Independent Bank Group Inc (IBTX) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Independent Bank Group third-quarter 2015 earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Torry Berntsen, President and Chief Operating Officer. You may begin.

Good morning. Welcome to the Independent Bank Group conference call to discuss financial results for the third-quarter 2015. I would like to thank you for joining us this morning. I will go over a few housekeeping items and then hand it over to David Brooks, our Chairman and CEO, to lead the presentation.

We issued our earnings release earlier this morning, and a copy is posted on our website, www.ibtx.com. We will be going over much of the release on this call. If you have any trouble accessing it, please call Robb Temple, 214-544-4777, and we will email you a copy.

Some of the remarks made today will constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. We intend such statements to be covered by the Safe Harbor provisions for forward-looking statements contained in the Act. Please see the text in this morning's release for additional information about the risks associated with these statements.

Please also note that if we give guidance about future results, that guidance will be only a statement of management's beliefs at the time the statement is made, predictions that we make may not continue to reflect management's beliefs, and we do not publicly update guidance.

We will discuss a number of financial measures considered to be non-GAAP under the SEC's rules. Reconciliations of these financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP are included in our earnings release.

At the conclusion of our remarks, we will open the telephone lines for questions. At that time, we will provide instructions for submitting your questions. With those reminders out of the way, I would like to outline the agenda for this call.

David will open with his thoughts regarding our third-quarter results. Michelle Hickox, our Chief Financial Officer, will lead you through the quarter's operating results and some balance sheet highlights. David will then close the presentation and open the phone lines for questions.

I will now turn it over to David.

Thanks, Torry. Good morning and welcome to our third-quarter earnings conference call. This was a transitional quarter for us. Our loan growth returned to historically strong levels while we made a decision to take an additional reserve for the potential risk of the current energy commodity price environment. While this decision impacted earnings for the quarter, we believe it positions us well for the possibility of lower oil and gas prices for a prolonged period.

With that background, I will address a few of the highlights.

We reported loan growth of 18.1% on an annualized basis for the quarter. This growth brings our year-to-date loan growth more in line with our expectation for the year. Much of the growth came in the latter part of the quarter, and as a result, earnings do not reflect the full effect of this increased growth. We expect to recognize the full benefits of the third-quarter growth in the fourth quarter, and the pipeline for the fourth quarter looks good as well, although we expect some headwind overall from the paydowns in the interview loan book. Third-quarter earnings were lower than expected, primarily due to this decision to take an additional provision for loan loss.

This provision recognizes the anticipated loss on our one nonperforming energy credit as well as builds up our general reserve. The additional provision increases our energy-related reserves to 3.4% of the energy portfolio. Although the energy portfolio is holding up well and our borrowers are cooperating, we believe this approach positions us well if, in fact, energy prices remain low for an extended period.

I want to emphasize that our asset quality remains strong. Total nonperforming assets decreased from the previous quarter and are consistent with levels from a year ago, and our aggregate criticized and classified energy credits represent 1.6% of total loans, which is consistent with the previous quarter.

Our loan growth was primarily in Dallas and Austin regions while we saw an overall reduction of [$17] million in the energy portfolio. We think that our non-energy-related growth demonstrates the continued overall health of the Texas economy.

Our announced Grand Bank transaction is proceeding ahead of schedule with closing scheduled for November 1 and our systems conversions scheduled for early 2016. Our teams are working very closely together identifying additional revenue and expense synergies.

In addition, Grand Bank has begun to reposition its balance sheet to improve earnings. We remain very excited about the long-term prospects of this strategic acquisition.

With that, I would like to ask Michelle to go over our 2015 third-quarter operating results. Michelle?

Thank you, David, and good morning, everyone. As noted in the earnings release, our third-quarter core net income was $8.9 million or $0.52 per diluted share compared to $9.5 million or $0.58 per diluted share for the third quarter of 2014 and to $10.5 million or $0.61 per diluted share for the quarter ended June 30, 2015. Net interest income was $38.1 million for the third quarter of 2015 compared to $32.4 million for the same quarter 2014 and $37.8 million for the linked quarter.

