Subprime crisis hits CPB parent
The 55.8 percent fall in earnings is blamed on homebuilders suffering in California
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Central Pacific Financial Corp., which three months ago assured investors it had no exposure to the subprime lending crisis, said yesterday that third-quarter net income plunged 55.8 percent after it took a $21.2 million provision for loan and lease losses due to a rapid downturn in California residential construction.
Clint Arnoldus, president and chief executive of Central Pacific, said the bank was hurt by the subprime downturn indirectly, after national homebuilders unloaded California inventory at 10 percent to 30 percent discounts and nearby local contractors who Central Pacific had provided loans to were left without buyers.
Central Pacific posted net income of $9.1 million or 30 cents a share, compared with $20.6 million or 67 cents a share, a year earlier.
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Three months ago, Central Pacific Financial Corp. assured investors it had no exposure to the subprime lending market.
But what a difference a quarter makes.
The parent of Hawaii's fourth-largest bank, Central Pacific Bank, said today that third-quarter net income plunged 55.8 percent after it took a $21.2 million provision for loan and lease losses due to a rapid downturn in California residential construction.
Central Pacific's net income of $9.1 million, or 30 cents a share, was 35 cents below analysts' estimates and the bank's stock tumbled nearly 7 percent in trading on the New York Stock Exchange.
A year ago, Central Pacific earned $20.6 million, or 67 cents a share.
Clint Arnoldus, president and chief executive of Central Pacific, said the provision is limited to California and the bank was "indirectly impacted" by the subprime crisis that hit the California real estate market.
Arnoldus, who added there were no similar problems in Hawaii, said many of the bank's projects are residential tract construction loans to local contractors in California who were left in a dilemma when the buyers disappeared.
"What happened is the national homebuilders took the strategy of just unloading inventory and they discounted it significantly from 10 to 30 percent, and many of our projects were located next to projects that national homebuilders have," Arnoldus said. "All that happened in a very short time."
Central Pacific, which last quarter identified two problem loans, said the loan-loss provision of $21.2 million was directly attributable to the bank downgrading 12 loans totaling $92 million with exposure to the California residential construction market.
In the year-earlier quarter, Central Pacific took just a $300,000 loan-loss provision, while in the second quarter of this year the bank's loan-loss provision was $1 million.
Analysts said they were not surprised by the earnings shortfall given that Central Pacific had warned last quarter of potential loan softness and that the bank had exposure to the California construction market.
"The question was how meaningful would the problems be, and it looks, hopefully, they've addressed the issue in the third quarter with the large provision, which is a little over 2 percent of average loans on an annualized basis," said analyst Brett Rabatin of FTN MidWest Research.
Joe Morford, an analyst with RBC Capital Markets, called the earnings "disappointing" but not necessarily surprising given Central Pacific's exposure to some of California's weaker markets like the Inland Empire and the Central Valley regions, where there have been significant declines in home values.
"They're not alone; several banks have had problems this quarter," Morford said. "We thought there was a risk they could fall short this quarter due to a higher loan-loss provision related to their California construction-lending exposure, but we couldn't quite quantify that."
Arnoldus said he had never seen a downturn occur so quickly.
"Typically, downturns have been part of a broader economic decline," he said. "In this case, it's a rifle shot right into the housing industry because the other economic indicators in California are still relatively strong. What happened in this case is the market got overheated by the subprime mortgages that were created, and that came to a grinding halt. Then the national homebuilders dumped inventory."
Central Pacific Chief Financial Officer Dean Hirata stressed that the action taken by the bank was a provision for loan losses -- putting money in reserve for potential losses -- rather than loan charge-offs.
"It's all part of the overall process to manage credit risk," Hirata said. "We are very proactive in taking a look at the loans and evaluating the loan grades, which in this case resulted in these downgrades and which, in turn, resulted in additional provisions for loan losses."
The bank also lowered its full-year 2007 guidance for the second time this year, after reaffirming its numbers at the end of the second quarter. Central Pacific is now projecting earnings per share of $2.31 to $2.36, down from its guidance of $2.75 to $2.85 at midyear and its forecast of $2.80 to $2.90 at the start of the year.
"I think this reserve is the beginning of the process of helping the investor understand the risk that's embedded in our California portfolio," Arnoldus said. "We've completely reviewed that portfolio and that ($21.2 million) represents the risk that we see in that portfolio."
Without the loan-loss provision, Hirata said Central Pacific's earnings would have been $20.9 million, or 69 cents a share.
"So we have a bank that continues to be a solid earner that's very strongly capitalized," Arnoldus said.
Revenue, which consists of net interest income and noninterest income, rose 1.5 percent to $64.6 million from $63.6 million a year earlier.
Net interest income, reflecting the difference between what Central Pacific pays depositors and what it brings in from loans, slipped 0.5 percent to $52.8 million from $53.1 million. Net interest margin decreased to 4.29 percent from 4.54 percent. Noninterest income, which includes fees and service charges, increased 11.4 percent to $11.8 million from $10.5 million.
"Interest margin compression and coming off a cyclically low credit environment makes earnings growth very difficult in the banking industry in the current environment," Rabatin said.
Total assets rose 5 percent to $5.6 billion from $5.4 billion a year ago. Loans and leases grew 8.2 percent to $4.1 billion from $3.8 billion, with Hawaii lending operations accounting for about 65 percent of the loan growth. Deposits increased 4.2 percent to $3.9 billion from $3.8 billion.
Nonperforming assets -- representing three of the loans that were downgraded -- more than tripled to $30.8 million from $8 million.