CVB Financial Corp (CVBF) 2013 Q3 法說會逐字稿

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.

At this time, all participants are in a listen-only mode. Later we will conduct a question and answer period. 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. 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 and 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 provisions, 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.

For the first nine months of 2013, we earned $70.3 million compared with $55.1 million for the first nine months of 2012. Earnings per share were $0.67 for the nine-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 Rodino, 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 America West 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 our 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 noncovered, 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 noncovered loans at September 30 of 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 noncovered 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 protection 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 one year from now.

Now, I would 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 (sic) -- 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 experience 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 years' 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 would 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 nine months ended September 30, 2013, compared with 33% for the six months ended June 30, 2013. Overall, our estimated effective tax rate may fluctuate based upon the ratio of taxable income to total income, considering tax advantage, municipal bond income, and non-deductible 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 proximately 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.

Firstly, all of our mortgage-backed securities are issued by Freddie Mac or Fannie Mae, which have the implied guarantee of the US government. We also have three 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 three months. We did this in anticipation of the current interest rate environment which was foreshadowed 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 four 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 have been on the rise. Construction, aided by a rebounding housing market, has led the 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 two 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 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.

Aaron Deer, Sandler O'Neill and Partners.

Question about the -- well, first off, it was great to see some really strong growth this quarter. And I am 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 have had during my seven-year tenure with the bank. So, best luck we have had in terms of new loans was September.

And our pipeline remains strong. So we are 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 two things is what led to the $100 million in growth.

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 build up here at the end of the year. Last year I think it was around $50 million or something like that. So that is a possibility this year as well.

Okay. And then, just a follow up on the comp line. You noted the increase this quarter. I'm wondering -- I know you have 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 is not merit increases. It is more -- it's the -- 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.

Robert Greene, Sterne, Agee.

It's a couple of questions. One is with the uptick in loan growth, obviously a very positive sign for you guys.

I am wondering does that change for your calculus at all in terms of your M&A outlook? I mean, does the -- with the new lending initiatives and the opening of the offices in some of these other parts of California, are you now more focused on organic growth and perhaps maybe doing a deal?

You know what? That is a great question, by the way. And it is something that we have 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 are fighting -- we have been fighting through that for the last four quarters, five quarters as we have been on offense.

And 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 have done haven't fully kicked in, like San Diego, our new hires in Orange County. They haven't started producing business yet. Hopefully, that is 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 are not going to deploy that capital through organic loan growth. We are going to deploy that capital through acquisitions.

So if we could get both those things humming, that is going to be the real great answer for CVB and our earnings growth.

Okay. Then just a follow-up as it relates to capital. Obviously, you guys are close to 11% TCE and capital formations is positive. You guys' returns are excellent this point.

I am just wondering, with the -- there is the FHLB advances which are -- I know it is very prohibitive, prepaid expense on that. But I was wondering, is there a 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 of maybe doing some more on the buyback?

Yes. Another good question. You know, 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 -- you know, the $200 million 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 is the answer on that.

As far as buybacks, M&A is still on our minds. We are having a lot of discussions out there. There is a lot of opportunities out there, both us reacting to some of those opportunities and also being proactive in the marketplace. It is just, we don't have anything to announce at this point, but we are working hard at it.

Julianna Balicka, KBW.

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 will have to get there? I mean, I know you want to be conservative, but there is outside pressures that sometimes force your methodology.

Yes. You know, we have a 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 have gone quarter over quarter.

A lot of that has to do with our unallocated reserves. If you look at our unallocated reserve, it has been running around 7% or something like that. So that is 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 as you see dairy improve more and you see real estate prices firm up more, that is going to have -- 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. So all those things (multiple speakers) stair step it.

And what is the remaining classified loans, so we can think about it 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 are down from the -- just in the last two quarters, we are down $55 million in classified loans, or close to 20%.

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 a comparison over the last -- in the second quarter it was [$1.138 million] and in the first quarter it was $954,000. So it was lower than those two quarters, but it is down.

And we would anticipate that that is going to -- I mean, I can't speak -- some of these prepayment penalties we get, we still keep the loan. We will get the prepayment penalty and we will keep the loan and extend the loan for them. So that is the win-win, right?

