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Central Pacific Financial Corp (NYSE:CPF)
Q3 2021 Earnings Call
Oct 27, 2021, 1:00 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Thank you for standing by, and welcome to the Central Pacific Financial Corporation Third Quarter 2021 Conference Call. [Operator Instructions] 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.
David S. Morimoto -- Executive Vice President, Chief Financial Officer
Thank you, Betsy, and thank you all for joining us as we review the financial results for the third quarter of 2021 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 2 of our presentation.
And now I'll turn the call over to our Chairman and CEO, Paul Yonamine.
Paul K. Yonamine -- Chairman and Chief Executive Officer, CPF; Executive Chairman, CPB
Thank you, David, and good morning, everyone. As always, we appreciate your interest in Central Pacific Financial Corp. I'd like to comment on some exciting news we sent out yesterday regarding some key executive management promotions to be effective January 1, 2022. They are as follows: Catherine Ngo, currently President of CPF and President and CEO of CPB, will become Executive Vice-Chair of the bank and the holding company. Arnold Martinez, currently EVP and Chief Banking Officer, will be promoted to President and Chief Operating Officer of the Bank and the holding company. David Morimoto, currently Executive Vice President and CFO, will be promoted to Senior Executive Vice President and CFO of the Bank and the holding company. And Kevin Dahlstrom, currently EVP and Chief Marketing Officer, will become EVP and Chief Strategy Officer of the Bank and the holding company. Catherine will continue to serve on the CPB Executive Committee responsible for the management of the bank. Working collaboratively with Catherine and myself, all three of the individuals promoted have played a key role in our financial success the past several years, and I am pleased that they will continue to be part of the team.
Our focus on our four key business pillars will continue as before. These include residential lending, small business, Japan market development and digital expansion. We will also continue to be active in the commercial real estate, C&I and consumer segments, with a focus on driving digital solutions to provide an exceptional customer experience. Our transformation to become a digital first bank is underscored with the upcoming launch of Shaka Checking, Hawaii's first and only digital bank account from a local financial institution. We are proceeding the November 8th launch with the state's largest ever social media influencer marketing campaign. We have over 2,000 people on the wait list who are looking to be the first to sign up for Shaka.
Product benefits include the opportunity to get your paycheck up to two days early, a reimbursement of ATM fees up to $20 a month and a higher than average return on funds in the account. We feel this product and other digital products like it will help to galvanize our position as the digital banking leader in Hawaii. We will, however, continue to leverage our branch network, updating and modernizing our facility and investing in the talent required to deliver these products to market with the strong customer service we are known for.
Like the rest of the country, the state of Hawaii experienced the spike in COVID case counts in August and September related to the Delta variant. To address this, our state put in place certain measures to curb further spread of the virus and we are pleased the state has been able to get the Delta variant under control, as we have seen a rapid decline in case counts in recent weeks. Given this positive trend, earlier this month, the Governor implemented the easing of restrictions on gatherings and events on Oahu. And last week, the Governor announced welcoming back fully vaccinated domestic travelers for business or pleasure, starting November 1st.
Our statewide vaccination rate has risen to over 70%, as many employers in the state have mandated vaccinations to protect their employees, their customers and the community in general. With these positive developments, local economists are projecting that visitor numbers will once again continue to rise and Hawaii will have a strong holiday travel season. The state of Hawaii unemployment rate declined to 6.6% in the month of September and is forecasted by the Department of Business Economic Development and Tourism to decline further to 6.4% in 2022. The housing market in Hawaii remained very hot with our median single-family home price surpassing the $1 million mark this past quarter. Overall, the Hawaii economy remains on track for recovery.
I'd like to now turn the call over to Catherine Ngo, our President. Catherine?
A. Catherine Ngo -- President, CPF; President and Chief Executive Officer, CPB
Thank you, Paul. Our financial results for the third quarter were very strong with quarterly pre-tax income again reaching a new record high. Our core loan growth picked up as anticipated and we are on track for a strong second half of the year. Our successful PPP effort continues to deliver strong fee income as forgiveness continues.
Our asset quality continues to be strong with non-performing assets at just 10 basis points of total assets as of September 30th. Additionally, total classified assets were less than 1% of total loans. Nearly all of the loans we granted, COVID related payment deferrals have returned to pay status. As of September 30th, we have just $1.3 million in loans remaining on deferral. Finally, net charge-offs declined to just $0.2 million in the third quarter.
