Oct 30, 2013
Executives
David Morimoto - SVP, IR John Dean - President and CEO Denis Isono - EVP and CFO Lance Mizumoto - EVP and Chief Banking Officer Bill Wilson - EVP and Chief Credit Officer
Analysts
Joe Morford - RBC Capital Markets Aaron Deer - Sandler O'Neill & Partners Don Worthington - Raymond James Jackie Chimera - KBW
Operator
Good afternoon ladies and gentlemen, thank you for standing by. And welcome to the Central Pacific Financial Corp’s Third Quarter 2013 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.
(Operator Instructions). This call is being recorded and will be available for replay shortly after its completion on the company’s website at www.centralpacificbank.com.
I would like to turn the call over to Mr. David Morimoto, Senior Vice President, Investor Relations.
Please go ahead, sir.
David Morimoto
Thank you, Emily and thank you all for joining us as we review our financial results for the third quarter of 2013. Joining us today are John Dean, President and Chief Executive Officer; Denis Isono, Executive Vice President and Chief Financial Officer; Lance Mizumoto, Executive Vice President and Chief Banking Officer; and finally Bill Wilson, Executive Vice President and Chief Credit Officer.
During the course of today’s call, management may make forward-looking statements. While we believe these statements are based on reasonable assumptions, may involve risks that may cause actual results to differ materially from those projected.
For a complete discussion of the risks related to forward-looking statements, please see our recent filings with the SEC. And now I turn the call over to John.
John Dean
Thank you, David and good morning everyone. We are pleased to report that our company’s financial performance for the third quarter continue to reflect solid growth in our balance sheet as well as continued improvement in our asset quality.
Through a total team effort we have worked diligently on our business plans to expand quality relationships with our clients and as a result, generate strong net loan growth and stable increases in core deposits during the quarter. A reduction in our allowance per loan and lease losses resulted in the credit to provisions for loan losses and a positive impact to our earnings.
With that current strong capital position and earnings consistency over the past 11 quarters our Board of Directors declared a second consecutive quarterly cash dividend of $0.08 per commons share, payable on December 16 to shareholders of record at the close of business on November 29. We continue to make good progress in the major initiatives that were started earlier in the year as part of our overall recovery and strategic plan.
The outsourcing of our core IT systems and the implementation of technology tools to better serve our customers are progressing well. And enhanced customer relationship management system or CRM as well as our data warehouse will play important roles in responding to our customers need.
Functional reorganization including a staff rightsizing plan was recently completed to better align our personnel structure with our strategic initiatives. Turning next to Hawaii’s economy, we continue to be encouraged by improving market conditions evidenced by increased commercial activity and consumer loan demand.
The visitor industry is on pace for another record year in 2013, although the rate of growth has eased considerably compared to a banner year in 2012. As of August, year-to-date arrivals were up by 4.9% and visitor spending up by 5.1% compared to the same period in 2012.
Growth in the construction industry has been accelerating, primarily driven by residential projects on Oahu. Construction on the $5.2 billion rapid transit system finally resumed in September after nearly a 13 months delay to the legal issues.
Government contracts, excluding rail were up by 40% in August compared to the same period of last year. The seasonally adjusted unemployment rate in Hawaii dropped to 4.3% in August reflecting a 1.6% drop in the past 12 months to its lowest level since July 2008.
Overall job growth is projected to increase by 2.1% this year with the growth in the construction industry projected to increase by 7%. Rail GDP is forecasted to increase by 3.1% this year.
As our visitor industry continues to grow at a safe pace and with the increasing activity in our construction industry we are encouraged by the positive outlook for the market conditions in Hawaii, as we continue to execute on our business plans. At this time, I would like to ask Denis Isono, our Chief Financial Officer to review the highlights of our third quarter financial performance, Denis.
Denis Isono
Thank you, John. For the third quarter of 2013 we reported net income of $10.2 million or $0.24 per diluted share compared to net income of $14.3 million or $0.34 per diluted share reported last quarter.
The decrease was primarily due to a one time gain in sale of foreclose assets or $7.2 million in the prior quarter. Net interest income for the quarter was $33.8 million compared to $33.2 million in the previous quarter.
Our net interest margin was 3.19% and 3.23% for the same respective quarters. The sequential quarter increase in our net interest income was due to an overall increase in our interest earning assets which included net increases of $115.4 million and $69 million in our average loan is investment securities portfolios respectively.
The increase in net interest income from the larger balances overcame the lower level of interest recoveries on loans previously placed on non-accrual status of $1.1 million. The sequential quarter decrease in net interest margin was primarily attributable to the lower recoveries of interest on non-accrual loan.
On a normalized basis, our net interest margin increased from 3.14% in the third quarter from 3.08% in the second quarter of this year. Our loan and leased portfolio increased by $111.2 million during the quarter and now stands at approximately $2.5 billion at September 30th.
