CPF is required to act as a source of strength to the bank under the Bank Holding Company Act. All of the funds CPF received from the sale of securities to the U.S. Treasury have been contributed by CPF to the bank as capital. CPF is obligated to pay its expenses, as well as dividends on its Fixed Rate Cumulative Perpetual Preferred Stock and payments on its subordinated debentures which fund payments on its outstanding trust preferred securities. CPF has limited capital resources to meet these obligations. Accordingly, in the third quarter of 2009, CPF elected to defer payment of dividends on its Fixed Rate Cumulative Perpetual Preferred Stock and trust preferred securities as described above. In the past, CPF has primarily relied upon dividends from the bank for its cash flow needs. CPF may continue to secure additional funds under this method; however, all dividends from the bank to CPF require prior approval from the Company’s regulators including the FDIC and DFI. There are no assurances that the FDIC and DFI will authorize the Bank to pay dividends to CPF.
Other sources of funds which may be available to CPF include independently raising additional capital or borrowing funds. As noted above, CPF is exploring all available measures to increase its capital base. Incurring, renewing or guarantying indebtedness by CPF also requires the advance approval of the FRB and the DFI. There are no assurances that CPF will be able to obtain funding from the issuance of equity or debt in the future.
Our objective in managing liquidity is to maintain a balance between sources and uses of funds in order to economically meet the cash requirements of customers for loans and deposit withdrawals and participate in lending and investment opportunities as they arise. We monitor our liquidity position in relation to changes in loan and deposit balances on a daily basis to assure maximum utilization, maintenance of an adequate level of readily marketable assets and access to short-term funding sources. We have employed, and continue to employ, a number of measures to improve our liquidity position, which includes reducing our reliance on non-core funding sources by growing core deposits and decreasing our loan-to-deposit ratio from 103.0% at December 31, 2008 to 89.6% at September 30, 2009. Furthermore, we also intend on pursuing the possibility of potential loan sales (both individually and in bulk), however, no formal plan has been finalized and specific loans have not yet been identified for sale.
Core deposits have historically provided us with a sizeable source of relatively stable and low cost funds but are subject to competitive pressure in our market. In addition to core deposit funding, we also have access to a variety of other short-term and long-term funding sources, which include proceeds from maturities of our investment securities, as well as secondary funding sources such as the FHLB-Seattle, secured repurchase agreements, federal funds borrowings and the Federal Reserve discount window, available to meet our liquidity needs. While we historically have had access to these other funding sources, the access to these sources may not be guaranteed due to the current volatile market conditions and the companies’ financial positions.
The bank is a member of and maintained a $952.7 million line of credit with the FHLB as of September 30, 2009. Long-term borrowings under this arrangement totaled $471.1 million at September 30, 2009, compared to $541.0 million of long-term borrowings at 2008 year-end. There were no short-term borrowings under this arrangement at September 30, 2009 or year-end 2008. FHLB advances outstanding at September 30, 2009 were secured by interest-bearing deposits at the FHLB of $0.7 million, our bank’s holdings of FHLB stock, other unencumbered investment securities with a fair value of $166.5 million and certain real estate loans totaling $1.1 billion in accordance with the collateral provisions of the Advances, Security and Deposit Agreements with the FHLB. Approximately $481.6 million remained available for future borrowings at September 30, 2009. The FHLB has the right to suspend future advances. If the FHLB determines in good faith that a material adverse change has occurred in our financial condition, they may consider this to be a form of default and would have the right to call all outstanding borrowings under this arrangement.
The bank also maintained a $389.3 million line of credit with the Federal Reserve discount window as of September 30, 2009. There were no borrowings under this arrangement at September 30, 2009, although there were $276.0 million in short-term borrowings at 2008 year-end. Advances under this arrangement are secured by an investment security with a fair value of $5.0 million and certain real estate loans totaling $699.9 million. At September 30, 2009, the entire $389.3 million was available to us for future borrowings. In September 2009, the bank was no longer eligible to access the FRB’s primary credit facility but still maintained access to its secondary facility. There was no change in the level of credit available to the bank; however, future advances will have higher borrowing costs under the secondary facility.
Proceeds from our January 2009 sale of preferred stock under the TARP CPP of $135.0 million, provided us with additional resources for our lending activities. If market conditions permit, proceeds from future capital raising initiatives may also provide another source of funds. Management does not rely on any one source of liquidity and seeks to manage availability in response to changing balance sheet needs and market conditions.
