CVB Financial Corp. (NASDAQ:CVBF) Q3 2023 Earnings Call Transcript

CVB Financial Corp. (NASDAQ:CVBF) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the Third Quarter 2023 CVB Financial Corporation and its subsidiary Citizens Business Bank Earnings Conference Call. My name is Cherie, 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.

David Brager: It looks like Christina may have some technical difficulties. Cherie, can you hear us okay?

Christina Carrabino: I’m on the line now.

David Brager: Okay. Go ahead, Christina.

Christina Carrabino: Thank you, Cherie, and good morning, everyone. Thank you for joining us today to review our financial results for the third quarter of 2023. Joining me this morning are Dave Brager, President and Chief Executive Officer; and Allen Nicholson, Executive Vice President and Chief Financial Officer. Our comments today will refer to the financial information that was included in the earnings announcement released today. To obtain a copy, please visit our website at www.cbbank.com and click on the Investors tab. 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, 2022, and in particular, the information set forth in Item 1A, Risk Factors therein.

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For a more complete version of the company’s safe harbor disclosure, please see the company’s earnings release issued in connection with this call. Now I will turn the call over to Dave Brager. Dave?

David Brager: Thank you, Christina, and good morning, everyone. For the third quarter of 2023, we reported net earnings of $57.9 million or $0.42 per share, representing our 186th consecutive quarter of profitability. We previously declared a $0.20 per share dividend for the third quarter of 2023, representing our 136th consecutive quarter of paying a cash dividend to our shareholders. Our net earnings of $57.9 million or $0.42 per share compares with $55.8 million for the second quarter of 2023 and or $0.40 per share and $64.6 million for the year-ago quarter or $0.46 per share. Although headwinds exist in the current operating environment, we continued our long history of producing solid quarterly earnings and returns on capital in the third quarter.

We produced a return on average tangible common equity of 18.82% and a return on average assets of 1.4% for the third quarter. Our pretax pre-provision income growth over the second quarter of 2023 was 5.7% as our pretax pre-provision income for the third quarter of 2023 was $82.6 million, compared with $78 million for the second quarter of 2023. This growth in earnings reflects the positive operating leverage we generated this quarter with total revenue growing by 4.2% compared to expense growth of 1.9%. We continue to be among the industry leaders with respect to expense control with a 40% efficiency ratio for the third quarter and full year 2023. Our net interest margin grew by 9 basis points from the second quarter of 2023 to 3.31% for the third quarter, reversing the trend of a declining net interest margin from the prior 2 quarters.

The expansion of our net interest margin was the net result of a 17 basis point increase in our earning asset yield, which offset a 9 basis point increase in our cost of funds. Total loans outstanding declined from the second quarter of 2023 by approximately $30 million to $8.88 billion at the end of the third quarter. Our allowance for credit losses increased to approximately $89 million on September 30 based on net recoveries of $28,000 and $2 million in provision for credit losses for the third quarter of 2023. Average total deposits for the third quarter increased by approximately $278 million compared to the second quarter of 2023. Our average noninterest-bearing deposits continue to be greater than 62% of our average total deposits. At September 30, 2023, our total deposits were $12.4 billion, decrease from June 30, 2023.

I would highlight that we continue to have 0 brokered deposits. Noninterest-bearing deposits declined by $292 million, while interest-bearing deposits increased by $253 million from the end of the second quarter of this year. The velocity of deposits moving to CitizensTrust continued to decline in the third quarter with approximately $170 million transferred off balance sheet in the quarter compared to $180 million in the second quarter and $370 million in the first quarter of 2023. Customer repos were $270 million at the end of the third quarter, which was $183 million lower than the balance at June 30, 2023. We’ve experienced a $773 million decline in deposits and customer repos from the end of 2022, which includes, as I just noted, the $720 million that was moved to CitizensTrust, where these funds were invested in higher-yielding liquid assets, such as treasury notes.

The bank continues to acquire new deposit customers. New accounts opened during the first 9 months of 2023 totaled approximately $867 million of new average deposits. We have historically maintained one of the lowest cost of deposits in the industry based on the customers we target and our business model. Our cost of deposits was 52 basis points on average for the third quarter of 2023, which compares to 35 basis points for the second quarter of 2023 and 5 basis points for the third quarter of 2022. From the first quarter of 2022 through the third quarter of 2023, our cost of deposits has increased by 49 basis points, representing a deposit beta of less than 7% since the Federal Reserve began this tightening cycle by increasing rates by 525 basis points.

