News Column

CVB FINANCIAL CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 11, 2014

The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of CVB Financial Corp. and its wholly owned subsidiaries. This information is intended to facilitate the understanding and assessment of significant changes and trends related to our financial condition and the results of our operations. This discussion and analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2013, and the unaudited condensed consolidated financial statements and accompanying notes presented elsewhere in this report. CRITICAL ACCOUNTING POLICIES The discussion and analysis of the Company's unaudited condensed consolidated financial statements are based upon its unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these unaudited condensed 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. 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 Loan Losses ("ALLL") Troubled Debt Restructurings Investment Securities Goodwill Impairment Acquired Loans Covered Loans Covered Other Real Estate Owned FDIC Loss Sharing Asset Non-Covered Other Real Estate Owned Fair Value of Financial Instruments Income Taxes Share-Based Compensation Our significant accounting policies are described in greater detail in our 2013 Annual Report on Form 10-K in the "Critical Accounting Policies" section of Management's Discussion and Analysis of Financial Condition and Results of Operations and in Note 3 to the Unaudited Condensed Consolidated Financial Statements, "Significant Accounting Policies," contained herein, which are essential to understanding Management's Discussion and Analysis of Financial Condition and Results of Operations. OVERVIEW For the second quarter of 2014, we reported net income of $25.5 million, compared with $24.5 million for the second quarter of 2013. This represents a year-over-year increase of $1.0 million, or 4.16%. Diluted earnings per share were $0.24 per share for the second quarter of 2014, compared to $0.23 for the same period of 2013. The allowance for loan losses was reduced by $7.6 million for the quarter.



On May 15, 2014, we announced the completion of our acquisition of American Security Bank ("ASB"), a Newport Beach, CA headquartered regional bank with approximately $433 million in total assets and five branch locations throughout Orange County, San Bernardino County, and Los Angeles County. Our financial statements for the second quarter include 45 days of ASB operations, post-merger.

At June 30, 2014, total assets of $7.42 billion increased $759.0 million, or 11.39%, from total assets of $6.66 billion at December 31, 2013. The increase in total assets at June 30, 2014 included $240 million in acquired loans and $30 million in acquired investment securities. Earning assets of $7.02 billion at June 30, 2014 increased $692.0 million, or 10.94%, when compared with $6.32 billion at December 31, 2013. The increase in earning assets during the first six months of 2014 was primarily due to $353.7 million increase in investment securities, a $71.0 million increase in total loans, and a $263.4 million increase in interest-earning deposits with the Federal Reserve Bank. 43



--------------------------------------------------------------------------------

Table of Contents

Investment securities totaled $3.02 billion at June 30, 2014, up from $2.67 billion at December 31, 2013. As of June 30, 2014, we had a pre-tax unrealized net gain of $41.5 million on our overall investment securities portfolio, compared to a pre-tax unrealized net loss of $16.1 million at December 31, 2013. During the second quarter of 2014, we purchased $276.4 million of MBS with an average yield of 2.14%. Our new purchases of MBS have an average duration of approximately four years. We also purchased $19.7 million in municipal securities with an average tax-equivalent (TE) yield of 3.85%. Total loans and leases, net of deferred fees and discount was $3.62 billion at June 30, 2014, compared to $3.42 billion at March 31, 2014 and $3.55 billion at December 31, 2013. Quarter-over-quarter, non-covered loans increased by $224.7 million, and covered loans decreased by $6.6 million. The increase in total loans included $240 million of loans acquired from ASB. The $224.7 million quarter-over-quarter increase in non-covered loans was principally due to increases of $206.8 million in commercial real estate loans, $23.7 million in commercial and industrial loans, and $16.6 million in construction loans. The overall increase in non-covered loans was partially offset by a $32.9 million decrease in dairy and livestock and agribusiness loans. Our dairy & livestock portfolio decreased by $37.0 million for the second quarter of 2014. The combination of higher milk prices and lower feed costs produced strong profitability for our dairy customers. This profitability led to significant paydowns on many of our customer's herd and feed lines with the Bank. Although the market for new loans remains competitive, our loan pipeline continued to build momentum throughout the quarter. Noninterest-bearing deposits were $2.96 billion at June 30, 2014, an increase of $399.2 million, or 15.57%, compared to $2.56 billion at December 31, 2013. At June 30, 2014, noninterest-bearing deposits were 52.62% of total deposits, compared to 52.41% at December 31, 2013 and 52.13% at June 30, 2013. Our average cost of total deposits for the quarter ended June 30, 2014 was 9 basis points, compared to 10 basis points for the same period of 2013.



