Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to the Central Pacific Financial Corp fourth quarter 2021 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.cpb.bank. I'd like to turn the call over to Mr. David Morimoto, Chief Financial Officer. Please go ahead.
Thank you, Charlie, and thank you all for joining us as we review the financial results for the fourth quarter of 2021 for Central Pacific Financial Corp. With me this morning are Paul Yonamine, Chairman and Chief Executive Officer, Catherine Ngo, Executive Vice Chair, Arnold Martines, President and Chief Operating Officer, and Anna Hu, Executive Vice President and Chief Credit Officer. We have prepared two supplemental side presentations that provide additional details on our earnings release and are 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 presentations.
Now I'll turn the call over to our Chairman and CEO, Paul Yonamine.
Good morning, everyone. As always, we appreciate your interest in Central Pacific Financial Corp. We are beginning the 2022 year with much excitement and optimism. Our financial results for 2021 are among our best ever. In fact, this is the best earnings report since before the Great Recession. Our recently announced executive leadership promotions went into effect starting January 1st, and our teams are energized and ready to continue our digital transformation. In addition to our earnings release this morning, we announced the launch of our banking-as-a-service strategy, and our team is pleased to share more details today. After an in-depth evaluation of the banking-as-a-service market, we identified an opportunity to enter this fast-growing market in a way that leverages our strengths. To maximize our impact as a banking-as-a-service provider, we will focus on partnering with select fintech companies to create strategic, customized programs resulting in new, differentiated financial products.
There is strong demand for this type of Banking-as-a-Service offering in the market today. We believe this creates a great opportunity for us to expand our reach beyond Hawaii and will drive future revenue generation to increase the value of the CPF franchise. Last quarter, we announced the launch of our new product, Shaka Checking. It is Hawaii's first and only digital bank account from a local financial institution. Shaka allowed us to test the product development and launch strategies that we will leverage in our future mainland Banking-as-a-Service programs. The Shaka account demand has far surpassed our initial expectations. We opened over 3,300 Shaka accounts since its launch in early November. It's obvious Shaka is serving a key need with a younger, tech-savvy audience in Hawaii.
It has a strong value proposition that includes getting your paycheck up to two days early, no ATM fees, and 24/7 digital convenience, among other benefits. As part of our Banking-as-a-Service initiative to drive additional growth beyond Hawaii, we are also pleased to announce that we will be making an equity investment in bank sponsorship of Swell, a new fintech company that we played a major role in developing. Swell is scheduled to launch in mid-2022, and we believe will provide a differentiated product offering that the market needs today. Swell's mission is to provide retail banking services to people via one integrated app that includes a digital checking account with a line of credit. Elevate is another equity investor in Swell and will be providing the systems and servicing for the Swell line of credit.
There is a revenue sharing agreement in place between Swell, Elevate, and CPF, and Elevate is also providing a credit enhancement structure to us. We are currently evaluating additional Banking-as-a-Service partnerships to create even more value for CPF and plan to announce further developments later in 2022. Finally, we are announcing the exciting new Banking-as-a-Service initiative. We remain committed to Hawaii and to continuing to build a successful and profitable franchise here. Here to talk about the Hawaii economy and our strong position here is Catherine Ngo, our Executive Vice Chair. Catherine.
Thank you, Paul. I'll start by giving an update on the Hawaii environment. We were pleased to have a strong visitor holiday travel season with the daily average air arrivals over 25,000 in November through December. Our statewide unemployment rate continued to decline and was at 6% in November 2021. While we were not immune to the COVID case spike related to the Omicron variant, our state has been able to manage through it, particularly as our vaccination rate is strong at approximately 75%. We have also not seen any significant slowdown in Hawaii business activity or investment due to Omicron. The housing market in Hawaii remains very hot with our median single-family home price holding at just over $1 million. Overall, the Hawaii economy remains on track for recovery.
