CVB FINANCIAL CORP

Financial Performance

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.

(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, investments and interest earning cash (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 ended December 31, 2023, 2022 and 2021. 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 policy, and the strength of the global, 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, the growth and maturity of earning assets, and derivative financial instruments. 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.

The tables below present 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

(1)

Includes tax equivalent (TE) adjustments utilizing a federal statutory rate of 21% in effect for the years ended December 31, 2023, 2022 and 2021. The non-TE rates for total investment securities was 2.48%, 2.00% and 1.53% for the years ended December 31, 2023, 2022 and 2021, respectively.

(2)

Includes loan fees of $3.1 million, $8.1 million and $27.5 million for the years ended December 31, 2023, 2022 and 2021, respectively. Prepayment penalty fees of $2.5 million, $6.9 million and $9.0 million are included in interest income for the years ended December 31, 2023, 2022 and 2021, respectively.

(3)

Includes interest-bearing demand and money market accounts.

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 and reflect an adjustment for the number of days as appropriate.

Rate and Volume Analysis for Changes in Interest Income, Interest Expense and Net Interest Income

Net interest income, before provision for credit losses of $488.0 million for 2023 decreased $17.5 million, or 3.47%, compared to $505.5 million for 2022. Interest income grew by $91.7 million, or 17.81% in 2023, offset by a $109.2 million increase in interest expense year-over-year. Cost of funds for 2023 increased by 77 basis points over 2022, while the earning asset yield grew by 74 basis points. Interest-earning assets decreased on average by $610.4 million, or 3.95%, from $15.44 billion for 2022 to $14.83 billion for 2023. Our net interest margin (TE) was 3.31% for 2023, compared to 3.30% for 2022.

Total interest income for 2023 of $606.3 million grew by $91.7 million, or 17.81%, when compared to 2022. Compared to 2022, average interest-earning assets decreased $610.4 million and the yield on interest-earning assets increased by 74 basis point from 3.36% for 2022 to 4.10% for 2023. The $610.4 million year-over-year decrease in earning assets resulted from a $471.9 million decrease in average earning balances due from the Federal Reserve and a decline of $360.1 million in average investment securities, offset by $216.5 million of growth in average loans. The 74 basis point increase in the earning asset yield over 2022 resulted from a 55 basis point increase in loan yields, from 4.49% for 2022 to 5.04% for 2023, as well as a change in the mix of earning assets. Average loans as a percentage of earning assets grew from 56.20% for 2022 to 59.97% for 2023. Average investments as a percentage of earning assets decreased to 37.63% for 2023 from 38.47% for 2022. The tax-equivalent yield on investment securities was 2.52% for 2023, compared to 2.03% for 2022.

Total interest income and fees on loans for 2023 of $448.3 million increased $59.1 million, or 15.19%, when compared to 2022. This increase in income was partly due to growth in average loans of $216.5 million, as well as higher loan yields. Loan yields were 5.04% for 2023, compared to 4.49% for 2022. Discount accretion on acquired loans decreased by $4.0 million and interest and fee income from PPP loans declined by $5.4 million compared to 2022. After excluding discount accretion and the impact from PPP loans, our loan yields grew by 63 basis points compared to 2022. Loan yields grew year-over-year, as rising interest rates contributed to an increase in yields on loans indexed to the Prime rate or other short-term indexes, as well as higher rates from newly originated loans.

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, 2023 and 2022. As of December 31, 2023 and 2022, we had $21.3 million and $4.9 million of nonaccrual loans, respectively.

Interest income from investment securities was $138.3 million for 2023, a $20.8 million, or 17.66%, increase from $117.6 million for 2022. This increase was driven by a 49 basis point increase in the yield on securities, compared to 2022. This 49 basis point increase in the yield on investment securities from the prior year period was impacted by the positive spread generated from the pay-fixed swaps we entered into at the end of the second quarter of 2023. The positive carry on these fair value hedges resulted in approximately $8.2 million of interest income associated with these interest rate swaps. Excluding the impact of these swaps, 2023 investment yields increased by 33 basis points from 2022. Average investment securities declined by $360.1 million from 2022.

