CVB Financial Corp. (CVBF) Q2 2015 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Second Quarter 2015 CVB Financial Corp and its subsidiary, Citizens Business Bank Earnings Conference Call. My name is Mike and I'm your operator for today. At this time, all participants are in a listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the presentation over to your host for today's call, Ms. Christina Carrabino. Ms. Carrabino, the floor is yours ma'am.

Thank you, Mike and good morning everyone. Thank you for joining us today to review our financial results for the second quarter of 2015. 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 Investor's 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, 2014, 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 $26.8 million for the second quarter of 2015, our second highest quarter of earnings on record. This compares to $15.8 million for the first quarter of 2015 and $25.5 million for the second quarter of 2014. Our second quarter pretax earnings were positively impacted by $2 million release of our allowance from loan losses. Earnings per share were $0.25 for the second quarter compared with $0.15 for the first quarter and $0.24 for the year ago quarter. Through the first six months of 2015 we earned $42.6 million compared with $54.1 million for the first six months of 2014. Earnings per share were $0.40 for the six month period ended June 30, 2015 compared with $0.51 for the same period in 2014. The second quarter represented our 153rd consecutive quarter of profitability and 103rd consecutive quarter of paying a cash dividend to our shareholders. Our cash equivalent net interest margin was 3.65% for the second quarter compared with 3.59% for the first quarter of 2015 and 3.55% for the year ago quarter. Total loans grew by $68.2 million or 1.84% for the second quarter to $3.78 billion. Our new loan productivity for the second quarter was stronger compared to the first quarter. During the second quarter our commercial real estate loans increased by $61 million, our commercial and industrial loans increased by $2 million, our single family residential mortgage loans increased by $9.4 million, and our dairy and livestock loan portfolio increased by $10 million. In terms of loan quality, non-performing assets defined non-accrual loans plus OREO were $30.1 million for the second quarter of 2015, unchanged from the prior quarter. Non-performing commercial real estate loans decreased $1.8 million during the second quarter offset by an increase of $1.2 million in non-performing single family residential mortgage loans and $713,000 in OREO. The allowance for loan and lease losses was $59.6 million or 1.57% of total loans at June 30, 2015 compared with $60.7 million or 1.63% of total loans at March 31, 2015. The reduction allowance was due to improved credit quality and net recoveries of $845,000 for the quarter. At June 30, 2015 we have loans delinquent 30 to 89 days of $1.9 million or 0.05% of total loans. Classified loans for the second quarter totaled $118.3 million. This was a $10.9 million decrease from the prior quarter. We will have more detailed information on classified loans available in our second quarter Form 10-Q. Now I’d like to discuss deposits. For the second quarter 2015 our non-interest bearing deposits increased to $3.25 billion compared with $3.13 billion for the prior quarter and $2.96 billion for the same quarter a year ago. This represents a $288.4 million or 9.74% increase year-over-year, and a 3.95% increase quarter-over-quarter. Average non-interest bearing deposits were $3.12 billion for the second quarter 2015, compared with $2.97 billion for the prior quarter and $2.74 billion for the same quarter a year ago. Non-interest bearing deposits now represent 54.23% of our total deposits, this is an all time high. Our total cost of deposits and customer repurchase agreements was 10 basis points for the second quarter compared with 11 basis points for the prior quarter. At June 30, 2015 our total deposits and customer repurchase agreements were $6.66 billion compared with $6.24 billion for the same period a year ago, and $6.46 billion at March 31, 2015. Average total deposits and customer repurchase agreements were $6.46 billion for the second quarter of 2015 compared with $6.36 billion for the prior quarter and $5.92 billion for the year ago quarter. Our ongoing objective remains to maintain a low cost stable source of funding for our loans and securities. Interest income, interest income for the second quarter of 2015 totaled $64.5 million compared with $64.2 million for the first quarter of 2015. Non-interest income was $8.3 million for the second quarter of 2015, compared with $8 million for the first quarter of 2015. Now expenses, we continue to closely monitor and manage our expenses. Non-interest expense for the second quarter was $31.5 million compared with $44.5 million for the first quarter. The decrease was principally due to the $13.9 million debt termination expense resulting from the repayment of $200 million Federal home loan bank advance during the first quarter. Non-interest expense was 1.69% of average assets for the second quarter, compared with 1.67% of average assets for the first quarter excluding the federal home loan bank debt termination expense. 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. Rich?

