Independent Bank Group Inc (IBTX) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Independent Bank Second Quarter 2017 Earnings Conference Call. (Operator Instructions) And now I would like to welcome the Marketing and Communications Director, Ms. Peggy Smolen. Please go ahead.

Good morning, everyone. I'm Peggy Smolen, Marketing and Communications Director for Independent Bank. Welcome to the Independent Bank Group Second Quarter Earnings Call. We appreciate you joining us. The related earnings press release and slide presentation can be accessed on our website at ibtx.com.

Before we get started, I would like to remind you that the remarks made today may include forward-looking statements. Those statements are subject to risks and uncertainties that could cause actual and expected results to differ. We intend such statements to be covered by safe harbor provisions for forward-looking statements.

Please see Page 5 of the text in this release or Page 2 of the slide presentation for our safe harbor statement.

All comments made during today's call are subject to that safe harbor statement. Please 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, 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 GAAP financial measures are included in our release.

Please note that we now use the term adjusted rather than core, which had been used in previous releases.

Note, Page 14 of the release for the reconciliation of adjusted non-GAAP financial measures, which are calculated the same as the calculation of core non-GAAP financial measures in previous releases.

I'm joined this morning by David Brooks, CEO; and Michelle Hickox, CFO.

At the end of their remarks, we will open the call to questions.

With that, I will turn the call over to David.

Thanks, Peggy. Good morning, everyone, and thank you for joining us today. As usual, I will briefly touch on some highlights for the quarter and then turn it over to Michelle to cover the operating results.

2017 continues to be a good year for our company. Second quarter adjusted earnings remain strong, adjusted net income was $22.7 million and represents a 42% increase in adjusted net income from first quarter 2017.

A quarterly earnings and annual trend chart is on Page 6 of the slide deck. Loan activity continues to be solid at 11.4% annualized growth for the second quarter. Austin and Houston led our regions in growth for the quarter with McKinney and Fort Worth having good growth as well.

Asset quality remained strong with credit metrics remaining at historically low levels. Nonperforming assets were up slightly due to the ORE acquired with Carlile, but other metrics were improved from last quarter.

We successfully closed the Carlile Bancshares transaction on April 1, which puts us at $8.6 billion in total assets as of the end of the second quarter. This translates to 46% compound growth since we completed our initial public offering in April 2013.

Michelle is going to go over more details on our second quarter results, and I will conclude with my final thoughts at the end. Michelle?

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

Our second quarter adjusted net income was $22.7 million or $0.82 per diluted share compared to $13.8 million or $0.74 per diluted share for the second quarter of last year and to $16 million or $0.84 per diluted share for the linked quarter.

As you can see on Slide 7, net interest income increased to $69.5 million in the second quarter from $47.9 million in the first quarter 2017. The net interest margin improved to 3.81% for the quarter, up 14 basis points from the previous quarter. This was due to the overall higher-average yield on the Carlile loan portfolio and increased deals on the Independent Bank historical portfolio during the quarter.

We were also able to maintain our deposit cost at 58 basis points, which was the same as the first quarter 2017, due to the lower cost of deposits acquired.

Total noninterest income increased $6.1 million compared to the second quarter last year and to $6.4 million compared to the previous quarter. The increase from last year in the linked quarter is primarily due to increased service charge income, mortgage income and increased earnings on BOLI policies, primarily driven by the Carlile acquisition.

Total noninterest expense increased $20.3 million from the second quarter last year and increased $23.3 million from the prior quarter. We recognized $7.3 million of acquisition expense during the second quarter, including $1.6 million reported in salaries and benefits compared to $459,000 and $475,000 in the prior year and the linked quarter.

The remaining increases in salaries and benefits, occupancy, data processing and other line items is primarily related to the acquisition, including $918,000 increase in core deposit intangible amortization.

The provision for loan loss expense was $2.5 million for the quarter, which increased from $2 million for the linked quarter and $2.1 million from the prior year. Generally, provision expense correlates with net loan growth and level of charge-offs.

Slide 14 in the slide deck illustrates our provision expense and charge-offs in each reported period.

Our effective tax rate for the quarter was 32.1% compared to 33.2% and 30% in the prior year and linked quarter, respectively. The decrease in our tax rate from prior year is primarily related to tax benefits recognized on vesting of restricted stock during the first and second quarter. This is due to adoption of new accounting guidance, which is effective in 2017.