Our asset quality continues to be very strong with non-performing assets at just 8 basis points of total assets as of December 31st. Additionally, total criticized loans were at about 1.5% of total loans. Finally, during the quarter, we had net recoveries of $900,000. I'd like to now turn the call over to Arnold Martines, our President and Chief Operating Officer. Arnold.
Thank you, Catherine. In the fourth quarter, our core loan portfolio increased by $183 million or 4% sequential quarter, which was offset by PPP forgiveness paid downs of $127 million. Year-over-year, our core loan portfolio increased by 10%. The core loan growth was broad-based across almost all loan categories. Our residential mortgage production continued to be very strong, with total production in the fourth quarter of $354 million as several large condominium projects in Honolulu were completed during the quarter, with CPB leading the takeout financing for the homeowners. Total net portfolio growth in residential mortgage and home equity was $146 million in the fourth quarter.
For all of 2021, we once again had record residential mortgage production totaling $1.2 billion, putting us near the top of all residential mortgage lenders in Hawaii. PPP forgiveness continues to progress well, with 99% of the loan balances originated in 2020 and 73% of the balances originated in 2021 forgiven and paid down through December 31st. During the fourth quarter, we continued consumer unsecured purchases with our established vendors on an ongoing flow basis. The purchases during the quarter all were within our established credit limits and had a weighted average FICO score of 750. As of December 31st, total mainland consumer unsecured and auto purchase loans were approximately 5.7% 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 have a healthy loan pipeline in all loan product categories, and we are expecting our favorable loan growth trends to continue in 2022. On the deposit front, we continue to see strong inflow of deposits, with total core deposits increasing by $66 million or 1% sequential quarter growth. On a year-over-year basis, total core deposits increased by $1 billion or 20%. Additionally, our average cost of total deposits in the fourth quarter was just 6 basis points. Finally, we plan to build upon our early success with our Shaka digital checking product going into 2022. With this differentiated product and its strong market acceptance, we expect account growth to continue.
We will be expanding our relationships with the new-to-CPB Shaka account holders, which represented over 50% of the new accounts, and explore further complementary product offerings using the Shaka brand. I'll now turn the call over to David Morimoto, our Chief Financial Officer. David.
Thank you, Arnold. Net income for the fourth quarter was $22.3 million or $0.80 per diluted share, an increase of $1.5 million or $0.06 per diluted share from the prior quarter. Return on average assets in the fourth quarter was 1.22%, and return on average equity was 16.05%. For the full 2021 year, net income was $79.9 million or $2.83 per diluted share. This compares to $37.3 million or $1.32 per diluted share in 2020. Net interest income for the fourth quarter was $53.1 million, which decreased by $3 million from the prior quarter due to less PPP fee income as the forgiveness process winds down.
Net interest income included $4.7 million in PPP net interest income and net loan fees compared to $8.6 million in the prior quarter. At December 31, unearned net PPP fees was $3.5 million. The net interest margin decreased to 3.08% in the fourth quarter compared to 3.31% in the prior quarter. The NIM normalized for PPP was 2.87% in the fourth quarter compared to 2.96% in the prior quarter. The normalized NIM decrease was driven by lower loan yields due to market pricing competition. While we expect market pricing for loans to remain competitive, our new loan origination yield in the fourth quarter approximated our overall loan portfolio yield, and our balance sheet is slightly asset sensitive.
Fourth quarter other operating income increased to $11.6 million from $10.3 million in the prior quarter. The increase was driven by higher mortgage banking income and higher bank-owned life insurance income. Other operating expense for the fourth quarter was $42.2 million, which included non-recurring expenses of $1.1 million of severance payments, $0.4 million branch consolidation costs, and $0.3 million in promotion expenses related to our Shaka digital checking launch. At the end of 2021, we consolidated one of our Honolulu branches into a nearby branch. We anticipate $0.8 million in annualized savings from this consolidation. With the continued successful customer migration to digital banking services, we plan to consolidate three additional branches in 2022.
