Earnings Call Transcript - CPF Q4 2023

Operator, Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. And welcome to the Central Pacific Financial Corp. Fourth Quarter 2023 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. And with that, I'd like to turn the call over to Ms. Dayna Matsumoto, Group Senior Vice President and Director of Finance and Accounting. Please go ahead.

Dayna Matsumoto, Group Senior Vice President and Director of Finance and Accounting

Thank you, Greg. And thank you all for joining us as we review the financial results of the fourth 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 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 President and CEO, Arnold Martines.

Arnold Martines, President and Chief Executive Officer

Thank you, Dayna, and aloha, everyone. We appreciate your interest in Central Pacific Financial Corp., and we are pleased to share with you our latest updates and results. We are proud of the recognition we recently received by Newsweek as one of the best regional banks in America for 2024. Also, in a few weeks, we will celebrate our 70th anniversary. It is an honor to lead this institution and continue our legacy of supporting the community. 2023 was another strong year for us as we successfully navigated the operating environment challenges while continuing to deliver solid results. We have a strong balance sheet, and our balanced growth strategy positions us extremely well for the future. During the fourth quarter, we completed a few balance sheet repositioning transactions that were good opportunities to gain greater future returns and efficiencies. We will continue to pursue similar opportunities that align with our strategy in 2024. The team will provide additional detail and insights on our fourth quarter financial and credit metrics, but let me start first with an update on the Hawaii market. The Hawaii tourism industry continues to do well, with Maui visitors recovering faster than anticipated. In the month of December, visitor arrivals to Maui were 75% of the previous year and total statewide arrivals were 90% of pre-pandemic 2019. Statewide, visitors from Japan continued to increase, up 92% from a year ago but still lagging pre-pandemic levels at only 49% of 2019. Total visitor spending was $1.96 billion in December, down 1% from a year ago and up 12% from December 2019. Total hotel occupancy in December was 72%, up 0.7% from a year ago, with an average daily rate of $428, down 3% from a year ago. Hawaii's statewide seasonally adjusted unemployment rate was 2.9% in December and continues to outperform the national unemployment rate of 3.7%. The University of Hawaii Economic Research Organization forecasts the state unemployment rate will remain very low at 2.5% in 2024. Real estate values in Hawaii are consistently strong. In December, the Oahu median single-family home price was $1 million, and the median condo sales price was $510,000. Home sale volumes continue to be down year-over-year. But with mortgage rates recently declining slightly, we are starting to see an increase in contract signings, and with limited inventory, properties continue to move quickly in our market. Overall, we are optimistic about Hawaii's economic outlook. While the state faces some headwinds and uncertainty, Hawaii's economy is proving to be resilient, and we hope to turn unfortunate events like the Maui wildfires into opportunities to rebuild and make our island communities stronger in the future. I'll now turn the call over to David Morimoto, our Chief Financial Officer. David?

David Morimoto, Senior Executive Vice President and Chief Financial Officer

Thank you, Arnold. Turning to our earnings results. Net income for the fourth quarter was $14.9 million or $0.55 per diluted share. Return on average assets was 0.79%, return on average equity was 12.55%, and our efficiency ratio was 64.12%. At year-end, our balance sheet reflected further strengthening of our liquidity position with higher levels of cash as we continue to balance our loan growth. Our total loan portfolio decreased by $70 million or 1.3% sequentially, primarily due to us continuing to let our Mainland loan portfolio run off, partially offset by growth in our Hawaii commercial real estate and C&I portfolios. Our total deposit portfolio decreased by $27 million or 0.4% sequentially as we ran off some higher-cost government time deposits. Total core deposits remained relatively flat despite some continued migration from demand deposits to CDs. From an average balance standpoint, the trends indicate the movement out of noninterest-bearing DDA is continuing to slow. Net interest income for the fourth quarter was $51.1 million and decreased by $0.8 million from the prior quarter, primarily due to higher funding costs. The net interest margin was 2.84% in the fourth quarter, a decline of 4 basis points sequentially. Our total cost of deposits was 1.22% in the fourth quarter, and our cycle-to-date total deposit repricing beta was 23%, which remains within our expectations. Our margin compression continues to narrow. And with that positive trend as well as the expected benefit from our pay-fixed receive float swap, we expect our net interest margin to trough in the first half of this year. As Arnold mentioned, during the fourth quarter, we completed a balance sheet repositioning where we sold an office real estate building and utilized a $5.1 million pretax gain to improve prospective earnings through an investment portfolio restructuring of approximately $30 million at a loss of $1.9 million in a branch lease termination, where we incurred a one-time charge of $2.3 million. Overall, the three nonrecurring transactions position our balance sheet for improved future performance, which we estimate to be an increase to annual pretax income of $2 million. Fourth-quarter other operating income was $15.2 million, which includes the aforementioned gain on the office sale and investment portfolio restructuring loss. Additionally, we had higher BOLI income in the fourth quarter, which was driven by the equity market rally and offset by higher deferred compensation expense. Other operating expenses totaled $42.5 million in the fourth quarter and included the charge on the early branch lease termination. Our effective tax rate declined to 22.3% in the fourth quarter, primarily due to higher tax-exempt income. Going forward, we expect our normalized effective tax rate to be 24% to 25%. During the fourth quarter, we did not repurchase any shares. Finally, our Board of Directors declared a quarterly cash dividend of $0.26 per share, payable on March 15th to shareholders of record on February 29th. Our Board of Directors also authorized a new share repurchase plan to repurchase up to $20 million of our common stock in 2024. I'll now turn the call over to Anna Hu, our Chief Credit Officer. Anna?

