CVB Financial Corp. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance-sheet comparisons are to December 31, 2018. Figures below are in U.S. dollars; financial-statement amounts are generally in millions unless stated otherwise.
Business context
CVB Financial Corp. operates Citizens Business Bank, a California-focused commercial bank serving businesses and individuals. The company reported 62 banking centers and three trust offices. Results include Community Bank, acquired August 10, 2018; the first-quarter year-over-year comparison therefore reflects a substantially larger company than in Q1 2018.
Financial performance and condition
- Earnings: Net income was $51.6 million, up 47.9% from $34.9 million in Q1 2018. Diluted EPS was $0.37 versus $0.32. Net interest income was $109.5 million, up 55.3%; noninterest income was $16.3 million, up 26.2%; and pre-tax income was $72.7 million.
- Margins and efficiency: Tax-equivalent net interest margin was 4.39%, versus 3.68% a year earlier. Management’s adjusted margin, excluding acquired-loan discount accretion and nonrecurring nonaccrual interest, was 4.07% versus 3.56%. The efficiency ratio was 41.01%, or 38.51% excluding acquisition expenses. Return on average assets was 1.84%; return on average equity was 11.14%.
- Unusual income and costs: Q1 included a $4.5 million gain on sale of a bank building and $3.1 million of acquisition-related expenses. Acquired-loan discount accretion was $7.2 million. These items affect comparability and underlying earnings.
- Assets and loans: Total assets were $11.30 billion, down 1.94% from year-end. Loans and leases were $7.61 billion, down 2.03%; management attributed much of the decline to seasonal dairy and livestock paydowns. Commercial real estate represented a substantial concentration: 76.3% of gross loans excluding acquired credit-impaired loans were real-estate loans.
- Credit quality: The allowance for loan losses was $65.2 million, or 0.86% of loans, versus $63.6 million and 0.82% at year-end. Nonperforming assets were $19.3 million, or 0.17% of assets, compared with $20.4 million and 0.18%. The allowance ratio is affected by acquired loans recorded at fair value without a corresponding allowance.
- Deposits, liquidity and borrowings: Deposits were $8.65 billion, down 2.0% from year-end; noninterest-bearing deposits were 58.9% of deposits. Cash and cash equivalents totaled $172.2 million. Customer repurchase agreements were $462.8 million; other borrowings were $153.0 million, down from $280.0 million at year-end; junior subordinated debentures were $25.8 million.
- Cash flow: Operating activities provided $54.5 million and investing activities provided $253.8 million; financing activities used $300.1 million. Cash increased $8.3 million during the quarter. Investing cash inflow included a $163.6 million net decrease in loans, while financing outflows included deposit reductions, borrowing repayments and dividends.
- Capital and shareholder returns: Stockholders’ equity was $1.89 billion. Company regulatory capital ratios were 11.38% Tier 1 leverage, 13.76% common equity Tier 1, 14.05% Tier 1 risk-based and 14.90% total risk-based; the company and bank exceeded well-capitalized thresholds. The board declared a $0.18 per-share quarterly dividend.
Material changes and management commentary
- Year-over-year growth in interest income and net interest income was driven principally by Community Bank’s acquired assets and loans, higher loan yields and a greater share of loans in earning assets. Interest expense also rose as funding costs and interest-bearing liabilities increased.
- Noninterest expense rose 43.6%, reflecting acquired operations, higher salaries and benefits, core-deposit intangible amortization, occupancy and equipment costs, and acquisition-related expenses. Management reported an adjusted efficiency ratio improvement after excluding acquisition costs.
- Six former Community Bank locations were consolidated during Q1 2019. Acquisition accounting remained provisional in part, including the fair value estimate for acquired impaired loans.
- Management described the balance sheet as asset-sensitive. A modeled 200-basis-point rate increase projected net interest income increases of 3.71% over 12 months and 7.22% cumulatively over 24 months; a 200-basis-point decrease projected declines of 4.93% and 9.84%, respectively. These are estimates, not forecasts.
- No specific earnings or financial guidance was provided. Management cautioned that results for the quarter are not necessarily indicative of full-year results.
Risks, contingencies and unusual items
- The bank’s lending and operations are concentrated in California, with significant exposure to commercial real estate; substantially all real-estate and construction loans are secured by California property. Economic weakness, falling property values, or borrower stress could increase credit losses.
- Deposits declined during the quarter, and management identifies deposit attraction, funding costs, liquidity, interest-rate movements, and competition as relevant risks. Interest-rate sensitivity estimates depend on assumptions about deposit behavior, prepayments and repricing.
- The company disclosed a court judgment against Citizens Business Bank in the Dunagan matter of approximately $1.34 million, including damages and legal fees. The company intends to appeal and believes insurance may cover all or a substantial portion; it does not expect a material adverse effect, but litigation outcomes remain uncertain.
- CECL was expected to become effective for the company in 2020. The company was developing its methodology and assessing the adoption impact; the filing did not provide a clear quantified estimate.
- Because company assets exceeded $10 billion following the 2018 acquisition, additional regulatory requirements apply, including central clearing requirements for most interest-rate swaps beginning in 2019.
Key facts investors should verify
- How much of reported earnings and margin reflects acquired-loan accretion, nonrecurring interest and the building-sale gain, and how acquisition integration costs evolve.
- Whether deposit balances and funding costs stabilize, and how liquidity and borrowing needs change.
- Credit performance in commercial real estate and dairy/livestock lending, including nonaccrual trends and the adequacy of the allowance after considering acquired loans.
- Final acquisition-date fair values, especially acquired impaired loans, and the expected realization of merger benefits and cost savings.
- The appeal, insurance coverage and ultimate exposure in the Dunagan litigation, as well as the eventual quantified impact of CECL adoption.