Central Pacific Financial - 10-Q quarterly report FY

Washington, D.C.  20549

FORM 10-Q

(Mark One)

Commission file number 0-10777

CENTRAL PACIFIC FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý   No  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  ý   No  o

As of July 30, 2004, the number of shares of common stock outstanding of the registrant was 16,127,107 shares.

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

Table of Contents

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PART I.   FINANCIAL INFORMATION

Forward-Looking Statements

This document contains forward-looking statements that are subject to risks and uncertainty. Such statements include, but are not limited to, (i) statements about the benefits of a merger between Central Pacific Financial Corp. (“CPF” or “Company”) and CB Bancshares, Inc. (“CBBI”), including future financial and operating results, cost savings and accretion to reported and cash earnings that may be realized from such merger; (ii) statements with respect to CPF’s plans, objectives, expectations and intentions and other statements that are not historical facts; and (iii) other statements identified by words such as “believes”, “expects”, “anticipates”, “estimates”, “intends”, “plans”, “targets”, “projects” and other similar expressions. These statements are based upon the current beliefs and expectations of CPF’s management and are subject to significant risks and uncertainties. Actual results may differ from those set forth in the forward-looking statements.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

•                  the business of CPF and CBBI may not be integrated successfully or such integration may be more difficult, time-consuming or costly than expected;

•                  expected revenue synergies and cost savings from the merger may not be fully realized or realized within the expected time frame;

•                  revenues following the merger may be lower than expected;

•                  deposit attrition, operating costs, customer loss and business disruption, including, without limitation, difficulties in maintaining relationships with employees, customers, clients or suppliers, may be greater than expected following the merger;

•                  the failure of CPF’s and CBBI’s shareholders to approve the merger;

•                  competitive pressures among depository and other financial institutions may increase significantly and may have an effect on pricing, spending, third-party relationships and revenues;

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•                  the strength of the United States economy in general and the strength of the Hawaii economy may be different than expected, resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on the combined company’s loan portfolio and allowance for loan losses;

•                  changes in the U.S. legal and regulatory framework; and

•                  adverse conditions in the stock market, the public debt market and other capital markets (including changes in interest rate conditions) and the impact of such conditions on the combined company’s activities.

Additional factors that could cause CPF results to differ materially from those described in the forward-looking statements can be found in CPF’s reports (such as Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K) filed with the Securities and Exchange Commission (“SEC”) and available at the SEC’s Internet web site (www.sec.gov). All subsequent written and oral forward-looking statements concerning the proposed transaction with CBBI or other matters attributable to CPF or any person acting on its behalf are expressly qualified in their entirety by the cautionary statements above. CPF does not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statement is made.

CPF amended its registration statement on Form S-4 to register the shares of CPF common stock to be issued in connection with the merger to include a joint proxy statement/prospectus for soliciting proxies from CPF and CBBI shareholders, in connection with meetings of such shareholders scheduled to be held on September 13, 2004.

Investors and security holders are urged to read the registration statement and joint proxy statement/prospectus and any other relevant documents, when available, as well as any amendments or supplements to those documents, because they will contain important information. Investors and security holders may obtain a free copy of documents filed with the SEC at the SEC Internet web site at www.sec.gov. Such documents may also be obtained free of charge from CPF by directing such request to: Central Pacific Financial Corp., 220 South King Street, Honolulu, Hawaii 96813, Attention: David Morimoto, (808) 544-0627.

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Item 1.             Financial Statements

CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes to unaudited consolidated financial statements.

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CENTRAL PACIFIC FINANCIAL CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

June 30, 2004 and 2003

1.                                       Basis of Presentation

The financial information included herein is unaudited, except for the consolidated balance sheet at December 31, 2003. However, such information reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of Management, necessary for a fair statement of results for the interim periods.

The results of operations for the three and six months ended June 30, 2004 are not necessarily indicative of the results to be expected for the full year.

