Good morning, ladies and gentlemen. And welcome to the Second Quarter of 2020 CVB Financial Corporation and its Subsidiary Citizens Business Bank Earnings Conference Call. My name is Nick and I’ll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer period.

Please note that this event is being recorded. I’ll now like to turn the presentation over to your host for today's call, Ms. Christina Carrabino. Please go ahead..

Thank you, Nick, and good morning, everyone. Thank you for joining us today to review our financial results for the second quarter of 2020. Joining me this morning are Dave Brager, 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. Before we get started, let me remind you that today's conference call will include some forward-looking statements.

These forward-looking statements relate to, among other things, current plans, expectations events and industry trends that may affect the company's future operating results and financial position. Such statements involve risks and uncertainties, and future activities and results may differ materially from these expectations.

Among other risks, the ongoing COVID-19 pandemic may significantly affect the banking industry and the company's business prospects. The ultimate impact on our business and financial results will depend on our future development, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic.

The impact on the economy, our customers and our business partners and actions taken by government authorities in response to the pandemic. 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, 2019 and in particular the information set forth in item 1A, Risk Factors therein.

Now I will turn the call over to Dave Brager.

Dave?.

Thank you, Christina, and good morning, everyone, and thank you for joining us again on our investor call for the second quarter.

As we announced in our second quarter earnings release yesterday afternoon, the effects of the COVID-19 pandemic continue to broadly impact the financial services industry, including Citizens Business Bank through the economic impacts of the stay-at-home orders, business closure orders and the widespread effects that require social distancing and health and safety measures in California.

Before we provide more details on the impact on our business and how we plan to continue to manage to this pandemic, Allen and I will report on our second quarter 2020 financial results.

Yesterday, we reported net earnings of $41.6 million for the second quarter of 2020 or $0.31 per share, which represented our 173rd consecutive quarter of profitability. We also declared an $0.18 per share dividend for the second quarter of 2020, which represented our 123rd consecutive quarter of paying a cash dividend to our shareholders.

Our net earnings of $41.6 million, compares with $38 million for the first quarter of 2020, and $54.5 million for the year ago quarter. Earnings per share of $0.31 for the second quarter, compares with $0.27 for the first quarter and $0.39 for the year ago quarter.

Through the first six months of 2020, we earned $79.6 million compared with $106.1 million for the first six months of 2019. Diluted earnings per share were $0.58 for the six-month period ended June 30, 2020, compared with $0.76 for the same period in 2019.

Our pre-tax pre-provision income was $70.3 million for the second quarter, which was $5 million higher than the prior quarter and $8.4 million lower than the second quarter of 2019.

We originated $1.1 billion under the SBA's Paycheck Protection Program resulting in approximately $8.5 million in loan interest and fee income during the second quarter of 2020. We recorded a credit loss provision of $11.5 million for the second quarter of 2020.

In comparison, we had a credit loss provision of $12 million in the first quarter of 2020 and a loan loss provision of $2 million in the second quarter of 2019. The additional provision in the second quarter was primarily the result of our forecast of a further deterioration in our economy due to the pandemic.

We will discuss our economic forecast in more detail later in this call. Now, I would like to discuss our deposits and loans. We had significant deposit growth of approximately $2 billion for the second quarter, due primarily to proceeds from PPP loans and our customers maintaining greater liquidity.

At June 30, 2020, our non-interest-bearing deposits totaled $6.9 billion, compared with $5.6 billion for the prior quarter and $5.3 billion for the year ago quarter. Non-interest-bearing deposits were 63% of total deposits at the end of the second quarter, compared with 61% for both the prior quarter and the year ago quarter.

At June 30, 2020, our total deposits and customer repurchase agreements were $11.5 billion, compared with $9.5 billion at March 31, 2020 and $9.1 billion for the same period a year ago.

Average non-interest-bearing deposits were $6.2 billion for the second quarter of 2020, compared with $5.2 billion for the prior quarter and $5.1 billion for the year ago quarter. Our average total deposits and customer repurchase agreements of $10.5 billion for the second quarter grew by $1.3 billion, or 14% from the first quarter.

Now moving on to loans. Total loans including $1.1 billion of PPP loans increased by $936 million, or 12.5% from the end of the first quarter. Excluding PPP loans, loans decreased by $161 million, including a $120 million decline in C&I loans. The C&I balances were impacted by a reduction in line usage from the end of the first quarter.

The bank's total unused loan commitments increased by approximately $117 million from March 31 to June 30 and the overall line utilization rate declined from approximately 53% at March 31, 2020 to 48% at June 30, 2020. Commercial real estate loans increased by $17 million over the prior quarter end.

