CVB Financial Corp (CVBF) 2012 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the third quarter 2012 Company CVB Financial Corp. and its subsidiary, Citizens Business Bank, earnings conference call. My name is Denise, 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. I would now like to turn the presentation over to your host for today's call, Christina Carrabino. You may proceed.

Thank you, Denise, and good morning, everyone. Thank you for joining us today to review our financial results for the third 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.cvbank.com and click on the Our 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 reports on Form 10-K for the year ended December 31, 2011 and, in particular, the information set forth in Item 1-A, risk factors, therein. Now I'll 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 $9.3 million for the third quarter of 2012 compared with $23.6 million for the second quarter of 2012 and $22.4 million for the year-ago quarter. Earnings per share were $0.09 compared with $0.23 for the second quarter and $0.21 for the year-ago quarter.

During the third quarter we repaid five outstanding fixed-rate loans from the Federal Home Loan Bank in an aggregate principal amount of $250 million with an average coupon of 3.39% and a weighted average remaining life of 2.6 years. The repayments of these advances resulted in a $20.4 million termination expense on a pre-tax basis. We also redeemed all of the remaining outstanding capital and common securities of the trust preferred securities in CVB's Statutory Trust I, totaling $20.6 million.

We made the prepayments to the Federal Home Loan Bank to de-leverage our balance sheet and reduce ongoing funding costs. Based on the current economic trends and interest rate pressure, we continue to evaluate our balance sheet management strategy in deploying our liquidity and managing our capital position as well as the longer-term effects these prepayments have on our net interest margin. Simply put, we believe it is tremendously important to position ourselves so that our cost of funds is as low as possible.

The Federal Reserve's commitment to maintaining low interest rates and QE3 has put additional pressure on asset yields. The refinancing pressure on our commercial real estate portfolio and the depressingly low interest rate yields on newly purchased securities combined to have a negative effect on our top-line income. De-leveraging is an alternative to purchasing securities.

Presently, we have one FHLB loan remaining in the amount of $200 million. It matures in November 2016 and bears interest at 4.52%. The prepayment penalty on this loan is approximately $31 million. Further interest rate cost savings could also be achieved by prepaying the $40 million in trust preferred securities in CVB's Statutory Trust II. These securities bear interest at 90-day LIBOR plus 2.85% and has zero prepayment penalty. We have made no decision regarding the prepayment of the remaining FHLB loan or the trust preferred securities in CVB's Statutory Trust II but are considering both as potential future cost-saving options.

Through the first nine months of 2012, we earned $55.1 million, down 8.13% from the same period in 2011. Earnings per share were $0.53 for the nine-month period ending September 30, 2012, compared with $0.50 for the same period in 2011. The third quarter also represented our 142nd consecutive quarter of profitability and 92nd 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 3.60% for the third quarter compared with 3.77% for the second quarter and 3.81% for the third quarter of 2011. During the second quarter of 2012, we had several non-performing loans that were paid in full, resulting in a 10-basis-point increase in interest income. Excluding this impact, net interest margin was down about 7 basis points for the third quarter, primarily due to the refinancing of higher-yielding loans.

Now let's talk about loans. At September 30, 2012, we had $3.44 billion in total loans net of deferred fees and discount compared with $3.39 billion at June 30, 2012. We now have one quarter in a row of organic loan growth. Non-performing assets, defined as non-covered, non-accrual loans plus OREO, increased in the third quarter to $76.5 million compared with $72 million for the prior quarter. The increase is attributed to an increase in dairy and livestock non-accruals. We have once again reported zero provision for funded loan and lease losses for the third quarter. The allowance for loan and lease losses was $92.1 million or 2.85% of outstanding loans at September 30, 2012, compared with $91.9 million or 2.89% of outstanding loans at June 30, 2012. We had net recoveries for the third quarter of $175,000 compared with net charge-offs of $30,000 for the second quarter of 2012.

We recorded $1.1 million in recoveries for the third quarter. At September 30, 2012, we had loans delinquent 30 to 89 days of only $1.71 million, or 0.05% of total non-covered loans. Classified loans for the third quarter were $302.5 million compared with $298.1 million for the prior quarter. The increase was due to downgrades in the dairy and livestock portfolio. We will have more detailed information on classified loans available in our third quarter Form 10-Q.

