We also provide a full complement of lending products, including commercial, agribusiness, consumer, SBA loans, real estate loans and equipment and vehicle leasing. Commercial products include lines of credit and other working capital financing, accounts receivable lending and letters of credit. Agribusiness products are loans to finance the operating needs of wholesale dairy farm operations, cattle feeders, livestock raisers, and farmers. We provide bank qualified lease financing for municipal governments. Commercial real estate and construction loans are secured by a range of property types and include both owner-occupied and investor owned properties. Financing products for consumers include automobile leasing and financing, lines of credit, credit cards, home mortgages, and home equity loans and lines of credit.
We also offer a wide range of specialized services designed for the needs of our commercial customers. These services include cash management systems for monitoring cash flow, a credit card program for merchants, courier
pick-up
and delivery, payroll services, remote deposit capture, electronic funds transfers by way of domestic and international wires and automated clearinghouse, and
on-line
account access. We make available investment products offered by other providers to our customers, including mutual funds, a full array of fixed income vehicles and a program to diversify our customers’ funds in federally insured time certificates of deposit of other institutions.
In addition, we offer a wide range of financial services and trust services through our CitizensTrust division. These services include fiduciary services, mutual funds, annuities, 401(k) plans and individual investment accounts.
We are a community bank with one reportable operating segment. See the sections captioned “Business Segments” in Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
and Note 3 —
Summary of Significant Accounting Policies
—
of the notes to consolidated financial statements.
The banking and financial services business is highly competitive. The competitive environment faced by banks is a result primarily of changes in laws and regulations, changes in technology and product delivery systems, and the ongoing consolidation among insured financial institutions. We compete for loans, deposits, and customers with other commercial banks, savings and loan associations, savings banks, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers, including online banks and
“peer-to-peer”
or “marketplace” payment processors, lenders and other small business and consumer lenders. Many competitors are much larger in total assets and capitalization, have greater access to capital markets and/or offer a broader range of financial products and services, including technology-based services. Additionally, some smaller competitors, including
non-bank
entities, may be more nimble and responsive to customer preferences or requirements.
Economic Conditions/Government Policies
Our profitability, like most financial institutions, is primarily dependent on interest rate spreads and noninterest income. In general, the difference between the interest rates paid by the Bank on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by the Bank on interest-earning assets, such as loans extended to customers and securities held in the investment portfolio, will comprise the major portion of our earnings. These rates are highly sensitive to many factors that are beyond our control, such as inflation, recession and unemployment, government monetary and other policies, and the impact which future changes in domestic and foreign economic conditions might have on us cannot be predicted.
Opportunity for banks to earn fees and other noninterest income have also been limited by restrictions imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) and other
government regulations. As the following sections indicate, the impact of current and future changes in government laws and regulations on our ability to maintain current levels of fees and other noninterest income could be material and cannot be predicted.
Our business is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve. The Federal Reserve implements national monetary policies (with objectives such as curbing inflation, increasing employment and combating recession) through its open-market operations in U.S. Government securities by buying and selling treasury and mortgage-backed securities, by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve in these areas influence the growth and performance of bank loans, investments, and deposits and also affect interest earned on interest-earning assets and paid on interest-bearing liabilities. In recent years, the impact of the Federal Reserve’s actions and policies have tended to assume even greater importance and impact on the lending and securities markets, and these actions and policies are continuing to evolve and change based on political and economic events and incoming data. Government fiscal and budgetary policies, including deficit spending, can also have a significant impact on the capital markets and interest rates. The nature and impact of any future changes in monetary and fiscal policies on us cannot be predicted.
Regulation and Supervision
The Bank is subject to significant regulation and restrictions by federal and state laws and regulatory agencies. These regulations and restrictions are intended primarily for the protection of depositors and the Federal Deposit Insurance Corporation (“FDIC”) Deposit Insurance Fund (“DIF”) and for the protection of borrowers, and secondarily for the stability of the U.S. banking system. The following discussion of statutes and regulations is a summary and does not purport to be complete nor does it address all applicable statutes and regulations. This discussion is qualified in its entirety by reference to the statutes and regulations referred to in this discussion. From time to time, federal and state legislation is enacted and implemented by regulations which may have the effect of materially increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers.
We cannot predict whether or when other legislation or new regulations may be enacted, and if enacted, the effect that new legislation or any implemented regulations and supervisory policies would have on our financial condition and results of operations. Such developments may further alter the structure, regulation, and competitive relationship among financial institutions, may limit the types or pricing of the products and services we offer, and may subject us to increased regulation, disclosure, and reporting requirements.
Legislation and Regulatory Developments
The federal banking agencies continue to implement the remaining requirements in the Dodd-Frank Act as well as promulgating other regulations and guidelines intended to assure the financial strength and safety and soundness of banks and the stability of the U.S. banking system. On February 3, 2017 the President of the United States issued an executive order identifying certain “core principles” for the administration’s financial services regulatory policy and directing the Secretary of the Treasury, in consultation with the heads of other financial regulatory agencies, to evaluate how the current regulatory framework promotes or inhibits the principles and what actions have been, and are being, taken to promote the principles. In response to the executive order, on June 12, 2017, October 6, 2017, October 26, 2017 and July 31, 2018, respectively, the United States Department of the Treasury issued four reports recommending a number of comprehensive changes in the current regulatory system for U.S. depository institutions, the U.S. capital markets and the U.S. asset management and insurance industries, around the following principles:
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Improving regulatory efficiency and effectiveness by critically evaluating mandates and regulatory fragmentation, overlap, and duplication across regulatory agencies; |
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Aligning the financial system to help support the U.S. economy; |
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Reducing regulatory burden by decreasing unnecessary complexity; |
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Tailoring the regulatory approach based on size and complexity of regulated firms and requiring greater regulatory cooperation and coordination among financial regulators; |
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Aligning regulations to support market liquidity, investment, and lending in the U.S. economy; and |
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Creating a regulatory landscape that better supports nonbank financial institutions, embraces financial technology and fosters innovation. |
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The scope and breadth of regulatory changes that will be implemented in response to the President’s executive order have not yet been determined. |
Capital Adequacy Requirements
Bank holding companies and banks are subject to similar regulatory capital requirements administered by state and federal banking agencies. The current capital rule changes (the “Current Capital Rules”) adopted by the federal bank regulatory agencies, which were fully effective on January 1, 2015, have been fully phased in. The risk-based capital guidelines for bank holding companies, and additionally for banks, require capital ratios that vary based on the perceived degree of risk associated with a banking organization’s operations, both for transactions reported on the balance sheet as assets, such as loans, and for those recorded as
off-balance
sheet items, such as commitments, letters of credit and recourse arrangements. The risk-based capital ratio is determined by classifying assets and certain
off-balance
sheet financial instruments into weighted categories, with higher levels of capital being required for those categories perceived as representing greater risks, and with the applicable ratios calculated by dividing qualifying capital by total risk-adjusted assets and
off-balance
sheet items. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors. Bank holding companies and banks engaged in significant trading activity may also be subject to the market risk capital guidelines and be required to incorporate additional market and interest rate risk components into their risk-based capital standards.
Regulatory Capital and Risk-weighted Assets
The Federal Reserve monitors our capital adequacy on a consolidated basis, and the FDIC and the DBO monitor the capital adequacy of our Bank. These rules implement the Basel III international regulatory capital standards in the United States, as well as certain provisions of the Dodd-Frank Act. These quantitative calculations are minimums, and the Federal Reserve, FDIC or DBO may determine that a banking organization, based on its size, complexity or risk profile, must maintain a higher level of capital in order to operate in a safe and sound manner.