Compared to June 30, 2019, total loans were $867 million higher, but when PPP loans are excluded, total loans declined by $230 million, or 3% over the prior year. This decrease in loans was generally across all loan segments.

Average loans for the second quarter increased by $564 million, compared with the first quarter of 2020 and increased by $489 million, compared with the year ago quarter. During the first quarter of 2020, PPP loans had an average balance of $670 million.

Net interest income before provision for credit losses was $104.6 million for the second quarter, compared with $102.3 million for the first quarter and $111.1 million from the year ago quarter.

The increase in interest income from the first quarter was the net result of additional interest and fee income recognized for PPP loans offset by a declining net interest margin. The decrease in net interest income from the prior year was primarily due to the decline in interest income from lower loan yields.

Our tax equivalent net interest margin was 3.7% for the second quarter of 2020, compared with 4.08% for the first quarter and 4.49% for the second quarter of 2019.

When the impact of PPP loans discount accretion on acquired loans and non-accrual interest paid is excluded the adjusted tax equivalent net interest margin was 3.42% for the second quarter, down from 3.87% for the prior quarter, and 4.08% for the year ago quarter.

Our net interest margin was negatively impacted during the second quarter by excess liquidity that resulted in more than $1 billion on average deposited at the Federal Reserve. Loan yields were 4.77% for the second quarter of 2020, compared with 4.95% for the first quarter of 2020 and 5.4% for the year ago quarter.

This decline was primarily due to the impact of the Federal Reserve's rate decreases and the decline in discount accretion income for acquired loans.

Excluding the impact of PPP loans, interest income related to purchase discount accretion and non-accrual interest paid loan yields were 4.44% for the first quarter, 23 basis points lower than the first quarter of 2020 and 42 basis points lower than the second quarter of 2019.

Our cost of deposits and customer repurchase agreements for the second quarter were 12 basis points and our total cost of funds was 13 basis points. Our cost of funds declined by eight basis points from the prior quarter, and 12 basis points from the second quarter of last year. Now, moving on to non-interest income.

Non-interest income was $12.2 million for the second quarter of 2020, compared with $11.6 million for the prior quarter, and $18.2 million for the year ago quarter. The second quarter of last year, included a $5.7 million net gain from the legal settlement of an eminent domain action on one of our banking center buildings located in Bakersfield.

During the current quarter, we generated record levels of swap fee income of $2.2 million, which was $1.8 million higher than both the prior quarter and the second quarter of 2019. Now expenses.

Non-interest expense for the second quarter was $46.4 million compared with $48.6 million for the first quarter of 2020 and $50.5 million for the year ago quarter.

Compared with the first quarter of 2020, salary and benefit expense declined by $2.2 million, which included approximately $1.1 million due to the timing of payroll-related tax expenses, and $1.2 million in higher deferred loan origination costs related, primarily to the origination of more than 4,000 PPP loans.

The second quarter of 2019 included $2.6 million in acquisition expense related to the Community Bank merger. Non-interest expense totaled 1.48% of average assets for the second quarter compared with 1.72% for the first quarter and 1.81% for the second quarter of 2019.

Our efficiency ratio was 39.75% for the second quarter of 2020 compared with 42.69% for the prior quarter and 39.09% for the second quarter of 2019. Now, turning to our asset quality metrics.

At quarter end, non-performing assets defined as non-accrual loans plus other real estate owned were $11.7 million compared with $11.3 million for the prior quarter and $13.6 million at June 30, 2019. As of June 30, 2020, we had OREO of $4.9 million, the same as the prior quarter.

At June 30, 2020, we had loans delinquent 30 days to 89 days of $2.6 million compared with $4.4 million at March 31, 2020. Classified loans for the second quarter were $86.3 million, a $2.7 million increase from the prior quarter. We will have more detailed information on our classified loans available in our second quarter Form 10-Q.

Through July 10, we granted temporary payment deferrals, primarily of principal and interest for loans in the amount of $1.27 billion. These deferments were primarily for 90 days with 93% of these loans being pass rated. Only 6% of these loans have received a second deferment and 94% of the deferments were granted between March and May.

At June 30, 2020 commercial loans to customers in the hotel, restaurant, entertainment and recreation industries represented approximately 4% of our commercial loans and loans to customers in retail trade were only 2% of our C&I loans. Commercial real estate loans on retail properties comprised 15% of our CRE loan portfolio at June 30, 2020.

At origination, the loans on retail properties were underwritten with loan to values averaging approximately 50%. It's important to note that, 56% of these loans were originated prior to 2017. I will now turn the call over to Allen Nicholson to discuss our effective tax rate, the allowance, capital levels and liquidity.

