CVB Financial Corp. (CVBF) Q3 2013 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Third Quarter 2013 CVB Financial Corp. and its Subsidiary, Citizens Business Bank, Earnings Conference Call. My name is Denise, and I am your operator for today. [Operator Instructions] I would now like to turn the presentation over to your host for today's call, Christina Carrabino. You may proceed, ma'am.

Thank you, Denise, and good morning, everyone. Thank you for joining us today to review our financial results for the third quarter of 2013. Joining me this morning are Chris Myers, President and Chief Executive Officer; and Rich Thomas, Executive Vice President and Chief Financial Officer. Our comments today will refer to the financial information that was included in the earnings announcement released yesterday. To obtain a copy, please visit our website at www.cbbank.com and click on the Our Investors tab. Before we get started, let me remind you that today's conference call will include some forward-looking statements. These forward-looking statements relate to, among other things, current plans, expectations, events and industry trends that may affect the company's future operating results and financial position. Such statements involve risks and uncertainties and future activities, and results may differ materially from these expectations. The speakers on this call claim the protection of the Safe Harbor provisions contained in the Private Securities Litigation Reform Act of 1995. For a more complete discussion of the risks and uncertainties that may cause actual results to differ materially from our forward-looking statements, please see the company's annual report on Form 10-K for the year ended December 31, 2012, and in particular, the information set forth in Item 1A, risk factors therein. Now I will turn the call over to Chris Myers.

