Cvb Financial Corp Q3 FY2024 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Third Quarter 2024 CVB Financial Corporation and its subsidiary, Citizens Business Bank Earnings Conference Call. My name is Shuri, and I'm your operator for today. Please note, this call is being recorded. I would now like to turn the presentation over to your host for today's call, Allen Nicholson, Executive Vice President and Chief Financial Officer. You may proceed.

Thank you, Shuri, and good morning, everyone. Thank you for joining us today to review our financial results for the third quarter of 2024. Joining me this morning is Dave Brager, President and Chief Executive 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 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, 2023, and in particular, the information set forth in Item 1A, Risk Factors therein. 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. I'll now turn the call over to Dave Brager.

Thank you, Allen. Good morning, everyone. For the third quarter of 2024, we reported net earnings of $51 million or $0.37 per share, representing our 190th consecutive quarter of profitability. We previously declared a $0.20 per share dividend for the third quarter of 2024, representing our 140th consecutive quarter of paying a cash dividend to our shareholders. We produced a return on average tangible common equity of 14.93% and a return on average assets of 1.23% for the third quarter of 2024. Our net earnings of $51 million or $0.37 per share compares with $50 million for the second quarter of 2024, or $0.36 per share and $57.9 million, or $0.42 per share for the prior year quarter. Quarter-over-quarter, our pretax pre-provision income grew by 2%, excluding net gains and losses. Total revenue, excluding gains and losses, grew by 2.9% or $3.7 million compared to the second quarter of 2024, primarily due to a $2.8 million increase in net interest income. Our core noninterest expense increased by 3.8% or $2 million compared to the prior quarter. On September 26th, we completed an early redemption of our $1.3 billion bank term funding program borrowing that was scheduled to mature in January of 2025. Total assets declined by approximately $750 million from the end of the second quarter of 2024 as the BTFP redemption was offset by more than $400 million of growth in deposits and customer repos. As part of our strategy to pay off the BTFP borrowings and deleverage our balance sheet, we executed two sale-leaseback transactions in which we sold and leased back two banking center buildings under long-term leases, realizing gain on sale totaling $9.1 million. In conjunction with these real estate transactions, we sold more than $300 million of available-for-sale investment securities at a cumulative loss of $11.6 million. Although total assets declined to $15.4 billion by September 30, 2024, average earning assets grew by $262 million, or 1.8%, from the second quarter of 2024 to the third quarter of 2024, which drove the $2.8 million quarter-over-quarter increase in net interest income. Our net interest margin was 3.05% in the third quarter, the same as the prior quarter. The third quarter is generally a strong deposit quarter for our bank. We experienced an increase in deposits and customer repos of $408 million from the end of the second quarter to September 30, 2024. The quarter-over-quarter growth in average deposits and customer repos was $251 million. Our average noninterest-bearing deposits were greater than 59% of our average total deposits for the third quarter of 2024. At September 30, 2024, our total deposits and customer repurchase agreements totaled $12.5 billion, a $762 million increase from December 31, 2023. The increase in total deposits and customer repos includes the addition of $400 million in brokered time deposits that were added to the balance sheet during the first quarter of 2024. For the first 9 months of 2024, approximately $200 million of deposits have moved to Citizens Trust. These funds were invested in higher-yielding liquid assets such as treasury notes. This compares to $800 million that was transferred during 2023. Our cost of deposits and customer repos was 101 basis points for the third quarter of 2024, which compares to 87 basis points for the second quarter of 2024 and 51 basis points for the year ago quarter. Our cost of non-maturity deposits has grown from 60 basis points in December 2023 to 88 basis points in September of 2024, while our cost of time deposits has grown from 1.84% in December of 2023 to 3.24% in September of 2024. From the first quarter of 2022 through the third quarter of 2024, our cost of deposits has increased by 95 basis points. Our deposit beta on non-maturity deposits from the beginning of the Fed's 525 basis point increasing rate cycle through the end of the third quarter of 2024 was 16%. Now let's discuss loans. Commercial real estate loan demand continues to be tepid. C&I line utilization also continues to be low, even though we have grown our total C&I loan commitments. Total loans at September 30, 2024, were $8.6 billion, a $109 million or 1% decrease from the end of the second quarter and a $332 million decline from December 31, 2023. The quarter-over-quarter decrease was led by a $46 million decline in commercial real estate loans, a $38 million decline in construction loans, and a $20 million decrease in commercial and industrial loans. The decrease in loans from the end of 2023 included a $77 million decrease in dairy and livestock loans. Dairy and livestock loans see higher line utilization at year-end, which is reflected in the 80% utilization rate at the end of the fourth quarter of 2023 compared to the 71% utilization rate at September 30, 2024. Commercial real estate loans declined by $166 million from December 31, 2023, as commercial real estate loan demand has weakened. Our CRE loan production for the first 9 months of 2024 has lagged the same period in 2023 by more than 30%. Construction loans declined by $52 million over the same period as construction loan origination has been minimal. C&I loans declined by $33 million when comparing the third quarter in balance to December 31, 2023. C&I line utilization continues to be at a rate of less than 30%. We compete on loans very selectively, which can impact new loan production and loan yields. Even considering the high credit quality of our new loan originations, yields on new loans in 2024 have been greater than 7.25%. However, loan rates have been under pressure recently from competition and near-term originations will likely average below 7%. Our continued focus on banking the best small- to medium-sized businesses and their owners, providing them our full array of products has resulted in a higher percentage of new loans in 2024 that are either owner-occupied or C&I loans. Nonowner-occupied loan originations in 2024 have been approximately 16% of total loan originations, which compares to approximately 26% for the same 9-month period in 2023. We believe our asset quality remains strong as nonperforming loans declined by $3 million and our classified loans remained relatively flat quarter-over-quarter. Our allowance for credit losses totaled approximately $83 million at September 30, the same as June 30, 2024. Net recoveries in the third quarter were $156,000 compared to net charge-offs of $31,000 in the second quarter of this year. At quarter end, nonperforming assets, defined as nonaccrual loans, plus other real estate owned, were $22.6 million or 15 basis points of total assets. The $22.6 million in nonperforming loans compares with $25.6 million for the prior quarter. Classified loans were $125 million for both the third quarter and the prior quarter. Classified loans as a percentage of total loans was 1.45% at quarter end. Classified dairy and livestock and agribusiness loans declined by $3.5 million due to paydowns, while classified commercial and industrial loans increased by $3.5 million, primarily due to the addition of one classified commercial and industrial loan. At September 30th, we had approximately $31 million of commercial real estate loans that were past due more than 30 days but less than 90 days. Two loans that comprised approximately 80% of these past due loans went on nonaccrual in October. We believe that these loans are well secured, and there are no anticipated charge-offs. In October, we also foreclosed on three nonperforming loans, one of which was a $2.2 million loan that was fully paid off by a third party that purchased the asset at foreclosure. Of the two remaining loans, a $4.8 million loan has become an OREO asset, but we have multiple offers that exceed our book value. The third loan is the previously discussed senior living facility participated loan acquired in the Suncrest merger. In October, the loan was foreclosed and became an OREO asset of approximately $4 million. There are multiple offers on this property, which we believe will result in a recovery of most or all of the charge-off we took in the first quarter of 2024. I will now turn the call over to Allen to further discuss our net interest income and additional aspects of our balance sheet. Allen?

