CVB Financial Corp (CVBF) 2012 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the first-quarter 2012 CVB Financial Corp. and its subsidiary, Citizens Business Bank, earnings conference call. My name is Amy and I will be your operator for today. (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 first quarter of 2012.

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 our earnings announcement released yesterday. To obtain a copy, please visit our website at www.CBBank.com, and click on the CVB 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.

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, 2011, 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. Good morning, everyone, and thank you for joining us again this quarter.

Yesterday, we reported earnings of $22.3 million for the first quarter of 2012, compared with $21.6 million for the fourth quarter of 2011 and up 34.1% from the $16.6 million for the year-ago quarter. Earnings per share were $0.21 for the first quarter, compared with $0.21 for the fourth quarter and $0.16 for the year-ago quarter.

The first quarter also represented our 140th consecutive quarter of profitability and 90th consecutive quarter of paying a cash dividend to our shareholders.

Excluding the impact of the yield adjustment on covered loans, our tax-exempt net interest margin was 3.69% for the first quarter, up from 3.62% for the fourth quarter and down from 3.78% for the first quarter of 2011. The quarter-over-quarter increase was primarily due to our $100 million prepayment of Federal Home Loan Bank debt late in the fourth quarter.

Despite the improved net interest margin, we continue to experience pressure on topline income in the form of a lower interest rate environment for our loan and investment portfolios. For example, as commercial real estate loans mature and/or come under competitive pressure, we are negotiating with clients to maintain the loans on our books, usually at lower interest rates and extended terms.

We feel fortunate to have prepayment penalties embedded in most of our commercial real estate loans. The prepayment language provides us with two primary benefits -- number one, fee income upon refinance, and number two, refinancing leverage with the client.

Simply put, customers will typically come to us before refinancing with another financial institution because they want to get a discount on the prepayment penalty. This gives us leverage to maintain the loan and/or collect a prepayment fee, usually both.

On the investment side, we are reinvesting cash flows from our portfolio with the current objective of maintaining about $300 million in short-term corporate cash. Anything above the $300 million generally will be invested in securities or will fund new loans, loans being our preference.

Our present strategy is in response to the Federal Open Market Committee's desire to maintain interest rates in the current range through 2014 and the tremendous amount of liquidity in the financial services industry.

Now let's talk about loans. We had $3.43 billion in total loans, net of deferred fees and discounts, for the first quarter of 2012, compared with $3.48 billion for the fourth quarter of 2011. Nonperforming assets continued to decline in the first quarter, representing the sixth straight quarter we have experienced a decline.

We once again reported zero provision for funded loan and lease losses for the first quarter. The allowance for loan and lease losses was $91.9 million, or 2.89% of outstanding loans at March 31, 2012, compared with $94 million, or 2.92% of outstanding loans at year-end 2011.

Net charge-offs for the first quarter were $2 million, compared with $1.6 million for the fourth quarter.

In total, our nonperforming assets, defined as noncovered, nonaccrual loans, plus OREO, totaled $66.7 million at March 31, 2012, a decrease of $9.8 million from $76.5 million at year-end 2011.

At March 31, 2012, we had loans delinquent 30 to 89 days of $11.2 million, or 0.35% of total noncovered loans. Classified loans decreased for the first quarter to $334.1 million, compared with $359.2 million for the prior quarter. We will have more detailed information on classified loans available in our first-quarter Form 10-Q.

Regarding our noncovered loan portfolio, we had $3.2 billion in total noncovered loans and leases at the end of the first quarter, a decline of $33.4 million from the end of the fourth quarter. Our dairy and livestock portfolio decreased by $57.7 million from the fourth quarter to the first quarter, due primarily to the seasonal borrowing patterns of these customers as they draw down on their lines during the fourth quarter and then repay them during the first quarter.

So, dairy loans excluded, we actually grew noncovered loans by $24 million for the first quarter.

Construction loans totaled $67.4 million at March 31, 2012, compared with $76.1 million at December 31, 2011, and our single-family residential mortgage pools were $125.8 million at March 31, 2012, compared with $134 million at year-end 2011. These two non-core loan categories continue to decline, representing $16.9 million in loan runoff for the first quarter.

Commercial real estate loans totaled $2 billion at March 31, 2012, compared with $1.9 billion at year-end 2011. The market remains very competitive for new loan originations for both commercial real estate and commercial and industrial loans. As we compete for this business, it is critically important for us to remain focused on credit quality, as the low interest rate environment leaves little room for underwriting error.

Moving on to 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 March 31, 2012, we had $305 million in total covered loans resulting from the San Joaquin Bank acquisition, compared with $330.4 million at year-end 2011. These loans have a carrying value of $245.7 million, a decrease of $16.9 million from year-end 2011.

