CVB Financial Corp. (CVBF) Q2 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Second Quarter 2012 CVB Financial Corp., and its subsidiary Citizens Business Bank, Earnings Conference Call. My name is Mike, and I'm the operator for today. [Operator Instructions] I would now like to turn the presentation over to your host for today's call, Christina Carrabino. Ms. Carrabino, the floor is yours, ma'am.

Thank you, Mike, and good morning, everyone. Thank you for joining us today to review our financial results for the second 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 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 record earnings of $23.6 million for the second quarter of 2012 compared with $22.3 million for the first quarter of 2012 and up 12.3% from $21 million for the year-ago quarter. This is the highest earnings for a fiscal quarter in our company history. In fact, the 5 most profitable quarters in our company history are our 5 most recent quarters. Earnings per share were $0.23 in the second quarter compared with $0.21 for the first quarter and $0.20 for the year-ago quarter. Through the first 6 months of 2012, we earned $45.9 million, up 22% from the same period in 2011. Earnings per share were $0.44 for the 6-month period ending June 30, 2012, compared with $0.35 for the same period in 2011. The second quarter also represented our 141st consecutive quarter of profitability and 91st 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 3.77% for the second quarter compared with 3.69% for the first quarter and down from 3.92% for the second quarter of 2011. During the second quarter, 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 slightly down, primarily due to the financing or run off of higher yielding loans. We continued to benefit from loan prepayment penalties, earning $814,000 for the second quarter, compared with $431,000 for the second quarter of 2011. Now let's talk about loans. At June 30, 2012, we had $3.39 billion in total loans, net of deferred fees and discount, compared with $3.43 billion at March 31, 2012.…

Thanks, Chris. Good morning, everyone. Our effective tax rate was 34.4% for the 6 months ended June 30, 2012, compared with 33.8% for the first quarter. This increase was due to higher taxable income related to current earnings trends. Overall, our effective tax rate is estimated, and may fluctuate, based upon the ratio of taxable income to total income considering tax advantaged municipal bond income and nondeductible expenses. Now, turning to our investment portfolio. During the second quarter of 2012, we provided an average of approximately $256.9 million in overnight funds to the Federal Reserve and received 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 67 basis points. At June 30, 2012, our available-for-sale investment securities totaled $2.3 billion, down $113.2 million from March 31, 2012. Investment securities currently represent approximately 35% of our total assets. Our available-for-sale investment portfolio continued to perform well. At June 30, 2012, we had an unrealized gain of $75.1 million, up from $71.4 million for the prior quarter. Firstly, all 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 a relatively modest $3.4 million. We continue to strategically reinvest our cash flow from our investment portfolio, carefully weighing current rates and overall interest rate risks. During the second quarter, we purchased only $30.9 million in mortgage-backed securities as our average yield was only 1.6%. 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 under 5 years, to avoid material expansion risk as interest rates may rise in the future. We also purchased $6.5 million in municipal securities with an average tax equivalent yield of 3.17%. Money-backed qualified municipal securities, that meet our investment criteria, remains challenging but still desirable. At the end of the second quarter, we held $1.58 billion in mortgage-backed securities, and $634.9 million in municipal securities. Combined, these represent 98% of our $2.3 billion investment portfolio. Now turning to our capital position. Our capital ratios are well above regulatory standards and remain above our peer group average. Our June 30, 2012 capital ratios will be released soon, concurrently with our second quarter Form 10-Q. Shareholders’ equity increased by $18.3 million to $748.3 million for the second quarter. This increase is attributable to retained profits of $23.6 million an increase in unrealized gain-on-investment securities of $2.2 million, and $1.4 million for various stock-based compensation items, partially offset by $8.9 million in cash dividends. Effective June 17, 2012, we redeemed 50% of the trust preferred securities in CVB Statutory Trust I. We paid approximately $20 million for this redemption, and this will save us about $664,000 annually. I will return the call back to Chris for his closing remarks.