Thank you, Christina. Good morning, everyone, and thank you for joining us again this quarter. Yesterday, we reported earnings of $24.2 million for the third quarter of 2013, compared with $24.5 million for the second quarter of 2013, and $9.3 million for the third quarter of 2012. This quarter represents the second-most profitable quarter in company history. Highlights for the quarter included over $100 million in organic loan growth, a $3.7 million reimbursement of legal expenses and a $3.8 million recapture of loan-loss provision due to improved credit metrics. Earnings per share were $0.23 for the quarter compared with $0.23 for the second quarter and $0.09 for the year-ago quarter. Through the first 9 months of 2013, we earned $70.3 million, compared with $55.1 million for the first 9 months of 2012. Earnings per share were $0.67 for the 9-month period ending September 30, 2013, compared with $0.53 for the same period in 2012. The third quarter represented our 146th consecutive quarter of profitability and 96th consecutive quarter of paying a cash dividend to our shareholders. Excluding the impact of the yield adjustment on covered loans, our tax exempt net interest margin was 3.48% for the third quarter, compared with 3.46% for the second quarter and down from 3.60% for the year-ago quarter. At September 30, 2013, we had $3.44 billion in total loans, net of deferred fees and discounts, compared with $3.34 billion at June 30, 2013. Overall, non-covered loans increased by $111.5 million and covered loans decreased by $10.5 million quarter-over-quarter. During the third quarter, our commercial real estate loans increased by $110.7 million, our residential loans increased by $12 million and our dairy and livestock loan portfolio increased by $4.4 million. The market for new loans continued to remain very competitive but the recent rise in long-term interest rates has started to moderate refinance pressure on our existing loans, particularly from the larger banks. Our recent growth in total loans is due to a combination of a strengthened new-loan pipeline and reduced loan runoff. As part of our effort to grow the bank, we recently hired Paul Rodeno, who is charged with leading our bank's expansion efforts in the greater San Diego market. Paul was previously the founder and CEO of Security Business Bank, which was sold in July 2012 to AmericanWest Bank. We expect to be opening our first business financial center in San Diego in early 2014. We are actively looking at other areas for expansion and have recently made important hires in the Orange County marketplace and also hired a new head of Citizens Home Loan. In terms of loan quality, nonperforming assets, defined as non-covered, nonaccrual loans plus OREO, decreased in the third quarter to $56 million, compared with $59.9 million for the prior quarter. Improved credit quality and improving economic factors resulted in a $3.8 million recapture of loan loss provision reflected in the operating results for the third quarter of 2013. The allowance for loan and lease losses was $80.7 million or 2.46% of total non-covered loans at September 30, 2013, compared with $85.5 million, or 2.70% of outstanding loans, at June 30, 2013. Net charge-offs for the third quarter were $994,000, compared with net charge-offs of $561,000 for the second quarter of 2013. At third quarter end, we had loans delinquent 30 to 89 days of $1.7 million, or 0.05% of total non-covered loans. Classified loans for the third quarter were $264.1 million compared with $304.4 million for the prior quarter. This represents a 13.2% decrease in classified loans quarter-over-quarter. Our classified loans decreased due to improvements in our commercial real estate, commercial and industrial and dairy loan portfolios. We will have more detailed information on classified loans available in our second quarter Form 10-Q. Moving on to covered loans. Covered loans represent loans in which we have loss-sharing protections from the FDIC as a result of our acquisition of San Joaquin Bank in October, 2009. At September 30, 2013, we had $177.9 million in total covered loans with a carrying value of $163.3 million, compared with $191.4 million with a carrying value of $173.8 million at June 30, 2013. As of third quarter end, our remaining purchase discount was $14.5 million. As a reminder, our loss-sharing agreement with the FDIC expires in October 2014, approximately 1 year from now. Now I'd like to discuss deposits. For the third quarter of 2013, our non-interest-bearing deposits increased to $2.54 billion, compared with $2.52 billion for the prior quarter and $2.32 billion for the same quarter a year ago. This represents a $214.1 million or 9.2% increase year-over-year, completely organic. Non-interest-bearing deposits now represent 51.85% of our total deposits. Our total cost of deposits and customer repurchase agreements for the third quarter was 12 basis points compared with 12 basis points for the prior quarter. At September 30, 2013, our total deposits and customer repurchase agreements were $5.46 billion, compared with $5.23 billion for the same quarter a year ago and $5.32 billion at June 30, 2014 -- 2013, excuse me. Our ongoing objective is to maintain a low-cost, stable source of funding for our loans and securities. Noninterest income. Noninterest income was $5 million for the third quarter of 2013 compared with $7.7 million for the second quarter of 2013. The quarter-over-quarter decrease in noninterest income was primarily due to a $2.5 million net pretax gain on the sale of one OREO property that occurred in the second quarter of 2013. Total interest income for the third quarter totaled $58.1 million compared with $56.6 million for the second quarter of 2013. The $58.1 million for the third quarter included $2.9 million of discount accretion from principal reductions and payoffs, as well as the improved credit loss experienced on covered loans. This compares to $3.5 million of discount accretion for the prior quarter. So if the discount accretion was eliminated, total interest income for the third quarter increased by $2 million or about 3.7% from the second quarter of 2013. Total investment income of $12.6 million increased $1.7 million or 15.3% from $10.9 million for the second quarter of 2013. Now expenses. We continue to closely monitor and manage our expenses. Noninterest expense for the third quarter was $25.7 million compared with $28.2 million for the second quarter. The $2.5 million quarter-over-quarter decrease was due to $3.7 million of insurance reimbursements for previous year's legal expenses, partially offset by a $1.3 million increase in salaries and employee benefits and a $500,000 provision for unfunded loan commitments. In terms of our expense management strategy, we are examining the size and location of all of our branches and determining their highest and best use. Branch banking is evolving and changing due to technology. As such, we anticipate some future savings in terms of downsizing existing brick-and-mortar. However, we also anticipate that much of these expense savings will be redeployed into technology and product enhancements for our customers. Now I'd like to turn the call over to Rich Thomas, our CFO, to discuss our effective tax rate, investment portfolio and overall capital position.

