Independent Bank Group Inc (IBTX) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Independent Bank third-quarter 2016 earnings conference call. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to introduce your host for today's conference call, Mr. James Tippit, Head of Corporate Responsibility. You may begin, sir.

Good morning, everyone. Welcome to the Independent Bank Group third-quarter earnings call. We appreciate you joining us this morning. We released our earnings press release last night. The release and a slide presentation can be accessed on our website at IBTX.com.

Before we get started I would like to remind you that remarks made today will include 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 or page 2 of the slide presentation 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.

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 and pages 15 to 17 of the slide deck.

I am joined this morning by David Brooks, CEO, who will give you some highlights and his thoughts about the quarter, and also Michelle Hickox, CFO, who will lead you through the quarterly operating results. At the end of their remarks, we will open it up for questions. I will now turn it over to David.

Thanks, James. Good morning, everyone, and thank you for joining us on the call this morning. Our third-quarter results continue to demonstrate our focus on consistent, strong performance. Here are a few highlights.

Our earnings continue to improve, with this being our highest reported quarterly net income to date. Third-quarter core earnings were $14.8 million and represent a 7.7% increase in core earnings from last quarter.

As indicated on slide 6, our earnings continue to grow quarter-over-quarter end year-over-year. We are getting results from the cost-save initiatives we implemented earlier this year, with a material decrease in our core efficiency ratio to below 53%.

Although loan growth slowed a bit from the first half of the year, it continues to be strong in all our markets, with annualized growth of 10.2% for the quarter. Total assets increased to $5.7 billion at quarter end, an increase of $1.2 billion over third-quarter 2015.

Our credit metrics continue to be at historically strong levels and remain below state and national peers, as shown on slide 10. As you know, maintaining a strong credit culture is a fundamental principle of our Company, and trends in this area remain favorable.

The size of our energy portfolio remained stable from last quarter at $126.5 million or 2.9% of total loans. We continue to resolve some problem credits in this sector as necessary, but we are pleased to note that we have had opportunities this quarter to participate in new deals as well.

I will now ask Michelle to go over more detail on our second-quarter operating results. Michelle?

Thank you, David, and good morning, everyone. Please note that slide 5 of the presentation includes selected financial data for the quarter.

Our third-quarter core net income was $14.8 million or $0.80 per diluted share, compared to $8.9 million or $0.52 per diluted share for the third quarter of last year, and to $13.8 million or $0.74 per diluted share for the linked quarter. Recall that we took a material reserve for the energy portfolio in third-quarter 2015 that impacted earnings during that quarter.

Net interest income remained stable during the third quarter at $45.8 million, compared to $45.9 million for the linked quarter. While interest income increased by $799,000, it was offset by interest expense on the subordinated debt issued at the end of the second quarter, as well as a slight increase in the cost of deposits, primarily due to increased cost of public funds.

Our net interest margin decreased more than expected for the quarter at 3.66%, compared to 3.96% for the linked quarter, and 4.08% for the same quarter last year. The decreases are due to lower yields on loans and securities, along with an increase in cost of money market and certificate of deposit accounts.

Although interest rate pricing on new loans this quarter was generally consistent with pricing in previous quarters this year, overall loan yields were negatively affected by lower fee income and the payoff of some higher-yielding energy loans that were accruing at default interest rates. In addition to those, there were several factors that contributed to the decrease in the margin from the linked quarter.

We moved our excess liquidity from our clearing correspondent non-interest-bearing account to an interest-bearing money market. The earnings credits on that account, which are reported in noninterest income, were offset by the additional interest we earned and had a neutral effect on that income, but diluted our margin by about 10 basis points.

We also experienced a high level of calls in our investment portfolio during the third quarter. Several municipal bonds had unamortized premiums that negatively affected the yields for this period. In addition, the interest expense on the recent subdebt offering decreased the margin by about 5 basis points.

Total noninterest income increased $1.1 million compared to the third quarter last year and was fairly stable compared to the prior quarter. The increase from last year is related to increased mortgage fee income, increased earnings on new BOLI policies, and a decrease in loss on premises and equipment. For the linked quarter, an increase of approximately $88,000 in service charge income and $132,000 in BOLI income was offset by a decrease in mortgage income and correspondent earnings credits as mentioned earlier.

Total noninterest expense increased $1.1 million from the third quarter last year, and decreased $4.1 million from the linked quarter. Overall increases in noninterest expense from the prior year are generally due to increased compensation, data processing, and the FDIC assessment associated with the Grand Bank transaction.

With respect to the decrease in the linked quarter, recall that we had $2.6 million of expense related to the Company's senior leadership restructuring in the second quarter. Our ongoing run rate on compensation was also reduced by these changes. In addition, mortgage and lending related bonus accruals and commissions were higher in the second quarter, and we also experienced a positive adjustment on our health and benefits expense during the third quarter.

