CVB Financial Corp (CVBF) 2011 Q2 法說會逐字稿

Good morning, ladies and gentlemen, welcome to the second quarter 2011 CVB Financial Corp. and its subsidiary, Citizens Business Bank, earnings conference call. My name is Amy and I'm your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer period. (Operator Instructions)

I would now like to turn the presentation over to your host for today's call, Christina Carrabino. You may proceed.

Thank you, Amy and good morning, everyone. Thank you for joining us today to review our financial results for the second quarter of 2011. Joining me this morning is Chris Myers, President and Chief Executive Officer; and Rich Thomas, Executive Vice President and Chief Financial Officer.

Our comments today will refer to the financial information that was included in the earnings announcement released last night. To obtain a copy, please visit our website at www.cbbank.com and click on the CBB Investors tab.

Before we get started, let me remind you that today's conference call will include some forward-looking statements. These forward-looking statements relate to, among other things, current plans, expectations, events, and industry trends that may affect the Company's future operating results and financial position. Such statements involve risks and uncertainties, and future activities and results may differ materially from these expectations.

The speakers on this call claim the protection of the Safe Harbor provisions contained in the Private Securities Litigation Reform Act of 1995. For a more complete discussion of the risks and uncertainties that may cause actual results to differ materially from our forward-looking statements, please see the Company's Annual Report on Form 10-K for the year ended December 31, 2010 and in particular, the information set forth in item 1A, Risk Factors therein.

Now, I will turn the call over to Chris Myers.

Thanks, Christina. All right. Good morning, everyone, and thank you for joining us again this quarter. Last night, we reported record earnings of $21 million for the second quarter of 2011, up 26.7% from $16.6 million for the first quarter of 2011 and up 10.6% from $19 million for the second quarter of 2010. This is the best quarter in our Company's history. Our next highest quarter was the third quarter of 2009 with reported earnings of $19.3 million.

Earnings per share were $0.20 for the second quarter compared with $0.16 per share for the first quarter and $0.18 for the year-ago quarter. These increases were largely due to, number one, improvement in the performance of our loan portfolio, which I'll talk more in-depth about later; number two, our ability to continue to grow our non-interest-bearing deposit base and lower our overall cost to deposits; and three, expense control.

Through the first six months of 2011, we earned $37.6 million, up 7% from the same period in 2010. Earnings per share were $0.35 for the six-month period ended June 30, 2011 compared with $0.33 per share for the same period in 2010.

The second quarter was our 137th consecutive quarter of profitability and 88th consecutive quarter of paying a cash dividend to our shareholders.

Now, let's talk about loans. Let's begin with our non-covered loan portfolio. Classified loans and non-performing assets declined in the second quarter. This represents the third straight quarter we have experienced a decline. We have been aggressively working through our problem loans and believe the quality of our loan portfolio has improved.

We reported zero provision for loan and lease losses for the second quarter. The allowance for loan and lease losses was $96.9 million or 3.04% of outstanding loans at June 30, 2011 compared with $101.1 million or 3.11% of outstanding loans at March 31, 2011.

Net charge-offs for the second quarter were $4.2 million compared with $11.2 million for the first quarter. We believe we've made tremendous progress over the past six months. In total, our non-performing assets, defined as non-covered, non-accrual loans plus Other Real Estate Owned, totaled $88.8 million at June 30, 2011, a decrease of $25.6 million from $114.4 million at March 31, 2011 and a decrease of $73.5 million from $162.3 million at December 31, 2010.

At June 30, 2011, we had loans delinquent 30 to 89 days of $3.9 million or 0.12% of total non-covered loans. Classified loans decreased substantially for the second quarter to $445.3 million compared with $588.7 million for the prior quarter and $654.1 million for year-end 2010.

Of the $143.4 million decrease from the first quarter to the second quarter, $92.9 million can be attributed to our dairy and livestock loan portfolio. Upgrades in the dairy and livestock loan portfolio are primarily a result of improved profitability and cash flow, as reflected in many of our dairy customers' 2010 year-end and 2011 first quarter financial statements. We will have more detailed information on classified loans available in our second quarter 10-Q.

Performing troubled debt restructured loans or TDRs increased $20.9 million for the second quarter to $32.8 million compared with $11.9 million for the prior quarter.

