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Edited Transcript of CVBF earnings conference call or presentation 25-Jul-19 2:30pm GMT

Q2 2019 CVB Financial Corp Earnings Call

Ontario Aug 8, 2019 (Thomson StreetEvents) -- Edited Transcript of CVB Financial Corp earnings conference call or presentation Thursday, July 25, 2019 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christina L. Carrabino

Clc Communications & Consulting - IR

* Christopher D. Myers

Citizens Business Bank, Inc. - President, CEO & Director

* E. Allen Nicholson

Citizens Business Bank, Inc. - Executive VP & CFO

* Raymond Vincent O'Brien

Citizens Business Bank, Inc. - Chairman of the Board

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Conference Call Participants

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* Aaron James Deer

Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst

* Gary Peter Tenner

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Luke Simeon Wooten

Keefe, Bruyette, & Woods, Inc., Research Division - Associate

* Matthew Timothy Clark

Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst

* Timothy Norton Coffey

FIG Partners, LLC, Research Division - Former VP & Research Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the second quarter 2019 CVB Financial Corporation and its subsidiary, Citizens Business Bank, earnings conference call. My name is Ben, and I am your operator for today. (Operator Instructions). Please note this call is being recorded.

I would now like to turn the presentation over to your host for today's call, Christina Carrabino. You may proceed.

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Christina L. Carrabino, Clc Communications & Consulting - IR [2]

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Thank you, Ben, and good morning, everyone. Thank you for joining us today to review our financial results for the second quarter of 2019. Joining me this morning are Chris Myers, President and Chief Executive Officer; Ray O'Brien, Chairman of the Board; and Allen Nicholson, Executive Vice President and Chief Financial Officer. Our comments today will refer to the financial information that was included in the earnings announcement released yesterday. To obtain a copy, please visit our website at www.cbbank.com and click on the Investors tab.

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

The speakers on this call claim the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. For a more complete discussion of the risks and uncertainties that may cause actual results to differ materially from our forward-looking statements, please see the company's Annual Report on Form 10-K for the year ended December 31, 2018, and in particular, the information set forth in Item 1A, Risk Factors therein.

Now I will turn the call over to Chris Myers.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [3]

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Thank you, Christina. Good morning, everyone, and thank you for joining us again this quarter. Allen and I are joined on the call today by our Chairman of the Board, Ray O'Brien.

Before we discuss our quarterly results, I would like to briefly address last week's announcement of my planned retirement and then ask Ray to say a few words from the Board's perspective.

On July 18, we announced that after 13 years as President and CEO, I have decided to retire effective March 15, 2020. After March 15 and as part of my retirement agreement, I will remain as a consultant through December 31, 2020, to help facilitate a smooth and orderly transition to the next President and CEO. In addition, I will serve in this consultant role to support both our associates and customer base and to provide strategic advice as needed.

Over the past 13 years, my leadership team has accomplished every major objective I put in front of them. Through it all, we have consistently produced outstanding financial results -- industry-leading in many respects. Given our current success and our overall strength and stability, I believe it is the right time to transition the company to a new generation of leadership.

I would like to thank the Borba family, Ray and all of my directors over the past 13 years for their support. It has been my pleasure and honor to lead this company, and I'm incredibly proud of all of our achievements.

Now I'd like to turn the call over to Ray. Ray?

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Raymond Vincent O'Brien, Citizens Business Bank, Inc. - Chairman of the Board [4]

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Thank you, Chris. As sad as we are to see you go, we wish you the absolute best in your retirement.

Let me begin by stating the Board is pleased with the company's current directions, strategy and performance. We are not considering any strategic changes to our business or financial model at this time -- business as usual. In addition, the Board continues to be very happy with Chris's and the bank's performance, and we are grateful for his continued leadership into next year during this transition.

Chris has a record of tremendous performance as our President and CEO, and we are appreciative of his long and exceptional service as the leader of our management team and as a fellow Director. He has led the bank through a period of tremendous growth and strengthened our franchise while maintaining an enviable track record of 169 consecutive quarters of profitability and 119 consecutive quarters of paying a cash dividend to our shareholders.

We believe our experienced senior management team and deep leadership bench will ensure there will be no disruption to our operation or stability, and the company will benefit from the long runway Chris has provided the bank for this transition.

A special committee of the Board has been formed to oversee the transition process. And thanks to the long lead time prior to Chris's departure, the Board will have ample time to conduct a thorough process to identify the right successor. This special committee will engage an outside executive search firm to assist in identifying and evaluating qualified internal and external candidates.

