CVB Financial Corp (CVBF) 2016 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the third-quarter 2016 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)

Please also note, this event is being recorded. I would now like to turn the presentation over to your host for today's call, Ms. Christina Carrabino. Ms. Carrabino, the floor is yours, ma'am.

Thank you, Mike, and good morning everyone.

Thank you for joining us today to review our financial results for the third quarter of 2016. Joining me this morning are Chris Myers, President and Chief Executive Officer; and Allen Nicholson, 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 investors' tab.

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

The speakers on this call claim the protection of the Safe Harbor provisions contained in the Private Securities Litigation Reform Act of 1995. For a more complete discussion of the risks and uncertainties that may cause actual results to differ materially from our forward-looking statements, please see the Company's annual report on Form 10-K for the year ended December 31, 2015, 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 net earnings of $25.4 million for the third quarter compared to $25.5 million for the second quarter of 2016 and $27.9 million for the year-ago quarter. Earnings per share were $0.23 for the third quarter, unchanged from the prior quarter. Earnings for the third quarter of 2015 were $0.26 per share.

Earnings for the third quarter of 2016 were positively impacted by a $2 million loan loss reserve recapture as we had approximately $2.1 million in recoveries. Nonrecurring items of note for the third quarter included a $550,000 gain on the sale of an investment security and $350,000 of merger-related expenses.

On September 22, we announced that we entered into a merger agreement with Valley Commerce Bancorp pursuant to which Valley Business Bank will merge into Citizens Business Bank. We are excited about this acquisition as Valley Business Bank, with approximately $416 million in assets, is a strong community bank with four branch locations in the lower Central Valley area of California.

This acquisition meets all the strategic attributes we look for in a transaction. Geographically, it strengthens our footprint in the Central Valley. Valley Business Bank has been a strong community bank for over 20 years with a strong core deposit base and good credit quality.

There are opportunities for us to add value to their customers by offering wealth management, trust services, more sophisticated treasury management products and services, expertise in agribusiness lending, and an overall higher legal lending limit. And, we expect the transaction to be modestly accretive to earnings and slightly dilutive to tangible book value at close with a tangible book value earnback within three years. The acquisition is expected to close in the first quarter of 2017, and we expect the systems conversion will be completed in the second quarter of 2017.

This acquisition should not preclude us from pursuing other potential acquisitions. Through the first nine months of 2016, we earned $74.4 million compared with $70.5 million for the first nine months of 2015. Diluted earnings per share were $0.69 for the nine-month period ended September 30, 2016 compared with $0.66 for the same period in 2015.

The third quarter represented our 158th consecutive quarter of profitability and 108th consecutive quarter of paying a cash dividend to our shareholders. Our tax equivalent net interest margin was 3.3% for the third quarter compared with 3.57% for the second quarter and 3.72% for the year-ago quarter.

The second quarter was positively impacted by the recapture of nonaccrued interest from three TDR loans. When this recapture is excluded, the tax equivalent net interest margin was 3.45% for the second quarter.

From an apples-to-apples perspective, the third quarter over the second quarter decline in net interest margin from 3.45% to 3.3% can be attributed to the following. Loan pricing pressure continued to be a factor related to loan retention. Simply put, we repriced some loans to retain them. No different than we have been doing for the past few years.

Prepayment penalties declined from $1.1 million to $800,000 quarter over quarter. The impact of loan repricing and lower prepayment penalties combined for about a 12-point decline in loan yields and an approximate 7--point decline in the net interest margin. A 6-basis point decline in our tax equivalent investment yields contributed to an additional 2-point decline in the net interest margin. The remaining 6 point decline in the net interest margin was due to a higher concentration in cash balances.

Total loans were $4.3 billion at the end of the third quarter. Loan originations remain strong and continue to be ahead of last year's pace. Loans grew by $57 million, or at an annualized rate of 5.4% from the end of the second quarter. This is slightly below our 8% organic growth goal.

The quarter-over-quarter increase was principally due to increases of approximately $26.9 million in commercial real estate loans, $15.1 million in commercial industrial loans, and $25.4 million in dairy and livestock and agribusiness loans. From a year-over-year perspective, net loans increased $473 million, or 12.4%.

