Independent Bank Group Inc (IBTX) 2015 Q4 法說會逐字稿

Good day Ladies and gentlemen, and welcome to the Independent Bank fourth-quarter 2015 earnings compounds called.

(Operator Instructions)

I would now like to introduce your host for today's conference call, Torry Berntsen. You may begin.

Thank you and good morning. Welcome to the Independent Bank Group conference call to discuss financial results for the fourth-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 last night and a copy is posted on our website. We will be going over much of the release on the call. If you have trouble accessing it please call Robb Temple, 214-544-4777, and we will email or fax 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 page 4 of the text in the 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 only be a statement of management's beliefs at the time the statement is made. Predictions that we make may not continue to reflect management's belief and we do not publicly update guidance.

In this call 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 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 the call. David will open up with his thoughts regarding the fourth-quarter results. Michelle Hickox, our CFO, 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 everyone. And welcome to Independent Bank's fourth-quarter and year-end 2015 earnings conference call.

We are pleased with the results for the quarter as we continue to execute our strategies in the midst of rapidly changing market conditions. Here are a few of the highlights.

Core earnings were strong and continued to grow. They increased sequentially and on a year-over-year basis fueled by organic and acquisition loan growth. Quarterly core earnings of $11.4 million are the best reported by our Company to date.

For the year net income available to common shareholders was $38.5 million compared to $28.8 million in 2014, an increase of 33.8%. Our organic loan growth accelerated during the quarter to 21% on an annualized basis. Growth was focused in the commercial real estate and non-energy C&I portfolios.

In spite of the significant decrease in our energy portfolio in 2015, organic loan growth was a healthy 16.1% for the year. This growth occurred across all of our markets.

The Grand Bank acquisition closed November 1 which was approximately three months after the announcement date. The integration of their branches and employees is going well and the system's conversion is on track and will be completed in a couple of weeks.

Total assets increased to $5.1 million at year-end, an increase of $1 billion over year in 2014. This represents material growth from the total assets of $1.8 billion as of our IPO in April 2013.

Our conservative credit culture remains important, especially in today's volatile market conditions and we remain focused on asset quality. Nonperforming assets represented 0.36% a total assets at year-end, consistent or flat with a year ago.

The credit team continues to closely supervise underwriting, monitor asset quality and maintain effective credit administration. Our team is very focused on our energy and Houston portfolios.

As of year-end, our energy production portfolio was $182.5 million, less than 5% of total loans. This represents a decrease of 13% from the third quarter. Our criticized and classified amount at year-end was $67.7 million or 1.7% of total loans, a consistent percentage with the previous quarter.

The oilfield-related services portfolio was $22.4 million or 0.6% of total loans at year-end. None of these loans are criticized or classified. Michelle will give further detail on the energy portfolio in her comments.

Houston portfolio continues to perform well. The total portfolio is $1.1 billion and represents 28% of our overall loan portfolio at year-end.

CRE represents 66% of the Houston portfolio and average loan size is approximately $326,000. 46% of the Houston CRE portfolio is owner occupied and office buildings represent only 6.3% of the Houston portfolio.

At year-end nonperforming Houston assets were only 0.17% of the Houston portfolio. Overall, we believe that our 2015 performance in the face of challenging economic conditions demonstrates that the Company's fundamentals remain strong.

And with that I'd like to ask Michelle to go over more details on our 2015 fourth-quarter operating results. Michelle?

Thank you, David. Good morning everyone.

As noted in the earnings release, our fourth-quarter core net income was $11.4 million or $0.63 per diluted share compared to $10.9 million or $0.64 per diluted share for the fourth quarter of 2014 and $8.9 million or $0.52 per diluted share for the quarter ended September 30, 2015. Net interest income increased during the fourth quarter to $42.2 million compared to $38.2 million for the fourth quarter of 2014 and $38.1 million for the third quarter of 2015. The increase in net interest income reflects increased average loan balances resulting from organic loan growth and loans acquired in the Grand Bank acquisition.

Our net interest margin was 3.96% for the fourth quarter compared to 4.28% for the prior-year quarter and compared to 4.08% for the third quarter. The decrease is primarily related to the Grand Bank balance sheet mix that we inherited as part of the transaction. The reduction in the margin was not as dramatic as we had previously estimated because we have been able to deploy the liquidity they had into loans quicker than anticipated.

Our core net interest margin which does not include accretion was 3.91% compared to 4.07% in the third quarter. Total noninterest income increased $293,000 compared to the fourth quarter last year and increased $455,000 from the prior quarter. The increase from the fourth quarter last year is primarily attributable to increased service charges on deposit accounts, gains on the sale of real estate and enhanced wealth management and correspondent fees offset by decreasing gains on securities sold.

The increase from the linked quarter relates to a decreased loss on the sale of premises and equipment and enhanced wealth management and correspondent fees offset by reduced mortgage fee income and a decrease in the gain on sale of loans. Total noninterest expense increased $3.6 million from the fourth quarter last year and $2.7 million from the prior quarter.