We increased our FDIC assessment accrual for the quarter by $254,000 compared to the linked quarter. This increase was offset by lower professional fees, which were down by approximately $260,000 due to lower legal costs related to the energy portfolio.

The provision for loan loss expense was $2.1 million for the quarter, which is comparable to the linked quarter and a decrease of $1.8 million from the prior third-year quarter, when we took additional reserves for the energy portfolio. Generally, provision expense correlates with net loan growth and level of charge-offs; however, because we had previously made provisions for a problem energy credit in 2015, the $3 million chargeoff we made this quarter did not result in additional provision expense. Note on slide 11 our provision expense and chargeoffs in each reported period.

Loans held for investment grew 2.6% from June 30, 2016, or 10.2% on an annualized basis. We continue to see growth across all of our regions.

As illustrated on slide 12, the energy portfolio was $126.5 million at September 30, 2016, versus $122.1 million as of the end of the second quarter and remains stable at 2.9% of total loans. Due to the chargeoff mentioned earlier and improved metrics in the energy portfolio, the energy-related allowance has decreased to 4.7% of the energy portfolio at quarter-end.

Nonperforming assets improved compared to the linked- and prior-year quarters due to disposition of ORE, payoffs, and the chargeoff mentioned earlier. Total nonperforming assets represented 0.23% of total assets at September 30, 2016, compared to 0.34% at both September 30, 2015, and June 30, 2016.

Deposit composition and costs are illustrated on slide 13. We experienced good deposit growth in the quarter, with total deposits ending at $4.42 billion at September 30, 2016, compared to $4.21 billion at June 30, 2016.

The average cost of interest-bearing deposits was up slightly to 0.51% for the quarter compared to 0.48% for the third quarter of 2015 and 0.50% for the second-quarter 2016. Increases are primarily related to competitive pricing on public fund time deposits.

Noninterest-bearing deposits have remained stable at approximately 26% of total deposits. Borrowings used for liquidity and interest rate risk purposes, as needed, remained stable during the quarter.

Note on slide 14 our capital position as of September 30, 2016. Our TCE ratio remained stable at 6.9% and our total capital to risk-weighted assets was 11.24%. All regulatory ratios remain in excess of well-capitalized levels.

That concludes my comments this morning, and I will turn it back over to David.

Thanks, Michelle. We are pleased with our performance this quarter. Our ROAA over 1% and efficiency ratio of sub-53% were the best we have reported in our three and a half years as a public company.

We're beginning to see the benefits of our restructuring and cost savings initiatives earlier this year, and we remain confident in continuing our improvement in these areas in the quarters ahead. Overall, I believe we are well positioned to continue to execute the strategies we have consistently outlined since the IPO: robust organic growth, strategic acquisition growth, undergirded by a strong credit culture across all the major markets in Texas. We have continued to add strength to our leadership team throughout the Company, which will allow us to continue our success as we grow the Company.

As I stated in our Q2 earnings call, there has been an increase in M&A discussions. Our operating performance has led to a stronger stock price, which makes for more possibilities in this area. I'm optimistic that these discussions will lead to opportunities in the quarters ahead.

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

(Operator Instructions) Matt Olney, Stephens.

Hey, thanks; good morning, guys. How are you? I want to start on the net interest margin.

Michelle, you gave us lots of color as to all the moving parts in the quarter. Can you give us an outlook as to your expectations for the margin over the next few quarters?

Yes. As you noticed -- and I tried to give you guys a lot of -- all the different pieces of what happened with the margin this quarter, because it was unexpected to me as well. But if you noticed, we had more liquidity over the quarter primarily due -- we had really good deposit growth; our loan growth came later in the quarter. So our average balances and liquidity were up, which, while having overall average earning assets didn't really hurt our interest income, it did hurt the margin.

I think going forward I would say we have some upside. I think our loan yields are going to stay stable. I think our investment portfolio yields will increase a bit.

And what we're seeing, our deposit costs are going to be stable this quarter. So I think stable to up a few basis points is probably a good run rate for now.

Within those loan fees, was 3Q a normalized level or is it unusually low?

No. I think our loan fees in the quarter were lower than they have been at the beginning of the year, and I would expect those to return to normalized levels this quarter as well.

Okay; that's helpful. Then on the expense side, Dave, you made the comment, I think, that you've seen some good progress in the expense side, but there's still more opportunity to be had. How do we think about the expense levels from here?

I know you talked about the efficiency ratio. So maybe that's a better context to think about.

Yes, so we're quite pleased with that. You're always -- when you make changes in structure and you know it all pencils out on paper, but you like to see it come through the income statement eventually, and we were happy to see that happen this quarter. I think we'll continue to see some progress in that regard, and I expect our efficiency ratio to continue to come down slightly.

Michelle, in terms of an ongoing quarterly run rate on noninterest expense?

Yes, I think we had been guiding toward that $27 million noninterest expense run rate. I think it's going to be a little lower than that.

I think this third quarter is probably a good run rate for fourth quarter and going forward. As David said, we still have some opportunities. I think we still could get some benefit going forward as well.