Thanks, Dave. Interest income grew by $6.7 million over the prior quarter. Our average balance of funds at the Federal Reserve increased from the second quarter by more than $500 million to approximately $1.2 billion. This growth generated an increase in interest income of $7.2 million. Interest income from our security portfolio declined by $1.2 million as we accelerated the decline in this low-yielding bond portfolio by selling $300 million of AFS securities during the third quarter, which contributed to a $127 million decline in average balance of our investment securities. Although average loans declined by $126 million compared to the second quarter of 2024, interest income on loans increased by more than $700,000 due to a 5 basis point increase in loan yields. Interest expense increased by $3.9 million over the prior quarter, reflecting a 9 basis point increase in our cost of funds. The increase in interest expense and our cost of funds was primarily due to an increase in interest expense on deposits and customer repos of $5.1 million. Interest-bearing deposits and customer repos grew on average by $279 million and the cost of deposits and customer repos grew by 14 basis points. Third quarter borrowing costs decreased by $1.2 million as average borrowings declined by $121 million. Our total investment portfolio declined by $305 million from the end of the second quarter of 2024, and by $550 million from December 31, 2023. AFS securities declined by $280 million from the end of the second quarter as we sold AFS securities during the third quarter with a book value of approximately $310 million. These security sales resulted in a pretax net loss of $11.6 million. The unrealized loss on AFS securities declined by $120 million from $488 million at June 30, 2024, to $368 million on September 30, 2024. Investment securities held to maturity or HTM securities totaled approximately $2.41 billion at September 30, 2024. The HTM portfolio declined by approximately $25 million from June 30, 2024. The tax equivalent yield on the entire investment portfolio was 2.67% for the third quarter of 2024, compared to 2.71% for the prior quarter. We continue to have positive carry on the fair value hedges we executed in late June of 2023. We received daily SOFR on these pay-fixed swaps, which have a weighted average fixed rate of approximately 3.8%. We recorded $4.3 million of interest income in the third quarter related to these swaps based on the spread of 170 basis points. The Federal Reserve's 50 basis point rate reduction in September and the anticipated rate reductions in November and December will reduce the spread we earn on these swaps. The market value of our fair value hedges, combined with our cash flow hedges, declined by approximately $35 million from the end of the prior quarter. As Dave noted previously, we executed two sale-leaseback transactions, and we sold two properties for an aggregate sale price of $17 million. We simultaneously entered into lease agreements with respective purchasers for initial terms of 15 and 18 years. These sale-leaseback transactions resulted in a pretax net gain of $9.1 million during the third quarter of 2024. We currently anticipate two additional sale-leaseback transactions during the fourth quarter of 2024. Once these transactions close, we expect to offset the corresponding gains with some loss trades from our AFS portfolio. Cash and cash equivalents declined to $453 million September 30th as a result of the redemption of the $1.3 billion of bank term funding program borrowings on September 26th. Our allowance for credit losses as of September 30, 2024, was $83 million, same level as the ACL was on June 30, 2024. Our third quarter ACL was 0.97% of total loans, which compares to 0.95% on June 30. Our ACL at December 31, 2023, was $86.8 million, which included a $5.9 million reserve for specifically identified nonperforming loans. Our reserves for specific loans have been essentially zero since the end of the first quarter of 2024. We did not record a provision in the first three quarters of 2024. 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. The resulting economic forecast resulted in real GDP declining slightly in the fourth quarter of 2024 and continuing to be negative in the first quarter of 2025. GDP growth is forecast to be less than 1% for all of 2025 before increasing to 1.4% in 2026 and then growth of 1.9% in 2027. Unemployment is forecast to increase with unemployment averaging 5.5% for all of 2025. The unemployment rate is forecast to stay higher than 5.5% until late 2027. Now turning to our capital position. At September 30, 2024, our shareholders' equity increased from the end of 2023 by $120 million to $2.2 billion. The company's tangible common equity ratio at September 30, 2024, was 9.7% compared with 8.7% at June 30, 2024, and 8.5% at December 31, 2023. Our regulatory capital ratios continue to grow and are among the highest in the industry. At September 30, 2024, our common equity Tier 1 capital ratio was 15.8%, and our total risk-based capital ratio was 16.6%. Our effective tax rate decreased during the third quarter of this year as a result of investments in tax credits, bringing our year-to-date effective tax rate to 26.25%. I'll now turn the call back to Dave for further discussions of our third quarter earnings.