The increase in each period is primarily related to increases in salaries and benefits, occupancy, data processing, FDIC investments and acquisition-related costs all associated with the Grand Bank transaction and integration. Expenses have also increased due to our growth including higher compensation accruals and also as a result of higher legal fees on some existing litigation.

The provision for loan loss expense was $2 million for the quarter, an increase of $219,000 from the fourth quarter of 2014 and a decrease of $2 million from the third quarter of 2015. The provision reflects loan growth as well as a moderate increase in general reserves for the energy portfolio in recognition of the continued decline in commodity prices. As you recall, we took a significant provision last quarter much of which was directly related to the energy portfolio.

As it relates to loans, for the fourth quarter organic loans held for investment grew 5.3% from September 30, 2015 or 21% on an annualized basis. Additionally, we added $273 million in loans through the Grand Bank acquisition. The composition of the overall loan portfolio remains comparable to previous quarters.

As David mentioned, energy E&P outstandings at the end of the fourth quarter were $182.5 million comprised of 25 borrowers. This represented 4.6% of the entire look portfolio.

We participate in three SNCs agented by other banks. In 2016 close to 50% of the portfolio is hedged at an average price of $54 per barrel. We currently have two nonperforming energy credits totaling $7.1 million and one performing classified credit totaling $17.1 million.

Aggregate criticized and classified energy credits totaled $67.7 million which is up from $56.4 million at the end of the third quarter. Energy-related reserves now make up 4.1% of the energy production portfolio. Oilfield service related balances represented an additional $22.4 million, or 0.6% of total loans outstanding at December 31, 2015.

The service loans were acquired in Houston acquisitions and represent 26 borrowers within the acquired banks had long-standing relationships. With respect to overall asset quality, total nonperforming assets represented 0.36% of total assets at December 31, 2015, the same as December 31, 2014 and compared to 0.34% at September 30, 2015. The slight increase compared to the linked quarter is due to the addition of a $2.9 million energy loan that was placed on non-accrual status in the fourth quarter.

With respect to funding, total deposits were $4.03 billion at December 31, 2015 compared to $3.25 billion at December 31, 2014 and $3.53 billion at September 30, 2015. $524 million of the increase was a result of the Grand Bank acquisition. We believe that Grand's lower cost of funds will benefit us going forward.

The average cost of interest-bearing deposits was 0.45% for the quarter, the same as for the fourth quarter last year and compared to 0.48% for the third quarter of 2015. Our year-to-date rate on total deposits decreased to 0.34%. 26.6% of our deposits are noninterest bearing, up from 25.2 at the end of 2014.

Total borrowings increased by $65.1 million from the fourth quarter of last year and increased by $36.8 million from the prior quarter. This reflects changes in the balances of short-term FHLB advances.

The Company and the bank were both well-capitalized at year-end. Earlier this month we redeemed the redeemed the SBLF preferred stock that was assumed in the Bank of Houston transaction in 2014.

The redemption was funded through a dividend paid from the bank. Both entities remain well-capitalized after the redemption.

That completes my outline of the highlights of our financial statement. So I will turn it back over to David.

Thanks, Michelle. We continue to believe in our fundamental business, the strength of our asset quality and our ability to execute our growth strategies.

We continue to monitor our energy portfolio at all levels of the organization. We remain in very active discussions with our borrowers which is a strength of the composition and structure of our portfolio.

Given the current energy environment and the impact it's had M&A activity in Texas, I'm sure to no one's surprise, has slowed. I continue to have dialogue with banks located in the identified markets where we plan to grow.

Over time, as the energy and capital markets improve these conversation should prove helpful as we continue to build out our footprint. We have continued to create long-term shoulder value. Both our tangible book value and earnings per share increased significantly during the year and we increased the quarterly dividend.

We remain committed to enhancing shareholder value. And every major decision is made with that commitment in mind.

In conclusion, we know that there are challenges ahead but we believe that our solid financial position, strong credit quality and commitment to our proven business model will continue to yield positive results. We also believe Texas is stronger, has greater diversity and is more resilient than in past energy downturns. We look forward to a solid 2016.

With that we will open the call to questions. Operator?

(Operator Instructions) Brad Gailey, KBW.

Hey guys, it's Brady. Good morning.

So you all have 16% loan growth in 2015 and you finished the year at a rate above that. How do you all think about loan growth as we head into 2016?

We're still cautious, Brady, around that. We did have a really good second half of the year. We do have good pipelines going forward.

We still have some headwind. In terms of energy paydowns you've seen our energy book declining. We project that to continue actually at an accelerated rate in the first quarter.

So that said we're cautious around growth rate. I think we said in our third-quarter call that low double digits, low teens kind of number is what we expect for what we're thinking about for 2016. And we haven't changed that based upon our loan growth last year, you know, it seems to always be lumpy.