Before I turn the call back to Chris to discuss our quarterly financial results, let me reiterate that we expect this to be a smooth transition for the company. Chris has been an extraordinarily successful President and CEO, and he will continue to lead us through March 15, 2020.

I will now return the call to Chris to discuss our financial results and the second quarter. Chris?

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [5]

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Thank you, Ray. All right, back to business. Yesterday we reported net earnings of $54.5 million for the second quarter of 2019 compared with $51.6 million for the first quarter of 2019 and $35.4 million for the year-ago quarter.

Our second quarter earnings were the highest quarterly earnings in company history, as were our year-to-date earnings of $106.1 million. Earnings per share were at a record level of $0.39 for the second quarter compared with $0.37 for the first quarter and $0.32 for the year-ago quarter.

The second quarter earnings were positively impacted by a $5.7 million pretax gain from the settlement of a lawsuit over an eminent domain condemnation of one of our banking centers and negatively impacted by $2.6 million in acquisition-related expenses. By comparison, our first quarter's earnings were positively impacted by a $4.5 million gain on the sale of a bank-owned building and negatively impacted by $3.1 million in acquisition costs related to the integration of Community Bank.

The second quarter of 2019 represented our 169th consecutive quarter of profitability and 119th consecutive quarter of paying a cash dividend to our shareholders. We'd like to say that twice because we're very happy about it.

Through the first 6 months of 2019, we earned $106.1 million compared with $70.3 million for the first 6 months of 2018. Diluted earnings per share were $0.76 for the 6-month period ended June 30, 2019, compared with $0.64 for the same period in 2018.

Our tax-equivalent net interest margin was 4.49% for the second quarter compared with 4.39% for the first quarter of 2019 and 3.82% for the year-ago quarter.

Total loans declined by $71 million or about 1% to $7.54 billion quarter-over-quarter. The decrease in loans included a $40 million decline in commercial and industrial loans and a $19 million decrease in dairy and livestock loans. Average loans declined by $104 million quarter over quarter.

Despite the negative loan growth for the quarter, new loan production is tracking ahead of 2018 by about 10%. We have seen increased payoffs, particularly from the former Community Bank loan portfolio. For many of these loans that were paid off early, we decided not to compete with the new lender, primarily due to underwriting concerns.

Loan yields were 5.40% for the second quarter of 2019 compared with 5.27% for the first quarter of 2019 and 4.81% for the year-ago quarter. Excluding interest income related to purchase discount accretion and nonaccrual interest paid, loan yields were 4.86% for the second quarter, which was 2 basis points higher than the first quarter of 2019. After excluding interest income related to purchase discount accretion and nonaccrual interest paid, our loan yields increased by 23 basis points over the second quarter of 2018.

At June 30, 2019, the allowance for loan and lease losses was $67.1 million or 0.89% of total loans compared with $65.2 million or 0.86% of total loans at March 31, 2019. During the second quarter of 2019, we recorded a provision for loan losses of $2 million. The provision was primarily due to loan growth of $102 million in non-acquired loans. Conversely, our portfolio of acquired loans decreased by approximately $173 million from the first quarter. The allowance for loan losses as a percentage of non-acquired loans was 1.36% at June 30, 2019, compared to 1.35% at March 31, 2019.

At quarter end, nonperforming assets, defined as nonaccrual loans plus other real estate owned, were $13.6 billion or 0.12% of total assets compared with $19.3 million or 0.17% of total assets for the prior quarter and $10.2 million or 0.13% of total assets at June 30, 2018. Total nonperforming assets included $8.4 million in nonperforming loans originated by Community Bank.

At June 30, 2019, we had loans delinquent 30 to 89 days of only $332,000. Classified loans for the second quarter were $49.4 million, a $2.6 million decrease from the prior quarter. Total classified loans included $20 million of loans acquired from Community Bank. We will have more detailed information on classified loans available in our second quarter Form 10-Q.

Now I'd like to discuss deposits. For the second quarter of 2019, our non-interest-bearing deposits totaled $5.25 billion compared with $5.10 billion for the prior quarter and $3.98 billion for the year-ago quarter. Non-interest-bearing deposits were 60.6% of total deposits at the end of the second quarter compared with 58.9% for the prior quarter and 60.9% for the year-ago quarter. At June 30, 2019, our total deposits and customer repurchase agreements were $9.08 billion compared with $9.12 billion at March 31, 2019, and $6.92 billion for the same period a year ago.

Our cost of deposits and customer repurchase agreements for the second quarter were 20 basis points, the same as the prior quarter. Our total cost of funds was 25 basis points, which is also equal to the prior quarter.

We continue to achieve our objective of maintaining a low-cost, stable source of funding for our loans and securities. As rising short-term interest rates have created pressure to increase funding costs industrywide, our cost of interest-bearing deposits increased by 4 basis points over the first quarter of 2019 on average. Notwithstanding, an increase in non-interest-bearing deposits and a decline in overnight borrowings resulted in our cost of funds remaining unchanged at 25 basis points.

Interest income. Interest income for the second quarter of 2019 totaled $116.8 million compared with $115.3 million for the first quarter and $74.8 million for the same period a year ago. The increase in interest income for the first quarter of 2019 was the result of 1 additional day of interest, $1.4 million in nonaccrual loan interest paid in the second quarter and an $815,000 increase in loan discount accretion.

The increase in interest income from the second quarter of 2018 was the result of $2.3 billion in growth in average earning assets and an increased yield on earning assets of 79 basis points. The second quarter of 2019 reflected a $7.4 million increase in loan discount accretion and nonaccrual interest paid over the second quarter of 2018.

The tax-equivalent yield on earning assets for the second quarter was 4.72% compared with 4.62% for the prior quarter and 3.93% for the year-ago quarter. When loan discount accretion and nonaccrual interest paid are excluded, the tax-equivalent yield on earning assets for the second quarter increased by 1 basis point compared to the prior quarter and by 49 basis points compared to the second quarter of 2018.

Interest expense. Interest expense for the second quarter of 2019 totaled $5.7 million, a $19,000 decrease over the first quarter and a $3.6 million increase over the second quarter of 2018. Average interest-bearing liabilities decreased by $240 million compared to the first quarter, while the cost of interest-bearing liabilities increased by 2 basis points. The increase in interest expense from the second quarter of 2018 can be attributed to higher average interest-bearing liabilities of $1.04 billion and a 28-basis-point increase in the cost of interest-bearing liabilities.

Net interest margin. Our tax-equivalent net interest margin grew from 4.39% in the first quarter to 4.49% in the second quarter. When the impact of discount accretion on acquired loans and nonaccrual interest paid is excluded, the adjusted tax-equivalent net interest margin increased by 1 basis point from 4.07% to 4.08%. Our adjusted tax-equivalent net interest margin grew by 38 basis points over the second quarter of 2018.

Non-interest income. Non-interest income was $18.2 million for the second quarter of 2019 compared with $16.3 million for the prior quarter and $9.7 million for the year-ago quarter. Non-interest income for the current quarter included a $5.7 million gain from the settlement of a lawsuit over an eminent domain condemnation of one of our branches, while the first quarter of 2019 included a $4.5 million gain on the sale of a building where a Citizens Business Bank center was previously located.

When material unusual items are excluded, non-interest income grew by approximately 5% over the prior quarter. Non-interest income grew by $8.5 million compared to the second quarter of 2018 or $2.8 million when the eminent domain gain is excluded. This increase was primarily due to higher bank service charges of approximately $1 million, primarily attributed to the additional income from Community Bank and higher fee income of approximately $550,000 in international services and interest rate swaps.

Now expenses. Non-interest expense for the second quarter was $50.5 million compared with $51.6 million for the first quarter of 2019 and $34.3 million for the year-ago quarter. The second quarter of 2019 included $2.6 million in acquisition expenses compared with $3.1 million for the prior quarter and $494,000 for the second quarter of 2018.

Compared to the first quarter of 2019, salary and benefit expense declined by $440,000 due to the timing of payroll-related tax expenses. The vast majority of the expense increase year-over-year is primarily attributed to the Community Bank merger.

Non-interest expense totaled 1.81% of average assets for the second quarter compared with 1.83% for the first quarter and 1.68% for the second quarter of 2018. Excluding acquisition expense, non-interest expense was 1.71% of average assets for the second quarter compared with 1.72% for the first quarter. Our efficiency ratio was 39.09% for the second quarter of 2019 or 38.77% when the eminent domain gain and acquisition expense are eliminated.

