CVB FINANCIAL CORP quarterly report, Q3 FY2014

CVB Financial Corp. — Q3 2014 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2014. CVB is a California-based bank holding company whose principal subsidiary, Citizens Business Bank, provides commercial banking, lending, leasing, and trust services, primarily in Southern California. Amounts below are in millions of dollars unless noted.

Financial results and position

Metric	Q3 2014	Q3 2013	Nine months 2014	Nine months 2013
Net interest income	$61.2	$54.0	$175.3	$161.2
Provision recapture	$1.0	$3.8	$16.1	$10.0
Noninterest income	$8.0	$5.0	$26.6	$19.4
Noninterest expense	$32.5	$25.7	$95.0	$84.8
Net earnings	$24.3	$24.2	$78.4	$70.3
Diluted EPS	$0.23	$0.23	$0.74	$0.67

Q3 net earnings were nearly flat year over year despite 13.5% growth in net interest income; higher expenses largely offset revenue growth. Nine-month net earnings rose 11.6%.
Q3 net interest margin was 3.50% (3.61% tax-equivalent); excluding acquired covered-loan discount accretion, tax-equivalent margin was 3.53%, versus 3.48% a year earlier. Nine-month tax-equivalent margin was 3.63%, versus 3.75%; excluding that accretion, it was 3.53%, versus 3.49%.
Quarterly return on average assets was 1.31%, return on average equity 11.26%, and efficiency ratio 46.91%. Nine-month figures were 1.49%, 12.77%, and 47.04%, respectively.
At September 30, total assets were $7.42 billion, up 11.4% from year-end 2013; total deposits were $5.76 billion, up 17.8%; and stockholders’ equity was $849.2 million, up 10.0%.
Gross loans, net of deferred fees and covered-loan discount, were $3.71 billion, up 4.5% from year-end. Commercial real estate made up about 68.8% of non-covered loans; substantially all real estate lending is secured by California property.
Cash and cash equivalents were $240.1 million, versus $94.7 million at year-end. For the first nine months, operating cash flow was $66.2 million (prior year $72.8 million), investing cash flow was negative $196.9 million (prior year negative $212.2 million), and financing cash flow was positive $276.1 million (prior year $172.4 million).
Deposits cost an average 0.09% in Q3. Noninterest-bearing deposits were 52.7% of deposits. Borrowed funds totaled $728.2 million, including $528.8 million in customer repurchase agreements and $199.4 million in FHLB advances; junior subordinated debentures were $25.8 million. No other borrowings remained at quarter-end.
The allowance for non-covered loan losses was $59.6 million, or 1.67% of non-covered loans, versus $75.2 million and 2.22% at year-end. Net recoveries for the nine months were $447,000, compared with $1.8 million in net charge-offs in the prior-year period.
Nonperforming assets were $43.3 million, or 0.58% of assets, versus $46.4 million and 0.70% at year-end. Nonaccrual loans were $37.1 million; total troubled debt restructurings were $78.2 million, of which $22.6 million were nonperforming.
Regulatory capital remained above “well-capitalized” thresholds: consolidated Tier 1 leverage 10.71%, Tier 1 risk-based 17.27%, and total risk-based 18.52%.

Material changes and unusual items

CVB completed its $57 million cash acquisition of American Security Bank on May 15, 2014. ASB had approximately $433 million in assets at announcement; its results are included from the acquisition date. CVB recorded $19.1 million of goodwill and $1.9 million in acquisition-related expenses for the first nine months. Most integration was completed by quarter-end, including system conversion, two branch consolidations, and closure of two electronic banking vestibules.
Q3 investment income increased with a larger securities portfolio; average investment securities rose $577.1 million year over year. Securities available for sale totaled $3.16 billion. Their net unrealized position shifted to a $31.2 million pretax gain from a $16.1 million loss at year-end, contributing to positive nine-month other comprehensive income.
Q3 noninterest expense included $640,000 of ASB acquisition costs. Management said branch and system consolidations were expected to generate greater cost synergies in Q4; the filing provides no quantified savings forecast.
Nine-month noninterest income included a $5.3 million gain on sale of a loan. Prior-year results included a $2.1 million securities gain, a $2.5 million OREO gain, and $4.1 million of insurance reimbursements for earlier legal costs.
The commercial-loan FDIC loss-sharing agreement related to the 2009 San Joaquin Bank acquisition was scheduled to expire in October 2014. The remaining FDIC loss-sharing asset was $331,000 at quarter-end.

Outlook, risks, and contingencies

The filing gives no formal earnings or revenue guidance. Management cited continued improvement in credit quality, but cautioned that future provisions may rise if economic or borrower conditions deteriorate. The allowance estimate is judgmental and sensitive to collateral values, borrower cash flows, and local economic conditions.
Management’s model showed estimated 12-month net interest income sensitivity of negative 2.30% for a 200-basis-point rate increase and negative 0.55% for a 100-basis-point decrease. Management characterized the balance sheet as slightly liability-sensitive over two years; outcomes depend on assumptions about rates, prepayments, and customer behavior.
Credit risks include concentration in California commercial real estate, borrower and collateral deterioration, and dairy/agriculture exposure to milk and feed prices, drought, and water availability. Five customer relationships represented 52.0% of nonperforming loans at quarter-end. One $9.7 million nonperforming construction loan accounted for 14.4% of construction loans.
The company disclosed an SEC investigation, begun with a 2010 subpoena, concerning its loan-loss allowance, underwriting, loan grading, and related communications. It had not received SEC contact on the matter since October 2011 and could not predict the investigation’s timing or outcome.
A related shareholder securities class action was on appeal after dismissal with prejudice; appellate briefing was completed, with oral argument expected in the following six to nine months. A related derivative suit was stayed pending the appeal. CVB reported no litigation reserves and said the outcome and potential loss could not be predicted; it warned pending legal or regulatory matters could materially affect results or financial condition.
Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter. The filing notes Basel III capital requirements were to become effective for the company beginning in 2015.

Important facts for investors to verify

Whether post-acquisition deposit, loan, revenue, and expense trends—and the promised integration synergies—persist in subsequent quarters.
Whether credit metrics and the reduced allowance remain appropriate, especially for commercial real estate, the large nonperforming construction exposure, TDRs, and California drought-sensitive borrowers.
How the securities portfolio’s interest-rate sensitivity, unrealized gains and losses, and mortgage prepayment or extension risk evolve.
The status and potential financial effect of the SEC investigation and shareholder litigation, and the expiration of the FDIC commercial-loan loss-sharing agreement.
Whether deposit growth, liquidity, capital ratios, and dividend capacity remain strong as regulatory capital requirements change.