And we had a really slow first quarter and a really big fourth quarter. And we think it will be lumpy again this year given we don't know when the paydowns come on energy as we get resolution of some of these credits. So I think low double digits is still a good guess for us for 2016.

All right. And then it's interesting if you look at some of your peer banks through this earnings season, you know Bank of Oklahoma increased their energy portfolio, Legacy Texas increased their energy portfolio.

You all are kind of headed in a different direction by decreasing it. But what's driving the shrinkage in energy? And then is there any way to guesstimate how much energy could shrink in 2016?

That's a great question, Brady. We just have seen this shrinkage as a result of resolution of credits. Our borrowers are going to the capital markets and either refinancing in some cases with some subordinated or secondary-type debt or they're selling assets in a lot of cases, either partial sales or complete sales of their portfolios and retiring debt.

So that's what's driving the paydowns. We could see it come down another 20% to 30% we think this year in balance. So we finished the quarter at $182.5 million in E&P production loans.

We wouldn't be surprised to see that come down to that $140 million, $150 million level this year when we bottom out. But again as we said going into 2015 we said that it would be best that we thought we would decline for a while and then see an opportunity in the second half of the year when prices stabilize to do more financing.

We have seen some opportunities to grow the portfolio or to book new loans in the second half of the year. We've been more focused on resolutions and so we do intend to be active in the market. We're looking for good opportunities but we just haven't seen credits that we were willing to take a position in in the fourth quarter.

All right and then finally, how top-heavy are you in your energy bill? You mentioned the three SNCs that are agented by others but how large are your largest energy borrowers?

That's a good question. I think their positions, our four largest are in the 12 to 18 range broadly, average 15 apiece. So I would say our SNCs I believe are the four SNCs totaled $66 million, something in that range give or take $1 million or two there, Brady.

I don't have the exact number in front of me but it's mid-upper 60s for the total of those four SNCs. We do expect one of those to be repaid in the first part of the year, first quarter, second quarter of the year through asset sales.

The other SNCs we're just working on and resolving. We don't have any imminent payoffs on the other three SNCs.

But beyond that then when you go outside of those four SNCs, Brady, our average probably goes down in that five to 10 range for the remaining credits on the E&P side. And a lot of those are where the sole lender we have guarantees and in some cases we have other collateral, real estate collateral, things like that in addition to the reserves that are pledged behind those loans.

So that is something that's different about our portfolio when you compare us to our peer banks. Our absolute exposure is down to on the E&P side below $200 million from a peak of close to $250 million. And when you look at the amount, the percentage of our credits that are SNCs and the percentage of our total book that are made up of SNCs it's less I think than a lot of the other banks that you're talking about.

And again we're not proclaiming that as a positive or a negative, we just say this is what we are if you will at this point. And we do think that gives us some additional control but it also makes our portfolio look different, Brady, in that we don't have a huge fall redetermination and a huge spring bring redetermination.

We certainly our SNCs obviously are on that schedule. But the rest of the credits are more on rolling re-determinations and our price deck adjusts very frequently and we're redetermining.

So we don't feel like we're facing a big bullet if you will in the spring of this big redetermination. And if prices stay in this low 30s range that that's going to be make a whole bunch of our credits slide over into substandard. We have continued to see some migration.

We saw our classifieds go down in the fourth quarter but OAEM special mention credits kicked up a little bit as we did some borrowing base redeterminations. And some of them were deficient to our policy and if I can say broadly about energy we feel good about where we are. Our team is working hard resolving credits and we're seeing paydowns as a result.

We still don't -- we're at a little over 4% reserved against our energy book. We made that as you recall in the third quarter, as we took an outsized provision in the third quarter in anticipation of these lower prices and what effect they might have in the fourth quarter. And we think that was appropriate and we feel well reserved at the end of the year.

I've listened to a number of the other calls and one of the I think questions that all of us are trying to get to it is what if oil prices stay in the upper 20s to low 30s for this entire year. I think that's an unrealistic scenario but I understand it's something we're all thinking about and it's certainly our credit folks are aware of that scenario. And I still don't believe, so all that to lead to my broad statement, I still don't believe that lower for longer means that we or the other banks broadly in this space are going to have huge credit losses because there's still assets, there's still cash flow.

You do your redetermination and happens is they fall out of compliance with our policy. And thereby they've still got cash flow but those cash flows don't pay back the debt in the half-life or whatever that asset pool.

And so you have extended payouts and you've got loans that are over 65% advanced against the collateral value. So therefore you're out of compliance. That means you've got to make it a mention or a substandard loan.

You've got to look and see what is the potential loss exposure and reserve against that. At the end of the day unless you think oil is going to stay at $28 or $30 for the next five years I just don't -- we don't see big losses coming down the pike.

But we could see as everyone continues to say more migration of these credits to being more special mention, more classified as they fall out of borrowing base but all that gets rectified in a hurry if and when oil prices go back up. We're not banking on that but we're certainly aware and don't believe that oil prices stay at $28, $30 for the next five years either.

Brady, just one point on that. You asked about what levels were at.

