CVB Financial Corp.

Moat: 2/5

Understandability: 1/5

Balance Sheet Health: 4/5

CVB Financial Corp. is a California-based bank holding company operating primarily through its subsidiary, Citizens Business Bank, offering a wide range of banking services and products, mainly in Southern and Central California.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

CVB Financial Corp. (CVBF) is a California-based financial institution primarily operating as Citizens Business Bank, a wholly-owned subsidiary. They have a long history and have established presence across Southern and Central California, serving small to medium sized businesses, as well as professional and individual clients. CVBF’s core operations center around providing financial services to individuals and businesses, which includes a blend of lending, deposit-taking, and wealth management services. Their success is dependent on a number of factors: including overall economic health of California, interest rate regime, and their efficiency and financial strength. The Company has been able to maintain high capital ratios, and consistently generates a positive economic spread (a measure of its profitability in lending business).

  • Revenue Distribution: The primary revenue streams for CVBF are net interest income, fees and commissions, and trading gains. Net interest income is generated from the difference between interest earned on loans and investments, and the cost of interest-bearing liabilities. Fee and commission income comes from services such as wealth management, trust administration, and transaction services. Trading income is often a small and more volatile contributor, based on market condition, the market position of trading instruments, and gains or losses on sales of financial assets and investments.
  • Industry Trends: The banking industry, especially regional banks like CVBF, is facing several trends. Firstly, the interest rate regime affects their profitability. The rising interest rates help generate higher interest income but also reduces the value of their fixed income securities. Further, they also put pressure on deposit rates and also increase the chance of defaults on their loans. The ongoing competition between different banks for lending and deposits is intense. Increased regulatory scrutiny and the changing regulatory landscape also adds uncertainty and cost in banking. Then, rapid digitization is forcing banks to invest heavily in technology. And lastly, the overall economic and credit health of California is very important for CVBF’s prospects.
  • Margins: CVBF has historically maintained a strong operating performance because of its high quality loan book and prudent lending principles. They have demonstrated very high net interest margins compared to other regional banks. However, as mentioned above, margins can fluctuate based on the interest rates environment. There is high volatility in this region, which makes consistency difficult.
  • Competitive Landscape: The banking industry is crowded, with a mixture of national, regional, and local players. CVBF distinguishes itself via its long-term relationships, and focus on customer service. The large banks have an edge in terms of scale and a more diverse client base and ability to cross-sell products. Online banks have an edge in technology and the ability to pay higher deposit rates. On the other side, credit unions and local banks can be more competitive with high-relationship approach. Local banks also have an edge in the local market and understanding the customers of the local regions. Regional banks like CVBF are more of the hybrid type. They have more reach and resources than local banks and credit unions, but also have a more personal touch than national players and can better compete with them in their chosen markets.
  • What Makes CVBF Different: CVBF is focused on a business banking approach. The company focuses heavily on providing a lot of products to businesses, including loans, financial services and wealth management products. They also have a conservative management team with very strong focus on risk management, which has allowed them to maintain low loan losses, a major factor in its favor, during normal and not so normal times.

Financial Analysis

This analysis emphasizes the latest financials released in the company’s 10-Q (for the period ending September 30, 2023) and 10K (for the year ended December 31, 2022) reports, and the most recent earnings call.

