CVB FINANCIAL CORP. The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources ofCVB Financial Corp. and its wholly owned subsidiary. This information is intended to facilitate the understanding and assessment of significant changes and trends related to our financial condition and the results of our operations. This discussion and analysis should be read in conjunction with this Annual Report on Form 10-K, and the audited consolidated financial statements and accompanying notes presented elsewhere in this report. IMPACT OF COVID-19 The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented volatility and disruption in financial markets and deterioration in economic activity and market conditions in the markets we serve. The pandemic has already affected our customers and the communities we serve and depending on the duration of the crisis, the adverse impact on our financial position and results of operations could be significant. In response to the anticipated effects of the pandemic on theU.S. economy, theBoard of Governors of theFederal Reserve System ("FRB") has taken significant actions, including a reduction in the target range of the federal funds rate to 0.0% to 0.25% and an indeterminate amount of purchases ofTreasury and mortgage-backed securities. OnMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security ("CARES") Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes the Paycheck Protection Program ("PPP"), a$349 billion program designed to aid small- and medium-sized businesses through 100% SBA guaranteed loans distributed through banks. These loans were intended to guarantee 24 weeks of payroll and other costs to help those businesses remain viable and keep their workers employed. The SBA exhausted the initial funding for this program onApril 15, 2020 , but legislation passed onApril 24, 2020 to provide additional PPP funds of$310 billion . During 2020, we originated and funded about 4,100 loans, totaling approximately$1.10 billion . In response to the COVID-19 pandemic, we also implemented a short-term loan modification program to provide temporary payment relief to certain of our borrowers who meet the program's qualifications. This program allows for a deferral of payments for 90 days. The deferred payments along with interest accrued during the deferral period are due and payable on the maturity date of the existing loan. As ofJanuary 15, 2021 , we had remaining temporary payment deferments of principal or of principal and interest in response to the CARES Act for six loans totaling$10 million . These deferments were primarily for 90 days, with 85% of these loans being rated special mention or classified. Further, onJanuary 13, 2021 , the SBA reopened the PPP for Second Draw loans to small businesses and non-profit organizations that did receive a loan through the initial PPP phase. At least$25 billion has been set aside for Second Draw PPP loans to eligible borrowers with a maximum of 10 employees or for loans of$250,000 or less to eligible borrowers in low or moderate income neighborhoods. Generally speaking, businesses with more than 300 employees and/or less than a 25% reduction in gross receipts between comparable quarters in 2019 and 2020 are not eligible for Second Draw loans. Further, maximum loan amounts have been increased for accommodation and food service businesses. Recently, the Bank began accepting applications for the second round of PPP loans. As ofJanuary 25, 2021 , we have received approximately 1,400 applications totaling$340 million . The fourth and third quarters of 2020 did not include a provision for credit losses, as the economic outlook was generally consistent with the forecast from the end of the second quarter. In comparison, the Company recorded a provision for credit losses of$23.5 million in the first half of 2020. We continue to monitor the impact of COVID-19 closely, as well as any effects that may result from the CARES Act. The extent to which the COVID-19 pandemic will impact our operations and financial results during 2021 is highly uncertain, but we may experience increased provision for credit losses if this pandemic results in economic stress greater than forecasted on our borrowers and loan portfolios and lower interest income if the current low interest rate environment continues. 45
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CRITICAL ACCOUNTING POLICIES
The preparation of these consolidated financial statements requires management
to make estimates and judgments that affect the reported amounts of assets and
liabilities, revenues and expenses, and related disclosures of contingent assets
and liabilities at the date of our financial statements. Actual results may
differ from these estimates under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective of
significant judgments and uncertainties, and are essential to understanding
Management's Discussion and Analysis of Financial Condition and Results of
Operations. The following is a summary of the more judgmental and complex
accounting estimates and principles. In each area, we have identified the
variables most important in the estimation process. We have used the best
information available to make the necessary estimates to value the related
assets and liabilities. Actual performance that differs from our estimates and
future changes in the key variables could change future valuations and impact
the results of operations.
Adoption of New Accounting Standard
Allowance for Credit Losses ("ACL")
- On January 1, 2020 , the Company adopted 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. We adopted this ASU
using a modified retrospective approach, as required, and have not adjusted
prior period comparative information and will continue to disclose prior period
financial information in accordance with the previous accounting guidance. The
adoption of ASU
2016-13,
resulted in a reduction to our opening retained earnings of approximately
$1.3 million , net of tax.
This ASU replaces the current "incurred loss" approach with an "expected loss"
model. The new model, referred to as the Current Expected Credit Loss ("CECL")
model, applies 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,
held-to-maturity
("HTM") securities, loan commitments, and financial guarantees. For loans and
HTM debt securities, this ASU requires a CECL measurement to estimate the
allowance for credit losses ("ACL") for the remaining contractual term, adjusted
for prepayments, of the financial asset (including
off-balance
sheet credit exposures) using historical experience, current conditions, and
reasonable and supportable forecasts. This ASU also eliminated the existing
guidance for purchased credit-impaired ("PCI") loans, but requires an allowance
for purchased financial assets with more than an insignificant deterioration of
credit since origination. Purchase Credit Deteriorated ("PCD") assets are
recorded at their purchase price plus an ACL estimated at the time of
acquisition. Under this ASU, there is no provision for credit losses recognized
at acquisition; instead, there is a
gross-up
of the purchase price of the financial asset for the estimate of expected credit
losses and a corresponding ACL recorded. Changes in estimates of expected credit
losses after acquisition are recognized as provision for credit losses (or
reversal of provision for credit losses) in subsequent periods. In addition,
this ASU modifies the OTTI model for
available-for-sale
("AFS") debt securities to require an allowance for credit impairment instead of
a direct write-down, which allows for reversal of credit impairments in future
periods based on improvements in credit. As a policy election, we excluded the
accrued interest receivable balance from the amortized cost basis of financing
receivables and HTM securities, as well as AFS securities, and disclose total
accrued interest receivable separately on the condensed consolidated balance
sheet.
For a full discussion of our methodology of assessing the adequacy of the
allowance for credit losses, see "Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operation - Risk Management
" and Note 3 -
Summary of Significant Accounting Policies
and Note 6 -
Loans and Lease Finance Receivables and Allowance for Credit Losses
of our consolidated financial statements presented elsewhere in this report.
46
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Business Combinations
- The Company applies the acquisition method of accounting for business
combinations. Under the acquisition method, the acquiring entity in a business
combination recognizes the assets acquired and liabilities assumed at their
acquisition date fair values. Management utilizes prevailing valuation
techniques appropriate for the asset or liability being measured in determining
these fair values. These fair values are estimates and are subject to adjustment
for up to one year after the acquisition date or when additional information
relative to the closing date fair values becomes available and such information
is considered final, whichever is earlier. Any excess of the purchase price over
amounts allocated to assets acquired, including identifiable intangible assets,
and liabilities assumed is recorded as goodwill. Where amounts allocated to
assets acquired and liabilities assumed is greater than the purchase price, a
bargain purchase gain would be recognized. Acquisition related costs are
expensed as incurred. Refer to Note 4 -
Business Combinations
of our consolidated financial statements presented elsewhere in this report
.
Valuation and Recoverability of Goodwill
- Goodwill represented $663.7 million of our $14.42 billion in total assets as
of December 31, 2020 . The Company has one reportable segment. Goodwill has an
indefinite 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, 2020 , 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
- 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, 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.
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.
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Recently Issued Accounting Pronouncements but Not Adopted as of December 31,
2020
Adoption
Standard Description Timing Impact on Financial Statements
ASU The FASB issued ASU 1st Quarter The Company established a
No. 2020-04, 2020-04, 2020 through LIBOR Transition Task Force in
Reference Reference Rate Reform: the 4th 2020, which has inventoried
Rate Reform Facilitation of the Quarter 2022 our instruments that reflect
(Topic 848): Effects of Reference Rate exposure to LIBOR, created a
Facilitation Reform on Financial framework to manage the
of the Reporting. The amendments transition and established a
Effects of in this update provide timeline for key decisions and
Reference temporary, optional actions to complete the
Rate Reform guidance to ease the transition from LIBOR in 2021.
on Financial potential burden in Although the Company is
Reporting accounting for assessing the impacts of this
transitioning away from transition and exploring
Issued March reference rates such as alternatives to use in place
2020 LIBOR. The amendments of LIBOR forvarious financial
provide optional instruments, primarily related
expedients and exceptions to ourvariable-rate loans,
for applying GAAP to our subordinated debentures,
transactions affected by and interest rate swap
reference rate reform if derivatives that are indexed
certain criteria are met. to LIBOR, we do not expect
The amendments primarily this ASU to have a material
include relief related to impact on the Company's
contract modifications and consolidated financial
hedging relationships, as statements.
well as providing a
one-time
election for the sale or
transfer of debt
securities classified as
held-to-maturity.
This guidance is effective
immediately and the
amendments may be applied
prospectively through
December 31, 2022.
ASU The FASB issued ASU 1st Quarter We do not expect the adoption
2019-12, 2019-12, 2021 of this ASU to have a material
"Income "Income Taxes (Topic 740): impact on our consolidated
Taxes (Topic Simplifying the Accounting financial statements.
740): for Income Taxes." This
Simplifying ASU removes certain
the exceptions for:
Accounting recognizing deferred taxes
for Income for investments,
Taxes" performing intraperiod
allocation and calculating
Issued income taxes in interim
December periods. This ASU also
2019 adds guidance to reduce
complexity in certain
areas, including
recognizing deferred taxes
for tax goodwill and
allocating taxes to
members of a consolidated
group.
ASU 2019-12
is effective for interim
and annual reporting
periods beginning after
December 15, 2020; early
adoption is permitted.
48-------------------------------------------------------------------------------- Table of Contents Standard Description Adoption Timing Impact
on Financial Statements
ASU The FASB issued ASU 1st Quarter 2021 The adoption of this ASU will
2020-01, 2020-01, not have an impact on our
Investments - Investments - Equity consolidated financial
Equity Securities Securities (Topic 321), statements.
(Topic 321), Investments - Equity
Investments - Method and Joint Ventures
Equity Method and (Topic 323), and
Joint Ventures Derivatives and Hedging
(Topic 323), and (Topic 815). This ASU
Derivatives and clarifies the interactions
Hedging between ASC 321, ASC 323
(Topic 815) and ASC 815 and addresses
accounting for the
Issued January transition into and out of
2020 the equity method and also
provides guidance on
whether equity method
accounting would be
applied to certain
purchased options and
forward contracts upon
settlement.
ASU The FASB issued ASU 1st Quarter 2022 The adoption of this ASU is
2020-06, 2020-06, not expected to have a
Debt - Debt with Debt - Debt with material impact on our
Conversion and Conversion and Other consolidated financial
Other Options Options (Subtopic statements.
(Subtopic 470-20)
470-20) and Derivatives and
and Derivatives Hedging - Contracts in
and Hedging - Entity's Own Equity
Contracts in (Subtopic 815-40):
Entity's Own Accounting for Convertible
Equity Instruments and Contracts
(Subtopic 815-40): in an Entity's Own Equity.
Accounting for This ASU reduces the
Convertible number of accounting
Instruments and models for convertible
Contracts in an instruments and allows
Entity's Own more contracts to qualify
Equity for equity classification.
Issued August 2020
ASU The FASB issued this 1st Quarter 2021 The adoption of this ASU is
2020-08 amendment to clarify that not expected to have a
Codification an entity should material impact on our
Improvements to reevaluate whether a consolidated financial
Subtopic callable debt security is statements.
310-20, within the scope of
Receivables - paragraph
Nonrefundable Fees 310-20-35-33
and Other Costs for each reporting period.
The amendments in this
Issued October Update are effective for
2020 fiscal years, and interim
periods within those
fiscal years, beginning
after December 15, 2020.
Early adoption of the
amendments is not
permitted.
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OVERVIEW
For the year ended December 31, 2020 , we reported net earnings of
$177.2 million , compared with $207.8 million for 2019. This represented a
$30.7 million , or 14.76%, decrease from the prior year. Diluted earnings per
share were $1.30 for 2020, compared to $1.48 for 2019.
The Company adopted ASU
2016-13,
commonly referred to as CECL which replaced the "incurred loss" approach with an
"expected loss" model over the life of the loan, effective on January 1, 2020 . A
$23.5 million provision for credit losses was recorded in the first half of
2020, due to the economic disruption and forecasted impact resulting from
COVID-19.
No provision for credit losses was recorded in either the third or fourth
quarter of 2020. The Company's economic forecast of macro-economic variables was
generally consistent, with modest changes, from the end of the second quarter of
2020 to December 31, 2020 . In comparison to the prior year, a $5.0 million loan
loss provision was incurred for 2019. For the year ended December 31, 2020 , we
experienced minimal credit charge-offs of $666,000 and total recoveries of
$358,000 , resulting in net charge-offs of $308,000 . During 2020, the Company
originated, under the SBA Paycheck Protection Program, approximately 4,100
loans, of which $883.0 million was outstanding at December 31, 2020 . Interest
and fee income from PPP loans was approximately $28.5 million for 2020.
At December 31, 2020 , total assets of $14.4 billion increased $3.14 billion , or
27.80%, from total assets of $11.28 billion at December 31, 2019 .
Interest-earning assets of $13.22 billion at December 31, 2020 increased
$3.20 billion , or 31.88%, when compared with $10.03 billion at December 31,
2019 . The increase in interest-earning assets includes a $1.81 billion increase
in interest-earning balances due from the Federal Reserve , a $784.2 million
increase in total loans, and a $562.8 million increase in investment securities.
The increase in total loans was due to the origination of approximately
$1.1 billion in PPP loans with a remaining outstanding balance totaling
$883.0 million at December 31, 2020 . Excluding PPP loans, total loans declined
by $98.8 million from December 31, 2019 . Our tax equivalent yield on
interest-earning assets was 3.71% for 2020, compared to 4.58% for 2019.
Total investment securities were $2.98 billion at December 31, 2020 , an increase
of $562.8 million , or 23.31%, from $2.41 billion at December 31, 2019 . At
December 31, 2020 , investment securities HTM totaled $578.6 million . At
December 31, 2020 , investment securities AFS totaled $2.40 billion , inclusive of
a
pre-tax
unrealized gain of $54.7 million , an increase of $32.8 from December 31, 2019 .