At June 30, 2014, we had $25.8 million of junior subordinated debentures, unchanged from December 31, 2013 and June 30, 2013.

The allowance for loan losses was $61.0 million, or 1.75% of total non-covered loans at June 30, 2014, compared to $75.2 million, or 2.22%, at December 31, 2013. The $7.6 million recapture of loan loss provision during the second quarter of 2014 was primarily the result of improved credit quality. This follows a reduction of $7.5 million for the first quarter of 2014, $6.8 million for the fourth quarter of 2013, $3.8 million for the third quarter of 2013, $6.2 million for the second quarter of 2013, and zero provision for loan losses for the previous eight fiscal quarters. Our capital ratios remain well-above regulatory standards. As of June 30, 2014, our Tier 1 leverage capital ratio totaled 10.99%, our Tier 1 risk-based capital ratio totaled 17.36%, and our total risk-based capital ratio totaled 18.61%. 44



--------------------------------------------------------------------------------

Table of Contents

ANALYSIS OF THE RESULTS OF OPERATIONS

Financial Performance For the Three Months Ended For the Six Months Ended June 30, Variance June 30, YTD Variance 2014 2013 $ % 2014 2013 $ %



(Dollars in thousands, except per share amounts) Net interest income

$ 57,159$ 52,595



$ 4,564 8.68 % $ 114,101$ 107,184$ 6,917

6.45 % Recapture of provision for loan losses 7,600 6,200 1,400 22.58 % 15,100 6,200 8,900 143.55 % Noninterest income 7,050 7,695 (645 ) -8.38 % 18,548 14,440 4,108 28.45 % Noninterest expense (31,324 ) (28,248 ) (3,076 ) -10.89 % (62,481 ) (59,046 ) (3,435 ) -5.82 % Income taxes (15,001 ) (13,776 ) (1,225 ) -8.89 % (31,123 ) (22,697 ) (8,426 ) -37.12 % Net earnings $ 25,484$ 24,466$ 1,018 4.16 % $ 54,145$ 46,081$ 8,064 17.50 % Earnings per common share: Basic $ 0.24$ 0.23$ 0.01 4.35 % $ 0.51$ 0.44$ 0.07 15.91 % Diluted $ 0.24$ 0.23$ 0.01 4.35 % $ 0.51$ 0.44$ 0.07 15.91 % Return on average assets 1.45 % 1.56 % -0.11 % 1.58 % 1.47 % 0.11 % Return on average shareholders' equity 12.48 % 12.58 % -0.10 % 13.58 % 11.95 % 1.63 % Efficiency ratio 48.78 % 46.85 % 1.93 % 47.10 % 48.55 % -1.45 %



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 the periods indicated: For the Three Months Ended For the Six Months Ended June 30, June 30, 2014 2013 2014 2013 (Dollars in thousands) Interest income Interest income-accretion $ 1,467$ 3,456$ 3,174$ 7,849 Noninterest income Decrease in FDIC loss share asset (1,467 ) (3,444 ) (3,174 ) (7,467 ) Net gain on sale of OREO 19 - 19 376 Noninterest expense Legal and professional 57 (91 ) 65 (222 ) OREO write-down - (14 ) - (14 ) OREO expenses (41 ) (4 ) (46 ) (62 ) Other expenses (appraisals, and etc.) (39 ) 173 (82 ) (102 ) Net (loss) income before income tax benefit (expense) related to covered assets $ (4 ) $ 76$ (44 )$ 358 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 decrease in the FDIC loss sharing asset as well as the other noninterest income and noninterest expenses related to covered loans. The discount accretion of $1.5 million for the second quarter 2014, recognized as part of interest income from covered loans, decreased $2.0 million, compared to $3.5 million for the second quarter of 2013. This decrease was reduced by the changes in the FDIC loss sharing asset, a net decrease of $1.5 million for the second quarter of 2014, compared to a net decrease of $3.4 million for the second quarter of 2013. At June 30, 2014, the remaining discount associated with the SJB loans approximated $9.5 million. Based on the regular forecast of expected cash flows of these loans, approximately $6.9 million of the discount is expected to accrete into interest income over the remaining lives of the respective pools and individual loans, which approximates 4.3 years and 1.3 years, respectively. The FDIC loss sharing asset totaled $996,000 at June 30, 2014. 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 on the related loans, not to exceed its remaining contract life, which expires in October 2014.