Under the Basel III Capital Rules, the Company’s and the Bank’s assets, exposures and certain
off-balance
sheet items are subject to risk weights used to determine the institutions’ risk-weighted assets. These risk-weighted assets are used to calculate the following minimum capital ratios for the Company and the Bank:
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, equal to the ratio of Tier 1 capital to quarterly average assets (net of goodwill, certain other intangible assets and certain other deductions). |
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CET1 Risk-Based Capital Ratio phase-in periods that began on January 1, 2015 and ended on January 1, 2018. The last phase of the Basel III Capital Rules’ transition provisions relating to capital deductions for mortgage servicing assets, certain deferred tax assets and investments in the capital instruments of unconsolidated financial institutions, and the recognition of minority interests in regulatory capital was delayed for certain bank holding companies and banks, including us and the |
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Bank, but a revised rule was finalized in July 2019 that will be effective in April 2020. Hybrid securities, such as trust preferred securities, generally are excluded from being counted as Tier 1 capital. However, for bank holding companies like us that have less than $15 billion in total consolidated assets, certain trust preferred securities were grandfathered in as a component of Tier 1 capital. In addition, because we are not an advanced approach banking organization, we were permitted to make a one-time permanent election to exclude accumulated other comprehensive income items from regulatory capital. We made this election in order to avoid significant variations in our levels of capital depending upon the impact of interest rate fluctuations on the fair value of our Bank’s available-for-sale securities portfolio. |
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Tier 1 Risk-Based Capital Ratio |
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Total Risk-Based Capital Ratio |
The total minimum regulatory capital ratios and well-capitalized minimum ratios are reflected in the charts below. For purposes of the Federal Reserve’s Regulation Y, including determining whether a bank holding company meets the requirements to be a financial holding company, bank holding companies, such as the Company, must maintain a Tier 1 Risk-Based Capital Ratio of 6.0% or greater and a Total Risk-Based Capital Ratio of 10.0% or greater. If the Federal Reserve were to apply the same or a very similar well-capitalized standard to bank holding companies as that applicable to the Bank, the Company’s capital ratios as of December 31, 2019 would exceed such revised well-capitalized standard. The Federal Reserve may require bank holding companies, including the Company, to maintain capital ratios substantially in excess of mandated minimum levels, depending upon general economic conditions and a bank holding company’s particular condition, risk profile and growth plans.
Failure to be well-capitalized or to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material adverse effect on our operations or financial condition. Failure to be well-capitalized or to meet minimum capital requirements could also result in restrictions on the Company’s or the Bank’s ability to pay dividends or otherwise distribute capital or to receive regulatory approval of applications.
In addition to meeting the minimum capital requirements, under the Basel III Capital Rules, the Company and the Bank must also maintain the required Capital Conservation Buffer to avoid becoming subject to restrictions on capital distributions and certain discretionary bonus payments to management. The Capital Conservation Buffer is calculated as a ratio of CET1 capital to risk-weighted assets, and it effectively increases the required minimum risk-based capital ratios. The Capital Conservation Buffer requirement was phased in over a three-year period that began on January 1, 2016. The
phase-in
period ended on January 1, 2019, and the Capital Conservation Buffer is now at its fully
phased-in
level of 2.5%.
The Tier 1 Leverage Ratio is not impacted by the Capital Conservation Buffer, and a banking institution may be considered well-capitalized while remaining out of compliance with the Capital Conservation Buffer.
The table below summarizes the capital requirements that the Company and the Bank must satisfy to avoid limitations on capital distributions and certain discretionary bonus payments (i.e., the required minimum capital ratios plus the Capital Conservation Buffer):
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Minimum Basel III Regulatory
Capital Ratio Plus Capital
Conservation Buffer |
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Effective January 1, 2019 |
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CET1 risk-based capital ratio |
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Tier 1 risk-based capital ratio |
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Total risk-based capital ratio |
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As of December 31, 2019, the Company and the Bank are well-capitalized for regulatory purposes. For a tabular presentation of the Company’s and Bank’s capital ratios as of December 31, 2019, see Note 18 —
of the notes to the consolidated financial statements.
Prompt Corrective Action Provisions
The Federal Deposit Insurance Act requires the federal bank regulatory agencies to take “prompt corrective action” with respect to a depository institution if that institution does not meet certain capital adequacy standards, including requiring the prompt submission of an acceptable capital restoration plan. Depending on the bank’s capital ratios, the agencies’ regulations define five categories in which an insured depository institution will be placed: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At each successive lower capital category, an insured bank is subject to more restrictions, including restrictions on the bank’s activities, operational practices or the ability to pay dividends or executive bonuses. Based upon its capital levels, a bank that is classified as well-capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment.
The prompt corrective action standards were changed to conform with the New Capital Rules. Under the new standards, in order to be considered well-capitalized, the bank will be required to meet the new common equity Tier 1 ratio of 6.5%, an increased Tier 1 ratio of 8% (increased from 6%), a total capital ratio of 10% (unchanged) and a leverage ratio of 5% (unchanged).
The federal banking agencies also may require banks and bank holding companies subject to enforcement actions to maintain capital ratios in excess of the minimum ratios otherwise required to be deemed well capitalized, in which case institutions may no longer be deemed to be well capitalized and may therefore be subject to certain restrictions such as taking brokered deposits.
In December 2013, the federal bank regulatory agencies adopted final rules that implement a part of the Dodd-Frank Act commonly referred to as the “Volcker Rule.” Under these rules and subject to certain exceptions, banking entities are restricted from engaging in activities that are considered proprietary trading and from sponsoring or investing in certain entities, including hedge or private equity funds that are considered “covered funds.” These rules became effective on April 1, 2014, although certain provisions are subject to delayed effectiveness under rules promulgated by the FRB. The Company and the Bank held no investment positions at December 31, 2019 which were subject to the final rule. Therefore, while these new rules may require us to conduct certain internal analysis and reporting to ensure continued compliance, they did not require any material changes in our operations or business.
useful life and is not amortized, but is tested for impairment at least annually, or more frequently, if events and circumstances exist that indicate that a goodwill impairment test should be performed. Such events and circumstances may include among others, a significant adverse change in legal factors or in the general business climate, significant decline in our stock price and market capitalization, unanticipated competition, the testing for recoverability of a significant asset group within the reporting unit, and an adverse action or assessment by a regulating body. Any adverse change in these factors could have a significant impact on the recoverability of goodwill and could have a material impact on our consolidated financial statements.
Based on the results of our annual goodwill impairment test, we determined that no goodwill impairment charges were required as our single reportable segment’s fair value exceeded its carrying amount. As of December 31, 2019, we determined there were no events or circumstances which would more likely than not reduce the fair value of our reportable segment below its carrying amount. Note 3 —
Summary of Significant Accounting Policies
of our consolidated financial statements presented elsewhere in this report
— Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Future realization of deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback or carryforward periods available under the tax law. Based on historical and future expected taxable earnings and available strategies, the Company considers the future realization of these deferred tax assets more likely than not.
The tax effects from an uncertain tax position are recognized in the financial statements only if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. Interest and penalties related to uncertain tax positions are recorded as part of other operating expense.
For complete discussion and disclosure of other accounting policies see Note 3 —
Summary of Significant Accounting Policies
of the Company’s consolidated financial statements presented elsewhere in this report.