At the same time, we are continuing to invest in select strategic branch locations, including acquiring real estate and leasing and developing fully modernized branches. The efficiency ratio increased to 65.6% in the fourth quarter due to lower net interest income and non-recurring expenses. We remain focused on driving positive operating leverage with our strategic initiatives to continue to improve efficiency. At December 31st, our allowance for credit losses was $68.1 million, or 1.36% of outstanding loans, excluding PPP loans. In the fourth quarter, we recorded a $7.4 million credit to the provision for credit losses due to continued improvements in the economic forecast and our loan portfolio, as well as net recoveries during the quarter of $0.9 million.
The effective tax rate was 25.4% in the fourth quarter, and going forward, we continue to expect an effective tax rate to be in the 24%-26% range. Our capital position remains strong, and during the fourth quarter, we repurchased 305,000 shares at a total cost of $8.4 million, or an average cost per share of $27.64. Yesterday, our board of directors approved a new share repurchase authorization of up to $30 million. Finally, our board of directors also declared a quarterly cash dividend of $0.26 per share, which was an increase of $0.01 or 4% from the prior quarter. Now I'll return the call to Paul.
Thanks, David. Central Pacific had a solid fourth quarter and 2021 year. Looking forward, we are very excited about the key items we announced today, which we believe will position us extremely well and enable us to deliver greater shareholder value in the near and long term. In summary, we had record 2021 earnings. We increased our quarterly cash dividend by 4%. We will continue share repurchases under our new $30 million board-approved authorization. We launched our Banking-as-a-Service strategy, which started with our successful Shaka digital checking launch in Hawaii. Upcoming soon, we will expand to the mainland with our Swell fintech investment, as well as other selected partners. Further, we remain committed to providing support to our employees, customers, and the community as we continue to progress through the economic recovery.
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. Back to you, Charlie. Thank you.
Our first question comes from Andrew Liesch of Piper Sandler. Your line is open. Please go ahead.
Hi. Good morning, everyone. Thanks for taking the questions. Got some questions on the Banking-as-a-Service initiative, like the long-term plan that this can provide for you. I'm just curious, what the revenue sharing agreement that you discussed, is this based on loan growth, deposit growth, a combination of both? How should we be thinking about how this could benefit CPF bottom line?
Yeah, thank you. This is Paul Yonamine. It is both, Andrew, and you know, we have it structured between the three organizations, between Swell, Elevate, and CPF. As we iterate, you know, with our launch this year and we have further learnings, there could be certain adjustments to that revenue-sharing arrangement. We will be glad to share more details on that as we get further along in the year.
Certainly. Look forward to hearing that. I guess the loss sharing or the credit protection that Elevate's providing, just to explain that a little bit more. Are they in a first loss position? How, obviously you don't need to go into too many details right now, as it's still pretty early stages, but how is that broadly structured?
Sure. You know, this is Paul again. You know, first, before I get into that, you know, I really want to commend Anna Hu, our Chief Credit Officer. You know, CPF has a history of keeping a very pristine loan portfolio. I think we know how to really take a hard look at credit, and it's some of those best practices that gets baked in to this Banking-as-a-Service strategy. Again, among the three organizations, we have a very solid credit management structure. For CPF as the bank sponsor to this fintech operation, we will be in a position to dictate the credit guidelines, and we'll be monitoring that very closely, definitely weekly, if not even daily.
You know, be rest assured that the way we have it structured in terms of managing risk, I believe we have three lines of defense. We have what we do here at CPF already, but also with Elevate, that is a proven fintech lender with over 20 years of experience, and also Swell, who is led by our former Chief Strategy Officer and Chief Marketing Officer, Kevin Dahlstrom. You know, I might just add that one of the core strengths that we have on this particular bank sponsorship is the relationships that we have with the other two organizations. Again, Kevin leading, being the CEO of Swell, and also at Elevate, where the Chief Strategy Officer of Elevate is a board of directors for CPF.
Our former chairman, my predecessor, John Dean, also serves on the board of Elevate. Relationships, at the end of the day, is what is going to harvest the real benefit of even a pure digital play.
