CVB Financial Corp (CVBF) 2014 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the First Quarter 2014 CVB Financial Corp and its subsidiary, Citizens Business Bank Earnings Conference Call. My name is Mike and I'm your operator for today. (Operator Instructions)

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

Thank you, Mike, and good morning everyone. Thank you for joining us today to review our financial results for the first quarter of 2014. Joining me this morning are Chris Myers, President and Chief Executive Officer; and Rich Thomas, Executive Vice President and Chief Financial Officer.

Our comments today will refer to the financial information that was included in the earnings announcement released yesterday. To obtain a copy, please visit our website at www.cbbank.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 or financial position. Such statements involve risks and uncertainties, and future activities and results may differ materially from these expectations. The speakers on this call claim the protection of the Safe Harbor provisions contained in the Private Securities Litigation Reform Act of 1995. For a more complete discussion of the risks and uncertainties that may cause actual results to differ materially from our forward-looking statements, please see the company's Annual Report on Form 10-K for the year ended December 31, 2013, and in particular, the information set forth in Item 1A, risk factors therein.

Now I will turn the call over to Chris Myers.

Thank you, Christina. Good morning, everyone, and thank you for joining us again this quarter. Yesterday, we reported earnings of $28.7 million for the first quarter of 2014, compared with $25.3 million for the fourth quarter of 2013, and $21.6 million for the first quarter of 2013. This quarter represents the most profitable quarter in Company history. Our first quarter earnings were positively impacted by a $7.5 million recapture of the loan loss provision, and a $2.3 million increase in interest income resulting from the payoff of one non-accrual loan.

Earnings per share were $0.27 for the first quarter, compared with $0.24 for the fourth quarter and $0.21 for the year-ago quarter. The first quarter represented our 148th consecutive quarter of profitability and 98th 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 first quarter, compared with 3.47% for the fourth quarter, and 3.54% for the year-ago quarter.

At March 31, 2014, we had $3.4 billion in total loans, net of deferred fees and discounts, compared with $3.55 billion in total loans at December 31, 2013. Overall, non-covered loans decreased by $132 million and covered loans decreased by $15 million quarter-over-quarter. Our dairy & livestock loan portfolio decreased by $76.3 million from the fourth quarter of 2013 to the first quarter of 2014. Higher milk prices contributed to strong profitability, which led to pay-downs on our herded feed lines.

In addition, we experienced our normal seasonal paydowns from dairy customers who drive down on their lines of credit during the fourth quarter to prepaid feed cost, and then repay these borrowings during the first quarter. Overall, the first quarter was slow in terms of loan demand, and competitive pressure seem to accelerate in terms of pricing and structure. At quarter end, our loan pipeline showed signs of improvement, but the competitive environment for new loans remained challenging.

In terms of loan quality, non-performing assets defined as non-covered non-accrual loans, plus OREO, were $46.7 million for the first quarter of 2014, compared with $46.4 million for the prior quarter. The allowance for loan and lease losses was $68.7 million or 2.11% of total non-covered loans at March 31, 2014, compared with $75.2 million or 2.22% of outstanding loans at December 31, 2013.

Net recoveries for the first quarter were $990,000, compared with net recoveries of $1.3 million for the fourth quarter of 2013. At March 31, 2014, we had loans delinquent 30 to 89 days of $960,000, or 0.03% of total non-covered loans.

Classified loans for the first quarter were $219 million, compared with $245.6 million for the prior quarter. This represents a 10.8% decrease in classified loans quarter-over-quarter. We will have more detailed information on classified loans available in our first quarter Form 10-Q.

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, 2014, we had $156.5 million in total covered loans with a carrying value of $145.3 million, compared with $173.1 million with a carrying value of $160.3 million at December 31, 2013. As of first quarter end, our remaining purchase discount was $11.2 million. As a reminder, our loss sharing agreement with the FDIC expires this year in October.

Now, I'd like to discuss deposits. For the first quarter of 2014, our noninterest-bearing deposits increased to $2.69 billion compared with $2.56 billion for the prior quarter and $2.37 billion for the same quarter a year ago. This represents a $321.9 million or 13.6% increase year-over-year, completely organic. Noninterest-bearing deposits now represent 52.61% of our total deposits.

