declined to 177 basis points of total loans, maintaining low levels. Provision expense for the quarter was $4.2 million, including $3.4 million added to the allowance and $0.8 million to the reserve for unfunded commitments. The decrease in provision expense was primarily driven by lower net charge-offs this quarter. We maintain a strong capital position to support the bank through the credit cycle and against additional impacts that could arise from periods of prolonged stress. At quarter end, our total risk-based capital was 15.7%. Looking ahead, we will continue to take a prudent approach to building our loan portfolio, one that considers a range of outcomes and builds margins of safety to protect against adverse conditions. Let me now turn the call back over to Arnold.

Arnold Martines, Chairman, President and CEO

Thank you, Ralph. In closing, our third quarter results reflect disciplined execution, strong profitability and prudent risk management in a dynamic market environment. I'm grateful to our employees for their dedication and innovation, which continue to drive our success. To our customers and shareholders, thank you for your trust and support as we execute our strategy and deliver long-term value. We are now happy to take your questions.

Operator, Operator

And our first question comes from the line of David Feaster from Raymond James.

David Feaster, Analyst

I wanted to start by discussing growth. I appreciate your comments, but I would like to understand what led to the decline in loans in Hawaii. What gives you confidence that growth on the islands will pick up? Additionally, could we touch on the impact of the government shutdown in the islands and the opportunities that arise from the disruptions across your footprint?

Arnold Martines, Chairman, President and CEO

Yes. Thanks, David. David Morimoto will take that question.

David Morimoto, Vice Chairman and Chief Operating Officer

Yes, we observed net growth in the Hawaii market in the areas we anticipated, specifically in construction, commercial and industrial, and commercial mortgage. However, this growth was offset by declines in residential loans, particularly in the residential mortgage and HELOC portfolios, which have faced some challenges due to the interest rate environment. If interest rates continue to stabilize, we are optimistic that we can reduce the decline in these two portfolios, which would positively influence future loan growth in Hawaii. Furthermore, we have a strong loan pipeline in Hawaii with several deals currently in progress. The timing is crucial, as many loans are expected to close between the fourth quarter and the first quarter. We are cautiously optimistic that future loan growth will be more balanced between the Hawaii and Mainland markets.

David Feaster, Analyst

Okay. That's helpful. And then maybe touching on the expense side. I appreciate the color that you gave in the guidance. It's a bit higher than what we've been expecting. It sounds like there's some cost savings with that op center consolidation. I know a decent amount of it's incentive accruals. But just kind of curious, as you think about the expenses, where are you investing today? I mean, are you seeing opportunities for new hires? Are there some other key investments that you guys are making? And just how do you think about your ability to drive positive operating leverage going forward?

Arnold Martines, Chairman, President and CEO

David, this is Arnold. Let me just maybe start, and then I'll turn it over to Dayna. Obviously, as you know, we have been investing in technology, harvesting some of the investments that we've made in the past to be able to drive efficiencies. So that continues to be an area where we focus on. We have a few systems that we're putting in place today. That's going to create a lot of efficiencies for us and just creates better tools for our employees to be able to support our customers and drive our effectiveness. And then I think just generally speaking, we are very focused on the development of our people and looking at areas where we have gaps and building skill levels in order to execute on our strategies as we move forward. So there will be some investment in people for sure. And I appreciate that you brought that up because the people are going to help us execute on the strategies. So with that, kind of overall, I'll turn it over to Dayna for additional further comments.

Dayna Matsumoto, Executive Vice President and Chief Financial Officer

Sure, sure. David, what I'll add is that managing expenses and our efficiency ratio continues to be a key focus of ours. This quarter, we were impacted by the onetime expense from our office consolidation, and this will create significant efficiencies going forward. Additionally, this quarter, as we had greater revenue, we needed to increase our incentive and commission accruals. This is a good thing. Our objective continues to be driving our efficiency ratio to the high 50% range and mid-50s over time, and we plan to achieve this through consistent revenue growth while we continue process automation and greater use of technology.