Thank you, Allen. Moving on to noninterest income. Our noninterest income was $12.8 million for the third quarter of 2024 or $15.3 million when net gains and losses are excluded. This compares with $14.4 million for the prior quarter. Third quarter BOLI income increased by $557,000 quarter-over-quarter, including the receipt of $320,000 in debt benefits that exceeded the cash surrender values in the third quarter of 2024. In addition, our trust and wealth management fees increased by approximately $140,000 compared to the second quarter of 2024. Now expenses. Noninterest expense for the third quarter was $58.8 million compared with $56.5 million for the second quarter of 2024. The $2.3 million quarter-over-quarter increase was primarily due to a $1.2 million increase in staff-related expense as annual salary increases became effective at the beginning of July. We also had an increase in regulatory assessment expense of approximately $700,000 due to the reduction of our accrual for the special FDIC assessment in the second quarter of 2024. Occupancy expense grew by $330,000 or 7% when compared with the prior quarter, including the impact of the higher occupancy costs for the two banking centers involved in the sale-leaseback transactions. More than half the growth in occupancy expense was seasonal in nature due to higher utility costs. The third quarter of 2024 included $750,000 in recapture provision for unfunded loan commitments compared to $500,000 in recapture in the second quarter of 2024. Noninterest expense totaled 1.42% of average assets for the third quarter of 2024 compared with 1.4% for the prior quarter. Our efficiency ratio was 46.53% for the third quarter of 2024. This compares with 45.1% for the second quarter. This concludes today's presentation. Now Allen and I will be happy to take any questions that you might have.

