Q4 2023 CVB Financial Corp Earnings Call

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the fourth quarter and year ended 2023 CVB Financial Corporation, and its subsidiary, Citizens Business Bank Earnings Conference Call. My name is Cherie, and I'm your operator for today. (Operator Instructions) Please be advised that today's call is being recorded.
I would now like to turn the presentation over to your host for today's call, Christina Carrabino. You may proceed.
You may.

Thank you, Cherie, and good morning, everyone. Thank you for joining us today to review our financial results for the fourth quarter and year ended 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 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, 2022, 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.
Now, I will turn the call over to Dave Brager. Dave?

Thank you, Christina, and good morning, everyone. For the fourth quarter of 2023, we reported net earnings of $48.5 million or $0.35 per share, representing our 187th consecutive quarter of profitability. We previously declared a $0.20 per share dividend for the fourth quarter of 2023, representing our 137th consecutive quarter of paying a cash dividend to our shareholders.
Our net earnings are $48.5 million or $0.35 per share compared to $57.9 million for the third quarter of 2023 or $0.42 per share, and $66.2 million for the year ago quarter or $0.47 per share. Fourth quarter earnings would have been $0.39 per share, excluding the $9 point (sic) [ 9.2 ] million dollar expense related to the FDIC special assessment.
We produced a return on average tangible common equity of 16.21%, and a return on average assets of 1.19% for the fourth quarter.
Net income was $221.4 million for the year ended 2023, a $14 million decrease compared to 2022. When excluding the $9.2 million FDIC special assessment, the decrease would have been $7.6 million.
Diluted earnings per share were $1.59 for 2023 compared to $1.67 for 2022. Our fourth quarter pretax pre-provision income decreased $10 million from the third quarter of 2023 primarily due to the expense accrual for the FDIC special assessment.
We continue to be among the industry leaders with respect to expense control as our efficiency ratio for the fourth quarter and full year 2023 was 40.98% and 40.3%, respectively, after excluding the FDIC special assessment. Our net interest margin declined by 5 basis points from the third quarter of 2023 to 3.26% for the fourth quarter. The decrease in our net interest margin was a net result of a 17 basis point increase in our cost of funds, which offset a 12 basis point increase in our earning asset yield.
Our net interest margin for all of 2023 was 3.31%, essentially the same as our 2022 net interest margin of 3.3%.
Total loans outstanding at the end of 2023 increased from the end of the third quarter of 2023 by approximately $30 million to $8.9 billion. Our allowance for credit losses decreased to approximately $87 million on December 31, based on net charge-offs of $153,000 and a $2 million recapture provision for credit losses in the fourth quarter of 2023.
Average total deposits for the fourth quarter decreased by approximately $429 million compared to the third quarter of 2023. Our average noninterest-bearing deposits continued to be greater than 61% of our average total deposits.
At December 31, 2023, our total deposits were $11.4 billion, a $925 million decrease from September 30, 2023. During the latter half of the fourth quarter, we experienced both the normal year-end seasonal deposit outflows as well as some unexpected deposit withdrawals that were directed to an external trust company for estate planning.
Although noninterest-bearing deposits declined by $380 million from the end of the third quarter, noninterest-bearing deposits represented 63% of total deposits.
Customer repos were $271 million at the end of the fourth quarter, which was consistent with the balance at September 30, 2023.