We cannot predict with any degree of certainty how long these market conditions may continue, nor can we anticipate the degree of impact such market conditions will have on loan origination volumes and gains or losses on sale results. Deterioration in the performance of other financial institutions, including write-downs of securities, debt-rating downgrades and defaults, have resulted in industry-wide reductions in liquidity and further deterioration in the financial markets may affect our liquidity position.
Information regarding our contractual obligations is provided in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K/A for the year ended December 31, 2008. There have been no material changes in our contractual obligations since December 31, 2008.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices such as interest rates, foreign currency rates, commodity prices and equity prices. Our primary market risk exposure is interest rate risk that occurs when rate-sensitive assets and rate-sensitive liabilities mature or reprice during different periods or in differing amounts. Asset/liability management attempts to coordinate our rate-sensitive assets and rate-sensitive liabilities to meet our financial objectives. The Asset/Liability Committee (“ALCO”) monitors interest rate risk through the use of interest rate sensitivity gap, net interest income and market value of portfolio equity simulation, and rate shock analyses. Adverse interest rate risk exposures are managed through the shortening or lengthening of the duration of assets and liabilities.
The primary analytical tool we use to measure and manage our interest rate risk is a simulation model that projects changes in net interest income (“NII”) as market interest rates change. Our ALCO policy requires that simulated changes in NII should be within certain specified ranges, or steps must be taken to reduce interest rate risk. The results of the model indicate that the mix of rate-sensitive assets and liabilities at September 30, 2009 would not result in a fluctuation of NII that would exceed the established policy limits.
Item 4. Controls and Procedures
As of the end of the period covered by this report and pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended, (the "Exchange Act"), the Company's management, including the Chief Executive Officer and Principal Financial and Accounting Officer, conducted an evaluation of the effectiveness and design of the Company's disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Based upon that evaluation, the Company's Chief Executive Officer and Principal Financial and Accounting Officer concluded, as of the end of the period covered by this report, that the Company's disclosure controls and procedures were effective in recording, processing, summarizing and reporting information required to be disclosed by the Company, within the time periods specified in the Securities and Exchange Commission's rules and forms.
As of the end of the period covered by this report, there have been no changes in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter to which this report relates that have materially affected or is reasonably likely to materially affect, the internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1A. Risk Factors
The following risk factors have been updated from the risk factors previously disclosed in our Annual Report on Form 10-K/A for the period ended December 31, 2008, filed with the SEC.
We have incurred significant losses and cannot assure you that we will be profitable.
We incurred a net loss of $138.4 million, or $4.83 loss per common share, for the year ended December 31, 2008, and a net loss of $215.0 million, or $7.67 per common share, for the nine months ended September 30, 2009, in each case due primarily to credit costs, including a significant provision for loan and lease losses. Although we have taken a significant number of steps to reduce our credit exposure, we likely will continue to incur significant credit costs through 2010, which we anticipate will continue to adversely impact our overall financial performance and results of operations.
A large percentage of our real estate loans are construction loans which involve the additional risk that a project may not be completed, increasing the risk of loss.
Approximately 28% of our real estate loan portfolio as of September 30, 2009 was comprised of construction loans. Sixty-four percent of these construction loans were in Hawaii, 32% in California and the remaining 4% in Washington. Repayment of construction loans is dependent upon the successful completion of the construction project, on time and within budget, and the successful sale of the completed project. If a borrower is unable to complete a construction project or if the marketability of the completed development is impaired, proceeds from the sale of the subject property may be insufficient to repay the loan. Further deterioration in any of the real estate markets we serve is likely to damage the marketability of these projects; as a result, we may incur loan losses which will adversely affect our results of operations.
A large percentage of our loans are collateralized by real estate and continued deterioration in the real estate market may result in additional losses and adversely affect our profitability.
Our results of operations have been and in future periods will continue to be significantly impacted by the economies in Hawaii, California and other markets we serve. Approximately 87% of our loan portfolio as of September 30, 2009 was comprised of loans primarily collateralized by real estate, 75% of these loans were concentrated in Hawaii, 22% in California and 3% in Washington. Deterioration of the economic environment in Hawaii, California or other markets we serve, including a continued decline in the real estate market, further declines in single-family home resales or a material external shock, may significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. In the event of a default with respect to any of these loans, amounts received upon sale of the collateral may be insufficient to recover outstanding principal and interest on the loan. As a result, we expect that our profitability would be negatively impacted by an adverse change in the real estate market.