Now let’s discuss loans. Total loans at September 30, 2023, were $8.9 billion, a $30 million decrease from June 30, 2023, and a $202 million or 2.2% decrease from the end of 2022. The quarter-over-quarter decline was led by a $61 million decline in commercial real estate loans. We also experienced an $18 million decrease in C&I loans as the line utilization declined from 31% at the end of the second quarter to 27% at the end of September 2023. Partially offsetting the decrease in commercial and real estate loans was a $49 million increase in dairy and livestock loans. Utilization on dairy and livestock loans was at 73% on September 30, 2023, which compares to 67% at the same point last year. From December 31, 2022, loans declined by $109 million after excluding the seasonal increase in dairy and livestock loans from year-end and PPP loan forgiveness.

Dairy and Livestock loans decreased by $87 million from December 31, 2022, as we experience a seasonal peak in line utilization in the fourth quarter of each year. Commercial real estate loans decreased by $42 million from the end of 2022 to September 30, 2023, and C&I loans decreased by approximately $11 million over the same period as line utilization decreased from 33% to 27%. In addition, construction loans declined by $25 million and consumer loans are lower by $23 million. Loan growth continues to be impacted by a slowdown in loan demand. Our new loan production weakened in the third quarter. New loan commitments were approximately $288 million in the second quarter of 2023 and approximately $217 million in the third quarter of 2023. In comparison, we originated $443 million of new loans in the third quarter of 2022.

New loan production at the end of the third quarter of 2023 was generated at average yields of approximately 7%. Although loans declined at quarter end from the end of the second quarter, we recorded a provision for credit losses of $2 million for the third quarter of 2023 to reflect a further deterioration in our economic forecast. Asset quality continues to be strong, and the trends remain stable. At quarter end, nonperforming assets, defined as nonaccrual loans plus other real estate owned, were $10 million or 6 basis points of total assets. The $10 million in nonperforming loans compared with $6.5 million for the prior quarter and $10.1 million for the year-ago quarter. The increase from the prior quarter was primarily due to a C&I loan that was placed on nonaccrual at the end of the third quarter.

During the third quarter, we experienced credit charge-offs of $26,000 and total recoveries of $54,000, resulting in net recoveries of $28,000 compared with net charge-offs of $73,000 for the second quarter of 2023. Year-to-date, net charge-offs were $122,000. Classified loans for the second quarter were $92 million compared with $78 million for the prior quarter and $64 million for the year-ago quarter. Classified loans as a percentage of total loans was 1.04% at quarter end. The $14.4 million increase in classified loans quarter-over-quarter was primarily due to a $24.4 million increase in classified commercial real estate loans, partially offset by a $10.2 million decrease in classified, dairy and livestock and agribusiness loans. The increase in classified loans for the commercial real estate category was primarily due to one relationship in which approximately $20 million of nonowner-occupied commercial real estate loans were downgraded due to the death of a borrower during the third quarter.

This loan is well collateralized and the property is currently listed for sale. We anticipate no loss once the property is sold. I will now turn the call over to Allen to discuss the allowance for credit losses, investments, borrowings and capital. Allen?

Allen Nicholson: Thanks, Dave. Good morning, everyone. As of September 30, 2023, our ending allowance for credit losses was $89 million or 1% of total loans, which compares to $87 million or 0.98% of total loans at June 30, 2023, and $85.1 million or 0.94% of total loans at December 31, 2022. For the quarter ended September 30, 2023, we recorded a provision for credit losses of $2 million compared to $500,000 for the quarter ended June 30, 2023, and $2 million for the third quarter of 2022. The provision for credit losses in the third quarter was driven by the change in our economic forecast, which resulted in lower projected GDP growth, lower commercial real estate values and higher unemployment when compared to our forecast at both June 30 and the end of 2022.

Our economic forecast continues to be a blend of multiple forecasts produced by Moody’s. We continue to have the largest individual scenario weighting on Moody’s baseline forecast, with downside risk weighted among multiple forecasts which individually reflect various degrees of economic recession in 2024 and early 2025. The resulting economic forecast reflects a modest decline in GDP in the first half of 2024, but a more significant decrease in commercial real estate values that persist through all of 2025 and an unemployment rate rising through 2025. The resulting weighted average forecast assumes GDP will increase by 2.1% in 2023, followed by a modest recession at the beginning of 2024, and full year GDP growth of just 0.3% for all of 2024.