As of quarter-end, our remaining purchase discount is $59.3 million.

Our ongoing strategy is to continue to work down the problem loans as expediently as possible and expand the good customer relationships. Remember, not all covered loans are bad loans.

Now I would like to discuss deposits. We continue to grow our non-interest-bearing deposits. For the first quarter of 2012, our non-interest-bearing deposits grew to $2.12 billion, compared with $2.03 billion for the prior quarter. This represents a 4.56% increase quarter over quarter, completely organic. Non-interest-bearing deposits now represent over 45% of our total deposits.

Our total cost of deposits for the first quarter was 14 basis points, compared with 15 basis points for the fourth quarter.

At March 31, 2012, our total deposits and customer repurchase agreements were $5.2 billion, $43.8 million higher than year-end 2011. We continue to seek what we've referred to as sticky deposits, deposits that we believe are high quality and will be more inclined to stick with us when the interest rates rise. Our ongoing objective is to maintain a low-cost stable source of funding for our loans and securities.

Moving on to non-interest income, non-interest income was $5.3 million for the first quarter of 2012, compared with $10.7 million for the prior quarter. Non-interest income was reduced by a $2.9 million net decrease in the FDIC loss-sharing asset and a $1.2 million impairment charge for a large held-for-sale note included in other non-interest income. The decrease in the loss-sharing asset in 2012 was primarily due to the improved credit loss experienced in our covered loan portfolio.

Non-interest income for the fourth quarter of 2011 was improved by a $1.3 million increase in FDIC loss-sharing assets.

So, if these three items are excluded, non-interest income -- really, core non-interest income was actually flat at $9.4 million quarter over quarter.

Now expenses, we continue to closely monitor our expenses and realize some of the benefits of the expense-reduction initiatives that were enacted in mid-2011. Non-interest expense for the first quarter was $30.2 million, a decrease of $4.5 million from $34.7 million for the fourth quarter and a decrease of $6.1 million from $36.3 million in the year-ago quarter. Overall, we are pleased with our progress in reducing expenses.

Now, I will turn the call over to Rich Thomas to discuss our effective tax rate, investment portfolio, and overall capital position. Rich?

Thanks, Chris. Good morning, everyone.

Our effective tax rate was 33.8% for the first quarter, compared to 30.5% for the fourth quarter. The increase was due to higher taxable income related to current earnings trends. The lower rate for the fourth quarter can be attributed to the year-end adjustments of our estimated effective tax rate utilized during the first three quarters of 2011.

Overall, our effective tax rate is estimated and may fluctuate based upon the ratio of taxable income to total income, considering tax-advantaged municipal bond income and non-deductible expenses.

Now, our investment portfolio. During the first quarter of 2012, we provided an average of approximately $224 million in overnight funds to the Federal Reserve and received a yield of approximately 25 basis points on collected balances.

We also maintained about $60 million in short-term CDs and money markets with other institutions, yielding approximately 66 basis points.

At March 31, 2012, our available-for-sale investment securities totaled $2.4 billion, up $171 million from year-end 2011.

Investment securities now represent approximately 37% of our total assets.

Our available-for-sale investment portfolio continued to perform well. At March 31, 2012, we had an unrealized gain of $71.4 million, down slightly from $71.5 million for the prior quarter.

Virtually all of our mortgage-backed securities are issued by Freddie Mac or Fannie Mae, which have the implied guarantee of the U.S. government. We have six private-label mortgage-backed issues, totaling a relatively modest $4 million.

We have been strategically reinvesting our cash flow from our investment portfolio, carefully weighing current rates and overall interest rate risk. During the first quarter, we purchased $318 million in mortgage-backed securities with an average yield of 1.82%.

We attempt to maintain a neutral position at the short end of the treasury curve by reinvesting in mortgage-backed securities with an average duration of about four years to avoid material extension risks as interest rates may rise in the future.

We also purchased $13.1 million in municipal securities with an average tax-equivalent yield of 3.58%. Finding bank-qualified municipal securities that meet our investment criteria remains challenging.

At the end of the first quarter, we held $1.68 billion in mortgage-backed securities and $646.7 million in municipal securities. Combined, these represent 98% of our $2.4 billion investment portfolio.

Now turning to our capital position. Our capital ratios are well above regulatory standards and above our peer group average. Our March 31, 2012, capital ratios will be released soon, concurrently with our first-quarter Form 10-Q. We anticipate these ratios to be at or above their December 31, 2011, levels.

We paid out approximately $8.9 million in cash dividends during the first quarter of 2012. Despite this, shareholders' equity increased $15.2 million to $730 million for the quarter.

Our strong capital position has enabled us to explore alternative opportunities to deploy our capital and liquidity. On January 7, we redeemed all the outstanding capital in common securities issued by First Coast Capital Trust II for a total consideration of approximately $6.8 million. The cost of these securities was three months LIBOR plus 3.25% per annum. This will save us about $250,000 annually.

