Jul 24, 2014
Executives
David Morimoto - SVP, IR John Dean - Chairman and CEO Denis Isono - EVP and CFO Lance Mizumoto - EVP and CBO Bill Wilson - EVP and CCO
Analysts
Janet Aldrich - RBC Capital Markets Aaron Deer - Sandler O’Neill & Partners
Operator
Good afternoon and welcome to the Central Pacific Financial Corp Second Quarter Earnings Conference Call. All participants will be in listen-only mode.
(Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.
I would now like to turn the conference over to Mr. David Morimoto.
Mr. Morimoto, please go ahead.
David Morimoto
Thank you, Ed and thank you all for joining us as we review our financial results for the second quarter of 2014. Highlights and comments will be provided by John Dean, Chairman and CEO; Lance Mizumoto, President and Chief Banking Officer; and Denis Isono, Executive Vice President and Chief Financial Officer.
Also present and available for questions are Catherine Ngo, President and Chief Operations Officer and Bill Wilson, Executive Vice President and Chief Risk Officer. During the course of today’s call, management may make forward-looking statements.
While we believe these statements are based on reasonable assumption, they involve risk and may cause actual results to differ materially from those projected. For a complete discussion of the risks related to forward-looking statements, please refer to our recent filings with SEC.
And now, I’ll turn the call over to John.
John Dean
Thank you, David and good morning everyone. We’re pleased to report another solid quarter of financial performance, resulting in net income of $9.2 million.
The second quarter net income was impacted by a provision for loan losses compared to the previous 13 quarters where we recognized credits to loan loss provisions. Denis Isono, our Chief Financial Officer, will provide more detail in his financial highlights during this quarter.
Loan growth continued to be strong in the quarter, driven by improving market conditions and our efforts to build upon our client relationships. Total deposits as well as core deposits maintained growth at a stable rate.
We continue to shift our asset mix from our investment securities to loans at higher yields. Our overall credit risk profile also continued to improve, with non-performing assets at 0.9% of total assets as of the end of the second quarter.
As a result of the Company’s earnings consistency and strong capital position, we completed $56.2 million stock repurchase from our two largest shareholders on April 7th. We reported last quarter that we repurchased $68.8 million of our common stock through a tender offer that closed on March 28th.
The combined $125 million stock repurchase represented 6.2 million shares for almost 15% of our Company’s outstanding common stock. In addition, we initiated a stock buyback program on May 20th, for up to $30 million and today we repurchased 3.4 million, or 181,200 shares, in the open market.
I am pleased to report that our Board of Directors increased the quarterly dividend on our Company’s common stock to $0.10 per share from $0.08 per share and is payable in September of this year. Overall, our Company continues to move in the right direction and meeting our revenue targets while strengthening our infrastructure to improve operational efficiencies and information management.
Turning to Hawaii’s economy; key economic drivers made positive strides during the first half of the year. And this upward trend is forecasted to continue for the remainder of 2014, with a projected real GDP growth of 2.4% for the year.
Construction activity continues to be robust, primarily in the residential condominium market in Honolulu. At the start of 2014, nearly $4 billion in private and public building permits were in place, excluding the $5 billion Honolulu Rapid Transit Project.
The total commitments to build in 2014 are forecasted to reach $4.7 billion. Year-to-date as of May, visitor expenditures were up by 3% compared to the same period last year while visitor arrivals remain stable.
In the month of May, airline capacity increased by 4.2% and visitor arrivals increased by 1.4% compared to the same period last year. The unemployment rate in June remained unchanged, in the previous two months at 4.4% compared to the national unemployment rate of 6.1%.
The forecast for the year-end unemployment rate was 4.2% and real personal income is projected to increase by 2.1% over the previous year. With the healthy construction pipeline and the key economic indicators moving in the right direction, we remain encouraged by the improving market conditions in Hawaii as we execute our business plans for 2014.
At this time, I’d ask Denis, Denis Isono our Chief Financial Officer, to review the highlights of our second quarter financial performance. Denis?
Denis Isono
Thank you, John. For the second quarter of 2014, we reported net income of $9.2 million or $0.25 per diluted share compared to net income of $9.8 million or $0.23 per diluted share reported last quarter.