In previous periods, this benefit was recorded directly to additional paid-in capital.

The rate in the second quarter was also negatively affected by $1.3 million of nondeductible acquisition expenses.

Organic loan growth during the quarter was good with loans held for investment, not including mortgage warehouse, growing 2.8% from March 31, 2017, or 11.4%, on an annualized basis. We continue to experience growth in all of our markets with Austin and Houston having the highest growth for the quarter.

See Slide 10 for annual loan growth comparisons. As anticipated, the Carlile acquisition improved our CRE concentrations. Total CRE to Tier 1 capital was 391% at June 30, 2017, down from 434% at March 31. See Slide 12 for the quarterly trend.

The Carlile loan portfolio we acquired included a warehouse lending portfolio, which totaled $120 million as of June 30, 2017, and was up about $20 million since close. These loans are included in commercial loans in the loan composition table in the release.

Post acquisition, all of our credit quality metrics remained strong. Total nonperforming assets were up slightly to 0.30% at June 30, 2017, from 0.27% of total assets at March 31, 2017, compared to 0.34% of total assets at June 30, 2016.

The increase is due to $10 million of ORE acquired from Carlile. Charge-offs remained low at less than 0.01% annualized for the quarter. The allowance for loan losses decreased to 59 basis points from 71 basis points of total loans at March 31 due to the accounting treatment for acquired loans whereby they are recorded at fair value and do not carry over the acquired bank's allowance for loan losses.

As of June 30, 2017, we have recorded a provisional estimated discount for the acquired portfolio of approximately $26 million. The recorded allowance for loan loss plus the remaining fair market value discount on loans acquired is approximately 1.11% of total loans held for investment as of June 30, 2017.

As illustrated on Slide 13, the energy portfolio increased to $124 million, up from $106 million at March 31, 2017 and from $122.1 million as of June 30, 2016.

Despite the increase in dollar amount, the energy portfolio now represents only 2% of total loans. The energy-related allowance is 5% of the energy portfolio at quarter-end.

Deposit composition and costs are illustrated on Slide 16. Deposits increased to $6.7 billion at June 30, 2017, compared to $4.7 billion at March 31, 2017, with $1.8 billion assumed in the Carlile acquisition.

The average cost of interest-bearing deposits at 58 basis points was stable from the first quarter and up 8 basis points from 50 basis points in the second quarter of last year. While we have not increased our stated rates on deposit products, we do have certain variable rate deposits in public funds with high betas that have been impacted by the Fed's rate increases.

Carlile's cost of funds was lower than ours and has helped mitigate increases in large depositors and public funds rate.

Borrowings used for liquidity and interest rate risk purposes as needed remained stable during the quarter.

Note on Slide 17, our capital position as of June 30, 2017. The acquisition was accretive to all of our regulatory capital ratios, which remain in excess of well-capitalized levels.

The TCE ratio increased to 7.6%, and our total capital to risk-weighted assets was 11.6%.

That concludes my comments this morning. And I will turn the call back over to David.

Thanks, Michelle. 2017 continues to show positive trends in profitability, margin, capital and loan growth.

At $8.6 billion in assets, we expect to continue to grow and are working on a plan to successfully cross the $10 billion threshold when that happens.

This quarter reflects the first quarter of operations after the Carlile acquisition. While we are pleased with these results, we expect to recognize significant additional benefits to this acquisition after the core system conversion and full integration of the Northstar Bank's operations in the fourth quarter.

We continue to have discussions with potential acquisition candidates in our Texas and Colorado markets. With the announced sale of our more rural Colorado branches, we have sharpened our focus on the Colorado Front Range and continue to evaluate ways to expand our presence in this region.

As always, we remain focused on consistent strong earnings performance and enhancing shareholder value and believe our results continue to demonstrate our commitment to those goals.

Thank you for joining us today. And we will now open the call to questions. Operator?

(Operator Instructions) And our first question is from the line of Brett Rabatin with Piper Jaffray.

Wanted to, I guess, first just ask about the discount accretion in the quarter, wasn't that much? Can you give us maybe a path of what you expect at the back half of this year and maybe into '18?

As you know, Brett, historically, we haven't had a lot of accretion because we are typically pretty conservative on the marks of the loans. And I think you noticed we said right now, we've just recorded a provisional amount.

