Central Pacific Financial Stock: 5.4% return with a 45% payout ratio (NYSE:CPF)
The last time I talked about Central Pacific Financial (NYSE: PCF) was in March 2021. The bank’s share price had nearly doubled in the six months prior to the article, but unfortunately CPF was unable to maintain the momentum and the stock price is currently just over 25% lower than where the stock was trading in March 2021. As we are now over eighteen months later and the bank reported over seven more terms, I thought this might be a good time to revise my 2021 thesis.
An overview of the third quarter results
Central Pacific is focused on the Hawaiian Islands, and tourism is obviously a very important source of revenue and a major contributor to the Islands’ GDP. In 2021, I was pleased to see that the largest position in the loan portfolio was residential real estate, which represented approximately 34% of the total loan portfolio with an additional 11% of the loan portfolio classified as value loans domiciliary with in addition to that, 10% of the loan portfolio consisted of consumer loans. While this still meant around 45% of the loan portfolio was exposed to commercial loans, the CPF was highly diversified and I believe this has helped the bank through the COVID crisis.
Fortunately, the bank also benefits from rising interest rates. Total interest income increased by just over 8% to almost $60 million and although interest expense more than doubled, net interest income still increased by approximately 4% to reach $55.4 million. And as you can see below, the net provision for loan losses was only a few hundred thousand dollars, which helped boost pre-tax income to $22.6 million. Although this is the lowest result for several quarters, keep in mind that the Q2 result was boosted by an $8.5 million gain on the sale of investment securities, whereas previous quarters included the reversal of provisions for loan losses.
So while you see a decrease in pre-tax profit, net profit and EPS, CPF actually did quite well and the reported EPS of $0.61 is a “clean” result: there is no has no non-recurring items that had a (positive or negative) impact on net income.
Meanwhile, the bank is still paying a quarterly dividend of $0.26 per share and the annualized dividend of $1.04 means the yield has risen to just over 5.4% based on the current share price. share of $19.19. It also makes Central Pacific very attractive to income investors.
Book value has gone down but CPF is playing smart
Another element of CPF that I certainly appreciate is the decision to move a bunch of available-for-sale securities into the “held-to-maturity” category. As you may know, securities classified as available-for-sale should be marked-to-market, which means that in the current interest rate environment, unrealized losses on these positions add up. This has no impact on the income statement, but has a negative impact on book value and book value per share. As you can see in the image below, CPF gradually reduced the position size of its available-for-sale securities and gradually built up held-to-maturity debt securities (which are not subject to mark-to-market requirement) .
This does not mean that CPF was immune to changes in interest rates, but it was able to limit the damage. At the end of September, the value of equity on the balance sheet was approximately $438 million, giving book value and tangible book value per share of $16.08. This means the stock is trading at a small premium of just under 20%, which is acceptable given the bank’s strong credit history and attractive earnings profile.
As explained earlier in this article, one of the main features why I liked Central Pacific in 2021 was its high exposure to residential real estate and non-commercial loans. I argued that 55% of the loan portfolio was made up of these consumer loans, with almost half of the loan portfolio being represented by loans related to residential real estate. Over the past eighteen months, CPF has further increased the proportion of its loan portfolio invested in residential real estate.
At the end of September, 48% of the $5.4 billion loan portfolio was invested in residential mortgages and home equity investments, with an additional 14% of the loan portfolio ( approximately $750 million) invested in consumer loans. The bank also disclosed the LTV ratios of these loans: the average LTV ratio in the residential mortgage and home equity segment is 64% and 61%, respectively. On top of that, the LTV ratio in the commercial mortgage segment is also only 61%, so while we can expect higher interest rates to have a negative impact on capitalization rates , the CPF should be quite protected thanks to the very decent LTV ratios. . And higher interest rates in the markets should also have a positive impact on net interest income, which could make it easier to increase loan loss provisions (if necessary) to further strengthen the level of provisions. .
Central Pacific Financial is an interesting bank. Rising interest rates should be positive for the bank, but we also need to keep an eye on how Hawaii is weathering this inflation crisis. I can imagine there will be an impact on the tourism industry as budgets will be cut while foreign tourists may be deterred by the strength of the US dollar.
That’s why I’m still a bit cautious but I think the bank offers good value for money. The dividend should be safe and provide nice compensation while waiting for the bank to trade at a multiple slightly above the 8x earnings at which CPF currently trades.
I don’t currently have any positions in the Central Pacific, but I’m certainly looking with interest.