Recently Issued Accounting Pronouncements but Not Adopted as of December 31, 2019
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Impact on Financial Statements |
ASU No. 2016-13, Financial Instruments- Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments |
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The FASB issued ASU No. 2016-13, “Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace the current “incurred loss” approach with an “expected loss” model. The new model, referred to as the Current Expected Credit Loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off- balance sheet credit exposures. This includes, but is not limited to, loans, leases, |
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We established a company-wide, cross-functional governance structure for implementation of this standard. We have developed a CECL allowance model that calculates reserves over the life of the loan and is largely driven by portfolio characteristics, risk-grading, macroeconomic variables and the associated economic outlook, as well as other key methodology assumptions. Those assumptions are based upon historical lifetime loss rate models segregated by three loan segments: Commercial and Industrial, Commercial Real Estate, and Consumer Retail. In addition to determining the quantitative life of loan loss rate to be applied against the portfolio segments, the ASU indicates management has the |
For the year ended December 31, 2019, we reported net earnings of $207.8 million, compared with $152.0 million for 2018. This represented a $55.8 million, or 36.73%, increase from the prior year. Diluted earnings per share were $1.48 for the year ended December 31, 2019, compared to $1.24 for 2018.
On August 10, 2018, we completed the acquisition of Community Bank (“CB”). Our financial statements for the year ended 2018 include 143 days of CB operations, post-merger. At close, Citizens Business Bank acquired $2.73 billion of loans. We also assumed $1.26 billion of noninterest-bearing deposits and $2.87 billion of total deposits.
At December 31, 2019, total assets of $11.28 billion decreased $246.7 million, or 2.14%, from total assets of $11.53 billion at December 31, 2018. Interest-earning assets of $10.03 billion at December 31, 2019 decreased $261.3 million, or 2.54%, when compared with $10.29 billion at December 31, 2018. The decrease in interest-earning assets was primarily due to a $200.0 million decrease in total loans and a $63.8 million decrease in investment securities, partially offset by a $7.3 million increase in interest-earning balances due from the Federal Reserve. Our tax equivalent yield on interest-earnings assets was 4.58% for 2019, compared to 4.17% for 2018.
Total investment securities were $2.41 billion at December 31, 2019, a decrease of $63.8 million, or 2.57%, from $2.48 billion at December 31, 2018. At December 31, 2019, investment securities HTM totaled $674.5 million. At December 31, 2019, investment securities AFS totaled $1.74 billion, inclusive of a
pre-tax
unrealized gain of $21.9 million. HTM securities declined by $70.0 million, or 9.40%, and AFS securities increased by $6.2 million, or 0.36%, from December 31, 2018. Our tax equivalent yield on investments was 2.50% for 2019, compared to 2.48% for 2018.
Total loans and leases, net of deferred fees and discount, of $7.56 billion at December 31, 2019, decreased by $200.0 million, or 2.58%, from $7.76 billion at December 31, 2018. The decrease in total loans included declines of $67.6 million in commercial and industrial loans, $46.3 million in SBA loans, $34.0 million in commercial real estate loans, $13.2 million in SFR loans, $10.8 million in dairy & livestock and agribusiness loans, $11.0 million in municipal lease finance receivables, and $12.3 million in consumer and other loans. The decline in these loan categories was generally the result of increased competition for new loan originations and higher levels of loan prepayments including a higher level of prepayment on loans from CB acquisition. Our yield on loans was 5.26% for the year ended December 31, 2019, compared to 4.97% for 2018. Interest income for yield adjustments related to discount accretion on acquired loans and nonrecurring nonaccrual interest paid was $30.8 million for 2019, compared to $16.9 million for 2018. Excluding the impact from discount accretion and nonaccrual interest paid, the yield on loans increased by 0.20%.
Noninterest-bearing deposits were $5.25 billion at December 31, 2019, an increase of $40.7 million, or 0.78%, compared to $5.20 billion at December 31, 2018. At December 31, 2019, noninterest-bearing deposits were 60.26% of total deposits, compared to 58.96% at December 31, 2018. Interest-bearing deposits of $3.46 billion declined by $163.3 million when compared to December 31, 2018. The cost of interest-bearing deposits for 2019 grew by 16 basis points but our overall cost of deposits of 0.20% increased by only seven basis points. This was due to the continued strength and concentration of noninterest-bearing deposits, which represented over 59% of total average deposits for 2019.
Customer repurchase agreements totaled $428.7 million at December 31, 2019, compared to $442.3 million at December 31, 2018. Our average cost of total deposits including customer repurchase agreements was 0.21% for 2019, compared to 0.14% for 2018.
At December 31, 2019, we had no short-term borrowings, compared to $280.0 million at December 31, 2018. At December 31, 2019, we had $25.8 million of junior subordinated debentures, unchanged from December 31, 2018. These debentures bear interest at three-month LIBOR plus 1.38% and mature in 2036. Our average cost of funds was 0.24% for 2019, compared to 0.16% for 2018.
The allowance for loan losses totaled $68.7 million at December 31, 2019, compared to $63.6 million at December 31, 2018. The allowance for loan losses was increased by $5.0 million in provision for loan losses and $47,000 in net recoveries. The allowance for loan losses was 0.91% and 0.82% of total loans and leases outstanding at December 31, 2019 and 2018, respectively. As of December 31, 2019, credit related discounts on acquired loans were $33.1 million.
Our capital ratios under the revised capital framework referred to as Basel III remain well-above regulatory standards. As of December 31, 2019, the Company’s Tier 1 leverage capital ratio totaled 12.33%, common equity Tier 1 ratio totaled 14.83%, Tier 1 risk-based capital ratio totaled 15.11%, and total risk-based capital ratio totaled 16.01%. Refer to our
Analysis of Financial Condition-Capital Resources
.
On August 10, 2018, we completed the acquisition of CB with approximately $4.09 billion in total assets and 16 banking centers. The total assets acquired from CB included $2.74 billion of acquired loans, net of an $82.7 million discount, $717.0 million of investment securities, and $70.9 million in bank-owned life insurance. The acquisition resulted in approximately $547.1 million of goodwill and $52.2 million in core deposit premium. At the close of the merger, the entire CB security portfolio was liquidated at fair market value, as was $297.6 million of FHLB term advances and $166.0 million of overnight borrowings assumed from CB. The assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting. The change in goodwill resulted from finalizing the fair value of impaired loans. The purchase price allocation was finalized in the second quarter of 2019. The consolidation of 10 banking centers was completed during the second quarter of 2019, in which four additional banking centers were consolidated into CBB banking centers.
We have included the financial results of the business combination in the consolidated statement of earnings and comprehensive income beginning on the acquisition date.
For the year ended December 31, 2017, we operated as two reportable segments: Banking Centers and Dairy & Livestock and Agribusiness. As a result of the Community Bank acquisition, along with changes in personnel, reporting structure, and operations, we
re-evaluated
our segment reporting for the third quarter ended September 30, 2018.
As of December 31, 2018 and 2019, we operated as one reportable segment. The factors considered in making this determination included the nature of products and offered services, geographic regions in which we operate, the applicable regulatory environment, and the materiality of discrete financial information reviewed by our key decision makers.
investment securities for 2018, compared to 2017. The nominal yield on investments increased by 9 basis points compared to 2017, while the tax equivalent yield increased by only four basis points due to the reduction of the federal tax rate on
tax-exempt
investments resulting from the Tax Reform Act. Dividend income from FHLB stock increased by $670,000 from 2017, due to a special dividend of $520,000 received from the FHLB in the fourth quarter of 2018.