The increase from the previous year resulted from our organic growth and loans acquired in the Houston Community acquisition. The increase on a sequential basis was due to higher average loan balances.

Our net interest margin were 4.08% for the third quarter compared to 4.04% for the prior year quarter and compared to 4.10% for the second quarter. The decrease from the prior quarter is primarily due to reduced accretion income on acquired loans. Our core net interest margin, which does not include accretion income, was 4.07% for the third quarter compared to 4.02% in the prior year quarter and 4.04% in the linked quarter.

Total noninterest income decreased $411,000 compared to third-quarter 2014 and decreased $310,000 compared to second quarter of 2015. The decrease from the prior year is the result of a decrease in gain on sale of loans. You may remember that we recognize the $1.1 million gain in third-quarter 2014 from the sale of the SBA loan portfolio acquired in the Bank of Houston acquisition and an increase in losses on sale of premises and equipment.

Offsetting the decrease were increases in deposit service charges and mortgage fee income. With respect to the linked quarter, the decrease was primarily related to loss on sale accruances and equipment, reduced mortgage fee income, and reduced gains on the sale of securities. The decrease was offset by an increase in deposit service charges and a gain on sale of loans.

Total noninterest expense increased $3.7 million compared to third quarter of 2014 and increased $1.4 million compared to second quarter of 2015. The increase from the prior year was due to increased salaries, occupancy, data processing, communication, and other noninterest expenses resulting from increased employees and locations added in the Houston community acquisition during fourth quarter, as well as overall loan growth.

On a linked quarter basis, the increase is related to higher operating expenses, including increased incentive compensation accruals for loan growth and mortgage activity, increased acquisition expenses related to the Grand Bank transaction, higher legal fees on existing litigation, and increased costs related to monitoring and servicing the energy portfolio.

We reported a $3.9 million provision for loan loss for the quarter, an increase of $3 million from the third quarter of 2014 and an increase of $2.2 million from the prior linked quarter. The significant increase in the provision this quarter is directly related to our increased organic loan growth, an increase in qualitative factors related to the energy portfolio generally, and an additional specific reserve on the existing nonperforming energy credit.

As it relates to loans, for the quarter, organic loans held for investment grew 4.6% from June 30, 2015 or 18.1% on an annualized basis. The composition of the overall loan portfolio remains comparable to previous corridors.

Energy E&P outstandings at the end of the third quarter were $209.6 million comprised of 27 borrowers representing 5.9% of the loan portfolio. For the remainder of the year, approximately 70% of our portfolio is hedged at a price of $67 per barrel. In 2016, close to 50% of the portfolio is hedged at an average price of $56 per barrel. As discussed in our prior earnings releases, we have one nonperforming energy credit which has a balance of $4.2 million.

During the third quarter, two performing energy credits were classified which have an aggregate balance of $28.5 million. Aggregate criticized and classified energy credits total $56.4 million. Oilfield service-related balances continue to represent less than 1% of total loan balances at September 30, 2015 and remain stable at $23 million. None of the oilfield service loans are criticized or classified.

With respect to overall asset quality, total nonperforming assets is $15.1 million and represented 0.34% of total assets at September 30, 2015 compared to 0.33% of total assets at September 30, 2014 and 0.37% at June 30, 2015. The decrease in the linked quarter is due to the sale of other real estate and the repossession of collateral and related charge-off of a previous nonaccrual loan.

With respect to funding, total deposits were $3.53 billion at September 30 compared to $2.81 billion at September 30, 2014 and $3.47 billion at June 30, 2015. We continue to focus on new ways to grow our core deposit base while keeping costs low. The Grand Bank acquisition will also have a positive impact on our deposits.

The average cost of interest-bearing deposits decreased to 0.48% for the quarter compared to 0.49% for the third quarter of 2014 and was slightly higher from the second-quarter 2015. Our year-to-date cost of deposits is 0.35%.

Total borrowings increased by $63 million from June 30, 2015 due to the use of short-term FHLB advances to fund late quarter loan growth.