Our first question will come from the line of Matthew Clark with Piper Sandler.

First one for me, just around the repayment of the BTFP. I wanted to get the yield on the securities sold. And then it looks like you also used some cash to pay that off. Can you just give us the moving parts in terms of the yield give up and so we can calculate the lift that you'll get in your NIM from the deleveraging?

The book yield on the securities we sold was less than 3%.

Okay. Any other pieces to the puzzle there? Or is it just cash and those securities?

Cash and securities. As I mentioned, we also grew deposits, which generated additional cash that we deployed.

Okay. And then it looks like deposit costs have stabilized in September based on Slides 41 and 47. What are your thoughts on deposit costs in general from here, assuming we get the forward curve?

A couple of things. During the last rate cut, we lagged the market on the way up with about a 16%-18% beta. We did lower some of our money market rates on the first cut. On future cuts we'll probably move closer to a 100% beta on the downside. We were about a 50% beta on the downside in the first cuts, which hasn't fully shown up in deposit costs yet. We saw a little movement below 60% on noninterest-bearing deposits, but they're still right there. Overall, it has definitely stabilized. We're still seeing some requests for higher rates, but most of those situations are being handled differently than in the rising rate environment. On the next cut, we'll take a deeper dive into rates that are probably 1.5% or higher and look at those. We did the first round on rates that were 2.5% or higher, and we'll keep ratcheting that down as the Fed makes moves. Allen, anything to add?

No, I think that covers it.

Okay. Great. And then last one for me, just on M&A and buybacks. Any update on whether or not you think you might be able to announce a deal before year-end? And if not, whether or not a buyback is likely?

We're sitting on an enormous amount of capital. One of the restricting factors prior to the last couple of quarters was our TCE ratio, which is much less of an issue today. We're working hard at putting together deals; banks are sold, not bought, so we have to stick to our pricing and deal structures, which sometimes prevents announcements. M&A is definitely our top option. Notwithstanding M&A, we still believe we have the opportunity to do more capital management with respect to buybacks. That's something we are evaluating and discussing, and I imagine we'll have something to announce relatively shortly.

One moment for our next question. And that will come from the line of David Feaster with Raymond James.

I wanted to touch on the growth outlook. You talked about tepid demand and competition being real headwinds. It's not exactly a great environment to be trying to grow in. I'm curious, how do you think about growth? Where are you seeing opportunities? And how do you win in that type of environment, where competition seems to be mispricing credit to an extent?

Ladies and gentlemen, please stand by. One moment please. Please remain on the line, your conference will be resumed shortly. Thank you. We do have our speakers back.

David, it wasn't that we didn't want to answer the question; we got disconnected. I apologize for that. Speaking to loan growth: demand is slow and competition is fierce. We've lost a couple of deals that were priced below 6%, which is surprising. We're still growing relationships, primarily more C&I operating companies. The investor commercial real estate side has been tepid. As rates stabilize and front-end of the curve comes down, we may see pickup in investor commercial real estate, which is all funded debt. On C&I, utilization is lower—20% to 30% utilization—so you have to do more volume to match CRE. Pipelines are okay. Deposit pipelines are good, loan pipelines lighter. We're very focused on relationship banking, which includes loans, deposits, and fee opportunities. There's some seasonality in the fourth quarter, but we're setting up the bank for 2025 and beyond with the payoff of the BTFP. We have liquidity and the ability to do more, so we're focused on growing relationships, but I expect continued headwinds and that it will be somewhat difficult going forward.