Thanks, Rich. Now let's talk about the California economy. Recent reports provided by local economists forecast continued growth in California, albeit slow, through 2012 and beyond. Most major sectors in California are growing again, and the recovery has spread from coastal areas to all parts of California, including hard-hit Inland region such as Riverside and San Bernardino counties. The industrial real estate market in the Inland Empire's East Valley, where many international companies have distribution hubs, is in full recovery according to real estate brokers. Leasing activity and empty office space absorption were strong in the second quarter, indicating that the market is continuing to stabilize. Employment growth in the public sector slowed in both California, and nationally, during the second quarter of 2012. The good news is that private-sector employment in California continued to rise and outstrip the nation in terms of year-over-year growth during March and April, the first time since March 2011. The dairy industry has been struggling through a period of industry downturn, which began in the fall of 2011, as a result of lower milk prices and higher feed cost. Although this downturn has continued into 2012, the downward trend for milk price futures appears to have reached bottom in mid-June. According to the Daily Dairy Report, milk futures are increasing from $1 to $3 per 100 weight for the months of July 2012 through 2013. U.S. exports of nonfat dry milk and skim milk topped 100 million pounds in May, which is the highest volume since October 2010. In addition, the growing popularity of Greek-style yogurt is now expanding beyond processing plants in New York State as construction has started on the first new plant in Idaho for this product. Feed prices have continued an upward trend as drought and high temperatures in the Midwest continue to impact corn production. Despite the recent lower forecast in weather conditions, the National Corn Growers Association reports that adequate amounts of corn will still be available to the market until the new season, which commences in October 2012. The full effects of the drought are yet to be determined. Financial results for our dairy portfolio were mixed for the first quarter of 2012, with many customers still showing profits despite the downturn. It seems that the most profitable dairy farms tend to be the larger operations with the capacity to grow their own roughages for feedstocks. In closing, we are pleased with our strong second quarter results, it was the most profitable quarter in our company's history. We attribute our continued success to being selective with our clientele, our focus on relationship banking, our strong credit culture and conservative nature and a very solid capital position. That concludes today's presentation. Now Rich and I will be happy to take any questions that you might have.

[Operator Instructions] The first question we have comes from Todd Hagerman of Sterne Agee.

A couple questions for you. First, Chris, just in terms of the spread income and the margin this quarter. Obviously, you had a benefit from the NPLs coming off. I'm just wondering if you'd talk a little bit about just how we should think about the margins going forward. If I think about the core margin at 3.67%, you have the TruPS redemption with the cost savings there. Certainly, you've consistently said that it's really a function of improving your loan growth. I'm just wondering, a, what's the outlook in terms of the NPLs coming off, in terms of another benefit in the coming quarters and just the dynamics between your loan growth versus -- you purchased securities at 1.6% this quarter and then the TruPS redemption. How should I think about margin with those moving parts in the spread?

Honestly a good question and everybody is very focused on our margin, and as appropriate. The margin has a lot of moving parts to it. And in general, I can tell you this. Our loans are repricing, and when they're repricing, they're going down. And our securities are repricing, and when they reprice, they're going down. Our cost to funds is going down as well. And historically, I think over the last year or so, things have probably parallelled each other, but our cost of funds, it's going to be difficult to decrease that as fast as that top line income is going, given our asset level stay proportionately the same. And that's why loan growth is very important. However, when you look at nonperforming loans, in fact, let's look at the second quarter. Yes, we did have some loans that we got paid off on and we captured some interest income and we said that was 10 basis points. But remember, this $10.9 million loan that this national shared credit that I talked about, remember, we also took the last 90 days of interest. And by the way, we are getting paid interest on that loan, it just became nonperforming. We put it on nonperforming for various reasons. But that interest that we've got in the 90 days was wiped out, and then that goes down to paying down principal, right? Once it becomes a -- once a loan becomes a nonperforming loan, any interest paid on that goes to principal, it doesn't go to interest. And then, someday if we get paid off full in that loan, that interest comes back in the interest income. And so that's what happened in the second quarter in terms of that 10-basis point stuff. But also, we had that $10.9 million…

Okay, that's helpful. Like you say, there's a lot of moving parts. But again, it's still seems to be the function to loan growth improving credit. But again, you've got the pressure on the earning asset yield and you've got to offset that.

One thing, Todd, is -- let's look at our NIM for the past 4 quarters. 3.81% for the third quarter of 2011, 3.62% for the fourth quarter of 2011, 3.69% for the first quarter of 2012 and 3.77% for the second quarter. So despite the fact there's been some bouncing around, we're still operating within a 20-basis point range over the last year.

Now, that's fair. And then just secondly, just on the expenses. Obviously, that's always been a focus and a hallmark of the company. I'm just wondering if you can just kind of give us an update, again, just in terms of some of the efficiency initiatives. Again, as you mentioned year-over-year that the costs are down sequentially. I'm just wondering some future projects to think about, whether it's brand consolidation or the like, that perhaps we haven't yet seen in the numbers.

