CPF (2019 - Q3)

Good afternoon, ladies and gentlemen. Thank you for standing by and welcome to the Central Pacific Financial Corp Third Quarter 2019 Conference Call. During today’s presentation, all parties will be in 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 would like to turn the call over to Mr. David Morimoto, Executive Vice President, Chief Financial Officer. Please go ahead. David Mo

Thank you, Ivy and thank you all for joining us as we review the financial results of the third quarter of 2019 for Central Pacific Financial Corp. With me this morning are Paul Yonamine, Chairman and Chief Executive Officer; Catherine Ngo, President; 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 the risks related to our forward-looking statements, please refer to our recent filings with the SEC.And now, I’ll turn the call over to Paul.

Thanks, David and good morning, everyone. I am pleased to report on the company’s solid financial performance for the third quarter of this year as well as for the year-to-date performance over the past nine months. We continued to generate strong loan and core deposit growth and maintained solid asset quality and capital ratios, both on a sequential quarter and a year-over-year basis. On a nine-month year-to-date basis compared to last year, we improved our net interest income, net interest margin, non-interest income and efficiency ratio. David will be providing the details of our financial highlights later in this call. Our profitability and strong capital position enabled us to repurchase 140,600 shares of CPF stock during the quarter. Year-to-date, we have repurchased 631,300 shares or roughly 2.2% of our common stock outstanding as of the end of 2018. Combined with cash dividends, we have returned $37.2 million in capital to our shareholders this year.At our last earnings call, we announced RISE2020, a comprehensive initiative to enhance customer experience, drive stronger long-term growth and profitability and improve shareholder returns. Since the launch, we have heard positive and encouraging feedback from our customers and employees. While still early in the initiative, we did successfully outsource residential mortgage servicing in the third quarter. On deck for the fourth quarter are the launch of the new website under the cpb.bank domain name, the employee pilot phase of our upgraded online and mobile banking platforms and the implementation of an end-to-end commercial loan origination system. Efforts to hit our 2020 milestones in our branch modernization and digital banking initiatives are progressing very well. The economic conditions and key leading indicators in Hawaii are projected to grow, but at a slower rate than in previous year. The bright spot may be in construction activity with a robust pipeline of high-rise residential buildings in the urban Honolulu. The visitor industry year-to-date as of August has shown solid increases in visitor arrivals of 5.2% over the same period last year. However, visitor expenditures were down slightly by 0.5%. The forecasted growth in 2019 for jobs is at 0.4%, real personal income at 1.2% and real GDP at 1.1%.At this time, I’ll turn it over to Catherine for our balance sheet highlights. Catherine?

Thank you, Paul. As our total assets have grown to nearly $6 billion or an increase of 4.3% from the same period a year ago, our balance sheet composition has been moving in the right direction, especially with regard to loan and core deposit growth. Total loans increased by $121 million or 2.8% over the previous quarter and by $390 million or 9.8% year-over-year. On a sequential quarter basis, increases were balanced across loan categories, led by $42 million in resi mortgages, $41 million in commercial mortgages, $25 million in consumer loans and $24 million in construction financing. On a year-over-year basis, the $390 million loan growth was also relatively balanced among the same loan categories with solid increases across all loan types.Asset quality continued to be strong with non-performing assets of $1.4 million, which represented 2 basis points of total assets. Total deposits increased on a sequential quarter basis by 1.2% and year-over-year by 0.7%. However, core deposits contributed to almost all of that growth with the sequential quarter increase of $58 million or 1.4%, led by a 3.6% increase in non-interest-bearing demand balances. The year-over-year increase in core deposits of $140 million or 3.5% was led by a 6.7% increase in interest-bearing demand and 6% increase in savings and money market balances. Our loan-to-deposit ratio was at 87% as of the end of the third quarter. We had successful core deposit campaigns during the quarter, including an enhanced premium business checking account promotion and the execution of targeted deposit gathering strategy. We’ve also initiated several business development initiatives that we feel will yield meaningful results going forward.At this time, I’ll turn the call over to David to review in more detail the highlights of our financial performance. David?