Okay. And I just wanted to touch on credit. You touched on this in your prepared remarks, talking about credit migration and some additional migration in October, and commentary on ORE trends. Your ability to sell at or above loan value and some other commentary speaks to your credit underwriting discipline. Can you touch on trends you're seeing in the book? We touched on ag pressures in the past. What are you hearing from clients? Where are they seeing pressures? Is there anything specific? To what extent does declining rates help alleviate pressures?

The issues I mentioned in our prepared remarks are unrelated to the interest rate environment. They involve a few specific relationships. The three loans I mentioned were multifamily properties with very low loan-to-values—between 25% and 45%—where the borrower went dark. We worked with the borrower; 1.5 months before, he brought in $1.5 million to bring everything current, then disappeared again. We put two properties up for sale, got outbid at one foreclosure, and took the second into OREO; we expect to close that this quarter. The senior living facility was a participatory loan from the Suncrest merger where we were not the agent; I would have moved faster than the agent bank. We now have the property, an operator who wants to buy it, and offers that should fully pay us off and recover the prior charge-off. Overall credit quality has been very stable. Ag, dairy, and livestock have improved significantly. There have been a few borrowers who needed to rightsize loans upon repricing or maturity, but mostly the situation is stable. Our underwriting at origination gives us a cushion if foreclosure becomes necessary.

That's good color. Last one from me: you touched on the healthy deposit pipeline and the increase in noninterest-bearing balances this quarter. When you look at the pipeline and what drove that increase, how much is from existing clients where you're gaining share versus new clients coming over? Where are you having success driving core deposit growth today?

We have several heavy noninterest-bearing lines of business we focus on: government services, title escrow, and property management. Those lines have done well. Title escrow and property management deposits remain below the highs of a couple of years ago because there have been fewer refinances and fewer escrows. The pickup this quarter has been driven by new relationships across various operating companies. Our title escrow and property management lines are having strong originations, and our government services group has done a great job. Historically, we have seasonality—second and third quarters are better for deposits. Some excess deposits have been moved into our trust group or outside investments, so we may not see identical patterns going forward. Relationship and deposit performance have been strong; on the loan side, we need to win our fair share of the right deals and may need to be a little more aggressive on pricing to do that.

One moment for our next question. And that will come from the line of Andrew Terrell with Stephens.

Maybe just a follow-up on one of Matt's questions around the securities that were sold during the quarter. Do you have the specific timing during the third quarter the securities were sold?

They were sold throughout the quarter, but heavier toward the back end, particularly in the last month. You could equate the average balance versus the point-to-point change and estimate the timing from there.

Okay. We should assume the securities sold have a yield pretty much in line with the current AFS portfolio or maybe a little below? I think it was 3.02% in the third quarter.

If you look at market yield, it was about 2.70%. The book yield on these securities was closer to 3%.

Got it. And then on deposit cost commentary: looking at non-maturity deposits by month, it looks like 88 basis points in September, elevated versus the rest of the quarter. I know rate cuts weren't overly impactful on a full month basis, but taking your earlier comments about getting some rate requests and a 50% beta on the first cut, should we expect that 88 basis point non-maturity cost in September has moderated so far?

Yes, I think that's accurate. There are many moving parts. We had some movement out of noninterest-bearing accounts in the most recent quarter, which raised average costs somewhat. In the next rate reduction, we'll probably move further down the rate spectrum of our customers and be closer to 100% beta on a 25 basis point cut. Overall, we should see the cost stabilize or decline slightly.

Okay. And then just one more on the securities portfolio: I think there was a hedge in place against the bond book. Did anything change from a hedging standpoint during the quarter given you sold some bonds?

No major changes. We continue to have capacity to sell more in the fourth quarter. The hedges were put on with the AFS portfolio where there was a lot of excess capacity, so we don't foresee issues. We may evaluate unwinding some portions of the three different fair value hedges as they shorten, which could change the fair value hedge implications, but that's only a possibility under evaluation.