Shifting to our employees, we are very pleased that 95% of our employees are now fully vaccinated against COVID-19. To protect our employees and customers, we started weekly COVID testing in September with a small group of un-vaccinated employees. We also offered a $500 cash incentive for un-vaccinated employees who got vaccinated after September 1st.
I'd like now to turn the call over to Arnold Martinez, our Chief Banking Officer. Arnold?
Arnold D. Martines -- Executive Vice President, Chief Banking Officer
Thank you, Catherine. In the third quarter, our loan portfolio increased by $184 million or 4% sequential quarter, which was offset by PPP forgiveness paydowns of $216 million. Year-over-year, our core loan portfolio increased by 7%. The core loan growth was broad-based across all loan categories except construction. Approximately $58 million or 32% of the quarter's loan growth came from Mainland consumer loans.
Our residential mortgage production continue to be very strong with total production in the third quarter of nearly $245 million and total net portfolio growth in residential mortgage and home equity of $72 million from the previous quarter. PPP forgiveness continues to progress well with 93% of the loan balances originated in 2020 and 40% of the balances originated in 2021, already forgiven and paid down through September 30th.
During the third quarter, we purchased an auto loan portfolio for about $20 million from one of our Mainland auto loan origination partners, and we continued consumer unsecured purchases on an ongoing flow basis based on our established credit guidelines. The purchase during the quarter had a weighted average FICO score of 750. As of September 30th, total mainland consumer, unsecured and auto purchase loans were approximately 5% of total loans. Both our Mainland and Hawaii consumer portfolios continue to perform well. Our target range for total Mainland loans, including commercial and consumer is around 15% of total loans. With Hawaii's steady economic recovery, we continue to see a healthy loan pipeline in all loan product categories. As such, we anticipate ending the year with strong loan growth.
On the deposit front, we continue to see strong inflow of deposits with total core deposits increasing by $267 million or 4.6% sequential growth. On a year-over-year basis, total core deposits increased by $1.1 billion or 21.6%. Additionally, our average cost of total deposits dropped in the third quarter to just 5 basis points. Finally, as the Hawaii economy continues to recover and investment activity increases, we are focused and prepared to help our customers meet their financial objectives.
I'll now turn the call over to David Morimoto, our Chief Financial Officer. David?
David S. Morimoto -- Executive Vice President, Chief Financial Officer
Thank you, Arnold. Net income for the third quarter was $20.8 million or $0.74 per diluted share, an increase of $2.1 million or $0.08 per diluted share from the prior quarter. Return on average assets in the third quarter was 1.15%, and return on average equity was 14.83%. Net interest income for the third quarter was $56.1 million, which increased by $4 million from the prior quarter due to core loan and investment portfolio growth, loan and investment yield improvements and slightly higher PPP fee recognition.
Net interest income included $8.6 million in PPP net interest income and net loan fees compared to $7.9 million in the prior quarter. At September 30th, unearned net PPP fees was $7.9 million. The net interest margin increased to 3.31% in the third quarter compared to 3.16% in the previous quarter. The NIM normalized for PPP was 2.96% in the third quarter compared to 2.93% in the prior quarter. The normalized NIM increase was driven by the increase in the investment portfolio yield, partially offset by an increase in excess balance sheet liquidity. Third quarter other operating income remained relatively flat at $10.3 million.
During the quarter, there was a decrease in bank-owned life insurance income of $0.7 million driven by market fluctuations. This was offset by higher service charges and fees. Other operating expense for the third quarter was $41.3 million, which was in line with the prior quarter. The efficiency ratio decreased to 62.3% in the third quarter due to higher net interest income. We remain focused on driving positive operating leverage with our strategic investments to continue to improve our efficiency.
As part of our ongoing efficiency initiatives, we recently announced the consolidation of our Kapiolani [Phonetic] branch into a nearby branch in Honolulu at the end of this year. We expect annual future savings of approximately $800,000 from this consolidation. With the continued migration of transactions to digital channels, we will continue to evaluate our branch network and consider both consolidation as well as expansion opportunities in 2022.