HTM securities declined by $95.8 million , or 14.21%, and AFS securities
increased by $658.7 million , or 37.85%, from December 31, 2019 . Our tax
equivalent yield on investments was 2.10% for 2020, compared to 2.50% for 2019.
Total loans and leases, net of deferred fees and discount, of $8.35 billion at
December 31, 2020 , increased by $784.2 million , or 10.37%, from $7.56 billion at
December 31, 2019 . The increase in total loans included $883.0 million in PPP
loans. Excluding PPP loans, total loans declined by $98.8 million , or 1.31%. The
$98.8 million decrease in loans included decreases of $123.1 million in
commercial and industrial loans, $31.8 million in construction loans,
$30.3 million in consumer loans, $22.6 million in dairy & livestock and
agribusiness loans, $13.0 million in SFR mortgage loans, and $4.9 million in
other loans. Partially offsetting these declines was an increase in commercial
real estate loans of $126.9 million . Our yield on loans was 4.68% for the year
ended December 31, 2020 , compared to 5.26% for 2019. 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. Interest income for yield
adjustments related to discount accretion on acquired loans was $17.4 million
for 2020, compared to $28.8 million for 2019.
Noninterest-bearing deposits were $7.46 billion at December 31, 2020 , an
increase of $2.21 billion , or 42.13%, compared to $5.25 billion at December 31,
2019 . The significant deposit growth in 2020 was primarily due to our customers
maintaining greater liquidity. At December 31, 2020 , noninterest-bearing
deposits were 63.52% of total deposits, compared to 60.26% at December 31, 2019 .
Our average cost of total deposits for 2020 was 0.12%, compared to 0.20% for
2019.
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Customer repurchase agreements totaled $439.4 million at December 31, 2020 ,
compared to $428.7 million at December 31, 2019 . Our average cost of total
deposits including customer repurchase agreements was 0.13% for 2020, compared
to 0.21% for 2019.
At December 31, 2020 , we had $5.0 million in short short-term borrowing with 0%
cost, compared to no borrowings at December 31, 2019 . At December 31, 2020 , we
had $25.8 million of junior subordinated debentures, unchanged from December 31,
2019 . These debentures bear interest at three-month LIBOR plus 1.38% and mature
in 2036. Our average cost of funds was 0.13% for 2020, compared to 0.24% for
2019.
The allowance for credit losses totaled $93.7 million at December 31, 2020 ,
compared to $68.7 million at December 31, 2019 . Due to the adoption of CECL,
effective on January 1, 2020 , a transition adjustment of $1.8 million was added
to the beginning balance of the allowance and was increased by $23.5 million in
provision for credit losses in 2020 due to the severe economic disruption
forecasted to result from the
COVID-19
pandemic. At December 31, 2020 , ACL as a percentage of total loans and leases
outstanding was 1.12%, or 1.25% when PPP loans are excluded. This compares to
0.91% at December 31, 2019 . As of December 31, 2020 , total discounts remaining
on acquired loans were $30.9 million .
The Company's total equity was $2.01 billion at December 31, 2020 . This
represented an increase of $13.9 million , or 0.70%, from total equity of
$1.99 billion at December 31, 2019 . This increase was primarily due to net
earnings of $177.2 million and a $22.7 million increase in other comprehensive
income resulting from the tax effected impact of the increase in market value of
our
available-for-sale
investment securities portfolio, partially offset by repurchases of common stock
of $91.7 million under our
10b5-1
stock repurchase program, and $97.7 million in cash dividends. Our tangible
common equity ratio was 9.6% at December 31, 2020 .
Our capital ratios under the revised capital framework referred to as Basel III
remain well-above regulatory requirements. As of December 31, 2020 , the
Company's Tier 1 leverage capital ratio totaled 9.90%, our common equity Tier 1
ratio totaled 14.77%, our Tier 1 risk-based capital ratio totaled 15.06%, and
our total risk-based capital ratio totaled 16.24%. We did not elect to phase in
the impact of CECL on regulatory capital, as allowed under the interim final
rule of the FDIC and other U.S. banking agencies. Refer to our
Analysis of Financial Condition - Capital Resources.
ANALYSIS OF THE RESULTS OF OPERATIONS
Financial Performance
Variance
Year Ended December 31, 2020 2019
2020 2019 2018 $ % $ %
(Dollars in thousands, except per share amounts)
Net interest income $ 416,053 $ 435,772
(23,500 ) (5,000 ) (1,500 ) (18,500 ) -370.00% (3,500 ) -233.33% Noninterest income
49,870 59,042 43,481 (9,172 ) -15.53% 15,561 35.79%
Noninterest expense (192,903 ) (198,740 ) (179,911 ) 5,837 2.94% (18,829 ) -10.47%
Income taxes (72,361 ) (83,247 ) (59,112 ) 10,886 13.08% (24,135 ) -40.83%
Net earnings $ 177,159 $ 207,827 $ 152,003 $ (30,668 ) -14.76% $ 55,824 36.73%
Earnings per common share:
Basic $ 1.30 $ 1.48 $ 1.25 $ (0.18 ) $ 0.23
Diluted $ 1.30 $ 1.48 $ 1.24 $ (0.18 ) $ 0.24
Return on average assets 1.37% 1.84% 1.60% -0.47% 0.24%
Return on average shareholders' equity 8.90% 10.71% 11.00% -1.81% -0.29%
Efficiency ratio 41.40% 40.16% 45.83% 1.24% -5.67%
Noninterest expense to average assets 1.49% 1.76% 1.89% -0.27% -0.13%
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Return on Average Tangible Common Equity Reconciliations
(Non-GAAP)
The return on average tangible common equity is a
non-GAAP
disclosure. The Company uses certain
non-GAAP
financial measures to provide supplemental information regarding the Company's
performance. The following is a reconciliation of net income, adjusted for
tax-effected
amortization of intangibles, to net income computed in accordance with GAAP; a
reconciliation of average tangible common equity to the Company's average
stockholders' equity computed in accordance with GAAP; as well as a calculation
of return on average tangible common equity.
Year Ended December 31,
2020 2019 2018
(Dollars in thousands)
Net Income $ 177,159 $ 207,827 $ 152,003
Add: Amortization of intangible assets 9,352 10,798 5,254
Less: Tax effect of amortization of
intangible assets (1) (2,765 ) (3,192 ) (1,553 )
Tangible net income $ 183,746 $ 215,433 $ 155,704
Average stockholders' equity $ 1,991,664 $ 1,939,961 $ 1,382,392
Less: Average goodwill (663,707 ) (665,026 ) (330,613 )
Less: Average intangible assets (38,203 ) (48,296 ) (26,055 )
Average tangible common equity$ 1,289,754 $
1,226,639
Return on average equity, annualized 8.90% 10.71% 11.00% Return on average tangible common equity 14.25% 17.56% 15.18% (1) Tax effected at respective statutory rates. Net Interest Income The principal component of our earnings is net interest income, which is the difference between the interest and fees earned on loans and investments (interest-earning assets) and the interest paid on deposits and borrowed funds (interest-bearing liabilities). Net interest margin is net interest income as a percentage of average interest-earning assets for the period. The level of interest rates and the volume and mix of interest-earning assets and interest-bearing liabilities impact net interest income and net interest margin. The net interest spread is the yield on average interest-earning assets minus the cost of average interest-bearing liabilities. Net interest margin and net interest spread are included on a tax equivalent (TE) basis by adjusting interest income utilizing the federal statutory tax rates of 21% in effect for the years endedDecember 31, 2020 , 2019 and 2018. Our net interest income, interest spread, and net interest margin are sensitive to general business and economic conditions. These conditions include short-term and long-term interest rates, inflation, monetary supply, and the strength of the international, national and state economies, in general, and more specifically, the local economies in which we conduct business. Our ability to manage net interest income during changing interest rate environments will have a significant impact on our overall performance. We manage net interest income through affecting changes in the mix of interest-earning assets as well as the mix of interest-bearing liabilities, changes in the level of interest-bearing liabilities in proportion to interest-earning assets, and in the growth and maturity of earning assets. See Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability and Market Risk Management - Interest Rate Sensitivity Management included herein. 52 -------------------------------------------------------------------------------- Table of Contents The table below presents the interest rate spread, net interest margin and the composition of average interest-earning assets and average interest-bearing liabilities by category for the periods indicated, including the changes in average balance, composition, and average yield/rate between these respective periods. Interest-Earning Assets and Interest-Bearing Liabilities Year Ended December 31, 2020 2019 2018 Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate (Dollars in thousands) INTEREST-EARNING ASSETS Investment securities (1) Available-for-sale securities: Taxable$ 1,854,964 $ 35,129 1.94%$ 1,580,850 $ 38,189 2.42%$ 1,869,842 $ 44,423 2.38% Tax-advantaged 37,110 923 3.50% 41,991 1,141 3.76% 52,550 1,565 3.98% Held-to-maturity securities: Taxable 438,190 9,542 2.18% 504,814 11,498 2.28% 534,642 11,848 2.22% Tax-advantaged 173,756 4,681 3.26% 211,899 5,890 3.36% 243,955 7,053 3.50% Investment in FHLB stock 17,688 978 5.53% 17,688 1,235 6.98% 19,441 2,045 (4) 10.52% Interest-earning deposits with other institutions 1,098,814 1,682 0.15% 120,247 2,269 1.89% 97,266 1,642 1.69% Loans (2) 8,066,483 377,402 4.68% 7,552,505 397,628 5.26% 5,905,674 293,284 4.97% Total interest-earning assets 11,687,005 430,337
3.71% 10,029,994 457,850 4.58% 8,723,370 361,860
4.17%
Total noninterest-earning assets 1,242,808 1,272,907 789,299
Total assets $ 12,929,813 $ 11,302,901 $ 9,512,669
INTEREST-BEARING LIABILITIES
Savings deposits (3) $ 3,530,606 8,803 0.25% $ 3,048,785 12,698 0.42% $ 2,656,660 7,250 0.27%
Time deposits 445,962 3,799 0.85% 487,221 4,422 0.91% 453,031 2,575 0.57%
Total interest-bearing deposits 3,976,568 12,602 0.32% 3,536,006 17,120 0.48% 3,109,691 9,825
0.32%
FHLB advances, other borrowings, and
customer repurchase agreements 511,404 1,682 0.33% 537,964 4,958 0.91% 499,526 2,990 0.60%
Interest-bearing liabilities 4,487,972 14,284 0.32% 4,073,970 22,078 0.54% 3,609,217 12,815 0.35%
Noninterest-bearing deposits 6,281,989 5,177,035 4,449,110
Other liabilities 168,188 111,935 71,950
Stockholders' equity 1,991,664 1,939,961 1,382,392
Total liabilities and stockholders'
equity $ 12,929,813 $ 11,302,901 $ 9,512,669
Net interest income $ 416,053 $ 435,772 $ 349,045
Net interest spread - tax equivalent 3.39% 4.04% 3.82%
Net interest margin 3.57% 4.35% 4.00%
Net interest margin - tax equivalent 3.59% 4.36% 4.03%
(1) Includes tax equivalent (TE) adjustments utilizing a federal statutory
rate of 21% in effect for the years ended December 31, 2020 , 2019 and
2018.
Non-tax
equivalent (TE) rate was 2.04%, 2.43% and 2.41% for the years ended
December 31, 2020 , 2019 and 2018, respectively.
(2) Includes loan fees of
years ended
penalty fees of
in interest income for the years ended December 31, 2020 , 2019 and 2018,
respectively.
(3) Includes interest-bearing demand and money market accounts.
(4) Includes a special dividend from the FHLB of $520,000 .
53-------------------------------------------------------------------------------- Table of Contents The following table presents a comparison of interest income and interest expense resulting from changes in the volumes and rates on average interest-earning assets and average interest-bearing liabilities for the periods indicated. Changes in interest income or expense attributable to volume changes are calculated by multiplying the change in volume by the initial average interest rate. The change in interest income or expense attributable to changes in interest rates is calculated by multiplying the change in interest rate by the initial volume. The changes attributable to interest rate and volume changes are calculated by multiplying the change in rate times the change in volume.
Rate and Volume Analysis for Changes in Interest Income, Interest Expense and
Net Interest Income
Comparision of Year Ended December 31,
2020 Compared to 2019 2019 Compared to 2018
Increase (Decrease) Due to Increase (Decrease) Due to
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
(Dollars in thousands)
Interest income:
Available-for-sale
securities:
Taxable investment securities $ 5,679 $ (7,608 ) $ (1,131 ) $ (3,060 ) $ (6,919 ) $ 811 $ (126 ) $ (6,234 )
Tax-advantaged
investment securities (132 ) (97 ) 11 (218 ) (315 ) (137 ) 28 (424 )
Held-to-maturity
securities:
Taxable investment securities (1,499 ) (525 ) 68 (1,956 ) (706 ) 377 (21 ) (350 )
Tax-advantaged
investment securities (1,061 ) (181 ) 33 (1,209 ) (927 ) (272 ) 36 (1,163 )
Investment in FHLB stock - (257 ) - (257 ) (184 ) (688 ) 62 (810 )
Interest-earning deposits with other
institutions 18,465 (2,085 ) (16,967 ) (587 ) 388 193 46 627
Loans 27,060 (44,273 ) (3,013 ) (20,226 ) 81,775 17,648 4,921 104,344
Total interest income 48,512 (55,026 ) (20,999 ) (27,513 ) 73,112 17,932 4,946 95,990
Interest expense:
Savings deposits 2,007 (5,097 ) (805 ) (3,895 ) 1,070 3,815 563 5,448
Time deposits (374 ) (272 ) 23 (623 ) 194 1,537 116 1,847
FHLB advances, other borrowings, and
customer repurchase agreements (245 ) (3,188 ) 157 (3,276 ) 234 1,610 124 1,968
Total interest expense 1,388 (8,557 ) (625 ) (7,794 ) 1,498 6,962 803 9,263
Net interest income $ 47,124 $ (46,469 ) $ (20,374 ) $ (19,719 ) $ 71,614 $ 10,970 $ 4,143 $ 86,727
2020 Compared to 2019
Net interest income, before provision for credit losses, of $416.1 million for
2020 decreased $19.7 million , or 4.53%, compared to $435.8 million for 2019.
