CVB Financial Corp. (CVBF) Q1 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the First Quarter 2012 CVB Financial Corp. and its subsidiary, Citizens Business Bank Earnings Conference Call. My name is Amy, and I will be your operator for today. [Operator Instructions] I would now like to turn the presentation over to your host for today's call, Christina Carrabino. You may proceed.

Thank you, Amy, and good morning, everyone. Thank you for joining us today to review our financial results for the first quarter of 2012. Joining me this morning is Chris Myers, President and Chief Executive Officer; and Rich Thomas, Executive Vice President and Chief Financial Officer. Our comments today will refer to the financial information that was included in our earnings announcement released yesterday. To obtain a copy, please visit our website at www.cbbank.com and click on the CVB Investors tab. Before we get started, let me remind you that today's conference call will include some forward-looking statements. These forward-looking statements relate to, among other things, current plans, expectations, events and industry trends that may affect the company's future operating results and financial position. Such statements involve risks and uncertainties, and future activities and results may differ materially from these expectations. The speakers on this call claim the protection of the Safe Harbor provision contained in the Private Securities Litigation Reform Act of 1995. For a more complete discussion of the risks and uncertainties that may cause actual results to differ materially from our forward-looking statements, please see the company's annual report on Form 10-K for the year ended December 31, 2011, and in particular, the information set forth in Item 1A, Risk Factors therein. Now I will turn the call over to Chris Myers.