Interest expense of $118.3 million for 2023 increased $109.2 million, compared to $9.2 million for 2022. Total cost of funds for 2023 was 0.83%, compared with 0.06% for 2022. This 77 basis point increase in cost of funds was the result of the increase in the cost of interest-bearing deposits and the addition of $1.35 billion of borrowings, on average, for 2023, at an average cost of 4.88%. Average interest-bearing deposits declined by $580.5 million when compared 2022. The average rate paid on interest-bearing liabilities increased by 168 basis points, to 1.84% for 2023 from 0.16% for 2022. Likewise, the rate on interest-bearing deposits for 2023 increased by 98 basis points from 2022. Noninterest bearing deposits continued to be greater than 60% of total deposits in 2023. Average noninterest-bearing deposits were 62.66% of our total deposits for 2023, compared to 62.85% for 2022.

Net interest income, before provision for (recapture of) credit losses of $505.5 million for 2022 increased $91.0 million, or 21.94%, compared to $414.6 million for 2021. Interest-earning assets grew on average by $1.34 billion, or 9.54%, from $14.10 billion for 2021 to $15.44 billion for 2022. Our net interest margin (TE) was 3.30% for 2022, compared to 2.97% for 2021. The 33 basis point increase in our net interest margin was primarily the result of a 34 basis point increase in earning asset yield, while maintaining our very low cost of funds that increased from five basis points for 2021 to six basis for 2022, during a period of time when the Federal Reserve increased short-term interest rates by 425 basis points.

Total interest income for 2022 of $514.7 million grew by $94.0 million, or 22.36%, when compared to 2021. The increase in interest income was due to a combination of growth in average interest-earning assets of $1.34 billion and a 34 basis point expansion of the earning asset yield, from 3.02% for 2021 to 3.36% for 2022. The $1.34 billion increase in average earning assets for 2022 benefited from the acquisition of $775 million of loans from Suncrest at the beginning of the year, as well as core loan growth, which excluding Suncrest and the $538.3 million decline in average PPP loans was $374.7 million, and a $1.88 billion increase in the average size of our investment portfolio. The 34 basis point increase in the earning asset yield was due to a 47 basis point increase in security yields, a seven basis point increase in loan yields, and impacted by the change in the composition of average earning assets, with the investment portfolio growing from 28.79% to 38.47% of average earnings assets, while funds held at the Federal Reserve on average declined from 13.64% to 5.15% for 2022, compared to 2021. Average loans as a percentage of earning assets declined from 57.22% for 2021 to 56.20% for 2022. Throughout 2022, we deployed some of the excess liquidity previously held on deposit at the Federal Reserve into additional investment securities by purchasing approximately $1.76 billion in securities.

Total interest income and fees on loans for 2022 of $389.2 million increased $32.6 million, or 9.14% when compared to 2021. The increase in interest income and fees on loans was primarily due to a $610.9 million increase in average loans, which included approximately $775 million in loans acquired from Suncrest on January 7, 2022. Average loans grew by approximately $374.7 million, when Suncrest and the $538.3 million decrease in average PPP loans are excluded. Loan yields were 4.49% for 2022, compared to 4.42% for 2021. Interest and fee income from PPP loans declined by $25.0 million from $30.5 million for 2021. Discount accretion on acquired loans decreased by $4.4 million compared to 2021. After excluding discount accretion, nonaccrual interest income and the impact from PPP loans, our ("core") loan yields grew by 17 basis points compared to 2021. Our core loan yields grew throughout 2022, as rising interest rates contributed to an increase from 4.08% in the fourth quarter of 2021 to 4.42% for the third quarter of 2022 and 4.67% in the fourth quarter of 2022.

There was no interest income that was accrued and not reversed on nonaccrual loans at December 31, 2022 and 2021. As of December 31, 2022 and 2021, we had $4.9 million and $6.9 million of nonaccrual loans, respectively.