Yes. We have a lot of initiatives going on and they're starting to be vetted through here. You're starting some of the good results and that's why our expenses are down. For instance, one of the things we're looking at is being as efficient as possible on the occupancy side, with our leases and we're actually closing an office in North Orange County and consolidating that within -- we have 3 offices within a 4-mile range at each other. We're closing one of those offices. We'll get some savings from that. We're consolidating another operation that we have in the bank. So we're picking up things here and there. If you look at our occupancy expense, for instance, from the first quarter to the second quarter, we're down $350,000 quarter-over-quarter on occupancy expense and down almost $400,000 from where we are at 12/31, 2011, on a quarterly basis. So let's say we can run $400,000 less than we did a year before, that's $1.6 million in saved expenses right there. We've talked about professional services, which includes legal bills. We're down $288,000, quarter-over-quarter, in terms of professional services expenses. Last year, that was running tremendously higher. So a lot of that is the function of improved credit quality and also the function of the SEC and shareholder litigation, and those legal expenses associated with, are dramatically drown. And we're also going to see some more reimbursements on that side because our insurance is kicking in on those legal expenses for the shareholder lawsuit, derivative lawsuit and we're also going after monies that we've spent in the past on the SEC lawsuit, because it's all tied together. So those are some of the things. We also have -- we're looking at things like our printing charges in the bank, our courier charges in the bank, how much money that we're actually paying on behalf of our clients. We're trying to leave no stone unturned in terms of our expense side. But we have to be smart about what we do, too, because service and long-term relationships are paramount to us. So we do want to get penny-wide pound foolish.

So based on that, it sounds as if, again, expenses could actually continue to trend modestly lower over the balance of the year given these initiatives. Is that fair?

Yes, we've always tried to drive that. You saw our efficiency ratio this quarter at 44.63%, I think it was. And in my mind, my goal was to be at 45% at the end of the year, and we've kind of already achieved that goal. And the question is, can we even drive that lower? And I'm hoping the answer is yes, but I can't make any promises there. But we've got to do this in the right way so that we are not cutting off any offense from the bank, because we're still on offense. But yes, we can get lean and mean. If we look at our customers, our business customers, they're doing the same thing in this economy right now. We're all in this sluggish economy and we wish we had a more robust growth environment. But right now, the best companies are really looking at their operations, looking internally and how they can be more efficient without cutting off their offense.

And the next question we have comes from Hugh Miller of Sidoti & Company.

First question I guess, was just with regards to -- you gave us some color on the local economy. I wanted to hear what you're hearing from your business clientele regarding demand for loans. Any products? Obviously, we saw an improvement in C&I with some pressure on the CRE. But what's kind of the appetite for borrowing that you're hearing from your business clients? And is there any chance for a meaningful improvement in the horizon here?

It's still sluggish. I think a lot of our borrowers, they're looking at refinancing their debt, trying to get as efficient as possible in their costs. We are seeing some activity on the M&A side, bigger companies buying smaller companies, managers buying out other minority managers in their company that have smaller shares. So we're seeing a lot of that consolidation type of stuff and efficiency type of things that you expect. And we are getting some new loans from that. We've seen a few good deals lately, that are kind of M&A-oriented, where a company is buying out another company or one of the principles is buying out another principal or something like that. So we're seeing some activity there. But most of our customers, if you sit around at their table, which we do quite frequently at lunch and different meetings, and ask them what's going on, they're saying, you know what, we're cautious in our optimism and we are looking at the whole world, right now, and we're trying to be as efficient as possible in the way we manage our business. In terms of expansion, the risk reward, I don't think is robustly there for them to really want to take a lot of risk in expanding their business unless they're sure they can bring some good money to the bottom line. Because when you look at the cost of health care, the uncertainty about taxes, what's going on with the European debt crisis, what's going on with the state of California, and all these things put together, workers' compensation insurance is starting to creep up a little bit. Business owners are concerned about all these factors. And the good news is most of these businesses have gotten through the tough stages here and they're hunkered down and they're waiting for their opportunities to seize the day, just like CVB Financial is waiting for the opportunity to seize the day. But it's just not quite there yet. So what we're doing is being as efficient as possible, just like our customers, and we're going to try to pick up some opportunities here and there. So I think, in a nutshell, that's about it. Our loan demand is better than it was a year ago, but still not where we want it to be.

Okay, great insight there. And the follow-up question is just with regards to looking at the other opportunity to leverage your balance sheet. And can you give us an update on M&A landscape? What you're seeing there? What kind of -- at this point, what's holding you back from pulling the trigger on something?

Well, we're actually in a lot of discussions with a lot of different financial institutions, and financial institutions actually reach out to us quite often. And because I think they look at our stock and see that it's got some activity to it and we've got some trading volume that goes on. A lot of these smaller banks don't have that. Their stocks are relatively illiquid. So that's compelling for them. But I think there's a differential in the price expectation of what we think things are worth and what a lot of these different principles of smaller banks think their bank's worth. In a nutshell, I look at these banks and I say, are they really going to be worth more to me, a year from now or 2 years from now, than they are today. And given the sluggish loan demand and the lack of loan growth in a lot of these different banks, and the prospects for lower yield on earning assets in terms of loans and securities, and the inability to reduce cost or cost to deposit that much more than already has been done. Those are all factors that go into my belief that a lot of these banks aren't going to be worth anymore money a year or 2 from now. So how do you pay them a multiple on earnings growth and so forth when you may not see that earnings growth. The earnings growth coming out of these smaller banks are really oriented towards improving in their nonperforming assets and recapturing some of the income off that. It's not as much on the offensive side. So that gap between what the projected income could be and what I think it might be, given the environment we're in, is I think not only prevalent for our bank but a lot of different banks and why you're not seeing more rapid consolidation of medium-sized banks like us buying smaller banks.