Our total cost of deposits in customer repurchase agreements for the last two quarters was 12 basis points. At March 31, 2014, our total deposits in customer repurchase agreements were $5.74 billion, compared with $5.19 billion for the same period a year ago and $5.53 billion at December 31, 2013. Our ongoing objective is to maintain a low cost stable source of funding for our loans and securities.

Interest income; interest income for the first quarter totaled $61.1 million, compared with $59.3 million for the fourth quarter of 2013. The $61.1 million for the first quarter included $1.7 million of discount accretion from principal reductions and payoffs, as well as the improved credit loss experienced on covered loans. This compares to $2.1 million of discount accretion for the prior quarter. So, if the discount accretion was eliminated, total interest income for the first quarter increased by $2.1 million or about 3.7% from the fourth quarter of 2013.

Total investment income of $15.6 million increased $1 million or 6.9% from $14.5 million for the fourth quarter of 2013. Non-interest income was $11.5 million for the first quarter of 2014, compared with $5.9 million for the fourth quarter of 2013. The first quarter included a pre-tax gain of $5.3 million for the sale of one loan held for sale at December 31, 2013.

Now expenses. We continue to closely monitor and manage our expenses. Non-interest expense for the first quarter was $31.2 million, compared with $29.3 million for the fourth quarter. The quarter-over-quarter increase in expenses was primarily due to a $1.2 million increase in salaries and employee benefits, principally due to increased health care costs for which we expect partial insurance reimbursement, new higher expenses and other employee benefits. Additional costs included merger-related expenses of $427,000 in connection with our proposed acquisition of American Security Bank, and $259,000 in branch consolidation costs due to the closures of one of our Bakersfield center location and the Stockton Business Financial Center.

Now I'd like to turn the call over to Rich Thomas, our CFO to discuss our effective tax rate, investment portfolio and overall capital position.

Thanks, Chris. Good morning, everyone. Our effective tax rate was 36% for the first quarter, compared with 34.4% for the prior quarter. Our effective tax rate varies depending upon tax advantaged income, as well as available tax credits.

Now on investment portfolio. During the first quarter of 2014, we sold an average of approximately $199.3 million in overnight funds to the Federal Reserve and received a yield of approximately 25 basis points on collected balances. We also maintained $70 million in short-term CDs with other financial institutions, yielding approximately 70 basis points.

At March 31, 2014, investment securities totaled $2.75 billion, up $86.4 million from the fourth quarter of 2013. Investment securities represented approximately 39.9% of our total assets at quarter end. At March 31, 2014, we had an unrealized gain of $8.7 million in our total investment portfolio, compared with an unrealized loss of $16.1 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 US government.

We also have three private label collateralized mortgage-backed securities totaling $505,000.

We have been strategically reinvesting our cash flow runoff from our investment portfolio, carefully weighing current rates, and overall interest rate risk. During the first quarter, we purchased $168.4 million of mortgage-backed securities with an average yield of 2.2% and an average duration of approximately four years. We also purchased $3.1 million in municipal securities during the first quarter with an average tax equivalent yield of 3.65%. Prepayment speeds in our investment portfolio have decreased and based upon current interest rates, we anticipate receiving approximately $25 million in monthly cash flow from our portfolio.

Now turning to our capital position. Our capital ratios are well above regulatory standards and we believe they still remain above our peer group average. Our March 31, 2014 capital ratios will be released soon concurrently with our quarter-end Form 10-Q. Shareholders' equity increased by $37.3 million to $809.2 million for the first quarter. The quarter-over-quarter increase was due to an increase of $28.7 million in net earnings, $4.9 million of various stock-based compensation items, and $14.4 million in unrealized gain on available for sale securities. This was offset by $10.6 million in cash dividends.

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

Thanks, Rich. Now let's talk about economic conditions. In terms of the dairy industry, feed cost continued to stabilize, and actually decrease, while mild prices increased. According to the California Department of Food and Agriculture, the CDFA, feed costs in California represented 64.8% of total milk production cost at the end of the fourth quarter of 2013, down from 65.4% of total milk production costs for the third quarter of 2013, and 66% for the fourth quarter of 2012.