We think that the discount we have we should be fairly close to what we ultimately get to. It's just that there were a lot of loans in this portfolio, and it's taken us a little longer to finalize our mark, specifically on the PCI credits. I don't anticipate accretion income will be much different than it was in this quarter, though. So I think that's a good expectation going forward.

Okay. And then just thinking about loan growth going forward, you had nice organic growth in the quarter, can you comment maybe on what the pipeline looks like? And your CRE concentration is lower. Does that make you think about CRE more? Can you give us maybe some color on the thoughts on your growth from here?

Sure, Brett. We have a bigger base now that we're growing from, but we still feel good about the guidance -- guidance isn't the right word, but our kind of the way we think about our loan growth in the low double digits, 11%, 11.5%, 12%, and that range is we think good for the balance of the year.

The pipeline is good. Where -- we just don't know with oil prices remaining challenged, we're just not seeing a lot of opportunities there to grow the portfolio. So that's one of the areas we expected to get some help from. And 2017, it hasn't materialized really in the first half of the year. We will see about the second half of the year.

CRE, we did drop materially when we rolled in with the Carlile portfolio. It doesn't change our thinking around. We're continuing to look for ways to diversify our portfolio, continuing to focus on hiring C&I lenders when we get a chance, particularly we seem to have some traction there in Fort Worth and in Denver. Colorado markets seem to have good C&I opportunities as well.

So we're really focused, Brett, on finding other lines of business other than just CRE. But we're still doing good, looking at good CRE opportunities, particularly in the growth markets around Texas, very competitive in that some of the larger banks that seem to have slowed down their CRE lending have jumped back in with full force and that's putting some pressure on pricing, but so far not on structure. And so we feel good about the quality of the credits we are seeing are very strong; just having to compete with our big competitors down here for those credits.

Okay. And then just last quick one on the margin. It would seem like your margin could hold at least at the present levels. I was curious, Michelle, if you were thinking about the margin differently?

No. I think that's a fair statement. We're slightly asset-sensitive now with Carlile, just slightly. So I anticipate that the margin will be stable. There may be slightly up a few basis points. Some of that has to do with how we are able to control deposit cost. But I think that's a good way to think about it.

And our next question comes from the line of Brady Gailey with KBW.

So with Carlile, you got the mortgage warehouse, which I know showed some nice growth in the second quarter. Longer term, what are your plans with that business? Are you committed to keeping it? Would you like to see the warehouse grow? Or what -- how are you going think about that segment?

I think it's -- we do plan to keep it, Brady, and we were able to grow at about $20 million in the first quarter that we had it. But I think it will be slow growth. And we are trying to shift the balance or the type of customer a little bit that's in that portfolio. And so we're transitioning it and growing it here, but we do want to keep it, we will grow it, but it will not be -- it's not going to go from $120 million or $150 million to $600 million in 1 quarter. It's going to take us 1 year or 2 to get it to where we want it to be. But fully implemented if it were $500 million, that would be great.

Okay. All right. And then on M&A, now that Carlile is in the books, where are you focusing more on M&A? Is it still Texas? I know you've talked about Colorado and your desire to potentially buy a small bank up there, but just give us an update on the conversations you're having and if there is a geography that you are more focused on now?

Well, our primary attention is still in Texas, Brady. We're a Texas-growth bank, and we're continuing to focus on Texas. And the larger opportunities are certainly -- that we are seeing are certainly in Texas. And a lot of conversation, lot of folks looking around, having discussions and price expectations, especially in Texas -- well, Texas and Colorado are very high.

Our Colorado strategy is beginning to come into focus for us as we announced the sale of 9 of our 18 branches up there. I would say the more rural, maybe a little less growth-oriented branches that we sold or are selling. And then that allows us to really focus there in the Front Range, Denver to the north and south, generally. And we're up there as well, having discussions and meeting people, and really just trying to get a lay of the land, if you will, in Colorado. And -- but we are coming into focus on being committed to staying there.

I think this is our first step. We're first getting the footprint to look the way we wanted to look and then how do we add on? I mentioned hiring lenders a moment ago. We're in active decision there with lenders across the Front Range, and then, also in discussions with some smaller banks up there as well. So that's our kind of broad strategy in terms of M&A.

And our next question comes from the line of Michael Rose with Raymond James.