Interest-earning assets increased on average by $1.66 billion , or 16.52%, from
$10.03 billion for 2019 to $11.69 billion for 2020. Our net interest margin (TE)
was 3.59% for 2020, compared to 4.36% for 2019.
Interest income for 2020 was $430.3 million , which represented a $27.5 million ,
or 6.01%, decrease when compared to 2019. Average interest-earning assets
increased to $11.69 billion and the average earning asset yield was 3.71% for
2020, compared to 4.58% for 2019. The 87 basis point decrease in the
interest-earning asset yield over 2019 was primarily due to a combination of a
58 basis point decrease in loan yields, a 39 basis point decline in the
non-tax
equivalent investment yields, and a change in mix of earning assets, with
average balances at the Federal Reserve growing to 9.11% of earning assets for
2020, compared to 1.14% for 2019. The increase in balances at the Federal
Reserve was impacted by $1.54 billion in average deposit growth for 2020. The
net interest margin for 2020 would have been about 30 basis points higher
without the $950.7 million year-over-year increase in average deposits at the
Federal Reserve , earning just 10 basis points.
Interest income and fees on loans for 2020 of $377.4 million decreased
$20.2 million , or 5.09% when compared to 2019 Average loans increased
$514.0 million for 2020 when compared to 2019, primarily due to
54
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$702.1 million in average PPP loans originated in the second quarter of 2020.
The PPP loans we originated resulted in approximately $21.4 million in fee
income and $7.1 million in loan interest during 2020. Discount accretion on
acquired loans and nonrecurring nonaccrual interest paid decreased by
$12.6 million compared to 2019. Loan yields decreased by 58 basis points from
2019. The significant decline in interest rates since the start of the pandemic
has had a negative impact on loan yields, which after excluding the impact from
PPP loans, discount accretion and nonaccrual interest income, causing loan
yields to decline by 36 basis points from 2019.
In general, we stop accruing interest on a loan after its principal or interest
becomes 90 days or more past due. When a loan is placed on nonaccrual, all
interest previously accrued but not collected is charged against earnings. There
was no interest income that was accrued and not reversed on nonaccrual loans at
December 31, 2020 and 2019. As of December 31, 2020 and 2019, we had
$14.3 million and $5.3 million of nonaccrual loans, respectively. Had these
nonaccrual loans for which interest was no longer accruing complied with the
original terms and conditions, interest income would have been approximately
$843,000 and $526,000 greater for 2020 and 2019, respectively.
Interest income from investment securities was $50.3 million for 2020, a
$6.4 million , or 11.36%, decrease from $56.7 million for 2019. The decrease was
primarily the result of a 39 basis point decline in the
non-tax
equivalent yield on investments as the decline in interest rates over the past
four quarters decreased yields on investment securities due to higher levels of
premium amortization, as well as lower yields on investments purchased during
2020. Partially offsetting the decline from lower rates was a $164.5 million
increase in the average investment securities for 2020 compared to 2019.
Interest expense of $14.3 million for 2020 decreased $7.8 million , or 35.30%,
compared to $22.1 million for 2019. The average rate paid on interest-bearing
liabilities decreased by 22 basis points, to 0.32% for 2020, from 0.54% for
2019. The rate on interest-bearing deposits for 2020 decreased by 16 basis
points from 2019. Average interest-bearing liabilities were $414.0 million
higher for 2020 when compared to 2019. On average, noninterest-bearing deposits
were 61.24% of our total deposits for 2020, compared to 59.42% for 2019. In
comparison to 2020, our overall cost of funds decreased 11 basis points, as our
average noninterest-bearing deposits grew by $1.10 billion . Average
interest-bearing deposits increased by $440.6 million for 2020, while the cost
of interest-bearing deposits decreased by 16 basis points.
2019 Compared to 2018
Net interest income, before provision for loan losses, of $435.8 million for
2019 increased $86.7 million , or 24.85%, compared to $349.0 million for 2018.
Interest-earning assets increased on average by $1.31 billion , or 14.98%, from
$8.72 billion for 2018 to $10.03 billion for 2019. The growth in
interest-earning assets was primarily the result of loan growth from the
acquisition of Community Bank ("CB"). Our net interest margin (TE) was 4.36% for
2019, compared to 4.03% for 2018.
Interest income for 2019 was $457.9 million , which represented a $96.0 million ,
or 26.53%, increase when compared to 2018. Average interest-earning assets
increased by $1.31 billion and the average interest-earning asset yield of
4.58%, compared to 4.17% for 2018. The 41 basis point increase in the
interest-earning asset yield over 2018 resulted from the combination of a 29
basis point increase in loan yields and the change in mix of earning assets.
Average loans as a percentage of earning assets grew from 67.7% in 2018 to 75.3%
in 2019. Conversely, average investment securities declined as a percentage of
earning assets from 31.0% in the prior year to 23.3% in 2019.
Interest income and fees on loans for 2019 of $397.6 million increased
$104.3 million , or 35.58% when compared to 2018 primarily due to loans acquired
from CB. Average loans increased $1.65 billion for 2019 when compared with 2018.
Discount accretion on acquired loans and nonrecurring nonaccrual interest paid
was $30.8 million for 2019, compared to $16.9 million for 2018, which increased
loan yields by nine basis points. In addition, loan yields increased by an
additional 20 basis points from the prior year primarily due to higher rates on
loans indexed to variable interest rates, such as the Bank's prime rate.
55
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There was no interest income that was accrued and not reversed on nonaccrual
loans at December 31, 2019 and 2018. As of December 31, 2019 and 2018, we had
$5.3 million and $20.0 million of nonaccrual loans, respectively. Had these
nonaccrual loans for which interest was no longer accruing complied with the
original terms and conditions, interest income would have been approximately
$526,000 and $1.3 million greater for 2019 and 2018, respectively.
Interest income from investment securities was $56.7 million for 2019, an
$8.2 million , or 12.59%, decrease from $64.9 million for 2018. This decrease was
the net result of a $361.4 million decrease in the average investment securities
for 2019 compared to 2018, partially offset by a two basis point increase in the
non
tax-equivalent
yield on securities. Dividend income from FHLB stock decreased by $810,000 from
2019, primarily due to a special dividend of $520,000 received from the FHLB in
the fourth quarter of 2018.
Interest expense of $22.1 million for 2019 increased $9.3 million , or 72.28%,
compared to $12.8 million for 2018. The average rate paid on interest-bearing
liabilities increased by 19 basis points, to 0.54% for 2019, from 0.35% for
2018. The rate on interest-bearing deposits for 2019 increased by 16 basis
points from 2018, as a result of higher rates on deposits acquired from CB and
competition from higher interest rates offered by our competitors. Average
interest-bearing liabilities increased by $464.8 million when compared to 2018,
primarily due to deposits assumed from CB. Average noninterest-bearing deposits
represented 59.42% of our total deposits for 2019, compared to 58.86% for 2018.
The overall cost of funds increased by only eight basis points due to the
continued strength and growth of noninterest-bearing deposits, during a period
of higher short-term interest rates.
Provision for Credit Losses
The provision for credit losses is a charge to earnings to maintain the
allowance for credit losses at a level consistent with management's assessment
of expected lifetime losses in the loan portfolio at the balance sheet date. On
January 1, 2020 , we adopted ASU
2016-13,
commonly referred to as CECL, which replaces the "incurred loss" approach with
an "expected loss" model over the life of the loan.
The allowance for credit losses totaled $93.7 million at December 31, 2020 ,
compared to $68.7 million at December 31, 2019 . Upon adoption of CECL, a
transition adjustment of $1.8 million was added to the beginning balance of the
allowance, with no impact on the consolidated statement of earnings, and was
increased by $23.5 million in provision for credit losses in the first half of
2020, due to the severe economic disruption forecasted as a result of the
COVID-19
pandemic. No provision for credit losses was recorded in the third or fourth
quarter of 2020. For 2020, we experienced minimal credit charge-offs of $666,000
and total recoveries of $358,000 , resulting in net charge-offs of $308,000 . This
compares to a $5.0 million loan loss provision and net recoveries of $47,000 for
2019 and a $1.5 million loan loss provision and net recoveries of $2.5 million
for 2018. The ratio of the allowance for credit losses to total loans and leases
outstanding, net of deferred fees and discount, as of December 31, 2020 , was
1.12%, or 1.25% when PPP loans are excluded. This compares to 0.91% and 0.82%,
as of December 31, 2019 and 2018, respectively. As of December 31, 2020 ,
remaining discounts on acquired loans were $30.9 million .
No assurance can be given that economic conditions which adversely affect the
Company's service areas or other circumstances will or will not be reflected in
increased provisions for credit losses in the future, as the nature of this
process requires considerable judgment. We may experience increases in the
provision for credit losses, in future periods, due to further deterioration in
economic conditions from the
COVID-19
pandemic. See "Allowance for Credit Losses" under
Analysis of Financial Condition
herein.
Noninterest Income
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.
56
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The following table sets forth the various components of noninterest income for
the periods presented.
Variance
Year Ended December 31, 2020 2019
2020 2019 2018 $ % $ %
(Dollars in thousands)
Noninterest income:
Service charges on deposit
accounts $ 16,561 $ 20,010 $ 17,070
453 4.76% 751 8.56%
Bankcard services 1,886 3,163 3,485 (1,277 ) -40.37% (322 ) -9.24%
BOLI income 8,100 5,798 4,018 2,302 39.70% 1,780 44.30%
Swap fee income 5,025 1,806 340 3,219 178.24% 1,466 431.18%
Gain on OREO, net 388 129 3,546 259 200.78% (3,417 ) -96.36% Gain on sale of building, net 1,680 4,776
- (3,096 ) -64.82% 4,776 -
Gain on eminent domain
condemnation, net - 5,685 - (5,685 ) -100.00% 5,685 -
Other 6,252 8,150 6,248 (1,898 ) -23.29% 1,902 30.44%
Total noninterest income
2020 Compared to 2019 Noninterest income for 2019 included a$5.7 million net gain from the legal settlement of an eminent domain condemnation of one of our banking center buildings in Bakersfield and$4.8 million in net gains on the sale of bank owned buildings, compared with a$1.7 million net gain on the sale of one of our owned buildings in 2020. Service charges on deposit accounts decreased by$3.4 million from 2019. This decrease was primarily due to the higher earnings credits generated by the significant increase in our customer's noninterest-bearing deposits held at the Bank. In addition, bankcard services decreased by approximately$1.3 million when compared to 2019, primarily due to the Durbin Amendment's cap on debit card interchange fees. The$1.9 million decrease in other income in 2020 included decreases in dividend income from various equity investments, other banking fee income and SBA servicing income when compared to 2019. The Bank enters into interest rate swap agreements with our customers to manage our interest rate risk and enters into identical offsetting swaps with a counterparty. The changes in the fair value of the swaps primarily offset each other resulting in swap fee income (refer to Note 20 - Derivative Financial Instruments of the notes to the unaudited condensed consolidated financial statements of this report for additional information). Swap fee income increased$3.2 million compared to 2019, due to higher volume of swap transactions. We executed on swap agreements related to new loan originations with a notional amount totaling$280.4 million for 2020, compared to$96.4 million for 2019. 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. AtDecember 31, 2020 , CitizensTrust had approximately$3.04 billion in assets under management and administration, including$2.18 billion in assets under management. CitizensTrust generated fees of$10.0 million for 2020, an increase of$453,000 compared to$9.5 million for 2019, 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. Income from our BOLI policies for 2020 included$2.8 million of death benefits that exceeded cash surrender values, compared to$502,000 of death benefits for 2019. 57 -------------------------------------------------------------------------------- Table of Contents 2019 Compared to 2018 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. AtDecember 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$1.8 million increase in BOLI income included a$1.2 million increase in income from$70.9 million of BOLI policies acquired from CB in the third quarter of 2018. Death benefits of$502,000 were included in our BOLI policies for 2019. Noninterest Expense The following table summarizes the various components of noninterest expense for the periods presented. Variance Year Ended December 31, 2020 2019 2020 2019 2018 $ % $ % (Dollars in thousands) Noninterest expense: Salaries and employee benefits$ 119,759 $ 119,475 $ 100,601 $ 284 0.24%$ 18,874 18.76% Occupancy 16,677 16,565 16,386 112 0.68% 179 1.09% Equipment 3,945 3,892 3,767 53 1.36% 125 3.32% Professional services 9,460 7,752 6,477 1,708 22.03% 1,275 19.69% Computer software expense 11,302 10,658 9,343 644 6.04% 1,315 14.07% Marketing and promotion 4,488 5,890 5,302 (1,402 ) -23.80% 588 11.09% Amortization of intangible assets 9,352 10,798 5,254 (1,446 ) -13.39% 5,544 105.52% Telecommunications expense 2,566 2,785 2,564 (219 ) -7.86% 221 8.62% Regulatory assessments 2,375 1,958 3,218 417 21.30% (1,260 ) -39.15% Insurance 1,636 1,475 1,735 161 10.92% (260 ) -14.99% Loan expense 1,159 1,439 1,103 (280 ) -19.46% 336 30.46% OREO expense 1,247 64 7 1,183 1848.44% 57 814.29% Recapture of provision for unfunded loan commitments - - (250 ) - - 250 100.00% Directors' expenses 1,420 1,230 1,073 190 15.45% 157 14.63% Stationery and supplies 1,172 1,179 1,207 (7 ) -0.59% (28 ) -2.32% Acquisition related expenses - 6,447 16,404 (6,447 ) -100.00% (9,957 ) -60.70% Other 6,345 7,133 5,720 (788 ) -11.05% 1,413 24.70% Total noninterest expense$ 192,903 $ 198,740 $ 179,911 $ (5,837 ) -2.94%$ 18,829 10.47% Noninterest expense to average assets 1.49% 1.76% 1.89% Efficiency ratio (1) 41.40% 40.16% 45.83%
(1) Noninterest expense divided by net interest income before provision for
credit 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 1.49% for 2020, compared to 1.76% and 1.89% for 2019 and 2018, respectively. The decrease in this ratio for 2020 was significantly impacted by the$950 million increase in average balances at theFederal Reserve . 58 -------------------------------------------------------------------------------- Table of Contents Our ability to control noninterest expenses in relation to the level of total revenue (net interest income before provision for credit 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 41.40% for 2020, compared to 40.16% for 2019 and 45.83% for 2018. 2020 Compared to 2019 Noninterest expense of$192.9 million for the year endedDecember 31, 2020 was$5.8 million , or 2.9% lower than 2019. There were no merger related expenses related to theCommunity Bank acquisition for 2020, compared to$6.4 million for 2019 and the year-over-year decrease also included a$1.4 million decrease in CDI amortization. A decrease in marketing and promotion expense in 2020 of$1.4 million was primarily due to COVID-19 restrictions on travel and entertainment. These decreases were partially offset by a$1.7 million increase in professional services expense, related to legal, audit, and other professional services. OREO expense also increased in 2020 by$1.2 million primarily due to a$700,000 write-down of one OREO property. 2019 Compared to 2018 Noninterest expense of$198.7 million for the year endedDecember 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. Income Taxes The Company's effective tax rate for the year endedDecember 31, 2020 was 29.00%, compared with 28.60% and 28.00% for the year endedDecember 31, 2019 and 2018, respectively. 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 - Income Taxes 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. 59
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ANALYSIS OF FINANCIAL CONDITION
Total assets of $14.42 billion at December 31, 2020 increased $3.14 billion , or
27.80%, from total assets of $11.28 billion at December 31, 2019 .