Thanks, Christina. Good morning, everyone, and thank you for joining us again this quarter. Yesterday, we reported earnings of $22.3 million for the first quarter of 2012 compared with $21.6 million for the fourth quarter 2011 and up 34.1% for the $16.6 million for the year ago quarter. Earnings per share were $0.21 for the first quarter compared with $0.21 for the fourth quarter and $0.16 for the year ago quarter. The first quarter also represented our 140th consecutive quarter of profitability and 90th consecutive quarter of paying a cash dividend to our shareholders. Excluding the impact of the yield adjustment on covered loans, our tax exempt net interest margin was 3.69% for the first quarter, up from 3.62% for the fourth quarter and down from 3.78% for the first quarter of 2011. The quarter-over-quarter increase was primarily due to our $100 million prepayment of Federal Home Loan Bank debt late in the fourth quarter. Despite the improved net interest margin, we continue to experience pressure on top line income in the form of a lower interest rate environment for our loan and investment portfolios. For example, as commercial real estate loans mature and/or come under competitive pressure, we are negotiating with clients to maintain the loans on our books, usually at lower interest rates and extended terms. We feel fortunate to have prepayment penalties embedded in most of our commercial real estate loans. The prepayment language provides us with 2 primary benefits: Number one, fee income upon refinance; and number two, refinancing leverage with the clients. Simply put, customers will typically come to us before refinancing with another financial institution because they want to get a discount on the prepayment penalty. This gives us leverage to maintain the loan and/or collect a prepayment fee, usually both. On the investment side, we are reinvesting cash flows from our portfolio with the current objective of maintaining about $300 million in short-term corporate cash. Anything above the $300 million generally will be invested in securities or will fund new loans, loans being our preference. Our present strategy is in response to the federal open market committee's desire to maintain interest rates in the current range through 2014 and a tremendous amount of liquidity in the financial services industry. Now let's talk about loans. We had $3.43 billion in total loans net of deferred fees and discounts in the first quarter of 2012, compared with $3.48 billion for the fourth quarter of 2011. Nonperforming assets continued to decline in the first quarter, representing the sixth straight quarter we have experienced a decline. We, once again, reported 0 provision for funded loan and lease losses for the first quarter. The allowance for loans and lease losses was $91.9 million or 2.89% of outstanding loans at March 31, 2012 compared with $94 million or 2.92% of outstanding loans at year end 2011. Net charge-offs for the first quarter were $2 million compared with $1.6 million for the fourth quarter. In total, our nonperforming assets, defined as non-covered, nonaccrual loans plus OREO, totaled $66.7 million at March 31, 2012, a decrease of $9.8 million from $76.5 million at year end 2011. At March 31, 2012, we have loans delinquent 30 to 89 days of $11.2 million or 0.35% of total non-covered loans. Classified loans decreased for the first quarter to $334.1 million compared with $359.2 million for the prior quarter. We will have more detailed information on classified loans available in our first quarter Form 10-Q. Regarding our non-covered loan portfolio. We had $3.2 billion in total non-covered loans and leases at the end of the first quarter, a decline of $33.4 million from the end of the fourth quarter. Our dairy and livestock portfolio decreased by $57.7 million from the fourth quarter to the first quarter, due primarily to the seasonal borrowing patterns of these customers as they draw down on their lines during the fourth quarter and then repay them during the first quarter. Both dairy loans excluded, they actually grew non-covered loans by $24 million in the first quarter. Construction loans totaled $67.4 million at March 31, 2012, compared with $76.1 million at December 31, 2011, and our single-family residential mortgage pools for $125.8 million at March 31, 2012, compared with $134 million at year end 2011. These 2 non-core loan categories continue to decline, representing $16.9 million in loan runoffs for the first quarter. Commercial real estate loans totaled $2 billion at March 31, 2012, compared with $1.9 billion at year end 2011. Market remains very competitive for new loan originations for both commercial real estate and commercial and industrial loans. As we compete for this business, it is critically important for us to remain focused on credit quality as the low interest rate environment leaves little room for underwriting error. Moving on to covered loans. Covered loans represent loans in which we have loss sharing protection from the FDIC as a result of our acquisition of San Joaquin Bank in October 2009. In March 31, 2012, we had $305 million in total covered loans resulting from the San Joaquin Bank acquisition compared with $330.4 million at year end 2011. These loans have a carrying value of $245.7 million, a decrease of $16.9 million from year end 2011. As of quarter end, our remaining purchase discount is $59.3 million. Our ongoing strategy is to continue to work down the problem loans as expediently as possible and expand the good customer relationships. Remember, not all covered loans are bad loans. Now I would like to discuss deposits. We continue to grow our non-interest-bearing deposits. For the first quarter of 2012, our non-interest-bearing deposits grew to $2.12 billion compared with $2.03 billion for the prior quarter. This represents a 4.56% increase quarter-over-quarter completely organic. Non-interest-bearing deposits now represent over 45% of our total deposits. Our total cost of deposits for the first quarter was 14 basis points compared with 15 basis points for the fourth quarter. At March 31, 2012, our total deposits in customer repurchase agreements were $5.2 billion, $43.8 million higher than year end 2011. We continue to seek what we refer to as sticky deposits, deposits that we believe are high quality and will be more inclined to stick with us when the interest rates rise. The ongoing objective is to maintain a low cost, stable source of funding for our loans and securities. Moving on to non-interest income. Non-interest income was $5.3 million for the first quarter of 2012 compared with $10.7 million for the prior quarter. Non-interest income was reduced by a $2.9 billion net decrease in the FDIC loss sharing asset and a $1.2 million impairment charge for a large held-for-sale note included in other non-interest income. The decrease in the loss sharing asset in 2012 is primarily due to the improved credit loss experienced in our covered loan portfolio. Non-interest income for the fourth quarter of 2011 was improved by a $1.3 million increase in the FDIC loss sharing asset. So if these 3 items are excluded, non-interest income -- actually, core non-interest income is actually flat at $9.4 million quarter-over-quarter. Now expenses. We continue to closely monitor our expenses and realize some of the benefits of the expense reduction initiatives that were enacted in mid-2011. Non-interest expense for the first quarter was $30.2 million, a decrease of $4.5 million from $34.7 million for the fourth quarter and a decrease of $6.1 million from $36.3 million in the year ago quarter. Overall, we are pleased with our progress in reducing expenses. Now I will turn the call over to Rich Thomas to discuss our effective tax rate, investment portfolio and overall capital position. Rich?