The next question comes from Aaron Deer of Sandler O'Neill & Partners.

Just, I guess, kind of maybe a follow-up question from the M&A discussion on capital. Share buybacks, you were active with them for a little while in the back half last year, but we haven't seen much so far this year. If it sounds like it does, that M&A just isn't going to materialize, given the price expectations, might we see that come back on the table?

Well, it potentially could. But we're not giving up on the M&A side. We're pedaling the bicycle hard. We meeting with a lot of different people, but it just hasn't happened yet. But we're not going to force something there either. We're not an organization that we feel cannot grow organically. We can grow organically, and we will grow organically. I mean, certainly that's my goal, right? And we've been doing tremendously on the side and not on the interest-bearing deposit side but on the noninterest deposit side. And you've seen our fee income growing, too. So we're accomplishing a lot of good things, just hasn't translated into loan side. When you look at our loans, I do want to address this, because if you look at our loans over the last -- let's flashback to June 30, 2011. Our total loans, net loans in the bank, were $3,430,000,000. And today, we're at $3 billion -- or at the end of June, we're at $3,293,000,000. That's a decrease of roughly $130 million, what is that? $134 million, $137 million-ish. If you look at that, on non-recovered loans, we're only down $12 million. It's all in the covered loans area or the vast majority of it is in the covered loan area. So I know I've been using that excuse here, because we've had to deal with these covered loans and the downsizing them. But our loans are pretty much flat, year-over-year, on the non-covered side. So we're close, we're close to growing loans and we're pushing pretty hard on that.

That's great. And then just a credit-related question. I notice the TDRs ticked up just a bit. What's it going to take to start seeing some of those move back to just regular performance status? I recognize that they're performing, what's going to bring them off TDR status?

Yes, I think when we look at these TDR's, we're not in the 2002, 2003, 2004 economy, where there's no new nonperforming assets coming online and there's not anymore negotiations with people about restructuring their loan or helping them out by giving them a 6-month interest-only period to help them get back on their feet or lease up a property or stuff. We're still dealing with a lot of that. And that's causing the slight uptick in troubled debt restructured loans is that we're still feeling a little bit of that sluggishness in the economy and having to help clients work through situations. But what we are seeing is a lot of firming up of the appraisal values of these properties, appraisals that we're seeing now, and it's not across the board, but quite frequently, we're seeing appraisal amounts that are actually at the same level, or higher, than they were a year ago. And that's a good sign. So as we're reappraising property, we're not having to further write-down most of these things. In fact, were having an uptick in appraisal value and that's kind of an interesting dynamic on the other side of it. So I do think that our TDRs are -- they could creep up a little bit more. It's hard to tell because we're just dealing one by one by one of these. And a lot of these TDRs are clients that we want to keep. So we have some good borrowers that we had to help through a situation, that are doing well, and we've restructured their loan and they're in a good place right now, whether we gave them a temporary restructure of x number of months interest only or had to extend their amortization longer than it was before. But a lot of these TDRs, we feel don't have loss content in them.

Next we have Tim Coffey of Fig Partners.

Chris, I wonder if you can kind of talk to me about the cash position that you're holding in the bank. It seems to be elevated and I'm wondering if there's any reason that you're holding that high.

Great question. And our cash position is a challenge for us because if you saw this quarter, we bought 30-something-million, what was it? In mortgage-backed securities, in CMO, $31.6 million, is that right?

$30.6 million.

$30.6 million in mortgage-backed securities and CMOs. Now that's not enough to cover that we're having, of our securities portfolio, on a quarterly basis. So the reason we didn't buy more of those is because of the 1.6% yield. Typically, we're buying 15-year mortgage-backs, and I think that had an average life of 4.9 years, and we're getting a 1.6% yield on it. It's gut-wrenching, right? So what we're trying to do is we'd rather grow loans, we'd rather find an alternative and we'd rather look at some other alternatives than that. So sometimes when the price ticks down, we're hoping the price ticks back up. One of the things that we've been looking at buying right now are SBA guaranteed loans, which are actually the securities of SBA guarantee loans, which yield a little bit over 2% and provide, I guess, is it a 0 risk?

A risk weight factor.

It's a 0 risk weight factor, so it's fully guaranteed by the government. And right now, that gives us a little bit more term risk because the average life of those is 7-plus years. But buying some of those, we get a yield of 2.10% or 2.20% or something like that. So we're shifting away a little bit, from the mortgage-backed agrees and CMOS, and starting to buy those SBA securities, if you will. Even though the duration is a little bit longer, they're 20-year loans that fully amortize. So we're capturing a lot more cash flow in the last 10 years of that than the first 10 years of that. But we'd much rather grow loans, but loan pricing competition is tremendous as well. It's a real fun environment.