Interest income from investment securities was $117.6 million for 2022, a $57.1 million, or 94.47%, increase from $60.4 million for 2021. Investment income growth resulted from higher levels of investment securities as a result of purchases of investment securities primarily funded by our funds on deposit at the Federal Reserve, which declined from $1.64 billion at the end of 2021 to $45.2 million at December 31, 2022. As our excess liquidity held at the Federal Reserve was invested into higher yielding investments, our balance at the Federal Reserve averaged $795.8 million for 2022, compared to $1.92 billion for 2021. Investment securities were $5.94 billion on average in 2022, a $1.88 billion increase compared to 2021. During 2022, we purchased approximately $1.76 billion in investment securities, with expected non-TE weighted average yield of approximately 2.94%. Overall, the tax-equivalent yield on securities grew from 1.56% in 2021 to 2.03% in 2022.

Interest expense of $9.2 million for 2022 increased $3.1 million, or 50.58%, compared to $6.1 million for 2021. Although short-term interest rates were 425 basis points higher by the end of 2022 in comparison to the end of the prior year, the average rate paid on interest-bearing liabilities increased by four basis points, to 0.16% for 2022 from 0.12% for 2021. As interest-bearing deposit costs only increased by one basis point, this four basis point increase was the result of overnight borrowings during the fourth quarter of 2022. Average interest-bearing liabilities were $589.9 million higher for 2022 when compared to 2021. On average, noninterest-bearing deposits were 62.85% of our total deposits for 2022, compared to 62.83% for 2021. Our overall cost of funds increased by one basis point compared to 2021, partially due to growth in average noninterest-bearing deposits of $1.02 billion, compared to the increase in average interest-bearing deposits of $600.0 million. Due to recent increases in market rates, we experienced some pressure to increase deposit rates, as reflected in our interest-bearing deposit costs increasing from 13 basis points in the third quarter to 22 basis points in the fourth quarter of 2022.

Provision for (Recapture of) Credit Losses

The provision for (recapture of) 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 as of the balance sheet date.

We recorded provision for credit losses of $2.0 million in 2023, and experienced credit charge-offs of $405,000 and total recoveries of $130,000, resulting in net charge-offs of $275,000. The year-to-date provision for credit losses of $2.0 million was the result of an overall increase in projected loss rates from 0.94% at the end of 2022 to 0.98% at December 31, 2023. For 2022, we recorded $10.6 million in provision for credit losses in 2022, and experienced credit charge-offs of $197,000 and total recoveries of $1.1 million, resulting in net recoveries of $893,000. The modest changes in projected loss rates continue to be driven primarily by economic forecast changes to various macroeconomic variables such as GDP growth, commercial real estate values and the rate of unemployment. Refer to the discussion of “Allowance for Credit Losses” in Item 7 –Management’s Discussion and Analysis of Financial Condition and Results of Operations contained herein for discussion concerning observed changes in the credit quality of various components of our loan portfolio as well as changes and refinements to our methodology.

No assurance can be given that economic conditions which affect the Company’s service areas or other circumstances will or will not be reflected in future changes in the level of our allowance for credit losses and the resulting provision or recapture of provision for credit losses. The process to estimate the allowance for credit losses requires considerable judgment and our economic forecasts may continue to vary due to the uncertainty of the future impact from the recent rise in interest rates, geopolitical events in Europe, and global inflation will have on future interest rates, unemployment, the overall economy and resulting impact on our customers. See “Allowance for Credit Losses” under Analysis of Financial Condition herein.

Noninterest Income

Noninterest income includes income derived from financial services offered to our customers, such as CitizensTrust, merchant processing and card services, international banking, and other business services. Also included in noninterest income are service charges and fees, primarily from deposit accounts, gains (net of losses) from the disposition of investment securities, loans, other real estate owned, and fixed assets, and other revenues not included as interest on earning assets.

The following table sets forth the various components of noninterest income for the periods presented.

The $9.3 million increase in noninterest income included $2.6 million in gain from an equity fund distribution related to a CRA investment, while 2022 included a $2.4 million net gain on the sale of one of our properties. Service charges on deposit accounts decreased by $1.2 million, or 5.44% from the year ended December 31, 2022. Trust management fees increased by $1.0 million, or 9.01% compared to 2022. Income from Bank-Owned Life Insurance ("BOLI") increased by $7.4 million from the prior year, primarily due to approximately $6.5 million net increase in cash surrender value resulting from the surrender and redeployment of various BOLI policies at the end 2023, which offset the tax expense impact of the taxable gains generated from the surrendered policies.