Interest-earning assets totaled $13.22 billion at December 31, 2020 , an increase
of $3.20 billion , or 31.88%, when compared with $10.03 billion at December 31,
2019 . The increase in interest-earning assets includes a $1.81 billion increase
in interest-earning balances due from the Federal Reserve , a $784.2 million
increase in total loans, and a $562.8 million increase in investment securities.
The increase in total loans was due to the origination of approximately
$1.10 billion in PPP loans with a remaining outstanding balance totaling
$883.0 million as of December 31, 2020 . Excluding PPP loans, total loans
declined by $98.8 million from December 31, 2019 .
Total liabilities were $12.41 billion at December 31, 2020 , an increase of
$3.12 billion , or 33.62%, from total liabilities of $9.29 billion at
December 31, 2019 . Total deposits grew by $3.03 billion , or 34.83%. This
significant deposit growth in 2020 was primarily due to our customers
maintaining greater liquidity in their deposit accounts. Total equity increased
$13.9 million , or 0.70%, to $2.01 billion at December 31, 2020 , compared to
total equity of $1.99 billion at December 31, 2019 . The $13.9 million increase
in equity was primarily due to net earnings of $177.2 million and a
$22.7 million increase in other comprehensive income from the tax effected
impact of the increase in market value of
available-for-sale
investment securities, partially offset by $97.7 million in cash dividends and
the repurchase of 4.9 million shares of common stock for $91.7 million under our
10b5-1
stock repurchase program. Our equity also decreased by $1.3 million as a result
of a cumulative effect adjustment to beginning retained earnings, net of tax,
due to the adoption of CECL on January 1, 2020 .
Investment Securities
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, 2020 , total investment securities were $2.98 billion . This
represented an increase of $562.8 million , or 23.31%, from total investment
securities of $2.41 billion at December 31, 2019 . The increase in investment
securities was primarily due to new securities purchased exceeding cash outflow
from the portfolio in 2020. At December 31, 2020 , investment securities HTM
totaled $578.6 million . At December 31, 2020 , our AFS investment securities
totaled $2.40 billion , inclusive of a
pre-tax
net unrealized gain of $54.7 million . The
after-tax
unrealized gain reported in AOCI on AFS investment securities was $38.6 million .
The changes in the net unrealized holding gain resulted primarily from
fluctuations in market interest rates. For the years ended December 31, 2020 and
2019, repayments/maturities of investment securities totaled $798.7 million and
$485.8 million , respectively. The Company purchased additional investment
securities totaling $1.28 billion and $540.6 million for the years ended
December 31, 2020 and 2019, respectively. There were no investment securities
sold during the year ended December 31, 2020 . During 2019, we sold 14 investment
securities at book value of approximately $152.6 million .
The tables below set forth our investment securities AFS and HTM portfolio by
type for the dates presented.
December 31,
2020 2019
Fair Value Percent Fair Value Percent
(Dollars in thousands)
Investment securities
available-for-sale
Mortgage-backed securities $ 1,904,935 79.41% $ 1,206,313 69.32%
CMO/REMIC 462,814 19.29% 493,710 28.37%
Municipal bonds 30,285 1.26% 39,354 2.26%
Other securities 889 0.04% 880 0.05%
Total
available-for-sale
securities $ 2,398,923 100.00% $ 1,740,257 100.00%
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December 31,
2020 2019
Amortized Amortized
Cost Percent Cost Percent
(Dollars in thousands)
Investment securities
held-to-maturity
Government agency/GSE $ 98,663 17.05% $ 117,366 17.40%
Mortgage-backed securities 146,382 25.30% 168,479 24.98%
CMO/REMIC 145,309 25.11% 192,548 28.55%
Municipal bonds 188,272 32.54% 196,059 29.07%
Total
held-to-maturity
securities $ 578,626 100.00% $ 674,452 100.00%
Fair Value $ 604,223 $ 678,948
The maturity distribution of the AFS and HTM portfolios consist of the following
as of the date presented.
December 31, 2020
After One After
Year Five Years
One Year or Through Through After Ten Percent to
Less Five Years Ten Years Years Total Total
(Dollars in thousands)
Investment securities
available-for-sale:
Mortgage-backed securities $ 807 $ 1,903,307 $ 821 $ - $ 1,904,935 79.41%
CMO/REMIC 8,803 350,905 81,052 22,054 462,814 19.29%
Municipal bonds (1) - 1,088 12,922 16,275 30,285 1.26%
Other securities 889 - - - 889 0.04%
Total $ 10,499 $ 2,255,300 $ 94,795 $ 38,329 $ 2,398,923 100.00%
Weighted average yield:
Mortgage-backed securities 4.80% 1.83% 3.37% - 1.84%
CMO/REMIC 0.48% 1.50% 2.26% 2.52% 1.66%
Municipal bonds (1) - 4.03% 2.48% 2.55% 2.58%
Other securities 2.74% - - - 2.74%
Total 1.00% 1.78% 2.30% 2.53% 1.81%
(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, 2020 was 3.26%.
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December 31, 2020
After One After
Year Five Years
One Year or Through Through After Ten Percent to
Less Five Years Ten Years Years Total Total
(Dollars in thousands)
Investment securities
held-to-maturity:
Government agency/GSE $ - $ - $ - $ 98,663 $ 98,663 17.05%
Mortgage-backed securities 262 134,978 9,031 2,111 146,382 25.30%
CMO/REMIC - 145,309 - - 145,309 25.11%
Municipal bonds (1) 2,462 24,961 66,530 94,319 188,272 32.54%
Total $ 2,724 $ 305,248 $ 75,561 $ 195,093 $ 578,626 100.00%
Weighted average yield:
Government agency/GSE - - - 1.92% 1.92%
Mortgage-backed securities 3.16% 2.21% 2.43% 3.43% 2.25%
CMO/REMIC - 2.26% - - 2.26%
Municipal bonds (1) 3.11% 2.80% 2.64% 2.10% 2.40%
Total 3.12% 2.29% 2.61% 2.02% 2.24%
(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, 2020 was 3.03%.
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,
2020 was 1.92% with a weighted-average life of 2.9 years. This compares to a
weighted-average yield of 2.54% at December 31, 2019 with a weighted-average
life of 3.6 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 93% of the securities in the total investment portfolio, at
December 31, 2020 , 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, 2020 , approximately
$64.4 million in U.S. government agency bonds are callable. The Agency CMO/REMIC
are backed by agency-pooled collateral. Municipal bonds, which represented
approximately 7% of the total investment portfolio, are predominately AA or
higher rated securities.
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The Company held investment securities in excess of 10% of shareholders' equity
from the following issuers as of the dates presented.
December 31,
2020 2019
Book Value Market Value Book Value Market Value
(Dollars in thousands)
Major issuer:
Federal National Mortgage
Association $ 1,133,321 $ 1,166,735 $ 963,002 $ 976,431
Federal Home Loan Mortgage
Corporation 1,058,957 1,084,494 805,841 815,311
Government National Mortgage
Association 413,991 421,025 271,154 268,879
Municipal securities held by the Company are issued by various states and their
various local municipalities. The following tables present municipal securities
by the top holdings by state as of the dates presented.
December 31, 2020
Amortized Percent of Percent of
Cost Total Fair Value Total
(Dollars in thousands)
Municipal Securities
available-for-sale:
Minnesota $ 11,055 38.5 % $ 11,588 38.3 %
Connecticut 5,653 19.7 % 5,910 19.5 %
Massachusetts 4,147 14.4 % 4,394 14.5 %
Iowa 2,345 8.2 % 2,430 8.0 %
Ohio 2,115 7.4 % 2,194 7.2 %
Maine 1,506 5.2 % 1,598 5.3 %
All other states (2 states) 1,886 6.6 % 2,171 7.2 %
Total $ 28,707 100.0 % $ 30,285 100.0 %
Municipal Securities
held-to-maturity:
Minnesota $ 44,820 23.8 % $ 46,243 23.7 %
Massachusetts 22,361 11.9 % 23,573 12.1 %
Ohio 17,781 9.4 % 18,502 9.5 %
Texas 17,135 9.1 % 17,706 9.1 %
Wisconsin 12,236 6.5 % 12,755 6.5 %
Connecticut 8,759 4.7 % 9,001 4.6 %
All other states (20 states) 65,180 34.6 % 67,398 34.5 %
Total $ 188,272 100.0 % $ 195,178 100.0 %
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December 31, 2019
Amortized Percent Percent
Cost of Total Fair Value of Total
(Dollars in thousands)
Municipal Securities
available-for-sale:
Minnesota $ 11,067 28.7% $ 11,274 28.6%
Connecticut 5,976 15.5% 6,103 15.5%
Iowa 5,831 15.1% 5,907 15.0%
California 5,675 14.7% 5,845 14.9%
Massachusetts 4,150 10.8% 4,260 10.8%
Ohio 2,125 5.5% 2,219 5.6%
All other states (3 states) 3,682 9.7% 3,746 9.6%
Total $ 38,506 100.0% $ 39,354 100.0%
Municipal Securities
held-to-maturity:
Minnesota $ 47,999 24.5% $ 48,695 24.4%
Massachusetts 24,700 12.6% 25,328 12.7%
Texas 21,586 11.0% 21,758 10.9%
Wisconsin 12,276 6.2% 12,416 6.2%
Washington 11,680 6.0% 11,873 6.0%
Ohio 9,523 4.9% 9,909 5.0%
All other states (20 states) 68,295 34.8% 69,382 34.8%
Total $ 196,059 100.0% $ 199,361 100.0%
We adopted ASU
2016-13
on January 1, 2020 , on a prospective basis. Under the new guidance, once it is
determined that a credit loss has occurred, an allowance for credit losses is
established on our
available-for-sale
and
held-to-maturity
securities. Prior to adoption of this standard, when a decline in fair value of
a debt security was determined to be other than temporary, an impairment charge
for the credit component was recorded, and a new cost basis in the investment
was established. As of December 31, 2020 , management determined that credit
losses did not exist for securities in an unrealized loss position.
The following table presents the Company's
available-for-sale
investment securities, by investment category, in an unrealized loss position
for which an allowance for credit losses has not been recorded as of
December 31, 2020 .
December 31, 2020
Less Than 12 Months 12 Months or Longer Total
Gross Gross Gross
Unrealized Unrealized Unrealized
Holding Holding Holding
Fair Value Losses Fair Value Losses Fair Value Losses
(Dollars in thousands)
Investment securities
available-for-sale:
Mortgage-backed securities $ 72,219 $ (101 ) $ - $ - $ 72,219 $ (101 )
CMO/REMIC 96,974 (249 ) - - 96,974 (249 )
Municipal bonds - - - - - -
Total
available-for-sale
securities $ 169,193 $ (350 ) $ - $ - $ 169,193 $ (350 )
The table below presents the Company's investment securities' gross unrealized
losses and fair value by investment category and length of time that individual
securities have been in a continuous unrealized loss position at December 31,
2019 , prior to adoption of ASU
2016-13.
Management previously reviewed individual securities to determine whether a
decline in fair value below the amortized cost basis is other-than-temporary.
The unrealized losses on these securities were primarily attributed to changes
in interest rates. The issuers of these securities have not, to our knowledge,
evidenced any cause for default on these securities. These securities
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have fluctuated in value since their purchase dates as market interest rates
have fluctuated. However, we have the ability and the intention to hold these
securities until their fair values recover to cost or maturity. As such,
management does not deem these securities to be other-than-temporarily-impaired.
December 31, 2019
Less Than 12 Months 12 Months or Longer Total
Gross Gross Gross
Unrealized Unrealized Unrealized
Holding Holding Holding
Fair Value Losses Fair Value Losses Fair Value Losses
(Dollars in thousands)
Investment securities
available-for-sale:
Mortgage-backed securities $ 20,289 $ (6 ) $ 97,964 $ (744 ) $ 118,253 $ (750 )
CMO/REMIC 177,517 (705 ) 34,565 (191 ) 212,082 (896 )
Municipal bonds - - 563 (2 ) 563 (2 )
Total
available-for-sale
securities $ 197,806 $ (711 ) $ 133,092 $ (937 ) $ 330,898 $ (1,648 )
Investment securities
held-to-maturity:
Government agency/GSE $ 28,359 $ (252 ) $ 19,405 $ (405 ) $ 47,764 $ (657 )
Mortgage-backed securities 10,411 (54 ) - - 10,411 (54 )
CMO/REMIC 23,897 (104 ) 166,193 (2,354 ) 190,090 (2,458 )
Municipal bonds 7,583 (32 ) 29,981 (533 ) 37,564 (565 )
Total
held-to-maturity
securities $ 70,250 $ (442 ) $ 215,579 $ (3,292 ) $ 285,829 $ (3,734 )
The Company did not record any charges for other-than-temporary impairment
losses for the year ended December 31, 2019 .