Our ability to maintain adequate sources of funding and liquidity and required capital levels may be negatively impacted by the current economic environment which may, among other things, impact our ability to pay dividends or satisfy our obligations.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of investments or loans, and other sources could have a substantial negative affect on our liquidity. Our access to funding sources in amounts adequate to finance our activities on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans or deposits are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.
The management of liquidity risk is critical to the management of our business and to our ability to service our customer base. In managing our balance sheet, our primary source of funding is customer deposits. Our ability to continue to attract these deposits and other funding sources is subject to variability based upon a number of factors including volume and volatility in the securities markets, our credit rating and the relative interest rates that we are prepared to pay for these liabilities. The availability and level of deposits and other funding sources is highly dependent upon the perception of the liquidity and creditworthiness of the financial institution, which perception can change quickly in response to market conditions or circumstances unique to a particular company. Concerns about our financial condition, or concerns about our credit exposure to other persons could adversely impact our sources of liquidity, financial position, including regulatory capital ratios, results of operations and our business prospects.
If the level of deposits were to materially decrease, we would have to raise additional funds by increasing the interest that we pay on certificates of deposits or other depository accounts, seek other debt or equity financing or draw upon our available lines of credit. We rely on commercial and retail deposits, and to a lesser extent, advances from the FHLB-Seattle and the Fed discount window, to fund our operations. Although we have historically been able to replace maturing deposits and advances as necessary, we might not be able to replace such funds in the future if, among other things, our results of operations or financial condition or the results of operations or financial condition of the FHLB-Seattle or market conditions were to change.
We constantly monitor our activities with respect to liquidity and evaluate closely our utilization of our cash assets; however, there can be no assurance that our liquidity or the cost of funds to us may not be materially and adversely impacted as a result of economic, market or operational considerations that we may not be able to control.
In addition, CPF must provide for its own liquidity. Substantially all of CPF’s revenues are obtained from dividends declared and paid by Central Pacific Bank, which now require prior approval from the Company’s regulators including the FDIC and DFI. If the bank is unable to pay dividends to CPF, whether as a result of actions by regulatory authorities or otherwise, CPF may not be able to satisfy its own obligations, including its debt obligations. The regulators have not permitted the bank to pay dividends to CPF since April 2009. In the third quarter of 2009, CPF elected to defer payment of dividends on its Fixed Rate Cumulative Perpetual Preferred Stock and trust preferred securities as described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources” in Part I, Item 2 of this quarterly report. By deferring these payments, our ability to pay dividends with respect to common stock, subject to approval from the FRB and DFI, can not be made until our obligations under our Fixed Rate Cumulative Perpetual Preferred Stock and trust preferred securities are brought current. The deferral of these payments may also, among other things, require us to satisfy these obligations before they otherwise would have become due or restrict us in our commercial activities.
At September 30, 2009, Central Pacific Bank was not in compliance with the elevated leverage capital ratio standard contained in its MOU with the FDIC. If the bank is unable to improve its capital position, it could have a negative impact on customer confidence, our costs of funds and FDIC insurance costs, our ability to make acquisitions, and our business, results of operation and financial conditions, generally. In addition, our bank’s ability to accept brokered deposits has been restricted, and the interest rates we pay are constrained, both of which could impact our liquidity. As a result of the bank’s recent examination, we expect the bank to consent to a formal enforcement order with the FDIC and DFI. The order is expected to require the bank, among other things, to increase capital and improve asset quality and liquidity.
If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
Recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system. On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”) in response to the current crisis in the financial sector. The U.S. Treasury and banking regulators are implementing a number of programs under this legislation to address capital and liquidity issues in the banking system. Additionally, on June 17, 2009, the U.S. Treasury released a white paper proposing sweeping financial reforms, including the creation of a Consumer Financial Protection Agency with extensive powers. If enacted, the proposals would significantly alter not only how financial firms are regulated but also how they conduct their business. There can be no assurance, however, as to the actual impact that the EESA will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the EESA to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the value of our securities.