Organic loan growth accounted for $314 million of the growth, or 8%, while County Commerce Bank loans accounted for $159 million of loan growth, or about 4%. The low interest rate environment and competitive pricing pressures continued to impact both loan retention and loan yields during the third quarter.

Excluding recaptured interest on nonaccrual loans, our loan yields were 4.41% in the third quarter, compared to 4.53% in the second quarter and 4.71% for the third quarter of 2015. Loan repricing has been a consistent theme over the past few years. The allowance for loan and lease losses was $61 million, or 1.42% of total loans at September 30, 2016, compared with $60.9 million, or 1.44% of total loans at June 30, 2016.

Net recoveries on loans for the third quarter were $2.1 million. In terms of loan quality, nonperforming assets defined as nonaccrual loans plus OREO, other real estate owned, were $13.5 million at the end of the third quarter, down from $23.5 million for the prior quarter primarily due to a large participation and a shared national credit that converted from nonaccrual to accrual during the third quarter.

At September 30, 2016, we have loans delinquent 30 to 89 days of only $522,000. Classified loans for the third quarter were $105 million, an $8 million increase from the prior quarter. We will have more detailed information on classified loans available in our third-quarter Form 10-Q.

Now, I would like to discuss deposits. For the third quarter of 2016, our noninterest-bearing deposits totaling $3.66 billion compared with $3.67 billion for the prior quarter and $3.3 billion for the year-ago quarter. This represents a $9 million decrease quarter over quarter and a $353 million increase or 11% year over year.

The ending balance at September 30, 2016, included a $147 million deposit from one customer that declined by $63 million from the end of the second quarter. This deposit will continue to decline throughout the remainder of the year and into 2017. Average noninterest-bearing deposits were $3.72 billion for the third quarter of 2016, compared with $3.44 billion for the prior quarter, an increase of 8%. Noninterest-bearing deposits represented 58% of our total deposits at quarter end.

Our total cost of deposits and customer repurchase agreements for the third quarter was 10 basis points compared with 11 basis points for the prior quarter. At September 30, 2016, our total deposits and customer repurchase agreements were $6.9 billion, compared with $6.57 billion for the same period a year ago and $7.18 million at June 30, 2016. Average total deposits and customer repurchase agreements were $7.1 billion for the third quarter of 2016, up $195 million from the prior quarter and $510 million higher than the third quarter of 2015.

We continue to focus on maintaining a low-cost stable source of funding for our loans and securities. As part of that focus, we had approximately $240 million of time deposits from the State of California mature and not renew during the quarter. We consider these deposits interest rate sensitive and elected not to renew the time deposits as they matured. This was our choice.

Interest income: interest income for the third quarter of 2016 totaled $65.2 million compared with $68 million for the prior quarter and $67.7 million for the same period a year ago. Excluding interest recaptured on nonaccrual loans, interest income for the second quarter of 2016 and third quarter of 2015 was $65.4 million and $64.9 million respectively.

Lower levels of prepayment penalty income also impacted the quarter as prepayment penalties declined by approximately $300,000 from the prior quarter and $1.1 million from the same quarter last year. Noninterest income was $9.2 million for the third quarter of 2016 compared with $9.3 million for the prior quarter.

Now, expenses: noninterest expense for the third quarter with $33 million compared with $34.4 million for the prior quarter. The decrease was generally split between temporary and nonrecurring expense items between the two quarters and seasonality of certain expenses. Noninterest expense was 1.59% of average assets for the third quarter compared with 1.73% for the second quarter.

Now, I would like to turn the call over to Allen Nicholson, our CFO, to discuss our effective tax rate, investment portfolio, and overall capital position. Allen?

Thanks, Chris. Good morning, everyone.

Our effective tax rate was 38.4% for the third quarter bringing our full-year effective tax rate to 37.5%. In comparison, our year-to-date effective tax rate was 36% for the same period a year ago. Our effective tax rate varies depending upon tax advantaged income, as well as available tax credits. The increase in the effective tax rate was impacted by the continued decline in tax exempt municipal bond interest income.