Loans
Total loans and leases, net of deferred fees and discounts, of $8.35 billion at
December 31, 2020 , increased by $784.2 million , or 10.37%, from $7.56 billion at
December 31, 2019 . The increase in total loans included $883.0 million in PPP
loans. Excluding PPP loans, total loans declined by $98.8 million , or 1.31%. The
$98.8 million decrease in loans included decreases of $123.1 million in
commercial and industrial loans, $31.8 million in construction loans,
$26.5 million in consumer and other loans, $22.6 million in dairy & livestock
and agribusiness loans, $13.0 million in SFR mortgage loans, $7.6 million in
municipal lease financings, and $1.1 million in other SBA loans. Partially
offsetting these declines was an increase in commercial real estate loans of
$126.9 million .
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Total loans, net of deferred loan fees, comprise 63.14% of our total earning
assets as of December 31, 2020 . The following table presents our loan portfolio
by type for the periods presented.
Distribution of Loan Portfolio by Type
December 31,
2020 2019 (1) 2018 2017 2016
(Dollars in thousands)
Commercial real estate $ 5,501,509 $ 5,374,617 $ 5,394,229 $ 3,376,713 $ 2,930,141
Construction 85,145 116,925 122,782 77,982 85,879
SBA 303,896 305,008 350,043 122,055 97,184
SBA - PPP 882,986 - - - -
Commercial and industrial 812,062 935,127 1,002,209 513,325 485,078
Dairy & livestock and
agribusiness 361,146 383,709 393,843 347,289 338,631
Municipal lease finance
receivables 45,547 53,146 64,186 70,243 64,639
SFR mortgage 270,511 283,468 296,504 236,202 250,605
Consumer and other loans 86,006 116,319 128,429 64,229 78,274
Gross loans
(Non-PCI) 8,348,808 7,568,319 7,752,225 4,808,038 4,330,431
Less: Deferred loan fees,
net (2) - (3,742 ) (4,828 ) (6,289 ) (6,952 )
Gross loans, net of deferred
loan fees
(Non-PCI) 8,348,808 7,564,577 7,747,397 4,801,749 4,323,479
Less: Allowance for credit
losses (93,692 ) (68,660 ) (63,409 ) (59,218 ) (60,321 )
Net loans
(Non-PCI) $ 8,255,116 $ 7,495,917 7,683,988 4,742,531 4,263,158
PCI Loans 17,214 30,908 73,093
Discount on PCI loans - (2,026 ) (1,508 )
Less: Allowance for credit
losses (204 ) (367 ) (1,219 )
PCI loans, net 17,010 28,515 70,366
Total loans and lease
finance receivables $ 7,700,998 $ 4,771,046 $ 4,333,524 (1) Beginning with
with
Non-PCI
loans and were reflected in total loans and lease finance receivables.
(2) Beginning with
loan fees by respective class of financing receivables.
As ofDecember 31, 2020 ,$314.4 million , or 5.72% of the total commercial real estate loans included loans secured by farmland, compared to$241.8 million , or 4.50%, atDecember 31, 2019 . The loans secured by farmland included$132.9 million for loans secured by dairy & livestock land and$181.5 million for loans secured by agricultural land atDecember 31, 2020 , compared to$125.9 million for loans secured by dairy & livestock land and$115.9 million for loans secured by agricultural land atDecember 31, 2019 . As ofDecember 31, 2020 , dairy & livestock and agribusiness loans of$361.1 million were comprised of$320.1 million for dairy & livestock loans and$41.0 million for agribusiness loans, compared to$323.5 million for dairy & livestock loans and$60.2 million for agribusiness loans atDecember 31, 2019 . Real estate loans are loans secured by conforming trust deeds on real property, including property under construction, land development, commercial property and single-family and multi-family residences. Our real estate loans are comprised of industrial, office, retail, medical, single family residences, multi-family residences, and farmland. Consumer loans include installment loans to consumers as well as home equity loans, auto and equipment leases and other loans secured by junior liens on real property. Municipal lease finance receivables are leases to municipalities. Dairy & livestock and agribusiness loans are loans to finance the operating needs of wholesale dairy farm operations, cattle feeders, livestock raisers and farmers. As ofDecember 31, 2020 , the Company had$190.2 million of total SBA 504 loans. SBA 504 loans include term loans to finance capital expenditures and for the purchase of commercial real estate. Initially the Bank provides two separate loans to the borrower representing a first and second lien on the collateral. The loan with 66 -------------------------------------------------------------------------------- Table of Contents the first lien is typically at a 50% advance to the acquisition costs and the second lien loan provides the financing for 40% of the acquisition costs with the borrower's down payment of 10% of the acquisition costs. The Bank retains the first lien loan for its term and sells the second lien loan to the SBA subordinated debenture program. A majority of the Bank's 504 loans are granted for the purpose of commercial real estate acquisition. As ofDecember 31, 2020 , the Company had$113.7 million of total SBA 7(a) loans that include a guarantee of payment from the SBA (typically 75% of the loan amount, but up to 90% in certain cases) in the event of default. The SBA 7(a) loans include revolving lines of credit (SBA Express) and term loans of up to ten (10) years to finance long-term working capital requirements, capital expenditures, and/or for the purchase or refinance of commercial real estate. As an active participant in the SBA's Paycheck Protection Program, we have originated approximately 4,100 PPP loans totaling$1.10 billion , with a remaining outstanding balance of$883.0 million as ofDecember 31, 2020 . As ofDecember 31, 2020 , the Company had$85.1 million in construction loans. This represents 1.02% of total gross loans held-for-investment. Although our construction loans are located throughout our market footprint, the majority of construction loans consist of commercial land development and construction projects inLos Angeles County ,Orange County , and the Inland Empire region ofSouthern California . There were no nonperforming construction loans atDecember 31, 2020 . Our loan portfolio is geographically disbursed throughout our marketplace. The following is the breakdown of our total held-for-investment commercial real estate loans, by region as ofDecember 31, 2020 . December 31, 2020 Commercial Real Estate Total Loans Loans (Dollars in thousands) Los Angeles County$ 3,543,375 42.4 %$ 2,234,357 40.6 % Central Valley 1,401,683 16.8 % 997,819 18.1 % Inland Empire 1,150,925 13.8 % 833,012 15.2 % Orange County 1,072,852 12.8 % 658,303 12.0 % Central Coast 497,024 6.0 % 367,787 6.7 % San Diego 227,664 2.7 % 160,572 2.9 % Other California 131,998 1.6 % 77,418 1.4 % Out of State 323,287 3.9 % 172,241 3.1 %$ 8,348,808 100.0 %$ 5,501,509 100.0 %
The table below breaks down our real estate portfolio.
December 31, 2020
Percent
Owner- Average
Loan Balance Percent Occupied (1) Loan BalanceCommercial real estate: (Dollars in thousands) Industrial$ 1,863,337 33.9% 53.0%$ 1,399 Office 998,673 18.1% 24.5% 1,608 Retail 784,402 14.3% 13.2% 1,702 Multi-family 618,333 11.2% 2.0% 1,627 Secured by farmland (2) 314,429 5.7% 98.0% 2,139 Medical 289,622 5.3% 44.8% 1,745 Other (3) 632,713 11.5% 56.5% 1,403 Total commercial real estate$ 5,501,509 100.0% 39.0%$ 1,546
(1) Represents percentage of reported owner-occupied at origination in each
real estate loan category.
(2) The loans secured by farmland included
dairy & livestock land and $181.5 million for loans secured by
agricultural land at December 31, 2020 .
(3) Other loans consist of a variety of loan types, none of which exceeds 2.0%
of total commercial real estate loans.
67-------------------------------------------------------------------------------- Table of Contents The pandemic has had a greater impact on certain industries, such a retail, hospitality, and entertainment. AtDecember 31, 2020 , commercial real estate loans on retail properties comprised$784.4 million and approximately 14.3% of total loans; none of these loans are on deferment and$5 million of these loans are classified. At origination, these loans on retail properties were underwritten with loan-to-values averaging approximately 49%. Approximately 51% of these loans were originated prior to 2017. AtDecember 31, 2020 , commercial and industrial and SBA loans to customers in the hotel, restaurant, entertainment, retail trade, or recreation industries represented approximately$97 million in loans, or approximately 1% of total loans;$2.6 million of these loans are classified and$2.7 million are on deferment. The table below provides the maturity distribution for held-for-investment total gross loans as ofDecember 31, 2020 . The loan amounts are based on contractual maturities although the borrowers have the ability to prepay the loans. Amounts are also classified according to repricing opportunities or rate sensitivity. Loan Maturities and Interest Rate Category After One Within But Within After One Year Five Years Five Years Total (Dollars in thousands) Types of Loans: Commercial real estate$ 250,873 $ 1,654,783 $ 3,595,853 $ 5,501,509 Construction 76,453 8,692 - 85,145 SBA 11,522 23,002 269,372 303,896 SBA - PPP - 882,986 - 882,986 Commercial and industrial 288,070 346,151 177,841 812,062 Dairy & livestock and agribusiness 260,241 99,065 1,840 361,146 Municipal lease finance receivables 96 6,223 39,22845,547 SFR mortgage 123 295 270,093 270,511 Consumer and other loans 9,903 16,757 59,346 86,006 Total gross loans$ 897,281 $ 3,037,954
Amount of Loans based upon: Fixed Rates$ 174,052 $ 2,408,735 $ 2,308,500 $ 4,891,287 Floating or adjustable rates 723,229 629,219 2,105,073 3,457,521 Total gross loans$ 897,281 $ 3,037,954 $ 4,413,573 $ 8,348,808 As a normal practice in extending credit for commercial and industrial purposes, we may accept trust deeds on real property as collateral. In some cases, when the primary source of repayment for the loan is anticipated to come from the cash flow from normal operations of the borrower, and real property has been taken as collateral, the real property is considered a secondary source of repayment for the loan. Since we lend primarily in Southern andCentral California , our real estate loan collateral is concentrated in this region. 68 -------------------------------------------------------------------------------- Table of Contents Nonperforming Assets The following table provides information on nonperforming assets as of the dates presented. December 31, 2020 2019 2018 (1) 2017 (1) 2016 (1) (Dollars in thousands) Nonaccrual loans$ 14,347 $ 5,033 $ 16,442 $ 6,516 $ 5,526 Loans past due 90 days or more and still accruing interest Nonperforming troubled debt restructured loans (TDRs - 244 3,509 4,200 1,626 Total nonperforming loans 14,347 5,277 19,951 10,716 7,152 OREO, net 3,392 4,889 420 4,527 4,527 Total nonperforming assets$ 17,739 $ 10,166 $ 20,371 $ 15,243 $ 11,679 Performing TDRs$ 2,159 $ 3,112 $ 3,594 $ 4,809 $ 19,233 Total nonperforming loans and performing TDRs$ 16,506 $ 8,389 $ 23,545 $ 15,525 $ 26,385 Percentage of nonperforming loans and performing TDRs to total loans, net of deferred fees 0.20 % 0.11 % 0.30 % 0.32 % 0.60 % Percentage of nonperforming assets to total loans outstanding, net of deferred fees, and OREO 0.21 % 0.13 % 0.26 % 0.32 % 0.27 % Percentage of nonperforming assets to total assets 0.12 % 0.09 % 0.18 % 0.18 % 0.14 % (1) Excludes PCI loans. Troubled Debt Restructurings Total TDRs were$2.2 million atDecember 31, 2020 , compared to$3.4 million atDecember 31, 2019 . AtDecember 31, 2020 , all of our TDRs were performing and accruing interest as restructured loans. Our performing TDRs were generally provided a modification of loan repayment terms in response to borrower financial difficulties. The performing restructured loans represent the only loans accruing interest at each respective reporting date. A performing restructured loan is categorized as such if we believe that it is reasonably assured of repayment and is performing in accordance with the modified terms. In accordance with regulatory guidance, if borrowers are less than 30 days past due on their loans and enter into loan modifications offered as a result of COVID-19, their loans generally continue to be considered performing loans and continue to accrue interest during the period of the loan modification. For borrowers who are 30 days or more past due when entering into loan modifications offered as a result of COVID-19, we evaluate the loan modifications under our existing troubled debt restructuring framework, and where such a loan modification would result in a concession to a borrower experiencing financial difficulty, the loan will be accounted for as a TDR and will generally not accrue interest. For all borrowers who enroll in these loan modification programs offered as a result of COVID-19, the delinquency status of the borrowers is frozen, resulting in a static delinquency metric during the deferral period. Upon exiting the deferral program, the measurement of loan delinquency will resume where it had left off upon entry into the program. As ofJanuary 15, 2021 , we had temporary payment deferments of principal, or of principal and interest on six loans in the amount of$10.0 million . These deferments were primarily for 90 days, with 85% of these loans being rated special mention or classified. 69 -------------------------------------------------------------------------------- Table of Contents The following table provides a summary of TDRs as of the dates presented. December 31, 2020 2019 Number of Number of Balance Loans Balance Loans (Dollars in thousands) Performing TDRs: Commercial real estate$ 320 1$ 397 1 Construction - - - - SBA - - 536 1 Commercial and industrial 43 1 78 2 Dairy & livestock and agribusiness - - - - SFR mortgage 1,796 7 2,101 8 Consumer and other - - - - Total performing TDRs$ 2,159 9$ 3,112 12 Nonperforming TDRs: Commercial real estate $ - - $ - - Construction - - - - SBA - - - - Commercial and industrial - - - - Dairy & livestock and agribusiness - - - - SFR mortgage - - - - Consumer and other - - 244 1 Total nonperforming TDRs $ - -$ 244 1 Total TDRs$ 2,159 9$ 3,356 13 AtDecember 31, 2020 and 2019, there was no ACL specifically allocated to TDRs. Impairment amounts identified are typically charged off against the allowance at the time a probable loss is determined. There were no charge-offs on TDRs for 2020, compared to$78,000 for the same period of 2019. 70 -------------------------------------------------------------------------------- Table of Contents Nonperforming Assets and Delinquencies The table below provides trends in our nonperforming assets and delinquencies as of the dates presented. December 31, September 30, June 30, March 31, December 31, 2020 2020 2020 2020 2019 (Dollars in thousands) Nonperforming loans (1): Commercial real estate $ 7,563 $ 6,481$ 2,628 $ 947 $ 724 Construction - - - - - SBA 2,273 1,724 1,598 2,748 2,032 Commercial and industrial 3,129 1,822 1,222 1,703 1,266 Dairy & livestock and agribusiness 785 849 - - - SFR mortgage 430 675 1,080 864 878 Consumer and other loans 167 224 289 166 377 Total$ 14,347 $ 11,775$ 6,817 $ 6,428 $ 5,277 % of Total loans 0.17% 0.14% 0.08% 0.09% 0.07% Past due 30-89 days: Commercial real estate $ - $ - $ 4 $ 210 $ - Construction - - - - - SBA 1,965 66 214 3,086 1,402 Commercial and industrial 1,101 3,627 630 665 2 Dairy & livestock and agribusiness - - 882 166 - SFR mortgage - - 446 233 249 Consumer and other loans - 67 413 - - Total $ 3,066 $ 3,760$ 2,589 $ 4,360 $ 1,653 % of Total loans 0.04% 0.04% 0.03% 0.06% 0.02% OREO: Commercial real estate $ 1,575 $ 1,575$ 2,275 $ 2,275 $ 2,275 SBA - 797 797 797797 SFR mortgage 1,817 1,817 1,817 1,817 1,817 Total $ 3,392 $ 4,189$ 4,889 $ 4,889 $ 4,889 Total nonperforming, past due, and OREO$ 20,805 $ 19,724$ 14,295 $ 15,677 $ 11,819 % of Total loans 0.25% 0.23% 0.17% 0.21% 0.16%
(1) As of
and industrial loans past due 90 days or more and still accruing interest.
