Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the fiscal year ended December 31, 2012

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from N/A to N/A

Commission file number: 1-10140

 

 

CVB FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

 

 

California   95-3629339
(State or other jurisdiction of
incorporation or organization)
 

(I.R.S. Employer

Identification No.)

701 N. Haven Avenue, Suite 350

Ontario, California

  91764
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: (909) 980-4030

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Class

 

Name of Each Exchange on Which Registered

Common Stock, no par value   NASDAQ Stock Market, LLC

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

As of June 30, 2012, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $1,028,962,542.

Number of shares of common stock of the registrant outstanding as of February 15, 2013: 104,900,623.

 

DOCUMENTS INCORPORATED BY REFERENCE

   PART OF

Definitive Proxy Statement for the Annual Meeting of Stockholders which will be filed within 120 days of the fiscal year ended December 31, 2012

   Part III of Form 10-K

 

 

 


Table of Contents

CVB FINANCIAL CORP.

2012 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

PART I

  

ITEM 1.

 

BUSINESS

     3   

ITEM 1A.

 

RISK FACTORS

     13   

ITEM 1B.

 

UNRESOLVED STAFF COMMENTS

     20   

ITEM 2.

 

PROPERTIES

     20   

ITEM 3.

 

LEGAL PROCEEDINGS

     21   

ITEM 4.

 

MINE SAFETY DISCLOSURES

     22   

PART II

  

ITEM 5.

 

MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     23   

ITEM 6.

 

SELECTED FINANCIAL DATA

     25   

ITEM 7.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS

     26   
 

GENERAL

     26   
 

CRITICAL ACCOUNTING POLICIES

     26   
 

OVERVIEW

     29   
 

ANALYSIS OF THE RESULTS OF OPERATIONS

     31   
 

RESULTS BY BUSINESS SEGMENTS

     40   
 

ANALYSIS OF FINANCIAL CONDITION

     43   
 

RISK MANAGEMENT

     59   

ITEM 7A.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     69   

ITEM 8.

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     70   

ITEM 9.

 

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     70   

ITEM 9A.

 

CONTROLS AND PROCEDURES

     70   

ITEM 9B.

 

OTHER INFORMATION

     72   

PART III

  

ITEM 10.

 

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

     73   

ITEM 11.

 

EXECUTIVE COMPENSATION

     73   

ITEM 12.

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

     73   

ITEM 13.

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

     73   

ITEM 14.

 

PRINCIPAL ACCOUNTING FEES AND SERVICES

     73   

PART IV

  

ITEM 15.

 

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

     74   

SIGNATURES

     75   


Table of Contents

INTRODUCTION

Cautionary Note Regarding Forward-Looking Statements

Certain statements in this report constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, Rule 175 promulgated thereunder, Section 21E of the Securities and Exchange Act of 1934, as amended, Rule 3b-6 promulgated thereunder, or Exchange Act, and as such involve risk and uncertainties. All statements in this Form 10-K other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws. These forward-looking statements relate to, among other things, anticipated future operating and financial performance, the allowance for credit losses, our financial position and liquidity, business strategies, regulatory and competitive outlook, investment and expenditure plans, capital and financing needs and availability, plans and objectives of management for future operations, expectations of the environment in which we operate, projections of future performance, perceived opportunities in the market and strategies regarding our mission and vision and statements relating to any of the foregoing.

Words such as “will likely result, “aims”, “anticipates”, “believes”, “could”, “estimates”, “expects”, “hopes”, “intends”, “may”, “plans”, “projects”, “seeks”, “should”, “will” and variations of these words and similar expressions help to identify these forward looking statements, which involve risks and uncertainties. Our actual results may differ significantly from the results discussed in such forward-looking statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include but are not limited to:

 

   

Local, regional, national and international economic conditions and events and the impact they may have on us and our customers;

 

   

Ability to attract deposits and other sources of liquidity;

 

   

Oversupply of inventory and continued deterioration in values of California real estate, both residential and commercial;

 

   

A prolonged slowdown in construction activity;

 

   

Changes in our ability to receive dividends from our subsidiaries;

 

   

The effect of any goodwill impairment;

 

   

Accounting adjustments in connection with our acquisition of assets and assumptions of liabilities from San Joaquin Bank;

 

   

The effect of climate change and attendant regulation on our customers and borrowers;

 

   

Our ability to manage the loan portfolio acquired from San Joaquin Bank within the limits of the loss protection provided by the Federal Deposit Insurance Corporation (“FDIC”);

 

   

Compliance with our agreements with the FDIC with respect to the loans we acquired from San Joaquin Bank and our loss-sharing arrangements with the FDIC;

 

   

Impact of reputational risk on such matters as business generation and retention, funding and liquidity;

 

   

Changes in the financial performance and/or condition of our borrowers;

 

   

Changes in the level of nonperforming assets and charge-offs;

 

   

Changes in critical accounting policies and judgments;

 

   

Effects of acquisitions we may make;

 

   

The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities, executive compensation and insurance) with which we and our subsidiaries must comply, including, but not limited to, the Dodd-Frank Act of 2010;

 

   

Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements;

 

   

Inflation, interest rate, securities market and monetary fluctuations;

 

   

Cybersecurity breaches of our systems or vendor systems;

 

   

Changes in government interest rate policies;

 

   

Fluctuations of our stock price;

 

   

Political developments or instability;

 

   

Acts of war or terrorism, or natural disasters, such as earthquakes, or the effects of pandemic flu;

 

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The timely development and acceptance of new banking products and services and perceived overall value of these products and services by users;

 

   

Changes in consumer spending, borrowing and savings habits;

 

   

Technological changes including but not limited to the adoption by customers and competitors of innovations such as mobile banking capabilities;

 

   

The ability to increase market share and to control expenses;

 

   

Changes in the competitive environment among financial and bank holding companies and other financial service providers;

 

   

Volatility in the credit and equity markets and its effect on the general economy;

 

   

The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;

 

   

Changes in our organization, management, compensation and benefit plans;

 

   

The costs and effects of legal and regulatory developments, including the resolution of legal proceedings or regulatory or other governmental inquiries, including, but not limited to, the current investigation by the Securities and Exchange Commission and the related class-action lawsuits filed against us, and the results of regulatory examinations or reviews; and

 

   

Our success at managing the multiple risks involved in the foregoing items.

For additional information concerning risks we face, see “Item 1A. Risk Factors” and any additional information we set forth in our periodic reports filed pursuant to the Exchange Act, including this Annual Report on Form 10-K. We do not undertake any obligation to update our forward-looking statements to reflect occurrences or unanticipated events or circumstances arising after the date of such statements, except as required by law.

 

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PART I

 

ITEM 1. BUSINESS

CVB Financial Corp.

CVB Financial Corp. (referred to herein on an unconsolidated basis as “CVB” and on a consolidated basis as “we” or the “Company”) is a bank holding company incorporated in California on April 27, 1981 and registered with the Board of Governors of the Federal Reserve System (“Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). The Company commenced business on December 30, 1981 when, pursuant to a reorganization, it acquired all of the voting stock of Chino Valley Bank. On March 29, 1996, Chino Valley Bank changed its name to Citizens Business Bank (the “Bank”). The Bank is our principal asset. The Company has three other inactive subsidiaries: CVB Ventures, Inc.; Chino Valley Bancorp; and ONB Bancorp. The Company is also the common stockholder of CVB Statutory Trust II and CVB Statutory Trust III. CVB Statutory Trust II was created in December 2003 and CVB Statutory Trust III was created in January 2006 to issue trust preferred securities in order to raise capital for the Company.

CVB’s principal business is to serve as a holding company for the Bank and for other banking or banking related subsidiaries, which the Company may establish or acquire. We have not engaged in any other material activities to date. As a legal entity separate and distinct from its subsidiaries, CVB’s principal source of funds is, and will continue to be, dividends paid by and other funds advanced from the Bank and capital raised directly by CVB. Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to CVB. See “Item 1. Business — Regulation and Supervision — Dividends.” As of December 31, 2012, the Company had $6.36 billion in total consolidated assets, $3.36 billion in net loans, $4.77 billion in deposits, $473.2 million in customer repurchase agreements, and $198.9 million in Federal Home Loan Bank (“FHLB”) advances.

On October 16, 2009, we acquired substantially all of the assets and assumed substantially all of the liabilities of San Joaquin Bank (“SJB”), headquartered in Bakersfield, California, in an FDIC-assisted transaction. We acquired all five branches of SJB, one of which we consolidated with our existing Bakersfield business financial center. Through this acquisition, we acquired $489.1 million in loans, $25.3 million in investment securities, $530.0 million in deposits, and $121.4 million in borrowings. The foregoing amounts were reflected at fair value as of the acquisition date.

The principal executive offices of CVB and the Bank are located at 701 North Haven Avenue, Suite 350, Ontario, California. Our phone number is (909) 980-4030.

Citizens Business Bank

The Bank commenced operations as a California state-chartered bank on August 9, 1974. The Bank’s deposit accounts are insured under the Federal Deposit Insurance Act up to applicable limits. The Bank is not a member of the Federal Reserve System. At December 31, 2012, the Bank had $6.36 billion in assets, $3.36 billion in net loans, $4.79 billion in deposits, $473.2 million in customer repurchase agreements, and $198.9 million in FHLB advances.

As of December 31, 2012, we had 41 Business Financial Centers located in the Inland Empire, Los Angeles County, Orange County and the Central Valley areas of California. Of the 41 Business Financial Centers, we opened 13 as de novo centers and obtained the other 28 in acquisition transactions. In October 2012, we closed a center location in Orange County, California. We consolidated this location into our Katella Business Financial Center, located less than two miles away.

We also have five Commercial Banking Centers, of which four were opened in 2008 and one was opened in 2009. Although able to take deposits, these centers operate primarily as sales offices and focus on business clients and their principals, professionals, and high net-worth individuals. These centers are located in Encino (in the San Fernando Valley), Los Angeles, Torrance and Burbank. The fifth one is located in our Headquarters building in Ontario, California We also have three trust offices in Ontario, Irvine and Pasadena. These offices serve as sales offices for wealth management, trust and investment products.

Through our network of banking offices, we emphasize personalized service combined with a full range of banking and trust services for businesses, professionals and individuals located in the service areas of our offices. Although we focus the marketing of our services to small-and medium-sized businesses, a full range of retail banking services are made available to the local consumer market.

We offer a wide range of deposit instruments. These include checking, savings, money market and time certificates of deposit for both business and personal accounts. We also serve as a federal tax depository for our business customers.

We provide a full complement of lending products, including commercial, agribusiness, consumer, real estate loans and equipment and vehicle leasing. Commercial products include lines of credit and other working capital financing, accounts receivable lending and letters of credit. Agribusiness products are loans to finance the operating needs of wholesale dairy farm operations, cattle feeders, livestock raisers, and farmers. We provide lease financing for municipal governments. Financing products for consumers include automobile leasing and financing, lines of credit, credit cards, and home equity loans and lines of credit. Real estate loans include mortgage and construction loans.

 

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We also offer a wide range of specialized services designed for the needs of our commercial accounts. These services include cash management systems for monitoring cash flow, a credit card program for merchants, courier pick-up and delivery, payroll services, remote deposit capture, electronic funds transfers by way of domestic and international wires and automated clearinghouse, and on-line account access. We make available investment products to customers, including mutual funds, a full array of fixed income vehicles and a program to diversify our customers’ funds in federally insured time certificates of deposit of other institutions.

We offer a wide range of financial services and trust services through our CitizensTrust division. These services include fiduciary services, mutual funds, annuities, 401(k) plans and individual investment accounts.

Business Segments

We are a community bank with two reportable operating segments: (i) Business Financial and Commercial Banking Centers (“Centers”) and (ii) Treasury. Our Centers are the focal points for customer sales and services. As such, these Centers comprise the biggest segment of the Company. Our other reportable segment, Treasury, manages all of the investments for the Company. All administrative and other smaller operating departments are combined into the “Other” category for reporting purposes. See the sections captioned “Results by Segment Operations” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 22 — Business Segments in the notes to consolidated financial statements.

Competition

The banking and financial services business is highly competitive. The increasingly competitive environment faced by banks is a result primarily of changes in laws and regulations, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers. We compete for loans, deposits, and customers with other commercial banks, savings and loan associations, savings banks, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers. Many competitors are much larger in total assets and capitalization, have greater access to capital markets, including foreign ownership, and/or offer a broader range of financial services.

Regulation and Supervision

Economic Conditions/Government Policies

Our profitability, like most financial institutions, is primarily dependent on interest rate spreads. In general, the difference between the interest rates paid by the Bank on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by the Bank on interest-earning assets, such as loans extended to customers and securities held in the investment portfolio, will comprise the major portion of our earnings. These rates are highly sensitive to many factors that are beyond our control, such as inflation, recession and unemployment, and the impact which future changes in domestic and foreign economic conditions might have on us cannot be predicted.

Our business is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System (the “FRB”). The FRB implements national monetary policies (with objectives such as curbing inflation, increasing employment and combating recession) through its open-market operations in U.S. Government securities by buying and selling treasury and mortgage-backed securities, by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions. The actions of the FRB in these areas influence the growth of bank loans, investments, and deposits and also affect interest earned on interest-earning assets and paid on interest-bearing liabilities. Government fiscal and budgetary policies, including deficit spending, can also have a significant impact on the capital markets and interest rates. The nature and impact of any future changes in monetary and fiscal policies on us cannot be predicted.

 

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The Company and the Bank are subject to significant regulation and restrictions by federal and state laws and regulatory agencies. These regulations and restrictions are intended primarily for the protection of depositors and the deposit insurance fund and for the protection of borrowers, and secondarily for the stability of the U.S. banking system. They are not intended for the benefit of shareholders of financial institutions. The following discussion of statutes and regulations is a summary and does not purport to be complete nor does it address all applicable statutes and regulations. This discussion is qualified in its entirety by reference to the statutes and regulations referred to in this discussion. From time to time, federal and state legislation is enacted and implemented by regulations which may have the effect of materially increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers.

Legislation and Regulation

The events of the past several years have led to numerous new laws and regulatory pronouncements in the United States and internationally for financial institutions. The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), enacted in 2010, is one of the most far reaching legislative actions affecting the financial services industry in decades and significantly restructures the financial regulatory regime in the United States. Dodd-Frank broadly affects the financial services industry by creating new resolution authorities, requiring ongoing stress testing of capital, mandating higher capital and liquidity requirements, increasing regulation of executive and incentive-based compensation and requiring numerous other provisions aimed at strengthening the sound operation of the financial services sector depending, in part, on the size of the financial institution. Among other things, the Dodd-Frank Act provides for:

 

   

capital standards applicable to bank holding companies may be no less stringent than those applied to insured depository institutions;

 

   

annual stress tests and early remediation or so-called living wills are required for larger banks with more than $50 billion in assets as well as risk committees of its board of directors that include a risk expert; such requirements may have the effect of establishing new best practices standards for smaller banks;

 

   

trust preferred securities must generally be deducted from Tier 1 capital over a three-year phase-in period ending in 2016, although depository institution holding companies such as the Company with assets of less than $15 billion as of year-end 2009 are grandfathered with respect to such securities for purposes of calculating regulatory capital. The proposed rules would also remove the grandfather exemption in Section 171 of Dodd-Frank for banks with less than $15 billion in assets, but more than $500 million, and would require the phase out of the inclusion of trust preferred securities from Tier I capital instead over ten years, beginning in 2013;

 

   

the assessment base for federal deposit insurance was changed to consolidated assets less tangible capital instead of the amount of insured deposits, which generally increased the insurance fees for larger banks, but had relatively less impact on smaller banks;

 

   

repeal of the federal prohibition on the payment of interest on demand deposits, including business checking accounts through 2012, and made permanent the $250,000 limit for federal deposit insurance;

 

   

the establishment of the Consumer Finance Protection Bureau (the “CFPB”), with responsibility for promulgating regulations designed to protect consumers’ financial interests and prohibit unfair, deceptive and abusive acts and practices by financial institutions, and with authority to directly examine those financial institutions with $10 billion or more in assets for compliance with the regulations promulgated or overseen by the CFPB;

 

   

limits, or places significant burdens and compliance and other costs, on activities traditionally conducted by banking organizations, such as originating and securitizing mortgage loans and other financial assets, arranging and participating in swap and derivative transactions, proprietary trading and investing in private equity and other funds; and

 

   

the establishment of new compensation restrictions and standards regarding the time, manner and form of compensation given to key executives and other personnel receiving incentive compensation, including documentation and governance, proxy access by stockholders, deferral and claw-back requirements.

As required by the Dodd-Frank Act, federal regulators have published for comment proposed regulations to (i) increase capital requirements on banks and bank holding companies, and (ii) implement the so-called “Volcker Rule” of the Dodd-Frank Act, which would significantly restrict certain activities by covered bank holding companies, including restrictions on proprietary trading and private equity investing. Final rules are expected in 2013.

 

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Many of the regulations to implement the Dodd-Frank Act have not yet been published for comment or adopted in final form and/or will take effect over several years, making it difficult to anticipate the overall financial impact on the Company and the Bank, our customers or the financial industry more generally. Individually and collectively, these proposed regulations resulting from the Dodd-Frank Act may materially and adversely affect the Company’s and the Bank’s business, financial condition, and results of operations, and could require the Company and/or the Bank to seek additional sources of capital in the future.

We cannot predict whether or when other legislation or new regulations may be enacted, and if enacted, the effect that new legislation or any implemented regulations and supervisory policies would have on our financial condition and results of operations. Such developments may further alter the structure, regulation, and competitive relationship among financial institutions, and may subject us to increased regulation, disclosure, and reporting requirements. Moreover, the bank regulatory agencies remain aggressive in the current economic environment in responding to concerns and trends identified in examinations, and this has resulted in the increased issuance of enforcement actions to financial institutions requiring action to address credit quality, liquidity and risk management and capital adequacy, as well as other safety and soundness concerns.

Bank Holding Company Regulation

Bank holding companies and their subsidiaries are subject to significant regulation and restrictions by Federal and State laws and regulatory agencies, which may affect the cost of doing business, and may limit permissible activities and expansion or impact the competitive balance between banks and other financial services providers.

A wide range of requirements and restrictions are contained in both Federal and State banking laws, which together with implementing regulatory authority:

 

   

Require periodic reports and such additional information as the Federal Reserve may require;

 

   

Require bank holding companies to maintain increased levels of capital (See “Capital Adequacy Requirements” below);

 

   

Require that bank holding companies serve as a source of financial and managerial strength to subsidiary banks and commit resources as necessary to support each subsidiary bank. This “source-of-strength” doctrine most directly affects bank holding companies where a bank holding company’s subsidiary bank fails to maintain adequate capital levels. In such a situation, the subsidiary bank will be required by the bank’s federal regulator to take “prompt corrective action.” See “Prompt Corrective Action Provisions” below.