Got you. That's great. Thank you for all that detail. I was not aware of that. Just one question for you, David. You mentioned the balance sheet being slightly asset sensitive. Could you go into a little bit more details on that? You guys have such a low cost sticky deposit base that I would think that it'd be a little bit more than slightly asset sensitive. What are the different factors at play there?
Yeah. Hey, Andrew. Yeah, the slightly asset sensitive, as you're aware, Hawaii banks tend to have a larger concentration in residential mortgage loans on their balance sheet than say, mainland banks. That's just a function of the market. It's pretty commonplace in Hawaii. Those loans tend to have fixed rates. Similar to the other local banks, you know, we have 50%-60% of our loan portfolio is fixed rate. But it is funded by a very strong, large, and stable core deposit base. Our current modeling in, say, a +100 rate environment has net interest income increasing about 5%. That modeling currently contemplates three tightenings in 2022, with the first occurring in March.
Our core deposit rate betas, on average, are about 15%, and that's based on historical experience.
Got it. That's very helpful. Thanks for taking all the questions today. I really appreciate it.
Thanks, Andrew.
Our next question comes from David Feaster of Raymond James. Your line is open. Please go ahead.
Hey. Good morning, everybody.
Hey, David.
I just wanted to maybe just follow up on that margin question, appreciate that sensitivity, and just kind of reading maybe between the lines on your prepared remarks, it kind of feels like we're about at the trough. Do you think we have troughed, or do you think that the first quarter is going to be the low point and that we can start expanding as you know, hopefully we start getting rising rates and an improving earning asset mix, just some of the growth given the growth initiatives that you've talked about?
Yeah, David. You know, the margin guidance for the next couple of quarters is probably 2.85%-2.95%, you know, on a core basis.
Yeah.
We believe the net interest margin on a core basis has troughed. As mentioned in the prepared remarks, the new volume loan yields approximate the portfolio yield, likewise on the investment portfolio side. That's the expectation on net interest margin.
Okay. You know, it's great to see the early success that you guys have had from the Shaka digital checking account initiative. Could you just maybe give us some insights into how much deposit growth you've generated from those 3,300 clients so far that you've onboarded, and just how you think about growth going forward, and maybe where you're seeing some early success on the cross-selling front?
Yeah. David, this is Arnold. Yeah. You know, we're pretty-
Pleased with the success of the Shaka product and the launch. As you know, we just launched that in November of last year, so it's probably a little early for us to talk about the, you know, the growth, the actual balance growth. We probably will talk about that in future quarters as the accounts start to mature. But I can tell you that we are focused on cross-sell and engaging and activating these new customers. As I mentioned in my opening remarks, more than 50% of the accounts opened are new customers to CPB, so we're pretty excited. More to comment on reporting on success here in future quarters.
It sounds like that the $123 million of deposit growth we saw. We're only starting to see a limited impact of that growth thus far. We should expect, you know, that kind of deposit growth to remain relatively strong through 2022.
That's correct. In fact, you know, on the subject of deposit growth, I'll just mention that, you know, we're looking as far as full-year guidance for you at the mid-single-digit% for growth in deposits. You know, we feel pretty good about that. We think there will be some outflows as the economy continues to take traction and recover. You know, our customers will have confidence in being able to spend again. With that said, you know, the things that we're doing, the Shaka launch, but even the rebrand last year, and just the vibe that we've created, we feel pretty confident that we'll continue to see nice deposit growth this year.
Okay. Then could you just maybe talk a bit about your outlook for expenses as we go into 2022? You know, we hear a lot about inflationary pressures just weighing on expenses for the industry. You got several tech initiatives obviously ongoing, but it seems like maybe a lot of the expenses are already in the run rate, just given what we did last year. You know, just curious how you think about expenses as we head into 2022. What a good core run rate and inflationary rate might be, just cognizant of a seasonally higher first quarter as well.
