How a Good Customer Became Liability

A seemingly solid lending relationship can get dangerously big. Chris Myers, president and chief executive of CVB Financial Corp., learned this lesson the hard way.

CVB started 2010 as one of the nation's top-performing banks, one that was allowed to buy a failed competitor. By the end of the year, CVB was largely on the defensive as it dealt with an informal inquiry from the Securities and Exchange Commission and the souring of an $82 million lending relationship.

CVB also faces litigation from shareholders, largely due to a dive in the stock price after the SEC action was disclosed in August.

Myers said in an interview Wednesday that CVB should never have let its biggest borrower get above $40 million in loans. Still, he said, "We weren't perfect through the recession, but we did a pretty damn good job in my opinion."

CVB, in Ontario near Los Angeles, said last week that it sold six of the seven loans tied to its biggest lending relationship. The sale netted $41 million, or about 4% less than what the loans were written down to and roughly half their principal balance. Now, CVB's largest loan is on the books at $38 million.

Analysts by and large still have positive things to say about CVB. Many of them said they do not understand why the company is taking so much heat from the SEC and certain investors when it continues to outperform other community banks.

"They've historically been a very solid institution, well managed, and they have a good board," said Aaron James Deer, an analyst at Sandler O'Neill & Partners LP. "I don't know of anything that has been quite so extreme" as the scrutiny CVB has received.

Myers said he understands some of the market's skepticism about CVB, given its location and its focus on commercial real estate.

"We're the largest Inland Empire-based bank next to the four that have all been taken over by the FDIC," he said. "That fact alone has caused people to look at us strangely when the next four local competitors have all failed."

CVB's was also among the most heavily shorted bank stocks in recent years. Short interest once accounted for almost 20% of its outstanding shares. It now makes up about 15%. Analysts said the short sellers were betting that CVB would incur bigger losses, given the fact that its largest client is a developer and the bank's concentration in Southern California.

CVB's recent bulk loan sale took a lot of that expected loss from the shorts away, said Joe Gladue, a senior analyst at B. Riley & Co.

"The fact that somebody bought the loans at such a modest discount to what they were currently held at indicates the bank has been doing fairly well, considering where they're located," he said.

CVB, founded by a dairy family, has predominantly been a CRE lender. Its specialty is financing owner-occupied properties.

Its largest lending relationship was with Garrett Group LLC, a development firm. The client's loans grew over a 12-year period, and at one point Garrett was CVB's most-profitable client, Myers said.

After Garrett defaulted, the relationship accounted for about 30% of the CVB's nonperforming loans. (According to regulatory filings, some of the issues stemmed from vacancies that constricted the borrower's cash flows.)

Myers said CVB does not plan on shifting away from its core commercial loan focus despite pains felt from lending in Southern California's real estate market. After losing $36 million on a single relationship, Myers is wary of letting the exposure to any client get too large.

Many bankers with real estate-related relationships could say the same. For example, Synovus Financial Corp. in Columbus, Ga., had lent up to $300 million to Sea Island Co. in Georgia, which filed for Chapter 11 bankruptcy in August.

Synovus began recognizing Sea Island's struggles in early 2009 by placing $220 million of its loans in nonaccrual status, which triggered several lawsuits that are still pending.

The suits primarily allege that Synovus misrepresented or failed to disclose material facts about its credit quality and its recording of impaired loans, including with Sea Island. By mid-December 2009 the SEC informed Synovus that it was conducting an informal inquiry into whether there was a violation of federal securities laws.

The process was reversed in CVB's case, where the suits were not filed until after CVB announced the SEC informal inquiry in August and its stock price fell more than 20% in a week. The suits were recently consolidated with the Jacksonville Police and Fire Pension Fund as lead plaintiff.

The consolidated complaint filed in March largely points to the Garrett relationship, accusing CVB of not recognizing problems early enough or disclosing them to investors, as well as to the SEC probe.

Gladue said CVB's increased reserves for that relationship prior to disclosing the SEC probe, coupled with its bulk loan sale, undermine the plantiffs' case. CVB has until May 13 to file a motion to dismiss the case.

Analysts wonder what sparked the SEC inquiry in the first place, and why it is targeting CVB's loan-classification methodology, something that is typically handled by the regulators. If the SEC wants to drill down on loan problems, analysts said, why wouldn't it start with banks under regulatory orders for the same problems, instead of one deemed healthy enough to buy failed banks?

"The regulators are in the bank at least once a year. They would know if there's a problem before anyone else does," said Tim Coffey, an analyst at FIG Partners LLC.

Myers said CVB was also examined by its regulators a few months before the inquiry. While he declined to discuss the lawsuit, he said there was a reason CVB opted to declare the loans impaired after revealing the SEC probe. That decision came after Garrett told CVB it did not have the cash flow to make payments. Before that, when CVB was collecting both principal and interest, Myers said it added about $25 million to reserves because of the decline in the value of the loans' collateral.

Now that its largest problem is mostly off the books, Myers said one of the most critical goals is to continue reducing nonperforming assets and making smaller commercial loans and strategic bank acquisitions.

"Our No. 1 goal is just to make sure we continue to build the bank in a quality way," he said. "A lot of banks have figured out how to put on quality assets … but we also want to make sure we put on the right earning assets."