Remember there are 25 borrowers in the portfolio. So that will give you 25 and the outstandings are $182.5 million so that will give you some kind of parameters to look at as well.

Great, thanks for the color, guys.

Brad Milsaps, Sandler O'Neill.

Hey, good morning guys. David, I appreciate the guidance on loan growth for this year.

I was just curious, looking at the GAAP capital ratio down below 7% now and some of the regulatory ratios getting pushed are you limited in any categories, particularly C&D or CRE in terms of what you'd be willing to grow there? Given I guess C&D was over 100% of some of your regulatory capital and of your risk-based capital number just kind of curious on the individual categories if you have any limitations there?

No, we obviously monitor that closely, Brad, but that's our bread-and-butter has been CRE as a community growth community bank. Over the years a lot of the things we do end up being real estate secured and we talk and happy to get into more details behind that.

But it's broad, it's diversified, it's a lot of owner-occupied. So we're not overly concerned about the CRE level.

The construction side we've been a strong line of business for us over the years has been our interim construction lending. We've stayed away broadly from development loans, meaning lots on the ground and spec land for future lots and things like that. Those have not been big lines of business for us.

We've also avoided so maybe a limitation, Brad, that we think about is given where we are, capital wise given where we are CRE we continue to feel strongly that we don't want to be a participant in big national-type real estate construction projects or large office buildings, large multifamily complexes. We haven't done that historically anyway but given our capital ratios we certainly wouldn't be a big player in those types of credits today going forward.

So we're going to continue to conduct our business as we have. We manage the risk and given that we've been a large real estate lender, Brad, for the entirety of our existence the regulators have been in year after year after year and looked at our monitoring systems, looked at the way we manage that credit and that risk and they've looked at our losses in each of the downturns and they've been minimal compared to our peers. So we'll stand on our track record on real estate.

Got it. That's helpful. And then secondly, I note you had two months of Grand Bank, just curious, Michelle, how quickly or how quickly you are able to reposition the balance sheet?

I know they did a lot of it before it came over. Just curious from a run rate perspective on expenses and then some of the revenue line items, is it where you want it to be and at what point did it get there during the quarter? Just trying to get a sense of what it can contribute on a full-quarter basis in the first quarter.

Yes, actually if you remember we were really projecting it would take us about six months to use their liquidity, rebalance their balance sheet. Our loan growth was so strong in the fourth quarter that actually happened a little quicker than what we thought it was going to.

If you noticed our NIM was much better than what I thought it would be considering that we brought them in two months earlier than we originally thought we would, at least in the fourth quarter. We will get more of the cost saves in the first quarter from the Grand acquisition.

The operational conversion is set for February 12. So we're be able to get some more cost out once that happens. There's a few employees that are staying through that date and just other costs from having to run through systems that we'll be able to eliminate.

I think if you look at our core expenses in the release I would expect they are going to be down a little bit from that, the run rate will be. I think some of the questions we have related to professional fees I expect that to be lower.

We had some unusual expenses in the fourth quarter but those may be elevated historically. There's some things in fourth quarter like I think somebody had a comment about advertising expense. That's always lumpy.

We usually frontload that. So I would expect that number will be a little higher in the first quarter. Fourth quarter we typically don't have as many expenses, so hopefully that's helpful.

Very much so. And just final question, if my math is right of the $27 million reserve about $7 million of it is assigned to the energy book, so that leaves you about $20 million for the rest of the portfolio. Can you just remind us what marks you have, what that reserve would look like if you looked at it on a I guess a legacy loan basis or non-acquired loan basis?

Yes. We still with the current marks post the Grand acquisition, Brad, we're at 1.01% overall to the overall portfolio. So an additional $10 million to $12 million of marks out there in addition to the reserve that you're seeing.

So that puts us what close to $40 million against the reserve on a $4 billion book. So we're just a hair over 1% which is consistent with where we've been in the past. If you take a look at what's in the loan-loss provision plus the marks against the acquired loans we've been in that 1% to 1.10% range consistently and that's where we still are.

Perfect. Thank you, guys.

Thanks. And one other thing I would say, Brad, to your question on efficiency and I think it was Michelle said it but it's going to take the first quarter here to get the costs where we -- so the first quarter that you should see a cost run rate that's pretty indicative is the second quarter of this year going forward. And certainly Michelle can provide more detail to the analysts regarding what we think that pro forma looks like in the second quarter going forward.

Actually, a lot of that goes away when you have the conversion on the expenses because you don't need to people to run similar things from both institutions.

Brett Rabatin, Piper Jaffray.

Hi, good morning. David, I wanted to just ask first on the loan growth you had in 4Q, could you give us some idea of origination rates that you were seeing in the fourth quarter? And then you talked some about what you weren't doing in commercial real estate as you guys think about 2016.

What are you doing and are you going to see more C&I relative to CRE? It sounds like maybe. And then what have you pulled back from anything in Houston and maybe some Houston comments on commercial real estate.