Nonperforming loans, defined as nonaccrual loans, nonperforming TDR loans and loans past due 90 days or more and still accruing interest, were$14.3 million atDecember 31, 2020 , or 0.17% of total loans. Total nonperforming loans atDecember 31, 2020 included$11.0 million of nonperforming loans acquired from CB in the third quarter of 2018. This compares to nonperforming loans of$5.3 million , or 0.07% of total loans, atDecember 31, 2019 . The$9.1 million increase in nonperforming loans was primarily due to increases of$6.8 million in nonperforming commercial real estate loans,$1.9 million in nonperforming commercial and industrial loans,$785,000 in nonperforming dairy & livestock and agribusiness loans, and$241,000 in nonperforming SBA loans. This was partially offset by a$448,000 decrease in nonperforming SFR mortgage loans and a$210,000 decrease in nonperforming consumer and other loans. AtDecember 31, 2020 , we had two OREO properties with a carrying value of$3.4 million , compared to four properties with a carrying value of$4.9 million atDecember 31, 2019 . We reflected a$700,000 write-down of one OREO property in the third quarter of 2020. During 2020, we sold two OREO properties, realizing a net gain on sale of$365,000 . There were no additions to OREO for the year endedDecember 31, 2020 . 71 -------------------------------------------------------------------------------- Table of Contents Changes in economic and business conditions have had an impact on our market area and on our loan portfolio. We continually monitor these conditions in determining our estimates of needed reserves. However, we cannot predict the extent to which the deterioration in general economic conditions, real estate values, changes in general rates of interest and changes in the financial conditions or business of a borrower may adversely affect a specific borrower's ability to pay or the value of our collateral. See " Risk Management - Credit Risk Management " included herein. Allowance for Credit Losses We adopted CECL onJanuary 1, 2020 , which replaces the "incurred loss" approach with an "expected loss" model over the life of the loan, as further described in Note 3 - Summary of Significant Accounting Policies of the notes to the unaudited condensed consolidated financial statements. The allowance for credit losses totaled$93.7 million as ofDecember 31, 2020 , compared to$68.7 million as ofDecember 31, 2019 . Our allowance for credit losses atDecember 31, 2020 was 1.12%, or 1.25% of total loans when excluding the$883.0 million in PPP loans. Upon implementation of CECL, a transition adjustment of$1.8 million was added to the beginning balance of the allowance and was increased by a$23.5 million credit loss provision for 2020 due to the severe economic disruption resulting from the COVID-19 pandemic. Net charge-offs were$308,000 for 2020. This compares to a$5.0 million loan loss provision and$47,000 in net recoveries for the same period of 2019. The allowance for credit losses as ofDecember 31, 2020 is based upon lifetime loss rate models developed from an estimation framework that uses historical lifetime loss experiences to derive loss rates at a collective pool level. We measure the expected credit losses on a collective (pooled) basis for those loans that share similar risk characteristics. We have three collective loan pools:Commercial Real Estate , Commercial and Industrial, and Consumer. Our ACL amounts are largely driven by portfolio characteristics, including loss history and various risk attributes, and the economic outlook for certain macroeconomic variables. Risk attributes for commercial real estate loans include OLTV, origination year, loan seasoning, and macroeconomic variables that include GDP growth, commercial real estate price index and unemployment rate. Risk attributes for commercial and industrial loans include internal risk ratings, borrower industry sector, loan credit spreads and macroeconomic variables that include unemployment rate and BBB spread. The macroeconomic variables for Consumer include unemployment rate and GDP. TheCommercial Real Estate methodology is applied over commercial real estate loans, a portion of construction loans, and a portion of SBA loans (excluding Payment Protection Program loans). The Commercial and Industrial methodology is applied over a substantial portion of the Company's commercial and industrial loans, all dairy & livestock and agribusiness loans, municipal lease receivables, as well as the remaining portion ofSmall Business Administration (SBA) loans (excluding Payment Protection Program loans). The Consumer methodology is applied to SFR mortgage loans, consumer loans, as well as the remaining construction loans. In addition to determining the quantitative life of loan loss rate to be applied against the portfolio segments, management reviews current conditions and forecasts to determine whether adjustments are needed to ensure that the life of loan loss rates reflect both the current state of the portfolio, and expectations for macroeconomic changes. For the year endedDecember 31, 2020 , the ACL increased by$25.0 million , including a$1.8 million increase from the adoption of CECL onJanuary 1, 2020 . The increase in the ACL was primarily due to$23.5 million in provision for credit losses recorded in the first half of 2020 resulting from the forecasted changes in macroeconomic variables related to the COVID-19 pandemic. Our economic forecast continues to be a blend of multiple forecasts produced by Moody's, including Moody's baseline forecast, as well as upside and downside forecasts. The baseline forecast continues to represent the largest weighting in our multi-weighted forecast scenario, while due to economic uncertainty a greater weighting was placed on the downside economic forecast, relative to the upside forecast. Our forecast assumes GDP will increase by 2.5% in 2021 and then grow by 3.6% in 2022 and 2023. The unemployment rate is forecasted to be 7.7% in 2021, before declining to 7.2% percent in 2022 and 5.7% in 2023. Management believes that the ACL was appropriate atDecember 31, 2020 and 2019. As there is a high degree of uncertainty around the epidemiological assumptions and impact of government responses to the pandemic that impact our economic forecast, no assurance can be given that 72 -------------------------------------------------------------------------------- Table of Contents economic conditions that adversely affect the Company's service areas or other circumstances will not be reflected in an increased allowance for credit losses in future periods. The table below presents a summary of net charge-offs and recoveries by type and the resulting allowance for loan losses and recapture of provision for credit losses for the periods presented. Year Ended December 31, 2020 2019 2018 2017 2016 (Dollars in thousands) Allowance for credit losses at beginning of period$ 68,660 $ 63,613 $ 59,585 $ 61,540 $ 59,156 Impact of adopting ASU 2016-13 1,840 - - - - Charge-offs: Commercial real estate - - - - - Construction - - - - - SBA (362) (321) (257) - - Commercial and industrial (195) (48) (10) (138) (120) Dairy & livestock and agribusiness - (78) - - - SFR mortgage - - (13) - (102) Consumer and other loans (109) (7) (11) (13) (16) Total charge-offs (666) (454) (291) (151) (238) Recoveries: Commercial real estate - - - 154 792 Construction 11 12 2,506 6,036 7,174 SBA 72 9 20 78 40 Commercial and industrial 10 255 82 118 630 Dairy & livestock and agribusiness - 19 19 19216 SFR mortgage 206 196 51 212 - Consumer and other loans 59 10 141 79 170 Total recoveries 358 501 2,819 6,696 9,022 Net recoveries (308) 47 2,528 6,545 8,784 Provision for (recapture of) credit losses 23,500 5,000 1,500 (8,500) (6,400) Allowance for credit losses at end of period$ 93,692 $ 68,660 $
63,613
Summary of reserve for unfunded loan commitments: Reserve for unfunded loan commitments at beginning of period$ 8,959 $ 8,959 $ 6,306 $ 6,706 $ 7,156 Impact of adopting ASU 2016-13 41 Estimated fair value of reserve for unfunded loan commitment assumed from Community Bank - - 2,903 - - Recapture of provision for unfunded loan commitments - - (250) (400) (450) Reserve for unfunded loan commitments at end of period$ 9,000 $ 8,959 $ 8,959 $ 6,306 $ 6,706 Reserve for unfunded loan commitments to total unfunded loan commitments 0.54% 0.56% 0.51% 0.66% 0.76% Amount of total loans at end of period (1)$ 8,348,808 $ 7,564,577 $ 7,764,611 $ 4,830,631 $ 4,395,064 Average total loans outstanding (1)$ 8,066,483 $ 7,552,505 $
5,905,674
Net (charge-offs) recoveries to
average total loans -0.004% 0.00% 0.04% 0.14% 0.21%
Net (charge-offs) recoveries to
total loans at end of period -0.004% 0.00% 0.03% 0.14% 0.20%
Allowance for credit losses to
average total loans 1.16% 0.91% 1.08% 1.29% 1.47%
Allowance for credit losses to
total loans at end of period 1.12% 0.91% 0.82% 1.23% 1.40%
Net (charge-offs) recoveries to
allowance for credit losses -0.33% 0.07% 3.97% 10.98% 14.27%
Net (charge-offs) recoveries to
provision for (recapture of)
credit losses -1.31% 0.94% 168.53% -77.00% -137.25%
(1) Net of deferred loan origination fees, costs and discounts.
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The ACL/Total Loan Coverage Ratio as of December 31, 2020 increased to 1.12%,
compared to 0.93% as of January 1, 2020 due to the forecasted impact on the
economy from the
COVID-19
crisis.
At implementation of CECL on January 1, 2020 , the reserve for unfunded loan
commitments included a transition adjustment of $41,000 for our
off-balance
sheet credit exposures. The Bank's ACL methodology also produced an allowance of
$9.0 million for our
off-balance
sheet credit exposures, which was unchanged from the allowance at January 1,
2020 .
While we believe that the allowance at December 31, 2020 was appropriate to
absorb losses from known or inherent risks in the portfolio, no assurance can be
given that economic conditions, interest rate fluctuations, conditions of our
borrowers (including fraudulent activity), or natural disasters, which adversely
affect our service areas or other circumstances or conditions, including those
defined above, will not be reflected in increased provisions for credit losses
in the future.
The following table provides a summary of the allocation of the allowance for
credit losses for specific loan categories at the dates indicated for total
loans. The allocations presented should not be interpreted as an indication that
loans charged to the allowance for credit losses will occur in these amounts or
proportions, or that the portion of the allowance allocated to each loan
category, represents the total amount available for future losses that may occur
within these categories.
Allowance for Credit Losses by Loan Type
December 31,
2020 2019 2018 2017 2016
Loans Loans Loans Loans Loans
as % of as % of as % of as % of as % of
Allowance Total Allowance Total Allowance Total Allowance Total Allowance Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
(Dollars in thousands)
Commercial real estate $ 75,439 65.9% $
48,629 71.0%
$ 37,443 66.6% Construction 1,934 1.0% 858 1.5% 981 1.6% 984 1.6% 1,096 1.9% SBA 2,992 3.6% 1,453 4.0% 1,062 4.5% 869 2.5% 871 2.2% SBA - PPP - 10.6% - - - - - - - - Commercial and industrial 7,142 9.7%
8,880 12.4% 7,520 12.9% 7,280 10.6%
8,154 11.0%
Dairy & livestock and agribusiness 3,949 4.4% 5,255 5.1% 5,215 5.1% 4,647 7.2%
8,541 7.7%
Municipal lease finance receivables 74 0.5% 623 0.7% 775 0.8% 851 1.5% 941 1.5%
SFR mortgage 367 3.2% 2,339 3.8% 2,196 3.8% 2,112 4.9%
2,287 5.7%
Consumer and other loans 1,795 1.1% 623 1.5% 726 1.7% 753 1.3% 988 1.8%
PCI loans - - - - 204 0.2% 367 0.6% 1,219 1.6%
Total $ 93,692 100.0% $ 68,660 100.0% $ 63,613 100.0% $ 59,585 100.0% $ 61,540 100.0%
74-------------------------------------------------------------------------------- Table of Contents Deposits The primary source of funds to support earning assets (loans and investments) is the generation of deposits. Total deposits were$11.74 billion atDecember 31, 2020 . This represented an increase of$3.03 billion , or 34.83%, over total deposits of$8.70 billion atDecember 31, 2019 . The average balance of deposits by category and the average effective interest rates paid on deposits is summarized for the periods presented in the table below. Year Ended December 31, 2020 2019 2018 Average Balance Rate Balance Rate Balance Rate (Dollars in thousands) Noninterest-bearing deposits$ 6,281,989 -$ 5,177,035 -$ 4,449,110 - Interest-bearing deposits Investment checking 478,458 0.08% 452,437 0.11% 438,112 0.08% Money market 2,599,553 0.31% 2,197,194 0.54% 1,834,540 0.36% Savings 452,595 0.09% 399,154 0.10% 384,008 0.10% Time deposits 445,962 0.85% 487,221 0.91% 453,031 0.57% Total deposits$ 10,258,557 $ 8,713,041 $ 7,558,801 The amount of noninterest-bearing deposits in relation to total deposits is an integral element in our strategy of seeking to achieve a low cost of funds. Average noninterest-bearing deposits totaled$6.28 billion for 2020, representing an increase of$1.10 billion , or 21.34%, from average demand deposits of$5.18 billion for 2019. Average noninterest-bearing deposits represented 61.24% of total average deposits for 2020, compared to 59.42% of total average deposits for 2019. Average savings deposits, which include savings, interest-bearing demand, and money market accounts, were$3.53 billion for 2020, representing an increase of$481.8 million , or 15.80%, from average savings deposits of$3.05 billion for 2019. Average time deposits totaled$446.0 million for 2020, representing a decrease of$41.3 million , or 8.47%, from total average time deposits of$487.2 million for 2019. The following table provides the remaining maturities of large denomination ($250,000 or more) time deposits, including public funds, atDecember 31, 2020 . Maturity Distribution of Large Denomination Time Deposits December 31, 2020 (Dollars in thousands) 3 months or less $ 35,384 Over 3 months through 6 months 15,277 Over 6 months through 12 months 27,685 Over 12 months 21,954 Total $ 100,300
Time deposits totaled
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Borrowings
The following table summarizes information about our term FHLB advances,
repurchase agreements and other borrowings outstanding for the periods
presented.