Interest expense of $12.8 million for 2018 increased $4.5 million, or 54.47%, compared to $8.3 million for 2017. The average rate paid on interest-bearing liabilities increased 10 basis points, to 0.35% for 2018, from 0.25% for 2017. Average interest-bearing liabilities were $299.1 million higher in 2018, compared to 2017, as we assumed $1.61 billion interest-bearing deposits from CB during the third quarter of 2018. Average noninterest-bearing deposits represented 58.86% of our total deposits for 2018, compared to 58.48% for 2017. Our total cost of funds in 2018 was 0.16%, compared to 0.12% in 2017.
Provision for Loan Losses
The allowance for loan losses is increased by the provision for loan losses and recoveries of prior losses, and is decreased by recapture of provisions and by charge-offs taken when management believes the uncollectability of any loan is confirmed. The provision for loan losses is determined by management as the amount to be added to (subtracted from) the allowance for loan losses after net charge-offs have been deducted to bring the allowance to an appropriate level which, in management’s best estimate, is necessary to absorb probable loan losses within the existing loan portfolio.
The allowance for loan losses totaled $68.7 million at December 31, 2019, compared to $63.6 million at December 31, 2018. The allowance for loan losses was increased by a $5.0 million loan loss provision for 2019 and by net recoveries of $47,000. This compares to a $1.5 million loan loss provision and net recoveries of $2.5 million for 2018 and an $8.5 million loan loss provision recapture and net recoveries of $6.5 million for 2017. The increase in provision for loan losses was primarily due to lower levels of net recoveries and additional provision due to loan growth during the period experienced within the commercial and industrial and commercial real estate segments of the
non-acquired
loan portfolio. We periodically assess the quality of our portfolio to determine whether additional provisions for loan losses are necessary. In addition to the growth in the
non-acquired
loan portfolio, the provision was the result of the net effect of modest increases in certain qualitative loss factors and reduced reserve requirements for moderate reductions in historical loss rates across the portfolio. We believe the allowance is appropriate at December 31, 2019. The ratio of the allowance for loan losses to total loans and leases outstanding, net of deferred fees and discount, as of December 31, 2019, 2018 and 2017 was 0.91%, 0.82% and 1.23%, respectively. As of December 31, 2019, remaining credit related discounts on acquired loans were $33.1 million. Refer to the discussion of Allowance for Loan Losses in Item 7 —
Management’s Discussion and Analysis of Financial Condition and Results of Operations
contained herein for discussion concerning observed changes in the credit quality of various components of our loan portfolio as well as changes and refinements to our methodology.
No assurance can be given that economic conditions which adversely affect the Company’s service areas or other circumstances will not be reflected in increased provisions for loan losses in the future, as the nature of this process requires considerable judgment. See “Allowance for Loan Losses” under
Analysis of Financial Condition
herein.
Noninterest income includes income derived from financial services offered, such as CitizensTrust, BankCard services, international banking, and other business services. Also included in noninterest income are service charges and fees, primarily from deposit accounts, gains (net of losses) from the disposition of investment securities, loans, other real estate owned, and fixed assets, and other revenues not included as interest on earning assets.
The following table sets forth the various components of noninterest income for the periods presented.
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) |
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Gain on sale of building, net |
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) |
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Gain on sale of branches, net |
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) |
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Gain on eminent domain condemnation, net |
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) |
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$ |
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$ |
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$ |
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$ |
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$ |
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|
The $15.6 million growth in noninterest income was primarily due to a $5.7 million net gain from the legal settlement of an eminent domain condemnation of one of our business financial center buildings in Bakersfield and a $4.8 million net gain on the sale of our bank owned buildings, compared with a $3.5 million net gain on the sale of one OREO in 2018. Service charges on deposit accounts increased by $2.9 million from 2018, primarily due to growth in service charges on deposits assumed in the acquisition of CB. The $3.4 million increase in other income included increases of $1.5 million in swap fee income, $1.0 million increase in international banking fee income, and $1.1 million in SBA servicing income and dividend income from various equity investments. For 2019, the Durbin Amendment’s cap on interchange fees became effective for the Company, which reduced our debit card interchange fee income for bankcard services by approximately $600,000 when compared to 2018.
CitizensTrust consists of Wealth Management and Investment Services income. The Wealth Management group provides a variety of services, which include asset management, financial planning, estate planning, retirement planning, private, and corporate trustee services, and probate services. Investment Services provides self-directed brokerage, 401(k) plans, mutual funds, insurance and other
non-insured
investment products. At December 31, 2019, CitizensTrust had approximately $2.86 billion in assets under management and administration, including $2.01 billion in assets under management. CitizensTrust generated fees of $9.5 million for 2019, an increase of $751,000 compared to $8.8 million for 2018, due to the growth in assets under management.
The Bank’s investment in BOLI includes life insurance policies acquired through acquisitions and the purchase of life insurance by the Bank on a selected group of employees. The Bank is the owner and beneficiary of these policies. BOLI is recorded as an asset at its cash surrender value. Increases in the cash value of these policies, as well as insurance proceeds received, are recorded in noninterest income and are not subject to income tax, as long as they are held for the life of the covered parties. Death benefits of $502,000 were included in our BOLI policies for 2019.
The $43.5 million in noninterest income included $3.5 million of net gain on the sale of one OREO. 2017 included $2.9 million in
one-time
gains related to an eminent domain condemnation of one of our banking center buildings, a $906,000 net gain on the sale of a branch acquired from VBB, a $542,000 net gain on the sale of our former operations and technology center, and a $402,000 gain on sale of an investment security. Excluding the net gains realized in 2018 and 2017, noninterest income increased by $2.5 million over 2017. Service charges on deposit accounts increased by $1.3 million over 2017, primarily due to the acquisition of CB.
At December 31, 2018, CitizensTrust had approximately $2.54 billion in assets under management and administration, including $1.80 billion in assets under management. CitizensTrust generated fees of $8.8 million for 2018, a decrease of $1.1 million compared to $9.8 million for 2017.
The $598,000 increase in BOLI income included $706,000 in BOLI income from $70.9 million of BOLI policies acquired from CB in the third quarter of 2018, which partially offset the $775,000 in income recorded in 2017 on the death benefit of a former director.
The following table summarizes the various components of noninterest expense for the periods presented.
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|
For the Year Ended December 31, |
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Salaries and employee benefits |
|
$ |
|
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|
$ |
|
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|
$ |
|
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|
$ |
|
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$ |
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Software licenses and maintenance |
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Amortization of intangible assets |
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Telecommunications expense |
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) |
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) |
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) |
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|
Recapture of provision for unfunded loan commitments |
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) |
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) |
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) |
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) |
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Acquisition related expenses |
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) |
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) |
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Total noninterest expense |
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$ |
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$ |
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$ |
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$ |
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$ |
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Noninterest expense to average assets |
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| |
(1) |
Noninterest expense divided by net interest income before provision for loan losses plus noninterest income. |
Our ability to control noninterest expenses in relation to asset growth can be measured in terms of total noninterest expenses as a percentage of average assets. Noninterest expense as a percentage of average assets was 1.76% for 2019, compared to 1.89% and 1.70% for 2018 and 2017, respectively.