We have experienced a $1.7 billion decline in deposits and customer repos from the end of 2022, which includes approximately $800 million that was moved to Citizens Trust where these funds were invested in higher-yielding assets such as treasury notes.
Overall, we have experienced a decline in deposit levels due to the cash burn on customer accounts resulting from inflationary pressures as well as the impact of higher interest rates that has led to deposits moving to higher-yielding alternatives such as money market funds and short-term treasury notes.
Our cost of deposits was 62 basis points on average for the fourth quarter of 2023, which compares to 52 basis points for the third quarter of 2023 and 8 basis points for the fourth quarter of 2022.
From the first quarter of 2022 through the fourth quarter of 2023, our cost of deposits has increased by 59 basis points, representing a deposit beta of less than 12%. Compared to the recent Federal Reserve tightening cycle of increasing the Fed funds rate by 525 basis points.
Now let's discuss loans. Total loans at December 31, 2023, were $8.9 billion, a $27 million increase from September 30, 2023, and a $174 million or 1.9% decrease from the end of 2022. The quarter-over-quarter increase included $73 million increase in dairy & livestock loans. Utilization on dairy & livestock loans was at 80% at December 31, 2023, which compares to 73% at the end of the third quarter. C&I loans also increased by $32 million as line utilization increased from 27% at the end of third quarter to 29% at the end of December 2023. These increases were partially offset by a $58 million decline in commercial real estate loans.
In comparison to December 31, 2022, loans declined by $168 million after excluding PPP loans. The majority of the decline was in commercial real estate loans, which decreased by $100 million from the end of 2022 to December 31, 2023.
We saw a decline in both construction and consumer loans of $22 million and $23 million, respectively.
C&I loans increased by approximately $21 million over the same period, although line utilization decreased from 33% to 29%. This aligns with our strategy of making the best small- to medium-sized businesses and their owners.
Loan growth continues to be impacted by a slowdown in loan demand. Our new loan production decreased throughout the second half of 2023, and new loan production for the fourth quarter of 2023 was generated at average yields exceeding 7%.
Although loans modestly increased at quarter end from the end of the third quarter, we recorded a $2 million recapture provision for credit losses for the fourth quarter of 2023 due to an improving economic forecast. Asset quality remains strong. At the end of the quarter, nonperforming assets, defined as nonaccrual loans plus other real estate owned, were $21 million or 13 basis points of total assets. The $21 million in nonperforming loans compared with $10 million from the prior quarter and $4.9 million for the year ago quarter. The increase from the prior quarter was primarily due to a CRE loan that is a loan participation acquired in the Suncrest merger that was placed on nonaccrual at the end of the fourth quarter.
During the fourth quarter, we experienced credit charge-offs of $181,000 and total recoveries of $28,000, resulting in net charge-offs of $153,000 compared with net recoveries of $28,000 for the third quarter of 2023. Year-to-date, net charge-offs were $275,000.
Classified loans for the third quarter were $102 million compared with $92 million for the prior quarter and $79 million for the year ago quarter. Classified loans as a percentage of total loans was 1.15% at quarter end. The $10 million increase in classified loans quarter-over-quarter was primarily due to a $9.8 million increase in classified commercial real estate loans.
I will now turn the call over to Allen to discuss the allowance for credit losses and additional aspects of our balance sheet. Allen?