Thank you, Catherine. Net income for the third quarter of 2019 was $14.6 million or $0.51 per diluted share compared to net income of $13.5 million or $0.47 per diluted share reported last quarter. Return on average assets in the third quarter was 0.99% and return on average equity was 11.11%. We are pleased we were able to post solid third quarter results, while investing for our future through our RISE2020 initiatives. Net interest income increased by $0.3 million to $45.6 million on a sequential quarter basis and the net interest margin was 3.30%. During the third quarter, we recorded a provision for loan and lease losses of $1.5 million compared to a provision of $1.4 million recorded in the prior quarter. Net charge-offs in the third quarter totaled $1.6 million compared to net charge-offs of $0.4 million in the prior quarter. The prior quarter included $0.9 million higher recoveries compared to the current quarter. At September 30, our allowance for loan and lease losses was $48.2 million or 1.10% of outstanding loans and leases.Third quarter other operating income totaled $10.3 million compared to $10.1 million in the prior quarter. Other operating expense for the third quarter was $34.9 million compared to $36.1 million in the prior quarter. The sequential quarter improvement was driven by a reduction in the reserve for unfunded loan commitments, promotions expense primarily related to our core deposit campaign in the prior quarter and an FDIC deposit insurance assessment credit in the current quarter. The efficiency ratio improved in the third quarter to 62.5% from 65.1% in the prior quarter. The effective tax rate was 25.2% in the third quarter. Going forward, we continue to expect the effective tax rate to be in the 24% to 26% range.Thanks. And now, we will turn the call to Paul.

Overall, we are pleased with another solid quarter and in maintaining a positive momentum throughout the first three quarters of the year. The RISE2020 initiative has infused another level of enthusiasm and commitment into our company to achieve the enhanced goals we have set in the coming years. On behalf of our management team, thank you for your continued support and confidence in our organization. We are confident that the timing is right to make a bold move and investment toward building a better bank for our employees, customers, community and shareholders for the long-term.At this time, we will be happy to address any questions you may have. Thank you very much.

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Aaron Deer with Sandler O’Neill & Partners.

Hi. Good morning, everyone.

Good morning, Aaron.

Good morning, Aaron.

Paul, maybe to just start, you mentioned the outsourcing of the mortgage servicing. Just curious to know what kind of impact that might have on both your mortgage revenue line and expense line as we head into the fourth quarter?

I think the outsourcing opportunity was one for our employees to get more focused on mortgage growth while making sure that we really cross the Ts and dot the Is on all regulatory compliance matters. This was not cost takeout play per se it was about strengthening our regulatory compliance and credit policies and getting our folks to really focus on the market. And so we made the transition and as with all migrations, there is always some bumps along the way, but I think our team did a great job pulling it together and is right on track right now.

Okay. And then I guess we are back at the interest recovery in the prior quarter. Looks like the core NIM was pretty flat sequentially. But your loan yields looks like those moved down a fair bit and given the late in the quarter drop in the prime rate and perspectives, additional rates coming, how are you thinking about the impact of falling loan yields on the margin, and to what extent do you expect to offset that with reduced funding costs?

I will have – Aaron, I will have Catherine respond to that.

I will start and then just in terms of the loan yields for this quarter and then I’ll turn it to David to talk about go forward. But the new loan yields for the quarter came in at 4.12% and that compares with our average portfolio yield of 4.25% and then as for go forward, David?

Hey, Aaron. I think we are comfortable for now to stick with the net interest margin guidance that we have been providing for several quarters now. So, we are sticking with the guidance for the next couple of quarters on the NIM of 3.25% to 3.35%. Regarding the outsized decline in the loan yield of sequential quarter, again, that was exacerbated by the non-recurring interest recoveries in the second quarter. So, we do believe we can still maintain that 3.25% to 3.35% guidance. That’s what we are holding to for now.

Okay. That’s great. And then, it looked like you’ve continued to run down the investment securities portfolio. I’m just curious, are we – is that done at this point or is there more to be done there? And how do you anticipate that impact in net interest income then moving forward if that portfolio continues to shrink?

Yes. It’s always going to be a function of the interaction between loan and deposit growth, but the rundown has largely – as you say, has largely taken place. We probably normally would run the investment portfolio in the 18% to 20% of assets. I think we’re right at the top-end of that range right now. So probably keep it in that range for the time being, but it’s always going to be a function. If we are able to generate outsized deposit growth, then it might trend a little higher, but normally we would run it in the 18% to 20% of total assets.

Got it. Okay. Thank you. I’ll step back.

Our next question comes from Luke Wooten with KBW.