Our ability to control noninterest expenses in relation to the level of total revenue (net interest income before provision for loan losses plus noninterest income) is measured by the efficiency ratio and indicates the percentage of net revenue that is used to cover expenses. The efficiency ratio was 40.16% for 2019, compared to 45.83% for 2018 and 43.84% for 2017.
Noninterest expense of $198.7 million for the year ended December 31, 2019 was $18.8 million higher than 2018. Salaries and employee benefit costs increased $18.9 million primarily due to additional compensation related to the newly hired and former CB employees who were retained after the merger and $1.9 million in higher stock related compensation expense. Higher expense for accelerated vesting of stock grants related to the amended employment agreement and additional stock grants related to the consulting agreement for the Company’s retiring Chief Executive Officer contributed to the increase in compensation costs for 2019. The year-over-year increase also included a $5.5 million increase in CDI amortization as a result of core deposits assumed from CB. Increases of $1.3 million in professional services, $1.2 million in software licenses and maintenance, and $1.5 million in other expense was primarily related to higher expenses related to the operations of a larger bank after the merger with CB. These increases were partially offset by a $10.0 million decrease in merger related expenses.
Noninterest expense of $179.9 million for the year ended December 31, 2018 was $39.2 million higher than 2017. The year-over-year increase included $16.4 million in merger related expenses for the acquisition of CB in 2018, compared to $2.1 million in acquisition costs related to the integration and systems conversion of VBB for the same period of 2017. Salaries and benefit costs increased by $13.5 million due to additional compensation related expenses for the newly hired and former CB employees. CB related expenses were the primary driver of a $3.2 million increase in occupancy expense and a $2.3 million increase in software licenses and maintenance. The year-over-year increase also included a $3.9 million increase in amortization of intangible assets due to core deposits assumed from CB.
The Company’s effective tax rate for the year ended December 31, 2019 was 28.60%, compared with 28.00% and 44.70% for the year ended December 31, 2018 and 2017, respectively. On December 22, 2017, the Tax Reform Act was enacted into law. Beginning in 2018, the Tax Reform Act reduces the federal tax rate for corporations from 35% to 21% and changes or limits certain tax deductions. During the fourth quarter of 2017, we recorded a $13.2 million
one-time
charge to income tax expense due to the tax rate reduction and
re-measurement
of our net DTA. Our estimated annual effective tax rate also varies depending upon the level of
tax-advantaged
income as well as available tax credits. Refer to Note 11 —
of the notes to consolidated financial statements for more information.
The effective tax rates are below the nominal combined Federal and State tax rate as a result of
tax-advantaged
income from certain municipal security investments, municipal loans and leases and BOLI, as well as available tax credits for each period.
ANALYSIS OF FINANCIAL CONDITION
Total assets of $11.28 billion at December 31, 2019 decreased $246.7 million, or 2.14%, from total assets of $11.53 billion at December 31, 2018. Interest-earning assets totaled $10.03 billion at December 31, 2019, a decrease of $261.3 million, or 2.54%, when compared with earning assets of $10.29 billion at December 31, 2018. The decrease in interest-earning assets was primarily due to a $200.0 million decrease in total loans and a $63.8 million decrease in investment securities, partially offset by a $7.3 million increase in interest-earning balances due from the Federal Reserve. Total liabilities were $9.29 billion at December 31, 2019, a decrease of $389.6 million, or 4.03%, from total liabilities of $9.68 billion at December 31, 2018. Total deposits declined by $122.6 million, or 1.39%. Total equity increased $142.9 million, or 7.72%, to $1.99 billion at December 31, 2019, compared to $1.85 billion at December 31, 2018. The $142.9 million increase in equity was due to $207.8 million in net earnings, a $30.9 million increase in other comprehensive income, net of tax, resulting from the net increase in market value of our investment securities portfolio, and $7.8 million for various stock based compensation items. This was offset by $100.9 million in cash dividends declared, and $2.6 million for the repurchase of common stock. During 2019, under our common stock repurchase program, we repurchased 48,000 shares of common stock at an average price of $20.02.
The Company maintains a portfolio of investment securities to provide interest income and to serve as a source of liquidity for its ongoing operations. At December 31, 2019, we reported total investment securities of $2.41 billion. This represented a decrease of $63.8 million, or 2.57%, from total investment securities of $2.48 billion at December 31, 2018. At December 31, 2019, investment securities HTM totaled $674.5 million. At December 31, 2019, our investment securities AFS totaled $1.74 billion, inclusive of a
pre-tax
unrealized gain of $21.9 million. The
after-tax
unrealized gain reported in AOCI on investment securities AFS was $15.4 million.
As of December 31, 2019, the Company had a
pre-tax
net unrealized holding gain on AFS investment securities of $21.9 million, compared to a
pre-tax
net unrealized holding loss of $23.6 million at December 31, 2018. The changes in the net unrealized holding gain resulted primarily from fluctuations in market interest rates. For 2019, total repayments/maturities of investment securities totaled $485.8 million, compared to $489.6 million for 2018. The Company purchased additional investment securities totaling $540.6 million and $98.7 million for 2019 and 2018, respectively. During 2019, we sold 14 investment securities at book value of approximately $152.6 million. At the close of the merger in the third quarter of 2018, we liquidated the entire investment security portfolio of $717.0 million acquired from CB. No other investment securities were sold in 2018.
The tables below summarize the fair value of AFS and HTM investment securities as of the dates presented.
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Investment securities available-for-sale |
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Mortgage-backed securities |
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$ |
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$ |
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Total available-for-sale securities |
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$ |
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$ |
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Investment securities held-to-maturity: |
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$ |
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$ |
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$ |
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$ |
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$ |
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|
Mortgage-backed securities |
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$ |
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$ |
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$ |
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$ |
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$ |
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Mortgage-backed securities |
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(1) |
The weighted average yield for the portfolio is based on projected duration and is not tax-equivalent. The tax equivalent yield at December 31, 2019 was 3.49%. |
The maturity of each security category is defined as the contractual maturity except for the categories of mortgage-backed securities and CMO/REMIC whose maturities are defined as the estimated average life. The final maturity of mortgage-backed securities and CMO/REMIC will differ from their contractual maturities because the underlying mortgages have the right to repay such obligations without penalty. The speed at which the underlying mortgages repay is influenced by many factors, one of which is interest rates. Mortgages tend to repay faster as interest rates fall and slower as interest rate rise. This will either shorten or extend the estimated average life. Also, the yield on mortgage-backed securities and CMO/REMIC are affected by the speed at which the underlying mortgages repay. This is caused by the change in the amount of amortization of premiums or accretion of discounts of each security as repayments increase or decrease. The Company obtains the estimated average life of each security from independent third parties.
The weighted-average yield on the total investment portfolio at December 31, 2019 was 2.54% with a weighted-average life of 3.6 years. This compares to a weighted-average yield of 2.55% at December 31, 2018 with a weighted-average life of 4.3 years. The weighted average life is the average number of years that each dollar of unpaid principal due remains outstanding. Average life is computed as the weighted-average time to the receipt of all future cash flows, using as the weights the dollar amounts of the principal
pay-downs.
Approximately 90% of the securities in the total investment portfolio, at December 31, 2019, are issued by the U.S. government or U.S. government-sponsored agencies and enterprises, which have the implied guarantee of payment of principal and interest. As of December 31, 2019, approximately $76.0 million in U.S. government agency bonds are callable. The Agency CMO/REMIC are backed by agency-pooled collateral. Municipal bonds, which represented approximately 10% of the total investment portfolio, are predominately AA or higher rated securities.