Net gain on sales of OREO was $19,000 and $376,000 for the six months ended June 30, 2014 and 2013, respectively.

45



--------------------------------------------------------------------------------

Table of Contents

Noninterest expense, including OREO expenses, legal and professional expenses and other covered asset related expenses, totaled $63,000 and $400,000 for the six months ended June 30, 2014 and 2013, respectively. Gross covered loans decreased $43.2 million to $148.2 million at June 30, 2014 from $191.4 million at June 30, 2013. 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 (TE) 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. 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. See Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operation -Asset/Liability and Market Risk Management - Interest Rate Sensitivity Management included herein. The tables below present the interest rate spread, net interest margin and the composition of average interest-earning assets and average interest-bearing liabilities by category for the periods indicated, including the changes in average balance, composition, and average yield/rate between these respective periods: 46



--------------------------------------------------------------------------------

Table of Contents For the Three Months Ended June 30, 2014 2013 Average Yield/ Average Yield/ Balance Interest Rate



Balance Interest Rate

(Dollars in thousands) INTEREST-EARNING ASSETS Investment securities (1) Taxable $ 2,272,756$ 11,686 2.05 % $ 1,704,935$ 5,431 1.28 % Tax-advantaged 571,740 5,186 4.97 % 617,695 5,511 4.89 % Investment in FHLB stock 26,264 526 8.03 % 48,321 467 3.88 % Federal funds sold and interest-earning deposits with other institutions 288,103 260 0.36 % 206,912 209 0.40 % Loans held-for-sale - - 0.00 % - - 0.00 % Loans (2) 3,517,984 42,091 4.80 % 3,348,307 41,519 4.97 % Yield adjustment to interest income from discount accretion on covered loans (10,801 ) 1,467 (20,013 ) 3,456 Total interest-earning assets 6,666,046 61,216



3.80 % 5,906,157 56,593 3.98 % Total noninterest-earning assets

369,328 375,281 Total assets $ 7,035,374$ 6,281,438 INTEREST-BEARING LIABILITIES Savings deposits (3) $ 1,867,228 877 0.19 % $ 1,600,525 834 0.21 % Time deposits 691,188 345 0.20 % 702,121 324 0.19 % Total interest-bearing deposits 2,558,416 1,222 0.19 % 2,302,646 1,158 0.20 % FHLB advances and other borrowings 852,257 2,835 1.33 % 739,015 2,840 1.54 % Interest-bearing liabilities 3,410,673 4,057 0.48 % 3,041,661 3,998 0.53 % Noninterest-bearing deposits 2,735,042 2,399,930 Other liabilities 70,373 59,706 Stockholders' equity 819,286 780,141 Total liabilities and stockholders' equity $ 7,035,374$ 6,281,438 Net interest income $ 57,159$ 52,595 Net interest income excluding discount on covered loans $ 55,692$ 49,139 Net interest spread - tax equivalent 3.32 % 3.45 % Net interest spread - tax equivalent excluding discount 3.23 % 3.21 % Net interest margin 3.44 % 3.57 % Net interest margin - tax equivalent 3.55 % 3.71 % Net interest margin - tax equivalent excluding discount 3.46 % 3.46 % Net interest margin excluding loan fees 3.39 % 3.52 % Net interest margin excluding loan fees - tax equivalent 3.50 % 3.65 %



(1) Non tax-equivalent (TE) rate was 2.37% and 1.89% for the three months ended

June 30, 2014 and 2013, respectively.

(2) Includes loan fees of: $769 and $786 for the three months ended June 30, 2014

and 2013, respectively.

Prepayment penalty fees of $791 and $1,139 are included in interest income

for the three months ended June 30, 2014 and 2013, respectively.