We had $3.23 billion in total non-covered loans and leases at the end of the third quarter, an increase of $50.6 million from the end of the second quarter. For the third quarter, our commercial real estate loans increased by $47.1 million, our dairy and livestock portfolio increased by $7.4 million and our commercial and industrial loans grew by $2 million. While we are encouraged by our quarter over quarter growth, all organic, we remain cautious in our optimism as the market is very competitive for new loan originations.

Moving onto 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 September 30, 2012, we had $235.9 million in total covered loans remaining from the San Joaquin Bank acquisition with a carrying value of $207.3 million compared with $246.6 million with a carrying value of $210.1 million at June 30, 2012.

As of quarter end, our remaining purchase discount was $28.6 million. We anticipate that the majority of the remaining purchase discount will be gradually extinguished by October 2014, which is the five-year anniversary of the San Joaquin Bank acquisition.

Now I would like to discuss deposits. We continue to grow our non-interest-bearing deposits. For the third quarter of 2012, our non-interest-bearing deposits grew to $2.32 billion compared with $2.25 billion for the prior quarter and $2.03 billion from the end of last year. This represents a 3.2% increase quarter over quarter and a 14.62% increase for the year, completely organic. Non-interest-bearing deposits now represent approximately 49% of our total deposits.

Our total cost of deposits for the third quarter was 12 basis points compared with 13 basis points for the second quarter. If customer repurchase agreements are included, our cost of deposits was 13 basis points for the third quarter.

At September 30, 2012 our total deposits and customer repurchase agreements were $5.23 billion, $63 million higher than at June 30, 2012, and $116 million higher than at December 31, 2011.

Moving on to non-interest and interest income, non-interest income was $2.6 million for the third quarter of 2012 compared with $2.3 million for the prior quarter. Non-interest income for the third quarter was reduced by a $7.1 million net decrease in the FDIC loss-sharing asset compared with $9.3 million for the second quarter. Non-interest income for the second quarter also included $2 million in gain on sale of 11 covered loans held for sale. The decrease in the loss-sharing asset was primarily due to the continuing resolution of covered assets and reflects improved credit loss experienced in our covered loan portfolio. If the loss-sharing items are excluded from both quarters, non-interest income was $9.7 million and $9.6 million for the third and second quarters, respectively.

Interest income and fees on loans for the third quarter totaled $52.6 million compared with $55.2 million for the second quarter. The $52.6 million for the third quarter included $7 million of discount accretion from accelerated principal reductions payoffs as well as the improved credit loss experience on covered loans. This compares to $7.5 million of discount accretion for the prior quarter.

Now expenses -- we continue to closely monitor and manage our expenses. Excluding the effect of a $20.4 million FHLB prepayment penalty, non-interest expense for the third quarter was $29.6 million, up slightly from $28.9 million for the prior quarter and down significantly from $32.9 million for the year-ago quarter.

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. The effective tax rate for the third quarter and the first nine months of 2012 was 25% and 33%, respectively. The estimated annual effective tax rate was adjusted down to 33% during the quarter from 34.4%. This was primarily due to the effect of reducing our estimated taxable income for 2012 as a result of the FHLB debt termination expense incurred during the quarter.

Now to our investment portfolio -- during the third quarter of 2012, we provided approximately $247.8 million in overnight funds to the Federal Reserve and received a yield of approximately 25 basis points on collected balances. We also maintained about $70 million in short-term CDs and money markets with other financial institutions, yielding approximately 68 basis points. At September 30, 2012, investment securities totaled $2.3 billion, down $2.1 million for the second quarter of 2012. Investment securities currently represent approximately 36% of our total assets.

Our available for sale investment portfolio continued to perform well. At September 30, 2012, we had an unrealized gain of $83.6 million, up from $75.1 million for the prior quarter. We have no preferred stock 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 six private-label mortgage-backed issues totaling $2.9 million. We have been strategically reinvesting our cash flow from our investment portfolio, carefully weighing current rates and overall interest rate risk. During the third quarter we purchased $86.6 million in mortgage-backed securities with an average yield of 1.97%. We also purchased about $52 million of US government agency securities with an average yield of 1.98%. Our new purchases have been investing in MBS securities with a projected duration between 5 and 7 years. We also purchased $3.5 million in municipal securities with an average tax-equivalent yield of 3.30%. Finding bank-qualified municipal securities that meet our investment criteria remains challenging but desirable.

Now turning to our capital position, our capital ratios are well above regulatory standards and we believe they remain above our peer group average. Our September 30, 2012 capital ratios will be released soon, concurrently with our third quarter 10-Q.