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

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E. Allen Nicholson, Citizens Business Bank, Inc. - Executive VP & CFO [6]

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Thanks, Chris. Good morning, everyone. Our effective tax rate was 29% for both the second quarter and the first quarter of 2019 compared with 28% for the second quarter of 2018. The slight increase from the prior year was due to the greater relative increase in taxable income compared to the increase in tax-advantaged income.

Looking to our investment portfolio, at June 30, 2019, our combined available-for-sale and held-to-maturity investment securities totaled $2.3 billion, a $79 million decrease from the first quarter and a $374 million decrease from June 30, 2018. At quarter end investment securities available for sale totaled $1.6 billion. Due to lower interest rates, the portfolio went from a pretax unrealized loss of $4.2 million to a pretax unrealized gain of $15.3 million.

In addition, we own held-to-majority investment securities totaling $728 million. The tax-equivalent yield on the total security portfolio was 2.53% for the second quarter compared with 2.57% for the first quarter and 2.48% for the second quarter of 2018. During the second quarter, we purchased $17.3 million in mortgage-backed securities with an average yield of 2.51%.

Now turning to our capital position, for the first 6 months ended June 30, 2019, shareholders' equity increased by $85.5 million to $1.94 billion. The increase was primarily due to $106.1 million in net earnings and the $26.6 million increase in other comprehensive income from the tax-affected impact of the increase in market value of available-for-sale securities. Partially offsetting these increases to equity were $50.4 million in cash dividends.

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

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [7]

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Thank you, Allen. Let's talk about economic conditions. Turning to the California economy according to various economic reports, California's unemployment rate was 4.2% in May 2019 compared with 4.3% in April 2019 and 4.2% in May 2018. The state's 111-month employment expansion is the second longest on record, behind the 133 month-long expansion of the 1960s. Seven of California's 11 major industries gained jobs in May. The biggest job gains were in construction, reflecting an increase in homebuilding. This was followed by gains in leisure and hospitality and government jobs.

There is a continued housing demand in California. The supply of existing homes has increased slightly and is expected to remain lean while the high demand for housing continues. New home construction continued to increase at a modest pace for the first half of 2019.

In terms of the dairy industry, milk prices are expected to be higher for the remainder of 2019 due to the strong economy and an increased demand for nonfat dry milk exports. Notwithstanding, milk prices are projected to still remain slightly under the cost of production while feed prices are expected to be flat or decrease modestly.

In closing, we're extremely pleased with our financial results for the first 6 months of 2019. It has truly exceeded our expectations. Our strategy remains unchanged as we remain focused on continuing to grow the bank in a conservative and balanced way.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions). Our first question comes from Gary Tenner with D.A. Davidson.

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Gary Peter Tenner, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [2]

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Chris, congratulations on your announcement. I wanted to ask a couple of questions, one on the loan front and then one on the outlook on rates. So on the loans year-to-date down 3%, you highlighted the core production this quarter relative to the runoff in the acquired portfolio. But how are you thinking about the second half of the year as it relates to runoff in the portfolio and your own production?

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [3]

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Yes, the loan thing is a tougher thing for me to determine when we're going to go back to comprehensive organic growth, which is clearly our objective. We haven't gotten there yet. So in the third quarter, I think it's tough to say whether we'll have positive growth or not, whether it will be flat or down a little bit. But I do feel like it's coming.

I think we're probably 75% through filtering through the Community Bank loans to determine what we're keeping and what we're not keeping as those renewals transpire. Remember, we're still less than a year from the close date of that deal, so that's the headwind there.

It's going to turn, and I think it will -- I'm hoping we'll have positive growth loan in the third quarter, but I would bet we'd have positive loan growth in the fourth quarter.

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Gary Peter Tenner, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [4]

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Okay. Just out of curiosity, the credits that you mentioned from Community Bank where there was several that you walked away from competing for because of underwriting, are those loans that you would have identified in that vein at -- when you closed the deal or did anything deteriorate within that bucket of loans?

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [5]

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No, there wasn't much really deterioration. It's just that whenever there's a merger, there's a lot -- there's enhanced competition. So there's a lot of banks that are coming after our clients and so forth. And some of those structures of those deals can change, and some of the structures we may have tried to renegotiate to tighten it down. So you don't know whether you're going to keep that business or not.

Examples of that could be requiring a personal guarantee or not. There are some credits where we say if we're not going to guarantee we're not going to -- if you're not going to guarantee, we're not going to do this deal. And other banks may release the guarantee, and then the borrower may say, "Well, if I can move for the same price and not have to guarantee this loan", sometimes they'll make that move. And we're trying not to compromise our credit standards and stick to what has built this company for -- and helped us have our great track record for 45 years.

