Central Pacific Financial Corp.
Q4 2007 Earnings Call Transcript

Published: 20 Feb 2008

[Operator:]

Please stand by, we are about to begin. Good day and welcome to the Central Pacific Financial Corporation Fourth Quarter Earnings call. Today’s call is being recorded. This call may contain forward looking statements concerning projections of revenues, income, earnings per share, capital expenditures, dividends, capital structure or other financial items concerning plans and objectives of management for future operations concerning future economic performance or concerning any of the assumptions underlying or relating to any of the foregoing. Forward looking statements can be identified by the fact that they do not relate strictly to historical or current facts and may include the words believe, plans, intends, expects, anticipates, forecasts, or words of similar meaning. While we believe our forward looking statements and the assumptions underlying them are reasonably based, such statements and assumptions are by their nature subject to risks and uncertainties and thus could lead or prove to be inaccurate or incorrect. Accordingly, actual results could materially differ from projections for a variety of reasons to include but not limited to the impact of local, national and international economies and events including natural disasters on the company’s business and operations and on tourism, the military and other major industries operating within the markets we serve. The impact of legislation affecting the banking industry, the impact of competitive products, services, pricing, and other competitive forces, movements and interest rates, loan delinquency rates and changes in asset quality generally and the price of the company’s stock. For further information on factors that could cause actual results to materially differ from projections, please see the company’s publicly available Securities and Exchange Commission filings including the company’s Form 10-K for the last fiscal year. The company does not update any of its forward looking statements. At this time for opening remarks and introductions, I’d like to turn the call over to Mr. Clint Arnoldus, Chief Executive Officer. Please go ahead sir.

[Clint Arnoldus:]

Thanks, Clarissa and thanks to all of you that have joined us today to review Central Pacific Financial Corp.’s financial performance for the quarter of December 31st, 2007. I have with me here today, Dean Hirata, our Chief Financial Officer, Blenn Fujimoto, our Hawaiian Market Officer, and Curtis Chinn our Chief Risk Officer. I’ll be addressing the highlights of our company and our marketplace including steps we’re taking to manage our California loan portfolio. Curtis will then discuss the company’s commercial real estate loan portfolio and Dean will then provide a detailed financial report of our fourth quarter and our year end result. And after we’ve completed our remarks, we’ll be happy to take any questions that you have. I want to start by telling you that Central Pacific Financial Corp. is in the process of performing a Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets Impairment Test on the goodwill of its subsidiary, Central Pacific Bank. This is due to inherent volatility that we’re all seeing in the financial markets. I want to make clear that any potential charge related to the impairment of acquisition related goodwill would be a non-cash charge reducing net income in the current period but with no impact on cash flows, tangible book value, or regulatory capital. All of our analysis of goodwill is ongoing; we’re committed to completing it and issuing a final release in a timely manner. Although a potential impairment charge which would reduce our net income, the fundamentals of our bank remain very strong. Let me say a few words about our fourth quarter highlights. Central Pacific Financial Corp. today reported net income for the fourth quarter of 2007 of $3.5 million, or $0.12 per diluted share excluding the potential impact of any goodwill impairment charge. This is compared to $18.8 million, or $0.61 per diluted share reported in the fourth quarter of 2006, and $9.1 million, or $0.30 per diluted share reported in the third quarter of 2007. As we reported in our preannouncement on January 11, 2008, the fourth quarter of 2007 results include the following items. Credit costs of $32.9 million, and an after tax loss on investment portfolio repositioning of $1 million, or $0.04 per diluted share. For the year ended December 31st, 2007 CPF reported net income of $53.8 million, or $1.77 per diluted share excluding the potential impact of any goodwill impairment charge compared to $79.2 million, or $2.57 per diluted share reported in 2006. As we previously announced, our fourth quarter results were negatively impacted by increased credit costs due to continued deterioration in California’s housing market. In spite of the recent increased credit costs, we continue be profitable and our capital base remains strong. Compared to December 31st, 2006, our total deposits increased by 4.1%, loans and leases increased by 7.7% and total assets grew by 4.4% to $5.7 billion dollars as of December 31st, 2007. Now let me say a few words about California. Although we can’t really predict when California’s housing market will stabilize, we’re working to stay ahead of any further deterioration specifically in the residential construction market. We continue to take an active approach to provide additional loan loss provisions and we’ve added the resources we need to determine the best strategy for dealing with each problem in California and residential construction loan. We hired additional senior level personnel with real estate experience to manage our California operations, we’ve also retained outside real estate consultants. These experts will assist our efforts to achieve positive workouts and collections on credit issues in our California loan portfolio. In Hawaii, we’re not currently experiencing the challenging market conditions faced in California and our Hawaii commercial and residential real estate loan portfolio continues to perform. The Hawaii market also continues to provide us with attractive opportunities for growth and market share expansion. The economy in Hawaii is expected to expand moderately in 2008; job growth and real personal income growth are both forecasted to continue. Growth in tourism, which is our state’s primary industry, has slowed as a result of the slowing in the national economy and a continued weakness in Japanese visitor arrivals. The visitor industry which saw modest declines in arrivals and sluggish spending this year is expected to be essentially flat in 2008 before increasing in 2009. At Central Pacific Bank we continue to expand our footprint throughout the state of Hawaii. Earlier this month we opened a new branch in Lahaina, Maui which offers the latest in banking technology. We’ve also made notable improvements to our branch network in Honolulu. We’ve completed the renovation of our Kalihi branch in December; expect to open a new and improved branch in Kopahulu in the coming months. We believe these improvements will provide our customers with increased convenience and will allow us to become a more visible part of the communities that we’re serving. In total, Central Pacific Bank has thirty nine branches across the state of Hawaii. We’re also moving forward with our community based banking strategies. This model is designed to increase our competitive posture and deposit gathering, particularly in the small business sector. In essence, we’ve decentralized our banking expertise and empowered our front line to become fully integrated within our marketplace. We’ll continue to pursue opportunities to be first in market on products and services. We’ve done this with our flagship exceptional product, Remote Deposit Central and our new Choice Checking product in October. These innovative initiatives provide Central Pacific Bank with a competitive advantage and an opportunity to attract the customers. We’re confident in the financial strength and outlook of our company. We know our dividend is important to our shareholders and quite frankly it’s also important to us. That’s why I want to underscore that we intend to maintain our dividend at current levels. In 2007, the company’s board of directors authorized the repurchase of up to 2.1 million shares of the company’s common stock. The company completed the repurchase of these shares in December, 2007. In January, 2008 the company’s board of directors approved an additional stock repurchase plan authorizing the company to repurchase up to an additional 1.2 million shares. At this time, I’m going to turn the call over to our Chief Risk Officer, Curtis Chin, who will discuss the company’s commercial real estate loan portfolio. Curtis?