Just wanted to start on the commentary around loan growth. Last quarter, you mentioned Houston as being the strongest market; this quarter, Austin and Houston. But was more curious as to how you guys are thinking about Dallas and the Greater Dallas market at this point? I know there is not the corporate relocation pipeline backfill that you've had over the past 5, 10 years in that market. So just wanted to think -- wanted to see your thoughts on how you're thinking about the core Dallas market and your expectations for growth there?

Great question. We've got our energy -- is headquartered in Dallas, Michael. So that's been a little bit of the challenge there. And then secondly behind that is, it seems like a lot of our larger customers, investments funds and some folks who do mid-size and little bit larger real estate projects have been in more in a sell mode than they have been in an investment mode. And so we've gotten paid off on a number of transactions with our good core customers there. And some of them, I think, feel like the market's awfully strong right now in terms of prices to reinvest. So we've seen more of a cautious approach on their part. So our typical pipeline where we generated good loans and some volume in Dallas has not been as robust the first half of the year.

We do see that turning a little bit here as we look at the pipeline for the second half of the year. It looks like we are seeing a lot of great opportunities there that will fund in the late third and maybe in the fourth quarter. So we expect second half year to be better. But the first half of the year in Dallas proper wasn't as good as we had hoped.

The North Dallas -- kind of Collin County, as you alluded to, Michael, the corporate relocations, with that whole Plano, Frisco, McKinney, Allen, Collin County generally is very strong. And those -- that team also had a good first half of the year. So I would say, in the Dallas area, it's been more the North Dallas where all those relocations are happening. They are in the legacy area, and then, Fort Worth has been stronger. So in North Texas, it has been kind of Fort Worth and North Dallas.

And then, Houston, Austin have been the strengths so far. But really, we continue to see good activity across the entire footprint, including the Front Range. We're getting some really good traction in the Front Range in Colorado, want some good opportunities there as well.

Okay. So just a follow-up. If you think that the Dallas market will be a little bit stronger in the back half of the year and the other markets are still performing well, as you just mentioned the Front Range Colorado -- why wouldn't the growth expectations, perhaps, be a little bit higher? I'm just trying to figure out what the offset would be if you expect Dallas to come out a little bit stronger in the back half?

We're always cautious, Michael, around these larger acquisitions, because we're just transitioned there. While we tend to do a very good job hanging on to key customer-facing lenders and customer-facing depository treasury folks, there's always still some transition. So it's just hard to predict what the payoffs are going to be there. And if people -- some people decide to move their business because they may be in a business line that we are not as favorable on as maybe Carlile was. And so we're -- and just the numbers get harder, right, when you got a $6.5 billion loan portfolio instead of a $4.5 billion loan portfolio.

So the percentages get harder, but yes, we feel very confident in the 11%, 12%. It could be better than that in the second half of the year, but we just can't -- we're not counting on that internally because we just know that historically when we look in hindsight that while we do a good job generating new business that when you bring in a new portfolio, there is just going to be some transitions and payoffs there that we weren't expecting.

Okay. And maybe just one final one from me. Just thinking about Colorado, you guys are, obviously, selling the 9 branches. I'll be curious as to what the cost of funds in those branches are and maybe the strategic rationale? But also we've seen several deals announced in and around the Denver market as of late. So just curious as to what opportunities you see at this point?

And then, I know, you've talked about strategic decisions there and perhaps evaluating where you want to be there long term. Based on what your comments have been and your body language seems like you are committed to that market, but I guess, what would drive you to stay there? I mean, do you really need to get an acquisition to grow the franchise bigger there? Or would you consider a sale of what you have there at some point?

The cost of funds at those branches was similar to what we had across the market. So what we're selling is 9 branches and about $200 million, give or take, of assets there in those 9 branches.

One of the challenges we inherited in Colorado was 18 locations and $600 million in assets, meant that we were looking average branch sizes in the low to mid-30s. And as I think I've mentioned in the last couple of quarters that our goal there, if we were going to stay, is going to be -- to have to get bigger in the Front Range and then get our efficiency better -- our leverage better there. And this is kind of step 1 to doing that.

This takes our average branch size of remaining 9 branches to $43 million to $45 million, up from $33 million to $35 million. So that's a little helpful. And then we're just going to look for other opportunities there in the Front Range to get up from $400 million more than that $800 million to $1 billion range in the next year with -- by adding lenders and by adding maybe a smaller bank or 2 in strategic locations. And if we can do that, then I think we will be off and running where we want to be.