Shareholders' equity increased by $6 million to $754.2 million for the third quarter. During the third quarter, we regained the remainder of the trust preferred securities in CVB Statutory Trust I. We paid approximately $20.6 million for this redemption. This will save us about $600,000 annually.

Now I will return to Chris for the closing remarks.

Thanks, Rich. Let's talk about the California economy. The California economy is improving and unemployment is slowly declining. According to the state's Employment Development Division, the California unemployment rate stood at 10.6% in August 2012 compared with 11.9% in August 2011 and economic forecasters predict the rate will fall to 8.5% in 2014.

Job growth during the last quarter, although still slow, showed steady gains across the states' major regions and was largely a result of improvement in sectors that were hit hard during the recession. A rebound in travel and tourism has lifted leisure and hospitality employment. Rebounding real estate markets help the construction and financial sectors, and the coastal cities have seen employment growth due to a large concentration of technology jobs.

California's port activity continues to benefit the Inland Empire. Available warehouse space is declining and the region is in the midst of a slow recovery, somewhat hindered by the residual effects of the mortgage crisis, the great recession and the meltdown in government finances.

However, according to local economists, the Inland Empire's geographic location, competitive cost structure, age profile and available land should make it one of the nation's fastest-growing population centers and Southern California's top job generator.

Our dairy and livestock clients continue to experience a difficult operating environment. Milk prices are up compared with the prior two quarters but high feed costs continue to put pressure on profit margins. According to the California Department of Food and Agriculture data for the second quarter of 2012, feed costs in California represent approximately 65% of total milk production costs compared with approximately 62.5% of total milk production costs for the second quarter of 2011. That ratio is an important thing to track.

In closing, as we head into the final months of 2012, our strategic focus remains unchanged -- quality loan growth, non-interest-bearing deposit growth, non-interest income growth, expense control and growth through acquisition.

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

(Operator instructions) Hugh Miller, Sidoti & Company.

I was wondering -- I guess you -- can you just give us a little bit of color on the risks that you foresee in the dairy lending portfolio and if you are seeing farmers that are increasing their slaughter rates in order to stay current on their loans?

What we see in the dairy industry is certainly the second quarter and most of the third quarter were difficult periods of time as feed costs were still high and milk prices were lagging. But towards the end of the quarter we saw milk prices go up, and that has helped offset some of these costs. So we're looking at that ratio I mentioned in the call here and look forward to seeing what that looks like going forward. So we are starting to see the improvement in terms of the milk price side, and that has helped, offsetting what is a very difficult feed cost side.

In terms of the overall dairies, dairies that tend to grow their own feed seem to be doing better than dairies that don't grow their own feed and have to purchase the feed out in the marketplace. And then there's a certain size to a dairy that needs to happen because there are economies of scale here in this business. And so we are seeing the medium to larger sized dairies that grow their own feed as being the ones that are showing the better results.

Okay, but do you see the potential for risk if we are seeing pressure on the farmers in that they are slaughtering their cows, which obviously would weigh on future milk production, which is helping them to remain current on loans and provide some cash flow now but at the expense of cash flow later? Is that a risk that you're seeing at all with some of the dairy farmers you are working with?

No. I think, actually, beefing the cows is actually a good thing for the dairy business because it takes away future production. And we are seeing more and more of that, and dairy men are looking at what their strategic alternatives are, from beefing their cows or selling their dairy farms or converting things over to more farming as opposed to dairy farms, etc., all of the above.

But you are absolutely right; a lot of the milk capacity, as that goes out because dairy farmers will beef their cows, is going to bring down the supply side, which is then going to help prices.

Okay, and then the follow-up question is that obviously we typically see a seasonal influence on loan growth with the dairy lending portfolio, dependent upon how strong their profitability has been in a given year. So would you anticipate that we are unlikely to see that seasonal benefit in the fourth quarter, just given the environment we've seen this year?

You know, that is certainly a possibility. And it's hard for us to project what we are going to see. But if you notice, dairy loans grew quarter over quarter. And that was dairymen drawing down on their lines as things get tighter. So my guess is, and it's purely a guess, is that we won't see as much seasonal run-up at the end of the year, but still hard to project here as we've got a couple months left.

Okay, thanks, I'll get back in the queue.

Todd Hagerman, Sterne Agee.