My follow-up question, that is, given the cash position, given the struggles you're just talking about and your capital position. Have you thought about increasing the cash dividend at all?

We do talk about that at our board meetings and we have had those discussions, but so far we've just elected not to do it. Typically, the board meeting that we're talking about, our dividend is the board meeting in the month prior to -- well, actually, the month of the close of the quarter. So we talk about that in June and September. So it'll probably be September before we talk about that next.

Okay, next question we have comes from Julia Balicka of KBW.

I want to ask a couple questions. One, could you talk a little bit about what's going on in the San Bernardino area, with the city bankruptcy? What kind of impact, if any, direct or indirect, we may be seeing at CVB?

Okay. And why I don't address the -- there are 2 cities that have actually declared bankruptcy in the state of California so far, there's Stockton and there's Mammoth. And the City of San Bernardino has not yet declared bankruptcy, although the city council has approved it. But yet officially, they haven't been bankrupt. As far as our exposure to those 2 cities, City of Mammoth and the City of Stockton, it's nominal. We do have some relationship with one of those 2, but our loss exposure, we feel, is very minimal or nothing. In terms of the City of San Bernardino, we do have a relationship with them. We also feel our loss exposure with the City of San Bernardino, should they go bankrupt, is nominal, if at all.

Okay, great. And then also, I wanted to follow-up on the loans that you sold this quarter, the held-for-sale group of loans. What was the collateral on those?

These are our church loans, right, Rich?

Yes, they are.

What happened is San Joaquin Bank had a church lending program, which is I think a tricky lending area. I'll be diplomatic on that. And these church loans were not only located in California, but they were located throughout the nation. And so we, for the past year, have been pressing hard on the FDIC to allow us to sell these loans as opposed to having to go foreclose on these loans throughout the country, because it's going to be a difficult and expensive thing to do and you may not get to the finish line when you're going into Louisiana to foreclose on some local church. So we sold these loans. And, Rich, do you have the numbers as far as the gross loan balance, where they were marked and what we actually sold them for?

I do, Chris. The growth loan balance, Julianna, was about $17.6 million. We had a mark on those to where we were carrying those and held-for-sale on our balance sheet. That balance was about $3.7 million in the held-for-sale on the balance sheet. We actually got net proceeds on that sale of $5.9 million and we recognized a gain of about $2 million on that.

But the gain, remember, the gain is then shared back in another category because we only keep 20% of that gain.

It's included in the decrease of the FDIC receivable line item. So it's about $1.8 million, that $2 million went back to the FDIC as a sort of a recovery for their loss that they've guaranteed us with the loss-share agreement.

So all of that work for measly $200,000 for us. But anyways, that's the negative side of these FDIC-assisted acquisitions, is these loans you're working on, you're killing yourself to work these things out, and at the end of the day, there's just not that big of a differential between if we lose a little or gain a little bit, it's just what category it's going in and out off. But it's good to get those off the books because we don't have to now work those, what was it? 11 loans or something like that?

11 loans.

11 loans. We don't have to work those 11 loans and have a special asset person or persons dedicated to dealing with all those things.

Next we have Brian Zabora with Stifel, Nicolaus.

Question on C&I, was the increase due to increased loan utilization or an extension of new credits?

New credit. I think our line utilization is still sluggish. I think a lot of these companies are hunkering down and they're making a little bit of money and they're paying things down. But no, we have some good new business volume on some deals on C&I, and we're working really hard there. But again, it's a lot of effort for not as much results as we like. But hopefully that a lot of effort will pay out in the long run.

Can you give a sense of the loan pipeline, maybe at the end of the quarter versus first quarter?

I'd say the pipeline is fairly flat. Maybe a little bit up. I mean, we've got some good -- we have some really good pipeline in the second quarter. But remember, if you look at our non-covered loans quarter-over-quarter, we, on a discounted basis, this just means net of our discount, we were down $36 million during the quarter. So $36 million of our decline quarter-over-quarter was due to the FDIC covered loans, not due to the non-covered loans. And when you look at -- if you really look at the non-covered loans quarter-over-quarter, we're only down $8 million, and that was a function of really the -- a slight decline in the dairy, the continued rundown of our mortgage pools and then some decline in commercial real estate, which is loans that are paying off because of a refinance or something like that, and we're usually capturing prepayment penalty fees on those.

And just lastly, you recently hired a new head of commercial banking. Give a sense of what that means and maybe what that means as far as adding additional lenders.