Thanks, Dave. Good morning, everyone.
As of December 31, 2023, our allowance for credit losses was $86.8 million, or 0.98% of total loans, which compares to $89 million or 1% of total loans at September 30, 2023, and $85.1 million or 0.94% of total loans at December 31, 2022.
From the end of 2022 to the end of 2023, our allowance for credit losses increased by $1.7 million, while loans declined by $174 million over that same period. The changes in our allowance over the last few quarters have been primarily due to changes in our economic forecast.
For the quarter ended December 31, 2023, we recorded a $2 million recapture provision for credit losses. This compares to $2 million in provision for the third quarter of 2023, and $2.5 million in provision for the fourth quarter 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. The resulting economic forecast reflects a modest decline in GDP for the first 3 quarters of 2024, with a return to positive GDP growth in the fourth quarter of 2024. GDP is forecasted to increase by 0.92% in 2025 before reaching a more robust growth rate of 2.6% in 2026.
Commercial real estate values are forecasted to continue their decline until reaching their lowest level in the third quarter of 2024.
Unemployment is forecasted to rise in 2024 and throughout 2025. The unemployment rate is forecasted to exceed 5% in 2024 and then peak at 5.7% in the first quarter of 2025. The unemployment rate is forecasted to then decline to less than 5% by the third quarter of 2026.
Total borrowings at the end of the fourth quarter were approximately $2 billion, including $1.9 billion of advances from the bank term funding program. Our borrowings increased by $950 million from September 30, 2023, and by approximately $1.1 billion from the end of 2022.
The $1.9 billion of bank term funding program borrowings, which had a weighted average borrowing rate of 4.78% at the end of 2023, will mature in May and December of 2024.
Our total investment portfolio declined by $389 million from December 31, 2022, to $5.4 billion as of December 31, 2023, as the majority of our cash flows generated from the portfolio were not reinvested during the year. The overall decrease in our investment portfolio from December 31, 2022, was primarily due to a $299 million decline in investment securities available for sale or AFS securities. AFS securities totaled $2.96 billion at the end of the fourth quarter, inclusive of a pretax net unrealized loss of $450 million, a decrease in the unrealized loss from September 30 to December 31, 2023, of $179 million resulted in a net increase in AFS securities of $58 million.
Investment securities held to maturity or HTM securities totaled approximately. $2.46 billion at December 31, 2023. The HTM portfolio declined by approximately $25 million from September 30, and by $90 million from the end of 2022, as cash flows were not reinvested throughout 2023.
The tax equivalent yield on the entire investment portfolio was 2.71% for the fourth quarter of 2023, compared to 2.64% for the prior quarter, and 2.36% for the fourth quarter of 2022. The increase in the yield has been the result of the positive carry on fair value hedges we executed on in late June of 2023.
The fourth quarter of 2023 when compared to the year ago quarter had $4 million of interest income from the positive carry on the swaps. We received daily SOFR on these pay-fixed swaps, which has a weighted average fixed rate of approximately 3.8%.
At the end of the fourth quarter, we executed on a partial restructuring of our bank-owned life insurance or BOLI portfolio. We surrendered $68 million of policies, which resulted in a $4.5 million market value write-down of the cash render value of these policies, and approximately $6.5 million in additional tax expense. The purchase of $109 million of new BOLI policies at the end of December included an increase of cash render value of approximately $10 million.
On a net basis, noninterest income was positively impacted by $6.5 million, offsetting the $6.5 million increase in tax expense. The new policies will have an initial crediting rate that is approximately 300 basis points higher than the policies we surrendered.
Now turning to our capital position. The company's tangible common equity ratio at December 31, 2023, was 8.51% compared with a prior quarter's ratio of 7.73% and 7.4% at December 31, 2022.
At year-end, our shareholders' equity increased from the third quarter of 2023 by $126.6 million to $2.08 billion. That increase reflects an increase in our OCI of $103.6 million due to the impact of lower interest rates that decreased the unrealized loss in our AFS portfolio.
Equity increased for the 12 months of 2023 by $129.5 million. Retained earnings increased in 2023 as year-to-date income of $221 million was offset by $112 million in dividends. The resulting year-to-date dividend payout ratio was 50.4%. Our OCI increased by $31 million from the end of 2022.
The 10b5-1 stock repurchase plan we initiated in 2022 expired on March 2, 2023. During the first quarter of 2023, we repurchased approximately 792,000 shares of common stock at an average price of $23.43, totaling $18.5 million in stock repurchases. There were no shares purchased during the remaining quarters of 2023.
Our regulatory capital ratios are well above regulatory requirements to be considered well capitalized and above the majority of our peers. At December 31, 2023, our common equity Tier 1 capital ratio was 14.6% and our total risk-based capital ratio was 15.5%.
I'll now turn the call back to Dave for a further discussion of our fourth quarter earnings.