During the second quarter, two of our troubled debt restructured borrowers, totaling $17.1 million in loans between the two, that had previously sought bankruptcy protection were returned to full accrual status. We did this because the bankruptcy plans for these credits were approved, payments were being made during the bankruptcy proceedings, new tenant leases were obtained during the proceedings, and current financial statements and rent-rolls demonstrated the borrowers' ability to continue meeting their debt obligations under our restructured agreements with them. These two loans currently carry an interest rate of 5% and 5.25% respectively.

We had $3.5 billion in total loans and leases at the end of the second quarter, a decline of $68 million from the end of the first quarter. A total of $41 million out of this $68 million decrease is due to our ongoing success in reducing our exposure to three non-core lending categories; number one, mortgage loan pools; number two, non-covered construction loans; and number three, problem covered loans.

In terms of loan demand and future loan growth, we're starting to see some positive momentum in new loan originations in our new business pipeline. However, we remain cautious in our optimism, as pricing competition is tough, particularly for the quality product we are seeking.

The dairy and livestock industry continues to show signs of improvement. Milk prices are up and beef prices are up, which have helped improve profitability and cash flow. However, we remain cautiously optimistic regarding this industry, as grain and hay prices continue to remain at historically high levels. In looking forward, we believe dairies that have the ability to control their feed cost and/or grow a significant portion of their own feed are at a competitive advantage.

Now, we will discuss covered loans. Covered loans represent loans in which we have loss-sharing protection from the FDIC as a result of our acquisition of San Joaquin Bank in October 2009. At June 30, 2011, we had $407.7 million in total covered loans, resulting from the San Joaquin Bank acquisition. These loans have a carrying value of $334.2 million.

We are working hard to resolve our problem covered loans. During the second quarter of 2011, we recognized $5.7 million of accelerated accretion on this portfolio compared with $2 million of accelerated accretion for the first quarter of 2011.

From an accounting standpoint, we expense all costs associated with our monitoring and collection efforts for these loans until such time we can demonstrate a loss on specific loans. Credit costs are covered by our loss-sharing agreement with the FDIC to the extent we incur a loss on a specific loan. From a logistics standpoint, we're required to file a loss-sharing report within 30 days at the end of each quarter, requesting reimbursement of these costs.

Now, when you look at this $5.7 million of accelerated accretion for the quarter, that doesn't tell us the truth, the whole complete story of what we're actually getting in terms of earnings from the covered loans. You have to deduct other things, which we'll talk about a little bit here too, like our loss this quarter of $1.7 million in loss sharing -- in the FDIC loss share asset.

We also had an OREO write-down of $1.3 million on covered loans and expenses of $126,000 and then we had legal and professional expenses of about $800,000 as well. So the net pre-tax impact of all this stuff put together for non-covered loans for the second quarter of 2011 was about $1.6 million to our benefit. But don't think it's a $5.7 million benefit, it's really a $1.6 million benefit, after all the noise is taken out.

Now, I'd like to discuss our deposit portfolio. We continue to grow our non-interest-bearing deposits. For the second quarter, our non-interest-bearing deposits grew to $1.89 billion, an increase of $77 million or 4% from March 31, 2011. Non-interest-bearing deposits now represent over 42% of our total deposits. We believe our non-interest-bearing deposits are a critical source of funds, as these deposits are more likely to stick with us when interest rates rise sometime in the future.

Total deposits were flat quarter-over-quarter as we continue to be disciplined in managing our overall deposit cost. We are not taking deposits for deposit sake, so to speak. We're not -- we'll increase our deposits as long as we think they are sticky, good core deposits.

Our total cost of deposit for the second quarter was 20 basis points compared with 25 basis points for the quarter ended March 31, 2011. The bank also considers customer repurchase agreements as an important source of funding. Customer repurchase agreements consist of an interest-bearing sweep account that is primarily utilized to provide individual business customers with interest on their excess deposits.

Total customer repurchase agreements at June 30, 2011 were $535 million compared with $578 million at March 31, 2011. The average cost of customer repurchase agreements was 37 basis points for the second quarter compared with 42 basis points for the first quarter.