But we would anticipate, as rates get a little bit higher, those prepayment penalties fees low moderate. But now rates are starting to come down a little bit, it could stay there. Who knows?

Eric Grubelich, Highlander Bank Holdings.

Eric Grubelich, good morning. The 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.

In terms of running assets, do you anticipate bolting on more securities going forward or do you see this unwinding? That is the first question.

And then, the second part of it is, are you managing -- given the -- 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 bogey or dollars of margin?

The answer to that is -- we are actually -- we are just looking at this situationally as we go along. Your comment about the level of securities as a percentage of our balance sheet, I think we are at 39.9% -- securities were, of our assets at the end of the quarter. That is a pretty robust level.

One of the things that we look at is how are we funding these securities. And we are funding them with deposits. And how strong are those deposits?

And if you look at our growth in deposits over the last year, it is really been on the non-interest 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 are 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 quote-unquote hotter money and then filter it in and buy securities and take additional interest rate risk.

So we pre-bought securities this quarter just because the rates ran up. And so when we see the longer [team] rates run up, we can get more yield and we know that we are 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 is now moderating down to about $30 million a month.

So for instance, in the quarter, 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 runoffs 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 is going to be used up by runoffs in the next three, four months. I don't know if you have anything to add to that, Rich, but.

That is exactly the strategy, Chris.

Yes. Okay. So -- and that's where we are. But we are not -- the answer is loans here. And we know the answer is loans.

And one of the things that we are also looking carefully at is the interest rate risk we are taking on those loans. So we haven't done many, if any, swaps this year.

And we are looking at that for some of our longer-term financing and maybe kicking more of that in, just to insulate us against interest risk, because we really prefer to book five-year fixed rate paper or seven-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 the securities portfolio, the -- so you are layering on swaps where you are doing more of this longer-term in nature commercial real estate lending.

Well, we have historically. We have historically done interest rate swaps that are loans, not on our securities. So we haven't done -- I don't think we have done any swaps this year because the rate market has not been there.

But, in total, of our commercial real estate portfolio, I would say for argument's sake is about $2.2 billion. We have $250 million of that on interest rate swaps. And the stuff that we have swapped is either 10-year fixed rate paper or 15-year fully amortizing fixed rate paper, for the most part.

Okay. And, just so I understand, the securities, that $305 million figure, was that -- 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 is just what we purchased.

Purchased (multiple speakers).

And it was actually at $311 million or something like that because we buy some munis, too. But it was like $305 million in mortgage-backed or -- (multiple speakers)

[$307 million and $7 million] up to $314 million total.

Okay (multiple speakers) mortgage-backs and $7 million in munis.

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

Yes.

Okay.

Mortgage was done later in the quarter.

Okay great. Thanks for the detail.

(Operator Instructions) Hugh Miller, Sidoti.

So, just in following up, it sounds like the opportunities on the M&A side and the things are looking at from what you are saying, it seems like it is improving. Can you just talk about -- first, are you still looking for kind of stronger franchises, non-turnaround stories?

And then, second, what is driving potentially that increase in opportunities? Is it kind of the potential for a rise in TARP rates or just a rise in overall evaluation from your currency standpoint? Or what are you seeing there?

The answer is yes, or 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 is our type of bank.

We are looking for stronger franchises where we can cross-sell a lot of our products into their clients. And they are in-market so we can do some cost savings, or they are 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 are trading over two times 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 are all involved in deals right now -- pretty large deals, so I think they are probably on the sidelines. I can't speak to that. I don't know. But I am guessing that they are on the sidelines.

So, a little bit more of our competition on deals appears to be coming from more of 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'd like to turn the call back to Mr. Myers.

Thank you very much. One last thing I wanted to mention that we were very excited about, we measure our income and obviously we look at our net interest income. We measure all kinds of different things.

But one thing we were very excited about was our total interest income for the quarter was up quarter over quarter for the first time in the last six quarters. So that's an important trend line for it. We call it kind of topline income.

So we feel and we are hopeful that we are going to continue that topline income growth. And then if we can hold the line on the expense side and continue to grow, that is going to bring greater profit level.

So this was the first quarter in the last six quarters, at least, probably longer than that, but I am looking at six quarters right now, and I can tell you that that is the first quarter that we showed that total interest income growth. So we are excited about that. And that is 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.