Thanks Chris, good morning everyone. Our effective tax rate remained at 35.5% for the second quarter. Our effective tax rate varies depending upon tax-advantage income as well as available tax credits. Now to our investment portfolio during the second quarter of 2015, we sold an average of approximately $296 million in average funds to the Federal Reserve and received a yield of approximately 25 basis points on collected balances. We also maintained an average of $24.9 million in short-term CDs with other financial institutions yielding approximately 86 basis points. At June 30, 2015 investment securities totaled $3.16 billion, up $125.9 million from the first quarter of 2015. Investment securities represented 41% of our total assets at quarter end. At June 30, 2015 we had an unrealized gain of $40.9 million in our total investment portfolio compared with an unrealized gain of $73.8 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 continue to monitor the interest rate environment carefully weighing current rates and overall interest rate risk. During the second quarter we purchased $109 million in mortgage backed securities with an average yield of 2.06% and an average duration of approximately four years. We also purchased about $144 million of collateralized mortgage obligations with an average yield of about 2.10% and $9 million in municipal securities with an average tax equivalent yield of about 3.63%. Despite the continued low interest rate environment, prepayment speeds in our investment portfolio appeared to have somewhat stabilized. And based upon current interest rates we anticipate receiving approximately $35 million in monthly cash flows from our portfolio. However, if rates remain low we may see faster prepayment speeds which could increase our estimated monthly cash flows. 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 June 30, 2015 capital ratios will be released soon concurrently with our quarter-end Form 10-Q. For the six months ended June 30, 2015 shareholders' equity increased by $15.9 million to $894 million from December 31, 2014. The increase was due to $42.6 million in net earnings and $6.1 million in various stock based compensation items offset by $25.5 million in cash dividends and $7.3 million decrease in unrealized gains on available for sale investment securities. 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 future prices continued to decline but appeared to be bottoming out and stabilizing. The National Milk Producers Federation attributed the market stabilization to signs of milk production slowing down to better match consumption needs. It remains to be seen how 2015 will ultimately pan out for the U.S. dairy industry as international demand, domestic supplies, and weather remain as important determining factors. According to the California Department of Food and Agriculture, feed cost in California represented 61.1% of total milk production cost for the first quarter of 2015. That is flat when compared to the fourth quarter of 2014. There continues to be much discussion about the California drought and its impact on the agricultural sector. According to economic research, the impact of the 2015 drought is not as severe as initially anticipated but remains a huge concern if lack of rainfall continues. Researchers found for the part farmers have been able to supplement water cuts by pumping ground water and digging deeper wells. We are watching the drought situation closely and as of yet have seen little effect on the prepayment of our loans. Turning to other items related to the California economy. According to various economic reports, California's employment development division reported the unemployment rate was 6.4% in May 2015 compared with 6.3% in April 2015 and 7.6% back in May 2014. Unemployment is expected to dip below 6% by late 2016. California is on firm footing as it enters year six of the current economic expansion. Jobs are up, California accounts for 16.2% of all new jobs created in the United States since 2010. Job growth has been very broad based with every major region and most major industries in California continuing to post significant job gains. Home prices are rising. New construction activity is occurring across the state. California also remains a top tourist destination and businesses and consumers are still driving growth in spending. These are all good things for California. In closing we are pleased with our second quarter financial results. We remained focused on quality loan growth, fee income expansion, continued strong core deposits, and overall operating efficiency. We believe a balanced growth plan including organic growth and strategic acquisitions remains the right corporate strategy for CVBF. That concludes today’s presentation and now Rich and I will be happy to take any questions that you might have.

Thank you, sir. [Operator Instructions]. The first question we have comes from Aaron Deer of Sandler O'Neill and Partners. Please go ahead.

Hey good morning everyone.

Good morning Deer -- Aaron.

Chris the loan growth this quarter is nice to see that pick back up again. I am just wondering if we can get an updates for the remainder of the year. It sounds like given the California economy trends that you are seeing that -- and they sound pretty positive on the outlook can you just give us a sense of what kind of growth maybe you would be looking for the overall portfolio by year-end?