At September 30th, our allowance for credit losses was $74.6 million or 1.55% of outstanding loans, excluding PPP loans. In the third quarter, we recorded a $2.6 million credit to the provision for credit losses due to improvements in the economic forecasts and our loan portfolio. The effective tax rate was 24.7% in the third quarter. Going forward, we continue to expect the effective tax rate to be in the 24% to 26% range. Our capital position remains strong and during the third quarter we repurchased 234,700 shares at a total cost of $5.9 million or an average cost per share of $25.12. Finally, on October 26, our Board of Directors declared a quarterly cash dividend of $0.25 per share, which was an increase of $0.01 or 4.2% from the previous quarter.
And now I'll return the call to Paul.
Paul K. Yonamine -- Chairman and Chief Executive Officer, CPF; Executive Chairman, CPB
Thank you, David. In summary, Central Pacific had a solid third quarter and we will continue to leverage our investments and innovate to progress toward our strategic targets, at the same time we maintained our strong credit, liquidity and capital position. Further, we remain committed to providing support to our employees, customers and the community as we continue to progress through the economic recovery. Finally and perhaps more importantly, we approach the future with a highly motivated management team with optimism and a sense of purpose. This team worked together to lead the implementation of RISE2020, a multi-faceted initiative designed to strengthen our position in the market by investing in our branches, ATM and our digital product offerings as well as continued focus on our four primary lines of business.
The results of these efforts are becoming increasingly apparent. With this team, we are well positioned to build on our past accomplishments and success as we continue to focus on service and value to customers, employees and shareholders. On behalf of our management team and employees, thank you for your continued support and confidence in our organization.
At this time, we'll be happy to address any questions you may have. Thank you. Over to you, Betsy.
Questions and Answers:
Operator
Thank you. [Operator Instructions] The first question comes from Andrew Liesch of Piper Sandler. Please go ahead.
Andrew Liesch -- Piper Sandler -- Analyst
Hi, good morning and congratulations on the promotions. I just wanted to ask about the margin and the securities purchases here with -- with the rise, with the recent rise in the tenure and the steeper curve, this increased your appetite to add more to the securities book?
David S. Morimoto -- Executive Vice President, Chief Financial Officer
Yeah, Andrew, it's David. Yeah, obviously, with the recent rise in the tenure, we are -- we are looking to continue to redeploy excess liquidity into both loan growth and potentially continue to grow the investment portfolio. It has been nice to see that mortgage spreads have not come to total the offset the increase in treasury. So we find the HSE MBS market quite attractive right now.
Andrew Liesch -- Piper Sandler -- Analyst
Got it. And then can you just remind us what you purchased during the quarter, what sort of yields you're getting?
David S. Morimoto -- Executive Vice President, Chief Financial Officer
One the investments, new purchase yields was a weighted average 170, which compares to the current portfolio yield of roughly 185. So we're getting pretty close to where are things are at parity.
Andrew Liesch -- Piper Sandler -- Analyst
Got it. Very helpful. And then just turning to loan growth, really good color there on what you've got in the quarter. But on the C&I, you had really nice increases in both Hawaii and on the Mainland. What's driving the growth in those two markets?
Arnold D. Martines -- Executive Vice President, Chief Banking Officer
Yeah, hi. This is Arnold. Yeah, so you know, we've been very -- we've been very lucky to have some -- some of our new talent that we've acquired coming over to the bank as well as our team in their business development efforts. So we've made a lot of great traction in building a nice strong pipeline in those areas. I want to say that we're really proud of the efforts in the third quarter. We had solid loan growth in all loan categories except for a modest decline in construction, but that really was more because of timing on of construction loans. And so, yeah, we're really pleased with the efforts of the team.
Andrew Liesch -- Piper Sandler -- Analyst
Got it. That's very helpful. I'll step back. Thanks for taking the questions.
Operator
The next question comes from David Feaster with Raymond James. Please go ahead.
David Feaster -- Raymond James -- Analyst
Hey, good morning, everybody.
Paul K. Yonamine -- Chairman and Chief Executive Officer, CPF; Executive Chairman, CPB
Hi, David.
A. Catherine Ngo -- President, CPF; President and Chief Executive Officer, CPB
Good morning.