[Curtis Chinn:]

Thank you Clint, good morning. At 12/31/07 the Central Pacific commercial real estate portfolio totaled $2.4 billion, which was evenly divided between the Hawaiian market and the mainland. The credit quality of the bank’s $1.2 billion Hawaiian portfolio remains positive and is largely supported by the strength of the Hawaiian economy. Over 60% of the portfolio consists of term loans financing income producing properties. These loans are made to borrowers across diversified groups. At 12/31/07 our mainland portfolio totaled $1.2 billion with about 80% in the state of California and 10% in the state of Washington. Commercial construction and term financing totals about $885 million, of which $670 million is in the state of California. In aggregate, the credit quality of this segment remains favorable with less than 1% of the total classified. Our residential construction lending on the mainland totaled $323 million and includes roughly $150 million in land and acquisition development loans with the balance in vertical construction financing. California exposure represents about 95% or approximately $305 million. Loans made in the Inland Empire and the Central Valley region each total approximately $105 million. At 12/31/07, approximately two thirds of the bank’s mainland residential construction loans were classified. This included 100% of those loans made within the Inland Empire and nearly 50% in the Central Valley region. Loans not classified in the Central Valley continue to be adequately supported by project fundamentals and sponsor liquidity. As Clint mentioned in his opening remarks, the bank is actively working to manage our residential construction loan risk on the mainland. We have hired senior level real estate managers and have retained outside real estate consulting groups to assist us with the collections and workout plan. Our plans include loan restructures at note end or at the sale, as strategically on the mainland our focus is now on loan collection and problem resolution. At this point I’d like to turn the program over to Dean Hirata, our Chief Financial Officer. Dean?