Yes, we are pretty positive. We had a good quarter and the quarter would have even been better but if you see once again our prepayment penalties were elevated. And this is a second quarter in a row that we’ve had over $1 million in prepayment penalties and it’s a little frustrating on the competition side. Because I think -- what we feel are quality loans, we have a lot of quality loans and everybody and their brothers are chasing those quality loans. And so it presents a lot of competition with especially from the big banks. And so just as much as our production which is far ahead of last year’s production but we are still battling to keep some of these loans that we have and sometimes we are letting these things go and taking prepayment penalties because we simply are having a tough time competing with the longer term fixed rates that are out there. We are seeing sometimes 25 and 30 year amortizations fixed for 10 years at sub 4% and that’s hard for us to want to compete with that and feel like we are doing the best thing for our shareholders.

Okay, that brings up another question I had, given the -- it looks to me the FHLB especially then added about $0.05 to margin and then given the -- and Rich you can correct my math if I am off there but, and then given the prepay penalties and the FHLB borrowings that were paid down in the quarter I would have expected to see a little better core margin, can you give us kind of your thoughts on what’s happening on the asset side there and what we should expect?

Rich you jump in, but there is a lot of things first of all prepayment penalties are, you know, they’ve been running anywhere for the last five quarters that they been 740,000 to 1.4 million. This quarter it was 1.78 million. So it’s a little elevated but it’s not that much money. I think where we saw some stuff that we saw a lot of growth in the loan portfolio in the last month of the quarter, so I think that’s going to help us in terms of our interest income for the third quarter. And then the other part is we have a lot of money going overnight to the Fed right now and the reason for that is just because we haven’t reinvested that cash. So we have strong deposit growth and we are holding on to that cash which I think also suppresses some of our top line net interest income. But we feel pretty good about the third quarter. We have invested some of those dollars. We are looking to invest more but we are waiting for interest rates to pop up. The difference between us investing now at a lot of mortgage back securities and buying them at 2% or we are hoping that we can wait a few months and rates will go up a little bit. And if we can do that for the 2.5% that is a big difference for us. Because we are holding on those securities for an average of four plus years and if we get 2.5% on $300 million that is another $7.5 million in pretax income, so we are suppressing that a little bit. So I guess your comments, I think are good comments but I think we are pretty positive about it. The only thing I would say that we are less positive about is the competition and we put two loans on and one falls off and then so we are working hard to try to retain as much as we can but there is an interest rate component to that.

Sure, okay, that is good color, thank you Chris.

The next question we have comes from Matthew Clark of Piper Jaffray.

Hey, good morning guys.

Good morning.

Chris can you maybe quantify the production you had in the quarter, how that compared to the prior quarter and then maybe the payoffs as well, just to try and get a better sense of the magnitude here?

Yes, I will talk in general terms about that but I don’t want to get into something where every quarter I am reporting what this is and so forth because it can be a little choppy. But our production is in terms of loan outstanding this year is over $100 million higher than it was a year ago to the first six months. So we feel good about that number. The prepayment side of that is definitely higher than it was a year ago in terms of what we have lost through prepayments but I think just a little bump in interest rates here is going to slow down that prepayment side considerably and our production is running pretty solid. The other thing that really happened in the second quarter that we haven’t seen is our team up in Ventura which is what we call our option [ph] commercial banking center, Ventura County for you investors has got a great pipeline and we really saw none of that book of any substance in the second quarter. And we are going to see some of that kick-in in the third quarter along with our revitalized team that we have in downtown Los Angeles that has got some production coming on in the third quarter. So those are add-ons to our normal book if you will and we are feeling good about that. So, I think the only thing I am hedging my bets on here is prepayment pressure on some of our mostly fixed rate commercial real estate loans.

Okay, and then in terms of the pipeline can you also give us maybe a percentage change on the pipeline, maybe relative to the first quarter or even a year ago?

A year ago our pipeline kicked-in pretty well during the summer and I think we are running pretty parallel with where we were last year, maybe a little bit better this year in terms of just kind of -- last year I think our third quarter was our fastest growing loan quarter in terms of growth and it remains to be seen whether this third quarter will be our fastest this year. But we are certainly working hard towards that.

2% of the quarter is probably fair for the back half of the year here?