Now, let's talk about non-interest income. Non-interest income was $6 million for the second quarter of 2011 compared with $10 million for the first quarter of 2011. In the second quarter, non-interest income was negatively affected by two primary issues. Number one, a reduction in the FDIC loss-sharing asset of $1.7 million compared to an increase in the FDIC loss-sharing asset of $1.4 million for the first quarter, for a total impact of $3.1 million.

And two, a $1.7 million loss related to a held-for-sale loan. This held-for-sale problem loan was on our balance sheet for several quarters. There have been legal proceedings regarding the lien position on this real estate secured loan.

Recently, a preliminary decision by the court found that our lien position was not in a first priority position. After careful analysis of the preliminary court decision and valuation of the subject collateral, we wrote off the remaining carrying amount of $1.7 million. We are currently evaluating our future options regarding this preliminary ruling and may appeal, but that loan has been written down to zero.

Our overall non-interest income was positively impacted by continued revenue growth in our Citizens Trust division, which produced income of $2.3 million for the second quarter of 2011 compared with $2.2 million for the first quarter.

Now, expenses. Non-interest expense for the second quarter of 2011 was $37.2 million compared with $36.3 million for the first quarter of 2011 and $41.4 million for the second quarter of 2010. The increase over the first quarter is primarily due to an increase in professional services expense, which totaled $5 million for the second quarter, up $1.4 million from the first quarter.

The majority of the professional services expense is related to continued legal costs associated with our SEC inquiry and litigation matters, and credit costs associated with loan workouts and foreclosures.

One of our main goals for 2011 is expense control. We continue to closely monitor and manage other non-interest expense items and have seen recent improvement, I guess, except for the legal cost side.

Our effective tax rate was 32.6% for the second quarter, higher than the prior quarter's 30%. The increase is due to higher estimated total income levels.

Now, I would like to turn the call over to Rich Thomas to discuss our investment portfolio and our overall capital position. Rich?

Thanks, Chris. Good morning, everyone. During the second quarter of 2011, we provided an average of approximately $260 million in overnight funds to the Federal Reserve and received a yield of approximately 25 basis points.

At June 30, 2011, investment securities totaled $2 billion, down $38.8 million from the first quarter of 2011 and up $187 million from the fourth quarter of 2010. Investment securities represent approximately 31% of our total assets.

Our available-for-sale investment portfolio continued to perform well. At June 30, 2011, we had an unrealized gain of $43 million, up from $15 million in the prior quarter. We have no preferred stock or trust preferred securities in our portfolio.

Virtually all of our mortgage-backed securities are issued by Freddie Mac or Fannie Mae, which have the implied guarantee of the US government. We have eight private-label mortgage-backed securities totaling $6.3 million. We have been strategically reinvesting our cash flow from our investment portfolio, carefully weighing current rates and overall interest rate risk.

During the second quarter, we purchased $20.7 million in mortgage-backed securities with an average yield of 2.98%. And $13.9 million in municipal securities with an average yield of 5.44%. We maintain a neutral position at the short end of the Treasury curve by reinvesting in mortgage-backed securities, with an average duration of about 3.5 years to avoid material extension risk as interest rates rise.

Now, turning to our capital position, we paid out approximately $9 million in cash dividends during the second quarter of 2011. Despite this, shareholders' equity increased by $29.1 million to $683.7 million for the quarter. Our capital ratios are all well above regulatory standards and above our peer group average.

Our capital ratios at March 31, 2011 are summarized as follows. Tier-1 risk-based capital ratio was 17%. Total risk-based capital ratio was 18.4%. Tier-1 leverage ratio was 10.8%. Tangible capital ratio was 9.2%. Our June 30, 2011 capital ratios will be released concurrently with our second quarter Form 10-Q. We anticipate these ratios to be at or above their March 31, 2011 levels.

I will now turn the call back to Chris for some closing remarks.

Thanks, Rich. In terms of the California economy, we continue to see modest improvement. We feel activity is picking up in the commercial real estate sector, but prices remain relatively stagnant. As business owners expand their businesses, many prefer to enter into short-term commercial leases as opposed to purchasing real property. This provides them with more flexibility in a still uncertain economy.

However, as conditions improve, and hopefully they will, we anticipate landlords will demand longer-term lease contracts, which may result in increased purchasing activity, as business owners will see the logic in owning versus renting, particularly in a low fixed rate borrowing environment. For now, leasing appears to be preferred over buying in commercial real estate.