By deferring payments on our outstanding junior subordinated notes, we are prohibited from paying cash dividends on or repurchasing our common stock or preferred stock or making any payment on outstanding debt obligations that rank equally with or junior to the junior subordinated notes.
On August 20, 2009, we deferred regularly scheduled interest payments on our outstanding junior subordinated notes.The terms of our outstanding junior subordinated notes prohibit us from declaring or paying cash dividends on or repurchasing our common stock or preferred stock or making any payment on outstanding debt obligations that rank equally with or junior to the junior subordinated notes, while we have deferred interest thereunder.
Future dividend payments and common stock repurchases are restricted by the terms of the U.S. Treasury’s equity investment in us.
Under the terms of the Treasury Asset Relief Program’s (“TARP”) Capital Purchase Program (“CPP”), since we have shares of our fixed rate cumulative perpetual preferred stock (“TARP Preferred Stock”) issued and outstanding under the CPP, we are prohibited from increasing quarterly cash dividends on our common stock above $0.10 per share, and from making certain repurchases of our common stock and other equity or capital securities without the U.S. Treasury’s consent until the third anniversary of the U.S. Treasury’s investment or until the U.S. Treasury has transferred all of the TARP Preferred Stock it purchased under the CPP to third parties. Furthermore, as long as the TARP Preferred Stock issued to the U.S. Treasury is outstanding, dividend payments and repurchases or redemptions relating to our common stock and other equity or capital securities are prohibited until all accrued and unpaid dividends are paid on the TARP Preferred Stock, subject to certain limited exceptions. In the third quarter of 2009, we suspended the payment of cash dividends on our TARP Preferred Stock. As such, we are unable to pay dividends on our common stock unless these dividends are brought current.These restrictions, together with the potentially dilutive impact of the TARP Warrant, could have a negative effect on the value of our common stock.
The shares of TARP Preferred Stock issued to the U.S. Treasury impacts net income available to our common shareholders and earnings per common share, and the ten-year warrant issued to the U.S. Treasury to purchase up to 1,585,748 shares of our voting common stock at an exercise price of $12.77 per share (“TARP Warrant”) may be dilutive to holders of our common stock.
The dividends declared or accrued and deferred, as well as the accretion on discount on the TARP Preferred Stock issued to the U.S. Treasury will reduce the net income available to holders of common stock and our earnings per share. The TARP Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of our company. Additionally, the ownership interest of holders of our common stock will be diluted to the extent the TARP Warrant is exercised. Although the U.S. Treasury has agreed not to vote any of the shares of common stock it receives upon exercise of the TARP Warrant, a transferee of any portion of the TARP Warrant or of any shares of common stock acquired upon exercise of the TARP Warrant is not bound by this restriction.
If we are unable to redeem the shares of TARP Preferred Stock within five years, the cost of this capital to us will increase substantially.
If we are unable to redeem the shares of TARP Preferred Stock prior to February 15, 2014, the cost of this capital to us will increase substantially on that date, from 5.0% (approximately $6.8 million annually) to 9.0% per annum (approximately $12.2 million annually), plus all accrued dividends, further reducing the net income available to common shareholders and our earnings per common share.
Difficult economic and market conditions have adversely affected our industry.
The global and U.S. economies continue to experience a protracted slowdown in business activity as a result of disruptions in the financial system, including a lack of confidence in the worldwide credit markets. Currently, the U.S. economy remains in the midst of one of its longest economic recessions since the Great Depression of the 1930s. Dramatic declines in the housing market, along with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. Financial institutions have experienced decreased access to deposits and borrowings. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations and stock price. We do not expect that the difficult conditions in the financial markets are likely to improve in the near future. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. In particular, we may face the following risks in connection with these events:
| · | We potentially face increased regulation of our industry. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities. |
| · | The process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. The level of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates which may, in turn, impact the reliability of the process. |
| · | We may be required to pay significantly higher premiums to the FDIC because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. |
Our Hawaii and California commercial real estate and construction loan operations have a considerable effect on our results of operations.
The performance of our Hawaii and California commercial real estate and construction loan operations depends on a number of factors, including improvement of the real estate market in which we operate. As we have seen in the Hawaii and California construction and commercial real estate markets throughout 2009, the strength of the real estate market and the results of our operations could continue to be negatively affected by an economic downturn.