Well, we've hired a whole -- we've hired several people in the commercial lending space. We hired a new asset -- a new head of asset-based lending for us, who has just joined us in the last couple of months and came from a larger bank here based in Los Angeles. I won't say what bank. The head of our commercial banking, I've got to do a redo on that. He actually went back to its existing -- his former company, which is a little bit of an embarrassment, but it is what it is. But we're still building out the C&I and -- we have good internal C&I people. 1.5 years ago, we also recruited in a Deputy Chief Credit Officer who's a real C&I guy. So I think we've got the infrastructure in place to really grow this, and now it's about recruiting the right teams in who could help us do it. But we still have pretty good teams internally that have done a good job. It's just that we'd like to pick up the pace.

The next question we have comes from Gary Tenner of D.A. Davidson.

Just had a follow-up question regarding the securities reinvestment, you talked about buying some of those SBA-guaranteed loans. Do you think that you might be purchasing or just reinvesting between securities and SBA enough in the third quarter to offset runoff or would it be more than that to eat into the excess cash position in the third quarter?

Well, what we're trying to do is to keep our cash position between our money that's going into FDIC and our deposits. We have about $60 million, is that about right, Rich?

Right, yes.

Deposits that we have with other financial institutions, that we have an average yield of what was it? 60...

67 basis points.

67 basis points, which is kind of interesting, right? But they're quality financial institutions, so neither here nor there on that. So between those 2 areas, we target around $300 million in cash is what we're looking to carry right now. At the end of the fourth quarter, we were higher than that. In fact, we're over $400 million. So we probably will try to work that down. But if rates are just so low it just doesn't look compelling then we will keep a little bit more cash there even though we're getting 25 basis points overnight, and we'll keep it shorter and wait for an opportunity to jump in where we get better higher yield if the market turns. So that's the objective, but we can't keep accumulating cash. We don't want to see that cash get up to $500 million or $600 million. It just simply is something that we need to manage very closely. But if you look at our overall deposits, we really haven't grown our overall deposits, and that is on purpose, right? I'll tell you, and I said this to several of you, maybe independently. If you can fog a mirror, right now in the banking business, you can grow deposits. The question is what's the quality of those deposits? What's the cost of those deposits? And what's the stickiness of those deposits when rates go back up? So we are really refining our game as much as possible to just bring on what we think are sticky deposits that are high quality, that are low cost. And usually, that's non-interest-bearing deposit, and that's why we're sitting at 48% non-interest-bearing deposits right now.

Okay. And then, Rich, I don't know if you mentioned it, I may have missed it. What was the non-covered loan yield this quarter versus the first quarter?

I don't have that right at my fingertips.

The non-covered loan yield on -- I don't know that I have that here.

I don't have that right in front of me.

Okay. I thought you may mentioned it when you were running through some yields earlier but I thought I'd missed it perhaps.

In one of our 40-piece charts that we have in front of us. I know it's in there. But we can get back to you on that.

Next we have Joe Gladue of B. Riley.

I wanted to follow-up a little bit about the C&I segment. I heard from some other bankers that competition is very tough and there's some banks going out there offering extended terms on -- at these low rates. Just wondering if you can comment a little bit on the competitive environment and how long you're willing to extend loans out and what types of terms and rates you're getting on your C&I loans right now.

Well, Joe, thank you for the question, but I have to be a little careful how I answer this because I can give information to my competitors that I don't want to give. So I will be a little bit guarded in my remarks. But there's no question it's competitive out there. We are seeing reduced prices particularly in a quality dairy loans. And in some of those, we're seeing price competition for the strong dairy loan and rates, if anything, are going down in that segment. Not the okay dairies and not the lousy dairies or the ones that are just performing mediocre or are performing poorly, but the dairies that are performing well. There's no question that there's a lot of price competition. And I think that's the same thing on the commercial and industrial side, is that if it's a good deal, it's a good company, the pricing can get very competitive. And we are seeing extension of duration in some of those commercial loans. And typically, we'll want to see a 5-year amortization on a commercial loan if it's a term loan, and that can get extended in this kind of environment, on a C&I term loan. As far as our ability to compete, our cost to deposit and our efficiency ratio is pretty much as good as anybody in the game. So I think we can buy quality all day long, but at these rates you just can't take a lot of credit risk. So the guys that are doing crazy things and unnecessarily giving away guarantees and doing some other things to win business, that's not going to be our game. So we may miss some opportunities along the way because I'm not saying we wouldn't give up a guarantee on a loan but it's got to be for the right borrower, the right situation. But typically, we want to guarantee from that borrower. These are closely held, family-owned, privately held businesses and they should be supporting our businesses -- we should be supporting their business.

[Operator Instructions] The next question we have comes from Don Worthington of Raymond James.

In terms of the investment portfolio, the unrealized gain, would you plan on harvesting any of those?

It's extremely tempting. So I think we're over $75 million weren't we, Rich, for the quarter?

$75.1 million.