Chris, I just have a primary question that's effectively just in terms of the margin spread. Obviously, you guys were very busy in the quarter deleveraging. But if you could walk us through in terms of puts and takes on the margins, specifically -- obviously, the deleveraging is going to help your spread on a go-forward basis. But as I think about the securities purchases and some of the seasonality in dairy and so forth, I'm just trying to put together my spread and margin outlook for the Company, particularly with the pressure on rates and the securities.

Right. One of the things on our $250 million payback of the five FHLB loans -- we didn't do that until the very end of August. I think it was August 28 or something like that. So we didn't get the full benefit of that margin pickup for the quarter. So I think we are going to see -- hopefully, we will see the effects of that. We will see the effects of that for a full quarter in the fourth quarter. And the same thing on -- obviously, to a smaller scale -- with the trust preferred securities that we prepaid of $20 million, which we anticipate will save us, I think, about $600,000 annually.

So those are all just -- what we are trying to do is get our cost of funds as low as possible. And right now we feel our cost of funds is at a run rate of about 33 basis points for our total funding costs. I would like to see that get lower, but we have to look at the trade-offs between that and taking a big prepayment penalty on the remaining $200 million in FHLB yields. We are seeing more pressure -- we're seeing ongoing pressure, I should say, on our fixed-rate commercial loan portfolio, our commercial real estate portfolio. So there are repricings that continue to go along there. In most cases we are getting prepayment penalties and we are extending some of those loans, so I think that's good from a stability standpoint. And we do pick up some income on the fee income side. But there's no question that we continue to reprice loans.

And at the same time, as we are buying new securities to replace higher-yielding securities, there's going to be pressure on that as well. So our objective is somewhere -- and this is the ball park. But if we were to pay back $200 million, the remaining $200 million in our FHLB -- on our remaining FHLB loan and the $40 million in Trust Preferred II, which is at LIBOR plus 2.85%, we believe our cost of funds would be somewhere around 16, 17 basis points for the organization.

So that's where we feel the rubber will meet the road, so to speak. And after that it's very difficult for us to lower cost of funds beyond it.

Yes, and to that end, obviously you took a big charge this quarter in terms of the prepayment penalty. And as you mentioned, I think it was around 30 -- I forget the.

$31 million.

$31 million, right.

With $20.4 million as a pre-tax charge on that $250 million.

Right. So I'm just thinking again, as you think about the cost benefit analysis, like you said, you can basically cut your cost of funds in half, effectively. So just trying to get a better sense of, again, as you got -- because I was, quite frankly, a bit surprised that you did take that hit, given the extent of the penalty. But how should we think -- how should we really think about that going forward as the way you think about it from a cost/benefit standpoint?

Well, when we look at that $250 million, the average duration of that $250 million was 2.6 years. So when we saw QE3 and hear Bernanke talk about interest rates and future interest rates, we don't think there's a lot of risk in interest rates going up that would really affect our decision to prepay that. And remember, when you're looking at $250 million and we are saving call it 3.15%-ish on that money for that 2.6-year period, it's basically a wash and maybe a little bit advantageous to us.

The alternative to doing that is to keep purchasing securities. And to keep purchasing securities is -- we're taking interest rate risk on that side and we're having to go further out the curve to get yield. So this is all a balancing decision.

One of the things that we are very excited about, although we have to be cautious because it's not a robust economy, is we grew organically our loans by almost $50 million this quarter. And that is including our runoff on the San Joaquin Bank loans, a little bit downsizing of mortgage pools and all that kind of stuff. So we feel like we are starting to get some good traction there on the lending side. I can't make any promises to anybody, but we are working our tails off on growing loans organically. We are also coming out with a new residential mortgage product here next week that we are going to actually do residential mortgages, probably more jumbos than not, for our clients and for various potential clients. And we are excited about that program coming out, and really oriented towards lower loan to values and more the private banking sector.

Great, that's very helpful, I appreciate it.

Aaron Deer, Sandler O'Neill.

Just a couple of small questions -- one is the discount that you have remaining on the San Joaquin Bank portfolio, that $29 million -- do you expect that to be fully recovered, or do you expect there is going to be some offsets to that as fee performance in the portfolio is better or worse than expected?

Well, at this point, at $28.6 million, it's not a huge number anymore. We were, at one point, I think it was $200 million. Is that right? We were $198 million or something out of the gate. So we have been 90% or 80% or whatever it is through the game here. And we've got another eight quarters basically to -- until our loss sharing ends. So as we work down these loans, and that's why I said, in other words, we will gradually work through these things, the bigger, more toxic stuff that we are dealing with, with the San Joaquin Bank, for the most part is done.