So we are -- look it, there's -- Community Bank has a lot of great clients and a lot of great associates that are running those relationships, and it's been better than we thought. But we're, every day we're in there looking at that and making sure that we're making this Citizens Business Bank culture and not any other culture.

So it's an aggressive market out there. There's a lot of people who are still lending very aggressively. One of the things I think is a little crazy is pricing is still -- is very aggressive out there. At the end of the first quarter of 2019, we did an assessment of what we call our tier banks between $2 billion and $25 billion in the 6 Western states. And our cost of deposits was 66 basis points lower on average than those banks, $2 billion to $25 billion, in the 6 Western states.

So I am puzzled how we're having as much competition on price as we are because I guess banks are just willing to take lower margins or more fixed interest rate risk than we are at times. But for relationship banking, we're going to compete on price all day long. It's the transactional deals that don't have much deposits associated with them where we will try to get a little bit better, a higher price for it. And sometimes we won't win those deals.

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Gary Peter Tenner, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [6]

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That's great color, thank you. And since you've brought up the pricing on deposits, obviously, you all benefited as the Fed was tightening through your ability to keep those deposit costs as low as you have. How do you think about your ability to react to a potential cut in July?

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [7]

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Well, I think that from a competition standpoint, the cut's going to be good for us because it's going to alleviate some of the deposit pressure on the money market type accounts. And we've had to increase a lot of money market rates for different customers selectively. And then you saw that in our second quarter. We're up 4 basis points or something in interest base. And I know that doesn't sound like a lot to you guys, but if we're up 4 basis points, it means we probably increased by 8 basis points because there's an average effect in there.

But when you have 60% of your deposits in non-interest-bearing, it's just not that huge of a financial burden. In terms of 60% are not interest-bearing, 40% are interest-bearing if it goes up 4 basis points it's not a tremendous amount of money.

But we want to see a rate cut because I think that's going to moderate some of that interest-bearing pressure on our deposits. One of the things we're trying to do, and I think Allen and I are -- it's like one of those things, you pat each other on the back but no one ever knows -- is that we orchestrated this thing when we bought Community Bank, and we got rid of almost $1 billion in deposits that we felt were non-relationship or $1 billion in [quad bids] and borrowings and things like that. All that was about $1 billion. And we used Citizens Business Banks' $1 billion in deposits to fund those loans.

Right now we are running pretty close to equilibrium in terms of neither a borrower or a lender on overnight funds. And during the second quarter, we borrowed money in the beginning of the second quarter. By the end of the second quarter, we weren't borrowing any money. And right now, the last week or so, we've been running at a slight surplus, meaning we have more deposits than we do that are going into loans, so they're going into Fed funds.

So that's exactly where we want to be from an efficiency standpoint, and this is something that we talked about of how we orchestrated this, all the way back in August of last year. So that's why Allen and I are like, "Hey, we did it." We got exactly where we wanted to get it.

And so I think the company is running extremely efficiently right now, and our focus is to look at every asset we have in this bank. We want to be pound-for-pound the best. We're late in the economic cycle, and so we want to make sure that every asset counts and that we're looking at every asset carefully to make sure it's a right investment for CVB.

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Operator [8]

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Our next question comes from Aaron Deer with Sandler O'Neill & Partners.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [9]

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I guess sticking with that same theme, Chris, I guess I'm a little surprised to see it's just in that lower rates are good, just given the huge funding advantage that you have over competitors, so I would think that that could actually make that competition worse, no?

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [10]

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No, I agree with you if rates continue to come down. I just think the first quarter percent that's going to go in July is going to moderate some of the deposit competition a little bit. It's going to start putting the brakes on some of these banks out there that are offering crazy deals, which is annoying to us. So I think just from a competition standpoint, that will moderate a little bit.