That concludes my outline in the highlights of our financial statements, and I will turn it back over to David.

Thanks, Michelle. We are encouraged by the third-quarter results. Loan growth returned to anticipated levels, and we plan to build on that momentum going forward. Although the additional provision reduced earnings, we believe that this minimizes uncertainty in the energy portfolio.

Aside from the additional provision, earnings remain solid, and asset quality remains strong, despite the volatility in the energy markets. The Grand Bank transaction represents continued execution of our targeted acquisition strategy. We are quite pleased to have our regulatory approvals in hand and are on course from earlier than expected closing.

I continue to remain involved in M&A discussions and in developing and expanding relationships for future opportunities. I believe we will see more activity once we have some stability for a period of time in the oil prices.

We will continue to remain disciplined in our approach to acquisitions with respect to both strategic fit and valuation metrics. We are confident that our actions during third quarter will improve performance going forward and that our conservative approach will continue to yield positive results and enhance shareholder value.

And with that, we will open the call to questions. Operator?

(Operator Instructions). Matt Olney, Stephens Inc.

Hey, I think Michelle may have brought this up on the prepared comments, but can you just go over, again, the dollar amounts of total criticized energy loans in the third quarter and how this breaks down between classified, nonperforming and special mention?

Yes.

I don't have that detail. I just know the total.

I have it. It's --

Yes, the total criticized and classified number, Matt, is $56.4 million.

And then $4.2 million is that nonperforming, and then there's the $28 million that is the classified that's performing, and then the rest would be in the criticized. So you in essence have the $28 million that's classified and performing, you have the $4.2 million that's classified nonperforming, and then the difference between that and the $56.4 million is your criticized.

So it would be $24 million.

Right.

Okay. Got it. Thank you. And then outside of energy, any commentary about what you are seeing on credit quality or items that you are watching pretty closely today?

We feel really the same as we did at the end of the second quarter, Matt, regarding our portfolio. It's strong, performing well; we don't see any signs of weakness at this point. We are particularly paying attention to Houston and commercial real estate in Houston, looking for any signs of stress or strain so that we can get on it early. That's been -- part of our strategy over the years has been to get -- to identify early, address early. We think that's been one of the things that's helped us so far through this energy downtime. So no change.

The big change, Matt -- and I know a lot of folks are concerned appropriately so about any regulatory -- how the regulators are going to deal with not only the [SNIKs] but any other issues around the energy and how they are going to ask banks to classify and account for it. Our view is -- and the only thing that really changed materially for us from a credit quality standpoint third quarter over second quarter is that the oil was $58, $60, $62. We will call it $60 at the end of the second quarter, and it's been mid-$40s, and during the third quarter, it went -- tested, the loads went down to $38 and end of the quarter at mid-$40s.

And so the big driver, if you will, of our additional loan-loss provision was just when we look at our formula and the qualitative factors inside of our loan-loss reserve formula, we felt like -- that the possibility now of prolonged mid-$40s oil prices is a different scenario than we were looking at at the end of the second quarter. So we felt like we were properly reserved and everything fully accounted for, if you will, at the end of the second quarter, but the facts on the ground changed dramatically during the third quarter to oil price in the mid-$40s, and a lot of very smart people think that it's going to be in the mid-$40s for a while and that it will be a long, slow recovery, which we always thought, but a long slow recovery from a $60 base is different than a long, slow recovery from a $45 base.

Again, we don't see any big problems or big things coming down the track in terms of our portfolio specifically, but we just felt like there's more risk in an energy portfolio at $45 oil prices than there are at $60 oil prices, and we felt like we wanted to get ahead of the curve here and make a provision -- or adjust our formula accordingly. So that's what drove the additional loan-loss provisions. Just an acknowledgment that oil prices are $45 now, not $60.

And Matt, just to give you those exact numbers, on the criticized, we are $23.7 million, and on the classified, we're $32.7 million. But of that $32.7 million, $4.2 million is the only piece that is nonperforming. And on the classified, on the other piece, we feel very good about the rest of that strong asset values. We've estimated 1.5 times asset coverage on those other loans, so we feel good about the others that are on the classified category.

