Jan 25, 2017
Executives
David Morimoto - EVP and CFO Catherine Ngo - President and CEO Anna Hu - EVO and CCO
Analysts
John Moran - Macquarie Brett Rabatin - Piper Jaffray Aaron Deer - Sandler O'Neill Jackie Boland - KBW Laurie Hunsicker - Compass Point
Operator
Good afternoon, ladies and gentlemen. Thank you for standing by and welcome to the Central Pacific Financial Corp Fourth Quarter 2016 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.
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'd like to turn the call over to Mr.
David Morimoto, Executive Vice President and Chief Financial Officer. Please go ahead sir.
David Morimoto
Thank you, Elena, and thank you all for joining us as we review our financial results for the fourth quarter of 2016. With me this morning are Catherine Ngo, President and Chief Executive Officer and Anna Hu, 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, they involve risks that may cause actual results to differ materially from those projected.
For a complete discussion of risks related to forward-looking statements, please refer to our recent filings with the SEC. And now I’ll turn the call over to Catherine.
Catherine Ngo
Thank you, David and good morning everyone. I'm pleased to report that we ended 2016 with a strong fourth quarter and made significant improvements to keep [indiscernible] metrics on a year-over-year basis.
Net income in 2016 reflected a 2.5% increase over 2015 and included a much lower price to loan loss provisions compared to the previous years. In general, an increase in operating expense in 2016 was offset by higher gains and net interest income and non-interest income resulting in an improved efficiency ratio compared to the previous year.
We did recognize several one-time income and expense items in the fourth quarter, and David will provide more details of our net income composition. Loan and deposit growth, including core deposits, continued on a strong pace throughout the year, supported by favorable market conditions and a focus on strengthening customer relationships.
Year-over-year loan growth was realized across all lines of business, particular in the commercial mortgage, banking mortgage and the home equity areas. Deposit growth included a significant increase in non-interest bearing demand balances.
Asset quality also improved with a significant reduction in non-performing assets at the end of 2016 compared to the same period last year. Our capital position remained strong and together with our consistent profitability, we were able to repurchased approximately 797,000 shares of CPF stock or approximately 2.5% of the total outstanding shares as of December 31, 2016.
For the current year, our Board of Directors has authorized up to $30 million in the 2017 share repurchase plan to continue building shareholder value. Cash dividends were maintained at $0.16 per share payable on March 15 of this year.
From January to November 2016, the economic activity in Hawaii maintained an upward trend and the forecast remains positive going into 2017. Year-to-date as of November 2016, visitor arrivals increased by 3.0% to 8.1 million visitors and visitors expenditures increased by 4.1% to $14 billion over the same period in 2015.
Overall job growth in Hawaii as of November 2016 was up by 2.4% and real personal income was up by 3.0% over the same period last year. The unemployment rate in Hawaii dipped to 2.9% in December, the lowest level since September 2007 compared to the national December unemployment rate of 4.7%.
Real GDP across state is projected to increase by 2.0% in 2016 compared to an increase of 1.7% in the prior year. Hawaii’s Consumer Price Index increased in 2016 to 2.0% compared to 1.0% in 2015.
Market conditions and key economic factors in Hawaii are expected to continue on its upward trend in 2017 with the exception of the value and building permit being issued. However, with the current inventory of permits issued, we expect construction activity to remain robust in the coming year.
At this time I’ll turn the call over to David to review the highlights of our fourth quarter financial performance. David?
David Morimoto
Thank you, Catherine. Net income for the fourth quarter of 2016 was $12.2 million or $0.39 per diluted share compared to net income of $11.5 million or a $0.37 per diluted share reported last quarter.
As mentioned by Catherine, there were three large non-recurring items in the fourth quarter results. First, we realized a pretax $3.5 million gain on the sale of the fee interest in a former branch location.
This branch was consolidated with a nearby branch in the first quarter of 2016. Secondly, we purchased annuity to settle the pension obligation for roughly 30% of our curtailed defined benefit plan.
This resulted in the immediate recognition of $3.8 million in net actuarial losses in the quarter, which appears in the salaries and benefits line. This transaction eliminates the future pension cost and risk for that portion of the plan and moves us one step closer to plan termination.
Finally, we recognized a 700,000 pretax charge to early terminate a lease on office based in downtown, Honolulu. This was done to consolidate our residential mortgage operations into a building we own.
We expect that the annuity purchase and lease termination will reduce the bank's [ph] annual expense by roughly $0.5 million. Our return on average assets in the fourth quarter was 92 basis points and return on average equity was 9.46%.
For the full year 2016, total loans grew by 9.8% and total deposits increased by 3.9%. At year-end our loan-to-deposit ratio was 76%.