David Feaster, Analyst

Okay, that's helpful. Could you touch on the deposit side of the equation and what you are observing in the competitive landscape, along with some of the core deposit growth initiatives you have in place? Additionally, how do you view your ability to reduce deposit costs with Fed cuts, especially in light of the recent Fed cut and the competitive environment?

David Morimoto, Vice Chairman and Chief Operating Officer

David, it's David again. Regarding deposit growth, we remain cautiously optimistic. The fourth quarter will be a bit challenging due to some anticipated outflows. As a result, we expect our deposit growth to be relatively flat compared to last year. While we initially guided for low single-digit growth for the full year, it now appears that we will trend more toward flat growth based on what we know about the fourth quarter. Nonetheless, we are optimistic about 2026 and believe we can achieve low single-digit deposit growth then. Our strategies are consistent with what we've been implementing, but we will apply them with greater intensity moving forward. We are focusing on the fundamentals of banking and have seen positive results in the Hawaii market. Additionally, we are hopeful about our initiatives in Japan and Korea and expect these strategies to gain traction in 2026.

Operator, Operator

Our next question comes from the line of Matthew Clark from Piper Sandler.

Matthew Clark, Analyst

Just starting on the margin, interest-bearing deposit costs have increased slightly, but the NIM guide suggests you are expecting NIM expansion. Therefore, it seems those costs have peaked. Do you have the spot rate at the end of September for interest-bearing deposits?

Dayna Matsumoto, Executive Vice President and Chief Financial Officer

Matthew, it's Dayna. The spot rate on total deposits at the end of September was 100 basis points. Additionally, for the month of September, the margin was 3.51%. We continue to feel optimistic that it's moving in the right direction.

Matthew Clark, Analyst

Got it. Okay. Great. And then you're going to get a 2-month benefit from redeeming the sub debt. When you strip out the sub debt, it implies the rest of your long-term debt costs are about $623. Can you remind us of the duration of that long-term debt that's left? And I just want to try to forecast the rate.

Dayna Matsumoto, Executive Vice President and Chief Financial Officer

Sure. Matthew, we just have one $25 million FHLB advance outstanding, and it matures in February of 2028.

Matthew Clark, Analyst

Maybe there are some repos in that number. Do you have any information on loan growth this quarter, specifically regarding the Mainland segment, commercial real estate, and construction? Could you provide details on what you originated this quarter? I assume it consists entirely of participations and would appreciate an update on the size of the SNC portfolio.

David Morimoto, Vice Chairman and Chief Operating Officer

Matthew, it's David. I'll begin by addressing the Mainland aspect of your question, after which I'll hand it over to Dayna for further insights on the SNC details. In the third quarter, we observed growth in both the industrial and multifamily sectors, applicable to our commercial real estate and construction portfolios. To take a broader view on the Mainland lending strategy, I would emphasize that Hawaii will always remain our primary banking market. However, CPF has consistently had some loan exposure on the Mainland, stemming from certain structural factors related to the Hawaii banking market. This market has been known to have more deposit balances compared to available lending opportunities, primarily because Hawaii's economy is mainly service-oriented and lacks significant manufacturing. These structural elements explain why we maintain a portfolio on the Mainland. Lending in this area offers CPF geographic diversification, shorter-duration assets, and appealing risk-adjusted returns. That said, the growth in the third quarter was primarily driven by the Mainland. Moving forward, our focus will depend on the opportunities available, which might lead to variable growth scenarios favoring either Hawaii or the Mainland depending on the specific quarter.

Matthew Clark, Analyst

Great. And then just maybe on the SNC exposure at the end of the quarter.

Ralph Mesick, Senior Executive Vice President and Chief Risk Officer

Yes. This is Ralph. The total SNC exposure for the bank is approximately $526 million. This consists of about $190 million in Mainland commercial real estate and around $144 million in Mainland corporate lending, primarily large syndicated loans. This amount has been decreasing over the past year.

Matthew Clark, Analyst

Okay. That's helpful. And then the last one for me, just on the special mention and substandard balances, where those stood at the end of September.