There's a few loans here and there that we are still seeing what happens. But we've been through the wringer on that, and actually we are in the process of -- we have actually downsized our special asset department by a few people here in response to that, and that will help us lower some costs too. So we feel that it will be -- when we get to the end here in October 2014 we don't think there's going to be a big differential one way or another that's going to cause any kind of one-time this or one-time that of any substance.

Okay, and then inevitable question -- obviously, it's nice to see you guys getting some organic loan growth coming back. But can you give us an update on what you're thinking in terms of the M&A environment and any conversations that might be going on there?

Yes. I can't talk about the conversations that are going on but happy to talk about our strategy there. We are talking to different people, and really a lot of banks through intermediaries have reached out to us as well. But the expectations and so forth are -- there's still a gap between the what I consider is the seller's expectation of what they want and what we think is reasonable to pay. And a lot of that is based on the trends that are going on. And what you guys are looking at as well is the difficulty in achieving increasing margins and dealing with decreasing margins for spread banks. And all these community banks are spread banks. And just to give you an example, we looked at a bank, let's say, we'll just use a number, $500 million in assets and $200 million of those assets are in securities funded by what we think are inflated deposits due to the fact that all of the deposits have flown back into the bank, banks. And so when we look at those securities, which most -- a lot of them have been recently purchased over the last year or so, there's not a ton of gain in there.

So if we were to acquire that $500 million bank, what we would probably do is we would have to flush out a lot of those securities because we would not want to take the interest risk that's embedded in those. We would take the small game, flush it out, and we would be left with a $350 million bank instead of a $500 million bank. So when you look at what we are paying for that, we've got to take that into account on the earnings side and then the multiple of earnings, which is really what we are focused on.

I know the market looks at a certain multiple of tangible book, but we are trying to see what kind of earnings is this going to bring into our organization, what is the sustainability of that earnings and then how can we scale their business up and cross-sell our product into their business. Those are the factors we are looking when we make or look at a prospective acquisition.

And when you think about the pricing on that, how do you think about it in terms of return on investment or payback period? And what kind of reasonable -- what do you consider to be reasonable pricing on that front?

I think when we look at it, we are definitely -- we want to look at the expense side of the acquisition because it's hard to count on organic growth for these institutions, and really organic growth in loans in these institutions, because the deposit growth isn't really meaningful right now. The loan growth is meaningful. And so, when we look at these institutions, we say, okay, are they really growing loans? And what type of loans are they growing? And are these loans -- what kind of interest rate risk are they taking when they do these loans, in terms of are they 10-year fixed-rate loans? Are they five-year fixed-rate loans? So we're looking at the composition of the portfolio. And I think, as we look at those things we have to be very careful about what it's going to look like in two years down the line.

So in terms of what we are willing to pay for various institutions, a lot is predicated on that securities book, what we think of the loan book and our ability to cross sell our fee-based products into those banks, meaning we have our wealth management investment services, merchant bank card, cash management services, equipment leasing, vehicle leasing. A lot of banks don't have those type of products and services. So we really are looking at the composition of the client. Is it a business client or is a retail claim? And we are really after the community banks that have more business clients because we can cross-sell a lot of those products and services into them.

And that's going to dictate whether we pay one times tangible book or 1.5 times tangible book. The good news is we're trading at about 1.8 times tangible book, or maybe, I don't know, over the last couple days, 1.75 times tangible book. So it should be accretive to our earnings in a very short period of time. And really, I would say that an acquisition has to be accretive to our earnings coming out of the gate, especially in this kind of environment.

That's great, thanks, Chris.

Joe Gladue, B. Riley.

I think most of my questions have been answered, but just wondering if you could give us an update on the one -- I guess the sizable shared national credit that went into not accruals last quarter -- anything new on that?

Well, there actually is nothing new on that, which is a little frustrating. But it's a shared national credit, as you are well aware. It went into non-performing assets in the second quarter. It's approximately $10.8 million, $11 million, somewhere in there -- is that right, Rich?

Yes.

Okay. And the credit facility matures in June, and so we feel that's an important benchmark next year because the whole banking group is not completely aligned with what we should do on this. We are driving to get $1.00 on the dollar back on this credit. And so we think there's enough there to get all our money back on it, but we shall see.

It is paying interest. It is current on interest, and so they are making payments and so forth. But it is deemed non-performing due to the lack of -- it's a large construction loan, and it hasn't leased up as quickly as anticipated, like so many of these large construction loan development projects.