Anna Hu, Executive Vice President and Chief Credit Officer

Thank you, David. Our asset quality remained strong in the fourth quarter with nonperforming assets at 9 basis points of total assets and criticized loans decreasing to 0.92% of total loans. Our loan portfolio continues to be well diversified by loan type and industry sector. Over 75% of the loan portfolio is real estate secured, with a weighted average loan-to-value of 62%. Our commercial real estate portfolio represents 25% of total loans and is diversified across all asset types, with 8% of outstanding balances in this portfolio maturing in 2024. Our commercial real estate office and retail exposure remains low at 3.5% and 4.8% of total loans, respectively. The office portfolio has a weighted average loan-to-value of 56% and 71 weighted average months to maturity. The retail portfolio has a weighted average loan-to-value of 64% and 61 weighted average months to maturity. Our loan exposure to the Lahaina Maui area was $111 million or 2% of total loans before the August wildfire. Since then, balances have paid down slightly to $103 million or 1.9% of total loans as of December 31st. We estimate that $90 million or 87% of the total Lahaina Maui loans outstanding were not directly impacted by the wildfire, and $11 million or 11% that were directly impacted have sufficient insurance and land value coverage. We are monitoring the remaining $2 million of Lahaina loans, which includes primarily consumer unsecured and small business loans. The US Mainland loan portfolio continued to decline during the fourth quarter due to the continued runoff in the Mainland consumer portfolio to $308 million or 5.7% of total loans as of December 31st compared to $452 million a year ago. Net charge-offs were $5.5 million for the fourth quarter, which equates to 41 basis points annualized as a percent of average loans. The increase in net charge-offs was primarily from our Mainland consumer portfolio. This portfolio continues to run off as new purchases remain on hold as a prudent measure. With that said, we believe that our losses in this portfolio have peaked and will improve going forward. Overall, our loan portfolio remains solid. Our allowance for credit losses was $63.9 million or 1.18% of outstanding loans. In the fourth quarter, we recorded a $5 million provision for credit losses on loans primarily due to net charge-offs. Additionally, we recorded a $0.3 million credit to the provision for unfunded commitments for a total provision for credit losses of $4.7 million during the quarter. Overall, our strong risk management culture and conservative underwriting policies continue to serve us well. Our loan portfolio credit quality remains strong, and we continue to monitor the economic environment closely. Now I'll turn the call back to Arnold.

Arnold Martines, President and Chief Executive Officer

Thank you, Anna. In summary, we are pleased with our progress and results for 2023. We believe, with our strong liquidity, capital, and credit, we are well positioned to continue to deliver results with a focus on our mission of serving our customers and the broader community. As we celebrate our 70 years of serving Hawaii this year, I want to thank you for your continued support and confidence in our organization. At this time, we'll be happy to address any questions you may have.

Operator, Operator

And it looks like our first question comes from David Feaster with Raymond James.