Allen?.

Thanks, Dave. Good morning, everyone. Our effective tax rate was 29.23% for the second quarter compared to 28.75% for the first quarter of 2020 and 29% for the year ago quarter. Our year-to-date effective tax rate was 29%.

Our allowance for credit losses increased in the second quarter, as a result of our forecasting a greater decline in economic activity due to the pandemic. We recorded $12 million of provision for credit losses during the first quarter of 2020 and recorded an additional $11.5 million in the second quarter.

Including net charge-offs of $158,000 in the second quarter, our ending allowance for credit losses was $94 million or 1.29% of total loans when excluding the $1.1 billion in PPP loans. This $94 million reserve represents an amount that exceeds our entire classified loan balance.

Our economic forecast is a blend of multiple forecasts produced by Moody's. With the number of COVID-19 cases rising in California and the state backtracking on reopening the economy, our forecast increased the weighting on the downside economic forecast scenario. Moody's U.S.

baseline forecast continues to have the largest weighting our models and assumes GDP declined by 33% in the second quarter and will increase by 20% in the third quarter with a full year 2020 decrease in GDP of 5.6%. GDP is forecasted to be less than 2% in 2021, but rebounding to a strong 6.6% growth rate in 2022.

Unemployment is forecasted to have been at 14% in the second quarter. The bank continues to stay at an elevated level of approximately 9% through 2021 before declining to 7% in 2022. Now, turning to our capital position. For the first six months, shareholders' equity decreased by $35 million to $1.96 billion.

The decrease was primarily due to $92 million in stock repurchases during the first quarter and $48.8 million in cash dividends, offset by net earnings of $79.6 million and $24.9 million increase in other comprehensive income from the tax-affected impact of the increase in market value of available-for-sale securities.

Our overall capital position continues to be very strong. Our tangible common equity ratio was 9.6% at the end of the second quarter and our regulatory capital ratios are well above regulatory requirements to be considered well capitalized. At June 30, our common equity Tier one capital ratio was 14.5% and our total risk-based capital ratio was 16%.

We are also well positioned with a balance sheet that is highly liquid funded almost entirely with core deposits and availability of significant off-balance sheet sources of liquidity. At June 30, 2020 we had $1.8 billion on deposit at the Federal Reserve.

At the end of the second quarter, we started to deploy some of the excess funds into security purchases totaling $162 million. These mortgage-backed securities are expected to yield approximately 1.2%.

At June 30, 2020, our combined available-for-sale and held-to-maturity investment securities totaled $2.3 billion, a $33 million decrease from the first quarter and a $39 million decrease from June 30, 2019. At quarter end, investment securities available for sale totaled $1.68 billion.

The portfolio had a pretax unrealized gain of $57.3 million at the end of the quarter. This portfolio of securities comprised primarily of highly liquid government agency mortgage-backed securities. At quarter end, we had $25.8 million in sub debt and $10 million in zero interest advances from the FHLB.

The bank has available lines of credit exceeding $4 billion most of which is secured by pledge loans. I will now turn the call back to Dave for some closing remarks..

creating a safe and respectful working environment, treating others with compassion and respect and embracing a diverse and inclusive working environment. Our bank is committed to the following all applicable regulations, directives and guidance, in an effort to keep our associates and customers safe and healthy during this period.

In addition, in view of recent events occurring across the U.S., we have assured our associates of our continuing commitment to provide career and growth opportunities.

I also want to express my gratitude to our associates that have helped to ensure that Citizens Business Bank remains open to serve our customers and communities during these unprecedented times. We recently provided a special financial thank you award for qualified associates.

I have been exceptionally proud of the commitment and effort of our team over the past three months and I'm happy to report that our executive team and the Board enthusiastically supported this award program for our associates.

As in the case of all financial institutions in this environment, the pandemic continues to leave us and many of our customers with uncertainty, as to what will transpire in the future. We started seeing positive signs of economic recovery with California's reopening, as many counties began moving into phase three reopening.

Unfortunately, due to the spike in COVID-19 cases and hospitalizations, our governor rolled back some of the previously positive steps towards a full reopening and many businesses had to close or sharply curtail their operations after just recently reopening.

We hope that evolving national, state and local policies will continue to be supportive of the overall economy and the businesses that continue to be impacted.

In closing, as we move into the second quarter second -- excuse me, second half of 2020, we are focused on managing our banking business through the challenges presented by the pandemic and seeking to bolster our long-term track record of outperformance, particularly during troubled times that tend to highlight the benefits of our historically conservative and disciplined approach to managing capital and credit.