Looking to our investment portfolio. During the third quarter of 2016, our average interest earning balances at other financial institutions and at the Federal Reserve totaled $553 million. This represents an approximate increase of $172 million over the prior quarter. At quarter end, these balances totaled $223 million.

During the third quarter, these balances represented approximately 7% of our average earning assets, which compares to 5% in the prior quarter. At September 30, 2016, our combined available-for-sale and held-to-maturity investment securities totaled $3.11 billion, increasing $134 million or 4.5% from the second quarter of 2016. Investment securities represented 38.6% of our total assets at quarter end and were 38% of our average earning assets during the third quarter, down from 39% in the prior quarter.

At quarter end, investment securities available-for-sale totaled $2.23 billion, including a pre-tax unrealized gain of $62 million. In addition, we had held-to-maturity investment securities totaling $879 million. We continue to be selective in investing in securities in the current interest rate environment, carefully weighing market rates and overall price and duration risks.

During the third quarter, we repurchased $14 million in municipal bonds with an average tax equivalent yield of approximately 3.3%. In the current environment, there is a limited supply of municipal bonds that meet our investment criteria. During the quarter, we also purchased MBS and CMO securities totaling $331 million with an average expected yield of 2.02% and an average expected life of approximately four years.

We also purchased some SBA securities totaling $26 million with an average expected yield of 2.04% and an average expected duration of approximately six years. In total, the $371 million in security purchases are expected to have a 2% tax equivalent yield.

Prepayment speeds in our mortgage-backed investment portfolio have increased in recent months. Based upon the current interest rate environment, we presently project approximately $160 million to $170 million in quarterly cash flows from our portfolio including calls on municipal bonds.

Now, turning to our capital position, we continue to look at many different opportunities to deploy our capital and liquidity. In August, we announced that our Board of Directors authorized an increase in our common stock repurchase program. The Board's authorization increases the number of available for repurchase to 10 million shares, or approximately 9.3% of the outstanding shares. We did not purchase any common stock during the third quarter.

For the nine months ended September 30, 2016, shareholders equity increased by $79.9 million to $1 billion. The increase was due to $74.4 million in net earnings, $21.6 million for the issuance of common stock for the acquisition of County Commerce Bank, a $17.7 million net increase in unrealized gain on available-for-sale securities, and approximately $5.1 billion of various stock-based compensation items. This was offset by $38.9 million in cash dividends.

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

Thank you, Allen.

Before I discuss economic conditions, I would like to point out something that may seem trivial to many of our institutional investors at this point, but is important to know. In 2010, a class-action securities lawsuit was filed naming the Bank as defendant. Over the next five years, this case was dismissed several times in federal court and was most recently appealed by the plaintiffs to the Ninth Circuit. We are pleased to announce that on September 28, 2016, we signed a memorandum of understanding with the plaintiffs that would resolve our class-action securities litigation case. The resolution is subject to final court approval, but it would be funded solely with insurance proceeds and would involve no admission of liability by the Company whatsoever. It will be nice to put this matter behind us finally.

Now, let's talk about economic conditions. In terms of the California drought, we continue to see little effect in the retainment of our customers loans. Long-term issues related to the drought remain a concern. We shall see what winter brings in terms of snowpack and rain.

Turning to the California economy according to various economic reports. California's unemployment rate remains unchanged at 5.5% in August 2016, compared with 5.5% in July and 6% back in August 2015. Over the past year, non-farm employment in the state expanded 2.3% compared with 1.7% nationwide.

California's economy has maintained a steady course and is on track for a fifth consecutive year of economic growth, job creation, and lower unemployment. Nearly every major industry added jobs in the first several months of the year while business activity increased and wages advanced modestly.

The California housing market continued to move forward thanks to low mortgage rates fueling sales. The supply of existing homes increased, but remains lean and the new home construction continues to proceed at a modest pace.

In terms of the dairy industry, the forecast for the remainder of this year remains challenging but the outlook for 2017 appears to be on the upswing. The majority of industry analysts predict a steady rise in global dairy trade and demand from countries such as China and in Southeast Asia for the next decade due to population growth and rising income in developing nations.

