Heritage Financial Corp (HFWA) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Heritage Financial earnings conference call. All participants are in a listen only mode. Later we will conduct a question and answer session and instructions will be given at that time.

(Operator Instructions)

As a reminder this conference may be recorded.

I would now like to turn the conference over to your host, Mr. Brian Vance President and CEO. Sir, you may begin.

Thank you, Valerie.

I would like to welcome all that have called in, and those that may be calling in on the recorded version later. Attending with me this morning is Don Hinson, our CFO. Our earnings press release went out this morning before market opened, and hopefully all of you had an opportunity to take a look at the press release prior to the call. And I would ask that, as we work through the prepared comments, as well as question and answers, to keep in mind our forward-looking statements. And if you will bear with me just for a moment, I will read this statement as quickly as I can for the record here.

Statements concerning future performance developments or events, expectations for growth and market forecasts and other guidance on future periods constitutes forward-looking statements. Forward-looking statements are subject to a number of risks and uncertainties that might cause actual results to differ materially from stated expectations. Specific factors include but are not limited to the effective interest rate changes, risks associated with acquisition of other banks, and opening new branches, the ability to control costs and expenses, credit risks of lending activities, including changes in the level in trend of loan delinquencies and write-offs, changes in general economic conditions, either nationally or in our market areas.

These factors could impact the Company's financial results. You should not place undue reliance on forward-looking statements, and we undertake no obligation to update any such statements. The Company does not undertake -- or specifically disclaim any obligation to revise any potentially forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. Additional information on these and other factors are included in the Company's filings with the Security and Exchange Commission.

Highlights of our second quarter -- our diluted earnings per common share increased $0.11 for the quarter ended June 30, 2011, from $0.05 per diluted common share for the quarter ended June 30, 2010. Cash dividends declared in the amount of $0.05 per share, an increase of 67% from prior quarter. Originated loan balances increased $29.3 million during the quarter ended June 30, 2011. Ratio of non-performing originated assets to total originated assets decreased to 2.44% at June 30, 2011, from 2.65% at March 30, 2011. Also acquisition integration of our new Kent, Washington, branch was completed. Just a few comments about earnings -- we posted Q2 net income of $1.69 million, or $0.11 per share; which was an increase from Q1 2011 net income of $764,000, or $0.05 per share.

Our total loan loss provision for Q2 is $3.5 million; $2 million for originated loans and $1.5 million for purchased loans; compared to Q1 2011 provision of $4.4 million, which was $2.6 million for originated loans, and $1.8 million for purchased loans. And a Q2 2010 provision of $3.2 million. Net charge-offs for the quarter were $1.4 million, compared to $3.3 million in Q1 of 2011; and $1.7 million in Q2 of 2010. Our originated loan loss allowance to total originated loans decreased slightly, to 2.81% in June 30, 2011, from 2.84% at March 30, 2011.

At this time Don Hinson will take a few minutes and cover our balance sheet and income statement changes, as well as a few comments about our acquisition accounting. Don?

Thanks Bryan.

First I'll start discussing the balance sheet. We continue to have maintaining strong balance sheet while continue to leverage our cash balances. Investments were increased by $13.5 million during Q2, as we seek to improve yield while maintaining a strong liquidity position. Focal date total originated loans increased $29.3 million during the quarter as a result of increased loan production. This is the second consecutive quarter of originated loan growth. As a result of the loan growth, our loan to deposit ratio increased to 88.7%, from 87.8% at the end of Q1 2011. Our total deposits increased $8 million during Q2. Total loan maturity deposits, which are total deposits less all CDs, increased $13.6 million; while certificate of deposit accounts decreased $5.6 million.