Our ongoing strategy is to deploy our excess capital through, one, a bank or trust acquisition; two, ongoing cash dividends to our shareholders; three, redemption of trust preferred securities; and four, our stock repurchase program. The execution of these individual strategies will be weighed carefully against the ongoing business and interest rate environment.

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

Thanks, Rich.

Now, let's talk about the economy. In terms of the California economy, current statistics and various reports provided by local economists indicate that California remains on the road to recovery. When examining the underlying drivers of economic and job growth in California, the statistics point to an economy that is beginning to outshine the rest of the nation.

Consumers have shown steady increases in spending over the past two years, and California appears to beginning momentum. International trade has been playing a large role in speeding up California's economy, particularly on the export side. With the dollar falling and U.S. goods becoming increasingly affordable abroad, California's proximity and infrastructure to reach the east Asian markets, which have been expanding at above-average rates recently, has helped the state benefit from an increase in seaport and airport activity. California's labor markets are starting to make a turn for the better, particularly in private-sector employment.

We have a ways to go, but we seem to be moving steadily in the right direction.

According to the U.S. Department of Labor, California's unemployment rate was 10.9% in February 2012, down from its peak of 12.4% in February 2010.

In terms of the dairy and livestock industry, feed costs are up, milk prices are down, and the profit margins have tightened in recent months. Although California milk prices are down from 2011, they are still better than 2010.

Feed costs continue to put pressure on profit margins. According to the California Department of Food and Agriculture data for the fourth quarter of 2011, feed costs in California represented approximately 65% of total milk production costs. This compares to about 59% of total milk production costs for the fourth quarter of 2010.

In terms of corporate recognition, we were pleased to be added to the S&P SmallCap 600 Index in March. This is a positive message about our Company's ongoing growth and success.

We were also recently honored to have been named by Forbes as the 11th Best Bank in America for 2011. This recognition was based upon data supplied from SNL Financial on eight metrics regarding asset quality, capital adequacy, and profitability of the 100 largest publicly-traded banks and thrifts.

As we progress through 2012, we will continue to focus companywide on our critical few. These are drive quality loan growth; non-interest-bearing deposit growth; non-interest income growth; expense control; and grow through acquisitions and de novo.

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

(Operator Instructions). Aaron Deer, Sandler O'Neill & Partners.

Good morning, guys. Chris, just following up on your comments about the milk prices and feed and the impact that that has on the dairies, have your dairies said anything new about what -- the rainfall that we've had here in California this year and what impact that could have on feed prices going forward?

We haven't heard a ton of that, and the effect that we're having. Milk production is very strong, and in general -- you know, one of the other things that I think on the dairy -- I want to mention on the dairy side, too, is beef prices are a lot higher than they were in 2009.

So from that standpoint, that is a positive for the industry because when we look at our collateral, we lend a certain percentage against the value of the herd and the value of the feed, and the fact that beef prices are up gives us more comfort level as to the liquidation value of our collateral, should something adversely happen on one of the dairies.

And then, you give some thoughts in terms of securities reinvestment, and it sounds like loan pricing still is a challenge and maybe some relief on the funding costs. As those all come together, what are your thoughts over the next few quarters in terms of how those are going to impact the margin?

In today's world, loan prices -- I mean, the difference between putting a loan on the books and putting a security on the books, there is a big gap there. So, that's good news, to the extent you can put on quality loans.

But the overall kind of feeling of putting on a fixed-rate loan for five, seven, or 10 years at 4% to 5% is just not as good as it was four years ago when we were putting those same loans on at 5.5%, 6%, or 7%.

We are seeing more momentum on the loan side, and our pipeline is picking up, and we're working really hard at it. But again, as I said in the script here, we have to buy quality because when you're getting a 5% yield on a new loan, you have got to be right 99-plus times out of 100 to make money and to make good money. And so, we're very carefully thinking about the type of loans we put on the books.

In the absence of that loan growth, we are buying securities, but trying to keep that at a fairly -- at the shorter end of the curve, and really buying mostly -- we'd love to buy more municipals where we can find them that meet our investment criteria, but when we buy mortgage-backed securities, typically we're buying 15-year mortgage-backed securities and not 30-year.

It sounds like you're pretty hesitant to be putting on fixed-rate loan product, and yet it -- obviously that's more ideal than the (multiple speakers)

We're not hesitant to it. I think where we start getting a little bit gun-shy is on the 10-year fixed-rate stuff, which is typically running around, let's say, high 4%s, maybe 5%, and we're using a lot of interest rate swaps on those situations.