In closing, we are pleased with the execution of our strategy and feel we are well-positioned for continued success. We are excited about our merger with Valley Business Bank and look forward to welcoming their customers, associates, and shareholders. We remain focused on our growth initiatives and will continue to pursue strategic acquisitions to help us increase our market share and California geographic presence.

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

(Operator Instructions)

Matthew Clark, Piper Jaffray.

Good morning.

Good morning.

Can we just start on the repricing that you guys saw in the quarter on the loan front? And just curious, the magnitude of customers in terms of dollars that you guys repriced this quarter, what you repriced them to, and I guess what your outlook is for more of that activity going forward.

It really wasn't that much different than any other quarter. It's just I wanted to highlight it that that prepayment pressure continues to happen. In general, the yield on our portfolio right now -- on our loan portfolio is I want to say is 4.41% for the quarter. The average loan we're putting on the books right now is around 4%.

The yield on our securities portfolio for the third quarter was 2.38% the average yield, and the average security we're putting on the books for the third quarter was 2.07%. So you are looking at 30 basis points on the security side and 40 basis points on the loan side. Quarter after quarter, that will continue in this interest rate environment. Now, a little bit encouragement, we bought a lot of securities at the end of the quarter for the third quarter.

So that is going to help us a little bit in the fourth quarter because we had most of our cash balances is our higher cash balances were at the early part of the quarter and then we pushed those cash balances down at the end of the third quarter. As we exited those CDs, we talked about from a funding perspective and we put other excess cash to work with securities.

I think that's going to help our margin in the fourth quarter. We also, I want to mention that in terms of margin, the TDR, the nonperforming asset, the large loan that was a shared national credit, that went from nonperforming TDR to performing TDR at the end of the quarter. But we had no financial benefit for that in the third quarter.

The financial benefit of that will be felt over the next eight quarters. That loan matures two years from now as long as the loan continues to perform. We should have a good, if you will, recovery or interest income on that over the next eight quarters which will help our net interest margin.

So I think overall, I think the loan repricing is kind of business as usual. Prepayment penalties were slightly -- they were down by $300,000 for the quarter. That is a good indicator of how much we're doing in terms of repricing. I was a little surprised the net interest margin got to 3.30% as well but we really didn't have any windfalls in the quarter at all to help us on the net interest margin. This was kind of a bare bones for us, at least at this time in the quarter in terms of the margin.

Great. Great color. That's good. And then just on the increase in classified, I think it's roughly $8 million coming from the dairy livestock. Cattle and beef prices are down pretty dramatically more recently, and just curious what you are seeing, what your farmers are saying, and whether or not we could see this migration continue or not.

Yes, I think the word is, is that the first six months of 2015 were not good. 2016, I'm sorry -- living in the past. 2016 were not good. We see some improvement in the latter half of this year and feel like into 2017, it is going to get better. Despite the fact that we have had some downgrades in our dairy portfolio, for most of our dairies, they still have lending capacity. This is like asset-based lending. So the value of the herd and the value of the feed still has lending capacity in there with us. So we are not in any kind of panic mode.

We have increased our reserves in the portfolio but we're watching it closely. Again, in the total history of our bank, over the 20 -- we really started dairy lending in 1993, so let's call that 23 years. The total charge-offs in the dairy industry are around a little over $6 million net charge-offs over that entire period of time. We feel we have a good handle on this. We're trying to be proactive with all of our dairies, looking at all the factors, and make sure that we're properly reserved.

Got it. And just one last one. On capital management and share repurchase that you have authorized, just I know you didn't buy back any stock this quarter but just curious how active you might get with that program?

We put that in place and I think in general, I don't want to get into specifics, but in general when we are trading at 2 times tangible book and above, we're less inclined to repurchase shares because we feel like we can buy banks at 1.5 times tangible book and that makes sense for us to deploy our capital in that way. However, if our stock were to trade down, we have the optionality to go ahead and repurchase stock which then gets closer to where we would buy another bank.