Thanks, Chris. Good morning, everyone. Our effective tax rate was 33.5% for the 9 months ended September 30, 2013, compared with 33% for the 6 months ended June 30, 2013. Overall, our estimated annual effective tax rate may fluctuate based upon the ratio of taxable income to total income, considering tax-advantaged, municipal bond income and nondeductible expenses. Now to our investment portfolio. During the third quarter of 2013, we sold an average of approximately $90.2 million in overnight fed funds to the Federal Reserve and received a yield of approximately 25 basis points on collected balances. We also maintained $70 million in short-term CDs with other financial institutions, yielding approximately 69 basis points. At September 30, 2013, investment securities totaled $2.62 billion, up $185.7 million from the second quarter of 2013. Investment securities represented approximately 39.9% of our total assets at quarter end. At September 30, 2013, we had an unrealized gain of $7.3 million in our total investment portfolio, up modestly from $6.9 million for the prior quarter. Virtually all of our mortgage-backed securities are issued by Freddie Mac or Fannie Mae, which have the implied guarantee of the U.S. government. We also have 3 private label mortgage-backed securities totaling $679,000. During the third quarter, we purchased mortgage-backed and municipal securities in an aggregate amount of $314.7 million. These securities were purchased to offset the anticipated cash flows from our investment portfolio for the coming 3 months. We did this in anticipation of the current interest rate environment, which was foreshadowed by the Federal Reserve Bank signaling that they would taper the QE stimulus package. During the third quarter, we purchased $307.5 million in mortgage-backed securities with an average yield of 2.44% and an average duration of approximately 4 years. We also purchased $7.2 million in municipal securities during the third quarter with an average tax-equivalent yield of 4.01%. We elected to utilize short-term borrowings to facilitate a portion of these purchases. Prepayment speeds in our investment portfolio have decreased and, based upon current interest rates, we anticipate receiving approximately $27 million to $30 million in monthly cash flow from this portfolio, which is down from $40 million to $50 million in previous months. Now turning to our capital position. Our capital ratios are well above regulatory standards and we believe they still remain above our peer group average. Our September 30, 2013, capital ratios will be released soon, concurrently with our third quarter Form 10-Q. Shareholders equity increased by $16.1 million to $768.2 million for the third quarter compared with the second quarter. The quarter-over-quarter increase was due to an increase of $24.2 million in earnings, $2.2 million of various stock-based compensation items and $245,000 in unrealized gain on available-for-sale investment securities. This was offset by $10.5 million in cash dividends. I will now turn the call back to Chris for some closing remarks.

Thanks, Rich. Now let's talk about economic conditions. In terms of the dairy industry, milk prices have remained stable and feed costs appear to be moderating. According to the California Department of Food and Agriculture, the CDFA, feed costs in California represented 66.8% of total milk production costs at the end of the second quarter of 2013, compared with 66.9% of total milk production costs for the first quarter of 2013. We anticipate a further relative decline in reported feed costs for the third and fourth quarters of 2013. This should produce stronger profit margins for many of our dairy clients. Notwithstanding, it is difficult to project further out, as the future cost of feed will continue to be dependent upon many factors, which include weather, both domestically and globally. Turning to the California economy. According to the state's Employment Development division, the California unemployment rate was 8.9% in August 2013, compared with 9.3% in July and 10.8% back in August 2012. California continued to outpace the United States in terms of job growth on a consistent basis over the past year. With the exception of mining, government and manufacturing, employment in most major sectors has been on the rise. Construction, aided by a rebounding housing market, has led to job gains this year. Tourism remains a driving force, as well. The housing market also continued to recover, albeit slowly. Recently tightening inventory, rising mortgage interest rates and restrictive mortgage lending requirements contributed to the slower growth. The housing market is expected to continue to recover and show strength over the next 2 years before cooling to be more in line with historical averages. New construction has also bounced back and will continue to grow over the next few years, as we are chronically undersupplied in housing throughout the state. As we look to the future, we are highly focused on the following: number one, organic loan growth and the execution of our new loan initiatives; number two, the hiring of banking teams to help us expand faster into new geographic markets and further penetrate the existing markets; and three, the acquisition of community banks in our existing geographic market or in adjacent markets. So that concludes today's presentation. And now Rich and I will be happy to take any questions that you might have.

[Operator Instructions] Our first question comes from Aaron Deer from Sandler O'Neill & Partners. Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division: A question about the loan pipeline. First off, it was great to see some, really strong growth this quarter and I'm curious to know where the pipeline stands currently versus a few months ago, if you continue to have real optimism? And what you might be expecting for the dairy build heading into the end of the year?