Repurchase Other
Agreements FHLB Advances Borrowings Total
(Dollars in thousands)
At December 31, 2020
Amount outstanding $ 439,406 $ - $ 5,000 $ 444,406
Weighted-average interest rate 0.10 % - - 0.10 %
Year ended December 31, 2020
Highest amount at
month-end $ 501,881 $
- $ 10,000
- $ 5,674 $ 485,630
Weighted-average interest rate 0.24 % - 0.04 % 0.23 %
At December 31, 2019
Amount outstanding $ 428,659 $ - $ - $ 428,659
Weighted-average interest rate 0.44 % - - 0.44 %
Year ended December 31, 2019
Highest amount at
month-end $ 547,730 $
- $ 295,000
- $ 76,873
0.47 % - 2.51 % 0.77 %
At December 31, 2018
Amount outstanding $ 442,255 $
- $ 280,000
0.39 % - 2.53 % 1.22 %
Year ended December 31, 2018
Highest amount at
month-end $ 556,356 $
- $ 280,000
2,446 $ 31,648
0.31 % 1.59 % 2.09 % 0.44 %
At December 31, 2020 , our borrowings included $439.4 million of repurchase
agreements and $5.0 million in other short-term borrowing at an interest rate of
0%. At December 31, 2019 , our borrowings included $428.7 million in repurchase
agreements.
We offer a repurchase agreement product to our customers. This product, known as
Citizens Sweep Manager, sells our investment securities overnight to our
customers under an agreement to repurchase them the next day at a price which
reflects the market value of the use of funds by the Bank for the period
concerned. These repurchase agreements are signed with customers who want to
invest their excess deposits, above a
pre-determined
balance in a demand deposit account, in order to earn interest. As of
December 31, 2020 , total funds borrowed under these agreements were
$439.4 million with a weighted average interest rate of 0.10%, compared to
$428.7 million with a weighted average rate of 0.44% as of December 31, 2019 .
At December 31, 2020 , we had $5.0 million in short-term borrowings that were
interest free advances from the FHLB, compared to no borrowings at December 31 .
2019.
At December 31, 2020 , our junior subordinated debentures of $25.8 million
represent the amounts that are due from the Company to CVB Statutory Trust III.
The debentures have the same maturity as the Trust Preferred Securities. These
debentures bear interest at three-month LIBOR plus 1.38% and mature in 2036.
Refer to Note 13 -
Borrowings
of the notes to the consolidated financial statements for a more detailed
discussion.
At December 31, 2020 , $6.07 billion of loans and $1.81 billion of investment
securities, at carrying value, were pledged to secure public deposits, short and
long-term borrowings, and for other purposes as required or permitted by law.
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Aggregate Contractual Obligations
The following table summarizes the aggregate contractual obligations as of
December 31, 2020 .
Maturity by Period
Less Than Over
One One Year Four Years Five
Through Through
Total Year Three Years Five Years Years
(Dollars in thousands)
Deposits (1) $ 11,736,501 $ 11,697,276 $ 29,251 $ 9,362 $ 612
Customer repurchase agreements (1) 439,406 439,406 - - -
Junior subordinated debentures (1) 25,774 - - - 25,774
Deferred compensation 22,142 689 1,098 619 19,736
Operating leases 22,382 6,800 9,389 4,472 1,721
Affordable housing investment 1,950 1,026 864 47 13
Total $ 12,248,155 $ 12,145,197 $ 40,602 $ 14,500 $ 47,856 (1) Amounts exclude accrued interest.
Deposits represent noninterest-bearing, money market, savings, NOW, certificates
of deposits, brokered and all other deposits held by the Bank.
Customer repurchase agreements represent excess amounts swept from customer
demand deposit accounts, which mature the following business day and are
collateralized by investment securities. These amounts are due to customers.
Junior subordinated debentures represent the amounts that are due from the
Company to CVB Statutory Trust III. The debentures have the same maturity as the
Trust Preferred Securities. These debentures bear interest at three-month LIBOR
plus 1.38% and mature in 2036.
Deferred compensation represents the amounts that are due to former employees
based on salary continuation agreements as a result of acquisitions and amounts
due to current and retired employees under our deferred compensation plans.
Operating leases represent the total minimum lease payments due under
non-cancelable
operating leases. Refer to Note 23 -
Leases
of the notes to the consolidated financial statements for a more detailed
discussion about leases.
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Off-Balance
Sheet Arrangements
The following table summarizes the
off-balance
sheet items at December 31, 2020 .
Maturity by Period
Less Than One Year Four Years After
One to Three to Five Five
Total Year Years Years Years
(Dollars in thousands)
Commitment to extend
credit:
Commercial real estate $ 309,966 $ 50,755 $ 91,502 $ 136,108 $ 31,601
Construction 89,987 62,964 27,023 - -
SBA 257 41 - - 216
SBA - PPP - - - - -
Commercial and industrial 928,767 623,258 193,791 5,793 105,925
Dairy & livestock and
agribusiness (1) 140,926 109,823 31,049 - 54
SFR Mortgage 3,786 - 500 - 3,286
Consumer and other loans 131,604 9,227 13,389 3,186 105,802
Total commitment to extend
credit 1,605,293 856,068 357,254 145,087 246,884
Obligations under letters
of credit 53,164 51,856 1,308 - -
Total $ 1,658,457 $ 907,924 $ 358,562 $ 145,087 $ 246,884 (1) Total commitments to extend credit to agribusiness were
at December 31, 2020 .
As of December 31, 2020 , we had commitments to extend credit of approximately
$1.61 billion , and obligations under letters of credit of $53.2 million .
Commitments to extend credit are agreements to lend to customers, provided there
is no violation of any material condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Commitments are generally variable rate, and
many of these commitments are expected to expire without being drawn upon. As
such, the total commitment amounts do not necessarily represent future cash
requirements. We use the same credit underwriting policies in granting or
accepting such commitments or contingent obligations as we do for
on-balance
sheet instruments, which consist of evaluating customers' creditworthiness
individually. Due to the adoption of CECL on January 1, 2020 , a transition
adjustment of $41,000 was added to the beginning balance of the reserve for
unfunded loan commitments. The Company recorded no provision or recapture of
provision for unfunded loan commitments for the year December 31, 2020 and 2019.
The Company had a reserve for unfunded loan commitments of $9.0 million as of
December 31, 2020 and 2019 included in other liabilities.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the financial performance of a customer to a third party. Those
guarantees are primarily issued to support private borrowing or purchase
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
When deemed necessary, we hold appropriate collateral supporting those
commitments.
Capital Resources
Our primary source of capital has been the retention of operating earnings and
issuance of common stock in connection with periodic acquisitions. In order to
ensure adequate levels of capital, we conduct an ongoing assessment of projected
sources, needs and uses of capital in conjunction with projected increases in
assets and the level of risk. As part of this ongoing assessment, the Board of
Directors reviews the various components of our capital.
Total equity increased $13.9 million , or 0.70%, to $2.01 billion at December 31,
2020 , compared to total equity of $1.99 billion at December 31, 2019 . The
$13.9 million increase in equity was primarily due to $177.2 million in net
earnings, a $22.7 million increase in other comprehensive income resulting from
the tax
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effected impact of the increase in market value of our investment securities
portfolio, and $4.7 million for various stock based compensation items. This was
offset by $91.7 million in stock repurchases under our
10b5-1
stock repurchase program, $97.7 million in cash dividends declared and a
cumulative effect adjustment to beginning retained earnings of $1.3 million , net
of tax, due to the adoption of CECL on January 1, 2020 . Our tangible common
equity ratio was 9.55% at December 31, 2020 .
During 2020, the Board of Directors of CVB declared quarterly cash dividends
totaling $0.72 per share. Dividends are payable at the discretion of the Board
of Directors and there can be no assurance that the Board of Directors will
continue to pay dividends at the same rate, or at all, in the future. CVB's
ability to pay cash dividends to its shareholders is subject to restrictions
under federal and California law, including restrictions imposed by the Federal
Reserve , and covenants set forth in various agreements we are a party to
including covenants set forth in our junior subordinated debentures.
On August 11, 2016 , our Board of Directors approved a program to repurchase up
to 10,000,000 shares of CVB common stock in the open market or in privately
negotiated transactions, at times and at prices considered appropriate by us,
depending upon prevailing market conditions and other corporate and legal
considerations. There is no expiration date for this repurchase program. For the
year ended December 31, 2020 , the Company repurchased 4,944,290 shares of CVB
common stock outstanding under this program. As of December 31, 2020 , we have
4,585,145 shares of CVB common stock remaining that are eligible for repurchase
under the common stock repurchase program.
The Bank and the Company are required to meet risk-based capital standards under
the revised capital framework referred to as Basel III set by their respective
regulatory authorities. The risk-based capital standards require the achievement
of a minimum total risk-based capital ratio of 8.0%, a Tier 1 risk-based capital
ratio of 6.0% and a common equity Tier 1 ("CET1") capital ratio of 4.5%. In
addition, the regulatory authorities require the highest rated institutions to
maintain a minimum leverage ratio of 4.0%. To be considered "well-capitalized"
for bank regulatory purposes, the Bank and the Company are required to have a
CET1 capital ratio equal to or greater than 6.5%, a Tier 1 risk-based capital
ratio equal to or greater than 8.0%, a total risk-based capital ratio equal to
or greater than 10.0% and a Tier 1 leverage ratio equal to or greater than 5.0%.
At December 31, 2020 , the Bank and the Company exceeded the minimum risk-based
capital ratios and leverage ratios required to be considered "well-capitalized"
for regulatory purposes. For further information about capital requirements and
our capital ratios, see "Item 1.
Business-Regulation and Supervision-Capital Adequacy Requirements
".
At December 31, 2020 , the Bank and the Company exceeded the minimum risk-based
capital ratios and leverage ratios, under the revised capital framework referred
to as Basel III, required to be considered "well-capitalized" for regulatory
purposes. We did not elect to phase in the impact of CECL on regulatory capital,
as allowed under the interim final rule of the FDIC and other U.S. banking
agencies.
The table below presents the Company's and the Bank's risk-based and leverage
capital ratios for the periods presented.
December 31, 2020 December 31, 2019
Minimum
Required
Adequately Plus Capital Well CVB Financial Citizens CVB Financial Citizens
Capitalized Conservation Capitalized Corp. Business Corp. Business Capital Ratios
Ratios Buffer Ratios Consolidated Bank Consolidated Bank Tier 1 leverage capital ratio
4.00% 4.00% 5.00% 9.90% 9.58% 12.33% 12.19% Common equity Tier 1 capital ratio 4.50% 7.00% 6.50%
14.77% 14.57% 14.83% 14.94% Tier 1 risk-based capital ratio 6.00% 8.50% 8.00%
15.06% 14.57% 15.11% 14.94% Total risk-based capital ratio 8.00% 10.50% 10.00%
16.24% 15.75% 16.01% 15.83%
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RISK MANAGEMENT
All financial institutions must manage and control a variety of business risks
that can significantly affect their financial performance. Our Board of
Directors (Board) and executive management team have overall and ultimate
responsibility for management of these risks, which they carry out through
committees with specific and well-defined risk management functions. The Risk
Management Plan that we have adopted seeks to implement the proper control and
management of key risk factors inherent in the operation of the Company and the
Bank. Some of the key risks that we must manage are credit risks,
asset/liability, interest rate and market risks, counterparty risk, transaction
risk, compliance risk, strategic risk, cybersecurity risk, price risk and
foreign exchange risk. These specific risk factors are not mutually exclusive.
It is recognized that any product or service offered by us may expose the Bank
to one or more of these risks. Our Risk Management Committee and Risk Management
Division monitor these risks to minimize exposure to the Company. The Board and
its committees work closely with management in overseeing risk. Each Board
committee receives reports and information regarding risk issues directly from
management.
Credit Risk Management
Loans represent the largest component of assets on our balance sheet and their
related credit risk is among the most significant risks we manage. We define
credit risk as the risk of loss associated with a borrower or counterparty
default (failure to meet obligations in accordance with agreed upon terms).
Credit risk is found in all activities where success depends on a counter party,
issuer, or borrower performance. Credit risk arises through the extension of
loans and leases, certain securities, and letters of credit.
Natural disasters, such as storms, earthquakes, drought and other weather
conditions, effects of pandemics, as well as natural disasters and problems
related to possible climate changes, may from
time-to-time
cause or create the risk of damage to facilities, buildings, property or other
assets of Bank customers, borrowers or municipal debt issuers. This could in
turn affect their financial condition or results of operations and as a
consequence their ability or capacity to repay debt or fulfill other obligations
to the Bank.