Of this decrease, $3.5 million was related to certificate of deposit accounts assumed in the Cowlitz Bank and Pierce Commercial Bank acquisitions, including $2.0 million of Internet CD accounts which were repriced at the time of acquisition and continue to run off. There are approximately $7.5 million of Internet CDs remaining. Our non-maturity deposit ratio is a very strong 68.1% of total deposits. In addition, the percentage of non-interest demand deposits to total deposits has increased to 17.5%, up from 17.2% at the end of Q1; and up from 14.9% at the end of Q2 2010. The continued improvement of our deposit mix has resulted in the lowering of our cost of deposits to 0.61% for Q2 2011, down from 0.68% in Q1 2011; and 0.93% in Q2 2010.

Total equity increased $2.3 million during Q2. The equity-to-assets ratio increased to 15.4% at June 30, compared to 15.2% at March 31; and the ratio of tangible common equities to tangible assets increased to 14.4% at June 30, from 14.3% at March 31. Our book value per common share increased to $13.14 at June 30, 2011, from $12.99 in March 31, 2011; and a tangible book value per common share increased to $12.20 at June 30, from $12.04 at March 31.

Spend a few minutes discussing the effects of our acquired loans. During the quarter we recorded a provision for loan losses on purchased loans in the amount of $1.5 million. This was due primarily to certain pools of loans experiencing a decrease in estimated cash flow. The change in FDIC indemnification asset was a negative $1.7 million in the quarter ended June 30, 2011; compared to a positive $800,000 in the quarter ended March 31, 2011. Cash flows on acquired loan portfolios will continue to be re-estimated on a quarterly basis.

Moving on to net interest margin, our net interest margin for Q2 was 5.93%. This is an 85 basis point increase, from 5.08% in Q1 2011; and 133 basis point increase, from 4.60% in Q2 2010. The increase is due substantially to increased loan yields as a result of discount accretion on acquired loan portfolios. The effect on the non-interest margin of incremental discount accretion over stated note rates on the acquired loan portfolios for Q2 2011, was approximately 104 basis points. This compares to 32 basis points in the prior quarter, ended March 31, 2011. Interest reversals on nonaccrual originated loans impacted the net interest margins for Q2 2011 for approximately 13 basis points; compared to 12 basis points for Q1 2011, and 21 basis points for Q2 2010. Without the effects of incremental discount accretion and interest reversals on nonaccrual loans, net interest margin for Q2 2011 increased 17 basis points from the prior quarter. This increase is mostly due to lowering the levels of overnight cash to fund loan growth and investment purchases.

In addition, sustained focus on non-maturity deposit growth and pricing strategies continue to drive cost of funds lowered, which is also contributing to our strong net interest margin. Our cost of funds for Q1 2011 was 0.75%, compared to 0.82% for Q1 2011; and 1.08% for Q2 2010. Moving on to non-interest income -- Non-interest income was $853,000 for Q2 2011, compared to $2.1 million for Q2 2010. The decrease was due substantially to the change in the FDIC indemnification assets. In addition, service charges on deposits for Q2 2011 increased $196,000 from the same period in the prior year, due to increases in deposit accounts as a result of the Cowlitz and Pierce acquisitions.

Discussing the impacts of non-interest expense for the quarter, our non-interest expense was $13.2 million for Q2 2011; compared to $8.5 million for Q2 2010. The increase was due to increased salaries and benefits of $2.9 million, increased occupancy and equipment expense of $729,000, increased data processing of $220,000, and increased state and local tax expense of $213,000. These increases are due primarily to the Cowlitz and Pierce acquisitions. Non-interest expense decreased $477,000 from the prior quarter, ended March 31, 2011. Non-interest expense control has been a focus of ours, and will continue to be. However, continuing growth for related expenses and other expenses such as loan-resolution costs will make it likely that we will see a higher than historical efficiency ratio over the near term. For Q2 2011 our efficiency ratio was 69.3%, compared to 65.7% Q2 2010.

Brian will now have an update on overall loan quality changes in loan growth, as well as some closing comments.

Thanks Don.