 

   

Limit on dividends payable to shareholders and restrictions on the ability of bank holding companies to obtain dividends or other distributions from their subsidiary banks. The Company’s ability to pay dividends on both its common and preferred stock are subject to legal and regulatory restrictions. Substantially all of the Company’s funds to pay dividends or to pay principal and interest on our debt obligations are derived from dividends paid by the Bank;

 

   

Terminate an activity or terminate control of or liquidate or divest certain subsidiaries, affiliates or investments if the Federal Reserve believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any bank subsidiary;

 

   

Require the prior approval of senior executive officer or director changes and prohibit golden parachute payments, including change in control agreements, or new employment agreements with such payment terms, which are contingent upon termination;

 

   

Regulate provisions of certain bank holding company debt, including the authority to impose interest ceilings and reserve requirements on such debt and require prior approval to purchase or redeem securities in certain situations;

 

   

Approve acquisitions and mergers with banks and consider certain competitive, management, financial or other factors in granting these approvals, in addition to similar California or other state banking agency approvals which may also be required.

Other Restrictions on Activities

Subject to prior notice or Federal Reserve approval, bank holding companies may generally engage in, or acquire shares of companies engaged in, activities determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Bank holding companies which elect and retain “financial holding company” status pursuant to the Gramm-Leach-Bliley Act of 1999 (“GLBA”) may engage in these nonbanking activities and broader securities, insurance, merchant banking and other activities that are determined to be “financial in nature” or are incidental or complementary to activities that are financial in nature without prior Federal Reserve approval. Pursuant to GLBA and Dodd-Frank, in order to elect and retain financial holding company status, a bank holding company and all

 

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depository institution subsidiaries of a bank holding company must be well capitalized and well managed, and, except in limited circumstances, depository subsidiaries must be in satisfactory compliance with the Community Reinvestment Act (“CRA”), which requires banks to help meet the credit needs of the communities in which they operate. Failure to sustain compliance with these requirements or correct any non-compliance within a fixed time period could lead to divestiture of subsidiary banks or require all activities to conform to those permissible for a bank holding company. CVB has not elected financial holding company status and neither CVB nor the Bank has engaged in any activities determined by the Federal Reserve to be financial in nature or incidental or complementary to activities that are financial in nature.

CVB is also a bank holding company within the meaning of Section 3700 of the California Financial Code. Therefore, CVB and any of its subsidiaries are subject to examination by, and may be required to file reports with, the California Department of Financial Institutions (“DFI”). DFI approvals may also be required for certain mergers and acquisitions.

Securities Exchange Act of 1934

CVB’s common stock is publicly held and listed on the NASDAQ Stock Market (“NASDAQ”), and CVB is subject to the periodic reporting, information, proxy solicitation, insider trading, corporate governance and other requirements and restrictions of the Securities Exchange Act of 1934 and the regulations of the Securities and Exchange Commission (“SEC”) promulgated thereunder as well as listing requirements of NASDAQ.

Sarbanes-Oxley Act

The Company is subject to the accounting oversight and corporate governance requirements of the Sarbanes-Oxley Act of 2002, including, among other things, required executive certification of financial presentations, requirements for board audit committees and their members, and disclosure of controls and procedures and internal control over financial reporting.

Bank Regulation

As a California commercial bank whose deposits are insured by the FDIC, the Bank is subject to regulation, supervision, and regular examination by the DFI and by the FDIC, as the Bank’s primary Federal regulator, and must additionally comply with certain applicable regulations of the Federal Reserve. Specific federal and state laws and regulations which are applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds, their activities relating to dividends, investments, loans, the nature and amount of and collateral for certain loans, servicing and foreclosing on loans, borrowings, capital requirements, certain check-clearing activities, branching, and mergers and acquisitions. California banks are also subject to statutes and regulations including Federal Reserve Regulation O and Federal Reserve Act Sections 23A and 23B and Regulation W, which restrict or limit loans or extensions of credit to “insiders”, including officers, directors, and principal shareholders, and loans or extension of credit by banks to affiliates or purchases of assets from affiliates, including parent bank holding companies, except pursuant to certain exceptions and terms and conditions at least as favorable to those prevailing for comparable transactions with unaffiliated parties. Dodd-Frank expanded definitions and restrictions on transactions with affiliates and insiders under Sections 23A and 23B and also lending limits for derivative transactions, repurchase agreements and securities lending and borrowing transactions

Pursuant to the Federal Deposit Insurance Act (“FDI Act”) and the California Financial Code, California state chartered commercial banks may generally engage in any activity permissible for national banks. Therefore, the Bank may form subsidiaries to engage in the many so-called “closely related to banking” or “nonbanking” activities commonly conducted by national banks in operating subsidiaries or subsidiaries of bank holding companies. Further, pursuant to GLBA, California banks may conduct certain “financial” activities in a subsidiary to the same extent as may a national bank, provided the bank is and remains “well-capitalized,” “well-managed” and in satisfactory compliance with the CRA. The Bank currently has no financial subsidiaries.

Enforcement Authority

The federal and California regulatory structure gives the bank regulatory agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of appropriate loan loss reserves for regulatory purposes. The regulatory agencies have adopted guidelines to assist in identifying and addressing potential safety and soundness concerns before an institution’s capital becomes impaired. The guidelines establish operational and managerial standards generally relating to: (1) internal controls, information systems, and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest-rate exposure; (5) asset growth and asset quality; and (6) compensation, fees, and benefits. Further, the regulatory agencies have adopted safety and soundness guidelines for asset quality and for evaluating and monitoring earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves. If, as a result of an examination, the DFI or the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory or that the Bank or its management is violating or has

 

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violated any law or regulation, the DFI and the FDIC, and separately the FDIC as insurer of the Bank’s deposits, have residual authority to:

 

   

Require affirmative action to correct any conditions resulting from any violation or practice;

 

   

Direct an increase in capital and the maintenance of higher specific minimum capital ratios, which may preclude the Bank from being deemed well capitalized and restrict its ability to accept certain brokered deposits;

 

   

Restrict the Bank’s growth geographically, by products and services, or by mergers and acquisitions, including bidding in FDIC receiverships for failed banks;

 

   

Enter into or issue informal or formal enforcement actions, including required Board resolutions, memoranda of understanding, written agreements and consent or cease and desist orders or prompt corrective action orders to take corrective action and cease unsafe and unsound practices;

 

   

Require prior approval of senior executive officer or director changes; remove officers and directors and assess civil monetary penalties; and

 

   

Terminate FDIC insurance, revoke the charter and/or take possession of and close and liquidate the Bank or appoint the FDIC as receiver.

Deposit Insurance

The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The FDIC insures our customer deposits through the Deposit Insurance Fund (the “DIF”) up to prescribed limits for each depositor. Pursuant to Dodd-Frank, the maximum deposit insurance amount has been permanently increased to $250,000 and all non-interest-bearing transaction accounts were insured through December 31, 2012 without an extension of this date. The amount of FDIC assessments paid by each DIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other supervisory factors. The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a risk to the DIF or that may prejudice the interest of the bank’s depositors. The termination of deposit insurance for a bank would also result in the revocation of the bank’s charter by the DFI.

Our FDIC insurance expense totaled $3.2 million for 2012. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures or if the FDIC otherwise determines, we may be required to pay even higher FDIC premiums than the recently increased levels. These announced increases and any future increases in FDIC insurance premiums may have a material and adverse effect on our earnings and could have a material adverse effect on the value of, or market for, our common stock.

Capital Adequacy Requirements

Bank holding companies and banks are subject to various regulatory capital requirements administered by state and federal banking agencies. Increased capital requirements are expected as a result of expanded authority set forth in Dodd-Frank and the Basel III international supervisory developments described below. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting, and other factors. At December 31, 2012, the Company’s and the Bank’s capital ratios significantly exceeded the minimum capital adequacy guideline percentage requirements of the federal banking agencies for “well capitalized” institutions. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources.”

The current risk-based capital guidelines for bank holding companies and banks adopted by the federal banking agencies are expected to provide a measure of capital that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets, such as loans, and those recorded as off-balance sheet items, such as commitments, letters of credit and recourse arrangements. The risk-based capital ratio is determined by classifying assets and certain off-balance sheet financial instruments into weighted categories, with higher levels of capital being required for those categories perceived as representing greater risks and dividing its qualifying capital by its total risk-adjusted assets and off-balance sheet items. Bank holding companies and banks engaged in significant trading activity may also be subject to the market risk capital guidelines and be required to incorporate additional market and interest rate risk components into their risk-based capital standards.

 

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Qualifying capital is classified depending on the type of capital:

 

   

“Tier 1 capital” currently includes common equity and trust preferred securities, subject to certain criteria and quantitative limits. Accordingly, the capital received from trust preferred offerings qualifies as Tier 1 capital, but is subject to the new provisions of Dodd-Frank. Under Dodd-Frank, depository institution holding companies with more than $15 billion in total consolidated assets as of December 31, 2009, will no longer be able to include trust preferred securities as Tier 1 regulatory capital after the end of a 3-year phase-out period beginning 2013, and would need to replace any outstanding trust preferred securities issued prior to May 19, 2010 with qualifying Tier 1 regulatory capital during the phase-out period. For institutions with less than $15 billion in total consolidated assets, existing trust preferred capital will still qualify as Tier 1 to be phased out over a ten year period. Small bank holding companies with less than $500 million in assets could issue new trust preferred which could still qualify as Tier 1; however, the market for any new trust preferred capital raises is uncertain.

 

   

“Tier 2 capital” includes hybrid capital instruments, other qualifying debt instruments, a limited amount of the allowance for credit losses, and a limited amount of unrealized holding gains on equity securities. Following the phase-out period under Dodd-Frank, trust preferred securities will be treated as Tier 2 capital for institutions with more than $15 billion in total consolidated assets.

 

   

“Tier 3 capital” consists of qualifying unsecured debt. The sum of Tier 2 and Tier 3 capital may not exceed the amount of Tier I capital.

Under the current capital guidelines, there are three fundamental capital ratios: a total risk-based capital ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio. To be deemed “well capitalized” a bank must have a total risk-based capital ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio of at least ten percent, six percent and five percent, respectively. There is currently no Tier 1 leverage requirement for a holding company to be deemed well-capitalized. At December 31, 2012, the respective capital ratios of the Company and the Bank exceeded the minimum percentage requirements to be deemed “well-capitalized”. As of December 31, 2012, the Bank’s total risk-based capital ratio was 19.03% and its Tier 1 risk-based capital ratio was 17.77%. As of December 31, 2012, the Company’s total risk-based capital ratio was 19.49% and its Tier 1 risk-based capital ratio was 18.23%. The federal banking agencies may change existing capital guidelines or adopt new capital guidelines in the future and have required many banks and bank holding companies subject to enforcement actions to maintain capital ratios in excess of the minimum ratios otherwise required to be deemed well capitalized, in which case institutions may no longer be deemed well capitalized and may therefore be subject to restrictions on taking brokered deposits.

The Company and the Bank are also required to maintain a leverage capital ratio designed to supplement the risk-based capital guidelines. Banks and bank holding companies that have received the highest rating of the five categories used by regulators to rate banks and that are not anticipating or experiencing any significant growth must maintain a ratio of Tier 1 capital (net of all intangibles) to adjusted total assets of at least 3%. All other institutions are required to maintain a leverage ratio of at least 100 to 200 basis points above the 3% minimum, for a minimum of 4% to 5%. Pursuant to federal regulations, banks must maintain capital levels commensurate with the level of risk to which they are exposed, including the volume and severity of problem loans. Federal regulators may, however, set higher capital requirements when a bank’s particular circumstances warrant. As of December 31, 2012, the Bank’s leverage capital ratio was 11.21%, and the Company’s leverage capital ratio was 11.50%, both ratios significantly exceeding regulatory minimums.

The regulatory agencies’ risk-based capital guidelines are based upon the 1988 capital accord (“Basel I”) of the internal Basel Committee on Bank Supervision (“Basel Committee”), a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines, which each country’s supervisors can use to determine the supervisory policies they apply to their home jurisdiction. In 2004 the Basel Committee proposed a new capital accord (“Basel II”) to replace Basel I that provided approaches for setting capital standards for credit risk and capital requirements for operational risk and refining the existing capital requirements for market risk exposures. U.S. banking regulators published a final rule for Basel II implementation requiring banks with over $250 billion in consolidated total assets or on-balance sheet foreign exposure of $10 billion (“core banks”) to adopt the advanced approaches of Basel II while allowing other banks to elect to “opt in.” The regulatory agencies later issued a proposed rule for larger banks that would give banking organizations that do not use the advanced approaches the option to implement a new risk-based capital framework that would adopt the standardized approach of Basel II for credit risk, the basic indicator approach of Basel II for operational risk and related disclosure requirements. A definitive rule was not issued.

In December 2010, the Basel Committee released its final framework for strengthening international capital and liquidity regulation, now officially identified as “Basel III.” If and when implemented by the U.S. banking agencies and fully phased-in, it would require bank holding companies and their bank subsidiaries to maintain substantially more capital than currently required, with a greater emphasis on common equity. The Basel III capital framework, among other things:

 

   

introduces as a new capital measure, Common Equity Tier 1 (“CET1”), more commonly known in the United States as “Tier 1 Common,” and defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and expands the scope of the adjustments as compared to existing regulations;

 

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if fully phased in as currently proposed, requires covered banks to maintain: (i) a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%); (ii) an additional “SIFI buffer” for those large institutions deemed to be systemically important, ranging from 1.0% to 2.5%, and up to 3.5% under certain conditions; (iii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation); (iv) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation); and (v) as a newly adopted international standard, a minimum leverage ratio of 3%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (as the average for each quarter of the month-end ratios for the quarter); and

 

   

an additional “countercyclical capital buffer,” generally to be imposed when national regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk, that would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when fully implemented.

In June 2012, the U.S. federal bank regulatory agencies jointly issued a notice of proposed rulemaking to increase capital requirements for almost all banks and bank holding companies as required by the Dodd-Frank Act and make them consistent with the international Basel III agreement. Higher risk weighting would be required for exposures that are more than 90 days past due or are on nonaccrual status and for certain commercial real estate facilities that finance the acquisition, development or construction of real property. The proposed rules also require unrealized gains and losses on certain securities holdings to be included in calculating capital ratios. The proposed rules would apply to all depository institutions and top-tier bank holding companies with assets of $500 million or more. The proposed rules include new minimum risk-based capital and leverage ratios, which would be phased in during 2013 and 2014, and would refine the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The proposed rules would also establish a "capital conservation buffer" of 2.5% above the new regulatory minimum capital ratios, and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase each year until fully implemented in January 2019. An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary executive bonuses, if its capital level falls below the buffer amount. These limitations would establish a maximum percentage of eligible retained income that could be utilized for such actions.

The proposed rules, including alternative requirements for smaller community financial institutions, would, when finalized, become effective in stages through 2019. The proposed rules would also remove the grandfather exemption in Section 171 of Dodd-Frank for banks with less than $15 billion in assets, but more than $500 million, and would require the phase out of the inclusion of trust preferred securities from Tier I capital instead over ten years, beginning in 2013. The proposed new framework was to have been effective January 1, 2013; however, due to the number of comment letters received by the federal banking agencies in response to the notice of proposed rule making, the initial implementation has been postponed indefinitely. While the proposed new regulatory capital requirements will likely result in generally higher regulatory capital standards for the Company, it is difficult at this time to predict when or how many of the proposed provisions will ultimately be adopted or whether broader exemptions may be provided for community banks. In addition, bank regulators may also continue their past policies of expecting banks to maintain additional capital beyond the new minimum requirements. The implementation of more stringent requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Company's net income and return on equity, restrict the ability to pay dividends and require the raising of additional capital.

Prompt Corrective Action Provisions

The Federal Deposit Insurance Act (“FDIA”) provides a framework for regulation of depository institutions and their affiliates, including parent holding companies, by their federal banking regulators. Among other things, it requires the relevant federal banking regulator to take “prompt corrective action” with respect to a depository institution if that institution does not meet certain capital adequacy standards, including requiring the prompt submission of an acceptable capital restoration plan. Supervisory actions by the appropriate federal banking regulator under the prompt corrective action rules generally depend upon an institution’s classification within five capital categories as defined in the regulations. The relevant capital measures are the capital ratio, the Tier 1 capital ratio, and the leverage ratio.

 

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A depository institution’s capital tier under the prompt corrective action regulations will depend upon how its capital levels compare with various relevant capital measures and the other factors established by the regulations. A bank will be: (i) “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and a leverage ratio of 4.0% or greater and is not “well capitalized”; (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters.

The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be “undercapitalized.” “Undercapitalized” institutions are subject to growth limitations and are required to submit a capital restoration plan. The regulatory agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The bank holding company must also provide appropriate assurances of performance with potential liability of up to 5.0% of the depository institution’s total assets at the time it became undercapitalized.

Dividends

It is the Federal Reserve’s policy that bank holding companies should generally pay dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. It is also the Federal Reserve’s policy that bank holding companies should not maintain dividend levels that undermine their ability to be a source of strength to its banking subsidiaries. Additionally, in consideration of the current financial and economic environment, the Federal Reserve has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.

The Bank is a legal entity that is separate and distinct from its holding company. CVB receives income through dividends paid by the Bank. Subject to the regulatory restrictions which currently further restrict the ability of the Bank to declare and pay dividends, future cash dividends by the Bank will depend upon management’s assessment of future capital requirements, contractual restrictions, and other factors.

The power of the board of directors of the Bank to declare a cash dividend to CVB is subject to California law, which restricts the amount available for cash dividends to the lesser of a bank’s retained earnings or net income for its last three fiscal years (less any distributions to shareholders made during such period). Where the above test is not met, cash dividends may still be paid, with the prior approval of the DFI, in an amount not exceeding the greatest of (1) retained earnings of the bank; (2) the net income of the bank for its last fiscal year; or (3) the net income of the bank for its current fiscal year.

Operations and Consumer Compliance Laws

The Bank must comply with numerous federal and state anti-money laundering and consumer protection statutes and implementing regulations, including the USA PATRIOT Act of 2001, the Bank Secrecy Act, the Foreign Account Tax Compliance Act (effective 2013), the CRA, the Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National Flood Insurance Act, the California Homeowner Bill of Rights and various federal and state privacy protection laws. Noncompliance with any of these laws could subject the Bank to lawsuits and could also result in administrative penalties, including, fines and reimbursements. The Bank and the Company are also subject to federal and state laws prohibiting unfair or fraudulent business practices, untrue or misleading advertising and unfair competition.

These laws and regulations mandate certain disclosure and reporting requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, servicing, collecting and foreclosure of loans, and providing other services. Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to enforcement actions, injunctions, fines or criminal penalties, punitive damages to consumers, and the loss of certain contractual rights.

 

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Dodd-Frank provides for the creation of the CFPB as an independent entity within the Federal Reserve and as a new regulatory agency for United States banks. It has broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards, and contains provisions on mortgage-related matters such as steering incentives, determinations as to a borrower’s ability to repay and prepayment penalties. The bureau’s functions include investigating consumer complaints, conducting market research, rulemaking, supervising and examining bank consumer transactions, and enforcing rules related to consumer financial products and services. Banks with less than $10 billion in assets, such as the Bank, will continue to be examined for compliance by their primary federal banking agency.

Available Information

Reports filed with the SEC include our proxy statements, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. These reports and other information on file can be inspected and copied on official business days between 10:00 a.m. and 3:00 p.m. at the public reference facilities of the SEC on file at 100 F Street, N.E., Washington D.C., 20549. The public may obtain information on the operation of the public reference rooms by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains the reports, proxy and information statements and other information we file with them. The address of the site is http://www.sec.gov. The Company also maintains an Internet website at http://www.cbbank.com. We make available, free of charge through our website, our Proxy Statement, Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and current Report on Form 8-K, and any amendment there to, as soon as reasonably practicable after we file such reports with the SEC. None of the information contained in or hyperlinked from our website is incorporated into this Form 10-K.

Executive Officers of the Company

The following sets forth certain information regarding our executive officers, their positions and their ages.

Executive Officers:

 

Name

  

Position

   Age  
Christopher D. Myers    President and Chief Executive Officer of the Company and the Bank      50   
Richard C. Thomas   

Chief Financial Officer of the Company and Executive Vice President and

Chief Financial Officer of the Bank

     64   
James F. Dowd    Executive Vice President and Chief Credit Officer of the Bank      60   
David A. Brager    Executive Vice President and Sales Division Manager of the Bank      45   
David C. Harvey    Executive Vice President and Chief Operations Officer of the Bank      45   

Mr. Myers assumed the position of President and Chief Executive Officer of the Company and the Bank on August 1, 2006. Prior to that, Mr. Myers served as Chairman of the Board and Chief Executive Officer of Mellon First Business Bank from 2004 to 2006. From 1996 to 2003, Mr. Myers held several management positions with Mellon First Business Bank, including Executive Vice President, Regional Vice President, and Vice President/Group Manager.

Mr. Thomas assumed the position of Chief Financial Officer of the Company and Executive Vice President and Chief Financial Officer of the Bank on March 1, 2011. Mr. Thomas initially joined the Bank as an Executive Vice President Finance and Accounting on December 13, 2010. Previously, Mr. Thomas served as Chief Risk Officer of Community Bank. From 1987 to 2009, he was an audit partner of Deloitte & Touche LLP.

Mr. Dowd assumed the position of Executive Vice President and Chief Credit Officer of the Bank on June 30, 2008. From 2006 to 2008, he served as Executive Vice President and Chief Credit Officer for Mellon First Business Bank. From 1991 to 2006, Mr. Dowd held several management positions with City National Bank, including Senior Vice President and Manager of Special Assets, Deputy Chief Credit Officer, and Interim Chief Credit Officer.

Mr. Brager assumed the position of Executive Vice President and Sales Division Manager of the Bank on November 22, 2010. From 2007 to 2010, he served as Senior Vice President and Regional Manager of the Central Valley Region for the Bank. From 2003 to 2007, he served as Senior Vice President and Manager of the Fresno Business Financial Center for the Bank. From 1997 to 2003, Mr. Brager held management positions with Westamerica Bank.

Mr. Harvey assumed the position of Executive Vice President and Chief Operations Officer of the Bank on December 31, 2009. From 2000 to 2008, he served as Senior Vice President and Operations Manager at Bank of the West. From 2008 to 2009 he served as Executive Vice President and Commercial and Treasury Services Manager at Bank of the West.

 

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ITEM 1A. RISK FACTORS

Risk Factors That May Affect Future Results — Together with the other information on the risks we face and our management of risk contained in this Annual Report or in our other SEC filings, the following presents significant risks which may affect us. Events or circumstances arising from one or more of these risks could adversely affect our business, financial condition, operating results and prospects and the value and price of our common stock could decline. The risks identified below are not intended to be a comprehensive list of all risks we face, and additional risks that we may currently view as not material may also impair our business operations and results.

Risk Relating to Recent Economic Conditions and Government Response Efforts

Difficult economic and market conditions have adversely affected our industry

After suffering sharp declines over the past several years, the pace of housing price declines has appeared to slow more recently, although existing delinquencies and foreclosures continue to create overhang. This in turn has negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions. In addition, while there are signs that general economic conditions, including the employment markets, have started to show improvement, such signs remain tentative, and compared to prior periods of growth, most areas and industries continue to experience reduced availability of commercial credit and high unemployment. This in turn has negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. These economic conditions and tightening of credit has led to increased commercial and consumer delinquencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. The resulting economic pressure on consumers and businesses and the lack of confidence in the economy and financial markets may adversely affect our business, financial condition, results of operations and stock price. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. In particular, we may face the following risks in connection with these events, or any downward turn in the economy:

 

   

The process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. The level of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates which may, in turn, impact the reliability of the process.

 

   

The Company’s commercial, residential and consumer borrowers may be unable to make timely repayments of their loans, or the decrease in value of real estate collateral securing the payment of such loans could result in significant credit losses, increasing delinquencies, foreclosures and customer bankruptcies, any of which could have a material adverse effect on the Company’s operating results.

 

   

The value of the portfolio of investment securities that we hold may be adversely affected by increasing interest rates and defaults by debtors.

 

   

Further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations, may result in changes in applicable rates of interest, difficulty in accessing capital or an inability to borrow on favorable terms or at all from other financial institutions.

 

   

Increased competition among financial services companies due to expected further consolidation in the industry may adversely affect the Company’s ability to market its products and services.

If economic conditions do not significantly improve, there can be no assurance that we will not experience an adverse effect, which may be material, on our business, financial condition and results of operations.

U.S. and international financial markets and economic conditions could adversely affect our liquidity, results of operations and financial condition

As described in “Business — Economic Conditions, Government Policies, Legislation and Regulation”, turmoil and downward economic trends have been particularly acute in the financial sector. Although the Company and the Bank remain well capitalized and have not suffered any significant liquidity issues as a result of these events, the cost and availability of funds may be adversely affected by illiquid credit markets and the demand for our products and services may decline as our borrowers and customers continue to realize the impact of an economic slowdown, previous recession and ongoing high unemployment rates. In view of the concentration of our operations and the collateral securing our loan portfolio in Central and Southern California, we may be particularly susceptible to adverse economic conditions in the state of California, where our business is concentrated. In addition, adverse economic conditions may exacerbate our exposure to credit risk and adversely affect the ability of borrowers to perform, and thereby, adversely affect our liquidity, financial condition, results or operations and profitability.

 

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We may be required to make additional provisions for credit losses and charge off additional loans in the future, which could adversely affect our results of operations

For the year ended December 31, 2012, we recorded zero provision for credit losses, charged off $5.3 million, and had net recoveries of $3.8 million. As of December 31, 2012, we had $2.17 billion in commercial real estate loans, $61.3 million in construction loans and $160.7 million in single-family residential mortgages. Although there are signs that the U.S. economy may be emerging from a period of severe recession followed by slower than normal growth, business activity and real estate values remain below pre-recession levels, and may not recover fully or could again decline from current levels, and this in turn could affect the ability of our loan customers to service their debts, including those customers whose loans are secured by commercial or residential real estate. This, in turn, could result in loan charge-offs and provisions for credit losses in the future, which could have a material adverse effect on our financial condition, net income and capital. In addition, the Federal Reserve Board and other government officials have expressed concerns about banks’ concentration in commercial real estate lending and the ability of commercial real estate borrowers to perform pursuant to the terms of their loans.

Volatility in commodity prices may adversely affect our results of operations.

As of December 31, 2012, approximately 9.8% of our total gross loan portfolio was comprised of dairy, livestock and agribusiness loans. Recent volatility in certain commodity prices, including milk prices, could adversely impact the ability of those to whom we have made dairy and livestock loans to perform under the terms of their borrowing arrangements with us. In addition, certain grains are being diverted from the food chain into the production of ethanol which is causing the price of feed stocks for dairies to remain high, therefore putting pressure on margins of milk sales and cash flows. These situations, as well as others, could result in additional loan charge-offs and provisions for credit losses in the future, which could have a material adverse effect on our financial condition, net income and capital.

Risks Related to Our Market and Business

Our allowance for credit losses may not be appropriate to cover actual losses

A significant source of risk arises from the possibility that we could sustain losses because borrowers, guarantors, and related parties may fail to perform in accordance with the terms of their loans and leases. The underwriting and credit monitoring policies and procedures that we have adopted to address this risk may not prevent unexpected losses that could have a material adverse effect on our business, financial condition, results of operations and cash flows. We maintain an allowance for credit losses to provide for loan and lease defaults and non-performance. The allowance is also appropriately increased for new loan growth. While we believe that our allowance for credit losses is appropriate to cover inherent losses, we cannot assure you that we will not increase the allowance for credit losses further or that regulators will not require us to increase this allowance.

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to acquire deposits or borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. Many if not all of these same factors could also significantly raise the cost of deposits to our Company and/or to the banking industry in general. This in turn could negatively affect the amount of interest we pay on our interest-bearing liabilities, which could have an adverse impact on our interest rate spread and profitability.

The actions and commercial soundness of other financial institutions could affect our ability to engage in routine funding transactions.

Financial service institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to different industries and counterparties, and execute transactions with various counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual funds, and other institutional clients. Defaults by financial services institutions, even rumors or questions about one or more financial institutions or the financial services industry in general, could lead to market wide liquidity problems and further, could lead to losses or defaults by the Company or other institutions. Many of these transactions expose us to credit risk in the event of default of the applicable counterparty or client. In addition, our credit risk may increase when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due to us. Any such losses could materially and adversely affect our consolidated financial statements.

 

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Our loan portfolio is predominantly secured by real estate and thus we have a higher degree of risk from a downturn in our real estate markets

A further downturn in our real estate markets could hurt our business because many of our loans are secured by real estate. Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies, and acts of nature, such as earthquakes and national disasters particular to California. Substantially all of our real estate collateral is located in California. If real estate values, including values of land held for development, continue to decline, the value of real estate collateral securing our loans could be significantly reduced. Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans. Commercial real estate loans typically involve large balances to single borrowers or group of related borrowers. Since payments on these loans are often dependent on the successful operation or management of the properties, as well as the business and financial condition of the borrower, repayment of such loans may be subject to adverse conditions in the real estate market, adverse economic conditions or changes in applicable government regulations.

Additional risks associated with our real estate construction loan portfolio include failure of developers and/or contractors to complete construction on a timely basis or at all, market deterioration during construction, cost overruns and failure to sell or lease the security underlying the construction loans so as to generate the cash flow anticipated by our borrower.

Continued declines in real estate values, coupled with the current economic downturn and an associated increase in unemployment, may result in higher than expected loan delinquencies or problem assets, a decline in demand for our products and services, or a lack of growth or decrease in deposits, which may cause us to incur losses, adversely affect our capital or hurt our business.

We are exposed to risk of environmental liabilities with respect to properties to which we take title

In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. While we will take steps to mitigate this risk, we may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean-up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, while there are certain statutory protections afforded lenders who take title to property through foreclosure on a loan, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we become subject to significant environmental liabilities, our business, financial condition, results of operations and prospects could be adversely affected.

We may experience goodwill impairment

If our estimates of segment fair value change due to changes in our businesses or other factors, we may determine that impairment charges on goodwill recorded as a result of acquisitions are necessary. Estimates of fair value are determined based on a complex model using cash flows, the fair value of our Company as determined by our stock price, and company comparisons. If management’s estimates of future cash flows are inaccurate, fair value determined could be inaccurate and impairment may not be recognized in a timely manner. If the fair value of the Company declines, we may need to recognize goodwill impairment in the future which would have a material adverse effect on our results of operations and capital levels.

Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial performance

A substantial portion of our income is derived from the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and the interest paid on deposits, borrowings and other interest-bearing liabilities. Because of the differences in the maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. At December 31, 2012 our balance sheet was slightly asset-sensitive over a one-year horizon assuming no balance sheet growth, and as a result, our net interest margin tends to expand in a rising interest rate environment and decrease in a declining interest rate environment. Accordingly, fluctuations in interest rates could adversely affect our interest rate spread and, in turn, our profitability. In addition, loan origination volumes are affected by market interest rates. Rising interest rates, generally, are associated with a lower volume of loan originations while lower interest rates are usually associated with higher loan originations. Conversely, in rising interest rate environments, loan repayment rates may decline and in falling interest rate environments, loan repayment rates may increase. In addition, in a rising interest rate environment, we may need to accelerate the pace of rate increases on our deposit accounts as compared to the pace of future increases in short-term market rates. Accordingly, changes in levels of market interest rates could materially and adversely affect our net interest spread, asset quality, as well as loan origination and prepayment volume.

 

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We are subject to extensive government regulation that could limit or restrict our activities, which, in turn, may hamper our ability to increase our assets and earnings

Our operations are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Similarly, the lending, credit and deposit products we offer, including our new residential mortgage lending operation which commenced origination activities in 2012, are subject to broad oversight and regulation. Because our business is highly regulated, the laws, rules, regulations and supervisory guidance and policies applicable to us are subject to regular modification and change. Perennially, various laws, rules and regulations are proposed, which, if adopted, could impact our operations by making compliance much more difficult or expensive, restricting our ability to originate or sell loans or further restricting the amount of interest or other charges or fees earned on loans or other products.

Additional requirements imposed by the Dodd-Frank Act could adversely affect us.

Recent government efforts to strengthen the U.S. financial system have resulted in the imposition of additional regulatory requirements, including expansive financial services regulatory reform legislation. Dodd-Frank sets out sweeping regulatory changes. Changes imposed by Dodd-Frank include, among others: (i) new requirements on banking, derivative and investment activities, including modified capital requirements, the repeal of the prohibition on the payment of interest on business demand accounts, and debit card interchange fee requirements; (ii) corporate governance and executive compensation requirements; (iii) enhanced financial institution safety and soundness regulations, including increases in assessment fees and deposit insurance coverage; and (iv) the establishment of new regulatory bodies, such as the CFPB As many provisions still await final implementing rulemaking and regulations, we cannot yet assess the full impact of Dodd-Frank on us.

Revisions to Regulation Z, which implements the Truth in Lending Act (TILA), are being made pursuant to Dodd-Frank which would apply to all consumer mortgages (except home equity lines of credit, timeshare plans, reverse mortgages, or temporary loans), mandating specific underwriting criteria for home loans and providing for various repayment options to the borrower. This may impact our underwriting of single family residential loans in our new residential mortgage lending operation and could have a resulting unknown effect on potential delinquencies. In addition, the uniformity of the requirements may make it difficult for regional and community banks to compete against the larger national banks for single family residential loan originations.

Current and future legal and regulatory requirements, restrictions and regulations, including those imposed under Dodd-Frank, may adversely impact our profitability and may have a material and adverse effect on our business, financial condition, and results of operations, may require us to invest significant management attention and resources to evaluate and make any changes required by the legislation and accompanying rules, and may make it more difficult for us to attract and retain qualified executive officers and employees.

The impact of new regulatory standards will likely impose enhanced capital adequacy requirements on us

The Federal Reserve has proposed new capital requirements on banks and bank holding companies as required by Dodd-Frank and incorporating the Basel Committee international capital, leverage and liquidity guidelines which are expected to have the effect of raising our capital requirements and imposing new capital requirements beyond those required by current law. Increased regulatory capital requirements (and the associated compliance costs), whether due to the adoption of new laws and regulations, changes in existing laws and regulations, or more expansive or aggressive interpretations of existing laws and regulations, may have a material adverse effect on our business, liquidity, financial condition and results of operations.

Failure to manage our growth may adversely affect our performance

Our financial performance and profitability depend on our ability to manage past and possible future growth. Future acquisitions and our continued growth may present operating, integration, regulatory and other issues that could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We could be liable for breaches of security in our online banking services. Fear of security breaches (including cybersecurity breaches) could limit the growth of our online services

We offer various internet-based services to our clients, including online banking services. The secure transmission of confidential information over the Internet is essential to maintain our clients’ confidence in our online services. In certain cases, we are responsible for protecting customers’ proprietary information as well as their accounts with us. We have

 

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security measures and processes in place to defend against these cybersecurity risks but these cyber attacks are rapidly evolving (including computer viruses, malicious code, phishing or other information security breaches), and we may not be able to anticipate or prevent all such attacks, which could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers’ confidential, proprietary and other information. Advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology we use to protect client transaction data. In addition, individuals may seek to intentionally disrupt our online banking services or compromise the confidentiality of customer information with criminal intent. Although we have developed systems and processes that are designed to prevent security breaches and periodically test our security, failure to protect against or mitigate breaches of security could adversely affect our ability to offer and grow our online services, constitute a breach of privacy or other laws, result in costly litigation and loss of customer relationships, negatively impact the Bank’s reputation, and could have an adverse effect on our business, results of operations and financial condition. We may also incur substantial increases in costs in an effort to minimize or mitigate cyber security risks and to respond to cyber incidents.

Our business is exposed to the risk of changes in technology

The rapid pace of technology changes and the impact of such changes on financial services generally and on our Company specifically could impact our cost structure and our competitive position with our customers. Salient although not exclusive examples of such developments are the rapid movement by customers and some competitor financial institutions to web-based services, mobile banking and cloud computing. Because of our relatively smaller size and limited resources, our Company has typically followed rather than lead such developments and applications by larger institutions and technology providers, and we are reliant on legacy systems and software that may not be as efficient or adaptable as those utilized by competitors. Our failure or inability to anticipate, plan for or implement technology change could adversely affect our competitive position, financial condition and profitability.

Our controls and procedures could fail or be circumvented

Management regularly reviews and updates our internal controls, disclosure controls and procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and on the conducts of individuals, 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. Any failure or circumvention of our controls and procedures, and any failure to comply with regulations related to controls and procedures could adversely affect our business, results of operations and financial condition.

We may engage in FDIC-assisted transactions, which could present additional risks to our business

On October 16, 2009, we acquired substantially all of the assets and assumed substantially all of the liabilities of San Joaquin Bank from the FDIC. We may have opportunities to acquire the assets and liabilities of additional failed banks in FDIC-assisted transactions. Although these FDIC-assisted transactions typically provide for FDIC assistance to an acquirer to mitigate certain risks, such as sharing exposure to loan losses and providing indemnification against certain liabilities of the failed institution, we are (and would be in future transactions) subject to many of the same risks we would face in acquiring another bank in a negotiated transaction, including risks associated with maintaining customer relationships and failure to realize the anticipated acquisition benefits in the amounts and within the timeframes we expect. In addition, because these acquisitions are structured in a manner that would not allow us the time and access to information normally associated with preparing for and evaluating a negotiated acquisition, we may face additional risks in FDIC-assisted transactions, including additional strain on management resources, management of problem loans, problems related to integration of personnel and operating systems and impact to our capital resources requiring us to raise additional capital. We cannot assure you that we will be successful in overcoming these risks or any other problems encountered in connection with FDIC-assisted transactions. Although we have entered into a loss sharing agreement with the FDIC in connection with our acquisition of loans from San Joaquin Bank, we cannot guarantee that we will be able to adequately manage the loan portfolio within the limits of the loss protections provided by the FDIC from the San Joaquin Bank acquisition or any other FDIC-assisted acquisition we may make. Our inability to overcome these risks could have a material adverse effect on our business, financial condition and net income.

Income that we recognized and continue to recognize in connection with our 2009 FDIC-assisted San Joaquin Bank acquisition may be non-recurring or finite in duration

Through the acquisition of San Joaquin Bank, we acquired approximately $673.1 million of assets and assumed $660.9 million of liabilities. The San Joaquin Bank acquisition was accounted for under the purchase method of accounting and we recorded an after-tax bargain purchase gain totaling $12.3 million as a result of the acquisition. This gain was included as a component of other operating income on our statement of earnings for 2009. The amount of the gain was equal to the amount by which the fair value of assets purchased exceeded the fair value of liabilities. The bargain purchase gain resulting from the acquisition was a one-time gain that is not expected to be repeated in future periods.

 

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Our decisions regarding the fair value of assets acquired, including FDIC loss sharing assets, could be different than initially estimated, which could materially and adversely affect our business, financial condition, results of operations, and future prospects.

We acquired significant portfolios of loans in the San Joaquin Bank acquisition and we may acquire other loan portfolios in similar acquisition scenarios. Although the San Joaquin Bank loans were marked down to their estimated fair value, there is no assurance that the acquired loans will not suffer further deterioration in value resulting in additional charge-offs. The fluctuations in national, regional and local economic conditions, including those related to local residential, commercial real estate and construction markets, may increase the level of charge-offs in the loan portfolio that we acquired from San Joaquin Bank (or that we may acquire in a similar future transaction) and correspondingly reduce our net income. These fluctuations are not predictable, cannot be controlled and may have a material adverse impact on our operations and financial condition, even if other favorable events occur.

Although we have entered into loss sharing agreements with the FDIC which provide that a significant portion of losses related to the assets acquired from San Joaquin Bank will be borne by the FDIC, we are not protected for all losses resulting from charge-offs with respect to those assets. Additionally, the loss sharing agreements have limited terms. Therefore, any additional charge-offs of related losses that we experience after the term of the loss sharing agreements will not be reimbursed by the FDIC and would negatively impact our net income.

Our ability to obtain reimbursement under the loss sharing agreement on covered assets depends on our compliance with the terms of the loss sharing agreement.

We must certify to the FDIC on a quarterly basis our compliance with the terms of the FDIC loss sharing agreement as a prerequisite to obtaining reimbursement from the FDIC for realized losses on covered assets. The required terms of the agreement are extensive and failure to comply with any of the guidelines could result in a specific asset or group of assets permanently losing their loss sharing coverage. As of December 31, 2012, $221.6 million, or 3.5%, of our assets were covered by the FDIC loss sharing agreement. No assurances can be given that we will manage the covered assets in such a way as to always maintain loss share coverage on all such assets.

We face strong competition from financial services companies and other companies that offer banking services

We conduct most of our operations in California. The banking and financial services businesses in California are highly competitive and increased competition in our primary market area may adversely impact the level of our loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. These competitors include national banks, regional banks and other community banks. We also face competition from many other types of financial institutions, including savings and loan associations, finance companies, brokerage firms, insurance companies, credit unions, mortgage companies and other financial intermediaries. In particular, our competitors include major financial companies whose greater resources may afford them a marketplace advantage by enabling them to offer products at lower costs, maintain numerous locations, and mount extensive promotional and advertising campaigns. Areas of competition include interest rates for loans and deposits, efforts to obtain loan and deposit customers and a range in quality of products and services provided, including new technology driven products and services. If we are unable to attract and retain banking customers, we may be unable to continue our loan growth and level of deposits.

We rely on communications, information, operating and financial control systems technology from third-party service providers, and we may suffer an interruption in those systems

We rely heavily on third-party service providers for much of our communications, information, operating and financial control systems technology, including our internet banking services and data processing systems. Any failure or interruption of these services or systems or breaches in security of these systems could result in failures or interruptions in our customer relationship management, the Bank’s reputation, general ledger, deposit, servicing and/or loan origination systems. The occurrence of any failures or interruptions may require us to identify alternative sources of such services, which may result in increased costs or other consequences that in turn could have an adverse effect on our business.

We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects

Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and experience in, the California community banking industry. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. In addition, legislation and regulations which impose restrictions on executive compensation may make it more difficult for us to retain and recruit key personnel. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, risk management, marketing and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly

 

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dependent upon the abilities of key executives, including our President and Chief Executive Officer, and certain other employees. In addition, our success has been and continues to be highly dependent upon the services of our directors, some of whom may be considering retirement, and we may not be able to identify and attract suitable candidates to replace such directors.

Managing reputational risk is important to attracting and maintaining customers, investors and employees

Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct or fraud, failure to deliver minimum standards of service or quality, compliance deficiencies, government investigations, litigation, and questionable or fraudulent activities of our customers. We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental scrutiny and regulation.

We are subject to legal and litigation risk, including a pending investigation by the SEC, a consolidated class action lawsuit and a similar state law derivative action which could adversely affect us.

Because our Company is extensively regulated by a variety of federal and state agencies, and because we are subject to a wide range of business and consumer laws and regulations at the federal, state and local levels, we are at risk of governmental investigations and lawsuits as well as claims and litigation from private parties. We are from time to time involved in disputes with and claims from customers, vendors, employees and other business parties, and such disputes and claims may result in litigation or settlements, any one of which or in the aggregate could have an adverse impact on the Company’s operating flexibility, employee relations, financial condition or results of operations, as a result of the costs of any judgment, the terms of any settlement and/or the expenses incurred in defending the applicable claim.

We are subject to an investigation by the SEC. In addition, two federal securities class action lawsuits, which have been consolidated, were filed against us and certain of our officers, and a state law derivative action was filed in the name of the Company against our directors. Although the consolidated federal action complaint and a first amended complaint were each dismissed by the federal district court in January and August, respectively, of 2012, the plaintiffs were given leave by the court to file a second amended complaint, which the plaintiffs filed in September, 2012.

We are unable, at this time, to estimate our potential liability in these matters, but we may be required to pay judgments, settlements or other penalties and incur other costs and expenses in connection with the SEC investigation and the consolidated federal lawsuit and the state law derivative action, which could have a material adverse effect on our business, results of operations and financial condition. In addition, responding to requests for information in the SEC investigation and the federal and state lawsuits may divert internal resources away from managing our business. See “Legal Proceedings”

Federal and state laws and regulations may restrict our ability to pay dividends

The ability of the Bank to pay dividends to the Company and of the Company to pay dividends to its shareholders is limited by applicable federal and California law and regulations. See “Business — Regulation and Supervision” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Cash Flow.”

The price of our common stock may be volatile or may decline

The trading price of our common stock may fluctuate widely as a result of a number of factors, many of which are outside our control. In addition, the stock market is subject to fluctuations in its share prices and trading volumes that affect the market prices of the shares of many companies. These specific and broad market fluctuations could adversely affect the market price of our common stock. Among the factors that could affect our stock price are:

 

   

actual or anticipated quarterly fluctuations in our operating results and financial condition;

 

   

changes in revenue or earnings estimates or publication of research reports and recommendations by financial analysts;

 

   

credit events or losses;

 

   

failure to meet analysts’ revenue or earnings estimates;

 

   

speculation in the press or investment community;

 

   

strategic actions by us or our competitors, such as acquisitions or restructurings;

 

   

actions or trades by institutional shareholders or other large shareholders;

 

   

fluctuations in the stock price and operating results of our competitors;

 

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actions by hedge funds, short term investors, activist shareholders or shareholder representative organizations;

 

   

general market conditions and, in particular, developments related to market conditions for the financial services industry;

 

   

proposed or adopted regulatory changes or developments;

 

   

anticipated or pending investigations, proceedings or litigation that involve or affect the Company and/or the Bank; or

 

   

domestic and international economic factors unrelated to the Company’s performance.

The stock market and, in particular, the market for financial institution stocks, has experienced significant volatility in recent years. The market price of our common stock and the trading volume in our common stock may fluctuate and cause significant price variations to occur. The trading price of the shares of our common stock and the value of our other securities will depend on many factors, which may change from time to time, including, without limitation, our financial condition, performance, creditworthiness and prospects, future sales of our equity or equity related securities, and other factors identified above in “Cautionary Note Regarding Forward-Looking Statement”. The capital and credit markets have been experiencing volatility and disruption for more than four years. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. A significant decline in our stock price could result in substantial losses for individual shareholders and could lead to costly and disruptive securities litigation. Extensive sales by large shareholders could also exert sustained downward pressure on our stock price.

Anti-takeover provisions and federal law may limit the ability of another party to acquire us, which could cause our stock price to decline

Various provisions of our articles of incorporation and by-laws and certain other actions we have taken could delay or prevent a third-party from acquiring us, even if doing so might be beneficial to our shareholders. The Bank Holding Company Act of 1956, as amended, and the Change in Bank Control Act of 1978, as amended, together with federal regulations, require that, depending on the particular circumstances, either Federal Reserve approval must be obtained or notice must be furnished to the Federal Reserve and not disapproved prior to any person or entity acquiring “control” of a state member bank, such as the Bank. These provisions may prevent a merger or acquisition that would be attractive to shareholders and could limit the price investors would be willing to pay in the future for our common stock.

Changes in stock market prices could reduce fee income from our brokerage, asset management and investment advisory businesses

We earn substantial wealth management fee income for managing assets for our clients and also providing brokerage and investment advisory services. Because investment management and advisory fees are often based on the value of assets under management, a fall in the market prices of those assets could reduce our fee income. Changes in stock market prices could affect the trading activity of investors, reducing commissions and other fees we earn from our brokerage business.

We may face other risks

From time to time, we detail other risks with respect to our business and/or financial results in our filings with the SEC.

For further discussion on additional areas of risk, see “Item 7. Management’s Discussion and Analysis of Financial Condition and the Results of Operations — Risk Management.”

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None

 

ITEM 2. PROPERTIES

The principal executive offices of the Company and the Bank are located in Ontario, California, and are owned by the Company.

As of December 31, 2012, the Bank occupied a total of 49 premises consisting of (i) 46 Business Financial and Commercial Banking Centers (“Centers”) of which two Centers are located at our Corporate Headquarters, (ii) a Corporate Headquarters and two operations/administrative centers, and (iii) a storage facility. We own 11 of these locations and the remaining properties are leased under various agreements with expiration dates ranging from 2013 through 2020, some with lease renewal options that could extend certain leases through 2034. All properties are located in Southern and Central California.

 

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As of December 31, 2012, our consolidated investment in premises and equipment, net of accumulated depreciation and amortization totaled $35.1 million. Our total occupancy expense, exclusive of furniture and equipment expense, for the year ended December 31, 2012, was $10.8 million. We believe that our existing facilities are adequate for our present purposes. The Company believes that if necessary, it could secure suitable alternative facilities on similar terms without adversely affecting operations. For additional information concerning properties, see Note 9 of the Notes to the Consolidated Financial Statements included in this report. See “Item 8. Financial Statements and Supplemental Data.”

 

ITEM 3. LEGAL PROCEEDINGS

Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against us or our affiliates. Where appropriate, we establish reserves in accordance with FASB guidance over contingencies (ASC 450). The outcome of litigation and other legal and regulatory matters is inherently uncertain, however, and it is possible that one or more of the legal or regulatory matters currently pending or threatened could have a material adverse effect on our liquidity, consolidated financial position, and/or results of operations. As of December 31, 2012, the Company does not have any litigation reserves.

In addition, the Company is involved in the following significant legal actions and complaints.

On July 26, 2010, we received a subpoena from the Los Angeles office of the SEC regarding the Company’s allowance for credit loss methodology, loan underwriting guidelines, methodology for grading loans, and the process for making provisions for loan losses. In addition, the subpoena requested information regarding certain presentations Company officers have given or conferences Company officers have attended with analysts, brokers, investors or prospective investors. We have fully cooperated with the SEC in its investigation, and we will continue to do so to the extent any further information is requested. We cannot predict the timing or outcome of the investigation.

In the wake of the Company’s disclosure of the SEC investigation, on August 23, 2010, a purported shareholder class action complaint was filed against the Company in an action captioned Lloyd v. CVB Financial Corp., et al., Case No. CV 10-06256-MMM, in the United States District Court for the Central District of California. Along with the Company, Christopher D. Myers (President and Chief Executive Officer) and Edward J. Biebrich, Jr. (our former Chief Financial Officer) were also named as defendants. On September 14, 2010, a second purported shareholder class action complaint was filed against the Company in an action originally captioned Englund v. CVB Financial Corp., et al., Case No. CV 10-06815-RGK, in the United States District Court for the Central District of California. The Englund complaint named the same defendants as the Lloyd complaint and made allegations substantially similar to those included in the Lloyd complaint. On January 21, 2011, the Court consolidated the two actions for all purposes under the Lloyd action now captioned as Case No. CV 10-06256-MMM (PJWx). That same day, the Court also appointed the Jacksonville Police and Fire Pension Fund (the “Jacksonville Fund”) as lead plaintiff in the consolidated action and approved the Jacksonville Fund’s selection of lead counsel for the plaintiffs in the consolidated action. On March 7, 2011, the Jacksonville Fund filed a consolidated complaint naming the same defendants and alleging violations by all defendants of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and violations by the individual defendants of Section 20(a) of the Exchange Act. Specifically, the complaint alleges that defendants misrepresented and failed to disclose conditions adversely affecting the Company throughout the purported class period, which is alleged to be between October 21, 2009 and August 9, 2010. The consolidated complaint seeks compensatory damages and other relief in favor of the purported class.

Following the filing by each side of various motions and memoranda and a hearing on August 29, 2011, the District Court issued a ruling on January 12, 2012, granting defendants’ motion to dismiss the consolidated complaint, but the ruling provided the plaintiffs with leave to file an amended complaint within 45 days of the date of the order. On February 27, 2012, the plaintiffs filed a first amended complaint against the same defendants, and once again, following filings by both sides and another hearing on June 4, 2012, the District Court issued a ruling on August 21, 2012, granting defendants’ motion to dismiss the first amended complaint, but providing the plaintiffs with leave to file another amended complaint within 30 days of the ruling. On September 20, 2012, the plaintiffs filed a second amended complaint against the same defendants, and the Company filed its third motion to dismiss on October 25, 2012. The District Court has taken the Company’s third motion to dismiss under submission, and the Company intends to continue to vigorously contest the plaintiff’s allegations in this case.

On February 28, 2011, a purported and related shareholder derivative complaint was filed in an action captioned Sanderson v. Borba, et al., Case No. CIVRS1102119, in California State Superior Court in San Bernardino County. The complaint names as defendants the members of our board of directors and also refers to unnamed defendants allegedly responsible for the conduct alleged. The Company is included as a nominal defendant. The complaint alleges breaches of fiduciary duties, abuse of control, gross mismanagement and corporate waste. Specifically, the complaint alleges, among other things, that defendants engaged in accounting manipulations in order to falsely portray the Company’s financial results in connection with its commercial real estate portfolio. Plaintiff seeks compensatory and exemplary damages to be paid by the defendants and awarded to the Company, as well as other relief. On June 20, 2011, defendants filed a demurrer requesting dismissal of the derivative complaint. Following the filing by each side of additional motions, the parties have subsequently filed repeated notices to postpone the Court’s hearing on the defendants’ demurrer, pending resolution of the federal securities shareholder class action complaint, and these postponements are currently extended to at least September 11, 2013.

 

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Because the outcome of these proceedings is uncertain, we cannot predict any range of loss or even if any loss is probable related to the actions described above.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the NASDAQ Global Select National Market under the symbol “CVBF.” The following table presents the high and low sales prices and dividend information for our common stock during each quarter for the past two years. The Company had approximately 1,673 shareholders of record as of February 15, 2013.

 

Quarter
Ended

   High      Low      Cash Dividends
Declared
 
12/31/2012    $ 12.17       $ 9.43       $ 0.085   
9/30/2012    $ 12.95       $ 11.35       $ 0.085   
6/30/2012    $ 11.92       $ 10.16       $ 0.085   
3/31/2012    $ 11.97       $ 9.99       $ 0.085   
12/31/2011    $ 10.27       $ 7.28       $ 0.085   
9/30/2011    $ 10.00       $ 7.41       $ 0.085   
6/30/2011    $ 9.94       $ 8.18       $ 0.085   
3/31/2011    $ 9.32       $ 7.83       $ 0.085   

For information on the statutory and regulatory limitations on the ability of the Company to pay dividends to its shareholders and on the Bank to pay dividends to the Company, see “Item 1. Business-Regulation and Supervision — Dividends” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Cash Flow.”

Issuer Purchases of Equity Securities

On July 16, 2008, our Board of Directors approved a program to repurchase up to 10,000,000 shares of our common stock(such number will not be adjusted for stock splits, stock dividends, and the like) 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 our current stock repurchase program. There were no issuer repurchases of the Company’s common stock as part of its repurchase program in the fourth quarter of the year ended December 31, 2012. As of December 31, 2012, there were 7,765,171 shares remaining to be purchased.

Performance Graph

The following Performance Graph and related information shall not be deemed “soliciting material” or be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing.

The following graph compares the yearly percentage change in CVB Financial Corp.’s cumulative total shareholder return (stock price appreciation plus reinvested dividends) on common stock (i) the cumulative total return of the Nasdaq Composite Index; and (ii) a published index comprised by Morningstar (formerly Hemscott, Inc.) of banks and bank holding companies in the Pacific region (the industry group line depicted below). The graph assumes an initial investment of $100 on January 1, 2008, and reinvestment of dividends through December 31, 2012. Points on the graph represent the performance as of the last business day of each of the years indicated. The graph is not necessarily indicative of future price performance.

 

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LOGO

COMPARISON OF CUMULATIVE TOTAL RETURN

(PERFORMANCE GRAPH)

ASSUMES $100 INVESTED ON JANUARY 1, 2008

ASSUMES DIVIDEND REINVESTED

FISCAL YEAR ENDING DECEMBER 31, 2012

 

Company/Market/Peer Group

   12/31/2007      12/31/2008      12/31/2009      12/31/2010      12/31/2011      12/31/2012  

CVB Financial Corp.

   $ 100.00       $ 119.68       $ 91.16       $ 95.00       $ 113.41       $ 122.17   

NASDAQ Composite

   $ 100.00       $ 59.03       $ 82.25       $ 97.32       $ 98.63       $ 110.78   

Peer Group Index

   $ 100.00       $ 75.06       $ 61.90       $ 76.64       $ 67.52       $ 81.00   

 

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ITEM 6. SELECTED FINANCIAL DATA

The following table reflects selected financial information at and for the five years ended December 31. Throughout the past five years, the Company has acquired other banks. This may affect the comparability of the data.

 

     At or For the Year Ended December 31,  
     2012     2011     2010     2009     2008  
     (Dollars in thousands, except per share amounts and percentages)  

Interest income

   $ 262,222      $ 269,720      $ 317,289      $ 310,759      $ 332,518   

Interest expense

     25,272        35,039        57,972        88,495        138,839   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     236,950        234,681        259,317        222,264        193,679   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for credit losses

     —          7,068        61,200        80,500        26,600   

Noninterest income

     15,903        34,216        57,114        81,071        34,457   

Noninterest expense

     138,160        141,025        168,492        133,586        115,788   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings before income taxes

     114,693        120,804        86,739        89,249        85,748   

Income taxes

     37,413        39,071        23,804        23,830        22,675   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS

   $ 77,280      $ 81,733      $ 62,935      $ 65,419      $ 63,073   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share

   $ 0.74      $ 0.77      $ 0.59      $ 0.56      $ 0.75   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.74      $ 0.77      $ 0.59      $ 0.56      $ 0.75   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends declared per common share

   $ 0.34      $ 0.34      $ 0.34      $ 0.34      $ 0.34   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends declared on common shares

   $ 35,642      $ 35,805      $ 36,103      $ 32,228      $ 28,317   

Dividend pay-out ratio (2)

     46.12     43.81     57.37     49.26     44.90

Weighted average common shares:

          

Basic

     104,418,905        105,142,650        105,879,779        92,955,172        83,120,817   

Diluted

     104,657,610        105,222,566        106,125,761        93,055,801        83,335,503   

Common Stock Data:

          

Common shares outstanding at year end

     104,889,586        104,482,271        106,075,576        106,263,511        83,270,263   

Book value per share

   $ 7.28      $ 6.84      $ 6.07      $ 6.01      $ 5.92   

Financial Position:

          

Assets

   $ 6,363,364      $ 6,482,915      $ 6,436,691      $ 6,739,769      $ 6,649,651   

Investment securities available-for-sale

     2,449,387        2,201,526        1,791,558        2,108,463        2,493,476   

Net non-covered loans

     3,159,872        3,125,763        3,268,469        3,499,455        3,682,878   

Net covered loans (5)

     195,215        256,869        374,012        470,634        —     

Deposits

     4,773,987        4,604,548        4,518,828        4,438,654        3,508,156   

Borrowings

     698,178        958,032        1,095,578        1,488,250        2,345,473   

Junior subordinated debentures

     67,012        115,055        115,055        115,055        115,055   

Stockholders’ equity

     762,970        714,814        643,855        638,228        614,892   

Equity-to-assets ratio (1)

     11.99     11.03     10.00     9.47     9.25

Financial Performance:

          

Net income to beginning equity

     10.81     12.69     9.77     10.64     14.84

Net income to average equity (ROE)

     10.31     12.00     9.40     10.00     13.75

Net income to average assets (ROA)

     1.19     1.26     0.93     0.98     0.99

Net interest margin (TE) (3)

     4.06     4.04     4.28     3.72     3.41

Efficiency ratio (4)

     54.64     52.45     53.25     44.04     50.75

Credit Quality (Non-covered Loans):

          

Allowance for credit losses

   $ 92,441      $ 93,964      $ 105,259      $ 108,924      $ 53,960   

Allowance/gross non-covered loans

     2.84     2.92     3.12     3.02     1.44

Total non-covered nonaccrual loans

   $ 57,997      $ 62,672      $ 157,020      $ 69,779      $ 17,684   

Non-covered nonaccrual loans/gross non-covered loans

     1.78     1.95     4.65     1.93     0.47

Allowance/non-covered nonaccrual loans

     159.39     149.93     67.04     156.10     305.13

Charge-offs, net of recoveries

   $ 1,523      $ 18,363      $ 64,865      $ 25,536      $ 5,689   

Charge-offs, net of recoveries/average non-covered loans

     0.05     0.57     1.86     0.68     0.16

Regulatory Capital Ratios

          

For the Company:

          

Leverage ratio

     11.50     11.19     10.58     9.63     9.84

Tier 1 capital

     18.23     17.79     16.61     15.06     14.18

Total capital

     19.49     19.05     18.00     14.45     15.54

For the Bank:

          

Leverage ratio

     11.21     10.92     10.54     9.58     9.65

Tier 1 capital

     17.77     17.36     16.55     14.99     13.93

Total capital

     19.03     18.63     17.82     16.26     15.19

 

(1) Stockholders’ equity divided by total assets.
(2) Dividends declared on common stock divided by net earnings.
(3) Net interest income (TE) divided by total average earning assets.
(4) Noninterest expense divided by net interest income before provision for credit losses plus noninterest income. Please also refer to “noninterest expense and efficiency ratio reconciliation (non-GAAP)” on page 31 of this Form 10-K.
(5) Covered loans are those loans acquired from SJB and covered by a loss sharing agreement with the FDIC.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS

GENERAL

Management’s discussion and analysis is written to provide greater detail of the results of operations and the financial condition of CVB Financial Corp. and its subsidiaries. This analysis should be read in conjunction with the audited financial statements contained within this report including the notes thereto.

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.

Allowance for Credit Losses: Arriving at an appropriate level of allowance for credit losses involves a high degree of judgment. Our allowance for credit losses provides for probable losses based upon evaluations of known and inherent risks in the loan and lease portfolio. The determination of the balance in the allowance for credit losses is based on an analysis of the loan and lease finance receivables portfolio using a systematic methodology and reflects an amount that, in our judgment, is appropriate to provide for probable credit losses inherent in the portfolio, after giving consideration to the character of the loan portfolio, current economic conditions, past credit loss experience, and such other factors as deserve current recognition in estimating inherent credit losses. The provision for credit losses is charged to expense. 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 Notes 3 and 6 of our Consolidated Financial Statements presented elsewhere in this report.

Investment Securities: The investment portfolio is an integral part of our financial performance. Accounting estimates are used in the presentation of the investment portfolio and these estimates do impact the presentation of our financial condition and results of operations.

We classify as held-to-maturity securities those debt securities that we have the positive intent and ability to hold to maturity. Securities classified as trading are those securities that are bought and held principally for the purpose of selling them in the near term. All other debt and equity securities are classified as available-for-sale. Securities held-to-maturity are accounted for at cost and adjusted for amortization of premiums and accretion of discounts. Trading securities are accounted for at fair value with the unrealized gains and losses being included in current earnings. Available-for-sale securities are accounted for at fair value, with the net unrealized gains and losses, net of income tax effects, presented as a separate component of stockholders’ equity. Realized gains and losses on sales of securities are recognized in earnings at the time of sale. Purchase premiums and discounts are recognized in interest income using the effective-yield method over the terms of the securities. For mortgage-backed securities (“MBS”), the amortization or accretion is based on estimated average lives of the securities. The lives of these securities can fluctuate based on the amount of prepayments received on the underlying collateral of the securities. Our investment in FHLB stock is carried at cost. The classification and accounting for investment securities are discussed in detail in Note 5, “Investment Securities,” of the Consolidated Financial Statements presented elsewhere in this report.

The fair values of investment securities are generally determined by reference to an independent external pricing service provider who has experience in valuing these securities. In obtaining such valuation information from third parties, management has evaluated the methodologies used to develop the resulting fair values. Management performs an analysis on the broker quotes received from third parties at least quarterly to ensure that the prices represent a reasonable estimate of the fair value. The procedures include, but are not limited to, initial and on-going review of third party pricing methodologies, review of pricing trends, and monitoring of trading volumes. Prices from third party pricing services are often unavailable for securities that are rarely traded or are traded only in privately negotiated transactions. As a result, certain securities are priced via independent broker quotations, which utilize inputs that may be difficult to corroborate with observable market based data. Additionally, the majority of these independent broker quotations are non-binding.

 

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At each reporting date, securities are assessed to determine whether there is an other-than-temporary impairment (“OTTI”). Such impairment, if any, is required to be recognized in earnings. The determination of other-than-temporary impairment is a subjective process, requiring the use of judgment and assumptions. We examine all individual securities that are in an unrealized loss position at each reporting date for other-than-temporary impairment. Specific investment-related factors that we examine to assess impairment include the nature of the investment, severity and duration of the loss, the probability that we will be unable to collect all amounts due, an analysis of the issuers of the securities, and whether there has been any cause for default on the securities and any change in the rating of the securities by the various rating agencies. Additionally, we evaluate whether the creditworthiness of the issuer calls the realization of contractual cash flows into question. We reexamine the financial resources, intent and the overall ability of the Company to hold the securities until their fair values recover. Management does not believe that there are any investment securities, other than those identified in the current and previous periods, which are deemed to be “other-than-temporarily” impaired as of December 31, 2012.

Income Taxes: We account for income taxes using the asset and liability method by deferring income taxes based on estimated future tax effects of differences between the tax and book basis of assets and liabilities considering the provisions of enacted tax laws. These differences result in deferred tax assets and liabilities, which are included in our balance sheets. We must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and establish a valuation allowance for those assets determined to not likely be recoverable. Our judgment is required in determining the amount and timing of recognition of the resulting deferred tax assets and liabilities, including projections of future taxable income. Although we have determined a valuation allowance is not required for any of our deferred tax assets, there is no guarantee that these assets are recoverable.

Goodwill and Goodwill Impairment: We have acquired entire banks and branches of banks. Those acquisitions accounted for under the purchase method of accounting have given rise to goodwill and intangible assets. ASC Topic 805 (previously SFAS No. 141), Business Combinations, requires an entity to record the assets acquired and liabilities assumed at their fair value as of the acquisition date. These fair values are determined by use of internal and external valuation techniques. The excess purchase price is allocated to assets and liabilities respectively, resulting in identified intangibles. The identified intangible assets and liabilities are amortized over the estimated lives of the assets or liabilities. Any excess purchase price after this allocation results in goodwill.

Under ASC 350 (previously SFAS No. 142, Goodwill and Other Intangibles), goodwill must be allocated to reporting units and tested for impairment. The Company tests goodwill for impairment at least annually, or more frequently if events or circumstances, such as adverse changes in the business, indicate that there may be justification for conducting an interim test. Impairment testing is performed at the reporting-unit level (which is the same level as the Company’s two major operating segments identified in Note 22 of the Company’s consolidated financial statements presented elsewhere in this report). Under the market approach utilized, the fair value is calculated using the current fair values of comparable peer banks of similar size, geographic footprint and focus. The market capitalization and multiple was used to calculate the market price of the Company and each reporting unit. The fair value was also subject to a control premium adjustment, which is the cost savings that a purchase of the reporting unit could achieve by eliminating duplicative costs. If the fair value is less than the carrying value, then the second part of the test is needed to measure the amount of goodwill impairment. The implied fair value of the reporting unit goodwill is calculated and compared to the actual carrying value of goodwill allocated to the reporting unit. If the carrying value of reporting unit goodwill exceeds the implied fair value of that goodwill, then the Company would recognize an impairment loss for the amount of the difference, which would be recorded as a charge against net income. There was no recorded impairment as of December 31, 2012.

Acquired Loans: Acquired loans are valued as of the acquisition date in accordance with ASC 805 Business Combinations (formerly FAS 141R Business Combinations). Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (formerly SOP 03-3 Accounting for Certain Loans or Debt Securities Acquired in a Transfer). Further, the Company elected to account for all other acquired loans within the scope of ASC 310-30 using the same methodology.

Under ASC 805 and ASC 310-30, loans are recorded at fair value at the acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses is not carried over or recorded as of the acquisition date. In situations where loans have similar risk characteristics, loans were aggregated into pools to estimate cash flows under ASC 310-30. A pool is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation. The Company aggregated non-distressed loans acquired in the FDIC-assisted acquisition of San Joaquin Bank in ten different pools, based on common risk characteristics.

Under ASC 310-30, the excess of the expected cash flows at the acquisition over the fair value is considered to be the accretable yield and is recognized as interest income over the life of the loan or pool. The excess of the contractual cash flows over the expected cash flows is considered to be the nonaccretable difference. Subsequent to the acquisition date, any increases in cash flow over those expected at the acquisition date in excess of fair value are recorded as an adjustment to the

 

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accretable yield on a prospective basis. Any subsequent decreases in cash flow over those expected at the acquisition date are recognized by recording an allowance for credit losses. Any disposals of loans, including sales of loans, payments in full or foreclosures result in the removal of the loan from the ASC 310-30 portfolio at the allocated carrying amount.

Covered Loans: We refer to “covered loans” as those loans that we acquired in the SJB acquisition for which we will be reimbursed for a substantial portion of any future losses under the terms of the FDIC loss sharing agreement. The majority of the loans acquired in the FDIC-assisted acquisition of SJB are included in a FDIC shared-loss agreement. Covered loans are reported exclusive of the expected cash flow reimbursements expected from the FDIC. At the date of acquisition, all covered loans were accounted for under ASC 805 and ASC 310-30. Subsequent to acquisition all covered loans are accounted for under ASC 310-30.

Covered Other Real Estate Owned: All other real estate owned acquired in the FDIC-assisted acquisition of SJB are included in a FDIC shared-loss agreement and are referred to as covered other real estate owned. Covered other real estate owned is reported exclusive of expected reimbursement cash flows from the FDIC. Fair value adjustments on covered other real estate owned result in a reduction of the covered other real estate carrying amount with the estimated net loss charged against earnings and a corresponding increase in the estimated FDIC loss sharing asset based on the appropriate loss-sharing percentage.

FDIC Loss Sharing Asset: In conjunction with the FDIC-assisted acquisition of SJB, the Company entered into a shared-loss agreement with the FDIC for amounts receivable under the shared-loss agreement. At the date of the acquisition the Company elected to account for amounts receivable under the shared-loss agreement as a loss sharing asset in accordance with ASC 805. Subsequent to the acquisition, the loss sharing asset is adjusted for payments received and changes in estimates of expected losses and is not being accounted for under fair value. The loss estimates used in calculating the FDIC loss sharing asset are determined on the same basis as the related covered loans and is the present value of the cash flows the Company expects to collect from the FDIC under the shared-loss agreement. The difference between the present value and the undiscounted cash flow the Company expects to collect from the FDIC is accreted or amortized into noninterest income over the life of the FDIC indemnification asset. The FDIC indemnification asset is adjusted for any changes in expected cash flows based on the loan performance. Any increases in cash flow of the loans over those expected will reduce the FDIC indemnification asset and any decreases in cash flow of the loans over those expected will increase the FDIC indemnification asset. Increases and decreases to the FDIC indemnification asset are recorded as adjustments to noninterest income.

Non-Covered Other Real Estate Owned: Other real estate owned (“OREO”) represents properties acquired through foreclosure or through full or partial satisfaction of loans, is considered held-for-sale, and is recorded at the lower of cost or estimated fair value at the time of foreclosure. Loan balances in excess of fair value of the real estate acquired at the date of foreclosure are charged against the allowance for credit losses. After foreclosure, valuations are periodically performed as deemed necessary by management and the real estate is carried at the lower of carrying value or fair value less costs to sell. Subsequent declines in the fair value of the OREO below the carrying value are written down to fair value with a direct charge to noninterest expense. Any subsequent operating expenses or income of such properties are charged to noninterest expense or income, respectively. Revenue recognition upon disposition of a property is dependent on the sale having met certain criteria relating to the buyer’s initial investment in the property sold.

We are able and willing to provide financing for entities purchasing loans or OREO assets. Our general guideline is to seek an adequate down payment (as a percentage of the purchase price) from the buyer. We will consider lower down payments when this is not possible; however, accounting rules require certain minimum down payments in order to record the profit on sale, if any. The minimum down payment varies by the type of underlying real estate collateral.

Fair Value of Financial Instruments: We use fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. Investment securities available-for-sale and interest-rate swaps are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a non-recurring basis, such as impaired loans and OREO. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets. Further, we include in Note 21 to the consolidated financial statements information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used and its impact to earnings. Additionally, for financial instruments not recorded at fair value we disclose the estimate of their fair value.

Stock-based Compensation: Consistent with the provisions of ASC 718, Stock Compensation, we recognize expense for the grant date fair value of stock options and restricted shares issued to employees, officers and non-employee directors over the their requisite service periods (generally the vesting period). The service periods may be subject to performance conditions.

At December 31, 2012, the Company has three stock-based employee compensation plans. The Company accounts for stock compensation using the “modified prospective” method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are measured at fair value as of the grant date with compensation costs recognized over the vesting period on a straight-lined basis. Also under this method, unvested stock awards as of January 1, 2006 are recognized over the remaining service period with no change in historical reported earnings.

 

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The fair value of each stock option grant is estimated as of the grant date using the Black-Scholes option-pricing model. Management assumptions used at the time of grant impact the fair value of the option calculated under the Black-Scholes option-pricing model, and ultimately, the expense that will be recognized over the life of the option.

The grant date fair value of restricted stock awards is measured at the fair value of the Company’s common stock as if the restricted shares were vested and issued on the date of grant.

Additional information is included in Note 19, “Stock Option Plans and Restricted Stock Awards,” of the Consolidated Financial Statements included herein.

OVERVIEW

For the year ended December 31, 2012, we reported net earnings of $77.3 million, compared with $81.7 million for 2011, a decrease of $4.4 million, or 5.45%. Diluted earnings per share were $0.74 per share for the year ended December 31, 2012, a decrease from $0.77 per share for 2011. This decrease was due to the $20.4 million in pre-tax debt termination expense, which represents the present value of future interest payments and lender hedge termination fees, resulting from the repayment of $250.0 million of fixed rate loans to the Federal Home Loan Bank (“FHLB”). The terminated FHLB loans carried an average coupon rate of 3.39% and a weighted average remaining life of 2.6 years. The Company also elected to redeem $48.0 million in junior subordinated debentures during 2012 bearing interest at 2.85% to 3.25% above the 90-day LIBOR. These repayments were made to reduce future interest expense.

Net income for the year ended December 31, 2012 produced a return on beginning equity of 10.81%, a return on average equity of 10.31% and a return on average assets of 1.19%. The efficiency ratio for 2012 was 54.64% (46.58% excluding the FHLB debt termination), compared to 52.45% (51.21% excluding the prior year FHLB debt termination) for 2011.

Net interest income, before provision for credit losses of $237.0 million for the year ended December 31,2012 increased $2.3 million, or 0.97%, compared to $234.7 million for 2011. Excluding the impact of the yield adjustment on covered loans, tax equivalent (TE) net interest margin was 3.66% for 2012, compared with 3.78% for 2011. Total cost of funds decreased to 0.44% for 2012 from 0.60% for 2011.

Noninterest income was $15.9 million for 2012, compared with $34.2 million for 2011. Noninterest income for 2012 was reduced by a $21.9 million net decrease in the FDIC loss sharing asset, compared to an increase of $171,000 for 2011.

As a percentage of average assets, noninterest expense was 2.13% for the year ended December 31, 2012, compared to 2.17% for 2011. If the FHLB debt termination expense of $20.4 million and $3.3 million for 2012 and 2011, respectively, are eliminated from this calculation, non-interest expense was 1.82% for 2012 and 2.12% for 2011. In terms of dollars, this represents a year-over-year decrease of $19.9 million. The decrease was primarily attributable to decreases of $7.5 million in legal expenses, $4.6 million in OREO related expenses, $1.5 million in salaries and related expenses, $1.4 million in regulatory assessments, $1.3 million in other professional expenses, and $1.3 million in amortization of intangible assets.

Total assets of $6.36 billion at December 31, 2012 decreased $119.6 million, or 1.84%, from total assets of $6.48 billion at December 31, 2011. Earning assets totaled $6.04 billion at December 31, 2012, a decrease of $92.4 million, or 1.51%, when compared with earning assets of $6.13 billion at December 31, 2011. The decrease in earning assets was primarily due to a decrease in interest-earning cash as a result of prepaying $250.0 million of FHLB Advances and $48.0 million of Trust Preferred Securities and a $35.1 million decrease in loans, partially offset by a $247.5 million increase in investment securities.

Investment securities totaled $2.45 billion at December 31, 2012, up from $2.20 billion at December 31, 2011. As of December 31, 2012, we had a pretax unrealized gain of $74.6 million of which $41.7 million is attributed to our municipal securities portfolio and $32.9 million is attributed to the remainder of the portfolio which is predominantly our mortgage-backed securities (“MBS”) portfolio.

For the year ended December 31 2012, we purchased $546.1 million of MBS with an average yield of 1.79%, $23.1 million of municipal securities with an average tax-equivalent yield of 3.42%, $166.3 million of SBA Pools with an average yield of 1.79% percent, and $176.5 million of callable Agencies with an average yield of 1.74%.

 

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Total loans and leases, net of deferred fees and discount of $3.45 billion at December 31, 2012 decreased by $35.1million, or 1.01%, from $3.48 billion at December 31, 2011. Non-covered loans grew by $32.2 million, while total covered loans declined by $67.3 million. Non-covered commercial real estate loans totaled $1.99 billion at December 31, 2012, an increase of $41.8 million when compared with December 31, 2011. The market remains very competitive for new loan originations for both commercial real estate and commercial and industrial loans. We continue to focus our sales efforts on these two key areas but continue to remain cautious in terms of credit quality.

We continue to grow our noninterest bearing deposits. As of December 31, 2012, our noninterest bearing deposits grew to $2.42 billion, an increase of $393.1 million, or 19.39%, compared to $2.03 billion at December 31, 2011. At December 31, 2012, noninterest bearing deposits were 50.71% of total deposits, up from 44.04% at December 31, 2011. Our total cost of deposits for the year ended December 31, 2012 were 13 basis points, compared to 19 basis points for 2011.

Our capital ratios are well-above regulatory standards. As of December 31, 2012, our Tier 1 leverage capital ratio totaled 11.50%, our Tier 1 risk-based capital ratio totaled 18.23% and our total risk-based capital ratio totaled 19.49%.

Total equity increased $48.2 million, or 6.74%, to $763.0 million at December 31, 2012, compared with total equity of $714.8 million at December 31, 2011.

 

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ANALYSIS OF THE RESULTS OF OPERATIONS

Financial Performance

 

     For the Year Ended December 31,  
     2012     2011     2010  
     (Dollars in thousands, except per share amounts)  

Net earnings

   $ 77,280      $ 81,733      $ 62,935   

Earnings per common share:

      

Basic (1)

   $ 0.74      $ 0.77      $ 0.59   

Diluted (1)

   $ 0.74      $ 0.77      $ 0.59   

Return on average assets

     1.19     1.26     0.93

Return on average shareholders’ equity

     10.31     12.00     9.40

Noninterest Expense and Efficiency Ratio Reconciliation (Non-GAAP)

We use certain non-GAAP financial measures to provide supplemental information regarding our performance. Noninterest expense for the year ended December 31, 2012, includes a debt termination expense of $20.4 million. We believe that presenting the efficiency ratio, and the ratio of noninterest expense to average assets, excluding the impact of debt termination expense and related net interest expense savings, provides additional clarity to the users of financial statements regarding core financial performance.

 

     For the Year Ended December 31,  
     2012     2011     2010  

Net interest income

   $ 236,950      $ 234,681      $ 259,317   

Noninterest income

   $ 15,903      $ 34,216      $ 57,114   

Noninterest expense

   $ 138,160      $ 141,025      $ 168,492   

Less: Termination expense on borrowings

     (20,379     (3,310     (18,663
  

 

 

   

 

 

   

 

 

 

Adjusted noninterest expense

   $ 117,781      $ 137,715      $ 149,829   
  

 

 

   

 

 

   

 

 

 

Efficiency ratio

     54.64     52.45     53.25

Adjusted efficiency ratio

     46.58     51.21     47.35

Adjusted noninterest expense

   $ 117,781      $ 137,715      $ 149,829   

Average assets

   $ 6,485,942      $ 6,505,508      $ 6,771,817   

Adjusted noninterest expense to average assets

     1.82     2.12     2.21

Income and Expense Related to Covered Assets

The following table summarizes the components of income and expense related to covered assets excluding normal accretion of interest income on covered loans for 2012, 2011 and 2010:

 

     For the Year Ended December 31,  
     2012     2011     2010  
     (Dollars in thousands)  

Interest income-accelerated accretion

   $ 22,607      $ 12,586      $ 26,740   

Other income-increase/(decrease) in FDIC loss share asset

     (21,916     171        (15,856

Other income-gain/(loss) on sale of OREO

     996        446        (916

Other Income-gain on sale (loss) of loans held-for-sale

     815        —          —     

Expenses-legal and professional

     (1,358     (2,011     (1,912

Expenses-OREO write-down

     (586     (4,484     (1,917

Expenses-OREO expenses

     (284     (988     (616

Expenses-Other expenses (appraisals)

     (225     (485     (376
  

 

 

   

 

 

   

 

 

 

Net income before income taxes related to covered assets

   $ 49      $ 5,235      $ 5,147   
  

 

 

   

 

 

   

 

 

 

 

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Income and expense related to covered loans include accretion of the difference between the carrying amount of the covered loans and their expected cash flows, net increase (decrease) in the FDIC loss sharing asset as well as the other noninterest expenses related to covered loans.

2012 Compared to 2011

The discount accretion of $22.6 million in 2012, recognized as part of interest income from covered loans, increased $10.0 million, compared to $12.6 million in 2011. This increase was reduced by the changes in FDIC loss sharing asset, a net decrease of $21.9 million in 2012, compared to a net increase of $171,000 in 2011.

Loans acquired from the SJB acquisition continued to perform better than originally expected. At December 31, 2012, the remaining discount associated with the SJB loans approximates $25.3 million. Based on the current forecast of expected cash flows, approximately $16.4 million of the discount is expected to accrete into interest income over the remaining lives of the loans. The FDIC loss sharing asset totaled $18.5 million at December 31, 2012. The loss sharing asset will continue to be reduced by loss claims submitted to the FDIC with the remaining balance amortized on the same basis as the discount, not to exceed its remaining life of the loss share contract of approximately 1.75 years.

The Company also recognized net gain on sales of covered assets of $1.8 million for 2012, compared to $446,000 in 2011.

Noninterest expense related to covered assets includes OREO expense, legal and professional expenses and other covered asset related expenses totaled $2.5 million and $8.0 million for 2012 and 2011, respectively. Covered loans decreased $109.9 million to $220.5 million at December 31, 2012 from $330.4 million at December 31, 2011.

2011 Compared to 2010

The discount accretion of $12.6 million in 2011 decreased by $14.1 million from $26.7 million in 2010. This decrease was partially offset by a $16.0 million increase resulting from the changes in the FDIC loss sharing asset ($171,000 net increase in 2011, compared to a net decrease of $15.9 million in 2010).

The Company also recognized net gain on sales of covered OREO of $446,000 in 2011 compared to a loss of $916,000 for 2010. Noninterest expense related to covered assets includes OREO expense, legal and professional expense and other covered asset related expenses, which totaled $8.0 million in 2011, up from $4.8 million in 2010.

 

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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 (earning assets) and the interest paid on deposits and borrowed funds (interest-bearing liabilities). Net interest margin is the taxable-equivalent of net interest income as a percentage of average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin. The net interest spread is the yield on average earning assets minus the cost of average interest-bearing liabilities. 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. As of December 31, 2012, our balance sheet is slightly asset-sensitive over a one-year horizon assuming no balance sheet growth; meaning interest-earning assets will generally reprice faster than interest-bearing liabilities. Therefore, our net interest margin is likely to modestly increase in sustained periods of rising interest rates and decrease modestly in sustained periods of declining interest rates. We manage net interest income through affecting changes in the mix of earning assets as well as the mix of interest-bearing liabilities, changes in the level of interest-bearing liabilities in proportion to earning assets, and in the growth of earning assets.

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:

 

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Interest-Earning Assets and Interest-Bearing Liabilities

 

    For the Year Ended December 31,  
    2012     2011     2010  
    Average           Yield/     Average           Yield/     Average           Yield/  
    Balance     Interest     Rate     Balance     Interest     Rate     Balance     Interest     Rate  
    (Dollars in thousands)  

INTEREST-EARNING ASSETS

 

Investment securities (1)

                 

Taxable

  $ 1,657,050      $ 32,025        1.96   $ 1,359,434      $ 37,310        2.77   $ 1,318,601      $ 49,720        3.78

Tax-advantaged

    640,309        22,718        4.89     624,340        23,640        5.37     651,811        25,394        5.51

Investment in FHLB stock

    65,792        671        1.02     80,091        242        0.30     93,461        324        0.35

Federal funds sold & interest-earning deposits with other institutions

    276,753        1,055        0.38     461,837        1,438        0.31     337,908        1,125        0.33

Loans HFS

    3,755        21        0.56     4,471        56        1.25     3,078        54        1.75

Loans (2)

    3,466,284        183,125        5.28     3,623,137        194,448        5.37     4,067,702        213,932        5.26

Yield adjustment to interest income from discount accretion

    (38,713     22,607          (81,847     12,586          (162,667     26,740     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total earning assets

    6,071,230        262,222        4.47     6,071,463        269,720        4.61     6,309,894        317,289        5.20

Total non earning assets

    414,712            434,045            461,923       
 

 

 

       

 

 

       

 

 

     

Total assets

  $ 6,485,942          $ 6,505,508          $ 6,771,817       
 

 

 

       

 

 

       

 

 

     

INTEREST-BEARING LIABILITIES

                 

Savings deposits (3)

  $ 1,715,151        4,123        0.24   $ 1,741,128        5,592        0.32   $ 1,698,628        9,947        0.59

Time deposits

    767,533        1,788        0.23     910,965        3,116        0.34     1,188,878        8,306        0.70
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest-bearing deposits

    2,482,684        5,911        0.24     2,652,093        8,708        0.33     2,887,506        18,253        0.63

FHLB advances and other borrowings

    951,065        19,361        2.01     1,200,613        26,331        2.19     1,484,356        39,719        2.68
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Interest-bearing liabilities

    3,433,749        25,272        0.73     3,852,706        35,039        0.91     4,371,862        57,972        1.33
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Noninterest-bearing deposits

    2,220,714            1,905,605            1,669,611       

Other liabilities

    81,950            65,847            61,021       

Stockholders’ equity

    749,529            681,350            669,323       
 

 

 

       

 

 

       

 

 

     

Total liabilities and stockholders’ equity

  $ 6,485,942          $ 6,505,508          $ 6,771,817       
 

 

 

       

 

 

       

 

 

     

Net interest income

    $ 236,950          $ 234,681          $ 259,317     
   

 

 

       

 

 

       

 

 

   

Net interest income excluding discount

    $ 214,343          $ 222,095          $ 232,577     
   

 

 

       

 

 

       

 

 

   

Net interest spread—tax equivalent

        3.74         3.70         3.87

Net interest spread—tax equivalent excluding discount

        3.33         3.43         3.32

Net interest margin

        3.92         3.87         4.11

Net interest margin—tax equivalent

        4.06         4.04         4.28

Net interest margin—tax equivalent excluding discount

        3.66         3.78         3.76

Net interest margin excluding loan fees

        3.87         3.83         4.07

Net interest margin excluding loan fees—tax equivalent

        4.01         4.00         4.23

 

(1) Non tax-equivalent (TE) rate was 2.40% for 2012, 3.09% for 2011, and 3.82% for 2010.
(2) Includes loan fees of: $2,761 for 2012, $2,124 for 2011, and $2,646 for 2010.

Prepayment penalty fees are included in interest income, and are as follows: $3,701 for 2012, $1,862 for 2011, and $1,362 for 2010.

(3) Includes interest-bearing demand and money market accounts.

 

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Net Interest Income and Net Interest Margin Reconciliations (Non-GAAP)

We use certain non-GAAP financial measures to provide supplemental information regarding our performance. The 2012, 2011 and 2010 net interest income and net interest margin include a yield adjustment of $22.6 million, $12.6 million and $26.7 million, respectively, from discount accretion on covered loans. We believe that presenting the net interest income and net interest margin excluding the yield adjustment provides additional clarity to the users of financial statements regarding core net interest income and net interest margin.

 

     For the Year Ended December 31,  
     2012     2011     2010  
     Average                  Average                  Average               
     Balance      Interest     Yield     Balance      Interest     Yield     Balance      Interest     Yield  
     (Dollars in thousands)  

Total interest-earning assets (TE)

   $ 6,071,230       $ 270,764        4.47   $ 6,071,463       $ 279,587        4.61   $ 6,309,894       $ 317,289        5.20

Discount on acquired loans

     38,713         (22,607       81,847         (12,586       162,667         (26,740  
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-earning assets, excluding SJB loan discount and yield adjustment

   $ 6,109,943       $ 248,157        4.06   $ 6,153,310       $ 267,001        4.34   $ 6,472,561       $ 290,549        4.65
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

   

Net interest income and net interest margin (TE)

      $ 245,492        4.06      $ 244,548        4.04      $ 259,317        4.28

Yield adjustment to interest income from discount accretion

        (22,607          (12,586          (26,740  
     

 

 

        

 

 

        

 

 

   

Net interest income and net interest margin (TE), excluding yield adjustment

      $ 222,885        3.66      $ 231,962        3.78      $ 232,577        3.76
     

 

 

        

 

 

        

 

 

   

The following table presents a comparison of interest income and interest expense resulting from changes in the volumes and rates on average 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

 

     Comparison of Year Ended December 31,  
     2012 Compared to 2011     2011 Compared to 2010  
     Increase (Decrease) Due to     Increase (Decrease) Due to  
     Volume     Rate     Rate/
Volume
    Total     Volume     Rate     Rate/
Volume
    Total  
     ( Dollars in thousands )  

Interest income:

                

Taxable investment securities

   $ 7,981      $ (11,224   $ (2,042   $ (5,285   $ 1,270      $ (13,289   $ (391   $ (12,410

Tax-advantaged securities

     663        (3     (1,582     (922     (1,501     (297     44        (1,754

Investment in FHLB stock

     (43     578        (106     429        409        (68     (28     313   

Fed funds sold & interest-earning deposits with other institutions

     (574     323        (132     (383     (47     (47     12        (82

Loans HFS

     (9     (31     5        (35     24        (15     (7     2   

Loans

     (5,631     (5,797     105        (11,323     (23,384     4,474        (574     (19,484

Yield adjustment from discount accretion

     (6,634     35,211        (18,556     10,021        (13,287     (1,724     857        (14,154
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

     (4,247     19,057        (22,308     (7,498     (36,516     (10,966     (87     (47,569

Interest expense:

                

Savings deposits

     (29     (1,396     (44     (1,469     251        (4,586     (20     (4,355

Time deposits

     (488     (1,002     162        (1,328     (1,945     (4,280     1,035        (5,190

FHLB advances and other borrowings

     (8,216     1,355        (109     (6,970     (7,604     (7,273     1,489        (13,388
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

     (8,733     (1,043     9        (9,767     (9,298     (16,139     2,504        (22,933
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 4,486      $ 20,100      $ (22,317   $ 2,269      $ (27,218   $ 5,173      $ (2,591   $ (24,636
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

2012 Compared to 2011

Excluding the impact of the yield adjustment on covered loans, our net interest margin (tax equivalent) was 3.66% for 2012, compared to 3.78% for 2011. Total average earning asset yields (excluding discount) decreased 28 basis points to 4.06% for 2012 from 4.34% for 2011. Total cost of funds decreased to 0.44% for 2012 from 0.60% for 2011. Net interest margin was up slightly year-over-year primarily due to an 18 basis point decrease in the cost of interest-bearing liabilities, offset by a decrease in the yield on average earning assets.

The average yield on loans was 5.28% for 2012, compared to 5.37% for 2011. This year-over-year decrease in loan yield was primarily due to the refinancing of higher yielding loans and lower rates on new originations. The average balance of total loans decreased $156.9 million to $3.47 billion for 2012, compared to $3.62 billion for 2011. The $11.3 million decrease in total interest on loans was partially offset by the $10.0 million increase in the discount accretion from covered SJB loans, primarily due to improved credit loss experienced on covered loans. We also earned $3.7 million in loan prepayment penalty fees for 2012, compared with $1.9 million for 2011.

Total average earning assets for 2012 were $6.07 billion, a decrease of $233,000 from $6.07 billion for 2011. This decrease was principally due to a $185.1 million decrease in average interest-earning cash to $276.8 million, compared to $461.8 million for 2011 as a result of prepaying $250.0 million of FHLB advances during the third quarter of 2012. The average investment in FHLB stock also decreased $14.3 million to $65.8 million for 2012, compared to $80.1 million for 2011. The total average loan balance, net of discount, also decreased $114.4 million. These decreases were partially offset by an increase of $313.6 million in lower yielding investment securities to $2.30 billion for 2012, compared to $1.98 billion for 2011.

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 status, all interest previously accrued but not collected is charged against earnings. There was no interest income that was accrued and not reversed for nonaccrual loans at December 31, 2012 and 2011. As of December 31, 2012 and 2011, we had $58.0 million and $62.7 million of non-covered nonaccrual loans, respectively. Had non-covered nonaccrual loans for which interest was no longer accruing complied with the original terms and conditions, interest income would have been approximately $3.9 million and $3.5 million greater for 2012 and 2011, respectively.

Fees collected on loans are an integral part of the loan pricing decision. Net loan fees and the direct costs associated with the origination of loans are deferred and deducted from total loans on our balance sheet. Net deferred loan fees are recognized in interest income over the term of the loan using the effective-yield method. We recognized loan fee income of $2.8 million for 2012 and $2.1 million for 2011.

Interest income on investments of $54.7 million for 2012 decreased $6.2 million, or 10.18%, from $60.9 million for 2011. Total yield (TE) on investments was 2.78% for 2012, compared to 3.59% for the same period in 2011. We have been strategically reinvesting our cash flow from our investment portfolio, carefully weighing current rates and overall interest rate risks and we continually adjust our investment strategies in response to the changing interest rate environment. For the year 2012, we purchased $546.1 million of mortgage-backed securities with an average yield of 1.79%, $23.1 million of municipal securities with an average tax-equivalent yield of 3.42%, $166.3 million SBA Pools with an average yield of 1.79%, and $176.5 million of callable Agencies with an average yield of 1.74%. Finding bank-qualified municipal securities that meet our investment criteria remains challenging, but desirable.

Interest expense of $25.3 million for 2012 decreased $9.7 million, or 27.87%, compared to $35.0 million for 2011. The average rate paid on interest-bearing liabilities decreased 18 basis points, to 0.73% in 2012 from 0.91% in 2011 as a result of the lower interest rate environment in 2012 as well as the mix of interest-bearing liabilities. The decline in interest expense was driven by lower rates paid and lower average balances on deposits as reflected by the decrease in our average cost of interest-bearing deposits (0.24% for 2012, compared to 0.33% for 2011). Average interest-bearing deposits of $2.48 billion for 2012 decreased $169.4 million, or 6.39%, from $2.65 billion in 2011. Average noninterest-bearing deposits increased $315.1 million to $2.22 billion, or 47.22% of total average deposits for 2012, compared to $1.91 billion, or 41.81% of total average deposits for 2011. The decrease in rates paid on deposits (0.13% for 2011 compared to 0.19% for 2011) also contributed to our lower cost of funds.

Other borrowings typically have higher interest costs than interest-bearing deposits. The $7.0 million decrease in interest from other borrowings was primarily due to the redemption of $250.0 million of fixed rate loans from the FHLB during the third quarter of 2012, and $48.0 million redemption of junior subordinated debentures during 2012. These FHLB loans carried an average coupon rate of 3.39% and a weighted average remaining life of 2.6 years. We also repaid $100.0 million of FHLB loans, with a coupon rate of 2.89%, at the end of December, 2011. On January 7, 2012, we redeemed all outstanding debentures and trust preferred securities issued by First Coast Capital Trust II for a total consideration of approximately $6.8 million. During 2012, we redeemed $41.2 million of CVB Statutory Trust I junior subordinated debentures bearing interest at 2.85% above the 90-day LIBOR.

 

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2011 Compared to 2010

Net interest income, before provision for credit losses, decreased $24.6 million, or 9.50%, over net interest income of $259.3 million for 2010. This decrease in net interest income for 2011 resulted from a decrease of $47.6 million in interest income, partially offset by a decrease of $22.9 million in interest expense. The 17 basis point decrease in our net interest spread (TE) resulted from a 59 basis point decrease in the yield on average earning assets, offset by a 42 basis point decrease in the average cost of interest-bearing liabilities.

Interest income of $269.7 million decreased $47.6 million, or 14.99% compared to total interest income of $317.3 million for 2010. The decrease in interest income was primarily due to a $444.6 million decrease in the average balance of loans for 2011 which decreased interest income by $23.4 million. In addition, there was a $14.1 million decrease in the discount accretion from covered SJB loans, and $13.3 million from a 101 basis point decrease in the yield on taxable investment securities as result of the decreasing interest rate environment. The discount accretion represents accelerated principal payments on SJB loans and is recorded as a yield adjustment to interest income. As a result, the average yield (TE) on interest-earning assets decreased to 4.61% in 2011, or 59 basis points, from 5.20% in 2010. Average earning assets decreased by $238.4 million, or 3.78%, from $6.31 billion for 2010, compared to $6.07 billion for 2011. Excluding the accelerated accretion, the yield in interest-earning assets would have been 4.34% for 2011 compared to 4.65% for 2010.

As of December 31, 2011 and 2010, we had $62.7 million and $157.0 million of non-covered nonaccrual loans, respectively. There was no interest income that was accrued and not reversed for nonaccrual loans at December 31, 2011 and 2010. Had non-covered nonaccrual loans for which interest was no longer accruing complied with the original terms and conditions, interest income would have been approximately $3.5 million and $5.2 million greater for 2011 and 2010, respectively.

Fees collected on loans are an integral part of the loan pricing decision. Net loan fees and the direct costs associated with the origination of loans are deferred and deducted from total loans on our balance sheet. Net deferred loan fees are recognized in interest income over the term of the loan using the effective-yield method. We recognized loan fee income of $2.1 million for 2011 and $2.6 million for 2010. The decrease in loan fee income during 2011 was due to a decrease in loan originations as a result of the sustained weakness in the economy resulting in declining loan demand.

Interest income includes dividends earned on our investment in FHLB capital stock. For the year ended December 31, 2011 and 2010, dividends earned on FHLB stock totaled $242,000 and $324,000, respectively. In 2009, the FHLB announced that there can be no assurance that the FHLB will pay dividends at the same rate it has paid in the past. However, the FHLB did declare and pay dividends during both 2010 and 2011.

Interest expense of $35.0 million for 2011 decreased $22.9 million, or 39.56% compared to $58.0 million for 2010. The average rate paid on interest-bearing liabilities decreased 42 basis points, to 0.91% in 2011 from 1.33% in 2010 as a result of a decreasing interest rate environment in 2011 as well as the mix of interest-bearing liabilities. Other borrowings typically have a higher cost than interest-bearing deposits. The average cost of borrowings decreased to 2.19% for 2011 from 2.68% for 2010 and was primarily due to a $283.7 million decrease in the average balance of other borrowings for 2011 which increased interest expense by $7.6 million. The prepayments of a $250 million structured repurchase agreement and $100 million in FHLB advances in 2010 resulted in an additional reduction of $5.6 million in interest expense compared to 2010. The $100.0 million in FHLB maturities, which we elected not to renew, also contributed to the decrease in the average cost of borrowings for 2011. The decline in interest expense was driven by lower rates paid and lower average balances on deposits as reflected by the decrease in our average cost of interest-bearing deposits (0.33% for 2011 compared to 0.63% for 2010). Average interest-bearing deposits decreased $235.4 million, or 8.15%, from $2.89 billion in 2010 to $2.65 billion in 2011. Average noninterest-bearing deposits increased $236.0 million to $1.91 billion, or 41.81% of total average deposits for 2011, compared to $1.67 billion, or 36.64% of total average deposits for 2010. The decrease in rates paid on deposits (0.19% for 2011 compared to 0.40% for 2010) also contributed to our lower cost of funds.

Provision for Credit Losses

We maintain an allowance for credit losses that is increased by a provision for non-covered credit losses charged against operating results. The provision for credit losses is determined by management as the amount to be added to the allowance for credit losses after net charge-offs have been deducted to bring the allowance to an appropriate level which, in management’s best estimate, is necessary to absorb probable credit losses within the existing loan portfolio.

Our provision for credit losses on non-covered loans was zero for 2012, $7.1 million for 2011 and $61.2 million for 2010. The decrease in the provision for credit losses was primarily due to overall improvement in the performance of our loan portfolio. We believe the allowance is appropriate at December 31, 2012. We periodically assess the quality of our portfolio to determine whether additional provisions for credit losses are necessary. The ratio of the allowance for credit losses to total non-covered net loans as of December 31, 2012, 2011 and 2010 was 2.84%, 2.92% and 3.12%, respectively.

 

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No assurance can be given that economic conditions which adversely affect the Company’s service areas or other circumstances will not be reflected in increased provisions for credit losses in the future, as the nature of this process requires considerable judgment. Net charge-offs totaled $1.5 million for 2012, $18.4 million for 2011, and $64.9 million in 2010. See “Risk Management — Credit Risk” herein.

SJB loans acquired in the FDIC-assisted transaction were initially recorded at their fair value and are covered by a loss sharing agreement with the FDIC. Due to the timing of the acquisition and the October 16, 2009 fair value estimate, there was no provision for credit losses on the covered SJB loans in 2009. In 2012 there were $657,000 in net recoveries, compared to $893,000 in net charge-offs in 2011, for loans in excess of the amount originally expected in the fair value of the loans at acquisition. Our reduction of provision for credit losses on covered SJB loans was $657,000 in 2012, compared to provision of $893,000 for credit losses in 2011. An offsetting adjustment was recorded to the FDIC loss-sharing asset based on the appropriate loss-sharing percentage.

Noninterest Income

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

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

 

     For the Year Ended December 31,  
     2012     2011     2010  
     (Dollars in thousands)  

Noninterest income:

      

Service charges on deposit accounts

   $ 16,106      $ 15,768      $ 16,745   

CitizensTrust

     8,169        8,683        8,363   

Bankcard services

     3,650        3,144        2,776   

BOLI Income

     2,973        3,259        3,125   

Gain on sale of securities

     —          —          38,900   

Increase (decrease) in FDIC loss sharing asset, net

     (21,916     171        (15,856

Impairment loss on investment security

     —          (656     (904

Gain/(loss) on OREO

     1,544        1,076        (242

Gain/(loss) on loans held for sale

     815        (1,651     (598

Other

     4,562        4,422        4,805   
  

 

 

   

 

 

   

 

 

 

Total noninterest income

   $ 15,903      $ 34,216      $ 57,114   
  

 

 

   

 

 

   

 

 

 

2012 Compared to 2011

Noninterest income for 2012 was reduced by a $21.9 million net decrease in the FDIC loss sharing asset, partially offset by a $1.8 million net gain on sale of covered assets. Our credit loss experience on loans acquired from the SJB acquisition continued to improve. At December 31, 2012, the remaining discount associated with the SJB loans approximated $25.3 million. Based on the current forecast of expected cash flows, approximately $16.4 million of the discount is expected to accrete into interest income over the remaining lives of the loans. The FDIC loss sharing asset totaled $18.5 million at December 31, 2012. The loss sharing asset will continue to be reduced by loss claims submitted to the FDIC with the remaining balance amortized on the same basis as the discount, not to exceed the remaining life of the loss share contract of approximately 1.75 years.

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. CitizensTrust had approximately $2.10 billion in assets under management and administration, including $1.58 billion in assets under management, as of December 31, 2012. CitizensTrust generated fees of $8.2 million in 2012, compared to $8.7 million in 2011.

The Bank invests in Bank-Owned Life Insurance (BOLI). BOLI involves the purchasing 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. BOLI income for 2012 decreased $286,000, or 8.78%, from $3.3 million 2011.

 

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2011 Compared to 2010

Noninterest income of $34.2 million in 2011 decreased $22.9 million, or 40.09%, over noninterest income of $57.1 million for 2010. This decrease was primarily due to $38.9 million in net gain on sales of securities for 2010, compared to zero gain on sale of securities for 2011, partially offset by a $15.9 million net reduction in the FDIC loss sharing asset.

During 2011, we recognized a $656,000 other-than-temporary impairment on a private-label mortgage-backed investment security, which was charged to other operating income. There were no securities sold during 2011.

CitizensTrust generated fees of $8.7 million in 2011. This represented a modest increase of $320,000, or 3.83%, from fees generated of $8.4 million in 2010. BOLI income of $3.3 million in 2011 reflected a slight increase of $134,000, or 4.29%, compared to BOLI income earned in 2010.

Noninterest Expense

The following table sets for the various components of noninterest expense for the periods indicated.

 

     For the Year Ended December 31,  
     2012     2011     2010  
     (Dollars in thousands)  

Noninterest expense:

      

Salaries and employee benefits

   $ 68,496      $ 69,993      $ 69,419   

Occupancy

     10,822        11,261        12,127   

Equipment

     4,651        5,322        7,221   

Professional services

     6,249        15,031        13,308   

Software licenses and maintenance

     4,269        3,669        5,031   

Stationery and supplies

     3,592        3,645        4,965   

Promotion

     4,869        4,977        6,084   

Amortization of intangibles

     2,159        3,481        3,732   

Provision for unfunded commitments

     (1,000     (918     2,600   

Debt termination

     20,379        3,310        18,663   

OREO expense

     2,146        6,729        7,490   

Regulatory assessments

     3,596        4,970        8,774   

Loan expense

     2,084        2,436        1,804   

Other

     5,848        7,119        7,274   
  

 

 

   

 

 

   

 

 

 

Total noninterest expense

   $ 138,160      $ 141,025      $ 168,492   
  

 

 

   

 

 

   

 

 

 

2012 Compared to 2011

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. Excluding the impact of the debt termination expense, noninterest expense measured as a percentage of average assets was 1.82% for 2012, compared to 2.12% for 2011.

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. For 2012, the efficiency ratio was 54.64%, compared to 52.45% for 2011. The $20.4 million in debt termination expense was the main reason for the increase in our efficiency ratio. Excluding the impact of the debt termination expense, the efficiency ratio was 46.58% and 51.21% for 2012 and 2011, respectively.

Excluding the $20.4 million debt termination expense, the overall decrease of $19.9 million in noninterest expense was primarily attributable to decreases of $7.5 million in legal expenses (included in professional services), $4.6 million in OREO expense, $1.5 million in salaries and employee benefits, $1.4 million in regulatory assessment fees, and $1.3 million in intangible amortization expense.

Overall salaries and related expenses decreased $1.5 million compared to 2011. At December 31, 2012, we employed 809 associates (589 full-time and 221 part-time), compared to 809 associates (578 full-time and 231 part-time) at December 31, 2011. Salaries and related expenses as a percent of average assets was at 1.06% for 2012 and 1.08% for 2011.

 

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The $8.8 million decrease in professional services expense was primarily due to a decrease of $7.5 million in legal expenses associated with credit and collection issues, the Securities and Exchange Commission investigation, and other litigation issues in which the Company is involved. See “Item 3 — Legal Proceedings”.

2011 Compared to 2010

Total noninterest expense of $141.0 million for 2011 represented a decrease of $27.5 million, or 16.30%, over noninterest expense of $168.5 million for 2010. The overall decrease was primarily attributable to decreases of $15.4 million in prepayment penalties on FHLB advances, $2.7 million in supplies and software expense, $3.8 million for regulatory assessment fees, and $1.9 million in equipment expenses. We also recorded a reduction in our reserve for unfunded commitments of $918,000 during 2011, compared to an increase in our reserve for unfunded commitments of $2.6 million during 2010.

Professional services totaled $15.0 million for 2011, compared to $13.3 million for 2010. The 2011 increases were primarily due to increases in legal expenses for credit and collection issues, a Securities and Exchange Commission investigation and other litigation issues in which the Company is involved.

Salaries and related expenses totaled $70.0 million for 2011, an increase of $574,000, or 0.83%, over salaries and related expenses of $69.4 million for 2010. At December 31, 2011, we employed 809 associates (578 full-time and 231 part-time) compared to 811 associates (572 full-time and 239 part-time) at December 31, 2010. Salaries and related expenses as a percent of average assets increased to 1.08% for 2011, compared to 1.03% for 2010.

Income Taxes

The Company’s effective tax rate for 2012 was 32.62%, compared to 32.34% for 2011, and 27.44% for 2010. The effective tax rates are below the nominal combined Federal and State tax rates as a result of tax-advantaged income from certain investments and municipal loans and leases as a percentage of total income for each period. The majority of tax-advantaged income is derived from municipal securities.

RESULTS BY BUSINESS SEGMENTS

We have two reportable business segments: which are (i) Business Financial and Commercial Banking Centers and (ii) Treasury. The results of these two segments are included in the reconciliation between business segment totals and our consolidated total. Our business segments do not include the results of administration units that do not meet the definition of an operating segment. There are no provisions for credit losses or taxes in the segments as these are accounted for at the corporate level.

Business Financial and Commercial Banking Centers

Key measures we use to evaluate the Business Financial and Commercial Banking Center’s performance are included in the following table for years ended December 31, 2012, 2011, and 2010. The table also provides additional significant segment measures useful to understanding the performance of this segment.

 

     For the Year Ended December 31,  
     2012     2011     2010  
     (Dollars in thousands)  

Key Measures:

      

Statement of Operations

      

Interest income

   $ 175,835      $ 182,187      $ 242,087   

Interest expense

     11,304        15,295        34,181   
  

 

 

   

 

 

   

 

 

 

Net interest income

   $ 164,531      $ 166,892      $ 207,906   
  

 

 

   

 

 

   

 

 

 

Noninterest income

     23,020        21,622        23,204   

Noninterest expense

     45,189        49,802        51,922   
  

 

 

   

 

 

   

 

 

 

Segment pre-tax profit

   $ 142,362      $ 138,712      $ 179,188   
  

 

 

   

 

 

   

 

 

 

Balance Sheet

      

Average loans

   $ 2,621,327      $ 2,639,628      $ 2,822,184   

Average interest-bearing deposits and customer repurchases

   $ 2,739,389      $ 2,946,270      $ 3,179,968   

Yield on loans

     5.72     5.96     6.04

Rate paid on interest-bearing deposits and customer repurchases

     0.26     0.35     0.71

 

(1) Interest income and interest expense include credit for funds provided and charge for funds used, respectively. These are eliminated in the consolidated presentation.
(2) Yield on loans excludes SJB discount accretion as this is accounted for at the Corporate level.

 

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For the year ended December 31, 2012, Business Financial and Commercial Banking Centers’ segment pre-tax profits increased by $3.7 million, or 2.63%, compared to 2011. This was primarily due to a decrease in noninterest expense of $4.6 million, a decrease in interest expense of $4.0 million, and an increase in noninterest income of $1.4 million, offset by a decrease in interest income of $6.4 million. The decrease in net interest income was primarily due to a 24 basis point decrease in the loan yield in 2012, compared to 2011.

For the year ended December 31, 2011, segment pre-tax profits decreased by $40.5 million, or 22.59%, compared to 2010. This was primarily due to a decrease in interest income of $59.9 million, offset by a decrease in interest expense of $18.9 million. The decrease in interest income was primarily due to a $182.6 million, or 6.47% decrease in the average loan balance in 2011, compared to 2010. The decrease in interest expense was primarily due to a decrease in rates paid on deposits and a decrease in average interest-bearing deposits and customer repurchase agreements. During 2011 average interest-bearing deposits and customer repurchase agreements decreased $233.7 million, or 7.35%, compared to 2010.

Treasury

Key measures we use to evaluate Treasury’s performance are included in the following table for the years ended December 31, 2012, 2011 and 2010. The table also provides additional significant segment measures useful to understand the performance of this segment.

 

     For the Year Ended December 31,  
     2012     2011     2010  
     (Dollars in thousands)  

Key Measures:

      

Statement of Operations

      

Interest income

   $ 56,559      $ 62,732      $ 76,651   

Interest expense

     56,666        56,386        73,786   
  

 

 

   

 

 

   

 

 

 

Net interest income

   $ (107   $ 6,346      $ 2,865   
  

 

 

   

 

 

   

 

 

 

Noninterest income

     —          (655     37,997   

Noninterest expense

     729        807        1,462   

Debt termination

     20,379        3,310        18,663   
  

 

 

   

 

 

   

 

 

 

Segment pre-tax profit (loss)

   $ (21,215   $ 1,574      $ 20,737   
  

 

 

   

 

 

   

 

 

 

Balance Sheet

      

Average investments

   $ 2,297,359      $ 1,983,774      $ 1,970,412   

Average interest-bearing deposits

   $ 240,002      $ 240,302      $ 240,316   

Average borrowings

   $ 363,152      $ 552,155      $ 796,321   

Yield on investments-TE

     2.78     3.59     4.35

Non-tax equivalent yield

     2.40     3.09     3.82

Rate paid on borrowings

     4.09     3.80     4.00

 

(1) Interest income and interest expense include credit for funds provided and charge for funds used, respectively. These are eliminated in the consolidated presentation.

For the year ended December 31, 2012, the Company’s Treasury department reported segment pre-tax loss of $21.2 million. The decrease was primarily due to $20.4 million in debt termination expense as a result of prepaying $250.0 million of FHLB advances during 2012, compared to $3.3 million debt termination expense in 2011. Excluding the $20.4 million and $3.3 million in debt termination expense for 2012 and 2011, respectively, segment pre-tax loss was $836,000 for 2012, compared to pre-tax profit of $4.9 million for 2011. This year-over-year decrease was primarily due to a decline of $6.2 million in interest income due to an 81 basis point decrease in yield on investments in 2012, partially offset by zero realized gains or losses for 2012, compared to an impairment loss of $655,000 for 2011.

For the year ended December 31, 2011, Treasury segment profits decreased by $19.2 million compared to 2010. The decrease was primarily due to $38.9 million in gain on the sale of investment securities in 2010, and a decrease of $15.4 million in prepayment penalties in 2011. This was partially offset by a $13.9 million reduction in interest income due to a 76 basis point decrease in yield on investments in 2011. Interest expense decreased $17.4 million primarily due to a decrease of $244.2 million in average borrowings from 2010 to 2011.

 

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Other

 

     For the Year Ended December 31,  
     2012     2011     2010  
     (Dollars in thousands)  

Key Measures:

      

Statement of Operations

      

Interest income

   $ 87,097      $ 89,233      $ 99,268   

Interest expense

     14,571        27,790        50,722   
  

 

 

   

 

 

   

 

 

 

Net interest income

   $ 72,526      $ 61,443      $ 48,546   
  

 

 

   

 

 

   

 

 

 

Provision for cedit losses

     —          7,068        61,200   

Noninterest income

     (7,117     13,249        (4,087

Noninterest expense

     71,863        87,106        96,445   
  

 

 

   

 

 

   

 

 

 

Pre-tax loss

   $ (6,454   $ (19,482   $ (113,186
  

 

 

   

 

 

   

 

 

 

Balance Sheet

      

Average loans

   $ 809,999      $ 906,133      $ 1,085,929   

Average interest-bearing deposits and customer repurchases

   $ 270      $ (3,555   $ 35,202   

Yield on loans

     6.87     5.49     6.48

 

(1) Interest income and interest expense include credit for funds provided and charge for funds used, respectively. These are eliminated in the consolidated presentation.

The Company’s administration and other operating departments reported pre-tax loss of $6.5 million for the year ended December 31, 2012. This represented a decrease of $13.0 million or 66.87%, from pre-tax loss of $19.5 million for 2011. The reduction in pre-tax loss was primarily attributed to a decrease of $15.2 million in noninterest expense, an increase of $11.1 million in net interest income, and a decrease of $7.1 million in provision for credit losses, partially offset by a net decrease in FDIC loss sharing asset of $22.1 million. Interest income in 2012 included $22.6 million in accelerated accretion on SJB acquired loans, compared to $12.6 million in 2011.

Pre-tax loss for 2011 decreased $93.7 million to $19.5 million, from pre-tax loss of $113.2 million for 2010. The reduction in pre-tax loss was primarily attributed to the decrease in provision for credit losses of $54.1 million, an increase in noninterest income of $17.3 million, an increase in net interest income of $12.9 million, and a decrease in noninterest expense of $9.3 million. Interest income in 2011 included $12.6 million in accelerated accretion on SJB acquired loans, compared to $26.7 million in 2009.

 

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ANALYSIS OF FINANCIAL CONDITION

The Company reported total assets of $6.36 billion at December 31, 2012. This represented a decrease of $119.6 million, or 1.84 %, from total assets of $6.48 billion at December 31, 2011. Earnings assets totaled $6.04 billion at December 31, 2012. This represented a decrease of $92.4 million, or 1.51%, from total earning assets of $6.13 billion at December 31, 2011. The decrease in earning assets was due to a decrease in interest-earning cash as a result of prepaying $250.0 million of FHLB advances. Total liabilities were $5.60 billion at December 31, 2012, down $167.7 million, or 2.91%, from total liabilities of $5.77 billion at December 31, 2011. Total equity increased $48.2 million, or 6.74%, to $763.0 million at December 31, 2012, compared to total equity of $714.8 million at December 31, 2011.

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. The tables below set forth information concerning the composition of the investment securities portfolio at December 31, 2012 and 2011.

At December 31, 2012, we reported total investment securities of $2.45 billion. This represented an increase of $247.5 million, or 11.23%, from total investment securities of $2.20 billion at December 31, 2011. Investment securities comprised 40.61% of the Company’s total earning assets as of December 31, 2012. No securities were sold in 2012 and 2011.

At December 31, 2012, securities held as available-for-sale had a fair value of $2.45 billion with an amortized cost of $2.37 billion. At December 31, 2012, the net unrealized holding gain on securities available-for-sale was $74.6 million that resulted in accumulated other comprehensive gain of $43.3 million (net of $31.3 million in deferred taxes). At December 31, 2011, the net unrealized holding gain on securities available-for-sale was $71.5 million that resulted in an accumulated other comprehensive gain of $41.5 million.

Composition of the Fair Value of Investment Securities Available-for-Sale

 

     December 31,  
     2012     2011     2010  
     Fair Value      Percent     Fair Value      Percent     Fair Value      Percent  
     (Dollars in thousands)  

Investment securities available for sale:

               

Government agency

   $ 359,300         14.67   $ 46,507         2.11   $ 106,273         5.93

Residential mortgage-backed securities

     887,598         36.24     888,000         40.33     808,409         45.12

CMO/REMICs—Residential

     571,960         23.35     604,508         27.46     270,477         15.10

Municipal bonds

     625,429         25.53     652,037         29.62     606,399         33.85

Other securities

     5,100         0.21     10,474         0.48     —           0.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total investment securities

   $ 2,449,387         100.00   $ 2,201,526         100.00   $ 1,791,558         100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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The maturity distribution of the available-for-sale portfolio at December 31, 2012 consists of the following:

 

     December 31, 2012  
     One Year  or
Less
    After One
Year
Through
Five Years
    After Five
Year
Through
Ten Years
    After Ten
Years
    Total     Percent
to Total
 
     (Dollars in thousands)  

Maturity distribution:

            

Government agency

   $ 151,000      $ 12,171      $ 196,129      $ —        $ 359,300        14.67

Mortgage-backed securities

     8,069        805,852        73,677        —          887,598        36.24

CMO/REMICs

     79,071        479,147        13,742        —          571,960        23.35

Municipal bonds (1)

     34,417        419,709        141,571        29,732        625,429        25.53

Other securities

     5,100        —          —          —          5,100        0.21
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 277,657      $ 1,716,879      $ 425,119      $ 29,732      $ 2,449,387        100.00
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average yield:

            

Government agency

     1.69     0.94     1.89     0.00     1.77  

Mortgage-backed securities

     4.08     2.12     2.86     0.00     2.20  

CMO/REMICs

     1.06     1.88     4.53     0.00     1.83  

Municipal bonds (1)

     3.98     3.88     3.63     4.03     3.83  

Other securities

     5.95     0.00     0.00     0.00     0.06  

Total

     1.94     2.48     2.72     4.03     2.47  

 

(1) The weighted average yield is not tax-equivalent. The tax-equivalent yield as of December 31, 2012 was 5.20%

The maturity of each security category is defined as the contractual maturity except for the categories of mortgage-backed securities and CMO/REMICs whose maturities are defined as the estimated average life. The final maturity of mortgage-backed securities and CMO/REMICs 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/REMICs 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 investment portfolio at December 31, 2012 was 2.47% with a weighted-average life of 3.1 years. This compares to a weighted-average yield of 2.99% at December 31, 2011 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 75% of the securities in the investment portfolio, at December 31, 2012, are issued by the U.S. government or U.S. government-sponsored agencies which have the implied guarantee of payment of principal and interest. As of December 31, 2012, approximately $106.0 million in U.S. government agency bonds are callable.

As of December 31, 2012 and 2011, the Company held investment securities in excess of ten-percent of shareholders’ equity from the following issuers:

 

     December 31, 2012      December 31, 2011  
     Book Value      Market Value      Book Value      Market Value  
     (Dollars in thousands)  

Major issuer:

           

Federal Home Loan Mortgage Corp.

   $ 599,266       $ 611,270       $ 613,392       $ 626,453   

Federal National Mortgage Association

     924,010         943,031         853,139         867,186   

Small Business Administration

     165,496         166,418         —           —     

 

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The following table presents municipal securities by the top six holdings by state:

 

     December 31, 2012  
     Amortized Cost      Percent of
Total
    Fair Value      Percent of
Total
 
     (Dollars in thousands)  

State:

          

New Jersey

   $ 83,911         14.4   $ 89,567         14.3

Illinois

     61,962         10.6     65,946         10.6

Michigan

     73,288         12.6     77,697         12.4

Texas

     48,020         8.2     51,793         8.3

Washington

     33,586         5.7     37,029         5.9

California

     25,099         4.3     25,828         4.1

All other states

     257,826         44.2     277,569         44.4
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 583,692         100.0   $ 625,429         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 
     December 31, 2011  
     Amortized Cost      Percent of
Total
    Fair Value      Percent of
Total
 
     (Dollars in thousands)  

State:

          

New Jersey

   $ 87,056         14.3   $ 93,769         14.4

Illinois

     75,981         12.5     80,240         12.3

Michigan

     73,827         12.1     78,635         12.1

Texas

     48,852         8.0     52,729         8.1

California

     37,913         6.2     38,438         5.9

Washington

     36,469         6.0     39,835         6.1

All other states

     248,477         40.9     268,391         41.1
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 608,575         100.0   $ 652,037         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Municipal securities held by the Company are issued by various states and their various local municipalities.

The following tables provide the composition of investment securities that have been in a continuous unrealized loss position, as well as the unrealized losses associated with those investments:

 

     December 31, 2012  
     Less Than 12 Months      12 Months or Longer      Total  
     Fair Value      Gross
Unrealized
Holding
Losses
     Fair
Value
     Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
 
     (Dollars in thousands)  

Held-to-maturity:

                 

CMO

   $ —         $ —         $ —         $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-sale:

                 

Government agency

   $ 51,134       $ 248       $ —         $ —         $ 51,134       $ 248   

Residential mortgage-backed securities

     55,118         127         —           —           55,118         127   

CMO/REMICs—residential

     74,784         572         69,042         838         143,826         1,410   

Municipal bonds

     13,110         162         975         21         14,085         183   

Other securities

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 194,146       $ 1,109       $ 70,017       $ 859       $ 264,163       $ 1,968   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     December 31, 2011  
     Less Than 12 Months      12 Months or Longer      Total  
     Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
     Fair Value      Gross
Unrealized
Holding
Losses
 
     (Dollars in thousands)  

Held-to-maturity:

                 

CMO

   $ 2,383       $ —         $ —         $ —         $ 2,383       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-sale:

                 

Government agency

   $ —         $ —         $ —         $ —         $ —         $ —     

Residential mortgage-backed securities

     75,754         334         —           —           75,754         334   

CMO/REMICs—residential

     133,471         665         —           —           133,471         665   

Municipal bonds

     22,184         203         —           —           22,184         203   

Other securities

     2,500         4         —           —           2,500         4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 233,909       $ 1,206       $ —         $ —         $ 233,909       $ 1,206   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The tables above show 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, 2012 and 2011. The unrealized losses on these securities were primarily attributed to changes in interest rates. The issuers of these securities have not, to our knowledge, established any cause for default on these securities. These securities have fluctuated in value since their purchase dates as market 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 except for one bond held-to-maturity described below. A summary of our analysis of these securities and the unrealized losses is described more fully in Note 5 — Investment Securities in the notes to the consolidated financial statements. Economic trends may adversely affect the value of the portfolio of investment securities that we hold.

For the years ended December 31, 2011, and 2010, the Company recorded net other-than-temporary impairment losses on the held-to-maturity investment security in the amounts of $656,000, and $904,000, respectively. The Company did not record any charges for other-than-temporary impairment losses during the year ended December 31, 2012.

Non-Covered Loans

At December 31, 2012, total non-covered loans, net of deferred loan fees, were $3.25 billion. This represented an increase of $32.6 million, or 1.01%, from non-covered loans of $3.22 billion at December 31, 2011. The loan portfolio was affected by real estate trends, diminished loan demand and the weakening of the economy. The overall increase was attributed to the following:

 

   

$53.1 million increase in commercial and industrial loans.

 

   

$41.8 million increase in commercial real estate loans.

 

   

$26.2 million decline in purchased mortgage pool loans.

 

   

$16.4 million decline in construction loans.

 

   

$15.8 million decrease in the dairy and livestock portfolio.

The table below presents the distribution of our non-covered loans at the dates indicated.

 

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Table of Contents

Distribution of Loan Portfolio by Type (Non-Covered Loans)

 

     December 31,  
     2012     2011     2010     2009     2008  
     (Dollars in thousands)  

Commercial and Industrial

   $ 547,422      $ 494,299      $ 460,399      $ 413,715      $ 370,829   

Real Estate

          

Construction

     59,721        76,146        138,980        265,444        351,543   

Commercial Real Estate

     1,990,107        1,948,292        1,980,256        1,989,644        1,945,706   

SFR Mortgage

     159,288        176,442        218,467        265,543        333,931   

Consumer, net of unearned discount

     47,557        51,436        56,747        67,693        66,255   

Municipal Lease Finance Receivables

     105,767        113,460        128,552        159,582        172,973   

Auto and equipment leases

     12,716        17,370        17,982        30,337        45,465   

Dairy and Livestock/Agribusiness

     336,660        347,677        377,829        422,958        459,329   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross Loans (Non-Covered)

     3,259,238        3,225,122        3,379,212        3,614,916        3,746,031   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less:

          

Allowance for Credit Losses

     (92,441     (93,964     (105,259     (108,924     (53,960

Deferred Loan Fees

     (6,925     (5,395     (5,484     (6,537     (9,193
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Net Loans (Non-Covered)

   $ 3,159,872      $ 3,125,763      $ 3,268,469      $ 3,499,455      $ 3,682,878   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Commercial and industrial loans are loans to commercial entities to finance capital purchases or improvements, or to provide cash flow for operations. 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. Consumer loans include installment loans to consumers as well as home equity loans 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.

Our loan portfolio is primarily located throughout our marketplace. The following is the breakdown of our total non-covered held-for-investment commercial real estate loans by region as of December 31, 2012.

 

     December 31, 2012  

Non-Covered

Loans by Market Area

   Total Non-Covered Loans     Commercial
Real Estate  Loans
 
     (Dollars in thousands)  

Los Angeles County

   $ 1,190,214         36.5   $ 795,566         40.0

Inland Empire

     627,173         19.2     485,176         24.3

Central Valley

     662,420         20.3     389,297         19.6

Orange County

     461,001         14.1     187,585         9.4

Other Areas (1)

     318,430         9.9     132,483         6.7
  

 

 

    

 

 

   

 

 

    

 

 

 
   $ 3,259,238         100.0   $ 1,990,107         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Other areas include loans that are out-of-state or in other areas of California.

Our real estate loans are comprised of industrial, office, retail, single-family residences, multi-family residences, and farmland. We strive to have an original loan-to-value ratio less than 75%. This table breaks down our non-covered real estate portfolio, with the exception of construction loans which are addressed in a separate table.

 

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Table of Contents
     December 31, 2012  

Non-Covered Commercial and

SFR Real Estate Loans

(Dollars in thousands)

   Loan Balance      Percent     Percent
Owner-
Occupied (1)
    Average
Loan
Balance
 

Single-family residential—Direct

   $ 53,280         2.5     100.0   $ 362   

Single-family residential—Mortgage Pools

     106,008         4.9     100.0     260   

Multi-family

     119,055         5.4     —          1,063   

Industrial

     564,633         26.3     35.2     898   

Office

     360,074         16.8     30.2     958   

Retail

     334,696         15.6     11.0     1,307   

Medical

     128,497         6.0     37.1     1,530   

Secured by Farmland

     150,285         7.0     100.0     2,087   

Other

     332,867         15.5     48.7     1,311   
  

 

 

    

 

 

     
   $ 2,149,395         100.0     40.2     1,121   
  

 

 

    

 

 

     

 

(1) Represents percentage of reported owner-occupied in each real estate loan category.

In the table above, Single-family residential-Direct represents those single-family residence loans that we have made directly to our customers. These loans totaled $53.3 million. In addition, we have purchased pools of owner-occupied single-family loans from real estate lenders, Single-family residential-Mortgage Pools, totaled $106.0 million. These loans were purchased with average FICO scores predominantly ranging from 700 to over 800 and overall original loan-to-value ratios of 60% to 80%. These pools were purchased to diversify our loan portfolio. Due to market conditions, we have not purchased any mortgage pools since August 2007.

 

Non-Covered

Construction Loans

   December 31, 2012  
   SFR & Multi-family  
(Dollars in thousands)    Land Development            Construction            Total         

Los Angeles County

   $ 2,818         62.1   $ —           —        $ 2,818         56.0

Inland Empire

     493         10.9     —           —          493         9.8

Central Valley

     478         10.5     496         100.0     974         19.3

Orange County

     —           —          —           —          —           —     

Other Areas (1)

     748         16.5     —           —          748         14.9
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 4,537         100.0   $ 496         100.0   $ 5,033         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Nonperforming

   $ —           —        $ —           —        $ —           0.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     Commercial  
     Land Development            Construction            Total         

Los Angeles County

   $ 663         8.5   $ 23,987         51.2   $ 24,650         45.1

Inland Empire

     4,392         56.1     12,206         26.0     16,598         30.3

Central Valley

     2,767         35.4     10         0.0     2,777         5.1

Orange County

     —           —          —           —          —           —     

Other Areas (1)

     —           —          10,663         22.8     10,663         19.5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 7,822         100.0   $ 46,866         100.0   $ 54,688         100.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Nonperforming

   $ —           —        $ 10,663         22.8   $ 10,663         19.5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Other areas include loans that are out-of-state or in other areas of California.

As of December 31, 2012, the Company had $59.7