Declines in the market for commercial property are causing commercial borrowers to suffer losses on their projects and they may be unable to repay their loans. Defaults of these loans or further deterioration in the credit worthiness of any of these borrowers would further negatively affect our financial condition, results of operations and prospects. Declines in housing prices and the supply of existing houses for sale are causing residential developers who are our borrowers to also suffer losses on their projects and encounter difficulty in repaying their loans. Since the third quarter of 2007, we have significantly increased our provision for loan losses as a result of these challenging conditions.
Our allowance for loan and lease losses may not be sufficient to cover actual loan losses, which could adversely affect our results of operations. Additional loan losses will likely occur in the future and may occur at a rate greater than we have experienced to date.
As a lender, we are exposed to the risk that our loan customers may not repay their loans according to their terms and that the collateral or guarantees securing these loans may be insufficient to assure repayment. During 2008, our provision for loan and lease losses amounted to $171.7 million, compared to $53.0 million in 2007 and $1.4 million in 2006. During the third quarter of 2009, our provisions for loan and lease losses amounted to $142.5 million, compared to $22.9 million and $21.2 million in the comparable periods in 2008 and 2007. Our current allowance may not be sufficient to cover future loan losses. We may experience significant loan losses that could have a material adverse effect on our operating results. Management makes various assumptions and judgments about the collectibility of our loan portfolio, which are regularly reevaluated and are based in part on:
| · | Current economic conditions and their estimated effects on specific borrowers; |
| · | An evaluation of the existing relationships among loans, potential loan losses and the present level of the allowance for loan and lease losses; |
| · | Results of examinations of our loan portfolios by regulatory agencies; and |
| · | Management's internal review of the loan portfolio. |
We may experience further impairment of our goodwill, which would adversely impact our results of operations.
During the second quarter of 2008, we wrote off all of the remaining goodwill associated with our Commercial Real Estate reporting unit and in the third quarter of 2009 we wrote off $50.0 million of goodwill associated with our Hawaii Market reporting unit as it was considered to be impaired at that time. We continue to evaluate the remaining $102.7 million of goodwill assigned to our Hawaii Market reporting unit for impairment. Estimates of fair value of our Hawaii Market reporting unit are determined based on a complex model using cash flows and company comparisons. If management's estimates of future cash flows are inaccurate, the fair value determined could be inaccurate and impairment may not be recognized in a timely manner. Further declines in market capitalization and other factors such as the significant deterioration of the Hawaii Market reporting unit’s operations may lead to a reasonable possibility of further impairment of our goodwill, which would adversely impact our results of operations.
Governmental regulation and regulatory actions against us may impair our operations or restrict our growth.
We are subject to significant governmental supervision and regulation. These regulations are intended primarily for the protection of depositors. Statutes and regulations affecting our business may be changed at any time and the interpretation of these statutes and regulations by examining authorities may also change. Within the last several years, Congress and the President have passed and enacted significant changes to these statutes and regulations. There can be no assurance that such changes to the statutes and regulations or to their interpretation will not adversely affect our business. In addition to governmental supervision and regulation, we are subject to changes in other federal and state laws, including changes in tax laws, which could materially affect the banking industry. We are subject to the rules and regulations of the FRB, FDIC and DFI. If we fail to comply with federal and state bank regulations, the regulators may limit our activities or growth, fine us or ultimately put us out of business. Banking laws and regulations change from time to time. Bank regulations can hinder our ability to compete with financial services companies that are not regulated in the same manner or are less regulated. Federal and state bank regulatory agencies regulate many aspects of our operations. These areas include:
| · | The capital that must be maintained; |
| · | The kinds of activities that can be engaged in; |
| · | The kinds and amounts of investments that can be made; |
| · | The locations of offices; |
| · | Insurance of deposits and the premiums that we must pay for this insurance; and |
| · | How much cash we must set aside as reserves for deposits. |
In December 2008, the members of the board of directors of Central Pacific Bank entered into a memorandum of understanding (“MOU”) with the FDIC and the DFI to address certain issues that arose in the bank’s regulatory examination in August 2008. The issues required to be addressed by management include, among other matters, to review and establish more comprehensive policies and methodologies relating to the adequacy of the allowance for loan and lease losses, the re-evaluation, development and implementation of strategic and other plans, to increase and maintain the bank’s leverage capital ratio at or above 9% and to obtain approval of the FDIC and the DFI for the payment of cash dividends by the bank to us. Effective April 1, 2009, CPF entered into an MOU with the FRB and the DFI that parallels the MOU Central Pacific Bank’s directors entered into with the FDIC and the DFI and includes our agreement to obtain the approval of the FRB and the DFI for CPF to increase, renew, incur or guarantee indebtedness, pay dividends and make payments on our Trust Preferred securities.