Hey, David, it's David. Yeah, I think your commentary was right on point. You know, as we've stated previously, we started the investments in our initiatives last year. Actually, it was the prior year, but it did ramp up last year. That was designed, you know, because we knew we had the tailwinds of PPP income and credit provisioning. Because we had those tailwinds, we started investing last year. The outlook for expenses now is, you know, roughly flat. I would say it's probably $40 million-$42 million per quarter is the guide. It's like a 0% to +2% year-over-year increase is what we're looking at for 2022.
Okay. That's helpful. Thanks, everybody.
Thanks, David.
As a reminder, if you would like to ask a question, please press star followed by one on your telephone keypad now. Our next question comes from Laurie Hunsicker of Compass Point. Your line is open. Please go ahead.
Great. Hi. Thanks. Good morning. Just sticking with where David was on expenses, and so obviously netting out your one-time items, I can see how you're at that $40 million-$42 million expense run rate. Can you just help us in terms of timing on when your three branches are planning to close in 2022?
Sure. Hey, Laurie. It's David. Under the current plan, and obviously things can change, but under the current plan, we're looking at two consolidations in the second quarter. You know, those branches tend to be smaller branches, so the one-time expense there is roughly $300,000 pre-tax, and prospective annual savings is about $500,000. Then the third consolidation is currently planned in the third quarter. There we have one-time expense of $200,000, prospective annual savings of $400,000. We're looking at total annual savings about $900,000 from the 2022 consolidations on an annual run rate basis.
Okay, how should we be thinking about core expense growth for 2023?
Yeah. Laurie, I would say, you know, we're in that $160 million-$165 million on an annual basis in 2022. 2023 is a little ways out, but I would say we're targeting like, you know, in the 2%-3% range annual growth, which is really inflation. There's so much uncertainty right now with regard to COVID, market interest rates, excess balance sheet liquidity, and our Banking-as-a-Service strategy. There's a lot of moving parts to the expense line. I think the bottom line message on expenses is we plan to be nimble, as we've been throughout the last several years. We're gonna adjust our expenses based on revenue opportunities.
If there's great revenue opportunities, if our Banking-as-a-Service strategies gain traction, we'll take advantage of it and we will increase our expenses to take advantage of that if it has, you know, commensurate revenue opportunities.
Okay. That makes sense. Those are great numbers. Thanks for the color on that. Arnold, I just wanted to go back to something you said. You said consumer loans, you were targeting 15% of your book. When is your thought on when consumer loans get to that level? You're currently at 12%. How should we be thinking about that?
Yeah. Hi, good morning, Laurie. Actually, when I said 15%, it includes both commercial and consumer. It's consumer and commercial, 15% as a percentage of our total loan portfolio. Right now, on the consumer side, for the mainland, we're at about 5.7%. You know, we'll probably be in that 6%-7% range, I would say. I mean, I don't see us growing, you know, more than that in the near term.
Okay. Got it. Okay. This is for all of you. I guess if you could help us think a little bit about the Swell Elevate fintech. Can you help us think about how much you plan to add in loans over the duration of, you know, 2022 as you're obviously just ramping up, and more importantly, 2023, and what the coupons are looking like on those and anything around FICO?
Thanks, Laurie. I'm gonna start on that. This is Paul. You know, as you mentioned as well, you know, in 2022, we will be, you know, ramping things up. We'll be, you know, there'll be an iteration process this year as we review customer acquisition costs, yields, default rates, you know, we'll be figuring out, you know, how deeply to step on the gas pedal on this. That's one of the real benefits of the relationship with Swell and Elevate, is that we have that degree of flexibility as we look at risk going forward. I can tell you that Swell will become a good part of our future growth. Naturally, we continue to see great opportunities here locally.
Hopefully when Japan opens up, we'll see many opportunities with Japanese investors coming into Hawaii again. In terms of this digital play, working with Elevate, again, a very proven fintech lender with over 20 years of experience, and also with Swell, led by an individual who had much to do with our digital strategy here in Hawaii and our ad marketing campaign, that I think this is a good group that will be driving future potential for us. You know, Laurie, at this time, it's really difficult for me to provide you with any specifics on, you know, number of, you know, loan originations and things during 2023. Once again, I do believe that our initiative with Swell will become a key part of our future growth.