Loan pipeline has certainly picked up. In fact, September was the strongest loan production month we've had during my 7-year tenure with the bank. So the best month we've had in terms of new loans was September and our pipeline remains strong. So we're very excited about that. I think when you look at the moderation of the runoff, because as rates go up a little bit, the prepayment pressure on us from other banks trying to refinance our loans at low rates moderates. And so the combination of those 2 things is what led to the $100 million in growth. Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division: And the expectations for the dairy build that you typically see coming into the end of the year?

Yes, I think a lot of the seasonality of the dairy borrowings is predicated on their ability to make money. And we feel, with feed prices moderating and milk prices remaining fairly stable, that should help their profit margins. So we do think that the third and fourth quarter is going to -- should be profitable quarters for many of our dairies. So that would mean that we probably will have a seasonal buildup here at the end of the year. Last year I think was around $50 million or something like that. So that's a possibility this year, as well. Aaron James Deer - Sandler O'Neill + Partners, L.P., Research Division: Okay. And then just a follow-up on the comp line. You noted that the increases, Chris [indiscernible], but I'm wondering -- I know you've been doing some hiring. I'm just wondering how much of that is related to new hires or merit increases versus any sort of bonus true-up that might have been in that number?

It's not merit increases. It's more -- I would say the majority of it is bonus true-up and then there is some acquisition dollars for some of these new teams that we brought in, too. So probably 80% of that is bonus true-up -- I'm just giving you a ballpark, and 20% is new hires and some upfront money for those new hires.

The next question is from Robert Greene from Sterne Agee. Robert Greene - Sterne Agee & Leach Inc., Research Division: Just a couple of questions. One is with the uptick in loan growth, obviously a very positive sign for you guys. I'm wondering, does that change sort of your calculus at all in terms of your M&A outlook? I mean, with the new lending initiatives and the opening of the -- I guess, the offices in some of these other parts of California, are you now more focused on organic growth than perhaps maybe doing a deal?

You know what? That's a great question, by the way, and it's something that we've been talking about internally quite a bit here. The answer is, we, unlike some of our competitors, don't have to do an acquisition to grow. And we strongly believe that and we've been fighting through that for the last 4 quarters, 5 quarters as we've been on offense. So this quarter was really kind of a breakthrough for us in terms of our loan productivity and our ability to generate and get our pipeline moving and a lot of our new initiatives kicking in. But a lot of the new initiatives that we've done haven't fully kicked in, like San Diego, our new hires in Orange County, they haven't started producing business yet. Hopefully that's going to come, too. So the answer is, we want to do both, and with our capital levels -- we want to deploy that capital, too. And we're not going to deploy that capital through organic loan growth. We're going to deploy that capital through acquisitions. So if we can get both of those things humming, that's going to be the real great answer for CVB and our earnings growth. Robert Greene - Sterne Agee & Leach Inc., Research Division: Okay. And then just a follow-up as it relates to capital. Obviously, you guys are close to 11% TCE and capital formation is positive. Your guys' returns are excellent at this point. I'm just wondering with the -- there's the FHLB advances, which are -- I know it's a very prohibitive, I guess, prepay expense on that but I was wondering, is there kind of a tipping point where you look closer at that in terms of kind of repositioning your liabilities? Or is there ever a thought or maybe doing some more on the buyback?

Yes, another good question. When the 10-year Treasury was up around 3%, we had a lot of conversations about potentially paying back some or all of the FHLB, the $200 million dollars that we have at 4.52%. As that rate is moderated back down, the prepayment penalty becomes pretty dramatic and so it becomes less compelling for us to do that. So that's the answer on that. As far as buybacks, M&A is still on our minds. We're having a lot of discussions out there. There's a lot of opportunities out there, both us reacting to some of those opportunities and also being proactive in the marketplace. It's just we haven't -- we don't have anything to announce at this point but we're working hard at it.

Our next question is from Julianna Balicka from KBW. Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division: I have a couple of questions. Could you discuss, in terms of the provision -- negative provision this quarter makes sense in light of your reserve coverage but, in light of the turnaround in loan growth, could you kind of elaborate in terms of your target reserve coverage and how quickly you'll have to get there? I mean, I know you want to be conservative but there's outside pressures that sometimes force your methodology?