Alright, thank you, I guess that's all I had.

(Operator instructions) Brian Zabora, Stifel Nicolaus.

A question on expenses -- you indicated in the Q&A that you may get some cost saves or you are getting some cost saves from special assets groups being downsized. But with expenses up a little bit in the quarter, do you feel like you are reaching a floor as far as potential costs saves outside of credit related?

You know, it's a delicate balance between saving money on one side and then reinvesting our business on another side. So I don't know if we've reached a floor. We just recently closed one of our locations in North Orange county. That's going to save us some money. We just did that October 5 or 10 or something like that; that's the first week of October. So now we have 46 business financial centers instead of 47. So that's going to save us a couple hundred grand a year.

So we are doing things like that all the time. But we are also reinvesting in the infrastructure of our Company and a lot of technology-related things because we are all seeing this world where cyber-fast and everything going on, we are seeing attacks on the big banks. And you will see their online banking has got -- I think one of the big banks had their online banking shut down for a day or two or whatever it was. We are seeing a lot more of that activity, too. So we are concerned about that and we're trying to stay ahead of the curve. And so there are software and investments that go into technology that will help us, number one, be more fluid with our clients in handling their banking relationships so they don't have to -- we don't have to have as much brick-and-mortar.

So there's kind of a trade-off going there -- less brick-and-mortar, more investment in technology. So I think those things will probably offset each other, for the most part. But eventually, it will go down because, simply put, we're just not seeing as much foot traffic in our branches as we did five years ago. And we need to construct our branches or reconstruct our branches accordingly so that we don't have as much brick-and-mortar. And really, our branches are getting more and more focused to our associates and our employees and recruiting people and providing a good working environment than it is for our customer because our customers just simply are not coming into the bank as more. They are using online banking, remote deposit capture, ACH, wires, you name it, to do a lot of their banking activity.

Greg, that's helpful. And then one more question on commercial real estate growth -- was there a specific type that you saw better demand or better growth, or was it broad-based?

It's pretty broad-based, and it's all in-market stuff and it's all just the typical stuff that we would normally do. I think a lot of this is as a result of our people just really focused on loan growth and getting out there in the marketplace. And we are out there to buy quality, and we don't want to take a lot of lending risk at this juncture because when you are lending money out at 4%, 4.5% or whatever it is, you simply have to be right pretty much every time to make money. And so we are very focused on the quality side of it and then trying to manage the interest rate side of it, too. And we have done some interest rate swaps on these loans as well, and you will see, if you look at our financials, we are going to have the best year ever in terms of interest-rate swap fee income in 2012. In fact, I think right now we are about $1.1 million in swap fee income this year, and I think our highest year ever was $1.1 million and we've still got three months left.

Great, thanks for taking my question.

Don Destino, Harvest Capital.

I must have mis-pressed the button; I thought I had taken myself out. But you did a great job answering most of my questions and Aaron's question about M&A. I guess the other question I would ask you, since I have you, is just what are the benefits of the FHLB payoff? Are there any economic benefits? Is there any way that at the end of the 2.5 years in which you would have had the FHLB outstanding that your tangible book value is higher because you paid it off than if you had not paid off?

You know, it's a trade-off. And it's like, do you want to take your poison over the next 2.6 years, or do you want to take it right now? And I think there's a certain mentality in our organization that we want to be as efficient as possible and we want to have as lowest cost of funds as possible and operate our business accordingly. I don't think there's a lot of risk in that $250 million that prepaid over the next 2.6 years, in terms of interest rates going up and us feeling foolish that we prepaid that debt now. But we are going to have to think a lot harder on this next $200 million because it has four years left. And it's harder to say -- it's harder -- that extra 1.4 years or whatever it is that's out there is something we've got to scratch our heads on pretty hard before we make that decision because it is a trade. It's a monetary trade-off, and if rates stay exactly where there are, we will be slightly better off paying it back now than we would paying it back over time. But if interest rates moved up, we could be a lot more foolish by doing this. And that's where that four-your decision is different than the 2.6-year decision. And we are having a lot of discussions on it.

But just to have the -- in the marketplace, I think you are running a business, we are running a business and we are looking out there and saying we're going to make loans out in the marketplace -- well, I feel more comfortable going to sleep at night knowing that I'm making a 4% loan if my cost of funds to the organization are 16 basis points than I do if they were 50 basis points, like they were in the second quarter. So that mentality in buying quality and preserving our margin is psychologically important. But from a monetary standpoint, I don't think there's much difference.