David Feaster -- Raymond James -- Analyst
I just kind of wanted to follow-up on that last line of questioning, you just kind of get your sense on thoughts on the organic growth outlook just given the hires that you've made and the strength of the pipeline and the production that you're generating, we kind of talked high single digits, you've knocked that out of the park. Just curious your thoughts on growth going forward and expectations for production as well?
Arnold D. Martines -- Executive Vice President, Chief Banking Officer
Yeah, thanks. Thanks a lot. This is Arnold. As we move into the -- into Q4, our pipeline looks pretty strong across all loan categories. I think the improving economic conditions in Hawaii is going to help to build our pipeline as we move forward. Looking at Q4, CRE, resi and consumer will probably be the drivers for us. For resi, we expect to have somewhat of a supercharged quarter. We're looking at production in the $300 million to $320 million range, really augmented by a few high rise projects that have completed in which we are the lead take out, take out lender.
And then with regard to how that translates to gain on sale, we are looking at $1.2 million to $1.5 million range in Q4 and as we start to ship back to normal mix between sell and portfolio of loans, I think I've mentioned in the past quarter and past quarters that we've -- because of the PPP fee income that we've been been opportunistic about putting more of the resi loans in the portfolio, but we start -- we're starting to see a shift in that as we move forward in the future.
David Feaster -- Raymond James -- Analyst
Okay, no, that's great color. And then just maybe touching on expenses, appreciate the detail on the branch closure. Could you maybe just talk about some of the puts and takes as we look forward, just balancing the continued investments that you have with the cost saving initiatives that we've talked about, just what you think is a good run rate going forward as we had in '20 Q and just some of the puts and takes within that line?
David S. Morimoto -- Executive Vice President, Chief Financial Officer
David, it's David. Right now, we're sticking with the quarterly guidance of $40 million to $42 million on total other operating expense. We think that's a good run rate.
David Feaster -- Raymond James -- Analyst
Okay. Okay and then just maybe on the deposit front, it sounds like this -- the new mobile platform, the Shaka initiative and then you've got the Japan initiative. Just-- it sounds like the early read on Shaka is pretty good with 2,000 folks that are already trying to sign up. Just curious what you're seeing on the Japan side and then expectations for this in deposit growth going forward?
Paul K. Yonamine -- Chairman and Chief Executive Officer, CPF; Executive Chairman, CPB
Thanks, David. This is Paul Yonamine. Interestingly, even during the pandemic when the Japanese can't travel to Hawaii really because they have their quarantine measures still in play, we've seen a rise on deposits from our Japanese customers. So we're quite optimistic that once travel resumes, which will probably be hopefully early next year. It's still really difficult to tell that we'll see a bump up on more deposits coming into Hawaii. We plan to very proactively reconnect with a lot of our Japanese customers, prospects, to see if we can continue building our deposit base as well.
As far as Shaka -- the Shaka checking account is concerned, we started our social media program just three weeks ago. We're quite pleased that there is 2,000, over 2,000 people on the wait list. Some of the challenges in front of us is to -- once we launch Shaka checking on November 8th, is to convert them into customers, which we feel quite optimistic about, but we will continue doing a lot of proactive marketing to try and increase more new customers with that platform.
David Feaster -- Raymond James -- Analyst
Got it. That's helpful.
Paul K. Yonamine -- Chairman and Chief Executive Officer, CPF; Executive Chairman, CPB
Thanks, David. [Operator Instructions] The next question comes from Laurie Hunsicker with Compass Point. Please go ahead.
Laurie Hunsicker -- Compass Point -- Analyst
Yeah, hi, thanks. Good morning. Just hoping that you could help us think about net interest margin a little bit, obviously PPP impact was outsized this quarter and you have told there is $7.9 million unamortized fees remaining that you provided. So if we think about most of that happening in the fourth quarter into the first quarter, how should we think about what margin is looking like as we kind of move past that? And specifically to any comments on your cost of deposits is remarkably well, your core deposits ex CD is sitting at 3 basis points [Indecipherable] movement there. So I guess how should we be putting everything together? Any help, any guidance you can give us will be appreciated.