  • Income Statement:
    • Net Interest Income: Net interest income (NII) is the bank’s primary source of revenue, and it has shown some impressive gains lately, mainly on the back of higher interest rates. However, recently, this growth is slowing down as the benefits of higher interest rates are now being offset by increase in funding costs (higher deposit rates) and an increase in allowances for credit losses. In 2023, NII has ranged between $146 and $176 million.
    • Noninterest Income: Noninterest income, derived from service fees and other activities, provides an alternate source of revenue, but is relatively small and does not offset the decline in net interest margin (NIM) completely.
    • Net Income: As interest rates have increased rapidly, while interest expenses have also gradually gone up, net income has also seen an impressive growth. However, the net income is expected to reduce as the economic environment weakens and asset quality deteriorates. In 2023, net income has ranged between $100 and $130 million per quarter.
  • Balance Sheet:
    • Assets: The company’s assets are largely loans (around $11.5 billion) and investment securities (around $5.2 billion). Cash and cash equivalents are also an important part of their assets.
  • Liabilities: Liabilities are primarily deposits and borrowings. Deposits make up nearly two-thirds of its liabilities.
  • Equity: Equity levels are high. Retained earnings comprise most of the equity, which is great from the investor’s point of view. * Capital Ratios: The bank’s capital position is strong, well above the minimum requirements. The tangible common equity tier 1 capital ratio is 12.4% as of September 30, 2023.
  • Other Important Metrics:
    • Loans: Total loans make up over half of the bank’s total assets, and they have grown significantly in the past. As interest rates rise, this growth is expected to slow down. Moreover, as overall credit and economic health worsens, there will be higher loan loss provisioning, which will reduce profitability.
    • Nonperforming Loans: Nonperforming loans are a small percentage of total loans and have been relatively stable over the past year. However, these are likely to increase if the economic environment deteriorates further.
    • Return on Equity and Assets: Both ROE and ROA are high, showing profitability as well as its ability to use assets effectively. However, the overall ROE is decreasing as the costs increase.

Moat Rating

Moat: 2/5 - CVBF has a limited moat, mainly from the strong customer relationships and the local brand, but it does not have enough competitive advantage to give it a long-term wide moat.

  • Intangible Assets (2/5): CVBF enjoys a degree of customer loyalty in its local market, a product of its long-standing presence and community ties. It has some brand value and an expectation of good service. However, in banking, a good brand name alone is rarely a sustainable competitive advantage. People are mainly driven by better rates and less hassles in banking. That is why they switch banks often. It may help customer acquisition, but cannot be relied on to generate above average profitability over the long run.
  • Switching Costs (2/5): While some of CVBF’s customers, such as businesses, may face moderate switching costs due to the integration of banking services with their operations, the majority of retail banking customers have low switching costs. Banks are not exactly unique or special and transferring funds from one bank to another is relatively easy. As discussed above, people can switch banks fairly easily for a better interest rate or for convenience.
  • Network Effects (0/5): Network effects don’t apply to banks as customers are more likely to stick to larger banks, whose branches and ATM networks are large. Network effects are important for platform-based businesses like Facebook and Google where the value increases with each new user addition. This dynamic is absent in banking.
  • Cost Advantages (2/5): CVBF does have higher operating margins and lower costs than many other banks because of its very profitable business. However, there is still potential for competition and the ability of competitors to copy these practices, such as using newer, more efficient software or digital infrastructure. In short, these advantages cannot be considered as a sustainable economic moat.
  • Size Advantage(3/5): CVBF has been able to generate economies of scale due to its size which leads to lower operating costs, but those economies are easily replicated. While the number of branches give them an edge in terms of providing customer service, a lot of new banks, including online ones, have entered in the sector which removes much of that advantage.
  • Regulations (3/5): While banks are heavily regulated, this can be a competitive advantage, because it makes it more difficult for new entrants to start a bank. The regulatory structure acts like a barrier to entry. CVBF, with more than 50 years of operation, is well acquainted with the regulations. However, all these regulations are similar for everyone in the sector. There are some niche financial services areas where very specific approvals are required which would make the businesses protected. However, CVBF is a very broad and general commercial bank which does not enjoy such a moat.

Risks to the Moat and Business Resilience

The economic moat of CVBF is susceptible to a number of risks, which could affect its performance and long-term growth.