That's kind of where we are. We have excess capital, we know we need to deploy that, our number one preference is to do that through organic loan growth. Our number two preference is to do that through acquisitions, and number three would be to look at buying back stock.

Got it. Thank you.

Aaron Deer, Sandler O'Neill.

Hello. Good morning, guys. Chris, to start, maybe it looks like you're already starting to see a little bit of ramps in the egg book. What is your expectation for borrowing here in the fourth quarter amongst your dairy farmers? Maybe what's kind of your outlook for loan growth generally?

I'm going to give you guesstimates so do not hold me to this, but this is just based on conversations with the way it feels with the head of our dairy. I met with him last week. Last year, we had about $85 million run up in seasonal dairy loans -- ish. $85 million, and that really started a little bit in the third quarter but was mostly felt in the fourth quarter. This year, we feel that run up is going to be about $60 million and it started little bit in the third quarter but most of it is going to be felt in the fourth quarter, too.

So that is kind of where we are on that. That's just a guesstimate so don't hold me to it. It is just based on the fact that the dairies haven't been as profitable this year but there still is going to be some deferral based on their cash basis accounting status which is they like to expense everything at the end of the year and defer taxes to the extent they can.

Right. And generally? For the loan outlook?

I think we are still, again, our organic growth target is 8%. We were at a run rate of around 5.5% this quarter. So we are a little behind that. The pipeline is good. It's not great. It's good. We are running ahead of where we were last year in loans and I expect we will finish the year ahead of what we did last year in loans. And last year was our record organic loan growth year. So I feel good about it. I don't feel great about it.

Okay. Allen, maybe you can help give some color on expectations for some of the margin effects. Obviously, some of the excess liquidity that was on the balance sheet during the quarter weighed on the margin to some extent. As some of that gets deployed here in the fourth quarter, what kind of rebound might we get in terms of a basis point impact on the margin? And also, with this loan that has been pulled back to performance status, how might that affect it?

I think Chris, first of all, pointed out what the impact was in the prior quarters, so I think you can get some estimate about that for going forward as we try to bring this down into the maybe south of 5% of earning assets. A year ago, it was about 4%. So I think we would like to be somewhere closer to that as a percentage of earning assets that are in cash. And we certainly do have some positive headwind around that one particular loan but we've got securities. They are going to be coming off, as I mentioned. $160 million, $170 million coming back. Those come back at about a yield of about 2.20%.

We can reinvest if rates stay where they are right now, a little bit north of 2, so that's a headwind. And certainly on the loan portfolio, Chris already pointed that out. We had a very base, I would say, quarter at 3.30%. No unusual items. If we continue to have a base next quarter, I think we will probably going to be somewhere in the couple of basis points up or down.

Okay. Thanks. I will get back into the queue. Thanks, guys.

Jackie Bohlen, KBW.

Hello. Good morning. I wondered, you had mentioned in the prepared remarks about temporary and nonrecurring items and expenses. I just wanted to see -- I know some of that was in 2Q but if there were anything noticeable in 3Q and kind of what you think about the run rate going forward?

On the expense side, there is a little choppiness going on because we have acquisitions going on. We did the County Commerce Bank acquisition. Now we have entered into the Valley Business Bank acquisition so we had some expenses in there. There were other some legal expenses that we've had that's been elevated a little bit. I think they're going to moderate through the -- probably moderate more in the first quarter of 2017 than the fourth quarter of 2016 but I think that is a good sign because we're working through some of that.

The expense side, I think it's still going to be elevated a little bit from where I'd like it to be. But a lot of that has to do with some of the things we're doing like the Valley Business Bank acquisition and we're moving our operations center. We bought a new building that we are going to close here in the fourth quarter. We're excited about that.

That's going to give us some more efficiencies ultimately, but temporarily we'll incur some expenses while we're doing the move and things like that. I feel good about our efficiency and our ability to manage those expenses. But I do think there's a transitional period probably going on for the next couple of quarters while we are doing all this acquisition and the move in the building and so forth that may cause a little choppiness there.

Okay. And the moving into the new building, does that provide -- once you get through the one-time costs and everything associated with that, is it more a move for ease or is it more a move to drive efficiency?