Maybe just to spend a little time first on loan growth. As reported earlier, for the second consecutive quarter our originated loan portfolio increased. We also reported that overall net loans increased -- something that earlier this year I did not believe we could accomplish until Q4. We believe this is a significant evidence that our organic growth initiatives are working. Most all of our lenders -- legacy, acquired, and hired lenders -- are booking new lending relationships, as well as continuing to grow their pipelines.

During Q2, we booked a total of $61 million in loans. This total represents new loans to new borrowers, new loans to existing borrowers, as well as renewed loans. As reported earlier, originated loans increased $29.3 million. Many things influence net loan balances, such as new loans, loan payments, and prepayments; and advances in pay downs on existing lines of credit. We analyzed all new loans over $300,000 for the quarter, which represents a total of $31.7 million. And these loans break down as follows -- 6 multi-family loans totaling $16.6 million; 20 CNI and owner-occupied CRE loans, totaling $10.8 million, of which 8 of these loans were medical-dental loans; 2 non-owner-occupied CRE loans totaling $4.3 million.

As we have discussed in earlier conference call's multifamily loans have been a focus of ours, and as this have been a strongly performing sector in this Pacific Northwest. At the same time we see a potential bubble building in this sector, and we will continue to monitor growth, as product growth later in the cycle will invariably have lower cap rates and higher risks associated with it. Today our multi-family exposure is only $59 million, or about 6% of our total portfolio.

I'll spend a few moments and talk about our loan quality. Nonperforming originated loans decreased $392,000 from the prior quarter. Additionally, total originated potential problem loans decreased 5.5%, to $47.3 million from $50.1 million. Another way to look at overall credit quality is to total our originated nonperforming loans, plus total originated potential problem loans; and they were down $3.1 million, quarter-over-quarter. Our originated residential construction loans as of June 30 totaled $23.8 million, or 3% of total loans.

This total breaks down as follows -- residential land $5 million; single family homes $9.2 million; and A&D residential at $9.6 million. Our total nonperforming originated loans of $29 million breaks down as follows -- commercial, $9.4 million; owner-occupied CRE, $800,000; investor-owned CRE, $1.8 million; and real estate construction at $16.9 million. And I will break down that real estate construction as follows -- single family residence, $500,000; A&D lots for sale, $7.1 million; and condo projects, $9.3 million; as well as consumer at $100,000. All potential problem originated loans of $47.3 million are as follows -- construction, $9.9 million; CNI, $25.2 million; owner-occupied CRE, $6 million; investor-owned CRE, $5.7 million; residential mortgages, $400,000; and consumer, $100,000. Our coverage ratio remain strong at 86.9% at the end of the quarter, which is up slightly, from 83.2% for Q1 2011. And our allowance of total originated loans at quarter end was a likewise strong 2.81%.

Our coverage ratio remains one of the strongest in the Pacific Northwest, which demonstrates our proactive management of and reserving for problem credits. Just a few comments about OREO. At the quarter end, our OREO balance was $1.9 million; and during the quarter we disposed of $1.3 million of OREO properties. We are actively working through these assets to final resolution. Like to give you just my thoughts and my general review of this past quarter. As I stated a couple of times, I'm particularly pleased with our loan growth. We have discussed our focus on organic growth strategies for the last several quarters, and have hired a number of new lenders. Our expense and efficiency ratio have grown over the last several quarters as a result of this strategy. And clearly this strategy is beginning to show results. We continue to look for additional new lenders to augment our newly-acquired markets.

During the quarter we completed the Kent branch acquisition, and look forward to growing our presence in that market. We also announced the hiring of Brett Bryant as our Market Executive in Clark County, Vancouver, Washington; which we believe will allow us to grow our visibility, presence, and assets in that important market. In total, we continue to execute our growth strategies in the new markets that we have recently acquired. I continue to be pleased with the acquired loan portfolios, as both portfolios are performing better than originally expected. The core performance of the organization as evidenced by an improving core net interest margin that Don detailed for you, as well as our pre-tax pre-provisioned return on average assets of 1.76% -- I'm sorry, 1.76% demonstrates the core financial strength of the Company.

And just with some closing comments on general outlook -- our overall view of 2011 really hasn't changed in the last several quarters. The general economic outlook for the Pacific Northwest will remain muted for at least the balance of this year. We continue to see real estate devaluation and high unemployment, in which both have a continuing dampening effect on the Pacific Northwest economy. As we have discussed on several occasions, we intend to add 1 to 2 [denotable] branches to Heritage Bank each year. And we acquired our Kent Branch during Q2, which makes 33 branches in our system. And we continue to look for other branching opportunities.

Although the FDIC assisted opportunities have slowed, we continue to be actively involved in opportunities presented to us. Additionally, we have been quite active in our discussions with other community banks for potential open bank transactions, and remain optimistic about these growth opportunities.

I would welcome any questions you may have, and once again refer you to our forward-looking statements in our press release as the answer any of these questions dealing with the forward-looking comments.

And Valerie with that, I would open the lines for questions from our listeners.

Thank you. (Operator Instructions) One moment please. Our first question comes from Jeff Rulis from D.A. Davidson. Your line is open.

Good morning Brian and Don.

Good morning Jeff.

On a -- Brian maybe following up on the credit discussion. If you look at the quarter, the decision to grow reserves after three quarters of running that down a bit, in a quarter where you've had really the lowest net charge-offs over that span, I guess kind of explain the rationale there?

Well, Jeff, I think that I certainly understand your question. And I think one of the processes that we all find ourselves in these days is a -- methodology for allowance process that is a bit formulaic.

And as we work through the allowance processes, there's lots of things that go into that. In terms of improving credits, improving economic trends. As well as certain credits that may be deteriorating as well certain economic trends that may be deteriorating and it's not just a process that is linear in that if certain trends improve over all, then it would hold true that the provision would also improve.

That's not necessarily the case because of the formulaic process of the ALLL. Having said that, I would say that the provision for our originated portfolio was less than it has been in several quarters, which I think indicates an overall improving trend. And I think as we work through this cycle, you will see that provision coming down. And it may not necessarily relate to actual losses as we normalize our ALLL on a more historical basis.

That's -- I've said a lot of, probably nothing. Except that it's not a real -- what do I want to say, it's not a science I guess it's in art.

Got you. No, I appreciate the commentary. Moving gears of the loan portfolio, you've now had a couple of growth quarters out of the construction segment. Is it safe to assume that that category has essentially bottomed-out, especially with the commercial construction picking up?

Yes. If I understand your question, the single-family construction issues, I think, are really beginning to bottom out. The -- commercial construction totals did increase. One, a couple reasons for that. I think one of the more significant reasons were, one of the multi-family properties and new loans at we booked, was a significant loan in that it was a purchase and renovation. So, a portion of the loan was funded which was the purchase side. And then, because it was a fairly large project, at least for us, there's a substantial amount of that loan that went into the construction side of it as it's a renovation project. So, most of that's commercial construction is multi-family related.

But -- okay so, just to clarify-- if you total the residential and commercial construction, that total construction bucket further runoff may be muted or may actually grow going forward?

Yes, I don't know that -- I think the growth we saw on the commercial construction this past quarter was a bit out of character. I'm not sure that we would see that kind of growth on a normal basis. So, I don't think we can expect that growth going forward. That sort of percentage-wise growth, anyway.

Got it. And then 1 last one. Tax rates have historical been in the 32% 33% range year-to-date you're at 27%. You're seeing any guess as to which number you'll end up closer to buy year-end?

I will have Don take a shot at that.

Yes, it is a little lower this year. We have actually purchased more tax exempt securities, which is driving part of that down. I would probably expect it to creep up over time. As our taxable income increases, our charge-offs decrease. But right now it is lower and it will probably stay a little lower than historical. Probably for the remainder of the year.

Okay thanks.

Thanks Jeff.

Thank you. Our next question comes from Kevin Reynolds of Wunderlich Securities. Your line is open.

Good morning guys.

Hi Kevin.

You mentioned Brian, -- I was trying to keep up with you said you see a bubble forming and was at multi-family?

Multi-family Yes.

Okay. So, I think that speaks to -- I interpret that to speak to kind of irrational competition out there. Chasing down loans. Now you've seen good solid loan growth, and I think one of your neighbors in the state up there saw the same thing today.

How would you characterize your loan growth versus what others are doing? Are you stealing from -- or gaining share from other banks out there? And if so, what is the profile, the kind of bank that's losing share to you right now? And do you see that getting better, getting worse from your perspective? Better opportunities or fewer opportunities? Will they finally get it right?

Let me speak first of all to the multi-family. Having just given my general conservative nature as we take a look at a sector that I think has performed very strongly during the cycle in the last couple, 3 years. I'm referring just specifically to multi-family. We find a lot of folks chasing that's products with some pretty aggressive pricing. And we see a lot of new product coming on the market in the terms of -- in the way of the construction stuff. And I see cycles like this. And my guess is, were going to go through another cycle with this one some point in the future. And we are going to continue to be very internally vigilant on the quality of the product and the cap rates et cetera. So we don't find ourselves participating in that bubble as we go through in the latter part of the cycle. And I'm not predicting that that will happen. It's a possibility, were just mindful of it. But again as I indicated, we've only got about 6% of our total portfolio in that product today.

I think as it pertains to just loan growth in general, in terms of how are we getting it. You know we've hired I think 11 new lenders in the last 9 months. And in many cases those lenders are migrating over their portfolio, so in a form you could say that we are stealing that. Those particular growth opportunities. I think that as we work through the cycle, and as our legacy lenders become more outwardly focused as opposed to inwardly focused and working on problem assets and problem credit resolution, I think they are more active in the marketplace. They're spending more time with building their pipelines and again, being externally focused.

I think in that case, what were finding is that there is considerable market dislocation with 16 banks that have closed in the state. There's a lot of banks that remain open that don't have available capital to grow. Some of those banks are still downsizing their portfolios. And I think that, because of the position that we have -- our lenders are not internally focused, they're externally focused and the market dislocation and thanks for still wanting to manage down some of their concentrations. All of that gives us the opportunities that we have and what we're seeing now with the loan growth.

So, I know the loan growth -- when I talk about difficulties in the economy and the loan growth that maybe many other banks aren't posting yet. One might say, what's the quality of that growth? And that's why I spent a little bit of time in sharing with you the types of loans that we are growing. And you can see that many of them are to the medical and dental community. To what I think is a strong sector of multi-family. So I think that's at the very good about the quality of loans were putting on. So again, long question to a couple -- long answer to a couple questions you had there.

Well, and actually want to make sure that I was clear too. I'm not at all question quality what you guys are booking. I'm just wondering by whether or not you effectively pick the low hanging fruit or is there more to come? Do think that opportunity is still a pretty good one in the near-term to add quality loans from other institutions out there? Or have you done most of what you can?

No, I think there is more opportunities. When I watch our internal pipelines, as they continue to grow. So, I feel pretty optimistic about continuing our organic loan growth.

Okay thanks a lot, good quarter.

You bet, thank you.

Thank you. Our next question comes from Tim Coffey of FIG Partners. Your line is open.

Thank you. Good morning Brian, good morning Don. A question about reserves and credit quality. Of your reserves for just the legacy portfolio, what amount of those are the result of the FAS 114 reviews?

Don is pulling up a couple reports here to look at it. I don't know that -- while he's looking at that report -- I don't know that our reserve process for our originated loans has really changed much in the last several quarters, in terms of specific reserves versus FAS 5 reserve. I think they probably been pretty normal. But Don, do you have --?

Tim, are asking how much of the reserve is for 114?

Yes

It's about $4.6 million.

Okay. And then, what were the delinquencies, the 30 to 89 day early-stage latencies?

On the originated?

Yes.

The 30 to 90 was about $2 million. $2.1 million.

Okay. You guys had a pretty good drop in the early stage delinquencies then?

Yes, we have.

Is that the result of doing anything differently in the collection process or is it --this might go against what you said earlier -- improving economy?

I think it's probably accommodation of a lot of things.

But I think 1, it -- and I think probably the biggest reason is as we just worked through the cycle and get on what I hope is approaching the tail end of it. We just have I think more of a dialed in process with folks to manage -- forward-manage their portfolios that I think probably eliminates some past-dues even before they arrive. And then aggressively work the past-dues that we already have.

So, I think it's a combination of a lot of things. But I was, like you, particularly pleased with the overall decrease in our past due percentages this past quarter.

Do you think that's going to carry over to forward quarters?

I think so. I'm not seeing anything, I guess, as we look at all of our potential problem loans, I'm not seeing anything there. At least with large ticket loans, because those are the ones that tend to move the needle. And I'm not seeing any of the particularly large dollar amounts that particularly concern me.

Okay. And then if we could just kind of look at the salary and administrative costs plus occupancy expenses? Are those starting to flatten out a little bit? Or do you expect they will increase this next quarter?

I wouldn't expect salary increase -- they'll increase if we continue to hire, if we find lenders that we can bring on to help build our loan portfolio, other than that, we're not really expecting to have a lot of increase. We did add a branch this last quarter. So, but that didn't have a lot of FTE in that. So, I wouldn't expect it to go up a lot in the next couple quarters. Same with the occupancy expense. I wouldn't expect that to really increase much over the next few quarters.

Okay. And then Brian, just make sure I got this number right, you said you hired 11 lenders in the last 9 months?

That's correct.

Alright. Great. Thanks. Those are all my questions.

Thanks Tim.

Thank you. Our next question comes from Jacque Chimera with Keefe, Bruyette & Woods. Your line is open.

Hello, good morning everyone.

Hello Jackie.

Brian, looking to the loan growth that you had in the quarter, was it centered in any 1 geography? Or was it more broad spread across your footprint?

It was broadly across the footprint. I guess that's another thing I was pleased with. Were seeing nice growth in the Portland/Vancouver area, as well as the Seattle/Bellevue area, were seeing it from all areas of the organization from a geographic point of view. And that's really been our focus.

And I'll remind folks. When we acquired, especially the Cowlitz organization, we were pretty clear that we did so because we wanted to expand our geographic footprint. And then when we acquired it, we said that we don't have much in the Portland/Vancouver, and the Seattle/Bellevue markets, and it's our goal to build out those markets. And we have hired a number of lenders in those new markets for us. And we're building out that footprint. And for that I'm particularly pleased.

Great. And then, you had mentioned that the net loan growth had returned and you weren't really expecting that till the fourth quarter. Obviously the majority of that is through the organic portfolio. With any of that tied to a slower run-off in your acquired portfolios?

Maybe. When I made that comment, I want to be clear, I have been expecting organic loan growth from our acquired lenders, our hired lenders as well as our legacy lenders. It's just that I didn't expect the net overall growth to be positive until later this year, perhaps the fourth quarter. And so that I think was a pleasant surprise. Did it come from less run-off on acquired portfolios? I think that generally we are seeing lesser run-off on those portfolios than we anticipated earlier. There is still run-off, don't get me wrong. But I think we are able to restructure some deals, and improve some of the deals to where we can maintain them as an asset. But at least we see that it has the potential of being a quality earning asset down the road. More so than, I think, we thought we might as we went into both acquired portfolios.

Okay.

Thank you. Our next question comes from Tim O'Brien with Sandler O'Neill & Partners. Your line is open.

Hello, guys.

Hello Tim.

Don, regarding the discounted yield accretion contribution this quarter. Could you break out -- was some of that to do to unscheduled payoffs or paydowns in the acquired portfolio?

Well I think some of it is, but it all flows in through the pool accounting. So, I really can't give you a specific amount of what that would be. Because there's a lot of factors. Part of it may be payoffs, part of it is cash flow re-estimations, part of it is collection efforts. So there's a lot of different factors that flow through that. I really couldn't --

Yes. All right.

And then -- one other question to follow up on that multi-loan that you kind of broke out and highlighted, Brian, that was a little bit larger and such. What size was that loan? And relative to your comments about a hot market in multi -- how did you get comfortable underwriting that particular loan? Can you give us some credit profile of that loan? Underwriting profile?

Sure. First of all I think probably the most important piece to that loan is was to and existing, known, borrower to us. A relationship that we had a very strong history with and somebody that has demonstrated long-term success in managing multi-family projects. That particular project was in the -- total project was in the $14 million, of which about 50% was acquisition, and roughly -- and these are just rough numbers -- another 50% was a substantial renovation to the project.

And it's vacated I guess? How many units is it?

You know Tim, I can't give you that sort of detail.

That's okay, Brian. What market was it in?

Yes it was in the Tacoma/Puyallup market. It was a good-sized project, as the dollar amount would indicate. And the units were, and are, occupied. But it's a project that has multiple buildings. And so, they are able to move folks out, re-renovate and then re-lease.

Okay thanks that's great color. And then, on the $22 million-plus in commercial loans are you guys booked, can you give a little bit of color on rates and floors? What were you able to price those at, generally speaking? I know that there's some variance, probably.

Sure. And just generally speaking, when I take a look at the new loans that we booked and the detail that I went through with you earlier, in terms of that $31 million, the average yield of all of those loans was 5.87%. And as I'm looking at the list of these loans -- just looking down the list -- it looks like 7%, 7.5% might be on the high side for some of the agricultural credits, which tend to be a little higher yield. But most of that yield is in that 5.5% to 6.25% range.

And are you able to impose floors?

Yes. We are still -- we still get floors almost all of our CNI stuff that we booked. And the floors very. Typically we might look at a 5 or a 6 floor -- it might be a prime plus a number, but with a floor in it. So we are still able to do that.

Did you do see any increased line utilization this quarter?

Yes we did. Especially in our agricultural lines. And for those of you that may not be aware, I'm speaking specifically to the Central Valley Bank affiliate in central part of the state in Yakima. Those loans, as you would guess, the production cycle is such that those loans are being drawn on. And so those balances are increasing.

And for the non-ag Brian, was any increase meaningful or was it really noise from your perspective?

You know, I think there was -- and I can't really tell on it without going into it loan-by-loan in our systems -- but just the lift overall, I would guess that we saw a little bit of increase in our existing lines of credit as well. But that's just anecdotal.

Okay. And then last question, regarding your reserve and provisioning with regard to this quarter, is it -- am I accurate in characterizing the situation, is a lot of that provision you took was to reflect or set asides for the new loans that you brought in? And that keeping your reserve elevated relative to your loan book is -- you're just comfortable doing that based on your broader market outlook? So here not going to allow that reserve ratio to drift down at this point for a while maybe? Especially with your additional new loans and so you'll provision accordingly? Just to have that safety net in place going forward?

Yes. Tim I think certainly the new loan growth as part of that process. First time in several years that allowances might be increasing as a result of new loan growth. I think that just generally speaking, where our allowance is overall, I see that staying pretty constant for the balance of the year. You know, if we really see improvement in the economy and the prospects for the economy as we move into 2012 improving, then we may see that begin to drift down late in the year, but I'm fairly comfortable with where they are now given the economy and the overall performance of our portfolio, certainly.

Thanks a lot.

You bet, Tim.

Thank you. Our next question comes from Ross Haberman with Haberman Management. Your line is open.

Good morning guys, how are you?

Good, Ross.

I might have missed this, did you discuss your margin and are spread and your expectation for the rest of the year? Is there much more room to lower the positive rates? Thanks.