The five-year -- typically, the five-year fixed-rate and the seven-year fixed-rate we're putting on our books. The 10-year fixed-rate or the 15-year fully-amortizing fixed-rates, we may swap those loans. We may not swap those loans. It depends on the relationship and the circumstances, but I think right now we've swapped about -- of our commercial real estate loans, we have nearly $200 million in interest rate swaps on our books of a $2 billion portfolio.

I think what our objective is to do is to try to remain as much interest rate neutral as we can, neither liability sensitive or asset sensitive, so that when rates shock up 300 basis points, if they ever did shock up 300 basis points, we're still making the same amount of money that we are today or more.

And right now, we've been more neutral than we have in a long, long time in this Company in terms of asset sensitivity and liability sensitivity, and so we want to keep that. So we're being careful about that longer-term fixed-rate paper, putting that on our books, and thinking very carefully about it.

Just to add a little more color on that, that decision is typically very relationship based. If we have a real strong long-term customer with a lot of deposits, and that commercial real estate fixed-rate loan is being funded primarily by that same customer's operating deposits, we feel more comfortable in putting that on our books as opposed to swapping it.

The more transactional nature credits that are more for real estate and investor-type properties are the ones we're typically swapping out.

That's very helpful. Thanks, Chris.

Hugh Miller, Sidoti & Company.

Good morning, Chris. Obviously, you guys referenced the focus on M&A as a means to kind of leverage the balance sheet, and I was wondering if you could just give us an update on kind of what you are seeing there with regards to the landscape in Southern California, the opportunities that you see, and also any disconnect between buyers' and sellers' expectations that has held you back at this point, or what has held you back?

We're having a lot of conversations with a lot of different people, so there's a lot of -- there's more conversational activity than there was six months ago or a year ago, no question about it.

I think the reason we haven't announced anything as of yet is we're carefully thinking about the price of what we're buying and the sustainability of that franchise going forward. Most of these smaller banks are really -- deposits are easy, right? Now the sticky deposits are not as easy, but deposits generally are easy to get.

So a lot of these smaller banks are flush with a lot of deposits, and then you have to look carefully at, what are they doing with those deposits? Are they able to grow loans and quality loans? Are they taking too much credit risk? Or are they buying securities with these and taking a lot of interest rate risk?

So today, when we go ahead and look at these smaller banks and look at them, we have to look at where those dollars are going and what kind of interest rate risk they're taking and do they have a franchise that is -- and what is happening with their margins? And they may be putting on loans and so forth, but at what margin and what kind of fixed-rate interest rate risk.

So when I look at a bank, or Rich and I look at a bank, and we see something that might be valued at X dollars today, we really want to think about, what is this bank going to be worth next year and the year after that, all things being equal? And then, what are we paying as a multiple of this bank?

And so, somewhere in there, there's a difference between what we think the bank is worth and what typically the sellers are thinking it's worth.

And just to add a little bit more to that, we're really not focused on that bank trading at 0.7 times book. That's a kind of a bank that is fractured that got through the process here.

We want to buy a bank that has Citizens Business Bank-type customers in there so that we can go in there, buy the bank, and capture more of that customer wallet by cross-selling more products because we have a lot more products and services to sell than those small banks. So we want to uplift that customer relationship and expand that customer relationship.

But if it's got a transactional nature to it, or an SNL feel to it, and it's a fractured bank, we don't really get that out of those customers. And in the banks that are healthier, they want a bigger price, and so we're kind of looking at them, saying, well, you keep taking all these deposits and buying securities and taking interest rate risk. We really can't pay you for that.

So that's where there's a little bit of a disconnect there, but we're trying hard.

Great color there. I do appreciate that.

Then the follow-up question is just on -- the yield on the loan portfolio looks like it had a nice pickup compared to Q4, maybe up about 30 basis points or so. And I was wondering if you could just give us some color on how much of that is driven by prepayment penalties and kind of reductions in the nonperforming assets versus anything on the competitive pricing landscape or loan portfolios shift.

Yes, you know what, and a chunk of that is prepayment penalties.

We -- in the first quarter of 2012, we procured $869,000 in prepayment penalties, and that is prepayment penalties that we're putting into fee income. There are more than that in total -- in terms of total prepayment penalties because -- and I'm not the one to give you the accounting discussion on this. I think Rich could do a better job on that, but if there's that material change -- when you refinance one of your own loans, if there's not that much of a material change in the cash flow income stream, then those prepayment penalties go into interest income as opposed to fee income.

So we actually did more than $869,000 in prepayment fees, but the $869,000 in prepayment fees are really indicative of fees that there was a material change in the relationship or we had to recap the entire loan, and that's why we charged the prepayment fee. Does that make sense?

It certainly does, but do you know on a percentage basis, of the 30 basis-point pickup in loan yield, what was from the prepayments?