It's really a move out of expansion. We were kind of packed to the gills in our operations and technology building where we are, so I think the whole team over there is really excited about getting a bigger building. The bigger building is going to provide us more efficiencies ultimately once we get through it, and I think will be cost neutral probably within -- Allen, what do you think? Nine months?

9 to 12 months. Yes.

9 to 12 months will be cost neutral from where we were before to where we are. We're just going to have some transitional expenses getting over there.

Okay. And I would guess a lot of that will probably be mixed in with acquisition costs and everything else. So it sounds like expenses will be a little choppy over the next several months, a couple of quarters, and then kind of smooth out once you've got the costs saved from your acquisition in there.

Yes. I agree with that. And one thing I want to mention about the acquisition before I forget is that we're at about 62% or something like that loan to deposit ratio, and Valley Business Bank is at 82%, 83% loan to deposit ratio, somewhere in that area. So that is a good thing because we are going to be -- they have -- their loans -- their average loan yield is higher than ours. We're going to be funding those with their deposits, and if they have any impure deposits that we don't like, we can fund those from our deposits.

That's some of the -- I think that's some of the synergy that we get with the merger like that bank and then one of the attractiveness -- attractive parts about Valley Business Bank is they did have a higher loan to deposit ratio than we did. We just had to make sure that we felt comfortable with those loans and we did substantial due diligence and do feel comfortable with our loan portfolio.

Okay, great. Thanks, Chris. That's great added color.

Brian Zabora, Hovde Group.

Thanks. Good morning.

Good morning, Brian.

A question on, you mentioned the one pipeline that you thought was good, not great. With the liquidity that you have, you mentioned the possibility of purchasing loans last quarter. Is that a greater possibility? Are you looking at packages? And just your thoughts around that.

We had some vigor behind that a few months ago and we were looking at that. We were kind of excited to try to do that. But we went through and looked at some of these packages and so forth and we were not as enthusiastic as we were a few months ago. We just can't find the right fit, and we are very -- again, we are very disciplined about what we're trying to build in this bank.

I think you have seen from other banks there has been some credit things coming through this quarter. Haven't seen that for a long time but we are starting to see some of that stuff. One of the I think the great things about this bank, albeit sometimes boring, is that we stick to what we know how to do. A lot of times we get through and do due diligence and look in these portfolios and go, we wouldn't have done it that way. We wouldn't have done it that way. So we just can't get our arms around it and get comfortable with it.

So I think we are going to continue to look at that. But I'm just not as optimistic as I was a few months ago that we're going to be able to get anything done there because it's really got to make a lot of sense for us. And I think that we just put our heads down, keep building out the teams, keep growing organically, and we are going to get there on the loan to deposit ratio. It is just not going to be in the next quarter.

It is going to take us slowly but surely, and we were going to keep building that in. One of the great things I think we are doing right now is we're really looking at the efficiency on our deposits, too. We're trying to get away from any deposits that we think are overly interest rate sensitive or non-relationship deposits. And that was part of that we exited those state CDs because those are transactional deposits. They were costing us about 33 basis points. We were taking that money, put it into overnight fed funds at 50 basis points. But there is no relationship there.

The bottom line is if we want to go back and get those deposits because we have this tremendous loan growth, well we can go get them. So there's no reason to carry it on our books and just get ourselves closer to $10 billion in assets artificially. We want to make sure when we go over $10 billion in assets, our earning assets are as efficient and pure as possible, not a bunch of overnight cash sitting on our balance sheet.

That makes sense. And then just you kind of mentioned teams or you're hiring. Are you looking at adding additional teams, or did you make any additions during the quarter?

We are close on a couple things right now. I don't have anything to announce. We are working on two teams right now. So that's definitely a part of who we are and what we are doing. We will keep you guys posted when we can say.

I do want to say this. The teams we have brought in are all now operating properly. I mentioned that last quarter and San Diego and up in the Central Coast is doing well. Our downtown LA office is doing well. All of them are -- it's not exponential growth, but it is just plodding growth. They're getting bigger and they're getting more traction in each of those offices. It is great. If we can do this organically, it's almost like buying a bank without having to pay for a bank. You just pay for the people.