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

47



--------------------------------------------------------------------------------

Table of Contents For the Six Months Ended June 30, 2014 2013 Average Yield/ Average Yield/ Balance Interest Rate



Balance Interest Rate

(Dollars in thousands) INTEREST-EARNING ASSETS Investment securities (1) Taxable $ 2,171,572$ 21,965 2.03 % $ 1,748,440$ 12,178 1.40 % Tax-advantaged 571,476 10,464 5.01 % 621,750 11,052 4.87 % Investment in FHLB stock 28,981 1,130 7.86 % 52,306 810 3.12 % Federal funds sold and interest-earning deposits with other institutions 278,732 505 0.36 % 149,875 344 0.46 % Loans held-for-sale 182 - 0.00 % 37 1 5.45 % Loans (2) 3,500,791 85,040 4.90 % 3,374,919 83,172 4.97 % Yield adjustment to interest income from discount accretion on covered loans (11,744 ) 3,174 (22,033 ) 7,849 Total interest-earning assets 6,539,990 122,278



3.89 % 5,925,294 115,406 4.07 % Total noninterest-earning assets

364,747 383,577 Total assets $ 6,904,737$ 6,308,871 INTEREST-BEARING LIABILITIES Savings deposits (3) $ 1,786,445 1,756 0.20 % $ 1,617,065 1,716 0.21 % Time deposits 681,535 652 0.19 % 707,004 683 0.19 % Total interest-bearing deposits 2,467,980 2,408 0.20 % 2,324,069 2,399 0.21 % FHLB advances and other borrowings 903,751 5,769 1.29 % 772,628 5,823 1.52 % Interest-bearing liabilities 3,371,731 8,177 0.49 % 3,096,697 8,222 0.54 % Noninterest-bearing deposits 2,657,203 2,361,498 Other liabilities 71,693 73,349 Stockholders' equity 804,110 777,327 Total liabilities and stockholders' equity $ 6,904,737$ 6,308,871 Net interest income $ 114,101$ 107,184 Net interest income excluding discount on covered loans $ 110,927$ 99,335 Net interest spread - tax equivalent 3.40 % 3.53 % Net interest spread - tax equivalent excluding discount 3.29 % 3.25 % Net interest margin 3.52 % 3.65 % Net interest margin - tax equivalent 3.63 % 3.78 % Net interest margin - tax equivalent excluding discount 3.53 % 3.50 % Net interest margin excluding loan fees 3.46 % 3.59 % Net interest margin excluding loan fees - tax equivalent 3.58 % 3.73 %



(1) Non tax-equivalent (TE) rate was 2.37% and 1.97% for the six months ended

June 30, 2014 and 2013, respectively.

(2) Includes loan fees of: $1,560 and $1,527 for the six months ended June 30,

2014 and 2013, respectively.

Prepayment penalty fees of $1,376 and $2,093 are included in interest income

for the six months ended June 30, 2014 and 2013, respectively.

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

48



--------------------------------------------------------------------------------

Table of Contents

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

We use certain non-GAAP financial measures to provide supplemental information regarding our performance. Net interest income for the three months ended June 30, 2014 and 2013 include a yield adjustment of $1.5 million and $3.5 million, respectively. Net interest income for the six months ended June 30, 2014 and 2013 include a yield adjustment of $3.2 million and $7.8 million, respectively. These yield adjustments relate to discount accretion on covered loans, and are reflected in the Company's net interest margin. We believe that presenting net interest income and the net interest margin excluding these yield adjustments provides additional clarity to the users of financial statements regarding core net interest income and net interest margin. For the Three Months Ended June 30, 2014 2013 Average Average Balance Interest Yield Balance Interest Yield (Dollars in thousands) Total interest-earning assets (TE) $ 6,666,046$ 63,122 3.80 % $ 5,906,157$ 58,618 3.98 % Discount on acquired covered loans 10,801 (1,467 )



20,013 (3,456 )

Total interest-earning assets, excluding SJB loan discount and yield adjustment $ 6,676,847$ 61,655 3.70



% $ 5,926,170$ 55,162 3.73 %

Net interest income and net interest margin (TE) $ 59,065 3.55 % $ 54,620 3.71 % Yield adjustment to interest income from discount accretion on acquired covered loans (1,467 ) (3,456 ) Net interest income and net interest margin (TE), excluding yield adjustment $ 57,598 3.46 % $ 51,164 3.46 % For the Six Months Ended June 30, 2014 2013 Average Average Balance Interest Yield Balance Interest Yield (Dollars in thousands) Total interest-earning assets (TE) $ 6,539,990$ 126,114 3.89 % $ 5,925,294$ 119,463 4.07 % Discount on acquired covered loans 11,744 (3,174 )