Okay. That's great color. Thanks, guys.

Brady Gailey, KBW.

So, you know, it sounds like loan growth picked up in the back part of 3Q, and the pipeline is good headed into 4Q. What's the source of the pickup in loan growth, what sort of product are you putting on it, or what's happening that's driving a little uptick?

You know, Brady, we haven't changed a thing. We have been -- our loan officers have been out hustling all year like we always do, looking for owner-occupied real estate for C&I loans, equipment loans, medical office, building loans, those types of things, and that's really -- there's been no change in the complexion of what we're booking with the exception of the fact that last year, if you look at year over year, last year we were booking energy credits all through the year, and that's the one, not only missing piece, but it's the headwind a little bit there in that we had an -- almost a $20 million paydown in our energy book over the course of the third quarter.

But in terms of what we're adding, it's exactly the same complexion, and we haven't put on any special pricing or anything to drive that. It just happens that it was slower in the second quarter, and as we've said all along for two and a half years as a public company, our loan growth just happens to be a little bit lumpy.

Some quarters are strong and some we get extraordinary paydowns, etc. But nothing grow -- 18 -- I think 18% plus growth in the third quarter was higher, but it was really just a reflection of 8% in the second quarter. So when you put the whole year together, we are running just under 14%, and that's about what we thought coming into the year. So we are right on track with what we see in the fourth quarter, not knowing exactly what the energy paydowns will be, although we do expect some more significant paydowns in the fourth quarter.

It looks to be kind of in that same range, Brady, that low mid-teens kind of growth is what we expect in the fourth quarter. So if we had to call it right now, we think for the year we are going to be in that 13%, 14% range, and that's a little slower than we thought coming in the year, only because we expected the energy there to be opportunities to make energy loans and we just haven't seen that.

So far our customers -- the loans that are getting paid off tend to be coming from equity, recapitalizations of the companies or subordinated debt or that type of thing. So we're not seeing the opportunity to finance a lot of energy at this point, and that's different than we would've guessed.

But so far our loan growth, especially in Dallas and Austin, is running very good and at historical levels. Houston is still growing, but it's slowed a little bit here this year. We are running right now at an annual pace about 8% growth in Houston, and again, same asset categories we've always seen, just a little slower there.

So, if you look at it, Brady, probably in the Austin and the Dallas areas, we are running close to 20% annualized growth during the course of this year.

Okay. All right. Great. And of the $210 million that's in the energy book, how much of that is shared national credits? And have you all heard, it sounds like regulators are going to do another second SNIK review in the winter of this year. Have you all heard anything about that?

Yes, the same thing that everyone else has heard, Brady. We have -- we are only -- of our 27 relationships, only three of them are SNIKs. One of them is a SNIK that we agent, and we participate in two other SNIKs agented by other Texas banks. So -- and the total of those three outstanding --

It's actually $55 million.

Of the SNIKs --

It was $55 million.

Okay. Got it. So yes, those three SNIKs totaled $55 million exposure to us, Brady. And we've heard that there's going to be another round of SNIK reviews and that we will see what comes out of that. It will be interesting to see. That should not be material to us. One of those SNIKs, I believe, Dan, is already in the classified bucket, correct?

It is.

Correct. So yes, one of those three SNIKs is already classified, Brady, so we don't expect any further downgrades on that. So really we have two credits that, I guess, would be subject to potential downgrades. But those two credits are in really good shape. So we're not expecting -- we don't expect the SNIK review to have any ill effects on our portfolio.

Okay. And then lastly on M&A, you will close Grand here in a couple weeks. I realize you all are probably a little preoccupied to almost all the synergy mess, but is your focus in kind of calling efforts on targets changed at all with M&A, or are you still up there hustling like you were a year ago?