That is great. Thanks for taking my questions.

Gary Tenner, D.A. Davidson.

Good morning. I just wanted to ask regarding the County Commerce acquisition, a couple of quarters out from that now. What have you seen in terms of loan balances at that franchise? I think they were 158 you had mentioned when the deal was a closed. Have you gotten any benefit from the larger lending capacity? Have you seen run off in the portfolio? What is the kind of the update there?

Overall, we're up from where we were when we purchased it. That is good. We have seen some benefit. We're gaining more and more traction. We have some good talented people there. They are getting acclimated to the Citizens Business Bank way. So I think the integration has gone very well on that.

The proof is going to be in that region, which we will report as we go along, how the loans and deposits grow quarter after quarter, time after time. And we have some good people up in that area. We have good leadership in that area. I'm excited about that. I think it was everything we thought it would be.

And I think the -- Joe Kreutz ran a good bank there. I will say that I'm as pleased as I expected to be. I think we are doing some good things there. I'm optimistic about it, but again, it is not exponential growth. We have new teams in there. We're just plodding away. We are cross-selling. We're doing all of the things we need to do. We are educating clients. That takes time. But that's a great market for us.

Okay. Thanks, Chris.

Tim Coffey, FIG Partners.

The first question I have here for you, Chris, is kind of the structure of the Valley Commerce transaction and the kind of special dividend that you allowing them to pay. Has that generated any additional calls to you from similarly over-capitalized banks?

I don't know specifically that that structure triggered any calls but we do have banks that reach out to us from time to time and we do have discussions with them. I think that -- I like that structure because when you have a small bank that's overcapitalized, we don't need their capital. We don't need their excess capital. We like their base capital. We kind of like that 8% capital and then anything above that we consider somewhat excess capital, especially with our capital levels.

So that's exactly what we did. We said listen, we are not going to pay a multiple on excess capital but we will pay you a fair multiple for the nice earning bank that you've had and that's kind of how we worked it out. And so I think it was kind of win-win for both of us, and part of -- we are allowing them to do that special dividend. They want to try to get the right tax treatment on there for their shareholders so they can treat that I think as more of a long-term capital gain. Is that right, Allen?

Yes.

So they can treat it as a long-term capital gain. So that's why the acquisition is going to close in February and probably not January. So that's an extra month for them to somehow get that treatment. I'm not sure exactly how that works but that was the gist of the whole thing. I think it was a creative structure that was a win-win.

You would be inclined to use that structure again then?

Absolutely, if they have excess capital.

Okay. And then a little while ago, you stole a bit of my thunder by taking about the banks in your market that are starting to see credit blips. From where you sit, do you see any similarities or kind of explanatory variable on what's happening?

I've said this for the last few quarters. Credit isn't perfect right now. There is a little choppiness going on. We feel like we are in a good position, but I do think that one of things that we focus on in our Company and our executive team talks a lot about is, are we the subject matter experts in what we are doing? Are we right people to know this market, what we are lending into, and this product type that we are lending into? And in the type of businesses.

We are not a technology -- we are not a technology bank. We don't bank a lot of high-tech companies, so we don't lend in that area. We are not the subject matter experts on entertainment lending, and so we don't lend in that area. So we stick to where we feel we have good expertise and have developed good expertise over the years. And we have to expand that as we go along, but we have to be careful how we expand that.

One of the areas we are looking now is more medical practices, veterinarians, and doctors, and so forth. But as we go and as we lend into those areas, we are being very careful about how we think about that and how we expand our lending into that areas because we don't want to get pounded by a learning curve of things we don't know that cause bad credit problems. And I think in the spirit of people trying to grow fast in a good economy, they get over exuberant about these things and sometimes they grow faster than they should.

And that's why I said our target loan growth is -- this is not a great economy. It's a fair to good economy, right. It's not a great economy. On a 1 to 10, it's a 6.5. And so we shouldn't be lending like it's a 10. We should be lending like it's a 6.5 and trying to take market share from our clients, and that's what we are doing.