GDP then grows at 1.1% in 2025. The unemployment rate is forecasted to be 3.8% in 2023 and 5.2% in 2024 with peak unemployment of 5.7% in 2025. Total borrowings declined by $375 million from June 30, 2023, as cash balances were drawn down by $378 million over that same time period. Borrowings as of September 30, 2023, consisted of $870 million from the bank term funding program that mature in 2024 with a weighted average rate of 4.87%, as well as $250 million of remaining short-term advances from the Federal Home Loan Bank. As of September 30, the cost of these FHLB advances were 5.05%. All of the FHLB borrowings will mature within the fourth quarter of this year. We continue to shrink our investment portfolio. Our total investment portfolio declined by $280 million from June 30, 2023, to $5.4 billion as of September 30.

Of the approximately $120 million of cash flows generated by our investments during the third quarter of ’23, we reinvested approximately $30 million in short-term treasuries. The overall decrease in our investment portfolio was primarily due to $195 million decline in investment securities available for sale, or AFS securities. AFS securities totaled $2.87 billion at the end of the third quarter, inclusive of a pretax net unrealized loss of $628 million. Investment securities held to maturity, or HTM securities, totaled approximately $2.49 billion at September 30, 2023. The HTM portfolio declined by approximately $23 million from June 30 as cash flows were not reinvested during the quarter. The tax equivalent yield on the entire investment portfolio was 2.64% for the third quarter of 2023 compared to 2.37% for the prior quarter.

The increase in yield for the third quarter benefited from a $3.8 million of interest income from the positive carry on fair value hedges we executed in late June of this year. We receive daily SOFR on these pay fixed swaps that have a weighted average fixed rate of approximately 3.8%. Now turning to our capital position. The company’s tangible common equity ratio at September 30, 2023, was 7.73%, consistent with the prior quarter’s ratio of 7.75%, while being higher than the 7% at September 30, 2022. Shareholders’ equity decreased from the second quarter by $50 million to $1.95 billion at the end of the third quarter. Our OCI declined by $82 million due to the impact of higher interest rates that increased the unrealized loss on our AFS portfolio.

At the end of the second quarter of 2023, we entered into $1 billion in notional pay-fixed rate swaps as fair value hedges to mitigate the risks of rising interest rates on our capital. These pay-fixed swaps have maturities ranging from 4 to 5 years. At September 30, 2023, we recorded a fair value adjustment associated with the swap derivatives which increased other comprehensive income by $17.6 million, partially mitigating the impact to OCI of the decline in the fair value of our AFS portfolio. Equity increased for the first 9 months of 2023 by $3 million. Retained earnings increased as year-to-date income of $173 million was offset by $84 million in dividends for the 9 months of this year. The resulting year-to-date dividend payout ratio was 48.4%.

The 10b5-1 stock repurchase plan we initiated in 2022 expired on March 2, 2023. There were no shares purchased during the second and third quarters of 2023. During the first quarter of this year, we did repurchase approximately 792,000 shares of common stock at an average price of $23.43, totaling $18.5 million in stock repurchases. Our overall capital position continues to be very strong. Our regulatory capital ratios are well above regulatory requirements to be considered well capitalized and above the majority of our peers. At September 30, 2023, our common equity Tier 1 capital ratio was 14.4%, and our total risk-based capital ratio was 15.3%. I’ll now turn the call back to Dave for further discussion of the third quarter earnings.

David Brager: Thank you, Allen. Net interest income before provision for credit losses was $123.4 million for the third quarter compared with $119.5 million for the second quarter and $133.3 million for the year-ago quarter. Our tax equivalent net interest margin was 3.31% for the third quarter of 2023 compared with 3.22% for the second quarter and 3.46% for the third quarter of 2022. Interest income grew by nearly $7 million over the prior quarter as our earning asset yield increased 17 basis points quarter-over-quarter based on the combination of 6 basis point increase in loan yields and the impact of $3.8 million a positive carry on pay-fixed swap derivative income in the third quarter. Third quarter average earning assets decreased by $68 million from the second quarter due to an increase in both average investment securities of $147 million and average loans outstanding of $30 million.