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Gross
Unrealized
Holding
Losses |
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Gross
Unrealized
Holding
Losses |
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Gross
Unrealized
Holding
Losses |
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Investment securities available-for-sale: |
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|
Mortgage-backed securities |
|
$ |
|
|
|
$ |
|
) |
|
$ |
|
|
|
$ |
|
) |
|
$ |
|
|
|
$ |
|
) |
| |
|
|
|
|
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|
|
) |
|
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) |
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) |
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) |
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) |
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) |
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale securities |
|
$ |
|
|
|
$ |
|
) |
|
$ |
|
|
|
$ |
|
) |
|
$ |
|
|
|
$ |
|
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities held-to-maturity: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
|
|
|
$ |
|
) |
|
$ |
|
|
|
$ |
|
) |
|
$ |
|
|
|
$ |
|
) |
Mortgage-backed securities |
|
|
|
|
|
|
|
) |
|
|
|
|
|
|
|
) |
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) |
| |
|
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) |
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|
) |
| |
|
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) |
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|
) |
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|
|
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total held-to-maturity securities |
|
$ |
|
|
|
$ |
|
) |
|
$ |
|
|
|
$ |
|
) |
|
$ |
|
|
|
$ |
|
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
|
The Company did not record any charges for other-than-temporary impairment losses for the years ended December 31, 2019 and 2018.
Prior to April 1, 2019, our loans and lease finance receivables consisted of purchase credit impaired (“PCI”) loans associated with the acquisition of San Joaquin Bank (“SJB”) on October 16, 2009, and loans and leases receivables excluding PCI loans
(“Non-PCI
loans”). The PCI loans are more fully discussed in Note 3 —
Summary of Significant Accounting Policies
of the notes to the consolidated financial statements. At December 31, 2019 and December 31, 2018, the remaining discount associated with PCI loans was zero and our total gross PCI loan portfolio represented less than 0.2% of total gross loans and leases at December 31, 2019 and December 31, 2018. Beginning with June 30, 2019, PCI loans were accounted for and combined with
Non-PCI
loans and were reflected in total loans and lease finance receivables.
Total loans and leases, net of deferred fees and discounts, of $7.56 billion at December 31, 2019, decreased by $200.0 million, or 2.58%, from $7.76 billion at December 31, 2018. The decrease in total loans included declines of $67.6 million in commercial and industrial loans, $46.3 million in SBA loans, $34.0 million in commercial real estate loans, $13.2 million in SFR loans, $10.8 million in dairy & livestock and agribusiness loans, $11.0 million in municipal lease finance receivables, and $12.3 million in consumer and other loans. The decline in these loan categories was generally the result of increased competition for new loan originations and higher levels of loan prepayments, including higher levels of prepayment on loans acquired from CB.
Total loans, net of deferred loan fees, comprise 75.44% of our total earning assets as of December 31, 2019. The following table presents our loan portfolio by type for the periods presented.
Below is a summary of our average cash position and statement of cash flows for the years ended December 31, 2019 and 2018. For further details, see our “
Consolidated Statements of Cash Flows
” under Part IV consolidated financial statements of this report.
Consolidated Summary of Cash Flows
| |
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|
|
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|
|
| |
|
|
|
| |
|
|
|
|
|
|
| |
|
|
|
Average cash and cash equivalents |
|
$ |
|
|
|
$ |
|
|
Percentage of total average assets |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
$ |
|
|
|
$ |
|
|
Net cash provided by investing activities |
|
|
|
|
|
|
|
|
Net cash used in financing activities |
|
|
|
) |
|
|
|
) |
| |
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents |
|
$ |
|
|
|
$ |
|
|
| |
|
|
|
|
|
|
|
|
Average cash and cash equivalents increased by $60.5 million, or 26.56%, to $288.4 million for the year ended December 31, 2019, compared to $227.9 million for 2018.
At December 31, 2019, cash and cash equivalents totaled $185.5 million. This represented an increase of $21.6 million, or 13.16%, from $163.9 million at December 31, 2018.
In the normal course of its business activities, we are exposed to market risks, including price and liquidity risk. Market risk is the potential for loss from adverse changes in market rates and prices, such as interest rates (interest rate risk). Liquidity risk arises from the possibility that we may not be able to satisfy current or future commitments or that we may be more reliant on alternative funding sources such as long-term debt. Financial products that expose us to market risk include securities, loans, deposits, debt, and derivative financial instruments.
The table below provides the actual balances as of December 31, 2019 of interest-earning assets and interest-bearing liabilities, including the average rate earned or incurred for 2019, the projected contractual maturities over the next five years, and the estimated fair value of each category determined using available market information and appropriate valuation methodologies.
| |
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| |
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| |
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| |
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| |
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|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities available-for-sale (1) |
|
$ |
|
|
|
|
|
% |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Investment securities held-to-maturity (1) |
|
|
|
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning deposits due from Federal |
|
|
|
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans and lease finance receivables (2) |
|
|
|
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets |
|
$ |
|
|
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits |
|
$ |
|
|
|
|
|
% |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
| |
|
|
|
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Junior subordinated debentures |
|
|
|
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-bearing liabilities |
|
$ |
|
|
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
(1) |
These include mortgage-backed securities which generally prepay before maturity. |
| |
(2) |
Gross loans, net of deferred loan fees, costs and discounts. |
Interest Rate Sensitivity Management
During periods of changing interest rates, the ability to
re-price
interest-earning assets and interest-bearing liabilities can influence net interest income, the net interest margin, and consequently, our earnings. Interest rate risk is managed by attempting to control the spread between rates earned on interest-earning assets and the rates paid on interest-bearing liabilities within the constraints imposed by market competition in our service area. The primary goal of interest rate risk management is to control exposure to interest rate risk, within policy limits approved by the Board of Directors. These limits and guidelines reflect our risk appetite for interest rate risk over both short-term and long-term horizons. We measure these risks and their impact by identifying and quantifying exposures through the use of sophisticated simulation and valuation models, which, as described in additional detail below, are employed by management to understand net interest income (NII) at risk and economic value of equity (EVE) at risk. Net interest income at risk sensitivity captures asset and liability re pricing mismatches and is considered a shorter term measure, while EVE sensitivity captures mismatches within the period end balance sheets through the financial instruments’ respective maturities or estimated durations and is considered a longer term measure.
One of the primary methods that we use to quantify and manage interest rate risk is simulation analysis, which we use to model NII from the Company’s balance sheet under various interest rate scenarios. We use simulation analysis to project rate sensitive income under many scenarios. The analyses may include rapid and gradual ramping of interest rates, rate shocks, basis risk analysis, and yield curve scenarios. Specific balance sheet management strategies are also analyzed to determine their impact on NII and EVE. Key assumptions in the simulation analysis relate to the behavior of interest rates and pricing spreads, the changes in product balances, and the behavior of loan and deposit clients in different rate environments. This analysis incorporates several assumptions, the most material of which relate to the
re-pricing
characteristics and balance fluctuations of deposits with indeterminate or
non-contractual
maturities, and prepayment of loans and securities.
Our interest rate risk policy measures the sensitivity of our net interest income over both a
one-year
and
two-year
cumulative time horizon.