$75.1 million. I think about 60% of that is attribute to the municipals and 40%, the CMOS and mortgage-backed. I don't know that we would never say never on that, but we'd have to figure out, okay, what we are going to do with those proceeds? And that's a big question. And it's potentially -- we could look at paying down FHLB debt, prepaying our trust preferred. We have some trust -- we still have $60 million in trust preferred at LIBOR plus 3.25%, 30-day LIBOR plus 3.25%. That's right, Rich?

90-day LIBOR plus 3.25%.

Right. So those are all potential things that we could do if we were to harvest some of those gains. I think if we were to harvest any of those gains, it would be held in mortgage-backed and the CMOs and probably not in municipals, because we're looking for good municipals all day long. And we've been able to be pretty successful, knock on wood, in buying the right municipal securities along the way. So I would say, never say never, but it's not -- we're searching for yield and searching for quality. And unless we feel that we're going to lose money somehow by not selling these things or we have a great opportunity to redeploy the money somewhere else, I don't know that it's a front burner of things for us right now.

Okay. And then any update on the SEC inquiry?

The ongoing SEC investigation and so forth. So let me give you a whole update on the SEC and also the shareholder lawsuit. So on the SEC, the investigation is almost -- has been pending for just about 2 years. I think it was announced in early August of 2010, so almost 2 years into this. We and our counsel have fully cooperated with the SEC staff and we'll continue to do so to the extent any further information is requested or we have further conversations with them. And last, we've received no indication from the staff as to when its investigation will be concluded formally or whether if there's any additional information will be sought. There's really not much going on there. In terms of the shareholder lawsuit, we advised everybody last quarter that in January 2012, the federal judge and the class action dismissed the plaintiff's initial complaint because it did not meet depleting thresholds under the Private Securities Litigation Reform Act. But as we expected, the judge gave the plaintiff's leads to file an amendment complain, which they did. And then the plaintiff filed their amended and restated complaint in February, and we filed our motion to dismiss this amended complaint in March. The federal judge held a hearing in early June and we believe this went well for our side, but both sides are currently awaiting the judge's ruling and order now that the and arguments are complete. And this is based on the amended complaint again. We intend to continue to vigorously contest the plaintiff's claims, which we believe are entirely without merit, as long as the action is allowed to continue, which we can control. In the meantime, the companion state court derivative shareholder action is on hold until September, and that's really going to be a product of what happens with the shareholder's lawsuit. Well, that's pretty much all I got for you on that, but we feel very good about where we are. We feel very confident in our litigation suits, both with the shareholder and the derivative side. As I mean, simply look at our numbers, look at our performance, and in my humble opinion, we did a good job along the way here, in a very, very difficult situation, difficult economy and the way we handled the vast majority of our credits. So here we are, and I wish I had that magic answer for you saying that the SEC went away and they closed this investigation, but that's really beyond our control.

The next question we have comes from Eric Goblewitz [ph] of Hollander Bank Holdings.

That shared national credit that you talked about earlier in the call, I didn't see any detail on that in the press release. Did you say that was about a $10 million credit? And can you give us any other color as to the industry and whether to have an exam-related item for World Bank?

Yes, I'll be happy to do that. The credit is roughly $55 million or $50 million, $55 million in aggregate. We have a 20% participation in that. It's a construction loan on a retail property. It's agented by a major bank, one of the 10 largest banks in the country. And then 2 of the 10 largest banks in the country are both -- one is the agent, one is the participant. There are 4 banks total in the whole deal. And we have a 20% participation level, so our exposure is $10.9 million.

So was that because the lead decide to classify it or was it driven by a snick exam-related issue?

The latter.

Okay. That's what I thought.

One thing I want to talk about, which I think you analysts should look at along the way here. Because I always say this to Rich, on the accounting side, and I think he looks at me and smiles and shakes his head. But okay, so let's talk about this credit that we had, this $10.9 million credit that we have as a participation. We have this graded, internally, as a substandard credit, and we reserve against our substandard credit typically somewhere between, call it, 5% and 15%. On all our substandard credits, we typically have a reserve of 5% to 15% of the actual loan amount. So what happens is when this credit actually becomes nonperforming, we have to do an impairment analysis. And so the impairment analysis, based on what ultimately is the value of the property and et cetera, et cetera. Well we do the impairment analysis then we take our most recent appraisal or take the most recent appraisal conducted by the agent of this credit and we have 0 impairment for the second quarter. So now, what I had was -- previously, I had a 10% or 15% reserve allocated for this credit, and now impairment comes through and the impairment analysis shows we have 0 impairment. So we're sitting there, I felt a lot more comfortable having my substandard reserve against this than I do have 0 impairment. So what you're seeing is that you look at our loan loss reserve and our loan loss allowance, and you're seeing, as we go quarter-over-quarter, we have more and more unallocated reserves. And that unallocated reserve is kind of based on stuff like this, where something goes from substandard when I had a reserve to nonperforming and I want to kind of keep a reserve in there, but legally and accounting-wise, we can't do that, so we want to increase our unallocated reserves for the unknown factors. And whether those unknown factors or European debt crisis or a credit that we only are 20% participant in, which we're not really controlling in terms of the decision-making or what's going to happen with this. I mean, we'd like to put the pedal to the metal and sometimes the agent so forth aren't quite as aggressive as we would be. So that's the kind of a strange thing that goes on here, but we're thinking carefully through those different things. And that's why you're seeing our reserve. Why we're not adding to our reserve, you're seeing us not eviscerate our reserves or release our reserves because of these kind of moving parts that are out there that we want to make sure that we're covered for, whether it's the European debt crisis, California economy, city bankruptcies that are accelerating in California. Whatever it is, we want more and more unallocated reserve to cover the unknowns.