Thank you, Allen. Net interest income before provision for credit losses was $119.4 million for the fourth quarter compared with $123.4 million for the third quarter and $137.4 million for the year ago quarter.
Our tax equivalent net interest margin was 3.26% for the fourth quarter of 2023, compared with 3.31% for the third quarter of 2023. Our net interest margin has trended within a somewhat narrow range over the past 3 quarters, with the second quarter at 3.22%, and our full year at 3.31%.
Interest income grew by nearly $2 million over the prior quarter as interest income on loans grew by $2.5 million as a result of an 11 basis point increase in loan yields. Offsetting the growth in loan interest income was a $500,000 decline in interest on investment securities due to a $214 million decline in average balance -- in the average balance of the investment portfolio.
Interest income from our pay-fixed swaps increased by approximately $200,000 from the prior quarter. Interest expense increased by $5.9 million over the prior quarter as our cost of funds decreased by 17 basis -- increased, excuse me, by 17 basis points from the third quarter of 2023.
Interest expense on deposits increased by $2.4 million due to a 22 basis point increase in the cost of interest-bearing deposits, while average interest-bearing deposits declined by $67 million quarter-over-quarter. The cost of interest-bearing deposits was 1.59% in the fourth quarter compared to 1.37% in the prior quarter.
Interest expense on borrowings increased by $3.5 million as average borrowings in the fourth quarter increased by $267 million compared to the prior quarter and the cost of borrowings rose by approximately 25 basis points. The $18 million decline in net interest income from the year ago quarter resulted from a 43 basis point decrease in net interest margin and a $217 million decline in average earning assets. The year-over-year net interest margin decline was due to a 96 basis point increase in our cost of funds, offsetting a 49 basis point increase in earning asset yields. The increase in earning asset yields was a result of higher loan and investment yields in the fourth quarter of 2023 compared to the fourth quarter of 2022 as well as an improved asset mix in which average loans grew from approximately 59.7% of earning assets in the fourth quarter of 2022 to 60.5% in the fourth quarter of 2023.
Loan yields were 5.18% for the fourth quarter of 2023 compared with 4.78% for the year ago quarter. Investment security yields increased by 35 basis points from a yield of 2.36% in the prior year quarter to 2.71% in the fourth quarter of 2023, including the positive carry on the pay-fixed swaps. The $17.5 million decline in net interest income from 2022 was driven by a $600 million average decline in interest-earning assets as our net interest margin of 3.31% for 2023 was essentially the same as the 3.3% margin in 2022.
Moving on to noninterest income. Noninterest income was $19.2 million for the fourth quarter of 2023 compared with $14.3 million for the prior quarter and $12.5 million for the year ago quarter. Our customer-related banking fees, including deposit services, international and merchant bank card decreased by $87,000 compared to the third quarter and declined by $782,000 when compared to the fourth quarter of 2022.
Although our trust and wealth management fees decreased by $165,000 compared to the prior quarter, year-over-year, ECs grew by $214,000.
Fourth quarter BOLI income increased by $6.4 million compared to the third quarter and increased by $6.5 million compared to the fourth quarter of 2022 primarily due to the surrender and redeployment of BOLI policies Allen just described.
Fourth quarter CRA investment income increased by $1.1 million over the third quarter of 2023 and by approximately $700,000 over the fourth quarter of 2022 primarily due to underlying asset valuation increases. The third quarter also included $2.6 million of income from an equity fund distribution related to one of our CRA investments.
For the entire year of 2023, noninterest income grew by $9.3 million over 2022, including $7.4 million of higher BOLI income, a $1.2 million decline in deposit service charges was offset by a $1 million increase in higher trust fees and more than $600,000 of swap fees in 2023.
CRA-related investment income was $5.4 million higher in 2023, while 2022 included a $2.4 million gain on the sale of a banking center building.
Now expenses. Noninterest expense for the fourth quarter was $66 million compared with $55 million for the third quarter of 2023 and $54 million for the year ago quarter. The $10.9 million quarter-over-quarter increase was primarily due to the fourth quarter expense of $9.2 million resulting from the FDIC special assessment. Regulatory assessment expense was $11.3 million in the fourth quarter of 2023, a $10 million increase from the fourth quarter of 2022.
The fourth quarter of 2023 included $500,000 in recapture provision for unfunded loan commitments compared to a $900,000 in recapture for the third quarter of 2023. There was no provision in the -- for the fourth quarter of 2022.
Salaries and employee benefit costs increased $908,000 quarter-over-quarter. This increase includes approximately $400,000 associated with year-end employee awards. Salary expense increased by 1.3% or approximately $300,000, and bonus and profit sharing increased by another $300,000 based on full year earnings.
The $11.5 million increase in noninterest expense year-over-year includes the $10 million increase in assessment expense and an increase of $1.5 million in total salaries and employee benefits compared with the prior year quarter. Salary expense grew by $1.1 million or 4.8% over the fourth quarter of 2022.
Deferred loan origination costs were also lower than the prior year quarter, resulting in additional employee expense of $550,000.
Marketing and promotion expense increased over 2022 by approximately $380,000 as these expenses returned to pre-pandemic levels. As we continue to invest in new technology, software expense increased by more than $300,000 or 9.5%. The increase in technology demonstrates our commitment to improving efficiencies and providing an excellent customer experience.
Noninterest expense totaled 1.62% of average assets or 1.39%, excluding the FDIC special assessment for the fourth quarter of 2023. This compares with 1.33% for the third quarter and 1.32% for the fourth quarter of 2022.
Our efficiency ratio was 47.6% or 40.98%, excluding the FDIC special assessment for the fourth quarter of 2023. This compares with 39.99% for the prior quarter and 36.31% for the fourth quarter of 2022.
This concludes today's presentation. Now Allen and I will be happy take any questions that you might have.