Milk prices have been rising in recent months. According to data from the US Department of Agriculture, dairy farmers were paid approximately $23.50 for 100 pounds of milk in February, 2014, up from $21 in January and approximately $17.50 in February 2013. Prices vary depending on what class of milk is being sold. A variety of factors are driving up milk prices, including US dairy exports. Milk exports are at historic highs, particularly to China, the world's top dairy importer. Milk prices are expected to remain high throughout 2014.

There has been much discussion and concern over the drought in California, as the state is the biggest agricultural producer in the United States in terms of dollars of produce sold. California dairy farms with a capacity to grow their own roughages for feedstocks, and those located near aquifers will fare better during the drought. Spring is typically a good time for milk production, even despite the drought, as cows produce more milk in drier, warmer, but not hot conditions.

Turning to the overall California economy, according to various economic reports, every sector of a state's labor market, with the exception of government, experienced job growth in the past year. According to the State's Employment Development Division, the California unemployment rate was 8% in February 2014, compared with 8.1% in January, and 9.4% back in February, 2013.

Residential real estate prices increased with medium home prices up by more than 20% in 2013. The number of homes sold is now slowing, as buyers are adjusting to a sharp rise in home prices and borrowing costs, and inventory is expected to remain tight. Notwithstanding, the California housing market should continue to be an economic bright spot for 2014 and beyond.

Tourism remained a solid driver of California's economic recovery. Hotel occupancy has increased and sales tax receipts generated by restaurants and hotels have continued to improve. International trade picked up in the second half of 2013 and should continue to be a positive influence on California's economy over the next year. Port activity at the Los Angeles and Long Beach Ports remained strong.

In our effort to accelerate growth, we are actively focused on acquisition opportunities with respect to community banks in or adjacent to our geographic footprint. In February, we announced the acquisition of American Security Bank, a community and business banking franchise located in Southern California with branch presence in Newport Beach, Corona, Laguna Niguel, Lancaster, Victorville and Apple Valley. We believe the Bank and its strong team of associates is a great fit for us. Both organizations share a common philosophy and approach to community banking with an emphasis on serving the financial needs of small to medium sized business customers and their owners. We anticipate this transaction will close this quarter.

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

(Operator Instructions) Hugh Miller, Sidoti.

Hi, good morning.

Good morning.

I guess, to start off with a question with regards to the loan sale you guys had mentioned with the $5 million gain, I was wondering if you could give us some color on that with regards to pricing, the type of loan, I guess the rationale for selling it and whether or not we should expect this on a go-forward basis?

Yes, the loans was a non-performing loan with us, and it had been in our portfolio for a couple of years. We know it was secured by commercial real estate piece of property and the price of that property and the leasing of that property had improved dramatically. And we were able to recover about 90% of the original loan amount, of obviously a substantial charge-off that we had taken a couple of years ago.

Okay, alright that's helpful. And then I guess the second follow-up question, just with regards to -- if you could talk about the lending environment, both from the sense of competition and whether or not we're seeing an intensification there? And then also, you gave some commentary about the economic environment starting to look like it's improving and whether or not you're seeing your business borrowers, the discussions you're having with them, are they -- is their appetite growing to take on risk and to borrow and so forth?

Yes, the whole lending side -- I was disappointed in our loan growth in the first quarter in some respects, but not all respects. We had $132 million decline in non-covered loans, and that's what we really focus on. Of that, $80 million plus was attributed to dairy and agricultural. The dairy is actually -- we knew $35 million, $40 million of that was going to come back to us in terms of just the seasonality on the dairy side. The other 40-ish million that came back to us on that side was really a product of -- our dairy is making a lot of money because of the huge gap between what has happened in milk prices. I mean, milk prices were $23.5 per hundredweight in February. That's $6 more than it was a year before. That's a huge increase. You're talking about an increase that is 30 something -- 30% to 35% increase in milk prices year-over-year. So the dairies are really harvesting and making a lot of money right now, which is great because it improves our credit as well.

So we saw some improvement in our classified loans and that's why you saw our classified loans go down to $26 million quarter-over-quarter. So that was the good -- I mean I consider that kind of a good thing, because the health of our dairies is strengthening very rapidly. We have large reserves against our dairies. I think our reserves at the end of the quarter were $18 million, $19 million against that whole portfolio, on roughly [$350 million-ish] in total dairy loans, if you include the real estate loans in there. So that's a large reserve to have against that, and so we probably will see some further improvement in terms of the dairy loan rates going forward, although can't predict.