  • Macroeconomic Factors: Economic downturns and recessions can lead to higher loan defaults, lower loan demand, and reduced consumer confidence-all of which will severely impact CVBF’s business.
  • Interest Rate Risk: Fluctuations in interest rates can affect CVBF’s profitability by lowering its net interest margins, particularly since loan and deposit yields can vary. In an environment of high interest rates, they would have to pay more on deposits and would eventually lose many customers if they don’t. If interest rates fall, then NII is expected to go down because loans that were under higher rates would become less profitable.
  • Competition: The financial sector is crowded. National banks may offer more products at the scale, while online banks might offer better interest rates. This can significantly affect the customer base and revenues.
  • Regulatory Changes: Changes in the regulatory environment could significantly increase costs, which can be hard to pass on to customers, and reduce profits.
  • Technological Disruption: New technologies that enable fintech companies to give financial services easily, such as online banking apps and AI-based lending facilities, are a potent threat to CVBF. If they don’t keep up with the changes, they can lose more customers.
  • Operational Risks: IT outages, cyber security attacks, lack of qualified personnel, and loss of key employees could adversely affect the business.

Despite these risks, CVBF has shown resilience in the face of adversity. The company is well-capitalized and has strong liquidity to face future problems. The long-term growth and financial planning of the bank also helps it in planning for future uncertain events and making correct decisions. Also, as a regional bank, they are deeply familiar with the market and the customer preferences in their geographic location, which they can leverage to increase their business.

Understandability Rating

Understandability: 1/5 - CVBF operates a relatively straightforward business model. It acts as a traditional bank. Therefore, the overall business model is simple to understand.

  • Traditional Banking: Most people have an understanding of what a bank does, its main revenues from lending, and its main costs from operating and funding its operations through deposits.
  • Relatively Stable Industry: The banking industry is very stable, especially in the US. There are not many rapid changes that disrupt the businesses of banking, unlike technology.
  • Well-Established Metrics: Investors can have very easy access to a bank’s financial information and evaluate it through a number of well established metrics. * However: Despite the ease with which people can understand its operations, detailed insight into financial statements of a bank may require technical experience. The ratios are more complex and may be hard for new or casual investors.
  • Conclusion: The core workings of the bank, what it does and how it makes profits, are simple and easy to understand, hence it gets a 1/5 rating in understandability.

Balance Sheet Health Rating

Balance Sheet Health: 4/5 - CVBF has a very strong balance sheet, showing the sound and resilient nature of the business.

  • Strong Capitalization: Capital ratios are significantly higher than the regulatory minimum.
  • Low Loan Losses: Non-performing loans are low, and the bank has maintained a provision for credit losses. But this may increase in a recessionary environment.
  • Adequate Liquidity: The cash balances and assets which can be readily converted into cash are high and will help in time of trouble.
  • Asset Quality: While loan quality was fairly good in the last couple of quarters, there have been some signs of a deterioration. A downturn in the economy may also result in a higher level of charge-offs.
  • Liability Maturity: Liabilities are predominantly deposits that are a long-term source of stable funding. And also, the maturities of liabilities is well spread out.

Recent Concerns

There have been some concerns highlighted by analysts in recent earnings calls.

  • Slowdown in Loan Growth: The higher interest rates and economic uncertainty have led to the slow down in new loan originations. This may affect the overall growth and profitability for the coming quarters.
  • Increase in Loan Loss Provisions: The management is expecting a potential increase in credit losses as the economic situation may worsen. This will hurt profitability and may also lead to reduced overall NII.
  • Cost Pressures: Competition for deposits is heating up as new banks start to increase deposit rates. Also, the operating costs of the bank have been increasing steadily. All these are negatively impacting the margin and profitability.
  • Management Commentary: The management is very cautiously optimistic about the future. Their main focus is on risk management and building up capital. While they are looking for expansion, the pace has significantly slowed down due to overall uncertainty in the macro economy.

Summary

CVBF has a decent business with some limited moat driven by its local customer relationships. It has a stable business model and conservative management team. However, in the current environment, they are likely to be affected by slowdown in lending, and increased losses and expenses. These trends are going to negatively impact its profitability.