Yes, we have a pretty, pretty complicated formula to get to what our reserves are going to be. And so we put that all in the mix and look at everything and, even despite the fact that we were able to grow loans by $100 million this quarter, we still, based on our methodology, still came out that we needed to release some reserves to be consistent with the way that we've gone quarter-over-quarter. And a lot of that has to do with our unallocated reserve. If you look at our unallocated reserve, it's been running around 7% or something like that. So that's kind of a little bit of a benchmark there. In terms of our reserves, I think another driver there was our classified loans went down $40 million quarter-over-quarter, and a lot of that is -- was centered in commercial real estate loans and then, secondarily, dairy loans. And so as you see dairy improve more and you see real estate prices firm up more, that's going to have a -- that should have a positive effect on our classified loan levels, which in turn is going to have an effect on our formula, which is going to drive down our reserve methodology. And all of this kind of [indiscernible]... Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division: And what is the remaining classified loans, so we can think about as we think about possible negative provisions going forward?

Well, our classified loans at the end of the quarter were $264 million. And just to give you some comparisons, quarter-over-quarter it was $304 million at the end of the second quarter, $320 million at the end of the first quarter. So we're down from -- just in the last 2 quarters, we're down $55 million in classified loans or close to 20%. Julianna Balicka - Keefe, Bruyette, & Woods, Inc., Research Division: Okay, very good. And then one more follow-up. What was the prepayment penalties in your interest income this quarter?

Prepayment penalties. Another good question. We actually got more prepayment penalties than we thought we would get this quarter. And it was $856,000. And to give you comparisons over the last -- in the second quarter, it was $1,138,000, and in the first quarter it was $954,000. So it was lower than those 2 quarters but it's down. And we would anticipate that, that is going to -- I mean, I can't speak to -- some of these prepayment penalties we get, we still keep the loan. We'll get the prepayment penalty and we'll keep the loan and extend the loan for them. So that's the win-win, right? But we would anticipate, as rates get a little bit higher, those prepayment penalty fees will moderate. But now rates are starting to come down a little bit, it could get -- it could stay there. Who knows?

Our next question is from Eric Grubelich from Highlander Bank Holdings.

That's Eric Grubelich. Loan growth was very good. I was kind of questioning -- you mentioned earlier in the call about purchasing mortgage-backed securities. Your portfolio is still very big. Do you -- in terms of earning assets, do you anticipate bolting on more securities going forward? Or do you see this unwinding? That's the first question. And then the second part of it is are you managing -- given, I guess, I think the comment you made about -- I guess, some short-term borrowing was used to finance the purchase of the mortgage securities and the munis. Are you really managing this to a certain spread bogie? Or dollars of margin?

The answer to that is we're actually -- we're just looking at this situation as we go along. Your comment about the level of securities as a percentage of our balance sheet, we run -- I think we're 39.9% of securities were -- of our assets at the end of the quarter. That's a pretty robust level. One of the things that we look at is how are we funding those securities? And we're funding them with deposits. And how strong are those deposits? And if you look at our growth in deposits over the last year, it's really been on the noninterest side. It hasn't been on the interest-bearing side. So as long as we can bring in non-interest-bearing deposits or really low-cost deposits, we're going to continue to build deposits. Those higher-priced money market deposits and CDs and so forth are not attractive to us right now because what we don't want to do is take in a bunch of that "hotter money" and then filter it in and buy securities and take additional interest-rate risk. So we did -- we prebought securities this quarter just because the rates ran up. And so when we see the longer-term rates ran up, we could get more yield and we know that we're going to be throwing off a certain amount of cash flow per month. And typically, that's been about $50 million a month and it's now moderating down to about $30 million a month. So for instance in the quarter -- just in the third quarter, let's say from a logic standpoint, that we know we're going to have $120 million to $150 million in securities runoff in cash flow for the quarter. Well this quarter, we bought a little over $300 million in securities. So we really bought ahead of ourselves by about $150 million. But we know that's going to be used up by runoff in the next 3, 4 months. I don't know if you have anything to add to that, Rich?

That's exactly the strategy, Chris.