Clearly, if we're unable -- if we're sitting here a year from now still at $400 million, $500 million in assets in 9 locations, then we have to take a look and see what our best investment of capital and return on capital market might be. But right now, we're very optimistic that we'll be able to get it to scale, get those -- get a branch footprint of 10 to 12 branches with $75 million to $90 million per branch, which would be highly efficient and very profitable for us. And again, we really like that Denver corridor market. We think it's good as any of the Texas markets. And so we see it as a growth opportunity. We have to execute there over the next 12 months, to your point Michael, to justify staying there, but we think we will.

And our next question comes from the line of John Pancari with Evercore ISI.

Okay. Couple of things. On the loan growth, I just wanted to see if we can get a little bit of granularity around the growth you saw on the quarter ex Carlile, per C&I and then CRE? So how much did C&I grow on a linked-quarter basis ex the Carlile numbers?

I would say it's more balanced than we had saw in the first quarter with more C&I. I don't have exact percentages, John, I'm sorry. But I would say it's pretty balanced this quarter between CRE and C&I, the growth we did see ex-Carlile.

Okay. All right...

So we're seeing a trend toward more C&I with a little less focus on CRE as a general trend as we look at the pipeline. But as I've said in the past and I don't want to belabor it again or sound defensive, but we're going to continue to make good CRE loans. It's just at the core of what we do.

And while we're working to diversify and working to hire C&I lenders and looking at new lines of business and the mortgage warehouse and hoping to get some help from energy at some point here, we're still going to make good core neighborhood CRE loans and growing suburbs and in the heart of the banker markets and it's at the core of what we do. And we've included some details, I know, on our slide deck about our CRE, our breakdown, our portfolio.

And one of the things we're going to do I've got some details on the retail portion of the CRE portfolio, and we are going to release during this next quarter, as soon as we get good combined Carlile numbers in with our numbers, a better detail or more detail on the breakdown, specifically of our retail portfolio. I've got that for Independent Bank before the Carlile, which -- and we think the Carlile piece looks a lot like what we've got. But anyway, we're going to give more clarity and granularity around the retail part of our CRE portfolio as well here in the next couple of months.

Okay. That's helpful. That's helpful. And then, on the Carlile transaction, just can you remind us of the -- your expectation for the timing of the realization of the cost saves?

Yes. Great question, because I know our efficiency ratio ticked up -- just our core efficiency ratio ticked up just a little bit this quarter. And that's purely the result of adding in all of the overhead from Carlile and really not being able to realize almost any of the cost saves yet.

The data conversion is on track and looking very good for the first week of October. And that will be the triggering event for the data cost and a lot of the human resource cost reductions we'll see. And so we believe you're not -- we're not going to see much help at all in the third quarter. But in the fourth quarter, you will begin to see it. And by the first quarter of '18, we'll see the first -- I think it'll be the first with a clean quarter, will be the first quarter of '18 when we see virtually 100% of the cost saves of the Carlile transaction in our numbers.

We'll see 60%, 70% of it in the fourth quarter and then 100% of them in the first quarter of next year, but we're not going to see much help. So I think our core -- Michelle can comment on this, but I think our core efficiency ratio in the third quarter would still be slightly elevated until we get out and we'll see it trend down in the fourth, and then I think down to where we expect it to be longer term in the first quarter of '18.

John, I think with -- in the second quarter with the people and data processing and then other, like, communications, data lines that we have that are redundant, it's probably around $2 million of costs that we have right now ongoing that will eventually go away. The conversion happens at the beginning of October, but we'll probably carry most of those people almost through the end of October. So really November, December of this year is when we'll get a benefit, and as David said, probably get a full run rate starting with first quarter of '18.

And that's $2 million a quarter, right?

Right.

Got it. Got it. Okay. And then one more for me. The -- what is -- what was the average yield that you are getting on the mortgage warehouse book for the quarter?

I don't know, John, what the total rate is with the fees and everything. I've seen some of the deals coming through loan committee, and they are floating rate in the mid- to upper 4s is what we are seeing and then some fees on top of that. So I would guess, this is purely a guess, we can get you that number, John, but around 5% would be the yield on the total portfolio.

All right. So you are pretty darn close to your overall average yield of your overall loan book right now?

Yes. Yes. That sounds right.

And our next question comes from the line of Michael Young with SunTrust.