Yes, it hasn't changed at all, Brady. The only thing that's changed obviously is the environment we've got in Texas. We have been more focused in the Dallas areas, and Austin, San Antonio, Dallas, Fort Worth, Austin, San Antonio have -- we've had more discussions there the last six months, I guess, than we have in Houston. But overall, discussions remain the same. The determining factors have a lot to do with the currency of the buyers, the expectations of the sellers in terms of price, and then obviously a big factor we always find is the cultural fit and objectives going forward. And so we continue to work that. I continue to be optimistic that we're going to see activity.

It's really the volatility in the energy prices that kind of creates the chill. I think if they settle out at a certain level, people know what to expect. And so my expectation is that if we can get some stability in oil prices, whether it's in the $40s or the $50s or $60s, then you will see more activity because people get a confidence around, okay, we know what the environment is now, we can adjust our expectations and move forward.

Okay. Great. Thanks for the color.

Brad Milsaps, Sandler O'Neill.

David, I was kind of curious if you could just break down the provision this quarter, maybe in the components that you talked about, what the dollar amount was for growth, and then maybe the Q factors in this specific reserve?

Michelle?

Yes, let me try to address that one, Brad. If you remember, we've always commented that we generally try to put away about 1% of our loan growth, which would have put the provision just for growth this quarter at about $1.4 million. Then we took an additional specific provision on our nonperforming energy credit of $1.2 million for the quarter. And then I think there was probably $500,000 of other general allocation related to loans that were brought on that were re-underwritten for the Bank of Houston, and then pretty much the rest of that provision would be related to the energy qualitative factors.

No, that's great. That's very helpful. And Michelle, maybe just to stick with you on expenses, obviously had a tick-up again this quarter. Just kind of curious what your outlook might be there if loan growth is maybe not as strong as you thought from the beginning of the year and trying to get to some of the numbers that are out there. Just kind of curious your outlook for expenses.

Yes, as we talked about in the release and our comments, comp expense was up primarily due to incentives because our loan growth was really strong, our mortgage group has done really well. So we had additional accruals there. And if that -- if our loan growth continues to the end of the year, I expect that run rate will be good.

But we did have -- I was a little surprised. We had some expenses in our noninterest expense this quarter that -- not that it wasn't planned for, it was just stuff that kind all of hit in the same quarter, and it's across several different categories, data processing, loan expenses related to collection efforts on the energy portfolio that either won't repeat or we may even get reimbursed by borrowers. Occupancy expense, we did a lot of refreshing of branches this quarter, and so that won't repeat. And then public relations, we had some unusual or higher expenses the normal.

So I think all-in-all, we probably have about $400,000 in our noninterest expense that wouldn't be -- I wouldn't include that in our run rate going forward.

Okay. Great. And then just to follow up on the Grand acquisition, David, I was looking at their call report -- their earnings maybe for the last reporting period were a little bit less than they had been historically. Is that just them readying their balance sheet to come over with you guys? Maybe preloading some charges from pay off of FHLB and things like that, or is there anything else that might be going on there?

Correct, Brad. We actually think they've been -- we know they have been repositioning their balance sheet in accordance with our discussions and where they know we plan to head with it once we close. And so they have -- we deemed all of their FHLB advances. There was a significant prepayment penalty, if you will, on those advances. So that was, I think, in the quarter and accounted for a lot of the decline.

We are actually -- we feel good about -- very good about where they are and think that we will actually be able to accomplish the redeployment of the balance sheet in the manner that we expect to do it, that we've communicated previously quickly here and the fact that we are closing a month or two sooner than we had expected.

We will -- we didn't announce that deal -- I believe it's mid-July, and so getting it closed in three and a half months from the time we announced will, I think, be the fastest we've gotten one closed. So we have got the approvals, and we are headed to closing. So we feel good -- great about that. So we will have even longer to -- we will have an extra couple of months this year to get the cost saves out and get the balance -- begin to get the balance sheet repositioned. So we're actually slightly more positive about the earnings the next two or three quarters from the Grand acquisition than we were before.

Great. Thank you, guys.

Michael Young, SunTrust Robinson Humphrey.

I was just curious if you could give us an update on what your price deck is on the energy reserve base lending book and what efforts you are taking to stress test the book, how you've done that through your methodology?