In addition, due to the ongoing economic downturn and the resultant deterioration in the Hawaii and California commercial real estate markets and adverse impact on our loan portfolio and financial results, we may be the subject of additional regulatory actions in the future and face further limitations on our business, which would impair our operations and restrict our growth. Bank regulatory authorities have the authority to bring enforcement actions against banks and bank holding companies for unsafe or unsound practices in the conduct of their businesses or for violations of any law, rule or regulation, any condition imposed in writing by the appropriate bank regulatory agency or any written agreement with the authority. Possible enforcement actions against us could include the issuance of a cease-and-desist order that could be judicially enforced, the imposition of civil monetary penalties, the issuance of directives to increase capital or enter into a strategic transaction, whether by merger or otherwise, with a third party, the appointment of a conservator or receiver, the termination of insurance of deposits, the issuance of removal and prohibition orders against institution-affiliated parties, and the enforcement of such actions through injunctions or restraining orders.
As a result of bank’s recent FDIC examination in August 2009, we expect that the bank will consent to a formal enforcement action with the FDIC and DFI. We anticipate that the enforcement action will require, among other things, directives to strengthen capital, improve asset quality, and maintain liquidity, which are strategies that we are currently pursuing. Given that Central Pacific Bank was not in compliance with the elevated leverage capital ratio standard contained in the FDIC MOU at September 30, 2009, we expect this noncompliance to be addressed in the impending formal enforcement action. We do not expect to receive a draft of such enforcement order until after the formal examination report is received and we are not able to determine the full extent of that order until a draft of such has been received.
Our business could be adversely affected by unfavorable actions from rating agencies.
Ratings assigned by ratings agencies to us, our affiliates or our securities may impact the decision of certain customers, in particular, institutions, to do business with us. A rating downgrade or a negative rating could adversely affect our deposits and our business relationships. On August 6, 2009, Fitch Ratings downgraded the long-term Issuer Default Ratings of CPF and Central Pacific Bank to ‘CCC’ and ‘B’, respectively, and revised the Rating Outlook for Central Pacific Bank to Negative. On September 30, 2009, Fitch Ratings also downgraded the ratings of our trust preferred securities to “CC” to reflect the deferral of dividend payments on these securities. On November 2, 2009, Fitch Ratings further downgraded the long-term Issuer Default Ratings of Central Pacific Bank to ‘CCC’. These ratings downgrade may contribute to a loss of deposits and further downgrades to us, our affiliates or our securities could further reduce deposits and result in the loss of relationships.
The FDIC has imposed a special assessment on all FDIC-insured institutions, which will decrease our earnings in 2009.
In May of 2009, the FDIC announced that it had voted to levy a special assessment on insured institutions in order to facilitate the rebuilding of the Deposit Insurance Fund. The assessment is equal to five basis points of Central Pacific Bank’s total assets minus Tier 1 capital as of June 30, 2009. This represented a charge of approximately $2.5 million which was recorded as a pre-tax charge during the second quarter of 2009. The FDIC recently indicated that it may require banks to prepay insurance premiums for a period of up to three years by December 31, 2009.
If our investment in the FHLB-Seattle is classified as other-than-temporarily impaired or as permanently impaired, our earnings and shareholders' equity could decrease.
We own common stock of the FHLB-Seattle to qualify for membership in the Federal Home Loan Bank System and to be eligible to borrow funds under the FHLB-Seattle's advance program. The aggregate cost of our FHLB-Seattle common stock as of September 30, 2009 was $48.8 million based on its par value. There is no market for our FHLB-Seattle common stock.