I don't know. I'd have to get out my calculator (multiple speakers)

I'll crunch it. Thank you very much.

Yes, but the $869,000, sorry about that. I just don't -- I don't have (multiple speakers)

That's quite all right. Thank you.

Rich, I don't know if you have any number on that in front of you, either.

I don't have that, Hugh, right at my fingertips.

But to give you some more color on that, last year at this time we had $235,000 in prepayment penalties in the first quarter.

You're talking about $634,000 in difference quarter over quarter, year over year, in terms of prepayment fees that are dropping to the bottom line.

Tim Coffey, FIG Partners.

Thanks, good morning. To stay on the yield question a little bit, those commercial real estate loans that you were talking about earlier on the call, Chris, the ones that you renegotiated or came into the office for renewal, what were the new rates on them?

Well, you know, I have to be careful about what I throw on rates. I'll give you ballparks because we do have competitors out there.

But typically, paper that was written four years ago that was in the 6% or maybe low 6% range, that same paper is going at probably, on average, about 1.25% cheaper today. A lot depends on the duration. Is it a five-year fixed-rate? Is it a seven-year fixed-rate? Is it 10-year fixed-rate?

And there are also clients that are choosing to do variable rate stuff, and we have products that are one-year LIBOR-based loans that adjust once a year that -- the good news on those is that they -- we don't take a lot of interest rate risk with those, right, because the rate changes every year.

So, the rates are down, are coming down on that, but I will say that I believe that our activity is picking up in terms of our pipeline and so forth, so we're hoping to deploy more of our excess cash into loans than securities and feel like we have good momentum there.

But we're also playing a lot of defense on our existing loans because it's not like we walk up to customers with four or five years left on their loan and say, hey, by the way, you got a 6% rate and I'd like to refinance to 5% today. We have prepayment penalties in there that protect us on that, and usually what happens is the client will come to us and say, listen, I -- so and so bank is willing to do this deal at 5% or 4.75%. What are you guys going to do for me? Can you refinance this?

And then, we talked to them about the prepayment penalty, and we work a deal to keep it in the bank and either charge the full prepayment penalty or give them hopefully what is just a modest discount on the prepayment penalty. But a prepayment penalty gives us leverage in the negotiations because they want to come through us because they don't want to pay the prepayment penalty.

And typically, our prepayment penalties are six-month interest on the outstanding principal balance. Not in all cases, but typically that's it. So if you have a 6% loan, that's a 3% prepayment penalty.

Okay. And then, the follow-up question. Is -- writing those loans down to the lower rates, the low rates that you're writing them down to, is that just the cost of business or is there an strategic alternative in terms of monetizing -- you know, increase in the monetization of the relationship? I realize it's likely a mix of both, but which ones heavier weighting as loans that have come back into the bank recently? Is it kind of the cost of (multiple speakers)

It's just a reality of the new interest rate world that we're living in.

And I mean, the other day we were looking at a decision, and we had just an AA+ credit tenant on a loan, and we looked at it. It was a seven-year fixed-rate, and I didn't like the rate we were having to bid to get on this deal, but when I looked at it, I really said, okay, I'm not taking any credit risk here at all. I mean, the tenant is as good a tenant as you could get in a building, and it was a $3 million, $4 million, $5 million loan, somewhere in that range.

So would I rather take that paper on at X percent or would I rather buy securities which are going to yield me for that same, probably -- I'll get a security in the low twos for that same type of duration, whereas I'm getting at least a couple more percent on that loan and taking virtually no risk.

So when I say credit quality, there are transactions we will do or transactional-oriented deals we will do, but we try to make them completely -- or you can't make anything completely. We try to make them as bulletproof as possible in terms of credit risk, lower loan to values, really strong metrics in terms of the tenants and the type of property, etc., etc. So we're really buying quality assets in that case.

And remember, with our cost of funds, and when you have a 14 basis-point cost of deposits, if we put a loan out at 4.5%, that's a pretty good margin, right? That's not too bad, and we'll take that. We just have to be careful about how much interest rate risk we're taking because if rates do come back up, what's going to happen?

And that's why we're doing interest rate swaps and that's why we're looking -- thinking very carefully about the duration risks that we're taking, both on the securities portfolio and on the loan portfolio.

Julianna Balicka, KBW.

Good morning. I have a couple of questions. On the CRE loans that you are defending versus the ones that are leaving the bank, do you have a sense to what kind of banks they are going to?

Well, we're not seeing a tremendous amount that are leaving the banks -- leaving the bank. I'll tell you the process we go through, and I probably share too much of this, but I will anyways.

What happens is if somebody comes up to us and says, listen, I've got an opportunity to refinance your loan with somebody else at a cheaper price, the first thing I do is say, get that to our credit people. Let's look at the value of that piece of real estate, what we would appraise that for, and are we properly margined on that deal.