Question and Answer Session

Operator

(Operator Instructions) Matthew Clark, Piper Sandler.

Hey, guys, good morning, numbers. If we could just start with the BOLI restructuring. Can you give us a sense for how we should think about that run rate going forward?

Well, Matthew, I think in the prepared remarks, I noted how much we invested in new BOLI and the fact that it generates -- initial crediting rates are going to be 300 basis points higher than the prior income. So I mean, I think we bought $109 million.

Okay. $109 million is total now?

Yes.

Okay. And then just some -- a couple of questions around the margin. Can you give us the spot rate on deposits at the end of December? And if you had the average margin in the month of December, help us with it.

I can tell you what we published. So if you look at our IP deck, the cost of deposits for the month of December was 64 basis points, which compares to, I think, 62 for the quarter. And we also noted that the -- our borrowings at an average rate, at the end of the period of time of 4.78%. So those are -- that would give you some good starting points.

Okay. And then just on deposits, the outflow in non-interest-bearing. Anything unusual there? And how is the overall deposit pipeline, given all the disruption?

Yes. So as you know, we have normally, and maybe 2020 being the exception, but normally, we have about a 4% to 6% deposit outflow in the fourth quarter due to taxes, bonuses, other things that happen.
We did call out in the prepared remarks, we did have one large relationship that moved some money to an external trust company. That was unexpected. But outside of that, everything has been pretty stable. And normally, we start to see those deposits start to come back to us towards the end of the first quarter, and the deposit pipelines are strong. They remain strong. It's just the sales cycle on operating companies is a little bit longer, both from an implementation perspective. But yes, we continue to open new relationships, and we haven't lost any relationships, the relationship that moved the money is still a very large depositor of the bank.

Okay. And then just on the hiring side of things, what's that activity like, again, with all the consolidation and banks kind of going away?

Yes, it's actually. It's interesting. I think it's been very good. We've been able to pick up some very good talent, I believe, they're newer, but they're coming sort of from who you would expect them to come from. We have some people from Western Alliance. We have some people from First Republic. We have some people from City National.
So we have -- there is some disruption there. And I do think it's going to be an advantage for us as we continue to get through this cycle.

Okay. And then last one for me, just around M&A, any change in the conversations you're having with potential targets?

Yes. Not really any change. I think it has maybe intensified a little bit. But there's still some challenges obviously with merges and other things, but we are definitely having conversations. There's nothing imminent, but we are definitely looking for opportunities there.

Okay. Thank you.

You're welcome.

Operator

Tim Coffey, Janney Montgomery Scott.

Dave, just looking out to '24, what do you expect that with the balance sheet? Do you think we can see some additional shrinkage this year?

Look, we anticipate that we're going to be growing the balance sheet, both from a deposit acquisition perspective and then continue to move the mix. But it will continue, I mean just based on loan demand and based on pipelines, I think it's going to be slow just like it has been in 2023. I mean the only change to that, and Allen can jump in here if he wants to, would be just how we manage the borrowings and how we reinvest the cash flows, and if we just pay down debt, vis-a-vis, invest in other opportunities.
I don't know, Allen, if there's anything you want to add to that?