Sure. So we saw good origination across the footprint, Brett, in the fourth quarter and it really was nothing unusual. It's the same core business we've been doing for the last way 25 years.

It's a lot of owner-occupied real estate, banking professionals, medical office buildings, investments for wealthy families that are investing their family office money into real estate projects to generate income. And that was across the footprint, although Austin and Dallas are certainly growing faster than Houston at this point. But I think when we look to the originations for the year it was around 20% growth in the Dallas and Austin markets and then about 12% growth in Houston.

And then we've got some areas that are not as growthy further north of Dallas and some of our central Texas locations are not as high growth. But in our higher growth markets of Dallas, Austin and Houston, for the full-year of 2015, we saw about 20, 20 and 12 approximately.

So that's how the spread was across the footprint in originations. And again a lot of smaller credits and staying in our sweet spot of that $3 million to $10 million where most of the originations were.

As far as Houston goes, we've been quite pleased with the portfolio there. I think we put in our releases we've got our portfolio at the end of year was approximately $1.1 billion of which approximately 65% was CRE.

That CRE broken down broadly across many categories and approximately 50% or 46% owner-occupied. Importantly there I think when you look at our portfolio in Houston, CRE portfolio in particular, to note that our multifamily exposure is approximately $25 million or about 2% of our Houston portfolio and our office building component is about $70 million or 6% of the Houston portfolio.

So when you put those two together 8%, 9% of that total portfolio is in office and multifamily which is the category most people are most concerned about. And with a lot of particular focus on some of the larger projects that are just coming to market or have recently come to market and are having to go out and try to fill the buildings or the apartments and thereby putting a lot of pressure on rates. We're just not a participant in those credits.

And so when you look at our portfolio it tends to be very much smaller, very granular, average loan size in Houston of $326,000. And if you look at the average CRE maybe for a little better look, average CRE loan is $850,000 in Houston.

So that portfolio is well seasoned. It was just as we continue to grow there it's been with the same customer base that we acquired when we merged with Bank of Houston and Houston Community Bank.

We've got a terrific team of lenders on the ground down there that have long and deep relationships. We've got seasoned veterans of 30-plus years leading the charge down there.

We've got a terrific group of younger women and men on the ground there cultivating relationships every day. We're just not participating in large syndicated credits there. We're building relationships one at a time down there.

And frankly Houston while it has slowed down and there's continuing concern and we're very much monitoring the situation there we're actually encouraged to grow 12% in 2015 in the face of what a lot of people think is Houston falling into the Gulf of Mexico is just not true in our experience at this point. It doesn't mean we're not continuing.

And certainly the lower oil prices for this year would cause concern around more layoffs and things at the large service companies based in Houston and the Southern Texas area. So we're watching, paying close attention but we have almost I think we put in in our classified credits in Houston were 0.17%.

That's better than if you look at the rest of the Company across the state. And I've heard our Chief Risk Officer say that that portfolio was very clean going in and it's held up better than most of the portfolios we've acquired in acquired banks over the years. So it's doing terrific.

We've got the right people. We've retained the folks that joined us in those acquisitions have stayed on and worked hard and taken up the Independent Bank flag and done a good job with it.

So we're happy with where we are in Houston but we're like everyone else. On the energy portfolio and on the Houston portfolio we're watching and we're slicing it seven different ways and studying it every day and every week to look for weaknesses or risk factors. So far we're not seeing it.

Okay, I appreciate all the color on that. Then just thinking about the funding base, do you guys -- your loan to deposit ratio obviously is still kind of close to 100% but I guess I'm just curious as you think about maybe slower growth this year than 2015, is it possible to change maybe the mix of the funding base some and how you guys think about the loan to deposit ratio here and your outlook on deposits?

We've been working hard to build a treasury management team the last two years. We believe we're finally going into 2016 completely staffed with seasoned professionals and veterans from various of the other regional Texas banks have joined up. And we put a very strong focus on that.

Every loan we book there is a discussion around how the deposits look with that customer, how can we get a larger share of larger wallet share with that customer. That said, it's a tough battle when you're booking loans at 20% a year, 16% a year it's been a challenge.

We've mitigated that somewhat over the years by acquiring deposit rich franchises such as the Grand acquisition that was 50% loan to deposit and blended them in. As Michelle said because of the accelerated loan growth in the fourth quarter we loaned up a lot of those funds already and we went from 98% to 90% or 92% back up to 98% in a quarter. So a lot of I guess volatility in our own loan to deposit ratio there.

But long term we've got to do a better job at that, Brett. We've invested in the people. We put the attention on it from my office and all the executive team here across the organization.

At the end of the day as you point out if our loan growth slows a bit to the low double-digits range then that will give us a chance to catch our breath on that. But ultimately we've got to continue to find merger partners as well that are deposit rich with good, sticky, low-cost deposits and continue to blend that as a part of our growth strategy. But for the foreseeable future, Brett, we're going to be a high loan deposit bank.

Okay, thanks for all the color.