[Dean Hirata:]

Thank you, Curtis. My discussion will cover the fourth quarter and full year 2007 consolidated financial highlights for Central Pacific Financial Corp. and its subsidiaries. Fourth quarter 2007 net income was $3.5 million, excluding the potential impact of any goodwill impairment charged compared to $18.8 million for the fourth quarter of 2006 and $9.1 million for the third quarter of 2007. The decrease is primarily due to credit costs of $32.9 million in the current quarter as a result of downgrade of twenty four loans totaling $201 million with exposure primarily to the California residential construction market. On a diluted earnings per share basis, net income was $0.12 for the current quarter excluding the potential impact of any goodwill impairment charge compared to $0.61 for the fourth quarter of 2006 and $0.30 for the third quarter of 2007. Net income for 2007 excluding the potential impact of any goodwill impairment charge was $53.8 million compared to $79.2 million for 2006. The decrease was primarily due to the increased credit costs. On a diluted earnings per share basis, net income was $1.77 for 2007 excluding the potential impact of any goodwill impairment charge compared to $2.57 for 2006. Key performance ratios based on net income for the fourth quarter of 2007 and full year respectively were as follows

[Operator:]

This is the conference center. I’d like to turn the conference back over to Mr. Arnoldus. Please go ahead.

[Clint Arnoldus:]

Thank you. I apologize we’ve had some technical difficulties and we’re not even sure at what point we lost our connection, but probably the best way to proceed is just to go into Q&A right now and we’ll fill you in as best we can. We just don’t know where we lost you. I do apologize.

[Operator:]

Thank you. The question and answer session will be conducted electronically. (Operator Instructions) We’ll take our first question from Brett Rabatin with FTN Midwest.

[Brett Rabatin:]

Hi Clint. Hi everybody, how are you doing?

[Clint Arnoldus:]

Hey Brett. I don’t know where you lost us.

[Brett Rabatin:]

You were talking about the credit quality and the loan portfolio and just going over some of the aspects of the California book and I really just want to start with, I want to make sure I understood, I thought I heard mentioned that the movement into MTAs and the press release in this case 6 California land loans to 5 borrowers for $34.7 million but then if I understood the commentary that you were talking about there were 2 loans in Washington for $8.7 million and then 4 loans in California, I missed the number. Can you guys walk me through what the right numbers are for the MTAs there?

[Curtis Chinn:]

Brett, this is Curtis.

[Brett Rabatin:]

Hey Curtis.

[Curtis Chinn:]

The two loans in Washington aggregated at $5 million.

[Brett Rabatin:]

Okay, then so the rest was California?

[Curtis Chinn:]

Yes.

[Brett Rabatin:]

And were there 6 or 4?

[Curtis Chinn:]

The total was 6 loans moving into MTA, two of which were Washington.

[Brett Rabatin:]

Okay, so there’s 4 in California and 2 in Washington.

[Curtis Chinn:]

I’m sorry, that was 1 in Washington and the rest in California.

[Brett Rabatin:]

Okay, so 5 in California and 1 in Washington.

[Curtis Chinn:]

Sorry about that.

[Brett Rabatin:]

Alright, and just FYI, I think you just kind of dropped off a little bit maybe thirty seconds after discussing that, and then I guess the other thing I caught right near the end was you mentioned the provision in the fourth quarter included specific reserves. Can you tell me what that number was that you have set aside from provisioning the 4Q on the non-accrual list, what your specific reserves are?

[Curtis Chinn:]

We’re calculating that.

[Brett Rabatin:]

And while you’re looking for that, if I also heard correctly, early in the call you mentioned two thirds of the residential portfolio in California, $323 million was classified so A, is the classified total for residential then about $210 million or so and if I understand correctly if 100% of loans in the Inland Empire are classified, that would mean the Central Valley is significantly less or maybe 40% of that piece is classified. Can you walk me through how much of the total portfolio is classified and then each one of those segments?

[Curtis Chinn:]

Yeah, you’re right. The number is about $210 million is classified, 100% of the Inland Empire or $105 million, the Central Valley, the classified number is $48 million out of the 105 so that sounds like close to a little less than 50%.

[Brett Rabatin:]

Okay, and so let me make sure I’m correct here, so $210 million is the classified mainland. Did you give a number or did I miss it for total classified loans for the portfolio?

[Curtis Chinn:]

Total classified is $235 million.

[Brett Rabatin:]

$235 million, so only about another $25 million out of the rest of the portfolio is classified.

[Curtis Chinn:]

Correct.

[Brett Rabatin:]

Okay. And maybe we can circle back offline about some of this stuff, but I’m just not sure if I understand, you’re talking about still buying back stock in the press release at least when you pre-announced earnings and you indicated you’ve got a million or two shares to refer to the center and I realize your capital levels are not constricted currently but with about 5% of the total portfolio or a little more than that classified, I’m not sure if I understand the reasoning behind continuing to buy back stock. Can you walk me through the decision process there and how you’re looking at capital?