Net interest income increased by $0.3 million sequential quarter and our net interest margin declined by three basis points to 3.22%. The sequential quarter decline in NIM was driven by a two basis point increase in the cost of interest bearing liabilities combined with continued high premium amortization on MBS investments.
We expect MBS premium amortization to begin to slow in the first quarter of 2017. As a result, we expect the NIM to remain in the 3.20 to 3.30 range over the next couple of quarters.
During the fourth quarter we recorded a credit to the provision for loan and lease losses of $2.6 million, compared to a credit of $0.7 million recorded in the prior quarter. Net charge-offs in the fourth quarter totaled $0.1 million and included a $0.9 million recovery on a commercial mortgage loan.
Our allowance for loan and lease losses at year-end was $56.6 million or 1.61% of outstanding loans and leases. Other operating income of $13.8 million and other operating expense of $37.5 million were both depleted by the previously mentioned non-recurring items in the quarter.
The recorded efficiency ratio for the fourth quarter was 17.1%. Normalizing for the non-recurring items would result in an efficiency ratio for the fourth quarter of 66.0%.
In the fourth quarter, our effective tax rate was 34.5% versus 35.8% in the third quarter. We expect our normalized effective tax rate to approximate 34% to 36% going forward.
At December 31, 2016 our net deferred tax asset was $59 million. That completes the financial summary, and now, I'll return the call over to Catherine.
Catherine Ngo
Thank you, David. In summary, I am confident that we can maintain the positive momentum we realized in 2016 and to the coming year with regard to our financial performance, operational efficiencies and expanding and strengthening customer relationships.
With a clearly defined business plan for 2017 I believe we are well positioned to achieve our business goals. I would like to take this opportunity to thank our employees, customers and shareholders for their continued support and confidence in our organization, as we work toward achieving our 2017 goals.
At this time we will be happy to address any questions you may have. Thank you.
Operator
We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from John Moran with Macquarie.
Please go ahead.
John Moran
Hey, thank you. It’s John Moran with Macquarie.
Hey, guys, I just, I guess, firstly on loan growth, I think last quarter, Catherine, we were kind of targeting mid to high single-digits for '17 and kind of across all categories. Wondering if that’s - if that still stands and if you’ve any kind of update.
It sounds like you’re still pretty constructive on construction development, with CRE and some of the other things going on the island?
Catherine Ngo
Sure. For 2017, we are projecting loan growth in that - still the mid to high single-digits.
John Moran
Mid to high, okay and that would be across categories, correct?
Catherine Ngo
Generally, across all categories, yes. So we’ll see perhaps a decline in our construction activity, but otherwise I would say across all our loan asset classes.
John Moran
Okay. Got it, thanks.
And were there any portfolio purchases in this quarter’s numbers and then if you had the balance of mainland mix?
Catherine Ngo
Sure. So there were no purchases in the fourth quarter of 2016.
And then the balances for mainland to mix at the end of the year was a $137.4 million.
John Moran
Okay. So basically unchanged that as we think of linked quarter.
And then purchase activity is not a plan you guys are looking for this growth all kind of to come organic on island, right?
Catherine Ngo
Generally, the activity will be on island. However to the extent there are - there is runoff in the purchase portfolio on the mainland to withstand their good opportunities of yield wise again about risk, we could replace the runoff with additional purchases in 2017.
John Moran
Okay. Got you.
And then I just, I’m going to switch gears real quick over to deposits, the non-interest bearing was up a bunch this quarter looked really, really good. I’m wondering if any of that was - and I know you guys have some seasonality there, but wondering if any of that was seasonal or if you expect it to back out and then anything you see in terms of pricing?
Catherine Ngo
I better turn that question over to David. David?
David Morimoto
Hey, John. I think like most banks, we do have some runoffs in non-interest bearing demand on the corporate side, going into year-end.
So there was some of that. But I wouldn’t say, it was a significant amount.
There weren’t any - like very large or short term deposits in the quarter.
John Moran
Okay. Great, thanks very much guys.
David Morimoto
Thanks.
Catherine Ngo
Thanks, John.
Operator
Our next question comes from Brett Rabatin with Piper Jaffray. Please go ahead.
Brett Rabatin
Hi, good morning everyone.
Catherine Ngo
Good morning, Brett.
Brett Rabatin
Wanted to first ask, you bought back a decent amount of stock in the fourth quarter, and you’ve got another authorization of $30 million. I was just curious, how active you think you’ll be this year with the buyback and as you see it going, what you might be do with capital given the growth prospects you guys are looking at?