That's great. And then just a follow-up on Don Worthington's question about the securities portfolio. Maybe the other side of that, the MBS, it looks like you've got $33 million pretax gain. On a balanced basis, it looks like it's about 2 points. How does that compare to where you are in those securities above par? What I'm just trying to understand is what your potential risk is if prepayments accelerate and you not only lose the nice gain you have but also any premium you may have paid for securities as well.

What we do, Eric, is we, on a monthly basis, we look at a number of reports that are out there, CUSIP specific about prepayment speeds. We go through the entire portfolio, CUSIP by CUSIP, look at the CPR, PSA rates and we modify our amortization of those premiums accordingly. So, I mean, we're very active. And then I would tell you that in addition to that, we have guests that come in every other month to our full board, to our balance sheet management committee, and we have nondisclosure agreements with these individuals or individual companies, and they get a tape drive, of our portfolio and they do the same thing and look at prepayments and potential prepayments and where accelerations might be coming down the road in the next 1, 2 months. And so we're looking for third-party sort of verification of the methodology that we use to solidify the, I guess, the sanity of all the exercise that we go through. We continue to look at Bloomberg screens and we look at other services that are out there, that we engage to help us monitor on a go-forward basis, our MBS portfolio, for exactly that reason.

I don't know if you can be specific or not, but if you looked at the portfolio in aggregate, are you in this like 1.04%, 1.05% in a portfolio that's marked like 1.06%, 1.07%?

We do have premiums, Eric, in our portfolio, but those premiums are being amortized over what we anticipate the average lives of those securities, and we continue to adjust them. I don't have in front of me exactly what the net premium-to-total portfolio is at this point in time as far as a ratio, the 1.02% or 1.05%. But we try to be very conservative on our amortization of those premiums based on all the scenarios that I just painted for you earlier, and make sure that we're amortizing those premiums over the shortest lives as we need to.

One thing to add to that, it's -- all these things are built into the price of the security, right? So for us to try to say, you know what, we're expecting faster prepayments speeds to happen. Well, in a perfect market economy, that should already be built into the price-backed security. It's a little bit of a guessing game there, and we're very fortunate to have a very strong person who runs our treasury group and has been managing this for several years for us. And we have great advisers, too, not only do we have the advisers of some of the nation's best investment company that come in here every other month to present us on these very things, but we also have a consultant. We used George Darling as our consultant. He comes in quarterly and kind of gives us a whole evaluation of our balance sheet and our interest rate and our exposure and all those type of things. So we've got a lot of things that we're listening to. And there are people who come in and say, listen, we're anticipating faster prepayments speeds and advising us on these different things. So we are looking at exactly what you're talking about. But one of the things that we've got to project is how much of that is already built into the securities, and is there really something in there that we could make something better off. And then what did we do with that money? Right now, we're floating in cash like crazy, and I'd love to prepay some of our FHLB debt, but boy, that is huge prepayments on that stuff. I mean we roughly have $450 million in FHLB debt. And my guess the prepayment penalty all in is going to be over $40 million on that portfolio. But we also have $60 million of our roughly $85 million, $87 million in trust preferred left that's sitting in there at that LIBOR plus 3.25%. So that's something that we may chip away at as we did in the second quarter. We paid down $20 million of that and that's going to save us $664,000, and we may look to continue to do that because we want to get as lean and mean on the cost side and the funding cost side as we can.

Well, at this time, there are no more questions. I'd like to turn the conference back over to Mr. Myers for any closing remarks. Sir?

Okay, thank you. Well, thank you very much, everyone, for joining us on our call today. We appreciate your interest and look forward to speaking with you again on our third quarter 2012 earnings conference call in October. In the meantime, please feel free to contact me or Rich Thomas, and have a great day. Take care.

You too, sir. And we thank you and the rest for the management for your time. The conference call is now concluded. At this time, you may disconnect your lines. Thank you and take care.