Okay, that's helpful. Then last question for me, as far as the loan growth. Can you just talk about the growth throughout the quarter and the pipelines at this point heading into the fourth quarter? Thanks.

Sure. Thanks, Matt. We had a good quarter. A little slower than the first half, as I mentioned, but we have a good pipeline for the fourth quarter and as we look out into in 2017 continue to see our growth in that low double digits 12%, give or take a little, on average.

We were 12.4% year-to-date through the first three quarters across those nine months, and would expect that to be in line for the fourth quarter as well. And as Michelle said, I do think we're going to see some -- a little bit of tailwind on the NIM as our fees return to a more normalized level.

Also as we're booking -- we approved two energy loans in the third quarter. We funded one of those; one will fund in the fourth quarter. And then we have some other deals in the pipeline we're looking at right now.

Given what's happened in that industry, we're seeing a little better pricing there than in some of our other lines of business. Anyway, I think on the NIM side, we'll see a little bit of tailwind on the loan side as well.

Great. Thanks, guys.

Brad Milsaps, Sandler O'Neill.

Good morning. Hey, Michelle, just back to the margin for a moment, what drove the decision to make the change in the -- to move, I guess, the cash from noninterest-earning assets to earning assets? And then how quickly did you expect to work that down?

You guys are sitting on more than you might typically. Just curious what the plan would be there.

To be honest, Brad, we had some excess liquidity that we were holding in one of our correspondent accounts that -- the way we accounted for that is earnings credit. It was showing up in noninterest income. And just to diversify our risk we moved it to some other correspondent accounts at other banks that are money market interest-earning.

So as I tried to explain in the release -- I know it's a little bit confusing -- it was neutral really to net income, but it was dilutive to our margin. And it was really just a risk diversification decision for the most part.

And that was 10 basis points, Brad, of the decline in the NIM, was not really 10 basis points to our bottom line. It was just 10 basis points that was coming -- flowing through as noninterest income and now flows through as interest income and dilutes the NIM.

Got it. Yes, I just was curious what the background -- what drove the decision.

Then, Michelle, maybe how quickly -- is that where you want to be from a liquidity standpoint? Or how quickly do you plan to work that number down?

Yes. No, we have more liquidity. I think if you look at our liquidity numbers historically, it's quite a bit more than what we typically have had.

But like I said, we had good deposit growth this quarter. We had a lot of paydowns in our securities portfolio that we had not been able to get reinvested by the end of the quarter, which we are currently working on. So I expect to see that come down some this quarter, by the end of the year.

Great. Then, David, maybe just on the loan growth, where are you seeing new loans getting approved in terms of pricing today, relative to where -- the current book yield?

Is some of the pressure coming from the mix change? Maybe you're doing more variable rate loans versus fixed. Just curious; any color there would be helpful.

Yes. I think, Brad, what we've seen as it relates to the NIM has been a paydown of energy loans which were higher-yielding. Some of those were in default and accruing at higher interest rates, and we were able to collect that. So that had probably held our NIM up a few bps higher than it would have been otherwise. So as that resolved itself -- and as I said, I think as we add back some energy loans, that will be positive.

In terms of the rates, the mini-perm real estate loans, three- to five-year, have been very stable now for the last 12 months. So we haven't seen any pressure there. What we're booking, as Michelle said earlier, tends to look a lot like what's being paid off.

One of the things that contributed to the liquidity that Michelle's been speaking about is we did have an extraordinary amount of paydowns in the third quarter. I think I've heard some other of our colleagues around the state say the same thing, for whatever reason.

A lot of assets seemed to sell and third quarter. And again, we don't know if that's a trend or it's just cyclical or seasonal. We'll see.

But even with all the energy paydowns we had -- for instance, in the second quarter our paydowns were really about the same level in the third quarter without the energy paydowns. So that led to -- the amount of loans we booked in the quarter was right in line with what we expected, and probably would have seen loan growth in the 12%, 13% range for the quarter had it not been for a higher level of payoffs than we've had in the past.

We have, Brad, been doing some more commercial loans, C&I loans that tend to be floating rate, at LIBOR plus whatever. And that has, I think, put a little bit of pressure on the NIM on the loan side.

But by and large, as Michelle did the analysis for the quarter, a lot of moving parts, right? More paydowns than we expected, and we booked some energy loans, and we booked some C&I loans, we booked some real estate loans. And when you shuffle it all together and see what you've got, it was probably down a basis point or 2, but the pressure really hasn't been on the loan side.

Great. Thank you.

Brady Gailey, KBW.

Hey, good morning, guys. Maybe, David, just talk a little bit about the health of commercial real estate in Texas and especially the city of Houston; and then where you guys finished the quarter on CRE-to-capital, that ratio.

So, good questions, Brady. We are really stable in Houston with where we have been, total CRE portfolio around $875 million. About 41%, 42% of that is owner-occupied, so investor real estate, $575 million, somewhere in that range.