Credit risk in the investment portfolio and correspondent bank accounts is in
part addressed through defined limits in the Company's policy statements. In
addition, certain securities carry insurance to enhance the credit quality of
the bond. Limitations on industry concentration, aggregate customer borrowings,
geographic boundaries and standards on loan quality also are designed to reduce
loan credit risk. Senior Management, Directors' Committees, and the Board of
Directors are provided with information to appropriately identify, measure,
control and monitor the credit risk of the Company.
The Bank's loan policy is updated annually and approved by the Board of
Directors. It prescribes underwriting guidelines and procedures for all loan
categories in which the Bank participates to establish risk tolerance and
parameters that are communicated throughout the Bank to ensure consistent and
uniform lending practices. The underwriting guidelines include, among other
things, approval limitation and hierarchy, documentation standards,
loan-to-value
limits, debt coverage ratio, overall credit-worthiness of the borrower,
guarantor support, etc. All loan requests considered by the Bank should be for a
clearly defined legitimate purpose with a determinable primary source, as well
as alternate sources of repayment. All loans should be supported by appropriate
documentation including, current financial statements, credit reports,
collateral information, guarantor asset verification, tax returns, title
reports, appraisals (where appropriate), and other documents of quality that
will support the credit.
The major lending categories are commercial and industrial loans, SBA loans,
owner-occupied and non owner-occupied commercial real estate loans, construction
loans, dairy & livestock and agribusiness loans, residential real estate loans,
and various consumer loan products. Loans underwritten to borrowers within these
diverse categories require underwriting and documentation suited to the unique
characteristics and inherent risks involved.
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Commercial and industrial loans require credit structures that are tailored to
the specific purpose of the business loan, involving a thorough analysis of the
borrower's business, cash flow, collateral, industry risks, economic risks,
credit, character, and guarantor support. Owner-occupied real estate loans are
primarily based upon the capacity and stability of the cash flow generated by
the occupying business and the market value of the collateral, among other
things. Non owner-occupied real estate is typically underwritten to the income
produced by the subject property and many considerations unique to the various
types of property (i.e. office, retail, warehouse, shopping center, medical,
etc.), as well as, the financial support provided by sponsors in recourse
transactions. Construction loans will often depend on the specific
characteristics of the project, the market for the specific development, real
estate values, and the equity and financial strength of the sponsors. Dairy &
livestock and agribusiness loans are largely predicated on the revenue cycles
and demand for milk and crops, commodity prices, collateral values of herd,
feed, and income-producing dairies or croplands, and the financial support of
the guarantors. Underwriting of residential real estate and consumer loans are
generally driven by personal income and debt service capacity, credit history
and scores, and collateral values.
SBA loans require credit structures that conform to the various requirements of
the SBA programs specific to the type of loan request and the Bank's loan policy
as it relates to these loans. The SBA 7(a) loans are similar to the commercial
and industrial loans that are tailored to the specific purpose of the business
loan, involving a thorough analysis of the borrower's business, cash flow,
collateral, industry risks, economic risks, credit, character, and guarantor
support for both the Bank and the SBA. Once granted the SBA 7(a) loans require
the Bank to follow SBA servicing guidelines to maintain the SBA guaranty which
typically ranges from 75% to 90% depending on the type of 7(a) loan. SBA 504
loans are similar to the Bank's Owner-occupied real estate loans. As such they
are primarily based upon the capacity and stability of the cash flow generated
by the occupying business and the market value of the collateral, among other
things. When the Bank funds an SBA 504 transaction, which includes the 50% first
trust deed loan and the 40% second trust deed loan, the initial risk is centered
in completing the SBA's requirements to provide for the payoff of the second
trust deed loan from the subordinated debenture. Once the 504 second is paid
off, the remaining first trust deed loan is then managed under the same
requirements applied to the Bank's owner-occupied commercial real estate loan.
It should be noted that both the SBA 7(a) and 504 programs provide loans for
commercial real estate acquisition. However, the terms and advances rates
available under the 7(a) program are outside of the Bank's standard loan
programs and risk profile and therefore require a credit enhancement in the form
of the SBA guaranty. Additionally, the interest rates for the 7(a) program are
typically variable and can adjust as often as monthly with quarterly adjustment
the most typical. SBA 504 loan interest rates for the first trust deed loan are
at the Bank's discretion and subject to competitive pressures from other banks.
Implicit in lending activities is the risk that losses will occur and that the
amount of such losses will vary over time. Consequently, we maintain an
allowance for credit losses by charging a provision for credit losses to
earnings. Loans determined to be losses are charged against the allowance for
credit losses. In this regard, it is important to note that the Bank's practice
with regard to these loans, including modified loans or troubled debt
restructurings that are classified as impaired, is to generally charge off any
loss amount against the ACL upon evaluating the loan at the time a probable loss
becomes recognized. As such, the Bank's specific allowance for loans, including
troubled debt restructurings, is relatively low since any known loss amount will
generally have been charged off.
Central to our credit risk management is its loan risk rating system. The
originating credit officer assigns borrowers an initial risk rating, which is
reviewed and possibly changed by credit management. The risk rating is based
primarily on an analysis of each borrower's financial capacity in conjunction
with industry and economic trends. Credit approvals are made based upon our
evaluation of the inherent credit risk specific to the transaction and are
reviewed for appropriateness by senior line and credit management personnel.
Credits are monitored by line and credit management personnel for deterioration
in a borrower's financial condition, which would impact the ability of the
borrower to perform under the contract. Risk ratings may be adjusted as
necessary.
Loans are risk rated into the following categories: Pass, Special Mention,
Substandard, Doubtful, and Loss. Each of these groups is assessed and
appropriate amounts used in determining the adequacy of our allowance for
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losses. The Impaired and Doubtful loans are analyzed on an individual basis for
allowance amounts. The other categories have formulae used to determine the
needed allowance amount.
The Company obtains a semi-annual independent credit review by engaging an
outside party to review a sample of our loans and leases. The primary purpose of
this review is to evaluate our existing loan ratings.
Refer to additional discussion concerning loans, nonperforming assets, allowance
for credit losses and related tables under the Analysis of Financial Condition
contained herein.
Transaction Risk
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 Management
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, vendors or business
partners 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.
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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
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.
Strategic planning sessions, with members of the Board of Directors and
Executive Leadership, are held annually. The strategic review consists of
results of strategic initiatives, an assessment of the economic outlook,
competitive analysis, and an industry outlook, including a legislative and
regulatory review.
Cybersecurity Risk
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.
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ASSET/LIABILITY AND MARKET RISK MANAGEMENT
Liquidity and Cash Flow
The objective of liquidity management is to ensure that funds are available in a
timely manner to meet our financial obligations when they come due without
incurring unnecessary cost or risk, or causing a disruption to our normal
operating activities. This includes the ability to manage unplanned decreases or
changes in funding sources, accommodating loan demand and growth, funding
investments, repurchasing securities, paying creditors as necessary, and other
operating or capital needs.
We regularly assess the amount and likelihood of projected funding requirements
through a review of factors such as historical deposit volatility and funding
patterns, present and forecasted market and economic conditions, individual
customer funding needs, as well as current and planned business activities.
Management has an Asset/Liability Committee that meets monthly. This committee
analyzes the cash flows from loans, investments, deposits and borrowings. In
addition, the Company has a Balance Sheet Management Committee of the Board of
Directors that meets quarterly to review the Company's balance sheet and
liquidity position. This committee provides oversight to the balance sheet and
liquidity management process and recommends policy guidelines for the approval
of our Board of Directors, and courses of action to address our actual and
projected liquidity needs.
Our primary sources and uses of funds for the Company are deposits and loans.
Our deposit levels and cost of deposits may fluctuate from
period-to-period
due to a variety of factors, including the stability of our deposit base,
prevailing interest rates, and market conditions. Total deposits of
$11.74 billion at December 31, 2020 increased $3.03 billion , or 34.83%, over
total deposits of $8.70 billion at December 31, 2019 . This significant deposit
growth was primarily due to our customers maintaining greater liquidity.
In general, our liquidity is managed daily by controlling the level of liquid
assets as well as the use of funds provided by the cash flow from the investment
portfolio, loan demand and deposit fluctuations. Our definition of liquid assets
includes cash and cash equivalents in excess of minimum levels needed to fulfill
normal business operations, short-term investment securities and other
anticipated near term cash flows from investments. To meet unexpected demands,
lines of credit are maintained with correspondent banks, the Federal Home Loan
Bank and the Federal Reserve , although availability under these lines of credit
are subject to certain conditions. The sale of investment securities can also
serve as a contingent source of funds. We can obtain additional liquidity from
deposit growth by offering competitive interest rates on deposits from both our
local and national wholesale markets.
At December 31, 2020 , we had $25.8 million in subordinated debt and $5.0 million
in FHLB short-term borrowings at 0% cost. The Bank has available lines of credit
exceeding $4 billion , most of which is secured by pledged loans. Our balance
sheet has significant liquidity and our assets are funded almost entirely with
core deposits. Furthermore, we have significant
off-balance
sheet sources of liquidity.
CVB is a holding company separate and apart from the Bank that must provide for
its own liquidity and must service its own obligations. Substantially all of
CVB's revenues are obtained from dividends declared and paid by the Bank to CVB.
There are statutory and regulatory provisions that could limit the ability of
the Bank to pay dividends to CVB. In addition, our regulators could limit the
ability of the Bank or CVB to pay dividends or make other distributions. For the
Bank, sources of funds include principal payments on loans and investments,
growth in deposits, FHLB advances, and other borrowed funds. Uses of funds
include withdrawal of deposits, interest paid on deposits, increased loan
balances, purchases, and noninterest expenses.
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Below is a summary of our average cash position and statement of cash flows for
the years ended December 31, 2020 and 2019. For further details, see our "
Consolidated Statements of Cash Flows
" under Part IV consolidated financial statements of this report.
Consolidated Summary of Cash Flows
Year Ended December 31,
2020 2019
(Dollars in thousands)
Average cash and cash equivalents $ 1,226,262 $ 288,425
Percentage of total average assets 9.48%
2.55%
Net cash provided by operating activities$ 185,096 $
208,182
Net cash (used in) provided by investing activities (1,268,758 )
325,323
Net cash provided by (used in) financing activities 2,856,304 (511,935 )
Net increase in cash and cash equivalents$ 1,772,642 $
21,570
Average cash and cash equivalents increased by$937.8 million , or 325.16%, to$1.23 billion for the year endedDecember 31, 2020 , compared to$288.4 million for 2019. AtDecember 31, 2020 , cash and cash equivalents totaled$1.96 billion . This represented an increase of$1.78 billion , or 955.51%, from$185.5 million atDecember 31, 2019 . Market Risk In the normal course of its business activities, we are exposed to market risks, including price and liquidity risk. Market risk is the potential for loss from adverse changes in market rates and prices, such as interest rates (interest rate risk). Liquidity risk arises from the possibility that we may not be able to satisfy current or future commitments or that we may be more reliant on alternative funding sources such as long-term debt. Financial products that expose us to market risk include securities, loans, deposits, debt, and derivative financial instruments. The table below provides the actual balances as ofDecember 31, 2020 of interest-earning assets and interest-bearing liabilities, including the average rate earned or incurred for 2020, the projected contractual maturities over the next five years, and the estimated fair value of each category determined using available market information and appropriate valuation methodologies. Maturing Five Years December 31, Average Estimated Fair 2020 Rate One Year Two Years Three Years Four Years and Beyond Value (Dollars in thousands) Interest-earning assets: Investment securities available-for-sale (1)$ 2,398,923 1.97 %$ 12,694 $ 149,991 $ 613,608 $ 686,367 $ 936,263 $ 2,398,923 Investment securities held-to-maturity (1) 578,626 2.48 % 34,306 42,548 84,513 149,053 268,206 604,223 Investment in FHLB stock 17,688 5.53 % - - - - 17,688 17,688 Interest-earning deposits due from Federal 1,879,418 0.15 % 1,878,678 - 740 - - 1,879,455 Reserve and with other institutions Loans and lease finance receivables (2) 8,348,808 4.68 %
897,281 1,413,759 555,899 483,212 4,998,657
8,349,870
Total interest-earning assets $ 13,223,463 Interest-bearing liabilities: Interest-bearing deposits$ 4,281,114 0.32 %$ 4,241,889 $ 24,154 $ 5,096 $ 1,312 $ 8,663 $ 4,281,952 Borrowings 444,406 0.23 % 444,406 - - - - 444,349 Junior subordinated debentures 25,774 2.10 % - - - - 25,774 19,431 Total interest-bearing liabilities$ 4,751,294 $ 4,686,295 $ 24,154 $ 5,096 $ 1,312 $ 34,437 $ 4,745,732
(1) These include mortgage-backed securities which generally prepay before
maturity.
(2) Gross loans, net of deferred loan fees, costs and discounts.
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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 repricing 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, when rates are ramped up 200bps or ramped down
100bps over a
12-month
time horizon.
Estimated Net Interest Income Sensitivity (1)
December 31, 2020 December 31, 2019
24-month Period 24-month Period
Interest Rate Scenario 12-month Period (Cumulative) Interest Rate Scenario 12-month Period (Cumulative)
+ 200 basis points 11.10% 19.60% + 200 basis points 5.20% 10.00%
- 100 basis points -1.20% -2.40% - 100 basis points -2.10% -4.60%
(1) Percentage change from base scenario, but the current low interest
rate environment limits the absolute decline in rates as the model
does not assume rates go below zero.
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
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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. Our exposure in
the rates down scenario is impacted by the current low interest rate environment
and the model does not assume that rates go below 0.01%.
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, 2020 and
December 31, 2019 , 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 December 31, 2020 December 31, 2019
100 bp decrease in interest rates -21.0% -17.5% 100 bp increase in interest rates 16.1% 14.2% 200 bp increase in interest rates 28.4% 25.5% 300 bp increase in interest rates 34.4% 30.0% 400 bp increase in interest rates 41.6% 36.2% 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. Counterparty Risk 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 ispredominately
supported by insurance companies that carry an AM Best rating of B+ 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;
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• 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
credit with other major U.S. banks. These lines of credit are available
for overnight borrowings; and
• At
at 0% cost. Our secured borrowing capacity with the FHLB was
$4.29 billion , of which $4.29 billion was available as of
2020.
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.
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