2.                                       Comprehensive Income (Loss)

Components of other comprehensive income (loss), net of taxes, is presented below:

3.                                       Segment Information

The Company has two reportable segments: financial services and treasury.  The segments reported are consistent with internal functional reporting lines.  They are managed separately because each unit has different target markets, technological requirements, marketing strategies and specialized skills.  The financial services segment includes retail branch offices, corporate lending, construction and real estate development lending, trust services, investment services and international banking services.  A full range of deposit and loan products, and various other banking services are offered.  The treasury segment is responsible for managing the Company’s investment securities portfolio and wholesale funding activities.

The all others category includes Central Business Club of Honolulu and activities such as residential mortgage lending, mortgage servicing, electronic banking, and management of bank

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owned properties.

The accounting policies of the segments are consistent with the Company’s accounting policies that are described in Note 1 to the consolidated financial statements in the Annual Report on Form 10-K, for the year ended December 31, 2003 filed with the SEC.  The majority of the Company’s net income is derived from net interest income.  Accordingly, Management focuses primarily on net interest income, rather than gross interest income and expense amounts, in evaluating segment profitability. Intersegment net interest income (expense) is allocated to each segment based on the amount of net investable funds provided (used) by that segment at a rate equal to the Bank’s average rate on interest-sensitive assets and liabilities. All administrative and overhead expenses are allocated to the segments at cost. Cash, investment securities, loans and their related balances are allocated to the segment responsible for acquisition and maintenance of those assets.  Segment assets also include all premises and equipment used directly in segment operations.

Segment profits and assets are provided in the following table for the periods indicated.

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4.                                       Accounting Pronouncements

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51” (“FIN 46”).   FIN 46 provided a new framework for identifying a variable interest entity (“VIE”) and determining when a company should include the assets, liabilities, and noncontrolling interests and results of activities of a VIE in its consolidated financial statements.  In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51” (“FIN 46R”).  For pubic entities that have interests in VIEs or potential VIEs commonly referred to as special-purpose entities, the application of FIN 46R was required in financial statements for periods ending after December 15, 2003. Application by public entities for all other types of VIEs was required in financial statements for periods ending after March 15, 2004.  The Company’s statutory trusts, CPB Capital Trust I, CPB Capital Trust II, and CPB Statutory Trust III, were deemed to be VIEs, and were consolidated in the consolidated financial statements as of December 31, 2003.  As of March 31, 2004, upon the adoption of FIN 46R, the Company’s statutory trusts were deconsolidated from the Company’s consolidated financial statements.  The application of FIN 46R did not have a material impact on the Company’s consolidated financial statements.

5.                                       Stock Compensation Plans

The Company has elected to apply the provisions of APB No. 25, and provide the pro forma disclosure provisions of SFAS No. 148.

The following table presents pro forma disclosures of the impact that the 2003, 2002, 2000 and 1999 option grants would have had on net income and earnings per share had the grants been measured using the fair value of accounting prescribed by SFAS No. 148.

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6.                                       Pension Plans

Central Pacific Bank (the “Bank”) has a defined benefit retirement plan (“Pension Plan”) covering substantially all of its employees.  The plan was curtailed effective December 31, 2002, and accordingly, plan benefits were fixed as of that date.

The following table sets forth the components of net periodic benefit cost for the Pension Plan:

In 1995 and 2001, the Bank established Supplemental Executive Retirement Plans (“SERP”) which provide certain officers of the Bank with supplemental retirement benefits in excess of limits imposed on qualified plans by Federal tax laws.

The following table sets forth the components of net

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periodic benefit cost for the SERP:

The Company disclosed in its financial statements for the year ended December 31, 2003, that it expected to contribute $1.7 million to its Pension Plan and $215,000 to its SERP in 2004.  As of June 30, 2004, the Company made contributions of $900,000 to its Pension Plan and $135,000 to its SERP, and presently anticipates that its contributions for 2004 will approximate the amounts disclosed at year-end 2003.