Good morning, guys. Just wanted to dig in on expenses for a second, so with the – in the current quarter, you guys had the reversal for the unfunded commitments reserve and then also the drop-off for the promotional campaign. Just wanted to see for the guide on the $34 million to $36 million for the fourth quarter, should we anticipate that running back up to around – closer to the higher-end of that range or how should we look at that going forward? And then also just for the 2020 balance, maintaining the $36 million to $38 million and just kind of wanted to hear how the expense outlook was looking?

Okay. Hey, Luke, it’s David. Yes, I think the way you are thinking about it is correct. We were roughly $35 million in the third quarter, but yes, there was the reduction and the reserve fund funded that’s not – we can’t necessarily count on, so $35.5 million seems like a good guide for the fourth quarter, $35 million to $36 million for the fourth quarter. And then looking forward into 2020, the $36 million to $38 million range is an appropriate range for 2020 and that would incorporate the anticipated investments related to RISE2020 and the normal inflationary increases in other expense line items.

Okay, that’s helpful. And then just kind of on the deposit campaign, I know you guys finished up with the exceptional plan deposit campaign in 2Q. Would you guys consider implementing another campaign considering the success of that plan? Or kind of how do you feel about doing something like that at this point in the cycle?

Hi, Luke. This is Paul. We are still in dialog on the campaigns. There is no question that we’ll be doing deposit campaigns, but as to the nature of it, the timing, we’re currently in discussion on that, but you can expect us to really drive more deposit growth in subsequent quarters.

Okay, that’s helpful. And then just on the deposit growth this quarter, really core funded, and just wanted to know if any of that was – I know you guys had talked last quarter about the addition of Japanese deposit accounts and I was wondering if any of it was related to that or I know you guys had been kind of pushing for a lot more of those deposit accounts.

As you know, working with Japanese companies or with the Japanese market always takes some time, but I think we have made some good progression and growth in this current quarter and we expect to continue placing a focus on that market opportunity, given the strength and the economy there and the appetite for a lot of Japanese investors and consumers wanting to globalize. So, we will continue to place the focus. Again, things in Japan sometimes take a little time, but I think we’re making some good progress.

Okay, that’s helpful. And then just lastly, have you guys seen a lot of traction on the new online and mobile banking platform? I know it’s planned to roll out, I think, either late 4Q or early 1Q ‘20, but just wanted to see how the traction was building on those accounts.

There hasn’t been any traction on the new platform because it hasn’t – it’s not established yet. Our plans are to roll it out in the early part of 2020. I can tell you that our current implementation is on schedule. We’re quite pleased and proud and confident that I could really help our business and our bank going forward. So, we’ll keep you posted on our progress on that in subsequent quarters.

Okay. Thank you. I will step back.

[Operator Instructions] Our next question comes from Laurie Hunsicker with Compass Point.

Yes. Hi, good morning.

Hi, Laurie.

Good morning, Laurie.

Good morning.

Just wanted to circle back to where Luke was going. Do you have an actual balance of where your Japanese deposits stood? I think you gave us as of 2Q, it was $500 million. Is that unchanged or do you have a new number?

And currently, we’re at about $545 million. And so again, some progress. We’re hoping to continue to focus on the opportunity there and the interest among the average Japanese consumer and in the Hawaii market.

Okay, great. Thanks. And then just going back to expenses, I know you have the FDIC assessment credit, but how much is still remaining in terms of what we could see roll into fourth quarter?

Hey, Laurie, it’s David.

Hi, David.

Hey, what came through is roughly a quarter of it. So there is roughly $1.2 million remaining. And then when – the timing on when that credit would be obtained is a function of the deposit insurance fund as you know.

Sure. Okay, good. And then on the RISE2020, I saw that third quarter was $1.2 million expenses baked in and that compared to the June quarter of $1 million and so that kind of sits roughly with the guidance you gave us, but I wonder if you could refresh us in terms of what the RISE2020 will be embedded into both the fourth quarter and then the full-year 2020 how we should be thinking about that. Thanks.

Yes, Laurie, so, yes, $1.2 million in the second quarter. Right now, our estimate of the RISE2020 related expenses in the fourth quarter – estimate is roughly $1.3 million in the fourth quarter.

Okay.