22,033 (7,849 )

Total interest-earning assets, excluding SJB loan discount and yield adjustment $ 6,551,734$ 122,940 3.78



% $ 5,947,327$ 111,614 3.78 %

Net interest income and net interest margin (TE) $ 117,937 3.63 % $ 111,241 3.78 % Yield adjustment to interest income from discount accretion on acquired covered loans (3,174 ) (7,849 ) Net interest income and net interest margin (TE), excluding yield adjustment $ 114,763 3.53 % $ 103,392 3.50 % The following tables present 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. 49



--------------------------------------------------------------------------------

Table of Contents Comparision of Three Months Ended June 30, 2014 Compared to 2013 Increase (Decrease) Due to Rate/ Volume Rate Volume Total (Dollars in thousands) Interest income: Taxable investment securities $ 1,833$ 3,318$ 1,104$ 6,255 Tax-advantaged securities (408 ) 90 (7 ) (325 ) Investment in FHLB stock (215 ) 504 (230 ) 59 Fed funds sold & interest-earning deposits with other institutions 78 (19 ) (8 ) 51 Loans HFS - - - - Loans 2,010 (1,369 ) (69 ) 572 Yield adjustment from discount accretion (1,591 ) (738



) 340 (1,989 )

Total interest income 1,707 1,786 1,130 4,623 Interest expense: Savings deposits 154 (95 ) (16 ) 43 Time deposits (9 ) 30 - 21 FHLB advances and other borrowings 872 (760 ) (117 ) (5 ) Total interest expense 1,017 (825 ) (133 ) 59 Net interest income $ 690$ 2,611



$ 1,263$ 4,564

Comparision of Six Months Ended June 30, 2014 Compared to 2013 Increase (Decrease) Due to Rate/ Volume Rate Volume Total (Dollars in thousands) Interest income: Taxable investment securities $ 2,951$ 5,504$ 1,332$ 9,787 Tax-advantaged securities (872 ) 309 (25 ) (588 ) Investment in FHLB stock (360 ) 1,227 (547 ) 320 Fed funds sold and interest-earning deposits with other institutions 297 (73 ) (63 ) 161 Loans HFS 4 (1 ) (4 ) (1 ) Loans 3,160 (1,246 ) (46 ) 1,868 Yield adjustment from discount accretion (3,666 ) (1,894



) 885 (4,675 )

Total interest income 1,514 3,826 1,532 6,872 Interest expense: Savings deposits 98 (52 ) (6 ) 40 Time deposits (53 ) 23 (1 ) (31 ) FHLB advances and other borrowings 979 (883



) (150 ) (54 )

Total interest expense 1,024 (912



) (157 ) (45 )

Net interest income $ 490$ 4,738



$ 1,689$ 6,917

Net interest income, before the provision for loan losses of $57.2 million for the second quarter of 2014 increased $4.6 million, or 8.68%, compared to the second quarter of 2013. Interest income and fees on loans for the second quarter of 2014 totaled $43.6 million, which included $1.5 million of discount accretion from accelerated principal reductions, payoffs and improved credit loss experienced on covered loans acquired from SJB. This represented a $1.1 million, or 2.46%, decrease when compared to interest income and fees on loans of $44.7 million for the first quarter of 2014, which included $1.7 million of discount accretion on covered loans, and a decrease of $1.4 million, or 3.15%, from the second quarter of 2013, which included $3.5 million of discount accretion on covered loans. Excluding the impact of the yield adjustment on covered loans, our tax equivalent (TE) net interest margin was 3.46% for the second quarter of 2014, compared to 3.60% for the first quarter of 2014 and 3.46% for the second quarter of 2013. Total average earning asset yields (excluding the discount on covered loans) were 3.70% for the second quarter of 2014, compared to 3.87% for the first quarter of 2014 and 3.73% for the second quarter of 2013. Total cost of funds of 0.26% for the second quarter of 2014, decreased 2 basis points from 0.28% for the first quarter of 2014 and decreased 3 basis points from 0.29% for the second quarter of 2013. During the first quarter of 2014, we had one non-performing commercial real estate loan that was paid in full, resulting in a $2.3 million increase in interest income. This positively impacted our net interest margin by approximately 15 basis points for the first quarter of 2014. 50



