CPF (2020 - Q3)

Good afternoon, ladies and gentlemen. Thank you for standing by and welcome to the Central Pacific Financial Corp.'s Third Quarter 2020 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.cpb.bank. I'd like to turn the call over to Mr. David Morimoto, Executive Vice President, Chief Financial Officer. Please go ahead, sir. David Mo

Thank you, Greg, and thank you all for joining us as we review the financial results of the third quarter of 2020 for Central Pacific Financial Corp. With me this morning are Paul Yonamine, Chairman and Chief Executive Officer; Catherine Ngo, President; Arnold Martines, Executive Vice President and Chief Banking Officer; and Anna Hu, Executive Vice President and Chief Credit Officer. We have prepared a slide presentation that we will refer to in our remarks today. The presentation 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 two of our presentation. And now, I’ll turn the call over to Paul.

Thank you, David, and good morning everyone. As always, we appreciate your interest in Central Pacific Financial Corp. The State of Hawaii as well as our company continues to manage well through the COVID-19 pandemic. While the State of Hawaii experienced an uptick in infections in the late summer, this led to a second government mandated shutdown. The infection rate has recently dropped with the latest seven day average number of infections and positivity rate of 54 and 2.2% respectively, as of October 26. After several delays to initial targeted days, the State of Hawaii reopened out of state tourism on October 15th for visitors that provide evidence of a negative COVID-19 test. This is a key step in the process of Hawaii's economic recovery. In the first week after reopening, we've been pleasantly surprised by the daily air arrival numbers, which have been in the 5,000 to 8,000 range per day compared to less than 2,000 per day since March and 30,000 per day pre-pandemic. Additionally on October 22, Oahu made progress by moving to Tier 2 of its recovery plan that met the requirements of having the seven day average COVID cases at less than 100 and positivity rate of less than 5%. Tier 2 allowed Oahu to further reopen certain parts of the economy. At Central Pacific, we continue to push forward with our key RISE2020 strategies, while at the same time prudently managing through the pandemic. In August, we launched our new online and mobile banking platforms, which includes many industry-leading features and functionality. The new digital platforms have been very well received by the market with an Apple mobile app rating of 4.8 out of 5. Additionally, we continue to replace our entire ATM network in full function machine, and implemented this quarter an 8:00 P.M. Hawaii time cutoff for same day ATM deposit processing, the latest cutoff time of all banks in the state. The revitalization of our building headquarters is progressing well and is on track for an opening date in January 2021. We continue to thoroughly review and regularly monitor our loan portfolio to appropriately manage the credit risk and the pandemic environment. During the third quarter, our total balance of loans on payment deferrals decreased by nearly 50%, as a significant portion resumed payments. At the end of the quarter, our loans on deferral was down to only 6% of total loans excluding PPP loans. Last week, we announced that we successfully completed a $55 million private placement subordinated note offering. We believe this will also -- excuse me we believe this will allow the bank to continue to support our customers and community, while also providing future capital flexibility. I'd like to now turn the call over to Catherine to share more about our Pandemic Preparedness Plan and the work of our CPB Foundation. Catherine?

Thank you, Paul. Our Pandemic Preparedness Plan continues to be in place and we have not had any disruption in our business. Currently have 28 branches open to fully serve our customers. Four branches remain temporarily closed due to the pandemic. During the third quarter, we consolidated three new supermarket branches into our larger neighboring branches, as these market branches were too small to allow for adequate social distancing and are on track with consolidating the fourth previously disclosed branch in the fourth quarter. Much of our back office teams continue to work flexible remote schedules, and all employees are required to complete a daily online health questionnaire prior to starting each workday. We believe the actions taken will continue to enable us to provide a safe environment for both our employees and customers. The CPB Foundation continues to be active in helping the community with relevant and timely programs. Third quarter, our foundation was one of the two presenting sponsors of the maiden Hawaii festival, featuring more than 200 employee small businesses and 10,000 products. The festival previously held at our local Honolulu arena pivoted quickly to become an online marketplace this year, attracting over 100,000 unique visitors over the three-day launch weekend, contrast to the 60,000 attendees for the festival in-person that recorded in earlier years. The Online Festival enables struggling small businesses to sell their Hawaii-made products year-around to a wide base of local, national and international shoppers bringing in much needed revenue during the current challenging environment and is a good step forward to economic diversification through exporting. We're glad that our foundation was able to provide support towards a successful initiative. I'd like to turn the call over now to Arnold Martines, our Executive Vice President and Chief Banking Officer. Arnold.