Service fees on deposits include analysis fees, NSF fees, as well as other deposit fees. For 2023, service fees on deposits declined by approximately $1.2 million, when compared to 2022. More than half of this decline was due to lower NSF fee income in 2023.

Trust and Investment Services represents our CitizensTrust group. The CitizensTrust group is made up of wealth management and investment services. They provide a variety of services, which include asset management, financial planning, estate planning, retirement planning, private and corporate trustee services, and probate services. Investment Services provides self-directed brokerage, 401(k) plans, mutual funds, insurance and other non-insured investment products. At December 31, 2023, CitizensTrust had approximately $4.0 billion in assets under management and administration, including $2.81 billion in assets under management. CitizensTrust generated fees of $12.6 million for 2023, compared to $11.5 million for 2022. The increase in fees in 2023 included both the impact on market values of changes in equity and fixed income markets but also increased flows of funds from customers, including liquidity management of funds formerly on deposit with the Bank.

The Bank’s investment in BOLI includes life insurance policies generally acquired through acquisitions or the purchase of life insurance by the Bank on a select group of employees to fund deferred compensation plans. 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. At the end of the fourth quarter of 2023, the Company partially restructured its BOLI assets by surrendering various policies valued at approximately $68 million, resulting in a write-down of asset values of more than $4 million and additional income tax expense and penalties of more than $6 million. This combined restructuring charge was offset by increases of approximately $10 million to the cash surrender value resulting from the purchase of $109 million of new policies during the quarter, reflecting a net increase to noninterest income of $6.5 million and additional tax expense of approximately $6.5 million. The new policies will have an initial crediting rate that is approximately 300 basis points higher than the policies that we surrendered. Separate account BOLI policies that fund deferred compensation increased in value in 2023, compared to declines in value in 2022, due to the overall performance of the selected investments within these policies. Income from our BOLI policies for 2023 also included $935,000 of death benefits that exceeded cash surrender values, compared to $3.6 million of death benefits for 2022.

The Bank has entered 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 these non-hedged swaps primarily offset each other resulting in swap fee income. Generally speaking, our volume of back-to-back interest rate swaps is impacted by the level and shape of the yield curve and the Bank's management of interest rate risk. Swap fee income was higher than 2022, primarily due to LIBOR indexed swaps that were converted to term SOFR in 2023 generating fee income of approximately $620,000. We executed on swap agreements related to new loan originations with a notional amount totaling $1.0 million for 2023. There were no executed swap agreements related to new loan originations for 2022. Refer to Note 19 —Derivative Financial Instruments of the notes to the consolidated financial statements of this report for additional information.

The $2.6 million increase in noninterest income included an increase of $4.2 million, or 24.66%, in service charges on deposit accounts, $2.4 million in net gain on the sale of one of our properties, and a $2.1 million gain from a distribution related to one of our CRA investments. Income from BOLI declined by $3.1 million from the prior year, as we incurred a $2.7 million decline in the market value of separate account life insurance policies that are used to fund our deferred compensation liabilities. Offsetting the $2.1 million gain on a CRA investment, 2022 also included a $1.1 million decrease in certain CRA investments due to valuation changes. Noninterest income for 2021 included $1.2 million net gain on the sale of three OREO properties and $890,000 for recovery of an acquired loan charged off prior to a previous acquisition.

At December 31, 2022, CitizensTrust had approximately $2.9 billion in assets under management and administration, including $1.92 billion in assets under management. CitizensTrust generated fees of $11.5 million for 2022, which were nearly flat compared to $11.6 million for 2021. Market conditions have continued to negatively impact assets under management and trust fee income. Additionally, a large trust relationship with more than $800 million in assets was transitioned to a financial institution outside of California. The transition was completed by the end of 2022, with the impact on fee income expected to be reflected in 2023. Offsetting this transfer of assets and the impact of the market on our assets under management and administration, was the growth in managed assets from $350 million of our customer deposits that are now being managed by CitizensTrust in various liquidity strategies.

Income from our BOLI policies for 2022 included $3.6 million of death benefits that exceeded cash surrender values, compared to $3.9 million of death benefits for 2021.

Swap fee income decreased $382,000 compared to 2021, as there were no executed swap agreements related to new loan originations for 2022. There were no executed swap agreements related to new loan originations for 2022, compared to $25.3 million for 2021. The volume of interest rate swaps can be impacted by competitive factors, as well as the current and forecasted interest rate environment.

Noninterest Expense

The following table summarizes the various components of noninterest expense for the periods presented.

(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 1.41% for 2023, compared to 1.28% for 2022 and 1.24% for 2021, respectively. This ratio was negatively impacted by a $9.2 million expense accrual for the FDIC Special Assessment that will be collected over eight quarters starting in 2024. The ratio was negatively impacted in 2022 as a result of $6 million of acquisition expense associated with Suncrest. The increase in this ratio from 2022 to 2023, also reflects the impact of inflationary pressures on staff related expenses, which grew by 5.77%. The increase in this ratio for 2022 compared with 2021 reflects the impact of inflationary pressures on staff related expenses and expense growth associated with Suncrest.

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) can be measured by the efficiency ratio and indicates the percentage of net revenue that is used to cover expenses. The efficiency ratio was 42.00% for 2023, compared to 38.98% for 2022 and 41.09% for 2021. The increase in the efficiency ratio in 2023 was primarily due to increased regulatory assessment expense, including the FDIC Special Assessment, and inflationary pressures on staff related expenses.

Noninterest expense of $229.9 million for the year ended December 31, 2023 was $13.3 million higher than 2022. Year-over-year increases included $12.2 million in regulatory assessments, including the $9.2 million FDIC special assessment, and $7.6 million in salaries and employee benefits, primarily due to inflationary pressures on salaries and benefits and a $2.9 million decline in the contra expense for deferred origination costs due to fewer loan originations. Marketing and promotion expense increased over 2022 by approximately $460,000, as these expenses returned to pre-pandemic levels. As we continue to invest in new technology, software expense increased by $548,000, or 4.06%. The increase in technology costs demonstrates our commitment to improving efficiencies and providing an excellent customer experience. These increases were partially offset by a $6.0 million decrease in acquisition expense. The year-over-year decrease also included a $500,000 recapture of provision for unfunded loan commitments recorded in 2023.

Noninterest expense of $216.6 million for the year ended December 31, 2022 was $26.8 million higher than 2021. The year-over-year increase included a $13.7 million increase in salaries and employee benefits, which included additional compensation related expenses for the newly hired and former Suncrest associates. Occupancy and equipment increased by $3.0 million due to the addition of seven banking centers resulting from the acquisition of Suncrest, two of which were subsequently consolidated by the end of the second quarter of 2022. Acquisition expense related to the merger of Suncrest was $6.0 million for 2022, compared with $962,000 for 2021. The increase in software expense of $1.9 million, included costs associated with the continued use of Suncrest's legacy banking systems, prior to conversions, as well as continued investments in technology. A $1.7 million increase in marketing and promotion expense for 2022 was primarily due to the impact that the COVID-19 pandemic had on marketing and promotional events in 2021. Professional service expense grew by $1.4 million, including increased costs for legal and employee recruiting of $854,000. The year-over-year increase also included a $1.0 million recapture of provision for unfunded loan commitments recorded in 2021.

Income Taxes

The Company’s effective tax rate for the year ended December 31, 2023 was 29.80%, compared with 28.30% and 28.60% for the years ended December 31, 2022 and 2021, respectively. During the fourth quarter and full year of 2023, our effective tax rate was impacted by more than $6 million in combined income tax expense and penalties resulting from the surrender of various BOLI policies. Our estimated annual effective tax rate also varies depending upon the level of tax-advantaged income from municipal securities and BOLI as well as available tax credits. Refer to Note 10 —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.