Our price deck is the lowest it's been, Michael. It reflects the current price of oil in the mid-$40s and just ever so slightly increases the next couple of years going forward. I don't -- so I think that -- we've got -- our price deck is right in line. Of course, we follow and have conversations with the regulators on a regular basis about what all the banks' price decks are looking like, and ours is just kind of right in the middle of the pack.

Michael, we update ours as frequently and as regularly as anybody and really look at it diligently on a monthly basis.

Okay. And then what methodology are you using to stress test the book? Is it bottoms up, or are you going credit by credit? Is that the process, or do you do it top down? Just curious there.

Yes, we do it credit by credit, Michael. Look at the -- as we stress test and --

We will look at it credit by credit, Michael, on each. We are in the process of going through the redeterminations on one more time. This could be the third time -- this will be the third time since we -- the price downgrade. And then we're looking at what our hedge book is and what that turns out to be in 2015 and 2016. We are actually -- I have added some more hedges even during the course of after this quarter.

Okay. Great. And just one last one if I can. Curious you are mentioning the slowdown a little bit in Houston. Do you plan to hire more in Austin and Dallas to pivot the growth going forward?

I think we are always going to hire good officers, good lenders in all of the markets that we are in. So I wouldn't say that we will be focused there, although most of our hires this year have been and not so much intentionally, but we just hire where the right opportunity is and the right people are has been in Austin and Dallas. But we continue to have discussions with offices in Houston as well. And so we're just -- it's situational and lumpy and all those things, but we do feel good about our ability to continue to hire over the next few quarters.

Okay. Thanks.

Stephen Moss, Evercore ISI.

Just wondering going back to loan growth here, it sounds like the pipeline has stalled heading into fourth quarter. What are you guys thinking about 2016 given the mixed dynamics going on?

Yes, we're just working on our budgets right now, Steve, but we are -- we are bracing for it to be a little slower in Houston. But so far, we see a lot of strength in Austin and in Dallas, Fort Worth, North Texas. And so when you average all that together and balance it up, I think we're going to be looking at a low double-digit kind of projection. Without having our budget done, 12% is probably a good way to think about it for us going forward just given the uncertainty in the headwinds on the energy side. I think our core business will continue to grow mid-teens, but then when you take out some energy paydowns and allow for a possible slowdown in Houston, that's kind of the number we look at -- kind of a low double-digit number.

Okay. And then was curious also, you mentioned that on the oilfield service book -- I know it's a small book, but there's no criticized or nonperforming assets there. Just wondering what is within that book, and are you seeing any signs of stress?

No. No signs of stress at all. That's obviously a portfolio. Even though it's small, it gets a lot of attention, and our account relationship managers there are in weekly contact with our customers. We look at it again credit by credit, relationship by relationship, and no concerns at all at this time about that piece of the book.

Okay. Are they -- credits -- are they more serviced in terms of trucking and delivery, or how should we think about that -- what is -- what are the underlying businesses?

Just really -- I couldn't characterize it for you, Steve, in terms of it's all transportation or it's all whatever. It's some pipe companies, some that are specialty -- make specialty drilling -- things for the drills, drill bits, if you will. And so machine shops -- so yes, it's a very general portfolio and very spread out.

Generally third, fourth generation ownership and not much leverage. And so literally, if you ask our concern level and we feel good, as I said earlier, about our credit, but I think CRE and Houston would be something that we are paying every bit as much attention to as we are paying to this.

Okay.

We just don't see any risk. We don't see any material risk there.

Got you. And then on those, just wondering if you could update us on what you are seeing in terms of loan pricing? Have things changed given lower oil price that perhaps you are getting a little bit better stability in terms of loan pricing?

We think loan pricing has been fairly stable, although people are trying to grow loans. We're still in a very competitive, difficult market, but loan prices seem to be stable. We're not seeing anything -- anyone behaving badly in that arena, if you will, at this point in time. So so far, I think our NIM reflects that. Our core NIM was up a couple basis points in the quarter, so I think that's an indication that our pricing is holding up quite well.

Okay. Thank you very much.

Brett Rabatin, Piper Jaffray.