So now let's talk about the other half of the loan growth side, which was -- we did have some good resolution like the loans we sold here. Those were obviously in our loan totals -- the loan we sold here, that we took the gain on. So that reduces our loans, but January and February the pipeline was soft and we were a little surprised by that. Same thing happened to us last year, if you look at our last first quarter and even into the second quarter of last year, we had tremendous softness on the loan side and we gained a lot of momentum in the second half of the year.

We're starting to see good momentum in the pipeline and still not where we wanted to be, but we're not -- one of the things that we're focused on is making sure we maintain our credit discipline. When you're lending money out at rates, which are typically sub-5% right now, you got to be careful about how you're lending. We are seeing competition accelerate, we're seeing looser structure, we're seeing some crazy pricing, and I'll tell you what, a lot of that is coming from the big banks. And I will say that the first quarter was a surprise to us on several credits that we had in the pipeline that didn't come to fruition, we didn't win, and that was attributed not so much from a relationship perspective, but from the pricing and the structure side.

We are accelerating our marketing efforts. We're accelerating our calling activity. We've got a bunch of new hires that we had in the second half of the year of 2013 that we believe will start kicking in. They haven't materially kicked in yet, not only our San Diego locations, but our agribusiness hires and some other hires that we've done. So I'm cautiously optimistic, but I'm also a little concerned about the fact that I think some of the big banks are coming down in the market in pricing to win market share. And maybe that's because of their frustration with what's going on in the residential mortgage side, because I know they have loan softening on that side. We're not afraid to compete on price as long as we're not taking an excessive amount of interest rate risk along the way. And so, we have to manage that going forward. I still believe we're going to experience positive growth on the loan side for 2014 going forward. That's certainly our objective. And that was a long answer to your question, but I think it's not a simple question to ask right now.

It's very, very helpful, the color there is very helpful indeed. I guess just with the one area that you touched on was just -- in the discussions you're having with the business borrowers, are you getting any sense that they're kind of -- given the economic trends, is demand increasing for borrowing or is it still kind of sluggish?

No, I think we are seeing some modest increase, and it depends. But I looked at some numbers in terms of loan growth, and I can't cite the article that I saw the other day, but -- or maybe a week or two ago. But the growth segments were really orient to the larger loans, $25 million and up, and $10 million and up. We're really playing in seven-figure loan territory, that's most of our loan growth has experienced a seven-figure loans, not eight-figure loans. And so we are not doing -- we have not done any new loan participations in years. So we have one national shared credit in the bank. So we're not growing through someone else's loan growth and participating in their loans, and I know some other banks are doing that and we are trying to remain as pure as possible.

We believe our initiatives, our citizens home loan initiative, we hired a new head of construction loans about four or five months ago, our construction loan portfolio, our pipeline is starting to kick in. Again, I mentioned San Diego, I mentioned agribusiness, we have a lot of new things that are kicking in and just been a little slower than we'd like, but we remain committed to growing our loan portfolio in a pure way that's going to stand the test of time when the next recession comes.

Great. I appreciate the insight. Thank you.

Julianna Balicka, KBW.

Good morning. A quick housekeeping question. On the loans that you sold, the NPAs, what was the underlying size of the loan that you sold and what was it originally, or I guess in the most pre-charge-off level?

I'll give you some ballparks on that. At one point -- I'm sorry -- you're talking about the loan that we sold -- I am sorry -- sorry about that. The loan was originally about a $10 million loan, and we had marked it down to obviously less than half of that amount, and then we sold it for -- maybe a little bit less than that $10 million.

Okay, got it. And then couple of questions. On the -- you mentioned that the big banks are giving up, not just pricing, but also on structure, so what are some of the structure loosenings that you're seeing in the marketplace? And as you talk about [residential], what kind of loans are we talking about? (multiple speakers) pretty broad?

That's a good question. And on the C&I side, the commercial/industrial loans, meaning non-real estate secured typically, where we're taking a broad form filing or it's an unsecured credit facility of the business. We're seeing a lot of releases of guarantees, we're seeing aggressive pricing on that side, we're seeing fewer covenants along the way, deals that we think might be asset-based and they should be monitored more closely, we are seeing looser structures and non-asset based formulas.