Because just because somebody wants to refinance their rate doesn't mean necessarily that we need to refinance it because it may be at 90% loan to value now because prices have dropped. So the first thing you need to do is look at where you're margined because it may not really be refinanceable and they may not have leverage on you, the customer meaning.

But once we determine that it is refinanceable, then we go down into, okay, what do we need to do to keep this loan and what's our leverage in this in terms of prepayment penalty, etc., etc.? And if we determine that we do want to keep this loan, I'd say over nine times out of 10 we're keeping that loan.

I'd say the pressure is really oriented -- there's a couple of the big banks that are very aggressive there. But there's also some of these smaller niche banks that are very aggressive on rates. It's all over the map.

And I'm seeing smaller banks take 10-year fixed-rate interest rate risk, which I think is a real tough thing for a small bank to take, but we're seeing them do it. The big banks are more readily accustomed to taking that 10-year fixed-rate, and I think they are more prevalent in the marketplace as doing the 10-year fixed-rate paper.

But what a lot of the smaller banks are doing is they don't want to take the 10-year fixed-rate, so they're really getting aggressive on their five-year fixed-rate pricing. And really, there's almost a 1% difference between five-year fixed-rate pricing and 10-year fixed-rate pricing in the commercial real estate mini perm loan market right now.

That makes sense. And so, if I think about your loan yield progression going forward, it sounds like a good amount of your commercial real estate book has already turned over, or the borrowers that could have probably approached you by now. So -- and the prepayment penalties have kind of kept your yields somewhat steady. I mean, if I back out accretable yield component, the accelerated accretion component out of your yields this quarter looks like your loan yields only shifted by four basis points, right?

But as the process of revamping or turning your portfolio over goes on, the prepayment cushion is going to drop off. So do you have a sense of how much we should be thinking about two, three quarters from now as a linked quarter change in yields?

Hard to gauge that, and it's hard for me to give you some real information on that because one of the other things you've got to take into account is our nonperforming assets. Our nonperforming loans are improving.

So now, I think quarter over quarter, our nonperforming loans were down about $9 million. So now we have $9 million that either -- a chunk of that went on is now a performing loan or TDR performing. You saw our TDR performings were up by a few million dollars quarter over quarter, so if you look at that, some of these loans were getting back in the fray and they're now paying us interest and paying us principal, and they're turning back into performing loans.

So the income off loans that wasn't there before is now coming back into our income stream, so that helps our loan yield.

I remember a year ago last September, we had $162 million or something like that in nonperforming loans, and today we're down at, I think, $56 million or something like that.

Okay, that makes sense. And then I have a final question, then I'll step back. On the classified loans number, in terms of thinking about the annual turnover in reappraising related to tax year and your classified dairy component, is there a number that we should be kind of thinking about where that should trend to for the next quarter, the improvement in classifieds?

We're going to give you a breakdown with our 10-Q on the classified loans because we're still finalizing the mix of that whole thing, but what's happened over the last year, really, is the decline in our classified loans is -- a lot of it was driven by the dairy loans, and so that's starting to moderate a little bit.

And then, now, some of the drivers in classified loans going down are more our general loans. So a lot of the dairy loans have improved. Now the dairy business is softening a little bit right now. It's not bad, but it's not as robust as it was six months ago. So we'll have to see -- we'll have to gauge that as we go forward.

But overall, I think we feel the trends continue to be positive on the classified loan side and I just can't project whether that's going to continue because I don't know what's going to happen with the economy, and in particular what's going to happen in the dairy business, either.

Okay, very good. Thank you very much.

Joe Gladue, B. Riley & Co.

Good morning. I guess I'd like to talk a little bit about loan growth and I guess I'll start with the construction and mortgage sectors have been a drag on the loan portfolio for quite some time, and I guess I'm trying to gauge when that might end. Particularly on the construction side, it looks like they were down about 18% or 20% in the quarter. Just wondering if that was one large loan that was paying off or if the [times] in that portfolio could tail off over the next few quarters.

The good news is is that when we sat here four years ago, our construction loans and our mortgage pools together, four or five years ago, were over $700 million combined.

And today, those numbers are 100 -- I think at the end of the quarter were $193 million-ish between the two of them. So we've already seen over $500 million in rundown of those, absorbed that, and here we are today.

So, the construction loans are not going to go to zero because we're always going to be doing some type of construction loans for -- even if we just do them for customers and their million-dollar homes and things like that, there's going to be something there. So I think the construction loan runoff is -- may decline some more, but at $67 million, it's just getting to the point where it's not going to go that much lower.

The mortgage pools, we're going to continue to run down over time because we're not buying any new mortgage pools. So eventually, that will run completely off, but that has some tenure to it because these are mortgages that people are holding, and unless they refinance them or pay them off, they're just going to continue to stay on there.

