Saturday, July 18, 2009

CVB Financial: Turnaround In The Making?

[Note: Corrected dividend amount. Rate was accurate.]

Last week was a wild one for CVB Financial. On Monday, it was one of the few bank stocks to sink to a 52-week low. Its October low was $9.51, as made on October 9th; its March low was $5.62, as made on March 9th. As of Wednesday, a technical analyst would have looked at the chart and said "avoid." There was no sign, fundamental or technical, that CVB Financial's prospects weren't going to be eroded by the current California gloom.

This impression changed flat-out when CVB announced its 2Q earnings on Thursday. According to the press release filed with the SEC, CVB earned 17 cents in the second quarter. Although its 2Q '09 earnings dropped 19.0% from 2Q '08's, and reduced its 12-month trailing EPS from 69 cents to 65 cents, the 12.8% gain the stock made last Thursday suggests that the market has been overdiscounting CVB as of late. The effect of Thursday's earnings surprise would even make a flexible technical analyst reconsider its prospects.

CVB is a bank holding company whose operating arm is Citizens Business Bank. Citizens plys its trade in several counties in California, a state that's going through a rough patch now. Its largest category of loans, as of June 30th, was commercial real estate: 54.2% of its gross loan portfolio. Far in second was dairy and livestock (11.2%), and commercial & industrial was a close third (10.3%). All other categories of loans, including single-family real estate and real-estate construction loans, each make up less than 10% of its gross loan portfolio. The predominance of commercial real estate loans explains why CVB's been panned: commercial real estate has been widely pinpointed as the next bubble to burst, and CVB is located in California.

Its earnings have already suffered somewhat over the last year. CVB's 1Q '09 (diluted) EPS was down 36% from 1Q '08's. 4Q '08's were down 12.5% from 4Q '07's. On the other hand, 3Q '08's were up 10.5% from 3Q '07's, and 2Q '08's were up 16.7% over 2Q '07's. 1Q '08's were flat with respect to 1Q '07's. These six quarters, including the above-mentioned 2Q '09, run the gamut of the current recession.

Of course, CVB may be in for an earnings shock. It seems to be an unlikely candidate for one, though. Its 10-year average earnings (1999-2008) is 55 cents. EPS growth over ten years, as measured by logarithmic regression, is 9.93%. This makes CBV an S&P beater, but not by much. Its 10-year return on equity is 16.61%.

More to the point, though, the standard deviation for its 1999-2008 annual earnings is only 18 cents. That's less than 30% of its current 12-month trailing earnings, suggesting that its earnings haven't been on that much of a roller-coaster ride in the last decade. Over those ten years, its earnings only dropped once from the previous year: 2007's decline of 13.3% from 2006's. 2009 looks like it's going to be a another decliner year: the current 12-month trailing earnings of 65 cents are currently 13.3% (10 cents) below the corresponding 12-month trailing earnings of one year ago. That's the same figure as for its worst full fiscal year in the last 10. There's no hint that EPSs are going to turn up as of yet, relative to same-period a year earlier, but the pace of decline has been moderating. CVB's return on average assets (ROAA) has slumped, but 2Q '09's 0.99% is better than its ROAA for the first half of '09. The same moderation applies to its return on average equity and its efficiency ratio. All three metrics are down in 2Q '09 with respect to 2Q '08, but all are up from 1Q '09's figures. Despite this quater-to-quarter improvement, management increased the loan-loss-allowance to non-performing-loan ratio from 1Q '09's 137% to 2Q's 146%.

If there's any lurking commerical real estate earnings-eater in CVB's portfolio, it must be hiding well. Although CVB's total non-performing loans quadrupled from $12.3 million at June 30 '08 to $51.3 million at June 30 '09, and show no sign of decreasing, all but $12.6 million come from residential construction and land loans ($17.4 million) and commercial construction loans ($21.3 million). Only $7.0 million in commercial real estate loans are non-performing as of June 30th. This means that only 0.356% of its extant commerical real estate portfolio was non-performing as of the end of '09's second quarter. The troubles CVB's had come primarily from the same areas splayed all over the financial headlines these past nine months.

There is, however, a possibility that CVB may be in for further trouble. As noted above, management did increase the provisions-to-nonperforming ratio in 2Q. There may be some trouble from commercial real estate loans in the near future. It does have its hand in some municipal finance receivables. Although this category comprises only 4.57% of its gross loan portfolio, and currently has no non-performing loans, it could have some in the near future given the State of California's budgetary woes. As noted above, CVB's overall non-performing loans are still increasing. They may not be out of the woods yet, suggesting that an investor now will have to wait for some time for CVB to recover. So, its valuation metrics have extra relevance.

As of June 30th, CVB's book value was $6.44 per share. If accumulated other comprehensive tax-netted income is included in shareholder's equity, its book value is $6.86. Its close on Friday, $6.20, is below both figures. The company is far from being a dollar selling at fifty cents, though; its price is barely below book.

Its dividend is 8.5 cents per share quarterly, or 34 cents annually. At Friday's closing price, the stock yields 5.48%. Its current payout ratio, relative to 12-month trailing earnings as of 2Q '09, is 55.4%. In contradistinction to its 1Q earnings drop, cash flow from operations was up by 50.0% from 1Q '08. Free cash flow was up 53.3%. If changes in working capital are held constant, free cash flow was up 9.63% from 1Q '08 to 1Q '09. There are no available figures for 2Q '09 as of yet, but the figures currently available show a well-covered dividend. CVB did not cut its dividend during the last twelve months, nor was there any pressure for it to do so even in 1Q '09. Over the last four years (2005 to 2008) CVB's free cash flow has averaged 247% of its dividend payouts. In 1Q '09, free cash flow was 377% of dividend disbursements. There's evidently a good free-cash-flow margin of safety with respect to the dividend. Nor are there any immediate threats evident in 2Q '09's results press release.

From the above, a picture of CVB can be formed. It hasn't been a big grower, but its moderate EPS growth goes with a relatively non-volatile earnings distribution. If the 18-cent standard deviation for the last ten years is an accurate representation, then there's only a 5.4% chance that its 12-month trailing earnings will fall further to reach its 36-cent dividend payout. Although CVB has had its troubles recently, which have not yet started to reverse, there is no emergent black swan in its most current financials.

To sum up: CBV is a frowned-upon bank holding company that's recently had a positive earnings surprise. It's currently, although slightly, selling below book value. It isn't a fast grower, but its earnings have not been that volatile over the past decade. Its non-performing loans have shot up in the last year, to 1.42% of total loans from 0.35% as of a year earlier, but its earnings decline and credit deterioration are currently moderating. Its dividend yield is 5.48%, and the dividend has a large free-cash-flow margin of safety. There is little current evidence of any real trouble in its predominant loan category, commercial real estate. At Friday's close of $6.20, and its 1999-2008 10-year average EPS of 55 cents, its P/E ratio is 11.27 for those earnings. Its 10-year EPS growth rate of 9.93% is below that P/E, but not by much. Its current P/E of 8.99 is below that rate, although not by much.

I can't say that CVB is a real bargain for a deep value investor, as it's selling at about book. But I can say that it's an apparent promising turnaround candidate, although a definite answer will have to be supplied by the reader.

Note: I should add that I'm not licensed to act as an investment advisor in my home jurisdiction of Ontario, Canada, nor am I qualified to be so.

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