CVB Financial Corp. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; balance-sheet comparisons are generally with December 31, 2012. CVB operates Citizens Business Bank, a California-focused commercial bank serving businesses and individuals through banking centers, lending, leasing, and trust services. Financial statements are unaudited.
Financial performance and condition
Amounts below are in millions except per-share data and ratios.
| Metric | Q3 2013 | Comparable period | Nine months 2013 | Comparable period |
|---|---|---|---|---|
| Net interest income | $54.0 | $59.7 in Q3 2012 | $161.2 | $181.3 in 9M 2012 |
| Net earnings | $24.2 | $9.3 in Q3 2012 | $70.3 | $55.1 in 9M 2012 |
| Diluted EPS | $0.23 | $0.09 in Q3 2012 | $0.67 | $0.53 in 9M 2012 |
| Net interest margin | 3.55%; 3.48% TE excluding acquired-loan discount accretion | 3.94%; 3.60% TE excluding accretion | 3.61%; 3.49% TE excluding accretion | 4.00%; 3.69% TE excluding accretion |
| Efficiency ratio | 43.63% | 47.52% in Q3 2012, excluding debt termination expense | 46.94% | 46.38% in 9M 2012, excluding debt termination expense |
- Balance sheet at September 30: Assets were $6.56 billion, up 3.1% from year-end 2012. Deposits were $4.90 billion, including $2.54 billion of noninterest-bearing deposits (51.8% of total). Stockholders’ equity was $768.2 million.
- Loans and credit: Loans, net of deferred fees and acquired-loan discount but before the allowance, were $3.44 billion. Non-covered loans were $3.29 billion; commercial real estate represented 65.56% of gross loans. The $80.7 million allowance was 2.46% of non-covered loans, down from $92.4 million and 2.84% at year-end 2012. The company recorded a $3.8 million loan-loss provision recapture in Q3 and $10.0 million for the first nine months.
- Asset quality: Non-covered nonperforming assets were $56.0 million, or 0.85% of assets, versus $72.8 million and 1.14% at year-end 2012. Non-covered nonperforming loans were $49.5 million, down from $66.0 million at September 2012. Troubled debt restructurings totaled $87.2 million: $28.0 million nonperforming and $59.2 million performing. Six customer relationships accounted for 55.3% of nonperforming loans.
- Cash flow and liquidity: For 9M 2013, operating cash flow was $72.8 million, investing cash flow was negative $212.2 million, and financing cash flow was positive $172.4 million. Cash and cash equivalents ended at $131.4 million, up from $98.4 million at year-end 2012. The average loan-to-deposit ratio for the nine-month period was 71.01%.
- Funding and debt: At quarter-end, customer repurchase agreements were $565.9 million, FHLB advances $199.1 million, and other borrowings $42.5 million; junior subordinated debentures were $25.8 million, down from $67.0 million at year-end after redemptions. The company reported $807.5 million of borrowed funds, excluding junior subordinated debentures.
- Capital and dividends: Company Tier 1 leverage, Tier 1 risk-based, and total risk-based capital ratios were 11.44%, 17.87%, and 19.13%, respectively; the Bank also exceeded “well-capitalized” regulatory thresholds. The nine-month dividend declared was $0.285 per share.
Material changes and unusual items
- Q3 net earnings rose 162% year over year, but the comparison was materially affected by unusual items: Q3 2013 included a $3.8 million loan-loss recapture and $4.1 million of insurance reimbursements for prior legal costs; Q3 2012 included $20.4 million of debt-termination expense related to redeemed FHLB borrowings.
- Net interest income fell 9.7% in Q3 and 11.1% for the first nine months year over year. Lower loan yields and reduced acquired-loan discount accretion contributed; Q3 accretion was $2.9 million versus $7.0 million in Q3 2012. Lower funding costs partly offset the decline.
- Investment securities increased to $2.62 billion from $2.45 billion at year-end. The portfolio’s pretax net unrealized gain fell to $7.3 million from $74.6 million, primarily due to interest-rate movements. Accumulated other comprehensive income declined by $39.0 million after tax during the first nine months.
- Loans increased $101.0 million quarter over quarter, led by commercial real estate, while total loans were nearly flat versus year-end. Management cited improved new-loan pipeline and reduced runoff; it also noted competitive loan pricing and continuing mortgage refinancing pressure.
- The company purchased $314.7 million of securities during Q3, using short-term borrowings for part of the purchases. The portfolio’s weighted-average life increased to 4.6 years from 3.1 years at year-end, while its weighted-average yield declined to 2.28% from 2.47%.
Management commentary, outlook, and risks
- Management attributed the loan-loss recapture to improved credit quality and economic conditions, citing lower classified loans, improving commercial real estate conditions, and better dairy-sector conditions. It cautioned that future provisions could rise if economic or borrower conditions deteriorate.
- No specific earnings or financial guidance is provided. Management described the balance sheet as well matched over one year and slightly asset-sensitive over two years. Its model estimated 12-month net interest income changes of negative 1.34% for a 200-basis-point rate increase and negative 0.28% for a 100-basis-point decrease; management cautioned that estimates depend on assumptions and are not forecasts.
- Key exposures include California real estate and commercial lending concentration, borrower credit deterioration, interest-rate and mortgage prepayment/extension risk, deposit and other funding availability, and changes in securities values. The FDIC loss-sharing agreement on acquired San Joaquin Bank assets is nearing its commercial-loan coverage end; the filing states that the agreement expires in October 2014 and the remaining loss-sharing asset was $7.0 million.
- Legal matters remain significant. The SEC investigation, initiated by a 2010 subpoena, concerns the allowance methodology, underwriting, loan grading, provisions, and certain investor communications. A related securities class action was dismissed with prejudice on September 27, 2013; plaintiffs appealed on October 24, 2013. A related derivative action is stayed pending the appeal. The company reported no litigation reserves and said it cannot predict the outcomes or estimate a range of loss.
- Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting during the quarter. The filing says no material risk-factor changes from the 2012 Form 10-K.
Important facts for investors to verify
- How much of reported earnings growth reflects recurring operations versus the provision recapture, legal-cost insurance reimbursement, and prior-year debt-termination charge?
- Whether net interest income and margins can stabilize as acquired-loan accretion declines and loan yields remain under competitive pressure.
- Trends in classified and nonperforming credits, especially the concentrated customer relationships, commercial real estate, and dairy and livestock portfolios; also assess the allowance against changing conditions.
- The effect of the securities portfolio’s lower unrealized gains, longer duration, and rate sensitivity on capital and future earnings.
- Developments in the SEC investigation and securities-litigation appeal, and any resulting financial, regulatory, or reputational consequences.
- Funding needs and liquidity, including short-term borrowing used for securities purchases, customer repurchase balances, and the terms and wind-down of the FDIC loss-sharing arrangement.