Recent published reports indicate that certain member banks of the Federal Home Loan Bank System may be subject to accounting rules and asset quality risks that could result in materially lower regulatory capital levels. In an extreme situation, it is possible that the capitalization of a Federal Home Loan Bank, including the FHLB-Seattle, could be substantially diminished. Consequently, we believe that there is a risk that our investment in FHLB-Seattle common stock could be deemed other-than-temporarily impaired at some time in the future. If this occurs, it would cause our earnings and shareholders' equity to decrease by the after-tax amount of the impairment charge.
Because of our participation in the TARP’s CPP, we are subject to several restrictions including restrictions on compensation paid to our executives.
Pursuant to the terms of the TARP CPP, we adopted certain standards for executive compensation and corporate governance for the period during which the U.S. Treasury holds an investment in us. These standards generally apply to our Chief Executive Officer, Chief Financial Officer and the three next most highly compensated senior executive officers. The standards include (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to senior executives; and (4) agreement not to deduct for tax purposes executive compensation in excess of $0.5 million for each senior executive. In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of our compensation programs in future periods and may make it more difficult to attract suitable candidates to serve as executive officers.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. There is no assurance that any such losses would not materially and adversely affect our results of operations.
The fiscal, monetary and regulatory policies of the Federal Government and its agencies could have a material adverse effect on our results of operations.
The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its policies determine in large part the cost of funds for lending and investing and the return earned on those loans and investments, both of which affect the net interest margin. It also can materially decrease the value of financial assets we hold, such as debt securities. Its policies also can adversely affect borrowers, potentially increasing the risk that they may fail to repay their loans. Additionally, on June 17, 2009, the U.S. Treasury Department released a white paper proposing sweeping financial reforms, including the creation of a Consumer Financial Protection Agency with extensive powers. If enacted, the proposals would significantly alter not only how financial firms are regulated but also how they conduct their business. Changes in FRB policies and our regulatory environment generally are beyond our control, and we are unable to predict what changes may occur or the manner in which any future changes may affect our business, financial condition and results of operation.
The price of our common stock may be volatile or may decline.
The trading price of our common stock may fluctuate widely as a result of a number of factors, many of which are outside our control. In addition, the stock market is subject to fluctuations in the share prices and trading volumes that affect the market prices of the shares of many companies. These broad market fluctuations could adversely affect the market price of our common stock. Among the factors that could affect our stock price are:
| · | Actual or anticipated quarterly fluctuations in our operating results and financial condition, in particular, further deterioration of asset quality; |
| · | The impending formal enforcement action with the FDIC and the DFI which we expect the bank to consent to; |
| · | Suspension of trading of our common stock on or delisting from the New York Stock Exchange (“NYSE”) if we become non-compliant with continuing listing standards, including the minimum $1 price rule; |
| · | Removal of our common stock from certain market indices, such as the removal of our common stock from the S&P Small Cap 600; |
| · | Changes in revenue or earnings estimates or publication of research reports and recommendations by financial analysts; |
| · | Failure to meet analysts' revenue or earnings estimates; |
| · | Speculation in the press or investment community; |
| · | Strategic actions by us or our competitors, such as acquisitions or restructurings; |
| · | Actions by institutional shareholders; |
| · | Additions or departures of key personnel; |
| · | Fluctuations in the stock price and operating results of our competitors; |
| · | Future sales of our common stock, including sales of our common stock in short sales transactions; |
| · | General market conditions and, in particular, developments related to market conditions for the financial services industry; |
| · | Proposed or adopted regulatory changes or developments; |
| · | Anticipated or pending investigations, proceedings or litigation that involve or affect us; |
| · | Domestic and international economic factors unrelated to our performance; or |
| · | The incurrence of continuing losses. |
The stock market and, in particular, the market for financial institution stocks, has experienced significant volatility recently. In recent months, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers' underlying financial strength. As a result, the market price of our common stock may be volatile. In addition, the trading volume in our common stock may fluctuate more than usual and cause significant price variations to occur. Accordingly, the shares of our common stock that an investor purchases may trade at a price lower than that at which they were purchased. The trading price of the shares of our common stock and the value of our other securities will depend on many factors, which may change from time to time, including, without limitation, our financial condition, performance, creditworthiness and prospects, future sales of our equity or equity related securities, and other factors. Volatility in the market price of our common stock may prevent you from being able to sell your shares when you want or at prices you find attractive.
A significant decline in our stock price could result in substantial losses for individual shareholders and could lead to costly and disruptive securities litigation.