But when we look at $16.9 million in runoff for the first quarter, remember in our talk here a little bit earlier, if you look at our loan growth quarter over quarter, or lack of loan growth quarter over quarter, and you take out the $57.7 million in seasonal dairy loans, difference in dairy loans, $57.7 million, we actually had positive loan growth for everything else, including our covered loans and including our construction loans and including our mortgage pools.

Now it wasn't a huge amount because if you look at it, we grew $24 million on our noncovered loans, and then if you net out -- I'm doing this on the fly a little bit -- so you net out the $16.9 million decrease in our covered loans, that still produces about a $7 million growth in loans, excluding the dairy loans, quarter over quarter.

So we did have -- in our mind, we had positive overall loan growth in the Company once you take the seasonality of the dairy loans, albeit it was only about $7 million, [modest]. So that's a good sign for us. It means, you know what? Maybe we're bottoming out here. Maybe we're on the rise. Maybe we are coming. And I feel like our portfolio is gaining momentum, too.

But we are challenged on the refinancing side, and so that is -- we had -- recently, we had a $13 million loan payoff because the property got sold. So that's a -- by the way, the funny thing about that, that was a substandard credit. So good news/bad news, right? It was a substandard credit, but it was paying us. It was a performing substandard credit, but it paid off, so we're like, yay, it went away, but boo, we're not getting that interest income anymore. That's the way were living today on those kind of things.

And just a follow-up on that, most of that growth in the loan portfolio during the quarter was in the CRE side, and just wondering if you could give us an idea of what the pipeline looks like or what your thoughts are for the rest of the year.

We're really focused on -- I mean, I'd say the pipelines that we're trying to drive are really focused on our C&I and our commercial real estate loans, and to a -- and we're also very focused on dairy and livestock and agribusiness. But we have to be careful in those areas, more so the dairy and livestock area. We just have to make sure we're picking and choosing the right clients.

So, we're optimistic that we're going to be able to grow loans in those categories for the remainder of the year. Dairy and livestock, maybe I will hedge a little bit on that because I want to make sure that the industry is going to do well in the next six months, but on the commercial real estate and the C&I, we feel like we have good momentum on both.

Brian Zabora, Stifel Nicolaus.

Yes, good morning, a question on expenses. You said you'd realized some of your expenses -- mid-2011 initiative. Can you give us a sense of how much more may be realized, either efficiency ratio or any kind of details you can provide?

If you look at our efficiency ratio, we were at, I think, 47.31%, is that the number? Yes, 47.31% for the quarter, and I've come out and I've said, listen, I'd love to drive our efficiency ratio to 45% or slightly below that.

That's an ambitious goal. I think it's not just about expenses. It's also about income and that ratio that we need to do. But I think that a lot of the initiatives that we've done across the Company have kicked in, and that's a big part of why our expenses are down not only quarter over quarter, but substantially from where they were a year-ago quarter.

And it's professional services, it's different types of categories. You know, we are working a lot on the occupancy side, too, and we haven't realized as much as we'd like there in terms of our renegotiating leases, consolidating offices. All those things are in the forefront of our mind, and we're working on them.

So, there's not a stone unturned here, but one of the important things is that we don't want to do anything in our expense-reduction mode here to cut off our offense. So we need -- we're still on the offense, we're still -- this Company is a company that needs to grow, wants to grow, can grow. But we need to -- when you grow as rapidly as we did and other banks did in the early to mid 2000s, there are some efficiencies you can gain from simply looking at the way you did things, the way you grew, and your expense load.

And certainly on the professional services side, a big component of that is legal, and I've talked before about how our legal costs are substantially lower than they were in 2011, or at least it seemed to be trending in that direction.

Great. And also, just a question on competition. You talk a lot about rates -- banks willing to go longer term. Can you give a sense if people are wavering on credit, or I guess coverage ratios, whatever it may be?

It's funny. I think the structure is getting a little looser, longer-term amortizations, and just a little bit, but not materially because I think the industry gets, for the most part, that at these low interest rates, you can't take a ton of risk.

And I'm seeing the big banks get really aggressive on rates for things that line up, low loan to values, great tenants, great cash flows. It almost seems like they have some type of matrix that they're putting out that's very risk-based because they may look at the same loan and have a 45% loan to value as opposed to a 70% loan to value and have a lot lower rate for that 45% loan to value than the 70% loan to value.

So it seems that it's very risk-based, some of those, and we're doing the same thing, probably not as chart oriented or matrix oriented as the big banks were because we're very customized in what we do, but we're thoughtfully thinking about risk and return.

Thank you very much, very helpful.

Gary Tenner, DA Davidson.