Okay. Elevate is subprime. Are you intending to do subprime unsecured?
No, we're not.
Is that the intent?
Yeah.
Okay. You're gonna go-
We are not intending to do. I'm sorry?
What is the line in the sand of how low you're gonna go on FICO? Can you help us understand that?
Right. Our focus right now, Laurie, is to look at what we call near prime. You know, mind you that Elevate being in the subprime space for roughly 20 years, they have considerable experience and IP in terms of assessing. They've automated the process of assessing the creditworthiness of, you know, potential prospects. We will be leveraging a lot on Elevate's current lending management system. It's already built. There's nothing that we need to rebuild. Actually that's another great feature of this current alliance that we have and why we're not showing a great deal more expense on our books today, because it really is the coming together of existing technologies and business processes.
What is your definition of near prime? How do you think about that on a FICO?
David, what was the FICO score?
Yeah. Laurie, it's in the 650 area. What I will say, Laurie, and we will be happy to share more details as we get closer to launch and as we get to launch of Swell. There is a desire to keep some of this behind the curtain for now. What I will say with regard to near prime is we're not going with necessarily just a FICO definition of near prime. As you're well aware, you know, a lot of the online digital lenders today have multiple and sometimes hundreds of different inputs into their credit models, and FICO being one of the hundred inputs. You know, while it is an input, it is not the only input that we'll rely on.
We're gonna be focused on more of the digital lending experience of Elevate.
Okay, great.
Yeah, and just-
Just last question. What-
Paul again, Laurie.
Oh, go ahead.
You know what, if I could just add again, the near-prime segment, you know, in the continental U.S. is probably the most underserved segment in terms of credit today. We've done a fair amount of analysis, and as David has covered, it doesn't just boil down to FICO scores, and this is really what we're counting on with Elevate, with their 20 years of experience in how to identify and segment that near-prime group.
Okay. Sorry, just two more questions. What is your target launch date then for Swell? When do we start to see these add to your balance sheet? What's your best guess?
Laurie, as we've disclosed, we're targeting mid-2022, so I'd say 630.
Okay, great. Lastly, can you just share with us a little bit about Kevin? I'm not familiar with Kevin Dahlstrom. Just any high-level thoughts.
Sure
You can share with us would be great. Thank you.
All right. Thanks, Laurie. Kevin was with Central Pacific Financial Corp for two years. We were very fortunate to bring him on board after a great stint with Mr. Cooper, you know, in the continental U.S., one of the largest online digital mortgage lenders. Prior to that, at Mr. Cooper, he was the chief marketing officer there. Very involved in the rebranding, a lot of the social influencer strategy, and you know, basically driving their digital marketing initiative. Prior to that, actually, Kevin worked for Elevate as well, where he was also the chief marketing officer. Again, this goes back to this strength that we have on relationships.
You know, we all know each other, which I find extremely important, you know, as becoming a bank sponsor. I think as a matter of fact, it's a critical success factor as banks sponsor fintechs, that they have that type of relationship, you know, that's been built up over the years. You know, Central Pacific Financial Corp, if you know, and many thanks to, you know, all of the people who follow us, but we have had a good history of hitting our targets this past three years, especially in the digital arena.
You know, Kevin was very involved in the final implementation of our new mobile and online platform, which is now rated 4.8 on Apple and Android, and I believe could be the highest rated platform now in the state of Hawaii. We're quite proud about that. You know, it took a lot of work, but we executed and we got it done. It's a lot of that discipline that Kevin brings to the Swell organization along with his marketing capabilities, and we're very, you know, we're looking very positively to the future as a result of that.
Great. Thanks. I'll leave it there.
There are no further questions at this time, so I'll turn the call back over to Paul Yonamine, Chairman and CEO, for closing remarks.
Great. Thank you very much for participating in our earnings call for the fourth quarter of 2021. We look forward to future opportunities to update you on our progress. Thank you.
This concludes today's call. Thank you for joining. You may now disconnect your lines.