Net interest income for the quarter was $35.9 million compared to $35.8 million in the previous quarter. Our net interest margin was 3.35% and 3.31% for the same respective quarters.
Sequential quarter increase in net interest income and net interest margin was primarily due to the growth in our average loan portfolio of $97.1 million and a reduction in our average investment securities portfolio of $147.3 million. The sequential quarter increase in net interest income and net interest margin was accomplished despite our successful efforts to repurchase stock and reduce shareholders’ equity.
Our loan and lease portfolio ended the quarter at $2.79 billion, an increase of $96.7 million from the $2.70 billion at the end of the first quarter. We continue to be encouraged by our ability to meaningfully grow on loan and lease portfolio.
Lance Mizomoto will provide more insight into the loan portfolio later in this cal. Our investment securities portfolio ended the quarter at $1.47 billion.
The taxable equivalent yield on our investment portfolio declined to 2.60% from 2.62% reported for the first quarter. During the second quarter, we sold investment securities totaling $162.2 million as part of a balance sheet optimization strategy to improve our interest rate risk profile.
These securities had a weighted average life of 5.7 years and average yield of 2.60%, and the sale resulted in a gain of 240,000. Non-interest income for the quarter totaled $12.0 million, up from $10.1 million in the previous quarter.
The increase in other operating income for the last quarter was primarily due to higher unrealized gains on loans held for sale and interest rate locks of $0.5 million. Higher net gain on the sales of foreclosed assets was $0.4 million and higher income recovered on non-accrual loans previously written-off was $0.4 million.
Non-interest expense for the quarter totaled $32.9 million, up from 31.9 million in the previous quarter. The increase in other operating expense from last quarter was primarily due to a higher provision for unfunded loan provision of $0.8 million, higher legal and professional services of $0.4 million and the reversal of interest on income tax continues in the first quarter of $0.4 million.
This was partially offset by lower salaries and employee benefit of $0.9 million and a lower provision for losses in residential and mortgage loan repurchases of $0.6 million. Our efficiency ratio for the quarter decreased to 68.25% compared to 69.50% in previous quarter.
Our cost improvement initiatives from 2013 are continuing to have an effect on the efficiency ratio. We continue to work on further improving our efficiency ratio with our IT outsourcing, and other changes that are expected to be completed during the year.
In the second quarter of 2014, we reported income tax expense of $3.9 million compared to $5.5 million in the previous quarter. Income tax expense in the second quarter included a true-up adjustment $0.5 million.
Excluding this adjustment, the effective tax rate for the quarter was 32.9% and we expect that rate, our rate for the rest of the year will remain above at that level. As of June 30, 2014 our net deferred tax assets totaled $114.6 million.
During the quarter, we reported a provision for loan and lease losses of $2.0 million compared to credit of $1.3 million reported in the previous quarter. The provision for loan and lease losses was primarily attributable to net loan charge-offs of $1.6 million and $96.7 million increase in our loans and lease portfolio.
Included in the $1.6 million net charge-offs are $2 million in charge-offs related to two negative loans, which we have been closely monitoring over the past several quarters. Both loans are graded sub-standard.
At June 30th we determined a previously taken charge-offs. Aside from these two individual loans, we would have reported a net recovery for the quarter.
Non-performing assets ended the quarter at $42.1 million, a decrease of $11.9 million from the $54.0 million reported in the last quarter. The decrease was primarily due to the return of a main and commercial loan of $8.8 million to accrual status.
The allowance for loan and lease losses as a percentage of total loans and leases decreased to 2.99% at June 30, 2014 from 3.08% at March 31, 2014. Our allowance for loan and lease losses as a percentage of non-performing assets was 198.47% at June 30, 2014 compared with 153.87% at March 31, 2014.
Lastly, at June 30, 2014, our capital ratios continued to exceed the levels required to be considered well capitalized institution for regulatory purposes. Our Tier 1 risk-based capital, total risk-based capital and leverage capital ratio was 17.06%, 18.33% and 11.64% respectively compared to 18.63%, 19.90% and 12.62% respectively at March 31, 2014.