And that's very stable with where we've been all year. We're continuing to book real estate loans there that replace the payoffs.

Again, that portfolio is largely what was there when we purchased the two banks we purchased in Houston. So very small pieces, very granular; continues to hold up extremely well. We've seen no headwind at all in Houston.

In fact, our loan growth for the quarter was strongest in Austin and followed by Houston, and then we've had a lot of paydowns in the Dallas area. And again that's our oldest, most seasoned portfolio, so we weren't surprised when we did see paydowns that they came more in North Texas, where we've had a book of business that was built a lot during the 2008, 2009, 2010 through 2012 time frame, when our customers were buying distressed real estate.

And they've since made a lot of money on that distressed real estate by turning it around and selling it into a stronger market. So that's what happened there.

In terms of CRE broadly, I know that's the topic that's getting a lot of conversation around the country. We certainly have been a real estate lending bank for 28 years, and we haven't shied away from that. We think we do it very well.

Just a reminder, if you look at our performance of our portfolio in the most recent downturn -- but the numbers would be similar going back 28 years in every downturn -- that our real estate portfolio and our CRE portfolio, to give you a relative number, Brady, we were in the mid-500s in 2008, 2009, going into the big downturn. And if you look at our numbers, our classified, anyway you want to measure it -- past-due loans, classified loans, substandard, nonperforming, charge-offs -- we had a fraction of what the other Texas banks had and half of a fraction of what the national banks had.

So again, that's not to say we -- where they say past performance is not indicative of future results. But we feel good about -- we've got the same team, the same policies, the same philosophies, the same types of loans. And so we haven't really changed the way we do business over the years.

We've just gotten bigger, and some of the numbers are a little bigger. But the philosophy of big cash equities and real borrowers, real projects, not a lot of speculative, not a lot of land, not a lot of C&I -- and so we feel very good about that.

Our number is and remains in excess of the regulatory guidelines, the 300/100, Brady. But we have a policy in place approved by our Board.

We just finished our annual exam. The real estate portfolio, as you can imagine, got a good look since our energy portfolio has become less than 3% of our total loans.

So we feel good about where we are. We're continuing to make real estate loans. We intend to continue to make real estate loans. We're not slowing down.

We're going to continue to abide by our policy and our targets and everything. So our CRE portfolio again is very diversified geographically.

And look, one of our guiding principles of credit philosophy here has been: Don't take big bites, don't take big pieces. Our hold limits and hold targets on loans I think are materially less than a lot of banks that are our size that have the same limits that we do.

Again now, one might argue: Well, you're leaving earnings on the table, and you'd have a better NIM and all that if you guys took bigger pieces. And we just don't think that's the right philosophy long-term.

So we feel very strong about where we are, very good about where we are. Our exam and our ongoing dialog -- and not just our recent exam, but our ongoing exam with our regulators is real, it's good, it's substantive.

They know exactly how we think about things, and they are always encouraged by our Board involvement and the fact -- the way we monitor and all that. Look, I know some banks have gotten pushback from their regulators, and I can only speak to what our situation is. But I do think it counts and I don't think that analysts and investors, Brady, have been as discerning as they should be about the differences between institutions and history and what's happened to those institutions over the last three or four or five downturns.

What does the management group look like? Have they changed their philosophy around what types of loans and what types of commercial real estate they are doing?

We remain largely owner-occupied in our portfolio, and we've been at it and doing it for a long time. So I'll quit belaboring the point, but I think we are a real estate lending bank; we're going to continue to do that.

It's a core competency of ours, we do it well, and we're going to continue to do it.

Okay. So linked quarter, you're over the 300/100. Did they change much linked quarter?

I think I remember you all were actually a little over 400% last quarter. Was that roughly unchanged, like 410%, roughly?

Yes, we're up slightly from that, a few basis points. I don't have the calculation in front of me, Brady, but it was -- I think we were 410% and we're up a few bps from that, but --

Okay. Then, you mentioned the M&A comment again, David. Can you just remind us what size you're interested in acquiring, what markets you liked, and then just what sort of bank do you like?

Is your next deal going to be more funding focused given you have good loan growth and your loan-to-deposit ratio is 100%? Or just what's the characteristics of what you would be interested in on the M&A front?

Sure. It continues, as I said, to see a lot of discussion. Some we're involved in; others I see others involved in across the state. So I think there is a lot of activity, if you will, that we think will result in partnerships and mergers and deals over the next few quarters. All deals are hard to do, and it's hard to get them to the finish line, as my colleagues know across the state.

But broadly the size that we've talked about, Brady, has been $500 million to $3 billion is the size that -- really anything less than $500 million is not that helpful for us at this point. Anything above $3 billion would, in our mind, move that toward a merger-of-equal type discussion. So as we're thinking about acquisitions and merger partners, we think $500 million to $3 billion.