You know what that is our goal but again lot of factors come into that. So, our goal is to produce that 2% in organic growth per quarter and we have not been able -- if you look at that we just did -- in fact I am doing a presentation to our sales team this afternoon and I will give you some rough numbers from June 30, 2014 to June 30, 2015. Our non-interest bearing deposits grew just under 10%, this is pure organic, so it is about 9.7% to 9.8% somewhere in there from June 30, 2014 to June 30, 2015. Our loans are up 4.5% from June 30, 2014 to June 30, 2015. So, and as much as our goal is to grow 2% a quarter, we only grew 1.125% per quarter for the last year. So, we are hoping to do better than that and we are pursuing it hard. Lot of factors go in there.

Okay, I think just last one loan pricing, I know we have talked in the past, more recently with the weighted average loans, new loans going on around 4%, have you any relief given, I know the competition obviously remains fierce but there has been some relief in curve, at least the belly of the curve and I am just curious whether or not that has picked up at all?

Yes, a little bit. But it is -- the 10 year treasury bounced up close to 200 to 250 and then it has come back down again. And so -- but it is still elevated from what it was sub to [ph] so that is good thing. But yes, we have seen a little uptick in those rates and that is a positive for us. I mean, we are not talking anything hugely substantial but everything at this point helps right.

Yes, okay I will step back, thanks.

The next question we have will come from Julia Smith, KBW.

Good morning.

Good morning.

Good morning. I have a couple of follow ups, you had discussed that you still have excess cash and liquidity for redeployment once rates rise a little bit more. So in terms of having seen you go back to purchasing NBSs and securities this quarter, should we think about maybe a cause for the third quarter before you resume assuming rates continue to pickup or should we kind of think about continuing level of purchases and there may be an increased in the volume of purchases once rates come up?

I think we want to deploy our deposits into assets and certainly our first choice is loans. And so we are working hard to deploy as much of that as possible into those loans. In the absence of that we buy securities which is we say every quarter. As those securities ebb and flow and the rates ebb and flow, we will hold cash back when we feel like rates are a little bit disproportionately lower than what were they have historically been. And then we’ll try to deploy it when the rates go up a little bit. So I don’t think that strategy is changing going forward. I do think our deposit growth is like it’s a building wave that keeps coming and we actually are trying to look in our portfolio at non sticky deposits that we think are going to be rate sensitive that are going up and shed ourselves of those things right now. And so if you look at year-over-year I just talked about the 9.7%ish growth year-over-year from June to June 2014 to 2015, our total deposits only grew about 6.5%. So the non-interest bearing goes up 9.7, total deposits go up about 6.5%, I think that’s about right. Rich you correct me if I am wrong. But I think that’s what we are trying to make sure that, so when rate start moving up and the competition for these non-core deposits elevates and people start paying more and more banks that are well funded as we are going to have chase up the rate. And so we are trying to make sure that we really think about how we are dealing with that now. So we don’t get any false deposits that are funding securities that create an issue on the margin side down the line.

And how do you quantify that dollar amount of these excess deposits so to speak?

Yes, I don’t think we have a kind of excess deposits, I really don’t and I don’t know I have the numbers saying these are excess deposits. Well, some of these will have to see how they perform but I can tell you we had a situation where we had our substantial money market account in the bank, call it $20 million and we can borrow overnight at the Fed. We have $300 million going to the Fed overnight getting 25 basis points and the client wanted 35 basis point in their money market. And we looked at it and said why would we do this and you know what that same client when rates go up 25 or 50 basis points its only a transactional client who want to get 50 or 75 basis points. So we know we are going to be chasing now we are not, so we said no we are not going to go ahead and pay you that. If you want your 25 basis points we’ll give you 25 basis points but we are not giving you the 35. So those kinds of decisions we are making along the way. Now if that company had an operating deposit relationship with us and we can dollar average those deposit cost lower, then we probably would have stretched maybe as high as that 35 basis point.

Okay that makes sense and then one more question and I’ll step back, in terms of your reserve levels I know you discussed previously that given your lack of loss performance you gaining some pressure on releasing reserve so can you update us maybe where that is going?