We frequently conduct client lunches in our boardroom as a way to gather feedback from our many small-to-medium-sized privately held business owners. Typically, we'll have eight to ten business owners around our boardroom table discussing the current economy and overall business environment. We go around the table one by one and ask each of the owners to provide their thoughts on the economy and their company's current growth and profitability trends.

For the median business owner, sales and profits are up over the past 12 months. However, these same business owners remain cautious about committing themselves to large capital expenditures and/or a major expansion of their workforce. They remain uncertain about ongoing healthcare costs, California's financial difficulties, global economic unrest and future tax rates.

So, by and large, our clients see improvement in their own businesses year-over-year, but question the sustainability of this improvement given the aforementioned uncertainties.

In general, California housing prices have not improved quarter-over-quarter and unemployment remains relatively unchanged in the state. Looking forward, according to data provided by local economists, unemployment will decline modestly over the next year and single-family home prices will remain relatively static with a slight overall increase. So we anticipate more of the same sluggishness for the next few quarters, maybe a little bit better.

In terms of our acquisition strategy, we continue to look at opportunities in or adjacent to our current footprint. We will consider both FDIC-assisted and conventional M&A deals. Based on general industry knowledge today, we are optimistic that industry M&A activity will accelerate sometime in the next 12 to 18 months. We are presently positioning our Company to take advantage of consolidation opportunities within our footprint.

In summary, we're extremely proud that we achieved record earnings for the second quarter of 2011. And as we head into the final six months of 2011, our strategic focus remains unchanged; quality loan growth, non-interest-bearing deposit growth, non-interest income growth and expense control.

Well, that concludes today's presentation. Now, Rich and I will be happy to take any questions that you might have.

(Operator Instructions) Todd Hagerman, Sterne Agee.

Good morning, everybody. Chris, just a couple of questions on the credit side. You mentioned the improving trends in terms of classified assets. Wondering if you could just give us a little bit more flavor for -- if I think about the paydown in the dairy portfolio, the reduction in the mortgage pools again this quarter, how should I think about, in particular, the level of substandard from March, which was exceptionally high and how that would have trended here in the quarter with the meaningful paydowns and where that kind of leaves you with the classified criticized at the end of the quarter?

Well, we certainly -- as the numbers speak, I think it was -- I spoke of -- I think it was $654 million going to $588 million going down to $445 million for this quarter. So, we've seen really, almost a $200 million decrease in a six-month period of time, right? And a lot of that is things that I just spoke about. Most companies are making money -- most companies are more profitable now than they were a year ago. Certainly, in the dairy business, we've seen a dramatic turnaround since -- from 2009 to 2010. And the interim so far 2011, most of our dairies are making money there too.

So when you look at -- when we underwrite credit and we see the primary source of repayment, which is cash flow/income and that turns negative, right away, you've got a credit that's probably going to be graded at least special mention and maybe even likely graded substandard.

So as these companies start showing profitable operations and dairies show profitable operations, those credits are going to get upgraded from classified substandard to special mention or even straight pass grade. So that's what's really happening here and we're seeing that transition as we speak. Now, whether that continues or not, obviously we can't forecast that, but it feels like it's going to continue.

Okay. And I guess what I am getting at is, as I think about in March, you reported roughly $200 million of substandard dairy credit. And if I think about the improving cash flows and financial position of many of those customers, again, many of which are not necessarily on non-accrual status, but the point I'm getting at I guess is that, I should expect to see a pretty substantial improvement within the substandard bucket this quarter with the upgrades?

Well, if you look at dairy, we have -- at the end of the first quarter, we were $199 million in dairy and livestock loans that were classified. And at the end of the second quarter, we're $106 million. So there is a $92 million, almost $93 million improvement in classifieds, just in dairies.

Julianna Balicka, KBW.

Good morning. Excellent quarter.

Thank you.

I have a couple of follow-up questions, please. One, to kind of maybe to continue on a topic that Todd was just addressing. In terms of the upgrades that you were -- the upgrades that happened this quarter, a lot of them I believe may have been driven by received financial statements that you received from your borrowers that typically happen in the second quarter around tax time, correct?