David Feaster, Analyst

Maybe just high level, I'd like to start on how you think about the potential impacts of Fed cuts. Obviously, that would benefit on the credit side. But is your sense there that maybe there's a decent amount of pent-up loan demand and we could see loan growth accelerate, especially on the mortgage front maybe and just how do you think about your ability to reprice deposits lower, if we do get Fed cuts?

Arnold Martines, President and Chief Executive Officer

I'll start, and then I'll turn it over to David for the second part of your question. With regard to the loan growth side of it, we do feel good about that this year. We think that the operating environment is going to normalize a bit. It has to be better than last year for sure. So we're building a strong loan pipeline as we move into the first half of 2024. We see most of the activity in the CRE and C&I loan categories, but we do expect residential and home equity and small business to also support growth in 2024. As you know, we continue to let the Mainland consumer loan portfolio run off until we have better visibility on what happens in the US continent from an economic perspective. So with all that said, we anticipate full year 2024 loan growth to be in the low single-digit percentage range. I'll just add that we see Q1 as a transitional quarter for loan growth, given that some folks are waiting to see what happens with the interest rates, to your point earlier. But all in all, we anticipate an improving operating environment supported by Hawaii's resilient economy. And I have to tell you, our bankers are excited and engaged for what we hope to be a good year to help our customers achieve their broader investment goals. So let me maybe have David cover some of the repricing part of your question?

David Morimoto, Senior Executive Vice President and Chief Financial Officer

On the potential for rate cuts and what our plans are on the deposit pricing side, as we saw last year, we implemented a product segmentation strategy. We created some higher-yield options for customers that were seeking higher yields, and those accounts obviously have high betas. So we would anticipate that those high beta accounts would react pretty much 100% beta with the move in market rates. So on an overall basis, our expectation is that rate cuts would be somewhat beneficial to CPF and our net interest margin. But having said that, as we've consistently said, we do view the balance sheet as relatively well matched. So both in the rising rate environment and a falling rate environment, we don't see really large swings in our net interest margin. Our net interest margin tends to stay in a pretty well-defined range. Hopefully, that helps, David.

David Feaster, Analyst

And since we were just talking about deposits, let's stay there. I was hoping you could touch on maybe some of the deposit trends you're seeing and some of the drivers of the NIB outflows, whether you started to see that reverse course at all. And just how do you think about deposit growth as we look forward, and some of the initiatives you put in place? Have you started to see any benefits from your Japanese partnership or any inflows from insurance proceeds in the wildfires? Or just kind of curious, again, some of the drivers of the flows in the quarter and then kind of the outlook going forward and some of your initiatives?

David Morimoto, Senior Executive Vice President and Chief Financial Officer

Core deposits overall remained relatively stable sequentially, which is a positive sign. There has been some ongoing movement within core deposits from DDA to interest-bearing accounts, but Dayna Matsumoto conducted a solid analysis. We have been monitoring the quarterly average balances of DDA, and early in 2023, the sequential quarterly declines were around $80 million to $90 million for DDA. In the third quarter, this decline reduced to $55 million, and in the fourth quarter, it further decreased to $30 million. These figures reflect quarterly average balances, indicating an improving trend. DDA accounts for approximately 28% of total deposits, consistent with the levels seen in late 2019 before the pandemic. All signs suggest that the outflow from noninterest-bearing accounts is continuing to decelerate. We will need to reverse this trend and foster growth again, and our teams are highly focused on achieving that.

David Feaster, Analyst

And then maybe the last one from me, just touching on the capital priorities. You talked about a pause last quarter on the buyback. You've made several balance sheet moves, but those are capital neutral. I'm just curious maybe your appetite for additional securities restructurings or share repurchases. We put in the new program this quarter. Just curious, your thoughts on capital priorities given the strength of your capital base.

David Morimoto, Senior Executive Vice President and Chief Financial Officer

Capital management remains consistent. We will continue to pay the quarterly cash dividend at similar payout levels, and we are open to all alternatives beyond that. The Board has provided us with another authorization for the share repurchase plan, and as mentioned, there are still opportunities for further balance sheet restructurings. We will evaluate those options against each other. With the buyback, we have insider knowledge, so we will make decisions that we believe are prudent in addition to the cash dividend.

David Feaster, Analyst

And just confirming, it sounds like the margin guidance you're talking about for a trough in the first half, that does incorporate rate cuts?