But you're absolutely right. If rates go -- if we have 3 or 4 rate decreases, that will put pressure on our margin, as our variable-rate loans will -- the yield on those will go down. And I don't think our deposit costs will go down as fast as -- I know our deposit costs won't go down as fast as those variable-rate loans. So it will put margin pressure on us, no question about it. But I think the first quarter percent is going to help. From a competition standpoint and a business retention standpoint, it's going to help us.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [11]

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Sure, okay. And then I guess touching on the asset side, if we do get a couple of rate hike here in the back half of the year, maybe give us a sense of what percentage of the book now is tied to the short-term rates and is going to see repricing, either on a monthly or quarterly basis, and what kind of rate floors might be in place on some of your credits to help minimize the downside.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [12]

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Yes, our best estimate on that is 25% is tied to prime or short-term LIBOR. We do have some rate floors. Over the past year, we've been putting in rate floors. What happens is, is when rates go back up and your rate floors are too low, you get rid of your rate floors because you don't want to have a low rate floor. When they're paying 5.5% and your rate floor is 3%, it doesn't mean anything. So we got rid of some rate floors, and now we're starting to put them back in where we can. And some of that's particularly on the dairy side, agribusiness side, and then to some extent, our C&I side.

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Aaron James Deer, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research and Equity Research Analyst [13]

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Okay. And then, Allen, forgive me if I missed this, but can you just give the exact dollar amounts of what the accretion and interest recoveries were in the quarter?

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E. Allen Nicholson, Citizens Business Bank, Inc. - Executive VP & CFO [14]

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Sure. We had about $1.4 million in nonaccrual interest paid and approximately $8 million in discount accretion.

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Operator [15]

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Our next question comes from Matthew Clark with Piper Jaffray.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [16]

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Can you speak to the expense outlook? I think you've probably got the rest of the cost saves done from the Community Bank deal, but just want to get your thoughts on the types of investments you might need to make from here and just the overall expense outlook.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [17]

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Matthew, can you repeat that question? It was mumbled.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [18]

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Sorry. Just on expenses, wanted to get a -- I think the cost saves from the deal fully came through this quarter. Just want to get your thoughts on the outlook and the types of investments you might need to make from here.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [19]

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On the expense side, I think we still, the second quarter we were still reducing expenses. We had -- I don't know -- it was $2.6 million in acquisition expenses, is that what it was?

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E. Allen Nicholson, Citizens Business Bank, Inc. - Executive VP & CFO [20]

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That's correct.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [21]

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$2.6 million in acquisition expenses. I would guess that that acquisition expense would, or nonrecurring type of acquisition-related expenses would be probably several hundred thousand dollars for the third quarter, down significantly from the prior 2 quarters. We've done all our office consolidations, all that.

So the third quarter should be a very pure quarter for us in terms of how we're going to operate, what our margins are going to be. We're not anticipating another $5 million gain on something that we've had the last 2 quarters, and we won't have large acquisition-related expenses. So I think the third quarter's going to be, our fruit will be a relatively -- now, I can't predict this, still, a couple of months left -- a relatively uneventful one-time event quarter for us.

And then on the -- were you asking about our acquisition strategy? I wasn't clear on the second part.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [22]

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No, just the reinvestments you need to make from here from a technology standpoint.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [23]

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I think the technology, I think, regulation, all those things now that were over $10 billion, we're having to spend more money on that, and we're starting to staff up in that area, too. So I do think that that will be an expense headwind for us going in. But on the technology side, we've already been investing a lot of dollars in.

So I would say that's an expense headwind. I think we've been running -- right now we look at our efficiency ratio at 38%-ish, and I would say that a year from now, I would expect our efficiency ratio to be running at probably 40%, maybe 41% or something, due to some of the costs of going over $10 billion and the staffing up for that and so forth, so which still is a great number.

And the other number we focus on is our non-interest expense divided by our total assets. Is that total assets or total earning assets?

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E. Allen Nicholson, Citizens Business Bank, Inc. - Executive VP & CFO [24]

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Total average assets.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [25]

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Total average assets. And our goal there is 1.70%, and we've been running a little bit above that, and I expect us to get right about at that number, too, at about 1.70%. So that's our long-term goals, and it's run a 40% efficiency ratio and a 1.70% non-interest expense divided into total average assets.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [26]

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Got it. And then I know the number's not large, but can you update us on the Durbin impact in the upcoming quarter, quantify that?

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [27]

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Yes. It's a great question, and one of the things that's been a pleasant surprise for us, that's been a little better than we thought, was our fee income, our non-interest income, with us and Community Bank together, there's been some good synergies there on our international side, on interest rate swaps.

We're having what is -- if we finish like we should finish the year out, we should have the best year ever in interest rate swap fee income and the best year ever in international income. And then our fee income on service charges has gone up quite a bit.