David S. Morimoto -- Executive Vice President, Chief Financial Officer
Sure. Hey, Laurie, it's David. So, when you normalize for PPP, the core NIM was 296 in the third quarter, which was a 3 basis point expansion from the second quarter. And what we're guiding to for the next few quarters is a NIM in the 290 to 3% range. So we're hoping that the NIM is relatively at its trough and we can start to hopefully see increases as we roll into 2022. But the sequential quarter NIM, the 3 basis points expansion, the majority of that came from our bond swaps that we executed in the investment portfolio. So we were successful in doing the bond swaps to down and coupon MBS bond swaps which brought the premium amortization under control. So that was the majority of the sequential quarter increase. So, loan and deposit -- core loan and deposit yields were relatively flattish sequential quarter, which obviously is a good thing. If we can, then now if we can drive asset yields up from here, we'll see might some margin expansion.
Laurie Hunsicker -- Compass Point -- Analyst
Got it, got it. Okay, thanks. And then I guess the longer bond secure, your auto purchasing and the $20 million book that you purchased, when in the quarter was that? Was that early, late, middle? Or maybe more broadly, if you don't have that right at your fingertips, do you of the auto information, what's Hawaii, what's Mainland and just generally how we should think about where that book is going to grow?
Arnold D. Martines -- Executive Vice President, Chief Banking Officer
Yeah, Laurie, this is Arnold. Yeah, I don't know -- I don't have that information right at hand on when that auto purchase closed, but we can get back to you on that, that's not a problem. As far as -- as far as the mix in the strategy, I mean right now we are -- we have basically both auto loans and unsecured on the Mainland, and I believe it's like a 40/ 60 split, 40 of auto, 60 unsecured consumer.
As far as the strategy is concerned, we look at the Mainland kind of more holistically from a perspective our total loan portfolio. So we've always looked at about a 15% Mainland to total loan portfolio and we try to manage the consumer and CRE and the snick exposure on the Mainland. And so that's kind of how we looked at it and I can assure you that we also have a fairly disciplined risk management process behind all of this. We've been doing this for a while and between our -- our line of business management as well as our credit management, Anna Hu and our credit folks, we pretty have a pretty strong grasp on this.
I think as I mentioned earlier, the Hawaii economy is trailing the Mainland and and so it was opportunistic for us as we announced earlier in the second quarter I believe that when we restarted our consumer loan programs that it was opportunistic for us to kind of start that movement on the Mainland. And this actually performed very well for us and we're very, very pleased with -- with the overall efforts and the performance of those portfolios.
Laurie Hunsicker -- Compass Point -- Analyst
Thanks, that's helpful. Just one more question, I guess maybe for you as well as David. The reserve to loans are now 148 or 155 [Phonetic] ex PPP. Just any guidance you can give us there on where you think that eventual number settles down? I mean, as we're trying to model and provision and obviously your credit is looking pristine, how should we be thinking about where reserves to loan will most likely settle?
David S. Morimoto -- Executive Vice President, Chief Financial Officer
Yeah, Laurie, it's David. So the ACL and ACL coverage ratio as we -- as we've stated previously, is going to be consistently -- directionally consistent with the net impact of the economic forecasts, net charge-offs, loan migration and net loan growth. But what I think we're seeing across the industry and what we're expecting here at CPF is that the ACL to total loans coverage ratio will gradually revert back to the day one CECL coverage ratio, which was in the 115 to 120 of loans area.
Laurie Hunsicker -- Compass Point -- Analyst
Right, that's helpful. Thank you so much.
David S. Morimoto -- Executive Vice President, Chief Financial Officer
Thanks, Laurie.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Paul Yonamine for any closing remarks.
Paul K. Yonamine -- Chairman and Chief Executive Officer, CPF; Executive Chairman, CPB
Thanks, Betsy. Thank you very much everyone for participating in our earnings call for the third quarter of 2021. We look forward to future opportunities to update you on our progress. Thank you.
Operator
[Operator Closing Remarks]
Duration: 31 minutes
Call participants:
David S. Morimoto -- Executive Vice President, Chief Financial Officer
Paul K. Yonamine -- Chairman and Chief Executive Officer, CPF; Executive Chairman, CPB
A. Catherine Ngo -- President, CPF; President and Chief Executive Officer, CPB
Arnold D. Martines -- Executive Vice President, Chief Banking Officer
Andrew Liesch -- Piper Sandler -- Analyst
David Feaster -- Raymond James -- Analyst
Laurie Hunsicker -- Compass Point -- Analyst
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