Wanted to, I guess, first just ask on the loan growth you had in the quarter, I know payoffs have been a bit of a headwind for growth. Can you talk about maybe payoffs like maybe a number or just incrementally how much that was less of a headwind in 3Q versus where it was in 2Q?

I think, Brett, payoffs were actually fairly consistent in the second and the third quarter. So that's good loan growth from the third quarter, and what we saw -- and again as David pointed out, it was more back ended. So you didn't get the full effect of it for the quarter. But payoffs were relatively consistent on a quarter basis.

Yes, payoffs were $255 million, Brett, versus $250 million in the second quarter, so just right on the same.

Oh, okay. Great. And then just -- I guess thinking about Houston, everyone is kind of watching Houston and thinking about commercial real estate there. Could you maybe just give us your thoughts on your exposure to energy corridor and how much you might have in office versus apartment, what have you, in that market?

Yes, Brett, I'm going to let Torry give you some details behind the portfolio there.

Actually we feel very good about the Houston portfolio from a CRE standpoint. Our office portfolio is a little less than 9%, and if you look at that 9%, close to 69% of that or actually 68% of that is owner-occupied.

On the whole CRE portfolio that we have in Houston, we're close to 49% owner occupied, which is a bigger number than our overall portfolio. And again, the portfolio is actually very granular in Houston, and we have about -- the average loan size in Houston is around $300,000.

So overall, very conservative numbers, consistent with what we told you at the end of the second quarter. Again granular, we haven't seen any downticks in anything, and again, we feel good about where it's at.

And that 9%, Brett, of office exposure tends to be Class B office buildings that are in -- have a lot of equity and a strong tenant base, and even if those big new buildings coming on spill over, we think that our borrowers -- those tend to have guarantees on them, and we have almost no or varying significant exposure in the energy corridor on the west side of Houston in terms of office and apartments.

And so we -- we're concerned, right? We are watching, and we are aware of the concern about Houston. We still like that market an awful lot and feel like that's a place that banks and businesses are going to want to be over the next five plus, 10 plus years. And so we are paying attention, but we're not overly concerned about it right now.

Okay. That's great color. Thank you.

(Operator Instructions) John Moran, Macquarie.

Just a couple of ticky-tack follow-ups. Most of might have been asked at this point, but circling back on the E&P credit, the one in P&L, there was, if I'm not mistaken, a $1.5 million specific reserve against that last quarter, and then it was added to this quarter, $1.2 million. That certainly feels like it's marked to move. Do you have any sense in terms of resolution there? Is that something that you guys are, I would imagine, aggressively working out?

Correct. We are focused on aggressively resolving that one. I think -- I don't think we had quite $1.5 million at the end of the second quarter. I think it was more like $1.3 million, but yes, your point is correct that we put some pretty aggressive marks against that credit. That -- as we've spoken about in the past, John, an unusual situation. It has a lot of facts and circumstances around it, none of which are shared by any of our other energy credits. So we feel like we will get that one resolved here shortly, and we feel like we've got it appropriately reserved now given all of the -- given what the oil price points are now and what the appetite is out there for acquiring assets or loans. Okay?

Got it, yes. And then the other one that I had was -- I guess in round numbers, just under 30% of the book, criticized and classified today. Do you have a sense of where that has kind of gone to in past cycles, or -- and then a loss giving classified, where that might shake out? I mean I would think on the second part of that question, it's a pretty low number.

Yes, we -- we have the one nonperforming where we've made a significant provision and feel like we will realize a loss on that here this quarter or next, coming up soon, and we've got it appropriately reserved.

Beyond that, the two substandard loans is an example, John, in the energy book. Both have, Torry mentioned earlier, about -- our current market value of the collateral on those loans is approximately 150% of the outstanding balance on those loans. So we feel like we are in -- our borrowers are in very good position to resolve that, and they are cooperating and working hard to get those resolved.