[Dean Hirata:]

Hey Brett, this is Dean. Again just starting with the 1.2 million shares, I mean that’s strictly an authorization and again we are looking to preserve capital as we discussed due to the uncertainty in the overall market conditions of the California housing market, but at the same time we do have a buy back program in place. But again our focus is on reserving capital and again that authorization is just what’s in place. We don’t anticipate buying back shares at the levels that we have been buying it back again what we did in the fourth quarter. Again, it’s strictly an authorization just to give us the ability to buy back shares but again we do have confidence in the outlook.

[Brett Rabatin:]

Okay, and then did you guys calculate a number for the specific reserves?

[Curtis Chinn:]

Yeah, Brett, and that was about $12 million in specific reserves.

[Brett Rabatin:]

Okay, great. Thank you for all the color.

[Operator:]

Our next question comes from Joe Morford with RBC Capital Markets.

[Joe Morford:]

Thanks, good afternoon everyone.

[Curtis Chinn:]

Hi Joe.

[Joe Morford:]

I guess the first just following up on Brett’s question, clarify a bit further. The 5 land loans in California that came in are they all in the Empire with some in the Central Valley, or what kind of geographic representation do you have there?

[Curtis Chinn:]

Hang on one second.

[Joe Morford:]

Okay. Maybe while you’re looking for that the other question on the credit was the $2 million CNI charge off in Hawaii, if you could just give us a little color on that was that a real estate related business or just kind of one off in something else?

[Curtis Chinn:]

The CNI?

[Joe Morford:]

For the CNI charge off, was it real estate related or…

[Curtis Chinn:]

No.

[Joe Morford:]

Okay.

[Curtis Chinn:]

I’m sorry Joe, your first question again?

[Joe Morford:]

I was curious, the 5 land loans that came into MPA from California in the fourth quarter, where in California, was it Inland Empire, was it Central Valley, was it kind of a mix or…

[Curtis Chinn:]

It was mixed.

[Joe Morford:]

Okay, and then the last question is tell us a bit more about the people you’ve hired to kind of help you work out this portfolio, where they’ve come from and kind of specifically how they’re tasked to work this out. To downsize this portfolio, are you now more willing to consider short sales, or bulk sales, or how are you going to go about this going forward?

[Curtis Chinn:]

Well in terms of the additional people we’ve hired, we’ve brought in one gentleman who is a former chief credit officer, actually two who were former chief credit officers, both [inaudible] banks as well as large banks in Southern California and other states in the western region. We’ve also brought in someone with fairly extensive workout background in Southern California in real estate. In terms of the specific strategy, as I mentioned we are looking at restructuring and refinancing where it makes sense. We would look at loan sales and asset sales. We’ll consider on an individual basis and we may also look at the bulk of where we’re evaluating our options at this point.

[Clint Arnoldus:]

I would add to those people that we’ve brought in, three of them I have worked with earlier in my career in the real estate market that was also in trouble in the late ‘80s, early 90’s. So I’ve seen them function and know the quality of work they can do. So they are a significant addition to us to bring further insight into what we need to do in California.

[Joe Morford:]

Okay. That’s great. Thanks for the help.

[Operator:]

Next we’ll go to Brent Christ with Fox-Pitt Kelton.

[Brent Christ:]

Good morning guys.

[Curtis Chinn:]

Hey Brent.

[Brent Christ:]

To the extent you’re considering any loan sales or bulk asset sales what type of haircuts are you seeing out there in the marketplace in terms of what people are willing to pay for some of these properties.

[Curtis Chinn:]

That range is pretty broad.

[Brent Christ:]

I guess on the low end in terms of a deeper haircut.

[Clint Arnoldus:]

You know it depends on if you’re looking at individual sales or bulk sales.

[Brent Christ:]

I guess either…

[Clint Arnoldus:]

On a bulk sale we saw 20% to 40% on the dollar, probably $0.40 on the dollar, but we wouldn’t be doing anything at that level but that’s kind of an indicator we got on a bulk sale.

[Curtis Chinn:]

We were able to consummate one sale in the fourth quarter and on that transaction we received $0.875 on the dollar.

[Brent Christ:]

Got you, okay, that’s helpful. And then a couple of other quick questions. In terms of the goodwill impairment process could you talk a little bit about the timing from your perspective, when you think that may be complete and kind of the factors that you’re incorporating into the analysis.