So, we're trying to retain some of our discipline, but along the way we've got to pick and choose which ones we're going to be able to compete on in terms of giving them a more liberal structure in which ones we don't. And our philosophy in general is, you can't take a mediocre or a poor credit and make it a good credit by putting a bunch of covenants on it. But we're trying to focus on the stronger borrowers and giving them flexibility. But by flexibility in most, most times, we're not going to give up a personal guarantee. These are private companies, are giving us CPA reviewed financial statements, they are not audited financial statements typically. And so the owners have to be shoulder-to-shoulder with us in terms of making sure that business is successful in repaying our loan. So that's part of it right there.

On the commercial real estate side, we're starting to see longer-term fixed rate commitments. We're seeing deals where banks will commit 20-year fixed rate loans, fully amortizing, fully fixed for 20 years. That's tough for us to put on our books. That's too much interest rate for us. Now we can try to swap those loans, but then we'll be back into the swap rates we're looking at, we're suddenly getting LIBOR plus 175 is the rate that we're going to get on that on an adjustable rate. When you look at LIBOR plus 175 and you put in what 30-day LIBOR is 20 basis points, that means we're going to get a variable rate on that loan of [195] out of the chute. That's a really low yield for us to accept to be able to reserve for that credit, to be able to manage the risk of that credit, not to mention the oversight and time we put into that. I mean we can pick up the phone and buy a mortgage-backed security with an average four year duration and get 2.2%. And it doesn't cost any overhead, I don't have to keep any reserves for that. And it's -- there is no credit risk.

So those are the type of things we're thinking through along the way here. I'd like to see the 10-year treasury rate go higher, Julianna. It's at --- I mean, watch it's like [2.68] or something like that this morning, and we watch that pretty closely, but 3% and above would be very good for a Citizens Business Bank.

Got it. And is this getting worse year-over-year, this competition on structures?

I felt like when the -- it's really weird, because a year ago, remember when the 10-year treasury, we got to [1.60] or whatever it was in March and April and May [last year]. Competition became clearly brutal there and I think a lot of the big banks just look at the indices and put their same spread over these indices. So the pricing can get crazy. Whereas we not only look at the indices, but also look at kind of a common sense [tact] and say, I am not going to lend 10-year fixed rate money at below 4%. And there comes a time when you just draw a line in the sand and say, you know what I just can't feel comfortable going to sleep at night knowing that I am going to have a 10-year fixed rate loan at 3.75, I've got to reserve for that, I've got to take the credit risk of that, et cetera, et cetera. So sometimes, the competition, it just doesn't pass the snow test.

And so, we're thinking through those on a deal by deal basis, and I'm confident that we're going to have success going forward, but we've got to get on the bicycle and pedal faster in terms of our marketing activities to be able to compete in this kind of environment.

Got it. Makes sense. Thank you very much.

Aaron Deer, Sandler O'Neill.

Hi, good morning everyone. Chris, it's been really good color on this call so far. I appreciate all the insight into the competitive environment. Switching gears and looking at the ASB deal, I am wondering how things are coming together over there and if there's any change to expected timing of the close?

No, we feel pretty confident, although we're not under -- ultimate control of that, because we have to get our regulatory approvals, but we feel pretty confident it's going to close in the second quarter, and we've been having a lot of meetings with company and the associates, feel very good about the way things are progressing, and feel like it's going to be a good fit for us. So we're excited to get it done and -- but we -- obviously what happens as we get our regulatory approvals, there is a 15-day kind of waiting period, that's mandatory, and then we should close shortly after that. So once we get our regulatory approval, we should be under 30 days closing from there, and hopefully we'll get that pretty quickly.

That's great. And not to get ahead of things, but any further conversations at this point with other potential partners in the market?

I'm having meetings here and there and conversations, but we're -- I'll say this, we are focused on looking at buying good banks, they can be small banks, but we want good banks that are making money and have meaning in the marketplace. And thinking of how we expand our footprint, can we take advantage of overlap and reduce some expenses. If you can get both of those things in a deal, that's what we're looking for. But the more troubled banks that survived are probably not on our target. We're looking for the better performing banks, and even if it's $200 million in asset, that's fine. Obviously, we'd like to do a larger deal than that, given our size, but quality first and then getting us into the right markets and hopefully having some good expense saves along the way.