Thanks, Chris. Good morning, everyone. Our effective tax rate was 33.8% for the first quarter compared to 30.5% for the fourth quarter. The increase was due to a higher taxable income related to current earnings trends. The lower rate in the fourth quarter can be attributed to the year-end adjustments of our estimated effective tax rate utilized during the first 3 quarters of 2011. Overall, our effective tax rate is estimated and may fluctuate based upon the ratio of taxable income to total income, considering tax advantage, municipal bond income and nondeductible expenses. Now our investment portfolio. In the first quarter of 2012, we provided an average of approximately $224 million in overnight funds in the Federal Reserve. We received a yield of approximately 25 basis points on collected balances. We also maintained about $60 million in short-term CDs and money markets with other financial institutions, yielding approximately 66 basis points. At March 31, 2012, our available-for-sale investment securities totaled $2.4 billion, up $171 million from year end 2011. Investment securities now represent approximately 37% of our total assets. Our available-for-sale investment portfolio continued to perform well. At March 31, 2012, we had an unrealized gain of $71.4 million, down slightly from $71.5 million for the prior quarter. Virtually, all of our mortgage-backed securities are issued by Freddie Mac or Fannie Mae, which have the implied guarantee of the U.S. government. We have 6 private label mortgage-back issues, totaling a relatively modest $4 million. We have been strategically reinvesting our cash flow from our investment portfolio, carefully weighing current rates and overall interest rate risk. During the first quarter, we purchased $318 million in mortgage-backed securities with an average yield of 1.82%. We attempt to maintain a neutral position at the short end of the treasury curve by reinvesting in mortgage-backed securities with an average duration of about 4 years to avoid material extension risk as interest rates arise in the future. We also purchased $13.1 million in municipal securities with an average tax equivalent yield of 3.58%. Finding bank-qualified municipal securities that meet our investment criteria remains challenging. At the end of the first quarter, we held $1.68 billion in mortgage-backed securities and $646.7 million in municipal securities. Combined, these represent 98% of our $2.4 billion investment portfolio. Now turning to our capital position. Our capital ratios are well above regulatory standards and above our peer group average. Our March 31, 2012 capital ratios will be released soon concurrently with our first quarter Form 10-Q. We anticipate these ratios to be at or above their December 31, 2011 levels. We paid out approximately $8.9 million in cash dividends during the first quarter of 2012. Despite this, shareholders' equity increased $15.2 million to $730 million for the quarter. Our strong capital position has enabled us to explore alternative opportunities to deploy our capital and liquidity. On January 7, we redeemed all the outstanding capital and common securities issued by First Coast Capital Trust II for total consideration of approximately $6.8 million. The cost of these securities was 3-month LIBOR plus 3.25% per annum. This will save us about $250,000 annually. Our ongoing strategy is to deploy our excess capital through: One, a bank or trust acquisition; two, ongoing cash dividends to our shareholders; three, redemption of trust-preferred securities; and four, our stock repurchase program. Execution of these individual strategies will be weighed carefully against the ongoing business and interest rate environment. I will now turn the call back to Chris, for some closing remarks.

Thanks, Rich. Now let's talk about the economy. In terms of the California economy, current statistics and various reports provided by local economists indicate the California remains on the road to recovery. When examining the underlying drivers of economic and job growth in California, the statistics point to an economy that is beginning to outshine the rest of the nation. Consumers have shown steady increases in spending over the past 2 years and California appears to be gaining momentum. International trade has been playing a large role in speeding up California's economy, particularly on the export side. With the dollar following -- falling and U.S. goods becoming increasingly affordable abroad, California's proximity and infrastructure to reach the East Asian markets, which have been expanding at above average rates recently, has helped the state benefit from an increase in seaport and airport activity. California's labor markets are starting to make a turn to the better, particularly in private sector employment. We have a ways to go, but we seem to be moving steadily in the right direction. According to the U.S. Department of Labor, California's unemployment rate was 10.9% in February 2012, down from its peak of 12.4% in February 2010. In terms of the dairy and livestock industry, feed costs are up, milk prices are down and the profit margins have tightened in recent months. Although California milk prices are down from 2011, they are still better than 2010. Feed costs continue to put pressure on profit margins. According to the California Department of Food and Agriculture, [indiscernible] the fourth quarter of 2011, feed costs in California represented approximately 65% of total milk production cost. This compares to about 59% of total milk production cost in the fourth quarter of 2010. In terms of corporate recognition, we were pleased to be added to the S&P's SmallCap 600 index in March. This is a positive message about our company's ongoing growth and success. We were also recently honored to have been named by Forbes as the 11th best bank in America for 2011. This recognition was based upon data supplied from SNL Financial on 8 metrics regarding asset quality, capital adequacy and profitability of the 100 largest publicly traded banks and thrifts. As we progress through 2012, we will continue to focus company-wide on our critical view. These are: drive quality loan growth, non-interest-bearing deposit growth, non-interest income growth, expense control, and grow through acquisitions in de novo. That concludes today's presentation. Now Rich and I will be happy to take any questions that you might have. Let's go.

[Operator Instructions] Our first question is from Aaron Deer with Sandler O'Neill & Partners.

A question, just following up on your comments about the milk prices and feed, the impact that, that has on the dairies. Has the -- have your -- there is said anything new about what's the rainfall that we've had here in California this year and what impact that could have on feed prices going forward?

No. We haven't heard a ton of that and the effect that we're having -- milk production is very strong. And in general -- but one of the other things that I think on the dairy, I want to mention on the dairy side too is feed prices are a lot higher than they were in 2009. So from that standpoint, that's a positive for the industry, because when we look at our collateral, we land a certain percentage against the value of the herd and the value of the feed and the fact that the prices are up, it gives us more comfort level as to the liquidation value of our collateral should something adversely happen on one of the dairies.

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

Well, I mean, in today's world, I mean, loan prices, I mean, the difference between putting a loan on the books and putting out security on the books are -- there's a big gap there. So that's good news to the extent you can put on quality loans. But the overall kind of feeling of putting on a fixed rate loan for 5, 7 or 10 years at 4% to 5% is -- it's just not as good as it was 4 years ago when we were putting the same loans on at 5.5%, 6% or 7%. We are seeing more momentum on the loan side and we -- and our pipeline is picking up, and we're working really hard at it. But again, as I said in the script here, we have to buy quality, because when you're getting of 5% yield on a new loan, you just -- you got to be right 99-plus times out of 100 to make money and to make good money. And so we're very carefully thinking about the type of loans we put on the books. In the absence of that loan growth, we are buying securities but trying to keep that at a fairly -- at the shorter end of the curve and really buying mostly -- we love to buy more municipals where we can find them that meet investment criteria. But when we buy mortgage-backed securities -- typically, we're buying 15-year mortgage-backed securities and not 30-year.

All right. It sounds like you're pretty hesitant to be putting non-fixed rate home product and yet obviously that's more ideal than the security...

We're not hesitant to it. I think where we start getting a little bit gun shy is on a 10-year fixed-rate stuff, which is typically running around, let's say, high 4s, maybe 5%, and we're using a lot of interest rate swaps on those situations, the 5 year, typically, the 5-year fixed rate and the 7-year fixed rate we're putting on our books. The 10-year fixed-rate or the 15-year fully amortizing fixed rates, we may swap those loans, we may not swap those loans. It depends on the relationship and the circumstances. But I think right now, we've swapped about, of our auto commercial real estate loans, we have nearly $200 million in interest rate swaps on our books of a $2 billion portfolio. And it's -- I think what our objective is to do is to try to remain as much interest rate neutral as we can neither liability sensitive or asset sensitive so that when rate shock up 300 basis points if they ever did shock up 300 basis points we're still making the same amount of money that we are today or more. And right now, we've been more neutral than we have in a long, long time in this company in terms of asset sensitivity, liability sensitivity. And so we want to keep that. And so we're being careful about that longer-term fixed-rate paper putting that on our books and thinking very carefully about it. Just to add a little more color on that, that decision is typically very relationship based. If we have a real strong, long-term customer with a lot of deposits and that commercial real estate fixed-rate loan is being funded primarily by that same customer's operating deposits, we feel more comfortable in putting that on our books as opposed to swapping it. The more transactional nature credits that are more for real estate and investor type properties are the ones we are typically swapping out.

Our next question is from Hugh Miller with Sidoti & Company.

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

Well, we're having a lot of conversations with a lot of different people. So there's a lot of -- there's more conversational activity than there was 6 months ago or a year ago, no question about it. I think the reason we haven't announced anything as of yet is we're carefully thinking about the price of these, of what we're buying and the sustainability of that franchise going forward. Most of these smaller banks are really -- what -- deposits are easy, right? Now the sticky deposits are not as easy, but deposits generally are easy to get. So a lot of these smaller banks are flushed with a lot of deposits and then you have to look carefully. What are they doing with those deposits? Are they able to grow loans and quality loans? Are they taking too much credit risk? Or are they buying securities with these and taking a lot of interest rate risks? So today, when we go ahead and look at these smaller banks and we have to look at where those dollars are going. And what kind of interest rate risk they're taking, and do they have a franchise that is -- and what's happening with our margins? And they may be putting on loans and so forth, but at what margin and what kind of fixed rate, interest rate risks. So when I look at a bank, or Rich and I look at a bank, and we see something that might be valued at X dollars today, you really want to think about, well, what is this bank going to be worth next year and the year after that all things being equal? And then, what are we paying as a multiple of this bank? And so somewhere in there, there's a difference between what we think the bank is worth and what typically the sellers are thinking it’s worth. And just to add a little bit more to that, we're really not focused on that bank trading at 0.7x book. That's a kind of a bank that's fractured that got through the process here. We want to buy a bank that has Citizens Business Bank type customers in there, so that we can go in there, buy the bank and capture more of that customer wallet by cross-selling more products because we have a lot more products and services to sell than those small banks. So we want to uplift that customer relationship and expand that customer relationship. But if it's got a transactional nature to it or an SNL feel to it and it's a fractured bank, we don't really get that out of those customers. And then the banks that are healthier, they want a bigger price. And so we're kind of looking at them saying, well, you keep taking all these deposits and buying securities and taking interest rate risks, we really can't pay you for that. So that's where there's a little bit of a disconnect there, but we're trying hard.

Great color there. I do appreciate that. And the follow-up question is just on the bill on loan portfolio. It looks like it had a nice pick up compared to 4Q, maybe up about 30 basis points or so, and was wondering if you could just give us some color on how much of that is driven by prepayment penalties and kind of reductions in the nonperforming assets versus anything on the competitive pricing landscape or loan portfolio shift.