The typical deal, Brady, that we would -- that I would be looking at today in any of the major markets -- so we haven't changed our philosophy around Dallas, Fort Worth, Austin, San Antonio, and Houston and that triangle in Texas being where we want to build our Bank and build it out over time. We think there's a lot of room to grow in those markets, a lot of banks that I think will be sold or will partner up over the next few years. And so there's plenty of opportunity to grow in that triangle of the four major metro areas in Texas, so we intend to stay there.

And then a lovely deal for us, Brady, would be a deal that was a strong core deposit bank, and so a merged entity would result in more liquidity and a lower loan-to-deposit ratio. They might -- it might result in a lower CRE ratio. So if we found a bank that maybe did more C&I or was strong in SBA or some things that we have historically not done as much of, would be helpful.

And then if it was a merger that resulted in a little bit higher capital ratio coming out the other side, that would be a positive for us as well. Again, we've said we feel comfortable with our capital ratios where they are; but as we continue to grow and if we picked up some capital strength as a part of a merger, that would be a positive as well.

Again, we can -- I said in the past, we have a lot of control over that if we do a merger, in terms of how much stick, how much cash we do. And the fact that our stock has done relatively well this year I think gives us a good position as we talk to potential partners about making sure we meet their liquidity requirements and everything, but also would expect that any deal we do we'd be using a lot of our stock as a part of that, which again will help, I think, enhance our post-merger capital ratios.

So good deposits, maybe a more diversified lending platform, and stronger capital ratios: all those things would be good. We continue to think about we're looking for -- it's not rocket science. We're looking for strong earnings accretion, and we're not wanting to take any more tangible book value dilution than we absolutely have to. And if we do take tangible book value dilution, we want to earn back on a relatively quick basis; and our mindset around that has not changed at all.

Okay, great. Thanks for the color.

Michael Young, SunTrust Robinson.

Hey, good morning. Just wanted to take all your comments on the CRE into context and maybe think about how we should think about growth going forward. 9% growth this quarter; you mentioned heavier paydowns -- assume that was in CRE.

But do you think we could return to more of a historical 20% to 30% growth rate there? Or should we expect it to be a little slower for the next couple quarters?

Well, Michael, we've been pretty consistent in saying this year that it was low double-digit. Take that as 11% to 13% or 12% or however you want to think about it.

Our growth for the quarter was 10.2%. I'm not sure -- you said 9%?

Just CRE. I'm just talking about the CRE book specifically.

Okay, got it. So as we think about this quarter and going forward, I still think the lower double digits is a good number for us. I think that we had historically grown our loan book 20%, but that was when we were a much smaller bank, and so I don't expect that we're going to grow -- see loan growth rates in the 20% range.

I think that would certainly raise a lot of attention from a lot of people, including our Board of Directors, if we started growing the loans 20% at this point. But I do think we're a growth bank, organic growth bank. The markets are really strong.

We expect Dallas-Fort Worth and North Texas to have a big bounce-back quarter this quarter, and Houston continues to do extremely well. As I mentioned, they were our second leading growth market in the third quarter.

And Austin, we have really good competitive position in Austin. And we seem to get a look at the really good deals in Austin generally, and a lot of those are our good customers.

So we're going to be able to continue to grow, Michael, in that low double-digit range for the foreseeable future. Dependent on what obviously is somewhat driven by the economy, driven by if we're successful in making an acquisition at some point here, what -- how that changes the shape of our lending platform.

But we're going to continue to do what we've done well for 28 years and what we've done for three and a half years as a public company. And as I mentioned in my comments, what we do is not real complicated. We're an organic growth company; we make strategic acquisitions; we do it in the umbrella of a strong credit team and a strong credit policy and a strong credit history. And we're going to keep executing that.

Okay. Do you have an in-house limit on CRE concentration as a percent of capital?

We do. We do. The Board has reviewed it, and we have a policy and will adhere to that policy.

Okay, great. Then just last --

If the point of the question, Michael, is: Is that internal limit going to cause us to have to slam on the brakes? The answer is no.

Okay, so you have plenty of ceiling on that? Okay. Then just lastly for me, you mentioned better opportunities in Houston to lend with others shying away. Are you seeing a commensurate increase in pricing in that market as well?

No. Just stable pricing and very consistent with what it's been really since we purchased the Bank two and a half years ago.

Okay. Actually one more if I can. Just within the non-owner-occupied portfolio there, you mentioned good stability. Obviously, we're hearing headwinds, but this is more at the top end of the market, the Class A space. Can you just give us a feel for what is in that portfolio for you guys?

Sure. Happy to give you some details on this. We've shared this before and it really hasn't changed much, Michael.

But if you look at our office down there, for example -- let's see here, where is the office? Yes. Of that $870 million of CRE we have down there including owner-occupied, Michael, $78 million of that was office building. So less than 10% is office; and that's up from $74 million a year ago, if that helps.

So we're basically flat in that. The rest of it is made up of about the same amount of industrial and manufacturing warehouse type space is another 10% of the portfolio. Office warehouse, about 10% of the portfolio. Single-family residential, about 20% of the portfolio.