Yes. A lot of times, just as a cultural thing on credit, our credit underwriters are more inclined to feel more comfortable upgrading a credit on a year-end financial statement than they are in an interim financial statement. But that's not an absolute. It depends on the trend, it depends on the customer, et cetera. But I would say, as a general statement, we're more inclined to upgrade credits with a year-end financial statement that may have a CPA reviewed or even audited a financial statement as opposed to an interim, which may only have a Company-prepared or a lesser credit -- I mean, a CPA review.

Exactly, that makes sense. So therefore, from that inclination, how should we think about ongoing improvement in classified loans in the third and fourth quarter coming up?

Well, I -- obviously, we have to see what the economy does. But we're also -- the flow-through -- not all companies have a fiscal calendar year-end. I mean, some of these have first quarter, second quarter, it's all over the map. Now, I'll say this, I think a good chunk of them have calendar year, fiscal year-ends, but not all of them. So I think we're going to see continued improvement [out in there]. It feels like we're having continued improvement. And also just based on these discussions we're having with business owners, they see improvement. Again, they are cautious about it, they're running their businesses lean and mean, but in general, we see things getting better.

Tim Coffey, FIG Partners.

Thanks. Good morning, gentlemen.

Good morning.

Hey, Chris, what was the net gain or loss on the sale of OREO?

Net gain or loss on the sale of OREO, okay, I think it's pretty small, but it's -- do we have that -- we have a figure for that, guys, what we did for the quarter?

We can get one.

Okay. I can follow-up with you later on.

Yes. I'm -- I think our total OREO expense was $1.7 million for the quarter, of which $1.5 million was covered and $200,000-ish was non-covered.

Oh, okay. Okay.

Right.

Yes. What are you seeing in the early-stage delinquencies, the 30 to 89 days? Those have dropped quite a bit from the $6 million or so that you saw in the fourth quarter. I think you've answered this question a number of ways, but is -- the drop, is that a head fake or do you think it's going to stay below what we saw at the end of last year?

Well, you know what, we've had two consecutive quarters in a row where we were at 0.11% of our non-covered loans and 0.12% of our non-covered loans for the first and second quarter respectively. You know what, our people are on this and what we're actually seeing is intra-quarter, we're seeing more solid results. Usually, at the end of the quarter, we really have a big push to make sure this looks good, because you want to make sure you're all dialed into that. But even month by month, we've seen improvement. So I think we're going to continue to do well there.

Aaron Deer, Sandler O'Neill.

Good morning, guys.

Aaron, how are you doing?

Good, thanks. A question on the loan book, I guess. The -- there is obviously a big drop in balances in a quarter, a lot of that's centered in the dairy. I'm wondering how much of that is just from these -- from the dairy. I mean, you're having more cash on hand and paying that down because it's -- obviously, a lot of that is unseasonal since we usually see that in the first quarter. And then, I was wondering if you could give us a sense of where the loan pipeline stands today relative to where it was at March 31?

Yes, in terms of our -- we are still shedding ourselves off some non-core loans. And I do think that we're, I don't know, in the seventh inning of that baseball game probably. But we still got a couple innings to play there.

In terms of our core lending areas, which we consider commercial and industrial business lending, commercial real estate, both owner occupied and non-owner occupied, dairy and livestock lending and agro business lending, those four areas, we -- in terms of C&I, we see -- I think we're a little better off than we were at the end of March. In terms of CRE, I'd say the same thing. Dairy and livestock area, we've had a substantial drop in our portfolio. Some of that's seasonal, but some of that's also we've shed ourselves off some problem assets or some deals. We still want to grow that area, but we want to grow with quality dairies.

And again, we're focused on a lot of dairies that we're looking at dairies, the quality dairies. And we're also looking strategically at ones that may grow a substantial portion of their feed to just keep them competitive on the cost side. So I feel like pipeline is a little better than it was in the first quarter, but no tremendous differential.

Now, strategically, our salespeople are really focused on growing loans, so we're getting after this. We've incented them appropriately and it's a big focus of our Company. I don't know whether we're going to see net loan growth for the third quarter or the fourth quarter of this year, all things considered, but we're certainly driving to get to that point.

Okay. Great. Thank you.

Joe Gladue, B. Riley.

Yes. Hi, Chris. Actually, I just -- would -- wanted to follow up on that last question a little bit just in terms of potential loan growth in the second half. You've seen -- in the first half, you had some pretty sharp declines in the construction book, down almost 50% from year-end.