Our strategy remains focused on protecting shareholder value, by continuing to manage the bank in a disciplined and balanced manner and to evaluate growth opportunities carefully and selectively. In closing, I would like to thank our customers for their ongoing loyalty, our shareholders for their continued support and trust.

Please stay healthy and safe. That concludes today's presentation. Now, Allen and I will be happy to take any questions that you might have..

Thank you. We’ll now begin the question-and-answer session. [Operator Instructions] First question comes from Jackie Bohlen of KBW. Please, go ahead..

Hi. Good morning, everyone..

Good morning, Jackie..

I just have a question on the PPP fees. I saw the $6.8 million that you had on slide 14 in the presentation.

And I wanted to see if that included the interest earned on the balances? Or if that was just purely related to fees?.

That was just the recognition of the fees..

Okay..

So the interest itself was about $1.7 million..

Okay..

The total was $8.5 million, Jackie, that we highlighted..

Okay. $8.5 million. Okay. Sorry, I somehow missed that..

That's all right..

Okay.

And then how are you internally modeling the payoff of these loans and your forgiveness expectations of them?.

We're estimating that the average life is going to be about 15 months. Almost all of them have a 24-month term. There's very few that had a term longer than that. But we'll monitor it quarterly and see how that performs. We do expect that most of our customers are anxious to have the forgiveness. But we're still waiting on the SBA to have things set up.

But 15 months is our expectation on average..

Okay.

And is that -- you're amortizing the fee structure then over 15 months and not 24 months?.

We're doing an effective yield so at a loan level..

Okay. Okay. Thank you. And then just one more and then I'll step back in queue. I realize that this is a very difficult question to answer. But I just want to get your thoughts on balance sheet size.

If as these PPP loans pay off, if you'll see meaningful declines in deposits? Or if you think customer liquidity will remain elevated? I mean, just how you're thinking about that over the next couple of quarters?.

Yes. So I mean, obviously we were surprised. I mean it felt like every time we made a PPP loan for $1, we got $2 of deposit. So I think for the most part our customers are maintaining higher levels of liquidity. We monitor that really on a daily basis.

Most of the first round of the PPP I believe that they've spent that those funds for payroll and other things. The money is fungible. I think there's some -- potentially some slowdowns in investment and things and people are wanting to maintain the liquidity right now.

So we are modeling that it will decline slightly, but we are also investing a portion of those excess funds and hoping to do loans first. But absent the loan opportunity we've invested a little bit in securities as well. But we think it's going to remain elevated I believe through -- at least through the end of the year. But that's still to be seen..

Okay. Great. Thank you. I'll step back..

Thanks..

Thank you. Next question comes from David Feaster of Raymond James. Please go ahead..

Hey, good morning, everybody..

Good morning, David..

Hey, David..

I just wanted to start on redeferral rate. I mean, the early read that you've got at 6% is extremely low. And we're kind of at that crossing point with most of the deferrals happening in March and April.

Just curious if you think this is just the beginning? Or that we could actually kind of stay in this high single low double-digit redeferral rate realm? Just curious on any trends that you're seeing and what you expect with redeferral rates?.

Yes. It's a good question. And those numbers were actually after the quarter end. Those were as of July 10, the 6% redeferral rate. We anticipate that to remain low. However, we also as we've said in the first round, we wanted to make sure that our customers come out of this relatively as strong or stronger than they were before.

But the one thing -- and we did it on the first round, but the one thing we're doing a little bit more on the second round is we really want to understand if there's any underlying credit issues. We really want to be able to look at that deal.

And in many cases where they're asking for a second deferral if they -- I'll use the term don't need it, we're going to have harder conversations with them. And we're going to want something in return for that. So there has been some of the situations on the first 6% where we've taken additional collateral, where we've looked at the structure.

There's ask for paydowns. So there's been different situations, but we're looking at every single one individually. I anticipate it to remain lower, but I believe that it will be -- that ultimately it will be higher than 6%. I just can't make a guess on where the actual number will end up..

Yes. That's fair. And then I guess just kind of following up on that. I mean, assuming that we get more redeferrals going forward that probably translates into additional risk rating downgrades.

I guess, how do you think about the reserve going forward, the reserve build? I mean, do you think most of the heavy lifting is largely done and we'll only see modest reserve builds in the second half of the year? Or that as more risk rating downgrades could come that we might see more additional large reserve builds in the back half of the year?.

Yes. I'll start on this and I'll let Allen fill in any blanks. But I think for the most part in the first two quarters it's been largely driven by just the economic forecast and our modeling. In the third quarter, we do believe that we're going to see some more credit downgrades. We don't know what that extent is going to be.