Shopping centers, being retail shopping centers, are about 15% of the portfolio. And then healthcare makes up another 10%, 12% of the portfolio.

So hopefully those -- the rest are just diversified, everything from churches to owner-occupied type projects, dental offices, healthcare, etc. So it's very diversified, very granular. The average loan size in that portfolio remains $911,000 is the average CRE loan size in Houston across that whole $900 million portfolio.

Okay perfect. So not a lot of the Class A in there.

No. Class A is a little more expensive generally than $900,000. That might be your rent payment for a year, but --

Right. Thanks, guys; I appreciate it.

Ammar Samma, Raymond James.

Hey, good morning, David, Michelle. I wanted to get some color on the provisioning this quarter. We've heard your peers talk about their provision reflecting the recent SNC exam in early October.

Does your provision reflect that guidance at all? And what are you hearing from regulators on your SNCs?

Yes, it does reflect that, which is basically nothing. We didn't have any effect from SNC exam in the third quarter.

Again, SNCs are a very small part of what we do, Ammar, and the ones that we have -- now a year ago, one of our -- or a few months ago, maybe in the spring; I have little trouble remembering the exact time frames. But we had a small oilfield service credit in Houston that was a piece of our oilfield service portfolio, a few million dollars that was downgraded in a SNC exam. But it's since paid off, resolved itself.

But, no, we haven't seen any pressure on SNC provision. Or we haven't had any SNC downgrades, I guess is the easy way to say that.

Okay, great. Then one more for me on the allowance. That was down a few basis points in the quarter, about 68 basis points. What does that number look like when you add back the marks on the acquired loans? And how low do you see that allowance going here in the next few quarters?

Yes. When you add back the marks -- and it went down by the way, Ammar, because we took the $3 million charge against an energy loan in the quarter that had been provided for -- and we've been talking about it for two years. But we had provided for it and we finally took the chargeoff in the third quarter, so that lowered the gross amount in our loan loss reserve and lowered that ratio a few bps.

But including our marks on acquired loans, we're right around 90 basis points, today. We've said historically and we continue to have this philosophy and policy is to put in 1% of our loan growth plus any losses we have during the quarter; and that number will trend up over time, because at 68 basis points, if we're putting in 1% of the growth, that averages it up over time.

But I think in terms of provisioning going forward, as we look at our low double-digit growth, the asset quality numbers are at historically strong levels, so we're not expecting any outsized provisions -- certainly not for energy and we don't see it on real estate at this point.

So that said I think the run rate -- I think we've been consistent, I believe, Michelle, this quarter. We put in $2.1 million every quarter this year, I believe. So that's a pretty good indication of what our run rate is at the current growth level. So we don't expect any changes up or down for that.

Even though our energy portfolio still has a 5% reserve against it, we have continued to work through that, but we think that's more than adequate. But last quarter someone asked about if we saw in the future an ability to do negative provisioning. We don't see that either out of energy or anywhere else.

With our growth rate, it would be unusual for us to back down our provisioning just because we intend to continue to grow, as I mentioned earlier.

Okay, that's great. Thanks a lot. Then maybe one last one real quick if I could. The reserve is also down; you talked about that chargeoff and better asset quality trends in general in energy, down to 4.7%. I wonder if there was any more color there. And how much of that 4.7% is on specific credits?

Most of the 4.7% is general reserve against the portfolio. So we don't have any more big credits or big provisions like that one. We've got a few hundred thousand here and there I think against them, but it's almost all -- almost 100% of it is general reserve.

And we think it's more than adequate, as I said earlier. Our portfolio is about $125 million; and we resolved over $150 million of difficult credits, companies, or groups that were overlevered two years ago going into the downturn. We had a portfolio of almost $300 million.

So over the course -- and I might point out that the total losses we've had, a little over $4 million, actual chargeoffs we've taken, amount to about 1.4% of the total loans in that portfolio going into the downturn in 2004. So if you take a look at our losses and relate that back to the portfolio we had to deal with going into the end of 2004, we lost -- our total chargeoff severity, if you will, was about 1.4% of those loans.

And we feel like that number is going to -- we don't -- we're not expecting any other losses at this point, let me put it that way. So that's why we think that the 5% reserve is good.

If we had another problem or something we felt like we were going to lose money on, we'd have it specifically reserved. And we don't have any of the loans specifically reserved, so.

All right, that's great. Thank you both.

Kevin Fitzsimmons, Hovde Group.

Hey, good morning, everyone. Hey, Michelle, this one is probably for you. Just another question on the margin, but looking out a little longer.

I know you said stable to maybe up a little in fourth quarter. But how should we think about the trajectory over 2017 over, say, several quarters -- and not assuming rate hikes? So is the way to think about it that that 10-bp impact from shifting where cash is being allocated, that's more of a permanent impact to the margin? And then on the other 20 bps, some of that is obviously pressure on loan yields, some of it's excess liquidity.