Great. Thanks. That was my questions.

(Operator Instructions)

Aaron Deer, Sandler O'Neill.

Hello, guys. Just a couple of clean-up questions, and pardon me if this was addressed and I missed it. In the expense categories, the compensation line was down. Was there a true-up in the bonus accrual or is this a good run rate going forward?

There wasn't a true-up in the bonus accrual. There was some noise there. We did probably have what I would characterize as about $400,000 in the prior quarter that was very temporary in nature but it wasn't bonus related. And generally, I think as we transition to County Commerce in the quarter there, the prior quarter there were also some probably some expense, comparable lower expenses in the third quarter from that. But nothing really -- if there was anything directional, we would let you know but I really can't comment beyond that.

Okay, and then how about in the other operating expense line? That was down like $0.5 million or something in the quarter. Anything behind that?

A lot of I would say smaller items. Some expenses related to software, communication are sometimes one-time in nature. But I wouldn't call them nonrecurring. Some of that is just timing of certain expenses that happened, so once again nothing directional.

Very good.

In effect, there is going to be some choppiness. There has been some choppiness in the last couple quarters and there is going to be some choppiness in the next couple of quarters, but I think that we're watching the expenses very closely. We're thinking carefully about it, and we are trying to streamline as much as we can to position ourselves to consistently achieve that 45 percentage efficiency ratio. I think that is achievable.

But there may not be a quarter here were we bump up to 48 or 47 as we're going through the building, or we had some true-up on our medical benefit expenses that we had to have. Some of the -- (multiple speakers). There was a worker's comp true-up, and that's what I was thinking of. And so there is just little things here that are going to hit you little bit here and there, but nothing of any -- we don't see anything of any great magnitude that's going to at least that's foreseeable at this point.

Sure. I appreciate the follow-up. Thank you.

Matthew Clark, Piper Jaffray.

Hello. Couple of quick ones, too, for me. Just on the tax rate. It's been drifting a little higher of late and just wanted to make sure we touch on kind of the assumption going forward here?

Well, we do a full-year forecast of our taxable income and what that effective tax rate is. And as you we saw, we bumped it up little bit. We were assuming it would probably be about 37%. It grew to 37.5%. Some of the things that can happen that can cause that to change is we generally don't forecast provision recapture, sort of that's fully taxable. So that can create some noise. But our best estimate right now is 37.5%. If we have some wins in the fourth quarter, it could grow slightly.

The tax rate was 38.44% for the third quarter because we had to do a little catching up. So we would guesstimate that again that the fourth quarter will be that 37.5% from a modeling standpoint. Actually, Allen and I have a little bet on that but that's another story.

(Laughter) we can't disclose it either.

And then just one on the recoveries. I think a couple of quarters ago, we talked about you having some good visibility on some larger recoveries coming through. Just wanted to see if you thought there was some more left here at least in the fourth quarter of size?

Yes. I think we have -- my guess is, and I'm very close to this, is that we've got another three or four quarters of recoveries that will have at times more substance than the other. But I would expect that we'll continue to have, knock on wood I hope, unless there is a surprise in the credit side, positives -- we will have net recoveries over the next few quarters in aggregate.

And we do have some things in the pipeline to recover, and we are working diligently to get after them before the next recession hits. Anyways, yes. It's still positive, but I think that we are in the early part of the fourth quarter, in terms of a football analogy, in terms of our recoveries but we still got some more to run here for the next few quarters.

Got it. Thank you.

I hope that answers your question.

Yes.

(Operator Instructions)

At this time, there appears to be no further questions. So I would like to turn the conference call back over to Mr. Myers for any closing remarks. Sir?

Thank you. And to all of our shareholders, we appreciate your interest and look forward to speaking with you again on our fourth-quarter and year ended 2016 earnings conference call in January. In the meantime, feel free to contact me or Allen Nicholson, our CFO. Have a great day and thank you very much for listening. Take care.

And we thank you, sir, and to the rest of the management team for your time also today. The conference call has now concluded. At this time, you may disconnect your lines. Again, we thank you all for participating. Take care and have a great day.