David, I wanted to start -- you'd mentioned in your prepared remarks that you are doing some early work on preparations for crossing $10 billion. Just with the organic growth that you expect that looks like that could happen as early as -- early 2019 or with an acquisition maybe next year. Maybe you could just give us an update on what preparations have already begun and what you have left to do? And then your thoughts on how you would cross $10 billion, whether it would be a larger acquisition or if you are okay with just crossing it slowly?

Sure. I'll let Michelle comment on the prep. She's been -- she and -- primarily, she and her team and Jim White, our Chief Operating Officer of the bank, are also taking the lead on this. But Michelle, you want to talk about our prep so far?

Yes. So we're in the process of developing a timeline, Michael. It's -- based on our expectation, 2020 would be the first time we have to submit a stress test for DFAST. So we're preparing a time line basically to get ready for that. And it looks like those costs, just to get to that point over the next 3 years, are about $2.5 million.

As it relates to the Durbin piece, that's also probably $2.5 million of revenue that we'll lose currently, as it relates to that. But that -- you're right, we could -- it could be organically. We could get there by the end of next year. Most likely, if it's organic growth, that would be pushed out a year with an acquisition of the 2020 time line is good.

Okay. And David, maybe just bigger picture, I mean, do you want to cross that threshold with potentially a larger acquisition? We have seen that a lot in the past. Are you okay with kind of taking the efficiency ratio profitability hit for a shorter period of time?

Yes, our view on that, Michael, is we'll take whatever the market gives us. And so -- yes, if you are asking my personal preference, I'd love to do a $3 billion acquisition in 2018 and get to $13 billion by the end of -- $13 billion, $14 billion by the end of '18. That would be great.

Those are hard deals to do, hard deals to find. And the alternative we could do a couple of $1 billion to $1.5 billion deals, that would also get us there. There aren't -- there is not a large target group of $3 billion to $5 billion banks in Texas for us. And so consequently, the number of those deals and everything make it unlikely that we get to execute it exactly the way it would in a dream scenario, but we are extremely comfortable growing through organically, which would be end of fourth quarter of -- our current modeling shows fourth quarter of '18 to first quarter of '19 is when we would grow through $10 billion organically. And as Michelle said, probably $2.5 million to do all the modeling between now and 2020 to be prepared for that, that assumes we go through by the end of '18.

And then the ongoing Durbin costs $2.5 million, but are ongoing. Once we have the DFAST, our estimates right now are that -- once we have the DFAST modeling and everything in place for that first submission by 2020, that ongoing to keep that going is maybe $0.5 million a year. So if you take that $0.5 million a year plus the Durbin income of $2.5 million, our ongoing costs of about $3 million equates to, give or take, $0.06 a share on our earnings. Projected earnings out there would be $5 plus a share. So it's -- you're talking about 1% of our income, so to speak, to go through organically; that doesn't bother us.

I mean, obviously, as I said, I'd rather make a big acquisition and get through in a big way, but we're very comfortable growing through organically. And we think we got a good handle on the cost, and we have a plan in place now. And as I said, Michelle and Jim are doing a good job with their teams of getting us ready for that.

And I think it's also helpful -- we get the benefit of a lot of folks who have been working on this for the last several years. And I think when it first -- this whole $10 billion threshold first came out a number of years ago, there wasn't a lot of clarity about if the banks going through $10 billion will going to have to spend the same amount of money that the CCAR banks are spending at $50 billion, and so there's a lot of concern. And but now as the regulators have gotten their hands around it, the banks gotten their hands around it, I think there's much better clarity today than we even had 2 years ago on what we have to do exactly. And then now discussion around combining that with some CECL work and all that. So we're just taking a holistic look at -- as a $12 billion, $15 billion, $20 billion company, what are the things we need to do, and we are making prep for that now.

That's great color. One last follow-up maybe for Michelle. Just on the 9 branches that you're selling and then it looks like another 4, maybe that you're consolidating from your release. Is that all incorporated within the original 35% cost save guidance related to Carlile? Or is that above and beyond at some point?

The 9 in Colorado that we are selling are -- were not considered in our initial models. And -- but that's virtually no change in our EPS. I think the effect of that -- their direct expenses, allocated expenses, is less than a $0.01 per share effect that we anticipate that will have.

And our next question comes from the line of Matt Olney with Stephens.

David, in the prepared remarks, you mentioned some higher NPAs from the Carlile deal. Can you just remind us what are those NPAs specifically? And what is the plan from moving those out of the bank?