So should we think of it as maybe some -- as that excess liquidity gets put to work, loan growth picks up a little from what we saw in third quarter, there is room for that margin to actually creep higher over the course of the year? And where do we get to? Thanks.

Right. Yes, I think that's accurate, Kevin. I think that's a good way to look at it.

If you looked at our margin over the last couple of years, it's bounced around a little bit, but generally within about a 10 basis point range, depending on our accretion, which you notice we had very little accretion this quarter.

So I think a good way to look at it is I do expect it will trend up a few basis points over the next quarter, next year. I'm not -- I don't think at this point back it's going to get back up to the level it was; but I do think we intend to keep that liquidity in the money markets where we have it now.

So I do think for the time being that's going to be a permanent change. You can look at it that way.

Okay. But all things equal, you probably have room for a low single-digit type of basis point expansion on any given quarter looking out?

I think, yes, a few bps each quarter is probably a good way to look at it.

Okay; okay, great. David, just one for you, I know there's been a lot of questions about M&A and on the CRE threshold. I just want to connect those two issues, because I think one thing you pointed out that's critical is that your regulators -- or you get the sense that your regulators are very comfortable.

Because I've heard other banks say that even though they are comfortable with their own commercial real estate concentration, it's just not worth the risk to be so much above the concentration limits for when they go for approval for acquisitions. So I'm assuming from your commentary your regulators are very comfortable and you wouldn't expect any surprise when you guys go to get deals approved.

Well, I think it's always risky ground, Kevin, to jump out there and say what your regulators are going to do. I continue to say we've had a very good, very open relationship with our regulators over a long decades period of time.

Obviously, they still hold us accountable, and we still feel like they are there as a part of how we think about the future of the Company. But, no, I don't -- we haven't had any indication that a merger application would be negatively impacted by the fact that our CRE ratio is above the guideline, and would not expect that.

But that said, as I mentioned earlier in the call, as I look at acquisition partner candidates, the fact that a blended balance sheet might lower that ratio materially and/or might give us other proven platforms of C&I and SBA lending, those would all be positives.

So you don't get everything you want in any bank -- and I'm sure if anybody were looking at us, we wouldn't be anyone's perfect dream candidate. Because we are a particular bank; we do things a certain way. We think we've got a lot of strengths.

Do we wish we had a robust C&I platform, a little more robust than we do? Sure we do.

But that said, loss severities in C&I historically when things get difficult haven't been that great either. So that's -- accounts receivable and inventory and that type of collateral doesn't always hold up that well in a downturn either.

But we are communicating well with our regulators about CRE. We continue to talk to them about our merger and acquisition strategies.

But we are mindful -- let me say it this way. We are mindful of the level. As I mentioned earlier, going into the last downturn we were 550%.

Part of that is a result, too, Kevin, of the fact we do run our Bank leanly capitalized. So again I think all that gets taken into consideration.

But we think over time we will see that number reduce. So whether it's organically, as we continue to focus more -- part of what has set us back a bit has been this energy downturn, because we had seen some nice C&I and energy loan growth there in 2012 through 2014, and we were able to lower those ratios a bit. And then we've dealt with that over the last couple of years.

But we are also focused on doing more owner-occupied, been focused a little bit on that as well as the C&I side. But those things take time, right?

Over time our culture is and has been we're a real estate lending bank. We do it really well.

And to be oversimplistic about this, when we hire lenders, we talk across our Company and say: Wow, we'd rather have accounts receivable as inventory than a garden office building down here on the corner. Intuitively sometimes that's just a hard pitch to make.

We understand the value of diversification, and we expect and intend to bring that CRE ratio down over time by diversification of our lending. So not by slowing down lending, but by diversifying the lending that we're doing.

We are actively working on that now. But again, we don't -- it's going to take some time. We could help it with an acquisition; but otherwise we're going to continue to do it organically, and we continue to communicate well with our regulators about that.

Great. Thanks, David. One quick follow-up. You've mentioned that the pace of conversations is very active. Is it just a matter of enough time going by with oil prices being higher and more stable, and some of these would be sellers getting comfortable? Is it also just the higher stock prices for the would-be sellers that are public?

Is it just a matter of comfort on both the buyer and the seller front that you see this gradually -- the pace of conversations getting more active?

Yes, well said, Kevin. I think it has to do with all those things you mentioned. But I think as much as anything, it has to do with especially the larger banks that have been around for a long time deciding they want to pick a partner.

That's a very intricate decision for them as a Board and a management team and a shareholder group to make, and they want to make sure they get it right. So more than ever -- and we've been buying banks for a long time; we made our first acquisition in 1988 -- and I would say more than any time in our history of buying banks, we're seeing a lot of analysis by the seller of our Company, if you will. And of not only us but of our peers and our competitors who are also trying to buy banks in Texas.