So we're running about, right now we've been running about $2.5 million a quarter higher than we were pre-acquisition, which is $10 million in pretax a year. About $400,000 a quarter will be taken out of that-ish by the Durbin. Is that the right number, Allen?

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E. Allen Nicholson, Citizens Business Bank, Inc. - Executive VP & CFO [28]

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Yes.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [29]

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So I think if you're modeling, a guesstimate would be that income, that non-interest income in addition from where we were before, is about $2.1 million a quarter once we get past the third quarter. Or do we -- when does --?

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E. Allen Nicholson, Citizens Business Bank, Inc. - Executive VP & CFO [30]

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It becomes effective in July, yes, so it's already effective.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [31]

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It's already effective?

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E. Allen Nicholson, Citizens Business Bank, Inc. - Executive VP & CFO [32]

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Yes.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [33]

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That's not good. All right, well, I guess effective this quarter, we're going to be $400,000 down due to Durbin Amendment.

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Matthew Timothy Clark, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [34]

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Okay, and then just on the provision with loan balances shrinking this quarter, you guys still added to reserves by quite a bit. I assume that's just renewals of the Community Bank loans, but given where your nonperformers are, just a little surprised to see that provision up this quarter.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [35]

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Yes, and this is something that we've gone through quite a bit, is as we transition loans from Community Bank onto Citizens Business Bank books, the -- Allen, I'm going to have you help me with this too -- so discount accretion goes away.

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E. Allen Nicholson, Citizens Business Bank, Inc. - Executive VP & CFO [36]

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Matthew, we segregate the portfolios that have been acquired. And because of the credit discounts, we don't typically have a loan loss allowance. But as there's a transition of those loans, if they're renewed, et cetera, and they move and we have accounted for all the accretion, then we're starting to put provisioning on that. So we had an over $102 million increase in our non-acquired loan portfolio that drove most of that provisioning and a significant decline in the Community Bank acquired portfolio.

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Operator [37]

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Our next question is from Luke Wooten with KBW.

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Luke Simeon Wooten, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [38]

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Just wanted to push back into that fee income. I know you guys had great growth in AUM quarter-over-quarter. Just wanted to see -- this is in the trust and investment services line item. Just wanted to see how we should model that going forward and if you see growth in that continuing at the same clip.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [39]

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Yes, some of that growth in the AUM was more liquidity management, and so it's not driving as much fee income as you would normally see true AUM growth. And part of that was a defensive move as interest rates -- a defensive move to compete on the interest rate basis without having to put those on our CBB -- Citizens Business Bank books. Some of those deposits, we shipped it over to Citizens Trust, where they can offer a higher rate.

I think you're going to see those deposits, if rates come down, migrate back into the bank and used for funding. As they become less expensive, we'll want them back. But when they have a 2% or higher number on them right now, though, we're going to migrate them to Citizens Trust because we want to keep them within the family. So that was as bad as you there.

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Luke Simeon Wooten, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [40]

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Okay, thanks for that. And then I know you guys talked a little bit about the loan growth, seeing it still a little slow in the third quarter and pick up, probably, in the fourth quarter. And should we model deposit growth somewhat in the same lines as that, or do you see that loan growth will follow and they're interrelated with the relationship basis of the deposit base?

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [41]

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Yes, I think both of them are very competitive right now. I think that there's -- the deposit side, there is -- I think there's good opportunity for us to grow organically. We're gauging our annual growth at about 5% on the deposit side, and we want to keep close to that 60% non-interest-bearing number. We like that number. It's one of the best in the country, and it's a huge advantage over the competition.

So I think you'll see more of the same on the deposit side. I think we will see -- I think we will get back to net growth on the deposit side. And we saw the non-interest-bearing growth quarter-over-quarter, but it was almost swapped out. The non-interest-bearing went up $200 million and the interest-bearing went down $200 million, so we're a breakeven over the quarter.

I think you'll see the aggregate number start to grow again and proportionately with the non-interest-bearing and interest-bearing, hopefully. That's just all about relationship and bringing in new customers and so forth.

The loan side is, again, a little bit -- we're still, again, 75% through the sifting through the Community Bank portfolio. We've got a little bit more runway there, so I think that will be a little bit more challenged on the deposit side.

But the key to this organization is that we grow 3 ways. We grow what we call same-store sales, and that's our deposits and our loans and fee income. Need to grow organically, office over office, year over year, et cetera, et cetera. That's the goal.