So the increase was primarily from some CRE, I would say, legacy or historic CRE at Carlile -- sorry, ORE, not CRE, ORE, Other Real Estate Owned, foreclosure real estate that Carlile had carried on their books. We marked it accordingly for quick disposition, and we're in the process of disposing of it. But that was really it, and lot of that was in Colorado, some CRE that they had inherited from one of the acquisitions they made in Colorado.

And then we're also -- there was some, as we've been looking at consolidating the locations and some administrative space that Carlile had over in that core I-35 corridor. And we've got a building or 2 over there that we're going to dispose off, that are also carrying an ORE right now. So really nothing that we didn't expect at all, Matt, just some ORE that we'll dispose of here, hopefully, in the next few quarters.

Okay. That's helpful, David. And then on the deposit cost, can you just speak to the deposit cost from Independent Bank stand-alone versus the impact of Carlile? And just any comments on deposit pricing in your markets? And have you noticed any difference yet between the Texas and the Colorado markets as far as deposit pricing?

Yes. We actually just did an analysis of our Colorado markets when we were looking at our rate sheets this past week. And it doesn't really appear that there is a big significant difference there.

If you just looked at Independent Bank only ex Carlile for the quarter, our cost of deposits was about -- up about 5 basis points on a stand-alone basis. We have still not changed our stated rates. We have gotten some exception requests, which we're handling on a case-by-case basis depending on the relationship with the customer, the amount of funds that they hold with us, the kind of commitment to stability of the funds. So as we talked about in the past, the highest beta are on our public funds accounts, which as we've gotten money in from our specialty treasury group and with the additional liquidity that Carlile has given us, we've not been as aggressive in bidding on those funds.

I think our public funds are down to about 12% of total deposits just from us not bidding. And then Carlile really didn't have that many public funds. And in fact, most of the public funds they had are in those 9 branches in Colorado that we are selling.

Okay. That's helpful. And then, Michelle, just lastly, any thoughts on the effective tax rate that we should be forecasting for the third quarter?

I think the 32% rate is probably a good rate going forward.

And our next question is from Brad Milsaps with Sandler O'Neill.

This is actually Peter Ruiz on for Brad. Most of my questions have been answered, but just kind to want to follow-up on expenses. Looks like you guys did a really good job of holding in expenses, especially considering your commentary that you didn't get a lot of cost saves out quite yet. So maybe just thinking in terms of what expenses look like maybe heading into maybe fourth quarter and then into first quarter with the branch consolidations? Are we looking at maybe like a quarterly expense rate near $40 million or so? Or is that a little too aggressive?

I think that's too low. I think, in Q3 of this year, our core run rate on expense is probably going to be fairly comparable to what it was this quarter. And then as we talked about earlier, I think there's about $2 million of expense that's redundant. So we'll get about 2/3 of that out in the fourth quarter of this year, which puts us, I think, at about $42 million a quarter run rate. So that's probably a better way to look at it. I think $40 million is probably a little low.

And our last question is from the line of Brett Rabatin with Piper Jaffray.

I just wanted to follow up on capital. You guys are always at a little tighter levels than maybe some peers. And I was just curious how you think about capital ratios going forward? Are you looking at maybe doing some subdebt? Or do you think your ratios are just going to stay at current levels?

Darn, Brett, we're at 7.6%. We're feeling pretty good. We are having capital-happy dance over here at 7.6% TCE, and what do we have, 11.6% on total capital ratio.

I think we feel good about where we are, Brett, on that. Not planning at this point. We think we're -- our capital stack is about what we wanted to be in terms of the percentage of subdebt versus common and all that in our capital stack today.

So -- and also our models show that we are with our current run rate, especially once we get the conversion done on Carlile and get the benefit of those cost saves, which will drive our ROAs up. Our efficiency ratio is down at an 11%, 12% growth rate. We accrete capital organically. So really the catalyst for us on any capital event would be an acquisition or acquisition announcement of some sort. And barring that, I think we are very comfortable with our capital ratios where they are and really organically going forward.

And with that, we conclude the Q&A session. I will turn the call back to David Brooks for his final remarks.

Thank you. If there are no further questions, then that will conclude our second quarter 2017 earnings call. We appreciate your attendance, and thank you for your interest in Independent Bank Group. Have a great day.

And ladies and gentlemen, thank you for participating in today's conference. This concludes the program, and you may all disconnect. Have a wonderful day.