We are again encouraged by the fact that we are able to meaningfully grow our loan and lease portfolio. Lance Mizumoto will provide more insight into the loan portfolio later in this call.
Our investment securities portfolio decreased by $8.2 million during the quarter and totaled approximately $1.8 billion at September 30, 2013. The taxable accrual and yield on our investment portfolio improved to 2.18% from 2.12% reported in the second quarter.
We continue to evaluate various investment opportunities and strategies to further improve the yield on our investment portfolio and strengthen our non-interest margin. Non-interest income for the quarter totaled $11.9 million, down from $17.8 million in the previous quarter.
The decrease was primarily due to higher gain on sale of foreclosed assets reported in the previous quarter, including the gain on sale of one asset of $7.2 million. Contributing to the difference was also lower net gains on sales of residential loans of $1.4 million which were partially offset by higher unrealized gains on loans held for sale and interest rate locks of $1.9 million.
Non-interest expense for the quarter totaled $36.5 million, up from $35 million in the previous quarter. The sequential quarter increase was primarily attributable to a premium paid on the repurchased of preferred stock of two subsidiaries of $1.9 million and higher salaries and employee benefits of $900,000 which included the severance, pre-retirement and retention benefits totaling $1.3 million related to the staff rightsizing plan mentioned by John earlier.
Other variances included a higher net credit related charge that reserved for unfunded commitments and foreclosed asset expense of $500,000. This increase was partially offset by a lower provision for repurchased residential mortgage loans of $1.3 million and a lower amortization of other intangible assets of $500,000.
As we go forward there will be additional accruals for the severance, early retirement, retention benefits in the fourth quarter of 2013 and into next year for employees with worked to date extending into 2014. Our adjusted efficiency ratio for the quarter which excludes net gains on sales of foreclosed assets, foreclosed asset expense and the amortization of certain intangible assets was 78.0%, compared to 76.7% in the previous quarter.
The previously mentioned premium paid on repurchase of deferred stock and the staff rightsizing plan expenses impacted our efficiency ratio for the quarter, excluding these expenses, our efficiency ratio for the quarter would have been 71.1%. In the third quarter of 2013, we recorded net income tax expense of $2.2 million compared to $1.9 million in the previous quarter.
The income tax expense was attributable to higher pre-tax income that was forecast when we recognized the reversal of valuation allowance of the deferred tax asset in the first quarter. As of September 30, 2013, our net deferred tax assets totaled $139.3 million.
In addition to reporting another strong quarter of profitability we also continue to make progress in our ongoing efforts to improve our credit risk profile. During the quarter, we recorded a credit to the provision for loan and lease losses of $3.2 million compared to a credit of $200,000 in the previous quarter.
The credit was a result of continued improvement in our asset quality as evidenced by a $1.9 million of the decrease in our non-performing assets from $60.9 million at June 30, 2013 to $59.0 million at September 30, 2013. The decrease in non-performing assets was attributable to $6.1 million reductions which were partially offset by $4.3 million in additions.
Besides reducing our non-performing assets, we also reported net recoveries in the quarter of $1.3 million, comparatively we reported net recoveries of $500,000 last quarter. The allowance for loan and lease losses, as a percentage of loans and leases decreased to 3.43% at September 30, 2013 from 3.67% in June 30, 2013.
Our allowance for loan and lease losses as a percentage of non-accrual loans decreased to 59.94% at September 30, 2013 from 162.95% at June 30, 2013. Lastly, at September 30, 2013, our capital ratios continue to exceed the levels required to well capitalize institution for regulatory purposes.
Our Tier 1 risk-based capital, total risk-based capital and leverage capital ratios were 21.30%, 22.58% and 13.96% respectively compared to 21.55%, 22.83% and 14.24% respectively at June 30, 2013. That completes our financial summary and I now like to turn the call over to Lance Mizumoto who will provide additional background related to our banking activity.
Lance?
Lance Mizumoto
Thanks, Denis. Total loans increased by 17.7% over the same period a year ago and loan growth in the third quarter was driven primarily by the improving conditions in our marketplace, as well as our continued focus on building quality relationships with our customers.
As a result, we generated significant increases in our commercial, consumer and residential mortgage portfolio balances. Our commercial loan pipeline remains healthy and has been strengthened by the increased activity in private commercial and residential development projects in Hawaii.
Consumer loan demand has been stable and we have realized success with [PB] `loan program another unsecured term loan for the promotions. Residential mortgage activity continued to decline overall particularly with the refinancing market due to the rise in interest rates.
However we have maintained a strong share of the purchase market through relationships with our business referral sources. We remain optimistic for further growth in our loan portfolio and believe there are more opportunities going forward as the activity in the construction industry begins to ramp upwards.