Thanks, good morning. I just had one quick question. You mentioned there should be $9 million, I think, of remaining purchase discount on the San Joaquin loans. What was the discount accretion this quarter, not including the accelerated discount accretion?

Okay, I think I'm going to turn that one over to Rich. Rich, are you prepared to answer that discount accretion question?

Hi, Gary. What we've done in our 10-Q before is we've put a table in there for basically some transparency on the effect of the San Joaquin charges in the P&L. We'll be putting that same schedule in this quarter for our 10-Q, but there's clearly been improvement in our credit quality.

We've looked at the default rates and we've looked at the severity of those defaults, and clearly that's down from day one and it continues to progress downward. I don't have the exact number of the total accretion for this quarter in front of me, but as you saw, the accelerated accretion was about $4.7 million in interest income for this quarter.

Okay, so we will have to wait for the Q to get the rest of the information. Okay, and then, just with regard to the SEC investigation, and I apologize. There is some feedback here on my line. We've seen professional services charges come down for three quarters in a row. I imagine some of that is related to legal and some may be related to some credit stuff. Can you just make any comment on the status of that investigation? We're going on two years now since that was announced.

Yes, this summer will be our two-year anniversary, right? Hopefully we won't have a two-year anniversary, but I don't know what will happen there.

We continue to fully cooperate with them. We're just not in a position to say how long it will last. It's not under our control, and so, we can't really make any prediction as to the outcome.

But overall, we remain very focused on running our business and figuring out ways to grow revenue, and the SEC investigation is, on a day-to-day basis, really not a factor in anything that I'm dealing with right now or Rich is dealing with right now. We're running our business, and that's off to the side.

Okay, and I certainly appreciate that. Just wanted to see about an update. Okay. Thank you, guys.

(Operator Instructions). Jonathan Elmi, Macquarie.

Good morning, guys. Thanks for taking my question. Just quickly on the classified assets, obviously you guys have done a great job bringing those down over the last year or so, but then, as you pointed out, a lot of that progress did come from the dairy portfolio. So if the industry is starting to soften a little bit again, should we expect to see the pace of classified improvement start to flatten out a little bit? And if so, how should we think about that in relation to the pace of reserve releases going forward?

Good question, and I'll try to answer it as best I can, but I don't have a crystal ball on a lot of that stuff.

We are -- on classified loans, we've been pleased with the progress that we've seen, and as we look at the dairy and look at our other loans and so forth, and the economy, certainly that is going to be a big factor of how that kind of progression transpires in the future. It is hard to say whether the classified loans could kick back up on the dairy and livestock side or on the commercial real estate side or whatever, but overall, quarter after quarter, we've made some progress there.

But you're absolutely correct. If classified loans continue to fall, that will put more and more pressure on our reserve and -- the releasing reserve, but there are a lot of financial metrics out there that go into our formula to create our reserve. And as we look at those, we review those very carefully, and we review them not only internally but with our accountant, KPMG, at the end of the quarter and go through that whole systematic approach of how we reserve for loans.

And right now, we haven't had to take any reserves in -- I think it's been four quarters in a row, and I can't forget whether the next quarter we're going to take a reserve or not, but we feel pretty good about certainly the credit quality improvement that we've had and are hoping it continues.

Okay, great. That's all I had. Thanks a lot for the color.

Julianna Balicka, KBW.

Hi, thank you. You talked a little bit about the M&A outlook for smaller banks that you might be interested in buying, but could you talk a little bit about M&A for non-bank acquisitions?

You know, really, when we look at that, we're starting to scratch a little bit on that to see if there is some type of acquisition we can make on the lending side, whether it is buy a company that does equipment leasing or loans or something like that. But we haven't done a ton on that.

Again, we're very relationship oriented, and some of these acquisitions will have -- that we have looked at will have an equipment portfolio or a lease and loan portfolio, and a lot of it is out of state.

So we look at it and say, you know what? We're just buying a loan; we're not creating a relationship, and that's not really what we do. We are a relationship bank and we're trying to build long-term relationships with our clients and cross-sell the heck out of all our products and services to them. That is fundamentally what our strategic objective is. So that's where it gets a little difficult.

On the trust side, we are looking at different things, and whether it's in a fixed-income or more of an equity-based firm, boutique firm, so we are looking at that. But again, we haven't been able to bring one of those to the finish line, either, and never in the history of our company, but we do have, I think, the foundation of some really good people in that area, and we could -- we might get lucky here in the future, but so far, nothing.

Very good. Thank you.

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

We thank you very much for joining us on our call today and appreciate your interest and look forward to speaking with you again on the second-quarter 2012 earnings conference call in July.

In the meantime, please feel free to contact Rich Thomas or me, and have a great day. Thank you very much.

The conference has now concluded. Thank you for your participation and please disconnect your lines.