Yes.

And still seeing some declines in commercial real estate. But there was some growth in C&I. Just wondering can that -- is that rapid pace in the construction decline going to slow down and will it -- will CRE demand be enough to make up -- I guess, really just trying to gauge when those curves cross and you can see some growth in that loan portfolio as a whole?

Yes. No, good question. Our non-covered construction loans are only $85 million right now. I mean, our total non-covered construction loans are $85 million. So, we're again at the point where just -- it's not going to go down much further, because we do have some good construction loans that we still want to keep in there. Now, there are some construction loans that we're still shedding ourselves on. But it's just -- it's not the number it once was. Remember, that number was over $350 million three years ago and now, we're down to $85 million in that category.

As far as commercial real estate, I guess, your comment that we're down quarter-over-quarter in commercial real estate. But remember this, that also includes covered commercial real estate. Our non-covered commercial real estate is actually pretty flat quarter-over-quarter and our C&I is actually up slightly quarter-over-quarter. So we feel like we're doing some good things on the lending side. It's just not proving itself out that much, because we're still shedding ourselves off these non-core assets. That should slow down in the next quarter or two, and we should be able to reverse that trend. I mean, we have to see -- the economy is part of that. There is a lot of factors that go into that, but our full attention is on growing quality loans right now. And the four areas I mentioned are our focus.

Okay. Thank you.

Brian Zabora, Stifel Nicolaus.

Thanks. Good morning. Just a question on the loan loss provision, given the improvement across the board in the quarter, should we expect this as your provision for the next couple of quarters or what might change the provision levels going forward?

Well, when we establish what our provision is, there's -- we have a pretty detailed formula and we look at all the loan gradings and assign different rated risks to them and then reserve accordingly. So it all kind of boils down off a whole bunch of different reserve ratios based on those grading of the credits. And then, we come out with what the reserve is. And so certainly, in the second quarter, with $4.2 million in net charge-offs and the modest decline in our overall loan portfolio and the improvement in classified loans and so forth, the formula kicked out that we didn't need to reserve anything. So hopefully, that will continue, but again it remains to be seen what's going to happen as we go forward. But it feels like that's the case.

Great. The next question on M&A. Why do you think the M&A transactions have been pretty slow to date? And what -- do you think -- I think you mentioned maybe 12 to 18 months is what you're looking as far as time frame where you think that activity might pick up?

Yes, and it could be sooner than that too, but really the issue right now is mark-to-market accounting and how much goodwill you're going to take on your balance sheet; seller expectations and how much they think they're -- how much really most of the banks that we look at will probably buy over book value, because we're looking at more quality and more of a strategic fit than we are just a pure financial deal. We're looking for a strategic and a financial deal, but really we want to make it sure it's strategic and it fits our type of business bank, community bank focus.

So those are a little bit of a challenging areas right now. And also, we want to see the banks that we're looking at buying. If possible, we want to make sure we got our arms around their non-performing assets and see that their trends behave like our trends, like we've had three straight quarters of significant reductions in non-performing assets and classified loans. Well, we want to see that in some of the banks that we'll be purchasing. So we may be a quarter or two away from that, but we are really -- I can tell you, we're really focusing more and more on that.

Joe Stieven, Stieven Capital.

Good morning, Chris.

Hi, Joe. How are you?

Great. Listen, almost all my questions have been answered except for one, but I'll go ahead and ask it anyway. You guys obviously still have an outstanding SEC investigation. This is after you guys continued to report very strong numbers. So can you give us any update on that?

Unfortunately, I can't other than the stop lines are we continue to be fully cooperative and we are not in a position to say how long this is going to last and we can't make any prediction to the outcome. These are all things that our counsels advice us to say and that's kind of where we are in this whole thing.

I do think we are making tremendous progress on the financial side, and I'll say this, we have not lost our business focus in any which way and we're running our business day-to-day and hopefully that will be resolved in the near future. But I just don't have any guidance on that at all and don't have any feel, because it's really beyond our control.

Chris, thank you. Keep up the good work.

Thanks, Joe.

Hugh Miller, Sidoti.