[Dean Hirata:]

Okay, Brent. Just to give you some background on the goodwill. Goodwill was created at the time of the merger between Central Pacific Bank and Citibank going back to the fourth quarter of 2004 again which represented the excess of the purchase price of the book value of Citibank at that time. We’re now in the process of doing a fair evaluation of the company to determine if in fact the goodwill is impaired and we expect the analysis to take approximately two to three weeks.

[Brent Christ:]

Okay and we’ll have some type of announcement at that point should there be an impairment.

[Dean Hirata:]

Yes.

[Brent Christ:]

Got you, okay, and then just lastly and in light of the recent moves by the Fed how are you guys thinking about your net interest margin going forward and your ability to pass along some of the lower rates in the form of lower deposit costs?

[Dean Hirata:]

The overall decline in the interest rate environment, it will have a slight negative impact to our net interest margin as our assets do initially re-price faster than our liabilities. But one of the things that we did in January of this year is that we did enter into a prime swap of about $400 million where we are receiving fixed and paying floating and again this is to reduce just our overall asset sensitivity to that part of the portfolio. In addition, we will look at lowering rates where we can on certain of our deposit products.

[Brent Christ:]

And what was the rate on that swap?

[Dean Hirata:]

We’re receiving 6.25% fixed for five years and paying prime floating.

[Brent Christ:]

Got you, okay. Thanks.

[Operator:]

(Operator Instructions) We do have a question from Fred Cannon with KBW.

[Fred Cannon:]

Thanks. Just a couple of follow ups, on the potential goodwill impairment, is the issue primarily because the West Coast loan production officers were part of CBVI and there was associated goodwill and that was what was driving a potential write down?

[Dean Hirata:]

The analysis has really been driven by the fact that our market cap is below the book value and as part of that the test for impairment there is step one and step two and the fact that the market cap is below book value, that bars us to move to step two which is the fair evaluation that we’re now in the process of completing.

[Fred Cannon:]

So you have to do a new fair evaluation of the CBVI goodwill, is that right?

[Dean Hirata:]

Yes.

[Fred Cannon:]

Okay. Secondly, maybe if Clint could address the overall West Coast strategy at this point in time, in two parts, one is that the construction portfolio you’re putting into a kind of runoff mode it appears, and I wanted to find out if that was just the West Coast construction or the entire West Coast loan outstandings that are being put in this runoff mode and secondly how you plan to strategically move forward on the West Coast following this kind of workout time period.

[Clint Arnoldus:]

Well, the runoff is in the residential construction in California. We’re trying to come up with the best alternative that we can to get that off of our books. So, that’s an ongoing process and this real estate consulting firm that we mentioned in our comments is going to play an integral part on that and in fact we have a call with them, with our first pass tomorrow, so as I say that’s an ongoing process. But that’s something that is certainly in our short term goals with that portfolio. In terms of going forward, we continue to believe that California plays an important role in our future. I think the question is, is in what format and the timing of getting into that format. So, that’s something we’re meeting with our board of directors about this month and so we’ll be able to answer that in more detail in our next quarterly call.

[Fred Cannon:]

Alright, at this point Clint, you remain committed to the loan production offices or you’re kind of looking strategically at various alternatives?

[Clint Arnoldus:]

We’re looking strategically at various alternatives.

[Fred Cannon:]

Okay, thanks very much.

[Clint Arnoldus:]

You bet.

[Operator:]

Gentlemen, there appear there are no further questions in the queue.

[Clint Arnoldus:]

Okay, I don’t know how big of an audience I’m speaking to at this point. I know we had some problems, but for those of you who are still on I want to thank you for participating in our call. A couple of things I’d just like to reiterate in conclusion. Central Pacific Financial Corporation is very well capitalized and fundamentally solid and we’re prepared for some of the challenges that we’ve encountered in California. Going forward in 2008 we’re going to continue to actively manage our exposure in that California market. But the Hawaii market is healthy, we’re going to continue to create and execute innovative deposit gathering strategies, we’re going to continue to work hard to expand our footprint in the communities that we live and work in and we really believe here in this company our employees are the best in the state and I’m confident that we’ll be able to work successfully together to do its best for our customers and our shareholders and communities. So, thank you again for your interest in our company.

[Operator:]

This concludes today’s conference if you’d like to listen to an audio replay of this call, you can do so by dialing 888-203-1112 and entering access code 4155913. Again that phone number is 888-203-1112 and access code 4155913. The replay of today’s call will be available starting this evening at 6

[Clint Arnoldus:]

Thank you.