Yes, you know what I think we released $2 million this quarter and my dream is not to release any reserves and grow loans enough so we grow into our improving credit metrics. I think you could see a continuation of our improving credit metrics but I think you’ll see recoveries be very strong throughout the remainder of the year and into 2016. And as we recovered loans, that’s going to feed into our allowance and build up our loan loss reserve and then we have to figure out what we are going to do with that loan loss reserve. Are we going to use it for a loan growth, or are we going to have to unwind some more reserves along the way. But remember that with net recoveries of over 1.7 million so far this year year-to-date, we released $2 million in reserves it's almost dollar for dollar there. We are getting more recovery, we are getting net recoveries and we are just releasing them.

Got it, makes sense. Thank you very much.

Great.

[Operator Instructions]. Well at this time we are showing no further questions. We’ll go ahead and conclude today’s question-and-answer session. Actually I apologize gentlemen, we do have a follow up from Matthew Clark of Piper Jaffray.

Hey sorry, figured we didn't ask about M&A before the call ends, any updates on that front whether not you are seeing more books of business or whether not conversations has increased since last quarter?

No we are having conversations no question about it. Nothing to announce at this point but we are, I said earlier I think the previous quarter that my goal was to have a deal announced in 2015 and that remains a goal. And I think it’s a realistic goal but nothing at this time to announce. We are having conversations and so forth and both proactively and somewhat reactively to different situations and we are working hard in that part of that. But meanwhile its business as usual, building the bank organically through what we call our same store sales which is each office needs increase their loans deposits and fee income that’s our goal. And also building out these new teams that we have built out in the last year plus San Diego, Ventura County. We also have just hired a team into Santa Barbara which I wanted to make sure everybody knew. We don’t have a permanent office location so we haven’t officially announced that but we just hired a three person team in Santa Barbara. So we’ll be -- our objective is to be opening in Santa Barbara either late third quarter or early fourth quarter. So we continue to have good organic and de-novo growth and we’d love to supplement that with an acquisition announce before the end of the year. But, no news on that yet.

Okay and then on your C&I portfolio, obviously it has been languishing here a little bit, was loan utilization down at all in the quarter, just curious whether not that masked some of the production?

No, it was pretty flat and some of our new teams are really more C&I teams. So I think you are going to see our C&I pickup in the third quarter and fourth quarter of this year. So we were a little bit underwhelmed by only growing it, I think it was $2.2 million in the quarter and we hope to do better than that if that’s your pace in that. But I think we are poised to grow C&I, I really do and the teams that we are hiring both in Ventura and Santa Barbara are middle market C&I teams. And we think they are going to produce some decent balances forth that will help us with our normal growth trends.

Okay, thanks guys.

Alright.

Next we have a follow up from Julia Smith.

Hi, I wanted to –

I got a question, is this Julianna Balicka?

It is, I think the operator decided that my foolish last name was too much difficult, Smith is easier and I agree.

Okay.

I did not change my last name.

Alright.

Alright in terms of the securities purchases the reason they have come late in the quarter so that should I’ll see it will be a positive factor to think about going forward into next quarter?

Rich, security purchases were later portion of the quarter is that correct?

They were Julianna.

And I don’t think we purchased anything until I want to say conservatively May 15th or after.

Yes.

And it was probably more late May and after, is that right.

Yes. You’ve seen the yield curve. I mean as Chris indicated earlier it bounced up and it bounced down like yesterday close I think at 232 or so.

The 10 year treasury.

So I mean that gets us below a 2% coupon on 15 year NBS and that’s pretty painful when you are thinking about a four year duration lock in into something like that.

Got it, okay. Thank you very much.

But we would love to see interest rates go up we just were a little concerned that the short term interest rates go up and the long term interest rates do nothing. And that will be painful for all banks but we are hoping that the yield curve just shift up.

Got it. Alright, thank you very much.

Thanks.

Thank you Ms. Balicka, sorry about that Ma’am. Looks like we have no further questions at this time. I’d like to hand the conference back over to Mr. Myers.

Well thank you all very much for joining us on our call today and we appreciate your interest and look forward to speaking with you again on our third quarter 2015 earnings conference call in October. In the meantime feel free to call Rich Thomas or myself. Have a great day. Thank you very much. Have a good summer bye-bye.

And we thank you sir and to the rest of the management team for your time also today. The conference call is now concluded. At this time you may disconnect your lines. Thank you again everyone and have a great day.