Hi, most of my questions were answered. But just had, I guess, one follow-up on your commentary on M&A. And if you're looking at franchises that are kind of higher quality, trading at premiums to tangible look and book, I guess, when you look at that, how do you view the opportunities for generating synergies? Do you expect them to be kind of with the deposit mix, repositioning or branch consolidation, how do you kind of view that as opposed to looking at a turnaround franchise?

Well, a couple of ways. One way is, it's going to be tough for us to stomach paying a bigger multiple over book than what we trade at, unless the company is really strong. So that's going to be a tough thing for us to stomach.

The second thing is, we need some cost saves in that and some substantial costs saves to be able to do that deal, because the economic winds aren't strong enough to really go ahead and do an out-of-market acquisition and rely on an uplifting of their loan portfolio and other assets to take you to the promised land in terms of getting this to the bottom line number we want to see in terms of our return on our investments.

So we want to see some substantial cost saves. I mean, a good example would be -- a good target example would be San Joaquin Bank for us, if it was a healthy bank, what we bought two years ago or almost two years ago. And five locations, the dominant community bank presence -- dominant community bank position in the marketplace. And we took five locations, we now have four locations. They had a data center, we closed that down. They had over 150 people when we acquired them; today, we have about -- I think we have less than 70 or fewer than 70 people that still remain within the organization. It's been a good home run for us. We'd like to see a deal like that in a specific market where we already are and can achieve those same results.

And I know that you guys have been kind of lining up your ducks here and looking at franchises. But have you identified a handful that you feel as though are kind of similar in nature to that and just waiting at the opportunity to pounce if the credit trends get your comfort levels higher?

We certainly -- we kind of have our thoughts about who in each market we consider are the most important players and definitely are interested in having conversations with them as we go forward. But beyond that, it's just -- we got to wait for the right timing, the right price and all those things, and that's hard to predict, whether that's three months away or a year away or whatever it is.

Todd Hagerman, Sterne, Agee.

Hi. A couple of follow-ups, Chris. One, the press release suggests that the Safety and Soundness Exam just ended, I'm assuming or is it fair to say that the discussions that were held are reflected in the quarter's results?

We can't comment on anything on the Safety and Soundness Examination. We just made -- a year ago in this -- for the second quarter or second quarter results of 2010, we reported that we had our Safety and Soundness Exam and that's all we're saying right now is we had our Safety and Soundness Exam again. And it really is -- the Safety and Soundness Exam is usually an annual thing. Obviously, that changes depending on what the FDIC or the OCC or the DFI wants to do. But ours was almost the same timing as it was last year, a little bit later this year than it was last year. So ours is maybe 13 months gap between the full Safety and Soundness Exam than it was before. So --

Okay. And then, just if I could in thinking about your profitability and future returns, you obviously had record quarter, nearly 13% return on capital. Capital levels are running at the highest in the Company's history, if you will. How do you guys think about kind of your profitability metrics 12, 24 months out? I mean, where does this -- where can this Company go to with a materially higher kind of capital base and balance sheet so we think about the earnings power in the next couple of years?

Well, I think we need -- right now, our focus is on -- our first -- our preference with our excess capital is to put it to work through acquisitions and that's our first order. Now, we also have [$10 million] shares authorized, I think we've used [$600,000], so now it's [$9.4 million] of shares to buy back our own stock, authorized by the Board of Directors. But our first priority is try to find a good acquisition and use our capital to deploy in that acquisition and make more money off that than what we're making off now and grow our earnings that way.

But when we look at our earnings growth, we look at three areas of focus. Same-store sales, which is growing each of our offices; fee income, deposits and loans year-over-year; also acquiring teams from other banks, which we've done a good job over the last few years. We've acquired like six different teams from other banks, which has really helped our deposit growth and to some extent our loan growth or I guess held the line on future loan runoff, right?

And then, the third area is acquisitions. And right now, we feel like out of those three areas where we're going to probably get the most oomph here over the next 12 to 24 months is going to be on the acquisition side.

Okay. Thanks very much for the comments.

Julianna Balicka, KBW. Ms. Balicka? Okay. Aaron Deer, Sandler O'Neill.

Hey, guys. Just a couple of quick follow-ups. One, on the margin going forward, I was wondering if -- when you're looking at your funding base and the growing amount of excess liquidity, if there is any consideration to FHLB paydowns going forward?