But in our investor presentation, we outlined on the deferral amounts and it's an interesting slide. It shows what's being deferred and then you go to the COVID impacted industries, it shows what percentage is classified.

And so I think that the third quarter and the fourth quarter are going to be more driven by assuming that things get better from an economic forecast standpoint or at least stay the same it's going to be driven more by the credit migration. So I don't know Allen, if you want to add anything to that..

Yes. The only thing I would add is you could see credit migration, increase loss rates within our modeling. But if we also get to the point where the economic forecast is more reflective of an improvement and not the decline that could have some mitigating impact to future builds..

Okay. That’s helpful. And I'm sorry David, just one quick thing. I mean as Allen mentioned our allowance for credit losses is over 100% of our classified loans. 900% of our non-performers..

Yes. That's a good point. .

And then I guess last one for me. Just wanted to get your thoughts on organic loan growth going forward. You had mentioned the loans ex PPP were down a bit more than expected. It seems like this is largely due to decreasing C&I utilization. But just curious as of the trends that you're seeing.

How much of the decline outside of maybe declining utilization was from maybe more of a strategic perspective where you're tightening the credit box versus elevated payoffs and paydowns or asset sales or just simply limited demand for new credit? Just curious what you're seeing there and the pipeline heading into the next quarter..

Yes. So we normally don't give a lot of detail here. But I will tell you this that as far as loan demand, we are seeing loan demand. We actually in the first six months of 2020 produced more gross loans than we did in the first six months of 2019. So we are still seeing demand from our customers and prospects. We're active.

Our first priority is to grow quality loans. We want to be able to do that in this environment. Obviously, we have to be very disciplined about how we look at that because of the uncertainties related to the pandemic.

But we've also seen heightened prepayments and that's evidenced by just the prepayment penalties that we've recognized in the first six months. So we're about 50% up year-over-year in prepayment penalties in the first six months. And that's really related to I think where rates are and refinances on commercial real estate loans.

And our philosophy on that is when there's a relationship, we're going to compete hard and by relationship I mean, deposit relationship and loan relationship.

If we're dealing with a transaction that is industry-type that's maybe not as attractive today, we're going to look at that a little bit differently than if we have somebody that's self-funding their loan relationship with their deposits or close to self-funding their loan relationship. We're going to compete on price.

But we've been losing some commercial real estate loans at sub-2.75% 10-year rates to some of the larger banks. And you can see that in the net interest margin of those banks. And you can see that impact in our loan yields from the first to second quarter for us as well. So, we want to compete. We want to grow loans. We've produced more loans.

But we're also seeing some run-off on the back end, but we're not losing relationships..

Okay, terrific. That’s helpful. Thank you..

Next question comes from Gary Tenner of D.A. Davidson. Please go ahead..

Thanks. Good morning..

Good morning, Gary..

Just wanted to follow-up on the deferrals, the 6%, obviously on the second deferral at this point.

In terms of the remainder, the remainder as of June 30 -- or actually, I'm sorry July 10, what's the kind of point in time where those would actually expire in terms of the original 90 days? Is that by the end of July or broadly the end of August?.

Yeah. So, obviously the ones that were done in March have expired. The ones that are in April were almost to the point where they would have expired.

But I think that the process, probably I'd say be more complete by the end of August than the end of July, as far as that will be -- really where we'll have a much better idea of what that kind of second deferment looks like. So we have a little bit of game to play there.

So that's why I suggested that that number, that 6% number is going to be higher. I just don't know how much higher..

Okay, great. And then, in terms of the investment, I think you mentioned $162 million of the excess liquidity invested at quarter end. Your point taking that obviously, your preference will be able to grow loans.

Generally speaking, if the loan growth in the back half of the year does not materialize, where do you think the comfort level is in terms of the incremental investment into the securities portfolio?.

Gary, I think it will somewhat depend on the market and the opportunities. But, we're monitoring, and as Dave said, liquidity very closely. We do plan on investing far more than $162 million in the quarter, but it will somewhat depend on opportunities. We look on a daily basis.

Certainly, we want to reinvest the cash flow out of the portfolio as it comes through. But, we probably will look to invest a fair amount of that back into the bond portfolio, if we can find appropriate bonds..

Thanks. Thank you..

[Operator Instructions] At this time, there are no more questions. I'd now like to turn the call back over to Mr. Brager. Please go ahead..

Great, thank you. I want to thank everybody for joining us this quarter. We appreciate your interest and look forward to speaking with you in October for our third quarter 2020 earnings call. Please let Allen and I know if you have any questions. Have a great day. Stay safe, and thank you for listening..

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect..