CVB Financial Corp. — Q3 2018 Form 10-Q
Business context and reporting period
Quarter and nine months ended September 30, 2018; unaudited. CVB Financial operates Citizens Business Bank, a California-focused commercial bank serving businesses and individuals. On August 10, 2018, it completed the acquisition of Community Bank (CB); Q3 results include 51 days of CB operations. CB added 16 banking centers and approximately $4.09 billion of assets at closing. The company now reports as one operating segment.
Key financial metrics
Dollar amounts below are in millions unless stated otherwise.
| Metric | Q3 2018 | Comparable period / balance date |
|---|---|---|
| Net interest income before loan-loss provision | $92.8 | $71.7 in Q3 2017; $72.7 in Q2 2018 |
| Provision for loan losses | $0.5 expense | $1.5 recapture in Q3 2017 |
| Noninterest income | $10.1 | $10.0 in Q3 2017 |
| Noninterest expense | $48.9 | $34.7 in Q3 2017; includes $6.6 of CB acquisition-related expense |
| Net earnings | $38.6 | $29.7 in Q3 2017; $35.4 in Q2 2018 |
| Diluted earnings per share | $0.30 | $0.27 in Q3 2017; $0.32 in Q2 2018 |
| Net interest margin, tax-equivalent | 4.06% | 3.70% in Q3 2017 |
| Efficiency ratio | 47.49%; 41.03% excluding acquisition expenses | 42.44% in Q3 2017; 42.13% excluding acquisition expenses |
| Cash from operations, nine months | $116.6 | $106.3 in first nine months of 2017 |
| Cash from investing / financing, nine months | $874.2 / $(940.7) | Net cash and cash equivalents increased $50.1 to $194.5 |
| Total assets | $11,480.3 | $8,270.6 at December 31, 2017 |
| Loans, net of allowance | $7,522.5 | $4,771.0 at December 31, 2017 |
| Total deposits | $9,109.8 | $6,546.9 at December 31, 2017 |
| Stockholders’ equity | $1,818.6 | $1,069.3 at December 31, 2017 |
| Borrowings and customer repurchase agreements | $30.0 other borrowings; $25.8 junior subordinated debentures; $399.5 customer repos | $0, $25.8, and $553.8, respectively, at December 31, 2017 |
Material changes versus comparable periods
- Q3 net earnings rose 29.9% year over year, while diluted EPS rose from $0.27 to $0.30. Compared with Q2 2018, earnings increased 9.0% but EPS declined from $0.32, reflecting the larger share count following the acquisition-stock issuance.
- For the first nine months, net earnings were $108.8 million, up 25.7% from $86.6 million; diluted EPS was $0.94 versus $0.79. Net interest income increased 13.7% to $236.0 million, and tax-equivalent net interest margin increased to 3.87% from 3.62%.
- Assets increased 38.8% from year-end, primarily from CB. The company issued $722.8 million of common stock and paid $180.7 million cash as acquisition consideration; purchase accounting recorded $546.3 million goodwill and a $52.2 million core deposit intangible. The purchase-price allocation remained subject to adjustment.
- CB contributed $2.73 billion of acquired loans and $2.87 billion of deposits. Excluding acquired CB loans, loans grew only $17.7 million, or 0.37%, over the first nine months.
- Higher loan balances and acquired-loan discount accretion supported quarterly interest income and margin. Deposit and borrowing costs also increased: Q3 average cost of total deposits was 0.15% versus 0.09% in Q2 and Q3 2017; total cost of funds was 0.18% versus 0.12% in both comparison quarters.
- Available-for-sale securities had a $44.5 million pretax unrealized loss at quarter-end, compared with a $2.9 million unrealized gain at year-end 2017. Nine-month other comprehensive loss, net of tax, was $34.6 million, primarily reflecting securities-value changes attributed by management to interest rates.
Outlook, risks, contingencies and unusual items
- The filing provides no formal earnings or revenue guidance. Management describes the interest-rate profile as asset-sensitive; its model estimates that a 200-basis-point rate increase would raise net interest income 4.44% over 12 months and 8.37% cumulatively over 24 months. These are model estimates, not forecasts, and depend on deposit, prepayment, pricing and other assumptions.
- Management expects to meet fully phased-in capital conservation buffer requirements. At September 30, consolidated CET1 was 12.94%, Tier 1 risk-based capital 13.22%, total risk-based capital 14.00%, and Tier 1 leverage 12.52%; the Bank and company exceeded well-capitalized regulatory thresholds. CVB’s assets first exceeded $10 billion in Q3, triggering additional regulatory requirements.
- Credit exposures merit monitoring. Approximately 75.1% of gross loans were real-estate loans, including $5.27 billion of commercial real estate loans; substantially all real-estate and construction loans are secured by California properties. Nonperforming loans were $16.4 million, including $8.6 million acquired from CB; nonperforming assets were $16.9 million, or 0.15% of assets. The $60.0 million allowance equaled 0.79% of loans, a ratio reduced by acquired CB loans recorded at fair value without a corresponding allowance. Management considered the allowance appropriate but cautioned that future losses could require higher provisions.
- Unfunded commitments to extend credit totaled $1.65 billion, with $54.4 million of letters of credit and a $9.2 million reserve for unfunded commitments. Commitments may not be drawn, but could create funding needs.
- Q3 acquisition-related costs were $6.6 million; nine-month costs were $7.9 million. The company’s unaudited pro forma nine-month results, assuming CB had been acquired earlier, showed net income of $138.3 million and diluted EPS of $0.99 versus $118.4 million and $0.85 in 2017; the filing cautions these figures are illustrative and not predictive.
- On November 7, 2018, after quarter-end, a court ruled against the Bank in the Dunagan litigation and awarded approximately $1.35 million, including damages, fees and costs. The company intends to appeal and says insurance may cover all or a substantial portion; it does not expect a material adverse effect.
- Management identifies economic and California real-estate conditions, interest-rate changes, deposit funding and liquidity, acquisition integration and synergies, credit quality, regulatory changes, and operational, cybersecurity and vendor risks as factors that could affect results.
Most important facts for investors to verify
- Post-acquisition earnings power: separate recurring CB contribution and loan discount accretion from acquisition costs and other nonrecurring items.
- Integration progress and final CB purchase accounting, including acquired-loan marks, goodwill, intangible amortization and potential synergies.
- Underlying loan growth and credit performance, especially acquired nonperforming loans, California commercial real-estate concentration, and allowance adequacy.
- Deposit retention and funding costs, liquidity sources and the effect of the company’s newly above-$10-billion asset status.
- How interest-rate movements affect net interest margin and securities’ unrealized losses; confirm model assumptions and the company’s capacity and intent to hold securities.
- Outcome, appeal and insurance coverage of the Dunagan case, and any other material legal or regulatory developments.