We are seeking to raise additional capital which will result in substantial dilution or a decline in the price of our common stock.
Given the elevated levels of our credit costs and the impending formal enforcement action, we are exploring all options to raise a significant amount of capital. We are not restricted from issuing additional shares of common stock, including any equity securities that are convertible into or exchangeable for, or that represent the right to receive, common stock and we intend on resuming with our capital raising initiatives. At this time, we are assessing the amount of additional capital that we will require and the potential avenues to obtain it. However, we anticipate that we will need to raise significant additional capital. The issuance of any additional shares of common or preferred stock or convertible securities or the exercise of such securities will result in substantial dilution to shareholders of our common stock given our current stock price and the required levels of capital. There is no assurance that we will be able to raise the significant additional capital that we require. Our inability to raise required capital could result in additional regulatory action against us or affect our ability to continue in business.
In addition, we face significant business, regulatory and other governmental risk as a financial institution, and it is possible that capital requirements and directives could in the future require us to further change the amount or composition of our current capital, including common equity.
Issuances or exchanges of significant amounts of our common stock or equity-related securities, or the perception that such sales will occur, also could adversely affect prevailing trading prices of our common stock and could impair our ability to raise capital through future offerings of equity or equity-related securities. No prediction can be made as to the effect, if any, that future issuances or exchanges of shares of our common stock or equity-related securities or the availability of shares of our common stock for future issuance or exchange will have on the trading price of our common stock.
Our common stock is equity and therefore is subordinate to our and our subsidiaries' indebtedness and preferred stock.
Shares of our common stock are equity interests in us and do not constitute indebtedness. As such, shares of the common stock will rank junior to all current and future indebtedness and other non-equity claims on us with respect to assets available to satisfy claims against us, including in the event of our liquidation. We may, and Central Pacific Bank and our other subsidiaries may also, incur additional indebtedness from time to time and may increase our aggregate level of outstanding indebtedness. Additionally, holders of our common stock are subject to the prior dividend and liquidation rights of any holders of our preferred stock then outstanding. Under the terms of our outstanding fixed rate cumulative perpetual preferred stock, our ability to declare or pay dividends on or repurchase our common stock or other equity or capital securities is subject to restrictions in the event that we fail to declare and pay (or set aside for payment) full dividends on the fixed rate cumulative perpetual preferred stock. Our board of directors is authorized to cause us to issue additional classes or series of preferred stock without any action on the part of our stockholders. If we issue preferred shares in the future that have a preference over our common stock with respect to the payment of dividends or upon liquidation, or if we issue preferred shares with voting rights that dilute the voting power of the common stock, then the rights of holders of our common stock or the market price of our common stock could be adversely affected.
There is a limited trading market for our common stock and as a result, you may not be able to resell your shares at or above the price you pay for them.
Although our common stock is listed for trading on the NYSE, the volume of trading in our common stock is lower than many other companies listed on the NYSE. A public trading market with depth, liquidity and orderliness depends on the presence in the market of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given our current stock price levels, we are at risk of falling under the NYSE’s $1 minimum stock price rule, in which case, our common stock may be subject to suspension of trading and delisting from the NYSE. In the event this was to occur and we are not able to cure this deficiency, it would further reduce the market liquidity of our common stock.
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits
| Exhibit No. | | Document |
| | | |
| 31.1 | | Rule 13a-14(a) Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 * |
| | | |
| 31.2 | | Rule 13a-14(a) Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 * |
| | | |
| 32.1 | | Section 1350 Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002 ** |
| | | |
| 32.2 | | Section 1350 Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002 ** |
* Filed herewith.
** Furnished herewith.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | CENTRAL PACIFIC FINANCIAL CORP. |
| | (Registrant) |
| | |
| | |
| Date: November 9, 2009 | /s/ Ronald K. Migita |
| | Ronald K. Migita |
| | Chairman, President & Chief Executive Officer |
| | |
| | |
| Date: November 9, 2009 | /s/ Dean K. Hirata |
| | Dean K. Hirata |
| | Vice Chairman and Chief Financial Officer |
Central Pacific Financial Corp.
Exhibit Index
| Exhibit No. | | Description |
| | | |
| 31.1 | | Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | | |
| 31.2 | | Certification of the Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | | |
| 32.1 | | Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | | |
| 32.2 | | Certification of the Principal Financial and Accounting Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