--------------------------------------------------------------------------------

Table of Contents

The average balance of total loans increased $169.7 million to $3.52 billion for the second quarter of 2014, compared to $3.35 billion for the second quarter of 2013. The increase included $128.9 million of average loans acquired from ASB on May 15, 2014. The average yield on loans (excluding the discount on covered loans) was 4.80% for the second quarter of 2014, compared to 4.97% for the second quarter of 2013. Lower rates on mortgages continued to result in refinancings during the second quarter of 2014 as we continued to see competitive pressure on rates in all classes of loans. We earned $791,000 in loan prepayment penalty fees for the second quarter of 2014, compared with $585,000 for the first quarter of 2014 and $1.1 million for the second quarter of 2013. Total average earning assets of $6.67 billion increased $759.9 million, or 12.87%, from $5.91 billion for the second quarter of 2013. This increase was principally due to a $521.9 million increase in average investment securities to $2.84 billion for the second quarter of 2014, compared to $2.32 billion for the second quarter of 2013. Total average loans, net of deferred fees and discount on covered loans, increased $178.9 million primarily due to a $210.4 million increase in average non-covered loans to $3.37 billion for the second quarter of 2014, compared to $3.16 billion for the second quarter of 2013. The increase in non-covered loans included $128.9 million of average loans acquired from ASB on May 15, 2014. Average overnight funds sold to the Federal Reserve and interest-earning deposits with other institutions also increased $81.2 million. These increases were partially offset by a $22.1 million decrease in average investment in FHLB stock. In general, we stop accruing interest on a loan after its principal or interest becomes 90 days or more past due. When a loan is placed on nonaccrual, all interest previously accrued but not collected is charged against earnings. There was no interest income that was accrued and not reversed on nonaccrual loans at June 30, 2014 and 2013. As of June 30, 2014 and 2013, we had $44.0 million and $53.4 million of non-covered nonaccrual loans, 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 $769,000 and $1.6 million for the three and six months ended June 30, 2014, respectively, compared to $786,000 and $1.5 million for the three and six months ended June, 2013, respectively. Interest income on investments of $16.9 million for the second quarter of 2014, increased $5.9 million, or 54.19%, from $10.9 million for the second quarter of 2013. Total TE yield on investments was 2.64% for the second quarter of 2014, compared to 2.24% for the same period in 2013. During the second quarter of 2014 we purchased $276.4 million in MBS with an average yield of 2.14% and an average duration of approximately four years. We also purchased $19.7 million in municipal securities with an average TE yield of 3.85% and an average duration of approximately seven years during the second quarter of 2014. Interest expense of $4.1 million for the second quarter of 2014 increased $59,000, or 1.48%, compared to $4.0 million for the second quarter of 2013. Average interest-bearing deposits increased $255.8 million to $2.56 billion for the second quarter of 2014, compared to $2.30 billion for the second quarter of 2013. The average rate paid on interest-bearing liabilities decreased 5 basis points to 0.48% for the second quarter of 2014, from the second quarter of 2013, as a result of the continued low interest rate environment experienced for the second quarter of 2014, as well as the mix of interest-bearing liabilities.