The decline in those assets was offset by an increase of $121 million in average funds on deposit at the Federal Reserve. Interest expense increased by $3.2 million over the prior quarter as our cost of funds increased by 9 basis points from the second quarter of 2023. Interest expense on deposits increased by $5.7 million due to the combination of a $288 million increase in average interest-bearing deposits in the third quarter and a 41 basis point increase in the cost of interest-bearing deposits. The cost of interest-bearing deposits was 1.37% in the third quarter compared to 96 basis points in the prior quarter. Interest expense on borrowings however declined by $2.6 million as average borrowings declined by $209 million. The $10 million decline in net interest income from the year-ago quarter resulted from a 15 basis point decrease in net interest margin and a $484 million decline in average earning assets.

The year-over-year net interest margin decline was due to an 87 basis point increase in our cost of funds, offsetting a 67 basis point increase in earning asset yields. The increase in earning asset yields was the result of higher loan and investment yields in the third quarter of 2023 compared to the third quarter of 2022, as well as an improved asset mix in which average loans grew from approximately 56% of earning assets in the third quarter of 2022 to 59% in the third quarter of 2023. Loan yields were 5.07% for the third quarter of 2023 compared with 4.56% for the year-ago quarter. Investment security yields increased 52 basis points from a yield of 2.12% in the prior year quarter to 2.64% in the third quarter of 2023. Moving on to noninterest income.

Noninterest income was $14.3 million for the third quarter of 2023 compared with $12.7 million for the prior quarter and $11.6 million for the year-ago quarter. Our customer-related banking fees, including deposit services, international and merchant bankcard services, increased by $224,000 compared to the second quarter and declined by $171,000 when compared to the third quarter of 2022. Although our trust and wealth management fees decreased by $69,000 compared to the second quarter of 2023, year-over-year, these fees grew by $379,000. Third quarter BOLI income declined by $549,000 as the second quarter of 2023 included $806,000 in death benefits that exceeded the asset value of certain BOLI policies. BOLI income decreased by $439,000 compared to the third quarter of 2022.

The third quarter of 2022 included $1.8 million in death benefits received, which was partially offset by more favorable market impacts on separate account policies during the third quarter of 2023. Compared to the second quarter of 2023, CRA investment income increased as the third quarter included $2.6 million of income from an equity fund distribution related to one of our CRA investments. Now expenses. Noninterest expense for the third quarter was $55 million compared with $54 million for the second quarter of 2023 and $53 million for the year-ago quarter. The third quarter of 2023 included $900,000 in recapture of provision for unfunded loan commitments compared to $400,000 in provision for the second quarter of 2023. There was no provision for the third quarter of 2022.

Salaries and employee benefit costs increased $1.2 million quarter-over-quarter, including annual salary increases that were effective at the beginning of the quarter. The quarter-over-quarter increase in salary expense was approximately $800,000 or 3.3% higher than the second quarter. As loan originations were lower in the third quarter, the contra expense from deferred loan origination costs declined, therefore increasing staff expense by almost $300,000. The $2 million increase in noninterest expense year-over-year included an increase of $1.5 million or 4.6% in salaries and employee benefits. Salary expense grew by 3.5% or approximately $800,000 over the second quarter of 2022. Deferred loan origination costs were also lower than the prior year quarter, resulting in an additional staff expense of $800,000.

Regulatory assessment expense increased by more than $800,000 over the prior year quarter. Noninterest expense totaled 1.33% of average assets for the third quarter of 2023. This compares with 1.32% for the second quarter and 1.25% for the third quarter of 2022. Our efficiency ratio was 39.99% for the third quarter of 2023. This compares with 40.86% for the prior quarter and 36.59% for the third quarter of 2022. This concludes today’s presentation. Now Allen and I will be happy to take any questions you may have.

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Q&A Session

Operator: [Operator Instructions]. And our first question will come from the line of Matthew Clark with Piper Sandler.

Matthew Clark: I want to first touch on the $850 million, I think, comes due next year. What’s your plan for that? Are you going to just pay it off or are you going to refinance some portion of it?

Allen Nicholson: Well, I mean, I think — that’s a fairly long time in the future. But strategically, we’d love to just continue to grow deposits and pay it off with deposits as well as security paydowns over that period of time. So — but we’ll see what the future brings.

Matthew Clark: Okay. And then just along those lines on the deposit side, could you just touch on the pipeline there? I think when we were together a couple of months ago, I mean, it sounded like things had increased quite a bit just given all the disruption in the markets and how — since the turmoil. And I think end of period noninterest-bearing deposits were down, but the average was relatively flat. So just any color around the movement there in the pipeline.