The decline in our capital levels from prior quarters was primarily the result of the repurchases of our common stock and in private purchases and stock buyback program mentioned earlier by John. That completes our financial summary.
And I’d 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 and good morning everyone. The quarter-over-quarter increase in total loans and leases by $96.7 million or by 3.6% can be attributed to increases of residential mortgages of $46.8 million, $27.3 million in consumer loans, $14.2 million in commercial mortgages and $13.2 million in construction and development loans.
Offsetting declines in loan balances included $3.5 million in commercial loans and $1.3 million in leases. The average balances of our total loans and leases increased by $97.1 million or by 3.6% in the second quarter compared to the previous quarter.
The year-over-year increase in total loans of $421.1 million was primarily driven by residential mortgages, consumer loans, and commercial loans. Our core customer base remains stable throughout the quarter and our core deposit base increased by 19.4 million.
We continue to focus on strengthening our customer relationships and originating quality credits across all loan types. In addition to enhancing our revenue sources, we have been aggressively working on operational process improvements through technology as well as expanding our electronic transaction channels through mobile access.
Going forward, the market conditions in Hawaii continue to look encouraging for future business development. The accelerated development of residential units on Oahu has been matched by strong consumer interest.
And we still see growing optimism within our local business community. That completes my summary on our business development activity.
And I will now turn the call back to John for his closing remarks. John?
John Dean
Thank you, Lance. In summary, we continued to make significant progress during the second quarter as evidence by our earnings before taxes and probations.
Our asset composition, credit risk profile and loan loss reserves are moving steadily more normalized pre-recession levels. While we still have work to do in the area of process improvements and operational efficiencies, we’re pleased with the direction and pace of our progress.
We remain confident that the improving market conditions in Hawaii will provide future opportunities for quality growth. I’d like to take this opportunity to thank our shareholders and customers for their continued support and confidence as we work hard to attain the milestones of our business plan.
At this time, we’ll be happy to address any questions you may have. Thank you.
Operator
Thank you. We will now begin the question-and-answer session.
(Operator Instructions) Our first question comes from Joe Morford of RBC Capital Markets. Please go ahead.
Janet Aldrich
Good afternoon. It’s actually Janet Aldrich for Joe.
Just wanted to follow-up on the balance sheet optimization strategy that you’ve been talking about, trying to understand how much are you willing to run-down the securities portfolio or is it just a matter of replacing loans or having the loans replaced whatever you run-off in the portfolio.
RBC Capital Markets
Good afternoon. It’s actually Janet Aldrich for Joe.
Just wanted to follow-up on the balance sheet optimization strategy that you’ve been talking about, trying to understand how much are you willing to run-down the securities portfolio or is it just a matter of replacing loans or having the loans replaced whatever you run-off in the portfolio.
John Dean
Janet, I’m going to turn it over to Denis our CFO for the question.
Denis Isono
The investment portfolio is probably about 30% of assets and our objective has been to run down to reallocating to the loan portfolio down to about 20% that we have targeted. So you’ll see little more and more run-off on the portfolio slightly in the loan growth.
Janet Aldrich
Okay, that’s helpful. And then in terms of the loan growth, it looks like it’s picked up.
So where did you end the quarter in terms of your pipeline?
RBC Capital Markets
Okay, that’s helpful. And then in terms of the loan growth, it looks like it’s picked up.
So where did you end the quarter in terms of your pipeline?
John Dean
I’m going to turn it to Lance, our CBO.
Lance Mizumoto
Hi Janet, this is Lance. In terms of our pipeline, I think it’s been fairly steady.
So, we’re still continuing to see opportunities in the marketplace. And I think with the continued strength in the Hawaii economy, we’re continuing to see activities not only in the construction and development loan side but also on the commercial side.
Janet Aldrich
Okay, and then finally in terms of the provision that you took this quarter just trying to understand. You still have a fairly high level of reserve coverage.
So was the idea that this was intended to cover both the net charge-offs and the growth? And how we should think about it going forward?
Thanks very much.
RBC Capital Markets
Okay, and then finally in terms of the provision that you took this quarter just trying to understand. You still have a fairly high level of reserve coverage.