I appreciate that. And then, if I may, just a quick tax question for Rich. I know this quarter you had some outsized income with the gain and that might have pushed the tax rate a little higher, but I also know that you guys had the benefit of some of the enterprise tax credits go away. So I'm just try to gauge what the -- what we should be thinking of in terms of effective tax rate going forward?

Aaron, we try to estimate our tax, it's not on an annual basis, in accordance with the GAAP requirements, and we did get impacted this year as you saw in the first quarter by the enterprise credits for interest and also the hiring credits that California's legislation changed for 2014 and in the future, as Governor Brown is trying to focus those dollars on creating new jobs for people coming into California.

So we continue to watch that carefully, but as we've stated before, it's really dependent upon those tax credits, which are dwindling because of the California legislation, as well as the municipal securities that fit our portfolio have been very difficult to find, and that drives some interest income that we get tax-advantaged treatment for, as well as our municipal leases in our loan portfolio, etc. So we don't predict future outcomes of our tax rate, but all those things come into play as we try to forecast what our annual rate would be for income taxes.

Okay, that's helpful. Thank you very much.

You're welcome.

Doug Johnson, Evercore.

Good morning, guys. Switching gears again to -- this time to expenses, there is a few -- looks like one-time items in there this quarter. And professional services were also a little bit higher than they've been running. Just trying to get a sense of what sort of is the base to start with in terms of looking forward and what kind of growth in the expense base should we expect from here, excluding the deal?

The expense side was elevated this quarter and our expenses quarter-over-quarter, [Rob], I think $1.8 million, $1.9 million. $1.2 million of that was in salary and benefits and really -- mostly oriented towards the medical benefit side. We do expect anywhere from $400,000 to $600,000 in reimbursement from insurance in the second quarter from some of those expenses that we incurred in the first quarter on the medical benefit side. So that's something that we feel like it's a little bit -- was a little lumpy in the first quarter. And then we had the deal costs associated with the merger, which were $425,000-ish, doing this off the top of my head, and then another $260,000-ish in branch consolidation costs. So I look at probably $1 million to $1.2 million of those expenses in the first quarter, should not reoccur unless something unique comes along, right? But they should be non-recurring.

So, there is some elevation on the expense side and the salary side due to the new hires we've had. And so, I don't want to say that that $1.8 million, $1.9 million, some of that maybe, call it $600,000, $700,000 is probably embedded in there, is more permanent increase based on us reinvesting in these new teams and so forth to grow our business. One thing I also want to mention is, no one has asked any question about our deposit growth. And our deposit growth is phenomenal, and we're really excited about our funding right now. I mean the purity of our funding, the transparency of our funding, the fact that we are close the 53% non-interest bearing deposits, even if we take those non-interest bearing deposits and buy mortgage-backed securities at 2.2% with a four-year duration, I feel very comfortable doing that because I'm not borrowing money to buy those securities, we're finding it off our customer portfolio. And non-interest bearing deposits are not sketchy deposits. These are things that we think are very sticky and so funding, funding, funding is huge for us. And I know no one is talking about funding. But I'll you, the core strength of CVB Citizens Business Bank is our funding and that funding is phenomenal. You look at the growth of that funding, I'm so proud of our teams, and the job they've done to build that, and the deposit niches we have had. So, if we can -- our funding is as good as anybody in the business, and we feel that that's going to let us compete against anybody for quality loans. And sometimes we won't play because of interest rate risk, but that's a business decision. It's not -- we can compete with anybody on a pricing standpoint on the loan side too.

Got it. Thanks for that. Just maybe sticking with more on the balance sheet, related to the funding, maybe just in terms of the size of earning asset, size of the balance sheet, I know earlier, maybe it was a couple of quarters ago, you kind of pre-purchased some securities and the securities portfolio has kept growing. Just trying to get a sense of, assuming you get -- loan growth rebounds a little bit, should we expect, and you get sort of kind of stable deposit growth as you've been getting, should we expect the securities portfolio to kind of come down a little bit from where it is currently?