Yes. I mean, Tim, we do anticipate the securities portfolio to continue to roll down. And that will fund potentially loan growth or paying down debt. And that will really, I think, be really predicated on loan demand as 2024 continues.

Okay. And then, Allen, if the Fed does nothing, what happens with the loan yields, let's say, on a quarterly basis?

They would most likely increase modestly. We do have a large book of adjustable loans. And as those adjust, almost all of those will adjust upwards as well as the fact that, as Dave alluded to in comments, new business comes on well over 7% which is a couple of 100 basis points more than the portfolio. So it won't be significant, but we would expect modest improvements in loan yields if everything is sort of stable.

Okay. And do you have -- just how much of the book reprices this quarter?

We don't get that specific, we've tried to point out on our IP deck because we give a lot of clarity around the office CRE portfolio, and that would tell you it's probably 20%, 25% of maturities in repricing as an example. It's generally in line with most of the portfolio on the CRE side.

Yes. It's a good proxy for the rest of the commercial real estate portfolio

Okay. Okay. That's very helpful. Those my questions, thank you very much for your time.

Operator

(Operator Instructions) [George Zavoico], KBW.

Just wanted to kind of touch on credit a little bit. I appreciate the commentary you gave on that NPL moving. But maybe, if you could just talk a little bit about the CRE portfolio as a whole, how it's holding up and what you guys are seeing in your markets?

Yes. So I think, generally speaking, it's holding up very well. We do put some good detail in our investor presentation related to classified loans in the commercial real estate area. And I think, just generally speaking, we did have a little bit of movement in classified loans. We did have a little uptick in nonperforming. The, 1 uptick in nonperforming as a loan I've discussed before which is the senior living facility, that loan just matured. We moved it to nonaccrual. We're still working with the borrower. We believe that we'll get out of that line.
Just overall, though, I think the portfolio has been extremely resilient, and we continue to have a lot of early warning signs. We do annual term loan reviews. We review our stress testing on the commercial real estate side as well as on the C&I side. If there's failed loans in that, we're out in front of them. But we do get updated information on any loan over $1 million in our portfolio annually at least. And then if it fails the stress test, we have more, more frequent conversations with the borrower if there's something that we should be worried about.
But overall, it's been very, very stable, and I feel pretty good about where we are there.

And then if I could just get 1 more in here. I know you said growth for balance sheet is probably pretty slow. If we were to get a decent amount of cuts this year in the back half of the year, would you expect loan demand to pick up pretty heavily? And what are you guys maybe seeing if rates start to come down there in the pipeline?

Yes. It's interesting. We generally base the pricing on our loans on treasuries. If it's a term loan, if it's a C&I loan, obviously, it's based on prime or SOFR primarily. But as far as commercial real estate is going, I think that we're starting to see a little pickup in the pipeline, it's not really material, but I think people are maybe just getting a little more accustomed to rates starting with 7s and 8s in front of them versus the shock that occurred in the last 15, 18 months as rates started going up.
So people still want to do stuff. People still are looking for opportunities. I think they were sort of waiting a little bit just to see if the world broke. And now that it has not and it appears pretty stable, at least today, the economy seems pretty stable, I think we'll start to see a little pickup on the loan demand side, and we'll see how it plays out through the year, depending on rates. But I think rates are becoming less of a deterrent for people doing things as they get more used to the current environment.

Operator

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

Great. Thank you. During the course of 2023, Citizens Business Bank not only remains safe and sound, but also produced earnings that were the second highest in the company's history despite the difficult operating environment.
We remain committed to our strategy of banking the best small and medium-sized businesses and their owners. We work hard to earn and maintain the trust of our customers and business partners. And we want to thank all of our customers and associates for their loyalty and dedication over the past year.
I want to thank everybody for joining us this quarter. We appreciate your interest and look forward to speaking with you in April for our first quarter 2024 earnings call. And as always, you can let Allen and I know if you have any questions. Have a great day and thank you for listening.

Operator

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