So was the idea that this was intended to cover both the net charge-offs and the growth? And how we should think about it going forward?
Thanks very much.
John Dean
Bill, Bill Wilson, our Chief Credit Officer.
Bill Wilson
Good morning Janet. Probably less of the provision being dictated specifically by those two charge-offs more just the impact of those two specific charge-offs on the methodology is what drove the reserve.
We would expect that going forward we do need these two large charge-offs as being anomalous I think the benefits and as the newer legacy issues being dealt with as we look forward we would expect that we will continue the path that we’ve been on over the last several quarters.
Janet Aldrich
Okay thank you very much.
RBC Capital Markets
Okay thank you very much.
John Dean
Thank you, Janet.
Operator
Our next question comes from Aaron Deer of Sandler O’Neill & Partners. Please go ahead.
Aaron Deer - Sandler O’Neill & Partners
Good morning guys. Denis, I’m going to go back to you on your questions or to your answer rather to the mix shift on the earning assets.
Just to clarify. Is it your expectation that the earning asset levels probably stays fairly leveled but that you just get a shift out of the securities book into loans or you actually looking to reduce the overall size of the loan book?
And on an absolute levels such that you see a lower level of earning assets.
John Dean
I might jump in if I can here in first, John here. I’m not sure I’m following you.
You’re saying again, obviously we stated earlier that we see the shift going from the investment portfolio over to the loan portfolio. We think we can have that continue to grow without total assets necessarily growing for a while.
Is that your question?
Aaron Deer - Sandler O’Neill & Partners
It’s more along the lines of -- as that mix shift occurs, is the loan, do you expect the loan growth to fully replace the reduction in investment securities such that the level of earning assets stays leveled?
David Morimoto
Aaron it’s David. I think that’s the general philosophy.
But obviously the quarter, the sequential quarter loan growth, will not line up exactly with the sequential quarter investment portfolio run-off. And we’re not going to be necessarily selling every quarter out of the investment portfolio.
So it’s going to be somewhat opportunistic. I’m not sure if that helps.
But we could end up borrowing at some point and leveraging off the balance sheet a little, so it’s not going to be a direct offset.
Aaron Deer - Sandler O’Neill & Partners
Okay. And then on the expense side, I think you guys are still working hard to get some of these efficiency improvements.
So just wondered if you could give us an update on kind of what your expectations are for operating expenses going forward and remind me where the target efficiency level is and when we hope to get there.
John Dean
Yes. Well Aaron, the targeted normalized run-rate for operating expense we expect between 31 million and 33 million and then we’ll return to buyer’s much the efficiency we should now as quickly as we can in a reasonable manner.
So, we’re looking in through again into the below 60s in the near-term. Does that help?
Aaron Deer - Sandler O’Neill & Partners
Yes. And then lastly Lance, if I was just hoping you could give a little more color on and you sounded like when you were talking about the expectations for growth, you sounded positive on the commercial side.
Just to be clear you’re talking about CNI versus commercial real-estate and what kind of growth you anticipate?
Lance Mizumoto
I think that the growth is going to be more on the commercial real-estate side as well as our construction activity. Although, you’re seeing -- we’re seeing ancillary benefits of the construction activity on the CNI front as contractors or sub contractors are looking to expand either their working capital lines looking for properties to occupy.
There is lot of them like to occupy their own footprint. So it’s a combination of both commercial real-estate activities as well as CNI.
Aaron Deer - Sandler O’Neill & Partners
Okay.
Lance Mizumoto
So the pipeline again I think it’s still fairly strong and we’re continuing to see more activity as the economy continues to stay strong.
Aaron Deer - Sandler O’Neill & Partners
That’s great. Okay thanks for taking my question.
Lance Mizumoto
Thank you.
Operator
(Operator Instructions) Well, this concludes our question-and-answer session. I would like to turn the conference back over to Mr.
John Dean for any closing remarks.
John Dean
Thank you. And thank you everyone for participating in our earnings call for the second quarter of 2014.
We look forward to future opportunities to update you on our progress. Have a good day.
Operator
The conference is now concluded. Thank you for attending today’s presentation.
You may now disconnect.