Well I'll make a comment on that, and ask Don to fill in some color. we've been saying for several quarters that we didn't see our margin expansion as much of a possibility. But we continue to see cost of funds slip lower by marginal amounts. I think the other part that -- to the net interest margin that has been a bit surprising to me is, is that I think our lenders are doing a particularly good job of pricing these new assets that are coming onboard.

I spoke about the multi-family product. Without getting into specific rates to that product, the rates that we're able to obtain are marginally higher than what I know has been quoted by other creditors -- or other banks out there because we've seen their flyers. So, I think we did a pretty good job on the yield side of our earning assets. I think probably from an overall point of view, net interest margin certainly I think will hold steady as we work through this. Don, thoughts for that? Yes. You know some of that -- if you take that the effects of the acquired loan discounts, I would say that we will probably remain pretty steady, I think we'll probably see a little bit of downward pressure on the loan side as things happen, but at the same time, I think we'll be able to lower our costs of deposits slightly -- going forward. Again that's -- the lower it gets the less impact it has, as far as how far it goes down, but probably come down little bit more on the deposit side. But you might also see that kind of legacy come down a little bit also, as rates stay down in this area for a while. Both sides come down a little. Overall the margin will probably stay pretty much the same.

Okay, thanks guys.

Thanks Ross.

Thank you. One moment please. (Operator Instructions) Our next question comes from Jackie Chimera with Keefe, Bruyette & Woods. Your line is open.

Hello, sorry about that, I somehow got cut off before I finished my questions.

No problem.

I have 1 or 2 questions for you, Don. It looks like for the last few quarters the fees and then the interest income accretion and the provision have essentially offset. Do you feel comfortable that, that's likely to continue going forward?

Well I think it's very likely to happen. At the same time, we may actually see some positive effects. It's really hard to say when we do these cash flow re-estimations, exactly what's going to happen. We feel comfortable with the overall quality and performance of the loan activity. But sometimes, depending on what pool a loan that may have some movement is in, one pool may go one way and it effects provisioning that happens instantaneously, and other ones may improve that affect yields and you get the effect down the road. So it's really hard to predict depending on which loans, and what pools. But overall I would say I am hopeful, if anything, it will improve over time that the impact to the bottom-line.

Okay great, and thank you for that chart. I don't recall. I don't think it was the former press releases, and it was really helpful.

Great.

And then looking at the link quarter uptick in compensation expenses, was that more from new hires or incentive comp related to the loan growth, or was it evenly split between the 2?

We don't pay any incentive compensation, but annually in March of each year. So, that would not have been a part of it. When I say that, incentive comp related to lending activities there are some retail or branch incentives programs out there. But the lender incentive is paid annually. So, I think probably most of that increase is due to increased lenders that we've been bringing on board.

Also, just an annual increase is -- offices increases happen at the beginning of second quarter. It also has the effect on that.

Good point.

And then, for the last 2 quarters we've seen, the reinitiation of the dividend and the increase in the most recent quarter. Assuming that earnings continue to traject up, are you talked with the payout ratio, where it's at? Might we see the future dividends if earnings continue to go up?

Jackie, I think when it comes to dividend payout ratios, we may be a bit high today from where we would be on a more traditional, normalized earnings point of view. I think probably -- and I think we've discussed this on a couple of occasions -- that a normalized dividend payout is probably going to be the 30%, 35% range. And that depends on a lot of factors. And I know that dividend payout ratio exceeds that by a bit today. But, I think we are quite a ways away from normalized earnings. And you couple that with strong capital position and, I think, improving trends and I'm comfortable with that payout ratio as it stands today.

Okay. Great. Thank you very much.

Sure. Thank you for your questions.

Thank you.

(Operator Instructions)

One moment please. I'm showing no further questions at this time.

Okay Valerie I appreciate everyone's calling in today. And look forward to seeing some of you folks had the KBW conference in New York next week. So, thanks for tuning in today.

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