Steve Moss, Evercore ISI.

Good morning, guys. I was wondering -- circling back to the Houston exposure if you could give us loan-to-value ratios and debt service coverage for that portfolio?

For the entire portfolio?

For the commercial real estate.

Yes, for the commercial real estate I don't think -- I don't think we have run the metrics or if we have let me say it this way, I haven't seen the metrics on a portfolio across the entire portfolio looking at a portfolio-wide debt service coverage and all that. I will tell you that those deals typically are 1.5% to 2.5% debt service coverage on those smaller credits that we've got down there that are the core of the book.

I think our loan-to-values tend to be in the 50% to 65% range on those credits typically. A lot of them as I mentioned earlier are seasoned credits, they have guarantees that are the family offices, they are to small businesses, they are to doctor practices, doctor groups that have been in practice for 10, 20-plus years.

So we just don't, I'm not sure if that answers your question specifically, Steve, and I know you're trying to get his what is the risk of the sensitivity. But I can just tell you broadly and certainly we can get you some statistics back of our internal to the extent we have portfolio-wide numbers on that.

But given how small and how granular that portfolio is, I'm not sure that that really even if I could tell you it's 1.8 times coverage that doesn't mean that we wouldn't have two or three that are at 1.1. So I'm not sure that that's --

That's helpful overall color, helpful there. And then the other thing I was wondering about is what percentage of your energy loans have subordinated debt relative to your position?

I'm sorry. Ask that again.

What percentage of energy loans have subordinated debt?

Probably two of our 25 credits have subordinated debt behind us.

Would those be the larger credits or --

Correct. Yes, larger credits. And one in particular that we expect substandard that we're expecting to be paid off on this quarter has sub-debt behind it. So that would be one of the two.

Okay. And then with regard to the acquired oilfield service loans I'm wondering if you can quantify what the discount is on that portfolio?

The mark credit mark?

Yes.

It was really inconsequential because those credits were all well secured strong cash flow guarantors. When you take out I believe there are 20, how many credits Torry? 26 credits in that --

In that credit 22.4 portfolio.

Yes, so $22 million portfolio with 26 credits in there, 26 relationships, Steve. And so they are all generally really some of those credits you would look at and think that's really more of a traditional C&I machine shop in the heart of Houston. But because they had a significant part of the revenue coming from the oilfield we classify them as an oilfield service credit but in reality it's a third-generation machine shop with not that much leverage.

They've all paid down debt where need be. And so we really -- that's obviously a portfolio that's gotten a lot of attention and got a tremendous amount of attention on the going inside because that's not a business we were in. And so as we often do when we're looking at a bank that's in a line of business that's not in our core, we tend to look twice at those and reserve double what they really need and in this case we did not see the need to put extraordinary reserves against it.

And so I don't recall what the total reserve for that for the total mark against the Houston portfolio was around 1%. And I would expect that book would have been about the same, Steve.

Okay. That's helpful. Thank you very much.

Kevin Fitzsimmons, Hovde Group.

Hey, good morning David and everyone. First question I had it's probably for Michelle, and I apologize if you went over this already, I was just wondering I thought I heard you say that the margin held in a little better than you all had thought. But just looking forward if you can give us a little sense for how you expect the margin to go from here either on a reported, I know on a reported basis a little tough with accretion income but maybe on a core basis.

Yes. I think our accretion income is going to be probably lumpy like it has been historically. But generally it's a 2 to 3 basis points difference on a quarterly basis. And based on our projections we think our margin will probably be stable this year --

From where it was --

From where it was in the fourth quarter. And really where I said I expected it, it was higher than I expected it to be was because we were able to bring Grand in with two months left in the quarter.

And with their balance sheet mix I really thought that the margin would drop probably 10 basis points more than what it did. So the ability for us to move their liquidity into loans as quickly as we did really helped our margin in the fourth quarter.

Okay great. And that's stable outlook versus fourth quarter, that's on the core margin, correct?

Right, yes.

Okay. And one quick follow-up, David, this is for you and this is probably a tough one to answer but just looking out over the next few years, on the one hand I have to imagine you sense an opportunity, there's probably banks that are pulling back that are retreating from energy altogether and so there's an opportunity to further penetrate and expand some relationships.

On the other hand I have to imagine that a bank coming out of this experience that we're still in, the energy cycle, there may be a little sensitivity about well do we want to expand our concentration into energy given that we're going to go through these things every once in awhile. So how do you balance that and how is your outlook on that? Thanks.

That's a great question Kevin. I think everybody's looking here going wow you know, this has been more difficult than we expected obviously a year or 18 months ago with lower for longer. That said, we're committed to being in the business.

We're building a first-rate regional bank in Texas. I think it's a line of business that you need to be in, you need to do it well.

We've seen here during this downturn continued importance of conservative underwriting and assuming bad things when you underwrite a credit to make sure you're prepared for it if it happens. So we're going to be looking for opportunities and as soon as there's some stability in these prices and people get confident that it's we've seen the lows then I think there will be opportunities.