And that's where we are. But we're not -- the answer is loans here, and we know the answer is loans. And one of the things that we're also looking carefully at is the interest rate risk we're taking on those loans. So we haven't done many, if any, swaps this year and we're looking at that for some of our longer-term financing and maybe kicking more of that in just to insulate us against interest-rate risks. Because we really prefer to book 5-year, fixed-rate paper or 7-year, fixed rate paper than 10-year, fixed-rate paper. But we have been doing 10-year, fixed-rate loans on commercial real estate loans to win the business and keep the business.

So just apart from my question about securities portfolio, so you are layering on swaps where you're doing more of this longer-term-in-nature, commercial real estate lending?

Well, we have historically. We have historically done interest-rate swaps on our loans, not on our securities. So we haven't done -- I don't think we've done any swaps this year because the rate market has not been there. But in total, of our commercial real estate portfolio, which say for argument's sake is about $2.2 billion, we have $250 million of that on interest-rate swaps. And it's not that we've swapped. It's either 10-year, fixed-rate paper or 15-year, fully amortizing, fixed-rate paper for the most part.

Okay, that's great. And just so I understand, the securities, that $305 million figure, was that the -- I didn't have last quarter's number. Was that the end-of-period balance increase, the net increase? Or just what you purchased net of roll-off?

That's just what we purchased, right?

Purchased.

B It was actually a $311 million or something because we buy munis, too. But it was like $305 million in mortgage-backed.

$307 million and $7 million, up to $314 million total.

$307 million in mortgage-backed and $7 million in munis.

Was that -- I looked at your average balance at the end of period. It seemed like maybe it was done later in the quarter then?

Yes. Mortgage was done later in the quarter.

[Operator Instructions] Our next question is from Hugh Miller from Sidoti. Hugh M. Miller - Sidoti & Company, LLC: So just -- I guess in following up, it sounds like the opportunities on the M&A side and the things that you're looking at, from what you're saying, it seems like it's improving. Can you just talk about, first, are you still looking for kind of stronger franchises, non-turnaround stories? And then, second, what's driving potentially that increase in opportunities? Is it kind of the potential for the rising in -- TARP rates or just a rise in overall valuation from your currency standpoint? Or what are you seeing there?

The answer is yes for all of the above. But no, we are looking for stronger institutions. I don't think -- for the most part, and you never say never, but for the most part I don't see us do a deal at below tangible book value. I don't think that's our type of bank. We're looking for stronger franchises where we can cross-sell a lot of our products into their clients, and they're in-market so we can do some cost savings or in adjacent markets that get us into markets where we can leverage our existing management talent to help them build their base of clients as we absorb them in. As far as -- our currency is running pretty strong right now. We're trading over 2x tangible book. And the competition for M&A is moderated here somewhat from the traditional -- especially in Southern California, from the traditional banks. I mean, you have -- some of that competition comes from people like Pacific Western or an Umpqua or even Sterling, and they're all involved in deals right now, pretty large deals. So I think they're probably on the sidelines. I can't speak to that. I mean, I don't know, but I'm guessing that they're on the sidelines. So a little bit more of our competition on deals appears to be coming from more the cash buyers, which are the banks that are funded through different equity investors. So we feel that, with our currency, we have an advantage over them in terms of purchasing the stronger banks.

[Operator Instructions] At this time, there are no further questions so I would like to turn the call back to Mr. Myers.

Thank you very much. One last thing I wanted to mention that we're very excited about. We measure our income and obviously we look at our net interest income, we measure all kinds of different things. One thing we were very excited about was that our total interest income for the quarter was up quarter-over-quarter for the first time in the last 6 quarters. So that's an important trend line for us. We call that kind of top line income. So we feel and we're hopeful that we're going to continue that top line income growth. And then if we can hold the line in the expense side and continue to grow, that's going to bring greater profit level. So this was the first quarter in the last 6 quarters, at least, probably longer than that -- but I'm looking at 6 quarters right now and I can tell you that's the first quarter that we've showed that total interest income growth. So we're excited about that. And that's pretty much it. I thank you all for joining us on our call today and we appreciate your interest and look forward to speaking with you again on our fourth quarter and year-end 2013 earnings conference call in January. In the meantime, please feel free to contact me or Rich Thomas, and have a great day. Thanks.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.