Ultimately, I mean, I don't know if we would see it come down. What I'd like to do is continue to grow our deposits and see all those deposits go into loans. Our securities portfolio, it's in the money right now. I think our -- what was it -- $8 million or $9 million, somewhere in there in terms of gain, going from -- I believe a negative at the end of the fourth quarter. So that's a function of interest rate more than anything else. But I like the securities portfolio. I think -- I'll give you some more color on a loan that we decided not to enter, it's a construction loan and it's a $4 million construction loan and one of the big banks prices that construction at LIBOR plus 225, 30-day LIBOR plus 225. And we decided not to compete on that basis and because, I just for construction lending and all the work you put to get, we're going to get a yield of 2.45%. I then have to reserve against that construction loan at 80 basis points or 90 basis points, even if at the past grade credit. So you look at the yield on that, and the short-term nature of a construction lending and all the work we put into it, it's just not enough to make it worth our while.

And so, now, that was more of a transactional construction loan for a good customer and so forth, we may choose to compete at that rate and we're picking and choosing our spots along the way. Sorry I digress from your question a little bit, but I just want you guys to understand, the environment that we're dealing with right now, and the transparency and the really close handling of every business decisions we're making here with my management team and they're doing a good job too.

Understood. Thanks for that. One more if I could, just your credit quality obviously very good, getting better. Pre-2007, or pre-2008 that area you had -- that range you had reserve coverage 100 basis points of loans or lower. So, any reason to think that it can't -- assuming the economy stays good and credit continues to prove that the reserves can't get down to there again eventually?

No. I hope not. I mean, I think we went as low as 87 basis points in our reserve at one point. And in the scheme of things, there's a whole formula that we come up with to establish what our reserve is, and there's a lot of science behind this, there are some art behind this that comes up in this formula of how to reserve and look at previous losses and how they figure in to project future losses. But I just think fundamentally, in the long run, it's not healthy for a bank to get sub 1% in a loan loss reserve. It's just not good, because sooner or later, we're going to hit a recession. We did in the early 80s, we did in the early 90s, and then we waited 15 years till 2007 to get another recession. Another one is going to happen, and 87 basis points is not a sufficient reserve.

If for some reason, we were pushed to that level through accountants, through SEC or whatever is there, that's pushing those reserves down behind the scene, I think that we would scratch our head and say, well, we probably need to keep a little bit more capital to offset the fact that our loan loss reserve got that low, but we were determined and bound to try to have a fully adequate reserve on our loans, and we don't think that's 87 basis points.

Alright, Chris. Thanks a lot for taking my question.

[Matt Schaefer], DA Davidson.

Hi, good morning. I was wondering if you guys could, one, give an estimate on the systems' conversions, the timing of it, for ASB. And then secondly, when you think any cost saves might be phased in?

Good question. We would -- we have not defined a conversion timeframe at this point, but we would put that within four months of the close of the acquisition on the outside, and hopefully quicker than that. We haven't made decision -- permanent decisions on any office closures and things like that, but we're getting closer to making those decisions, and looking at the cost saves and so forth, but our -- I think, realistically we should have everything normalized and so forth by the end fiscal calendar year here. So we will have to fully integrate it, fully convert it, get all of our cost saves by the end of the year. There will be a way. We'll have some cost saves that will happen upon merger, and then we'll have the -- and then the remaining cost saves will be achieved by the time we consolidate the data processing and all that. So I would say, late third quarter, early fourth quarter is my best guesstimate to have all those things completed.

Okay, great, thanks for the detail.

(Operator Instruction) Julianna Balicka, KBW.

Hi. I have a couple of follow-ups, please. One, you had good interest income recoveries this quarter and also good actual net recoveries in the charge-off line. So could you talk about the pipeline of recoveries as you see them right now for 2Q, 3Q in the near future?