We've got a number of our borrowers that are well capitalized and sitting on cash and anxious to do something and so we think we'll see opportunities. We think we will see that portfolio grow but as I mentioned earlier I suspect we'll see that E&P piece of the portfolio decline in the $140 million, $150 million range before we begin to see some upward mobility.

We hope that's in the second half of the year. We haven't planned for that and that's not in our numbers if it were to happen. We've only figured in a headwind at this point but energy is a business that we have been in.

We got in about three, four years ago now and we built our portfolio in what people thought was the raciest of times, our portfolio was holding up quite well. And so we feel good about our broad underwriting.

We will work through the problems and issues like all of our colleagues are doing across the state and across the Southwest. And we're committed to be in the business for the long haul and I think at the peak we were about 8% of our portfolio in energy. We're down to below 5% on 4.5% on the E&P piece of the portfolio.

So it's reduced dramatically and we didn't expect it to reduce that dramatically but we also didn't expect oil prices to go to $26 and change either. So we're adapting on the ground.

We've got a terrific team. And I will say to people who produce those loans and who have the relationships that hung in there with us and are helping us work through them and they are at the table and working with the customers and the customers have been terrific.

Great. Thank you.

Michael Young, SunTrust.

Good morning. David, I'm curious on the M&A side just given the lower capital levels right now and the oil or energy price volatility in the market, how long do you think it will be before you guys can be active on that front?

Think it's hard to know obviously if we knew exactly when oil prices were going up and bank stock prices seem to be marching in lockstep these days with energy prices I would know the answer to that. But I think it's probably instructive, Michael, that when we announced our last transaction last summer with Grand Bank our price was between $43 and $44 and that deal was accretive and met all of our bars and terrific deposit base and great locations and great officers and directors, etc.

So I think we would need to see some increase in stability and oil prices and we'd need to see bank stocks follow that in order for us to be active in the market, although it's interesting. The lower and longer these prices go for oil I think it does cause a lot of other banks, privately held banks across the state to think about hey, if we were thinking we wanted to find a merger partner in the next few years, what does that look like and what are our price expectations?

And I do hear more and more people talking about hey, we just want to make sure we find the right partner who's got the right strategic vision and conservative credit culture and so we'll see. That may change some of those metrics, that's why a hesitate to give you a hard number of saying hey, if our stock gets to X we're in the game but we continue to have discussions. We continue to build and try to nurture relationships we've had for a long time and we feel like when the opportunity presents itself we'll be as well-positioned as anyone, Michael, to operate in.

Okay, great. Then ask a follow-up just given the work you've done I guess on the energy side to bring that portfolio down and maybe the confidence you have in Houston is there any interest in doubling down on that? Would you look at a bank that has energy or Houston exposure or are you trying to stay away from that at this point?

We will look at every opportunity but it would be a pretty high bar for us to double down on energy or Houston at this point. And again that is not at all to say we're not ecstatic with the partners we've made in Houston and the book of business we have and our lenders there and our teams there. But if you're asking me if we would be wanting to buy another $1 billion or $2 billion of Houston assets today, that would be a high bar for us.

Okay great. And if I could sneak one last one in, you know just on the deposit side I know you have a lot of municipal funding accounts that have been core for a long time.

And I'm curious sort of your outlook for those in potentially rising rate environment. How often are those sort of repriced or are you seeing any additional competition for those deposits at this point?

Yes, they tend to reprice, rebid every couple of years. We've had in most cases we've got long-standing relationships with those portfolios. That said they are public funds and their boards and the school boards and the city councils, etc., have a fiduciary responsibility to the taxpayer which we understand to maximize the return on their available funds.

So they have other vehicles, state pools, money market-type funds that pricing has been very stable at about 50 basis points on those funds to date. But that's something when we do our asset liability model we make provisions for that. So when we say our asset liability model is basically balanced, slightly asset sensitive but basically balanced we have put into our model because we do have this book of municipal deposits and we know that they can be more price-sensitive than some of our other deposits we have that modeled into our model.

Okay great. Congrats on the good quarter.

John Moran, Macquarie capital.

Hey, good morning guys. How's it going?

A couple of quick follow-ups and then one sort of ticky-tack modeling question. The line utilization on the overall production book, and then could you just remind us how many of those are in MCR and how that process is going?

Great. So about 60% of the credits we have are on MCRs at this point, John.

And the line availability as you might imagine with prices coming down and the price decks hitting the deck so to speak, that has used up most of the availability. So we have our existing E&P borrowers have very little unused availability at this point. So we do not expect any advances or increases in our portfolio coming from that source.

Got it. Then the MCR process itself, everything has been orderly, it continues to be it sounds like?

Very much so. And a lot of times once a borrower goes on MCRs that means the basic business model in that business as you know, John, is to have a proven field, be drilling wells, increasing proven and producing oil flow and gas flow, that's creating cash flow. You go to the bank, you increase your line, you drill more wells.