One moment for our next question. And that will come from the line of Gary Tenner with D.A. Davidson.

Regarding plans to do possibly another sale-leaseback transaction with AFS sales, would the expectation or goal be to reinvest or maybe go towards reducing other wholesale funding or broker deposits?

There are a couple of things on the table we're evaluating. It's likely we'll reinvest some or all of the proceeds. We're also evaluating whether to take any of the hedges off the balance sheet. From a wholesale funding perspective, we have $500 million with the FHLB, which we aren't really considering changing. We have $400 million in brokered CDs—$300 million of which are cash flow hedges that we likely won't touch—but there is $100 million that are 90-day resets that we'll evaluate from an interest rate risk versus cost of funding perspective. So yes, some reinvestment is likely.

I appreciate that. With regard to loan yields in the third quarter, the 5 basis points expansion—was there any noise within that? As we think about the fourth quarter, ballpark the impact of the 50 basis point rate cut on loan yields, all else equal?

There was nothing unusual. It's part of the slow increase we've seen; the Fed impact was muted. We categorize variable loans as those that reprice within a year. Depending on dairy borrowings, that could be 25% to 27% of the portfolio, but only roughly 10% or a bit more reset immediately. We saw those resets. Others reset quarterly or monthly and some didn't fully reset until October, so the impact from the 50 basis point cut will bleed out over time.

One moment for our next question. And that will come from the line of Kelly Motta with KBW.

Turning back to margin: now that you paid down the BTFP borrowings, you still have the $500 million of FHLB. Wondering, of the repos, is there color as to where those rates currently are so we can back into how to think about those customer accounts as we look ahead?

If you're talking about repurchase agreement sweep deposit accounts: we did see some movement into repos last quarter from noninterest-bearing deposits, which increased those rates a bit. Repurchase agreement sweeps are cash management tools customers use for excess deposits. The majority of that portfolio is very low priced, though a few relationships are a bit higher. Depending on Fed actions, those rates should start to come down.

Our customer repos experienced a very low beta until the most recent quarter where we had movement out of noninterest-bearing accounts, so the average cost of those rose over 2%. Now, those repo rates will probably fall quicker than the noninterest-bearing deposits as well.

Putting together the moving pieces of NII: you paid down some BTFP with a negative carry. Net-net, with rates lowering, initial pressure on NII from here at least off this level—is that fair? Or do you think the actions you took should more than offset the initial hit from lower rates?

Think about NII this way: we had positive carry on the BTFP, which was over $7 million, so paying it down is a headwind from an NII perspective. We also made $4.3 million on the pay-fixed swaps; the Fed reductions at the end of September and potential cuts in November and December will reduce that spread and could eventually make it negative. These are headwinds to NII going forward. It won't go negative in the fourth quarter, but those factors are pressures to monitor.

Have you quantified your expectation for future security sales as we start to think through the size of the balance sheet?

We sold about $300 million in the prior quarter. I anticipate future security sales will probably be less than that. The securities we sell in the future likely will have a lower yield than the ones sold earlier. Given current rates, unrealized losses on any additional sales could expand, which may mitigate some of the cash proceeds. My rough estimate is future sales could be one-third to one-half of that prior sale size, but it's subject to market conditions and our balance sheet needs.

I'm showing no further questions in the queue at this time. I would now like to turn the call back over to Mr. Brager for any closing remarks.

Great. Thank you, Shuri. Citizens Business Bank continues to perform consistently in all operating environments. Our solid financial performance is highlighted by our 190 consecutive quarters—or more than 47 years—of profitability and 140 consecutive quarters of paying cash dividends. We remain focused on our mission of banking the best small- to medium-sized businesses and their owners through all economic cycles. I would like to thank our customers and associates for their commitment and loyalty. Thanks for joining us this quarter. We appreciate your interest and look forward to speaking with you in January for our fourth quarter 2024 earnings call. Please let Allen or I know if you have any questions. Have a great day.

This concludes today's program. Thank you all for participating. You may now disconnect.