The second way is we open up new de novo locations. We've opened up in Stockton and San Diego and Santa Barbara over the last few years and are building those things out.

And then the third way is through acquisition. And the bank is, while my retirement may put us a little bit on the sideline on the acquisition trail here, there's no reason that this company, with its balance sheet, its earnings power, the talent here, can continue on with acquisitions once we get through the leadership transition here.

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Luke Simeon Wooten, Keefe, Bruyette, & Woods, Inc., Research Division - Associate [42]

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Okay, that's very helpful. And my last question was just going to be on capital management. And so it sounds like the de novo is -- the bank's more geared toward de novo in the near term than M&A, and then also just pairing that off with repurchases and dividend increases, just the full capital management picture if you wouldn't mind just clarifying that a little bit.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [43]

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Yes, I think we have a great rich man's problem. We're, right now we're running at $50 million a quarter in profitability plus, and our dividends are about half of that. And if we're not -- if our growth is flat, that means organically, we're creating $100 million in new capital a year without any growth, and that's after dividends. That's a lot of capital. So we have to figure out how to deploy that.

So the bank does need to get back on the acquisition trail. I do think there's just a transitionary period here through until the new CEO is named, to probably do that. But never say never, right? If the right opportunity came along, I think I've got a very talented management team, and Allen and I have worked on a lot of these deals and know how to price them, and Allen does, too. And I've involved my key other executives in that as well, and they've been part of that learning curve, too, over the last 4 years. So I think that the transition should be pretty smooth, and these guys know what they're doing.

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Operator [44]

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[Operator Instructions.] Our next question comes from Tim Coffey with Janney.

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - Former VP & Research Analyst [45]

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Hey, Chris, I want to get your thoughts on the potential seasonality of the dairy portfolio in the back half of this year, because last year, the second half was very strong relative to what we saw in '17. I'm just wondering, are you getting a sense that it might slow down a little bit relative to last year?

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [46]

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Every time I think it will, because the dairies have not been overly profitable in the last year, so you'd think that it should slow down a little bit. But some of these dairies are powering through. So I do think it's going to probably -- I would estimate the seasonal run-up in the late third quarter and mostly in the fourth quarter will be $60 million to $80 million.

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - Former VP & Research Analyst [47]

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Okay, okay. And then I heard your comments on opening the de novo branches. Have you been looking at trimming in other parts of your footprint in terms of total footings?

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [48]

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Well, we've done that with the acquisition. We had 16 locations. We cut that, and we're only keeping 6. Now granted, some of those, most of those are transitioned to our offices, but a couple of those have been transitioned the other way.

So I don't know that we'll do any pruning of our tree at this point. I think there's little things here and there we can do as we don't need as much brick and mortar in some offices, so we may look at realigning. That's like where we sold one of our bank buildings, our eminent domain, we moved a half-mile down the street but we didn't close that office.

So we're running pretty efficient right now. There's not a ton -- I'm not talking about we're going to consolidate another 5 or 6 offices. Right now we've got this organization pretty streamlined, and it's about positioning ourselves for future growth.

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Timothy Norton Coffey, FIG Partners, LLC, Research Division - Former VP & Research Analyst [49]

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And are there any parts of the improved footprint, or adjacent to your footprint, that you like right now and think could be a de novo candidate?

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [50]

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Yes. Any and all where we can find a good team that's in relative close proximity geographically to where we are. So I'd like to drive up the Central Coast. I'd like to densify in San Diego even more, so we're looking for more people in San Diego, and then up to the Central Valley as well.

We're in Stockton and we'd love to backfill in Modesto and Merced and then get into Sacramento. Those are all markets that we'd like to either get into through acquisition or through de novo as we -- and then eventually into Northern California if the right opportunity came in. And so those are all exciting things that we have in the future. It's just a question of how they get done and when they get done.

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Operator [51]

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(Operator Instructions). Okay, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Myers for any closing remarks.

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Christopher D. Myers, Citizens Business Bank, Inc. - President, CEO & Director [52]

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Yes, and thank you for joining us on the call today. I will -- I have committed myself to finishing strong here in the next 7.5 months of my tenure as President and CEO, and I reiterate that I have a great team of people. We've worked very closely together, and I really want to thank all of my associates for the great things we've accomplished. And I have high expectations for the next 7.5 months under my leadership and also Citizens Business Bank for many years to come after that.

That's it. We'll talk to you guys in October for our third quarter 2019 earnings call, and have a great day.

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Operator [53]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.