Do you have to keep in mind as you are doing your planning that you did spend that money, say, in the third quarter and make sure when you are thinking about operating expenses that you are not spending the extra go-forward income just because you've got extra income because you paid that loan off?

Well, I just think we have plenty of cash. Our cash position right now is -- we paid off $250 million in FHLB debt by using our cash. And our cash position right now is growing back to about the same level it was before we paid that $250 million. So we are accumulating cash very quickly. Our first desire is to take that cash and make loans and grow our loans organically. That's the best thing that we can do; that's the best thing for our organization in terms of yield and profit and the bottom line.

I'm sorry; I stated the question very clumsily. How I meant it was I know that some firms or some banks have targeted an efficiency ratio or budget out based on an efficiency ratio. And when you are taking the pain early and then getting the higher earnings going forward, are you keeping in mind that you did take that pain early and that, all else being equal, your efficiency ratio should be lower than it would have been otherwise?

Yes, I guess so. I think that efficiency ratio -- we have done a lot to work on the denominator of that, on the expense side and so forth. And now we've got to really work on the numerator of that; we've got to get that income up. And so ultimately, right now, what are we trying to do? We are working really hard to get our top-line income growing. And right now, it isn't. It's still shrinking, and that's just a product of having $3.4 billion in loans and $2.3 billion in securities repricing on us faster than we can reduce our cost of funds. And so the only way to do that is to make 4.5% yielding loan as opposed to buying securities at 1.75% or 2%. So that pickup, that incremental -- the gap between the yield on loans and the yield on securities is the largest we've seen it, at least in my six-year tenure here at the bank. So that's why growing loans is so important because we are buying securities at 1.75% or 2% or whatever it is -- 2% on a good day -- and going out a little further on the curve to do that, whereas if we go make a loan that's 5-, 7-, 10-year fixed-rate loan, we are probably going to get somewhere between 4% and 4.5% yield on that. Even if we make a variable rate loan, we are going to get a 3.25% or 3.5% yield on that.

Thank you very much, Chris.

(Operator instructions) Gary Tenner, D.A. Davidson.

I just had two questions. One, what was the average securities yield just for the third quarter?

Rich, do you have that number?

I do, I've got it.

Average security yield for the third quarter -- that's just mortgages there.

I have in the spreadsheet.

Give us a minute on that. We'll give it to you.

Sure. And, Rich, while you are looking that up, I also had a question -- I don't know if you mentioned this. If you did, I missed it -- just the pop-up in comp expense in the third quarter? Was that bonus accrual related? What was --

Yes, it was bonus accrual related. And also, we pay midyear bonuses and so forth, and the midyear bonuses were a little bit higher than what we had projected, mid-year bonuses to our sales teams.

So would you expect that 17.5 to get back down to the 16.5 range, or is that 16.5 rate more of a run rate, do you think, now?

It's hard to say at this point. It depends how we finish the year on the sales side and how we finish -- our bonus program for our senior leadership team is all tied to our performance. And it's based on earnings, how we control expenses, how we grow loans, how we grow our non-interest-bearing deposits. And then our non-interest income. Those five components are really -- the senior leadership team is tied very much to those five components. The sales team is just based on the productivity of loans and non-interest-bearing deposits and fee income as well.

So hard to say. We are hoping to finish strong. I'd like to be able to pay more bonuses, but I think that the expense side -- we don't feel like we are increasing expenses. We should be able to hold the line here pretty well. I think that whatever, $700,000, difference is -- hopefully, we are able to bring that back to where it was.

And Gary, this is Rich again. Including the balances at the Federal Reserve Bank, our yield on investments was 2.4% for the quarter.

Okay, including the overnight excess at the Fed? Okay.

Yes, included -- that's a blended with the Fed funds sold, so to speak, 2.40%.

(multiple speakers) at 25 basis points.

2.40%?

Right.

Okay, great, thanks guys.

(Operator instructions) Aaron Deer, Sandler O'Neill.

Just a couple of quick technical questions, one is on the tax rate. Obviously, it was lower this quarter, given the prepayment penalty. Just wondering if we can expect to see that come back up to the 35-ish level or if the 25 is going to be the run rate to get that set for the year.