Yes, you know what, and a chunk of that is prepayment penalties and we, in the first quarter of 2012, we procured $869,000 in prepayment penalties. And that's prepayment penalties that we're putting into fee income. There are more than that in total -- in terms of total prepayment penalties because -- and I'm not the one to give you the accounting discussion on this. I think Rich could do a better job on that. But if there's not that material change -- when you refinance one of your own loans, if there's not much of a material change in the cash flow income stream, then those prepayment penalties go into interest income as opposed to fee income. But we actually did more than $869,000 in prepayment fees, but the $869,000 in prepayment fees are really indicative of fees that there was a material change in the relationship or we had to recap the entire loan and that's why we charged the prepayment fees. Does that make sense?

It certainly does. But do you know on a percentage basis, of the 30 basis point pick up in loan yield, what was from the prepayments?

I don't know. I'd have to get out my calculator. Yes, but the $869,000 -- sorry about that, I just don't -- I have it.

That's okay. That's quite all right.

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

I don't have that too. Not at my fingertips.

But to give you some more color on that, last year at this time, we had $235,000 in prepayment penalties in the first quarter. We're talking about $644,000 difference quarter-over-quarter, year-over-year in terms of prepayment fees that are dropped into our -- the bottom line.

Our next question is coming Tim Coffey with FIG Partners.

[indiscernible] your question a little bit, those [indiscernible] say loans that you were talking about earlier on the call, Chris, the ones you renegotiate or the payment to the office for renewal, what are the new rates on them?

Well, I have to be careful about when I throw a rate. But I'll give you ballparks because we do have competitors out there. But typically, paper that was written 4 years ago that was in the 6% or maybe low 6% range, that same paper is going at probably on average about 1.25% cheaper today. And it depend -- a lot depends on the duration, is it a 5-year fixed rate? Is it a 7-year fixed rate? Is it a 10-year fixed rate? And there are also clients that are choosing to do variable rate stuff. And we have products that are 1 year LIBOR-based loans that adjust once a year. The good news I know is just that -- is that they -- we don't take a lot of interest rate risks with those, right? Because the rate changes every year. So rates are down or coming down on that, but I will say that I believe that our activity is picking up in terms of our pipeline and so forth, so we're hoping to deploy more of our excess cash into loans and securities and feel like we have good momentum there. But we're also playing a lot of defense on our existing loans because it's not like we walk up to customers with 4 or 5 years left in their loans and say, hey, by the way, you got a 6% rate and I'd like to refinance it to 5% today. We have prepayment penalties in there that protect us on that and then -- and usually, what happens is the client will come to us and say, listen, so-and-so bank is willing to do this deal at 5% or 4.75%. What do you guys going to do for me? Can you refinance this? And then, we talk to them about the prepayment penalty and we work a deal to keep it in the bank and either charge the full prepayment penalty or give them a hopefully what is just a modest discount on the prepayment penalty. But a prepayment penalty gives us leverage in the negotiations because they want to come through us because they don't want to pay the prepayment penalty. And typically, our prepayment penalties are 6 months interest on the outstanding principal balance, not in all cases, but [indiscernible]. So if you have a 6% loan, that's a 3% prepayment penalty.

Okay. And then the follow-up question. Is [indiscernible] down to low rates, the low rates that you're writing down to, is that just the cause of business or is there a kind of a strategic alternative in terms of monetizing, increasing monetization of the relationship? And I realized that might be a mix of which one is heavier weighting and loans that have come back to the bank recently, is it kind of the cost of...

No, it's just a reality that no interest rate world we're living in. And I mean, the other day, we were looking at the decision and we had a -- just an AA+ credit tenant on a loan and when we looked at it, it was a 7-year fixed rate and I didn't like the rate we were having to bid to get on this deal. But when I looked at it, I really said, okay, I'm not taking any credit risk here at all. I mean, the tenant is as good a tenant that you could get in a building and it was a $3 million, $4 million, $5 million loan, somewhere in that range. And so would I rather take that paper on at x percent or would I rather buy securities which are going to yield me for that same -- probably, I'll get a security in the low 2s for that same type of duration whereas I'm getting at least a couple more percent on that loan and taking virtually no risk. So when I say credit quality, there are transactions we will do or transactions or deals we will do, but we try to make them completely, or you can't make anything completely, we try to make them as bullet proof as possible in terms of credit risk. Lower loan devalues, really strong metrics in terms of the tenants and the type of properties, et cetera, et cetera. So we're really buying quality assets in that case. And remember, we’re cost to funds and we have a 14 basis point cost of deposits. If we put a loan out at 4.5%, it's pretty good margin, right? That's not too bad, and we'll take that. We just have to be careful about how much interest rate risks we're taking because if rates do come back up, what's going to happen? And that's why we're doing interest rate swaps and that's why we're looking -- thinking very carefully about the duration risk that we're taking, both on the securities portfolio and on the loan portfolio.

Our next question comes from Julianna Balicka with KBW.

I have a couple of questions on the CRE loans that you are defending and versus the ones that are leaving the bank. Do you have a sense to what kind of banks they are going to?

Well, we're not seeing a tremendous amount that are leaving the banks. Leaving the bank is where -- I'll tell you the process we go through. I'll probably [indiscernible] too much on this, but I will anyway. What happens is, if somebody comes up to us and says, listen, I've got an opportunity to refinance your loan with somebody else at a cheaper price. The first thing I do is say, get that to our credit people. Let's look at the value of that piece of real estate, what we would appraise that for and are we properly margined on that deal. Because just because somebody wants to refinance their rate doesn't mean necessarily that we need to refinance it. Because it may be at 90% loan-to-value now because prices have dropped. So the first you need to do is look at where your margin because it may not really be refinanceable and they may not have leverage on you, the customer meaning. But once we determine that it is refinanceable, then we go down into, okay, what do we need to do to keep this loan and what are -- what's our leverage in this in terms of prepayment penalty, et cetera, et cetera. And if we determine that we do want to keep this loan, I'd say, over 9x out of 10x, we're keeping that loan. I'd say the pressure is really oriented. There's a couple of the big banks that are very aggressive there. But there's also some of these smaller niche banks that are very aggressive on rates. And it's all over the map and I'm seeing smaller banks take 10-year fixed rate interest rate risk, which I think is a real tough thing for a small bank to take, but we're seeing them do it. The big banks are more readily accustomed to take in that 10-year fixed rate and I think they are more prevalent in the marketplace than doing the 10-year fixed rate paper. But a lot of -- what a lot of the smaller banks are doing is they don't want to take the 10-year fixed rate, so they're really getting aggressive on their 5-year fixed rate pricing. And really, there's almost a 1% difference between 5-year fixed rate pricing and 10-year fixed rate pricing in the commercial real estate medium term loan market right now.

Okay, okay, that makes sense. And so if I think about your loan yield kind of progression kind of going forward, it sounds like a good amount of your commercial real estate book has kind of already turned over or the [indiscernible] could have probably approached you by now, so -- and the prepayment penalties have kind of kept your yields somewhat steady. I mean, if I back out accretive [ph] yield component, the accelerated accretion component of your yields this quarter, it looks like your loan yield's only like shifted by 4 basis points, right? But as the process of revamping your -- or turning your portfolio over goes on, the prepayment cushion is going to drop off. So do you have a sense of how much we should be kind of thinking about 2, 3 quarters from now as the link quarter change yields?

Well, hard to gauge that and it's hard for me to give you some real information on that because one of the other things you got to take into account is our nonperforming assets, our nonperforming loans are improving. So now I think quarter-over-quarter, our nonperforming loans were down about $9 million. So now we have $9 million that either -- that a chunk of that went on is now a performing loan or a TDR performing -- I saw our TDR performing is up by a few million dollars quarter-over-quarter. So if you look at that, some of these loans were getting back in the fray and they're now paying us interests and paying us principal and they're turning back in the performing loan. So the income of loans that wasn't there before is now coming back on our -- into our income stream, so that helps our loan yield. I remember a year ago last September, we had $162 million or something like that in nonperforming loans. And today, we're down at like $56 million or something like that.

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

Well, we’re going to give you a breakdown with our 10-Q on the classified loans because we're still finalizing the mix of that whole thing. But what happened over the last year really is the decline in our classified loans is a lot of it was driven by the dairy loans. And so that's starting to moderate a little bit and then now, some of the drivers in classified loans going down are more -- are general -- just our general loans. So a lot of the dairy loans have improved. Now the dairy business is softening a little bit right now. It's not bad, but it's not as robust as it was 6 months ago. So we’ll have to see, we have to gauge that as we go forward. But overall, I think we feel the trends continue to be positive on the classified loans side and I just can't project where that's going to continue because I don't know what's going to happen with the economy and in particular, what's going to happen in the dairy business either.

Our next question is from Joe Gladue with B. Riley.

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

Well the good news is, is that when we sat here 4 years ago, our construction loans and our mortgage pools together, before 5 years ago, were over $700 million combined. And today, those numbers are $100 million, and I think at the end of the quarter, we're 193 million dollars-ish between the 2 of them. So we've already seen over $500 million in rundown of those absorb that and here we are today. So the construction loans are not going to go to 0 because we're always going to doing some type of construction loans or even if we just do them for customers and their million-dollar homes and things like that, there's going to be something there. So I think the construction loan runoff is -- may decline some more, but at $67 million, it's just -- it's getting to the point where it's not going to go that much lower. The mortgage pools we're going to continue run down over time because we're not buying any new mortgage pools. So eventually, that will run completely off and -- but that has some tenure to it because these are mortgages that people are holding unless they refinance them or pay them off, they're just going to continue to stay on them. But I mean, when we look at $16.9 million in runoff for the first quarter, remember when I -- in our talk here a little bit earlier, if you look at our loan growth quarter-over-quarter or lack of loan growth quarter-over-quarter, and you take out the $57.7 million in seasonal dairy loans, difference in dairy loans, $57.7 million, you actually have positive loan growth for everything else, including our covered loans and including our construction loans and including our mortgage pulls. That wasn't a huge amount because if you look at it, we grew $24 million on our non-covered loans. And then, if you net out, I'm doing this on the fly a little bit, so if you net out the $16.9 million decrease in our covered loans, that still produces about a $7 million growth in loans, excluding the dairy loans quarter-over-quarter. So we did have, in our mind, we had positive overall loan growth in the company once you take the seasonality of the dairy loans, albeit it was only $7 million modest, so that's a good sign for us. It means like, hey, you know what? Maybe we're bottoming out here. Maybe we're on the rise. Maybe we're coming. And I feel like our portfolio is gaining momentum too. But we are challenged on the refinancing side and so that is, I mean, we had -- recently, we had a $13 million loan payoff because the property got sold. So that's a -- and by the way, the funny thing about that, that was a substandard credit. So good news, bad news, right? It was a substandard credit that was paying us. It was a performing substandard credit but it paid off. So we're like, yay, it went away, but boo, we're not getting that interest income anymore. We were living today on those kinds of things.

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

We're really focused on -- I mean, I'd say the pipelines that we're trying to drive are really focused on our C&I and our commercial real estate loans. And to a -- and we're also very focused on dairy and livestock and agribusiness, but we have to be careful in those areas as -- more so in the dairy and livestock area. We just got to make sure we're picking and choosing the right clients. So we're optimistic that we're going to be able to grow loans in those categories for the remainder of the year, dairy and livestock and maybe I'll hedge a little bit on that because I want to make sure that the industry is going to do well in the next 6 months. But on the commercial real estate and the C&I we feel like we have good momentum on both.

Our next question is from Brian Zabora with Stifel, Nicolaus.

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

Well, if you look at our efficiency ratio, we were at, I think, 47.231% [ph], is that the number? Yes, 47.31% for the quarter. And I've come out and I said, listen, I'd love to drive our efficiency ratio to 45% or slightly below that. That's an ambitious goal. I think it's not just about expenses, it's also about income in that ratio that we need to do. But I think that a lot of the initiatives that we've done across the company have kicked in and that's a big part of why our expenses are down not only quarter-over-quarter but substantially from where they were a year ago quarter. And it's Professional Services, it's different types of categories. We're working a lot on the occupancy side too and then we haven't realized as much as we like there in terms of our renegotiating leases, consolidating offices. All of those things are in our -- in the forefront of our mind and we're working on them. So there's not a stone unturned here. But one of the important things is that we don't want to do anything in our expense reduction mode here to cut off our offense. So we needed -- we're still on the offensive, we're still -- this company is a company that needs to grow, wants to grow, can grow and -- but we need to -- when you grow as rapidly as we did and other banks did in the early to mid-2000s, there are some efficiencies you can gain from simply looking at the way you did things and the way you grew and then your expense load. And certainly on the Professional Services side, the big component of that is legal, and I talked before about how our legal costs are substantially lower than they were in 2011 or at least seem to be trending in that direction.

And also just a question on competition. Talk a lot about banks are willing to go longer term, do you have a sense of people who are wavering on credit or just cover ratio whatever it may be?

No. It's funny. I think they're -- the structure is getting a little looser and longer-term amortizations and just a little but not materially, because I think the industry gets, for the most part, that at these low interest rates, you can't take a ton of risk. And I'm seeing the big banks get really aggressive on rates for things that lineup, low loan-to-values, great tenants [ph], great cash flows. It almost seems like they have some type of matrix that they're putting out that's very risk-based, because they may look at the same loan and have a 45% loan-to-value as opposed to 70% loan-to-value and have a lot lower rate for that 45% loan-to-value than the 70% loan-to-value. So it seems that it's very risk based or that some of those and we're doing the same thing, probably not as chart oriented or matrix oriented that the big banks were, because we're very customized in what we do, but we're thoughtfully thinking about risk and return.

Our next question is from Gary Tenner with D.A. Davidson.

I just had one quick question. You've mentioned the shift, the $9 million, I think, of remaining purchase discount on the San Joaquin loans. What was the -- just kind of accretion this quarter, not including the accelerated discount accretion?

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

Gary, what we've done in our 10-Q before is we've put a table in there for basically some transparency on the effect of the San Joaquin charges in the P&L. We will put in that same schedule in this quarter for our 10-Q. But there's clearly a bit improvement in our credit quality. We've looked at these default rates and we looked at the severity of those defaults and clearly, that's down from day 1 and continues to progress downward. I don't have the exact number of the total accretion for this quarter in front of me but as you saw, the accelerated accretion was about $4.7 million in interest income for this quarter.

Okay. I'll have to wait for the queue to get the rest of the information. Okay, and then just with regard to the SEC investigation, and I apologize there's some feedback here in my line. We've seen Professional Service charges come down for 3 quarters in a row. I imagine some of that's related to legal, some may be related to credit stuff. Could you just make any comment on the status and investigation that were going on 2 years now since that was announced?

This summer will be our 2-year anniversary, right? Hopefully, we won't have a 2-year anniversary but I don't know what will happen there. We continue to fully cooperate with them. We're just not in a position to say how long it will last, not under our control. And so we can't really make any prediction as to the outcome and -- but overall, we remain very focused on running our business and figuring out ways to grow revenue and the SEC investigation is on a day-to-day basis. It's really not a factor in anything that I'm dealing with right now or Rich is dealing with right now. We're running our business and that's soft in the side.

[Operator Instructions] Your next question is from Jonathan Elmi with Macquarie.

Just quickly on the classified assets. Obviously, you guys have done a great job bringing those down over the last year or so. But as you pointed out, a lot of that progress did come from the dairy portfolio. So with the industry starting to soften a little bit again, I mean, should we expect to see the pace of classified improvement sort of flatten out a little bit? And if so, how should we think about that in relation to the pace of reserved leases going forward?

Well, it's a good question and I'll try to answer the best I can, but I don't have a crystal ball on a lot of that stuff. We are -- on classified loans, we've been pleased with the progress that we've seen. And as we look at the dairy and look at our other loans and so forth and the economy, certainly that's going to be a big factor of how that kind of progression transpires in the future. It's hard to say whether the classified loans could kick back up on the dairy and livestock side or on the commercial or real estate side or whatever. But overall, quarter after quarter, we've made some good progress there. The -- but you're absolutely correct, if classified loans continue to fall, that will put more and more pressure on our reserve and the releasing reserve and -- but there are a lot of financial metrics out there that go into our formula to create our reserve. And as we look at those, we review those very carefully and we review them not only internally, but with our account, with KPMG at the end of the quarter and go through and kind of go through that whole systematic approach of how we reserve for loans. And right now, we haven't had to take any reserves in, I think it's been 4 quarters in a row and I can't predict whether the next quarter, we're going to take a reserve or not. But it -- we feel pretty good about certainly the credit quality and improvement that we've had and are hoping that it continues.

Your next question is a follow-up from Julianna Balicka with KBW.

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

Really, when we look at that, we're starting to scratch a little bit on that to see if there is some type of acquisition we can make on the lending side, whether it's by a company that does equipment leasing or loans or something like that, but we haven't done a ton on that. Again, we're very relationship oriented and some of these acquisitions will have, that we look out, will have an equipment portfolio or lease or loan portfolio and a lot of it out of state. So we look at it and say, you know what, we're just buying a loan, we're not a creating a relationship. And that's not really what we do. We're a relationship bank, we're try to build long-term relationships with our clients and cross-sell a heck out of all our products and services to them. That's fundamentally what our strategic objective is. So that's where it gets a little difficult. On the trust side, we are looking at different things and whether it's in a fixed income or more than equity-based firm, boutique firm, because we are looking at that. But again, we haven't been able to be one of those to finish the line either and never in the history of our company, but we do have I think the foundation of some really good people in that area and we could -- we might get lucky here in the future, but so far nothing.

[Operator Instructions] At this time, there are no more questions, so I would like to turn the call back to Mr. Myers.

All right, well, we thank you very much for joining us on our call today and appreciate your interest and look forward to speaking with you again on the second quarter 2012 earnings conference call in July. In the meantime, please feel free to contact Rich Thomas or me and have a great day. Thank you very much.

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