David Morimoto, Senior Executive Vice President and Chief Financial Officer

Our internal baseline forecast includes three 25 basis point cuts in 2024, but none in the first quarter. It's important to highlight the impact of the interest rate swap we initiated in early 2020, which will take effect on April 1, 2024. We are paying a fixed rate of 210 while receiving Fed funds at a floating rate. Currently, we have a gain of 340 basis points on 115 million. According to our forecast, if those three 25 basis point cuts occur in 2024, the swap is expected to contribute 1.8 million in net interest income, add 2 basis points to the net interest margin, and increase earnings per share by $0.05.

Operator, Operator

And our next question comes from Andrew Liesch with Piper Sandler.

Andrew Liesch, Analyst

Can you provide insight into the repositioning of the securities and the $2 million, as well as the $2 million for the offices? How much of that amount do you anticipate will contribute to the bottom line, and how much will be reinvested back into the franchise?

Arnold Martines, President and Chief Executive Officer

Andrew, that's a good question for David.

David Morimoto, Senior Executive Vice President and Chief Financial Officer

Again, like all banks, we continue to invest in our franchise. We've undertaken multiple technology initiatives. Initially, we focused on enhancements to customer-facing technology. More recently, our attention has shifted to the back office with new software implementations. To answer your question, it’s unlikely that all of this will translate directly to the bottom line. However, I can guide you on our quarterly run rate for operating expenses, which we are estimating at $40 million to $41 million per quarter, leading to a full-year guidance for 2024 in the range of $160 million to $164 million. If you adjust 2023 for nonrecurring items, it shows a low single-digit annualized growth rate, which we believe is reasonable given the inflationary pressures we are all experiencing. I would say we are identifying some offsets to mitigate the full impact of inflation, keeping the annualized growth rate in expenses within the low single-digit range.

Andrew Liesch, Analyst

A good way to think about it. I noticed that the reserve ratio has been grinding higher the last few quarters. I guess, what are some of the drivers of the CECL model that's causing that to happen? Because outside of some of the losses in the Mainland consumer book, the credit performance has been excellent. So I'm just curious like what's driving in the CECL model the reserve ratio a bit higher?

David Morimoto, Senior Executive Vice President and Chief Financial Officer

So like all CECL models, there is a baseline economic forecast. We use Moody's for our economic forecast. Then there are qualitative factors that overlay on top of that. I think the gradual increase in basis points was primarily related to the Mainland consumer charge-offs. The Mainland consumer has shown some credit deterioration, but I would say that this deterioration is coming after an unusually good period where all consumers benefitted from fiscal stimulus. It seems like the increase is significant, but it's really just returning to what we would consider normal expectations. I'm not sure if that addresses your question, Andrew?

Andrew Liesch, Analyst

And then you alluded to it earlier that the high level of cash balances at quarter end or year-end, what are you thinking about those? Are those going to be redeployed somewhere, are there some more deposit declines in certain areas that can be used to fund? Just how should we think about the cash going forward?

David Morimoto, Senior Executive Vice President and Chief Financial Officer

There was additional cash build during the fourth quarter, and I forgot to mention. So we had 4 basis points of sequential quarter net interest margin deterioration in the fourth quarter, 2 basis points of that was a result of the increase in balance sheet liquidity. And so going forward, the plan is to not increase on-balance sheet liquidity further. I think we've done enough there. The fortress balance sheet is good; it's fortified enough. So we probably won't grow it any further, and we are looking at options to reduce on-balance sheet liquidity somewhat.

Andrew Liesch, Analyst

So right now, maybe just hold it in Fed funds and earn that before another option for it?

David Morimoto, Senior Executive Vice President and Chief Financial Officer

Obviously, Fed funds yielding close to 550, that's not a bad yield. Currently, the challenge is it's not going to stay there, right? So we're redeploying some of the on-balance sheet liquidity could make sense.

Operator, Operator

And it looks like we have no further questions. So at this time, I will turn the call back over to Arnold Martines for closing remarks. Arnold, the floor is yours.

Arnold Martines, President and Chief Executive Officer

Thank you, Greg. And thank you very much for participating in our earnings call for the fourth quarter of 2023. We look forward to future opportunities to update you on our progress. Thanks very much.

Operator, Operator

Thank you, Arnold. And ladies and gentlemen, that does conclude today's call. Thank you all for joining, and you may now disconnect.