The simulation model estimates the impact of changing interest rates on interest income from all interest-earning assets and interest expense paid on all interest-bearing liabilities reflected on our balance sheet. This sensitivity analysis is compared to policy limits, which specify a maximum tolerance level for net interest income exposure over a
one-year
horizon assuming no balance sheet growth, given a 200 basis point upward and either a 100 or 200 basis point downward shift in interest rates depending on the level of current market rates. The simulation model uses a parallel yield curve shift that ramps rates up or down on a pro rata basis over the
12-month
and
24-month
time horizon.
The following depicts the Company’s net interest income sensitivity analysis for the periods presented below.
| |
|
|
|
|
|
|
|
|
|
|
| |
|
Estimated Net Interest Income Sensitivity (1) |
| |
|
|
|
|
|
|
| |
|
|
|
24-month Period (Cumulative) |
|
|
|
|
|
24-month Period (Cumulative) |
| |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
(1) Percentage change from base.
(2) Policy at December 31, 2018.
Based on our current simulation models, we believe that the interest rate risk profile of the balance sheet is asset sensitive over both a
one-year
and a
two-year
horizon. The estimated sensitivity does not necessarily represent a forecast and the results may not be indicative of actual changes to our net interest income. These
estimates are based upon a number of assumptions including: the nature and timing of interest rate levels including yield curve shape,
re-pricing
characteristics and balance fluctuations of deposits with indeterminate or
non-contractual
maturities, prepayments on loans and securities, pricing strategies on loans and deposits, and replacement of asset and liability cash flows. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change.
We also perform valuation analysis, which incorporates all cash flows over the estimated remaining life of all material balance sheet and derivative positions. The valuation of the balance sheet, at a point in time, is defined as the discounted present value of all asset cash flows and derivative cash flows minus the discounted present value of all liability cash flows, the net of which is referred to as EVE. The sensitivity of EVE to changes in the level of interest rates is a measure of the longer-term
re-pricing
risk and options risk embedded in the balance sheet. EVE uses instantaneous changes in rates, as shown in the table below. Assumptions about the timing and variability of balance sheet cash flows are critical in the EVE analysis. Particularly important are the assumptions driving prepayments and the expected duration and pricing of the indeterminate deposit portfolios. EVE sensitivity is reported in both upward and downward rate shocks. At December 31, 2019 and December 31, 2018, the EVE profile indicates a decline in net balance sheet value due to instantaneous downward changes in rates, compared to an increase resulting from an increase in rates.
Economic Value of Equity Sensitivity
| |
|
|
|
|
Instantaneous Rate Change |
|
|
|
|
100 bp decrease in interest rates |
|
|
|
|
100 bp increase in interest rates |
|
|
|
|
200 bp increase in interest rates |
|
|
|
|
300 bp increase in interest rates |
|
|
|
|
400 bp increase in interest rates |
|
|
|
|
As EVE measures the discounted present value of cash flows over the estimated lives of instruments, the change in EVE does not directly correlate to the degree that earnings would be impacted over a shorter time horizon (i.e., the current year). Further, EVE does not take into account factors such as future balance sheet growth, changes in asset and liability mix, changes in yield curve relationships, and changing product spreads that could mitigate the adverse impact of changes in interest rates.
Recent developments in the financial markets have placed an increased awareness of Counterparty Risks. These risks occur when a financial institution has an indebtedness or potential for indebtedness to another financial institution. We have assessed our Counterparty Risk with the following results:
| |
• |
We do not have any investments in the preferred stock of any other company; |
| |
• |
Most of our investment securities are either municipal securities or securities either issued or guaranteed by government, agencies, including Fannie Mae, Freddie Mac, SBA or FHLB; |
| |
• |
All of our commercial line insurance policies are with companies with the highest AM Best ratings of A or above; |
| |
• |
We have no significant exposure to our Cash Surrender Value of Life Insurance since the Cash Surrender Value balance is predominately supported by insurance companies that carry an AM Best rating of A- or greater; |
| |
• |
We have no significant Counterparty exposure related to derivatives such as interest rate swaps. Our Counterparty is a major financial institution and our agreement requires the Counterparty to post cash collateral for mark-to-market balances due to us; |
| |
• |
We believe our risk of loss associated with our counterparty borrowers related to interest rate swaps is generally mitigated as the loans with swaps are underwritten to take into account potential additional exposure; |
| |
• |
As of December 31, 2019, we had $394.0 million in Fed Funds lines of credit with other banks. All of these banks are major U.S. banks, each with over $60.0 billion in assets. These lines of credit are available for overnight borrowings; and |
| |
• |
At December 31, 2019, we had no short-term borrowings with FHLB. Our secured borrowing capacity with the FHLB was $3.18 billion, of which $3.18 billion was available as of December 31, 2019. |
Transaction risk is the risk to earnings or capital arising from problems in service, activity or product delivery. This risk is significant within any bank and is interconnected with other risk categories in most activities throughout the Company. Transaction risk is a function of internal controls, information systems, associate integrity, and operating processes. It arises daily throughout the Company as transactions are processed. It pervades all divisions, departments and centers and is inherent in all products and services we offer.
In general, transaction risk is defined as high, medium or low by the Company. The audit plan ensures that high risk areas are reviewed annually. We utilize internal auditors and independent audit firms to test key controls of operational processes and to audit information systems, compliance management programs, loan credit reviews and trust services.
The key to monitoring transaction risk is in the design, documentation and implementation of well-defined procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, but not absolute, assurances of the effectiveness of these systems and controls, and that the objectives of these controls have been met.
Compliance risk is the risk to earnings or capital arising from violations of, or
non-conformance
with, laws, rules, regulations, prescribed practices, or ethical standards. Compliance risk also arises in situations where the laws or rules governing certain products or activities of the Bank’s customers may be ambiguous or untested. Compliance risk exposes us to fines, civil money penalties, payment of damages, and the voiding of contracts. Compliance risk can also lead to a diminished reputation, reduced business value, limited business opportunities, lessened expansion potential, and lack of contract enforceability. The Company utilizes independent compliance audits as a means of identifying weaknesses in the compliance program.
There is no single or primary source of compliance risk. It is inherent in every activity. Frequently, it blends into operational risk and transaction risk. A portion of this risk is sometimes referred to as legal risk. This is not limited solely to risk from failure to comply with consumer protection laws; it encompasses all laws, as well as prudent ethical standards and contractual obligations. It also includes the exposure to litigation from all aspects of banking, traditional and
non-traditional.
Our Risk Management Policy and Program and the Code of Ethical Conduct are cornerstones for controlling compliance risk. An integral part of controlling this risk is the proper training of associates. The Chief Risk Officer is responsible for developing and executing a comprehensive compliance training program. The Chief Risk Officer, in consultation with our internal and external legal counsel, seeks to provide our associates with adequate training commensurate to their job functions to ensure compliance with banking laws and regulations.
Our Risk Management Policy and Program includes a risk-based audit program aimed at identifying internal control deficiencies and weaknesses. The Compliance Management Program includes two levels of
review. One is
in-depth
audits performed by our internal audit department under the direction of the Chief Auditor and supplemented by independent external firms, and the other is periodic monitoring performed by the Risk Management Division. Annually, an Audit Plan for the Company is developed and presented for approval to the Audit Committee of the Board.
The Risk Management Division conducts periodic monitoring of our compliance efforts with a special focus on those areas that expose us to compliance risk. The purpose of the periodic monitoring is to verify whether our associates are adhering to established policies and procedures. Any material exceptions identified are brought forward to the appropriate department head, the Audit Committee and the Risk Management Committee.