Provision for Loan Losses

We maintain an allowance for loan losses that is increased by a provision for non-covered loan losses charged against operating results. The provision for loan losses is determined by management as the amount to be added to the allowance for loan 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. The allowance for loan losses was reduced to $61.0 million at June 30, 2014, primarily as a result of improved credit quality, compared to $75.2 million at December 31, 2013. We recorded a $7.6 million loan loss provision recapture for the three months ended June 30, 2014, compared to a $6.2 million loan loss provision recapture for the same period of 2013. We believe the allowance is appropriate at June 30, 2014. We periodically assess the quality of our portfolio to determine whether additional provisions for loan losses are necessary. The ratio of the allowance for loan losses to total non-covered net loans as of June 30, 2014 and December 31, 2013 was 1.75% and 2.22%, respectively. Refer to the discussion of "Allowance for Loan Losses" in Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations, contained herein, for discussion concerning observed changes in the credit quality of various components of our loan portfolio as well as changes and refinements to our methodology. No assurance can be given that economic conditions which adversely affect the Company's service areas or other circumstances will not be reflected in increased provisions for loan losses in the future, as the nature of this process requires considerable judgment. Net recoveries totaled $839,000 for the six months ended June 30, 2014, compared to net charge-offs of $784,000 for the same period of 2013. See "Allowance for Loan Losses" under Analysis of Financial Condition 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, which expires in October 2014. Due to the timing of the acquisition and the October 16, 2009 fair value estimate, there was no provision for loan losses on the covered SJB loans in 2009. During the six months ended June 30, 2014 and 2013, there was $39,000 in net charge-offs and zero in net charge-offs or recoveries, respectively, for loans in excess of the amount originally expected in the fair value of the loans at acquisition. 51



--------------------------------------------------------------------------------

Table of Contents

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 Three Months For the Six Months Ended June 30, Variance Ended June 30, Variance 2014 2013 $ % 2014 2013 $ % (Dollars in thousands) Noninterest income: Service charges on deposit accounts $ 3,905$ 4,145$ (240 ) -5.79 % $ 7,733$ 7,971$ (238 ) -2.99 % Trust and investment services 2,133 2,072 61 2.94 % 4,058 4,077 (19 ) -0.47 % Bankcard services 923 938 (15 ) -1.60 % 1,701 1,777 (76 ) -4.28 % BOLI income 601 627 (26 ) -4.15 % 1,239 1,370 (131 ) -9.56 % Gain on sale of investment securities, net - - - - - 2,094 (2,094 ) -100.00 % Decrease in FDIC loss sharing asset, net (1,467 ) (3,444 ) 1,977 57.40 % (3,174 ) (7,467 ) 4,293 57.49 % Gain on OREO, net 130 2,568



(2,438 ) -94.94 % 135 3,132 (2,997 ) -95.69 % Gain on sale of loans held-for-sale

- - - - 5,330 - 5,330 100.00 % Other 825 789 36 4.56 % 1,526 1,486 40 2.69 % Total noninterest income $ 7,050$ 7,695$ (645 ) -8.38 % $ 18,548$ 14,440$ 4,108 28.45 %



Second Quarter of 2014 Compared to Second Quarter of 2013

Noninterest income of $7.1 million for the second quarter of 2014 decreased $645,000, or 8.38%, over noninterest income of $7.7 million for the second quarter of 2013. Noninterest income for the second quarter of 2014 decreased primarily due to a $2.5 million net pre-tax gain on the sale of one OREO property in the second quarter of 2013, partially offset by a $1.5 million net decrease in the FDIC loss sharing asset during the second quarter of 2014, compared to a $3.4 million net decrease in the FDIC loss sharing asset for the second quarter of 2013. 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. At June 30, 2014, CitizensTrust had approximately $2.46 billion in assets under management and administration, including $1.86 billion in assets under management. CitizensTrust generated fees of $2.2 million for the second quarter of 2014, compared to $2.1 million for the second quarter of 2013. 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 of $601,000 for the second quarter of 2014 decreased $26,000, or 4.15% from the second quarter of 2013.



Six Months of 2014 Compared to Six Months of 2013

The $4.1 million increase in noninterest income for the first six months of 2014 was primarily due to a $5.3 million pre-tax gain on the sale of one loan held-for-sale and a $3.2 million net decrease in the FDIC loss sharing asset during the six months ended June 2014, compared to a $7.5 million net decrease in the FDIC loss sharing asset for the same period of 2013. Noninterest income for the six months ended June 30, 2013 included a net pre-tax gain of $2.1 million on the sale of investments securities and $2.5 million net pre-tax gain on the sale of one OREO property. 52



--------------------------------------------------------------------------------

Table of Contents

Noninterest Expense

The following table summarizes the various components of noninterest expense for the periods indicated. For the Three Months For the Six Months Ended June 30, Variance Ended June 30, Variance 2014 2013 $ % 2014 2013 $ % (Dollars in thousands) Noninterest expense: Salaries and employee benefits $ 18,614$ 17,088$ 1,526 8.93 % $ 38,031$ 34,388$ 3,643 10.59 % Occupancy 2,704 2,638 66 2.50 % 5,521 5,260 261 4.96 % Equipment 972 927 45 4.85 % 1,880 1,987 (107 ) -5.39 % Professional services 1,646 1,387 259 18.67 % 3,010 2,983 27 0.91 % Software licenses and maintenance 1,010 1,163