Thank you, Catherine. In the third quarter, we were able grow our loan portfolio by $27 million, despite the tough operating environment. Growth was broad-based, including residential mortgage, home equity, commercial mortgage and construction loans. Growth in these loan categories was partially offset by declines in our consumer and C&I loan portfolios. Driven by a record low interest rate environment, our residential lending team continued to outperform with record levels of production resulting in $4.3 million in mortgage banking income for the quarter with more than double the income from the same quarter a year-ago. During Q3, our bankers continued to engage our business customers that we assisted through the Paycheck Protection Program. Most importantly, we continue to advocate for the broader business community impacted by COVID-19. We recently launched our PPP Forgiveness portal, and have begun the process of assisting our customers applying for Forgiveness from the FDA. As expected, as businesses spend their PPP funding saw a quarter-over-quarter decline in our core deposit balances of $109 million. Despite that, our core deposit balances remained up over $650 million year-to-date. Additionally, our cost of total deposits declined by 7 basis points to 13 basis points. Providing best-in-class digital technology remains a key priority for us. In Q3, we launched our new consumer mobile platform and are nearly complete with the rollout of our new ATM fee as Paul mentioned earlier. We're seeing strong adoption and utilization of both digital channels. Our ATM deposit volume has substantially increased from a year earlier, due primarily to the enhanced deposit functionality now available to our ATMs and deposit volume has also increased for new consumer mobile platforms from a year earlier. As we moved into the fourth quarter, our bankers will continue to remain vigilant given the tough operating environment, but laser-focused to support our customers while exploring and engaging new opportunities and our customer base during this unprecedented time. Now I'd like to turn the call over to Anna Hu, our Executive Vice President and Chief Credit Officer to provide details on our credit and portfolio risk management activities. Anna?

Thank you, Arnold. At September 30, the loan portfolios totaled $5.03 billion with 54% consumer and 46% commercial. During the quarter, we continued monitoring the loan portfolio and provided support to our customers as they navigated through the uncertainty in the marketplace. We assisted our customers in providing a second loan payment deferrals if needed, and we were pleased to see a significant number of borrowers resume their monthly payment. At quarter end, the total balance of loans on payment deferrals declined to $291 million, or 6.5% of our total loan portfolio excluding PPP balances. Our re-deferral rate was 31% and was primarily driven by consumer small business and residential loans. These loans were initially granted a three-month deferral, followed by a second three-month deferrals. While a significant number of customers have returned to making loan payments, we expect some consumer customers will require a loan payment modification due to the continued elevated unemployment rate. In the commercial and commercial real estate loan portfolio, we've provided loan payment deferrals for $133 million in total loan balances. The two highest exposures by industry is real estate and rental and leasing totaling $47 million or 1% of the total loan portfolio excluding PPP balances and food service totaling $46 million or 1% of the total loan portfolio excluding PPP balances. The majority of the loans in the real estate category are supported by loans, low loan to value ratios, and in the food service category are supported by owners with good liquidity and access to capital. We expect some of our borrowers will need a loan modification at the end of their second loan payment deferral which will be evaluated on a case-by-case basis. Loan payment deferrals for our high-risk industries totaled $66 million, or 1.5% of the total loan portfolio excluding PPP balances. Additional details on our loan payment deferrals can be found on Slide 20 and 21. During the quarter, criticized loans increased by $34 million sequential quarter to $197 million or 4.4% of the total loan portfolio, excluding PPP balances. Special mention loans increased by $33 million to $149 million or 3.2% of the total loan portfolio, excluding PPP balances and classified loans increased by $1.5 million to $48 million, or 1.1% of the total loan portfolio excluding PPP balances. Loan downgrades were the result of our continued assessment of borrower risk based on the borrowers' near-term strategy and outlook, management's strength and actions they've taken over our financial condition and external funding and deferral support. Approximately 12% of special mention balances and 5% of classified balances also received PPP loans. Additional details on those rated special mention and classified can be found on Slide 22 and 23. Overall, we continue to believe our proactive and disciplined approach to credit and our diversified loan portfolios will allow us to remain strong through these unprecedented times. I'll now turn the call over to David Morimoto, our Executive Vice President and Chief Financial Officer. David?

Thank you, Anna. Net income for the third quarter of 2020 was $6.9 million or $0.24 per diluted share. Return on average assets in the third quarter was 0.42% and return on average equity was 4.99%. Our earnings continue to be impacted by higher provision for credit loss expense due to the current COVID-19 pandemic. Importantly, the third quarter increase in our provision was largely driven by the economic forecast and not an increase in actual loan losses. Additionally, our pre-tax pre-provision earnings for the third quarter was $23.7 million, which increased slightly from the prior quarter. Net interest income for the third quarter was $49.1 million which remained relatively flat on a sequential quarter basis. Net interest income included $3.4 million in PPP, net interest income and net loan fees. The net interest margin decreased to 3.19% in the third quarter compared to 3.26% in the prior quarter. The decrease was due to lower yielding PPP loans as well as the lower interest rate environment. The net interest margin normalized for PPP was 3.26% in the third quarter compared to 3.31% in the prior quarter. Third quarter other operating income totaled $11.6 million compared to $10.7 million in the prior quarter. The increase was primarily due to higher mortgage banking income of $0.8 million. Additionally, in the current quarter, we reinstated certain service charges that were temporarily suspended due to the pandemic. This resulted in an increase in service charges on deposit accounts, and other service charges and fees. Other operating expense for the third quarter was $37.0 million, which was an increase of $0.5 million compared to the prior quarter. The increase was driven by increases in several expense line items, and also included branch consolidation costs of $0.3 million related to the three in-store branch closures previously noted. Net charge-offs in the third quarter totaled $1.3 million compared to net charge-offs of $2.9 million in the prior-quarter. The charge-offs primarily came from the consumer loan portfolio and the C&I portfolio. At September 30, our allowance for credit losses was $80.5 million or 1.79% of outstanding loans, excluding PPP loans. This compares to 1.50% as of the prior quarter end. The efficiency ratio remained relatively steady at 60.9% in the third quarter compared to 60.8% in the prior quarter. The effective tax rate increased to 24.3% in the third quarter due to lower tax exempt bank owned life insurance income. Going forward, we expect the effective tax rate to continue to be in the 24% to 26% range. Our liquidity and capital positions remained strong and we continue to perform robust stress testing. We recently completed subordinated note offering, strengthened our capital ratios, which further allows us to support our customers and the community during the pandemic, and positions the company well for the future. The subordinated notes are considered Tier 2 capital, and is anticipated to increase our CPF total risk-based capital ratio by approximately 120 basis points. Our board declared a quarterly cash dividend of $0.23 per share, which will be payable on December 15 to shareholders of record at the close of business on November 30. Now, I will return the call to Paul.

Thank you, David. In summary, Central Pacific continues to make positive forward progress on our strategies, while at the same time manage well through the COVID-19 pandemic. We have a solid financial, credit, liquidity, and capital position to enable us to weather the storm. As the economic recovery gradually begins, we remain committed to providing support to our employees, customers, and the community. On behalf of our management team and employees, thank you for your continued support and confidence in our organization. At this time, we will be happy to address any questions you may have. Thank you.

We'll now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Jackie Bohlen with KBW.

Hi, good morning, everyone. Wanted to first start-off with balance sheet liquidity management; against other trends that we've seen, you did a really great job at managing your cash balances in the quarter. And I just wanted to look going forward and see if you think there's any more PPP run-off or other liquidity run-off that you expect, if you don't see that and you do start to have some sort of a mismatch perhaps between loan and deposit growth, understanding you've got PPP running off, what liquidity management plans are for that?

Hey Jackie, it's David. Yes, I think right now the outlook is that we hope to have the PPP loan forgiveness process. So the reduction in PPP loan balances closely mirror the rundown on the PPP balances in our deposits. So that's the current outlook, especially with the recent announcement on accelerated forgiveness for small dollar PPP loans.

Okay. And so, I guess what, to the extent that you may have excess liquidity, if that does happen, are you looking at security for investments? Or would you look to keep that in cash?

Yes, right now, the plan, Jackie, is to keep the investment portfolio roughly at its current size, so about $1.1 billion. To the extent we have excess liquidity, we're -- we're optimistic that we'll see some net loan growth as the economy starts to rebound. So we're looking cautiously optimistic to see some stronger net loan growth outside of PPP loans. But then obviously, to the extent that we do end up with excess liquidity, it could be put to work in the investment portfolio.

Okay. So then how are you understanding where you're coming from a liquidity management position and how are you thinking about the forward margin then, just in terms of pressures you might have on earning asset yields, and I know that there's maybe a little bit but not a ton of room to continue to dropdown deposit costs?

Yes, that's the challenge for the banking industry is the net interest margin outlook. So currently we're projecting a net interest margin range in the 3.10% to 3.20% range for the next couple of quarters. And that incorporates the sub-debt offering. It assumes a conservative reinvestment of the sub-debt proceeds so that -- that's currently assumed to go into investments. So to the extent that we do see some stronger loan growth that would help, so it incorporates the sub debt offering and then also incorporates some core net interest margin pressure as a result of the rate environment that you referenced, Jackie.

Okay. And then looking at the -- looking at -- sorry I'm getting a little bit cut, hopefully you can hear me? So the core loan yield versus where new generation was coming on. So I'm looking at the loan yield ex-PPP and thank you for the data that you're able to calculate that. Where are you seeing new origination Millennial versus the portfolio?

Hey, Jackie in the third quarter, new loan origination yields were roughly 3%. I will say that that that new loan origination yield is obviously very sensitive to the loan mix. So it does bounce around a little, depending on the mix of new loans in a particular quarter. But the third quarter was roughly 3%.

Jackie, this is Paul. We're going to have to see how with the opening of tourism, what the implications will be to the economy. And we're trying to be very cautiously optimistic, and we're hoping that there'll be more investments in general and more demand, and we're hopeful that that will show up in net interest margin over time.

Okay, great. Thank you both for all the added details, different technical questions. I appreciate it.

Sure. Thank you.

The next question comes from David Feaster with Raymond James.

Just following-up on the deposit question, do you have an estimate for how much PPP deposits are still sitting in deposit accounts and haven't been spent? And then just how successful have you been thus far in migrating the new PPP clients to the bank and just how deposits are trending and loan growth is trending early in the fourth quarter?

Hey, David, before we respond to that, can you hear us, okay. We're having some audio problems.

Yes, I can hear you.

Okay, good. I'm going to have Arnold Martines, our CBO to respond to that. Arnold?

Yes, hi. Good morning, David. So, as I mentioned earlier, deposit balances decreased in the first quarter as far as to standard PPP loans. So to your question -- we -- our expectation is that we're going to still have elevated deposits through the next few quarters as the businesses spend the dollars. But we have made really good progress in being able to engage and convert many, many of the customers that we assisted on the PPP with -- to the bank with operating accounts. It's really difficult at this point to really determine what the net amount is going to be just because we have inflows and outflows, obviously. But at some point in the future, we probably will be able to provide a little bit more color on that, David.

David, there were over well over 2,000 new customers, basically, through the PPP process, and Arnold and his team doing a great job converting many of them to become ongoing customers of the bank. So and we have some pretty good successes early on and we're still working on it.

Okay, that's helpful. And then just kind of taking your commentary about hoping for some loan growth as the economy recovers I mean, we've got the reopening started, things are trending a bit better than expected early on, just curious how your -- what your thoughts are on the pulse of the local economy, how your pipeline is trending and just any updates on what you're hearing from clients and customers?

So we still see a fair amount of strength in, what I would call the non-tourism sector, especially around construction. I mean we have such a vast shortage of housing even before COVID and that continues. So for many of the housing developments that are coming online, I mean it's a very robust market. And we're quite pleased of the fact that we continue to be lead takeout lender on a lot of these large housing projects. At the same time, the military sector continues to be very robust with a lot of new investments by the federal government, and the Department of Defense here in Hawaii. So, that's -- that's ongoing, clearly the reservations and the concerns are somewhat tacked on to the tourism sector. And with the opening on October 15th, we don't see a huge spread on COVID. And we can continue to welcome more tourists in here, by tourists meaning investors as well. I think we'll -- we should be able to expect an eligible uptick on opportunities and that's tourism-related as well, that would fare very well for us.

Okay, that's great color, I appreciate that. And then just last one, you guys have done a great job managing expenses in the face of these revenue headwinds. Just curious whether there's anything more one-time in nature in this that kept it lower and whether this is a good expense run rate going forward. And then whether the new digital platform, I mean that's a huge initiative for you all, I know just whether there's any efficiencies or any potential cost savings coming from that as we go forward?

The digital platform, David already is, I think -- Arnold and David touched on. We're seeing dramatic change of consumer behavior today. Lot more mobile deposit, lot more usage of the ATMs, and definitely people having quite an affinity to our new mobile platform. And we expect that to continue. We're going to be following that closely as to what the implications on changing consumer behavior and the effectiveness of our digital platform for us to continue to look at our branch network. As Catherine touched on, we closed three in-store branches, and we're going to continue taking a hard look at what else we could do while not inconveniencing our customers. And so that'll probably be something out there, but we don't have anything on the table today. But we're going to take a hard look at it.

The next question comes from Andrew Liesch with Piper Sandler.

Hey, good morning, everyone. I just want to touch on credit here for a little bit of increase in criticized loans. But notwithstanding, they're still very low as a percentage of the portfolio. And you did have a little bit of an increase in the provision here seems like that's related to those couple commercial borrowers that you mentioned. But I mean, how are you looking at the allowance from here? You certainly built the reserve nicely this year, as you've got the CECL and just with some of the qualitative and quantitative overlays, but do you think there's more reserve building to be done? Or do you think this is kind of a good level of where could kind of plateau for a while as we move through and the economy rebounds?

Yes, Andrew its David. We feel good, we feel good about where -- we feel we're appropriately reserved as of 9/30. The outlook going forward is going to be a function of the economy, the economic forecast, the real anemones [ph] the tourism and local economy and net charge-offs and loan migration. We feel they're appropriately reserved at 9/30. And then, to the extent that things trend positively and there the reserve average level could come down or vice versa. If we were to go the other ways, we would be directionally consistent with that. So it's hard to give you a precise answer other than to say it's going to be directionally consistent with what we see in the economy and the credit portfolio.

Okay, understandable. On the deferral slide in the presentation, just referenced, the commercial mortgage, construction C&I loans that you expect 25% to resume regular payments here this quarter. What are the other 75% telling you? Are they -- how do they feel about their situation, do you think they may need to come back and need more deferral time as we move into next year. Yes, just curious what the front-end of those borrowers is right now?

Hi, Andrew, this is Anna. So, I think in our residential or commercial real estate and our C&I book, we're seeing very positive downward trends in customers moving back to payments. What we're really focused on is probably the consumer. Again, the unemployment rate in September was about 15% and so there is some uncertainty around capital that we continue to monitor, to watch, and then to actively work with our customers as well to provide assistance.

Okay, thanks. And then just on the balance of PPP loans that are remaining, whether it's all of them? What's been the sense that you guys have gotten from the SBA so that the process is going pretty slowly. But in speaking with their customers and how long do you think these loans stick around on the balance sheets, before they're repaid and forgiven?

Yes, so Andrew, this is Arnold. So as I mentioned earlier, we opened our portal just recently. And I'll just give you kind of a flavor. As of October 26th, we had 76 loans in our pipeline, totaling $20 million submitted to the SBA for forgiveness. And we've had such for four loans for $158,000 approved by the SBA. Our expectation is that we're probably going to see most of the forgiveness happen in 2021. Just given what we're seeing as far as the turnaround times and just the activity that's coming through our forgiveness portal.

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

Yes, thanks. Good morning. Just wanted to say with Andrew's question on PPP. Can you just remind us as of September 30, what the net processing fees are remaining on your PPP book?

Hey, Laurie its David.

Hi, David.

So the total net processing fees were roughly $19 million. And as of 9/30, we still had roughly $15 million to be earned.

$15 million perfect, $15 million, okay. Great, thanks. And then can you and David, maybe this is a question for you or for you Anna. Can you give us a little bit of color on the two commercial credits? What types they were?

Hi, Laurie, this is Catherine. Are you talking about the commercial credits in non-performing?

Yes, I'm sorry; the two commercial relationships totaling $15 million that you all have said you don't expect to see further loss. But obviously we have movement there. Just wondered what they were and then what that extra piece of $3 million in secured collateral. Is there any other color you can give up?

Yes sure, I'll start and then maybe Anna will provide more detail. But, yes, we did see that $7.6 million increase in NPAs quarter-over-quarter. I'll share with you half of that amount real estate secured actually was paid-off this past Monday. And then the other half, the other piece is a real estate secured loan on a property here in Downtown, Honolulu. And the loan to value on that loan is 32%.

And what sorry, what type of real estate?

It's a commercial building in Downtown, Honolulu.

Okay, so office. Okay, okay. And then just -- just maybe some comment if you have then, your hotel book, just looking at your deferrals. You went from 3.3% to 28.8%, which is still remarkably low, remarkably low level relative to Mainland, remarkably low, just even thinking about the fact that Hawaii isn't open. Can you just help us think about that whole $59 million book and where you see that going? What you're expecting in terms of as we look forward is it going to stay at this level? And then also, can you just remind us what your hotel book looks like in terms of just very approximate properties, flags, or they beachfront? Just any color you can give us would be helpful.

So I'll start and then Anna can provide some details. So in our slide deck on Slide 16, you see our accommodation book of $59 million, and we have it broken out between C&I and CRE. The book comprises of a number of hotels with strong flags, so International flags, and then with strong bankers. And so just to give you some color on how we feel about that portfolio, many of the hotels have reopened with the reopening of tourism on October 15. Anecdotally, we're hearing that the owners are pleasantly surprised on the return of tourists. But I have to say and along the lines of what Paul mentioned earlier, the continued progress will depend on the continued influx of tourists, and then our ability to keep the infection rate down here in Hawaii.

Okay. And so is that a six-month deferral then that that you all granted? Is that how you're approaching this?

This is Anna. It's pretty much still on a three month by three months basis.

Okay.

With regards to the accommodation at $70 million, we actually feel really good about it; some of those hotels delayed their openings. So we're looking at a November 1 opening for the couple of hotels that are in that category.

Okay. Now, I mean it's low considering that Hawaii hasn't been open. Okay, and just let me know, along those lines so if I'm looking at your total commercial deferrals again really good improvement here going from 19.5% down to 8%. So can you help us think about -- with your stock trading, so just kind of to book how you're approaching something like potentially a buyback? We're seeing more and more mid-cap banks announce buybacks, just what are your thoughts? And certainly you obviously have the sub-debt raised but potentially could also be used to buy back stocks. So maybe if you could help us think about any thoughts around that, Paul or Catherine that would be great.

Yes, I'll have David respond to that, Laurie. David?

Hi, Laurie. Yes, again, I think the Hawaii economic recovery is obviously trailing the Mainland slightly with us just reopening tourism. So we're going to be monitoring the recovery of the local economy, as Paul mentioned earlier. And as we gain better visibility on the path forward, we could turn offensive with our robust capital position. And with the stock trading at 75% of tangible book value, that's a pretty good opportunity.

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

Okay, great. Thank you very much for participating in our earnings call for the third quarter 2020. We look forward to future opportunities to update you on our progress. Thank you very much.

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