Catherine Ngo
Sure. Let me hand that over to David.
David Morimoto
Hey, Brett. Yeah.
I think the plan is to continue to pay the quarterly cash dividend, at roughly in the 40%, 45% payout ratio and then to the extent that we have appropriate or adequate capital to support the business we do see a continued share repurchases. We do spend a lot of time around the repurchase process.
We have a pretty a sophisticated way that people look at the forward opportunity, forward earnings opportunities of the company. We look at the buyback IRs through three different metrics.
So it sort of like a M&A process that we go through, to people look at the IRR of the buybacks and that kind of drives our decisions on how much we repurchase at what market price levels, and that decision process goes throughout on a quarterly basis.
Brett Rabatin
Okay. And then I was hoping for some color, obviously a bit bigger negative provision this quarter and credit quality is really good.
If credit metrics hold and charge offs continue to be pretty modest would it would be far to assume that provisioning continues to be negative despite the growth given the reserve levels you guys have?
Catherine Ngo
I’m going to turn that question over to Anna. Anna?
Anna Hu
Hi Brett, this is Anna. Given where we are in the market place and assuming that credit quality we are at the top of where we are at, it really because of the portfolio mix of - we expect to continue to see both those moving generally in the same direction going forward.
Brett Rabatin
Okay. And then just lastly curious on any thoughts about the mortgage banking outlook as you see in 2017?
Anna Hu
Sure, so we had - of course in Q4 strong resi mortgage origination. In 2017 we expect the production to decline.
So while we saw $250 million in production in the fourth quarter of 2016 I would expect in Q1 that production level to be more in the $150 to $175 million range.
Brett Rabatin
Okay. Great, thanks for the color.
Anna Hu
Sure welcome.
Operator
Our next question comes from Aaron Deer at Sandler O'Neill and Partner. Please go ahead.
Aaron Deer
Hey, good morning everyone.
Catherine Ngo
Good morning Aaron.
Aaron Deer
I’d like to circle back to some of the margin related consideration. So I guess it started on the deposit side, as noted you guys have some strong non-interest bearing inflows and it seems like you still have plenty of liquidity coming off the securities book to fund your loan growth.
I’m just curious what was that a draw up the interest bearing deposit cost in the quarter?
Catherine Ngo
Hey, let me turn that over to David
David Morimoto
Hey Aaron. So the increase in interest bearing deposit cost was in the CE portfolios, and primarily in the government CE portfolio.
So we do have roughly $700 million in governments deposit and those deposits are relatively short duration. So and they do re-price off the front end of the curve.
So that's somewhat reflective of what we've seen over the last several months with the increase in LIBOR and treasury bill rates.
Aaron Deer
Okay. That's helpful.
And then you mentioned that the securities yields saw some pressure this quarter from premium amortization. I guess that was a little surprising given what we saw in rates, but that's likely to go down.
Can you give us what kind of what the impact of premium amortization was in the fourth quarter and where we might see that trends here go in the first quarter?
David Morimoto
Yeah, actually so our premium amortization unlike what we - you probably have seen in a number of institutions the way we are handling a doc [ph] today we have the outsourced the accounting [ph] service and those have historical speeds versus prospective speeds in determining average life and then really premium and amortization. So we see our - [indiscernible] drives the decline in amortization occurred on a little bit more of a like bases.
So amortization actually increased for us in the fourth quarter by a 100,000 relative to the third quarter. As we look forward we obviously expect that to decline.
What we did as we went back to the first quarter of ‘15 as kind of like a baseline and if amortization were to return to that level it’s a bit roughly about a 800,000 per quarter delta. So on a net interest margin basis I think that equates to five or six basis point of NIM, on the investment portfolio yield it's pretty significant.
It's probably in the high teens, 15% to 20% of investment portfolio yield.
Aaron Deer
That’s very helpful Thank you. And then the question on the kind of the rationalization of the operating costs relative to revenue has been a big part of the story for the past couple of years.
Can you - as you kind of look out, do you think that you can continue that time to going forward or there are going to be - need to be new investments in the personal franchise to kind of keep the revenues growing at the pace that they have been.
Catherine Ngo
Sure, Aaron. So as we reported in earlier quarters we have made significant investments in technology.
At this point we do expect these expense lines to hold pretty flattish in $32 million to $34 million range. So that would of course take into consideration talk about the cost, investment technology costs, which have been the larger drivers or are the larger drivers of the cost of expense line.
Aaron Deer
Okay, that's great. I'll step back.
Thank you.
Catherine Ngo
Thanks Aaron.
Operator
Our next question comes from Jackie Boland with KBW. Please go ahead.
Jackie Boland
Hi good morning everyone.