Ralph Mesick, Senior Executive Vice President and Chief Risk Officer

Yes. From a balance perspective, let's see. Special mention was $34.3 million. Classified was $62.1 million. So relatively flat from the prior quarter. And in general, I think we had mentioned on the last call, we have a couple of large credits that probably represent about a little over half of that. Both of those loans are secured. They're performing loans. We've done individual sort of assessments. We would expect no loss in the event that they did default, but they are performing and our expectation is that they'll continue to perform. The sponsors have, I think, meaningful equity invested in these projects. And I think they're very committed to working through the situations that they're facing today.

Operator, Operator

Our next question comes from the line of Kelly Motta from KBW.

Kelly Motta, Analyst

I was hoping to circle back to the expense side to David's question on compensation. You had mentioned some of that increase was related to step-up in bonus accruals. I'm just wondering how much of that, call it, $2 million was related to that. I appreciate the guidance about Q4, but just trying to get a good run rate as we kind of start the year next year.

Dayna Matsumoto, Executive Vice President and Chief Financial Officer

Kelly, it's Dayna. Of that $2.1 million, about $1.5 million was related to the incentive accruals.

Kelly Motta, Analyst

Okay. That's super helpful. And then I appreciate the new color on capital targets. It looks like you're currently within the range on TCE and above on CET1. Kind of wondering how you guys are thinking about this level here. Does that imply potentially some more capital return? And given your outlook for balance sheet growth, it would seem that absent maybe more aggressive buybacks that would build. So wondering how you guys are kind of thinking about managing that and kind of the intermediate-term trajectory of capital levels.

Dayna Matsumoto, Executive Vice President and Chief Financial Officer

Kelly, let me start off by saying that our target range considers a number of factors. First, our debt rating agency expectations. We also further maintain a level to protect against potential downside macroeconomic scenarios. And really, at this point in the cycle, we believe this is prudent. We also regularly perform capital stress tests, and those results are considered in our decisions. So with that said, we are currently slightly above our target range for CET1, and we are taking a more proactive but still prudent approach to capital return. So as I mentioned in the remarks, the priority is first for loan growth, and we are well positioned to support loan growth. We do plan to also continue share repurchases. The level and extent of those share repurchases will be a function of where the loan growth is and where the market is.

Kelly Motta, Analyst

That's helpful. Given the low single-digit outlook for next year, what would make you more confident that loan growth will increase enough to allow for more CET1 deployment into that range?

Arnold Martines, Chairman, President and CEO

Kelly, this is Arnold. We are all anticipating a decline in rates, and we believe there is pent-up demand, especially in the Hawaii market. People are waiting on the sidelines for rates to go down, and we are quite confident that if rates do decrease, we will see an increase in loan demand. Therefore, we think that if this happens, our focus will be on directing capital towards that area, as it would be the most beneficial for the company and our shareholders. However, we will adjust our strategy as we move forward based on how the market evolves and what opportunities arise.

Kelly Motta, Analyst

Got it. That's helpful. Last question for me. It looks like you have a new Japanese bank partner. Just if you could remind us about the potential opportunities that you see leveraging now your third relationship that you have with the bank over there.

Arnold Martines, Chairman, President and CEO

Yes, thank you, Kelly. This is Arnold. We are really enthusiastic about this development. It’s something we’ve been working on for a while. While we have existing relationships in Japan, we didn't have one in the Kansai area, specifically the Kyoto region, which also encompasses nearby areas like Osaka and Kobe. Our historical connections with Japan, beginning with Sumitomo Limited when our bank was established, are significant. We also have substantial business with Japanese companies operating in Hawaii. We believe the Kyoto region was a gap for us, and we are excited to now be able to move forward and hopefully enable our customers to collaborate and create economic opportunities both in Hawaii and in the Kyoto region.

Operator, Operator

There are no further questions. I will now turn the call back over to Jayrald Rabago for closing remarks.

Jayrald Rabago, Senior Strategic Financial Officer

Thank you, Dustin, and thank you all for joining our third quarter 2025 earnings call. We appreciate your continued engagement and look forward to updating you on our progress next quarter.

Operator, Operator

The meeting has now concluded. Thank you all for joining. You may now disconnect.