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Item 2.             Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires that management make certain judgments and use certain estimates and assumptions that affect amounts reported and disclosures made.  Accounting estimates are deemed critical when a different estimate could have reasonably been used or where changes in the estimate are reasonably likely to occur from period to period and would materially impact the Company’s consolidated financial statements as of or for the periods presented.  Management has discussed the development and selection of the critical accounting estimates discussed below with the audit committee of the Board of Directors, and the audit committee has reviewed the accompanying disclosures.

Allowance for Loan and Lease Losses.  The Company maintains the allowance for loan and lease losses (“Allowance”) at an amount sufficient to absorb probable losses inherent in the Company’s loan portfolio. For loans classified as impaired, an estimated impairment loss is calculated.  To estimate net loan charge-offs on other loans, the Company performs a migration analysis and considers other relevant economic conditions and borrower-specific risk characteristics. A migration analysis is a technique used to estimate the probability that a loan will progress through various grades of loan quality and ultimately result in a loan charge-off based on historical loan loss experience. Estimated loss rates are determined by loan category and risk profile, and an overall required Allowance is calculated.  Based on management’s estimate of the level of Allowance required, a provision for loan and lease losses (“Provision”) is recorded to maintain the Allowance at an appropriate level.  Since the Company cannot predict with certainty the amount of loan charge-offs that will be incurred, and because the eventual level of loan charge-offs are impacted by numerous conditions beyond the control of the Company, a range of loss estimates could reasonably have been used to determine the Allowance and Provision

Defined Benefit Retirement Plan.  Defined benefit retirement plan assets, which consist primarily of marketable equity and debt securities, are typically valued using market quotations. Independent actuaries through the use of a number of assumptions determine plan obligations and the annual pension expense. Key assumptions in measuring the plan obligations include the discount rate and the expected long-term rate of return on plan assets.  In determining the discount rate, the Company utilizes

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the yield on high-quality, fixed-income investments currently available with maturities corresponding to the anticipated timing of the benefit payments.  Asset returns are based upon the anticipated average rate of earnings expected on the invested funds of the plans.

Overview of Material Events

On April 23, 2004, CPF and CBBI announced that their boards of directors approved a merger agreement under which CPF will acquire all of CBBI’s outstanding shares for cash and stock with a value of $91.83 per share based on the closing price of CPF common stock on April 22, 2004.

The merger is conditioned upon, among other factors, shareholder and regulatory approvals and other customary conditions. CPF expects the transaction to close in the third quarter of 2004.

A special meeting of the shareholders of CPF is scheduled to be held on September 13, 2004 to vote on, among other things, the approval of the merger agreement.  A special meeting of the shareholders of CBBI is also scheduled to be held on September 13, 2004 to vote on the approval of the merger agreement.

CPF’s applications to acquire control of CBBI were approved by the Federal Reserve Board on December 15, 2003 and by the Hawaii Commissioner of Financial Institutions on February 3, 2004, each subject to certain conditions and limitations and on the basis of the information and terms provided.  In addition, the U.S. Department of Justice confirmed that the proposed transaction would not have a significantly adverse effect on competition. CPF has submitted further information with respect to the merger and the merger agreement to the Federal Reserve Board and the Hawaii Commissioner of Financial Institutions and has submitted an additional application with respect to the merger to the Hawaii Commissioner of Financial Institutions.  The Federal Reserve Board’s approval order requires that CPF complete the merger by September 15, 2004.  CPF expects to submit a request for an extension of that order.

If the merger is completed, each share of CBBI common stock will be converted into the right to receive an amount equal to $20.00 plus the product of 2.6752 multiplied by the average of the closing prices of CPF common stock over the 10 consecutive trading day period ending one day before the completion of the transaction.  A CBBI shareholder will be entitled to elect to receive merger consideration in the form of CPF common stock or cash for each CBBI share held.  However, because the total amount of cash consideration payable in the merger and the total amount of CPF common stock to be issued in the merger will be fixed at

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the time the merger is completed, a CBBI shareholder may receive consideration in a form other than the one elected with respect to some of his of her shares.

Under the terms of the merger agreement, each of CPF and CBBI has dismissed with prejudice all lawsuits filed by one party against the other related to the merger since May 2003.

As of June 30, 2004, the Company capitalized merger-related costs totaling $12.1 million. This amount is reflected as a component of other assets on the consolidated balance sheet.  For the three and six months ended June 30, 2004, merger-related expenses totaled $99,000 and $159,000, respectively, and are reflected as a component of other operating expense on the consolidated statement of income.

Financial Summary

For the quarter ended June 30, 2004, the Company reported net income of $8.7 million or $0.53 per diluted share, up 8.6% and 8.2%, respectively, from the same period last year. Contributing to this quarter’s results were loan and deposit growth, an increase in fee income, and an increase in tax credits.

For the six months ended June 30, 2004, net income was $16.6 million, little changed from the same period last year. Diluted earnings per share were $1.01 for the first six months of 2004, equaling the results for the comparable period last year.

The following table presents annualized returns on average assets and average shareholders’ equity and basic and diluted earnings per share for the periods indicated.

Material Trends

Hawaii’s economy continued to improve in 2004. The state’s unemployment rate, which has remained consistently below the national unemployment rate, was 3.1% in June 2004, compared to

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4.4% in June 2003.(1)  On the national level, the unemployment rate was 5.6% in June 2004, compared to 6.3% in June 2003.(2)

The housing market, supported by low mortgage interest rates, continues to show strong growth. Residential home sales on the island of Oahu for the first six months of 2004 were $2.1 billion, an increase of 39% over the same period last year.(3) The median sales price for single family homes and condominiums on Oahu increased over the same period last year by 24.0% and 17.0%, respectively.(4)

As a result of the strong housing market, the construction industry continues to reflect strong growth. In 2003, the number of construction jobs grew by 4.6% and the number of building permits increased by approximately 15.6% over the prior year.(5) As of June 30, 2004, the number of construction jobs grew by 2.1% from year-end 2003 and 3.6% from June 30, 2003.(6)

The top five industries in the state as of June 30, 2004, representing approximately 69.5% of total jobs, include: government, food services and accommodation, retail, healthcare, and professional services.(7) Total state personal income is forecasted to grow by 5.1% in 2004.(8)

The Hawaii tourism market continues to reflect strong growth. Total visitor arrivals for the first six months of 2004 increased by 9.3% over the same period last year.(9) Domestic and international visitor arrivals increased by 7.5% and 14.1%, respectively, for the first six months of 2004 compared to the same period last year.(10) Included in the international totals is a 17.6% increase in Japanese arrivals.(11) In 2004, total Japanese visitor arrivals, which decreased by 10.7% in 2003, are expected to increase by 24.5%.(12)

For the six months ended June 30, 2004, the hotel occupancy rate was 77.8% and the average daily room rate was $152.00, compared to 70.6% and $147.04, respectively, over the same period

(1) Hawaii State Department of Labor and Industrial Relations.

(2) Ibid.

(3) Honolulu Board of Realtors.

(4) Ibid.

(5) Hawaii State Department of Labor and Industrial Relations.

(6) Ibid.

(7) Ibid.

(8) Hawaii State Department of Business, Economic Development and Tourism.

(9) Ibid.

(10) Ibid.

(11) Ibid.

(12) University of Hawaii Economic Research Organization.

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last year.(13) For 2003, the annual hotel occupancy rate was 72.5% and the average daily room rate was $144.44.(14)

The results of operations of the Company in 2004 may be directly impacted by the ability of Hawaii’s economy to sustain positive growth. Loan demand, deposit growth, provision for loan losses, noninterest income, and noninterest expense will be affected by economic conditions through the end of the year.

Results of Operations

Net Interest Income

A comparison of net interest income for the three and six months ended June 30, 2004 and 2003 is set forth below on a taxable equivalent basis using an assumed income tax rate of 35%.

Net interest income, when expressed as a percentage of average interest earning assets, is referred to as “net interest margin.”

Average Balances, Interest Income & Expense, Yields and Rates (Taxable Equivalent)