Catherine Ngo
Good morning Jackie.
Jackie Boland
So looking at some of the events in the quarter with the derisking of the pension plan and then the terminative lease. As you look out do you see any other opportunities where you might be able to get savings of that nature?
Catherine Ngo
Let me start and then turn it over to David. We continue to look at opportunities and as I think about the branch strategy for example, there could be opportunities to reduce the footprint of any one of our branches.
We tend to have branches in classified 8,000 square foot range. And given our strategy focused on customer relationship and the kind of footprint that we would need to support that strategy.
That branch could be more than 3000 square foot range. So that would be an example of an opportunity for reduction in cost going forward.
Also in regards to our technology investments as we continue to automate and streamline, reduce the paper flow across our groups in the organization there could be expense reductions related to that.
Jackie Boland
All right. And those all play into the $32 million to $34 million range that you spoke about?
Catherine Ngo
They do Jackie.
Jackie Boland
Okay great. Thank you.
That's all I had. Everything else was asked?
Catherine Ngo
Thank you, Jackie.
Operator
[Operator Instructions] Our next question comes from Laurie Hunsicker with Compass Point. Please go ahead.
Laurie Hunsicker
Thanks good morning. I wanted to go back to Brett's question on how you all are approaching reserve.
And Anna something you said in terms of I guess the same direction. Meaning if we're looking at, as you've stated mid-to-high single digit loan growth and if credit still stays roughly in this band, does that mean potentially we could be seeing recoveries lead in if this $2 million to $2.5 million quarterly run-rate?
Anna Hu
Hi Laurie, this is Anna. We have seen unusual or unexpected recovery on those that we have charged off in the past.
And provided that we continue to see that that will contribute a lot towards us moving in the same direction. Should we not see that we will possibly see a leveling off?
Laurie Hunsicker
Was there an unexpected recovery in the quarter?
Anna Hu
Yes, there was.
Laurie Hunsicker
And how much was that?
Anna Hu
It's about $900,000 in the fourth quarter from one commercial mortgaged bar [ph].
Laurie Hunsicker
Okay. So I guess I have to net away if we net that out then it was - is $1.7 million to your comment on same direction, would that be - if we saw $1.5 million to $1.7 million continued recovery, I mean your reserves to loan is still beautiful.
You're sitting here at 1.61%. I mean how should we think about that, that's a pretty big swing into earnings?
Catherine Ngo
Anna?
Anna Hu
We believe we're adequately reserved. And we continue to experience improvement in asset quality from quarter-to-quarter in 2016 as well as a slight shifting in our portfolio mix.
So all of that will play into how we look at our reserves.
Laurie Hunsicker
Okay, and then just one last question on this. So at what point directionally do you shift, at what point does your reserves to loan outside of obviously deteriorating credit.
At what point do you shift and say we need to start providing, we need to match?
Anna Hu
I think once we start seeing an increase in deteriorating loans, at this point where we're at, at $9.2 million on non-performing assets is sort of where we see bottoming out on at about normalized levels. So as we do see or should we see into '17 or beyond, I would say at that point you would see us moving in opposite direction.
Laurie Hunsicker
Okay, but so for 2017 will probably continue to expect to see recoveries?
Anna Hu
Yes.
Laurie Hunsicker
Okay, great. And then just one last follow-up, I know you gave the Mainland’s SNIC [ph], do you have the Hawaii SNIC?
Catherine Ngo
Yes I do, Hawaii specific I have right here, the Hawaii SNICs are at $50.3 million.
Laurie Hunsicker
Okay, all right. So that puts your whole portfolio to $189 million, down a little bit.
How do you guys think about that? Is that going to be something that you continue just to run down or do you see that as staying roughly at the 5% level?
Catherine Ngo
So it's - I would distinguish between the Hawaii SNICs and the Mainland SNICs. In case of the Hawaii SNICs where there is the opportunity to build the relationship and of course these are companies that we’re close to people we know well, we understand and certainly understand the market much better here in Hawaii.
You could see us continuing to grow, the Hawaii SNIC portfolio. On the other hand in regard to Mainland, overtime we would expect to replace those balances with Hawaii customer relationships.
Laurie Hunsicker
Great, that’s helpful. Thank you.
Catherine Ngo
Sure Laurie.
Operator
This concludes our question-and-answer session today. I would like to turn the conference back over to Catherine Ngo for any closing remarks.
Catherine Ngo
Thank you very much for participating in our earnings call for the fourth quarter of 2016. We look forward to future opportunities to update you on our progress.
Operator
This conference is now concluded. Thank you for attending today's presentation.
You may now disconnect.