Yes, good question, Julianna. This is the second straight quarter in a row that we've had a net recovery. We had $1.3 million in the fourth quarter and we had $990,000, is that right, Rich? Yes. $990,000 in the first quarter. I'm guessing, but I think those trends are going to continue. I can't predict the charge-offs side, but the recovery side looks pretty strong. And why is that happening? Well, real estate prices have firmed up quite a bit, and tenant activity has improved. So a lot of these loans will be marked down loans along the way, commercial real estate loans back in 2009-2010. As we look at them going forward, those buildings were getting filled up, the tenants are paying. Those -- some of those loans are still sitting on non-performing, by the way, because what happens when -- and this is kind of an interesting thing, I've got to scratch my head on some of the time. But what happens is, is if we take a charge-off -- let's say we have a commercial real estate loan that was $3 million and we had to charge it down to $2 million and it became a non-performing loan during the recession. Well, today that building could be leased up, and doing well or we're getting paid now, and we've got paid for month after month after month, all those payments are going to pay down the principal of the loan, until it becomes an accrual based loan. And to get it off of non-accrual to an accrual based loan, we have to be able to prove out the cash flow, show that it's got positive cash flow and show that the building, the collateral is not impaired. That was at a reasonable loan to value. So to get -- to do all those things some of the time, can be difficult to prove those things up, even though we're getting paid. So money still comes in, they're paying us down and so I think we're going to see more and more of these recoveries as these loans mature or somebody else might come up and take out our loan. Sometimes borrowers who've gone through non-performing won't give us their financial statements. They're upset because we've stayed on them and we want our money back and we haven't given them concessions and they won't give us financial statements. Without those financial statements, it's hard for us to upgrade those loans. So they stay non-performing even though we're getting paid month after month after month.

Interesting. Okay, that makes sense. And then the second follow-up that I had is you had referenced right in your remarks some new hires that you have brought on. So could you just kind of go through who you've got on, who you are still planning on bringing on and what kind of pipelines of -- and books of both loans and deposits, is there any schemes where persons manage in their previous jobs who can have a more clear view of incremental new business we should be expecting?

I really -- I can't give any color on what I think our San Diego team is going to be able to produce going forward and certainly I don't want to -- but I say this, we have got now five people we've hired in the San Diego marketplace, four of which are our sales driven people in around the production loans. We've hired a couple of people in our agribusiness area. One, very senior person who is building his pipeline. Our head of construction lending is bringing over business and then our construction activity is increasing.

So all of these, I think are basics along the way. But to tell you that those groups are all going to produce $100 million in the next year, I can't tell you that. But I certainly feel like we've got good momentum there, they're doing the right activities and that activity should lead into more business for us. We've got -- I keep -- I use the analogy, we've got more oars in the water now, and we're really focused on what we think are the right places to lend into. We haven't chosen to go into mortgage warehouse lending. We feel hesitant to go in and put lines of credit and credit facilities to companies that are lending money to people that we wouldn't lend money to. And so that's an area that we haven't been in.

We do some SBA 7(a) lending, but we don't do a tremendous amount of 7(a) lending, because typically we're only -- our target clients is the top 25% of businesses and their respective business sectors in terms of quality. And SBA 7(a) lending is really not focused on that top 25% segment. There is some overlap now and then on that, but for the most part, that's not a big niche of ours. We are building our lending platform and our relationship platform that we think is going to be very sustainable. We're excited about Citizens home loans. Even though home lending has kind of softened dramatically, but we did have positive growth of $6 million in the quarter. Not a huge amount, but all that's organic loans, all that's coming from customer relationships or new customers to us and we think we can accelerate that over time as well. And that's kind of a precursor to where we really believe there is a private banking solution for us coming down the pipeline. We're not ready to say here's Citizens Business Bank private banking that's going to be the second coming, but we're building towards that, and balancing out our community banking initiative, our commercial banking initiative and our private banking initiatives.

Got it. That makes sense. Thank you very much for the background.

(Operator Instructions) Well, at this time, there appear to be no further questions. So, I would now like to turn the conference back over to Mr. Myers for any closing remarks. Sir?

Great. Thank you very much. And before I conclude today, I just want to say, I thought the first quarter was a great quarter for us in all but one respect, and that was the loan growth. But all of the other things were doing, really, really well, and I think loan growth will come. We're doing the right things. I'm an impatient person, our team is impatient about it too, but we're going to build it out in the right way, and we're going to build it in what we feel is transparent, which is sustainable, and we're going to do loans that are repeatable. We're not going to do a bunch of one-off loans to try to get to the promised land. And I know there is pressure out there. We feel the pressure out there from investors to grow our loans, and we're doing everything we can to do it, but we are going to do in a quality way. And we built our platform for the long run, and we're very committed to building things in a way that is going to stand the test of time.

So I appreciate all of you for joining us on our call today, and we appreciate your interest and look forward to speaking with you again in our second quarter 2014 earnings conference call in July. In the meantime, feel free to contact me or Rich Thomas. And have a great day. Thank you.

And we thank you, sir, and to the rest of the management team for your time today. We thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you and take care everyone.