And usually when you get into an environment like this and the MCRs are put in place to reduce those credits and to bring these loans back into conformance with the borrowing base or with policy of 65% say of loan-to-value, that usually is a tipping point if you will for a borrower to go okay, well I can in this environment execute my strategy of continuing to drill wells. And so a lot of times it causes them to think well, I need to recapitalize because I want to keep drilling or I need to sell off some noncore fields and use that money to go drill some or wells.

So my point in that, John, is that a lot of times once you set up MCRs then we'll see a sale of assets that either reduces the debt or that they use to go drill some more wells, get some more production and then the next borrowing base determination prices may not have gone up but they've got more proven producing wells that increase the borrowing base in terms of the amount of barrels they are producing and even at a lower price mitigates a little bit against the borrowing base problem that they might have. So all that to say yes, the borrowing base or the MCR process has gone well.

It's accomplished exactly what we're trying to do. But in some cases it's probably contributed to this decline in overall book because once you put someone in MCRs they go wow, maybe I need to just sell my assets or whatever and so you see some paydowns from that.

Understood. That's definitely helpful. Then I wanted to circle back on the services book, the $22.5 million around numbers and services.

It sounds like you said, or a good chunk of that maybe, is not what we in sort of the analyst community would consider like real pure services near or maybe like one step removed from the drill bit but rather a manufacturing business that has a significant portion of revenue tied in some way to energy. Could you tease that out for us a little bit and say how much is what we would define as traditional services versus manufacturing?

Yes, so traditional services if you think of that, John, as what's going on out at the wellhead, the drilling and the saltwater disposal and the campsites and all those things, that we have almost none of that. What we have is what grown out of the Bank of Houston was banking wealthy families, wealthy families often times over the years have had investments in companies that are more manufacturing- and transportation-related and secured by those types of assets. And again I'm not saying that means it's insulated from pressure.

Certainly they've seen their cash flows go down and they've had to reduce debt or pledge additional collateral or whatever the case may be. But we found those borrowers as I mentioned earlier those really look, that book looks a lot more like a traditional C&I book than what you think of when you think of oilfield service.

And in terms of stuff going on out in the field we have almost none of it in that portfolio. And again most of those are small credits, average size in that portfolio $850,000 per credit. And they've been on the books multigenerational, well-capitalized owners and families with other resources other than what's on the balance sheet of that Company and they've been willing to bring those to bear to keep those credits performing pass rated and cash flowing.

And we just as I mentioned earlier, John, there's no portfolio in the bank that's gotten more attention before we purchased it and since we purchased it than that portfolio has. And again that's not a prediction of future performance, it doesn't mean that we couldn't have a classified loan in that book but it means that right now what we've seen and what we have on the ground has all been extremely positive.

Much better than if you would have told us, John, that we were going to see this kind of oil price environment for this long and said do you think you'll have some classified criticized credits in that book we would've said certainly. But so far so good.

Understood. That is definitely helpful.

The last kind of follow-up is you guys mentioned the multifamily exposure in Houston and then the good detail on CRE owner-occupied and term. Do you have construction development and land there? I imagine it's probably pretty small.

Very little construction development and land at this point. About -- Torry I think you looked at some numbers before the call this morning. Would you --

Yes, roughly if you look at land and land development of the overall portfolio it's roughly around 7% of that of the $1.1 billion.

Okay yes, so 7% of the Houston exposure.

Correct. Yes.

(multiple speakers) of the $1.1 billion.

Right.

Okay. And then the last one for me just I guess a follow-up for Michelle. How much could we see dropout of the OpEx run rate in 2Q once you guys can flip the switch here and then what kind of operating leverage would that imply?

I don't know that I can give you firm numbers on that at this point. I do expect that our expenses will go down in Q2 but I hesitate to give you firm numbers right now. We do expect our efficiency ratio, it' bumped up at the end of 2015 but we expect that that's going to go back down to mid-50s, possibly even below that by the end of this year.

So I think a run rate, John, if you thought in Q2 about expenses that would yield a mid-50s kind of efficiency ratio and then hopefully as Michelle said as the year goes along we will get below that significantly. But is that fair, Michelle, mid-50s in the second quarter?

Right, yes, I think that's fair. And some of that, the decrease in efficiency is all going to come from generating revenue so --

Yes, I understand of course there's two parts to that equation. So thanks very much for taking the questions guys.

Matt Olney, Stephens.

Hey, good morning guys. How are you? All my questions have been addressed but I appreciate the great detail and congrats on the quarter.

Hey, thanks much, Matt. Hope you have a great day.

Brett Rabatin, Piper Jaffray.

My follow-up has been addressed. Thank you.

And I'm not showing any further questions at this time.

Okay. If that's it for the questions then that's going to conclude our fourth-quarter 2015 earnings call.

We appreciate everybody dialing in, appreciate your interest in Independent Bank Group and look forward to seeing you out on the road here this first quarter. Thanks.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.