We also generated solid growth in our deposits with increases in non-interest bearing and interest bearing checking, as well as government time deposits. While we have not been as aggressive in deposit gathering as opposed to pursuing quality lending opportunities, our focus on building total customer relationships have allowed us to continue growing our deposit portfolio.
Overall with the improving market conditions in Hawaii and the positive trend in the economic indicators for Hawaii, we are focused on expanding our base of customer relationships going forward. That completes my summary on our business development activity and I would like to turn the call back to John for his closing remarks.
John?
John Dean
Thanks, Lance. To summarize, we are pleased with our company’s progress throughout the year and our financial results for the third quarter.
We remain committed to the execution of our business plans, to improve operational efficiencies, enhance information systems and ability upon the strength of our kind relationships. We are on tract and well positioned for growth in meeting the challenges ahead.
And we would like to again express our appreciation to our shareholders and customers for their continued support and confidence. At this time, we’d be happy to address any questions you may have.
Thank you.
Operator
(Operator Instructions). And our first question is from Joe Morford of RBC Capital.
Please go ahead.
Joe Morford - RBC Capital Markets
Thanks. Good morning, everybody.
John Dean
Good morning, Joe.
Joe Morford - RBC Capital Markets
I guess first I have a question on the margin, excluding interest recoveries it appears actually grows maybe up to 7 basis points. Is that mostly be improving earning asset mix or is loan pricing perhaps beginning to improve and just in general how do you feel about your ability to….
John Dean
I'm going to turn it to Denis I don't think loan pricing is improving for anyone, Joe. So let met turn it to Denis.
Denis Isono
Yeah, Joe. It's really the mix that's changing, we are being able to shift more of our assets from the investment portfolio to loan and that's helping the margin.
Joe Morford - RBC Capital Markets
Okay. So given your expectations for growth, it sounds like you should deal reasonably and to let your ability to sustain margins around these levels then?
Denis Isono
Yeah. We're looking at margins to be between 310 and 320 for the quarter.
Joe Morford - RBC Capital Markets
Okay. And then just a question on the mortgage banking front, can you just talk a little bit about what the volumes were, originations volumes were this quarter and gain on sale margins.
How does that compare with last quarter and how does the pipeline look at period end?
John Dean
Let me turn it to Lance, Joe, Mizumoto who heads up all of our line functions. Lance?
Lance Mizumoto
Good morning, Joe.
Joe Morford - RBC Capital Markets
Good morning.
Lance Mizumoto
Our loan portfolio production as you may have guessed has gone down since interest rates have risen, but it’s still fairly strong. So I think given the loan pipeline going forward I think we're still cautiously optimistic, our origination volume will still be at a good level.
John Dean
I could add. I want to add a little bit, Lance if I may.
And I think you may know, Joe that this bank is more on the purchase side than the refinance side. And the real decline in the overall market that’s impacting banks in this marketplace and perhaps elsewhere is the decline in revise with the given rates as Lance mentioned.
So relatively speaking we should do well and the shift is taking place because it’s playing to our strength in this marketplace.
Joe Morford - RBC Capital Markets
Okay. Thanks so much.
John Dean
Thank you, Joe.
Operator
And our next question is from Aaron Deer of Sandler O'Neill. Please go ahead.
Aaron Deer - Sandler O'Neill & Partners
Hi. Good morning, guys.
John Dean
Good morning, Aaron.
Aaron Deer - Sandler O'Neill & Partners
Just following up on Joe’s question with respect to the margin, obviously the mix shift is having a positive impact, I’m wondering are there more plans with respect to TRUPS to pay down that can continue to kind of bring some uplift to that margin going forward?
John Dean
In terms of the pay down of the TRUPS, what we’ve talked about in the past, Aaron, this is John speaking is that obviously if TRUPS become available as they did for that what I guess it was one pool that we acquired it at a discount, we’d be very, very interested in looking to acquire, it’s a bit process and additional, pay-off additional TRUPS. Where we’re focused more now is less than and the repayment of TRUPS at par and looking more in terms of as I’ve mentioned in the past with our capital position either a one-time cash dividend or the repurchase of shares in the marketplace.
And those probably are on a high run our priority list than the retirement of more of the TRUPS that we have.
Aaron Deer - Sandler O'Neill & Partners
Okay. That's good color.
And then on the expense side, I guess even with the severance and retention charges if I back out the preferred redemption, seem like your expenses are really kind of at the bottom end of your, the guidance range that we talked about last quarter. Is it, are we kind of now at a peak level here, are there additional kind of initiatives that you’ve got coming online that could push those higher before we ultimately start seeing this drift down again the load of the range that you talked about previously?