Yes, we're talking about it. The prepays in that -- those FHLB borrowings are substantial. I think we looked at it recently in the aggregate portfolio of about $550 million-ish. We processed over $40 million to prepay all of that. So we have to look at that carefully and look at the pros and the cons, and by prepaying any of that, we affect our -- we also affect our total capital, which we like to deploy into acquisitions. So those are all considerations that we're looking at. There is a $100 million piece that I believe expires in April of 2013 that has a coupon of I think 2.89%. I'm not sure that's exactly exact, but it's close. We have considered prepaying that but haven't made any decision on that.

We also -- you look at our securities portfolio, we have -- at the end of the quarter, we had over $40 million in gains on that. We really don't need capital right now and we like the income, but there's a lot of levers we still have to pull, we feel.

Right. And then, just curiosity on the effective tax rate, given some of the mix changes you've had in your income and then, the true-up, I'm wondering if you can give us a sense of what the go-forward effective rate should be.

Well, when we look at it, it's really a function of what our tax-free income is vis-a-vis our taxable income is. And in the quarter here, the relative taxable income went up and our tax-free income, which is our municipal income and our BOLI income, really remained pretty flat. So to the extent that continues, our tax rate will be looked more like it would in the second quarter going forward. But heck, if we could find good municipal securities to buy that fit our underwriting techniques, I mean our underwriting qualifications, then we're going to buy more munies too and that would have an effect. So we're trying to buy more munies. We're just not finding as many as we like it within our -- given our what we think are fairly narrow buying, I guess, constraints.

Okay. That's helpful. Thanks, Chris.

I agree with that exactly, Chris. It's a function of the non-taxable income as compared to the taxable income that drives that ratio.

Correct.

Okay, thanks for taking my follow-ups.

Sure.

Joe Gladue, B. Riley.

Yes, just a quick numbers question. In the line for other non-interest expense, there was a decline from the first quarter of about $1.4 million. Just wondering what was driving that?

I think actually didn't other non-interest expense go up, it went up, $1.4 million for the quarter.

It's a non-interest income. The issue that hit that line item was, as Chris described in our previous discussion was, there was a loan that had been held for sale for some time and that loan had a preliminary ruling about our lien position. And so we wrote that held-for-sale loan down to zero. And that $1.7 million charge-off went through that line item.

Yes. So you look at that, you could argue that that's a one-time item, the $1.7 million going through there. But --

Okay, that --

Hopefully, we don't have another one come in the next quarter like that. We were a little -- that was a little bit surprising to us about the court ruling on that, but you may appeal.

Okay. All right. I had thought you had said that was the other non-interest income. I guess, I was talking about the other non-interest expense, but okay.

I thought you said income, sorry.

No, there was a decline in the other non-interest -- an increase -- no, a decline in other non-interest expense and then just trying to figure out about what's going to be a sustainable level or that was a --?

Actually, non-interest expense was $37.2 million for the quarter compared with $36.3 million for the first quarter.

Yes.

So that's the $900,000.

Yes, but the subline item, other non-interest expense was $7.3 million versus $8.7 million in the prior quarter.

One of the things that went through that line item is, as I'm sure you're aware is the FDIC insurance assessment is being calculated differently after April 1.

Okay.

Based upon total assets minus tangible equity.

Okay.

Prior to that, insurance had been -- FDIC insurance had been calculated based upon deposit levels. So we have been accruing based upon the assessment had been accrued, based upon the amount of deposits that we had on our balance sheet. And once we did another calculation as of April 1 when that new assessment calculation came into account, we had a slight overaccrual in our FDIC assessment that we reversed against that line item.

Okay. So that number -- the assessment part is likely to be lower than it was in the first quarter, but there was probably some catch-up in the second quarter that may not continue through?

That's correct.

Okay. Do you have a rough estimate of what that amount of catch-up was or --?

I don't have that right in front of me.

Okay. All right. I'll follow up. Thank you.

Thanks.

(Operator Instructions) At this time, there are no more questions. So I would like to turn the call back to Mr. Myers.

Well, we thank you all for joining us on our call today. We appreciate your interest and look forward to speaking with you again on our third quarter earnings conference call. In the meantime, please feel free to contact me or Rich if you have any follow-up or further questions. And have a great day. Thank you very much.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.