(153 ) -13.16 % 2,075 2,315 (240 ) -10.37 % Stationery and supplies

337 366 (29 ) -7.92 % 769 843 (74 ) -8.78 % Telecommunications expense 362 312 50 16.03 % 677 634 43 6.78 % Promotion 1,341 1,140



201 17.63 % 2,607 2,398 209 8.72 % Amortization of intangible assets

193 437 (244 ) -55.84 % 315 875 (560 ) -64.00 % OREO expense 113 33 80 242.42 % 138 363 (225 ) -61.98 % Regulatory assessments 997 865 132 15.26 % 1,958 1,755 203 11.57 % Loan expense 321 150 171 114.00 % 558 813 (255 ) -31.37 % Acquisition related expenses 638 - 638 100.00 % 1,065 - 1,065 100.00 % Other 2,076 1,742



334 19.17 % 3,877 4,432 (555 ) -12.52 %

Total noninterest expense $ 31,324$ 28,248 $



3,076 10.89 % $ 62,481$ 59,046$ 3,435 5.82 %

Noninterest expense to average assets 1.79 % 1.80 %

1.82 % 1.89 % Efficiency ratio (1) 48.78 % 46.85 % 47.10 % 48.55 %



(1) Noninterest expense divided by net interest income before provision for loan

losses plus noninterest income.

Second Quarter of 2014 Compared to Second Quarter of 2013

Our ability to control noninterest expenses in relation to asset growth can be measured in terms of total noninterest expense as a percentage of average assets. Noninterest expense measured as a percentage of average assets was 1.79% for the second quarter of 2014, compared to 1.80% for the second quarter of 2013. Our ability to control noninterest expenses in relation to the level of total revenue (net interest income before provision for loan losses plus noninterest income) is measured by the efficiency ratio and indicates the percentage of net revenue that is used to cover expenses. For the second quarter of 2014, the efficiency ratio was 48.78%, compared to 46.85% for the second quarter of 2013. Noninterest expense for the second quarter of 2014 increased $3.1 million, or 10.89%. The overall increase was primarily due to a $1.5 million increase in salaries and employee benefits, principally due to increased new hire expenses, other employee benefits, and expenses related to new associates acquired through ASB. The second quarter of 2014 included $638,000 for non-recurring merger related expenses in connection with our acquisition of ASB.



Six Months of 2014 Compared to Six Months of 2013

The $3.4 million increase in noninterest expense for the six months ended June 30, 3014 was primarily attributable to increases of $3.6 million in salaries and employee benefits expense and $1.1 million for non-recurring acquisition related expenses. The increases were partially offset by decreases of $560,000 in intangible amortization expense, $255,000 in loan expense, $240,000 in software licenses and maintenance, and $555,000 in other expenses. Other expense for the six months ended June 30, 2013 included a $1.0 million accrual for potential interest and penalties associated with previous years' federal and state income tax returns.



Income Taxes

The Company's effective tax rate for the three and six months ended June 30, 2014 was 37.05% and 36.50%, respectively. This compares to 36.02% for the second quarter of 2013. Our estimated annual effective tax rate varies depending upon tax-advantaged income as well as available tax credits. We benefited from approximately $1.1 million of enterprise zone tax credits reflected during the first half of 2013, many of which have been eliminated in 2014. The effective tax rates are below the nominal combined Federal and State tax rate as a result of tax-advantaged income from certain investments and municipal loans and leases as a percentage of total income as well as available tax credits for each period. The majority of tax-advantaged income is derived from municipal securities. 53



--------------------------------------------------------------------------------

Table of Contents

RESULTS BY BUSINESS SEGMENTS We have two reportable business segments: which are (i) Business Financial and Commercial Banking Centers ("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 loan losses or taxes in the segments as these are accounted for at the corporate level. Key measures we use to evaluate the segments' performance are included in the following table for the three and six months ended June 30, 2014 and 2013. These tables also provide additional significant segment measures useful to understanding the performance of this segment.


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters