CVB Financial Corp. (CVBF) Q3 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Third Quarter 2012 CVB Financial Corp. and its subsidiary, Citizens Business Bank, Earnings Conference Call. My name is Denise, and I am your operator for today. [Operator Instructions] Later, we will conduct a question-and-answer period. I would now like to turn the presentation over to your host for today's call, Christina Carrabino. You may proceed.

Thank you, Denise, and good morning, everyone. Thank you for joining us today to review our financial results for the third quarter of 2012. Joining me this morning is Chris Myers, President and Chief Executive Officer; and Rich Thomas, Executive Vice President and Chief Financial Officer. Our comments today will refer to the financial information that was included in our earnings announcement released yesterday. To obtain a copy, please visit our website at www.cbbank.com and click on the Our Investors tab. Before we get started, let me remind you that today's conference call will include some forward-looking statements. These forward-looking statements relate to, among other things, current plans, expectations, events and industry trends that may affect the company's future operating results 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 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 $9.3 million for the third quarter of 2012 compared with $23.6 million for the second quarter of 2012 and $22.4 million for the year ago quarter. Earnings per share were $0.09 for the third quarter compared with $0.23 for the second quarter and $0.21 for the year ago quarter. During the third quarter, we repaid 5 outstanding fixed-rate loans from the Federal Home Loan Bank in an aggregate principal amount of $250 million, with an average coupon of 3.39% and a weighted average remaining life of 2.6 years. The repayments of these advances resulted in a $20.4 million termination expense on a pretax basis. We also redeemed all of the remaining outstanding capital and common securities of the trust preferred securities in CVB Statutory Trust I totaling $20.6 million. We made the prepayments to the Federal Home Loan Bank to deleverage our balance sheet and reduce ongoing funding costs. Based on the current economic trends and interest rate pressure, we continue to evaluate our balance sheet management strategy in deploying our liquidity and managing our capital position, as well as the longer term effects these prepayments have on our net interest margin. Simply put, we believe it is tremendously important to position ourselves so that our cost of funds is as low as possible. The Federal Reserve's commitment to maintaining low interest rates and QE3 has put additional pressure on asset yields. The refinancing pressure on our commercial real estate portfolio and the depressingly low interest rate yields on newly purchased securities combined to have a negative effect on our top line income. Deleveraging is an alternative to purchasing securities. Presently, we have one FHLB loan remaining in the amount of $200 million. It matures in November 2016 and bears interest at 4.52%. The prepayment penalty on this loan is approximately $31 million. Further interest-rate cost savings could also be achieved by prepaying the $40 million in trust preferred securities in CVB Statutory Trust II. These securities bear interest at 90-day LIBOR plus 2.85% and has 0 prepayment penalty. We have made no decision regarding the prepayment of the remaining FHLB loan or the trust preferred securities in CVB Statutory Trust II, but are considering both as potential future cost-saving options. Through the first 9 months of 2012, we earned $55.1 million, down 8.13% from the same period of 2011. Earnings per share were $0.53 for the 9 months period ending September 30, 2012, compared with $0.50 for the same period in 2011. The third quarter also represented our 142nd consecutive quarter of profitability and 92nd consecutive quarter of paying a cash dividend to our shareholders. Excluding the impact of the yield adjustment on covered loans, our tax exempt net interest margin was 3.60% for the third quarter compared with 3.77% for the second quarter and 3.81% for the third quarter of 2011. During the second quarter of 2012, we had several nonperforming loans that were paid in full, resulting in a 10-basis-point increase in interest income. Excluding this impact, net interest margin was down about 7 basis points for the third quarter, primarily due to the refinancing of higher yielding loans. Now let's talk about loans. At September 30, 2012, we had $3.44 billion in total loans net of deferred fees and discount compared with $3.39 billion at June 30, 2012. We now have one quarter in a row of organic loan growth. Nonperforming assets, defined as non-covered, nonaccrual loans plus OREO, increased in the third quarter to $76.5 million compared with $72 million for the prior quarter. The increase is attributed to an increase in dairy and livestock non-accruals. We once again reported 0 provision for funded loan and lease losses for the third quarter. The allowance for loan and lease losses was $92.1 million or 2.85% of outstanding loans at September 30, 2012, compared with $91.9 million or 2.89% of outstanding loans at June 30, 2012. We had net recoveries for the third quarter of $175,000 compared with net charge-offs of $30,000 for the second quarter of 2012. We recorded $1.1 million in recoveries for the third quarter. At September 30, 2012, we have loans delinquent 30 to 89 days of only $1.7 million or 0.05% of total non-covered loans. Classified loans for the third quarter were $302.5 million compared with $298.1 million for the prior quarter. The increase was due to downgrades in the dairy and livestock portfolio. We will have more detailed information on classified loans available in our third quarter Form 10-Q. We had $3.23 billion in total non-covered loans and leases at the end of the third quarter, an increase of $50.6 million from the end of the second quarter. For the third quarter, our commercial real estate loans increased by $47.1 million, our dairy and livestock portfolio increased by $7.4 million, and our commercial and industrial loans grew by $2 million. While we are encouraged by our quarter-over-quarter growth, all organic, we remain cautious in our optimism as the market is very competitive for new loan originations. Moving on to covered loans. Covered loans represent loans in which we have loss sharing protections from the FDIC as a result of our acquisition of San Joaquin Bank in October 2009. At September 30, 2012, we had $235.9 million in total covered loans remaining from the San Joaquin Bank acquisition with a carrying value of $207.3 million, compared with $246.6 million with a carrying value of $210.1 million at June 30, 2012. As of quarter end, our remaining purchase discount was $28.6 million. We anticipate that the majority of the remaining purchase discount will be gradually extinguished by October 2014, which is the 5-year anniversary of the San Joaquin Bank acquisition. Now I would like to discuss deposits. We continue to grow our non-interest-bearing deposits. For the third quarter of 2012, our non-interest-bearing deposits grew to $2.32 billion, compared with $2.25 billion for the prior quarter and $2.03 billion from the end of last year. This represents a 3.2% increase quarter-over-quarter and a 14.62% increase for the year, completely organic. Non-interest-bearing deposits now represent approximately 49% of our total deposits. Our total cost of deposits for the third quarter was 12 basis points compared with 13 basis points for the second quarter. If customer repurchase agreements are included, our cost of deposits was 13 basis points for the third quarter. At September 30, 2012, our total deposits and customer repurchase agreements were $5.23 billion, $63 million higher than at June 30, 2012, and $116 million higher than at December 30, 2011. Moving on to non-interest and interest income. Non-interest income was $2.6 million for the third quarter of 2012 compared with $2.3 million for the prior quarter. Non-interest income for the third quarter was reduced by a $7.1 million net decrease in the FDIC loss sharing asset compared with $9.3 million for the second quarter. Non-interest income for the second quarter also included $2 million in gain on sale of 11 covered loans held for sale. Decrease in the loss sharing asset was primarily due to the continuing resolution of covered assets and reflects improved credit loss experienced in our covered loan portfolio. If the loss sharing items are excluded from both quarters, non-interest income was $9.7 million and $9.6 million for the third and second quarters, respectively. Interest income and fees on loans for the third quarter totaled $52.6 million compared with $55.2 million for the second quarter. The $52.6 million for the third quarter included $7 million of discount accretion from accelerated principal reductions, payoffs, as well as the improved credit loss experienced on covered loans. This compares to $7.5 million of discount accretion for the prior quarter. Now expenses. We continue to closely monitor and manage our expenses. Excluding the effect of the $20.4 million FHLB prepayment penalty, non-interest expense for the third quarter was $29.6 million, up slightly from $28.9 million for the prior quarter and down significantly from $32.9 million for the year ago quarter. Now I will turn the call over to Rich Thomas to discuss our effective tax rate, investment portfolio and overall capital position. Rich?

Thanks, Chris. Good morning, everyone. The effective tax rate for the third quarter and the first 9 months of 2012 was 25% and 33%, respectively. The estimated annual effective tax rate was adjusted down to 33% during the quarter from 34.4%. This was primarily due to the effect of reducing our estimated taxable income for 2012 as a result of the FHLB debt termination expense incurred during the quarter. Now to our investment portfolio. During the quarter, third quarter of 2012, we provided approximately $247.8 million in overnight funds to the Federal Reserve and received a yield of approximately 25 basis points on collected balances. We also maintained about $70 million in short-term CDs and money markets, with other financial institutions yielding approximately 68 basis points. At September 30, 2012, investment securities totaled $2.3 billion, down $2.1 million from the second quarter of 2012. Investment securities currently represent approximately 36% of our total assets. Our available-for-sale investment portfolio continued to perform well. At September 30, 2012, we had an unrealized gain of $83.6 million, up from $75.1 million for the prior quarter. We have no preferred stock in our portfolio. Firstly, 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-backed issues, totaling $2.9 million. We have been strategically reinvesting our cash flow from our investment portfolio, carefully weighing current rates and overall interest rate risk. During the third quarter, we purchased $86.6 million in mortgage-backed securities, with an average yield of 1.97%. We also purchased about $52 million of U.S. government agency securities, with an average yield of 1.98%. Our new purchases have been invested -- investing in MBS securities with a projected duration between 5 and 7 years. We also purchased $3.5 million in municipal securities with an average tax equivalent yield of 3.30%. Finding bank qualified municipal securities that meet our investment criteria remains challenging but desirable. Now turning to our capital position. Our capital ratios are well above regulatory standards, and we believe they remain above our peer group average. Our September 30, 2012, capital ratios will be released soon, concurrently with our third quarter Form 10-Q. Shareholders' equity increased by $6 million to $754.2 million for the third quarter. During the third quarter, we redeemed the remainder of the trust preferred securities in CVB Statutory Trust I. We paid approximately $20.6 million for this redemption. This will save us about $600,000 annually. Now I will return to Chris for the closing remarks.

Thanks, Rich. Let's talk about the California economy. The California economy is improving, and unemployment is slowly declining. According to the state's Employment Development Division, the California unemployment rate stood at 10.6% in August 2012 compared with 11.9% in August 2011. And economic forecasters predict the rate will fall to 8.5% in 2014. Job growth during the last quarter, although still slow, showed steady gains across the state's major regions and was largely a result of improvement in sectors that were hit hard during the recession. A rebound in travel and tourism has lifted leisure and hospitality employment. Rebounding real estate markets helped the construction and financial sectors, and the coastal cities have seen employment growth due to a large concentration of technology jobs. California port activity continues to benefit the Inland Empire. Available warehouse space is declining and the region's in the midst of a slow recovery, somewhat hindered by the residual effects of the mortgage crisis, the Great Recession and the meltdown in government finances. However, according to local economists, the Inland Empire's geographic location, competitive cost structure, age profile and available land should make it one of the nation's fastest-growing population centers and Southern California's top jobs generator. Our dairy and livestock clients continue to experience a difficult operating environment. Milk prices are up compared with the prior 2 quarters, but high feed costs continue to put pressure on profit margins. According to the California Department of Food and Agriculture, data for the second quarter 2012, feed cost in California represented approximately 65% of total milk production costs compared with approximately 62.5% of total milk production costs for the second quarter of 2011. That ratio is an important thing to track. In closing, as we head into the final months of 2012, our strategic focus remains unchanged: quality loan growth, non-interest-bearing deposit growth, non-interest income growth, expense control and growth through acquisition. That concludes today's presentation, and now, Rich and I will be happy to take any questions that you might have.

[Operator Instructions] Our first question will come from Hugh Miller of Sidoti & Company.

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

What we see in the dairy industry is certainly the second quarter and most of the third quarter were difficult periods of time, as feed costs were still high and milk prices were lagging. But towards the end of the quarter, we saw milk prices go up and that's helped offset some of these costs. So we're looking at that ratio I mentioned in the call here, and look forward to seeing what that looks like going forward. So we're starting to see improvement in terms of the milk price side and that's helped offsetting what is a very difficult feed cost side. In terms of the overall dairies, dairies that tend to grow their own feed seem to be doing better, and -- than dairies that don't grow their own feed and have to purchase the feed out in the marketplace. And then there's a certain size to a dairy that needs to happen because there's economies of scale here in this business. And so we're seeing the medium to larger sized dairies that grow their own feed as being the ones that are showing the better results.

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

No. I think actually the -- beefing the cows is actually a good thing for the dairy business because it takes away the future production. And we are seeing more and more of that. And dairy men are looking at what their strategic alternatives are, from beefing their cows or selling their dairy farms, or converting things over to more of farming as opposed to a dairy farms, et cetera, all of the above. But you're absolutely right. A lot of the mill capacity, as that goes out, because people -- because dairy farmers will beef their cows is going to bring down the supply side, which is then going to help prices.

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

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

Our next question will come from Todd Hagerman of Sterne Agee.

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

Okay. And we -- one of the things on our $250 million payback of the 5 FHLB loans, we didn't do that until the very end of August, I think it was August 28 or something like that. And so we didn't get the full benefit of that margin pickup for the quarter. And so I think we're going to see hopefully, we'll see the effects of that -- I mean, we will see the effects of that, for a full quarter, in the fourth quarter. And the same thing on the -- obviously, to a smaller scale with the trust preferred securities that we prepaid of $20 million, which we anticipate will save us I think about $600,000. Anyway, so those are all just -- what we're trying to do is get our cost of funds as low as possible. And right now, we feel our cost of funds is kind of at a run rate of about 33 basis points for our total funding costs. I'd like to see that get lower, but we have to look at the trade-off between that and taking a big prepayment penalty on the remaining $200 million in FHLB yields. We are seeing more pressure -- we're seeing ongoing pressure, I should say, on our fixed rate commercial loans portfolio -- our commercial real estate portfolio. And so there are repricings that continue to go along in there. In most cases, we're getting prepayment penalties and we're extending some of those loans. So I think that's good from a stability standpoint, and we do pick up some income on the fee income side. But there's no question that we continue to reprice loans. And at the same time, as we're buying new securities to replace higher yielding securities, there's going to be pressure on that as well. So our objective is somewhere, and this is a ballpark, but if we were to pay back $200 million, the remaining $200 million in our FHLB -- on our remaining FHLB loans and the $40 million in Trust Preferred II, which is at LIBOR plus 2.85%, we believe our cost of funds will be somewhere around 16, 17 basis points for the organization. And so that's kind of where we feel the rubber will meet the road, so to speak, and after that, I just -- it's very difficult for us to lower cost of funds beyond it.

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

$31 million.

$31 million, right.

With $20.4 million as a pretax charge on that $250 million.

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

When we look at that $250 million, the average duration of that $250 million was 2.6 years. So when we saw QE3 and then hear Bernanke talk about interest rates and future interest rates, we don't think there's a lot of risk in interest rates going up that would really affect our decision to prepay that. And remember, when you're looking at $250 million and we're saving, call it 3.15%-ish, on that money for that 2.6-year period, it's basically a wash and maybe a little bit advantageous to us. The alternative to doing that is to keep purchasing securities. And to keep purchasing securities is -- we're taking interest rate risk on that side and we're having to go out, further out the curve to get yield. So this is all kind of a balancing decision. One of the things that we're very excited about, although we have to be cautious because it's not a robust economy, as we grew organically, our loans, by almost $50 million this quarter. And that's including our runoff on the San Joaquin Bank loans, a little bit downsizing of mortgage pools and all that kind of stuff. So we feel like we're starting to get some good traction there on the lending side. It's not -- I can't make any promises to anybody, but we are working our tails off on growing loans organically. We're also coming out with a new residential mortgage product here, next week, that we're going to actually do residential mortgages, probably more jumbos than not, for our clients and for various potential clients. And we're excited about that program coming out. And it really oriented towards lower loan-to-values and more the private banking sector.

Our next question will come from Aaron Deer of Sandler O'Neill + Partners.

I guess, just couple of small questions. One is the discount that you have remaining on the San Joaquin Bank portfolio, the, I think, $29 million. What -- you expect that to be fully recovered or do you expect there's going to be some offsets to that, as the performance in the portfolio is better or worse than expected?

At this point, that $28.6 million is not a huge number anymore. We were at one point, I guess, it's $200 million, is that right? $198 million or something, out of the gate. So we have had -- we've been 90% or 80%, or whatever it is, through the game here. And we've got another 8 quarters basically to -- until our loss sharing ends. So as we work down these loans, and that's why I kind of said, and our words, we'll gradually works through these things. The bigger, more toxic stuff that we're dealing with, with the San Joaquin Bank for the most part is done. There's a few loans here and there that we're still seeing what happens, but we've been through the wringer on that. And actually, we're in the process of -- we've actually downsized our special assets department by a few people here in response to that and we're going to be -- that will help us lower some costs, too. So we are -- we feel that it will be -- when we get to the end here in October 2014, we don't think there's going to be a big difference, one way or another, that's going to cause any kind of onetime this or onetime that of any substance.

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

Aaron, I mean, I can't talk about the conversations that are going on, but happy to talk about kind of our strategy there. And we are talking to different people and, really, a lot of banks, through intermediaries, have reached out to us as well. But the expectations and so forth are -- there's still a gap between the, what I consider is the sellers' expectation of what they want and what we think is reasonable to pay. And a lot of that is based on the trends that are going on and when -- what you guys are looking out as well is the difficulty in achieving increasing margins and dealing with decreasing margins for spread banks. And all these community banks are spread banks. And just to give you an example, we look at a bank, let's say, we're going to use this number, $500 million of assets and $200 million of those assets are in securities, funded by what we think are inflated deposits due to the fact that all the deposits have flown back into the banks. And so when we look at those securities, which most -- a lot of them have been recently purchased over the last year or so, there's not a ton of gain in there. So if we were to acquire that $500 million bank, what we would probably do is we'd have to flush out a lot of those securities because we wouldn't want to take the interest risk that's embedded in those, we take the small gain, flush it out, and we'd be left with a $350 million bank instead of a $500 million bank. So when we look at what we're paying for that, we've got to take that into account on the earnings side and then the multiple of earnings, which is really what we're focused on. I know the market looks at a certain multiple tangible book, but we're trying to see how much is -- what kind of earnings does this guy bring into our organization? What is the sustainability of that earnings? And then how could we scale their business up and cross sell our product into their business? Those are the factors we're looking when we make an -- or look at a prospective acquisition.

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

Yes, I think it -- when we look at it, we're definitely -- we want to look at the expense side of acquisition. Because it's hard to count on organic growth through these institutions and really organic growth in loans in these institutions, because the deposit growth isn't really meaningful right now. The loan growth is meaningful. And so when we look at these institutions, we say, okay, are they really growing loans, and what type of loans are they growing and are these loans -- what kind of interest rate risk are they taking when they do these loans, in terms, all right, 10-year fixed rate loans or that 5-year fixed-rate loans? So we're looking at the composition of the portfolio. And I think, as we look at those things, we have to be very careful about what it's going to look like in 2 years down the line. So in terms of what we're willing to pay for -- various institutions, a lot is predicated on that securities books, what we think of loan book and our ability to cross sell our fee-based products into those banks, meaning, we have our Wealth Management, Investment Services, Merchant BankCard, Cash Management Services, equipment leasing, vehicle leasing, a lot of these banks don't have those type of products and services. So we really are looking at the composition of their client. Is it a business client or is it a retail client? And we're really after the community banks that have more business clients because we can cross sell a lot of those products and services into them. And that's going to dictate whether we pay 1x tangible book or 1.5x tangible book. The good news is we're trading about 1.8x tangible book or maybe, I don't know, the last couple of days, 1.75x tangible book. But so it should be accretive to our earnings in a very short period of time. And really, I would say that we -- an acquisition has to be accretive to our earnings, coming out of the gate, especially in this kind of environment.

Our next question will come from Joe Gladue of B. Riley.

Most of my questions have been answered. But just wondering if you do give us an update on one, I guess, the sizable shared national credit that went into non-accruals last quarter. Anything new on that?

There actually is nothing new on that, which is a little frustrating. But it's a shared national credit, as you are well aware. Nonperforming assets in the second quarter, it's approximately $10.8 million, $11 million, somewhere in there, is that right, Rich? Okay, and the credit facility matures in June. And so that's -- we feel that's an important benchmark next year because the Lowell [ph Banking Group is not completely aligned with what we should do on this. We are driving to get 100 cents on the dollar back on its credit. And so we think there's enough there to get all our money back on it, but we shall see. It is paying interest. It is current on interest and so they are making payments and so forth, but it is deemed nonperforming due to the lack of -- it's a large construction loan. And hasn't leased up as quickly as anticipated, like so many of these large construction loans, development projects.

[Operator Instructions] Our next question will come from Brian Zabora of Stifel, Nicolaus.

A question on expenses. You indicated in the Q&A that you may get some cost saves, or getting some cost saves on special assets that have been downsized. But with expenses up a little bit in the quarter, do you feel like you're reaching the floor as far as your potential cost saves outside of credit related?

It's a delicate balance between saving money on one side and then reinvesting in our business in another side. So I don't know if we reached the floor. We did -- we just recently closed one of our locations in North Orange County. That's going to save us some money. We just did that in October, I don't know, 5 or 10 or something like that, just the first week of October. So now we have 46 business financial centers instead of 47. So that's going to save us a couple of hundred thousand dollars a year. So we're doing things like that all the time, but we are also reinvesting in the infrastructure of our company and in a lot of technology-related things because we're all seeing this world where cyber theft and everything going on, we're seeing attacks on the big banks. And if you'll see their online banking, it's got -- I think one of the banks had, big banks, had their online banking shutdown for a day or 2, or whatever it was. We're seeing a lot of more of that activity, too. So we are concerned about that and we're trying to stay ahead of the curve, and so there are software and investments that go into technology that will help us, number one, be more fluid with our clients in handling their banking relationships that they don't have to -- we don't have to have as much brick-and-mortar. So there's kind of a trade off going there. Less brick-and-mortar, more invested in technology, so I think those things will probably offset each other for the most part. But eventually, it will go down because, simply put, we're just not seeing as much foot traffic in our branches as we did 5 years ago. And we need to construct our branches, or reconstruct were branches, accordingly, so that we don't have as much brick-and-mortar and really, our branches are getting more and more focused to our associates and our employees and recruiting people and providing a good working environment, than it is for our customer, because our customers just simply are not coming into the bank as more. They're using online banking, remote deposit capture, ACH wires, you name it, to do a lot of the banking activity.

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

It's pretty broad based. And it's all in-market stuff and it's all just the typical stuff that we would normally do. We -- I think a lot of this is, is the result of our people just really focused on loan growth and getting out there in the marketplace. And we will -- we're out there to buy quality. And we don't want to take a lot of lending risk at this juncture because when you're lending money out at 4%, 4.5% or whatever the rate is, you just simply have to be right, pretty much every time, to make money. And so we're very focused on the quality side of it and then trying to manage interest rate side of it, too. And we've done some interest rate swaps on these loans as well. And you'll see, if you look at our financials, our -- we're going to have the best year ever, in terms of interest rate swap fee income in 2012. In fact, I think, we're -- right now, we're about $1.1 million in swap fee income this year, and I think our highest year ever was $1.1 million and we still got 3 months left.

Our next question will come from Don Destino of Harvest Capital.

You did a great job answering most of my questions and Aaron's question about M&A. I guess, the other question I'd ask since I have you is, what are the benefits of the FHLB payoff? I mean, are there any economic benefits? Is there any way that, at the end of this 2.5 years in which you would've had FHLB outstanding, that your tangible book value is higher because you paid it off than if you had not paid it off?

It's a trade-off and it's like, do you want to take your poison over the next 2.6 years or do want to take it right now? And I think there's a certain mentality in our organization that we want to be as efficient as possible. And we want to have as lowest cost of funds as possible and operate our business accordingly. I don't think there's a lot of risk in that $250 million that we have prepaid over the next 2.6 years. In terms of interest rates going up and us feeling foolish that we prepaid that debt now. But we're going to have to think a lot harder on this next $200 million because it has 4 years left. And it's harder to say -- it's harder for that extra one point whatever 4 years, or whatever it is, that's out there is something we've got to scratch our heads on pretty hard before we make that decision because it is a trade. That's it. It's a monetary trade-off. And if rates stay where they are, we'll be slightly better off paying it back now than we would paying it back over time. But if interest rates moved up, we could be a lot more foolish by doing this. And that's where that 4-year decision is different than the 2.6-year decision, and that's -- we're having a lot of discussions on it. But just to have the -- in the marketplace, just think -- you're running a business, we're running a business and we're looking out there and say, we're going to make loans out of the marketplace. Well, I feel more comfortable going to sleep at night knowing I'm going to make a 4% loan if my cost of funds for the organization are 16 basis points than I do if they were 50 basis points, like they were in the second quarter. So that mentality and buying quality and preserving our margin is psychologically important. But from a monetary standpoint, I don't think there's much difference.

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

No, I just think -- we have plenty of cash. Our cash position right now is, we paid off $250 million in FHLB debt by using our cash. And our cash position right now is growing back about the same level it was before we paid that $250 million. So we are accumulating cash very quickly. Our first desire is to take that cash and make loans, and grow our loans organically. That's the best thing that we can do, that's the best thing that -- for our organization in terms of yield and profit and the bottom line.

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

Yes, I guess so. I think that efficiency ratio -- we've done a lot to work on the denominator of that, on the expense side and so forth. And now, we've got to really work on the numerator, that we have to get income up. And so, ultimately, right now, what are we trying to do? We're working really hard to get our top line income growing. And right now, it isn't. It's still shrinking, and that's just the product of having $3.5 billion -- $3.4 billion in loans and $2.3 billion in a securities repricing on us, faster than to reduce our cost of funds. And so, the only way to do that is to make 4%, 4.5% yielding loans as opposed to buying securities at 1.75% or 2%. So that tick up, that incremental -- the gap between the yield on loans and the yield on securities is the largest we've seen it, at least in my 16-year tenure here at the bank. So that's why we're growing loans. It's so important because were buying securities at 1.75% or 2%, or whatever it is -- 2% on a good day, and going out a little further on the curve to do that, whereas if we go make a loan that's a 5-, 7-, 10-year fixed rate loan, we're probably going to get somewhere between 4% and 4.5% yield on that. Even if we make a variable rate loan, we're going to get a, for me, in the quarter, a 3.5% yield on that.

[Operator Instructions] The next question will come from Gary Tenner of D.A. Davidson.

Just had 2 questions. One, what was the average securities yield just for the third quarter?

Rich, do you have that number?

I do. I got it. Average security yield for the third quarter -- just mortgage is there. I have it in the spreadsheet.

Gary, in a minute, we'll get it to you.

Sure. Rich, while you're looking that up, I had a question, I don't know if you mentioned this, I may have missed it. Just the pop-up in comp expense in the third quarter. Was that kind of bonus accrual related, what was...

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

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

Hard to say. That's how we finished the year on the sales side and how we finish -- our bonus program for our senior leadership team is all tied to our performance. And based on earnings, how we control expenses, how we grow loans, how we grow our non-interest-bearing deposits and then our non-interest income. Those 5 components are really -- the senior leadership team is tied very much to those 5 components. The sales team is just based on their productivity of loans and non-interest-bearing deposits and fee income as well. So hard to say. We're hoping to finish strong. I'd like to be able to pay more bonuses. But I think that the expense side, we don't feel like we're increasing in expenses. We should be able to hold the line here pretty well. I think that whatever, $700,000 difference is -- hopefully, we're able to bring that back to where it was.

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

Okay. Including the overnight excess at the Fed, okay.

Included, that's a blended with the Fed funds sold, so to speak, 2.40.

2.40.

[Operator Instructions] At this time, there are no more questions. So I would like to turn the call back to Mr. Myers. I'm sorry, we do have a couple of questions. [Operator Instructions] We have a follow-up question from Aaron Deer of Sandler O'Neill.

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

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

And our best guesstimate for the fourth quarter is a 33% tax rate.

Okay. And then I know you mentioned you closed the one office but occupancy costs were a little higher in the quarter. Is that -- was there a -- like a lease charge on that so we can expect to see that come down in the fourth quarter?

Yes.

And our next question will come from Diana (sic) [Julianna] Balicka of KBW.

A quick question, couple of quick questions. Since the M&A, [indiscernible] difficulty because of the gap between buyers and sellers. Do you have any comment on buybacks or special dividends and how do defend this matter in your commentary?

We didn't talk about that. We still have, how many shares do we have available to buy back at this point, that's been approved by the board. I think we're 7.8 million in shares remaining to buy back. So that is an option we're looking at. I think one of the things that we're looking at is, again, trying to reduce our cost of funds. So when we look at our excess dollars and so forth, one of the things we will look at is the Trust Preferred Statutory II. We still have 40 million of that at LIBOR plus 2.85%. So I think that's going to be something we'll look at. We could look at buying back our shares, and we will continue to strategically think about that because we do have a lot of capital. But our preference would be to put our capital to work in an acquisition. And I do think that over the next quarter or 2, we're going to see reality checks for a lot of these smaller banks because we're feeling the pressure on the margin side. And we're doing what we can to lower cost of funds, and we still got a little gain to be played there on the cost of funds, to lower cost of funds, to the preserve our margins. But it's got to be brutal pressure on some of these $500 million in asset banks, $600 million in asset banks, a lot more than us because we do have a greater amounts of fee income, more economies of scale and a bigger depth to our business and product lines. So I think these depressed interest rates are going to give CDOs out there, smaller banks, a big reality check over the next couple of quarters because they've been allowed to have pickups because their nonperforming assets have improved. And so I believe there's a little bit of illusion that, hey, our income is fine, we're doing okay. But they're not going to get those pickups going forward on the nonperforming assets, and they're going to be living with the reality that their assets are repricing, their securities are repricing. And where are they going to go on the cost of funds side? And they don't have the fee income to help build them out of there. One of the things you see about the big banks is the Wells' and the U.S. banks and so forth, 50% of their income is fee income, community banks, a lot of these guys have, if they're lucky, 10% of income is fee income.

That makes sense. And may be as a follow-up to that, a couple of quarters ago you talked about expanding to west L.A. for example, some other geographies and in the current environment with a focus on greater efficiency on costs. If you are opening up new branches into new markets, is it part of the menu, or is that something that is on hold for the moment?

That'll be part of the menu. In fact, we just hired a new team to go in downtown Los Angeles. So we're excited about that, they just started about a week ago. Again, I told you we closed the branch and we're kind of closing and opening as we see things set to realign where we are to make us as efficient as possible. But sure, we'd love to be in all those markets, but it's got to be the right team and the right place. And one of the things that we have to look at is -- whereas if you ask me this question 4 years ago, to open up a branch or open up a new location, I'd say, boy, I want those deposits because I want those deposits to fund my loan demand and all of those things. But today, the deposits just aren't that important. So when you look at buying something and you look at -- they are important long run, I don't want to say they're not important, but they're important in the long run. But in the short run, we're flushed with deposits, we're really trying to manage our deposit growth and focus on just the sticky deposits. And if you look at our record here over the last year, our deposits are up about 17% year-over-year on the non-interest bearing side, but we're only up like 3% in total deposits. So we're managing our costs and we're managing the stickiness of those deposits. Because we know when rates go back up that a lot of these deposits are going to go elsewhere, and we got the focus on what we think it's going to stick here and build that long-term deposit base. But if you open up the new branch, in a new territory and so forth, some of those are going to be sticky deposits, but we really don't need them right now. What are going to do with them? We'll buy securities or put them overnight to the Federal Reserve. So it really has to be a loan-oriented team, it's got to be about driving asset growth when you're looking at it these teams or you're buying a bank, too.

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

Thank you very much. And we appreciate all of you for joining us today on our call, and we appreciate your interest and look forward to speaking with you again on the fourth quarter and year end 2012 earnings conference call, which will occur in January. In the meantime, please feel free to contact me or Rich Thomas and have a great day. Thank you very much.

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