John Dean
Let me start and Denis may want to add. I think importantly you did see expenses with regard to a right sizing in the organization, that's going to continue next quarter, it will be impacted and then through next year.
So we've been, too many different programs early retirement program, through attrition that exist in all organizations, but with the elimination of some positions too, reducing our FTE. So you are going to see as you saw this quarter, additional expenses in that area for fourth quarter and then a smaller numbers, but throughout next year as we continue to right size the organization.
Aaron Deer - Sandler O'Neill & Partners
Okay. That's great.
And then just one more going back to the kind of outlook on the loan side, as Lance mentioned, the growth that you’ve put up over the past year is a little bit impressive particularly given the clean up in the portfolio. How is that, is that really optimistic, how is the pipeline today versus three months ago and is this kind of growth trajectory sustainable or would you expect to kind of moderate going forward?
John Dean
I am going to turn it to Lance if I could, Aaron.
Lance Mizumoto
Aaron, this is Lance. The pipeline has remained fairly strong.
As you can imagine again the economic conditions why are driving a portion of that growth. In addition, we’ve increased activity on our calling officers to generate more business activity.
So I think while we don’t think that loan growth at this level is sustainable, it’s still going to be strong, it’s probably going to moderate over the coming years.
Aaron Deer - Sandler O'Neill & Partners
Okay great. Thanks very much, guys.
Operator
The next question is from Don Worthington with Raymond James. Please go ahead.
Don Worthington - Raymond James
In terms of the income taxes, any guidance on kind of the tax rate going forward and an update on the valuation allowance against that DTA?
John Dean
Don, I am going to turn it over to Denis Isono.
Denis Isono
On the valuation allowance there is still a residual valuation reserve, it’s about $8 million I think, it’s relative to California taxes. Since we’re not in California anymore on a limited basis there, we are not going to realize that benefit.
Effective rate is, we’re trying to run about the 35% range.
Don Worthington - Raymond James
And then you had some net recoveries in the quarter, do you expect more of that activity, I know it’s still hard to predict, but just kind of see the potential for more recoveries?
John Dean
I am going to turn it Bill Wilson, our Chief Credit Officer and we are all interested in his response got yourself, Don. Bill?
Bill Wilson
Good morning, Don. I think you hit the nail on the head, it is hard to predict.
I would say that given the positive uplift in the local economy that it will certainly support those activities. So we’re hopefully we will continue but it’s difficult to predict.
Don Worthington - Raymond James
Okay, thank you.
Operator
(Operator Instructions) Our next question is from Jackie Chimera of KBW. Please go ahead.
Jackie Chimera - KBW
The $1.9 million charge, is that related to the decline in the non-controlling interest in the quarter?
John Dean
The $1.9 million in terms of the FTE change results.
Jackie Chimera - KBW
No, the charge on the preferred premium that was paid in the quarter, does that -- I noticed that was a decline in non-controlling interest as well are those two related?
John Dean
Yes, that’s exactly the paydown.
Jackie Chimera - KBW
Okay. Is there any tax impact on that?
John Dean
From what perspective are you talking about?
Jackie Chimera - KBW
Because I usually step out things like that from my operating EPS, but given what is going on with DTA, I am just not sure, if it’s tax affected, if it would be under a normal cirum, but if it does happen next year, would there have been a tax benefit to the charge or is it an after-tax charge?
John Dean
There is a tax benefit to the charge.
Jackie Chimera - KBW
Okay, thank you. And then just next as we are moving into bit of a higher rate environment, how is that impacting some of the paydowns and refinances that you have been getting, not in the residential mortgage portfolio but some of the other loan book that you have?
Lance Mizumoto
Jackie, this is Lance. We are seeing some paydowns taking place.
I think what we have collectively done is work with our existing clients to refinance or restructure some loans. So we'll see -- we've seen some price reductions, but again I think we've been encouraged by retain our customers at the same time.
Jackie Chimera - KBW
And do you think we are nearing an inflection point when the generation that you have in commercial real estate why offsets some of the ongoing runoff in the Mainland?
Lance Mizumoto
That's an interesting question. Certainly Bill Wilson has done a great job of reducing our NPAs and lot of it as you know were commercial real estate-related.
So we're at a point, where we would think that the amount of production that our commercial real estate offices are originating will outpace now the amount of NPAs. I think NPAs are slowing down.
The amount of commercial real estate NPAs are fairly low. So we anticipate growth in our commercial real estate portfolio going forward.
Jackie Chimera - KBW
Okay. Thank you very much for the color.
That was all my questions.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to John Dean for any closing remarks.
John Dean
Just to say thank you very much for participating in our earnings call for the third quarter of 2013. We look forward to future opportunities to update you on our progress.
Have a good day.
Operator
The conference has now concluded. Thank you for attending today's presentation.
You may now disconnect.