We actually -- again, some of those credits are going -- where they've got assets like that, John, they are going to -- depending on what their strategy is, they may be selling assets, they may be selling some assets to reduce the debt down to where it's back in performing non-classified status, or they may be raising additional equity. All those things are going on, and we actually expect the credits that are in our substandard bucket right now to be resolved in a way that is positive for the bank and for the customer here over the next quarter.

Got it.

We don't anticipate, in answer to your broad question, John, when we look at the energy book, we do not see any material losses coming out of that book. Now again, depending on how long oil prices stay down, depending on discussions with regulators -- all those things will determine -- there's credit migration to the right there, but that said, I think that our -- we've got a terrifically experienced team working on this, we got on it early, and our borrowers are resourceful, they continue to have lots of options to deal with the current stress, and they are executing their plans, and we're trying to facilitate that as best we can.

Got it. Yes, and then the last one for me, I don't remember the exact number, but I think coming out of the spring process, you guys had a bunch of borrowers that had kind of tripped into MCR, and if you have any kind of update in terms of -- I know it's early in the fall yet, but what borrowing bases are doing in terms of percentage decline and how many folks you would expect to end up in MCR this go around?

John, about 60% of our energy borrowers are on some form of MCRs right now. The preferred borrowing bases could trigger, I guess, a few more to get into MCR, but I don't think it's going to be material. We will see -- the fall borrowing bases again -- we've been on a continuing basis updating our thoughts on the valuation of collateral and cash flow more importantly and how to resolve these, so our view is a little different maybe than some of our peers in that while we are doing fall borrowing base redeterminations, those aren't going to reveal information we don't already have, I guess, broadly and likely won't affect our strategies in terms of how to work with those borrowers and help them resolve any concerns or issues that they've got or we've got.

So we're not -- the fall borrowing base determination is not a big train coming down the track. In our view, it's just -- it will be a little bit of additional updated information. It might affect how we ask a borrower to deal with it, but it's not -- there's not -- we don't expect any big surprises in the fourth quarter, I guess, regarding the borrowing base determinations are going to drive any new material, big new substandard loans, and/or any loss expectation that would drive energy loss provision.

Got it. So definitely still kind of manageable and ring fence (multiple speakers)

Extremely so. Given the commodity decline, as I mentioned earlier, from $60 oil at the end of the second quarter to $45 oil at the end of the third quarter, we feel like our team and our borrowers are doing a great job with that.

Perfect. I appreciate it, guys.

[Chad Kopke], Wells Fargo.

My question regards the acquisition of Grand Bank. Grand Bank's balance sheet is very flush with liquidity. Do you guys plan on maintaining that on your balance sheet or lending it out with the strong loan growth that you've had recently and then pushing that into the fourth quarter?

Yes, that is a good point, Chad. Our strategy with this acquisition has been they have a terrific deposit base, and that deposit base will fit nicely and with our balance sheet, and then we will invest some of it in short-term securities in the interim time. But we expect -- our loan growth runs $100 million to $150 million a quarter, so it won't take too long to loan that out.

All right. Thank you. That's it.

Adam France, 1492 Capital.

Can you speak to -- can you give us any more detail on the nonperforming energy credit? You said it was unique situation. Just E&P loan I'm assuming? What can you tell us without getting into trouble?

Adam, it is an E&P loan. It's a small loan. It originated in, I think, $4.5 million. It is currently at $4.2 million. There are some hedges in place there. It is secured by assets in the Midwest. Got to believe Denver, Wyoming kind of energy and P assets.

And so beyond that, the circumstances -- the credit itself started out looking like our normal E&P credits, but just as we work through it, we've discovered some things that make the characteristics of this credit and what went into the loan and the clatter pull and everything just different than our other credits.

Okay. Very good. Thank you.

And I'm showing no further questions at this time. I would like to turn the call back to management for closing remarks.

Thank you. I appreciate everyone dialing in. We continue to feel good about being able to execute our plans, and we have go our sleeves rolled up like a lot of our colleagues here in Texas. But we still feel like we are in the greatest markets in the country, and they will be over the next 10 years. So we're taking an appropriate view, we think, in that regard and appreciate everyone's support and we're happy to continue to communicate if we can help you in any other way. Have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a great day.