What really drove that adjustment in the tax rate is the decision to prepay the FHLB advances and the penalty that was incurred in regard to that because our tax-advantaged income for the year that's anticipated -- that level hasn't changed dramatically. And so when you decrease the taxable income in proportion to the overall income, naturally that rate is going to come down. So we are doing the best we can to estimate it. We think that that 33% on an annual basis is a pretty good estimate for 2012.

So, in essence, our best guesstimate for the fourth quarter is a 33% tax rate.

Okay, and then I know you mentioned you close the one office, but occupancy costs were a little higher in the quarter. Was there like a lease charge on it, so we can expect to see that come down, then, in the fourth quarter?

Yes.

Thanks very much.

Julianna Balicka, KBW.

A couple quick questions -- since the M&A idea is getting more difficult because of the gap between buyers and sellers, do you have any updated comments on buybacks or special dividends? And apologies if I missed that earlier in your commentary.

No, we didn't talk about that. We still have -- how many shares do we have available to buy back at this point that have been approved by the Board? I think we are -- 7.8 million shares remaining to buy back. So that is an option we are looking at.

I think one of the things that we're looking at is, again, trying to reduce our cost of funds. So when look at our excess dollars and so forth, one of the things we will look at is the Trust Preferred Statutory II. We still have $40 million of that at LIBOR plus 2.85%. So I think that's going to be something we look at. We could look at buying back our shares and we will continue to strategically think about that because we do have a lot of capital.

But our preference would be to put our capital to work in an acquisition. And I do think over the next quarter or two we are going to see reality checks for a lot of these smaller banks because we are feeling the pressure on the margin side. And we are doing what we can to lower cost of funds. And we've still got a little game to be played there on the cost of funds to lower our cost of funds to preserve our margins. But it's got to be brutal pressure on some of these $500 million in asset banks, $600 million in asset banks -- a lot more than us because we do have greater amounts of fee income, more economies of scale and a bigger depth to our business and product line.

So I think these depressed interest rates are going to give CEOs out there of smaller banks a big reality check over the next couple quarters because they have been allowed to have pickups because their non-performing assets have improved. And so I believe there's a little bit of illusion that, hey, our income is fine, we're doing okay. But they are not going to get those pickups going forward on the non-performing assets and they're going to be living with the reality that their assets are repricing, their securities our repricing. And where are they going to go on the cost of funds side? And they don't have the fee income to help build them out of there.

One of the things you see about the big banks is, the Wells and the US Banks and so forth, 50% of their income is fee income. Community banks -- a lot of these guys have, if they are lucky, 10% of their income is fee income.

That makes sense. And maybe as a follow-up to that, a couple quarters ago you had talked about expanding to West LA, for example, or some other geographies. And in the current environment with its focus on greater efficiency and cost, is even opening up new branches into new markets a part of the menu, or is that something that is on hold for the moment?

That will be part of the menu. In fact, we just hired a new team to go in downtown Los Angeles, so we are excited about that. They just started about a week ago. Again, I told you we closed the branch. And we are closing and opening as we see things, just to realign where we are and make those as efficient as possible. But sure, we would love to be in all those markets. But it's got to be the right team in the right place. And one of the things that we have to look at is, whereas if you ask me this question four years ago, to open up a branch or open up a new location, I would say, boy, I want those deposits because I want those deposits to fund my loan demand on all those things.

But today, the deposits just aren't that important. So when you look at buying something and you look at -- they are important long-run; I don't want to say they are not important. But they are important in the long run. But in the short run, we are flush with deposits. We are really trying to manage our deposit growth and focus on just the sticky deposits. As you look at our record here over the last year, our deposits are up about 17% year-over-year on the non-interest-bearing side, but we are only up like 3% in total deposits. So we are managing our cost and we are managing the stickiness of those deposits because we know when rates go back up that a lot of these deposits are going to go elsewhere and we've got to focus on what we think is going to stick here and build that long-term deposit base.

But if you open up a new branch in a new territory and so forth, yes, some of those are going to be sticky deposits. But we really don't need them right now. Where we going to do with them? We are going to buy securities or put them overnight into the Federal Reserve. So it really has to be a loan-oriented team. It's got to be about driving asset growth, when you're looking at these teams or you are buying a bank, too.

Yes, that makes sense, thank you very much for the color.

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

Thank you very much. We appreciate all of you for joining us today on our call, and we appreciate your interest and look forward to speaking with you again on the fourth quarter and year-end 2002 earnings conference call, which will occur in January. In the meantime, please feel free to contact me or Rich Thomas and have a great day. Thank you very much.

Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.