We recognize that customer complaints can often identify weaknesses in our compliance program which could expose us to risk. Therefore, we attempt to ensure that all complaints are given prompt attention. Our Compliance Management Policy and Program include provisions on how customer complaints are to be addressed. The Chief Risk Officer reviews formal complaints to determine if a significant compliance risk exists and communicates those findings to the Compliance Management and Risk Management Committees.
Strategic risk is the risk to earnings or capital arising from adverse decisions or improper implementation of strategic decisions. This risk is a function of the compatibility between an organization’s goals, the resources deployed against those goals and the quality of implementation.
Strategic risks are identified as part of the strategic planning process. Offsite strategic planning sessions, with members of the Board of Directors and Senior Leadership, are held annually. The strategic review consists of an economic assessment, competitive analysis, industry outlook and legislative and regulatory review.
A primary measurement of strategic risk is peer group analysis. Key performance ratios are compared to three separate peer groups to identify any sign of weakness and potential opportunities. The peer group consists of:
| |
1. |
Banks of comparable size; |
| |
2. |
High performing banks; and |
| |
3. |
A list of specific banks. |
Another measure is the comparison of the actual results of previous strategic initiatives against the expected results established prior to implementation of each strategy.
Cybersecurity and fraud risk refers to the risk of failures, interruptions of services, or breaches of security with respect to the Company’s or the Bank’s communication, information, operations, devices, financial control, customer internet banking, customer information, email, data processing systems, or other bank or third party applications. The ability of the Company’s customers to bank remotely, including online and through mobile devices, requires secure transmission of confidential information and increases the risk of data security breaches. In addition, the Company and the Bank rely primarily on third party providers to develop, manage, maintain and protect these systems and applications. Any such failures, interruptions or fraud or security breaches, depending on the scope, duration, affected system(s) or customers(s), could expose the Company and/or the Bank to financial loss, reputation damage, litigation, or regulatory action. We continue to invest in technologies and training to protect our associates, our clients and our assets. While we have implemented various detective and preventative measures which seek to protect our Company, our customers’ information and the Bank from the risk of fraud, data security breaches or service interruptions, there can be no assurance that these measures will be effective in preventing potential breaches or losses for us or our customers.
Price and Foreign Exchange Risk
Price risk arises from changes in market factors that affect the value of traded instruments. Foreign exchange risk is the risk to earnings or capital arising from movements in foreign exchange rates.
Our current exposure to price risk is nominal. We do not have trading accounts. Consequently, the level of price risk within the investment portfolio is limited to the need to sell securities for reasons other than trading.
We maintain limited deposit accounts with various foreign banks. Our Interbank Liability Policy seeks to limit the balance in any of these accounts to an amount that does not in our judgment present a significant risk to our earnings from changes in the value of foreign currencies.
Our asset liability model seeks to calculate the market value of the Bank’s equity. In addition, management prepares, on a monthly basis, a capital volatility report that compares changes in the market value of the investment portfolio. We have as our target to always be well-capitalized by regulatory standards.
ITEM 7A. |
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Market risk is the risk of loss from adverse changes in the market prices and interest rates. Our market risk arises primarily from interest rate risk inherent in our lending and deposit taking activities. We currently do not enter into futures, forwards, or option contracts. For quantitative and qualitative disclosures about market risks in our portfolio, see “Asset/Liability Management and Interest Rate Sensitivity Management” included in Item 7 —
Management’s Discussion and Analysis of Financial Condition and the Results of Operations
presented elsewhere in this report. Our analysis of market risk and market-sensitive financial information contain forward looking statements and is subject to the disclosure at the beginning of Part I regarding such forward-looking information.
ITEM 8. |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
Index to Consolidated Financial Statements
and Financial Statement Schedules
All schedules are omitted because they are not applicable, not material or because the information is included in the financial statements or the notes thereto.
For information about the location of management’s annual reports on internal control, our financial reporting and the audit report of KPMG LLP thereon. See “Item 9A.
.”
ITEM 9. |
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
1) |
Management’s Report on Internal Control over Financial Reporting |
Management of CVB Financial Corp., together with its consolidated subsidiaries (the “Company”), is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on our financial statements.
As of December 31, 2019, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2019 is effective. KPMG LLP, an independent registered public accounting firm, has issued their report on the effectiveness of internal control over financial reporting as of December 31, 2019.
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Opinion on Internal Control Over Financial Reporting
We have audited CVB Financial Corp. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2019, based on criteria established in
Internal Control – Integrated Framework (2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in
Internal Control – Integrated Framework (2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, the related consolidated statements of earnings and comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes (collectively, the consolidated financial statements), and our report dated March 2, 2020 expressed an unqualified opinion on those consolidated financial statements.
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
3) |
Evaluation of Disclosure Controls and Procedures; Changes in Internal Control over Financial Reporting |
We maintain controls and procedures designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Such information is reported to our management, including our Chief Executive Officer and Chief Financial Officer to allow timely and accurate disclosure based on the definition of “disclosure controls and procedures” in SEC Rule
13a-15(e)
and
15d-15(e)
promulgated pursuant to the Exchange Act.
As of the end of the period covered by this report, we carried out an evaluation of the effectiveness of our disclosure controls and procedures under the supervision and with the participation of our management, including our Chief Executive Officer and the Chief Financial Officer. Based on the foregoing, our Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report.
During the fiscal quarter ended December 31, 2019, there have been no changes in our internal control over financial reporting that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
ITEM 10. |
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
Except as hereinafter noted, the information concerning directors and executive officers of the Company, corporate governance and our audit committee financial experts is incorporated by reference from the section entitled “Discussion of Proposals recommended by the Board — Proposal 1: Election of Directors” and “Beneficial Ownership Reporting Compliance,” “Corporate Governance Principles and Board Matters,” and “Audit Committee” of our definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year. For information concerning the executive officers of the Company, see Item I of Part I hereto.
The Company has adopted a Code of Ethics that applies to all of the Company’s employees, including the Company’s principal executive officer, the principal financial officer, accounting officers, and all employees who perform these functions. A copy of the Code of Ethics is available to any person without charge by submitting a request to the Company’s Chief Financial Officer at 701 N. Haven Avenue, Suite 350, Ontario, CA 91764. If the Company shall amend its Code of Ethics as applies to the principal executive officer, principal financial officer, principal accounting officer or controller (or persons performing similar functions) or shall grant a waiver from any provision of the code of ethics to any such person, the Company shall disclose such amendment or waiver on its website at www.cbbank.com under the tab “Investor Relations.”
Information concerning management remuneration and transactions is incorporated by reference from the section entitled “Election of Directors” and “Executive Compensation — Certain Relationships and Related Transactions” of our definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year.
ITEM 12. |
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The following table summarizes information as of December 31, 2019 relating to our equity compensation plans pursuant to which grants of options, restricted stock, or other rights to acquire shares may be granted from time to time.
Equity Compensation Plan Information
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Number of Securities to be
Issued Upon Exercise of
Outstanding Options,
Warrants, and Rights (a) |
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Weighted-Average Exercise Price of Outstanding Options, Warrants, and Rights (b) |
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Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation Plans
(Excluding Securities
Reflected in Column (a)) (c) |
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Equity compensation plans approved by security holders |
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$ |
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Equity compensation plans not approved by security holders |
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$ |
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$ |
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Information concerning security ownership of certain beneficial owners and management is incorporated by reference from the sections entitled “Stock Ownership” of our definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year.