Then again, as we disclosed on last quarter, as you roll into 2020, it’s roughly a $7 million increase in expense related to RISE2020, but the full other operating expense guide that we’ve been providing that we mentioned earlier, the $36 million to $38 million quarterly run rate includes not only RISE-related expenses, but also just other inflationary expenses in other line items.

Okay.

Laurie, a big component in our RISE initiative, aside from the total dollar investment, is really how we’ve reorganized and how we are spearheading efforts into the market. And I think our team is really coming together and getting a lot more customer-oriented and making sure that we continue to bring in more growth to counter some of the short-term investments we’re going to be making for RISE2020.

Okay, great. That’s helpful. And just I want to make sure that I have the expense piece of it right. So, just when I look at the third quarter, the $1.2 million were obviously at a $4.8 million run rate. And when you talk about $7 million in 2020, so you are basically saying an annualized increase of what it will amount to about $2.2 million. Am I thinking about that the right way?

Yes. Again, a lot of the expenses – we strengthened our team in key strategic areas and we needed to do that to gear up and implement a lot of the RISE2020 initiatives. So, that’s correct.

Okay. Okay, great. And then strategically, I guess, as you’ve had a chance to look through everything, Paul, and sort of retweak how you are seeing the world, can you just take us through sort of a new lens in terms of how you would view de novo branching? I know you’re doing a redo of your current branches, but how are you thinking about that relative to RISE2020 or is that completely off the table?

Are you talking about our remaining branches?

No. In other words, the idea that you would potentially do any kind of de novo build-out that you would look at new branching.

As part of our branch optimization effort, Laurie, we are naturally looking at refreshes on store fronts. We have our CPB Lab that we’re going to be having in our main branch and that’s going to be a real catalyst for us to look at reconfiguration of remaining branches, but this isn’t all going to occur in 2020. This is over a certain period of time. And in that process, we are naturally looking at new opportunities, given the demographic changes on primarily on this island on Oahu. So, yes, definitely new branch opportunities are clearly on the table. I can tell you that we still need some time to really fed that profit up and we’ll keep you posted on subsequent quarters.

Okay, that’s great. And then just one last question on credit, David, hoping you can help me with this, obviously, your credit looks great, but the charge-offs appear to all be coming from – largely coming from the consumer category. So can you just update us in terms of how much of that charge-off balance is coming from Prosper or the other consumer categories? And then where the balance stands on Prosper and how you are approaching the growth on that?

Hi, Laurie. This is Catherine. I’ll….

Hi, Catherine.

Question, so the charge-offs on the consumer line came from a mix of Prosper and then also our consumer portfolio here in Hawaii, we had mentioned on earlier calls that we have various campaigns throughout the year on preapproved consumer loans, so some of the charge-offs in Q3 and then also in earlier quarters relate to also the Hawaii consumer portfolio.

Okay. And so where is your Prosper balance at the moment? I have it, as of June, it was $74 million?

Yes. So the Prosper balance is holding at about that. It’s actually – it’s in that range for Q3 as well.

Okay. And is the plan to kind of hold it at these levels or you looking to continue to grow?

It really is a function of opportunity and so, of course, focused on credit quality and then yields. So as we see those opportunities going forward, we will continue to purchase.

Okay, great. Thanks. I will leave it there.

Our next question is a follow-up from Aaron Deer with Sandler O’Neill and Partners.

Hi, thanks for taking the follow-up. Just curious the commercial loan growth in Hawaii, I guess, both on the C&I and the CRE line seemed a little weak in the third quarter. Just curious to know how much of that stemmed from pay downs or if you’re maybe seeing less demand from borrowers and then to the extent that, do you want to maybe give us a sense of your outlook for loan growth heading into 2020?

I’ll take that question, Aaron. So, yes, on the C&I line, as you know, is the – we had what I would say is medium loan growth in Hawaii, but if you look at the overall the C&I line, the decline relates to the decline in our SNCs on the mainland as far as go forward we have our officers very focused on continuing to be out there in the market and so we are optimistic about C&I growth in the fourth quarter and then next year.

Okay. And then how about with commercial real estate?

I would say the same for commercial real estate and again a function of relationships that we are building in our Hawaii market.

Okay. Good stuff. Thanks for taking my questions.

This concludes our question-and-answer session. I would like to turn the conference back over to Paul Yonamine for any closing remarks.

Okay. Thank you very much for participating in our earnings call for the third quarter of 2019. We look forward to future opportunities to update you on our progress.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.