There is a real -- I get a real sense that sellers are -- obviously, a big component of anyone's decision to sell has to do with price and value. But I would say that's a distinction, is a number of the sellers and especially the quality banks are thinking of this in terms of picking a partner for the long term, especially if they're going to take a big stock component. They care not only about the announced price of the deal, but they are really looking to make sure they partner with the right company that has the right culture and is going to do well in their communities after the fact, and that has a high probability that their stock is going to do well over the next few years.

So I think that's encouraging to me both for the likelihood of deals getting done, but it does take a little longer, Kevin, if folks aren't only focused on the sticker price. And so they put themselves up for auction and take the highest sticker price offer, but we're finding the sellers have always been thoughtful but I've found them to be even more thoughtful here recently around going: Gosh, we know; it's not rocket science who the buyers are out there. And they understand the importance of the buyer having a good stock price.

But it's more than that. It's going not only -- what's the price today and what does the currency look like today, but a lot of investigation about: Well, Independent Bank, what do your earnings look like the next two or three years? And are the regulators asking you about CRE and all those things?

So we're getting a lot of very good dialog from people who seem to be quite discerning these days about picking a partner. And in the long run -- I've said this for three and a half years since we went public, starting on the roadshow in the spring of 2013 -- that I think that the more discerning the sellers are, the better that is for us. We've got to a 28-year track record of our team, our ownership group, our management group, and we'll stand by that.

(Operator Instructions) Brett Rabatin, Piper Jaffray.

Hi, good morning. David, wanted just to ask on the fee income side of things. Could you guys give us an outlook for that as we think about the coming year? And then maybe any commentary on mortgage banking and results there versus what we've seen with some other players having more robust activity this quarter.

Yes, we had a good quarter in mortgage, Brett, and we're having a good year mortgage as well, keeping in mind we do not have a mortgage warehouse, but we do a lot of just mortgage origination and expecting that to be a record year for us this year. But in terms of the total numbers in total contribution to the bottom line, it's a very important business for us because it's so integrated into our interim construction business, interim home construction business, and into our other products and services that we offer.

I think that a good regional community bank needs to do mortgage well, and we think we do. But in terms of contribution to the bottom line, it's not a 10% or 20% contributor to our bottom line. It's a few percent of what we do every year.

So if they are up 20%, that might move our number up 1% of our bottom line. So it's important and extremely important to us strategically, but it's not going to drive a $0.05 outperformance next quarter in our earnings, if you will.

So just wanted to give you a relative feel for the percentage it is of what we do. The other part of your question, Brett, I'm sorry?

No, just an outlook for fee income as you think about the coming year. I know fee income isn't, like you mentioned, a big contributor to overall pretax income. But I was just curious if you have any initiatives on that to grow that faster when you think about the coming year.

We are paying attention to that. The addition of Jim White, our new Chief Operating Officer at the Bank level, has been important for us in that regard, to come in and really take a look at our structure and how we can drive additional revenue and top-line growth. We're in the midst of a number of projects on that front, and we think that's going to -- we'll see some of that showing up in 2017 as we go forward.

And the fee income on loans really can be a bit cyclical just depending on what types of loans we booked. The more interim construction lending we're doing, the more fees we tend to generate; that's a good fee business for us. So it's a bit cyclical.

I do think, as Michelle said earlier, that we'll see that we rebound to a more normal level, more normalized level in the fourth quarter. And then to your other question, I think it can grow into 2017 and beyond, and we're working on that and focused on that.

Okay, great. Thanks for the color.

John Moran, Macquarie.

Hey, good morning, guys. I am mostly set; I just have one ticky-tack one on the margin to go back to. I think you guys said that the fees and some interest recoveries and stuff created some noise in 2Q, and there was basically none of that in 3Q.

Do you have, by chance, either the dollar amount or the basis point contribution to margin from 2Q versus 3Q? And then what would be, like, a more normal, quote-unquote, level for that to run at?

I don't have that number, John, so I can't give that to you right this minute. But I think, like I said earlier, I think the current yield on the loan portfolio I think is going to be stable going forward and has some upside as our fee income gets back to more normal levels.

Got it. So better to just think about it as like up a couple basis points like you guys had said and (multiple speakers) --

Yes, I think that's right.

All right. So try not to split the atom on it. Okay.

Yes, I think there could be, over the next year 5 to 10 basis points of upside there, John, from what we saw in the third quarter. But as Michelle said, I wouldn't think about that necessarily as a 5 to 10 basis points in the fourth quarter. But that if -- depending on how things go, we get that over the course of the next four quarters.

Okay, got it. Thanks very much. The rest of mine are all taken care of.

I'm not showing any further questions at this time. I'd like to turn the call back over to our host.

Great. Well, we appreciate everyone dialing in this morning, interest. We continue to be encouraged about 2016 being our best year ever and encouraged about 2017.

The Texas economy still seems to be good; unemployment numbers have continued to drop; and we're seeing great activity across the markets including Houston. So all positive.

And thanks for your interest in Independent Bank, and feel free to reach back out if there's anything else we can do. Have a great day.

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