David Brager: Yes. The pipeline is still strong. I mean, when you’re working on operating companies, it does take quite some time to move those relationships. You have to get everything set up from a treasury management perspective. The deposit pipeline still remains strong, stronger than our loan pipeline in pure dollars, but the sales cycle is a little bit longer. It’s not like there’s a growing a commercial real estate loan. And so we’re continuing to focus on deposit growth. As you know, the fourth quarter is always a little bit more challenging for us just due to some seasonality. And just to give you some color on the deposits, the last 10 business days of the month of September, our deposits went down by $283 million, and that was a result primarily of the payment of taxes.

And I think that, that sort of got moved around and the timing just because of the fact that people could pay their taxes later in the year. And then ultimately, now the taxes don’t have to be paid until November, but most people had already sent out their taxes prior to that. So prior to the last 10 days, we were very stable on the deposit side, as evidenced by the average deposits being up so high during the quarter. So I feel relatively positive about the deposit pipeline. I feel relatively positive about the go-forward. But we do have some historical seasonality in the fourth quarter that will challenge us a little bit there as well. So I think all in all, we’re in a really good spot, but we have a lot of work to do. We have to execute.

Matthew Clark: Got it. Okay. And then on the securities portfolio, I mean, your CET1 is up another 30 basis points to 14.4%, and it seems like we’re in a higher-for-longer environment. I guess, can you give us an update on your appetite to restructure that portfolio, given your ability to easily absorb those losses?

Allen Nicholson: We always evaluate opportunities. But at this point, I don’t foresee anything of significance.

Matthew Clark: Okay. And then lastly, just any color around the uptick. I know it’s still relatively — a relatively small amount. But on the classified side, it looked like book non-owner and owner-occupied commercial real estate. Just any color there, your plans to kind of deal with those credits.

David Brager: Yes. So the majority of the increase was really one relationship, a loan. It’s paying, it’s current. It’s a mixed-use property across the street from UCLA that is listed for sale. They have an offer apparently on the property. We’re well collateralized. I anticipate that it should close in the fourth quarter. We don’t anticipate any charge-off, actually, the proposed sales price is significantly higher than our loan amount by 3x or 4x. So I don’t anticipate any problem there. I mean, obviously, the loan has to close. But it’s been — the credit trends have been very stable as well. The borrower died in the third quarter, and we downgraded the loan. But his heirs are in the process of — it’s listed and it should sell in the fourth quarter, barring any big problem.

Operator: [Operator Instructions]. Question will come from the line of Kelly Motta with KBW.

Kelly Motta: I was hoping you could give us a little bit of perspective on your outlook for loan growth. Could you talk a little bit about how the pipeline is? Remind us of any seasonality, any areas you may be getting more cautious. As well as provide any color on how pricing and spreads are holding up, and where new loan originations are coming on?

David Brager: Yes. So at the end of the fourth — or the end of the third quarter, excuse me, new loan originations were up over 7%. The pipelines, I would say, remained challenged. However, there are some things that we’re working on. The fourth quarter is always a good quarter for us. If you just look at the gross amount, because we have dairy advances, we anticipate that being pretty close to seasonal averages over — looking back over the years. But I still — the pipelines are definitely smaller than they were a year ago. Pricing is impacting people’s decisions. We still want to make quality loans, but I think there’s a lot of people that’s sort of waiting on the sidelines to see if things turn ugly where they can take advantage of those opportunities.

So I’m still aiming for that low single-digit growth. We didn’t hit it this quarter, obviously. We were down $30 million quarter-over-quarter, point to point. But we’re still booking new loans, but it’s a little less than half of what we were doing a year ago. I think I got all of your questions. Was there anything…

Kelly Motta: Sorry, that was like a five-parter. I appreciate the color on your appetite for securities, restructuring and how you’re approaching that. Just wondering, the $1 billion in swaps you put on really nicely helped the margin this quarter. Can you remind us — I think you said the rate on that was 3.8%. Just remind us what the tenure or duration is on that, and what your appetite could be about potentially adding more to swap out more of your securities exposure.

Allen Nicholson: Yes. Kelly, you’re correct. The average — the weighted average cost on those fixed swaps is 3.8%. And there are 4- and 5-year tenors, I would say weighted more towards 5. We’ll continue to evaluate. I don’t know that we think immediately that we need to do more in that space. We’re happy with how it’s positioned the balance sheet, but we will continue to evaluate that and other hedging opportunities.